October 23, 2011

MLPs, Outperformance & Fears Over Fracking

MLP insiders believe the industry’s efforts to educate drilling-area residents will reduce concerns over time.

It’s been a relatively good year for master limited partnerships (MLPs) compared to the overall stock market. Through early October , the S&P MLP Index has produced a total return of -2.71% versus the S&P 500 Index’s -7.6%.

On a price-only basis, MLPs are down -6.88% versus the S&P 500’s -9.03% result for the same period. MLPs continue to generate high distributions, and the long-term outlook for their profitable role in the energy supply chain is strong.

That doesn’t mean MLP investors can put their portfolios on autopilot, however, because the potential risks of fracking continue to gain attention.

Ask the average American for his or her opinion on fracking’s risks and you’ll likely get a blank stare unless the respondent lives near an oil or gas field. Fracking is shorthand for hydraulic fracturing, which Wikipedia defines as “the process of initiating and subsequently propagating a fracture in a rock layer, by means of a pressurized fluid, in order to release petroleum, natural gas, coal seam gas, or other substances for extraction.”

A less technical definition is that millions of gallons of high-pressure water, sand and proprietary chemicals are injected into a well. The pressure fractures the shale rock, creating fissures so the trapped natural gas can flow freely out of the well.

The process has been a boon to the energy industry—and MLPs—and there is research showing that fracking’s environmental risks are manageable. Nonetheless, there is a growing anti-fracking movement that claims fracking pollutes groundwater. A 2010 documentary, Gasland, generated controversy and brought national attention to fracking. Leaders in Philadelphia, New York City and Pittsburgh have voted to restrict drilling in and around their cities.

Videos on YouTube show homeowners in fracking-areas lighting fires from the methane fumes purportedly coming out of their water faucets. The issue continues to attract media attention: Forbes recently published an article, “The Facts vs. The Fracktivists,” that discussed criticisms of Chesapeake Energy’s exploration efforts. Potential backlash against the practice obviously concerns producers: witness the Exxon television commercial promoting the method’s safety, although the spokesman refers to “technologies” and doesn’t mention fracking directly.

At this point it isn’t clear if or how the anti-fracking movement will affect the industry or its regulation at the federal or states’ level but it’s a development that MLP investors should monitor.

Judd Cryer, senior research analyst with MLP-investment management firm Swank Capital in Dallas, agrees that there probably is greater pushback against fracking than in the past. However, his understanding of fracking is that is safe and he points to the industry’s record in his state of Texas.

“We’ve been doing it (fracking) for quite some time, for 5-6 years or more,” says Cryer, in a discussion with AdvisorOne. “We’re not seeing the issues that the media has kind of played up as potential environmental problems. We don’t see it here. We think it’s more noise but as far as our investment decisions go, it’s really more on a state-by-state basis.”

Cryer monitors the anti-fracking movement and believes that the industry’s efforts to educate drilling-area residents will reduce concerns eventually. He’s also confident that the movement won’t damage producers.

“(The) industry is taking a lot of steps to be more forthcoming, more transparent about what’s involved in fracking, how it’s done, the safety measures that are taken,” he says. “So, I think it’s an issue of education over time, and at this time we’re certainly not concerned that it’s going to be impacting in a negative way the producers.”

Page 2 of 2
Single page view Reprints Discuss this story
This is where the comments go.