Like the broader energy sector, master limited partnerships (MLPs) and the ALPS Alerian MLP ETF (NYSEArca: AMLP) – the largest MLP ETF – have taken some hits this due in large part to the coronavirus pandemic.
While the U.S. is experiencing a second wave of COVID-19 cases, markets may already priced in the worst for the energy sector and that could mean opportunity is afoot with MLPs.
“While the initial impacts of COVID-19 first appeared at the end of 1Q, the most severe impacts in terms of demand and oil production were squarely in 2Q, which could impact midstream results – though likely to a lesser degree than for oil producers or refiners,” writes Alerian analyst Stacey Morris in a recent report. “Of course, the weakness in oil prices with WTI prices briefly trading in negative territory in April and production shut-ins will more profoundly impact the results of exploration and production (E&P) companies.”
MLPs don’t make their money based on oil or gas prices. Unlike other energy sector stocks, 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.
Assessing Demand for Oil
The demand outlook for oil has recently been inconsistent with the economic reopening leading to increased consumption, but the opposite scenario could come to pass should more states shutter businesses again. However, producers are working to trim supply.
At the Joint Ministerial Monitoring Committee meeting Wednesday, the Organization of the Petroleum Exporting Countries and allied producers said they will limit record production cuts of 9.7 million barrels per day to 7.7 million barrels per day beginning in August through the end of the year amid possible signals of amelioration in the oil market.
“Turning to the demand side of the equation, US demand for petroleum products was down significantly in 2Q20 as COVID-19 countermeasures interrupted normal consumption patterns,” notes Morris. “Jet fuel was most severely impacted but only represented 10% of total US finished petroleum product demand in 2019. Gasoline and diesel also saw significant demand destruction.”
Master Limited Partnerships charge a fee for each barrel of petroleum or MMcf of natural gas transported. This covers smaller pipelines connecting wells to hubs or processing facilities for natural gas, which are more sensitive to production dynamics, along with Larger, longer pipelines that connect hubs or producing regions with end markets. These MLPs typically charge rent for third parties to use storage tanks.
Other funds with exposure to income-generating energy assets include the VanEck Vectors Energy Income ETF (EINC) and the Global X MLP ETF (NYSEArca: MLPA).
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