The proposal, uncovered by the National Association of Publicly Traded Partnerships (NAPTP), reportedly would call for all pass-through entities with gross receipts over $50 million to pay corporate tax. As we explain in the Flash Alert, this proposal differs from prior legislation regarding partnerships and the issue of “carried interest.” If passed, the proposal would eliminate the tax advantages of the MLP structure.

Talk of a new tax on MLPs brought back unpleasant memories of the “Halloween Massacre,” the infamous day the Canadian government announced it would modify the tax treatment of Canadian income trusts, causing a short-lived downturn for the group. One of the most common questions posed to us at the recent Las Vegas MoneyShow was if a similar overnight massacre could befall MLPs. In a word, the answer to that question is a resounding “no.” 

There can be no overnight change in the tax code governing MLPs because any tax proposal from the Obama administration or Treasury would need to be formulated into legislation and win approval in Congress. With Republicans controlling the House of Representatives and Democrats controlling the Senate, gridlock rules the day in the executive bridge. A proposal to tax MLPs has next to no chance of passing a Republican-controlled House. In fact, Rep. Dave Camp, a Michigan Republican in charge of the powerful House Ways and Means Committee, recently told The Hill newspaper, “[Taxing MLPs] isn’t something I’d be inclined to consider.” Camp’s comment suggests that any MLP tax will be dead on arrival.

In addition, such a proposal doesn’t enjoy widespread support on the Democrats’ side of the aisle either. In the past, several Democratic leaders have targeted MLPs for taxation, but most of the talk has focused on financial partnerships and private-equity funds. Prior proposals would have explicitly exempted energy-related partnerships from additional tax burdens.

Even when the Democrats controlled the House and Senate by significant margins, they were unable to pass legislation to tax carried interest earned by AllianceBernstein Holding LP (NYSE: AB) and other MLPs in the financial sector. This past failure suggests that such a proposal would stand little chance of passing, especially with the gridlock in Congress. The Obama MLP tax scare is a red herring; regard any downside in the group as a buying opportunity.

Meanwhile, our favorite MLPs continue to report impressive results. In particular, high oil prices and growing demand for natural gas liquids (NGL) from petrochemicals firms is powering demand for additional pipeline, processing and storage capacity. A new wave of organic expansion projects and an uptick in acquisitions have enabled MLPs to grow their distributions significantly thus far in 2011. Here’s a look at results from five of our top picks.

Five Alive

Enterprise Products Partners LP (NYSE: EPD)–Buy < 45
Targa Resources Partners LP (NYSE: NGLS)–Buy < 35
Regency Energy Partners LP (NasdaqGS: RGNC)–Buy < 29
Encore Energy Partners LP (NYSE: ENP)–Buy < 24
Legacy Reserves LP (NSDQ: LGCY)–Buy < 32

Enterprise Products Partners LP (NYSE: EPD) was a model of consistency in the first quarter, reporting a record  $694 million in distributable cash flow (DCF), up nearly 20 percent from the $580 million it posted a year ago. Management hiked the company’s distribution for the 27th consecutive quarter–this time to $0.5975 per unit, a 5.3 percent increase from the year-ago level.  

Enterprise generated enough DCF to cover its first-quarter payout by an impressive 1.4 times. The sale of some noncore assets bolstered DCF slightly, but even with $84 million in divestments backed out, the MLP covered its distribution by about 1.25 times.

Enterprise owns a vast pipeline, storage and processing network that spans more than 50,000 miles. Throughput was strong across the board, with the MLP reporting a 6 percent in natural gas volumes to a new quarterly record, NGL fractionation volumes up 16 percent and fee-based gas processing throughput up 38 percent year over year.

Although all Enterprise’s business segments performed well in the quarter, NGL pipelines and services was the star of the show. Gross operating margin, a measure of cash flow generated by the segment, jumped $67 million from 12 months ago. A jump in volume of NGLs processed, particularly in the Rockies and Texas’ Eagle Ford Shale, drove these gains.

We’ve written extensively about the importance of the NGLs market to many MLPs, including a detailed explanation of the industry in the March 15, 2011 issue The Saudi Arabia of Natural Gas Liquids. During Enterprise’s conference call to discuss first-quarter results, management devoted considerable time in its prepared remarks and in the subsequent Q-and-A session highlighting the growth in demand for NGLs and the consequent need to build processing plants, fractionation facilities and pipelines.

