Historically, investors buy Master Limited Partnerships, or MLPs, for their high yields. Oil and gas MLPs typically yield 5% or more, which is very attractive for investors seeking income. This is particularly true at a time when interest rates remain extremely low. Fixed income securities are offering low yields, which makes MLPs even more attractive for income.

However, the steep declines in oil and gas prices over the past year have caused tremendous price declines among MLP securities. The pervasive fear and constant negativity may persuade some investors to avoid MLPs altogether. But investors should know that the long-term investing case for many high-quality MLPs remains sound.

Fundamentally, oil and gas are still being used by millions of people each and every day. Demand is largely not the reason for commodity prices collapsing; instead, this is a supply-side problem. Due to abundant domestic supply of oil and natural gas in the United States, and revolutionary technological advances like hydraulic fracturing, production in the U.S. has reached levels not seen in several decades. And yet, OPEC has thus far refused to decrease its own production.

This has caused a massive decline in energy prices. West Texas Intermediate crude and Brent crude, the international benchmark, are both down approximately 50% from the highs seen last year. This has caused energy companies of all sorts a great deal of duress, but there are still companies that can support their distributions.

Many high-quality MLPs continue to raise distributions for their investors, which means the long-term investing case has not changed. For example, Enterprise Products Partners LP (EPD) yields 6%. Last quarter, Enterprise Products raised its annualized distribution to $1.52 per unit, a 5.6% year-over-year increase. The company has raised its quarterly distribution for 44 quarters in a row. Another example is Magellan Midstream Partners LP (MMP) which yields 5%. Magellan Midstream raised its distribution by 16% last quarter, year over year. The company has raised its distribution 53 times since its 2001 initial public offering.

The reason these MLPs can continue to raise their distributions even in such a difficult operating climate is because they are midstream MLPs. Midstream firms own and operate pipelines and terminals. The business model is run similarly to a toll road, in that the companies collect fees based on transportation and processing volumes. As a result, they are not entirely reliant on the price of the underlying commodity.

For example, Enterprise Products Partners generated $988 million of distributable cash flow last quarter. Its distributable cash flow covered Enterprise Products’ distribution last quarter by 1.3 times, which implies sufficient distribution coverage. Magellan Midstream Partners’ distributable cash flow grew 14% last quarter, year over year.
However, the same cannot be said for the upstream MLPs like Linn Energy (LINE). These firms are engaged in exploration and production of oil and gas. In order to fund exploratory activity and drilling new wells, upstream companies require a supportive commodity prices. Since energy prices have collapsed, Linn and other upstream MLPs have had to cut their distributions or suspend them entirely. As the cost of drilling wells and servicing debt is far above the current price of oil, its cash flow has declined substantially.

Consequently, the task for investors is to properly understand and contrast different business models. Not all MLPs are created equal; some will fare better than others during these difficult times. Investors may be better off investing in midstream MLPs, which appear best-equipped to navigate the environment of low commodity prices.