Could decreased fuel consumption lead to lower cash flows for MLPs?
Last week contained lots of talk about fuel efficiency thanks to President Trump’s announcement that he was ordering the Environmental Protection Agency (EPA) to review current Corporate Average Fuel Economy (CAFE) standards. These standards require automakers to produce more fuel-efficient vehicles that emit less pollution. Most would agree these are both good things, the only problem is cost. Automakers have made it clear that meeting the current standards will have a significant impact on production expenses and they’ll have no choice but to pass these on to consumers.
While we won’t know what bearing, if any, this could have on the energy industry until the review occurs, the headlines about fuel efficiency caused me to consider the relationship between demand at the pump and MLP cash flows. We’ve often had investors reason that less consumption means less product flowing through the pipes and therefore less “tolls” for MLPs (traditionally thought of as having toll-road business models). This isn’t an illogical idea, but certainly doesn’t capture the whole picture.
Let’s take a quick look at US gasoline demand over the past 30ish years. Looking at the chart, we see that demand hit a peak in 2005 and declined about 8% by 2014. Demand climbed from the bottom in 2015 and 2016 as consumers enjoyed lower-cost fuel.
Still, if US demand were to decline, here are three facts to consider:
- “Price” in the Price x Volume Equation. MLPs that operate interstate liquids pipelines, including refined product pipelines, are allowed by the Federal Energy Regulatory Commission (FERC) to increase tariffs each year based on inflation. Given this, even if the volume of crude oil transported were to go down slightly, the fees for moving product will generally trend upward overtime due to inflation, offsetting small differences in volume.
- Refined Product Exports. Exports of refined products are almost six times what they were in the 80s. If US consumption were to decline, it’s possible that exports to emerging markets could offset some of the potential drop in demand.
- Diversification. Most of the MLPs that operate refined product pipelines also have other sources of income. These other sources may be from refined product storage where the business model is based on contracted capacity, or crude oil pipelines, or crude oil storage.
We are often asked to compare the lifespan of the MLP asset class to a baseball game. Investors that fear the emergence of increased fuel efficiency and non-traditional sources of energy worry we’ve creeped into the 8th inning. However, remember that an efficient use of fuel is not a lack of use of fuel. Given all the possibilities throughout our world and the fact that over $500 billion of energy infrastructure still needs to be built within the US, we could be in an endless game.