MLP HINDSight

With the S&P 500 up 2.2% and the alerian mlp index up just 1.5%, MLPs lagged the market this week, but did make a brand new all time high, and a new 12 month low yield.  Commodity prices were up with natural gas making the biggest move, up 5.0% this week and helped by Thursday’s storage report.  For the year, MLP Index is up 13.5%, 15.1% with distributions.

Winners & Losers

Big moves this week, led by MPLX and BKEP, both up double digits.  GLP was up 9.1% after announcing CNG partnership.  GLP has changed the buzzwords associated with it the last year or two from heating oil and propane to Bakken railroads and compressed natural gas, so good work by them.  Not many MLPs in the red this week, and no real trend in the bottom five.

GLP jumped back ahead for the year.  Liquids and logistics MLPs dominate the top 5.  Only 3 MLPs are down for the year, hopefully you didn’t own all three on 12/31.

Historical Yield

Yield isn’t the best metric to evaluate MLPs, and it can be distorted by distribution coverage and broader interest rates, but its the most accessible and widely followed.  Its been a while since we’ve looked at yields here, so thought we’d take a closer look after the MLP Index closed the week at a fresh all time high.

See below for MLP Index yield charts looking back at various historical periods.  The MLP Index yield is currently 5.89%.  First up is the longest time period, which makes the last 2 years look expensive, but not at all-time lows reached in 2007.  Declining interest rates during most of this period and extremely low interest rates the last several years distort this picture.

The last five years, MLP Index averaged 7.39% yield, compared with the current 5.89% yield.  After the initial recovery from the financial crisis, the MLP Index has traded between 7% and 6%, with anomalies above and below that range quickly corrected.

Early June, MLP Index yield hit 6.86%, the highest its been in the last 12 months.  There was another spike up to 6.81% on 11/15/12, around distribution ex-dates.  The last time MLP Index yield was above 7% was back in October 2011, and at no point in the last two years has the MLP Index yield been higher than 7.5%.  Will MLPs ever yield that high again?  History says yes, but if you have recently come to MLPs, you may think this chart of recent history is normal, because as Daniel Kahneman repeats in his book Thinking Fast and Slow:  ”what you see is all there is”.

In February 2012, a little over a year ago, MLPs were yielding less than they are today (by 5 bps).  The MLP Index has increased in price by 6% since then and produced 12% total return.  Could that happen again the next 12 months?  What conditions would be necessary for a repeat 12%+ return the next 12 months for the index?  It would be hard to create a more benign broader stock market environment for MLPs than the last 12 months, with improving unemployment, crazy low interest rates and low grade crises / fears.

Commodity prices have been anything but benign the last 12 months, so maybe you hang your hat on a turnaround in NGL / natural gas prices that drives more activity and volumes.  But with the structural imbalances in those products and with oil production continuing to ramp, NGLs and crude oil may lag and weigh on MLPs.  Natural gas has already made a substantial recovery.  If those prices hold, the natural gas picture the rest of this year will be much better than it was last year, but still far away from making dormant basins economic again.

So, what’s the bull case for MLPs from here?  Any bull case has to be heavily reliant on increased yield appetite, new money flowing into the sector from new sources (pension funds, late adopting individuals, etc).  Something you hear when MLPs are at historically high valuations: maybe we’re at the inflection point whereby MLPs get repriced with lower yields like REITs.  I don’t think that’s happening, and I would at least wait until the MLP Index broke its all time low yield of 5.37% before starting to believe it.

Maybe your MLP bull case involves MLPs growing distributions more rapidly than the 7% that the MLP Index implied distribution grew in the last 12 months?  Seems pretty unlikely.  Proceed with caution, at the very least wait a week or two for MLP equity offerings to get rolling again before putting fresh money to work in broad MLP instruments (there remain individual MLPs that are likely to outperform the sector).

