MASTERCLASS: Energy - December 2016

On November 30th, a landmark deal was reached in Vienna in which members of OPEC agreed to cut oil production. The fluctuations in crude prices have sent global markets on a ride, and its stabilization may mean more opportunities in the energy sector. Today we have assembled a panel of MLP and REIT investors to share more about what's coming down the pipeline in 2017. Welcome to our ENERGY MASTERCLASS.

  • Jeff Jorgensen - Portfolio Manager & Director of Research at Center Coast Capital Advisors, LP

  • Jeff Fulmer - Senior Vice President at CorEnergy

  • Diego Kuschnir - Portfolio Manager, Managing Director, MBA at TPH Asset Management

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  • 52 mins 02 secs
Gillian: Welcome to Asset TV. I’m Gillian Kemmerer. On November 30th, a landmark deal was reached in Vienna in which members of OPEC agreed to cut oil production. The fluctuations in crude prices have sent global prices on a ride and its stabilization may mean more opportunities in the energy sector. Today we have assembled a panel of MLP and REIT investors to share more about what’s coming down the pipeline in 2017. Welcome to our Energy Masterclass. Thank you all so much for joining us here today. It’s an exciting time to be talking about energy, as if the last two years wasn’t, but it’s all good times. So I’d like to get started just by having a look back at some of the turmoil that’s been happening in the energy market over the past couple of years and understand a bit more about how you navigated it. So, Jeff, I’m going to start with you, how did you deal with the past couple of years in the rout in oil prices?

Jeff Jorgensen: Well, it was tough but we stuck to our principles. And I think that’s what’s been key for Center Coast throughout. You know, I think if you’re chasing quality, if that’s what you’re after in your investment process, if you’re looking for fee based, durable, stable growing cash flows, regardless of the commodity cycle, then I think you’ll be fine. Many times those names had been oversold, and there tended to be lots of market panic. And there was a lot of handholding as it related to our investor base. But I think now that the … we’ve been two years into this and people can see the cash flow generation that we had sold and they can see how the cash flow has performed, they see the good companies tend to do well through commodity cycles. I think if you’re chasing the latest thing, you’re chasing the latest trade, you’re trying to get too cute, you’re going to get burned by commodity prices.

Gillian: Did you find that the wave of bankruptcies at all hit your portfolio in a difficult way and you had to readjust?

Jeff Jorgensen: You know, we focus on midstream, that’s pipelines and infrastructure necessary to meet … where supply meets demand and to connect those two things. We focus on critical infrastructure. And in many instances we focus on investment grade companies. We’re 85% investment grade. So we weren’t necessarily concerned about bankruptcies within our investments. But early on, January and February this year, when things got really tough you had a lot of investors and ourselves included focusing on our counterparty risk, something we’ve always done, but it became heightened degree of sensitivity around who’s paying the bills on those pipelines. And we were happy to find that our diligence process worked. There were only a few instances where someone paying the bill was in bankruptcy. But even in those situations, a creditor is not going to get paid if he can’t get his hydrocarbon through a pipe. If you’re invested in good long term critical infrastructure, you should be fine. But it was certainly something we had to navigate; certainly something we had to walk our investors through, certainly something we had due diligence with even more scrutiny when things got tough.

Gillian: Makes sense. Diego, what about you, how did you navigate the past year and a half?

Diego Kuschnir: I would certainly echo some of what Jeff has said, right. It’s certainly a tough environment to be in because oftentimes fundamentals really didn’t matter as you went through this downturn, at least from a market perspective. The bottom line is we stick to our process. We do very fundamental research. And we think that’s a type of job that really is applicable throughout different environments. So the companies that we invested in performed admirably through this environment, at least from a fundamental perspective, and certainly that’s what we can control. We have a great degree of control. The other thing certainly is communication with investors; it was a time where a lot of investors were asking a lot of questions. There was a lot of panic in the marketplace, as we talked about counterparty risk, what do volumes do, prices, direct exposure; all those things obviously became paramount in the mind of investors. That’s something that we always do, so it was having that dialogue with investors, making sure they understand that we’re on top of it, that the fundamentals are still, you know, stable. But obviously, you know, it was a challenging environment.

Gillian: So increased scrutiny, but one you were already performing, that more had to kind of tell the investors, “Hey, we’ve got his, we can take care of it.”

Diego Kuschnir: You know, it’s showing them that, look, the fundamentals really aren’t changing. And quarter after quarter showing them that there’s a market and there’s also the fundamental side, markets usually overreact up and down. And so it’s important to see through those volatile swings.

Gillian: Perfect, thank you. And Jeff, ending with you, how did you look at the past year and a half to two years in the energy market?

Jeff: Well, I’m glad it’s behind us. It’s been a pretty rigorous year. We buy infrastructure directly. And so we had a couple of counterparties in our triple net leases, which as a REIT we enter into leases and we buy assets and then we lease them right back to the parties we just bought them from. So we have dependency on our operators to perform well. And we underwrote our assets with the intention of our structure being iron clad, and the past year has proven that to be the case. But living it was another thing, it was no fun, and we’re glad it’s behind us.

Gillian: Sure, so it sounds like having an intelligent due diligence process is really what helped you navigate through all of it.

