The Energy Infrastructure Newsletter • Fall 2020
As an investment advisor, you have been subscribed to the Energy Infrastructure Newsletter so that you and your clients can stay abreast of this powerful emerging subsector. Formerly the MLP Newsletter, the Energy Infrastructure Newsletter is published in partnership with the Energy Infrastructure Council, a nonprofit trade association dedicated to advancing the interests of companies that develop and operate energy infrastructure. EIC addresses core public policy issues critical to investment in America’s energy infrastructure.
In this Q&A, Quinn Kiley, senior portfolio manager for Tortoise, tells Advisor Access that the energy sector has responded to recent black swan events with discipline and a renewed focus on clean and renewable resources, including natural gas, solar and wind power, and hydrogen.
Despite Pandemic Hit, Energy Industry Remains Poised for Growth
Advisor Access: 2020 has been an outlier in many ways. How has that translated into the energy industry?
Quinn Kiley: We entered the year with oil priced near $60 per barrel, and the United States was the largest producer of oil and natural gas in the world. Prices had been supported by strong economic growth globally and agreements between OPEC and Russia to reduce production.
Both of these supports were upended early in March. The outbreak of the COVID-19 pandemic shut down economies, destroying demand for energy. Coincident with this biological crisis, Saudi Arabia and Russia began a price war, removing those previous production cuts and flooding the world with crude oil.
The result of these double black swan events was excess supply and insufficient demand. Global inventories for crude oil, refined products, and natural gas built at alarming rates and put severe pressure on commodity prices. In that environment, energy securities saw unprecedented price declines. Prices for securities and the commodities bottomed in March and April, and slowly reversed as economies reopened around the world. Importantly OPEC and Russia reinstated production cuts, and producers around the world cut production for economic reasons, as low prices did not support previous levels.
AA: How have energy companies responded to this new environment?
QK: The industry has been suffering under a lower commodity price environment for the last five years. During that time, investors have pressured management teams to focus on strong balance sheets, capital discipline, and free cash flow generation. Previously, the U.S. industry had been focused on growth of production. In a low-price regime, much of that previous capital was destroyed.
Even before COVID-19, management teams had received the message: Capital expenditure outlooks were lowered and debt was being paid down. The crisis accelerated these trends. The capital plans for oil and gas producers was lowered another 35%, bringing the year-over-year comparison down over 60% compared to 2019. Companies are signaling a further 20% reduction in 2021. These decisions by producers have midstream and downstream implications as well, and the overall industry is seeing greater discipline in capital spending.
AA: You mentioned that the COVID-19 crisis accelerated already ongoing trends. Can you expand on that?
QK: We have been forecasting a free cash flow inflection in 2020 for some time, and these reduced capital plans improve the free cash flow outlook for the energy companies we invest in.
The big question for management teams is, what to do with your excess cash flow? First, we believe free cash flow should fund the equity portion of any capital projects you move forward on. Second, cash should be directed to paying down debt when leverage is too high. Third, once a company reaches appropriate leverage levels, cash should be returned to investors through a combination of dividends and share buybacks, to the extent those shares are undervalued.
The pace of all these actions has ticked up this year, and although energy equities have not recovered with the broader market, these actions set up an attractive value proposition in the energy space.