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WACHOVIA CAPITAL MARKETS, LLC
MLP Primer -- Third Edition
Everything You Wanted To Know About MLPs, But Were Afraid To Ask • Primer Third Edition – A Framework For Investment. This report is an update to our second master limited partnership (MLP) primer. In this third edition, we have added new information based on questions and feedback received from investors over the past three years. Included in this edition are updated data about MLPs’ relative performance, the growth of MLPs as an asset class, and developments within the MLP sector (e.g., legislation, fund flow).
July 14, 2008
Master Limited Partnerships Michael Blum, Senior Analyst
( 2 1 2 ) 2 1 4 - 5 0 3 7 / mi c h a e l . b l u m@ w a c h o v i a . c o m
Sharon Lui, CPA, Senior Analyst
(212) 214-5035 / email@example.com
Eric Shiu, Associate Analyst
(212) 214-5038 / firstname.lastname@example.org
Praneeth Satish, Associate Analyst
(212) 214-8056 / email@example.com
Ronald Londe, Senior Analyst
(314) 955-3829 / firstname.lastname@example.org
Jeffrey Morgan, CFA, Associate Analyst
(314) 955-6558 / email@example.com
Please see page 93 for rating definitions, important disclosures and required analyst certifications.
WCM does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision.
MLP Primer -- Third Edition
WACHOVIA CAPITAL MARKETS, LLC EQUITY RESEARCH DEPARTMENT
Table Of Contents
I. II. Introduction -- A Framework For Investment........................................................................................................................ 5 Why Own MLPs? .................................................................................................................................................................. 5 A. Above-Average Performance And Good Portfolio Diversification......................................................................... 5 B. MLP Value Proposition -- Tax-Efficient Income Plus Growth ............................................................................... 8 C. MLPs Have Been Defensive During Economic Slowdowns................................................................................. 10 D. MLPs Are An Effective Hedge Against Inflation.................................................................................................. 11 E. Demographics........................................................................................................................................................ 11 F. MLPs Are An Emerging Asset Class .................................................................................................................... 12 Who Can Own MLPs? ......................................................................................................................................................... 16 A. Mutual Funds Can Own MLPs … But Most Do Not ............................................................................................. 17 B. Challenges Remain For Mutual Fund Ownership Of MLPs.................................................................................. 17 C. Tax Exempt Vehicles Should Not Own MLPs ...................................................................................................... 17 How To Build An Effective MLP Portfolio......................................................................................................................... 18 Types Of Assets In Energy MLPs And Associated Commodity Exposure ......................................................................... 18 A. A Brief Review Of The Evolution Of The MLP Sector ........................................................................................ 18 B. Asset Overview ..................................................................................................................................................... 19 Midstream (e.g., Pipelines, Storage, And Gathering And Processing)............................................................. 20 Propane............................................................................................................................................................. 26 Shipping ........................................................................................................................................................... 27 Coal .................................................................................................................................................................. 29 Upstream .......................................................................................................................................................... 29 Refining............................................................................................................................................................ 30 Compression..................................................................................................................................................... 31 Liquefied Natural Gas (LNG) .......................................................................................................................... 31 General Partner Interest.................................................................................................................................... 31 The Basics............................................................................................................................................................................ 32 A. What Is An MLP?.................................................................................................................................................. 32 B. Why Create An MLP? ........................................................................................................................................... 33 C. What Qualifies As An MLP?................................................................................................................................. 33 D. What Are The Advantages Of The MLP Structure?.............................................................................................. 33 E. How Many MLPs Are There? ............................................................................................................................... 33 F. What Is The K-1 Statement?.................................................................................................................................. 34 G. What Is The Difference Between A LLC And MLP? ........................................................................................... 34 H. Are MLPs The Same As U.S. Royalty Trusts And Canadian Royalty Trusts? ..................................................... 34 I. What Are I-Shares? ............................................................................................................................................... 35 Drivers Of Performance....................................................................................................................................................... 37 A. Distribution Growth............................................................................................................................................... 37 B. Access To Capital.................................................................................................................................................. 37 C. Interest Rates ......................................................................................................................................................... 38 D. Commodity Prices ................................................................................................................................................. 39 Key Terms ........................................................................................................................................................................... 39 A. What Are Distributions.......................................................................................................................................... 39 B. What Are Incentive Distribution Rights (IDR)...................................................................................................... 39 C. Calculating Incentive Distribution Payments ........................................................................................................ 40 D. Available Cash Flow Versus Distributable Cash Flow.......................................................................................... 41 E. Are MLPs Required To Pay Out “All” Their Cash Flow? .................................................................................... 41 F. What Is The Distribution Coverage Ratio And Why Is It So Important? .............................................................. 41 G. What Is The Difference Between Maintenance Capex And Growth Capex? ........................................................ 42
...................................................................................... XII........................................... 44 D........ Shift In Supply Resources Is Driving Energy Infrastructure Investment.................................................................................................................................................................................................. Current Tax and Legislative Issues......................................... 66 D........................ Tax And Legislative Issues......... 56 A Paradigm Shift In PIPE Dynamics ........................................................ Why? ................................................................................................ The Mechanics Of A Purchase And Sale Of MLP Units And The Tax Consequences ..................... Price-To-Distributable Cash Flow .................... 46 Canadian Royalty Trusts Tax Status Expected To Change In 2011................................................................... Return Of Upstream MLPs...................................................................................................................................................................................................................................................................................... State and Local Taxes and State Filing Requirements................................................................................................................................ What Is Maximum Potential Distribution (MPD)?........... 46 What Is The NAPTP?........ What Are The Tax Advantages For The LP Unitholder (The Investor)? ....................................... 57 Paid-In-Kind (PIK) Equity ............... XI......... 48 B......................................................... MLPs As An Estate Planning Tool............................... 65 Valuation Of MLPs............. 57 GP Subsidies ........................... Distribution Yield ...................................................................... 61 J............................................................................................................................ 46 G.............................................. 42 A............................................................................................................... 56 Hybrid Securities................................................................................. Publicly Traded General Partners -....... Two-Stage Distribution (Dividend) Discount Model .................................................................................................................................................................................................................. 58 The Multiplier ....................................................................................................... 61 Upstream MLPs Are Faced With Unique Challenges And Risks ................... Spread Versus The Ten-Year Treasury .................... 45 F................................ 42 B...................................... 48 C.............................. 61 Upstream MLPs Failed In The 1980s....... Emergence Of “Dropdown” MLPs........................Recognizing The Value Of The GP ................................. XIII............................................. Who Pays Taxes?........................................................................................................................................................ MLP Investor Base Is Changing.............. 58 Power Of The IDRs............................................................................................................................. 64 L................ 46 H... 48 A.................................. 69 Appendix................................................................................................................ 66 A........................................................................................ 60 General Partners Are Held In Different Entities ..... 60 I......................................................................................................................... 54 G....................................................................................................................... Dramatic Growth Of MLPs ............................................................ 46 NAPTP Is Working To Ensure GPs Are Not Impacted By Carried Interest ........................................................ 46 What Is The Risk Of MLPs’ Losing Their Tax Advantaged Status....................................................................................................................................................................................................................................................................................................... 62 K.................. 47 MLPs Income Tax Allowance In Pipeline Ratemaking ............................................................................................................................................................ Cost Of Capital Is Becoming A More Prominent Issue. 57 H.................................................................... 4 ..................................................... 58 Not All GPs Are Created Equal .. Financial Products Facilitate Participation In MLPs .................................................. Foreign Investor Ownership ......................................................... MLPs Are Employing Creative Financing Solutions To Fund Growth.................... 66 B.......... 67 Risks ......... 71 X......................................................................... 42 C........ 67 F................................ Enterprise Value-To-Adjusted EBITDA ..................................................................... Emergence Of MLP Indices ...........................................................................................................................Master Limited Partnerships WACHOVIA CAPITAL MARKETS.......................................................................................................................... MLPs Have Been Successful In Making Acquisitions And Investing Organically................................................................................ 47 Sector Trends ..................................................................................................... 56 PIPE Mania .............................................................................................................................................................................................................................. 61 What Should Be The Criteria To Invest Today? ........................................ Can MLPs Be Held In An IRA? ...................................................................................... 50 D.. 45 E............................................................. 51 E.......... 46 FERC Includes MLPs In Determining Pipeline ROEs......................................................................................................... LLC EQUITY RESEARCH DEPARTMENT IX............................................................................................................................ 66 C............................ 53 F.................................................... 66 E................................................................................................................................................ MLPs Continue To Enjoy Good Access To The Capital .........................
3% (3%) (14%) (10%) (5%) (9%) (12%) (22%) 8% 10% 1% 2% (0%) (7%) (15%) 39% 30% 27% 38% 33% 32% 23% 19% 29% 21% 17% 11% 5% 5% 16% 12% 5% 43% 42% 45% 24% 29% 27% 22% WCM MLP Index (TR) S&P 500 Index (TR) 1992 1994 1996 1998 2000 2002 2004 2006 2008YTD Wachovia MLP TR Index +15. In this third edition. pure-play publicly traded general partners. versus 3% and 3%. versus 12% for the S&P 500 REIT Index and 6% for the S&P 500 Index. Figure 1. dropdown stories.8% WCM MLP Index (TR) S&P 500 Index (TR) Source: FactSet Over the past five years. During the past three years. MLPs outperformed the S&P 500 in seven out of ten years. 5 . (2) Attractive value proposition of tax-efficient current income plus growth = a sustainable low-double-digit total return. etc. the Wachovia MLP Index has generated an average total return of 6. During this time frame. As always. we have added new sections detailing upstream MLPs. financing. respectively. II. Introduction -. MLP Total Returns Versus S&P 500 50% 40% Percent total return 30% 20% 10% 0% (10%) (20%) (30%) 1990 2000 Index performance 1600 1200 800 400 0 Dec-89 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 S&P 500 TR Index +9. versus 5. LLC EQUITY RESEARCH DEPARTMENT I.MLP Primer -. A. we suspect that relative to other asset classes. and (6) An emerging asset class. Therefore.9% for the S&P 500) with lower risk (beta of 0. (5) Demographics trends. feel free to call us with any questions or feedback. we have added new information to our “basics” section based on questions and feedback we have received from investors over the past few years. (4) An effective way to hedge inflation. versus 2. (3) A defensive investment. MLPs have delivered above-average total returns (an average of 17. Above-Average Performance And Good Portfolio Diversification From 1998 to 2007. MLPs are still relatively under-owned. Why Own MLPs? While interest and ownership of MLPs has certainly increased since the publication of our last primer. We provide a reference guide to familiarize investors with the MLP investment. In addition. Wachovia MLP Index generated an average total return of 6%.31). fund flow.2%. MLPs have also outpaced the broader market and most income-oriented investments with an average total return of 13%.3%.A Framework For Investment This report provides an update to our previous MLP primer published in August 2005. and developments within the MLP sector related to legislation. before delving into the details. we think it is important to answer the fundamental question of why should investors care about MLPs? The case for MLP ownership can be grouped into the following broad categories: (1) Performance and diversification.5% for the S&P 500.Third Edition WACHOVIA CAPITAL MARKETS. During the past three years (2005-08).
and that meet market capitalization and other requirements. and December. Total Return Performance Versus Other Indices 30% Wachovia MLP TR Index S&P 500 (TR) / Real Estate Investment Trusts 15% % total return S&P 500 (TR) / Utilities S&P 500 (TR) Index 0% (7%) (15%) (6%) (3%) (15%) 5% 6% 3% 12% 3% 13% 12% 6% 18% (16%) (16%) (17%) (30%) YTD 1-year 3-year 5-year Source: Bloomberg Performance As Measured By The Wachovia MLP Index We gauge energy master limited partnerships’ (MLP) performance using our Wachovia MLP Composite Index. and the Index is independently calculated by Standard and Poor’s using a float-adjusted market capitalization methodology. For each review date. the company must be structured as a limited partnership or limited-liability company and have a market capitalization of greater than $200 million. which was introduced in December 2006. May. All other securities that meet all eligibility criteria are added to the Index and all securities included in the Index that do not continue to meet the eligibility requirements are removed from the Index. including 11 general partnerships (GP). please visit www. LLC. securities are evaluated based on the close of trading on the last trading day (the evaluation date) of the month preceding the review (February. with changes effective after the close of trading on the third Friday of March. Real-time price quotes for the index are available on Bloomberg and Reuters under the symbol WMLP (and WMLPT for total return) and on FactSet Marquee under the symbol WML-CME.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. and is also subdivided into 13 subsectors. The Index is reviewed quarterly.com. June. LLC EQUITY RESEARCH DEPARTMENT Figure 2. The index is designed to give investors and industry participants the ability to track both price and total return performance for energy MLPs relative to the broader market. To be eligible for the index. August. For further information and historical performance data from 1990 (downloadable). Following a review. The Index composition is determined by Wachovia Capital Markets. September. the American Stock Exchange (AMEX) or NASDAQ. and November). all securities already included in the Index that continue to meet the eligibility criteria remain in the Index.wachoviaresearch. The Wachovia MLP Composite Index currently consists of 73 energy MLPs. The Index comprises energy master limited partnerships that are listed on the New York Stock Exchange (NYSE). 6 .
Over the past one. the correlation to the overall market is still less than one-half (see Figure 4). the correlation between the MLPs and the ten-year treasury yield was 0. Midstream MLP Index Oil & Gas A. the movements in MLP prices have not been highly correlated with changes in the broader stock market. The correlation between MLPs and the S&P 500 over the one. GP Composite Index General Partnerships 2.and five-year periods was 0. threeyear.and five year periods. respectively. Although the historical correlation to actual interest rate trends has been relatively low. it is still relatively low. LLC Portfolio Diversification MLPs exhibit low correlation to most asset classes and thus. but not that strong. Low correlation with the ten-year treasury. provide good portfolio diversification. The low degree of association reflects the transformation of MLPs from primarily ‘income’ investments to ‘growth and income’ investments.36 and only 0.MLP Primer -. commodity prices or other yield-oriented investments. Gathering & Processing MLP Index Marine Transportation ii. Historical Wachovia MLP Index Performance By Subsector Wachovia MLP Index WCM MLP Indices Performance Since 2005 WCM MLP Index 1. Oilfield Service Index Midstream S&P 500 Index Price 4% 16% 7% (3%) (10%) (1%) 5% 6% 4% 12% 4% 2% 4% (22%) 1% Note: The WCM Oilfield Service Index is as of June 18. Crude Oil MLP Index Propane ii. Relationship with the S&P 500 has been fairly consistent. Refined Products MLP Index 7.43 and 0.Third Edition WACHOVIA CAPITAL MARKETS. Propane MLP Index 6. The correlation between MLPs and these variables has been fairly consistent and below 0. 2007 Natural Gas Natural Gas Pipelines Gathering. in our view. Natural Gas MLP Index i.07. Historically. and five-year periods. Coal MLP Index 3. Processing. We believe a moderate rise in interest rates should be manageable for MLPs as any increase in rates should be partially offset by the increase in distributions throughout the year. Oil & Gas MLP Index Coal 4. in our view. on an absolute basis. Natural Gas Pipelines MLP Index B. interest rates. While this is high relative to other asset classes. Marine Transportation MLP Index 5. changes in investor 7 . LLC EQUITY RESEARCH DEPARTMENT Total Return 10% 20% 13% 5% (4%) 6% 11% 12% 11% 18% 10% 9% 10% (18%) 3% Figure 3. respectively.40.50 over the last one-year. and NGLs Petroleum Refined Products Oil Field Services Crude Oil Source: Standard & Poor's and Wachovia Capital Markets. Although the correlation between MLPs and the ten-year treasury has increased over time. Petroleum MLP Index i.
36 0. MLPs provide investors with current income. with their regulated earnings stream and significant dividend yields.36 0. the perception of commodity price risk can influence stock prices (over the short-term). the correlation between MLPs and Moody’s Corporate Bond Index was only about (0.10 0. Over the past five years. Unlike bonds with fixed interest payments. Figure 4. as measured by beta. Given median yields of 6-8% and a long-term sustainable distribution growth rate of 4-6%. In Figures 5 and 6. The correlation between MLPs and REITs was 0. respectively.42 0. with a median yield of 7.01) (0.02 0. energy infrastructure.8%.29 and 0. The influence of commodity price movements on MLPs is also relatively low. all else being equal.16 0. MLPs should be able to deliver low-double-digit total returns.34 0.S. overall.05) (0. Clearly though.31 0. MLP distributions have increased at a median five-year compound annual growth rate (CAGR) of 8. and refined products to a growing domestic market. energy infrastructure to deliver natural gas. over the past five years.00) (0. Bonds (0.42 0. in our view. Utilities provide a median yield of about 3.2%.Tax-Efficient Income Plus Growth MLPs provide an attractive value proposition. we highlight the median yield of MLPs relative to other indices and the upward trend of MLP distribution growth over the past eight years.07) B.36 0.12 0. and MLPs and the S&P Utilities Index were 0. Investors also benefit from lower risk.43 0. Over the past one and five years. and visible distribution growth. in our view.24 0.59 0. we believe it is generally low relative to other companies in the energy industry.2% and have increased dividends at an annual growth rate of approximately 9. LLC EQUITY RESEARCH DEPARTMENT psychology toward potential movements in interest rates (both the magnitude and timing) can affect the shortterm performance of MLPs.02 0. The MLP value proposition is underpinned by the sector’s growing role in providing the backbone of U. MLPs can increase distributions paid to unitholders and increase their asset base via acquisitions and/or internal growth projects. Utility stocks. 8 .19 0.41 0.30 0. Relationship with other yield-oriented investments also trending lower. crude oil.03 (0.34 and 0.31 0. MLP Value Proposition -.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.47 0. on average.6% (2003-07).07).S.29 0.35 0. respectively.40 Natural Gas 0.36 0. the correlation with crude oil and natural gas prices was 0.14) 0. the correlation with crude oil and natural gas prices was 0.12) 0.42 0. and a partially tax-deferred distribution. annually.21 and 0.14. As the number of publicly traded MLPs has grown in recent years and MLPs have established a track record of distribution increases. Relatively weak correlation with commodity prices.40 REITs 0. respectively.33 0. For the past year. in our view.38 0. Although MLPs’ exposure to commodity price risk varies.26 0. the movement of MLP unit prices have become tied more closely to the equities market than the bond markets.07 Utilities 0. with high current and tax-deferred income. Link to bonds is diminishing. For the next three years.21 0. Current income plus growth.42 0.31 10 Yr Treas (0. in our view.43 0.40.01) (0.13 0.32 Corp.31 and 0.32 over the past one and five years. we forecast distribution growth of 9% (10% including GPs) supported by a large slate of organic investments tied to the ongoing buildout of U. are the most comparable energy securities relative to the MLPs. respectively.14 Crude Oil 0.43 0.34 0.41 0.10.01) and (0. in our view. MLP Correlation With Other Asset Classes Correlation Of MLPs With Other Asset Classes S&P 500 2005 2006 2007 2008 YTD Last year Last 3 years Last 5 years Source: FactSet 0. respectively.21 0.
01. MLPs have averaged a beta of just 0.0% Wachovia MLP Index Source: Bloomberg and FactSet 7.75. Traditional energy companies such as those involved in exploration and production.6% 6. GPs) (% 14. while the beta for the S&P 500 Oil & Gas Equipment & Services Index ranged from 0. MLP Annual Distribution Growth (2000-07) Annual Distribution Growth (Excl.0% 10. 1.60.31 over the past year and an average beta of 0.0% 8.0% 0.0% 4. oilfield services.2% 2.56 and 1. the beta for the S&P 500 Oil & Gas Exploration & Production Index ranged from 0.6% 3.14 and 0.32 to 1.0% 2. and 0.MLP Primer -. The tax-deferred portion of the distribution is not taxable until the unitholder sells the security. An investor will typically receive a tax shield equivalent to (in most cases) 80-90% of cash distributions received in a given year.3% S&P 500 Index FTSE NAREIT All REIT Index S&P 500 Utilities Index Figure 6.36.0% 6% 6. The beta for the S&P 500 Utilities Index was between 0.31 for the Wachovia MLP Index. over the past five years (2004-2008). This compares with a range of 0.0% 0.Third Edition WACHOVIA CAPITAL MARKETS. Low risk.0% 2000A MLP Distribution Growth 2001A 2002A 2003A 2004A 2005A 2006A 2007A 3% 5% 5% 5% 9% 10% 9% Source: Partnership reports Tax efficient. and utilities have exhibited comparably more volatility with an average beta of 0.09. During this time frame.58 to 1. MLPs offer investors a tax-efficient means to invest in the energy sector. LLC EQUITY RESEARCH DEPARTMENT Figure 5.0% 6.0% Yield 4.0% 12.0% 2.9% Dow Jones Industrial 30 2.30 over the past five years. MLPs offer investors an alternative way to invest in energy with lower fundamental risk. Wachovia MLP Index Yield Versus Other Indices 8.95. respectively. 9 .
MLP (WCM Index Wachovia) Total Energy (S&P 500 .64 0.39 0. with total sector market cap of $2. Drillers (SPOILD). Utilities (UTIL).61 0.98 0.1 4 0.64 0. there are currently 78 MLPs with a combined market cap of approximately $134 billion. In 1994.77 0. That year.2% in 2007.1 1 .31 14 .68 0. there were just seven MLPs.3% during all four periods (the S&P 500’s total return during these four periods was 12. For purposes of this study.56 0.2%. as the MLP sector has changed dramatically during the past 15 years.42 0. Wachovia Capital Markets LLC.20 0. Thus.. Over the past 15 years.1 10 .39 0.30 0.00 0.1 9 0.71 0.39 0.98 0. periods during which the GDP was 2% or less were analyzed.47 0.60 0.32 1 .80 MLP Composite 1.28 1 .28 0. and Wachovia Economics Group 10 . rather than just periods of true economic recession (i.1 1 0. on average). MLPs grew distributions by 7.25 0. Integrated (XOI). a decline in GDP for two or more consecutive quarters).Energy) Source: Bloomberg.20 0.34 0. and Q2 2006 to Q1 2007.00 0. there were four periods during which GDP growth was 2% or less: Q1-Q4 1995.09 0.1 4 0.66 0. MLPs Have Been Defensive During Economic Slowdowns Our colleagues (Wachovia’s E&P energy research team) examined the performance of energy stocks and the energy subsector's performance during periods of slowing GDP growth.32 0. in our view.60 S&P 500 Oil & Gas Exploration & Production 1 . We caution that these data do need to be viewed with a skeptic’s eye. Service (S15OILE). Energy Sub-Sector Performance During Economic Slowdowns Note: Index Reference: E&P Index (S15OILP).83 0. The median distribution growth was 9. with a combined higher total return of 13.88 S&P 500 Oil & Gas Equipment & Services S&P 500 Utilities 1 .e.78 0.1 4 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008YTD Source: FactSet C.80 0.08 0. MLPs have outperformed the market (S&P 500) in three of four periods of economic slowdown.20 0. the data do suggest that MLPs are defensive in nature given their relatively high yields and prospects for distribution growth.34 0.33 0.22 0. Q4 2002 to Q3 2003.59 0.26 0. Figure 8.60 1.20 Beta 1. Over the past 15 years. Q2 2001 to Q2 2002. MLP Beta Relative To Other Energy Sectors 1.58 0.76 0.66 0. LLC EQUITY RESEARCH DEPARTMENT Figure 7.25 0.40 1. In contrast. FactSet.36 1 .01 0.40 0.57 0.7%.81 0.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.1 billion.
000 40. Figure 9.049 86. In addition. MLPs are an effective estate planning tool. According to the U. when the entire Baby Boom generation has reached the age of 65. Projected U. while MLPs increased distributions at a median of 9% (11% including GPs).000 60. relatively low risk (beta). Population Over The Age Of 65 Population (in thousands) 100.705 19. Census Bureau 11 .061 40.4% 20. utilities.000 0 2000A 2010E 2020E 65+ 2030E 2040E 2050E % of total U.4% 13.000 80.S. in our opinion.7% 16.Third Edition WACHOVIA CAPITAL MARKETS. LLC EQUITY RESEARCH DEPARTMENT D. Figure 10. By 2030.S.MLP Primer -. and taxadvantaged structure.S. Historical MLP Distribution Growth (Excluding GPs) Versus The CPI 12% Distribution Growth (Excl.3% 20.453 80. population 35.0% 71. seniors are expected to account for about 20% of the U. Census Bureau.1% in 2007 (as measured by the CPI). as MLP units can be passed to heirs with significant tax savings. We estimate 10% distribution growth (12% including GPs) in 2008 and 9% growth (10% including GPs) in 2009. and high-yield bonds have outperformed the market over the past few years. in our view.632 12.7% 25% 20% 15% 10% 5% 0% Source: U. the number of seniors (ages 65 and older) will increase sharply beginning after 2010 as the Baby Boom generation (those born between 1946 and 1964) begins to turn 65 years of age.S. We believe MLPs represent an attractive investment class for retirees due to their significant (and growing) income stream. For example. population.000 20.S. as retiring Baby Boomers seek current income in a tax-efficient structure. Current yields range from 5% to 13% (excluding GPs). inflation was 4. Demographics Demographics should continue to drive demand for income-oriented investments. GPs) (%) 10% 8% 6% 6% 4% 4% 2% 0% 1998A 1999A 2000A CPI 2001A 2002A 2003A 2004A 2005A 2006A 2007A 4% 3% 5% 5% 5% 10% 9% 9% MLP Distribution Grow th Source: Bureau of Economic Analysis and Bureau of Labor Statistics and Partnership reports E. MLPs Are An Effective Hedge Against Inflation. In Our View MLPs current (and growing) income stream can provide an effective hedge against inflation. Many income-oriented investments such as REITs.243 54.
Master Limited Partnerships
WACHOVIA CAPITAL MARKETS, LLC EQUITY RESEARCH DEPARTMENT
F. MLPs Are An Emerging Asset Class MLPs are emerging as a distinct asset class, akin to the development in the 1990s of real estate investment trusts (REIT). This is evident by the growth exhibited by MLPs over the past ten years in terms of number, size, and liquidity. In 1994, there were just seven energy MLPs with an aggregate market capitalization of approximately $1 billion. Currently, there are 78 energy MLPs, with a total market capitalization of approximately $134 billion. In 1994, average trading volume of our MLP universe was just 34,819 units per day. Year to date, our MLP Composite is trading an average of 153,442 units per day. Figure 11. Number And Market Capitalization Of Energy MLPs
$160 Total market capitalization of energy MLPs $140 Market capitalization ($ in billions) $120 $100 $80 $60 $40 $20 $0 9 $2 1995 12 $3 1996 12 $5 1997 15 $8 17 $8 18 $11 29 23 $18 $19 7 $1 1994 30 $30 Number of energy MLPs $112 73 $147 $134 78 100 90 80 70 60 50 40 30 20 10 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008YTD Number of MLPs
1 83 1 52
60 $70 42 34 $38
Source: FactSet and National Association of Publicly Traded Partnerships
Could The MLP Sector Develop Like The REITs? The modern-day REIT was created through the real estate investment trust tax provision, which established REITs as pass-through entities, thus eliminating double taxation of dividends. In the 1980s, certain real estate tax shelters were eliminated, increasing the investment in REITs. The Tax Reform Act of 1986 enabled REITs to manage properties directly, creating further incentives for the creation of additional REITs. Finally, in 1993, REITs’ investment barriers to pension funds were eliminated. This trend of reforms continued to increase the interest in and value of REIT investments. At the end of 2007, there were 152 publicly traded REITs operating in the United States with a total market capitalization of approximately $312 billion. (Source: National Association of Real Estate Investment Trusts) Figure 12. Historical Number Of REITs And Market Capitalization
$500 $450 $400 $350 $300 $250 $200 $150 $100 $50 $0
53 53 62 46 69 71 71 75 76 82 66 59 59 $ 224 $1 $2 $1 $2 $2 $2 $3 $4 $5 $8 $1 $1 $1 $1 $9 0 0 1 2 $ 1 $ 1 $ 32 $ 44 $ 58 3 6 $ 89 $1 $1 $1 $1 $1 $1 41 38 24 39 55 62 $ 308 $ 331 226 1 89
Total market capitalization of REITs Number of REITs
42 1 38 1 96 10 1 17 1 1 20 19 1
21 9 1 99
21 21 1 0
203 1 89 1 82 1 76 1 71
97 1 93 1
$ 438 $ 31 2
150 125 100 75 50 25 0
Source: National Association of Real Estate Investment Trusts®, Inc.
Number of REITs
$ in billions
MLP Primer -- Third Edition
WACHOVIA CAPITAL MARKETS, LLC EQUITY RESEARCH DEPARTMENT
Figure 13. Historical And Projected MLP Market Capitalization
$400 Total market capitalization of energy MLPs $350 $300 $ in billions $250
73 78 ? ? ?
140 120 100 80 Number of MLPs
Number of energy MLPs
$200 $150 $100 $50 $0
7 $1 9 $2 12 $3 12 $5 15 $8 17 $8 18 $11 23 $18 29 30 34 42
60 ? $147 ? $134
60 40 20 0
1994 1995 1996 1997
1998 1999 2000 2001 2002
2003 2004 2005 2006
2007 2008 2009E 2010E 2011E YTD
Source: National Association of Publicly Traded Partnerships and Wachovia Capital Markets, LLC estimates
Could MLPs Be On A Similar Trajectory? We think it is possible. The MLP sector has achieved several milestones that closely parallel milestones achieved by the REIT sector. These milestones led to the growth and prominence of the REIT industry, in our view. Figure 14 outlines the REIT/MLP parallels: Figure 14. REIT Versus MLP Milestones
REITs - Omnibus Reconciliation Act of 1993 allowed pension funds to own REITs - REIT Modernization Act of 1999 - Equity Office Properties Trust (EOP) was the first REIT added to the S&P 500 Index on October 1, 2001 - NAREIT All REIT Index yield has compressed to 6.6% from 8.0% in 2000 MLPs - With the passage of the American Jobs Creation Act in October 2004, mutual funds are now allowed to own MLPs - EPD has made the case to qualify for inclusion into the S&P 500 Index - The midstream MLP yield has compressed to 7.8% from an average of 9.1% in 2000
Source: FactSet and National Association of Real Estate Investment Trusts
As more assets are placed into the structure, we expect MLPs to proliferate. Two notable areas of potential growth are pipelines, and oil and gas reserves. Currently, about 37% of all energy pipelines in the United States are held by MLPs, implying room for consolidation within the sector. Increasingly, pipeline companies are recognizing that the MLP structure is most efficient for holding midstream assets. This is evident by the sale of two interstate pipelines to MLPs in 2006-07 and three initial public offerings of interstate pipeline MLPs over the past two years. Figure 15. U.S. Pipelines Owned By MLPs
MLP owned pipeline miles 37%
Note: Based on crude oil, natural gas, natural gas liquids, refined products pipeline miles Source: Department of Transportation, American Petroleum Institute (API), Association of Oil Pipe Lines (AOPL), and Partnership reports
On December 22, 2006, El Paso sold ANR Pipeline to TransCanada Corp. and TC Pipelines, L.P. (TCLP) for $3.3 billion. On September 15, 2006, GE Energy Financial Services and Southern Union Company sold Transwestern Pipeline to Energy Transfer Partners for $1.0 billion. According to the National Association of Publicly Traded Partnership estimates, energy related MLPs, currently own approximately 200,000 miles of
Master Limited Partnerships
WACHOVIA CAPITAL MARKETS, LLC EQUITY RESEARCH DEPARTMENT
pipelines: gathering and transmission, onshore and offshore pipelines, carrying natural gas, natural gas liquids, crude oil, and refined products (See Figure 16). El Paso Pipeline Partners, L.P. (EPB), Spectra Energy Partners, L.P. (SEP), and Williams Pipeline Partners, L.P. (WMZ) are three interstate pipeline MLPs, that held successful initial public offerings on November 16, 2007, June 27, 2007, and January 18, 2008, respectively. EPB sold approximately 33.2% of the partnership or 28.75 million common units at $20 per unit. SEP sold about 17% of the partnership or 11.5 million common units at $22 per unit, and WMZ sold approximately 47.5% of the partnership, or 16.25 million common units at $20 per unit. Figure 16. Miles Of Pipeline Owned By Energy MLPs
Total MLP pipeline miles owned Natural gas pipelines Refined products pipelines NGL/LPG pipelines Crude oil pipelines Total pipelines 70,000 40,000 20,000 70,000 200,000
Source: U.S. Department of Transportation, American Petroleum Institute (API), the Association of Oil Pipe Lines (AOPL), and Partnership reports
MLPs are the logical structure to house interstate pipelines and other midstream assets, in our view, due to their low-maintenance capital requirements and tax-advantaged status, which enables cash flow to be distributed to investors in a tax-efficient manner. Because MLPs do not pay corporate income tax, they can generate more free cash flow than a corporation given the same amount of operating income. Assets that generate stable cash flow and that require minimal capital reinvestment to sustain are ideally suited for the MLP structure, which pays the majority of its cash flow to unitholders on a quarterly basis. MLPs Are Also Suitable Investment Vehicles For Certain Oil And Gas Assets Upstream MLPs can play an important role in the recycling of cash flow associated with the exploration (at the C-Corp level) and production of oil and gas assets in the United States. By selling mature production/reserves to MLPs, E&P companies are able to reinvest cash proceeds into properties that have better geologic upside potential to which they can significantly add value by drilling wells. This process allows E&P companies to efficiently explore for new reserves without having to invest significant resources in the upkeep of mature reserves. The mature, low-decline production is placed into the MLP structure, where reserves can be harvested to support steady cash flow and divestitures. Upstream MLPs also benefit from this process as most E&P companies have historically underexploited mature fields, given the opportunity for higher returns (and higher risk) elsewhere. As a result, upstream MLPs receive not only a base of stable producing assets, but also an inventory of low-risk development drilling opportunities through which to maintain or modestly increase production.
Upstream MLPs do not pay corporate taxes and the majority of partnerships do not have incentive distribution rights (IDR) or management incentive interests (MII) (those that do have a max tier of 25%). LLC Typically. initial production rates from new wells are high. At this point. but decline rapidly for several years before leveling off.Third Edition WACHOVIA CAPITAL MARKETS. Upstream MLPs Fill A Niche Oil & Gas Company (CCorp) discovers new reserves via exploratory drilling Oil & Gas Company develops reserves and captures higher initial production and cash flow (and higher decline rates) Oil & Gas Company redeploys capital received from MLP Upstream MLP distributes predictable cash flow to unitholders from proved developed producing reserves Oil & Gas Company sells the mature reserves to an Upstream MLP after production rates have declined to a more manageable and stable level (5-6%) Common unitholders receive distributions Source: Wachovia Capital Markets. LLC Upstream MLPs Well Positioned To Compete For Mature Reserves Upstream MLPs are better positioned to compete in the oil and gas market for mature reserves than E&P companies. Appropriate Production Profile For The MLP Structure C-Corp Structure Oil And Natural Gas Production Curve MLP Structure Time Source: Wachovia Capital Markets. LLC EQUITY RESEARCH DEPARTMENT Figure 17. it makes sense for E&P companies to sell their mature properties and redeploy the proceeds into new plays with higher potential returns. these partnerships should be able to outbid E&P companies for acquisitions. Figure 18. Accordingly. in our view. while 15 .MLP Primer -.
