LOGiQ MLP & Infrastructure Income Class

Transcription

1 September, 2017 LOGiQ MLP & Infrastructure Income Class OppenheimerFunds Insert last day of month Commentary For the third quarter of 2017, master limited partnerships (MLPs), as measured by the Alerian MLP Index (AMZ), were down 4.8% on a price basis and generated a 3.0% total return loss, or including the impact of distributions. As measured by the Alerian MLP Infrastructure Index (AMZI), a more concentrated measure of midstream MLPs, the sector lost 5.9% on a price basis and 4.2% on a total return basis. For context, the broader market, as measured by the S&P 500, gained 4.0% on a price basis and 4.5% on a total return basis. The price of crude oil continued to exert undue influence on midstream, or energy infrastructure, equities over the period. While midstream stocks were, on average, mostly flat over July and September, an August pullback in crude from $50 per barrel to $46 per barrel weighed heavily on midstream equities. Despite a full recovery in crude oil prices, midstream equities frustratingly remain below July levels. Hurricane Harvey produced an extraordinary amount of flooding midquarter, but little wind or storm surge related damage to midstream infrastructure, and thus only transitory disruptions with insignificant sustainable impact upon midstream operators. Midstream subsectors experienced variable performance over the reporting period. On average, the Propane and Marine subsectors provided the best performance over the quarter, each of which had underperformed year-to-date. Conversely, the Natural Gas Pipelines and Diversified subsectors generated the weakest returns after exhibiting outperformance earlier in the year. Second quarter midstream operating performance was reported during the period and was, on average, slightly below expectations with EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, coming in 0.7% lower than consensus estimates, 0.1% higher than the first quarter of 2017 and 10% higher than the year ago period. Midstream entities announced 30 distribution increases, one reduction, and 40 that were unchanged from the first quarter. Approximately $5.2 billion of new midstream equity was issued over the quarter via marketed transactions, including one initial public offering, and we estimate an additional $2.0 to $3.0 billion was issued through at-the-market programs in which primary units trade into the market anonymously throughout the normal trading day. We estimate MLP-focused investment vehicles, including closed-end funds, open-end funds and index-linked products, experienced approximately $1.5 billion of inflows over the quarter. This imbalance of visible equity supply and demand likely partially contributed to the sector s relatively weak performance over the period. See next page

2 MLP capital investment over the quarter included approximately $6.2 billion of announced asset acquisitions and we estimate $6 to $7 billion of organic capital spending. New midstream project opportunities to alleviate localized capacity constraints, meet demand from new industrial capacity, and to fulfill export demand remain abundant, particularly in premier basins such as the Permian, Midcontinent, and Appalachia as well as Gulf Coast port, refinery, and petrochemical facilities. West Texas Intermediate (WTI) crude oil priced at the Cushing hub ended the quarter at $51.67 per barrel, up 12% from the end of the second quarter and 7% higher than the year-ago period. The spread between Brent crude, a proxy for international crude prices, and WTI ended the quarter close to $6 per barrel, widening from recent normalized levels of $1 to $3 per barrel. While the Brent-WTI spread is wider than normal, it is similar in magnitude to the spread between crude oil priced along the U.S. Gulf Coast and WTI. Importantly, this inland differential provides an arbitrage opportunity for industry participants with midstream capacity from inland basins to the Gulf Coast and is supportive for midstream providers seeking to contract new capacity, principally from the Permian basin. Henry Hub natural gas spot prices ended the quarter at $2.89 per million British thermal units (MMbtu), down 2% from the end of the second quarter and 2% lower than the year ago period. Natural gas priced in certain areas of Appalachia continued to widen relative to benchmark pricing over the period as delays to the full start-up of the Rover pipeline has impacted available basin takeaway capacity amidst the seasonally weakest part of the year for Appalachian pricing. For example, natural gas pricing near Leidy, PA exited the quarter at approximately $0.76 per MMbtu, a 74% discount to Henry Hub. Natural gas prices in the Permian basin (Waha) also ended the quarter at a wider-than-normal basis spread highlighting the need for additional midstream capacity out of the basin. Natural gas liquids (NGL) priced at Mont Belvieu ended the quarter at $31.27 per barrel, up 36% from the end of the second quarter and 39% higher than the year-ago period. Propane and butane pricing exhibited the strongest performance, up 52% and 48% over the quarter, respectively, but price strength was visible in all of the purity products driven by export volumes and impacts from Hurricane Harvey related outages. Frac spreads, a measure of natural gas processing economics, strengthened substantially over the quarter to settle at $0.49 per gallon, up 71% from the end of the second quarter and 72% higher than the year-ago period. Generally, the greater the frac spread, the greater the incentive for producers to seek natural gas processing capacity. 1

