ENERGY TEAM QUARTERLY REPORT

Transcription

1 ENERGY TEAM QUARTERLY REPORT May 5, 2016 PROFITABLE RISKS / UNPROFITABLE RISKS SM Loss avoidance is a key to long term investment success. We deem certain risks profitable, to be exploited with sound research, while other risks are inherently unprofitable and should be avoided. Introduction The quarter began badly for MLP investors who bore a pummeling alongside investors in energy commodities and broader equities in the first few weeks of the year. Benchmark crude prices broke below $30, having broken below $40 in the previous quarter, as global oil production continued to outpace demand. MLPs continued to trade in sympathy including those in the supposedly less commodity-sensitive infrastructure space. In mid-february, however, the trends reversed and MLPs bounced in a strong recovery to end the quarter down only 5.65% (as measured by our benchmark, the Alerian MLP Infrastructure Index). At the same time, because lower quality, higher leveraged names tended to benefit more strongly from the rebound, our outperformance which at one point was tracking into the hundreds of basis points for the quarter, eroded to a much more modest number by quarter end. With mixed news about supply and demand for energy products through the quarter, we expect further volatility in the commodity prices. However, with earnings of infrastructure companies continuing to show resilience, we believe valuations in the MLP space look extremely attractive. With mixed news about supply and demand for energy products through the quarter, we expect further volatility in the commodity prices. However, with earnings of infrastructure companies continuing to show resilience, we believe valuations in the MLP space look extremely attractive. The Quarter in Review In a quarter with markedly different market tones throughout, there were a number of issues to monitor. Among those that had the attention of the Capital One Asset Management Energy Team: Export Markets: As we noted in the last quarterly report, the U.S. lifted its decades-old ban on most crude oil exports in December 2015, leading to a rush among producers for pride of making the first export of domestic crude. That prize went to NuStar Energy and ConocoPhillips with a shipment made from Corpus Christi, TX on December 31 of last year. However, as important as crude oil is in the global economy, it s not the only product that matters. The U.S. reached two additional milestones for its burgeoning export industry in the first quarter, hard on the heels of the first crude export. The first was long-heralded and much anticipated. After a few delays, Cheniere Energy made its first export of liquefied natural gas (LNG) from its terminal on the Sabine Pass in Louisiana. This facility was the first-tomarket of a wave of proposals for LNG export facilities made when differentials between U.S. and certain international natural gas prices were very wide. Those differentials have since narrowed significantly due t May 5, 2016 QUARTERLY REPORT 1

2 Some readers may recall that we held Cheniere Energy Partners LP (CQP) at one point and sold it due to concerns about manage- ment and some pricing and compensation issues. There was a management change in December 2015 and, with this successful export, we are re-evaluating the position, though still concerned about overall conditions in the LNG market. to a number of factors, including softening demand and increased export capabilities from Australia, New Zealand and elsewhere. Cheniere has long-term contracts for much of its current export volumes, and market conditions are likely to improve with the global economy, but at least in the intermediate term the environment looks less bright for LNG export than only a couple of years ago. Some readers may recall that we held Cheniere Energy Partners LP (CQP) at one point and sold it due to concerns about management and some pricing and compensation issues. There was a management change in December 2015 and, with this successful export, we are re-evaluating the position, though still concerned about overall conditions in the LNG market. The second, somewhat more obscure milestone occurred only a couple of weeks later. On March 9 (again after a few delays), Sunoco Logistics Partners LP (SXL) made the first seaborne export of U.S. ethane from its terminal at Marcus Hook, PA. Ethane is the lightest of the natural gas liquids and is notably useful in the petrochemical industry. However, thanks to the spike in U.S. production brought about by the shale revolution, domestic supply far exceeded demand and much ethane that was produced was rejected generally meaning it was left as part of the natural gas stream being delivered rather than separated out for higher-value use. This ethane shipment (bound for Norway) paves the way for new markets in