Behind Cannibalization of MLPs Like Oneok Is a Need to Cut Costs

  • Simplification across midstream sector won’t kill off MLPs
  • There’s a race among pipeline owners to reduce capital costs

First came Kinder Morgan Inc., then Targa Resources Corp. and now Oneok Inc. -- pipeline giants keep buying up their master-limited partnerships, once darlings of the energy world.

Their moves raise a question: Are MLPs -- tax-advantaged, publicly traded partnerships that have proliferated in the past decade -- dying out?

"Definitely no," said Libby Toudouze, a partner and portfolio manager at Cushing Asset Management in Dallas.

What’s going on, Toudouze said, is pipeline operators are rushing to lower their costs of capital as competition heats up in America’s energy sector. The explosive growth of the shale boom is subsiding, ushering in a wave of consolidation among pipeline operators. Management teams are having to show increased caution with balance sheets after getting burned during the latest oil rout.

“Simplification is the continued theme -- it started last year, continued into this year, and will continue in the sector for a while,’’ said Rob Thummel, managing director at Tortoise Capital Advisors.

For some, that means shifting from the notoriously complicated MLP structure to more traditional and universally grasped business models.

“Corporations definitely have more access to institutional capital," said Jay Hatfield, a New York-based portfolio manager of the InfraCap MLP exchange-traded fund with $229 million in assets. "They’re in the indices, they’re more liquid, they can do equity offerings that are much larger with more liquidity.”

When Williams Cos. sold almost $2 billion in new equity last month, for example, it did so at the corporate level. It probably couldn’t have pulled that off at its Williams Partners LP unit, Hatfield said.

Growing Appetite

There’s a growing appetite for investing in America’s energy sector as oil and natural gas production rise and the prospects for exports increase, according to Thummel. Midstream companies, which transport and process those fuels, present one way of playing that trend with lower commodity risk. At the same time, institutional and overseas investors prefer to buy stakes in traditional corporations that have simpler tax processes, he said.

“There’s no doubt there’s been an increase in the number of institutional type of co-investors that you see running around the hallways of industry events compared to 10 years ago," Thummel said. “Corporations have a wider investment base than a traditional MLP.”

That said, there’s nothing flawed about the MLP model, which dates back to Apache Oil Company’s launch in 1981, according to the Master Limited Partnership Association. The entities pass their tax duties on to individual investors, lowering the overall rate. Over the decades, the sector’s become dominated by energy and natural-resource companies, especially pipeline operators.

Steady Payouts

For investors who are most interested in steady cash payouts, MLPs offer another advantage over corporations, according to Hatfield. Because they’re required to distribute most of their profits, they can’t slash their payouts as easily as corporations can.

“I don’t really want to invest in pipelines to get growth. I would rather invest in Facebook, or tech, for that,” Hatfield said. “I do it to get value and income. So there’s definitely investors like me and thousands of retail investors that want income; they’re not institutions.’’

To be sure, MLPs with high distribution levels have had to lower so-called “incentive distribution rights,” or special payments to the general partner for overseeing the business. On Wednesday, Oneok became the ninth MLP to eliminate or begin eliminating such payments in the past two years, Selman Akyol of Stifel Nicolaus & Co., wrote in a note Wednesday.

Despite moves away from the model, MLPs aren’t going away, Toudouze said. She pointed to Enterprise Products Partners LP, which climbed about 17 percent in the past year and has a market capitalization of $59 billion. Meanwhile, Noble Midstream Partners LP has nearly doubled in value since its initial public offering in September.

“There’s a jostling of positions happening right now to get your cost of capital down,” said Thummel, “so that you can compete as this sector continues to grow and potentially consolidates down the road.”

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