Why Are MLP Payouts So Confusing?

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It’s surprisingly difficult to figure out what dividends are doing for midstream energy infrastructure. Just about every company has a free pass on cutting its payout nowadays. Prudent cash management isn’t going to draw much criticism with the size of the economic shock we’re enduring. Given the beating energy stocks suffered during 1Q20, a few dividend cuts would have been forgiven.

In spite of this, the biggest midstream energy infrastructure companies have maintained their payouts. In 1Q earnings calls, the overall message was that while it was hard to make confident long term forecasts, management teams felt comfortable with the resiliency of their businesses. The result is that the top ten midstream energy infrastructure companies by market cap have raised their payouts by an average of 4.7% over the past year.

None of them reduced dividends at their most recent announcement dates. Cheniere Energy, Inc. (LNG) doesn’t pay a dividend. Kinder Morgan (KMI) raised theirs by 5% compared to the prior quarter.

As we noted recently, free cash flow growth remains a positive story for these companies (see Pipeline Cash Flows Will Still Double This Year).

Alerian has echoed the positive news about distributions. They noted that, “The majority of midstream constituents grew or maintained dividends over 1Q19.” This was supported by a chart showing 68.5% of Alerian MLP Infrastructure Index (AMZI) components by market cap did just that. It sounds like a great story.

Unfortunately, characterizing distributions in this way presents a misleading picture. A majority maintaining or growing suggests that aggregate payouts for the group are similarly stable. They are not.

Distribution cuts at MLPs have been far more prevalent than at corporations – because the AMZI index consists of MLPs, it is more exposed to crude oil pipelines and to gathering and processing than the American Energy Independence Index (AEITR), which reflects the North American midstream sector as a whole. AMZI doesn’t reflect the industry. MLPs also tend to have lower credit ratings. As a consequence, MLP distributions are turning out to be less resilient than those paid by pipeline corporations.

Most companies tend to raise distributions/dividends gradually, by a few percent at time. By contrast, cuts are often 50-100%. So even though the majority of AMZI by market cap maintained or raised their distributions, the payout on the Alerian MLP ETF, AMLP, has just been cut again.

The AMZI is down to only 20 constituent companies now, and because 11 of them slashed their distributions, this was enough to force AMLP to cut its payout. This contrasts with the story for AMLP’s index, AMZI, which is being spun to sound superficially good.

It turns out that size matters. The three biggest MLPs, which are in the top ten midstream companies by market cap, all maintained or grew their payouts. The biggest companies in this sector tend to be more stable and have higher credit ratings.

AMLP investors care more about another cut than the spin being put on its index.

SL Advisors publishes the American Energy Independence Index

We are invested in KMI and LNG

Energy Investors See Us Moving Again

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The energy sector has been leading the market’s rebound from the lows of March. Demand for crude oil plummeted, and the Saudi decision to simultaneously increase supply caused prices to briefly go negative. No investment sector in energy was safe, including midstream infrastructure.

U.S. oil production has already dropped by 1.6 Million Barrels per Day (MMB/D), from 13.1 MMB/D in mid-March to 11.5 MMB/D now. First quarter earnings calls updated investors on the collapse in demand. Magellan Midstream reported gasoline demand was down 24% in April (see More Solid Pipeline Results). Jet fuel was down by 75%.

However, there’s more to the U.S. energy business than crude oil. Natural gas demand has remained solid, helped by continued substitution away from coal. And propane exports have risen – as India’s refineries are producing less gasoline, they’ve also cut propane production which is often part of the same process. So we are exporting more propane to India, where it’s widely used for cooking.

The continued rise in the American Energy Independence Index (AEITR), which includes all the biggest pipeline companies in North America, reflects increasing optimism that economic activity is returning. The charts below show interesting data from Apple that estimate how much people are traveling based on their requests for directions from Apple Maps.

People are walking and driving more, although Atlanta is closer to normal than New York. What’s also interesting is that mass transit use isn’t recovering as quickly. Almost 21 thousand people have died in New York City, about a fifth of the U.S. total. There are many reasons for this concentration, but extensive use of mass transit is likely one of them. The public has clearly reached that conclusion. Although many expect working from home to reduce energy consumption for commuting, if large numbers of people avoid mass transit it’ll boost gasoline consumption, to the extent that it results in more road trips.