News of the (MLP) World

I was genuinely surprised there weren’t more equity deals this week besides the one from WPZ.  I’m still expecting the floodgates to open at some point soon.  Also, fyi, its Spring Break across Texas this week, so MLP execuives and senior bankers (just the ones that like to spend time with their families, smaller subset) may be taking this week off.  Also, it happens to be SXSW week here in Austin.  I haven’t ventured into town to check it out (As evidenced by my Saturday night posting).  Maybe I will next week just so I can send out a post from the SXSW scene like so many podcasts and movies do.

Equity

• Williams Partners (WPZ) prices public offering of 11.25mm common units at $49.14/unit, and announces 3.0mm unit private placement to Williams Companies, raising $679mm in combined net proceeds (press release)
  • WPZ prices 11.25mm common unit offering at $49.14/unit, raising $552.8mm in gross proceeds
  • WPZ concurrently sold 3.0mm common units directly to Williams (WMB) at per unit price equal to public offering price, net of underwriting discount, or $47.66/unit
  • Net proceeds of the offering to be used to repay borrowings
  • Public portion priced overnight at 2.79% discount to prior close

• El Paso Pipeline (EPB) entered into equity distribution agreement to issue up to $500mm in common units at the market (filing)

M&A / Growth Projects

• Exterran Partners (EXLP) announces acquisition of customer contracts relating to the operation of ~259,000 horsepower of compressor units for $174mm from Exterran Holdings, Inc. (press release)
  • EXLP to acquire contracts serving 50 customers together with approximately 370 compressor units used to provide compression services under those contracts, representing ~253,000 horsepower
  • Acquisition to be funded with 7.1mm EXLP common units issued directly to EXH
  • Transaction expected to close in March or April 2013

• Global Partners (GLP) announces agreement with OsComp Systems, Inc. to provide compressed natural gas (CNG) via truck to commercial, industrial and municipal customers in New England (press release)

• Eagle Rock Energy (EROC) announces new acreage dedication in Texas Panhandle under fee-based agreement with Apache Corp (press release)
  • EROC announces new fee-based gas gathering, processing and purchase agreement with Apache Corp to support Apache’s active drilling program in the Texas Panhandle
  • Apache has dedicated to EROC all existing and future wells drilled within a 106,000 acre area
  • Dedicated acreage covers the Granite Wash, Hogshooter, Tonkawa, Marmaton and Cleveland plays in the Anadarko Basin of the Texas Panhandle

• Boardwalk Pipeline (BWP) and Williams Companies form JV to develop Bluegrass pipeline project from Marcellus and Utica shale plays to Gulf Coast region (press release)
  • BWP and WMB to form JV to develop a pipeline project to transport NGLs from Marcellus and Utica shale to the U.S. Gulf Coast demand center
  • Proposed “Bluegrass Pipeline” would provide 200,000 bbls/day of mixed NGL takeaway capacity in Ohio, West Virginia and Pennsylvania, and would include:
    • Construction of new NGL pipeline from producing areas in West Virigina and Ohio to an interconnect with BWP’s Texas Gas Transmission system (Texas Gas) in Kentucky;
    • Converting a portion of Texas Gas from Kentucky to Eunice, LA from natural gas service to NGL service; and
    • Constructing new large scale fractionation plant and expanding NGL storage facilities in Louisiana and a new pipeline connecting these facilities to the converted line
  • Plan is to have the pipeline in service by second half of 2015

• Crosstex Energy Inc (XTXI) announces $50mm investment in a new company (E2) that will provide services for producers in the liquids-rich window of the Utica Shale play in Ohio. (press release)

Permain Differential

Several upstream MLPs that reported this week discussed the impact of wider differentials for Permian produced crude oil relative to Cushing.  Below is a chart showing the differential of West Texas Sour Crude to WTI in Cushing.  In mid-November that basis blew out and remained depressed until the end of January, but now sits at just a dollar.  For the previous 12 months, the basis differential has averaged -$6.31/bbl, compared with -$3.11 the last 5 years.  The blowout was caused by refinery downtime and increased production.  Upstream MLPs have combated this trend by adding basis swaps to lock in tighter differentials.  Click on the chart to see a larger version.