Rising demand from petrochemical plants continues to drive growth in this business. Chemicals companies make ethylene and propylene–the basic building blocks of most plastics–using either naphtha derived from crude oil or ethane and propane, two NGLs. With drilling activity in liquids-rich shale plays picking up, US production of NGLs has soared. This influx of NGLs has lowered the price of these key inputs relative to the Middle East and other markets.

Petrochemicals firms continue to expand their ability to produce ethylene and propylene from NGLs. In 2011 Dow Chemical (NYSE: DOW), Westlake Chemical Corp (NYSE: WLK), ConocoPhillips (NYSE: COP) and Chevron Corp (NYSE: CVX) have announced major expansions to their ethylene and propylene production plants, implying a sharp increase in demand for feedstock. Enterprise’s management estimates that ethane demand alone will increase by 200,000 to 300,000 barrels per day (bbl/day) by 2015.  

Analysts often ask Enterprise’s management whether the industry is overbuilding NGL-related infrastructure. Although the firm expects demand growth to support this expansion, the company also enjoys a degree of protection against overbuilding; the MLP only begins these projects after negotiating long-term contracts with that guarantee pricing and cash flow.

For example, Enterprise’s 600,000 bbl/day gas processing plant in the Eagle Ford Shale is already fully subscribed under long-term contracts. Management is now in discussions with producers to determine whether throughput volume would support additional capacity.

The MLP is currently expanding its NGL fractionation facility at the Mont Belvieu hub, adding a fifth train slated for completion in December. The fifth train is already fully contracted under 10-year deals, and Enterprise has filed permits to add another train at the facility. Management emphasized that the firm won’t build a sixth train unless long-term contracts support another addition. At this point, demand for another train appears robust.

Rising demand for NGLs translate into higher throughput volumes at Enterprise’s facilities and a need for additional capacity near fast-growing unconventional gas fields. Nevertheless, management has gradually reduced its direct exposure to NGL prices in recent years.

Like most gas processors, Enterprise historically has performed some work on an equity basis, accepting a certain volume of NGLs as compensation for use of its facilities. But management has replaced these agreements with fee-based deals that are less sensitive to commodity prices and guarantee a minimum level of cash flow over the long term. Accordingly, in the most recent quarter, Enterprise processed fewer equity volumes of NGLs while increasing its fee-based business by 38 percent from a year ago.

Exports also contributed to the strength of the Enterprise’s NGL-related businesses. The firm is upgrading its propane export terminal on the Gulf Coast, adding another 10,000 barrels per hour of export capacity. Producers have booked the terminal’s capacity completely through the end of 2012. If Enterprise had completed a planned expansion to the facility in 2010, the company would have become the world’s second-largest exporter of propane, behind only the Saudi Arabia.

Major capital spending projects will drive Enterprise’s distribution growth over the next few years. The firm already has $5 billion worth of construction initiatives underway. All of these projects are backed by long-term contracts and commitments that guarantee cash flows. Management expects the MLP to spend $3.5 billion in 2011, with balanced expended in 2012.

The largest of these undertakings is a $1.6 billion extension to its Haynesville pipeline, a project that’s slated for completion in September 2011 and is currently on time and under budget. This pipeline will carry natural gas from Louisiana’s Haynesville Shale, primarily to industrial facilities along the Gulf Coast.

The firm also has 21 projects of varying sizes underway in the Eagle Ford Shale, one of the hottest shale fields in the US. The Eagle Ford produces a combination of oil, NGLs and natural gas, all of which require dedicated midstream infrastructure. Enterprise has leveraged its existing assets in the area to become the preeminent player in the Eagle Ford.

In addition to projects already under construction, Enterprise has announced a number of undertakings that will soon begin construction. This list includes a new pipeline it’s building in conjunction with Growth Portfolio holding Energy Transfer Partners LP (NYSE: ETP) that will carry 400,000 bbl/day of crude oil from Cushing, Okla. to the Gulf Coast.

This pipeline will meet a critical demand at Cushing, the physical delivery point for the West Texas Intermediate crude that underlies futures contracts traded on the New York Mercantile Exchange.

Rising US imports of Canadian oil, higher domestic output from shale oil fields and an uptick in ethanol production have prompted pipeline operators to add new lines or reverse the flow of existing lines to carry crude south to Cushing and other refinery centers. This shift has not only glutted storage facilities at Cushing, but the reversed pipelines have limited flows out of the hub.

When an influx of crude oil overwhelms refining capacity, stockpiles build, and the price of WTI declines. WTI has traded at historic lows relative to similar grades of crude oil delivered to the Gulf Coast. This logistical logjam can only be resolved by the construction of new pipelines to move crude oil from Cushing to the Gulf Coast, an area that’s home to about 30 percent of the nation’s refining capacity.

