SAN ANTONIO—Neither the MLP structure nor the midstream sector itself are broken, a trio of finance experts told a packed house at Hart Energy’s inaugural Midstream Texas conference. Being stuck in a down cycle might make it appear that way, though.
“I think some MLPs are broken but I don’t think the MLP space is broken,” said Peter Augustini, partner with Energy Spectrum Capital. “Some of the MLPs were wandering into the area where private equity was more appropriate.”
The experts were responding to a question that challenged their relatively bullish outlooks for the sector, given upstream’s commodity price-induced doldrums. They emphasized that the MLP structure and the midstream energy sector were not one and the same, despite conditions that have brought the two together.
“For certain companies of certain size with a certain history, it may be advantageous to move to a C corp model, but generally speaking, MLP makes a lot of sense,” said Brandon Blossman, managing director of Tudor, Pickering, Holt & Co. LLC. “MLPs are codified into tax law as being largely an energy-type investment, so thank the IRS legislators for allowing that. But midstream would exist with or without the MLP. The MLP is just a tax-efficient way for largely retail investors to invest in infrastructure assets.”
What’s changed since MLPs began their market ascent, in tandem with the boom in unconventional oil and gas production, is the overall size of the sector. Success has meant that some players have outgrown the MLP structure, perhaps giving the retail investor the impression that it’s time to pivot toward C corps. Not necessarily.
“The advantage of a C corp today is that midstream is a much bigger sector than it was five years ago,” Blossman said. “You have to access more investors in total than you have historically. It’s not a small space anymore; it’s a big part of the energy landscape. It’s a big part of the public equity landscape today. You need C corps for the larger companies to access the investors that can only invest in C corps. They don’t have the structure and back office to invest in MLPs.”
Energy Spectrum Capital’s strategy for the last seven or eight years has depended heavily on MLPs as the exit market for assets built up from a private equity standpoint.
“We view our cost of capital in the 20%-plus range and it’s hard to get those kind of returns competing head-to-head with MLPs or existing assets with strong cash flow,” Augustini said. “We’ve positioned our activities to feed into the MLPs, particularly more in the early stage to take a little bit more of the growth capital on in, say, a greenfield project before there is cash flow.”
Morriss Hurt, managing director of Encap Flatrock Midstream, said his firm follows a similar strategy: “Get in early, take on some of that early-stage risk, hopefully for an outsized reward if we did our homework right, and also get lucky, which is a part of success for everyone.”
Hurt compared MLPs to a Canadian structure of income trusts that is no longer in place. He noted that the structure was not the only financial vehicle that is effective and that Canada’s industry remains robust without it.
In fact, the North American midstream’s future is a bright in the eyes of Tudor, Pickering, Holt & Co.
“Midstream as a sector is likely to do quite well, we believe very well,” Blossman said. “Not this year, not next perhaps but in the very near future.”
Joseph Markman can be reached at jmarkman@hartenergy.com.
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