MASTER LIMITED PARTNERSHIPS

Friday, September 12, 2008

Someone asked for a poll...ask and i shall post it. Something to contemplate over the weekend.

3 comments:

Anonymous said...: From Morningstar 9/12/08:

"I strongly suspect there are funky things going on behind the scenes there--a phenomenon I call the 'fellow-shareholder problem.' To put it lightly, not everyone owns stocks for the same reasons we do--to hold over the long term and collect rising streams of dividend income. Short-term, momentum-driven, highly leveraged money that is out there is being shaken by the ongoing credit crisis. In times of financial crisis, their actions may not be the product of hard-headed fundamental analysis. Many may have no alternative but to liquidate positions (both long and short) for lack of funding.

This, in turn, is my best guess for explaining what's going on in the MLP sector right now. About a month ago, I pointed out that the spread between MLP sector yields and 10-year Treasury bonds was close to a historic peak at 4.2 percentage points. Since then this spread has continued to increase; it now sits at 4.6 points in the MLPs' favor.

It's true that the sector's fundamentals have become a bit less certain amid volatility in the capital markets. These pipeline firms rely partially on new issues of LP units to fund expansion, and when prices fall and distribution yields rise, expansion can become more costly and less profitable. This week we increased our fair value uncertainty ratings for several of the Harvest's MLPs from low to medium, and top Builder holding Crosstex Energy Inc. XTXI now carries a high uncertainty rating. At present several of our fair values for midstream MLPs are under review (you can read more about this below), and I'll keep you posted as our fundamental reviews proceed.

I suppose there may also be folks attempting to trade around Hurricane Ike, perhaps even with a bit of justification. We already know that Crosstex Energy LP XTEX will be taking a modest cash-flow hit from Gustav (although not enough to jeopardize our distributions, in my estimation). And there is certainly the possibility of asset destruction and lengthy refinery outages. But what threatens near-term earnings here probably doesn't threaten long-term earning power, and the industry has bounced back from major storms before. After the experience of the 2005 storms, I find it reasonable to expect that our pipelines (and other energy infrastructure operators) will be well prepared.

That all being said, the weakness in MLP prices began before Ike clearly threatened the Texas coast--so I'm still inclined to cite investor irrationality as the cause of recent volatility. As it turns out, the wounded Lehman Brothers is a major holder of Crosstex's LP units (XTEX) and Magellan Midstream Holdings MGG, and several large hedge funds have been noted as big holders of MLPs in general. I can't be certain, but I suspect these "investors" couldn't just let these MLPs' distributions do the work; they just had to juice themselves with leverage to magnify potential gains (while greatly magnifying the prospect of forced loss). It may be that some of our fellow shareholders have no recourse but to sell at whatever price they can, and even the mere possibility that large dumping could take place is enough to push prices lower in the short run.

Yet I choose not to be a short-term, momentum-driven, highly leveraged investor--quite the opposite. I pay cash for my holdings. I buy for a handsome stream of future income that will take years to accumulate, not days. And I am resolved to continue my income-rich strategy for the long term.

I'm not calling a bottom for the MLP sector; volatility is sure to continue. But seeing MGG at a 7.2% current yield makes no economic sense to me: This particular partnership (and its subsidiary Magellan Midstream Partners MMP) has no need to access the capital markets anytime soon, and I still expect annual per-unit distribution growth in the 15% area for the next couple of years. As for Crosstex, I decided to 'brave the storms' by adding the LP units to one of my personal accounts this week at a current yield over 11% (I had already owned XTXI for some time).

Next week we'll know more about Ike's impact, and in the event any significant fundamental impacts emerge I'm ready to discuss them on DividendInvestor's Web site. But even if I don't have an abundance of ready resources to take advantage of current prices (the Harvest portfolio being fully invested), the selling required by other investors' weakened financial circumstances need be of no concern to me. I can just go on collecting my distribution checks, confident that falling prices will eventually attract buyers and reasonable market valuations will be restored.