Market For MLP Suitable Oil & Gas Reserves Exceeds 75 Tcfe. we estimate that approximately half of these reserves are proved developed producing. and Wachovia Capital Markets.1 trillion cubic feet (Tcf) of proved natural gas reserves and 21. Figure 19. Approximately 69% of total MLP units outstanding are currently held by retail investors. institutional investors such as mutual funds and other registered investment companies (RIC) were restricted from investing in MLPs because distributions and allocated income from publicly traded partnerships were considered non-qualifying income.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. Institutional And Retail Ownership Of MLPs Institutional 31% Retail 69% Note: Retail percentage include 7% ownership by foreign investors Source: Vinson and Elkins and Wachovia Capital Markets. Based on the average PDP ratio of large independent E&P companies in the United States. we expect mature reserves held in the MLP structure to trade at a slight premium to the same set of reserves under a C-Corp structure given the elimination of corporate level taxation. mutual funds are required to receive at least 90% of their income from qualifying sources listed in the tax laws.S. 16 . Source: EIA. After stripping these reserves out.0 billion barrels of proved crude oil reserves in the United States (as of December 31. only 6% of crude oil and 7% of natural gas have been placed in the structure. Total crude oil and gas reserves in the MLP structure currently total only 3. or approximately 152 Tcfe (91 Tcf of natural gas and 10 BBbls of crude oil/NGLs). Even assuming only 50% of these PDP reserves are suitable for the MLP structure implies a total potential reserve base of 46 Tcf of natural gas and 5 billion barrels of crude oil. there are approximately 211. Who Can Own MLPs? MLPs have traditionally been owned by retail investors. oil reserves in MLP structure 6% Est. with the remaining 31% of units held by institutions. natural gas reserves in MLP structure 7% Note: Assumes 50% of total proved U. This includes approximately 29 Tcf and 0. Potential Oil And Natural Gas Reserves Suitable For The MLP Structure Est.8 billion barrels of proved reserves located offshore and in Alaska. All else being equal. reserves (excluding offshore and Alaska) are proved developed producing (PDP) and about 50% of this amount is suitable for the MLP structure. LLC estimates III.3 Tcf of natural gas and 299 million barrels of crude oil. LLC EQUITY RESEARCH DEPARTMENT still generating a similar level of cash flow accretion to unitholders. LLC estimates Until 2004. Of Which MLPs Own 7% According to the Energy Information Administration (EIA). 2006). This implies that of the “MLP-able” reserves. Figure 20. To retain their special tax status as regulated investment companies (RIC). This is still true today. Partnership reports. proved natural gas reserves totaled 182 Tcf and proved crude oil reserves totaled 20 billion barrels in 2006 for the onshore/lower 48 states. both of which are likely not suitable for the MLP structure.
000 per year. some states have not adopted the legislation as law. mutual funds domiciled in certain states may still be restricted from owning MLPs. Mutual funds are required to designate investors’ income as ordinary income. Institutional interest in MLPs has increased with the formation of 11 MLP-focused closed-end funds ($4. While the mutual fund provision was adopted as federal law. Since some MLPs have operations (e. and return of capital. there are some restrictions to investment: (1) no more than 25% of a fund’s asset value may be invested in MLPs and (2) a fund may not own more than 10% of any one MLP. Challenges Remain For Mutual Fund Ownership Of MLPs Despite the passage of the American Jobs Creation Act. a list of which follows: • Timing issues. For example. LLC EQUITY RESEARCH DEPARTMENT Institutional Interest Is Growing MLPs are undergoing a transition in ownership from a predominantly retail base to more institutional ownership. hedge funds. creating potential legal issues for mutual funds domiciled in that state. • Federal/state law discrepancies. and access to private market transactions typically at discounts to the market price. Tax-Exempt Vehicles Should Not Own MLPs Tax-exempt investment vehicles such as pension accounts.. In addition. a mutual fund owner of a partnership may be required to file income tax returns in every state in which the MLP conducts business (even if no taxes are owed). pipelines and storage tanks) in many states. the administrative burden required for such an undertaking could be prohibitive. However. B. the investor would be required to file IRS form 990-T and may be liable for tax on the UBTI. This means MLP income is considered income earned from business activities unrelated to the entity’s tax-exempt purpose. this could lead to excise tax liability for the mutual fund or a mutual fund investor paying taxes not owed. professional management... but may not receive their MLP K-1s until late February or early March.Third Edition WACHOVIA CAPITAL MARKETS. • State filing requirements. in our view. This is due to a number of administrative challenges.7 billion of equity raised).) have increased participation in the sector. If a taxexempt entity receives UBTI (e.g. including the ability to participate in MLPs without the burden of K-1s (processed by the funds--investors receive a 1099). 17 . In certain instances. and endowment funds should not own MLP units because MLPs generate unrelated business taxable income (UBTI). These closed-end funds offer investors a number of advantages. Clearly. There are potential administrative burdens related to state filing requirements. IRAs. We recommend consulting a tax advisor before investing in MLPs within any of these structures. Please see the Appendix for a list of states in which each MLP operates. C. high net worth brokers. income from an MLP) in excess of $1. As a result. without the K-1s. mutual funds can now own MLPs. However.g. Massachusetts (a state that is home to many mutual funds) has not adopted the federal Mutual Fund Act as law. a mutual fund would have to make estimates that could prove incorrect. professional investors with pools of private funds (e.g. mutual funds have not participated in the MLP sector in large numbers to date. etc.MLP Primer -. long-term capital gains. A. Mutual funds begin processing their investors’ 1099s in November. and the passage of legislation that allows mutual funds to own MLPs. 401-Ks. Mutual Funds Can Own MLPs …But Most Do Not With the passage of the American Jobs Creation Act in October 2004.
sports teams. and gains from commodities. MLPs present risk/reward propositions. Risk And Growth Risk .Capital requirements .Leverage . were victims of low commodity prices.. and options (with certain limitations). ability to keep projects on time and on budget).Commodity exposure . process.” These sources were generally limited to natural resources or mineral activities including exploration. processing. and store natural gas. mining. Other qualifying income includes interest. • Invest with top management. individuals should evaluate the strength of the company’s management team. when Congress passed the Tax Reform Act of 1986 and the Revenue Act of 1987. dividend. A. these MLPs are typically large-cap companies that have grown and diversified their asset base to limit cash flow volatility during changes in economic cycles. The early MLPs consisted primarily of refined-product pipelines that were characterized as mature assets that required modest maintenance capital and generated stable cash flow that was distributed to unitholders with very modest growth expectations. In the late 1980s. aligned with those of the unitholder). and refined petroleum products and have limited exposure to commodity price risk. which includes lower-risk. The modern day MLP got its start in 1986-87.Execution . and other consumer activities.Visibility . transportation. prospective investors should consider factors outlined in Figure 21 when building an MLP portfolio: Figure 21. Like all investments. LLC and .Market position Growth . In assessing risk/reward. 18 . the predecessor upstream MLPs were essentially selfliquidating partnerships and were unable to sustain their distributions. MLPs were reincarnated as entities that generally own midstream assets that are used to transport. These assets were typically spun out of larger entities that could realize a higher value from these assets as publicly traded MLPs. a balanced portfolio. Investors should consider a management team’s (1) track record in successfully managing its business. development.e. exploitation and production operation). These factors include the following: • “Anchor tenants. Without reinvestment. income from the sale of stock. or marketing.Weather Source: Wachovia Capital Markets. we believe there are three primary factors that investors should take into consideration. gain from the sale of assets.Track record . How To Build An Effective MLP Portfolio In building an effective MLP portfolio. Prior to making any investment. In general. should be considered. but potentially lower-return MLPs and higher-risk MLPs with potentially higher returns. LLC EQUITY RESEARCH DEPARTMENT IV. an entity had to earn at least 90% of its income from “qualified sources. more factory-like. The anchor tenants are companies that have established a successful track record of delivering solid and sustainable results year after year.Organic versus acquisition dependent .. and (3) ownership interests (i. restaurants. (commodity related) forwards. Investors should consider their risk-tolerance level and make investments accordingly.Size . real property rents. In addition. refining. and depleting reserve base. income from the sale of property.e. (2) project management capabilities (i. MLPs were involved in various businesses including exploration and production (E&P) of oil and natural gas. or in the case of E&P companies. futures. • Balance risk and growth. a volatile natural gas market.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. The new laws stated that to qualify as a master limited partnership.Strength of sponsor V. These businesses were more cyclical in nature.” Investing in “anchor” or core MLPs is an effective way to build a solid foundation for an MLP portfolio. Types Of Assets In Energy MLPs And Associated Commodity Exposure A Brief Review Of The Evolution Of The MLP Sector In the 1980s.Stock liquidity . crude oil. which relied on exploratory drilling to sustain cash flow (current upstream MLPs own longer life reserves and employ a lower-risk.
the master limited partnership universe is made up of approximately 102 companies that are classified as publicly traded partnerships. B. the prototypical energy asset with the greatest degree of commodity. refined products. Although investors are becoming more comfortable with the MLP investment structure. etc. This change in focus was partially due to the sudden availability of midstream assets on the market. For example. Nevertheless. natural gas. Currently. Asset Overview In aggregate. the majority of energy assets introduced into the MLP structure since 1986 have evolved from more stable pipelines to increasingly more volatile cash flow businesses with greater risk. majors and large diversified energy players decided to monetize their mature assets with the intent of redeploying proceeds from the sale into higher-return investments. propane distribution. These include onshore and offshore pipelines that transport natural gas. the risk profile of MLPs has been increasing. with limited exposure to commodity price risk.g. the MLP structure has evolved to include assets that operate progressively closer to the wellhead. Beginning in the late 1990s. refining. across all commodities. and oil and gas reserves (introduced in the 1980s) were re-introduced to the MLP structure in 2006. Some asset types such as refining. gathering and processing operations. Currently. beginning with refined products pipeline assets in 1986 (Buckeye Partners. MLPs own assets involved in almost all aspects of energy. and lower cost of capital. merged. MLP Risk Profiles Less risk Pipelines and Storage/Terminals BWP BPL DEP EEP EPB EPD ETP GEL HEP KMP OKS MMP NS PAA SEP SGLP SXL TCLP TLP TPP WMZ Gathering & Processing APL CPNO DPM EROC HLND KGS MWE NGLS RGNC WES WPZ XTEX MMLP Propane and Heating Oil APU FGP GLP NRGY SGU SPH Shipping CPLP KSP NMM OSP TGP TOO USS Coal ARLP NRP PVR More risk Upstream ATN BBEP CEP DMLP ENP EVEP LGCY LINE PSE QELP VNR Note: Classification does not take into account hedging activities or parent/sponsor relationships Source: Wachovia Capital Markets. LNG. MLPs began reorienting their focus toward growth. In the following sections. These partnerships were dissolved. Specifically. marketing businesses. oil and coal production. Other MLPs. in our view. we outline the effect of commodity prices on each major asset class owned by MLPs. LLC EQUITY RESEARCH DEPARTMENT The MLP has seen a progression of different types of assets placed into the structure. L. making significant acquisitions. In a sense. and aggressively raising distributions. or restructured. and re-investment risk.MLP Primer -. and waterborne transportation. pipelines and storage) to more commodity-sensitive businesses (e. asphalt. storage assets. pursuing internal growth projects. fractionation facilities. to achieve returns superior to those of corporations. in part. oil and natural gas assets. and ammonia. drilling. MLPs formed in the late 1980s and early 1990s generally owned pipeline and storage assets that were largely fee-based.P.) with higher risk.Third Edition WACHOVIA CAPITAL MARKETS. the cash flow of some MLPs has been becoming more sensitive to commodity prices. to the cyclical nature of their businesses. the impact of commodity prices on MLP cash flow varies according to asset class. involved in the plastics and fertilizer industry did not survive as partnerships due. MLPs were able to take advantage of their unique tax-exempt structure. The MLP structure has evolved from stable cash flow generating assets (i. Thus..e. in our view. with varying degrees of commodity price sensitivity.). MLPs are engaged in every aspect of the energy value chain. reserve. with 78 being energy related. crude oil. Figure 22. LLC 19 ..
and/or refined petroleum products. or withdraw the product from storage. The maximum rate a pipeline can charge is adjusted annually based on changes in the Producer Price Index (PPI). whereby shippers reserve capacity on the pipeline and must pay the tariff regardless of their actual use of the capacity. In general. However. Midstream MLPs with pipeline and storage/terminal assets are typically characterized as generating stable. and hence.. which is in line with historical growth in demand for energy. The FERC determined that the PPI for Finished Goods plus 1. and (4) Market-based rates. and (4) a decline in commodity prices (resulting in a decline in drilling activity). but overall operate in competitive markets with less regulatory oversight. Some crude oil pipelines operate under buy/sell arrangements. risks related to investing in midstream MLPs include an economic slowdown. Railroad Commission of Texas). In general. and/or storage of crude oil.. This means shippers or the pipeline operator itself will purchase crude at one point on the pipeline and then simultaneously enter into a sales contract for that crude at another point on the pipeline. The rate is based on the actual costs experienced by the pipeline. The rate is agreed upon by the pipeline’s customers. (1) rising raw material and labor costs. 2006. jet fuel. (3) Settlement rate. crude oil. Historically these rates have averaged 11-13%.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.3% (PPI plus 1. (2) an over build of U. a government body that regulates tariffs and allowed rates of returns for pipeline companies. which could negatively affect energy demand. and storage/terminals) (2) Propane and heating oil (3) Shipping (marine transportation) (4) Coal and aggregates (operators and royalty model) (5) Upstream (exploration and production) (6) Refining (7) Compression (8) Liquefied natural gas (LNG) (9) General partner interests Midstream. Drivers. transportation. Acquisitions and major organic growth projects are generally required to meaningfully increase overall growth. and refined products) typically have fee-based revenue structures whereby the customer reserves storage capacity and pays an additional fee to blend. The growth in pipeline volumes typically average 2-3% per year. Growth can be higher depending on regional demographic growth patterns and expansions. natural gas liquids (NGL). high commodity prices have minimal (if any) direct effect. Typically. energy demand typically tracks GDP growth. Interstate natural gas 20 . gasoline. Interstate natural gas pipelines are regulated by the Federal Energy Regulatory Commission (FERC).S. storage assets (for natural gas. the pipeline is allowed to earn a reasonable return on its investment to cover operating costs. LLC EQUITY RESEARCH DEPARTMENT The types of assets in energy MLPs include the following: (1) Midstream (pipeline. (2) Cost of service.g. natural gas pipelines receive demand charges. which helps to provide a growing stream of income in excess of inflation trends. Risks. Rates for these pipelines are established in four ways: (1) Indexing. natural gas.3%) should be the oil pricing index for the five-year period beginning July 1. In theory. and taxes. The rate is established by supply and demand dynamics in a competitive market. Midstream MLPs are involved in the gathering and processing. Commodity price sensitivity. gathering and processing. (3) regulatory risk related to allowed rates of return. diesel. Finally. fee-based cash flow with minimal volatility in earnings. MLPs with pipeline and storage assets do not take title to the commodity.g. inject. distillates). Intrastate natural gas pipelines are monitored by state agencies (e. depreciation. energy infrastructure. The FERC also regulates crude oil and refined products pipelines (e.
e. TransMontaigne Partners.P. NuStar Energy. for further distribution to retail outlets. L. End-user destinations include airports. L.3%). L. L. Holly Energy Partners. due to their low cost structure (versus other transporters. TC Pipelines.P. L.P.P.P. Primary pipeline customers are refiners and marketers of the product being shipped.P. downturns). Earnings for crude and petroleum products pipelines are tied primarily to throughput (volume).P.. However. LLC EQUITY RESEARCH DEPARTMENT pipelines’ earnings are typically based on demand charges (similar to rent) and a small portion of earnings may vary with volume.P. Kinder Morgan Energy Partners. Natural Gas Pipeline MLPs MLP Boardwalk Pipeline Partners. and jet fuel) and refinery demand for crude oil are the main drivers of pipeline volume. L. The following is a summary of the sub-sectors of the midstream segment: • Natural gas pipelines. L. Pipeline and storage assets have historically been less exposed to economic cycles (i. High natural gas prices may spur drilling activity and benefit pipeline companies that can expand their systems that connect to basins of increasing supply. then distribute the natural gas to residential and/or commercial customers. and barge) and government-regulated nature. diesel fuel. Natural gas transportation pipelines are generally large diameter interstate pipelines used for long-distance transportation. Utilities or local distribution companies. high prices could also have the effect of causing conservation and curtailing demand.. depending upon economic cycles. Throughput in mainline natural gas transportation pipelines tends to be relatively stable due to continued growth in demand for natural gas from industrial. TEPPCO Partners. L. and terminals/truck racks. and jet fuel. etc. such as gasoline.P. Natural gas transportation pipelines receive natural gas from gathering systems and other pipelines and deliver it to industrial end users. utility companies. Martin Midstream Partners. Kinder Morgan Management.P. however. L.P. Refined products pipelines are common carrier transporters of refined petroleum products. consumer demand for refined products (i. gasoline. Ticker Primary Business Line BWP Natural Gas Pipelines EPB ETP SEP Natural Gas Pipelines Natural Gas Pipelines Natural Gas Pipelines TCLP Natural Gas Pipelines WMZ Natural Gas Pipelines Source: Partnership reports • Refined products pipelines.MLP Primer -. Refined product pipeline cash flow is stable based on the relatively inelastic baseload demand from end users of gasoline. diesel fuel.Third Edition WACHOVIA CAPITAL MARKETS.P. Refined Products Pipeline MLPs MLP Buckeye Partners. such as truck. Interstate petroleum products pipelines may benefit from higher commodity prices via regulations that allow pipelines to annually increase tariffs at a rate of producers’ price index (PPI + 1. Williams Pipeline Partners.P. El Paso Pipeline Partners. Throughput can exhibit minor fluctuations. Figure 23. Energy Transfer Partners.e.P. rail yards. L. commercial. L. L. Thus. Ticker Primary Business Line BPL HEP Refined Products Refined Products KMP Refined Products KMR Refined Products MMP Refined Products MMLP Refined Products NS SXL TPP TLP Refined Products Refined Products Refined Products Refined Products Source: Partnership reports 21 . LLC Magellan Midstream Partners. L. rail. and residential end users.P. L. Figure 24. Spectra Energy Partners. electric power sector. L. commodity prices do have an indirect impact on pipeline volume. diesel. Sunoco Logistics Partners. or storage facilities.
NGL pipeline fees are either contractual or regulated by a government agency (e. Terminal cash flow is affected by the amount of petroleum products stored. Crude oil terminal operators may use terminals as a natural extension of their pipeline system or may actively seek terminal throughput from third parties. (2) aquifers. steel. Crude Oil Pipeline MLPs MLP Enbridge Energy Management. Figure 25. fee-based cash flow. refiners are more dependent upon waterborne and Canadian imports because inland domestic crude oil production peaked during the 1970s. wells. and other hydrocarbons. L. and some are located near consuming markets. Storage/terminals. Ticker Primary Business Line EEQ Crude Oil EEP GEL PAA Crude Oil Crude Oil Crude Oil SGLP Crude Oil Source: Partnership reports Figure 26.P. natural gas can also be stored in liquid form (LNG) using above-ground storage facilities. Crude oil is also gathered via tank trucks from older. FERC). terminal cash flow is more subject to the operational expertise of the terminal operator/marketer. iso-butane. Marine terminals. natural gasoline.. • NGL pipelines. deliver them to end users. In the latter case. such as ethane. providing a steady source of demand for crude oil pipeline throughput.P. which are stored in above-ground facilities.e. refineries. Main crude oil trunkline systems feed refiners from waterborne imports. There are also terminalling facilities that handle products other than crude oil. gathering systems. Crude oil gathering pipelines transport crude from the wellhead to larger mainlines. natural gas. Unlike refined products and crude oil storage. L. or (3) salt cavern formations. The advantages of a depleted natural gas or oil field are that it uses existing infrastructure (i. • 22 . Plains All American Pipeline. Terminalling operations provide storage. and domestic production.P. However. and other dry-bulk materials. and pipeline connections). The most common form of natural gas storage in the United States is the use of depleted natural gas or crude oil fields because of their availability. Terminals consist of either inland or marine terminals. less productive wells where gathering pipelines are not economical. L. natural gas is primarily stored underground using (1) depleted reservoirs. SemGroup Energy Partners. vegetable oil products. which. distribution. Natural gas liquids (NGL) pipelines transport mixed NGL products. Genesis Energy. blending and other ancillary services to pipeline systems. Given the difficulty in building new refineries in the United States. are large storage and distribution facilities that handle crude oil or refined petroleum products.P. Inland terminals generally receive product from pipelines and distribute them to third parties at the terminal. coal. Crude oil pipelines provide stable. such as retail gasoline stations. NGL pipelines typically move NGLs from natural gas processing plants.P. usually located near refineries. L. butane.g. Crude Oil Value Chain Source: Plains All American Pipeline. These other products include asphalt. industrial chemicals. as well as the amount of blending activity that takes place at the facility. petrochemicals. existing refining capacity tends to be consistently used. fertilizers.Master Limited Partnerships • WACHOVIA CAPITAL MARKETS. Most NGL pipelines generate cash flow based on a fixed fee per gallon of liquids transported and volumes delivered. Canadian imports. LLC Enbridge Energy Partners. in turn is dependent upon petroleum product pipeline throughput. U. L. and import terminals to fractionation plants and storage facilities. LLC EQUITY RESEARCH DEPARTMENT Crude oil pipelines. ore. petroleum coke.S. propane. which. and refined products. in turn.
L. and hydrogen sulfide. the future delivery price of the commodity is above the current spot price. commonly referred to as NGL raw mix or ‘y’ grade. Processing.P. L. Natural gas prices influence producer drilling activity and the type of contract pricing. Processing. Processing. Western Gas Partners.P. Quicksilver Gas Service. or refined. 23 . Processing. Gathering. and NGLs RGNC Gathering. Natural gas gathering pipelines consist of small diameter (4”-6”) pipelines that connect completed natural gas wells to larger diameter (10”-30+”) natural gas pipelines.e. and NGLs HLND Gathering. Processing. Processing.P.P.P. L. Duncan Energy Partners L.MLP Primer -. L. and NGLs DPM Gathering. natural gas or crude oil) is below the current spot price. and NGLs EROC Gathering. and NGLs CPNO Gathering. In a contango market. and NGLs WPZ Gathering. and NGL MLPs MLP Atlas Pipeline Partners. Ticker Primary Business Line APL Gathering. the future delivery price of the commodity (i. Processing. in part. and NGLs Source: Partnership reports Figure 28. Enterprise Products Partners. Processing. and NGLs KGS Gathering.P. and/or processed to remove natural gas liquids. and NGLs XTEX Gathering. Processing. ONEOK Partners. natural gas from the wellhead must often be processed. giving producers and marketers incentive to store the commodity. and NGLs EPD Gathering.P. sulfur. the natural gas gathering system must hook up additional wells. L. L. Natural gas is gathered at the wellhead and then collected at central delivery points and transported to treating and processing plants. Processing. Hiland Partners. Gathering And Processing Value Chain Residue gas Raw NGL mix Natural gas processing and treating Residue gas and raw NGL mix transportation Natural gas production Gathering and compression Source: Targa Resources Partners. Williams Partners.P. To offset this decline and maintain overall gathering system volume.P.P.Third Edition WACHOVIA CAPITAL MARKETS. L. • Natural gas processing and fractionation.P. carbon dioxide. and NGLs NGLS Gathering. Processing. Targa Resources Partners L. Processing. Raw natural gas may be dehydrated to remove water. DCP Midstream Partners.P Copano Energy. L. Eagle Rock Energy Partners. As natural gas wells age. and NGLs WES Gathering.P. LLC EQUITY RESEARCH DEPARTMENT Terminals are affected by backwardated and contango markets. L.P.P. Processing. L. and NGLs MWE Gathering. by natural gas prices. L. Processing. Figure 27. LLC Crosstex Energy. The cash flow stability of natural gas gathering and processing systems is dictated.. Processing. and NGLs OKS Gathering. Processing. MarkWest Energy Partners. • Natural gas gathering. treated to remove chemical impurities. production naturally declines. L. Regency Energy Partners. to remove impurities in order to meet requirements for pipeline transportation. In a backwardated market. Prior to long-haul transportation. and NGLs DEP Gathering. resulting in less incentive to store the commodity. L.
Increases in the price of NGLs relative to natural gas increases gross margin. heating water. The processor gathers and delivers the natural gas to pipelines where the company resells the natural gas at the index price. butane.” while decreases in the price of NGLs relative to natural gas reduces gross margin. partnerships with gathering and processing assets have more commodity price exposure and tend to benefit during periods of high commodity prices. and natural gasoline. and as a feedstock for the petrochemical industry (i. Fractionation. normal butane. synthetic lubricants. Under the percentage discount. refrigerators and freezers). drying clothes. 24 . the processor must keep the producer “whole” on his natural gas that goes in and comes out of the processing plant. • Ethane is not used as a fuel. for the production of isooctane--a clean source of octane enhancement for gasoline). The partnership gathers natural gas from the producer. Natural gas is typically processed under three primary contracts that expose the processor to varying degrees of commodity price risk. in turn. Commodity price sensitivity. Ethylene is used in the production of detergents. which should. • Propane is used for heating homes. Gross margin increases as natural gas prices and NGL prices increase and decrease as natural gas prices and NGL prices decrease.e.. pipeline quality gas) and NGLs at market prices and remits to the producer an agreed upon percentage of the proceeds based on an index price. and other chemical products. propane. The partnerships gather and process natural gas on behalf of producers. • Keep-whole contracts. and fueling gas fireplaces and barbecue grills. processes the natural gas. the liquids serve a variety of purposes. a propellant in aerosol sprays. increase volume on gathering systems. plastic packaging materials. In general. The remaining 20% would be captured by the processing plant operator. The MLP sells the resulting residue gas (dry. Put another way.. Gas processors with primarily keep-whole contracts benefit most in an environment of high commodity prices because they are direct sellers of natural gas liquids. insulation. MLPs receive a fee for the volume of natural gas or NGLs that flows through its systems.e. • Iso-butane is used as a gas in refrigeration systems (i. not the price. iso-butane. iso-butane. • Normal butane is typically used for motor gasoline blending and as a feedstock for the production of plastics. • Natural gasoline is used primarily in motor gasoline blending and as a petrochemical feedstock. Once separated. Gross margin is directly related to the volume. • Percent-of-index contracts. propane. ethane. cooking and refrigerating food. of the commodity flowing through the system and the contracted fixed rate. A typical contract would entitle the producer to 80% of the proceeds from the sale of natural gas and NGLs through the plant. These liquids include ethane. LLC EQUITY RESEARCH DEPARTMENT Natural gas liquids.. the processor must replace the natural gas (on the basis) that was extracted while processing. High prices are likely to stimulate drilling activity and should increase production. NGLs are then further refined or fractionated into separate liquids (i. and natural gasoline) at fractionation facilities.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. NGLs are hydrocarbons that are separated from natural gas through various processes at natural gas processing plants. commonly referred to as the “frac spread. Because the extraction of the NGLs from the natural gas stream reduces the energy (Btu) content of the natural gas. The natural gas processor purchases natural gas at a percentage discount to a specified index price or a specified index price less a fixed amount. • Percent-of-proceeds contracts. and sells the resulting NGLs to third parties at market prices. but as a feedstock for the production of ethylene. A list of some of the most common types of contracts follows: • Fee-based contracts. The processor either purchases natural gas at the market price to return to the producer or makes a cash payment to the producer equal to the reduced energy content. gross margin increases when the price of natural gas increases and decreases when the price of natural gas decreases.e. It is also used as vehicle fuel and petrochemical feedstock.
e. However. Belvieu) To Crude Oil (WTI) Ratio (%) 2004 Average: 73% 2005 Average: 67% 2006 Average: 63% 90% 2007 Average: 70% (*) 2008 YTD Avg: 59% Current: 59. if the company is able to qualify). Historical NGL-To-Crude Oil Ratio 100% NGL (Mt. Some gathering and processing MLPs prefer to use dirty hedges to manage their NGL exposure due to a more liquid crude oil derivatives market (i. 133 allows companies to recognize all derivatives as assets or liabilities and at fair value. including swaps. Gathering and processing MLPs with commodity price exposure typically have hedging programs to mitigate a substantial portion of that price risk.00 80% 70% Data Missing 60% 50% Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Source: Bloomberg Mark-to-market hedge accounting. some companies may employ hedge accounting (i. a majority of the volatility is usually non-cash. The changes in the fair value of the derivatives are recognized in the company’s earnings over time unless certain hedging criteria are met. if the contract is marked-to-market.. NGL prices have been. Financial Accounting Standards Board (FASB) Statement No. MLPs. the futures contract is assigned a value based on current market prices. the value of a futures contract with an expiration date of one year from today is not known until it expires. to a lesser degree. The impact of mark-to-marketing accounting affects different parts of a company’s financial statements depending on whether the derivative is classified as “trading” or “other than trading. Derivatives classified as other than trading are also measured at fair value and recognized as assets or liabilities. etc. Hedge accounting. with the changes in value included as a component of stockholders’ equity until realized. Over the past three years. Figure 29. A company that uses mark-to-market accounting could report significant earnings’ volatility. on average. puts.0% Current NGL price ($/g): 1.” Derivatives classified as trading are recognized as assets or liabilities with the corresponding loss or gain recognized in the income statement. 25 . However. approximately 68% correlated with crude prices.e. as we believe the focus for MLPs should be on cash flow rather than earnings. We do not pay as close attention to earnings per unit (EPU). This price relationship between natural gas liquids and crude oil is meaningful for gathering and processing MLPs that use “dirty” crude oil hedges as a proxy to hedge NGL exposure (as opposed to hedging the individual NGL components). Realized gains and losses would be included in earnings. LLC EQUITY RESEARCH DEPARTMENT Hedging commodity price exposure. the use of dirty hedges could prove ineffective if the correlation between NGL and crude oil prices deteriorates. Price relationship between crude oil and natural gas liquids. In order to offset the mark-to-market movement of derivatives. the NGL market has limited liquidity) and a historically strong correlation between crude oil and NGL prices. in general. Partnerships use a variety of derivative contracts and option strategies to mitigate their exposure. Mark-to-market hedge accounting assigns a value to a company’s derivatives positions based on the current market prices for those derivative instruments. on a 3-5 year basis. For example. calls.Third Edition WACHOVIA CAPITAL MARKETS. collars. however.MLP Primer -.96 Current oil price ($/Bbl): $140.. tend to hedge 70-80% of their near-term exposure and.
Star Gas Partners. (source FASB) • Cash flow hedges.P Ferrellgas Partners. or firm commitment. Propane MLPs. household energy needs. L. (source FASB) • Net investment hedges. Propane MLPs distribute propane via truck to residential. declining wholesale propane prices aid earnings because retail prices tend to lag costs.S. Although.P. a commodity (i. Propane serves approximately 3% of total U. Inergy. Industrial customers use propane primarily as a fuel for forklifts and stationary engines. primarily for home and water heating. the hedged item) and its hedging instrument must have a correlation ratio between 80% and 125%. The gain or loss of a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation is reported in other comprehensive income (outside earnings) as part of the cumulative translation adjustment.P.P. The effective portion of the derivative’s gain or loss is initially reported in other comprehensive income (outside earnings) and subsequently reclassified into earnings (as either gains or losses in operating revenue) as the forecasted transactions occur. It is also an important feedstock used in the production of various chemicals and plastics. The gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. Suburban Propane Ticker Primary Business Line APU FGP GLP Propane Propane Gasoline and heating oil NRGY Propane SGU Propane SPH Propane Source: Partnership reports Figure 31. liability.e. tobacco curing. LLC EQUITY RESEARCH DEPARTMENT To qualify for FAS 133 hedge accounting. There are three different types of hedge accounting: • Fair value hedges. If these criteria are not met. A net investment hedge attempts to mitigate foreign currency exposure of a net investment in a foreign operation. Since propane distribution is a cost plus margin-type business. Propane MLPs MLP AmeriGas Partners L. commercial. L. Global Partners. industrial. and chicken brooding. hedge accounting cannot be applied. rising wholesale propane prices can squeeze margins when retail prices lag cost 26 . quick changes in propane costs can affect short-term results. Propane is a by-product of natural gas processing and crude oil refining. A cash flow hedge attempts to mitigate the exposure to changes in cash flow of a forecasted transaction. A fair value hedge attempts to mitigate the exposure to changes in the fair value of a recognized asset. and as a fuel for barbecues. L.P. Figure 30. Propane Energy Value Chain Source: Inergy. while agricultural customers use propane for crop drying.P.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. In general. The ineffective portion of the gain or loss is reported in earnings for the period in which the ineffectiveness occurs. Residential heating sales command the highest margin and are the greatest source of profit for propane distributors. L. which could lead to significant volatility in a company’s earnings.. and agricultural customers. L. and the company must have hedge documentation in place at the inception of the hedge.
and the inability to pass higher costs on to consumers. depending on the type of vessel and location. L.Third Edition WACHOVIA CAPITAL MARKETS. Risks to propane MLPs include warmer-than-normal weather. extremely high propane prices may cause conservation and may expose distributors to higher bad debt expense. Shipping Partners. Teekay LNG Partners. with the top ten retailers controlling approximately 39% of the propane market and more than 5. K-Sea Transportation Partners. Propane prices fluctuate based on winter heating demand. Propane remains a very seasonal business. The more significant driver of propane consumption is weather. Teekay Offshore Partners L. rising retail propane prices can lead to consumer conservation. as propane is used primarily for heating. For example. approximately 70% of annual cash flow is earned during the winter heating season (October through March). The propane industry remains extremely fragmented.P.000 300. Under normal circumstances. Shipping partnerships are subject to various governmental and industry regulations. L. Shipping MLPs transport energy products primarily via tankers or barges.000 retailers holding the remaining market share. heating oil. and crude oil. L. diesel fuel.P. liquefied natural gas.P. chemical producers. propane does have defensive characteristics similar to other utility services because residential and commercial customers require propane for basic needs such as space and water heating.000 Thousand barrels 400. significant variations can occur in any given year. Products shipped typically include refined petroleum products and by-products such as gasoline. Commodity price sensitivity. consumer conservation.S. petrochemical and commodity specialty products. in our view. asphalt. In addition. OSG America. in recent years the changing nature of competition has allowed margins to expand in the face of record propane prices. fuel oil.000 0 1981 1983 1985 1987 1989 Source: Energy Information Administration 1991 1993 1995 1997 1999 2001 2003 2005 2007 Risks. MLPs with propane assets are generally indifferent to price fluctuations as long as they can pass on price increases to customers.000 200. integrated oil & gas companies and energy marketing companies. Since the overall long-term growth rate for the propane distribution industry is less than 2% annually. Navios Maritime Partners. lubricants. Figure 32.P. L. Historical U. and chemical demand.P. LLC EQUITY RESEARCH DEPARTMENT increases. 2006 and 2007 experienced some of the warmest average annual temperatures ever recorded during the winter heating season. oil price trends. Figure 33. Shipping MLPs.MLP Primer -. Although average annual temperatures have been fairly constant over the past 30 years. jet fuel. as propane companies generate a majority of their revenue during the winter heating season. sulfur. Although influenced by weather. L. Drivers. 61%. The primary customers for shipping MLPs include large oil refiners. Propane distributors tend also to have higher working capital requirements when prices are very high. Shipping MLPs MLP Capital Product Partners. accretive acquisitions of smaller propane companies are a key to enhancing long-term performance.000 100. Consumption Of Propane 500.P.S. U. Ticker Primary Business Line CPLP International product tankers KSP Domestic tank vessels NMM International dry bulk OSP Domestic tank vessels TGP LNG vessels TOO Crude oil shuttle tankers and floating storage and offtake units USS Domestic tank vessels Source: Partnership reports 27 .P. However. L.
