In the previous issue, I discussed the outlook for oil and gas producers. Today, I will give a rundown of the prospects of the midstream, downstream, and renewable sectors in the aftermath of the recent presidential election.

The election of Donald Trump to the presidency potentially marks a radical departure from the path the country had been going down. I have recently discussed the potential impact of his election on the oil and gas, as well as coal sectors. Production will likely be incrementally higher than it would have been had Hillary Clinton won the election. Arguably the loss of energy-related jobs in places like Pennsylvania helped seal her defeat.

Midstream

Let’s first focus on the midstream sector, and how I think Trump’s election changes the picture there. Midstream businesses are those that move oil and gas from the site of production to processing plants, storage facilities, and end customers. Midstream consists largely of the oil and gas pipelines that crisscross North America. These pipelines are akin to an invisible road network — except they total about 2.5 million miles in length versus the 47,000 miles in the US Interstate Highway System:

Source: U.S. Department of Transportation

Midstream companies generally function as toll collectors for moving oil and gas, and are more insulated from the commodity price volatility that can impact the upstream and downstream sectors. As a result, many investors like the midstream space for its predictable income streams, and many midstream providers have structured themselves as master limited partnerships (MLPs), which provide additional tax benefits for investors.

Prior to the 2014 oil price collapse, the Alerian MLP Index (AMZ) — a composite of the 50 most-prominent energy MLPs — had vastly outperformed other income indices. In fact, in the decade before the 2014 crash, AMZ’s total return was more than double that of the S&P 500.

But the last two years have been tough. MLPs sold off along with the rest of the energy sector, with the AMZ dropping 32.6% in 2015 — its second worst annual performance on record. The only worse showing was during the financial crisis, when MLPs dropped 36.9% in 2008 before bouncing back with a 76.4% gain in 2009 and adding another 35.9% in 2010.

In addition to its economic woes, the midstream sector has faced an upswell of opposition to pipelines extending all the way to President Obama.

Opposition to the Keystone XL, an expansion of an existing pipeline moving crude oil from the Athabasca oil sands in Alberta to hubs and refineries in the U.S., turned into an environmental movement. Protests were held, and the Obama Administration backed environmentalists by delaying the pipeline for years before ultimately rejecting it.

Thus, a cottage industry was born of protesters who believed that if they could stop pipelines, they could keep the oil and gas in the ground. The objective is to combat climate change, but in reality the oil just ends up getting shipped by other, riskier means.

The latest high-profile target for this kind of protest was the Dakota Access Pipeline, where once again the Obama Administration has gotten involved on the side of the protesters. For more background on this issue, see Standing Rock on Shaky Ground.  

I have felt for a while now that these protests were starting to become more than just a minor nuisance for the midstream operators. When the rules can change right in the middle of your project, you are going to become a lot more conservative with capital. And that hampers growth.

Trump’s election changes all of that. There will be no more support at the highest levels of government for those blocking infrastructure projects. It now becomes an obvious conflict of interest, as Trump reportedly owns a stake in Energy Transfer Partners (NYSE: ETP), the primary owner of the Dakota Access Pipeline. The CEO of ETP has also donated to Trump’s campaign. Trump is being advised by long-time veterans of the oil and gas industry. But conflict or not, these are pretty good indicators of how he is going to handle new oil and gas pipeline projects.

The path we were heading down with respect to pipelines just abruptly ended. I think the midstream sector will be one of the biggest beneficiaries of this presidential election.

Certainly hostile state governments can block pipeline development. There are also some other near-term headwinds, such as low oil and gas prices and, recently, rising bond yields in the runup to a likely rate hike by the Federal Reserve. But the shift in direction at the top of the federal government will reverberate for years.  

In fact, immediately in the wake of Trump’s victory TransCanada announced that it’s prepared to restart talks with the Trump Administration on the previously rejected Keystone XL. I am not so sure the economics of the project still look favorable for TransCanada, but should the company wish to push ahead it can expect a very different outcome this time. Protests in front of the White House won’t matter this time around.      

