The ABCs of MLPs

In This Issue: The ABCs of MLPs The Battle for the Future Begins (Again) 15.2% per year for 10 years running? That's better than nearly 95% of stocks. And that's just the average for this overlooked sector that not one in 100 investors has a penny in. The best in this sector do even better. I'll give you 5 of my favorites – yielding an average of 7.6% – right now for free. Click here to learn more. The ABCs of MLPs 2/04/2015 By Chad Fraser If you're looking for steady, reliable income, midstream master limited partnerships (MLPs) are a great place to start. So says Investing Daily analyst Robert Rapier, one of the pros behind our Energy Strategist and MLP Profits advisories. "I am a relatively conservative investor," writes Rapier in the latest Energy Strategist. "I expect that I still have a number of years until retirement, but the closer that time comes, the more conservative I become. When I do retire, I, like many other investors, will mainly use my investments to provide a steady and fairly reliable income stream. This is where midstream MLPs excel." "Midstream" simply means these partnerships run the decidedly unsexy operations---think pipelines and storage tanks---that are nonetheless vital for getting oil and gas from field to market. (Not to be confused with upstream MLPs, which focus on production, or downstream partnerships, which refine and distribute fuel.) A Leg Up on Oil Prices A good way to think of midstream MLPs is as toll collectors, collecting a fee for every barrel of oil or cubic foot of natural gas that passes through the network. But they also enjoy an added benefit: their contracts typically lock in a big chunk of that income---even if a customer doesn't ship a drop. That means they're more insulated from whipsawing oil prices, like the ones we've seen lately, than their upstream or downstream cousins. Still, you shouldn't take that to mean they can't lose value, writes Rapier: "One component of an MLP's value rests on the expectation that it will be able to grow distributions [as dividends are known in the MLP world] by adding new infrastructure. If oil and natural gas prices remain depressed, the infrastructure build-out will slow, dampening distribution growth. "Thus, the prices of midstream MLP units have dropped along with the price of oil---but their decline has been relatively mild in comparison with drillers' shares." The numbers bear that out. Since it began its slide in late June, the price of oil has dropped around 52%. In that time, the Energy Select SPDR ETF (NYSE: XLE), which mainly consists of major oil and gas producers and oilfield service firms, has shed about 20% of its value. Meanwhile, the Alerian MLP Infrastructure Index ETF (NYSE: AMLP)---made up, as the name suggests, mainly of midstream partnerships---is down about 7%. But it's as long term-holdings that midstream MLPs shine: as Rapier demonstrates in his article, since inception in 1995, the Alerian ETF's underlying index, the Alerian MLP Infrastructure Index, has risen at a steady pace, with few significant corrections, while yielding an average of 7.5%. Below is a brief history of MLPs and a bird's-eye view of how they benefit investors. Further on, we'll examine one midstream partnership we recommend in MLP Profits. A Brief History of the (MLP) Universe MLPs trade on the major exchanges, just like stocks, and can be bought or sold through any broker. They raise capital by issuing units---the equivalent of shares of common stock. When you buy an MLP, you're known as an LP unitholder. But here's a key difference: MLPs don't pay tax at the corporate level. Instead, they pass through most of their income to investors in the form of regular distributions, which investors then pay individual tax on. That frees MLPs from the double taxation most corporations have to deal with (i.e., corporate tax at the corporation level and income tax at the shareholder level). The result? MLPs can provide limited partners---investors---with more cash. But there's more. Thanks to high depreciation and amortization charges, up to 90% of the cash distribution you get from an MLP is treated as a return of capital, which is not taxable when received. Instead, returns of capital reduce the cost basis of an investment in the MLP. The rest of the distribution---typically 10% to 20%---is taxed as ordinary income. But being able to defer the rest of the tax until the investment is sold is an advantage, because you can reinvest that income to generate compound returns that could more than pay for the eventual tax bill. Of course, there are some potential drawbacks with MLPs. One is that they can make your taxes more complicated. MLPs issue Schedule K-1 forms instead of the 1099 forms you may get from a corporation, and the K-1 package will include a state schedule that details the MLP's share of income or loss attributed to each state in which it operates (a pipeline, for example, may span five states). You may have to file state tax returns for each one---though most individual investors fall well under the threshold for having to do so. Apache Oil Company formed the first MLP in 1981. Other oil and gas and real estate firms followed, but the structure soon spread, drawing in everything from restaurants to