The master limited partnership (MLP) sector has picked up the past few years as investors have been attracted by both the investment portfolios as well as the steady returns they offer.

“Fundamentally there is a big interest in the MLP and yield markets because of the long-term, low-interest rate environment,” Deborah Byers, Americas oil and gas tax leader at Ernst & Young, tells Midstream Business.

These attractive yields should help the MLP sector continue to perform strongly in the years ahead, according to Byers. She noted that for the past decade this advantage has been the underlying reason for the sector’s solid performance. While it is was possible that overall economic decisions by the Federal Reserve (Fed) could impact the overall stock market, this advantage would still hold firm.

“It’s not crystal clear what the Fed is going to do. If they pulled back the stimulus spending, interest rates could increase, which would squeeze the MLP sector. However, the demand is there. We’ve studied the causes for this demand and don’t believe that demand is only tied to a cost-capital advantage. There is some other unexplained intrinsic value that is embedded [in the structure]. I think these components will keep MLPs performing really well vis-à-vis the overall stock market,” Byers says.

She adds that the market has been attracting new investors, especially from the institutional and foreign fronts. In addition, the sector has been attracting new entrants from the private sector that have been seeking an exit strategy after not getting the multiples they desired on asset sales.

“These companies went down a path of selling assets and found that the value uplift they were expecting to get wasn’t there. Some companies are now saying, ‘The heck with it, we’ll go into the IPO [initial public offering] market and get that multiple many times over,’” she says.

Historically, the biggest entrants from an IPO perspective have been from E&P companies spinning off their midstream divisions as public entities in order to maximize their values. According to Ernst & Young’s recent report, The MLP Journey, such spin-offs allow “the E&P company to unlock the value of its transportation and processing assets without sacrificing control.”

In addition, producers can seek to lower their cost of capital in order to fund their drilling. “Some of the bigger independents are being driven toward the MLP market by activist shareholder pressure, as well as the improved access to capital. Producers can either borrow money to drill, find a JV [joint venture] partner or they can create an MLP,” Byers said.

As the MLP universe expands, more companies are considering entry for several other reasons, including the ability to improve its sponsor’s stock valuation, set a value for its sponsor’s retained assets, the opportunity to create a strategic growth platform and the potential to access different investors.

As MLPs become more attractive to a wide-range of investors, it is opening the door for more diverse energy-related companies to join the sector as long as they can deliver steady distributions with reliable growth to investors.

“Once a company has evaluated whether it can qualify as an MLP, it needs to review its long-term strategy. If it is a company whose value creation is going to be primarily driven through growth capital reinvestment, then the MLP structure may not be the best for them. In this case a significant portion of the free cash flow needs to be reinvested.” “MLPs have significant pressure to redistribute their cash flow,” she says.

Byers doesn’t anticipate newer entrants as having much of an impact on the current MLPs in the sector aside from potentially providing another pool of assets for growth potential. Traditionally MLPs have focused on the production or transportation of natural resources such as gas and oil, but have been expanding this definition of late to include sand and water related to the production of hydrocarbons.

In addition, she expects the sector to expand its definition of transportation to include tankers to transport liquefied natural gas. “Transportation and logistics will continue to grow and will create a pool of assets, that if bundled the right way with a reasonable amount of qualifying income, could play a part in the MLP space.”

One of the hindrances of mergers in the MLP sector involves the general partnerships and their limited-partner units, which are valued differently than common units.

“The valuation [of these units] can get difficult and probably slow down negotiations,” Byers says, though she added that this will not stop some consolidation in the space.

There are also hindrances for the creation of an MLP as they require a certain size to justify the underlying costs. In order to support the costs and scales to maintain a successful MLP, at least a $200-million market evaluation is demanded, according to Byers.

While costs have grown for construction materials and labor in the midstream, this hasn’t had much of an impact on the MLP side of things since most capital expenditures (capex) have typically been part of the GP mix. Instead MLPs focus on maintenance capex, which isn’t as directly impacted by these market increases.

“The traditional midstream MLPs are somewhat insulated from these costs since they won’t typically take ownership of these assets until they’ve had time to mature. Where you’re going to see big cost overruns are on the new capital projects that are in development,” she says.

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