Last week, the IRS ruled that income from steam crackers — plants that are designed to processing natural gas liquids (NGLs) into chemicals called olefins — qualify for the MLP operating structure. The IRS also said that income from marketing, transporting and storing these olefins qualifies as MLP income.
Olefin and ethane production in the U.S. is expected to surge as current producers have access to huge and cheap reserves brought about by the hydraulic and fracturing revolution. Overall, analysts expect North American olefin manufacturers to generate substantial operating income until significant new NGL cracking capacity is built — probably sometime in 2018.
Betting On The Steam Crackers
So exactly which companies will benefit from the ruling? For starters, look at Williams (NYSE:WMB). Through its Geismar facility, the pipeline firm owns a light-end natural gas liquid (NGL) cracker that currently outputs roughly 1.35 billion pounds of ethylene.
Back in July — well before the IRS’s ruling — Williams agreed to drop down the facility to its MLP subsidiary Williams Partners (NYSE:WPZ). Williams Partners expects that the addition of the olefins unit would be accretive to distributable cash flow as well as bring more stability to those cash flows that are exposed to the market for ethane.
Williams Partners expects to fund the transaction largely with the issuance of more limited-partner units to Williams. WMB currently owns more than 68% percent of WPZ and will grab a bigger share of the MLPs steadily growing distributions as the deal can now legally take place.
Other companies could see similar benefits. New S&P 500 member LyondellBasell Industries (NYSE:LYB) and rival Westlake Chemicals (NYSE:WLK), for example, could see themselves with new MLP subsidiaries soon as well.
LyondellBasell has operations around the world, but its North American olefins unit — buoyed by cheap and abundant shale gas — has continued to see rising operating income. Likewise, Westlake’s largest business segment produces olefins and would likely qualify for an MLP structure given the IRS ruling — reason for investors to continue smiling on the pair.
This doesn’t even include the remaining major chemical players or the big oil producers who own olefin production capacity like Exxon (NYSE:XOM) or Chevron (NYSE:CVX). As we know, many of the larger oil firms have been looking at spin-offs of their refinery operations to unlock shareholder value. The IRS ruling could give them another avenue to pursue.
In the end, while it will take some time for us to see chemical MLPs on the market, the appeal and, now, the legality is there. For income seekers, that’s a win-win.
Ultimately it may not be a win-win should the U.S. follow the path taken by the Canadian govt. re their royalty trusts. As more and more large companies found it feasible to use royalty trust status, the more the govt. felt squeezed by the loss of up-front taxes. So no more royalty trusts.