Petrohawk Energy Corp.’s decision to spin off some of its mature domestic assets into a master limited partnership (MLP) (see Daily GPI, June 26) highlights the “reemergence of one of the most important trends in U.S. energy markets,” according to an energy analyst.
Five publicly traded exploration and production (E&P) companies spun off MLPs in 2006, and a “fairly firm backlog” was forecast earlier this year by Lehman Brothers’ Rick Gross, managing director of equity research (see Daily GPI, March 9).
“E&P MLPs have been building momentum over the past year and continued to gain a lot of traction in the second quarter,” wrote Morningstar analyst Eric Chenoweth. “In short, the tax-advantaged MLP structure appears to be luring more small- and mid-cap E&P firms — which make up a large portion of our energy coverage — to consider either adopting the structure themselves or selling assets to an existing MLP.
“CEOs we spoke with at a recent E&P conference are compelled by what they see as a potential increase in the market valuation of these assets under the MLP structure, citing a potential 9-10 times EBITDAX (earnings before interest, taxes, depreciation, amortization and exploration) multiple for them in an MLP, versus a 4-6 times EBITDAX multiple in a traditional corporation.”
The trend to spin off mature E&P assets into MLPs has been steady. XTO Corp. said in early June it might spin off its mature domestic properties later this year (see Daily GPI, June 5), and in April, Pioneer Natural Resources Co. announced it would form two MLPs to hold its Spraberry assets in West Texas and its Raton Basin assets in Colorado (see Daily GPI, April 24). Also in April, Plains Exploration & Production Co. said it was considering a spin-off of its Piceance Basin assets (see Daily GPI, April 19).
Two factors are driving MLP growth among E&Ps, according to Friedman, Billings, Ramsey & Co. Inc. (FBR) analysts. Distribution growth, followed by interest rate movements, together account for 86% of MLP stock price returns, analysts Amir Arif and Hui Wang wrote in a note to clients.
“Within the MLP space, we believe that the upstream MLPs provide the best distribution growth potential, and distribution growth of 6% and 15% would be needed to offset the negative impact from the 10-year rate moving to 5.50% and 6.00%, respectively,” said the FBR analysts. “With the large valuation gap on each acquisition and the large potential acquisition pool, we believe that this level of growth should be achieved in five and 11 months, respectively,” based on the historic upstream distribution growth rate to date of 16.5% annualized.
The FBR analysts suggested that for those investors interested in capturing the value creation from the MLP trend, “we would go long [on] a basket of upstream MLPs…”
MLP’s access to capital markets was sustained by a recent court decision that upheld the Federal Energy Regulatory Commission’s (FERC) inclusion of an income tax allowance in the rates of pipeline companies owned by MLPs, according to Standard & Poor’s credit analyst Charles LaPorta (see Daily GPI, May 30).
Last year FERC unanimously rejected an administrative law judge’s decision of a single-digit return on equity for Kern River Gas Transmission and interstate gas pipelines in general in favor of one in the double-digit range (see Daily GPI, Oct. 20, 2006).
“The U.S. Court of Appeals for the District of Columbia affirmed the FERC’s policy on permitting a tax allowance for regulated entities that are owned by partnerships including MLPs,” LaPorta wrote. “This decision clarifies FERC’s income tax allowance policy, which had been muddled in prior cases.
“The affirmation of the tax allowance further solidifies the MLP asset class and clears the way for more drop-downs by general partner owner C-corps.”
Midstream MLPs have long been an attractive spin-off for energy companies, and this year is proving no different. Apache Corp. in mid-June announced it was considering a partnership for some of its midstream assets (see Daily GPI, June 14), and El Paso Corp. in May said it remained on track to launch an MLP by the end of the year for some of its pipeline assets (see Daily GPI, May 9).
Southern Union expects to have an MLP in place by the end of September for some of its operations (see Daily GPI, March 2). And Chesapeake Energy Corp. CFO Marcus Rowland disclosed in May that bankers are pitching MLP deals targeting the company’s midstream and compression assets (see Daily GPI, May 7).
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