What happened
The price of oil bounded higher today. The U.S. oil price benchmark WTI was up more than 9% by 11:30 a.m. EST on Monday, fueled by news that a vaccine candidate against COVID-19 proved to be more than 90% effective in the final phase of its trial. This data sparked hope that the pandemic could be nearing the beginning of the end. That would enable the global economy to fully reopen, likely driving up demand for oil and refined products.
The rebound in crude prices sent most energy stocks soaring. One of the many subgroups getting a bounce today was midstream companies. Several rallied more than 10% in early morning trading, including ONEOK (OKE -0.39%), Kinder Morgan (KMI -0.64%), Williams Companies (WMB -0.48%), and Energy Transfer (ET 0.12%). Meanwhile, both Enbridge (ENB -1.21%) and Enterprise Products Partners (EPD 0.45%) were up at least 5% in early morning trading.
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So what
Fueling the rally in pipeline stocks is optimism that energy demand will continue recovering, which could push oil prices even higher in the future. That would give oil companies the confidence to drill more wells, which would boost the volumes flowing through midstream networks. This recovery would bolster pipeline company cash flows, providing further support for their high-yielding dividends.
On the one hand, pipeline companies are relatively immune to fluctuations in commodity prices and volumes. Many sign take-or-pay contracts with customers requiring them to pay for capacity on their systems even if they don't utilize that space. Because of their heavy emphasis on these types of agreements, Enbridge and Williams Companies both expect to achieve the midpoint of their initial 2020 guidance ranges for cash flow despite all the turbulence in the oil market.
However, that volatility has impacted the earnings of ONEOK, Kinder Morgan, Energy Transfer, and Enterprise Products Partners this year because they have some exposure to either volume fluctuations or commodity prices. For example, Kinder Morgan produces some oil while ONEOK, Energy Transfer, and Enterprise Products Partners earn some margin-based income that fluctuates with commodity prices and volumes. On a more positive note, the recovery in oil prices from the bottom in the second quarter has bolstered their results over the past few months. Because of that, they expect their full-year cash flows to only be marginally below their initial outlooks.
Meanwhile, 2021 is shaping up to be a much better year for the oil patch and midstream companies because oil demand and pricing should continue improving, especially once vaccinations begin. That would increase the volumes flowing through midstream systems and the associated cash flows earned by pipeline companies. In addition to that, higher oil prices would boost the commodity-price sensitive earnings of ONEOK, Energy Transfer, Enterprise Products Partners, and Kinder Morgan.
Now what
Optimism has returned to the energy sector today on the view that we're closer to an approved vaccine, which would enable the economy to return to normal and would boost energy demand. That would have a trickle-down effect on midstream companies as volumes flowing through their systems would recover, bolstering their cash flows. This improvement would put their dividends, which range in yields from 8% to 12%, on a more sustainable foundation.
