When the pandemic struck in the spring of 2020, and much of the developed world began sheltering in place, demand for fuel quickly evaporated, leading to tumbling oil prices that turned negative for the first time in history.
This sudden and drastic hit to the energy market was short-lived following a quick economic rebound. After being the worst-performing sector in 2020, energy proved the market leader last year.
However, while the energy market at large had a banner year in 2021, energy's middlemen, the midstream service providers like Enterprise Products Partners, largely failed to keep pace with the sector.
For Enterprise, this underperformance partially resulted from structuring the business so that around 90% of earnings come from fee-based contracts with low volumetric risk. While this structure provides downside protection, as witnessed in 2020 when cash flow only dropped 6%, it has prevented Enterprise from benefiting from rising oil prices over the past 18 months.
Further fueling underperformance has been concerns over the industry's excess supply of midstream assets and worries that American shale formations will provide less production in the years ahead than previously assumed.
Last year we addressed our confidence in Enterprise's ability to navigate the excess capacity issues that will likely dog the industry over the next few years. Enterprise's portfolio of fully-integrated midstream assets should remain in demand by its diversified customer base that includes some of the healthier producers in the market, with not one of them accounting for more than 10% of sales.
Even so, some recent research has added additional worries over the industry's overdeveloped infrastructure, suggesting American shale formations may have less production life remaining than previously thought.
While many producers refute this idea, production levels have not returned to pre-pandemic levels despite oil trading well above many producers' break-even prices. Various reasons have been given for why production has failed to recover fully despite elevated fossil fuel prices. Some point to producers being more disciplined and focused on improving balance sheets over increasing drilling following coming so close to insolvency in 2020.
Others suggest lingering concerns around Covid-related impacts on staffing and shipping logistics have made operations more difficult.
However, the biggest concern is that this could suggest some validity to worries that not as much oil remains in American shale formations as previously assumed.
Either way, with production settling at lower levels and too many midstream assets available, we may soon start to see consolidation amongst midstream operators, benefiting the stronger operators like Enterprise.
As an industry leader, Enterprise looks attractive relative to many of its peers, with a robust distribution yielding around 7.5%.
Unique to the industry, Enterprise has been able to finance all capital expenditures with cash flow in recent years despite industry struggles. The ability to internally finance projects has helped the midstream leader build a strong balance sheet and earned Enterprise some of the industry's highest credit ratings.
Enterprise's strong balance sheet coupled with its conservative payout ratio and diverse customer base reduces the likelihood of a distribution cut during inevitable periods of industry turbulence.
Because of these strengths and management's demonstrated financial conservatism, we are reaffirming Enterprise Products Partners Safe Dividend Safety Score.
That said, industry concerns remain but will likely take years to play out. Investors who are willing to stomach these external risks and believe American oil production has more life than some critics suggest may find Enterprise Products Partners an intriguing investment opportunity.
We will continue to monitor developments in these macro risks and provide updates as necessary.