#$mwe

Mid-April has seen a consecutive multi-day rise in oil prices, with West Texas Intermediate briefly hovering around $57, its highest level since last December. This comes as the Department of Energy reported declining crude production, along with a small rise in inventories.  Additionally, OPEC has predicted a decline in U.S. crude production for the second half of 2015. Escalating global conflict has also given prices a boost.

It’s too soon to say whether this recent upsurge will continue and typically markets take time to digest a steep rout in oil prices. Bears would say there’s more downside in oil prices to come; we feel prices have seen their lows for the year.

But irrespective of oil or gas price movements, we believe specific midstream MLPs that were hit hard along with the broader energy sector might represent a compelling alternative yield product for investors.

As is the case with REITs, not all MLPs are created equally.

Upstream MLPs have rightfully experienced the worst decline along with oil; because they focus on production, they are heavily exposed to the price swings of commodities.  As commodity prices have been extremely volatile to the downside, many upstream MLPs have cut distributions.

Midstream MLPs, on the other hand, focus on storage and transportation. They have long-term contracts that are largely fee-based or take-or-pay, often with built-in inflation adjustments. They may not offer yields as high as the upstream MLPs, but they are far less sensitive to commodity prices, and coverage ratios are typically better. Nonetheless, the midstream sector also fell approximately 20% due to the negative sentiment, as investors panicked and sold all related names, regardless of commodity sensitivity.

Seven companies in particular appear to have the greatest potential to experience sizeable price appreciation as the ratio between high quality midstream MLPs and high quality REITs converge. All have experienced some gains as industry insiders recognize the buying opportunity. Investors may also want to consider taking advantage of an unjustly battered sector since the convergence may be far from finished.  

Kinder Morgan (KMI) and Enterprise Products Partners (EPD) are two of the largest and most diversified companies in the space, and Plains All American Pipeline (PAA) is one of the largest midstream providers in North America. Given their large established asset footprints and relative yield spreads, all three look particularly compelling right now.

In addition, Energy Transfer Equity (ETE), MarkWest Energy Partners (MWE), Targa Resources (TRGP) and Williams Companies (WMB) look attractive, as they all have underappreciated asset footprints, potential to participate in M&A and/or high perceived commodity price sensitivity.

The return potential of these companies is illustrated in the following graphs, where the current yield spreads of the individual names are compared against their historical average (each versus the high-quality REIT index). 1 These reflect potential returns from spread compression only; company-specific growth or other factors could provide even more upside.

Disclaimer

This commentary is provided as general information only and is in no way intended as investment advice, investment research, a research report or a recommendation. Any decision to invest or take any other action with respect to the securities discussed in this commentary may involve risks not discussed herein and any such decisions should not be based solely on the information contained in this document. It should not be assumed that any securities discussed in this commentary will increase in value. Highland Capital Management Fund Advisors, L.P. (“Highland”) will not accept liability for any loss or damage, including, without limitation, any loss of profit that may arise directly or indirectly from use of or reliance on such information.

Statements in this communication may include forward-looking information and/or may be based on various assumptions. The forward-looking statements and other views or opinions expressed herein are made as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated and there is no guarantee that any particular outcome will come to pass. The statements made herein are subject to change at any time. Highland disclaims any obligation to update or revise any statements or views expressed herein.

In considering any performance information included in this commentary, it should be noted that past performance is not a guarantee of future results and there can be no assurance that future results will be favorable. Nothing contained herein should be deemed to be a prediction, projection or guarantee of future performance. Any targets contained herein have been prepared and are set out for illustrative purposes only, and no assurances can be made that they will materialize. They have been prepared based on our current view in relation to future events and various estimations and assumptions made by us, including estimations and assumptions about events that have not occurred, any of which may prove to be incorrect. Therefore, the forecasts are subject to uncertainties, changes (including changes in economic, operational, political, sovereign or other circumstances) and other risks, including, but not limited to, broad trends in business and finance, legislation and regulation, monetary and fiscal policies, interest rates, inflation, currency values, market conditions, all of which are beyond our control and any of which may cause the relevant actual, financial and other results to be materially different from the results expressed or implied by such forecasts.

No representation or warranty is made concerning the completeness or accuracy of the information contained herein. Some or all of the information provided herein may be or be based on statements of opinion. In addition, certain information provided herein may be based on third-party sources, which information, although believed to be accurate, has not been independently verified.

Highland and/or certain of its affiliates and/or clients hold and may, in the future, hold a financial interest in securities that are the same as or substantially similar to the securities discussed in this commentary. No claims are made as to the profitability of such financial interests, now, in the past or in the future and Highland and/or its clients may sell such financial interests at any time.

The information provided herein is not intended to be, nor should it be construed as an offer to sell or a solicitation of any offer to buy any securities. This commentary has not been reviewed or approved by any regulatory authority and has been prepared without regard to the individual financial circumstances or objectives of persons who may receive it. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Highland encourages any person considering any action relating to the securities discusse herein to seek the advice of a financial advisor.