How U.S. Production and Export Growth Benefit Midstream

The U.S. has notably become a major energy exporter in recent years, including taking the title of top LNG exporter in the first half of 2022.

There has been tremendous growth in U.S. production of oil and natural gas, and midstream companies are responsible for transporting oil and natural gas and ensuring it is in useful form, providing crucial infrastructure for the industry. 

Looking at production trends in the U.S. helps frame one of the key focuses in the midstream space over the past couple of years: free cash flow generation, Stacey Morris, head of energy research for VettaFi, said on October 27 during Back to the Fundamentals: How U.S. Production and Export Growth Benefit Midstream.

“We saw so much production growth in the years leading up to the pandemic. Midstream companies were spending billions and billions of dollars to facilitate that growth by building new pipelines, building new processing plants, building export terminals,” Morris said. “As growth has taken a more modest acceleration, that’s actually allowing companies to spend less in terms of capital spending, and generate more free cash flow, which we think is a sticky tailwind for this space.”

While the production of natural gas has remained strong, the production of oil has slowed down a bit in recent years. 

There are several components impacting oil production growth, including the slow recovery since volumes tumbled in 2020 with oil prices collapsing, producers being focused on capital discipline, and supply chain issues and labor constraints. While it may seem counterintuitive because midstream businesses are thought of as being volume driven, this is actually a really good environment for the midstream space, Morris said.

“This kind of sets up a Goldilocks scenario where you have some production growth – which is good, that brings opportunities – but you don’t have too much production growth that midstream companies have to start spending a lot of money, losing the free cash flow theme. That’s not going to happen at this kind of production growth level,” Morris said. “You also have more support for commodity prices: Oil prices are going to be higher when we don’t see as much supply come on the market.”

The production of natural gas saw a very modest decline compared to the decline seen in oil production between 2019 and 2020.

“I think that’s reflective of the stability of the demand backdrop for natural gas, the sort of baseline economic import of natural gas as it relates to electricity generation in the United States, and the increasing export opportunity for natural gas in the form of liquefied natural gas, or LNG,” Paul Baiocchi, chief ETF strategist for SS&C ALPS Advisors, said during the LiveCast.

Natural gas has the highest share of electricity generation in the U.S. and will likely continue to be the most important input into electricity generation going forward, according to Baiocchi. This is largely because natural gas is taking share from coal, as well as being used as a backstop for clean energy sources such as wind and solar. 

There are many longer-term tailwinds for natural gas. As consumers continue to pivot toward electric vehicles, the electricity demand will increase, meaning more natural gas demand. Another large tailwind has to do with LNG capabilities. 

“As a result of tremendous investment in LNG export capabilities and infrastructure in the United States, and the ongoing investment in that infrastructure, there’s a new outlet that didn’t exist even 5–10 years ago,” Baiocchi said. 

The export capacity of LNG from the United States is going to continue to grow, reaching 25 billion cubic feet per day, as soon as the next decade, Baiocchi said. 

“This is a really good story for the midstream space because it creates more demand for infrastructure and allows companies to enter really long-term contracts,” Morris said. “LNG sale agreements are usually for about 20 years, so the corresponding pipeline agreements for supplying an LNG facility also tend to be about 20 years.”

SS&C ALPS has two strategies that offer investors exposure to the energy infrastructure space: the Alerian MLP ETF (AMLP) which offers exposure to MLPs that operate in the energy infrastructure space, and the Alerian Energy Infrastructure ETF (ENFR), which provides exposure to the energy infrastructure space, but broadens the universe to include both C-Corps and MLPs. 

ENFR has a greater focus on total return, whereas AMLP has a greater focus on yield – between 80–85% of AMLP’s distributions historically have been considered a tax-deferred return of capital, Baiocchi said.

Notably, neither fund comes with the hassle of a K-1. 

For more news, information, and strategy, visit the Energy Infrastructure Channel.

vettafi.com is owned by VettaFi, which also owns the index provider for ENFR and AMLP. VettaFi is not the sponsor of ENFR and AMLP, but VettaFi’s affiliate receives an index licensing fee from the ETF sponsor.