The Dividend Cafe - My Eyes Have Seen Midstream Energy's Resurrection

Episode Date: June 3, 2022

I am doing three things in the Dividend Cafe today that I pretty much never do. For one thing, I am blatantly ripping someone off (you’ll see; it’s not as bad as it sounds). Secondly, I am getting pretty biographical (though I guess I do that every once in a while; last week being the most recent example). And then finally, I am really focusing on one pretty specific and even granular investment topic. Now that, I do every now and then – but not like this. You’ll see. So jump on into the Dividend Cafe to see me rip off someone else’s work, talk about a very personal and biographical aspect of my life, and apply it all to a really specific investment lesson and principle – one that should not be missed. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello and welcome to another episode of the Dividend Cafe. Very happy to be recording here in the California studio, although actually this will be the last time I'm recording from here for a little while. There'll be a lot more New York time and some travel and movement and so forth over the next month, month and a half. But today's Dividend Cafe is very different than the kind of typical course. And I hope you'll benefit from it. I hope you'll get something out of it. But I am doing something on purpose that's a little different today than

normal. For one thing, I never really rip anybody off. I guess there's various moments of inspiration and whatnot, but all the material we put out is pretty darn freshly originated and sourced. And yet the idea for what I'm going to talk about here today, I absolutely lifted from somebody else. So I'll give all that attribution. But the specifics of it are kind of my own story. And just as last week, when I was talking about our feelings on the housing market, I kind of walked through some of the history of my early life residential purchases and sales and things. I do have kind of a biographical component to this story, but it's all for the purpose of giving an analogy to an investment theme and an investment priority that is a really big deal to us at the Bonson Group. It's something that I've cared about a lot for 15 years and something that I think

clients deserve to understand. And hopefully those of you that are not invested in, I'll give it away now, the midstream energy space will be able to appreciate because I think you are missing out on something extraordinary if you're not. So here's what I've lifted. There's a gentleman by the name of Heinz Howard, who I've been reading for, I think, 11 and maybe 12, getting close to 12 years, who writes something called MLPguide.com. But he's a portfolio manager in the infrastructure asset team at CBRE. manager of the infrastructure asset team at CBRE. And he writes a weekly bulletin. It used to be a free deal. It's now a paid subscription thing. It's not very much, but I've read it every week, literally every single week without exception for ever since it started. And I like it a lot. It's good analysis. I think he might be a similar age to me. A lot of his pop culture references he uses when he writes.

He's very queer. He's a Gen Xer like myself. And I have benefited from some of his research and analysis as a midstream energy investor. He's writing about MLPs, master-owned partnership, and even apart from companies that are maybe not structured as MLPs from a tax and legal entity standpoint, they're in the space of transporting this huge comeback that's taken place in the midstream energy sector to struggles he's had with his eyesight over his life and how he just got kind of used to having contact lenses. He could see okay, not great. And then one day he got a new doctor, new prescription, and everything was just different. And everything was what it was until it wasn't. Then all of a sudden it was better. So his exact journey is a bit different than mine.

But the thing I'm lifting is using that analogy in my own life to where I want to go with midstream energy. I was diagnosed with a disease called keratoconus right after the time that my dad died when I was a very young man. And I must have had keratoconus before he died, but we didn't necessarily know. And then the acceleration of the disease was really rapid after this diagnosis. So your cornea is basically kind of deteriorating because you're getting, it's sort of like a blister, you get really, really steep middle part of your cornea, and it of course, alters your vision and could jeopardize your eyesight entirely. I was waiting for a donor for quite some time to I had to have transplants basically save my eyes, my left eye was 10 times legally blind, I could use a really, really weird contact lens that enabled

me to functionally see out of my right eye, but it was not safe. It was not good. It was not pleasant. It was painful. And the vision was atrocious. And I just prayed I'd get a donor and they'd heal my eyes. And then I did. I had a corneal transplant in 1997 in my left eye and another one in 1999 in my right eye. And so I still had to have glasses. I couldn't wear contacts. There was too much pain and other issues. The light sensitivity was much higher on the transplanted corneas. And then you have a bunch of sutures in your eye and some of they get loose and come out and that hurts and stuff. But I mean, I was just so grateful. My eyes were kind of healed. I wasn't going to lose my corneas and I could see much, much better, you know, than I

could before the surgeries. And I felt like I was living a reasonably functional life, but it just wasn't normal. It wasn't pleasant. And then in 2012, 10 years ago, the disease started to come back and there were traces of keratoconus coming around the periphery of my cornea. So I had to see this big hotshot guy up in Beverly Hills and he did a number of new surgeries and operations. I'll spare you all the details. And then really I was seeing the best out of my left eye I'd ever seen they thought they had mostly healed what was um kind of jeopardizing the health of the cornea in both eyes but all of a sudden the eyes were very very volatile i mean the stigmatism would go up a lot in one eye my

