Big Profits from Pipelines

By Roger Conrad • June 30, 2011

If the recent round of US economic data tells us anything, it’s that growth continues at the same sluggish pace it’s held since the bottom in early 2009. And there are no obvious catalysts to pull it higher, even as governments and central banks begin to exit the business of providing fiscal and monetary stimulus.

The upshot is we can expect more of the same in coming months. Any business that depends on faster economic growth can look forward to another tough year. Ditto for any company that depends on accelerating government spending to grow. And businesses depending on the less affluent and a drop in unemployment will also suffer.

For investors, any stock that’s run up on the premise of faster growth is likely to hit a wall. Conversely, however, any business that proves its resilience in this environment is likely to command a sizeable premium. And few businesses are in better shape now than energy pipelines.

Pipeline companies’ primary business is operating vital infrastructure. And the customers they rely on are arguably the strongest in the world–major energy companies like ExxonMobil (NYSE: XOM).

The ExxonMobils of the world had no problems paying their bills, even with oil bottoming out at less than $10 a barrel in the late 1990s. They maintained strength during the crash of 2008, as oil plummeted from over $150 to less than $30, and natural gas fared worse. And today they’re swimming in cash, with little debt and plenty of plans for growth, as global demand for US-produced natural gas liquids (NGL) swells.

Even after triggering the worst energy accident in a generation, BP (NYSE: BP) kept paying its bills to owners of pipelines and other infrastructure, just as it kept current on bond interest payments. Now it’s actually paying dividends again.

No other industry has that kind of backing. And it means once a pipeline company signs a contract, it can count on the revenue to keep flowing, come what may. Some contracts have a component based partly on the level of energy prices or throughput. Many today, however, are capacity-based. That means the pipeline owner gets paid no matter how much energy the producer winds up shipping.

Second, here in mid-2011 owners of pipelines and other energy infrastructure enjoy unprecedented demand for new projects. At the root is accelerating production from America’s shale oil and gas development and the ongoing discoveries of richer reserves.

Again, the customer base is the same. ExxonMobil, for example, is now the largest natural gas producer in the US. Meanwhile, companies like EOG Resources (NYSE: EOG) are ramping up their production of NGLs, which are increasingly popular substitutes for oil in a range of processes, including manufacturing plastics.

It works like this. Master limited partnerships (MLP) that own pipelines and related facilities talk to these extremely creditworthy customers about their production plans and what they need in the way of infrastructure to make them work. The MLPs then design projects to meet those needs, immediately signing the producers under long-term contracts. All the MLPs have to do is complete construction on time and on budget, which they’re very good at doing.

Here in mid-2011, profitability of new projects is further enhanced by record-low capital costs, for both new bond and new equity issues. Pipeline companies use a lot of capital. And whether you’re borrowing or issuing stock, it’s far cheaper to raise money when growth is slow and interest rates are generally low.

Today US corporate borrowing rates are at their lowest level in 50 years. Pipeline companies are issuing debt maturing in 30 years or more at interest rates of 6 percent and lower. That’s barely half what many were paying just a couple of years ago for short-term debt.

The bottom line is there’s rarely been a better time than now to finance new projects, which, in turn, feed more growth. And there’s rarely been a better time to lock away contracts with what are arguably the world’s most creditworthy customers.

Every time a new project is announced, the MLP’s cash flow forecast increases. More often than not, that means a distribution increase, which pushes unit prices higher, triggering capital gains for investors.

No Competition = More Mergers

One question we get from investors is if the pipeline business is so good, why isn’t there a flood of new competitors–who will eventually take the profitability out of the business by flooding the market with bids for projects?

That’s a cycle that plagues other businesses, notably construction. And when there’s a crash, the builders and even asset owners get clobbered.

That dynamic, however, doesn’t exist in the pipeline and energy infrastructure business. For one thing, even smaller facilities are expensive to construct, ruling out all but a handful of bidders.

The Lone Star Energy venture between 70 percent owner Energy Transfer Partners LP (NYSE: ETP) and 30 percent owner Regency Energy Partners LP (NSDQ: RGNC), for example, announced this month, will build a fractionator to separate the elements of natural gas liquids. The cost of $350 million to $375 million is only a fraction of the $1.925 billion paid by the partners for their venture’s initial assets, NGL facilities owned by privately held Louis Dreyfus.

