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JHVEPhoto Energy Income Performance Energy income performed broadly in line with the S&P 500 (SP500) during the week. The Alerian Midstream Energy Index was down 0.8% as the S&P 500 fell by 0.7%. A 1.8% rise in oil prices boosted E&Ps. The XOP’s 1.9% gain was the standout performer in energy. HFI Research Natural gas was weak for yet another week, down 7.2%. The week’s decline sent natural gas down nearly 70% from its 2022 high. While the natural gas price decline has been a setback for upstream energy companies and others with direct commodity price exposure, it will have far less of an impact on midstream cash flows. In recent years, midstream has transitioned away from commodity price exposure and toward fee-based business, in which cash flows depend on throughput volumes. Since a great deal of domestic U.S. natural gas is associated with oil production, increasing oil volumes have brought about increasing natural gas volumes. In addition, as oil production has become gassier, a higher percentage of natural gas per barrel of oil production has also grown midstream throughput volumes. We expect these trends to continue in 2023. Short-term, midstream may experience natural gas takeaway constraints in the Permian—which could negatively impact oil production growth—but any constraints are likely to be temporary. Rising Permian production provides midstream operators with opportunities to build long-haul pipelines that transport natural gas away from the basin. Expansions of existing pipelines and the development of new pipelines are already underway. If the industry can be disciplined and not overbuilt, well-positioned operators will see their cash flows benefit significantly. With the industry now emerging from two years of debt reduction, an increasing share of cash flows will be directed toward equity owners. On Wednesday, Kinder Morgan, Inc. (KMI) released fourth-quarter results this week, kicking off the energy sector’s earnings season. KMI’s results provide a glimpse into today’s favorable natural gas volumetric and pricing trends, which we expect to continue in 2023. Kinder Morgan’s Results Provide a Bullish Read on Natural Gas Midstream KMI reported fourth-quarter 2022 Adjusted EBITDA that beat consensus estimates by a slight 1.8%. Adjusted EBITDA increased by 8% over the fourth quarter of 2021. The company also delivered a 3% dividend increase, bringing its dividend to $1.10 on an annual basis. KMI shares now trade at a 5.9% dividend yield based on the increased payout. KMI’s natural gas assets outperformed our expectations during the quarter. Natural gas transportation volumes increased due in part to higher Texas Intrastate system throughput and increased Haynesville gathering and processing volumes. Fourth-quarter natural gas transportation volumes rose by 4.0% from the previous year, while NGLs increased by an impressive 13.8%. KMI benefitted from cold weather in December, which increased demand from natural gas power plants over the previous year’s levels due to recent coal plant retirements. HFI Research KMI’s Products Pipeline segment results were weaker than we expected, as volumes fell nearly across the board from the previous quarter and year-ago results. Jet fuel was the only gainer from the year-ago period. Crude volume declines were attributable to reduced output from the Bakken. We don’t believe KMI’s poor liquids pipeline showing provides a relevant read-through to other liquids-focused midstreamers. Turning to financial results, KMI full-year 2022 Adjusted EBITDA declined 5.4% from 2021, primarily due to the $1 billion one-time benefit derived from Winter Storm Uri in February 2021. After removing the impact of the storm, KMI’s full-year Adjusted EBITDA increased by an impressive 8.2%, driven by higher volumes and rate increases. The Adjusted EBITDA performance drove KMI’s year-end 2022 leverage ratio down to 4.1-times, below management’s long-term target of 4.5-times. Segment-level Adjusted EBDA showed the outperformance of KMI’s Natural Gas Pipelines segment, and the weaker performance in its Products Pipelines and Terminals segments, as shown in the table below. HFI Research Natural Gas Pipeline segment financial results were boosted by natural gas price volatility that occurred during severe winter weather in December. The volatility drove increased demand for KMI’s natural gas transportation services as customers moved natural gas from supply centers to demand centers. The segment is poised to get an additional boost when the Freeport LNG export facility returns to service. KMI’s Products Pipelines and Terminals segment EBDA fell by 10.3% due to lower volumes and higher operating costs that were not offset by higher rates. Carbon Dioxide segment EBDA increased by 22.8% due to an acquisition, higher realized crude oil, NGL, and carbon dioxide prices, as well as higher carbon dioxide volumes. The company doesn’t disclose the segment’s commodity price sensitivity, but we can surmise that its performance has improved. KMI is aggressively pursuing new projects in its Energy Transition Ventures, which management believes will be completed at an attractive EBITDA multiple of 3.4-times. These projects are aimed at building infrastructure for renewable liquids feedstocks and fuels. For 2023, management guided for $7.7 billion of Adjusted EBITDA, which would be 2.4% above the 2022 total of $7.52 billion. This is consistent with management’s