We believe midstream energy investments, including master limited partnerships (MLPs) are poised to benefit from the development of non-conventional resource basins and greater energy infrastructure capital spending.
Defining the infrastructure asset class
Midstream energy companies are engaged in the movement of energy-related natural resources from upstream producing wells to downstream end-users. Midstream businesses, such as pipelines, represent the “toll-roads” of the energy sector, and are characterized by long-lived real assets, high barriers to entry, limited direct commodity exposure, predictable fee-based revenue models and businesses tied to essential services. Midstream energy can be categorized into four general segments:
- Pipelines: Primary mode of transportation for moving crude oil and natural gas from production basins to demand centers
- Gathering and processing: Distribution systems and natural gas liquid (NGL) processing plants that facilitate the removal of byproducts
- Storage: Natural gas and crude oil storage facilities typically located near refineries or marine ports
- Refined products: Companies that process crude oil into a variety of petroleum products including gasoline, diesel, jet fuel, and heating oil
Fundamental upcycle continues to emerge
We believe global oil markets are rebalancing, which should help stabilize prices. Midstream energy fundamentals continue to improve as North American volumes trough and grow. In our view, North America will continue to gain market share as a global energy supplier. Energy demand remains strong, bolstered by low prices.
High income and growth potential
Midstream energy businesses are tied to tangible assets with cash flows that originate from volume-based usage fees and revenue that is often indexed for inflation. MLPs offer the potential for tax-advantaged income greater than that of other income-oriented securities such as utilities and bonds.
We see value in MLPs, which provide the potential for attractive current income and future growth. A substantial majority of distribution reductions have already occurred, though a few additional cuts are still likely. The deleveraging process is well underway as management teams have redirected cash flows to improve balance sheets. As the balance sheet repair cycle ends, we anticipate distribution growth will accelerate.
Benefits of MLPs and related midstream energy companies
Investing in publicly traded midstream energy securities offers the benefits of owning tangible energy-related assets through publicly-listed companies. Additionally, the pass-through delivery of MLP income allows for generally higher distributions.
View Cohen & Steers' MLPs analysis.
The views and opinions are subject to change without notice and represents an assessment of the market environment at a specific point in time, should not be relied upon as legal, investment or tax advice and is not intended to predict or depict performance of any investment. We consider the information to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of suitability for investment. Investors should consult their own advisors with respect to their individual circumstances.There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. There is no guarantee that a market forecast made in this commentary will be realized.
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Risks of Investing in MLP Securities
An investment in MLPs involves risks that differ from a similar investment in equity securities, such as common stock, of a corporation. Holders of equity securities issued by MLPs have the rights typically afforded to limited partners in a limited partnership. As compared to common shareholders of a corporation, holders of such equity securities have more limited control and limited rights to vote on matters affecting the partnership. There are certain tax risks associated with an investment in equity MLP units. Additionally, conflicts of interest may exist among common unit holders, subordinated unit holders and the general partner or managing member of an MLP; for example a conflict may arise as a result of incentive distribution payments.
The portfolio will be subject to more risks related to the energy sector than if the portfolio were more broadly diversified over numerous sectors of the economy. A downturn in the energy sector of the economy could have a larger impact on the portfolio than on an investment company that does not concentrate in the sector. In addition, there are several specific risks associated with investments in the energy sector, including the following: Commodity Price Risk, Depletion Risk, Supply and Demand Risk, Regulatory Risk, Acquisition Risk, Weather Risks, Exploration Risk, Catastrophic Event Risk, Interest Rate Transaction Risk, Affiliated Party Risk and Limited Partner Risk and Risks of Subordinated MLP Units. MLPs which invest in the energy industry are highly volatile due to significant fluctuation in the prices of energy commodities as well as political and regulatory developments.