More Money in MLPs Than Ever Before

There is a significant movement already under way to exploit the potential of the master limited partnership legal structure. Many businesses are opting to form master limited partnerships, or spin off existing assets into MLPs and take them public to maximize profits. In 2010, the market capitalization of MLPs was nearly 10 times what it was in 2001, with most of that gap forming between 2009 and 2011. The growth continues unabated, as 14 MLPs had their IPOs in 2012, and seven have hit the NYSE this year already, with more on the way. Today, I'll take a look at this trend, and what it ultimately means for income-oriented investors.

How we got here
The energy industry is quick to bemoan government heavy-handedness, but it was two pieces of legislation passed in the late '80s that made MLPs possible: the Tax Reform Act of 1986 and the Revenue Act of 1987. Designed to encourage the build-out of energy infrastructure, the tax advantages that MLPs offer are limited to businesses that generate 90% of their income from operations in real estate, natural resources, and minerals. It makes sense then, that most of our MLP options are in the energy sector.

Within the sector, midstream MLPs have really taken off in recent years. According to research by investment consultants at NEPC, MLPs only made up 10% of the oil and gas midstream sector in 1990. Today, that number has swelled to 44%. On the flip side of that coin, oil and gas exploration and production MLPs accounted for 21% of the industry in 1990, and only make up 14% of it today.

But this too is starting to shift. If you look at the most-recent IPOs on the New York Stock Exchange, you'll find many corners of the energy industry represented:

  • Tallgrass Energy Partners -- Natural gas midstream, debuted May 14
  • KNOT Offshore Partners (NYSE: KNOP  ) -- Shuttle tankers, debuted April 10
  • SunCoke Energy Partners (NYSE: SXCP  ) -- Coal/coke making, debuted Jan. 18
  • CVR Refining (NYSE: CVRR  ) -- Mid-continent refining, debuted Jan. 17

There have also been a few MLP-related funds to hit the market this year, including Global X Junior MLP ETF and Neuberger Berman MLP Income Fund.

Sweet deal
Yes, part of this rush can be attributed to a grab at cheap capital in a low-interest-rate environment, but the tax incentives for a master limited partnership cannot be underestimated.

Fortune recently addressed this topic, profiling Emerge Energy Services (NYSE: EMES  ) and its 2012 tax rate, which was 0.5%. Again, the partnership structure forces the company to pass the majority of its cash -- and its tax burden -- onto the limited partners. According to Fortune, Emerge Energy Services paid Uncle Sam absolutely nothing last year. Emerge took its show public this May and has yet to officially announce a distribution, but you can bet investors will see more cash than the federal government did.

Not for everyone
Even in these MLP-friendly times, some companies ultimately decide not to take their business to the Street. Quicksilver Resources (NASDAQOTH: KWKAQ  ) planned to spin off its subsidiary, Quicksilver Production Partners, into an oil and gas MLP this year, but withdrew its plans in May after recording quarter after quarter of dismal results.

Brookfield Renewable Energy Partners canceled its IPO just last week, citing "capital market concerns". In fact, if interest rates do begin to rise, it may dissuade other opportunists from their dreams of publicly traded status.

For now, at least, the wave continues. Not only are we expecting several more midstream IPOs this year, but there is a chance we will see renewable energy companies throwing their hats in the ring. If passed, the MLP Parity Act could open the tax-free door to renewables as well, giving investors many more options to choose from.

Bottom line
Many IPOs will hit the market over the next few months, joining the legion of opportunities already available to investors; in these conditions, due diligence remains as important as ever. Nothing is more crucial to the success of an investment than the underlying business and management's ability to execute on its vision. Choose wisely.

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