During darkest days of the previous oil and natural gas bear market, the traditional master limited partnership (MLP) model encountered myriad challenges. While results for some midstream infrastructure companies were sturdy in a perilous environment, other MLPs were strained by the delicate balancing act of increasingly complex corporate structures, meeting demand from the U.S. shale revolution and keeping income-hungry investors happy with big distributions and high yields.
Those factors and others sparked sharp spikes in MLP corporate leverage, lower coverage ratios and increased dependency on tapping capital markets. The traditional general partner (GP) / limited partner (LP) model many income investors are familiar with works well when growth is robust and equity costs are cheap. Conversely, that model is challenged in slow-growth environments and when equity financing costs are high.
Once bitten, some MLPs appear to have learned valuable lessons and are opting for simplified corporate structures. Some are even converting to traditional C-corporations, a movement in part started in 2014 by Kinder Morgan Inc. (KMI) when that company rolled three units into a single entity in an effort to allay investors’ balance sheet and structure concerns.
Additionally, some MLPs have been eliminating incentive distribution rights (IDRs) to conserve capital and shore up their balance sheets.
“We do think IDRs serve an import-ant purpose in the early stages of an MLP—they incentivize growth for both the Limited Partner (“LP”) and General Partner (“GP”)—but eventually (if the MLP has been successful in growing its distribution and likely generated some return for its investors along the way), simple math dictates that it does become a burden on cost of capital,” said Brookfied.1
Minding The Midstream
Amid the shifting dynamics of the MLP landscape, investors should not ignore energy infrastructure businesses, also known as midstream assets. The Alerian Midstream Energy Select Index (AMEI), a benchmark of North American energy infrastructure companies, is a widely followed gauge of midstream energy companies.
Energy infrastructure companies are at the forefront of the U.S. shale revolution, which has seen the U.S. become one of the world’s largest oil producers. Recently, the International Natural Gas Association of America (INGAA) evaluated the energy infrastructure requirements for the U.S. and Canada for 2035, arriving at a staggering total of $791 billion in oil and natural gas investments.2
Liquefied natural gas (LNG) represents another significant frontier for North American midstream players. Some of the largest emerging economies, primarily China and India, are also major polluters. However, these countries are working to reduce pollution and are including LNG in that equation.
“IHS Markit expects U.S. LNG export capacity to more than double in the next five years and rise to at least 10 billion cubic feet per day (Bcf/d) by 2023,” said the research firm. “Ten years ago, the prevailing assumption was that the U.S. supply base was being exhausted and that the country would have to become a major importer of liquified natural gas (LNG). Today, the United States is now on track to become one of the world’s major LNG exporters.”3
Investors looking for a diverse basket of midstream investments with the potential stable income can consider the Alerian Energy Infrastructure ETF (ENFR), which tracks the aforementioned Alerian Midstream Energy Select Index. ENFR holdings consist of a liquid subset of North American midstream companies and pass-through entities, with a 25% cap on Master Limited Partnerships (MLPs).”
1 Source: Brookfield February 2018 https://publicsecurities.brookfield.com/~/media/Files/B/BrookField-BIM/documents/us-mutual/center-coast-brookfield-mlp-focus-fund/Thoughts%20on%20the%20Recent%20Simplification%20Trend%20and%20MA%20Wave.pdf
2 Source: INGAA June 18, 2018 http://www.ingaa.org/File.aspx?id=34658
3 Source: IHS Markit https://ihsmarkit.com/Info/0618/shale-gale-turns.html
Important Disclosures & Definitions
Investors should consider investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other important information. For a prospectus for the above listed fund, please click here. Please read the prospectus carefully before investing. For additional information on the above listed funds, please click the respective link.
Standardized performance for the Alerian Energy Infrastructure ETF (ENFR) can be found here. Current holdings for ENFR can be found here.
Shares are not individually redeemable and the owners of shares may purchase or redeem shares from a fund in creation units (blocks of 50,000 shares) only.
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 ALPS Advisors, Inc. In addition, ALPS Advisors, Inc. assumes no responsibility to ensure the accuracy of the content written by the author.
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.
Investments in securities of MLPs involve risks that differ from an investment in common stock. MLPs are controlled by their general partners, which generally have conflicts of interest and limited fiduciary duties to the MLP, which may permit the general partner to favor its own interests over the MLPs.
A portion of the benefits you are expected to derive from the Fund’s investment in MLPs depends largely on the MLPs being treated as partnerships for federal income tax purposes. As a partnership, an MLP has no federal income tax liability at the entity level. Therefore, treatment of one or more MLPs as a corporation for federal income tax purposes could affect the Fund’s ability to meet its investment objective and would reduce the amount of cash available to pay or distribute to you. Legislative, judicial, or administrative changes and differing interpretations, possibly on a retroactive basis, could negatively impact the value of an investment in MLPs and therefore the value of your investment in the Fund.
The fund invests primarily in a particular sector and could experience greater volatility than a fund investing in a broader range of industries.
A bull market is a financial market in which prices are rising or are expected to rise.
A bear market is a financial market in which prices are falling or are expected to fall.
A coverage ratio is a measure of a company’s ability to service its debt and meet its financial obligations.
The Fund may be subject to risks relating to its investment in Canadian securities. Because the Fund will invest in securities denominated in foreign currencies and the income received by the Fund will generally be in foreign currency, changes in currency exchange rates may negatively impact the Fund’s return.
Investments in the energy infrastructure sector are subject to: reduced volumes of natural gas or other energy commodities available for transporting, processing or storing; changes in the regulatory environment; extreme weather and; rising interest rates which could result in a higher cost of capital and drive investors into other investment opportunities.
Alerian Midstream Energy Select Index: The Alerian Midstream Energy Select Index is a composite of North American energy infrastructure companies. The capped, float-adjusted, capitalization-weighted index, whose constituents are engaged in midstream activities involving energy commodities, is disseminated real-time on a price-return basis (AMEI) and on a total-return basis (AMEIX). One may not invest directly in an index.
The Alerian Energy Infrastructure ETF is not suitable for all investors. Subject to investment risks, including possible loss of the principal amount invested.
ALPS Portfolio Solutions Distributor, Inc. is the distributor for the Alerian Energy Infrastructure ETF.
ALPS Portfolio Solutions Distributor, Inc. is not affiliated with Alerian
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