Master limited partnerships
In simple terms, a master limited partnership, or MLP, is a publicly traded partnership company. MLP ownership is divided between a sponsor and the public. The sponsor is an individual or organization responsible for forming and operating the MLP. The sponsor typically owns 100% of the general partner, which, in turn, often holds a 2% stake in the publicly traded MLP.
The rest of the MLP ownership lies with limited partners. Shareholders of MLPs are called unitholders. Like REITs, MLPs are mostly exempt from corporate tax.
The history and the evolution
MLPs date back to 1981 when Apache Corporation (APA) floated the first one in US history under the name Apache Petroleum Company. MLPs mushroomed when other oil and gas companies as well as real estate companies followed suit.
Concerned by the possibility of corporations turning into tax-advantaged MLPs, Congress created section 7704 of the Internal Revenue Code in 1987 to restrict MLP usage.
MLPs are restricted to certain sectors including real estate and energy. To qualify for MLP status, a partnership must generate over 90% of its revenues from qualifying sources. MLPs also generally make significant distributions, which makes them an attractive avenue for income-seeking investors.
These are some of the highest distribution yields based on recent quarterly distributions:
- Natural Resource Partner LP (NRP) – coal, distribution yield 18.7%
- Seadrill Partners LLC (SDLP) – offshore drilling, distribution yield 17.3%
- Legacy Reserves LP (LGCY) – oil and gas, distribution yield 21.7%
The Energy Select Sector SPDR ETF (XLE) invests in some of the MLPs in the energy space.
In the next part, we’ll turn to the subject of our series—yieldcos.