Investors searching for income-generating investments are finding opportunities in the oil and gas pipelines that crisscross the country.
Many of the pipelines, holding tanks, and other equipment that help get fuel to consumers are owned by firms called master limited partnerships. They typically generate high income and tax benefits for investors because they are required by law to ‘‘pass through’’ much of their income and deductions to shareholders. In return, the partnerships pay no corporate tax.
These partnerships are similar to the more popular real estate investment trusts, but they own energy infrastructure instead of real estate. They trade on exchanges like stocks or exchange-traded funds.
Many financial advisers recommend them because of their high payouts to investors and because many let investors benefit from the booming energy industry without having to worry about oil or gas prices fluctuating. Most pipeline owners charge a set price for delivery that doesn’t change with the price of fuel.
‘‘It’s a great way to invest in this massive resource in the US without the commodity risk,’’ says Ethan Bellamy, a Robert W. Baird & Co. analyst.
An index of the 50 most prominent energy MLPs yields 5.7 percent, according to Alerian, a market research company. The S&P 500 yields 2 percent.
MLPs can hold wells; small pipelines that gather oil and gas from wells and funnel it to processing plants; big interstate pipelines; refineries; and fuel-distribution companies. The most popular, and safest, are so-called ‘‘mid-stream’’ MLPs that focus on delivering energy from place to place, financial advisers say. By avoiding oil and gas drilling and selling refined products, mid-stream MLPs are more insulated from volatile commodity prices.
Investors may soon also get to choose ‘‘green’’ MLPs. There is a bi-partisan movement in Congress supported by both the renewable industry and the oil and gas industry to allow companies to create renewable energy MLPs that include assets such as solar farms, wind farms, and collections of rooftop solar systems.
MLPs have gotten popular in recent years. Interest rates fell to extraordinarily low levels, boosting demand for investments that generate income. And soaring US oil and gas production has filled pipelines and created the need for more of them.
New partnerships have sprung up, and energy companies are spinning off parts of their companies into MLPs. The refiner Marathon Petroleum Corp. created an MLP with 1,800 miles of pipeline called MPLX in October. The partnership’s shares have risen 52 percent since then.
Alerian’s index of MLPs has outperformed the S&P 500 index for 12 of the last 13 years.
That highlights one of the risks of buying MLPs now. Investors are so enthusiastic that they have bid prices up relatively high. Financial advisers say it’s a risk, but it’s the same risk facing just about every income-generating investment, including bonds, dividend stocks, and REITs. If interest rates rise, investors may start to abandon these investments and prices may fall. But the growth of the US energy industry and the need to move that energy around gives advisers confidence these investments can still pay off.
Nathan Kubik, at Carnick & Kubik, a financial advisory firm in Colorado Springs, says investors should pick larger MLPs that cater to a diverse group of oil and gas companies so their payouts are not dependent on the strength of one or two oil and gas drillers. He recommends Kinder Morgan Partners, Williams Partners, and ONEOK Partners. Bellamy says Enterprise Products Partners is also a strong, stable MLP.
MLPs offer big tax advantages — but they can create some big tax headaches. Because MLPs pay no corporate taxes, it leaves them more cash to distribute to investors, but it puts the responsibility for paying tax onto investors. MLP cash distributions come in two categories, each of which is taxed differently.
‘‘For some individual investors, it becomes a tax nightmare,’’ Kubik warns.
Investors can get around the tax headache — but sometimes lose some of the advantages — by owning a mutual fund or an exchange traded fund that invests in MLPs.