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Upstream MLPs: Any babies getting thrown out with the bathwater?


Cunninghamew
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I have never been a big fan of upstream MLP's. I will go ahead and say that I think in the LT their business models are flawed. Its like a bad arbitrage game (below is an explanation of why I think they stink overtime). However, the recent negative press surrounding LINE and BBEP seems to be dragging down the entire group. My question is are there any worth starting research on? Are any babies being thrown out with the bath water?  ARP?

 

 

Why Upstream MLP's bug me

 

(1) you produce an extremely volatile commodity

(2) you distribute your earnings from producing said commodity

(3) the commodity or your resource potential is a depleting asset that you must replace to continue with distributions

(4) this means you have to find more places to drill and/or acquire other producing assets

(5) if  you are buying other producing assets during elevated or rising commodity price enviroments you are paying up for said resources

(6) so when commodity prices fall you are stuck holdings a depleting asset that has less value... distributable cash flow falls and so does the distribution

 

further compounding these issue are the way they go about biz

 

(1) all of these guys issues tons of equity, because it is to hard to fund CAPEX organically and pay a fat distribution

(2) after they issue equity they buy more producing assets/maintain existing ones

(3) this allows them to up their distributions

(4) the market rewards them for growing their distributions i.e. stock price increases

(5) this in turn lowers the cost of equity

(6) they retap the equity markets for capital

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I see them more like an oil & gas hedge fund. They invest in properties that have proven reserves, and receive a return on that investment through extracting and selling the oil & gas at market rates. Like a hedge fund, they limit market risk by purchasing various hedges on future prices. They can earn excess returns through the following methods:

 

1) Opportunistic reserve purchases (low price-to-value, or "value investing")

2) Good hedging strategy (market timing + exploiting contango in futures prices)

3) Operational efficiency (keeping costs low and extracting extra reserves)

 

All it takes is good management, just like a good value fund needs a good investor. I think if you look at it this way most of your negative points are moot.

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