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January 16, 2012

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MLP Week Thoughts: January Defect

MLPs had a rough week, down 1.8% in a week that saw the S&P 500 rise 0.9%.  After almost a month without an MLP equity offering, there were 3 equity deals this week for a total of more than $900 million, including a $611 million offering from LINE (only the 3rd $600mm+ follow on deal ever).  The brief respite from equity offerings was very nice, almost like I imagine walking on the moon might be without as much gravity to weigh you down.
A little bit of gravity certainly re-entered the MLP market, and (not coincidentally) a heavy dose of reality re-entered the natural gas markets.  Natural gas futures were down 14% this week, oil futures were down 2.6%, both helping to drag MLPs down for the week, and down for the year so far.  So much for the January effect (MLPs have averaged more than 3.5% returns in past January’s), at least so far.

Natural gas traders seem to have finally given up hope of any drilling slowdown to reduce supply or colder weather to provide a jolt for demand.  Natural gas futures are down more than 40% from this time last year, when the unusually cold and snowy weather was doing its best to reduce natural gas in storage, and some people were still expecting drillers to slow down given low prices.   Natural gas prices have been very similar to interest rates on Treasuries, in that people are always saying that both can’t get much lower, and yet they always do.  The takeaway here is that taking a directional bet on something just because its low relative to history is not advised.

So far in 2011, the MLP Index started with 3 positive days in a row, followed by 5 straight down days, then a slight tick up this Friday. See below for a year-to-date chart of the MLP Index compared with the S&P 500.  As you can see, the MLP Index is now down for the year, but no one is feeling sorry for MLP investors, as the index remains 13.8% above its close at the end of the third quarter, and 22.6% above its 12 month low (August 8th).

Expect a few trends to continue through distribution announcement season, which started this week.  Expect  to see propane MLPs, natural gas storage MLPs, and large cap MLPs to continue to lag.  Expect small caps, general partners and the large caps with sector-leading growth to continue to perform well.  Natural gas is going to continue to weigh on the sector as its dramatic moves lately (and over the last few years) start to get more press.
What are the catalysts that can get natural gas to stop falling before LNG export solutions start to come online in 4 years?  Maybe natural gas as a transportation fuel will start to gain some momentum as a result of more press.  Maybe ethane and NGLs demand will start to decline in the face of growing NGL supply, leading to lower NGL prices and a slowdown in drilling (demand hasn’t slowed yet, more crackers are being built to keep pace with growing ethane supply).  Maybe the weather will bail out natural gas like last year, but clearly that hasn’t happened so far this year.  In the absence of one of those catalysts, its hard to see how natural gas prices recover much in 2012.
There were 4 distribution announcements this week, 2 increases ($GEL and $PAA) and 2 maintains ($CPNO and $PNG).  Expectations are high for distributions in 2012 for the sector as a whole, with many MLP growth projects that were paid for with equity offerings in 2011 are set to come online and start contributing to MLP cash flow.
Disclosure: The information in this article is not meant to be financial advice, we are not your financial advisor and I am posting my comments for informational purposes only. 

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