What happened

Oil prices are snapping back today following yesterday's historic sell-off. Crude closed more than 10% higher on the day, fueled in part by a rash of spending cuts across the oil sector

That powered a ferocious rally in the midstream sectorEnable Midstream (NYSE:ENBL), for example, was up a jaw-dropping 131% at 3 p.m. EDT, while NuStar Energy (NYSE:NS)Noble Midstream Partners (NYSE:NBLX), and Western Midstream Partners (NYSE:WES) all rallied more than 20% by the mid-afternoon. 

A twist of pipelines with a bright sun shining through.

Image source: Getty Images.

So what

Yesterday's sell-off in the oil patch pummeled pipeline stocks. Several industry leaders tumbled more than 15%, while smaller midstream companies fell even further as investors bailed on the energy sector following oil's worst one-day decline since 1991. Fueling the sell-off in pipeline stocks were fears that the crash in crude oil prices might cause drillers to go bankrupt, which would affect their ability to pay midstream companies for transporting their production. That would affect the sector's ability to maintain its high-yielding dividends.

Even after today's rally, investors remain concerned that a wave of dividend cuts could be forthcoming. Enable Midstream, for example, still yields an eye-popping 28%, a clear sign that investors don't think it can maintain its current payout level. They hold similar views on the sustainability of the payouts of NuStar Energy (current yield 19%), Western Midstream (35%), and Noble Midstream Partners (50%).

The reason investors believe that these payouts won't last much longer is that oil companies will need to adjust their spending plans to the new reality of $30 oil. They'll produce less oil and gas, which will affect the volumes flowing through the gathering systems these companies operate.

Western Midstream has already experienced this firsthand. Its top customer, oil giant Occidental Petroleum (NYSE:OXY)slashed its capital spending plan and dividend following yesterday's oil rout. It probably won't ship as much volume through Western Midstream's assets, which would negatively affect its cash flow and ability to maintain its sky-high payout.

Noble Midstream, Enable Midstream, and NuStar Energy have similar risks because they focus on gathering oil and gas directly from wells. With energy companies likely finishing fewer wells this year, these companies will bear the brunt of that impact.

Now what

The market was worried about the long-term sustainability of these high-yielding energy companies long before crude crashed into the $30s. It now seems almost certain that many will have no choice but to reduce their high payout levels and redirect that cash toward paying down debt. Investors should thus avoid smaller midstream companies with sky-high yields.