The Securities Litigation Expert Blog

Master Limited Partnership Bubble Now Well Documented

Posted by Jack Duval

Feb 21, 2013 3:05:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

Two new reports are out documenting the bubble in shale gas and shale oil.  The first is "Shale and Wall Street" by Deborah Rogers and is published by the Energy Policy Forum.  (EPF)  The second is "Drill, Baby, Drill" by J. David Hughes and is published by the Post Carbon Institute.  (PCI)

The crux of these reports is that a bubble has formed due to: massive over-investment in shale gas extraction, heroic assumptions about shale gas and oil reserves, rapidly declining extraction rates, complex investment products used to finance the exploration, a flurry of Wall Street activity which generated large transactional fees for Broker-Dealers, and a wholesale lack of transparency.

Sounds a lot like the sub-prime bubble.

Our previous coverage of the MLP bubble can be found here, here, and here.

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Topics: Master Limited Partnerships, MLP, FINRA, shale oil, Energy Policy Forum, bubble, litigation, Senior Investors, investments, Master Limited Partnership, sub-prime, natural gas, shale gas, Compliance, Post Carbon Institute, Complexity

Master Limited Parternship Warning from Morningstar

Posted by Jack Duval

Nov 12, 2012 3:36:40 AM

Morningstar has issued a research note warning investors about the ALPS Alerian MLP ETF (AMLP).  (Morningstar)  The reason?  Hot money is flowing into this ETF because the industry giant, JPMorgan Alerian MLP Index ETN (AMJ), has hit its $5 billion asset limit and stopped creating new units.  This means AMJ is now a closed-end fund and that shares will fluctuate above and below NAV.

Here's what Morningstar has to say about why an ETF structure (as opposed to an ETN structure) is bad for MLPs:

 However, AMLP is not the right vehicle for the majority of investors, and it represents one of the rare cases when buying the ETF structure makes very little sense.

Legally MLPs can make up only 25% of a portfolio registered under the Investment Company Act of 1940. Most mutual funds and ETFs are structured this way. To get around this issue, AMLP is actually structured as a corporation that pays income tax: Before return is passed on to the investor, it must be taxed at the corporate level. Although AMLP's prospectus expense ratio is 0.85%, its gross expense ratio (which accounts for these tax liabilities) is almost 5% as of September. As a result, AMLP has lagged its index significantly. Over the past year AMLP lagged by 10%, and since inception it trailed by a shocking 40%. The upside? When MLPs are down, AMLP declines less because it can reverse some of the deferred tax liabilities it has accrued. For all but the most risk-averse yet desperate-for-yield investors, this downside protection is not enough to make up for the fund's structural issues...

Because of legislation forbidding open-end funds from owning more than 25% of their portfolio in MLPs, AMLP is structured as a C-corporation and pays income tax at the corporate level. Any taxable income from the underlying MLPs is an annual tax liability, and upon the sale of the portfolio's shares they must also pay up at the corporate level. AMLP accounts for these tax liabilities in the NAV, meaning that the total return of the fund can and does trail the index by massive amounts.

Thus the C-Corporation structure eliminates the deferred tax structure inherent in a MLP and pays the taxes along the way.  By Morningstar's calculation, this comes to about 5 percent per year, and causes serious underperformance against the index.


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Topics: Master Limited Partnerships, MLP, AMJ, investments, Master Limited Partnership, Morningstar, natural gas, ETF, ETN, Alerian, AMLP

Moody's Master Limited Partner Research

Posted by Jack Duval

Nov 11, 2012 2:27:36 AM

Moody's has come out with research on Oil and Gas bond covenants and has come to the conclusion that MLPs offer the least investor protection.  (Finanzen)

"Our review of bonds issued between January 2011 and October 2012 showed that those of US midstream limited partnerships have the worst covenant quality," says Andrew Brooks, Moody's Vice President and co-author of the report, "Midstream MLP Covenants Offer Least Investor Protection; E&Ps Near US Average." "Investor protection is weakest in the areas of restricted payments and liens subordination, reflecting these firms' focus on high shareholder distributions and externally financed growth."

The Moody's research can be found here.  (You'll need a subscription or $550.)

The MLP focus on paying out earnings leaves those firms in a perpetual refinance cycle.  That is, they cannot self-fund because they distribute their earnings to their investors.  This is the paradox and the Achilles Heel of MLPs.  The very thing that makes them attractive to yield-starved investors is what makes them vulnerable to sharp (and pro-cyclical) declines.

See our previous coverage on MLPs here, here, here, here, and here.

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Topics: Master Limited Partnerships, MLP, Moody's, investments, Master Limited Partnership, natural gas, Oil and Gas

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