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Investors may come back to midstream in 2018, analyst says

After a rocky past couple of years for the midstream energy sector, investors may be warming back up to the idea of investing in oil and gas pipeline companies in 2018, a Dec. 15 analyst report said.

"During our recent marketing meetings, we [detected] a gradual shift from negative to a more positive outlook for the midstream sector," Brian Zarahn, managing director for Mizuho Securities USA LLC's Americas research, said in a note on midstream investor sentiment for 2018.

"With some of the underperformance drivers largely behind us … and a favorable fundamental energy outlook, … we believe increased investor interest in the midstream sector will help drive improved energy infrastructure sector performance in 2018," he said.

Zarahn sees midstream companies benefiting from rising crude oil, natural gas and natural gas liquids production, paired with rising exports and more midstream project opportunities. These factors should support a recovery for a number of the sector's companies, he said. A substantial drop in commodity prices in recent years cut into some midstream operators' earnings.

The U.S. Energy Information Administration has projected that gas prices would rise in 2018, even with continued increases in production, because of demand. The EIA also projected U.S. gross exports to exceed 10 Bcf/d in 2018, which would be a 56% increase compared to 2016.

Commodity price increases are not necessarily a predictor of how midstream master limited partnerships will perform, though, Zarahn noted. The Alerian MLP index has splintered off from crude oil prices in the latter half of 2017. As WTI oil prices trended upward, the Alerian fell.

Heading into 2018, investors are keeping close watch on the impacts of potential tax code changes on the midstream segment, where the effects are expected to be mixed, according to the note. MLPs may lose some of the cost of capital advantage relative to C-corps, while C-corps could also be negatively impacted by tax code revisions, Zarahn wrote. Lower corporate tax rates could translate to lower pipeline rates, which may be a negative for gas pipeline operators, he explained.

Investors also are watching corporate structures, asking "which companies [will be] next to eliminate the complex general partner incentive distribution rights structure," the note said. Companies such as Andeavor Logistics LP that have eliminated incentive distribution rights, the payments a partnership makes to its general partner, have fared better in the marketplace. Mizuho expects Shell Midstream Partners LP and Phillips 66 Partners LP may come under pressure to come up with a plan for how to manage the growing cost of capital associated with their incentive distribution rights. Mizuho also sees the Energy Transfer Equity LP and Energy Transfer Partners LP family simplifying its corporate structure, although not until 2019.

"We believe the newfound interest stems from a view that the lagging energy sector (supported by $55+ oil price) could outperform the broader market which is at an all-time high," Zarahn said.