Why High Yielding Midstream MLP Investments Belong In My Income Growth Strategy

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Includes: APU, BWP, DCP, EIA, ENLK, EPD, EQM, ETP, GMLP, LNG, MMP, MPLX, NGLS, OKE, PAA, PSXP, SEP, SPH, SUN, SXL, TGP, TOO, XLE
by: Dividend Retriever

Summary

Before 2014 all was well in the energy sector until crude oil prices started to fall and cast a pall on the sector.

West Texas crude oil eventually fell 73% peak to trough and energy MLPs correlated with the price of oil.

Investors have since returned to the high yield energy MLP space as crude oil continues its reversion.

Annual Energy Outlook 2017

Investment Thesis:

Production and export of crude oil, petroleum products, natural gas, natural gas liquids are expected to rise over the short and long term.

Master Limited Partnership investors stand to benefit from this rising production.

As an income and growth investor, I want exposure to many growth and income sectors of the market. I want a diverse set of income producing assets that give both market correlated returns, and less or even non-correlated returns. Under the current economic conditions, even assets that are less sensitive to interest rate increases and a strengthening dollar are desirable.

After examining potential for increasing income in my portfolio for 2017, I want to discuss one of my income buckets, or sleeves, that encapsulate my investments, which provide my annual income stream.

I have four income sleeves: bonds (investment grade, inflation protected and high yield); dividend paying equities; alternate investments; and cash.

This article is scoped to alternate investments because I see potential for income and capital gains, more specifically, MLP (master limited partnership) investing.

Master limited partnerships (MLPs) trade on major stock exchanges in the U.S. and have, to say the least, certain tax benefits associated with them. Most MLPs are natural resources-based and are considered 'midstream' companies.

There are three broad categories of MLPs: upstream; midstream and downstream. See the image below to get a good idea of how these categories are interrelated and function differently.

Source: Eagle MLP Strategy Fund.

I am scoping the article further to only include midstream companies in the energy value chain because they dominate the MLP sector and have less sensitivity to crude oil and natural gas commodity prices.

Midstream companies generate their revenues in the energy value chain that includes: pipelines, processing plants and storage tanks. There are also shipping and marine transportation MLPs that transport LNG (liquefied natural gas) and other liquids across oceans to other continents.

Source: Enterprise Product Partners.

Let's take a look at the midstream energy value chain a little closer.

Natural gas pipeline MLPs

Natural gas pipeline MLPs manage pipelines both within state and across state lines. These pipelines deliver natural gas to power utilities, local distribution companies, storage tanks and even connect to other pipelines.

Midstream companies that are focused and generate a good deal of their revenues based on natural gas are: Enterprise Products Partners (NYSE:EPD); Energy Transfer Partners (NYSE:ETP); Spectra Energy Partners (NYSE:SEP); Boardwalk Pipeline Partners (NYSE:BWP); EQT Midstream Partners (NYSE:EQM), just to name a few.

Liquids pipelines and terminal MLPs

Liquids pipelines transport crude oil, petroleum products, natural gas liquids, refined products to refineries and storage tanks (terminals). Companies involved largely in this area are: Sunoco Logistics Partners (NYSE:SXL); Plains All American Pipeline (NYSE:PAA); Magellan Midstream Partners (NYSE:MMP); Phillips 66 Partners (NYSE:PSXP), just to name a few.

Natural gas liquids infrastructure MLPs

Natural gas gathered from wellheads (upstream) must be processed before it can be delivered to end users (downstream: utilities, residential, industrial etc.).

Natural gas and natural gas liquids (NGLS) MLPs process natural gas by compressing and fractionation that produce various products for use in industry. Companies involved in processing include: ONEOK Partners (NYSE:OKS); MPLX (NYSE:MPLX); DCP Midstream Partners (NYSE:DPM); EnLink Midstream Partners (NYSE:ENLK), etc.

Marketing/Retail MLPs

There are also MLPs that engage in the distribution of liquefied petroleum gases like propane and butane: Suburban Propane Partners (NYSE:SPH); AmeriGas Partners (NYSE:APU); Sunoco LP (NYSE:SUN).

