With little fanfare, Bakken Shale-focused oil producer Oasis Petroleum (OAS) completed an initial public offering (IPO) of its midstream arm, Oasis Midstream Partners (OMP), last September. The deal provided Oasis Petroleum with some cash to fund its expansion efforts while giving income-seeking investors a new high-growth, high-yielding option for their portfolio.

But while Oasis Midstream boasts some eye-catching numbers, income-seekers might want to consider putting this new master limited partnership (MLP) on their watch lists for the time being.

A sheet of $100 bills.

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Oasis Midstream Partners 101

Oasis Midstream owns stakes in oil, natural gas, and water infrastructure assets in the Bakken region underpinned by 15-year, fixed-fee contracts with Oasis Petroleum. As such, these assets generate relatively stable cash flow, which enables Oasis Midstream to pay its 9%-yielding distribution. Last quarter, for example, the company pulled in $11.5 million of distributable cash flow, which covered the payout by 1.12 times. 

However, one thing that's worth noting about Oasis Midstream is that it holds its midstream assets in structures called development companies, or DevCos. The company currently holds 100% of Bighorn, 40% of Beartooth, and 10% of Bobcat, with Oasis Petroleum owning the remaining interests of those last two. The DevCo structure allows Oasis Midstream to participate in the cash flow of the operating assets held by these entities while minimizing the amount of capital it needs to invest in expansion projects under development. As such, it provides the company with three layers of growth. First, volume growth from Oasis Petroleum and other producers connected to the existing assets will increase the cash flowing to Oasis Midstream via its stake in those entities. Second, the company will also benefit from the incremental cash flow as expansion projects in the DevCos come online. For example, the BigHorn DevCo is building a natural gas processing plant that should start-up later this year. Finally, the company holds the right of first offer to buy the remaining interests in the Beartooth and Bobcat DevCos from Oasis Petroleum. That trio of growth drivers provides Oasis Midstream with the line of sight that it can support 20% annual distribution growth over the next few years.

In many ways, Oasis Midstream is similar to Hess Midstream Partners (HESM), which also owns a portfolio of Bakken-focused midstream assets that support the growth of its oil-producing parent. But instead of using the DevCo structure, Hess Midstream holds 20% interests in three operating companies, one focused on gathering, another on processing and storage, and a third on terminal facilities. The strategy, however, remains the same, which is to deliver a fast-growing high-yield to income-seeking investors, with Hess Midstream on pace to increase its 6.3% yield at a 15% annual rate through 2020, fueled by a similar trio of growth drivers.

An oil pipeline in North Dakota

Image source: Getty Images.

Two things to keep an eye on

But while Oasis Midstream expects to deliver a fast-growing income stream, the fact that it relies on the support of just one company (Oasis Petroleum) and only operates in one basin (the Bakken) is a risk worth noting. That's why investors should monitor Oasis Midstream's efforts to diversify. One way the company plans to do that is by "aggressively building third-party relationships" in the Bakken, which could yield additional growth opportunities as well as reduce its reliance on Oasis. The company noted in its fourth-quarter report that it had some success late last year in obtaining third-party volumes for the Beartooth DevCo. Continued progress securing contracts from other producers will go a long way in reducing risk.

In addition, Oasis Petroleum acquired drillable land in the Delaware Basin last year, which could open the door for Oasis Midstream to build out infrastructure in that region to support its parent's position. The company noted that there are material midstream development opportunities in the area for its MLP, including the need to build pipelines to gather oil and gas as well as water as Oasis ramps up its activities in the future. However, Oasis Petroleum is just beginning development in the area so it could be a while before these opportunities materialize. It's also possible that Oasis Petroleum could decide to go with a third-party midstream provider that already operates in the region.

The early days of what could be a great income stock

Oasis Midstream seems like an exciting income stock, since it offers a generous 9% yield that should grow at a 20% annual rate for the next few years. But this fast-growing income stream does come with an elevated level of risk because of its total reliance on Oasis Petroleum's Bakken position to drive growth. That's why investors might want to add it to their watch lists for now and wait until the company has diversified a bit before putting it in their portfolios.