Vantage Point Advisors’ Energy Blog February 2021

2021 Outlook: Learning to Fly

Credit Suisse’s Report on US Midstream
and Master Limited Partnerships

 

In my opinion, this team of analysts did a great job of summarizing the key themes for 2021 in this recent analyst report.[1]

Free cash flow remains “king,” but in today’s low commodity price environment, reductions and deferrals of project capital expenditures are required.  Credit Suisse forecasts capital expenditures this year to be approximately half of last year’s rate.  While this may limit potential growth for the future, it does allow midstream companies to fund current distributions with internally generated free cash flow.

Given the low margin environment, Credit Suisse also does not predict an active year for midstream M&A.  The key challenge for any acquiring company is to produce excess returns on a midstream acquisition that has low margins.

Regulatory impacts to midstream companies are already being felt, with President Biden’s cancellation of the Keystone Pipeline and leases to drill on many federal properties.  Environmental issues are expected to become more expensive, in terms of current period expenditures and funding future asset retirement obligations.

Environmental, Social, and Governance, or “ESG,” synonymous with sustainability, refers to corporate activities that would maintain or enhance the ability of the company to create value over the long-term.  This initiative is playing out in the industry as institutional investors are telling their private equity firms that they will not provide capital unless ESG requirements are met.

The most widely discussed example of this is BlackRock where the CEO Larry Fink wrote a letter to CEOs in early 2020 stressing the importance of sustainability initiatives and reporting and stated BlackRock would vote against any management and boards that are not making sufficient progress on these initiatives.[2]

Consistent with the rest of the oil and gas industry, midstream companies are going to be focused on generating distributions and free cash flow, as compared to investing heavily for future growth.

WTI Strip Prices Increase

Over the past month, spot prices and near-term futures prices for the WTI contract increased by about $4.00 per barrel.

 

Oil Price Outlook

The price distribution below shows the crude oil spot price on February 1, 2021, as well as the predicted crude oil prices based on options and futures markets.  The blue lines are within one standard deviation (σ) of the mean, and the red lines are within two standard deviations.

Based on these current prices, the markets indicate that there is a 68% chance that oil prices will range from $43.00 and $63.00 per barrel in mid-May 2021.  Likewise, there is about a 95% chance that prices will be between $27.50 and $78.00.  By mid-June 2021, the one standard deviation (1σ) price range is $41.00 to $65.00 per barrel, and the two-standard deviation (2σ) range is $24.50 to $84.00 per barrel.

Key Takeaways

Remember, option prices and models reflect expected probabilities, not certain outcomes, but that doesn’t make it any less useful.  If someone asks you longingly if oil will be over $85 per barrel again soon, you now can respond with “the markets indicate there is a 97.5% probability that oil prices aren’t expected to get there by this July, so I wouldn’t count on it.”

For more information, contact:

Gregory E. Scheig, CPA/ABV, CFA, CMA
Vantage Point Advisors
Managing Director / Energy Practice Leader
Certified Mineral Appraiser
180 State St., Suite 225, Southlake, TX 76092

Phone: 214.254.4801

Email: gscheig@vpadvisors.com

 

[1] Credit Suisse, US Midstream & Master Limited Partnerships (MLPs) 2021 Outlook: Learning to Fly, Spiro M Dounis, CFA, Doug B Irwin, CFA and Charles Bryant, January 11, 2021

[2] January 13, 2021, Q&A: Why ESG Investing Will Impact Oil & Gas Landscape In 2021, https://www.jdsupra.com/legalnews/q-a-why-esg-investing-will-impact-oil-1392801/