At a time when Treasury yields have been nonexistent, MLP investors have been able to get high payouts that are viewed as quasi-dividends, due to some payouts representing income and some representing return of capital. The question to ask now is whether the risk-reward is there for new investors at the current prices. The unit prices of many key MLPs have been hit hard along with stocks in the past few weeks, and we wanted to take a risk-reward look for summer 2012. This sector could get a recovery, or it could face additional pressure like we saw in 2011.

If investors have been involved in the MLP sector since before, during or right after the great panic selling of 2008 and 2009, they are up huge if they held on. In many cases they have doubled their money or more. And as far as they are concerned they have been getting 5% to 8% in payouts each year (again, some income and some return of capital). The problem is that the prices here have become choppy and the MLP structures often have had secondary offerings on top of secondary offerings. Those secondary offerings have provided growth and acquisition capital, but some investors have started to worry that these secondary offerings may be the biggest contribution to the never-ending payout increases that have been seen in this sector.

MLPs in the energy space often attract the same sort of investors who would buy utility shares and preferred shares of banks, but they also overlap with REIT investors who look for above-market yields. This sector has enjoyed large price gains in the unit (share) prices, and investors are looking for any safe investments that have high payouts, compared to the world of no-returns in CDs and Treasuries. A wave of secondary offerings from many MLPs came before and during the recent market sell-off.

24/7 Wall St. has evaluated some of the top MLP investments to see how much implied upside remains in this sector. We have taken price performance as far as the sell-off from recent highs, as well as issues like the payout ratios (implied yield-equivalent) and the consensus price targets from Thomson Reuters. We have evaluated the following MLPs: Enterprise Products Partners LP (NYSE: EPD), Kinder Morgan Energy Partners LP (NYSE: KMP), Plains All American Pipeline LP (NYSE: PAA), ONEOK Partners LP (NYSE: OKS), Energy Transfer Partners LP (NYSE: ETP) and Enbridge Energy Partners LP (NYSE: EEP). These MLPs mentioned and covered here are some of the ones we track and keep on our watch list in the sector. These have market caps above $8 billion, they have a history of increased payouts each quarter, for the most part, and generally speaking these MLPs are all believed to have good management teams.

Investors have made a bundle here in this sector. MLPs are not really all that correlated to the price of oil because these are the partnerships (general and limited) for pipelines, terminals, and other facilities involved in the oil and gas sector in America. MLPs must derive 90% of their income from real estate, natural resources and commodities. The issuing of K-1 statements can make the structure more complicated, but the payouts often make that worth it for many investors seeking higher streams of cash flow.

We also have evaluated some of the key ETFs and closed-end funds in this sector. Be advise that just the three vehicles we have tracked in funds and ETFs have a combined market value of more than $11 billion.

Delta will pay $150 million for the refinery and expects to spend another $100 million to boost the plant’s capacity to make jet fuel, which is the reason Delta bought the refinery in the first place. The deal follows yesterday’s $5.3 billion acquisition by Energy Transfer Partners L.P. (NYSE: ETP) of downstream company Sunoco Inc. (NYSE: SUN).

A couple of interesting questions follow Delta’s entry into the refining business. First, will other airlines follow? United Continental Holdings Inc. (NYSE: UAL), US Airways Group Inc. (NYSE: LCC), and Southwest Airlines Co. (NYSE: LUV), like other large carriers, follow a hedging strategy that tries to even out the ups-and-downs of crude prices. When it works, as it did for Southwest in 2006 and 2007, management looks like geniuses and the airlines makes a ton of profit. When it doesn’t work, as it didn’t for Southwest a few years later, the less said the better.

The only reason to buy a refinery is to mitigate price risk on crude oil. Delta claims the cost of the refinery is equivalent to the price it would pay for one widebody jet. The company expects to save twice that much annually on fuel costs going forward. Before United and the other carriers jump into the refining business they will want to see if Delta can actually realize its projected savings.