***

Best regards,

Josh Peters, CFA
Equities Strategist
Editor of Morningstar DividendInvestor

Disclosure: Josh Peters, CFA, owns shares in the following stocks in his personal portfolio: BGH, BMS, FPO, GE, KFT, KMR, MGG, O, SYY, XTEX, XTXI.

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Midstream Master Limited Partnerships
Analyst Note 09-09-2008 | Jason Stevens

We are making several adjustments to our fair value uncertainty ratings for midstream energy companies, with a bias toward higher uncertainty ratings than we've had in the past. Broadly speaking, we think that persistent capital market weakness may limit midstream companies' access to capital in the short to medium term, which may result in reduced capital budgets for the remainder of this year and into 2009. Capital constraints severely damp acquisitions and make funding growth projects more expensive. Because midstream business models are capital-intensive, characterized by up-front investment with extended payback periods, a decrease in investment now would result in lower cash-flow growth prospects a few years from now.

Were this the only factor in play, we would be reducing our fair values estimates instead of raising uncertainty ratings. However, we continue to believe that our projections of cash flows over the next several years remain the "most-likely" case. For many midstream companies we cover, cash flows are highly predictable due to long-term contracts that generate steady fee-based income. We also feel comfortable with our cash-flow projections from the long list of projects currently under way or recently entered into service, which we believe will drive increases in distributable cash flow across the MLP space for the next several years. By raising uncertainty ratings rather than lowering fair value estimates, we are acknowledging wider ranges of possible outcomes around central cases we remain confident in.

We are also placing a handful of companies in our midstream coverage under review, as we are less confident in our base-case projections. We intend to review our base assumptions and uncertainty ratings and make adjustments as required. These names include Regency Energy Partners RGNC, Copano Energy CPNO, Plains All American Pipeline PAA, and refined products pipelines Sunoco Logistics SXL, Buckeye BPL BGH, and Magellan MMP MGG.

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Anonymous said...: From: The Energy Strategist

September 12, 2008

Your Guide to Understanding the Hedges

By Elliott H. Gue

Inside my subscriber-based service, The Energy Strategist, I recommend a handful of companies that are organized as publicly traded partnerships (PTP); the most common forms of PTP are Master Limited Partnerships (MLP) and limited liability companies (LLC). I’m also co-editor of The Partnership, a newsletter dedicated solely to investing in this group.
One stock I currently recommend in both publications is Linn Energy, a natural gas and oil producer primarily based in the Midcontinent of the US. This company currently offers a tax-advantaged yield of 13.2 percent, making it an attractive energy play for income-oriented investors. And, like all PTPs, Linn doesn’t pay any income tax at the corporate level.
The most common pushback and question I receive from subscribers and potential investors is why I would recommend a company that’s lost $12.55 per share over the trailing 12-month period.
At first glance, this looks ominous indeed. Linn has a float of around 115 million shares, so that works out to an overall loss of $1.44 billion. With only $9.6 million in cash on the books, surely this company should be, at best, slashing its dividends or headed to bankruptcy court. In fact, at a natural resource conference this week, no fewer than a dozen attendees asked me that very question.
This loss, reported on most major financial Web sites and in Linn’s quarterly filings with the Securities and Exchange Commission (SEC), is actually a totally meaningless figure. The reason has to do with how exploration and production (E&P) firms are required to account for their hedge positions.
Linn produces oil and natural gas, both commodities that can be extraordinarily volatile at times. If Linn simply produced oil and gas and sold its production at prevailing market prices, its cash flow would be highly variable.
Since the company pays out most of its spare cash as distributions (the PTP equivalent of dividends), changes in oil and natural gas prices would necessitate the constant adjustment of the payout. In good quarters, Linn would pay out a mountain of cash; in bad quarters, the PTP would pay very little. As you can imagine, investors looking for a solid, sustainable income stream over time are unlikely to appreciate that volatility.
To combat this variability and smooth out income over time, Linn extensively hedges its oil and natural gas production. To do this, the company enters into a variety of positions including collars, put options and swap positions.
I won’t delve into a detailed explanation of all three of these positions; suffice it to say that swaps guarantee Linn a fixed or near fixed price per barrel of oil or million British thermal units (MMBtu) of natural gas. Puts and collars offer Linn a minimum floor price for its production while offering the company some upside if oil and gas prices continue rising.
Let’s take a closer look at Linn’s current hedge book.

