The Big (And Profitable) Changes in MLPs

by | published October 15th, 2013

From the tax advantages to their high-paying yields, it’s hard to beat the returns of a Master Limited Partnership (MLP).

A very successful part of both my Energy Advantage and Energy Inner Circle services, MLPs have long been one of my favorite investments.

The good news for investors is that this market is about to heat up again, especially when it comes to energy-based MLPs.

You see, the shape and focus of these MLPs is changing fast and for the better – even though it hasn’t drawn much attention outside of these pages quite yet.

However, don’t expect all of this to remain under-the-radar for too much longer.

In fact, new “MLP clones” are beginning to emerge that are going to hand us some interesting investment options in the coming months.

For MLP investors, what is about to hit is really something quite new…

The Advantages of Master Limited Partnerships (MLPs)

Of course, MLPs have long been a particularly attractive partnership option.

And when a company decides to float a part of the partnership proceeds as an equity issuance, average retail investors are allowed to participate as well.

One of the advantages of this arrangement is that an MLP carries tax considerations that distinguish it from other limited partnerships. In an MLP, there are no corporate taxes paid, meaning that all profits are carried through to the individual tax returns of limited partners.

And when stock is issued on such a partnership it is tantamount to a percentage of the profits passing directly through to the shareholders.  Usually that translates into a dividend that is much higher than market averages.

It sounds like a perfect arrangement. But there are considerations on the other side investors need to account for.

For instance, MLPs must have a physical asset base.

That is, they have to be structured around tangible facilities. That’s why most are based on oil and gas pipelines.

Of course, there are some exceptions. My favorite outlier, about as non oil and gas as you can get, is Stonemor Partners LP (NYSE: STON). STON is an MLP that manages cemeteries. (It pays a 9.5% yield!)

As it stands, the problems for the dominant pipeline-based MLPs emerge in two ways.

First, during periods in which natural gas or crude oil prices are declining, the value of an MLP based on pipelines will also decline.

Since much of that network is actually used for storage rather than transit, MLPs usually benefit whether a producer needs to ship or store volume coming out of the ground. However, in times when storage capacity maxes out, MLPs will also suffer.

Second, the structure of assets comprising the base for the partnership is also important. Facilities in areas where production is declining or contains older pipelines that require either refurbishment or replacement will cut into the profitability of an MLP.

After all, there is no pass through income flow if operators are not using the pipelines. Therefore, MLPs are not automatically profitable at all times.

Yet there is another reason why limited partners are attracted to them.

In addition to the advantage of no corporate taxes, there is the added attraction of significant tax write offs on the underlying assets themselves. Owning a percentage of those assets (which every limited partner does in an MLP) allows for the proportional pass through of depreciations, capital incentives, and rollovers.

The partners, therefore, have reasons for sticking with an MLP even when profits decline. As for shareholders, they have to be more attentive to the market conditions.

A Whole New World For MLPs

The good news is there are some changes in MLPs that will provide additional options for the average investor. I have been tracking two that are particularly interesting. In each case, though, we are seeing an expansion of the assets utilized and the pass through elements available.

The first change involves the assets comprising the base of the MLP. While the essential structure is not changing (and actually could not unless legislation is altered), I now expect a dual move on the asset side: expansion into the upstream and downstream from the current pipeline (or midstream) emphasis, and crossovers between energy sources.

With these changes, MLPs are showing up at the wellhead – upstream where the actual oil and gas comes out of the ground.

At the same time, holdings in initial processing and separation, refineries, wholesale and retail distribution, along with terminal and underground storage facilities are moving the focus downstream.

This new mix of assets increases the options for investors, allowing MLPs to “verticalize” more of the overall operations.

It also provides increasing access to multiple points of profitability. And here crossovers are going to revise MLPs significantly.

Of course, there have always been MLPs in energy sources other than oil and gas.  Electricity production and distribution, for example, have been long represented in such partnerships, as have coal assets.

But now new partnerships are coming that will cut across energy types.

Expect to see the first versions, the first new “MLP clones” if you will, to emerge connecting natural gas assets with power production. Given the rapid transition from coal to gas as the generating fuel of choice, the “spark spread” (the difference between gas and electricity futures contract prices) will entice combinations of gas and electricity assets in the same MLP.

Similar crossovers will occur between coal and power facilities, liquefied natural gas (LNG) production and tanker fleets, and even transmission lines and emerging smart grid networks.

In each case, the new MLP will provide entry to asset elements that are actually working together in a continuous revenue or profit stream.

The second major advance is likely to be structures that allow for some pass through of the tax advantages currently reserved for the limited partners only. Now, stock holders are never going to achieve parity with the partners. The latter, after all, actually own the assets upon which the tax advantages are based.

Nonetheless, I expect to see MLP models that will augment dividends to share holders by monetizing some of the write offs currently enjoyed by the partners. There have even been some rumblings that the folks with big red noses, funny hats, oversized shoes, and undersized cars (i.e., the clowns of Congress) may even be considering a mandate in this direction.

All of which should hand us with some interesting new ways to make some serious money.

I’ll have much more on this as it develops.

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  1. Joe Howell
    October 15th, 2013 at 14:06 | #1

    I also think new RE clones will emerge…
    Those that offer a better approach to RE ownership than the REIT’s.
    I’d appreciate your thoughts.

  2. Jere Reid
    October 15th, 2013 at 14:16 | #2

    Dr. Moors What about the new pipelines they are using which go anywhere and not buried like the other steel lines???

  3. doug. muras
    October 15th, 2013 at 17:53 | #3

    as im an aussie the withholding tax was 39% on my last dividend from an
    mlp company. could you please advise on how much of this holding tax
    we can recover?

  4. John Folsom
    October 15th, 2013 at 20:02 | #4

    Thanks for the up date.It seems like it is time to Impeach Obama,fire Reed and Pelosi sooner than later .at 75 and a 43yr lawyer and a 20 yr Air Force office , We need to fie them now!

  5. John Folsom
    October 17th, 2013 at 16:23 | #5

    I appreciate the advance information regarding the mlp’s as I do invest in oil and gas as well as mlp’s ,gold and silver and bio techs as my mother died of cancer of the pancreas.

  6. Jerry
    October 24th, 2013 at 13:25 | #6

    As a new investor, what is an appropiate percentage of my portfolio to have in MLP’s ?

  7. Peter Addis
    October 29th, 2013 at 15:53 | #7

    Do you see any of the tax advantages attached to MLP’s discontinued or reduced in the coming budget for 2014?

  8. November 15th, 2013 at 10:40 | #8

    You can’t analyze an MLP the same as you would a regular stock. MLPs own lots of assets that result in large depreciation charges that subtract from reported earnings, but don’t affect the cash flow that fuels distributions. Your best prospects are MLPs with a strong distribution growth history and plenty of pipeline construction projects underway.

  9. Kathy Howell
    January 15th, 2014 at 01:58 | #9

    I own some stocks that are Limited Partnerships in pipelines, oil and natural gas, etc. Recently, one of my pipeline stocks issued new stocks and some of them were for the CEO’s of the MLP. The CEO’s already owned significant amounts of stocks from this LP. They were taking the stock as bonuses. With regard to the proxy vote on this process, I am sure that the CEO’s owned most of the stocks which gave them the advantage of having the majority votes.

    I believe that this action will dilute the price of the stocks and dividends. Is it legal for the CEO’s to do this?

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