casinos, hotels and cable companies. Little-remembered fact: even the NBA's Boston Celtics once operated as an MLP. As you might expect, none of this escaped Congress's notice. Worried about lost tax revenue, it legislated new rules in 1987 stating that at least 90% of an MLP's income must come from qualified sources, such as natural resources or real estate. Size Matters Few businesses---inside or outside the MLP universe---can boast the kind of reach MLP Profits recommendation Enterprise Products Partners (NYSE: EPD) has; it's the largest publicly traded MLP in the US. Enterprise operates 51,000 miles of pipelines, six offshore production platforms, 24 natural gas processing plants and numerous storage facilities. It also has a marine services business with 55 towboats and 176 barges, as well as natural gas liquids import/export facilities at the Houston Ship Channel. The units have posted a total return of 277% since MLP Profits first recommended them in May 2009. In early January, Enterprise raised its quarterly distribution by 5.7%, to $0.37 from $0.35, for a 4.2% yield. The move marked the MLP's 42nd consecutive quarterly hike. Late last year, Enterprise announced that it would extend its reach further through a $6-billion deal for Oiltanking Partners LP (NYSE: OILT). Among other assets, Oiltanking owns a terminal in the Houston Ship Channel that's connected to Enterprise's liquefied petroleum gas (propane or butane), octane-enhancement and propylene complex in Mount Belvieu, Texas. Investing Daily analyst Igor Greenwald sees the acquisition as just one of Enterprise's strengths, despite low oil: "[Enterprise's] long-term service contracts provide protection ... and a pool of retained and reinvested earnings secures the distribution," he wrote in the latest MLP Profits. "The Oiltanking buyout ensures the partnership will remain a key player in Gulf energy exports." Beat 95% of the Market With MLPs With their fat distributions and steady price gains, MLPs have made mincemeat out of stocks, returning 15.2% a year for 10 years running. That's better than 95% of US stocks! What's more, some let you pocket high yields for 10 years or more before you pay a single penny of tax. One of our favorites yields 11%, and you can defer taxes on 95% of your income---in some cases forever. Get the full story here. 48 Million Shocking Reasons You Can't Relax The numbers are in, and they're staggering. Forty-eight million Americans live in poverty. Sixteen percent of them are children. That doesn't sound like a country that's headed in the right direction to me. And things aren't looking much better for the millions of Americans just scraping by, either. A major market correction looms on the horizon, one that is statistically overdue by two years. Are you prepared? Sadly, most investors aren't. I'll give you five easy ways to protect yourself when you click here. The Battle for the Future Begins (Again) 2/03/2015 By Richard Stavros Hang on to your seats, my friends: The utilities industry is going to get a lot more interesting over the next 12 months, as executives start to lay out their strategic plans. And that means there will be lucrative opportunities for investors with the savvy to identify the firms best positioned for the long term. What has me so worked up? Utility executives rarely use the word "change." And when they do use that word, especially as frequently as they have in recent speeches and presentations, it's a potentially epochal portent of the shape of things to come. In this case, if past events are any guide, the industry is set to undergo a huge shake-up. The last few times change of this magnitude swept the industry, it led to all sorts of new investment opportunities--both good and bad. The electric deregulation of the 1990s produced energy-trading firms that went belly up with Enron by the early 2000s. But deregulation also produced wires-only companies (firms formed from the spin-off of utility electric transmission assets) that are arguably more stable than the utilities themselves. Subsequently, merchant generation really came into its own in the mid-2000s, paving the way for retail electric competition, where independent firms compete regionally for retail customers. But only a few merchant generators were real successes, and consequently plays on retail electric competition have had mixed results. The last time real change was in the air was from the threat of climate legislation in the mid-2000s. This pushed many utilities to develop renewable-energy strategies, which have proved profitable for some firms, enabling them to climb to the top of the industry. These firms took advantage of multi-year contracts as part of state renewable portfolio standards, creating additional stable, utility-like earnings. Longtime readers will recall that we've spent the past year discussing many of these changes in the pages of Utility Forecaster. But now we're shifting from discussing potential disruption to acceptance of such changes. And that means we must define how utilities will embrace new distributed renewable technologies and natural gas dynamics. Taking the Lead on Change In late January, at the United States Energy Association's 11th Annual State of the Energy Industry Forum, Edison Electric Institute