Europe, India and elsewhere. It is worth noting that as of March 31, 2016, SXL represented over 5% of our model portfolio, at an overweight to the benchmark. All this comes in the wake of substantial growth in the export of other hydrocarbons like propane and butane over the past 3 years. With the recent expansion of the Panama Canal allowing larger ships to move easily from the U.S. Gulf Coast to consumers along the Pacific Rim, the full range of liquid exports looks to be an important story in the future of U.S. energy infrastructure. Corporate Earnings: As we have said previously, we are somewhat taken aback by the degree to which infrastructure MLP prices even those of operations with theoretically limited commodity exposure have tracked crude oil prices down over the past couple of years. MLP price strength and weakness seems to have been tied lockstep with crude prices. In some cases, we believe investors are simply abandoning anything that seems to be tied to the energy sector, but there are some reasonable concerns regarding the effect of lower commodity prices on the infrastructure sector. Lower prices lead to lower production, leading to lower volumes through pipes and lower fees over time to infrastructure comresults May 5, 2016 QUARTERLY REPORT 2

3 Infrastructure companies, as was much spotlighted in happier days, tend to work under longterm contracts, some of which require payments even if a producer doesn t use the allotted capacity. Moreover, while lower prices may shift preferred sources of raw commodities toward overseas suppliers, the demand for hydrocarbons in the U.S. is quite inelastic and the pipes and storage facilities that take refined products to the final consumer remain as robustly used as ever. companies. Nonetheless, we believe the business results are supporting the case that MLPs are resilient to lower commodity prices. To be sure, earnings have trended lower since the price declines in crude began a couple of years ago, and growth projects from infrastructure firms have slowed. Earnings, though, have far from collapsed and first quarter earnings for the Alerian MLP Infrastructure Index showed strength versus the prior quarter. In short, the infrastructure industry taken as a whole remains profitable. This is not surprising. Infrastructure companies, as was much spotlighted in happier days, tend to work under long-term contracts, some of which require payments even if a producer doesn t use the allotted capacity. Moreover, while lower prices may shift preferred sources of raw commodities toward overseas suppliers, the demand for hydrocarbons in the U.S. is quite inelastic and the pipes and storage facilities that take refined products to the final consumer remain as robustly used as ever. We believe our focus on demand-pull rather than supply-push assets has been beneficial in this regard. Mounting Leverage: We have long emphasized ensuring that the companies in which we invest operate with a margin of financial safety. We prefer companies who comfortably cover their current distributions (and, absent that, have a clear path to reaching that goal). We also look carefully at the structure and level of the company s debt (and views from ratings agencies and the market about its creditworthiness). Firms with less distribution coverage and more debt face more stress and have fewer options in a difficult energy market or when access to capital markets slows or halts as it did in the financial crisis of While we are still able to identify partnerships that we believe have strong financials (and, in many cases, are backed by an even stronger sponsors), the overall indebtedness of the companies in the Alerian MLP Infrastructure Index is on the rise. Various metrics including debt-per-unit and debt-to-earnings have been climbing and in many cases are at historically high levels. Of course, impaired earnings help contribute to that trend as does a natural tendency of companies to favor debt financing when equity interests go too cheaply in the market. Nonetheless, the trend is a disturbing one and we are watching carefully to ensure that companies in our portfolio don t reach too far. Production and Supply: The imbalance in crude and other energy markets continues to drive results in both the commodities and the related stocks and partnerships. Developments during the quarter were mixed in this regard, but offered little hope for a rapid improvement. Although Saudi Arabia, Russia, Venezuela and Qatar reached preliminary agreement on a production growth freeze in February, the agreement appeared to have broken down by quarter's end in anticipation of a broader appearedn May 5, 2016 QUARTERLY REPORT 3

