Five Reasons MLPs Are Underperforming

MLPs were down 4.9% in August on a total return basis, marking the worst month since January 2016, when MLPs were down more than 11%. To answer concerns along the lines of “Will MLPs go down no matter what?”, here are five actual reasons why MLP performance has been less than expected recently.

5. OPEC Noncompliance
At least for the time being, MLPs correlate with oil in the minds of investors, so MLP stakeholders find themselves following the global energy markets closer than ever before. OPEC production remains near an all-time high (despite meetings and calls for production cuts) keeping prices low. Combined with the capitalist US now being a major swing producer, the market is not expected to balance until increases in global demand soak up the glut. A recent IEA report explores this idea in more depth.

4. Permania Shifts to Permoderation
The lone bright spot in energy this year, the Permian basin has finally shown itself to be fallible. Rig counts are still robust but a lack of completion crews has prevented production from increasing as predicted. As an example, Pioneer Natural Resources (PXD) expects their production growth to be at the lower end of previous guidance.

Additionally, wells are having higher than expected gas to oil ratios (GORs). While less oil production could reduce previously established demand for oil pipelines, on the other hand, more gas production could result in more demand for gas gathering and takeaway pipelines in the region. Not to mention, a more tempered increase in Permian oil production could tighten the global supply/demand balance.

3. Following 2Q17 Earnings, Lost Faith in 2H2017
At the beginning of the year, in nearly all guidance given by US producers (and by incorporation, many MLPs), the second half of the year was the predicted savior. Now, as the second half of the year is firmly underway and while there has been no particular piece of bad news, there has been a noticeable lack of good news to look forward to for 2H17. After so many months in a challenging environment, investor sentiment continues to drift down.

As MLP earnings reports came out, investors continued to trade stocks lower, despite a fairly neutral season. Energy Transfer Partners (ETP) issued a billion dollars worth of equity with units trading at five year lows.

At least one company sees these lows as well below their own valuations. Kinder Morgan (KMI), while not an MLP, is instituting a $2 billion buyback program.

2. Plains Disappoints
During their earnings announcement at the beginning of the month, Plains All American (PAA) and Plains GP Holdings (PAGP) missed in their Supply & Logistics segment, revised guidance downwards, and indicated a likely distribution cut. In response, Moody’s placed them under review for downgrade.

Just before Hurricane Harvey made landfall, the exchanges halted the trading of PAA. In a press release issued after market close and during a webcast none of our team was able to log into, Plains announced that it would be cutting the distribution 45.5%, which is following a 21.4% cut just last year. Along with continued asset sales, reduced hedging, and issuance of perpetual preferred equity, the move is designed to maintain its investment grade rating. Unfortunately, this was unsuccessful and Moody’s downgraded the company to a junk rating. Since the announcement, however, PAA has fallen 16.7%, and PAGP has fallen 16.9%.

1. Hurricane Harvey
In response to the hurricane and due to evacuation orders, the majority of refineries and steam crackers in South Texas closed (temporarily). As of mid-September, many were operational again. However, from reading MLP press releases, the overall impact of the downtime has been and will be relatively minimal compared to what some may have expected. From a financial standpoint, MLP assets are covered under insurance policies as well as business interruption insurance policies that typically cover loss of income.

While Harvey had a minimal impact on the actual prices of MLPs (the Alerian MLP Index (AMZ) was up a little over 2% in the days since the hurricane landed), the loss of human life and the difficulties experienced by our friends and colleagues who live in the area made this a truly terrible end to a month that was already quite disappointing.

On a Positive Note
On an early September call, a colleague noted that if I, a normally overly optimistic person, were this disheartened about recent events, he was going to take it as a marker of the bottom of the market and begin increasing his allocation. We had a good laugh, but he did push me for some silver linings. On a more positive note, interest rates remain unchanged, the FERC has again reached a quorum and pipeline approvals can recommence, and the long-term story remains unchanged (it’s true, none of the above points are long-term disasters—the thesis remains intact). Plus, it’s really hard to beat a 7.7% yield.

Sometimes, investors ask me when the other shoe is going to drop and what it might be. That’s an impossible question to answer, but at this point, even a centipede has to be running out of shoes.

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