At Berkshire’s virtual annual meeting recently, Warren Buffett mused that their cash hoard of $135BN didn’t seem that much. Stanley Druckenmiller said, “The risk-reward for equity is maybe as bad as I’ve seen it in my career.” The New Yorker thinks stock investors have lost their minds.

To not be bearish is to be insensitive – as if to dismiss the deaths and pandemic as economically meaningless.

Being negative is easy. Just think of all the closed stores, restaurants and sports events that have dramatically reduced options for leisure. I rarely need to visit the ATM because all I’m buying is gasoline, about once a month. It’s cheaper too, although I’d need to drive to a couple of planets for the savings to offset recent losses on my energy investments.

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The S&P500 is -8% for the year, a performance seemingly divorced from reality. Following  last year’s +31.5%, it might have been down 8% without coronavirus.

From a top-down perspective it’s usually easy to be bearish. There’s always something to worry about. But S&P500 earnings are estimated to be -20% this year and +27% in 2021, taking them back above last year’s. This is based on analyst estimates from early May, so for the most part reflects first quarter earnings and full year guidance. It’s hard to reconcile with the jump in the unemployment rate from 4.4% to 14.7%, but we must assume that’s incorporated in all those earnings forecasts.

The Equity Risk Premium (ERP, S&P500 earnings yield minus ten year treasury yield) still makes stocks look reasonably attractive. This is partly because interest rates are so low. But even if ten year treasury yields move up to 2% next year, equal to the Fed’s long term inflation target, the expected rebound in earnings will compensate.

If in fact earnings do rebound as forecast, it’s hard to see interest rates staying this low. For years bond investors have seemingly held a less optimistic view than equity investors, but the dichotomy seems as stark as it’s ever been.

To illustrate, Williams Companies (WMB) issued ten year debt at a yield of 3.56%, substantially below the dividend yield on their shares of 8.2%.  Like many big pipeline companies, quarterly earnings were better than expected (see More Solid Pipeline Results). WMB’s quarterly payout is up 5.3% year-on-year.

Although the ERP shows stocks to be cheap, Goldman’s forecast of $44 in 2020 S&P500 dividends is only a 1.5% yield .

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We’re heading into a period with no obvious historical precedent. A shut down of large swathes of the economy along with a big increase in debt is most analogous to war. The Committee for a Responsible Federal Budget now expects a Federal deficit of $3.8TN (versus $1.1TN pre-Coronavirus). They expect total Debt:GDP to reach 107% by 2023, exceeding the prior record of 106% hit just after the end of World War II. And these figures exclude any new Federal spending, although the House of Representatives recently passed another $3TN package.

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Given the dismal fiscal outlook, the stock market’s recent performance is even more impressive. And if you’re looking for a sector that’s rebounded nicely but is still down over 30% for the year, check out the pipeline sector.

One of the few pleasant surprises of recent weeks is that business for the major pipelines remains solid. Now that 1Q earnings season is complete, we have revised guidance from all the companies in the broad-based American Energy Independence Index.

Caution was evident throughout on earnings calls, as one company after another described the impact of collapsing transportation demand and the high degree of uncertainty around forecasts. Some of the figures were stunning — Magellan Midstream reported a 20% drop in demand for refined products (mostly gasoline) in April, and a 76% drop in jet fuel, although they did note an improvement in the latter part of the month.

As we entered 2020, the expectation for rapidly growing Free Cash Flow (FCF) underpinned a positive outlook for the sector (see The Coming Pipeline Cash Gusher from April last year). We provided a current look two months ago (see Updating the Coming Pipeline Cash Gusher), but with minimal new guidance.

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With new guidance provided on earnings calls, EBITDA and Distributable Cash Flow (DCF) have generally been revised down by 10-15%, a much smaller drop than many feared in March when the sector plunged. So our 2020 DCF forecast is now $51BN, versus $60BN a year ago. There is exposure to volumes and prices, but long term “take or pay” contracts provide solid support at times like this.