But it’s a cost well out of reach of most companies, including those in the energy business. That’s a major reason so many MLPs have pursued scale via mergers, acquisitions and construction–because it means greater ability to finance for faster growth.

Wall Street firms, of course, can raise that kind of money for the right customer when the market is booming. And as MLPs’ routinely successful equity and bond issues demonstrate, demand is high from institutions and individuals alike.

Prospective new entrants, however, face two other hurdles that are basically insurmountable. One is the close relationship between owners of pipelines and major energy companies. The other is NIMBY–the public’s “not in my backyard” attitude towards all new energy infrastructure.

Not so long ago major producers owned most of today’s US energy infrastructure assets. In many cases they spun off or sold these for cash in order to spur development of new reserves and output. But the facilities remained closely connected to their operations, and their owners became partners.

Up until recently the discoveries and development of low-cost oil and gas overseas had kept US production in steady decline for decades. With the revival of production via shale discoveries, however, this infrastructure is suddenly vital again, and so are the partnerships between big energy and infrastructure owners. Those alliances deepen with every new expansion project and as a result become increasingly difficult for a new entrant to break.

Meanwhile, NIMBY has made siting of “greenfield” energy development–including infrastructure–difficult to impossible in most areas of the country. Even the proposed Keystone XL pipeline, which could drastically reduce overseas energy imports to the US, has been held up on environmental grounds, with the Environmental Protection Agency now challenging the US State Dept’s standards in approving/disapproving the deal as too lax.

The result is the only place to build new energy infrastructure capacity is along existing right-of-ways owned–you guessed it–by the current roster of pipeline companies. Anything to do with oil and gas can count on a raft of lawsuits if it tries to find a real undeveloped location.

The lack of entry points leaves acquiring existing pipeline companies the only real way to get into or meaningfully expand in the business. That’s the primary motivation behind an emerging bidding war for major pipeline company Southern Union (NYSE: SUG), a battle that will only enhance the value of every pipeline and energy infrastructure company.

Southern Union owns some 15,000-plus miles of natural gas interstate pipelines linking fields of Texas and New Mexico with high-demand markets in the Midwest and Southeast. The company’s 5,500 miles of gas gathering pipelines treat, process and transport gas and gas liquids. And it owns gas distribution utilities in Missouri and Massachusetts serving half a million users. The company also owns one of North America’s largest import terminals for liquefied natural gas (LNG).

On Jun. 16 Energy Transfer Equity LP (NYSE: ETE)–the general partner (GP) for MLP Profits Portfolio picks Energy Transfer Partners and Regency Energy Partners–announced a merger agreement with Southern Union.

Under terms of the deal, Energy Transfer Equity agreed to swap each share of Southern Union for a new security worth a minimum of $33 per share and paying a quarterly dividend of at least 8.25 percent. Final value would depend on performance but could be worth up to $53 according to management.

For Energy Transfer Equity the appeal of adding Southern Union is manifold. First, it would nearly double its pipeline capacity to over 44,000 miles of natural gas pipelines with roughly 30.7 billion cubic feet per day of capacity. It will also reach Florida–where gas accounts for roughly half electricity generation–for the first time. The deal will be immediately accretive to Energy Transfer Equity cash flows, once it passes muster with stockholders of Southern and the various regulatory agencies. The latter include the Federal Energy Regulatory Commission as well as Missouri and Massachusetts officials.

For Energy Transfer Partners and Regency, the deal is exciting for potential asset “drop downs” from the general partner. Drop downs basically transfer assets from the books of the GP to the LP, which finances them as purchases funded by debt and equity issuances.

Funds are then transferred to the GP, which usually elects to take some of the proceeds in additional units of the LP to preserve percentage ownership.

From the GP’s point of view drop downs provide ready cash. They also improve tax-efficiency of cash flows from the assets, which, in turn, boosts after-tax cash flows. In this case drop downs would also enable Energy Transfer Equity to finance the $1.315 billion in existing Southern Union debt and loans that will mature between now and August 2013.

For Energy Transfer Partners and Regency, drop downs will immediately boost cash flow and almost certainly spur distribution increases. That will almost certainly push their unit prices higher as well.

After the close on Jun. 23, however, Williams Companies (NYSE: WMB) submitted a rival bid of $39 per share for Southern Union. That’s clearly a superior offer on its face. Not only is it higher than Energy Transfer Equity’s $33 bid, but it’s entirely in cash. The only risks to accepting are if Williams fails to win the necessary regulatory approvals, or if it fails to secure needed funding.