opiate would go up in another down up the the difference between the left and right eye was really a big deal. And even in the course of that, I want to, again, interject some gratitude because I think most people with a wildly different correction in their left eye from the right eye are really prone to migraines. And I didn't ever suffer from that. So I think that's a big blessing. But I pretty much really couldn't see much at night. The night vision was very suboptimal and got to a point where I don't drive at night ever. And there were severe dry eyes, very, very high light sensitivity.

And I was constantly having to get new glasses, new correction. Really, I would get them at least once a year, but I probably should have been getting them two or three times a year because the vision correction would change so much. And I just kind of learned to live with it. It wasn't great. I'm in front of a computer screen, reading books, reading research, you know, sometimes 16 hours in a day. It's a very different prescription now for when I'm looking at something near versus far and so you had to adjust around that and uh then the right eye for the last six months I haven't really seen out of my right eye at all and I no one really could understand why and there's a whole process there but um I can see it functionally on my left eye. And even though I put like 50 drops a day in

because of dryness and light sensitivity, and sometimes I would get an inflammation in the cornea that would hurt quite a bit, but really I could see okay on my left eye. So that was good, but the right eye was not. And so my eye doctor in California referred me to this specialist in Manhattan and started going through this whole process. And they tried doing a deal with a, and I'm wearing it now, but a special right lens over my right eye. Then getting the eye used to that and then putting a correction in that on top of correction in the glasses because there was severe scarring in my right eye. That's why I couldn't see. And even with glasses, if the cornea itself is scarred up, you're not going to be able to see out of it. But something about the

combination of the contact with the glasses has offset some of the impact from the scarring. And I went from about 20 over 200 vision in my right eye to 20, 30, and that's with correction. So I went from like basically not being able to see at all with correction in the right eye to 2030 which is just unbelievable and so that moment over these last several weeks as i've been going through this treatment and had to see a doctor five six different times in new york all of a sudden it's like a totally different world you know now i still i'm gonna have to have that scarring probably surgically dealt with. And I still have light sensitivity and dryness.

But all I'm saying is nothing was working. It was just kind of what it was. You get used to it being suboptimal. And then all of a sudden, it's just night and day different. OK, if you've kind of gone through this process with me so far, hopefully you're still here. What does this have to do with midstream energy? Well, it's kind of like this perfect analogy to exactly what's happened in the midstream space. That it's become functional. It's been suboptimal. There's been a lot of bruises and difficulties, but the industry and particularly investing in the industry is puttered along,

but not really where people believed it ought to be at some points facing what seemed like an existential crisis. Like you could lose your eye, you could lose this sector altogether to various bankruptcies and liquidations and governance challenges and regulatory challenges. and governance challenges and regulatory challenges. COVID almost seemed like it would be the final nail in the coffin. And then it just started working. Then the next treatment and glasses and contact and medical and whatnot, and all of a sudden it's better.

And that's kind of what happened in midstream. The brief history of the sector was that in concert with the fracking revolution in the United States, this sort of renaissance of U.S. energy produced a need where on one hand, we know that the U.S. capacity for production went just exponentially higher with crude oil more than doubling, with natural gas nearly doubling per day, millions of barrels of oil per day, billions of cubic feet of natty gas per day. That increased from that. And yet to get from the wells where the upstream people reside to the refiners or to end destinations where the downstream people reside, something has to move it. The oil and gas cannot just get there. And so this midstream sector became vital to the

implementation of energy success in our country. And we do put a lot of oil and gas on trucks, and we do put a lot of oil and gas on rail. And that is expensive and it's cumbersome and it's slow and it's not as environmentally safe. And yet the pipeline industry really became vital. And so you were getting not only great revenues as more and more oil and gas were coming through our pipelines. We were getting a lot of new pipelines because we had more and more need to move oil and gas and kind of create this infrastructure of U.S. energy. And those are the golden years, you know, after the fracking renaissance. And it happened to come just post financial crisis. So it was really blessed timing because our country was reeling economically. And this was the only growth industry out there at the time.

