Stay Away From MLPs For The Time Being
By Dan Dicker - Nov 06, 2015, 4:26 PM CST
In 2008, as oil was moving through its lows of $32 a barrel, there was obvious carnage going on in the stocks of oil companies. But one group was establishing themselves as the most battered, least favored of all the sub-sectors in the energy world – The pipeline and storage companies.
The MLP 'craze' was already at full tilt in the years leading up to the oil collapse, and dozens of pipeline and other midstream players happily watched their stocks soar in the tax-advantaged mania that the limited partnership vehicle delivered. They were so smart, writing down decaying assets and delivering 85 percent or more of their revenues to their 'partners' – hedge funds were using shares of the companies as placeholders for cash, lapping up the 'distributions' instead of settling for 3 percent on treasuries (at the time). Pensioners flocked to them. The model might have had a cyclical 'ponzi-like' feel to it, with ever-competing debt cycles, but as long as the product flowed and the distributions got paid, everyone was happy to look the other way.
Then the market nosedived.
As much as the continued production and transport of U.S. crude and natural gas was at risk, 2008 had an added ingredient that annihilated the MLP's – credit lock-up. Without available credit to fund necessary expansion, the group became untouchable. In 2008 and early 2009, MLP's dropped well over 50 percent of their value, with some of even the most conservative members paying…
In 2008, as oil was moving through its lows of $32 a barrel, there was obvious carnage going on in the stocks of oil companies. But one group was establishing themselves as the most battered, least favored of all the sub-sectors in the energy world – The pipeline and storage companies.
The MLP 'craze' was already at full tilt in the years leading up to the oil collapse, and dozens of pipeline and other midstream players happily watched their stocks soar in the tax-advantaged mania that the limited partnership vehicle delivered. They were so smart, writing down decaying assets and delivering 85 percent or more of their revenues to their 'partners' – hedge funds were using shares of the companies as placeholders for cash, lapping up the 'distributions' instead of settling for 3 percent on treasuries (at the time). Pensioners flocked to them. The model might have had a cyclical 'ponzi-like' feel to it, with ever-competing debt cycles, but as long as the product flowed and the distributions got paid, everyone was happy to look the other way.
Then the market nosedived.
As much as the continued production and transport of U.S. crude and natural gas was at risk, 2008 had an added ingredient that annihilated the MLP's – credit lock-up. Without available credit to fund necessary expansion, the group became untouchable. In 2008 and early 2009, MLP's dropped well over 50 percent of their value, with some of even the most conservative members paying distributions well into the teens. In retrospect, it proved to be both a disaster and a major opportunity.
Fast forward to 2015.
Much of the situation from 2008 seems eerily similar to me. With real negative interest rates, the distributions of the MLP's have again been a hiding place for pensioners and trust funds. But with the similar drop in oil and gas prices and the slashing of oil and gas capex budgets, the pipeline and storage companies again have the prospect of dropping volumes to deal with – and likely for the next few years.
While 2015 doesn't have the “X-factor” of petrified credit markets as in 2008, it has an equally difficult vulture of Federal Reserve rate hikes hanging over its head. Every whiff of a rate increase makes MLP distributions less tasty and pipeline companies less pleasing to own. And in comparison to 2008, when credit markets were restored to good health, rate hikes, once they start, won't stop for years.
It's a lousy time to own pipeline MLP's.
Look at the recent report from Energy Transfer Partners (ETP), outlining all of these things – lowered expected volumes, increases in carrying and borrowing costs. For now, the distributions aren't in jeopardy, but the wolves are at the gate and investors can feel it. ETP dropped another 4 percent on Thursday, taking all of the other MLP's (including my favorite, Kinder Morgan (KMI)) with it and now yields over 9 percent.
There is more downside to come, folks – and an investment in the MLP's now must be tempered with the knowledge that shares will go lower first. Anyone who is tempted by the 9 percent yield of ETP isn't seeing the whole picture here and the similarities to 2008.
If there is a plus side – it is that the MLP's proved in 2009 to be one of the best generational investments in the energy space going forward for the next three years, as new fracking technologies exploded the need for fresh midstream assets.
But that similar moment for our modern times is still several quarters away. I reiterate my plea for you to stay away from the MLP's.