4 U.S. production also showed surprising resilience early in the quarter, but dropped from about 9.2MM barrels per day at the outset to just over 9MM barrels per day by quarter s end, offering at least one point where lower prices were driving lower production, the natural corrective to low prices. broader meeting at Doha in April (which we now know failed to reach agreement). U.S. production also showed surprising resilience early in the quarter, but dropped from about 9.2MM barrels per day at the outset to just over 9MM barrels per day by quarter s end, offering at least one point where lower prices were driving lower production, the natural corrective to low prices. Economic growth globally, however, was anemic throughout the quarter, offering little prospect of relief on the demand side. Activity We took advantage of low prices in mid-february to add to 3 positions we already held Energy Transfer Equity LP (ETE), Kinder Morgan Inc. (KMI) and Spectra Energy (SEP). We felt that the market had greatly undervalued the long-term quality assets of these companies. This allowed us to put some available cash to work at an attractive entry point. Performance Our gross composite return for the quarter was -5.30%, putting us slightly ahead of the -5.65% return on our primary benchmark, the Alerian MLP Infrastructure index. Our secondary benchmark, the broader Alerian MLP Index returned -4.2%, leaving us well behind. The best 5 and worse 5 performers in the portfolio are noted in the table. In terms of relative performance versus our primary benchmark, we accrued most benefit by not owning Enbridge Energy Partners LP (EEP) and by owning MLPX LP (MLPX) and Kinder Morgan Inc (KMI). We were most hurt by our position in two companies in the middle of a troubled merger Energy Transfer Equity (ETE) and Williams Partners LP (WPZ). We were also hurt by not owning ONEOK Partners LP (OKS). Source: FactSet Research Systems, Inc. 04/30/16 Outlook We remain cautiously optimistic in the space. There are significant near-term risks of volatility from both commodity price movements and headline risks from bankruptcies on the production side or distribution cuts within the infrastructure space itself. However, the assets appear notably undervalued at the moment and we have some hope that a few quarters of reasonable earnings from the midstream will reassure investors and allow valuations to recover. May 5, 2016 QUARTERLY REPORT 4

5 Contact Information To learn more, contact your local Private Banking and Wealth Management Specialist. Long Island: Alan Cohen Mid-Atlantic: Jeff Hearle Sherry Koontz Louisiana: Richard Bouchner Henriette Harris New Jersey: Ken Iselhart New York: Lauren Kramer Texas: Joel Diaz Patrick Doyle MLP INFRASTRUCTURE STRATEGY MLP Infrastructures Latest 3 Months For Period Ended March 31, 2016 Year To Date Latest 1 Year Since Inception: 2/28/2014 MLP Infrastructure - Gross of Fees -5.30% -5.30% % % MLP Infrastructure - Net of Fees -5.52% -5.52% % % Alerian MLP Infrastructure Index -5.65% -5.65% % % Capital One Asset Management, LLC ( COAM ) is a wholly owned subsidiary of Capital One, N.A., which itself, is a wholly owned subsidiary of Capital One Financial Corporation and is a registered investment advisor. MLP Infrastructure Strategy - contains fully discretionary SMA accounts with an objective of MLP Infrastructure and for comparison purposes is measured against the Alerian MLP Infrastructure Index. Strategy focuses on those MLPs that are positioned in the midstream infrastructure part of the energy production chain; entities that own and operate the pipelines, tanks and other assets facilitate the movement and processing of oil, natural gas, and related products from the wellhead to the refiners and on to the end user. The team further narrows this universe to those companies that have assets and business strategies they believe most likely to provide stable, growing cash flows to their investors. The team then constructs a concentrated portfolio based on their view of the valuation of the candidate companies and their desire to diversify the portfolio by a variety of factors including geography and business lines. By bringing together professionals with investment management and energy backgrounds, the team examines the portfolio and its component partnerships through a range of perspectives to provide our investors with a thoughtful, high-conviction portfolio. The Alerian MLP Infrastructure Index, comprised of 25 energy infrastructure Master Limited Partnerships ( MLPs ), is a liquid, midstream-focused subset of the Alerian MLP Index (NYSE: AMZ). The index, whose constituents earn the majority of their cash flow from the transportation, storage, and processing of energy commodities, provides investors with an unbiased benchmark for the infrastructure component of this emerging asset class. The MLP Infrastructure Strategy composite was created April 30, The U.S. Dollar is the currency used to express performance. Gross of Fees returns are presented gross of