Why are they selling MLPs (today/this week/this month)? Why is Acme Partners down so much?

You’ll not be surprised to learn that I’ve fielded plenty of such questions over the last year. Experienced master limited partnership investors know the drill and understand that MLPs can be as volatile as any group of equities.

But even old hands with plenty of battle scars (and great long-term returns) want to understand what’s motivating the sellers. Do they get something we’re all missing?

We tend know the bull case for the sector by heart. But that’s not much help in understanding the slump and its persistent toll. And understanding is what we need to make the most rational decisions possible, since what we don’t understand we tend to fear.

It’s not enough to say that MLPs will bounce back because they always have, or because they’re akin to toll roads. It’s not even enough to note that most don’t directly traffic in crude or that some in fact operate in the downstream fuel sector enjoying its best stretch in years.

We need to study the bearish arguments to weigh risks as accurately as possible, and to assess when the trend might finally reverse.

For instance, while it’s true that relatively few MLPs have direct exposure to crude, more have indirect exposure by way on natural gas liquids that compete with crude as fuel feedstock. And more still have benefited from heavy demand for gas gathering and processing infrastructure in shale basins. Most of these basins wouldn’t have developed nearly as fast without $100-a-barrel crude, and they may never reclaim the old growth trajectory.

That’s hardly the end of the road for MLPs, tasked not only with facilitating production for the world’s most dynamic drillers but also with processing and shipping their output, as well as distributing it to hundreds of millions of energy consumers who are among the world’s richest.

But if low energy prices were to persist for years more processing and shipping contracts would expire, and need to be renegotiated in a very different environment, threatening the cash flows MLPs rely on to pay their distributions.

Is $40 crude sustainable over years? Almost certainly not. But here’s there thing: the market isn’t obligated to adequately reflect the long term. The market in the short term is a voting machine, not a weighing one, and is notoriously susceptible to short-term factors. If crude gets back to $80 in a couple of years or natural gas to $6, there will be plenty of time to bid all the beaten down tickers back up. But no one is going to trade based on those probabilities at this summer’s prices, and certainly not while eager sellers keep coming out of the woodwork.

With prices so weak it’s hard to think that Plains All American (NYSE: PAA) will be the last MLP to dim its distribution growth forecast. Of course we think none of our Best Buys will, and you may think the same about your holdings. But the warnings that have cropped up already and those that may still won’t exactly help to stem fund outflows.

This is another increasingly important consideration for MLPs. It used to be that they were mostly owned by retail investors prepared to hold them for a long time, in many cases until death.

But the sheer scale of MLP outperformance over the past two decades sparked feverish investor interest in the sector, resulting in a profusion of new active and passive MLP funds and an influx of institutional investors.


As of May 2014. Source: Wells Fargo

Institutions are not as content to buy and hold as Mom and Pop. Many have risk managers who insisted on cutting exposure at some of the most inopportune moments in the recent past.

A growing number of exchange-traded funds and exchange-traded notes has made it easier for everyone to get in and out quickly. ETFs and ETNs don’t offer the same tax advantages as a direct investment in MLPs, but they also don’t discourage sellers with a big deferred tax liability.

The net effect of these changes is that MLPs very recently have become easier to dump and, on average, harder to hold during times of stress.

And given the dramatic financing needs of the shale infrastructure and the intensified chase of yields amid low interest rates, MLPs clearly acquired more than their fair share of fair-weather fans over recent years.

As noted here 13 months ago (see “The Trend’s Not Your Friend in the End”) they assumed the growth and the capital gains would continue for years.

When the shale story curdled these latecomers likely soured on their investments faster than most. Many didn’t even have the experience of 2008-09 to lean on. Plenty decided they weren’t  the buy-and-hold type if they’d ever thought so, and did not have deferred taxes worry about while rushing for the exits.

So all of these factors have contributed to the present state of things: low oil prices, weak sentiment and a twitchier investor base have all taken their toll. It doesn’t mean that they’ll keep taking it indefinitely, nor will acknowledging those drags somehow make them stop.

Knowing what’s weighing on the sector does lend me a good deal of confidence that the current market malaise will lift once the commodity pricing environment improves. And the way commodity markets often work is that the more pain there is in the near term the less likely it is to stick around for the long run.

Oil at $45 a barrel has discouraged a lot of the longer-term investment needed to keep crude below $75 in the years to come, as well as a lot of the drilling that could have kept natural gas plentiful and cheaper for longer.

The good news is that the sellers of the recent weeks don’t appear to be focused on the long run. If they were, we’d have a lot more reasons to be worried.