Master limited partnerships (MLPs) are a force to be reckoned with in the asset-acquisition market. Commodity prices have fluctuated and risen to new highs many times in the past, but something more pervasive began affecting the A&D property-flow landscape in 2007. Research by property-marketer EnergyNet Inc. into the cause of this new asset-price regime led to the effect of the proliferation of E&P MLPs.

What type and size of oil and gas properties are E&P MLPs acquiring? Is this type of acquirer here for the long term? How are they affecting oil and gas property valuations? While each MLP is uniquely organized, they have two common themes: They are incessantly acquisitive, and need immediate and large supplies of capital.

As of early December, there were 10 publicly held E&P MLPs and their kin, LLCs: Encore Energy Partners, Quest Energy Partners, Vanguard Natural Resources LLC, Linn Energy LLC, Eagle Rock Energy Partners, BreitBurn Energy Partners, EV Energy Partners, Constellation Energy Partners LLC, Atlas Energy Resources LLC and Legacy Reserves. Plans for at least a dozen more upstream MLPs have been announced.

The existing 10 MLPs already own more than 3 trillion cubic feet equivalent of proved reserves and have a market capitalization of more than $10 billion.

To date, these upstream MLPs have remained disciplined in controlling their property acquisition costs. They have purchased long-lived reserves with reserve/production ratios of 13 to 23 years, and at prices of $1.80 per proved thousand cubic feet equivalent (Mcfe) to $2.25. In terms of production, they have paid between $11,000 per daily Mcfe to just over $20,500.

Their acquisition valuations so far are, to a large extent, in line with C-Corp purchases. Their target goal is to acquire only property sets with a 10% or shallower decline rate. Because they distribute 70% or more of their income to unit-holders, it is necessary to replace not just production but also reserves with only 25% to 30% of income, which is referred to as maintenance capex. This equates to about $2 per thousand cubic feet of gas or $12 per barrel of oil.

This is no easy task, and it is only possible with an inventory of appropriate, carefully selected properties. E&P MLPs are not in the exploration business.

As of mid-November, their reserves ranged from 62% to more than 90% proved develop producing. Generally, MLPs want to acquire operated properties because they have to control maintenance capex and quickly develop proved undeveloped reserves, exploit behind-pipe reserves and increase well-spacing opportunities.

Because of their market caps, they have to make significant acquisitions. Beginning in early 2006, by mid-2007 six MLPs had made 17 acquisitions valued at almost $5 billion. Some industry experts estimate the U.S. has about $200 billion in properties that fit upstream MLPs’ parameters.

Can the upstream E&P MLPs exist for the long term? This is extremely complex. The answer lies in each MLP’s ability to access low-cost capital on a timely basis to add reasonably priced reserves. If an MLP is not growing, it is dying; its longevity lies in the ability to maintain distributions to investors. This can only be done by holding maintenance capex down and growing distributable income.

The other critical hurdle is to not go the way of Canadian royalty trusts which, political intervention aside, became so competitive they started straying from their property parameters. They could not resist buying properties with steeper declines and requiring more maintenance capex.

Conventional industry wisdom suggests that, as more E&P MLPs enter the sector, an inevitable A&D metrics increase will result, fueled by the pressure of competition. There is little question that more will be paid for MLP-able properties.

David Marcell, managing director of Tristone Capital, suggests that MLPs could potentially cause the evolution of a two-tier property marketplace, consisting of MLP-attractive properties and properties which are not.

From EnergyNet’s point of view, MLPs have already significantly affected the A&D market. Smaller sellers have waited to sell, in some cases, to determine what the lower value threshold is for MLPs to be acquisitive. Those potential sellers have been accumulating properties in hopes of reaching that hurdle.

It will be interesting to see how many more E&P MLPs can make it through the SEC’s almost impossibly difficult labyrinth of requirements. Can they maintain acquisition-price discipline as competition heats? Will they be able to maintain distributions while competing for those properties?

Will the capital they need remain affordable as higher oil prices portend the prospect of inflation? Will there exist a hedging counter-market willing to handle the volume of trades necessary as this sector grows, particularly during price volatility?

The talent these MLPs have attracted so far is fully capable of finding the solutions to these potential issues.

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