JotCast | 9/30/20 Energy & Income Advisor Live Chat

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9/30/20 Energy & Income Advisor Live Chat

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Roger Conrad

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Welcome everyone to our monthly subscribers only live chat for Energy and Income Advisor.

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There is no audio. Just type in your questions and Elliott and I will get to them as soon as we can answer in a concisely and comprehensively. As always, we'll be sending you a link to the complete transcript of all Q&A at the conclusion of the chat, which will be when we've answered everything in the queue as well as what we've received via email.

Per usual, we're going to start with some answers to questions we received via email:

Q. Hi Folks. I’m sure when I'll be able to join the chat tomorrow so here's a question. I apologize for the length. I hope you can include it.

Why invest in midstream companies? That's the question I've been pondering for several months. Time was when MLPs had high payouts versus ordinary stocks, and the payouts increased by at least high single digits every year, some by double digits. Prices were stable and rising. Then one thing after another went wrong: The price of oil dropped from $100 to $20. There was a financial crisis and a housing crisis. Credit got tight and many MLPs cut payouts sending prices lower, and then began converting to C-corps in some investor unfriendly transactions.

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There was a deep recession, which lowered demand for energy. Fossil fuel and energy stocks were "out of favor" with a preference for renewables, which is still the case. In fact, use of renewables in growing and affecting the demand for fossil fuels -- not a good trend for midstream companies. Waiting for energy to be favorable again -(or even just OK) - is not a real strategy. Prices continue to go down and stay down, and payouts are growing more slowly if at all. In the words of the late Gilda Radner....it's always something.

What's an investor to do? I am coming around to the view that midstream companies should be thought of as high(er) yielding income assets. Period. You have to be sure that companies are strong businesses and that payouts are and will remain well covered. You have to buy at beaten down prices so you have a margin of safety on price. And you should invest for price stability -- not price appreciation. If you can get an 8 - 10% (or maybe a little higher) payout return that grows a bit

each year, with stable prices, then you have to be content with that. You are not going to get rich investing in midstream companies. But there is nothing bad about an 8-10% yield with price stability. (Of course there is inflation to consider.)

That brings me to Enterprise Products Partners (NYSE: EPD), Kinder Morgan Inc (NYSE: KMI), Williams Companies (NYSE: WMB) and Magellan Midstream Partners (NYSE: MMP) maybe, but nothing else. Are there names to add to this short list? If you disagree with my thesis, please let me know how. Thanks very much.—Mack

A. Thanks for your question Mack. I think you can add several midstream names to your list, all of which are currently in the Energy and Income Advisor model portfolio or the High Yield Energy List. Four with pretty locked in prospects now are Enbridge Inc (TSX: ENB, NYSE: ENB), Hess Midstream (NYSE: HESM), Pembina Pipeline (TSX: PPL, NYSE: PBA) and TC Energy (TSX: TRP, NYSE: TRP). All of these are actually C-Corps—Pembina and Hess converted from other structures in very shareholder friendly deals.

Our view at EIA for several years has been that there are too many midstream companies in the US and that consolidation is needed. Unfortunately, it’s so far come from liquidations and “takeunders” rather than high premium takeovers. But despite some extreme weakness in share prices of even the leaders this year, we are seeing the emergence of a handful of resilient companies that have the scale and balance sheets to produce very reliable returns going forward. And from these prices, it’s reasonable to expect

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sizeable capital gains as well as they prove that resilience.

Renewable energy adoption will continue to grow in coming years. That much seems fairly certain. But even under the most extreme optimistic scenarios for investment, we’re also going to be using oil and gas for many years to come. In fact, the combination of reduced CAPEX now, post-pandemic economic recovery and rising developing world usage are a pretty classic formula for revived demand and higher prices, at least by mid-decade and probably sooner.

