As the price of oil boomed, almost no bet seemed surer than master limited partnerships, which seemed to blend the growth appeal of the fracking revolution with the promise of high, relatively steady dividend-like yields. One sign of the buzz: 50 MLPs related to oil and gas went public between 2012 and last year. And then, the music stopped.
With oil down by half just since October, Wall Street is questioning the case for energy partnerships. As a group, last year's 14 IPOs ended the year little changed, having given back all of their 13 percent first-day trading gains, Renaissance Capital analyst Nick Einhorn said. Goldman Sachs' Theodore Durbin said the whole industry may need a different investment story: With investors skeptical that oil can deliver reliable growth, "the market is looking for alternatives to the traditional yield-plus-growth investment framework."
For regular investors, the appeal of partnerships' yield remains obvious. They pay as much as 40 percent for the riskiest, most beaten-up MLPs, according to Dividend.com, no mean trick with interest rates at historic lows. But the complexity of the MLP structure, as well as the huge differences between more than 160 publicly traded MLP and related funds that, to the uninitiated, are all basically in the oil and gas business when crude prices are crashing, make this a tough bet for the inexperienced.
"Retail investors are definitely panicked," Standard and Poor's analyst Michael Grande said. "There have been 40 percent to 50 percent stock price drops.''
The oil bust hasn't treated all oil companies equally, and that means different types of MLPs pose different risks now.
The business breaks down into three big buckets: exploration and production companies that drill for oil, so-called "midstream" companies that own pipelines to transport it or storage depots to hold it; and "downstream" companies that refine crude into finished products, like gasoline, and market it to consumers. The biggest oil companies—like Exxon Mobil and Chevron—are so-called "integrated" majors because they work in all of these businesses.
What the master limited partnerships have in common is that they are required to distribute nearly all of their earnings to owners of the limited partnership units. And most, especially in the exploration part of the business, borrow money to keep up their distributions, since they reinvest profits into drilling new wells when oil prices are high.
That reliance of borrowing to pay distributions is what's scaring the markets for the companies' debt and its partnership units alike. And that was driven home early this month, when drillers Linn Energy (LINE) and Breitburn Energy Partners (BBEP) both slashed their distributions, setting off fresh declines for already-battered units.
But worries about the drilling companies, representing about 20 of the 120-plus MLPs and industry-focused funds in the market, is much higher than for the 60-plus pipeline and other midstream companies.
At Standard & Poor's Capital IQ, energy-stock analyst Stewart Glickman said there isn't a single exploration and production MLP that has healthy fundamentals, such as improving prospects for boosting profits this year, though some companies, like Plains All American and Regency Energy Partners, are now cheap enough to be potentially good deals, he added.
The reason for treating the companies differently is pretty simple: Exploration companies get paid for each new barrel of oil, which are much cheaper now than in October, while pipeline companies usually get paid the same tolls to carry the stuff whether crude prices are $100 a barrel or $40.
"One of these is not like the others,'' Glickman said. "All that matters is whether the volume is there."
Even so, experts urge caution for retail investors tempted to try to time the bottom. The obvious risk is that no one knows how low oil will go or how long it will stay there. The less-obvious risks are that each company is a maze of differing contractual arrangements with key customers, governance differences between each publicly traded partnership, larger companies that act as general partner and manage the business, and even complicated tax paperwork that accompanies getting income from limited partnershps, Glickman said.
That's why small investors might be best off trying to chase any potential rebound—whether now or later—by investing in funds that own groups of the master limited partnerships, said Renaissance Capital's Einhorn.
"You have to dig deep into who the customers are, what the contracts are and what the particulars are,'' Einhorn said.
There are 23 exchange-traded funds that deal in units of energy-related master limited partnerships, ranging from the $8.7 billion Alerian MLP ETF (AMLP) to funds managing as little as $6 million. The biggest all focus on the infrastructure and pipeline side of the business instead of exploration and production. And the biggest pay high yields: The average for the three biggest energy MLP funds is 5.8 percent annually.
5 Biggest MLP Exchange-Traded Products
Alerian MLP ETF (AMLP): $8.74 billion
JP Morgan Alerian MLP Index ETN (AMJ): $5.29 billion
UBS E-TRACS Alerian MLP Infrastructure Index (MLPI): $2.16 billion
First Trust North American Energy Infrastructure Fund (EMLP): $1.02 billion
Credit Suisse Equal Weight MLP Index Exchange (MLPN): $763 million
Source: ETF Database, includes ETFs and ETNs
The three biggest exchange-traded funds—JP Morgan's Alerian MLP Index ETN (E-TRACS) Alerian MLP Infrastructure Index fund from UBS (MLPI) and the Alerian MLP Fund—are benchmarked to the Alerian MLP Infrastructure Index, which is down 21 percent since Sept. 30. That's better than the price of crude, because the pipeline companies aren't directly tied to oil prices, ETF Database analyst Stoyan Bojinov said.
But even sticking to the safe side of the oil business hasn't let people make money recently. All three of the top funds are in the red so far this year, losing between 6.5 percent and 10.2 percent in 2015's first seven trading days. And for the last year, their returns were clobbered by the 32 percent jump in the Dow Jones Equity All REIT Total Return Index, which tracks the performance of real estate investment trusts— another group of partnerships that distribute nearly all of their profits to owners in exchange for tax breaks.
But price drops or no, Bojinov reasoned that demand for oil is persistent enough that prices will stabilize and begin to rise, at least a little. When they do, investments in energy MLPs and their funds ought to bounce back with them. The question is, Will investors have the stomach to bet on that anytime soon? Maybe, Bojinov said, the biggest funds have been seeing net inflows of investor money throughout the bust, which has been a losing play so far.
"It's worth conservatively looking into MLPs, but only if you can tolerate volatility and have a long-term horizon,'' he said.