Price Differentials Are A Clear Signal Of A Need For Capital In The Oilier Part Of Midstream, Says Senior Vice President At Morgan Keegan; Read More Of His Take On The Oil And Gas Space In This Exclusive Interview
April 4, 2012 - The Wall Street Transcript has just published Oil & Gas: Master Limited Partnerships Report offering a timely review of the sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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John D. Edwards is Senior Vice President and Senior Equity Research Analyst for Morgan Keegan & Company, Inc., leading the firm's research effort covering publicly traded partnerships involved in energy and energy infrastructure. Before joining Morgan Keegan in 2006, Mr. Edwards was a Managing Partner of Vektor Investment Group, LLC, where he consulted on energy infrastructure projects and real estate development. He also worked in equities research with Deutsche Bank Securities Inc. as a Vice President and Senior Analyst covering natural gas pipelines, and as an Associate Analyst covering automotive suppliers. Mr. Edwards began his career in the energy industry with Edison International, where he worked in a variety of roles including regulatory finance, M&A, project finance and business development for independent power generation projects. He received his B.A. in economics from Occidental College in Los Angeles, and an MBA from California State University, Fullerton, and also has earned the Chartered Financial Analyst designation. He is also a Member of the CFA Society of Houston.
TWST: It may depend on which subsector you're talking about, but what is your overall sentiment on the space right now and why?
Mr. Edwards: The way we value it, we're looking for roughly a 8% to 20% total return over the next 12 months. And the way we get there is we look at what our distribution growth outlook is. We look at a target yield based on what the spread is relative to the U.S. 10-year Treasury issue. And then, using that information, we can sort of back-solve, if you will, and derive where we think the sector is likely to trade, and that gets us to a base case return of between 8% and 20%. Our bias is that it will be more toward the upside of that range, probably in the 10% to 16% range.
TWST: How did the units perform last year compared with what you're expecting this year?
Mr. Edwards: The return last year was just under 14% including distributions, beating the S&P 500 for the 12th year in a row. For this year, again, we're at looking roughly the midteens.
TWST: So you expect 2012 to be a better year?
Mr. Edwards: We are looking for a little stronger distribution growth in 2012, and as we indicated earlier, total return approximately equivalent to what we experienced in 2011. Last year, our target was a 4% to 6% distribution growth range, and again, we were close to the upper end of that range, around 6%. This year, our assumed range is between 5% and 8%, and with a target, if we want to narrow it, of probably in the 6.5% to 7.5% range. So we think things are going to be a little bit better this year than last year.
TWST: What's driving that growth?
Mr. Edwards: What's driving that is more capital investment in the sector. There is a substantial amount of capital deployed, and as those projects come on line, you're going to see growth in distributions. The sector invested around $19 billion last year, and in 2010, about $16 billion. You start putting that kind of capital to work, you're going to start generating some stronger distribution growth.
TWST: What are some of the notable projects or key areas these companies are particularly active in?
Mr. Edwards: This year, what we're really seeing take place is those companies involved in the oilier part of midstream is where there is a real need for capital. And one of the obvious indicators of that is you see right now is the wide differential between the price of Brent crude and the price of WTI, and then you see an even further discount between what WTI is and what crude coming out of North Dakota is selling for. You have somewhere in the neighborhood of a $50 differential between Brent crude, which is in the ballpark of $125 a barrel, and North Dakota crude, which has been in the $75/bbl range. And so that price differential is sending a clear signal of the need for oily type infrastructure.
TWST: So overall, are there better opportunities in the midstream right now?
Mr. Edwards: Yes, though I wouldn't put it as better opportunities. There are substantial opportunities in midstream. One of the ways to think about it is: Where is the midstream infrastructure needed, and what are the kinds of rates of return that the upstream players are making? The average rate of return that upstream players are getting on dry gas is very low.
It's averaging something like a 5% rate of return with a range of roughly 0% to 10%. That's one reason why you're seeing a big cutback in the number of gas rigs being deployed. Whereas the rate of return in natural gas liquids plays around some of these basins like the Anadarko (APC), Eagle Ford, Marcellus, etc., is approximately 50%, and then on oily plays - the Permian, Bakken, Niobrara, etc. - they're also averaging around 50%. So that means you're going to see a demand for infrastructure in these oilier areas as the producers continue to put capital to work drilling in these oilier plays.
TWST: What stood out for you as highlights or themes from the most recent quarterly earnings?
Mr. Edwards: I'd say, most companies did very well. I'd say you had more meets and beats than misses. I'd say that the distribution growth outlook was mostly confirmed, so it's quite strong and so, in essence, I think it confirmed our view that MLPs are poised to have a pretty good year.
TWST: What are your favorite names right now and why?
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