Uncovering Value in MLPs

Energy sector specialist Elliott Gue, editor of Energy & Income Advisor, helps unravel the complexity of master limited partnerships—highlighting two favorites for growth and income potential.

Steve Halpern: We're here today with Elliot Gue, editor of Capitalist Times and the Energy & Income Advisor. How are you doing today, Elliot?

Elliot Gue: Good, good. How are you? Thanks for having me on the program.

Steve Halpern: My pleasure. Today we're going to be discussing master limited partnerships, specifically, recent IPOs in the sector. First, let's look at the structure of these investments for our listeners who might not be familiar, and you note that MLPs are usually comprised of two entities. Could you explain that?

Elliot Gue: Sure, well MLP, or a master limited partnership, is typically comprised of a limited partner, or LP, and a general partner, or GP.

Now, when you buy an MLP you're typically buying a stake in the limited partnership and what that means is that you're entitled to receive regular distributions, which represent a share of the cash flows generated by that business.

But with the limited partner, you, typically, have no interest in the actual management of the MLP so, in other words, you're not making decisions or voting on decisions like, "shall we make this acquisition?" or to go ahead with a new pipeline construction project, or to go ahead with new oil storage terminal.

That management path is undertaken by the GP, or the general partner. Now what's really important about this relationship is that the LP—which is, basically, you and me who buy the MLP—we pay a fee to the general partner in exchange for managing and helping to grow those assets over time.

That fee is called an Intensive Distribution Right (or IDR) and, typically, those IDRs rise—the share of IDR rises as the underlying distributions of the LP to the MLP increases. The reason it works that way is it's basically incentivizing the general partner to make decisions that allow the underlying LP to grow its payout to new holders or shareholders.

It's typically a very good relationship, particularly in the earlier years of a partnership's existence because it's designed to encourage growth and yield, and MLPs—most people buy master limited partnerships for that yield.

The average MLP in the US yields a little over 6%, which, of course, is many times what the S&P yields right now, so it's typically a very good relationship but you have to watch it very carefully because at some point in the future, you can get into a situation where the general partner is taking too large a fee as an IDR out of that LP which affects their ability to grow distributions going forward.

Steve Halpern: As you pointed out, in order to attract investor attention, these MLPs offer particularly high yields in the first few years. What specific factors do you look at to determine if these distributions will be maintained and continue?

Elliot Gue: Right. Well, most master limited partnerships, or MLPs, are involved in what we call the midstream energy business. Basically, the energy business is divided up into three parts; you have upstream, which is actual oil and gas production. There are handfuls of about a dozen MLPs in that segment.

Then you have the midstream, which is really transportation and storage, so it's owning things like pipeline, like natural gas storage caverns like oil terminals and tankers. That would be midstream, transportation, and storage.

Then you have downstream, which is usually refining. There's just a couple of MLPs involved there. About 80% are involved in that midstream area, 80%, 90%. Now that area is typically very stable business.

Page 1 | Page 2 | Page 3 | Next Page The expert featured in this column, Elliott Gue, may or may not own positions in any investment vehicle mentioned here. The views and opinions expressed are his or her own.