Spending on growth projects is being cut at roughly the same pace. Every dollar not spent boosts FCF. Investors regard this as welcome acknowledgment of reality – energy management teams have often been too ready to reinvest back in their business, similar to their upstream customers.

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The top ten midstream energy infrastructure companies have shaved over $5BN from this year’s growth plans. Since there’s rough alignment between the drop in DCF and reduced growth capex, FCF still looks likely to double this year versus last. There can’t be many sectors that can be expected to generate such a result.

In turn, this is supporting dividends which are, for the most part, still being paid (see Pipeline Payouts Holding Up).

The story isn’t as positive for MLPs, which have been much more active in slashing payouts. The MLP-dedicated Alerian MLP ETF (AMLP) lowered its dividend again recently, reflecting what its components are doing. Compared with the midstream energy infrastructure sector, MLPs have more liquids/less natural gas exposure, more risky gathering and processing, and are more leveraged (see More Solid Pipeline Results). Only two of the ten biggest pipeline companies are MLPs, and size tends to bring diversification of flows as well as stability.

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Even after incorporating the impact of Coronavirus, FCF is still expected to double year-on-year. If it happens, it’ll represent a stunning turnaround for a much maligned sector.

It’s still too uncertain to extend that forecast out to 2021. Few companies would offer any type of confident guidance. In our first piece on the topic in April 2019, we were originally looking for FCF to double again next year. That would push the sector’s FCF yield above 11%.

This is why the rebound from the lows of late March has so much momentum.

For a graphic picture of how the restaurant business has shut down, it’s hard to beat the OpenTable chart below. For several weeks, U.S. dinner reservations on their system have run at 100% below normal (i.e. there were none).

What portion of this sector survives depends on the pace at which we re-open, combined with the public’s perception of risk.

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When it comes to risk assessment, human behavior is not always driven by numbers. Flying is an example – although aviation deaths are extremely rare, terrifying media coverage overwhelms the data, which is that around 150,000 commercial flights are completed safely every day worldwide (pre-Coronavirus).

Some find the imagery overpowers the logic, and as a result they drive because they feel safer, even though 38,000 Americans die annually on the roads.

That type of risk aversion does relatively little harm to society – the individual who chooses to drive 1,000 miles bears most of the additional risk from that decision.

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Fear of nuclear energy has caused much more harm, by impeding our use of a zero-carbon source of electricity, thereby increasing use of coal. HBO’s Chernobyl series last year could have done great harm to the future of America’s nuclear power business if its prospects weren’t already so bleak. In the popular imagination, the image of a peacetime mushroom cloud creates visceral opposition. Per terrawatt hour of electricity produced, nuclear kills 1/1,000^th as many people as coal. But the coal deaths from pollution are steady and unrelenting, while events leading to deaths from nuclear are spectacular.

There are still no recorded deaths from the 2011 nuclear accident at Fukushima, Japan, although 2,259 deaths are blamed on the subsequent evacuation. Three Mile Island also caused no deaths.

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Public policy decisions on Coronavirus seek to find a balance between minimizing loss of life from the virus itself, and the less measurable collateral damage (economic and health) from shutting down much of life as we knew it. Although there are instances of lockdown protests, opinion polls show widespread support.

Dinner reservations provide a view of how one industry is being impacted. Some regions are slowly reopening, and anecdotal evidence so far suggests that, even with the mandated reduced capacity to maintain social distancing, there are plenty of open tables.

Although policymakers will determine when businesses can re-open, the public’s assessment of risk may lag. Society’s vulnerable members are generally well defined as the older and those with other serious health issues (see footnote on chart below). Statistics on road deaths and aversion to nuclear power show both extremes of risk tolerance. We’ll soon find out where Coronavirus risk sits on this spectrum.

Chart note: Due to the time lag in filing death certificates, the CDC currently counts around 37K COVID-19 deaths, roughly half the generally accepted figure.