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The shipping category encompasses several different MLPs with distinctly different business models and operating environments. These business models include the following: • International product tankers. Product tankers typically transport refined petroleum products, typically gasoline, jet fuel, kerosene, fuel oil, naphtha and other soft chemicals and edible oils. The marine transport of petroleum products between receipt and delivery points addresses the demand and supply imbalances for the refined product, which is usually caused by a lack of resources or refining capacity in the consuming country. • Domestic tank vessels. Tank vessels, which include tank barges and tankers, transport gasoline, diesel, jet fuel, kerosene, heating oil, asphalt, and other products from refineries and storage facilities to other refineries, distribution terminals, power plants, and ships. The demand for domestic tank vessels is driven by the U.S. demand for refined petroleum products, which can be categorized by either clean oil (e.g., motor gasoline, diesel, heating oil, jet fuel, and kerosene) or black oil products (e.g., asphalt, petrochemical feedstocks, and bunker fuel). Clean oil demand is primarily driven by vehicle usage, air travel, and weather, while black oil demand is typically driven by oil refinery requirements and turnarounds, asphalt use, use of residual fuel by electric utilities, and bunker fuel consumption. • International dry bulk. Dry bulk vessels transport cargoes that consist primarily of major and minor bulk commodities. Major bulk commodities include coal, iron ore, and grain, while minor bulk commodities include steel products, forest products, agricultural products, bauxite and alumina, phosphates, petcoke, cement, sugar, salt, minerals, scrap metal, and pig iron. The demand for dry bulk trade is driven primarily by the demand for the underlying dry bulk product, which is, in turn, influenced by growth in global economic activity. • Liquefied natural gas vessels. Liquefied natural gas is transported by specially designed double-hulled ships from producing to growing nations. The vast majority of LNG shipments occur in Europe and Asia. LNG vessels receive liquefied natural gas from liquefaction facilities for transport to regasification facilities at the receiving terminal. LNG demand is driven by countries that consume significant quantities of natural gas but lack the local production and/or pipeline infrastructure to deliver natural gas to its markets. • Crude oil shuttle tankers and floating storage and offtake units. Shuttle tankers, which are commonly described as “floating pipelines,” are specially designed ships that transport crude oil and condensates from offshore oil field installations to onshore terminals and refineries. The primary differences between shuttle tankers and conventional crude oil tankers are that shuttle tankers are used in regions with harsh weather conditions (e.g., the North Sea) and have voyages that are shorter in duration. Floating storage and offtake (FSO) units provide on-site storage for offshore oil field installations. FSOs are secured to the seabed and receive crude oil from the production facility via a dedicated loading system. FSOs transfer crude oil to shuttle and conventional tankers through its export system. Shipping and marine transportation services are typically performed under spot and term contracts set under a competitive bidding process. The rates charged under these contracts can be based either on a daily basis or on a volume transported basis. The terms and awarding of contracts is based on (1) vessel availability and capabilities, (2) timing of customer’s schedule, (3) price, (4) safety record, (5) experience and reputation, (6) vessel quality, and (7) the supply and demand of products being shipped. Shipping contracts can vary in length depending upon the type of ship and operating market. Most contracts under the MLP (versus corporate) structure are longer term in nature (e.g., LNG contracts are typically under ten-year terms or more), which provides a shipping MLP with some cash flow stability. These longer-term contracts tend to have escalation clauses whereby certain cost increases such as labor and fuel are passed on to the customer. Shipping is subject to prevailing market trends, which tends to make spot market activity (i.e., for short-term contracts), and is volatile and therefore, less suitable for the MLP structure, in our view. Shipping MLPs, like pipeline MLPs, do not assume ownership of the products shipped. U.S. point-to-point shipping competition is somewhat limited from foreign competitors due to the Jones Act, which restricts such shipping to vessels operating under the U.S. flag, built in the United States, at least 75% owned and operated by U.S. citizens, and manned by U.S. crews. Drivers. The shipping industry is highly fragmented, which lends itself to consolidation. The current tight vessel supply and demand market condition should keep charter rates firm to increasing over the foreseeable future. As the industry rebuilds to meet government double-hull regulations, and as the 2015 deadline approaches, new larger, more efficient barges with long-term contracts should enhance the earnings stability
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and cash return on investment. Stringent safety requirements by customers should continue to work to the benefit of larger vessel operators spawning mergers within the industry. The potential to acquire dock, terminal, storage facilities, and other harbor-based facilities could help to vertically integrate or diversify the business model of vessel operators. Risks. Investments in shipping MLPs can be considered a higher-risk investment relative to pipeline MLPs, due to the following factors: (1) regulatory requirements (e.g., OPA 90 requires single-hulled vessels to be phased out by 2015); (2) short-term nature of contracts (versus pipeline MLPs); (3) spot market volatility; (4) competitiveness of the contract bidding process; (5) new build risk (i.e., up-front significant capital); (6) decline in demand for shipped products; and (7) potential repeal of the Jones Act. Commodity price sensitivity. Like pipeline MLPs, shipping MLPs typically do not take title to the product shipped; therefore, changes in commodity prices have a minimal direct impact on these companies. Shipping MLPs could potentially be indirectly affected by a (sustained) high commodity price environment (on the products transported), which ultimately results in a decrease in the demand for the products shipped (i.e., consumer conservation). Shipping MLPs’ earnings are more directly tied to the demand for the product shipped. Coal MLPs. The universe of coal MLPs consist of one coal producer and two coal royalty businesses that own, lease, and manage coal reserves. The royalty-oriented partnerships enter into long-term leases that provide the coal operators the right to mine coal reserves on the partnerships’ properties in exchange for royalty payments. A coal MLP’s royalty payments are based on the volume of coal produced and the price at which it is sold. In addition, since coal royalty MLPs do not operate any of the mines, their operating costs are typically limited to corporate and administrative expenses. Figure 34. Coal MLPs
MLP Alliance Resource Partners, L.P. Natural Resource Partners, L.P. Penn Virginia Resource Partners, L.P. Ticker Primary Business Line ARLP Coal operator NRP Coal royalty model PVR Coal royalty model
Source: Partnership reports
Drivers. The demand for and the price of coal is driven by a number of factors, both domestic and international. Domestically, demand is driven by (1) electricity demand because electric utility companies are the primary consumers of coal (more than 90%); (2) the relative price of natural gas and crude oil, as some power producers can alternate their fuel consumption based on the relative price of different fuels; (3) weather, which can influence electricity demand and hydro-electric production; and (4) environmental regulations. The demand for electricity is generally influenced by economic growth, weather patterns, and coal customer inventory trends. Internationally, demand for coal is also influenced by worldwide electricity demand, the value of the dollar, economic growth in developing countries, and demand for steel, which is derived from metallurgical coal (commonly referred to as met coal). Risks. Risks to both coal producer and royalty-based MLPs include declining coal prices, operational and geological issues, and regulatory issues (specifically environmental). Risks specific to coal royalty MLPs include (1) reliance on lessees to operate and produce on its reserves (i.e., the rate of production is dictated by the producer); and (2) no direct control over pricing (i.e., lessees negotiate new contracts with utilities and other end users directly). Commodity price sensitivity. MLPs with coal assets directly benefit during periods of high commodity prices. Coal MLPs own coal reserves and either lease their reserves and collect a royalty stream or mine the coal reserves directly. Since most coal is sold under long-term (1-3 year) contracts, higher coal spot prices do not immediately affect coal sales prices. When contracts roll over, they are typically renegotiated closer to prevailing spot prices. Upstream MLPs. Upstream MLPs are focused on the exploitation, development, and acquisition of oil and natural gas producing properties. These partnerships produce oil and natural gas at the wellhead for sale to various third parties. Typically, upstream MLPs do not partake in exploratory drilling, but rather own and operate assets in mature basins that exhibit low decline rates and long reserve lives. Accordingly, these assets require a relatively small amount of capital to fund low-risk development opportunities and have predictable production profiles.
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Figure 35. Upstream MLPs
MLP Atlas Energy Resources LLC BreitBurn Energy Partners, L.P. Constellation Energy Partners LLC Dorchester Minerals, L.P. Encore Energy Partners, L.P. EV Energy Partners, L.P. Legacy Reserves L.P. Linn Energy, LLC Pioneer Southwest Energy Partners, L.P. Quest Energy Partners, L.P. Vanguard Natural Resources, LLC Ticker Primary Business Line ATN 95% natural gas / 5% crude oil
BBEP 63% natural gas / 37% crude oil CEP 99% natural gas / 1% crude oil
DMLP Natural gas and crude oil royalty model ENP 32% natural gas / 68% crude oil
EVEP 76% natural gas / 24% crude oil LGCY 26% natural gas / 74% crude oil LINE 65% natural gas / 35% crude oil PSE 16% natural gas / 84% crude oil
QELP 99% natural gas / 1% crude oil VNR 74% natural gas / 26% crude oil
Source: Partnership reports
Upstream MLPs represent a lower-risk way to invest in oil and natural gas. Commodity risk is substantially mitigated via an actively managed hedging program. Most upstream MLPs have hedges that lock in prices for 70-90% of their anticipated production for 1-3 years. Upstream MLPs seek to address long-term commodity price and liquidity risk by maintaining conservative debt levels. Drivers. Because drilling and development activity of most upstream MLPs is focused primarily on maintaining, rather than increasing, production, most upstream MLPs rely on acquisitions funded with debt or equity to drive distribution growth. In addition, higher commodity prices should benefit the unhedged portion of upstream MLP production. This excess cash flow can be reinvested into acquiring mature reserves and/or help fund organic growth capex, both of which should support additional distribution growth. Risks. Some of the risks associated with investing in upstream MLPs include (1) declining commodity prices, (2) inability to hedge at attractive prices, and (3) a lack of acquisition opportunities. Commodity price sensitivity. MLPs that own oil and gas assets have the most direct exposure to commodity prices. Typically, these partnerships mitigate this exposure by hedging 70-90% of current production. Hedging serves to protect against decreases in commodity prices and hence, supports the consistency of distribution payments. However, a prolonged period of depressed commodity prices could force a partnership to reduce its distribution. Many upstream MLPs maintain a high coverage ratio in order to partially mitigate this risk. Refining. Refining MLPs produce specialty and fuel products from the refining of crude oil. Specialty products include lubricating oils, solvents, and waxes that are used as raw material components for basic industrial, consumer, and automotive products. Fuel products include unleaded gasoline, diesel fuel, and jet fuel. Figure 36. Refining MLPs
MLP Calumet Specialty Products Partners, L.P Ticker Primary Business Line CLMT Refining
Source: Partnership reports
There are also some MLPs that own asphalt storage assets. Asphalt is a darkish brown to black, sticky, and highly viscous substance produced from crude oil (i.e., the bottom of the barrel). Due to the consistency of asphalt, it is stored in heated terminals and transported via truck, rail, and/or barge, but not pipelines. Asphalt is used primarily for paving and roofing purposes. It is estimated that approximately 85% of asphalt consumed in the United States is used for road paving and about 10% is used for roofing products (i.e., shingles). The asphalt business is seasonal and must be applied to roads during warm weather conditions. Thus, asphalt companies typically experience higher demand from May to October and build inventory during the colder months (i.e., January through April). Drivers. Factors driving refining MLPs include (1) crack spreads (i.e., the spread between crude oil input prices and product output prices); (2) the demand for specialty and fuel products; (3) demand levels for road paving by government and municipalities; (4) demand for housing; and (5) economic activity.
Some of the risks associated with investing in refining MLPs include (1) rising feedstock prices (i.. Natural gas compressors are used to compress a volume of natural gas at an existing pressure to a higher pressure to facilitate delivery of the gas from one point to another. which house the GP interest and IDRs of the underlying MLP. environmental legislation (i. and (3) a slowdown in commercial and residential construction. Commodity price sensitivity.e.. Risks associated with investing in MLPs with domestic LNG assets include the LNG market not developing as quickly as anticipated and higher natural gas prices in international markets resulting in more LNG cargos delivered to Europe and Asia. and (4) along intrastate and interstate pipelines. An investment in a GP security is a leveraged play on the underlying MLP as the GP’s financial performance and distributions are dependent upon the underlying partnership’s operations and distribution growth prospects. LNG MLPs MLP Cheniere Energy Partners L. and (3) high natural gas prices. 31 . decline in commodity prices) and the inability to pass through rising operating costs. crude oil). However. (2) throughout gathering and distribution systems. which spur drilling activity. of which 10 are structured as master limited partnerships. Significant declines in natural gas prices could make it uneconomical for liquefaction plants. (2) demand for refined products. MLPs with compression assets have limited sensitivity (i.. (2) acquisitions. the LNG is returned to its gaseous state (i. Factors driving LNG growth includes global demand for natural gas. and (4) unscheduled refinery turnarounds. the natural gas is stored in specially designed facilities or delivered to natural gas consumers through pipelines. The primary risks associated with compression MLPs include a decline in drilling activity (i.e. the primary risks include (1) volatility of asphalt prices (this includes seasonality). re-gasification).e.P. (2) inability to hedge asphalt prices. (3) alternative/competing products. Risks. Compression is often applied (1) at the wellhead.e. LNG describes the process whereby natural gas is transformed from a gaseous to liquid state and shipped via marine tankers to consuming markets. Natural gas is cooled into liquid form at a liquefaction facility and transported via specially designed ships to markets that have insufficient natural gas supplies or limited natural gas pipeline infrastructure. The GP merely receives cash payments from the MLP and re-distributes these payments to its unitholders in the form of distributions after deducting public company expenses. Commodity price sensitivity.. General partner interest. Compression MLPs (also known as Oilfield Services MLPs) provide natural gas contract compression services.. restricting construction of coal fired power plants). Figure 38.MLP Primer -. Ticker Primary Business Line CQP LNG Source: Partnership reports Drivers. The IDRs entitle the GP to receive a disproportionate amount of incremental cash flow from the underlying MLP as it raises distributions to limited partners. relatively stable utilization rates) to commodity price fluctuations. The public GPs are typically corporate shells. Compression MLPs MLP Exterran Partners LP Ticker Primary Business Line EXLP Oilfield Services Source: Partnership reports Drivers. With respect to asphalt. (3) into and out of processing and storage facilities. lower domestic natural gas production. Once re-gasified. There are 11 publicly traded general partnerships. Some GPs also own LP units of the underlying MLP. Compression. Factors driving compression MLP growth include (1) production from unconventional resources.e. Liquefied Natural Gas. Upon delivery of the LNG to the receiving terminal. and construction of additional liquefaction plants. a prolonged period of depressed natural gas prices could affect drilling activity and utilization rates. Risks. LLC EQUITY RESEARCH DEPARTMENT Risks.Third Edition WACHOVIA CAPITAL MARKETS. Figure 37. They do not take title to the natural gas they compress and typically charge fees for services regardless of throughput.
Inc.. L.P.. L.). VI. Hiland Holdings GP. LLC Inergy Holdings. NYSE. Crosstex Energy. L. 32 . Ticker Primary Business Line AHGP General partnership PVG General partnership AHD General partnership XTXI General partnership EPE General partnership HPGP General partnership ETE General partnership BGH General partnership MGG General partnership NSH General partnership NRGP General partnership Source: Partnership reports Drivers.P. Source: Wachovia Capital Markets. LLC EQUITY RESEARCH DEPARTMENT Figure 39. and (3) receive cash distributions. Instead. Energy Transfer Equity. and AMEX) just like corporate stock (shares). Magellan Midstream Holdings. MLPs do not pay corporate level taxes. The Basics A. unlike a C corp. The primary risk associated with investing in GP MLPs is operational challenges at the underlying MLP and the potential impact of indiscriminate carried interest legislation. and (3) is eligible to receive an incentive distribution. Buckeye GP Holdings. Limited partnership interests (limited partner units) are traded on public exchanges (i. NASDAQ. Penn Virginia GP Holdings LP Atlas Pipeline Holdings. Enterprise GP Holdings. L. GP MLPs MLP Alliance Holdings GP.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. NuStar GP Holdings. What Is An MLP? Master Limited Partnerships (MLPs) are companies that are structured as a limited partnership rather than a C corporation (C corp. L.P. L. The MLP Versus A Standard C Corp Structure Typical Structure comparison Corporate level tax Unitholder / shareholder level tax Tax shield on distributions / dividends Tax reporting General partner Incentive distribution rights Voting rights K-1 1099 MLP C corp. Factors driving GP MLP performance include (1) distribution increases at the underlying MLP and (2) equity issuances. L.e. taxes are paid (on a partially deferred basis) by limited partner unitholders. (2) typically holds a 2% ownership stake in the partnership. Figure 40. Risks. (2) have no role in the partnership’s operations and management.P. The key differentiating factor for an MLP is that. The general partner (1) manages the daily operations of the partnership.P. L. The limited partners (or common unitholders) (1) provide capital.P.P.P. LLC Who Are The Owners Of The MLP? MLPs consist of a general partner (GP) and limited partners (LP).
a partnership must receive at least 90% of its income from qualifying sources such as natural resource activities. Figure 41. In general.1x 6.9x WMZ 11. most MLPs are involved in the energy markets. MLPs should be able to either (1) pay more for an acquisition than a corporation and realize the same cash flow accretion or (2) realize more accretion from an acquisition given the same acquisition price. For example. MLPs have traditionally enjoyed good access to capital.Third Edition WACHOVIA CAPITAL MARKETS. there are 102 MLPs traded on public exchanges.6x WMB 6. unlike corporate investors. This enhances the partnership's competitive position vis-à-vis corporations in the pursuit of expansion projects and acquisitions. mining or production.3x PXD 6. Valuation Arbitrage Between MLP And C-Corp EPB EV/EBITDA MLP median C-corp median 15. LLC estimates • • The ability to maintain control of the assets (via the GP interest). income from sale of real property. and marketing of any mineral or natural resource.7x APC 5.3x SEP 15.7x TOO 7. Currently.9x TK 10. Thus. What Qualifies As An MLP? To qualify as an MLP.7x PSE 6. Why Create An MLP? An MLP provides a number of benefits to the sponsor. except for WES and PSE. 33 . MLP investors are not subject to double taxation on dividends. Types Of Publicly Traded Partnerships 90 78 60 Count 30 14 2 0 Energy Minerals and Timber Real Estate Investment / Financial Other 5 3 Source: National Association of Publicly Traded Partnerships D. interest. due to their tax-advantaged status. Figure 42.1x SE 6.1x.7x EP 7.7x WPZ 10. What Are The Advantages Of The MLP Structure? Due to its partnership structure. versus 6.5x EXLP 11. MLPs typically enjoy a competitive advantage relative to corporations. How Many MLPs Are There? Currently.5x for the associated C corp. real estate rents. in our opinion. gain on sale of assets.8x • Note: MLP ratios are EV/adjusted EBITDA Note: Data based on Q1 2008. In addition.1x TGP 13. Natural resource activities include exploration.MLP Primer -. storage.5x WES 9. development.1x EXH 7. processing. The opportunity to capture potential upside from incentive distribution rights (IDR). 78 are energy related. MLPs with C corp sponsors currently trade at an estimated median 2008 enterprise value-to-adjusted EBITDA multiple of 11. E. Of those. transportation.1x 11. Assets within the MLP structure typically trade at higher valuations in the market than those same assets within a C corp structure. which are based on respective IPOs in Q2 2008 Source: Partnership reports and Wachovia Capital Markets. MLPs generally do not pay entity-level income taxes. A premium valuation. which makes financing acquisitions and organic projects feasible. and income and gain from commodities or commodity futures. refining. including the following: • A tax-advantaged structure with which to pursue growth opportunities. dividends. LLC EQUITY RESEARCH DEPARTMENT B. C.
. K-1 forms are usually distributed in late February or early March. royalty trusts are yield-oriented investments and have unique investment characteristics. gain.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. Unlike MLPs. Are MLPs The Same As U. L. LLC EQUITY RESEARCH DEPARTMENT F. federal income tax on distributions received from the MLPs and sales of the MLPs’ units. and credits) at his or her individual tax rate. The remaining portion of this distribution is to be treated first as a nontaxable return of capital to the extent of the purchaser’s tax basis in its common units on a dollar-for-dollar basis and thereafter as capital gain. Copano Energy. A trust’s profit is not taxed at the corporate level provided a certain percentage (e. NuStar GP Holdings.S. whereas MLP limited partner unitholders generally do not have voting rights. Constellation Energy Partners. U.P. and Vanguard Natural Resources are registered as a limited liability corporation (LLC). Structure Comparison Structure comparison Non-taxable entity Tax shield on distributions Tax reporting General partner Incentive distribution rights Management incentive interests Voting rights Source: Wachovia Capital Markets. Linn Energy. trusts are not actively managed entities. there were 73 energy MLPs registered as a limited partnership (LP). In addition. LLCs unitholders have voting rights. Thus.P.S. investors would receive a Form 1099 rather than a K-1.S.. Royalty Trusts? Canadian Royalty Trusts? No U. These MLPs also provide percentage estimates of total cash distributions made during a certain period that would be treated as “qualified dividend income” (this is similar to the percent estimate of federal taxable income-to-distributions provided by standard MLPs). and credits. common unitholder at the capital gains tax rate versus the ordinary income tax rate. H. The qualified dividend income would be taxable to the U. However. but will be subject to U. LLCs have all the tax advantages of MLPs.S. deductions.S.S. they are not MLPs. The primary differences between LLCs and MLPs are that LLCs do not have a GP or incentive distribution rights.. they do not make acquisitions or increase their asset base. U. loss. What Is The Difference Between A LLC And MLP? As of July 2008. It is similar to a Form 1099 received from a corporation.. Based on this election. however. Atlas Energy Resources. G. and some can be retrieved online (via the company’s website). Thus.S. dividends from trusts fluctuate with cash flow and should eventually dissipate. In addition. the loss can be carried forward and used to offset future income from the same MLP.S. federal income tax on the partnerships’ income. 34 . since these MLPs are structured as corporations. K-1 K-1 1099 There are three shipping MLPs: Capital Product Partners L. Navios Maritime Partners.P. L. If the partnership reports a net loss (after deductions). deductions.S. Instead. including no corporate level of taxation and tax deferral for unitholders. What Is The K-1 Statement? The K-1 form is the statement that an MLP investor receives each year from the partnership that shows his or her share of the partnership’s income. but may have management incentive interests (MII).g. federal income tax purposes. and Teekay Offshore Partners. cash flow is paid to investors as it is generated and only until the underlying asset is depleted. which elected to be taxed as corporations for U. In contrast. The investor pays tax on the portion of net income allocated to him or her (which is shielded by losses. A U. The dividends are then taxed as personal income. Figure 43. holders will not directly be subject to U. LLC LP LLC C corp. royalty trust is a type of corporate structure whereby a cash flow stream from a designated set of assets (typically oil and gas reserves) is paid to shareholders in the form of cash dividends. it is considered a “passive loss” under the tax code and may not be used to offset income from other sources. Six entities. 90%) of profit is distributed to shareholders as dividends.
including the following: • Cash is king. However. The discrepancy between valuations can be attributed to a number of factors. Thus. On the other hand. • No conversion provision. the i-shares are not entirely pari passu with the MLP common units. an investment vehicle similar to LP units was created known as i-shares (the "i" stands for institutional).MLP Primer -. I-shares have average trading volume of only 133. but instead. One year after purchase. all gains (including the most recent share distribution) are treated as long-term capital gains. I. MLP units are difficult to sell short. in our view. The cost basis of the initial investment does not change. which would cause the units to trade more closely.679 for the two MLP units. the i-share security could be an appropriate investment. EEQ has traded at a premium to EEP. Canadian royalty trusts are more similar to upstream MLPs in that Canadian trusts are actively managed entities (i. LLC EQUITY RESEARCH DEPARTMENT MLPs are actively managed entities that can make acquisitions and investments to increase their asset base and sustain (and grow) cash flow. for investors who prefer to reinvest dividends. • No natural arbitrage. The i-share discount. the only other i-share security is Enbridge Energy Management. LLC (EEQ). versus 383.3% discount to KMP. make acquisitions or investments to grow production). except distributions are paid in stock instead of cash. i-shares can be owned in an IRA account without penalty. Currently. Investors prefer cash distribution to stock dividends. Thus.869.. both EEQ and KMR have traded at a discount to their MLP unit equivalent. Since inception. a limited liability company. The ability to convert an i-share to a common unit was removed by the partnerships soon after the public offerings. EEQ trades at a 3. • Liquidity. Thus. Unlike MLP securities. though recently. in May 2001. is spread among more shares. in our view. LLC (KMR). Kinder Morgan was the first to offer i-shares with the creation and issuance of Kinder Morgan Management. Hence. Over the long term.e.8% premium to EEP and KMR trades at a 5. 35 . the primary differences between upstream MLPs and Canadian royalty trusts are that the trusts (1) are involved in the exploration and production of crude oil and natural gas (whereas upstream MLPs are involved in exploitation and production) and (2) tend to hedge a smaller percentage of their current production volume (while upstream MLPs typically hedge approximately 70-90% of a current year’s production). Currently. i-shares do not require the filing of K-1 statements and do not generate UBTI. Distributions to i-shareholders are treated similar to stock splits. What Are I-Shares? In order to expand the universe of potential investors in MLPs to institutional investors and tax-deferred accounts such as IRAs.Third Edition WACHOVIA CAPITAL MARKETS. The i-share structure is analogous to an automatic dividend reinvestment plan. no natural arbitrage opportunity exists. The i-shares are equivalent to MLP units in most aspects. MLP distributions are managed to be steady and sustainable (and often growing).
Otherwise. the first-in.Premium / (Discount) Premium / (Discount) 20% 16% 12% 8% 4% 0% 1/29/07 2/28/07 3/29/07 4/29/07 5/29/07 6/29/07 7/29/07 8/29/07 9/29/07 1/29/08 2/29/08 3/29/08 4/29/08 12/29/06 10/29/07 11/29/07 12/29/07 6/29/08 Source: FactSet What Are The Tax Consequences Of Owning I-Shares? When a shareholder receives a quarterly distribution in the form of additional i-shares. (This is similar to the way a stock split is calculated.) If shares were acquired for different prices or at different times. this does not trigger a taxable event. An investor’s tax basis is calculated as the initial amount paid for the shares divided by the total number of shares received both from the initial purchase and the subsequent quarterly distributions. A taxable event occurs only when a shareholder sells his or her share.Premium / (Discount) Premium / (Discount) 16% 12% 8% 4% 0% (4%) (8%) 12/29/06 10/29/07 11/29/07 12/29/07 1/29/07 2/28/07 3/29/07 4/29/07 5/29/07 6/29/07 7/29/07 8/29/07 9/29/07 1/29/08 2/29/08 3/29/08 4/29/08 5/29/08 5/29/08 KMP-to-KMR .Master Limited Partnerships WACHOVIA CAPITAL MARKETS. An i-shareholder pays capital gains tax on the sale (long-term capital gains if the holding period is greater than one year). first-out (FIFO) method is used. EEP And KMP Relative To The Underlying I-Shares EEP-to-EEQ . LLC EQUITY RESEARCH DEPARTMENT Figure 44. The holding period for shares received as distributions is marked to the date at which the original investment in the shares was made. the basis of each lot of shares can be used separately in the allocation. 36 6/29/08 .
publicly traded GPs have an average estimated three-year distribution growth CAGR of 21.one standard deviation Source: FactSet and Wachovia Capital Markets.MLP Primer -. most MLPs have historically enjoyed good access to the capital markets.2% and consequently trade at lower than average yield of 5. Fastergrowing MLPs have commanded lower yields. organic growth projects. The following chart plots our three-year distribution growth CAGR estimates against current yields. 37 .5% and trade at an above average yield of 9. 55% of the variation is explained). based on an estimated 0. Empirical evidence suggests there is an inverse relationship between anticipated distribution growth and MLP yield. the market may be forecasting different growth assumptions for certain MLPs or factoring in different levels of risk. LLC estimates B. new debt and equity). or cost-saving synergies should benefit from an approximate 0. while slower-growing MLPs have traded at higher yields. LLC EQUITY RESEARCH DEPARTMENT VII.e. propane MLPs have a forecasted three-year distribution CAGR of 5... An MLP generates value for unitholders by investing in projects that generate returns in excess of the partnership’s cost of capital. the potential flaw with this analysis is that our distribution growth forecasts could be incorrect.2% reduction in yield. all else being equal. Figure 45.1781x + 0.Third Edition WACHOVIA CAPITAL MARKETS. In comparison. This level of correlation does not preclude an MLP with a forecasted distribution growth rate of 8% from trading at a similar yield to an MLP with a forecasted distribution growth rate of 10%. Distribution Growth Distribution growth has been one of the primary drivers of MLP price performance. An MLP that is able to increase its forecasted annual distribution growth rate by 1% via accretive acquisitions. However.1%.5479 9% Current Yield 6% 3% 0% 5% 10% 15% 20% 25% 30% 35% Estim ated 3-Year Distribution Grow th CAGR Note: Dotted lines represent +/. MLPs with investment grade credit ratings generally enjoy better access to capital at a lower cost. Correlation Between Distribution Growth And Yield 12% y = -0. Access To Capital Access to capital remains the key to MLP distribution growth as acquisitions and organic investments are mostly funded with external capital (i. In addition. This is due to the fact that MLPs distribute the majority of their cash flow in the form of distributions each quarter. Alternatively.74 correlation between the two variables (i. Drivers Of Performance A.0946 R2 = 0.7%.e. For example.
415 $5. in 1999.000 $3.5%. As MLPs have become more growth oriented.150 $14.610 $9.75% from 5.687 2006A 2007A 2008YTD Equity Proceeds Source: Partnership reports Debt Proceeds C.701 $4. Over that same period. Interest Rates The movement of interest rates has historically been an important driver of MLP performance.505 $9.000 $4.07.6% from an average of 7. the impact of modest interest rate movements on MLP price performance has decreased. LLC EQUITY RESEARCH DEPARTMENT Figure 46.965 $5. Over the past five years. 38 . This is due to the fact that MLPs are yield investments that were traditionally viewed as bond-like substitutes. our MLP Composite declined 20.000 $4. investors are able to receive a higher risk-adjusted rate of return from government-backed debt or treasury securities. while the Composite yield increased to 10. the correlation between the 10-year Treasury yield and MLPs has been only 0.7%.000 $16. the Fed increased the target rate three times to 5. MLPs have historically traded at an average spread of 251 basis points (bps) to the 10-year U.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.000 $5.206 $8. the average spread between MLP yields and treasury yields declined to a low of 16 bps from a high of 512 bps. MLPs have underperformed during certain some periods of rapidly rising interest rates because as interest rates increase.975 $ in millions $12. For example.598 $0 2004A 2005A $5. Historical Equity And Debt Issuances $20.00%.S. As MLPs have accelerated distribution growth over the past ten years (19982007) to approximately 9% from 4%. treasury (from 2000 to 2008 year to date).
or “high splits” tier. What Are Incentive Distribution Rights (IDR)? At inception. Near-term fluctuations in natural gas and crude oil prices are unlikely to have a material impact on pipeline MLPs. LLC EQUITY RESEARCH DEPARTMENT Figure 47. historically it has been low relative to other companies in the energy industry. the GP receives an increasingly higher percentage of the incremental cash distributions. (Please see the Appendix for a list of energy MLPs and their incentive distribution rights levels. MLPs typically pay cash distributions to unitholders on a quarterly basis. Commodity Prices The influence of commodity prices on MLPs varies significantly by sub-sector. Although MLPs’ exposure to commodity price risk varies overall. Longer term. As the GP increases cash distributions to LPs. This is known as the 50/50. LLC VIII. Impact Of Commodity Prices On MLPs Short-Term Increase In Prices Natural Gas Pipeline MLPs Gathering & Processing MLPs 1 Upstream MLPs None Negative Positive Crude Oil None Positive Positive Sustained Increase In Prices Natural Gas Positive Negative Positive Crude Oil Positive Positive Positive Note 1: For primarily keep-whole contracts Source: Wachovia Capital Markets. In most partnerships. but are likely to affect earnings (on the unhedged portion of production or volume processed) of upstream and gathering and processing MLPs. this agreement can reach a tier in which the GP is receiving 50% of every incremental dollar paid to the LP unitholders.Third Edition WACHOVIA CAPITAL MARKETS. please see the “Asset Overview” section beginning on page 18. even long-haul pipeline MLPs could be affected from reduced transportation volume and/or fewer infrastructure opportunities. What Are Distributions? Distributions are similar to dividends. B. as well. and raise the quarterly cash distribution to reach higher tiers. For a more detailed discussion of the impact of commodity prices. Key Terms A. As a result.) 39 . Figure 48.MLP Primer -. increase the partnership’s cash flow. Historical Midstream MLP Yield Spread To The 10-Year Treasury 600 As of 7/11/08 the spread was 388 bps MLP Yield Spread To 10-Yr Treasury (Bps) 500 400 300 200 100 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: FactSet D. MLPs establish agreements between the general partner and the limited partners that outline the percentage of total cash distributions that are allocated between the GP and LP unitholders. a sustained reduction in natural gas or crude oil prices could curtail drilling by producers. The theory behind this arrangement is that the GP is motivated to build the partnership. which benefits the LP unitholders. in our view.
