Increasing U.S. energy demand has spawned a similarly growing investment space in Master Limited Partnerships (MLPs). These partnerships provide investors with the opportunity to share in the income generated mainly through the transportation, distribution and storage of oil and natural gas. In this exclusive interview with The Energy Report, Kenny Feng, president and CEO of Alerian, which maintains the Alerian MLP Index, gives us the ins and outs of the MLP business, highlighting the unique benefits and risks associated with these income-generating investment vehicles.

The Energy Report: Alerian is an independent provider of objective indices and underlying data for Master Limited Partnership investments. Can you explain what your company does?

Kenny Feng: First, Alerian creates and maintains four indices that track the energy MLP space. Just as someone would use the S&P 500 to gauge the performance of the broader U.S. economy, people use the Alerian MLP Index (AMZ:NYSE) to gauge the performance of the energy MLP space.

Secondly, we license our indices to investment banks and third-party exchange-traded fund (ETF) distributors to create investment products, which facilitate access to this asset class. These currently include JP Morgan, UBS, ALPS Fund Services Inc. and CIBC in Canada.

Thirdly, we are an information provider for the MLP space. As a sort of “Wikipedia” of MLPs, we are the first-pass information source for investors just finding out about the asset class through a CNBC spot or an article in Barron’s or through word of mouth. People are looking for sources of higher-income returns and learning that MLPs have historically provided them.

TER: Can you define an MLP for people who aren’t that familiar with the structure?

KF: Master Limited Partnerships are involved in four basic businesses at a very high level: transportation, storage, processing and exploration, and production of minerals and natural resources. By confining themselves to these specific activities, MLPs are not subject to entity-level taxation. They are, however, subject to the same reporting requirements as any other publicly-traded corporation. Approximately two-thirds of these names trade on the New York Stock Exchange, with most of the others trading on the NASDAQ.

TER: How did you get into the business of creating these indices?

KF: We actually kind of stumbled into it. In 2004, Alerian was launched as an asset manager for the MLP space. Being a pretty small fish in this pond we thought, “What can we do from a marketing standpoint?” Reading the different analysts’ research reports and talking to different MLP investor relation (IR) teams, we realized there wasn’t a third-party index capturing and benchmarking MLP performance. Everyone was calculating their own composite for the sector with different methodologies. We thought this would be great opportunity for us to launch an index that would be really helpful for all the different stakeholders. The Alerian MLP Index was launched on June 1, 2006.

Our methodology largely mirrors the construction of the S&P 500, which is a float-adjusted, market capitalization-weighted index. We were fortunate to have first-mover advantage and to be able to have the different stakeholders of the sector adopt it as the benchmark. Today you see the MLPs themselves using it in their corporate presentations. The media has adopted it, including CNBC, Barron’s and other publications.

In 2006-2007, people said to us, “We love your index, but I’m really more interested in traditional pipeline and storage.” They were looking to track what are called toll-road business models. So we launched the Alerian MLP Infrastructure Index (AMZI:NYSE) for those who are more focused on that midstream energy infrastructure component. Then, as the gas shale plays started to emerge in full force in the U.S., we decided to launch a gas infrastructure index—the Alerian Natural Gas MLP Index (ANGI:NYSE).

TER: Why did MLPs lack their own index for a full 20 years since their 1986 inception and before Alerian launched its index?

KF: That’s a great question. This asset class is still pretty small—about $250 billion (B) spread among just over 70 securities. That’s two-thirds the size of Exxon Mobil Corp.’s (XOM:NYSE) market cap, which is in the $375B range by itself. This hasn’t been an asset class that has historically interested a lot of institutions, and as a result has largely been held in retail hands. As oil prices have fluctuated over the past eight years between $30–150 per barrel, the pipeline and storage MLPs have not been directly exposed to those commodity-price fluctuations. It’s a stable business with very predictable growth in earnings and cash flow. This may not be exciting for a lot of people, but it generates stable cash flow, allowing MLPs to pay out consistent distributions over time.

TER: How does an energy infrastructure asset compare to other types of assets?

