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June 8, 2014

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MLP Week Thoughts: Trade the Model

MLPs and the markets were on cruise control this week, with the MLP Index up 4 of 5 days and closing at an all-time high for the second consecutive week.  Stocks and utilities were up this week as well, helped by moves from the European Central Bank and by U.S. data points like the May unemployment report.  The CBOE volatility index (VIX) closed at 10.7, its lowest level since early 2007.  The 10-year treasury yield was up 12 basis points to close at 2.60%.
Weekly MLP Review_6-6-14
In commodities, front month natural gas futures rose 4.1%, while spot propane prices at Mt. Belvieu declined 3.3% and remain the only major energy commodity that is down for the year.  Lower propane prices generally lead to higher propane exports in the spot market along the Gulf Coast, but clearly not enough to self-correct this week.
Fund Flows
According to our Bloomberg-fed database, fund flows into MLP funds (including open end funds, ETFs, and ETNs) in May totaled $2.1bn, the most in a month since November of last year, and up from $1.9bn in April. The biggest flows were into the Alerian MLP ETF, but close behind were two large actively-managed mutual funds.
Let’s say that you knew fresh investible cash would flow into the MLP sector at near record rates for several months to start the year.  Let’s also say you had a choice of investing in (1) smaller, more recently-IPOed MLPs that are either not in the MLP index or carry a small weight; or (2) large-cap MLPs with sector leading trading volumes and index weights.  The conditions seem tailor made for MLPs in the latter group to see greater than average fund flows, leading to outperformance.
It turns out that across every time period since the beginning of the year (except this week), the largest, most-liquid, most-heavily weighted, most diversified MLPs have underperformed (on average) the MLP Index. Below is a chart of the top ten highest-weighted MLPs in the Alerian MLP Index that shows just that (with a few exceptions: MMP all year, RGP and KMP recently).
Big Cap Performance
What does it mean? The ETFs receiving flows pump it into these top 10 names above other MLPs, generally.  However, the actively-managed funds that are getting fresh capital would rather invest that capital in names outside of the top ten, or names not included in the index (GPs, IPOs, newer MLPs).  Capital flows are supportive of the sector overall, but as other MLPs outside the top ten achieve liquidity levels that make them investable for large funds, those MLPs appear to be preferred by institutions.
Actively-managed fund flows of this magnitude are still a new phenomenon in the MLP space.  Large mutual funds generally have a model portfolio with a list of positions and target weights within the portfolio.  When such a fund gets a consistent stream of inflows, the manager can choose to direct those funds strategically and change the model portfolio as he goes, or he can choose to “trade the model”, which (in our firm at least) means to take that new capital and spread it around to the existing portfolio positions based on the model portfolio weights.
In the absence of much MLP-specific news, follow-on equity offerings or IPOs, and with a very low volatility stock market generally, there is no compelling reason for a fund manager to change the model, unless the manager has a view on valuations.  Also, the rise of at-the-market equity programs allow institutional investors to pick up large blocks of primary MLP units without disrupting the market too much.
I think that’s what’s been happening the last few months, but seemed more apparent this week with limited news flow.  Things may change if marketed equity issuance picks up and disrupts the long-leaning, low volatility equilibrium.  For this week at least, what has worked all year continued to work.
Winners & Losers
The top performing MLP so far this year (PSXP) was up the most this week at 11.3%.  Other high growth drop down MLPs were favored as well (RRMS, EQM and GLOP).  On the downside, CQP had an institutional seller execute a large block trade that pressured its unit price this week.  ENBL announced an acquisition funded with additional units issued to its sponsor, which may have led to its decline.
No repeats on either the positive or negative sides this week.
PSXP separated itself from the pack even further this week.  The order and composition of the bottom 5 remained intact week over week. TLLP and SRLP popped into the top 5 this week, displacing OILT and SUSP.
News of the (MLP) World
Another quiet news week in MLP land.  Some M&A and growth projects, no public equity or debt offerings.  We did have analysts days from PAA and MWE this week that sounded well attended on the webcasts. PAA management tone was interesting, as management balanced discussing its large growth project backlog ($7.5bn focused on the big 6 north American basins and Canada), while also outlining how drastically North American production could be impacted just a modest decrease in well completion activity (due to increasing underlying decline rates).
In MWE’s analyst day, management maintained distribution growth guidance in 2015 and 2016, and highlighted a long term distribution growth rate expectation of 10%+ once the multi-year buildout in the Marcellus and Utica shales.  Management also highlighted the need for NGL takeaway out of the northeast, and how critical the Mariner East project will be to balancing the market.  Growing condensate production was a topic for both PAA (out of Eagle Ford and Permian) and MWE (Utica).

  • Regency Energy (RGP) announces private sale of 14.4mm units for $400mm (~$27.78/unit) to a subsidiary of its GP, Energy Transfer Equity (press release)
  • Institutional shareholder sells down Cheniere Energy (LNG) and Cheniere Energy Partners (CQP) positions in block trades
    • CQP holder sells 9mm units at $33.50/unit, for proceeds to seller of approximately $300mm
    • LNG holder sells 1.2mm shares at $66.15, for proceeds to seller of approximately $80mm
  • No MLP IPO news, but there was some IPO action  just beyond MLP borders

M&A / Growth

  • Rose Rock Midstream (RRMS) announces acquisition of crude oil trucking assets from Chesapeake Energy Corp. for an undisclosed purchase price (press release)
    • Acquisition includes 124 trucks, 122 trailers operating in Texas, Oklahoma and Ohio
  • MarkWest Energy (MWE) and the Energy Minerals Group announce plans to add additional capacity at fractionation and marketing complex in Harrison County, Ohio (press release)
    • Expansion will double the propane and heavier fractionation capacity at the complex to 120,000 bbls/d when it comes online in 1Q 2015
  • Enable Midstream (ENBL) announces acquisition of additional interest in Southeast Supply Header (SESH) from Centerpoint Energy (press release)
    • ENBL to acquire an additional 25% of SESH, bringing total interest owned by ENBL to 49.9%
    • Funded with 6.3mm units issued to sponsor, for approximate value of $157.5mm
    • Acquisition adds $8-9mm in distributable cash flow
    • SESH is a 286-mile interstate pipeline that originates at the Perryville, LA hub and terminates in southeastern Alabama near the Gulf Coast
  • Summit Midstream (GP of Summit Midstream Partners) announces it has exercised its option to acquire a 40% equity interest in Ohio Gathering Company, LLC and Ohio Condensate Company, LLC from MarkWest and EMG (press release)
    • Summit reimbursed EMG and MWE $377mm, which represents 40% of all capital the JV has spent to date
    • The JV is expected to develop over $3.0bn of gas gathering and condensate stabilization infrastructure for its customers in the area


  • Natural Resource (NRP) announces President & COO Nick Carter will retire on 9/1/14 (press release)
    • Nick’s personality and his deft commentary on the coal markets will be missed on conference calls and at MLP conferences
    • I spent a few days in August 2005 with Nick and the executive team at NRP (all of which are still there) during the marketing of a unique MLP equity offering, when Lehman Brothers helped First Reserve execute the public sale of its subordinated unit position in NRP
    • The subordinated units traded under their own ticker (NSP) and traded at a discount to the common units  that remained meaningfully wide up until the day the subordinated units converted into common units
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