For those who may not know, each month we host a joint web chat for subscribers of The Energy Strategist (TES) and MLP Profits. The chat is conducted by Igor Greenwald, managing editor for TES and chief investment strategist for MLP Profits, and myself.

We place a priority on answering questions about portfolio holdings and recommendations during the chat, but often we get questions about companies we don’t currently recommend. Sometimes we may get questions that require an extended answer, or there may just be so many questions we can’t get to them all. For the most recent chat there were three MLP questions that warrant some elaboration.

Q: Do you anticipate any impact on MLP share prices in a rising interest rate environment?

We got a couple of questions about the effect of interest rates on expected MLP unit performance. Igor’s view is that the spring/summer MLP correction sort of inoculated against a repeat, and further that the economy isn’t strong enough to support significantly higher rates for a good long while. And as the economy strengthens, it should generate plenty of demand for new energy infrastructure, helping the MLP sector grow, he argues.

I would add that those MLPs that are highly leveraged will be most at risk as rates rise. I would further avoid those that have had a significant run-up that has depressed the yields to low levels. A low-yielding MLP like Phillips 66 Partners (NYSE: PSXP), which had a very big rally from its initial IPO price, could be particularly vulnerable to higher interest rates.

Q: What are the pros and cons of holding an MLP in a retirement account? And which would you recommend?

Opinions on this are split. A big advantage of MLP investing is the potential for deferring taxes on earnings. However, the income in retirement accounts is already tax deferred. Further, it is possible that the retirement account could end up owing additional taxes on MLP distributions, reducing the potential return to investors. Retirement accounts are taxed on “unrelated business taxable income” (such as partnership income) in excess of $1,000 in the aggregate. As a result, many financial planners  recommend that you not complicate your retirement account with MLPs.

Others argue that the steady cash distributions are a safe, conservative way to build up the value of the retirement account over time, even if the account ends up having to pay some taxes. The fact that the MLP isn’t paying corporate income taxes is a significant advantage over time with respect to its ability to generate higher income over time than would be possible for a corporation.

My view is that you first want to make sure that any of your fully taxable investments are protected in retirement accounts to the greatest possible extent before you start to consider putting MLPs in your retirement account. For example, investors with both taxable and tax-deferred investment accounts would generally be better off holding MLPs in the taxable accounts, where their tax deferral benefit would be more valuable, and where they would not generate a liability for unrelated business taxable income.

Of course, some MLP affiliates and/or sponsors are tax-paying corporations, and their shares can be held in a retirement account. MLP Profits portfolio picks suitable for IRA accounts include Kinder Morgan (NYSE: KMI), Williams (NYSE: WMB), Targa Resources (NYSE: TRGP) and Navios Maritime Partners (NYSE: NMM), all of which pay dividends and issue the 1099 miscellaneous income forms, rather than the more complicated K-1’s from partnerships.

Q: Linn Energy (NYSE: LINE) seems to have gotten thru the SEC looking them over. The merger with Berry seems to be on track, although at a higher purchase price. Do you think Linn is a good investment going forward?

This particular question was answered in the chat, but it warrants some additional commentary. We got half a dozen queries on Linn Energy during the chat, so there is obviously still a lot of interest there. Igor’s answer to this question was “All of that is true, and I expect the merger to close by year’s end, but I think Linn has some structural issues that go beyond Berry with its debt load and past acquisition quality, so I’m steering clear. There are better upstream MLPs in our portfolios.”

I would add that we have been pretty steadfast in believing that the SEC inquiry wouldn’t turn up anything substantive. However, we couldn’t recommend Linn with that inquiry hanging over the partnership. MLP investors in general are not looking to take on that kind of risk, and I suspect most didn’t think it was possible to see Linn drop like it did (down ~40 percent over the summer). This kind of volatility might be acceptable for aggressive speculators, but that doesn’t fit the profile of most MLP investors.

Now that the SEC cloud appears to be lifting and the merger with Berry looks to be imminent, we have taken another look at Linn. But after comparing to peer upstream MLPs, we feel that there are safer options, especially given the higher purchase price Linn had to pay for Berry, and Linn’s relatively high debt level. The present dividend yield of nearly 10 percent is certainly attractive, but our view is that the downside risk will continue to be unacceptably high for conservative investors.

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Portfolio Update

OILT Refills the Tank

There’s one thing MLP investors appreciate even more than a juicy yield: rapid growth that can support distribution increases in the future. That’s how Oiltanking Partners (NYSE: OILT) has rallied 70 percent year-to-date, including 26 percent since the end of September.

It’s easy to be enthusiastic about a partnership that’s just reported a 75 percent revenue gain year-over-year, all from organic growth thanks to the booming demand for crude and refined fuel storage along the US Gulf Coast. The distribution recently increased 18.7 percent year-over-year, but with the unit price up so much more the yield had dwindled all the way down to 2.8 percent.

OILT is taking advantage of the runup to raise some cheap equity capital with a secondary offering of nearly 3 million units, including the underwriters’ allotment. The unit price dropped 4.8 percent on the news in Monday’s afterhours trading, so there’s a good chance the yield will be a bit higher Tuesday. But despite the partnership’s obvious strengths it won’t be high enough for us to recommend additional buying at these levels. OILT remains a buy only below $50 for the moment.

— Igor Greenwald