3 The backwardated structure (in which future prices are lower than near-term prices) of the crude oil futures curve returned during the period as near term pricing rose sharply while longer-dated prices declined. The near-to-medium term backwardation of the natural gas futures curve held relatively firm over the period though longer-dated prices declined. Generally, for any commodity, a backwardated futures market acts to deter storage by removing the ability for traders to purchase and store the commodity today to sell at a higher hedged price in the future. Generally, providers of storage services prefer a contango market (in which future prices are higher than nearterm prices) and, therefore, market structure over the period shifted to being moderately negative for contracting available crude storage, while remaining generally unfavorable for longer-term natural gas storage. Please note, though we routinely review the pricing environments for the major energy commodities in our commentaries, we do so primarily to provide investors a more nuanced understanding of the broader energy markets. However, we choose to seek to exploit the logistical needs surrounding these products primarily through energy infrastructure MLPs that we believe are not overly exposed to changes in these prices. Over the quarter, the ten-year U.S. Treasury Bond yield increased by three basis points to end the period at 2.33%. The MLP yield spread at quarter-end, as measured by the implied yield of the AMZ index relative to the 10-year Treasury, widened by 33 basis points to 5.33%. The long-term average (2000-3Q2017) spread is 3.59%, which continues to suggest that 10-year treasury rates could increase materially before this spread approached its historical average. At period-end, the AMZ s indicated yield was 7.66%. Over the third quarter of 2017, REITs and utilities posted total returns of 0.9% and 3.2%, respectively, versus the AMZ s 3.0% loss. Price stability for these yield-oriented sectors likely reflects the unchanged interest rate environment over the period. Although MLPs are often associated with interest rates, given the yield-oriented return component, the energy market weakness over the period exerted a stronger influence on midstream equities. In observing the sector s underlying business drivers, we believe midstream operators are set to benefit from several tailwinds rather than headwinds. Out of the extreme energy industry turbulence that reflected the cyclical break in oil prices that began in late 2014, a new normal appears to have emerged. In this new-normal environment, crude oil prices are likely to stay significantly below pre-break levels but U.S. shale producers appear capable of delivering moderate production growth nonetheless. 2

4 As such, we see midstream assets benefiting from a durable period of volumes growth. Further, the massive, and expensive, build out of pipelines and other infrastructure needed to accommodate the new shale production basins also appears to be nearing completion. As a result, we believe many midstream operators sit in the enviable position of being able to flow growing volumes through existing assets rather than having to fund large capital spending budgets to build new capacity. Therefore, as the energy markets continue to normalize, the midstream sector appears poised to offer visible business growth at attractive valuations. 3Q17 Sector Commentary The MLP space, as measured by the Alerian MLP Index (AMZ), lagged crude oil prices during the quarter, with the AMZ ending the period down 4.8% while the West Texas Intermediate oil contract rose 10.5%. The decline in the AMZ can largely be attributed to the underperformance of a handful of large cap constituents (PAA, ETP, BPL), as the equal-weighted MLP universe was flat for the quarter. Outperformers Propane partnerships reversed last quarter s poor performance, outperforming the rest of the group in 2Q. The subsector s outperformance likely reflects investor value seeking in the oversold subsector in front of the onset of winter weather that can act as a catalyst to these weathersensitive businesses. Refining partnerships continued to perform well, following refining crack spreads which elevated above seasonal norms. Drawing inventories and weather-related logistical congestion were behind the move higher in refining profitability. Underperformers Petroleum Pipelines partnerships were the biggest underperformers during the period. Led by PAA s decision to further reduce the partnership s distribution, investors began to reduce exposure to several partnerships in the group that have perceived risk, particularly around balance sheet leverage and equity issuance needs. Natural Gas Pipelines partnerships were down for the quarter, although performance was mixed across the group. The negative group performance can be attributed to idiosyncratic factors for a couple of partnerships (ETP, BWP) and generalized investor aversion to any perceived risks. 3

