THE ENERGY MLP GOES INSTITUTIONAL: IMPLICATIONS FOR STRATEGY AND GOVERNANCE

Abstract

Master limited partnerships (MLPs) were popular in the 1980s because of the favorable tax treatment of their cash distributions. But since the Revenue Act of 1987, which imited the lines of business and income sources for which this tax treatment was available, virtually all remaining public MLPs have been in natural resource businesses.Institutional investors have traditionally avoided investing in master limited partnerships because any cash distributions must be treated as unrelated business income, creating an immediate tax liability. But in an innovative underwriting in May 001, Goldman Sachs offered shares in a limited liability company that would pay stock dividends equivalent to the cash distributions on its proportional ownership interest in Kinder Morgan Energy Partners, a pipeline operator. In effect, this structure allows tax‐exempt investors (institutions) to own an interest in Kinder Morgan Energy Partners without triggering unrelated business taxable income.An interesting aspect of this recent development is that while the MLP was originally viewed as a vehicle for slow‐growth firms to distribute cash and wind down operations, the “institutional” MLP could be used to facilitate growth by attracting needed investment to businesses currently housed in MLP form—typically energy transportation and storage infrastructure businesses (so‐called “mid‐stream” energy assets). The new structure raises some potential corporate governance challenges in that it is highly complex and offers investors only limited control rights. But the authors' conclusion is that the institutional MLP is likely to be a successful financing innovation whose tax‐favored status and extensive public disclosure will outweigh any governance concerns.