After Years of Growth, Is Midstream Capex Peaking?

Summary //

  • Midstream companies have increased capital spending to build the infrastructure assets necessary to facilitate growing energy production.
  • After significant growth in spending since 2016, growth capital expenditures are expected to peak for a majority of constituents in the AMZI and AMEI in the 2018-19 timeframe.
  • More moderate growth capital spending should be positive for midstream as free cash flow increases, enhancing financial flexibility.

Capital spending has been a hot topic across energy in the wake of the oil price drop in 4Q18 and in the aftermath of the broader oil downturn from 2014-2016. Investors want to see energy companies demonstrate capital discipline with the goal of achieving free cash flow and improved returns. The challenge for midstream companies continues to be balancing fiscal discipline with abundant growth opportunities. Today, we look at whether growth capital spending in midstream could be peaking and how moderating capex could be a positive for the space.

Midstream companies ramped spending to build the infrastructure needed for growing production.
With oil and natural gas production rising steeply over the past decade, energy infrastructure companies have increased capital spending to meet the need for new transportation, storage, and processing assets. The large-scale buildout of energy infrastructure over the last few years has been a direct response to increasing demand and the need to alleviate infrastructure constraints across hydrocarbons (think of Permian oil and gas pipeline bottlenecks, constraints for natural gas liquids pipelines and fractionation facilities). Production growth will likely continue as the US is expected to account for approximately 75% of the growth in global oil production to 2025 based on projections from the International Energy Agency. Furthermore, according to a report by the Interstate Natural Gas Association of America (INGAA), an estimated $463-579 billion in energy infrastructure spending will be required through 2035 in the US and Canada (read more). Midstream growth opportunities are clearly expected to remain plentiful. Notably, however, INGAA projects that midstream infrastructure spending will peak in 2019.

Are we at the peak of energy infrastructure growth capex spending?
Broadly speaking, 2018-2019 may represent the peak of energy infrastructure capex spending, as significant projects are brought online this year and into 2020. In order to understand the current context for capex spending and better evaluate if spending is peaking, we compiled the growth capex numbers for the past three years for the constituents in the Alerian MLP Infrastructure Index (AMZI) and the Alerian Midstream Energy Select Index (AMEI) as well as forward projections through 2020 based on company guidance and Bloomberg estimates. For companies without guidance, we used the median of Bloomberg estimates for growth capital spending. We caveat that 2020 guidance and estimates are subject to change as companies progress growth plans.

Looking at the historical data for the AMZI and AMEI, growth capital expenditures have ramped significantly since 2016. Nearly 80% of the AMZI and over 70% of the AMEI increased their spending over the period from 2016 to 2018, many of them substantially. About half of the constituents in the AMZI, for example, at least doubled their capex from 2016 to 2018. While some companies (especially those that are less mature) will continue to increase spending, the data suggests that most companies in the AMZI and AMEI are expected to reach peak spending in 2018 or 2019. The majority of constituents in both indices are expected to decrease spending in 2020 relative to 2019 based on company guidance and median growth capex estimates.

In the charts above, we primarily relied on Bloomberg estimates for 2020 growth capex because many companies have not provided 2020 guidance. The table below compares 2019 and 2020 guidance from midstream names that have given projections for both years, with many guiding to a decrease. As mentioned above, one reason for the moderation in spending is that companies are starting to complete some of the largest projects in their backlogs. For example, EQM Midstream (EQM) expects to complete the Mountain Valley Pipeline (MVP), a 2.0 Bcf/d natural gas pipeline on the East Coast, in 4Q19 at a total cost to EQM of $2.2 billion. EQM is estimating much lower capital expenditures in 2020 as a result, guiding to $800 million – a 61% decrease. With actual and estimated annual growth capex of $5 billion or more for 2016 to 2019, Energy Transfer’s (ET) median estimate for 2020 growth capex is only $3.1 billion. Magellan Midstream Partners (MMP) is currently guiding to $150 million in expansion capital spending in 2020, but management noted that number could increase if it spends some of its $500 million backlog in 2020. While 2020 numbers could certainly change, most companies are expecting a step down in spending.

Company Ticker 2019 Guidance ($MM) 2020 Guidance ($MM)
Andeavor Logistics – Press Release ANDX 600 600
Antero Midstream –Presentation AM 710 600
EQM Midstream – Press Release EQM 2050 800
Magellan Midstream Partners – Press Release MMP 1100 150
MPLX – Presentation MPLX 2200 2000

Other companies have not provided specific 2020 guidance but expect a sequential decline in growth capex. For example, ONEOK (OKE) and Targa Resources (TRGP) are expected to spend less in 2020 as major projects come online this year, with OKE management saying it expects a significant decrease in 2020 spending. Similarly, Western Midstream (WES) said in its May investor presentation that it expects 2020 capex to decline. CNX Midstream (CNXM) expressed in its 1Q19 presentation that it expects its capital budget to “decline substantially” in 2020 and beyond.

Moderating capex is generally positive for midstream.
In contrast to other sectors of energy, investors have generally been more receptive to MLPs and midstream companies raising capital spending guidance for growth projects expected to generate attractive returns (read more). As a recent example, Enterprise Products Partners (EPD) raised its 2019 growth capex guidance by 9% to $3.6 billion at the midpoint in conjunction with its 1Q19 earnings release and ended the day up 1.6%. It bears noting that results exceeded expectations, which factored into performance as well.

While investors have been sympathetic to midstream capex increases, reaching a peak in midstream spending could be positive in two ways: 1) companies generate greater cash flow as major projects built in recent years are brought online (read more), and 2) lower growth capital spending frees up cash for other uses. Simply put, greater free cash flow provides greater financial flexibility, allowing companies to reduce leverage, increase distributions, or repurchase shares/units. Growing free cash flow would also likely be welcomed by generalist investors. Separately, reduced growth capex may help alleviate investor fears of midstream potentially overbuilding infrastructure. Regardless, we view improving and sustaining free cash flow generation through prudent spending as one of the ways midstream management teams can demonstrate to investors that they are serious about capital discipline and achieving attractive returns (read more).

Bottom Line
After several years of significant capital spending on growth projects to facilitate robust US production growth, midstream growth capex appears to be peaking. For many companies, a decline in spending in 2020 reflects the completion of major projects that will now contribute to cash flow generation. Increased cash flow accompanied by lower spending sets the stage for free cash flow growth, with the potential for excess cash to be used for reducing leverage, increasing distributions, or buying back units/shares. If 2018-2019 proves to mark the peak for midstream spending, the prospect of enhanced free cash flow generation should be viewed positively by investors.

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