management fees and include the reinvestment of all income. Net of fees returns are reduced by a bundled fee which includes investment advisory, custody and administrative fees. Net of fees returns are calculated by deducting actual fees paid by member accounts in the Strategy. For period 7/1/2014-3/31/2016 net of fees returns are calculated by subtracting 0.85% annually, which is the highest fee applicable to this strategy. Capital One Asset Management, LLC claims compliance with the Global Investment Performance Standards: (GIPS ). Past performance is not indicative of future results. To receive a complete list and description of Capital One Asset Management, LLC Strategies and/or a Presentation that adheres to the GIPS standards, contact us toll free at , Or write Capital One Asset Management, LLC 299 Park Avenue, 31st Floor, New York, NY 10171, Or gipscompliance@capitalone.com. May 5, 2016 QUARTERLY REPORT 5

6 MLP INFRASTRUCTURE STRATEGY Composite Composite % Portfolios Total Firm Composite Year Composite Alerian MLP Number of Composite Benchmark Gross Of Internal with Bundled Assets Assets End Net Of Fees Infrastructure Accounts 3-yr Std Dev 3-yr Std Dev Fees Dispersion Fees (millions) (millions) % % % % N/R* N/R* 100% $ 3, $ * 10.78% 9.81% 8.18% <6 N/A N/R* N/R* 100% $ 3, $ 1.17 * Full year performance is not available due to composite inception on 2/28/2014; N/A - Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the full year; N/R* - 3 year standard deviation is not available due to less than 3 years of composite history at yearend. CAPITAL ONE ASSET MANAGEMENT, LLC ANNUAL DISCLOSURE PRESENTATION MLP INFRASTRUCTURE STRATEGY MLP Infrastructure Strategy - contains fully discretionary SMA accounts with an objective of MLP Infrastructure and for comparison purposes is measured against the Alerian MLP Infrastructure Index. Strategy focuses on those MLPs that are positioned in the midstream infrastructure part of the energy production chain; entities that own and operate the pipelines, tanks and other assets facilitate the movement and processing of oil, natural gas, and related products from the wellhead to the refiners and on to the end user. The team further narrows this universe to those companies have assets and business strategies they believe most likely to provide stable, growing cash flows to their investors. The team then constructs a concentrated portfolio based on their view of the valuation of the candidate companies and their desire to diversify the portfolio by a variety of factors including geography and business lines. By bringing together professionals with investment management and energy backgrounds, the team examines the portfolio and its component partnerships through a range of perspectives to provide our investors with a thoughtful, high-conviction portfolio. The Alerian MLP Infrastructure Index, comprised of 25 energy infrastructure Master Limited Partnerships ( MLPs ), is a liquid, midstream-focused subset of the Alerian MLP Index (NYSE: AMZ). The index, whose constituents earn the majority of their cash flow from the transportation, storage, and processing of energy commodities, provides investors with an unbiased benchmark for the infrastructure component of this emerging asset class. The MLP Infrastructure Strategy composite was created April 30, Capital One Asset Management, LLC claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Capital One Asset Management, LLC has been independently verified for the periods 12/31/ /31/2014. The verification report(s) is/are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firmwide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. Capital One Asset Management, LLC ( COAM ) is a wholly owned subsidiary of Capital One, N.A. (the Bank ), which itself, is a wholly owned subsidiary of Capital One Financial Corporation. COAM registered with the SEC in 2001 as a Registered Investment Adviser as a Separately Identifiable Division or Department ( SIDD ). In 2005 COAM changed its registration to a wholly owned subsidiary when it filed with the State of Louisiana as a Limited Liability Company. Assets under management include accounts of high net worth individuals, trusts and estates, corporations, foundations and endowments managed by Capital One Asset Management, LLC. Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Past performance is not indicative of future results. Returns are presented gross and net of fees and include the reinvestment of all income. Actual returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. The collection of fees produces a compounding effect on the total rate of return net of management fees. Net of fees returns are reduced by a bundled fee which includes investment advisory, custody and administrative fees. Net of fees returns are calculated by deducting actual fees paid by member accounts in the composite. For period 7/1/ /31/2015 net of fees returns are calculated by subtracting 0.85% annually, which is the highest fee applicable to this strategy. The current bundled fee schedule for the composite is 0.85% on the first $5 Million, 0.70% on the next $5 Million, 0.45% over $10 Million. Minimum annual fee is $4,250. Members of this composite that are managed by a sub-adviser selected by COAM are subject to an additional fee between 30 and up to 100 basis points, deducted monthly. Actual investment advisory fees incurred by clients may vary. The U.S. Dollar is the currency used to express performance. The policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. Starting 1/1/2014 internal dispersion is calculated using the equal-weighted standard deviation of all accounts that were included in the composite for a full year. Prior to 1/1/2014 internal dispersion is calculated using the asset-weighted standard deviation. The firm maintains a complete list and description of composites, which is available upon request. The minimum market value for inclusion in the composite is $50,000. May 5, 2016 QUARTERLY REPORT 6

7 Disclosures For informational purposes only. Neither the information nor any opinion expressed in this material constitutes an offer to buy or sell any security or instrument or participate in any particular trading strategy. Capital One, N.A., its affiliates and subsidiaries are not providing or offering to provide personalized investment advice through this communication, or recommending an action to you. Capital One, N.A., its affiliates and subsidiaries are not acting as an advisor to you and do not owe a fiduciary duty to you with respect to the information and material contained in this communication. This communication is not intended as tax or legal advice; consult with any and all internal or external advisors and experts that you deem appropriate before acting on this information or material. Wealth and Asset Management products and services are offered by Capital One, N.A. or one of its affiliates or subsidiaries. Investment management services are provided by Capital One Asset Management, LLC (COAM), a SEC registered investment advisor and wholly-owned subsidiary of Capital One, N.A Capital One. Capital One is a federally registered service mark. All rights reserved. Wealth and Asset Management products and services are offered by Capital One, N.A. ( Bank ). All investment management clients are clients of the Bank, who has delegated the investment management services to Capital One Asset Management (COAM) via a master services agreement. Investment management services provided by Capital One Asset Management, LLC, a SEC registered investment advisor and wholly-owned subsidiary of Capital One, N.A Capital One. All rights reserved. COAM registered with the SEC in 2001 as a Registered Investment Adviser as a Separately Identifiable Division or Department ( SIDD ). In 2005, COAM changed its registration to a wholly owned subsidiary when it filed with the State of Louisiana as a Limited Liability Company. Please refer to COAM s ADV Part 2, which is available upon request, for additional information on the Adviser. Recipients of this report will not be treated as a client by virtue of having received this report. No part of this report may be redistributed to others or replicated in any form without the prior consent of Capital One. All charts and graphs are shown for illustrative purposes only. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The information has been obtained from sources believed to be reliable but we do notwarrant its completeness, timeliness, or accuracy, except with respect to any disclosures relative to Capital One. The information contained herein is as of the date referenced, and we do not undertake any obligation to update such information. Any opinions and recommendations expressed herein do not take into account an investor s financial circumstances, investment objectives, or financial needs and are not intended for advice regarding or recommendations of particular investments and/or trading strategies, including investments that reference a particular derivative index or benchmark. Past performance is not indicative of future results. The securities described herein may be complex, may involve significant risk and volatility, may involve the complete loss of principal, and may only be appropriate for highly sophisticated investors who are capable of understanding and assuming the risks involved. The securities discussed may fluctuate in price or value and could be adversely affected by changes in interest rates, exchange rates, or other factors. Asset allocation and diversification do not assure or guarantee better performance, and cannot eliminate the risk of investment losses. Investors must make their own decisions regarding