KF: What makes the energy infrastructure asset unique is the underlying business type, a toll-road business model. Those stable cash flows and the fact that you can predict it with a greater degree of certainty than, let’s say, the advertising revenue of Google in any given quarter. It’s attractive to a lot of people.

The MLP revenue equation is very simple. It’s just price multiplied by volume. On the price side, you have a tariff on all interstate liquids pipelines that grows by PPI (Producer Price Index) plus 2.65%, federally mandated every single July. There is federally-mandated stability. On the volume side, you have energy demand growth in the U.S. averaging roughly 1% per year over the past 30 years.

TER: You touched on this earlier, but maybe you could go into a little more detail on how MLPs are valued compared to utilities and Real Estate Investment Trusts (REITs).

KF: MLPs are similar to utilities in that they are similarly exposed to inelastic energy demand. The difference is in how they are regulated. If a utility wants to implement something that will provide cost savings, the regulator will say, “It’s a great idea, and now I want 50% of your cost savings for my consumers.” With MLPs, the Federal Energy Regulatory Commission oversees all interstate pipeline activity. They have shown themselves to be constructive and efficient in their oversight.

MLPs are similar to REITs in that they own hard assets with permanent storage value. But REITs are much more exposed to economic cycles than MLPs and REIT distributions are consequently much more volatile. MLPs have raised their distributions on average by 3–6% each year through the 2008–2010 economic crisis, and they’re on pace to do the same this year.

TER: So it’s a good, solid, entrenched business that’s not going to change much.

KF: Exactly.

TER: Are there unique tax considerations investors need to make for MLPs?

KF: Absolutely. MLPs are partnerships. Instead of receiving the 1099 tax form you would get if IBM or Google paid a dividend, you’re going to get a Schedule K-1 form, which is essentially your allocation of deductions and income that come from the MLP itself. I always tell people that if you don’t find a Schedule K-1 to be burdensome, you should invest in MLPs directly, because MLP distributions are actually tax-deferred return of capital. When IBM or Google pays you a dividend, you’re going to be taxed at the qualified dividend rate. With MLPs, because of various deductions, the return of your distribution is actually a tax-deferred return of capital.

Roughly 70–100% of MLP distributions will be tax deferred. The balance is going to be taxed at your ordinary income rate. So if I receive a distribution of $1 and 80% of that is going to be tax deferred, then I’m only taxable for that remaining $0.20 at a 35% rate. So it’s $0.07 on a $1 distribution in the current year. Your cost basis will be adjusted downward accordingly. There will be a recapture upon the sale of MLP units, and that’s when the tax deferral catches up. There’s a recapture for that component, but certainly it does create a dynamic where, if you believe in the business and the asset, then certainly it’s going to defer that income all the way out until you sell. So it’s a great income tool, and also a great way to defer your taxes.

TER: How has the performance of MLPs compared to similar alternatives?

KF: Over the past 10 years, MLPs have returned approximately 17% annualized—obviously very strong. If you break down the actual performance, roughly 8% of that is a function of distribution growth. Another 6–7% of that is from yield, and the balance, that 3% or so, is really from valuation compression. So what’s been driving that? Part of that is just that the asset class has grown through acquisitions and organic growth projects. Ten years ago, it was 20 securities, $20B and today there are 70-plus securities and $250B. The other part is the tariff escalators that we talked about earlier.

TER: How do we know that this growth will continue?

KF: The Interstate Natural Gas Association of America (INGAA) estimates that there’s roughly $10B of new natural gas infrastructure that needs to go into the ground each year for the next 20 years. So you’re looking at a roughly $200B investment through 2030. When you compare that to a market cap in the space today of $250B, it’s pretty significant. What’s driving the spending is the changing supply-demand dynamics caused by the gas shale plays. Ten years ago, we didn’t know that some of these reserves were economically recoverable. As a result of changes in drilling technique and technology, those reserves are now recoverable at a much lower gas price.

