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.

.avia-image-container.av-sndivv-bffc77a842dd5150253c8ab15d9007f0 img.avia_image{ box-shadow:none; } .avia-image-container.av-sndivv-bffc77a842dd5150253c8ab15d9007f0 .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-1aupcf6-39eaa0175b748e92104eab8016f3dd04 img.avia_image{ box-shadow:none; } .avia-image-container.av-1aupcf6-39eaa0175b748e92104eab8016f3dd04 .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-tbb5du-f2d3a00088ebbd4c49a87933090e6d98 img.avia_image{ box-shadow:none; } .avia-image-container.av-tbb5du-f2d3a00088ebbd4c49a87933090e6d98 .av-image-caption-overlay-center{ color:#ffffff; }

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.”

.avia-image-container.av-rafoxc-8001c371d2a29ed7783d5257b715c15a img.avia_image{ box-shadow:none; } .avia-image-container.av-rafoxc-8001c371d2a29ed7783d5257b715c15a .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-s6l3kt-55393426ba6852a635ba5e52040ac60d img.avia_image{ box-shadow:none; } .avia-image-container.av-s6l3kt-55393426ba6852a635ba5e52040ac60d .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-wyrnp2-1b64524d3a07223ff978dd4a52be9c2d img.avia_image{ box-shadow:none; } .avia-image-container.av-wyrnp2-1b64524d3a07223ff978dd4a52be9c2d .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-p6l2eu-3ef34b123f0ffb4282be971eefe095e8 img.avia_image{ box-shadow:none; } .avia-image-container.av-p6l2eu-3ef34b123f0ffb4282be971eefe095e8 .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-plj1o6-49ab39ff7d03150f69a2240e934ab902 img.avia_image{ box-shadow:none; } .avia-image-container.av-plj1o6-49ab39ff7d03150f69a2240e934ab902 .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-18a05g6-ecaa2e76ad2453e2d85c726c38fad128 img.avia_image{ box-shadow:none; } .avia-image-container.av-18a05g6-ecaa2e76ad2453e2d85c726c38fad128 .av-image-caption-overlay-center{ color:#ffffff; }

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

.avia-image-container.av-nd5j06-669fa2f24699c88b72ee9cbc5f68b770 img.avia_image{ box-shadow:none; } .avia-image-container.av-nd5j06-669fa2f24699c88b72ee9cbc5f68b770 .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-3ujw0m-2010181339efada0c8296bed55807dc2 img.avia_image{ box-shadow:none; } .avia-image-container.av-3ujw0m-2010181339efada0c8296bed55807dc2 .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-n7oc8m-9bf351dd2967af46c4d2584b8fe8c84c img.avia_image{ box-shadow:none; } .avia-image-container.av-n7oc8m-9bf351dd2967af46c4d2584b8fe8c84c .av-image-caption-overlay-center{ color:#ffffff; }

.avia-image-container.av-x2gjme-d51bd5fd2d6651a7e9de503cac40e205 img.avia_image{ box-shadow:none; } .avia-image-container.av-x2gjme-d51bd5fd2d6651a7e9de503cac40e205 .av-image-caption-overlay-center{ color:#ffffff; }

.avia-image-container.av-v5veqe-9693cb76441d7d8d9efafe63068b40cf img.avia_image{ box-shadow:none; } .avia-image-container.av-v5veqe-9693cb76441d7d8d9efafe63068b40cf .av-image-caption-overlay-center{ color:#ffffff; }

.avia-image-container.av-zanmt2-82e3fd6d5a1588025182be6755335b5f img.avia_image{ box-shadow:none; } .avia-image-container.av-zanmt2-82e3fd6d5a1588025182be6755335b5f .av-image-caption-overlay-center{ color:#ffffff; }

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.

.avia-image-container.av-jqpgcb-1d7cd2275593149e9b225e71927c30b8 img.avia_image{ box-shadow:none; } .avia-image-container.av-jqpgcb-1d7cd2275593149e9b225e71927c30b8 .av-image-caption-overlay-center{ color:#ffffff; }

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.

The other day a client asked if we’d looked at insider buying among management teams of pipeline companies.

