WF MLP Primer IV

November 19, 2010
Equity Research
MLP Primer -- Fourth Edition
Everything You Wanted To Know About MLPs, But Were Afraid To Ask Primer Fourth Edition - A Framework For Investment. This report is an update to our previous MLP Primer (third edition) published in July 2008. The purpose of this reference guide is to familiarize investors with the Master Limited Partnership (MLP) investment. In this fourth edition, we have included some new information based on questions and feedback we have received from investors over the past couple of years. In addition, we have added and updated sections detailing topical issues and developments related to the MLP sector.
Master Limited Partnerships
Michael Blum, Senior Analyst ( 21 2 ) 2 1 4 -5 0 3 7 mi chae l. blum @wa c ho vi a. co m Sharon Lui, CPA, Senior Analyst ( 21 2 ) 2 1 4 -5 0 3 5 sha r on.lu i@ w achovi a. co m Eric Shiu, Associate Analyst ( 21 2 ) 2 1 4 -5 0 3 8 e ri c. s h iu @ w a c ho via . co m Praneeth Satish, Associate Analyst ( 21 2 ) 2 1 4 -8 0 5 6 pran e et h. s ati s h@ wa cho vi a. c om Hays Mabry, Associate Analyst ( 21 2 ) 2 1 4 -8 0 21 ha y s .m a b r y@ wa c ho vi a. co m Ronald Londe, Senior Analyst ( 3 1 4 ) 95 5 - 3 8 2 9 ro n .lo n d e@ wa c ho via . co m Jeffrey Morgan, CFA, Associate Analyst ( 31 4 ) 955 - 65 58 je ff .m o rgan @ wa c ho vi a. co m
Please see page 149 for rating definitions, important disclosures and required analyst certifications
Wells Fargo Securities, LLC does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision. MLPART111910-225541
WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT
Table Of Contents
I. Introduction ........................................................................................................................... 7 II. Why Own MLPs?..................................................................................................................... 7
A. B. C. D. E. F. G. H. I. J. A. B. C. MLP Total Return Value Proposition .....................................................................................................................................7 Attractive Yield ....................................................................................................................................................................... 8 Strong Performance Track Record......................................................................................................................................... 8 Tax Advantages ....................................................................................................................................................................... 9 Portfolio Diversification ........................................................................................................................................................ 9 A Lower Risk (Beta) Way To Invest In Energy.....................................................................................................................10 An Effective Hedge Against Inflation....................................................................................................................................10 Estate Planning Tool.............................................................................................................................................................. 11 Demographics ........................................................................................................................................................................ 11 Resilient Business Model During Periods Of Economic Weakness.....................................................................................12 Mutual Funds Can Own MLPs ..............................................................................................................................................13 Challenges Remain For Mutual Fund Ownership Of MLPs ................................................................................................13 Timing Issues .....................................................................................................................................................................13 State Filing Requirements .................................................................................................................................................13 Tax-Exempt Vehicles Should Be Cautious In Owning MLPs...............................................................................................13
III. Who Can Own MLPs?............................................................................................................ 12
IV. Risks To Owning MLPs ......................................................................................................... 13 V. How To Build An Effective MLP Portfolio ............................................................................. 14
A. B. C. D. A. Balance Risk And Growth......................................................................................................................................................14 Diversify Among MLP Sectors ..............................................................................................................................................14 Anchor Tenants ..................................................................................................................................................................15 Invest With Top Management...............................................................................................................................................15
VI. The Basics............................................................................................................................. 15

What Is An MLP?...................................................................................................................................................................15 Who Are The Owners Of The MLP? ..................................................................................................................................15 B. What Qualifies As An MLP? ..................................................................................................................................................15 C. What Are The Advantages Of The MLP Structure?..............................................................................................................16 D. How Many MLPs Are There? ................................................................................................................................................16 E. What Is The K-1 Statement?.................................................................................................................................................. 17 F. What Is The Difference Between An LLC And An MLP? ..................................................................................................... 17 G. Are MLPs The Same As U.S. Royalty Trusts? Canadian Royalty Trusts? .......................................................................... 17 H. What Are I-Shares?................................................................................................................................................................18 The I-Share Discount .........................................................................................................................................................18 What Are The Tax Consequences Of Owning I-Shares? ..................................................................................................19 I. Why Create An MLP? ............................................................................................................................................................19 A Premium Valuation ........................................................................................................................................................19 A Tax-Advantaged Structure With Which To Pursue Growth Opportunities .................................................................19 The Ability To Maintain Control Of The Assets (Via The GP Interest) ...........................................................................19 Incentive Distribution Rights (IDR) .................................................................................................................................19
VII. Key Terms ........................................................................................................................... 20

A. B. C. D. E. F. G. A. B. C. D. E. What Are Distributions?....................................................................................................................................................... 20 What Are Incentive Distribution Rights (IDR)?.................................................................................................................. 20 Calculating Incentive Distribution Payments...................................................................................................................... 20 What Is The Difference Between Available Cash Flow Versus Distributable Cash Flow?..................................................21 Are MLPs Required To Pay Out All Their Cash Flow?......................................................................................................21 What Is The Distribution Coverage Ratio And Why Is It So Important?............................................................................21 What Is The Difference Between Maintenance Capex And Growth Capex? ...................................................................... 22 Distribution Growth ............................................................................................................................................................. 23 Access To Capital .................................................................................................................................................................. 23 Commodity Prices................................................................................................................................................................. 24 Credit Spreads....................................................................................................................................................................... 24 Interest Rates ........................................................................................................................................................................ 25
VIII. Drivers Of Performance........................................................................................................23
Master Limited Partnerships F. G.
Economic Activity (GDP Growth) ........................................................................................................................................ 26 MLP Fund Flows And Liquidity ........................................................................................................................................... 26
IX. How Did MLPs Fair During The Credit Crisis? ...................................................................... 27 X. Tax And Legislative Issues ....................................................................................................30
A. B. C. D. E. F. G. H. I. J. Who Pays Taxes .................................................................................................................................................................... 30 What Are The Tax Advantages For The LP Unitholder (The Investor)? ............................................................................ 30 Some Tax Considerations And Disadvantages For The LP Unitholder...............................................................................31 The Mechanics Of A Purchase And Sale Of MLP Units And The Tax Consequences ........................................................ 32 Return Of Capital Versus Return On Capital....................................................................................................................... 33 Foreign Investor Ownership ................................................................................................................................................ 34 Treatment Of Short Sales ..................................................................................................................................................... 34 Can MLPs Be Held In An IRA? ............................................................................................................................................ 34 MLPs As An Estate Tax Planning Tool ................................................................................................................................ 35 Current Tax And Legislative Issues...................................................................................................................................... 36 What Is The National Association Of Publicly Traded Partnerships (NAPTP)? ............................................................ 36 What Is The Risk Of MLPs Losing Their Tax-Advantaged Status ................................................................................. 36 Canadian Royalty Trusts Tax Status Still On Track To Change In 2011 ......................................................................... 37 Public MLP Unitholders Unlikely To Be Affected By Carried Interest Legislation........................................................ 37 MLPs Included In FERC Process For Determining Pipeline ROEs ............................................................................... 37 MLPs Income Tax Allowance In Pipeline Ratemaking ................................................................................................... 38 How Can MLPs Pay Out More Than They Earn? ................................................................................................................ 38 Mark-To-Market Hedge Accounting.................................................................................................................................... 39 Hedge Accounting................................................................................................................................................................. 40 Partners Capital -- Implications For Debt-To-Capital Ratio .............................................................................................. 40
XI. MLP Accounting Nuances .....................................................................................................38

A. B. C. D. A.
XII. Sector Trends ...................................................................................................................... 40

Dramatic Growth Of MLP Sector ......................................................................................................................................... 40 MLP Average Trading Volume Continues To Grow ........................................................................................................41 B. MLP Investor Base Has Been Evolving.................................................................................................................................41 Institutional Investor Interest Growing........................................................................................................................... 42 C. Shift In Supply Resources Is Driving Energy Infrastructure Investment .......................................................................... 42 Natural Gas........................................................................................................................................................................ 43 Natural Gas Liquids .......................................................................................................................................................... 47 Crude Oil ........................................................................................................................................................................... 50 Renewable Energy............................................................................................................................................................. 53 D. Acquisition Capital Deployed Has Been Steadily Rising..................................................................................................... 54 E. MLPs Continue To Enjoy Access To Capital Markets ......................................................................................................... 56 F. MLPs Have Employed Creative Financing Solutions To Fund Growth ..............................................................................57 PIPEs (Private Investments In Public Equity)..................................................................................................................57 Hybrid Securities .............................................................................................................................................................. 58 Convertible Preferred Equity............................................................................................................................................ 58 Paid-In-Kind (PIK) Equity ............................................................................................................................................... 59 G. Publicly Traded General Partners Recognizing The Value Of The GP............................................................................ 59 What Makes The GP So Valuable? ................................................................................................................................... 59 Power Of The IDRs ........................................................................................................................................................... 60 The Multiplier ................................................................................................................................................................... 60 The Power Of Equity Issuance...........................................................................................................................................61 A Brief History Of GPs ...................................................................................................................................................... 63 Pure-Play GPs Are IPOd As Stand-Alone Entities .......................................................................................................... 64 Cost Of Capital Drives GP Transactions........................................................................................................................... 65 Cost-Of-Capital Considerations Driving GP Elimination Transactions ......................................................................... 65 Recent GP Transactions Could Be Also Be Motivated By Potential Carried Interest Legislation ................................. 67 Owning The GPs Better Aligns Investors With Management ......................................................................................... 67 GP Subsidies...................................................................................................................................................................... 68 IDR Reset Option Enables Management To Better Control Cost Of Capital ................................................................. 68 General Partner Nuances Not All GPs Are Created Equally ........................................................................................ 68 Is It Better To Own The GP Or Underlying MLP? ........................................................................................................... 69 GP/LP Conflicts Of Interest.............................................................................................................................................. 70 The MLP And GP Growth Rates Should Converge Over Time ........................................................................................ 71
H. Understand An MLPs Cost Of Capital ................................................................................................................................ 72 There Are Three Components To An MLPs Cost Of Capital .......................................................................................... 73 Incentive Distribution Rights Increase Cost Of Capital .................................................................................................. 73 CAPM Understates The Cost Of Equity ........................................................................................................................... 74 Is An MLPs Cost-Of-Capital Advantage Overstated? Yes And No ................................................................................. 74 I. Upstream MLPs .....................................................................................................................................................................75 Return Of Upstream MLPs ................................................................................................................................................75 Upstream MLPs Failed In The 1980s. Why? ....................................................................................................................75 What Should Be The Criteria To Invest Today? ...............................................................................................................75 Upstream MLPs Are Faced With Unique Challenges And Risks .....................................................................................75 J. Emergence Of MLP Products ............................................................................................................................................... 76 MLP Indices ...................................................................................................................................................................... 76 The Wells Fargo Securities MLP Index............................................................................................................................ 76 Financial Products Facilitate Participation In MLPs .......................................................................................................77 MLP Closed-End Funds (CEFs) Proliferate ..................................................................................................................... 78 MLP Exchange Traded Notes (ETNs) .............................................................................................................................. 79 Exchange-Traded Fund Alerian MLP ETF ...................................................................................................................80 Open-End Funds The SteelPath MLP Funds Trust .....................................................................................................80 Options ...............................................................................................................................................................................81 Total Return Swaps ...........................................................................................................................................................81 Credit Default Swaps .........................................................................................................................................................81
XIII. Valuation Of MLPs................................................................................................................82

A. B. C. D. E. A. B. C. D. E. F. G. H. I. J. K. L. Distribution Yield ................................................................................................................................................................. 82 Three-Stage Distribution (Dividend) Discount Model........................................................................................................ 82 Price-To-Distributable Cash Flow........................................................................................................................................ 83 Enterprise Value-To-Adjusted EBITDA .............................................................................................................................. 83 Spread Versus 10-Year Treasury .......................................................................................................................................... 83 A Brief Review Of The Evolution Of The MLP Sector ......................................................................................................... 84 Asset Overview Relative MLP Distribution Security ....................................................................................................... 84 The Natural Gas Value Chain ............................................................................................................................................... 86 The NGL Value Chain ........................................................................................................................................................... 94 The Crude / Petroleum Products Value Chain ...................................................................................................................105 Propane ............................................................................................................................................................................... 109 Marine Transportation .........................................................................................................................................................111 Coal....................................................................................................................................................................................... 114 Upstream (E&P)................................................................................................................................................................... 115 Refining................................................................................................................................................................................ 116 Asphalt ................................................................................................................................................................................. 116 Liquefied Natural Gas.......................................................................................................................................................... 117
XIV. Types Of Assets In Energy MLPs And Associated Commodity Exposure ................................84
Appendix...........................................................................................................................................119
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I.
Introduction -- A Framework For Investment
This report is an update to our previous MLP Primer (third edition) published in July 2008. The purpose of this reference guide is to familiarize investors with the Master Limited Partnership (MLP) investment. In this fourth edition, we have included some new information based on questions and feedback we have received from investors over the past couple of years. In addition, we have added and updated sections detailing topical issues and developments related to the MLP sector. As always, feel free to contact us with any questions or feedback.
II.
Why Own MLPs?
Since the publication of our last primer, the total market capitalization of MLPs has increased to $220 billion from $134 billion in July 2008 despite a decline in the number of publicly traded MLPs to 72 from 78 (primarily due to consolidation and ongoing private transactions). Although the size of the asset class, in terms of market capitalization, has grown approximately 146% over the past two years, we suspect that energy MLPs are still relatively under-owned in comparison to other asset classes. There are several reasons investors should consider owning MLPs as part of an overall investment portfolio, in our view. These include the following: 1. 2. 3. 4. 5. 6. 7. 8. 9. MLP Total Return Value Proposition Attractive Yield Strong Performance Track Record Tax Advantages Portfolio Diversification A Lower Risk (Beta) Way to Invest In Energy An Effective Hedge Against Inflation Estate Planning Tool Demographics
10. Resilient Business Model During Periods Of Economic Weakness
A. MLP Total Return Value Proposition

MLPs are well positioned to generate high-single-digit to low-double-digit total returns over time consisting of a tax-advantaged 6-8% yield and annual distribution growth of 3-5%. We view MLP yields as secure and nearterm distribution growth as highly visible. Our growth forecast is underpinned by a relatively healthy fundamental environment and the continued need for additional infrastructure investment to support shale play development (for both oil and natural gas), strong demand for NGLs by the petrochemical sector, and opportunities to build and expand storage to address supply and demand imbalances and support the development of renewable fuels. Figure 1. MLP Value Proposition
11.7%
5.3%
6.4%
Current Yield
3-Year Distribution Growth Estimate
Total Return Potential
Source: Wells Fargo Securities, LLC
B. Attractive Yield
Given the uncertain global economic outlook, a low interest rate environment, and continued market volatility in 2010, MLPs have been attracting incremental capital as investors focus on income-oriented securities. MLPs provide yields ranging from 5% to 10% with the potential for distribution growth of 3-5%. The groups yield compares favorably to other income-oriented investments on a risk-adjusted basis, in our view. Figure 2. MLP Yield Versus Other Yield Investments
9% 7.1% Current Yield (%) 6.3% 6% 6.0% 4.9% 4.7% 4.4% 2.8% 1.9%
3%
0% ML U.S. B-BB High Yield Wells Fargo Securities MLP Index Moody's BAA Moody's (Investment Municipal Grade) Index Bond Index FTSE NAREIT Index S&P 500 Utilities Index U.S. 10-Year Treasury S&P 500
Note: Wells Fargo Securities MLP Index yield is based on float-adjusted market capitalization Source: Bloomberg, FactSet, and Wells Fargo Securities, LLC
C. Strong Performance Track Record

From 2000 to 2009, the Wells Fargo Securities MLP Index outperformed the S&P 500 Index in eight out of ten years (on a total return basis). During this time frame, MLPs delivered an annual total return of 22.7% with lower risk (average beta of 0.38 over this time frame), versus 1.2% for the S&P 500. Figure 3. MLP Total Returns Versus S&P 500 TR Index
Total Return (2000-2010YTD)
80% 60% 43% 40% Total Return 20% 0% (20%) (40%) (60%) 2000 2001 2002 2003 2004 2005 2006 2007 S&P 500 TR Index 2008 2009 2010YTD Wells Fargo Securities MLP Total Return Index (9%) (12%) (22%) (38%) (37%) (0%) 42% 76%
45% 29% 17% 11% 5% 5% 27% 16% 12% 5% 26% 33%
8%
Index Wells Fargo MLP Index (TR) S&P 500 Index (TR) S&P REIT Index (TR) S&P Utilities Index (TR)
2000 42.9% (9.1%) NA 57.2%
2001 41.8% (11.9%) 6.5% (30.5%)
2002 (0.3%) (22.1%) (8.8%) (30.0%)
2003 45.2% 28.7% 28.8% 26.3%
2004 16.5% 10.9% 29.2% 24.3%
2005 4.8% 4.9% 12.5% 16.8%
2006 26.6% 15.8% 41.6% 21.0%
2007 11.7% 5.5% (17.1%) 19.4%
2008 (38.2%) (37.0%) (41.2%) (29.0%)
2009 75.9% 26.5% 25.0% 11.9%
2010 TD 33.3% 7.5% 21.5% 3.4%
Source: FactSet, Standard & Poors, and Wells Fargo Securities, LLC
In addition to real estate investment trusts (REIT) and Utilities, MLPs have also outperformed other yieldoriented securities, such as high yield and investment grade bonds, and the U.S. 10-Year Treasury. For the trailing three-, five-, seven-, and nine-year periods, MLPs generated annual total returns of 13.6%, 14.7%, 14.7%, and 15.7%, respectively. These MLP returns have exceeded investment grade bond returns (as measured by Moodys Corporate BAA Index) of 2.0%, 1.0%, 1.2%, and 3.0%, respectively, over these same periods and also compare favorably to high yield bond returns of 7.1%, 2.1%, 0.7%, and 4.5%. To note, for the trailing three-, five-, seven-, and nine-year periods, REITs generated annual returns of (4.8%), 1.0%, 6.8%, and 6.9%, respectively, while Utility annual returns were (5.6%), 3.8%, 9.6%, and 4.5%. Figure 4. Total Return Performance Versus Other Indices
44.1% 50% Wells Fargo MLP Index (TR) S&P Utilities Index (TR) 29.7% Investment Grade Bonds S&P REIT Index (TR) U.S. 10-Year Treasury Merrill U.S. High Yield B-BB
Total Return Performance
30.3%
40%
22.1%
30%
25.9%
9.7% 14.3% 4.0% 16.3%
14.7% 1.0% 3.8% 8.6% 1.0% 2.1%
12.5%
11.3% 2.0% 7.1%
20% 6.1%
14.7% 6.8% 9.6% 5.3% 1.2% 0.7%
13.6%
15.7% Trailing 9-Year 6.9% 4.5% 5.6% 3.0% 4.5%
0% (4.8%) (5.6%) YTD Trailing 1-Year Trailing 3-Year Trailing 5-Year
(10%)
3.1%
10%
Trailing 7-Year
Source: FactSet, Standard & Poors, and Wells Fargo Securities, LLC
D. Tax Advantages
MLPs offer investors a tax-efficient means to invest in the energy sector. An investor will typically receive a tax shield equivalent to (in most cases) 80-90% of cash distributions received in a given year. The tax-deferred portion of the distribution is not taxable until the unitholder sells the security. (Please see The Mechanics Of A Purchase And Sale Of MLP Units And The Tax Consequences for more details.)
E. Portfolio Diversification
Historically, MLPs have exhibited low correlation to most asset classes and thus, provide good portfolio diversification, in our view. Prior to the credit crisis/market correction in 2008, MLPs were not highly correlated with other asset classes, commodities, interest rates, or other yield-oriented investments, and thus, provided good portfolio diversification. During the credit crisis (2007-09), MLPs correlation increased dramatically, beta doubled, and price performance essentially mirrored the overall market (i.e., S&P 500 Index). As markets have normalized, MLP correlations to crude oil, 10-year Treasuries, credit spreads, and the S&P 500 Index have notably weakened. Specifically, MLPs correlation to the S&P 500 Index has declined considerably, to 0.45 from 0.96 during the credit crisis. In addition, the correlation between MLPs and both the high yield and investment-grade spread to Treasuries increased to negative 0.92, respectively, during the credit crisis (2007-09) from pre-credit crisis (2000-06) levels of negative 0.76 and negative 0.64, respectively (i.e., as spreads increased, the MLP Index declined). For 2010 to date, the correlations between MLPs and high-yield and investment-grade spreads have declined significantly, to 0.01 and 0.68, respectively. Pre-credit crisis, MLPs were more correlated to the movement in crude oil prices than natural gas prices. Over this time period, the crude oil correlation was 0.81, versus 0.46 year to date, and the natural gas correction was 0.63, versus negative 0.63 year to date. Although MLPs exposure to commodity price risk varies, overall, we believe it is generally low relative to other companies in the energy industry. Clearly though, the perception of commodity price risk can influence stock prices (over the short term), in our view.
Figure 5. Wells Fargo Securities MLP Index Correlation To Other Asset Classes
1.50 0.94 0.96 0.86 0.88 0.90 0.81 0.82 0.63 0.68 0.68 (0.86) (0.76) (0.92) 0.01 (0.64) (0.92) 0.68 0.01 (0.05) (0.57) (0.64) (0.63) (0.87) (0.76) (0.89) (0.92) Pre-Credit Crisis (2000-06) S&P 500 10 Yr Treas ML HY Bond Credit Crisis (2007-09) Natural Gas Utilities HY Spread To US10Yr (0.92) 2010 TD Crude Oil REITs IG Spread To US10Yr S&P 500 Pre-Credit Crisis (2000-06) (0.05) Credit Crisis (2007-09) 2010 TD 0.96 0.45 Natural Gas 0.63 0.52 (0.63) Crude Oil 0.81 0.40 0.46 10 Yr Treas (0.57) 0.86 (0.76) HY IG Spread Spread ML HY To To Utilities REITs Bond US10Yr US10Yr 0.68 0.88 0.82 0.94 0.90 0.81 (0.87) (0.89) (0.86) (0.76) 1.00 0.50 0.00 (0.50) (1.00) (1.50) 0.81
0.52
Source: Bloomberg, FactSet, Standard & Poors, and Wells Fargo Securities, LLC estimates
F. A Lower Risk (Beta) Way To Invest In Energy

MLPs offer investors an alternative way to invest in energy, with lower risk as measured by beta. MLPs had an average beta of just 0.61 over the past year and an average beta of 0.68 over the past five years (2005-09). Traditional energy companies such as those involved in exploration and production, oilfield services, and utilities have exhibited comparably more volatility, with an average beta of 1.29, 1.38, and 0.75, respectively, over the past five years. During this time frame, the beta for the S&P 500 Oil & Gas Exploration & Production Index ranged from 0.98 to 1.36 each year, while the beta for the S&P 500 Oil & Gas Equipment & Services Index ranged from 1.20 to 1.60. The beta for the S&P 500 Utilities Index was between 0.58 and 1.01. This compares to a range of 0.32 and 0.86 for MLPs.
G. MLPs Are An Effective Hedge Against Inflation

MLPs current and (growing) income stream can provide an effective hedge against inflation for the following reasons: 1. Inflation adjusters. Many pipeline MLPs have contracts, which adjust for inflation annually (PPI + 1.3%, for example); 2. Higher commodity prices. Inflation would likely cause commodity prices to increase, which would increase revenue and margin for commodity-sensitive MLPs (principally gathering and processing and upstream); 3. Distribution growth. Distribution growth has largely outpaced increases in the Consumer Price Index (CPI), making MLPs a good hedge against inflation; 4. Low price correlation with inflation and interest rates. MLP price performance is not as sensitive to interest rate movements and/or inflation as commonly perceived. While sudden spikes in interest rates have caused declines in MLP price performance, there has been only a 0.27 correlation between MLP price performance and the 10-year Treasury over the past five years.
Current MLP yields range from approximately 5% to 10% (excluding GPs). Further, MLPs have increased distributions at a historical five-year compound annual growth rate (CAGR) of 7.9%. In contrast, inflation as measured by the CPI has averaged 2.6% over the same period. We estimate 3.4% distribution growth in 2010 and 5.0% growth in 2011.
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Correlation
0.40
0.45
0.46
Utility stocks, with their regulated earnings stream and significant dividend yields, are the most comparable energy securities to MLPs, in our view. Utilities provide a median yield of about 4.4% and have increased dividends at an annual growth rate of approximately 4.4%, on average, over the past five years. For the next three years, we forecast distribution growth of 5.0% (5.3% including GPs), supported by MLPs participation in the ongoing buildout of the U.S. energy infrastructure. Figure 6. MLP Distribution Growth Versus The CPI
14% 12% 10% 8% 6% 4% 4% 2% 0% (2%) 2010E 1998A 1999A 2000A 2001A 2002A 2003A 2004A 2005A 2006A 2007A 2008A 2009A 2011E 4% 1% 6% 5% 4% 5% 2.9% 3.4% 5.0% 9% 10% 11% 10%
Median Distribution Growth
Median Distribution Growth
C PI
Source: Partnership reports, U.S. Bureau of Labor Statistics and Wells Fargo Securities, LLC estimates
H. Estate Planning Tool

MLPs can be utilized as a tax-efficient means of transferring wealth. When an individual who owns an MLP dies, the individuals MLP investments can be transferred to an heir. When doing so, the cost basis of the MLP is reset to the price of the unit on the date of transfer. Thus, the tax liability created by the reduction of the original unit holders cost basis is eliminated. To note, the step-up in cost basis may not be applicable this year due to the repeal of federal estate tax for 2010. We recommend that investors consult a tax or estate planning professional for advice.
I.
Demographics
Demographic trends should drive demand for income-oriented investments, in our view. Retiring Baby Boomers are likely to seek current income in a tax-efficient structure, which could drive demand for MLPs. According to the latest available data published by the U.S. Census Bureau, the age profile of the U.S. population for those older than 45 years of age is expected to account for approximately 41% of the total U.S. population by 2020, versus 35% in 2000. The U.S. Census Bureau projects the U.S. population to reach almost 336 million by 2020, of which more than 138 million (or 41%) will be 45 years of age or older. In 2000, the total U.S. population was 282 million and 98 million people (or 35%) were 45 years of age or older. Based on this time frame and data, this represents an approximate 42% increase in people 45 or older.
11
Master Limited Partnerships Figure 7. U.S. Population Age Profile Projection

100% 90% Percent of total U.S. population 80% 70% 60% 50% 40% 30% 20% 10% 0% 22% 35% 11% 2% 2000A Ages 85+ 11% 2% 2010E Ages 65-84 26% 39% 14% 2% 2020E Ages 45-64 25% 41% 17% 3% 2030E Ages 20-44 23% 42% 16% 4% 2040E Ages 5-19 Ages 0-4 23% 43% 37% 34% 32% 32% 31% 22% 20% 20% 19% 19% 7% 7% 7% 7% 7%
7% 19%
31%
22%
16% 5% 2050E
Source: U.S. Census Bureau
J. Resilient Business Model During Periods Of Economic Weakness

Perhaps the best illustration of MLPs resilient business model has been the sectors ability to maintain and, in most cases, increase distributions during periods of economic weakness or market turbulence. During the most recent credit crisis or economic downturn, of 2007-09, MLPs continued to demonstrate the long-term sustainability of their business model and cash flow stream. Although MLP price performance was poor (as all asset classes were almost perfectly correlated), a majority of the MLPs were able to successfully navigate through the turbulent period. Notably, approximately 78% of all energy MLPs either maintained or increased distributions during this period of severe economic stress, including all 16 large-cap pipeline MLPs. Only 16 out of 74 energy MLPs either cut or suspended their distributions during that time period. This compares favorably to the U.S. REIT industry, whereby 104 out of 122 domestic REITs (or 85%) either cut or suspended dividend payments during the most recent economic downturn.
III. Who Can Own MLPs?

MLPs have historically been predominantly owned by retail investors. This is still true today. However, MLP ownership by institutions has become more prevalent as the asset class has grown. Since MLPs generate unrelated business taxable income (UBTI), tax-exempt investment vehicles such as pension accounts, 401Ks, individual retirement accounts (IRAs), and endowment funds do not typically own MLP units. Figure 8. 2009 MLP Ownership Type
Foreign Ow nership 8%
Institutional Ow nership 27% Retail Ow nership 65%
Retail Ownership Institutional Ownership Foreign Ownership
Source: PricewaterhouseCoopers LLP, Partnership reports, and Wells Fargo Securities, LLC estimates
12
A. Mutual Funds Can Own MLPs

With the passage of the American Jobs Creation Act in October 2004, mutual funds were permitted to own MLPs. However, there are some restrictions to investment: (1) no more than 25% of a funds asset value may be invested in MLPs and (2) a fund may not own more than 10% of any one MLP. In April 2010, SteelPath launched the first MLP open-end (mutual) fund. The SteelPath Funds are registered investment companies and submit regular filings like other mutual funds. Yet unlike most mutual funds, which enjoy the tax benefits of being a regulated investment company, the SteelPath Funds elected to be a corporation (a C-Corp) for IRS reporting purposes. (Filing as a corporation allows SteelPath to invest more than 25% of its funds in MLPs) Consequently, the SteelPath Funds must pay corporatelevel income taxes. For more information please see Open-End Funds The SteelPath MLP Funds Trust.
B. Challenges Remain For Mutual Fund Ownership Of MLPs

Despite the passage of the American Jobs Creation Act, mutual funds have not participated in the MLP sector in large numbers to date. This is due to a number of administrative challenges, including the following: Timing issues. Mutual funds begin processing their investors 1099s in November, but may not receive their MLP K-1s until late February or early March. Mutual funds are required to designate investors income as ordinary income, long-term capital gains, and return of capital. However, without the K-1s, a mutual fund would have to make estimates that could prove incorrect. In certain instances this could lead to excise tax liability for the mutual fund or a mutual fund investor paying taxes not owed. State filing requirements. There are potential administrative burdens related to state filing requirements. Since some MLPs have operations (e.g., pipelines and storage tanks) in many states, a mutual fund owner of a partnership may be required to file income tax returns in every state in which the MLP conducts business (even if no taxes are owed). Clearly, the administrative burden required for such an undertaking could be prohibitive. Please see the Appendix for a list of states in which each MLP operates.
C. Tax-Exempt Vehicles Should Be Cautious In Owning MLPs

Tax-exempt investment vehicles such as pension accounts, 401-Ks, IRAs, and endowment funds should carefully evaluate whether they should own MLP units because MLPs generate unrelated business taxable income (UBTI). This means MLP income is considered income earned from business activities unrelated to the entitys tax-exempt purpose. If a tax-exempt entity receives UBTI (e.g., income from an MLP and other sources of UBTI) in excess of $1,000 per year, the investor would be required to file IRS form 990-T and may be subject to taxes on the excess UBTI above the $1,000 threshold. We recommend consulting a tax advisor before investing in MLPs through any of these structures.
IV. Risks To Owning MLPs

Tax and legislative. While there is no legislation currently aimed at MLPs, a removal or alteration of MLPs favored tax treatment would negatively affect performance. Further, legislation aimed at the oil and gas industry could affect MLPs (e.g., through carried interest, derivative legislation, cap and trade, and the climate bill). Capital markets access. MLPs are highly correlated to credit spreads and reliant on equity and debt markets to fund growth. Further, because MLPs pay out the majority all of their cash to unitholders, they must continually access the debt and equity markets to finance growth. If MLPs were unable to access these markets or could not access these markets on favorable terms, this could affect price performance and inhibit long-term distribution growth. A severe economic downturn. Energy demand is closely linked to overall economic growth. A severe economic downturn could reduce the demand for energy and commodity products, which could result in lower earnings and cash flow. Commodity price risk. Some MLPs have significant exposure to commodity price fluctuations, including partnerships involved in oil and gas production, gathering and processing, and coal. In addition, MLP unit prices tend to move in sympathy with commodity prices. For example, the Wells Fargo Securities MLP Index exhibited a correlation with crude oil prices of 0.89 in 2009.
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Rising interest rates. As evidenced from the period from 1998 to 1999, MLPs have generally underperformed during periods of rapidly rising interest rates. Thus, during periods when investors fear rapidly rising rates in the future or if rates were to rise faster than expected, this could affect performance. A decline in drilling activity. A slowdown in drilling activity could reduce oil and gas producer revenue, gathering fees, throughput volume into processing plants, and ultimately, pipeline volume. Execution risk related to acquisitions and organic projects. MLPs ability to grow is dependent, in part, on their ability to complete organic growth projects on time and on budget, and/or to successfully identify and execute future acquisitions. Regulatory risk. MLPs are regulated across a number of industries. Interstate pipelines are regulated by the Federal Energy Regulatory Commission (FERC). Coal is one of the most heavily regulated industries in the country, being subject to regulation by federal, state, and local authorities. Any number of regulatory hurdles could affect MLPs ability to grow. Environmental incidents and terrorism. Many MLPs have assets that have been designated by the Department of Homeland Security as potential terrorist targets, such as pipelines and storage assets. A terrorist attack or environmental incident could disrupt the operations of an MLP, which could negatively affect cash flow and earnings in the near term. Conflicts of interest with the GP. For certain MLPs, the GP of the partnership and the parent company that owns the GP are controlled and run by the same management teams. Some potential areas of conflict include (1) the price at which the MLP is acquiring assets from the GP, (2) the GP aggressively increasing the distribution to achieve the 50%/50% split level rather than managing distribution growth to maximize the long-term value of the underlying MLP, (3) the potential for management to place the interests of the parent corporation or the GP above the interests of the LP unitholders, and (4) underlying MLP equity issuances to fund growth initiatives benefit the GP regardless of whether the acquisition or project is accretive. Weather risk. Some MLPs cash flow, particularly those involved in the transportation (pipeline) and distribution of propane, are significantly affected by seasonal weather patters. For example, if an MLPs operating region experiences unseasonably warm weather, propane demand, and therefore, volume, could be negatively affected. In addition, weather patterns can affect coal MLPs via electricity generation end-user demand
V. How To Build An Effective MLP Portfolio

In building a diversified MLP portfolio, we believe there are four primary factors that investors should take into consideration:
A. Balance Risk And Growth

Like all investments, MLPs present risk/reward propositions. Investors should consider their risk-tolerance level and make investments accordingly. In general, a balanced portfolio, which includes lower-risk but potentially lower-return MLPs and higher-risk MLPs with potentially higher returns, should be considered. Figure 9. Risk And Growth
Risk - Capital requirements - Leverage - Stock liquidity - Execution - Commodity exposure - Weather
and - Market position
Growth
- Organic versus acquisition dependent - Visibility - Track record - Size - Strength of sponsor
B. Diversify Among MLP Sectors

Investors should diversify within the energy MLP sector. Figure 99 displays the MLPs based on their risk profile by sector. The Asset Overview Relative MLP Distribution Security section describes the basic types of MLPs and fundamentals underlying each MLP sector that investors should consider when constructing an MLP portfolio.
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C. Anchor Tenants
Investing in anchor or core MLPs is an effective way to build a solid foundation for an MLP portfolio. The anchor tenants are partnerships that have established a successful track record of delivering solid and sustainable results year after year. In addition, these MLPs are typically larger entities that have grown and diversified their asset base to limit cash flow volatility during economic cycles and have investment grade credit ratings.
D. Invest With Top Management

Prior to making any investment, individuals should evaluate the strength of the companys management team. Investors should consider a management teams (1) track record in successfully managing its business, (2) project management capabilities (i.e., ability to keep projects on time and on budget), and (3) ownership interests, i.e., aligned with those of the limited partnership (LP) unitholders.
VI. The Basics

A. What Is An MLP?
A master limited partnership is an entity that is structured as a limited partnership instead of as a C corporation (C corp.). Limited partnership interests (limited partner units) are traded on public exchanges (i.e., NYSE, NASDAQ, and AMEX) just like corporate stock (shares). However, unlike a C corp., MLPs do not pay corporate-level taxes. Instead, taxes are paid (on a partially deferred basis) by public limited partner unitholders (i.e., MLPs are pass-through entities). Figure 10. The MLP Versus A Standard C Corp Structure
Typical Structure comparison Corporate level tax Unitholder / shareholder level tax Tax shield on distributions / dividends Tax reporting General partner Incentive distribution rights Voting rights
Source: Partnership reports
MLP
C corp.
K-1
1099
Who Are The Owners Of The MLP? MLPs consist of a general partner (GP) and limited partners (LP). The general partner (1) manages the daily operations of the partnership, (2) typically holds a 2% equity ownership stake in the partnership, and (3) is usually entitled to receive incentive distribution payments. The limited partners (or common unit holders) (1) provide capital, (2) have no role in the partnerships operations and management, and (3) receive quarterly cash distributions.
B. What Qualifies As An MLP?

To qualify as an MLP, a partnership must receive at least 90% of its income from qualifying sources such as natural resource activities, interest, dividends, real estate rents, income from sale of real property, gain on sale of assets, and income and gain from commodities or commodity futures. Natural resource activities include exploration, development, mining or production, processing, refining, transportation, storage, and marketing of any mineral or natural resource. For practical purposes, most MLPs are involved in the energy markets.
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Master Limited Partnerships Figure 11. Types Of Publicly Traded Partnerships

Mortgage Securities 3% Real Estate 3% Minerals & Timber 2% Investment / Financial 9% Miscellaneous 4%
Energy Related MLPs 78%

Source: National Association of Publicly Traded Partnerships
C. What Are The Advantages Of The MLP Structure?

Due to its partnership structure, MLPs generally do not pay entity-level income taxes. Thus, unlike corporate investors, MLP investors are not subject to double taxation on dividends. This enhances the partnership's competitive position vis--vis corporations in the pursuit of expansion projects and acquisitions, in our view.
D. How Many MLPs Are There?

Currently, there are 93 MLPs traded on public exchanges. Of those, 72 are energy related. Figure 12. Number Of MLPs
80 70 Number of Partnerships 60 50 40 30 20 10 0 Energy Related MLPs Minerals & Timber Real Estate Mortgage Securities Investment / Financial Miscellaneous 9 2 3 3 4 72
Source: National Association of Publicly Traded Partnerships
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E. What Is The K-1 Statement?

The K-1 form is the statement that an MLP investor receives each year from the partnership that shows his or her share of the partnerships income, gain, loss, deductions, and credits. It is analogous to a Form 1099 received from a corporation. The investor pays tax on the portion of net income allocated to him or her (which is shielded by losses, deductions, and credits) at his or her ordinary income tax rate. If the partnership reports a net loss (after deductions), it is considered a passive loss under the tax code and may not be used to offset income from other sources. However, the loss can be carried forward and used to offset future income from the same MLP. K-1 forms are usually distributed in late February or early March, and some can be retrieved online (via the partnerships website or at www.taxpackagesupport.com).
F. What Is The Difference Between An LLC And MLP?

As of November 2010, there were 64 energy MLPs registered as limited partnerships (LP). Eight entities, Constellation Energy Partners, Copano Energy, Enbridge Energy Management, Kinder Morgan Management, Linn Energy, Niska Gas Storage Partners, NuStar GP Holdings, and Vanguard Natural Resources are registered as a limited liability company (LLC). LLCs have all the tax advantages of MLPs, including no corporate level of taxation and tax deferral for unitholders. The primary differences between LLCs and MLPs are that LLCs do not have a GP or incentive distribution rights, but may have management incentive interests (MII). In addition, LLC unitholders have broader voting rights, whereas MLP limited partner unitholders generally have only limited voting rights. Figure 13. Structure Comparison
Structure comparison Non-taxable entity Tax shield on distributions Tax reporting General partner Incentive distribution rights Management incentive interests Voting rights K-1 K-1 1099 LP LLC C corp.
MLPs Structured As C-Corps. There are three shipping MLPs: Capital Product Partners L.P., Navios Maritime Partners, L.P., and Teekay Offshore Partners, L.P., which elected to be taxed as corporations for U.S. federal income tax purposes. Based on this election, U.S. unitholders will not directly be subject to U.S. federal income tax on the partnerships income, but will be subject to U.S. federal income tax on distributions received from the MLPs and sale of the MLPs units. In addition, since these MLPs are structured as corporations, investors would receive a Form 1099 rather than a K-1. These MLPs also provide percentage estimates of total cash distributions made during a certain period that would be treated as qualified dividend income (this is similar to the percent estimate of federal taxable income-to-distributions provided by standard MLPs). The qualified dividend income would be taxable to the U.S. common unitholder at the capital gains tax rate versus the ordinary income tax rate. The remaining portion of this distribution is to be treated first as a nontaxable return of capital to the extent of the purchasers tax basis in its common units on a dollar-for-dollar basis and thereafter as a capital gain.
G. Are MLPs The Same As U.S. Royalty Trusts? Canadian Royalty Trusts?
No, U.S. royalty trusts are yield-oriented investments and have unique investment characteristics; however, they are not MLPs. A U.S. royalty trust is a type of corporate structure whereby a cash flow stream from a designated set of assets (typically oil and gas reserves) is paid to shareholders in the form of cash dividends (on either a monthly or quarterly basis). A trusts profit is not taxed at the corporate level provided that a certain percentage (e.g., 90%) of profit is distributed to shareholders as dividends. The dividends are then taxed as personal income. Unlike MLPs, U.S. trusts are not actively managed entities. Thus, they do not make acquisitions or increase their asset base. In addition, U.S. royalty trusts typically have no debt, which also reflects the royalty nature of their business. The U.S. royalty trusts cash flow is paid to investors as it is generated and only until the underlying asset is depleted. As a result, dividends from trusts fluctuate with cash flow and should eventually dissipate. In contrast, MLPs are actively managed entities that can make acquisitions and investments to increase their asset base and sustain (and grow) cash flow. Over the long term, MLP distributions are managed to be steady and sustainable (and often growing).
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On the other hand, Canadian royalty trusts are more similar to upstream MLPs in that Canadian trusts are actively managed entities (i.e., make acquisitions or investments to grow production). However, the primary differences between upstream MLPs and Canadian royalty trusts are that the trusts (1) are involved in the exploration and production of crude oil and natural gas (whereas upstream MLPs are involved in exploitation and production) and (2) tend to hedge a smaller percentage of their current production volume (while upstream MLPs typically hedge approximately 70-90% of the current years production). To note, Canadian royalty trusts will be required to change to a corporate form of taxation on January 1, 2011.
H. What Are I-Shares?

In order to expand the universe of potential investors in MLPs to institutional investors and tax-advantaged accounts such as individual retirement accounts (IRAs), an investment vehicle similar to LP units was created known as i-shares (the i stands for institutional). In May 2001, Kinder Morgan Management, LLC (KMR) was the first i-share created and mirrors Kinder Morgan Energy Partners (KMP). Currently, the only other i-share security is Enbridge Energy Management, LLC (EEQ), the i-share for Enbridge Energy Partners (EEP). The i-shares are equivalent to MLP units in most respects, except that distributions are paid in stock instead of cash. Distributions to i-shareholders are treated similarly to stock splits. The cost basis of the initial investment does not change, but instead, is spread among more shares. One year after purchase, all gains from disposition are treated as long-term capital gains. Unlike MLP securities, i-shares do not require the filing of K-1 statements and do not generate UBTI. Thus, i-shares can be owned in an IRA account without penalty. The i-share structure is analogous to an automatic dividend reinvestment plan, in our view. Thus, for investors who prefer to reinvest dividends, the i-share security could be an appropriate investment. The I-share discount. Historically, both EEQ and KMR have traded at a discount to their MLP unit equivalent; though recently, EEQ has traded at a premium to EEP. Currently, EEQ trades at a 0.2% premium to EEP and KMR trades at a 10.3% discount to KMP. The discrepancy between valuations can be attributed to a number of factors, in our view, including the following: Cash is king. Investors prefer cash distribution to stock dividends. Liquidity. I-shares have average daily trading volume of only 317,000, versus 1,025,500 for the two MLP units, in an aggregate. No natural arbitrage. MLP units are difficult to sell short. Thus, no natural arbitrage opportunity exists that would cause the units to trade more closely. No conversion provision. The ability to convert an i-share to a common unit was removed by the partnerships soon after the public offerings. Hence, the i-shares are not entirely pari passu with the MLP common units.
Figure 14. EEP And KMP Relative To The Underlying I-Shares

30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% (5.0%) (10.0%) Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Oct-10 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10
EEP-to-EEQ Premium/ (Discount)
KMP-to-KMR Premium/ (Discount)
Note: Based on a 4-day moving average Source: FactSet
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MLP Primer -- Fourth Edition What Are The Tax Consequences Of Owning I-Shares?
When a shareholder receives a quarterly distribution in the form of additional i-shares, this does not trigger a taxable event. A taxable event occurs only when a shareholder sells his or her share. An i-shareholder pays capital gains tax on the sale (long-term capital gains if the holding period is greater than one year). An investors tax basis is calculated as the initial amount paid for the shares divided by the total number of shares received both from the initial purchase and the subsequent quarterly distributions. (This is similar to the way a stock split is calculated.) If shares were acquired for different prices or at different times, the basis of each lot of shares can be used separately in the allocation. Otherwise, the first-in, first-out (FIFO) method is used. The holding period for shares received as distributions is marked to the date at which the original investment in the shares was made.
I.
Why Create An MLP?