MLPs edged up again this week, and so did the broader stock market.  The MLP Index finished February up 0.87% including distributions, which was the weakest February performance since 2009 (-5.4%).  March has been a weaker than average month for MLPs, and was  down in 2012 and 2011.  I would not be surprised to see MLPs drop slightly as a sector in March, and like most of the investing community, I’ve been surprised a correction, even a mild one, hasn’t happened yet. Proceed with caution and make sure you pick the right MLPs if you’re bringing new money to the sector right now.  If you don’t know how to pick the right ones, hire someone like me, or buy a pooled investment vehicle of some kind.

Oil futures have been up and down for the year, but was down all week, making YTD lows on 3 of the 5 trading days, including Friday’s close below $91 per barrel.  Natural gas futures were up for the second straight week, and natural gas storage chart is starting to look a little better, with storage levels 12% below a year ago (but still 16% higher then the 5 year average).  There have been plenty of false start with natural gas prices recently, and I’m certainly no expert on the dynamics of the natural gas storage market, but natural gas at $3.42/mmbtu is much better than spot prices a year ago of less than $2.50/mmbtu.

For the year so far, all things MLP have returned on average roughly the same amount, with variable distribution MLPs, GP holding companies and the MLP Index all producing a little better than 13% total return.  And that 13%+ total return has been much better than the broader stock markets so far this year, in a reversal of 2012 results.

Big Deal February

This week saw another $3.0bn in announced M&A transactions, bringing total announced M&A value for February to $7.8bn, after a very big January M&A amount of $6.8bn.  MLP M&A is on pace for more than $87bn in M&A this year, which would be a record by nearly $40bn over last year’s $52.5bn record MLP M&A.  This week there were 3 sizable drop down acquisitions this week (into RGP, DPM and WES), and Evercore partners was the big winner on the advisory side, advising on 2 of the 3 transactions.  That means there were some unhappy, possibly chewed-out investment bankers that didn’t advise on the deals.

The good news for unhappy bankers is there is probably plenty more M&A up for grabs in the deal pipeline.  And all that M&A will need to get financed, somehow, which will generate plenty of fees to share.  I’m expecting a big month for equity issuance in March, so position your portfolios accordingly, especially if you own an MLP that recently announced an acquisition, hasn’t issued equity in a more than a year, or has high leverage.

Because MLPs Got High

Regular readers are used to seeing the same charts here every week, especially since my posting has slowed to once a week.  But below is a fun chart that I posted about a year ago regarding the MLP Index and all-time highs.  The point of the chart is that MLPs have seemed expensive compared with their recent trading history for going on 17 years now, with the exception of 2003 and 2008.  So far this year, the Alerian MLP Total Retun Index has already made 16 new all time highs in 2013, well ahead of the pace of the last few years, and on pace for 96 new all time highs.  We will not get to 96, but we’ll probably see a few more all time highs this year.

Winners & Losers

OKS beat consensus expectations for 4Q 2012, but lowered 2013 guidance, and its units were off 6.4% for the week.  DPM announced a large drop down acquisition, but also executed a $446.9mm follow on equity offering, which led to weakness.  EVEP earnings provided no real update on the Utica sale process, leading to what appeared to be frustration selling on Friday.  On the plus side, TLP and CLMT were up big on no news.  CQP was up big after another round of equity was announced as completed via a registered direct offering.

CLMT’s big week catapulted it to the top spot in the sector, alongside GLP.  STON dropped out of the top five after a 2.4% drop for the week.  There are only 5 MLPs that have negative total returns YTD, with EEQ as the only newcomer to the list this week.

