When to Worry About MLPs

February 27th, 2014
in contributors, syndication

Investing Daily Article of the Week

by Robert Rapier, Investing Daily

The joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits (MLPP) took place two weeks ago. The chat is conducted by Igor Greenwald, who is managing editor for TES and chief investment strategist for MLPP, and myself.

There were six MLP questions remaining at the end of the chat that required an extended answer or a bit more research. Three were answered in last week’s issue, and today I tackle the three remaining questions: one on MLP equivalents in Canada and Australia, one on Enbridge Energy Partners (NYSE: EEP) and TC Pipelines (NYSE: TCP), and a third query on Access Midstream Partners (NYSE: ACMP), Crestwood Midstream Partners (NYSE: CMLP) and Mid-Con Energy Partners (Nasdaq: MCEP).

Follow up:

For answers to two remaining energy sector questions from the chat, see this week’s issue of The Energy Letter.

Q: Are the oil companies in Canada and Australia set up similar to MLPs in the States? If not, how do they differ?

In the past both countries did allow oil companies to structure themselves into tax friendly entities similar to MLPs, but both Canada and Australia eventually disallowed these structures, citing loss of tax revenue. Australia abolished income trusts in 1985, but Canada’s story is more interesting, and closer to home.

Before Oct. 31, 2006 income trusts in Canada paid little or no corporate tax and distributed the bulk of their earnings to investors, who then paid taxes according to their individual income tax rates. Sound familiar so far?

Then, in what became known as the Halloween massacre, Canadian Finance Minister Jim Flaherty announced that trusts would be taxed in the future at the same rate as corporations. The reason cited was that too many big companies were converting to trusts, which was costing the government $500 million a year in lost revenue. The tipping point for Canada was the announcement by two large telecom corporations that they would convert to trusts. At that point Canada decided that enough was enough and that if it didn’t put a stop to it more and more companies would seek to escape corporate taxes.

Overnight the market value of the oil and gas trusts — which had been paying out regular dividends of 10 percent or more — dropped by at least 15 percent as investors absorbed the new reality. The change to the tax code became effective in 2011, and the vast majority of these Canadian Royalty Trusts (CanRoy’s) have converted to or merged with corporations, or simply liquidated. As a result of the higher tax rates they now have to pay, most companies had to sharply cut dividends.

There are still high-yielding oil and gas investment options in Canada, but not so much in Australia. Our sister publication Canadian Edge covers some of the high-yielding options in Canada such as Parallel Energy Trust (14.4 percent yield) and Eagle Energy Trust (12.7 percent yield), but these dividends are not nearly as safe as were the old CanRoys prior to the tax change.

Some have argued that Canada’s decision to tax these income trusts as corporations is a cautionary tale for MLP investors in the US. After all, the US could make the same argument — that it’s losing revenue by allowing the MLP structure to exist. However, this is unlikely, as it would require an act of Congress, and many in Congress are strongly supportive of the current MLP structure. While it is true that the value of MLPs would be shaved if they were taxed at a corporate level, I think this is unlikely in the near future.

However, I think if we saw a similar situation to what happened in Canada — for example if ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) announced that they were going to spin off all their assets into MLPs, then Congress might be compelled to act by the resulting public outcry. But I think it would take a catalyst of that magnitude to change the current laws.

Q: Thoughts on ACMP, CMLP, and MCEP?

I mentioned Access Midstream Partners (NYSE: ACMP) in response to a question from last month’s chat. It is the successor to Chesapeake Midstream, after buying Chesapeake Energy’s (NYSE: CHK) midstream assets. At the same time Williams (NYSE: WMB) acquired a 50 percent stake in Access Midstream’s general partner from the master limited partnership’s private equity sponsor. This made ACMP the largest gathering and processing MLP in the nation, transporting more than 7% of US natural gas consumption in 2013 with gathering pipelines and facilities in the Barnett, Eagle Ford, Haynesville, Marcellus, Niobrara and Utica shales, and elsewhere in the Mid-Continent.

ACMP units have doubled in price over the past two years. The disadvantage to the large run-up is that growth in the distribution didn’t quite match the rise in the unit price. Thus, even though the distribution has increased, the yield has fallen from some 6 percent two years ago to just under 4 percent at the current unit price.

