A key argument for investing in energy-industry master limited partnerships (MLPs) is that they provide exposure to the energy sector while avoiding commodities’ price gyrations. That’s been true historically and it continues to hold.
Wells Fargo Securities recently re-examined the correlation between MLPs and crude oil price movements and published the results in the July 2011 issue of its “MLP Monthly” research bulletin.
“Over the past three years, MLPs have exhibited a 0.47 correlation with crude oil prices. Although MLPs’ exposure to commodity price risk varies, the perception of commodity price risk can influence stock prices (over the short term), in our view. The four Wells Fargo MLP sub-indices that have exhibited the highest correlation to crude oil over the last three years include upstream (0.55), coal (0.48), gathering and processing (0.45), and crude oil logistics (0.43).”
MLP-investors who want more or less commodity exposure than the historical averages can find it in the sector, however.
Quinn Kiley, senior portfolio manager with Fiduciary Asset Management, or FAMCO, of St. Louis, Mo., notes that MLPs have a broad range of commodity-price sensitivity.
For example, federally regulated long-haul pipelines have very little commodity-price sensitivity, because the majority of their revenues come from the fees or tariffs they charge to provide shippers access to their infrastructure capacity.
Consider a pipeline, says Kiley, which may have a cost associated with natural gas because it needs natural gas to run the compressors that compress the gas as it flows through its pipeline. That means there is some marginal exposure there but many of the pipelines’ contracts allow for a pass-through of fuel costs so that’s eliminated.
Consequently, the portfolio manager said, “You’re talking about 85, 90, 95% of that business having fixed fees and very little chance for commodity price swings to negatively impact them.”
The analysis shouldn’t stop at the sector- and sub-sector levels, though, Kiley cautions. “You have to look through the assets that they own and the contractual exposure that they have to really get a sense of that (exposure),” he explained.
The reality is that these MLPs are in various businesses,” Kiley continued. “Many of them are quite diverse and depending on where they are in the energy value chain, they may have more or less commodity price exposure. Our view is that about 27% of MLP cash flows have some sort of commodity-price sensitivity, whether that’s because they produce a commodity or because their contracts pay them either in kind or as a result of commodity price moves.”