Master limited partnerships

Author: Keith Martin Publication | June 5, 2018

Master limited partnerships are losing some of their appeal.

A number of gas pipeline companies are converting to corporations after the US reduced the corporate tax rate and the Federal Energy Regulatory Commission ruled that gas pipeline companies structured as MLPs cannot factor income taxes into the rates they charge customers for shipping gas in cases where rates are set on a cost-of-service basis. MLPs that ship gas at negotiated or market-based rates would not be affected.

An interesting question is whether renewable energy companies that have been pressing Congress for permission to use the structure will abandon the effort.

A master limited partnership is a partnership whose units are publicly traded. Partnerships are not subject to income taxes. This allows MLPs in theory to raise capital at higher multiples to earnings than a corporation would be able to do because the earnings are subject to only one level of taxes (at the investor level).

MLPs are not a good vehicle for accumulating earnings to make capital investments. Because income flows through to partners and is taxed to them, there is pressure not to retain cash that the partners need to pay taxes. In addition, some MLPs give the sponsor, who remains as general partner, “incentive distribution rights” that pull an increasing share of cash over time to the sponsor.

The potential investor base is also more limited than for a corporation. It consists mainly of wealthy individuals. Pension and sovereign wealth funds are not interested in investing. Investors in MLPs are considered to be engaged in business in all the states in which the MLP is active, making filing tax returns more complicated for investors.

Kinder Morgan shed the structure in 2015 in a roll up that was a taxable transaction for the existing investors. Enbridge Energy Partners, LP, Spectra Energy Partners, LP, Williams Partners LP, Tallgrass Energy Partners, LP and NuStar Energy, LP are just some of the MLPs that have announced plans so far this year to convert to corporations. Boardwalk Pipeline Partners, LP said it is also considering converting. Williams said it does not expect to have to pay taxes after the roll up until after 2024.

The Alerian index, which tracks MLP units of the top MLPs accounting for 85% of MLP value, tracked 50 MLPs three years ago. The number is down to 38. There are 122 publicly-traded partnerships today in total. Two investment funds that operate as publicly-traded partnerships, KKR & Co. and Ares Management, are both converting this year to corporations. {Ares already converted effective March 1.) One stock analyst estimated that the KKR conversion would broaden its potential investor base by seven times.

The Alerian index has lost roughly half its value from a peak in 2014.      

MLPs that own gas pipelines could be ordered by the Federal Energy Regulatory Commission to make billions of dollars in refunds later this year to pipeline customers as a result of the FERC decision in March that pipeline MLPs cannot include an income tax charge in cost-of-service rates. (For more about the FERC proceeding, see “Pipelines and Partnerships” in the April 2018 NewsWire.)

Roll ups can be both costly and complicated for investors. The investors are considered to exchange their units for buyout payments or stock in a taxable transaction. Each investor must compare the value received to the “basis” that he or she has in the MLP units. Basis is a fluid concept that makes it tedious to calculate because it changes over time. It goes up as the investor has to report a share of MLP income. It goes down as the investor reports a share of partnership losses. Debt at the MLP level also factors into basis, but is considered relieved and, therefore, part of the sales proceeds when the investor sells the MLP units. (For a discussion about the tax consequences to the investors when Kinder Morgan converted, see “Master Limited Partnerships” in the August 2014 NewsWire.)


Contacts

Keith Martin

Keith Martin

Washington, DC