Darren Schuringa knew he and his partners were on to something. After Schuringa’s former firm, Estabrook Capital Management was sold to the Bank of New York, he teamed up with MLP investing pioneers, Jim Hug and Len Edelstein, to form Yorkville Capital Management, a firm solely dedicated to MLP research and investing.

“The MLP asset class was really being overlooked by many investors and was under-represented, definitely in institutional portfolios, but also in individual portfolios. We saw a real opportunity to found a business around this wonderful asset class. That was in July 2006,” Schuringa told Midstream Business.

When Edelstein stumbled across MLPs in the early 1990s, it was a tiny asset class, Schuringa said, consisting of about 10 names with a market cap of about $10 billion. Today, MLP entities have a market capitalization close to $600 billion.

Cash-flow visibility

Between the hard assets—like pipelines, storage tanks and terminals—and the long-term contracts they require, the three recognized tremendous visibility into the companies’ future cash flows. The tax efficiency of income from the MLP structure was simply an added benefit.

“The more research we did into MLPs, the more comfortable that we became with the asset class,” Schuringa said. “We were all trained as credit analysts in our previous lives, and as credit analysts, we aren’t interested in the upside, but only look for the downside. ‘What are the risks? I don’t make any more money on the blue sky potential as a debt investor. I’m only interested that the interest payments get paid in a timely fashion and that I get my principal back upon maturity of the bond.’”

Only from MLPs

In hindsight, Schuringa said, the characteristics produced by MLPs could only come from U.S. energy infrastructure investments.

“You couldn’t get these fundamentals from other asset classes. Because of the long-term contracts and the fact that the pipelines are ultimately quasi-monopolies, competition isn’t part of your concern as it is with most other investments,” he said.

Those long-term contracts give investors tremendous visibility into future cash flows. What’s more, the vision granted is clear: There’s not a lot of volatility to the fundamental cash flows. Rather, long-term contracts and high quality counter-parties embody stability.

The next aspect of MLP investing, Schuringa said, is the growth profile of the partnerships.

“Now, distribution growth is where MLPs really decouple from a fixed-income alternative in a very meaningful fashion. MLPs deliver high current income, which is great, but I can get that from high-yield bonds. I can’t argue that I can get that high stability from high-yield bonds. Although, high-yield bonds are riskier and don’t offer the same stability of income. I can get stability from other infrastructure investments that are monopolies, to a large degree. I can even get that in a lot of utilities. But I can’t get the third aspect at the same level that MLPs deliver, which is significant growth in distributions,” he explained.

“When I put all of these attributes together, this becomes an asset class that stands alone relative to any other asset class that we can see on a global basis,” he added.

Something unique

All of that combined to convince the Yorkville team that MLPs were something unique—a different asset class.

“Other people were still debating: Is it an industry within energy? Is it a sector? No. And not just because it’s a hard asset, the fact it had low correlations and fundamentally behaved independently of anything else. That’s why it’s an asset class,” he said.

The firm is primarily focused on the energy infrastructure space, Schuringa said.

“We’re looking for investments that have stability of distribution going forward and clearly identifiable catalysts for future distribution growth. If investments that we can find outside of our core infrastructure holdings meet these two criteria, then we’re interested if the price is right,” he explained. “We believe it is a way that we can leverage the fundamental research that we do—a disciplined process that we’ve developed over 20 years. It allows us to deliver alpha while delivering on both of our primary objectives to our investors: stability and growth of income across the portfolio.”

On the horizon

Success during the next 12 to 18 months will remain based on the fundamentals, Schuringa said.

“If I ever start to stray off the fundamentals story, then I’m losing my way, and we haven’t in 20 years of investing in the asset class, and we don’t plan on it now,” he said.

Capex and new projects propelling some partnerships to drive distribution growth is a favorable backdrop to what Schuringa called success in the new energy frontiers: places like the Bakken and Marcellus shales where new infrastructure is critical to the enterprise. Recent reports suggest that during the next decade, there could be close to $1 trillion in capex simply in U.S. energy infrastructure.

“That capex story will continue to be the driving force,” Schuringa said.

But still, there are other factors, he explained: increasing flows and increasing volumes. At the end of the day, the network of pipelines traversing mostly the U.S. and Canada is a transportation system for which volume matters.

Potential new demand

What’s more, there are a dozen or so applications before the U.S. Federal Energy Regulatory Commission to export LNG. Schuringa added that if all of those applications meet approval, there’s a 21% demand increase. It would be external, not domestic, demand, but it’s something that would drive production and distribution growth.

“LNG exports will roll out over the next several years in the initial first wave” beginning with Cheniere’s year-end 2015 exports, he said, adding, “We see tremendous opportunities here for investments in transporting LNG on a global basis.”

And there will be opportunities for midstream assets more internationally, too.

“Especially in Mexico, I think there are a lot of opportunities opening up that will present themselves here first because these are the frontier monetization of shale assets,” Schuringa said.

The long-term play on MLPs, shared with Schuringa by a London Ph.D., goes something like this: Western governments are broke. There is aging infrainfrastructure in Europe and throughout North America.

“Who’s going to fund it?” Schuringa offered: “It’s not going to be the government. It will be private investors. So I think over time, like [real estate investment trusts] expanded globally, I wouldn’t be surprised if MLPs expanded globally as a financing structure as a way to democratically privatize governmental assets.

“Instead of doing what Russia did with creating oligarchs and placing power in the hands of a few, you take them public and ultimately, every citizen can buy a piece of the energy company or the water company or the transmission company. And longterm, hard assets with long-term stability of cash flow can be put into an MLP structure. It becomes more of an infrastructure investing tool that could fit more broadly all infrastructure projects.”

The Yorkville model

Ask Schuringa for a few investments, and he can rattle off names like a proud papa to illustrate Yorkville’s principles.

“We’ve had a lot of key projects that have made a lot of money over the years,” he said. “Emerge Energy Services is a more recent one. We think it will double its distributions due to capacity expansion from this year to next year.”

From detailing the plan for Emerge, Schuringa describes the investment with Tallgrass Energy Partners LP, a midstream play that has a growth profile of 30% distribution growth for the next three years—an estimate Schuringa describes as conservative. Tallgrass has a strong sponsor that is dropping down assets, providing a great deal of transparency into the parent company’s assets, many of which would fit into an MLP structure, he said.

Finally, there’s The Williams Cos. investment, an entity structured as a corporation but that owns exclusively MLP assets.

“It’s becoming a pure GP [general partner], so we like the turnaround story, the way it’s moving into more of a GP pure play. And we see distribution growth coming out of [Williams] of over 40%,” he said.

Still, there’s room for stock-picking, Schuringa warned.

“There are haves and have-nots within the space. There are good asset footprints and there are poor asset footprints, and strong sponsors and weak sponsors. Good management teams and weak management teams,” he said. “When they all come together it is reflected in partnerships that are capable of producing the eye-popping distribution growth rates that I’m describing.”

Deon Daugherty can be reached at ddaugherty@hartenergy.com or 713-260-1065.

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