LLC In this example. while the GP would receive 24%.00 ($4.50. which represents 75% of the distribution at that tier. At the declared distribution of $4.00.00 per unit. The GP receives 2%.00 $4. of that distribution at Tier 1.00 in our example.00 $2.00 $2. MLP XYZ’s yield of 8.00 and $2. between $0.30 $5. Thus.30 per unit. the LP receives $2.00 Source: Wachovia Capital Markets.00. the GP would receive 50% of the incremental cash. up to: $2.50. In other words. which represents 85% of the distribution at that tier. The GP receives 25% of the incremental cash flow. However.00 $2.09 $0.04 $0.00 $0. or the high-splits tier. Thus.50. which is the incremental cash flow above $3. if the distribution is increased to $5.00 + $1. This same formula is applied at the subsequent tiers.00 $4. which equates to $0.50 per unit and the GP receives $0.00.e. which equates to $0.59 $0. the adjusted yield of 10.04 $0.00 per unit.00 per unit.04 is derived by grossing up the $2.00).00 and less than or equal to $2.00)..e.04 $2. the formulas for Tiers 1-4 would apply. As the cash distribution is increased beyond $4.50 $0.30 $5. which is the incremental cash flow above $2.30 $1. In other words. it actually needs $2.00 Source: Wachovia Capital Markets.50 per unit but less than or equal to $3. Tier 4 (i. Based on this schedule.00. which equates to $1.13 $0.00 per LP unit.04 per unit. which represents 50% of the distribution at that tier.30 = $5. the LP receives $0. the LP receives $2.50 and less than or equal to $3.6% reflects distribution payments to both the LP and GP (i. LLC 40 .17 $1. the GP receives approximately 5% of the total distribution paid. and for the incremental $1. $4.00 received by LP unitholders represents 98% of the total cash distribution paid to the GP and LP unitholders. Figure 49. the LP would receive $1.. or approximately 9% of total distributions paid.30 $2. $4. MLP XYZ Distribution Tiers LP% Tier 1 Tier 2 Tier 3 Tier 4 98% 85% 75% 50% GP% 2% 15% 25% 50% LP distr.50 $3. At Tier 2. Tier 2 includes distributions greater than $2.30 98% 95% 91% 76% 2% 5% 9% 24% MLP XYZ Stock price Distribution to LPs Yield Total distributions Adjusted yield $50. the $2.e. Figure 50.00 $2.00.50 $3. This $0.09 per unit. and Tier 3 includes distributions greater than $2.0% $5.00. Tier 1 includes all distributions less than or equal to $2..04 $0. one to pay the LPs and one to pay the GP.30 ÷ $50. 50/50 splits). LLC EQUITY RESEARCH DEPARTMENT C.50 $3.00 and the GP would receive an additional $1.00 per limited unit. if the MLP wants to raise its distribution to limited partners by $1. The GP also receives 50% of the incremental cash flow.00 8.50 $0. Calculating Incentive Distribution Payments In the following table we illustrate the mechanics of how cash flow is allocated between the limited partners and the general partner based on a hypothetical incentive distribution rights schedule (see Figure 49). the LP unitholders would receive 76% of total cash distributions.00 ÷ $50.00 Above $3.00 Cumulative Cumulative distribution allocation of cash flow (%) Distribution per unit per unit LP GP Total LP GP Total LP GP $2.0% reflects distributions made only to the LP unitholders (i.00 to $5. at Tier 1.00 in hand.00 per unit but less than or equal to $2.00 per unit).63 $3.00 per unit. As outlined in Figure 50.00 distribution to LP unitholders by 98% and then multiplying by 2% ([$2. The GP receives 15% of the incremental cash flow.00.00 $2.13 per unit.00 $0.00 $1.50 per unit. or $0. we assume MLP XYZ declares a distribution of $4. is achieved when distributions are greater than $3. as well.6% Tier 1 Tier 2 Tier 3 Thereafter LP% 98% 85% 75% 50% GP% 2% 15% 25% 50% Above $3. the LP receives $1.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. which is the incremental cash flow above $2. MLP XYZ Incentive Distribution Tiers Distribution up to: $2. which represents 98% of the distribution at that tier. the LP receives $0.67 $2.00. At Tier 3. At this level.00/98%] × 2%). At Tier 4.30 10.
thereby increasing the partnership’s base of sustainable earnings. NRP) or wide commodity spreads (PAA). reflecting the stable. CEP and ATN’s MIIs are capped at 15% and 25%. PVR..0. cash flow accrues to the MIIs until they are eligible to receive the cash flow. Available and distributable cash flow is commonly calculated in the following ways: Figure 51. this “windfall” of cash is being used to pay down debt or to fund internal growth projects. In contrast. respectively.MLP Primer -. Thus. high coal prices (ARLP. What Is The Distribution Coverage Ratio And Why Is It So Important? A partnership’s distribution coverage ratio is the ratio of cash flow available to common unitholders and the general partner to the cash paid to an MLP’s common unitholders and the general partner (i. e. On the other hand. Are MLPs Required To Pay Out “All” Their Cash Flow? Under a typical partnership agreement.e.Third Edition WACHOVIA CAPITAL MARKETS. propane MLPs that have a cash flow stream that is sensitive to weather typically carry coverage ratios of at least 1. Distribution Coverage Ratio Calculation Distributions paid (to GP and LP) Source: Wachovia Capital Markets. 41 .1x range. However. the MIIs are not paid out to the holder until certain criteria are met (e.g. available cash flow for the GP and LP divided by distributions paid to the GP and LP). F. however. LLC EQUITY RESEARCH DEPARTMENT Management Incentive Interests (MII) Are Similar To IDRs Management incentive interests (MII) function in the same way as incentive distribution rights.2-1.1.g.” including future capital expenditure and financing requirements. The MIIs entitle the holder (e. the MLP is required to pay out all “available cash” to unitholders in the form of distributions. fee-based cash flow that underpins their businesses.3x. What Is The Difference Between Available Cash Flow And Distributable Cash Flow? We define available cash flow as the cash flow that is available to the partnership to pay distributions to both LP unitholders and the GP. LLC Distribution coverage ratio = Available cash flow (to GP and LP) Coverage ratios vary depending on the type of MLP and the inherent cash flow volatility in the underlying assets of the partnership. management) to receive an increasingly greater proportion of the MLP’s cash flow as distributions exceed certain thresholds. we calculate distributable cash flow as the cash flow available to the partnership to pay distributions less cash paid to the GP. Some MLPs have generated significant excess cash (or maintain higher distribution coverage ratios) for reinvestment in organic growth projects. most pipeline MLPs have coverage ratios in the 1.. Paying out the vast majority of cash flow is a strong discipline that incentivizes management to operate the partnership efficiently and to take extra precautions when contemplating acquisitions and/or organic capital projects. management teams have significant discretion in determining what is considered available cash flow. Figure 52. E. Available And Distributable Cash Flow Calculation Net income (+) depreciation and amortization (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow to LP unitholders OR EBITDA (-) interest expense (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow to LP unitholders Source: Wachovia Capital Markets.. For example. For both CEP and ATN. D. Constellation Energy Partners (CEP) and Atlas Energy Resources (ATN) are currently the only MLPs that have MIIs.. Management’s rationale for withholding cash flow is that the current earnings may not be sustainable due to unusual circumstances. target distribution levels and distribution coverage ratios).g. of incremental cash flow. LLC Distributable cash flow can also include cash distributions received from equity interests and reflect adjustments for non-cash items such as mark-to-market adjustments for derivative activity. This usually includes all cash flow that would be required for “the proper conduct of the business.
Tax And Legislative Issues A. thereby reducing the amount of current taxable income. when the investment was made. Who Pays Taxes? Because an MLP is a partnership and not a corporation.e. LLC EQUITY RESEARCH DEPARTMENT The distribution coverage ratio is significant for two reasons: • Traditionally. including accelerated depreciation and amortization deductions. Partners in an MLP (the limited partner unitholders and the GP) are required to pay tax on their allocable share of the partnership's income. IX. 42 . However. • All else being equal. who are then required to pay tax on his or her share of allocated net income regardless of whether they receive distributions. an MLP with assets in Texas is required to pay margin taxes. The tax-deferred portion of the distribution is not taxable until the unitholder sells the security. (2) Net income from the partnership is allocated each year to unitholders. an investor typically pays income taxes roughly equal to 10-20% of distributions received each year. We prefer the first definition. in our view. Taxes are not paid on the portion of allocated income that is shielded by deductions until the investor sells the security. distributions are well in excess of any tax liability. These deductions often offset a majority of the allocated income. return of capital). This is how it works: (1) LP unitholders receive quarterly cash distributions from the partnership each year. Thus. The third definition is the least meaningful. In general. and stock price at that time B.7% of its federal gross income apportioned to Texas. and deductions. What Are The Tax Advantages For The LP Unitholder (The Investor)? Limited partners typically receive a tax shield equivalent to (in most cases) 80-90% of their cash distributions in a given year. the greater the safety of the distribution. as it places a disproportionately large emphasis on commodity prices. Growth capex is the investment a partnership can make to enhance or expand capacity and increase cash flow. as reserves would also need to be replaced at some point. losses. The unitholder pays capital gains taxes as well as ordinary income tax on deferred income when he/she sells the security. There are currently three prevailing maintenance capex definitions used by upstream MLPs: • Under the strictest sense. and tax credits. Given its effect on distributable cash flow. the higher the ratio. which has a maximum effective tax rate of 0. G. • A more lenient approach is to define the metric as the capital required to replace annual production • Finally. as it fully reflects the cost of maintaining the asset base.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. The amount of taxes a LP unitholder pays is determined by several factors including the unitholder’s percentage ownership in the partnership. Distributions reduce the unitholder’s original basis in his/her units (i. gains. variance in the definition of maintenance capex can have significant ramifications for distribution policy and valuations. losses. For example. Focusing just on maintaining production may not be sustainable over the long term. a higher coverage ratio would give management increased flexibility to raise its distribution. maintenance capex can be defined as the capital required to maintain production and to replace reserves. The unitholder is also allocated a share of the MLP’s deductions (such as depreciation and amortization). there is some tax leakage at the MLP level if the partnership owns foreign assets and/or operates in a state with margin taxes. What Is The Difference Between Maintenance Capex And Growth Capex? Maintenance capital expenditure includes investments a partnership must make in order to sustain its current asset base and cash flow stream. maintenance capex can be viewed as the capital needed to sustain cash flow. investors have considered the coverage ratio to be representative of the cushion that a partnership has in paying its cash distribution. an MLP does not pay corporate-level federal income taxes. Upstream MLPs are currently divided on how to define maintenance capex.. In this context.
the depreciation period for all of the assets within the MLP restarts. Figure 53. the difference between cash distributions and allocated taxable income) creates a tax deferral for the investor.). etc. the 80-90% tax deferral would typically be restored in the following year. A termination of the partnership occurs if more than 50% of the total outstanding units of the partnership changes hands in one year. Tax Deferral Can Go Below 80-90% If an MLP does not continue making investments. Since most MLPs in recent years have been growing via acquisitions and expansion projects. When the units are sold. Thus. this has not yet become an issue. The remaining 80-90% is deferred until the investor sells the security. The net effect (i.e. LLC EQUITY RESEARCH DEPARTMENT This is the tax-deferral benefit of owning a MLP. When the investor sells the security. MLP Tax Deferral Rates Ticker Tax Deferral Rate AHD 75% AHGP 50% APL 80% APU 70-80% ARLP 70% ATN 60% BBEP 50% BGH 90% BPL 75% BWP 80% CEP 70% CLMT 80% CPLP 60% CPNO 80% CQP 80% DEP 80% DPM 70% EEP 90% EEQ NA ENP 80% EPB 80% EPD 90% EPE 90% EROC 80% ETE 60% ETP 80% Source: Partnership reports Ticker EVEP EXLP FGP GEL GLP HEP HLND HPGP KGS KMP KMR KSP LGCY LINE MGG MMLP MMP MWE NGLS NMM NRGP NRGY NRP NS NSH OKS Tax Deferral Rate 40% 80% 90% 90% 70% 80% 80% 90% 80% 95% NA 80% 90% 100% 90% 80% 51% 90% 80% 44% 50% 80% 70% 80% 80% 90% Ticker Tax Deferral Rate OSP 80% PAA 80% PSE 15% PVG 70% PVR 80% QELP 80% RGNC 80% RVEP NA SEP 80% SGLP 80% SGU 80% SPH 80% SXL 80% TCLP 80% TGP 80% TLP 80% TOO 30% TPP 90% USS 90% VNR 70% WES 70% WMZ 80% WPZ 80% XTEX 80% XTXI 0% Median 80% 43 . In that case. While this all may seem a bit confusing.Third Edition WACHOVIA CAPITAL MARKETS. However. An investor’s tax basis is adjusted downward by distributions and allocation of deductions (such as depreciation) and losses. the amount of depreciation allocated to the limited partners would be significantly less than the typical level and the tax shield on distributions would decrease. there is a recapture of the deductions (depreciation. the amount of income in a given year that would be deferred would decrease over time below the typical 80-90% level. an investor will typically pay ordinary income tax equal to only 10-20% of cash distributions received. the tax shield created by depreciation and other deductions decreases. Investors should consult with a tax advisor concerning their individual tax status. When this occurs. Another circumstance in which an investor’s tax shield could go below 80-90% is a termination of the partnership. a portion of the gain is paid at the capital gains rate and a portion of the gain (resulting from the tax shield created by allocated deductions) is taxed at the ordinary income tax rate. meaning the income that was deferred by the deductions becomes taxable income and is taxed as ordinary income.MLP Primer -. the bottom line is this: in any given year.. and upward by the allocation of income.
07. to $21 from $20 per unit.22 (i.80 $0.00)..20 $0.e. Tax-Deferral Calculation Annual distribution Tax deferral rate Tax deferred portion of distribution Taxable portion of distribution Ordinary income tax rate Tax due on year 1 distribution received Source: Wachovia Capital Markets. $1.00 per unit (i. the unitholder pays the same tax of only $0.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.00 distribution (i. LLC estimates $1. respectively.. 7% rather than the ordinary income tax rate of 35%).80 $0. We also assume no distribution increases over the five-year period and an ordinary income tax and long-term capital gains tax rate of 35% and 15%. as we assume the distribution of $1.00 5.00 4.8% Year 2 $22 $1. In addition.00.07 $0.e.e..2% Sell Unit At The End Of Year 5 $25 $1.00 4. as we assume the MLP unit price has appreciated 5%.80 × 5 × 35%). The Mechanics Of A Purchase And Sale Of MLP Units And The Tax Consequences We provide a simplified example illustrating the mechanics of a purchase and sale of an MLP unit and the associated tax consequences.07 $2.80 $0.07 on the $1.0%) • Is 80% tax deferred At the end of year 1.07 $0. we assume one MLP unit is (1) purchased for $20.80 $0.00 4.20 × 35% $0.07 $0.00 × 80% $0.75 ([$25 .75 + recapture of deferred taxes on prior year distributions of $1. The total related taxes paid at the end of year 5 is $2. the unitholder not only pays the $0.20 $0.0% 80% 35% 15% $0.40 ($0.20 $0.4% Year 4 $24 $1.80 $0. Figure 55.20 $0.00 per unit increase in the unit price each year).00 is maintained.00 per unit • Has an annual distribution of $1.6% Year 3 $23 $1. and (3) sold at the end of year five for $25. the MLP’s yield at the end of the year is 4. LLC estimates $0.$20] × 15%) and recapture of the deferred tax related to distributions in years 1-5 of $1.20 $0. the unitholder is required to pay taxes of only $0.80 $0.00 per unit (and yields 5.07 Year 1 $21 $1.00 ÷ $21.. Buy And Sell Mechanics Of An MLP Security Simplified MLP Buy And Sell Mechanics Unit price Annual distribution Yield % of distribution tax deferred (tax shield) Ordinary (personal) income tax rate Capital gains tax rate Tax deferred portion of distribution Taxable portion of distribution Tax paid at the end of each year on distributions received (at 35%) Tax paid when units are sold at the end of year 5: Capital gains tax paid (on unit price increase to $25 from $20) Ordinary income tax paid (on deferred portion of distributions) Tax paid on year 5 distribution Total tax paid at the end of year 5 Source: Wachovia Capital Markets.00 4.e. (2) held for five years. but also a capital gains tax of $0.40 + tax due on year 5 distribution of $0.00 per unit.0% At the start of year 1. we assume the following about the MLP unit: • Is purchased for $20. 44 . due to the MLP’s tax-deferral rate of 80% (See Figure 55 for calculation).07 $0.22 Unit Purchase Price $20 $1. LLC EQUITY RESEARCH DEPARTMENT C.75 $1.07 Annual distribution minus tax deferred portion of distribution equals taxable portion of the distribution At the end of years 2-4. a $1.07). Figure 54.07 tax on the distribution of $1. In our example.40 $0.00 4. Since we assume the unitholder sells the MLP unit at the end of year 5.8% (i. capital gains tax of $0.
State And Local Taxes..65 $27..00 $25.00).75 $2.e.00]-1).50 38% Source: Wachovia Capital Markets. the investor would realize a before tax total return of 50% (i.00 ÷ $20.00 $25. Can MLPs Be Held In An IRA? Technically yes.40 ($0.000 per year in an IRA would trigger adverse tax consequences for the plan sponsor.e. [total return ÷ original cost basis]-1 [$30.75 ([$25 . LLC estimates $4.$20] × 15%) • The recapture of the deferred tax related to distributions in years 1-5 of $1. LP unitholders may be required to file state and local income tax returns and pay state and local income taxes in some or all of the various jurisdictions in which an MLP conducts business or owns property. Investors may be subject to state and local taxes and return filing requirements even if he or she does not live in any of those jurisdictions.35] × 5) Figure 57.. 45 . LLC EQUITY RESEARCH DEPARTMENT Figure 56.93 × 5) Total return on investment Percent total return on investment $20.000 would be subject to tax. Income from MLPs and other sources of UBTI that exceeds $1.65 ([total distributions received – tax paid on annual distributions when received] × 5 years) ([$5.00). LLC estimates D.e. The after-tax total return would be approximately 38% in this example.80 × 5 × 35%) • The receipt of after-tax distributions of $4.07 $2.00 × 5) Total return on investment Percent total return on investment $20. Therefore.MLP Primer -. We recommend placing MLP units in traditional brokerage accounts to avoid this issue and to ensure that the investor receives the full tax advantages of the security.22 In this simplified example.Third Edition WACHOVIA CAPITAL MARKETS.00) plus the total distributions received from years 1 to 5 (i. divided by the original purchase price (i. UBTI exceeding $1.00 × 35% $1.00 . but we would not recommend it.40 $4.00 $5. $25.00 $30. $5. MLPs can be held in IRAs.75 $1. The investor’s total return of $30 is composed of the unit sales price at the end of year 5 (i.00 50% After-Tax Calculation Unit purchase price (original cost basis) Unit sale price (at the end of year 5) (-) Capital gains tax (-) Recapture of deferred tax (+) After tax distributions received ($0. Taxes Paid At The End Of Year 5 (The Sale) Total deferred portion of distribution (years 1-5) Ordinary income tax rate Recapture of deferred tax related to year 1-5 distributions Unit price at the end of year 5 Unit price at the start of year 1 Unit price appreciation Capital gains tax rate Capital gains tax paid on unit price appreciation Recapture and capital gains related taxes due Tax due on year 5 distribution received Total taxes paid at the end of year 5 Source: Wachovia Capital Markets.40 $25 $20 $5 × 15% $0. Please see the Appendix for a list of states in which each MLP operates.e.00 $0. Income from an MLP is considered UBTI for tax-exempt entities such as an IRA. $20. Estimated Total Return On Investment Before Tax Calculation Unit purchase price (original cost basis) Unit sale price (at the end of year 5) Distributions received ($1. E.$0. And Return Filing Requirements In addition to federal income taxes.. Our after tax calculation reflects the following: • The investor payment of a capital gains tax of $0.15 $0.
The NAPTP hosts an annual conference that allows its PTP members to provide company presentations to current and prospective investors. 35%).. The incentives were put into place to attract sufficient capital to support infrastructure development (i. The issue is that fund managers at Blackstone receive compensation in the form of carried interest that is then taxed as capital gains (taxed at 15%) as opposed to ordinary income (i. 2006. loss.. or marketing. as Congress could use these potential tax revenues to reduce current and future deficits. G. LLC EQUITY RESEARCH DEPARTMENT F. Trusts formed before November 2006 would be given a four-year reprieve until 2011. The association currently represents the interests of 73 publicly traded partnerships (PTPs). distributions to a non-U. loss revenue due to the tax structure of a royalty trust).org.S. While most of the early trusts were confined to real estate and energy. energy infrastructure. energy infrastructure in the past five years (2003-07) and are expected to invest significant amounts of capital over the foreseeable future. while others would begin paying taxes in 2007. H. mining. person are typically reduced by withholding taxes at the highest applicable effective tax rate. refining. and U. announced a tax fairness plan proposal that would change the favorable tax status of Canadian royalty trusts by 2011. NAPTP Is Working To Ensure That GPs Are Not Affected By Carried Interest Legislation With the initial pubic offering (IPO) of the Blackstone Group in 2007. Canadian royalty trusts would be taxed like all other Canadian corporations. Current Tax And Legislative Issues What Is The National Association Of Publicly Traded Partnerships (NAPTP)? The NAPTP is a trade association formed in 1983 that represents the interests of publicly traded partnerships (including publicly traded LLCs taxed as partnerships) and their respective employees on legislative and regulatory issues in Washington. The Canadian government has taken this action to close what amounts to a significant tax loophole (i. MLPs have invested more than $23 billion on U. development.e. and pay federal income tax at regular rates on his or her share of net income or gain. the tax liability created by the reduction of the original unitholders cost basis is eliminated.S. Concern has also been raised over the fact that Blackstone is channeling its management fees (non-qualifying 46 . Congress will continue to support MLPs’ favorable tax treatment given their integral involvement in the buildout of U. In our opinion. These bills exempted MLPs from corporate taxation. When doing so. of which 70 are energy MLPs. When an individual who owns an MLP dies. transportation. the risk of MLPs losing their tax-advantaged status is low. federal tax return to report his or her share of an MLP’s gain. D. pipelines and storage facilities) that would efficiently move energy products to consuming markets. at the full 31. In addition. Canada’s Finance Minister.naptp.). Thus. James Flaherty.S. District Court of Appeals recently upheld a new ruling by the FERC that allows MLPs to include an income tax allowance in pipeline ratemaking. many companies in other sectors have converted or are contemplating conversion to the trust structure. person who owns an interest in a MLP may be required to file a U. the individual’s MLP investments can be transferred to an heir.S. The advantages of the MLP tax structure were originally developed by Congress in mid. or income deduction. Foreign Investor Ownership A non-U.S. as long as at least 90% of their income is derived from natural resource or mineral activities (including exploration. the PTP structure has come under scrutiny by Congress. in our view. the cost basis of the MLP is reset to the price of the unit on the date of transfer.C.S. MLPs As An Estate Planning Tool MLPs can be used as a tax-efficient means of transferring wealth.to late 1980s. Under this proposal.e. The proposal is not yet law. processing. Additional information in regards to the association can be found at www. through the passage of the Tax Reform Act of 1986 and the Revenue Act of 1987. What Is The Risk Of MLPs’ Losing Their Tax-Advantaged Status? There has been some concern among investors that MLPs could be at risk of losing their tax benefits.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. Mr.5% rate.. Further. etc. Canadian Royalty Trusts Tax Status Expected To Change In 2011 On October 31.e. states. the U. However.S.
the NAPTP has been working to educate Congress on the differences between energy GPs and private equity funds. District Court of Appeals upheld a policy decision made by the Federal Energy Regulatory Commission in May 2005. An eligible unitholder is an individual or entity subject to U. FERC Includes MLPs In Determining Pipeline ROEs The Federal Energy Regulatory Commission (FERC) is the regulatory body responsible for determining the allowed rate of return (ROE) charged by interstate natural gas and oil pipelines. The inclusion of MLPs is a positive. In contrast. The NAPTP is working diligently with Committee staff and Treasury Department officials to help educate members about the differences in operations and income between publicly traded GPs and private equity funds. Another potential issue is the creation of corporate subsidiaries to convert non-qualifying income (such as management fees) into qualifying income via the payment of dividends to the partnership. U. now that carried interest has made it onto a list of potential revenue offsets. the FERC adopted a new policy to include MLPs as proxy pipeline companies in establishing the allowed ROEs charged by interstate natural gas and oil pipelines.MLP Primer -. However. if an MLP thinks it deserves to charge a higher rate on its pipeline. This included both private equity funds and publicly traded GPs.S. Congress may disallow the use of “blocker corporations. short-term growth rate two-thirds weighted + long-term growth rate one-third weighted). It is unlikely that there will be any new legislation on carried interest in 2008. which receive carried interest in the form of incentive distribution payments. federal income tax on income generated by the MLP is also considered an eligible unitholder as long as all of the entity’s owners are subject to U. MLPs that own FERC-regulated pipelines require their unitholders to be “eligible” holders. we believe Congress will be able to differentiate between tax avoidance and a legitimate business rationale for a corporate subsidiary for an energy MLP. the rates on new interstate pipeline systems are subject to FERC approval. The earlier bills were written so as to target any PTP that received compensation in the form of carried interest. all MLPs but publicly traded GPs). it can seek a rate case wherein the FERC acts as a mediator.Third Edition WACHOVIA CAPITAL MARKETS. as some rates are market based or negotiated with shippers. 2007. In determining an allowable pipeline rate.” Some energy MLPs hold corporate subsidiaries for purposes ancillary to their MLPs. in our view. 47 . The FERC’s methodology for calculating ROE is the dividend yield plus the projected future growth rate of dividends (i.e. 2008.e. Again. The long-term implications of the FERC’s policy change will likely not come to light until it’s implemented in an actual rate case.The carried interest issue has no bearing on conventional MLPs (i. (unlike c-corps) an MLP’s long-term growth rate (using GDP as a proxy) will be adjusted by 50% in calculating the ROE. However. private equity funds attempt to convert services (ordinary) income into capital gains income and thereby.S.S.. Such an example may be to house a foreign operation because the MLP structure may not be accepted in other countries. in our view. federal income tax on the income generated by the MLP. given the increasing number of pipeline assets owned (and being constructed) by public MLPs. In addition.. Specifically. the carried interest of a publicly traded GP (IDR) is passed through as ordinary income and taxed at the higher rate at the unitholder level. While not all interstate pipelines are subject to cost of service ratemaking. The income tax allowance is a major component for owners of interstate pipelines in determining a pipeline’s cost of service. LLC EQUITY RESEARCH DEPARTMENT income) to corporate subsidiaries that then pay dividends back to the PTP (qualifying income). it is likely to resurface in the future. An entity not subject to U. On April 17.S. federal income taxation. The original policy allows pipelines owned by MLPs to include an allowance for income taxes in determining their pipeline tariffs as long as the partnerships can show that some entity pays federal income tax. the FERC uses a proxy group of several publicly traded companies in the same industry as a benchmark. pay taxes at a lower rate. MLPs Income Tax Allowance In Pipeline Ratemaking On May 29. However.
Figure 59. Sector Trends A. to 11 from only 5 in 2004. LLC EQUITY RESEARCH DEPARTMENT XI.. Domestic Retail Ownership Has Been Declining 100% 23% Percent Ownership 75% 7% 50% 76% 25% 0% Retail 2005 Foreign Investors Institutional 2006 2007 74% 62% 22% 31% Source: Vinson and Elkins Money managers and hedge funds are emerging as major MLP investors. These funds were early investors in the sector and now hold significant positions in a number of MLPs. The number of MLP-focused closed-end funds has more than doubled. Figure 58. however. increasing to 160.e. Dramatic Growth Of MLPs Over the past ten years. Likewise. the average market cap has increased to $1. liquidity has improved dramatically for the MLP universe. Over that time period. 48 . the total market capitalization of the energy MLP universe has grown to roughly $147 billion in 2007 from approximately $1 billion in 1994.000 units per day to date in 2008 from an average volume of 35. The funds also provide private funding for MLPs to supplement public equity offerings to finance growth initiatives. The number of energy MLPs has increased more than tenfold. A growing group of hedged funds and closed-end funds have emerged as significant investors in MLPs. primarily hedge funds and closed-end funds). to 78 in 2008 (to date) from 7 in 1994. Institutional ownership in MLPs is growing. Number Of MLPs And Market Capitalization $180 Market capitalization ($ in billions) $160 $140 $120 $100 $80 $60 $40 $20 $0 7 $1 1994 9 $2 1995 12 $3 1996 12 $5 1997 15 $8 1998 17 $8 1999 18 $11 2000 29 23 $30 2003 $38 30 34 $70 42 $112 Total market capitalization of energy MLPs Number of energy MLPs 60 73 $147 $134 78 80 70 Number of MLPs 60 50 40 30 20 $19 2002 10 0 2004 2005 2006 2007 2008YTD $18 2001 Source: FactSet and National Association of Publicly Traded Partnerships B. MLP Investor Base Is Changing MLPs are still predominantly owned by retail investors. the MLP universe has grown by any measure.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. the MLP investor base is changing.000 units per day in 1994. In addition. as it is estimated that approximately 31% of MLP units (as measured by float) are currently held by institutions (i.9 billion from $307 million.
when MLPs experience periods of weakness. in our view. An investor in a closed-end fund receives a 1099 form. 15 Renaissance Technologies LLC 16 Energy Income Partners LLC 17 Magnetar Financial LLC 18 Eagle Global Advisors LLC 19 Glickenhaus & Co. 49 . are not subject to the restrictions related to qualifying income and UBIT. Closed-end funds are organized as corporations (as opposed to regulated investment companies.MLP Primer -. LLC EQUITY RESEARCH DEPARTMENT Figure 60.Third Edition WACHOVIA CAPITAL MARKETS. themselves. The MLP closed-end funds pay a dividend that is meant to generate a yield on par with the MLP investments. Benefits to investing in a MLP closed-end fund include the following: • These portfolios are professionally managed and provide diversification for investors. Top 20 Institutional Holders Top 20 Institutional Holders (3/31/08) 1 Kayne Anderson Capital Advisors LP 2 Neuberger Berman LLC 3 Tortoise Capital Advisors LLC 4 Swank Advisors 5 Lehman Brothers Asset Mgmt LLC 6 Fiduciary Asset Management LLC 7 Pictet Asset Management SA 8 Argyll Research LLC 9 Fidelity Management & Research 10 Macquarie Fund Adviser LLC 11 Macquarie Investment Management Ltd. 12 RR Advisors LLC 13 Fayez Sarofim & Co.) and thus. There are now 11 closed-end funds that invest solely in MLPs (and one with 25% invested in MLPs). Finally. some funds may use the weakness as a buying opportunity. etc. 14 Omega Advisors. 20 Jennison Associates LLC Note: Holder list does not include investors owning MLPs via total return swaps Source: FactSet Emergence Of MLP Closed-End Funds Beginning with Tortoise Energy Infrastructure Corporation (TYG) in 2004. MLP closed-end funds are playing an increasingly prominent role in the MLP sector. thereby lending stability to MLP valuations. Inc. • These funds can be invested within IRA accounts without being subject to UBTI. • Closed-end funds can engage in private market transactions that are not readily available to the public. tax-exempt entities. the MLP sector witnessed the creation of closed-end funds that invest primarily in MLP securities. The funds often provide private funding for MLPs to supplement public equity offerings to finance growth initiatives. There are two closed-end funds that are now funding privately held MLPs that could ultimately become public entities when they mature. • Investors receive simplified tax reporting through a single 1099 rather than multiple K-1s.
with a market cap of $134 billion. LLC EQUITY RESEARCH DEPARTMENT Figure 61.8% 7. Shift In Supply Sources Is Driving Energy Infrastructure Investment The recent development of several new resource plays. Appalachia.7%) $1.66 $27.5%) (7.71 $22.9%) (0.3%) 2.22 $21. MLPs are playing and should continue to play a major role in this energy infrastructure boom.S. and processing capacity.2% 8.9% (11. Louisiana.4% 9.00 $20.4% 7.00 $25.0% 7. and steadily increasing demand from traditional markets have created the need for significant energy infrastructure.93 $25.09 $17.54 $24.00 $25.S.39 $27. We expect mutual fund participation to increase over time for a couple of reasons. energy complex makes its way into the MLP structure. some mutual funds began to “dip their toes” in the MLP waters. pipeline system has historically been designed to transport natural gas and crude oil production from the Gulf Coast to markets in the Northeast and West.0% 7.00 $25.6% NAV/ Share $40.01 $22.00 $25.251 $873 $151 $101 $548 $401 $105 IPO Date 12/23/04 6/24/04 12/22/04 9/21/06 9/27/04 6/27/05 8/27/07 2/2/07 2/24/04 5/26/05 10/27/05 IPO Price $25.38 $28.00 $25.9%) N/A (13. MLP Closed-End Funds MLP Closed End Funds BlackRock Global Energy and Resources Trust Fiduciary Energy Income Growth Fund Fiduciary Claymore MLP Opportunity Fund Kayne Anderson Energy Development Company Kayne Anderson MLP Investment Company Kayne Anderson Energy Total Return Fund Cushing MLP Total Return Fund Tortoise Capital Resources Corporation Tortoise Energy Infrastructure Corporation Tortoise Energy Capital Corporation Tortoise North American Energy MLP Closed End Fund Average: MLP Closed End Fund Median: MLP Composite Median: Ticker BGR FEN FMO KED KYN KYE SRV TTO TYG TYY TYN Price 7/14/08 $34.00 $15.9%) (12.60 $23.4% 7.7% 7.040 $142 $356 $228 $1.05 $19.74 $17.00 Source: Bloomberg and FactSet Will Mutual Funds Get More Involved In The Sector? In 2007.4% 7.00 $20.4% 7.5% 7.6%) (8. C. and the Rockies is creating the need for significant infrastructure development to transport supply from these new areas to the traditional consuming markets. including the following: (1) MLPs are gaining prominence in the energy sector as many traditional energy companies are contemplating or have announced plans to form MLPs.93 $22.38 $26. As more of the U.3% 6.60 $28. (2) The MLP universe has grown significantly.3% 8. storage. primarily pipelines. the MLP sector is growing to a size that soon cannot be ignored.85 $30.40 Premium (Discount) Market Cap to NAV ($ In MM) (14. traditional investors who want to own energy will need to seriously evaluate MLPs as an investment. The development of new resource plays in North Texas. 50 .Master Limited Partnerships WACHOVIA CAPITAL MARKETS. While still comparatively small (the market cap of Microsoft is $235 billion). increasing imports (both LNG and crude products).20 $11. The U.7%) (12.35 N/A $30.80 Current Yield 4.00 $20. in our view. Oklahoma.90 $26.00 $25.8%) (19.
