New technologies have unlocked oil and natural gas sources which we believe offer US companies a lasting competitive advantage in the global market. The BP Capital TwinLine Energy Fund invests in companies across the full spectrum of the energy supply-demand value chain which the Advisor believes are well-positioned to take advantage of the opportunities related to the American Energy and Industrial Renaissance. The fund focuses on capital appreciation with 25-40 holdings.
The BP Capital TwinLine MLP Fund invests in midstream Master Limited Partnerships (MLPs) and C-Corps involved in the transportation, storage, gathering and processing of oil and natural gas. The Fund seeks to maximize total returns via capital appreciation as well as significant current income, typically treated as “return of capital” to the investor.
We believe we have three key competitive advantages:
- Informational Alpha: The Funds gain a unique perspective in the energy investment landscape from their affiliation with BP Capital, which manages commodity/energy equity hedge funds and holds private assets and mineral interests.
- Energy Value Chain: The Funds invest in companies across the energy supply-demand value chain which the Advisor believes are well positioned to take advantage of the opportunities related to the American Energy and Industrial Renaissance
- Deep Energy Experience: The Funds were launched with the goal of “twinning” alongside the legacy of Boone Pickens in order to leverage industry knowledge, investment experience, deep relationships, and trust earned over the past 60 years.
In the final quarter of 2017, the US energy sector continued to build upon many of the positive developments from the third quarter. Most notable was a further reduction in crude inventories, particularly in the US, where consistent weekly draws were reported by the Department of Energy throughout the period. Total US crude inventories in 4Q17 fell by 40.5m barrels and were down a dramatic 111m barrels since the 2017 high at the end of the first quarter. Large inventory reductions in the latter half of 4Q were even reported at the Cushing, OK hub, the location where inventories had previously been most stubbornly high. The decline in crude inventories were partly offset later in the quarter by seasonal increases in gasoline and distillate inventories, which had both experienced accelerated draws in 3Q as a result of refinery downtime with Hurricane Harvey.
OPEC’s continued policy of production cuts regarding its members and a new extended group of countries (including Russia) should be largely credited for oil’s increased tightness in recent months. The cartel’s program initiated on 1/1/2017 for 1.8m barrels per day of production cuts was extended throughout 2018 when the group reconvened this past November. Some oil skeptics have questioned future compliance to the cuts from some OPEC countries with the Brent crude price now at roughly $70/barrel. Still, we believe the one OPEC country most driving policy, Saudi Arabia, will remain committed to the cuts, given its plans to IPO state-owned Saudi Aramco later this year and the large reduction in the Kingdom’s monetary reserves in recent years under low crude prices.
Apart from OPEC, a jump in the reported monthly US oil production figures in September and October of last year highlighted the risk from increased supply from US shale. We note these higher production figures follow reported monthly figures that had significantly lagged the weekly reports for much of the year. (The monthly figures are thought to be more accurate than the weekly reports.) Still, as we detailed in our Dec 8, 2017 piece “Extrapolation – When Excel Loses Touch with Oilfield Realities,” we believe even at higher oil prices, there exists numerous real-world constraints to US shale production growth.
Maybe the most critical inflection point for the sector occurred in late 3Q when Anadarko Corporation (APC) announced its plans to use cash on hand to repurchase up to 10% of its shares, instead of plowing those funds back into development expenditures or making an expensive acquisition. The news was welcomed by Wall Street and was viewed as an indication of prudent capital allocation and a willingness to listen to the wishes of shareholders. Encouragingly, other producers have followed APC’s lead in discussing their intentions for maintaining capital discipline even after the recent rise in oil prices. We believe this newfound shareholder-friendly focus presents the opportunity for the sector to be viewed in a new light, attracting longer-term investors rather than just those looking for a trade.
Equity performance within the energy group improved late in 4Q17, but not enough to offset what was a dismal return for many energy stocks in 2017 relative to other sectors. Even after the latest stock price appreciation, energy remained only 6.1% of the S&P 500 at the end of the year. This is despite many investors now concluding that it represents one of the few sectors in the market where valuations remain reasonable. We would agree with this and remain constructive on the sector in 2018, particularly considering the present environment of favorable global supply/demand fundamentals for crude and the recent more shareholder friendly approach taken by many US oil producers.
