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.

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.

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.

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

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.

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.

We are invested in all of the companies mentioned above.

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.

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.

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.

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.

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.

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.

Approximately 80% of our investments in midstream energy infrastructure are corporations – we invest in MLPs selectively. There’s a big difference between investing in pipeline corporations with their wide investor base, and MLPs whose pool of natural buyers is withering.

That’s why eight of the ten biggest names in the American Energy Independence Index (AEITR) are corporations. Last week, Bloomberg published Pipeline Funds Imperiled With Even MLPGuy Seeing Their End. MLP-dedicated funds, and more importantly their investors, face some tough decisions in the months ahead.

MLPs long ago lost the support of their traditional investor: the older, wealthy American willing to accept the tax complexity of a K-1 in exchange for attractive, tax-deferred yields. The Alerian MLP ETF (AMLP) has cut distributions by a third since 2014, reflecting what MLPs have done (see When Will MLPs Recover?). These investors feel betrayed, and they’re not coming back.

The Alerian MLP Infrastructure Index (AMZI), which is what AMLP tries to track, has a float-adjusted market cap of just $61BN. This is too small to justify a sector-based approach, a point made in the past by CBRE’s Hinds Howard (known as @MLPGuy on Twitter). Regulatory limits cap holdings of big MLPs, causing smaller MLPs to be overweighted. The AEITR is 73% companies rated BBB or better, compared with  just  42% in the AMZI.

Publicly traded funds represent an important part of the MLP investor base. At the end of February, Wells Fargo estimated there was $30BN in such funds, of which Closed End Funds (CEFs) represented over 40%. Showing arrogant recklessness, these CEFs entered March with leverage of up to 40%, and in the subsequent forced deleveraging they blew up.

We’ve often warned about this, most recently in November (see Should Closed End Funds Use Leverage?). Their rapid demise contributed significantly to the overall selling of MLPs in mid-March. These portfolio managers owe everyone else an apology (see The Virus Infecting MLPs). It’s been the worst month in memory for pipelines — the AEITR is -40%. But the Kayne Anderson MLP/Midstream Fund (KYN) is down 65% for the month. The Clearbridge Energy MLP Fund (CEM) is -80%. The Tortoise Energy Infrastructure Fund (TYG) is -82%. This group has destroyed most of their client capital. They have no risk management. MLP CEFs no longer exist as a practical matter. They can’t do much more damage.

Open-ended MLP-dedicated mutual funds such as those run by Steelpath (now owned by Invesco), Center Coast Brookfield and Mainstay Cushing face a choice. The extreme volatility and diminished pool of names make it unlikely they’ll attract many new clients. Like AMLP, their complex, tax-inefficient structure has always been a burden, because they pay corporate taxes on profits (see MLP Funds Made for Uncle Sam). Invesco recently had to spend $400 million correcting mis-stated NAVs dating back to 2015 – evidently the tax treatment even confused the fund’s accountants. Today, all these funds are a long way from having to pay corporate taxes.

It must make sense for them to broaden their mandate to include pipeline corporations, whose market cap is roughly twice as big as MLPs. Doing so will place further downward pressure on MLPs as these funds diversify their holdings.

Tax-exempt U.S. institutions and non-U.S. investors rarely invest in MLPs, because they face onerous tax liabilities if they do. Valuations are so depressed that some may decide it’s worth the trouble. But they’re likely to stick to the big three of Enterprise Products (EPD), Energy Transfer (ET) and Magellan Midstream (MMP).

The result is that it’s hard to identify much natural demand for MLPs. By contrast, pipeline corporations can be bought by anyone. This absence of investors has led to even the three biggest MLPs performing worse than the three biggest pipeline corporations in the last month. The broader trend for pipeline corporations to outperform MLPs began early last year. The American Energy Independence Index is 80% corporations, and has beaten the Alerian MLP Index by 14% since then.

Moreover, compared with pipeline corporations, MLPs are (1) more exposed to crude oil with less natural gas, where demand is more stable, (2) more exposed to gathering and processing, which depends heavily on production from the specific areas served, (3) riskier credits, with more BBB- (one notch above junk) and below than corporations, and 4) less protective of investor rights, with poorer corporate governance and in some cases blatant conflicts of interest. In other words, the MLP-dedicated portfolio has more of what’s most vulnerable (see Today’s Pipelines Leave MLPs Behind).

The smaller MLPs are especially short of natural buyers. Years ago when the MLP industry had its own conference, StonMor (STON) was an incongruous participant as an MLP in the “deathcare” business (funeral homes and cemeteries). They had a complex structure even for an MLP, and they were out of place among energy investors. They’re now a corporation, and following various self-inflicted problems in 2016 are trading at roughly 5% of their value from years back. They didn’t fit in anybody’s portfolio.

MLPs unable to interest institutions will similarly struggle to attract natural buyers.

Investors in MLP-dedicated strategies should ask themselves: who are the likely buyers of what they own? For now, everything is so cheap that they could easily bounce. But over the longer run, we think MLP-dedicated funds will wish to diversify, which could mean selling most of their MLPs and buying pipeline corporations. A conversion of one of the big three would probably force the issue.

This will hurt performance, and nobody wants to be invested in the last fund to make that shift. Diversified exposure to midstream energy infrastructure through corporations, with just a handful of big MLPs, offers plenty of upside once we get past the coronavirus. But CEF investors saw their MLP allocations reduced in a fire sale, thanks to incompetent portfolio management. Having incinerated most of their investors’ capital, MLP CEFs won’t be a source of demand going forward. High net worth investors have been abandoning MLPs for years. ESG funds buy the biggest pipeline corporations (see our video ESG Investors Like Pipelines) but not MLPs because of their weak governance.

Open-ended ETFs and mutual funds that are loaded up with MLPs are likely to diversify. So if a portfolio of MLPs no longer makes sense, their only place is as part of a bigger portfolio. And if an investor owns just a few MLPs, she’s likely to focus on the big ones. A portfolio of MLPs has an uncertain future.

Disclosure: SL Advisors manages investment products designed to incorporate the advantages described above.