Last month, I discussed the perennial worries of MLP investors that some day Congress could revoke the preferential tax treatment MLPs enjoy (see As MLPs Test Limits, Trust Inertia.) Quite the opposite has happened in fact, as in recent years case-by-case Internal Revenue Service (IRS) rulings have expanded the range of activities qualifying for the MLP treatment.

But as the number of entities seeking partnership status continued to grow, so did the potential for a government clampdown. In fact, President Obama’s 2016 budget proposal proposes to treat publicly traded partnerships for fossil fuels as C corporations starting in 2021, which the U.S. Treasury claims would save taxpayers $1.7 billion over the next 10 years.

While this proposal is seen as a long shot, last week the Treasury and IRS did propose new rules that rattled some investors in the nontraditional MLPs. (See: Qualifying Income From Activities of Publicly Traded Partnerships With Respect to Minerals or Natural Resources.)

Some paper and packaging companies, including International Paper (NYSE: IP) and Rock-Tenn (NYSE: RKT), had requested an IRS ruling on spinning off their containerboard operations as MLPs. The new IRS rules appear to preclude that, and sent the shares of many containerboard makers lower. The IRS ruled that once chemicals or foreign substances are added to lumber, sawdust, and woodchips to convert them into paper, pulp and plywood, MLP status is no longer an option.

I had discussed the potential for a future unfavorable ruling in recent columns on the IPO for Enviva Partners (NYSE: EVA), which processes wood chips into wood pellets for export. Enviva doesn’t appear to have been affected by the ruling, and its units continue to trade above the IPO price.

Westlake Chemical Partners (NYSE: WLKP), on the other hand, did not fare so well. Westlake manufactures petrochemicals, vinyls, polymers and building products. The partnership went public last summer after requesting and receiving a favorable private-letter ruling from the IRS to the effect that its business constitutes “qualifying income” for MLP status.

But the new IRS rules say that some activities that qualified under previous private letter rulings will no longer do so. The proposal includes a 10-year grace period for partnerships currently reporting qualifying income from activities that would no longer qualify.

In a press release following the release of the proposed new rules, Westlake acknowledged that “such final regulations would make it difficult or impossible for the Partnership’s production, transportation, storage and marketing of ethylene and its co-products to continue to qualify as ‘qualifying income’ after the proposed ten-year transition period.”

Despite the proposed 10-year transition period, WLKP units lost as much as 30% of their value over the next three days:

This ruling was also unwelcome news for other chemical companies, such as Methanex (NASDAQ: MEOH), that had hoped to spin off certain assets as MLPs.

The IRS did indicate that this rule wouldn’t affect the vast majority of MLPs. So for most MLP investors, it’s business as usual for now. We’ll have more analysis of the new proposal in the May issue of MLP Profits.  

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Getting Behind EQT GP Holdings        

EQT GP Holdings (NYSE: EQGP) is making its market debut today after pricing a 23 million unit initial public offering at $27 per unit, well above the estimated $21 to $24 range. EQT GP Holdings is a master limited partnership representing its sponsor EQT’s (NYSE: EQT) interests in EQT’s primary MLP affiliate EQT Midstream (NYSE: EQM).

EQT is a big, low-cost natural gas driller in the sweet spot of the Marcellus shale, and EQT Midstream, as its name suggests, is helping move its parent’s swiftly swelling  gas volumes from wellhead to the processing plant and beyond. As the general partner of one of the fastest growing MLPs and reaper of its incentive distribution rights, EQT GP Holdings offers leveraged exposure to all that growth.

It holds the 2% general partner interest and 30% of the limited partner units in EQT Midstream alongside escalating incentives that, all told, are forecast to double EQGP’s income over the next two years.

Source: EQT GP Holdings prospectus

For insights into the recent business trends at EQT Midstream, see the portfolio update at the bottom of the April 28 MLP Investing Insider. For the importance of the midstream business to its parent, see Uncovering a Hidden Midstream Winner from December recommending the purchase of EQT shares largely on the strength of the embedded midstream value.

As noted at the time, while EQM’s limited partners would see their per-unit distributions double in five years at the present rate of increase, EQGP’s haul would increase 16-fold over the same span.

I could carp here about EQGP’s tiny yield, which at $27 per unit and the promised initial distribution would fall just shy of 1.4%, and drop down to 1.2% or so if the unit price should hit $30 today.

But that would be missing the point. EQGP will be bought not for its income but for the potential capital appreciation tied to growth.  Demand for such new midstream growth vehicles proved resilient even while the rest of the MLP sector went out of fashion amid the oil crash last winter. Based on the track record of similar recent offerings, expect strong first-day gains and further levitation from there.

We’re comfortable enough with this prognosis to recommend buying EQGP before today’s close; we’ll add it to the Aggressive Portfolio at that first closing price, which will also serve as our initial Buy limit. Adding EQGP alongside EQM and EQT increases our exposure to the sponsor, a good thing given EQT’s Marcellus position and value proposition.

 — Igor Greenwald