How Midstream Defends Against Rising Interest Rates

Last week, the Federal Reserve hiked rates for the first time since 2023 amid persistent inflation concerns. With markets pricing in at least one more hike this year, monetary policy remains top of mind for income-focused investors. Investors often ask how midstream performs in rising interest rate environments relative to other equity income investments.

In short, the sector tends to remain highly resilient, driven by compelling yields, long-term fixed debt, and built-in contractual inflation adjustments. Read more below to explore the historical data and understand why midstream is well-positioned to navigate higher rates while continuing to return capital to shareholders.

• Midstream companies offer competitive yields compared to bonds, and their yield is independent of interest rate moves.
• Midstream operates under long-term contracts that often include inflation adjustments. Inflation can be a tailwind for midstream.
• Midstream historically remains resilient when interest rates climb, consistently outperforming traditional income investments like utilities and REITs.

For traditional equity income investments, rising interest rates present several issues. First, they increase competition for investor capital as fixed-income investments, including Treasury and corporate bonds, become more attractive.

MLP yields remain more than 100 basis points above the bond benchmark, while broader midstream yields now sit below corporate bonds, given strong performance. Importantly, investors should note MLPs and midstream carry additional risk as equities. In the chart below, MLPs are represented by the Alerian MLP Infrastructure Index (AMZI), and broader midstream is represented by the Alerian Midstream Energy Select Index (AMEI), which is 75% U.S. and Canadian corporations and 25% MLPs. MLPs have historically offered higher yields than their C-Corp counterparts. Both MLPs and C-Corps have prioritized returning capital to shareholders in recent years through consistent dividend growth and opportunistic buybacks backed by solid free cash flow generation.

Another concern is that higher rates drive up borrowing costs. Midstream companies generally reduced debt as they started to generate meaningful free cash flow coming out of the pandemic. Midstream/MLPs do not have the same debt burden as utilities, which are more sensitive to rising rates. Indeed, the space has typically preferred fixed rate, long-term debt providing some insulation from near-term rate changes.

Finally, the persistently high inflation that triggered last week’s rate hike is largely neutralized by midstream’s underlying business model. Broad price increases are generally offset by built-in contractual adjustments. For instance, interstate liquids pipelines adjust rates annually using an index based on PPI-FG. Meanwhile, long-term contracts across the space routinely feature annual inflation escalators. For example, Enterprise Products Partners (EPD) highlights that approximately 90% of its long-term contracts include escalation provisions to limit the impact of inflation on cash flows and distributions. Combined with inherent exposure to real assets, these structural advantages have helped midstream and MLPs typically outperform in periods of elevated inflation.

To better understand how midstream equities weather rising rates, historical performance provides helpful context. The chart below highlights distinct periods since late 2021, when the 10-Year Treasury yield was rising, comparing the performance of MLPs and broader midstream against utilities and REITs.

Overall, MLPs and midstream have consistently outperformed utilities and REITs during these windows of increasing Treasury yields. Utilities, in particular, are highly sensitive to interest rate hikes due to their capital-intensive business models and significant reliance on debt, often resulting in negative returns when the cost of capital climbs.

It’s worth noting that macroeconomic factors have also provided a strong tailwind for the broad energy sector this year. WTI oil prices have surged 74.6% year-to-date through September 18, largely driven by supply disruptions tied to the Iran war. With the crude futures curve shifting higher for 2027 and 2028, rising U.S. production estimates provide volume tailwinds for the midstream space.

Setting commodity prices aside, if a persistently higher rate environment prompts a broader market rotation toward value-oriented investments, energy equities, including midstream, stand to be key beneficiaries.

While many factors influence midstream performance, contractual inflation protections, fixed debt, and a strong historical track record should ease investor concerns about rising rates. Midstream/MLPs can remain resilient in a rising rate environment, while continuing to generate durable free cash flow and returning capital to shareholders through dividend growth and buybacks.

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AMZI is the underlying index for the Alerian MLP ETF (AMLP) and the ETRACS Alerian MLP Infrastructure Index ETN Series B (MLPB). AMEI is the underlying index for the Alerian Energy Infrastructure ETF (ENFR) and the Alerian Energy Infrastructure Portfolio (ALEFX).

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vettafi.com is owned by VettaFi LLC (“VettaFi”). VettaFi is the index provider for AMLP, MLPB, ENFR, and ALEFX, for which it receives an index licensing fee. However, AMLP, MLPB, ENFR, and ALEFX are not issued, sponsored, endorsed or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing or trading of AMLP, MLPB, ENFR, and ALEFX.

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