The US government is frequently caricatured as a tool of rich people. Look closely, though, and the rich sometimes have their money consumed in ways that serve the state. These include maintaining the US position in the global energy balance of power. Consider how the investor class was induced by the favourable tax treatment of master limited partnerships (MLPs) to throw gobs of capital at the shale energy business. Between 2009 and 2014 the market capitalisation of MLPs more than tripled to $500bn as investors hungered for high pre-tax “yields” based on cash flow from hard assets.
No one apart from law firm and investment bank associates could read the K-1 prospectuses that document MLPs. Investors could see pictures of pipelines and complicated processing plants bought with their money after fees and underwriting costs were deducted. Those looked real. In recent weeks much attention has been paid to an arcane change in the Federal Energy Regulatory Commission’s allowed rates of return on regulated pipeline assets.
This has led to a 10 per cent drop in the value of the Alerian MLP index price, and some reasonable comments about how the FERC-related sell-off was overdone. It is true that the FERC action applied only to a few pipeline assets. The sector’s problems, however, started earlier. The deflation of the MLP bubble began close to its peak in 2014 when infrastructure group Kinder Morgan, then industry leader, decided to stop being an MLP and fold itself into a simple corporation. Shortly after this, the Alerian index price peaked. Since then other major MLPs have followed Kinder Morgan.
The decline in MLP prices was a self-reinforcing phenomenon, since the rise in yields meant that the new equity issuance required by the MLP model became too expensive, which led to smaller or more highly leveraged capital spending, and so on. Many investors seem to have thought of MLPs as a way to receive a cash return in excess of bond yields, which would grow as MLP assets increased with investment. This worked to begin with, but the industry became too big for the structure. Since an MLP pays out most of its cash flow after covering debt and maintenance capital expenditure, new money has to be raised for expansion. If MLP economics followed the simple explanation given to retail investors, then the end of capital market access would just mean that MLPs would gradually pay their regular “distributions”, including returns on, and of, capital.