Last week we held the monthly joint web chat for subscribers of The Energy Strategist (TES) and MLP Profits. The chat is conducted by Igor Greenwald, who is managing editor for TES and chief investment strategist for MLP Profits, and myself.

We got to most of the questions during this session, but there were a few that required an extended answer, or a bit more research. Of the remaining questions, there were about twice as many specific to MLPs versus those that pertained to conventional energy sector corporations. Below I will address most of the remaining MLP questions from the chat. For questions that weren’t MLP-specific, see this week’s issue of The Energy Letter.

Q: Are the general partner units always the best to hold for long term gains and MLP units for current income?

This question really piqued my interest. Intuitively, I felt like it was probably true, but I didn’t want to answer the question until I could dig into it a bit more. I thought it would be interesting to have a look at the historical performance of a few publicly-traded general partners versus their limited partner to find out if that hypothesis is supported.

Consider Kinder Morgan Energy Partners (NYSE: KMP) and its general partner Kinder Morgan  (NYSE: KMI). Over the past year, KMI did indeed outperform KMP, but if we track performance back to the IPO of KMI on Feb. 10, 2011 — KMP outperformed KMI during significant time periods. But both generally tracked each other quite closely in terms of returns.


Next consider Energy Transfer Partners (NYSE: ETP) and Energy Transfer Equity (NYSE: ETE), which owns the general partner and went public in 2006. ETE has significantly outperformed ETP since its IPO, particularly over the past four years:

But it is important to note that ETE also has interests in Sunoco Logistics Partners (NYSE: SXL) and Regency Energy Partners (NYSE: RGP).

Finally, consider NuStar Energy (NYSE: NS) and its general partner NuStar GP Holdings (NYSE: NSH). Like ETE, NSH went public in 2006 and has also significantly outperformed its limited partner since:

The vast majority of partnerships don’t have a publicly-traded GP. But in each of these three cases in which the GP is publicly traded, the GP tends to outperform the LP units on long-term gains, an advantage somewhat offset by the typically higher LP yield.

General partners tend to benefit in the long run from incentive distribution rights due from the partnership they manage, which entitle them over time to a rising proportion of the affiliate’s cash flow as it grows, and also, notably, every time the affiliate issues equity

However, there are time periods in all three cases where the LP outperformed on capital appreciation, so your mileage may vary. It will certainly vary with the particulars of the incentive distribution rights, the growth rate and the GP’s other interests.

Q: Is there any tax reason to not hold MLPs in private foundations?

There are additional tax reporting rules for MLPs in private foundations and IRA accounts. Some financial advisors recommend avoiding direct ownership of MLPs in these types of accounts, and instead purchasing an investment vehicle that owns MLPs, or an MLP that has chosen to be taxed as a corporation, in order to avoid the extra tax hassle. If I were seriously considering buying an MLP for a private foundation, I would first consult a tax attorney or a good CPA with experience in these issues.

Q: What are your thoughts on APU?

AmeriGas Partners (NYSE: APU) is the country’s largest retail propane marketer, serving some 2 million customers in all 50 states from approximately 2,100 distribution locations. Units initially dropped about 6 percent last week when an affiliate of Energy Transfer Partners announced a public offering of the 8 million AmeriGas common units that it currently holds. The units yield 7.9 percent, and AmerGas has done a good job of growing distributions over time. The biggest concern is that demand for propane had declined before the recent upswing due to increasing efficiency in buildings and appliances, as well as from customers switching to competing fuels like natural gas. This has led to inconsistent distributable cash flow (DCF), and in 2012 the partnership experienced a shortfall in its distribution coverage.

AmeriGas Partners distribution metrics. Source: APU Investor Presentation.

Nevertheless, the partnership’s growing distribution per unit has been impressive, and company guidance indicates another solid year after a good 2013. The market has been lukewarm toward AmeriGas, as its yield indicates, on perceptions of declining market share and weak propane prices. But propane prices have rebounded in recent months on stronger agricultural and export demand, while APU continues to deliver as promised. The units look very tempting at the current price and yield.

Q: Please comment on Legacy Reserves. It seems to be marching in place.

Among the non-variable MLPs, the upstream MLPs had the worst performance of any subsector in 2013. The upstream group was up about 10 percent as a whole, while the Alerian MLP Index returned 28 percent. Legacy Reserves (Nasdaq: LGCY) actually returned about 14 percent for the year, well above the upstream average. But most of that gain took place in the first quarter of 2013, and then for the rest of the year units traded in a pretty tight range.