Jeff: Absolutely.

Gillian: Well, we had an interesting OPEC meeting just a couple of days ago in Vienna. And I’m actually going to cue up a graphic that demonstrates some of the impact, although it is early. Now, every time we’ve talked about an OPEC meeting for the past two years, it’s been sort of with an [inaudible] an actual agreement come, but it appears that at this particular meeting there has been an agreement to cut production. So, Diego I’m actually going to start this with you, what are sort of your medium to long term forecasts for crude oil prices in light of this decision?

Diego Kuschnir: So we are probably a little bit more bullish than current STRIP would indicate. Our view was that markets were starting to heal themselves pre the OPEC meeting and this just, you know, brings things forward and probably makes it a little bit better in the near to medium term.

Gillian: I remember, Pierre Andurand was on Bloomberg yesterday, the hedge fund manager and he was talking about his long term view. And he said that even if they hadn’t come to an agreement, he felt that non-OPEC ex US producers were already cutting back enough to actually stabilize prices, would you agree with that?

Diego Kuschnir: Yeah, absolutely. So that’s why, you know, we certainly felt that the healing was in place. It’s just the timing of it obviously, you know, was more uncertain than it is today. So this brings it forward and I think it makes it more appetizing.

Gillian: Perfect, Jeff.

Jeff Jorgensen: You know, our long term view on oil prices is similar to Diego’s, there could be an overcorrection and things could end in high 60s, low 70s. But I think US oil and gas producers have figured out how to make it work in the 40s and in the 50s. And I think that’s where OPEC really failed. If you’re a successful cartel then you control the market and you control the prices. And you don’t incentivize new technology to come in and disrupt you. But what I think what’s happened in the Lower 48, North American production is that they let the cat out of the bag and there’s no putting it back in. They kept prices unnaturally high for way too long. We figured out how to do this and all of a sudden we increased our reserves to a point where I think we may have the world’s largest natural reserves based on a recent study of [inaudible] Energy. And this goes from back in 2006 where we were talking about peak oil. So the cartel got greedy, they left prices too high, now we can do it at 40/50 bucks, and not only where it settles in long term, but we’ll make it work. And I think it’s the power of free market production and the power of kind of innovation that we’ve seen in Lower 48 production.

Gillian: Some of the more complicated exploration and production projects have been halted obviously with lower oil prices. Do you think that we’re coming to a place where we might see a reopening of some of these let’s say deep sea drilling projects that we’re halted?

Jeff Jorgensen: I think you could see that and I think it depends on who you’re talking about. If you’re a producer and you’ve got a massive Permian position and it’s undrilled. I don’t know if you’re even fussed with that yet. But if you’re a large international oil company and that’s all you’ve got, well, you may go back and look at those. And those are really different, they have to 20-30 year time horizons, they’re invested on over longer term cycles. And I think they’re a little more short term price agnostic, if you will. I think that plays an important part in balancing production. But I think what you have now is that a lot of the majors, the major independents in the US have gone through a massive land [inaudible], massive amounts of economic production at 40 and 50 dollars in the US. And I think they’re going to be a hard group to wrangle and a hard group to control, no matter how compliant OPEC may be as they, you know, work through this cut.

Gillian: Okay. And, Jeff, what about you, what is your mid to long term view here?

Jeff: Well, it’s optimistic in terms of stability. So anything that brings stability to the market is welcome from our perspective. Something that our counterparties can rely on and that they can borrow on and they can execute on, and in the case of deepwater, Gulf of Mexico for an example, a lot of those projects I think are really coming into vogue again, which is some sign of stability, even in the mid 50s range, where a lot of those full cycle breakeven costs are down in the mid 40s. And those are long term, as Jeff had said, those are long term commitments. So I definitely see growth there and your bigger and more economic plays and the Permian and your STACK, SCOOP plays, the deep Utica dry gas play is really promising even at low gas prices. And now we’ve seen some uptake recently as winter approaches. So there’s a lot of optimism for production and US producers have demonstrated [inaudible] to get out there and drill as soon as possible. So that’s what we’re expecting, yeah.

Gillian: And I know everyone’s really sick of talking about this, but are we out of contango?

Jeff: I don’t feel we are just yet.

Gillian: Are getting there.

Jeff: I think there’s going to be some dips and some peaks still to be lived through, how about you gentlemen?

Diego Kuschnir: I mean I think that’s the direction. I think we’re fairly comfortable, yeah. The one thing maybe I would add on your prior question on the drilling. I think the big beneficiary of the recent OPEC meeting clearly are US producers. I mean I think that’s the overwhelming winner here. OPEC cuts production, the deep offshore drilling, that’s probably not coming back for a while, so we’re talking West Africa, deep offshore Brazil, that’s probably those very long lead time projects, probably struggle in this environment. Because I don’t think anyone wants to put capital for a still volatile price environment coming right out of this, especially with so much acreage and availability here in the Lower 48 or even, you know, Gulf of Mexico, right. So I think that’s where you’re going to see the bulk of the incremental supply over the next couple of years to meet really the balancing of demand.