Which brings us to the second question: how does Delta expect to mitigate crude oil price risk? When the possible refinery acquisition first became known, there were reports that JPMorgan Chase & Co. (NYSE: JPM) would take on the crude oil trading that would be needed to supply the refinery. As announced today:

[Delta subsidiary] Monroe is partnering with leading energy companies to supply crude oil and receive jet fuel in exchange for Trainer’s non-jet fuel outputs. Under a three-year agreement, BP will supply the crude oil to be refined at the facility. Monroe Energy will exchange gasoline and other refined products from Trainer for jet fuel from Phillips 66 and BP elsewhere in the country through multi-year agreements.

The “leading energy companies” are ConocoPhillips and BP plc (NYSE: BP). If BP is supplying the crude, the price will be set at or very near Brent crude prices. Jet fuel is generally more expensive than gasoline and other refined products. As Brent prices rise, jet fuel prices will also rise and probably rise faster than gasoline or diesel prices. Thus, Monroe/Delta will be trading lower-priced products for a higher-priced product. No savings there.

The only way for Delta to make sure it saves money is to source its crude more cheaply. In the US, that means getting crude from North Dakota’s Bakken field to the East Coast. There’s no pipeline (yet) to do that. Surely the lack of cheap crude is why JPMorgan is no longer in the picture. The proposed sale of Sunoco’s 335,000-barrel/day Philadelphia refinery to The Carlyle Group will not be concluded if the private equity firm cannot find a source of cheaper crude.

Delta apparently believes that by sourcing crude from BP the airlines has insulated itself from crude price risk. Not having seen details of the contract it’s hard to say. But oil companies are not charitable organizations and BP won’t have made any big concession on price.

Shares of Delta are up about 2.2% in the pre-market at $11.20 in a 52-week range of $6.21-$11.60. A new annual high is certainly within reach today.

Paul Ausick

Sunoco shareholders will receive payment equal to $25 in cash and 0.5245 ETP common units for each share of Sunoco stock they own. Sunoco shareholders can choose to take $50 in cash, 1.0490 ETP common units, or the cash-common unit split, although the aggregate cash paid will be capped at 50%.

ETP also receives the general partner interest, incentive distribution rights, and 32.4% Sunoco interest in Sunoco Logistics Partners (NYSE: SXL).The owner of ETP’s general partner, Energy Transfer Equity L.P. (NYSE: ETE) will forego its right to about $210 million in incentive distributions from ETP over the next 12 quarters as part of the deal. After the deal closes Sunoco and Sunoco Logistics Partners “will operate under the Energy Transfer Equity, L.P. umbrella of companies.”

One thing that ETP won’t get is Sunoco’s refining business:

[U]nder the merger agreement, Sunoco will continue its plans for exiting its refining business as previously announced, as well as continue its plans for the proposed refinery joint venture being discussed by Sunoco and The Carlyle Group.

The joint-venture deal with Carlyle would keep Sunoco’s 335,000 barrel/day Philadelphia refinery in operation. As currently being discussed, Sunoco would contribute the Philadelphia refinery to a joint venture with Carlyle in exchange for a non-operating minority stake. The company would have no obligations to support the refining operations.

This acquisition is a pretty smart move for ETP. Its current cash flow comprises 100% natural gas transportation and logistics, and the Sunoco deal cuts the company’s natural gas cash flow to 70% of the firm’s total and adds a 30% cash flow from liquids transportation. Given the turmoil in natural gas production and pricing, ETP’s diversification into liquids couldn’t have come at a better time.

Sunoco’s shares are trading up 21% at $49.50 in the pre-market this morning, above the company’s 52-week range of $27.76-$43.43. ETP’s shares are up about 2.9% at $49.29 in a 52-week range of $38.08-$54.71.

Paul Ausick

Adtran Inc. (NASDAQ: ADTN) Reiterated Buy with $39 target at Argus.

Agrium Inc. (NYSE: AGU) named Value stock of the day at Zacks.

Amazon.com, Inc. (NASDAQ: AMZN) Started as Neutral at SunTrust Robinson Humphreys.

AT&T, Inc. (NYSE: T) Raised to Overweight at JPMorgan.

Chipotle Mexican Grill Inc. (NYSE: CMG) Reiterated Buy and raised target to $480 at Argus.

