Investing in MLPs
MLP income & total return strategies in a volatile energy environment
September 16, 2015 | Gaylord Texan Resort & Convention Center - Grapevine, TX
September 19, 2015
Given market events, the timing of our Investing in MLPs conference enabled investors to gain deep insight into relevant industry topics unfolding in our low commodity price environment. Our partner, MLPData, summarized a few of the key points discussed throughout the conference by the presenters, which consisted of Fund Managers, Tax Experts, Analysts, MLP Management, and RIA’s managing MLP allocations.
What to Expect in 2015 and 2016: Most presenters agreed that they expect to see volatility and perhaps more downside risk as Fall credit redeterminations take place, creating headlines of E&P distress, along with the potential for small and peripheral MLPs to announce distribution cuts in December. These risks are unrelated to MLP fundamentals, but rather reflect market sentiment where units are being sold without asking questions. 2016 is considered the year of opportunity if investors are able to pick up oversold units in Q4 of 2015. Estimates are that US production will fall between 250k and 900k bpd before the end of the year, allowing the market to re-balance and stabilize crude in the $50-$60 range. Although volume reductions are not what MLP investors would hope for, operators can build budgets and infrastructure around higher prices, which will lead to growth projects.
Bankruptcy Risk of Take or Pay Contracts: With looming announcements of E&P bankruptcy, exemplified by this week’s announcement of Samson’s pre-packaged Chapter 11 bankruptcy filing, the audience was looking for insight into how might a Midstream operator be impacted if a take or pay customer were to declare bankruptcy. Presenters responded by describing that each Bankruptcy filing could be different, but the midstream operator will have a period of uncertainty regarding their contract terms. However, the expectation is that to the extent there are Chapter 11 filings by customers of midstream services, these filings will not result in the customer terminating operations, but more likely addressing their balance sheet and continuing to require the midstream services. Those who are more captive to limited midstream alternatives will have the least amount of leverage to alter their take or pay commitments in the event of bankruptcy filing. Although there were many questions about this topic, the presenters did not expect bankruptcy driven take or pay reductions to have a material impact on 2016 cash flows, and the headline risks were more worrisome than the actual impact.
The Impact of Fund Flows: There is no question that the recent performance of MLPs have been driven by the plethora of new Closed End Funds, Mutual Funds and ETFs which have been launched since 2010, raising over $30B in new capital to soak up MLP equity issuance and increase demand for units. Those flows have since shifted and have turned modestly negative as retail investors liquidate energy exposure. However, several fund managers mentioned the strong inflows related to new institutional money which may be indicating that MLPs have hit bottom.
Raising Capital: MLPs usually fund new projects with 50% equity and 50% debt, the former of which is nearing 10% for many units, and even higher when considering the impact of IDRs. At a double digit cost of equity financing, few new projects look attractive when considering Return on Invested Capital. Recent new issuances have not been well received, increasing yields further. Some management teams are faced with reducing distributions if the market does not value their units in line with the assumption of no distribution cuts. Accessing the public markets for equity issuance will likely be a last resort to sponsor financing and private equity, the latter of which reportedly is near $20B of available capital awaiting opportunity.