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January 5, 2016

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2015 Year in Review: Debrief after Decline

Looking back is painful when stock market outcomes have gone awry. But the clarity of hindsight should be taken advantage of to improve future investing outcomes as we all strive to be better investors. In that light, we review the expectations from last year and what surprised me and all of you relative to your sentiment on key statistics.
First, a quick review of performance and key variables. MLPs were down 32.6% in a flat stock market in 2015. Interest rates rose slightly, but the trend and rhetoric of higher rates hurt utilities, which underperformed stocks. Oil prices were down less than MLPs at 30.5%, and natural gas prices closed out the year below $2.50/mmbtu.
MLP 2015 Review
MLPs have now underperformed the S&P 500 for 4 straight years. The AMZ price index in December reached new multi-year lows not seen since 2009, while the total return index hadn’t fallen that low since 2011.
Review of 2015 Prop Bet Lines
Each year for the last 4 years, I propose what I believe are approximately consensus expectations for certain MLP statistics, and we all vote on them. See last year’s lines here. Then a year later, we check in and see how we all did.   I only got 4 out of 10 this year, whereas readers overall got 5 of 10, so not great predictive power, but a solid source for overall MLP sentiment at the time.

  • Line: 12
  • My Pick: Under
  • Reader Pick: Under (63% of the vote)
  • Actual 2015 Results: 6

We’ve seen an average of 10 MLP IPOs over the last 10 years, 100 in total, including 74 since the beginning of 2010. So, with just 6 IPOs, 2015 was below average, but the recent IPO drought doesn’t look like it will last as long as the 2 year total shut down we saw from May 2008 through April 2010.
MLP 2015 IPOs
The IPO market has been closed since the last MLP IPO priced in June 2015, but I would expect the market to open up at some point in 2016. Similar to the slowdown in infrastructure buildout that can be expected in the current commodity price environment, I would expect to see a new normal for MLP IPOs running at a more modest mid-single digit clip rather than 10 per year.
Part of the reason for a new normal is that there aren’t many MLP-able assets left that aren’t already in an MLP. The backlog of high quality midstream MLP IPOs has dwindled. Almost all independent refinery operators have logistics MLPs now and utilities with pipeline assets like NiSource and Dominion have spun out their midstream businesses into MLPs.
2. Alerian MLP Index Returns vs. S&P 500

  • Line: Pick ‘em
  • My Pick: Over
  • Reader Pick: Over (74% of the vote)
  • 2015 Result: -3397 basis points
  • 2014 Result: -880 basis points
  • 2013 Result: – 482 basis points
  • 2012 Result: -1050 basis points

After outperforming for 12 straight years to start the millennium, MLPs have underperformed for 4 consecutive years since the end of 2011. 2012 saw challenges that resulted from weaker natural gas and NGL prices, 2013 was a strong year for both MLPs and the S&P 500, and then 2014/2015 MLPs and broader energy stocks underperformed on the oil price collapse. So, I got this pick wrong largely because I underestimated the length and depth of the commodity price decline.   By pushing out the oil balance point, the recovery in MLP unit prices was pushed out as well.
3. AMZ (cap-weighted) vs. AMZE (equal weight)

  • Line: Pick ‘em
  • My Pick: AMZE
  • Reader Pick: AMZE (64% of the vote)
  • 2015 Result: AMZ +459 basis points
  • 2014 Result: AMZ +1078 basis points
  • 2013 Result: AMZE +291 basis points

This line is a way to make a call on large MLP returns vs. small MLP returns, because the constituents are the same, but small caps have larger weights in the equal weight index. I picked the equal weight version based on the optimistic MLP case for 2015 returns that seemed possible as late as June of last year.
Large caps underperformed early in the year, and as the index constituents rotated to newer, high-growth MLPs, I expected the equal weight version to outperform. But in the 2H oil price decline and subsequent energy credit crunch that called the MLP business into question, there was a flight to higher quality, larger MLPs (although even among those performance varied widely). If KMI were in the MLP Index, the AMZE might very well have outperformed. In the chart below, we highlight 2015 performance of the top 10 largest MLPs and KMI.
2015 Return_10 Largest
Owning the 10 largest MLPs and KMI with market cap weightings would have led to a 38% decline in 2015, significantly worse than the MLP Index return of -32.6%. Without KMI included, the total return of the top 10 largest MLPs matched the Alerian MLP Index return at -32.6%. Making the right call on these 10-11 stocks every year can make a huge difference in portfolio returns relative to passive indices.
BPL, MMP, OKS and EPD were the clear winners. MMP and EPD have lower leverage than other large MLPs, and generally operate with higher distribution coverage. BPL benefitted from thematic tailwinds in refined products and storage. OKS is a quandary, but traded better after executing a large private placement transaction in August that removed equity needs for the remainder of the year.
 4. General Partner Holding Company IPOs

  • Line: 2
  • My Pick: Over
  • Reader Pick: Over (44% of vote, Push came in second with 37%)
  • 2015 Result: 2, 3 if you count CPGX
  • 2014 Result: 0