Energy Transfer Equity. LP (NYSE: ETE) Started as Outperform at Credit Suisse.

Energy Transfer Partners. L.P. (NYSE: ETP) Started as Outperform at Credit Suisse.

Google Inc. (NASDAQ: GOOG) Started as Buy at SunTrust Robinson Humphreys.

Human Genome Sciences Inc. (NASDAQ: HGSI) Started as Neutral at UBS.

Marathon Petroleum Corporation (NYSE: MPC) named Bull of the Day at Zacks.

Netflix, Inc. (NASDAQ: NFLX) Started as Buy at SunTrust Robinson Humphreys.

Nokia Corporation (NYSE: NOK) Cut to Hold at SocGen.

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JON C. OGG

determined that a material weakness existed in its controls over the completeness, accuracy and presentation of its accounting for income taxes, including the tax provision and related tax assets and liabilities.

The company is scheduled to file its Form 10-K on April 9th, and the CFO said:

We have reviewed our significant agreements and believe we can complete the filing within the time periods allotted. The generally non-cash nature of the items which require adjustment, primarily goodwill and tax reserves, does not impact our debt covenants or our liquidity.

That’s the bad news. The good news is that the company will begin work this month on a portion of the Red River Gathering Pipeline being built by Energy Transfer Partners LP (NYSE: ETP). Willbros, which will construct a 97-mile long segment of the system, did not indicate the value of the contract.

Investors like the good news much better than the bad, boosting Willbros’ share price by more than 25% this morning, to $4.06 in a 52-week range of $3.13-$11.87.

Paul Ausick

Teucrium Commodity Trust has filed a preliminary Form S-1 with the US SEC for a new agriculture ETF to be called the Teucrium Agricultural Fund, which would be listed on the NYSE under the symbol ‘TAGS’. The new fund’s objective is to track the daily changes in the net asset values of four Teucrium-sponsored ag funds, including the Teucrium Corn Fund (NYSE: CORN). The proposed fund, really a fund-of-funds, would also include changes to three funds that Teucrium has not yet launched: the Teucrium Wheat Fund; the Teucrium Soybean Fund; and the Teucrium Sugar Fund. Proposed symbols for the three are ‘WEAT’, ‘SOYB’, and ‘CANE’, respectively.

The proposed fund would be rebalanced as often as every day, and unlike many other commodity ETFs that include mostly next-to-expire contracts, the fund will follow a different scheme. Teucrium’s corn fund has no exposure to spot month contracts and neither will any of the other three single commodity funds.

The new single commodity funds would follow the example of the corn fund, holding 35% of second-to-expire contracts, 30% of third-to-expire contracts, and 35% of the following December contracts. Thus, an April investor would own June, July, and December futures. The intent of the scheme is to smooth but the effects of either backwardation or contango on investor returns.

Unlike the PowerShares DB Agriculture Fund (NYSE: DBA), the proposed fund is far more targeted, eliminating exposure to cattle, cocoa, coffee, cotton, and other commodities. The new Teucrium fund would also be the first ETF to give investors exposure to commodities through a fund-of-funds, or ETF-of-ETFs, structure.

No launch dates for the three commodity-specific funds or the new ag fund have been announced.

A contributing factor to high US oil prices has been the absence of a crude oil pipeline to move crude from the storage/pricing hub at Cushing, Oklahoma, to the US Gulf coast, where so much of US refining capacity exists. Two major pipeline companies, Enterprise Products Partners, L.P. (NYSE: EPD) and Energy Transfer Partners, L.P. (NYSE: ETP) have announced plans to build a 400,000 barrel/day piple from Cushing to Houston.

Such a pipeline is also a key part of the Keystone XL pipeline proposed by TransCanada Corp. (NYSE: TRP) and currently awaiting approval from the US State Department. ConocoPhillips Corp. (NYSE: COP) owns the Seaway pipeline which transport crude from the Gulf coast to Cushing, but has rejected the idea of reversing the pipeline’s flow.

