MLPs: Mid-Year Review

 |  Includes: EEP, KMP, KMR, SPP
by: Avi Morris

MLPs have been one of the most exciting groups in the markets in the first half of 2009. The Alerian MLP Index began the year at 176 and rose to 221 for a 26% advance. Alerian also has a second index which includes reinvested income. That one started the year at 428 and rose 31% to 560. Each index began on Dec 31, 1995, at 100. The first index has performed quiet well over the long term, especially when compared to other industry groups.

However with reinvested income the compounded annual growth rate has been nearly 13%, an envy for almost any industry.

The last two years have been a difficult time for MLPS as for all securities. The MLP index peaked at 342 in July 2007 after which it collapsed to around 300. It remained near 300 for another year before plunging almost 50 in September 2008 to near its present value.

This year MLPs had a major sell-off in February and early March (along with the stock market), but recovered strongly in the last three months. That rally has been pretty much straight up until the last few weeks when profit taking took the index down 20 points. Even so, it's back at levels of early October 2008. The yield for index is still a high 9¼% or 575 basis points above the 10 year Treasury bond (a 200 point spread has been considered a typical spread).

There was disappointment for some MLPs, but their problems have not bled through to the rest of the industry. Constellation Energy (CEP) in Q1 slashed the annual distribution rate from $2.25 to 52¢ and last week had to eliminate it for the 3rd quarter. Two other MLPs cut their distributions in the 2nd quarter so they could concentrate on reducing debt. This negative news has not disturbed other MLPs, at least so far.

Kinder Morgan (KMP & KMR) is the largest MLP and has an excellent track record (highlighted in their annual record). During the large price swings for the MLP Index (MLPs typically are low beta securities), their securities have been fairly flat this year. The stock equivalent, KMR, had not strayed far from 40 for much of 2009 but has finally risen to 44s in June when other MLPs were selling off. They have had not trouble this year raising additional capital to finance more pipelines.

Enbridge Energy (EEP & EEQ) pipelines bring shale oil from Canada to the upper Mideast. Currently they are pretty much doubling the capacity of their oil pipelines (called liquid business). However, a green environmental group has asked the Secretary of State to deny an expansion in their shale oil pipeline because they consider to be "dirty" oil.

Continuing the large gains for MLPs in the first half of 2009 will not be easy. Last year US Treasuries had one of their best years in history, reducing the yield on the 10 year Treasury to near 2% as frightened money sought safety in Treasuries.

This year, money flowed out. The 10 year Treasury bond has fallen sharply causing its yield to shoot up to 3½% (4% at the peak 2 weeks ago). There has been a greater willingness to accept risk this year to obtain higher yields (with MLPs and other high yield stocks). If the recovery from the deepest recession in years is not quick, money may again seek more safety.

Disclosure: no position in any security mentioned