In last week’s issue I discussed a category of master limited partnership that performs well when natural gas prices are low. The three MLPs with fertilizer production as a core business — Terra Nitrogen (NYSE: TNH), CVR Partners (NYSE: UAN), and Rentech Nitrogen Partners (NYSE: RNF) — own the top three year-to-date performances among MLPs. This is because natural gas prices are a major input in the manufacture of fertilizer (and in the case of UAN they influence the price of its primary input of petroleum coke).

Today I would like to cover another sector that should perform well in an environment of low natural gas prices: MLPs that manufacture chemicals that are derived from natural gas. There are two in this category: OCI Partners (NASDAQ: OCIP) and Westlake Chemical Partners (NYSE: WLKP).

OCI Partners actually makes nitrogen fertilizer as well, but its main business line is methanol production. The partnership owns and operates OCI Beaumont, an integrated methanol and ammonia production facility on the Texas Gulf Coast. OCI Beaumont has a methanol production capacity of 730,000 metric tons (MT) per year and an ammonia production capacity of 265,000 MT per year.

Methanol is produced from methane, which is the primary constituent of natural gas. About 30 million British thermal units (MMBtu) of natural gas is required to produce a metric ton of methanol. At present the spot price of natural gas is $2.66 per MMBtu, which means it takes about $80 of natural gas to produce 1 MT of methanol. Natural gas is the largest variable cost input, so fluctuations in the price of natural gas have the largest impact on margins from the input side. This month, the world’s largest methanol producer, Methanex (NASDAQ: MEOH) shows the listed price for methanol for methanol at $416/MT. The selling price is obviously also key to the margins, but analogous to oil refiners that generally make their best margins when oil prices fall, methanol producers generally earn better margins when natural gas prices fall.

OCIP debuted on Oct. 4, 2013. The IPO priced at $18, below expectations, and right before a winter season that saw natural gas inventories seriously depleted and prices moving sharply higher. The price of natural gas remained elevated for most of 2014, and that ate into OCIP’s margins.

OCIP is a variable distribution MLP. The quarterly distribution is dependent on the performance of the methanol and ammonia businesses, and higher gas prices in 2014 resulted in lower distributions.

The unit price had risen to $28 by January 2014, and then the first quarterly distribution of 2014 was a respectable $0.61/unit. But higher gas prices resulted in lowered guidance, and after the quarterly distribution fell to $0.26/unit in the fall of 2014, the unit price fell back below the IPO price (as it remains today). At the current price and based on the most recent quarterly distribution of $0.26/unit, the current annualized yield of OCIP is 5.9%. The next quarterly report is scheduled for March 16.

Westlake Chemical Partners was formed by Westlake Chemical (NYSE: WLK) to operate, acquire and develop ethylene production facilities and related assets. WLK is a manufacturer and supplier of petrochemicals, vinyls, polymers and building products produced at 16 plants across North America and one in China. Westlake Chemical Partners’ business and operations are conducted through OpCo, a partnership between Westlake Chemical Corporation and Westlake Chemical Partners.

Ethane is the second most abundant constituent of natural gas, and is primarily used to produce ethylene, which is the world’s most widely used petrochemical. The flood of new shale gas supplies has overwhelmed the market for ethane, sending the price plummeting. This in turn has made the economics of ethane derivatives manufacture like ethylene and polyethylene extremely attractive in the U.S. Westlake Chemical Partners is the only MLP operating solely in this niche, while others like Enterprise Products Partners (NYSE: EPD) and Sunoco Logistics (NYSE: SXL) are diversifying into petrochemicals.

Westlake Chemical Partners’ assets include three production facilities that convert ethane into ethylene, with an aggregate annual capacity of approximately 3.4 billion pounds. Assets also include the Longview Pipeline, a 200-mile ethylene pipeline with a capacity of 3.5 million pounds per day that runs from Mont Belvieu, Texas to the Longview, Texas chemical complex.

Westlake Chemical Partners derives substantially all of its revenue from its ethylene production facilities. Westlake’s downstream polyethylene (PE) and polyvinyl chloride (PVC) production facilities consume most of the ethylene produced by OpCo. OpCo has a 12-year ethylene sales agreement in place with Westlake, which has committed to purchase 95% of OpCo’s planned ethylene production each year on a cost-plus basis that is projected to generate a fixed margin of $0.10 per pound, or $323 million annually based on the current capacity.