Energy has rebound strongly from the market’s low on March 23rd. The S&P Energy ETF (XLE) is up 64%, matching the broad-based American Energy Independence Index (AEITR) and handily beating the S&P500 which is up 31%%. Although the YTD figures still show the energy sector down over 35%, quarterly earnings reports continue to provide plenty of positive news (see More Solid Pipeline Results, Pipeline Payouts Holding Up and listen to our recent podcast, Pipeline CEOs Provide Optimism).The story with MLPs continues to be less positive. 24 have now reduced or eliminated distributions in recent weeks, according to MLPData.com. The Alerian MLP ETF, AMLP, reduced its distribution again last week, such that it’s now 50% lower than five years ago.

This reflects the general trend of MLPs in recent years.Investors in MLP closed end funds (CEF) have had an even worse deal. Many CEF fund managers exhibited reckless arrogance in maintaining maximum leverage during the collapse in March (see The Virus Infecting MLPs). The strong rebound in energy hasn’t helped much – for example, the Tortoise Energy Infrastructure fund (TYG) is still down 75% for the year. Like other MLP CEFs, they were forced to dump positions at the lows in late March, locking in permanent losses and increasing the unrealized losses of those investors who prudently avoided leverage.
Tortoise recently followed this up by announcing they were suspending distributions on three of their MLP CEFs. MLP investors are by now de-sensitized to such abuse. MLP CEFs have destroyed enough capital that they’re no longer a meaningful factor in the sector.

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MLP earnings calls have included some long overdue criticism of management teams. The sycophantic analyst who precedes his question with “great quarter guys” is receding as investors count the cost of poor management. JPMorgan’s Jeremy Tonet questioned Enlink’s generous stock-based compensation, which he pointed out was an eye popping $9MM in the quarter, and quite dilutive. It’s a transfer of over 1% of the company’s market cap each quarter. Tonet followed up as seeming bewildered as to what were the key metrics for that compensation, since it’s been relatively constant for several quarters while the business has deteriorated.

Plains All American, a large crude oil pipeline operator, received some pointed feedback from Ganesh Jois of Goldman Sachs: “Firstly, on your CapEx outlook for 2021 and beyond; in a flat to declining U.S. production environment, I’m wondering what it is exactly that you might be thinking of spending on? And the second question I have is, we’ve now seen 3 distribution cuts from you all. At what point is a unitholder going to be prioritized when it comes to capital allocation, as opposed to bondholders and generally asset build-out?”

In other words, why are they still spending any money on new crude pipelines. They just took a $2.5BN impairment charge, the cost of overpaying for acquisitions in years past. They’re still planning to spend $1.1BN this year. As serial mis-allocators of capital, you’d think they’d take a break from it for a few quarters.

The contrast with bigger corporations like Enbridge and Pembina is stark. These companies keep paying their dividends and have a conservative culture that rewards investors over the long term.

The lesson is increasingly clear; pipeline corporations generally have better corporate governance and are run more conservatively. Most MLPs are to be avoided. The big ones (Enterprise Products; Energy Transfer and Magellan Midstream) are worth holding, but many smaller MLPs that too often look as if they’re run for the benefit of management should be avoided.

MLP-dedicated funds, such as the now diminutive MLP CEFs mentioned above as well as AMLP, are stuffed full of the MLPs which have few other natural buyers. The outperformance of pipeline corporations versus MLPs is well established, and likely to continue.

We are invested in the names mentioned above.

Ever since the 2008 financial crisis ushered in permanently low interest rates, perhaps the biggest question in finance has been why long term rates remain so low (see Real Returns On Bonds Are Gone). On Monday, the U.S. Treasury announced plans to issue $2.99 trillion in marketable debt this quarter, and $4.5 trillion this fiscal year. The second quarter sum alone is more than double what we borrowed last year.