Enterprise is also eyeing projects in the Rockies and in west Texas and New Mexico. The Permian Basin of Texas is of the nation’s fastest growing oil-producing regions; horizontal drilling and fracturing techniques have enabled producers to boost output from these mature fields. Most of the region’s infrastructure is decades old and insufficient to accommodate rising output.

All told, Enterprise has no shortage potential growth projects. During the MLP’s conference call to discuss third-quarter earnings, management noted that the firm would need to invest $1 to $1.5 billion annually in new projects to grow its distribution at the same rate as in recent years. But management plans to spend $3.5 billion in 2011 and $2.5 billion or more per annum over the next few years; Enterprise may grow its payout at an even faster rate. Enterprise Products Partners LP rates a buy under 45.

Targa Resources Partners LP (NSDQ: NGLS) offers even more exposure to the NGL business and potential upside in gas processing margins than Enterprise Products Partners. In the first quarter, Targa generated DCF of $72.1 million, enough to cover its $0.5575 per unit distribution by 1.31 times. The MLP’s quarterly payout represents a 1.8 percent increase over the fourth quarter of 2010 and a 7.7 percent boost from a year ago.

The company operates two segments: natural gas gathering and processing, and logistics and marketing. The company’s North Texas Gathering System posted a 6 percent jump in throughput volumes, driven primarily by strong drilling activity in the Barnett Shale. Although the Barnett is known primarily as a gas play, segments of the field produce significant quantities of oil and NGLs. The production of liquid hydrocarbons makes these parts of the Barnett profitable to produce, even with natural gas prices at depressed levels.

The San Angelo Operating Unit (SAOU) is located in the Permian Basin, a region where wells typically produce oil alongside quantities of NGLs and natural gas. Activity in parts of the Permian Basin have has picked up in recent quarters, as producers have found horizontal wells and fracturing techniques can increase output dramatically. One such play is the Wolfberry Trend, located in the west Texas portion of the Permian. Targa reported a 17 percent jump in first-quarter volumes in the SAOU, driven primarily by increased output and drilling activity in the Wolfberry.

Throughput increased despite a winter plagued by weather-related disruptions to drilling and well-completion activities–a testament to the productivity of the Permian and Barnett, as well as the quality of Targa’s onshore gathering and processing assets.

That being said, the MLP’s Versado gas gathering system in Texas and New Mexico took a hit from the cold weather and natural field declines. The regions served by Versado don’t offer as much potential production growth as North Texas or SAOU.

The company’s coastal gathering and processing business, located in Texas and New Mexico, processes volumes from the Gulf of Mexico. In the wake of the Macondo oil spill, drilling activity and production has declined in the region, particularly in the shallow water. But with the government beginning to approve drilling projects in the deepwater Gulf, this situation will eventually reverse–though it will be some time before activity returns to pre-spill levels.

Although total inlet volumes into Targa’s coastal segment were down 9 percent year-over-year, the connection of several offshore gas fields boosted throughput at its VESCO offshore gathering and processing system by 18 percent. Because input into VESCO tends to be richer in NGLs than other systems in Targa’s coastal segment, this increase had a substantial impact on the business unit’s results.

Unlike Enterprise Products Partners, Targa’s gathering and processing business offers more exposure to NGL prices and processing margins. At present, processing margins remain robust thanks to strong NGL prices and the relatively depressed price of natural gas.

Source: Bloomberg

This graph compares the price of a mixed barrel of NGLs to the average of the next 12 months worth of natural gas futures prices.

The depressed price of gas relative to NGLs incentivizes producers to maximize the amount of NGLs extracted from their fields. Meanwhile, Targa’s processing contracts ensure that the firm enjoys higher margins when NGL prices rise.

The downstream business, which includes fractionation, storage, terminal and marketing assets, didn’t fare as well in the first quarter. Volumes fractionated decreased by 14 percent from the fourth quarter of 2010 and operating margins were off 27 percent.

These disappointing results stem primarily from temporary factors and don’t represent a decline in demand for NGL fractionation and distribution. For example, cold weather caused a temporary shortage of liquids in Mont Belvieu market, reducing the availability of feedstock for fractionators. Meanwhile, the company received certain end-of-year payments related to its downstream business in the fourth quarter of 2010, making for a difficult comparison.

