Energy Infrastructure
Brookfield Energy Infrastructure January 2022 Industry Overview: An Attractive Backdrop
Article
Feb 18, 2022
- The broad midstream universe, as measured by the Alerian Midstream Energy Index (AMNA), increased 9.76% in January.
- Master Limited Partnerships (MLPs), as measured by the Alerian MLP Index (AMZ), gained 11.07% in January.
- The broader market, as measured by the S&P 500 Index, decreased by 5.17% in January.
Midstream equities once again had a strong start to the year as year-end volatility dissipated and the macro narrative continued to be constructive. From a commodity perspective, U.S. crude prices were up 14% on the month, and at the end of January a barrel of U.S. crude was trading above $88, a level not seen since October 2014. Meanwhile, natural gas prices skyrocketed by 37% as cold weather finally showed up in the U.S. We believe, the rise in commodity prices occurred due to the ongoing themes that we have been discussing for a while—demand resilience, geopolitical turmoil, and ongoing global upstream underinvestment. In our view, these themes paint a positive backdrop for midstream equities.
Crude Undersupply Concerns
Crude markets endured a lot of noise in the fourth quarter of 2021—in our view, driven by the emergence of the Omicron variant and a coordinated Strategic Petroleum Reserve (SPR) release by the U.S. and other countries created significant volatility at the end of November and into December. Both items proved to be short-lived; global mobility once again proved resilient in the face of a COVID-19 variant and a release of oil from government inventories proved to be an inadequate measure to address true supply/demand fundamentals.
In January, concerns about persistent global undersupply again resurfaced. One area of particular concern was whether OPEC+ will actually be able to produce as much oil as the coalition says it can produce. Reuters reported that in December, the group once again failed to hit the quota of 400 thousand barrels of month-over-month growth that its taper is targeting. The chart below shows that this trend was persistent throughout the second half of 2021.
Source: Bloomberg, February 7, 2022
In our opinion, if OPEC+ continues to be unable to satisfy its targeted production increases in 2022, it could signal to the markets that OPEC+ “spare capacity” is not as high as many believe, and the call on non-OPEC+ (i.e., North American production) to grow at a higher rate could come sooner rather than later.
Geopolitical Turmoil
Global geopolitics continued to rattle commodities, with the saga in Ukraine taking center stage. We have previously written regarding our opinion about the folly of restraining domestic supply and increasing our allies’ reliance on other sources of hydrocarbons, and January offered a fairly stark reminder of the potential consequences of such policies. During the month, as NATO allies ramped up their rhetoric against Russian aggression in Ukraine, not all parties were on board, notably Germany.The reason for Germany’s seemingly softer stance could potentially be tied to its energy dependence: Russia accounts for 32% of Germany’s natural gas supplies. With Germany reducing its reliance on both coal and nuclear power, gas is becoming an increasingly important component of the country’s energy mix and ensuring power reliability. More broadly, the prospects of any disruptions to Russian hydrocarbon supply added a geopolitical risk premium to commodity prices that partly helped to fuel the commodity rally, in our view.
Surging Natural Gas Prices
In the U.S., an exceptionally warm start to winter finally gave way to some colder weather in January. This, coupled with continued robust demand overseas for U.S. liquefied natural gas, drove NYMEX gas prices up 37% over the course of the month. In fact, during the first four weeks of January, the U.S. Energy Information Administration reported a draw of a staggering 872 billion cubic feet (bcf) of gas from U.S. storage inventories—this compares to draws of 641 bcf and 539 bcf for comparable periods in 2021 and 2020, respectively. The strong domestic demand, coupled with ongoing appetite for U.S. liquefied natural gas, has sent inventory levels back below historical averages and contributed to the increase in prices.
Source: US Energy Information Administration, week ending January 28, 2022
Implications for Midstream Equities
We believe today’s backdrop should benefit North American midstream equities. With energy reliability and security front and center, OPEC+ failing to meet its quotas, and resilient global demand, we believe the appetite for American oil and gas will continue to increase globally. Importantly, we believe the U.S. infrastructure landscape is already sufficiently built out to absorb several years of production increases from most U.S. basins, meaning that capex budgets will remain low relative to the prior decade and our constituents’ free cash flow profile will continue to improve.
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INDEX DEFINITIONS
The Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities, is disseminated real-time on a price-return basis (AMZ) and on a total-return basis (AMZX).
The Alerian Midstream Energy Index is a broad-based, capped, float-adjusted, capitalization-weighted index of North American energy infrastructure companies.
The S&P 500 Index is an equity index of 500 widely held, large-capitalization U.S. companies.
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