Given the sharp drop in yields, there’s evidently no shortage of buyers. Corporations have been eager to borrow money too. Apple had $94BN in cash and marketable securities as of the end of March – and yet they borrowed $8.5BN in the bond market on Monday. Liquidity is king. At Saturday’s virtual annual meeting, Warren Buffet mused that the $137BN in cash held by Berkshire, “…isn’t all that huge when you think about worst-case possibilities.”

The most fundamental responsibility of a corporate treasurer is to ensure adequate liquidity for any plausible scenario.

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Oneok (OKE) offers an interesting example, because they tapped the bond market for $1.65BN in early March, and just returned for $1.5BN this week. Like most pipeline companies, cuts to spending on new projects exceed their estimated drop in EBITDA. This cash is going to be held, and hopefully not needed. It’ll sit in treasury bills, partially answering the question of who’s going to buy all this new debt the U.S. is issuing.

The negative spread between OKE’s 6.31% blended cost and the 0.10% yield on treasury bills will cost $93MM annually. The $8.5BN Apple raised will also sit in treasury bills alongside the $94BN they already have. These are both small components of the cost of uncertainty.

The Federal government’s fiscal and monetary response has been appropriately massive. They’ve been so effective that Berkshire Hathaway was unable to negotiate any expensive, emergency investments.

The cost is rapidly mounting. Excessive caution was justified in the early days of the pandemic. Hospitals in New York faced the real threat of being overwhelmed, so shutting the economy down to “flatten the curve” was expedient. This has transitioned to a strategy of suppression, with a less clear exit but an increasingly visible and staggeringly big cost.

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Fatality rates based on known cases reflect the 2% of the population that’s been tested, and people are often infectious without showing symptoms. Data increasingly shows Coronavirus to be highly contagious but with a fatality rate in the ballpark of the flu for those that are young and otherwise healthy.  For those between 18-49 years of age, the flu has a mortality rate around 0.02%. Coronavirus anti-body tests are revealing substantial portions of the population to have been already infected. New York City estimates a 19.9% citywide rate. Combined with the city’s fatality rate of 161.17 per 100,000 population, this suggests the fatality rate may be close to 0.81%, skewed towards the elderly.

The vulnerable are well known; 96% of New York City patients hospitalized for Coronavirus had additional health issues, often obesity, diabetes or a heart condition. Dr. Scott Gottlieb, a former FDA commissioner regularly on CNBC, said mitigation hasn’t worked, “as well as we expected.” The virus isn’t going away anytime soon.

Suppression can only go so far. We’re going to have to adapt to the virus. The data suggests people under 44 have extremely low risk, but lockdown strategies rarely differentiate based on risk factors. Targeted stay at home orders for older people and those with health vulnerabilities would allow a return to more normal economic activity, arresting the spiraling debt with little increased health risk. We accept 38,000 road fatalities annually, which could be reduced with lower speed limits. Society already makes these tradeoffs.

Few of us are epidemiologists, and deferring to the experts was correct at the outset. But given the huge economic impact and $TNs in Federal spending, we’d all better do our best to become better informed. It’s correctly becoming a political issue.

We are invested in OKE

Earnings season for big pipeline companies has continued to be encouraging. Enterprise Products (EPD) reported results largely as expected and lowered 2020 growth spending by $1BN. The reductions in capex have been welcomed by investors who have long complained about the level of reinvestment by energy companies. Any reductions in EBITDA have been matched by lower outlays on new projects, which supports free cash flow.

Jim Teague, EPD’s CEO, opened the call by remembering an outbreak of polio as a young boy, “It was a highly contagious virus. It struck without warning…my mom contracted polio…we practiced our own kind of social distancing. What I don’t remember is shutting down the entire economy and 30 million people losing their jobs in one month.”

Teague offered another personal perspective, ”As a young naval officer in an attack helicopter squadron in the Mekong Delta, Vietnam, I took a great deal of pride that I was part of a special fraternity. I have that same kind of pride today.” The wartime analogy strikes a chord with many.

