June, 2016 | By William Bunn
Fort Washington believes the time has returned for investors with patience and a long-term investment horizon to consider gaining or increasing exposure to midstream energy.
Our view is predicated on our risk/reward outlook for midstream securities, which are pricing in minimal or negative growth despite contracted volumes that provide visible growth opportunities. The broad-based and, in many cases, irrational selloff of midstream securities is overdone. Lastly, and critical to our outlook is that we see green shoots emerging within subsectors of midstream energy.
Opportunities that we want to highlight include, but are not limited to: capital market access, stronger pricing for natural gas liquids, and LNG (liquefied natural gas) exports.
We believe the most significant headwind facing the industry is continued weakness in crude oil prices, which has been driven by an oversupply. The conditions supporting the oversupply must be resolved prior to any normalization in prices. We anticipate the market will be well on its way to a resolution come late 2016 with equity volatility normalizing in the middle of the second half of 2016.
We are seeking to outperform the Alerian MLP Index (AMZ) while seeking attractive total returns. To this end we are wary of companies with significant exposure to coal, retail propane, or companies engaged in risky exploration or production activities. In contrast, we have been actively increasing our exposure in the refinery logistics space. In addition, we are moving more aggressively into marine transportation, seeking to capitalize on greater export opportunities. We are avoiding oversupplied crude tankers while focusing on exporters of LNGs and NGLs (natural gas liquids). Finally, we have been increasing our exposure to natural gas transportation companies with long-haul pipelines that link prolific supply basins with end markets. We are indifferent to corporate structure and are willing to invest across all the structures of midstream equities.
In summary, it is our view that the market appears to be testing a floor in midstream valuations. While there remains a significant risk of macro disruptions from OPEC, our view is that the risk-reward profile over the coming months favors owning midstream equities. Particularly given the ongoing OPEC negotiations for a production freeze, we believe market forces will have pushed supply and demand closer to an equilibrium by the end of the year. In our opinion, allocations should be made prior to an equilibrium being achieved and investors with a long-term horizon and ability to withstand market volatility on a long-term call should be prepared to make an allocation by year-end.
1 Ethane rejection occurs when ethane is left in the natural gas stream (i.e. not processed at a processing plant). This happens when the $/mmbtu price for ethane is lower than the price for natural gas and the natural gas stream can safely absorb the higher btu ethane. This creates a floor price for ethane.
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