Did Kinder Morgan Just Kill the Master Limited Partnership (MLP)?

by | published August 12th, 2014

With its bombshell consolidation announcement on Sunday, Kinder Morgan Inc. (NYSE: KMI) has suddenly become the third largest energy company in America.

In a $71 billion deal, Kinder Morgan is bringing all of it publically traded companies under one roof as a single C-corporation.

This move has called into question the entire Master Limited Partnership (MLP) approach.

That’s because Kinder Morgan largely pioneered these partnerships, creating what was by far the largest of them all, controlling much of the oil and natural gas that is transported daily in the U.S.

So, does this massive consolidation mark the end of MLPs as a main driver in the energy sector?

Here’s my take on the matter…

Is This the End for MLPs?

In a word, the answer is no.

Remember, MLPs rushed onto the scene to become the hot way to consolidate assets, primarily in the midstream transport of oil and gas. That meant taking ownership over pipelines and related terminals, feeder systems, storage, and gathering points.

Over time, Kinder Morgan ended up being the granddaddy of them all.

The primary advantage of the MLP structure is the lack of a corporate taxing level. All of the profits flow directly to the private tax returns of the partners – much like an “S” corporation in the private sector. As the “S” approach became the leading vehicle for small business creation nationwide, the MLP emerged as the venue of choice to consolidate energy assets.

The MLP benefits the average retail investor in this way: When MLP partners float a portion of equities shares for general trading, they also move along to individual investors a portion of the flow-through profits.

In most cases, that translates into a much higher than average annualized dividend to go along with the appreciation potential of the resulting stock shares.

And with today’s low interest rates, high-yielding MLPs, especially those that pay dividends, are very attractive.

However, as the MLP universe expanded, some disquieting elements appeared.

First, for the general partners (the actual owners of the partnership), having the profits passed through directly looked great on paper. But for some of them, the resulting accounting problems intensified and the actual tax liability became an impediment.

For average folks, of course, having to pay more taxes simply because you were making more money sounded great. Most would have welcomed such a capital gains problem!

It was the second emerging problem that resulted in a more serious concern. Maintaining high dividends for many MLPs resulted in the need to keep acquiring new assets to put in the package.

Initially, that wasn’t much of a roadblock, since the new acquisitions added genuine additional value to the MLP. This was especially the case with its bedrock asset type – pipelines.

With pipelines, an MLP could profit in at least two ways.

If gas or oil had to be moved from point A to point B, the MLP was paid by the companies either extracting or processing the hydrocarbons. But there’s another side to this story. The volume coming out of the ground also needed to be stored in advance of the transport.

Pipelines offer a much more efficient (and profitable way) of storage over the construction of new underground or above ground facilities. This is especially the case with natural gas. In many regions of the country, the absolute majority of pipeline capacity is used for storage.

In fact, there has been more money spent on putting loops in existing pipeline networks than in building new direct lines for transit.

These loops increase the overall storage capacity. That’s the only reason they’re added. From the vantage point of transport, loops are inefficient (taking longer to get from one place to another simply adds to overhead expense).

In this case, it’s the “acquisition problem” that eventually prompted Kinder Morgan to break up its MLPs. Of the four companies to be separated, three are primary asset-based holdings: KMI, Kinder Morgan Energy Partners LP (NYSE: KMP), and El Paso Pipeline Partners, L.P. (NYSE: EPB).

Together, these three MLPs have over $58 billion in market cap and pay very nice dividends: 4.7% for KMI, 6.9% for KMP, and a whopping 7.5% for EPB.

It was the cycle of acquiring new assets for such a huge partnership, thereby allowing for the continuation of such high dividends, that finally prompted KMI management to change direction.

Those assets were becoming too expensive, creating a drain on the partnership’s bottom line.

Of course, it will take some time to unravel this massive structure. Early indications from the market clearly point toward investors liking the new approach. Stock prices for all three zoomed yesterday (but will certainly settle back today).

The Demise of the MLP Has Been Greatly Exaggerated

Which leaves us with the question posed at the outset of today’s OEI. Does the Kinder Morgan decision mean the end for MLPs?

Again the answer is no – not by a long shot.

In fact, we are already seeing a movement toward what I call MLP clones. These new entities are becoming the next generation of master limited partnerships. Rather than the KMI model (gobble up everything you can and become really big), the new profit center for MLPs involves consolidating strategically placed assets.

What I mean by this is a move to consolidate assets at important “pricing points” in the entire process. Most of these new partnerships are still in the midstream sector and relate to pipelines. But more of them are moving upstream (toward field production) and downstream (into processing, wholesale, and even retail distribution).

This is a new version of “verticalizing.”

Except these days, the goal is not to control each aspect of the overall sector or acquire as much as possible. Rather, the singularly important components are identified – those providing a service disproportionately crucial at which profits can be maximized – and those are prioritized for acquisition.

In fact, I have been recommending these types of partnerships to my Energy Advantage and Energy Inner Circle subscribers and the stock values have been increasing nicely, while maintaining their high dividends.

But unlike Kinder Morgan, there’s no need for these companies to become too big. Rather, it is the acquisition of strategic assets that allows for the continuation of the strong dividends.

In this case, it’s the positioning of the assets that accomplishes this, not the size of the holdings.

And we should expect more MLPs just like these to follow. That is really what the Kinder Morgan move is signaling to the markets.

PS. I delivered an urgent briefing last week on how the chaos in Iraq is about to “go global.” To get the full report, including what it means for your money, just go here.

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  1. Mike R
    August 12th, 2014 at 17:01 | #1


    What is your opinion as to whether the Treasury will move to eliminate the MLP as a form of ownership. I understand they have placed a moratorium on new MLP’s and are considering eliminating them altogether in order to gain more immediate tax revenue. Would this require legislation? If MLP’s were forced to become corporations what in your opinion would happen to the share price and distributions/dividends of existing MLP’s?

  2. Bernie Torbik
    August 12th, 2014 at 18:00 | #2

    I can’t help but wonder if some of Kinder’s move was precipitated by anticipation of tax reform in 2015, regardless of the victor in the Nov’14 Congressional elections. A lower, flatter tax structure, stripped of loopholes and other detritus, could make MLPs less attractive. The good news is that Kinder will be out in front of whatever reform emerges.

  3. August 12th, 2014 at 21:42 | #3

    So where does that leave us now? Don’t buy any new MLP’s ?? Hang
    on to the Present MLP’s for how long? Unload them how soon and unload
    them and replace them with what ??? or just put the cash in our mattress for the time being ??

    Thanks much from a totally disabled War Veteran !!!
    Sincerely, Russ Young

  4. Kevin Beck
    August 14th, 2014 at 07:37 | #4

    One other factor was the way the company had to fund its expansion.

    MLP’s cannot retain funds for future expansion; they have to either issue debt or equity at the time of the expansion. And KMI was able to borrow at lower rates of interest than any of its pipeline partnerships could.

    This roll-up would result in immediate reductions in future costs of funds for the corporation without having to dilute unit-holders in their pipeline partnerships. It would also result in the corporate parent being able to fund some projects internally, without having to seek funding in the stock or bond markets in the future, resulting in better internal planning at the corporate treasury.

  5. William C Crosby
    August 14th, 2014 at 22:09 | #5

    Dear DR Kent Moors,
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