Master Limited Partnerships: 2018 and Beyond

After all the bankruptcies, restructurings, and share dilutions in the MLP sector during the 2014-2017 fall in the price of oil, I decided to take a close look at the balance sheets of these companies to determine which ones had seemingly learned their lessons and were better prepared for the next cycle’s pricing declines in the price of oil and other natural resource commodities.

Upon reviewing the top fifteen MLPs by market capitalization, I gave up on the exercise. I don’t think you could make the argument that any of the top fifteen MLPs could survive $50 per barrel oil without cutting their distributions to unitholders, and many of them would repeat the exact same hardships that previously occurred.

The terms of investing in the large oil MLP market segment is analogous to this: “If the price of oil is high, you will collect fat quarterly distributions. If it is nice, you’ll collect above-average distributions. If a 1986, 1998-1999, 2014-2016 period occurs and extends for a long period of time, your distributions will almost certainly be cut and dilution and bankruptcy will be an ever-present risk.”

That is not how management teams should be discharging their duties. Distributions should only occur, at a minimum, in the event that the core business is strong enough to survive the types of recessions and adverse operating circumstances that have occurred over the prior two generations. It is the only that long-term shareholders, rather than short-term speculators and short-term income investors, can be best served. Otherwise, what is the point in collecting 40% in an income return on your investment if you reinvest it into something that will be destroyed, or, if you take the money and invest elsewhere, assume the risk that your initial investment would be wiped out if you don’t sell presciently.

Perhaps this shouldn’t come as a surprise, as even the colossals of the industry like Royal Dutch Shell have come to be blanketed in debt (compare Royal Dutch Shell’s $32 billion in debt in 2012 to $86 billion in debt in 2018).

When a business pays a dividend or makes any type of distribution, the threshold question should be: “If I invest in this business, an choose to reinvest the income generated along the way, can I have a high degree of confidence that something will have accumulated by the end of my contemplated investing period?”

Right now, that question can be answered affirmatively with the oil majors, as even the burden of Shell’s debt can be handled by its enormous earnings capacity. But that question cannot be answered affirmatively in the MLP space. Extended good times are the only scenario in which MLP investors can earn impressive returns. Elsewise, they will collect distributions, pay taxes on them, and then suffer the possibility of permanent capital destruction during the next commodity decline that takes the price of oil below $50 per barrel for an extended period of time. I would be shocked if any conservative investor could look at the balance sheets of a well-known MLP and be satisfied with what he sees.