One of the biggest questions surrounding MLPs is how interest rates and recent index declines will affect the future of oil and natural gas production and prices. This has led to confusion about the issues facing MLPs following the economic collapse in Greece, which led to a year-to-date Alerian MLP Index decline to 11 percent. This drop kept in line with recent declines as the Alerian Index has dropped over 25 percent since August 2014. However, these drops were felt across the market as comparative returns for stocks and bonds continued to fall over the last year. Although most importantly, despite the declines, MLPs have significantly outperformed other asset classes over the last 12 months, which is a reminder that there is tremendous value for investors in the midstream MLP sector.
MLPs continue to infrastructure build-outs
Despite some critics in the investment community calling it a bear market, midstream MLPs have reported high level returns in the first two quarters of 2015. Results, distribution outlooks and new project prospects continue to grow. In fact, with export-focused projects growing with the abundant supply of natural gas in North America, there is a clear demand for significant increases in infrastructure support to distribute oil and gas to the market.
Companies like Kinder Morgan Inc. now have a project backlog comprised of $18 billion in cap-ex across North America, and confirmed their previous guidance of 10 percent distribution growth for the next five years. Enterprise Product Partners has maintained its previous plans to spend $2.5 billion in new development this year with a reported project backlog of $7 billion in cap-ex for the next two to three years. Meanwhile, Plains All American Pipeline Partners re-confirmed plans to spend $9 billion through 2020 on crude oil infrastructure projects, with expected distribution growth around 7 percent. Similarly, Energy Transfer Partners just announced that the company will increase its scale in the Northeast with $1.5 billion cap-ex into new projects in the Marcellus region. Like most other high-performing MLPs in the midstream sector, ETP explained that the firm will continue to spend on new projects as the capital costs because they will be supported in the long-term by fee-based agreements. Ultimately, these are just some examples, but a common theme among these midstream partnerships is that while there is reason for caution in the short-term for oil and gas supply and demand fundamentals, MLPs expect long-term prices to trend higher as global demand will inevitably continue to grow in the next two years.
Supply outpacing demand
According to recent reports from the Department of Energy, Q3 of 2015 is expected to see a rise in demand for oil supply with a strong summer driving season. This is good value in the short-term as refineries work through their North American oil inventories. However, more excitingly is the fact that there is an emerging global shift in natural gas supplies, which places North America at the forefront of the next infrastructure boom. It is also a reminder to investors that MLPs have one of the most significant long-term prospects throughout alternative asset classes. In fact, a recent BP report found that there will be a significant rise in global demand for natural gas for the next 20 years. However, in order to meet this demand, U.S. shale gas production will need to grow to 4.5 percent on average per year till 2035. All told, BP expects demand to grow from 92 million barrels per day to 111 million barrels per day by 2035, with 50 percent of this increase in supply extracted and transported from North America.
Long-term value is a theme among MLPs
With the need for new midstream infrastructure in North America, MLPs have a positive outlook for yields over the next two decades. Particularly now with valuations lower following the 25 percent decline since 2014, MLPs are showing that they deserve a risk premium. Relative to other asset classes, spreads of MLPs have widened to historic levels compared to Treasuries, REITS, corporate bonds, and high yield bonds, making them extremely attractive for investors focused on the long-term. Compounding these spreads is the fact that the distribution yields of the Alerian MLP Index are currently 6.4 percent, but with oil and gas supply outpacing global demand for oil infrastructure projects at the moment, MLPs have the potential for very attractive total returns.