Energy

Analysts Pick MLPs Insulated From Low Oil Prices

It has been no secret that the falling price of oil has taken its toll on the energy sector. Still, the drop may not be as universally bad as some of the trading in oil and gas giants and in segments such as master limited partnerships (MLPs) may indicate. A fresh report this week from Merrill Lynch’s MLP team actually highlights which MLPs may be mostly insulated from the carnage in oil prices. The caveat here should be obvious in that persistently lower prices may overshadow a group far longer than just a few trading sessions.

The Merrill Lynch commodity team recently lowered its West Texas Intermediate (WTI) average 2015 forecast to $84 per barrel — with Brent averaging $90 in 2015. Still, the team noted that $70 to $75 Brent could be the most likely scenario in 2015. A key observation is that oil under $80 per barrel is fine, but under $70 is less and is under its prior worst case scenario.

So, it turns out that large MLP players such as Kinder Morgan, Enterprise, Magellan Midstream, Buckeye, Plains All American and others could actually be partially insulated if Merrill Lynch is accurate in its assessment. The MLP call from Merrill Lynch signals that for the midstream MLP sector to find a true floor, crude oil markets would need to find a bottom and the latest moves have arguably been destabilizing. The firm is sticking by its prior call — not all MLPs are created equal.

Enterprise Products Partners

Enterprise Products Partners L.P. (NYSE: EPD) is considered to be a lower business risk MLP, owing to its large, diverse asset base and strong organic growth outlook. Downside risks to Merrill Lynch’s price objective are supply chain disruptions, the loss of key customers, a sustained period of low natural gas prices and a severe hurricane season. Any of these risks could negatively impact volumes at the company’s pipelines and storage facilities and demand for gathering, processing and storage of natural gas and natural gas liquids (NGLs).

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A high natural gas to crude oil ratio would negatively impact natural gas processing economics, leading to lower processed volumes of natural gas, lower NGL production and lower demand for Enterprise Products’ services and use of its facilities. From a macro perspective, risks are an increasing interest rate environment, the company’s need to externally finance growth initiatives since it distributes the bulk of its operating cash flow, and a stricter regulatory environment, which would increase operating and maintenance expenses. Furthermore, the tax treatment of Enterprise Products depends on its status as a partnership for federal income tax purposes: should it become subject to taxes, its performance could be materially affected.

Units of Enterprise Products closed Monday down over 2% at $36.32. Merrill Lynch has a price objective of $43 for the stock, compared to the consensus analyst price target of $43.74. It has a 52-week trading range of $15.19 to $41.38 and a market cap of almost $69 billion.

Kinder Morgan

Kinder Morgan Inc. (NYSE: KMI) is now a corporation again rather than being the parent of three different MLP entities. We recently highlighted how funds and ETFs would treat Kinder Morgan after the merger. Merrill Lynch believes that Kinder Morgan faces some downside risks ranging from the pending merger falling through to unfavorable capital markets that could hinder Kinder Morgan’s ability to complete drop-downs. Other downside risks are a decline in crude oil production and potentially the pricing at Kinder Morgan Energy Partners’ CO2 segment, an outright decline in demand for refined products or natural gas, cost overruns at organic growth projects, an economic slowdown impacting energy demand and supply chain disruptions.

Shares of Kinder Morgan closed down about 1% at $40.81. Merrill Lynch has a price objective of $47 for the stock, compared to the consensus target of $44.38. The 52-week trading range is $30.81 to $42.49.

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Magellan Midstream Partners

Magellan Midstream Partners L.P. (NYSE: MMP) faces business risks to the price objective of a slowdown in refined products demand growth, cost inflation or timing delays at its expansion projects, and supply chain disruptions. This would negatively impact volumes transported through the company’s pipelines and stored at its terminal facilities. Also, margins could decline at Magellan Midstream Partners’ petroleum products blending business. However, this business should represent less than 15% of its ongoing operating margin. Upside risks are additional organic growth announcements and higher than expected distribution growth.

