mlps & their role in the energy infrastructure · what is an mlp? 3 an mlp is a publically...
TRANSCRIPT
MLPs & Their Role In The Energy Infrastructure
Tom Long, Group CFO
Energy Transfer Equity
May 19, 2016
MASTER LIMITED PARTNERSHIPS 101
2
I. What is an MLP?
II. History of MLPs
III. How MLPs Work
IV. Investing in MLPs
What is an MLP?
3
An MLP is a publically traded partnership
MLPs operate active businesses, primarily energy related
Their operations are managed by a general partner (GP)
MLPs are traded on a public exchange (NYSE, NASDAQ, etc.) or over the counter
market
Shares in an MLP are called “units,” and shareholders are called “unitholders”
MLPs typically pay out the bulk of their operating cash flows on a quarterly basis in the
form of distributions (not dividends) to their limited and general partners
MLPs are relatively high-yielding securities whose primary objective is to grow cash
distributions over time
A key benefit of the MLP relates to pass-through taxation
History of MLPs
44
The first MLP was launched in 1981: Apache Oil Company
Other oil and gas MLPs soon followed and were joined by real estate MLPs
Their purpose was to raise capital from smaller investors by offering them a partnership
investment in an affordable and liquid security
In the 1980’s, MLPs began to be used in other industries: hotels and motels, restaurants,
cable TV, investment advisors, even an amusement park and the Boston Celtics
Section 7704 of the tax code outlines and limits partnership tax treatment to PTPs earning
>90 percent of their income from specific sources referred to as “qualifying income”
Through the passage of the Renewable Energy and Job Creation Act in September 2008,
qualifying income was expanded to include the transportation and storage of renewable
fleets
Practically speaking, the vast majority of MLPs operate what could be considered
infrastructure energy assets
History of MLPs
5Excludes cross-ownership
Source: Alerian – As of March 31, 2016
In 1995, there were 16 MLPs with a total market cap of $7 billion. As of March 31, 2016, there were 118
energy MLPs totaling $304 billion in market cap
MLPS By Group
6
2009 MLPs By Group 2016 MLPs By Group
Today’s MLPs primarily focus on energy-related industries and natural resources
Energy & Natural Resources
85%
Investment/Financial11%
Real Estate (Incl Mortg Securities) 2%
Other2%
Energy & Natural Resources
37%
Real Estate 31%
Other32%
Source: Citi – As of May 2016
Midstream MLPs10%
E&P (Upstream)21%
Marine Transportation1%
Natural Resources (Other)
5%
Real Estate Properties30%
Investment/Financial6%
Hotels, Motels, Restaurants
12%
Other15%
MLPs By Industry
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Midstream MLPs44%
E&P (Upstream)9%
Downstream7%
Oilfield Svcs 2%
Propane & Refined Fuel 3%
Marine Transportation7%
Natural Resources (Coal)
5%
Natural Resources (Other)
8%
Real Estate Properties2%
Investment/Financial11%
Other2%
2009 MLPs By Industry 2016 MLPs By Industry
The majority of MLPs today engage in oil and gas midstream activities – gathering, processing, natural
gas compression, transportation and storage
Source: Citi – As of May 2016
MLP Structure and Distribution Mechanics
8
Sponsor
General
Partner
The MLP
Operating Subsidiaries
100%Ownership Interest
98% LP Interest
2% General Partner100% IDRs
100%
Lenders
Public
Common Units
GP Manages Partnership
Generally has ~2% ownership stake in
partnership
May have incentive distribution rights (IDRs)
An MLP is governed by a partnership agreement, which lays out the ownership rights and
obligations of both the limited partners (LPs) and the general partners (GPs)
One or More General Partners (GPs)
Thousands of Limited Partners (LPs)
Illustrative MLP Structure
Source: Citi – As of May 2016
Unitholders = LPs holding publicly-traded units
Provide capital
Have no role in partnership’s operations or
management
Receive quarterly cash distributions
Typical IDR Structure
LevelDistribution
Target
Share of Incremental Cash Flows
GP LPs
One Up to 115% 2% 98%
TwoOver 115%
Up to 125%15% 85%
ThreeOver 125%
Up to 150%25% 75%
FourIn excess of
150%50% 50%
How MLPs Work: IDRs
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The Parent / Sponsor benefits from a GP promote
While the elimination of corporate level taxes is the driving factor behind value creation from contributing
assets to an MLP, characteristics of the MLP structure provide additional benefit to the parent / sponsor
The forced payout of all excess cash generated by the partnership imposes a higher level of discipline on
management
The tax-advantaged structure creates a more competitive acquisition vehicle for accretive growth, which
benefits the parent / sponsor through its general partner interest via the incentive distribution structure
As a result, the parent / sponsor captures an increasing percentage of the overall cash flow of the MLP