U. In 2007. Between 2008 and 2012. or 18% of FY2007 total expenditure. Energy Infrastructure MLPs are involved in 15 of 33 new major pipeline projects on file at the FERC that could cost more than $14 billion in total. as they typically provide (1) more attractive returns. D. MLPs invested approximately $65 billion in organic expansion projects and acquisitions. Organic Investments Driven By The Buildout Of U. MLPs Have Been Successful In Making Acquisitions And Investing Organically Over the past five years.S. gathering systems.4 billion in 2005. MLPs spent an estimated $10.8 billion on organic growth projects. 51 . in our view. During this time frame. The top five MLPs that invested accounted for $12 billion. annual growth and acquisition capital investment increased to $28 billion from $4 billion.) We believe MLPs will continue to play an increasingly larger role in the growth of energy infrastructure in the United States. up from $6. LLC EQUITY RESEARCH DEPARTMENT Figure 62.MLP Primer -. Natural Gas Supply Basin Map Source: Spectra Energy Corp.S.Third Edition WACHOVIA CAPITAL MARKETS. mostly centered on new interstate and intrastate pipelines. and processing plants. while cash paid for acquisitions tallied $41 billion. (Please see the Appendix for a list of the announced/proposed pipeline projects. From FY2003 to FY2007. storage.4 billion in 2006 and $3. we estimate that our MLP universe will spend approximately $35 billion of growth-capital expenditure. Organic projects remain the investment of choice (as opposed to acquisitions). cash deployed in internal growth projects totaled $24 billion (or about 37% of the total investment). and (2) greater visibility to distribution growth.
05 billion acquisition of Dominion’s natural gas and oil exploration and production operations in the Mid-Continent Basin and APL’s $1. Oklahoma.0 $1.0 $8.0 $4.4 2005A $10.1 billion in H2 2007. acquisition multiples continued to climb.0 $4. to $17. 43%.6 billion in 2007 from $2. Acquisition activity was focused around oil and gas reserves. and coal properties.6 $10.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.0 $12. Notwithstanding the market’s overall turbulence and the credit meltdown.4 $17. In 2007.0 $0. we are forecasting $32 billion of acquisitions for 2008 to 2012.8 billion in 2006.7 2004A $6.0 $12.0 $0.5x in H1 2008.7 2004A $3. gathering and processing assets.9 Total Capex ($B) 2005A 2006A 2007A 2008E Acquisition capex Source: Partnership reports Acquisition Multiples Have Risen Excluding oil and gas reserves.0 $8.5%--includes primarily asphalt and compression acquisitions.0 $16. The increase is being driven by the proliferation of new MLPs and the growth orientation of most management teams. Figure 64. 52 . LLC EQUITY RESEARCH DEPARTMENT Figure 63. MLPs still announced acquisitions totaling $11.0 $16. The largest transactions in 2007 included LINE’s $2. In our models.0 $2. up from 9. Historical Acquisitions $20.4 $16. aggregate MLP acquisition capital deployed has increased at an annual CAGR of 63%. 12. other. and Texas.4x in 2005. Currently. 1.6 billion.8 $6.2 Total Capex ($B) 2006A 2007A 2008E Organic growth capex Source: Partnership reports and Wachovia Capital Markets.3 2003A $1. Historical Organic Capex Investments $20. MLPs paid an average EBITDA multiple of 9.5 2003A $9. MLPs made/announced 92 acquisitions totaling $17.and upstream-related transactions. up from $9.5 billion in 2003.8 $4. 31%. particularly for gathering and processing assets. LLC estimates Acquisition Capital Deployed Has Been Steadily Rising Since 2003.1x in 2006.2%. which largely include projected dropdown. and higher than the average multiple of 8. implying ample room for consolidation by this sector. approximately 37% of all energy pipelines in the United States are held by MLPs.85 billion acquisition of Anadarko’s gathering and processing assets in Kansas.
8x 9. as distribution growth has been one of the primary drivers of price performance. Historical Acquisition Multiples 12x EBITDA Multiple 10x 8. interest rates have remained relatively low. upstream. geographic). E.7x 9. in our view. …But Returns Still Exceeding Cost Of Capital MLPs continue to possess a competitive (and low) cost of capital. returns are exceeding cost of capital. the median cost of capital of our MLP Composite is now 11. Master limited partnerships that have “dropdown” opportunities trade at a median yield of 6. L.. compression. thereby making the acquisition look more attractive on a forwardlooking basis. shipping. LLC EQUITY RESEARCH DEPARTMENT Figure 65. etc. Further. there is less integration risk with “dropdown” assets than with third-party acquisitions. Thus. in our view. respectively for the midstream MLP peer group. which can potentially be sold to the MLP to support future distribution growth. we expect their cost of capital will begin to increase.0x 9.4x. In addition. in our view. in general. in our view. LLC estimates The increase in multiples can be attributed to a number of factors.). The dropdown model has proven to be a successful strategy. versus 7. As this occurs. in August 2005. Some MLPs have acquired assets at seemingly rich valuations with the intention of enhancing or investing in the assets to increase the EBITDA run rate. we expect acquisition multiples to decrease. While the timing of “dropdown” acquisitions is not always certain.P. These partnerships can be involved in any area of the energy sector (midstream.5x. As interest rates inevitably rise and MLPs are successful in raising distributions and incentive distributions to the GP.Third Edition WACHOVIA CAPITAL MARKETS. With so many new entrants to the MLP market (ten IPOs since 2005) competition for assets has been intense. even at higher multiples.7x 8x 8. these MLPs have been able (and willing) to pay more because they have a lower cost of capital and/or because the assets represent a strategic investment for the partnership (e. as evidenced by the premium valuations afforded in the market for MLPs with this business model. Thus. which. The Emergence Of “Dropdown” MLPs Dropdown MLPs are a relatively new subsector of the MLP universe.4x 8. Since then. This strategy bears watching. in our opinion. For perspective. newer MLPs are typically paying only 2% of their cash flow to the general partner. in our view. with the ten-year treasury yield at just 3. The first dropdown MLP to launch an IPO was Williams Partners. as returns will have to be higher to justify the increased cost of capital.2x 9.9% and 11. In addition. as we believe it introduces additional risk in the form of execution and timing.1x 9. Investors seem willing to pay a premium for the visibility of future visible growth.MLP Primer -. in our view. Dropdown MLPs have sponsor companies that own MLP qualifying assets. 53 . there have been nine IPOs of dropdown MLPs. MLP management teams typically feel a certain pressure to increase distributions.g.3%.9%. the market is clearly ascribing a certain value to the growth afforded by having a parent company with significant “MLP-able” assets. MLPs that have dropdown opportunities are not reliant on third-party acquisitions or on finding internal organic projects to fuel growth. has enabled them to make acquisitions even at higher multiples.5x 6x 2005 Average Weighted EBITDA Multiple 2006 Median EBITDA Multiple 2007 2008 YTD Source: Partnership reports and Wachovia Capital Markets.8% and 2009E enterprise value (EV)-to-adjusted EBITDA multiple of 11.
981 $8.000 $4. In addition.8x 11.9% P/DCF 2008E 2009E 10.701 $2.000 Equity Proceeds ($MM) $14.259 $454 2004A $1.000 $9. Historical MLP Equity Offerings Gross Proceeds From Equity Offerings $20.415 $2.610 $5.379 2005A 2006A 2007A $3. and $3.5 billion raised via direct placement of equity from institutional investors.598 $2.549 $10. raising $1.1x 10.2 billion for IPOs.8% 7.5x Source: FactSet and Wachovia Capital Markets.802 $0 Source: Partnership reports 54 .Master Limited Partnerships WACHOVIA CAPITAL MARKETS.836 $5. up from $14. and total amount of capital raised by MLPs continue to increase. size. MLPs Continue To Enjoy Good Access To Capital The number.572 $2.9 billion in 2006. MLPs raised a total of $14. Dropdown MLPs Versus Midstream MLPs Yield Dropdown MLPs Midstream MLPs 6.972 $3.0 billion for secondary offerings. which was given partial equity credit by the rating agencies. LLC estimates F.756 $3. On the equity front.6x EV/Adjusted EBITDA 2008E 2009E 11. $3.4 billion. there were three hybrid securities issued.794 $5. LLC EQUITY RESEARCH DEPARTMENT Figure 66.4x 11.5x 10.7 billion of equity. This included $8.2x 9. Figure 67.000 IPOs Private Placements Public Secondaries Units To Sponsor/Seller $15.781 $1.7 billion.823 $1.171 $817 2008YTD $2. Total debt and equity issued topped $18.7x 11. The year 2007 marked another record in terms of capital-raising by MLPs.
95% 6. thus.000 Investment Grade Non-Investment Grade $8.050 55 .6%. Figure 69.05% 5. we have seen a stark dichotomy develop between investment grade and non-investment grade MLPs.030 $4.000 $3.000 $3.60% Term (Yrs) 10 10 30 5 5 10 30 5 10 30 5 10 10 30 10 10 10 Proceeds ($MM) $300 $600 $300 $250 $250 $350 $400 $350 $600 $550 $400 $700 $400 $400 $350 $600 $250 $7.Investment Grade Versus Non-Investment Grade During the recent credit crunch and economic slowdown.965 $1.340 $5.95% 5. 2008 Year-To-Date Investment Grade Debt Offerings Date Issuer 1/10/08 BPL 2/6/08 KMP 2/6/08 KMP 3/24/08 BWP 3/24/08 TPP 3/24/08 TPP 3/24/08 TPP 3/25/08 ETP 3/25/08 ETP 3/25/08 ETP 3/31/08 EPD 3/31/08 EPD 3/31/08 EEP 3/31/08 EEP 4/1/08 NS 4/18/08 PAA 7/9/08 MMP Average / Total Source: Partnership reports and FactSet Investment Grade MLP Debt Offerings Rate 6.40% 6.675 $3.150 $5.625 $3.1 billion in new issues at an average interest rate of 6.956 $8.55% 6. Investment grade MLPs continue to have good access to the public markets for both debt and equity.505 $1. For non-investment grade MLPs.50% 5.65% 6.Third Edition WACHOVIA CAPITAL MARKETS.475 $3.000 $2.65% 7.50% 5. Historical MLP Debt Offerings Gross Proceeds From Debt Offerings $10. accessing credit facilities has been the best alternative for debt financing.000 $4.800 $2.MLP Primer -.65% 6.90% 6. investment grade MLPs have raised $7.50% 6. During the recent credit crunch.156 Debt Offerings ($MM) $6.50% 7. the public debt markets have been volatile and more expensive.00% 6.975 $6.475 $2.50% 7. LLC EQUITY RESEARCH DEPARTMENT Figure 68.750 $0 2004A 2005A 2006A 2007A 2008YTD Source: Partnership reports A Dichotomy In The Market -.70% 7. For 2008.50% 6. investment grade rated MLPs continued to enjoy good access to capital as the high-grade debt market remained open and relatively unchanged as it relates to price.
thereby eliminating the equity overhang. as management teams must demonstrate to unitholders that acquisitions and projects are accretive to justify financing. non-investment grade MLPs have raised $2. and (3) the stock price would respond positively. in part. in our view. fewer regulatory issues) and less costly (e. strategic. Nevertheless. This shift in the financing paradigm can best be described as follows. After the announcement of the event.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. MLPs raised more than $8. yield-seeking investors. high yield debt markets remain open for MLPs.156 MLPs have traditionally been disciplined acquirers. 2008YTD High Yield Debt Offerings Date Issuer 1/7/08 ATN 4/8/08 MWE 4/23/08 NRGY 5/6/08 ATN 5/13/08 CPNO 6/5/08 NGLS 6/16/08 LINE 6/23/08 APL Average / Total Source: Partnership reports and FactSet High Yield Offerings Rate 10.2 billion in eight offerings at an average interest rate of 9.5 billion of equity via PIPEs.75% 7. A PIPE is a direct equity investment in publicly traded equity. MLPs with equity financing needs were punished in their valuations in H2 2007. (2) in conjunction with the acquisition. the MLP would announce a PIPE. Investors (in the PIPEs) benefited by purchasing the stock at a discount that was based on the preview price of the units. as the expected financings created an overhang on MLP unit prices. Growing institutional interest. etc. The MLP benefited by pre-funding an acquisition and thereby eliminating any potential overhang or erosion in the stock price as the market would normally anticipate an equity offering to fund the transaction. This dynamic has caused MLPs to be disciplined acquirers.25% 9. In 2008. MLPs’ favorable relative price performance. MLPs Are Employing Creative Financing Solutions To Fund Growth PIPE Mania The amount of equity raised from institutional investors participating in private investments in public equity (PIPE) has grown over time and reached an all-time high in 2007. G. LLC EQUITY RESEARCH DEPARTMENT Non-investment grade MLPs have relied mostly on revolving credit facilities to finance debt. PIPE investors who had purchased the stock at a discount to the previewed price would get a double boost in their returns. Investors in many of the early PIPEs outperformed because the equity placements were typically tied to an event (acquisition or investment).e.0% Figure 70.. the MLP (1) announces an acquisition.75% 8.g. MLPs raised approximately $363 million of equity via PIPEs. Management teams are now more guarded when talking about equity needs and are exploring ways to avoid excessive equity issuances. Since MLPs distribute all available cash to unitholders. The number of MLP equity deals steadily increased to 62 in 2007 from 37 in 2003. no need for a roadshow) than secondary offerings. (2) in conjunction with the 56 .01% Term (Yrs) 10 10 8 10 10 10 10 10 Proceeds ($MM) $250 $500 $200 $150 $300 $250 $256 $250 $2.g. as the high yield and term loan B credit markets remain volatile and expensive. and the opportunity to forego the sometimes tedious process of filing and marketing a secondary offering. in our view. the increasing strong demand for MLP capital. In the new paradigm. In 2007. the stock typically responded favorably (assuming the deal was accretive. In 2007. an MLP would (1) announce an acquisition or large capex project.75% 9. In addition.. which provided the investors with additional return.75% 8. A Paradigm Shift In PIPE Dynamics Market psychology shifted in late 2007 as it related to PIPE issuances. the relatively attractive pricing (discounts of 6-7%). the median size of equity deals has increased to approximately $162 million year in 2007 from $79 million in 2003.). organic and acquisitions).75% 8.. PIPEs became a preferred method for MLPs to finance (the equity portion of) expansion projects and acquisitions due to the easy access to large pools of capital. In 2004. PIPEs can be an effective way to raise capital as they are typically more time efficient (e. and the current low interest rate environment explain. In the old paradigm.88% 8. they must access the capital markets to finance growth (i.25% 10.
The reason is that the GP receives the benefit of higher distributions (as the LP raises the distribution).. hybrid) securities. we believe PIPEs will continue to play a role in financing MLP growth. Because acquisitions are so accretive to GP owners. $300 million in July 2006. typically at LIBOR + bps premium). EPD became the first MLP to issue junior subordinated (i.MLP Primer -. LLC EQUITY RESEARCH DEPARTMENT acquisition. A MLP that raises capital through the issuance of PIK equity (1) minimizes cash outflow that helps bridge the time until a project or acquisition starts to generate meaningful cash flow and (2) removes any overhang related to potential equity offerings. everyone focuses on the lock-up expiration date.e. PIPE Dynamics--Perpetual Equity Overhang Old Paradigm MLP announces an acquisition or organic growth project New Paradigm -.e. and (3) the stock goes down because either there is an overhang to finance the transaction or the PIPE creates the overhang. and $50 million in September 2006). that is. In the case of MLPs. 57 . This could be an indication of a high price being paid for an asset. future PIPEs will likely be smaller in size with fewer investor participants. junior subordinated notes) pay a fixed coupon rate for a stipulated period of time and then a floating coupon rate for balance of the term of the note (i. In 2006. GP Subsidies Another creative financing solution used by MLPs is to have the general partner effectively subsidize a transaction. The additional stock received by the unitholder is equivalent to the value of the quarterly distributions paid to common unitholders.e. similar to i-shares).e. Paid-In-Kind (PIK) Equity Paid-in-kind equity is an LP unit that receives distributions in the form of additional stock (i. in our view.. However. Paid-in-kind equity is typically eligible to convert into common units after a certain period. but also realizes an increase in cash flow as the MLP issues additional equity to finance the transaction.A Perpetual Equity Overhang MLP announces an acquisition or organic growth project MLP announces a PIPE thereby eliminating the equity overhang MLP announces a PIPE thereby eliminating the equity overhang MLP does not announce a PIPE or equity offering Stock goes up on anticipation of a distribution increase Stock goes down because investors focus on the lockup Stock goes down because there is an overhang to finance transaction Source: Wachovia Capital Markets. Hybrid securities are given partial equity credit by the rating agencies. In addition.Third Edition WACHOVIA CAPITAL MARKETS. $200 million in August 2006.. In these instances. raising $550 million via three tranches (i. the GP can afford to temporarily subsidize an acquisition to improve the accretion for the LP unitholder. we may see more one-day-marketed or overnight secondary offerings versus traditional multi-day-marketed secondary offerings to reduce the negative impact of an impending equity offering. Hybrid Securities A hybrid security is an investment vehicle that has characteristics of both a debt and equity security. the MLP announces a PIPE or instead announces that it will issue equity in conjunction with closing. LLC Although there has been a shift in the market psychology surrounding equity issuances.e. the GP temporarily forgoes incentive distribution rights payments in order to make an acquisition immediately and sufficiently accretive to limited partnership unitholders. We expect hybrid securities to become more prevalent due to the partial equity credit given by the rating agencies and the market’s acceptance of the security... the partnerships’ hybrid securities (i. In addition. we believe management teams have become even more sensitive in projecting potential equity offerings for fear of creating additional selling pressure on their stock prices. it demonstrates the beneficial impact to the GP when the MLP makes an acquisition. Figure 71. Thus.
from ExxonMobil up to $20MM / $15MM 2 yrs / Forever SXL Apr-08 Source: Partnership reports H. Crosstex Energy. For example.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. 58 .Recognizing The Value Of The GP In January 2004. from Anadarko Help finance $689MM Rainbow acquisition Help finance $200MM acq. distribution growth for successful GPs can be significantly higher than that of LPs.85B acq. and Vanguard Natural Resources) established as LLCs (rather than the traditional LP structure) with no GP entity to maximize the long-term growth of the partnership.5 yrs 4 yrs Reason For Subsidy Help finance $530MM acq.4MM Length Of Subsidy 2 yrs 2 yrs 5 yrs 1 1.8MM ~$1. LLC EQUITY RESEARCH DEPARTMENT Figure 72. Eleven GPs have been spun out as separate. Inc. while the underlying MLPs have only been able to increase their distribution at a rate of 11%. For example.4B acq. buyers of GPs have recognized the value of the IDRs typically held by the GP. in our view.5MM $20-15-15-10-5MM ~$6..e. GPs have been able to raise their distributions at a three-year CAGR of 32% (2005A to 2007A). Publicly Traded General Partners GP Alliance Holdings GP LP Atlas Pipeline Holdings LP Buckeye GP Holdings LP Crosstex Energy Inc. there are three publicly traded partnerships (i. publicly traded entities to highlight and maximize their value. Summary Of Past GP Subsidized Transactions Date Announced MMP NRGY PAA (I) APL PAA (II) Nov-04 Aug-05 Jun-06 Jun-07 Apr-08 Annual Cash Subsidy $4. Energy Transfer Equity LP Enterprise GP Holdings LP Hiland Holdings GP LP Inergy Holdings LP Magellan Midstream Holdings LP NuSTAR GP Holdings LLC Penn Virginia GP Holdings LP Source: Partnership reports Ticker AHGP AHD BGH XTXI ETE EPE HPGP NRGP MGG NSH PVG IPO date May-06 Jul-06 Aug-06 Jan-04 Feb-06 Aug-05 Sep-06 Jun-05 Feb-06 Jul-06 Dec-06 Power Of The IDRs Clearly. The value of the GP lies in the fact that the GP receives a disproportionate amount of the incremental cash flow of the underlying partnership as LP distributions are increased due to the IDRs. Publicly Traded General Partners -. The Multiplier The multiplier represents the rate of cash flow growth to the GP relative to LP growth. a GP’s ownership of incentive distribution rights with a 50% tier creates the leverage that enables the GP to increase its distribution at a faster rate than the underlying MLP. from Shell Help finance $230MM Stagecoach acquisition Help finance $2. The role of the GP and the incentive distribution rights typically held by the GP have gained recognition. Figure 73. Finally. Hence. The multiplier is determined by a number of structural characteristics related to the assets owned by the GP. held the first initial public offering for a stand-alone pure-play general partner interest. Copano Energy. Other MLPs have chosen to amend the IDRs to limit the cash flow that goes to the GP.7MM ~$1. Linn Energy. of PPX Help finance $1.
except per unit data) Current distribution per unit Units outstanding (in millions) Total distribution % of cash flow to GP MLP common units owned by GP ( in millions) GP distributable cash flow Cash flow to LP unitholders Cash flow to GP Total cash distribution to LP & GP Distributions to GP from LP units Distributions to GP from GP interest and IDRs Incremental SG&A expense GP distributable cash flow Multiplier effect Source: Wachovia Capital Markets. LLC estimates PVG EPE XTXI ETE HPGP AHGP How the math works.0x 3.7x 1.9x 1.8x 1.Third Edition WACHOVIA CAPITAL MARKETS. Forward GP Multiplier Estimates 4.9x 1.2x 3.8x $20 $20 $40 $2 $20 $0 $22 With 10% increase $220 $85 $305 $22 $85 $5 $102 % growth 10% 31% 15% 10% 31% 0% 28% 59 .00 per unit • 50 million common units outstanding • A 10% distribution increase • High splits level (i.1x 2.00 50 $200 24% 5 Current period Incremental $200 $65 $265 $20 $65 $5 $80 2.9x 1.e.0x 0. 50/50 tier) • Distribution tiers from Figure 49 And the following assumptions at the GP: • $5. GP Multiplier Underlying MLP ($ in millions..MLP Primer -.0x 2.0 million of incremental SG&A expenses • 5 million underlying MLP units owned by the GP Figure 75.8x 1.2x 2.6x 1.0x Multiplier Effect 2. Our example assumes the following at the underlying MLP: • A current distribution of $4.0x 1. LLC EQUITY RESEARCH DEPARTMENT Figure 74.0x AHD NRGP MGG NSH BGH Median Source: Partnership reports and Wachovia Capital Markets. The GP’s leverage to the underlying MLP’s distribution growth can be defined as the ratio of the pure-play GP’s distribution growth rate relative to that of the underlying MLP.7x 2. LLC Current period $4.
the slower the growth. unit holders is generally slower than the growth rate achieved by the IDRs.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. C-Corp versus MLP). its growth rate should equal the growth rate of the MLP. the underlying MLP should be able to increase its distributions at a faster rate and sustain its growth rate for a longer period of time. we believe the following factors should be considered: • Growth profile of the underlying MLP. Some public securities hold only the GP interest along with a share of a MLP’s limited partner units (typically subordinated to the common units). The incremental expenses at the GP level.e. Their cash flow is based solely on distributions declared by the underlying MLPs.e. the 2% GP interest and IDRs entitle the GP to receive a disproportionate amount of the MLP’s incremental cash flow (i.. The underlying partnership should have a lower cost of capital (relative to MLPs with maximum IDRs of 48%).. if the GP is receiving 50% of the distributions of the underlying MLP. the partnership would need to pay incremental distributions to LP unit holders and the GP of $20 million each.P. • Percentage of cash flow accruing to IDRs. All of the publicly traded pure-play GPs incur incremental SG&A expense. Not All GPs Are Created Equal When comparing publicly traded pure-play GPs and their leverage to the underlying MLPs (i. With the exception of MGG.e. if the MLP raises its distribution per unit by 10%. the cumulative percentage of distributions attributable to IDRs increases. (For a list of publicly traded entities holding GP interests. Taken to the extreme. in our view. which should enable it to compete more effectively for acquisitions and realize higher returns on all investments (acquisitions and expansion projects). a 10% distribution increase at the MLP would enable the GP to raise its distribution by approximately 28%. Thus. all else being equal. XTXI is the only publicly traded pure-play GP structured as a corporation. The greater the number of LP units held at the GP. the multiplier effect is approximately 2. Since the underlying MLP is at the “high-splits” level. all else being equal. management’s decision to cap the IDRs may benefit the GP in the long run. Hence. Corporate taxes. publicly traded pure-play GPs typically own limited partnership units of the underlying MLP. Most IDRs are capped at 48%. interest and SG&A expense and taxes). • Structure of the GP (i. The reason is that the growth of distributions to L. Other GP interests are held within companies involved in other businesses or that own other energy assets.. and TPP are the only underlying MLPs with publicly traded GPs. all 11 publicly traded pure-play GPs do not own any independent assets. NS. • Incremental expense at the GP (i. such as interest expense. 50%). LLC EQUITY RESEARCH DEPARTMENT Based on these assumptions. General Partners Are Held In Different Entities Publicly traded GPs are housed in a variety of public entities. reduce the cash available to pay the GP’s unit holders. However.) 60 .8x (i. EPD. Currently.. the GP’s growth rate of 28% divided by the underlying MLP’s distribution growth of 10%). • Percentage of GP’s cash flow attributable to LP units held.e. its growth rate slows and converges with the growth rate of the underlying MLP. meaning the GP can reach a level where it can receive 50% of the incremental cash flow (48% for the IDRs plus 2% for the GP interest). Hence. the ratio of the pure-play GP’s distribution growth relative to that of the underlying MLP). reduce the cash available to pay dividends. all else being equal.e. • Maximum IDR level. Thus. A GP’s potential leverage to the underlying MLP’s growth is based on the maximum incentive distribution level that is stipulated in the partnership agreement. Over time. the distribution growth of a GP associated with a fast-growing underlying MLP should be higher than that of a GP and supported by one with modest growth prospects. as the cumulative percentage of distributions to the GP increases. the IDRs of which are capped at 23%. Thus. please see the Appendix. all else being equal.
Generally. instead of relying on exploration to support cash flow. • Constellation Energy Partners LLC (CEP). 70-90%) in order to lock in prices and reduce commodity price exposure. • Legacy Reserves. modest debt) and a more robust distribution coverage ratio (i. LP (EVEP). LLC (VNR) Upstream MLPs Failed in the 1980s. LP (QELP). A displacement in either of these markets could hamper a partnership’s ability to pursue acquisitions and increase distributions. Absent acquisitions. the factory-like development of a well-known reserve base. • Quest Energy Partners. There are inherent challenges associated with a depleting asset base. • EV Energy Partners. LLC EQUITY RESEARCH DEPARTMENT I. and hedging tools were not available to mitigate commodity price risk. • Strong management team. The oil and gas MLP needs to be actively and conservatively managed to maintain reserves and roll over hedges. an oil and gas MLP can set distributions at a long-term sustainable level. • Exploitation and not exploration--low drilling risk.Third Edition WACHOVIA CAPITAL MARKETS. 61 . There are currently ten publicly traded upstream MLPs. Upstream MLPs are dependent on debt and equity markets to finance acquisitions. The MLP mantra must be strictly adhered to. in our view.MLP Primer -.P.” With price certainty. a partnership’s asset base is eroding and reinvestment opportunities may be limited. in our view.e. 1. • Commodity price exposure. in our view.e. The partnerships should hedge a significant percentage of their expected production (i. LP (LGCY). LP (ENP). i.” • Upstream MLPs Are Faced With Unique Challenges And Risks • Depleting asset base. Reserves in certain regions of the United States are more appropriate for the MLP structure. • Conservative balance sheet and high distribution coverage ratio. An incremental $20 million of cash flow on a base of $100 million is meaningful at 20%. Why? The business model was flawed and execution was poor. with slow depletion rates. • Encore Energy Partners. Upstream MLPs are suitable for yield-oriented investors that seek more direct exposure to oil and gas assets and have a higher risk tolerance. (PSE). and • Vanguard Natural Resources. low development costs. a prolonged period of low commodity prices could force upstream MLPs to cut their distribution absent acquisitions.. Return Of Upstream MLPs The IPO of Linn Energy in January 2006. We would prefer an oil and gas MLP to lock in prices for a multiyear time period (to the extent the market allows). marked the return of oil & gas producing assets to the MLP structure. • Active hedging strategy. Declining commodity prices. they will likely need to make ever larger acquisitions to sustain growth. LP (BBEP). consisting of the following: • Atlas Energy Resources LLC (ATN).. • Pioneer Southwest Partners.e. but on a base of $500 million is less so at 4%. • Dependence on acquisitions. “never. all else being equal. Oil and gas MLPs should focus on exploitation. As upstream MLPs increase in size. Reserves suitable for the oil and gas MLP structure should be characterized as predominantly proved developed and long-lived. • Linn Energy LLC (LINE)... What Should Be The Criteria To Invest Today? Appropriate reserve base.e. balance sheets were over-leveraged. ever cut the distribution. MLPs with more volatility in their underlying businesses should maintain a more conservative balance sheet (i. even at the expense of “leaving some upside on the table. • Financing growth. even with hedges. L. these partnerships relied on relatively risky drilling to sustain production. can pressure earnings and narrow coverage ratios. • BreitBurn Energy Partners. Although an active hedging program mitigates commodity price risk.2x). in our view.
The cost of GP equity is the forward GP yield (cash flow being paid to the GP over the next four quarters) plus the expected growth in cash flow payments to the GP as the MLP raises its distribution over time.. Thus.Master Limited Partnerships • WACHOVIA CAPITAL MARKETS.e. An MLP’s total cost of equity is the weighted cost of LP equity plus the weighted cost of GP equity. all else being equal. There Are Three Components To An MLP’s Cost Of Capital MLPs have three principal sources of capital: LP equity. This represents an LP unitholder’s expected return for the risk undertaken in owning LP units of an MLP (i. in our view. As upstream MLPs increase in size and number. This advantage erodes over time due to the GP incentive distribution rights. An MLP’s hurdle rate for new investments should therefore be greater than the weighted average cost of these three capital sources. an investor’s required rate of return). this cost-ofcapital benefit is temporary and exists only when the MLP is at the lower incentive distribution level. In addition. LP equity. Because of this high degree of leverage. By ignoring the growth component. GP equity is substantially more expensive than LP equity. However. Cost of capital is therefore the weighted average cost of GP equity. MLPs are generally thought to have a lower cost of capital than C-corps. due to their taxadvantaged partnership structure and low cash flow outlay to the general partner. Competition. or the forward cash yield (distributions paid to LP unitholders over the next four quarters adjusted for the GP cut) plus total distribution growth. For an MLP. high drilling activity can lead to faster decline rates as new wells typically come online with steeper decline rates. Cost of LP equity. in turn. 62 . increases annual maintenance capital requirements. In Our View J. as the MLP is more successful in raising distributions. the cost of equity is understated and transactions that are initially accretive could become dilutive in later years as the partnership pays incremental distributions on the original units issued to finance the transaction. competition over MLP suitable assets could intensify. we believe the cost of equity is best defined as adjusted yield (forward yield adjusted for GP promote) plus distribution growth. its cost of capital increases and this advantage erodes away. driving acquisition multiples higher and reducing potential accretion. (2) setting distributions and (3) choosing among financing alternatives. it must pay a greater percentage of its total cash flow to the GP. The conventional methodology used to calculate an MLP’s cost of equity is flawed. As the MLP increases its distribution. the level of spending required to sustain production also increases. Cost of GP equity. LLC EQUITY RESEARCH DEPARTMENT • High maintenance capex. but also to future distributions that will presumably be higher. The general partner typically has just a 2% interest in the assets of the MLP. and debt. LLC estimates Equity owners are entitled not only to the current distribution. 2%. Defining Cost Of Equity Conventional Thinking On Cost Of Equity Cost of equity = Cash yield WCM's Cost Of Equity Definition Cost of equity = Forward cash yield + Growth Cost of equity = Current yield Percentage cash flow to LP Cost of equity = Forward yield (1) Percentage cash flow to LP + Growth Note (1): Forward yield = next four quarterly distributions divided by current unit price Source: Wachovia Capital Markets. we argue that today’s yield (the unit price) reflects some underlying distribution growth assumption. but could be entitled to 50% of the MLP’s cash flow through IDRs. as it incorrectly equates an MLP’s cash yield to the partnership’s cost of equity. GP equity. The cost of LP equity is the forward yield (distributions paid to LP unitholders over the next four quarters) plus expected distribution growth. In fact. paradoxically. Cost Of Capital Is Becoming A More Prominent Issue. which. Figure 76. As an upstream MLP’s asset base increases in size. Properly defining and forecasting cost of equity has important ramifications for (1) making investment decisions. and debt.
the cost of equity would be less than the cost of debt. implying that the partnership would need to target investments with returns in excess of approximately 18% in order to sustain the 10% return to investors. LLC estimates 63 . As the partnership increases its distribution and triggers higher distribution tiers.MLP Primer -. LLC EQUITY RESEARCH DEPARTMENT Figure 77. MLPs Have Three Main Sources Of Capital Cost of GP equity = Implied GP yield + GP interest growth $ Cost of LP equity = Forward yield + distribution growth Cost of debt Source: Wachovia Capital Markets. If that were the case.7% forward yield + 3. Lifecycle Of MLP With 50/50 Splits--IDR Premium 20. the percentage of cash flow accruing to the general partner increases. we assume the MLP targets a 10% return to investors (6. in many instances. the partnership should have a cost of equity of approximately 11. increases the partnership’s cost of equity.0% 8.0% 16.5% premium over the 10% targeted return to investors. equity owners demand a higher return because of the higher incremental risk that they carry.3% perpetual distribution growth) over the life of the partnership. the GP commands 50% of available cash flow. an MLP with IDRs needs to make increasingly larger (or more accretive) investments in order to prevent erosion in investor returns. the partnership with IDRs will have a higher cost of equity than an MLP without IDRs. if the partnership wanted to continue returning 10% to investors. LLC estimates Intuitively. it would have to make investments in excess of this 11. Figure 78 illustrates the lifecycle of a hypothetical MLP with IDR tiers capped at 50% of cash flow. representing a 1.5% equity hurdle rate. 2% of cash flow accrues to the general partner. cost of equity should be higher than the cost of debt because creditors get paid before equity owners. Figure 78. For simplicity.Third Edition WACHOVIA CAPITAL MARKETS. At the extreme. which. Incentive Distribution Rights Increase Cost Of Capital IDRs create an increasingly large disconnect between an investors’ required rate of return (LP cost of equity) and an MLP’s total cost of equity.0% Total Cost Of Equity 18. At year 0. Alternatively. When 15% of cash flow is accruing to the GP. when the MLP is first created.0% 12.0% Cost Of Equity 14. As a result.0% 10. In other words. Again.0% 0% 10% 20% 30% % Cash Flow Paid To GP 40% 50% 60% Investor Return (LP cost of equity) IDR Premium (GP cost of equity) Source: Wachovia Capital Markets. in turn. it is a mistake to think of cost of equity for a MLP as just the yield. In other words.5%. For two MLPs targeting an equal rate of return to unitholders. an MLP without IDRs targeting a 10% return to investors would have a cost of equity approximately equal to 10% over the life of the partnership.