EPD maintained its distribution. When asked about customers claiming force majeure to get out of take-or-pay pipeline contracts, Teague responded, “We’ve looked at all our contracts, and we feel pretty comfortable that we’re not going to have any issue with force majeure as it relates to price.”

Cheniere Energy handily beat expectations with their 1Q20 results. Of more concern to investors is the outlook for Liquified Natural Gas (LNG) shipments, with reports of as many as 20 being delated or cancelled. CEO Jack Fusco addressed this in his opening remarks,”…our long term contracts do not include provisions for renegotiations.” He added, “In instances where that (cancelation) occurs, the fixed liquefaction fee is still paid to us and our marketing affiliate has the option to market the volume into the global marketplace.”

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Cheniere continues to expand their export facilities, both at Sabine Pass, LA where they’re adding a sixth train and also at Corpus Christie, TX. They don’t expect coronavirus to harm either the cost or completion schedule of these projects. They reaffirmed previous full year guidance on distributable cash flow and EBITDA.

Magellan Midstream provided some interesting recent volume statistics, in that refined product demand was down 24% in April but “only” 20% in the last week of April. CEO Mike Mears thinks that this category could return to last year’s levels by 3Q20, which most would agree is more positive than consensus.

One analyst asked about interest from private equity firms in acquiring publicly traded MLPs. Mears responded, “We haven’t spent a lot of time talking to private equity firms about acquiring Magellan. That wouldn’t be at the top of our list.”

TC Energy noted that their outlook was largely unchanged with their CEO Russ Girling commenting on their Friday afternoon earnings call that “with approximately 95% of our comparable EBITDA coming from regulated or long-term contracted assets, we are largely insulated from the volatility associated with volume throughput and the commodity prices that are being experienced by many others. Aside from the impact of normal maintenance activities and seasonal factors to date, we have not seen any meaningful change in the utilization of our assets, which further reinforces their critical nature to North America.”

Large midstream companies are generally maintaining dividends and where 2020 results are guided lower, cuts in growth spending more than offset (see Pipeline Payouts Holding Up). In the 2014-16 downturn, MLP distribution cuts were widespread. The payout on the Alerian MLP ETF (AMLP) is the lowest in its history, and 36% below its level of 2016. In a familiar story, 21 MLPs have recently cut distributions. EPD and MMP are an exception to this pattern, which puts them in the company of large pipeline corporations. The components of the broad-based American Energy Independence Index (which is 80% corporations) currently yield 10.5%.

We are invested in all  all the names  mentioned above.

Most companies get a free pass today on cutting their dividend. So far this month nine S&P500 companies have suspended their dividend, with another half dozen making reductions. Goldman Sachs expects S&P500 dividends to be reduced by 25%.

Energy has been hit as much as any sector. Pipeline stocks have fallen hard, with the broad-based American Energy Independence Index (AEITR) down 36% for the year. It has rebounded strongly in April, up 35% so far this month.

Part of the reason is that the dividend story is turning out to be much less bleak than expected. Most big companies have provided updates, and so far only eight have reduced dividends. Only one of those (Macquarie Infrastructure) has suspended its payout. Using their weighting in the AEITR, 20% of the index has lowered dividends.

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A pleasant surprise is that 13 companies still pay dividends that are higher than a year ago, representing 64% of the index. This group includes some big names, such as Enbridge, Kinder Morgan (KMI) and Williams Companies (WMB). Some of these have yet to declare a “post-Coronavirus collapse” dividend, but we think those planning to cut have already communicated. KMI had originally planned to increase their dividend by 25%. The fact that they raised it at all last week was welcome news to many investors. The week before, WMB had said they expected to fund this year’s dividend payments and growth spending from internally generated cash.

Most energy infrastructure companies providing updates have reaffirmed prior guidance or lowered it modestly. All have lowered their planned spending on growth projects, and generally the spending reductions are bigger than any forecast drop in EBITDA. Although the rest of the year is too uncertain to make any confident forecasts, a dollar not spent is a dollar of Free Cash Flow (FCF). Prior to coronavirus, we were looking for FCF to double this year (see Updating the Coming Pipeline Cash Gusher) . Lower spending was a key reason, and 20% cuts are common.