5 Contributors CrossAmerica Partners, LP (CAPL) CAPL outperformed over the period following the closing of Alimentation Couche-Tard s acquisition of CAPL s general partner. The acquisition provides the potential for CAPL to distribute fuel to Couche-Tard s larger convenience store footprint MPLX, L.P. (MPLX) MPLX units outperformed over the period as the company and its sponsor, Marathon Petroleum (MPC), advanced their ongoing dropdown and incentive distribution rights ( IDR ) restructuring plan. Specifically, MPLX acquired a 25% interest in the Explorer Pipeline, a 35% interest in the Southern Access Extension Pipeline, and a 41% interest in the Louisiana Offshore Oil Port from MPC for $1.1 billion. MPC holds midstream assets with an additional $1 billion of annualized EBITDA that are expected to be dropped to MPLX during Targa Resources Corp. (NYSE: TRGP) TRGP shares outperformed over the period likely reflecting investor value hunting after underperforming earlier in the year and as the frac spread, a measure of natural gas processing economics, improved during the quarter. We believe TRGP s premier position in the Permian basin and Gulf Coast provides one of the best opportunity sets in the gathering and processing subsector. Detractors Genesis Energy, LP (GEL) GEL units underperformed over the period on negative investor sentiment related to the acquisition of the trona-based exploration and production businesses of Tronox Limited. Although the acquisition was accretive to distributable cash flow per unit and GEL s leverage, the assets acquired were not traditional midstream assets and not well understood by MLP investors. We expect improving sequential quarterly results as new projects recently placed into service demonstrate increased utilization and contribute to operating results. Additionally, the newly acquired trona business, while not a traditional midstream asset, brings a very stable margin profile that is expected to generate consistent future cash flows. 4

6 Energy Transfer Partners, L.P. (ETP) ETP underperformed over the period as market participants continue to adjust portfolio weightings following its merger with Sunoco Logistics and ahead of the partnership s reduced weighting in the AMZ resulting from Alerian s updated index methodology. ETP expects to target near term distribution growth in the low double digits while maintaining coverage in excess of 1.0x. With several multi-billion dollar projects expected to enter service in the latter half of 2017 and early 2018, we believe ETP is well positioned to deliver on its projections. Buckeye Pipeline Partners, LP (BPL) BPL underperformed over the period following the partnership s second quarter earnings call in which management guided to a softer near-term storage market. However, the partnership has a proven history of managing through storage cycles well and, any weakness is likely transitory. Further, during the quarter BPL issued over $200 million in equity through a private placement to alleviate equity financing needs through the first half of

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8 LOGiQ Capital 2016, LOGiQ Asset Management Ltd. and LOGiQ Capital Partners Inc. are subsidiaries of LOGiQ Asset Management Inc. (TSX:LGQ), collectively "LOGiQ". Forward-looking Statements: The information contained in this transcript may include estimates, projections and other "forward looking statements", which are generally expressed in the future tense, or using words such as "expect", "anticipate", "believe" or "may", whether or not they are expressly identified as forward looking statements. Any such statements pertaining to our investment products were based on assumptions that we believed to be reasonable at the time, but which may prove to be incorrect. As a result, any forward looking statements may prove to be incorrect and actual performance may differ materially from that predicted in any forward-looking statements. The information and material presented herein are for information purposes only and not to be used or construed as a public offering, an offer to sell or the solicitation of an offer to buy any securities, which may only be made pursuant to a prospectus or an exemption. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund and hedge fund investments. Please read the offering memorandum before investing. Indicated rates of return are the historical annual compounded total returns, including changes in share value and reinvestment of all dividends and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds and hedge funds are not guaranteed, their values change frequently and past performance may not be repeated. Comparisons to indices and other benchmarks are inherently unreliable indicators of future performance. The opinions expressed herein reflect those of the individual portfolio manager. These opinions are subject to change at any time based on market or other conditions, and LOGiQ disclaims any responsibility to update such views. These opinions may differ from those of other portfolio managers or of LOGiQ as a whole. These views are for informational purposes only and are not intended to be a forecast of future events, a guarantee of future results or investment advice. All data referenced herein are from sources deemed to be reliable but cannot be guaranteed. These views may not be relied upon as investment advice and, because investment decisions are based on numerous factors, may not be relied upon as an indication of trading intent on behalf of LOGiQ. If specific securities are referenced, they have been selected by the portfolio manager on an objective basis to illustrate the views expressed herein. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities. Referenced securities may not be representative of the portfolio manager's current or future investments and are subject to change at any time. 77 King Street W. 21st Floor Toronto, Ontario M5K 2A1 Toronto: Toll Free: logiqasset.com logiqasset.com