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  • Roger S. Conrad

Changes to the MLP Portfolio

By Roger S. Conrad on Aug. 18, 2015

Energy-focused master limited partnerships (MLP) held up reasonably well when oil prices began to collapse in mid- to late 2014. In fact, the Alerian MLP Index hit its all-time high toward the end of August 2014 and gave up only 9 percent of its value in the back half of the year.

However, the new year hasn’t been kind to MLPs, with the benchmark Alerian MLP Index down 17.5 percent on the year. The selling pressure has intensified after the short-lived recovery rally in energy stocks and the price of West Texas Intermediate crude oil proved to be nothing more than an oversold bounced.

We repeatedly warned investors not to confuse this period of seasonal strength–when refineries traditionally run all out to meet elevated gasoline demand during the summer driving season–with a V-shaped recovery in oil prices.

Our outlook called for oil prices to suffer a second leg down, with the pressure intensifying in fall and winter, when refineries usually shut down some of their capacity for maintenance and upgrades.

Valero Energy Corp (NYSE: VLO) and other refiners have warned that this year’s turnaround season could involve more outages than usual because the industry ran flat out in the spring and summer to take advantage of robust demand for gasoline and favorable crack spreads.

And even after record refinery runs and gasoline demand this summer, resilient production and overseas imports have ensured that US crude-oil inventories remain about 26 percent above their five-year average for this time of year.

(Click graph to enlarge.)US Oil Inventories

This overhang, coupled with the prospect of reduced demand, suggests that oil prices could suffer significant downside this fall. Albeit painful, such a correction could accelerate the process of squeezing production from marginal acreage and ratchet up the pressure on upstream operators with stretched balance sheets.

Raising debt and equity capital has also become more expensive for high-yield energy producers, while lower oil and gas prices could prompt banks to reduce upstream operators’ borrowing bases this fall and next year.

What about the pullback in midstream MLPs, names that regularly tout the resilience of their fee-based cash flow and many of which survived the late 2008 and early 2009 collapse in energy prices with nary a scratch?

Some of the downside in the Alerian MLP Index reflects investors’ negative sentiment toward the energy sector, fears of further near-term downside in crude prices and the uncertainties associated with an environment where oil prices remain lower for longer.

Aggressive distribution cuts by Linn Energy LLC (NSDQ: LINE), which eliminated its payout completely, and other upstream MLPs haven’t helped matters.

But bigger forces are also at play. The long-awaited rollover in US oil output appears to have started, with the Energy Information Administration’s (EIA) most recent Drilling Productivity Report showing month-over-month production declines in the Bakken Shale, Eagle Ford Shale and Niobrara Shale that started in April or May 2015.

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    • Elliott H. Gue

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor

    • Roger S. Conrad

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor