Investors should consider the benefits of the energy infrastructure sector and incorporate a midstream exchange traded fund strategy to help enhance their portfolios.
In the recent webcast, Steady As They Go: How Energy Infrastructure May Weather Volatile Markets, Stacey Morris, Head of Energy Research, VettaFi, helped frame the energy infrastructure’s place in the broader energy sector. Energy infrastructure or midstream companies help connect the supply and demand aspects of the market.
Specifically, midstream pipeline business models operate on a PRICE x VOLUME basis. They follow fee-based contracts, and minimum volume commitments provide insulation from commodity price volatility, generating stable cash flows. Storage facilities are leased under long-term contracts, similar to rent, offering cash flow stability with contract lengths varying from one to five years. Additionally, processing plants process natural gas and natural gas liquids into a usable form, and some contracts offer guaranteed facility space at a premium.
Morris argued that investors should consider the energy infrastructure space because of its potentially attractive yields, fee-based revenues, inflation-protected cash flows, and diversification benefits. Midstream MLPs and C-Corps may offer compelling yields above those provided by REITs or utilities. Midstream companies transport, process, and store hydrocarbons, a crucial role that generates predictable fee-based revenues. They offer exposure to real long-lived assets that may generate inflation-protected cash flows. Additionally, the sector exhibits a low correlation to other income-oriented investments, including utilities and bonds – MLPs are not included in broad market indices.
Midstream yields are currently one of the most attractive among income-generating investments. For example, the Alerian MLP ETF (AMLP) underlying index, AMZI, shows a current yield of 7.7%, and the Alerian Energy Infrastructure ETF (ENFR) underlying index, AMEI, has a 5.6% current yield. In comparison, the REITs category shows a 3.8% current yield, utilities come with a 3.5% yield, and the S&P 500 has a 1.9% yield.
Looking ahead, Morris outlined ongoing positive trends, notably in the natural gas markets, that could continue to support the sector outlook. Specifically, the International Energy Agency forecasts global natural gas demand in 2030 will be 15% higher than in 2020, and demand in 2050 will be 13% higher than in 2030. U.S. natural gas production has surpassed pre-pandemic levels, and the U.S. was already the world’s largest LNG exporter in 1H22. Many AMZI and AMEI constituents are primarily focused on handling and processing natural gas, accounting for 57.2% of AMZI by weighting and 70.3% of AMEI by weighting.
Paul Baiocchi, Chief ETF Strategist, SS&C ALPS Advisors, also highlighted the midstream sector’s robust business model with compelling free cash flow yields. AMZI shows a free cash flow yield of 14.3%, and AMEI shows a free cash flow yield of 12.7%. In comparison, S&P 500 components show a free cash flow yield of 4.8%.
Baiocchi argued that this high free cash flow yield helps supports the sector’s attractive dividend payments and can help provide further value for investors through stock repurchases.
To help investors better gauge what type of midstream ETF strategy is the best fit, Baiocchi explained that AMLP provides energy infrastructure master limited partnership exposure. AMLP offers generally high tax-deferred distributions, is exposed to entity-level taxation, provides an income investor objective, is best used in a preferred taxable account type, and is reported on a 1099 tax form.
ENFR, on the other hand, provides access to a broader energy infrastructure MLPs and corporations segment. The ETF generally offers moderate tax-deferred distributions, is not exposed to entity-level taxation, provides a total return investor objective, is best used in a tax-deferred account type, and is reported on a 1099 tax form.
vettafi.com is owned by VettaFi, which also owns the index provider for AMLP and ENFR. VettaFi is not the sponsor of AMLP or ENFR, but VettaFi’s affiliate receives an index licensing fee from the ETF sponsor.
Financial advisors interested in learning more about the energy infrastructure sector can watch the webcast here on demand.