Broadly speaking, the traditional energy sector is off to a rough start this year, but the midstream beckons and that asset class is accessible via the Alerian Energy Infrastructure ETF (NYSEArca: ENFR).

ENFR tracks the Alerian Midstream Energy Select Index (CME: AMEI). ENFR acts as a type of hybrid energy infrastructure ETF, which could help investors capture some of the high yields from MLPs but limits the tax hit from solely owning MLPs. Importantly, many midstream MLPs and energy infrastructure companies are working to deleverage their balance sheets.

There are some compelling reasons to embrace midstream assets, including ENFR, over traditional integrated oil companies.

“We think midstream companies that could benefit from higher demand for export infrastructure and related pipelines, wider differentials, and higher demand for liquefied natural gas, given oil-linked contracts,” according to Morningstar.

Additionally, the midstream space is usually more defensive and less volatile than other energy segments due to steady, reliable cash flows.

Mulling The Midstream

“The macro landscape for midstream remains constructive. US oil and natural gas production hit fresh record highs in November (latest monthly data), and energy exports from the US continue to grow, including exports of liquefied natural gas (LNG),” according to a recent report from Alerian. “In its Annual Energy Outlook 2020, the Energy Information Administration (EIA) forecasts that US oil production will grow to 14 million barrels per day (MMBpd) in 2022 and continue at that volume level through 2045. Natural gas production is expected to see continued growth through 2050, albeit at a more moderate pace than in the past two decades. The US is on track to become a net energy exporter this year.”

ENFR acts as a type of hybrid energy infrastructure ETF, which could help investors capture some of the high yields from MLPs but limits the tax hit from solely owning MLPs. Importantly, many midstream MLPs and energy infrastructure companies are working to deleverage their balance sheets.

“With US production growth moderating, midstream growth capital spending is declining and free cash flow has come into focus (read more),” notes Alerian. “Free cash flow is the next step in midstream’s financial transformation, which has seen the space shift from a heavy reliance on equity markets prior to oil’s collapse to now largely self-funding equity. Midstream is beginning to reach an inflection point of generating free cash flow after dividends, with a few names likely to mark the milestone this year and more names following next year. This should pave the way for improvements like leverage reductions and potential increases in shareholder returns through buybacks or dividend hikes, similar to what was observed in the refining sector in recent years.”

For more information on master limited partnerships, visit our MLPs category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.