US olefins may see tax breaks in master limited partnerships

By Joseph Chang

NEW YORK (ICIS)–As if US petrochemical producers needed yet another incentive to build ethane crackers, it got just that from the Internal Revenue Service (IRS) tax authority.

On 12 October, the IRS issued a Private Letter Ruling in response to an unnamed company called “X”, concluding that “income derived by X from processing NGLs [natural gas liquids] into olefins will constitute qualifying income within the meaning of [the Master Limited Partnership structure]”.

“We further conclude that income derived by X from marketing, transporting and storing olefins will constitute qualifying income within the meaning of [the MLP structure]”, the IRS said.

Businesses engaged in the production and transportation of US natural resources such as oil and gas as well as fertilizers can qualify for an MLP structure.

Current MLPs include Calumet Specialty Products Partners, Enterprise Products Partners, PetroLogistics LP and Sunoco Logistics Partners.

The IRS ruling opens the door to petrochemical companies potentially “dropping US ethylene production assets into MLPs”, which would have significant tax benefits, said Deutsche Bank’s chemical analyst David Begleiter.

He estimates the potential tax benefit to LyondellBasell at around $700m (€539m) of earnings before interest, tax, depreciation and amortisation (EBITDA) in 2013, or $1.25/share. For Westlake the benefit would be around $200m (€154m) in EBITDA or $2.97/share and for Dow Chemical $550m in EBITDA or 47 cents/share.

Shares of US commodity chemical companies jumped this week on the back of the ruling. On 16 October, shares of LyondellBasell surged 5.7%, and on 17 October they powered ahead another 2.5% to a new all-time high of $55.74.

However, some Wall Street analysts contend the overall rally was an overreaction.

“Shares in US petrochemical producers rallied 5-8% [on 16 October] on optimism that the IRS could allow MLP structures for olefin producers and possibly even extend the same principles to other commodity chemicals,” said Laurence Alexander, analyst with US-based investment bank Jefferies & Co.

“Barring specifics on potential deal structures and acceptable assets, this could well prove aggressive discounting,” he added.

Alexander said it could take two to three years for companies to find ways to navigate an MLP carve-out process, “particularly if they wait for clarity as to the degree to which the IRS allows chemical firms to explore putting vertically integrated assets into an MLP”.

Frank Mitsch, analyst with US-based investment bank Wells Fargo, also suggests a lengthy process for putting existing assets into an MLP.

“Although the IRS Private Letter Ruling … does present some interesting structural options, it by no means is a law or sets precedence given its fact- and company-specific nature,” said Mitsch.

“We believe undertaking an MLP classification is a highly complicated and time-consuming process – one which needs to be examined carefully to determine value creation for all interested shareholders,” he added.

While carving out existing assets into an MLP could be quite complicated, putting a new asset – such as an ethane cracker – into such as structure may be less so. This could present a lower cost way to fund new projects, said Jefferies’ Alexander.

“A more likely alternative, in our view, is for companies to explore MLP structures for new US ethylene crackers, which would represent a much lower cost of funding, due to investor appetite for yield,” he said.

Publicly-traded MLPs typically provide higher income yields than publicly-traded stocks because of their advantaged tax structure.

An MLP is required to “pay out all earnings not needed for current operations and maintenance of capital assets to their unit holders in the form of quarterly cash distributions”, according to the National Association of Publicly Traded Partnerships.

The fact that investors place higher valuations on publicly-traded MLPs than their commodity chemical counterparts means financing through an MLP structure for such projects could make sense.

Alexander points out that the benchmark Cushing MLP 30 Index currently trades at about 10.8 times estimated 2013 EBITDA versus an average of 5.8 times EBITDA for commodity chemical companies.

The analyst asks an intriguing question: “Could the IRS extend the MLP structure to cover other commodity chemical producers – [such as] ethanol, methanol or acetic acid?”

($1 = €0.77)