When the price of oil tumbles by 25 percent in a few months, you can expect shares of exploration and production companies to follow suit. Even Growth Portfolio holding Linn Energy LLC (NSDQ: LINE), which has hedged all of its expected oil production through 2015, dipped to less than $36 per unit in recent weeks.

However, the selloff has also afflicted units of master limited partnerships (MLP) that own pipelines and other midstream assets. This downturn gave savvy investors an opportunity to add to positions in Conservative Portfolio holdings Enterprise Products Partners LP (NYSE: EPD) and Kinder Morgan Energy Partners LP (NYSE: KMP), both of which slipped below our buy targets for the first time in months.

Midstream MLPs that handle natural gas liquids (NGL) have pulled back considerably in recent months. For example, Growth Portfolio holding Targa Resources Partners LP (NYSE: NGLS) has given up almost 16 percent since May, wiping out the sizable gain posted during the rally earlier this year.

Rising institutional ownership of MLPs has contributed to the recent selloff. Over the past several years, institutions have accumulated larger positions in MLPs, thanks to new tax laws largely exempting them from tax complications. Today, institutional investors own almost half of Targa Resources Partners’ outstanding units.

Whereas individual investors often favor a buy-and-hold strategy with MLPs, fund managers tend to pay more attention to shifts in market momentum and have higher turnover rates in their portfolios. Institutional investors rotating assets out of equities and energy-related names have contributed to the recent selloff.

The recent slide in the unit prices of midstream MLPs has sparked concerns that these firms are vulnerable to weakening oil and NGL prices, not to mention the ultra-depressed price of natural gas.

But these firms already proved their resilience during the last market meltdown. Although the 24-hour media cycle has shortened investors’ memories, most midstream MLPs maintained their distributions when oil and gas prices plummeted in late 2008 and early 2009.

Enterprise Products Partners, for example, grew its quarterly distribution by 4.4 percent during these trying times and has now increased its payout in 31 consecutive quarters. In 2008 lower commodity prices reduced the blue-chip MLP’s fourth-quarter revenue by 32 percent from the prior year. Fortunately, commodity hedges offset some of this weakness, while asset additions boosted throughput and margins. Enterprise Products Partners’ previous strength amid a steep drop in energy prices–not to mention an impressive slate of growth projects expected to come onstream–suggests that the MLP will weather the current challenges with aplomb.

That being said, midstream operators aren’t entirely insulated from weak commodity prices.

Producers may scale back planned oil and NGL output, temporarily reducing demand for additional midstream capacity and weighing on effected MLPs’ ability to grow their distributable cash flow. At the same time, falling energy prices may prompt some fiscally weak exploration and production outfits to renege on existing contracts with midstream operators.

Midstream MLPs whose assets are backed by contracts that include fees based on energy prices will suffer a diminution in cash flow, particularly if they’ve opted not to offset this exposure with hedges.

Although midstream MLPs continue to access the capital markets with ease, the misplaced perception that these firms have exposure to oil and NGL prices could constrain their ability to finance acquisitions and expansion projects. Such a development would constrain distribution growth. As pass-through entities that disburse the majority of their cash flow to investors, publicly traded partnerships rely on the debt and equity markets to fund acquisitions and organic growth projects.

But investors shouldn’t get caught up in the fear-mongering in which the mainstream media specializes. We continue to expect the stock market to follow the pattern of 2010 and 2011, with fear ruling the tape for much of the summer. Savvy investors should regard this volatility as an opportunity to lock in elevated yields on our favorite Portfolio holdings.

For those who hold a less sanguine outlook for equities and the global economy, remember the lesson of the 2008-09 meltdown: As along as an MLP maintains (and preferably increases) its distribution, the unit price eventually will recover.

Enterprise Products Partners’ stock, for example, plummeted to $16 per unit in October 2008, compared to more than $30 per unit in July. But by mid-September 2009, the units had recovered to July 2008 levels and headed higher in subsequent months.

Rather than succumbing to panic, skittish investors must assess whether the decline in commodity prices and the threat of economic weakness will damage their holdings’ balance sheets, derail growth and/or threaten the distribution.

If you have confidence in these midstream MLPs’ business prospects, you can take advantage of the prevailing uncertainty and volatility to buy these names at a discount.