Gillian: Okay. We’re talking about supply factors, but demand equally important. So, Jeff, starting with you, what do you think the demand factors are in play right now? Are you bullish on demand going into 2017?

Jeff Jorgensen: Well, it depends on the commodity and it depends on the market. So if we take them one by one, if you think about natural gas, it’s probably where we’re most bullish demand from a domestic perspective. You’ve got an increasing market share gain in the L&G world that the US is going to participate in. So we have an L&G kind of tailwind as facilities get built out in 17, 18, 19 and beyond in the US. You also have exports to Mexico a little bit under question with the Trump administration, but still a tailwind. You have industrial demand and it’s set to pick up here in the US, [inaudible] demands set to pick up in the US from a natural gas perspective as well as a natural gas liquids perspective. And you also have coal switching, which I don’t think is going to slow down necessarily or reverse itself necessarily. It was more economic than it was policy driven in my opinion, and so natural gases, quite a bit of tailwinds from a demand perspective domestically, when you move to natural gas liquids, and that’s ethane, propane, butane, iso and natural gasoline. You know, we have been the largest or the most prominent exporter or propanes and butanes for quite some time now, I think since 14, and we expect that to continue. I think you see a lot of emerging nations where we’re exporting propane into South America, and over the year up in some of the Asia, I think we see nice demand there, a nice demand growth.

And on the natural gas liquid side domestically, you have [inaudible] has been built on the Gulf Coast to take advantage of what’s happened. And that is cheap, cheap, cheap hydrocarbon prices in the US. And cheap prices can hurt supply, they can stimulate demand. So that’s what you’ve seen as I outlined on the natural gas side. So what you’ve seen with the petrochemical increase in demand on the Gulf Coast. And then now in the northeast with Shell in the NGL side. And on the crude side and refined products side, again we’re a large exporter of refined products, domestic demand [inaudible] in the last six flat, just slightly down longer term. But I think it’s the emerging nations, I think it’s the BRIC nations that are going to lead the charge from a demand perspective, that’s a freely exportable as a refined product or now as a crude product with the lifting of the ban a year ago. So outside of renewables taking over market share than we expect, I think the demand picture, particularly with natural gas looks really strong.

Gillian: Jeff, what do you think about that?

Jeff: I think long term the outlook for natural gas is going to remain strong. Whether or not an implementation of coal fired power plants or a slowdown of the retirement of coal fired power plants, or the most of them have already been retired, it’s going to impact the natural gas market. We don’t have any strong views there. But over the long term with L&G exports, even the possibility of utilization of natural gas for vehicles, the long term I think continues to look strong and environmentally it’s the right solution for this country. It cuts carbon omissions.

Gillian: So natural gas, one to watch, Diego, what about you, what do you think about the demand factors at play?

Diego Kuschnir: I certainly would agree on the natural gas side. It’s a significantly more inelastic product and it has tailwinds behind it. Echoing some of the sentiments, L&G, because of the ample supply of natural gas here in this country, we’re going to be at an advantage in terms of being able to export L&G across the globe. And we’re doing it in regions that probably we weren’t really thinking we would, Latin America etc, and Europe. On the switching coal to natural gas, that’s just going to continue. We’re not building new coal plants. I don’t that very near term; the pace might change a little bit. But clearly that’s the direction, companies are not investing capital and long term capital into coal plants which on a state by state level and even on a federal level it’s just going to be very hard to justify over the long term. On the crude side, I think that’s the bigger question, that’s the global economy, what does the macro look like? Certainly things feel okay at the moment. There is nothing that would point to a material slowdown coming down the pipeline in 2017. But obviously that remains to be seen.

Gillian: Okay. So natural gas aside, Jeff, what are some other trends that you are interested in or keeping an eye on in 2017?

Jeff: Well, we’re living in … we’re about ready to accept a new administration and the volatility and impact that that might have, we can guess, but none of us really know. And so easing up on the regulatory environment, that could allow additional pipelines to be built, that could make offshore producers’ lives a little more tenable, is something that we’re going to be watching. But tax reform being bipartisan, we don’t really see an impact there, that’s negative, but more likely positive. And just the activity and pace and what US producers pick up and get through with their developed uncompleted, or their drilled and uncompleted wells and start moving into drilling their PUDs or [inaudible] undeveloped locations. The pace at which that happens and the cost that they’re activating drilling programs at the crude oil price will be all very interesting to watch in the coming year.

Gillian: Okay. I’ve heard it, so that the only thing we’re certain about with the Donald Trump administration is uncertainty. So it’s definitely something to keep an eye on, Diego.

Diego Kuschnir: Yeah. No, clearly, you don’t know what you don’t know; I think that’s what we need to be on the lookout for. But specifically to our sector I think things look as promising as they have in quite some time, both from a rebound in the actual commodity and commodity prices as well as from a more favorable regulatory environment, certainly that’s the view or that seems to be the sense that we’re getting early on. So I think, you know, a combination of factors make it, you know, a pretty attractive place to be as we head into 2017.

Gillian: Okay. And, Jeff, trends.

