Master limited partnerships are the big news in the equity market, but there could be some problems, according to Shannon Nome, Houston-based managing director and lead E&P research analyst for Deutsche Bank.
There are currently six E&P MLPs in the market with some $8- to $9 billion of market capitalization. That has grown from just $6 billion six months ago. "So what could go wrong?" she said at a joint Houston Energy Finance Group and IPAA program recently. The answer: changes in tax laws, interest rates, commodity-price hedging, overly aggressive expansions and an ill-advised rush to acquire assets.
Tax-law changes are a legitimate concern, she said. The chance that Congress will "pull the rug out from under MLPs" and take away the tax advantage is of primary concern to MLPs. However, to some extent, the chance of that happening is mitigated due to the fact that MLPs have been limited to natural resources since 1987, so they do not cause any large tax issues in the U.S.
In Canada, trusts were being formed across all industries, including retail and automotive, increasingly reducing total government tax receipts.
U.S. legislators are aware of the problem the tax-exemption rollback has caused the E&P industry in Canada: a 40% drop in drilling year-on-year. So, it is unlikely they will change tax law on U.S. E&P MLPs.
"I think the biggest risk to the MLP structure is the competition for assets that closes the arbitrage gap," None said. "All the capital that is raised has to chase assets to ensure distributions. Also, the current rush to acquire assets will bid up the price of low-capital-intensive assets, and ultimately drive overly aggressive expansion leading to execution failure, whether that is too much geographic diversity or other causes."
The model upstream MLP, she added, will have an LLC structure with no incentive distribution rights, minimized cost of capital to ensure a long-term sustainable model, low-capital-intensive and long-lived assets, ample drop-down potential from the master partner, adequately hedged commodity risk and low debt.
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