Oil & Gas Price Outlook February 2017

Rising Interest Rates’ Effect on Master Limited Partnerships

Oil and gas MLPs (“Master Limited Partnerships”) are publicly traded limited partnerships.  MLPs are most commonly present in the energy industry, providing and managing resources such as oil and gas pipelines.  These types of business endeavors are conducive to producing regular income, thus enabling MLPs to offer attractive income yields, because they earn stable income that is often based on long-term service contracts.1,2

On December 15, 2016

The Federal Reserve increased its target interest rate range by 0.25%, to 0.50-0.75%.  This marked the first interest rate increase since December 2015 and represented only the second change in interest rate policy since December 2008.  Looking forward, more than half of economists surveyed by The Wall Street Journal3 expect the Federal Reserve to leave short-term interest rates unchanged at its next two policy meetings, and then raise them again in June.  Nearly 60% of the business and academic economists polled in recent days said the Fed would next raise its benchmark federal-funds rate at its June 13-14 policy meeting, up from 48% in the previous survey. Roughly a quarter said they expect the Fed to raise rates again at its March 14-15 meeting, while 11% expect the next increase when Fed officials meet in May.

Oil & Gas Price Outlook February 2017

Given their income focus (as opposed to growth), MLPs essentially compete against bonds and bond funds within an investor’s portfolio.  Rising interest rates, driving up the yield to maturity on bond investments, will provide investors more attractive, income focused investment yields versus those provided by MLPs.

Wells Fargo’s analysis shows that spikes in interest rates can affect MLP performance, but gradual changes do not have a significant impact.  As shown in the graphic below, when interest rates rise significantly, the MLP sector tends to underperform the S&P 500.

Oil & Gas Price Outlook February 2017

Another consideration is that higher interest rates can also affect an MLP’s incremental borrowing costs and consequently reduce its cash flow available for distributions.  One positive offset to this effect would be the expected increase in oil and gas prices, discussed below.

Crude Oil Outlook

While futures markets aren’t a crystal ball, their price levels, and related options are useful for estimating future ranges or “confidence intervals” for crude oil and natural gas prices.

The graphic below shows the crude oil price on February 14, 2017, and predicted crude oil prices based on options on oil futures contracts (ticker /CL).  The blue lines are within one standard deviation (σ) of the settlement price (green line) and the red lines are within two standard deviations for each month (for a refresher on standard deviations, see the January 2016 blog).

Oil & Gas Price Outlook February 2017

Based on the February 14, 2017, prices, the markets indicate that in mid-April 2017, there is about a 68% chance that oil prices will be between $48.00 and $60.00 per barrel. Likewise, there is about a 95% chance that prices will be between $40.50 and $69.00.  For a longer-term view, by mid-December 2017, the +/- 1σ price range is $40.00 to $70.00 per barrel, with an expected value of $55.39.

Natural Gas Outlook

We can do the same thing for natural gas futures, currently trading at $2.91 per MMBTU on the Henry Hub (ticker /NG).  Although more affected by seasonal factors than crude oil, in April 2017, the +/- 1σ price range is $2.55 to $3.65 per MMBTU and the 2σ range (95%) is $2.15 to $4.45 per MMBTU.  The expected value of natural gas prices in mid-April 2017 is $3.08 per MMBTU.

1. February 6, 2017, Wells Fargo Equity Research, “MLPs: Do Rising Interest Rates Matter?”

2. http://www.investopedia.com

3. Wall Street Journal, February 9, 2017

Tags: Oil & Gas Price Outlook February 2017, Gas Price Outlook Feb 2017, Oil Price Outlook Feb 2017

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