Energy prices have been witnessing downside for a while now. Prices have declined around 30% from multi-year highs of above $76 a barrel in early October. Oil is facing a two-pronged attack — rising supply from major producers and apprehension of economic slowdown that will dampen demand. Also, the OPEC-led supply cuts are unlikely to offset the market surplus.

While the direction of crude's movement is anybody's guess, it will be prudent for investors to maintain caution in these uncertain times and withdraw for a while. Meanwhile, Master Limited Partnerships (MLPs) are a safer bet amid the commodity price volatility and offer considerable returns with low risk.

As the name implies, MLP is a form of partnership that regularly pays attractive distribution yields. An MLP includes a variant of stock market investment, where investors buy units (not shares) of the partnership (not company) that trade on exchanges. The benchmark Alerian MLP Index, tracking 40 partnerships, is an appropriate tool to follow the movement in MLPs.  

The surge in oil and natural gas production in the past few years has made pipelines, storage and associated energy infrastructure MLPs  attractive bets in the energy midstream space. This is because these network providers generate a major portion of their revenues from fee-based contracts based on volume and are not affected by commodity price fluctuations.

What are MLPs?

MLPs differ from regular stocks as interests in them are referred as units and the unitholders (not shareholders) are partners in the business. Importantly, these hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly traded securities.

Finally, the assets that these partnerships own — oil and natural gas pipelines and storage facilities — typically provide stable fee-based revenues and have limited, if any, direct commodity-price exposure. This enables these MLPs to pay out higher distributions.

There are two types of ownership involved with MLPs — the general partner and the limited partners. The general partner is responsible for making all decisions related to the company’s operations and is reimbursed per performance. The limited partner provides capital and receives a share in the profits from cash flows.

Importantly, these hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly-traded securities.

The FERC Tax Ruling of 2018

On March 15, 2018, the Federal Energy Regulatory Commission (FERC) ruled that the interstate oil and natural gas pipelines owned by MLPs can no longer avail credit for income taxes that are not paid. Revising the 2005 Policy Statement for Recovery of Income Tax Costs, the federal regulators found that the longstanding income tax allowance in their cost-of-service fees will lead to double recovery of costs for the asset class that are not subject to corporate income taxes.

On July 18, 2018, the FERC issued a final rule on the Income Tax Allowance Policy for these MLPs. This included amendments from the original ruling on March 15, to which the market reacted positively. Particularly, FERC incorporated two major concessions to MLP pipeline owners. First, the entities were permitted to include a tax allowance in their cost of service pricing under certain circumstances for a three-year period. Also, FERC removed accumulated deferred income tax balances for MLPs and the same won’t be reimbursed to customers.

Impact on MLPs

Consequently, partnerships charging cost-based rates for interstate transportation service will be compelled to lower customer tariffs to move oil, gas and refined products around the country by the amount of their income tax allowances. A reduction in cost recovery is likely to affect cash flows.

While the FERC ruling is a headwind for MLPs, it must be noted that the move will not affect all partnerships and assets. In particular, the changes are not likely to have any impact on pipeline companies that are structured as ‘C-Corporations’ like Kinder Morgan, Inc KMI and ONEOK, Inc OKE . The federal revision will not be applicable to MLPs owning midstream assets that begin and terminate within the same state.

Meanwhile, MLPs with significant ‘cost-of-service’ exposure and large amounts of interstate pipelines, including Energy Transfer Partners and Spectra Energy Partners SEP, are in troubled waters. The change in income tax policies will result in rate reduction and lower cash flow for pipelines owned by these MLPs.

Higher Returns & Low Risk

Most MLPs are involved in processing and transportation of energy commodities such as natural gas, crude oil and refined products under long-term contracts.These partnerships have relatively consistent and predictable cash flows, unlike exploration and production (E&P) companies, whose profits are highly correlated with commodity prices.

MLPs are an attractive investment option for income-focused investors in the current environment. Along with high yields ranging from 4-6%, MLPs have low correlations with many other asset classes including equities as well as commodities and provide diversity to the portfolios.

What Next

Though a number of MLPs came out with press releases claiming negligible or no material impact from the FERC ruling, the tax policy change has led to wide-ranging concerns and uncertainty. With the new rule expected to be adopted by 2020, the issue is likely to be a concern in the future.

Investors are always seeking stocks that offer upside as they have double benefits. Their growth can attract investors and generate significant gains. Considering these parameters, we have selected three MLP’s that are likely to deliver exceptional growth in 2019.

Our Choices

Allentown, PA-based CrossAmerica Partners L.P. CAPL is involved in the distribution of motor fuels, consisting of gasoline and diesel fuel, through about 1,200 locations. The partnership also owns and leases about 900 sites used in the retail distribution of motor fuels. The partnership has a distribution yield of 14.1%. Since 2016, we have seen an upside in distribution yield. The distribution coverage for the third quarter was 1.10 times compared with 1.02 times in the year-ago quarter. The Zacks Rank #1 (Strong Buy) MLP has an expected earnings growth of 3,150% for 2019.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Houston, TX-based Enterprise Products Partners LP EPD is among the leading midstream energy players in North America. The partnership has a distribution yield of 6.6%. The distribution coverage for the third quarter 2018 was 1.7 times compared with 1.2 times in the year-ago quarter. The partnership, sporting a Zacks Rank #1, has an expected earnings growth of 6.8% for 2019.

Houston, TX-based Sunoco L.P. SUN is engaged in the distribution of motor fuels to convenience stores, independent dealers, commercial customers and distributors. The partnership has a distribution yield of 11.95%.The distribution coverage for the third quarter was 1.73 times compared with 1.28 times in the year-ago quarter. The partnership, which carries a Zacks Rank #2 (Buy), has an expected earnings growth of 57.3% for 2019