Trade of the Day: Energy Transfer Equity (ETE)

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Thanks to special exceptions in the U.S. tax code, it is possible for oil pipeline companies to form a publicly listed limited partnership. These look and act like stocks but are a little different than the typical S&P 500 component. These entities are called Master Limited Partnerships (MLPs) and there are more than 100 of them listed on various exchanges in the United States. Investors are drawn to them for exposure to the growing oil industry and the above-average dividend distribution rate.

An MLP is usually a combination of two or more publicly listed securities. The first component(s) is a limited partnership that owns and operates the oil pipeline assets. Because it is a limited partnership it can avoid most corporate taxes at the federal and local level. However, its limited partners (AKA shareholders) are responsible for paying taxes on the partnership’s income. This mostly avoids the problem of double-taxation other corporations/shareholders deal with.

The second component is an entity that owns the general partner in each limited partnership. This entity may also be a limited partnership and can be publicly listed. The firm that owns the general partner manages the limited partnership and gets a management fee (or “incentive distribution”) from the limited partnership. The percentage of profits distributed from the limited partnership to the partners (shareholders) and what is returned to the general partner is outlined in the partnership agreement.

Confused Yet? Hold On – It Will Make Sense Soon

The diagram below illustrates the relationship I have described. A pool of shareholders/limited partners collect a dividend from any or all of the limited partnerships in the organization that they have an interest. Each of these limited partnerships are publicly listed and may hold different assets and/or an interest in each other. Investors can also have ownership in the company/partnership that controls the general partners, as well.

limited partnership
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You should be able to tell from the diagram and description that these are complicated entities. It is pretty safe to assume that complications due to tax regulations are inefficient by nature and can be expensive to manage and maintain. Eventually, competition, Congress, and industry changes make these kinds of structures obsolete. That hasn’t happened yet, but the unwinding process may be getting underway.

For example, this week the Kinder Morgan partnerships – Kinder Morgan Inc. (KMI), Kinder Morgan Energy Partners, L.P. (KMP), Kinder Morgan Management LLC (KMR) and El Paso Pipeline Partners, L.P. (EPB) – announced that they are consolidating under Kinder Morgan Inc. (KMI), which owns the general partner of the other three limited partnerships.

In the long run, the company believes this will enhance its ability to acquire capital and will save it money in the long run. All four Kinder Morgan entities are up on the news.

A Different Kind of Growth

Oil pipeline companies are having a tough time growing right now. The regulatory environment is getting more difficult and it may be a while before we see the kind of growth that occurred over the last few years. That will give companies with an asset base an opportunity to consolidate and “grow” through acquisition and streamlining their operations.

We like Energy Transfer Equity (ETE) as a stock that could continue to rise as investors build in the potential for the Energy Transfer companies – Energy Transfer Partners, L.P. (ETP), Energy Transfer Equity, L.P. (ETE), Sunoco Logistics Partners L.P.  (SXL) and Regency Energy Partners LP (RGP) – to consolidate like the Kinder partnerships. The oil transportation business continues to look stable and growth/efficiency improvements are more likely among the bigger firms.

limited partnership
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Energy Transfer Equity (ETE): Chart Courtesy of eSignal

As you can see in the chart above, ETE has hit support at $54 and caught a little bit of a bounce before the Kinder Morgan announcement already. We expect that speculation for a similar move by Energy Transfer will drive prices back up to $60 per share in the short term. Traders may choose to place stop losses under support at $54 per share or use call options as an alternative to an outright long position.

Note: A Master Limited Partnerships is not like a regular stock. The dividends are attractive and the business might be compelling, but there are unique tax complications for individuals who invest in these stocks. This isn’t necessarily a bad thing but before you look at an investment, you should talk to a qualified tax advisor about any potential problems that may arise in your portfolio.

John Jagerson and Wade Hansen are the editors of SlingShot Trader, helping investors capture options profits trading the news by using a proprietary 100% news-driven trading platform that turns event-driven pricing inefficiencies into fast profits. Get in on the next trade and get 1 free month today.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/08/trade-of-the-day-energy-transfer-equity-ete-limitedpartnership/.

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