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Matt Winkler
Matt Winkler
Articles (113) 

2 High-Dividend Oil Plays

MLPs are at the same price level as they were when oil was $26 a barrel. Dividends are high for many, and a double bottom is now being tested

April 13, 2018 | About:

Master limited partnerships have fallen way out of favor since 2014. The Alerian MLP Index (AMLP), which tracks 85% of the total market cap of energy MLPs, is now testing a double bottom last reached in February 2016, when oil hit a low of $26 a barrel. Oil is now 2.5 times that price and MLPs haven’t moved.

This has given some MLPs very high dividends. Two leveraged MLP exchange-traded notes, in particular, have spectacular yields of nearly 20%. They are UBS ETRACS 2x Monthly Leveraged Alerian (MLPQ) and UBS AG ETRACS 2x Monthly Leverage S&P (MLPZ), which track the Alerian and S&P MLP indexes respectively.

Given the possible double bottom here, is now the time to get into these funds? Let’s consider.

First, when I say these MLP indexes haven’t moved since the oil bottom, this is on a price return basis only. On a total return basis, which takes into account dividends received (this is the main point of owning an MLP after all), they are up significantly, nowhere near a double bottom. On a total return basis, the Alerian index is 37% higher than the February 2016 oil bottom.

For people who have chosen dividend reinvestment, then, they are 36% higher despite the capital value of these securities going nowhere for the last two years and sentiment being very bearish. Imagine what could be if MLPs come back into favor. What kind of potential total return are we looking at?

The MLP bull market began in November 2008, just as the VIX was spiking to all-time records and four months ahead of the general stock market. It ended with the oil crash of 2014. During that six-year bull run, total return was a spectacular 410%. That would make a leveraged ETN total return much higher still.

However, what happens next for MLPs is not so clear. One would think that prices conform more or less to the price of oil. But comparing the price of oil with the Alerian index reveals this is not quite the case. While the index does tend to fall when the price of oil falls drastically, as in 2008 and 2014, MLPs have not historically risen during bull markets in oil. As can be seen in the chart below, during the 2008 oil spike, the index actually declined significantly. Conversely, as oil declined about 9% from 2006 to 2007, the index actually rose 32.5%.

So MLPs don’t quite follow oil, but they don’t really follow the broader stock market either. Stocks have continued higher since 2014, while MLPs have not, obviously due to the oil crash of 2014. So they do rise with stocks if oil is stable, but not if oil declines. Given the uncertain correlations here, what seems the best strategy is first waiting to see if this double bottom holds and if we are indeed in a bear market in stocks, and then slowly scaling in and buying dips over time if it does.

While these two ETNs are leveraged, increasing their risk, dividends are double as well, mitigating the risk somewhat. Second, there seems little chance that oil will fall significantly from here. Geopolitical tensions, trade disputes and record deficits will both hurt the dollar and at least keep oil prices stable, and we’ve already seen what MLPs can do in a stable oil price environment.

Buying the dips will help ensure keeping the yield high and help guard against short-term collapse in MLP prices if we are in a new bear market in stocks generally. You may not get an 800% return in six years, but barring another oil crash, which is very unlikely, a long-term continuation of the MLP bear market seems just as unlikely.

Disclosure: No positions.

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