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Getting Paid to Play The Energy Patch

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Getting Paid to Play The Energy Patch

The energy sector lagged the broader market in 2017, but the group cobbled together some momentum late in the year. On the back of rebounding oil prices and soaring U.S. output, some of that momentum is making its way to 2018 and that bullishness is affecting master limited partnerships (MLPs).

For example, the Alerian MLP Infrastructure Index (AMZI Index) jumped 5.94% in January. That is the underlying index for the Alerian MLP ETF (AMLP), the largest* exchange traded fund (ETF) dedicated to MLPs. MLPs are an asset class beloved by income investors due to dividend yields that exceed those of traditional equity investments. To gain the tax-advantaged status of MLPs, these partnerships must pay out significant percentages of their cash flows in the form of distributions.

It is not unusual for MLPs to sport higher dividend yields than competing income assets, such as real estate and Treasuries.

More Than Just A Yield Play

Obviously, the yields on many MLPs and the related ETFs are eye-catching, but there are other catalysts for this asset class and funds such as AMLP.

One of those catalysts is soaring U.S. oil production, which is meaningful for MLPs because, on a historical basis, MLPs are not highly correlated with oil futures’ price action. Rather, the “toll-road” business model of MLPs is more levered to the storage and transportation side of the oil and natural gas equation.

Improving production trends have given way to rising growth expectations for midstream operators, the area of the energy landscape in which MLPs dwell. Eras of increased oil volatility, such as the commodity’s 2014-2015 bear market, prompted some market participants to overlook the solid fundamentals associated with some MLPs. That situation could reverse this year amid stellar output expectations in the U.S.

In November, U.S. oil output topped 10 million barrels per day (bpd) for the first time since 1970, but the key difference between then and now is that U.S. production was on a downslope back then. The opposite is true today. In fact, the Energy Information Administration (EIA) expects U.S. crude output to steadily climb this year before reaching 11 million bpd in late 2019. By some estimates, the U.S. will soon surpass Saudi Arabia and Russia as the world’s largest oil producer.

COURTESY: AMERICAN ENTERPRISE INSTITUTE

Another reason AMLP may have the wind at its back this year is the recently passed Tax Cuts and Jobs Act. That legislation reduces the federal corporate tax rate from 35% to 21%, which is a boon for a bevy of sectors, but in particular energy, which was previously among the highest taxed groups in Corporate America.

While MLPs already received favorable tax treatment, the new tax code could prompt MLPs to increase investment at a time of rising U.S. output.

Tax reform “appropriately preserves the favorable tax attributes for master limited partnerships and encourages MLPs to continue investing in infrastructure growth opportunities, which contributes to U.S. job and GDP growth,” said Enterprise Products Partners LP (EPD), 10.40% of AMLP’s weight, on a January conference call.

Back To Distributions

From 2016 through late 2017, some MLPs took painful, but necessary steps to shore up their balance sheets, including intense deleveraging and, in some cases, dividend cuts. Of course, no income investor enjoys reading headlines about negative distribution action, but the deleveraging efforts in the MLP space look promising as free cash levels are on the rise, a sign that MLP management teams could renew their focus on growing payouts.

As of early February, the AMZI Index yielded 7.44%, good for a spread of 460 basis points (bps) over 10-year Treasuries. That is above the 10-year median spread of 414 bps.

Cash flows for MLPs have been rising in recent years, a trend that is expected to continue over the next several years. Those expectations are supported by reduced capital expenditures and soaring volumes on the back of surging U.S. output of crude and natural gas.

Another reason AMLP may have the wind at its back this year is the recently passed Tax Cuts and Jobs Act. That legislation reduces the federal corporate tax rate from 35% to 21%, which is a boon for a bevy of sectors, but in particular energy, which was previously among the highest taxed groups in Corporate America.

While MLPs already received favorable tax treatment, the new tax code could prompt MLPs to increase investment at a time of rising U.S. output.

Tax reform “appropriately preserves the favorable tax attributes for master limited partnerships and encourages MLPs to continue investing in infrastructure growth opportunities, which contributes to U.S. job and GDP growth,” said Enterprise Products Partners LP (EPD), 10.40% of AMLP’s weight, on a January conference call.

Back To Distributions

From 2016 through late 2017, some MLPs took painful, but necessary steps to shore up their balance sheets, including intense deleveraging and, in some cases, dividend cuts. Of course, no income investor enjoys reading headlines about negative distribution action, but the deleveraging efforts in the MLP space look promising and free cash levels are rising.

As of early February, the AMZI Index yielded 7.44%, good for a spread of 460 basis points (bps) over 10-year Treasuries. That is above the 10-year median spread of 414 bps.

Cash flows for MLPs have been rising in recent years, a trend that is expected to continue over the next several years. Those expectations are supported by reduced capital expenditures and soaring volumes on the back of surging U.S. output of crude and natural gas.

Disclosure:
An investor should consider the investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus which contain this and other information call 866.675.2639 or visit www.alpsfunds.com. Read the prospectus carefully before investing.
Alerian MLP ETF shares are not individually redeemable. Investors buy and sell shares of the Alerian MLP ETF on a secondary market. Only market makers or “authorized participants” may trade directly with the Fund, typically in blocks of 50,000 shares.
ALPS Advisors, Inc. (AAI) has engaged IRIS Werks, LLC (IRIS) to produce analysis and commentary on ALPS-advised ETFs. IRIS currently has a compensated business relationship with AAI. AAI is not affiliated with IRIS.
The content and opinions expressed in this article are that of the author and not the views and opinions of AAI.  In addition, AAI assumes no responsibility to ensure the accuracy of the content written by the author.
There are risks involved with investing in ETFs including the loss of money. Additional information regarding the risks of this investment is available in the prospectus. Past Performance is not indicative of future results.
ALPS Portfolio Solutions Distributor, Inc. is the distributor for the Alerian MLP ETF. AAI is affiliated with ALPS Portfolio Solutions Distributor, Inc.
The author is not an investment professional and this article should not be considered investment advice. While the information and statistical data contained herein are based on sources believed to be reliable, the author takes no responsibility to ensure the accuracy of the content. Additionally, this article should not be relied on or be the basis for an investment decision. Information that is historical is not indicative of future results, and subject to change.
“Standardized performance for the Alerian MLP ETF (AMLP) can be found here.  Current holdings for AMLP can be found here.”
*: Based on assets under management as of 2/15/2018. Source: Bloomberg.
Sources:
http://www.alpsfunds.com/AMLP
https://www.oppenheimerfunds.com/advisors/article/crude-oil-production-vs-price-what-matters-to-mlps
https://www.alerian.com/indices/amzi-index/
https://www.aei.org/publication/historic-energy-milestone-us-oil-output-surges-to-new-record-highs-reflecting-americas-deep-pools-of-ingenuity-risk-taking-and-entrepreneurship/
https://www.bloomberg.com/quote/EPD:US
ALR000660 01/31/2019
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