News of the (MLP) World

A very active M&A week, fairly active equity week with some unusual equity deals getting done, but no debt deals.  Also, I issued a report on EROC’s earnings beat, reiterating my price target and adjusting my estimates.  Email me if you weren’t on the distribution and would like the report.  Other covered MLPs (QRE, MEMP and VNR) report earnings next week, so stay tuned for more reports next week.

Equity

• DCP Midstream (DPM) prices upsized public offering of 11mm common units at $40.63/unit, raising $446.9mm in gross proceeds (press release)
  • One day book build, with file to price decline of 3.9%
• Enbridge Energy Management (EEQ) prices sale of 9.0mm shares to underwriters at $26.44/unit, raising net proceeds of $238.0mm (press release)
• Cheniere Energy (CQP) announces private placement of 17.6mm common units, raising $372.2mm in net proceeds (press release)
  • Reduced equity overhang with no market disruption, market liked that

M&A

• Vanguard Natural Resources (VNR) announces acquisition of natural gas, NGL and oil properties in the Permian Basin for $275mm from Range Resources (press release)
  • VNR to acquire natural gas, NGL and oil properties in southeast New Mexico and West Texas area of Permian Basin
  • Asset details:
    • 137 Bcfe of proved resrves (78% PDP) on 7,000 net acres
    • Current production: 17 mmcfe/d (41% natural gas and 59% oil and NGLs) with 20 year reserves/production ratio
  • Acquisition to be financed with borrowings on VNR’s credit facility

• Martin Midstream (MMLP) announces acquisition of six liquefied petroleum gas pressure barges and two commercial push boats for $50.8mm (press release)

• Regency Energy (RGP) announces acquisition of Southern Union Gathering Company, LLC for $1.5bn from Southern Union Company (jointly owned by Energy Transfer and Energy Transfer Equity) (press release)
  • Purchased from Southern Union Company (jointly owned by Energy Transfer (ETP) and Energy Transfer Equity (ETE))
  • Acquired assets include 5,600-mile gathering system and ~500 mmcf/d of processing and treating facilities in west Texas and New Mexico for natural gas and natural gas liquids
  • Transaction to be partially funded with $900mm of new RGP units issued to Southern Union Company, including $150mm of new Class F common units that will not receive distributions for the next 8 quarters
  • Remaining $600mm will be paid in cash funded from long-term borrowings
  • ETE has agreed to forego incentive distribution rights payments associated with the newly issued units for 8 quarters and to eliminate $10mm annual management fee due from RGP for two years post-closing
  • Expected to close in 2Q 2012 and expected to be “slightly accretive” in 2013

• DCP Midstream (DPM) announces $626mm Eagle Ford drop down acquisition from DCP Midstream, LLC (press release)
  • DPM to acquire additional 47% interest in its existing Eagle Ford joint venture with DCP Midstream, LLC, bringing total total JV stake for DPM to 80%
  • Eagle Ford JV owns five cryogenic processing plants with 760 mmcf/d processing capacity and ~6,000 miles of gathering systems, three fractionators with 36,000 bbls/d capacity, the newly constructed Eagle Plant (200 mmcf/d processing capacity), and the Goliad Plant currently under construction (will have 200 mmcf/d processing capacity)

• Western Gas (WES) announces acquisition of 33.75% interest in Marcellus Shale gas gathering systems from Anadarko and Chesapeake for $623.5mm (press release)
  • WES to acquire a 33.75% interest in both the Liberty and Rome gas gathering systems from Anadarko Petroleum Corp (APC) for $490mm
  • WES will separately acquire a 33.75% interest in the Larry’s Creek, Seely and Warrensville gas gathering systems from an affiliate of Chesapeake Energy Corp for $133.5mm
  • Assets acquired serve producers in north-central Pennsylvania and have total combined throughput of 1.2+ bcf/d
  • APC acquisition to be financed with $220mm cash on hand, $246 in borrowings and $25mm worth of WES units
  • APC acquisition represents a 7.6x EBITDA multiple, is expected to be immediately accretive and close by 3/1/13
  • Chesapeake acquisition will be financed with borrowings on WES’s credit facility, and is expected to close by 3/15/13
  • Chesapeake acquisition represents a 9.7x 2013 EBITDA multiple

MLPs followed the broader market slightly lower this week, with some fireworks on the edges around earnings and deals (PVR and LINE, for example).  Natural gas and propane were both up big, but gold futures closed at their lowest point since late June, and are down 7.2% from the high for the year of 1695.4 reached on January 22.  Oil hit its lowest point this year on Thursday, and closed down 3.4% for the week.

