How Kinder Morgan Impacts Master Limited Partnerships

How Kinder Morgan Impacts Master Limited Partnerships

Pipe with Wood Lagging - http://en.wikipedia.org/wiki/File:Pipe_with_Wood_Lagging.jpg
Pipe with Wood Lagging

This week Kinder Morgan Inc., the biggest pipeline company in North America, announced that it will consolidate its master limited partnerships, Kinder Morgan Energy Partners and El Paso Pipeline Partners, with Kinder Morgan Management LLC and organize into a single C-corporation. By absorbing the partnerships, the company will reduce borrowing expenses, and devote more available cash to expanding its pipeline network through acquisitions and new construction.

With the move, Kinder Morgan will abandoned the master limited partnership (MLP) structure it helped popularize for the energy industry. MLPs allow companies to raise funds in the same way as a corporation does, but instead pay taxes as a partnership, thereby avoiding corporate taxes. The MLP structure provides the flexibility and opportunity to raise capital from smaller investors directly from the stock market. Income from the partnership is passed along to investors as dividends, who pay taxes on a portion of that income based on their individual tax rate.

MLPs face greater scrutiny

With Kinder Morgan restructuring as a traditional corporation, questions have emerged about what will happen to many other MLPs. In August, the U.S. Treasury Department added more uncertainty to the issue, announcing that it was examining whether MLPs were depriving the government of needed tax revenue. The U.S. Government has recently placed a renewed focus on the corporate tax code and its loopholes, following a rise of inversion deals over the last couple of years. Previously, most new partnerships were formed after being granted so-called private letter rulings from the IRS. However, this year those letters were temporarily stopped over concerns that the standards were becoming too loose. There’s no word yet on when the IRS will start issuing them again.

MLPs remain popular for O&G industry

Despite increased scrutiny from the federal government, the interest in MLPs remains strong, especially within the oil and gas industry. That’s in part because of the tax advantages and high yields they generate in a low interest rate environment. MLPs offer investors an opportunity to capitalize on surging oil and gas prices, while shielding themselves from volatile commodity prices. For this reason, MLPs have boomed in recent years. In 2009, there were 66 such companies, worth a combined $160 million. Today there are well over 100 MLPs, worth more than $500 billion in total.

It seems that if anything, Kinder Morgan simply outgrew the MLP structure. It was increasing its dividends by 5 or 6 percent a year, which, when compared to other faster-growing MLPs, made it a less attractive stock for investors to own. Kinder Morgan Energy Partners, the largest MLP of the Kinder Morgan empire, had also reached a tipping point at which it was paying a majority of its dividends to the Kinder Morgan corporation – its general partner – and not to shareholders. In 2013, it paid about half of its $3.3 billion in cash to Kinder Morgan Inc.

It’s likely that other big master limited partnerships will soon face the same challenges as Kinder Morgan. The question is, will they follow suit and amalgamate into one single entity, or will the tax benefits of MLPs encourage them to pursue other alternatives?