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

In an ugly year for the market, one group of energy stocks -- known as master limited partnerships, or MLPs -- has held its own. Some MLPs, carrying names such as Williams Energy Group (WEG:NYSE ) and El Paso Energy Partners (EPN:NYSE ), 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 dependable cash-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 of interest. 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, MLP shareholders will be left holding the bag.

"The MLPs are overpaying for assets and then not reinvesting in their maintenance," says Karl Miller, a former executive of El Paso and Enron who now manages an energy investment fund. "Eventually, it will get to the point where they can't reload these MLPs [with assets] fast enough to keep up with the income payments to investors."

Conflicts and Risks

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

"Traditionally, the buyers of these assets have been other energy companies," said Jon Cartwright, senior energy analyst at Raymond James. "But many of these companies are in a fight for their lives. If they don't sell assets, their risk of bankruptcy goes up."

It is against this dismal backdrop that energy traders have recently announced asset sales -- viewed by some as particularly convenient -- to their own MLPs.

The appeal, for energy companies such as Williams (WMB:NYSE ) and El Paso (EP:NYSE ), 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 barely hold them back," one MLP critic said.

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

El Paso Energy Management has agreed to pay El Paso $782 million for gathering assets viewed by some as less reliable cash generators than those typically favored by MLPs. And the selling price, some say, may not even be a fair one.

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

El Paso insisted that transactions with its MLP are prudent ones, reviewed by an independent board of directors before they are approved. The company said its MLP is loaded with solid assets whose returns speak for themselves.

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

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

The Enron Example

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

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

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

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

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

Taking a Stand

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

Currently, Wulff has strong sell recommendations on all Kinder Morgan securities, despite their strong performance in recent years. He also has issued a strong sell recommendation for El Paso Energy Partners and 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 El Paso's energy infrastructure assets ... and the stock is down some 75% since we re-established coverage," wrote Wulff, an independent energy analyst at McDep Associates, in a recent sell report. But "the company's strategy to use a high-greed partnership to reduce excessive debt appears unsound to us."

Wulff is convinced that MLPs like those operated by Kinder Morgan and El Paso are little more than modern-day pyramids destined for collapse. "Essentially, much of the money from new investors goes to pay off existing investors," 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 MLPs sound 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 Securities created a stir when she slapped a hold recommendation on Kinder Morgan Energy Partners early this year, back when hold still meant sell. Like Wulff, she questioned whether the Kinder Morgan MLP could possibly maintain its acquisition-driven growth.

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

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