Data as of May 31, 2020 unless otherwise noted.

PERFORMANCE (TOTAL RETURNS)
BENCHMARKS MAY 2020 YTD
Alerian MLP Index (AMZX) 8.95% -30.21%
Alerian Midstream Energy Select Index (AMEIX) 7.12% -28.31%
ICE BofAML U.S. High Yield Energy Index (HY Energy) 12.73% -21.79%
S&P 500 Energy Index (S&P Energy) 1.88% -34.49%
Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Markets cautiously optimistic as green shoots appear: Energy markets, while still well below pre-COVID levels, extended their rebound among other risk assets in May. S&P Energy climbed 1.88% in May but underperformed the rest of the equity markets after being the top-performing sector in April. Q1 earnings reports showed that energy sector EPS fell -21% y/y.1 The midstream sector showed strong performance last month, with the AMZX and AMEIX returning 8.95% and 7.12%, respectively. Each, however, still yields more than 10% as the sector is challenged by declining U.S. production volume in the face of low prices. HY Energy logged its second consecutive stellar month, up 12.73% as crude prices rose and the broader high yield market rallied. Spreads have tightened sharply but remain well wide of historical averages.1 The energy sector remains challenged; commodity prices are still extremely low, demand is challenged, and companies have announced large cuts to capital spending. However, green shoots are beginning to appear, and there is some evidence that March and April may have been the nadir for the sector.

U.S. oil production is dropping – what does it mean for midstream? The COVID-19 crisis and commensurate economic shutdowns have caused energy demand and prices to collapse. Crude producers have cut back on production in an attempt to bring supply more in line with demand. Much of this reduction has been in the form of voluntary cuts by OPEC+, but production in North America has also slowed significantly as private firms cut back. In the U.S., crude output sits at 11.4 MMbpd, 11.6% below December 2019 levels, and active crude rig counts have fallen by two-thirds this year as firms have shut in all but their most efficient rigs.1,2 As a volume-driven business, this certainly impacts midstream, and stock performance this year implies that the impacts may be significant. While the current environment will certainly affect investments in new projects, many midstream firms have contractual protections in place that help insulate them from rapid dips in volume. Among these are minimum volume commitments (MVCs), which stipulate a minimum volume and fee that will be paid by the producer to the infrastructure firm, regardless of actual volume. While not all contracts include MVCs, data from Alerian shows that many of the larger midstream companies have significant revenue tied to these protections.3 Of course, there is still risk of upstream customers not being viable going forward. However, we continue to believe the midstream sector offers a compelling risk/reward profile, especially at current valuations.

KEY TAKEAWAYS

  • Midstream led a continued recovery for the broader energy sector in May.
  • While falling production volume is a negative for midstream, many firms have protections in place to help mitigate impacts.

1 ICE BofAML U.S. High Yield Energy Index.
2 Baker Hughes.
3 Alerian.


Index descriptions: Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs) and is a float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization. Alerian Midstream Energy Select Index is a composite of North American energy infrastructure companies and is a capped, float-adjusted, capitalization-weighted index, whose constituents are engaged in midstream activities involving energy commodities. ICE BofAML U.S. High Yield Energy Index is designed to track the performance of U.S. dollar-denominated high yield rated corporate debt publicly issued in the U.S. domestic energy market. S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) energy sector.

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This energy market commentary and any accompanying data is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The energy market commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such energy market commentary. The energy market commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the energy market commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.