Targa has some exciting organic expansion projects underway. Management boosted guidance for total capital expenditures this year to $250 million–up from an estimated $200 million last quarter. And management hinted that this estimate is conservative because it only includes publicly announced projects.

One of the most exciting potential growth prospects is a major expansion for the firm’s Galena Park NGL export terminal, located on the Houston Ship Channel. International demand for NGLs is extremely strong, and US prices are highly competitive in the global market.

In Targa’s conference call to discuss first-quarter earnings, management announced that it had inked a long-term, fee-based export contract and would sink $13 million into expanding Galena Park’s capacity. Once this project is completed, the facility will be able to handle 5 to 8 loads of 145,000 barrels of NGLs in a month. Smaller liquefied petroleum gas carrier ships would transport these NGLs to South America. Management indicated that the firm will generate a margin of at least $300,000 to $400,000 per cargo load.

But Targa’s ambitions for Galena Park extend beyond this initial $13 million in upgrades. Management may spend at least $200 million to expand Galena Park’s export capacity so that it can accommodate the larger vessels that service Europe and Asia–an enormous growth opportunity.

Plans to expand the capacity of the Cedar Bayou Fractionattor–part of a joint venture with Growth Portfolio holding DCP Midstream Partners LP (NYSE: DPM)–by 100,000 barrels per day also promise to boost the firm’s DCF. This facility will handle NGLs transported from the Permian Basin and Eagle Ford Shale via DCP Midstream’s Sandhills Pipeline.

In the first quarter, Targa also acquired a refined products and crude oil terminal along the Houston Ship Channel for $29 million. The facility includes 544,000 barrels of storage capacity, all of which is leased to customers. This is Targa’s first significant foray outside its NGL business, but terminals are an extremely profitable asset to own. Meanwhile, the experience of Conservative Portfolio holding Sunoco Logistics Partners LP (NYSE: SXL) suggests that smart terminal expansions can be lucrative.

With exposure to a strong NGL market and a potentially massive export project, Targa has the potential to grow its distribution at an annualized pace of 6 to 8 percent over the next few years. Buy Targa Resources Partners LP up to 35.

Aggressive Portfolio holding Regency Energy Partners LP (NasdaqGS: RGNC) plans to boost its exposure to the NGLs through its new Lone Star joint venture with Energy Transfer Partners LP (NYSE: ETP). This deal, coupled with volume growth in the Permian Basin and Eagle Ford, should enable Regency to boost its distributions by the third quarter. This would be the firm’s first dividend increase since August 2008.

Regency historically has focused gathering and processing assets and has significant exposure to commodity prices. In the first quarter, the company reported solid results from its main gathering systems; total drilling activity was up 2 percent around its gathering lines as compared to the fourth quarter of last year. The firm has four main gathering systems in south Texas, west Texas, north Louisiana and Mid-Continent. All are expected to show double-digit increases in throughput volume, save for its Mid-Continent operations.

The south Texas gathering and processing system is expected to post the strongest volume growth in 2011, thanks to its proximity to the liquids-rich Eagle Ford Shale. Modest investments would enable Regency to ensure that its infrastructure keeps pace with production growth, though there’s also room for aggressive organic growth projects.

The company’s west Texas operations continue to benefit from an uptick in activity in parts of the oil-rich Permian Basin, including Wolfberry and Bone Springs. The rig count in this region jumped 10 percent from fourth-quarter levels.

The north Louisiana system includes the Haynesville Shale, a dry-gas play. Weak gas prices have prompted many producers to move rigs out of the Haynesville and into oilier fields such as the Eagle Ford. Nevertheless, the Haynesville’s low production costs will make it a go-to play as soon as natural gas price recover. Even better, drilling activity in Louisiana’s oil- and NGL-rich Cotton Valley play has jumped, spelling at least a modest increase in volumes for Regency’s system in the region.

Throughput in Regency’s Mid-Continent gathering and processing facilities should decline slightly, primarily because the surrounding fields feature less liquids content. But any decline in the Mid-Continent should be offset by growth in other regions.

The main focus of growth for Regency is the Lone Star joint venture with Energy Transfer, the first major project between these two MLPs after Energy Transfer’s general partner (GP) purchased Regency’s GP in 2010. The undertaking includes a 1,000-mile pipeline to transport NGLs from the Permian Basin of west Texas and the Barnett Shale of north Texas to the key Mont Belvieu hub on the Texas Gulf Coast. In Mont Belvieu, the venture owns fractionation capacity and NGL storage assets.

