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Master Limited Partnerships A Primer
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What is an MLP?

• A master limited partnership (MLP) is typicallya
  Delaware limited partnership with limited partner
  interests (called common units or units)
  tradedon a securities exchange (NYSE, Nasdaq, or
  AMEX), just like shares of common stock of a
  corporation
• Some MLPs have been structured as limited
  liability companies (LLCs) rather than
  partnerships they have the same tax advantages
  as a limited partnership but are structured
  differently

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Typical MLP structure (basic)
limited partner interest (common and subordinated
units)
Public Unitholders
Parent/Sponsor Entity
general partner interest and incentive distribut
ion rights
100
limited partner interest (common units)
MLP (Delaware LP)
General Partner (often a Delaware LLC)
100
Operating Subsidiaries (usually LPs or LLCs)
Assets
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What entities are involved in an MLP?

• Parent/sponsor
• Forms the MLP contributes the MLPs intitial
  assets
• Owns the general partner
• General partner (GP)
• Manages operations and activities of the MLP
• Typically wholly-owned by ultimate parent or
  sponsor of MLP
• The officers and directors of the GP typically
  have same authority and functions as the officers
  and directors of a publicly traded corporation

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What entities are involved in an MLP?

• MLP
• The issuer of common units to public investors
• Typically a holding company with no direct
  operating assets or employees
• Employees providing services to the MLP are
  generally employed by the GP, the parent/sponsor
  or an affiliate
• OLP
• Typically a subsidiary of the MLP that owns the
  operating assets

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What entities are involved in an MLP?

• Public limited partners (LPs or Unitholders)
• Public investors who provide capital to the MLP
  in exchange for common units
• No vote on management of the MLP or election of
  GP board of directors other than on extraordinary
  matters
• Receive cash distributions on their common units
  similar to corporate dividends
• Historically, public limited partners were
  retail investors (i.e., individual investors)
  but now certain institutional investors such as
  mutual funds can invest subject to certain
  restrictions

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How are MLPs formed?

• The parent/sponsor forms a limited partnership
  and contributes assets to the MLP in exchange for
  a limited partner interest (common units and
  subordinated units)
• Subordinated units are junior to the common
  units for a certain period of time (the
  subordination period), they receive distributions
  only after the common units have been paid in
  full
• Subordinated units serve as a form of guarantee
  to the public unitholders
• The parent/sponsor also forms, owns and controls
  the GP (and therefore controls the MLP)
• The GP retains a general partner interest
  (typically 1-2) in the MLP
• The MLP then goes public by conducting an IPO
  and issuing common units to the public

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Typical MLP structure (basic)
limited partner interest (common and subordinated
units)
Public Unitholders
Parent/Sponsor Entity
general partner interest and incentive distribut
ion rights
100
limited partner interest (common units)
MLP (Delaware LP)
General Partner (often a Delaware LLC)
100
Operating Subsidiaries (usually LPs or LLCs)
Assets
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What are incentive distribution rights?

• IDRs
• Typically held by the GP or parent/sponsor
• Sometimes referred to as the high splits
• Entitle the holder to an increasing percentage of
  cash distributions as certain thresholds are met
• Incentivize the GP to grow the MLP and manage the
  business efficiently

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What are cash distributions?

• Similar to corporate dividends paid to
  stockholders
• Each quarter the MLP is required (by contract,
  not by law) to distribute to unitholders 100 of
  its available cash
• Available cash is typically defined as cash
  flow minus discretionary reserves
• The MLP promises to pay a minimum quarterly
  distribution each quarter, but the goal is to
  continually increase the quarterly distribution

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What qualifies as an MLP?

• Under the federal tax code, an MLP must receive
  at least 90 of its gross income from qualifying
  sources
• Qualifying income includes income and gains
  derived from the exploration, development, mining
  or production, processing, refining,
  transportation (including pipelines transporting
  gas, oil or products thereof), or the marketing
  of any mineral or natural resource (including
  fertilizer, geothermal energy, and timber).
• MLPs are most commonly involved in natural
  resource extraction, processing and
  transportation and related businesses
• The qualifying income definition was recently
  amended to include income derived from the
  storage and transportation of ethanol and
  biodiesel
• Qualifying natural resource activities generally
  include

• Exploration
• Development
• Mining or production
• Processing

• Refining
• Gathering and transportation
• Marketing
• Storage

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What are the primary advantagesof the MLP
structure?

