Investors have been taking a second look at the midstream lately and many, apparently, do not like what they see. Their concerns have caused the benchmark Alerian Index to sag by some 20% for the year as September began.
Doesn’t sound like the hot sector that has been trumpeted as a long-term, growth-and-income generator, does it? Midstream’s growth prospects and cash flow should attract people tired of piddling returns elsewhere.
So what’s going on? Hidden deep inside energy’s current fog is a bright midstream story. It just may not be as shiny as it once was. Overall for energy, the blame lies in what Tudor, Pickering, Holt & Co. called “the nuttiness of the market in recent days” in a September report.
Compared to the commodity-sensitive upstream sector, midstream looks pretty good. A fee-for-service business model has become the rule so revenues likely will remain comparatively stable. But given upstream’s headaches, analysts want to notch back their forecasts. After all, midstream serves upstream so there has to be an impact. Moody’s Investor Service announced a sector downgrade in an August report.
“We changed our outlook for the global midstream energy industry to stable from positive on Aug. 17, 2015,” Moody’s said. “This outlook reflects our expectation for the fundamental business conditions in the industry over the next 12 to 18 months.
“Our move to a stable outlook for the global midstream energy industry reflects our view that the industry’s EBITDA growth will slow to 3% to 5% in 2015, with the slowdown likely to continue into 2016,” it continued. “Deep cuts in capital spending and slowing production in the exploration and production sector have reduced midstream spending on growth projects, which had been the principal driver of EBITDA upside. Our midstream sector outlook had been positive since September 2010, reflecting heavy levels of energy infrastructure spending, largely for U.S. oil and natural gas shale resource development, which generated substantial midstream EBITDA growth.”
Midstream’s prospects look positive compared to the overall stock market, Deutsche Bank said in a report, and current prices create a buying opportunity. “The space is now trading at some of the most compelling valuations in the past 5+ years,” the analysis said, adding that “… We don’t think there is a fundamental justification for the relative underperformance vs. energy (-200 bps [basis points] since peak, -500 bps YTD) or vs. other income-oriented products (-3,950 bps since peak, -2,000 bps YTD).”
Wells Fargo in an MLP update noted not all MLPs are created the same and commodity-risked upstream partnerships have far different economics right now than their fee-for-service, take-or-pay protected midstream cousins.
“Consequently, while we believe the MLP structure could be suitable for a range of energy businesses, it’s important for investors to make the distinction (both in the market and in their portfolios) between primarily fee-based stable midstream MLPs and other types of partnership securities,” it said.
So what happens as 2015 enters its final quarter and 2016 capex planning begins?
Tudor Pickering had a philosophical view: “Within midstream, strategic reaction to diminished growth opportunities/domestic volume contraction will be interesting to watch.” Deutsche Bank emphasized that “(we) reiterate our ‘be selective’ call.” Wells Fargo agreed and said, “Consequently, while it’s difficult to predict when the tide will turn, we do view the current weakness as a good entry point for long-term investors.”
Whatever the future holds, midstream’s prospects throughout North America hinge greatly on what happens in Texas with its significant upstream production, big downstream customer base and sprawling infrastructure between them. Furthermore, the Lone Star State serves as a hub for much of North America’s midstream business. If you are a participant, or investor, in this space I believe Hart Energy’s first Midstream Texas conference this month will be worth your time. I hope to see you there.

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