Back in 2015, FERC launched its 5-year review of the liquids pipeline index through a notice of inquiry in late June with a decision in December. We expect the upcoming five-year review to begin shortly now that pipelines have filed FERC form 6 for 2019. On pages 2-3 of this report, we provide a history of the index and its nuances, and discuss potential ways for FERC to address the 2018 change in MLP tax policy for liquids pipelines. On pages 4-5, we provide our forecast for the FERC index level for the 2021-26 period through our analysis of 75 pipeline filings using FERC’s methodology in the last review. Lastly, we discuss estimated company exposures and implications.
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This report highlights utilities CEO pay, incentives, stock ownership, change of control info and much more. The punchline is that utility CEO pay is relatively well aligned with the things investors care most about – EPS and shareholder return. But the bar is set surprisingly low by some companies to get 100% target payouts, often at the low end or below their official guidance. Operational, safety and customer service metrics are also a focus and we think are important for L-T value in the utility sector. Carbon reduction and power fleet transition are gaining steam as AEE, AEP and POR have joined XEL and SO in targeting these.
Earlier in the year, we discussed how NEE’s significant weighting in the UTY and strong performance was helping the utilities index keep pace with the broader market. As the sector has struggled to find its footing in recent weeks, we wanted to once again highlight NEE’s impact on the index, as the sector’s underperformance without NEE is even more notable. Much like Technology has become the whole show at ~40% of the S&P 500, on a smaller scale NEE has been a strong driver of the UTY. NEE now makes up 18% of the index – up from 17% earlier this year (D, DUK, and SO are the next biggest weightings at 9-10%). Since the end of 2019, the UTY has lagged the S&P 500 by just 0.5%. However, when excluding NEE this grows to 5.5%. Quite impactful for just 5 months of performance.
We’re updating our commentary on U.S. power demand in accordance with updated EIA data, as well as the latest weekly weather data from NOAA. Power demand was up 7% WoW, but down 7% YoY for the week-ended 5/30. Relative to the 4-year average, demand was down 6%. While the previous two weeks showed modest further deterioration in the trend, demand still seems to be tracking within the range of upper-single-digit percentage declines. Most notable though was the decline in ERCOT (Texas) demand this week, as it had largely been bucking the demand decline trend. We remain in a shoulder period from a weather perspective, where degree days are less impactful. Total degree days (HDDs and CDDs) were down again, but only by 11%, as the seasons change. Cooling degree days were up 8% versus last year and 37% versus normal when looking across the U.S. in aggregate. Heating degree days were down 62% versus last year and 68% versus normal.
Just a month ago in our Utility Trader, we upgraded the Regulated Utilities sector to Market Outperform for the first time in several years. We then followed up last week with a more in-depth reiteration as the group continued to underperform. The sector finally woke up the last 2 days beating the market by 350bps. For the month, however, utilities ended up 60bp behind the market (up 3.9% vs S&P 500 up 4.5%) and they still trail by 220bps YTD (down 8% vs the S&P down 5.8%). We have spent most of this year trying to explain why utilities have been underperforming. More than anything, we think it has simply been a function of a very narrow stock market focus on growth/momentum stocks and then on virus recovery plays.
ACP faces more uncertainty after the 9th Circuit Court of Appeals in San Francisco denied the DoJ’s request to stay a MT judge’s ruling, which vacated the use of NWP-12 for gas and oil pipelines. This is the latest blow to ACP, and one that risks further delays and makes the project resumption decision even more complex. D stock has rightly had a nice run on the VA clean energy law opportunities. But with the stock a top performer YTD and trading at average regulated valuation for the first time in a few years, we believe D is no longer cheap with or without ACP (5% of EPS); downgrade to Peer Perform with a $85 PT.
On Thursday afternoon (5/28/20) the Ninth Circuit Court of Appeals refused to stay a lower court’s ruling that vacated the Army Corps NWP12 water permit for oil/gas pipelines. The refusal to stay the ruling was a disappointment relative to expectations and will almost certainly mean delays for pipeline projects that had been relying on NWP12 for water crossings. Of the projects it appears that MVP has the most flexibility to work around it but delays are likely. Substantial work on KXL and ACP may be stymied well into next year. We downgrade Dominion in a separate note (link).
We hosted several members of NI’s mgmt. team, including CEO Joe Hamrock and CFO Donald Brown, for a virtual meeting today. The punchline was that mgmt. is hopeful to offset impacts from COVID and dis-synergies from the CMA sale when looking out to 2021, with the goal of crafting a plan to still meet the $1.36-1.40 range that was pointed to on the YE19 call. This was encouraging to hear given commentary on the Q1 call less than a month ago where NI was noncommittal on expectations for 2021, which will be the basis for its 5-7% growth thereafter. Our 2021E is at the bottom of that range ($1.36), which assumes some spillover of COVID pressures/dis-synergies that aren’t fully offset. We remain Outperform rated with a $26 PT as LT fundamentals remain solid and the plan post-CMA should be a lot easier to execute on.
We never would have guessed utilities would underperform amidst a pandemic-driven recession. They are trailing the market by 500bps YTD and by 735bps from the market peak. Other defensive, yield sectors like Staples and REITs are underperforming too. The market is very narrowly focused on growth/momentum or recovery plays. For several years, utilities traded at lofty 10-20% premiums driven by long-term favorable trends: 1) high single digit total returns amidst a low interest rate, low growth economy; 2) earnings stability through the economic cycle; and 3) ESG friendly growth in renewables and in electrification. Our conviction in these LT trends is even higher today than before while valuation is now at a 10% discount to the market (2021E) and the yield spread to bond yields is at a record. The Presidential election is a potential catalyst as utilities seem less impacted than others if the Democrats win. As the market focuses past the U, V or W recovery to the next letter, we think utilities will meaningfully benefit.
We’re updating our commentary on U.S. power demand in accordance with updated EIA data, as well as the latest weekly weather data from NOAA. Power demand was up 4% WoW, but down 9% YoY for the week-ended 5/23 – the worst YoY mark since we started tracking this data in mid-March. Relative to the 4-year average it wasn’t much better – demand was down 8%, which was close to the worst we’ve seen. Mild weather likely isn’t helping, but we’re becoming increasingly concerned on this trend. Total degree days (HDDs and CDDs) fell by nearly 30% WoW. Heating degree days were down 21% versus last year and 6% versus normal when looking across the U.S. in aggregate. Similarly, cooling degree days were down 23% versus last year and 4% versus normal. See more detail within for charts and tables, as well as the slides that we will continue to update intra-week.
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