A premium valuation. Assets within the MLP structure typically trade at higher valuations in the market than those same assets within a C-corp. structure. For example, MLPs with C-corp. sponsors currently trade at an estimated median 2011 enterprise value-to-adjusted EBITDA multiple of 12.6x, versus 7.0x for the associated C corp. Figure 15. Valuation Variance Between MLP And C-Corp. Sponsor
18.0x 16.0x 14.0x 2011 EV / EBITDA Multiple 12.0x 10.0x 8.0x 6.0x 4.0x 2.0x 0.0x EXH PSE EXLP SEP SE EP TGP TOO TK CHKM WMB EPB WPZ WES PXD CHK APC 5.2x 10.0x 9.4x 7.4x 5.9x 13.1x 17.0x
An MLP provides a number of benefits to the sponsor, including the following:
13.0x
12.9x
12.6x
8.7x 7.3x
8.5x
8.9x 8.1x 6.8x 5.5x
Note: MLP multiples are enterprise value (EV)-to-adjusted EBITDA Source: FactSet and Wells Fargo Securities, LLC estimates
A tax-advantaged structure with which to pursue growth opportunities. MLPs typically enjoy a competitive advantage relative to corporations, due to their tax-advantaged status. In general, MLPs should be able to either (1) pay more for an acquisition than a corporation and realize the same cash flow accretion or (2) realize more accretion from an acquisition given the same acquisition price. In addition, MLPs have traditionally enjoyed good access to capital, which makes financing acquisitions and organic projects feasible. The ability to maintain control of the assets (via the GP interest). The general partner can retain control of the asset while maintaining just a 2% equity interest in the MLP. The opportunity to capture potential upside from incentive distribution rights (IDR).
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VII. Key Terms

A. What Are Distributions?
Distributions are similar to dividends. MLPs typically pay cash distributions to unitholders on a quarterly basis.
B. What Are Incentive Distribution Rights (IDR)?

At inception, MLPs establish agreements between the general partner and the limited partners that outline the percentage of total cash distributions that are allocated between the GP and LP unitholders. The incentive distribution rights, which are typically owned by the general partner, entitle the GP to receive increasing percentages of the incremental cash flow as the MLP raises distributions to limited partners. Initially, the general partner receives only 2% of the partnerships cash flow. However, as certain pre-determined distribution levels are met, the GP receives an incremental 15%, then 25%, and up to 50% of incremental cash flow. The purpose of the IDRs is to incentivize the general partner to raise the quarterly cash distribution to reach higher tiers, which benefits the LP unitholders, as well. Typically, the GP must increase the distribution by 50% from the initial public offering (IPO) to reach the 50% IDR tier. (Please see the Appendix for a list of energy MLPs and their incentive distribution tiers.)
C. Calculating Incentive Distribution Payments

In the following table we illustrate the mechanics of how cash flow is allocated between the limited partners and the general partner based on a hypothetical incentive distribution rights schedule (see Figure 16). Based on this schedule, Tier 1 includes all distributions less than or equal to $2.00 per unit, Tier 2 includes distributions greater than $2.00 per unit but less than or equal to $2.50 per unit, and Tier 3 includes distributions greater than $2.50 per unit but less than or equal to $3.00 per unit. Tier 4 (i.e., 50/50 splits), or the high-splits tier, is achieved when distributions are greater than $3.00 per unit. Figure 16. MLP XYZ Distribution Calculation
LP% Tier 1 Tier 2 Tier 3 Tier 4 98% 85% 75% 50% GP% 2% 15% 25% 50% LP distr. up to: $2.00 $2.50 $3.00 Above $3.00
Source: Wells Fargo Securities, LLC estimates
In this example, we assume MLP XYZ declares a distribution of $4.00 per LP unit. As outlined in Figure 17, at Tier 1, between $0.00 and $2.00, the LP receives $2.00, which represents 98% of the distribution at that tier. The GP receives 2%, or $0.04 per unit, of that distribution at Tier 1. This $0.04 is derived by dividing the $2.00 distribution to LP unitholders by 98% and then multiplying by 2% ([$2.00 98%] 2%). In other words, the $2.00 received by LP unitholders represents 98% of the total cash distribution paid to the GP and LP unitholders. This same formula is applied at the subsequent tiers. At Tier 2, which is the incremental cash flow above $2.00 and less than or equal to $2.50, the LP receives $0.50, which represents 85% of the distribution at that tier. The GP receives 15% of the incremental cash flow, which equates to $0.09 per unit. At this level, the LP receives $2.50 per unit and the GP receives $0.13 per unit. In other words, the GP receives approximately 5% of the total distribution paid. At Tier 3, which is the incremental cash flow above $2.50 and less than or equal to $3.00, the LP receives $0.50, which represents 75% of the distribution at that tier. The GP receives 25% of the incremental cash flow, which equates to $0.17 per unit, and $0.30 in total (or approximately 9% of total distributions paid). At Tier 4, which is the incremental cash flow above $3.00, the LP receives $1.00, which represents 50% of the distribution at that tier. The GP also receives 50% of the incremental cash flow, which equates to $1.00 per unit. Thus, if the MLP wants to raise its distribution to limited partners by $1.00, it actually needs $2.00 in hand, one to pay the LPs and one to pay the GP. At the declared distribution of $4.00 in our example, the LP unitholders would receive 76% of total cash distributions, while the GP would receive 24%. As the cash distribution is increased beyond $4.00, the GP would receive 50% of the incremental cash. Thus, if the distribution is increased to $5.00 per limited unit, the formulas for Tiers 1-4 would apply, and for the incremental $1.00 ($4.00 to 5.00), the LP would receive $1.00 and the GP would receive an additional $1.00, as well.
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MLP XYZs yield of 8.0% reflects distributions made only to the LP unitholders (i.e., $4.0050.00 per unit). However, the adjusted yield of 10.6% reflects distribution payments to both the LP and GP (i.e., $4.00 + $1.30 = $5.30 $5.30 $50.00). Figure 17. MLP XYZ Incentive Distribution Tiers
Distribution up to: $2.00 $2.50 $3.00 Above $3.00 Cumulative Distribution Cumulative distribution allocation of cash per unit per unit flow (%) LP GP Total LP GP Total LP GP $2.00 $0.50 $0.50 $1.00 $0.04 $0.09 $0.17 $1.00 $2.04 $0.59 $0.67 $2.00 $2.00 $2.50 $3.00 $4.00 $0.04 $0.13 $0.30 $1.30 $2.04 $2.63 $3.30 $5.30 98% 95% 91% 76% 2% 5% 9% 24%
MLP XYZ Stock price Distribution to LPs Yield Total distributions Adjusted yield $50.00 $4.00 8.0% $5.30 10.6% Tier 1 Tier 2 Tier 3 Thereafter
LP% 98% 85% 75% 50%
GP% 2% 15% 25% 50%
D. What Is The Difference Between Available Cash Flow Versus Distributable Cash Flow?
We define available cash flow as the cash flow that is available to the partnership to pay distributions to both LP unitholders and the GP. On the other hand, we calculate distributable cash flow as the cash flow available to the partnership to pay distributions to LP unitholders. Available and distributable cash flow are commonly calculated in the following ways: Figure 18. Available And Distributable Cash Flow Calculation
Net income (+) depreciation and amortization (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow to LP unitholders OR EBITDA (-) interest expense (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow to LP unitholders
Distributable cash flow can also include cash distributions received from equity interests and reflect adjustments for non-cash items such as mark-to-market adjustments for derivative activity.
E. Are MLPs Required To Pay Out All Their Cash Flow?

Under a typical partnership agreement, the MLP is required to pay out all available cash to unitholders in the form of distributions. However, the board of directors for an MLP has significant discretion in determining what is considered available cash flow. This usually excludes all cash flow that would be required for the proper conduct of the business. Some MLPs have generated significant excess cash (or maintain higher distribution coverage ratios) for reinvestment in organic growth projects. Managements rationale for withholding cash flow is that the current earnings may not be sustainable due to unusual circumstances, e.g., high coal prices (ARLP) or wide commodity spreads (PAA). Thus, this windfall of cash is used to pay down debt or to fund internal growth projects, thereby increasing the partnerships base of sustainable earnings. Paying out the vast majority of cash flow is a strong discipline that incentivizes management to operate the partnership efficiently and to take extra precautions when contemplating acquisitions and/or organic capital projects, in our view.
F. What Is The Distribution Coverage Ratio And Why Is It So Important?

A partnerships distribution coverage ratio is the ratio of cash flow available to LP unitholders and the general partner to the cash paid to an MLPs LP unitholders and the general partner (i.e., available cash flow for the GP and LP divided by distributions paid to the GP and LP). Figure 19. Distribution Coverage Ratio Calculation
Distribution coverage ratio = Available cash flow (to GP and LP) Distributions paid (to GP and LP)
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Coverage ratios vary depending on the type of MLP and the inherent cash flow volatility in the underlying assets of the partnership. For example, propane MLPs that have a cash flow stream sensitive to weather, typically target coverage ratios of at least 1.1x. In contrast, most pipeline MLPs have coverage ratios in the 1.0-1.1x range, reflecting the stable, fee-based cash flow that underpins their businesses. The distribution coverage ratio is significant for two reasons: Traditionally, investors have considered the coverage ratio to be representative of the cushion that a partnership has in paying its cash distribution. In this context, the higher the ratio, the greater the safety of the distribution. All else being equal, a higher coverage ratio would give management increased flexibility to raise its distribution.
G. What Is The Difference Between Maintenance Capex And Growth Capex?

Maintenance capex is typically defined as expenditure that is made to (1) replace partially or fully depreciated/obsolete assets, (2) maintain the existing operating capacity or operating income of an MLPs assets, and (3) extend the useful life of assets (e.g., routine equipment and pipeline maintenance). On the other hand, growth capex is capital expenditure that is made to increase the partnerships long-term operating capacity or cash flow. Some examples of growth capex include acquisitions, and the construction and development of additional facilities. Well connectsmaintenance or growth capex? There is some discrepancy among gathering and processing MLPs on their classification of expenditure for new well connections. The more conservative approach is to classify well connects required to replace expected reductions in natural gas gathering volume as maintenance capex, in our view. However, there are some MLPs that classify new well connections as growth capital as these partnerships consider well connects as bringing new production onto their systems (and not as replacements for the declining production of current wells). Assuming all else being equal, the use of the more conservative approach will result in lower distributable cash flow, whereas the classification of well connects as growth capital could potentially overstate an MLPs true sustainable distributable cash flow. Limited visibility into pipeline integrity spending. Although the FERC requires companies to disclose costs associated with natural gas pipeline maintenance on Form 2 filings, the agency does not require companies to report total pipeline integrity spending (i.e., costs associated with inspection plus repairs). Consequently, absent voluntary disclosure by individual companies, it is difficult to analyze pipeline spending trends within the industry. In addition to limited disclosure, accounting methodologies can further obscure the actual amount of maintenance-related spending a company undertakes. Notably, costs associated with pipeline inspection are expensed on a partnerships income statement. In contrast, costs associated with pipeline repair are capitalized and do not affect the income statement. However, pipeline repair costs are included in maintenance capex and hence, deducted before calculating distributable cash flow (a non-GAAP measure). Finally, maintenance capex spending can vary from year to year as improvements in pipeline inspection technology can lead to spikes in pipeline integrity expenses. For example, the increased use of pipeline inspection gauges (PIGS) following the Pipeline Safety Act of 2002 resulted in an uptick in maintenance capex spending as these instruments utilized sophisticated magnetic and ultrasonic imaging technology to identify pipeline anomalies that had previously gone unnoticed. Maintenance capex and upstream MLPs. Upstream MLPs are currently divided on how to define maintenance capex. There are currently three prevailing maintenance capex definitions used by upstream MLPs: Under the strictest sense, maintenance capex can be defined as the capital required to maintain production and to replace reserves. A more lenient approach is to define the metric as the capital required to replace annual production. Finally, maintenance capex can be viewed as the capital needed to sustain cash flow.
We prefer the first definition, which seems most conservative, as it fully reflects the cost of maintaining the asset base. Focusing on maintaining production may not be sustainable over the long term, as reserves would also need to be replaced at some point. The third definition is the least meaningful, in our view, as it places a disproportionately large emphasis on commodity prices. Given its effect on distributable cash flow, variance in the definition of maintenance capex can have significant ramifications for distribution policy and valuations.
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VIII. Drivers Of Performance

A. Distribution Growth Distribution growth has been one of the primary drivers of MLP price performance. Empirical evidence suggests that there is an inverse relationship between anticipated distribution growth and MLP yield. Fastergrowing MLPs command lower yields, while slower-growing MLPs have traded at higher yields. For example, publicly traded GPs have an average estimated three-year distribution growth CAGR of 7.9% and consequently, trade at a lower than average yield of 4.3%. In comparison, upstream MLPs have a forecasted three-year distribution CAGR of 3.8% and trade at an above-average yield of 8.0%. The following chart plots our three-year distribution growth CAGR estimates against current yields. An MLP that is able to increase its forecasted annual distribution growth rate by 1% via accretive acquisitions, organic growth projects, or cost-saving synergies should benefit from an approximate 0.2% reduction in yield, based on an estimated 0.59 correlation between the two variables (i.e., 35% of the variation is explained). This level of correlation does not preclude an MLP with a forecasted distribution growth rate of 8% from trading at a similar yield to an MLP with a forecasted distribution growth rate of 10%. In addition, the potential flaw with this analysis is that our distribution growth forecasts could be incorrect. Alternatively, the market may be forecasting different growth assumptions for certain MLPs or factoring in different levels of risk. Figure 20. Correlation Between Yield And Distribution Growth
11% y = -0.2105x + 0.0783 R 2 = 0.3515
9%
Yield
7%
5%
3% 0%
2%
4%
6%
8%
10%
12%
14%
16%
3-Ye ar Distribution CAGR
Note: Dotted lines represent +/- one standard deviation Source: FactSet and Wells Fargo Securities, LLC estimates
Drivers behind MLP distribution growth include (1) broader economic conditions, which govern access to capital and credit spreads, (2) sensitivity to commodity prices, (3) organic growth opportunities, and (4) acquisitions. We discuss the first two aforementioned drivers in more detail in the text that follows. Please refer to pages 43-55 on a discussion on energy infrastructure investment and acquisitions.
B. Access To Capital
Access to capital remains a key to MLP distribution growth as acquisitions and organic investments are mostly funded with external capital (i.e., new debt and equity). This is due to the fact that MLPs distribute the majority of their cash flow in the form of distributions each quarter. An MLP generates value for unitholders by investing in projects that generate returns in excess of the partnerships cost of capital. MLPs with investment grade credit ratings generally enjoy better access to capital at a lower cost, all else being equal. However, most MLPs have historically enjoyed good access to the capital markets.
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Master Limited Partnerships Figure 21. Historical Equity And Debt Issuances
$25,000 MLP Equity Issuances MLP Debt Issuances $20,000 $18,801
$20,586
$ in millions
$15,000
$14,920 $14,701
$9,080
$16,257
$10,000 $7,119 $5,000 $3,579
$9,563 $4,598 $5,610
$9,415
$10,760
$11,506
$4,965
$5,150
$5,505
$3,540 $0 2003
2004
2005
2006
2007
$4,100
2008
2009
C. Commodity Prices
The influence of commodity prices on MLPs varies significantly by sub-sector. Near-term fluctuations in natural gas, natural gas liquids, and crude oil prices are unlikely to have a material impact on pipeline MLPs, but are likely to affect earnings (on the unhedged portion of production or volume processed) of upstream and gathering and processing MLPs. Longer term, a sustained reduction in natural gas, natural gas liquids, or crude oil prices could curtail drilling by producers. As a result, even long-haul pipeline MLPs could be affected from reduced transportation volume and/or fewer infrastructure opportunities. Although MLPs exposure to commodity price risk varies, historically it has been low relative to other companies in the energy industry, in our view. For a more detailed discussion of the impact of commodity prices, please see the Asset Overview Relative MLP Distribution Security section beginning on page 86. Figure 22. Impact Of Commodity Prices On MLPs
Short-Term Increase In Prices Natural Gas Pipeline MLPs Gathering & Processing MLPs 1 Upstream MLPs None Negative Positive NGLs None Positive Positive Crude Oil None Positive Positive Sustained Increase In Prices Natural Gas Positive Negative Positive NGLs Positive Positive Positive Crude Oil Positive Positive Positive
Note 1: For primarily keep-whole contracts Source: Wells Fargo Securities, LLC
D. Credit Spreads
A significant change in credit spreads (relative to the 10-year United States Treasury) typically signals that investors have begun to re-rate default expectations. Widening credit spreads typically put pressure on all yieldoriented securities as the market is pricing in a greater risk premium into equities. As a result, access to capital could become more challenging (i.e., more expensive), though still viable. In addition, widening spreads across the capital structure could cause investors to flock to alternative investments with more attractive yields or lower perceived risk profiles. Furthermore, during times of uncertainty, some investors may prefer to own the public bonds of specific MLPs rather than the equities, given their relative seniority in the capital structure and attractive yields. Currently, investment grade and high-yield spreads stand at 316 basis points (bps) and 427 bps, respectively, versus a five-year historical average (2005-09) of 263 bps and 515 bps. During the recent sub-prime credit crisis, the investment grade and high-yield credit spreads peaked at 1,622 bps and 614 bps, respectively. Notably, the correlation between MLP performance (as measured by the Wells Fargo Securities MLP Index) and high-yield credit spreads in 2009, over the past three and five years was (0.96), (0.88), and (0.74) respectively.
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$8,975
$7,282
Figure 23. High Yield And Investment Grade Credit Spreads To The 10-Year Treasury
1,800 Basis-point spread to Ten-Year U.S. Treasury 1,600 1,400 1,200 1,000 800 600 400 200 0 Jan-00 Jan-05 Jun-00 Jun-05 Oct-03 Mar-04 May-03 Dec-02 Apr-01 Sep-01 Apr-06 Sep-06 Feb-02 Aug-04 Feb-07 Nov-00 Nov-05 Jul-02 Jul-07 Historical High Yield Spread Average High-Yield (ML U.S.) Spread To Treasury Investment-Grade (Moody's) Spread To Treasury
Historical Investment Grade Spread Average Jan-10 May-08 Dec-07 Mar-09 Aug-09 Jun-10 Oct-08 Nov-10
Source: Bloomberg
E. Interest Rates
The movement of interest rates and investor anticipation of a rise in interest rates have historically been important drivers of MLP performance. This is due to the fact that MLPs are yield investments that were traditionally viewed as bond-like substitutes. MLPs have underperformed during certain periods of rapidly rising interest rates because as interest rates increase, investors are able to receive a higher risk-adjusted rate of return from government-backed debt or Treasury securities. For example, in 1999, the Fed increased the target rate three times, to 5.75% from 5.00%. Over that same period, our MLP Composite declined 20.5%, while the Composite yield increased to 10.6% from an average of 7.7%. MLPs have historically traded at an average spread of 339 bps to the 10-year U.S. Treasury (from 2000 to 2010 year to date). As MLPs have become more growth oriented, the impact of modest interest rate movements on MLP price performance has decreased. Between 2001 and 2007, MLPs accelerated distribution growth to approximately 11% in 2007 from 5% in 2001. Consequently, the average spread between MLP yields and Treasury yields declined to a low of 16 bps in 2007 from an average of 302 bps in 2001. Over the past five years, the correlation between the 10-year Treasury yield and MLPs has been only 0.27. MLPs are now trading at a median yield of 6.4%, which represents approximately a 359-basis-point spread above the 10-year Treasury yield. The spread between midstream MLP yields and Treasuries has averaged 339 bps since 2000 and has ranged from 16 bps to 512 bps. Figure 24. Historical MLP Yield Spread To The 10-Year Treasury
1,800 1,600 1,400 Basis-point spread to Ten-Year U.S. Treasury 1,200 1,000 800 600 400 200 0 (200) Jan-00 Jan-05 Mar-04 May-03 May-08 Dec-02 Dec-07 Sep-06 Mar-09 Sep-01 Aug-04 Aug-09 Apr-06 Apr-01 Feb-02 Feb-07 Jan-10 Nov-00 Nov-05 Nov-10 Jul-02 Jul-07 Oct-08 Oct-03 Jun-00 Jun-05 Jun-10 Historical MLP Yield Spread Average MLP Yield Spread To Treasury
Source: FactSet
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F. Economic Activity (GDP Growth)

The overall health of the U.S. economy is a determining factor in MLP performance, in our view. Historically, U.S. energy consumption has closely tracked overall economic activity levels. On a historical basis, the average correlation of U.S. GDP growth versus total energy consumption is about 0.86. An increase in energy consumption should lead to an increase in the production, handling, and transportation of energy commodities, which generally benefit MLPs. Figure 25. Annual Percent Change In Energy Consumption And Gross Domestic Product
6%
4% Annual % Change 2%
0%
-2% -4%
-6%
07
08 20
04
97
99
00
02
93
92
95
90
91
98
96
03
94
05
01
20
06
20
19
19
20
20
20
20
19
19
19
19
19
19
19
Total Energy C onsumption
19
Gross Domestic Product
Note 1: Energy consumption in 2001 and 2009 was negatively affected by the downturn in economic activity Source: Bureau of Economic Analysis and EIA
G. MLP Fund Flow And Liquidity

Given the relative illiquidity of the MLP sector, fund flow is a meaningful driver of MLP performance, in our view. Notably, the market cap of the entire energy MLP sector is approximately $220 billion, versus $350 billion for Exxon Mobil. In addition, the median daily trading volume for MLPs is only 218,000 units, versus 22.3 million shares for Exxon Mobil. MLPs have traditionally been a predominantly retail-owned product. However, the rising institutional interest has led to new fund flow into the sector, which has resulted in increased overall trading liquidity. Institutional investors as a percentage of total MLP ownership increased to 27% in 2009 from 23% in 2005, according to the data from PricewaterhouseCoopers. Year to date, there have been 12 new MLP products announced. The total capital raised from these products is approximately $3.0 billion. Figure 26. Median MLP Daily Trading Volume
250 Median Daily Trading Vol. (000s) 218 200 150 100 53 50 0 2003 2004 2005 2006 2007 2008 2009 2010 TD 97 92 98 144 162
82
Source: FactSet
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20
20
20
09
IX. How Did MLPs Fair During The Credit Crisis?

Performance. MLPs actually underperformed the broader stock market during the period described as the credit crisis of July 2, 2007, to December 31, 2008. For the period, the Wells Fargo MLP index decreased 49%, versus a loss of 41% for the S&P 500. On a total return basis, the Wells Fargo MLP index generated a loss of 43%, versus 39% for the S&P 500. At its peak, the Wells Fargo MLP index was yielding 5.3% as of July 13, 2007, while at its trough, the index yield was 14.3% at November 21, 2008. Figure 27. MLP Performance During The Credit Crisis
480 Wells Fargo Securities MLP Index Performance PIPE unwinding 440 Total return swaps 400 360 320 280 240 200 160 Jan-02 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Credit spreads widen dramatically Lehman goes bankrupt Closed end fund deleveraging Retail investor capitulation Hedge fund redemptions
Source: FactSet
What drove this performance? A unique confluence of factors contributed to the overall volatility and steep decline in MLP valuations during this period. These factors can be separated into fundamental and technical reasons that explain the sectors performance during this period. Fundamental Drivers (1) Access to capital. Since MLPs pay out the majority of their cash flow in the form of distributions but spend significant capital to grow, they are highly dependant on the debt and equity capital markets. During the credit crisis, many MLPs could not access the public debt or equity markets, nor could they access other forms of capital (i.e., bank debt, private equity, etc.) on reasonable terms. With many MLPs in the midst of capital projects, their ability to fund these projects became a source of concern for investors, which pressured valuations. (2) Higher cost of capital. As a result of the credit crisis and the resulting decrease in equity valuations, the cost of incremental capital became very high. As a result, the growth projects of some MLPs already under way became breakeven to dilutive. In addition, the hurdle rate to justify new projects was very high, thereby reducing the amount of capital deployed and lowering future distribution growth expectations for MLPs. (3) Widening credit spreads. High-grade and high-yield credit spreads widened to historic levels, causing most yield-based securities to widen in sympathy. (4) Lower commodity prices. From July 3, 2008 to December 22, 2008, crude oil prices declined to a low of $31.41 from a high of $145.29 per barrel. This price volatility caused many commodity-sensitive MLPs (e.g., upstream and gathering and processing) to experience significant volatility in cash flow. Some were forced to reduce or suspend distributions due to a decrease in cash flow or because of (potential) debt covenant violations. Technical Drivers In addition to the fundamental factors described in the preceding text, MLP equity valuations were affected by a number of technical factors, which exaggerated the downward movement in prices, in our view. These factors highlighted another fundamental risk to the sector, namely, the relative lack of liquidity for MLPs (see risks on page x). The period leading up to the credit crisis was marked by an inflow of institutional investor capital, including several general and MLP-dedicated hedge funds. This inflow of capital helped fuel the run-up in prices as MLPs enjoyed unprecedented access to large pools of capital. However, this rapid influx ultimately led to higher volatility to the downside when these institutional investors became forced sellers of MLPs into a relatively illiquid market.
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PIPEs concentration. From 2003 to 2007, the MLP industry experienced a rapid increase in private investment in public equity (PIPE) transactions as hedge funds and closed-end funds made significant direct investments in MLPs. In total, MLPs raised $8.5 billion of PIPE equity in 2007, including two deals in excess of $1 billion. While PIPEs enabled certain MLPs to finance large acquisitions and grow rapidly, the transactions created significant concentration risk as a small group of institutional investors held significant interests in MLPs, which represented multiple days of the MLPs average trading volume. Total return swaps (TRS). Certain funds began investing in the MLP sector via total return swaps for a number of reasons, including(1) to avoid the administrative burdens of receiving K-1s, (2) as a way for nonU.S. investors to gain exposure to the MLP sector, and (3) as a means of masking their positions to their competitors. While TRS increased fund flow into the MLP sector, they were ultimately another form of leverage for institutional investors as the investment banks that offered swap products typically required only 10-20% of collateral. What is a total return swap? Investors can gain exposure to an MLP without direct ownership via a total return swap agreement. In a total return swap, an investor receives a synthetic security that mimics the performance of the underlying security. This includes any distributions generated by the underlying MLP and the benefit of the MLPs price appreciation over the life of the swap. However, if the price of the MLP decreases over the swaps life, the holder of the TRS will be required to pay the counterparty (usually a brokerage firm) the amount by which the asset has declined in price. The counterparty owns the underlying MLP security and receives payments from the investor over the life of the swap based on a set rate. Forced selling by leveraged funds. In retrospect, many of the institutional funds that invested in the sector did so with significant leverage. As the credit crisis worsened, both the cost of lending and stock performance were negatively affected. As a result, these funds experienced redemptions and forced deleveraging, which, in turn, caused the forced selling of MLP securities into a relatively illiquid market. Lack of sector liquidity. While MLPs are generally a rather illiquid sector (average daily liquidity of $219 million for large-cap pipeline MLPs in 2010, compared to $1.8 billion for Exxon Mobil during the same period), the overall market experienced reduced liquidity during the credit crisis, which was even more impactful for MLPs. Thus, a lack of liquidity contributed to exaggerated movements in price as institutional investors were forced to sell positions into a weak market. The credit crisis, the ultimate test of MLP durability? While MLPs underperformed the overall market during the credit crisis on a price-performance basis; the sector performed relatively well from a fundamental perspective. Specifically, all 13 investment grade MLPs and all 20 pipeline MLPs maintained or increased distributions during the period, demonstrating the sustainability and durability of their underlying cash flow and business model, in our view. In total, only 16 out of 74 MLPs were forced to reduce or suspend distributions (or 23%). In contrast, 85% of REITs (or 104 out of 122 U.S. equity REITs) reduced or suspended dividends during the credit crisis, according to Wells Fargo Securities REIT Equity Research Team. The MLPs that did reduce or eliminate distributions were involved in more cyclical or commodity-sensitive businesses, including upstream, gathering and processing, and marine transportation. Figure 28. MLP Distribution Reductions And Suspensions During The Most Recent Credit Crisis
Quarterly Distributions Declared Ticker CLMT BKEP USS QELP AHD CEP XTXI HPGP XTEX HLND EROC BBEP ATN APL KSP OSP
1
Date Of Final Distrib. Cut/Suspension Q1'08 Q2'08 Q2'08 Q4'08 Q1'09 Q1'09 Q1'09 Q1'09 Q1'09 Q1'09 Q1'09 Q1'09 Q1'09 Q2'09 Q3'09 Q3'09 $0.45 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.03 $0.00 $0.00 $0.00 $0.45 $0.00
Q1'08A Q2'08A Q3'08A Q4'08A $0.45 $0.40 $0.45 $0.41 $0.43 $0.56 $0.36 $0.28 $0.62 $0.83 $0.40 $0.50 $0.59 $0.94 $0.76 $0.38 $0.45 $0.00 $0.00 $0.43 $0.51 $0.56 $0.38 $0.31 $0.63 $0.86 $0.41 $0.52 $0.61 $0.96 $0.77 $0.38 $0.45 $0.00 $0.00 $0.40 $0.51 $0.56 $0.32 $0.32 $0.50 $0.88 $0.41 $0.52 $0.61 $0.96 $0.77 $0.38 $0.45 $0.00 $0.00 $0.00 $0.06 $0.13 $0.09 $0.10 $0.25 $0.45 $0.41 $0.52 $0.61 $0.38 $0.77 $0.38
Q1'09A Q2'09A Q3'09A $0.45 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.03 $0.00 $0.00 $0.15 $0.77 $0.38 $0.45 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.03 $0.00 $0.00 $0.00 $0.77 $0.38
Note 1: CLMTs Q4 2007 distribution per unit was $0.63. Source: Partnership reports
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Sidebar: Credit Crisis Highlighted The Value Of An Investment Grade Credit Rating. The credit crisis highlighted the dichotomy in access to capital between investment grade and non-investment grade. As noted, all 12 investment-grade rated MLPs were able to maintain (and even increase distributions during the credit crisis. These MLPs enjoyed access to public debt and equity markets throughout the period, though at a higher cost of issuance. In contrast, non-investment grade MLPs were largely shut out of public markets for a larger portion of the credit crisis. Non-investment grade MLPs were forced to pair-back capital spending, fund growth capital on revolving credit facilities, and enter into joint ventures to access necessary capital (often not on ideal terms) to meet their capital obligations for certain projects. During the credit crunch, investment grade credit rated MLPs continued to enjoy access to capital as the highgrade debt market remained open, though at higher rates (especially in late 2008). In 2008, investment grade MLPs raised almost $9.2 billion via 21 issuances at an average interest rate of 7.3%. Notably, the rates on these issuances trended considerably higher (in the 9-10% range) in December 2008 (see Figure 29) as the weak economic environment intensified. Beginning in H2 2009, debt markets improved with a stabilizing economy and MLPs were able to issue long-term debt at more normalized rates. For 2010 year to date (through November 15, 2010), we have seen investment grade MLPs raise approximately $9.9 billion via 17 issuances at an average rate of 5.2%. Figure 29. Investment Grade Debt Offerings: 2008 Versus 2010 Year-To-Date
16 14 Number of Investment Grade Debt Offerings 9.6% 12 10 8 6 4 2 0 Q1 Q2 2008 No. of Offerings 2008 Average Rate Q3 Q4* 2010T D No. of Offerings 2010T D Average Rate 2.0% 5.5% 5.4% 7.1% 6.3% 6.4% 4.3% 4.1% 4.0% 6.0% 8.0% 12.0%
10.0%
Average Investment Grade Rate
0.0%
Note: 2010 data as of November 16, 2010 Source: Partnership reports
During the credit crisis, non-investment grade MLPs relied mostly on revolving credit facilities to fund their capital obligations as the high-yield and term loan B credit markets were volatile and expensive. Investment grade MLPs were still able to raise debt during a turbulent environment in late 2008 (i.e., December 2008). On the other hand, there were no high-yield offerings in H2 2008, as the debt markets were closed (i.e., too expensive) for non-investment grade MLPs. In 2008, non-investment grade MLPs raised about $2.4 billion in nine offerings at an average interest rate of 8.8%, with all of the offerings occurring during the first seven months of the year. For 2010 year to date, there have been 19 issuances by high-yield MLPs, raising approximately $10.0 billion at an average rate of 7.6%.
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Master Limited Partnerships Figure 30. High Yield Debt Offerings: 2008 Versus 2010 Year-To-Date
$4.0 Amount Raised From Non-Inv. Grade Offerings ($ in Billions) $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 $0.5 $0.0 Mar-08 Mar-10 Apr-08 Nov-08 Apr-10 Jul-08 Jan-08 Jan-10 May-10
$0.3 $0.7 $0.8 $0.2 $0.7 $0.3 $2.5
$3.7
$1.4 $1.1
$0.5
$0.1
$0.3
Jul-10
May-08
Dec-08
Sep-08
Sep-10
Jun-08
Jun-10
Aug-10
Nov-10*
Aug-08
Feb-08
Feb-10
Note*: 2010 data as of November 16, 2010 Source: Partnership reports
X. Tax And Legislative Issues

A. Who Pays Taxes
Because an MLP is treated as a partnership and not a corporation for federal income tax purposes, an MLP incurs no federal income tax liability and does not pay corporate-level federal income taxes. However, there is some tax leakage at the MLP level if the partnership owns foreign assets and/or operates in a state with franchise (margin) taxes. For example, an MLP chartered or organized in Texas, or doing business in Texas is required to pay franchise (margin) taxes. The tax is assessed at a rate in the range of 0.5-1.0% on Texas sourced taxable margin, which is defined as the lesser of (i) 70% of total revenue or (ii) total revenue less (a) cost of goods sold or (b) compensation and benefits. Partners in an MLP (the limited partner unit holders and the GP) are required to take into account their allocable share of the partnerships income, gains, losses, and deductions, including accelerated depreciation and amortization deductions in computing their federal income tax liability. However, distributions by an MLP are generally not taxable to a unitholder unless the amount of cash distributed is in excess of his or her adjusted tax basis. In general, the ratio of taxable income to distributions for an MLP is approximately 20% (the median). The amount of taxes a LP unitholder pays is determined by several factors, including the unitholders percentage ownership in the partnership, when the investment was made, and stock price at that time. To note, if the partnership generates a net loss (after deductions), it is considered a passive loss under the tax code and may not be used to offset income from other passive activities or investments. However, the loss can be carried forward and used to offset future income from the same MLP.
B. What Are The Tax Advantages For The LP Unitholder (The Investor)?
Taxed-Deferred Income As previously noted, a unitholder is typically allocated an amount of federal taxable income from an MLP that is roughly equivalent to 20% of the cash distribution received each year. In other words, the MLP distributions received by a limited partner (i.e., the investor) are approximately 80% tax deferred (on a median basis) in a given year. Thus, the investor would pay ordinary income tax only on the income allocated to him or her, which roughly equates to 20% of the distributions received in that year. The tax-deferred portion of the distribution is not taxable until the investor sells the security. The tax deferral rates (or ratios of non-taxable income to distributions) differ for each MLP and are listed in Figure 31.
30
Dec-10*
Oct-08
Oct-10
MLP Primer -- Fourth Edition Figure 31. MLP Estimated Tax Deferral Rates
100% 90% Tax Deferral Rates (%) 80% 70% 60% 50% 40% 30% 20% 10% 0%
Tax Deferral Can Go Below 80% If an MLP does not make continual investments, the tax shield created by depreciation and other deductions could decrease. In that case, the amount of distributions in a given year that would be tax deferred would decrease over time below the typical 80% level. Since most MLPs in recent years have been growing via acquisitions and expansion projects, this has not yet become an issue. Technical termination. Another circumstance in which an investors tax shield could go below 80% is a technical termination of the partnership. A termination of the partnership for federal income tax purposes occurs if there is a sale or exchange of 50% or more of the partnerships capital and profit interests during any 12-month period. Implications of a technical termination include (1) the closing of the MLPs taxable year for all unitholders. The MLP would file two tax returns for the fiscal year in which the technical termination occurred and unitholders would receive two Schedule K-1s for that year unless the IRS grants a special relief; (2) the MLP would be treated as a new partnership for tax purposes; (3) a significant deferral of depreciation deductions allowable in computing the MLPs taxable income could occur, which could result in a higher ratio of taxable income-to-distributions (i.e., a lower tax-deferral rate) for the partnership; and (4) the event would not affect the MLPs classification as a partnership for federal income tax purposes. In general, the tax deferral for the MLP (median of 80%) would be restored for the following year.
C. Some Tax Considerations And Disadvantages For The LP Unit Holder

Timing of K-1 availability. Because MLPs are partnerships, investors receive Schedule K-1s instead of 1099s for tax reporting. The K-1 tax form is the statement that an MLP investor receives each year from the partnership that shows his or her share of the partnerships income, gain, loss, deductions, and credits. K-1 forms are usually distributed in late February or early March, which can make it difficult for investors to meet the April 15 Federal and State tax filing deadline. Most K-1s can be retrieved online (via the partnerships website and at www.taxpackagesupport.com), and many popular tax software programs (e.g., Turbo Tax) have easy-to-use forms for K-1 reporting. Potential for multiple filings. In addition to federal income taxes, LP unitholders may be required to file foreign, state, and local income tax returns, and pay state and local income taxes in some or all of the various jurisdictions in which an MLP conducts business or owns property. Investors may be subject to foreign, state, and local taxes and return filing requirements even if he or she does not live in any of those jurisdictions. Potential for tax liability even if distributions are eliminated. An MLP may allocate taxable income to unitholders even during periods when it does not pay a distribution. Accordingly, a unit holder may be required to pay tax on his or her share of allocated income regardless of whether he or she receives a distribution from the MLP. Potential for tax liability when distributions exceed tax basis. In general, MLP distributions are not taxable to the unitholders for federal income tax purposes. However, if a cash distribution exceeds a unitholders tax basis immediately before the distribution (e.g., would reduce the cost basis to zero), the excess will typically be treated as a gain from the sale of the unit and will be taxed accordingly.
EEP BBEP KMP EPD G EL DEP LINE FGP BGH EPE ETP NKA NS WPZ BWP OKS SXL MMP PNG EPB SEP MMLP CQP EXLP TLP TCLP BKEP CPNO NGLS RGN CMLP CHK EROC APL Med. XTEX ENP NRGY SPH SGU KSP PVR PVG NSH BPL HEP CLMT WES APU OXF AHD PAA DPM LGCY PSE CEP G LP TGP NRP ARLP MWE EVEP VNR CPLP ETE AHGP NMM TOO
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D. The Mechanics Of A Purchase And Sale Of MLP Units And The Tax Consequences
We provide a simplified example illustrating the mechanics of a purchase and sale of an MLP unit and the associated tax consequences. In our example, we assume one MLP unit is (1) purchased for $20.00 per unit, (2) held for five years, and (3) sold at the end of year five for $25.00 per unit (i.e., a $1.00 per unit increase in the unit price each year). We also assume no distribution increases over the five-year period and an ordinary income tax and long-term capital gains tax rates of 35% and 15%, respectively. Figure 32. Simplified MLP Purchase And Sale Mechanics
Unit Purchase Price MLP XYZ unit price Annual distribution per unit Distribution yield % of distribution tax deferred (tax shield) Ordinary (personal) income tax rate Capital gains tax rate Tax deferred portion of distribution Taxable portion of distribution Tax paid at the end of each year on distributions received (at 35%) Cost basis in MLP XYZ Tax paid when units are sold at the end of year 5: Capital gains tax paid (on unit price increase to $25 from $20) Ordinary income tax paid (on "return of capital" - reduction in investor's cost basis from $20 to $16) Tax paid on year 5 distribution Total tax paid at the end of year 5 $0.75 $1.40 $0.07 $2.22 Taxed at long-term capital gains tax rate of 15% This is also equivalent to the tax deferred portion of the distributions over the 5-year period (i.e. $0.80/unit per year 5 years = $4.00), which is taxed at the ordinary income tax rate. $20.00 $20 $1.00 5.0% 80% 35% 15% $0.80 $0.20 $0.07 $19.20 $0.80 $0.20 $0.07 $18.40 $0.80 $0.20 $0.07 $17.60 $0.80 $0.20 $0.07 $16.80 $0.80 $0.20 $0.07 $16.00 The tax deferred portion of the distribution is considered a "return of capital," which reduces the investor's cost basis Year 1 $21 $1.00 4.8% Year 2 $22 $1.00 4.6% Year 3 $23 $1.00 4.4% Year 4 $24 $1.00 4.2% Sell Unit At The End Of Year 5 $25 $1.00 4.0%
Each year the MLP pays a cash distribution of $1.00 per unit, but also allocates taxable income equal to 20% of the distribution to the investor. As a result, the investor pays tax on income of $0.20 per unit. The investor pays tax of $0.07 per unit, which is based on the ordinary income tax rate (of 35%) multiplied by the taxable income allocated ($0.20 per unit or 20% of the distribution received). Figure 33. Tax-Deferral Calculation
Annual distribution Tax deferral rate Tax deferred portion of distribution Taxable portion of distribution Ordinary income tax rate Tax due on year 1 distribution received
$1.00 80% $0.80 $0.20 35% $0.07
Annual distribution minus tax deferred portion of distribution equals taxable portion of the distribution
The investors tax basis in the unit is reduced by $0.80 per year (i.e., the distribution of $1.00 per unit reduces the tax basis and the income allocated of $0.20 per unit increases the tax basis, which nets to $0.80 per unit or the tax-deferred portion of the distribution). For example, at the end of year 1, the investors tax basis is reduced to $19.20 from $20.00. At the end of five years, the investors tax basis in the security is $16 per unit (i.e., the annual tax-deferred portion of the distribution of $0.80 x five years).
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MLP Primer -- Fourth Edition Figure 34. Adjustment In Investors Tax Basis
$ per unit Cost basis - start period Tax deferred portion of distribution Cost basis - end period Year 1 $20.00 $0.80 $19.20 Year 2 $19.20 $0.80 $18.40 Year 3 $18.40 $0.80 $17.60 Year 4 $17.60 $0.80 $16.80
Year 5 $16.80 $0.80 $16.00
At the end of years 2-4, the unitholder pays the same tax of only $0.07, as we assume the distribution of $1.00 is maintained. Since we assume the unitholder sells the MLP unit at the end of year five, the unitholder not only pays the $0.07 tax on the distribution of $1.00, but also a capital gains tax of $0.75 ([$25-20] 15%) and recapture of the deferred tax related to distributions in years 1-5 of $1.40 ($0.80 5 35%). The total related taxes paid at the end of year 5 is $2.22 (i.e., capital gains tax of $0.75 + recapture of deferred taxes on prioryear distributions of $1.40 + tax due on year five distribution of $0.07). Figure 35. Taxes Paid At The End Of Year Five (The Sale)
Total deferred portion of distribution (years 1-5) Ordinary income tax rate Recapture of deferred tax related to year 1-5 distributions Unit price at the end of year 5 Unit price at the start of year 1 Unit price appreciation Capital gains tax rate Capital gains tax paid on unit price appreciation Recapture and capital gains related taxes due Tax due on year 5 distribution received Total taxes paid at the end of year 5
$4.00 35% $1.40 $25 $20 $5 15% $0.75 $2.15 $0.07 $2.22
The tax ramifications are as follows. The investor would book a capital gain of $5.00 per unit (the gain to $25 from $20 and pay tax at the long-term capital gains rate ($5.00 x 15% = $0.75). The gain of $20.00 per unit from $16.00 per unit is referred to as re-capture and represents the tax-deferred income received throughout the five years of ownership. Thus, the $4.00 gain is considered ordinary income and taxed at the ordinary income rate ($4.00 x 35% = $1.40).
E. Return Of Capital Versus Return On Capital

As illustrated in Figure 34, the tax-deferred portion of the distribution received by an investor is considered a return of capital as it reduces the investors cost basis in the MLP security. In our example, we assume an investor purchases a unit of MLP XYZ for $20, which pays a distribution of $1.00 per unit. Based on an 80% tax-deferral rate, $0.80 of the distribution is tax deferred, which reduces the investors cost basis in MLP XYZ to $19.20 from $20.00 at the end of year one. Specifically, the distribution of $1.00 per unit reduces the investors cost basis and the allocation of $0.20 per unit increases the cost basis, which nets to a decrease of $0.80 per unit. After five years and assuming no change to MLP XYZs tax deferral rate, the investors return of capital would be $4.00 (i.e., $0.80 per unit per year five years = $4.00), which reduces the investors cost basis to $16.00 from $20.00. The return of capital is taxed at the investors ordinary income tax rate upon sale of the investment. If we also assume the investor sells MLP XYZ at the end of year five and that MLP XYZs unit price has appreciated to $25, the investor would realize a return on capital of 25% before taxes (i.e., [$25-20] $20 = 25%).
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F. Foreign Investor Ownership

A non-resident alien and foreign corporation, trust, or estate that own MLP units will be considered to be engaged in business in the United States. Consequently, a foreign investor will be required to file a federal tax return to report the individuals share of an MLPs income, gain, loss, or deduction and pay federal income tax at regular rates on its share of the MLPs net income or gain. In addition, the MLP will reduce quarterly distributions to a foreign unitholder by withholding taxes (at the highest applicable effective tax rate). The foreign unitholder could obtain credit for the withholding taxes by securing a taxpayer identification number from the IRS and submitting Form W-8BEN to the MLPs transfer agent. A foreign corporation that owns MLP units could also be subject to additional tax liability and reporting requirements (e.g., U.S. branch profit tax at a rate of 30%, federal income tax on gain from the sale of MLP units, etc.).
G. Treatment Of Short Sales

If an investor lends his or her MLP units to a short seller to cover a short sale of units, the transaction may be considered as a sale and trigger a taxable gain or loss from the disposition. During the loan period, any cash distributions received by the unitholder could be fully taxable as ordinary income. Since the investor would not be considered a partner, the MLP would not allocate any income, gain, loss, or deduction to the unitholder during the loan period.
H. Can MLPs Be Held In An IRA?

