It’s been a brutal 12-month stretch for energy-related master limited partnerships (MLPs). They fell out of favor last autumn on concerns that plunging energy prices would imperil energy industry cash flows, and they’re taking fresh hits on concerns that an imminent rise in interest rates will diminish the appeal of income-producing equities.
The turnabout from a few years ago has been quite stunning. “It had been a golden era for MLPs, but now we’re in the dark ages,” says Michael Underhill, CEO of Capital Innovations. “The selling has been indiscriminate.”
Underhill remains a steadfast bull in support of MLPs, but concedes that investors are going to take a case-by-case look at each firm in terms of asset exposure. Indeed, the smaller exploration and production MLPs are seeing a sharp drop in cash flow due to oil prices in the range of $40 a barrel.
At the other end of the spectrum are large-cap MLPs, “which are not very sensitive to energy prices,” says Bruno del Ama, CEO of Global X funds. These infrastructure firms tend to focus on fee-based contracts for storage and transportation of oil, gas and distillates. The fact these MLPs have also sold off sharply seems less justifiable.
Take Plains All America Pipeline LP, for example. The company recently announced plans to freeze its dividend for the near term. There are no thoughts of reducing the payout, according to management. Yet shares have been pummeled anyway, falling from the 52-week high of $60 to a recent price around $33. That has pushed the distribution yield north of 8 percent, which is far above the rates offered by fixed-income debt. (The Alerian MLP index currently yields 7.25 percent, or roughly five percentage points higher than 10-Year Treasuries).
Such high-yield spreads in relation to fixed-income benchmarks have often signaled a buying opportunity for MLPs. On August 11, analysts at Credit Suisse delivered an across-the-board ratings upgrade for MLPs, noting “with yield spreads around 500 basis points, total returns in the next 12 months have been positive 100 percent of the time.” The average one-year gain in such instances has been 31 percent.
Underhill thinks some MLPs will cut their distributions, offset by payout hikes at other MLPs. The key takeaway is that industry-wide distributions will most likely be flattish in the next 12-18 months.
But an eventual rebound in energy prices, coupled with plans for long-term expansion of domestic energy industry output, should help MLPs return to a path of distribution growth in 2017 and beyond. Meanwhile, investors can be contented with very robust current distribution yields.
Two Flavors
There are more than 20 MLP-centric exchange-traded products operating as either funds (ETFs) or notes (ETNs). The ETFs are structured to help investors avoid the onerous filing of K-1 tax forms, which is required when individual MLPs are owned. They’re also structured to pass their dividend distributions on to investors, and as a result they typically carry gross expense ratios exceeding 5 percent.
The reason for this is complicated, but in short it’s due to MLP ETFs' status as C Corps and, consequently, how their tax liability is calculated for both share price appreciation and dividend distributions.
In contrast, ETNs simply generate ordinary income, at personal tax rates. The downside is these are credit instruments, and theoretically subject to issuer default, though such a scenario is quite unlikely.
The core management expense ratios for most of these funds and notes are in the 80 to 90 basis point range, though the Global X MLP ETF (MLPA) and the Global X MLP Energy & Infrastructure ETF (MPLX) sharply undercut those fees with a 0.45 percent expense ratio.