The joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits (MLPP) took place two weeks ago. There were a number of questions remaining at the end. I answered about half of the remaining questions in last week’s MLP Investing Insider. Today I tackle four more that were left.

Q: Should oil prices stay low for much of this year, are there any MLPs that will likely go out of business?

This is a question that has been coming up a lot. I think it would take several years of prices like this before they would threaten any midstream businesses, but the upstream providers have been getting hit pretty hard. Most will probably be forced to cut their distributions, and many have already announced dramatically lower payouts. The ones in the most trouble will be the most highly indebted ones with insufficient commodity hedges to ride out the slump.

According to the National Association of Publicly Traded Partnerships (NAPTP), there are 16 publicly traded partnerships engaged in upstream operations: 

Some of the upstream partnerships listed will likely be among the first casualties if oil prices remain low. Will any go out of business this year? I think it’s unlikely, but it really depends on how low oil prices go and how long they stay there, the relative production split between oil, natural gas, and natural gas liquids (NGLs), the level of hedging against lower prices and the extent of debt the partnership has taken on. 

 Q: What is your current take on ETP?

With a market cap of $23 billion, Energy Transfer Partners (NYSE: ETP) is among the largest of the MLPs. If I had five MLPs in a portfolio, it would be one of them. We like it at the current price, but this week’s news that ETP will buy Regency Energy Partners (NYSE: RGP) in an $11 billion cash and stock deal initially drove down the unit price of ETP by more than 6%.

ETP also has just announced a $0.02 increase in its quarterly distribution to $0.995 per common unit ($3.98 annualized) for the quarter ended Dec. 31. This was the sixth consecutive quarter that ETP raised its distribution. The latest payout is up 8.2% year-over-year and puts the annualized yield at 6.5% — not bad for a solid midstream operator with relatively modest commodity exposure.

Q: Do you know when the APL merger will be completed?

Atlas Pipeline Partners (NYSE: APL) is a midstream natural gas partnership operating in the Mid-Continent and Permian basin. Atlas Pipeline owns and operates gas-processing plants and multiple treating facilities, as well as two intrastate gas gathering pipeline systems. In October, Targa Resources Partners (NYSE: NGLS) agreed to acquire Atlas Pipeline Partners for $5.8 billion, including assumption of $1.8 billion of existing APL debt. Each APL common unitholder would receive 0.5846 units of Targa Resources Partners and a one-time cash payment of $1.26 per APL common unit for total consideration of $38.66 per APL common unit, which was a 15% premium to the trading price of APL at that time. Concurrently with that merger, NGLS parent Targa Resources (NYSE: TRGP) is to acquire the midstream interests of APL parent Atlas Energy (NYSE: ATLS) for approximately $1.9 billion.

Last week, APL and TRP mailed proxy materials to unitholders, paving the way for votes on the merger agreements. Subject to the expected approval by unitholders, the mergers are expected to be completed on Feb. 28.

Q: What is your current opinion of KMI?

Kinder Morgan (NYSE: KMI) just reported quarterly results for the first time since completing the big merger with affiliated MLPs in November. For the year, the company’s entities generated $7.5 billion in segment earnings before DD&A and certain items, up 9% from 2013. KMI reported distributable cash flow (DCF) of $2.6 billion, up from $1.7 billion for 2013. The company declared a quarterly dividend of $0.45 per share, a 10% increase year-over-year representing a current annualized yield of 4.3%.

For 2015, the company expects to pay out $2 per share, up 15% from 2014, 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 (MMBtu) of natural gas. At $50/bbl crude and $3.20/mmBTU natural gas, the excess coverage would shrink to $436 million.

KMI also recently announced a $3 billion acquisition of Bakken midstream operator Hiland Partners. KMI paid 10 times its estimate of Hiland’s 2018 EBITDA for these midstream assets, signaling faith in a bright future for the Bakken despite the recent crude slump.

KMI has a respectable cushion against falling oil prices, and the stock probably has limited downside. It is one we like and recommend, and it would be on my short list of steady income plays.

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

Portfolio Update

Energy Transfer’s Yield Grab

Let’s cut to the chase about the claimed “substantial cost savings, capital efficiencies and valuable ancillary benefits” of the $18 billion Regency Energy Partners (NYSE: RGP) buyout announced yesterday by Energy Transfer Partners (NYSE: ETP).

The real reason those two MLPs, both managed by Energy Transfer Equity (NYSE: ETE), are merging is that the buyout of Regency’s limited partners on the cheap in the wake of that MLP’s disproportionate recent decline will significantly curb cash outflows for the merged entity while boosting ETE’s long-term profit share as the general partner.

This is very much the same rationale that drove Kinder Morgan’s (NYSE: KMI) recent buyout of its affiliated MLPs, with the welcome difference that Regency unitholders will not face adverse tax consequences since they’re getting mostly equity in another MLP in the deal rather than C-Corp stock.

Between Sept. 30 and Jan. 15 the unit price of RGP slumped 34%, versus a 6% dip for ETP over the same span. This is because, as a gatherer and processor of natural gas, RGP is far more exposed to drilling activity levels and natural gas prices than ETP, which is primarily an interstate shiper with a significant downstream component.

As a result of the drop, RGP’s annualized yield had risen to 8.6% as of Friday, vs. 6.0% for ETP as of that date. Replacing higher-yielding RGP units with lower-yielding ETP ones will save on the distributions, thereby lowering the cost of capital for investments in RGP assets.

Just as importantly from the perspective of general partner ETE, the merger of two affiliates helps ETE in two ways, both related to the issuance of new ETP units to finance the merger. First, even the modest 13% premium offered by ETP will increase the market capitalization of the units from which ETE collects its incentive distribution rights. And since ETE was already entitled to a larger proportion of ETP’s cash flow and RGP’s, replacing RGP units with ETP’s is a another win for the general partner.

This is why ETE had to commit to $320 million in incentive distribution rebates to ETP over the next five years. So its upside from the transaction will be reduced in the near term but undiminished starting in 2020 and thereafter. This is why general partner equity has tended to outperform, representing as it does the interests of the ultimate decision makers.

Accordingly, ETE remains the #3 Best Buy below $66 after raising its own distribution 30% year-over-year Monday, for a current annualized yield of 3% with lots of long-term upside.

ETP retains its ranking as the #4 Best Buy below $70, with a 6.6% annualized yield following Monday’s unwarranted price drop and the 8.2% year-over-year distribution increase. The addition of RGP assets incrementally increases its commodity exposure and overall risk to be sure, but it should also improve distribution coverage and the potential to grow the payout even faster, at least until the IDR rebates expire.

RGP remains a Hold.

ETE and (to a lesser extent) ETP are both winners in this transaction, at the expense of RGP unitholders forced to sell low. Overall, the Energy Transfer will pay out less to the limited partners financing its projects than it would have with Regency as an independent entity.

But with bond yields in Europe turning negative and US income yields near historic lows, the payouts of ETE and ETP continue to offer plenty of relative value.             

— Igor Greenwald