Technically yes, MLPs can be held in individual retirement accounts (IRA). However, we would not recommend doing so due to potential tax consequences. Employee benefit plans and most other organizations exempt from federal income tax, including IRAs, 401Ks, and other retirement plans, are subject to federal income tax on unrelated business taxable income (UBTI). In general, all income allocated to investors from MLPs is considered UBTI. If an IRA earns more than $1,000 of UBTI annually from all MLPs held and other sources of UBTI, the excess income (above $1,000) is subject to tax. The custodian of the IRA would file IRS Form 990-T and pay the tax on UBTI in excess of $1,000 from funds in the account. In addition, it would pay estimated tax if it expects the tax for the year will be $500 or more. Consequently, it may not be tax efficient to own MLPs in an IRA given that the excess UBTI may be taxed twice (i.e., the IRA would be taxed on UBTI above $1,000 and the owner or beneficiary could also be taxed on distributions of that income). We recommend placing MLP units in traditional brokerage accounts to avoid this issue and to ensure that the investor receives the full tax advantages of the security. However, if an investor wanted to hold MLPs in a tax-exempt account, we have provided a simplified example calculating the maximum number of units in one MLP security that an investor can hold (in such an account) without triggering adverse tax consequences. In our example, we assume (1) a MLP XYZ unit price of $30.00, (2) total distribution payments of $2.10 per unit (implying a yield of 7.0%), (3) a tax-deferral rate of 80%, (4) MLP XYZ maintains its distribution rate, (5) MLP XYZ does not experience any material gains from asset sales (which would otherwise be applied to an investors UBTI limit and lower the number of MLP XYZ units that can be held in a tax-exempt account), and (6) the investor has no other sources of UBTI. On the basis of these assumptions, the MLP income (UBTI) allocated to the investor would equal $0.42 per unit (i.e., the ratio of income to distributions of 20% multiplied by the total distribution of $2.10 per unit). Since the threshold for UBTI is $1,000 per year, we divide the UBTI threshold by the amount of income allocated (i.e., $0.42 per unit) to calculate the maximum number of units that an investor can own of MLP XYZ. This equals 2,381 MLP XYZ units. Based on this number of units and the amount of income allocated by the MLP of $0.42 per unit, the investors tax-exempt account would receive income of $1,000 for the year.
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Figure 36. Maximum MLP Holding Number Of Units Before Exceeding UBTI Limit
MLP XYZ unit price Annualized distribution per unit Distribution yield Tax deferral rate Taxable portion of distribution (20%) UBTI threshold Max. ownership number of MLP XYZ units Market value of MLP XYZ units MLP XYZ income received in one year Adverse tax consequences triggered?
$30.00 $2.10 7.0% 80% $0.42 $1,000 2,381 $71,429 $1,000 No
However, since most MLPs are likely to increase their distributions over time, an investors UBTI limit could be easily exceeded. In our example, if we assume MLP XYZ raises its distribution by 5% (See Period 2 in Figure 37) to $2.21 from $2.10 in the prior period, while holding all else equal, the investors annual UBTI would approximate $1,050, triggering adverse tax consequences for the investor since the income has exceeded the $1,000 limit. Figure 37. UBTI Limit Could Be Easily Exceeded
Period 1 MLP XYZ unit price Annualized distribution per unit Distribution yield Tax deferral rate Taxable portion of distribution (20%) UBTI threshold Max. ownership number of MLP XYZ units Market value of MLP XYZ units MLP XYZ income received in one year Adverse tax consequences triggered?
Period 2 $30.00 $2.21 7.4% 80% $0.44 $1,000 2,381 $71,429 $1,050 Yes
$30.00 $2.10 7.0% 80% $0.42 $1,000 2,381 $71,429 $1,000 No
I.
MLPs As An Estate Planning Tool
MLPs can be used as a tax-efficient means of transferring wealth. When an individual who owns an MLP dies, the individuals MLP investments can be transferred to an heir. When doing so, the cost basis of the MLP is reset to the price of the unit on the date of transfer. Thus, the tax liability created by the reduction of the original unitholders cost basis is eliminated. To note, the step-up in cost basis may not be applicable for the 2010 tax year. Currently, estate tax regulations are in a period of flux due to the repeal of federal estate taxes for 2010 and the potential for Congress to reinstate the estate tax law and apply regulations retroactively. We recommend that investors consult a tax or estate professional for advice.
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J. Current Tax And Legislative Issues

What Is The National Association Of Publicly Traded Partnerships (NAPTP)? The NAPTP is a trade association formed in 1983 that represents the interests of publicly traded partnerships (including publicly traded LLCs taxed as partnerships) and their respective employees on legislative and regulatory issues in Washington, D.C. and in all states. The association currently represents the interests of 93 publicly traded partnerships (PTPs), of which 72 are energy MLPs. The NAPTP hosts an annual conference that allows its PTP members to provide company presentations to current and prospective investors. Additional information regarding the association can be found at www.naptp.org. What Is The Risk Of MLPs Losing Their Tax-Advantaged Status? There has been some concern among investors that MLPs could be at risk of losing their tax benefits, as Congress could use this potential tax revenue to reduce current and future deficits. However, the risk of MLPs losing their tax-advantaged status is low, in our view. The advantages of the MLP tax structure were originally developed by Congress in mid- to late 1980s, through the passage of the Tax Reform Act of 1986 and the Revenue Act of 1987. These bills exempted MLPs from corporate taxation, as long as at least 90% of their income is derived from natural resource or mineral activities (including exploration, development, mining, processing, refining, transportation, or marketing, etc.). While the current Administrations adverse stance toward the oil and gas industry and the need for revenue offsets have caused some concern among MLP investors, MLPs role in the energy and investor markets make it unlikely that Congress would take actions to harm the MLP structure, in our view. U.S. energy infrastructure investment. Congress established the MLPs favored tax status, in part, to encourage investment in U.S. energy infrastructure. This has largely proven successful as MLPs have been a major participant in the recent buildout of energy infrastructure (e.g., pipelines, storage, processing plants, etc.) across multiple commodities (e.g., natural gas, crude oil, refined products, ethanol, etc.). From 2005 to 2009, MLPs (Wells Fargo Securities MLP coverage universe) invested almost $50 billion in organic growth capital spending, largely in support of the aforementioned infrastructure projects. In addition, MLPs are expected to continue to invest significant amounts of capital in the foreseeable future. MLPs are predominantly retail owned. Despite an increase in institutional ownership, the MLP investor base is still predominantly retail. According to PricewaterhouseCoopers, almost 65% of MLP securities are held by retail investors. Many of these investors own MLPs because of their tax advantages and high yields. Some, particularly retirees, rely on MLP yields for income. Thus, any action to remove the MLPs tax status or otherwise would likely directly affect many U.S. citizens (in particular, retirees). Lessons from Canadian trusts demonstrate ramifications of tax status modifications. In late 2006, the Canadian government announced plans to begin taxing Canadian trusts at a tax rate ranging from 31% to 35% starting in 2011. The impetus for the change in tax law was the potential for significant lost tax revenue as many companies in Canada (in sectors beyond energy and real estate) had converted, or were contemplating conversion, to the trust structure. Canadian trusts were off about 20%, on average, in response. Given the ramification, as demonstrated in Canada, we suspect the Administration would think twice before changing the tax status of MLPs, which would likely result in a similar decline in valuation in the U.S. MLP sector. Further, the U.S. government already addressed these issues with the passage of the Tax Reform Act of 1986 and the Revenue Act of 1987, which essentially limited the types of assets that qualify for the MLP structure (i.e., natural resource or mineral activities including exploration, development, mining, processing, refining, transportation, or marketing, etc.). MLPs beginning to play a larger role in renewable energy infrastructure. MLPs already play a significant role in the storage and blending of bio-diesel and ethanol, and this role could be expanded to other renewable fuels and infrastructure. For example, KMP has committed significant capital to handle renewable fuels across its various business lines. Management estimates that the partnership will handle 250 thousand barrels per day (MBbls/d) of renewable fuels in 2010, or 25-30% of the U.S. market. Kinder Morgan is already operating a small ethanol pipeline in Florida. In addition, Magellan Midstream Partners and POET Ethanol Products are exploring the potential construction of an ethanol pipeline. Several refined product MLPs continue to make investments in storage and blending facilities to handle ethanol and biodiesel (e.g., Magellan Midstream Partners, NuStar Energy, and TransMontaigne Partners). Potential tax revenue from MLPs would be insignificant. The entire energy MLP market capitalization is just $220 billion. To put this in perspective, the market cap of Exxon Mobil, alone, is $350 billion. In 2009, a report furnished by the Joint Committee on Taxation quantified the lost tax revenue from not taxing MLPs at the corporate level at just $2.6 billion for the time period of 2008-2012. Also, MLP unitholders do pay taxes; however, MLP unitholders are not subject to double taxation as the partnership is not taxed at the entity level.
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MLP Primer -- Fourth Edition Canadian Royalty Trusts Tax Status Still On Track To Change In 2011
On June 22, 2007, the Canadian government passed into law the Tax Fairness Plan, which included a tax on distributions paid by Canadian Energy Trusts. For those Canadian Energy Trusts that were formed before November 1, 2006, the distribution tax will apply starting on January 1, 2011, while the other trusts created after October 31, 2006, began paying taxes in 2007. Under this proposal, Canadian royalty trusts would be taxed like all other Canadian corporations, at the full 31.5% rate. The Canadian government took this action to close what amounted to a significant tax loophole (i.e., loss revenue due to the tax structure of a royalty trust). While most of the early trusts were confined to real estate and energy, many companies in other sectors converted or contemplated the conversion to the trust structure. Public MLP Unitholders Unlikely To Be Affected By Carried Interest Legislation The PTP structure came under increased scrutiny following the initial pubic offering (IPO) of a number of private equity and hedge fund managers structured as PTPs. Some members of Congress took issue with the fund managers form of compensation, which is in part treated as a form of carried interest, which is taxed as capital gains (taxed at 15%), as opposed to ordinary income (i.e., 35%). While this concern is not related to energy MLPs, proposed legislation to tax carried interest at ordinary income tax rates could potentially affect the general partners of MLPs. To note, the carried interest issue has no bearing on conventional MLPs (i.e., all MLPs, but publicly traded GP MLPs). The proposed legislation was written so as to target any PTP that received compensation in the form of carried interest. This included both private equity funds and publicly traded GP MLPs, which receive carried interest in the form of incentive distribution payments. However, the NAPTP has been working to educate Congress on the differences between energy GPs and private equity funds. Specifically, private equity funds attempt to convert services (ordinary) income into capital gains income and thereby, pay taxes at a lower rate. In contrast, the carried interest of a publicly traded GP MLP (IDR) is passed through as ordinary income and taxed at the higher rate at the unitholder level. Based on the language included in the latest proposed carried interest bill, the provisions should not result in material tax implications for GP MLPs and their public unitholders or jeopardize the partnerships PTP status under section 7704 of the Internal Revenue Code, in our view. However, the bill, as written, could have negative tax implications for a manager of a GP upon the sale of his or her GP (carried interest) ownership. If the manager is deemed as a provider of investment management services (e.g., advising in, purchasing, selling, and managing a specified asset), then the disposition will be taxed at ordinary income, instead of capital gain, rates. The definition of a manager is open to interpretation by the Treasury, but could include senior management of the partnerships and active large investors or owners of units (such as private equity firms). To note, the flurry of transactions in late 2010 to acquire or eliminate the GP and/or IDRs was, in part, driven by managers desire to effectively sell or convert their GP interest to MLP common units ahead of any potential passage of carried interest legislation, in our view. (For more information concerning general partners, please see Publicly Traded General Partners - Recognizing The Value Of The GP). MLPs Included In FERC Process For Determining Pipeline ROEs The FERC is an independent agency that regulates the interstate transportation of electricity, natural gas, and oil. In April 2008, FERC adopted a new policy to include MLPs as proxy pipeline companies in establishing the allowed rate of returns, return on equity (ROE), for interstate natural gas and oil pipelines that adopt cost of service ratemaking. The change was driven by the increasing number of pipeline assets owned by MLPs. To note, not all interstate pipelines have cost-of-service rates. Other tariff types include index-based, marketbased, settlement rates, and negotiated rates with shippers. Nuances in calculating ROE. Under the FERCs discounted cash flow (DCF) model, ROE equals the dividend yield plus the projected future growth rate of dividends (i.e., short-term growth rate two-thirds weighted + long-term growth rate one-third weighted). For MLPs, the FERC does not cap an MLPs distribution at its EPU in determining the yield, but instead uses the distribution as a proxy for the dividend. However, (unlike C corporations) an MLPs long-term growth rate (using GDP as a proxy) is reduced by 50% in calculating the ROE. Assuming GDP growth of 2.0%, this equates to a 1.0% reduction in the long-term growth rate forecast. This adjustment applies not only to MLP-owned gas pipelines, but also to oil pipelines, which have previously realized the full benefit of the long-term growth rate and inclusion in the proxy group. In addition, the ROE calculation does not incorporate the impact of incentive distributions paid to an MLPs general partner. We believe that this understates an MLPs cost of equity (i.e., hurdle rate for investments), which invariably increases as it increases its distribution.
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Master Limited Partnerships MLPs Income Tax Allowance In Pipeline Ratemaking
The FERC currently allows MLPs to include an income tax allowance when determining their cost-of-service. Utility companies and producers (the primary customers of pipelines) had argued that MLPs should not be able to use the income tax allowance since MLPs do not pay income taxes. In 2004, a U.S. Court of Appeals remanded a previous FERC ruling that allowed MLPs to use a partial income tax allowance. In May 2005, after review of the remanded case, the FERC issued a statement allowing partnerships to include income tax allowance provided the entity can show that income generated by the entity was subject to an actual or potential tax liability. Notably on April 6, 2010, in a case involving several shippers versus Sante Fe Pacific Pipeline (SFPP, L.P., a subsidiary of Kinder Morgan), an Administrative Law Judge (ALJ) issued a proposed decision to the California Public Utilities Commission (CPUC) contrary to previous CPUC and FERC rulings. The ALJ found that SFPP, L.P. did not demonstrate that its limited partners had a corporate tax liability in addition to the tax liability paid by its limited partners only after recognition of distributed income. Furthermore, the ALJ noted that the court had no evidence related to the tax on the partnerships income after distribution. While this ruling was advisory in nature, Kinder Morgan ultimately settled the case along with additional rate challenges ten days later for approximately $205 million. It is important to note that FERCs May 2005 ruling permitted cases to be reviewed on a case-by-case basis. While any changes to FERCs treatment of tax allowance could negatively affect a MLPs ROE on interstate pipelines, we believe that the FERC will adhere to its original statement and continue to permit MLPs to use income tax allowance when calculating cost of service.
XI. MLP Accounting Nuances

A. How Can MLPs Pay Out More Than They Earn?
In analyzing MLPs, we typically do not focus on earnings per share or earnings per unit (EPS/EPU), as we believe the focus for MLPs should be on cash flow. This is due to the fact that cash flow determines how much can be paid out to unitholders in the form of distributions. We believe that earnings may misrepresent true economic value because of accounting conventions for non-cash items such as depreciation and amortization and non-cash market-to-market adjustments for commodity and interest rate hedges. Therefore, we tend to focus on cash flow metrics, in particular, distributable cash flow, as this determines how much cash flow can be paid out in the form of distributions. The primary non-cash items which explain the differences between earnings and distributable cash flow are as follows: (1) Depreciation & amortization expense versus maintenance capital expenditures. Per accounting rules, assets are depreciated over their useful lives as defined by GAAP. For example, pipeline assets are depreciated over 35 years. In reality, many pipelines are able to operate well beyond their depreciable lives with proper maintenance spending. Consequently, distributable cash flow (which deducts maintenance capex) will be higher than earnings (which deduct deprecation expense). (2) Non-cash mark-to-market adjustments for future derivative positions. MLPs with future hedges in place must mark these positions to market every quarter even though there is no cash flow impact to the partnership until the hedge settles in the future. Consequently, a movement in the shape of the NYMEX future curve will impact earnings but has no bearing on the current quarters cash flow. (3) Cash versus GAPP interest expense. Interest expense on the income statement can contain certain non-cash items such as the amortization of certain financing charges. The DCF calculation excludes these non-cash expenses. (4) Non-cash general and administrative expense. G&A expense will often include non-cash compensation expense tied to the movement of the partnerships unit price during the quarter. Since this has no cash impact, this expense is excluded from DCF. (5) Equity income versus cash distributions from unconsolidated affiliates. MLPs with ownership in joint ventures or other non-controlling subsidiaries will report equity income on their income statements. However, cash distributions received from affiliates/subsidiaries often times differs from equity income. As a result, the DCF calculation will deduct equity income but add back distributions received from affiliates resulting in a discrepancy between the two metrics.
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In Figure 38, we provide a simplified example illustrating how an MLP is able to pay out more in distributions than what the partnership reports on its income statement in the form of earnings per unit. The following example assumes the following: Revenue of $500 million Operating expense of $350 million Depreciation expense of $50 million G&A expense of $20 million Interest expense of $10 million Maintenance capex of $25 million Distribution coverage ratio of 1.0x (or excess cash flow of $0 million) 25 million units outstanding Distribution of $3.00 per unit MLP is in the 50/50 distribution tier
On the basis of these assumptions, the MLPs earnings per unit (EPU) is $2.02 versus DCF per unit and a distribution per unit of $3.00. The main variance between these two calculations is how depreciation expense (a non-cash charge) is used in calculating net income and distributable cash flow. On the income statement, depreciation expense is subtracted in determining net income, while it is added back to determine DCF. To note, DCF takes into account maintenance capex, which reduces available cash flow for distributions. Figure 38. Comparison Of Earnings Versus Cash Flow
$ in millions, except per unit data Simplified Income Statement Revenue (-) Operating expense Gross margin (-) Depreciation expense (-) G&A expense Operating income (-) Interest expense Net income General partner (GP) interest Limited partner (LP) interest Earnings per unit (EPU) Units outstanding (MM) Net income (+) Depreciation expense (+) Interest expense EBITDA $500.0 $350.0 $150.0 $50.0 $20.0 $80.0 $10.0 $70.0 $19.5 $50.5 Distribution per unit $2.02 25.0 $70.0 $50.0 $10.0 $130.0 Units outstanding (MM) Distribution coverage ratio Excess cash flow 25.0 1.00x $0.0 $3.00 Distributable Cash Flow Calculation Net income (+) Depreciation expense (+) Interest expense EBITDA (-) Interest expense (-) Maintenance capex Available cash flow Cash paid to GP Distributable cash flow (DCF) DCF per unit $70.0 $50.0 $10.0 $130.0 $10.0 $25.0 $95.0 $20.0 $75.0 $3.00
B. Mark-To-Market Hedge Accounting

Mark-to-market hedge accounting can obscure the ongoing cash flow generating capability of the MLP and could result in significant earnings volatility; however, a majority of the volatility is usually non-cash. To note, we do not focus on earnings per unit (EPU), because we believe the focus for MLPs should be on cash flow rather than earnings.
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Mark-to-market hedge accounting affects MLPs that maintain future hedge positions, principally to mitigate exposure to commodity price volatility. Per accounting rules, the MLP must assign a value to its derivatives positions based on the current market prices for those future derivative instruments. For example, the value of a futures contract with an expiration date of one year from today is not known until it expires. However, if the contract is marked-to-market, the futures contract is assigned a value based on current market prices. The impact of mark-to-marketing accounting affects different parts of a companys financial statements depending on whether the derivative is classified as trading or other than trading. Derivatives classified as trading are recognized as assets or liabilities with the corresponding loss or gain recognized in the income statement. Derivatives classified as other than trading are also measured at fair value and recognized as assets or liabilities, with the changes in value included as a component of stockholders equity until realized. Realized gains and losses would be included in earnings. In order to offset the mark-to-market movement of derivatives, some companies may employ hedge accounting (i.e., if the company is able to qualify).
C. Hedge accounting
Financial Accounting Standards Board (FASB) Statement No. 133 allows companies to recognize all derivatives as either assets or liabilities and measure those respective instruments at fair value. To qualify for FAS 133 hedge accounting, a commodity (i.e., the hedged item) and its hedging instrument must have a correlation ratio between 80% and 125%, and the company must have hedge documentation in place at the inception of the hedge. If these criteria are not met, hedge accounting cannot be applied, which could lead to significant volatility in a companys earnings. There are three different types of hedge accounting:
Fair value hedges. A fair value hedge attempts to mitigate the exposure to changes in the fair value of a recognized asset, liability, or firm commitment. The gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. (source FASB) Cash flow hedges. A cash flow hedge attempts to mitigate the exposure to changes in cash flow of a forecasted transaction. The effective portion of the derivatives gain or loss is initially reported in other comprehensive income (outside earnings) and subsequently reclassified into earnings (as either gains or losses in operating revenue) as the forecasted transactions occur. The ineffective portion of the gain or loss is reported in earnings for the period in which the ineffectiveness occurs. (source FASB) Net investment hedges. A net investment hedge attempts to mitigate foreign currency exposure of a net investment in a foreign operation. The gain or loss of a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation is reported in other comprehensive income (outside earnings) as part of the cumulative translation adjustment.
D. Partners Capital -- Implications For Debt-To-Capital Ratio

Because MLPs generally pay out more in distributions than they earn (on an accounting basis), partners capital (akin to shareholders equity) on the balance sheet will tend to decrease each quarter, absent any new issuance of equity units. Specifically, net income increases partners capital, while distributions paid reduce the balance. As a result, an MLPs debt-to-capital ratio will often seem very high (as the denominator, partners capital, is decreasing). For this reason, MLP investors and the credit rating agencies tend to focus on the MLPs debt-to-EBITDA and EBITDA-to-interest expense ratios when monitoring the credit health of the partnership. These metrics measure the MLPs ability to service debt obligations with operating cash flow.
XII. Sector Trends

A. Dramatic Growth Of MLPs
Over the past ten years, the MLP universe has grown by any measure. The number of energy MLPs has increased more than tenfold, to 72 in 2010 (to date) from 6 in 1994. In addition, the total market capitalization of the energy MLP universe has grown to roughly $220 billion in 2010 from approximately $2 billion in 1994. Over that time period, the average market cap has increased to $3.1 billion from $297 million.
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MLP Primer -- Fourth Edition Figure 39. Number Of MLPs And Market Capitalization
$250 $225 $200 Market capitalization ($ in billions) $175 $150 $125 $100 $75 $50 $25 $0 6 $2 1994 8 $3 1995 11 $4 1996 11 $6 1997 15 17 18 $47 $11 1998 $11 $16 1999 2000 2001 2002 2003 2004 2005 $27 $30 $55 24 $71 31 32 36 47 Total market capitalization of energy MLPs Number of energy MLPs
100 $220 74 77 70 90 80 70 60 $145 $159 $90 50 40 30 20 10 0 2006 2007 2008 2009 2010YTD Num ber of MLPs
72
60
$109
Source: FactSet and National Association of Publicly Traded Partnerships
MLP Average Trading Volume Continues To Grow Liquidity has improved dramatically for the MLP universe, increasing to 218,000 units per day to date in 2010 from an average volume of 35,500 units per day in 1994. Since 2003, the average daily trading volume for energy MLPs has increased to $563 million from $55 million, or a 39% CAGR. This is likely due to the significant positive fund flow by closed-end funds, as well as a renewed interest by institutional investors. Year to date, large-cap pipeline MLPs made up 53% of the total daily traded value, followed by gathering and processing MLPs, 14%; upstream MLPs, 11%; and general partner MLPs, 7%. Of note, the average daily trading value represents the variable weighted average daily price (VWAP) multiplied by the total number of shares traded that day for each MLP. Figure 40. Average Daily Trading Value By MLP Sub-Sector
$600
$563
$500
($ in Millions)
$400
$349 $286
$377
$300
$200
$146 $85 $55 $113
$100
$0 2003 Large-Cap Pipeline 2004 Small-Cap Pipelines 2005 2006 2007 Upstream MLPs 2008 Propane Ship Coal 2009 2010 YTD
Gathering & Processing
General Partner
Source for chart and table: FactSet
B. MLP Investor Base Has Been Evolving

MLPs are still predominantly owned by retail investors. However, institutional investor interest in the sector has increased. The level of institutional interest has ebbed and flowed over the past few years. In the 2006-08 time frame, there was a significant increase in institutional ownership primarily by hedge funds, a few traditional mutual funds, and newly created closed-end funds. These investors participated in the MLP sector via direct investments, private investment in public equity (PIPE), and total return swaps. However, many of these funds suffered significant losses during the in mid- to late 2008. Subsequently, MLP ownership swung back to its traditional retail investor base. We estimate approximately 90-95% of secondary equity sold in 2009 was to retail investors.
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Master Limited Partnerships Figure 41. Breakdown By MLP Ownership Type

100% 22% 75% 2% 22% 4% 7% 50% 76% 25% 74% 65% 8% 8% 31% 29% 27%
Percent Ownership
62%
63%
0% 2005 2006 Retail 2007 Foreign investors 2008 Institutional 2009
Source: PricewaterhouseCoopers LLP, Partnership reports, and Wells Fargo Securities, LLC estimates
Institutional Investor Interest Growing In 2009 and 2010, the MLP sector has experienced another uptick in institutional interest primarily due to MLPs attractive yield characteristics relative to alternatives. In some ways, the nature of the capital flowing to the sector is different. A combination of newly formed closed-end funds, family wealth offices, and additional inflows to MLP dedicated funds can be mostly characterized as investors with long-term time horizons. However, a portion of the new capital has come from newly created MLP products (ETNs, ETFs, open-ended mutual funds) and traditional hedge fund investors. For a more detailed discussion of new products, please see Emergence Of MLP Products. Figure 42. Portfolio Composition Of Top 20 MLP Institutional Investors
Capital ($ in millions) Kayne Anderson Capital Advisors LP Tortoise Capital Advisors LLC Neuberger Berman LLC Fiduciary Asset Management LLC Argyll Research LLC Swank Energy Income Advisors LP Eagle Global Advisors LLC Fayez Sarofim & Co. Janus Capital Management LLC Glickenhaus & Co. Energy Income Partners LLC NFJ Investment Group RR Advisors LLC ClearBridge Advisors LLC Northwestern Investment Management Co. LLC Atlantic Trust / Invesco Advisers, Inc. Miller/Howard Investments, Inc. Harvest Fund Advisors LLC Westwood Management Corp. (Texas) PTP Holdings LLC Invested $4,600 $3,213 $2,863 $1,119 $881 $716 $701 $687 $615 $451 $408 $407 $400 $393 $373 $315 $282 $263 $252 $237 # Of Positions 47 39 48 47 12 44 33 7 6 24 36 14 16 30 16 33 19 35 28 14 Portfolio By Sector (Excludes PIPEs and TRS) Midstream 76% 92% 55% 80% 98% 62% 66% 97% 74% 72% 74% 81% 83% 78% 59% 78% 89% 78% 83% 72% GPs 12% 2% 35% 9% 2% 24% 20% 3% 26% 11% 17% 0% 1% 7% 34% 13% 6% 13% 14% 16% Upstream 0% 1% 2% 3% 0% 5% 0% 0% 0% 6% 0% 0% 17% 10% 7% 1% 2% 3% 0% 0% Propane 5% 5% 1% 5% 0% 3% 3% 0% 0% 2% 4% 13% 0% 6% 0% 2% 3% 1% 2% 11% Coal 0% 0% 0% 2% 0% 5% 0% 0% 0% 2% 3% 5% 0% 0% 0% 1% 0% 0% 2% 0% Shipping 5% 1% 7% 0% 0% 2% 11% 0% 0% 6% 2% 0% 0% 0% 0% 0% 0% 6% 0% 0%
Note: Data as of 6/30/10 Source: FactSet
C. Shift In Supply Resources Is Driving Energy Infrastructure Investment

Recent shifts in the supply sources of crude oil and natural gas have created the need for significant energy infrastructure. New resource plays have altered the flow of pipeline volume across the country. This, in turn, has increased demand for both pipeline capacity to transport supply from these new areas to traditional consuming markets and storage capacity to mitigate supply and demand imbalances created by new pipeline
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routes. In addition, import and export dynamics have shifted in response to changing global cash cost considerations for producing raw and finished commodity-based products (e.g., increasing imports of heavy crude oil from Canada and finished petroleum products from Asia). Finally, the market for natural gas liquids (and associated infrastructure) has expanded rapidly over the past several years, primarily due to a divergence in crude oil and natural gas prices, which has incentivized producers to shift capital away from dry natural gas plays (i.e., low in liquids content) in favor of wet natural gas plays (i.e., high in liquids content). To note, over the past five years (2005-09), MLPs invested approximately $50 billion on organic expansion projects. Figure 43. Historical Organic Capex Investments
$18.0 $16.0 Organic Capex ($ in Billions) $14.0 $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0.0 2000A 2001A 2002A 2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010E $0.4 $0.9 $1.0 $1.0 $1.4 $2.7 $5.5 $13.3 $11.5 $12.8 $16.5
Note: Data based on companies under coverage only Source: Partnership reports and Wells Fargo Securities, LLC estimates
In the following section, we have provided a high level overview of MLP-relevant trends occurring in the (1) natural gas, (2) natural gas liquids, (3) crude oil, and (4) renewable energy sectors and associated infrastructure opportunities for midstream MLPs. In addition, we have included a table showing gathering, processing, and transportation exposure by region for midstream MLPs under coverage (see Appendix). Natural Gas Over the past few years, the midstream industry has benefited along with producers in the development of unconventional natural gas shale plays by building necessary infrastructure (e.g., pipelines, storage, processing, and fractionation capacity). The U.S. pipeline system has historically been designed to transport natural gas and crude oil production from the Gulf Coast to markets in the Northeast and West. However, the development of new resource plays in Texas (i.e., North, South, and West), Oklahoma, Louisiana, Appalachia, and the Rockies is creating the need for significant infrastructure development to transport production from these new supply regions to the traditional end markets in the Northeast. Although we expect the magnitude of future capital investments to be less substantial than peaks seen in 2008, MLPs should continue to play a major role in this energy infrastructure boom, in our view.
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Master Limited Partnerships Figure 44. Major U.S. Natural Gas Shale Plays
Source: Energy Information Administration
MLPs have been a major participant in the buildout of U.S. energy infrastructure. From 2005 to 2009, MLPs were involved in 27%, or 69 out of 254 U.S. natural gas pipeline infrastructure projects. According to the Energy Information Administration (EIA), total domestic natural gas pipeline investments, capacity additions, and pipeline miles added totaled $29.3 billion, 112.2 billion cubic feet per day (Bcf/d), and 11,278 miles, respectively over this time frame. Based on EIA and partnership data, we estimate that MLPs accounted for 59%, 36%, and 53%, respectively of these totals. (Please see the Appendix for a list of the MLP-related pipeline projects.)
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Figure 45. Historical U.S. Natural Gas Pipeline Infrastructure Investments

Miles Of Natural Gas Pipeline Added 5,000
4,000
3,000
2,000
1,000
0 2005A 2006A
2005A $1.3 8.2 1,152 31 $0.4 35% 2.7 32% 618 54% 6 19%
2007A
2006A $2.3 12.7 1,582 46 $0.8 36% 2.8 22% 389 25% 7 15% 2007A $4.2 14.9 1,663 50 $1.6 39% 5.2 35% 691 42% 16 32%
2008A
2008A $11.6 44.6 3,893 84 $5.3 46% 14.0 31% 2,219 57% 26 31% 2009A $9.9 31.9 2,988 43 $9.1 92% 15.3 48% 2,092 70% 14 33%
2009A
Total 2005-09 $29.3 112.2 11,278 254 $17.3 59% 39.9 36% 6,009 53% 69 27%
$ in billions U.S. natural gas pipeline investments Associated capacity additions (Bcf/d) Pipeline miles added No. of natural gas pipeline projects MLP-related investments % of total MLP-related Bcf/d additions % of total MLP-related pipeline miles added % of total MLP-related projects % of total
Note: The 2009 capacity addition of 31.9 Bcf/d is based on the EIAs forecast that it published in a September 2009 report entitled, Expansion of the U.S. Natural Gas Pipeline Network: Additions in 2008 and Projects through 2011 as the EIA did not provide the actual capacity addition figure in its Natural Gas Year-In-Review 2009 that was released in July 2010. As a result, we believe 2009 MLP-related Bcf/d additions as a percent of total additions could be understated since actual 2009 U.S. natural gas pipeline investments (of $9.9 billion) and pipeline miles added (of 2,988 miles) were below the EIAs forecast of $11.9 billion and 3,643 miles, respectively (published in September 2009). Source: EIA and Partnership reports
A significant portion of the capital invested in the natural gas sector between 2005 and 2008 was associated with growing production in the Barnett Shale region. Given the rapid pace of capital deployment during this time period, midstream companies were able to quickly construct the necessary gathering, processing, and transportation capacity to support the ramp-up in production. According to our calculations, 15 MLPs provide gathering, processing, and/or transportation services in the Barnett Shale. This implies that more MLPs have a midstream presence in the Barnett Shale than any other major producing region in the United States. In contrast, less developed emerging natural gas and crude oil plays such as the Marcellus or Bakken Shales have just 3-5 MLPs with meaningful midstream exposure.
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Master Limited Partnerships Figure 46. MLP Midstream Exposure By Region
18 # Of MLPs With Midstream Exposure 15
More Developed
Less Developed
15
12
12
12
9 8 7 7 6 6 6 5 5 4 4 3 3 3 3 2 1
0 Barnett Permian Anadarko / Hugoton San Juan Granite Wash DJ Basin Woodford / Arkoma Williston / Bakken Eagle Ford Powder River Marcellus Bossier Jonah / Pinedale Haynesville Fayetteville Piceance Niobrara Uinta Cotton Valley Monterrey
Source: Partnership reports and Wells Fargo Securities, LLC
Gas storage capacity has increased in response to growing production, but growth likely to slow. The buildout of new pipeline infrastructure generally requires the construction of supporting storage capacity. As an example, new pipelines require storage for load balancing purposes and new electric generation plants require some local market storage. Over the past five years, total U.S. storage capacity increased 3.8%, according to the EIA, or by more than 300 Bcf. Notwithstanding, we anticipate the rate of storage expansion to slow over the next few years given (1) the likelihood for increased domestic natural gas production, (2) high deliverability rates of recent salt-cavern storage expansions, and (3) relatively tight basis differentials. The aforementioned factors could reduce seasonal spreads, reducing the incentive to construct additional storage capacity. In aggregate, there is approximately 4.5 trillion cubic feet (Tcf) of working storage capacity in North America, including 3.9 Tcf in the United States and 0.6 Tcf in Canada, according to the EIA and Canadian Gas Association. Since 2005, U.S. total working gas in underground storage has averaged 2.5 Tcf and recently reached a record 3.8 Tcf in November 2010.
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MLP Primer -- Fourth Edition Figure 47. U.S. Total Working Natural Gas In Underground Storage
4.5 4.0 Working Gas (Tcf) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Natural Gas Liquids Wide crude oil to natural gas ratio encourages producers to pursue liquids-rich plays. The growing divergence between crude oil and natural gas prices has incentivized E&P producers to divert capital to liquids-rich gas plays. In turn, this has resulted in gathering, processing, and fractionation expansion opportunities for midstream companies. Notably, NGL production from processing plants is currently at levels last achieved in 2001. In addition, NGL fractionation volume is at record levels, with plants running at near 100% utilization. The following figure summarizes gathering, processing, and transportation exposure by MLP separated by dry natural gas plays and wet natural gas/crude oil plays. Figure 48. MLP Midstream Exposure By Commodity
12 Exposure to wet natural gas/crude plays Approximate # Of Supply Regions 10 Exposure to primarily dry natural gas plays Less Basin Diversity
-0 Ju 0 l-0 Ja 0 n0 Ju 1 l-0 Ja 1 n0 Ju 2 l-0 Ja 2 n0 Ju 3 l-0 Ja 3 n0 Ju 4 l-0 Ja 4 n0 Ju 5 l-0 Ja 5 n0 Ju 6 l-0 Ja 6 n0 Ju 7 l-0 Ja 7 n0 Ju 8 l-0 Ja 8 n0 Ju 9 l-0 9
8 3 3 4 3 5 3 2 6 3 3 6 2 6 4 3 2 3 5 5 5 4 4 5 2 5 3 1 1 2 1 APL PVR 2 1 DPM 1 2 2 1 1 NGLS 2 2 4 2 3 2 3
Ja n
0 MWE BWP KMP DEP ETP WPZ EPB EEP EPD OKS WES CHKM RGNC PAA CPNO
1 CMLP
MMLP
SEP
As noted, producers are focusing more on resource plays that contain higher levels of crude oil and wet gas (i.e., NGLs) due to the enhanced value for crude oil and natural gas liquids (i.e., higher prices) relative to natural gas. Based on data from the Wells Fargo Securities Exploration and Production Equity Research Team, the average breakeven natural gas price for the liquids rich Eagle Ford shale is $2.99, versus $6-7 per million British thermal units (MMBtu) for the more conventional and drier producing regions.
EROC
XTEX
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Figure 49. Natural Gas And Crude Oil Breakeven Price Forecasts
$8 $7 $6 $ per Mcfe $5 $4 $3 $2 $1 $0
Eagle Fo rd M arcellus Haynesville (H o rizo ntal) Wo o dfo rd M arcellus (Vertical) Fayetteville B arnett B o ssier Co tto n Valley (H o rizo ntal) A ntrim C o tto n Valley (Vertical) P iceance
$6.75 Average breakeven price $4.01 $2.99 $4.07 current Henry Hub natural gas price $5.70 $4.84 $4.85 $4.97 $5.04 $5.05 $5.94 $6.18
$90 $80 $70 $60 $ per Boe $50 $40 $30 $20 $10 $0 Monterey C alifornia Bakken - North Dakota/Montana Spraberry - West Texas Pettet - East Texas (Horizontal) $34.95 $37.78 $45.20 $60.20 Average breakeven price current WTI crude oil price
Source: FactSet and Wells Fargo Securities, LLC estimates
Even higher-cost natural gas plays can be made economic after factoring in the pricing uplift from processing NGLs. As shown in the following figure, we estimate that producers could realize a $3 per MMBtu uplift on realized natural gas prices by processing NGLs based on Mont Belvieu pricing and ratios. In contrast, we estimate that the pricing benefit from processing NGLs was just $1 per MMBtu ten years ago. NGL content is so rich in certain regions that many producers have indicated that they could economically drill new wells even if natural gas prices collapse to zero.
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MLP Primer -- Fourth Edition Figure 50. NGL Pricing Uplift

