The Alerian Problem

What do you do if your fund’s index is shrinking? This is the dilemma that many retail investors in MLP-dedicated mutual funds and ETFs will be confronting in the months ahead.

The trend for MLPs to simplify by combining with their corporate General Partner (GP) is well established. The recent Federal Energy Regulatory Commission (FERC) ruling (see FERC Ruling Pushes Pipelines Out of MLPs) prompted us and other observers to conclude that this trend is likely to continue, if not accelerate (see Are MLPs Going Away?). Last week Tallgrass Energy Partners (TEP) combined with its GP Tallgrass Energy GP (TEGP), the first such announcement since the FERC ruling on taxes and one of the few simplifications to result in a bounce in the stock price. TEP will drop out of the Alerian Index, reducing the number of constituents to 41. At the end of 2015 it stood at 50.

On Monday, oil driller Legacy Reserves LP (LGCY) announced they were converting from an MLP to a corporation, causing their stock to jump 11%. CEO Paul Horne clearly will not miss running an MLP. In the press release, he noted that, “…we look forward to stepping out from the dark cloud we have been under as an upstream MLP.” On Friday, Viper Energy Partners LP (VNOM) jumped 10% after electing to be taxed as a corporation. Simply by agreeing to be a taxpayer, thereby issuing 1099s instead of K-1s, they became more valuable. Their presentation noted, “VNOM will be uniquely positioned as a first-mover and leading public minerals yield vehicle without the limitations of an MLP.” These moves reflect the disdain investors have developed for the MLP structure, and the bigger ones contemplating their own conversion will have taken note.

The reduced corporate tax rate makes MLPs relatively less attractive. FERC’s elimination of imputed tax expense, although inconsequential in the near term, will affect cashflows for some interstate natural gas pipelines and, in a couple of years some liquids pipelines too. Moreover, MLP yields remain stubbornly high. They are attractively valued, but as such they represent an expensive source of equity capital for issuers. The older, wealthy American who is the typical MLP investor wants steady income. The shifting of cashflows to fund new infrastructure projects demanded by the Shale Revolution has alienated him (see Will MLP Distributions Pay Off?). All these factors are reducing the value of putting eligible assets in an MLP.

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Disclosure: We are short AMLP

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