Jeff Jorgensen: Echo all of that, I mean a lot of uncertainty but I think a lot of tailwinds. There’s been a lot of regulatory headwinds this summer particularly, as it relates to projects in the pipeline side. And to see the potential of that gets reversed, I think is tremendously exciting. And then, look, what we’ve done under the Obama administration from a domestic oil and gas perspective has been tremendously exciting. I still think it’s early innings, and I think the potential is even more exciting going forward. So how producers react, how this regulatory environment shakes out, how quick the new administration can make things more friendly, I think it’s going to be a fun ride, hopefully not as fun as the last two years.

Gillian: I’m not sure fun was the adjective. So, Diego, let’s talk a little bit about capital markets now. What do you see coming down the pipe for capital markets and how might that impact consolidation in the energy space?

Diego Kuschnir: Yeah. So interestingly that obviously was one of the big concerns in the space, if you look back 12/18/24 months ago, that was one of the main headlines in the space. Now having gone through the process, what we have found out is that yet again there was plenty of capital, perhaps it took different forms. Perhaps it was a bit more expensive than, certainly more expensive than they used to be. But plenty of capital in this space, right, whether it be from, you know, the usual sources as well as many new sources of capital on the private side, preferred side. So that’s an, you know, that’s an area which I think, you know, if we take some lessons, you know, on a going forward basis, that’s something we should keep in mind, that there’s always capital available for good companies, good projects and good assets. Obviously on a going forward basis I think the world looks all that much better. So it would not be a surprise to see the vacuum that you saw on the downside, to kind of see on the upside, right, with a lot of capital starting to chase some of these companies in some of this space.

Gillian: Okay. Jeff, how are you thinking about it, is it something that’s impacting your day to day decisions?

Jeff: Well, in 2015 with the precipitous drop in late 14 of commodity prices, so I think a lot of people were anticipating an increased M&A level of activity. So…

Gillian: It’s happening across sectors really.

Jeff: Right, exactly. And so that is now finally taking form because the bid ask spreads has decreased. So we’re seeing some activity there. We’re now probably facing increased interest rates, which is going to raise return expectations, so that’s going to have to play in. And the lower cost of capital, folks are going to be distinguished from higher cost to capital [inaudible] probably even further. But we think it’s a pretty rich environment right now, from our perspective, to go out and acquire assets and we’re getting people calling us as opposed to us calling them right now, because the market is improving. And that wasn’t happening so much last year.

Gillian: I’m not surprised. And, Jeff, how are you thinking about the movements in capital markets right now?

Jeff Jorgensen: Capital markets, to echo these gentlemen, was tremendously important to the importance of MLPs, what we invest in exclusively, to the performance of that asset class in 2015. And I think it was probably one of the biggest detractors for performance, kind of went hand in hand with crude. Back in the day when I was an investment banker you could do any old follow on and everyone would gobble it up and it would trade really well, and those were the days. You could do a $300 million equity deal for LINN Energy, easy, no problem. They’ll come back a week later, do it again, those days are numbered. I think the high quality companies have proven that they can issue equity. Now, look, when monies are short we may get into a period of time we’re upstream MLPs, issuing equity again. But I don’t necessarily want to get there. MLPs, infrastructure assets need to be driven by quality companies. And good companies, quality companies should be the ones with access to capital, access to long term capital. And I think you’ll see a lot more handholding, structured deals, really thoughtful ways that companies raise equity. There’s been some great convertible preferreds done recently. There’s been some pipe deals. There’s been some over the wall transactions, that really help, and companies are really thinking about how to more, you know, disciplined, a more disciplined way to raise their equity capital. On the debt capital market side as interest rates go up, I think investment grade companies stand the benefit and perhaps become consolidate towards where they can lower their cost of capital from a debt perspective, to echo what Jeff was saying.

Gillian: Okay. I think it will be interesting given that this panel features both MLP and a REIT investor to kind of help us understand a bit about each structure. And we have both institutional and advisors watching this program, so it will be helpful for them to understand some of the nuanced differences between the structures: So, Jeff, starting with you, can you help us understand the tax structure of a REIT versus MLPs?

Jeff: Sure. So you have a tax efficient structure like you do with MLPs, unlike MLPs anyone can own a REIT, and so it’s a 1099 experience. And so whether you’re a tax exempt, whether you’re a fund, whether you’re a foreign investor, you can own REITs. You’re not going to have a withholding and association with owning a REIT. And so it’s a broader audience. It tends to be a much higher percentage of institutional investors in the REIT market, so will be broader based too than the MLP space. So you’ve got about anywhere from two-thirds to 80% depending on the REIT, generally, that’s institutional. And MLPs will be more down in the 30-45% institutional, and a lot of that’s insider.

Gillian: Okay. And Jeff, do you have anything to add to this?

Jeff Jorgensen: I think the big difference is the K1. And I think that that creates a different investor base. And there are solutions to that in the MLP world, but they come with bells and whistles. And it’s how you package kind of an MLP product, there are MLP lookalike C-Corps, General Partners. They are leveraged to the growth of an MLP or a Kinder Morgan which is now effectively a C-Corp. It’s a C-Corp, but it’s for all intents and purposes an MLP, planes, their GP tracker stock or I guess their C-Corp tracker stock that they’ll have, they have now. There are a lot of alternatives, if you will, but MLPs generate K1s. So companies like ours have come up with structures that have helped put them all together into a 1099 vehicle. You could talk for hours about the bells and whistles of how it’s a little bit different from a deferred tax perspective and as all that goes. But really I think the big issue is the 1099 versus the K1.

