Hate MLPs? 2 Smart Alternatives to Invest In Midstream Infrastructure

When you look at the investment options in the midstream oil and natural gas space, the field is chock-full of master limited partnerships. That makes sense, since these companies are structured to throw off tax-advantaged income to unitholders from the largely stable, fee-based assets they own.

But there are other options, and they pay dividends too. If you don't want to own an MLP like industry bellwether Enterprise Products Partners L.P. (EPD 1.41%), then take a look at ONEOK, Inc. (OKE 2.25%) or CorrEnergy Infrastructure Trust, Inc. (CORR).

The partners

There's nothing inherently wrong with owning units of a master limited partnership like Enterprise. In fact, this large and well-run energy infrastructure company has been rewarding investors for years with distribution increases. The streak is up to an impressive 21 years worth of annual hikes. The yield today is also notable, at 6.9% -- largely because the midstream sector is out of favor today.

Image source: Getty Images

However, there are reasons you might not want to invest in an MLP. Enterprise is a pass-through entity, so unitholders get treated as if they were owners. All of the profits and losses flow through on a pro-rata basis to unitholders. This is good in that it allows MLPs to pay substantial distributions, and benefits like depreciation pass through to the unitholder, so the distributions normally have a tax shield associated with them. But figuring all of this out is complex and requires a separate tax form known as a K-1. Owning an LP might actually require you to get an accountant to figure all of this out.

Moreover, since you are treated as an owner, you technically should be paying tax in every state in which the partnerships you own operates, though most investors do not. Additionally, because of the MLP structure, partnerships like Enterprise generate a type of income that creates problems for tax advantaged retirement accounts like IRAs. It is best to avoid putting an MLP in a retirement account. In the end, the income is nice, but the headaches that come along with MLPs are not.

Just a plain old company

Not all midstream pipeline companies are structured as partnerships, however. For example, ONEOK is just a regular company. It had an MLP that it controlled, but ONEOK decided to buy it out and absorb its assets into ONEOK's operations in 2017. Income investors shouldn't pass this company over just because it isn't a midstream MLP: ONEOK offers a robust 5.4% dividend yield. And that dividend has been increased for 16 consecutive years. Those are pretty desirable stats.

Source: Yahoo! Finance.

A key difference here is that you avoid all of the tax headaches associated with the MLP structure, and those dreaded K-1 tax statements. The normal tax forms you receive from your broker will be all you get, and enough to complete your taxes in a timely fashion (K-1s have a habit of showing up at the last possible moment). And you can put ONEOK in a tax advantaged account like an IRA without fear of upsetting Uncle Sam. Or, better yet, you could put it in a Roth IRA and avoid taxes on the income you generate altogether.

The only wrinkle here, and it's a small one, is that ONEOK pays corporate taxes. That means your dividends could be subject to double taxation -- once at the company level and then again when you receive them. Even if you own this company in a Roth IRA, avoiding the taxes you have to pay on the income, the IRS is still getting a take of the profits in the form of corporate taxes.

The real estate route

Which is where one final corporate structure comes into play: a real estate investment trust (REIT) like CorrEnergy. This is a unique structure, in that the company owns assets and rents them to customers who operate them and pay all of the expenses to maintain them. Enterprise and ONEOK own assets and operate them, with their customers paying for the use of the pipes and facilities. It seems a subtle difference, but it is an important one.

As an REIT, CorrEnergy passes income through to investors without paying income tax on it. If it operated the assets it wouldn't be able to do that. But think about this for a moment: the only tax that gets collected is from investors, who treat the dividends as regular income. But if you put CorrEnergy into a Roth IRA, you would effectively cut Uncle Sam out of the equation and avoid paying any taxes on the dividends CorrEnergy pays -- no corporate taxes, and no personal income taxes. And CorrEnergy throws off a lot of income, offering investors an 8% yield.

CORR Dividend Per Share (Quarterly) data by YCharts

What is most interesting about CorrEnergy, however, is that this relatively small REIT managed through the deep oil downturn that started in mid-2014 without too much trouble. This is a big deal, because it survived the bankruptcy of a key customer without being forced to cut its dividend. Effectively, the downturn was a stress test that proved this company's unique model for owning energy infrastructure. The pipelines CorrEnergy rents to energy companies are vital arteries that allow them to get their product to market. These pipes can't be replaced, so the companies have little choice but to keep paying rent, even when they are going through difficult times.

There's more room here than you thought

In the end, if you are looking to invest in the midstream energy business you don't have to be locked into master limited partnerships like Enterprise Products Partners. You have other options. That includes regular corporations like ONEOK and tax-advantaged structures like REITs such as CorrEnergy. All three of these structures tend to pay sizable distributions in the energy infrastructure space, with unique advantages and disadvantages to each depending on where you choose to own them. Now that you have a broader view of the options in the energy infrastructure space you can make a more informed decision about how you want to invest in the sector.