Master limited partnerships (MLPs) are expanding organically and through acquisitions like never before, resembling the build-`up of the energy merchant sector in the late 1990s, according to a new report by Fitch Ratings. The sector also has caught the eye of private equity firms, which are buying ownership stakes in MLPs, which may change the outlook for the industry.
The current atmosphere surrounding the growth of the MLP sector is "euphoric," said Fitch analyst Hugh Welton, who presided over a conference call on Tuesday. He and a team of analysts wrote the 19-page report, noting that current high natural gas and oil prices have pushed the strong growth in the sector.
"At first glance, the prevailing mood resembles the build-up of nonregulated power generating and energy trading activities in the late 1990s and 2000, when aggressive construction, overpriced investments and investor exuberance dominated and precipitated the ultimate collapse," the report said. "However, in stark contrast to the unpredictable and volatile nature of energy merchant activities, most energy assets falling into the hands of MLPs, with certain exceptions, are time tested with a proven capability of generating predictable cash flows throughout a variety of commodity price and economic cycles."
MLPs are tax-advantaged partnerships that are designed to allow for public trading of partnership units. They are exempt from paying federal taxes on income, and they distribute a high proportion of their income to their partners, who in turn pay income taxes on the distribution -- thus avoiding double taxation. Only certain operations like natural resources or energy-based activities are eligible to form MLPs. Qualifying businesses include pipeline transportation of natural gas, oil and refined products, liquid and bulk material storage, midstream activities, retail propane distribution and coal production.
Energy companies with stable credit have used MLPs for long-term strategic reasons, said Fitch, but there is a "changing cast of players," led by private equity firms, that are moving into the sector like never before.
Similar to the recent acquisitions by banking institutions to gain a foothold in the energy merchant sector, private equity firms are buying up ownership stakes in energy MLPs, according to Fitch. For instance, Carlyle/Riverstone Global Energy and Power Fund recently bought out the general partnership interests of both Buckeye Partners LP and Magellan Midstream Partners LP. Lehman Brothers also recently acquired a 36% interest in Pacific Energy Partners LP.
But Fitch warned that financial institutions are not necessarily in the business for the long run, and their move into the sector may alter MLPs in the future. Unlike traditional energy companies, "financial buyers appear to be more return-focused and are likely to have shorter overall investment horizons," Fitch noted.
The MLP sector is expected to flourish in the near term, with more acquisitions and organic growth, according to Fitch. However, "the exuberant expansion of MLPs could ultimately slow down as a result of rising interest rates or the overbid prices of energy assets that qualify for MLP ownership."
"Not surprisingly, the near-term outlook for virtually all phases of the midstream sector is positive due to the robust pricing environment for natural gas and crude oil. Higher natural gas prices have boosted the working rig count in core producing U.S. basins including the Rockies and the Gulf of Mexico. This trend bodes well for continued cash flow growth in gathering services through new well connects and extended reserve lives of key producing basins."
To see the full report, visit www.fitch.com.
Intelligence Press Inc. All rights reserved. The preceding news report
may not be republished or redistributed, in whole or in part, in any
form, without prior written consent of Intelligence Press, Inc.