One explanation for the disparity between required rate of return and actual return is that investors could be underestimating future distribution growth. an investor’s required rate of return). and ultimately.. in our view. The following chart outlines the differences between the indices. 64 . GPs. instead. Figure 79. We believe another major benefit of the Wachovia MLP Index is that price and total return performance can also be obtained for 13 sub-indices. If the MLP increases its distribution at a greater rate. in our view. the calculation is not calibrated to capture the increasingly higher percentage of cash flow that accrues to an MLP’s general partner over time. K. it equates to excess returns for the investor.e.3). Citi. In other words. in our view. and LLCs MLPs. LLC. a market-risk premium of 5%.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. we believe cost of equity under the capital asset pricing model (CAPM) does not capture the cost of GP equity. However. and LLCs Standard & Poor's Standard & Poor's Source: Wachovia Capital Markets.e. which is significantly higher than the required rate of return as defined by CAPM methodology. GPs. and Standard & Poor’s) have introduced MLP indices that allow investors to track the price and total return performance of the MLP sector. We estimate our universe of MLPs will increase distributions by an average of 9-10% in 2007 and 2008.8% (assuming a risk-free rate of 4%. Alerian. Alerian Capital Management. In comparison. Comparison Of MLP Indices Comparison of MLP indices Index launch date Ticker . lower market capitalization threshold and unrestricted number of index constituents) provide a more representative picture of MLP industry performance. as a good portion of its perceived advantage becomes negated after factoring in distribution growth expectations set by investors and the effect of increasingly higher payments to the GP through IDRs.price performance / total return Market capitalization weighting Minimum market cap ($ in millions) Timing of rebalance Maximum index constituent weighting Index base Index base date Index sub sectors Number of current index members Constituent types Calculation Wachovia 12/11/2006 WMLP / WMLPT Float-adjusted $200 Quarterly None 100 12/31/1989 Yes 73 Alerian 6/1/2006 AMZ / AMZX Float-adjusted $500 Quarterly None 100 12/31/1995 No 50 (maximum) Citi 7/18/2006 CITIMLP / CITIMLPT Full market cap $500 Quarterly None 100 12/31/1999 No 47 MLPs only Dow Jones S&P 9/6/2007 SPMLP / SPMLPT Float-adjusted $300 Annual (in July) 15% 1000 7/20/2001 No 40 MLPs. the fact remains that MLPs are tax-efficient vehicles to pass cash flow to unit holders. it is this tax-advantaged structure that allows MLPs to trade at a premium to C-Corps. our MLP index has delivered a historical ten-year average total return of approximately 18% (versus 6% for the S&P 500). Is An MLP’s Cost-Of-Capital Advantage Overstated? Yes And No An MLP’s cost of capital advantage over a C-Corp could be exaggerated. and Standard & Poor’s The primary advantage of the Wachovia MLP Index is that the broader index inclusion requirements (i. GPs. and LLCs Standard & Poor's MLPs. we believe it provides a better guide for LP cost of equity (i. Emergence Of MLP Indices Due to the growth and prominence of the MLP sector over the past couple of years. four financial institutions (Wachovia. Citi. For our MLPs under coverage. the average cost of equity as defined by CAPM is about 7. LLC EQUITY RESEARCH DEPARTMENT CAPM Understates The Cost Of Equity As it relates to MLPs.. and an average beta of 0. in our view. up from the historical 4-6% rate during 1998-2004. An investor requiring a 10% annual return might purchase an MLP yielding 6% under the assumption that the MLP will be able to grow its distribution at 4%.
LLC L. This includes any distributions generated by the underlying MLP and the benefit of the MLP’s price appreciation over the life of the swap. WCM GP Composite Index 2. • Wachovia MLP index warrant. WCM Marine Transportation MLP Index 5. WCM Propane MLP Index 6. The counterparty owns the underlying MLP and receives payments from the investor over the life of the swap based on a set rate. However. if the percentage change in the value of the index is positive. In October 2007. Wachovia introduced cash-settled call warrants linked to the performance of the Wachovia Composite MLP Index. net of fees. WCM Refined Products MLP Index Bloomberg Index Tickers Price Performance Total Return WMLP WCHWGPS WCHWCOA WCHWEXP WCHWMAR WCHWPRO WCHWMID WCHWGAS WCHWGNP WCHWNGP WCHWPET WCHWCRD WCHWRFP WCHWMLPT WCHWGPST WCHWCOAT WCHWEXPT WCHWMART WCHWPROT WCHWMIDT WCHWGAST WCHWGNPT WCHWNGPT WCHWPETT WCHWCRDT WCHWRFPT 7. WCM Crude Oil MLP Index ii. WCM Natural Gas MLP Index i. In a total return swap. Financial Products Facilitate Participation In MLPs In the past few years. an investor receives a synthetic security which mimics the performance of the underlying security. WCM Petroleum MLP Index i. WCM Midstream MLP Index A. net of fees. WCM Oilfield Services MLP Index N/A N/A Note: WMLP index price performance quotes are real-time and all other index quotes are end of day. • Total return swaps. WCM Coal MLP Index 3. LLC EQUITY RESEARCH DEPARTMENT Figure 80. With more institutional investors involved in the sector.” BSR investors receive distributions in the form of a monthly coupon. new financial products have been created to facilitate investment in the MLP sector. • Options. WCM MLP Sub-Indices And Related Bloomberg Tickers WCM MLP Sub-Indices WCM MLP Index 1. Upon exercise of the warrant. The Wachovia and Alerian instruments provide diversification for investors and are administratively less burdensome than direct ownership in MLPs (e. the MLPs have experienced an increase in options trading volume. No principal protection on the ETN exists. WCM Oil & Gas MLP Index 4. The cash settlement amount at maturity equals to the principal amount multiplied by an index ratio based on the performance of the Alerian MLP Select Index. Alerian Capital Management launched the BearLinx Alerian MLP Select Exchange Traded Note (ETN). investors receive a cash payment (settlement value) equal to the notional amount of the warrant multiplied by the percentage change. It was the first ETN linked to an MLP Index (the Alerian MLP Select Index) and is listed on the NYSE under the symbol “BSR. Source: Standard and Poor’s and Wachovia Capital Markets. WCM Gathering & Processing MLP Index ii. 65 . Investors can also gain exposure to an MLP without direct ownership via a total return swap agreement. We expect additional structured products around the MLP market to be created over time to spur additional investment in the sector. the total return receiver will be required to pay the counterparty (usually a brokerage firm) the amount by which the asset has fallen in price.MLP Primer -. In May 2007. if the price of the MLP decreases over the swap's life. WCM Natural Gas Pipelines MLP Index B.g. • BearLinx Alerian ETN. receive 1099s and not K-1 statements)..Third Edition WACHOVIA CAPITAL MARKETS.
The most common valuation method typically focuses on yield due to the fact that MLPs are income-oriented securities. Risk profile. ranging from a high of 10. Our DDM assumes a required rate of return (ROR) of 9. Growth prospects. We believe the disparity in yield can also be partially explained by the growth profile of various MLPs.500 0 Dec-06 Source: Bloomberg Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 XI.000 37.0-3. We believe the focus for MLPs should be on cash flow rather than earnings (or P/E). For our DDM model. faster-growing MLPs should command a lower yield because it is assumed that the growth in cash flow would generate increases in distributions that. in turn..1%. or more variability in cash flow) typically trade at a higher yield in the market as investors require greater return to compensate for the increased risk. Some investors will look at yield to determine relative value.000 112. B. From 1998 to 2007.000 187. would translate into greater appreciation of the underlying security. and interest rate environment. Valuation Of MLPs A. assets subject to commodity price risk. D.3%.5%. Distributable cash flow is defined as the cash available to be distributed to limited unitholders after payments are made for sustaining capital expenditures. MLP Option Contract Trading Volume 225. LLC EQUITY RESEARCH DEPARTMENT Figure 81.0-11. higher leverage. Two-Stage Distribution (Dividend) Model Our primary tool for valuing MLPs is a two-stage distribution (dividend) discount model (DDM). We then use a long-term growth rate of 0. Others will project a distribution for year-end and then apply a target yield to their projection to determine a fair value for the security. resulting in a higher total return. EBITDA generated by the partnership is used to support the cash distributions 66 . See “Drivers of Performance – Distribution Growth” for additional information. depending upon the individual MLPs outlook. our MLP universe has had a median yield of 7.500 75. Distribution Yield MLPs can be valued using a number of techniques. we project a distribution growth rate over five years.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. asset mix. which employs a risk-free rate (using the 10-year Treasury yield as our benchmark) and a market-risk premium.8% to a low of 5. growth prospects. The disparity in yield among MLPs can be explained by several factors including risk profile (financial and operational). Price-To-Distributable Cash Flow To determine relative value. MLPs with profiles that are perceived to be riskier (e. C. we focus on price-to-distributable cash flow (DCF) multiples. weather risk.500 Daily trading volume 150. For example. and management team.g.0%. Enterprise Value-To-Adjusted EBITDA When comparing MLPs’ value on the basis of an EV-to-EBITDA multiple. we use adjusted EBITDA rather than adjusted enterprise value. other cash obligations. and cash distributions to the GP.
it is the distribution that could be paid such that the distribution coverage ratio equals 1.Third Edition WACHOVIA CAPITAL MARKETS.($25 × 10%) $23 Source: Wachovia Capital Markets. with an average of 238 bps over the ten-year period from January 1998 to 2007.(EBITDA × % cash flow to GP) $25 . we would deduct approximately $2. and its current distribution coverage ratio. pay if it distributed all of its sustainable available cash flow. 2. This is the maximum distribution a partnership could. We view the spread versus the Treasury as a good measure of investors’ appetite for assuming risk over time as it relates to owning MLPs. Spread Versus The 10-Year Treasury The midstream MLP yield is currently trading at approximately 400bps above the 10-year treasury. Alternatively. LLC EQUITY RESEARCH DEPARTMENT to both the limited and general partners. 4 EV-to-adjusted EBITDA EV-to-adjusted EBITDA EV-to-adjusted EBITDA 8. Potential distribution upside based on MPD is a function of a partnership's sustainable cash flow. in order to produce an “apples-to-apples” comparison. Therefore. Figure 83. 67 . LLC E. However.0x. enterprise value reflects only the interest of the limited partners. if a partnership has an enterprise value of $200 million and is generating EBITDA of $25 million with 10% of its cash flow going to the general partner. we deduct the cash flow accruing to the general partner from EBITDA. size. 3. What Is Maximum Potential Distribution? Maximum potential distribution (MPD). the percentage of cash flow accruing to its general partner. Figure 82. We believe this is the most appropriate way to adjust EBITDA when comparing it to enterprise value.9x = = = = EV EV $200 $200 ÷ ÷ ÷ ÷ adjusted EBITDA EBITDA . However.MLP Primer -. and growth orientation of MLP investments has changed over time. Enterprise Value-To-Adjusted EBITDA Calculation 1. Midstream MLP Spread To The 10-Year Treasury (1998-2007) 600 MLP Yield Spread To 10-Yr Treasury (Bps) 500 400 300 200 100 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: FactSet F.5 million from EBITDA in calculating our EV-to-adjusted EBITDA multiple. Yields on midstream MLPs have maintained spreads over the 10-year treasury as wide as 512 bps and as narrow as 16 bps. in theory. we caution that measuring current spreads versus a historical average may not be valid as the number. For example.
in our view. in our view.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. This calculation determines the distribution coverage ratio. • Available cash flow = The partnership’s projected net income + DD&A expense – Interest Expense Maintenance Expense – Other Cash Expenses (Income) for the trailing-12-month period. To do so.. We prefer to calculate the distribution coverage ratio as available cash flow (i. DCF is divided by the declared annual distribution. propane MLPs. The latter is typically the cash flow that is left after maintenance capital expenditure.3x because of the impact of weather on cash flow. Our MPD calculations are based on the following assumptions: • Sustainable cash flow = The partnership’s estimated minimum available cash flow for the period between the trailing 12 months in question and 2012. This excess cash flow is a cushion and suggests that the partnership’s distribution is safe in the event that cash flow decreases in the short term.2x or greater. set their distributions below MPD to maintain a coverage ratio of at least 1. Thus. before the subtraction of cash paid to the GP) divided by the cash distributions paid to both the LP unit holders and GP. although we suspect that it may sometimes be erroneously defined as such. LLC EQUITY RESEARCH DEPARTMENT MPD is a proxy for free cash flow to limited partners. This is to ensure that MPD is based on a sustainable cash flow base. and distributions paid to the general partner. DCF should be more appropriately used as a measure to determine the safety of the declared distribution. other factors to consider before investing include a partnership’s risk profile (e. we consider price-to-MPD multiples in addition to price-to-DCF multiples. financial leverage). For example.2-1.e.MPD Does Not Tell The Whole Story Partnerships typically set their distributions (at a sustainable run rate) below MPD to account for cash flow volatility and financial leverage. Consequently. growth outlook.g. in our view. In concert with MPD.0x. while the latter measures excess cash flow available to pay both limited partners and the general partner. • Total distributions paid = Distributions paid to the partnership’s limited partners and general partner based on the average units outstanding at the end of each quarter for the trailing-12-month period. Caveat -. cash interest expense. DCF is not equivalent to how high the distribution can be set. reflecting their exposure to coal prices. 68 . A ratio of less than 1 indicates that the partnership may be borrowing to pay its distributions and that the current distribution may not be sustainable. A ratio above 1 indicates that the partnership is generating more than sufficient cash flow to pay its distribution. In other words. and management team. This is to account for distributions associated with anticipated equity issuances. their distribution coverage ratios are often above 1. MPD should not be used in isolation to analyze MLPs. MPD Is Different Than Distributable Cash Flow (DCF) MPD is different than distributable cash flow (DCF). in general. The former more precisely quantifies free cash flow to limited partners.. Coal MLPs typically maintain a distribution coverage ratio of 1.
such as pipelines and storage assets. they must continually access the debt and equity markets to finance growth. MLP management teams have been successful in dealing with similar uncertainties related to the MLP landscape over recent years. Any number of regulatory hurdles could affect MLPs’ ability to grow. Conflicts of interest with the GP. For certain MLPs. gathering fees. Commodity price risk. If commodity prices are weaker than expected. MLP valuations could also be negatively affected if Congress revoked MLPs’ special tax treatment. (3) the potential for management to place the interests of the parent corporation or the GP above the interests of the LP unit holders. future cash flow and distribution growth rates could be adversely affected. many MLPs have assets tied to unconventional shale plays. Many MLPs have assets that have been designated by the Department of Homeland Security as potential terrorist targets. in part. Execution risk related to acquisitions and organic projects. and coal. Coal is one of the most heavily regulated industries in the country. on their ability to complete identified organic growth projects on time and on budget and/or to successfully identify and execute future acquisitions. If an MLP’s operating region experiences unseasonably warm weather. In particular. state. particularly those involved in the transportation (pipeline) and distribution of propane. being subject to regulation by federal. which could negatively affect cash flow and earnings in the near term. Regulatory risk. Tax and legislative risk. LLC EQUITY RESEARCH DEPARTMENT XII. and ultimately. A decline in drilling activity. Energy demand is closely linked to overall economic growth. Risks Growth is dependent on access to external capital. If MLPs were unable to access these markets or could not access these markets on favorable terms. (2) the GP aggressively increasing the distribution to achieve the 50%/50% split level rather than managing distribution growth to maximize the long-term sustainability of the partnership. investor psychology could be influenced by election rhetoric concerning tax laws. MLPs’ ability to grow is dependent. gathering and processing. A terrorist attack or environmental incident could disrupt the operations of an MLP. and (4) underlying MLP equity issuances benefit the GP regardless of whether the acquisition or project is accretive. and local authorities. which could result in lower earnings and cash flow. A severe economic downturn could reduce the demand for energy and commodity products. MLPs are regulated across a number of industries. the GP of the partnership and the parent company that owns the GP are controlled and run by the same management teams. Specific to the former. Headline risk exists related to potential legislative changes on the treatment of carried interest and challenges to FERC tariff regulations. are dependent on cold weather for their earnings.MLP Primer -. Because MLPs pay out the majority all of their cash to unit holders. If the MLPs are unsuccessful in completing projects on time or within budget or if the partnerships cannot identify attractive acquisitions. propane demand. could be negatively affected. A severe economic downturn. and therefore. Some MLPs. as 2008 progresses. which typically have a higher cost structure. throughput volume into processing plants. Some potential areas of conflict include (1) the price at which the MLP is acquiring assets from the GP. Weather risk. Environmental incidents and terrorism. Thus. pipeline volume. 69 . this could inhibit longterm distribution growth. Intrastate pipelines are typically regulated by the FERC. lower commodity prices are more likely to affect drilling in these regions before drilling is curtailed in more convention oil and gas fields. A slowdown in drilling activity could reduce oil and gas producer revenue. Some MLPs have significant exposure to commodity price fluctuations including partnerships involved in oil and gas production. Even though these issues may appear daunting. some MLPs’ cash flows could be negatively affected. volume.Third Edition WACHOVIA CAPITAL MARKETS.
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LLC EQUITY RESEARCH DEPARTMENT XIII.MLP Primer -.Third Edition WACHOVIA CAPITAL MARKETS. Appendix 71 .
LLC Future price Base gas (or cushion gas). A backwardated market usually occurs when demand exceeds supply. Base gas refers to the volume of gas that is needed as permanent inventory in a storage reservoir (i. A blendstock is a liquid compound that is mixed with petroleum products to improve the petroleum’s characteristics.. The higher future price is often due to the cost associated with storing and insuring the underlying commodity. 2P reserves (proved + probable).Master Limited Partnerships WACHOVIA CAPITAL MARKETS. 3P reserves (proved + probable + possible). blendstocks are mixed with motor gasoline to increase the gasoline’s octane or oxygen content. Blendstocks. Amine is a type of chemical used to remove impurities from natural gas in order to make the natural gas suitable for pipeline transport. Possible reserves indicate there is at least a 10 % probability or “less likely than probable” chance that the reserves will be producing. 72 . Backwardated Market Backwardated Market Conditions Commodity price $150 $100 $50 $0 Spot price Source: Wachovia Capital Markets.e. Probable reserves indicate there is at least a 50% probability or “more likely than not” chance that the reserves will be producing in the future. A market condition in which future commodity prices are greater than spot prices. Proved reserves indicate there is at least a 90% probability or “reasonable certainty” that the reserves will be producing in the future. Backwardation. depleted natural gas or oil field. Amine. LLC Future price Contango. aquifer. Available cash flow is the cash flow available to the common unit holders and the general partner. and/or salt cavern) to maintain adequate pressure and deliverability rates throughout the withdrawal season. Figure 84. Figure 85. LLC EQUITY RESEARCH DEPARTMENT MLP Glossary Of Terms 1P reserves (proved). Contango Market Contango Market Conditions Commodity price $150 $100 $50 $0 Spot price Source: Wachovia Capital Markets. A market condition in which future commodity prices are lower than spot prices. Available cash flow. For example.
” MLPs typically distribute all available cash flow (i. the deliverability rate it is at its highest when the reservoir is most full and declines as working gas is withdrawn. Compression. A dekatherm is a measurement of energy content. LLC OR EBITDA (-) interest expense (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow Distribution.MLP Primer -. A corporation (C Corp. injection capacity is usually expressed in MMcf/day or dekatherms/day. 73 . LLC EQUITY RESEARCH DEPARTMENT British thermal unit (Btu): A unit of measurement for energy representing the amount of heat required to raise the temperature of one pound of water one degree Fahrenheit.e. A storage facility’s injection rate is the amount of gas that can be injected into a storage facility on a daily basis. Coalbed methane (CBM). One dekatherm is the approximate energy content of 1. For example.) is a distinct legal entity. As with deliverability. Methane found in coal seams. the cash yield would be 7. the MLP is required to distribute all of its “available cash. but have no liability to business creditors. In contrast to the deliverability rate. and is dependent on factors comparable to those that determine deliverability. separate from its shareholders and employees. the injection rate is at its lowest when the reservoir is most full and increases as working gas is withdrawn. or withdrawal capacity).Third Edition WACHOVIA CAPITAL MARKETS. A storage process in which the same quantity of natural gas is injected into and withdrawn from storage within a certain period of time. The injection capacity of a storage facility is also variable. The current yield is calculated by taking the current declared quarterly distribution annualized and dividing it by current stock price. However. and provides an alternate definition of the required rate of return (or cost of equity) of a given asset. or any other parties. Current yield. minus the risk-free rate. Deliverability refers to the amount of natural gas that can be delivered (withdrawn) from a storage facility on a daily basis (this also known as the deliverability rate. The shareholders contribute capital. a corporation protects its owners from being personally liable in the event that the company is sued (i. management typically has some discretion in how much cash flow it chooses to pay out. The CAPM maps the relationship between risk and expected return. A dirty hedge is the use of crude oil derivatives to hedge natural gas liquids (NGL) exposure. tax authorities. Corporation. DCF is the cash flow available to be paid to common unit holders after payments to the general partner. Natural gas is compressed to a higher pressure to facilitate delivery of gas from one point to another. Cycling. We define cash yield as an MLP’s current yield adjusted for its GP share of cash flow. Dekatherm. Distributable cash flow (DCF). Dirty hedge. Injection capacity (or rate).000 cubic feet of natural gas (or 1 Mcf). Cash or adjusted yield. withdrawal rate. if the GP is receiving 10% of an MLP’s total distributions and the partnership’s units trade at a 7% yield. Figure 86..% of cash distributions paid to GP]). As a separate legal standing entity.e. Capital asset pricing model (CAPM). limited liability).8% (current yield / [1 . which may have a claim on corporate earnings and assets. cash flow from operations less maintenance capex) to unit holders in the form of distributions (similar to dividends). In a typical partnership agreement. It is defined as the risk-free rate (typically the 10-year treasury) plus (+) beta multiplied (×) by the expected market return (typically the historical return of a given market index). Available And Distributable Cash Flow Calculation Net income (+) depreciation and amortization (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow Source: Wachovia Capital Markets. In general. Deliverability is usually expressed in terms of millions of cubic feet per day (MMcf/day) or dekatherms per day.. Deliverability.
00 $3. The producer retains ownership of both the dry gas and the NGLs. An MLPs’ EPU is synonymous with a C corp. Downstream. EBITDA multiple. A dropdown is the sale of an asset from the parent company (or sponsor company) to the underlying partnership.00 $2. The ratio is calculated by dividing available cash flow by distributions paid. therefore. the processor receives a fee for processing.5% return).gov) 74 . Dropdowns can also be defined as a transaction between two affiliated companies. Under the fee-based arrangement. and oil. Downstream relates to the refining and marketing sectors of the energy industry. (Definition source – www. the greater the safety of the distribution.ferc. See definition for Organic capex. The FERC is an independent agency that regulates the interstate transmission of electricity. The FERC also reviews proposals to build liquefied natural gas terminals and interstate natural gas pipelines.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. a $100 million investment at an 8x EBITDA multiple.00 $4. Expansion capital expenditures (CAPEX). An EBITDA multiple is the expected return an acquisition or organic growth project is estimated to generate. Earnings before interest. Excess cash flow. Excess cash flow is the cash flow that remains after distributions have been paid to common and subordinated unit holders and general partner. Fee-based. Figure 88. The coverage ratio indicates the cash available for distribution for every dollar to be distributed. Dropdown. EPU is calculated by dividing net income allocated to the limited partners divided by the weighted average units outstanding at the end of the period. EBITDA is a useful tool when comparing companies that incur large amounts of depreciation expense because it excludes these non-cash items that could understate the company’s true performance. as well as licensing hydropower projects. This measure excludes the potential distortion that accounting and financing rules may have on a company’s earnings. Figure 87. For example. LLC Distribution yield. Federal Energy Regulatory Commission (FERC). Distribution tiers indicate the percentage allocations (and the associated thresholds) of available cash flow between common unitholders and the general partner based on specified target distribution levels. EBITDA is a non-GAAP measure used to provide an approximation of a company’s profitability. would be expected to generate approximately $12. natural gas. depreciation and amortization (EBITDA). LLC Distribution coverage ratio = Available cash flow (to GP and LP) Distribution tiers. It is also associated with the sale of products after they are refined or processed. LLC EQUITY RESEARCH DEPARTMENT Distribution coverage ratio. The distribution yield is synonymous to a dividend yield. Investors typically associate as the “cushion” a partnership has in paying its cash distribution.’s earnings per share (EPS). taxes. up to: $1. Distribution Coverage Ratio Calculation Distributions paid (to GP and LP) Source: Wachovia Capital Markets.5 million on an annual basis (or a 12. In this context. the higher the ratio is.00 Distribution tiers Tier 2 Tier 3 Tier 4 (high splits) Thresholds Percent allocations Source: Wachovia Capital Markets. Hypothetical Distribution Tiers Percent of cash flow to: Distribution tiers Tier 1 LP 98% 85% 75% 50% GP 2% 15% 25% 50% LP distr. Earnings per unit (EPU).
Fracturing is a process employed in the production of natural gas that typically involves the pumping of water (at very high pressures) to create an extensive crack in the rock formation. deductions. Interstate pipelines are regulated by the FERC. General partner (GP). IDRs can reach a tier wherein the GP is receiving 50% of every incremental dollar paid to the LP unit holders. Intrastate pipelines are regulated by state. An intrastate pipeline is a pipeline that operates within one state. Incentive distribution rights. the processor retains title to the NGLs produced from the natural gas stream to sell at market prices. A K-1 is similar to Form 1099 received by shareholders of a corporation. The LLC structure affords the additional benefit of better corporate governance relative to the typical MLP structure. LLC unit holders have voting rights. Injection season. (2) generally has a 2% ownership stake in the partnership. provincial. Frac spread. LPGs are typically a mixed form of propane and butane. We define forward yield as an MLP’s next four quarterly distributions (i.Third Edition WACHOVIA CAPITAL MARKETS. The crack in the rock exposes an increased surface area that allows a greater amount of natural gas to be produced. Limited partner. Keep-whole. iso-butane.” The processor must then replace the BTUs that it extracts from the natural gas stream (via the extraction of NGLs) with equivalent BTUs of natural gas.e. At inception. the volume and BTU content of the dry gas is reduced. By extracting the NGLs. coal. April 1 to October 31) during which producers and pipelines inject natural gas into storage for use during the winter months. The LLC structure provides some additional benefits as compared to the LP structure. The GP (1) manages the day-to-day operations of the partnership. gain. Liquid petroleum gases. This is known as the 50/50. In most partnerships. (2) has no role in the MLPs’ operations or management. Intrastate pipelines. Liquefied natural gas. or local jurisdictions. MLPs establish agreements between the GP and LP that outline the percentage of total cash distributions that are to be allocated between the GP and LP unit holders. or “high splits” tier. normal butane. Fractionation. Fracturing. The K-1 form is the statement that an MLP investor receives each year from the partnership that shows his or her share of the partnership’s income. ethane. In a keep-whole arrangement. Liquefaction. See definition for processing margin. An interstate pipeline is a pipeline that transports product across state lines. propane.e.MLP Primer -. Fractionation is the process that involves the separation of the NGLs into discrete NGL purity products (i. This refers to the period of time (i.. 75 . including natural gas. and natural gasoline). The LP (1) provides capital. A holder of a keepwhole contract would be long NGL prices and short natural gas prices. I-shares are equivalent to MLP units in most aspects. Hydrocarbon. LLC EQUITY RESEARCH DEPARTMENT Forward yield. and (3) is eligible to receive an incentive distribution (through the ownership of the MLPs’ incentive distribution rights). whereas unit holders of a standard MLP structure (LP) do not have this right.e. Incentive distribution agreement. IDRs allow the holder (typically the general partner) to receive an increasing percentage of quarterly distributions after the MQD and target distribution thresholds have been achieved. LNG is natural gas that has been condensed into liquid form (via either pressure or refrigeration)... total distributions received over the next 12 months) divided by an MLP’s current unit price. and credits. This is referred to as “shrinkage. The process that changes natural gas from a gaseous state to a liquid state. K-1 statement. LPGs are created (as a by-product) during the refining of crude oil or from natural gas production. Interstate pipelines. except the payment of distributions is in stock instead of cash. loss. and crude oil. I-shares do not generate UBTI. and (3) receives cash distributions. Investors in i-shares receive a 1099 statement (not K-1). An organic compound made of carbon and hydrogen atoms used as sources of energy. Limited liability company. I-Shares.
An LDC is a company that obtains the major portion of its revenues from the operations of a retail distribution system for the delivery of gas for consumption by residential customers. although limited partners enjoy limits on their liability. MLPs are also commonly referred to as “partnerships. LLC EQUITY RESEARCH DEPARTMENT Local distribution company. iso-butane. The pricing differential is the difference between a pipeline’s contractual cost of natural gas supply and the market price. Maximum potential distribution. propane.” Methane. processing. Organic growth capital expenditure. Alternatively. This is natural gas that has impurities removed. MLPs are limited partnership investment vehicles consisting of units (rather than shares) that are traded on public exchanges. Under percent of liquids (POL) contracts. it owns natural gas and benefit when the price increases. Pipeline quality gas is typically 95% methane. but instead. Master limited partnership. the processor receives a percentage of the NGLs only. Creditors generally have the right to seek return of capital distributed to a limited partner if the liability for which payment is sought arose before the distribution. Looping.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. transportation. expenses. Looping involves the installation of additional pipeline next to an existing pipeline to increase the system’s capacity. in theory. Long. Parking. treating. All partners are liable for the obligations of the partnership. As a practical matter. Methane is also known as natural gas. (Source: NAPTP) Percent of proceeds or liquids. however. Natural gas liquids. MLPs consist of a general partner and limited partners. Pricing differential. Parking is the temporary storage of natural gas for a pipeline customer. Limited partners may also be liable for substantial tax liabilities that could be determined through the audit process long after they have sold their interest. A play is a proven geological formation that contains petroleum and/or natural gas. or storage of a product after it is produced from the wellhead. and natural gasoline). Midstream. Maintenance capex is the investment required to maintain the partnership’s existing asset. maintenance capex. MQD is the minimum distribution the partnership plans to pay to its common and subordinated unit holders. 76 . and cash flow to the GP). The partnership does not guarantee its ability to pay out the MQD during any quarter. Oil or gas play. butane. Pipeline customers may park natural gas to avoid selling the gas at a low price. this is unlikely to happen to a PTP investor. NGLs are extracted from the raw natural gas stream into a liquid mix (consisting of ethane. it is the distribution that could be paid such that he distribution coverage ratio equals 1. the processor gathers and processes the natural gas and then sells the residue gas and produced NGLs at market prices. It is the most commonly found hydrocarbon gas. This right survives the termination of a partner’s interest. Organic capex is investments used to expand a company’s operating capacity or operating income over the long term. is an aggregate of all the partners. If a holder is “long” natural gas. In a percentage of proceeds (POP) arrangement. they are not fully shielded in the way shareholders are. pay if it distributed all of its sustainable cash flow. Maintenance capital expenditure. The NGLs are then typically transported via pipelines to fractionation facilities. Natural gas processing involves the separation of raw natural gas into “pipeline quality” gas and natural gas liquids. Processing. A partnership is not considered to be a separate entity. MPD represents the maximum distribution a partnership could. Holders of POP or POL contracts are effectively long on natural gas or NGL prices. upon initial public offering (assuming the company is able to generate sufficient cash flow from its operations after the payment of fees. Partnership.0x (no excess cash flow). Midstream relates to the gathering. but before it is distributed to the end use market for consumption. Pipeline quality gas. Minimum quarterly distribution. The processor receives a percent of the resulting dry gas and/or NGLs.
had been previously completed) for production. This is a measure of the decline in production from crude oil and natural gas reserves. In addition.e. the buyer is obligated to pay for a product (i. Proved developed producing reserves. the subordination period could be terminated at an earlier date if the partnership achieves certain criteria. A percentage of the cash distribution to the unitholder that is tax deferred until the security is sold. Royalty payment. and extends through July 1. PUDs are reserves that are recovered through new wells (on undrilled acreage) or from existing wells that require significant capital expenditure (to be recompleted). The tax deferral rate is an approximation provided by the partnership and is only effective for a certain period of time.Third Edition WACHOVIA CAPITAL MARKETS. kerosene. Subordinated units. NGLs. 2006. However. PV-10 (standardized measure). Throughput. Recompletion. Upon expiration of the subordinated period.e. they benefit when the price of natural gas declines. Residue gas. These products are primarily used as fuels by consumers (gasoline. Companies are allowed to increase their rates on an annual basis on July 1. LLC EQUITY RESEARCH DEPARTMENT Production decline rate. 2011. Subordinated units increase the likelihood that (during the subordinated period) there will be sufficient available cash to be distributed to the common units. a partnership may lease out its coal reserves to operators for the right to mine the partnership’s coal reserves in exchange for royalty payments. Take-or-pay contract. Shale is a form of sedimentary rock that contains crude oil or natural gas.. and heating oil). natural gas. the subordinated units will not be entitled to receive distributions until the common units have received the MQD plus any arrearages from prior quarters. 77 . Refined petroleum products. The tax deferral rate on distributions ranges from 40-90%. A recompletion is the completion of an existing wellbore (i..3%.) regardless of whether the buyer takes delivery of the product. The calculation is based on current commodity prices and is discounted at 10%. the units will convert to common units on a one-for-one basis. PV-10 is the after tax present value of estimated future cash flow of proved reserves. etc. The subordination period is the period of time that subordinated units will not be entitled to receive any distributions until the common units have received the MQD plus any arrearages from prior quarters. The processing margin is the difference between the price of natural gas and a composite price for NGLs on a BTU-equivalent basis. A royalty is a type of payment received based on either a percentage of sales revenue or a fixed price per unit sold. Reside gas is the natural gas that remains after processing and treating. crude oil. jet fuel. The FERC has allowed interstate natural gas and oil pipelines to increase the (maximum) rates charged to shippers based on the use of an index system. The process that changes natural gas from a liquid state to a gaseous state. The subordination period typically last for three years from the date of the partnership’s initial public offering. Subordination period. Subordinated units are subordinate in the capital structure to common units. For a period of time.MLP Primer -. diesel. Under this type of agreement. The current index is valid for a five-year period that began on July 1. The amount of natural gas or NGLs transported through a pipeline system. Producer Price Index (PPI) adjustment. The total gas in storage refers to the volume of storage in the underground facility at a particular time. For example. PDPs are reserves that can be recovered via existing wells and through the use of existing equipment and operations. Processing margin. Crude oil refineries process and refine oil into refined petroleum products. Tax deferral rate. Regasification. subordinated units are not entitled to distribution arrearages. The index system is based on the Producer Price Index for finished goods plus 1. Total gas in storage. If a holder is “short” natural gas. Short. Shale. Proved undeveloped reserves.
