Midstream energy equities have outperformed the broader market year to date and delivered attractive returns over the last few years. Looking forward, we believe the strong performance from the asset class can continue. We’re bullish on energy infrastructure, or midstream, as part of a diversified infrastructure portfolio, given improvements in the underlying industry, supportive demand drivers, and midstream companies’ compelling income and growth characteristics. 

Improvements in the underlying industry 

In recent years, midstream companies have:

• Significantly improved their corporate finance models;
• Meaningfully reduced leverage;
• Enhanced corporate governance; and 
• Shifted to living within free cash flows.

The transition to a self-funded business model has largely eliminated the need to rely on external debt and equity financing to fund growth and distributions, while also allowing the sector to become more defensive than in previous business cycles. This is evident in how the midstream sector has been much less sensitive to the performance of other asset classes, including crude oil and broader equities, than it used to be, with the sector’s year-to-date relative outperformance indicative of this dynamic. Over the long term, we expect midstream companies’ strong free cash flow and healthy balance sheets will help insulate these firms’ attractive income and distributions from potential broader market volatility.

Supportive demand drivers 

We believe natural gas consumption growth tied to the artificial intelligence (AI)-driven buildout of data centers—and energy infrastructure companies’ ability to benefit from this tailwind—are still underappreciated by the market. Data centers require significant, reliable, 24/7 energy to power AI, a trend that we see meaningfully increasing natural gas demand as forecasts for additional capacity from gas power plants continue to surprise to the upside. In fact, in the most recent analysis of U.S. utilities' Integrated Resource Plans (IRPs), natural gas generation growth is forecast to rise at a steady clip for at least the next decade, a departure from projections that showed plateauing growth just three years ago.

We believe the following characteristics of natural gas underpin its market position as a critical resource for U.S. energy needs:

• Abundant, low-cost domestic supply;
• A robust network of existing infrastructure; and
• A lower emissions profile than other dispatchable alternatives, such as coal.

At the same time, these abundant, low-cost resources have positioned North America as one of the world’s most secure sources of energy and a coveted source of supply for global export markets looking to avoid exposure to potential geopolitical risks. In fact, North American liquefied natural gas (LNG) export facilities currently under construction are set to double the U.S.’s current export capacity of roughly 13 billion cubic feet per day (Bcf/d) by the end of the decade, providing additional cash flow tailwinds for midstream companies.

Compelling income and growth profile 

The improvements to the industry and the strong fundamental tailwinds support a compelling current income profile, and growth of that income into the future, as do the unique features of underlying midstream businesses. These features, which we believe help differentiate energy infrastructure as an investment opportunity versus other income-oriented asset classes and broader equities, include:

• Fee-based contracts with inflation escalators;
• Operating cash flow that largely covers capital expenditure and dividend obligations, with additional room for share buybacks, additional deleveraging, or strategic M&A; and
• Predominantly investment-grade balance sheets.

In our view, these attractive attributes make energy infrastructure a solid investment opportunity alongside other real asset sectors that are potential beneficiaries of the AI theme, including renewables and broader infrastructure.

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