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Why MLP ETFs May be the Best Energy Bets for 2017?

Sanghamitra Saha

Master limited partnerships or MLPs have been on an uptrend lately with several energy-related investments. The largest MLP ETF Alerian MLP ETF AMLP gained over 1.7% in the last five trading sessions (as of December 13, 2016) though the space previously struggled immensely with sliding oil prices. So far this year (as of December 13, 2016), the fund is up just over 2.2%.

Whatever be the case, MLPs are well-positioned to close out 2016 and enter 2017. Below we highlight reasons which may lead MLPs to log a Santa Clause Rally in the coming days.

Jump in Oil Prices: As soon as oil price staged a rally on the prospect of output cuts by OPEC and non-OPEC countries, most of the energy MLPs also started marching northward. Hopes of tightening supplies and some pickup in demand on global economic recovery added to the optimism in the oil patch.

Oil prices slipped below $30/ barrel in February but are presently hovering over $50 and some analysts expect to see a $60/barrel soon. U.S. crude ETF United States Oil Fund USO and Brent crude ETF United States Brent Oil Fund BNO added 4.7% and 5.3% since the OPEC deal (as of December 12, 2016) and lent support to other forms of investments which are energy-related (read: How to Bet on Oil with Leveraged ETFs).

Lure of Dividends: MLPs are known for their high-yielding nature as these do not pay taxes at the entity level and are thus able to pay out most of their income (more than 90%) in the form of dividends like the REIT firms. While most traditional income asset classes produced miniscule yields, MLPs lured investors with their higher payouts.

Moreover, an improving U.S. economy and a soaring stock market call for a Fed rate hike – the only one in 2016 – this month. Bets on faster rate hikes and rising inflationary expectations on Trump’s pledges for fiscal reflation have already boosted U.S. benchmark Treasury bond yields (read: Is the Treasury Bond ETF Rally About to End?).

The yield on the 10-year U.S. Treasury was 2.48% on December 13, 2016. Only high-yielding MLP ETFs can now beat out the benchmark Treasury yield and have the potential to deliver capital gains. Also, such high yields at times make up for capital losses incurred by investments.

Yes, MLPs underperform in a rising rate environment as these have to depend on the debt market to finance their operations or fresh projects. Naturally, higher rates would cut back their profitability. But investors should note that many MLPs use a fixed rate debt for their borrowings.

Strong Industry Rank

The dual benefits of an oil price rally and high-yielding nature amid Fed policy tightening might favor MLP ETF investing at the current level. Investors should note that the Zacks Industry Rank of the energy and pipeline MLPs is in the top 2%.

ETF Choices

Below we highlight a few MLP ETFs which are on momentum and offered some of highest returns in the last five trading sessions (as of December 13, 2016).

Direxion Zacks MLP High Income ETF ZMLP-- Yields 8.47% annually

Alerian MLP ETF AMLP – Yields 8.33% annually

VanEck Vectors High Income Infrastructure MLP ETF YMLI – Yields 7.51% annually

Global X MLP ETF MLPA -- Yields 7.46% annually

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