A New Partnership
Rise of MLPs to accelerate consolidation of convenience and fuel marketing.
An MLP Rundown
The number of midstream and downstream MLPs has grown over the past year, with assets ranging from terminals and pipeline interests to a single refinery and a wholesale distribution network. Following is a rundown of the more notable offerings, including those already launched and those to come.
IPO Filed • Susser Petroleum Partners (SUSP)
Upside: Strong leadership, consistent performer, great growth capacity in Texas market, option over next 3 years to purchase up to 75 Stripes sites from its sponsor, which the MLP will lease back to its general partner.
Downside: High opening price of $23/unit, first time the company will be committing to dividends.
• Lehigh Gas Partners (LGP)
Upside: Solid distribution base of gasoline and diesel to roughly 570 retail sites, of which half are owned or leased by prospective MLP sponsor.
Downside: Lost $3 million in 2010; it rebounded with a $9.6 million profit in 2011. Last month’s IPO of more than $105 million will repay debt and reimburse its general partner.
• Northern Tier (NTI)
Upside: Owns a refinery in Minnesota and boasts a strong retail network of more than 160 company-run and 67 franchised outlets.
Downside: Refining-based companies face significant exposure to commodity prices and do not set a minimum quarterly distribution. IPO to Come • MPLX LP (MPLX)
Marathon Petroleum Corp. was spun off in 2011 from Marathon Oil. In July, after pressure from an activist investor, the refiner-marketer and pipeline operator—which also includes the Speedway c-store chain—filed a registration statement in anticipation of the formation of an MLP with an initial asset of a 51% interest in pipeline assets and a 100% interest in a butane cavern.
Upside: Classic midstream MLP, strong network of pipeline and terminal assets, reliable revenue streams.
Downside: MPC’s spinoff driven by parent company to drive greater E&P and maximize shareholder value; investors would absorb company’s pipeline tax burdens.
• Alon USA Partners
Upside: Spinoff of independent refiner Alon USA Energy, Alon USA Partners operates a refinery in Big Spring, Texas, that boasts 70,000-barrel capacity and flexibility to produce sour crude oils; can exploit differentials between West Texas Intermediate (WTI) crude oil and Brent crude oil; solid stable of retail outlets.
Downside: Company faces significant exposure to volatile commodity swings and doesn’t set a minimum quarterly distribution.
• Valero Energy
Upside: Robust refiner with 16 refineries and combined throughput of 3 million barrels/day; expecting infusion of $3.5 billion in reported planned divestiture of nearly 1,000 c-stores and gas stations in the U.S. and 775 units in Canada.
Downside: Highly vulnerable to margin volatility in commodity markets.
An MLP Glossary
Master limited partnerships (MLPs): Limited partnership investment vehicles consisting of units (rather than shares) that are traded on public exchanges. MLPs consist of a general partner and limited partners. Also known as “publicly traded partnerships.”
General partner (GP): Manages day-to-day operations of the partnership. Typically has a 2% ownership stake in the partnership and is eligible to receive an incentive distribution through the ownership of the MLP’s incentive distribution rights.
Limited partners: Provide capital, have no role in the MLP’s operations or management, and receive cash distributions.
Distribution: In a typical partnership agreement, the MLP is required to distribute all of its “available cash.” MLPs typically distribute all available cash flow to unit holders in the form of distributions.
Distributable cash flow (DCF): Cash flow available to be paid to common unit holders after payments to the GP.
Minimum quarterly distribution (MQD): The minimum distribution the partnership plans to pay to its common and subordinated unit holders upon initial public offering.
Distribution coverage ratio: The “cushion” a partnership has in paying its cash distribution. The higher the ratio, the greater the safety of the distribution.
Cash or adjusted yield: An MLP’s current yield adjusted for its GP’s share of cash flow. For example, if the GP is receiving 10% of an MLP’s total distributions and the partnership’s units trade at a 7% yield, the cash yield would be 7.8%.
Current yield: Current declared quarterly distribution annualized divided by current stock price.
Forward yield: An MLP’s estimated next four quarterly distributions divided by an MLP’s current unit price.
Incentive distribution rights (IDRs): Allow the holder (typically the GP) to receive an increasing percentage of quarterly distributions after the MQD and target distribution thresholds have been achieved.
Tax deferral rate: Percentage of the cash distribution to the unit holder that is tax-deferred until the security is sold. The tax deferral rate on distributions ranges from 40% to 90%.
A Taxing Situation
One of the core engines for MLP growth is its pass-through tax status. It’s a benefit designed to support growth of the country’s energy infrastructure.
“The energy-infrastructure business in particular is very capital-intensive; you have to get a lot of capital up front to build a pipeline or buy an ongoing system,” says Mary S. Lyman, executive director of the National Association of Publicly Traded Partnerships, Arlington, Va., a trade association that represents MLPs. “It’s also fairly low return. Particularly if you own a regulated pipeline, there’s only a certain amount you’re going to be able to give back to investors.
“The MLP structure, by taking the corporate tax out of the equation, lowers the cost of capital so that the company can make investments and still provide investors with an attractive rate of return that they will want in an investment.”
That is why it was particularly alarming to the MLP universe when energy MLPs were added to an annual list of tax expenditures circulated by a joint House-Senate Ways & Means committee, which also specifies how much potential revenue is lost due to these expenditures.
According to Lyman, the revenue lost due to the pass-through tax structure of MLPs is “pretty small comparatively,” or about $300 million a year.
“Since we’re now on the list of tax expenditures, that makes us more vulnerable when people say, ‘Let’s get rid of tax expenditures so we can lower the corporate rate,’ ” says Lyman. “That’s one reason we feel vulnerable with tax reform—although the fact that there’s not a lot of revenue in taking our tax benefit away gives us some comfort.”
A perhaps greater threat is that whenever there is a wholesale reform of the tax code, discussion always arise on how business entities should be taxed. “One question is: Should more entities be paying corporate tax?” she says. “Do we have the correct line between entities that pay corporate tax and those that can be pass-through and pass it on to investors like MLPs do? There are some people who say entities that are very large and traded should pay the corporate tax.”
In fact, in a research report by investment firm Wells Fargo, analysts said that if President Obama is re-elected, it would be “on the margin, a net negative for the MLP sector.” The report says the president’s Framework for Business Tax Reform calls out that “large companies are increasingly avoiding corporate tax liability by organizing themselves as pass-through businesses.”
Lyman says the association is “pretty optimistic but cautious” that MLPs will not lose their tax benefit, and her group has been actively meeting with Ways & Means finance committee members to educate them about MLPs. Should they lose the status, it will put the brakes on the growth of the MLPs and the MLP structure.