What Happened in October: Winter Is Coming but the Cold Never Bothered Me Anyway

The best costume I saw this year was Jon Snow White. Go ahead, google it. It’s fabulous, and (with a little stretching) it’s a great analogy for what’s happening with energy infrastructure and MLPs. On the surface, MLPs were up 9.7% in October, and while I’m more than happy to celebrate that success, please remember how ugly the situation had become through September 29th. And no one is pretending that things aren’t difficult right now. Some MLPs, like old school Disney princesses, are perfect just as they are and need only wait for their prince to come. Some MLPs, like the (way awesomer) modern princesses, must fight to change their situation.

Winter Is Coming

Targa Resources Partners (NGLS) and its GP Targa Resources Corporation (TRGP) provided a preliminary financial outlook for 2016, and it did not inspire confidence in near-term fundamentals. TRGP will grow dividends in 2016 by 15% with approximately 1.0x coverage, while NGLS will grow distributions 0% with coverage of 0.90x-0.95x. Just another reminder than the GP does not owe fiduciary duty to the LP, so choose wisely if you are only going to invest in one. But both stocks were up on the announcement, showing just how low expectations really were.

Making an even bigger splash this month was Kinder Morgan (KMI) releasing next year’s guidance earlier than normal. For the first time in 13 years of releasing guidance, they cut guidance. For 2016, instead of the 10% dividend growth previously announced, it is now expecting 6%-10%.

As further announcements are made, most are in line with the comments of Plains All American Pipeline (PAA)’s CEO, Greg Armstrong, although perhaps not in as plain of language:

“We remain constructive on the intermediate to long-term outlook for crude oil prices, activity levels, and PAA’s growth prospects. In the near term we remain cautious due to the impacts of excess capacity and related competitive pressures, and our fourth quarter guidance reflects our most current view of the near term environment.”

The Cold Never Bothered Me Anyway

Let’s be clear, KMI’s 6% dividend growth on the low end is less than the 10% previously expected, but on top of a 7.5% yield at the end of October, that would still point to a double-digit total return over the next 12 months.

Other energy infrastructure companies and MLPs are reporting similar growth. Of the 50 names in the Alerian MLP Index (AMZ), 32 raised their distribution this past quarter, 18 maintained their distribution, and no MLPs cut distributions. On a weighted average basis, the names in the AMZ grew distributions 1.7% from last quarter. Let me insert my usual caveat: some MLPs smooth out distribution increases over the year, some increase distributions only annually, and some make quarter-by-quarter decisions. This means that minor quarterly variations are normal and expected. On a year-over-year basis, the names currently in the AMZ have raised their distributions by 7.4%.

Shell Midstream Partners (SHLX) raised its distribution 7.9% this past quarter, and 26.2% since it first started paying distributions earlier this year. That makes it one of eight companies which raised their distributions by more than 5% this quarter, and one of 15 companies to raise distributions by more than 10% in the past year.

When Will My Reflection Show Who I Am Inside?

Let me point out a further caveat: it is a requirement for inclusion in the AMZ that an MLP maintain or grow its distribution, and most Production + Mining names have already cut their distributions. So the news that Legacy Reserves (LGCY) cut its distribution even further (now less than 25% of what it was last year) is not included in the AMZ distribution growth calculation as LGCY has not been an AMZ constituent since June 2015.

Other names that cut or suspended distributions this month:

MLP Distribution Change Industry
 LINN Energy (LINE) and LinnCo (LNCO)  Suspended indefinitely  Production + Mining | Hydrocarbon
 Mid-Con Energy Partners (MCEP)  Suspends distribution  Production + Mining | Hydrocarbon
 Emerge Energy Services (EMES)  No distribution this quarter  Production + Mining | Frac Sand
 Natural Resource Partners (NRP)  Reduces distribution 50%  Mineral Interest
 Memorial Production Partners (MEMP)  Reduces distribution 55%  Production + Mining | Hydrocarbon
 Foresight Energy (FELP)  Reduces distribution 55%  Production + Mining | Coal
 Hi-Crush Partners (HCLP)  Suspends distribution  Production + Mining | Frac Sand

Prince Charming Disease.

What is interesting about this list is that these are all names that are directly sensitive to the price of at least one commodity. Now, when most people think about MLPs, they think of midstream companies with stable and growing distributions, and when you think of commodity price sensitivity, you think of variability. Yet only one of these names—EMES—is a variable distribution MLP. The rest attempt to smooth their distributions over time through a series of hedging contracts and careful asset management. These are not midstream businesses, and they have a different place in investor portfolios. Perhaps it’s time to have their distribution policies reflect the business models inside?

Fairy tales have long encouraged us to focus on conflict, and to believe the world will end without heroic intervention. They encourage us to look for magical perfection in happy endings. But fairy tales are not real. Times may be tough, but they aren’t as catastrophic as some would have you believe. MLPs will probably not conquer all tail risk forever and ever, but distributions on balance are still growing. Winter is coming, but Jon Snow White doesn’t need a prince.

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