Regency and Energy Transfer acquired the basic Lone Star assets earlier this year and have announced their first organic expansion to this business: a 100,000 bbl/day of additional fractionation capacity that will cost $350 to $375 million and begin operations in early 2013.

Regency’s management expects to capital spending on future expansions could total $1.5 billion, with Regency paying roughly one-third of the bill and Energy Transfer picking up the remainder of the tab.

Given the strong margins available in the NGL business and Lone Star’s proximity to the Barnett and Permian, Regency’s growth potential is impressive.

In the first quarter, Regency’s DCF failed to cover its distribution. We never like to see MLPs fail to cover their quarterly payout, but Regency’s shortfall doesn’t concern us. Cash flows from Lone Star and volume growth at Regency’s major systems should bolster DCF considerably over the next two quarters, pushing the coverage ratio to between 1.1 and 1.2 by the third quarter of 2011. As Regency targets distribution coverage of 1.1 times, the MLP could boost its payout later this year. Regency Energy Partners LP rates a buy under 29.

The Producers

Aggressive Portfolio recommendation Encore Energy Partners LP (NYSE: ENP) cut its distribution by $0.01 in the first quarter to $0.49 per unit. At current prices, the MLP’s units yield 8.8 percent.

The company produced 8,463 barrels of oil equivalent per day (boe/day) in the first three months of 2011, compared to 9,034 boe/day in the year-ago quarter–a decline of 6.3 percent. Encore’s production mix has remained the same over the past 12 months: roughly two-thirds crude oil, 5 percent NGLS and the balance natural gas. Higher oil prices offset a decline in production, ensuring that DCF fell only slightly, from $27.9 to $27.8 million. DCF covered the company’s lowered distribution by a healthy 1.24 times.

Disruptions related to adverse weather didn’t help, but excluding these temporary challenges, the MLP’s output slipped by a little more than 4 percent. Much of this fall in production reflected the natural decline associated with older fields.

The market had expected Encore Energy to cut its distribution. The partnership pays out a minimum annualized distribution of $1.73 ($0.4325 per quarter) and then pays out one-half of all excess cash flow above a coverage ratio of 1.1 times. Management also made it clear during its conference call to discuss first-quarter earnings that investors should expect further reductions over the next few quarters.

But this isn’t a case of pain without a gain: Encore’s aggressive capital expenditure plans should enable the firm to grow DCF down the line. In the first quarter, Encore invested $1.2 million in its operations. Management plans to spend $3.2 million on capital projects in the second quarter and $10.3 million in the third quarter. Increased capital expenditures eat into Encore’s cash available for distribution.

Over the long term, these investments should yield significant production upside and halt the gradual decline in output. Planned spending includes eight development wells in the company’s oil-rich Elk Basin play in Wyoming. However, management stated that it would take at least a quarter or two for this capital spending to show up in the form of increased production and DCF.

We’re not overly concerned about Encore’s spending plans or future distribution cuts because by Vanguard Natural Resources LLC (NYSE: VNR) likely will acquire the MLP before the end of 2011. In March, Vanguard Natural Resources offered 0.72 of its units for each unit of Encore as part of a deal with former owner Denbury Resources (NYSE: DNR).Vanguard Natural Resources already owns Encore’s general partner and 46 percent of its outstanding units. 

The deal is currently being reviewed by Encore’s conflicts committee and third-party evaluators. Over the past few months, Encore’s units have traded at a slight premium to this takeover price, implying that the market expects Vanguard to sweeten its offer for Encore to around 0.75 to 0.78 units. Regardless of the final price, the deal should go through.

The upshot is that investors should focus on Vanguard Natural Resources’ growth potential and distribution power. Here, the news is far rosier. Vanguard bumped up its first-quarter payout by $0.01 to $0.57 per unit, pushing the payout 8.6 percent higher from year-ago levels.

Also, Encore’s declining output doesn’t reflect the quality of its fields; rather, the outfit’s former GP Denbury Resources put the MLP on the sales block and did little to support future growth. Vanguard Natural Resources is far more motivated in that regard, and its management has demonstrated its ability to grow production and distributions over time. Vanguard Natural Resources plans to dramatically ramp up capital spending associated with Encore’s assets, suggesting that opportunities abound.

In fact, Vanguard Natural Resources expects to spend $20 million on developing Encore’s assets in 2011 and just $19 million on its legacy assets.

As Vanguard Natural Resources controls Encore, it reports results on a consolidated basis; these results aren’t comparable to Vanguard’s standalone production in 2010. In the first quarter, the combined company produced 13,273 boe/day, about 57 percent of which was oil, 7.5 percent of which were NGLs and the remainder of which was natural gas. On a standalone basis, Vanguard Natural Resources produced 4,810 boe/day in the first quarter, up 11 percent over the same quarter one year ago.

