Tortoise Talk 4Q2020

Energy 1/25/2021
2020 was certainly like no other. The COVID-19 global pandemic affected every part of our lives and the essential asset in which Tortoise invests. Energy demand concerns and volatile commodity prices plagued the energy sector. After a tumultuous year, energy appears to be on its way to recovery with high hopes for 2021. The sustainable infrastructure sector, particularly renewable energy, had a strong year propelled even higher by anticipated Biden Administration energy policy. As we move into 2021, with COVID-19 vaccinations being administered throughout the world driving energy demand toward pre-COVID-19 levels and the push toward cleaner energy gaining momentum, we are optimistic that 2021 will be a strong year for investors in these essential assets sectors.
Download as PDF

Total returns (%)

As of 12/31/2020. Source: Bloomberg. It is not possible to invest directly in an index. Please see index definitions on disclaimer page.
Past performance is no guarantee of future results.

Energy infrastructure

Broad energy

The broader energy sector, as represented by the S&P Energy Select Sector® Index, finished the fourth quarter in positive territory, returning 28.3%, bringing 2020 performance to -32.84%. Energy markets and prices experienced significant volatility throughout the year driven by the uncertainty around energy demand due to COVID-19. Looking ahead to 2021, all eyes are focused on energy demand and the subsequent rollout of COVID-19 vaccinations. Pfizer and Moderna’s November announcements of positive data regarding their vaccines for COVID-19 led to a stock market surge, with beaten down energy companies leading the charge, along with commodities such as crude oil. With the growing belief in vaccine success and visibility to significantly improved economic activity, 2021 energy demand growth could exceed anything ever seen on a year-over-year basis.

Following the price war between Saudi Arabia and Russia in early March, the Organization of Petroleum Exporting Countries (OPEC) and their Non-OPEC partners (OPEC+) announced deep production cuts with a clear goal of balancing the global crude oil market. The market dramatically shifted from an approximate 20 million barrels per day (b/d) surplus in April to an approximate 4 million b/d deficit in July, providing the path for market rebalancing. Overall adherence to the production cut agreement remained strong in the second half of 2020 leading to inventory draws. Entering 2021, the global crude oil market remains in deficit, supported by the OPEC+ crude oil production cut agreement, and expected inventory draws are expected to continue throughout 2021.

U.S. crude oil production declined in 2020 in response to the supply-demand imbalance resulting from the economic shutdowns and stay-at-home orders in March and April. This resulted in the first annual decline in U.S. production since 2016. Specifically, U.S. crude oil production fell from a record 12.9 million barrels per day (b/d) in November 2019 to 11.2 million b/d in November 20201. EIA forecasts that U.S. crude oil production will average 11.1 million b/d in 2021.

For U.S. producers, 2020 was a year of change. The COVID-19 pandemic accelerated producers’ capital discipline as investors focused on higher free cash flow generation and return of capital to shareholders. This free-cash-flow emphasis led to a host of M&A deals as exploration & production (E&P) companies prioritized the importance of scale, diversity and strengthening balance sheets in a challenging oil price environment.

While oil dominated the headlines, natural gas continued to provide a cleaner burning source. As a result, we continue to see natural gas as a critical source of energy supply going forward. During 2020, a reduction in natural gas demand caused by COVID-19 initially resulted in the convergence of global natural gas prices. However, in the final months of the year, LNG exports from the U.S. rapidly shot back up driven by increasing demand for natural gas in Asia and resulting in Asian gas prices trading at a premium relative to the U.S. Henry Hub prices. Domestically, the backdrop of slowing production growth and strong domestic and export demand paints a picture of improving natural gas fundamentals in the future. Rising U.S. energy exports of liquids and natural gas are expected to positively affect the U.S. trade deficit and to ultimately help reduce global CO2 emissions, along with renewables, as they take market share from coal.


Midstream energy had a strong fourth quarter with the Tortoise North American Pipeline IndexSM returning 17.6% and the Tortoise MLP Index® returning 29.6%, bringing the 2020 performance to -20.9% and -27.0%, respectively. There were several contributors to midstream energy’s negative performance for the year including: negative energy sentiment following energy demand uncertainty, excess pipeline takeaway capacity related to the COVID-19 pandemic resulting in lower production, and political rhetoric focused on an energy transition to cleaner energy sources. Midstream companies structured as C-Corporations continued to benefit from several items versus MLPs, including: stronger corporate governance, broad market index inclusion for some companies, lack of K-1s, and a more certain corporate structure.

