Masters of The Midstream – MLPs Exit The Toll Road

The specialized corporate structures called Master Limited Partnerships (MLP’s) have become part of the landscape for midstream energy companies. They have helped provide efficient access to investment capital to build out infrastructure that is now delivering new shale basin natural gas and oil production to market. MLP investors have enjoyed high yield returns from these tax-advantaged companies with low risk toll road income. Newer MLP structures appear to be moving away from the safety of toll road income into riskier commodity price exposure. Today we investigate this trend in the MLP market.

As we stated last time, in case you should get the wrong idea – a quick upfront disclaimer. RBN Energy does not advocate investment in MLPs. We are not an investment advisor and we don’t give investment advice.  The purpose of this article is not investment advice or endorsement.

Last week we ran part one of a series on MLPs (see Masters of The Midstream). The MLP structure was created by congress in the 1980’s with the intention to encourage investment in energy infrastructure.  We described how the MLP partnership structure differs from a regular “C” corporation and the way in which these companies do not pay taxes on corporate profits but “pass through” their earnings to unit holders. In many of these structures control is held by a General Partner (GP) with a small (2 percent) interest. The remaining unit holders are Limited Partners (LPs) who receive quarterly cash distributions from the MLP but have no say in day-to-day activity. The GP can also leverage incentive distribution rights (IDRs) to gain additional income when the distribution rises above minimum qualifying levels. The income from these IDRs (known as splits) becomes more lucrative for the GP as the MLP increases distributions.

We also noted that around 80 percent of MLP type structures are involved in the energy and natural resource businesses, many of them in the midstream in between production and marketing. The logic behind operating these types of business as an MLP is that they tend to produce reliable, consistent streams of income. Midstream energy companies own and operate assets that transport, process and store crude oil, natural gas, NGLs and petrochemicals. These midstream functions enable oil and gas producers to get their products from the wellhead to the market. The toll road analogy is often used to describe how these businesses with a steady cash income from assets can payout predictable cash distributions to MLP unit holders every quarter.