An Opportunity For The Solar Sector: The Master Limited Partnerships Parity Act

Contributors
Written by Marcus McGregor & Eric Gallic
on August 12, 2015 No Comments
Categories : E-Features

On June 24, U.S. Sens. Christopher Coons, D-Del., and Jerry Moran, R-Kan.; U.S. Reps. Ted Poe, R-Texas-02, and Mike Thompson, D-Calif.-05; and their co-sponsors re-introduced legislation to broaden the definition of qualifying income for master limited partnerships (MLPs) to include renewable and alternative sources of energy, such as solar power.

This bipartisan MLP Parity Act (S.B.1656, H.B.2883), originally introduced in early 2013, aims to have the definition of qualifying income for MLPs include renewable and alternative sources of energy such as wind, closed- and open-loop biomass, geothermal, municipal solid waste, hydropower, marine and hydrokinetic energy, and fuel cells.
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One of the key benefits of the MLP structure is that it is a publicly traded partnership combining the tax advantages of a partnership with the capital-raising and liquidity advantages of a publicly traded corporation.

Although a majority of Republicans and Democrats support an ‘all of the above’ energy strategy, the largest component of the MLP universe has historically been MLPs that are focused on midstream oil-and-gas activities (i.e., pipelines). This is because midstream MLPs, with their mature business models that depend largely on long-term take-or-pay contracts for the transportation of hydrocarbons, are able to support the steady stream of cash distributions that income-oriented MLP investors demand.

The MLP Parity Act aims to level the playing field by extending MLP benefits to the alternative energy industry; supporters such as Sen. Coons note that the federal government should not be in the business of picking winners and losers in the energy market.

The act would require a powerful tweak to the federal tax code in that it would expose renewables and alternative sources of energy to significant private capital in the energy market. Note that only the transportation and storage of alternative fuels, such as ethanol and biodiesel, were added to the list of qualifying income in 2008 (more on this below).

Solar companies would benefit from the lack of ‘double taxation’ with the MLP structure because income ‘passes through’ to investors and is taxed at the individual investor level. The resulting lower tax burden means that, for a given level of risk in its underlying assets, operations and financing arrangements, a solar MLP would have a lower cost of capital than would a similar risk under a C-corporation structure.

In essence, a solar business with the MLP structure would have more financial flexibility, which would be supportive of distribution growth to MLP investors.

However, opponents of the MLP Parity Act might argue that this added financial flexibility to support growth may prove difficult for alternatives and renewables because many of the alternative energy technologies considered by the act are far less mature and inherently more risky. However, given inherent geopolitical risks associated with crude oil production, it may prove appealing to MLP investors seeking socially responsible investments.
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The U.S. Energy Information Administration noted in its 2014 annual energy outlook that solar and wind energy are expected to remain the primary sources of renewable capacity growth in the U.S. going forward, given the limitations associated with geothermal, waste and biomass resources.

We believe this will be one of the key investment considerations should the MLP Parity Act make its way into the tax code. Additionally, other attractive factors include the expectation that solar technologies will achieve cost reductions – which, along with a larger resource base, could result in higher growth than other renewables under favorable conditions.

Note that the Internal Revenue Service's definition of allowable income for MLPs has been in existence for decades. Congress, worried that many corporations would convert to MLPs in order to gain access to cheaper capital and avoid corporate taxes, sought to limit conversions by passing legislation in 1987 that prescribed the type of income that a publicly traded partnership could earn while maintaining its pass-through tax status.

Congress' list of allowable or ‘qualifying’ income included dividends, interest, rents, capital gains and income from natural resources-related activity. Originally, ‘natural resources’ meant resources that are depletable under Section 613 of the Federal Tax Code (26 U.S. Code Section 613), such as oil, natural gas, coal and timber.

The MLP Parity Act enjoys bipartisan support, but with broader tax reform remaining an oft talked-about possibility on Capitol Hill and the 2016 presidential election fast approaching, prospects for its passage remain uncertain.

Marcus McGregor is director of investment research and product development for Conning, a global investment management firm based in Hartford, Conn. Eric Gallic is Conning's assistant vice president of investment research and product development.

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