A Bumpy Road to a Familiar Low-growth Destination
PGIM Fixed Income explains why it expects to see secular factors overtake cyclical trends as already-building headwinds slow the global economy.
A powerful combination of surging inflation and soaring energy prices, fueled by the war in Europe, is driving strong investor interest in the energy sector.
Short-term: The global supply crisis will take time to resolve due to severe underinvestment in the sector in recent years, making it impractical to quickly ramp up production. This should keep energy prices elevated near term.
Long-term: While prices should fall over time, they will likely remain more elevated than in recent years, especially in the midstream energy/master limited partnership space, which provides the “plumbing” for energy sources. Strong secular tailwinds from diversification of energy sources, particularly in European countries that are turning away from Russian oil, and a larger global transition to cleaner energy sources provide strong, long-term tailwinds for midstream energy.
In an effort to reduce carbon emissions, the world is in the early stages of a multi-decade energy transition. Demand for natural gas is especially strong and is expected to continue growing for several decades as it is a cleaner-burning energy source, making it a sought-after commodity for renewable energy as well.
The U.S. is a low-cost natural gas producer and has one of the most stable political climates, making it a potentially high-demand source for countries seeking to diversify their energy sources. U.S. liquified natural gas exports have been rising and are near record levels, putting the U.S. on track to soon become the leading global exporter of natural gas. But U.S. exports are at maximum capacity with the existing infrastructure, and significant capital investment will be necessary to build more export terminals to meet the growing demand. Given the multi-year process required to build new re-gasification terminals, this could create a long-term growth tailwind for U.S. midstream energy companies. This may also help alleviate some of the regulatory hurdles to building pipelines that midstream energy companies have been subject to recently.
Minimally impacted by interest rates: Immediate cash flow impacts on MLPs from potentially higher interest rates are minimal as most MLPs typically use fixed-rate debt to finance long-term energy infrastructure projects. While rising rates could potentially negatively impact MLPs over the short term as other yield-oriented investments become relatively more competitive, historically MLPs have been a strong performer in rising rate environments.
Hedge against inflation risks: Additionally, most MLP contracts have built-in inflation adjustors, allowing corporations to pass through higher costs to users.
Risks—Investing involves risks. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic uncertainties. Investing in emerging markets is very risky due to the additional political, economic, and currency risks associated with these underdeveloped geographic areas. Investments in growth stocks may be especially volatile. Value investing involves the risk that undervalued securities may not appreciate as anticipated. It may take a substantial period of time to realize a gain on an investment in a small or midsized company, if any gain is realized at all. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively impact the ability to make distributions. There is no guarantee a REIT’s investment objectives will be achieved. Diversification and asset allocation do not guarantee profit or protect against loss. Investments in in Master Limited Partnerships (MLP) and MLP-related investments are subject to complicated and in some cases unsettled accounting, tax, and valuation issues, as well as risks related to limited control and limited rights to vote, potential conflicts of interest, cash flow, dilution, and limited liquidity and risks related to the general partner’s right to force sales at undesirable times or prices. MLPs are also subject to risks relating to their complex tax structure, including losing its tax status as a partnership, resulting in a reduction in the value of the MLP investment. Many MLP investments are in the energy sector and subject to a greater degree to risk of loss as a result of adverse economic, business, regulatory, environmental, or other developments affecting industries within that sector than investments more diversified across different industries. Diversification and asset allocation do not guarantee profit or protect against loss.
The views expressed herein are those of investment professionals at Jennison Associates LLC (“Jennison) at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. This commentary is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services. This commentary does not constitute investment advice and should not be used as the basis for any investment decision. This commentary does not purport to provide any legal, tax, or accounting advice. PGIM Investments LLC is a registered investment advisor with the U.S. Securities and Exchange Commission. PGIM Custom Harvest does not provide tax, legal, or accounting advice. This material is for information purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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