There were a couple of positive themes standing out for midstream businesses throughout the year. First, resiliency. Resilient cash flows confirm the essential nature of the assets that midstream businesses operate. Strong contractual obligations (take or pay contracts) and customer profiles (large, investment grade rated counterparties) helped midstream energy companies generate consistent cash flow from operations even in the low and volatile 2020 price environment. At the onset of the COVID-19 pandemic, we forecasted midstream EBITDA declining 8%-10% in 2020. However, heading into the final months of 2020, companies revised their forecasts higher and EBITDA is expected to only be down 3-5% for the year. Notably, companies with significant natural gas businesses and/or take or pay contracts reaffirmed guidance, whereas others with cash flows tied to wellhead volumes provided a wider range of outcomes.

Free cash flow yield (2021E)

Source: Bloomberg

The other clear trend in earnings was virtually every midstream energy company transitioning to a capital allocation focused on positive free-cash-flow after dividends. This is a stark change made possible by declining capital expenditures for midstream projects and sale of non-core assets. We forecast growth capex to decline by approximately $16 billion YTD as midstream rationalizes project spending. This shift in spending has allowed the midstream sector to not only be free cash flow positive, but materially so, especially compared to other asset classes and the S&P 500. In 2021, we expect midstream companies to have $8 billion of free cash flow after distributions and by 2024 we expect $21 billion of free cash flow after distributions.

We believe midstream companies will more directly return cash flow to shareholders in the form of dividends, debt reduction and share buybacks. While continuing to pay out very high dividend yields, we are advocating for companies to utilize stock buybacks to create their own flows and help turn the tide on stock performance. The numbers show that this can be achieved while still reducing leverage in a meaningful way.

During the last few months of the year, the buybacks announcements started coming in earnest. In early October, Targa Resources Corp. (TRGP) announced a $500 million stock buyback program. MPLX LP (MPLX) and Plains All American LP (PAA) followed suit, announcing significant buyback programs for $1 billion and $500 million, respectively for the three largest during the quarter. In total, 10 midstream companies announced share buyback programs in 2020, including six during the fourth quarter. We believe, the forthcoming free cash flow and share buyback themes can help can drive sustainable outperformance for the midstream sector.

While the 2020 presidential election created headline risks for the energy sector, we believe the consensus path forward for the Biden Administration will focus on getting Americans back to work with supportive policies versus policies aimed at opposing the oil and gas industry or destroying jobs. The predominant theme around Biden’s energy plan is to address climate change and create substantial job opportunities for Americans. The topic of climate change and related opportunities for the overall economy was one of the four pillars of the convention platform, integrated into an overall vision of revitalization of America. We expect market economics to dictate the trajectory of future energy supply and demand. Renewables and natural gas are more economic than coal in generating electricity and will likely continue to take share, while crude oil will likely remain the predominant fuel source in the transportation sector for the near future.

Finally, despite past comments early on during the campaign, we do not expect a ban on fracking. It is worth noting that under the Obama Administration, the ban on crude oil exports was lifted which was supportive of the energy industry. Ironically, regulatory pressures have the potential to tighten new supply, pushing oil and gas prices up, and making existing infrastructure more valuable.

2020 also ushered in continued questions about midstream energy’s role in an energy transition environment. During the year there were three oil majors, Royal Dutch Shell PLC (RDS.A), Total SE (TOT) and BP PLC (BP), that openly discussed a path forward around renewable energy. The European Union (EU) moved further towards renewables and 7 of the 10 largest economies stated their intention to have net-zero emissions by 2050. While the energy transition will take time to play out, midstream management teams openly discussed the role their companies could play in such a transition. Pipeline infrastructure, for example, could be repurposed to transport hydrogen. As the world continues to demand more energy and less carbon, we are encouraging midstream companies to view energy transition opportunistically.

Within the downstream portion of the energy value chain, the refining sector remained among the most challenged sectors in 2020 due to the COVID-19 pandemic. Refinery utilization has recovered from the depths of the economic contraction in March and April but remains below 2019 levels. Permanent refinery closures have and should continue to help balance the market from a supply and demand perspective. From a U.S. refined product standpoint, we believe gasoline and diesel will continue to inch towards pre-COVID levels during 2021 while a slower recovery should be expected in jet fuel. As U.S. energy demand recovers in 2021, U.S. refinery utilization and throughput should exhibit strong growth and return to more normalized levels.

Natural gas liquids, unlike the refining sector, has proved resilient despite challenges faced during the COVID-19 pandemic. Strength can be seen in LPGs (liquid petroleum gases) where demand is driven by global population growth and improvements in living standards in Asia, notably in China and India.

