In the ever-evolving world of energy investments, midstream companies often stand out for their defensive qualities, especially when market volatility creates waves in commodity prices. As investors with a focus on achieving financial independence and retiring early (FIRE), understanding these dynamics becomes essential for making long-term, stable investment decisions.
Midstream companies, with their fee-based business models, provide a unique opportunity for stability, offering dependable cash flow even during periods of market uncertainty. In this post, we will dive into the core concepts of midstream’s fee-based EBITDA, its defensive nature, and why this makes it a valuable component in the investment portfolios of those working towards FIRE.
Background: The Midstream Sector in the Energy Market
The energy market is notoriously volatile, particularly when it comes to commodity prices like oil and natural gas. Historically, energy investments have been highly correlated with price movements in these commodities. However, midstream companies, which focus on the transportation, storage, and processing of these commodities, operate under a unique business model that provides them with a layer of protection against these fluctuations.
The key factor that sets midstream apart is the fee-based revenue model. Unlike upstream and downstream segments, which are heavily affected by changes in commodity prices, midstream businesses often rely on long-term contracts that guarantee cash flow. This business model can be particularly appealing to investors seeking stability and predictability as they pursue financial independence.
Key Concepts: Fee-Based EBITDA & Defensiveness
Before diving deeper, let’s break down two key concepts central to understanding midstream’s position in the energy sector:
Fee-Based EBITDA
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a common metric used to measure the profitability of companies. When we talk about “fee-based” EBITDA, we refer to earnings derived from services provided under long-term contracts. For midstream companies, this typically includes fees from transporting oil and gas through pipelines, processing natural gas, or storing energy products.
The fee-based model is advantageous because it doesn’t rely on commodity price fluctuations. Even if oil prices drop or natural gas production slows down, midstream companies can still collect revenue through their contracts, providing them with steady cash flow. This is why a fee-based EBITDA is often seen as more defensive during periods of market instability.
Defensiveness in Midstream Companies
In the context of the broader energy market, “defensiveness” refers to the ability of a company or sector to maintain stable performance during market downturns. Midstream companies, with their fee-based revenue structures, are seen as more defensive compared to upstream or downstream sectors, which are directly impacted by commodity price swings.
During periods of falling oil prices or a market downturn, midstream companies often see less volatility in their stock prices and revenues. This makes them attractive to investors, especially those following the FIRE philosophy, who prioritize stable and predictable returns over speculative growth.
Detailed Explanation: How Midstream’s Fee-Based Model Works
The fee-based business model of midstream companies provides a layer of security that shields them from the volatility that plagues other sectors of the energy market. Let’s take a deeper look at how this works and why it matters to investors.
Revenue from Long-Term Contracts
Midstream companies generate most of their revenue through long-term contracts with their customers, which include major oil and gas producers, utilities, and other industrial consumers. These contracts often include take-or-pay provisions, meaning the customer agrees to pay for a certain volume of service regardless of whether they use it or not.
For example, a pipeline operator may enter into a contract with an oil producer to transport a set amount of oil through its pipeline over the next decade. Even if the price of oil drops and the producer cuts back on production, the pipeline operator will still receive payments as agreed upon in the contract.
This business model provides midstream companies with revenue visibility, which is crucial for investors focused on financial stability and growth, particularly in the context of FIRE.
Regulated and Fee-Based Businesses
A significant portion of midstream companies’ earnings is derived from regulated assets, such as pipelines, storage facilities, and processing plants. These regulated assets typically operate under a cost-of-service model, where the company is allowed to charge customers a fee that reflects the cost of operating and maintaining the asset, along with a reasonable return on investment.
Because these assets are subject to regulation, midstream companies often enjoy a predictable and stable cash flow. This is particularly important in a market where volatility can lead to unpredictable revenue streams for other types of energy businesses.
