MLPs increasingly popular for service firms

Master limited partnerships in the energy sphere aren’t just for pipeline companies anymore – this corporate structure is now being increasingly used by oilfield services companies to provide more control over investment decisions, according to a Tudor Pickering analyst’s note.

Bermuda-based Seadrill, an offshore deepwater drilling company with a fleet of 66 shallow and deepwater drillships, has been the latest to announce it plans a corporate restructuring for some of its assets.

“Seadrill will initially seek to build the MLP with a combination of deepwater, tender and possible jack-up assets in order to reduce the risk for investors and to increase Seadrill’s flexibility,” the company said in a written statement. “The Board of Seadrill sees the establishment of a MLP as an important step forward in order to lower future financing costs and to increase dividend capacity.”

MLPs trade on a security exchange, but for tax purposes, function like a limited partnership, with taxable income flowing through to individual partners and shareholders, who pay individual taxes rather than state and federal income tax.

Another advantage of MLPs for oilfield services companies, according to Tudor Pickering, is the way they force companies to run a tight ship on investment decisions.

“The structure appeals in a sector that’s often over invested, (with) realized poor returns, as a capital discipline form,” wrote Tudor Pickering in the note. “MLPs pay out most of their cash flow so when they want to grow, they have to come to the market to issue units to finance. This means they have to present a cogent investment case for the expenditures.”

The MLP structure has been designed largely with the energy industry in mind. Its use is limited by the IRS to companies who generate almost all their income from certain kinds of work, which includes the production, processing and transportation of hydrocarbons.

Because of the eligibility requirements and the mandatory distributions, pipeline companies, which have a stable income flow, have been the predominant users of the MLP form in the energy sector.

Whether they can be successfully used by oilfield services companies remains to be seen.  For companies with stable income, MLPs are seen as a relatively cheap form of funding, with two groups of partners – general partners, who manage the company, and limited partners, who are the investors. Investors receive payment through quarterly required distributions.

But fluctuations in income streams could undermine the usefulness of the MLP structure.

“Volatile income streams, shorter term contract durations (if contract coverage exists at all) and capital intensity are all questions around appropriateness of many OFS business models for MLP structure,” wrote Tudor Pickering in the analyst’s note. “But, if valuation uplift is achieved, expect followers.”

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