Legacy appears to be among the better managed upstream MLPs. The partnership recently recorded its 12th consecutive increase in the distribution, which puts the annualized yield at 8.4 percent. The distribution coverage was solid at 1.3x, and debt remained modest relative to cash flow. Analysts were pleased with the latest quarter, and barring a complete collapse in the price of oil, Legacy should have no problem continuing to grow distributions.

Next week I will address two remaining MLP-related questions that actually entailed seven different partnerships.

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Portfolio Update

Kinder Morgan’s Boss to Critics: Sell to Me

Kinder Morgan Energy Partners (NYSE: KMP) needed to deliver strong fourth-quarter results in the wake of the recent controversy over its growth prospects that left its capital appreciation lagging badly behind that of most other MLPs last year. And the second-largest US pipeline operator did just that Wednesday, delivering revenue and earnings above estimates that boosted the unit price 1.2 percent the next day.

Revenue was up 29 percent year-over-year, aided significantly by the acquisition of Copano Energy last year and the dropdown of assets that general  partner Kinder Morgan (NYSE: KMI) acquired as part of its deal for El Paso Pipelines. Those additions also lifted distributable cash flow 28 percent.

But on a per unit basis that translated into a considerably smaller 6.8 percent year-over-year gain given $1.1 billion in equity issuance by KMP and its affiliate Kinder Morgan Management (NYSE: KMR) over the course of last year. The distribution increased by an even more modest 5 percent to $1.36 per KMP unit ($5.44 annualized) and is forecast to rise another 5 percent this year. KMI is projected to see a more significant slowdown in its own distribution growth, from 14 percent in 2013 to 8 percent this year.

The partnership family’s larger size may be playing its part, along with a downturn in gas trading and storage income that would have left the flagship natgas transportation segment’s bottom line down 3 percent year-over-year without the benefit of the Copano acquisition, instead of the reported 40 percent gain.

In any case, Kinder Morgan founder, CEO and chairman Richard Kinder is in no mood to concede that his family of partnerships has grown too large. He challenged his company’s critics on the conference call to sell him more KMI shares in addition to the 828,000 he bought in mid-December  in the market for $27.6 million. He noted that KMI and KMP “underperformed the market by a wide margin” in 2013, resulting in “the greatest disconnect to appropriate valuation since the period in 2006, just before we took the first KMI private.”

Asked to elaborate later during the conference call, Kinder didn’t tip his hand on the measures he might take to persuade the market this time around.  But he noted the similarities in the huge backlog of growth projects planned by the partnership family than and now, and pledged to once more prove the doubters wrong.  “So I guess my message to [critics] was you sell, I’ll buy, and we see who comes out the best in the long run,” said the billionaire.

The partnership’s latest results were boosted by increased oil production in the CO₂ segment and strength in the Products Pipelines and Terminals businesses.

The partnership is spending heavily on a variety of expansion projects likely to prove quite lucrative, including a crude pipeline from the Eagle Ford shale to the Texas Gulf Coast and another that would carry Canadian oil sands crude to a terminal on that country’s West Coast.

Kinder Morgan’s purchase of American Petroleum Tankers and State Class Tankers for $962 million is expected to close this month, and Kinder extolled the move into coastal marine shipping as a strategic benefit that will give customers more options to move swelling domestic crude volumes.

And he continues to see lots of upside potential in natural gas, as input to the growing number of LNG projects now moving ahead, a pipeline export to fast-growing Mexico and, increasingly, the fuel of choice in the Northeast US given the region’s proximity to the gas wells in the Marcellus and the Utica.

Still, longer-term worries remain. During the Wednesday conference call, one analyst asked if management’s current long-term distribution growth guidance — 9-10 percent for KMI and 5-6 percent for KMP — was still valid. Kinder replied that “we haven’t completed running those numbers” and said updated growth targets through 2018 would be shared during an analyst day presentation due next week.

If the expected growth rate stays strong and KMI and KMP continue their recent recoveries in the market, KMI shares especially could once again look attractive. They currently yield 4.6 percent, and long-term distribution growth could approach 10 percent based on KMI’s incentives as the general partner of a large and expanding MLP family. But we would like to see more of Rich Kinder’s cards first.  Continue to Hold KMI and KMP.