Midstream Energy: A Disconnect between Fundamentals and Prices

Published May 5, 2020

Global Chief Investment Officer

Last week’s “Behind the Markets” podcast focused on how fast we are going to reopen the economy and reasons to be optimistic about treatments for a potential second wave of the coronavirus. We also discussed disruption in the oil market and its impact on midstream energy companies with Brian Kessens, Senior Portfolio Manager at Tortoise Advisors, a firm that focuses on essential assets.

Kessens on the Oil Markets

The story I find particularly interesting is that pipeline fundamentals were supposed to be resilient when facing declines in oil prices, given their long-term futures contracts exposure and pricing that is not directly tied to spot prices.

Kessens believes we will see a rebound in oil in the third quarter and that the wells will not all come back online as quickly as they were shut down. For companies to ramp up production again, he believes we need higher prices to incentivize production.

He added that oil prices could very well go negative again in the next few weeks, referring to June futures contracts that expire later this month, as storage is still full.

Midstream Fundamentals Stronger than Expected

However, the fundamental case for midstream companies is that they are more insulated from oil prices than market prices have been implying.

Kessens estimates cash flows should be down anywhere from 5% to 20%, whereas by the end of March the whole sector was down 50%. There were some technical selling pressures in March that exacerbated the declines due to leverage components in the close-end fund space.

There have been some record spreads between midstream dividend levels and the 10-Year U.S. Treasury as well.

The average dividend yield in a number of master limited partnerships (MLPs) was over 10%, and Kessens believes the yield is stable but could actually grow another 2%. This dividend growth is lower than historical but still with a 10% average dividend yield likely pricing in the expectation of cuts. If we do see growth, this will be one of more interesting segments of the market.

This was a great discussion, and you can listen to it below:

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About the contributor

Jeremy Schwartz, CFA

Global Chief Investment Officer

Jeremy Schwartz has served as Global Chief Investment Officer since November 2021 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity Indexes, quantitative active strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree in May 2005 as a Senior Analyst, adding Deputy Director of Research to his responsibilities in February 2007. He served as Director of Research from October 2008 to October 2018 and as Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a head research assistant for Professor Jeremy Siegel and, in 2022, became his co-author on the sixth edition of the book Stocks for the Long Run. Jeremy is also co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” He received his B.S. in economics from The Wharton School of the University of Pennsylvania and hosts the Behind the Markets podcast. Jeremy is a member of the CFA Society of Philadelphia.

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