On the acquisitions side, which is the other component of the growth, companies such as Exxon Mobil, BP Plc. (BP:NYSE; BP:LSE) and Chevron Corporation (CVX:NYSE) have midstream assets that they’re not really getting credit for. They have an incentive to sell these assets (which they effectively operate as cost centers) down to the MLPs and redeploy that capital into a drilling budget. The MLPs, obviously, have an incentive to operate these assets more efficiently. Because of their pass-through tax status, they’re able to pay a little bit more than the traditional corporation and still have the acquisition be accretive. The synergies with their existing assets create an opportunity to continue allowing their distribution to grow as a result of these acquisitions.

So the two components of growth are organic growth and acquisitions. That’s going to allow the trajectory of this asset class to continue going forward. We wouldn’t tell you 17% is anything to expect on a going-forward basis but if you do some basic math, research analysts expect 3-5% distribution growth, combined with a current yield of 6-6.5%, which gives a 9-12% total return. On a cash flow-volatility basis, the risk-reward would generate what we think compares pretty favorably to other asset classes.

TER: Is there anything on the negative side that could change the economics of this business?

KF: Investors with a long-term commitment to the asset class are going to be better rewarded over the long run just because there will be volatility in the shorter term. Let’s talk about a couple of the risks.

The first is interest-rate risk. These are yield-sensitive instruments, to a certain degree. In times of gradual or slow interest rate rises, MLPs have shown to be largely protected due to their distribution growth component. So it’s not a completely fixed-income security. If you do see a spike in interest rates, such as in 1994, for that short period of time MLPs suffered just like any other yield-oriented equity class. If you expect yields to double over the next year on 10-year treasuries, then you should really be careful with this asset class because they do pay a distribution, and the yield component is going to be an issue.

Another side of it is just a broader equity risk. MLPs, historically, have been largely uncorrelated to the broader S&P 500 at about 0.3-0.4%. The asset class has become more well-known and everything has been more correlated in recent years. With more volatility in the broader markets, you are going to have broader equity risk that people might not have thought about, historically, because of their cash-flow business.

Another component is that MLPs are an emerging asset class. About 60% of the $250B market cap is in public hands. The balance is held by sponsors. So there’s really only $150B of MLP equity out there. Some of these securities are going to be fairly illiquid. Investors need to know how much volume is trading on a given day and whether there are any large blocks that may unlock at some point to create an overhang on the stock itself.

Beyond that, you have environmental risk around hydraulic fracturing (fracking). The U.S. Environmental Protection Agency is going to release a study at some point next year detailing its perspective on fracking, which could make it more tightly regulated than it is today. So, environmental legislation would be a risk because it would reduce some of those growth opportunities that currently exist.

Finally, there is tax reform legislation, and MLPs could get swept up in that. We don’t believe they will, because Congress does understand that these assets are critical to U.S. energy security as well as being thought of like other infrastructure assets, such as airports, toll roads, hospitals and schools.

TER: What key points should people bear in mind when considering MLP investments?

KF: MLPs present an opportunity to invest in the long-term build-out of U.S. energy infrastructure. The key elements that make this asset class attractive are: (1) stable cash flow, which is anchored by what are effectively regional monopoly-type business models; (2) benign overarching federal regulation, which has been very supportive over the long term, and (3) this tremendous resource in U.S. gas shales, which represents an opportunity for the infrastructure companies that need to move this gas from these new supply centers to new demand centers.

From an investment-opportunity standpoint, if you’re looking for a stable source of cash income, I think MLPs are certainly worthy of consideration. With a 6–7% yield and a 3–5% conservative distribution growth on a going-forward basis, you’re still looking at low-teens returns with a fairly stable cash-flow profile for the pipeline and storage MLPs, in particular.

If you’re looking for a total return proposition, with an opportunity to build out these assets over the next 5 to 20 years, there’s a return potential that could be even greater than that, as shown by some of these individual partnerships over the past 10 years.

TER: It looks like MLPs are kind of a win-win for everybody involved.

KF: We certainly think so.

TER: Thanks for joining us and providing these valuable insights.