Dividend hikes in this environment are surprising. We’re all enduring a crash course in epidemiology, but it’s fair to say that the companies maintaining and raising their dividends are comfortable that these are sustainable based on consensus forecasts of the economic rebound from the Coronavirus. The yield on the AEITR is 10%.

MLPs are only about a third of the pipeline sector. Only two of the ten biggest companies are MLPs —  Energy Transfer and Enterprise Products. Magellan Midstream is another well-run MLP that’s just outside the top ten. But the rest tend to be smaller and more oil focused, with weaker balance sheets and more gathering and processing exposure. This is why 17 MLPs had cut distributions as of last Friday, according to Hinds Howard at CBRE Clarion Securities. Yesterday on Twitter he noted the figure had reached 21.

The bottom line is that the dividend outlook so far is surprisingly positive for midstream energy infrastructure. However, for investors in MLP-dedicated funds or with portfolios heavily weighted towards MLPs, the news hasn’t been as good.

We are invested in all the names mentioned above.

Monday was the day crude oil futures traded as low as negative $41 per barrel. As with the 1987 stock market crash, Monday’s participants will recall that date for the rest of their lives, the way I do October 19, 1987. Shortage of oil storage is the problem – nobody is going anywhere, so we’re not using much gasoline or jet fuel. Some have commented, only half-jokingly, that being paid $40 to take a barrel of oil would draw in a lot of buyers with the ability to temporarily repurpose other forms of storage.

But oil is a nasty product to handle. It is highly toxic, and leaks noxious gases such as hydrogen sulfide. If the air that you’re breathing contains as little as 0.1%, it kills you within seconds. This is why Texans aren’t filling up their swimming pools with the stuff.

The May futures contract traded 231 thousand times on Monday. One contract is equivalent to 1,000 barrels of oil. It traded from $17.85 to minus $40.32, a range of $58.17 which must be a record. A trader careless enough to be long 1,000 contracts who suffered a $10 adverse price move before dumping his position would lose $10 million. Given the volume and daily range, yesterday’s losses will be big enough to draw their own press coverage.

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The United States Oil Fund, LP (USO) is an ETF that gives investors exposure to crude prices. Watching it has been the financial equivalent of a train wreck lately. Retail investors piled in last week, adding $1.6 billion of inflows. “Crude can’t stay this low” is sufficient analysis for many. Crude pricing is unlikely to correct before such adherents are wiped out.

Many have concluded crude prices are wrong, but few have questioned USO’s raison d’etre. This is an ETF that buys futures contracts. Crude is in contango, meaning prices in the future are higher than today. Some interpret this as a forecast that the market must rebound, but forward prices are a poor predictor of what actual prices will be. What is clear is that the buyer of, say, July futures confronts the inevitable “rolldown” as today approaches July and actual supply/demand for crude increasingly determines the price. The rolldown is the price difference incurred as the holder of the July contract “rolls” into August by selling July and buying August at a higher price.

The bullish crude view has to constantly paddle upstream against the rolldown current. USO apparently rolled May futures into June last Friday, on terms that looked more like paddling up through spring rapids. Wiser and poorer for the experience, on Sunday they announced an improvement in their strategy. Henceforth, 20% of their futures positions will be invested in later-dated contracts, thus avoiding having to roll them all at once.

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What is the point of an ETF that buys and holds futures contracts? Why don’t retail investors wishing to speculate on crude oil simply buy the futures themselves? Or an oil royalty trust? USO is a dumb way to bet on crude prices. A year ago, the July 2020 WTI futures contract was trading at $60 and yesterday was at $23, down 62%. Over that time USO has dropped from $13 to $3, down 77%. Its structure makes it hard to figure out how much it should move for a given change in crude prices. If crude can go negative, as the May futures did on Monday, can USO? Could USO go bankrupt?