BP CAPITAL TWINLINE ENERGY FUND REVIEW
During the quarter ending December 31, 2017, the BP Capital TwinLine Energy Fund (TLEF) Institutional Shares rose 9.7%. During the same period, the S&P North American Natural Resources and the S&P 500 Energy Indices increased by 5.9% and 6.0%, respectively. For the full year 2017, the TLEF rose 2.2%, versus 1.2% and -1.0% for the S&P North American Natural Resources and the S&P 500 Energy Indices. Since its inception on 12/31/2013, the TLEF is up 2.1% on an annualized basis, significantly outperforming the S&P North American Natural Resources Index and the S&P 500 Energy Index annualized returns of -2.2% and -1.9%, respectively, during that period.
Performance in the fourth quarter for the TLEF was led by a rebound in upstream energy stocks (E&Ps and oilfield service), as well as continued favorable performance from end-user segments. Midstream positions (including MLPs) had the worst performance in 4Q17. In particular, continued improvement in energy fundamentals, combined with tailwinds from the broader equities market, resulted in the overall strong performance for the portfolio in the quarter.
The outperformance relative to benchmarks in 4Q17 was largely driven by stock selection within the sector. Still, the portfolio’s exposure throughout the energy value chain had some changes on the margin in 4Q17. At the end of the quarter, exploration and production stocks (E&Ps) remained the portfolio’s largest weighting at 33%, up 1% from its weighting in all the prior quarters of 2017. The portfolio’s oilfield services exposure rose to 22% at the end of 4Q17, up from 20% at the end of the third quarter and 17% at the end of the second quarter. This increase was largely driven by our intention to increase exposure to the completions portion of shale production where services are currently the tightest. The fund’s midstream exposure fell throughout 2017, ending the year at 21%, down from 23% at the end of 3Q, 26% at the end of 2Q, and a high of 28% at the end of the first quarter. This decline partly reflects price underperformance by the group relative to other subsectors. Finally, our end user weighting was 17% at the end of 4Q, down slightly from 19% at the end of the prior quarter as we harvested some gains in the subsector in recent months.
Returns quoted represent past performance, which does not guarantee future results. Current returns may be lower or higher. Returns shown for more than 1-Year are annualized. Performance current to the most recent month-end may be obtained by calling 1-855-40-BPCAP (1-855-402-7227). Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost.
Q417 MIDSTREAM MARKET REVIEW
Two contradictory investment themes characterized the midstream sector during the fourth quarter 2017. First, sector fundamentals generally improved, supported by meaningful increases in both crude oil pricing and U.S. lower 48 production volume. Second, midstream sector stock prices moved lower, at odds with strengthening fundamentals, resulting in a breakdown in the sector’s correlation with the commodity. For investors, the conflicting drivers of market sentiment resulted in a heightened level of uncertainty that drove many investors to sit on the sidelines waiting for signs of clarity.
Tightening supplies bring higher crude prices even with advancing U.S. volume growth During the quarter, unprecedented compliance across OPEC’S production quota alliance resulted in a meaningful drawdown in petroleum storage inventories here at home and abroad. In the U.S., crude oil inventories were reduced by 40mmbbls bringing current supply levels closer to the seasonal 5-year historical average. Importantly, this inventory reduction came even with the continued rebound in U.S. shale volumes which rose to a yearly high at the end of December to 9.8mmbbls/d, an increase of 230mbbls per day during the quarter.
In response to tightening global crude oil fundamentals, average NYMEX WTI crude pricing rose during the fourth quarter averaging $55.39 per bbl up $7.22 per bbl. Likewise, Natural Gas Liquid (NGL) prices also gained, with the composite NGL barrel rose $0.09 to an average of $0.76 per gallon.
Midstream equity price correlation to Crude pricing breaks down during the quarter, what gives? Tightening oil supplies and corresponding price improvement meant little for midstream investors, however, as most of the quarter’s performance reflected the uncertainty resulting from a host of sector specific risks which kept supportive investment money flows restrained. Let’s take these risks one at a time.
1) EQUITY IPO OVERHANG During October, the public offering of BP midstream partners (BPMP) presented investors with nearly $900mm in new equity for investment. As with any significant equity offering, investors often make room for the purchase of newly created shares by liquidating a portion of existing portfolio holdings. While the size of the BPMP offering was small relative to the sector’s overall market cap, some small degree of selling pressure associated with the BPMP deal likely contributed to overall sector weakness.
