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The Rise and Fall of Master Limited Partnerships

A decade ago, master limited partnerships (MLPs), were a favored investment class for income investors. They have unique tax advantages that resulted in significant advantages over other income equities.

In a nutshell, MLPs aren't taxed at the corporate level. MLPs pass profits directly to unitholders in the form of periodic distributions. This arrangement avoids the double taxation of corporate income and dividends affecting traditional corporations and their shareholders and, all things being equal, should deliver more money to unitholders.

A Decade of Superior Returns

The Alerian MLP Index (AMZ) is a composite of prominent energy MLPs, capturing most of the sector's market capitalization. Most of these MLPs are in the "midstream" energy sector, which involves transporting and storing oil and gas. The AMZ is a good benchmark for the MLP sector.

Before the oil price downturn in 2014, the AMZ had more than doubled the return of the S&P 500 over the previous decade. The average yield of the AMZ during that time was about 7.5% (currently it's at 6.9%).

Between the beginning of 2005 and the oil price downturn that began in late 2014, the AMZ generated a total return of 249% versus 122% for the S&P's 500-stock index, 118% for utilities, 117% for real estate investment trusts (REITs), and 59% for bonds.

This amounts to an average annual return over that time of 13.3% for MLPs, 8.3% for the S&P 500, 8.1% for utilities, 8.1% for REITs, and 4.7% for bonds.

With returns like that, money flooded into MLPs. But the following decade would bring on a series of unfortunate events.

Misfortune Hits the Industry

First, the price war that OPEC initiated with U.S. shale producers in late 2014 ultimately impacted the midstream sector.

Conventional wisdom long held that since midstream MLPs function as toll collectors for transporting oil and gas, they were more insulated from the commodity price volatility that can impact oil producers. This is true, but during a long downturn in oil and gas prices, contracts expire and MLPs may have to renew agreements under less favorable terms.

That is exactly what happened. Consequently, following the 2014 crash in oil prices, many MLPs found themselves doing what was once unthinkable. They had to cut distributions.

Investors who had gravitated to MLPs for predictable income streams suddenly found that there was more risk in the space than they had come to expect.

As a result, MLPs suffered a steep drop in 2015. Then, President Trump signed a tax overhaul bill that dropped the corporate tax rate from 35% to 21%. This was great for corporations, but it significantly reduced the key tax advantage an MLP held over a corporation.

Next, a ruling by the Federal Energy Regulatory Commission (FERC) to reverse a longstanding policy on MLP tax costs for interstate pipelines drove up the cost of business for some. Some MLPs were significantly impacted by this ruling, again reducing one of the advantages they held over a comparable C-corp.

Even a bellwether (at that time) MLP like Kinder Morgan saw its unit price decline by 70%. Declines like this can be expected for aggressive investors, but for income investors, it was a nightmare.

Kinder Morgan ultimately rolled its MLPs up in the parent corporation, with significant tax implications for those holding those units. Tax-advantaged deferred income is one of the most compelling reasons for owning an MLP.

But, if the MLP gets converted to a corporation, then the IRS is finally going to get paid. This is the last thing MLP investors want to see because it can create an immediate tax burden from the accrued tax benefits.

MLPs Today

The number of MLPs has shrunk dramatically in recent years. According to the Energy Infrastructure Council (EIC), which maintains a list of publicly traded MLPs, there are currently about 45 MLPs spread across about 10 categories. But many of the major MLPs have been either converted to corporations, were acquired, or were absorbed by their general partner.

The most recent high-profile acquisition was in 2023, when ONEOK, Inc. acquired Magellan Midstream Partners, L.P. in a cash-and-stock deal valued at approximately $18.8 billion.

Today, there are only four MLPs with a market capitalization of at least $20 billion. The bellwether of the group is Enterprise Products Partners LP, with a market capitalization of $63.3 billion and a current yield of 7.1%.

While the MLP sector has been through a tumultuous decade, companies like EPD that have survived and adapted represent some of the strongest players in the midstream energy infrastructure space. For income investors willing to do their homework, MLPs can still potentially offer attractive tax-advantaged yields and exposure to the critical assets that support U.S. energy production and transportation.

By Robert Rapier

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