TWST: Please start with an overview of your coverage universe.

Mr. Bellamy: We have 22 names under coverage. What's changed since we last spoke is that I have expanded our coverage in the royalty trust sector, and we've dropped coverage of the MLP closed-end funds in order to focus more directly on the MLP space. That's really just to manage bandwidth, not for any major change that has gone on with the closed-end funds.

We have, as a percentage of the instruments that are outstanding, most of the upstream MLPs covered - that is, the MLPs that produce oil and gas. And then we have select small- and mid-cap midstream names under coverage. These are the transportation providers, gatherers and processors of oil and gas.

And then, we have royalty trusts under coverage. We have five right now. Most of these are the new vintage trusts that have recently gone public, and these royalty trusts, I think, are an important component of the broader energy landscape right now.

TWST: What's your overall sentiment or outlook on the space right now and why? How does it differ among those three segments?

Mr. Bellamy: Yes. I would say it differs actually on a more granular basis. But from the top-down perspective, let's start with monetary policy. The Fed is really cornered into keeping interest rates low for a very long time, which is very good for MLPs because they're yield-based instruments - as long as it's impossible to get any real returns on your money by buying Treasuries or putting your money in cash - income investments and other yield-based products, of which MLPs are foremost in terms of valuation. So that, I think, is a long-term tailwind that is good for the sector.

Just as an aside, the Fed really is responsible for cleaning up the mess of Congress, which can't balance the budget, so the only thing they can do is offset the lack of fiscal sanity with monetary policy to stimulate the economy. The other side of that is that stocks in general, but MLPs even more so, are positively correlated with inflation. I think you're already seeing inflation to some extent with oil prices and retail gasoline prices, but I think we will see asset inflation as the printing presses are on both here in the United States and in Europe. I think that is also a positive tailwind for MLPs.

To get more specific, most of these products have performed very well, with some notable exceptions. But as a whole, the MLP space has done very well and continued to outperform the rest of the market through the end of 2011. Not as good of a January or a first quarter as the broader stock market, but that's not unreasonable considering the outperformance in 2011.
Obviously, what we're seeing in the United States shouldn't surprise anyone now. Probably, the healthiest place in the U.S. economy is the oil and gas development sector. MLPs, both as upstream and midstream participants, benefit, both in terms of new oil and gas exploitation that's occurring in the United States that's creating opportunities for new upstream development and shifting of capital and resources in the upstream, and it's also creating the need for infrastructure to move those products to new places. The MLPs are really a critical link in taking this new oil and gas production in the U.S. and getting it to the consumers who need it. And so from a secular standpoint, the fundamentals are robust for most of the MLP sector. And I say most because we've been so successful with natural gas development in the U.S. that we have a major oversupply situation on extraordinary production increases.

In addition to that, we had and are continuing to have an extremely warm winter, which has reduced the demand for natural gas for heating and has created a natural gas oversupply situation that's probably not finished yet. We're seeing low natural gas prices, so for producers that are weighted toward natural gas price realization, including some MLPs in that category, that's not a positive tailwind.

But on the other hand, we're starting to see signs of increased natural gas consumption in the United States in multiple areas. The biggest lift medium term for natural gas is going to be electric power generation, as we've seen a shift from coal to natural gas in electric power generation. Just yesterday we got an announcement that we will see some new natural-gas-fired pickup trucks, but fleet vehicles have already started to use natural gas pretty substantially, so I think that's a medium- to long-term tailwind for the group as well.

And then, we may see LNG exports. A number of projects have been applied for in the first quarter that are probably going to come on line in 2015, which could lift natural gas and actually serve to offset some of our reliance on crude oil imports if we're, in fact, able to export natural gas. So from a balance-of-trade perspective, that could be positive. But for the balance of the year, I'm still fairly bearish on natural gas and wouldn't be surprised to see sub-$2 prices on NYMEX.

Within the MLP sector, there are certain places that have been really challenged by these low natural gas prices, primarily retail propane providers, and that's because wholesale propane prices have remained fairly high. We've had this warm winter so there hasn't been a lot of consumption. And then also, in many places natural gas and retail propane will compete, and so to the extent that natural gas is cheaper, it encourages switching to natural gas as the grid expands.