The IPO had initially been expected to price in a range of $19 to $21 per unit, generating estimated proceeds of $225 million. However, strong demand pushed the price up to $24 by the time the IPO priced on July 30. Units began trading at $30.28, but have since pulled back just below $28. WLKP’s partnership agreement provides for a minimum quarterly distribution of $0.275 per unit for each whole quarter, or $1.10 per unit on an annualized basis. Its first full-quarter distribution came in at exactly the minimum, but the coverage was a healthy 1.15x. At the current price, this projects to an annual yield of 3.9%.

So far this year the performance of these two chemical manufacturing MLPs has not mirrored the gains of the fertilizer-only MLPs. Year-to-date OCIP is up 11.6%, while WLKP has declined 3%. I expect the fortunes of both to brighten in the months ahead assuming natural gas prices remain low, which I expect to be the case for the remainder of the year.

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

Portfolio Updates

Western Cooking, Makes Great Buy      

As we’ve noted time and again, the current period of sharply lower U.S. crude prices benefits refiners by lifting their margins while also stimulating demand.

The two refining plays included in the Jan. 21 edition of Best Buys, CVR Refining (NYSE: CVRR) and Delek Logistics (NYSE: DKL), have since rallied 45% and 20% respectively (though we still haven’t quite broken even since recommending CVRR 18 months ago).

Meanwhile, Western Refining (NYSE: WNR) has returned nearly 40% for the Aggressive Portfolio in 14 months, and while it didn’t make the latest Best Buys list it’s now making us regret that omission.

The operator of two refineries in the oil-glutted Southwest made an extra $200 million in the just-reported fourth quarter as input costs slid much more sharply than product sales, which were aided by fatter markups at Western’s 261 filling stations.

Gross margin per throughput barrel just about tripled year-over-year. And it’s risen sharply from those levels so far this year. On top of the improved U.S. fuel demand and ample crude supply, WNR will benefit from a strike now affecting 12 U.S. refineries and rising gasoline prices to its west following the recent accident at ExxonMobil’s (NYSE: XOM) refinery in southern California.

Western has an enterprise value of  $5.3 billion, and returned $553 million to shareholders last year via share repurchases and regular and special dividends, all without appreciably increasing its debt. The company partially financed this largesse by selling logistics assets into an affiliated master limited partnership. The MLP trades at a dramatically higher valuation that the parent’s EV/trailing EBITDA of 4.8.

Given the overwhelming likelihood that much of the current windfall will end up in shareholders’ pockets soon enough, we’re increasing the buy limit on WNR to $57.

In contrast to the strength in oil refining, sharply lower crude prices have been bad news for gatherers and processors of natural gas, since they get paid in part with natural gas liquids (NGL) priced off crude.

Fingers Crossed at DCP

DCP Midstream Partners (NYSE: DPM) has been one of the weakest performers in our portfolios on worries about the effect of lower NGL realizations, its unit price dropping 25% over the last four months.

Standard & Poor’s recently downgraded both the partnership and its corporate sponsor, adding to investors’ worries, since a downgrade by another agency would shut DPM’s access to buyers of investment-grade credit, potentially increasing financing costs. The sponsor, a joint venture between Phillips 66 (NYSE: PSX) and Spectra Energy (NYSE: SE), is in the midst of its own restructuring and really not in a position to help much.

Given that ominous background, management did its best to highlight positives during the recent earnings conference call, starting with the promise to increase the distribution by “up to” a penny per unit per quarter this year, commodity prices permitting, of course. If DPM could deliver the “up” in “up to,” that would produce annual growth above 5% for a fully-covered payout already yielding an annualized 8.1%.

The partnership expects 60% of its margin to come from fee-based arrangements this year, and 75% of the remainder dependent on commodity prices has been hedged, leaving a total commodity exposure of just 10% according to DPM. That 10% is still enough to swing the annual bottom line $750,000 for every penny per gallon change in NGL prices and $250,000 for every swing of $0.10 per million British thermal units in natural gas prices.

Unless NGL prices recover significantly, either DPM or its general partner may still need a capital infusion from (most likely) Phillips 66, which can afford it and is unlikely to devalue its stake in the venture by leaving it ailing. What’s not in doubt is DPM’s staying power. It should be able to at least maintain the current distribution if NGL prices don’t drop much further.

At this point, much of the bad news looks priced in. Buy DPM below $42.

— Igor Greenwald