After a lackluster performance in May, pipeline master limited partnerships (MLPs) stabilized in June. During the month, MLPs booked modest gains of about 1% amid widespread losses in other income-producing securities such as utilities and real estate investment trusts, as well as in commodities and broader equities.

For second-quarter, MLPs barely outperformed the broader equity markets and significantly lagged their yield-generating counterparts. Overall, fisrt-quarter MLP performance appears tepid compared to the steep gains of 2009 and 2010 and highlights the market’s risk-aversion and preference for low-beta yield amid a weak interest rate environment.

Trend reversal

On a subsector level, June MLP performance shows a trend reversal whereby May’s laggards were June’s top gainers. Apart from the general partners, which have shown consistent leadership, the next best subsectors in June were the crude oil and refined products companies (+1.6%), followed by natural gas and natural gas liquids pipelines (+1.5%).

These two subsectors outpaced other commodity-sensitive groups such as exploration and production companies (-3.6%) and gathering and processing companies (+0.1%), both of which had been among the better performers earlier in the year.

Concerns over the impact of $4 gasoline on driver mileage weighed on the crude oil and refined products MLPs in May. However, this subsector saw capital inflows in June on optimism about several planned pipelines intended to reduce regional oil-price spreads.

New projects

Among these projects, Enterprise Product Partners LP and Energy Transfer Partners LP’s proposed Double E Pipeline would provide 450,000 barrels per day of crude oil take-away capacity from Cushing, Oklahoma, to the Gulf Coast. Notably, on July 7, the two companies announced a three-week extension of the pipeline’s binding open season, leaving one to wonder whether this is simply meant to provide additional time for shippers to receive approvals, or more critically, if it suggests a lack of shipper interest.

Until June, natural gas liquids (NGLs) and gathering and processing MLPs had been among the biggest MLP beneficiaries of the acceleration in shale-gas drilling. Interestingly, insufficient pipeline take-away capacity from the emerging liquids-resource basins has hampered NGL production, despite significant increases in overall wet natural gas drilling.

In its 2011 supply-demand outlook, the Interstate Natural Gas Association of America estimated that $10 billion per year of midstream infrastructure investment will be needed, including $2.6 billion for gathering and processing, $600 million for NGLs pipelines and $1.3 billion for crude oil pipelines. However, until this infrastructure is built, the recent disconnect whereby NGL production has lagged natural gas production could persist, despite more targeted wet-gas activity.

WTI-Brent crude differential

As for crude oil, the financial community has been operating under the assumption since first -quarter 2011 that West Texas Intermediate (WTI) prices will trade at a significant discount to global crude oil grades, such as Brent, for a protracted period.

The rationale is that increasing Bakken and Eagle Ford oil production, combined with rising oil imports from Canada, will continue to overwhelm the infrastructure that can move the oil out of Cushing, the pricing hub for WTI. The resulting supply bottlenecks have and will persist in pressuring prices, even as more pipelines are built.

More recently, this thesis has been broadened to include Light Louisiana Sweet (LLS) prices in addition to WTI, reflecting the emergence of a “new pricing paradigm,” in the words of analysts at Sterne Agee Group Inc. They argue that, given expectations for soaring quantities of crude and condensate from the Williston Basin in North Dakota and Montana, the Eagle Ford in Texas and Canadian oil sands, supply to the Gulf Coast will outweigh demand, especially as new pipelines facilitate transportation to the region.

As a result, Gulf-based LLS prices, which currently track Brent, will also face significant pressure, comparable to WTI. In other words, the investment world is forecasting a sustained discounted pricing level in the U.S. relative to the international oil markets and an even more fragmented market within various regions of the U.S.

Keystone XL

A significant factor in this thesis is the assumption that TransCanada Corp.’s planned Keystone XL pipeline will come online to bring 500,000 to 700,000 barrels of Canadian bitumen per day to Gulf-based refineries. Of note, this project has yet to receive approval from the State Department, despite the application submission back in September 2008 and an average authorization timeline for similarly-sized projects of only two years.

Head of State Hillary Clinton initially indicated support for the pipeline, but the project has recently faced serious objections from the Environmental Protection Agency. Although pipeline accident rates have fallen sharply, an analysis by engineers at the University of Nebraska found that in its application, TransCanada underestimated the number and volume of leaks that could impact water supplies. In the context of ExxonMobil Corp.s recent pipeline leak along the Yellowstone River in Montana, and a more vocal environmental lobby, the stakes are a little higher for this pipeline to come to fruition.

Tamar Essner is associate director of energy advisory services for Thomson Reuters.