The ability to move crude by pipeline to the Gulf coast will send lower cost WTI crude to US refineries now paying Brent crude prices for the mostly seaborne crude now being refined. This should help re-balance the current $10-$15/barrel spread now favoring Brent crude.

TransCanada’s current Keystone pipeline transports about 1 million barrels/day of Canadian crude to Cushing, so even if both pipelines were built, there is enough crude to make both commercially successful.

Finally today, rare earths miner Avalon Rare Metals, Inc. (AMEX: AVL) has filed a $500 million shelf registration with the US SEC. Avalon trails Molycorp, Inc. (NYSE: MCP) in both expected time to production and market cap. Rare Element Resources Ltd. (NYSE: REE) is even further behind, but if there is room for another producer outside China, it’s probably got a chance.

Avalon’s plan could take five years before it makes any sales, and its development costs could top $1 billion. The only question about this $500 million registration is whether or not it will be enough to do the job.

Paul Ausick

Another deposit off to the northeast was known as the Haynesville shale, most of which is located in northwestern Louisiana with related deposits into southwestern Arkansas and east Texas. As exploration developed in the Haynesville shale, the estimated size of the resource was calculated at more than 250 trillion cubic feet of natural gas. That’s more than enough to supply the entire US consumption of natural gas for 10 years at current rates. The Haynesville shale is believed to be the largest natural gas reservoir in North America.

Drilling began in the Haynesville shale in about 2008 and the area is now dotted with wells drilled by more than two dozen companies. The following list names the 15 largest publicly traded companies by their net acreage holdings in the Haynesville shale as reported on their 2009 annual reports. Net acreage is equal to wholly-owned leases plus participation shares in jointly held leases.

Chesapeake Energy Corp. (NYSE: CHK) – 514,425 net acres
EnCana Corp. (NYSE: ECA) – 429,000 net acres
EOG Resources, Inc. (NYSE: EOG) – approximately 370,000 net acres
Petrohawk Energy Corp. (NYSE: HK) – 360,000 net acres
Forest Oil Corp. (NYSE: FST) – 250,098 net acres
Exxon Mobil Corp. (NYSE: XOM) – 166,000 net acres
EXCO Resources Inc. (NYSE: XCO) – 155,945 net acres
Plains Exploration & Production Co. (NYSE: PXP) – 111,000 net acres
Goodrich Petroleum Corp. (NYSE: GDP) – 84,859 net acres
Comstock Resources Inc. (NYSE: CRK) – 72,638 net acres
St. Mary Land & Exploration Co. (NYSE: SM) – approximately 41,000 acres
El Paso Corp. (NYSE: EP) – approximately 40,000 net acres
Continental Resources Inc. (NYSE: CLR) – 24,200 net acres
Cabot Oil & Gas Corp. (NYSE: COG) – 5,852 net acres

Plains also owns 20% of Chesapeake’s interest in the Haynesville shale. Exxon got its share of the play with its purchase last year of XTO Energy.

Three pipeline companies also have extensive operations in the Haynesville play. Kinder Morgan Energy Partners, L.P. (NYSE: KMP) owns a 50% share of a joint venture with PetroHawk, which owns and operates a pipeline and gathering system that will handle more than 800 million cubic feet/day by the end of 2010. Energy Transfer Partners L.P. (NYSE: ETP) is completing the Tiger Pipeline, a 175-mile, 42-inch interstate pipeline that will interconnect with other interstate pipelines to haul the gas to the east and northeast US. DCP Midstream Partners LP (NYSE: DPM) owns and operates some 4,660 miles of gathering and transport pipeline in the Haynesville play.

Oil field services companies also participate by providing the high pressure pumping systems and fluids that break up the shales and allow the gas to flow to the surface. Halliburton Co. (NYSE: HAL), Schlumberger Ltd. (NYSE: SLB), and Baker Hughes Inc. (NYSE: BHI) are among the players here.

The fracturing techniques and the fluids used to force the cracking have come under some scrutiny. The services companies have long held that their fluid formulas are proprietary, and they have refused to give up the exact formulas for the fluids. Some localities and environmental groups are trying to force the companies to release the formulas in order to determine if the chemicals are making their way into local drinking water supplies.