You invest in midstream energy companies like these standouts now because (1) they have staying power and will benefit from that recovery, (2) they’re about as cheap as they’re ever likely to get as stocks and (3) they have the earnings and balance sheets to continue paying those big dividends even in this very weak environment. When a market has been decimated like midstream, it’s always very difficult to imagine the possibility of a recovery—let alone have the patience to wait on it. But that’s a

also proven time and again the best time to place bets on such a recovery.

Q. I am concerned about the war against petroleum-fueled cars in our country. I hold a large number of midstream MLPs and companies. What will suffer the most with a decrease in the use of gasoline powered cars and an increase in the use of electric cars? I imagine I should be planning to eventually lighten my load when prices recover somewhat. Thanks—Jack A.

A. Thanks Jack. There’s definitely a desire in the US public for greater future use of electric vehicles—and politicians have characteristically responded, i.e. California’s declaration that you won’t be able to buy gas-powered vehicles in the state starting in 2035.

On the other hand, that appetite to date is not matched in actual orders for vehicles—which remain tepid for EVs overall as low gasoline prices fuel orders for trucks. That suggests when the US economy does recover post-pandemic that demand for gasoline will rise. And with US oil and gas producers cutting back on CAPEX, whatever supply glut we have now will disappear in a hurry.

If so, that will mean higher energy prices and eventually a big time recovery in oil and gas stocks up and down the energy value chain. Midstream companies specifically will benefit from producers trying to get more product to market in an environment where multiple projects have been postponed or cancelled the past several years.

As I answered in the previous question, it’s pretty hard to imagine this as a scenario right now, with even midstream companies like Enterprise yielding north of 11%. But that’s always been the case in every cycle before it turns higher.

You can make a case that in the very long term—say the second half of this century—use of EVs for transportation and wind/solar/storage for generating electricity could reduce or even eventually eliminate oil and gas usage. But even California is waiting 15 years to propose just eliminating sales of new gas-powered vehicles—that’s not the cars already on the road, the number of which is likely to continue growing. Bottom line is there’s still a

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lot of time to make a lot of money in energy stocks, particularly from these prices.

Q. Hi guys. A couple of questions for you:
1.   Thoughts on California’s 2035 ban on gasoline engines and impact on Chevron Corp (NYSE: CVX)?
2.   In general, the technicals for oil have been horrendous for at least six months. However oil prices are at $40, not $30. It feels much like momentum rather than fundamentally driven investment decisions. Thoughts?
3.   Energy Transfer (NYSE: ET)–updates on the lawsuit on the ND pipeline and comments on the recent weakness?

Thank you!--Alan R.

A. Hi Alan. First off, California’s proposal is only for new cars sold in the state. At this time, no one is proposing a ban on all gasoline cars already on the road. That could change. But I think the fact they’re only talking about new sales is a pretty clear admission of how difficult it will be to produce EVs that are cheap enough, reliable enough and have a long enough range to replace gasoline powered companies—which are becoming more efficient every year—on a mass basis. Assuming that is an attainable goal, we would obviously see an impact on gasoline demand at that time. But that’s also 15 years in the future, which does give Chevron time to adapt its business model. One possibility is they’ll do what Total is doing and expand its integrated model to include other forms of energy, and the deal with Algonquin Power & Utilities may be a forerunner of more to come. But in any case, the California action is not as radical for the industry as it may sound.

Second, regarding technicals for energy, they’ve certainly been horrific for sector stocks. But as you point out, the commodity (oil) has been basically locked in place around $40 a barrel and even natural gas is back at $2.50 per million BTU after being all over the map. The challenge for companies is adapting their business model to the current level of prices, which generally means reducing CAPEX and cutting expenses up and down the energy value chain. We saw success for the leaders in Q2 and there’s no reason not to expect the same in Q3 results we’ll see next month. When this resilience will be recognized in share prices is obviously uncertain. But our view is value will eventually win out and if we’re patient and build positions now, we’re going to see some big gains in the next 2-3 years.