__ __ __ __ __1. Assumes GP splits as outlined to the left.
10%
20%
30%
40%
50%
$0 $200 $400 $600 $800 $1,000
% of Total DCF to GP
Hypothetical Impact of the GP Promote (1)
Total DCF
Characteristic MLP LLC Corporation
Taxable at entity level No No Yes
Tax items flow through Yes Yes No
Tax deferral on distributions Yes Yes No
Tax reporting K-1 K-1 Div-1099
General Partner Yes No No
IDRs Yes No No
Investor Voting Rights No Yes Yes
How MLPs Work: Taxation
10
Corporations are taxed at the corporate level and again at the shareholder level. MLPs are
taxed only once at the unitholder level and generally a portion of MLP cash distributions are
tax deferred
How MLPs Work: Taxation
11
Tax savings have motivated the rise of the $300+ billion market cap MLP asset class, driving a
meaningful amount of economic activity
According to the United States Joint Committee on Taxation, tax savings to investors as a result
of MLP-qualifying income is expected to continue increasing for the foreseeable future
0.1 0.1 0.1 0.1 0.1
1.1 1.2 1.2 1.2 1.2
$1.2 $1.3 $1.3 $1.3 $1.3
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2015E 2016E 2017E 2018E 2019E
Ta
x S
avin
gs, U
S$ in
bill
ions
E&M Other Energy-Related
Source: Citi as of May 2016
Annual US Income Tax Savings to Individual MLP Investors ($bn)
How MLPs Work: Qualifying Income
12
Qualifying Income Test: 90% or more of gross income from qualifying
activities
Failure of qualifying income test results in corporate treatment
• Non-qualifying income can be included in the MLP by using a C-corp
blocker
• Given the consequences if failed, MLPs maintain their non-qualifying
income assets well below the 10% limit
Lower-level entities, not the MLP, own the assets and conduct operations
Qualifying Income Test Overview
(1)
(1)
What Assets Are Best Suited For MLPs?
13
High Low
Key characteristics of “qualifying” assets
“Qualifying” assets that involve the extraction, transportation, storage, fractionation or distribution of a
natural resource make ideal candidates for an MLP
Numerous successful MLPs have been completed for a variety of industries
1. Depending on hedging profile.
Strong Cash Flow
ModestCapEx
SuitableVolatility
Growth Prospects
Asset Life
LNG
Terminal
FERC
Pipeline
Gathering
Pipeline
Long-
Lived E&P
Product
Pipelines /
Product
Terminals
Gas
Processing
/ NGL
Fractionation
Coal
Royalty
Coal
MiningFertilizer Timber Propane
Maritime
TransportRefining
MLP Tax Treatment Example
Year 1: 1,000 units purchased @ $20
- Investor receives cash distributions of
$3.00/unit
- Investor pays tax on net taxable income:
$2.00 of income and $1.50 of depreciation
($0.50/unit)
Basis Is: $20,000
-$3,000
+$500
Adj.
Basis:$17,500
Year 2: All units sold @ $25
- Gain per unit: $25 - $17.50 = $7.50
$25,000
$7,500
- Depreciation recaptured-taxed at ordinary
income rates
- Taxed at capital gain rates
$1,500
$6,000
Investing MLPs: Taxation
14
The tax-deferred portion of the cash
distributions are recaptured at ordinary
income tax rate when an MLP investment is
sold
Any gain above the unitholders’ original cost
basis is taxed as a capital gain
The difference between the reduced cost
basis and the original cost basis is taxed as
ordinary income-this is called “recapture”
Taxation of MLP Distributions
Important Note
MLP Tax Treatment Example
A portion of cash distributions received from
MLPs are a return of capital and tax-deferred
Your basis is lowered each year by the
amount of the distributions minus your share
of net partnership income
The idea is that all income you receive from
the partnership is taxed once and only once –
either in the year you receive it, or when you
sell your units
Summary
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• Benefits
MLP can illuminate / highlight value of business(es) inside an integrated corporate structure
Creates a platform for growth through third party acquisitions and organic development
through access to low cost equity capital
Monetization at premium valuation (driven by yield rather than multiple)
Parent / Sponsor retains substantial upside potential through retained LP units and General
Partner “promote”
Parent / Sponsor retains operating control
Structures are available to mitigate and/or defer up-front taxable gain associated with IPO
proceeds
Flexible structuring vehicle
Establishes a “ready” buyer of additional assets owned by parent / sponsor
Benefits