ESG Considerations for The Alerian Midstream Energy Dividend UCITS ETF | MMLP

Author: Michael Laitkep, Senior Research Analyst, Alerian

Summary

• ESG reporting has continued to gain traction in midstream with seven more constituents of the Alerian Midstream Energy Dividend Index (AEDW), the underlying index of our midstream energy ETF, publishing their inaugural sustainability reports since August. Overall, 21 of 31 AEDW constituents provide sustainability reports.   
• Energy infrastructure has made notable improvements in ESG reporting and performance.
• Going forward, midstream companies should continue to adopt comprehensive and transparent sustainability reporting and strive to improve their safety, emissions, and governance metrics.

One of the most popular trends in investing over the last few years has been the rise of environmental, social, and governance (ESG) investment considerations. Energy infrastructure may not be the first sector that comes to mind when thinking of ESG-friendly investments, but adoption of sustainability reporting has become more commonplace among midstream companies. Although midstream certainly still has a way to go in its efforts to cater to ESG considerations, there have been notable improvements since Alerian’s ESG white paper, First Steps: Introducing ESG Issues in Midstream, was published in October 2019. This piece examines developments in sustainability reporting and performance in the space and discusses the next steps for the industry, focusing on the Alerian Midstream Energy Dividend Index (AEDW).

ESG reporting continues to gain traction in midstream.

Even against the backdrop of a challenging and noisy macro environment for energy this year, ESG has remained in focus for investors and midstream management teams alike. Since August, seven more energy infrastructure companies have published their inaugural sustainability reports, bringing the total across constituents of the AEDW Index to 21. This excludes Phillips 66 Partners (PSXP), whose parent publishes ESG data for the MLP.  Overall, Canadian corporations tend to be leading the way in terms of ESG reporting in midstream with the large US C-Corps also providing sustainability reports. MLPs as a group have shown improvement in recent months as some of the largest MLPs, including Energy Transfer (ET), Enterprise Products Partners (EPD), and Magellan Midstream Partners (MMP) have released sustainability reports, while EPD and others have integrated ESG into broader investor materials. As an example, a recent presentation from EPD included a dedicated sustainability section that highlighted the role US energy will play in improving quality of life around the world. A handful of companies have also updated their sustainability reports in the last year to include additional data or a more comprehensive discussion of their operations, demonstrating the industry’s ongoing commitment to ESG reporting.

With sustainability and ESG considerations increasingly on the minds of investors, ESG should similarly be a focus for midstream management teams trying to attract new investors to the space. The momentum around ESG-minded investing continues to grow, especially among younger investors, and midstream should be responsive to this trend. For midstream, ESG reporting is likely a prerequisite for attracting generalist investors with ESG sensitivities. Additionally, ESG adoption could benefit midstream as greater public scrutiny is placed on energy infrastructure projects. Pipelines tend to receive criticism from environmental groups, but in reality, they are the safest method of oil and natural gas transportation. Transparent data around worker safety, pipeline spills, and emissions may help reassure stakeholders that companies operate in a safe and effective manner.

Midstream shows improvement in key ESG metrics and increases transparency.

In our initial analysis of ESG in midstream, linked above, we noted that the first steps for energy infrastructure companies would be to engage with investors, increase disclosures, and promote uniformity and transparency in those disclosures. Based on recently published sustainability reports, it seems that the space is in the process of taking these steps. The increase in reporting has made it easier for investors to compare the ESG performance of individual companies and gauge an operator’s standing among the industry. While there is still some variability in the metrics disclosed, most sustainability reports tend to include common key data points. The widespread adoption of a reporting framework, such as those offered by the Global Reporting Initiative (GRI) or Sustainability Accounting Standards Board (SASB), could help further improve uniformity across the industry. Many midstream companies already utilize one or both of these frameworks in sustainability reporting.

Recent sustainability reports also show improvement in key metrics in recent years, particularly in regard to safety. Given the nature of the midstream business, sustainability reports often place a strong emphasis on safe operations, which has only been amplified by the ongoing pandemic. A key example of this among AEDW constituents is Crestwood Equity Partners (CEQP), which ties 20% of company compensation to five safety metrics, such as Total Recordable Incident Rate (TRIR). TRIR, a measure of work-related injuries or illnesses, is included in each sustainability report of the 21 constituents providing them except for International Seaways (INSW), which reports lost time incident rate alone. For the companies reporting, TRIR fell by 11.0% on average on a year-over-year basis as of the most recent reporting period. Several companies even provide TRIR goals. Gibson Energy (GEI) and ONEOK (OKE), after seeing declines in their injury rates in 2019, stated targets for further reducing TRIR in 2020.

