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July 7, 2013

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Week Thoughts: Fuse Lit, Everybody Runs

MLPs were down 1.1% this week, while the S&P 500 was up 1.6%.   There were no capital markets deals in the MLP space this week, given the awkward mid-week holiday and short trading day on Wednesday.  But there were some big moves in key variables that impact MLPs (we’ll get to LINE below…).  Domestic oil prices were up big (WTI +6.9%), widely attributed to the change of control in Egypt.  10 YR US treasury rate was up 24 basis points to close at its highest point (2.72%) since August 2011, widely attributed to strong payroll number Friday and prior month upward revisions.  The more than 20 basis points move on Friday didn’t cause a massive selloff in MLPs, but it should be a headwind in the coming months, as the market continues to price in a reduction in Fed support.
Weekly Review_7-5-13
Below is a scary chart for MLP investors.  I’ve written in the past about how MLPs can and have done well in periods of rising interest rates.  My justification for that has always been that the operations of MLPs do better when the economy is doing better, and rising rates are usually a symptom of that circumstance.  As rates continue to climb out of the financial crisis bomb shelter they’ve been in, it will be interesting to see how the new MLP market (with more institutional products and capital than ever before) performs.

10 Yr Treasury Yield

The Alerian MLP Index’s spread to US 10 YR rate is lower than its been in years, but nowhere close to all time low (which is 26 basis points almost 6 years ago exactly – 7/13/07).  Regardless of the history, the trend below isn’t great to see.

Alerian Spread to Treasury

Winners & Losers
Now we’ll get into what everyone was watching this week…  LINE was the biggest loser this short week, down an incredible 29.3% since last Friday, reaching prices LINE hadn’t seen in more than 3 years.  LINE is now down more than 40% from its late January high of $39.33, just before Bronte Capital started writing negative articles on LINE.  The big drop happened early in May when Hedgeye got involved, and it drifted lower before seeming to reach a bottom on June 17th at $30.52.  LINE rallied to as high as $34.50 in late June.
Then on Monday afternoon, LINE’s press release regarding the SEC informal inquiry hit the wires.   LINE was down 18.7% Tuesday and 15.7% on a short Wednesday.  On Friday, LINE was down another 10.7% in early trading that saw LINE’s price reach as low as $20.35, before bouncing 15.2% from there to close +2.9% for the day.  All eyes will be on LINE next week as well to see if Friday’s low was the capitulation and things will calm down, if LINE will sink lower still, or if we see more short squeezes sending LINE higher.
Plenty of opinions have already been given about LINE on the Internet.  I don’t cover it as a research analyst, and I don’t own it for clients or in our fund.  Besides showing what happened, I don’t have much else to say.  So, don’t ask me if you should sell it (unless we have a relationship that goes beyond you reading my blog), don’t ask me how long the SEC inquiry will take, or if the BRY merger with LNCO will go through, or if I think LINE will cut its distribution if it doesn’t go through.  Don’t ask me to respond to some random contributor at Seeking Alpha saying that LINE is a case-in-point for why some MLPs are ponzi schemes…
Ok, maybe I can respond to that one: I do not think MLPs are like ponzi schemes, but there are certain MLPs that have riskier assets than others.  I believe there are many MLPs that would be sustainable businesses without acquiring further assets.  I can see how the idea might pop into someone’s head that upstream MLPs have characteristics of ponzi schemes, because upstream MLPs pay out all their cash and they own declining assets.  But any MLP that raises money in the equity market to pay distribution would have a very hard time raising equity, and a very hard time getting a credit facility from a bank.  For upstream MLPs, the sustainability of current cash flow depends on whether or not maintenance capex of 25%-%30% of EBITDA can indefinitely maintain cash flow, and that depends on the production profile of the properties of the individual MLP (and their balance sheets to some extent).  Another wild card is commodity price, which can mask or expose other issues, depending on whether the trend is up or down.
More broadly, it is a challenge to grow a company that is paying out all (or most) of its available cash flow, but many midstream MLPs have proven over more than a decade that it can be done (EPD, KMP, PAA being the most prominent I can think of).   What I worry about with some MLPs is the weight that investors are putting on distribution growth in valuation.  If an MLP has its valuation based on certain (high) growth assumptions, then not being able to acquire more assets would cause a major drop in that MLP’s valuation.  Take a standard drop-down MLP for example.  It goes public with a high valuation on the expectation that it will acquire assets from its parent.  If the drop downs don’t happen, its valuation will get adjusted much lower, and that scares me more than the MLP being able to maintain distributions (for most MLPs I buy, I have a high degree of certainty about their ability to maintain at least current distributions).
My concern with the LINE action was that panic selling spread to other upstream MLPs, causing serious carnage for BBEP, QRE and ARP (in the chart below).  VNR, EVEP, and LRE were also down more than 5%.  On average, upstream MLPs were down 7.4% this week, on a week that saw oil prices rise sharply.  LINE sold off and others followed, like so many daisy chains of firecrackers that were sold this week across the country.  Unlike firecrackers, however, I don’t think upstream MLPs are doomed to blow up.  The reality of the MLP sector is that some MLPs do blow up from time to time (see the 3 distribution cuts last year), but we’ve seen no distribution cuts among upstream MLPs since early 2009, and that was under much different macro conditions (and certainly none of those were the result of SEC inquiries).