Nevertheless, Q4 results were outstanding, and ACMP appears positioned to outperform most of its peers. Fourth quarter 2013 adjusted EBITDA was $241 million, an increase of just over 100 percent compared with Q4 2012. Distributable cash flow (DCF) totaled $180 million in  Q4 2013, up 120 percent from a year ago. For the full year, adjusted EBITDA was $859 million, an 80 percent increase over 2012. Full-year DCF totaled $635 million, an increase of 87 percent compared without 2012, and resulted in a coverage ratio of 1.49 times for 2013.

Crestwood Midstream Partners (NYSE: CMLP) looks attractive at the current price. Last October it finalized its merger with Inergy Midstream. Following the merger, Crestwood announced the acquisition of Arrow Midstream for $750 million, which gave it 150 miles of crude gathering lines, 160 miles of natural gas gathering pipes and 150 miles of water pipes in the heart of the Bakken formation. According to Crestwood the deal will allow the partnership to process 18 percent of the Bakken’s crude production.

The partnership also owns the COLT Hub — an open-access rail terminal serving producers, refiners and marketers — which it inherited from Inergy. The hub has 720,000 barrels of crude oil storage and two 8,700-foot rail loops, and can accommodate 120-car unit trains with a capacity of more than 120,000 barrels per day by rail (and is currently being expanded to 160,000 bpd).

Last month CMLP declared the partnership’s quarterly cash distribution of $0.41 per unit for the quarter ended Dec. 31, representing the seventh consecutive distribution increase. Units currently yield 7 percent.

Mid-Con Energy Partners (Nasdaq: MCEP) own about 13.1 million barrels of oil-equivalent reserves in Oklahoma and Colorado. Crude oil accounts for 99 percent of the MLP’s estimated reserves, a favorable asset base given the continued high price of oil. Like most upstream MLPs, MCEP operates in established plays that feature limited drilling risk and predictable decline rates.

MCEP suffered collateral damage from last year’s Linn Energy (Nasdaq: LINE) mess even though it is less leveraged than Linn and carries very little debt relative to its cash flow and market cap. The partnership had the same up-and-down Q4 as other upstream MLPs, rallying early only to fade in the stretch as crude prices pulled back. The waterflooding specialist boosted its quarterly distribution 6 percent year-over-year to an annualized $2.06 per unit, for an 8.9 percent yield at the most recent closing price.

While acquisitions boosted year-over-year output 32 percent, it slipped 3 percent sequentially as some previously producing wells were injected to refresh the recovery rate while other newly drilled ones awaited completion.  The distribution hike amid slowing production lowered the coverage ratio to 1.19x, and management cast its decision to take some of the wells offline as an investment in their future.

But management didn’t provide much clarity on when the current injections might start to pay off, beyond intent to raise distributions this year. The partnership is also working on a near-term acquisition to spur growth, according to management. In any case, MCEP is one we like, but we do consider it near fair value.

Q: I have a sizable MLP portfolio. I have positions in EEP and TCP. What is your current opinion on each? Neither represents more than 7 percent of my MLP holdings. Any replacement ideas?

I like both Enbridge Energy Partners (NYSE: EEP) and TC Pipelines (NYSE: TCP) at their current price points. EEP has thousands of miles of oil and gas pipelines, and they have a dominant position in the Bakken. Of the 583,000 bpd of pipeline export capacity from the Bakken in 2013, Enbridge owns a total of 355,000 bpd (61 percent). Enbridge will see some competitors this year in the Bakken, but 2016 will see them regain their dominant position as they have a number of projects in the pipeline.

TC Pipelines has interests in over 5,560 miles of FERC regulated, interstate natural gas pipelines and a combined total deliverable capacity of 8.9 billion cubic feet per day (bcf/d). This infrastructure supplies approximately 8 percent of the United States daily gas volume, and shouldn’t be affected if sponsor TransCanada’s (TSX, NYSE: TRP) Keystone XL pipeline is rejected.

TCP Pipelines assets. Source: TCP

TCP currently yields 6.9 percent, and is fairly priced, albeit not deeply discounted. EEP is probably a bigger bargain at current prices, but I wouldn’t be quick to toss either from my portfolio.

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