Although we cover the entire master limited partnership (MLP) space, when it comes to actual investment recommendations, we focus our coverage on midstream MLPs that derive a majority of their income from fee-based contracts. That means they get paid based on the volume of energy products they store or transport, so they’re only indirectly exposed to volatile commodity prices.

Nevertheless, one of the exploration and production MLPs that went public last year could offer an intriguing opportunity. Atlas Resource Partners LP (NYSE: ARP) is currently rated “hold” in the MLP Profits “How They Rate” table and has a safety rating of “0.” And its units are down a little more than 27 percent from their 52-week high.

However, thanks to rising production following a series of acquisitions last year, management has raised its 2013 distribution guidance to a cumulative payout of $2.35 to $2.50 per unit. Even at the low end of that range, the resulting yield is over 10 percent at current unit prices.

The MLP just boosted its latest quarterly distribution to $0.48 per unit, an 11.6 percent rise from the prior quarter and a 20 percent jump from its first full quarterly payout. Its distributable cash flow (DCF) increased about 30 percent sequentially to $18.5 million, which was sufficient for a coverage ratio of 1.1.

Shortly after the MLP was spun off from Atlas Energy LP (NYSE: ATLS), our initial take was that its outsized exposure to natural gas would pose a significant headwind over the next few years, as the abundance of natural gas supply continues to weigh on prices.

We also noted that its general partner’s (GP) incentive distribution rights entitle it to an increasing percentage of the distribution as it grows over time. And based on management’s targeted payout range, the distribution could hit the threshold otherwise known as the “high splits” some time later this year. Once the quarterly payout reaches $0.60 per unit, the GP will receive 48 percent of the incremental cash available for distribution above and beyond that point.

That may sound esoteric, but what it means in practice is that it’s difficult for common unitholders to enjoy further distribution growth once the payout rises above that level. But depressed unit prices and the prospect of a 10 percent-plus yield may make such considerations largely academic.

But what about the MLP’s sizable exposure to natural gas? After all, such high yields aren’t all that meaningful if they can’t be sustained. ARP owns an interest in over 10,100 oil and natural gas producing wells in key shale plays situated in Texas and Appalachia. And after last year’s acquisition activity, natural gas comprised an even larger share of ARP’s mix of production revenue during the third quarter than it did during the prior year.

Natural gas accounted for almost 81 percent of the MLP’s $24.7 million in production revenue during the third quarter, as compared to roughly 9 percent for oil and just over 10 percent for natural gas liquids (NGL).

To mitigate the risk from the vagaries of energy commodity prices, ARP has an aggressive hedging program. For instance, the MLP has already hedged 90 percent of its 2013 natural gas production at an average price of $3.89 per thousand cubic feet, which is about 5 percent higher than analysts’ consensus forecast for the average price of natural gas this year.

Meanwhile, management is further diversifying the MLP’s production mix via acquisitions. In late December, ARP closed on a deal to acquire proved reserves of 35 million barrels of oil equivalent (MMboe) in the Barnett Shale and Marble Falls near Ft. Worth, Texas. The former DTE Energy Co (NYSE: DTE) assets have estimated proved reserves of 24 percent oil, 33 percent NGLs, and 43 percent natural gas. 

While gas and oil production account for about one third of ARP’s overall revenue, the MLP also has an investment partnership business where it raises capital for its own drilling activities in concert with third parties. These investment partnerships are a key source of fee-based revenue, which provides some stability relative to its income from production. Because ARP shares the investment with these other entities, it earns ongoing fees from administration and oversight, well services, and gathering.

While well construction accounts for 48.6 percent of overall revenue, the latter three fee-based services account for 18.2 percent of revenue.

ARP’s near-term prospects may remain closely tied to natural gas, but future acquisitions could eventually change that. In the meantime, its fee-based revenue and rising production from acquisitions should support the distribution in the near to medium term.

Around the Portfolios

Enterprise Products Partners LP (NYSE: EPD) had a record year thanks to the high volumes resulting from production growth in the Eagle Ford and Haynesville Shale plays. It also benefited from strong demand for natural gas liquids (NGL) from a resurgent petrochemicals industry.

While fourth-quarter gross margin for natural gas processing and NGL marketing fell $66 million, that was more than offset by fee-based revenue, including record pipeline volumes for NGL, crude, refined products and petrochemicals that were up 13 percent from a year ago to a record 4.5 million barrels per day (bpd). Gross operating margin from onshore crude pipelines and services jumped 101.5 percent year over year to $135 million.

Meanwhile, growth in natural gas pipeline volumes was flat. NGL fractionation rose 15 percent to over 700,000 bpd, while NGL production fell 14 percent to 96,000 bpd.

For full-year 2012, Enterprise generated $4.1 billion in distributable cash flow (DCF), an increase of 10 percent from the prior year. That enabled the MLP to boost its cumulative distribution by 5.6 percent year over year to $2.57 per unit. About $1.2 billion of its DCF was attributable to the sale of non-core assets. That compares to about $1 billion in such sales for 2011. But even when 2012 DCF is adjusted lower by the amount of asset sales, the coverage ratio is still an ample 1.3.

By contrast, its DCF for the fourth quarter fell almost 38 percent to $886 million. However, the $543 million year-over-year difference in DCF can be explained by the variation in asset sales in the respective quarters. In the fourth quarter of 2011, the company sold $593 million worth of assets versus $31 million in the most recent quarter. Excluding assets sales from both quarters, DCF rose by $39 million. And that was sufficient for a very conservative coverage ratio of 1.5.

Enterprise has increased its distribution for 34 consecutive quarters, with the latest quarterly distribution of $0.66 per unit representing a 6.5 percent increase from a year ago.

The MLP undertook $2.9 billion worth of growth projects last year, completing most of them on or below budget and on time or ahead of schedule. Among these projects was the construction of a sixth NGL fractionator in Mont Belvieu, Texas, a major NGL hub near the Gulf Coast. Enterprise also expanded its natural gas and NGL pipeline systems in the Eagle Ford.

As for future growth, Enterprise has invested roughly $7.2 billion in major capital projects through 2015, with about a third scheduled to commence operations this year. A majority of these projects will generate fee-based revenue and will therefore be accretive to cash flows, starting sometime during the second quarter.

Management is continuing to transition its natural gas processing segment to a fee-based business. Fee-based natural gas volumes rose 15 percent during the fourth quarter to 4.7 billion cubic feet per day. All of these developments support distribution growth.

Currently yielding 4.7 percent, units of Enterprise Products Partners continue to rate a buy on dips to 55 or lower in the Conservative Portfolio.