Energy-focused master limited partnerships (MLP) held up reasonably well when oil prices began to collapse in mid- to late 2014. In fact, the Alerian MLP Index hit its all-time high toward the end of August 2014 and gave up only 9 percent of its value in the back half of the year.
However, the new year hasn’t been kind to MLPs, with the benchmark Alerian MLP Index down 17.5 percent in 2015. This selling pressure has prompted many investors to question whether their longtime favorites can maintain their distributions, let alone maintain their growth trajectory.
Some investors also worry that the MLP structure itself has a fatal flaw, a concern that reflects the market’s tendency to view the group as a whole during times of panic.
Aggressive distribution cuts by Linn Energy LLC (NSDQ: LINE), which eliminated its payout completely, and other upstream MLPs that produce oil and gas haven’t helped investor sentiment.
Examining the factors at play in the recent correction can help to identify the pockets of risk and the best-positioned names for when the market returns to its senses and focuses on individual stories.
In part, the indiscriminate selling of MLPs stems from an extended period of indiscriminate buying while oil prices remained elevated and US hydrocarbon production surged.
Although buy-and-hold investors historically have gravitated toward MLPs for their above-average yields, the huge growth opportunity created by the shale oil and gas revolution shifted the focus from accumulating payouts to yield compression—or price appreciation that outstrips distribution increases.
The exodus of institutional investors from Access Midstream Partners LP—a name that had targeted annual distribution increases of at least 15 percent—after its tie-up with higher-yielding Williams Partners LP (NYSE: WPZ) revealed this dichotomy. (See Four Takeaways from the Year’s Biggest Acquisition in the Energy Patch.)
But the easy-to-understand growth story that attracted so many investors has morphed into a confusing morass of oversupply, counterparty risk and uncertainty regarding future production growth.
The severe downdraft in the prices of crude oil and natural gas liquids (NGL)—and the likelihood that these prices will remain lower for longer—suggests that US production growth will slow and output will decline, diminishing demand for incremental midstream capacity and creating volumetric risk for some MLPs.
In fact, the long-awaited rollover in US oil output appears to have started, with the Energy Information Administration’s (EIA) most recent Drilling Productivity Report showing month-over-month production declines in the Bakken Shale, Eagle Ford Shale and Niobrara Shale that started in April or May 2015.