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Midstream Energy Sell-Off Has Been Overdone

OPEC’s decision to maintain production quotas has sent oil prices lower and created a number of good opportunities to buy quality businesses, writes Morningstar’s Jason Stevens.

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Midstream stocks are selling off in the aftermath of OPEC’s Thanksgiving Day decision to maintain existing production quotas, dashing the market’s hope that OPEC would step in and remove excess crude oil supply from the market. By our estimates, oil markets are oversupplied by roughly 1 million barrels a day, which may increase into early 2015 absent a production response. We think that the market’s reaction is overdone, particularly if you consider that 1 million to 2 million barrels a day of excess supply is equivalent to 1.1% to 2.2% of daily consumption, and depletion alone removes roughly 4% of total production each year. Moreover, the supply surge from U.S. shale oil has been well anticipated by markets, leaving us to wonder what has changed fundamentally in the market’s awareness that has dropped the energy sector as a whole by 20% since September 1. We suggest investors pay attention to oil demand, as any further weakness could spark another leg down in oil markets. That said, over the medium term we’d expect lower crude prices to stimulate demand, supporting our expectation of higher prices in the future.

We think the market reaction among midstream firms in particular has been overdone. While some U.S. MLPs do have modest direct crude oil or natural gas liquids price exposure, the vast majority of cash flows are linked to long-term, fee-based contracts, supporting relatively stable cash flows despite market tumult. Moreover, midstream firms create value by building new assets. Despite low oil prices, we continue to see robust project pipelines from firms in our coverage.

Jason Stevens does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.