Energy market commentary: October 2019

Data as of October 31, 2019 unless otherwise noted

Performance (total returns)

Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Energy sector underperformance continues: Energy markets declined in October despite broad equity markets gaining and crude prices remaining essentially flat. Midstream, which has outperformed other subsectors for much of the year, lagged in October. Markets have had to digest the reality that lower crude prices have slowed the rate of production growth in the U.S. Supply has grown 8% this year compared to 20% in 2018, while rig counts have declined by 21%.¹ S&P Energy underperformed the broader index by 4.5%, as crude prices in the mid-$50s/bbl are clearly not enough to get markets comfortable with large-cap energy. HY Energy continued to underperform the rest of the high yield market. The difference between spreads on energy bonds and the rest of the market hit 362 bps, the largest discrepancy since April 2016. The CCC and lower area of the market has been especially weak throughout the year.¹

MLPs have been MIA in 2019 midstream rally: Despite midstream outperforming most of the energy sector so far in 2019, MLPs have lagged significantly behind infrastructure firms structured as C-corps. The AMZX has underperformed the AMEIX by 10.8% YTD, suggesting investor preference for C-corp structures.¹ What could explain this performance discrepancy? First, there are simply fewer midstream MLPs than there were five years ago. Many large midstream bellwethers, such as Kinder Morgan and Enbridge, have done away with the MLP structure and converted to C-corps. This has left just a few large players, namely Energy Transfer, Enterprise Products Partners and MPLX, dominating the MLP space. Second, investors may simply view C-corps more favorably. Corporations tend to have better governance and transparency than firms structured as partnerships. Finally, corporations may have access to a broader investor base than publicly traded partnerships. They are more likely to be included in major indexes and thus may have access to demand from ETFs that track those indexes. Additionally, investors receive a 1099-DIV tax form rather than the laborious K-1 that MLP holders receive, making them more attractive to smaller investors. Whatever the reason, MLPs have materially underperformed midstream C-corps throughout the year, justifying the decisions by many firms to go through these complex restructurings.

Key takeaways

• Energy markets traded up in September on a temporary global supply crunch.
• MLP underperformance suggests investors may prefer companies structured as corporations.