From The Wall Street Journal
Pipeline stocks are back from the dead.
Revved up earnings, thanks to record U.S. oil and gas production, and clarity on a federal tax ruling have lifted shares of energy master limited partnerships, which own and operate pipelines.
These companies, known as MLPs, have helped themselves as well. They’ve sold assets to pay down debt, reduced dependence on stock offerings to raise cash, and simplified corporate structures to eliminate governance issues. Over the past six months, the benchmark Alerian MLP Index has risen 9.3%, outpacing the S&P 500’s 7.4% gain.
MLPs, which avoid corporate taxes by paying out earnings to shareholders, gained popularity with yield-chasing investors over the last decade.
A period of historically low interest rates coincided with the shale boom, which necessitated big investments in infrastructure to carry oil and gas from new drilling fields unlocked by modern extraction techniques. More recently, rising interest rates and a prolonged slump in energy prices that prompted MLPs to cut their once sacrosanct distributions took some of the shine off the stocks.
“The market voted with their feet in late 2015 and 2016 and investors got a lot more picky in what they wanted in a stock,” said Becca Followill, senior managing director at U.S. Capital Advisors LLC in Houston. “The last few years you’ve seen these companies get fixed.”
From a peak in August 2014, the Alerian MLP index lost 63% before bottoming out in February 2016. MLP shares rebounded somewhat alongside rising U.S. oil prices but were dealt a fresh blow in March.
On March 15, the Federal Energy Regulatory Commission announced a ruling that threatened tax advantages for some pipeline-owning MLPs. Shares of some of the country’s largest pipeline operators, including Enbridge Energy Partners LP and Williams Cos., plunged more than 10% that day.
But regulators offered additional details last month around the ruling that alleviated many investor concerns. The sector index has since climbed 7.1%.
Pipeline operators have also broadly benefited from resurgent production in nearly every drilling region in the country and commodity prices that have stabilized amid strong demand. Ms. Followill wrote in a note to clients that third-quarter earnings results were broadly the pipeline sector’s best since 2014.
As Energy Transfer Partners LP Chief Executive Kelcy Warren put it earlier this month: “A monkey could make money in this business right now. It’s not hard.”
Analyst and investors also point to a big reduction in equity issuance by pipeline operators, which in earlier years made a habit of tapping equity markets whenever they needed cash. Such offerings dilute the value of existing shares. Through July, MLPs issued $3.7 billion of equity, compared with nearly $36 billion in 2014, according to Goldman Sachs Asset Management Group.
Pipeline operators have in many cases turned to private-equity firms to make up the difference, selling assets and stakes in major projects to big investment firms, such as Blackstone Group LP,KKR & Co. and Global Infrastructure Partners. Such firms have flocked to the pipeline business because it has historically been a way to invest large sums and receive reliable returns at a time when other deals, such as leveraged buyouts and other infrastructure projects, have become more scarce.
There is more than $135 billion of ready-to-invest cash in North America-focused energy and infrastructure funds, according to private fund tracker Preqin.
“Private equity is filling the gap,” said Jason Downie, managing partner at Tailwater Capital, a Dallas firm that recently raised $1 billion to invest in pipelines and other energy infrastructure.
On Wednesday, for instance, Tailwater’s Silver Creek Midstream, LLC agreed to pay Genesis Energy, L.P. $300 million for a Wyoming oil pipeline system. Genesis said it would use the cash to pay down its debt.
Another trend that has been drawing investors to MLPs are mergers designed to streamline corporate structures and remove governance issues.
For instance, Energy Transfer Partners, Mr. Warren’s company, is merging with its parentEnergy Transfer Equity LP in a deal scheduled to close later this year. A key element of the combination will be the elimination of incentive distribution rights which entitle Energy Transfer Equity to a larger cut of payouts from Energy Transfer Partners than other shareholders.
Such complexities are unique to MLPs and have “kept some investors on the sidelines,” said Jeff Jorgensen, portfolio manager in Brookfield Asset Management Inc.’s public equities arm.
The wave of simplification deals “demystifies what was a very niche asset class and gets the focus back on fundamentals,” he said.