Source: Company Presentation, Sept. 4, 2008
This chart shows Linn’s total hedge position going out through 2014, the final year for which Linn currently has hedges in place. The percentages are based on estimated production for 2008.
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As you can see, Linn is hedged at close to or more than 100 percent out through 2011. The hedge book primarily consists of swaps but the put and collar position actually increases as we move forward in time from about a third this year to close to 50 percent in 2011. After 2011, Linn still has significant volumes hedged; if history is any guide, the PTP will gradually add to its hedges in those out years over time.
Let’s look at the same basic data in terms of price. Check out the two charts below.

Source: Company Presentation, Sept. 4, 2008

Source: Company Presentation, Sept. 4, 2008
As you can see, Linn’s overall natural gas hedges provide it with floor price protection in the $8 to $8.50 per MMBtu range out through 2011. And because puts account for about a third to a half of hedged volumes, Linn does get some upside exposure to rising gas prices. Since I’m generally bullish on natural gas, I see this as a positive.
The same is true for oil. On a blended basis, Linn’s hedges give it a floor around $78 per barrel this year and around $100 per barrel in 2009 and 2010. An even larger percentage of oil hedges are puts and collars, so Linn also has significant upside exposure to oil prices even though its downside is protected.
Obviously, Linn hedges a good deal more than most traditional E&P firms. But, there’s good reason for that. Linn must generate reliable cash flows so that it can back up that generous 13 percent yield.
That brings me to the problem with looking at Linn’s reported earnings figures. Under generally accepted accounting principles (GAAP) accounting rules, Linn must mark-to-market its hedges each and every quarter. That means that it must revalue all of the puts, swaps and collars it purchases to fair market value covering around five years worth of its oil and natural gas production. Any marked-to-market change in the value of this hedge book must be booked at earnings, whether it’s a profit or a loss.
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By definition, the value of hedges is supposed to rise when oil and gas prices fall. The change in the value of the hedges offsets the volatility caused by the fall in prices. In contrast, when energy prices rise, the value of hedges will, by definition, fall. Therefore, in strong energy markets when Linn goes to revalue its hedges, the company will be forced to take a large accounting hit to its earnings figure. And because these hedges cover five years of Linn’s production, the swings in the value of the hedge book are truly gigantic. During its February conference call, Linn noted that a $0.50 rally in gas and $5 for oil produces a $165 million mark-to-market loss.
The strong run-up in energy prices over the past year produced a big loss for Linn’s hedges. This factor accounts for that ominous earnings figure that’s reported by most of the financial Web sites.
But there’s absolutely one key point to remember: These mark-to-market losses do NOT represent actual cash flow for Linn. The company isn’t required to make payments or post margin related to its hedge book.
The loss or gain only becomes “real” when the hedge expires. However, at that time, Linn has actually produced the oil or gas covered by the hedge. Linn isn’t speculating in the futures market. Rather, it’s simply using hedges to lock in a minimum price for its production over time. Linn is an industry operator with real oil and gas backing up its hedging operations. Linn has stated unequivocally that it never has to post any margin or cash related to these mark-to-market losses.
Here’s an exchange between Michael Linn and an analyst from the company’s most recent quarterly call:
Analyst: ….I just wondered if you all have any concerns about margin—the effect of that big negative increase [on the hedge book], the effect on liquidity and margins. How you all are affected by that and also whether you’ve seen any reversal of that since the end of the quarter?
Michael Linn: Good questions. Number one, we hedge exclusively within our bank group, which have 100 percent security on our assets, so we are not subject to any margin calls at all, ever. So that’s the good news. On your second question, commodity prices have declined quite a bit from the end of the second quarter and, if they were to stay at current levels, we would have a fairly large mark-to-market gain in the third quarter.
Source: Linn Second Quarter Conference Call, Aug. 7, 2008
Due to this distortion, earnings per share (EPS) figures and the long list of financial ratios based on earnings carry no real meaning for Linn.
Instead of earnings, the accepted measure of performance for PTPs like Linn is distributable cash flow (DCF). This measure strips out all non-cash charges from the earnings number including mark-to-market activity, depreciation and amortization.
In addition, DCF nets out an expense commonly called maintenance capital spending. The maintenance charge is the base level of spending required to maintain all of the PTP’s equipment and assets. In Linn’s case, this would be roughly the amount of cash needed to maintain its production at existing wells.
On this basis, Linn earned $0.99 in DCF per unit (share in PTP parlance) in the second quarter of 2008. Since Linn paid a distribution of $0.63, it covered its distribution 1.57 times. That’s a healthy level of coverage. And based on its current hedges, Linn could maintain its payout through at least 2011 regardless of what happens to oil and natural gas.
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The Energy Letter is a bi-weekly e-zine written by Elliott H. Gue and published by KCI Communications, Inc. In addition to The Energy Letter, Mr. Gue also publishes The Energy Strategist, a premium bi-weekly newsletter on the energy markets.