The second subsector that's been challenged is natural gas storage. When you have a storage oversupply situation, the value of the storage goes down. When you have limited seasonal spreads on natural gas because of that storage situation, then the intrinsic economics of gas storage decline commensurately. And then there are some natural gas pipelines that either have contracts coming up or are staying at reduced intrinsic economics because increased supply in many places has produced the differentials between natural gas prices at different points in the United States. The incentive to move gas from places of supply to places of demand has decreased in many areas, and so many pipelines are being used in different ways than they were designed, particularly in intrastate movement of natural gas in Texas. That's a good example of where some of the price spreads have really compressed noticeably. Those trends, with the exception of the warm winter, aren't likely to reverse themselves anytime soon.

TWST: You mentioned we may see LNG exports. How far in the future is that?

Mr. Bellamy: The first likely candidates for that is Cheniere Energy (LNG). What's interesting about Cheniere is it started out as an LNG import company, but as the supply situation in the United States changed with unconventional resources, tight resources - we've got this oversupply situation now - they actually have decided to go the other way and serve as an exporter of LNG.

The thing that has occurred lately that is of most interest and most likely to, I think, take that project to fruition is that on February 27, Blackstone (BX) announced that it was going to invest $2 billion into Cheniere Energy Partners (CQP) in order to facilitate the construction of the liquefaction train on the Gulf Coast at Sabine Pass. The first two trains are expected to be $4.5 billion to $5 billion, so they've got a significant sum of capital behind them from a premier financier. And so I think it's likely, both from a regulatory and from a financing perspective, that that project gets done.

Now the problem with megaprojects like this is that they take time to complete. They're going to start that construction project now, but gas prices could be significantly different by the time they're done. I think that the economics will be substantial enough for them to export gas profitably to Europe, for example, but that's a lot of risk. The supply situation, as we've seen in the last five years, can change pretty drastically over the course of two or three years.

TWST: Are there any other companies that stand to benefit from exporting?

Mr. Bellamy: I would say it's really the domain of the supermajors. Globally, it takes a lot of capital to put in the ground and to construct these terminals, particularly on the liquefaction side, which is more capital intensive. So I think it's going to be mostly the domain of the supermajors, and Cheniere is the only direct participant in the MLP sector, with the exception of - let's call them quasi-MLPs, because they're offshore, they're not technically MLP, but they are generally grouped in with the sector - like Teekay LNG (TGP). You can see that stock has done extremely well, because LNG shipping, I think, is a pretty compelling business to be in given the number of projects globally and the fact that we still see some pretty big price disparities globally between areas of supply and areas of demand, particularly Europe and Japan. After the tsunami and the nuclear accident in Japan, their LNG consumption is going to go up substantially. So in terms of global demand, I think that's going to tighten the market for LNG.

And just to round things out, within the subsectors the most compelling place in the MLP sector right now - and you've seen a pretty substantial move in stock prices - is in crude oil gathering and transportation. Names like Sunoco Logistics (SXL) and Plains All American (PAA) have done very well. If you see the disparity between, say, Brent crude and WTI crude, there is a strong transportation differential in the U.S., and so the growth in domestic production, which has really turned around after long declines in the 1970s, has put these guys in the catbird seat in terms of growing new infrastructure and in terms of the margins that they're seeing in moving crude oil.

TWST: You mentioned upstream and midstream companies benefiting from new exploration in the U.S. What are the key locations for that?

Mr. Bellamy: The key locations, in the order that they're most compelling to me right now, are the Mississippi Lime, where SandRidge (SD) and Chesapeake (CHK) are spending time and capital; followed by the Bakken, which is in the Williston Basin in North Dakota; followed by the Eagle Ford, which is in South Texas, where dozens of infrastructure projects are sprouting up in order to move products out of South Texas; the Utica Shale in Ohio, which I think is really going to drive the economics of Ohio in the coming decade and is only going to be a positive stimulus for the Rust Belt; the Niobrara, which is in Colorado and Wyoming, which has not really accelerated in terms of production volumes yet, but I think stands to also be a pretty significant new supply basin; the Granite Wash in the Texas Panhandle/Oklahoma, which is a horizontal development, and which is one of the places where Linn Energy (LINE) is most active. And of course, you have to conclude with the Permian Basin, which is a long-standing producing area in the United States with formations like the Wolfberry, the Wolfbone, Bone Springs, Avalon Shale, which are all drawing significant investment dollars and have pretty strong rates of return. Many of the big infrastructure projects being completed in the MLP sector are designed to move natural gas liquids from the Permian Basin to the Gulf Coast.

