Small-Cap MLPs May Be Worth Watching After Kinder Morgan's Acquisition Of El Paso

by: Zvi Bar

On Sunday, October 16, Kinder Morgan (NYSE:KMI) announced plans to acquire El Paso Corporation (EP). In May, El Paso announced its own plans to split itself into two companies: a pipeline company and an exploration and production company. Kinder Morgan has also stated it plans to sell El Paso’s exploration and production division. Kinder Morgan will gain approximately 43,000 miles of gas pipelines from El Paso, increasing its gas pipelines to about 67,000 miles.

This deal is being seen as a possible starting salvo for a coming barrage of consolidation among pipeline companies that distribute oil and gas within the United States. Many of these assets are presently housed in Master Limited Partnerships (MLPs), including some under the Kinder Morgan umbrella. With every added deal, there is less and less non-competitive pipe out there, and some of the small-cap MLPs may be purchased to obtain key pipelines or merely expand pipe miles within the MLP.

An MLP is a type of partnership that is publicly traded on a securities exchange. MLPs combine the tax structure of limited partnerships with the liquidity of publicly traded securities. Usually, private partnerships are relatively illiquid compared with public equities. Most MLPs are publicly traded oil and gas pipeline businesses that earn stable income from the transport of oil, gasoline and/or natural gas.

Many MLPs derive their revenue based on the amount of product transported and are not sensitive to price fluctuations, except where they affect demand. Some MLPs involve other natural resources, and certain other industries, but oil and gas are the most common sectors. MLPs usually provide their investors, the limited partners, with distributions similar to dividends, but which are often taxed differently. MLP tax issues can make them unsuitable for IRAs and similar retirement accounts.

Below are five small-cap MLPs that currently yield over 8%, as well as their two-week, one-month and 2011-to date performance rates.

  1. Breitburn Energy Partners L.P. (BBEP)
    • Yield: 9.7%
    • 2-weeks: 7.59%
    • 1-month: -6.08%
    • 2011-to-date: -13.56%
  1. Calumet Specialty Products Partners LP (NASDAQ:CLMT)
    • Yield: 11.1%
    • 2-weeks: 6.32%
    • 1-month: 1.87%
    • 2011-to-date: -15.49%
  1. Encore Energy Partners LP (NYSE:ENP)
    • Yield: 9.37%
    • 2-weeks: 17.23%
    • 1-month: 0.15%
    • 2011-to-date: -10.73%
  1. Ferrellgas Partners LP (NYSE:FGP)
    • Yield: 9.92%
    • 2-weeks: 1.92%
    • 1-month: -7.36%
    • 2011-to-date: -21.32%
  1. Martin Midstream Partners LP (NASDAQ:MMLP)
    • Yield: 8.76%
    • 2-weeks: 10.19%
    • 1-month: -2.79%
    • 2011-to-date: -11.63%

Several of these MLPs have performed exceedingly well to begin the fourth quarter of 2011. The equity of each of these five individual small-cap MLPs is positive over the last two weeks, with ENP gaining over 17% ad BBEP, CLMT and MMLP all rising between 6% and 11%. See the two-week chart below:

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Nonetheless, the equity each of these small-cap MLPs is down between 10% and 22% so far within 2011, before counting paid distributions. See the 2011-to-date comparison chart, below:

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It is expected that the distribution growth of pipeline MLPs can grow at a rate at or ahead of inflation, based upon energy demand and price growth. Non-competitive pipelines have an industry standard annual price increase of CPI + 2.65%, which is generally superior to other long-term lease rates.

MLPs are partnerships, so they do not pay corporate income taxes. The tax liability of the MLP is passed on to its unit holders. Each investor receives a K-1 statement that details his or her share of the partnership's net income. That income is then taxed at the investor's individual tax rate. MLPs may also make cash distributions that are not taxed but which will reduce the cost-basis of partnership shares/units and create a tax liability that is deferred until the MLP is sold.

Disclaimer: This article is intended to be informative and should not be construed as personalized advice, as it does not take into account your specific situation or objectives.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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