Kenny Feng, CFA, is the president and CEO at Alerian, an independent provider of objective indices, data sets, and analytics for the Master Limited Partnership (MLP) sector. Over $5 billion is directly tied to Alerian’s indices, including the leading benchmark of MLP equities: the Alerian MLP Index. Mr. Feng is a former managing director and portfolio manager at SteelPath Capital Management LLC, a Dallas-based MLP investment manager. Prior to his experience at SteelPath, Mr. Feng covered MLPs, electric and gas utilities and diversified gas companies at Goldman, Sachs & Co., in the firm’s Global Investment Research Division. Mr. Feng graduated summa cum laude with a Bachelor of Science in economics from the Wharton School and a Bachelor of Arts in international studies from the University of Pennsylvania. He also serves on the advisory board of Midstream Business, a monthly publication addressing the need for business market intelligence on North American midstream energy infrastructure.

MLPs may be the best-kept secret on Wall Street. Representing the midstream segment of the energy supply chain, Master Limited Partnerships offer stable returns through U.S. energy infrastructure investment. In this exclusive interview with The Energy Report, Fund Manager Hinds Howard explains the peculiarities of this growing niche market and shares some quality stocks at fire-sale prices.

The Energy Report: Master limited partnerships (MLPs) are something most investors in the energy field are probably not all that familiar with. Can you give us a brief overview of exactly what they are and how they work?
Hinds Howard: MLPs are companies that engage in transportation, storage, processing, refining, marketing, exploration, production or mining of natural resources and minerals. Because they restrict their operations to these specific activities, the tax code allows their equity, sold in units rather than shares, to trade on public securities exchanges like the shares of a corporation but without entity-level taxation. Operationally they represent the midstream segment of the energy supply chain, linking producers to demand centers via pipelines, storage facilities and other infrastructure assets. They provide a way to invest in the buildout of U.S. energy infrastructure in the coming decades.

MLPs produce regular quarterly income for investors, who are considered limited partners. That income comes in the form of tax-deferred distributions. There’s no tax requirement that MLPs distribute most of their cash flow. MLPs file partnership tax returns every year and report income on a schedule K-1. MLPs have a general partner which controls operations of the company and limited partner investors have limited voting rights. Historically this sector has been under-owned by large institutions. Roughly 70% of the sector is owned by retail investors either through brokers or just individually.

TER: So these are essentially vehicles for investors to be able to buy and sell tax shelters in a public market.

HH: That’s right. The original MLPs in the early eighties were exploration and production companies with variable distribution models. If production and prices were up, the distribution was up; if it was down, the distribution was down. The 1986 tax code change created a new era in MLPs, starting with Buckeye Partners, L.P. (BPL:NYSE). Rich Kinder bought the general partner of Enron Liquids Pipeline L.P. in 1997 and changed the name to Kinder Morgan Energy Partners, L.P. (KMI:NYSE), which was the first growth MLP that saw value in buying assets and growing distribution over time. That spawned the new generation of growth MLPs that tended to use the MLP structure to more aggressively grow distributions over time.

TER: How did you decide to start Curbstone Group and specialize in these limited partnerships?

HH: My specialization in MLPs predates Curbstone Group. My grandfather, who was CEO of a publicly traded utility company in Houston, first introduced me to MLPs in the mid-1990s. He liked the high quality, hard-to-replace assets, as well as their monopoly-like competitive advantages and cash-flow yields.

After college, I joined Lehman Brothers as an investment banker and participated in executing nine MLP IPOs. In the process, I got to know the sector a little better. Then I moved with three colleagues to join Lehman Brothers Private Equity, where the four of us were given $400 million (M) of Lehman Brothers’ balance sheet money to invest in MLPs. As the junior member of the team, I served as the primary research analyst for that fund and continued in that capacity after we raised a $600M private partnership fund from outside investors.

I left Lehman in July 2007 because I wanted to go out and build something on my own. At first that did not include MLPs, but in mid-2008 I was drawn back into the sector, seeing the opportunity to invest in MLPs at fire sale prices. In the process, I met my two partners, Houston-based money managers Mike Catalano and Ryan Krueger. We quickly realized our outlooks matched up concerning worldwide demand growth for scarce resources.

