”The modern MLP was born out of the Tax Reform Act of 1986, which lowered the top marginal tax rate paid by individuals to a level below that paid by corporations. The passage of this legislation caused many companies to change to the partnership structure in order to take advantage of the tax benefits. As numerous companies made the switch to the MLP structure, lawmakers passed the Revenue Act of 1987 to help protect corporate tax receipts.
“This legislation required publicly traded partnerships to receive 90% of their income from qualified sources. Qualifying sources include natural resource activities such as exploration, development, production, mining, refining, and transportation (including pipelines) of oil, natural gas, minerals, geothermal energy, and timber.
“The spirit of the 1987 legislation was to: 1) protect corporate tax receipts by prohibiting all businesses to seek a tax beneficial structure, and 2) provide incentives for the domestic development of natural resources and the build out of critical infrastructure such as oil and gas pipelines. Looking back it appears that these incentives have largely worked. A large majority of new pipeline and storage projects that have been constructed over the last several years have been undertaken by energy related MLPs. In our coverage universe alone, MLPs have spent over $61 billion on expansion projects over the last five years and a result the cost to move and store natural gas has declined dramatically.
“This is important especially when production is growing because expanded infrastructure is needed for consumers to ultimately benefit from lower prices at the point of sale. Without expanded infrastructure, pricing would remain depressed at the point of production yet the price to the consumer would not change dramatically as bottlenecks in the system restrict this new production from getting to the market. This price disparity manifests itself through regional price differentials also known as basis differentials. Through infrastructure investment these regional pricing differentials are alleviated and reduced pricing can be passed onto the consumers. Over the last five years natural gas basis differentials and storage margins have come down substantially as a result of infrastructure investment.
“New and expanded infrastructure has also provided producers with easy access to liquid market hubs at attractive pricing for the oil and gas that they produce. As a result, domestic production of both natural gas and crude oil have shown improving production trends. This is particularly interesting in regards to domestic crude oil production that had been showing an almost unrelenting decline for over 25 years until 2009 when domestic production finally rose from around 4.5 million barrels a day to around 5.5 million bpd currently.
“Similarly, low natural gas prices have provided the petrochemical industry with a globally competitive feedstock (ethane) that is reviving domestic industrial demand. As a result, MLPs in our coverage universe have announced investments of more than $10 billion over the next 3 years toward new infrastructure projects to get these new sources of production to revitalized industrial consumers.
“Taking into consideration these facts it is our opinion that the MLP structure provides an efficient way to fund infrastructure investment that allows for cheap and reliable transportation and development of natural resources that benefit the US economy. In short, we believe the MLP structure is part of an effective energy policy that is proven to work over an extended period of time. In our view, removing the benefits of this structure could lead to reduced investment in domestic energy resources and infrastructure, while increasing regional price volatility and the ultimate cost to the consumer.”
This is very well said, and one of the many reasons I expect the attempt to change the tax structure very unlikely. Look for the MLPs to move back up over the next few weeks and months.