Investors in energy-focused master limited partnerships could be understood crying for mercy. The sector rebounded late last week, but the midstream benchmark Alerian MLP index is still down a brutal 16% in January, and 46% for the past year.
The problem here, as with global markets, is falling crude-oil prices. In good times, MLPs do not correlate with oil prices, since they mostly earn revenue from long-term contracts based on volumes of gas and oil they transport, but in bad times, they do.
U.S. crude bounced on Thursday and Friday to $32 a barrel from a low near $27, but there is no denying that oil is likely to stay lower for longer. On Friday, Moody’s put 122 energy companies on review for downgrades, citing “a prolonged period of oversupply that will continue to significantly stress the credit profiles of companies in the oil-and-gas sector.” Moody’s sees oil at an average price of $33 a barrel in 2016 and $38 in 2017.
“Our view is you’re going to have to see some type of stabilization in the commodity before you see the MLP group recover,” says Darin Turner, who manages MLP, infrastructure, and real estate funds for Invesco. “We think we still have three to six months of this kind of persistent volatility.”
Driving the January drop in MLPs are concerns about counterparty risk—the potential that oil-and-gas-producing customers could go bankrupt. “That’s a key focus of ours right now,” says Matt Sallee, portfolio manager at Tortoise Capital Advisers. Even in a bankruptcy, contracts with MLPs often have seniority, he says, but there’s a possibility of rate renegotiations: “We’re hoping for the best but preparing for the worst.”
Other worries have been with MLPs for much of the past year. MLPs pay out the bulk of their cash flows in dividends and require infusions from capital markets to fund growth. But as their stocks fell and dividend yields rose, fresh capital has become expensive and scarce. Some MLPs, such as Plains All-American Pipeline (ticker: PAA), have turned to private deals, but others have resorted to dividend cuts. Kinder Morgan (KMI), not technically structured as an MLP but still a bellwether, recently slashed its dividend 75% and its 2016 capital-spending budget by $900 million (see Follow-Up).
“Kinder is saying, let’s spend within our means,” says Stewart Glickman, group head for energy equity research at S&P Capital IQ. “There are still a lot of MLPs out there that haven’t done that yet,” he says. “Kinder cut its dividend first, but it’s not the last.”
Investors have sold off Energy Transfer Equity (ETE) and Williams (WMB), judging their plan to merge misguided and pricey in the tough environment. Both were big holdings of MLP funds. Many closed-end funds have bumped up against leverage limits as stocks fell and had to unload holdings, exacerbating the selloff.
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