The Riskiest Income Investment in Your Portfolio Is…

Investors love these investments for their high-yield income.
Unfortunately, many investors have been burned by the object of their affection.
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I refer to energy master limited partnerships (MLPs).
You can understand why income investors overlook the risk when you consider their structure.
MLPs pay no federal income tax if they generate at least 90% of their income from qualifying sources: producing, processing, storing, and transporting natural resources.
By avoiding Uncle Sam, MLPs can pay an immediate high-yield income. Investors can readily lock-in 8% and 9% distribution yields from the start. Distribution growth can occur afterward.
What could go wrong?
Everything, if you ignore the fundamentals.
Oil and natural gas are volatile commodities.
Oil that trades at $100/barrel this year will trade at $40/barrel the next.
As the price of the commodity goes, so goes the MLP’s distribution.
And you can be sure that as the distribution goes, so goes unit value.
Upstream MLPs are the most volatile. The group is composed of the wildcatters who punch holes in the ground to extract the energy.
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It’s a risky business.
Five years ago, downstream MLPs were pumping out high-yield distributions at a pace that matched their high-yield production. Everyone was at full throttle. West Texas Intermediate Crude (WTIC) was priced above $100/barrel.
Fast forward two years, and we find WTIC priced at $30/barrel. Distributions were throttled back to a mere idle before they stalled altogether.
Former high-yield upstreamers Breitburn Energy, EV Energy Partners, Linn Energy soon went bust. Mid-Con Energy Partners (NASDAQ: MCEP) hangs on as a mere penny stock.
The downstream guys – the refiners, the petrochemical manufacturers – are less exposed to the price volatility, but they’re still exposed.
Calumet Specialty Products LP (NASDAQ: CLMT), a refiner and specialty lubricants manufacturer, continually increased its quarterly distributions during the heyday. As the MLP distribution rose, so rose the unit price – all the way up to $40.
But then came falling oil prices, and with it, falling refining margins. Calumet’s quarterly distribution ceased to grow before it was eventually eliminated.
Calumet is now a non-distributing MLP with a $4.50 unit price.
Analysts frequently recommend staying midstream. This means staying with the pipeline, gathering, and storage providers.
We can find some logic in the recommendation.
These MLPs tend to be large and geographical diversified. Their businesses are more stable.
They’re essentially toll-takers. Other energy producers pay them to move their output to point B from Point A. The output must move regardless of energy prices.
Less exposed, but still exposed.
When energy prices plunged in 2016, fewer tolls were taken. These big boys were eventually forced to cut their respective distributions.
Investors responded as you would expect. They cut their respective unit prices.
Plains All American Pipelines (NYSE: PAA) saw its units cut in half after reducing its distribution. When Energy Transfer Operating (NYSE: ETP-PE) cut its quarterly distribution, investors cut the unit price by 40%.
Like everything in life, you lessen your chances of getting burned once you understand the risks. You’ll understand the risks once you have mastered the fundamentals.
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You have nothing to lose and a lot of income to gain.
Good Fortunes,
Stephen Mauzy