The election has come and gone and everyone now seems very focused on the fiscal cliff. Volatility has increased post-election as evidenced by the 5.3% drop in the S&P 500 Index (SPX) from its November 6th close to November 15th close, with volatility more amplified for Master Limited Partnerships (MLPs) as the Alerian MLP Index (AMZ) experienced a 8.7% decline.*
During that time my MLP Protocol Sprint Portfolio also experienced a slightly larger sell off of about 9.7%*, which makes sense given its focus on the riskier end of the MLP spectrum of investment opportunities. The key of course will be to gain value faster than the indexes as well.
The ever present fear of tax code changes is always impactful to MLP unit prices and there has been some additional noise about possible changes in tax credits for oil and gas drilling activities, which would directly impact the Upstream MLPs.
These specific issues amplify the fiscal cliff concerns with respect to MLPs; however, the risk of tax code changes to the Qualifying Income section for energy related MLPs is low. In recent years the IRS has actually been proactive in clarifying/expanding the definition of energy related Qualifying Income via numerous Private Letter Rulings.
Additionally, the overall enterprise value of the energy related MLPs is approximately $520 billion (94 total entities). To put that number in perspective, the enterprise value of just ExxonMobil (XOM) is approximately $480 billion. In its aggregate, the entire energy related MLP space is still just not that big. So the benefit to the government for changing that particular part of the tax code is relatively small – making the risk low (but with the government the risk is never zero).
In spite of the shifting and uncertain market conditions, new MLPs can still come to market with a total of three MLP IPOs in November. The third MLP IPO was Alon USA Partners, LP (ALDW) which owns a 70,000 barrel per day refinery in Big Spring, Texas and priced its IPO on November 19th at $16 per unit (20% below its expected price). Alon USA Partners is a Variable Rate MLP, meaning that its distributions will go up and down depending on the very volatile underlying cash flow of the refinery.
The lowered price meant an improved risk return trade-off: the units opened for trading at $17. Variable Rate MLPs are extremely risky and will behave well while the distributions are moving up and very badly when distributions are moving down, so the general and regional crack spread environment will be watched very closely for any signs of adverse trends.
Speaking of an adverse trend, Hi-Crush Partners, L.P. (HCLP) was another recent MLP IPO from August. Hi-Crush Partners is another atypical MLP that mines Northern White sand in Wisconsin for use as proppant in well fracking procedures and sells about 90% of its output to four major oilfield service companies under take-or-pay long term contracts.
On the morning of November 13th the partnership announced its third quarter results, which also included the news that Baker Hughes, Inc. (BHI) had cancelled its contract. The Baker Hughes contract, which commenced in May of 2012, represented approximately 16% of the partnership’s sales volumes and raises concerns that other customers could decide to cancel or re-trade their contracts as well.
The long term contracted sales arrangements were a key strength to the HCLP investment, so the increased uncertainty triggered an exit decision and the position was exited for an approximate 11.2% gross loss. The demand for premium frac sand remains robust and HCLP should be able to sell those volumes elsewhere, but the price is now less certain. Moreover, they will be spending money and time to sue Baker Hughes and to defend against class action lawsuits.
HCLP may find another party for a long term contract and recover nicely, but in keeping with the Sprint Portfolio philosophy if you stumble, even slightly, you are out of the race for now.
And the sprint continues…
Disclosures: Performance discussed is net of advisory fees, and includes reinvestment of dividends or other earnings.
Any index comparisons provided in the blog is for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships (MLPs) that provides investors with an unbiased, comprehensive benchmark for this emerging asset class. The index, which is calculated using a float-adjusted, capitalization-weighted methodology, is disseminated real-time on a price-return basis (NYSE: AMZ) and on a total-return basis (NYSE: AMZX).
Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.