How MLPs Can Help Investors Tap Into the Booming Energy Industry

MLPs give investors a way to ratchet down commodity risk without sacrificing return.

A nodding donkey rig pumps crude up from the ground on an oil field
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Watson likes Enterprise Products Partners (symbol: EPD) because it has a very diverse footprint in the industry. From pipelines to natural gas liquids processing, the company has "enviable new growth projects" to look forward to, Watson says. "This is a name that's providing potential," he adds. "It's a risk-reward balance—it's a company that's got a bulletproof underlying business, that provides decent growth in a low-risk way."

Reid also has a couple of favorites in the MLP space, which currently boasts around 90 members with a total market capitalization of more than $300 billion. Targa Resources (TRGP) is one promising MLP Reid has his eye on, and not just because it's yielding around 7.6 percent.

"It's really cheap and it's going to grow a lot," Reid says. "They did an acquisition and their stock fell, but they're still getting projected returns in the 13 to 15 percent range." Another favorite of Reid's is William's Partners (WPZ), a pipeline company that's been beaten up a bit this year.

What Are the Risks?

According to Stevens, the specter of massive tax-code reform is the main risk when it comes to MLPs. Currently, the asset class enjoys a structure that allows it to avoid paying corporate taxes and instead pass through the income—and taxes—to unitholders. If that structure is invalidated, MLPs could starting having to pay taxes on their income, which would reduce the cash distributed to unitholders and drive down the stock price.

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Another byproduct of its structure that could impact investors is that because MLPs do not retain earnings, there's no "bucket" to finance growth projects. That means MLPs constantly have to come to the market to raise new capital. If markets are down and an MLP can't access the capital it needs, the growth part of the total return equation would suffer, Stevens says.

"If you take growth off the table, total return prospects aren't as good and stock prices would quickly reflect that," he adds.

Finally, though they are billed as a way to dampen the commodity risk associated with investing directly in the oil and gas production industry, MLPs don't protect investors from everything. Like any investment, those interested in entering the MLP space should do their homework, and find out exactly what sectors of the energy industry the MLP operates in.

"Don't assume MLPs have no commodity price risk at all," Watson says. "Some names are taking a fair amount and some aren't, so it's important to know what you're getting into."