Most MLPs are fairly well insulated from commodity price volatility because they derive the bulk of their income from fee-based assets. For the most part that's true of ONEOK Partners (NYSE:OKS), with fees providing a solid foundation for its cash flow. That said, the commodity price exposure it does have did ding its third-quarter results, which were reported Tuesday after markets closed.

ONEOK Partners results: The raw numbers

Metric

Q3 2015 Actuals

Q3 2014 Actuals

Growth (YOY)

Adjusted EBITDA

$403.7 million

$388.6 million

3.9%

Distributable cash flow

$302.8 million

$298.3 million

1.5%

Distribution coverage ratio

0.91

1.05

N/A

Data source: ONEOK Partners.

What happened with ONEOK Partners this quarter? 
ONEOK Partners benefited from strong volume growth:

  • ONEOK's NGL segment did most of the heavy lifting, with its operating income up 19.4% year over year. Fueling this growth was a 49% increase in NGL volumes, primarily from the acquisition of the West Texas LPG pipeline system.
  • The natural gas pipeline segment's operating income was up 4.1% year over year because of higher storage revenue from increased rates and higher transportation revenues from higher rates on one of its systems.
  • The laggard was the company's natural gas gathering and processing segment, which experienced a 49% year-over-year drop in operating income. This drop is directly due to that segment's exposure to commodity prices.
  • To mitigate the impact of commodity price volatility, ONEOK Partners is restructuring many of its percent-of-proceeds contracts to fee-based contracts. It expects its fee-based margin to increase to more than 70% next year, after being about 50% this year.
  • Despite the increased income, ONEOK's coverage ratio was below 1.0 during the quarter, because of an increase in the unit count. While this is a sign of caution, the company expects the coverage ratio to be above 1.0 in 2016.

What management had to say 
CEO Terry Spencer, commenting on the company's results, said: "Earnings growth continued in the third quarter as natural gas liquids and natural gas volumes increased in our highest-margin areas, despite unplanned operational outages in the Williston Basin and minor timing delays in well completions in the Mid-Continent. ... The unplanned operational outages in the Williston Basin, which have been resolved, affected the partnership's third-quarter results by approximately $16 million in the natural gas gathering and processing and natural gas liquids segments combined."

Volume growth was really the key to ONEOK Partners' quarter and would have been even stronger if not for those unplanned outages. Further, that volume growth helped the company overcome weakness caused by its exposure to commodity prices. It's a weakness the company is working to fix. Spencer noted:

We continue to take important steps to increase fee-based earnings in all three of our business segments. ... Within the last year, we've announced new, largely fee-based investments in our natural gas liquids and natural gas pipelines segments. ... In the natural gas gathering and processing segment, we have successfully converted a portion of our percent-of-proceeds contracts to largely fee-based contracts, resulting in a nearly 20% increase in the average fee collected in the third quarter compared with a year ago.

This focus on acquiring fee-based assets will continue to strengthen the company's cash flow foundation, while the conversion of contracts to those based on fees will help mitigate more of its exposure to commodity price volatility. This situation is expected to push the company's distributable cash flow high enough that it will once again attain a coverage ratio of greater than 1.0, which is important for distribution security.

Attaining that stronger coverage ratio is also important to the company's general partner, ONEOK (NYSE:OKE). Because virtually all of ONEOK's income is derived from its management of, and ownership interest in, ONEOK Partners, it really needs to see that critical ratio rise above 1.0 and stay there. Otherwise, ONEOK runs the risk of seeing its own dividend growth halt, or, worse, get cut.

Looking forward 
ONEOK Partners is reaffirming its 2015 guidance for distributable cash flow in a range of $1.08 billion to $1.26 billion. Further, with the growth projects it has under way, and the focus on converting more of its contracts to fee-based, it is also reaffirming its expectation that its coverage ratio will be above 1.0 next year.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Oneok. The Motley Fool recommends Oneok Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.