2) INTRA-INDUSTRY COMPETITION In pursuit of projects in areas like the Permian basin, both public and private midstream companies have shown a willingness to pursue project opportunities at the expense of project returns. As an example, during the fourth quarter, several new pipelines transporting crude out of the Permian basin were proposed by both public and private midstream companies, some having limited volume commitment at the time of project announcement. In our view, the willingness to ‘green-light’ such projects with limited visibility on financial return has heightened the risk to project returns and led investors to price that risk into equity values, yet another reason for equity weakness.
3) DISTRIBUTION REALIGNMENT During October, Genesis Energy Partners, LP (GEL) reduced its per unit distribution and Enterprise Products Partners, LP (EPD) reduced its per unit distribution growth rate. While the reasons for the respective moves were different, the reductions renewed investor fear over the impact of declining payouts and left many to question who might be next. Heightened uncertainty with respect to sector payouts was a primary contributor to sector weakness during the quarter.
4) TAX REFORM During November and into December, midstream investors had to contend with potential change in MLP tax status as congress debated the eventual tax reform package presented and finally passed by President Trump. The ultimate signage of the Tax Reform and Jobs Act came without detriment to the MLP structure and its relative attractiveness to C-Corps, but not before weighing on investor’s minds and likely keeping them on the sidelines leading up to the last several weeks of the year.
5) TAX LOSS SELLING Midstream sector performance during 2017 was no doubt challenging for investors, and to make matters worse, given the sectors relative underperformance to the broader market, many of the sector’s losers saw further pressure associated with year-end tax loss strategies. The stock market’s version of ‘kicking the sector while it was down’ rang true as many of the worst performers slid lower into the year-end without support.
6) IDR ELIMINATION/SIMPLIFICATION ISSUES The necessary but costly process of Incentive Distribution Right (IDR) elimination has presented a challenge to certain midstream companies seeking to maintain the favor of public unit holders. While IDR elimination frees the LP unit holder from a higher cost of capital, fear of the IDR payoff which generally comes as a ‘one-time’ equity issuance has created an overhang in companies anticipating IDR elimination. In our view, the fourth quarter closure of several IDR elimination transactions, renewed investor awareness of impending future IDR elimination transactions and weighed on many of the equities facing the eventuality of an IDR transaction.
The multitude of risk factors just described led many investors to call a ‘time-out’ on midstream investment, limiting important capital flow into the equity sector over the quarter and year. As tracked by UBS, sector equity inflows decreased in 2017 falling 80% year over year from $16.2 Billion to $3.2 Billion. While early signs of sector inflows thus far in 2018 are suggestive of a sector inflow rebound, investor confidence and corresponding appetite going forward will depend upon improved clarity around many of the risk factors pressuring equities in 2017.
An early rebound in equity prices in 2018 has provided a much-needed sense of relief for investors who endured frustrating performance during 2017. The fading of tax reform fears and the absence of tax loss selling has lifted significant pressure from the sector allowing equities to lift back toward their historical valuation average. Market focus now turns to much needed clarity around sector competition, sector distribution growth rates and of course, IDR elimination and GP/LP simplification. In our view, clarity around distribution risk should diminish given continued improvement in the sector’s fundamental backdrop. In addition, recent evidence of coordination by companies participating in joint ventures and other value additive arrangements suggests that intra-industry competitive forces can be managed, and finally candidates facing IDR elimination are now clearly defined. In sum, we believe improving investor confidence around each of these issues will likely attract the return of investor flows to the sector and the process further extend the improvement we’ve seen thus far in 2018.
As always, our effort is focused managing these risks to distinguishing sector ‘have’s and have not’s’ in an effort to design an optimal portfolio mix of companies for our investors. We look forward to the challenge the sector brings in 2018.
Top contributors to BPMIX during the quarter included BP Midstream Partners, LP (BPMP) which performed well following its October Initial Public Offering and Shell Midstream Partners, LP (SHLX) which performed with resiliency despite downtime associated with Hurricane Harvey. Targa Resources (TRGP) benefited from partial sale of its Grand Prix Pipeline to private equity player Blackstone Group, LP, and finally Rice Midstream, LP (RMP) and Enterprise Products Partners, LP (EPD) all posted modestly positive quarterly returns supporting overall portfolio outperformance relative to the benchmark AMZX.