Gillian: And, Diego, what are just some of the opportunities associated with owning MLPs?

Diego Kuschnir: Well, we certainly think that the value proposition today is very interesting. It’s probably like it tends to do especially with such a [inaudible] ownership, it’s an industry that is, as we saw in 2008/2009, I mentioned before, when there’s a vacuum to the downside there is a lot of panic in the space, price discovery takes longer. And so we certainly think that it’s a long term very attractive asset class. And I think you get to enter the asset class at a very attractive entry point today. At the end of the day these are very, very, for the most part, Jeff was mentioning, these are very stable long life assets, which are structurally important to the US into the flow of hydrocarbons in the US. So I think getting the chance to own them at particularly attractive valuations today, it’s what makes the investment compelling.

Gillian: And there’s some … I’m sorry, did you have something to add to that?

Jeff Jorgensen: Yeah, I was going to interject. And one thing that we’ve been saying lately and I think MLPs get treated as an asset class. We talk about MLPs as an asset class. We’re an MLP manager; their sell side is organizing MLP verticals. Investment bankers are MLP investment bankers. But I think that’s doing the asset class a disservice, it’s doing a lot of companies a disservice. MLP is just a structure, there is good ones, there is bad ones. It’s just like a REIT, you’ve got to do your diligence, and whether you’re doing it in a C-Corp form or a tax advantaged MLP form, this is a company with either you’ve got good assets or bad assets, either a good management team or a bad management team. So when we lump them all together I think that contributed to the downturn, everyone said, “Oh my goodness, what have I bought?” I bought MLPs and there’s upstream MLPs, downturn over sentiments, going bankrupt and must mean all MLPs are going bankrupt. No, a lot of them are really good companies, they’ve been around a long time. And so I think just like C-Corps, just like REITs, just like LLCs, you’ve got to say, “Is this a good company? Do its assets survive commodity prices? Is it fit to stand through financial market downturns, capital market freeze-ups, commodity price downturns?” They’re all different. And so that’s where we do our work, right, and spend all of our time trying to figure the good from the bad.

Gillian: So due diligence is key. Jeff, what are the opportunities associated in REITs?

Jeff: So instead of looking at just the company and its current performance, we’re really focused hard on the asset itself. And so when you look at a REIT, you’ve got a lot of companies that are trying to prepare the balance sheets right now. You’ve got a lot of companies that want to get back to drilling, if there’s some instability in the market occurs, but even they want to drill on cash flow and their flexibility is limited to develop a CAPEX budget. So when we look at assets, which we own directly, we’re looking at that asset’s criticality relative to that company. So if a company has 1,000 miles of pipeline and you’re looking to buy a really good 150 mile pipeline, that’s one thing. But if you’re looking at an asset that controls 40% of that company’s revenue, that’s a much better thing. And so we want to buy assets, and we’re only interested in buying assets that that company cannot live without. And when we do that we find that even under dire straits of a bankruptcy, that the lenders and the company alike want to maintain their operation. In order for them to maintain their operation they need to adhere to the lease that we’ve structured the triple net lease. So that stability to our investors is certainly deemed attractive. From an operator’s perspective though, they have the ability to enter into a lease, to monetize it for cash on the barrel head and maintain full operational and commercial control of that asset going forward. We’re a REIT, we don’t want to operate. They’re going to operate. They’re going to continue to pay insurance and taxes under the triple net lease. And it’s a very compelling story for an operator who has attached assets and does not want to lose control. And that will drive, we think, growth.

Gillian: And you’re not holding the operational risk?

Jeff: And we’re not holding the operational risk, that’s right.

Gillian: Okay. This actually plays well into the discussion I wanted to have with each one of you about your due diligence process. You’ve alluded to the fact that it’s a good process. But I want to understand why each of you have good due diligence processes. So, Jeff, starting with you, you can detail the process for us or if you’d like to share an anecdote about a company that you either did or did not invest in. I think it’s always helpful for our viewers to understand a bit more about how you choose your portfolio companies?

Jeff Jorgensen: Sure. And I think this plays into the first question you asked, which was how did you survive through the downturn? And as I think we all said that is we stuck to our guns, we stuck to the principles that we know have worked in past cycles. And we knew it would work eventually through this cycle. So we do a bottoms up fundamental analysis of every company, it’s a contract by contract, asset by asset look at companies. We don’t necessarily go out and say, “Hey, I want to buy 50% natural gas pipelines, and 20% crude pipelines.” And we don’t have that view. We go out and we try to find the 20 or 25 best MLPs, or midstream C-Corps available to our investors, that are operating infrastructure, as I’ve mentioned, as designs of weather cycles, whatever cycle that may be. And has also has inelastic demand, limited sensitivity to seasonal weather patterns, you know, operated by best in class management. And has really had high barriers to entry business models, so no trains, no cars, no services businesses, really stuff that’s hard to replicate, that’s what we’re looking for.

