Even as pipeline titan Kinder Morgan backs away from the master limited partnership structure that it helped pioneer for many years, the move isn’t likely to deter other energy companies from using the tax-friendly structure to get more value out of their pipeline and storage assets.
“This isn’t the death of the MLP structure itself,” said Michael Grande, director, utilities and infrastructure practice for ratings agency Standard & Poor’s. “Companies that are still forming MLPs and spinning off certain parts of their assets into this structure is something we’ll see continue.”
Houston-based Kinder Morgan announced Aug. 10 it would consolidate four of its oil and gas pipeline and storage partnerships into a single corporation in a $71 billion deal. The company essentially outgrew the MLP structure, which began to cost more money and become complex to maintain.
Master limited partnerships have become a prime tool for energy companies to invest in oil and gas infrastructure, especially as the U.S. shale boom has driven the need for more pipelines to handle climbing production.
Those midstream assets can be spun off from the parent company as an MLP, a tax vehicle developed in the 1980s. The partnerships are publicly traded, but act as a pass-through entity. The partnership gets tax breaks while passing earnings directly on to shareholders and to the general partner who manages it.
Kinder Morgan’s combined companies, traded under the symbol KMI, will be the largest energy infrastructure company in North America and the third largest energy company overall with an estimated enterprise value of $140 billion, according to Richard Kinder, chairman and CEO.
The day after Kinder Morgan’s announcement, Canonsburg oil and gas driller Rice Energy announced it would spin off its natural gas gathering pipelines and water distribution assets into an MLP.
Rice will join local producers like Pittsburgh-based EQT Corp., Cecil-based Consol Energy Inc., and a slew of others that have opted to use a master limited partnership to invest in energy infrastructure.
But the playing field for MLPs is a little different for mature companies several years into it.
One reason is that the amount of money they pass on to the general partner — the incentive distribution rights — begins to really ramp up as the MLP hits certain goals for growth.
Still, companies with master limited partnerships are able to get more value for those assets than if they were tucked into the corporate entity, said Nicholas D. Cacchione, director, chief compliance officer for consulting firm IHS Herold Inc.
And it’s an attractive deal for investors.
“The yield is very good and hard to come by in the investment landscape these days,” Mr. Cacchione said. “If you can get a 5 percent, 6 percent, 7 percent yield on something, that’s a good deal.”
EQT Corp., a driller with a significant amount of midstream assets, chose the MLP route in 2012 to get more value out of those, Mr. Grande noted. “They created the MLP and have done very well,” he said. “There’s a whole backlog of midstream assets they can drop into that MLP. They’re focusing on their core competencies in E&P and now own a midstream company with a separate value in the market.”
Overall, exploration-and-production companies are looking to diversify or finance production growth, Mr. Grande noted.
But the game changes as time goes on.
A young MLP can grow as the parent company moves pipeline assets into it. Such partnerships can compete against other small and mid-sized companies and reach double-digit growth that will satisfy investors, Mr. Grande said.
“Kinder Morgan had a backlog of organic projects, but the analogy is that you’re on a treadmill that you can never get off of. You have to find larger and larger deals to maintain that growth rate,” Mr. Grande said.
“The perception of the markets was that it wasn’t enough to satisfy equity holders’ insatiable appetite for yield,” he said. “It wasn’t that [Kinder Morgan] was doing anything wrong, but they felt that they could find better opportunities elsewhere. The equity market got sour on Kinder Morgan for a while.”
Kinder Morgan got too big
Kinder Morgan owns an interest in and operates 80,000 miles of pipelines that ship oil and natural gas. In this region that includes Tennessee Gas Pipeline, a 13,900-mile natural gas system connecting the Gulf of Mexico to the northeastern U.S. Among projects to expand that system, the company also has proposed the Utica Marcellus Texas Pipeline to take natural gas liquids from this region to the Gulf Coast of Texas.
For a company of that size, the decision to consolidate four entities — Kinder Morgan Inc., Kinder Morgan Energy Partners, Kinder Morgan Management and El Paso Pipeline Partners — under the Kinder Morgan Inc. umbrella “dramatically simplifies the ... story by transitioning from four separately traded equity securities today to one security going forward, and by eliminating the incentive distribution rights and structural subordination of debt,” said Richard Kinder in a statement.
As MLPs, those companies needed to make acquisitions that would be immediately accretive on their distributions. That gets tougher on a larger scale.
“They’re a sort of perpetual motion machine until they get too big,” said Mr. Cacchione. “With Kinder Morgan, that will probably be a blueprint for MLPs once they get to a certain size.”
Another factor that played in the company’s consolidation was the incentive distribution rights for the general partner, the funds it earns for managing the business, Mr. Cacchione said.
The rate typically starts off small. The general partner may hold a 2 percent interest in the MLP. But that scales up over time. In Kinder Morgan’s case, incentive distribution rights were siphoning off about 50 percent of the cash flow, Mr. Cacchione noted.
“If you’re one of the general partners, you have a gold mine going,” he said.
Another potential challenge on the horizon for master limited partnerships is the issue of tax reform.
“Every time tax reform gets mentioned, it tends to make the MLP industry very nervous,” Mr. Cacchione said. “It wouldn’t be unheard of to have a tax reform bill that MLP would lose their tax-favored structure.”
Reuters reported last week that the U.S. Treasury Department is looking into increased use of such partnerships as a business structure and what they mean for future tax revenues.
Stephanie Ritenbaugh: firstname.lastname@example.org or 412-263-4910