As it turns out, Fools, energy companies are just like teenagers: They want what all their friends have. The item that all the kids are clamoring for these days is a midstream master limited partnership. Earlier this week, Devon Energy Corporation (NYSE:DVN) announced that it could no longer ignore the midstream temptation and is considering creating an MLP to better reflect the value of its assets. Today we’ll take a look at what those assets are, and why it might make sense to spin off an MLP. But first, let’s remind ourselves what the midstream MLP space looks like.
The in crowd
Midstream master limited partnerships typically consist of a network of pipelines, and some combination of natural gas processing centers, NGL fractionation facilities, terminals, and storage facilities. The size of these partnerships ranges from very large — industry leader Kinder Morgan Inc (NYSE:KMI) is the third-largest energy company in the U.S. — to relatively small.
There are multiple ways to structure an MLP, however. For example, Enterprise Products Partners L.P. (NYSE:EPD) doesn’t have an external GP, and therefore doesn’t pay a general partner any incentive distribution rights, which lowers Enterprise’s cost of capital and allows it to retain more cash for expansion. Kinder Morgan is the GP of Kinder Morgan Energy Partners LP (NYSE:KMP) and gives investors the opportunity to profit from the midstream industry without the headache of additional tax paperwork.
Because MLPs have to pay out so much cash, the yields for these MLPs tend to be high. Enterprise yields 4.7%, Kinder Morgan Energy Partners yields 5.9% right now, and Energy Transfer Partners LP (NYSE:ETP) yields 7.6%.
New kids on the block
Increasingly, oil and gas companies are spinning off their midstream assets to take advantage of the MLP structure. At the end of last year, Marathon Petroleum Corp (NYSE:MPC) spun off MPLX LP (NYSE:MPLX). Exploration and Production company QEP Resources Inc (NYSE:QEP) has its midstream IPO slated for the second quarter, and Phillips 66 (NYSE:PSX) plans to IPO its midstream MLP during the second half of this year.
During the fourth-quarter conference call for Plains All American Pipeline, L.P. (NYSE:PAA), an analyst asked CEO Greg Armstrong whether we’d see some contraction from all of this MLP action. Armstrong’s response gives us a clue about why so many companies are considering Devon’s move right now:
My understanding is that there [are] probably 10 to 15 more in the hopper. It would surprise me if the answer is that number just gradually goes up and doesn’t contract at all with respect to some consolidation. … And there’s fundamental industrial logic as to why some of that consolidation should happen. It’s easier to do when the markets aren’t as robust as they are right now, because, quite candidly, people, you know capital is abundant and it’s relatively cheap. And people would rather do their own MLP than they would consolidate.
Now that we understand the motivation behind Devon’s plan, let’s take look at the details.
Devon’s plan
Devon has considerable midstream assets, including 6,500 miles of pipeline, 300 compressor units, and eight gas processing plants spread across its footprint in the U.S. and Canada. The company’s Bridgeport plant has an NGL processing capacity of 50,000 barrels per day, making it one of the largest in the United States.
Because of its significant midstream asset footprint, Devon originally considered forming an MLP in 2007, though it eventually decided not to go ahead with it. Given these previous considerations, the high-quality assets, and the fact that capital is widely available, I have a hard time imagining this spinoff won’t come to fruition.
Boutique midstream
This MLP spinoff trend almost creates a subsector of the midstream industry. It’s very unlikely that the new Devon MLP, or MPLX, or Phillips 66’s MLP will start buying up vast amounts of assets and building out pipeline networks all across the country. And while they can certainly compete with some of the smaller MLPs, it is highly unlikely that they will ever go toe-to-toe with the bigger outfits like Kinder Morgan and Enterprise, or the Canadian giants TransCanada Corporation (USA) (NYSE:TRP) and Enbridge Inc (USA) (NYSE:ENB). Instead, these companies are making an effort to maximize the return on their existing assets, with maybe a little buying and selling along the way to keep investors happy.
Foolish takeaway
As more midstream MLPs come to be, it is important for investors to carefully evaluate and re-evaluate these opportunities. The high yields may be tempting, but not every MLP will be a buy.
The article 1 New Energy MLP in the Works originally appeared on Fool.com and is written by Aimee Duffy.
Fool contributor Aimee Duffy owns shares of Plains All American Pipeline. Click here to see her holdings and a short bio. If you have the energy, follow her on Twitter, where she goes by @TMFDuffy.The Motley Fool recommends Enterprise Products Partners and Kinder Morgan. The Motley Fool owns shares of Devon Energy and Kinder Morgan.
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