President Tom Kuhn, whose association represents investor-owned utilities, outlined the challenges. "As you are aware, 'change' is the buzzword in our industry today. I always say that there are three key drivers to change: shifts in public policy, new technologies, and evolving customer and market expectations. How our industry adapts to and leads these changes, while continuing to provide value to our customers, will define our long-term success," Kuhn said. And Kuhn was laser-focused on three particular issues: 1) The Environmental Protection Agency's (EPA) proposed rule to regulate greenhouse gas emissions of existing plants, which will lead to mass coal-plant shutdowns; 2) the growing interest in the use of distributed-generation systems such as customer-owned wind power and rooftop solar panels; and 3) cybersecurity and new advances in technology integration. Of course, Kuhn leads an association whose members include a number of utilities that will be hurt by the EPA's new emissions rules. These regulations would force utilities to incur heavy costs to replace coal plants, while losing market share to firms who are ahead of them on the renewable-energy front. As such, Kuhn called for the relaxation of interim requirements in the EPA rule, since he believes the industry cannot comply with present goals. He also made the case for the grid to be the backbone of the technological revolution, particularly as the industry is spending billions on its modernization to do just that. And Kuhn insisted that both those with and those without distributed generation help pay for this effort, since the absence of the former would make the economics of this system upgrade unsustainable. Although Kuhn's proposals are clearly designed to protect coal utilities and vertically integrated utilities in the short term, even if his ideas were fully adopted that still would not be enough to preserve the status quo over the medium to long term. And I think Kuhn understands this. For as much time as he spent describing the need for certain policies, he also spent considerable time explaining how these new technological breakthroughs would transform the U.S. economy. His remarks lead me to believe that investors should expect a showdown between those utilities that lead these changes and those that don't. And just what will this change look like? David Crane, CEO of NRG Energy Inc (NYSE: NRG) really wowed attendees of the company's investor meeting in mid-January. In his presentation entitled, "Win Today, Win Tomorrow, Win the Future," he detailed rooftop solar's incredible potential for value creation. He likened the industry transformation that's underway to the move that telecoms made from fixed line to cellular. Crane observed that in the telecom space the incumbent that fully embraced the future technology continued to compete aggressively and win new market share. He showed how the successors of two Baby Bells, AT&T Inc (NYSE: T) and Verizon Communications Inc (NYSE: VZ), came to dominate the space for new technologies and go from a combined $40 billion market capitalization in 1988 to $540 billion in 2014, increasing their aggregate market cap by 13.5x. Most investors would be quite pleased with such growth if it happens in the utilities space. What's the winning blueprint? Crane says it comes down to three things. The first, as mentioned, is embracing new technology. Second, firms must change their culture from being a fixed-asset company to a customer-focused company built on a foundation of fixed assets and technological expertise. Lastly, a successful utility must be a consolidator of value of the traditional sector along the way. In other words, even a firm that's embracing technological change must still be able to beat its peers by operating under the traditional business model while it remains dominant. That's how Crane believes NRG will win the future. And his template could prove useful as a way to begin thinking about how to identify tomorrow's top utility investments. Utility Forecaster subscribers receive the full article, where we identify which companies are best positioned to take advantage of the changes that are occurring in the industry. This article originally appeared in the Utility & Income column. Never miss an issue. Sign up to receive Utility & Income by email. Warning: Idle Investors Will Drown A new technology wave is rolling through cyberspace. It will change every facet of our lives. Many companies won't survive. But the wave will usher in a new round of winners. We're at the tipping point right now! Smart companies have already spent $399 billion on this technology. But in the next 4 years, spending will DOUBLE! These 4 'next wave' profit winners are where the smart investors will be for massive gains. The rest will miss it. Details here. You are receiving this email at benjamart.ss.stock@blogger.com as part of your subscription to Investing Daily's Stocks To Watch, published by Investing Daily. To ensure delivery directly to your inbox, please add postoffice@investingdaily.com to your address book today. Email Preferences | About Us | Premium Services | Contact Us | Privacy Policy Copyright 2015 Investing Daily. All rights reserved. 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