Shipping MLPs

There are also MLPs that own and operate floating storage, regasification units, liquefied natural gas (LNG) marine transportation: Golar LNG Partners (NASDAQ:GMLP); Teekay LNG Partners (NYSE:TGP); Teekay Offshore Partners (NYSE:TOO).

Many larger MLPs are involved in multiple business lines along the value chain like EPD, WPZ, MPLX, ETP.

Now, I have already stated that I own alternative investments in my income sleeve. I own midstream MLPs at the partnership level which provide a very nice income stream, a growing dividend yield, capital gains as well as tax benefits.

But I want to look further into these investments since they are an industry within the larger energy sector. And, more importantly, the energy sector as measured by the energy sector ETF (NYSEARCA:XLE) has had a total return of 33.69% in the last 52 weeks.

Obviously, the energy sector is in favor now, especially in light of the potential for focus on less environmental regulation and more job creation according to the plans of the president-elect. To compare how this sector has performed in relationship to other sectors of the market, check out the quilt chart in my latest article here where I have done recent sector comparisons.

Let's look at how the MLP space is performing to get a sense of what investors think. That is to say, I want to see the degree of enthusiasm for MLPs since this will show if investors are indeed putting their money on the line.

The Alerian MLP index (AMZ) is the leading gauge of energy master limited partnerships. According to Alerian, the index has a total return of 18.3%. This figure is the price change of the index plus the dividend yield. The S&P 500 has returned 12% in comparison.

The total return for the MLP sector for 2016 is telling me there is both investor interest and income potential through distribution yield.

Even more important than what investors think and where they are putting their money, is what the future will bring. In other words, I want to ask the question regarding whether or not there will be energy production growth in the future. I want to know about the prospects for the MLP space to grow. I want to invest in equities today that have an above average dividend yield, future dividend growth and even a capital gains 'kicker.'

To answer this question, I need some fresh research data. More to the point, I need answers from the U.S. Energy Information Administration [EIA].

The Annual Energy Outlook 2017 provides long-term energy projections for the United States with projections to 2040.

I am particularly interested in the production of natural gas, natural gas liquids and crude oil since they are commodities and finished products transported by MLPs. As you can see below, production of natural gas, crude oil and natural gas liquids are projected to rise.

Here's the EIA on U.S. natural gas and crude oil production:

Natural gas production accounts for nearly 40% of U.S. energy production by 2040 in the Reference (base) case. Varying assumptions about resources, technology, and prices in alternative cases significantly affect the projection for U.S. production.

Crude oil production in the Reference case increases from current levels, then levels off around 2025 as tight oil development moves into less productive areas. Like natural gas, projected crude oil production varies considerably with assumptions about resources and technology.

The EIA also stated: "the United States is projected to become a net energy exporter by 2026." This is also an exciting aspect that will benefit investors in the MLP space, in as much as, it takes pipelines and shipping resources to bring commodities and finished products to U.S. export terminals and delivery to overseas (shipping MLPS) import terminals.

U.S. becomes United States energy exporter by 2026

By now, you might be asking the question about the trend or impact for crude oil and natural gas prices going forward. I will try to answer that question with the following graph.

Future EIA Oil & Natural Gas price projections

It is clear to me from the above graph that the EIA has projected a 'V' bottom in Brent oil (global benchmark) and in natural gas. This gives me a degree of comfort: that these two commodity prices are expected to rise and MLPs fare better in a modestly and moderately rising crude oil, natural gas and natural gas liquids market.

Variant Viewpoint

I want to address the notion that the U.S. energy market, namely, crude oil, is no longer a growth story. This notion has been pervasive in the media in the last two years due to falling price of crude oil.

Tight Oil dominates US production.

'Tight oil' refers to light crude oil extracted from shale rock (tight formations) by fracking. According to the EIA, crude oil production rises in all three scenario's to 2022 at least, but even a quicker pace under the 'reference' (base) case and 'high oil and gas resource & technology scenario.'