Weighted average cost of capital. Unlike C Corps.. Withdrawal season. A workover is the operations on a producing well to resume or increase production.. Treating. Total gas storage capacity is the maximum volume of gas that can be stored in an underground storage facility based on the physical characteristics of the reservoir. MLP units are synonymous with C Corp. and endowment funds) is considered “income earned from business activities unrelated to the entity’s tax-exempt purpose” or UBTI. A tax-exempt entity that receives more than $1. Upstream relates to the production of oil and natural gas from the wellhead (also known as exploration and production). WACC represents the cost to the entity of financing and should be the hurdle rate for new investments. pension accounts. Well bore. Unrelated taxable business income. Working gas.e. it is the proportional weight of equity and debt in a partnership’s capital structure. Wellhead. November 1 to March 1) in which natural gas supplies are withdrawn from storage for use during the heating season.’s shares. and operating procedures at the site.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. Working gas capacity refers to total gas storage capacity minus base gas. Upstream. Units. installed equipment.e.000 per year of UBTI may be held liable for the tax on the UBTI. 78 . As it relates to MLPs. A well bore is the hole created by a drill bit. Natural gas gathered with impurities higher than what is allowed by pipeline quality standards is treated with liquid chemicals (i. Working gas is the volume of gas in the reservoir above the level of base gas.. The natural gas is treated at a separate facility before being processed. The wellhead is also the point at which natural gas or crude oil emerges from the ground to the surface. The period of time (i. Working gas capacity. Workover. The equipment at the surface of a crude oil or natural gas well used to control the pressure of the well. MLPs do not realize a tax benefit on their debt (since they do not pay corporate taxes). MLP income received by a tax-exempt entity (e. amine) to remove the impurities.g. 401-K. LLC EQUITY RESEARCH DEPARTMENT Total gas storage capacity. Working gas is available to the marketplace.
MBbls/d: One thousand barrels per day.Third Edition WACHOVIA CAPITAL MARKETS. Mcf: One thousand cubic feet of natural gas. LLC EQUITY RESEARCH DEPARTMENT Energy Industry Abbreviations Bbls: Barrels Bcf/d: One billion cubic feet per day MBtu: One thousand Btus. MMBbls/d: One million barrels per day. MBbls: One thousand barrels. MMBtu: One million Btus. 79 . Tcf: One trillion cubic feet of gas. MM: In millions. MMcf: One million cubic feet of natural gas. MMBbls: One million barrels. MMBtu/d: One million Btus per day.MLP Primer -. MMcf/d: One million cubic feet of natural gas per day.
000 cf 1 MMcf = 1.000 Btu (nominal) = 1.000 cf 1 Tcf = 1.000 cf 1 Bcf = 1.000 cf 1.1724 barrels of oil 80 .000.8 MBtu of natural gas 1 Mcf of natural gas = 0.000.000. LLC EQUITY RESEARCH DEPARTMENT Basic Energy Conversion Factors 1 barrel = 42 gallons 1 Mcf = 1.000.000.000.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.9 Btu (actual) 1 barrel of oil = 6 Mcf of natural gas 1 barrel of oil = 5.1667 barrels of oil 1 MBtu of natural gas = 0.026.
87 $0.33 $0.55 $0.40 $0.70 $0.30 $0.64 $0.38 $0.68 $0.54 $0.38 $0.76 $0.43 $0.36 $0.36 $0.70 $0.68 $0.25 $0.44 $0.94 $0.29 $0.28 $0.33 $0.64 $0.38 $0. LLC EQUITY RESEARCH DEPARTMENT Figure 89.63 $0.32 $0.45 $0.25 $0.28 $0.40 $0.15 $0.46 $0.75 $0.57 $0.28 $0.74 $0.94 $0.67 $0.40 $0.46 $0.99 $1.40 $0.MLP Primer -.63 $0.28 $0.45 $0.50 $0.59 $0.39 $0.44 $0.99 $0.56 $0.66 $0.18 $0.39 $0.38 $0.60 $0.53 $0.45 Current IDR Split 50% 50% 25% 2% 0% 2% 2% 25% 25% 25% 2% 50% 25% 25% 50% 2% 50% 50% 25% 50% 50% 25% 50% 50% 2% 50% 50% 25% 50% 50% 25% 50% 2% 15% 15% 15% 2% 25% 2% 2% 50% 15% 15% 0% 15% 2% 25% 0% 0% 0% 0% 0% 0% 15% 2% 15% 50% 15% 15% 2% 50% 2% 2% 15% 2% 2% 2% 50% 50% 50% 50% Source: Partnership reports Coal Shipping MLPs Propane MLP Upstream MLPs Drop Down MLPs Midstream MLPs 81 .45 $0.40 $0.55 $0.63 $0.31 $0.50 $0.95 $0.41 $0.33 $0.99 $0.50 $0.28 $0.55 $0.43 $0.50 $0.59 $0.50 $0.30 $0.40 $0.38 $0.45 $0.46 $0.44 $0.70 $0.28 25% Tier $0.82 $0.41 $0.45 $0.51 $0.96 $0.72 $0.18 $0.44 $0.28 $0.56 $0. MLP IDR Tiers MLP IDR Tiers Ticker ATLAS PIPELINE PARTNER LP BUCKEYE PARTNERS LP BOARDWALK PIPELINE PARTNERS CALUMET SPECIALTY PRODUCTS COPANO ENERGY LLC CHENIERE ENERGY PARTNERS LP DUNCAN ENERGY PARTNERS LP ENBRIDGE ENERGY PRTNRS -LP ENBRIDGE ENERGY MGMT LLC ENTERPRISE PRODS PRTNER -LP EAGLE ROCK ENERGY PARTNRS LP ENERGY TRANSFER PARTNERS -LP GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP HILAND PARTNERS LP QUICKSILVER GAS SERVICES LP KINDER MORGAN ENERGY -LP KINDER MORGAN MANAGEMENT LLC MARTIN MIDSTREAM PARTNERS LP MAGELLAN MIDSTREAM PRTNRS LP MARKWEST ENERGY PARTNERS LP NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP RIO VISTA ENERGY PARTNERS LP SUNOCO LOGISTICS PRTNRS L P TC PIPELINES LP TRANSMONTAIGNE PARTNERS LP TEPPCO PARTNERS -LP CROSSTEX ENERGY LP Midstream MLP Median DCP MIDSTREAM PARTNERS LP EL PASO PIPELINE PARTNERS LP EXTERRAN PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP SPECTRA ENERGY PARTNERS LP SEMGROUP ENERGY PARTNERS LP WESTERN GAS PARTNERS LP WILLIAMS PIPELINE PARTNERS WILLIAMS PARTNERS LP Drop Down MLP Median ATLAS ENERGY RESOURCES LLC BREITBURN ENERGY PARTNERS LP CONSTELLATION ENERGY PRTNRS ENCORE ENERGY PARTNERS LP EV ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC QUEST ENERGY PARTNERS LP PIONEER SOUTHWEST ENRG PRTNR VANGUARD NATURAL RESOURCES Upstream MLP Median AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP GLOBAL PARTNERS LP INERGY LP SUBURBAN PROPANE PRTNRS -LP Propane MLP Median CAPITAL PRODUCT PARTNERS LP K-SEA TRANSPORTATION -LP NAVIOS MARITIME PARTNRS-REDH OSG AMERICA LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP US SHIPPING PARTNERS LP Shipping MLP Median ALLIANCE RESOURCE PTNRS -LP NATURAL RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Coal MLP Median APL BPL BWP CLMT CPNO CQP DEP EEP EEQ EPD EROC ETP GEL HEP HLND KGS KMP KMR MMLP MMP MWE NS OKS PAA RVEP SXL TCLP TLP TPP XTEX DPM EPB EXLP NGLS RGNC SEP SGLP WES WMZ WPZ ATN BBEP CEP ENP EVEP LGCY LINE QELP PSE VNR APU FGP GLP NRGY SPH CPLP KSP NMM OSP TGP TOO USS ARLP NRP PVR Quarterly Distribution Thresholds 15% Tier $0.32 $0.33 $0.47 $0.47 $0.53 $0.31 $0.38 Current Quarterly Distribution $0.61 $0.53 $0.60 $0.36 $0.35 $0.49 $0.04 $0.38 $0.53 $0.54 $0.50 $0.59 $0.31 $0.49 $0.48 $0.65 $0.35 $0.33 $0.45 $0.50 $0.40 $0.47 $0.49 $0.23 $0.53 $0.85 $0.50 $0.23 $0.42 $0.55 $0.45 $0.35 $0.59 $0.55 $0.33 $0.53 $0.31 $0.38 $0.42 $0.38 $0.75 $0.59 $0.70 $0.53 $0.42 $0.95 $0.68 $0.43 $0.58 $0.40 $0.33 $0.52 $0.40 $0.29 $0.50 $0.60 $0.44 $0.53 $0.47 $0.53 $0.56 $0.33 $0.63 $0.49 $0.40 $0.39 $0.45 $0.53 $0.36 $0.96 $0.25 $0.60 $0.25 $0.46 $0.50 $0.42 $0.44 $0.62 $0.29 $0.50 $0.83 $0.59 $0.53 $0.69 $0.50 $0.71 $0.54 $0.90 $0.72 $0.35 $0.62 $0.45 $0.62 $0.63 $0.46 $0.15 $0.43 $0.35 $0.45 $0.87 $0.43 $0.38 $0.53 $0.44 $0.29 $0.75 $0.41 $0.45 $0.61 $0.44 $0.40 $0.78 $0.42 $0.58 $0.43 $0.70 $0.43 $0.66 $0.60 $0.33 50% Tier $0.33 $0.56 $0.51 $0.56 $0.Third Edition WACHOVIA CAPITAL MARKETS.70 $0.90 $0.
LP & TC Pipelines. & ExxonMobil CenterPoint Energy CenterPoint Energy & Spectra Energy El Paso El Paso Eastern Shore Natural Gas Company El Paso/ Bear Energy Enbridge Energy Partners Enbridge Energy Partners Enbridge Energy Partners Energy Transfer Partners Enterprise Products Partners & Questar Florida Gas Transmission Kinder Morgan Energy Partners Kinder Morgan Energy Partners Kinder Morgan & Energy Transfer Partners Kinder Morgan Energy Partners Oneok Partners Oneok Partners. LP Southern Natural Gas Company Spectra Energy Corporation Spectra Energy Corporation Spectra Energy Corporation Spectra Energy Corporation TransCanada Pipeline USA TransCanada Pipeline USA TransCanada Pipeline USA Transcontinental Gas Pipe Line Corporation Transcontinental Gas Pipe Line Corporation Projects Involving MLPs: 15 Source: FERC and Partnership reports Project Name Gulf Crossing Pipeline Fayetteville & Greenville Laterals E. LLC EQUITY RESEARCH DEPARTMENT Figure 90. ConocoPhillips.The Alaska Gas Pipeline Project Tontitown Project Southeast Supply Header Project High Plains Expansion Project Raton 2010 Expansion Project EasternShore EnergyLink Project Ruby Pipeline Project Southern Access Alberta Clipper E.Texas To Mississippi Expansion Southeast Expansion Denali . Major U.S.Texas Extension (Clarity) Phoenix Expansion White River Hub Project Phase VIII Expansion Project Rockies Express Louisiana Pipeline Mid-Continent Express Colorado Lateral Expansion Project Overland Pass w/ Expansion Bison Pipeline Project South System Expansion III Project Phase V Project East to West Hubline Expansion M&NE Phase IV (Canaport) Expansion Ramapo Pathfinder Pipeline Project Yuma Lateral Project Palomar Pipeline 85 North Expansion Project Sentinel Expansion Project MLP 82 .Master Limited Partnerships WACHOVIA CAPITAL MARKETS. Pipeline Projects Sponsor Boardwalk Pipeline Partners Boardwalk Pipeline Partners Boardwalk Pipeline Partners Boardwalk Pipeline Partners BP.
LLC EQUITY RESEARCH DEPARTMENT Figure 91. States With MLP Pipeline And Storage Assets BWP Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming X BPL DEP EEP X X X X X X X X X X X EPB X EPD X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X ETP GEL X X Pipelines And Storage MLPs HEP KMP OKS MMP NS X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X PAA X SEP SGLP SXL X TCLP TLP TPP X WMZ X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Source: National Association of Publicly Traded Partnerships 83 .Third Edition WACHOVIA CAPITAL MARKETS.MLP Primer -.
States With MLP Gathering And Processing Assets APL Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming CPNO DPM EROC HLND Gathering And Processing MLPs KGS MMLP MWE X X X X NGLS RGNC WES WPZ XTEX X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Source: National Association of Publicly Traded Partnerships 84 . LLC EQUITY RESEARCH DEPARTMENT Figure 92.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.
MLP Primer -. LLC EQUITY RESEARCH DEPARTMENT Figure 93. States With MLP Coal And Upstream Assets ARLP Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming Coal MLPs NRP X PVR ATN BBEP CEP X ENP Upstream MLPs EVEP LGCY LINE PSE QELP VNR X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Source: National Association of Publicly Traded Partnerships 85 .Third Edition WACHOVIA CAPITAL MARKETS.
LLC EQUITY RESEARCH DEPARTMENT Figure 94.Master Limited Partnerships WACHOVIA CAPITAL MARKETS. States With MLP Propane And Shipping Assets APU Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Propane And Heating Oil MLPs FGP GLP NRGY SGU X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X SPH CPLP KSP Shipping MLPs NMM OSP TGP TOO USS X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X Source: National Association of Publicly Traded Partnerships 86 .
Spectra Energy Sunoco. L. L.S. SemGroup.P. L. L. Enervest and EnCap Enterprise GP Holdings. Genesis Energy. Inc. El Paso Corporation Enbridge.P. Inc.P. Holly Corporation Inergy Holdings. L. StarGas Partners. Quest Resource Corp.P. Navios Maritime Partners L. L. Dorchester Minerals Management L. U.P.P. LLC Capital Maritime & Trading Corp.P.P. Capital Products Partners.P. DCP Midstream. Atlas Energy Resources. L.P.P. L. Hiland Holdings GP. Crosstex Energy. L. L. Loews Corporation Magellan Midstream Holdings. L.P. OSG America. L. Quicksilver Resources. Calumet Specialty Products Partners. El Paso Pipeline Partners. Kinder Morgan Energy Partners.P. Teekay LNG Partners.P.P.P. Enbridge Energy Partners. L. SemGroup Energy Partners. L. Kinder Morgan. Inc. Martin Midstream Partners. LLC EQUITY RESEARCH DEPARTMENT Figure 95. L.P. Targa Resources Partners. L. Penn Octane Corp. L.P. DCP Midstream Partners. Regency Energy Partners.P.P. Dorchester Minerals. Enterprise Products Partners. L.P. L. Hiland Partners. Ferrellgas. Inc.P.P. L. GE Energy Financial Services Global Companies LLC and Global Montello Group Corp. Constellation Energy Group Corbin J.MLP Primer -. (Morgan Stanley Capital Group Inc. NuStar Energy L. Inc.P. L. L. L.P. Energy Transfer Partners. L. Cheniere Energy Partners. TC Pipelines.P. L. L. Anadarko Petroleum Corp. L.Third Edition WACHOVIA CAPITAL MARKETS. L. Ticker ARLP WES ATN APL BPL CPLP CQP CEP NRP XTEX DPM GEL DMLP EPB EEP ENP ETP EVEP EPD DEP TPP EXLP FGP RGNC GLP HLND HEP NRGY KMP KSP BWP MMP MMLP EROC NMM NS OKS OSP RVEP PVR SGU PSE PAA QELP KGS SGLP SEP SXL NGLS TGP TOO CLMT TCLP TLP APU USS WPZ WMZ Source: Company reports 87 .P. Teekay Shipping Corporation Teekay Shipping Corporation The Heritage Group (and others) TransCanada Transmontaigne. LLC Williams Companies Williams Companies Note: High-lighted cells indicate publicly traded GP MLP Ticker AHGP APC ATLS AHD BGH Private LNG CEG Private XTXI Private DNR Private EP ENB EAC ETE Private EPE EPD EPE EXH Private GE Private HPGP HOC NRGP Private Private LTR MGG Private Private NM NSH OKE OSG POCC PVG Private PXD Private QRCP KWK Private SE SUN Private TK TK Private TSX Private UGI Private WMB WMB Master Limited Partnership Alliance Resource Partners. TEPPCO Partners.P. L. Penn Virginia GP Holdings.P. United States Shipping Master.P. L. L. L. L.P. L. Inergy. L. Magellan Midstream Partners.) UGI Corp. Enterprise GP Holdings. L. Ferrelgas Partners.P. Kestrel Heat. L. L. Duncan Energy Partners. Sunoco Logistics Partners.P.P.P.P.P. Pioneer Southwest Energy Partners. L. Cheniere Energy Inc.P. Crosstex Energy. Encore Energy Partners. Jr.P.P.P.P. L.P.P.P.P. Constellation Energy Partners.P. NuStar GP Holdings. Robertson. Exterran Energy Partners. Plains All American Pipeline. LLC (which is a 50/50 joint venture between Spectra Energy / ConocoPhillips) Denbury Resources. Inc. L.P. L. Williams Partners. Boardwalk Pipeline Partners. L. L. L. Spectra Energy Partners. L. Eagle Rock Energy Partners. L. L.P. L. Buckeye GP Holdings. L. Natural Resource Partners.P. Inc. Inc. L. Encore Acquisition Company Energy Transfer Equity. Buckeye Partners.P. Holly Energy Partners.P. Inc.P. K-Sea General Partner. L.P. L. LLC Pioneer Natural Resources Plains GP Holdings.P. Enterprise Product Partners. Penn Virginia Resource Partners. L.P. K-Sea Transportation Partners.P. Atlas GP Holdings. Inc.P.P. Rio Vista Energy Partners. ONEOK Partners. L. LLC ONEOK. Transmontaigne Partners. Shipping Partners. EV Energy Partners. Inc. L. GPs And Their Underlying MLPs Publicly Traded GP Interest (except where noted) Alliance Holdings GP.P.P.P. Global Partners. Targa Resources.P. Atlas America. Williams Pipeline Partners. L. L. Amerigas Partners. Overseas Shipholding Group Inc.P.P. L. L. L. L.P. Martin Resource Management Corp. L. L. Exterran Holdings Inc. Western Gas Partners. L. Teekay Offshore Partners.P. Quest Energy Partners.P. L.P.P. Quicksilver Gas Service. L. LLC Atlas Pipeline Partners. Natural Gas Partners Navios Maritime Holdings Inc. L.P.
187 $1.50 $57.558 238.4% 6.8% 6.696 $608 $483 $283 $732 $2.86 $11.726 $470 $1.780 27.188 338.279 55.19 $31.569 $3.87 $24.041 104.624 73.382 55.88 $22.8% 8.51 $33.62 $24.32 $30.954 $462 $640 $2.50 $46.2% 6.53 $18.66 $16.950 10.212 $2.45 $17.11 $20.00 $38.30 $13.60 $48.552 $725 $818 $556 $1.803 $3.03 $32.00 $32.9% 52-Week Low High $37.6% 7.224 $2.99 $31.1% 7.17 $22.17 $36.8% 7.465 69.21 $55.822 82.92 $71.696 35.3% 4.00 $38.113 410.392 148.736 $1.209 $541 $7.1% 6.953 $382 $1.5% 8.53 $27.552 37.82 $30.95 $18.726 $1.75 $38.462 138.00 $17.02 $25.9% 0.98 $20.246 27.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.200 $1.079 103.0% 5.718 179.407 231.683 $567 $3.00 $31.08 $36.65 $41.199 $396 $306 $140 $404 $928 $375 $25 $375 $1.133 4.1% 8.373 $2.046 10.230 462.920 $711 $3.781 243.171 28.4% 8.308 127.9% 6.6% 7.237 $164 $1.00 $21.38 $40.70 $47.00 $16.50 $48.1% 10.440 $718 $1.516 $1.229 $687 $1.8% 6.187 71. Vol.686 $1.0% 4.5% 5.60 $28.08 $30.79 $52.117 $5.11 $21.25 $16.837 16.45 $37.50 $55.324 $411 $639 $399 $731 $2.853 $2.223 98.12 $35.5% 6.660 $223.015 203. Tax Deferred 80% 75% 80% 80% 80% 80% 80% 90% NA 90% 80% 80% 90% 80% 80% 80% 95% NA 80% 51% 90% 80% 90% 80% NA 80% 80% 80% 90% 80% 80% 70% 80% 80% 80% 80% 80% 80% 70% 80% 80% 80% 60% 50% 70% 80% 40% 90% 100% 15% 80% 70% 70% 70-80% 90% 70% 80% 80% 80% 80% 60% 80% 44% 80% 80% 30% 90% 80% 70% 70% 80% 70% 75% 50% 90% 90% 60% 90% 90% 50% 80% 70% 0% 75% 75% 80% Date: 7/14/2008 88 General Partnerships Coal Shipping MLPs Propane MLPs Upstream MLPs Drop Down MLPs Midstream MLPs .410 $676 $846 $1.604 $919 $2.45 $24.15 $26.56 $21.57 $29.367 $353 $4.22 $18.14 $26.1% 7.57 $18.226 156.497 90.60 $55.99 $49.0% 7.803 67.66 $29.696 138.41 $16.018 $1.3% 8.844 $2.31 $13.89 $57.49 $20.455 $547 $795 $669 $867 $4.47 $65.81 $11.4% 4.410 $676 $843 $1.65 $22.00 $43.26 $16.30 $17.90 $44.762 $1.592 $6.8% 8.00 $25.628 $20.3% 5.996 206.74 $28.15 $23.64 $1.994 28.61 $41.40 $39.061 353.169 197.47 $54.654 257.9% 8.60 $19.93 $9.40 $36.290 157.17 $15.147 $55 $1.358 33.73 $44.2% 7.48 $20.704 126.89 $60.918 $1.5% 7.07 $31.1% 8.013 182.099 197.683 $567 $4.216 244.0% 8.3% 8.575 $1.378 226.2% 8.272 $1.9% 9.443 $1.680 $7.9% 7.10 $26.210 $194 $1.37 $52.7% 7.350 157.194 132.00 $34.9% 7.4% 20.5% 7. MLP Market Data MLP Market Data ($MM.20 $13.994 7.672 $5.115 3-Month Avg.00 $31.29 $7.33 $28.892 $1.65 $40.65 $17.660 $2.92 $12.75 $18.10 $30.516 $1.14 $8.206 92.022 $818 $799 $2.90 $40.475 $1.394 82.1% 10.86 $33.03 $34.81 $19.5% 10.365 184.005 55.212 $1.3% 10.55 $26.232 113.897 34.70 $51.1% 9.00 $45.439 151.99 $42.25 $26.71 $19.08 $40.08 $21.73 $39.16 $45.3% 4.217 576.881 $670 $544 $460 $550 $14.410 114.0% 9.5% 9.12 $33.262 $2.43 $26.50 $51.808 358.021 $1.36 $42.39 $49.01 $31.00 $50.93 $43.00 $28.99 $25.82 $28.39 $58.521 $752 $900 $695 $633 $21.24 $23.13 $27.01 $39.24 $11.40 $38.57 $35.328 $2.89 $46.9% 10.54 $37.725 $2.384 $1.111 878.151 $966 $1.958 78.0% 11.57 $30.50 $32.151 $2.02 $20.201 $322 $2.50 $39.79 $21.203 300.706 121.1% 9.781 $1.01 $23.53 Current Yield 9.253 $4.262 $13.50 $69.140 $7.274 $7.295 $19.1% 9.6% 6.22 $31.7% 6.25 $15.025 457.570 Est.2% 6.2% 5.50 $23.2% 9.237 $2.55 $13.07 $17.7% 11.61 $18.38 $26.28 $19.7% 6.20 $14.41 $2.332 66.43 $23.764 $457 $5.094 $352 $1.04 $37.898 $1.84 $31.8% 5.915 $748 $640 $294 $481 $2.00 $62.96 $41.131 $5.4% NM 10.95 $41.4% 13.00 $17.59 $41.86 $23.087 200. LLC EQUITY RESEARCH DEPARTMENT Figure 96.47 $26.033 $4.11 $32.50 $58.78 $19.663 15.822 119.16 $27.74 $40.5% 11.189 39.90 $41.6% 6.14 $12.2% 5.75 $23.541 29.1% 12.905 37. 285.1% 9.212 $1.212 $1.70 $27.97 $16.68 $24.388 $4.7% 6.48 $24.452 111.8% 15.00 $53.13 $15.9% 8.89 $19.67 $48.12 $24.85 $20.306 $1.64 $63.1% 8.632 $608 $359 $181 $624 $1.11 $19.934 87.437 $28 $1.32 $46.75 $19.50 $15.4% 5.99 $29.7% 8.10 $46.82 $54.10 $37.8% 9.84 $22.41 $47.911 $941 $1.048 $753 $2.13 $56.674 $10.39 $28.53 $44.38 $35.15 $1.53 $33.55 $25.5% 9.9% 5.52 $45.9% 5.17 $4.35 $28.39 Market Cap $1.990 $930 $1.911 $2.604 $1.88 $31.988 $1.33 $24. except per unit data) ATLAS PIPELINE PARTNER LP BUCKEYE PARTNERS LP BOARDWALK PIPELINE PARTNERS CALUMET SPECIALTY PRODUCTS COPANO ENERGY LLC CHENIERE ENERGY PARTNERS LP DUNCAN ENERGY PARTNERS LP ENBRIDGE ENERGY PRTNRS -LP ENBRIDGE ENERGY MGMT LLC ENTERPRISE PRODS PRTNER -LP EAGLE ROCK ENERGY PARTNRS LP ENERGY TRANSFER PARTNERS -LP GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP HILAND PARTNERS LP QUICKSILVER GAS SERVICES LP KINDER MORGAN ENERGY -LP KINDER MORGAN MANAGEMENT LLC MARTIN MIDSTREAM PARTNERS LP MAGELLAN MIDSTREAM PRTNRS LP MARKWEST ENERGY PARTNERS LP NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP RIO VISTA ENERGY PARTNERS LP SUNOCO LOGISTICS PRTNRS L P TC PIPELINES LP TRANSMONTAIGNE PARTNERS LP TEPPCO PARTNERS -LP CROSSTEX ENERGY LP Midstream MLP Median DCP MIDSTREAM PARTNERS LP EL PASO PIPELINE PARTNERS LP EXTERRAN PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP SPECTRA ENERGY PARTNERS LP SEMGROUP ENERGY PARTNERS LP WESTERN GAS PARTNERS LP WILLIAMS PIPELINE PARTNERS WILLIAMS PARTNERS LP Drop Down MLP Median ATLAS ENERGY RESOURCES LLC BREITBURN ENERGY PARTNERS LP CONSTELLATION ENERGY PRTNRS ENCORE ENERGY PARTNERS LP EV ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC PIONEER SOUTHWEST ENRG PRTNR QUEST ENERGY PARTNERS LP VANGUARD NATURAL RESOURCES Upstream MLP Median AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP GLOBAL PARTNERS LP INERGY LP STAR GAS PARTNERS -LP SUBURBAN PROPANE PRTNRS -LP Propane MLP Median CAPITAL PRODUCT PARTNERS LP K-SEA TRANSPORTATION -LP NAVIOS MARITIME PARTNRS LP OSG AMERICA LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP US SHIPPING PARTNERS LP Shipping MLP Median ALLIANCE RESOURCE PTNRS -LP NATURAL RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Coal MLP Median ATLAS PIPELINE HOLDINGS LP ALLIANCE HOLDINGS GP LP BUCKEYE GP HOLDINGS LP ENTERPRISE GP HOLDINGS LP ENERGY TRANSFER EQUITY LP HILAND HOLDINGS GP LP MAGELLAN MIDSTREAM HLDGS LP INERGY HOLDINGS LP NUSTAR GP HOLDINGS LLC PENN VIRGINIA GP HOLDINGS CROSSTEX ENERGY INC General Partnership MLP Median All MLPs Average All MLPs Median All MLPs Sum Source: Partnership reports and FactSet Ticker APL BPL BWP CLMT CPNO CQP DEP EEP EEQ EPD EROC ETP GEL HEP HLND KGS KMP KMR MMLP MMP MWE NS OKS PAA RVEP SXL TCLP TLP TPP XTEX DPM EPB EXLP NGLS RGNC SEP SGLP WES WMZ WPZ ATN BBEP CEP ENP EVEP LGCY LINE PSE QELP VNR APU FGP GLP NRGY SGU SPH CPLP KSP NMM OSP TGP TOO USS ARLP NRP PVR AHD AHGP BGH EPE ETE HPGP MGG NRGP NSH PVG XTXI Price 7/14/2008 $38.8% 5.07 $28.614 $2.22 $14.61 $21.50 $33.929 43.05 $30.68 $17.264 71.51 $12.35 $34.799 67.375 $1.33 $25.88 $32.0% 7.554 $456 $2.513 $1.114 113.273 $9.392 25.51 $18.50 $17.29 $38.4% 9.7% 6.517 $3.544 $12.98 $37.914 66.541 198.689 Enterprise Value $2.706 42.360 $584 $2.2% 6.48 $10.40 $25.31 $43.258 15.80 $52.3% 4.00 $19.24 $61.00 $24.32 $42.53 $21.86 $2.529 183.193 93.95 $45.000 114.187 $145.00 $35.570 133.04 $29.9% 8.60 $20.89 $23.809 $558 $1.8% 8.45 $15.178 $1.237 $558 $1.90 $19.