The tax treatment of Magellan Midstream depends on its status as a partnership for federal income tax purposes. Should Magellan Midstream Partners become subject to taxes, its performance could be materially affected. From a macro perspective, financial risks are rising interest rates, which would be negative for MLP valuations in general, a stricter regulatory environment that would increase operating and maintenance expenses, and the need for the company to turn to the capital markets to finance growth initiatives since the partnership distributes the bulk of its operating cash flow.

Units of Magellan Midstream closed down Monday about 4.5% at $79.13. Merrill Lynch has a price objective of $90 and the consensus target is $90.81. It has a 52-week trading range of $58.11 to $90.08 and a market cap of almost $18 billion.

Buckeye Partners

Buckeye Partners L.P. (NYSE: BPL) is considered a relatively low business risk MLP, owing to its negligible commodity price sensitivity, investment grade credit rating and modest organic growth outlook. Upside risks: more BORCO, Perth Amboy and HES terminal expansions, and improvement at Merchant Services. Downside risks to Merrill Lynch’s price objective are a slowdown in refined products demand growth, an outright decline in demand, higher prices, cost inflation or timing delays at Buckeye’s expansion projects and supply chain disruptions.

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This would negatively impact volumes transported through Buckeye’s pipelines and stored at its facilities. Buckeye’s tax treatment depends on its status as a partnership for federal income tax purposes. Should the company become subject to taxes, its performance could be materially affected. From a macro perspective, financial risks are rising interest rates, which Merrill Lynch believes would be negative for MLP valuations in general.

Units of Buckeye Partners closed Monday down 2.6% at $74.85. Merrill Lynch has a price objective of $86, and the consensus price target is $83.61. The 52-week trading range is $63.77 to $85.14 and the market cap is $9 billion.

Energy Transfer Partners

Energy Transfer Partners L.P. (NYSE: ETP) could experience some yield compression, given its resumption to distribution growth, robust organic growth backlog and interest in other Energy Transfer entities. The company’s target distribution rate is in-line with other large cap MLPs under coverage. Business risks to the price objective on Energy Transfer Partners are execution risk around integrating acquisitions, lower-than-expected returns on growth projects, a sustained decrease in natural gas commodity prices or lower basis differentials. Increasing costs may also reduce the returns realized on the company’s growth projects.

Units of Energy Transfer Partners closed Monday down over 4% at $62.43. Merrill Lynch has a price objective of $80 for the stock, compared to the consensus analyst price target of $72.92. It has a 52-week trading range of $51.65 to $69.66 and a market cap of $22 billion.

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Plains All American Pipeline

Plains All American Pipeline L.P. (NYSE: PAA) is another MLP considered a lower-risk business as a result of its diverse asset base, investment grade balance sheet, low direct commodity sensitivity, seasoned management team and solid organic growth outlook. Business risks to the price objective are a decrease in crude oil price volatility, a decrease in domestic crude oil supply, an outright decline in demand due to higher prices, economic slowdown or other reasons, and supply chain disruptions. This would negatively affect volumes transported through the company’s pipelines and stored at its facilities.

Cost inflation and project timing delays are also potential risks to the partnership’s capital spending program, as several other expansion projects are competing with Plains All American for labor and materials. The tax treatment of the company depends on its status as a partnership for federal income tax purposes. Should PAA become subject to taxes, its performance could be materially affected. From a macro perspective, financial risks are rising interest rates, which would be negative for MLP valuations in general, and a stricter regulatory environment, which would increase operating and maintenance expenses.

Units of PAA were closed down over 3% at $49.72 on Monday. Merrill Lynch has a price objective of $61, compared to the consensus price target of $63.76. PAA has a 52-week trading range of $46.63 to $61.09 and a market cap of $18 billion.

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As a reminder, the Merrill Lynch views were aimed at covering the more insulated MLPs against lower oil prices. They addressed dozens of companies, and our focus was on the larger MLPs and the MLPs that the firm had better things to say about compared to most. If oil keeps heading lower, it will be a tide that pulls all energy-related ships out to sea.

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