MLPs were mauled in 2015 in the last two months of the year. Mutual fund redemptions and tax-loss selling created a huge and unexpected downdraft. Here are some numbers.
Performance (based on Alerian Total Return Index values as of 12/18/2015):
- Year-to-date partnerships performance: -40.76%
- Quarter-to-date performance: -14.54%
- Yield on Alerian Index: 9.67%
While October was a good month for MLPs, November, December, and year-to-date were dismal. The MLP market is now focused squarely on credit, as demonstrated by financial leverage, counterparty risk, and partnership guidance for distribution sustainability.
As we cautioned in last quarter’s review, we are positive on an intermediate and long-term basis but think the market will exhibit volatility in the near-term future. In the very short term we expect a bounce, perhaps at year-end or the beginning of January as tax-loss selling abates. After that, the market catalyst to better performance will depend on the price outlook for oil and natural gas, capital spending plans announced by exploration and production companies, and guidance given by midstream MLPs.
It is clear that many MLPs will have difficulty raising new capital to expand or complete existing infrastructure at present borrowing costs and cost of equity capital. There are several routes to solving this problem. MLPs can postpone, stretch out, or cancel new capital expenditures to try to ride out the storm. They can get capital injections from sponsors or general partners. MLPs can form joint ventures with outside investors to complete projects. Absent any of these alternatives, partnerships can cut distributions and fund projects out of retained earnings. This recently was the case with Kinder Morgan (N:KMI) (KMI – technically not an MLP) and the Teekay Shipping group of companies (we do not own either in our strategy).
A number of other names have come under market scrutiny. To demonstrate negative sentiment in MLPs, one just has to look at the recent performance of Oneok Partners (N:OKS). Recently, OKS announced that they expect to maintain their distribution next year with 1.0x coverage. This is not typically great news, but it was better than market expectations, and the units have advanced smartly since that announcement.
In 2016, we expect to see more combinations of MLPs, either consolidations within a group or other buyer’s coming in and buying all or part of an MLP. Longer-term, there are a number of positives that could help the group, including the lifting of the ban on crude oil exports, the completion of petrochemical projects to soak up excess natural gas product supply, and the completion of export terminals to ship out LNG and LPG to foreign markets at higher prices.
Despite all the gloom, we expect MLPs on average to raise distributions next year in the low to mid single-digit range. Some MLPs currently yield more than 700 basis points (7%) over 10-year US Treasury bonds (the average is about 375 bps). However, as Credit Suisse (N:CIK) has pointed out, the 700 bps spread is a relatively rare occurrence that happens only about 3% of the time.
We remain cautious and point out that MLPs will continue to have their challenges. When oil prices bottom and credit spreads calm down, we would expect MLP prices to rise. However, we don’t expect to see those two factors come together for at least another 3–6 months and perhaps longer. In the meantime, investors are being paid high yields to wait out the storm – if they have the stomach for it.
Written by Rick Daskin, CFP, CFA ®.