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More Organic, Riskier Growth for MLPs Forecast

The steady earnings from oil and natural gas pipeline and midstream assets will continue to be the backbone of energy-based master limited partnerships (MLP), but expect more organic, risker growth and commodity-driven partnerships in the future, an RBC Capital Markets energy analyst said Thursday.

Energy analyst Mark Easterbrook opened the two-day RBC Capital Markets MLP Conference in Dallas on Thursday. He noted U.S. energy sector MLPs have grown at an average rate of 13% so far this year, earning about $74 billion.

"MLPs were very strong in 2006," said Easterbrook. "Prices were up 24%, distributions were reinvested. They really performed well, especially the natural gas MLP pipeline sector, the processing sector...Some of the large caps have done very well."

At the 2005 RBC conference on MLPs, the investment bank had forecasted partnerships for gas pipelines and propane would be underperformers. RBC had forecast MLPs to grow on average about 10% in 2006, but the outlook was off by more than 3%, to the delight of investors.

"What we missed last year [in the 2006 forecast is that], we were very skeptical on interest rates, we thought there might be more competition in other yields. We expected to see some weaknesses..." But Easterbrook noted there continued to be "a lot of [general partnerships] GPs come out last year. That trend has peaked for now, and we're not going to see the same activity in 2007. MLPs had a strong distribution growth in the beginning in 2006, a lot better than our 10% forecast."

RBC expects that in 2007, the coal and shipping MLP group will be underperformers. However, like this year, the market may prove to be stronger than expected.

"If you go look at our underperforming [MLPs] for next year, we've got coal and shipping. They are probably very good stories that may show up nicely in 2007."

In any case, the MLP market shows no signs of slowing. Easterbrook said MLP growth in 2007 will be "down a little bit," but RBC still expects average growth to be around 9.5%.

"For 2007, we are lowering our expectations, 9.5% instead of 13%, but the strong distribution growth will continue. We expect to see more capital formation, expected secondaries and pipeline public offerings coming out in the next three to four months. More MLPs are branching out."

What poses more risk for the MLP sector is how it is growing, Easterbrook noted. MLPs were long considered a "safe" investment because they grew mostly on acquisitions of stable assets, such as regulated pipes. However, many are growing their operations organically, which can strain balance sheets and cause additional risks in commodity price volatility and changed ownership structures.

For example, Oneok Partners LP, Boardwalk Pipeline Partners LP and Energy Transfer Partners LP said in June they will jointly build a $1 billion, 1 Bcf/d interstate pipe from North Texas to Cohoma County, MS (see Daily GPI, June 12). And Kinder Morgan Inc. MLP Kinder Morgan Energy Partners is jointly building the $4 billion Rockies Express pipeline with Sempra Energy and ConocoPhillips to link Rockies gas to eastern markets (see Daily GPI, Aug. 23; Aug. 18, 2005). The project, once completed, will be one of the largest new domestic pipelines built in more than 20 years.

But risk or not, energy companies in just the past few weeks have issued a string of announcements to spin off more pipeline and midstream assets through MLPs and general partnerships. On Thursday, Targa Resources said it was readying an initial public offering of its Fort Worth-based midstream operations (see related story). On Wednesday, Constellation Energy Group Inc. spun off its exploration and production unit, Constellation Energy Partners LLC (see Daily GPI, Nov. 16).

Earlier this month, Anadarko Petroleum Corp. said it was still considering an MLP for some of its midstream assets (see Daily GPI, Nov. 8). And Duncan Energy Partners LP, a subsidiary of Houston-based Enterprise Products Partners LP, has filed to spin off in early 2007 (see Daily GPI, Nov. 3). Duncan initially will own some of Enterprise's Gulf Coast midstream assets, including its Mont Belvieu, TX, storage facilities.

Some investors have expressed concerns about possible tax changes to MLPs following an announcement by Canada earlier this month to begin taxing the country's profitable income trusts, Easterbrook noted (see Daily GPI, Nov. 16; Nov. 2). However, Canada's loss may be MLPs' gain.

MLPs and Canadian energy income trusts share some tax-advantage characteristics, but "a lot of groups misunderstand Canadian trusts and MLPs and how they work," he said. "With the ruling in Canada...we saw a lot of price movement on the downside, a lot of people worried about the potential of what might happen to MLPs, but we don't think so.

"On the relative side to the U.S. economy, MLPs are a lot smaller than Canadian trusts," he said. "There is a very broad definition in Canada for income trusts...," but "the MLP is a very narrow, qualified definition...It's very different here in the United States." And Easterbrook said RBC had "seen nothing on the radar screen" to indicate U.S. officials might go the same route and redefine MLPs.

"To turn this around, this might be a positive for MLPs," he said. "Right now the market cap on Canadian income trusts is Canadian $196 billion. Of that, 22% is owned by foreign investors, mostly investors in the U.S. If they decide to pull out" of the energy income sector, "they may look for similar vehicles in the U.S., which would likely be MLPs or REITs [real estate investment trusts]."

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