any securities or financial instruments mentioned or discussed herein, and must not rely upon this report in evaluating the merits of investing in any instruments or pursuing investment strategies described herein. In no event should Capital One be liable for any use by any party, or for any decision made or action taken by any party in reliance upon, or for any inaccuracies or errors in, or for any omissions from, the information contained herein. For any selfdirected IRA account that may hold a hard-to-value asset as determined by Wealth &!sset Management ( W!M ), the IR! owner must provide W!M with an annual independent third party valuation of the asset from someone qualified to perform the valuation. If the IRA owner fails to timely provide such valuation, the Bank reserves the right to assess the IRA for the cost and expense of the valuation in order to fulfill IRS reporting requirements. The U.S. Dollar is the currency used to express performance. Returns are presented gross of management fees and include the reinvestment of all income. Actual returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. The collection of fees produces a compounding effect on the total rate of return net of management fees. As an example, the effect of investment management fees on the total value of a client s portfolio assuming (a) quarterly fee assessment, (b) $1,000,000 investment, (c) portfolio return of 8% a year, and (d) 1.00% annual investment advisory fee would be $10,416 in the first year, and cumulative effects of $59,816 over five years and $143,430 over ten years. Additional information regarding the policies for calculating and reporting returns is available upon request. Complete disclosures regarding the firm's services and fees is available in form ADV Part 2 and can be obtained upon request. Investments in MLPs may involve risks greater than or different from an investment in common stock or other equity investments. For example, the general partners of MLPs may have conflicts of interest which may permit the general partner to favor its own interests over the interests of the MLP. Investments in energy infrastructure companies may be adversely affected by changes in energy prices, exploration, production spending, government regulation, changes in exchange rates and depletion of natural resources. MLPs are generally treated as partnerships for federal income tax purposes and therefore have no federal income tax liability at the entity level. Treatment of an MLP as a corporation for federal income tax purposes could adversely affect the value of an investment in an MLP and the amount of income it is able to distribute. The COAM Infrastructure MLP and Energy Income portfolios are available through Separately Managed Accounts structures and are not mutual funds or exchange traded products. MLP investors do not generally receive the same fundamental protections owed to shareholders of corporations or traditional partners. Of particular note, as limited partners, MLP unit holders typically have no right to vote in governance and other decisions. To receive a complete list and description of Capital One Asset Management, LLC Strategies and/or a Presentation that adheres to the GIPS standards, contact us toll free at , Or write Capital One Asset Management, LLC 280 Park Avenue, 23rd Floor, New York, NY 10017, Or gipscompliance@capitalone.com. Capital One, N.A. is not recommending an action to you as the municipal entity or obligated person; Capital One, N.A. is not acting as an advisor to you and does not owe any duty pursuant to Section 15B of the Exchange Act to you with respect to the information and material contained in this communication; Capital One, N.A. is acting for its own interests; [and] you should discuss any information and material contained in this communication with any and all internal or external advisors and experts that you deem appropriate before acting on this information or material. As of 07/27/15, the top 10 holdings in the Capital One Asset Management Energy MLP Strategy are: Enterprise Products Partners L.P., Williams Partners, L.P., Plains All American Pipeline, L.P., Magellan Midstream Partners, L.P., Energy Transfer Equity, L.P., Buckeye Partners, L.P., Sunoco Logistics Partners, L.P., EQT Midstream Partners, L.P., Tesoro Logistics L.P., Kinder Morgan Inc Class, L.P., and Valero Energy Partners, L.P. are subject to change and are not recommendations to buy or sell any security. Current and future holdings are subject to risk. This is only an opinion and not a prediction or promise of events to come. Not FDIC Insured Not Bank Guaranteed May Lose Value No part of this document Not a Deposit may be reproduced Not in Insured any manner by any Federal without Government written permission Agency from Capital One s Wealth and Asset May 5, 2016 QUARTERLY REPORT 7