Energy CEO: O&G MLPs Poised to Benefit from Shale Scramble

HOUSTON (Dow Jones Newswires), Dec. 23, 2010

Master limited partnerships that focus on acquiring mature oil-and-gas properties are poised to go on a shopping spree for conventional assets shed by energy companies needing cash for emerging shale plays, says QR Energy LP's (QRE) chief executive.

Energy-focused MLPs are partnerships that own and operate oil and gas assets, distribute all their income to shareholders, and aren't taxed at corporate rates. Most of them own pipelines but others like Houston-based QR Energy, own oil-and-gas producing properties.

Domestic producers of oil and gas are flocking to shale rock formations that require specialized drilling techniques to unlock their wealth. To fund their capital-intensive drilling programs, many producers must either tap credit markets, sign joint venture agreements with larger, international companies, or sell their aging oil and gas producing assets.

"What we are seeing is a pretty large increase in the divestiture of more traditional assets, which is creating an opportunity for us because those are the type of assets we want to own," QR Energy CEO Alan Smith said.

QR Energy had a $300 million initial public offering last week. The firm has properties in Texas, Arkansas and Louisiana that produce about 5,000 barrels of oil equivalent a day.

Unlike traditional oil and gas companies that use a great portion of their capital to explore for new resources in order to growth production, upstream MLPs such as QR Energy don't engage in exploration. They focus on exploiting mature fields with low production declines. MLPs have a competitive advantage relative to corporations because they don't pay income tax, a benefit that translates to a lower cost of capital.

MLPs pay out most of their earnings to their unit holders on a regular schedule, making them a popular alternative to bonds for individual investors, particularly wealthy investors looking to minimize taxes on investment income. Because the main goal of MLPs is to offer steady yields to investors, between 70% to 80% of their production is hedged.

Some analysts said oil-and-gas MLPs such as QR Energy are also likely to continue benefiting from strong interest by yield-hungry investors as their returns are more attractive relative to other alternatives, including 10-year Treasurys.

"In an environment where people don't know yet exactly what is going on and where they see U.S. treasury yields as low as they are, investing in an MLPs seems very compelling," Christopher Sighinolfi, an energy analyst with UBS, said.

MLP unit prices plunged in 2008, but the Alerian MLP Index of 50 energy partnerships, which include upstream partnerships, returned 76% in 2009. The index is up another 24% in 2010, with components yielding an average of 6%, compared with a total return of 12.8% year-to-date for the Standard & Poor's 500, which yields 1.9%. Ten-year Treasury notes are yielding 3.34%.

MLPs that hold oil producing assets and haven't hedged 100% of their production are also likely to benefit from an expected increase in oil prices, Sighinolfi said. Oil prices have broken through the $90 a barrel barrier and some analysts forecast they could reach $100 a barrel next year. About 55% of QR Energy's production is oil.

QR Energy's Smith expects his partnership to profit from the divestiture of conventional mature assets by major oil companies such us as ConocoPhillips, which is in the midst of a major restructuring plan to shore up finances. "The majors own a lot of those legacy, mature, high-quality assets. They are very careful when they let them go, but when they do they will find a lot of companies anxious to make that type of transactions," he said.

Shares of QR Energy were trading 60 cents up at $20.

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