MLP 101

Master Limited Partnerships 101:
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Understanding MLPs
2010 National Association of Publicly Traded Partnerships
Master Limited Partnerships 101 p

I. I II. II III. IV. V. VI. What is an MLP and why should I care? History of MLPs MLPs Today How MLPs Work Owning MLP Units g For more information
What is a Master Limited Partnership? (MLP)

A more accurate term and the one used term, in the tax code, is publicly traded partnership. partnership Simply it is a partnership or an LLC that Simply, partnership, has chosen partnership taxation, that trades on a public exchange (NYSE (NYSE, NASDAQ, AMEX) or over the counter market. market
Why should I be interested in Master Limited Partnerships?

The two biggest reasons:
Income: In an environment of fluctuating share prices, income becomes more valuable Tax Advantages: Because MLPs are partnerships, investors get more of th t hi i t t f the income and pay less tax on it.
Are master limited partnerships (MLPs) and publicly traded partnerships (PTPs) the same thing?

Simple answer: For most purposes, yes. The two terms are used g y interchangeably. Technical answer: Technically, no. An MLP is a partnership with a certain structure, not necessarily publicly traded ( (though most are). And some PTPs are g ) not MLPs, but publicly traded limited liability companies (LLCs) taxed as partnerships. hi
History of MLPs sto y o s

Master limited partnerships have been around for almost three decades
History of MLPs y
The first MLP was launched in 1981: Apache Oil Company. It purpose was t raise capital from Its to i it l f smaller investors by offering them a partnership investment i an affordable t hi i t t in ff d bl and liquid security. Other oil and gas MLPs soon followed and were joined by real estate MLPs.
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History of MLPs y
Rapid Growth in the 1980s The number of MLPs grew to well over 100. MLPs began to be used in other industries: hotels and motels, restaurants, cable TV, investment advisors even amusement parks and advisors, the Boston Celtics. Congress and tax officials worried about disincorporation--i.e., that large numbers of corporations would become MLPs to avoid p corporate tax.
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History of MLPs
In 1987 Congress passed legislation to define and li it publicly traded partnerships d limit bli l t d d t hi It c eated Sect o 7704 o t e Tax Code, limiting t created Section 0 of the a t g partnership tax treatment to PTPs earning >90 percent of their income from specific sources. Existing PTPs with bad income were grandfathered. Most gradually went private, were acquired or converted to other structures; only three remain today.
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History of MLPs y
What kinds of income can a PTP earn?
Interest, dividends, and capital gains Rental income and capital gains from real estate l d l f l Income and capital gains from natural resources activities ti iti Income from commodity investments Capital gains from sale of assets used to generate the above types of income
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History of MLPs y
Qualifying Natural Resources include:
Oil, gas, petroleum products Coal and other minerals Timber Any other resource that is depletable under section 613 of the federal tax code Ind st ial source carbon dioxide (added in 2008) Industrial so ce ca bon dio ide Ethanol, biodiesel, and other alternative fuelstransportation and storage only (added in 2008)
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History of MLPs y
Qualifying Natural Resource Activities include: Exploration, development & production (E&P) Mining Gathering and processing Refining Compression Transportation (pipeline, ship truck) (pipeline ship, Storage, marketing, distribution But not retail sales (no gas stations)
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History of MLPs y
During the late 1980s and the 1990s: g
Many of the original oil and gas MLPs left the market, unable to maintain distributions as oil and gas prices dropped.
Many of the original real estate MLPs disappeared during the real estate slump or converted to REITs. Integrated energy companies began selling or spinning off midstream assets ( th i i i ff id t t (gathering, processing, pipelines, distribution) to MLPs to p pursue more profitable investments. p
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History of MLPs y
During the 2000s: g
The number of MLPs in oil and natural gas midstream businesses steadily increased. y They were joined by MLPs engaged in marine transportation of petroleum products and in petroleum distribution. Beginning in 2006 exploration and production MLPs began to make a comeback. S Several general partners of MLP went public as MLP l l t f MLPs t bli MLPs themselves in 2005 and 2006. g g p Several investment managers turned their holding companies into PTPs (e.g., Blackstone).
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History of MLPs y
In 2008 qualifying income was expanded by Congress for the first time since 1987. Qualifying natural resources activities now include transportation and storage of biofuels such as ethanol and biodiesel. Industrial carbon dioxide now qualifies as d i l b di id lf a natural resource.
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History of MLPs y
Alternative fuels qualifying under the 2008 addition include: Ethanol and methanol and other alcohol fuels and fuel mixtures Biodiesel fuels and biodiesel mixtures Liquified petroleum gas Liquified hydrogen Liquified or compressed natural gas Liquid fuels derived from coal Liquid fuels derived from biomass
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Master Limited Partnerships
Today
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MLPs Today y
Currently there are roughly 90 MLPs traded on NYSE, Currently, NYSE AMEX, NASDAQ; more OTC and on pink sheets (exact count is hard to get). Todays MLPs primarily focus on energy-related industries and natural resources. Most are in oil and gas midstream industries; others are in other oil and gas activities and coal. A few remain in real estate; most of the rest are in investment/financial activities. There are also a number of PTPs that are not active businesses but simply publicly traded commodity funds.
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MLPs Today
Changes in Industry Concentration
Industry (does not include commodity pools)
Oil and Gas Midstream Oil & Gas Exploration. & Production O&G Marine Transportation Propane & Heating Oil Distribution Coal Leasing or Production Other Mi Oth Minerals, Timber l Ti b Real Estate-Income Properties Real Estate- Developers, Homebuilders Real Estate-Mortgage Securities Hotels, Motels, Restaurants Investment/Financial I t t/Fi i l Other Businesses
1990 10% 21% 1% 0% 0% 5% 14% 4% 13%