Regarding Energy Transfer, as we pointed out when the judge order the Dakota Access Pipeline shut immediately, that project accounts for only about 5% of total company EBITDA. As such it’s not a make or break revenue source on its own, though in combination with weakness elsewhere a permanent shutdown could induce management to cut the distribution—as so many now expect with shares priced to yield nearly 22%. The DAPL partners have succeeded in persuading the courts to keep the pipeline open while the appeals process continues. That looks like it will remain the case, and in fact Energy Transfer expects to open expanded capacity on the pipeline by the end of the year—which is contracted. Obviously, opposition is fierce and the courts could decide to force closure. But at this point, it’s hard to argue a big dividend cut isn’t already priced in for ET shares. It’s not a safe income investment but for aggressive investors we still believe it’s worth sticking with.

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Q. As you know, EIA Portfolio member Brookfield Renewable Partners now has a C-Corp share traded NYSE symbol BEPC and partnership units traded as BEP, or BEP-U in Toronto. My question is why have their prices diverged so much since we received BEPC shares? Maybe more people want the BEPC? I ask this because the dividend yield for BEPC is 3% and BEP is 3.34%. Thanks for your guidance on all these stocks. Without your logic and reason it would be easy for emotions to take over and sell everything.—Eric F.

A. Thanks Eric. BEP and BEPC represent identical ownership in Brookfield and pay the same dividend. And when the company raises its payout in February 2021, the increase will be the same for both classes of shares. The only difference is the C-Corp has opened the company to a new group of investors that couldn’t hold partnership units.

Both the units and C-Corp shares actually hit new all-time highs today, which means we’re making good money with both. My view is at some point the prices will converge—as it’s a great arbitrage opportunity for those without tax issues. I could not predict when. But again these are two ways to own the same company. Our current advice is to hold onto both—though if the gap persists, we may sell the BEPC to buy more BEP.

Q. Pressure keeps mounting on fossil fuel usage. I feel like this is the tobacco industry replaying itself toward fossil fuel energy companies. I am starting to feel that this is an uphill battle with my investments in your recommendations being clobbered. What is the catalyst that you see that turns this around. I am having a hard time finding one.—Ron K.

A. It’s certainly easy to feel that way Ron. But the eventual catalyst for a recovery in energy stocks is the same as it’s always been. That’s a stronger global economy. As we’ve said, the key for individual companies is to keep adjusting businesses to lower for longer energy prices and resulting lower output for oil and gas in the US—other than natural gas and NGLs for export, which remain pretty robust especially considering the pandemic’s impact on major importers.

It’s tempting to throw out everything here. But even if 2035 is doable as a date for ending new gasoline powered vehicle sales in California, that’s something entirely different from banning them from the roads—which means they’ll still be in use and burning gasoline. And the number of vehicles in the road is still projected to rise the next few years. That means we’ll see a recovery in demand and prices when the global economy cycles out of the pandemic crisis.

Regards tobacco companies, I would argue there are far more differences than similarities with energy now. But tobacco stocks however you may feel about them continue to make investors money—so from that standpoint they would not be a bad precedent.

Again, the economy is the thing for recovery. And the key to riding it is at the individual company level—the small number that are resilient as businesses and that we’re focused on in Energy and Income Advisor.

Q. When I look at the actively managed portfolio and add up the cost I am getting only $43,895.58. Yet, the recommendations are for a $100,000 hypothetical model. Does this mean that the other $56,104.42 is due to stocks sold at a loss? I know my losses are close to that currently. Can you please explain how you get to $100,000 using the shares recommended? I think there should be totals with and overall portfolio returns. Thanks Ed D.

A. Hi Ed. We do have returns for each of the individual positions, including how much we’ve made or lost with them. It’s obviously been a tough market for energy stocks the past few years and the portfolio returns do reflect some large losses in some of the positions, though a few large gains in others like Brookfield. That’s consequently had an impact on overall portfolio value as well. This is a question we can expound on a bit more during the chat if you’d like to ask a follow up—or later with an email if that suits.

Elliott Gue