Can you afford to miss out on an investment opportunity that has returned 66% to investors over the past five years – and has beaten every major market index in 11 of the past 12 years?

That’s the promise, and the potential of Master Limited Partnerships (MLPs), an energy investor’s answer to a long-unanswered question – how can I get income and growth appreciation out of a single investment – and earn a big tax break in the bargain?

In short, MLPs are publicly traded investment partnerships. MLPs have unit holders, and not shareholders, and are targeted toward the energy sector (primarily oil and gas), and trade on major exchanges such as the New York Stock Exchange, or Nasdaq.

For Canadians, MLPs are akin to their former Energy Income Trusts, as both can send most of their income—with almost no taxes—to unit holders.

Energy-related MLPs have one critical legal threshold to clear: In order for a partnership to qualify as one, the partnership must get 90% of its cash flows from commodities (usually oil and gas).

MLPs merge the tax benefits of a traditional limited partnership with the liquidity of a publicly traded company. The MLP doesn’t pay taxes from the profit. Instead, the money is only taxed when the partnership’s unit-holders receive their cash distributions.

And yes, MLPs are growing.

According to industry figures, over the past 10 years, MLP market cap growth has grown from $25 billion to $350 billion. MLPs own oil and gas pipelines, transportation and processing, refining, and storage sectors.

When it comes to MLPs, the positives have outweighed the negatives, but that doesn’t mean you should jump in eyes closed and head first.

Let's look at one key benchmark, the Alerian MLP Index (AMZ).

Since December 31, 2007, the index has returned 66.6% for investors, with about 32% of that from capital gains. Compare that to the S&P 500, where returns slid by 1.55% over the same time frame.

2012 was no exception: over its first six months, MLPs kept up the pace, outperforming all major investment indexes.

QUICK FACTS

 

There’s lots to love about MLPs:

• They combine the income-producing benefits of bonds with the capital appreciation advantages of stocks – and combine them into one energy investment that has outpaced every other leading investment benchmark in 11 of the last 12 years.
• On top of that performance, factor in a tax element that wipes clean 80%-to-90% of your tax burden on that investment.
• Combine that performance with an oil and gas industry investment that, historically, makes money no matter what commodity prices are doing.

That’s where MLPs may just may change the way you look at investing, altogether... especially in the more conservative part of your portfolio.

They are particularly engaging in a tepid economy, where finding oil and gas investments with reduced downside risk and returns that beat average dividend stocks is no easy task.

Can MLPs be a game-changer for you? Sure – if you know the lay of the land, and if you know how to play them right.

Here are some key points on MLPs:

1. How long have MLPs been around?

While the first MLP, Apache Oil Company, was formed in 1981, the investment vehicle really gained momentum in 1986, via the Tax Reform Act, and in 1987, via the Revenue Act. Both pieces of legislation stated that as long as 90% of MLP revenues originated from natural resources related to the exploration, development land ownership, and investment gains and losses, they would be considered “established” MLP structures.

Later in the decade, MLPs morphed into midstream ownership entities that owned assets that transported, refined and stored oil and gas products. That “asset ownership” feature helped MLPs reduce their exposure to volatile oil and gas prices, and provided a steady and reliable cash flow for MLP investors.

Historically, investors have been drawn to MLPs for two significant reasons:

• Income generation -- In volatile markets, where high investment risk is par for the course, income-generation is a priority.
• Tax benefits – Since master limited partnerships are considered legal, qualified partnerships by the I.R.S., unit holders earn more income – but pay less tax on that income.

MLPs have taken a pivotal, even leadership role in getting energy to U.S. consumers. They generally trade at a higher valuation than regular corporations (the industry calls those “C-corps”) and can therefore raise money for big projects more cheaply than them.

As owners of the storage facilities and pipelines needed to transport oil, gas and other commodities from the refineries to consumers, MLPs are ideally positioned to benefit from rising energy demand.

2. How are MLPs structured?

MLPs are generally structured with a General Partner (GP) acting as management, and the Limited Partners (LP) providing the capital.

• MLPs can have one or more General Partners, who can have a 2% ownership stake in the partnership.
• MLPs can have thousands of Limited Partners (known as unit holders) who own publicly traded units. Limited Partners play no role in the management of the partnership, and are eligible for quarterly cash distributions.

Most MLPs have a tiered-hierarchy, with a General Partner at the top of the organization, and are tasked to manage the MLP on behalf of unit-holders. Typically, General Partners have a 2% interest in the MLP, while the participation rate varies for individual Limited Partners, and they are tasked with providing financial capital, and benefit from investment gains from the partnership.

Unlike stocks, MLP partners own “units" of the partnership, and the number of units owned represents a Limited Partner’s stake in the partnership. Typically, Limited Partners look for two investment results from MLPs – strong yield and solid growth. In both areas historically, investors have often been rewarded handsomely.

Operationally, MLPs offer investors the following benefits:

• As a partnership, MLPs aren’t taxed like corporations. That “pass through” structure means unit holders aren’t “double-taxed” on dividends they receive. For the partnership, that tax structure means a lower cost of capital, thus giving MLPs a big advantage in generating more assets.
• MLP’s unique tax structure allows for more money to funnel to investors. And since MLPs are publicly traded, that enables MLPs to gain access to a wider ranger of investors.

3. How Can Individual Investors Get Going With MLPs?

Historically, MLPs were only available to the public as individual investments, but in recent years they’ve become available as closed-end funds and exchange-traded funds, and are now widely available on financial exchanges.

Some of the most widely traded individual MPs include:

*To read the rest of my MLP report, including a list of some of the strongest MLPs in the Market, simply enter your email in the box to the right. You'll get immediate access to my complete findings on MLPs (delivering some of the best dividends in oil & gas today) – and I'll also begin sending you my weekly Free Alerts via email, so you can get a leg up on all my top oil and gas investments.

Keith Schaefer, Publisher

Oil & Gas Investments Bulletin

DISCLOSURE: I own none of the stocks mentioned in this report; I do own other MLPs in the Oil & Gas Investments Bulletin portfolio, not stated here.

About Oil & Gas Investments Bulletin

Keith Schaefer, Editor and Publisher of Oil & Gas Investments Bulletin, writes on oil and natural gas markets - and stocks - in a simple, easy to read manner. He uses research reports and trade magazines, interviews industry experts and executives to identify trends in the oil and gas industry - and writes about them in a public blog. He then finds investments that make money based on that information. Company information is shared only with Oil & Gas Investments subscribers in the Bulletin - they see what he’s buying, when he buys it, and why.

The Oil & Gas Investments Bulletin subscription service finds, researches and profiles fast growing oil and gas companies. The Oil and Gas Investments Bulletin is a completely independent service, written to build subscriber loyalty.