The midstream sector has become a stable niche for investors over the past two years, as companies have by and large exercised capital discipline as cash flows increased, analysts said during an Aug. 13 seminar. 

Speakers discussed the factors that have affected the energy market over the first part of 2024 and how the large midstream companies have remained insulated from much of the volatility. New York-based financial firm VettaFi hosted the online program, 2024 State of Energy: Midstream/MLPs Stand Out.

“If you look at the S&P 500 and break it down by sector, the energy sector is lagging the S&P, year to date,” said Paul Baiocchi, chief exchange-traded fund strategist at SS&C ALPS Advisors. “But midstream, and especially midstream MLPs, are actually outperforming the S&P.”

The total return of the midstream sector relative to the S&P 100 has been 19.9%, year-to-date, according to VettaFi. Baiocchi said that different economic factors are in play in different sectors of the energy industry.

“Despite the fact that we are at record levels of production in the United States for things like crude oil, natural gas and natural gas liquids, the macro environment is very much as uncertain as it’s been over the course of the current decade,” he said.  

Several of the U.S. oil and gas industry’s high-consumption customers, such as China, may be facing a recession. Analysts are also uncertain about OPEC’s commitment to keep production rates low to maintain crude oil prices of more than $70/bbl.

The natural gas market is expecting to see a massive jump in demand with increased LNG exports and a developing power-hungry artificial intelligence data sector, but Henry Hub prices have stagnated at under $2.50 for most of 2024. However, the U.S. Energy Information Administration said in an Aug. 6 report that a ramp up of LNG exports from new facilities in Texas and Louisiana, “will push the Henry Hub price to average about $3.10/MMBtu from November through March.”

Large midstream companies, primarily dependent on a fee-based revenue model, aren’t as susceptible to commodity price swings. Generally, midstream companies are paid at a steady rate for the molecules passing through their networks. Recently, the business model has allowed midstream companies to build up cash reserves.

The sector is in a different position than it was in the 2010s. According to an S&P report at the end of the decade, midstream companies had amassed massive amounts of debt, thanks to an infrastructure buildout required to keep up with a booming oil and gas sector. The large-scale buildouts slowed down as the decade ended, and the sector began a general recovery.

According to Stacey Morris, head of energy research at VettaFi, midstream companies began generating surplus free cash flow in 2020. At the beginning of the decade, firms were primarily interested in paying off debt or repairing balance sheets.

“Now, the companies are very well positioned to return that excess cash to shareholders,” primarily through dividends and buybacks, Morris said.

VettaFi reported that 94% of the companies in the Alerian Energy Infrastructure Exchange-Traded Fund, which focuses on the midstream sector, had increased their dividends year-over-year.

After the second quarter, several midstream companies either raised their guidance or reported that they were close to the top half of their estimates for the year, Morris noted. For example, Energy Transfer raised its full-year EBITDA guiding by $300 million when it released its projections on Aug. 7. For the second quarter, the company reported net income of $1.31 billion and adjusted EBITDA of $3.76 billion.

Morris said the trends should hold steady for the present.

“Investors who are maybe looking at the space wondering if it's run too much, if they're late to the party, … this is not a space where evaluations have become overextended or where things are looking particularly expensive,” she said.

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