Why do people bother with it? As well as being of dubious value to investors, few probably realize that they get stuck with a K-1 instead of a 1099, as USO is a partnership.

People buy USO because it’s easy to buy an ETF in a brokerage account, but more complicated to trade futures. Often it requires a separate agreement.

The reason is that the SEC regulates equities, including ETFs, while the CFTC regulates futures. USO and crude oil futures are both financial instruments – they ought to have a single regulator. The Senate Banking Committee oversees the SEC. The Senate Agriculture Committee oversees the CFTC, reflecting the original importance of agricultural futures. Brokers make valuable campaign contributions to the senators who oversee their regulator. The Finance/Real Estate/Insurance sector is the biggest source of such funding to the Senate Agriculture committee. No senator wants to give that up.

Merging the two regulatory agencies has often been suggested in the past, but is widely acknowledged to be a political non-starter. Even the passion for reform that followed the 2009 financial crisis was insufficient to overcome the economics.

USO is a result of our fractured regulatory structure, which is caused by the need for senators to raise money. USO buyers made a bad market call, but multiple overseers of financial instruments led to a poorer vehicle, which ultimately cost them even more. Yesterday USO was trading at a 27% premium to its NAV, indicating continued strong demand for this flawed ETF. It’s an instance of regulatory failure, caused by campaign contributions outweighing a more intelligent regulatory framework.

As the world’s economy has stopped moving, demand for transportation fuel has collapsed. The latest weekly report from the U.S. Energy Information Administration (EIA) presents the statistical reality in our country. Gasoline supplies are down 46% from a year ago. Kerosene (jet fuel) is down 72%. Nobody has anywhere to go.

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Interestingly, propane supplies are up. Natural gas liquids are part of the hydrocarbon value chain. At one end is methane, the simplest molecule. This is the natural gas that produces electricity, heats homes and runs through your gas stove. It’s known in the industry as “dry gas”. Natural gas liquids (NGLs) are successively more complex molecules of carbon and hydrogen; these include ethane (can be burned but is mostly used as a feedstock for plastics); propane (heating and cooking where methane supply isn’t available), butane and others. The hundreds of blends of crude oil sit at the more complex end.

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In today’s energy market, the farther you are from transportation fuel, the better.

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Natural gas demand has held up. Power demand has risen compared to a year ago. Residential/Commercial is up because people are spending more time at home. And we’re exporting more. There is almost no evidence of coronavirus in this part of the energy market.

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NGLs don’t receive much attention, but there are two reasons investors in midstream energy infrastructure sector care: (1) NGLs require processing when extracted to separate them into their useful products, creating multiple opportunities to “touch” each molecule and charge a fee, and (2) the U.S. produces around 26% of world consumption, far bigger than our share for natural gas or crude oil.  NGL exports continue to make new records.

Many Indians  cook and heat their homes with Liquid Petroleum Gas (LPG), a combination of propane and butane. Methane requires too much pressure to go in the ubiquitous gas bottles seen all over the world, so LPG meets the needs of consumers without a natural gas hook up. The U.S. exported over 100 thousand barrels per day of NGLs to India in 2019.

Last week Bloomberg ran a story highlighting rising LPG prices (see One Fuel Is Thriving During the World’s Biggest Lockdown). In Asia, LPG is often produced as a byproduct of refining crude oil, and lower gasoline demand means refineries are cutting output. LPG demand in India is up, whereas demand for transportation fuels is down 20% or more. James Mann of the Texas Pipeline Association warned that cutting oil production would have the unintended consequence of also reducing NGLs and gas, potentially leaving  some customers short of needed  product.

Some big U.S. midstream energy infrastructure companies generate a significant portion of their profits from NGLs. Last Tuesday the Texas Railroad Commission held hearings on a request to curb Texan oil production (called “pro-rationing”). Enterprise Products Partners CEO Jim Teague was invited to give his view. He was against pro-rationing, and went on to note that their LPG export facilities were in high demand.

