Statement of the Letitia Chambers, Coalition of Publicly Traded Partnerships,
 and Chambers Associates Incorporated

The Coalition of Publicly Traded Partnerships is pleased that the Subcommittee has provided this opportunity to share its views on tax provisions that affect the production and supply of energy. The Coalition is a trade association representing publicly traded partnerships (PTPs) and those who work with them.

PTPs, also referred to as master limited partnerships or MLPs, are partnerships which are traded on public stock exchanges. They combine the benefits of a partnership investment with the affordability and liquidity of stocks and bonds, and are valued by investors for the income they provide through quarterly cash distributions and the potential for growth in both income and market value.

Publicly traded partnerships are highly relevant to the issues being examined by this Subcommittee because in addition to the benefits they provide investors, PTPs benefit energy consumers by providing an efficient and effective means of channeling needed capital to companies that build, maintain, and operate our nation’s energy infrastructure. About half of all PTPs are in the energy sector, but their importance far exceeds their numbers, for these PTPs represent two-thirds of PTPs’ market capital and close to three-quarters of assets owned by PTPs. However, they are prevented from fully realizing their capital formation potential by a provision--or more specifically, an omission–in the tax code.

Although PTPs, as a liquid security providing a steady income stream, should be an excellent investment for mutual funds, they are not able to access capital from this source because they are not on the tax code’s list of qualifying income sources for mutual funds. The reason they are not on the list is that PTPs did not exist at the time that the mutual fund provisions, including the qualifying income list, were placed in the Code. This means that a mutual fund whose gross income from PTPs and other "nonqualifying" sources exceeds 10% of its total gross income will lose its regulated investment company status under the tax code. Faced with this Draconian possibility and the burden of tracking income percentage, mutual fund managers turn away from PTPs. With only the retail market available to them, PTPs find that raising capital for building energy infrastructure is far more difficult and costly than it should be.

The Publicly Traded Partnership Equity Act (H.R. 1463), sponsored by Rep. Wally Herger and a bipartisan group of cosponsors¹ would rectify this omission by adding income derived from PTPs to the qualifying income list for mutual funds. This change in the tax law would:

• Increase the flow of capital into the energy industry and fund investments in energy infrastructure which supports the U.S. economy as a whole.
• Help lower energy prices for consumers by reducing the cost of capital to energy companies.
• Benefit current PTP unitholders through the increase in value of their units resulting from increased activity in PTP units and greater interest in PTPs by Wall Street analysts and bankers.
• Provide an opportunity for the millions of individuals who invest in mutual funds to participate in an investment that offers very attractive returns.
• Eliminate the artificial constraints of the tax code and place decisions on mutual fund investment in PTPs where they belong--with mutual fund managers

For these reasons, we believe that the provisions of H.R. 1463 should be part of any energy-related tax bill considered by this Subcommittee and by the Ways and Means Committee as a whole.

It is appropriate to consider PTPs in the context of an energy bill, because they began as a way for the energy industry to raise additional capital. The energy industry, like the real estate industry, had always used partnerships as a means of raising equity capital, because partnerships allowed investors more direct participation than the corporate form, not only in the earnings of the business but also in the considerable benefits that the tax code confers on these industries.

The nature of partnership investment in the time before PTPs, however, meant that this form of equity could be raised only from investors in the upper-income tiers, often those seeking a tax shelter. To become a limited partner, it was necessary to invest a very large amount of money--$10,000 to $20,000 at a minimum. Once an investor was in a partnership, it was very hard to get out before the partnership was liquidated, which typically did not occur for a number of years. Many partnership deals did not receive the tough SEC scrutiny that protects investors in publicly traded securities. Thus, limited partnerships appealed only to investors with considerable disposable income and either a high tolerance for risk or a desire to minimize tax liability.

The PTP was the vehicle for addressing these disadvantages of partnerships. Partnership interests were divided into units which were sold at affordable prices and traded on public stock exchanges, providing liquidity for investors who were wary of the long-term required by nontraded partnerships. With public trading of units came the full panoply of regulation that the SEC requires for publicly traded entities--securities registration, proxy statements, 10-K reports, and the like. This allowed energy companies to market partnerships for the first time to middle class investors who were seeking not a tax shelter but an investment that would provide them with a steady cash flow and potential for growth.

The first PTP, an oil company formed in 1981, was Apache Oil Company. Apache was followed by a number of others, as both energy and real estate companies discovered the advantages of this new means of capital formation. PTPs were formed in a number of other industries as well.

In 1987, Congress enacted section 7704 of the tax code, which defined PTPs eligible for partnership tax treatment as those earning their income from natural resource activities, interest, dividends, real estate rents and capital gains, and commodities income. While the growth of new PTPs in other areas has diminished since 1987, PTPs continue to be an important feature of the energy industry, with each year bringing both new partnerships and new equity issues by existing partnerships.

