Pipes Of Pain

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.”