Like it was this forward-moving, just gazillions of new jobs, new revenues, new opportunity. You have your kind of peripheral collateral growth that was coming about. And it was a glorious thing. And then 2014, late 2014, the Saudis and OPEC just said, okay, we're not putting up with US shale anymore. This is a competitive force that we don't want to have to deal with. And they thought, well, their break even levels to produce oil are far higher than ours. So we'll cut into our profit margins substantially for the purpose of recapturing market share, but we're going to put these guys under. They flooded the world with oil and the U.S. energy sector collapsed in 2015 and

2016. And because of capital markets innovations in both private equity and private debt, because breakeven costs continue to come lower, better technology, better innovation, they didn't put US shale under, but they bruised it quite severely. And then we kind of bruised ourselves because out of that, all of a sudden we went into this extended period of kind of an ESG extremism, very strong hostility against financing oil and gas in our own country, a lot of political pressure, a lot of regulatory pressure. There was a presidential administration through the Trump years that was friendly to the fossil industry, but they were fighting against cultural forces, congressional opposition and whatnot that

was very negative. And at the same time, I don't think that the energy sector was helping itself a lot either. There was some bad governance, particularly in the midstream, general partners that had really unfavorable terms with their limited partners. You had a lot of financial recklessness and overly levered companies, and then they couldn't access equity markets anymore. They couldn't fund growth by issuing new equity, but they certainly weren't going to be able to fund growth with issuing new debt because they were already over levered. And therefore you couldn't fund any growth and you were kind of stuck on your balance sheet without access to equity or debt capital.

And so this was a perfect storm through these years. And you think, wow, that sounds awful. What's the good news? Well, before we get to the good news, then you had the final blow, the death blow that wasn't a death blow, and that was the pandemic. And so you really had a complete and total collapse of demand. And so you really had a complete and total collapse of demand. And the supply needs were so low that transportation of oil and gas went away. And the midstream sector looked like it was left for dead.

But out of that moment, the analogy to my eyes is someone came up with a new prescription and a new treatment. And just as medicine and healthcare, whether you're talking about devices, pharmaceuticals, treatments, oncology, all these things that have been really wonderfully advancing and still are. You didn't see nothing yet. That happened with the financial engineering in the US energy sector too. More capital discipline, more reasonable ratios in their distributions, completely improved governance. And the sector just came roaring back. From the bottom COVID level, which is a difficult, again, it's a cherry picked place, level, which is a difficult, again, it's a cherry picked place. But to make the point, things are up about 160% in, let's call it a two year period. But even just year to date,

it's up 25 to 30%, depending on which benchmark you're looking at, in a period of time where broad markets, S&P, NASDAQ are down 15, 20, 25%. So you have come roaring back, and yet yield spreads still indicate incredible value. It isn't like those yield spreads have tightened on a historical basis. They're still very wide, which is code for attractive, good value, great cash flow generation, great fundamentals. Now, could this go away again? Could there be another setback in the eyes, another reversal, another complexity that requires a whole new surgical treatment and whatnot? Of course there could be. But the main things that are needed right now, I feel very good about. That's a strong capital discipline, reasonable ratios and how they distribute dividends to shareholders,

and then an overall healthy backdrop to just the broad sentiment of the U.S. energy industry. Right now, I think that's in early ending. So people are now embracing the idea when you talk about Putin and OPEC and Russia, people are embracing the idea, not just of US having energy independence that was sort of mocked five years ago, but they're saying we want to become a big supplier to the rest of the world. Let's export our natural gas. Let's liquefy and add a gas, put it on ships and send it to Europe and Asia. So there's a whole engine of growth out there around the midstream sector. It's something

I believed in for 15 years. It's something I've studied religiously for 12 years. And now it's something that is really, really born fruit here in this last year, year and a half. And it just kind of happened because it happened. A new set of glasses, a new treatment brought this about. And those fundamentals were important. The ups and downs were necessary. But that is the way sometimes these things go with our own health, with my eyes, with the U.S. midstream energy sector. And so we see great value looking ahead.

We have great appreciation for what's happened over the last year, year and a half. I'm very proud of the conviction we've maintained and the very astute observations of what was happening and needed to happen and how we positioned around that in our own strategy development for investing in this space. And here we are. for investing in this space. And here we are. So I can see you as I'm sitting here taping, and hopefully you can hear me and understand what this analogy is about and why we are so grateful to be invested in the US midstream energy sector and what our plans are in that sector for the foreseeable future. It won't be a smooth ride. There will be more ups and downs, but this has been a comeback for the ages,

and we're grateful to have seen it. Okay, enough of my puns and analogies. I think you get the point. Thanks so much, as always, for listening to and watching the Dividend Cafe. Please do subscribe if you're not getting it through a feed. It's better for us and better for you if you do it that way. And we encourage you to share it far and wide to others as we continue growing the audience of the Dividend Cafe,

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