Three Themes in the MLP Sector
07/22/2016 10:00 am EST
In assessing the current state of the MLP market, Elliott Gue thinks the easy gains have been made and selectivity is now key to future gains. Here, the editor of Energy and Income Advisor discusses three themes impacting the sector, along with some of his favorite current buys.
Steve Halpern: Joining us today is Elliott Gue, the newsletter of industries leading energy sector expert and the editor of Energy and Income Advisor. How are you doing today, Elliott?
Elliott Gue: I'm doing well, Steven. Thanks for having me on your show.
Steve Halpern: Today we're going to focus on MLPs, a sector where you continue to see some select opportunities but you caution the easy money's been made. How does this impact your strategy and outlook for this sector?
Elliott Gue: Yeah, you know, this sector has been through a real roller coaster ride over the last seven, eight months. The beginning of the year, there was pretty much indiscriminant selling across the board.
Good MLPs were getting hit alongside those that are shakier and had to cut distributions and now we're kind of seeing the mirror image of that where pretty much everything is doing well.
In fact, some of the junkier, lower-quality MLPs are doing better this year in percentage terms than the higher quality names. They got really battered in the beginning of the year and now they've rallied and overshot on the upside so I think that the way that's impacting our strategy is that you have to be much more selective now.
A lot of names have run up as a herd, sort of as a group, so far this year and we still think there are a few good values out there but there's also an awful lot of names you have to be really careful about that have simply run up way too far, way too fast based on things like short covering.
A lot of investors were short betting on a decline in these MLPs earlier this year. They've had to cover. That's pushed the MLPs up and a lot of names, I think, are vulnerable to distribution cuts later this year. So a lot of problems are out there -- names that we want to avoid, but also selectively some buys as well.
Steve Halpern: Now, in your latest research report you highlighted a trio of themes that you feel will play an important role going forward. If you don't mind, let's walk through these three themes and maybe as you describe the themes you'll also be kind enough to mention a name or two of stocks that falls under it. The first theme you call “Pumping up the Volume”. Can you explain this?
Elliott Gue: Sure, well, the main risk that MLPs have to lower commodity prices, Master Limited Partnerships typically own mid-stream energy assets like pipelines.
Their main risk isn't actually the price of oil or the price of natural gas, it's really the volumes of oil or natural gas moving through their pipelines. They make more money when volumes are rising than they do when volumes are falling and that's very much a regional issue in the United States.
Some plays in the United State, some oil and gas plays, are profitable at lower commodity prices and they're still seeing some volume growth or at least flat volumes even though prices have come way down.
Other parts of the United States need much higher oil prices, much higher gas prices to be economic so let me give you an example. The Permian Basin of west Texas and New Mexico, this is one of the most economic plays in the United States.
Some producers can make money even with oil in the $20s with wells in this region -- so we haven't seen volumes from the Permian Basin come down much at all even though oil prices have come down $100 plus just a couple years ago to as low as the mid-20s earlier this year.
For example, we want to focus on names that have exposure to the Permian Basin of west Texas and New Mexico. One example is a company Magellan Midstream Partners (MMP), one of the higher quality MLPs out there. The company has an investment grade credit rating.
Several pipelines in the Permian Basin of west Texas and we think that this would be a decent buy at current levels but we'd really love it if it would dip down into the upper 60s. We think that'd be a great entry point on that name.
Steve Halpern: Now, the second theme is what you refer to as “Stepping on the Gas”. In this case, I assume you're referring to natural gas. Can you discuss this theme?
Elliott Gue: We are referring to natural gas. Natural gas prices is pretty much, as every investor knows, has absolutely plummeted over the last few years though they've rallied a little bit over the last couple of months. And they're a fraction of the prices that we saw just not too many years ago.
But what we are seeing is very rapid growth and demand for natural gas partly because the price of natural has come down so far over the last few years. US utilities are switching from burning coal over to burning natural gas.
Of course, also helping that trend is the fact that natural gas is less polluting and more environmental friendly than coal.
We think this is a trend you're going to continue to see and you're going to continue to see more and more gas demand in the United States. This is not a price call but a call on growing demand.
The other big trend that I don't think gets enough attention is the massive amount of exports from the United States of natural gas going to Mexico.
Not too many years ago, Mexico was actually a supplier of gas to the United States. But last year, for the first time in history, the US actually exported more natural gas to Mexico than we did to Canada.
We think this is a trend you're going to continue to see -- Mexican gas production kind of on the down slope whereas US gas production on the uptrend so we're going to see more exports there.
A number of different way you can play that; I would focus on companies that are exposed to the Marcellus Shale of Appalachia. This is the lowest cost gas play in the United States. This is a play that can make money even with gas prices down as low as $1 a million BTUs in some cases.
Steve Halpern: Now, the third theme you humorously call a “Cracking Good Time”, not to be confused with cracking. Could you explain what cracking is and how you apply this theme to your strategy?
Elliott Gue: Yeah, this is actually a chemicals play. There are two major petrochemicals out there that you have to be aware of. They are propylene and ethylene.
They're the base chemicals used to make all sorts of different plastics and other petrochemicals and they're typically manufactured in plants known as crackers.
So the term cracking mean converting ethane which is a natural gas liquid that occurs naturally with natural gas in fields around the US. Ethane is converted into ethylene, propane is converted into propylene.
We've seen a massive oversupply of both ethane and propane in recent years because of the rapid growth in US natural gas production. There's just too much of it.
So what's happened is a lot of chemicals companies -- and not just US chemical companies but European chemical companies, even Middle Eastern chemical companies -- are building crackers on the US gulf coast to take advantage of our abundant and low cost ethane and propane.
It's even cheaper to manufacture ethylene and propylene here in the US than it is in parts of the Middle East, which has traditionally been the low cost producer.
Over the next few years a lot of these crackers are opening up on the US gulf coast and that's going to spell a big increase in demand for ethane and propane and it's going to be a boom to MLPs that supply these plants in the US gulf coast.
A classic example is Enterprise Products Partners (EPD), again, one of your highest quality MLPs out there. Solid credit rating, low risk, low commodity price exposure, but also a huge owner of plants that are used to separate this ethane and propane from the natural gas stream.
Also, becoming a major exporter of natural gas liquids like ethane and propane as well as ethylene and propylene out of the gulf coast, it’s a really good high quality play on this trend.
Steve Halpern: Again, our guest is energy expert, Elliott Gue, of Energy and Income Advisor. Thank you so much for your time today.
Elliott Gue: Thanks, Steve.
By Elliott Gue, Editor of Energy and Income Advisor