TWST: Are these companies growing by acquisitions or is it more internal organic growth?

Mr. Bellamy: I would say there's more acquisition activity in the upstream. For example, BP (BP) recently sold for $1.2 billion its assets in the Hugoton to Linn Energy, which represented 6% of BP America's U.S. production. That's just a reallocation of capital within the portfolio. They're trying to move capital into higher-return projects globally, but that's a supermajor selling assets to an MLP.

Then there are numerous $50 million, $100 million, $250 million transactions that we've seen. As companies seek to fund their development inventory, they're looking at MLPs, with MLPs having such good access to capital as the natural buyers of these assets and most efficient holders of proved, developed, producing reserves. I think that trend will continue. It's not, in my view, a function of C-corporations being in distress, but rather their cost of capital is higher, their shareholders are looking to them to deploy capital in higher-return-type activities, and MLPs are best suited to squeeze more blood from the turnip, so to speak, in terms of owning these proved assets and reaping the cash flow from them.

That's not to say we won't see continued M&A activity and acquisition activity in the midstream. I just think there is more to be done in the upstream sector relative to the size of the upstream sector right now. You could see continued movement of some pipeline assets, particularly as the production and disposition of fossil fuels changes the way assets are valued. And then, clearly, we're going to continue to see drop-down activity from C-corporation parents that sponsored MLPs, for example Chesapeake Midstream (CHKM), which is sponsored by and controlled by Chesapeake; Western Gas Partners (WES), which is sponsored by, controlled by and majority held by Anadarko (APC); and Rose Rock Midstream (RRMS), which is sponsored by and controlled by SemGroup (SEMG). All of these companies are poised to drop assets into the MLPs to drive growth, and I think that trend is likely to continue pretty strongly.

TWST: What are your favorite names and top investment picks right now?

Mr. Bellamy: Our favorite name is really a repeat of 2011, which is EV Energy Partners (EVEP). We feel pretty strongly that they will monetize their 150,000 net acre position in Ohio in the second half of 2012, and when they do that I think there's going to be significant value creation for the partnership. That could be an outright sale. It could be a swap for assets with some other energy firm in the U.S., but I think it stands to add a significant amount of value to EVEP.

On the midstream side, we like Regency Energy Partners (RGP), which we think, ultimately, will be bought by Energy Transfer Partners (ETP). Those entities are both controlled by Energy Transfer Equity (ETE), which right now is merging with Southern Union. (SUG) And I think that once that merger is complete, they'll look to blend those equities together.

In terms of other top picks, we like Vanguard Natural Resources (VNR) right now. They are coming off the merger with Encore Energy Partners, and I think that some Encore holders got VNR units and either took profit or didn't want VNR for whatever reason. And I think the market still misinterprets and sees Vanguard as being more natural gas weighted than they are. Vanguard is actually one of the more oily names here. So in the short run, they've lagged the rest of the group after the merger, and I think they could just catch up. But I also think as the market begins to understand that Vanguard is now mostly an oil company and is mostly targeting oil development, then I think Vanguard units could outperform their peers.

TWST: Are there any names you're cautious about?

Mr. Bellamy: Cautious would be an understatement for a few names that we're fairly bearish on and have "underperform" ratings on. With respect to Inergy L.P. (NRGY), the horse has really left the barn, so to speak, in terms of the big move down. They have exposure both to gas storage and to retail propane. They've got a pretty significant asset on the Gulf Coast called Tres Palacios that they're recontracting now for gas storage. I don't expect them to get much out of customers in terms of recontracting. And they've said that they're going to cut their distributions, but have not disclosed how much. So it's tough to buy a name like that where it's uncertain where the distribution is going to shake out, and they've had a pretty tough time of it - some by their own doing by paying too much for assets, and some by just bad luck of being exposed to the warmest winter in the last 60 years.

Their saving grace, however, is subsidiary carve-out Inergy Midstream (NRGM), which we're positive on, and that has very high-quality cash flows. If NRGY is to turn around, it will be driven most likely by NRGM, which they own and control. I think NRGM's growth is going to be critical to NRGY, but we're still not ready to jump back in on NRGY yet.

