I plan to post a series of entries on the basics of MLPs and archive them on this site as a resource for anyone interested. I figured I would start with the most basic concepts of MLPs.
Master Limited Partnerships (MLPs) are limited partnerships that are publicly-traded on US securities exchanges (most are on NYSE or NASDAQ). The LP structure allows MLPs to avoid corporate income tax, instead flowing income and losses through to the limited partners. As a result of large cash distributions and large depreciation expenses, the cash received by investors of MLPs is typically greater than 80% tax deferred, as the allocated net income is typically much less than distributions received.
In order to qualify for partnership tax treatment, an MLP must generate at least 90% of its income from “qualifying income” as defined by Section 7704(d) of the United States Internal Revenue Code of 1986 (the “Code”). A wide range of natural resources operations fit within this definition, including the exploration, development, mining, production, processing, refining, transportation, or marketing of any non-renewable mineral or natural resource.
The first MLP went public in 1981 (Apache Oil Company), and many other oil and gas MLPs followed in the early and mid 1980s. MLPs rapidly expanded, and even expanded into other industries, such as: restaurants, cable television companies, hotels, amusement parks, nut farms and even the Boston Celtics. Congress and the IRS worried about broader movement of companies from the corporate structure to MLP structure, so congress passed Section 7704 of the US tax code, limiting partnership tax treatment for MLPs that fall within the specific operating categories above. The goal of maintaining the tax break for natural resource companies was to encourage investment in energy infrastructure and natural resources in the US.
Congress’ plan has clearly worked, and has led to billions of dollars of US energy infrastructure investment over the past two decades. Today, there are 78 natural resources-focused, publicly-traded MLPs and LLCs. The market cap of the sector has grown from less than $5 billion in 1996 to more than $150 billion currently. There were no IPOs in 2009, but several MLPs were consolidated into their parent companies or otherwise bought out (TPP, MGG, HLND, HPGP, ATN).
Read more about the basics of MLPs:
MLP Basics II – Distributions / IDRs
MLP Basics III – IPOs
MLP Basics IV – FAQ
MLP Basics V – Subsector Overview