But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.
New petrochemical master limited partnerships (MLPs) could emerge
The IRS recently ruled that qualifying income would include the activity of processing natural gas liquids into olefins, which covers ethylene and propylene plants. This activity falls under the operations of many petrochemical companies such as LyondellBassell (LYB) and Dow Chemical (DOW). These companies could take advantage of the tax code change by spinning off these assets into an MLP structure, thereby avoiding certain taxes and realizing a higher valuation on these assets.
MLP structure could also cover renewable resources
Legislation has been introduced (but not yet passed) to allow renewable energy companies to use the MLP structure. Under the proposed legislation, renewable energy includes wind, biomass, geothermal, solar, hydropower, and biodiesel. The change was proposed in order to allow renewable energy companies to gain cheaper and easier access to capital.
However, note that the nature of these renewable resources businesses may involve volatile cash flows. Additionally, renewable energy is generally an emerging sector, and many renewable energy companies may have short track records and uncertain prospects, which is different from the cash flow profile of most traditional midstream MLPs.
A possible impact of this extension of MLPs is that for some non-traditional MLP names with more volatile cash flows operating with an MLP structure, distributions may fall far below expectations or possibly to zero given the increased downside risk. For example, Calumet cut its distribution from $0.63 per unit in 1Q08 to $0.45 per unit in 2Q08, and the distribution didn’t recover to former levels until 1Q13. As MLPs often trade on distribution yield, a distribution cut can often result in a dramatic stock price drop. Actually, from 1Q08 to 2Q08, CLMT’s stock price dropped from ~$37.03 per unit on January 4 (the highest point in 1Q08) to a $11.56 per unit on May 16 (the lowest point in 2Q08). MLPs have a reputation for stable and growing cash flows, and the increase in use of the MLP structure to cover assets that have more volatile cash flows might mar the asset class’ reputation.
This analysis continues in Part 3.
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