Institutional Perspectives

Key Takeaways

• We continue to believe MLP stocks at current levels are attractive on an absolute and relative basis. 
• Delays in permitting new pipeline projects should become less of an issue in the Trump administration compared to the Obama administration.
• The global oil market is on course to move from oversupplied to undersupplied, and is why we continue to believe that incremental U.S. oil barrels are needed to avert a shortage of oil.
• MLP distribution growth should remain intact. We estimate infrastructure MLP stocks will deliver roughly 6% distribution growth in 2017 following roughly 3% growth in 2016.
  

We continue to believe MLP stocks at current levels are attractive on an absolute and relative basis. In contrast to utility and REIT stocks, MLP stocks continue to trade at valuation levels below historical averages.

The unexpected victory of Donald Trump in November’s presidential election initially boosted energy stocks, as a Trump presidency potentially has positive implications for MLP stocks over the next four years.

• Within days of Trump’s inauguration, he signed two executive orders clearing regulatory delays for two large pipeline projects - the Dakota Access Pipeline and Keystone XL.
• On February 28, in an address to Congress, President Trump outlined his vision of $1 trillion in infrastructure spending in the U.S. over the next 10 years - further bolstering the potential positive impacts of Trump’s presidency for MLP companies.
• Delays in permitting new pipeline projects should become less of an issue in the Trump administration compared to the Obama administration.
• Lead times to receive drilling well permits on U.S. federal lands increased during the Obama administration. A Trump presidency could see a more streamlined process for well permits, which could allow more development of federal lands, leading to increasing production and the need for incremental transportation infrastructure.

Trump campaigned on a vision of U.S. energy independence. He advocated increased drilling activity as a means to achieve this policy goal. An administration that encourages drilling activity will likely benefit energy MLP companies from the resultant need for transportation infrastructure.

Following 10 consecutive years of growth, U.S. energy production declined by roughly 2.5% in 2016. Yet, MLP companies were able to grow distributions by 3% in 2016 with acquisitions more than offsetting the slight decline in infrastructure throughput volumes. In 2017, we expect U.S energy production to rebound. Drilling rig counts are a leading indicator for production volumes. Crude oil rig count is up 128% since June 2016 and natural gas rig count is up 122% since August 2016. Since drilling activity began recovering in mid-2016, U.S. oil production has increased from a low of 8.4 million barrels per day to 9.3 million barrels per day. We expect drilling rig counts to continue increasing over the balance of 2017, and U.S. energy production should continue to rise along with the rig count. Primary areas of production growth should be the Permian Basin (Texas), SCOOP/STACK (Oklahoma), Eagle Ford (Texas) and Marcellus (Pennsylvania).

 

Exhibit 1: U.S. Oil and Gas Rig Counts

Source: Baker Hughes

 

The global oil market is on course to move from oversupplied to undersupplied. Global oil demand is expected to increase by 1.4 million barrels per day in 2017. OPEC is likely to cut output by roughly 1.5 million barrels per day throughout 2017 and non-OPEC production outside the U.S. is expected to be flat in 2017. This almost 3 million barrels per day tightening of supply/demand fundamentals is moving the oil market from oversupplied to undersupplied. This looming undersupply is a key reason oil prices have rebounded and is why we continue to believe that incremental U.S. oil barrels are needed to avert a shortage of oil.

OPEC’s recent action suggests a change in the organization’s strategy. Since OPEC was founded in 1960, the organization has managed production volumes (and resultant impact on oil prices) to maximize market share. OPEC’s recent actions to reduce output indicate an effort to maximize price - even if at the expense of market share. OPEC countries need at least $50 per barrel (and likely higher) oil prices to ensure economic stability in their countries. U.S. oil shale plays are economic at oil prices substantially lower than $50 per barrel. As a result, OPEC has realized they will lose market share over time to U.S. shale plays. OPEC is now acting to maximize the price of oil (and thus revenue) at the expense of market share. The initial public offering (IPO) of Saudi Aramco further incentivizes Saudi Arabia to ensure a high oil price to maximize pricing of the IPO. OPEC’s announced production cuts added roughly $10 per barrel to oil prices. Though its market share has been reduced, the production cut maximizes revenue for Saudi Arabia - positioning Saudi Aramco to receive a higher valuation when it goes public in 2018.

MLP distribution growth should remain intact. We estimate infrastructure MLP stocks will deliver roughly 6% distribution growth in 2017 following roughly 3% growth in 2016. Higher current yields, higher cash flow growth expectations, and lower valuations leave MLP stocks well positioned relative to utilities or REIT stocks, in our view.