• Special tax treatment under the tax code An MLP
  is not required to pay corporate income tax (no
  double taxation)
• More cash is available for distribution than is
  available in a traditional corporation
• Provides an MLP with a competitive advantage
  versus a traditional corporation
• The cash distributions to investors are
  generally75-90 tax deferred until the sale of
  the common unit.
• Cash distributions can (and typically do) exceed
  taxable income

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What are the disadvantages of the MLP structure?

• Structural complexity
• An MLP must be vigilant about its qualifying
  income
• MLPs cannot accumulate cash like a corporation
  and, therefore, are dependent on external sources
  of capital to fund growth
• Lack of liquidity (obstacle to institutional
  ownership)
• Some businesses that generate qualifying income
  are better suited to the MLP structure than
  others
• Fee-based businesses (e.g., pipelines) provide a
  more dependable revenue stream than do businesses
  that have commodity price risk, production risk,
  or both

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Structural complexity!
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History of MLPs

• First MLP Apache roll up of private
  partnerships (1981)
• First drop down MLP Transco Exploration
  Partners, Ltd. (July 1983)
• Followed by many (gt25) other oil and gas MLPs
  over the next five years, none of which survived
  depleting asset base and short-lived reserves
  commodity price risk (no hedges available) and
  high leverage
• Timber MLPs followed IP Timberlands, Ltd
  Rayonnier Timberlands, Ltd Mauna Loa Macadamia
  Nut Partners, Ltd Plum Creek Timber
• Other industries began to pursue MLPs
  (amusement parks, fertilizer, barges, chemicals,
  snowmobiles, even professional sports (Boston
  Celtics))
• 1986 federal tax law changes limited the tax
  benefits of the MLP structure to MLPs generating
  qualifying income
• Pipeline MLPs followed Buckeye Partners, L.P.
  (1986) Santa Fe Pacific Pipeline Partners
  (1988) Kaneb Pipeline Partners (1989) TEPPCO
  Products Pipelines (1990) Lakehead Pipeline
  Partners (n/k/a Enbride) (1991) Enron Liquids
  Pipelines (n/k/a Kinder Morgan) (1992) Leviathan
  Gas Pipeline Partners (1993) Northern Border
  Partners (1993)
• Rebirth of EP MLPs Linn Energy, LLC (January
  2006)

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How has the MLP universe grown?

• Since 1995, the MLP universe has grown
  substantially
• In December 1995, the Alerian MLP Index, a
  widely-used MLP price index, had 12 constituent
  MLPs with an aggregate market capitalization of
  approximately 5.6 billion
• In December 2008, the 50 most prominent MLPs
  making up the Alerian MLP Index had an aggregate
  market capitalization of approximately 80
  billion (126 billion as of December 2007)
• The MLP market has attracted attention from all
  the major Wall Street investment banks and an
  increasing number of institutional investors

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MLPs ? At the crossroads?

• The Alerian MLP Index was down more than 36 in
  2008 on a total return basis (vs. 37 for the SP
  500)
• Low correlation to broader market?
• Several MLPs have cut their distributions and/or
  dramatically reduced their capital expenditure
  budgets
• Many MLPs are trading at yields in excess of 20
  (and some have yields in excess of 50)
• An MLPs yield is its current quarterly
  distribution (annualized) divided by the current
  trading price of its common units
• As investors perceive that there is more risk
  associated with an MLP, they drive the price of
  its units down, which causes its yield to
  increase
• During 2007, yields in the 6-8 range were more
  common

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MLPs ? What does the future hold?

• Return to retail / partial retreat by
  institutional investors
• Consolidation in the MLP sector
• MLPs can grow without having to access the
  capital markets by using common units to
  acquire other MLPs
• Some smaller MLPs are trading at very low
  valuations and their limited partners might be
  happy to take the units of a bigger, stronger MLP
  in exchange
• Increasing emphasis on MLPs with significant
  drop-down potential or well capitalized
  sponsors