It is a paradox of the energy business today that U.S. oil and gas production is at record levels but the business of piping the stuff around is in the pits.
More than a few of the industry’s wounds were self-inflicted. Like their exploration and production clients, hubris led many of them into riskier, tenuously linked businesses financed with too much debt. Insiders, aided by large stakes and sometimes breathtakingly skewed incentives, reaped much of the reward while distributing pain more widely. Assets were often enclosed in master limited partnerships, offering tax benefits and high payouts predicated on the idea these businesses were essentially immune from the commodity cycle (it will shock you to learn this notion was rather oversold). Tax reform and a jarring reappraisal of pipeline-tariff setting by federal regulators delivered hammer blows in 2018.
Speaking with analysts in January, Steven Keane, CEO of Kinder Morgan Inc., observed that “private equity likes our assets better than you do,” the “you” being public markets. And he’s right. On Monday, minority investors in Teekay Offshore Partners LP, which operates a fleet of energy vessels, received an unsolicited offer from Brookfield Business Partners LP priced almost 10 percent below where the units closed last week. Earlier this month, meanwhile, Buckeye Partners LP announced it was selling itself for $11.1 billion, including assumed debt, to IMF Global Infrastructure Fund – a 27% premium, yes, but also where Buckeye traded only just over a year ago.
It’s tough to stoke competitive tension when the generalist investor remains AWOL. The question is, though, what exactly would that generalist investor come back to?
Membership of the Alerian MLP Index has dropped from 50 in early 2016 to 35 today. Mergers and acquisitions account for some of that (Buckeye is the sixth-largest constituent), along with a rash of collapses and conversions to regular C-corp or similar structures.
I pulled together a list of 88 listed securities that operate in North American energy infrastructure (apart from utilities) using the Bloomberg Terminal and data from Energy Income Partners LLC and CBRE Clarion Securities. I divided it into C-corps, big MLPs, sponsored entities (MLP subsidiaries that exist to buy assets from a parent company) and smaller standalone MLPs. The group’s total market capitalization clocks in just shy of $600 billion – or only a little bit bigger than the combined value of just two oil majors, Exxon Mobil Corp. and Chevron Corp. And this relatively small pool has become highly concentrated.
Roughly half the market cap of a group long identified (somewhat lazily) by the shorthand of “MLP sector” consists of companies that aren’t MLPs. Adding just the top six of those to the four big independent MLPs – Enterprise Products Partners LP, Energy Transfer LP, Plains All American Pipeline LP, and Magellan Midstream Partners LP – creates a list of 10 out of these 88 companies accounting for almost two-thirds of the entire market cap.
Outside of the C-corps and the big four MLPs, sponsored entities dominate what’s left. Smaller standalone MLPs, meanwhile, number 41, almost half the ranks but just 5% of the market cap. More than half of those aren’t traditional midstream businesses. A final 3% is made up of three companies currently being acquired, including Buckeye.
Almost a quarter of this entire pool isn’t even available to the generalist investor, because the partnerships have higher levels of insider or parent-company ownership. Consequently, C-corps dominate the $463 billion free float of the group even more starkly. The top six of those plus the big four MLPs account for almost three-quarters of the entire pool. Take out all the C-corps, the big four, and the three acquisition targets, and you’re left with just $65 billion of float divided between 65 entities.
Average free float drops off pretty quickly after the C-corps and the big four MLPs; it is just $400-$600 million apiece for the 40 non-midstream standalone and sponsored MLPs.
Even if interested, therefore, generalist investors may struggle to deploy money at scale in a number of these securities. Moreover, with the center of gravity having shifted so far toward C-corps in terms of liquidity, more of the big MLPs may well take the plunge and convert, in a self-reinforcing process.
Beyond these, the dominance of the sponsored entities among the smaller MLPs is also significant, says Hinds Howard, a midstream portfolio manager at CBRE Clarion Securities (and AKA @MLPguy). Because these partnerships are controlled by a parent, they “can be dramatically impacted by things outside the normal course of business for a regular company,” he says. These can include, on the plus side, providing support by taking back equity or committing to use a minimum level of capacity on a pipeline. But co-dependency carries its own risks, such as potentially creating so-called “orphaned MLPs” or the dreaded drag of incentive distribution rights (see this).
As we are now seeing with activists pressing for smaller frackers to consolidate in order to cut costs and raise liquidity, that long tail of smaller partnerships looks ripe for change.
Yet, despite the greater concentration, “the investment universe is not shrinking,” says Jim Murchie, founder and CEO of Energy Income Partners, which manages funds focused on energy infrastructure (including utilities). Having watched the long rise of independent pipeline companies, the MLP boom-and-bust and subsequent reconstruction of the industry, Murchie observes that “the pipes are still in the ground; it’s the financing of the pipes that is changing.”
This chimes with the Buckeye deal. Clearly, there is value in energy infrastructure in the midst of an energy boom. What keeps generalist investors away is a legacy of poor performance and governance, all too often associated with the MLP structure in particular. If public markets can’t see what private equity can, then the problem may not be those assets underground, but the convoluted structures built on top of them.