Leveling the Playing Field: The Case for Master Limited Partnerships for Renewables

Leveling the Playing Field: The Case for Master LiTwo essential objectives are required to spur investment in energy, or most any other venture: the mobilization of capital and the reduction of risk. Utilizing markets and policies by extending Master Limited Partnership (MLP) status to renewable energy investments can help achieve both of these goals.

MLPs offer individual investors a tax-advantaged and relatively predictable investment. For companies seeking capital, the MLP structure offers financial, economic and legal benefits that have been shown to attract capital. In the years that MLPs have been present in the energy sector, this vehicle has attracted significant investment capital. In 1996, there were 12 publicly traded MLPs with a market capitalization of approximately $8 billion. As of January 2011, there were about 75 publicly traded MLPs representing over $270 billion in market capitalization, a compounded annual growth rate of 20 percent. Further, the proportion of MLPs focused on the energy sector has grown significantly. In 1990, a little over a third of all MLPs were energy focused.

Today, that figure stands at 80 percent. According to our financial modeling, expanding the MLP structure to renewables could result in an additional $3.2 billion to $5.6 billion capital inflow into the industry between now and 2021, depending upon economic and market conditions.

However, the renewable energy sector has been largely excluded from these benefits. Expanding MLPs to include renewable energy sources could attract capital to the sector, reduce the risk of investments, impose some market discipline on the players, and offer a way to grow a sector of the economy that will be important in meeting America’s future energy needs.

Background

Master limited partnerships began to appear in the 1980s as a result of the Tax Reform Act of 1986 (TRA) and the Revenue Act of 1987 (IRC). The TRA created tax-free publicly traded partnerships. As a result of lower marginal individual income tax rates under TRA, the partnership business structure became more attractive in relation to the corporate business structure, which had a higher marginal tax rate.

IRC required that these structures generate at least 90 percent of their income from qualified sources such as real estate or natural resources. Section 613 of the Federal Tax Code defines qualified sources as crude oil, natural gas, petroleum products, coal, other minerals, timber and any other depletable resource. In 2008, the list was broadened to include carbon dioxide, ethanol and biodiesel. Activities that can be used to generate income include exploration and production, mining, gathering and processing, refining, transportation, storage, marketing and distribution.

Most MLPs operate in the energy sector, especially midstream activities including pipelines, gathering systems, processing systems and storage facilities. Today, 80 percent of the roughly 75 publicly traded MLPs earn their income from natural resources.