Management teams are incredibly important to us. We come from a background of operations, not me personally, my partners, we are former CEOs of energy MLPs and worked in industry. And so I think knowing and understanding management teams and why they do the things they do, has helped us in our process. For a long time we’ve avoided one specific management team, we thought that if you’re going to invest with this one particular management team, I’ll just say it, Energy Transfer, then you invest where the CEO does. And if you invest where the CEO does, he’s going to look out for himself, because they don’t own many of the limited partnership units. That’s not the same with every general partner, as the general partner, Energy Transfer equity. They just don’t own a high percentage of LP and it’s most of their economic … most of their growth comes from the General Partner in the IBR. So he’s going to do what’s best for that entity. And it’s not the same way with every General Partner, then this situation has a long track record of looking out for the GP and not the LP. So we’ve avoided that LP and most recently he’s showed his true colors with an acquisition that was most very obviously favored towards where his ownership was and not towards the Limited Partners. So by avoiding that Limited Partner, I think it showed where our due diligence process, it’s a little bit nuanced from others, we are focused on management and focused on corporate governance, where it can kind of benefit our investors longer term.

Gillian: Yeah, it’s an absolutely great anecdote to explain that. So alignment of interests is one of the qualitative factors you’re looking at and management teams, makes sense. Diego, what’s your process like?

Diego Kuschnir: So we’re very lucky that we have a great team with us that do a lot of very deep value research. Again we are bottoms up, we look at essentially we’re buying collections of assets. That’s the way we think about our investments. And what’s the sanctity of this contract’s band of assets? How critical are the assets to both the company as well as to the broader infrastructure that how interconnected they are. The tenor of those contracts, the sanctity of the contract, we like to see companies that have, you know, that you can be a pipeline company but you could be a demand driven pipeline, you could be a supply driven pipeline. In our view it’s historically demand driven pipelines tend to have much better quality and sanctity than supply driven pipelines. So those are all factors that we put into consideration. This is an industry where we’ve talked about, and Jeff, mentioned, a lot of retail investors, that oftentimes do a sort of by dividend yield style of investing. And yet, this is an industry where you have probably one of the highest amounts of quantifiable data available, perhaps not necessarily filed with SEC or financial filings, but a lot of regulatory filings. So there’s a lot of data that can be gathered. And again, just to pull up this contract by contract, asset by asset analysis. So that’s a lot of what we do.

We have a great research team with us. We have a team of data gathering analysts that helps with this. And as we were talking a little before, yes, we live with these management teams at the end of the day, you need to understand their history, how they look at the world, how they run their businesses. And typically good management teams do better than bad management teams, and that’s something that I think in time and in history you learn that and you make the right decisions [inaudible] them.

Gillian: You mentioned the criticality of the assets, how do you determine that?

Diego Kuschnir: Well, for example, if we’re talking about demand driven assets versus supply driven assets, so if you have a pipeline, in the last couple of years every time, you know, naming names, a company on the natural gas side, let’s pick Chesapeake as an example. Every day they had a bad day, every natural gas pipeline company had a bad day in the MLP midstream market. Yet, an inordinate amount of pipelines are supplying to utility companies. So Con Edison has contracts to buy gas from individual different pipelines. And so obviously the risk profile of those two, that’s what keeps these lights on. So the counterparty, the criticality of having the access to that natural gas, to that contract, or the [inaudible] side on the NGL side, or the crude on the refiner side. So that’s one of the ways we think about in terms of, you know, is this asset working without the hydrocarbon?

Gillian: Excellent, Jeff, how do you think about your process? And you come from an engineering background.

Jeff: Right, yeah. So I’ll echo what Diego and Jeff said, I think they really summed it up well in that the management team, the asset, the contracts, okay. Because ultimately you’re looking at an operating model of that asset, what type of EBITDA is coming off of that asset? From a criticality standpoint though, you could just simply … you can do a criticality analysis of any group of infrastructure or assets. But if you look at a company’s income statement and then you subtract out that asset, what happens if that asset is removed from operation, if who owns that asset turns it off on you, okay? Or there’s something that wipes out that asset, if that scenario is completely unacceptable and highly painful for that company that spells criticality in capital letters. Those are the type of assets we want to own.

Gillian: Do you have an example of a company that you’ve chose to invest in or chose not to?

Jeff: Well, for an example, we own a liquid gathering system on the Pinedale Anticline. The operating company has 94% of its production coming out of the Pinedale Anticline. The only way that that production can occur is by keeping our pipeline operational. In contrast to sitting down with … recently I was sitting down with an MLP CFO and he was saying, “Well, you know, Jeff, we’ve got some non-strategic assets. And maybe we’d be interested in, you know, in having you look at those.” I said, “No.” I said, “I don’t think we’d be interested because you’ve already described them as non-strategic.”

Gillian: Interesting, great point. So let’s talk a little bit, we mentioned management teams that were abstinent, didn’t have their interests aligned with the rest of their investors. So, Jeff, starting with you, what are some of the other risks you’re assessing actively at the corporate level?

