Master Limited Partnerships (MLPs) versus Integrated Oil Companies

One of the regular readers of this blog asked me about MLPs (Master Limited Partnerships).  In many ways, MLPs are like REITS.  They pay no income tax if they pass through all of their income to shareholders.  However, since these trusts are technically partnerships they also pass through expenses and tax benefits.  Many of these were issued in the 80's as a type of tax shelter.  Long since then the tax benefits have been used up and now they are simply income vehicles.  Most MLPs own the royalties associated with oil and gas wells.  However, there are trusts (especially in Canada) that own all sorts of real operating businesses.

As an oil play I think one can do much better owning integrated oil companies with lots of oil and gas properties rather than these royalty trusts themselves.  The trusts are often complicated and the trust owners often (but not always) do not own the upside in oil prices.  The exploration company that developed the oil field sells the mineral rights to a trust and then takes a contract to be the exclusive developer of that oil field.  They also usually take an option on any increase in production or oil prices that gives them upside.  

Right now, most of these trusts are yielding 7-9%.  And since they pay out all their earnings that equates to a price earnings ratio (p/e) of 11-14.  Why would I own one of these trusts at a p/e of 11-14 when I can own Conoco Phillips (COP) at p/e of 6.8, Chevron (CVX) at a p/e of 9.5 or Occidental Petroleum (OXY) at a p/e of 7.3?  And those are trailing p/e's that do not take into account the recent increases in crude oil.  That’s not to say that there are not times when the royalty trusts are not a better deal.  But right now is NOT one of those times.  I bought a group of Oil Royalty Trusts (Oil MLPs) in 2001.  I have sold about half my positions and switched into integrated oil companies.  (The three mentioned above (CVX, COP, OXY) plus BP (BP) and the Norwegian state oil company, Statoil (STO).)  I have large capital gains in the others and do not want to recognize the income and pay tax just yet.  I live in a very high tax state and will probably wait until I move to pay taxes on those gains.  The oil MLPs I own and yields are as follows: L L E Royalty Trust*: LRT (0%), Hugoton Royalty Trust: HGT (7.2%), Mesa Royalty Trust: MTR (7.1%), B P Prudhoe Bay UTS**: BPT (12.2%).


*L L E Royalty Trust had rigs damaged or destroyed in last years hurricanes.  They are producing oil or gas right now.  This is a highly speculative position not part of my income strategy.

**B P Prudhoe Pay has a past payout at a rate of 12% but earnings are lower at rate that would imply a 7.2% yield.

Socially Responsible Angle:  I think all oil companies damage the environment.  BP has some nice advertising that says they are green but I don't buy it.  You cannot influence the behavior of an MLP as they are pass through vehicles.  Every big oil company in the US and UK have shareholder proposals opposed by management that demand better environmental behavior.  If you own one of these don't forget to vote your proxy.  
 

I own every security mentioned above.  COP, OXY, CVX, BP, STO, LRT, HGT, MTR, BPT.

Disclaimer:

Nothing in this blog is meant to be specific financial advice or a recommendation to buy or sell.  I do not give investment advice.  Do your own research.  Do not rely on anything in this weblog to make investment decisions.  I do not log all my trades here. I only describe or mention those that I think might be interesting. Consult an investment professional familiar with your specific financial situation before buying or selling any security.