Tax-Smart Income Hunter November Issue
OK to Good Q3 Results in the MLP Sector
Over the past month, I have been over the results, with varying degrees of scrutiny, of the earnings reports and announced distributions of about 120 companies in the MLP sector. My biggest impression is that the spread of results across the sector is much more diverse than when everyone was making a lot of money at $100 per barrel oil. I was quite surprised at the number of companies that posted very good results for the third quarter. These were MLPs that stood apart from a crowd that is mostly focused on controlling costs and keeping business close to normal as the energy sector works through the current low price environment.
As I noted in my email sent to subscribers last week, about two-thirds of the MLP universe announced distribution increases for the third quarter, and only five reductions were announced, not including variable payout partnerships. There is a move to lower distribution growth rates, but most of the companies organized as partnerships plan to keep growing payout, but likely at a slower pace than in the recent past. The market has more than priced in the slower growth rate, with the current average yield on infrastructure MLPs at 7.3%, and many yielding close to double digits or higher. The last time MLP yields moved this high was in 2009, and the following year was one of the best in the short history of the sector for price gains. Although, with some MLP values down 50% over the last year, we need some nice gains just to get back to even if you have holdings that were established in 2014 or early this year. I know that I have a couple of those types of MLP positions.
One energy sector meme that I now read everywhere is that “lower for longer” energy prices is the accepted future of crude oil and natural gas values. It scratches my contrarian itch when I see the same outlook from every source I read. I read this recently, and it sums up my thoughts about the current outlook for energy prices:
“It is axiomatic that just prior to a trend change, there will be maximum agreement that the trend will not and cannot possibly end.”
I am not sure what will trigger a move to higher energy prices, but I would bet that this will happen sooner rather than later. Much of the analyst community seems to forget that the natural global crude oil production decline rate is about 5% per year. Right now global consumption is 94 million barrels per day. Excess production comes in at 2 million bpd. Forecasts have consumption growing by 1.5 million bpd in 2016. With energy’s low commodity prices, $200 billion of planned production growth spending has been canceled or put on hold this year.
Without the capital spending, it seems inevitable that global production should soon start to slow, and fall below the daily consumption rate. Then the barrier to higher prices becomes the large amounts of crude oil in storage, such as the 490 million barrels in the U.S., about 120 million barrels above the 5-year average. I expect that when the market starts to see a drawdown of the crude inventory level, that will be when the price starts to move upward, possibly on a pretty steep trajectory.
One final point. The U.S. onshore production companies can bring in a new well in less than a month and there is a huge inventory of potential drilling sites. Offshore projects, almost anywhere else in the world take years, if not decades to develop and bring production online. The current low energy price environment is turning the U.S. into the global swing producer for crude oil. When the price gets back up to $60, the land-based producers can drill profitably and will do so. Offshore producers will need to wait for even higher prices before their potential projects become financially sustainable. I can see a scenario where production ramps up in the continental U.S. while the rest of the world does not invest in new production products, digging a production shortage hole that will take a long time to fill.
Consider this quote from Plains All American Pipelines CEO Greg L. Armstrong:
“Big picture, many of the larger exploration production companies are significantly reducing their international and deepwater spending, and increasing their focus on the U.S.”
Revamping Buy and Sell Recommendations for Subscribers
With the Tax-Smart Income Hunter still in a beta development phase, I want to make some changes concerning the buy and sell recommendations I provide for subscribers. The catalyst for this change comes from my review of the third quarter earnings reports in the MLP sector. With the energy sector, including most MLPs, in a bear market for share/unit values, I am finding a few shining lights in the darkness. These are companies with business or service offerings that allow them to thrive and grow right now. This tends to be reflected in their unit prices.
I will be working with our web developers to revamp how the Tax-Smart Income Hunter recommendations are transmitted to you, where they can be found on the Investors Alley website, and what information will be included to help you with your investment decisions. In these days of hard to find MLP returns I want to make sure you get information on those MLPs that have the best potential to provide positive returns.
I am still trying to work out how I want the recommendations list to look and function, but you can expect to see new, interesting MLP recommendations coming as early as next week.
Recommendations Update
As I discussed earlier, the recommendations list will soon change to list MLPs that can do better in the current energy markets. From the current recommended MLP lists, the income focused MLPs are a mixed bag.
Note that I am recommending sales of two portfolio positions, PAA and NTI.
Oneok Partners LP (NYSE: OKS) continues to hang in there with a modest 4% loss since it was added to the portfolio at the end of July 2015.
NGL Energy Partners LP (NYSE: NGL) is not even close to being in the trouble a 14% yield would indicate. The company has significant propane retail operations that will boost cash flow for the next two-quarters, and I expect the unit price will show significant recovery by late Spring.
Plains All American Pipeline, LP (NYSE: PAA) has born the brunt of much of the fears of lower crude prices affecting MLP values. I am recommending that PAA be sold to take a tax loss that can be used this year or carried forward. The money can be reinvested into the publicly traded general partner, Plains GP Holdings LP (NYSE: PAGP). PAGP yields 8% and will generate a higher rate of distribution growth when Plains reaches the point of per unit cash flow growth. That may not happen until 2017, but PAGP is more likely to have some dividend increases next year. PAGP is a 1099 reporting company.
I am also recommending selling and closing out open positions in Northern Tier Energy LP (NYSE: NTI). Northern Tier is going to be bought out by its GP sponsor, Western Refining, Inc. (NYSE: WNR). With refining spreads in Q4 that are much lower than the first 9 months of 2015, I don’t see any additional value to be gained in the NTI units. The position has gained about 9% total return since it was recommended on August 26.
The news is somewhat better in the growth focused recommendations list.
The refining company sponsored MLPs, Valero Energy Partners LP (NYSE: VLP) and Phillips 66 Partners LP (NYSE: PSXP) are staying flat as the rest of the MLP space declines. Annual distribution growth will remain in the 25% range for the next year, which should start to generate the total returns we are looking for.
The two Marcellus Shale midstream services companies, CONE Midstream Partners LP (NYSE: CNNX) and EQT Midstream Partners LP (NYSE: EQM) reported surprisingly strong results for Q3. The market continues to be hard on the unit prices, but these two companies are doing well, have distribution growth projections that are very well supported by drop down and in-development projects.
Tallgrass Energy GP LP (NYSE: TEGP) has announced just one full quarter distribution since its May 2015 IPO. From the Tallgrass earnings conference call, 40% annual distribution growth seems highly probable for the next several years at least.
Out of the IRA appropriate recommendations, I want to cover the InfraCap MLP ETF (NYSE: AMZA). This actively managed ETF holds the large, high-quality midstream MLPs included in the Alerian Infrastructure Index. AMZA boost returns with moderate leverage and covered call selling. This fund provides investment exposure to the financially strongest MLPs with a current 15%+ yield. The dividend is growing by 1% every quarter.