Checkup on MLPs
January 10, 2010
– Comments (8)
The Master Limited Partnership sector has been joining in the general stock market rebound. As many readers know, MLPs in general have a unique tax structure: most of their income isn't taxed, you instead pay capital gains taxes when you sell the underlying units. This tax deferral can be quite powerful. MLPs in the energy sector are generally pipelines that transport liquids or gases. Some MLPs are connected to exploration and production companies. There are a few miscellaneous MLPs, like Cedar Fair (FUN) or AllianceBernstein (AB).
Over the last two years, I've liked the pipeline MLPs the most. They are generally not exposed to commodity price risk. They mainly transport fluids and earn volume-linked fees based on the amount of gas or whatever they transport. So, commodity price fluctuations don't directly impact them. Also, their contracts usually have inflation adjusters, which is great.
When I think of pipeline MLPs, I first think of the quality of the underlying asset base. Basically, is the MLP connected to a stable and growing collection of usually natural gas assets? Based only on my opinion, I sort MLPs into three groups:
Highest quality assets - my preferred investments:
Kinder Morgan Partners (KMP)
Magellan Midstream Partners (MMP)
Energy Transfer Partners (ETP, ETE)
High quality assets:
Enterprise Products Partners (EPD)
Buckeye Partners (BPL, BGH)
Teppco Partners (merged into EPD)
Spectra Energy Partners (SEP)
Lower quality assets:
Quicksilver Gas Services (KGS)
Legacy Reserves (LGCY)
Crosstex Energy (XTEX, XTXI)
General partners essentially manage the limited partner and can usually be thought of as a leveraged bet on the limited partner. Additionally, the GPs receive incentive distributions. They have a tiered structure where above a certain volume, they will take, for example 25% of the limited partner's cash flow, and above a higher volume they will take 50%. Those percentages vary by the entity, for example EPD's highest tier is 25%. Frankly, that creates a conflict of interest. The GP and LP can only generate cash by selling new units. If the GP wants to expand its operations, it can issue units of the LP. This dilutes the limited partner. Additionally, if the limited partner is in the high splits (e.g. 50%, as with KMP), the GP is basically leaving the limited partner with only 50% of the cash flows from whatever new pipelines it builds - this is a bit of a raw deal for the limited partner.
That's actually why I sold Kinder Morgan Partners -the partnership is so big that its growth rate has to slow, and it's so far into the high splits that unitholders get only half the incremental (and slowing) growth in cash flow.
On the other hand, because general partners are essentially a leveraged bet on the limited partner, they really suffer when the LP gets into trouble. This happened earlier in 2009 with Crosstex Energy, which found itself overleveraged at precisely the wrong moment. This could have happened with Quicksilver Gas Services, which depends solely on its highly leveraged parent Quicksilver Resources (KWK) for fluids to transport - fortunately, KWK made it through the crisis, but still has to contend with depressed natural gas prices. I used to own KGS, but got scared away after the crisis.
I own Energy Transfer Partners' general partner, ETE. I also own Enterprise GP Holdings, which is the GP of EPD and which holds a stake in ETE. ETE has a very high quality asset base; although its partner is actually exposed to some commodity price risk, because it owns some gas directly, I think the asset base is stable enough to warrant a bet on the general partner. This is, I think, the riskiest of the high quality stocks I own. While EPE doesn't own the very best assets, it benefits from a portfolio effect.
I used to own Legacy Reserves and Quicksilver. Their current asset bases are lower-quality, but I thought that high energy prices would enable both to rapidly grow their distributions. That turned out to be a poor bet - I misread the market. I still think that energy prices will rebound, but I'm content to hold on to EPE and ETE at this point.
With the MLP sector in general having advanced, I think there are fewer obvious buys. However, I do think that ETP is a buy. EPE is a buy also. I wouldthink about MMP if it dropped a few dollars.
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