$16 Pricing Uplift From Processing NGLs ($/MMBtu) Natural Gas Price ($/MMBtu) $12 ($ per MMBtu) $2 $8 $1 $1 $4 $1 $2 $0 1999 2000 2001 2002 2003 2004 2005 2006 2007 $4 $1 $2 $2 $3
$3
$3 $9 $9 $7 $7 $4 $5 $2
$1 $5 $6 $3
$4
2008
2009
2010 YTD
Our E&P equity research team forecasts NGL and condensate production growth of 57% for five of the largest independent E&P producers over the next three years. This should present midstream MLPs with strong demand for NGL gathering, processing, fractionation, and transportation services, in our view. Figure 51. Liquids Growth Expectations For Large E&P Independent Companies
1,750 APA 1,500 Liquids Production (MBbls/d) APC EOG DVN C HK
1,250 1,000
750 500
250 0 2008A 2009A 2010E 2011E 2012E 2013E
Source: Company data and Wells Fargo Securities, LLC estimates
Infrastructure buildout in liquids-rich plays. Over the past 12-18 months, a number of energy MLPs have announced organic expansion and greenfield projects to further develop the infrastructure in these oil and liquids-rich plays. Based primarily on identified organic growth opportunities, we estimate that MLPs have invested in or plan to invest at least $3.6 billion of capital in these plays. We suspect that the level of investments in these regions is likely to increase considerably given that producers have only recently begun to deploy significant capital in these areas.
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Master Limited Partnerships Crude Oil
Shale development could spur next wave of investment. Recent advancements in drilling technology have made commercial production of crude oil from shale plays economic. Specifically, the success of horizontal drilling and fracturing efforts in unconventional natural gas shale plays is prompting a reevaluation of earlier assessments of technically recoverable reserve potential in crude oil shale plays. For example, in 1995 the United States Geological Survey (USGS) performed a study on the Bakken Shale (fairway, intermediate, and outlying regions of the play). The agency indicated that resources within the play were large, but only 151 million barrels (the midpoint of the range) were technically recoverable. In contrast, the USGS updated its assessment of the Bakken Shale in 2008 and increased its technically recoverable reserve estimate to 3,650 million barrels (the midpoint of the range), which represents a nearly 25-fold increase in recoverable reserves. Domestic onshore crude oil development could be the next big thing for U.S. independent E&P companies, in our view. New crude oil plays, including the Bakken Shale, Alberta Basin, Eagle Ford Shale, Niobrara Shale, and Barnett Shale Combo, will require significant new infrastructure to transport the production to end markets. This, in turn could represent a meaningful opportunity for MLPs in the crude oil space (e.g. BKEP, EEP, EPD, GEL, MMP, NS, PAA, and SXL). To note, after declining for more than two decades, U.S. crude oil production increased in 2009 and is on pace to increase in 2010. Figure 52. Historical U.S. Crude Oil Production
12,000 U.S. Crude Oil Production (MBbls/d)
10,000
8,000
6,000 First meaningful uptick in U.S. crude oil production in over 20
4,000
2,000
0 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
The uptick in domestic crude oil production is likely to continue, in our view, as oil rig count levels have reached highs last experienced in the late 1980s. As of November 12, 2010, the domestic crude oil rig count stood at 720, which represents an approximate 302% increase from the rig count at June 5, 2009.
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MLP Primer -- Fourth Edition Figure 53. Domestic Crude Oil Rig Count
900 800 700 U.S. Oil Rig Count 600 +302% 500 400 300 200 100 0 1987 1988 1990 1991 1992 1993 1995 1996 1997 1998 2000 2001 2002 2003 2005 2006
C rude oil rig count (11/12/10): 720
C rude oil rig count (6/5/09): 179
2007
2008
Source: Energy Baker Hughes
Impact of rising Canadian oil sands production. With the stabilization of crude oil prices above $70 per barrel (bbl), a lower-cost environment, and improved access to capital, the fundamental outlook for Canadian oil sands projects has improved. Western Canada Sedimentary Basin (WCSB) production is expected to increase by 1.25-1.50 MMBbls/d (or at a 4-5% CAGR) over the next ten years, which should support continued volume growth on pipeline systems designed to transport Canadian heavy oil production into the United States. This would include Enbridge Energy Partners (EEP)s Lakehead system, Kinder Morgan (KMP)s Express and Trans Mountain pipelines, and TransCanadas Keystone pipeline. Figure 54. Projected WCSB Production Supply And Demand
Source: Enbridge Inc. and CAPP 2010 Forecast
2010
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Keystone Pipeline could disrupt volume flows and present infrastructure opportunities. The construction of TransCanadas $12 billion Keystone Pipeline system, coupled with continued oil sands growth in Western Canada, could present midstream MLPs with new growth opportunities, in our view. According to the Canadian Association of Petroleum Producers, Western Canadian Sedimentary Basin production is expected to increase at a 4-5% CAGR over the next ten years. A significant portion of this incremental production will likely be imported into the United States through the Keystone pipeline system. Because Keystone will touch major crude oil market centers (e.g., Cushing, Patoka, and Port Arthur), the pipeline has the potential to disrupt volume flow across a number of U.S. pipelines and storage terminals. In turn, this could present opportunities for MLPs with crude oil assets (particularly storage). The first phase of Keystone delivers crude oil directly to Patoka. The second phase of Keystone expands the pipelines reach to Cushing. Finally, the last phase of Keystone (Keystone XL) extends the pipeline all the way down to the Gulf Coast region. To note, upon completion, the Keystone System will be the only pipeline capable of transporting crude oil from Western Canada straight down to the Gulf Coast. Figure 55. Overview Of Keystone Phases
Starting Point Phase I Phase II Phase III Phase IV Hardisty Steele City Cushing Hardisty Key Delivery Points Patoka Steele City Cushing Port Arthur Nederland Steele City Port Arthur Keystone (Final) Hardisty Patoka Cushing PADD Region PADD II PADD II PADD II PADD III PADD III PADD II PADD III PADD II PADDII 1090 910 Q1'13 Capacity (MBbls/d) 435 590 500 700 Contracted (MBbls/d) 218-340 495 380 380 Expected Full Service H1'10 Mid-2011 Q1'13 Q1'13
Source: TransCanada Aforementioned supply trends spurring demand for storage. Crude oil storage at Cushing, Oklahoma (i.e., the pricing hub for U.S. crude oil futures) is expected to increase by 29% in 2011 due to a number of recently announced projects by midstream MLPs. In comparison, over the past four years, storage capacity increased at a much more modest CAGR of 7%. Demand for crude oil storage at Cushing has been supported by the aforementioned supply trends (e.g., Canadian crude oil imports via Keystone and rising domestic crude oil production), as well as temporarily lower demand (i.e., lower refinery utilization due to the impact of the economic downturn and governmental policies directed at emission reduction).
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MLP Primer -- Fourth Edition Figure 56. Storage Capacity At Cushing, Oklahoma
60.0 58.4 3.1 Cushing Storage Capacity (MMBbls) 50.0 42.8 40.0 34.9 30.0 16.8 20.0 43.2 44.3 46.7 6.8
- Other 1 - TPP>EPD - SGLP>BKEP
12.1
- MMP
- EEP
10.0 BP 0.0 2006 2007 2008 2009 2010E
18.5
- PAA
2011E
Note 1: Other consists of Sunoco Logistics (0.3 MMBbls) and ConocoPhillips (0.8 MMBbls) Source: Company data and Wells Fargo Securities, LLC estimates
Renewable Energy In addition to providing midstream services around traditional hydrocarbons, many MLPs are involved with the transportation and blending of renewable fuels (e.g., ethanol). MLPs that own refined products pipelines and/or liquids terminals are typically able to modify existing assets to handle ethanol at only modest incremental costs. Large players involved with the transportation and blending of ethanol include BPL, KMP, MMP, NS, PAA, and SXL. Figure 57. MLPs With Ethanol Exposure
Storage Of EthanolGasoline Blends BPL KMP MMP NS PAA SXL Source: Partnership reports Yes Yes Yes Yes Yes Yes Yes Ethanol Blending Yes Yes Yes Yes Yes Evaluating Ethanol Transportation
Government mandates provide visible long-term demand for biofuels. On December 19, 2007, the Renewable Fuel Standard (RFS) was revised with the signing of the Energy Independence and Security Act of 2007. The new law requires the minimum production levels of approximately 15.2 billion gallons of ethanol by 2012. According to the Renewable Fuel Association, production of ethanol was estimated to be 10.6 billion gallons in 2009. The expected increase in ethanol supply between 2009 and 2012 will likely be supported by increased used use of ethanol as an additive in gasoline production. Notably, on October 13, 2010, the Environmental Protection Agency agreed to let refiners add as much as 15% ethanol (up from 10% previously) to new gasoline blends for vehicles produced in 2007 and later. The EPA indicated a decision on whether to extend the higher ethanol ratio for vehicles made in 2001-06 will be made after further testing.
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Master Limited Partnerships Figure 58. Historical And Future Ethanol Production
18
Biofuel Mandate 15 Billion Gallons Per Year
12
2009 Estimate
0 2010M 2015M 2020M 2022M 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E
Source: RFA
D. Acquisition Capital Deployed Has Been Steadily Rising

From 2005-09, total aggregate MLP acquisition capital deployed totaled $43.9 billion, peaking at $17.6 billion in 2007. Although, the total amount of acquisitions declined in 2008 and 2009, activity has resumed in 2010, as year-to-date acquisitions have totaled $14.0 billion (through November 15, 2010). In 2009, MLPs made or announced 48 acquisitions totaling $4.9 billion, down from $6.2 billion in 2008 and $17.6 billion in 2007. The decline in acquisition activity was likely due to the repercussions from the sub-prime credit crisis, which resulted in a preservation of capital by most MLPs. Acquisition activity for 2009 was focused around pipelines, 28%, gathering and processing assets, 21%) oil and gas reserves, 20%, and storage, 12%) The largest transactions in 2009 included a $530 million dropdown acquisition of NGL assets and PAAs $427 million acquisition of Vulcan Capital's 50% indirect interest in PAA Natural Gas Storage, LLC (PNGS). In our models, we are forecasting approximately $36 billion of acquisitions for 2010-15, which largely include projected dropdown- and upstream-related transactions.
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MLP Primer -- Fourth Edition Figure 59. Historical Acquisition Capex

$20,000 $16,000 Total MLP Acquisitions ($ In Millions) $12,000 $8,000 $4,796 $4,000 $0 2004 $ in millions Pipelines Storage Gathering/Processing/Fractionation Upstream Marine Transportation Coal Propane Other Total 2004 $2,683 $384 $680 $0 $55 $29 $946 $20 $4,796 2005 2005 $1,633 $1,562 $1,744 $0 $106 $71 $228 $0 $5,343 2006 2006 $3,072 $637 $4,218 $900 $106 $334 $550 $5 $9,822 2007 2007 $1,722 $1,663 $4,803 $7,283 $418 $223 $48 $1,431 $17,590 2008 2008 $2,668 $706 $781 $563 $1,413 $25 $42 $0 $6,198 $17,590
$14,025 $9,822 $6,198
$5,343
$4,909
2009 2009 $1,373 $597 $1,040 $967 $135 $399 $276 $123 $4,909
2010 TD 2010 TD $4,383 $1,527 $4,568 $1,990 $850 $73 $49 $585 $14,025
Source: Partnership reports and Wells Fargo Securities, LLC estimates
Year to date in 2010, the average acquisition multiple has increased to 7.9x from 6.6x in 2009. Higher acquisition multiples year to date reflect the healthier capital markets and more competitive acquisition landscape, in our view. Further, MLPs lower cost of capital positions the partnerships to pay more for acquisitions, all else equal. Figure 60. Estimated Acquisition Multiples Paid
12.0x 10.0x Average Forward EBITDA Multiple Paid On MLP Acquisitions 8.3x 8.0x 6.0x 4.0x 2.0x 0.0x 2004 2004 Pipelines Storage Gathering/Processing/Fractionation Upstream Marine Transportation Coal Propane Other Total 8.0x 8.0x 6.3x 7.0x 7.1x 8.3x 7.4x 2005 2005 8.3x 11.6x 9.7x 4.6x 7.4x 8.3x 2006 2006 8.4x 9.2x 9.2x 5.0x 9.1x 7.5x 8.1x 2007 2007 13.9x 10.0x 9.9x 6.5x 9.0x 7.3x 6.3x 9.6x 9.1x 2008 2008 9.3x 8.3x 10.0x 5.0x 9.1x 5.5x 7.9x 2009 2009 8.2x 8.8x 6.7x 5.4x 6.0x 5.8x 6.4x 5.3x 6.6x 2010 TD 2010 TD 9.4x 8.3x 9.0x 6.5x 7.1x 7.3x 7.9x 7.4x 8.1x 9.1x 7.9x 6.6x 7.9x
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E. MLPs Continue To Enjoy Good Access To Capital

The number, size, and total amount of capital raised by MLPs continue to increase. Through November 15, 2010, MLPs have already raised the highest amount of capital (equity and debt) in a single year. Total debt and equity issued has already topped $31.8 billion, exceeding 2008 and 2007 totals of $20.6 billion and $18.8 billion, respectively. Year to date, MLPs have raised total equity of $11.9 billion. This includes $9.3 billion for secondary offerings, $1.3 billion for IPOs, $750 million for units sold to sponsors or sellers of assets acquired by MLPs, and $555 million via direct placement of equity from institutional investors. In the credit markets, MLPs have issued $19.9 billion of debt, which is comprised of investment grade and non-investment grade debt issuances of approximately $9.9 billion and $10.0 billion, respectively. Notably, the debt raised to date is the most on record, while the equity raised to date is the second most on record. Figure 61. Historical MLP Equity Offerings
$16,000 $14,701 $14,000 $2,981 Gross Equity Proceeds ($ in MM) $12,000 $10,000 $8,000 $6,000 $4,598 $4,000 $3,781 $2,000 $0 $363 $454 2004 IPOs
$11,869 $750 $9,415 $2,836 $5,736 $2,823 $2,747 $3,658 $1,354 $1,636 2005 2006 2007 $3,756 $3,171 $363 $817 2008 $6,627 $555 $267 2009 $1,299 2010TD $9,080 $7,367 $473
$8,549
$4,242
$9,266
Private placements
Public secondaries
Units to sponsor/seller
The number of MLP equity offerings steadily increased to 60 in 2009 from 50 in 2005 (and versus 60 year to date). In addition, the median size of equity deals has increased to approximately $140 million for 2010 yearto-date transactions from $106 million in 2005. Growing familiarity with the asset class, institutional interest, yield-seeking investors, MLPs favorable relative price performance, and the current low interest rate environment explain, in part, the increasing strong demand for MLP capital, in our view.
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MLP Primer -- Fourth Edition Figure 62. Historical MLP Debt Offerings
$20,000 Gross Debt Proceeds ($ in MM)
$19,920
$15,000 $11,506 $10,000 $2,356 $8,975 $1,825 $4,965 $1,340 $3,625 $0 2004 2005 2006 Investment grade 2007 2008 2009 $5,150 $1,475 $3,675 $5,505 $2,030 $3,475 $4,100 $350 $3,750 $9,150 $7,150
$10,020
$5,000
$9,900
2010TD
Non-investment grade
F. MLPs Have Employed Creative Financing Solutions To Fund Growth

PIPEs (Private Investments In Public Equity) The PIPE is a financing tool used by MLPs to help fund growth capital investments. A PIPE is a direct equity investment in publicly traded equity. PIPEs can be an effective way to raise capital as they are typically more time efficient (e.g., have fewer regulatory issues) and less costly than secondary offerings. The amount of equity raised from institutional investors participating in private investments in public equity grew over time and reached an all-time high in 2007. In 2003, MLPs raised approximately $283 million of equity via PIPEs. In 2007, MLPs raised more than $8.5 billion of equity via PIPEs. For 2010 year to date, total equity raised via five PIPE issuances totaled $555 million. In 2007, PIPEs became a preferred method for MLPs to finance (the equity portion of) expansion projects and acquisitions due to the easy access to large pools of capital, relatively attractive pricing (discounts of 6-7%), and the opportunity to forego the process of filing and marketing a secondary offering, which sometimes resulted in stock price erosion during the marketing period for the deal. Investors in many of the early PIPEs outperformed because the equity placements were typically tied to an event (acquisition or investment). The MLP benefited by pre-funding an acquisition and thereby eliminated any potential overhang or erosion in the stock price as the market would normally anticipate an equity offering to fund the transaction. Investors (in the PIPEs) benefited by purchasing the stock at a discount that was based on the preview price of the units. After the announcement of the event, the stock typically responded favorably (assuming the deal was accretive, strategic, etc.), which provided the investors with additional return. Since 2007, the number of PIPEs declined significantly, which is likely due to a combination of the credit crisis (institutional investors had no available liquidity) and MLP management teams more cautious approach in using PIPEs for financing. While PIPEs afforded quick and relatively inexpensive access to capital, they also created concentration risk for the issuer as a small group of institutional investors owned a significant percentage of the public float. Thus, an MLP announcing a PIPE to finance a capital investment could inadvertently create an overhang on their units as it could cause investors to focus on the expiration date of the lock-up period as a future point for potential selling pressure.
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Master Limited Partnerships Figure 63. Historical PIPE Issuances

$10,000 $8,549 $8,000 $ in millions 32
40 35 30 25 20 15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 TD Number of PIPE issuances
$6,000 15 15 $2,823 $2,000 5 $283 $0 7 $1,354 $363 3 $363 4 $267 5 $555
$4,000
PIPE Issuances
No. of PIPE issuances
Hybrid Securities A hybrid security is an investment vehicle that has characteristics of both a debt and equity security. In the case of MLPs, the partnerships hybrid securities (i.e., junior subordinated notes) pay a fixed coupon rate for a stipulated period of time and then a floating coupon rate for the balance of the term of the note (i.e., typically at LIBOR + bps premium). In 2006, EPD became the first MLP to issue junior subordinated (i.e., hybrid) securities, raising $550 million via three tranches (i.e., $300 million in July 2006, $200 million in August 2006, and $50 million in September 2006). Hybrid securities are typically given partial equity credit by the rating agencies (i.e., 50% equity credit by Moodys Investor Services and Standard & Poors, and 75% by Fitch Ratings). Figure 64. MLP Hybrid Securities
($ in millions) MLP Enterprise Products Partners L.P. Enterprise Products Partners L.P. Enterprise Products Partners L.P. Enbridge Energy Partners L.P. (Cl A) Ticker Notes EPD Junior Subordinated Notes A EPD EPD EEP Junior Subordinated Notes B Junior Subordinated Notes C Junior Subordinated Notes Fixed Coupon Rate 8.38% 7.03% 7.00% 8.05% Floating Coupon Rate LIBOR + 3.71% LIBOR + 2.68% LIBOR + 2.78% LIBOR + 3.80% Obligation $550 $683 $286 $400 Maturity Date August 2066 January 2068 June 2067 October 2067 Credit Rating S&P BB BB BB BB+ Moody's Ba1 Ba1 Ba1 Baa3 Equity Credit 50% 50% 50% 50%
Convertible Preferred Equity Convertible preferred equity provides unitholders with the option to convert their preferred units into common units. The preferred unitholder can convert the units to common anytime after a predetermined date, while the company or issuer can force a conversion if certain conditions are met. In most cases, the holders of the preferred units receive a distribution payment that is either equal to the partnerships quarterly distribution or set at a fixed rate that is above the MLPs current distribution. The preferred distribution is paid in either cash or in-kind (i.e., additional MLP units). The preferred units are senior (in the capital structure) to common stock, but are subordinate to bondholders. MLPs have issued preferred equity in order to strengthen their balance sheets (i.e., deleverage), finance an acquisition or capital expansion plan (i.e., removes interim funding needs), reinvest cash flow (i.e., defer distribution payments), and add a strategic partner.
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MLP Primer -- Fourth Edition Figure 65. MLP Convertible Preferred Equity Issuances
($ in millions except per unit data) Quarterly LP Unitholder Date Jul-10 MLP Copano Energy L.L.C. Ticker XTEX CPNO KSP BKEP Distribution Investor $0.0000 $0.5750 $0.0000 $0.0000 The Blackstone Group TPG Capital KA First Reserve, LLC Vitol and Charlesbank
Preferred Quarterly Unitholder Amount $125 $300 $100 $140 Distribution $0.2125 $0.7263 $0.1833 $0.5525 Preferred Distribution Premium -26.3% --Distribution Type Cash or PIK PIK PIK Cash
Jan-10 Crosstex Energy L.P. Sep-10 K-Sea Transportation Partners L.P. Oct-10 Blueknight Energy Partners LP
Note: Quarterly LP unitholder distribution represents MLPs distribution at the time of the announced transaction. Source: Partnership reports
Paid-In-Kind (PIK) Equity Paid-in-kind equity is an LP unit that receives distributions in the form of additional stock (i.e., similar to i-shares). The additional stock received by the unitholder can be either equal to the value of the partnerships current quarterly distribution paid to common unitholders or set at a fixed rate that is at a premium to the MLPs distribution. Paid-in-kind equity is typically eligible to convert into common units after a certain period. A MLP that raises capital through the issuance of PIK equity (1) minimizes cash outflow that helps bridge the time until a project or acquisition starts to generate meaningful cash flow and (2) removes any overhang related to potential equity offerings.
G. Publicly Traded General Partners -- Recognizing The Value Of The GP

Understanding the general partner interest is key to understanding the MLP sector, in our view. As noted, the general partner manages the MLPs operations and typically owns a 2% equity interest in the MLP. The GP also owns the incentive distribution rights (IDR), which entitles it to receive an incrementally larger percentage of total cash flow as it raises distributions to limited partners. GP interests are held in a variety of structures including (1) privately held, (2) within publicly traded C corporations, and (3) as stand-alone holding companies that are also structured as publicly traded partnerships. (Please see Figure 71 for a list of all general partners.) What Makes The GP So Valuable? The value of the GP is threefold, in our view. (1) IDR Leverage. The GP owns the incentive distribution rights (IDR), which entitle it to receive a disproportionate amount of the incremental cash flow of the partnership. In most partnerships, this agreement can reach a level where the GP is receiving 50% of every incremental dollar paid to the LP unitholders. This creates significant leverage for GP cash flow and enables cash flow growth at the GP to be roughly 1.5-2.0x the rate of the underlying MLP (common referred to as the GP multiplier). (2) Minimum investment, maximum control. The GP controls the underlying MLP and its assets, but typically owns just a 2% equity interest. This is especially useful for a company that owns significant mature assets suitable for an MLP structure. The company can place these assets into the MLP structure, potentially receive a higher market value for the assets, and own an investment vehicle with a lower cost of capital with which to access the capital markets. Finally, the company can sell additional assets to the MLP over time (the so-called dropdown model), which benefits both entities. With dropdowns, the MLP has visible distribution growth that should enhance the partnerships valuation. The GP owner benefits by monetizing assets at attractive valuations and realizing increase cash flow through its ownership of the IDRs as the MLP increases distributions. (3) Increased financial flexibility. A publicly traded GP also creates additional financial flexibility for management and can potentially benefit the MLP. Management can effectively use the GPs financial resources to help fund attractive growth opportunities at the underlying MLP. This could include having the GP purchase LP units to fund the equity portion of an acquisition or tapping the debt financing capacity of the GP. As a publicly traded entity, the GP can also facilitate acquisitions by raising equity via public and private transactions and/or issuing units to potential sellers in exchange for their assets. For example, in 2006, Crosstex Energy, Inc. (XTXI), a publicly traded GP, helped finance an acquisition at the underlying MLP (XTEX) by providing approximately $180 million of cash in exchange for 6.4 million XTEX senior subordinated units. The units were not entitled to receive distributions until they convert to common units. XTXI, in effect, helped subsidize the acquisition by forgoing at least $20 million of cash flow over 18 months until XTEX could realize the full EBITDA run rate for the transaction.
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Master Limited Partnerships Power Of The IDRs
The value of the GP lies in the fact that the GP receives a disproportionate amount of the incremental cash flow of the underlying partnership as LP distributions are increased due to the IDRs. Hence, distribution growth for GPs is typically significantly higher than that of LPs. For example, GPs have been able to raise their distributions at a two-year CAGR of 19% (2007A to 2009A; excludes AHD, HPGP, MGG, and XTXI), while the underlying MLPs have only been able to increase their distribution at a rate of 7%. The Multiplier The multiplier represents the rate of cash flow growth to the GP relative to LP growth. The multiplier is determined by a number of structural characteristics related to the assets owned by the GP. For example, a GPs ownership of incentive distribution rights with a 50% tier creates the leverage that enables the GP to increase its distribution at a faster rate than the underlying MLP. Figure 66. GP MLP Multiplier Estimates
2.5x 1.9x 1.9x 1.7x 1.5x 1.4x
2011E GP Multiplier
2.0x
1.0x
0.5x
0.3x
0.0x XTXI Hypothetical Underlying MLP APL ARLP ETP RGNC NS 2011 Distrib. Increase 1.0% 1.0% 1.0% 1.0% 1.0% General Partner AHD
1
ETE
NSH
AHGP Implied 2011 Distrib. Increase 0.3% 1.4% 1.9% 1.7%
AHD (1) Estimated GP / LP Multiplier 0.3x 1.4x 1.9x 1.7x
AHGP ETE NSH
XTEX 1.0% XTXI 1.9% 1.9x Note 1: Only an estimated 37% of AHDs cash flow (pro forma for pending transaction with ATLS) is derived from its LP/GP ownership interests in APL. Hence, the partnership has a significantly lower multiplier than other publicly traded GPs. Source: Wells Fargo Securities, LLC estimates
How the math works. The GPs leverage to the underlying MLPs distribution growth can be defined as the ratio of the pure-play GPs distribution growth rate relative to that of the underlying MLP. As an example, we have highlighted the mechanics of the GP multiplier effect between Alliance Resource Partners (ARLP) and Alliance Holdings GP (AHGP). Our example assumes the following at ARLP: A current annualized distribution of $3.32 per unit 36.7 million common units outstanding A 10% distribution increase High splits level (i.e., 50/50 tier) Distribution tiers from Figure 67
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MLP Primer -- Fourth Edition Figure 67. Distribution Tiers For GP Multiplier Example (For Figure 68)
($ per unit) LP% Tier 1 Tier 2 Tier 3 98% 85% 75% GP% 2% 15% 25% LP distr. up to: $1.10 $1.25 $1.50
Tier 4 50% 50% Above $1.50 Note: ($ per unit) Source: Wells Fargo Securities, LLC estimates
And the following assumptions at AHGP: $2.4 million of incremental SG&A expenses 15.5 million underlying MLP units owned by the GP
Figure 68. Mechanics Behind GP Multiplier

Underlying MLP - ARLP ($ In Millions Except Per Unit Data)
Distributions Paid Current distribution per unit (annualized) Units outstanding (in millions) Total distributions to LP unit holders % of cash flow to GP MLP common units owned by GP ( in millions) Current $3.32 36.7 $121.9 37.0% 15.5
General Partner - AHGP

GP Distributable Cash Flow Cash flow to LP unit holders Cash flow to GP Total cash distribution to LP & GP Distributions to GP from LP units Distributions to GP from GP interest and IDRs (-) Incremental SG&A expense Incremental interest expense Other GP distributable cash flow Multiplier effect Current $121.9 $71.7 $193.6 $51.6 $71.7 $2.4 $0.0 $0.0 $120.9 1.4x Incremental Cash Flow $12.2 $12.2 $24.4 $5.2 $12.2 $0.0 $0.0 $0.0 $17.4 With 10% Increase $134.1 $83.9 $218.0 $56.8 $83.9 $2.4 $0.0 $0.0 $138.2 Percent Growth 10.0% 17.0% 12.6% 10.0% 17.0% 0.0% NA NA 14.4%
On the basis of these assumptions, a 10% distribution increase at the MLP would enable the GP to raise its distribution by approximately 14%. Hence, the multiplier effect is approximately 1.4x (i.e., the GPs growth rate of 14% divided by the underlying MLPs distribution growth of 10%). Since the underlying MLP is at the high-splits level, the 2% GP interest and IDRs entitle the GP to receive a disproportionate amount of the MLPs incremental cash flow (i.e., 50%). Thus, if the MLP raises its distribution per unit by 10%, the partnership would need to pay incremental distributions to LP unitholders and the GP of $12.2 million each. The Power Of Equity Issuance The GP benefits when the MLP issues common equity even without any increase in the distribution. The reason is that the GP receives a percentage of the total cash flow of the MLP entity based on the number of units outstanding. For example, the MLPs stated distribution level (and yield) represents the distribution made only to the LP unitholders. However, the MLP must also make payments to the GP based on the IDRs. Thus, the actual distribution payment per unit includes both payments to the LP and GP. As a result, the issuance of additional common units (and the distributions that are required on each unit) will result in additional cash flow accruing to the GP.
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In the following examples, we illustrate the impact of no equity issuance, $75 million, $125 million, $250 million, and $375 million of equity issuance at the underlying MLP to distribution growth at the general partner. Our examples exclude the impact of any potential distribution increases at the MLP. Our examples are based on the following assumptions at the underlying MLP and GP: An underlying MLP distribution of $2.50 per unit; No change to the underlying MLP distribution; An assumed equity offering yield of 8.0% (or $31.25 per unit); The equity offering is completed at the start of the year; The underlying MLP is in the 50% tier; 50.0 million LP units outstanding (pre-equity issuances) The GP owns no LP units in the underlying MLP; Incremental SG&A expense at the GP is $1.0 million per year; GP maintains a 1.0x distribution coverage ratio (no excess cash flow); 10.0 million GP units outstanding; and The current GP distribution is $2.08 per unit.
In the base scenario, we assume the MLP finances a $150 million investment entirely with debt (i.e., no equity). Under this assumption, the GP receives $21.8 million of distributions from its ownership of the underlying MLPs 2% GP interest and incentive distribution rights (IDRs). From this amount we subtract the GPs incremental SG&A expense of $1.0 million, leaving the GP with approximately $20.8 million of distributable cash flow. This would imply a GP distribution of $2.08 per unit based on our assumed 10.0 million units outstanding and 1.0x distribution coverage ratio. In scenario 1, we assume the MLP finances the same $150 million investment with 50% equity. Based on this financing assumption, the underlying MLP raises $75 million of equity via a 2.4 million unit secondary issuance at $31.25 per unit. Since, we are assuming no distribution increases at the underlying MLP, the increase in the distributions received by the GP from the underlying MLP (to $22.9 million from $21.8 million) is due solely to the 2.4 million equity issuance at the underlying MLP. If we subtract the GPs incremental SG&A expense of $1.0 million from its distributions received of $22.9 million, the GPs distributable cash flow is $21.9 million, which would imply a distribution of $2.19 per unit. This is approximately 5.0% higher than the GPs base distribution of $2.08 per unit. To further illustrate the power of the equity issuance, we replicated the mechanics behind scenario 1 under higher investment assumptions. For scenarios 2, 3, and 4, we assume MLP investments of $250 million, $500 million, and $750 million, respectively, are financed with $125 million (or 4 million units), $250 million (or 8 million units), and $375 million (or 12 million units) of equity. In scenarios 2, 3, and 4, we the estimate that the GP could raise its distribution (above the base GP distribution) by 8.4%, 16.8%, and 25.2%, respectively, according to our calculations.
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MLP Primer -- Fourth Edition Figure 69. MLP Equity Issuance Impact On GPs Distribution Growth
Underlying MLP assumptions: Investment ($ in MM) % equity financing Equity issuance ($ in MM) Offering price New units issued (in MM) LP Units Outstanding Pro Forma LP Units Outstanding Annualized Distribution GP assumptions: Common units owned by GP Cash distributions from LP units Cash distributions from GP interest Total cash distributions Incremental GP expenses Distributable cash flow GP Distribution/DCF per unit: Based on current GP distribution Based on new GP distribution % distribution growth GP units outstanding $2.08 $2.08 0.0% 10.0 $2.08 $2.19 5.0% 10.0 $2.08 $2.26 8.4% 10.0 $2.08 $2.43 16.8% 10.0 Base $150 0% $0 $31.25 0.0 50.0 50.0 $2.50 Base 0.0 0.0 21.8 21.8 1.0 20.8 Scenario 1 $150 50% $75 $31.25 2.4 50.0 52.4 $2.50 Scenario 1 0.0 0.0 22.9 22.9 1.0 21.9 Scenario 2 $250 50% $125 $31.25 4.0 50.0 54.0 $2.50 Scenario 2 0.0 0.0 23.6 23.6 1.0 22.6 Scenario 3 $500 50% $250 $31.25 8.0 50.0 58.0 $2.50 Scenario 3 0.0 0.0 25.3 25.3 1.0 24.3
Scenario 4 $750 50% $375 $31.25 12.0 50.0 62.0 $2.50 Scenario 4 0.0 0.0 27.1 27.1 1.0 26.1
$2.08 $2.61 25.2% 10.0
Note 1: % distribution growth is based on the current GP distribution of $2.08 per unit Source: Wells Fargo Securities, LLC estimates
A Brief History Of GPs General Partner entities were originally either privately held or held within larger public C-corporations. Early GP transactions were mostly private negotiations; however, the cash flow multiples paid for GP entities increased over time as more investors recognized the inherent value of the GP entity. By our count, there have been 42 transactions involving the sale or partial sale of the General Partner interest from 1996 to 2010. The multiples paid for GPs have varied significantly, ranging from as low as 2.9x to as high as 58.4x forward-12months (FTM) cash flow, by our calculations. Since 2005, the General Partner interest has been valued at an average FTM cash flow multiple of approximately 20x in public and private market transactions. Figure 70. Historical Average GP Transaction Multiples By Year
35.0x 31.5x 30.0x Average FTM Multiple Estim ate
25.0x 21.4x 20.0x 18.5x 19.7x 18.6x 16.6x 15.0x 10.9x 10.0x 6.2x 5.0x NA NA NA NA NA 6.7x 12.0x
0.0x
97
05
06
96
00
04
99
08
02
98
01
03
07
09 20 20
19
19
20
20
20
20
20
20
20
20
19
19
20
Note: FTM is forward 12 months Source: Company reports and Wells Fargo Securities, LLC estimates
10
TD
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There are 21 MLPs owned by publicly traded C-corporations (excluding publicly traded GP MLPs). These entities receive distributions from the MLP, but must then pay corporate income tax on their distribution (typically at a 35% tax rate). In addition, dividends from these entities are also taxed at 15% to individuals. The corporate structure of the GP mitigates some of the tax advantages of MLP cash flow. However, this double tax burden could be offset by interest expense or sheltered by net operating losses (NOL) at the GP level. To varying degrees, the companies valuations reflect a partial recognition of the value of the general partner. Arguably, these companies could receive a greater market value for their GP interests if held as a stand-alone entity. Figure 71. GPs And Their Underlying MLPs
General Partner of Underlying MLP Alliance Holdings GP, L.P. Anadarko Petroleum Corp. Atlas GP Holdings, L.P. Capital Maritime & Trading Corp. Carlyle Riverstone Cheniere Energy Inc. Chesapeake Energy Corp. Constellation Energy Group Crestwood Holdings Partners, LLC Corbin J. Robertson, Jr. Crosstex Energy, Inc. DCP Midstream, LLC Dorchester Minerals Management L.P. El Paso Corporation Enbridge, Inc. Energy Transfer Equity, L.P. Enervest and EnCap Enterprise GP Holdings, L.P. Enterprise Products Partners, L.P. Exterran Holdings Inc. Ferrellgas, Inc. Energy Transfer Equity, L.P. Holly Corporation Kestrel Heat, LLC Kinder Morgan, Inc. KSea General Partner GP LLC Legacy Reserves GP, LLC Loews Corporation Martin Resource Management Corp. Natural Gas Partners Navios Maritime Holdings Inc. NuStar GP Holdings, LLC Ticker Master Limited Partnership AHGP Alliance Resource Partners, L.P. APC AHD Western Gas Partners, L.P. Atlas Pipeline Partners, L.P. Ticker ARLP WES APL CPLP NKA CQP CHKM CEP CMLP NRP XTEX DPM DMLP EPB EEP ETP EVEP EPD DEP EXLP FGP RGNC HEP SGU KMP KSP LGCY BWP MMLP EROC NMM NS General Partner of Underlying MLP Oxford Resources GP, LLC ONEOK, Inc. Penn Octane Corp. Penn Virginia GP Holdings, L.P. Pioneer Natural Resources Plains All American GP LLC Plains All American Pipeline, L.P. Quintana Capital Group Slifka Family Spectra Energy Sunoco, Inc. Targa Resources, Inc. Teekay Shipping Corporation Teekay Shipping Corporation The Heritage Group TransCanada Corp. Morgan Stanley Capital Group UGI Corp. Vanguard Natural Resources, LLC Vitol Holding and Charlesbank Capital Partners Wexford Capital Williams Companies None None None None None None None None None Ticker Master Limited Partnership Private Oxford Resource Partners, L.P. OKE POCC PVG PXD PAA ONEOK Partners, L.P. Rio Vista Energy Partners, L.P. Penn Virginia Resource Partners, L.P. Pioneer Southwest Energy Partners, L.P. PAA Natural Gas Storage, L.P. Ticker OXF OKS RVEP PVR PSE PAA PNG GEL GLP SEP SXL NGLS TGP TOO CLMT TCLP TLP APU ENP BKEP RNO WPZ BBEP BPL CPNO NRGY LINE MMP MWE SPH VNR
Private Capital Products Partners, L.P. Private Niska Gas Storage Partners, LLC LNG CHK CEG Cheniere Energy Partners, L.P. Chesapeake Midstream Partners, L.P. Constellation Energy Partners, L.P.
Private Plains All American Pipeline, L.P. Private Genesis Energy, L.P. Private Global Partners, L.P. SE SUN TK TK TRP MS UGI VNR Spectra Energy Partners, L.P. Sunoco Logistics Partners, L.P. Teekay LNG Partners, L.P. Teekay Offshore Partners, L.P. TC Pipelines, L.P. Transmontaigne Partners, L.P. Amerigas Partners, L.P. Encore Energy Partners, L.P.
Private Crestwood Midstream Partners, L.P. Private Natural Resource Partners, L.P. XTXI Crosstex Energy, L.P. Private DCP Midstream Partners, L.P. Private Dorchester Minerals, L.P. EP ENB ETE EPE EPD EXH ETE HOC El Paso Pipeline Partners, L.P. Enbridge Energy Partners, L.P. Energy Transfer Partners, L.P. Enterprise Product Partners, L.P. Duncan Energy Partners, L.P. Exterran Energy Partners, L.P. Regency Energy Partners, L.P. Holly Energy Partners, L.P.
Private Targa Resources Partners, L.P.
Private Calumet Specialty Products Partners, L.P.
Private EV Energy Partners, L.P.
Private Blueknight Energy Partners, L.P. Private Rhino Resource Partners, L.P. WMB ---------Williams Partners, L.P. Breitburn Energy Partners, L.P. Buckeye Partners, L.P. Copano Energy, LLC Inergy, L.P. Linn Energy, LLC Magellan Midstream Partners, L.P. MarkWest Energy Partners, L.P. Suburban Propane Partners, L.P. Vanguard Natural Resources, LLC
Private Ferrelgas Partners, L.P.
Private StarGas Partners, L.P. Private Kinder Morgan Energy Partners, L.P. Private K-Sea Transportation Partners, L.P. Private Legacy Reserves, L.P. LTR Boardwalk Pipeline Partners, L.P. Private Martin Midstream Partners, L.P. Private Eagle Rock Energy Partners, L.P. NM NSH Navios Maritime Partners L.P. NuStar Energy L.P.
Source: Company reports
Pure-Play GPs Are IPOd As Stand-Alone Entities Beginning in 2001 with the IPO of Kaneb Services LLC, GP entities were spun off as pure-play publicly traded entities. The GPs were taken public as stand-alone entities as a means to achieve the following: (1) Highlight the intrinsic value of the incentive distribution rights; (2) Monetize an investment as private equity sponsors and others used the IPO as a partial exit strategy; and (3) Facilitate growth at the MLP and/or consolidation opportunities for the entity. Figure 72. Current GP Valuation Metrics Versus IPO Metrics
IPO MLP Crosstex Energy Inc. Inergy Hldgs L P Com Enterprise GP Holdings L.P. Energy Transfer Equity L.P. Magellan Midstream Holdings L.P. Alliance Holdings GP L.P. NuSTAR GP Holdings LLC Atlas Pipeline Holdings L.P. Buckeye GP Holdings L.P. Penn Virginia GP Holdings L.P. Median Ticker XTXI NRGP EPE ETE MGG AHGP NSH AHD BGH PVG Date 1/13/04 6/21/05 8/24/05 2/3/06 2/10/06 5/10/06 7/14/06 7/21/06 8/4/06 12/5/06 IPO Price $6.50 $22.50 $28.00 $21.00 $24.50 $25.00 $22.00 $23.00 $17.00 $18.50 Initial Distrib. $0.40 $0.90 $1.00 $0.70 $0.78 $0.74 $1.20 $0.96 $0.82 $0.94 IPO Yield 6.2% 4.0% 3.6% 3.3% 3.2% 3.0% 5.5% 4.2% 4.8% 5.1% 4.1% IPO P/DCF1 14.1x 26.5x 27.2x 25.6x 28.8x 28.4x 17.6x 23.5x 19.5x 19.9x 24.5x $24.50 $43.01 $35.35 $14.90 $63.49 $38.83 Price 11/16/10 $9.17 Current Yield 3.1% 3.6% 5.6% 4.7% 5.4% 1.3% 6.4% 4.7% 25.4x 18.0x 21.9x 18.7x 15.9x 18.7x P/DCF 2010E 2011E 24.1x 17.4x 18.5x 18.3x 25.3x 27.0x 21.3x
No longer trading
No longer trading
No longer trading
Note: XTXIs IPO price and initial distribution have been adjusted to reflect 3-for-1 stock split on December 15, 2006 Note 1: IPO price-to-discounted cash flow (P/DCF) is based on our DCF estimate at IPO. Source: FactSet, Partnership reports, and Wells Fargo Securities, LLC estimates
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MLP Primer -- Fourth Edition Cost Of Capital Drives GP Transactions
Beginning in 2002 with Enterprise Products Partners, several MLPs took steps to reduce their cost of capital by reducing or eliminating the incentive distribution rights. (For a detailed discussion of MLP cost of capital, please see Understand A MLPs Cost Of Capital). In 2002, Enterprise Products Partners reduced the top tier of its IDRs to 25% from 50% to reduce the total cash flow being paid to the general partner and thereby reduce its cost of equity. NuStar LP, MarkWest Energy Partners, Suburban Propane Partners, Sunoco Logistics Partners, TC PipeLines LP, and TEPPCO Partners (before being acquired by EPD) have also taken steps to reduce or eliminate their IDRs in order to lower their cost of capital and compete more effectively for acquisitions and incremental investments. In addition, 12 MLPs have gone public with either no IDRs or IDRs with a maximum level of 25% or below. There are currently ten MLPs that are paying 20% or more of their total cash flow to the GP (based on our MLP Universe). As these MLPs increase distributions, they will be paying an increasing percentage of their total cash flow to the GP. This GP tax is a burden which could impede the long-term growth and viability of the MLP, in our view. Figure 73. Percent GP Cash Flow To MLPs
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
Percent Of Cash Flow Paid To GP
Cost-Of-Capital Considerations Driving GP Elimination Transactions Beginning in 2008 with MarkWest Energy Partners, L.P.s (MWE) proposal to acquire its publicly traded general partner, MarkWest Hydrocarbon, Inc. (MWP), there has been a series of similar announcements of MLPs acquiring their respective publicly traded general partners. Besides the MWE and MWP merger, which was completed in February 2008, other MLPs that have announced intentions to merge or have already merged including Buckeye Partners, L.P. (BPL) and Buckeye GP Holdings, L.P. (BGH), Inergy, L.P. (NRGY) and Inergy Holdings, L.P., Enterprise Products Partners, L.P. (EPD) and Enterprise GP Holdings, L.P. (EPE), Magellan Midstream Partners, L.P. (MMP) and Magellan Midstream Holdings, L.P. (MGG), Penn Virginia Resource Partners (PVR) and Penn Virginia GP Holdings (PVG), and Natural Resource Partners (NRP) and Natural Resource Partners GP (private). The management teams involved in each of these mergers expect to complete the transactions before year-end 2010. We believe the primary motive behind each of these transactions is the MLPs desire to reduce their cost of capital in order to improve their competitive position and support continued growth in LP distributions. The transactions serve as further confirmation that the IDRs owned by the GP could become a significant hindrance to sustaining growth as the MLPs push further into their respective IDR tiers. With the exception of the EPD/EPE planned merger, all of the transactions have been announced or consummated when the MLP was at their highest tier and when at least 20% of aggregate cash flow was accruing to the general partner.
KMP ARLP ETP PAA NRGY SXL WPZ BPL PVR OKS GEL DPM EPD HEP EEP NS NGLS EVEP MMLP TLP SEP BWP TGP EPB CMLP TOO EXLP RGNC APU WES APL XTEX NKA PNG TCLP CHKM FGP NRP OXF ENP DEP LGCY PSE MMP BKEP CPNO EROC MWE BBEP LINE VNR SPH KSP
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There are other factors that are driving IDR elimination transactions, such as (1) potential carried interest legislation (see the following section entitled, Recent GP Transactions Could Be Also Be Motivated By Potential Carried Interest Legislation); (2) a sp0nsor-driven transaction facilitated by the capital requirements of the GP sponsor (i.e., Sunoco Inc./SXL); and (3) exit strategies for private equity-owned GPs (BPL/BGH). Notwithstanding, we believe the primary driver of transactions to reduce or eliminate the IDRs is cost-of-capital considerations. Notable transactions we believe were driven by cost-of-capital concerns include the following: ETP/ETE/RGNC. The transaction between ETP, ETE, and RGNC provides Energy Transfer with a lower cost-of-capital entity (RGNC) through which to pursue acquisitions and growth projects that may not be accretive at the ETP level. SXL and TCLP. IDR resets by both SXL and TCLP effectively lower distribution payments to their general partners, which, in turn, lowers the MLPs cost of capital. PNG. The IPO of PAAs natural gas storage business provides PAA with a lower cost of capital entity through which to facilitate the growth of Plains natural gas business. BPL/BGH, EPD/EPE, MMP/MGG, NRGY/NRGP, NRP/NRPs GP, and PVR/PVG. These MLPs have or plan to acquire their publicly traded general partners due to long-term cost of capital considerations. KMP. Kinder Morgan has announced two GP subsidies year to date in 2010, one of which was to offset dilution from a joint venture project with PetroHawk. When the GP foregoes IDR payments on a temporary basis, this effectively reduces the partnerships cost of capital.
Since 2007, the median forward DCF multiple paid to acquire GP interests in publicly traded MLPs has been 19.7x. To note, this multiple is based on estimated DCF and includes the cost of acquiring (1) the 2% GP interest and incentive distribution rights, (2) distributions received from ownership in LP units of the underlying MLP, and (3) GP-level SG&A expenses. Alternatively, we estimate that the median multiple paid by buyers to acquire solely the 2% GP interest and associated IDRs in publicly traded MLPs has been 18.1x. Figure 74. Overview Of Historical GP Buyout Transactions
Total Value Paid ($MM) Date MWE (GP) MGG HPGP BGH * NRGP * EPE * PVG * NRP (GP) Sep-07 Mar-09 Apr-09 Jun-10 Aug-10 Sep-10 Sep-10 Sep-10 LP Units + $157 $0 $35 $5 $204 $2,212 $490 $0 GP Interest + $651 $1,148 $17 $1,155 $1,735 $5,541 $467 $882 Debt $0 $0 $0 $0 $0 $1,095 $0 $0 = Total $808 $1,148 $52 $1,160 $1,939 $8,848 $957 $882 MWE (GP) MGG LP Units 13.5x 14.7x 14.4x 18.0x 12.9x 14.4x 14.7x
1
Multiple Paid GP Interest 18.1x 11.6x 19.2x 20.1x 20.7x 15.9x 15.1x 18.1x 17.3x
1
Total CF 20.5x 12.0x 22.3x 19.7x 19.9x 14.8x 15.1x 19.7x 17.8x
=
Breakdown Of Forward Cash Flow ($MM) Date MWE (GP) MGG HPGP BGH * NRGP * EPE * PVG * NRP (GP) Sep-07 Mar-09 Apr-09 Jun-10 Aug-10 Sep-10 Sep-10 Sep-10 LP Units + $12 $0 $0 $14 $140 $38 $0 GP Interest + $36 $99 $60 $86 $305 $29 $58 Other, net = ($8) ($4) ($9) ($2) ($75) ($3) $0 Total $39 $95 $52 $99 $370 $65 $58
HPGP BGH * NRGP * EPE * PVG * NRP (GP) Median Average
Note * - Pending transactions as of 11/19/10 Note 1: Excludes SG&A and interest expense Source: Partnership reports, FactSet, and Wells Fargo Securities, LLC
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Recent GP Transactions Could Be Also Be Motivated By Potential Carried Interest Legislation We also believe the transactions have been, in part, motivated by GP owners desire to monetize their interests ahead of any potential negative tax implications of carried interest legislation on their GP ownership. Based on the language included in the latest proposed carried interest legislation, the provisions should not result in material tax implications for GP MLPs and their public unitholders or jeopardize the partnerships PTP status under section 7704 of the Internal Revenue Code, in our view. However, the bill, as written, could have negative tax implications for a manager of a GP upon the sale of his or her GP (carried interest) ownership. If the manager is deemed as a provider of investment management services (e.g., advising in, purchasing, selling, and managing a specified asset), then the disposition will be taxed at ordinary income versus capital gain rates. The definition of a manager is open to interpretation by the Treasury, but could include senior management of the partnerships and active large investors or owners of units (such as private equity firms). Figure 75. List Of Publicly Traded General Partnerships
GP Alliance Holdings GP LP Atlas Pipeline Holdings LP Buckeye GP Holdings LP Crosstex Energy Inc. Energy Transfer Equity LP Enterprise GP Holdings LP Hiland Holdings GP LP Inergy Holdings LP Magellan Midstream Holdings LP NuSTAR GP Holdings LLC Penn Virginia GP Holdings LP Ticker AHGP AHD BGH XTXI ETE EPE HPGP NRGP MGG NSH PVG IPO date Status May-06 Jul-06 Aug-06 Jan-04 Feb-06 Aug-05 Sep-06 Jun-05 Feb-06 Jul-06 Dec-06 Publicly traded Publicly traded No longer publicly traded - Merged with BPL Publicly traded Publicly traded No longer publicly traded - Merged with EPD No longer publicly traded - Merged into private company No longer publicly traded - Merged with NRGY No longer publicly traded - Merged with MMP Publicly traded Publicly traded - Planned merger with PVR
Note 1: The planned merger for PVG by its respective underlying MLP is expected to be completed by year-end 2010 Note 2: HPGP was merged into a private company due to the credit crisis, not to lower its cost of capital Source: Partnership reports
Owning The GPs Better Aligns Investors With Management In general, management teams have a greater direct ownership interest in the GP than in the underlying MLP. On average, management teams own 42% of the GP units, versus 32% of the underlying MLP units. This is likely a testament to the value of the GP and IDRs, in our view. To note, most public GPs own a significant stake of LP units. Thus, management would also own an indirect interest in the MLP. Figure 76. Ownership Of The GP And Underlying MLP
Insider Ownership As A % Of Total Units O/S
100%
Insider Ownership Of LP Units Insider Ownership Of GP Units
80% 65% 63%
77%
60% 44%
56%
31%
30%
40%
41%
18%
17%
61%
62% 0% Crosstex 14%
20% 9% 0% Atlas Alliance Buckeye
0%
Enterprise
Energy Transfer
Nustar
Penn Virginia
Source: FactSet
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Master Limited Partnerships GP Subsidies
A general partner has the ability to subsidize a transaction with its limited partnership and effectively temporarily reduce the cost of equity for the IDRs. In these instances, the GP temporarily forgoes incentive distribution rights payments in order to make an acquisition immediately and sufficiently accretive to limited partner unitholders. This could be an indication of a high price being paid for an asset. In addition, it demonstrates the beneficial impact to the GP when the MLP makes an acquisition. Because acquisitions are typically so accretive to GP owners, the GP can afford to temporarily subsidize an acquisition to improve the accretion for the LP unitholder. Figure 77. Summary Of Past GP Subsidized Transactions
Announce Date MMP NRGY PAA (1) APL PAA (2) SXL (1) WPZ WPZ NGLS NRP KMP EPD
1
Annual Cash Subsidy $4.8MM ~$1.5MM $20-15-15-10-5MM up to $20MM / $15MM ~$6.7MM ~$1.4MM $29MM up to $10MM up to $32MM $14.7MM ~$31MM $70-60-55-52-41MM
3 1 2
Length Of Subsidy 2 yrs 2 yrs 5 yrs 2 yrs - forever 1.5 yrs 4 yrs 1 yr 1 yr 2.1 yrs 0.5 yrs 1.5 yrs 5 yrs
Reason For Subsidy Help finance $530MM acq. from Shell Help finance $230MM Stagecoach acquisition Help finance $2.4B acq. of PPX Help finance $1.85B acq. from Anadarko Help finance $689MM Rainbow acquisition Help finance $200MM acq. from ExxonMobil Support distribution Support distribution Support $530MM downstream acq. from TRI Support Deer Run Mine acquisition Support $875MM KinderHawk joint venture Support EPD / EPE merger
Nov-04 Aug-05 Jun-06 Jun-07 Apr-08 Apr-08 Apr-09 Apr-09 Jul-09 Sep-09 Apr-10 Sep-10
Note : This is a G&A expense subsidy to support distribution Note 2: This is a G&A expense subsidy to support distribution Note 3: This is based on EPD's current annualized distribution of $2.30 per unit Source: Partnership reports
IDR Reset Option Enables Management To Better Control Cost Of Capital The reset option gives management better control of the partnerships cost of capital over the long term and allows the MLP to better compete for acquisitions and/or invest in organic projects that would otherwise not be accretive to cash distributions when the partnership becomes deep in the splits, in our view. As stipulated by an MLPs partnership agreement, the general partner holds the right to reset, at higher levels, the minimum quarterly distribution and incentive distribution levels. The cumulative cash flow accruing to the GP would not be altered, but instead, the future cash flow stream would be affected. Specifically, the GP would receive a lower percentage of incremental cash flow at the reset (higher) MQD than the 50% of incremental cash flow that it would receive under the initial distribution schedule. Hence, by resetting the incentive distribution tiers, the MLPs cost of equity is effectively reduced. In exchange for resetting the incentive distribution levels, the GP would receive a certain number of underlying MLP common units and additional general partner units. General Partner Nuances -- Not All GPs Are Created Equally Significant differences exist among the GPs, including the following: (1) structure, (2) amount of distribution leverage (i.e., the multiplier effect), and (3) characteristics of the underlying MLPs; all of which ultimately determine the distribution growth potential of the GP and drive valuation, in our view. When considering relative valuations for publicly traded general partners, we think the following factors should be considered: (1) Maximum IDR level. A GPs potential leverage to the underlying MLPs growth is based on the maximum incentive distribution level that is stipulated in the partnership agreement. Most IDRs are capped at 48%, meaning the GP can reach a level where it can receive 50% of the incremental cash flow (48% for the IDRs plus 2% for the GP interest). Some have IDRs capped at 23%. Managements decision to cap the IDRs may benefit the GP in the long run, in our view. The underlying partnership should have a lower cost of capital (relative to MLPs with maximum IDRs of 48%), which should enable it to compete more effectively for acquisitions and realize higher returns on all investments (acquisitions and expansion projects). Thus, the underlying MLP should be able to increase its distributions at a faster rate and sustain its growth rate for a longer period of time, all else being equal.
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(2) Leverage (i.e., the multiplier) -- percentage of GPs cash flow attributable to LP units held. Publicly traded pure-play GPs typically own limited partnership units of the underlying MLP. The greater the number of LP units held at the GP, the slower the growth, all else being equal. The reason is that the growth of distributions to LP unit holders is slower than the growth rate achieved by the IDRs. Over time, as the cumulative percentage of distributions to the GP increases, its growth rate will slow and converge with the growth rate of the underlying MLP. Taken to the extreme, if the GP is receiving 50% of the distributions of the underlying MLP, its growth rate should equal the growth rate of the MLP. Put another way, the higher the percentage of cash flow accruing to the GP, the slower the growth rate at the GP, all else being equal. (3) Percentage of cash flow accruing to IDRs. Over time, the cumulative percentage of distributions attributable to IDRs should increase. Taken to the extreme, if the GP is receiving 50% of the distributions of the underlying MLP, its growth rate should equal the growth rate of the MLP. Thus, as the cumulative percentage of distributions to the GP increases, its growth rate should slow and converge with the growth rate of the underlying MLP. (4) Percentage of GPs cash flow attributable to LP units held. Publicly traded pure-play GPs typically own limited partnership units of the underlying MLP. The greater the number of LP units held at the GP, the slower the growth, all else being equal. The reason is that the growth of distributions to L.P. unitholders is generally slower than the growth rate achieved by the IDRs. (5) Growth profile of the underlying MLP. A GPs cash flow is based solely on distributions declared by the underlying MLPs. Hence, the distribution growth of a GP associated with a fast-growing underlying MLP should be higher than that of a GP and supported by one with modest growth prospects, all else being equal. (6) Incremental cost at the GP level (i.e., Interest and SG&A expense and taxes). All of the publicly traded pure-play GPs incur incremental SG&A expense. The incremental expense at the GP reduces the cash available to pay the GPs unitholders. (7) Structure of the GP (i.e., C-Corp versus MLP). As of November 16, 2010, XTXI is the only publicly traded pure-play GP structured as a corporation. Corporate taxes, all else being equal, reduce the cash available to pay dividends. Is It Better To Own The GP Or Underlying MLP? Because GP distributions will grow faster than those of the underlying MLP, it might seem obvious that investors should always elect to own the GP rather than the MLP, all else being equal. However, investors must look at the relative valuations. For example, the faster growth may already be reflected in the price of the GP units, while the growth prospects of the MLP may not be fully recognized in the unit price. In addition, investors must consider their investment objectives. Investors seeking yield and more current income may opt for the MLP. In addition, the tax-deferral rate for distributions on the MLP could be higher than that of the GP. On the other hand, investors seeking more growth and a higher total return might opt to invest in the MLP. Figure 78 outlines some of the differences between the MLPs and their respective GPs. Figure 78. Underlying MLP Versus GP Metrics
AHD Price (11/16/10) Distribution/Unit Current Yield Estimated Tax Deferral 3-Mo. Avg. Trading Volume Insider Ownership $14.90 $0.20 1.3% 75% 157,610 65% NSH Price (11/16/10) Distribution/Unit Current Yield Estimated Tax Deferral 3-Mo. Avg. Trading Volume Insider Ownership $35.35 $1.92 5.4% 80% 100,116 17% APL $23.38 $1.20 5.1% 80% 487,754 9% NS $65.77 $4.30 6.5% 80% 168,702 18% AHGP $43.01 $2.00 4.7% 50% 50,724 56% PVG $24.50 $1.56 6.4% 80% 217,201 0% ARLP $60.16 $3.32 5.5% 70% 102,137 44% PVR $26.96 $1.88 7.0% 80% 142,379 61% EPE $63.49 $2.30 3.6% 90% 166,654 77% XTXI $9.17 $0.28 3.1% 0% 386,934 14% EPD $42.55 $2.33 5.5% 90% 1,104,635 31% XTEX $13.71 $1.00 7.3% 80% 216,424 62% ETE $38.83 $2.16 5.6% 60% 278,899 41% ETP $50.40 $3.58 7.1% 80% 748,756 30%
Source: Bloomberg, FactSet, and Wachovia Capital Markets, LLC estimates
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Master Limited Partnerships GP/LP Conflicts Of Interest
There exist several potential conflicts of interest for GP and MLP investors, in our view. With only a 2% equity interest (limited risk) but the greatest potential upside, GP owners could drive MLPs to make riskier investments (acquisitions) in order to increase distributions. This is especially true as more private equity owners have made investments in GPs. The private equity GP owners investment time horizon may not always be in sync with the LP investor. For example, an MLP (controlled by the same management team as the GP) could hypothetically make a $1 billion acquisition that is nominally accretive to LP unitholders or even slightly dilutive. However, if the MLP financed the acquisition with 50% equity, the transaction would likely be highly accretive to the GP, even without any increase in the distribution rate (see Figure 79). The counter argument to the preceding assertion is that the GP would not make poor investment decisions that could jeopardize the partnerships distribution, commonly referred to as the theory of dont kill the golden goose. Notably, at the 50% incentive tier, the GP would share equally in the pain if the distribution was reduced. The best alignment of interest is when the owner of the GP also owns a significant stake in limited partner units, in our view. Hypothetical acquisition where GP/LP interests are not aligned. In the following example, we illustrate a scenario whereby an acquisition is dilutive for the LP unitholders, but accretive to the GP. Our examples will illustrate two main points: (1) General Partners are incentivized to seek increasingly riskier investments due to the higher returns relative to risk that they can receive, especially at the 50/50 splits. This is regardless of whether these investments are accretive for LP unitholders. (2) General Partners receive a disproportionate return relative to their modest 2% equity investment in the partnership. LP unitholders receive lower returns while bearing a greater proportion of the risk (through a greater investment). Our example looks at a hypothetical MLP trading at $25 per unit with a $2.50 distribution (or a 10% yield). We assume the partnership completes a $100 million acquisition at an EBITDA multiple of 9.0x EBITDA and finances the transaction with 50% debt (at an interest rate of 8.5%) and 50% equity (2 million units at $25 per unit). In this case, the GP would also make a $1 million investment to maintain its 2% equity stake in the partnership (i.e., the portion of financing related to equity GP interest $50 million 2% = $1 million). To calculate the potential accretion from the transaction, we first deduct (from EBITDA of $11 million $100 million acquisition 9.0x transaction multiple) approximately $1 million for sustaining capex (assume maintenance capex is 10% of EBITDA). Since we are financing the acquisition with 50% debt, we deduct interest expense of $4 million ($50 million of new debt at an 8.5% interest rate). The new units (i.e. 2 million) issued to finance the balance of the transaction are entitled to the current distribution (even assuming there was no incremental cash flow from the acquisition). Thus, we deduct an additional $8 million to account for distributions to the new equity LP unitholders and the GP. The $8 million consists of $5 million to the new LP unitholders (2 million units $2.50 distribution) and $3 million to the GP (since the GP gets 40% of the cash flow 2 million $2.50 60%). In this scenario, the acquisition would actually be dilutive to the overall partnership by $2 million (or $0.02 per LP unit). However, as Figure 79 illustrates, it would still be in the GPs interest to complete the acquisition as the GP would receive $2 million of incremental cash flow from its $1 million investment, a 206% cash return on investment. The reason is that as long as the MLP issues new equity, the GP receives incremental cash flow, regardless of the accretion to the LP unitholders. In this way, the interest of the GP and LP unitholders is not always aligned. What makes the GPs position so advantageous is the fact that while the GP controls 50% of the incremental cash flow, the GP has only a 2% equity investment. In contrast, the new investors who invested $49 million to finance the acquisition, receive a 10% return on their investment in the form of $5 million in distributions based on the pre-acquisition distribution of $2.50 per unit (10% yield), which is partially offset by the dilution of the transaction.
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Figure 79. Dilutive Acquisition With GP At 50% Incentive Distribution Level