Here’s a rundown of the challenges facing midstream publicly traded partnerships and the extent to which individual names are exposed to these risk factors. This table provides vital statistics on all the midstream-focused holdings in our model Portfolios and outlines the risk factors to which each is exposed.

Source: Bloomberg, MLP Profits

Growth Projects

Rising production from the nation’s emerging shale oil and gas plays continues to drive demand for expanded takeaway capacity. Thus far, midstream MLPs have pursued smart growth by inking contracts and commitments from major customers prior to building new assets and financing these projects with inexpensive equity and debt capital. This conservative approach ensures solid returns on cash flow and has fueled robust distribution growth in recent years.

Bearish investors worry that the upsurge in domestic energy production, coupled with a recession in Europe and a weak global economy, will constrain commodity prices. In such an environment, producers would likely scale back drilling activity, weighing on demand for midstream assets in certain basins.

However, we’ve yet to see signs that this scenario is playing out. For example, Enterprise Products Partners on June 20 announced plans to construct one of the world’s largest propane dehydrogenation units on the Texas Gulf Coast. The new facility is supported by long-term, fee-based contracts executed with companies that have investment-grade credit ratings. Management expects the plant to come onstream in the third quarter of 2015.

Units of Growth Portfolio holding DCP Midstream Partners LP (NYSE: DPM) have given up about 7.9 percent since May 1, reflecting concerns about the recent decline in NGL prices. Nevertheless, management has pursued a number of growth opportunities that should boost the firm’s distributable cash flow and offset the firm’s exposure to energy prices.

Not only has DCP Midstream Partners expanded its gas processing capacity in east Texas that serves the Eagle Ford Shale, but the firm has also formed a joint venture with Anadarko Petroleum Corp (NYSE: APC) and Enterprise Products Partners to build a 435-mile NGLs pipeline running from Colorado to Texas.

The publicly traded partnership’s general partner also recently dropped down minority interests in two non-operated fractionation facilities in Mont Belvieu, Texas, for $200 million. Management expects the deal to be immediately accretive to cash flow and reaffirmed the goal of growing the firm’s distribution by 6 percent to 8 percent in 2012. Buy DCP Midstream Partners LP when the stock slips to less than 40.

Conservative Portfolio holding Sunoco Logistics Partners LP (NYSE: SXL) last month announced an oil transportation project that’s expected to come onstream in the second half of 2014. Management expects the company’s oil takeaway capacity to surge by as much as 350 percent over the next two years. Buy Sunoco Logistics Partners LP when the stock dips to less than 33.

Will demand for midstream assets that handle oil and NGLs dry up? The answer hinges on how much lower liquids prices decline and the extent to which producers regard these drops as permanent. When MLPs start to build assets on speculation rather than securing capacity commitments prior to construction, you can rest assured that the market has topped.

Thus far, companies that own NGL-related infrastructure haven’t downgraded their outlooks substantially. Targa Resources Partners warned that its distribution coverage ratios would slip this year but emphasized that this critic metric would likely exceed 1.0 in 2012 and 2013.

Management noted that this forecast includes a 10 percent to 15 percent increase in the MLP’s distribution in 2012 and a higher payout in 2013, all of which will be fueled by about $1 billion worth of new NGL-related infrastructure. More than 75 percent of these growth projects will generate fee-based cash flow that’s insulated from fluctuations in commodity prices.

All the other midstream MLPs in our model Portfolios boast solid lists of growth projects that should fuel distribution growth for the next two years and help to offset any lost cash flow from lower energy prices.

However, investors should be wary of publicly traded partnerships that focus on natural gas storage, especially Niska Gas Storage Partners LLC (NYSE: NKA). Although management has reduced the limited liability company’s flexible capacity to 40 percent, little capital is allocated to growth projects for the next two years.

The firm faces an uphill battle to maintain its distribution, leaving scant cash flow to reduce debt. Units of Niska Gas Storage Partners LLC trade at less than half their price in spring 2011 but still rate a Sell in How They Rate.

Investors should also steer clear of sell-rated Cheniere Energy Partners LP (AMEX: CQP). The MLP’s overleveraged and fiscally weak parent will make converting its terminals for importing liquefied natural gas (LNG)–a losing proposition over the past four years–into an export facility phenomenally could prove difficult. Sell Cheniere Energy Partners LP.

