Five MLP-fund managers spoke recently with Research magazine for the 2011 Guide to Master Limited Partnerships regarding the sector's recent performance and its outlook, as well its potential risks and rewards.
This year's panel includes:
• Jeff Fulmer, senior advisor, Tortoise Capital Advisors, L.L.C., Leawood, Kan.
• Quinn Kiley, senior portfolio manager, Fiduciary Asset Management (FAMCO), St. Louis;
• Kevin McCarthy, president and CEO, Kayne Anderson Energy Closed-End Funds, and co-managing partner, Kayne Anderson Capital Advisors, Houston;
• Jerry Swank, managing partner and founder, Swank Capital, Dallas;
• Brian Watson, director of research, SteelPath Fund Advisors, Dallas.
What factors are likely to boost MLPs over the next few years?
McCarthy: Generally, we believe that new energy infrastructure development will be a catalyst for distribution growth in the MLP sector. Production in unconventional basins—especially the Marcellus Shale in Pennsylvania, the Eagle Ford Shale and Barnett Shale in Texas, and the Haynesville Shale in Louisiana—will drive the construction of new energy infrastructure to transport energy products to major population centers.
We believe that MLPs are the most direct way to capitalize on this trend. Another factor that will drive MLP returns is the continuation of a robust NGL market. Due to high prices and the current supply/demand imbalance, NGL volumes are expected to grow as E&P companies reallocate rigs to drill in liquids-rich areas, as opposed to drilling for natural gas.
Many gathering and processing MLPs have announced plans to increase capacity for fractionation, or separation of NGLs into individual products such as ethane, propane, butane, and natural gasoline.
Other MLPs have announced projects for processing plants and pipelines to handle these NGLs.
Finally, with the current environment providing ample access to capital, public MLPs are once again focusing on acquisitions and growth projects that we expect will lead to distribution increases. MLPs' 2010 capital spending for acquisitions and expansions was over $40 billion, the highest total we've seen since 2007 and more than double the level in 2009, and we expect that trend to continue in the near term.
Swank: I think the industry assets' size has become so big, $300 billion, that I think you're going to have more institutionalization, and I see it happening in two ways. One is more products: more closed-end funds, mutual funds, ETFs, ETNs, etc., to allow a larger base, and that's pretty much the retirement-plan pension business.
On the other side, you'll continue to get institutional investors now, such as big state funds—kind of like what happened in the REIT market in the late '90s. On the fundamental side, this whole oil and natural gas liquids play is in the second inning here, and I believe it's going to drive infrastructure, build-out connectivity and earnings and dividend growth of these MLPs for the next few years.
Fulmer: Robust growth through project build-outs and acquisitions should bode well for MLPs in the near term and lead to increased investor distributions. Capital investments targeting liquids-rich shale plays, notably the Eagle Ford shale in Texas, the Marcellus shale in Pennsylvania and West Virginia, and the Bakken shale in North Dakota are expected to be pronounced and should result in accretive growth.
Pipeline takeaway capacity remains short of peak production in all three of these regions and both MLPs and C corp pipeline companies are coming to the rescue. We think MLPs will invest over $20 billion in the next three years for needed infrastructure to connect regions of supply-push to areas of demand-pull.
Substantial momentum is also evident in the acquisition arena and likely to continue, with over $9 billion invested during the first five months of 2011. Over the next three years, we are projecting over $35 billion of M&A in the sector.
Kiley: We continue to think investors will be drawn to MLPs' attractive yields and the fact that the majority of MLPs are increasing their quarterly distributions.
Recent events would support the idea that the near term will continue to be volatile, although we do believe prices are going higher from current levels.
Increased merger and acquisition activity and accelerated capital expenditures on new infrastructure are the most likely drivers of positive performance over the short term.
Although we currently view the MLP group as fairly valued and with an attractive return outlook, headline risk around energy tax policy could create some choppy waters in the weeks and months ahead.
Watson: To be clear, our primary focus is on long-term performance and, in fact, we base our investment decisions on the assumption of a five-year holding period. Nonetheless, over the next three years the continued development of domestic shale and unconventional resource basins will allow these businesses to grow substantially.
We expect MLPs will be the dominant builders and operators of the logistical assets needed for this development and to connect these supply regions to the points of demand.
Triple digit year-over-year increases in rig counts in the Eagle Ford, Niobrara, and Bakken shales have strained takeaway capacity from these as well as other basins as current infrastructure is insufficient. Further, we expect the pace of acquisitions of midstream assets by MLPs from existing C corps will continue at a healthy clip.
Lastly, we believe investors will continue to diversify away from the REIT and utility sectors into the MLP sector. Each of these trends should be supportive of the space.