Vanguard Natural Resources’ DCF in the first quarter was $0.94, enough to cover its payout by 1.64 times. Management indicated that this coverage ratio would likely decline as capital spending ramps up later in the year. Nonetheless, management is targeting full-year distribution coverage of 1.4 to 1.45 times, a level that’s well above average for MLPs that produce oil and natural gas.

Higher investment in Encore’s fields should enable Vanguard Natural Resources generate significant organic growth. During a conference call to discuss first-quarter earnings, Vanguard’s management indicated it had bid on several acquisitions in the quarter but only landed a few small deals. Over the long term, Vanguard Natural Resources should make meaningful acquisitions around its core plays. Encore Energy Partners LP rates a buy under 24. You should hold the stock through the coming merger with Vanguard Natural Resources.

Legacy Reserves LP’s (NSDQ: LGCY) operates primarily in the Permian Basin of west Texas and New Mexico, one of the hottest producing regions of the US right now.

The Permian has been in production for over a century and is a mature oil-producing region, but modern drilling and completion techniques have given a new lease on life to portions of the play. One of the hottest plays within the Permian is the Wolfberry, located around Midland, Texas. Legacy has a strong position in the Wolfberry and is ramping up spending on drilling in the region.

In the first quarter, Legacy grew its production and DCF 10 percent from the fourth quarter of last year. Growth stemmed from new wells and $81 million worth of acquisitions in the Permian.

Legacy announced its second consecutive quarterly distribution boost, raising the payout to $0.53 per unit–up from $0.525 per unit in the fourth quarter and $0.52 two quarters ago. Before that, the MLP held its payout at $0.52 for 10 consecutive quarters. Although the magnitude of recent distribution increases is modest, we’re encouraged that the MLP has returned to a model of steadily increasing its payout over time.

The firm’s DCF of $0.54 covered its raised quarterly payout just 1.02 times–a low level of distribution coverage relative to peer Linn Energy LLC (NSDQ: LINE), which covered its first- quarter payout 1.15 times. But several mitigating factors make up for this relative weakness.

First, DCF isn’t a generally accepted accounting principle (GAAP); the way in which different MLPs calculate this metric varies. We always examine how an MLP calculates DCF to avoid comparing apples to oranges.

Partnerships typically calculate DCF by adding back non-cash charges to earnings and maintenance-related capital expenditures, a measure of the investment a company needs to make to maintain its assets in good working order. However, Legacy’s conservative calculation of DCF includes some of the capital it spends to grow production. Based on this conservative approach, Legacy should easily sustain its distribution.

Legacy also reported some highly unusual weather-related distortions in the first quarter. Temperatures fell to 6 degrees Fahrenheit for three days near its core operations in the Permian. As a result, demand for heating forced the local utility to institute rolling blackouts in an effort to conserve electricity, temporarily shutting down pumping equipment in Legacy’s fields.

Even worse, about 400,000 bbl/day of refining capacity was offline, forcing some facilities out of operation for a month. As refineries came back online late in the quarter, a backlog of oil had yet to be refined.

Legacy’s management estimates that weather-related issued reduced production by about 550 boe/day in the quarter. If we add that back into the firm’s reported output, production growth in the first quarter would have been closer to 15 percent.

These disruptions also inflated costs. Per barrel expenses were up 11 percent in the quarter to $21.03 per barrel. If we back out weather-related expenses and the cost of integrating recent acquisitions, total per barrel costs fall to about $19.17.

The bottom line for Legacy is that the company’s oil-focused production in the Permian is heavily advantaged in the current environment of $100 crude oil. Management maintained its guidance for $52 million in total capital spending for 2011, but hinted that their success in the Wolfberry could prompt a more aggressive drilling program. During the Q-and-A session, management indicated that returns on organic growth projects in the Permian “have never been higher.”

Acquisitions are also likely, but management has emphasized that it will remain pricing discipline. Several firms have noted that new buyers in the Permian have driven up acquisition costs. Last year, Legacy expanded its operations geographically by purchasing fields in Wyoming. Management has indicated that these new additions have performed well. We suspect that more acquisitions outside the Permian are a possibility as Legacy gains expertise in other regions.

With Legacy’s DCF and distribution coverage likely to rise steadily through 2011, we expect the MLP to hike its payout throughout the year. Buy Legacy Reserves LP under 32.