What Are Midstream Energy Companies?

Midstream energy companies are the link between the Upstream producers and the Downstream companies that refine, distribute, and use energy products. Midstream companies provide services such as gathering systems, long-distance pipelines, processing, and storage. They are a vital and growing component in the US energy infrastructure.

World's Largest Network of Energy Pipelines

What Makes Midstreams Different from Other Companies?

Essential services. Midstream companies are a key component in the delivery of essential services throughout the United States. Midstream pipeline and processing companies bring natural gas and crude oil from its extraction source to essential service providers such as utilities and refineries.

Durable revenues. Midstream companies often generate their revenue from long-term, fee-based contracts. While commodity prices influence some companies' earnings, most earn fees on volume, not price. These contracts have end dates, usually ranging from five to 20 years, but it's atypical that a shipper (an Upstream company) or a receiver (a local utility, for example) will switch to another Midstream service provider when the lease ends.

Need for capital growth. Midstream companies are not geographically limited—they can build facilities and operate where the need arises. The emergence of shale-drilling technology has created a demand for Midstream infrastructure in many new areas around the country. Meeting that demand requires these companies to raise capital to build out their capacities.

Industry Factors

Energy prices can be highly cyclical. For example, prices for oil and natural gas recently peaked in the summer of 2014, fell significantly through early 2016, and subsequently rebounded in the spring. Quite a few Midstream companies during that period saw their stock price drop by over 50%. During the downturn, many investors had concluded that lower commodity prices would curtail profits and lead to dividend reductions.

But this analysis overlooked a key aspect about the energy infrastructure business. Commodity transport volumes have a bigger impact on Midstream companies than commodity prices, and it's the demand for energy that drives volume over time. That demand continues to grow strongly. According to June 2016 data from the US Energy Information Administration, US crude oil consumption is up over 5% from the same period in 2014, while natural gas consumption is up nearly 10%, led by utilities' displacement of coal-fired generation with gas.

In our view, investors should have been focusing on higher demand rather than lower prices, since Midstream companies benefit from higher volumes. Of course, lower commodity prices can eventually result in lower fees collected for transporting the oil and gas. US crude production has been declining, which has created concern over volumes. In addition, there is concern over gas-gathering volumes in certain areas (Barnett, Haynesville, for example) due to low commodity prices. In turn, low prices are what is leading to pipeline contracts being renegotiated.

Company-specific Factors

Each Midstream company's advantages and disadvantages vary. Instead of lumping all Midstream companies together, investors should consider a company's performance on the following metrics:

  • Distribution coverage
  • Distribution growth history and outlook
  • Direct exposure to commodity prices
  • Balance sheet strength
  • Quality of management team

Though possessing these desired qualities may not entirely immunize a Midstream company from market-induced price swings, it can help identify companies that will weather the down markets and prosper when valuations return to normal.

INVESTMENT PRODUCTS: ARE NOT FDIC INSURED • MAY LOSE VALUE • ARE NOT BANK GUARANTEED

© 2017 Miller/Howard Investments, Inc. All rights reserved.

This material represents Miller/Howard Investments' views. These views may change based on changing circumstance. The information provided should not be considered a recommendation to buy or sell any security, and should not be considered investment, legal, or tax advice. Information is obtained from sources believed to be credible and reliable, but its accuracy, completeness, and interpretation cannot be guaranteed.
: