Several years ago, master limited partnerships in the midstream oil space were critical darlings among investors. They enjoyed double-digit annualized returns, steadily increasing distribution rates, tax-deferred income and low correlation to other asset classes. They offered an income stream for yield thirsty investors at pass-through tax rates.

Even though they were attached to a dirty and volatile commodity, oil, it was only tangentially: They are, in effect, just “tollway” owners, charging rent for the oil passing through their pipes. Many investors saw them as a fat pitch in 2008 when their prices were low and the fracking boom had led to go-go production.

That fat pitch has turned into a sinking curve. When the price of oil plunged in 2014, so did MLP values. After tripling from the end of 2008 to September 2014, the S&P 500 MLP Index plunged almost 62% from that high to a low in February 2016.

“Oil prices going down is usually not good for MLPs just because they experience heightened levels of correlations as oil prices fall; particularly, as our research shows, once it goes below $45 a barrel, that tends to heighten the correlations quite a bit,” says Rohan Reddy, a research associate at Global X Funds. Supply and demand still matter to MLPs, in other words.

This year, the hurt just won’t stop. In March, a ruling by the Federal Energy Regulatory Commission came down that seemed to pinch shut some of the tax advantages enjoyed by MLPs. On the Ides of March, $118 million flowed out of the Alerian MLP ETF in just one day, according to Bloomberg.

The question now is when will investors wade back in or should they? The yields, after all, have become fairly tantalizing. The Alerian ETF itself enjoys a yield of 8.62%, and its top names offer similar juicy dividend numbers.

Part of the problem with MLPs before the price of oil tanked was that, like all companies in the energy space, they were lathered up with leverage in the giddy years of the fracking boom, partly because there was so much infrastructure demand, and partly because they wanted to keep pumping up those popular cash distributions.

Hydraulic fracturing not only helped the U.S. tap vast new amounts of natural gas but created new ways to get at oil, which is still coming out at record levels. In 2008, the U.S. was producing 5 million barrels a day, according to the U.S. Energy Information Administration. The average was over 9.3 million last year. So much black gold is oozing from America’s pores that the U.S. robbed Saudi Arabia of its swing oil production role on the world stage. When the Saudis decided to not cap production in 2014, oil prices collapsed. They’ve firmed up since then, but the people who know the most say there’s no way of knowing where oil prices can go.

Gary Bradshaw, a portfolio manager with Dallas-based Hodges Mutual Funds, which runs a billion and a half in assets, says MLPs are struggling for a number of reasons.  “What happened in the downturn in 2015-2016,” he says, “volumes were down and those pipelines were not pushing through enough volume in either crude or natural gas, and therefore [MLPs’] EBITDA was down. We’ve almost overbuilt many of the pipelines out there. A lot of these companies had to finally cut their dividends, he says “and it really left a sour taste with investors.”

Since oil’s crash (West Texas Intermediate fell to $27 a barrel in January 2016), MLPs have had to demonstrate balance sheet virtue to investors—scrape debt off their books and curtail infrastructure spending. Prudence is the new watchword.

Tax Changes

MLPs have been touted as a godsend to retail investors for their tax benefits. They’re pass-through entities: Eighty percent of cash distributions investors receive from them is considered return of capital and tax free.

After the Tax Cuts and Jobs Act passed in 2017, Global X’s Reddy says they retained most of their taxable benefits relative to what the C corporation would. The corporate tax on C corporations fell drops from 35% to 21%. MLPs now get a 20% deduction on a cash payout as well as a from a 39.6% individual tax rate to a 37% tax rate. Those two things together means “the income rate on MLP income that is paid out to unitholders falls from 39.6% to 29.6%,” Reddy says.

Two more changes in the tax laws are going to affect the capital structures of the MLPs themselves, Reddy says: the interest deduction limitation and immediate expensing provisions on capex. The interest deduction is now capped at 30% of adjustable taxable income, and he says MLPs might thus issue less debt and turn instead to alternative sources of financing, maybe preferred equity or self-funding. They could also turn to common equity, though investors will watch for dilution of shares, Reddy says.

On the other hand, the law now allows MLPs to expense 100% of capex spending in the year it’s spent. “So this is obviously somewhat beneficial to companies looking to increase capex spending because it helps them from a tax perspective as well.”

And that’s happened at a time more oil pipes are needed for more oil fields coming online. That demand together with the potential changes in MLP capitalization and favorable tax treatment for capex under the tax law could incentivize MLPs to start spending more on infrastructure in the future. The fall in the C corp tax rate might also prompt some midstream MLPs to simply change their structures to C corps or fold up into their general partners.

“Energy production levels [are also important],” Reddy says, “because [MLPs] are getting paid to transport oil and natural gas.” That affects the rates they are getting, he says, “so there is recontracting risk. That’s one of the issues that hurt MLPs [in 2017] is that a lot of these contracts were signed in the later part of the last decade and they could be 10- to 15-year contracts that were coming up towards the expiration. And the market was sort of forecasting that there would be renegotiated rates on that and cash flows could fall as a result.”

Many MLPs are avoided by mutual funds because of their K-1 tax structure. For that reason, Bradshaw at Hodges likes companies that have been converted into C corps.

He likes two pipeline companies that he thinks are great buys: ONEOK, which recently bought in its MLP and converted it into a C corp. “ONEOK does pay a handsome dividend,” he says. The company is geographically diversified, with pipelines in the Mid-Continent region in Oklahoma, the Williston Basin in Wyoming and North Dakota and the Permian Basin in Texas. “They’ve got about 38,000 miles of pipeline for natural gas and natural gas liquids,” he says. The cost of capital at ONEOK has gone down, Hodges says, and the company never cut its dividend through the oil wreck (It was at 77 cents per unit in the first quarter of 2018.) “Their coverage ratio—how much their cash flow covers their dividend—is 1.3 times. And that’s very strong.” (Cash flows coverages below “1,” like that suffered by Plains All American, means a company paid out more than it earned.) When you see a coverage ratio of less than 1, Hodges says, you worry about whether the company can maintain the dividend. He likes Targa Resources for similar coverage reasons: The stock is $45 and pays an 8.07% dividend yield. “I think that stock could go to $65 over the next 12 to 18 months,” Hodges says.

Mayukh Poddar, a portfolio manager at Altfest Personal Wealth Management, says that aside from Williams Partners, his firm otherwise does not have a large MLP presence. He noted that many MLPs had used leverage to fund their payouts, but he also thinks they have likely reached the end of that cycle; and Altfest doesn’t expect any more dividend cuts. “Most of them have the income now to support that dividend.”

However, he is concerned about MLPs’ exposure to interest rates, he says. Higher global rates will buffet income-generating investments like MLPs and utilities, which tend to underperform against Treasurys.

MLPs, it should be noted, are suitable only for retail, non-retirement accounts because they use leverage, are prone to generating unrelated business taxable income (UBTI) and issue K-1s. For that reason, Altfest doesn’t want to expose its investors to them. One way around that to get exposure to midstream oil is to buy companies as C corps or to use ETFs, which are already C corps. It’s also another reason the new tax laws might make an MLP’s conversion into a C corporation more attractive. (Kinder Morgan famously made this move in 2014.)

FERC Gets Involved

Jeremy Held, the senior vice president and director of research at ALPS Advisors, the advisor to the Alerian MLP ETF, said that MLPs were unfairly hurt by the Federal Energy Regulatory Commission ruling that was handed down in mid-March. The commission said it would “no longer … allow [MLP] interstate natural gas and oil pipelines to recover an income tax allowance in cost of service rates.” The commission was reacting to a court decision that said one MLP was enjoying a double recovery of income tax costs—”both an income tax allowance and a return on equity determined by the discounted cash flow methodology,” FERC said. Investors saw the ruling and quickly punished MLPs.

According to Held, however, many MLPs don’t use this methodology. The two largest MLPs in his index, Enterprise Products Partners and Magellan Midstream Partners, for instance, both came out right after the ruling and insisted that it wouldn’t affect their operations. Held says, “I think the really important takeaway … the impact is going to be very nuanced and it’s much more complicated than what the initial market reaction was. You really have to dig into the details for each MLP to see what the major impact was.”

Held says that interest rates are also less influential on MLPs in benign rate environments. MLPs, which as distribution vehicles have a lot in common with REITs, are somewhat interest rate sensitive, but Held says historically their sensitivity has depended on the whether overall interest rates are high when MLPs’ spread over Treasurys is low.

Connor Browne, a portfolio manager at Thornburg Investment Management, and Greg Mazares, an equity research analyst at the firm, say the Thornburg Value Fund is looking at companies that are free-cash-flow positive and have investment grade credit ratings showing an ability to spend within cash flow and eschew debt. The MLPs in the $1 billion fund are Enterprise Product Partners and Teekay LNG Partners, an MLP in the shipping space.

Enterprise, they say, is a leader in exporting a lot of the hydrocarbons that are produced in the U.S.—oil and a lot of the liquefied natural gas—and the company has built huge export capacity in the Houston Ship Channel, becoming, according to various sources, the nation’s largest crude exporter. Mazares says, “By being one of the early movers in energy exports and getting on that before others, you can set contract terms with companies that have demand for those services before competition comes in.” Mazares and Browne also say that it’s better not to be in an MLP with incentive distribution rights, where the MLP gives as much as 50% of the cash flow back to its parent as the cash flow ramps up. “Enterprise got rid of that structure earlier than most,” Mazares says.

Browne, like Bradshaw, says that it’s important for an MLP to be able to maintain its distribution from cash flow generated, especially in different scenarios for the commodity price. “Many of the MLPs that hurt investors were overdistributing and were dependent on raising capital by selling shares at high prices just to maintain their distribution. What we look for and what we think we have in Enterprise is a company that distributes much less of its cash flow, therefore has a lower yield than it otherwise would, which is less exciting potentially to financial advisors, but [it has] a much safer distribution.”