MLPs: What to Watch in 2018

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For the most part, 2017 was a down year for master limited partnerships with the average one in the Alerian MLP ETF decreasing 14%. A range of factors drove that drop, including lower-than-expected volumes flowing through their midstream systems and issues financing expansion projects. That said, 2018 could be a much better year for MLPs, with four catalysts potentially driving valuations higher in the coming year.

Look for expansion projects to drive cash flow (and distributions) higher

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One of the reasons many MLPs declined in 2017 was that cash flow slipped versus 2017 at many companies due to the continued impact of the oil market downturn. For example, Crestwood Equity Partners' (NYSE: CEQP) distributable cash flow through the third quarter was down nearly 24% versus the same period in 2016 due to asset sales and declining volumes. However, Crestwood has completed three expansion projects this year and had two more on pace to enter service in 2018. Those projects should bolster Crestwood's cash flow in 2018, putting it in the position to finally start increasing its distribution in the second half of next year.

Crestwood is one of several MLPs with a slew of expansion projects entering service in the near term. Enterprise Products Partners (NYSE: EPD), for example, completed $4.2 billion of growth projects at the end of 2017 and had another $2.5 billion on the docket for 2018 while Energy Transfer Partners (NYSE: ETP) has more than $10 billion of expansions expected to be on line by early 2019. Those new additions should fuel significant cash flow growth for these companies, giving them more money to distribute to investors.

Expect more growth projects to get the green light

Many MLPs have been quickly refilling their growth project backlogs. Enterprise Products Partners started the year with $5.3 billion of projects in its backlog and had increased that to $9.1 billion by the third quarter.

That trend should continue in 2018 since many MLPs have several potential expansion projects in development. For example, Williams Partners (NYSE: WPZ) noted that medium- and longer-term projects continue emerging across its portfolio, with the Gulf of Mexico representing a significant opportunity thanks to the proximity of its assets to five recent discoveries on the Mexico side of the Gulf. Meanwhile, both Energy Transfer and Enterprise Products Partners are working to secure several more projects that could drive growth in the coming years. As MLPs lock up these new expansion projects, it will give investors more clarity on their ability to grow distributions in the coming years.

Keep an eye out for more companies to eliminate this costly fee

One of the trends in the MLP sector over the past several years is that companies have been getting rid of their incentive distribution rights. For example, last month MPLX (NYSE: MPLX) agreed to hand over $10.1 billion of newly issued units to its parent in exchange for eliminating the IDRs. In the meantime, Williams Partners gave up 289 million of its units to get rid of the IDRs controlled by its parent.

Given this trend, more MLPs will likely make moves to eliminate this costly fee in 2018. One of the prime candidates is Energy Transfer Partners, which is one of several MLPs that could choose to merge with its parent company or hand over units to end this costly fee.

See if a consolidation wave hits

Speaking of mergers, 2017 saw few strategic transactions in the sector. However, that could change in 2018. MPLX has a long-term objective to become a consolidator in the midstream space. While the company currently has its hands full with the IDR transaction and a large asset dropdown deal with its parent, it could be on the prowl later in the year. Both Energy Transfer and Enterprise Products Partners have a history of making acquisitions to drive growth.

On the other side of things, one MLP that could become an acquisition target is Crestwood. The company has done an excellent job of shoring up its financial situation and bolstering its growth prospects, which makes it more attractive to buyers. It's one of several smaller MLPs that could get gobbled up by larger rivals in 2018 if a new consolidation wave hits the sector.

2018 could be a much better year for investors

While 2017 was a down year for MLP investors, several catalysts could reverse that trend in 2018. In-process organic growth projects alone should fuel significantly more cash into the coffers of MLPs, which would give them more money to send back to investors and help drive up valuations. In addition, the sector could see lots of strategic activities as MLPs continue eliminating costly fees while others buy up rivals to expand. These factors could enable investors to do very well with MLPs this year, with it possible for the better-performing ones to fuel total returns above 20% as they make up for the ground lost last year.

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Matthew DiLallo owns shares of Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.