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Midstream earnings may shrink amid producer restraint, Permian pipe competition

Essential Energy Insights - June 11, 2020

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Midstream earnings may shrink amid producer restraint, Permian pipe competition

Investors may welcome a potential decline in earnings for North American oil and gas pipeline companies as they release third-quarter financial results alongside slowing production.

While declining rig counts indicate the setup for midstream fundamentals heading into earnings "isn't great," according to CBRE Clarion Securities portfolio manager Hinds Howard, he and Raymond James & Associates Inc. financial adviser Justin Jenkins agree that unit holders are more focused on following independent oil and gas drillers in cutting spending to generate free cash flow.

"We suspect a modest earnings miss paired with a surprise to the downside on CapEx for 2020 will be well received by investors as lower spend in 2020 likely trumps earnings," UBS analysts wrote in an Oct. 13 note to clients.

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Most of the 11 major North American pipeline companies analyzed by S&P Global Market Intelligence should see year-over-year gains in adjusted EBITDA, according to analyst consensus. Only four firms, however, are expected to record revenue growth, as the Alerian Master Limited Partnership Index dipped 5% during the third quarter and the price of West Texas Intermediate crude oil slid 7.5% to settle at $54.07 per barrel on Sept. 30. Kinder Morgan Inc. missed that consensus and posted $1.83 billion in adjusted EBITDA when it kicked off the reporting period Oct. 16.

Energy Transfer LP, Enterprise Products Partners LP and Plains All American Pipeline LP — which outperformed during the second quarter in large part due to exposure to a Midland-Houston oil price spread that widened to nearly $9/bbl in the second quarter — are all likely to see revenues dip as that differential tightened significantly, according to the consensus. Analysts at energy investment bank Tudor Pickering Holt & Co. wrote in an Oct. 9 note to clients that those "outsized marketing opportunities and commodity margins have faded," while BMO Capital Markets called the Permian Basin's crude value chain "extremely fierce" and "hypercompetitive."

"In August, we saw both [Energy Transfer] and Epic Crude Holdings LP cut spot tariffs to market on their Permian crude pipelines, presumably to entice pipeline utilization," BMO analysts wrote in an Oct. 11 note to clients. "Last week, [Enterprise] announced another 450 million barrel-per-day pipeline ... which while supported by long-term producer contracts, only exacerbates potential tariff and return compression for the foreseeable future."

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The top five midstream companies' stock prices also fell during the third quarter, and Tudor Pickering Holt predicts that equity performance during earnings will depend on upstream providers' commentary.

Another key issue that could be a hot topic among management teams is that as the midstream sector continued to lose institutional funding, private equity seemed more hesitant to step in as a source of capital in the third quarter, especially as some investment firms struggled to unload assets.

"Interest from private equity appears to be waning after reported challenges with precedent midstream investments, as evidenced by [Occidental Petroleum Corp.'s] announcing its intent to hold onto its stake in [Western Midstream Partners LP] for now after shopping it around," Howard wrote in an Oct. 13 blog post.