M

idstream assets came to everyone’s attention last year, when a cyberattack shut down the Colonial Pipeline for 5 days, disrupting energy flows and causing a state of emergency in 17 states. The pipeline provides nearly half of the refined oil products supply on the east coast and can carry 3 million barrels of fuel per day between Texas and New York.

Midstream companies have done very well this year, rallying from January through the summer as energy prices increased around the world. But, when the Biden Administration began releasing oil reserves from the SPR, energy stocks, and midstream companies especially, declined from their highs as the potential for shrinking margins reduced perceived valuations. Despite this, many still present strong opportunities, either from a value, growth, or dividend perspective.

As established, Europe will likely face an energy crisis through next year, regardless of the outcome of the war in Ukraine. Russia has little-to-no incentive to trade with Europe after the BRICS nations filled in trade gaps, and Putin accelerated a joint-initiative with China to bring natural gas to every corner of his country.

And, with Natural Gas recently reclassified as clean energy, it will quickly fall into place as the global alternative to other forms of energy. Finding appropriate midstream opportunities requires some nuance. It’s important to consider the mode of transportation: whether by pipeline, rail, or boat. LNG shipping companies might benefit from more exports to Europe, while pipeline specialists will benefit more from increased movement between storage hubs across the country.

total lng exports and market share by export market (2021)
source: GIIGNL

Global LNG liquefaction capacity, a measure of overall market capabilities, grew in 2021. Significant projects came online in the United States during the first quarter of 2022, which increased global capacity by 3% YoY, and made the United States the market with the second largest global share, with 18.2% of overall capacity. The United States increased its total operational capacity by 25% from 69.1 million tons per annum (MTPA) at the end of 2020 to 86.1 MTPA in April 2022.

Additionally, average utilization rates for those facilities increased significantly last year from 74% to 81%. The International Gas Union projects that LNG demand will grow further as the ongoing Russia-Ukraine conflict continues to impact global gas supply, reinforcing LNG’s critical role in global energy security. In 2021, Russia contributed to 8.0% of global LNG exports, out of which, 43.9% were to Europe, while the remaining 56.1% were to Asia Pacific and Asia. Russia accounts for 13% of liquefaction capacity worldwide, which is now inaccessible to the west thanks to sanctions over the conflict in Ukraine.  

One strong market participant who could benefit from increased international flows is Enterprise Products Partners ($EPD). EPD is a well-diversified midstream player with a history of above-average returns and a favorable cash flow structure, since most earnings come from fee-based contracts.

The company quickly recovered its revenues after the 2020 slowdown, and it continues growing through its latest expansion in the Permian Basin and acquisition of the US-based Navitas Midstream Partners for $3.25b. This solidifies its position as a key player in Midwest, South, and Lower East coast regions.

At the same time, EPD has one of the highest credit ratings in the midstream, with a BBB+ stable outlook rating from the most renowned rating agencies. Its cost of debt is 4.4% (2.2% adjusted for inflation) while boosting 23.5% returns on invested capital. Since the company has one of the lowest leverage ratios (3.1x), it may acquire an A-rated credit rating.

With a market cap of $57.45b, it trades at an attractive 11.8x price-to-earnings ratio. While slightly above average for the industry, it actually fares well against its peers, who have an average P/E closer to 15x and much higher Price/Sales ratios.

epd distribution map (pipelines and transportation routes)
source: epd investor relations

Economists often argue that the underlying cash flows of US midstream companies are not very sensitive to fluctuations in energy prices.

For EDP, this means a stable dividend of 7.2% well above the industry average of 4.6%. Over the last decade, it increased from $1.3 per share to $1.9 per share while the cash payout ratio remained at a reasonable 58%.

The Company also leases underground salt dome natural gas storage facilities located in Texas and Louisiana and owns an underground salt dome storage cavern in Texas. Enterprise is one of the few MLPs that provide midstream services across the full hydrocarbon value chain.

EPD has a strong record of acquisitions during a time when demand for midstream assets is growing and competitors are consolidating. Additionally, the failure of clean energy solutions to provide consistent power has created strong peak-season demand for natural gas, increasing convenience yields for stockpilers while the liquid natural gas futures term structure remains volatile and awkwardly shaped. Exposure to a commodity driven asset can be a healthy diversifier for a portfolio with no other commodity driven price exposure.

spread between pipeline and market priced lng
source: flex investor relations

Another name with international promise is Flex LNG ($FLNG) which engages in seaborne transportation of liquefied natural gas (LNG). As of lately, it owned and operated 9 M-type electronically controlled gas injection LNG carriers and 4 vessels with generation 10 dual fuel propulsion systems. Although based in Bermuda, the company is de-facto Norwegian, and its major shareholder is  Norwegian-born, Cypriot oil magnate John Fredriksen.

Without Russia's supply, Europe is now facing a shortage of roughly 125 billion cubic meters of gas ‚Äď the amount delivered during ¬†normal conditions in 2021. Even with coordinated demand reduction and other saving measures, the shortage will still be considerable, dislocating prices between energy markets that completely ban Russian energy, or only partially dilute it. FLNG can benefit from wide spreads in energy markets, especially LNG. For example, $40MM of LNG in the US is worth $244MM in Asia, which generates a tremendous fee and resale profit.

Meanwhile, Norway reopened its Hammerfest LNG terminal after a 20-month closure due to a fire, adding capacity of 4.3 million MPTA. Norway has been pushing its energy exports due to the ongoing energy crisis.

Thus, it is not surprising that Flex LNG recently secured 3 new long-term contracts, adding 24 years of backlog - pending orders that are yet to be fulfilled. This all contributes to a very high level of earnings visibility going forward. With a dividend yield of 9.1% and a P/E ratio of 9x, Flex LNG offers exposure to this thematic investment at a reasonable price.

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Posted 
Sep 15, 2022
 in 
Daily Nugget
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