Last week Green Plains Partners (NASDAQ: GPP) made history for publicly traded partnerships. GPP is a Delaware limited partnership formed by Green Plains (NASDAQ: GPRE) — the nation’s fourth-largest ethanol producer — to provide ethanol and fuel storage, terminal and transportation services as the primary downstream logistics provider for an ethanol marketing and distribution business handling approximately 1.2 billion gallons per year.

Much like a midstream oil or gas pipeline, GPP will generate a substantial portion of its revenue under fee-based commercial agreements for receiving, storing, transferring and transporting ethanol and other fuels from the parent’s 12 ethanol plants. GPP’s payments are not based on the value of the ethanol so they don’t have any direct exposure to fluctuations in commodity prices. More on that further down.

Initial assets of the partnership include:

• 27 ethanol storage facilities located near the parent’s 12 ethanol production plants in Indiana, Iowa, Michigan, Minnesota, Nebraska and Tennessee. These ethanol storage assets have a combined capacity of 26.6 million gallons that can be loaded onto railcars and tanker trucks. In 2014, the ethanol storage assets handled 95.6% of the combined daily average production capacity of the parent’s ethanol production plants.  

• Eight fuel terminal facilities owned and operated through a wholly-owned subsidiary. These have fuel holding tanks and access to major rail lines for transporting ethanol or other fuels. The Birmingham, Alabama facility is one of 20 in the U.S. capable of receiving and offloading ethanol and other fuels from unit trains.

• Transportation assets that include a leased fleet of approximately 2,200 railcars with an aggregate capacity of 66.3 million gallons as of March 31 dedicated to transporting ethanol and other products from the storage terminals to refineries and international export terminals under commercial agreements with the parent.

Much of the revenue and cash flow will be initially derived from commercial agreements with Green Plains. At the closing of the IPO GPP entered into a 10-year fee-based storage and throughput agreement, a six-year fee-based rail transportation services agreement, and a one-year fee-based trucking transportation agreement.

The partnership agreement provides for a minimum quarterly distribution of $0.40 per unit for each whole quarter, or $1.60 per unit on an annualized basis. This minimum quarterly distribution will require available cash of approximately $13 million per quarter. Pro forma distributable cash flow for 2014 and for the 12 months ended March 31 would have been $54.1 million and $54.6 million, respectively. Estimated distributable cash flow over the next year is approximately $57.1 million.

The parent owns the general partner, which owns the incentive distribution rights (IDRs). Additional available cash from operating surplus will be distributed according to the following schedule:

• First, 98% to all unitholders, pro rata, and 2% to the general partner, until each unitholder receives a total of $0.46 per unit for that quarter

• Second, 85% to all common unitholders and subordinated unitholders, pro rata, and 15% to the general partner, until each unitholder receives a total of $0.50 per unit for that quarter

• Third, 75% to all common unitholders and subordinated unitholders, pro rata, and 25% to the general partner, until each unitholder receives a total of $0.60 per unit for that quarter

• Finally, 50% to all common unitholders and subordinated unitholders, pro rata, and 50% to the general partner.

The IPO had been projected to price between $19 and $21 per unit, giving a midpoint yield based on the minimum quarterly distribution of 8% annualized. But demand for the units was weak, so it actually priced at $15, for an annualized yield of 10.7%. That’s very attractive for a midstream MLP, but keep in mind that this is no typical midstream MLP. There are some very particular risks involved.

In this week’s Energy Letter, I go into the particulars of the Renewable Fuel Standard (RFS), the legal mandate that governs U.S. policy on renewable fuels. As the S-1 filing for the IPO notes, there is a special risk that ethanol consumption mandates set by the RFS could change:

“The ethanol industry is dependent on government usage mandates affecting ethanol production and any changes to such regulation could adversely affect the market for ethanol and our results of operations. Future demand will be largely dependent upon the economic incentives to blend based upon the relative value of gasoline versus ethanol, taking into consideration the relative octane value of ethanol, environmental requirements and the RFS II mandate.”

The U.S. Environmental Protection Agency (EPA) has in fact proposed reducing that mandate, which has vested ethanol interests lobbying hard to maintain the status quo. There are several elements at play here, which you can read about in this week’s Energy Letter.

Another risk is that while this partnership technically has no direct exposure to ethanol prices, investors in midstream oil and gas MLPs know that soft commodity prices will hurt the unit prices of the MLPs that transport oil and gas. So volatile ethanol prices would be expected to have an impact on the price of the MLP units. Ethanol prices are also influenced by corn prices. So the MLP has exposure to multiple commodities.

Finally, being the first MLP in this space has some risk with respect to tax implications. As noted in the S-1, GPP did not seek a ruling specific to its business:

“We have not requested a ruling from the Internal Revenue Service, or IRS, with respect to our treatment as a partnership for U.S. federal income tax purposes. The IRS may adopt positions that differ from the conclusions of our counsel expressed in this prospectus or from the positions we take, and the IRS’s positions may ultimately be sustained.”

Of particular note, the S-1 states:

“If the Internal Revenue Service were to contest the U.S. federal income tax positions we take, it may adversely impact the market for our common units, and the costs of any such contest would reduce distributable cash flow to our unitholders.”

Thus, this MLP has a set of risks that are different than that of typical midstream oil and gas MLPs. Investors clearly felt like 8% wasn’t enough yield given those risks. This is one that I would personally avoid given all the uncertainty and the number of outside influences that can affect the underlying business.  

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

Portfolio Update

Used Ships at a Buoyant Price  

Getting the hand-me-down Chevy from Dad instead of a new BMW is bad enough. Having to pay Dad more than what he bought it for is worse, way worse.

That seemed to be the grudge GasLog Partners (NYSE: GLOP) unitholders were nursing last week, after their partnership announced the purchase of three liquefied natural gas carriers from parent GasLog (NYSE: GLOG) for $483 million, thereby increasing the size of its fleet to eight ships.

Almost exactly a year earlier, GasLog had purchased those same three ships from their charterer BG Group for $468 million. It then got a year’s worth of income out of them using up a year of their charter terms in the process, before turning around and selling them to its MLP affiliate at a $15 million markup.

To cover a portion of the purchase price GLOP launched a 7.5 million unit secondary offering that priced at a 4.4% discount to the prior day’s close and set its buyers back as much at the next one,

The partnership justified paying 9.4 times the ships’ projected EBITDA over the next year by noting that the deal would help it increase its quarterly distribution by 7% to 10%, provided the board goes along with management’s recommendation. Between the prospective payout hike and the markdown of the units, the annualized yield based on the expected third-quarter distribution is now up to 8.1%.

Since MLPs like GLOP are often valued based on their yield, it’s reasonable to assume buyers will help the unit price rebound in due time, whether after the next distribution hike or after a year or more of promised double-digit payout growth.

The trouble is that rapid distribution growth will be accompanied by the even faster accumulation of debt, while the benefits of that debt-fueled growth will have to be shared with the sponsor by means of incentive distribution rights.

When MLPs were hot last year, there’s a good chance a dropdown like this would have been well received. But in today’s tougher stretch, a fat yield clearly isn’t enough for limited partners doubtful about the longer-term value of a transaction with self-interested sponsor.

We think the yield will prove too tempting in the end. But if it does and the unit price bounces, we’ll be looking to cut and run on this financing vehicle. In the meantime, we’re downgrading GLOP to a Hold.

— Igor Greenwald