Without the use of corporate structures called Master Limited Partnerships (MLPs) the midstream infrastructure build out that helped make the U.S. shale revolution possible over the past 5 years would have taken far longer to gain traction. MLPs were very successful as the market grew and high prices encouraged new oil and gas production. But along the way some of the businesses these structures were applied to crossed the line from toll-road fee based infrastructure into exposure to commodity prices. For this reason and others, today MLPs are struggling to attract growth capital in a low price environment. Today we conclude our series analyzing the future of MLPs.
Before we start – a big disclaimer. RBN Energy does not advocate investment in MLPs. We are not an investment advisor. The purpose of this blog is not investment advice or endorsement.
In Episode 1 of this series, we provided a refresher on MLPs and their current market. Recall that these are tax efficient, publically traded partnerships used mostly as investment vehicles for oil and gas midstream infrastructure. Over 84% of MLPs are involved in energy and natural resource industries. In theory, MLPs are designed for businesses with secure, stable cash flows – fee based, “toll-road” revenues that should not fluctuate dramatically with commodity prices.
MLPs were integral to the shale midstream infrastructure build out over the past few years. They sold partnership units to investors that offered the prospect of income from cash distributions as well as growth from increasing unit values - then used those funds to develop billions of dollars in midstream assets. As MLP prospects soared, the widely followed Alerian AMZ Index that tracks MLP returns increased 286% from 189 at the beginning of January 2009 to a high point of 540 in late August 2014. Then came the crude oil price crash. The AMZ index fell 46% since it’s high in August 2014 to finish 2015 at 290.
In Episode 2 we dived into two MLP issues that have sparked concern about how appropriate these structures are as vehicles for midstream infrastructure build out in an era of falling oil prices. The first is whether the toll-road analogy really protects MLP investors in an industry down cycle such as that being experienced today. The risks of most MLP infrastructure projects like pipelines and terminals are underwritten by shipper “take-or-pay” commitments that guarantee capacity payments required to generate a return on investment – regardless of commodity prices. But if shippers don’t survive the down cycle or can’t meet those take-or-pay commitments - the MLP is left holding the bag. The second issue is the common practice of setting up MLPs so that the controlling General Partner (GP) owns a minority 2% interest in Limited Partner (LP) units but receives an outsize return based on Incentive Distribution Rights (IDR’s). Analysis from Alerian shows that from a list of 54 Midstream GPs with IDRs – 43% or 23 MLPs currently return “High Splits” of 48% to the GP. In many such cases – as industry stalwart Keith Bailey argued in Episode 2 - the resulting uneven distribution of MLP cash to the GP can easily force LP unit holders to take risks not commensurate to the returns they will achieve.
This time we discuss other perceived MLP issues/flaws that have impacted these once popular investment vehicles in a low price environment.