Regulatory landscape

One of the key regulatory announcements of 2020 was the Army Corps of Engineers announcing it began work on an environmental impact statement for the Dakota Access Pipeline, something the district court requested for the better part of the year. Another requirement of the court was that the Corps determine a remedy for the fact that the pipeline no longer has a permit to cross Federal land. 

We are closely monitoring Dakota Access Pipeline developments as the fate of pipeline impacts several midstream companies. In other pipeline news, in July, the Supreme Court agreed to reinstate streamlined permitting for pipelines across the country, except for Keystone XL. This is positive for the most notable project under construction, the Mountain Valley Pipeline, Equitrans’ 300+ mile natural gas pipeline which is nearing completion after a series of several delays.

Sustainable infrastructure

Renewable energy

2020 started out strong for new renewables installation on the heels of a 2019 that itself was the second and third-strongest years ever for solar and wind, respectively. Like most of the economy, renewables then saw a COVID-driven decline bottom-out during the second quarter, but rebounded substantially in the following months. Utility solar in particular has been only minimally impacted by COVID-19 related construction delays. For solar, more than 19 giga watts (GW) of installations are expected for the full year of 2020 – making it the most capacity installed in a single year in the U.S. and an increase of new growth of around 40% over 20192. Activity remains concentrated in the southwest and southeast, with Texas ahead of Florida and California in year-to-date installations2. According to the U.S. Energy Information Administration, wind installation is also expected to see a strong finish to the year with as much as 23 GW of new capacity coming on line in 2020.

The pandemic caused little to no slowdown in new project announcements as growth is expected to continue in the coming years with a backlog of more than 150 GW over the next five years. That includes major announcements we’ve seen this year from the likes of Amazon, Google, and Microsoft, among others, as well as from several individual states. This represents market share gain for renewables as, between them, wind and solar represent more than 70% of all U.S. electricity-generating capacity additions in 20202. This is not surprising, given that on a levelized cost of energy basis (LCOE) wind and utility-scale solar tend to be a cheaper option than building out any new fossil fuel powered options. Support from the incoming Biden Administration should serve to only provide further momentum to this trend.

Concluding thoughts

We feel strongly that the future of energy will be driven by a combination of natural gas and renewables to meet growing energy demand while simultaneously reducing global CO2 emissions. There are many tailwinds driving the move to cleaner energy with the Biden Administration and the trends toward ESG investing. We are positioning the funds to take advantage of these trends and have an optimistic outlook for 2021 and beyond.

1 Energy Information Administration, December 2020 STEO
2 Solar Market Insight Report, 2020 Q4

This commentary contains certain statements that may include “forward-looking statements.” All statements, other than statements of historical fact, included herein are “forward-looking statements.” Although Tortoise believes that the expectations reflected in these forward-looking statements are reasonable, they do involve assumptions, risks and uncertainties, and these expectations may prove to be incorrect, Actual events could differ materially from those anticipated in these forward-looking statements as a result of a variety of factors. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this publication. Tortoise does not assume a duty to update these forward-looking statements. The views and opinions in this commentary are as of the date of publication and are subject to change. This material should not be relied upon as investment or tax advice and is not intended to predict or depict performance of any investment. This publication is provided for information only and shall not constitute an offer to sell or a solicitation of an offer to buy any securities.

The Tortoise MLP Index® is a float-adjusted, capitalization-weighted index of energy MLPs. The Tortoise North American Pipeline IndexSM is a float-adjusted, capitalization-weighted index of pipeline companies (MLPs, corporations, LLCs) domiciled in the U.S. or Canada. The S&P 500® Index is an unmanaged, market-value weighted index of stocks that is widely regarded as the standard for measuring large-cap U.S. stock market performance. The S&P Energy Select Sector® Index is a modified market capitalization-based index of S&P 500 companies in the energy sector involved in the development or production of energy products. The Alerian Midstream Energy Index is a broad-based composite of North American energy infrastructure companies. The capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities, is disseminated real-time on a price-return basis (AMNA) and on a total-return basis (AMNAX).

Tortoise North American Pipeline IndexSM and Tortoise MLP Index® (the “Indices”) are the property of Tortoise Index Solutions, LLC, which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices) to calculate and maintain the Indices. The Indices are not sponsored by S&P Dow Jones Indices or its affiliates or its third party licensors (collectively, “S&P Dow Jones Indices”). S&P Dow Jones Indices will not be liable for any errors or omission in calculating the Indices. “Calculated by S&P Dow Jones Indices” and its related stylized mark(s) are service marks of S&P Dow Jones Indices and have been licensed for use by Tortoise Index Solutions, LLC and its affiliates. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC (“SPFS”), and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”).

It is not possible to invest directly in an index.