Greenhouse gas emissions are another key component of sustainability reporting and will likely be a primary consideration for ESG-focused investors going forward. While emissions metrics continue to vary from company to company, each midstream sustainability report provided some data detailing the company’s environmental impact. The majority of reports even mention the threat that climate change poses to both the environment and their businesses, with Enbridge (ENB), TC Energy (TRP), and Williams (WMB) each including more extensive sections on climate change in their reports. In late August, WMB announced the goal of reducing greenhouse gas emissions by 56% from 2005 levels by 2030 as the company targets net zero carbon emissions by 2050. WMB is investing $400 million in solar projects to power company facilities in nine states. Similarly, in November, ENB announced a net zero emissions goal for 2050 alongside additional ESG targets for the coming years. As WMB and ENB exemplify, ESG considerations and midstream can be compatible.

Furthermore, midstream can help facilitate a transition to cleaner natural gas in the US and around the world through exports of liquefied natural gas. Approximately 63% of the constituents in the AEDW Index by weighting are primarily focused on transporting and processing natural gas, which has been widely touted as the bridge fuel of the energy transition. Until renewable power becomes more widely available or reliable, natural gas is going to play an important role in providing affordable, cleaner power, especially relative to coal.

Governance factors are a major component of the ESG discussion for midstream. The table below provides an update on the governance metrics for constituents of AEDW, some of which are holdings in our midstream energy ETF. Note that Plains GP Holdings (PAGP) is excluded given its overlap with Plains All American (PAA). In terms of board independence, 20 of 31 companies analyzed have a majority independent board. No company has a board that is majority female, and three companies do not have a female board member at all. Since August, board dynamics and management teams’ skin in the game have not broadly changed. However, many of the names listed below, namely CEQP and Genesis Energy (GEL), saw skin in the game tick up earlier this year as midstream insiders took advantage of the sell-off in 1Q20 to purchase significant amounts of their company’s shares on the open market, better aligning their financial interests with those of their shareholders (read more).

Another notable governance improvement that has continued over the last year has been the elimination of incentive distribution rights (IDRs) by MLPs. IDRs have widely fallen out of favor with investors, and their removal helps lower an MLP’s cost of capital while better aligning the interests of the general and limited partners (read more). Since October 2019, DCP Midstream (DCP), Noble Midstream Partners (NBLX), and Shell Midstream Partners (SHLX) have all closed IDR elimination transactions. As shown in the chart below, 95.4% of AEDW by weighting no longer has IDRs, a notable improvement from 60.9% at the end of 2016. Going forward, the portion of the MLP universe with IDRs is expected to continue to shrink.

What are the next steps for ESG in midstream?

Midstream has begun to take its first steps in advancing its sustainability profile through general improvements in ESG reporting and metrics, but where does the space go from here? First and foremost, the measures adopted by the companies highlighted in this report need to be embraced by the rest of the energy infrastructure universe. The improvement in the overall number of companies issuing sustainability reports has been notable in recent months and now represents the majority of names in the index. However, 10 companies still do not issue these informative reports. Additionally, when companies do address ESG considerations, it should be in a comprehensive and transparent manner, preferably with a standardized reporting framework for investors to easily compare. Finally, management teams should continue to prioritize ESG issues by emphasizing safety, reducing emissions, committing to diversity, and aligning their interests with those of shareholders. Alternative energy projects, such as investment in wind or solar energy, could represent an opportunity for midstream operators to improve their emissions profiles while potentially diversifying their revenue streams. Though the industry clearly has a way to go, the strides made within the last several months should provide investors with confidence that the ESG focus within energy infrastructure is here to stay.

Bottom Line

Growing investor focus on ESG considerations has required companies across industries to address related concerns, including midstream. While midstream makes money by transporting, storing, and processing hydrocarbons, the nature of the business does not make ESG concerns irrelevant, and on the other extreme, it does not preclude any investors with ESG sensitivities from investing in midstream. ESG investing can encompass midstream investing if midstream companies continue to provide transparent and comparable sustainability reports and demonstrate improvements in ESG metrics over time.

About Alerian Midstream Energy Dividend UCITS ETF

Our Midstream energy ETF is a UCITS compliant Exchange Traded Fund domiciled in Ireland. The fund seeks to provide diversified exposure to energy companies involved in the processing, transportation and storage of oil, natural gas and natural gas liquids in the US and Canadian market. The fund tracks a dividend-weighted index based on the liquid, dividend-paying portion of the US and Canadian energy infrastructure market and includes MLPs and C-Corps.   When you trade ETFs, your capital is at risk.  

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