The following slides show the importance of NGLs to some of North America’s biggest pipeline companies.

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We are invested in all of the companies mentioned above.

Yesterday the Texas Rail Road Commission (RRC) began their public hearings via Zoom on a request from some oil companies that they limit oil production (“proration”) to avoid unnecessary waste (see Navigating the Collapsing Oil Market). On the surface, it seems a pretty straightforward question. The pandemic has crushed oil demand, which is estimated to be down 30% globally. At the same time, OPEC+ has collapsed into acrimony because of a dispute between Saudi Arabia and Russia.

The Saudis responded by increasing production into an already oversupplied  market. Oil storage is at a premium, and is expected to run out within months. To a U.S. oilman, this looks like a thinly veiled effort to bankrupt the U.S. energy business, permanently lowering our supply and allowing others to profit later from resulting higher prices.

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So Scott Sheffield, CEO of Pioneer Resources (PXD) testified before the RRC about the substantial energy job losses that will occur without action by the RRC. Matt Gallagher from Parsley Energy (PE) echoed Sheffield’s comments.  They argued that without the regulator imposing production limits on Texas oil production, the industry will suffer widespread bankruptcies and a permanent drop in employment.

They were followed by Lee Tillman, CEO of Marathon Oil, and it suddenly became more complicated. Tillman noted that naturally a company that only produces crude oil in the Permian in west Texas will favor pro-rationing. But Marathon produces in Texas, Oklahoma, New Mexico and North Dakota. Production will be cut, but some of Marathon’s most profitable wells are in the Eagle Ford, in south Texas. They might not choose to cut any Texas production. The message was clear – if the RRC imposes pro-rationing, in Marathon’s case it could result in more Texans losing their jobs than needed.

Diamondback’s CFO Kaes Van’t Hof went a step further, saying that they’d respond to prorationing by laying down all rigs, punishing oil service companies.  He pointed out that they had signed long-term contracts for the oil they produce, and had hedged their future production.  Diamondback was once a small company too, which didn’t stop them from running their business responsibly (subtle dig at Pioneer and Parsley).

So the view from the moral high ground is different, depending on which part of it you’re standing on. RRC member Ryan Sitton, a proponent of prorationing, tried to build the case on avoidance of waste which allows the RRC to limit production. It’s a dubious theory – if crude oil is being produced and sold to a consumer, how does one objectively define that as wasted even if the price is ruinously low? And the RRC has long permitted flaring of unwanted “associated” natural gas that is produced with oil (Texas Reconsiders Flaring), even though this is waste by any definition.

It’s also not clear whether other oil-producing states will follow the lead of Texas if the RRC does choose prorationing. Under U.S. law, companies are not allowed to co-operate in limiting production, and the Federal government cannot impose limits other than on Federal land or offshore. So the question falls to the states.

Tillman argued in favor of the free market being allowed to work, noting that production will drop anyway, as it should given collapsing demand. But when asked if he supported U.S. efforts to control market forces via organized production cuts with Saudi Arabia and Russia, he defended this as a geopolitical issue correctly solved with diplomacy.

It’s hard to escape the conclusion that U.S. oil producers want the free market to work until it no longer works for them, at which point they demand government intervention.

Saudi Arabia shouldn’t be able to pump oil at their desired level if low prices bankrupt U.S. producers, while sheltering under U.S. military protection. Trump probably pointed that out, and a group of nine U.S. senators definitely did. Playing the military card is just another form of the free market, no less important than securing pipeline capacity for future oil production.

It’s easy to see why cartels are so unstable.

It’s hard to see why a pipeline company would want the government to step in and compel them to make space for the less responsible companies that hadn’t already secured take-away capacity for their oil.  The American energy industry may emerge stronger, by letting the markets and the bankruptcy process move the acreage from the weakest hands to the strongest.