Master Limited Partnerships (“MLPs”) returned 4.74% during the month of December compared to +1.10% for the S&P 500. December produced a positive feel-good ending to an otherwise bleak year for midstream investors. Midstream companies benefitted from colder than normal temperatures across the country (especially the Northeast and Mid- continent), a sweeping tax overhaul, and an anecdotal reversal in tax loss-selling. We believe midstream companies are well-positioned going into 2018 with strong fundamental tailwinds and improved investor sentiment.
Cold Temperatures Cause Regional Gas Spikes
Cold weather throughout the month of December caused regional gas prices to spike which should benefit midstream operators in those areas once Q4 earnings are reported. High prices incentivize higher throughput if pipeline capacity exists to get molecules to demand centers. While benchmark Henry Hub prices (Gulf Coast) were actually down 3% on the month, closing at $2.95/Mbtu at month-end, cold temperatures in the Northeast and the Mid-continent caused prices to spike to levels last seen during the polar vortex in early 2014 – prices at the Boston/New England City Gate reached a high of $33.83/MBtu on December 26, 2017. Storage withdrawals started the month on a bearish note, but ramped up during the last 2 weeks ending the month with an 85 Bcf deficit versus the 5-year moving average. Storage withdrawals are expected to remain strong into early 2018 as colder than normal temperatures continue to deplete storage levels, a bullish near-term price indicator.
Tax Reform Beneficial to MLPs and C-Corps
After weeks of intense political debate and rhetoric the Trump administration managed to pass a sweeping tax overhaul that decreased the corporate tax rate from 35% to 21%, among other things. The “other things” were overshadowed and many investors lost sight of the fact that MLPs benefitted just as much as corporations from this reform. Broadly speaking, we expect significant benefits for most investors of MLPs or MLP investment funds structured as C-corps from the new tax code, including the 20% pass-through income deduction and the lowering of the corporate tax rate. For many direct MLP investors, the ultimate tax liability could be reduced by as much as 10%. While the lower corporate tax rate in the final version of the bill is a relative benefit to C-corps over MLPs, the MLP “rate advantage” is largely intact. The table to the left illustrates the effect of the tax reform on C-corps and MLPs (we are not tax professionals and our tax analysis should not be relied upon as investment advice).
Looking Ahead to 2018
As we close out the year we can say that the market pain experienced this year was disappointing and very frustrating. That said, we believe midstream companies are now in a better position to succeed over the long-term. All the while, the U.S. energy industry continues to present a tremendous opportunity for midstream infrastructure as we sit at or near record crude oil, natural gas and NGL production levels. The crash in commodity prices driven by robust US production has spurred new demand across the product value chain, a trend that continues to benefit midstream entities today. As we look ahead to 2018 we anticipate setting new records for production, transportation, and consumption of U.S. hydrocarbons globally, and we believe our companies today are better able to reap these rewards than they were at the start of 2017.
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