Understanding the Black Swan Theory

The black swan theory, as developed by Nassim Nicholas Taleb, describes rare, high-impact events that are unpredictable and often misunderstood after they occur. These events are surprising and often rationalized with the benefit of hindsight, even though their probability is so low that they are typically beyond the realm of normal expectations in areas such as history, science, finance, and technology. The term itself originates from an ancient belief that all swans were white, a belief that changed when black swans were discovered, teaching a valuable lesson about the limits of human knowledge and prediction.

Taleb’s theory highlights the psychological biases that prevent individuals and societies from fully acknowledging uncertainty. It emphasizes the disproportionate impact that these rare events can have, reshaping our understanding of the world in profound and unexpected ways.

The Role of Master Limited Partnerships (MLPs)

Master Limited Partnerships (MLPs) are a unique financial structure in the U.S., combining the tax advantages of limited partnerships with the liquidity of publicly traded securities. To qualify for tax benefits, MLPs must generate at least 90% of their income from specific sources like the production, processing, and transportation of natural resources. These structures have been popular for energy companies and others involved in depletable resources, offering investors a way to benefit from consistent income distributions while avoiding corporate taxes.

However, MLPs have recently been affected by a major policy shift, making them an example of a black swan event in the financial sector. This unexpected change in how MLPs are allowed to account for income taxes has had a significant impact on their value, causing panic among investors and shifting the landscape for these once stable investment vehicles.

A Black Swan Event for MLP Investors

A major shift occurred on March 15th, 2018, when the Federal Energy Regulatory Commission (FERC) presented a dramatic change in policy that directly impacted MLPs. Historically, MLPs have been able to recover income tax allowances in their cost of service, passing on more pre-tax income to investors. However, a recent court ruling in United Airlines vs. FERC has forced the issue into the spotlight, with the court finding that pipeline operators were effectively receiving a “double recovery” on income tax costs.

As a result, the FERC is considering eliminating this tax allowance, which would require pipeline operators to adjust the rates they charge customers to ship oil, gas, and refined products. This policy change has sent shockwaves through the MLP sector, with companies like Energy Transfer Partners and Williams Companies seeing drastic declines in stock prices. This sudden, unforeseen policy shift is a classic example of a black swan event: an unpredictable and high-impact change that completely alters the dynamics of an investment market.

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