A tax break used by oil and gas pipeline companies such as Kinder Morgan Energy Partners LP (KMP) will cost the U.S. government $7 billion through 2016, about four times more than previously estimated, Congress’s tax scorekeepers said this month.
The nonpartisan Joint Committee on Taxation quadrupled its cost estimate for exempting the fast-growing “master limited partnerships” from corporate income tax in the year ended in September to $1.2 billion from $300 million. The annual cost will rise to $1.6 billion by fiscal 2016, the committee said.
The revision reflects the growth of tax-free publicly traded partnerships. They have taken over the U.S. pipeline business and are expanding into the rest of the oil and gas industry, partly by gobbling up dozens of tax-paying companies. With President Barack Obama and congressional Republicans calling for a tax overhaul, the higher cost estimate may make it harder for industry to protect the MLP subsidy, said John Buckley, a tax professor at Georgetown University Law Center.
“A bigger number always means it’s a bigger target,” said Buckley, who as a Democratic congressional aide helped draft the 1987 law that included the partnership exemption.
Canada ended a similar break in 2011, saving an estimated $500 million a year.
Lawmakers led by Senator Chris Coons, a Delaware Democrat, are pursuing a proposal to extend the MLP break to renewable energy companies such as wind and solar-power producers. Proponents in both chambers of Congress introduced bills last year that failed to win passage.
Coons plans to reintroduce the bill in March, said Ian Koski, a spokesman for the senator.
The estimate increased primarily because the latest data show MLP’s are generating more income than before, said Thomas Barthold, the chief of staff of the committee, in an e-mail.
The market value of the MLP industry has grown to about $370 billion, more than double its size as recently as 2009, according to data compiled by Bloomberg. Pretax income for about 90 MLP’s rose to a record $16.9 billion in 2011, Bloomberg News reported last month.
Last year, the committee estimated the cost of the MLP exemption at $1.4 billion for the four years ended in 2015. The new estimate pegs the cost during those same four years at about $5.4 billion.
Today, Linn Energy LLC (LINE), a Houston-based publicly traded partnership that produces oil and gas, said it agreed to buy Berry Petroleum Co. (BRY) for $2.42 billion. It’s the first time a publicly traded partnership has bought a listed oil and gas producer that’s a tax-paying corporation, or “C-Corp,” Linn said in a statement.
The transaction will “demonstrate how much value can be created by tax-efficiently converting a C-Corp with the right assets into an MLP,” said Kolja Rockov, Linn’s chief financial officer, on a conference call.
Berry, based in Denver, set aside $81.3 million for corporate income taxes in the first three quarters of 2012, after recording a $142.2 million tax benefit in 2011 because of a net loss.
MLP’s don’t pay corporate income taxes because they’re structured as partnerships, and they don’t distribute taxable dividends. Individual members pay personal income tax on any profits, offsetting to some extent the government’s loss of revenue.
In 1987, six years after large businesses started forming publicly traded partnerships, Congress passed a law requiring them to pay the same taxes as corporations, a rate that is currently 35 percent.
The law included an exception for industries involving oil and gas and other natural resources. Since then, the pipeline industry has mostly shifted to the partnership structure. Two of the biggest are Houston-based Kinder Morgan, run by billionaire Richard Kinder, and Enterprise Products Partners LP.
The law spurs investment in energy infrastructure that outweighs the cost of the lost tax revenue, said Mary Lyman, the executive director of the National Association of Publicly Traded Partnerships. She said MLP’s that transport and store oil and gas spent $113 billion on capital investment from 2007 to 2012.
“You compare that to even the higher estimate. That seems like a good benefit to cost ratio,” Lyman said.
Corporate tax overhauls outlined by both Obama and Dave Camp, the Republican chairman of the House Ways and Means Committee, would lower the corporate tax rate while eliminating some breaks. Any reduction in the corporate rate would lower the cost of the subsidy for MLP’s, even if their special tax status is left in place, Buckley said.
Investor demand for MLP equity securities, known as partnership units, has led a variety of companies from outside of the pipeline business to convert to the form. New MLPs that went public in the past two years include CVR Partners LP (UAN), which uses refinery byproducts to make fertilizer, and Hi-Crush Partners LP (HCLP), which digs up the sand used in the hydraulic fracturing of oil and gas wells.
Congress expanded the break in 2008 to include companies that transport and store biofuels such as ethanol.