During the past 10 years, investment trends and demands have evolved dramatically. From 2005-2006, the distribution of many master limited partnerships (MLPs) reached the highest incentive distribution right (IDR) split level. As a result, investors were interested in becoming MLP general partner (GP) owners since GPs typically receive a higher percentage of incremental cash distributions as distributions to the limited partnerships increase. To quench investor demand, several MLP GPs went public during this time period.
From 2006-2007, as crude oil and natural gas commodity prices soared, the sector experienced a resurgence of exploration and production MLPs. Additionally, during the 2006-2007 time period, as the crude-to-gas parity ratio expanded, the gathering and processing MLP subsector was born to take advantage of high-processing margins.
Fast forward to today. As mentioned in last month’s issue, a handful of private-letter rulings issued by the Internal Revenue Service during the past few years have broadened the scope of MLP qualifying income, thereby resulting in the formation of more non-traditional (non-infrastructure) MLPs. During the past six months, there have been 11 MLP initial public offerings (IPOs), of which only three have been considered infrastructure. Aside from Western Gas Equity and New Source Energy, the remaining six MLPs fell under Alerian’s category description of “Other.”
If other companies follow suit with similar IPOs, many of these “other” MLPs may potentially become their own MLP subsector one day. Just seven years ago, coal and gathering and processing MLPs were categorized as “other” by MLP analysts. Now, they are widely accepted and closely followed subsectors in their own right.
In the future, if the U.S. allows the export of natural gas to non-free trade agreement countries, gas production could increase and more compression MLPs, like USA Compression Partners, could go public. Or, if production of Canadian or Bakken crude continues to grow, more refineries that can process lower-grade crudes could monetize their assets in an MLP structure, similar to CVR Refining LP.
While non-traditional MLPs may take the spotlight in the near term, infrastructure MLPs will continue to be the higher-demand investment vehicle. In March, Phillips 66 filed for the registration of Phillips 66 Partners, which will consist of traditional midstream pipeline and storage assets serving its refineries.
Tallgrass Energy Partners, which owns 4,645 miles of pipeline, 15 billion cubic feet (Bcf) of storage and various processing plants, filed as well. CenterPoint Energy, OGE Energy Corp and ArcLight Capital Partners announced plans to form an MLP together— one that will rival some of the largest market-cap MLPs. That MLP would own more than 8,400 miles of interstate pipelines, 2,300 miles of intrastate pipelines, 11,000 miles of gathering pipeline, 90 Bcf of storage and 11 processing plants. Western Refining also announced plans in March to explore the formation of an MLP for its midstream and logistics assets.
While the number of non-traditional MLPs as a percent of total MLPs may increase, when considering them as a percent of total market cap, infrastructure MLPs will continue to represent the vast majority of the investment set. Some non-traditional MLPs may have more cyclical businesses, pay variable distributions, or own one or two assets.
Traditional gold-standard infrastructure MLPs operate business models benefitting from inelastic energy demand, generate consistent and growing distributions and have diversified asset and customer bases. So, will traditional MLPs ever move out of the picture? We think not.
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