- Commodities market is currently experiencing a supply side destruction
- U.S. oil rig count has been on the decline, and the market tends to anticipate that it will push up prices
- Consequently, with breakeven costs at $45 per barrel due to roll costs, many traders are now looking at MLPs where payouts are sustainable
Master limited partnerships and sector-related exchange traded funds have been caught in the energy markets’ volatile swings, potentially leaving the asset class an opening to outperform as fundamentals pull through.
“Midstream MLPs’ revenues are more resilient to oil price fluctuations than upstream oil companies’ revenues yet they are trading more like upstream oil companies,” James Butterfill, Executive Director and Head of Research & Investment Strategy at ETF Securities, said in a research note. “We believe there is potential for an upward correction as MLP resilience becomes apparent.”
The commodities market is currently experiencing a supply side destruction, which has helped contribute oil’s rebound, Butterfill explained in an interview with ETF Trends. Specifically, the U.S. oil rig count has been on the decline, and the market tends to anticipate that it will push up prices. Meanwhile, Butterfill believes demand will be flat at worse.
The strategist also pointed out that oil levels are sustainable at over $45 per barrel based on current costs. Meanwhile, Saudia Arabia’s costs are above $100 a barrel, which are being undercut by the nascent shale oil hydraulic fracturing or fracking industry where average costs are about $65 to $70 a barrel.
Consequently, with breakeven costs at $45 per barrel due to roll costs, many traders are now looking at MLPs where payouts are sustainable.
MLPs primarily deal with the distribution and storage of energy products, so their business model is less reliant on the commodities market since MLPs profit off the quantity of oil and natural gas they are able to move around. Consequently, MLPs have historically shown a weaker correlation to energy prices over longer periods as MLPs act more like energy toll roads, profiting on the volume of oil moving through their pipelines.
“We believe midstream MLPs are trading at levels that reflect the distress in the energy sector,” Butterfill said. “By virtue of the resilience of their revenue streams, current valuations on EV/EBITDA basis and managed debt levels, midstream MLPs are well positioned to appreciate given a turnaround in stressed capital markets and sentiment.”
For instance, energy infrastructure or master limited partnerships, such as the JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ) and Alerian MLP ETF (NYSEArca: AMLP) have declined 37.0% and 32.0% over the past year as West Texas Intermediate crude oil prices decreased close to 50% and the S&P 500 energy sector dropped almost 20%.
Looking at the precious metals space, Butterfill pointed out that gold has made a great run as a defensive asset, but bullion is now fairly priced and could remain flat from here on out unless sentiment changes. The strategist pointed to factors like inflation, speculative positioning, foreign exchange rates, a so-called Brexit or an elected non-establishment president like Donald Trump could further roil the precious metals market.
The ETFS Physical Swiss Gold Shares (NYSEArca: SGOL) has increased 18.9% year-to-date, with Comex gold futures now trading at around $1,253.9 per ounce.