Intermediary/MLP: central free cash flow

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Summary

  • Stable cash flow and a significant reduction in growth capital expenditure plans should support midstream companies’ strong free cash flow (FCF) generation for years to come.
  • Midstream’s abundance of FCF has supported debt reduction, a proliferation of buyback programs and broad-based dividend growth over the past year.
  • With capital expenditure reductions measured in the billions, it is easier to see why energy infrastructure FCF is so important and sustainable.

As there has been no shortage of bad news in equity and commodity markets over the past few weeks, today’s note highlights a steady tailwind for the midstream sector – strong free cash flow generation ( FCF). VettaFi research frequently mentions robust midstream FCF, which is fueling buyouts and dividend increases, but it’s useful to quantify FCF at the company level. A brief overview of midstream capital spending trends helps explain why energy infrastructure companies are generating so much excess cash and why this tailwind is long-lasting.

Energy Infrastructure Free Cash Flow: Bring in billions.

Permanent revenue attraction aside, one of the key elements of the investment thesis for the midstream in recent years has been significant free cash flow generation. The abundance of FCF has supported debt reduction, a proliferation of buyback programs (read more) and widespread dividend growth over the past year (read more). The table below shows the estimated 2022 FCF (operating cash flow less capital expenditure) and FCF returns for some of the biggest names by weighting the entire Alerian index suite based on consensus estimates. FCF returns posted average 11.3%, more than double the S&P 500’s FCF return of 5.0% at the end of June.

Based on the consensus estimates presented in the table, all 14 names are expected to generate positive FCF, and all but TC Energy (TRP) are expected to generate excess cash flow even after dividends. Keep in mind that the dividend yields of most of these companies are north of 5%. With few exceptions, companies generally spend more cash on paying dividends than on capital investments, as the execution rate of capital expenditures has dropped significantly. Note that consensus capital expenditure estimates do not include acquisitions announced this year.(1)

Why is interim free cash flow so high and can it continue?

A brief history of interim capital expenditures is helpful in understanding the magnitude and sustainability of interim free cash flow generation. From 2010 to 2019, annual U.S. oil production increased from 5.5 million barrels per day (MMBpd) to 12.3 MMBpd, and marketed natural gas production increased from 61.3 billion feet cubes per day (Bcf/d) to 99.9 Bcf/d. Energy infrastructure companies have spent hundreds of billions of dollars to facilitate this tremendous growth by building pipelines, processing facilities, export terminals and other critical infrastructure backed by long-term, fee-based contracts. know more). As U.S. output growth accelerated in 2018 and 2019, intermediate capital spending peaked.

Capital spending was already declining in 2020 with moderate production growth, but budgets were then further reduced in the wake of the pandemic as US energy production fell (read more). Spending plans rebounded slightly as the macro environment strengthened, but remain well below 2019 levels for nearly all midstream companies. Of the 14 names in the table above, all but TRP had lower CAPEX in 2021 compared to 2019, and on average, the decline in CAPEX from 2019 to 2021 was 62.9%. In dollars, the average decline was $1.7 billion, with a range of $800 million to $3.1 billion.

With capital expenditure reductions measured in the billions, it is easier to see why energy infrastructure FCF is so important and sustainable. Intermediate capital spending is very unlikely to return broadly to the levels seen in 2018 and 2019 when US oil production growth was very strong (up 2.9 MMBpd or ~30% from Dec 2017 to Dec 2019) . According to the Energy Information Administration’s forecast, U.S. oil production is not expected to return to pre-pandemic highs until the fourth quarter of 2023. In other words, the need for new infrastructure will not be as great. that he was. There are opportunities for growth today (read more), but the frenetic infrastructure building of the 2010s is unlikely to happen again as production growth rates are likely to be more modest in the future and much infrastructure have already been built, which could reduce costs. effective extensions.

Since capital expenditure should remain measured, it is important to discuss the other component of FCF – operating cash flow. Infrastructure construction in the 2010s led to growth in cash flow for midstream companies. These long-lived assets will likely continue to generate charges that will generate stable cash flows for years to come, whether oil prices are $120, $80 or $60 a barrel. There is also potential for growth through new projects, extensions of existing assets or acquisitions.

Conclusion :

Stable cash flow and a significant reduction in growth capital expenditure plans should support midstream companies’ strong free cash flow generation for years to come, allowing companies to return cash to shareholders through dividends and redemptions.

For more news, insights and strategy, visit the Energy Infrastructure channel.


AMNA is the underlying index of the ETRACS Alerian Midstream Energy Index ETN (AMNA). AMZI is the underlying index of the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB). AMEI is the underlying index of the Alerian Energy Infrastructure ETF (ENFR) and ALPS Alerian Energy Infrastructure Portfolio (ALEFX).

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(1) Significant acquisitions announced this year include the purchase of Navitas Midstream by Enterprise Products Partners (EPD) for $3.25 billion, the acquisition of assets of Trace Midstream by Williams (WMB) for $950 million and the acquisition of Lucid Energy by Targa Resources (TRGP) for $3.55 billion. .

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