We think some of the most overvalued instruments in the equity market are in the royalty trust sector. I think that many individual investors do not understand that some of the terms in drilling trusts have high initial growth rates followed by sharp declines in both production and distribution, and don't understand that the yields being offered are not sustainable and very much unlikely to persist in the future.

We have two "underperform" ratings in the royalty trust sector, but probably our least favorite in terms of valuation would be ECA Marcellus Trust I (ECT). They're exposed to dry gas in the Northeast, and I think gas prices could go down more from here, even though they are trembling along after 10-year lows. I think on a valuation basis on futures, they're reflecting a yield to maturity of probably around 0% to 2%. When the IPO came, their yield to maturity was around 9%. And other trusts, I think, have this problem where the market is just incorrectly assuming that the yields are sustainable over the long term, and so I'm most cautious on some of those names.

TWST: You mentioned NRGY cutting distribution. For the space as a whole, how have distributions been trending?

Mr. Bellamy: Distribution growth has been outstanding. Over the next five years, based on me and my peers, aggregate estimates for the roughly 75 names in the MLP sector, we're looking at growth on a compound annual basis of 5%, which I think is very compelling relative to the rest of the equity markets. Right now, we're running in line with long-term average growth of about 6.5%, as of this most recent quarter. I think that's very compelling. If you saw no change in yield and just got that, I think you'd be looking pretty good in terms of yield-oriented products.

TWST: Is that making the sector more of a mainstream investment, more attractive to a greater variety of investors?

Mr. Bellamy: If there is an investor out there who hasn't had their broker discuss MLPs with them by now, they should fire their broker and find another broker. I think MLPs have been mainstreaming for the last 10 years. I think there has been enough written about them now, and enough people who've made enough money on them that they should be a tool for just about any investor.

There are a number of things to be cautious about in terms of where you place them - potential unrelated business, taxable income exposure in IRAs, cost basis tracking, a little bit of an extra headache on tax filing requirements. But for the most part, they're good instruments by yield, they are still pretty reasonably valued here, and the fundamental tailwinds are pretty strong.

Mainly, what I tell people is, once you get into this sector, you're going to fall in love with these and want to have 40% of your portfolio in them - don't do that. They are equities. They are correlated to the broader market, although maybe less so than some other instruments, but don't fall in love with them and don't overallocate with them, just like any other asset class.

TWST: Beyond what we've discussed, what sticks out for you from the most recent quarterly earnings, any particular highlights or themes?

Mr. Bellamy: The main enigma within the MLP space right now is: Will petrochemical demand keep up with natural gas liquids production, particularly ethane? Most of the MLPs themselves think that it will. They're certainly the experts, but at the same time, they are, to an extent, talking their book. We're concerned, in 2013 and beyond, that demand may not keep up with the increased supply for ethane, which would be a negative for the gathering and processing sector. I think the main theme really is access to capital is producing a situation where MLPs can really go out and utilize their cost of capital. Most MLPs, I would say, have twice as many potential organic projects than they do access to the capital, and access to capital really has never been stronger.

But in terms of themes, it's really liquids, liquids, liquids. You follow the producers, and you follow the rigs if you're a midstream company; and if you're an upstream MLP, 90% to 100% of your development budgets are being focused on getting as much crude oil and natural gas liquids out of the ground as you can. And so it all comes down to triple-digit oil prices produce fantastic margins for producers and create substantial demand for new infrastructure from the midstream.

TWST: Do you have any final thoughts or advice to add?

Mr. Bellamy: If you're an investor and you like MLPs, they're a great product, but pick your spot. We've got lots of equity that's been issued lately, and probably more to come. The one key indicator that I recommend people follow is the VIX. If you know nothing else about MLPs and the market and haven't been paying attention, any time the VIX is above 25, you can bet that credit spreads have been widening, asset values look compelling on a spread-to-Treasuries basis, and that's a good entry point. If you don't like where the market is now or where MLPs are and you're waiting for an entry point, that's a pretty good barometer for when to put money to work.

TWST: Thank you. (MN)

Note: Opinions and recommendations are as of 03/06/12.

Ethan Bellamy

Senior Research Analyst

Robert W. Baird & Co.

777 E. Wisconsin Ave.

Milwaukee, WI 53202

(800) 792-2473 - TOLL FREE

www.rwbaird.com