For Williams the primary appeal is to acquire pipelines and infrastructure that would give the company control over nearly 25 percent of US gas supply shipments. That would yield numerous opportunities for savings and synergies without diluting existing shareholders. It’s also a strategic move that’s right in line with Williams’ plan, announced in February, to spin off all of its oil and gas exploration business and focus on energy infrastructure.

It will almost surely mean substantial asset dropdowns for Williams Partners LP (NYSE: WPZ) and therefore higher distributions and unit price appreciation. That’s because the purchase price of $4.86 billion will have to be met in cash. Adding in the $1.315 billion in Southern Union debt needing refinancing, that’s $6.175 billion in financing needs. Throw in $700 million in the acquirer’s own refinancing needs through 2012 and the total capital need is 40.9 percent of Williams Companies’ market capitalization.

The easiest way by far to raise that money without excessive dilution will be to drop down assets to the LP. And that, again, means higher distributions and, ultimately, capital gains for investors.

Winners and Winners

It’s always highly speculative to try to forecast the results of bidding wars. At this point Southern Union’s board has reaffirmed its commitment to Energy Transfer’s offer, while pursuing more details of Williams’ offer.

For its part, Energy Transfer stated this week that it still views its offer as “superior,” despite an initial target value of $33 versus $39 for Williams. Ironically, that appears to be the case for two significant investor groups, individual investors and Southern Union executives who may wind up tilting the balance one way or the other.

Energy Transfer Equity’s offer is tailored to management’s tax concerns and keeps them around, both as executives and via equity ownership. Individual investors, meanwhile, are promised a tax-advantaged yield superior to most else in the market that’s based on very secure assets and has an opportunity to grow. That’s not as sure and immediate as cash. But, ultimately, it could prove a lot more profitable.

All that notwithstanding, my view is Energy Transfer Equity will have to sweeten the terms of its offer to prevail. Unsolicited bids like Williams’ have a tendency to become hostile. And once they do, it’s very difficult to pull them off, even when a company is 77 percent owned by institutions, as Southern Union is.

The real question here is almost certainly whether Energy Transfer is prepared to work with Southern Union’s management to come up with a deal that’s clearly superior, even if it doesn’t match $39 per share in cash. If it does, it will win. If it doesn’t, Williams will win.

Either way, we’re now seeing pipelines grab a higher value in the market place. And we almost certainly haven’t seen the last deal in this sector.

As for the bidders, the worst Energy Transfer Equity will do is walk away with a termination fee of at least $92.5 million plus expenses of up to $12.5 million. That can only be good news for Energy Transfer Partners and Regency, which continue to move aggressively in their midstream partnership to expand their NGLs transportation and processing capability.

Meanwhile, should Energy Transfer Equity have to pay more to win the bidding war, Energy Transfer Partners and Regency stand to gain even more, because a higher purchase price will almost certainly force more asset drop downs. These are likely to include the increasingly valuable pipeline from Texas to Florida, a state now producing half its power from gas and which will only use more in coming years.

The Lone Star Energy partnership announced it will build a 530-mile NGLs pipeline connecting Eagle Ford Shale production to a processing plant in Jackson County, Texas. The venture has also secured capacity on an Energy Transfer Partners’ owned NGL pipeline from Jackson County to major facilities in Mont Belvieu, Texas, including a 100,000-barrels-per-day NGL fractionation facility the pair expects to open by the first quarter of 2013.

These projects further weight cash flows at Regency and Energy Transfer Partners to energy midstream infrastructure, which increases reliability and, ultimately, distribution growth. Adding Southern Union assets will no doubt fire up growth further. But both are set for good things without them, particularly from these prices. Energy Transfer Partners is a buy up to 55, while Regency Energy Partners remains a buy up to 29.

As for Williams Partners, we continue to rate the MLP a buy up to 45 but would probably raise that if parent Williams Companies is successful with its bid. The LP continues to expand, locking in key infrastructure assets in the Bakken Shale area of North Dakota with the purchase of natural gas liquids pipeline last month. It has a 14.6 percent equity interest in the Aux Sable and Sable NGL partnership.

