In the United States definition, a Master Limited Partnership (MLP) is a publicly traded limited partnership that qualifies under section 7704 of the IRS. In this sense, a partnership is quite different from a corporation in the sense that it is treated as an aggregate of the partners that makes up the partnership rather than a separate entity.
MLPs do not issue shares to raise money just like other publicly traded companies. Instead, the partners in an MLP own specific portions of the partnership called ‘Units.’ One advantage of MLPs is that it combines the tax benefits that a limited liability company enjoys with the liquidity of publicly traded companies. The MLP is structured in such a way that the companies do not pay taxes on corporate profits, but their earnings are passed through to unit holders. In an MLP setting, there is usually a general partner (GP) who owns as little as a 2% interest in the partnership and is involved in the day-to-day operations of the company. The remainder of the units is held by Limited Partners (LP) that receive cash distributions on a quarterly basis and has no say in the day to day activities of the company. To be listed as an MLP and enjoy the attendant tax benefits, a partnership must have to generate at least 90 percent of their income from what the IRS calls “Qualifying” Sources. These qualifying sources as listed by the IRS includes, income from exploration, mining, extraction, transportation of alternative fuels like biodiesel and the refining of oil and gas.
Master Limited Partnerships have become a feature for the majority of midstream energy companies. Because of their tax-exempt nature, these vehicles have helped to provide access to investment capital that is used to build infrastructure delivering shale basin natural gas and oil production to the market. The reason for increased investment in MLPs is not far-fetched; investors in MLPs have enjoyed high returns on their investments from these tax-advantaged MLPs with low risk. However, newer MLPs are beginning to move away from the safety of the toll road to more risky commodity price exposure, making an investment in MLPs a bad bet.
As stated above, new MLPs are beginning to shift their attention from the less risky investments to exposures to commodity prices. Today, many of these MLPs are struggling to make returns commensurate with the new risk taken by unit holders, hence posing a challenge to the attractiveness and long-term survival of MLPs. Note that, the idea behind setting up MLPs and investing in them is that they tend to generate reliable and steady revenue streams of income- that is assuming a risk-free environment. However, with the current fluctuation in the prices of oil, these have become bad bets on MLPs for investors. Another issue with MLPs is that the risk of most of the infrastructural projects such as terminals and pipelines are underwritten by shippers who guarantee capacity payments that are required to generate some returns on investment even with fluctuating and falling commodity prices. This would have been a good way to cushion the risk of loss of investment. But with the current down cycle in the industry, if shippers are not able to make these commitment payments, MLPs are left to bear the burden of these defaults. Therefore, investors are beginning to consider the long-term future of MLPs and considering whether to invest in this industry or not. I believe many investors will divest from MLPs- at least for the time being- pending when the energy industry, and by extension commodity prices, will be rebound.
If you have been the victim of a bad bet on an MLP, you need to find a lawyer to protect you today.