12%
2010 46% 11% 7% 8% 6% 2% 3% 0% 3%

0%
6% 15%
8% 5%
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MLPs Today: Changes in Industry Groups

MLPs by Industry Group-1990
Other 32% Energy and E d Natural Resources 37%
Real Estate (incl. mortgage securities) 31%

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MLPs Today: Changes in Industry Groups

MLPs by Industry Group Today y y p y
Energy and Natural Resources 80%
Other Businesses 5%
Investment 8%
Real Estate 7%
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MLPs Today: Changes in Industry

MLPs by Industry - 1990
Other Businesses 15% Investment/ Financial 5% Oil and Gas Exploration & Production 21%
Hotel, Motel, Restaurant 12%
Oil and Gas Midstream 10%
Oil and Gas Marine Transportation 1% Real estatemortgage securities 13% Minerals and Timber 5% Real estate-income properties 14%
Real EstateDevelopers, Homebuilders 4%
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Master Limited Partnerships by Industry-2010
O& G Midstream Operations 46% Other Businesses 5% Investment/Financial 8%
Real Estate - Mortgage Securities 3%
Real Estate Properties 3% Other Minerals, Timber 2% Coal 6% Oil & Gas E&P G 12% Propane & Heating Oil 8%
Marine Transportation 7%
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1990 2010
Oil & Gas Midstream Propane & Heating Oil Coal Real Estate-Properties Investment/Financial
Marine Transportation Oil and Gas & Production Other Minerals, Timber Real Estate-Mortgage Securities Other Businesses
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HOW MLPs WORK
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How MLPs Work

MLPs that are limited partnerships have: p p
One or More General Partners (GPs)
GP Manages Partnership Generally has ~2% ownership stake in partnership Has incentive distribution rights (IDRs)
Th Thousands of Li i d Partners (LPs)/Unitholders d f Limited P (LP )/U i h ld

Unitholders = LPs holding publicly traded units Provide capital Have no role in partnerships operations or management Receive quarterly cash distributions
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HowMLPsWork yp p TypicalLimitedPartnershipStructure
Corporate Parent or Other Owners Pipeline GP LLC General Partner (2%)
LP Interest 2% GP Interest LP Interest
UnitholdersLimited Partners
Pipeline MLP, L.P. p ,

100% Owned
Pipeline Operating LLC (or L.P.) LP)
Operating Subsidiaries
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HowPTPsWork y MLPWithPubliclyTradedGP
Corporate Parent or Other Owners
Pipeline GP Holdings, L P. Holdings L.P

LP Interest 100% Membership Interest
Public GP Holdings, L.P. Pipeline UnitholdersLimited Partners
Pipeline GP LLC General Partner

<2% GP Interest
Public UnitholdersUnitholders Limited Partners
Pipeline MLP, L.P.