Note that all of the MLP Profits Conservative Holdings are major pipeline companies and are in rapid expansion mode. Genesis Energy Partners LP (NYSE: GEL), Spectra Energy Partners LP (NYSE: SEP) and Sunoco Logistics Partners LP (NYSE: SXL) continue to benefit from generous asset drop downs from deep-pocketed parents Spectra Energy (NYSE: SE) and Sunoco Inc (NYSE: SUN), respectively. Enterprise Products Partners LP (NYSE: EPD) and Magellan Midstream Partners LP (NYSE: MMP) have taken their general partners in house, gaining scale and lower capital costs needed to grow. Kinder Morgan Energy Partners LP (NYSE: KMP) is one of the oldest and largest MLPs and continues to expand steadily.

For more information on these companies, see our analysis of their first-quarter numbers and conference calls in the articles listed and hyperlinked below:

Conservative Holdings

Growth Holdings

Aggressive Holdings

Other buy-rated pipeline companies include Buckeye Partners LP (NYSE: BPL) and Plains All-American Pipeline LP (NYSE: PAA). Buckeye this month completed the $165 million purchase of 650 miles of refined petroleum products pipeline form BP North America, along with 10 million barrels of energy storage capacity. That will immediately add to distributable cash flow while boosting the MLP’s storage capacity by 19 percent. Storage like pipelines is a fee-for-service business, fitting very well with the rest of Buckeye. The MLP has boosted distributions for 28 consecutive quarters. Buckeye Partners is a buy up to 70.

Plains is a target of frequent reader queries, owning to the similarity of its business to many of our favorites. Its general partner is 35 percent owned by Occidental Petroleum Corp (NYSE: OXY) and 25 percent by investment firm Kayne Anderson. The focus is pipelines and related infrastructure, with growth targeted at 3 to 5 percent a year in distributable cash flow.

The company has a significant biofuels flow, subsidies for which could be at risk in current federal budget negotiations. But that’s unlikely to affect either cash flow or distributions even in a worst case. Meanwhile, the MLP is enjoying growth opportunities in the Eagle Ford Shale and is one of the few in its sector to enjoy an investment grade credit rating. With seven consecutive quarters of dividend growth under its belt, Plains All-American Pipeline is a buy up to 67.

The Next Round of Numbers

The books are now closing on the second quarter of 2011. Odds are the numbers will be just as robust for our favorite master limited partnerships as the first quarter was. That means more distribution growth and, ultimately, higher prices for our favorites.

The market volatility of the past couple months has dragged virtually every MLP Profits Portfolio holding lower. And judging from the reaction of some readers, there’s plenty of fear out there that could lead to more selling.

That’s par for the course during times of uncertainty. MLP units aren’t bonds or bank certificates of deposit. Rather, they’re equity in these companies. High dividend yields usually anchor prices over time. And a rising distribution always leads to a higher unit price.

In the near term, however, prices can be quite volatile. No one should ever forget the events of March 15, for example, when Enterprise Products Partners opened and closed the day above $40 per unit, but hit a low of $27.81 in between.

My view is still that the damage was due to a lot of trailing stop-losses being executed at the same time. Investors that sought to protect themselves were cashed out at horrifically low prices, while everyone else was made whole in a matter of hours.

In the final analysis, that extreme volatility was completely meaningless to Enterprise Products and its investors. And the same is likely to hold true this time around, just as it did during the Flash Crash of spring 2010 and its fear-drenched aftermath.

Those who kept their eye on the ball and stuck with strong MLPs are receiving higher distributions than ever, with the promise of more increases to come. But it’s always easy to succumb to the fear level of the market and abandon good positions on what proves to be temporary volatility.

One reason I like earnings season is it’s the one time a strong company has to call its skeptics to the carpet. Mainly, our MLPs are in the sweet spot. They continue to enjoy near-record low capital costs–Enterprise Products’ 57-year debt still yields barely 6 percent to maturity–at the same time they enjoy record opportunity for low-risk investment in energy infrastructure and production.

That’s a formula for rising cash flow and distributions that’s rarely been seen before. First-quarter numbers showed every sign both factors were set to continue for some time to come. So has the news flow on our MLPs since then, which has been chock full of low-cost financings, accretive asset acquisitions and new low-risk construction.

Below I list estimates and confirmed announcement dates for second quarter results. Estimates are courtesy of Bloomberg and are based on the timing of previous quarters’ release dates and conference calls. As a result, they’re subject to changes and shouldn’t be relied on fully.

