Master Limited Partnerships: Big Subsidies for Fossil Fuels

Econintersect:  Income hungry investors have been using MLPs (Master Limited Partnerships) as vehicles to get higher returns on their savings.  Examples of such investments are Kinder Morgan Energy Partners (NYSE:KMP) which yields 6.1%, Energy Transfer Partners (NYSE:ETP) yielding 6.9% and Enterprise Products Partners (NYSE:EPD), 4.3% yield.  A new report charges that these benefits for investors come at a big government subsidy cost.

Picture from Energy Transfer Partners website.

Before going to the report, the operation of master limited partnerships should be summarized.  Investors benefit from more than just the high dividend payout; the tax treatment of the payout creates additional advantage.  Part of each dividend is treated as return of capital through assignment to the limited partner investor of equipment depreciation.  This has the added benefit of converting part of the tax liability for the investor to a deferred long-term capital gain realized when the partnership is dissolved or the MLP shares are sold on the secondary market.  For high income investors the tax-deferral can be a very important feature.

More information on master limited partnerships is available at Wikipedia.

The loss of tax revenue that might otherwise be collected is not the only consideration in this situation.  Another, and possibly even more important factor, is the financial impediment for development of alternative energy technologies that do not receive this type of subsidy.  Here is an excerpt from the conclusion section of the executive summary for the report:

Special legislative provisions have allowed a select group of industries to operate as tax-favored publicly-traded partnerships more than 25 years after Congress stripped eligibility for most sectors of the economy. These firms, organized as Master Limited Partnerships, are heavily concentrated in the oil and gas industry. Selective access to valuable tax preferences distorts energy markets and creates impediments for substitute, non-fossil, forms of power, heating, and transport fuels.

Financial innovations, combined with statutory changes and regulatory rulings from the IRS have gradually expanded and routinized the conversion of tax-paying corporate assets into tax-favored MLPs. The pace of growth has been accelerating in recent years, reaching about $385 billion in fossil-fuel assets that are exempt from corporate income taxes as of the end of March 2013. Strong investor demand for MLP units, coupled with surging new investment into fracking-related oil and gas projects and a large amount of existing oil and gas assets still held as tax-paying C-corporations all indicate large scale growth in tax-favored oil and gas assets is likely in the near term.

The research reported that the federal estimates of the size of the tax advantage are substantially too small:

This review also suggests that the official estimates of revenue losses may be understating the actual tax cost of fossil fuel MLPs by billions of dollars per year; losses over the 2009 to 2012 period for which we have data may have been as high as $13.6 billion, more than six times federal estimates for the same period.

In the grand scheme of things the $4 billion a year subsidy is actually a pittance, per the following excerpt from Wikipedia:

The global fossil fuel subsidies were $523 billion and renewable energy subsidies $88 billion in 2011.^[1] According to Fatih Birol, Chief Economist at the International Energy Agency without a phasing out of fossil fuel subsidies, we will not reach our climate targets.^[2]

Editorial comment: Oh, the wonders of the free market!

John Lounsbury

Hat tip to Roger Erickson.

Sources:

• Too Big to Ignore:  Subsidies to Fossil Fual Master Limited Partnerships (Doug Koplow, Executive Summary, Earth Track, July 2013)
  

• New report exposes billions per year in additional fossil fuel subsidies (David Turnbull, Oil Change International, 22 July 2013)

• Master limited partnership (Wikipedia)

• Energy Subsidies (Wikipedia)