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The decade in midstream: Growth, a crash and the shrinking MLP universe


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The decade in midstream: Growth, a crash and the shrinking MLP universe

While booming oil and gas production drove a physical transformation in the U.S. pipeline industry over the past decade, midstream experts said the enormous infrastructure build-out on its own could not counter the structural headwinds the sector faced from growing financial challenges during those 10 years.

In 2009, according to the U.S. Energy Information Administration, the U.S. exported 1,072 Bcf of natural gas, major LNG import facilities were still coming online, and crude exports totaled just 524,000 barrels that year due to a federal law that only allowed shipments to Canada. Ten years later, the U.S. has six operating LNG export facilities and several pipelines that have already fueled over 3.3 Tcf of gas exports to dozens of countries from January through September of 2019. Meanwhile, crude shipments are on track to exceed the 75.3 million barrels recorded during the same period thanks to a 2015 vote by Congress to overturn the ban.

"The fact that the U.S. today is now a net energy exporter is frankly amazing. Nobody ever expected to see that day," Tortoise Capital Advisors LLC Managing Director Rob Thummel said in an interview, citing Cheniere Energy Inc.'s Sabine Pass LNG terminal and a slew of pipelines for transporting oil and gas from West Texas' Permian Basin to the Gulf Coast as "game-changing" projects for the midstream sector.

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A decade ago, the biggest midstream providers were still developing what would become massive pipeline networks. Thummel said that toward the end of 2009, Energy Transfer LP "did something nobody else had done, which is provide natural gas producers in the Barnett Shale with access to three or four different pricing points." According to the U.S. Pipeline and Hazardous Materials Safety Administration, the country added over 3,200 miles of gas transmission pipelines from 2011 through 2018 for a total of roughly 304,810 miles.

As construction exploded, so did pipeline companies' equity values. The top 10 U.S. midstream companies had a combined market cap of $100.8 billion at the end of 2009 versus $287 billion today.

Of the top U.S. midstream companies that existed at the end of 2009, however, only four of those names are still around due to an enormous wave of consolidation set in motion by collapsing commodity prices in 2014. That crisis revealed cracks in the popular master limited partnership model that prioritized high shareholder payouts and tapping capital markets, but once public capital closed its doors to the energy industry, pipeline partnerships had no choice but to decrease unit holders' take.

"The staggering 100-plus distribution cuts really opened investor eyes to how-not stable many of these companies were, and not just the small companies, but some of the biggest in the industry," CBRE Clarion Securities portfolio manager and MLP expert Hinds Howard said in an interview. "What we are seeing now is the aftermath of that shock and how challenging it will be to rebuild faith that these companies can be relied upon to prudently allocate capital going forward."

Dedicated midstream investors that had relied on steady income from MLPs for years fled the sector en masse, and the pool of institutions that took their place demanded those partnerships look and act more like corporations to balance their books and boost stock prices.

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There had already been momentum to at least simplify the MLP model — with Magellan Midstream Partners LP and Buckeye Partners LP eliminating required payouts to their general partners in 2009 and 2010, respectively — but the wave of consolidation that wiped out some of the largest pipeline partnerships began when Kinder Morgan Inc. folded Kinder Morgan Energy Partners LP, Kinder Morgan Management LLC and El Paso Pipeline Partners LP into Kinder Morgan Inc. in November 2014. That activity crested in 2018 after an unfavorable tax ruling from the Federal Energy Regulatory Commission, which prompted Williams Cos. Inc. and Enbridge Inc. to roll up their MLPs while other midstream partnerships elected to merge with their general partners and/or convert to C-corps.

Today, according to data compiled by CBRE's Howard, there are 30 midstream partnerships compared to the 34 that existed at the end of 2009. While the 87 energy MLP IPOs launched in the past 10 years stopped that gap from widening further, the Alerian index is down 60% on a price return basis from an Aug. 29, 2014, high as of market close on Dec. 19, 2019, as remaining partnerships face mounting pressure to get rid of incentive distribution rights and improve corporate governance.

"Ten years ago, MLPs traded at a premium to corporations because they traded on yield based on very high payout ratios. That and ready access to capital made MLPs able to offer the highest prices in M&A auctions, outbidding private equity or corporate buyers," Howard said. "That has flipped today, where MLPs yield 10% and are at a disadvantage relative to private equity and corporations for M&A opportunities."