Master Limited Partnerships (MLPs) Demystified

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Many investors are seeking additional strategies to help improve portfolio diversification and increase the yield generated by their investment portfolio. MLPs have been receiving a lot of attention recently and may indeed help investors achieve both of these objectives as part of a thoughtful, well-planned investment strategy. However, MLPs are more complicated than traditional stock and bond investments and these complexities may seem intimidating to potential investors. With that, the goal of this piece is to help demystify MLPs by providing a broad framework for understanding these investments and, importantly, how to effectively implement in a client’s portfolio. Given the accompanying tax complexities, investors should consult with a tax professional before investing in MLPs.

A Brief Look at the U.S. Energy Infrastructure

In order to provide some context for the investment implications of MLPs it’s useful to have a general sense of the current energy landscape. Many MLPs are involved with the transportation of energy commodities from point of production to processing facilities. This pipeline network is vital to our country’s economic health and infrastructure and forms our “economic cardiovascular system.” Approximately two-thirds of the oil and petroleum products transported annually are via these pipelines. The map on page 3 illustrates the U.S.’s crude oil, carbon dioxide, liquid natural gas, and refined products pipeline network that serves the U.S.

U.S. Energy Production Growth and MLPs

Today, the United States is the fastest-growing energy-producing nation in the world and is rapidly becoming the new “Middle East” based on our energy reserves. According to the U.S. Energy Information Administration (EIA), as of 2012 (the latest results available), the U.S. was the second-largest oil producer in the world, just behind Saudi Arabia, and is expected to become the largest oil producer, perhaps as early as 2015. It is also now forecast that the United States may become energy independent by as early as 2020. It is generally estimated that between $250 and $300 billion will be invested in energy infrastructure in order to develop the U.S.’s unconventional shale reserves over the next 10-20 years in order to meet this growth potential. Portfolio managers that specialize in MLP investing routinely cite this as an important part of the investment rationale for investing in MLPs. The EIA reports that there are over 665 trillion cubic feet of technically recoverable shale gas and 58 billion barrels of technically recoverable shale oil resources in discovered shale plays. Indeed, the growth of MLPs is closely tied to the U.S. rebirth in oil and natural gas production and infrastructure.

Fairly recently, advances in hydraulic fracturing technology, or “fracking”, have made the current shale drilling boom possible. Hydraulic fracturing involves the use of water pressure to create fractures in rock that allow the oil and natural gas it contains to escape and flow out of a well. This makes it possible for shale oil extraction to produce oil and natural gas in places where conventional technologies have been ineffective.

The shale gas map on page 4 shows the “plays” that are found throughout the country. These plays are geographic areas where companies are actively looking for natural gas and shale oil reserves in shale rock.