I look forward to some fresh drama in the markets under the header of sequestration, and I expect to see at least 2 follow on offerings after the capital markets calm of the last few weeks of earnings releases.  Its just math that if MLPs need $20bn+ in annual equity capital, that’s at least $400mm per week (based on a very optimistic 50 weeks with the capital markets open).  We’ve had a quiet few weeks, and the sector needs to play capital raising catch up, which I expect to weigh on MLPs this week.

Variable distribution MLPs were the big losers for the week (down 4% on average), led by RNF (-11.3%) and PDH (-8.3%).  GPs had a mixed week, ranging from ATLS up 4.5% to NSH down 4.0%, but are keeping pace with the Alerian MLP Index for the year so far. ATLS was helped by strong ARP earnings release on Thursday, on which I will be publishing a report on Monday.

MLPs got press in Barron’s for the second straight week.  Last week, Barron’s highlighted the “controversy” around LINE’s practice of capitalizing put premiums and its distributable cash flow calculation.  More on LINE’s much better week below.  This week’s Barron’s cover story hit on the major trends in the sector and tapped real pros in the space, Kyri Loups and Chris Eades, for the discussion.  This is when Barron’s MLP coverage is at its best, highlighting the sector as a whole.  Barron’s coverage can get into trouble when trying to keep up with individual names, which is understandable, given the multitude of new MLPs and MLP products in recent years.

JCT Update

A few weeks ago, the Joint Committee on Taxation released its latest estimate of what all of the current tax breaks in the tax code cost the government in lost revenue (click here to download the report).  The Committee estimates that MLP line items will total $7.0bn for the next 5 years (2012-2016), up from the five year estimate of $1.5bn in 2012′s report, or 4.7x more. Click here to read a good summary of the situation from Bloomberg.  The annual number of $1.6bn for 2016 in 2013′s report also quadrupled from $0.4bn estimated for the final year (2015) in 2012′s report.

I’ll be out with more thoughts on this and taxes in a report at some point in the next few weeks, but the short answer is I am not worried about MLPs losing their tax advantage in 2013.  Last year, I went through and totaled all the line items up (14 pages worth) and it ended up being $6.1 trillion total.  I haven’t done that work yet this year, but if the number is similar in this year’s 5 year estimate, MLPs would still represent around 1/10th of 1% of the overall tax “expenditures”.

Winners and Losers

LINE was the big winner this week, unleashing the power of a fully armed and operational LNCO on the market with its $4.3bn acquisition of Berry Petroleum. LINE’s likes to highlight how its market cap is bigger than the rest of the upstream sector combined, but if they stay busy, LINE may be able to say it acquired more assets in 2013 than all other upstream MLPs combined (certainly the case thus far). I still contend that the acquisition opportunity set is big enough to satiate upstream MLPs large and small.  But LINE is operating on a whole other level, and if it had a tougher sounding name it might be considered the evil empire of the upstream MLP space (Linn + Berry sounds like a frozen yogurt flavor).

The flurry of good news on LINE couldn’t have been choreographed better or come at a better time. After playing defense against shorts last week, LINE was on offense this week. The big acquisition lowered leverage (all stock for stock), it was announced as very accretive, and LINE management confirmed intent to change to a monthly distribution. None of this is good news for shorts, which had all the momentum heading into the week.

OXF, which was on the bottom last week, was there again this week, after another double digit percent loss this week.  Not sure if it will recover at this point.  PVR lowered guidance and reported weak earnings, leading to a double digit drop this week as well.

