Focused on Fundamentals: The 2016 Midstream MLP Roundtable

The breakevens from shale continue to decline as costs decrease and efficiencies improve. We've continued to underestimate the technological improvement in the production sector.

Over the more intermediate term, we expect exports of propane and butane to continue in a bigger way and ethane to be exported from the Northeast to European chemical facilities this year. We believe this need to move additional volume increases the strategic value of coastal infrastructure.

Kiley: While the advent of crude oil, lease condensate and LNG exports in recent months has been interesting for energy industry watchers, we do not think there is ultimately a huge impact on MLPs as a result.

These new markets for volumes are helpful, on the margin, but longer-term demand growth and commodity price stability would go further to advancing MLP security prices going forward.

Is now a good time to invest, given recent price declines? Why or why not?

Feng: Whether or not now, or any given point, is a good time to invest depends on an investor's investment objectives and risk tolerance. Longer-term investors seeking low-double-digit returns and participation in the build-out of North American energy infrastructure may find current prices appealing.

That said, those investors will be asked to stomach continued volatility in the near and medium term given weak commodity prices, volume uncertainty, limited capital markets access, counterparty concerns, higher interest rates, and project deferrals and rationalization.

Kessens: We think a no-growth yield for MLPs is 9 to 10%. The current yield on the Tortoise MLP Index is more than 10%, which implies no or even negative growth in the sector. We don't think that's the case.

We believe growth in 2016 will be in the mid-single digits as cash flow from ongoing and recently completed internal projects are put into service. We calculate nearly $140 billion in midstream MLP and C-Corp pipeline projects between 2015 and 2017.

While current investor sentiment is driven by the direction of crude oil prices, our long-term conviction in the cash flow growth from additional pipeline infrastructure needs and existing assets remains.

When investors appreciate this, we think market participants will look back on the existing period of capitulation and recognize the opportunity that was at hand. Warren Buffett's mantra to "be greedy when others are fearful" seems very apt.

Kiley: Investors with medium- to longer-term investment horizons may find many opportunities to initiate new positions or add to existing allocations as current valuations look attractive for many midstream MLPs. However, we expect continued volatility in the MLP space.

Investors with shorter investment horizons might find this unsuitable, given their tolerances. As with the financial crisis, MLPs underperformed the broader energy sector.

We expect MLPs to outperform the broader energy industry going forward, as commodity prices are unlikely to recover to previous levels any time soon.

What other trends in midstream MLP investing would you like to highlight, and why do you see them as important for the industry's future success?

Feng: We expect merger and acquisition activity to ramp up in 2016. As the saying goes, in a downturn, first you sell your bad assets, then you try to find a joint venture partner for your slate of growth projects, and finally, as a last resort, you sell your good assets or the whole company.

There are many illiquid, small-cap MLPs with private equity sponsors who did not sign up for a macro environment that necessitates additional post-IPO cash investment at the limited partner level as a show of support to the marketplace. As management expectations begin to incorporate lower-for-longer pricing, well-capitalized MLPs should have opportunities to consolidate.

We also expect companies that stick around to seek alternative sources of financing, including preferred equity, payment in kind (or PIK) units, converts and second lien debt.

Kessens: Capital market access, whether traditional equity or non-traditional structured deals, continues to be important for MLPs to meet growth financing needs. While overnight equity capital market access is currently challenged, there are several ways for MLPs to access equity capital including Private Investments in Public Equity or PIPEs, parent/sponsor support, using excess cash flow for funding needs and accessing private capital.

Kiley: Over the last three years, we have seen a shift in how investors gain exposure to the MLP space. Closed-end funds were the first exchange-traded products to offer MLP exposure. In recent years, more and more retail flows are coming in through open-end products like ETFs (exchange-traded funds), ETNs (exchange-traded notes) and mutual funds.

It is likely that the investors exiting these positions in the fourth quarter are tax-loss selling and switching between investment vehicles, and therefore increasing volatility in the space. Higher volatility going forward as a result of these structural changes in the market should be expected, although not likely as severe as what we experienced in 2015.