What happened
Oil prices tumbled on Friday after Russia refused to agree to an OPEC-led plan to reduce oil supplies further. By 1:15 p.m. EST, the U.S. oil benchmark, WTI, had tumbled nearly 8%, causing a massive sell-off across the industry, with several large producers plunging more than 10%.
The carnage in the energy sector isn't sparing anyone, including midstream companies, which don't have much direct exposure to oil prices. Several tumbled more than 10% by the mid-afternoon, including ONEOK (OKE +2.32%), Targa Resources (TRGP +2.16%), Plains GP Holdings (PAGP +1.45%), Enable Midstream Partners (ENBL +0.00%), and EnLink Midstream (ENLC +0.00%).
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So what
Lower oil prices will have some impact on the cash flows produced by midstream companies. ONEOK, for example, expects to get 5% of its earnings from commodity-based activities this year and another 5% from the difference in commodity prices from one region to another. While that means it gets 90% of its earnings from stable sources like fee-based contracts, the other 10% has some variability. Because of that, it might not make as much money this year as it initially anticipated.
Targa Resources is at an even greater risk because fees support only 80% of its projected earnings in 2020. If its commodity-based earnings come in below expectations, Targa might need to reduce its dividend. Investors seem worried that might happen, considering today's sell-off pushed its yield up near 13% in a clear sign that the market doesn't believe the payout is sustainable.
Another concern is that with oil prices falling, drillers will likely need to reduce their capital spending plans. If that happens, they'll complete fewer wells than planned this year, which means that midstream companies would transport and process fewer volumes. EnLink Midstream, for example, expected its customers in the Permian Basin to grow their volumes by 35% to 50% this year, which would have boosted the profit of its Permian segment from $146 million last year to a range of $200 million to $210 million this year. However, with crude crashing, its customers might need to cut spending, which could cause EnLink's Permian volumes to come in below the low end of its outlook. That would squeeze its cash flow, which might force the company to cut its payout once again. Even after a reduction of more than 33% earlier in the year, EnLink's yield has risen to an eye-popping 25% after today's plunge.
Investors are also worried about Enable Midstream's ability to maintain its sky-high payout, which now yields more than 25%. One factor driving their concern is how the company will finance its planned $640 million investment in the Gulf Run Pipeline project if market conditions continue deteriorating. Investors seem to think the company will have no choice but to reduce its distribution and use those funds to finance construction so that its balance sheet doesn't weaken.
Weaker market conditions are already having an impact on Plains GP Holding and its affiliated MLP, Plains All American Pipeline (PAA +1.81%). That company expects earnings from its market-sensitive supply and logistics segment to plunge this year. The company is taking proactive measures to maintain a strong balance sheet by selling assets so that it can finance expansion projects while continuing to support its 12%-yielding payout.
Now what
Investors continue to bail out on energy stocks due to the seemingly unending volatility in oil and gas prices. Dividend yields are spiking as investors anticipate another round of dividend reductions.
One stock, however, that should be immune to a reduction is ONEOK. As noted, it gets 90% of its income from stable fee-based sources. On top of that, it has a strong balance sheet, so it has the flexibility to finance its expansion program, which has it on track to grow its earnings by 25% this year and another 20% in 2021. While it might not grow quite that fast due to the current market turbulence, it should still expand its cash flow at a well above average pace. Add in its now 6%-plus dividend yield, and it's an even more attractive buy after today's sell-off.
