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Oil-Gas Partnerships Regaining Favor In Volatile Energy Market

Investors looking for direction on oil prices these days can find forecasts ranging from $40 a barrel all the up to $250. And uncertainty, as everyone knows, is an investor's worst enemy.

That's one of the reasons why oil and gas partnerships, which are less sensitive to the gyrations of commodity prices and are offering some handsome returns, are returning to vogue this year for those looking to get a stake in the energy trade. After getting beaten up along with the rest of the financial markets the past two years, yields are now ranging from high single-digits to more than 20 percent in some cases.

The partnerships, which take varying forms, expose investors less to the unpredictable moves of crude prices and more to the ever-growing need for energy exploration, particularly in natural gas.

They carry substantial tax advantages, making them even more attractive to investors looking to diversify their portfolios.

"There's a lot of good news in this area for investors," says Steve Stahler, president of the Stahler Group in Baton Rouge, La., a firm that focuses on finding inflation-proof investments for clients. "They can't sit around and wait until oil prices stabilize. There are some clear opportunities across the board."

There are various avenues in which investors can expose themselves to oil and gas partnerships, with the most popular being master limited partnerships that can be bought and sold essentially like stocks.

Oil and gas limited partnerships, though, often require a $5,000 minimum investment that can sometimes go even higher. Limited partners join with general partners who actually perform the energy exploration and bear unlimited liability.

Investment advisors are leaning more towards companies that rely on fees for income — such as exploration and pipeline companies — rather than on commodity prices, such as big energy producers.

"The key from an investor standpoint is can you distinguish between MLPs that are fee-based and those MLPs that have commodity exposure," says Mike Collier, a partner at Price Waterhouse Coopers' transaction services division. "The ones that are fee-based are not going to suffer from continuing exposure to commodities."

Collier believes that MLPs more heavily concentrated on natural gas will do better than companies focused on crude. Analysts generally have been more enthusiastic lately about the future of natural gas based primarily on its scarce supply relative to crude and a desire by governments to find alternative energy sources.

The direction of crude prices has been the subject of intense debate, with some predicting a normalization of prices closer to $40 or $50 a barrel or so at one end of the spectrum and others, most recently Gazprom, saying global demand will push crude higher, to perhaps as much as $250 a barrel.

For the near term at least, the consensus seems to be lower.

"We still don't have the fundamental strength in this market. We still don't have the support of supply and demand," says Darin Newsom, energy analyst at DTN in Omaha, Neb., who calls the recent jump in crude prices past $70 a barrel "perfectly normal for this time of year" even though it was a bit higher than Newsom's forecast last month.

"It certainly is not supported by the fundamentals," John Kingston, of energy analyst Platts, said on CNBC. "You've got some slack in the system but you've got a weaker dollar, you've got fears of inflation, you've got the prospect that you're going to have a strong economy. But right now I don't know of too many analysts who think this is fundamentally driven."

Such volatility is what has most MLPs in the oil arena focused more on areas other than direct sales.

"There are quite a few MLPs that are just in crude oil, but most aren't directly exposed to crude oil movement. Most are focusing on transportation and storage," says Simon Tait, a partner in Price Waterhouse Coopers' assurance practice. "MLPs that have access to capital and have the ability to maintain and grow their distributions are in great shape and they're just waiting for the opportunities to come along."

Additional value for MLPs comes from tax breaks.

The partnerships originated with the Revenue Act of 1987 to push energy exploration in the Gulf of Mexico. They are exempt from corporate income taxes as long as 90 percent of their gross income falls within federal guidelines for exploration and development purposes.

They are embraced because of their steady cash flow, generally long life in operation and high dividends.

Some of the better values among oil and gas partnerships, Stahler says, include Atlas Pipeline Partners, TC Pipelines and Energy Transfer Partners .

"Pipelines are a good idea," he says. "If we see the prices moving up I think it's a good way of locking in some nice cash flow."

Going forward, there are a number of dynamics at play that investors in the MLP and oil-and-gas partnership space will be examining.

Among them will be the Obama administration's tax policies toward oil exploration. As long as the current tax breaks stay in place oil exploration will continue to be profitable, but if the shift moves strongly over to the alternative energy side, natural gas will benefit and oil prices are likely to keep going up.

"Those that are saying it will go up to the same level where it peaked last year, I think they're right," Price Waterhouse's Collier says. "We're going to pay the price for having slowed down our exploration and production activities. As long as their outlook is not immediate term but more intermediate to longer term then oil investments are going to be pretty attractive."

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