Jeff Jorgensen: Oh my goodness, well, already test some of the big ones, and that’s capital markets access and cost of capital. And I think in an externally funded business model, that is the MLP market, you need to make sure that your investment is competitive, or its projects to be built in a way that’s accretive to holders. We can participate in M&A to the extent that that becomes more important, which we think it will. Can it participate in M&A effectively over time? And so cost of capital is tremendously important. And so access to capital, cost to capital are tremendously important. Again, I mentioned some of the kind of big picture stuff that we’re looking for. We’re looking for limited weather sensitivity. We don’t want a hurricane in the gulf to take down a critical asset, 60% of your cash flows. We don’t favor propane MLPs that are begging for a cold winter. If a cold winter comes, great for them, if not, oops, we can’t control that and meteorologists still can’t figure that out either, so how could we? And then we’re looking at all the traditional kind of financial metrics, you know, making sure that you’ve got a clean balance sheet that you, you know, you’ve got good ratings again, or 80/85% investment grade, that goes into the cost of capital. Making sure your covered ratios are at adequate levels, that you’re not growing your distribution too fast, which we saw led to some cuts on the downturn and really that your counterparties are critical, and that your counterparties are solid, that they are investment grade as well. And so you’ve seen Chesapeake, a good example, you know, a major counterparty drilled our pipelines that we don’t like. And we don’t love those pipelines because of who’s paying the bills.

Gillian: Is all this information easily accessible for you or do you find that you have to be creative about your due diligence?

Jeff Jorgensen: It takes work. If it was too easy then, you know, anyone could do it. We’ve got a great team, much like these guys do. You know, and we have a lot of data that’s great and a lot of regulatory filings, a lot of meetings with management. We spend a lot of time talking to management teams and trying to figure things out and reading through countless documents. And there really is a lot of data out there for your taking, it’s just compiling it and knowing what to do with it is the trick.

Gillian: Makes sense. Jeff, what are some of the risks that you’re assessing?

Jeff: Well, we are not willing to take commodity risk on what we call our base rent. And so the base rent provides the stability to our investors. Our investors are driven by stability and accept the fact that we’re not going to advertise as much growth as many of the MLPs. But they’re willing to accept a lower growth profile given stability. So in that base rent structure of our contracts we want no commodity risk associated with it, in other words, the commitment to pay rent every single year at a given level is inked in stone, right from the get go. Now, above and beyond the base rent, we do have upside, above and beyond base rent, having a built in inflationary escalator, which provides some upside, yes. But the major part of the upside we call participating rent. And the concept behind participating rent, Gillian, is if things go really well for our operating partner, then we get a piece of that upside. And that is something that we are willing to take commodity exposure on, volume and commodity exposure in the form of revenue upside.

Gillian: Okay. And I know, I remember reading on your website there’s some other risks that you look at or even geological etc, irrelevant given your background.

Jeff: Yeah. Well, yeah, as a geologist and petroleum engineer I’m biased in that way to look at the upstream assets. But I think as these gentlemen will agree, that any time you’re investing in a pipeline or a piece of midstream infrastructure, you care a lot about what is upstream from that pipeline and what is downstream. And you really need to have that whole story combined to underwrite that asset or that group of assets. And so if you’re dealing with a group of assets, that’s tied into the [inaudible] or the BOC, then that’s very different than a group of assets that’s tied into the Permian right now. And you’re going to take that into account in terms of your risk assessment of those cash flows.

Gillian: Sure. Diego, last but not least, how do you think about risk?

Diego Kuschnir: Yeah. I mean, I think they mentioned most of the things. Clearly the topics are management, they’re important, so it’s something that we pay a lot of very close attention to. And then obviously the impact of price of the commodity, volumes, whether they’re supply and demand, counterparty risk, those are all obviously incredibly important things. We pay a lot of attention to regions, basins. As a firm we look at midstream MLPs but we also look at the broadly defined energy infrastructure. And so I think to Jeff’s point here, one thing that differentiates us probably from some of our peers is that we really do take a very close look at the well head to the burner tip, if you want. So what is really the entire complex? And what are the risk across this complex? And we think specific to midstream, understanding, right, what’s on the left and what’s on the right is just as important as understanding the piece in the middle.

Gillian: I’m going to stay with you for a moment and this might also be considered in the risk bucket, there is a conference going on down the street of the Waldorf Astoria, it’s energy related. There are protests outside regarding the Dakota pipeline. I’ve heard it described as Donald Trump’s keystone. What legislative risks do you see coming down the horizon and are you worried about this increasing environmentalist movement?

Diego Kuschnir: I want to be careful how I phrase this. So I don’t know that concern or I’d consider it a risk. I think the way we look at it from a business perspective, clarity I think is hugely important. And I think to the degree that politicians let outside factors influence the decision making, that’s problematic because of course if the rule of the land or the law doesn’t apply, or sometimes apply, that becomes problematic. And I think that’s something that we pay a lot of attention to, to the degree that a pipeline shouldn’t be built because it does not meet the conditions that it should meet, it shouldn’t be built. But if you have met them and if you’ve gotten your approvals, there should be a pretty clear path to do so. So that’s something that we pay a lot of attention to. We have companies that we hire that specifically look at the pipeline by pipeline, permitting by permitting issues. Because it’s clearly a very important consideration, the hope and expectation is that as we get into this new administration, perhaps some of these items will become perhaps a little bit more clear, but certainly something worth paying a lot of attention to.

