Commodity prices and MLPs
MLPs have less commodity price exposure, because they follow the “toll road” business model and have tariff-based contracts governed by the FERC, which are linked to the PPI (producer price index).
How volatile commodity prices affect MLPs
The influence of commodity prices on MLPs varies significantly by subsector. MLPs involved in oil and gas production, gathering and processing, and coal have significant exposure to commodity price fluctuations. In addition, MLP unit prices tend to correlate with commodity prices.
Short-term fluctuations in natural gas liquids, natural gas, and crude oil prices don’t have much impact on pipeline MLPs, but they can affect earnings on the unhedged portion of production or volume processed. However in the long term, if there is continued downfall in energy price, it can affect drilling activity, which in turn may have an effect on pipeline MLPs, as they would have a lower volume of natural resources to transport.
The effect of commodity price on the cash flow of a MLP is also determined by the type of contract a particular MLP has. MLPs that keep whole, margin sharing, and percentage of proceeds contracts have a greater effect of commodity price volatility because they have a fair exposure to the commodity volume tied up to their cash revenues as compared to fee-based contracts that don’t have any such obligation.
Some of the MLPs that are active in transportation, gathering and processing activities, and have fair exposure to commodity price volatility are Enterprise Products Partners (EPD), MarkWest Energy Partners (MWE), ONEOK Partners (OKS), and Buckeye Partners (BPL). These MLPs have a combined weight of 28.84% in the Alerian MLP ETF (AMLP).
In the next article, we’ll discuss the changing natural gas scenario in the US.