previous guidance in its December 2022 update. The important takeaway from KMI’s results was the impressive volume growth in the company’s natural gas transportation business. It supports our preference for natural gas-weighted midstream equities. KMI’s fourth-quarter and full-year 2022 financial results were in line with our expectations. They do not change our valuation or price target. We reiterate our Hold rating and $19.50 price target. One potential risk to shareholders comes from repurchases. KMI repurchased slightly less than $1 billion of shares in 2022, most of which we estimate to have been made within the range of intrinsic value. As such, the repurchases are little more than capital allocation PR, as they fail to add value for shareholders. If KMI’s shares rise above their intrinsic value and management continues to repurchase shares, repurchases at those elevated levels would detract from shareholder value. Weekly HFI Research Energy Income Portfolio Recap Our portfolio declined by 0.4% during the week, slightly worse than its benchmark, the Alerian MLP Index, which was down 0.1%. HFI Research The week’s biggest winner, Martin Midstream Partners (MMLP), was up 3.1% on no news. MMLP units benefitted from the pullback in interest rates and increasing demand for high-yield debt, both of which bode well for an eventual refinancing of MMLP’s near-term debt maturities. MPLX (MPLX) was the second-best performer, up 1% on no news. Our portfolio’s underperformers during the week were natural gas-weighted operators whose equities fell with the week’s 6.0% decline in natural gas prices. Cheniere Energy (LNG), EnLink Midstream (ENLC), and Black Stone Minerals (BSM) were the biggest declines and were all down more than 2%. Cheniere and BSM offer an attractive combination of discounted equities relative to our estimate of intrinsic value and a strong long-term outlook. We recommend both as Buys. ENLC also has a strong outlook but given the stock’s recent run-up to multi-year highs, we’d wait for a pullback before adding to the name. News of the Week Jan. 18. ONEOK (OKE) announced a 2% increase in its common dividend, from $0.935 to $0.955. We expected the increase, as we explained in a recent article. This is OKE’s first dividend hike since January 2020, and we expect additional increases over the coming quarters. OKE’s cash flows are reaping the rewards of a multi-year infrastructure buildout that will reward its unitholders with increased dividends for years to come. Management expects 10% Adjusted EBITDA growth in 2023 due to OKE’s MB-5 fractionation plant and Demicks Lake III processing facility coming online this year. However, OKE shares have run up in 2023 and now trade above our $66.00 price target. We rate the units as a Hold. Jan. 19. Environmental groups sued the U.S. government to overturn its approval of the Port Oil Terminal (SPOT), which is being developed by Enterprise Products Partners (EPD) and Enbridge (ENB). The SPOT is planned to be the largest offshore export terminal in the U.S., with the capacity to load two VLCCs at a time and load 2 million barrels of oil per day. The terminal has already received the approval of the EPA and the Department of Transportation’s Maritime Administration. We expect it to overcome the legal challenge. Nevertheless, environmental activists have an unprecedented reach into the judiciary these days. They have successfully used it to cancel other formerly approved projects. If they prove successful with the SPOT, we don’t expect a material impact on EPD. However, a cancellation could be a setback to ENB if it interferes with the company’s recent Gulf Coast infrastructure expansion aimed at extending ENB’s vertical integration. Jan. 20. Western Canadian oil transportation hit several operational snags all at once. Oil-sands upgrading facilities operated by Syncrude and Canadian Natural Resources (CNQ) faced disruptions and supply cuts which reduced volumes on Enbridge’s Mainline system. ENB also experienced issues at its Express Pipeline after third-party utilities cut rates. At the same time, TC Energy’s (TRP) and Pembina Pipeline (PBA) also encountered operational problems. TRP’s Keystone Pipeline was hit by power outages due to ice accumulation. This is the third in a series of operational setbacks for TRP that raises concerns about a pattern of operational deficiencies. PBA had a spill on one of its NGL pipelines in Alberta. The disruptions increased prices for the low-sulfur Canadian crude oil grades. They also caused an increase in the spread between Canadian heavy grades and WTI. We don’t expect these incidents to have a material impact on Adjusted EBITDA for major Canadian operators, though we’re growing more concerned about TRP’s deteriorating operational track record. We discuss the matter here. Capital Markets Activity Jan. 17. Crestwood Equity Partners LP (CEQP) announced a private offering of $600 million of 7.735% Senior Notes due 2031. It intends to use the proceeds to repay borrowings on its revolving credit facility. Jan. 18. Genesis Energy, L.P. (GEL) announced a cash tender offer to purchase its 5.625% senior secured notes due 2024. The tender offer is contingent upon GEL’s successful completion of a debt offering. Also on January 18, GEL announced the offering of $400 million of senior unsecured notes due 2030. The offering is intended to fund the purchase of its tender offer. HFI Research

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