Publicly Traded Partnerships Today

There are currently about fifty PTPs trading on the New York, American, and NASDAQ exchanges, with another in registration. Based on their year 2000 10-Ks, the total market capital of all PTPs is about $19 billion, total assets about $32 billion, and total annual revenue about $39 billion.

About half of these PTPs are in the energy business. For the most part, these are not the old oil and gas partnerships of the eighties, but partnerships which are actively engaged in building and operating the infrastructure that gathers oil and natural gas from underground and offshore sites, processes it into liquified natural gas and petroleum products, stores crude oil, natural gas, and refined products in bulk terminals, and transports them via pipeline and truck to communities throughout the United States. A number of PTPs also deliver propane to industrial and rural customers throughout the United States. In addition, one PTP is involved in coal mining and marketing.

Operating through PTPs works well for these companies because of the good fit between the nature of their businesses and the nature of partnerships. In a partnership, it is particularly important that investors receive regular and substantial cash distributions because of the fact that it is the partners who pay income tax on the partnership earnings. An investment that requires an investor to pay tax on income he doesn’t receive (his allocated share of partnership income) will not do well in the market unless it pays out cash to the investor that comfortably exceeds that tax; therefore, a partnership must own assets that generate a reliable income stream. The energy companies that operate through PTPs meet this test by using the capital raised by issuing equity units to acquire or build assets such as pipelines that will then generate income for several years without much additional investment.

While they constitute about half of the number of PTPs on the market, the energy PTPs overwhelmingly dominate the PTP universe by just about every other measure. They represent about two-thirds of PTP market capital, close to three-fourths of the assets held by PTPs, and nine-tenths of the total income earned by PTPs.

The information in this table was drawn from the Coalition's compilation of 10-K filings for 2000. It does not capture a snapshot of PTP market capital at a fixed point in time, both because 10-Ks usually report market capitalization at the time the report is filed rather than as of the end of the fiscal year, and because some PTPs have fiscal years other than the calendar year and thus filed some months earlier than the others.

However, A.G. Edwards & Co., an active underwriter of energy PTP offerings and the source of several analyses of PTPs operating in the midstream and pipeline energy sectors, recently compiled such a snapshot. They found that as of May 29, 2001, the total combined market capitalization of PTPs is $27.1 billion. The increase relative to the figures in the table is largely due to several offerings that occurred early in 2001, two of which were IPOs and the rest equity offerings by existing PTPs, all in the energy field. Other A.G. Edwards findings include:

• The top 10 PTPs, all in the energy field, currently represent 68% of total market capitalization in PTPs.
• The 12 midstream energy/ pipeline PTPs listed on the New York Stock Exchange:
  • Have enterprise values (market equity plus debt) ranging from $6 billion to $461 million and a combined enterprise value of $22.5 billion.
  • Have combined revenue of over $20 billion.
  • Have a current yield ranging from 5.5% to 10.3%, and an average yield of 7.2%.
  • For the ten that were trading last year (two are 2001 IPOs), the annual growth in distributions ranged from 1.4% to 16.4% , with an average of 5.4%.

The Coalition compilation shows that the annual distributions for these PTPs during calendar year 2000 ranged from $1.84 to $3.50 per unit, with an average of $2.48 (the average for all energy PTPs was $2.00, and for all PTPs was $1.66). For more detail, see Exhibit 1 following this testimony.

These energy partnerships have a substantial presence in energy producing states. In Louisiana, for example, energy PTPs own $1.6 billion in assets or property, plant, and equipment located in the state; employ 1,474 residents; and have an annual in-state payroll of $88 million--and this does not count the three propane PTPs with operations in that state. Louisiana residents own 3.9 million units in these PTPs, valued at $160 million.

Similarly, in Texas energy PTPs own $3.6 billion in assets or property, plant, and equipment located in the state; employ 2,787 residents, and have an annual in-state payroll of $178 million--again not counting the three propane PTPs, as well as one natural gas producer and one crude oil gatherer. Texas residents own units in these PTPs valued at $6.9 billion.

A list of the PTPs operating in the state of each Subcommittee member can be found in Exhibit 2 accompanying this testimony.

The Issue: Lack of Mutual Fund Ownership

At this point you may be asking yourself where the catch is in this rosy picture. The catch is this: these PTPs could be raising substantially more capital, acquiring more assets, building more energy infrastructure, transporting more energy products to the places where they are so urgently needed, than they are at this time. The reason that they have not done so is that they are currently operating with one hand tied behind their backs: they are raising capital with virtually no access to institutional investors. The reasons for this can be found in the tax code. One reason is the unrelated business income tax (UBIT) rules applying to tax-exempt investors such as pension funds. The second, and the one we are asking you to address at this time, is the regulated investment company (RIC) rules, which govern mutual funds.

