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The Pros and Cons of MLPs – And Three Potential Plays

One of the most rewarding ways to invest in the oil and gas industry is through master limited partnerships (MLPs).

But not every investor has a thorough understanding of what exactly an MLP is, or how it works.

So allow me to explain…

Let There Be MLPs

Originally approved by Congress back in 1986, MLPs were created as a way to goose the market for domestic energy production by offering some very attractive incentives to the companies, and their investors, to build out our internal energy infrastructure.

Though interest faded out after the go-go 80s, MLPS are now back on investors’ radar. And for good reason.

In an age of practically zero-percent interest rates– and more Americans worrying about the tax bite taken by the government every April – MLPs are back in fashion.

See, to spur investment in the energy markets, MLPs get special tax treatment – they pay no income taxes, but in return, they must pass at least 90% of all revenue on to unit holders.

And MLPs can pay out extraordinary income.

In fact, of the 83 listed MLPs in the oil and gas market, 14 pay out more than 10%.

And the top MLPs in the market right now pay out more than 20%.

Those are some pretty sweet returns.

And as an investor in an MLP, you get some pretty sweet tax treatment yourself.

The Taxman Cometh

Because of the way the laws are structured, the money paid out to investors is considered “return of capital” rather than capital gains. So, until you make back your initial investment, the money you receive from the MLP is tax-free.

Of course, there are some complications, but for a potential 20% per year, they may be worth it.

Take tax filing, for instance.

When you own stock, you’re just a shareholder in the company. But with an MLP, you’re considered a partner. Therefore, at the end of the year, you’ll receive a K-1 tax form, instead of a regular 1099. It’s a small inconvenience, but one some would rather avoid.

Still, if a little extra paperwork doesn’t bother you, here are some MLPs to consider…

Three Moneymaking MLPs

As I mentioned earlier, you have a number of choices – 83 listed MLPs in the oil and gas sector.

And those 83 break down into different subcategories – upstream (explorers and producers), midstream (pipelines and transportation) and downstream (refiners and sellers of end product).

One of the highest-yielding MLPs is CVR Refining LP (CVRR) – a refiner that yields a sweet 20.53%.

Based in Sugar Land, Texas, CVRR owns and operates a 115,000-barrel-per-day (bpd) refinery in Coffeyville, Kansas and a 70,000-bpd refinery in Wynnewood, Oklahoma.

It also controls and operates supporting infrastructure, including approximately 350 miles of pipeline, over 125 crude oil transports, a network of strategically located gathering tank farms, and over six million barrels of owned and leased storage capacity.

CVRR was spun off of CVR Energy (CVI) to handle its refinery and storage operations. So it’s relatively new to the market, having listed in January of this year.

You might also look at Eagle Rock Energy Partners (EROC), which pays out an enviable 13.8% yield.

Eagle Rock specializes in the gathering, compressing, treating, processing, and transporting of natural gas and natural gas liquids.

It also trades natural gas on the open market and develops interests in producing oil and gas properties.

And finally, there’s Kinder Morgan Energy Partners LP (KMP) – a household name in the energy markets.

KMP concentrates its operations in five different business segments: oil products pipelines, natural gas pipelines, carbon dioxide, storage terminals and Kinder Morgan Canada.

The company has also been active in accumulating additional assets, including the Tennessee Gas Pipeline and a 50% interest in the El Paso Natural Gas Pipeline.

Though shares have been trading flat for the past 52 weeks, KMP sports a decent yield of almost 7%.

So, there are three energy MLPs to consider for your portfolio. Each has a different specialty, and each comes with some nice returns and tax advantages.

Of course, there’s a simpler way to gain exposure to the MLP market…

But you have to be careful how you play it.

We’ll discuss the possibilities in my next article.

And “the chase” continues,

Tim Diering