Capital Investment Advisors

MLPs in 2017: The rise of a more conservative energy transportation industry

When it comes to stock performance, the last three years haven’t played out well for the pipeline industry. Beginning in 2014, crude oil prices started what appeared to be a free fall, casting a pall across the entire energy sector. Consider that West Texas crude oil fell 73% peak to trough during this time, and energy Master Limited Partnership’s (MLPs) correlated with the plummeting price of oil. See what I mean?

Today, the energy industry has gained back some of this lost momentum and is positioned for a comeback. The specter of a failing industry has lifted, and now investors can look at the energy pipeline space as one that has cleaned up its act after years of wandering off the beaten path.

So, if you can handle the volatility that comes with MLP price swings, MLPs may be worth considering. However, due to the volatility and added risk, we caution that MLP’s should only make up a small portion of portfolios.

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Look across the sector, and you’ll see why. Oil and energy pipeline companies have gotten their act together. As a group, these companies regularly pay out distributions of between 4% to 7% annually. And, even with range-bound oil prices coming in at $40 to $60 per barrel, these companies should continue to pay significant distributions.

Let’s turn back to prior years’ downturn. We’ve looked at distribution rates, but to paint the picture of what really derailed the pipeline industry, more context is needed. Consider two points.

There are two reasons why the last two years haven’t been great for the pipeline industry.

First, despite the original and traditional fee-based MLP model, many MLP/pipeline companies migrated away from being pure, predictable oil and natural gas transportation providers. Beginning around 2010, they began chasing more lucrative business lines within the energy sector.

Think of these companies as originally operating as pure storage and toll roads for fossil fuels, most charging to use their storage facilities and pipeline networks. But, over time they decided to shift lanes and dove into the much more volatile business of exploration and production (E&P). What happened next? Because MLPs migrated towards more oil price-sensitive business lines, they suffered when oil prices cratered from $100 to $26.

This move exposed MLPs a rocky road over the past few years. Looking to the stock market to provide a map, EMLP (an MLP and utility company ETF) is down about 3% over the past two years. Another energy transportation ETF, MLPI is down 25% over the past two years, but much of the loss was recovered in the back half of 2015.

What’s new?  I’m glad you asked. Fortunately, many of the MLP players have decided to get back to their roots. They’ve migrated back to the more stable, predictable part of the energy business. You know, that old, stodgy, boring business of running oil from state to state through a pipeline? Yep, that one. Today’s MLPs have shifted their focus back to simple transportation and fossil fuel storage endeavors.

Couple this return to predictability with the billions of dollars of new pipeline projects coming back online under President Trump (think the Keystone XL, Dakota Access, and Atlantic Sunrise projects), and MLPs may be positioned for a true renaissance.

Their lesson learned? Don’t fix something unless it’s broken.

Where does that leave us in today’s economy?

Looking first at distributions, companies like Kinder Morgan have cut distributions and are living much more within their cash flow. Margins across the board are almost 4% higher than their five-year average. And fees are playing an increasingly important role in this new old way of doing business.

Williams Partners (WPZ) is slated to hit close to 97% of their business in “toll fees” in 2017, compared to just 60% four years ago. Magellan Midstream Partners (MMP) has gone from being 80% fee-based to 91%. Plains All American Pipeline (PAA) grew from 59% fee-based in 2011 to 90% in 2017. These are dramatic shifts towards a more stable cash flow business. And it’s a stable cash-flow-oriented way of doing business – a toll road centric model with long-term contracts with oil producers.

As a group, these companies yield about 5% higher than Treasuries, translating to 7% versus 2% per annum. They come in 3% higher than REITs, at 7% versus 4%. Now you see, if one can handle the added risk, why the MLPs of today are worth a look – it comes down to cash flow and distribution potential.

Speaking of potential, MLPs’ potential for sustainability and growth is also a factor worth considering. The U.S. has the largest network of energy pipeline in the world, with more than 2.4 million miles of pipe carrying oil, gas, and electricity. About 72,000 miles is designated for crude oil transport, and roughly 300,000 miles is for natural gas delivery.

Still, few people are aware of the economic impact of this vital underground network that delivers an economically integral product like liquid petroleum and natural gas. Think about what crude oil and petroleum products provide us, from gasoline to jet fuel, from home heating oil to diesel for delivery trucks.

Remember that pipelines are energy lifelines; they make our country run. Pipelines play a critical role both in everyday lives and the function of our nation’s industries. This network delivers reliability, safety, and efficiency to the nation’s economy. And from where I stand, they’re recommitted to delivering these things to the market again, too.

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