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The Black Swan in MLP's

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March 16, 2018

The Black Swan in MLP's

Author: Jeff Ivory

Topics: The Market, Industry Ideas

From Wikipedia, “The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. The term is based on an ancient saying that presumed black swans did not exist – a saying that became reinterpreted to teach a different lesson after black swans were discovered in the wild.”

“The theory was developed by Nassim Nicholas Taleb to explain: The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology. The non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities). The psychological biases that blind people, both individually and collectively, to uncertainty and to a rare event's massive role in historical affairs.”

Which brings us to MLP’s, or Master Limited Partnerships. An MLP is defined as, from Wikipedia, “In the United States, a master limited partnership (MLP) is a limited partnership that is publicly traded, also known as a publicly traded partnership. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. To obtain the tax benefits of a pass through, MLPs must generate at least 90% or more of their income from qualifying sources such as from production, processing, storage, and transportation of depletable natural resources and minerals. In addition, real property rents also qualify.”

To understand how MLP’s are now involved in a “Black Swan” event it is good to refer to Forbes’ article today. From Forbes, “a worse surprise came today (March 15th, 2018), sending MLP investors into a panic. At midday Energy Transfer Partners is down 8.5%, Williams Companies is off nearly 12%, Enbridge down 7% and Enterprise Products Partners down 6%. The Alerian MLP exchange traded fund has shed 7%. The huge moves are the result of this staff presentation today by the Federal Energy Regulatory Commission, which signals dramatic changes ahead in how MLPs are allowed to account for income taxes.”

What happened? Again, from Forbes, “The partnerships (MLP’s) are pass-through entities -- distributing pre-tax income to unit holders, who then are responsible for paying taxes on it according to their individual situations. For more than a decade MLPs have been able, in the FERC's words, "to recover an income tax allowance in their cost of service" -- effectively boosting the amount of pre-tax income to be passed through. That perk is likely over, due to a D.C. circuit court decision in United Airlines vs. FERC, which found a pipeline operator to be enjoying a "double recovery" of income tax costs. FERC says that it will issue a notice of proposed rule making, which will address the impact of eliminating the income tax allowance on interstate pipeline rates. Pipeline operators would presumably have to reduce by the amount of their allowances the rates they charge customers to ship oil, gas and refined products around the country.”

A change in policy, from an entity like the FERC, is effecting the value calculation on MLPs for investors. This is a great example of a “Black Swan” event.

 

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