Conservative Holdings

  • Enterprise Products Partners LP (NYSE: EPD)–Jul. 25 (confirmed)
  • Genesis Energy Partners LP (NYSE: GEL)–Aug. 5 (estimate)
  • Kinder Morgan Energy Partners LP (NYSE: KMP)–Jul. 21 (estimate)
  • Magellan Midstream Partners LP (NYSE: MMP)–Aug. 3 (estimate)
  • Spectra Energy Partners LP (NYSE: SEP)–Aug. 5 (estimate)
  • Sunoco Logistics Partners LP (NYSE: SXL)–Jul. 27 (estimate)

Growth Holdings

  • DCP Midstream Partners LP (NYSE: DPM)–Aug. 5 (estimate)
  • Energy Transfer Partners LP (NYSE: ETP)–Aug. 9 (estimate)
  • Inergy LP (NYSE: NRGY)–Aug. 9 (estimate)
  • Kayne Anderson Energy Total Return Fund (NYSE: KYE)–N/A
  • Targa Resources Partners LP (NYSE: NGLS)–Aug. 5 (estimate)
  • Teekay LNG Partners LP (NYSE: TGP)–Aug. 11 (estimate)

Aggressive Holdings

  • Encore Energy Partners LP (NYSE: ENP)–Aug. 5 (estimate)
  • Legacy Reserves LP (NSDQ: LGCY)–Aug. 4 (estimate)
  • Linn Energy LLC (NSDQ: LINE)–Jul. 29 (estimate)
  • Navios Maritime Partners LP (NYSE: NMM)–Jul. 26 (estimate)
  • Penn Virginia Resource Partners LP (NYSE: PVR)–Jul. 27 (estimate)
  • Regency Energy Partners LP (NSDQ: RGNC)–Aug. 9 (estimate)

As always, we’ll report the relevant data and analyze what it means for our MLPs as the numbers come in. Meanwhile, here’s what we’ll be looking for in the reports as well as in management answers to questions during the accompanying conference calls.

Distribution coverage ratio. This is the inverse of the payout ratio, expressed as profits divided by the quarterly distribution rate.

In general, the higher the coverage ratio is, the safer the distribution, but there are two caveats. First, profits are measured not as earnings per share but as distributable cash flow (DCF) per unit. DCF takes into account the fact that MLPs don’t pay corporate taxes and minimize earnings per share. Second, the more fee-based and less-commodity price sensitive an MLP’s DCF is, the lower a distribution coverage ratio it can sustain over the long pull.

A pure pipeline MLP, for example, can pay a safe distribution with a coverage ratio averaging 1-to-1 over a period of quarters, as its revenue is extremely predictable and secure. An energy producer should have deeper coverage–say, 1.4-to-1–to be considered equally safe.

Most MLPs report their coverage ratios. Alternatively, you can calculate them by subtracting maintenance capital costs from operating cash flow, not including one-time items.

Asset additions. MLPs increase distributions by adding assets, either by building them or buying them. New deals must be accretive to distributable cash flow to benefit general partners, so they’re never done otherwise.

Conference calls are often useful for progress reports on new construction or acquisitions in progress.

Debt financings. Very few MLPs have meaningful amounts of debt to refinance over the next couple years. That means they’re not vulnerable to a reprise of the 2008 credit crunch, as they can simply sit back and wait for better conditions before issuing new bonds or even equity units.

I’m looking to ensure against new vulnerability as well as progress on any outstanding refinancing needs.

Challenges and contingencies. Every business encounters challenges from time to time, especially if its goal is to grow investors’ wealth. Environmental hurdles and safety regulations are ever-present in the energy business. So are lawsuits. Reading from Genesis Energy LP’s (NYSE: GEL) most recent Form 10-K filed with the Securities and Exchange Commission: “We are subject to lawsuits in the normal course of business and examination by tax and other regulatory authorities.”

Most of these items amount to little more than the cost of doing business and are well provided for by management. Again reading from Genesis’ report: “We do not expect such matters presently pending to have a material adverse effect on our financial position, results of operations or cash flows.”

But as investors we do want to be aware if there is potential for worsening. Form 10-Qs also filed with the SEC are useful for this kind of information in between the annuals. Look under “Legal Proceedings.”

Dividend growth. We generally get the word on distribution growth a couple weeks or so before numbers are announced. On Apr. 14, for example, Enterprise Products Partners announced a distribution increase for the 27th consecutive quarter.

Of course, not every MLP does increase its distribution every quarter. But every increase is a sign of underlying strength at the MLP, and a good reason to hold on. Over time MLP prices follow distributions higher, though the pace is often uneven due to market events.

