It’s hard to imagine how the massive build out of pipelines and processing plants required to deliver shale hydrocarbon production to end use markets in the past 5 years could ever have occurred without the corporate structures known as Master Limited Partnerships (MLP’s). These tax-efficient vehicles financed shale infrastructure by selling partnership units to investors that offered income in the form of cash distributions as well as growth from increasing unit prices. But the leading Alerian AMZ Index of MLP market capitalization fell 46% from August 2014 to December 31, 2015 in the wake of the oil price crash. Today we begin a series looking at past success and future prospects for MLPs.
The Disclaimer
Before we start – a big disclaimer. RBN Energy does not advocate investment in MLPs. We are not an investment advisor. The purpose of this blog is not investment advice or endorsement.
What Are MLP’s?
We posted a two part educational blog series on Master Limited Partnerships (MLP’s) back in October 2012 (see Masters of The Midstream). The following paragraph recaps our explanation of what makes these companies different from regular corporations.
MLPs are a particular type of US corporate structure established by Federal tax reform legislation in the 1980s with the primary intention to encourage investment in certain qualified investments. Mostly the MLP rules ended up encouraging their use for energy infrastructure investment, particularly in oil and gas midstream companies. MLPs are partnerships that trade on public exchanges. A partnership differs from a corporation because it is considered to be the aggregate of its partners rather than a separate entity. Instead of individual stockholders owning stock that is issued by a company as just one of a number of ways to raise money, partners in an MLP own distinct pieces of the partnership called units. These units are like individual fractions of the partnership and their attractiveness lies in their favorable tax treatment. Because the partnership is not an entity, it pays no corporate taxes on its profits. Tax liabilities are instead “passed through” to individual unit holders who pay tax on their share of MLP profits at their individual tax rate. Unit holders typically receive cash distributions from their MLP every quarter based on earnings but are also allocated a share of depreciation on MLP assets intended to offset the tax liability on cash distributions. Bottom line – MLPs avoid corporate tax and that reduces their cost of capital. Like a lot of tax law this is pretty complex stuff and we are only scratching the surface. There are plenty of other resources out there to learn more from – for example here is a link to a glossary of terms. Additional useful information is available from the Master Limited Partnership Association (MLPA) website.
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About the song
The lyric “What’s the sense in changing horses in midstream” is from the Bob Dylan song “You’re A Big Girl Now” from his acclaimed album “Blood On The Tracks” that reached #1 on the Billboard 200 in 1975.
Comments
Who is the competition of MLPs? This question is so important because capital must be generated so project can be started. Big Oil does not invest its own money, Big Oil borrow billions of dollar, why is that? Big Oil of before OPEC is no more; Big Oil has become a junior partner, the junior of most Joint Ventures (JV) or 49% partner. Big Oil none the less take most if not all the risks of any project, by providing the technology but giving up half of the profits. This is the case in most third world producers. Borrowing permits to control the risks from the political instabilities of just about all major JV partners. The major Middle East producers such as Aramco have a 60/40 percent split, a worst JV situations. The financial risks have increased dramatically with the crash of oil prices. Even though the interest rates are lower, the capital amortization becomes longer than one O&G business cycle, which most observers take to be 5 years. MLPs have replaced the banks and have allowed O&G corporations to take risks that otherwise would not have been possible. The banking regulation makes it practically impossible for large capital to be available to the O&G industry. The banking regulation the “reserve close” is the principal culprit. Therefore MLPs have replaced banks in the financing of projects. Can Big Oil finance project by keeping on the books loan payment for up to 20 years? These risks will endanger the corporate bottom line. These risks associated with banking loans do not fluctuate with the market conditions. There reside the principal differences with a MLP financing. The risks are shared with the investors. The new banking regulations have created a new state control banking industry, which is forcing the O&G industry, to quote only one, to enter into a “New Business Model”.