Continued move up in interest rates could be negative for MLPs

By Ingrid Pan, Sr Energy Analyst • Feb 6, 2013 9:46 am

Master limited partnerships (MLPs) can be sensitive to rate movements, as many investors view MLPs as a yield instrument. To think of it simply, if rates on US government Treasurys increase, investors should expect rates on MLPs to theoretically increase as well. This is because many view US Treasurys as one of the safest yielding investments in the financial universe, and therefore if the rates on Treasurys increase, the yield required from MLPs (and all other yield instruments) should also increase. When the yield on MLPs increases, the price and valuation of MLPs decrease.

The yield on the benchmark ten year Treasury moved from 1.950% to 2.016% for the week ended February 1. Treasury bonds have weakened somewhat from mid-2012 to present as seen in the top graph.

However, in the context of a longer time period, Treasury yields are still close to all-time lows. The below graph shows historic yields on the ten year Treasury from the beginning of 2001 to present.

One can see that only in the past few years the ten year Treasury has yielded below 2%. This is mostly a consequence of the Federal Reserve pumping money and liquidity into the financial system. The below graph shows the yields on the Alerian MLP Index versus ten year Treasury yields.

Except for the period of the financial crisis, where investors pulled money out of riskier investments such as equities (which MLPs are) and poured it into cash and Treasuries, MLPs yields have often moved directionally the same as Treasury yields.

The slight movement upward in Treasury yields this past week is theoretically a negative for MLPs. If rates continue to increase, for example to pre-recession levels of 4-5%, it could be a negative for MLPs and the Alerian MLP Index (AMLP). Major names in the index include Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), and Plains All American Pipeline (PAA). Many market participants believe that interest rates will not rise significantly in the near future as the Federal Reserve continues to keep rates low given the current shaky nature of the US economy and relatively high unemployment. However, owners of interest rates should still be aware of rate movements and how they affect MLPs.

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