You see, in addition to market price, crude oil and natural gas production is related to increases in technology and resource availability and accessibility in basins. Put another way as technology and access improves, the cost to produce these commodities falls, lowering break-even prices, thus increasing incentive to "drill baby drill."

All of the graphs, quotes and commentaries above related to the EIA's Energy Outlook for 2017 suggest there will be more energy infrastructure needed going forward to transport the produced volumes of these commodities. My sense is the growth story is still intact, and now with improving global and national economies, the story should continue.

Another variant viewpoint is that access to capital for growing pipeline businesses has 'dried up.' And, this may be true in some cases, but I noticed this press release where BWP priced 500mm of 4.45% senior notes. In October 2016, Phillips 66 Partners priced $1.125B of senior notes at an attractive interest rate. So I would say, I have seen enough capital activities to suggest MLPs still have access to capital.

I want to make additional investments in MLPs, more specifically mid-stream MLPs that are the transporters of the commodities and have less commodity price risk than their upstream counterparts. I want to add MLPs to diversify my energy holdings and increase income from my energy investments.

I already hold traditional oil companies such as XOM, BP and TOT that provide an income stream, but my MLPs provide income from a different aspect or source, and together make an attractive energy sector dividend yield.

To give you an idea of which companies are involved in the mid-stream space...

The Alerian Index Constituents (sorted by classification):

Name Sector Classification Ticker Price Units Mkt Cap
Terra Nitrogen Company LP Catalytic Conversion TNH $103.13 18.5 $1,908
Antero Midstream Partners LP Gathering & Processing AM $28.00 177.3 $4,964
Crestwood Equity Partners LP Gathering & Processing CEQP $24.60 76.1 $1,873
DCP Midstream Partners LP Gathering & Processing DPM $36.52 114.7 $4,191
Enable Midstream Partners LP Gathering & Processing ENBL $15.87 432.4 $6,862
EnLink Midstream Partners LP Gathering & Processing ENLK $17.12 393.1 $6,730
MPLX LP Gathering & Processing MPLX $32.48 383.6 $12,460
ONEOK Partners LP Gathering & Processing OKS $44.10 285.8 $12,605
Rice Midstream Partners LP Gathering & Processing RMP $22.38 101.9 $2,281
Summit Midstream Partners LP Gathering & Processing SMLP $22.75 72.1 $1,640
Western Gas Partners LP Gathering & Processing WES $55.85 164.8 $9,202
Williams Partners LP Gathering & Processing WPZ $35.46 612.6 $21,723
Teekay LNG Partners LP Marine Transportation | LNG TGP $15.20 79.6 $1,209
Teekay Offshore Partners LP Marine Transportation | Petroleum TOO $5.00 155.6 $778
AmeriGas Partners LP Marketing | Retail APU $45.68 92.9 $4,245
Suburban Propane Partners LP Marketing | Retail SPH $29.99 60.8 $1,823
Sunoco LP Marketing | Wholesale SUN $24.46 95.6 $2,338
Cheniere Energy Partners LP Other | Liquefaction CQP $27.55 451.1 $12,427
Boardwalk Pipeline Partners LP Pipeline Transportation | Natural Gas BWP $17.69 250.3 $4,428
Columbia Pipeline Partners LP Pipeline Transportation | Natural Gas CPPL $17.15 100.7 $1,726
Dominion Midstream Partners LP Pipeline Transportation | Natural Gas DM $27.80 93.2 $2,592
Enterprise Products Partners LP Pipeline Transportation | Natural Gas EPD $25.98 2104.2 $54,667
EQT Midstream Partners LP Pipeline Transportation | Natural Gas EQM $72.15 80.6 $5,814
Energy Transfer Partners LP Pipeline Transportation | Natural Gas ETP $35.03 507.1 $17,763
Spectra Energy Partners LP Pipeline Transportation | Natural Gas SEP $45.64 306.0 $13,964
TC Pipelines LP Pipeline Transportation | Natural Gas TCP $54.34 67.0 $3,641
Buckeye Partners LP Pipeline Transportation | Petroleum BPL $65.17 140.2 $9,138
Enbridge Energy Partners LP Pipeline Transportation | Petroleum EEP $24.07 397.5 $9,567
Genesis Energy LP Pipeline Transportation | Petroleum GEL $34.31 118.0 $4,048
Holly Energy Partners LP Pipeline Transportation | Petroleum HEP $33.09 62.8 $2,077
Magellan Midstream Partners LP Pipeline Transportation | Petroleum MMP $73.49 227.8 $16,740
NGL Energy Partners LP Pipeline Transportation | Petroleum NGL $19.15 127.4 $2,439
NuStar Energy LP Pipeline Transportation | Petroleum NS $47.95 78.5 $3,763
Plains All American Pipeline LP Pipeline Transportation | Petroleum PAA $32.39 722.4 $23,397
Phillips 66 Partners LP Pipeline Transportation | Petroleum PSXP $46.48 107.2 $4,982
Shell Midstream Partners LP Pipeline Transportation | Petroleum SHLX $27.10 177.3 $4,805
Sunoco Logistics Partners LP Pipeline Transportation | Petroleum SXL $23.49 331.5 $7,786
Tallgrass Energy Partners LP Pipeline Transportation | Petroleum TEP $45.44 72.1 $3,277
Tesoro Logistics LP Pipeline Transportation | Petroleum TLLP $48.22 103.0 $4,965
Valero Energy Partners LP Pipeline Transportation | Petroleum VLP $42.00 67.4 $2,829
Alliance Resource Partners LP Production & Mining | Coal ARLP $23.80 74.4 $1,770
Golar LNG Partners LP Regasification GMLP $22.93 64.1 $1,469
Martin Midstream Partners LP Storage | Liquids MMLP $17.95 35.5 $636

