Looking to boost the income yield on your portfolio and reduce inflation risks? MLPs and MLP ETFs may be the answer. But as MLP ETFs soar, this advisor struggles with his conscience. What’s the big deal?
Master Limited Partnerships or MLPs as they are known are probably the hottest trend in investing. Why? Because they play on the energy sector which is booming in the US because we are now sloshing around with Black Gold and natural gas as we have become a major energy exporter.
MLPs are businesses that engage in energy infrastructure activities, including the processing, storage and transportation of minerals and natural resources – most notably but not exclusively oil. They are becoming a favorite in investing circles because they have a low correlation to energy prices and the broader equities markets. While they are associated with the energy sector, they are not tied to the ups and downs of oil, gas or other commodity prices. This is because they act like a toll-road in the nation’s energy infrastructure. Regardless of what’s going on with a particular commodity’s price, the MLP operator gets paid a fee for service for moving the stuff from Point A to Point B. As a result, MLPs are ideally situated as the U.S. pushes around more and more volume for its own use and for export.
MLPs Outpace Most Stocks
Through the end of 2012, nearly every sub-sector in the infrastructure space generally did well with positive average returns ranging from a low of 3% for natural gas transporters to 40% for diversified general partnerships. Individual stock performance ranged from a low of -70% for coal to up 99% for the largest diversified partnerships. So while individual stocks or partnerships may not have done well, the strategy of accessing a diversified group through an index made ETF investing clearly superior on a risk-managed basis.
New Supply Means New Demand
In the Bakken, an oil region centered on Western North Dakota, there is projected capacity of 3 to 5 billion barrels of oil and 2 trillion cubic feet of gas. As a result production has boomed, increasing more than 1,300 percent since 2008 to nearly 1 million barrels a day. In the Eagle Ford Shale located in South Texas there are reports of 10 billion barrels of oil. In the Northeast centered between Pennsylvania and New York, the Marcellus Shale may hold up to 4.5 trillion cubic feet of natural gas.
An absence of pipeline infrastructure means the bulk of all this crude moves by rail, often in mile-long “unit trains” that travel straight through U.S. and Canadian towns. This is a trend that bodes well for the entire range of MLP pipeline infrastructure operators with more than $200 billion in capital expenditures expected over the next 25 years needed to accommodate this demand.
Dangers of Rolling Pipelines
In the near term though there are problems. New energy supply sources require new ways to move stuff from the fields to refiners to end users. While railroads play a big part here, we’ve seen recently how transporting oil by train has resulted in some really catastrophic events after train derailments in places like Canada, Alabama and North Dakota One notable event occurred in Lac Magantic in July 2013 leaving a wake of destruction and death in a small town. This was particularly jarring to me as I’ve ridden through that town on two different bike excursions on my way from Maine to Quebec. Thinking about how a mile long train rolled out of control into that small, picturesque lakeside town just got me to thinking.
So What’s the Fracking Problem?
Admittedly, I should be happy about the prospects for MLPs since I’ve been a proponent of including MLPs in all portfolios I create for clients. My core holding is Alerian MP ETF (NYSEArca: AMLP) but I also like other offerings through Yorkville ETF Advisors.
Accessing MLPs has become a whole lot easier with the development of ETFs and even mutual funds. During my time at Merrill Lynch, the only folks who could get into these were those who were accredited investors with high incomes or net worth and then only by buying a limited partnership position with a high minimum investment.
What’s not to love about an asset that is not tied to commodity price swings, can act as an inflation hedge as transport fees rise to cover increased costs, and produces an enviable yield (6% or higher in many cases) while offering capital appreciation to boot?
Although I don’t consider myself an environmental purist, I’m still bothered by the impact on local communities and our water aquifer sources by the chemicals involved in the hydraulic fracturing or ‘fracking’ which requires pumping large quantities of chemicals and water underground to get access to these natural gas deposits and shale oil. This process is controversial to say the least. In a dramatic way, these problems were highlighted in the movie Gasland and in a lesser degree the Matt Damon film Promised Land. But with demand high for energy, it’s likely to continue making the increased productivity and output of these shale regions possible.
And therein lies the struggle of conscience. As a fiduciary adviser I’m charged with doing what is in the best interests of my clients. For those who are looking for a solid source of income and inflation hedge for their portfolios, MLPs are as important as the air we breathe or the water we drink. On the other hand, pipelines make it possible to transport energy obtained from the ground through controversial means that may actually harm the air and water we need.
So by doing right for my clients I may actually be doing harm to the broader world around us.
Because pipelines aren’t the actual culprit here and using them reduces the dangers inherent with rail transport, I’ll stay on the MLP bandwagon. But I’m uneasy with exploration and production practices so intend to be vocal in whatever way possible to put pressure for more stringent environmental safeguards and regulations at the wellhead. For now, that’s the most plausible fiduciary position I can take though I still feel queasy about it.
