Changing Horses in Midstream? The Future of Master Limited Partnerships – Part II – IDRs

For the past decade or more, master limited partnerships (MLPs) have been one of the most popular forms used by energy companies to capitalize themselves and one of the most rewarding for their investors. These investments offered income, in most cases steadily growing, at a time of historically low interest rates.  They also offered capital appreciation as the sector more often than not was one of the best performing in terms of equity returns.  So what explains the rapid collapse in value that has been experienced over the past few months?  Today in Part 2 of RBN’s series on MLPs, we delve further into that question, looking at Incentive Distribution Rights (IDRs) and our friends at Alerian provide a list of 118 MLPs including the “IDR splits”.

Today’s Contributor

Today’s blog post is from Keith Bailey, a legend in the energy industry who was the CEO of Williams when Rusty worked for that company a few years back. Keith has served on the boards of MarkWest Energy and Williams Pipeline Partners (the predecessor company to Magellan), and today is on the boards of Cloud Peak Energy and Aegis Insurance Services. This is Keith’s third RBN blog submittal.

The Disclaimer

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.

Recap

In Episode 1 of this series, we provided a brief refresher course on MLPs and the current state of the MLP 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-like” revenues that should not fluctuate dramatically with commodity prices.

MLPs were integral to the shale midstream infrastructure build out over the past few years.  These companies sold new partnership units to investors that offered the prospect of income in the form of 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 crashed 46% since it’s high in August 2014 to finish the year at 290 on December 31, 2015. 

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What’s the Problem?

If the theory of MLPs is that they are fee-based toll roads, why should the collapse in crude prices make such a big difference to their value?  Pundits have offered a number of reasons, some of which have been important factors, others that have been only marginal contributors. For example, some have argued that since MLPs tend to trade on yield – specifically the yield versus interest rates, and the Federal Reserve is raising interest rates, that MLPs are consequently less attractive.  It could be a factor, but frankly the small basis point increase we have seen so far and the modest increases that are likely over the next few months hardly explain the type of devaluation that has occurred.

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