Stabilizing Oil Prices, Demand to Benefit MLPs in 2017

Master limited partnerships may become attractive investments again for people seeking both income and growth after these vehicles saw a few years of sharp losses because of plunging oil prices.

MLPs have features of limited partnerships, but trade like a stock. They generally invest in energy infrastructure projects, and many analysts' favorite investments in the sector focus on the so-called midstream, which usually are pipelines that carry crude oil and natural gas to refineries. MLPs create steady income, but because building pipelines are big, expensive projects they depreciate over a long time.

With energy prices stabilizing now that the OPEC said it is willing to cut oil production, and there is an incoming U.S. presidential administration friendly to fossil-fuel production, the outlook for MLPs appears to be on firmer footing, say energy experts.

[See: The Best Energy Stocks to Buy for 2017.]

"The table is set for the energy sector. A lot of uncertainties are off the table," says Rob Thummel, portfolio manager of Tortoise Capital Advisors in Leawood, Kansas. "Prices have stabilized and are probably range bound. Fifty to 60 dollars (for crude oil) is a sweet spot for MLPs and any other energy stock. Producers can earn an adequate return at that level and consumer demand will remain strong. For MLPs, demand for the commodity is key."

Supply and demand balancing out. With global oil supplies likely to be falling after a few years of a production glut and consumer demand still strong, that bodes well for MLPs. Furthermore, U.S. production is likely stable, too, after sliding from its peak in 2015 during the oil-price drop, says Darin Turner, managing director and portfolio manager for Invesco Real Estate in Dallas.

"What that creates is a relatively positive fundamental environment for MLPs," Turner says. "We're almost doing a 180 from where we were 18 months ago, when everybody thought U.S. production was never going to be as high as it was back in 2014 and '15."

Under President Barack Obama, the oil industry struggled with getting pipeline permits to build new infrastructure, say Turner and Jay Hatfield, portfolio manager at the InfraCap MLP exchange-traded fund (ticker: AMZA).

A combination of a friendlier presidential administration and improved technology to make U.S. producers much more cost-efficient should bode well for the sector, Hatfield says.

"There are two reasons for higher MLP prices. One, the U.S. is the lowest-cost marginal producer in the world. ... Second, we no longer have a president whose primary energy policy is to eliminate fossil fuels," Hatfield says. "That was the primary driver of Obama's energy policy. They opposed all energy-related projects, specifically pipelines like Keystone and the Dakota Access pipeline. This administration will be at least open to approving them. That's a pretty big improvement."

Thummel says even though oil prices were volatile this year, the sector itself had "a good year," noting the first exports of liquid natural gas and methane, and the first crude-oil exports since the 1970s-era oil embargo lifted.

Some risks remain. There is demand for crude oil and natural gas both domestically and from abroad, and to meet that demand pipelines need to be built to get energy from places like the Marcellus deposit in the eastern U.S. to the Gulf of Mexico.

However, public opposition to pipeline construction is well-documented, such as protests about the Keystone XL pipeline that would run from Canada into the U.S. and most recently the Dakota Access pipeline. Both crossed major waterways, and protests about the Dakota Access pipeline also concerned the potential impact on Native American communities.

[See: Oil ETFs: 8 Ways to Invest in Black Gold.]

Invesco's Turner says protests about building new pipelines remain a risk, especially when pipelines run close to populated areas. While on the campaign trail, Donald Trump said he would have approved the Keystone pipeline, and it's possible his administration may make permitting easier, but public concerns are not likely to go away, Turner says.

"There's a general view of continued dependence on fossil fuels, plus building energy infrastructure in people's back yard is always going to be a topic of high debate," Turner says. "What we do believe is people at times don't connect the dots on that we're building out this pipeline infrastructure specifically as it relates to natural gas and using that natural gas to displace the use of coal."

Cheap prices encouraged many power plants to switch to natural gas from coal, which also has one-third to half the carbon emissions of coal.

Thummel agreed regulatory risks might be an issue, more on the state side than the federal level. While protests may result in regulators requesting more environmental impact studies before making final approvals, regulators also need to weigh the financial impact on consumers, he says.

"Pipelines are the cheapest and also the safest way to transport energy in the U.S. anywhere," he says. "Regulatory lags will continue to extend as regulators request additional info. We don't think that causes pipeline building to be stopped, but it possibly slows the pace of it."

There is also demand from Mexico for U.S. natural gas as that country modernizes its electricity grid to run on natural gas instead of oil, Thummel says.

"Those opportunities could continue to expand, but if there are concerns about protectionism, that would be a negative," Thummel says.

Hatfield says for investors interested in MLPs, he likes two energy companies, both of which he says are currently undervalued. Williams Partners ( WPZ) owns the largest pipeline infrastructure, with a focus on natural gas. More natural gas pipelines need to be built to satisfy the demand for this fuel, he says.

Another pick is Energy Transfer Partners ( ETP), but he says investors should wait on this one. The firm is merging with Sunoco, which is expected to be completed in the first quarter of 2017. This firm is also building the Dakota Access pipeline, which he expects will eventually be approved.

[Read: Bottoming MLPs Offer a Bright Spot for Energy Investors.]

"We think it's substantially undervalued because of the merger and the protests," he says.

Debbie Carlson has more than 20 years experience as a journalist and has had bylines in Barron's, The Wall Street Journal, the Chicago Tribune, The Guardian, and other publications. Follow her on Twitter at @debbiecarlson1.