Pipeline Operating LLC (or L.P.) Operating Subsidiaries
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How PTPs Work MLP St Structure t

Incentive Distribution Rights (IDR) The IDR is a share of cash distributions paid to GP. It generally starts at 2% (vs. 98% to LPs). g y ( ) As quarterly distribution to LPs goes up, and targeted distribution levels achieved, IDRs to GP increase with each marginal increase in distributions. IDR Rationale Incentive for General Partner to grow the business. p Compensation for unit subordination.
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How MLPs Work MLP Structure

Example: Incentive Distribution Tiers p LP distribution up to
LP %
Tier 1 Tier 2 Tier 3 Tier 4 98% 85% 75% 50%
GP%
2% 15% 25% 50%
$ $2.00 $2.50 $3.00 Above $3.00

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How MLPs Work LLCs LLC

MLPs That Are LLCs:
Have members rather than partners thousands of public unitholders own membership interests rather than LP interests Have no GP. Management owns same membership interests as unitholders Have no IDRs All members, including public unitholders, have voting rights g g
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How MLPs Work Typical LLC Structure

Management Public Unitholders (Members) Other Owners (Members)
Energy Co LLC Co.,
Operating Subsidiaries
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How MLPs Work

In both Limited Partnerships and LLCs: Lower-level entities, not the MLP, own the assets and conduct operations Taxation is on a pass-through basis There is no corporate or other entity-level tax All tax items flow through to the LPs or , p y members, who pay tax at their own rates
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How MLPs Work

Characteristic
Taxable t tit level T bl at entity l l Tax Items Flow Through Tax Deferral on Distributions Tax Reporting General Partner IDRs Investor Voting Rights
MLP No N Yes Yes K-1 Yes Yes No
LLC No N Yes Yes K-1 No No Yes
Corporation Yes Y No No DIV-1099 No No Yes

Source: Wachovia
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How MLPs s Work

Benefits of Operating as an MLP: Pass-through tax structure (no double taxation) means lower cost of capital, providing advantage in acquiring and maintaining assets g Can own rate-regulated assets and still give investors an attractive rate of return P bli trading allows MLP to raise funds from broader Public t di ll t i f d f b d range of investors than non-traded partnership p g p g Operating as an MLP rather than a corporation gives management greater control Lack of entity-level tax leaves more cash to distribute to investors
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How MLPs Work

Disadvantages of MLP Structure Qualifying income restrictionslimited to certain types of businesses Tax complexity and expense Fe retained ea nings m st raise debt o Few etained earningsmust aise or equity for expansion or acquisition Disincentives for investors K 1s state taxes investorsK-1 s, Limited investor pool because of tax laws applying to institutional investors
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Master Limited Partnerships 101
Being an MLP B i Investor
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Being an MLP Investor g

Being an MLP unitholder is different from being a corporate stockholder: Taxation of your investment is very f different and usually more favorable Depending on the structure, you may not have voting rights (limited partners generally dont; LLC members do)
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Being an MLP Investor Taxation

Partnership Tax Basics: Income
An MLP is a pass-though entity which pays no tax itself. The unitholder is treated for tax purposes as if he is directly earning the MLPs income. y g Each unitholder is allocated on paper a share of the MLPs income, gain, deductions, losses, and credits. This is reported annually on the K-1. The unitholder calculates his share of taxable income and pays tax on it at his own tax rate.
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Being an MLP Investor

Taxation Example
Amountpershare/unit: Amount per share / unit: GrossIncome Deductions TaxableIncome Federalcorporatetax Statetax(assumes5%rate) State tax (assumes 5% rate) Entitysnetincome ( ) Shareholdersfederaltax(28%) Shareholdersstatetax(5%) Corporation $4.00 $3.00 $1.00 $0.35 $0.05 $0 05 $0.60 $0.17 $ $0.03 PTP $4.00 $3.00 $1.00 $0.00 $0.00 $0 00 $1.00 $0.28 $ $0.05
Netincometoshareholder
$0.40
$0.67
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Tax Basics: Distributions
You will receive quarterly cash distributions, which are not the same as your share of the MLPs income. Distributions are based not on income but on distributable cash flow (DCF), which is: Net earnings, plus
Depreciation (which is subtracted from income in the earnings calculation but is not a cash expense) minus expense), Maintenance Cap Ex (the amount needed for maintainance and repair of assets used in producing income)
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Tax Basics: Distributions
Under the tax code, the distributions are a return of capital and are not taxed when received received. Your basis in your partnership units (the amount you paid + adjustments) is lowered by the amount of the distribution. Thus when you sell your units, your taxable Thus, units gain (sales price minus adjusted basis) is y increased by the amount of the distributions.
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Corporations - Dividends
C Corporation pays tax on earnings i i After-tax earnings paid to shareholder as dividend Shareholder pays tax on dividend
Partnerships - Distributions
Partnership does not pay tax; income and deductions flow through to partners Partners pay tax on net earnings (regardless of cash received) Cash distribution treated as tax deferred return of capital
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Basis Adjustments
Your basis is adjusted not only by y distributions but by tax items:
Your share of partnership income each year adjusts the basis upwards. p Your share of deductions like depreciation adjusts it downwards. The idea is that all income you receive from the partnership is taxed once and only onceeither in the year you receive it, or when you sell your units
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Being an MLP Investor - Taxation j p Adjusted Basis Example

