In January, U.S. stocks rebounded significantly from their tepid 2011 performance, booking their best start to the year in more than a decade, while master limited partnerships (MLPs) and other defensive securities underperformed.

In early February, investors were handed resounding support for their risk-seeking rotation into equities. On the first Friday of the month, the government released its monthly jobs report which economists called "unquestionably positive" and "game changing."

The big question

The big question for the capital markets now is: Has the U.S. economy truly turned a corner, or is the blowout employment number an aberration similar to the temporary drops in the jobless rate that we experienced about a year ago?

Critically for MLPs, if the employment situation continues to materially improve, the likelihood of interest rates staying at zero through the end of 2014 will diminish. This would undoubtedly make MLPs less attractive relative to other yield-driven securities, especially as MLPs approach fair value. Moreover, MLPs rely upon favorable access to the credit and debt markets, which could be adversely impacted if rates rise.

However, whereas historically, investments in MLPs were driven primarily by appetite for yield, the market is now also focused on secular growth trends. Investors today are willing to pay bigger premiums for MLPs that have greater distribution growth rates than for the MLPs that currently have the highest yields.

The preferred sources of distribution growth are not third-party acquisitions or higher fee-based contracts, but organic buildouts and dropdowns. For the former, investors are looking for MLPs that are well situated to invest in new infrastructure to serve liquids-yielding shale resources, particularly in the Marcellus, Bakken, Eagle Ford and Permian Basin. For the latter, the market is focused on MLPs with the ability to purchase assets from an E&P sponsor at attractive valuations which could support distribution growth.

Pouring capital in

Investors have poured capital into selected MLPs with footprints in the right resources and with asset dropdown capacity, leaving those partnerships trading at compressed yields as the underlying unit prices were bid higher. The market has focused instead on low price and discounted cash-f­low multiples and compelling deferred-year yields that are implied by strong growth outlooks from the shale oil and natural gas liquids resources.

While smaller partnerships have been able to grow their distributions at faster rates, the market places a premium on mature companies that can use their size to execute projects more efficiently. For example, while Enterprise Products Partners LP is the largest MLP, it has had an outsized 15% run-up over the past 52 weeks despite a 5% distribution growth rate, as compared to an 8% distribution growth rate in smaller partnerships. Two of Enterprise's biggest projects now involve the use of existing assets to provide leverage (the ethane pipeline from the Marcellus to the Gulf Coast and the reversal of the Seaway pipeline).

Meanwhile, those MLPs exposed to areas of the midstream world that face broader challenges, such as natural gas pipelines and storage, retail propane distribution and refined products pipelines, have underperformed, despite, or perhaps because of, their higher yields.

Commodity prices

While oil prices have been strong, natural gas prices sank 16.26% in January, closing the month at $2.50, pressured by an unseasonably warm weather outlook, which caused inventories to balloon to record levels relative to their historical averages.

The monthly sell-off in the front-month contract occurred even with a massive short-covering induced rally which caused a 14.3% price spike in gas prices during the final week of the month as major producers such as Chesapeake Energy Corp. and ConocoPhillips Inc., among others, announced that they would curtail their natural gas rig activity due to falling prices. By February, the overall rig count had fallen by 88, down 21% this year and 58% from the 2010 peak.

While most MLPs are considered to be relatively insulated from commodity price fluctuations due to hedges and the stability of fee-based contracts, the precipitous decline in natural gas prices and the resulting reduction in drilling rigs has had adverse impacts on basis differentials (summer-winter spreads) and volumes for several natural gas pipeline and storage partnerships.

Also, recent demand data suggests that higher crude oil and gasoline prices coupled with a weak economy have led to consumer conservation, which has hurt operators of refined products pipelines. Data from this past summer, for example, shows that U.S. motor gasoline demand levels averaged 3% to 4% below 2010 levels. Among MLPs with refined product pipelines that have released their fourth-quarter 2011 results so far, most reported modest year-over-year declines in third-quarter 2011 volumes, although some volume declines were offset by recently implemented tariff increases.

Tamar Essner is associate director of energy advisory services for Thompson Reuters Advisory Services and can be reached at tamar.essner@thompsonreuters.com, 646-822-3646.