Midstream master limited partnerships (MLP) continue to struggle this year after a stark sell-off that occurred throughout 2015, which was the worst year for the sector in recent memory as concerns about revenue, contracts, counterparty credit risk and high expenses persisted.
Emily Hsieh, director of global operations for Alerian, which has five real-time MLP and energy infrastructure indices tracking about 120 MLPs, said the value of the sector fell 33% from the beginning of the year to the end. At the same time, the S&P 500 gained 1.5%, she said.
The downturn in oil and gas prices and the flagging producers tied to MLP revenue streams compounded investor concerns and helped accelerate last year's sell-off (see Daily GPI, Oct. 22, 2015). If anything, the situation is likely to get worse before it gets better, Hsieh told an audience on Thursday at Hart Energy's Marcellus-Utica Midstream conference in Pittsburgh.
"We're really entering into a new territory. You've got fears of China demand, [Exploration and Production] counterparty risk and people calling for $20 oil," she said. "So between the fundamentals and the technicals, at this point, really nothing is in line.
"MLPs, since December, have been down 20%, not to mention the volatility levels have really picked up," Hsieh added. "The index is swinging plus or minus five points in one day."
The MLP, which provides the tax benefits of a limited partnership and the liquidity of a publicly traded company, had become a bellwether for investors with its stable high yields generated through distributions from available cash flow. Billions of dollars have poured into the midstream MLP space in recent years, fueled by the rise of oil and natural gas production across the country.
Pulling from Alerian's data, Hsieh said in the 10 years prior to 2015, MLPs returned about 17% to investors, far exceeding similar investment classes such as utilities or real estate investment trusts (REIT), which returned about 11% and 10%, respectively. But since last year's sell-off, the 10-year total return growth has narrowed to about 8.7%
"Obviously we're still a little bit ahead of some of the other industries, but with the decline from last year as well as this year, you're effectively wiping out any of the gains MLPs have seen in the last five years."
To be sure, some of the sector's leading companies continue to perform well. It's a diverse space involved in gathering oil, gas and liquids, long-haul transportation, storage terminals, processing and refined petroleum products. And while no midstream MLP has yet eliminated its distributions, many have reduced their payouts significantly.
Hsieh said investors have started scrutinizing what MLPs own and what sort of contract structures -- fee-based, take-or-pay or minimum volume commitments -- they have. Investors are paying closer attention to customer diversity and where a company's assets are located.
Hsieh also said investors have readjusted to distribution growth of 3-4%, rather than the 6-7% that was common prior to last year's losses.
"MLPs are going to have to provide more clarity on counterparty risk," she said. "Gone are the days [when] they can put into their presentations, 'we have fee-based cash flows.' Really, what investors want to know is who their customers are, what their profile is and how long it will take before those contracts are renegotiated."
Hsieh said it will be imperative for MLPs to secure more financing, maintain distributions, address counterparty risks, which continue to cause the most uncertainty for the sector with the headwinds producers are facing, and better position their assets in attractive basins.
With commodity prices showing no signs of dramatically improving anytime soon, Hsieh said some operators would continue to fare better than others this year.
"The MLP market right now is very complex," she said. "There's going to be some clear winners and there's going to be some losers in 2016. This year is not going to be a pretty year. But at the end of the day, the energy industry is very resilient. The need for energy infrastructure is still there."