Energy MLPs are an alternative asset class with unique characteristics that offer potential benefits for investors, including:
Master Limited Partnerships are publicly traded partnerships that primarily operate energy infrastructure such as pipelines and storage facilities. Demand for that infrastructure is soaring thanks to the recent renaissance in domestic oil and gas production: The U.S. is now the largest producer of natural gas in the world, and has overtaken Saudi Arabia as the world’s largest oil producer. What’s more, infrastructure operators are paid on long-term contracts, which can insulate MLPs from the effects of fluctuating energy prices.
In an MLP, a general partner manages the business operations, but investors can buy in as limited partners (called unitholders) who are entitled to a portion of the income those operations generate. Income is typically paid out in quarterly cash distributions, but changes in voting rights or dilution of partnership shares could affect the amount or timing of those payments.
High yields, stable income: Yields typically run 5%-6% annually, roughly double the yield of the Barclays Aggregate Bond Index over the past decade. Energy companies sign long-term contracts to guarantee access to storage and transportation infrastructure, so MLP distributions tend to be very stable over time.
Tax treatment: The tax rules that created MLPs were intended to spur investment in a capital-intensive infrastructure build out. Because MLPs are pass-through entities, they pay no tax themselves. Instead, the IRS treats unitholders as if they receive an MLP’s income directly. However, typically between 85%-100% of those distributions are treated as return of capital and are tax-deferred, counting as capital gains when the investment is sold.
Strong potential returns: MLP distributions tend to grow at a rate faster than inflation: In the last decade, MLP distributions have grown an average of about 6% a year. That means an MLP investment can provide a non-correlated income stream as well as total return potential to supplement a portfolio’s fixed-income or balanced holdings. MLP returns could suffer, though, if regulatory changes revoke MLPs’ partnership status and special tax treatment.
Because of MLPs’ unique tax structure, investors should consult their advisor or tax professional to learn more about potential tax implications of an MLP investment.