Energy Infrastructure

Brookfield Energy Infrastructure Overview: The Outlook for Midstream Amid Recent Events

Article

May 13, 2022

  • The broader midstream universe, as measured by the Alerian Midstream Energy Index (AMNA), returned -2.15% in April.
  • Master Limited Partnerships (MLPs), as measured by the Alerian MLP Index (AMZ), returned -0.09% in April.
  • The broader market, as measured by the S&P 500 Index, returned -8.72% in April.

The energy industry’s performance in April was fairly muted, while broader market concerns and a pullback in some large technology stocks resulted in meaningful outperformance for energy equities during the month. Russia’s war in Ukraine and shutdowns in China continued to drive the fundamental narrative for oil supply-demand balances, as crude oil ended up 4.4% on the month. Energy equities, however, were more correlated to broader market equities than crude oil during April, resulting in negative monthly performance.

Although recession concerns have started to loom over energy markets, midstream equities have performed well despite persistent inflation and rising interest rates. An anecdotal vote of confidence for the U.S. energy sector came recently from Warren Buffet’s Berkshire Hathaway (NYSE: BRK), which at its annual meeting at the end of the month disclosed it had significantly increased its stake in supermajor Chevron Corporation (NYSE: CVX), totaling approximately $26 billion at the end of March 2022.1

The Near-Term Outlook for U.S. Energy is Still Bullish Despite Inflation, High Fuel Prices
We continue to see a bullish macroeconomic outlook for midstream equities; however, energy inflation, like the record fuel prices we are seeing today—retail gasoline and diesel set highs during April and May—is unsustainable over the long term and could eventually lead to demand destruction. In the United States, we might be seeing the impact of high prices on diesel and gasoline markets already, as four-week rolling demand is starting to tick down modestly in the absence of any local COVID-related lockdowns. We assume that high prices are the likely culprit for these modest demand impacts. COVID-related refinery shutdowns, trade disruption from the war in Ukraine, and a general lack of investment by the industry are key reasons volatility appears to have increased in today’s energy markets.

Importantly, we do not expect that these dynamics will negatively impact midstream cash flows over the short term due to the diversification of the industry across the oil & gas commodity spectrum and the ability of some companies to benefit from higher prices. Moreover, we believe the current supply-demand dynamic and record high prices show that the world needs more U.S. oil and gas, not less. Finally, another solid and nearly-complete midstream earnings season is a strong indicator to us of the positive fundamental setup for U.S. energy that we see continuing for quite some time.

The Long-Term Outlook is Even Brighter With Energy Transition Announcements
We believe the need for oil & gas continues , and the runway for cash flow generation from traditional midstream activities should be measured in decades instead of years. We fully acknowledge, however, that the world will transition to cleaner fuels over time, and we unequivocally believe this will be an opportunity for midstream service providers rather than a headwind. Thinking back to 2020, we frequently had to address concerns around terminal value, as investors feared that traditional oil & gas assets could be obsolete in a matter of years. But a bevy of announcements from midstream companies over the last few years, including many during the first quarter of 2022, give us increasing confidence that midstream cash flows will have longevity and that terminal value concerns continue to be premature and overblown.

Looking forward over the long term, cash flows from traditional oil, natural gas and natural gas liquids (NGLs) might eventually be replaced with cash flow from carbon dioxide sequestration and transport or hydrogen storage and transport—just to name a couple of areas that will be pivotal, long-lived parts of the energy transition. Traditional midstream companies have the most experience, from a regulatory, permitting and engineering perspective, with taking hydrocarbons out of the ground, and we believe these same companies will be able to leverage that expertise to move other forms of energy, like hydrogen, or sequester pollutants like carbon dioxide into impermeable reservoirs forever.

Here are just a couple recent announcements from midstream companies along this part of the value chain:

  • In February, EnLink Midstream, LLC (NYSE: ENLC) and Talos Energy Inc. (NYSE: TALO), an offshore exploration & production company, announced a memorandum of understanding (MOU) to develop jointly a complete carbon capture, transportation and sequestration solution in Louisiana;2
  • In May, ENLC built upon its announcement with Talos by signing a letter of intent (LOI) to transport carbon dioxide for a subsidiary of Occidental Petroleum Corp. (NYSE: OXY), a diversified energy company, from industrial emitters in the Mississippi River corridor to large sequestration hubs that the OXY subsidiary Is developing;3
  • In April, Enterprise Products Partners L.P. (NYSE: EPD) announced an agreement similar to the ENLC-OXY LOI for the Houston to Beaumont/Port Arthur areas, and;4
  • In April, Plains All American Pipeline LP (NASDAQ: PAA) signed a MOU to conduct a low-carbon hydrogen (electrolyzer produced) and subsurface storage feasibility study in Ontario.5

These are just a few of the exciting announcements that we expect could represent a greater percentage of cash flows for the energy infrastructure industry over time and would serve as a long-term complement to the hydrocarbon-based cash flows of today. Initially, investments like this are expected to be relatively small, but we believe they provide long-term, viable commercial opportunities outside of the traditional hydrocarbon stream for decades to come.

Meanwhile, U.S. midstream providers are working hard to mitigate the existing emissions footprint of the natural gas value chain to enhance and improve its position as a dispatchable, on-demand lower-carbon partner to renewable power. In April, the largest independent liquefaction company in North America, Cheniere Energy Inc. (NYSE: LNG), announced that it would collaborate with a number of gathering & processing companies and academic institutions to monitor, quantify, report and verify greenhouse gas emissions specific to Cheniere’s supply chain. Mitigating supply chain emissions likely makes these cargoes more attractive to environmentally-conscious buyers in Europe and other regions, creating a competitive advantage for Cheniere and those that participate in its liquefaction value chain.

The bottom line: We believe the runway for energy infrastructure companies to capitalize on oil & gas and energy transition opportunities is a long one, and we do not believe this fact pattern is being valued in midstream equity values today.

1 https://www.cnbc.com/2022/04/30/warren-buffett-significantly-increases-chevron-bet-now-in-berkshires-top-4-positions.html
2 https://investors.enlink.com/news-and-presentations/press-releases/2022/02-15-2022-220521209
3 https://investors.enlink.com/news-and-presentations/press-releases/2022/05-03-2022-214522596
4 https://www.enterpriseproducts.com/investors/news-releases?article=/news-releases/news-release-details/enterprise-and-oxy-low-carbon-ventures-sign-letter-intent-gulf
5 https://ir.paalp.com/profiles/investor/ResLibraryView.asp?ResLibraryID=107851&BzID=789&g=549&Nav=0&LangID=1&s=0

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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.

OTHER DEFINITIONS
One million BTU is a measure of heat energy equal to 1,000,000 BTU, which are equal to the amount of heat energy required to increase the temperature of one pound of water one degree Fahrenheit.

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