Stay Calm with Your MLP Holdings

by Investing Daily
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Submitted by Investing Daily as part of our contributors program.

Build it and they will come: When these words are matched by deeds it will be a clear warning that America’s ongoing energy midstream expansion is at an end.

Fortunately, despite the headwinds facing the energy industry this year we’re still a long way from there. The latest evidence is ONEOK Partners LP’s (NYSE: OKS) decision this week not to go through with its Bakken Crude Express Pipeline.

The Bakken Shale region of the upper US Midwest boasts the most prolific light oil reserves in North America, and its eventual development is assured.

ONEOK, however, was unable to secure “sufficient long-term transportation commitments” in a recent “open season.” Despite the promise of the project, management was unwilling to take the near-term financial risk that revenue wouldn’t be there at completion.

Adhering to conservative financial and operating strategies keeps a lid on master limited partnerships‘ (MLP) near-term risks as well. Should the US government go over a fiscal cliff and a resulting recession drag down energy prices further, for example, North American producers would likely reduce drilling plans for 2013 even more.

Energy midstream MLPs that have tied projects to contracts, however, would see little material impact on their cash flows. Tighter credit conditions would also have minimal impact, as management teams have used the record-low borrowing rates of the past three years to reduce MLP investments‘ traditional dependence on credit lines and other near-term funding sources.

Tabled projects do come at the price of reduced future revenue. ONEOK Partners still plans USD2.2 billion in 2013 capital expenditures, and management says it still has USD4.2 billion to USD4.8 billion in projects underway in the Bakken region alone.

As a result it’s not changing projections for annual cash flow growth of 17 percent to 21 percent through 2015 or expected annual distribution growth over that time of 10 percent to 15 percent.

A deeper slump in North American energy drilling would no doubt force more retrenchment of growth plans for midstream MLPs. And despite the security of existing assets and contracts, less new development will eventually cut into growth of cash flow and distributions.

That’s a good reason to keep a close watch on MLP valuations now, particularly those that have much lower yields than rivals because of investor expectations of rapid distribution growth. If those projections aren’t met unit prices will come down, even if dividends are still safe.

The good news is there are more high-quality MLPs selling at bargain prices than in many months. That’s in large part due to lingering fears about the fiscal cliff and its potential impact on the US economy as well as worries a federal budget deal could involve more levies on MLP income.

We won’t have definitive answers to these questions until there is a deal in Washington. But MLP investors can rest assured about two things while we wait.

First, financially strong and growing companies always build wealth for investors, no matter how they’re taxed. Canadian energy midstream income trusts, for example, have been North America’s top-performing dividend-paying stocks since they lost their tax advantages on Halloween night 2006.

Second, trusts’ gains were thanks to reliable revenue growth, something all MLPs would maintain even if they are eventually taxed. That includes energy producers such as Linn Energy LLC (NSDQ: LINE), which has locked in lofty selling prices for all of its projected oil and natural gas output through 2016 and 2017, respectively.

The bottom line is don’t sell your solid MLP holdings prematurely in December. In fact, it’s a good time to identify the MLPs you want to hold for the year ahead.

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