What happened
Shares of midstream pipeline and storage companies Targa Resources (TRGP 0.67%), Energy Transfer (ET 0.44%), and Western Midstream Partners (WES -0.17%) skyrocketed more than 80% in April, according to data provided by S&P Global Market Intelligence.
Targa and master limited partnership (MLP) Energy Transfer's gains were impressive, with shares up 87.6% and 82.6%, respectively, for the month. Fellow MLP Western Midstream's shares, on the other hand, truly skyrocketed with a 167.9% gain. The longer-term picture isn't as pretty. Shares of all three are down more than 40% year to date, with Energy Transfer's unit price (MLP-speak for share price) down 40.7%. Western Midstream's unit price has sunk 64.9% so far in 2020, with Targa's shares tumbling 66.6% year to date.
Image source: Getty Images.
So what
MLPs are famous for offering high distribution yields. True to form, Energy Transfer and Western Midstream were offering high payouts of 9.5% and 12.5% as 2019 drew to a close. Targa Resources, though not an MLP, was close behind with an 8.9% yield. Those yields were high compared to what the companies had traditionally offered, but not too far out of line with the rest of the sector.
Then came the oil price crash of early March, which pummeled share and unit prices of companies across the oil and gas sector. As those prices plummeted, yields exploded. On March 18, the low point for the oil and gas sector, Energy Transfer briefly found itself yielding more than 25%, while Western Midstream and Targa's yields hit 69% and 77%, respectively.
This couldn't last, of course. That very evening, Targa announced a 90% dividend cut, to $0.10 per share, along with a 24% capital spending reduction. On April 20, Western Midstream cut its distribution by 50%, ending a seven-year streak of quarterly distribution increases. The MLP also slashed its projected 2020 capital expenditures by 45%. Energy Transfer, on the other hand, left its distribution unchanged.
Right now, that gives Energy Transfer about a 16% yield and Western Midstream a roughly 18% yield, while Targa is yielding about 3%. As U.S. oil prices rose from their lows, OPEC+ managed to hammer out an agreement on global production cuts, and an anticipated string of producer bankruptcies failed to materialize, investors decided that maybe pipeline companies weren't in such bad shape after all, and they bid up shares.
Now what
The biggest area of concern for the U.S. oil industry right now is a shortage in storage capacity. Because demand for fuel has cratered thanks to the coronavirus, oil producers -- which are still pumping oil -- are running out of places to put it. That would seem likely to benefit pipeline and storage companies such as Targa, Western Midstream, and Energy Transfer.
However, Targa Resources' pipelines are almost entirely devoted to natural gas and natural gas liquids (NGLs) as opposed to crude oil. Western Midstream and Energy Transfer handle both gas and crude oil, as well as refined products, but they have much larger gas pipeline networks than crude oil networks.
With producers cutting shale rigs left and right, and with concerns that some of them might yet declare bankruptcy, there's a chance that the amount of gas being produced in the U.S. is about to decline sharply. If that happens, it's not clear what the impact will be on gas pipeline companies. On one hand, many of their pipelines are supported by long-term fixed-rate contracts with gas production companies, and those contracts may still have to be honored, meaning the pipeline companies get paid regardless of how much gas is flowing through the pipes.
On the other hand, especially if producers start declaring bankruptcy, the companies may wind up unable to collect their fees, leaving them with excess pipeline capacity they can't fill. They may also have to take on additional debt to fund their payouts or complete expansion projects.
With so much unclear right now, it's probably best to leave the entire oil and gas sector alone until there's more clarity about where things are heading.