$ in millions, except per unit data MLP Pre-Acquisition Assumptions Units outstanding Current price Current annualized distribution Current yield Current split level: Limited partners General partner Cost of debt % of cash distributions to: Limited partners General partner Cost of equity Cost of capital 60% 40% 16.3% 12.4% 50% 50% 8.5% 50.0 $25.00 $2.50 10.0% Acquisition Assumptions Acquisition price ($ in millions) Financing arrangement: Debt Equity Transaction unit issuance EBITDA multiple EBITDA Sustaining capex Interest expense Incremental distributions from additional units outstanding Excess cash flow Cash flow to general partner Cash flow to LP unitholders Pro-forma units outstanding Incremental CF / LP Unit Return On Return On Investment Analysis General partner Existing (pre-acquisition) LP unitholders New LP unitholders (investors) Total Investment $1.0 $0.0 $49.0 $50.0 Cash Flow $2.1 ($1.2) $4.9 $5.8 Investment 206% (1%) 10% 12% 50% 50% 2.0 9.0x $11.1 $1.1 $4.3 $8.2 ($2.4) ($1.2) ($1.2) 52.0 ($0.02) $100.0
Source: Wells Fargo Securities, LLC estimates The MLP And GP Growth Rates Should Converge Over Time For a partnership with a maximum 50% IDR tier, the growth rates of the MLP and GP must eventually converge, mathematically speaking. The reason is that as the MLP increases its distribution, a larger proportion of the incremental cash flow will accrue to the GP, up to 50% of the total. Currently, Kinder Morgan Energy Partners has the largest percentage of its total cash flow accruing to the GP, at 45%. Thus, over time, the multiplier (i.e., the rate at which cash flow grows to the GP relative to the LP) will decrease. For example, at the beginning of 2006, the median GP multiplier was approximately 2.5x, versus the current median multiplier of 1.7x. This suggests that over time the premium at which GPs trade relative to MLPs should decrease; in other words, price-to-cash flow multiples should come down and yields should increase more in line with the underlying MLPs. Notwithstanding, the ultimate convergence of growth rates is likely to take many years. For example, assuming the MLP could increase its distribution by 10% annually, we calculate that it would take approximately 53 years for the growth rates of the MLP and GP to converge.
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Figure 80. Hypothetical Convergence Of MLP And GP Distribution Growth Rates

45% 40% Distribution Growth Rates 35% 30% 25% 20% 15% 10% 5% FY1 FY6 FY11 FY16 FY21 FY26 FY31 FY36 FY40 FY45 FY50
Underlying MLP Distribution Growth Rate
GP Distribution Growth Rate
H. Understand An MLPs Cost Of Capital

MLPs are generally thought to have a lower cost of capital than C-corporations, all else being equal, due to their tax-advantaged partnership structure and initial low cash flow outlay to the general partner of 2%. However, this cost-of-capital benefit is temporary and exists only when the MLP is at the lower incentive distribution level. This advantage erodes over time due to the incentive distribution rights. As the MLP increases its distribution, it must pay a greater percentage of its total cash flow to the GP. Thus, paradoxically, as the MLP is more successful in raising distributions, its cost of capital increases and this advantage erodes away. For an MLP, we believe the cost of equity is best defined as adjusted yield (forward yield adjusted for GPs share of cash flow) plus distribution growth. The conventional methodology used to calculate an MLPs cost of equity is flawed, in our view, as it incorrectly equates an MLPs cash yield as the partnerships cost of equity. Figure 81. Defining Cost Of Equity
Conventional Thinking On Cost Of Equity
Cost of equity = Cash yield
Our Cost Of Equity Definition

Cost of equity = Forward cash yield + Growth
Cost of equity
Current yield Percentage cash flow to LP
Cost of equity
Forward yield (1)
+ Growth
Percentage cash flow to LP
Note (1): Forward yield = next four quarterly distributions divided by current unit price Source: Wells Fargo Securities, LLC estimates
Equity owners are entitled not only to the current distribution, but also to future distributions that will presumably be higher. In fact, we argue that todays yield (the unit price) reflects some underlying distribution growth assumption. By ignoring the growth component, the cost of equity is understated and transactions that are initially accretive could become dilutive in later years as the partnership pays incremental distributions on the original units issued to finance the transaction. Properly defining and forecasting cost of equity has important ramifications for (1) making investment decisions, (2) setting distributions, and (3) choosing among financing alternatives.
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MLP Primer -- Fourth Edition There Are Three Components To An MLPs Cost Of Capital
MLPs have three principal sources of capital: LP equity, GP equity, and debt. An MLPs hurdle rate for new investments should therefore be greater than the weighted average cost of these three capital sources. Cost of LP equity. The cost of LP equity is the forward yield (distributions paid to LP unitholders over the next four quarters) plus expected distribution growth. This represents an LP unitholders expected return for the risk undertaken in owning LP units of an MLP (i.e., an investors required rate of return). Cost of GP equity. The cost of GP equity is the forward GP yield (cash flow being paid to the GP over the next four quarters) plus the expected growth in cash flow payments to the GP as the MLP raises its distribution over time. The general partner typically has just a 2% interest in the assets of the MLP, but could be entitled to 50% of the MLPs cash flow through IDRs. Because of this high degree of leverage, GP equity is substantially more expensive than LP equity. An MLPs total cost of equity is the weighted cost of LP equity plus the weighted cost of GP equity, or the forward cash yield (distributions paid to LP unitholders over the next four quarters, adjusted for the GP cut) plus total distribution growth. Cost of capital is therefore the weighted average cost of GP equity, LP equity, and debt. Figure 82. MLPs Have Three Main Sources Of Capital
Cost of GP equity = Implied GP yield + GP interest growth
Cost of LP equity = Forward yield + distribution growth Cost of debt
Intuitively, cost of equity should be higher than the cost of debt because creditors get paid before equity owners. In other words, equity owners demand a higher return because of the higher incremental risk that they carry. Again, it is a mistake to think of cost of equity for a MLP as just the yield. If that were the case, in many instances, the cost of equity would be less than the cost of debt. Incentive Distributions Increase Cost Of Capital IDRs create an increasingly large disconnect between an investors required rate of return (LP cost of equity) and an MLPs total cost of equity. For two MLPs targeting an equal rate of return to unitholders, the partnership with IDRs will have a higher cost of equity than an MLP without IDRs. As a result, an MLP with IDRs will need to make increasingly larger (or more accretive) investments in order to prevent erosion in investor returns. Assuming a yield of 7%, a cost of debt of 7%, IDRs capped at 25%, and distribution growth of 3%, we estimate that an MLP would need to make investments at a 10x EBITDA multiple or lower in order for the investments to stay accretive over the life of the MLP. Alternatively, MLPs not burdened by incentive distributions would be able to pay up to an 11-12x multiple while supporting 3% distribution growth (or pay a lower multiple and support a faster growth rate). Figure 83. IDRs Affect Maximum Purchase Multiples
Maximum IDR Tier 50% 25% Maximum EBITDA Multiple 1 7-8x 10x
2% 11-12x Note 1: Represents the maximum EBITDA multiple that can be paid on an investment for the transaction to remain accretive over the life of the MLP Source: Wells Fargo Securities, LLC estimates
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Figure 84 illustrates the lifecycle of a hypothetical MLP, with IDR tiers capped at 50% of cash flow. For simplicity, we assume the MLP targets a 10% return to investors (7% forward yield + 3% distribution growth) over the life of the partnership. At year 0, when the MLP is first created, 2% of cash flow accrues to the general partner. As the partnership increases its distribution and triggers higher IDR tiers, the percentage of cash flow accruing to the general partner increases, which, in turn, increases the partnerships cost of equity. When 15% of cash flow is accruing to the GP, the partnership will have a cost of equity of approximately 12%, representing a 2% premium over the 10% targeted return to investors. In other words, if the partnership wanted to continue returning 10% to investors, it would have to make investments in excess of this 12% equity hurdle rate. At the extreme, the GP will command 50% of available cash flow, implying that the partnership would need to target investments with returns in excess of approximately 20% in order to sustain a 10% return to investors. Alternatively, an MLP without IDRs targeting a 10% return to investors would have a cost of equity approximately equal to 10% over the life of the partnership. Figure 84. Lifecycle Of MLP With 50/50 Splits--IDR Premium
22% Total Cost Of Equity 20%
18% Cost Of Equity
16%
IDR Premium (GP cost of equity)
14%
12% Investor Return (LP cost of equity) 10%
8% 0% 10% 20% 30% % Cash Flow Paid To GP 40% 50% 60%
CAPM Understates The Cost Of Equity As it relates to MLPs, we believe cost of equity under the capital asset pricing model (CAPM) does not capture the cost of GP equity. In other words, the calculation is not calibrated to capture the increasingly higher percentage of cash flow that accrues to an MLPs general partner over time; instead, we believe it provides a better guide for LP cost of equity (i.e., an investors required rate of return). For MLPs under coverage, the average cost of equity as defined by CAPM is about 7.8% (assuming a risk-free rate of 4%, a market-risk premium of 5%, and an average beta of 0.3). In comparison, our MLP index has delivered a historical ten-year average total return of approximately 18% (versus 6% for the S&P 500), which is significantly higher than the required rate of return as defined by CAPM methodology. One explanation for the disparity between required rate of return and actual return is that investors could be underestimating future distribution growth. An investor requiring a 10% annual return might purchase an MLP yielding 6% under the assumption that the MLP will be able to grow its distribution at 4%. If the MLP increases its distribution at a greater rate, it equates to excess returns for the investor, in our view. Is An MLPs Cost-Of-Capital Advantage Overstated? Yes And No An MLPs cost-of-capital advantage over a C-Corp could be exaggerated, in our view, as a good portion of its perceived advantage becomes negated after factoring in distribution growth expectations set by investors and the effect of increasingly higher payments to the GP through IDRs. However, the fact remains that MLPs are tax-efficient vehicles to pass cash flow to unitholders, and ultimately, it is this tax-advantaged structure that allows MLPs to trade at a premium to C-Corps, in our view.
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I.
Upstream MLPs
Return Of Upstream MLPs The IPO of Linn Energy in January 2006 marked the return of oil and gas producing assets to the MLP structure. Upstream MLPs are suitable for yield-oriented investors that seek more direct exposure to oil and gas assets and have a higher risk tolerance, in our view. There are currently eight publicly traded upstream MLPs, consisting of the following:

BreitBurn Energy Partners, LP (BBEP); Constellation Energy Partners LLC (CEP); Encore Energy Partners, LP (ENP); EV Energy Partners, LP (EVEP); Legacy Reserves, LP (LGCY); Linn Energy LLC (LINE); Pioneer Southwest Partners, L.P. (PSE); and Vanguard Natural Resources, LLC (VNR)
Upstream MLPs Failed In The 1980s. Why? The business model was flawed and execution was poor, in our view. Generally, these partnerships relied on relatively risky drilling to sustain production, balance sheets were over-leveraged, management incentives were not aligned with the public investors interests, and hedging tools were not available to mitigate commodity price risk. What Should Be The Criteria To Invest Today? Appropriate reserve base. Reserves in certain regions of the United States are more appropriate for the MLP structure. Reserves suitable for the oil and gas MLP structure should be characterized as predominantly proved developed and long-lived, with low depletion rates.
Manageable drilling risk. Oil and gas MLPs should focus on exploitation, i.e., the factory-like development of a well-known reserve base, instead of relying on exploration to support cash flow. Yet we believe some higher-risk drilling may be acceptable within the context of a mature, low-decline portfolio of reserves. In addition, having an inventory of drilling locations provides a partnership with an alternative method of growth if multiples in the third-party acquisition market increase to uneconomic levels. Active hedging strategy. The partnerships should hedge a significant percentage of their expected production (i.e., 70-90%) in order to lock in prices and reduce commodity price exposure. We would prefer an oil and gas MLP to lock in prices for a multiyear time period (to the extent the market allows), even at the expense of leaving some upside on the table. With price certainty, an oil and gas MLP can set distributions at a long-term sustainable level. Conservative balance sheet and high distribution coverage ratio. MLPs with more volatility in their underlying businesses should maintain a more conservative balance sheet (i.e., modest debt) and a more robust distribution coverage ratio (i.e., at least 1.2x), all else being equal, in our view. Strong management team. The oil and gas MLP needs to be actively and conservatively managed to maintain reserves and roll over hedges, in our view.
Upstream MLPs Are Faced With Unique Challenges And Risks Depleting asset base. There are inherent challenges associated with a depleting asset base. Absent acquisitions, a partnerships asset base is eroding and reinvestment opportunities may be limited. Commodity price exposure. Declining commodity prices, even with hedges, can pressure earnings and narrow coverage ratios. Although an active hedging program mitigates commodity price risk, a prolonged period of low commodity prices could force upstream MLPs to cut their distribution absent acquisitions. Financing growth. Upstream MLPs are dependent on debt and equity markets to finance acquisitions. A displacement in either of these markets could hamper a partnerships ability to pursue acquisitions and increase distributions. Dependence on acquisitions. The majority of upstream MLPs have modest drilling inventory that is utilized to maintain, rather than increase, production. Consequently, most upstream MLPs will need to make accretive acquisitions in order increase distributions, all else being equal.
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High maintenance capex. As an upstream MLPs asset base increases in size, the level of spending required to sustain production also increases. In addition, high drilling activity can lead to faster decline rates as new wells typically come online with steeper decline rates, which, in turn, increases annual maintenance capital requirements. Competition. As upstream MLPs increase in number, competition over MLP suitable assets could intensify, driving acquisition multiples higher and reducing potential accretion.
J. Emergence Of MLP Products

MLP Indices Due to the growth and prominence of the MLP sector over the past few years, six financial institutions (Wells Fargo Securities, Alerian, Citi, Standard & Poors, Swank Capital, and Tortoise) have introduced MLP indices that allow investors to track the price and total return performance of the MLP sector. The following chart outlines the differences between the indices. Figure 85. MLP Index Comparison
Comparison of MLP indices Index launch date Ticker - price performance / total return Market capitalization weighting Minimum market cap ($ in millions) Timing of rebalance Maximum index constituent weighting Index base Index base date Index sub sectors Number of current index members Constituent types Calculation Wells Fargo Securities 12/11/2006 WMLP / WMLPT Float-adjusted $200 Quarterly None 100 12/31/1989 Yes 66 MLPs, GPs, and LLCs Standard & Poor's Alerian 6/1/2006 AMZ / AMZX Float-adjusted $500 Quarterly None 100 12/31/1995 No 50 (maximum) MLPs, GPs, and LLCs Standard & Poor's Citi 7/18/2006 CITIMLP / CITIMLPT Full market cap $500 Quarterly None 100 12/31/1999 No N/A MLPs only Dow Jones S&P 9/6/2007 SPMLP / SPMLPT Float-adjusted $300 Annual (in July) 15% 1000 7/20/2001 No 41 MLPs, GPs, and LLCs Standard & Poor's Tortoise 1/28/2010 TMLP / TMLPT Float-adjusted $200 Quarterly 10% 100 12/31/1999 Yes 63 MLPs, GPs, and LLCs Standard & Poor's Cushing 30 1/6/2010 MLPX / MLPXTR Equal weighted $500 Quarterly Equal weighted 100 8/1/2001 No 30 (maximum) MLPs, GPs, and LLCs Standard & Poor's
Source: Wells Fargo Securities, Alerian, Citi, Standard & Poors, Cushing 30, and Tortoise Capital Advisors
The Wells Fargo Securities MLP Index We gauge energy master limited partnerships performance using the Wells Fargo Securities MLP Composite Index, which was introduced in December 2006. The index is designed to give investors and industry participants the ability to track both price and total return performance for energy MLPs relative to the broader market. The Index comprises energy master limited partnerships that are listed on the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) or NASDAQ, and that meet market capitalization and other requirements. The Wells Fargo Securities MLP Composite Index currently consists of 66 energy MLPs, including 8 general partnerships (GP), and is also subdivided into 14 subsectors. To be eligible for the index, the company must be structured as a limited partnership or limited-liability company and have a market capitalization greater than $200 million. The Index composition is determined by Wells Fargo Securities, LLC, and the Index is independently calculated by Standard and Poors using a float-adjusted market capitalization methodology. The Index is reviewed quarterly, with changes effective after the close of trading on the third Friday of March, June, September, and December. For each review date, securities are evaluated based on the close of the last trading day (the evaluation date) of the month preceding the review (February, May, August, and November). Following a review, all securities already included in the Index that continue to meet the eligibility criteria remain in the Index. All other securities that meet all eligibility criteria are added to the Index and all securities previously included in the Index that do not continue to meet the eligibility requirements are removed from the Index. Real-time price quotes for the index are available on Bloomberg and Reuters under the symbol WMLP (and WMLPT for total return) and on FactSet Marquee under the symbol WML-CME. For further information and historical performance data from 1990 (downloadable), please visit www.wellsfargoresearch.com.
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Figure 86. Historical Wells Fargo Securities MLP Index Performance By Subsector
2010 YTD Price Perf. Oilfield Services Index Crude Oil Index Propane Index Petroleum Index Refined Products Index Natural Gas Pipelines Index Midstream Index Marine Transportation Index Upstream Index Natural Gas Index Coal Index Gathering & Processing Index General Partnership Index S&P 500 Index Wells Fargo Securities MLP Index 3.5% 15.7% 17.9% 19.1% 20.4% 19.5% 25.1% 23.5% 27.0% 30.9% 35.2% 37.0% 38.2% 5.7% 25.0% Total Return 11.9% 23.2% 26.0% 26.3% 27.4% 27.6% 33.0% 34.1% 38.2% 39.6% 45.2% 46.0% 46.4% 7.5% 33.3% General Partnership Index Gathering & Processing Index Coal Index Natural Gas Index Upstream Index Marine Transportation Index Midstream Index Natural Gas Pipelines Index Refined Products Index Petroleum Index Propane Index Crude Oil Index Oilfield Services Index 0% 10% 11.9% 20% 30% 40% 50% 27.6% 27.4% 26.3% 26.0% 23.2% 33.0% 34.1% 39.6% 38.2% 46.4% 46.0% 45.2% Wells Fargo Securities MLP Index S&P 500 Index 7.5% % Total Return 33.3%
Source: Standard & Poor's and Wells Fargo Securities, LLC
Please see page 77 for a list of the current constituents of the Wells Fargo Securities MLP Index, as well as the energy MLPs included within each of the MLP sub-indices. As of our last quarterly update in September 2010, the Wells Fargo Securities MLP Index is comprised of 66 constituents. Figure 87. Wells Fargo Securities MLP Sub-Indices And Related Bloomberg Tickers
Bloomberg Index Tickers Wells Fargo Securities MLP Sub-Indices Wells Fargo Securities MLP Index 1. Wells Fargo Securities GP Composite Index 2. Wells Fargo Securities Coal MLP Index 3. Wells Fargo Securities Oil & Gas MLP Index 4. Wells Fargo Securities Marine Transportation MLP Index 5. Wells Fargo Securities Propane MLP Index 6. Wells Fargo Securities Midstream MLP Index A. Wells Fargo Securities Natural Gas MLP Index i. Wells Fargo Securities Gathering & Processing MLP Index ii. Wells Fargo Securities Natural Gas Pipelines MLP Index B. Wells Fargo Securities Petroleum MLP Index i. Wells Fargo Securities Crude Oil MLP Index ii. Wells Fargo Securities Refined Products MLP Index 7. Wells Fargo Securities Oilfield Services MLP Index 8. Wells Fargo Securities Storage MLP Index Price Performance WMLP WCHWGPS WCHWCOA WCHWEXP WCHWMAR WCHWPRO WCHWMID WCHWGAS WCHWGNP WCHWNGP WCHWPET WCHWCRD WCHWRFP NA NA Total Return WCHWMLPT WCHWGPST WCHWCOAT WCHWEXPT WCHWMART WCHWPROT WCHWMIDT WCHWGAST WCHWGNPT WCHWNGPT WCHWPETT WCHWCRDT WCHWRFPT NA NA
Note: WMLP index price performance quotes are real-time and all other subsector index quotes are end of day. Source: Standard and Poors and Wells Fargo Securities, LLC
Financial Products Facilitate Participation In MLPs Since 2004, numerous financial products have been created to facilitate investment in the MLP sector. The introduction of new MLP investment vehicles could signal a natural evolution as the MLP sector matures to encompass more investable products. It is also more likely these investment vehicles could broaden the ownership pool for the MLP sector and increase overall liquidity for MLPs. However, these vehicles are also likely to increase sector volatility, in our view.
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Master Limited Partnerships Figure 88. MLP Products Introduced In 2010

Date Mar-10 Mar-10 Mar-10 Mar-10 Apr-10 Apr-10 Jul-10 Jul-10 Jul-10 Aug-10 Sep-10 Oct-10 Product Name UBS E-TRACS Alerian MLP Infrastructure SteelPath MLP Income Fund SteelPath MLP Select 40 Fund SteelPath MLP Alpha Fund ClearBridge Energy MLP Fund Credit Suisse - Cushing 30 MLP Index UBS E-TRACS 2x Leveraged Long Alerian UBS E-TRACS Alerian Natural Gas MLP Index Tortoise MLP Fund, Inc. ALPS Alerian MLP ETF UBS E-TRACS 1xMonthly Short Alerian MLP Infrastructure Total Return Index UBS E-TRACS Wells Fargo MLP Index Ticker MLPI MLPDX MLPFX MLPAX CEM MLPN MLPL MLPG NTG AMLP MLPS MLPW Underlying MLP Index
Product Type Exchange Traded Note Open-End Fund Open-End Fund Open-End Fund Closed-End Fund Exchange Traded Note Exchange Traded Note Exchange Traded Note Closed-End Fund Exchange Traded Fund Exchange Traded Note Exchange Traded Note
Alerian MLP Infrastructure Index Cushing 30 MLP Index 2x Alerian MLP Infrastructure Index Alerian Natural Gas MLP Index Alerian MLP Infrastructure Index Alerian MLP Infrastructure TR Index Wells Fargo MLP Index
Source: Bloomberg, FactSet, Standard & Poors, and Wells Fargo Securities, LLC
In addition to closed-end funds (CEF), the advent of MLP exchange-traded funds (ETF) and exchange-traded notes (ETN) provide diversification for investors and are administratively less burdensome than direct ownership in MLPs (e.g., receive 1099s and not K-1 statements). Year to date in 2010, the industry has seen the emergence of six ETNs, two CEFs, three open-end funds, and one ETF. We expect additional structured products around the MLP market to be created over time to spur additional investment in the sector. Figure 89 provides a brief overview of MLP-focused products. Figure 89. Summary Of MLP Financial Products
Direct Investment Tax deferral Tax efficient means to transfer wealth No management fees Real-time pricing Distribution increases Closed-End Funds (CEF) Distribution yield mirrors direct investment Professional management Qualifying dividend Participation in PIPEs Form 1099 / No K-1s Diversification Suitable for retirement accounts K-1s Management fee CEF pays corporate tax No tax deferral Leverage Delayed pricing causes premium/discount Management fee No tax deferral Credit risk to ETN issuer Leverage Coupon is fixed Potential tracking error Management fee Performance may not mirror MLP basket Pays corporate tax Sales charge and account fee Minimum investment ($3,000) Exchange Traded Notes (ETN) Performance mirrors MLP basket Lower management fee than CEF Form 1099 / No K-1s Diversification Suitable for retirement accounts Real-time pricing Exchange Traded Funds (ETF) No credit risk to issuer Form 1099 / No K-1s Diversification Suitable for retirement accounts Real-time pricing Open End Funds Professional management Form 1099 / No K-1s Daily liquidity at NAV Suitable for retirement accounts Access to fund family
Pros Cons
Equity only exposure Not suitable for retirement accounts
MLP Closed-End Funds Proliferate Beginning with Tortoise Energy Infrastructure Corporation (TYG) in 2004, the MLP sector witnessed the creation of closed-end funds that invest primarily in MLP securities. There are now 11 closed-end funds that invest solely in MLPs and one with 25% invested in MLPs. Closed-end funds are organized as corporations (as opposed to regulated investment companies, tax-exempt entities, etc.) and thus, are not subject to the restrictions related to qualifying income and UBIT. CEFs pay a dividend that is meant to generate a yield on par with the MLP investments themselves. Notably, CEFs are subject to federal income tax and typically use varying degrees of leverage to compensate for this disadvantage. Benefits to investing in a MLP closed-end fund include the following:

These portfolios are professionally managed and provide diversification for investors; These funds can be invested within IRA accounts without being subject to UBTI; Investors receive simplified tax reporting through a single 1099 rather than multiple K-1s; and Closed-end funds can engage in private market transactions that are not readily available to the public.
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MLP closed-end funds are playing an increasingly prominent role in the MLP sector, in our view. Closed-end funds represent approximately $8.6 billion of capital invested in the MLP sector in comparison to the groups total market cap of $219.3 billion. The funds often provide private funding for MLPs to supplement public equity offerings to finance growth initiatives. There are two closed-end funds that are now invested in privately held MLPs that could ultimately become public entities when they mature. Finally, when MLPs experience periods of weakness, some funds may use the weakness as a buying opportunity, thereby lending stability to MLP valuations. Notably, the second- and third-largest MLP closed-end funds were launched in mid-2010; they were Tortoise MLP Fund, Inc. (raised approximately $1.1 billion in July 2010) and the ClearBridge Energy MLP Fund (raised $1.27 billion in June 2010). Figure 90. MLP Closed-End Funds
MLP Closed-End Fund ClearBridge Energy MLP Fund Inc. Cushing MLP Total Return Fund Energy Income & Growth Fund Fiduciary/Claymore MLP Opportunity Fund Kayne Anderson Energy Total Return Fund Kayne Anderson MLP Investment Co. MLP & Strategic Equity Fund Inc Tortoise Energy Capital Corp. Tortoise Energy Infrastructure Corp. Tortoise MLP Fund, Inc. Tortoise North American Energy Tortoise Power and Energy Infrastructure All MLP Closed-End Funds Mean All MLP Closed-End Funds Median Ticker CEM SRV FEN FMO KYE KYN MTP TYY TYG NTG TYN TPZ Price 11/16/10 $20.81 9.60 27.35 20.06 27.30 27.43 17.43 27.12 36.80 23.99 26.35 $23.38 3-Month Avg Vol 213,031 247,864 40,283 150,860 85,517 396,959 76,984 82,384 71,606 206,583 18,654 62,260 137,749 83,951 Market Value (mm) $1,327.2 248.2 262.6 487.0 937.6 1,848.7 257.8 522.7 992.8 1,089.2 165.6 $162.3 $691.8 $504.9 Dividend Yield 6.7% 9.4% 6.7% 6.8% 7.0% 7.0% 4.8% 5.9% 5.9% 6.0% 5.6% 6.4% 6.5% 6.5% NAV Per Share $21.17 8.43 25.67 19.49 26.68 27.34 17.43 25.91 33.78 25.45 25.03 $24.81 $23.43 $25.24 Premium / (Discount) To NAV (1.7%) 13.9% 6.5% 2.9% 2.3% 0.3% 0.0% 4.7% 8.9% (5.7%) 5.3% (5.8%) 2.6% 2.6% YTD Return 2.8% 21.9% 25.6% 19.8% 25.3% 18.0% 15.2% 24.5% 24.7% (4.0%) 26.1% 22.2% 18.5% 22.1% IPO / Inception 6/25/10 8/27/07 6/24/04 12/22/04 6/27/05 9/27/04 6/29/07 5/26/05 2/24/04 7/27/10 10/27/05 7/29/09 -
Source: Bloomberg and FactSet
MLP Exchange-Traded Notes There are currently seven ETNs that track the performance of specific MLP indices, of which six ETNs were created in 2010. ETNs work as an alternative to ETFs and receive an IRS Form 1099 in lieu of a K-1 for tax purposes. Unlike ETFs and CEFs, ETNs are a form of senior unsecured debt and, therefore, carry credit risk to the issuer. ETNs are designed to provide investors with returns that are tied to the performance of a particular market index or strategy, less an applicable tracking fee. In other words, the ETN investor will receive variable quarterly coupons (from the underwriting bank) tied to the cash distributions paid on the MLPs in the index. Similar to other debt securities, ETNs have a maturity date and are backed by the credit rating of the issuer. The cash settlement amount at maturity equals to the principal amount multiplied by an index ratio based on the performance of the underlying MLP Index, net of fees. No principal protection on the ETN exists. Since ETNs are backed by the credit of the underwriting bank(s) (the issuers), the value of the ETN could decline if the issuers credit rating is downgraded. ETNs are traded on major stock exchanges, e.g., the New York Stock Exchange (NYSE). Figure 91. MLP Exchange-Traded Notes And Exchange-Traded Fund
Price MLP Exchange Traded Notes Alerian MLP ETF Credit Suisse Cushing 30 MLP Index ETN JPMorgan Alerian MLP ETN UBS E-TRACS 2x Leveraged Long Alerian E-TRACS Alerian Natural Gas MLP Index UBS E-TRACS Alerian MLP Infrastructure UBS E-TRACS Wells Fargo MLP Index MLP Exchange Traded Notes Mean MLP Exchange Traded Notes Median Ticker AMLP MLPN AMJ MLPL MLPG MLPI MLPW 11/16/10 $15.79 23.12 35.88 23.20 32.44 27.57 29.21 $24.71 % of 52 Week High 96.8% 96.1% 96.7% 92.7% 93.4% 97.3% 96.2% 96.6% 95.7% 96.4% Market Value (MM) $368.7 84.0 1,973.4 9.3 57.0 11.0 186.6 $27.2 $339.6 $70.5 Dividend Yield 6.3% 5.0% 5.0% NA 10.3% 5.2% 5.3% 5.7% 6.1% 5.3% NAV Per Share $15.78 $23.21 $36.00 $23.08 $32.70 $27.76 $29.37 $24.87 $26.60 $26.32 Total Net Assets (MM) $368.5 84.7 1,973.4 9.4 55.9 11.0 159.1 NA $380.3 $84.7 Issuer N/A CS JPM UBS UBS UBS UBS UBS -
UBS E-TRACS 1xMonthly Short Alerian MLP Index MLPS
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Master Limited Partnerships Exchange-Traded Fund -- Alerian MLP ETF
On August 25, 2010, Alerian launched the first-ever MLP ETF. The Alerian MLP ETF (NYSE Arca: AMLP) is designed to track the price and yield performance of the Alerian MLP Infrastructure Index (NYSE: AMZI), which consists of 25 energy MLPs focused on the transportation, storage, and processing of energy commodities. Benefits of the AMLP include (1) investors receive a single Form 1099 instead of a K-1, (2) investors have the potential to receive quarterly dividends, and (3) unlike ETNs, there is no credit risk associated with an ETF. The AMLP charges a management fee consistent with recently launched ETNs (0.85%). A drawback of the ETF structure is that it is less tax efficient because it is structured as a corporation (i.e., there is double taxation). Thus, the performance of the ETF may not track the underlying index. Investing in a MLP ETF does not allow the investor to receive the tax benefits associated with direct ownership of MLPs. For tax reporting purposes, the Alerian MLP ETF will generate a Form 1099 and not a K-1. Thus, this product can be held in retirement accounts, such as IRAs and 401-Ks. (Please refer to the MLP Exchange-Traded Notes And Exchange-Traded Fund comparable in Figure 91 for AMLP data.) Open-End Funds -- The SteelPath MLP Funds Trust On March 31, 2010, SteelPath Funds launched the first open-end fund focused on the energy MLP sector. While the SteelPath Funds are registered investment companies and submit regular filings like other mutual funds, the SteelPath Funds are categorized as corporations for IRS taxation purposes. This enables the funds to invest more than 25% of their assets in MLPs. Consequently, SteelPath funds do not receive the tax-free benefits that most mutual funds enjoy. Since SteelPath pays corporate income tax, the funds performance may not directly track the underlying basket of stocks owned by the fund. Benefits of the SteelPath funds include the following:

The funds are professionally managed; Provide daily liquidity at net asset value (NAV); Investors receive a singe 1099 instead of a K-1; and The funds structure eliminates UBTI issues, which allows the investor to hold the fund in tax-exempt accounts.
Figure 92.SteelPath Funds Compared To A Typical Mutual Fund

SteelPath Funds Structure What does it mean? Typical Mutual Fund
Registered Investment Company under the Investment Company Act of 1940 Law focuses on Fund disclosure to the investing public Requires companies to disclose financial condition and investment policies Corporation ("C-Corp") Pays corporate income tax (~35%) No limit on MLP investments Regulated Investment Company Tax free benefits 25% limit on MLP investments
Tax Selection with the IRS What does it mean?
Source: Fund reports and Wells Fargo Securities, LLC
The SteelPath MLP Funds Trust is comprised of three series: the SteelPath MLP Select 40 Fund, the SteelPath MLP Alpha Fund, and the SteelPath MLP Income Fund. The SteelPath MLP Select 40 Funds investment strategy is to invest at least 90% of the funds net assets in the equity securities of a minimum of 40 MLPs that primarily derive their revenue from energy infrastructure assets, or energy-related assets or activities. The SteelPath MLP Alpha Funds investment strategy is to invest at least 90% of the funds net assets in a concentrated portfolio of 20 midstream MLPs. The SteelPath MLP Income Funds investment strategy is to generate a high level of inflation-protected current income, primarily through investments in the larger, more liquid energy MLPs.
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MLP Primer -- Fourth Edition Figure 93. MLP Open-End Funds (Mutual Funds)
($ in millions except per unit data) MLP Open-End Fund SteelPath MLP Alpha Fund Class A SteelPath MLP Select 40 Fund Class A SteelPath MLP Income Fund Class A MLP Open-End Fund Total / Median Ticker MLPAX MLPFX MLPDX NAV 11/16/10 $10.67 10.68 $10.75 Total Assets $192 317 $120 $629 Dividends YTD $0.49 0.49 $0.63 $0.49 Implied Yield 6.1% 6.3% 7.1% 6.3%
Minimum Investment $3,000 3,000 $3,000 $3,000
YTD Return 6.7% 6.8% 7.5% 6.8%
Front Load 5.8% 5.8% 5.8% 5.8%
Mgmt Fee 1.10% 0.70% 0.95% 0.95%
Options With more institutional investors involved in the sector, MLPs have experienced an increase in option trading volume. Option contracts give investors the right (not the obligation) to buy or sell an underlying asset at a specific price. Options allow investors to (1) hedge their position or (2) speculate on the movement of a stock. From 2003 to 2006, 1,182 MLP options were traded per day on average. With the start of the credit crisis, the amount of MLP options traded increased to average 14,084 per day in 2007, compared to 1,622 per day in 2006, representing a 759% increase. Since 2008, the number of MLP options has increased along with the industrys public profile. In 2010 year to date (through November 15), almost 45,000 MLP put or call options are purchased each day. Figure 94. MLP Average Daily Option Volume
50,000 45,000 Average Daily Options Traded 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 2003 2004 2005 2006 2007 2008 2009 2010TD 528 936 1,622 1,640 14,084 9,527 22,714 44,979
Source: Bloomberg
Total Return Swaps Investors can also gain exposure to an MLP without direct ownership via a total return swap agreement. In a total return swap, an investor receives a synthetic security which mimics the performance of the underlying security. This includes any distributions generated by the underlying MLP and the benefit of the MLPs price appreciation over the life of the swap. However, if the price of the MLP decreases over the swaps life, the total return receiver will be required to pay the counterparty (usually a brokerage firm) the amount by which the asset has fallen in price. The counterparty owns the underlying MLP and receives payments from the investor over the life of the swap based on a set rate. Credit Default Swaps Investors can receive credit protection against public, MLP debt by entering into credit default swaps (CDS). Typically, a CDS represents a bilateral contract between a buyer of bonds and a seller of protection on these bonds. These swaps lower the risk of default as risk is transferred from the holder of the note to the seller of the swap. The spread represents the cost (or premium) of insuring bonds against a potential default. A wider CDS spread implies that bond investors are more concerned about an underlying companys financial position. Conversely, a narrower CDS spread implies that bondholders are confident in a companys ability to meet its bond payment obligations. In 2010, MLP CDS spreads have averaged approximately 125 bps, which compares to a three-year average of 174 bps and 443 bps in December 2008, during the height of the credit crisis.
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Master Limited Partnerships Figure 95. Average MLP CDS Spreads

Avg 5-Yr CDS Spread Of Investment Grade MLPs (Bps) 500 450 400 350 300 250 200 150 100 50 0 82 301 329 443 432
376 377 342 251 170 148 122 136 133 130 116 2009
Note: Large-cap pipeline MLP group consists of: EEP, EPD, ETP, KMP, MMP, OKS, and PAA Source: FactSet and Bloomberg
XIII. Valuation Of MLPs

A. Distribution Yield
MLPs can be valued using a number of techniques. The most common valuation method typically focuses on yield due to the fact that MLPs are income-oriented securities. Some investors will look at yield to determine relative value. Others will project a distribution one year forward and then apply a target yield to their projection to determine a fair value for the security. From 2000 to 2009, our MLP universe had a median yield of 7.3%, ranging from a high of 19.2% (November 21, 2008) as a result of the credit crisis to a low of 5.1% (July 10, 2007). The disparity in yield among MLPs can be explained by several factors, including risk profile (financial and operational), growth prospects, and the interest rate environment. Risk profile. MLPs with profiles that are perceived to be riskier (e.g., assets subject to commodity price risk, weather risk, higher leverage, or more variability in cash flow) typically trade at a higher yield in the market as investors require greater return to compensate for the increased risk. Growth prospects. We believe the disparity in yield can also be partially explained by the growth profile of various MLPs. For example, faster-growing MLPs should command a lower yield because it is assumed that the growth in cash flow would generate distribution increases that, in turn, would translate into greater appreciation of the underlying security, thus resulting in a higher total return. See Drivers of Performance Distribution Growth for additional information.
B. Three-Stage Distribution (Dividend) Discount Model

Our primary tool for valuing MLPs is a three-stage distribution (dividend) discount model (DDM). For our DDM, we project a distribution growth rate over five years. For years 6-10, we assume a distribution CAGR of 0.0-3.5%. We then apply a long-term growth rate of 0.0-3.8% (depending upon the individual MLPs outlook, asset mix, and management team). Our DDM assumes a required rate of return (ROR) of 8.0-12.0%, which is based on a risk-free rate (using the 10-year Treasury yield as our benchmark) and a market-risk premium.
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Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 2008 2010
88 104 102 112 130 160 150 138 143 132 119
108 131 117 89 101 112 117 151
C. Price-To-Distributable Cash Flow

To determine relative value, we focus on price-to-distributable cash flow (DCF) multiples. We believe the focus for MLPs should be on cash flow rather than earnings (or P/E). Distributable cash flow is defined as the cash available to be distributed to limited unitholders after payments are made for sustaining capital expenditure, other cash obligations, and cash distributions to the GP.
D. Enterprise Value-To-Adjusted EBITDA

When comparing MLPs value on the basis of an EV-to-EBITDA multiple, we use adjusted EBITDA rather than adjusted enterprise value. EBITDA generated by the partnership is used to support the cash distributions to both the limited and general partners. However, enterprise value reflects only the interest of the limited partners. Therefore, in order to produce an apples-to-apples comparison, we deduct the cash flow accruing to the general partner from EBITDA. For example, if a partnership has an enterprise value of $200 million and is generating EBITDA of $25 million with 10% of its cash flow going to the general partner, we would deduct approximately $2.5 million from EBITDA in calculating our EV-to-adjusted EBITDA multiple. We believe this is the most appropriate way to adjust EBITDA when comparing it to enterprise value. Figure 96. Enterprise Value-To-Adjusted EBITDA Calculation
1. EV-to-adjusted EBITDA EV-to-adjusted EBITDA EV-to-adjusted EBITDA 8.9x = EV adjusted EBITDA EBITDA - (EBITDA % cash flow to GP)
2.
EV
3.
$200
$25 - ($25 10%)
$200
$23
E. Spread Versus 10-Year Treasury

The median MLP yield is currently trading at approximately 363 bps above the 10-year Treasury. Yields on MLPs have maintained spreads over the 10-year Treasury as wide as 1,600 bps and as narrow as negative 8 bps, with an average of 334 bps over the ten-year period from January 2000 to 2009. We view the spread versus the Treasury as a good measure of investors appetite for assuming risk over time as it relates to owning MLPs. However, we caution that measuring current spreads versus an historical average may not be valid as the number, size, and growth orientation of MLP investments has changed over time. Figure 97. MLP Spread To The 10-Year Treasury (2000-10 Year To Date)
1,800 1,600 Basis-point spread to Ten-Year U.S. Treasury 1,400 1,200 1,000 800 600 400 200 0 (200) Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Historical MLP Yield Spread Average MLP Yield Spread To Treasury
Source: FactSet
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XIV. Types Of Assets In Energy MLPs And Associated Commodity Exposure

A. A Brief Review Of The Evolution Of The MLP Sector
In the 1980s, MLPs were involved in various businesses including exploration and production (E&P) of oil and natural gas, restaurants, sports teams, and other consumer activities. These businesses were more cyclical in nature, or in the case of E&P companies, were affected by low commodity prices, a volatile natural gas market, and depleting reserve base, which relied on exploratory drilling to sustain cash flow (current upstream MLPs own longer life reserves and employ a lower-risk, more factory-like, exploitation and production operation). Without reinvestment, the predecessor upstream MLPs were essentially self-liquidating partnerships and were unable to sustain their distributions. In the late 1980s, MLPs were reincarnated as entities that generally own midstream assets that are used to transport, process, and store natural gas, natural gas liquids (NGL), crude oil, and refined petroleum products and have limited exposure to commodity price risk. These assets were typically spun out of larger entities that could realize a higher value from these assets when placed into publicly traded MLPs. The early MLPs consisted primarily of refined-product pipelines that were characterized as mature assets that required modest maintenance capital and generated stable cash flow that was distributed to unitholders with very modest growth expectations. MLPs were basically bond-like substitutes with high yields and very modest growth. The modern day MLP got its start in 1986-87, when Congress passed the Tax Reform Act of 1986 and the Revenue Act of 1987. The new laws stated that to qualify as a master limited partnership, an entity had to earn at least 90% of its income from qualified sources. These sources were generally limited to natural resources or mineral activities including exploration, development, mining, processing, refining, transportation, or marketing. Other qualifying income includes interest, dividend, real property rents, income from the sale of property, gain from the sale of assets, income from the sale of stock, and gains from commodities, futures, (commodity related) forwards, and options (with certain limitations). The industry has seen a progression of different types of assets placed into the MLP structure, beginning with refined products pipeline assets in 1986 (Buckeye Partners, L.P.). Some asset types such as refining, and oil and gas reserves (introduced in the 1980s) were re-introduced to the MLP structure in 2006. Other MLPs, involved in the plastics and fertilizer industry did not survive as partnerships, due, in part, to the cyclical nature of their businesses. These partnerships were dissolved, merged, or restructured. Nevertheless, the majority of energy assets introduced into the MLP structure since 1986 have evolved from more stable pipelines to increasingly more volatile cash flow businesses with greater risk, in our view. In a sense, the MLP structure has evolved to include assets that operate progressively closer to the wellhead, the prototypical energy asset with the greatest degree of commodity, drilling, reserve, and re-investment risk. Beginning in the late 1990s, MLPs began reorienting their focus toward growth, making significant acquisitions, pursuing internal growth projects, and aggressively raising distributions. This change in focus was partially due to the sudden availability of midstream assets on the market. For example, majors and large diversified energy players decided to monetize their mature assets with the intent of redeploying proceeds from the sales into higher-return investments. The meltdown of Enron and the independent power producer (IPP) sector created an opportunity for MLPs to acquire pipeline assets at relatively attractive valuations. MLPs were able to take advantage of their unique tax-exempt structure, and lower cost of capital, to achieve returns superior to those of corporations. Figure 98. Evolution Of The MLP Sector
Compression Propane Products Pipeline & Terminal Plastics* Refining* Timber* Crude Pipeline Fertilizer* Natural Gas Pipeline Crude Marketing & Gathering Gathering, Processing, & Fractionation Coal Shipping LNG Refining Exploration & Production Natural Gas Storage
1986
1987
1988
1989
1991
1992
1993
1994
1998
1999
2004
2005
2006
2010
*Note - The Plastics, Refining, Timber, and Fertilizer MLPs) introduced in the above time line were either dissolved or converted into another entity. Source: Partnership reports and Vinson & Elkins, LLP
B. Asset Overview Relative MLP Distribution Security

In aggregate, the master limited partnership universe is made up of approximately 93 companies that are classified as publicly traded partnerships, with 72 being energy related. The MLP structure has evolved from stable cash flow generating assets (e.g., pipelines and storage) to more commodity-sensitive businesses (e.g., oil and natural gas assets, asphalt, refining, etc.) with higher risk, in our view. Currently, MLPs are engaged in every aspect of the energy value chain. Thus, the impact of commodity prices on MLP cash flow varies according to asset class.
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MLP Primer -- Fourth Edition Figure 99. Energy MLP Risk Profiles
Less risk Propane and Heating Oil Gathering and Processing
More risk
Pipelines and Storage Terminals
Shipping
Coal
Upstream/ Other
Note: Classification does not take into account hedging activities or parent/sponsor relationships Source: Wells Fargo Securities, LLC
Most MLPs offer stable distributions. Absent a significant deterioration in economic conditions from current levels, we believe certain subsets of the MLP sector offer investors a compelling value with secure distributions and attractive yields. These MLP subsets offer secure to rock solid distributions, in our view, with predominantly fee-based cash flow and direct commodity exposure that ranges from modest to minimal (or none). Figure 100. Relative MLP Distribution Security
Median Yield "Rock Solid" Distributions These MLPs have predominantly fee-based cash flows and minimal (or no) direct commodity exposure.
5.7%
BPL, BWP, EPB, MMP, PNG, SEP, SXL, TGP
Median Yield
"Secure" Distributions
6.4%
APU, CHKM, CMLP, DEP, EEP, EPD, ETP, EXLP, GEL, KMP, NKA, NRGY, NS, OKS, PAA, RGNC, SPH, TCLP, TLP, TOO, WES, WPZ
All Other MLPs
These MLPs have moderate commodity exposure and/or other non-fee based activities (marketing, volumetric risk, etc).
Median Yield
7.4%
APL, ARLP, BBEP, BKEP, CPNO, DPM, ENP, EROC, EVEP, FGP, HEP, KSP, LGCY, LINE, MMLP, MWE, NGLS, NRP, OXF, PSE, PVR, VNR, XTEX
These MLP have meaningful commodity exposure/other non-fee based activities and/or a projected 10 coverage ratio less than 1x.
Note: To note, the preceding list does NOT reflect our investment ratings and/or valuation ranges. Note: Excludes GPs and i-units, which would share the same risk profile as their underlying MLP. Source: Wells Fargo Securities, LLC estimates
The types of assets in energy MLPs include the following:
Midstream
o o o o o
Gathering and Processing Compression Pipelines Fractionation Storage and Terminals
Propane Shipping (marine transportation) Coal and aggregates (operators and royalty model) Upstream (exploration and production) Refining Asphalt Liquefied natural gas (LNG)
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Master Limited Partnerships Midstream
Midstream is a broad term than encompasses all aspects of the energy value chain except the production of oil and gas, and the distribution of energy products to end markets (i.e. the function of electric and gas utility companies). Midstream includes all types of commodities and encompasses the gathering and processing, transportation, and/or storage of crude oil, natural gas, natural gas liquids (NGLs), and/or refined petroleum products. In the following sections, we have provided a summary of each of these asset classes. We have organized the assets by each energy value chain for natural gas, natural gas liquids, and crude oil and petroleum. For each of these asset types, we have provided a general subsector overview, as wells as a discussion on industry and sector drivers, revenue drivers, risks, and commodity price sensitivity for each subsector.
C. The Natural Gas Value Chain

The natural gas value chain includes the production, treating, gathering, transportation and storage of natural gas. Notably, it is highly integrated with the natural gas liquids (NGL) value chain as NGLs are primarily produced through natural gas processing. Figure 101. Natural Gas Value Chain
Source: Plains All American Pipeline, L.P.
(1) Natural Gas Production Raw natural gas produced at the wellhead comes in many different types of forms and classifications, including the following:
Dry and wet natural gas: Natural gas is classified as dry or wet depending on the amount of NGLs present. Dry or lean natural gas contains less than 1 gallon of recoverable NGLs per Mcf of gas (GPM) and is composed primarily of methane. Wet or rich natural gas could contain as much as 5-6 GPM. The amount of NGLs contained in the natural gas stream can vary depending upon the region, depth of wells, proximity to crude oil, and other factors. For example, natural gas production in deepwater Gulf of Mexico and in the Rockies typically contains in excess of 4 GPM. In comparison, gas produced along the continental shelf areas of the Gulf of Mexico contains 1.0-1.5 GPM. In 2008, approximately 4% of total proved reserves in the United States were considered wet.
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MLP Primer -- Fourth Edition Figure 102. Dry Versus Wet Domestic Natural Gas Reserves
300,000
Proved Natural Gas Reserves (Bcf)
250,000 4.2%
4.1% 4.2% 4.9% 4.3% 4.4% 4.1% 4.3%
4.1%
200,000 4.9% 150,000 5.0%
100,000
50,000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Proved Dry Natural Gas Reserves
Proved Wet Natural Gas Reserves
Source: EIA
Associated and non-associated gas: Associated or casing head gas is raw natural gas that has become dissolved in oil accumulations and is produced as a by-product along with crude oil. If the gas is in contact but not in solution with crude oil, it is known as associated free gas. Associated gas is typically rich, with heavier NGLs. Alternatively, non-associated gas is natural gas that is free from contact with crude oil (ex. dry natural gas is non-associated gas). In 2008, approximately 13% of total proved wet natural gas reserves in the United States were considered associated. Figure 103. Non-associated Versus Associated Domestic Natural Gas Reserves
300,000
Proved Wet Natural Gas Reserves (Bcf)
250,000 15.2% 200,000 19.0 18.4% 17.8% 16.9% 15.9% 15.3% 15.5%
12.8%
150,000
21.6%
21.7%
100,000
50,000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Nonassociated Proved Wet Natural Gas Reserves
Associated Proved Wet Natural Gas Reserves
Source: EIA
(2) Natural Gas Gathering Natural gas gathering systems consist of a network of small diameter (4-6) pipelines that collect and transport raw natural gas (from producing natural gas wells) to a central delivery point for transport to a processing and treating facility or directly to the interstate pipeline system (if the gas does not require processing). Gathering systems are designed to be flexible, in order to gather natural gas at different pressures, transport gas to different plants, and connect new wells to accommodate additional production (without the need for significant incremental capital expenditure).
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Master Limited Partnerships Figure 104. MLPs With Natural Gas Gathering Assets
Atlas Pipeline Partners L.P. Chesapeake Midstream Partners Copano Energy LLC Crestwood Midstream Partners L.P. Crosstex Energy L.P. DCP Midstream Partners L.P. Duncan Energy Partners L.P. Eagle Rock Energy Partners L.P. Enbridge Energy Partners L.P. Energy Transfer Partners L.P.
APL CHKM CPNO CMLP XTEX DPM DEP EROC EEP ETP
Enterprise Products Partners L.P. Kinder Morgan Energy L.P. Markwest Energy Partners L.P. Martin Midstream Partners L.P. ONEOK Partners L.P. Penn Virginia Resource Partners L.P. Regency Energy Partners L.P. Targa Resources Partners L.P. Western Gas Partners L.P. Williams Partners L.P.
EPD KMP MWE MMLP OKS PVR RGNC NGLS WES WPZ
Industry/sector drivers. Throughput on natural gas gathering systems is dependent on regional drilling activity by E&P producers. While gathering volume is not directly influenced by fluctuations in natural gas prices, volume could move commensurately with pricing over the long term as producers right-size drilling budgets in response to drilling economics. In the current commodity price environment, producers have shifted their drilling programs from dry natural gas producing areas to wet natural gas (i.e., with high natural gas liquids content) producing regions in order to capitalize on more favorable economics (i.e., higher returns). This, in turn, has resulted in a need to develop additional gathering infrastructure in these new supply regions. Revenue drivers. Natural gas gathering is a fee-based activity, as revenue is generated based on a fee per unit (Mcf) of natural gas gathered. However, since this activity is volume based, revenue is dependent upon the pace of drilling activity within a partnerships gathering footprint and the ability to connect new producing wells to gathering systems. To note, some gathering systems are supported by acreage dedications, which commit the producer to utilize the partnerships gathering system for all current and future production for a predetermined period (which can sometimes be for the life of the producers reservoir lease). In some instances, the producer will guarantee a minimum level of volume to the gatherer. Risks. The primary risk for MLPs with gathering assets is declining natural gas prices. Other risks include rising raw material and labor costs, a material change in regulatory requirements or standards for the systems geographic location, and an overbuild of U.S. energy infrastructure. Commodity price sensitivity. MLPs with gathering assets do not take title to the natural gas they handle and do not have direct exposure to the price of natural gas. However, changes in commodity prices can ultimately affect the partnerships system volume. A declining natural gas price environment can cause producers to suspend their drilling operations or shut-in wells. A decline in producer drilling activity would likely lower gathering volume, resulting in lower cash flow, all else being equal. (3) Treating And Dehydration Following the gathering process, various contaminants in the natural gas stream must be removed before transportation on intrastate or interstate pipelines. Contaminants typically found within the natural gas stream include water vapor, carbon dioxide (CO2), and hydrogen sulfide (H2S). In order to comply with downstream pipeline and end-user quality specifications, natural gas is dehydrated (to remove saturated water) and chemically treated to extract contaminants (e.g., CO2 and H2S). Natural gas that is saturated with water can form ice that can obstruct parts of a pipeline system. In addition, water can cause pipeline corrosion when combined with CO2 and H2S. Natural gas with high levels of CO2 and H2S can also harm pipelines and could result in a failure to meet end-user requirements. The amine treating process involves a continuous circulation of amines as the chemical is attracted to CO2 and H2S. The impurities are absorbed from the natural gas stream by the amines as they come into contact with each other. The amines are then removed from the natural gas stream, resulting in pipeline quality gas. To note, the amines are recycled after the impurities have been removed via a heating process.
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MLP Primer -- Fourth Edition Figure 105. MLPs With Treating And Dehydration Businesses
Kinder Morgan Energy L.P. Regency Energy Partners L.P.
KMP RGNC
Industry and sector drivers. Similar to gathering, the main drivers for treating include a higher natural gas price environment (to spur drilling activity). However, unlike gathering assets, which are immobile and dependent on production growth within a particular region, treating assets are mobile and can be moved in response to shifts in drilling activity. Hence, while broader fluctuations in natural gas supply and demand will affect demand for treating, regional exposure is mitigated given the mobility of treating assets. To note, the aforementioned drivers assumes that the natural gas produced requires treating and dehydration to meet pipeline specifications. Revenue drivers. Treating businesses generate 100% fee-based revenue. MLPs typically utilize three types of contracts in the treating business, which includes (1) a volumetric fee-based contract based on the amount of gas treated, (2) a fixed fee monthly operating fee, or (3) a fixed monthly rental fee. Meaningful revenue growth could likely come from acquisitions or the addition of third-party treating contracts. Risks. The primary risk for MLPs with treating assets is a declining natural gas price environment, lower pipeline quality specifications, and the development of supply basins with low CO2 levels. Commodity price sensitivity. MLPs with treating assets typically do not have direct exposure to commodity prices. However, changes in commodity prices can ultimately affect the partnerships treating volume. A declining natural gas price environment can cause producers to suspend their drilling operations and/or shut in wells. A decline in producer drilling activity would likely lower the MLPs treating volume, resulting in lower cash flow. (4) Compression A compressor is used to compress a volume of product at an existing pressure to a higher pressure to facilitate delivery of the gas from one point to another. Compression is often applied (1) at the wellhead, (2) throughout gathering and distribution systems, (3) into and out of processing and storage facilities, and (4) along intrastate and interstate pipelines. Within the life of a well, pressure eventually falls below the levels of the connecting gathering lines, which causes natural gas to no longer flow into the gathering lines. Compression is applied to the reservoir to facilitate flow from the well. As well pressure changes, adjustments to the amount of compression horsepower are required. Compression operators can provide producers with specialized needs, which potentially can improve production rates and increase volume. Figure 106. MLPs With Compression Businesses
Exterran Partners L.P. Regency Energy Partners L.P.
EXLP RGNC
Industry and sector drivers. Compression is essential to natural gas production and transportation and less correlated with drilling and exploration activities. Compression growth will be driven by the potential increase in production from unconventional natural gas sources (i.e., shale gas and coalbed methane), in our view. Notably, unconventional wells typically produce at lower pressures, which require more horsepower of compression relative to conventional natural gas plays. According to the EIA, shale gas and coalbed methane will consist of 34% of total U.S. natural gas production by 2035, versus 17% as of 2008 (latest data available). In addition to increased production from unconventional plays, older natural gas wells will require progressively higher compression over time to produce the same volume of gas.
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Master Limited Partnerships Figure 107. U.S. Natural Gas Production By Source, 1990-2035E
25
Alaska 20 Trillion Cubic Feet Shale gas 15 Coalbed methane
10
Other lower 48 onshore (including tight gas)
5 Lower 48 offshore 0 1990 2000 2008E 2015E 2025E 2035E
Source: EIA
Compressor utilization also depends on the producers views on outsourcing. Many producers choose to outsource their compression requirements, as the purchase of compression units could be a significant capital investment. Operators would be required to modify and replace compressors to retain efficiency, as well, and pipeline pressures change over time. By outsourcing their compression needs, producers are able to deploy their capital on investments related to their primary business (e.g., development of reserves). Revenue drivers. Compression revenue is driven by the amount of operating horsepower (HP utilization rate) and the rate per HP charged to the customer. Compression MLPs typically generate revenue from a fixed, monthly fee per HP for compression services and may be incentivized to minimize the amount of downtime on the compressor units. These partnerships realize stable, fee-based cash-flow even during periods of limited or disrupted production. Commodity price sensitivity. Because compression providers do not take title to the natural gas they compress, direct exposure to commodity prices and volatility is relatively limited. In addition, fuel to operate compression units is provided by the natural gas producer, which further limits commodity risks. In addition, compression demand is driven more by natural gas production and consumption rather than exploration activities, which is directly affected by commodity prices. Risks. A decline in natural gas production would negatively affect demand for compression services. In addition, producers efforts to lower their operating costs in a low natural gas price environment could result in a higher return rate for third-party compressor units. (5) Natural Gas Processing Prior to long-haul transportation, natural gas from the wellhead must often be processed to remove heavier NGL components, or refined to remove impurities in order to meet specifications for pipeline transportation. A natural gas processing plant typically receives non-pipeline quality or wet natural gas via a gathering system and separates (1) pipeline quality or dry natural gas for transportation on interstate and intrastate natural gas pipelines from (2) raw NGL product mix for transportation on NGL pipelines to fractionation facilities and ultimately various end markets, including petrochemical plants. For more details on natural gas processing and the NGL value chain, please see the section D entitled The NGL Value Chain.
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MLP Primer -- Fourth Edition (6) Natural Gas Pipelines
Interstate natural gas pipelines. Interstate natural gas transportation pipelines in the United States are regulated by the Federal Energy Regulatory Commission (FERC), a government agency. Interstate pipelines transport gas across multiple states and are analogous to the interstate highways used for transportation. Natural gas transportation pipelines receive natural gas from gathering systems and other pipelines, and deliver it to industrial end users, utility companies, or storage facilities. Utilities or local distribution companies then distribute the natural gas to residential and/or commercial customers. Throughput in mainline natural gas transportation pipelines tends to be relatively stable due to steady growth in demand for natural gas from the industrial, commercial, electric power sector, and residential end users. Figure 108. MLPs With Natural Gas Pipeline Assets
Master Limited Partnership Boardwalk Pipeline Partners L.P. Copano Energy LLC Crosstex Energy L.P. Duncan Energy Partners L.P. El Paso Pipeline Partners L.P. Enbridge Energy Partners L.P. Energy Transfer Partners L.P. Enterprise Products Partners L.P. Kinder Morgan Energy L.P. Martin Midstream Partners L.P. ONEOK Partners L.P. Regency Energy Partners L.P. Spectra Energy Partners L.P. TC Pipelines L.P. Western Gas Partners L.P. Williams Partners L.P.
Interstate Pipelines BWP CPNO XTEX DEP EPB EEP ETP EPD KMP MMLP OKS RGNC SEP TCLP WES WPZ
Intrastate Pipelines
Industry and sector drivers. In general, the growth in pipeline volume is closely tied to growth in demand for energy, which tracks GDP growth. Growth can be higher depending on regional demographic growth patterns and expansions. As an example, natural gas pipeline companies should benefit from states (e.g., Florida) constructing natural gas-fired electric generation plants (as opposed to coal-fired plants) to meet increasing demand for electricity. This anticipated increase in electricity demand is related to the expected population growth (related to the retiring Baby Boomer generation) in the Southeast region of the United States. Meaningful growth for MLPs with natural gas pipeline assets can be achieved through the consummation of acquisitions, the construction of new interstate pipelines, and the expansion of existing pipeline systems to new markets or customers. Revenue drivers. Interstate natural gas pipelines predominantly generate fee-based revenue with minimal volumetric risk. New pipelines are generally backed by long-term take-or-pay contracts wherein shippers reserve capacity on the pipeline and pay demand charges independent of whether capacity is actually utilized. A small portion of an interstate pipelines earnings may vary with volume. Notably, this relates to interruptible services provided to the pipelines customers that have not reserved capacity on the system. These customers pay usage fees based on the actual volume of natural gas transported, stored, injected, or withdrawn from the pipeline system. Interruptible services usually account for less than 10% of a pipelines earnings. The transportation rate an interstate natural gas pipeline charges a customer can be one of the following: (1) the maximum rate allowable by the FERC, which is based on the pipelines average cost of providing service, (2) a discounted rate from the maximum rate, (3) a market-based rate, or (4) a negotiated rate between the pipeline and the shipper.
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Pipeline operators can also generate incremental revenue through fuel retention margin. Pipelines are typically allowed to recoup fuel transportation costs by retaining a portion of the natural gas transported across pipeline systems. By optimizing its pipeline system (e.g., transporting gas from other parts of the pipeline system at a cheaper cost), a pipeline operator can generate a small margin by selling the excess gas into the spot market. Therefore, during periods of low natural gas prices and/or low pipeline volume, fuel retention margin decreases. Park and loan services. Natural gas pipelines can also generate incremental revenue by providing customers with park and loan services (this typically requires FERC approval). Pipeline MLPs that offer this service allow the customer to deliver natural gas onto the pipeline system to be held (park) until a future date (e.g., until demand improves). The pipeline customer can also temporarily borrow gas from the pipeline operator (loan) to be paid back at a later date (e.g., in order to meet temporary peaks in demand). By providing park and loan services, the pipeline operators are able to help their customers balance their supply and demand needs. Risks. Interstate natural gas pipeline assets have historically been less exposed to economic cycles (i.e., downturns), due to their low cost structure (versus other transporters, such as truck, rail, and barge) and government-regulated tariffs. The primary risks for MLPs with natural gas pipeline assets include (1) a slowdown in economic activity, (2) rising raw material and labor costs, (3) an overbuild of U.S. energy infrastructure, (4) regulatory risk related to allowed rates of return, (5) lower re-contracting rates, and (6) a decline in commodity prices (resulting in a decline in drilling activity). Commodity price sensitivity. In general, interstate natural gas pipeline assets do not take title to the commodity, and hence, commodity price fluctuations have a minimal (if any) direct impact on cash flow. Earnings for interstate natural gas pipelines are typically based on demand charges (similar to rent), or a regulated tariff rate. Longer term, tariffs on interstate pipelines could vary as expiring contracts are renewed at prevailing market-based transportation rates, which would likely be affected by basis differentials and the markets to which the pipeline can provide access. Intrastate natural gas pipelines. Intrastate natural gas pipelines perform essentially the same functions as interstate pipelines (i.e., connect producers to other intrastate or interstate pipelines and end-user markets), except that intrastate pipelines operate within state borders. An intrastate pipeline system generally transports natural gas between many different hubs and points within a particular state (the largest being Texas). Hence, basis differentials (i.e., the spot cost of transporting gas from one hub to another) among multiple hubs are a key driver of pipeline intrastate segment revenue. Some major trading points within Texas include Katy, Waha, Houston Ship Channel, and Carthage. Many intrastate pipeline operators leave a small amount of open capacity on their systems in order to opportunistically take advantage of high basis differentials. MLPs that own intrastate pipelines are subject to state regulation based on the locations of their pipelines. Some intrastate pipelines are also subject to limited regulation by the FERC. For example, an intrastate pipeline is allowed to transport gas on behalf of an interstate pipeline or a local distribution company (LDC) that is served by an interstate pipeline without being subject to FERC regulation. However, the pipeline is required to make certain rate and other filings/reports that are in compliance with FERC regulations. (7) Natural Gas Storage Natural gas storage assets are regulated by the FERC. These assets are an integral and necessary part of the natural gas value chain given the linear rate of production throughout the year and the seasonal nature of consumption (i.e., more natural gas is consumed than produced in the winter months, while less natural gas is consumed than produced the summer months). Thus, natural gas storage acts as the balancing mechanism or buffer to balance supply and demand. Customers for natural gas storage include financial institutions, producers, marketers, utilities, pipelines, and municipalities.
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MLP Primer -- Fourth Edition Figure 109. MLPs With Natural Gas Storage Assets
Boardwalk Pipeline Partners L.P. Buckeye Partners L.P. Duncan Energy Partners L.P. Energy Transfer Partners L.P. Enterprise Products Partners L.P. Inergy L.P. Kinder Morgan Energy L.P. BWP BPL DEP ETP EPD NRGY KMP Niska Gas Storage Partners ONEOK Partners L.P. PAA Natural Gas Storage L.P. Spectra Energy Partners L.P. Sunoco Logistics Partners L.P. Williams Partners L.P.
NKA OKS PNG SEP SXL WPZ
Industry and sector drivers. The following outlines some of the factors that could influence the value of storage, which includes the following:
Natural gas consumption patterns. Rising consumption in natural gas should also increase the need for storage. According to the EIA, U.S. natural gas consumption increased at a CAGR of 0.4% from 1998 to 2008 (to 63.5 Bcf per day from 61.0 Bcf per day). For 2009, natural gas consumption actually declined to 62.6 Bcf/day, primarily due to the economic downturn. U.S. natural gas consumption is expected to increase at a CAGR of 0.4%, to 68.1 BCF per day by 2035. Higher peaks for storage. The peak storage levels for natural gas (which typically occur in the fall) continue to increase, suggesting further demand for storage. This increase in storage is partly due to the increase in residential use of natural gas as a fuel source, which is highly seasonal. In 2008, 56.7 million, or 51.2%, of occupied homes in the United States used natural gas as their heating source. This represents an 11% increase since 1997, or a CAGR of 1%. In seven out of the past nine years, the month of October has been the peak storage month for natural gas, averaging 3.4 Tcf of storage. Further, the total amount of working natural gas in storage recently peaked at 3.84 Tcf on November 11, 2010. This is likely the result of continued strength in natural gas production, driven by shale development coinciding with relatively weak demand due to the economic environment. Growth of natural gas-fired electric generation. Natural gas-fired electric generation continues to increase as a percentage of the total market, implying greater future demand for natural gas and greater potential swings in demand based on seasonal weather patterns (i.e., summer). While coal currently dominates Americas power generation source (at 46%), the current U.S. administration has made a commitment to finding a power source that releases less carbon dioxide emissions and is an abundant natural resource. Due to its relatively low cost and supply outlook, due to recent shale production, natural gas has the ability to make a significant contribution to Americas energy requirements, in our view. Reduction in industrial baseload demand. Industrial demand for natural gas continues to decrease over time, which should increase the overall swings in supply and demand. This is due to the fact that industrial demand represents the most stable and linear demand source for natural gas as it is relatively unaffected by weather and other factors (i.e., it runs throughout the year). The industrial sector has decreased its total demand for natural gas to only 6.1 Tcf in 2009 from 8.1 Tcf in 2000, which represents a decrease of 25%. With less baseload industrial demand for natural gas, the seasonal swings in demand and supply could be more pronounced, increasing the value of storage, in our view. Seasonal spreads. Winter summer spreads have narrowed over the past few quarters due to the combination of (1) a warmer-than-normal summer and (2) record natural gas production. We anticipate storage spreads could improve over time as weather returns to normal and inventory is reduced to more manageable levels. Volatility. Increased volatility in natural gas prices and spreads could enhance the value of storage. Since 2000, the volatility of natural gas prices has increased with greater dips and swells. The standard deviation of Henry Hub natural gas prices from 1991 to 1999 was $0.53 per MMBtu, versus $2.35 per MMBtu from 2000 to year to date. On an annual basis, standard deviation for natural gas prices peaked in 2005, when the industry saw prices range from $5.50 to $15.39 per MMBtu. As noted, volatility increases the value of storage as users can take advantage of price swings to capture arbitrage opportunities. Increased supply. U.S. natural gas supply continues to increase, driven by low-cost shale development across North America. According to the EIA, natural gas supply is expected to increase to 24.8 Tcf in 2035 at a CAGR of 0.3%. If production increases faster than demand, this could cause an imbalance between supply and demand, which would increase the value of storage (i.e., lower spot prices and higher futures prices). Alternatively, if natural gas production increases at a rate commensurate with demand, natural gas price volatility could be reduced, this, in turn, would decrease the value of storage. To note, demand for storage could continue to grow modestly even under this scenario as a storage requirements typically increase linearly as the market for a commodity expands.
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LNG. An increase in U.S. LNG imports could also increase the demand for storage. LNG imports are intermittent and entirely driven by the global gas market. According to the EIA, LNG imports are expected to increase at a CAGR of 1.2%, to 826 Bcf by 2035 from 608 Bcf in 2010.
Revenue drivers. For the most part, natural gas storage companies generate a majority of their revenue from long-term fee-based contracts, while a smaller percentage of revenue is derived from short-term feebased contracts and marketing activities. The main revenue drivers for these MLPs are organic capex investments and third-party acquisitions that would complement the partnerships existing footprint (i.e., provide operational synergies) or provide geographic diversification (i.e., via new and existing development projects). Another avenue for growth is the acquisition of distressed storage assets. These types of are likely to consist of either (1) mature, fully developed facilities that are under liquidity constraints and/or (2) development-oriented projects that have encountered financing or geologic or execution challenges. Risks. The primary risks for MLPs with natural gas storage assets include (1) an overbuild of domestic natural gas storage, (2) lower re-contracting rates, (3) a decline in natural gas prices and volatility, and (4) rising interest rates. Lowering natural gas prices reduce the value of storage, all else being equal, as volatility based on a lower absolute price implies lower absolute margin. A high interest rate environment increases the carrying cost for natural gas storage (i.e., to finance working capital). Commodity price sensitivity. Natural gas storage operators who lease capacity to third parties do not take title to the commodity, and hence, commodity price fluctuations have a minimal (if any) direct impact on cash flow. A majority of revenue generated from natural gas storage assets is from reservation fees (i.e., demand charges) for the contracted capacity. Natural gas storage assets also generate cycling fees (a variable fee that is not affected by commodity prices) based on the actual volume injected or withdrawn by customers. Thus, natural gas storage rates are not directly affected by a sustained high (or low) commodity price environment. However, natural gas storage operators who hold capacity for their own account are exposed to fluctuations in prices and the shape of the NYMEX futures curve for natural gas. The main driver affecting storage rates is winter-summer natural gas price spreads, which represents the intrinsic value of a storage contract. To note, the winter-summer NYMEX forward spread is the difference between the highest- and lowest-price month for the future April through March period (i.e., 12-month period). Other factors that influence storage pricing include (1) overall natural gas price volatility, (2) the magnitude and duration of storage contracts, (3) the level of service provided (i.e., the number of turns, or maximum allowed injection and withdrawals per season), (4) the type of customer, and (5) location.
D. The NGL Value Chain