We started Curbstone in April of 2009 based on our shared view of hard assets, but also to create a reliable income stream for investors in an environment where yields on cash and bonds have become tiny. I manage the MLP portfolio, which represents roughly half of the firm’s overall portfolio.

TER: So even though the dates don’t go back all that far, you and your partners are old-timers in this business, so to speak.

HH: That’s right.

TER: Why should investors be interested in MLPs versus other alternatives such as exchange-traded funds (ETFs) or individual energy stocks?

HH: Individual energy stocks certainly have their place, but for someone who is looking for yield and income, I would recommend MLPs. Generally, the ETFs don’t track the MLP indexes very well. The exchange traded notes (ETNs) don’t offer the same tax benefits of direct ownership in MLPs and they are passive vehicles. The risk profiles of MLPs are broader than most people realize or understand. There are very highly commodity price-sensitive MLPs and also very low commodity price-sensitive names, so active management matters for MLPs.

It’s important to do a little homework and make sure you’re investing in the companies that fit your risk tolerance. I believe individual MLPs are the way to go. The passive ETF vehicles track 50 MLPs at most. So one blowup can have a material negative impact, unlike the S&P 500 or the Russell 2000, where you’re getting a lot of diversification. Curbstone offers the best of both worlds—the professionally managed active investment portfolio and direct ownership of MLPs with full tax benefits. In the MLP sector, there is still an opportunity to outperform passive vehicles through knowledgeable, disciplined security analysis.

TER: You touched on prices and trading strategy. Tell us about the volatility and the price performance of MLPs compared to ETFs.

HH: Over the past 10 years through the end of August, the Alerian MLP Index shows that the MLP sector has produced average annual returns of about 19.3%, including distributions. 2010 (which saw 35.9% total return for the MLP index) and 2009 (74.4% total return) were both very strong years for MLPs as they recovered off their bottom. So far this year, MLPs have been down on a price basis around 2.4%, but if you include the distributions they’re up around 2.1% through the end of August.

MLPs have historically been much more volatile than the business that they own due mainly to the sector’s relatively small $250 billion market capitalization and relatively small trading volumes. The top 10 most-active MLPs average about $40M in trading value per day. One way to look at it is Kinder Morgan Energy Partners, the most actively traded MLP, trades about 0.25% of its market cap on a daily basis, compared with ExxonMobil that trades about 1% of its market cap on a daily basis. Lighter trading volume exaggerates price movements in either direction.

TER: So people buy these things more like bonds for the yield and they don’t have reason to trade them all that much.

HH: That’s right. The largest portion of MLP owners are the sticky mom-and-pop investors that buy and hold. What shows up in the daily markets are the marginal buyers and sellers who contribute to the volatility.

TER: What are the tax implications of buying and owning MLPs?

HH: They can be complicated, however any tax CPA should be able to figure it out. K-1s are not fun to do on your own. Generally, if you hold MLPs in a taxable account and don’t trade very often, the K-1 headache is manageable. Once you figure it out for one MLP and one K-1, it’s easy to do more. In terms of planning for taxes, after you’ve held an MLP for several years, your tax basis gets whittled down because they distribute more to you in returns of capital than you’re allocated in net income. So if you own an MLP for 10 years that is producing and increasing distributions, it’s likely that at the end of that 10 years you’ll have a zero basis. When you go to sell that MLP, you’ll get taxed at ordinary income rates from zero up to the price that you paid. Anything above your purchase price is going to be capital gains. The ordinary income recapture aspect to these MLPs tends to shock people when they sell them, so you just need to be aware of that and plan accordingly.

TER: About how many MLPs are out there and what should investors be looking for if they decide to get into this particular space? What’s attractive and what should they stay away from?

HH: There are about 80 or so publicly traded MLPs with something for everyone’s risk tolerance. Some brokers and financial advisors tend to still describe MLPs as a toll road pipeline business. But the truth is there’s a wide range of risk profiles among the assets owned by MLPs. So, step one would be to call Curbstone (just kidding).