Step-by-Step Guide: Analyzing Midstream’s Fee-Based EBITDA for FIRE Investments
For those pursuing financial independence, midstream companies can be a powerful addition to an investment strategy. Here’s a step-by-step guide to analyzing midstream’s fee-based EBITDA when considering it for your portfolio:
1. Understand the Company’s Business Model
Before investing in any midstream company, it’s crucial to understand their business model. Look for companies that generate a significant portion of their revenue from long-term contracts or regulated assets. The more of their revenue that is fee-based, the more stable and predictable their earnings will be.
2. Assess the Fee-Based Revenue Proportion
Check the company’s financial reports for the percentage of revenue that comes from fee-based contracts. Leading midstream companies often have upwards of 90% of their EBITDA coming from these fee-based sources. This high proportion indicates a greater level of stability and reduces exposure to market fluctuations.
For example, as of March 2025, Enbridge (ENB) has 98% of its cash flows from contracted services, which makes it an attractive option for conservative investors. Similarly, ONEOK (OKE) and Targa Resources (TRGP) expect over 90% of their earnings in 2025 to come from fee-based activities.
3. Evaluate the Longevity and Stability of Contracts
Next, assess the length and terms of the contracts that support the company’s fee-based revenue. Long-term, take-or-pay contracts with investment-grade customers are ideal, as they provide the company with a predictable revenue stream for years to come.
4. Review Regulatory and Market Conditions
Since many midstream companies operate regulated assets, it’s important to understand the regulatory environment in which they operate. Changes in regulations or rate adjustments can affect the company’s ability to generate revenue. However, regulated assets are often subject to predictable rate reviews, which adds a level of security.
5. Consider Dividend Stability
Many midstream companies distribute a significant portion of their earnings as dividends. These dividends can be a key component of an investment strategy for those pursuing FIRE. Look for companies with a strong history of consistent and growing dividend payments.
Tips for Investing in Midstream Companies for FIRE
- Prioritize Fee-Based Companies: As discussed, companies that derive most of their revenue from fee-based contracts are more stable. These companies are less vulnerable to swings in commodity prices, making them ideal for long-term growth.
- Diversify Your Portfolio: While midstream companies offer stability, it’s important to diversify your investments to spread risk. Look for opportunities in different energy sub-sectors, such as renewable energy, to balance out your portfolio.
- Look for High-Quality Contracts: Contracts with investment-grade customers and long durations provide added security. Check the company’s customer base and contract terms to ensure stability.
- Monitor Regulatory Changes: Keep an eye on regulatory developments in the energy sector. Changes in policies or regulations could impact midstream companies’ ability to charge for services, which may affect revenue and cash flow.
Case Studies or Examples
Enbridge (ENB)
Enbridge is one of the largest midstream companies in North America, and it provides a great example of the power of fee-based business models. With 98% of its cash flows coming from contracted services, Enbridge remains resilient even when commodity prices fluctuate. The company’s focus on investment-grade customers further enhances its stability, making it a reliable source of steady income for investors.
ONEOK (OKE)
ONEOK, another leading midstream player, is set to generate 90% to 95% of its 2025 earnings from fee-based contracts. This heavy reliance on fee-based revenue allows ONEOK to weather commodity price fluctuations more effectively than many other energy companies.
FAQ
Q1: Why is midstream a defensive sector?
Midstream companies are defensive because their revenue is primarily derived from long-term, fee-based contracts, which provide stability and predictability in cash flows, even when commodity prices fluctuate.
Q2: How do take-or-pay contracts work in midstream?
Take-or-pay contracts require customers to pay a fee for a set amount of service, regardless of whether they use the full capacity. This guarantees revenue for midstream companies, making them more insulated from market volatility.
Q3: What percentage of EBITDA should I look for in fee-based revenue?
Look for companies with at least 80% of their EBITDA coming from fee-based revenue. Companies with higher percentages, such as 90% or more, offer greater stability.
Conclusion
For those on the path to financial independence, midstream companies offer a powerful way to generate steady cash flow and reduce exposure to market volatility. By focusing on companies with a strong fee-based revenue model, long-term contracts, and regulated assets, you can add a layer of defensiveness to your portfolio. With their predictability, midstream companies are an attractive choice for FIRE investors seeking long-term stability and income.