So far this year, Energy Transfer (ET) dominates with $108MM, representing 63% of all the insider buys so far. Kelcy Warren receives plenty of criticism, not least from this blog (see Energy Transfer’s Weak Governance Costs Them), but he’s certainly invested in his business. He’ll be frustrated at having made those purchases in February, because ET lost more than half its value during the March collapse. But investors appreciate his conviction.

.avia-image-container.av-oc7yho-22cecea50cb76dc3a37254fe61ed5993 img.avia_image{ box-shadow:none; } .avia-image-container.av-oc7yho-22cecea50cb76dc3a37254fe61ed5993 .av-image-caption-overlay-center{ color:#ffffff; }

Kinder Morgan (KMI) saw $25MM of insider buying, along with $7MM of sales. Rich Kinder is a long-time buyer of his eponymous stock. He alienated an entire class of investors in 2014, when KMI cut the dividend to finance a backlog of growth projects, and simplified their structure in a tax-adverse manner for many. He created a verb — to be “Kindered” is when faithful investors are hit with both the abrupt cancellation of promised distributions and an untimely tax bill (see Kinder Morgan: Still Paying for Broken Promises). But Kinder has bought KMI at regular intervals, including at prices much higher than today’s.

Enterprise Products Partners (EPD) saw $12MM in buying from the Duncan family. And Nustar Energy LP saw almost $5MM in buys. That three of these four are MLPs (as was Kinder Morgan years ago) shows that management teams can accumulate real wealth more easily at the helm of an MLP, with its weak corporate governance, than at a corporation.

Magellan Midstream (MMP) was an outlier among respected companies, in that it had insider sales of just under $1MM.

There was no activity at Macquarie Infrastructure (MIC), perhaps unsurprisingly since they withdrew 2020 guidance and suspended their dividend.

Plains All American (PAGP) saw $4MM of buying even as they cut their distribution by 50%, while still planning to spend half of their previously planned growth capex budget. Many investors would have preferred still less spending and a maintained distribution, but this company has lost 90% of its value since the August 2014 peak. Poor capital allocation has a long history at PAGP.

Most other names saw some insider buying, including several well-run companies. Enbridge (ENB), Cheniere (LNG), Oneok (OKE), Pembina (PPL) and Williams Companies (WMB) fall into this category. This is a very positive step by all these buyers, because the science around viruses is a key factor driving energy demand in the months ahead. Nobody has the information they’d like.

The biggest insider selling was at Targa Resources (TRGP), where Rene Joyce, a member of the Risk Committee, was forced to sell to meet a margin call. TRGP saw no insider buying either. Back in 2014 TRGP briefly touched $140 a share, when ET was rumored to be interested in an acquisition. Joyce’s forced sale at $7 reflects the same judgment that caused TRGP to spurn ET’s approach.

Given the recent leverage-induced catastrophe in MLP closed end funds (see The Virus Infecting MLPs), if Rene Joyce was to move to either Kayne Anderson or Tortoise, it seems likely both his old firm and his new one would improve their risk management.

We are invested in all the names mentioned above.

Coming into 2020 the pipeline sector was in good shape. Spending on growth projects peaked in 2018, and lower growth capex combined with rising cashflow from existing assets were set to drive Free Cash Flow (FCF) higher. Across the companies that are in the American Energy Independence Index it was on course to more than double, from $9BN last year to $21BN this year (see Updating the Coming Pipeline Cash Gusher).

Some companies have been providing updated guidance in recent weeks. The top ten companies represent 60% of the sector by market cap. Four of them have already revised their spending lower for the remainder of the year, with only Enbridge reiterating prior growth project guidance.  We expect the remaining five to revise their numbers in the weeks ahead.

Global crude oil demand is estimated to have fallen by 25% or more in April, and the collapse in crude prices is the dominant energy story. But pipelines carrying natural gas, natural gas liquids and facilities supporting Liquefied Natural Gas (LNG) exports represent 62% of the sector’s market cap, versus just 28% for petroleum products. Natural gas demand has so far shown little coronavirus impact (see Natural Gas Demand Still Stable). Midstream MLPs are more weighted towards crude oil than pipeline corporations, which has hurt recent relative MLP performance (see The Disappearing MLP Buyer).