PVR’s bad week dropped it close to the bottom of the sector for the year.  OXF’s free fall continues, and its anti-lead widened vs. all other MLPs.  GLP lost the top spot after flying a little too close to the sun YTD, and falling back a bit this week on what appears to be profit taking.  STON took over the top spot, but its neck and neck for the top three, which is a fairly motley crew of small cap, special situation MLPs.

News of the (MLP) World

Equity

• Kinder Morgan Energy (KMP) prices spot offering of 4.0mm common units at $86.35/unit, raising $345.4mm in gross proceeds
  • Gross proceeds of $345.4mm
  • Offering part of KMP’s routine capital raising program (this is KMP’s 3^rd similar sized spot offering since June 2012)
  • Spot offering, priced at 2.1% discount to prior close
• Boardwalk Pipeline (BWP) files S-3 registering up to $500mm of equity and debt securities

M&A / Growth Projects

• Magellan Midstream (MMP) announces acquisition of 800 miles of refined products pipeline from Plains All American Pipeline (PAA) for $190mm
  • MMP to acquire 800 miles of refined petroleum products pipeline, including:
    • Rocky Mountain pipeline system, consisting of 550 miles of common carrier pipeline that also includes 4 terminals with nearly 1.7mm barrels of storage capacity
    • New Mexico pipeline system, consisting of 250miles of common carrier pipeline that transports refined products from El Paso to Albuquerque, NM, and transports products south to the Texas-Mexico border
  • Acquisition is immediately accretive to MMP’s distributable cash flow per unit
  • Assets are not considered core to PAA’s ongoing operations

• Linn Energy (LINE) and LinnCo (LNCO) announce acquisition of Berry Petroleum Company (BRY) for $4.3bn in total consideration
  • LINE to acquire all of BRY’s outstanding shares and will assume BRY’s outstanding debt
  • First ever acquisition of a public corporation by an upstream MLP
  • Expected to close by June 30, 2013
  • Structured as a tax free exchange that will use LinnCo LLC (LNCO) shares at a 1.25 LNCO:BRY ratio
  • Approximately 19.8% premium to prior close for BRY shares
  • After the exchange, the BRY assets will be moved to LINE in exchange for LINE units issued to LNCO
  • Announced distributable cash flow per unit accretion in 2013 of $0.40 per unit
  • LINE and LNCO to increase quarterly distributions 6.2% and 8.5%, respectively, in the quarter following transaction close
  • BRY’s proved reserves are 1.65 Tcfe (75% oil ), will increase LINE’s liquids reserves to 54% from 46% pro forma
  • BRY’s current production is approximately 240 MMcfe/d

• Kinder Morgan Energy (KMP) announces KW Express (partnership between KMP and Watco Companies) will construct 210 Mbbl/d crude by rail project on the Houston Ship Channel
  • KMP announces that KW Express (a partnership between KMP and Watco Companies) entered long-term agreement with Mercuria Energy Trading Company to construct a 210,000 bbl/d crude by rail project
  • Project will be located at the Greens Port Industrial Park on the Houston Ship Channel
  • Facility will allow Mercuria to source crude from various origination locations including Cushing, West Texas, the Bakken Shale and western Canada for delivery by rail into the Houston Ship Channel
  • KW Express will own 85% of the project and will construct and operate the project, Mercuria will retain 15% interest

CORPORATE ANNOUNCEMENTS

• Linn Energy (LINE) management confirms that LINE will move to a monthly distribution payment from a quarterly payment
  • Enterprise Products (EPD) announces election of Randa Duncan Williams to Chairman of the Board of its GP, and announces creation of Office of the Chairman, which will include Randa Duncan Williams, Michael Creel (CEO), and Jim Teague (COO)

• Vanguard Natural Resources (VNR) announces monthly distribution of $0.2025 per unit, no change from prior month