In a normalized MLP capital market environment, my expectation was that we would see more GP IPOs in 2015 than we saw. EQGP and TEGP got their IPOs done early in 2015, and if the market stabilized around mid-year, I expected to see other MLPs that had reached the 50% IDR tier to seek GP IPOs and showcase value created by their MLP stakes. I thought the GPs of PSXP, MPLX, DM, or TLLP might pursue GP IPOs.
I also thought some MLPs with private GPs would look to monetize their IDRs with a GP IPO (perhaps SMLP or NGL). Those plans have all been shelved for the time being, but as MLPs recover and the market starts to place premium multiples on GP cash flows again, expect this trend to re-emerge.
5. MLP Consolidations / G.P. Sales

  • Line: 7
  • My Pick: Over
  • Reader Pick: Over (68% of the vote)
  • 2015 Result: 11 (ETP/RGP, ETE/WMB, CEQP/CMLP, TRGP/NGLS, MPLX/MWE, Azure/FISH, Murray/FELP, VNR/LRE, VNR/EROC, Brookfield/NKA, WNR/NTI)

The line is based on announced transactions, so even though ETE/WMB hasn’t closed it counts for 2015 and even though EPD/OILT closed in 2015, it counts towards 2014. There were a number of smaller consolidations and GP sales this year, and I would expect a similar pace of such transactions in 2016, as the MLP sector continues to rationalize. There are still more than 100 MLPs, which seems like a high number in the current environment.
A number of MLPs will face challenges in finding new growth opportunities and in financing the ones they do find. Other MLPs may look to backfill development growth by acquiring other MLPs. KMI and PAA were both very vocal at this time last year regarding their desire and ability to be consolidators in a down market. Although KMI did make a large midstream acquisition of Hiland early in 2015, I think management of both KMI and PAA have been disappointed with their ability to source attractive strategic M&A over the last year.
6. MLP Distribution Cuts

  • Line: 6
  • My Pick: Over
  • Reader Pick: Over (88% of the vote)

This was the worst year for distribution cuts in the history of the MLP sector. The E&P MLP business model collapsed as every single E&P MLP reduced distributions. Several coal, marine transportation and services MLPs also cut. We have still not seen an outright distribution cut from a midstream MLP, but we saw more than one stealth distribution cut as higher yielding MLPs were taken out by lower yielding companies (MPLX/MWE, TRGP/NGLS, and CEQP/CMLP).
It is reasonable to assume that at least one midstream MLP will exhaust their options in 2016 and will cut their distribution rather than continue to pay extremely high yields, especially after KMI blazed the trail in early December with its sector-shaking dividend cut.
7. MLPs Bought by Corporations (exiting MLP structure like Kinder Morgan)

  • Line: None
  • My Pick: None
  • Reader Pick: 1 or More (60% of vote)
  • 2015 Result: 2 (TRGP/NGLS, WNR/NTI)

Last year it seemed like the KMI takeout of its MLPs was a one off event, and that the benefits of such a transaction were specific to KMI.  However, as the sector came under increasing pressure, the option of a GP taking out its MLP structure and reducing overall cash outflows from the MLP became increasingly attractive.  TRGP announced the buyout of its MLP, and others are reviewing that option now.
 8. Equity Issuance in Marketed Offerings

  • Line: $26.7bn
  • My Pick: Under
  • Reader Pick: Under (90% of the vote)
  • 2015 Result: $14.0bn

Readers had this one nailed and so did I, which means none of us should have been surprised at the capital markets challenges MLPs faced in 2015. How draconian the capital markets would prove was probably the nuance we were surprised by, as equity issuance was more than $12bn through the first half of the year. But the final two quarters saw less than $1bn issued in each.
9. MLP Sub-Sector Returns

  • My Pick: Gathering & Processing MLPs (-48%)
  • Actual Winner: Natural Gas Pipeline MLPs (-15%)

Commodity prices did not snap back in 2015 and neither did gathering & processing MLPs. So, for the second straight year natural gas pipeline & storage MLPs led all MLP sub-sectors. Although no natural gas pipeline MLPs were positive for the year, the worst performing one (TCP) was down 27.4%, well ahead of the AMZ’s pace.
The second best subsector was oil & refined products pipeline & storage, the subsector that produced the top 5 best performing individual MLPs. But there were some big losers in that subsector as well, including PAA (-52.8%), MPLX (-46.6%), EEP (-38.9%) among the large capitalization ones.
10. 2015 Average WTI Spot Oil Price

  • My Pick: $55-65/bbl
  • Your Pick: $45-55/bbl (48% of the vote)
  • 2015 Result: $48.66/bbl

Readers had this one right. At the time of the vote, oil prices had averaged around $47/bbl for the first few weeks of 2015. My expectations were for a quicker balance, which clearly didn’t happen.
Top 10 Winners & Losers of 2015
One final chart to wrap up 2015: the top and bottom 10 MLP performers in 2015. Not picture below are the following MLPs that have suspended distributions: LINE, NSLP, MCEP, BBEP, HCLP, and RNO. Avoiding those names and any others with material exposure to commodity prices and producer activity levels was the way to play 2015. Logistics MLPs with refinery sponsors were the big winners.
Top 10 Bottom 10_2015

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