Conflicts between consumers, central banks, and traders
I have no in depth knowledge of these two recently recommended MLPs by Barrons (primarily because they were sector laggards that ought to catch up. Offer a few general thoughts about thes and other pipeline/processor MLPs.
In contrast to Line which is organized as an LLC, these MLPs havr General Partners as a separate management organization that is poised to suck off their profits when they hit a threshold in earnings. KMP is now in this boat, so its ability grow profit is now curtailed, and many retail unit holders appear to be clueless.
The pipeline MLPs are generally fully valued, but with continuation of low NG prices are probably overvalued for a couple of reasons.
First, with inflation looming, they will not be able to fully pass along their infrastructure cost to weal producers, so their income will not be able to keep up with inflation. Line, by contrast, has a lower cot and maintenance basis that it can better manage to keep up with inflation.
Second, because the pipeline MLPs are now paying in the range of 5-6.5% yield, if they cannot keep up with inflation and higher interest rates, you get a poor yield, and the prices of their units will get hit; so you get the bad combination of low yield and capital loss on units (shares) held.
Back to the issue of having a separate GP as the company's boss instead of the company managing itself with direct fiduciary responsibility--I think that stinks. The GP has a fiduciary responsibility to manage its enterprise for its owners, and that entails conflicts with the MLP unit owners. For example, it has the Incentive Distribution Rights (IDR) arrangement that limits the profitability of the MLP it controls. A company should be able to run itself to advantage its owners, instead of being run to be bled by others.
Finally, the pipeline MLPs are locked in to the particular land where they operate. If the EPA decides that the gas producers are damaging the ecology in their area of operations and so must reduce output are stop output, the pipeline cannot pick up sticks and move elsewhere--they get crushed. The Marcellus shale production is under threat by local politicians, and environmentalists, with EPA in a study mode.
Good post – thank you However I would think the value of real productive assets provides an inflation hedge rather than exposure too inflation. Toll rates for outfits like EPD could lag general inflation but at some point would adjust. I believe the biggest danger to the pipe line MLPs is not higher 10 year interest rates but the EPA regulating gas in such a way as to artificially make it cost as much as imported oil. Right now the ability to take wet gas and fraction is very much a license to print cash. This enables the historic wide spread between gas and oil. I would note that as long as clean gas remains it at an irrational discount to oil the MLPs will continue to print money. The danger to pipe MLPs is gas selling at the energy equivalent to imported oil. It would not kill them but it would pull the very favorable wind from their sails. Clean gas remains a cyclical demand commodity. Demand is closely tied to general industrial and electrical production. At some point the economy will demand much higher delivery volumes. So we have secular trend in gas adoption and a truly expanding economy to drive both volumes and transportation pricing. This is why Line benefits so greatly from a sharply slopping futures market for clean gas. EPD has a better structure than KMP. But KMP also sells at a significant discount. Both are focused on new projects and organic expansion of existing assets. Distribution growth is lagging behind true free cash because there are so many extremely high ROI projects. The state level regulation is not a big concern for me. Penn is going ahead on the M and more jobs for them if New York and other states do not get their act together. Looking across an artificial line and seeing folks doing better is a powerful incentive to get it done. M is huge but not alone. They are ‘finding’ more gas across the country. My personal opinion, for whatever it is worth, is that both Line and pipe MLP remain very attractive investments. Mr. Market has not fully discounted the continuing transition to gas in domestic manufacturing, , electrical generation, chemical production (one reason DD has been on a tear) and perhaps and hopefully in transportation. It will probably be distribution constraints rather production capacity that slows the process. Traditionally MLPs are valued close to the 10 TB. Rates just took a big jump and this may well be the reason for the recent sell off. But, this relationship might not be appropriate given the depths of this recession and our recovery potential. The pipe MLPs are even doing some price arbitrage today to take advantage of higher prices in underserved or supplied markets. This could happen on a very large scale as the economy recovers.