Significant detractors from BPMIX during the quarter included Enbridge Energy Partners, LP (EEP) which has been hampered by investor concern of slowing or delayed distribution growth. Buckeye Partners, LP (BPL) which was impacted by its decision to halt increases to its distribution payout rate. Spectra Energy Partners, LP (SEP) which has been pressured by investor concerns over a potentially dilutive impending IDR elimination transaction. HESS Midstream Partners, LP (HES) which may have been impacted by concerns over activist pressures imposed on its C-Corp Sponsor parent HESS, Inc. (HES) and finally Andeavor Logistics, LP (ANDX) which closed the acquisition of Western Refining Logistics, LP (WNRL) and a significant IDR elimination transaction during the quarter.
* Returns for periods greater than 1 year are annualized; Inception (12/31/13)
Returns quoted represent past performance, which does not guarantee future results. Current returns may be lower or higher. Performance current to the most recent month-end may be obtained by calling 1-855-40-BPCAP (1-855-402-7227). Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Total annual operating expenses for Class I are 1.60% for the TwinLine Energy Fund and 1.96% for the TwinLine MLP Fund. Returns for Class A different due to different charges and expenses.
As with any mutual fund, it is possible to lose money by investing in the BP Capital TwinLine® Funds. An investment in either Fund is subject to other risks that are more fully described in the prospectus, including but not limited to risks in Master Limited Partnerships (“MLPs”) include, cash flow, fund structure risk and MLP tax risk plus regulatory risks. The prices of MLP units may fluctuate abruptly and trading volume may be low, making it difficult for the Funds to sell its units at a favorable price. Most MLPs do not pay U.S. federal income tax at the partnership level, but an adverse change in tax laws could result in MLPs being treated as corporations for federal income tax purposes, which could reduce or eliminate distributions paid by MLPs to the Funds.
An investment in the BP Capital TwinLine® MLP Fund is, also, subject to risks, include but are not limited to non-diversification, energy-related sector, small-cap and mid-cap stocks, initial public offerings, high-yield “junk” bonds, and derivatives. The Fund is treated as a regular corporation, or “C” corporation, for U.S. federal income tax purposes. Accordingly, unlike traditional open-end mutual funds, the Fund is subject to U.S. federal income tax on its taxable income at the graduated rates applicable to corporations (currently a maximum rate of %) as well as state and local income taxes. The Fund will not benefit from current favorable federal income tax rates on long-term capital gains, and Fund income and losses will not be passed on to shareholders. The BP Capital TwinLine® MLP Fund may, also, invest in MLPs that are taxed as “C” corporations.
An investment in the BP Capital TwinLine® Energy Fund is, also, subject to risks, include but are not limited to non-diversified, energy-related sector, small-cap and mid-cap stocks, initial public offerings, high-yield “junk” bonds. The Fund expects that a significant portion of its distributions to shareholders will be characterized as a “return of capital” because of its MLP investments. If the Fund’s MLP investments exceed 25% of its assets, the Fund may not qualify for treatment as a regulated investment company (“RIC”) under the Internal Revenue Code (“Code”). The Fund would be taxed as an ordinary corporation, which could substantially reduce the Fund’s net assets and its distributions to shareholders.
Investors should consider the investment objective, risks, charges, and expenses of the BP Capital TwinLine Funds carefully before investing. A prospectus with this and other information about the Funds may be obtained by calling 1-855-40-BPCAP (1-855-402-7227). Read the prospectus carefully before investing.
Shares of the Funds are distributed by Foreside Fund Services, LLC, not affiliated with BP Capital.
Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index.
The S&P 500 Index (S&P 500) is an index of 500 stocks used industry wide as a macro level indicator of the overall U.S. equity market.
The S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the GICS® energy sector.
The S&P North America Natural Resources Index represents U.S. traded securities that are classified under the GICS® energy and materials sector excluding the chemicals industry and steel sub-industry.
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships (MLPs) that provides investors with a benchmark for the MLP asset class. The index, which is calculated using a float-adjusted, capitalization-weighted methodology, is disseminated real-time on a price-return basis (AMX) and on a total-return basis (AMZX).
Lipper Energy MLP Funds– Average of the funds that invest primarily in Master Limited Partnerships (MLPs) engaged in the transportation, storage and processing of minerals and natural resources.