Dwindling Pipeline Capacity Causes FOMO

FOMO (Fear of Missing Out) hasn’t been much of a problem for energy infrastructure investors over the past year or so. Feelings of WAIL (Why Am I Long?) and (ahem) WTF have been far more common. So the recent rally in the sector has led many investors to enquire why. Earnings only began to be released on Wednesday when Kinder Morgan (KMI) announced a 60% dividend increase and $500MM of stock repurchases since December. Although the dividend hike was expected, the stock nonetheless gained ground. KMI’s 2014 simplification, when they moved from four public entities to one, heralded the conflict between the old and new business model.

Shale Revolution-induced growth opportunities pursued by management collided with the desire of income-seeking investors for steadily growing cashflows (see Will MLP Distribution Cuts Pay Off?). An adverse tax outcome and two distribution cuts followed for original investors in Kinder Morgan Partners. MLP simplification became synonymous with abuse of your core investors, at least until Tallgrass (TEGP and TEP) recently managed to execute one that was well received.

Nonetheless, the persistent high yields on MLPs betray the skepticism of their traditional investor base of older, wealthy Americans. Last year Oneok (OKE) combined with its MLP Oneok Partners, inflicting a KMP-type tax bill on long-time MLP holders. One friend of mine held its predecessor Northern Border Partners from the 1990s, and received an unexpected tax bill on deferred income recapture that was timed to suit OKE, not him. Such investors are not about to commit new money to MLPs. This is the problem facing MLPs but not corporations. MLPs are cheap, but they’ve alienated their core investor base, which is already narrow. This is why investors need to look for broad energy infrastructure exposure including corporations, and not be limited to MLPs (see The American Energy Independence Index). KMI’s $500MM stock buyback would not have happened when they were structured as an MLP.

Substantive developments to explain the rally are few, although Saudi comments favoring $80 oil have helped. Technical analysts have noted that energy infrastructure shows signs of bottoming, something not heard since 2016. Energy stocks are gaining more airtime on CNBC. More tangibly, on Wednesday, the WSJ’s Is the U.S. Shale Boom Hitting a Bottleneck gathered substantial attention by suggesting, “…the U.S. shale boom appears to be choking on its own growth…”

The article included a chart (reproduced here) that is a true object of beauty to any pipeline owner. The problem of sharply growing crude oil production in the Permian is testing the limits of take-away pipeline capacity.  Crude oil located in Midland is usually worth less than in Houston, where it’s conveniently near refineries and export facilities. The price difference is typically going to be limited by the cost of pipeline transportation, which is around $2-3 per barrel. Permian output is currently 3.1 Million Barrels per Day (MMB/D), with pipeline take-away capacity of 3.2MMB/D.

The price differential has widened beyond the pipeline tariff because not all the crude wishing to travel to Houston can get in a pipeline. Some is moving by rail (around $8 per barrel) while truckers charge from $10 to as high as $15-20 (truck drivers are in high demand in Texas).

This is a problem for Permian oil producers, since the increased cost of getting their product to market eats into margins. However, it’s a profit opportunity for pipeline owners, since the portion of their capacity that is sold at market rates is now much more profitable. Bottlenecks are good for infrastructure owners. They make money from regional price differentials in excess of the costs of storage and transportation. When Plains All American (PAGP) cut their distribution last year, they blamed it on a collapse in their Supply and Logistics division as regional price differentials were boringly close to transportation costs, minimizing arbitrage opportunities.

Some additional pipeline capacity can be squeezed out through more efficient utilization. Drag reducing agents (millions of tiny polymer string segments) can be mixed with crude which, through the magic of hydrodynamics, reduce turbulence as the liquid travels. But meaningful new capacity isn’t expected until 2H19, which on current trends should maintain the steep Midland-Houston discount and support continued higher pipeline tariffs. Among the beneficiaries of this are PAGP, Energy Transfer Equity (ETE) and Enterprise Products Partners (EPD).

We are invested in EPD, ETE, KMI, PAGP and TEGP

Print Friendly, PDF & Email

Important Disclosures

The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy,  completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments.  Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)

This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r

Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.

All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.

Past performance of the American Energy Independence Index is not indicative of future returns.

Print Friendly, PDF & Email
1 reply
  1. Elliot Miller
    Elliot Miller says:

    I respectfully disagree that the traditional MLP investor base, which enjoys the tax deferral aspect of their distributions as an attribute of such investments, need look to corporations for energy infrastructure ideas. There are many MLP investments still credible and available and not likely to impose a tax burden on their most loyal and long term unit holders by merging with a C corporation. And the tax deferral is worth forgoing KMI’s stock buy backs to investors such as myself; and don’t forget that EPD did not preclude a post-2019 unit buy back plan.
    One other point to note about this article is that energy infrastructure is not limited to crude oil, but also includes natural gas and natural gas liquids, which my own investments emphasize.


Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.