Amid heightened volatility, oil price has nicely rebounded from the low levels it hit in mid February. This is especially true as the price hit a three-month high in last week’s trading session with U.S. crude climbing above $38 per barrel and Brent popping above $41 per barrel.
Impressive gains came on the back of improving demand/supply dynamics, which are rebuilding investors lost confidence in the rebalancing of the oil market. Some of the major developments include hopes of a deal by major oil producers to freeze oil output at the January level, signs of falling domestic and the Organization of the Petroleum Exporting Countries (OPEC) production, receding fears of recession in the U.S., and signs of stabilization in China and the other developed economies.
Additionally, the latest data that shows a big gasoline and diesel inventory drawdown injected more optimism into the oil market. All these have spurred a rally in every corner of the energy space. In particular, master limited partnerships (MLPs) have been leading the energy space over the past one-month period. Though their revenues are not dependent on oil price, these stocks were also victims of the oil collapse. Now, with the rally in price and investors’ hunt for income-focused securities, MLPs have benefited the most (read: 4 Energy ETFs Outperforming on Oil Rebound).
MLPs: A Good Bet?
Most MLPs are engaged in the processing and transportation of energy commodities such as natural gas, crude oil, and refined products. As such, they are not directly linked to the price of oil and are likely to be the major beneficiaries of an oil boom in the long term. Acting as toll-takers, these MLPs earn revenues on the volumes that flow through pipes and not on the commodity price. This nature of business will definitely give a boost to these stocks given the U.S. shale boom.
MLPs have relatively consistent and predictable cash flows, making them safer and less risky than other plays in the broader energy space. These represent an attractive investment option for income-focused investors as MLPs pay out substantially all of their income to investors on a regular basis. In addition to high yields and the potential for capital appreciation, MLPs also have lower volatility and provide diversification benefits to the portfolio.
Nevertheless, like all high-income products, MLPs tends to react negatively to a rising rate environment. This is because as yields rise, MLPs might face problems in raising fresh capital from debt markets for funding new projects thereby hurting their profitability. But this doesn’t seem as too much of a concern at present as the Fed will follow a slower rate hike path this year. Additionally, most MLPs use a fixed rate debt for their borrowings.
Further, investors hold MLPs for a long time due to tax consequences and thus do not react adversely to rising interest rates unlike other rate sensitive assets like utilities and REITs (read: MLP ETFs Trading at a Huge Discount to NAV).
Given the pros and cons, MLPs seem great picks for this year. Below we highlight four MLP ETFs that could be excellent choices for investors’ seeking to tap the oil price rebound while at the same time looking for a high yield. All these products have delivered handsome returns from a one-month look.
Infracap MLP ETF (AMZA – ETF report)