Changes in income mix. Since the 2008 debacle MLP management teams have generally been quite conservative. Companies like Energy Transfer Partners has strived to weight their revenue mixes more heavily toward fee-based businesses by buying and/or building energy infrastructure. This shields them from energy price swings and means they can sustain a lower distribution coverage ratio, though it may slow growth down the road.

We won’t necessarily react to a change in income mix with a change in buy/hold/sell advice. But such deals can induce us, for example, to move an Aggressive Holding into the Growth Holdings, as we did at one time with Williams Partners when it merged with its pipeline-holding sister MLP.

Not every MLP we own stacks up equally on all of these criteria. Our Conservative Holdings do best, followed generally by our Growth and Aggressive Holdings. That’s clear from the safety ratings of each.

However, MLPs that don’t stack up well for safety can be screaming buys for more aggressive investors, if they offer offsetting growth potential and yield. That’s why we recommend three groups of MLPs, so investors can line up their holdings within their own risk/reward parameters.

It’s all about what you value. Make sure what you hold matches with your own preferences. If you want only yield and safety, for example, you should weight more heavily to the Conservative Holdings. Buy Aggressive Holdings only if you don’t mind taking a bit more risk for a greater reward.

Questions and Answers

Here are answers to some questions asked by MLP Profits readers over the past week.

In a recent article on the continuing consolidation in the utilities sector, an analyst stated that practically every utility today is thinking flattened growth of demand for energy. There has been a deceleration of electricity demand over the last several decades. What does this mean for the U.S based pipelines that transport natural gas if demand for electricity is in fact flat going forward?

First off, forecasts for energy supplies, prices and demand don’t have a very good track record. But the Energy Information Administration (EIA) does provide some pretty good statistics for past demand in electricity. And based on their information, US power demand growth on a percentage basis has definitely declined over past decades.

This is in part due to the law of large numbers. The bigger something gets, the harder it is to produce a large percentage gain. That’s one reason emerging market economies grow so much faster than developed ones–it’s a lot easier to move the meter.

The current long-term projection of the EIA is for 1 percent annual demand growth in the US through 2020. That doesn’t sound like much, and it is a deceleration from previous decades’ growth rates. On the other hand, it’s still an enormous number for a system a large as the US. It’s also making some pretty aggressive assumptions regarding energy conservation that may or may not be achieved. Either way, we’re talking a lot of new power that’s got to come from somewhere.

Second, roughly a third of the coal-fired capacity in the US is likely to be shut down over the next 10 years. Even if President Obama is defeated in 2012 elections and Environmental Protection Agency (EPA) rules on carbon dioxide emissions are overturned in 2013, it won’t alter the fact that America’s coal-fired power fleet is aging.

The 6,000 megawatts of plants American Electric Power (NYSE: AEP) plans to shut down to comply with EPA rules average more than 50 years in age. They’re increasingly uneconomic to run in any case.

That’s a lot of capacity to bring off the market, and it’s set to be matched by companies across the country, particularly in the Northeast, where most of the old plants are. And it doesn’t include the nuclear plant capacity likely to come off line.

Exelon Corp (NYSE: EXC) has already announced the shuttering of the Oyster Creek nuclear plant in 2019, 10 years ahead of schedule, due to New Jersey’s insistence that it build massive cooling towers at the site. The US Dept of Justice is apparently teaming up with the Nuclear Regulatory Commission (NRC) to override the state of Vermont’s veto of a new 20-year license granted to Entergy Corp’s (NYSE: ETR) Vermont Yankee nuclear plant.

But it’s far from certain what the verdict will be in the courts or whether it will come soon enough to avoid a shutdown. Entergy’s Indian Point (New York) and Pilgrim (Massachusetts) nuclear plants also face opposition to staying open, as the NRC considers relicensing. And shutting any of them will again mean a lot of generating capacity that needs to be replaced.

At this point there’s still a lot of misguided belief in the public and apparently among many politicians that renewable energy, like solar and wind, can replace this capacity. That’s impossible, since the even the biggest wind farm generates less than 200 megawatts of power versus 1,000 for an average coal or nuclear plant. But even if government overrides the market, there will still have to be spare capacity for when the wind doesn’t blow or when the sun doesn’t shine.

