MLPs: This Time Is Different

It’s hard to find research that is bearish on MLPs, which is not especially comforting from a contrarian standpoint. The most negative case is probably the view that crude is going to $30 and will take MLPs lower with it. Before ascribing some additional insight to sellers, remember that over $40BN of retail money accesses the asset class inefficiently via taxable, C-corp funds such as AMLP (see Some MLP Investors Get Taxed Twice). Our investors, self-selected as they are, are an intelligent bunch. But they (you) are not representative of an investor base that includes those who accept a 35% corporate tax drag on their returns. Investment insight is going to be rare among this subset, and based on published fund flows they are responsible for some portion of the recent selling.

For those who enjoy analyzing statistical qualities of returns, the chart below compares the correlation of MLPs with crude oil and subsequent performance. It turns out that following periods of high MLP/crude correlation, MLPs do rather well. The 30 day correlation is 0.61, so the 90 day correlation used in the chart below is most assuredly heading higher over the next few weeks. A high 90 day correlation is typically followed by a good 90 day return. The correlation of this relationship is 0.63. It’s been said that if you torture the data enough it’ll tell you whatever you like, and some may believe that’s what’s going on here.

On the other hand, MLPs and crude oil shouldn’t move together nearly as much as they do, so when they dance too closely perhaps nervous sellers create an opportunity. In researching the components of the Alerian MLP Index, we calculate that only 25% of the cashflows are derived from crude oil. Some large MLPs have very little crude exposure, including Enterprise Products (EPD) at 17% and Williams Partners (WPZ) with 5%. Others such as Oneok Partners (OKS) and EQT Midstream (EQM) have 0%. And this is the percentage of their cashflows derived from volumes of crude passing through their systems, which are only loosely affected by the price of crude. Natural Gas Liquids (mostly Ethane, Propane, Butane, Iso-butane and Pentane) are most commonly separated from the natural gas (Methane) with which they’re extracted. NGL prices tend to move with crude oil, but together these still represent less than half the cashflows of the Alerian index. As with crude, volumes are the principal driver of NGL-related cashflows, with their prices being of secondary importance. Nonetheless, MLP prices move with crude oil, reinforcing the understandable fixation MLP investors have with oil even though it’s hard to justify based on underlying fundamentals. In our fund we have an overweight to crude oil-oriented infrastructure businesses, but we estimate this at around 32%, so 7% higher than the index.

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Disclosure: None.

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