All 50 states are relaxing constraints. I for one have been amazed – shocked, in fact – at how easily state governors can restrict our freedom for an extended period of time with seemingly little legislative oversight. The gradual recovery in travel is a welcome sign that we’re emerging onto the other side of the pandemic.

Airline activity is starting to pick up as well – in recent days the TSA reports air passenger traffic reached 15% of normal, doubling from early May. Signs are that America is gradually emerging from its lockdown. The consequent increase in energy use is drawing investors to the sector.

We are invested in Magellan Midstream, and all the components of the AEITR.

Falling Emissions Are Good For Energy

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The International Energy Agency (IEA) expects CO2 emissions to fall 8% this year. This is six times the reduction that followed the 2008 financial crisis, reflecting the far greater drop in economic activity. Transportation has plummeted — peak congestion on roads in March was estimated down 50-60% in major cities around the world including Los Angeles, Sao Paolo and Mumbai. The IEA estimates that aviation fuel demand was down 27% in March. This likely understates the actual fall. TSA figures show passenger traffic through security checkpoints down over 95% in March and April.

Even the most die-hard climate extremist can hardly cheer this news, given the circumstances. But the size of the drop will take emissions back almost a decade. If the world had only twelve years left before climate change catastrophe, as Alexandra Ocasio-Cortez (AOC) asserted last year, we can now make it to 2040.

Energy demand from the transportation sector may never fully recover. Working from home has been less disruptive than imagined. On earnings calls with pipeline companies, whenever the topic came up CEOs noted that working remotely was fine. Facebook is just one company whose workforce will largely be remote for the rest of the year. Less commuting, less business travel and vacations closer to home could become permanent. Declining use of public transport for fear of infection may partially offset this, but overall the pandemic’s impact on energy demand will most likely be a long-lasting reduction.

Coal demand has also been hit hard. China burns half the world’s coal, and it produces around 70% of their electricity. Nothing meaningful can happen on climate change without China (listen to our podcast: China Keeps Warming the Planet).  The lockdown lowered Chinese power demand, shrinking coal consumption. In the U.S., coal-fired power demand in 1Q was down by a third compared with a year ago (a mild winter, cheap natural gas and greater use of renewables helped).

Climate extremists will continue to press their case, but they’re unlikely to gain new adherents in the next few years. Falling emissions and the urgency of repairing the huge economic damage we’re enduring will drive public policy. As we count the human cost of the lockdown in terms of neglected health, business failures and emotional trauma, returning to the economy we had will be a priority.

We need to be better prepared for the next pandemic. The World Health Organization (WHO) called climate change the biggest global health threat of the 21st century. They warn of 250,000 additional deaths annually from climate sensitive diseases starting in 2030 (like AOC, they believe we have around a decade left). Coronavirus deaths will be multiples of this figure when the numbers are finally added up.

The WHO’s website on climate change adds that, “The direct damage costs to health is estimated to be between USD 2-4 billion per year by 2030.” This number is derisively insignificant compared to the trillions we’re spending in America in financial support alone. Similar fiscal support along with economic losses are occurring globally.

The WHO pursued politically correct groupthink (listen to our podcast: Climate Change Was Never Our Biggest Threat). They were trying to be woke. It’s time they woke up.

This reordering of priorities is bullish for the energy sector. Jim Cramer often points out that young money managers won’t invest in fossil fuels because of climate change. Many will retain that bias, but that’s now yesterday’s trade. At the margin, rebuilding our economy and the current sharp drop in emissions will trump global warming. High school dropout Greta can resume her education — remotely. The world’s focus has shifted.

Pipeline Cash Flows Will Still Double This Year

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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.

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.

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.

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.

How Risky is Dining Out?

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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.

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.

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 1/1,000th 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.

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.

The Market Recovers With Energy

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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.

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.

The U.S. Borrowing Pandemic

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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.

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.

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

More Solid Pipeline Results

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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.”

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.

Pipeline Payouts Holding Up

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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.

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.

Can An ETF Go Negative?

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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.

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.

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.

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