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Anonymous said...: In theory at least, capital markets are supposed to be the vehicles that transmits a nations savings into investments.

The time is long past to ban "naked short selling" as an illegal abusive tactic ( including baning the market maker exception ) because of the damage this practice has done to confidence that the system fairly rewards good decisions and punishes bad ones.

I don't have a position in Lehman or the other short targets, but it's clear that stocks are not being valued by their prospects, rather by money flows.

In normal markets, the shorts would beat down a stock, shake out weak hands, then institutions would step in and buy these stocks cheaply.

That expains how value investor Bill Miller was able to achieve his long record at Leg Mason of beating the S+P until recently.

HE would buy a stock thats out of favor, then wait until it's in favor.

We could play this game too by emulating that game plan.

Well with stocks being pushed into colapse on speculative bear raids, that strategy isn't one that works anymore.

Now stocks are being beaten down by the shorts into bankruptcy, and are strong enough that institutions don't want to step in when there is the likelyhood that their investments will be wiped out in any reorginization due to "Moral Hazard."

Paulson's takeover of Fannie and Freddie destroyed both common and preferred shareholders when there could have been a solution that merely damaged them.

What was particulary ugly was what was done to the preferred shareholders, they answered the call to help recapitalize the GSE by buying 20 billion in new preferreds since NOV 2007. Now their investment will be virtually entirely wiped out.

Preferred investors have concluded that it's a "Moral Hazard" to own preferred shares in banks and have sold off these shares shapely.

In addition small banks who have held F+F preferreds ( and took a 25 billion hit ) as part of their core capital are now facing being cut off from the issuance of new preferreds (one of the few markets for raising capital that still was functioning with 65 billion raised this year) because preferred investors realize that it's now a "Moral Hazard" to be part of the solution of recapitalizing banks.

Another GSE "Farmer Mae" (AGM) held F+F preferreds as part of their core capital. They were down about 30% on Friday when this was revealed.

-----------------------------------

How does this effect MLP investors?

Firstly, Limited Partner units are really closely akin to Preferred shares in that LPUs have a superior call on distributable funds, limited say on management, but LPUs have a kicker in they have a possibility of higher distributions.

Hedge funds might drive MLPs down based on "speculation" that demand destruction combined with a lock-out of MLPs to bank financing will force MLPs to raise capital in the Equity markets raising the spectre of massive dilution.

The only thing that MLPs can do to defend themselves is to suspend all capital projects, so as to take the need to raise capitial off of the table.; 9/13/2008 11:39 AM