General Electric Co. (NYSE: GE) has recently introduced a new mobile fracking solution in what appears to be a giant opportunity in what the company called “energy efficient, fully transportable, cost effective and that it will enable onsite frac water recycling.”

Haynesville and other natural gas regions have been highlighted in many documentaries and many articles of late.  Some are favorable, some are very critical.  T. Boone Pickens and others are also touting natural gas as the bridge fuel that can get America off of foreign energy dependence.  This is work in progress with an unfinished outcome.  There are billions upon billions of dollars at stake.

Paul Ausick

Morningstar’s Paul Larson gave several sector picks today in the MLP sector, most of which are true MLPs.  Larson outlined Energy Transfer Equity, L.P. (NYSE: ETE).  It owns the general partner of two other MLPs, Energy Transfer Partners (NYSE: ETP) and Regency Energy Partners (NASDAQ: RGNC) in natural gas transportation businesses and ETP also owns a propane distribution business.

Enterprise GP Holdings L.P. (NYSE: EPE) was also given a positive outlook from Larson, and this is involved in a stock merger with Enterprise Products Partners L.P. (NYSE: EPD) that is still a deal pending unitholder approval.

Larson also likes TransCanada Corp. (NYSE: TRP), although this is a pipeline company in Canada that is not structured as a MLP and its dividend yield of 4.1% is more straightforward without many of the traditional tax headaches associated with an MLP.  Larson called it undervalued with a fair value estimate of $43.00 versus $37+ today.  Another of his alternative picks is Kinder Morgan Management LLC (NYSE: KMR) as being basically a different share class of one of the largest MLPs, Kinder Morgan Energy Partners.  Full Larson/Morningstar presentation

There are a couple of other means of investing in MLPs in a diversified manner that other pickers rarely make note of.  Kayne Anderson MLP Investment Company (NYSE: KYN) and JPMorgan Alerian MLP Index ETN (NYSE: AMJ) offer diversification with a return of capital component that still replicates income for investors.

Kayne Anderson MLP Investment Company (NYSE: KYN) is a closed-end equity mutual fund launched and managed by KA Fund Advisors, LLC that invests in the public MLP sector.  Its dividend can fluctuate and a recently announced payout of $0.48 per share for the last quarter is anticipated that a significant portion of the distribution will be treated as a return of capital for tax purposes.  That $0.48 rate has been paid for seven quarters (down from $0.50 before) and it has sold more shares and the current implied yield (again, not exact because return of capital) and its $26.10 share price compares to a 52-week trading range of $20.03 to $27.54.

JPMorgan Alerian MLP Index ETN (NYSE: AMJ) is an exchange-traded note that has a spotty dividend history since its 2009 launch.  If you smooth out the dividend it would have an implied yield of close to 5.2%.  At $33.95, the 52-week trading range is $24.26 to $34.15.

Before you chase these yields just as routine dividends, you will need to learn the tax structure, as well as the limitations and implications in investing in this asset class.

JON C. OGG

Alas, the companies have announced that the deal is dead. OGE’s chairman, CEO, and president said that “conditions in the financial markets are such that any partnership completed in the near term would not likely be economically beneficial to OGE.” ETP’s chairman and CEO echoed that sentiment, “We regret that the capital markets have prevented us from accomplishing our plans to combine these businesses in a strategic joint venture.”

If two major energy companies can’t line up the financing they need to form a regulated return business, this is not good news for any company.

Paul Ausick

The offering price was listed as $34.05 per common unit.This was less of a discount than many other offerings we haveseen when you consider that shares are down almost 5% and are tradingat $33.41 today. 

Joint book-runners in the deal are Credit Suisse, Citi,Morgan Stanley, UBS, and Wachovia Capital Markets.  Barclays Capital,Deutsche Bank Securities, Raymond James, and RBC Capital Markets areall listed as co-managers of the deal. The underwriters were given anoverallotment option to purchase up to 900,000 additional common unitsover the next 30-day period.

Jon C. Ogg
January 22, 2009