Thus, if I had to place a bet on one sector that should perform substantially better under a Trump Administration than it would have under a Clinton Administration, midstream would be near the top of the list (as would coal). I still think the long-term outlook for coal is dim, but not as dark as it would have been. But, for the energy investor looking to avoid the volatility of coal, midstream is where I would go.  

Renewables

The growth trajectory of renewable energy also changed with Trump’s election. I have been long-term bullish in particular on solar power but much less so on renewable fuels. Solar costs have declined dramatically, making the technology increasingly competitive with fossil fuels. Favorable government policies around the world have certainly helped fuel solar’s exponential growth:

Wind power has grown rapidly as well, but the declines in its cost curve over the past two decades aren’t nearly as impressive as those of solar power. Further, solar power lends itself more to small-scale, local opportunities like commercial and residential rooftop arrays.

Biofuels are a different story. While wind and solar compete mostly against coal, natural gas, and nuclear power, biofuels are a substitute for fuels derived from oil. They are based on industrial processes that have been around for more than 100 years in some cases. This more mature technology isn’t seeing the sort of cost declines that will make it competitive with oil. With situational exceptions I am mostly bearish on biofuels, which tend not to be competitive if deprived of government support like U.S. ethanol quotas.

Trump has been critical of solar and wind power (“kills all your birds”) at times while campaigning. He did say he loves ethanol, as most politicians do when in Iowa, but keep in mind that he is being advised by people who do not.

Thus, it wasn’t a big surprise that wind, solar, and biofuel stocks suffered double-digit losses within a couple of days of the election. The world’s largest maker of wind turbines, Vestas Wind Systems (CPH: VWS) fell 14% the day after Trump’s win.

I am still bullish on solar stocks in the long run, because I think solar power can compete in an unsubsidized market. But the speed of adoption has likely been slowed by Trump’s election, so my growth expectations have been lowered.     

Refiners

This brings us finally to the downstream sector, which is the business of refining, marketing and distributing the products made from oil and natural gas. Because refiners benefit from the differences between the price of inputs like oil and natural gas and that of products like gasoline and diesel, they generally do well when oil prices are falling, and vice versa.

We have traded in and out of the refiners on multiple occasions over the past four years. While there are other factors that come into play, if we feel like oil prices are going to fall, we may rotate into refiners.

That was a profitable place for us to be for most of 2015, but we rotated back out of them in September of that year. It proved to be a timely call, because over the next six months the best stock of the bunch we sold, Tesoro (NYSE: TSO), dropped 15.6%, while most others were down 40%-plus.

Over the past six months the refining sector has bounced back a bit, primarily as a result of record gasoline demand and continued low costs for oil and natural gas. At the same time, it didn’t do as well is it might have had it not been for the cost of the government biofuel blending mandate. Companies like Valero (NYSE: VLO) have reported spending hundreds of millions of dollars per quarter to comply.

Those advising Trump will tell him to ditch the Renewable Fuel Standard (RFS), and the sell-off in ethanol stocks following his election betrays fears that at the least the mandate will be weakened. While that may come to pass, there is a great deal of bipartisan support for the RFS. Further, it isn’t clear that Trump is even interested in repealing it.

But Trump came out strongly against excessive regulation in his campaign, and refiners are certainly one of the most stringently regulated industries. Trump will probably try to slow the adoption of new requirements, and potentially roll back some current rules.

Regardless of what Trump may or may not do for the refining sector, are market conditions yet conducive to a rosier outlook than a year ago? There is still risk if oil prices rise, but many refiners have managed to generate solid cash flow in the current environment. Most refining stocks are considerably cheaper than a year ago, and growing demand helps offset the risk of rising oil prices.

We are watching the refining sector closely, and in fact last month we added Marathon Petroleum (NYSE: MPC) back to the Growth portfolio. We are starting to once again warm to the sector, so don’t be surprised to see us adding a few more to the portfolios in coming months.        

Summary

The surprise election of Donald Trump will shift the fortunes of certain energy sectors. Fossil fuel production, transportation, and refining are likely to benefit, while renewables appear headed for a bumpy ride. As always, there will continue to be good and bad companies in every sector. We will highlight the best ones, while taking advantage of the opportunities presented by Trump’s victory.

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