The Great Squeeze

Chesapeake Energy Corp’s (NYSE: CHK) mismanagement and balance-sheet woes have yielded an ongoing stream of negative headlines and questions about the company’s solvency. Given the scope of Chesapeake Energy’s operations, investors also worry about the health of midstream operators that handle the producer’s output. Not surprisingly, Chesapeake Midstream Partners LP (NYSE: CHKM), which was spun off by Chesapeake Energy in July 2010, has borne the brunt of this scrutiny.

Over the past year, Chesapeake Energy has moved aggressively to increase its liquids output. Falling oil and NGL prices set back that strategy, increasing the company’s shortfall of cash flow.

As part of its effort to raise capital through asset sales, Chesapeake Energy last month announced the $2 billion sale of its 42 percent interest in Chesapeake Midstream Partners to Global Infrastructure Partners. The firm also plans to divest its pipeline development unit and several pipelines in the Midwest to Chesapeake Midstream Partners.

Not only does the deal eliminate Chesapeake Midstream Partners’ direct exposure to its sponsor’s financial woes, but the proceeds from the sale will also shore up Chesapeake Energy’s financial position. That’s a huge plus for the midstream MLP, which generates about 75 percent of its distributable cash flow from its former parent.

Chesapeake Midstream Partners expects to grow its distribution by 15 percent in 2012 and 2013; the MLP rates a buy up to 31 in How They Rate.

A number of other MLPs have close ties to an individual producer. For example, Anadarko Petroleum in May 2008 spun off some of its midstream assets as Western Gas Partners LP (NYSE: WES). The producer oversees the publicly traded partnership’s daily operations as its general partner and still owns 42.2 percent of the common units.

This backing has enabled Western Gas Partners to raise capital at favorable rates; in late June, the MLP sold $520 million worth of notes at a coupon rate of about 4 percent. As Elliott noted in last month’s issue /mlp-profits/articles/7399/other-opportunities, drop-down transactions from Western Gas Partners’ parent should continue to fuel distribution growth.

A prolonged drop in energy prices akin to what transpired in late 2008 would weigh on Anadarko Petroleum’s earnings, incentivizing the company to accelerate plans to drop down assets to Western Gas Partners. Buy Western Gas Partners LP up to 48 for its superior distribution growth and sound financial footing.

General partners also own significant equity stakes in TC Pipelines LP (NYSE: TCP) and Williams Partners LP’s (NYSE: WPZ). TransCanada Corp (TSX: TRP, NYSE: TRP) owns 31 percent of TC Pipelines, while Williams Companies (NYSE: WMB) holds 73.7 percent of Williams Partners’ common units. Both parent companies also operate in the midstream space, which provides ample opportunity for drop-down transactions and limits exposure to swings in commodity prices. TC Pipelines LP rates a buy up to 47; Williams Partners LP is a buy up to 60.

All the midstream names in our model Portfolios boast diversified client bases that would limit the damage in the event that one customer falls upon hard times and fails to meet its obligations. The majority of our Portfolio holdings also have diversified ownership bases, with the exception of Conservative Portfolio holding Spectra Energy Partners LP (NYSE: SEP); Spectra Energy Corp (NYSE: SE) owns 63.2 percent of the publicly traded partnership’s outstanding common units. Investors shouldn’t worry about Spectra Energy falling upon hard times; the general partner generates more than 80 percent of its cash flow from fee-based business lines.

With a capital spending plan that calls for $1 billion annually through at least mid-decade, Spectra Energy Partners LP rates a buy up to 33.

Contract Risk

MLPs with business lines that have unhedged exposure to commodity prices could take a hit from the decline in oil and NGL prices.

However, many midstream MLPs have sought to pare their exposure to fluctuations in energy prices after oil and natural gas prices tanked in late 2008 and early 2009. This conservatism, coupled with producers’ desire to take advantage of elevated commodity prices in recent years, has led to an upsurge in fixed-fee and take-or-pay contracts that guarantee cash flow regardless of whether a customer uses the reserved capacity.

The Federal Energy Regulatory Commission (FERC) regulates a number of contracts involving major pipelines. Recently, FERC has been slow to grant owners of certain key pipelines the ability to charge market-based rates or to recover system investment.

