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A rare growth engine in the downtrodden merchant energy business isrunning on empty, some investors say.

In an ugly year for the market, one group of energy stocks -- known asmaster limited partnerships, or MLPs -- has held its own. Some MLPs, carrying names such as

Williams Energy Group



El Paso Energy Partners


, are the offspring of embattled energy merchants hammered by business setbacks and accounting scandals. Despite such ties, energy MLPs have managed to avoid the share-price erosion crippling their parents, and even have outperformed the market overall.

In a nutshell, energy MLPs acquire pipelines and other dependablecash-generating assets -- often from their own parents -- and, thanks to a generous tax break, pass on much of the resulting income to investors in the form of hefty distributions.

This arrangement has become increasingly attractive as cash-strapped merchant energy companies race to bolster sagging balance sheets, and risk-averse investors sprint to the safety of dividend yield.

But some analysts and investors see the setup as rife with conflicts ofinterest. They say the partnerships are willing to overpay for assets, particularly those owned by their parents, because acquisitions fuel cash flow and dividend growth. The parents doubly benefit by deleveraging while raking in rising general-partner fees. And at the end of the day, the critics charge, MLPshareholders will be left holding the bag.

"The MLPs are overpaying for assets and then not reinvesting in theirmaintenance," says Karl Miller, a former executive of El Paso and


who now manages an energy investment fund. "Eventually, itwill get to the point where they can't reload these MLPs

with assets fastenough to keep up with the income payments to investors."

Conflicts and Risks

For many energy traders, forced to sell assets into an already floodedmarket, MLPs have been a godsend.

"Traditionally, the buyers of these assets have been other energycompanies," said Jon Cartwright, senior energy analyst at Raymond James."But many of these companies are in a fight for their lives. If they don'tsell assets, their risk of bankruptcy goes up."

It is against this dismal backdrop that energy traders have recentlyannounced asset sales -- viewed by some as particularly convenient -- totheir own MLPs.

The appeal, for energy companies such as


(WMB) - Get Free Report


El Paso

(EP) - Get Free Report

, is clear. They can raise buckets of much-needed cash by selling assets that generate stable, but limited, income (think regulated pipelines) to their MLPs. As general partners of the MLPs, the companies maintain actual control of the infrastructure and continue to collect profits -- up to 50% of the total -- from the assets they sold.

"This is such a good deal for the general partners that you can barelyhold them back," one MLP critic said.

In April, cash-strapped Williams raised a cool $1 billion by sellingWilliams Pipe Line to its own MLP. More recently, El Paso said it hadtargeted a buyer for its San Juan gathering assets. The interested party?El Paso Energy Management, a new MLP that's essentially a derivative of thecompany's existing MLP.

El Paso Energy Management has agreed to pay El Paso $782 million forgathering assets viewed by some as less reliable cash generators than thosetypically favored by MLPs. And the selling price, some say, may not even bea fair one.

"If these assets are so great, why isn't somebody else offering to paythe same price for them?" one short-seller asked. "There's so much conflictof interest in this type of transaction that any sensible investor wouldhave to know he's getting screwed."

El Paso insisted that transactions with its MLPare prudent ones, reviewed by an independent board ofdirectors before they are approved. The company saidits MLP is loaded with solid assets whose returnsspeak for themselves.

"The unit holders of El Paso Energy Partners havereceived a total return well over 100%" since 1998, acompany spokesman said.

But at least one energy MLP, also known for strongreturns, is failing famously.

The Enron Example

EOTT Energy Partners, an MLP spawned by Enron, offers an extremeillustration of the high price MLP investors can pay for the missteps oftheir general partners.

As part of its now infamous "asset-lite" strategy, Enron shed some ofits less attractive assets to its own MLP. Critics, including EOTTinvestors, have since accused Enron of heavily overcharging the MLP forassets that are now almost worthless. As evidence, they point for exampleto the $117 million EOTT spent on an energy plant that Enron had justrevalued at a fraction of that amount.

Some say Enron secured an artificially high price for the facility bypromising EOTT future business. But just months after the acquisition,Enron was bankrupt and unable to honor the long-term contracts tied to thisfacility and other assets it had sold to its MLP.

Those defaults, along with EOTT's sudden bankruptcy risk, caused theMLP's business to dry up -- and, with it, the precious dividends toinvestors. In the months since Enron's collapse, EOTT shares have tumbledfrom $23 to 60 cents.

That disaster, or at least the conflicts that helped fuel it, hasstirred new concern about other MLPs in the sector.

Taking a Stand

Kurt Wulff, a veteran energy analyst best known for his lucrative stockpicks during the takeover craze of the 1980s, has taken aim against some ofthe largest MLPs and their general partners.

Currently, Wulff has strong sell recommendations on all

KinderMorgan securities, despite their strong performance in recent years. Healso has issued a strong sell recommendation for El Paso Energy Partnersand even punished El Paso itself -- once among his favorite companies --for operating what he describes as a "high-debt, high-greed" partnership.

"We are nervous about making a sell recommendation because we like ElPaso's energy infrastructure assets ... and the stock is down some 75%since we re-established coverage," wrote Wulff, an independent energyanalyst at McDep Associates, in a recent sell report. But "the company'sstrategy to use a high-greed partnership to reduce excessive debt appearsunsound to us."

Wulff is convinced that MLPs like those operated by Kinder Morgan andEl Paso are little more than modern-day pyramids destined for collapse."Essentially, much of the money from new investors goes to pay off existinginvestors," Wulff said. "Pyramid schemes work well until they don't."

Kinder Morgan dismisses Wulff's criticism, calling him a "contrarian"whose views differ radically from mainstream analysts who consider MLPssound investments.

"His analysis is completely out to lunch," said Kinder Morgan President Mike Morgan. "He's not burdened by the facts at all."

But another respected energy analyst has raised similar concerns,particularly about Kinder Morgan. Carol Coale of Prudential Securitiescreated a stir when she slapped a hold recommendation on Kinder MorganEnergy Partners early this year, back when hold still meant sell. LikeWulff, she questioned whether the Kinder Morgan MLP could possibly maintainits acquisition-driven growth.

"These energy companies are dumping assets at high prices into theirMLPs, then taking in substantial fee income as the general partner," Millersaid. "It's a fleecing of MLP shareholders.

"They're hoping the market will just close its eyes -- but everybody'sstarting to wake up to what they're doing."