The only thing that can pick up the slack here is natural gas. Only gas-fired power plants can be built to scale and swiftly enough (18 months as long as enough pipeline capacity is in place) to replace shuttering plants as demand continues to rise.

Nothing is a sure bet. I think fuel switching and 1 percent annual demand growth are pretty immutable forces. But even if you don’t believe me, consider that pipeline and other energy infrastructure is not built in this country unless it’s pretty much fully contracted ahead of time.

We saw clearly in late 2008 that this infrastructure is still used and the dollars flow to its owners, whether oil is over $150 or less than $30. And despite natural gas prices’ slide from upper teens to lower single digits since late 2005, the same is true for gas infrastructure.

That’s a lot of revenue security for owners of pipelines. And as long as those dollars flow, so will their distributions.

Say there’s an explosion on a pipeline owned by a master limited partnership, with massive destruction of property and loss of life. Are unit holders liable if management is charged with crimes? Could we be sued for property damages?

“Limited partner” means your potential exposure ends with the amount of your investment. In other words, an MLP can go bankrupt and its price can go to zero. But you’re not going to be sued beyond that point.

Obviously, we don’t want to hold anything that goes to zero. And energy is a dirty and dangerous business. Even wind and solar farms kill wild life. And if a multi-ton turbine should come loose, anyone in its path wouldn’t stand much of a chance.

That being said, accidents throughout the energy industry are extremely rare. Pipeline leaks and even explosions have been much in the news lately, as opposition to shale gas drilling has ramped up in many areas. The fatal explosion in PG&E Corp’s (NYSE: PCG) territory has also raised awareness of aging infrastructure, particularly gas distribution systems in long-settled areas of the country.

On the whole, however, the industry’s record is quite solid, very likely in part because companies know the risks of a misstep. It also needs to be said that companies are heavily ensured against such calamities. Leaks in Enbridge Inc’s (NYSE: ENB) pipelines this year, for example, have barely put a dent in profitability, despite massive publicity.

One can always imagine a calamity that overwhelms insurance coverage and has the public out for blood. And no MLP is anywhere close to the size of BP, which did survive such a catastrophe when its Macondo deepwater well in the Gulf of Mexico exploded. That’s one reason why no one should have all their money in MLPs, or any one sector for that matter.

Every investment has risks. And safety troubles in a worst-case are a risk to pipeline stocks and MLPs. These companies, however, are immune to a great many other risks where there’s a far more clear and present danger. And barring the worst-case, they’re growing and paying out big yields. That, in my mind, makes them worth taking the ever-present but remote risk of an accident.

The Sand Dune Lizard is highly likely to be placed on the endangered species protection list in the near future. West Texas and eastern New Mexico oil and gas properties will be significantly and negatively impacted when this occurs. What effect would you anticipate on the value of MLP producers and pipeline owners?

As with safety, environmental concerns are a part of doing business for energy companies. It’s the very rare producer or infrastructure owner that isn’t the target of at least one lawsuit. That keeps the legal teams of MLPs busy. But in practice it has little impact on profits and distributions.

If what you say is true about the Sand Dune Lizard, energy companies will have to figure out a way around it. That will no doubt cost money, which if experience is any guide will be passed along to energy users. The Permian Basin of West Texas and New Mexico has been drilled for years, and much of the new output is actually from reserves that have been long defined and are now economic to drill using new technology. That should make it lot easier to made adjustments in this region than say in the Marcellus Shale, much of which has never been drilled extensively for oil and gas.

One could imagine a scenario in which production costs rose at the same time energy prices are falling. In fact, oil prices in the US have now fallen under $90 a barrel and gas has slumped back toward $4 per million British thermal units. And sooner or later that will force at least some producers to shut in capacity.

Much natural gas production recently, for example, has been supported by the newfound popularity of natural gas liquids that occur with it, for example the Eagle Ford Shale region of south Texas. NGLs are a low-cost substitute for oil in many industrial processes, such as manufacturing plastics. US NGLs are being exported in record amounts, which shield them from the US gas and oil market price volatility. But low global oil prices would certainly make them a lot less profitable to produce and could restrict production.

Even in this scenario, however, our MLP Profits Portfolio Holdings are well protected. Our producers are hedged on selling prices for oil and gas, and our pipelines and infrastructure companies are protected by long-term contracts. As 2008 proved, they get paid no matter where energy prices go. That means we get paid with distributions, even in the extremely unlikely event that Sand Lizard protection does trigger a quantum leap in operating costs.

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