Gillian: So, clarity is key. Jeff, what are you thinking about in terms of the legislative landscape?

Jeff Jorgensen: Oh goodness, I’m glad you got to take that one first, that’s a dizzy. It’s hard to pick out one specific legislative thing that we just don’t know is going to exist. But I will say the environmentalist movement is certainly very well organized. And they certainly have some targets in mind. And I think they very intentionally went after Dakota access, from all the intelligence gathering that we’ve done, we found that to be a very intentional move. They thought it could be most disruptive to kind of the fossil fuel industry in the US. So I don’t think it needs to be taken for granted. And I think pipeline companies need to do everything that they can to make sure that they are accommodating federal and state level environmental issues. And they need to do it ahead of time. And that goes back into something we’ve said, all of us have said, management teams, management teams with experience, management teams that know how to do this. People that have built pipelines before many, many times should be able to navigate these waters a lot more effectively than those that are new to it, and that are flippant about it. And I think that’s a key part of our diligence process, pinpointing one specific issue. And I have some pipelines in the back of my head that I think are going to be targeted next, but we don’t need to go into that. But, you know, I think it all comes back to who’s building these pipelines, what’s their track record, how responsible are they?

Gillian: Okay. And, Jeff, lastly with you, how are you thinking about the legislative temperature right now?

Jeff: You know, legislation has been proven to be pretty hard to change. And so I think we’re talking about tweaks and not major changes. But rationale, if rationale can prevail and we can hear out concerns that are justified, environmentally based and accommodate those and have a process as Diego said, that navigates through those waters, that’s what we need. And I think pipeline companies sometimes can do a better job telling the whole story too, as to the safety of pipelines is second to none. Some statistics have proven that, or have demonstrated that they’re about 25 times as safe as rail and 3,000 times as safe as truck. And as long as we have this appetite for hydrocarbons, it needs to get transported, no matter where it comes from. And you know, taking oil from the Canadian heavy oil sands, the Keystone project and getting that down to the Gulf Coast, the story that no one ever told was well, our refineries on the Gulf Coast, many of them are optimized to digest heavy oil. So where do we get that heavy oil? We get it from Venezuela. How much do we really want to get from Venezuela? Do we want to have a dependency on Venezuela or do we want to have a dependency on our friendly neighbor to the north? And I think that answer’s pretty obvious, but you never heard it brought up. All of those factors should be brought to light and taken into consideration in making these decisions.

Gillian: Really interesting points. So I can hardly believe it but we’re coming to the end of our discussion. So I want to give each of you an opportunity either to share with us one thing that you think our viewers should take away about the energy market coming up in 2017 or something they should take away about your business. So, Jeff, I’ll start with you.

Jeff Jorgensen: I’ll talk specifically about the MLP market because that’s what we focus on. And I would point out just one fact and I think it goes to how right now I think is a very attractive time for MLPs. And that is from December of 2015 to December 2016, the Benchmark Index, which is the Alerian, is basically flat. Now, you’ve had some distributions so you have a positive total return. It seems like we’ve gone through a lot. We’ve had, you know, a big fallout in January and February, a big recovery since then, commodity prices have stabilized, rigs are now being added. The capital markets are more accommodative. You’ve had the first MLP IPO, one that failed in 2015, come out. And then the list goes on, you have a more accommodative administration. All of these factors going in to prove, to me, or seem to me, that we’ve got a lot more firmer floor. We’re standing on firmer ground than where we were in December of 2015. You know, where are we? Same spot, and to me that presents an opportunity for anyone who’s listening, everyone who might be interested in MLPs.

Gillian: Great points. Diego.

Diego Kuschnir: I certainly would agree and I mentioned it before, we think that it’s a pretty unique entry point into this space today, even when you compare it to … certainly with the broader market, but even when you compare it within other areas of the energy patch. We were just looking at this chart earlier today, the Alerian Index, the ratio of the Alerian Index to the XLE, which is the broader energy index, or to the SMP, it’s at lows for the last decade. So even when you compare it to the XLE, which is certainly, you know, part of the energy complex that did have more impact, you know, direct impact from commodity prices and the crisis and pretty big magnitudes, MLPs still are trading at some of the cheapest levels we’ve seen versus most other sectors. And, you know, to Jeff’s point, with the tailwinds that we’re starting to get behind us now, I think could be a very compelling opportunity set.

Gillian: Yeah. So, attractive entry points, some tailwinds coming down. Jeff, what about you?

Jeff: 2017 is shaping up to be a good year, from what we’ve lived through the past couple of years. I would just encourage viewers, Gillian, that are looking for direct investment in infrastructure with their tax exempt accounts or non-US investors, just for them to know that there’s avenues that they can use to garner direct access, and that’s in this novel REIT structure that we’re managing right now. And we fully expect to be annihilated by others as we become better known. But for right now we’re focused on growing our REIT.

Gillian: Excellent, perfect. Well, thank you all so much for joining us, this has been a great discussion and we look forward to catching up with you. Thanks so much for joining us. I’m Gillian Kemmerer, this was the Energy Masterclass.