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By Peter Staas on Mar. 9, 2018

This year started on a promising note for master limited partnerships (MLP), with the Alerian MLP Index rallying hard from mid-December 2016 to the end of January. But this momentum has reversed over the past month, sending this basket of 40 prominent publicly traded partnerships close to the low hit at the end of November 2017.

Last week’s installment of Energy Investing Weekly explored the confluence of factors that have contributed to weakness in midstream MLPs, from a rash of distribution cuts and governance-related concerns to the lack of depth in the market for these securities.

At the height of the shale oil and gas revolution, MLPs issued equity regularly to enthusiastic investors who coveted the group’s tax advantages, leverage to growing US hydrocarbon output and above-average yields in a low-rate environment.

The proceeds from these transactions usually went toward growth projects or asset drop-downs, as MLPs and their sponsors took advantage of investors’ willingness to pay premium valuations for tax-deferred cash flow streams. This sanguine environment enabled many MLPs to disburse the bulk of their cash flow to unitholders via quarterly distributions.

Fast-forward to 2018. The Alerian MLP Index yields 8.2 percent, compared to the Bloomberg US REIT Index’s 4.7 percent yield and the Dow Jones US Total Market Utilities Index’s 3.6 percent yield. Among the energy-related partnerships covered in our MLP Ratings, 47 offer indicated yields that exceed 8.2 percent.

This higher cost of equity capital represents a major headwind for names seeking to fund near-term growth projects and earn an economic return on investment. Equally important, the market has punished MLPs that have issued equity, particularly in instances where the stock is already widely held.

For example, Shell Midstream Partners LP (NYSE: SHLX), which generates the bulk of its cash flow growth via asset drop-downs from Royal Dutch Shell (LSE: RDSA, NYSE: RDS A), gave up almost 10 percent of its value after the MLP announced a $680 million equity offering on Feb. 1.

MLPs have responded to these challenges by curtailing their equity issuance. Although the total number and value of MLP initial and secondary offerings have trended lower in recent years, they have fallen off a cliff in 2018: Year to date, only a few intrepid partnerships have issued equity on the public market.

(Click graph to enlarge.)
P Quarterly Equity Issuance

This reticence to issue common stock—outside of at-the-market deals—suggests that, at least thus far, MLPs have lived up to their commitments to reduce their equity issuance.

However, with US onshore oil and gas production continuing to grow and upstream operators ramping up activity levels in the Permian Basin and capacity-constrained areas, midstream MLPs have ample growth opportunities on their plates. And the backlog of potential drop-down transactions remains robust for the MLPs that rely on this strategy to drive cash flow growth.

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    • Roger S. Conrad

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

    • Elliott H. Gue

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    • Peter Staas

      Managing Editor: Capitalist Times and Energy & Income Advisor