Energy Income Weekly: Rallying Into The End Of 2022

Note: This article was originally published on December 24.

Energy Income Performance

Energy income managed a positive close this week in the face of surging interest rates and plunging natural gas prices. A 7% rally in oil prices supported energy equities.

Oil drew support from a slightly better near-term outlook driven by the end of the SPR releases, China’s reopening, and the prospect that Russia may cut production. These bullish factors are likely to gain steam in 2023. At the moment, bearish factors remain at the forefront. China is hunkering down in response to the spread of Covid, while the physical market is lackluster, with Brent timespreads falling from the previous week.

Income-producing energy equities saw mixed price action, with gainers slightly outnumbering decliners. Companies with the greatest commodity exposure were the strongest performers, as they have been all year. G&Ps and royalty trust owners did well this week even if they were weighted toward natural gas.

Dorchester Minerals, L.P. (DMLP) was the biggest gainer on no news. We’ve been fans of this ultra-conservative royalty operator, which should do well next year amid strong oil prices.

Global Partners (GLP) has been surprisingly strong of late despite its skimpy distribution coverage. The units gained after the company announced the acquisition of terminal assets in an 8-K filing with the SEC. Global Partners and other gasoline station owners tend to see their profits increase when oil and gasoline price decline, so the rally makes sense in anticipation of consensus-beating fourth-quarter results.

Viper Energy Partners (VNOM), another well-run royalty company, rounded out the week’s top three performers on no news. Its exposure to oil prices and relatively liquid stock makes it more closely tied to oil prices.

The week’s losers were comprised mainly of the financially weaker players. These companies tend to require access to capital markets and as such are more directly impacted by interest rates, which surged higher during the week.

Tellurian (TELL) shares fell by 24% as the market loses faith in the company’s ability to see its Driftwood LNG project through to completion. TELL is in need of a deep-pocketed financial partner but will have a hard time finding one unless it offers favorable terms that we doubt will be palatable to TELL’s Chairman Cherif Souki.

At this point, Souki, for all his marketing savvy, is becoming more of a liability than an asset to TELL shareholders. Souki’s compensation has historically taken the form of large options grants on favorable terms to him. If TELL stock performs poorly, his options packages can get “reloaded” at the lower prices, thereby taking a bigger chunk of future equity upside for himself and away from existing shareholders. These compensation arrangements also render Souki less impacted by the dilution of TELL’s ongoing equity sales. Until TELL’s Driftwood is close to completion or its leadership changes, we recommend avoiding TELL shares.

Besides having weaker financial positions, the worst performers of the week have something else in common: they’re all small-cap MLPs. We noticed that micro-cap and small-cap MLPs had been relentlessly hammered during the week, mostly on high volume. The selling was indiscriminate and came on high volume.

We suspect the selling was partly in response to new IRS rules regarding foreign investors’ participation in U.S. partnerships. The rules came into effect in November and foreign investors were notified by their brokers about certain withholding requirements last week. Among the hardest-hit units have been CSI Compressco, LP (CCLP), which fell on no news after it outperformed in the previous week, Summit Midstream, LP (SMLP), NGL Energy Partners LP (NGL), and Genesis Energy, LP (GEL)-all of which traded down more than 6% on no news.

We believe the overselling of these names provides an attractive opportunity for long-term investors who are interested in these names to buy.

Weekly HFI Research Energy Income Portfolio Recap

Our portfolio underperformed its benchmark, the Alerian MLP Index, by 1.9%. Its exposure to underperforming MLPs was the main culprit. We used the price action to sell our holdings in Kinetik (KNTK) and allocate half the proceeds, respectively, to two MLPs, Plains All American (PAA) and Calumet Specialty Products Partners (CLMT).

PAA became more attractive after we revised our valuation higher in light of the company’s recent outperformance. See our rationale in our PAA article here.

CLMT was the third-worst performer in our coverage universe. Again, we’re left scratching our heads about why the units are so weak when transformational catalysts like only weeks away. We believe CLMT units remain in “pound the table” buy territory.

Martin Midstream Partners (MMLP) units got slammed during the week on high volume and no news. It was the second-worst performer in our coverage universe. Its fundamental outlook remains unchanged, as does our bullish conviction on the name. We’re looking for the units to snap back in early 2023 when we expect the current selling pressure to have run its course.

Our portfolio benefitted during the week from owning the fourth through seventh best performers in our coverage universe. EnLink Midstream (ENLC), Targa Resources (TRGP), and Hess Midstream (HESM) are all commodity-exposed G&Ps that participated in the overall G&P rally.

We were pleased to see USD Partners (USDP) finally trade up, bucking the trend among micro-cap MLPs.

Among other news for our holdings, Energy Transfer (ET) director Richard Brannon purchased 80,000 units at $923,810 for an average price of $11.55 per unit. Enterprise Products Partners (EPD) co-CEO Jim Teague purchased 21,150 units for $499,159 at an average price of $23.60.

News of the Week

Dec. 20. Oneok (OKE) riled a permit with the FERC for a new intrastate natural gas pipeline that would connect the Permian Basin’s production to international markets. The project, dubbed the Saguaro Connector Pipeline, would carry 2.8 Bcf/d of natural gas for 155 miles from the Waha hub. OKE expects to make a final investment decision in mid-2023.

Dec. 23. TC Energy (TRP) received approval from regulators to restart the Keystone pipeline, according to the company’s website. TRP shut down the pipeline on December 7 after it spilled 14,000 barrels of oil in rural Kansas. To date, almost 7,700 barrels have been recovered. The pipeline carries 622,000 barrels of oil per day from Hardisty, Alberta, to the U.S. Gulf Coast. Its shutdown left refiners short of crude and caused them to borrow barrels from the U.S. strategic petroleum reserve. It didn’t have a major effect on Canadian oil prices. The company hasn’t provided an update about the financial impact of the spill, but we don’t expect it to miss its guidance due to the spill.

Capital Markets Activity

None.