As has been widely noted, energy is the best-performing group in the S&P 500 to this point in 2021. That’s giving rise to master limited partnerships (MLPs) and the ALPS Alerian MLP ETF (NYSEArca: AMLP).
AMLP seeks investment results that correspond generally to the price and yield performance of its underlying index, the Alerian MLP Infrastructure Index. The index is comprised of energy infrastructure MLPs that earn a majority of their cash flow from the transportation, storage, and processing of energy commodities.
While midstream energy assets and MLPs are on a tear to start 2021, some analysts believe there’s more upside to be had in this group.
“The broad Alerian Midstream Energy Index (AMNA) and the Alerian MLP Infrastructure Index (AMZI) have gained 41.1% and 54.6%, respectively, since the end of October on a price-return basis. In the first week of March alone, the AMZI was up over 11%, even outpacing the 10.0% gain in the Energy Select Sector Index (IXE) as oil prices hit new relative highs,” writes Alerian analyst Stacey Morris.
How Do MLPs Make Money?
MLPs primarily deal with the distribution and storage of energy products, so their business model is less reliant on the commodities market. MLPs profit off the quantity of oil and natural gas they are able to move around. Consequently, they have historically shown a weaker correlation to energy prices over longer periods as the investment vehicle acts more like an energy toll road, profiting on the volume of oil moving through the pipelines.
There are strong fundamentals underpinning AMLP’s resurgence, and some indicate more is on the way.
“Even though oil prices are back above pre-COVID-19 levels, many macro tailwinds have yet to materialize,” adds Morris. “The vaccine-driven demand recovery remains more of a summer 2020 or 2H20 story. Improving demand would benefit midstream companies with refined product assets. In terms of US production, oil prices have not been high enough for long enough to garner a production response. If oil markets can stabilize at these levels or even move higher, production is likely to respond, albeit at a more measured pace given a focus on capital discipline for US producers. Improvements in production would benefit midstream volumes. With 8 MMBpd of oil production currently curbed by OPEC+, a careful unwind of those cuts over time as demand improves will likely be key to keeping oil markets stable.”
Additionally, midstream balance sheets are in solid shape.
“While energy companies are broadly pursuing free cash flow, midstream is differentiated in its ability to generate free cash flow after robust dividends and its visibility to free cash flow regardless of the commodity price environment. Many midstream companies have buyback authorizations in place which could be an added tailwind in this recovery,” concludes Morris.
Other funds with exposure to income-generating energy assets include the VanEck Vectors Energy Income ETF (EINC) and the Global X MLP ETF (NYSEArca: MLPA).
For more on cornerstone strategies, visit our ETF Building Blocks Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