.avia-image-container.av-m6iw1a-d594b79f152618c940d7d95e9c765df5 img.avia_image{ box-shadow:none; } .avia-image-container.av-m6iw1a-d594b79f152618c940d7d95e9c765df5 .av-image-caption-overlay-center{ color:#ffffff; }

Our recently updated FCF blog assumed 2020 growth capex of $37BN. Reductions here will provide a cushion to offset any shortfall in cashflow, since a dollar not spent is a dollar of additional FCF. Four companies on the list (Oneok, Pembina, Williams and Inter Pipeline) have lowered growth spending by $1.4BN, around 23%. Enbridge said on their recent update that they’d raised the return hurdle for new projects. Enterprise Products is likely to lower their spending, last estimated at $3-4BN. Others have yet to provide any new guidance.

It’s also worth noting that first quarter spending was already completed by the time these updates were provided, so the 23% reduction is in practice more like a 31% cut for the remaining nine months of the year. If we assume a 23% cut in the industry’s originally planned $37BN 2020 spending, that’ll free up an additional $8.5BN to support FCF.

We are invested in the names listed above.

Crude oil drew the headlines this week. Trump’s Wednesday tweet forecasting a 10 Million Barrel per Day (MMB/D) agreed supply reduction (“Could be as high as 15 Million Barrels”) caught markets off guard. The demand collapse is astonishing. The world was consuming around 100 MMB/D of crude oil and liquids before the coronavirus. Estimates are for a 20-25% drop in April. Every producer is feeling the financial pain, which ought to concentrate minds as OPEC holds an emergency video meeting on Monday.

Natural gas demand is both more regional and more stable. Some midstream energy infrastructure companies, such as Williams (WMB) and Cheniere (LNG) are entirely natural gas focused, even though their stock prices move with energy sentiment. Crude moves the S&P Energy ETF (XLE), of which they are components, so their stock prices follow.

.avia-image-container.av-1je3fw3-90666e1e5595696d4054a67d8ef8a9f1 img.avia_image{ box-shadow:none; } .avia-image-container.av-1je3fw3-90666e1e5595696d4054a67d8ef8a9f1 .av-image-caption-overlay-center{ color:#ffffff; }

U.S. natural gas production is heavily influenced by domestic prices. Although in recent years we’ve become a net exporter, over 90% of output is consumed domestically. Given the collapse in global crude demand, we’re interested in domestic natural gas demand.

The seasons dominate. Winter is the peak period as households and commercial buildings need heat. The power sector uses more in the summer as electricity demand rises for air conditioning. The chart shows the monthly pattern.

.avia-image-container.av-4xo2dv-ccce0e6baa50d768cb001c1ed845773a img.avia_image{ box-shadow:none; } .avia-image-container.av-4xo2dv-ccce0e6baa50d768cb001c1ed845773a .av-image-caption-overlay-center{ color:#ffffff; }

The Energy Information Administration (EIA) releases weekly data, which can provide a clue about how demand is being affected by the shut down’s effect on the economy.

We’ve taken the last two weeks, which cover late March to April 1. Since consumption is typically falling this time of year, a sequential weekly drop is normal. Multiplying by 31/7 to get the monthly rate, those two weeks are running at 2,393 Billion Cubic Feet (BCF) and 2,229 BCF respectively. These two figures sit comfortably between last year’s March total of 2,658 BCF and April’s 1,984 BCF.

.avia-image-container.av-nxzp3n-7682413030b959efc07e77f282440139 img.avia_image{ box-shadow:none; } .avia-image-container.av-nxzp3n-7682413030b959efc07e77f282440139 .av-image-caption-overlay-center{ color:#ffffff; }

Looking a little more closely, power demand is stronger than a year ago, continuing a trend of natural gas substituting for coal. And lower crude production will also mean less associated natural gas output from areas like the Permian, which will benefit those drillers focused on pure-play natural gas.

There’s no historical precedent for what we’re experiencing, and it wouldn’t be surprising to see natural gas consumption falling even after adjusting for the seasonals. So far, that doesn’t seem to be happening which supports the encouraging updates provided by natural gas oriented pipeline corporations.

We are invested in WMB and LNG.