Year 1: 1,000 units purchased @ $30.00. Basis is: Investor receives total cash distributions of $2.50/unit Investor is allocated and pays tax on net taxable income of $.50/unit Adjusted Basis Year 2: All units sold @ $32.00 Gain per unit - $32 00 - $28 00 $32.00 $28.00
$30,000 - $2,500 + $ 500 $28,000 $32,000 $ 4,000 4 000

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Being an MLP Investor Taxation T ti

Important Note: Not all of the gain when units are sold is taxed at capital gains rates. The gain resulting from basis reductions due to depreciation is taxed at ordinary income rates p y this is called recapture. Gain attributable to your share of some types of assetssubstantially appreciated inventory and unrealized receivablesis also taxed as ordinary income.
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Often you will hear someone say that 80% of the MLPs distribution is tax-deferred. In reality, 100% of the distribution (in our example, all $2.50 per unit) is tax-deferred What they really mean is that the unitholders allocated share of taxable income ($ 50 per ($.50 unit in the example) equals only 20% of the distribution.
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Being an MLP Investor Advantages Ad antages

Income:
MLPs pay out earnings not needed for current operations and maintenance of capital assets to their unitholders in the form of quarterly cash distributions. Most MLPs strive to increase their distributions as often as is possible and prudent. prudent
Tax benefits: no double taxation, sheltering of income, tax deferral on distributions LiquidityMLPs provide the tax benefits of p partnerships without tying up your money for p y g py y years.
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Being an MLP Investor Advantages Ad antages

MLPs may be suitable for investors: y Looking for a source of regular income payments Motivated by yield Seeking a combination of income and growth Wanting to reduce/defer taxes on their investments Interested in estate planning: as with other securities, the basis in PTP units is stepped up to fair market value at deaththe heir receives a fresh start with no taxation of previous distributions
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Being an MLP Investor Challenges

As we ve seen, tax reporting for an MLP weve investment is more complex than for shares in a corporation.
Investor receives a K-1 instead of a 1099 The K-1 reports investors share of all MLP tax items, which investor must enter on his/her own return MLPs make the process as easy as possible Many possible. post K-1s online, and they can be downloaded into Turbotax.
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Being an MLP Investor Challenges

State tax issues:
Technically, partners owe tax on their share of income allocable to each state in which PTP operates p Practically, after PTP income is divided among all partners and all states, and depreciation and other deductions applied, each unitholders income in each d d ti li d h ith ld i i h state will generally be too small to tax, except for those with large holdings.
PTPs dont lend themselves well to investment through retirement plans or mutual funds g p
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Being an MLP Investor Retirement Reti ement Plans

Think carefully before investing your IRA, 401(k), or other retirement plan in MLPs. MLPs These plans are tax-exempt already, so dont need the tax advantages advantages. More importantly, the plans share of net partnership income over $1 000 (not the $1,000 distributions) is likely to be subject to unrelated (UBIT) unrelated business income tax (UBIT) .
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UBIT is imposed on tax exempt entities (including tax-exempt retirement plans) that earn income from a business that is not related to the purpose of their tax exemption. p g , Because MLPs are pass-through entities, taxexempt partners (e.g., your IRA) are treated as directly earning the MLPs business income and are taxed on it. Investment income like interest, dividends, and royalties is not taxed.
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Some analysts feel MLPs are still a good investment for IRAs and other retirement funds, because: g The tax is on net income. Passthrough of depreciation and other deductions means net income may be below $1,000. Even if tax is owed, the income may be sufficient to produce a very good return. If your IRA or 401(k) does owe UBIT, it, not you, owes the tax. The plan custodian should file a p return and pay tax from the plans funds.
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Being an MLP Investor Mutual Funds

Since the American Jobs Creation Act of 2004 (AJCA), MLPs have been a qualifying ( ), q y g source of investment income for mutual funds. Before then, mutual funds were limited to 10% gross investment in MLPs and other d h nonqualifying income sources.
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Being an MLP Investor: Mutual Funds