The Commission is currently deliberating whether to let Enbridge (NYSE: ENB) and Enterprise Products Partners charge market-based rates on the recently reversed Seaway Pipeline, which transports oil to the Gulf Coast from Cushing, Okla.

FERC had previously refused market-based rates for the Seaway Pipeline, preferring to set a regulated rate. The Court of Appeals for the District of Columbia Circuit, however, this spring ruled it was wrong to deny a market-based rate for ExxonMobil Corp’s (NYSE: XOM) Pegasus line, forcing FERC to reconsider its decision on the Seaway Pipeline.

The Commission is also considering Conservative Portfolio Buckeye Partners LP’s (NYSE: BPL) application to charge market-based rates on one of its pipeline systems.

That pipeline owners would pursue market-based rates suggests that management teams remain relatively sanguine in their outlook.

Any business that involves buying and selling energy commodities has some exposure energy prices. MLPs that own gas processing facilities generate profit margins based on the difference between the cost of raw natural gas and the ethane, propane, butane and other NGLs that are removed from the stream.

At any given time, the price of these commodities can vary widely. NGL prices, for example, tend to track the price of crude oil because they trade in a global market and serve as substitutes for naphtha and other oil derivatives in key industrial processes. The extent to which management locks in an MLP’s receivable and payables through hedging dictates that stability of these firm’s cash flows.

In constructing our three model Portfolios, we consider the extent to which each holding is exposed to fluctuations in energy prices. The names in our Conservative Portfolio garner much of their distributable cash flow from fee-generating assets; for these MLPs, asset additions tend to drive distribution growth–not commodity prices.

Our Aggressive Portfolio includes names whose businesses have the most exposure to energy prices and houses all our upstream holdings.

Since 2007, Aggressive Portfolio holding Regency Energy Partners LP (NYSE: RGP) has diversified its business lines and almost doubled its fee-based cash flow to more than 80 percent of total cash flow. Along the way, the MLP has strengthened its balance sheet, while management’s plan to expand its Edwards Lime gathering system in the Eagle Ford shale testify to a company with plenty of opportunity to grow its distributable cash flow.

Regency Energy Partners LP continues to rate a buy under 29, but we are relocating the stock to the Growth Portfolio to reflect the firm’s reduced exposure to commodity prices.

The Growth Portfolio primarily comprises midstream MLPs that own a mixture of fee-generating assets and gathering and processing operations where margins vary with price of raw energy and refined products. Our Growth Portfolio holdings’ first-quarter results confirmed that management teams have taken steps to mitigate the steep decline in natural gas prices.

What remains to be seen is how the drop in oil and NGL prices will affect second-quarter earnings. As always, we’ll have in-depth analysis of each Portfolio holdings’ quarterly report and management’s conference call.

Value investors should consider building a position in Growth Portfolio holding Energy Transfer Partners LP (NYSE: ETP). The stock recently pulled back because of a wave of knee-jerk selling related to a recent equity issue and concerns about its ability to integrate Sunoco (NYSE: SUN) and Southern Union assets acquired from its general partner, Energy Transfer Equity LP (NYSE: ETE). Investors shouldn’t expect the MLP to hike it distribution until these transformational deals close.

Energy Transfer Partners slashed its exposure to the vagaries of the propane distribution after selling these operations to AmeriGas Partners LP (NYSE: APU), though the firm now owns a 25.6 percent stake in the latter MLP.

Offering a distribution yield of about 8 percent, Energy Transfer Partners LP rates a buy up to 50.

Meanwhile, investors should stand aside on Inergy Midstream LP (NYSE: NRGM). As you might recall, Inergy Partners LP (NYSE: NRGY) spun off its midstream energy assets in an initial public offering to raise capital after the unseasonably warm winter devastated its propane business.

In April, Inergy announced the sale of its retail propane assets to Suburban Propane Partners LP (NYSE: SPH) for roughly $1.8 billion in total considerations.

Although this move makes strategic sense–management has focused on growing the midstream business rather than building scale in propane distribution–the move raises an important question: What’s the value of Inergy other than its majority stake in Inergy Midstream’s common units and its general partner interest in the recently spun-off MLP? Management has yet to provide a satisfying response. Inergy Midstream LP continues to rate a hold.