Note: Prices are as of December 16, 2016. My holdings are boldfaced.

This list gives an investor a sense for market capitalization and the sector each midstream MLP predominantly operates. The companies boldfaced are companies in which I share partnership.

There are many other ways to gain access to the mid-stream MLPs:

Direct partnership investment (above);

ETF investments: AMLP; MLPA; MLPX; EMLP; MLPJ

ETN investments: AMJ; ATMP; MLPI; MLPS; IMLP; MLPW; MLPG

Closed End Funds: TYG; TTP; NTG; FEN; FEI; FPL; KYN; GMZ; DSE

There are also many other open end funds from companies like Goldman Sachs (NYSE:GS), Steelpath, Cohen & Steers, BP capital, Invesco, Oppenheimer.

These lists are not inclusive of all products available, but I wanted to give a sense for investment vehicles available.

Other considerations

MLPs have tax benefits that make them attractive to some investors but less attractive to others because of K-1 statement filing. But many investors accept the K-1 annoyance to attain tax benefits and to participate in individual equity partnership selection.

MLP units carry risks similar to any other stock because they represent the equity capital of a business.

MLPs are concentrated in the energy sector and can correlate to sharp moves in commodity pricing.

The MLP space, in general, is complicated from many different aspects. I can only begin to touch on the scope of MLP investing in this article. I therefore have planned a series of articles whereby I explain in more detail:

MLP business models, tax implications, K-1s, key metrics, capital market access, interest rate sensitivity, relative sector performance, sector correlations, the 'Trump Factor,' valuation, 'OPEC factor,' just to name a few.

If you would like to follow along with me on the MLP path, I would appreciate you hitting the "Follow" button. Thank you!

Disclosure: I am/we are long XOM, BP, TOT, MPLX, GMLP, TGP, EPD, SEP, GEL, PSXP, OKS, GEL, SXL, XLE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, portfolio asset mix, diversification. Readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. I am not a certified market technician. Investing in public securities is speculative and involves risk, including possible loss of principle. The reader of this article must determine whether or not any investments mentioned in this article are suitable for their portfolio, risk tolerance and accepts responsibility for their decisions.