There are still some limitations:
No more than 25% of a mutual funds assets can be invested in MLPs A fund cannot own more than 10% of any MLP
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Being an MLP Investor: Mutual Funds

The fund is the limited partner, is allocated the taxable income and receives the K-1 The fund also receives cash distributions If the fund passes on at least 90% of its income as dividends, it is not taxed on its share of partnership income The funds MLP income is included in the regular dividends paid to shareholders p
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Being an MLP Investor:

Investing Through M t l F d I ti Th h Mutual Funds
Advantages
Simplicity: You get a dividend and a 1099, 1099 no state tax issues S it bl for Suitable f retirement plans: dividends are not subject to UBIT.
Disadvantages
Loss of tax benefits: Income not offset by losses; no deferral of distributions Few options available at present time: Few mutual funds currently invest in MLPs, although this is slowly changing.
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Being an MLP Investor: Other Forms of Ownership

Closed-end funds like regular mutual funds, resolve the tax difficulties of ownership but at the cost of some of the tax benefits. Unlike regular funds, may invest entirely in MLPs. A good solution for IRAs and 401(k)s. Fiduciary / Claymore MLP Opportunity Fund Energy Income & Growth Fund Tortoise Capital funds (Energy Capital, Energy p ( gy p , gy Infrastructure, etc.) Kayne Anderson Energy Total Return, MLP Investment funds I-Shares: Kinder Morgan and Enbridge offer investment in their MLPs through a publicly traded LLC taxed as a corporation which manages and owns shares of the MLP. MLP Distributions are paid in the form of additional shares.
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Publicly Traded Partnerships 101 y p
How can I find out more about MLPs?
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VisittheNAPTPwebsite
www.naptp.org
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ContactInformation
Mary Lyman y y Executive Director, NAPTP 1801 K Street, NW Suite 500 Washington, D.C. 20006 (202) 973-4515 973 4515 mlyman@naptp.org
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MLP 101

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Master Limited Partnerships 101:

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

What is a Master Limited Partnership? (MLP)

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

Master Limited Partnerships 101 p

Why should I be interested in Master Limited Partnerships?

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

Master Limited Partnerships 101 p

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

Master Limited Partnerships 101 p

History of MLPs sto y o s

2010 National Association of Publicly Traded Partnerships

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

Master Limited Partnerships

2010 National Association of Publicly Traded Partnerships

1990 10% 21% 1% 0% 0% 5% 14% 4% 13%

2010 46% 11% 7% 8% 6% 2% 3% 0% 3%

MLPs Today: Changes in Industry Groups

Real Estate (incl. mortgage securities) 31%

MLPs Today: Changes in Industry Groups

2010 National Association of Publicly Traded Partnerships

MLPs Today: Changes in Industry

Hotel, Motel, Restaurant 12%

Oil and Gas Midstream 10%

Real EstateDevelopers, Homebuilders 4%

2010 National Association of Publicly Traded Partnerships

MLPs Today: Changes in Industry

Real Estate - Mortgage Securities 3%

2010 National Association of Publicly Traded Partnerships

MLPs Today: Changes in Industry

2010 National Association of Publicly Traded Partnerships

Master Limited Partnerships 101 p

HOW MLPs WORK

2010 National Association of Publicly Traded Partnerships

How MLPs Work

Th Thousands of Li i d Partners (LPs)/Unitholders d f Limited P (LP )/U i h ld

2010 National Association of Publicly Traded Partnerships

Pipeline MLP, L.P. p ,

Pipeline Operating LLC (or L.P.) LP)

Pipeline GP Holdings, L P. Holdings L.P

Public GP Holdings, L.P. Pipeline UnitholdersLimited Partners

Pipeline GP LLC General Partner

Public UnitholdersUnitholders Limited Partners

Pipeline MLP, L.P.

How PTPs Work MLP St Structure t

How MLPs Work MLP Structure

$ $2.00 $2.50 $3.00 Above $3.00

2010 National Association of Publicly Traded Partnerships

How MLPs Work LLCs LLC

How MLPs Work Typical LLC Structure

Energy Co LLC Co.,

2010 National Association of Publicly Traded Partnerships

How MLPs Work

How MLPs Work

MLP No N Yes Yes K-1 Yes Yes No

LLC No N Yes Yes K-1 No No Yes

Corporation Yes Y No No DIV-1099 No No Yes