MLP Primer

MLPs: Stable income & inflation protection… real companies with hard assets that produce steady cash flows

MLP basics by Swank Energy Income Advisors

National Association of Publicly Traded Partnerships (NAPTP)
Educational materials & MLP primer

Overview of Master Limited Partnerships – “Utility-like companies which own energy infrastructure assets”

Master limited partnerships, referred to as MLPs, are limited partnership entities with publicly traded securities, which own energy infrastructure assets in North America. These entities are taxed as partnerships as opposed to corporations, giving them a cost of capital advantage given that they do not pay entity level taxes. MLPs provide basic everyday services such as gathering, processing, storage and transportation of crude oil, natural gas and natural gas liquids to the energy companies that explore for and produce crude oil and natural gas such as Anadarko, Apache, Chesapeake and Devon. MLPs are listed and trade on the NYSE, AMEX and Nasdaq, just like any other public equity security. Today, MLPs are the primary companies that build, operate and maintain the energy infrastructure in North America. The primary assets of MLPs are crude oil pipelines, natural gas pipelines, natural gas liquids pipelines and petroleum product pipelines, terminals and storage facilities; natural gas and natural gas liquids gathering, treating and fractionating systems; propane storage and distribution systems; and other eligible natural resource businesses. Swank monitors every publicly traded MLP and maintains in-depth, detailed models on the majority of the MLP universe. In addition, Swank maintains close ties with the MLP management teams. MLPs are subject to Securities Exchange Commission regulations as publicly traded companies and must file 10-Ks, 10-Qs, and notices of material changes like any publicly traded corporation. MLPs must also comply with the record keeping and disclosure requirements of the Sarbanes-Oxley Act of 2002.

The majority of MLPs operate in energy infrastructure businesses that tend to be insulated from general economic risk and have historically produced stable cash flows. It is the stability of these cash flows that allows the MLPs to have sustainable and growing cash distributions that are paid out to investors on a quarterly basis. The MLP sector benefits from the following positive factors:

Traditional integrated energy companies have three basic lines of business which make up the energy chain: Upstream, Midstream and Downstream. The majority of MLPs operate in the midstream sector, which basically involves the transportation of crude oil and natural gas from the supply centers (crude oil and natural gas fields and basins) to the demand centers (retail, commercial or industrial end-users). In this way, MLPs are a critical component in the energy value chain, and thus enjoy some inelasticity for their services and stability of their businesses through any economic environment. Today the MLP asset class is comprised of 78 publicly traded companies across 9 sub-sectors (as defined by Swank) with a market capitalization of approximately $145 billion as of Sept 21, 2009. As the MLP asset class has grown, some of the newer sub-sectors are now more commodity sensitive than the basic energy infrastructure players. The Cushing® 30 MLP Index will track the more stable infrastructure MLP’s and exclude the more commodity-sensitive MLPs.

Based on the existing sources of crude oil and natural gas, the demand for new energy infrastructure in North America exceeded $75 billion at year end 2008, according to Energy Institute of America. A decade ago the traditional integrated energy companies built and operated the North American energy infrastructure, but today MLPs have the operating expertise and most efficient entity structure to build and maintain the infrastructure assets. The unbundling of energy services and the subsequent de-integration of the energy sector provided this opportunity for MLPs. The increased prominence of independent exploration and production companies has allowed for additional growth and investment opportunities in the midstream sector for MLPs. In addition, given the need and desire for energy independence, companies in the energy infrastructure sector in North America, and MLPs in particular, are poised for strong growth over the next decade.

Today MLPs are mostly owned by retail investors, but with the stability of the businesses, the opportunity for income and growth, and the inherent inflation protection associated with the businesses, we believe that institutional ownership in this asset class will increase.

The evolution of the MLP asset class is very similar to another high yielding equity asset class - Real Estate Investment Trusts or REITs. REITs have become the accepted structure and most efficient way for investors to gain exposure to various real estate assets. The yield and growth prospects that public REITs offer to investors has created huge institutional ownership over the past several decades. Today, MLPs are in the early stages of the same evolution and offer better yields, higher growth and a more stable business than REITs. We foresee institutional participation in the asset class continuing to increase, as the opportunity set in MLPs has grown significantly (78 publicly traded equities, $145 billion market capitalization as of September 21, 2009) and structural barriers to entry that had precluded widespread mutual fund ownership have been changed. Today the improved liquidity and market capitalization has reached a point where MLPs could comprise a meaningful portion of a utility or energy-focused or an income-oriented fund. Over the next decade, capital inflows will create a revaluation in the sector relative to other yield-oriented and energy equities. In the interim, the fundamental strength from the solid business models will allow the MLPs to generate attractive risk-adjusted total returns. Over the next decade, as they continue to build out the energy infrastructure of North America we would expect MLPs to produce mid-teens annualized total returns comprised of current cash distributions and future growth of that distribution.