One of the things you look at first is coverage ratio. You want to make sure that the cash flow generated is higher than the cash flow distributed; otherwise the distribution is not sustainable. Look for a distributable coverage ratio of 1.0 times or greater after the general partner’s take of the distribution. Removing the general partner distribution is not a simple calculation, but once you do that, coverage ratio is calculated by taking the distributable cash flow per LP unit and dividing it by the current distribution per unit. The ratio can be looked at from either a forward- or backward-looking perspective.

Two companies that have been particularly good at managing their coverage ratio are Alliance Resource Partners, L.P. (ARLP:NASDAQ) and Enterprise Products Partners, L.P. (EPD:NYSE). Alliance hasn’t issued new equity since 2002 and has grown its distribution at an annual rate of 11.8% since its IPO, largely because it has consistently maintained a coverage ratio of greater than 1.5 times. A company that has a one times coverage ratio and doesn’t retain a lot of its cash will have to access the capital markets more often than a company that has a high coverage ratio.

Enterprise Products issues a lot of equity each year. But, lately management seems to have realized that given how large the company is, it may not be able to get all the cash it needs from the public markets each year in order to satisfy its growth needs. Enterprise has been increasing its coverage ratio by retaining the excess cash to fund organic growth projects and now has around 1.4 times coverage. Those are on the high end. The low end would be companies that have coverage ratios of 0.7/0.8 times. You also want a strong management team that’s executed well in the past. That’s a given for any company. Also, while price-to-earnings ratios are not widely tracked for valuation purposes, you don’t want an MLP that doesn’t have positive earnings over a long period of time. That’s a red flag.

TER: What kinds of things can go wrong with an MLP? Have there been some disaster stories over the years or some that have underperformed?

HH: There have been both. One thing that can go wrong is an MLP can raise its distribution too high too fast, and then for some reason its cash flow decreases and the MLP has to cut its distribution. That’s happened in the past for companies in the gas-gathering and processing business. When natural gas prices plummeted and volumes dried up on their pipelines, they had to cut their distributions. That gets back to the issue of what is an appropriate distribution coverage level for a given MLP’s business risk.

There are also companies in the natural gas storage business that have fallen on hard times because natural gas storage is not as attractive as it once was. Those are issues that are more related to the industry. There also can be problems for MLPs (like any other company) when they pay too much for acquisitions.

TER: This is not unlike owning a real estate asset that produces rental income.

HH: That’s right. MLPs generate recurring cash flow and it’s just a matter of how stable they can make it and how far-out they can lock it in with long-term contracts.

TER: What are some particularly attractive companies our readers may be interested in?

HH: The MLPs that have outperformed this year are the general partners (GPs). Several MLPs have taken their GP holding companies public. Those have done really well because the GP’s growth profile is much higher than the underlying MLP. That’s because as the MLPs raise their distribution, the GP gets more and more of the cash flow—typically as much as 50% of the incremental cash flow. With Kinder Morgan Energy Partners, 45% of its total distributed cash flow goes to its general partner as well as 50% of each incremental increase in the distribution. Growth at the GP level will be roughly twice that of the MLP level. Alliance Holdings GP L.P. (AHGP:NASDAQ), Targa Resources Corp. (TRGP:NYSE), Energy Transfer Equity, L.P. (ETE:NYSE) and Kinder Morgan Energy Partners L.P. are all attractive GPs at this point.

TER: So when you’re buying the general partners, it’s like cutting into the management portion of the company, where salaries are good regardless of how the company is doing.

HH: That’s true. The GPs get more cash flow in one of two ways: either by raising the distribution per unit at the underlying MLP or by issuing more equity at the underlying MLP, increasingly the number of units outstanding. So, aligning yourself with the general partner of an MLP that issues a lot of equity is a good thing. There’s also scarcity value with GPs. There are only seven pure play GPs that trade publicly and at least five that were public a few years ago have been taken private or merged with their MLPs over the last few years.

TER: Do you foresee more MLPs forming or is there a limited supply of assets large enough to support these kinds of companies?

