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Big midstream stocks outperform peers, broader market in rebuilding year

The largest U.S. gas and oil pipeline companies have had a bounce-back 2016, outperforming their midstream peers and the benchmark S&P 500 but underperforming gas producers, which rallied back from a deeper trough.

A basket of the top 10 midstream companies and master limited partnerships by market capitalization, weighted equally, gained 27% when accounting for dividend distributions for the year through Dec. 27, according to S&P Global Market Intelligence data. During the same time, the 43-member Alerian MLP index, which tracks the energy master limited partnership sector, was up 19% on a total-value basis. The 61-member S&P Oil and Gas Production Index gained 41% for the year through Dec. 27.

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It was largely a rebuilding year for big midstream companies after energy prices plunged in 2015 and into early 2016, John England, Deloitte LLP's North America oil and gas leader, said in a Dec. 14 note. "The midstream segment largely stayed in a holding pattern in 2016 as upstream retrenchment reduced the need for new pipeline investment."

The list of top midstream companies includes Kinder Morgan Inc. and Williams Cos. Inc., which are not part of the MLP Index because they are organized as corporations. Kinder Morgan shares gained 42% through Dec. 27, and Williams shares gained 31%, pushing the top-10 index even higher.

"Equity values for midstream players suffered with the rest of the industry, especially after a bankruptcy court terminated a ... pipeline contract, thus setting off concerns about more widespread contract abrogation or renegotiation," England said.

The prospects for the coming year under a new White House administration appear brighter for the segment, but analysts' enthusiasm is tempered.

"With crude prices bottoming in early 2016, management teams faced a shift in market perception of distribution policy versus balance sheet fundamentals," Credit Suisse said in a Dec. 19 note. "Those that needed to cut or suspend growth did so in order to focus on reducing leverage and building coverage resulting median growth ~5%. Now that most houses appear to be in order, we expect distribution growth to increase, though to be conservative we continue to assume ~4-6% in 2017 over 2016."

"While we believe the new administration will be more accommodating towards midstream infrastructure investments, not all pending projects will be favorably impacted," Credit Suisse midstream analyst John Edwards said. "Projects which have faced executive pushback will likely be reexamined (Keystone XL) and/or built ([Dakota Access Pipeline]). Projects in which state regulators are the primary obstacle to completion (Constitution, Mariner East II) still face headwinds."

"Trump bump? Not necessarily for gas pipelines," Washington Analysis LLC analyst Rob Rains wrote Dec. 16. "We retain a mixed outlook for natural gas pipelines, particularly northeastern projects, due to the persistent tension between state and federal regulators, which we do not expect to be alleviated by the incoming Trump administration."

Barclays analyst Richard Gross reviewed midstream stock performance skeptically after the election, despite the green shoots of progress seen by others. "The [Alerian] continues to lag the energy complex post OPEC and the overall market post-election," Gross said Dec. 12. "This has occurred in spite of a litany of Energy infrastructure/MLP conferences delivering a message of recovery, select organic opportunity (Permian, SCOOP/STACK, etc.) and stabilization. It would appear this message is bit like preaching to the choir in that the ultimate source of funding (retail, pension plans, income funds) for the sector has not subscribed to the sermon."

In addition to corporates Kinder Morgan and Williams, the top-10 basket includes the MLPs Energy Transfer Partners LP, Williams Partners LP, MPLX LP, Enterprise Products Partners LP, Spectra Energy Partners LP, Plains All American Pipeline LP, Magellan Midstream Partners LP and ONEOK Partners LP.