| Sarasota Herald-Tribune
Master Limited Partnerships (MLPs) haven’t been a particularly rewarding investment over the past decade, but they have done better lately. According to the Alerian MLP Index, the leading benchmark for MLPs, it has been minus 0.9% for the past decade compared to 13.9% for the S&P 500. However, last year it was 103.1% compared to 56.4 % of the S&P 500. The biggest attraction of MLP are distributions, which were most recently at 8.6%.
MLPs are a confusing class of securities in that they are listed on exchanges but are not stocks; they pay dividends that look like dividends but aren’t; and they have more complex tax implications for investors than stocks. To become an MLP, a company must meet stringent IRS requirements, including 90% of the company’s revenue from companies such as the energy sector.
An advantage for many investors is that they have to make quarterly distributions. Since these are partnerships, they avoid corporate income tax at the federal and state levels. However, the stream of income is still taxed once again by the individual investor. In addition, a major part of the distribution is a tax-privileged capital repayment. This means that investors do not have to pay any taxes on this part of the distribution until the MLP is sold, and the effective tax rate for the remaining distributions can be favorable under current tax law.
There are three different types of MLPs: “Upstream”, “Midstream” and “Downstream”. Upstream MLPs either actively drill for oil or gas or provide services to companies that do so. Midstream MLPs take the oil or gas from the wells, pipeline it to refineries or gas processing plants, and store or transport the processed product to distribution centers Downstream companies store and distribute the refined products to consumers.
Each of these three MLP classes makes money in different ways, which leads to different risk / reward profiles.
Upstream MLPs’ profits are tied to oil and natural gas prices. When oil prices are low, their profits can disappear or become losses, sometimes requiring dividends to be cut or canceled. In the worst case, since MLPs are heavily leveraged, this can lead to bankruptcy.
Midstream MLPs are “toll roads” that transport oil and natural gas at a fixed cost under long-term contracts, usually with an inflation staircase. Thus they are not directly influenced by the raw material prices. However, they are affected by changes in the amount of oil and gas they transport. The bankruptcy of a large manufacturer could invalidate a contract with them and reduce their income. The prices of these should be more stable than those of the upstream MLPs.
Downstream MLPs, such as companies that supply end users with propane or gasoline, are influenced by the demand for their products, not the prices of raw materials. You buy the product and then you increase the price. When commodity prices fall, product prices fall and catalyze end consumer demand. Therefore, their prices should hold up well even in the event of a hypothetical drop in commodity prices.
Even with oil prices soaring, moderate investors interested in energy MLPs should focus on the midstream or downstream.
All data and projections are for illustrative purposes only and are not intended as an incentive to buy or sell any securities. Past performance is not an indication of future results. If you have a financial problem that you would like to see discussed in this column, or if you have other comments or questions, please contact Robert Stepleman c / o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or rsstepl @ tampabay. rr.com. He provides advisory services through Bolton Global Asset Management, an SEC registered investment advisor and an associate of Dow Wealth Management, LLC