A meeting last week of the Organization of Petroleum Exporting Countries (OPEC) concluded with a decision not to cut the organization’s production quotas. Crude oil prices slumped as a result and many MLPs went on sale as well. While the oil gloom discounted MLPs across the board, those associated with hydraulic fracturing were especially hard hit.  

Two high-flying MLPs that specialize in sand used in hydraulic fracturing — Hi-Crush Partners (NYSE: HCLP), and Emerge Energy (NYSE: EMES) — both saw declines exceeding 25% over the two trading sessions following the OPEC meeting.

Hit just as hard were the upstream MLPs. “Upstream” refers to oil and gas producers, and even though many of them hedge their output against falling prices, they are much more exposed to longer-term commodity fluctuations than are the more traditional midstream MLPs.

The National Association of Publicly Traded Partnerships currently classifies 16 partnerships as upstream businesses:


A sampling of these names shows the carnage that took place following the OPEC meeting:

So what’s an MLP investor to do at this point? Assuming you have the risk tolerance for upstream MLPs, does this sell-off make the sector a buy?

Not necessarily. Not all upstream MLPs are equal. Those that are predominantly natural gas producers also sold off, but natural gas prices have actually held up nicely this year, and have spent most of the year above their 2013 levels:


So, if an MLP is weighted toward natural gas and still sold off sharply, it will probably turn out to be the better bargain in the near term than those that are predominantly tied to oil production.

Of great interest at the end of the year will be the annual reporting required by the U.S. Securities and Exchange Commission (SEC). The SEC requires upstream producers to provide what is known as a Standardized Measure (SM). This measure is included in the annual 10-K filing, and is the present value of the future cash flows from proved oil, natural gas liquids (NGLs), and natural gas reserves, minus development costs, income taxes and existing exploration costs, discounted at a 10% annual rate. All oil and gas producers traded on a US stock exchange must provide the Standardized Measure in filings with the SEC, and they must calculate these numbers in a specific way.

The prices used in these calculations are typically the average commodity price that was received over the previous 12 months. What that means in light of the oil price collapse is that you will see the SM value for oil-oriented upstream MLPs decline relative to last year’s figure (unless they have a reserves increase large enough to offset the price decline), while gas-oriented upstream MLPs should maintain their value.

As these 10-K filings start to be released, we will be closely scrutinizing them to determine which upstream MLPs are traded at the lowest multiples relative to their expected cash flow. What I expect we will see is that the natural gas producers have gotten relatively cheaper since natural gas values have held up well under the sell-off.

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

Portfolio Update

Memorial, Vanguard Look Cheap for a Trade  

I’m on record as a critic of upstream MLPs. I don’t think the MLP model is sustainable in the long run for oil and gas producers, and I’ll explain why in more detail in the forthcoming issue of MLP Profits.

Over the past 18 months or so we’ve purged all of the upstream MLPs from our portfolios of recommendations and, based on their prices today, saved subscribers who followed our lead much money and grief in the process, I’d like to believe.

It’s taken the massive current slump in oil prices to reveal that the fat yields upstream MLPs offer doesn’t do much to cushion the drops in periods of extreme market dislocation.

But now that some of the recent complacency has been wiped away and fear is rampant about further downside in energy prices, the trader in me believes investors will soon go back to what they have recently done, which is chasing yield, even as oil and gas prices pick up in response to, among other things, stronger U.S. economic growth.

So, as a trade, as distinct from an investment, we’re adding Memorial Production Partners (NYSE: MEMP) and Vanguard Natural Resources (NYSE: VNR) to the Aggressive Portfolio.

MEMP is uniquely well hedged on its commodity exposure for years to come, and even after the bounce of the past two days offers a 14% yield that’s likely to be whittled down by means of capital appreciation in a less fearful environment.

VNR has relatively low operating costs and its strategy of reducing its dependence on crude revenue has been vindicated by the events of this fall. Despite today’s rebound, the unit price is still down some 15% since we dumped VNR from our portfolio in October. Those who followed our lead and are willing to take another shot here will have saved more than the annual distribution, and still get to collect a yield of 11.6% at the current unit price.  

Buy MEMP below $17 and VNR below $23. I’ll have more on both partnerships in the next issue of MLP Profits.   

— Igor Greenwald