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Managing Your MLP Holdings

February 29, 2012 | About:
Today, MLPs are still in the sweet spot: Not only does the nation face a critical shortage of midstream infrastructure to support growing output from prolific shale oil and gas plays, but most MLPs also have easy access to relatively inexpensive debt and capital.

My favorite MLPs continue to grow their distributable cash flow through acquisitions and organic growth projects, but all my infrastructure-related picks secure commitments from customers before turning the first shovelful of earth for new pipelines, fractionators or gas processing facilities.

In late 2011, some investors fretted that a study linking water contamination to hydraulic fracturing in Pavilion, Wyo. would prompt the government to restrict the practice and derail the shale oil and gas revolution. Fracturing, or stimulation, increases the permeability of the reservoir rock, allowing the formerly trapped hydrocarbons to flow from the reserve rock into the well. This process involves pumping large quantities of water and a small percentage of chemicals into the rock formation at high pressure, which produces a network of cracks. This production technique is critical to unlocking oil and gas isolated in shale and other “tight” reservoir rocks. For more information on hydraulic fracturing, see my Colleague, Elliott Gue’s, Seeking Alpha instablog post, Hydraulic Fracturing: What’s it All About.

In the abovementioned instablog post, Elliot debunked speculation that the Environmental Protection Agency’s “smoking gun” would lead to restrictive regulations on hydraulic fracturing, explaining why the unique situation analyzed in the report had little bearing on activity in commercial-scale shale oil and gas plays.

President Barack Obama likewise put these fears to rest during his 2012 State of the Union address, highlighting the nation’s rising output of natural gas and encouraging its widespread adoption for power generation and transportation. Such an endorsement effectively rules out overly restrictive regulations that would curtail hydraulic fracturing.

Although the government may mandate the disclosure of the chemicals used in fracturing fluid, drilling should continue apace in the Eagle Ford Shale and the nation’s other major unconventional oil and gas plays. Spears & Associates, the preeminent provider of data on pressure pumping, estimates that global spending on this critical service will surge 23 percent in 2012, to $52 billion. Much of this spending will occur in North America.

Frenzied drilling activity in the Bakken Shale in North Dakota, the Eagle Ford Shale in South Texas and other oil-rich plays has enabled the US to grow it annual oil output for the first time in decades. Even more impressive, this increase in overall oil volumes has occurred despite a sharp decline in production offshore Alaska and in the Gulf of Mexico.

Meanwhile, robust drilling in the nation’s shale plays also enabled the US to surpass Russia as the world’s leading producer of natural gas and has dramatically depressed gas prices in the closed North American market. Despite gas prices that continue to hover near record lows, US output has continued to grow. Exploration and production firms have shifted their emphasis from dry-gas fields to plays that also produce large amounts of higher-value natural gas liquids (NGL) that improve wellhead economics.

This upsurge in onshore oil and gas output has occurred in the Bakken Shale and other regions that lack legacy takeaway and processing capacity, while even the Permian Basin in west Texas–an area that’s produced oil since the 1920s–requires additional infrastructure to handle growing volumes. With ready access to capital, MLPs will build much of this midstream capacity.

Despite these strong fundamentals, recent inflows into the Master Limited Partnership space have pushed valuations to frothy levels. We can’t emphasize enough the importance of adhering to our buy targets and taking some profits off the table when a big winner throws off the balance of your portfolio.

Some investors balk at taking some profits in MLP positions that have rallied considerably–after all, no one likes to pay taxes. If you hold yourMLP investments in a taxable account, you’ll likely be paying on a cost basis that’s been reduced by accumulated distributions that count as a return of capital.

Investors should grit their teeth and remember that regardless of the tax you pay on your gains, you’ll reap more profit than if you lose some of your paper profits in a correction. Moreover, the 15 percent tax rate on long-term capital gains is the lowest in decades.

If you hold your MLPs in an IRA, taking some money off the table won’t trigger a taxable event. Nonetheless, some investors will rationalize their decision not to take profits by reminding themselves that they’re earning a higher return on their original investment than they could earn by investing new money. But a 10 percent correction in the market could more than wipe out a year’s worth of income from any MLP.

Don’t equate taking profits with bailing out. In these uncertain times, taking what the market gives you will lock in hard-won gains. You can always reinvest the proceeds when stock prices inevitably pull back.

About the author:

Roger Conrad
Investing Daily provides stock market advice and investment newsletters to help independent investors achieve a secure and rewarding financial future. The site’s coverage focuses on finding the most profitable emerging trends in the investment universe to bring investors pragmatic and in-depth coverage of the names that are taking advantage of these opportunities.

Visit Roger Conrad's Website


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