2 $25.0 $3.3 $32.4 $18.2 $82.4 $11.479 $407 $514 $0 $580 $1.1 $4.8 $37.8 $66.3 $20.2 $79.5 $28.8 $114.540 $0 $200 $150 $200 $150 $200 $0 $73 $973 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $150 $50 $200 NA NA NA NA NA NA NA NA NA NA NA NA $123 $0 $6.2 $62.9 $42.1 $10.9 $24.7 $14.4 $54.2 $15.0 $207.1 $65.4 $35.5 $93.3 $20.0 $1.5 $71.8 $17.5 $25.450 $500 $30 $645 $24 $40 $56 $40 $808 $20 $150 $225 $150 $150 $320 $105 $60 $192 $83 $6.1 $111.100 $24 $48 $35 $82 $2.7 $77.6 $24.9 $74.159 $72 $112 $1.0 $23.4 AHD AHGP BGH EPE ETE HPGP MGG NRGP NSH PVG XTXI NA NA NA NA NA NA NA NA NA NA NA NA $36.920 $1.7 $15.0 $321 $28.4 $18.2 $16.2 $32.2 $121.120 DPM EPB EXLP NGLS RGNC SEP SGLP WES WMZ WPZ $6.9 $209.0 $60.313 % EBITDA 5% 11% 13% 6% 16% 9% 11% 8% 8% 4% 4% 7% 4% 8% 16% 9% 3% 13% 12% 7% 12% 11% 10% 7% 8% 4% 3% 13% 13% 7% 5% 6% 23% 37% 16% 10% 17% 22% 32% 32% 18% 24% 28% 39% 26% 9% 9% 3% 7% 8% 24% 12% 29% 24% 29% 9% 7% 9% NA NA NA NA NA NA NA NA NA NA NA NA 13% 10% Organic Growth Spending 2007A $144 $34 $1.2 ARLP NRP PVR $76.0 $67.4 $41.6 $24.7 $63.111 2010E $18.0 $23.4 $199 ATN BBEP CEP EVEP LGCY PSE QELP VNR $54.2 $11.6 $14.3 $20.2 $37.2 $3.5 $27.5 $5.000 $0 $0 $0 $0 $0 $0 $94 $208 $302 $0 $150 $50 $200 NA NA NA NA NA NA NA NA NA NA NA NA $111 $0 $5.4 $39.0 $35.3 $13.856 $41 $0 $708 $0 $0 $36 $683 $1.5 $23. LLC estimates Date: 07/14/08 89 .4 $275 $58.9 $7.111 $79 $32 $100 $0 $210 $16 $94 $189 $299 $53 $75 $177 $305 NA NA NA NA NA NA NA NA NA NA NA NA $269 $41 $13.3 $81.607 $30 $2.365 $109 $300 $450 $175 $854 $420 $105 $50 $475 $300 $14.5 $65.2 $348 $60.Third Edition WACHOVIA CAPITAL MARKETS.2 $18.5 NA NA NA NA NA NA NA NA NA NA NA NA $44.2 $6.870 $0 $105 $62 $25 $183 $90 $0 $25 $43 $15 $548 $78 $44 $10 $0 $0 $0 $57 $0 $188 $30 $9 $39 $5 $83 $4 $0 $0 $4 $234 $0 $12 $246 NA NA NA NA NA NA NA NA NA NA NA NA $95 $41 $4.5 $220.MLP Primer -.8 $29.1 $21.1 $5.7 $3.2 $19.4 $8. LLC EQUITY RESEARCH DEPARTMENT Figure 97.4 $61.1 $72.3 $23.2 $55.7 $66.489 2008E $217 $100 $3.0 $128.9 $14.0 $71.0 $14.6 $21.2 $13.6 $6.498 $571 $0 $0 $0 $713 $41 $0 ($0) $0 $300 $127 $13 $7 $13 $0 $6.966 $50 $998 $10 $10 $88 $18 $3.253 $13.5 $91.671 $483 $485 $194 $0 $0 $0 $4.1 $18.7 $34.4 $134.0 $196.0 $11.415 2010E $0 $200 $0 $0 $0 $0 $0 $150 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $350 $150 $500 $575 $0 $350 $300 $350 $350 $575 $750 $3.7 $21.2 $141.0 $28.608 $615 $0 $0 $705 $55 $0 $0 $0 NA $828 $2.6 $24.5 $70.5 $62.9 NA NA NA NA NA NA NA NA NA NA NA NA $40.203 $1.5 $6.3 $1.0 $16.9 $30.268 $21 $0 $25 $12 $78 $55 $0 $11 NA $41 $243 $143 $22 $19 $0 $0 $0 $92 ($0) $275 $47 $30 $84 $17 $177 $10 $351 $21 $382 $106 $0 $38 $145 NA NA NA NA NA NA NA NA NA NA NA NA $264 $50 $13.0 $7.7 $20.2 $28.0 $110.6 $43.940 2007A $1.5 $20.4 $10. except per unit data) ATLAS PIPELINE PARTNER LP BUCKEYE PARTNERS LP BOARDWALK PIPELINE PARTNERS COPANO ENERGY LLC DUNCAN ENERGY PARTNERS LP ENBRIDGE ENERGY PRTNRS -LP ENTERPRISE PRODS PRTNER -LP EAGLE ROCK ENERGY PARTNRS LP ENERGY TRANSFER PARTNERS -LP Ticker APL BPL BWP CPNO DEP EEP EPD EROC ETP GEL HEP HLND KGS KMP MMLP MMP MWE NS OKS PAA SXL TLP TPP XTEX 2008E $16.2 $6.2 $60.5 $2.505 2010E $255 $50 $135 $70 $0 $500 $500 $25 $284 $25 $20 $56 $0 $738 $10 $150 $100 $150 $150 $410 $75 $5 $113 $50 $3.0 $12.0 $4.4 $21.1 $38.5 $23.5 $29.027 $140 $7 $1.418 $30 $78 $25 $50 $208 $124 $4 $19 $18 $43 $598 $171 $66 $16 $0 $0 $0 $58 $0 $310 $38 $19 $157 $11 $225 $10 $438 $27 $475 $135 $0 $37 $172 NA NA NA NA NA NA NA NA NA NA NA NA $312 $62 $16.2 $46.3 $27.152 $300 $500 $246 $700 $1.4 $27.2 $16.198 2009E $270 $50 $562 $70 $0 $1.2 $21.7 $22.6 $241.0 $1.2 $70.1 $69.8 $2.752 Midstream MLPs Drop Down MLPs Upstream MLPs Propane Ship Coal General Partnerships GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP HILAND PARTNERS LP QUICKSILVER GAS SERVICES LP KINDER MORGAN ENERGY -LP MARTIN MIDSTREAM PARTNERS LP MAGELLAN MIDSTREAM PRTNRS LP MARKWEST ENERGY PARTNERS LP NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP SUNOCO LOGISTICS PRTNRS L P TRANSMONTAIGNE PARTNERS LP TEPPCO PARTNERS -LP CROSSTEX ENERGY LP Midstream MLP Total DCP MIDSTREAM PARTNERS LP EL PASO PIPELINE PARTNERS LP EXTERRAN PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP SPECTRA ENERGY PARTNERS LP SEMGROUP ENERGY PARTNERS LP WESTERN GAS PARTNERS LP WILLIAMS PIPELINE PARTNERS WILLIAMS PARTNERS LP Drop Down MLP Total ATLAS ENERGY RESOURCES LLC BREITBURN ENERGY PARTNERS LP CONSTELLATION ENERGY PRTNRS EV ENERGY PARTNERS LP LEGACY RESERVES LP PIONEER SOUTHWEST ENRG PRTNR QUEST ENERGY PARTNERS LP VANGUARD NATURAL RESOURCES Upstream MLP Total AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP INERGY LP SUBURBAN PROPANE PRTNRS -LP Propane MLP Total K-SEA TRANSPORTATION -LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP Shipping MLP Total ALLIANCE RESOURCE PTNRS -LP NATURAL RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Coal MLP Total ATLAS PIPELINE HOLDINGS LP ALLIANCE HOLDINGS GP LP BUCKEYE GP HOLDINGS LP ENTERPRISE GP HOLDINGS LP ENERGY TRANSFER EQUITY LP HILAND HOLDINGS GP LP MAGELLAN MIDSTREAM HLDGS LP INERGY HOLDINGS LP NUSTAR GP HOLDINGS LLC PENN VIRGINIA GP HOLDINGS CROSSTEX ENERGY INC General Partnership MLP Total All MLPs Average All MLPs Median All MLPs Sum Source: Partnership reports and Wachovia Capital Markets.3 $8.7 $83.083 2009E $0 $200 $0 $0 $100 $0 $0 $150 $0 $125 $0 $0 $0 $0 $0 $0 $128 $0 $0 $0 $0 $0 $0 $0 $703 $150 $500 $575 $700 $170 $300 $350 $200 $595 $1.3 $5.9 $34.1 $12.104 $63 $151 $309 $192 $647 $548 $81 $25 $176 $392 $12.6 $77.000 $5.9 $1.0 $20.4 $8.0 $35.4 $25.2 $15.000 $4.0 $13.1 $30.000 $0 $113 $42 $50 $179 $90 $0 $22 $44 $15 $555 $123 $44 $13 $0 $0 $0 $56 $0 $235 $40 $8 $85 $8 $141 $4 $315 $0 $319 $243 $0 $12 $255 NA NA NA NA NA NA NA NA NA NA NA NA $144 $50 $7.725 $0 $0 $53 $200 $150 $160 $80 $73 $716 $2 $1 $44 $0 $46 $230 $0 $0 $230 $0 $3 $210 $213 NA NA NA NA NA NA NA NA NA NA NA NA $213 $76 $11.400 $1.6 $42.2 $77.2 $208.4 $137.8 $268 APU FGP NRGY SPH $27.1 $61.189 $11.893 2009E $17.736 Acquisition Spending 2008E $9 $900 $0 $0 $300 $0 $0 $154 $0 $311 $194 $0 $0 $0 $6 $12 $241 $675 $0 $676 $200 $136 $338 $0 $4.8 $3.1 $54.1 $54.1 $12.6 $33.1 $72.3 $24.0 $5.5 $64.4 $60.9 $13.9 $67.8 $360 $29.5 $2.0 $28.5 KSP TGP TOO $22.7 $8.279 $1.5 $11. MLP Capex Forecast Maintenance Capex Spending ($MM.900 $0 $200 $150 $200 $150 $250 $0 $50 $1.2 $101.
LLC estimate 90 .710 $474 $135 $2.096 $651 $188 $2.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.572 $0 None None $3 None None $14 $1.793 $557 $4.601 $3.287 $2.579 ARLP NRP PVR $240 $513 $414 $414 AHD AHGP BGH EPE ETE HPGP MGG NRGP NSH PVG XTXI $25 $1 None $1.084 $553 Date: 7/14/2008 None None None BBNone None None None None None None No No No No No No No No No No No None None None No No No BBNone None No No No None B+ B+ B+ No No No No None None None None None None None None No No No No No No No No None None None None None None None None None BBBNo No No No No No No No No Yes S&P Debt Rating B+ BBB BBB+ BBNone BBB BBBNone BBBNone BBNone None BBB None BBB B+ BBBBBB BBBBBB None BBBNone Investment Grade No Yes Yes No No Yes Yes No Yes No No No No Yes No Yes No Yes Yes Yes Yes No Yes No Midstream MLPs Drop Down MLPs Upstream MLPs Propane Ship Coal General Partnerships GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP HILAND PARTNERS LP QUICKSILVER GAS SERVICES LP KINDER MORGAN ENERGY -LP MARTIN MIDSTREAM PARTNERS LP MAGELLAN MIDSTREAM PRTNRS LP MARKWEST ENERGY PARTNERS LP NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP SUNOCO LOGISTICS PRTNRS L P TRANSMONTAIGNE PARTNERS LP TEPPCO PARTNERS -LP CROSSTEX ENERGY LP Midstream MLP Median DCP MIDSTREAM PARTNERS LP EL PASO PIPELINE PARTNERS LP EXTERRAN PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP SPECTRA ENERGY PARTNERS LP SEMGROUP ENERGY PARTNERS LP WESTERN GAS PARTNERS LP WILLIAMS PIPELINE PARTNERS WILLIAMS PARTNERS LP Drop Down MLP Median ATLAS ENERGY RESOURCES LLC BREITBURN ENERGY PARTNERS LP CONSTELLATION ENERGY PRTNRS EV ENERGY PARTNERS LP LEGACY RESERVES LP PIONEER SOUTHWEST ENRG PRTNR QUEST ENERGY PARTNERS LP VANGUARD NATURAL RESOURCES Upstream MLP Median AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP INERGY LP SUBURBAN PROPANE PRTNRS -LP Propane MLP Median K-SEA TRANSPORTATION -LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP Shipping MLP Median ALLIANCE RESOURCE PTNRS -LP NATURAL RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Coal MLP Median ATLAS PIPELINE HOLDINGS LP ALLIANCE HOLDINGS GP LP BUCKEYE GP HOLDINGS LP ENTERPRISE GP HOLDINGS LP ENERGY TRANSFER EQUITY LP HILAND HOLDINGS GP LP MAGELLAN MIDSTREAM HLDGS LP INERGY HOLDINGS LP NUSTAR GP HOLDINGS LLC PENN VIRGINIA GP HOLDINGS CROSSTEX ENERGY INC General Partnership MLP Median All MLPs Average All MLPs Median Source: FactSet.289 $1. LLC EQUITY RESEARCH DEPARTMENT Figure 98.640 $82 $356 $235 $83 $7.366 $255 $953 $796 $2.579 $1.293 $1. MLP Credit Metrics Total ($MM. except per unit data) ATLAS PIPELINE PARTNER LP BUCKEYE PARTNERS LP BOARDWALK PIPELINE PARTNERS COPANO ENERGY LLC DUNCAN ENERGY PARTNERS LP ENBRIDGE ENERGY PRTNRS -LP ENTERPRISE PRODS PRTNER -LP EAGLE ROCK ENERGY PARTNRS LP ENERGY TRANSFER PARTNERS -LP Ticker APL BPL BWP CPNO DEP EEP EPD EROC ETP GEL HEP HLND KGS KMP MMLP MMP MWE NS OKS PAA SXL TLP TPP XTEX Debt $1.091 $465 $296 None $243 $1.020 $2.000 $1.271 $1. Standard & Poor's.150 $857 $549 $928 KSP TGP TOO $333 $1.000 $503 ATN BBEP CEP EVEP LGCY PSE QELP VNR $829 $131 $136 $270 $136 None $123 $103 $136 APU FGP NRGY SPH $1.647 $1. and Wachovia Capital Markets.088 $1.751 $6.120 DPM EPB EXLP NGLS RGNC SEP SGLP WES WMZ WPZ $655 $503 $217 $639 $1.
9% 11.2% 15.0% 25.7% 19.8% 7% 6% Propane 0.7% 4.5% 0.2% 5.6% 13.8% 4.1% 8.2% 14.7% 2.1% 1997A 14.2% 6.6% 3.1% Not Under Coverage 22.1% 22.0% General Partnerships 19.9% (0.5% 7.1% 28.9% 5.7% 7.2% 10.0% 9.9% 2005A 18.5% 31.0% 1996A 7.5% 35.3% 8.6% 4.9% 5.5% 21.4% 12.0% 4.8% 4.1% 2002A (14.5% 15.5% 21.0% 0.4% 9.4% 16.1% 4.5% 8.3% 100.5% 10.9% 6.2% 3.6% 7.0% 6.1% 3.1% 20.3% 12. LLC EQUITY RESEARCH DEPARTMENT Figure 99.1% 0.7% 6.8% 10.5% 0.2% 11.5% 13.0% 5.1% 8.2% 8.6% 8.1% 8.3% 12.0% 3.3% Source: Partnership reports and Wachovia Capital Markets.7% 5.2% 7.5% 7.4% 14.3% 8.2% 13.0%) 0.4% 5.5% 0.6% 11.4% 25.7% 1.8% 16.MLP Primer -.5% 14.2% 2.4% 0.0% 12/30/07 2007A 5.1% 6.3% 29.9% 6.6% 8.8% 9.8% 3.0% 10.0% 0.9% 9.7% 10.0% 5.4% 9.8% 17.1% 25.0% 0.6% 16.9% 7.2% 5.7% 9.5% 13.5% 2.1% 19.1% 5.2% 4.7% 9.2% Not Under Coverage 12.9% 18.9% 5.7% 5.8% 0.0% 10.7% 12% 10% 8.7% 2.3% 10.0% 0.0% 18.1% 2.8% 7.8% 10.8% 21.2% 6.1% 11.5% 7.0% 5.1% 5.1% 14.2% 8.0% 4.1% 4.0% 19.7% 43.8% 5.1% 9.7% 8.1% 35. GPs) 3.7% 23.2% (66.1% 4.0% 0.0% 0.5% 0.6% 0.6% 4.6% 9.6% 1.6%) 2.1% 0.2% 9.0% 8.0% 0.2% 12.0% 18.8% 14.5% 0.4% 10.0% 0.0% 3.5% 11.3% 25.6% 6.0% 9.3% 2001A 27.4% 6.5% 47.3% 5.5% 61.0% 27.2% 21.3% Drop Down MLPs 24.2% 24.7%) 3.8% 0.5% 6.6% 17.4% 9.9% 5.3% 9.0% 0.2% 18.0% 0.9% 4.5% 9.0% 13.8% 25.9% 6.6% 0.0% 13.8% 5.3% 16.5% 6.9% Not Under Coverage 31.0% 0.5% 9.5% 9.1% 8.5% 23.4% 7.3% 4.9% 10.2% 21.8% 9.5% 0.9% Not Under Coverage 9.1% 18.1% 11.3% 33.1% 22.8% 5.3% 7.4% 1.4% 25.1% 7.4% 1999A 3.2% 21.1% 30.0% 4.1% 4.5% 19.1% 35.6% 8.3% 15.1% 1.7% 5.0% 0.0% 42.2% 0.7% 30.8% 0.3% 14.0% 12.6% 1.4% 22.0% Coal Upstream MLPs 0.4% 25.3% 17.5% (15.0% 15.2% 22.2% 2.2% 0.8% 4.4% 23.0% 7.7% 3.9% Not Under Coverage 1.4% 0.1% 44.1% 37.0% 9.9% 5.3% 0.8% 1.5% 4.2% 0.9% 6.8% 13.3% 35.0% 1.2% 17.7% 12.0% 2003A 11.9% 5.2% 16.5% 12.8% 22.5% 13.0% 12.3% 0.3% 25.2% 10.8% 19.8% 35.6% 14.0% 16.0% 10.9% 4.3% Midstream MLPs 4.0% 15.9% 16.0% Not Under Coverage 8.6% 9.0% 6.2% 33.7% 6.0% 0.4% 7.0% 12.0% 2004A 11.9% 6.0% 0.6% 12.3% 16.0% 5.2% -19.9% 7.2% 7.3% 22.0% 4.2% 6.4% 8.8% 8.4% 19.8% 6.0%) 4.3% 6.0% 0.5% 7.5% 0.8% 7.0% 0.6% 13.5% 23.0% 0.0% 26.8% 12.2% (50.5% 17.3%) 13.4% 13.5% 11.6% 12/30/08 12/30/09 12/30/10 2008E 2009E 2010E 9.2% 23.7% 6.8% 12.2% 8.0% 0.5% 11.7% 12.7% 0.2% 18.2% 16.7% 30.9% 32.5% 0.0% 32.3% 12.0% 0.7% 11.0% 5.4% 9.4% 3.0% 15.3% 0.2% 20.1% 5.4% 7.0% 0.0% 0.0% 12.4% 11. MLP Historical And Forecast Distribution Growth Rates Annual Distribution Growth (Four Quarters Declared12/29/00 12/31/01 12/31/02 12/31/03 12/31/04 Declared) Versus Previous Four Quarters 12/31/05 12/30/06 12/31/93 12/30/94 12/29/95 12/31/96 12/31/97 12/31/98 12/31/99 1994A APL BPL BWP CLMT CPNO DEP EEP EPD EROC ETP GEL HEP HLND KMP MMLP MMP MWE NS OKS PAA SXL TCLP TLP TPP XTEX Median DPM EPB EXLP NGLS RGNC SEP SGLP WES WPZ WMZ Median ATN BBEP CEP DMLP EVEP LGCY LINE PSE QELP VNR Median ARLP NRP PVR Median KSP TGP TOO USS Median APU FGP GLP NRGY SGU SPH Median AHD AHGP BGH EPE ETE HPGP MGG NRGP NSH PVG XTXI Median Median Distribution Growth For All MLPs Median Distribution Growth For All MLPs (Excl.9% 0.5% 2006A 7.3% 16.9% 14.0% 6.4% 13.3% 10.5% 6.0% 7.1% 12.2% Not Under Coverage 20.8% 10.3% 1.1% 9.1% 1.1% 17.3% 5.7% 11.9% 40.4% 18.3% 0.5% 6.0% 9.0% 3.1% 9.0% 0.7% 10.1% 6.9% 28.0% 10.5% 14.1% 14.4% 11.6% 26. LLC estimates 91 .1% 6.8% 13.7% 0.8% 7.5% 6.6% 49.6% 27.0% 0.7% 8.0% 1.0% 0.5% 6.3% 1998A 22.3% 15.7% 16.4% 15.9% 14.4% 21.0% 7.6% 30.1% 9.Third Edition WACHOVIA CAPITAL MARKETS.0% Shipping Not Under Coverage 10.6% 6.0% 7.0% 0.7% 18.5% 12.1% 10.6% 3.0% 0.8% 11.3% 20.1% 0.9% 7.1% 8.0% 10% 9% 4.2% 27.8% 6.6% 7.1% 6.3% 8.6% 3.3% 12.3% 0.6% 2000A 10.1% 11.1% 4.0% 4.2% 11.0% 2.9% 18.6% 2.9% 6.8% 15.5% 37.0% 0.0% 1.0% 0.6% 13.4% 6.4% 0.9% 15.4% 2.6% 9.1% 0.6% 1.2% 4.0% 5.7% 1995A 0.4% (64.0% 8.2% 8.9% 7.5% 0.0% 0.1% 6.1% 8.3% 13.7% 2.6% 6.6% 9.6% 5.7% 8.1% 22.0% 0.5% 11.0% 3.5% 12.8% 5.3% 1.0% 1.0% 49.8% 7.6% 12.4% 14.1% 4.4% 18.0% 3.0% 50.2% 3.5% 6.1% 7.9% 37.9% 7.8% 6.0% 12.8% 5.9% 3.0% 0.5% 8.6% 26.1% 7.7%) 2.4% 2.1% 3.7% 5.9% 5.8% 2.
Master Limited Partnerships WACHOVIA CAPITAL MARKETS. MLP Distribution Growth CAGRs Since IPO ETE AHD NRGP XTXI EVEP ENP CPNO PVG LINE ATN DPM SGLP WPZ MGG CLMT HLND HPGP BGH XTEX EPE NGLS GEL AHGP NRP MWE CEP MMP EXLP BBEP KMP LGCY BWP SXL ETP HEP APL NRGY ARLP CPLP PVR KSP VNR RGNC TOO EPD TGP SEP NS PAA GLP TLP NSH MMLP EROC KGS BPL TPP TCLP QELP OKS SPH EEP DEP APU USS FGP 35% 34% 32% 30% 29% 28% 28% 23% 23% 23% 21% 20% 20% 20% 19% 19% 19% 19% 17% 17% 17% 15% 15% 14% 13% 13% 13% 13% 13% 13% 12% 12% 11% 10% 10% 10% 10% 10% 10% 9% 9% 9% 9% 9% 8% 8% 8% 7% 7% 7% 7% 7% 7% 7% 7% 5% 5% 5% 5% 4% 4% 3% 2% 1% 0% 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% .0x^4) Note: GEL distribution CAGR is post restructuring brought about after DNR purchased GEL's GP Note: ENP distribution CAGR reflects growth in the MLP's sustainable MQD distribution Source: Partnership reports 92 . LLC EQUITY RESEARCH DEPARTMENT Figure 100.MLP Note: Distribution CAGRs based on annualized quarterly distribution growth rate since IPO (i.e.General Partnership . 1.
L.. Atlas Pipeline Partners.P. L..P.P... Crosstex Energy. L. Atlas Pipeline Holdings... L.P. Western Gas Partners.P.. L. L.P. Energy Transfer Partners. within the past 12 months.P...P.P.. Williams Pipeline Partners. Genesis Energy. Sunoco Logistics Partners L. L. LLC. L. L.. Kinder Morgan Management. L.P. L. L.P. Pioneer Southwest Energy Partners. Crosstex Energy.. Boardwalk Pipeline Partners. L. L.P..P.. L. Wachovia Capital Markets. BreitBurn Energy Partners L... Duncan Energy Partners.L. LLC.P. L.P. LLC. TEPPCO Partners.. TransMontaigne Partners L. Wachovia Capital Markets..P. Enbridge Energy Partners. Hiland Partners. EV Energy Partners.. L. Inc.P. Energy Transfer Equity. MD 21202 ATTN: Research Publications Additional Information Available Upon Request I certify that: 1) All views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers discussed. SemGroup Energy Partners. El Paso Pipeline Partners. L. LLC or its affiliates received compensation for investment banking services from AmeriGas Partners. NuStar Energy.P. Copano Energy L. L.P.. L. MarkWest Energy Partners.. Duncan Energy Partners.P.. L. Plains All American Pipeline.P.P. L.P.P.P. LLC. L. L. L.P. L.P. Energy Transfer Partners.. Hiland Holdings GP. Enterprise GP Holdings L. EV Energy Partners. Atlas Pipeline Holdings.. Inergy Holdings.P.P. L. Martin Midstream Partners... Kinder Morgan Energy Partners. L.P. L. L. Spectra Energy Partners.. is.P. Genesis Energy.. Inergy.P. L. L. L. L. Williams Partners L. Wachovia Capital Markets... L.P. Atlas Energy Resources..P... LLC. Williams Pipeline Partners.P. Quest Energy Partners. L. L.P...L.. L. LLC or its affiliates intends to seek or expects to receive compensation for investment banking services in the next three months from Alliance Holdings GP.. directly or indirectly. Enterprise GP Holdings L.. Quest Energy Partners. L..P. Atlas Pipeline Holdings..P. Holly Energy Partners. L. L.P... Regency Energy Partners..P.. NuStar Energy..P. L. L.P.... TransMontaigne Partners L.. ONEOK Partners.. Teekay LNG Partners. Hiland Holdings GP. LLC. Natural Resource Partners L. Quicksilver Gas Services. Boardwalk Pipeline Partners. and 2) No part of my compensation was.C. Regency Energy Partners.P.P. LLC or its affiliates managed or comanaged a public offering of securities for Atlas Energy Resources.P. L.P. L.P. Legacy Reserves.P. Enbridge Energy Partners. Atlas Pipeline Partners. Teekay Offshore Partners.P. L.. El Paso Pipeline Partners.P.P.P. L. Enterprise Products Partners L.. L.. L.P..... Plains All American Pipeline. Williams Partners L.. L. have beneficial ownership of 1% or more of any class of the common stock of BreitBurn Energy Partners L. L. Pioneer Southwest Energy Partners..P.. L..P.P. L. L. L.. L. L.. Constellation Energy Partners LLC.. L. Inergy.. Kinder Morgan Energy Partners.P...P.P..P. L. Penn Virginia GP Holdings.P. Plains All American Pipeline.P. L.P. Martin Midstream Partners..P... Quest Energy Partners. Energy Transfer Equity. TEPPCO Partners. L.P. Buckeye Partners. please go to www. L. Enterprise Products Partners L.. L. Legacy Reserves.P. L.P. ONEOK Partners.P.P.. Exterran Partners..P. L. LLC. L.P. L. L..P. Exterran Partners. Crosstex Energy..P. Suburban Propane Partners.P.P.L. Regency Energy Partners. L..P..C. Copano Energy L.. L. Quest Energy Partners..C. L. SemGroup Energy Partners. L.P.. Genesis Energy. Baltimore. Crosstex Energy. L. L.P. L.. L..P. L. L.. NuStar Energy. L. Copano Energy L. Atlas Energy Resources. El Paso Pipeline Partners.P. in the past 12 months. AmeriGas Partners. L..P. Legacy Reserves.... L.. LLC.C. 1st Floor.P. Targa Resources Partners..P.P. L.P.. L.P.P.P.. Enterprise Products Partners L..P.. Copano Energy L. L.P. SemGroup Energy Partners.. Enbridge Energy Partners..P. L.. L..P.P.P. L. L.P. Eagle Rock Energy Partners... K-Sea Transportation Partners.P.. L. Western Gas Partners.P. Copano Energy L.P. Vanguard Natural Resources.P. Buckeye Partners. Teekay LNG Partners. L.P. Teekay LNG Partners.. DCP Midstream Partners. Magellan Midstream Partners. Williams Pipeline Partners. L. Crosstex Energy.P. L. L. Buckeye Partners.P.P..P.P. Exterran Partners.... Atlas Energy Resources. Regency Energy Partners. L. LLC.P. Hiland Partners. Penn Virginia Resource Partners...P. NuStar GP Holdings.P. L. Genesis 93 .P.. or will be.. Legacy Reserves. L.. L. Spectra Energy Partners. Enterprise Products Partners L. L.. L.P..P. Atlas Pipeline Partners. Boardwalk Pipeline Partners. El Paso Pipeline Partners. Enterprise GP Holdings L.P.L.P.P.P. L...P. Inergy... Buckeye Partners.. related to the specific recommendations or views expressed by me in this research report. TEPPCO Partners.P.P.P.P. Penn Virginia Resource Partners..MLP Primer -.P. L.. Boardwalk Pipeline Partners. TransMontaigne Partners L.... Duncan Energy Partners. L..P.Third Edition WACHOVIA CAPITAL MARKETS.P. Crosstex Energy. L.P. L. L. Magellan Midstream Partners. ONEOK Partners. L. MarkWest Energy Partners. L.. Eagle Rock Energy Partners.P.. L.. L.P.P.. L... Ferrellgas Partners. Buckeye GP Holdings L.P. L.. Inergy..wachoviaresearch.. L.P.P. L.com or write to 7 Saint Paul Street.. Hiland Holdings GP. Hiland Partners. L. L.P.P. BreitBurn Energy Partners L. Penn Virginia GP Holdings. L.. L. L. Crosstex Energy.. L..P..P. L.P.. Atlas Pipeline Partners.P.. L...P.. Targa Resources Partners. Targa Resources Partners.... L.P.P.P.P.P... L.P. Buckeye GP Holdings L.P. Magellan Midstream Partners..P. Kinder Morgan Energy Partners.. L. L. Inc.P.P.P.P.. DCP Midstream Partners. L. Williams Partners L. LLC and/or its affiliates. Buckeye GP Holdings L.P.P..L.. L.P. AmeriGas Partners. Magellan Midstream Holdings. L.. L.P. Energy Transfer Partners.P. Wachovia Capital Markets. Inc. LLC maintains a market in the common stock of Alliance Holdings GP. Vanguard Natural Resources. Exterran Partners. L.P.P. L. Alliance Resource Partners. Energy Transfer Partners. Vanguard Natural Resources. LLC EQUITY RESEARCH DEPARTMENT Required Disclosures To view price charts for all companies rated in this document. NuStar GP Holdings. SemGroup Energy Partners. DCP Midstream Partners. Targa Resources Partners. Energy Transfer Equity.P.. L.. L.C.P..P.. K-Sea Transportation Partners... L.P. Genesis Energy.. L.P. Inergy Holdings. Enbridge Energy Partners..P. L. L.. Crosstex Energy. MarkWest Energy Partners.. LLC.. Penn Virginia Resource Partners.. Magellan Midstream Holdings. L.P. L. Wachovia Capital Markets. DCP Midstream Partners. MD5202. L. L. Sunoco Logistics Partners L.
MarkWest Energy Partners. LLC.P. Energy Transfer Equity... L.. L.. LLC. L.. LLC received compensation for products or services other than investment banking services from Atlas Energy Resources. Regency Energy Partners. Energy Transfer Equity. Crosstex Energy. Natural Resource Partners L.P. L.P. DCP Midstream Partners.P.P..P.. Inc.. L.P. SemGroup Energy Partners.P.. Constellation Energy Partners LLC. Enterprise Products Partners L.P... LLC does not compensate its research analysts based on specific investment banking transactions. or during the 12-month period preceding the date of distribution of the research report was. Pioneer Southwest Energy Partners.P.... ONEOK Partners.P. L.P..P. L. Crosstex Energy...P.P.. Magellan Midstream Holdings.P..P.. Penn Virginia Resource Partners. L... L. Magellan Midstream Partners.P..P. Crosstex Energy.P. L. DCP Midstream Partners.. Atlas Pipeline Holdings. currently is. Boardwalk Pipeline Partners.P. L. Teekay Offshore Partners. L. Wachovia Capital Markets. Enterprise Products Partners L. Eagle Rock Energy Partners. L.P.. L.P..P.. L..P. TEPPCO Partners. L. Duncan Energy Partners.. L.. L. LLC.P.P...P.P. L. L. Atlas Energy Resources. Spectra Energy Partners. DCP Midstream Partners..P. Crosstex Energy.... L.... L.P. Atlas Pipeline Holdings..P.P. L.P.P.P. L.. Atlas Energy Resources. LLC.. L. Williams Partners L..P. Inc. Kinder Morgan Energy Partners. L. Enterprise Products Partners L. Constellation Energy Partners LLC.P. a client of Wachovia Capital Markets. Energy Transfer Equity. L.P. MarkWest Energy Partners.. Enterprise GP Holdings L.. NuStar Energy. L. Vanguard Natural Resources. Kinder Morgan Energy Partners.. Boardwalk Pipeline Partners..P..P.P. Crosstex Energy.P. LLC.. L.P.P.. Kinder Morgan Management.. L.P. Quest Energy Partners. L..P. LLC.P..P.P. Spectra Energy Partners. or during the 12-month period preceding the date of distribution of the research report was. which includes. L. L. Buckeye GP Holdings L. LLC EQUITY RESEARCH DEPARTMENT Energy..P. SemGroup Energy Partners.P.P. Natural Resource Partners L..P.. DCP Midstream Partners. L.P. L.P. L. Atlas Pipeline Holdings.. Inc. Kinder Morgan Management.. K-Sea Transportation Partners. L. L.. ONEOK Partners. BreitBurn Energy Partners L... LLC. Kinder Morgan Energy Partners. L.P..P. L.P. L..P.P.P. Energy Transfer Partners. Hiland Holdings GP.P.P. L. Penn Virginia GP Holdings.. L. L... L. Enterprise GP Holdings L.P.P. Pioneer Southwest Energy Partners. L. Inergy Holdings... L. L. L. TransMontaigne Partners L.P. Genesis Energy. Enbridge Energy Partners. Atlas Pipeline Holdings. Williams Pipeline Partners.. MarkWest Energy Partners. Buckeye Partners.P. Wachovia Capital Markets.P. Plains All American Pipeline.P. L. Crosstex Energy.. Inergy. L.C. Pioneer Southwest Energy Partners.P.. L...P.P.P.. L. Wachovia Capital Markets. LLC.P... TEPPCO Partners. Plains All American Pipeline. L. Hiland Holdings GP. Kinder Morgan Energy Partners. L.P.P. Constellation Energy Partners LLC. Western Gas Partners. Targa Resources Partners.. Spectra Energy Partners. Regency Energy Partners. currently is. L. L.P. L.. Crosstex Energy. L. LLC. L. LLC. a client of Wachovia Capital Markets.P. Duncan Energy Partners... Eagle Rock Energy Partners.P. Pioneer Southwest Energy Partners.P.P.P. L.P..P. Regency Energy Partners. Inc.. Williams Pipeline Partners. currently is.P. Kinder Morgan Management.. Teekay LNG Partners..P.P. Hiland Partners. Magellan Midstream Holdings.P.P. Enbridge Energy Partners.P. Spectra Energy Partners. L... Enterprise Products Partners L. 94 . L. Atlas Pipeline Partners. L. Eagle Rock Energy Partners..P. L. El Paso Pipeline Partners.. Inergy. a client of Wachovia Capital Markets. L. L.. L. Enterprise GP Holdings L. L.P.P.P.. L. L.. Targa Resources Partners.. TEPPCO Partners... Exterran Partners. L.P. Sunoco Logistics Partners L.P. Regency Energy Partners.P. L.P. SemGroup Energy Partners.. L.P.. L.P. L.. L. Williams Partners L. NuStar GP Holdings. Legacy Reserves.P. Boardwalk Pipeline Partners.P. or during the 12-month period preceding the date of distribution of the research report was. Energy Transfer Partners.. NuStar GP Holdings...P. LLC.. TEPPCO Partners... L. ONEOK Partners. Targa Resources Partners.P. L. LLC. L. L... Targa Resources Partners.P. L. L... L. Inergy Holdings. Spectra Energy Partners.P. Wachovia Capital Markets... LLC. Kinder Morgan Management. Kinder Morgan Energy Partners. L.. but is not limited to investment banking revenue..P. Kinder Morgan Management. Pioneer Southwest Energy Partners. Natural Resource Partners L.P.P. L. Targa Resources Partners. L. Enbridge Energy Partners.P. L..P.P.. Enterprise GP Holdings L.P.P... ONEOK Partners. L. L. NuStar Energy..... SemGroup Energy Partners. Quest Energy Partners. L. Atlas Pipeline Partners. Crosstex Energy.P. LLC. Kinder Morgan Energy Partners. LLC.. Duncan Energy Partners. Energy Transfer Equity.P.. L. Kinder Morgan Management. L. in the past 12 months.P.P. Wachovia Capital Markets.P.P. Duncan Energy Partners. L.Master Limited Partnerships WACHOVIA CAPITAL MARKETS.. Teekay LNG Partners.P. L. WCM’s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm. L. Copano Energy L. L. Regency Energy Partners.P. L. L.. LLC provided investment banking services to AmeriGas Partners. L.P. L.. L..P..P. Energy Transfer Partners. LLC provided noninvestment banking securities-related services to BreitBurn Energy Partners L. TransMontaigne Partners L. L...P. L.P. L. MarkWest Energy Partners. L.P. SemGroup Energy Partners. Hiland Partners.P.P..P.. L. L. L. L. Exterran Partners. L. Kinder Morgan Management. L.. L.P. L.P. L. Pioneer Southwest Energy Partners... L...L..P.P.. L. L.P. Legacy Reserves.. L. BreitBurn Energy Partners L.P.P.P. K-Sea Transportation Partners..P. L. Western Gas Partners. MarkWest Energy Partners. Energy Transfer Partners. Exterran Partners.P. Pioneer Southwest Energy Partners. L. L. L. Sunoco Logistics Partners L. Penn Virginia Resource Partners.. Teekay Offshore Partners.P. L. Exterran Partners. L.... L.P.P.. Enbridge Energy Partners.P. L... L.P. ONEOK Partners.P. LLC provided nonsecurities services to Atlas Energy Resources.P. L. Western Gas Partners. Magellan Midstream Partners.. Vanguard Natural Resources. TEPPCO Partners.P. L..P. LLC. L.. LLC.P. Boardwalk Pipeline Partners. Atlas Pipeline Partners. LLC. L... Atlas Pipeline Partners. Penn Virginia GP Holdings. Kinder Morgan Energy Partners.P.
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