Approximately 65% of total NGLs supplied in the United States are derived from domestic natural gas processing. The remaining 35% is derived from refining and imports. From start to finish, the process of stripping NGLs from the natural gas stream and transporting fractionated NGL products to end markets or storage encompasses the operations of 21 MLPs under coverage. Figure 110. MLPs Involved In The NGL Value Chain
Processing APL DEP EPD MMLP OKS WES CMLP DPM EROC MWE PVR WPZ CPNO EEP ETP NGLS RGNC XTEX Interstate Pipelines
Wet Natural Gas Production
Gathering
Intrastate Pipelines
NGL Fractionation EPD CPNO DEP DPM MMLP MWE NGLS OKS WPZ XTEX
Raw NGL Pipelines BPL EPD DEP DPM EROC OKS
NGL Storage EPD DEP DPM MMLP MWE NGLS NRGY OKS WPZ
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Natural gas liquids. NGLs are hydrocarbons that are found and produced along with natural gas. NGLs are typically separated from the natural gas stream through natural gas processing. NGLs are comprised of six marketable products, which include ethane (C2), propane (C3), butane (C4), iso-butane, and natural gasoline (C5). These products account for 37%, 32%, 11%, 6%, and 14%, respectively, of a NGL barrel at Mont Belvieu, Texas, the largest NGL hub in the United States. The NGL value chain consists of the following steps: Figure 111. NGL Value Chain
Source: Enterprise Products Partners, L.P.
(1) Natural Gas Processing Prior to long-haul transportation, natural gas from the wellhead must often be processed to remove heavier NGL components, or refined to remove impurities in order to meet specifications for pipeline transportation. A natural gas processing plant typically receives non-pipeline quality or wet natural gas via a gathering system and separates (1) pipeline quality or dry natural gas for transportation on interstate and intrastate natural gas pipelines from (2) raw NGL product mix for transportation on NGL pipelines to fractionation facilities and ultimately, petrochemical plants. Figure 112. MLPs With Natural Gas Processing Assets
Atlas Pipeline Partners L.P. Copano Energy LLC Crestwood Midstream Partners L.P. Crosstex Energy L.P. DCP Midstream Partners L.P. Eagle Rock Energy Partners L.P. Enbridge Energy Partners L.P. Energy Transfer Partners L.P. Enterprise Products Partners L.P. Inergy L.P.
APL CPNO CMLP XTEX DPM EROC EEP ETP EPD NRGY
Kinder Morgan Energy L.P. Markwest Energy Partners L.P. Martin Midstream Partners L.P. ONEOK Partners L.P. Penn Virginia Resource Partners L.P. Regency Energy Partners L.P. Targa Resources Partners L.P. Western Gas Partners L.P. Williams Partners L.P.
KMP MWE MMLP OKS PVR RGNC NGLS WES WPZ
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Types of processing methods. The term natural gas processing refers to a number of different processes that occur in the following stages: (1) gas-oil separation, (2) condensate separation, (3) dehydration, (4) nitrogen extraction, and finally (5) methane separation. Herein, we describe the two main techniques behind the final step in the process, methane separation, which refers to the actual separation of methane (i.e., natural gas) stream from NGL components. Approximately 90% of the natural gas processing plants in the United States utilize one of the following techniques for methane separation: (1) absorption method or (2) cryogenic expander process.
Lean oil absorption. The lean oil absorption method utilizes specially formulated oils to absorb heavier NGL components from the incoming gas stream. As natural gas passes through the absorption tower, NGLs are captured by the absorption oil, which has an affinity to NGLs. The absorption oil is then fed into oil stills, where the mixture is heated above the boiling point of NGLs but below that of oil, hence separating the NGLs from the absorption oil. This process recovers approximately 75% of butanes, 8085% of pentanes, and 40% of ethane from the natural gas stream. Higher recoveries can be achieved via the use of refrigerated absorption oil. Nevertheless, this process is inherently less effective at recovering ethane than the cryogenic method, a description of which follows. Cryogenic expansion. Most modern processing plants utilize the cryogenic expander process to extract NGLs. This process is highly efficient at extracting ethane, with recoveries in the 90-95% range, versus 40% under the absorption method. Cryogenic expansion involves the rapid cooling of natural gas via expansion to approximately negative 120 degrees Fahrenheit. At this temperature, ethane and the other NGL components condense out of the natural gas stream, while methane remains in its gaseous form.
Figure 113. Picture Of A Natural Gas Processing Plant
Source: Copano Energy
Types of processing modes. While processors are obligated to extract heavier NGL components from a producers natural gas stream, they are not always required to process ethane. Because ethane is the lightest NGL component (i.e., it is the closest in composition to methane), it can be left in the natural gas stream and transported by pipelines. Accordingly, the processing of ethane is a discretionary option available to the processor. Modern processing plants can switch between full processing (ethane is processed) and ethane rejection (ethane is not processed) modes, depending on processing economics.
Ethane rejection. Most modern processing plants have the ability extract heavier NGL components but leave ethane in the natural gas stream when processing economics are unfavorable. This process is known as ethane rejection, as the processor is choosing not to extract ethane and instead, leaving it in the natural gas stream. Ethane rejection usually occurs when the processing margin (specifically the ethane margin) turns negative or uneconomic (i.e., below a plants fixed operating costs). At this point, a processor would likely avoid (if given the option) having to process ethane, as doing so would incur a loss. To note, the remainder of the NGL stream (i.e., propane+) is still processed. Alternatively, when processing economics are favorable (i.e., when ethane is worth more as a distinct product than as part of the natural gas stream), a processor would opt to extract ethane.
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Conditioning mode. Some processing plants have the ability to dramatically reduce processing volume for all NGL components under what is known as conditioning. Under a conditioning agreement, a company processes natural gas (typically for a fee) to the minimum extent necessary to meet pipeline specifications. Unlike ethane rejection, when only the processing of ethane is bypassed, conditioning allows a processor to bypass the processing of all NGL components. As a result, overall NGL output is significantly reduced, which allows the processor to minimize commodity exposure during periods of unfavorable processing margin. Full recovery. Full recovery refers to normal operating conditions when a processing plant is extracting both ethane and the heavier NGL components.
End products of natural gas processing. Processing plants accept wet natural gas and produce two primary end products: (1) residue natural gas and (2) raw natural gas liquids, as well as a mixture of byproducts.
Residue natural gas. Residue or dry natural gas refers to the resulting natural gas stream after heavier NGL components have been extracted through processing. Residue natural gas consists primarily of methane and ethane (depending on processing economics), and is suitable for transportation on natural gas pipelines. Most major interstate natural gas pipelines in the United States require natural gas Btu values of less than 1,000. In comparison, wet natural gas has a Btu value in excess of approximately 1,100. Raw NGL mix. Raw NGL mix or y grade refers to the heavier NGL components that are extracted via natural gas processing. The resulting NGL mix is commingled product consisting of ethane (depending on whether ethane rejection took place), propane, butane, iso-butane, and natural gasoline. It is not until fractionation, the next step in the NGL value chain, that the raw NGL mix is further separated into individual NGL components.
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Condensate. Condensate or lease condensate refers to a specific portion of the NGL stream. Some of the heavier NGL components (i.e., iso-butane and natural gasoline) exist as a gaseous state only at underground pressures. These molecules will immediately condense to a liquid state when brought to atmospheric conditions, hence the name condensate.
Other by-products. Several important by-products are produced via natural gas processing and natural gas treatment, including Helium, carbon dioxide, and hydrogen sulfide.
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Helium. The worlds supply of helium comes exclusively from natural gas production, with the United States responsible for 80% of overall helium production. Helium is used primarily in magnetic resonance imaging, semiconductor processing, and rocket engine construction by NASA. Carbon dioxide. In 2004, approximately 6.2 Bcf of carbon dioxide was produced in seven processing plants in the United States. To note, the level of CO2 produced during natural gas processing is significantly lower than that of fuel oil and coal. According to the EIA, CO2 emissions total 121 lbs. per MMBtu of natural gas, versus more than 200 lbs. per MMBtu equivalent of coal. Carbon dioxide produced by natural gas processing is used primarily for support of tertiary-enhanced oil recovery production within the region. Hydrogen sulfide. Almost of the worlds supply of elemental sulfur is recovered through the desulfurization of oil and natural gas. According to the U.S. Geological Survey, approximately 15% of U.S. sulfur production is derived from natural gas processing plants. Natural gas and crude oil/condensate high in sulfur content is referred to as sour; conversely, natural gas and crude oil light in sulfur content is referred to as sweet.
Industry and sector drivers. A relatively wide ratio between the price of crude oil and the price of natural gas is incentivizing producers to focus drilling in oil and liquids-rich areas (as opposed to areas with dry natural gas), where economics are more favorable. This has resulted in a slight uptick in processing volume. In addition, this relative price relationship has made natural gas-based ethane the preferred feedstock of the petrochemical industry at the expense of crude-based naphtha, resulting in strong demand for NGLs.
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Master Limited Partnerships Revenue Drivers Natural Gas Processing Contracts
Natural gas processors generate earnings under three basic types of processing arrangements: (1) keep whole (KW), (2) percentage of proceeds/index/liquids (POP/POL/POI), and (3) fee-based. Figure 114 provides a breakdown of estimated processing volume by contract type for MLPs that own gathering and processing assets. Figure 114. Breakdown Of Contract Structures And Hedging For MLPs With Processing Assets
Processing Contracts Keep MLP Atlas Pipeline Partners L.P. Crestwood Midstream Partners LP Copano Energy L.L.C.
2 2 1
POP / POL 83% 0% 31% 34% 67% 37% 59% 61% 31% 41% 36% 0% 5% 28% 37% 35%
Fee Based 6% 100% 37% 60% 0% 27% 35% 38% 39% 8% 61% 100% 53% 44% 43% 39% Other 0% 0% 0% 0% 0% 0% 0% 0% 0% 25% 0% 0% 0% 0% 2% 0%
Ticker APL CMLP CPNO DPM EEP EPD EROC MMLP

2
Whole 11% 0% 32% 5% 33% 36% 6% 1% 30% 26% 3% 0% 42% 28% 18% 19%
DCP Midstream Partners L.P.
Enbridge Energy Partners L.P. (Cl A) Enterprise Products Partners L.P. Eagle Rock Energy Partners L.P. Martin Midstream Partners L.P. MarkWest Energy Partners L.P. Targa Resources Partners L.P. ONEOK Partners L.P. Western Gas Partners LP Williams Partners L.P. Crosstex Energy L.P. Average Median
2 3
MWE NGLS OKS WES WPZ XTEX
Note 1: Based on volume, except where noted Note 2: Processing contracts based on gross margin Note 3: 100% of commodity exposure is eliminated through long-term swap agreements with APC Source: Partnership reports and Wells Fargo Securities, LLC estimates
Fee-based contracts. The MLP receives a fee for the volume of natural gas that flows through its processing plant. Gross margin is directly related to the volume, not the price, of the commodity flowing through the system and the contracted fixed rate. Percentage-of-proceeds (POP). The processor gathers and processes natural gas on behalf of producers. The MLP sells the resulting residue gas (dry, pipeline quality gas) and NGLs at market prices and remits to the producer an agreed upon percentage of the proceeds based on an index price. A typical contract would entitle the producer to 80% of the proceeds from the sale of natural gas and NGLs through the plant. The remaining 20% would be captured by the processing plant operator. Accordingly, POP contracts share price risk between the producer and processor. Gross margin increases as natural gas prices and NGL prices increase and decrease as natural gas prices and NGL prices decrease. A percentageof-liquids (POL) contract is a type of POP contract where the processor receives a percentage of the NGLs only.
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MLP Primer -- Fourth Edition Figure 115. General Formula To Calculate Percentage Of Proceed Margin
Percentage Of Proceeds: (+) NGL Proceeds (+) Residue Gas Proceeds (+) Condensate Proceeds (=) Total POP Margin
Gross NGL volume * processor's equity interest = equity NGL volume. Equity NGL volume * realized NGL price = POP NGL proceeds Gross residue gas volume * processor's equity interest = equity residue natural gas volume. Equity residue gas volume * realized natural gas price = POP residue gas proceeds Gross condensate volume * processor's equity interest = equity condensate volume. Equity condensate volume * realized condensate price = POP condensate proceeds
Keep-whole (KW). The partnership gathers natural gas from the producer, processes the natural gas, and sells the resulting NGLs to third parties at market prices. Because the extraction of the NGLs from the natural gas stream reduces the energy (Btu) content of the natural gas, the processor must replace the natural gas (i.e., the shrinkage) that was extracted while processing. The processor either purchases natural gas at the market price to return to the producer or makes a cash payment to the producer equal to the reduced energy content. Put another way, the processor must keep the producer whole on his natural gas that goes in and comes out of the processing plant. Rule Of Thumb For Assessing Keep Whole Margin The relative values of crude oil prices and natural gas prices provide a quick read on processing profitability. As a rule of thumb, if natural gas is trading for less than 90-100% of the price of crude oil (on a Btu basis), then processing margin is typically positive. Figure 116. Processing Margin Versus Natural Gas-To-Crude Oil Ratio
$1.20 R 2 = 0.4184 $1.00 Processing Margin ($/Gallon) $0.80 $0.60 $0.40 $0.20 $0.00 ($0.20) 20%
30%
40%
50%
60%
70%
80%
90%
100%
Natural Ga s To Crude Oil Ratio (%)
Source: FactSet
Risks. Risks for processors include low or declining NGL prices. In addition, lower oil and gas prices could result in less drilling activity, and therefore, reduced volume for processing. Commodity price sensitivity. Processing economics can be sensitive to both NGL prices and the spread between NGL and natural as prices. Because the primary processing contracts are POP and keep whole, processors are typically long NGLs prices. For keep whole prices, processors benefit when NGL prices are high relative to natural gas prices.
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Master Limited Partnerships (2) Fractionation
NGL fractionation is the process of separating raw NGL mix produced by natural gas processing plants into discrete NGL purity components (i.e., ethane, propane, normal butane, iso-butane, and natural gasoline). Once separated, the liquids serve a variety of purposes primarily in the petrochemical industry. Figure 117. MLPs With Fractionation Assets
Copano Energy LLC Crosstex Energy L.P. Duncan Energy Partners L.P. Enterprise Products Partners L.P. Inergy L.P.
CPNO XTEX DEP EPD NRGY
Markwest Energy Partners L.P. Martin Midstream Partners L.P. ONEOK Partners L.P. Targa Resources Partners L.P. Williams Partners L.P.
MWE MMLP OKS NGLS WPZ
Fractionation process. The fractionation process is accomplished by applying heat and pressure to the mixture of raw NGL hydrocarbons and separating each discrete product at the different boiling points for each NGL component of the mixture. The raw NGL mixture is passed through a specific series of distillation towers: de-ethanizer, de-propanizer, debutanizer, and de-isobutanizer. The name of each of these towers corresponds to the NGL component that is separated in that tower. The raw NGL mixture first passes through the de-ethanizer, where its temperature is increased to the point where ethane (the lightest component) boils off the top of the tower as a gas and is condensed into a purity liquid that is routed to storage. The heavier components in the mixture at the bottom of the tower (i.e., propane, butane, iso-butane, and natural gasoline) are routed to the second tower (de-propanizer), where the process is repeated, and the next lightest component (propane) is separated. This process is repeated until the mixture of liquids has been separated into its purity components. End products of NGL fractionation include ethane, ethane/propane mixtures (EP), commercial propane, propane/butane mixtures (LPG), butane, butane/gasoline mixtures, and natural gasoline. Figure 118. Simplified Diagram Of NGL Fractionation Process
Ethane (C2) Propane (C3)
Natural Gas Liquids
__ __ __ __ __ __ __
..... Condensor
De-Ethanizer
__ __ __ __ __ __ __
..... Condensor
De-Propanizer
__ __ __ __ __ __ __
..... Condensor
Butane (C4)
De-Butanizer
N. Gasoline (C5)
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MLP Primer -- Fourth Edition Industry And Sector Drivers Fractionation Capacity Likely To Remain Constrained Through 2011
Key midstream players EPD, OKS, and NGLS have indicated that their NGL fractionators are operating at or near capacity. In the near term, this could act as a bottleneck to prevent incremental supply of NGL components from reaching the market. Although companies are working to address market demand for fractionation capacity, the incremental capacity is unlikely to come online before 2011. Further, the majority of new fractionation capacity is already reserved under long-term contracts. Thus, frac capacity could remain tight even after these expansions are complete. Several midstream companies have announced fractionation capacity expansions. In total, we calculate 468 Mbbls/d of announced fractionation capacity (18.9% of current capacity) expansions that are likely to come into service primarily in 2011 and beyond. Figure 119. Historical And Forecasted U.S. NGL Fractionation Capacity (Net) By Company
Frac Capacity (MBbls/d) Company Name ONEOK Partners Enterprise Products Targa Resources Partners ConocoPhillips ExxonMobil Williams Partners DCP Midstream Crosstex Energy Promix Duncan Energy MarkWest Devon Energy Corp. Ineos BP Copano Energy DCP Partners Formosa Fort Chicago Enbridge Inc Energy & Minerals Group Valero Energy Energy Transfer Huntsman Marcam Targa Resources Inc Total Frac Capacity 2006A 486 395 291 265 151 112 60 74 73 57 24 40 55 34 0 18 40 37 37 0 8 1 44 8 36 2,346 Current 556 476 312 265 152 112 86 41 73 57 24 40 55 38 22 42 40 37 37 0 8 1 0 0 0 2,471 Future 616 591 397 293 152 104 86 73 64 60 56 55 47 44 42 40 37 37 24 8 1 0 0 0 2,939 1,500 2006A Current Future 1,700 U.S. NGL Fractionation Capacity 112 2,700 +18.9% 2,900 3,100
2,500 +5.3% 2,300 2,939 2,100 2,471 1,900 2,346
Note: Above figures reflect capacity totals based on proportionate share interests in U.S. fractionators Source: Partnership reports and Wells Fargo Securities, LLC
Based on the aforementioned expansions, we calculate that U.S. NGL fractionation capacity could increase to 2,939 Mbbls/d from 2,471 Mbbls/d currently. Figure 120 highlights fractionation capacity by region and company, pro forma for all announced expansion projects.
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Figure 120. Map Of U.S. NGL Fractionation Capacity (Pro Forma For All Announced Projects)
Mid-Continent ONEOK Partners Williams Partners ConocoPhillips Capacity (MBbls/d) 488 54 43
Chicago Fort Chicago Enbridge Inc Williams Partners Capacity (MBbls/d) 37 37 13
Appalachia MarkWest Energy & Minerals Group
Capacity (MBbls/d) 60 24
584 978
87
84
695
511
Texas/New Mexico ConocoPhillips ExxonMobil Enterprise Products Duncan Energy Ineos Copano Energy Formosa DCP Partners DCP Midstream Targa Resources Partners Valero Energy Energy Transfer
Capacity (MBbls/d) 170 140 108 64 55 44 40 25 25 15 8 1
Mont Belvieu Targa Resources Partners Enterprise Products ONEOK Partners DCP Midstream ConocoPhillips Devon Energy Corp. BP
Capacity (MBbls/d) 314 285 128 80 80 56 35
Louisiana Enterprise Products Crosstex Energy Promix Targa Resources Partners Williams Partners DCP Partners ExxonMobil BP
Capacity (MBbls/d) 198 86 73 68 46 17 12 12
Revenue Drivers NGL Fractionation Contracts
NGL fractionation contracts are typically fee-based in nature, with fees ranging from $1.00-1.50 per bbl. While direct commodity exposure is minimal, fractionators are typically exposed to volumetric risk. NGL production volume has remained relatively stable over the past ten years. However, there have been periods of time when unfavorable processing economics have forced processors into ethane rejection mode. This serves to rapidly reduce overall NGL volume, as ethane is the largest component of the NGL barrel. As a result, fractionation volume would be adversely affected. Due to the tight fractionation market, fractionators are re-contracting for longer terms, with rates doubling and tripling from several years ago. Notably, one prominent market player said it has recontracted a large portion of its frac capacity under 7-10 year contracts. Enterprise has quoted frac rates of $0.05-0.07 per gallon, versus rates of $0.02-0.03 per gallon five years ago. The new contracts are being done under frac-or-pay terms (i.e., customers reserve capacity and pay demand charges regardless of utilization). This replaces a longstanding contract structure, which was predicated on volume movements and spot pricing. We believe the change in contract length and structure is a significant event for the industry and is indicative of the midstream sectors positive long-term belief in U.S. NGL market fundamentals.
NGL Marketing Contracts NGL marketing encompasses a broad array of activities, including (1) utilizing NGL pipelines to capture NGL product price differentials between two market centers (i.e., Mont Belvieu and Conway) and (2) using NGL storage facilities to profit from seasonal variances. Because marketing profitability is tied to arbitrage opportunities in the market, cash flow volatility streams can be variable. Most MLPs that participate in NGL marketing do so to optimize the value of their NGL business and not as a source of cash flow through which to fund distributions.
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Risks. The primary risk to fractionation is reduced utilization of capacity. A reduction in fractionation utilization could be due to lower NGL prices, a change in the relationship between crude oil and natural gas prices, or a weakening economic activity, which would reduce demand for NGL products. Commodity price sensitivity. Fractionation services do not have direct sensitivity to commodity prices as this is typically fee-based. However, a decline in NGL prices is likely to result in less demand for fractionation services, which could reduce the utilization for frac capacity, resulting in reduce revenue and cash flow. (1) NGL Pipelines NGL pipelines transport (1) raw NGL mix (or unfractionated NGLs) from natural gas processing plants, refineries, and import terminals to fractionation plants and storage facilities, and (2) transport purity NGL products from fractionation facilities to petrochemical plants and other end markets. NGL pipeline volume is typically higher during from October to March, due to propane (residential heating) and normal butane (motor gasoline blending) demand. Figure 121. MLPs With NGL Pipeline Assets
Buckeye Partners L.P. DCP Midstream Partners L.P. Duncan Energy Partners L.P. Enterprise Products Partners L.P. Kinder Morgan Energy L.P.
BPL DPM DEP EPD KMP
Martin Midstream Partners L.P. ONEOK Partners L.P. Transmontaigne Partners L.P. Williams Partners L.P.
MMLP OKS TLP WPZ
Industry And Sector Drivers. A relatively wide relationship between the price of crude oil and natural gas is incentivizing producers to focus drilling in oil and liquids-rich areas (as opposed to areas with dry natural gas), where economics are more favorable. This has resulted in a slight uptick in processing volume. In addition, this relative price relationship has made natural gas-based ethane the preferred feedstock of the petrochemical industry at the expense of crude-based naphtha, resulting in strong demand for NGLs. As a result, NGL pipeline volume has been and should continue to remain strong into the future. (For more information on the NGL Industry And Sector Drivers, please refer to the Natural Gas Processing and Fractionation sections.)
Revenue drivers. Most NGL pipelines generate cash flow based on a fixed fee per gallon of liquids transported and volume delivered. Rates charged by intrastate NGL pipelines are regulated by state agencies and are typically contractual fees negotiated between the pipeline and shippers. Rates charged by interstate NGL pipelines are regulated by the FERC. Interstate NGL pipelines could adopt the following ratemaking methodologies: (1) (2) (3) (4) Indexing. Pipeline operators can charge rates up to a prescribed ceiling, which changes annually based on inflation (as measured by the Producer Price Index for finished goods); Cost of service. The rate is based on costs incurred by the pipeline to provide transportation service; Settlement rate. The rate is agreed upon by the pipelines customers; and Market-based rates. The rate is established by supply and demand dynamics in a competitive market.
However, as with NGL fractionation, NGL pipeline revenue is driven by volume. (To note, pipeline operators can sometimes secure shipper commitments before a new pipeline is built, which serves to mitigate volumetric risk). During periods of ethane rejection, NGL transportation volume is adversely affected due to the reduction in ethane volume. Commodity price sensitivity. NGL pipelines generate fee-based revenue and therefore, do not have direct sensitivity to commodity prices. However, a weak economic environment could reduce demand for NGLs and result in lower volume being transported. In addition, a narrowing of the crude oil-to-natural gas ratio would potentially provide fewer incentives for producers to drill for liquids-rich natural gas, which could reduce the amount of NGL produced by gathering and processing plants.
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Risks. NGL transportation volume can decline if demand for NGLs decreases, which would likely occur if there is a slowdown in the economy. In addition, a narrowing of the crude oil and natural gas price ratio could make crude-based naphtha more attractive as a feedstock to the petrochemical industry relative to natural gasbased ethane, which could result in lower NGL volume. Finally, NGL pipeline volume can decrease during periods of ethane rejection. As a reminder, ethane rejection occurs when ethane prices fall below the price of natural gas on a BTU equivalent basis. When this occurs, natural gas processors will choose to reject ethane (i.e., leave it in the natural gas stream) rather than extract it. (2) NGL Storage NGLs are stored in large underground caverns formed out of geological salt domes. Storage facilities are typically capable of handling mixed NGLs, individual NGL products, and other petrochemical products. NGL products are distributed to customers such as petrochemical manufacturers, heating fuel users, refineries, and propane distributors. NGLs are stored and priced in two main hubs: Mont Belvieu, Texas and Conway, Kansas. Mont Belvieu is the larger of the two and is the price reference point for North American NGL markets. Storage capacity at this hub is highly valuable because Mont Belvieu is located near the Gulf Coast, where most of the U.S. petrochemical companies (primary users of NGLs) are located. Mont Belvieu also serves the U.S. Northeast market, while Conway serves the U.S. Midwest market. Figure 122. MLPs With NGL Storage Assets
Crosstex Energy L.P. Duncan Energy Partners L.P. Enterprise Products Partners L.P. Inergy L.P. Markwest Energy Partners L.P.
XTEX DEP EPD NRGY MWE
Martin Midstream Partners L.P. ONEOK Partners L.P. Targa Resources Partners L.P. Transmontaigne Partners L.P. Williams Partners L.P.
MMLP OKS NGLS TLP WPZ
Industry and sector drivers. Demand for NGL storage decreases in the fall or winter months, when propane inventory is drawn down for heating. Demand for butanes, natural gasoline, denaturant, and diluents are subject to some seasonality (e.g., vehicle miles are higher in the summer and the government air emission restrictions impact when butane is blended with gasoline). Storage contracts are usually awarded based on the operators fees, number of pipeline connections available, location relevant to major hubs (i.e., Mont Belvieu and Conway), and operational dependability. Besides MLPs, other storage owners include integrated major oil companies and chemical companies. Revenue drivers. Storage operators derive a majority of their revenue from fee-based contracts, while a smaller amount is generated by throughput fees and optimization and marketing businesses. NGL storage profitability is determined by (1) the amount the throughput fee, (2) storage capacity under reservation, and (3) the amount of throughput delivered into and withdrawn from storage. (1) Fee-based. The rate is based upon the amount of NGL volume a customer has injected into underground storage. Operators charge fees based upon the number of days a customer has NGL product in storage multiplied by a pre-negotiated storage rate; (2) Reservation fees. Customers have the ability to enter into capacity reservation agreements, which are typically longer term in nature. This gives the customer a guaranteed amount of storage for a period defined under the contract. The operator then collect a reservation fee based upon the customers level of storage capacity rather than actual volume stored. If customers exceed their storage capacity, they are charged excess storage fees; and (3) Throughput fees. The fee is in addition and based on the amount of product injected into storage or withdrawn out. In addition to providing third-party services, some operators will participate in NGL marketing, which encompasses a broad array of activities, including (1) utilizing NGL pipelines to capture NGL product price differentials between two market centers (i.e., Mont Belvieu and Conway) and (2) using NGL storage facilities to profit from seasonal variances. Because marketing profitability is tied to arbitrage opportunities in the market, cash flow streams can be variable. Most MLPs that participate in NGL marketing do so to optimize the value of their NGL business and do not view it as a steady source of cash flow to fund distributions.
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Commodity price sensitivity. Storage revenue is fee-based and therefore, not subject to commodity price volatility. However, reduced basis differentials and volatility could reduce arbitrage opportunities and therefore, reduce utilization of the asset. Risks. While operators do not take ownership to the product they store, NGL storage operators are exposed to risks associated with lower NGL prices, basis differentials, and the price relative to natural gas. Operating margins typically decline during periods of narrow basis differentials between Mont Belvieu and Conway, which decreases optimization opportunities and NGL volume.
E. The Crude / Petroleum Products Value Chain

Crude oil is first collected from the wellhead via gathering lines and truck, 37%, or from import terminals, 63%),and transported via pipeline to refineries. Once at the refinery, crude oil is turned into different refined petroleum products such as gasoline, diesel, jet fuel, kerosene, and heating oil. Refined products are then shipped to various end-use markets. Refined petroleum products are moved via pipelines, barges and tankers, rail and truck; however, pipelines are the most cost-efficient mode of transportation and currently account for 60% of all domestic crude oil transportation. Figure 123. Crude Oil Value Chain
(1) Crude Oil / Petroleum Pipelines Crude lease gathering. Crude is collected via gathering lines for onshore domestic production. For production fields that are not near pipelines or have modest production levels, crude is gathered via truck and transported to a central point for delivery into the crude oil pipeline grid. Crude oil pipelines. Crude oil gathering pipelines transport crude from the wellhead to larger mainlines. Regulated main crude oil trunkline systems feed refiners from waterborne imports, 9%), Canadian imports, 14%, and domestic production, 37%. U.S. refiners are more dependent upon waterborne and Canadian imports since domestic crude oil production peaked at 9,637 MBbls/d in 1970 (versus 5,361 MBbls/d in 2009). Thus a majority of U.S. refineries are located near marine terminals, primarily on the Gulf Coast. Crude oil can also be gathered via tank trucks from older, less productive wells.
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Master Limited Partnerships Figure 124. MLPs With Crude Oil Pipeline Assets
Blueknight Energy Partners L.P. Enbridge Energy Partners L.P. Enterprise Products Partners L.P. Genesis Energy L.P. Holly Energy Partners L.P. Kinder Morgan Energy L.P.
BKEP EEP EPD GEL HEP KMP
Magellan Midstream Partners L.P. Nustar Energy L.P. Plains All American Pipeline L.P. Sunoco Logistics Partners L.P. Williams Partners L.P.
MMP NS PAA SXL WPZ
Refined products pipelines. Refined products pipelines are regulated common carrier transporters of refined petroleum products, such as gasoline, diesel fuel, and jet fuel. Primary pipeline customers are refiners and marketers of the product being shipped. End-user destinations include airports, rail yards, and terminals/truck racks, for further distribution to retail outlets. Refined product pipeline cash flow is stable based on the relatively inelastic base load demand from end users of gasoline, diesel fuel, etc. However, throughput can exhibit fluctuations depending upon economic cycles. Figure 125. MLPs With Refined Product Pipeline Assets
Buckeye Partners L.P. Enterprise Products Partners L.P. Holly Energy Partners L.P. Kinder Morgan Energy L.P. Magellan Midstream Partners L.P.
BPL EPD HEP KMP MMP
Nustar Energy L.P. Plains All American Pipeline L.P. Sunoco Logistics Partners L.P. Transmontaigne Partners L.P.
NS PAA SXL TLP
Figure 126. Refined Products Value Chain
Industry and sector drivers. Earnings for crude and petroleum products pipelines are tied primarily to throughput (volume). Thus, consumer demand for refined products (i.e., gasoline, diesel, and jet fuel) and refinery demand for crude oil are the main drivers of pipeline volume. Revenue drivers. Crude oil and refined products pipelines are regulated by the FERC. Pipelines adopt one of the following ratemaking methodologies: Indexing. The maximum rate a pipeline can charge is adjusted annually based on changes in the Producer Price Index (PPI). This indexing methodology was instituted to streamline rate making for pipelines in competitive markets and provide a means of funding pipeline integrity and power costs. The FERC has proposed to continue the use of the Producer Price Index for Finished Goods plus 1.3% (PPI+1.3%) as the
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annual adjustment to oil and petroleum products pipeline rate ceilings for a five-year period starting July 1, 2011. FERC reviews this index on a five-year cycle, which commenced in 1996. Figure 20 indicates the historical trend for the actual tariff adjustments based on the index as it progressed from PPI 1% in 1996 to PPI + 1.3% in 2006. Figure 127. Annual FERC Index-Based Rate Adjustments
10.0% Annual FERC Indexed Rate Adjustment (%)
8.0% 6.1% 6.0% 3.8% 2.0% 0.8% 4.3% 3.2% 3.6% 5.2%
7.6%
4.0% 1.7% 0.9%
2.0%
0.0% (0.4%) (2.0%0 (0.6%) (1.8%) (1.3%) (1.3%)
(4.0%0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Note: Annual FERC rate adjustments reflect preceding TTM periods ended June 30. For example, the 2011 (1.3%) is based on the TTM period ended June 30, 2011. Source: FERC
Notably, those pipelines that are deemed to be in competitive markets are allowed to charge market-based rates. However, the index methodology does tend to set the tone for negotiating rates on a broader basis. The indexing of tariffs can help to insulate oil and products pipeline revenue during periods of inflation. Figure 128 highlights the relative exposure of refined products pipeline MLPs to the tariff rate indexing methodology. Figure 128. MLPs With FERC Indexed-Based Pipeline Tariffs
Rates Based On: Ticker BPL HEP KMP MMP NS Market 60% 60% 10% Index 40% Mostly Mostly 40% 90%
SXL Source: Partnership reports and Wells Fargo Securities, LLC estimates
Cost of service. Cost of service is a type of ratemaking methodology wherein the pipeline operator has the ability to adjust its tariff in order to generate enough revenue to recover its costs and earn an adequate return on its rate base. At the beginning of each calendar year, a pipeline would set its tariff for the year based on its expectations for volume and operating costs. To the extent that actual volume and/or operating costs differ from projections, costs could be recouped in future years by setting a higher tariff. Settlement rate. The rate is agreed upon by all shippers on the pipeline. Market-based rates. The rate is established by supply and demand dynamics in a competitive market. Some crude oil pipelines operate under buy/sell arrangements. The pipeline operator itself will purchase crude at one point on the pipeline and then simultaneously enter into a sales contract for that crude at another point on the pipeline. Crude is typically purchased at a set index price and sold at index plus a margin, effectively locking in a rate for the pipeline operator. Negotiated rates. For new service, the rate can be a special contractual agreement between the customer and the pipeline.
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Commodity price sensitivity. In general, MLPs with petroleum and crude oil pipeline assets have minimal direct exposure to commodity prices and provide stable, fee-based cash flow. Risks. Refined product and crude oil demand is closely linked to overall economic growth. A severe economic downturn could reduce the demand for these products, which could result in lower throughput volume. (2) Crude Oil / Refined Products Terminals Terminalling operations provide storage, distribution, blending, and other ancillary services to pipeline systems. Terminals consist of either inland or marine terminals. Inland terminals generally receive product from pipelines and distribute them to third parties at the terminal, which delivers the product to end users, such as retail gasoline stations. Marine terminals, usually located near refineries, are large storage and distribution facilities that handle crude oil or refined petroleum products. Terminal cash flow is typically affected by the amount of petroleum products stored, which, in turn, is dependent upon petroleum product pipeline throughput, as well as the amount of blending activity that takes place at the facility. Crude oil terminal operators may use terminals as a natural extension of their pipeline system or may actively seek terminal throughput from third parties. When seeking volume from third parties, terminal cash flow is more subject to the operational expertise of the terminal operator or marketer. There are also terminalling facilities that handle products other than crude oil, natural gas, and refined products. These other products include asphalt, petrochemicals, industrial chemicals, vegetable oil products, coal, petroleum coke, fertilizers, steel, ore, and other dry-bulk materials. Figure 129. MLPs With Crude Oil And Refined Products Terminals
Blueknight Energy Partners L.P. Buckeye Partners L.P. Enbridge Energy Partners L.P. Enterprise Products Partners L.P. Genesis Energy L.P. Global Partners L.P. Holly Energy Partners L.P.
BKEP BPL EEP EPD GEL GLP HEP
Kinder Morgan Energy L.P. Magellan Midstream Partners L.P. Martin Midstream Partners L.P. Nustar Energy L.P. Plains All American Pipeline L.P. Transmontaigne Partners L.P.
KMP MMP MMLP NS PAA TLP
Industry and sector drivers. MLPs with crude oil and refined products storage typically benefit from periods of steep contango and market volatility. Storage demand is at a premium during periods of high contango spreads (future commodity prices on the NYMEX future curve are greater than spot prices). Hence, market participants can buy crude at spot prices, store the product, and simultaneously sell forward on the NYMEX curve at a higher price, locking in a profit. During periods of backwardation (future commodity prices are lower than spot prices), market participants will sell as much product as possible to take advantage current prices. Thus, storage is typically less utilized during periods of market backwardation. The volatility of crude oil prices also drives storage fundamentals. Wide swings in oil prices and shifts in the shape of the future curve will usually lead to increased volume at storage facilities as producers and energy traders try to capture arbitrage opportunities. In addition to contango spreads and price volatility, macro economic factors dictate the amount of petroleum products consumed; therefore, volume has historically increased during periods of gross domestic product (GDP) expansion, when the economy uses more energy.
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MLP Primer -- Fourth Edition Figure 130. Crude Oil Contango

