What is a Master Limited Partnership?

Limited partnerships are well known in the business world, but like many aspects of finance, they come in a wide variety of shapes and sizes. One example is the master limited partnership.

A master limited partnership, or MLP, is a type of limited partnership that is publicly traded. While the limited partner is the person (or persons) who provides capital to the MLP, the general partner is the person (or persons) responsible for managing the MLP’s operations. The limited partner receives income distributions from the MLP’s cash flow, and the general partner receives compensation from the performance of the MLP.

MLPs are most commonly found in the resource, financial services and real estate industries.

To the uninitiated, an MLP may sound suspiciously like a corporation, but that is not the case. Whereas corporations are classified as separate entities entirely, MLPs are considered the cumulative result of their various partners.

According to the National Association of Publicly Traded Partnerships (NAPTP), the first MLP was launched in 1981: Apache Oil Company.

“Other oil and gas MLPs soon followed and were joined by real estate MLPs,” the NAPTP states. “Their purpose was to raise capital from smaller investors by offering them a partnership investment in an affordable and liquid security.”

The number of MLPs grew exponentially, with the United States Congress introducing rules defining and limiting these types of partnerships in 1987.

The NAPTP also states that MLPs can only earn money from income and capital gains from natural resource activities, interest, dividends and capital gains, rental income and capital gains from real estate, income from commodity investments and capital gains from sales of assets used to generate these types of income.

How do MLPs work?

According to the NAPTP, there are generally one or more general partners and they typically have approximately a 2-percent stake in the partnership.

Meanwhile, there are often thousands of limited partners, also known as unitholders, as these are the individuals who own the publicly traded units of the MLP. These individuals provide capital and receive cash distributions, but have no role in the operation or management of the MLP.

General partners may also have what are known as incentive distribution rights (IDR).

“The IDR is a share of cash distributions paid to the [general partner] in many MLPs,” the NAPTP states. “It generally starts at 2 percent (vs. 98 percent to [limited partners]). As quarterly distribution to [limited partners] goes up, and targeted distribution levels achieved, IDRs to [general partners] increase with each marginal increase in distributions.”

The advantages of IDRs is that they may create incentive for the general partners to grow the business, according to the NAPTP. However, IDRs can also increase the cost of capital since every new asset yield must be high enough to cover shares for both general partners and limited partners.

What are the advantages and disadvantages for investors?

Like with standard limited partnerships, there are benefits related to taxation.

“Pass-through tax structure (no double taxation) means lower cost of capital,” the NAPTP states. “This is important in capital intensive energy industries.”

The organization goes on to say that MLPs also allow companies to build and operate low-return assets while still providing high rates of return to investors.

While MLPs can provide various benefits, they don’t come without some unique disadvantages as well. While shareholders in corporations have voting rights, this may not be the case for unitholders in MLPs. Ultimately that depends on the structure of the MLP, but investors typically find themselves without any control over the direction of the company.

Additionally, while tax breaks can be enjoyed, the way MLP investments are taxed is often quite complex, which can lead to complications down the road.

Which MLPs performed best in 2014?

Based on year-over-year distribution growth, the following three MLPs posted the best performance during 2014:

Tallgrass Energy Partners

Focused on midstream energy assets in North America, Tallgrass Energy operates natural gas transportation and storage services in the Rocky Mountain and Midwest regions of the US.

The MLP experienced 37.82-percent year-over-year distribution growth.

The company declared a quarterly cash distribution in a January 5 media release.

“This represents a 54 percent increase from the fourth quarter of 2013 and an 18.3 percent sequential increase from the third quarter 2014 distribution of $0.41. It is TEP’s sixth consecutive increase since its IPO in May 2013,” states the release.

Western Gas Equity Partners

Coming in second with a year-over-year distribution increase of 36.26 percent is Western Gas.

Based in Delaware, Western Gas’ assets are located throughout Texas, the Rocky Mountain region, North-Central Pennsylvania and the mid-continent. In addition to natural gas, Western Gas also works in gathering, processing, compressing, treating and transporting crude oil.

EQT Midstream Partners

Finally comes EQT Midstream, which has assets in the Appalachian Basin. This MLP owns 700 miles of Federal Regulatory Energy Commission-regulated interstate pipelines serving the natural gas industry. Additionally, EQT owns more than 1,600 miles of Federal Regulatory Energy Commission-regulated, low-pressure gathering lines.

EQT saw year-over-year distribution growth of 27.91 percent.

The company reported in December that its earnings before interest, taxes, depreciation and amortization are expected to be between $330 and $345 million in 2015, with distributable cash flow forecast to reach between $280 and $295 million.