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Industry Overview- August 2017

Master Limited Partnerships (“MLPs”) returned -4.94% during the month compared to +0.31% for the S&P 500. The AMZ reached a 2017 low halfway through the month despite an overall solid Q2 earnings season as crude prices and select headlines weighed on the space.

Crude Prices

Crude correlation trended lower for the second month in a row in August, with a 0.42 correlation between WTI and the AMZ. However, crude prices were down 5.9% on the month and helped contribute to the overall negative sentiment in the space. Crude correlation for 2017 YTD is at 0.57.

As we have stated before, we welcome the prospect of decreased correlation to commodity prices for the midstream sector. We believe we are transitioning to an environment where US producers will act as price-setters for global commodities, as opposed to reacting to crude prices set by others (OPEC). As US producers continue to drill bigger and bigger wells at lower and lower prices, US volumes should continue to grow and our hydrocarbons should compete for a growing stake of international market share. As a result, we believe the success of midstream companies is not contingent on the price of the commodity, and midstream companies should be able to thrive in a low-price environment where the cause of low prices is due to efficient drilling by US producers.

Earnings Were Good… With One Notable Exception

The majority of Q2 2017 earnings results were released in August, and on the whole, the earnings season was a positive one. Nearly 75% of Fund constituents met or beat consensus expectations for the quarter. Fund constituent weighted average distributions per unit grew 2.2% over Q1 ’17. Several constituents announced a strong slate of new growth projects, US crude production approached all-time highs, and some companies were able to increase annual guidance due to strong operational tailwinds.

However, the positive announcements were overshadowed by an earnings miss and weak guidance from Fund constituent Plains All American (NYSE: PAA) related to its Supply & Logistics (“S&L”) business. PAA released quarterly earnings during the month that came with a downward guidance revision in their S&L business and an indication of another distribution cut. By the end of the month, they announced they had decided to cut their distribution by 45%. We continue to believe that the headwinds PAA is facing in its S&L business are unique to PAA, and no other midstream participant has a similar scale marketing presence that can meaningfully pressure their leverage and coverage levels. Furthermore, PAA still has one of the most exciting crude transport businesses servicing the growing Permian basin, which allows for it to guide to 15% growth in its fee-based businesses.

A Big Equity Offering

Fund constituent Energy Transfer Partners (NYSE: ETP) came to market with a $1 billion equity offering during the month, putting technical pressure on the whole space. While the deal came with sticker shock due to size alone, the offering priced at a modest 5% discount and has traded relatively well since. ETP had previously telegraphed its equity needs and this deal clears them out of the capital markets until the second half of 2018, removing an ongoing equity overhang from their ATM use.

Hurricane Harvey

Hurricane Harvey slammed into the Gulf Coast on Friday, August 25th, making landfall just east of Corpus Christi. Over the course of the next several days, the storm inundated the Gulf Coast with record rainfall, impacting operations of pipelines, refineries, export docks, petrochemical facilities, and other key energy infrastructure assets.

At this point we are not aware of any long-term damage sustained by any critical infrastructure assets operated by our Constituents. We do expect there to be short-term outages and market dislocations, which will hurt some companies and allow others to benefit, but we think the impacts will be transitory in nature. We would expect that even for our constituents that do have significant Gulf Coast exposure, aggregate Q3 results may be impacted by 2-5%, with no material long-term impacts.

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