The steady earnings master limited partnerships (MLPs) have traditionally made by acquiring oil and natural gas pipeline and midstream assets will continue to be the backbone of the tax-advantaged entities, but more organic and commodity-driven partnerships are expected going forward, executives predicted last week.

Speaking at the RBC Capital Markets MLP Conference in Dallas last week, energy analyst Mark Easterbrook said the appeal of the MLPs is their earnings growth rate: U.S. energy sector partnerships have grown at an average clip of 13% so far this year, earning close to $74 billion. That rate of growth was stronger this year than RBC had forecast at its annual conference in 2005.

“They were very strong this year,” Easterbrook said of MLP’s performance. “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.”

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 may underperform — or not.

“If you go look at our underperforming [MLPs] for next year, we’ve got coal and shipping.” But, said Easterbrook, variables such as pricing and weather could pay dividends in the coal and shipping sectors’ favor. “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 sector is how its appeal has broadened, Easterbrook noted. MLPs were long considered a “safe” investment to manage because they grew mostly on acquisitions of stable assets, such as regulated pipes.

The traditional, less risky partnership offerings resemble those similar to one announced earlier this month by Duncan Energy Partners LP, a subsidiary of Houston-based Enterprise Products Partners LP. Duncan plans to spin off from Enterprise in early 2007 (see NGI, Nov. 6). Initially it will own some of Enterprise’s Gulf Coast midstream assets, including its Mont Belvieu, TX, storage facilities. Last week, Targa Resources Inc. also announced plans for an offering next year of its considerable midstream processing assets in North Texas (see related story).

Many energy partnerships are moving into more costly, organic growth, which carries more risks: strained balance sheets, commodity price volatility and changed ownership structures. Keeping those investments in line requires disciplined management, with a focus on maintaining a strategy that aligns with the rest of the company’s interests.

For example, in June three gas pipeline partnerships — Oneok Partners LP, Boardwalk Pipeline Partners LP and Energy Transfer Partners LP — teamed up to jointly begin building a $1 billion, 1 Bcf/d interstate pipe from North Texas to Cohoma County, MS (see NGI, June 12). And Kinder Morgan Inc.’s MLP Kinder Morgan Energy Partners, which has a big stake in the growing gas production in the Rocky Mountains, is jointly building the $4 billion Rockies Express pipeline with Sempra Energy and ConocoPhillips to link Rockies gas to eastern markets (see NGI, Nov. 6).

Some of the gas-focused partnerships are going it alone to organically grow their business. Enbridge Energy Partners LP President Terrance L. McGill said last week his partnership has traditionally looked for accretive assets to acquire, with maybe “one or two years of greenfield projects” in their portfolio. However, McGill said the partnership, which concentrates its gas assets in Texas, is now focused on organic growth because “we have enough powder now to make something happen.”

Among other things, Enbridge Energy Partners is working on a $610 million East Texas 36-inch pipe system expansion and extension, which will carry 700 MMcf/d in East Texas to markets in southeastern Texas to interconnect with several interstate pipes. The expansion is scheduled for completion in 2007. The partnership also recently completed a $74 million East Texas midstream project, which included commercial start up of the 120 MMcf/d Henderson, TX, processing plant. Projects also are under way to add 125 MMcf/d of capacity for the Anadarko system and 35 MMcf/d for the North Texas system by early next year.

“We’ve begun to change after four years, now that the pipe is bigger, we’re starting to shift from acquisitions to expansion,” McGill told the RBC audience. He cautioned that once the expansions are completed, “we’ll start to shift back” to fewer organic ventures. The expansions, he said, will give the partnership “healthy growth. We’re starting to get diversification that we wanted. There are great opportunities to take advantage of.”

Diversified midstream operator Energy Transfer Partners LP has had its share of acquisitions and its share of organic growth, and most of it has been in Texas. The company has been a huge benefactor in the growth from the Barnett Shale, and it has several pipeline expansions under way. It also surprised the market in September by acquiring its first interstate transporter, Transwestern, for $1.465 billion.

Co-CEO Ray Davis said organic and acquisitive growth go hand in hand to make things happen at Energy Transfer because of the markets it is operating in. The Barnett Shale needs more infrastructure, the Gulf Coast needs more infrastructure.

If Energy Transfer was in a “static industry,” or it was “static company,” growth guidance would not be difficult to determine, Davis said. “But in the growth mode that we are in and we are going to be in, there are so many variances. Are commodity prices going to stay up? I don’t see $3 gas on the horizon. I don’t know what the weather’s going to be on our organic growth projects…We try to forecast what we know. We try to be on the conservative end.”

Energy Transfer’s two-year average annual distribution growth between August 2001 and August 2006 was 30%.

“We are put together mostly by acquisitions,” said Davis. “We didn’t just try to buy cash flow, but we tried to get specific, targeted assets.”

Easterbrook noted that 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 (see related story). However, he thinks 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,” Easterbrook 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.” RBC “sees 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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