Master Limited Partnerships have been market leaders from the depths of the recession almost 3 years ago. The Alerian MLP Index (AMZ) rose over 150% from the lows in November 2008 to last April, outpacing every index. Since then, like the stock market, it has been tough sledding. In May, the index plunged 39 (10%) from its peak to 351 in just 3 weeks and then went sideways above 350. Last week the index went wild and plunged, dropping from 363 to 315 (13%) by August 8, in 5 trading sessions. The largest previous decline was in July 2007 when the index dropped 47 (from a peak) in 3 weeks. Last week, the index had record breaking gyrations:
Traditionally the MLP index has had a very low beta, except in late 2008. In simple terms, a 1% daily move is considered big. In Q4 2008 and early 2009 there were 19 days with double digit daily swings (6 up and 13 down). One day had a 24 decline and another had a reaction gain of 35. The daily swings last week compare with the wildest days of late 2008. The index recovered this week, but dropped 11 to 344 today (August 18), breaking through the critical support level of 350. This volatility has raised uncertainty which may bring a revaluation of MLPs (i.e higher risk).
During the sell-off in May there was concern about a reexamination of the preferred tax status for MLPs (most of the distributions are not taxed in the current year). They get this special treatment because building energy infrastructure is a national priority. While there have been no new developments, in the current environment looking for ways to make substantial cuts in the federal deficit, all preferred tax treatments will be examined and there is no way to predict the future. As a result, investors may want higher yields (lower unit prices) on MLPs. At its peak in April, the yield on the index fell to a near record low of 5.85% and then soared to 7.39% last week. Now it's returned to 6.77%, still fairly low.
Most investors are interested in stocks and I favor Enterprise Products (NYSE:EPD), Kinder Morgan (NYSE:KMP) (NYSE:KMR) and Enbridge Energy (NYSE:EEP) (NYSE:EEQ). The first 2 are the 2 largest MLPs with long track records raising distributions annually for more than 10 years. The stocks of Kinder Morgan (KMR) and Enbridge Energy (EEQ) are included for those who do not need current income, but would rather receive stock dividends which do not generate 1099s. EEP is my favorite. It brings 2/3 of the Canadian oil (Canada is the largest supplier for the U.S.) to Cushing, Oklahoma and has a substantial natural gas business centered in Oklahoma.
Enbridge, Inc (NYSE:ENB), a large Canadian energy company, is the general partner (manager of the business at EEP). During the financial meltdown in 2008, it purchased more than 16 million units of EEP at $30.76, for approximately $500 million. The investment was made to finance growth projects at EEP and give it increased participation in EEP growth. When money was not readily available, that investment was critical for the 2009 capital program at EEP. EEP expanded its Clarity natural gas pipeline and the second stage of Southern Access pipeline which was opened in April 2010. The investment doubled.
This illustrates how investing in MLPs should work. If unsettled economic conditions continue, MLPs, like stocks, will experience more selling. Extreme volatility can reappear (as it did today) with heavy selling in the stock market. Falling prices raise MLP yields to more attractive rates, bringing opportunity for long term investors. EPD yields 5.9%, KMP yields 6.8% and EEP yields 7.8%, far above the 2.1% Treasury bond yield. Longer term fundamentals are the basis of all MLP investing. 3 Years ago, ENB made a substantial increase in its investment at EEP when risk averse was the driving force in the stock market. That did well and the annual yield has risen from 13%. MLPs will continue to do well and the next distribution paid in December will feel good.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.