HH: The IPO market has been very hot this year. There have been at least seven MLP IPOs this year with another eight more on file, making 2011 the most active IPO year we’ve had since 2007, when there were at least 13 IPOs. The market is wide open and more capital continues to flow to the sector.

TER: With more companies getting into this market, is there danger of a bubble?

HH: I think it’s definitely hard for a small company to come in and compete. But there are still a lot of assets housed at large integrated oil companies. They might spin off MLPs, which are fairly attractive because there is a suite of assets the parent company can sell over time at attractive prices to the MLP.

There’s also a lot of energy infrastructure that needs to be built in this country; roughly $10B worth a year for the next 20 years, according to some estimates. There is enough opportunity out there for more MLPs to exist, but you have to be wary and consider the quality of the asset.

Before the credit crisis hit, MLPs were already in a tailspin from mid-2007 on. Many exploration and production MLPs were financing their acquisitions through private investments in public equity deals where large institutions bought large blocks of shares that grew the share counts without growing the amount of shares that were freely traded. When the restrictions expired on those blocks and the institutions unwound those purchases, there were not enough buyers and the sector tanked. I think the institutional investors have learned their lesson from that experience, but you can never stop bankers from bringing out what they think will sell to retail investors.

TER: What are your expectations for the oil and gas markets in the next 6–12 months and what effect might that have on MLPs?

HH: I don’t have a specific number for each, but I expect oil to be higher than it is today in 12 months, as the dollar remains weak and monetary policy loose. Money flow should favor oil prices more so than natural gas prices. As costs for drilling oil increase and global demand continues to grow, oil prices should continue to have an upward bias. Natural gas prices are harder to predict than most other commodities. But I do believe the relationship between oil and gas will remain at these elevated levels, particularly in the U.S., where we have excess natural gas.

What can change the natural gas picture is an export solution, which I don’t expect in the near term. I think natural gas prices will stay down. Natural Gas Liquids (NGL) prices will remain high because NGLs are priced on oil and the inputs are natural gas. The margin for producing NGLs is very high right now. That’s going to be good for gathering and processing MLPs for the next 12 months, as it has been for the previous 24 months.

TER: Any other final thoughts on how our readers can best position themselves in MLPs?

HH: There are some high-growth, low-yielding MLPs that everyone should have in their portfolios. El Paso Pipeline Partners, L.P. (EPB:NYSE) and Western Gas Partners, L.P. (WES:NYSE) are the names I would point to. Investors should consider putting together a yield barbell portfolio that includes high-quality, high-growth yield names as well as higher-yielding MLPs. That’s a group of “fallen stars” MLPs that haven’t cut their distributions but have been trading like they will never increase distributions ever again. They aren’t distressed and they all have issues to work through, but chances are they will resume growth at some point. The option value on growth is underpriced and you can get paid a 10% yield on a few of them just for waiting.

Putting those together into a pretty simple portfolio that includes some low-yield names and some high-yield names should be a good strategy for the next 12 months. In that fallen stars category I would put names like Energy Transfer Partners L.P. (ETP:NYSE), Inergy Holdings, L.P. (NRGP:NYSE), Boardwalk Pipeline Partners, L.P. (BWP:NYSE), Global Partners L.P. (GLP:NYSE) and Regency Energy Partners, L.P. (RGNC:NASDAQ).

TER: That certainly is a wide range of diversified opportunities to put together your own little yield portfolio. Investors who aren’t familiar with this sector would do well to deal with someone who specializes in it.

HH: Or they should just call me.

TER: Well, that’s true. Thank you very much for your input, Hinds.

Professional money manager and investor Hinds Howard, together with Ryan Krueger and Mike Catalano, founded Curbstone Group, a registered investment advisor, in 2009. Howard manages Curbstone’s investments in Master Limited Partnerships (MLPs). Howard is a native of Houston, Texas, graduated from Boston University and received his MBA from Babson College. He has traded MLPs since 1995 and covered the sector with Lehman Brothers MLP Partners, a hedge fund within the company’s private equity division.