Upstream MLPs Take a Beating

In last week’s MLP Investing Insider (Upstream or Up the Creek?) I discussed the “upstream” MLPs, which are those focused on the extraction of oil and gas. As I mentioned in that article, this MLP category has far more downside risk than most when oil and gas prices are weakening. As if on queue, the price of West Texas Intermediate broke decisively below $90 per barrel last week, with the front-month contract closing the week at $85.82.  

The outcome was a bloodbath for upstream MLPs. By the end of the week, much of the upstream sector had capitulated to the reality of falling oil prices. Seven of the 10 worst performing MLPs last week were upstream MLPs mentioned in last week’s issue. The worst performer for the week was Viper Energy Partners (NASDAQ: VNOM), down 24.2% for the week and 43.3% since its July IPO. As we warned investors in Stingy Viper Soars, Foresight Found Lacking, “Given the commodity risk associated with Viper Energy Partners’ business model and the now paltry 3.2% yield, this security could prove quite poisonous should commodity prices fall or interest rates rise.”

In addition to VNOM, two other MLPs dependent on drilling — Atlas Energy (NYSE:ATLS) and Legacy Reserves (NASDAQ: LGCY) — both had losses for the week of over 20%. Emerge Energy Services (NYSE: EMES), which provides sand used for hydraulic fracturing (fracking), was down 21.9% for the week. EMES is still up nearly 400% since its 2013 IPO, but has now shed more than 40% in six weeks.

Downstream MLPs Rise

Is there a safe haven for MLP investors when oil prices are rapidly falling? The MLP declines were broad-based last week, with only half a dozen MLPs seeing gains for the week. Two of the gainers were refining MLPs — Alon USA Partners (NYSE: ALDW) and CVR Refining (NYSE: CVRR). Like the upstream MLPs, the downstream MLPs can be very volatile, and are therefore only suitable for investors with a high risk tolerance.

But the downstream sector — where the refinery MLPs reside — is one that can rise when oil and gas prices are declining. I explained in a 2012 Energy Letter article — Rockets and Feathers — the reason for this. It comes down basically to consumer behavior.

When prices are rising, consumers are more discerning about price when filling up with gasoline. When prices are declining, they are happy enough at the falling prices that they aren’t likely to drive all over town looking for lower prices. This behavior can benefit fuel retailers, wholesalers, and refiners even as the upstream sector suffers. For more information on downstream MLPs, see my November 2013 article Don’t Give Up on the Refiners.  

Although the downstream names are not an appropriate choice for conservative MLP investors, those attracted to the higher risk upstream MLPs may find the refining plays more attractive in the current environment.  

Dominion Midstream Partners Debuts

For most MLP investors, the midstream sector will continue to hold the most appeal. This week, a new midstream offering will debut. We have previously covered the impending IPO of Dominion Midstream Partners (ticker will be DM), and this week it will finally launch in a $350 million offering.

To recap, Dominion Resources (NYSE: D) is a $41 billion provider of electricity and natural gas in the eastern US. The company has a broad portfolio of assets, some of which it has expressed interest in dropping down into an MLP. One of its assets is the Cove Point liquefied natural gas (LNG) terminal on Maryland’s Chesapeake Bay.

Last fall Dominion became the fourth company to win an LNG export license from the Department of Energy. Last month the company received final approval for LNG exports from the Federal Energy Regulatory Commission (FERC). The license allows Dominion to export 0.82 billion cubic feet per day (Bcfd) of natural gas. The project cost is estimated at $3.8 billion, and 100 percent of the available capacity of the facility is contracted with two parties: Sumitomo/Tokyo Gas and GAIL (India) Limited. Both contracts are long-term fixed reservation fee agreements with a 20-year term commencing on the date the project is placed in service.

The MLP structure is unique in that initially the sole cash flow generating asset will be a preferred equity interest in Dominion Cove Point LNG, which entitles the limited partner to the first $50 million of annual cash distributions made by Cove Point. Future distribution growth is expected to take place primarily through assets dropped down from Dominion Resources.

The offering for Dominion Midstream Partners is for 17,500,000 common units that are expected to price between $19 and $21. The minimum quarterly distribution is forecast at $0.70 on an annualized basis. At the midpoint of the offering, this represents a stingy 3.5% annual yield, but Dominion Resources is already developing a number of future assets to be dropped down, which should enable distributions to grow for the foreseeable future. MLP investors spooked by the recent action in the upstream MLPs should find much less volatility with Dominion Midstream Partners.     

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Enterprise a Port in Storm

With energy investors in a state of near-panic, the $6 billion acquisition announced on Oct. 1 by Enterprise Products Partners (NYSE: EPD) has already been almost forgotten. Yet the deal for the Gulf Coast petroleum storage and port facilities owned by Oiltanking Partners (NYSE: OILT) and the master limited partnership’s privately held German sponsor showcased Enterprise’s faith in continued growth of North American oil production and, eventually, exports.

Enterprise is paying $4.6 billion, almost evenly split between cash and equity, for OILT’s general partner and most LP units, plus another $1.4 billion in equity to exchange all OILT units held by the public for those in EPD. Because this is a merger between two master limited partnerships, there are no tax implications for investors.

OILT limited partners will not get a premium in the exchange, but they will get EPD units’ higher yield and much greater scale and diversification, albeit with less spectacular growth. The timing was fortunate for them, because without the deal OILT would likely have fared much worse last week as a leveraged play on domestic crude production.

EPD, meanwhile, was very briefly down 12% Friday on a huge spike in volume (and 22% below the record intraday high set exactly one month earlier). But it quickly recovered to finish 1.4% lower on the session. Following the predictable 5.8% year-over-year distribution increase announced Friday, units now trade at a prospective yield 4%. That yield is backed by mostly fee-based long-term contracts that have delivered 54% more cash than Enterprise has needed to pay its distributions during the first half of the year.

For its $6 billion Enterprise gets ownership of Oiltanking’s marine terminal in Houston, which it was already using to export liquefied petroleum gas, another marine terminal in Beaumont, Texas, and 24 million barrels of adjacent storage capacity. These assets will allow Enterprise to continue to play a leading role in US energy exports, assuming the current slump in crude prices doesn’t stop shale development.

It likely won’t. Many shale producers are well-hedged well into the future, and many can continue to make a profit at the current price. Global demand growth is likely to require plenty of US shale development as well in the long run. Enterprise certainly has the financial strength and the long-term contracts to withstand lots of near-term volatility in commodity prices.

EPD remains as safe an investment as you are likely to find in the energy sector. Buy EPD below $42.50.

— Igor Greenwald