The joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits (MLPP) took place last week. The chat is conducted by Igor Greenwald, who is managing editor for TES and chief investment strategist for MLPP, and myself.

Given the rapidly changing dynamics in the energy market, it wasn’t surprising that we received nearly 90 questions/comments during the course of the chat. While we addressed about two-thirds of them during the chat, there were a number of questions remaining at the end. In this week’s column I answer some of the remaining questions (and I may address a few more next week). Meanwhile, in this week’s Energy Letter, I address the most common question in the chat: “What’s up with oil prices?”

Q: How are stock prices of midstream MLPs going to hold up if oil goes to $30 per barrel?

It will depend on what expectations have been priced in, and on the location of the assets. Many of the more conservative MLPs should be fine for even a couple of years, although their price would almost certainly decline more if crude headed to $30. The midstream services providers with very low yields based on expectations of rapid distribution growth would be most at risk along with those with a lot of exposure to the Bakken, where oil production would decline drastically if the price of a barrel spent much time at $30. I don’t think oil will visit $30 even briefly, but if it did it wouldn’t stay there long (for reasons explained in this week’s Energy Letter).  

Q: Any thoughts on OKS and OKE?

ONEOK Partners (NYSE: OKS) and its general partner ONEOK (NYSE: OKE) are involved in gathering, processing, storage and transportation of natural gas and natural gas liquids (NGL). They have suffered along with the rest of the energy sector during the oil price decline, with OKS and OKE down 21% and 28% respectively over the past year. The decline is probably too steep for a midstream MLP, but ONEOK Partners does have some exposure to NGL pricing, and and NGLs have declined along with the price of oil.

In December, ONEOK Partners projected 2015 operating income of $1.32 billion to $1.48 billion, an increase of 11% to 25% over 2014. This projected increase assumes higher volumes of processed natural gas and NGLs. This forecast would bump the 2015 yield above 8% based on the recent unit prices.

The biggest concern I have at the moment with ONEOK is the recent sharp drop in natural gas prices, and my expectation of soft pricing for the rest of this year. They do have 75% of their expected 2015 equity natural gas production hedged at an average price of $4.03 per million British thermal units (MMBtu), but that still leaves some exposure to lower natural gas prices. That could force the partnership to reduce guidance if gas prices remain soft. On the other hand, that expectation may be already baked in at least to some extent given the decline in the unit price despite the expected increase in income.

In summary, I think these are decent picks with limited downside at this point, with most of the commodity price exposure already reflected in the unit price. I wouldn’t have a problem with either of these in my portfolio.

Q: What do you think of HCLP?

Igor and I have written an article on the hydraulic fracturing sand providers for MLP Profits. I will summarize what I wrote about Hi-Crush Partners (NYSE: HCLP), a pure-play domestic producer and supplier of frac sand used in all major US shale basins.  

Hi-Crush Partners went public in 2012, and was 2013’s best-performing energy MLP with a gain of 142%. On Aug. 29, 2014 the unit price closed at a record high above $69, marking a gain of 246% since the IPO two years earlier. But HCLP corrected sharply as the oil price crashed. By the end of 2014 units were down 55% since the summer peak — but still up 66% from the IPO price.

HCLP has 7.5 million tons of annual sand production capacity in Wisconsin and over 30 years of reserves. In 2014, 3.8 million tons of frac sand were contracted, and for 2015 6.6 million tons — 88% of production capacity — is already under contract. As of year-end 2014, the contracts had an average remaining life of 4.2 years. The partnership has onsite rail capacity for unit trains, and 6,000 railcars under management for handling shipping logistics.

For the most recently reported quarter (Q3 2014), HCLP set records for revenue, sales volumes, EBITDA and earnings. The partnership reported earnings before interest, taxes and depreciation and amortization (EBITDA) of $43.9 million, versus $19.5 million in Q3 2013.  Distributable cash flow of $32.3 million for Q3 2014 corresponded to distribution coverage of 1.40x. HCLP was also added to the Alerian MLP Index during the third quarter.

HCLP has an Enterprise Value (EV) of $1.4 billion, an Enterprise Value/EBITDA of 12.3, Total Debt/Equity (mrq) of 120.6, and a current ratio of 2.7. Despite the decline in oil prices, HCLP projected growth of 25% in 2015 during the third-quarter conference call. However, oil at that time was still trading at $75/barrel (bbl). It is not at all clear what the picture looks like at $50/bbl oil.

The unit price will likely soar as oil prices recover, but as evidenced by the steep recent decline HCLP is not for the faint of heart.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Kinder Morgan Goes Shopping

Kinder Morgan (NYSE: KMI) marked its first report since the recent consummation of its merger with affiliated MLPs in the expected way on Wednesday, announcing a multi-billion dollar acquisition.

The rationale is similar: the more businesses Kinder Morgan buys, the bigger its depreciation tax deduction in future years, leaving more cash flow for dividends and interest payments on the debt financing the acquisitions.

The amuse-bouche it swallowed this week was interesting because the seller was none other than Continental Resources (NYSE: CLR) Chairman and CEO Harold Hamm. The $3 billion (including $1 billion in assumed debt) to be paid by Kinder Morgan for privately owned Hiland Partners, a Bakken crude gatherer, gas processor and oil pipeline operator, should help Hamm reliquify his personal balance sheet after recently paying nearly $1 billion in a divorce judgement.

The timing of the deal is curious, coming with crude at $46 a barrel, or roughly $40 more than where it stood when Hamm sold all of Continental’s oil hedges. Kinder Morgan is now making its own bet on a recovery, and it’s not getting Hiland cheap despite the deeply discounted oil.

It’s claiming a 10x EBITDA multiple based on its projections for Hiland in 2018 but saying only that the deal will be “modestly accretive” to its cash available to pay dividends this year, which implies a multiple as high as 18x.

CEO Richard Kinder said the high price tag is justified by Hiland’s footprint in one of the Bakken’s lowest-cost “sweet spots” and by the growth potential of its Double H pipeline shipping crude south to Wyoming and ultimately down to Cushing, Oklahoma and the Gulf via connecting pipelines.

Hiland has long-term acreage commitments from top customer Continental for crude gathering, and also serves Oasis Petroleum, XTO Energy, Whiting Petroleum and Hess.

In other news, Kinder Morgan declared a fourth-quarter dividend of 45 cents a share representing 10% growth year-over-year, out of cash available for distribution of 60 cents a share. The company aims to pay out $2 per share representing 15% annual growth over the coming year, with $654 million of excess coverage based on its forecasts of an average $70 per barrel price for crude and $3.80 per million British thermal units of natural gas.

At $50/bbl crude and $3.20/mmBTU natural gas, the excess coverage would shrink to $436 million. Every $10 off the price of a barrel of crude costs the company $100 million.

CEO Richard Kinder also confirmed that he will hand over that title to Chief Operating Officer Steve Kean in June, but stay on as executive chairman.

Kinder Morgan’s share price held its ground on news of the acquisition, suggesting shareholders continue to prioritize dividend growth. Beyond the 15% increase this year, the company has committed to 10% annual growth in the payout through 2020, without increasing its already high debt leverage. It is highly likely to keep acquiring and selling stock to get there. Buy KMI below $45.     

— Igor Greenwald