Master Limited Partnerships (“MLPs”) returned +0.69% during the month compared to +2.06% for the S&P 500. The AMZ continued to bounce off its 2017 low made during August, supported by rising crude prices (+9%), some positive financing announcements (after some that weighed on the space in August), and the dissipation of some technical headwinds at the very end of the quarter related to methodology changes of the industry benchmark, the Alerian MLP Index.
Crude Price Support
Crude correlation ticked higher in September, with a correlation of 0.54 between prices changes in WTI and the AMZ. WTI crude prices were up 9.41% on the month, crossing the $50 mark for multiple days in a month for the first time since May, and the AMZ level may have increased as a result of this crude strength. Crude correlation for 2017 YTD remains at 0.57 (as of 9/30/2017).
We have discussed our thoughts on crude correlation before, but we do believe that at some point the midstream industry will enter a new paradigm, one in which production growth (for all commodities) drives performance instead of crude prices. We expect the cash flow growth from production growth to materialize, which could have the added effect of lowering cash flow multiples, making the space attractive to new capital and potentially increasing fund flows.
Hurricanes Harvey, Irma, and Maria
Since we had written our August monthly, the fallout from Hurricane Harvey and subsequent damage from Irma and Maria has been made a little clearer. Importantly, our constituents have maintained that they have not sustained any long-term damage to critical infrastructure. As it relates to Harvey, we believe most of the impact will be felt by gatherers & processors in the Eagle Ford and by some downstream pipelines / NGL storage near Mont Belvieu and Cedar Bayou. There are some petrochemical facilities that experienced brief downtime as a result of Harvey, with only one that we know of continuing to be offline.
With respect to Irma and Maria, we similarly expect any impacts to Floridian and Caribbean infrastructure to be minimal and transitory and only specific to a few names. We continue to expect that aggregate Q3 results may be impacted by 2- 5%, with no material long-term impacts. Please see our press release issued 8/30/2017 for more information.
Positive Capital Markets News, Including The Elimination of Some Overhangs
In terms of capital financing and corporate finance announcements, September stood in stark contrast to August. While August brought the $1.0B ETP overnight offering and the announcement of PAA’s balance sheet improvement measures, both negatively impacting the space, September’s financing announcement struck a decidedly more optimistic tone.
The monthly highlight, in our view, was PSXP’s drop-down and simultaneous financing announcement. After having numerous meetings with PSXP management over the past 2 years in which we stressed the importance of securing financing ahead of a drop-down announcement and coming out with a “positive roll-out” / messaging, the partnership did just that. On 9/22/17, PSXP announced a $2.4B drop-down of certain assets at an in-line market multiple, having already secured common preferred unit financing. Importantly, parent PSX also took back common units as part of the transaction. The messaging surrounding the deal was excellent—not only did this transaction fix a clear overhang in PSXP’s units, but management even articulated that they would not need to access the overnight equity markets until 2019.
PSXP wasn’t the only name with a splashy financing announcement during the quarter; both BPL and SHLX announced direct offerings to dedicated midstream players during the quarter; the debt markets continued to stay open as three midstream players issued notes with good coupons, and; Fund constituent ENLK issued preferred units with a coupon more than 300 bps inside of the distribution rate of its common. We think these deals show flexibility midstream entities have to raise capital critical for important growth projects, and they have the added effect of alleviating some near-term capital markets concerns.
Alerian Methodology Changes
We think suspected changes to the AMZ’s weightings methodology may have been weighing on midstream equities for a while now. Trading desks across the space made it clear that some funds had been preparing for a multitude of different potential changes taking place, including: a cap of index weights to something less than 20%; inclusion of C-corps, and; inclusion of general partners, among other things.
Near the end of the quarter, on 9/28/17, the AMZ announced a couple of the changes it would formally announce the next day (announced a day early due to market rumors), including: capping weights for the AMZ at a 10% weighting (EPD the most impacted name given its current 20% weighting), and not including C-corps. We think some hedge funds / fast money had shifted capital expecting certain outcomes around the methodology changes, and we expect the alleviation of this headwind finally to mitigate volatility for a few specific names.
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