The selling abated for a bit on Friday, but it was still a very ugly week.  The disturbing price action has raised questions about the upstream MLP space, which is understandable when the largest upstream MLP by far is down 29% in a week, but is not justified for MLPs like VNR, MEMP, and ARP.  The upstream MLP business model can work, and there are still plenty of mature assets for the group to buy at prices higher than corporate E&P or private equity buyers can pay.
On the winning side of the ledger this week, there wasn’t as clear a trend with the top 5 consisting of a compression MLP, a shipping MLP, an upstream MLP, and two more traditional midstream MLPs.  There was a trend in the variable distribution MLPs, with each of the refinery MLPs down sharply (NTI -7.3%, CVRR -11.8%, ALDW -17.4%).  CLMT was down 6.5%.  The refinery action seems was probably impacted by a reduced spread between Brent crude and WTI, down to less than $5 this week.


As bad as its been for LINE, EVEP has still had a worse year, by a fairly wide margin. Changes this week: BBEP replaced EROC in the bottom 5, PSE and BPL replaced EQM and AMID in the top five.


News of the (MLP) World


Very light week for press releases, but likely a very busy one for most investor relations departments.  I’d like to give a shout out to all of the wonderful, hard working investor relations professionals in the MLP space.  Its a tough job dealing with both retail and institutional investors, and I’m sure the wide range of questions you receive means there is rarely a dull day.

Equity / Debt

  • No deals

M&A / Growth Projects

  • QR Energy, LP (QRE) announces acquisition of oil properties in the Ark-La-Tex area from a private seller for $110mm
    • 6.0 MMBoe of proved reserves (70% PDP, 92% oil)
    • 900 Boe/d, 99% operated
    • R/P of 18.3 years with 7-8% decline rate per year
  • NGL Energy Partners (NGL) announces acquisition of assets of Crescent Terminals, LLC and partnership interests in Cierra Marine
    • Cierra Marine: adds 4 additional tow boats and 7 crude oil barges
    • Crescent: adds 130,000 bbls storage capacity in South Texas, and  ability to throughput up to 20,000 bbls/d to markets along Gulf Coast

Corporate Actions

  • Linn Energy (LINE) voluntarily discloses informal SEC inquiry into Berry Petroleum acquisition, LINE’s use of non-GAAP financial measures and its hedging strategy
  • Linn Energy (LINE) announces monthly distribution of $0.2416/unit, $2.90/unit annualized
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