Capturing Higher Distribution Growth in MLPs

There are two types of partners in a Master Limited Partnership structure, a general partner and limited partners.

The general partner manages the master limited partnership and typically holds a 2% economic interest in it. The general partner also receives a percentage of the profits off the top, before the limited partners get their cut. These so called Incentive Distribution Rights allow the general partners to take a higher proportion of incremental amounts over a certain threshold levels. This provides the general partner with a strong motivation to raise distributions to unitholders, which is appealing to them.

The last tier is typically 50/50, which means that general partners receive 50% of any incremental cash flows above a certain threshold level. This could however increase the cost of equity for the MLP and dilute ownership claim of limited partners.

Limited partners are not involved in the day-to-day management of the MLP, and have limited liability. Once the MLPs reach the highest IRD threshold the distribution growth for Limited Partners slows down, while it increases for general partners.

Some MLP's such as Kinder Morgan (KMP), energy Transfer Partners (ETP) and Oneok Partners (OKS) have already reached the top 50% IDR level. Other MLPs such as Entrerprise Products Partners (EPD) have capped their incentive distribution rights threshold to a maximum of 25%. Check my analysis of Kinder Morgan Partners.

One way to capture the higher distribution growth potential is to purchase the General Partner Units traded on US exchanges. Not a lot of GPs are traded however. One general partner that has reached the 50% incentive distribution rights threshold is Energy Transfer Equity (ETE), which is the GP for Energy Transfer Partners (ETP).

Another major General Partner, whose units could be bought by ordinary investors is Enterprise GP Holdings (EPE). It owns the general partner and limited partner interests in Enterprise Products Partners L.P. (EPE), TEPPCO Partners, L.P (TPP) and Energy Transfer Equity, L.P. Check my analysis of Teppco Partners L.P..

Disclosure: Author is long Kinder Morgan Partners

Comments

[William H Jones]

Take ETP/ETE for example... can you enlighten us on how much the distributions to ETP shareholders will slow going forward and in turn how much they will grow for ETE shareholders, since the threshold has been reached? I am trying to wrap my head around this with some concrete numbers...

thanks

2009 May 21 02:29 PM

[thinking ahead]

Some of the stuff in this article looks familiar:

On Apr 07 03:28 PM thinking ahead wrote:

> A tip for fellow MLP holders: once cashflows reach certain thresholds,
> amounts diverted to the GP increase. These are called incentive distribution
> rights (IRD's), and they usually top out at tier 3 - 50%, after 15%
> and 25% steps. Most of the more established MLP's have already reached
> the top 50% IDR level (e.g. KMP, ETP, OKS). EPD is an example of
> a MLP that has a lower IDR threshold - 25% maximum.
>
> Once MLP's reach tier 3, the distribution growth typically slows
> - not stops, just slows - because more of the growth is being sent
> to the GP. It's all a way to incentivize the GP to do a good job
> for the MLP unit holders.
>
> One way to take advantage of this is to buy the GP's. But there are
> far fewer available, because these are the most profitable parts
> of the partnership structure and the smart guys like Kinder and Dan
> Duncan and Lowes like to keep the GP slot for themselves. But there
> are some available. One that has reached the 50% IDR limelight is
> ETE. ETE is the GP for well known ETP. If ETE follows the past pattern
> it should start to boost dividends significantly, while ETP grows
> somewhat slower that in the past. I've left some detail out to keep
> this post short, so do your reading. Disclosure: I own both ETP and
> ETE, along with KMP,BWP and EPD.

2009 May 21 04:37 PM