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Commodity Q&A: Three MLPs Headed for DisasterWith Matt Badiali, editor, S&A Resource ReportWednesday, January 7, 2009 Q: Will APL find its way back from its lows? Does the drop have to do with its business model or the Great Selloff of 2008? – P.S.
A: A year ago, Atlas Pipeline Partners (APL), which owns natural gas pipelines, traded at $45 per share. Today, it trades around $8. That's a drop of about 80%.
While that had something to do with the general market selloff, Atlas is also in trouble... The company owes about $1.4 billion in debt. It must pay about $88 million per year in interest on that debt. The company's earnings, through the first three quarters of 2008, were negative. That's before it paid the interest and taxes it owed. So Atlas had to dip into its cash reserves to cover its debt payments.
Right now, Atlas only has about $43 million in cash. The ship is taking on water faster than the crew can bail.
Like a lot of other pipeline companies, Atlas is organized as a master limited partnership (MLP). So the company must pay out most of its earnings as dividends. Atlas' current dividend is, theoretically, $3.84 per share, a yield of nearly 52%.
With negative earnings, that dividend is unsustainable. I expect the company to cut it down in the immediate future. I think the stock price already reflects that, so I doubt it will fall much from here. That's the good news. The bad news is, I don't think the stock will recover anytime soon.
I've noticed a couple other MLPs in the same boat as Atlas...
Cheniere Energy Partners owes $2.2 billion in debt, with about $68 million in interest due this year. The company only has $11,000 in the bank. That spells disaster.
DCP Midstream Partners owes $655 million in debt, with about $34 million in interest due this year. The company has around $22 million in the bank to cushion the fall, but it'll still be ugly.
As my colleagues have written, there's a huge opportunity in MLPs right now. Many fantastic companies have gotten incredibly cheap. But as with any investment, before you buy, do your homework.
Q: With such large spreads in the price of oil, it seems there is money to be made taking delivery of oil and selling it into the future. Can an average investor take part in this strategy? – G.H.
A: Not anymore, though the opportunity was big.
Last week, "spot" oil prices (that is, oil prices that day) were around $35 per barrel, while the six-month "strip" price was around $50. (The strip price is what you would pay to secure delivery of oil in six months.)
That's a huge spread for such a short time. Theoretically, traders could have bought oil at the spot price, sold it out at the six-month price, and paid to store it for six months. Monthly storage costs run between $0.70 and $1.50 per barrel. The math works out to at least a $6-per-barrel profit in six months (about 17%) without using leverage. It would have been virtually impossible for the average individual investor to pull it off, but several large oil companies and trading houses used the strategy.
According to the Financial Times, the situation was a result of the financial crisis. You see, after the oil price crashed from $147 to $35, banks decided oil speculation was too high risk (yes, they figured it out just a little late).
Normally, traders could borrow money, buy oil on the spot market, and sell the futures contract to collect the spread. As traders piled in, the spread would vanish. But until recently, they weren't getting the loans they needed to buy the oil... so the proverbial suitcase of cash was out there for the taking.
Since then, the market has worked itself out. The spot oil price is up around $50 per barrel, and the six-month strip price is $56. That tells me liquidity is returning to the oil industry, and the market is working again. In short, the opportunity was short-lived... and only for the big boys.
Good investing,
Matt
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