PTPs don’t have access to mutual funds because they didn’t exist when the mutual fund rules were written. Mutual funds were created to provide individuals with a convenient affordable means of owning a varied portfolio of securities that they would otherwise buy themselves on the market. Thus, the income that a mutual fund could earn and pass through to its investors was limited to that derived from the securities on the market at the time: interest, dividends, payments with respect to securities loans, gains from the sale of securities and foreign currency, etc.

The rule that was written into the Code was that this sort of income must constitute 90 % of the mutual fund’s gross income in order for the mutual fund to qualify as a RIC with passthrough tax status. Partnership income–be it the partnership income allocated to the investor on which the investor pays tax or the cash distribution paid to the partner--is nowhere on the list because, as discussed in the previous section, traditional nontraded partnerships were not the sort of safe, liquid, common securities investment for which mutual funds were created.

PTPs, however, are exactly that sort of investment. Liquid, affordable, and completely SEC regulated, providing a steady stream of income for distribution to mutual fund investors, they are as worthy of qualification under the RIC rules as any other public security.

In other words, PTPs are living under an archaic rule that was written before they existed with a completely different type of partnership in mind. It is long past time for this section of the tax code to be brought into the 21st century.

What is the effect of this rule on PTPs? Quite simply, mutual funds rarely buy their units. If gross income from the PTP, along with any other "nonqualifying" sources exceeds 10% of the fund’s total, the mutual fund will lose its RIC status. This is not a risk that most mutual fund managers want to take. Moreover, they do not want to assume the burden of tracking income percentages to make sure they do not go over the line when they can avoid the whole problem by sticking to stocks and bonds.

As a result, only about 10% of PTP common units examined by A.G. Edwards were owned by institutional investors (exempt organizations and mutual funds), while 55% of the common shares of midstream energy corporations were held by institutions. And this is in a market where mutual funds now account for an estimated 80% share of all equity offerings, where 20% of all market equity is held by mutual funds, and mutual funds have almost $7 trillion in assets under management.

In practical terms, this means that when existing PTPs want to issue equity, or energy businesses want to create new PTPs, in order to finance their plans for acquisition of new assets, broadening their infrastructure, and more efficiently meeting the country’s energy needs, they can do so only to the extent that individual investors are willing and able to buy them. As a result, PTP managers wishing to raise a certain amount of capital must do it in several smaller offerings instead of one large one, increasing the cost of capital, or must assume more debt than they would prefer. They must even check to be sure that none of the other PTPs are planning an offering that is near in time to theirs, because the retail market can only absorb so many PTP units at a time. Needless to say, this hampers, delays, and increases the cost of every major project or acquisition that these companies wish to undertake.

There is no reason for PTP managers to be limited in this way when there is such a need for the energy infrastructure that they could be financing. The Publicly Traded Partnership Equity Act (H.R. 1463) would put an end to this restrictive situation and modernize this bit of the tax code by simply adding income derived from PTPs to the qualifying income list in the RIC rules. H.R. 1463, which has been sponsored in past years by Chairman Thomas, has been introduced this year by Rep. Wally Herger and a bipartisan group of cosponsors. It has been approved by Congress already, as part of the Taxpayer Refund and Relief Act of 1999, which was vetoed by President Clinton.

Enactment of the Publicly Traded Partnership Equity Act would:

• Increase the flow of capital into the energy industry and fund investments in energy infrastructure which supports the U.S. economy as a whole.
• Help lower energy prices for consumer by reducing the cost of capital to energy companies.
• Benefit current PTP unitholders through the increase in value of their units resulting from increased activity in PTP units and greater interest in PTPs by Wall Street analysts and bankers.
• Provide an opportunity for the millions of individuals who invest in mutual funds to participate in an investment that offers very attractive returns.
• Eliminate the artificial constraints of the tax code and place decisions on mutual fund investment in PTPs where they belong--with mutual fund managers.

If this Subcommittee and the Ways and Means Committee as a whole decide that this is an appropriate time to enact tax measures to help address the energy situation, we urge that this provision be included. It is simple, it is noncontroversial, it is low-cost (the Joint Tax Committee estimated its cost as only $170 million over ten years in the 1999 bill), and it does not require any government intervention in the energy industry or the capital markets. It simply gives PTPs the freedom to do more of what they have been doing so well all along--raising capital to build the infrastructure to process, store, and transport the energy products that are critically need to meet our nation’s energy requirements.

1. Reps. Crane, Houghton, Ramstad, Foley, English, Matsui, Neal, and McKeon are original cosponsors; Reps. Hayworth and Cooksey have also signed on.