PPL:CC - Energy Income Weekly: Falling Commodity Prices Pull Energy Equities Lower

Summary

• Energy equities fell hard during the week as commodity prices fell and investors grew jittery about the oil market’s medium-term recovery prospects.
• Equities tied to natural gas prices were particularly weak.
• We expect smoother sailing for the energy equities once first-quarter oil inventory builds abate over the coming weeks.

Energy Income Performance

The energy sector took a beating, ending the week down 6.3% versus the 0.3% decline for the S&P 500. E&Ps fell the most, with the XOP down 7.2%, while midstream fared better, ending the week down 1.2%.

Energy equities followed energy commodities lower. Both crude oil and natural gas had a rough week. WTI was down 4.2% as the market digested inventory builds that have occurred in recent weeks throughout the world. While builds are seasonally normal during this time of year, recent builds have exceeded historical norms.

In addition, the Russian supply losses anticipated in the wake of EU sanctions have not materialized, as Russia has found willing buyers for its crude and refined products in India and China. Oil traders have also been spooked by inventory builds in China among industrial minerals, which implies that the economic boost from the nation's reopening may be weaker than expected.

Our medium-term view on crude oil remains unchanged. We expect first-quarter inventory builds to be consumed in the second quarter, giving way to draws in the third and fourth quarters. WTI and Brent prices should anticipate the third-quarter draws, so we expect them to rally in the mid-to-late second quarter. The high rate of crude inventory draws we expect in the second half from historically normal levels are likely to send oil prices significantly higher.

Energy investors shouldn't lose sight of the fact that commercial crude inventories are only now approaching historically normal levels. Getting to this point required adding 430 million barrels-equivalent to 1.2 million barrels per day-to commercial crude inventories from global strategic petroleum reserves and China demand losses throughout 2022.

This week, we were encouraged that the physical market remains in backwardation despite recent inventory builds and falling front-month prices.

Meanwhile, the natural gas drubbing continued during the week, sending prices down another 9.5%. Natural gas can't catch a break amid forecasts for continued cold weather and relentless domestic production increases. The looming upstart of Freeport LNG should offer some support to prices, but only a stretch of cold weather can save it from a growing oversupply.

After the week's losses, the energy sector has become the worst-performing sector in the S&P 500 (SP500), down 4.2% year-to-date versus the 6.2 gain for the S&P 500. We believe the underperformance has presented investors with juicy long-term buying opportunities. We continue to favor energy equities with exposure to higher oil prices in our most recent equity purchases.

Energy Income Equity Performance

NGL Partners ( NGL ) was the best-performing equity in our coverage universe during the week, up a whopping 32.7%. The company surprised the market in the previous week by announcing $98.1 million of debt reduction during the fourth quarter as well as its intention to repay all its 2023 senior notes by mid-year. The units continued to respond to the announcement this week. On Wednesday, NGL announced it was increasing the commitment on its asset-based lending facility to $600 million on a permanent basis. The units offer significant upside, even after their recent run, if the company can further reduce its leverage. However, significant risks to equity owners remain, and they keep us away from the units.

The worst performers in our coverage universe were all exposed to natural gas. Sitio Royalties ( STR ), Cheniere Energy Partners ( CQP ), and Tellurian ( TELL ) all traded more than 8% lower in response to plunging gas prices on no company-specific news. We suspect Bank of America's downgrade of TELL stock on Tuesday was the main reason behind its 16.6% decline.

In earnings news, DT Midstream ( DTM ) beat consensus fourth-quarter Adjusted EBITDA of $221 million with its report of $227 million. Management also raised DTM's full-year 2023 Adjusted EBITDA guidance. Despite the beat, DTM shares took a beating in response to the company's forecast for higher capex. DTM joins other energy companies like Devon Energy ( DVN ) in getting punished for announcing larger-than-expected capex budgets. DTM's management didn't provide much detail on the higher capex forecast other than to indicate that previous years' capex was low, with several organic projects having been delayed. This year represents a catch-up. We don't see any reason for the selloff. DTM's cash flow prospects remain unchanged, and its 5.3% yield remains safe.

Weekly HFI Research Energy Income Portfolio Recap

Our portfolio outperformed its benchmark, the Alerian MLP Index, by 0.8%, though it declined by 0.4%.

Calumet Specialty Products Partners ( CLMT ) was the standout performer, with a 10.0% gain. As the largest position in our portfolio, it exerts an outsized influence on performance. This week, CLMT received a boost from news that PBF Energy ( PBF ) sold a 50% interest in its St. Bernard Renewables project that is currently under construction to Eni SpA ( E ). PBF sold the stake for $835 million, more than the facility's total cost of $650 million. We look forward to management's commentary on the performance of CLMT's Montana Renewables facility.

Plains All American ( PAA ) traded 2.3% higher. Its only news during the week was that it closed on the sale of its 21% stake in the Fort Saskatchewan facility to Keyera for $367 million. We expect management to allocate the proceeds toward paying down debt.

Our portfolio's losers were closely tied to natural gas. EnLink Midstream ( ENLC ) was the worst performer, down 9.3% after it missed consensus Adjusted EBITDA expectations. ENLC reported Adjusted EBITDA of $337.2 million versus expectations of $350 million. The company attributed most of its fourth-quarter miss to severe weather, which management said reduced fourth-quarter EBITDA by $11 million. Management expects 5% Adjusted EBITDA growth in 2023, which we believe is conservative, given recent performance of its Permian and Louisiana segments.

Energy Transfer ( ET ) gained 0.2% after reporting a 4.9% fourth-quarter Adjusted EBITDA beat. ET reported $3.44 billion of Adjusted EBITDA versus consensus of $3.28 billion. However, full-year 2023 EBITDA guidance was a tad light, at $13.1 billion at the midpoint of management's range, versus consensus of $13.2 billion. Overall, ET had another outstanding year in 2022, and we applaud management for addressing the company's leverage and returning its distribution to its pre-pandemic level.

Martin Midstream Partners ( MMLP ) reported fourth-quarter earnings that featured a good performance outside of its butane blending business, which suffered losses in the fourth quarter and which the company is in the process of winding down. We covered its earnings report extensively on the chat and in an article, to which we refer readers for details.

Cheniere Energy ( LNG ) shares have been weak due to falling natural gas and LNG prices. This week's 4.7% decline brings the units further into undervalued territory. Black Stone Minerals ( BSM ) units fell by 4.4%, also in response to declining natural gas prices. Its financial results are partially protected from hedges struck last year when natural gas prices were higher.

News of the Week

Feb. 17. Williams ( WMB ) executed agreements with Chevron ( CVX ) to support natural gas development in the Haynesville Basin and deepwater Gulf of Mexico. In the deal, WMB will provide gathering and processing services for CVX assets. CVX also agreed to a long-term capacity commitment on WMB's Louisiana Energy Gateway projects. We're not confident that WMB's projects will earn satisfactory returns for shareholders, particularly in today's higher interest rate regime. We rate WMB a Hold and would not add to the name unless prices fell considerably.

Capital Markets Activity

Feb. 14. Canadian midstream companies Enbridge ( ENB ) and Pembina ( PBA ) announced conversion results for certain series of their preferred shares. ENB announced conversion results for its Series 19 and Series D Preferred Shares, and PBA announced conversion results for its Series 21 Preferreds.

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