What happened
In March, units of midstream pipeline master limited partnerships DCP Midstream (DCP) and Noble Midstream Partners (NBLX) fell by 73.9% and 77.2%, respectively, while shares of midstream pipeline company Targa Resources (TRGP 0.77%) fell by 78.7%, according to data provided by S&P Global Market Intelligence.
These were some of the worst performances in the energy industry, and much worse than the overall midstream pipeline segment as a whole, as measured by the Dow Jones U.S. Pipeline Index, which only fell 37.7% for the month, or the Hennessy Midstream BP Investor Fund, which was down 45.7%. And it was far worse than the S&P 500, which only made a 12.5% retreat. But that's what happens when you cut your payout, and all three companies announced dividend or distribution cuts during the month.
Image source: Getty Images.
So what
The reason the overall oil and gas industry performed so poorly in March was primarily due to collapsing oil prices. Global oil oversupply had already been keeping prices from rising significantly above the $60/barrel range for several months. That oversupply persisted even though the OPEC+ alliance, which consists of Russia as well as all the OPEC members, including Saudi Arabia, had been limiting production.
On March 6, though, OPEC+ talks about renewing the production limits, which were set to expire at the end of March, fell apart. Russia refused to curtail production, which it saw as primarily benefiting U.S. shale oil producers. Shale oil production, which relies on complex techniques like hydraulic fracturing and horizontal drilling, is more expensive than traditional drilling.
Russia vowed to ramp up production, and Saudi Arabia did the same, and other OPEC members followed suit. Saudi Arabia then began offering discounts to its biggest customers, flooding the market with cheap oil. WTI Crude, the primary U.S. benchmark, toppled from more than $50/barrel to -- briefly, on March 30 -- less than $20/barrel.
Then what
With oil prices so low, U.S. shale producers -- many of which had been struggling to turn a profit at $50/barrel oil -- immediately went into triage mode. Shale driller Apache Corporation announced an immediate end to its Permian Basin operations. Whiting Petroleum has already filed for bankruptcy protection. Many others have begun deactivating their U.S. shale wells.
U.S. midstream pipeline companies have different levels of exposure to shale, largely depending on what kind of pipelines they operate. For example, a company that primarily operates long-haul pipelines delivering refined fuel to large urban markets isn't going to be as affected by the current situation as a company that operates a gathering system collecting crude oil from various wells in the Permian Basin.
These three companies, unfortunately for their investors, had a lot of exposure to shale drilling. Both Targa and DCP primarily operate gathering pipeline systems in shale basins in Texas and Oklahoma. The long-haul pipelines in which they each have a stake -- including the Gulf Coast Express gas pipeline, in which they both are partners -- run from shale basins to processing facilities on the Gulf Coast. And since shale drillers generally extract both gas and oil, it doesn't matter that Targa is mostly focused on gas and DCP on natural gas liquids (NGL).
Noble Midstream, the smallest of these three companies, operates crude oil and gas-gathering systems in Colorado's DJ shale basin and Texas' Permian Basin, plus a single crude oil pipeline out of the Permian.
In other words: shale, shale, shale. And that's why all three companies slashed their payouts. DCP cut its distribution in half, to $0.39/unit; Noble Midstream reduced its payout by 73%, to $0.1875/unit; Targa slashed its monthly dividend by 89%, to just $0.10/share.
Now what
If shale drilling dries up -- which is looking more and more likely as oil prices sink -- these pipeline companies might see some one-time payments as drillers pay fees for canceling their contracts, but it's still going to be a huge blow to their businesses. And none of these companies has a sterling financial record. Targa posted net losses for all of 2019. DCP has a debt load that's an eye-popping 9.4 times EBITDA. Noble is in the best shape of the three but has still increased its debt load by nearly 650% over the last three years.
A major reason for investing in midstream companies -- especially MLPs -- is for a reliable, generous dividend or distribution yield supported by solid growth prospects. All three companies have cut their payouts by at least 50%, and shale growth in the U.S. has lurched to a halt.
There are much more attractive companies in the midstream space: Investors would be best served by avoiding these three underperforming ones.
