October saw two developments in the expansion of energy master limited partnerships (MLPs) beyond the traditional midstream oil and gas world.

First, Norway-based offshore oil and gas driller Seadrill Ltd., listed on the New York Stock Exchange (NYSE), announced the initial public offering (IPO) of its wholly owned subsidiary Seadrill Partners LLC. Seadrill Partners owns, operates and acquires offshore drilling rigs, which are under long-term contracts with oil majors such as Royal Dutch Shell, BP PLC, ExxonMobil, Chevron and Total. The offering successfully priced at $22, the high end of its expected range, and sold 8.75 million units to generate net proceeds of about $175.5 million. Seadrill Partners' units opened even higher, at $24, in debut trading on the NYSE. All of which is to say that the first driller MLP now exists and investor demand was very high.

The second—and more significant—MLP development occurred October 12 when the Internal Revenue Service (IRS) issued a Private Letter Ruling (PLR), which concluded that income derived from "processing NGLs (natural gas liquids) into olefins" and income derived from "the marketing, transportation and storing of olefins" is considered a qualifying source of revenue for incorporation into an MLP.

The IRS decision applies only to the entity that filed the request, the identity of whom is confidential, and the IRS stipulated that the PLR may not necessarily be used as precedent. However, the decision suggests that the IRS is adopting a liberal approach in its interpretation of what constitutes "pass through" income that can qualify for MLP status.

Shares of U.S. chemical companies jumped by more than 5% the day after the decision was released. The expectation was that the ruling could enable chemical companies to capitalize on the tax efficiencies and lower cost of capital of MLPs by spinning off some of their qualifying assets into new and independently traded MLP vehicles. According to Morgan Stanley, MLPs trade at an approximate 44% premium to C-corporations on an enterprise value-to-EBITDA basis.

If chemical companies are able to form MLPs with some of their assets, what impact would this have on the broader MLP universe, more than half of which consists of exploration and production and midstream partnerships?

The advantages of MLPs could encourage petrochemical companies to build more steam crackers in the U.S., which could drive demand for NGLs. Steam crackers use NGLs, such as ethane, as feedstock to produce ethylene. New steam crackers would be beneficial for the earnings capacity of the MLPs that produce and transport NGLs, as these MLPs suffered from severe liquids pricing weakness in the first two quarters of this year. Per-barrel NGL prices were down approximately $20 per barrel (bbl.) year-over-year in second-quarter and third-quarter 2012.

According to Platts, U.S. ethylene production capacity could expand by 30% or more by 2017, based on recent plans announced by major chemical producers. And new steam crackers could account for as much as 9 million metric tons per year of expanded capacity.

Another possible outcome from the IRS decision is that existing midstream MLPs with NGL services could add chemical production assets to their portfolio. Many of these MLPs have net long exposure to NGL prices, which are not only structurally weak but also difficult to hedge. A petrochemical acquisition for this type of MLP could shift its commodity price exposure from an NGL, such as ethane, to ethylene, the latter of which is expected to remain strong and to be less volatile than the former.

In fact, analysts speculate that the IRS PLR referred to The Williams Cos., which in July announced plans to sell its Geismar, Louisiana, ethylene cracker to its associated MLP, Williams Partners LP, pending regulatory approval. In this way, the stable, fee-based revenues of Williams Partners could be used to counter the volatility of NGL cracking. However, as olefins manufacturing is a cyclical industry, petrochemical MLPs would probably trade at a discount to more traditional energy MLPs, which have more predictable revenues.

During the past several months, this column has focused not only on expansion of traditional energy infrastructure assets housed in the MLP structure—such as pipelines. It has also addressed the creation of new types of MLPs including catalytic cracking and dehydrogenation, water pipeline delivery, crude oil refining and oilfield environmental services. However, there remain numerous practical constraints, apart from satisfying the qualifying income test, which could limit the potential for some non-traditional assets—such as olefins processing—from rotating into the MLP structure.

While the recently issued PLR highlights the growing trend to rotate new types of businesses into the MLP structure, the emergence of new MLPs could bring more volatility to the asset class and greater competition for capital. And, as MLPs distribute all available cash to their unit holders, their management teams must use the public capital markets to fund all growth investments. In other words, the investment community will be more influential in deciding the merits of projects and acquisitions in the domestic energy and petrochemical landscape.

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