Strategy Spotlight

MLP & Energy Outlook: Opportunity Amid A More Stable Price Backdrop

More stable oil prices should continue to support a favorable outlook for midstream energy assets.

The sharp decline in oil prices during 2014 and 2015 raised questions concerning the long-term outlook for North American energy assets. But as John Devir and Bek Ahmedov discuss in the following Q&A, the energy revolution in the U.S. remains very much intact – and PIMCO’s MLP & Energy Infrastructure Strategy can provide an attractive way to gain exposure to it.

Q: What is PIMCO’s MLP & Energy Infrastructure Strategy?

John Devir: PIMCO MLP & Energy Infrastructure is an actively managed strategy that invests in publicly traded Master Limited Partnerships (MLPs) and related midstream energy companies. The strategy provides exposure to one of the most attractive secular growth stories in North America – the revolution in production techniques that has opened up vast reserves of oil and gas for exploitation.

Midstream energy companies derive their revenues from operating critical infrastructure, ranging from transportation pipelines for crude oil to gathering and processing pipelines for natural gas liquids, as well as storage and terminal facilities. Since MLPs generate the majority of their revenues via fee-based contracts which are usually capacity- and not price-driven, they have less direct exposure to commodity prices than more traditional equity investments. The sector has become more investable in the last few years and in our view has reached the critical mass needed to achieve sufficient diversification with an attractive risk/return profile.

PIMCO MLP & Energy Infrastructure Strategy focuses on total return rather than simply yield. Whilst the target universe is predominantly equity securities, the strategy has the flexibility to tactically invest in both the equity and debt of midstream energy companies. This allows us to look for the best opportunities across the whole capital structure.

Q: What is your outlook for the MLP sector?

Devir: The MLP sector has rebounded strongly over the last 12 months, in line with oil prices stabilizing. Although the sector underperformed in 2015, when a number of large companies cut dividends, much of this was due to company-specific issues rather than problems with business models as a whole – a point we made in a blog post in September. Since then our views haven’t changed. We think MLPs continue to offer attractive long-term total return potential, backed by a favorable blend of fundamental and technical factors.

Q: Can you talk more about the fundamental and technical factors supporting this view?

Devir: From a top-down perspective, we think that oil prices are likely to be more stable going forward, underpinned by strong global demand growth and better production discipline by OPEC. This should lead to an increase in North American production, which would be positive for midstream MLPs as it means higher volumes through the pipelines and higher revenues for the sector. We also think that the Trump administration could be net positive for the energy sector – for example, we already saw support for the Keystone pipeline within the administration’s first week. And if inflation picks up, as the market expects, MLPs should perform well as many revenue streams are inflation-linked.

From the bottom up, MLP balance-sheet quality has improved as a result of deleveraging in the last 14 months‒18 months, and the worst of the ratings downgrade cycle is likely behind us. Importantly, we see some $50 billion‒$60 billion of growth opportunities for MLPs during FY2017-2020, which should allow them to increase distributions over time. In fact, we expect distributions to grow by 3%‒5% over the coming years &ndash