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Master Limited Partnerships
by Harry Domash
How to Find the Best MLPs •
Tax & Liability Considerations •
Limited Partnerships are similar to real estate investment trusts in that they do not pay income
taxes, and their shares trade on the major stock exchanges just like
regular stocks. However, REITs and MLPs are different in structure. Unlike
REITs, which are a special type of corporation, MLPs are partnerships. An
MLP’s general partner is responsible for running the partnership, and
individual investors are limited partners.
Master Limited Partnerships
get special tax treatment. An MLP does not incur income taxes. Its income
is allocated among all partners in proportion to their ownership interest.
qualify for the tax benefit, 90% of an MLP’s income must come
from activities in real estate, commodities, or natural resources such as
mining, timber or energy production and related activities.
However, MLPs may not be suitable for IRAs and other tax-sheltered
accounts. Be sure to review the
Tax & Liability
Considerations section before you buy.
Limited Liability Company (LLC)
A “Limited Liability Company” or
LLC has no master partner to take a cut off the top. All of the profits go
to unitholders. Thus, in theory at least, LLC distributions should grow
faster than similar MLPs. In practice, however, it's difficult to find
examples where that has actually happened. For tax purposes, LLCs are
treated the same as MLPs.
divided the Master Limited Partnership and LLC universe into the following categories:
special tax treatment afforded MLPs seems to have a special appeal to
major oil and natural gas producers. Many of them have transferred their
petroleum and natural gas pipeline assets to MLPs that the oil companies
control as general partners.
Within pipelines, we have crude oil/refined
products (gasoline, heating oils) pipelines and natural gas pipelines.
Crude oil pipeline operators enjoy a
are regulated and are based on the volume of product transported, not by the price of oil. So
while earnings may dip if the winters are too warm, or the summers too
cool, long-term, earnings growth reflects expansion activities.
natural gas pipeline operators often also operate gas-gathering systems, which connect
individual wells to public pipelines, which then connect to processing plants. Typically, gathering and processing contracts do expose pipeline operators to changes in the price of natural gas and its byproducts. So, natural gas pipeline operators’ profit margins can vary with the price of the commodity. Some operators employ hedging strategies to reduce their susceptibility to price swings. But not all do because that limits their upside potential.
We also have a diversified product
pipeline category for firms operating both natural gas and crude oil
These partnerships sell propane and/or
heating oil products to residential, commercial, industrial and
agricultural customers. Except for Inergy, which is an aggressive
acquirer, most propane retailers are relatively slow growers.
Exploration & Production
Exploration and production partnerships
generally produce crude oil, natural gas, or coal from reserves that they
own. The only exceptions are coal mine owners Natural Resource Partners
and Penn Virginia Resource Partners. They own the mines, but contract with
others to do the digging.
Most oil and natural gas exploration and
production partnerships are new to the game and have yet to produce
consistent and predictable cash flow growth.
Shipping partnerships fall into two groups.
Some provide specialized oil or refined product transportation services in
U.S. coastal areas, and the others are conventional oil tanker operators.
Real Estate Property & Finance
This is a diverse group. One invests in
tax-exempt mortgage revenue bonds, another owns apartment communities,
and the third provides financing to apartment developers.
An interesting collection of partnerships
that don't fit neatly into the other categories. Some are intriguing
energy plays, while others, such as an amusement park operator and an
investment manager, are in entirely unrelated businesses.
Those would not be allowed MLP
status under current law, but were already in business before the
current rules were enacted and are allowed to continue operating.
As mentioned, MLPs are controlled by a general partner. The GP typically
holds a 2% general partner interest in the MLP plus additional limited
Typically, the general partner is entitled to
a percentage of the MLP’s cash flow off the top, that is, before the
limited partners get their distributions. That percentage, called
“incentive distribution rights,” or IDRs, varies with the total amount of
distributable cash flow earned each quarter. The IDR may start at a low
percentage, say 5%, but then ramps up to as high as 50% as distributable
cash flow grows.
Most general partnerships are privately held,
but a few are publicly traded. In those cases, the general partner
typically pays most of its IDR cash to its shareholders.
Over time, because its IDR percentage
increases, the general partner’s dividends grow faster than the
distributions to MLP unitholders. On the downside, general partner’s
yields run in the 3% to 4% range instead of 5% to 7% for many MLPs.
Nevertheless, because their dividends grow faster, general partners’ total
returns typically exceed the corresponding MLP returns.
General partners may be organized as regular
corporations, or as MLPs. When they are organized corporations,
shareholders avoid the tax reporting issues that discourage
many investors from considering MLPs.
See the complete list of MLPs and General Partners in the