Generic Crude Oil Contract: CL2-CL1 Average Quarterly Price Differential $3.19 $4.30 $3.30 $1.34 $2.30 $1.30 $0.04 $0.30 Q1'08 ($0.48) ($0.70) ($1.70) ($0.11) $9.00 $7.00 $1.69 $1.25 $5.00 $ per Bbl $0.76 $0.50 $3.00 $1.00 ($1.00) ($3.00) Q3'08 Q4'08 Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 11/16/2010 ($5.00) 1/2/08 3/2/08 5/2/08 7/2/08 9/2/08 11/2/08 1/2/09
Generic Crude Oil Contract: CL2-CL1 Price Differential
$ per Bbl
$1.05
$0.89
Q2'08
$0.40
3/2/09
5/2/09
7/2/09
9/2/09
11/2/09
1/2/10
3/2/10
5/2/10
7/2/10
9/2/10
Revenue drivers. Operators of terminal and storage assets generate fees from providing storage for crude oil and petroleum products under short- and long-term storage. Storage contracts typically last one year and can provide storage for a few days up to several months. Revenue is generated by charging producers a fixed rate to lease storage capacity. In addition, storage operators receive an incremental fee-based charge based upon the amount of product moved in and out of the terminal. Storage operators can provide additional services such as blending and additive injection, which are typically margin-based. Terminals are unregulated, and therefore, charge market-based rates. Commodity price sensitivity. Storage operators typically do not take possession of the commodity stored or delivered through their terminal. While a majority of revenue is generated by fee-based contracts, most owners of storage assets reserve an amount of storage for their own, proprietary use in order to take advantage of contango opportunities.
F. Propane
Propane is the only commodity wherein MLPs play a role in virtually every aspect of the energy value chain. MLPs are responsible for (1) gathering and processing wet natural gas production, (2) transporting and fractionating the raw NGL product mix, (3) marketing propane on a wholesale basis, and (4) distributing retail propane to end users. Propane companies are typically denoted as being involved in the final two steps in this value chain: wholesale propane marketing and retail propane distribution. Figure 131. MLPs With Propane Assets
Amerigas Partners L.P. DCP Midstream Partners L.P. Energy Transfer Partners L.P. Ferrellgas Partners L.P.
APU DPM ETP FGP
Inergy L.P. Martin Midstream Partners L.P. Suburban Propane Partners L.P.
NRGY MMLP SPH
Wholesale propane suppliers generally act as intermediaries that facilitate the purchase of propane by retail distribution companies, petrochemical plants, and large non-residential customers. Wholesale propane businesses procure propane through multiple sources including: (1) directly from fractionation facilities (44% of total propane supply in 2009), (2) refineries (44%), (3) imports (12%), or (4) other NGL marketers. Retail propane companies purchase propane in bulk from wholesale propane companies and distribute propane via truck to residential, commercial, industrial, and agricultural customers. The largest end users of propane are the residential (28% of total demand in 2009) and petrochemical (27%) sectors. Notably, propane is used for home and water heating and as a feedstock in the production of various chemicals and plastics. The remaining 45% of propane demand originates from the industrial, agricultural, and transportation sectors. Industrial customers use propane primarily as a fuel for forklifts and stationary engines, while agricultural customers use propane for crop drying, tobacco curing, and chicken brooding.
11/2/10
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Master Limited Partnerships Figure 132. Propane Value Chain
Source: EIA
Industry and sector drivers. Since the overall long-term growth rate for the propane distribution industry is less than 2% annually, accretive acquisitions of smaller propane companies are key to enhancing long-term performance. The propane industry remains extremely fragmented, with the top five retailers controlling approximately 31% of the propane market and more than 5,000 retailers holding the remaining market share, 69%. Figure 133. Market Shares Of Propane Distribution Companies
Inergy 3% Suburban Propane 4%
Heritage Propane 6%
Ferrellgas 8%
Independent Marketers 69%
AmeriGas 10%
Source: ICF International and AmeriGas Partners
Revenue drivers. Wholesale propane suppliers typically generate revenue by charging customers a fixed margin in excess of the companys floating indexed-based supply cost. For example, a wholesale propane supplier will purchase propane at an index-based cost (e.g., either local index pricing or Mont Belvieu plus transportation costs) and then market the propane to retail companies at the index-based supply cost plus a fixed margin, hence, generating a fixed margin in the transaction. The margin and amount of propane volume supplied to propane retailers is typically fixed under one-year contracts, with renewals occurring in the spring. To note, wholesale propane suppliers may elect to market propane to customers under a fixed volume and pricing contract. In this scenario, the wholesale propane supplier will enter into offsetting derivative transactions in order to mitigate commodity price sensitivity.
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Retail propane distributors generate revenue under a similar structure. These companies procure propane from wholesale propane suppliers at a floating index-based price and then pass through the cost of acquiring the propane plus a margin to customers (i.e., retail propane price). In general, declining wholesale propane prices aid earnings because retail prices tend to lag costs. Although rising wholesale propane prices can squeeze margin when retail prices lag cost increases, in recent years the changing nature of competition has allowed margin to expand in the face of rising propane prices. In addition, rising retail propane prices can lead to consumer conservation. Under normal circumstances, approximately 70% of annual cash flow is earned during the winter heating season (October through March). Risks. Risks to MLPs with propane assets include warmer-than-normal weather, consumer conservation, economic activity (e.g., housing starts), attrition to less expensive energy sources, and the inability to pass higher costs on to consumers.
Conservation. Although heating degree days increased by an average of 3-4% annually between 2007 and 2009, we estimate that residential propane demand increased by only 1-2% annually during the same time period. Part of the variance was due to the impact of customer conservation, which has been a persistent challenge to the propane industry for the past several years. Relatively high propane prices and largely warmer-than-normal weather have led many propane customers to reduce thermostat settings and/or delay refilling propane tanks. Switching to natural gas. Propane competes with several other sources of energy, some of which are less expensive on an equivalent BTU-value basis. While propane enjoys a cost advantage over electricity, natural gas and fuel oil are generally less costly than propane for home heating. Year-to-date 2010 residential heating fuel costs for propane were 27% less expensive compared to electricity, but 25% more expensive than fuel oil and 125% more expensive than natural gas.
Commodity price sensitivity. On the whole, margin for wholesale and retail propane businesses is not directly affected by commodity price fluctuations given the cost plus margin nature of contracts. However, the ability to maintain margin is contingent on partnerships being able to pass on price increases to customers (i.e., retail distributors on the wholesale side and end-use customers on the retail side). However, extremely high propane prices may cause conservation and may expose distributors to higher bad debt expense. Propane distributors tend also to have higher working capital requirements when prices are very high.
G. Marine Transportation
Shipping MLPs transport bulk commodities (typically energy products or dry bulk) via tankers, barges, and dry bulk vessels. Products shipped on tankers typically include crude oil, as well as refined petroleum products and by-products such as gasoline, heating oil, diesel fuel, jet fuel, lubricants, asphalt, fuel oil, sulfur, petrochemical and commodity specialty products, and liquefied natural gas (LNG). Dry bulk vessels primarily carry iron ore, coal, grains, and minor bulk commodities such as steel, fertilizer, and potash. The primary customers for shipping MLPs include large oil refiners, chemical producers, integrated oil & gas companies, energy marketing companies, commodities traders, and major mining companies. Shipping partnerships are subject to various governmental and industry safety regulations, depending on the type of vessel and location. Figure 134. MLPs With Marine Transportation Assets
Master Limited Partnership Capital Product Partners L.P. Enterprise Products Partners L.P. Genesis Energy L.P. K-Sea Transportation L.P. Martin Midstream Partners L.P. Navios Maritime Partners L.P. Teekay LNG Partners L.P. Teekay Offshore Partners L.P. Ticker CPLP EPD GEL KSP MMLP NMM TGP TOO Intl. Product Tankers Domestic Tank Vessels (1) International Dry Bulk Liquefied Natural Gas Vessels Crude Oil Shuttle Tankers
Note 1: Domestic Tank Vessels includes inland barges Source: Partnership reports
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Industry and sector drivers. Continued commodity demand growth from emerging markets, infrastructure development, expanding global ton-miles, and broader OECD demand growth typically drive the global shipping markets. The shipping industry is highly fragmented, which lends itself to consolidation. Stringent safety requirements by customers should continue to work to the benefit of larger vessel operators spawning mergers within the industry. The potential to acquire dock, terminal, storage facilities, and other harbor-based facilities could help to vertically integrate or diversify the business model of vessel operators. Shipping and marine transportation services are typically performed under spot and term contracts set under a competitive bidding process. The rates charged under these contracts can be based either on a daily basis or on a volume-transported basis. The terms and awarding of contracts are based on (1) vessel availability and capabilities, (2) timing of customers schedule, (3) price, (4) safety record, (5) operators experience and reputation, (6) vessel quality, and (7) the supply and demand of products being shipped. Shipping contracts can vary in length depending upon the type of ship and operating market. Most contracts under the MLP (versus corporate) structure are longer term in nature (e.g., LNG contracts are typically under ten-year terms or more), which provides a shipping MLP with some cash flow stability. These longer-term contracts tend to have escalation clauses whereby certain cost increases such as labor and fuel are passed on to the customer. Shipping is subject to prevailing market trends, which tends to make spot market activity (i.e., for short-term contracts), and is volatile and therefore, less suitable for the MLP structure, in our view. Shipping MLPs, like pipeline MLPs, do not assume ownership of the products shipped. U.S. point-to-point shipping competition is somewhat limited from foreign competitors due to the Jones Act, which restricts such shipping to vessels operating under the U.S. flag, built in the United States, at least 75% owned and operated by U.S. citizens, and manned by U.S. crews. The shipping category encompasses several different MLPs with distinctly different business models and operating environments. These business models include the following: (1) International Product Tankers Product tankers transport refined petroleum products, typically gasoline, jet fuel, kerosene, fuel oil, naphtha and other soft chemicals and edible oils. The marine transport of petroleum products between receipt and delivery points addresses the demand and supply imbalances for the refined product, which is usually caused by a lack of resources or refining capacity in the consuming country. Revenue drivers. Charter rates are influenced by (1) length of haul; and (2) type of product being transported, while type and availability of vessels needed, in turn, are determined by shifting macroeconomic trends that shape global energy supply and demand patterns, including the following: (1) weather patterns; (2) contango and backwardated petroleum markets; and (3) the level of offshore floating inventory and currency fluctuation. Longer hauls from new refineries in Asia, India, and OPEC should also enhance revenue growth over the long term. Risks. Investments in shipping MLPs can be considered a higher-risk investment relative to pipeline MLPs, due to the following factors: (1) regulatory requirements (e.g., OPA 90 requires single-hulled vessels to be phased out by 2015); (2) contract rollovers (versus pipeline MLPs); (3) spot market volatility; (4) competitiveness of the contract bidding process; (5) new build risk (i.e., significant up-front capital); (6) decline in demand for shipped products; and (7) potential repeal of the Jones Act. Commodity price sensitivity. Like pipeline MLPs, shipping MLPs typically do not take title to the product shipped; therefore, changes in commodity prices have a minimal direct impact on these companies. Shipping MLPs could potentially be indirectly affected by a (sustained) high commodity price environment (on the products transported), which ultimately results in a decrease in the demand for the products shipped (i.e., consumer conservation). Shipping MLPs earnings are more directly tied to the underling demand for the product shipped. (2) Domestic Tank Vessels Tank vessels, which include tank barges and tankers, transport gasoline, diesel, jet fuel, kerosene, heating oil, asphalt, and other products from refineries and storage facilities to other refineries, distribution terminals, power plants, and ships. The demand for domestic tank vessels is driven by the U.S. demand for refined petroleum products, which can be categorized by either clean oil (e.g., motor gasoline, diesel, heating oil, jet fuel, and kerosene) or black oil products (e.g., asphalt, petrochemical feedstocks, and bunker fuel). Clean oil demand is primarily driven by vehicle usage, air travel, and weather, while black oil demand is typically driven
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by oil refinery requirements and turnarounds, asphalt use, use of residual fuel by electric utilities, and bunker fuel consumption. Revenue drivers. Revenue is driven by charter rates and volume shipped, which, in turn, are a function of the supply of vessels and demand for transportation service, both of which are a product of economic activity and regional refinery utilization. Future revenue growth will depend on a healthy recovery in economic activity and a tightening in the supply of tank vessels. Risks. Investments in shipping MLPs can be considered a higher-risk investment relative to pipeline MLPs, due to the following factors: (1) regulatory requirements (e.g., OPA 90 requires single-hulled vessels to be phased out by 2015); (2) short-term nature of contracts (versus pipeline MLPs); (3) spot market volatility; (4) competitiveness of the contract bidding process; (5) new build risk (i.e., significant up-front capital); (6) decline in demand for shipped products; and (7) potential repeal of the Jones Act. Commodity price sensitivity. Like pipeline MLPs, shipping MLPs typically do not take title to the product shipped. However, changes in commodity prices tend to have a somewhat more direct impact on these companies. Shipping MLPs could potentially be indirectly affected by a (sustained) high commodity price environment (on the products transported), which ultimately results in a decrease in the demand for the products shipped (i.e., consumer conservation). Shipping MLPs earnings are more directly tied to the demand for the product shipped. (3) International Dry Bulk Ships Dry bulk vessels transport cargoes that consist primarily of major and minor bulk commodities. Major bulk commodities include coal, iron ore, and grain, while minor bulk commodities include steel products, forest products, agricultural products, bauxite and alumina, phosphates, petcoke, cement, sugar, salt, minerals, scrap metal, and pig iron. The demand for dry bulk trade is driven primarily by the demand for the underlying dry bulk products, which are, in turn, influenced by growth in global economic activity. Revenue drivers. Global demand for various commodities will continue to affect demand for dry bulk vessels. Drivers influencing trends should include (1) growth in demand from developing countries in Asia (China) and India; (2) expansion of long-haul miles; (3) continued port congestion that reduces vessel supply; (4) weather patterns; and (5) the slow economic recovery of the major industrial nations of the world. Risks. Investments in shipping MLPs can be considered a higher-risk investment relative to pipeline MLPs, due to the following factors: (1) regulatory requirements (e.g., OPA 90 requires single-hulled vessels to be phased out by 2015); (2) short-term nature of contracts (versus pipeline MLPs); (3) spot market volatility; (4) competitiveness of the contract bidding process; (5) new build risk (i.e., significant up-front capital); (6) decline in demand for shipped products; and (7) potential repeal of the Jones Act. Commodity price sensitivity. Like pipeline MLPs, shipping MLPs typically do not take title to the product shipped; therefore, changes in commodity prices have a minimal direct impact on these companies. Shipping MLPs could potentially be indirectly affected by a (sustained) high commodity price environment (on the products transported), which ultimately results in a decrease in the demand for the products shipped (i.e., consumer conservation). Shipping MLPs earnings are more directly tied to the demand for the product shipped. (4) Liquefied Natural Gas Vessels Liquefied natural gas (LNG) is transported by specially designed double-hulled ships from producing to growing nations. The vast majority of LNG shipments occur in Europe and Asia. LNG vessels receive liquefied natural gas from liquefaction facilities for transport to re-gasification facilities at the receiving terminal. Revenue drivers. LNG demand is driven by countries that consume significant quantities of natural gas but lack local production and/or pipeline infrastructure to deliver natural gas to its markets. Drivers include (1) weather patterns; (2) price differentials; (3) development of liquefaction and re-gasification facilities; and (4) global economic growth. Risks. Investments in shipping companies that have a spot market orientation can be considered a higher-risk investment relative to pipeline MLPs, due to the following factors: (1) regulatory requirements (e.g., OPA 90 requires single-hulled vessels to be phased out by 2015); (2) short-term nature of contracts (versus pipeline MLPs); (3) spot market volatility; (4) competitiveness of the contract bidding process; (5) new build risk (i.e., significant up-front capital); (6) decline in demand for shipped products; and (7) potential repeal of the Jones Act. LNG shipping MLPs (specifically TGP) mitigate the above risks by only entering into long-term contracts. Commodity price sensitivity. Like pipeline MLPs, LNG shipping MLPs typically do not take title to the product shipped; therefore, changes in commodity prices have a minimal direct impact on these companies. Shipping MLPs could potentially be indirectly affected by a (sustained) high commodity price environment (on the products transported), which ultimately results in a decrease in the demand for the products shipped (i.e.,
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consumer conservation). However, given the long-term nature of LNG vessel contracts these MLPs are less affected by supply and demand factors. (5) Crude Oil Shuttle Tankers And Floating Production And Storage and Offtake Units Shuttle tankers, which are commonly described as floating pipelines, are specially designed ships that transport crude oil and condensates from offshore oil field installations to onshore terminals and refineries. The primary differences between shuttle tankers and conventional crude oil tankers are that shuttle tankers are designed to be used in regions with harsh weather conditions (e.g., the North Sea) and have voyages that are shorter in duration. Floating production and storage and offtake (FPSO or FSO) units provide on-site storage for offshore oil field installations. FSOs are secured to the seabed and receive crude oil from the production facility via a dedicated loading system. FSOs transfer crude oil to shuttle and conventional tankers through its export delivery system. Some specialized units (FPSOs) contain facilities that receive the oil production, process it and then store the crude before transferring it to a shuttle tanker for delivery to onshore facility for storage or refining. Revenue drivers. Factors that drive the shuttle tanker sector include (1) the level of offshore drilling activity; (2) the current low level of new builds; and (3) the expansion of offshore drilling in Brazil, Australia and West Africa. Risks. Investments in shuttle tanker shipping MLPs can be considered a higher-risk investment relative to pipeline MLPs, due to the following factors: (1) regulatory requirements; (2) potential spot market volatility; (3) competitiveness of the contract bidding process; (4) oil spills and (5) the natural production decline in mature offshore fields, like the North Sea. Commodity price sensitivity. Like pipeline MLPs, shuttle tanker MLPs typically do not take title to the product shipped; therefore, changes in commodity prices have a minimal direct impact on these companies. In addition, due to the potential for reservoir damage and the cost of shutting-in offshore wells, offshore oil production is generally maintained even during periods of low oil prices. Shipping MLPs could potentially be indirectly affected by a (sustained) high or low oil price environment, which ultimately results in an increase or decrease in the demand for the products shipped. However, higher oil prices could also stimulate offshore drilling to the benefit of the sector.
H. Coal
The universe of coal MLPs consists of three coal producer and two coal royalty businesses. The royaltyoriented partnerships enter into long-term leases that provide the coal operators the right to mine coal reserves on the partnerships properties in exchange for royalty payments. A coal MLPs royalty payments are based on the volume of coal produced and the price at which it is sold. In addition, since coal royalty MLPs do not operate any of the mines, their operating costs are typically limited to corporate and administrative expenses. The coal-producing MLPs actually mine raw coal, negotiate contract terms, and, in some cases, own the reserves. Figure 135. MLPs With Coal Assets
Alliance Resource Partners L.P. Natural Resource Partners L.P. Oxford Resource Partners L.P.
ARLP NRP OXF
Penn Virginia Resource Partners L.P. Rhino Resource Partners L.P.
PVR RNO
Industry and sector drivers. The demand for and the price of coal is driven by a number of factors, both domestic and international. Domestically, demand is driven by (1) electricity demand because electric utility companies are the primary consumers of coal (more than 90%); (2) the relative price of natural gas and crude oil, as some power producers can alternate their fuel consumption based on the relative price of different fuels; (3) weather, which can influence electricity demand and hydro-electric production; and (4) environmental regulations. The demand for electricity is generally influenced by the following: (1) economic growth; (2) weather patterns; and (3) coal customer inventory trends. Internationally, demand for coal is also influenced by: (1) worldwide electricity demand; (2) the value of the dollar; (3) economic growth in developing countries; and (4) demand for steel, which in turn drives demand for metallurgical coal (commonly referred to as met coal). (1) Coal Operator Overview Revenue drivers. Over the intermediate term, coal mine operator revenue is likely to be influenced by (1) the pace of recovery in electricity demand; (2) demand for met coal from China; and (3) government regulation directed at coal mine operators and electricity utilities (air quality standards).
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Risks. Risks to coal producer MLPs include the following: (1) coal price volatility; (2) controlling operational costs; (3) geological issues; and (4) regulatory issues (specifically permitting delays and changing environmental regulations). Commodity price sensitivity. MLPs with coal assets directly benefit during periods of high energy commodity prices. Since most coal is sold under long-term (1-3 year) contracts, higher or lower coal spot prices do not immediately affect the majority of coal sales prices. However, when contracts roll over, they are typically renegotiated closer to prevailing spot prices, which can be volatile. (2) Coal Royalty Model Overview Revenue drivers. Coal royalty-based MLPs revenue drivers are underpinned by the performance of coal mine operators, but tend to be less volatile because they do not incur operational costs. Thus, royalty coal MLPs revenue is driven solely by the price, volume, and production mix (met coal versus steam coal) of its lessees. Risks. Risks to both coal producer and royalty-based MLPs include (1) coal price volatility; (2) operational and geological issues; and (3) regulatory issues (specifically permitting and environmental issues). Risks specific to coal royalty MLPs include (1) reliance on lessees to operate and produce on its reserves (i.e., the rate of production is dictated by the producer); and (2) no direct control over pricing (i.e., lessees negotiate new contracts with utilities and other end users directly). Commodity price sensitivity. MLPs with coal assets directly benefit during periods of high energy commodity prices. Coal royalty MLPs own coal reserves and collect a royalty stream of income. Since most of their lessees coal is sold under long-term (1-3 year) contracts, higher coal spot prices do not immediately affect coal sales prices. However, when contracts roll over, they are typically renegotiated closer to prevailing spot prices, which can be volatile.
I. Upstream (E&P)
Upstream MLPs are focused on the exploitation, development, and acquisition of oil and natural gas producing properties. These partnerships produce oil and natural gas at the wellhead for sale to third parties. Typically, upstream MLPs do not undertake exploratory drilling, but rather, own and operate assets in mature basins that exhibit low decline rates and long reserve lives (i.e., the focus is primarily on maintaining, rather than increasing, production). Accordingly, these assets require a relatively small amount of capital to fund low-risk development opportunities and have predictable production profiles. Figure 136. MLPs With E&P Businesses
Breitburn Energy Partners L.P. Constellation Energy Partners Eagle Rock Energy Partners L.P. Encore Energy Partners L.P. EV Energy Partners L.P.
BBEP CEP EROC ENP EVEP
Kinder Morgan Energy L.P. Legacy Reserves L.P. Linn Energy LLC Pioneer Southwest Energy L.P. Vanguard Natural Resources
KMP LGCY LINE PSE VNR
Industry and sector drivers. Upstream MLPs rely predominantly on external financing (debt and equity) in order to fund acquisitions. Thus, access to capital plays a significant role in growth for these companies. In addition, a higher commodity price environment is beneficial to the unhedged portion of upstream MLP production. This excess cash flow can be reinvested to acquire mature reserves and/or to help fund organic growth initiatives, both of which should support additional distribution growth. Other factors affecting sector performance include service costs, rig/crew availability, and the activity level of the acquisition market as growth via acquisition is the primary driver of growth. Revenue drivers. The main revenue drivers for upstream MLPs are increasing commodity prices, acquisitions, and organic drilling. Risks. Some of the risks associated with investing in upstream MLPs include (1) declining commodity prices, (2) inability to hedge at attractive prices, (3) lack of access to capital markets, and (4) a lack of acquisition opportunities. Commodity price sensitivity. MLPs that own oil and gas assets have the most direct exposure to commodity prices. These partnerships mitigate this exposure by maintaining a rolling 36-month hedge program. Typically, upstream MLPs hedge about 70-90% of current production. Hedging serves to protect against decreases in commodity prices and hence, supports the consistency of distribution payments. However, a prolonged period of depressed commodity prices could force a partnership to reduce its distribution. Many
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upstream MLPs maintain a high coverage ratio in order to partially mitigate this risk. Upstream MLPs also seek to address long-term commodity price and liquidity risk by maintaining conservative debt levels.
J. Refining
Currently, there is one refining MLP that produces specialty and fuel products from the refining of crude oil and other feedstocks. Specialty products include lubricating oils, solvents, and waxes that are used as raw material components for basic industrial, consumer, and automotive products. Fuel products include unleaded gasoline, diesel fuel, and jet fuel. The fuels products industry uses the 3/2/1 crack spread as a proxy to provide an estimate of the per barrel margin that would be generated assuming that three barrels of crude oil are converted, or cracked, into two barrels of gasoline and one barrel of heating oil. Figure 137. MLPs With Refining Assets
Calumet Specialty Products L.P.

CLMT
Industry and sector drivers. Factors driving the refining sector include (1) crack spreads (i.e., the spread between crude oil input prices and product output prices), (2) the demand for specialty and fuel products, and (3) overall economic activity. Revenue drivers. Refining MLPs cash flow is subject to commodity price fluctuations (i.e., crude oil). Thus, the MLPs gross margin is dependent upon the price at which it can sell its specialty products and fuels and the price for crude oil and other feedstocks (i.e., input costs). Revenue drivers for refining companies include complementary and strategic acquisitions and organic growth projects. Some examples of internal growth projects include capacity additions, debottlenecking, and processing unit product mix enhancements. Risks. Some of the risks associated with investing in refining MLPs include (1) rising feedstock prices (i.e., crude oil); (2) demand for fuel, refined products, and specialty hydrocarbon products; (3) alternative/competing products; and (4) unscheduled refinery turnarounds.
K. Asphalt
There are also some MLPs that own asphalt refining and storage assets. Asphalt is a highly viscous substance produced from crude oil (i.e., the bottom of the barrel), which is predominantly used for road paving. Due to the consistency of asphalt, it is stored in heated terminals and transported via truck, rail, and/or barge, but not pipelines. It is estimated that approximately 85% of asphalt consumed in the United States is used for road paving and about 10% is used for roofing products (i.e., shingles). The asphalt business is seasonal and must be applied to roads during warm weather conditions. Thus, asphalt companies typically experience higher demand from May to October and build inventory during the colder months (i.e., November through April). The primary market for asphalt is (1) the Department of Transportation (DOT), (2) municipalities, and (3) commercial (e.g., parking lots, weigh stations, and underlayments for rail lines). Figure 138. MLPs With Asphalt Assets
Blueknight Energy Partners L.P. Martin Midstream Partners L.P. Nustar Energy L.P.
BKEP MMLP NS
Industry and sector drivers. The main drivers behind the sector include factors that drive demand for asphalt including the pace of federal, state, and local government highway spending, demand for housing, and economic activity. In addition, a reduction in asphalt supplies due to declining imports, lower refinery utilization rates, and increase number of coker projects at refineries can also serve to bolster margins due to a tighter supply and demand dynamic. Coker capacity additions are expected to be one of the main factors driving tighter asphalt supplies. Coker projects allow refineries to produce higher value products (e.g., gasoline, diesel, and jet fuel) from heavier less expensive crude oils, which reduce aggregate market asphalt supplies. Revenue drivers. MLPs with asphalt storage assets generate predominantly fee-based revenue. The primary revenue driver behind MLPs with this type of asset includes acquisitions and organic growth projects in order to expand handling capacity. Revenue generated from asphalt refining assets is sensitive to commodity price fluctuations. The cash flow profile from asphalt refining assets are usually enhanced via organic capex initiatives that can include improvements in a refinerys (1) ability to handle more types of crude oil, (2) energy efficiency, and (3) product yields.
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Risks. The primary risk for MLPs with asphalt storage assets is re-contracting risk. The main risks associated with MLPs that own asphalt refining assets include (1) volatility of asphalt prices (this includes seasonality), (2) inability to hedge asphalt prices, (3) a slowdown in commercial and residential construction, and (4) declining product yield values.
L. Liquefied Natural Gas

LNG describes the process whereby natural gas is transformed from a gaseous to liquid state and shipped via marine tankers to consuming markets. Natural gas is cooled into liquid form at a liquefaction facility and transported via specially designed ships to markets that have insufficient natural gas supplies or limited natural gas pipeline infrastructure. Upon delivery of the LNG to the receiving terminal, the LNG is returned to its gaseous state (i.e., re-gasification). Once re-gasified, the natural gas is stored in specially designed facilities or delivered to natural gas consumers through pipelines. Figure 139. MLPs With LNG Assets
Cheniere Energy Partners L.P. El Paso Pipeline Partners L.P.
CQP EPB
Industry and sector drivers. Factors driving LNG growth includes global demand for natural gas, domestic natural gas production, environmental legislation (i.e., restricting construction of coal fired power plants), and construction of additional liquefaction plants. Revenue drivers. MLPs involved in the LNG industry generate predominantly fee-based revenue (e.g., reservation fee contracts) from long-term throughput utilization agreements (TUA). The fees generated from these contracts are typically paid on a monthly basis. The main revenue drivers for these MLPs are organic capex investments and third-party acquisitions that would expand the partnerships liquefaction/regasification capacity. Risks. Risks associated with investing in MLPs with domestic LNG assets include the LNG market not developing as quickly as anticipated and higher natural gas prices in international markets resulting in more LNG cargos delivered to Europe and Asia. In addition, there is some customer concentration risk, as the domestic MLPs LNG assets are contracted out to only 3-5 customers. Commodity price sensitivity. Significant declines in natural gas prices could make it uneconomical for liquefaction plants.
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118
Appendix
119
120
Coal Index PP Ticker: WCHWCOA TR Ticker: WCHWCOAT ARLP DMLP ENP CMLP CPNO CQP DEP DPM EEP EEQ EPB EPD Natural Gas Index PP Ticker: WCHWGAS TR Ticker: WCHWGAST APL BWP CMLP CPNO CQP DEP DPM EPB PNG OKS NKA XTEX NGLS WPZ HEP MWE WES GEL MMP TLP ETP TCLP EEQ MMLP SXL EROC SEP EEP KMR PAA EPD RGNC BPL KMP NS TR Ticker: WCHWPETT PP Ticker: WCHWPET Petroleum Index NS NKA XTEX NGLS WPZ MWE WES MMP TLP MMLP TCLP KMR SXL KMP SEP HEP RGNC LINE BWP GEL PNG LGCY VNR BPL ETP PAA TOO FGP NRGY SPH NRP PVR BBEP EVEP PSE APL EROC OKS CPLP NMM TGP APU GLP SGU EXLP NKA PNG TR Ticker: WCHWEXPT TR Ticker: WCHWMIDT TR Ticker: WCHWMART TR Ticker: WCHWPROT TR Ticker: N/A TR Ticker: N/A PP Ticker: WCHWEXP PP Ticker: WCHWMID PP Ticker: WCHWMAR PP Ticker: WCHWPRO PP Ticker: N/A PP Ticker: N/A Upstream Index Midstream Index Marine Transportation Index Propane Index Oilfield Services Index Storage Index Gathering & Processing Index Crude Oil Index PP Ticker: WCHWCRD TR Ticker: WCHWCRDT EEQ EEP GEL PAA PP Ticker: WCHWGNP TR Ticker: WCHWGNPT APL CMLP CPNO XTEX DPM OKS MWE WPZ EPD WES EROC NGLS EPB SEP DEP RGNC BWP ETP TCLP TR Ticker: WCHWNGPT PP Ticker: WCHWNGP Natural Gas Pipelines Index Refined Products Index PP Ticker: WCHWRFP TR Ticker: WCHWRFPT BPL HEP KMP KMR MMP MMLP NS SXL TLP
General Partnership Index
PP Ticker: WCHWGPS
TR Ticker: WCHWGPST
AHD
PVG
NSH
AHGP
EPE
NRGP
PP = Price Performance TR = Total Return MLP subsector index quotes are available on Bloomberg Source: Standard & Poors and Wells Fargo Securities, LLC estimates
Figure 140. Wells Fargo Securities MLP Index Constituents By Industry, Sector, And Subsector
BGH
ETE
MLP Primer -- Fourth Edition Figure 141. Breakdown Of MLPs By Asset Class
Master Limited Partnership BOARDWALK PIPELINE PRTNRS-LP BUCKEYE PARTNERS LP EL PASO PIPELINE PARTNERS LP ENBRIDGE ENERGY PRTNRS -LP ENERGY TRANSFER PARTNERS -LP ENTERPRISE PRODS PRTNER -LP KINDER MORGAN ENERGY -LP MAGELLAN MIDSTREAM PRTNRS LP NISKA GAS STORAGE PARTNERS NUSTAR ENERGY LP ONEOK PARTNERS -LP PAA NATURAL GAS STORAGE LP PLAINS ALL AMER PIPELNE -LP SPECTRA ENERGY PARTNERS LP SUNOCO LOGISTICS PARTNERS LP WILLIAMS PARTNERS LP BLUEKNIGHT ENERGY PRTNRS LP CHENIERE ENERGY PARTNERS LP DUNCAN ENERGY PARTNERS LP EXTERRAN PARTNERS LP GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP MARTIN MIDSTREAM PARTNERS LP TC PIPELINES LP TRANSMONTAIGNE PARTNERS LP ATLAS PIPELINE PARTNER LP CALUMET SPECIALTY PRODS -LP CHESAPEAKE MIDSTREAM PRTNRS COPANO ENERGY LLC CRESTWOOD MIDSTREAM PTNRS LP CROSSTEX ENERGY LP DCP MIDSTREAM PARTNERS LP EAGLE ROCK ENERGY PARTNRS LP MARKWEST ENERGY PARTNERS LP REGENCY ENERGY PARTNERS LP TARGA RESOURCES PARTNERS LP WESTERN GAS PARTNERS LP BREITBURN ENERGY PARTNERS LP CONSTELLATION ENERGY PRTNRS ENCORE ENERGY PARTNERS LP EV ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC PIONEER SOUTHWEST ENERGY -LP VANGUARD NATURAL RESOURCES AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP GLOBAL PARTNERS LP INERGY LP SUBURBAN PROPANE PRTNRS -LP CAPITAL PRODUCT PARTNERS LP K-SEA TRANSPORTATION -LP NAVIOS MARITIME PARTNERS LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP ALLIANCE RESOURCE PTNRS -LP NATURAL RESOURCE PARTNERS LP OXFORD RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP RHINO RESOURCE PARTNERS LP ALLIANCE HOLDINGS GP LP ATLAS PIPELINE HOLDINGS LP BUCKEYE GP HOLDINGS LP CROSSTEX ENERGY INC ENERGY TRANSFER EQUITY LP ENTERPRISE GP HOLDINGS LP NUSTAR GP HOLDINGS LLC PENN VIRGINIA GP HOLDINGS LP
Ticker BWP BPL EPB EEP ETP EPD KMP MMP NKA NS OKS PNG PAA SEP SXL WPZ BKEP CQP DEP EXLP GEL HEP MMLP TCLP TLP APL CLMT CHKM CPNO CMLP XTEX DPM EROC MWE RGNC NGLS WES BBEP CEP ENP EVEP LGCY LINE PSE VNR APU FGP GLP NRGY SPH CPLP KSP NMM TGP TOO ARLP NRP OXF PVR RNO AHGP AHD BGH XTXI ETE EPE NSH PVG x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x
Large Cap Pipeline MLPs
Small & Mid Cap Pipes
Gathering & Processing MLPs
Propane MLP
Upstream MLPs
Shipping
Coal
General Partnerships
ur al G C as ru de Pi pe oi lin R lp ef es ip in el ed in es pr N G od L .p Pi ip pe N el lin at in ur es es al G Tr as ea G tin at g he C rin om An d g pr D eh es N yd si at on ra ur tio al n G Fr as ac Pr tio oc na N es tio at si ur n ng al G C as ru de St or /P ag N et G e ro L lT St or er m ag In in e te al rn s at io D na om lp es ro tic du In ta te ct nk rn ta at ve nk io Li ss er na qu s el ld ef s ry ie d C bu na ru lk de tu ra oi lg ls Pr as hu op ve ttl an e ss ta e el C nk s oa er l s U ps tr ea m R ef in in g A sp ha lt Li qu ef ie d G N P at In ur te al re G st as

Midstream x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x x Marine Transportation Other x x x x x x x x x x x x
N at
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Master Limited Partnerships Figure 142. Estimated Breakdown Of Fee-Based Cash Flow By MLP
Breakdown Of Cash Flow Percentage FeeBased 95% 100% 75% 100% 70% 80% 80% 85% 65% 85% 70% 80% 98% 100% 65% 75% 83% BKEP CHKM DEP EXLP GEL HEP MMLP TCLP TLP 100% 100% 100% 100% 60% 100% 65% 100% 100% 92% APL CPNO DPM EROC CMLP MWE NGLS RGNC WES XTEX 10% 25% 55% 35% 100% 80% 20% 75% 98% 80% 58% BBEP ENP EVEP LGCY LINE PSE VNR 0% 0% 0% 0% 0% 0% 0% 0% APU FGP NRGY SPH 100% 100% 100% 100% 100% KSP TGP TOO 100% 100% 100% 100% ARLP NRP OXF PVR 0% 0% 0% 5% 1% 65% 80% Percentage Other (i.e. Commodity, Spread, etc) 5% 0% 25% 0% 30% 20% 20% 15% 35% 15% 30% 20% 2% 0% 35% 25% 17% 0% 0% 0% 0% 40% 0% 35% 0% 0% 8% 90% 75% 45% 65% 0% 20% 80% 25% 2% 20% 42% 100% 100% 100% 100% 100% 100% 100% 100% 0% 0% 0% 0% 0% 0% 0% 0% 0% 100% 100% 100% 95% 99% 35% 20%
Partnership BUCKEYE PARTNERS LP BOARDWALK PIPELINE PRTNRS-LP ENBRIDGE ENERGY PRTNRS -LP
Ticker BPL BWP EEP EPB EPD ETP KMP MMP NKA NS OKS PAA PNG SEP SXL WPZ
Large-Cap Pipeline MLPs Small-Cap Pipelines Gathering & Processing MLP Upstream MLPs Propane Ship Coal
EL PASO PIPELINE PARTNERS LP ENTERPRISE PRODS PRTNER -LP ENERGY TRANSFER PARTNERS -LP KINDER MORGAN ENERGY -LP MAGELLAN MIDSTREAM PRTNRS LP NISKA GAS STORAGE PARTNERS -LP NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP PAA NATURAL GAS STORAGE LP SPECTRA ENERGY PARTNERS LP SUNOCO LOGISTICS PRTNRS L P WILLIAMS PARTNERS LP Average BLUEKNIGHT ENERGY PRTNRS LP CHESAPEAKE MIDSTREAM PARTNERS DUNCAN ENERGY PARTNERS LP EXTERRAN PARTNERS LP GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP MARTIN MIDSTREAM PARTNERS LP TC PIPELINES LP TRANSMONTAIGNE PARTNERS LP Average ATLAS PIPELINE PARTNER LP COPANO ENERGY LLC DCP MIDSTREAM PARTNERS LP EAGLE ROCK ENERGY PARTNRS LP CRESTWOOD MIDSTREAM PTNRS LP MARKWEST ENERGY PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP WESTERN GAS PARTNERS LP CROSSTEX ENERGY LP Average BREITBURN ENERGY PARTNERS LP ENCORE ENERGY PARTNERS LP EV ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC PIONEER SOUTHWEST ENERGY -LP VANGUARD NATURAL RESOURCES Average AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP INERGY LP SUBURBAN PROPANE PRTNRS -LP Average K-SEA TRANSPORTATION -LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP Average ALLIANCE RESOURCE PTNRS -LP NATURAL RESOURCE PARTNERS LP OXFORD RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Average Average Median
Note: Excludes hedges Source: Partnership reports and Wells Fargo Securities, LLC estimates
122
MLP Primer -- Fourth Edition Figure 143. MLP Projects Related To Liquids-Rich Plays
MLP Enbridge Energy Partners, L.P. ONEOK Partners, L.P. ONEOK Partners, L.P. ONEOK Partners, L.P. ONEOK Partners, L.P. ONEOK Partners, L.P. ONEOK Partners, L.P. Plains All American Pipeline, L.P. Kinder Morgan Energy Partners, L.P. / Copano Energy, LLC Energy Transfer Partners, L.P. Energy Transfer Partners, L.P. Energy Transfer Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. / Duncan Energy Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. Enterprise Products Partners, L.P. MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / The Energy & Minerals Group MarkWest Energy Partners, L.P. / Sunoco Logistics Partners, L.P. Buckeye Partners, L.P. Kinder Morgan Energy Partners, L.P. Ticker Project Name EEP OKS OKS OKS OKS OKS OKS PAA KMP / CPNO ETP ETP ETP EPD EPD EPD EPD / DEP EPD EPD EPD EPD EPD EPD EPD MWE MWE MWE MWE MWE MWE MWE North Dakota Expansion Program Bakken Pipeline Overland Pass Expansion Bushton Fractionator Upgrade Garden Creek Processing Plant Description For U.S. portion of project
Resource Play Bakken Shale Bakken Shale Bakken Shale Bakken Shale Bakken Shale Bakken Shale Bakken Shale Bakken Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Eagle Ford Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale Marcellus Shale
Investment (MM) $370.0 $475.0 $37.5 $125.0 $180.0 $192.5 $192.5* $180.0 $137.0 NA
525 615 mile NGL pipeline with a capacity of up to 60,000 Bbls/d To increase the pipelines capacity to 255,000 Bbls/d To increase the capacity to 210,000 Bbls/d from 60,000 Bbls/d A new 100 MMcf/d natural gas processing facility
Stateline I Processing Plant A new 100 MMcf/d natural gas processing facility TBD - Stateline II Processing Plant Bakken North Project Eagle Ford Gathering joint venture None Dos Hermanas Chisholm Pipelines White Kitchen Lateral Related to Anadarko Petroleum production Related to EOG Resources production Shoup and Armstrong facilities Mont Belvieu Frac 4 Mont Belvieu Frac 5 None None None Wilson Gas Storage None Majorsville I Majorsville II Houston I and II Houston III Houston Fractionation TBD - Houston IV TBD - Smithfield I A new 100 MMcf/d natural gas processing facility 103-mile crude oil pipeline with a capacity of 50 MBbls/d (expandable to 75 MBbls/d) To build approximately 85 miles of 30 and 24 pipe To build a 50-mile pipeline with initial capacity in excess of 350 MMcfe/d 50 mile pipeline with a capacity of 400 MMcf/d 83 mile pipeline with an initial capacity of 100 MMcf/d (expandable to 300 MMcf/d) To build a 60-mile pipeline with capacity in excess of 200 MMcf/d To construct a new 17-mile natural gas gathering pipeline in Dimmit County, Texas 140-mile crude oil pipeline with a capacity of 350,000 Bbls/d Shoup frac expansion to to 77 MBPD and Armstrong frac expansion to ~20 MBPD 75 MBPD NGL fractionator 75 MBPD NGL fractionator 168-mile rich east-west natural gas mainline A new 600-900 MMcf/d natural gas processing plant A 64-mile residue gas pipeline to connect the new processing plant to Wilson Storage A 5 Bcf expansion 127-mile NGL pipeline to Mont Belvieu with a capacity of 60 MBPD A 120 MMcf/d processing plant A 150 MMcf/d processing plant Combined 155 MMcf/d processing complex A 200 MMcf/d processing plant A 60,000 Bbl/d fractionation complex A 200 MMcf/d processing plant A 120 MMcf/d processing plant An ethane pipeline with a capacity of 50,000 Bbls/d An anticipated ~400-mile NGL pipeline could have a capacity of 90,000-150,000 Bbls/d To construct a 250-mile pipeline with an initial capacity of 75,000 Bbls/d
$35.0
$261.0 $261.0*
$116.0
+ $1,000.0*
NA NA $77.5
MWE / Mariner Project SXL BPL KMP Union Pipeline Project Cochin Pipeline Expansion
Total MLP investments announced / completed year-to-date ($ in millions)
$3,640.0
Note*: Indicates Wells Fargo Securities, LLC estimates Source: Partnership reports and Wells Fargo Securities, LLC estimates
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124
Dry / Modestly Wet Gas Plays NGL-Rich Gas Plays Oil Plays
y lle Va J D M
3 5 G 5 1 G T G G T G-T T G-P T T G-P G-T T T G T T G-P P G-T G-P-T G P-T T G-T T G-P-T T G-P G-P-T G-P-T G T T G G G G-P G-P G-P-T G-P G-P-T G-P G-P G-P T T G-T T T T G-P-T G-T T T G G-P-T T P-T G-P-T T T T G-P-T G-P-T G-P-T G-P-T G-P-T G-P-T G-P-T T T T T G-P G-P G-P G G-P T G-T G G G-P-T 4 4 4 6 7 8 3 10 10 2 6 2 8 5 4 8 2 7 8 2 0 0 6 6 5 5 4 4 3 3 3 3 1 1 2 2 3 5 6 4 3 1 3 6 7 4 2 9 6 5 6 8 5 4 1 6 4 3 6 7 3 3 2 3 10 7 5 12 0 0 1 1 0 0 2 2 2 1 3 3 G G T G T T
tt er n si to ne os ot ar C B B B o l ta To
in as sv tte de ne w ye ay Po Fa H r er nt a n to ar is br ill io W N
e ill s llu ce ta ar in U M ey
lle vi
er iv rR
APL
on ot e al ug ed sh /A /H a in rd o W rd n an ce /P rk Fo fo te ia Ju an da le ah ni od rm g n n o ce ra na Pe Jo Pi G A Ea W Sa G-P G-P G-P a om rk n ke ak B /
BWP
CHKM
CMLP
G-P
CPNO
G-P-T
DEP
DPM
EEP
G-P
G-P-T
EPB G-P G T G G-P G G G-P
EPD
G-T
EROC

3 3 0 3 3 12 2 7 1 0 1 7
ETP
G-P-T G-P-T
KMP
MMLP
MWE
NGLS
G-P
OKS
PAA
PVR
G-T
RGNC
SEP
WES
WPZ
XTEX
G-P-T
Figure 144. Midstream MLP Geographical Exposure By Major Producing Region
# Gather
# Process
# Transport
11
# Total
15
Legend:
T - Transportation (Least Risky)
G - Gathering
P - Processing (Most Risky)
Figure 145. Investment Grade Debt Offerings: 2008 Versus 2010 Year To Date
Date Jan-08 Feb-08 Feb-08 Mar-08 Mar-08 2008 Investment Grade Offerings Mar-08 Mar-08 Mar-08 Mar-08 Mar-08 Mar-08 Mar-08 Mar-08 Mar-08 Apr-08 Apr-08 Jul-08 Dec-08 Dec-08 Dec-08 Dec-08 Issuer BPL KMP KMP BWP TPP TPP TPP ETP ETP ETP EPD EPD EEP EEP NS PAA MMP EPD KMP EEP ETP Rate 6.05% 5.95% 6.95% 5.50% 5.90% 6.65% 7.55% 6.00% 6.70% 7.50% 5.65% 6.50% 6.50% 7.50% 7.65% 6.50% 6.40% 9.75% 9.00% 9.88% 9.70% 7.28% Term (Years) 10 10 30 5 5 10 30 5 10 30 5 10 10 30 10 10 10 5 10 10 10 Proceeds ($ in MM) $300 $600 $300 $250 $250 $350 $400 $350 $600 $550 $400 $700 $400 $400 $350 $600 $250 $500 $500 $500 $600 $9,150 2010 Investment Grade Offerings Date Feb-10 Feb-10 Feb-10 Feb-10 Feb-10 Feb-10 May-10 May-10 May-10 May-10 May-10 Jul-10 Aug-10 Aug-10 Sep-10 Sep-10 Nov-10 Issuer WPZ WPZ WPZ SXL SXL EEP EPD EPD EPD KMP KMP PAA MMP NS EEP DPM WPZ Rate 3.80% 5.25% 6.30% 5.50% 6.85% 5.20% 3.70% 6.45% 5.20% 5.30% 6.55% 3.95% 4.25% 4.80% 5.50% 3.25% 4.13% 5.17% Term (Years) 5 10 30 10 30 10 5 30 10 10 30 5 11 10 30 5 10 Proceeds ($ in MM) $750 $1,500 $1,250 $250 $250 $500 $400 $600 $1,000 $600 $400 $400 $300 $450 $400 $250 $600 $9,900
Average / Total
Average / Total
Figure 146. High Yield Debt Offerings: 2008 Versus 2010 Year To Date
Date 2008 High Yield Offerings Jan-08 Apr-08 Apr-08 May-08 May-08 Jun-08 Jun-08 Jun-08 Jul-08 Issuer ATN MWE NRGY ATN CPNO NGLS LINE APL FGP Rate 10.75% 8.75% 8.25% 10.75% 7.75% 8.25% 9.88% 8.75% 6.75% 8.82% Term (Years) 10 10 8 10 10 10 10 10 5 Proceeds ($ in MM) $250 $500 $200 $150 $300 $256 $250 $200 $2,356 2010 High Yield Offerings $250 Date Feb-10 Mar-10 Mar-10 Mar-10 Mar-10 Mar-10 Apr-10 Jun-10 Aug-10 Sep-10 Sep-10 Sep-10 Sep-10 Oct-10 Oct-10 Nov-10 Nov-10 Nov-10 Nov-10 Issuer XTEX SPH MMLP LINE EPB FGP PVR EPB NGLS LINE NRGY ETE BBEP RGNC MWE FGP SGU EPB EPB Rate 8.88% 7.38% 8.88% 8.63% 6.50% 8.63% 8.25% 6.50% 7.88% 7.75% 7.00% 7.50% 8.63% 6.88% 6.75% 6.50% 8.88% 4.10% 7.50% 7.57% Term (Years) 8 10 8 10 10 10 8 10 8 11 8 10 10 8 10 11 7 5 30 Proceeds ($ in MM) $725 $250 $200 $1,300 $425 $280 $300 $110 $250 $1,000 $600 $1,800 $305 $600 $500 $500 $125 $375 $375 $10,020
Average / Total
Average / Total
125
Master Limited Partnerships Figure 147. Historical GP Transactions

Percent Acquired 100.0% 100.0% 56.0% 100.0% 9.9% 9.9% 50.0% 52.5% 100.0% 23.0% 44.0% 100.0% 82.5% 100.0% 9.9% 100.0% 100.0% 19.6% 19.0% 16.0% 17.6% 35.1% 20.0% 100.0% 40.6% 17.1% 100.0% 37.1% 100.0% 32.4% 17.7% 63.0% 100.0% 91.0% 10.3% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% $1,160 $1,853 $9,123 $950 $1,160 $1,853 $9,123 $950 Price ($MM) $63 $6 $42 $42 $88 $89 $425 $4 $30 $52 $21 $235 $175 $193 $63 $1,100 $45 $88 $81 $398 $507 $539 $300 $700 $380 $83 $76 $179 $345 $130 $128 $412 $900 $154 $53 $1,148 Implied Value ($MM) Buyer $63 $6 $75 $42 $889 $897 $850 $8 $30 $225 $48 $235 $212 $193 $632 $1,100 $45 $450 $426 $2,489 $2,882 $1,536 $1,497 $700 $935 $485 $76 $481 $345 $400 $722 $654 $900 $169 $510 $1,148 BMC Acquistion Co. (management) SPH Management Investor Group (including management) Madison Dearborn/Carlyle Riverstone Goldman Sachs El Paso Corp Enterprise Products Partners Investor Group (including management) LaGrange Energy, LP Public (IPO) Vulcan Capital Carlyle/Riverstone Global Energy and Power Fund II, LP ONEOK, Inc. Valero, LP EPCO Inc. EPCO Inc. Lehman Brothers Merchant Banking Group Public (IPO) Remaining 7 GP Owners Public (IPO) Public (IPO) Public (IPO) Public (IPO) Plains All-American Pipeline, LP Public (IPO) Public (IPO) Suburban Propane Partners, L.P. Public (IPO) Morgan Stanley Capital Group (MSCG) Public (IPO) Public (IPO) ArcLight Capital Partners, Kelso, and Lehman Brothers Enterprise GP Holdings, LP GE Energy Financial Services (GEFS) MarkWest Energy Partners, L.P. Magellan Midstream Partners, L.P. Harold Hamm Buckeye Partners, L.P. Inergy, L.P. Enterprise Products Partners Penn Virginia Resource, L.P. Natural Resource Partners, L.P.
Date
Partnership
FTM Cash Flow ($MM) $3.4 $1.0 $3.8 $14.3 $94.0 $94.0 $94.0 $2.8 $3.0 $16.7 $15.1 $18.7 $13.7 NE $72.2 $75.7 $1.4 $24.1 $30.2 $105.7 $228.0 $57.8 $59.5 $26.9 $54.8 $24.0 $0.0 $23.3 $14.3 $17.8 $37.7 $22.9 $48.9 $2.9 $35.9 $99.0
FTM Multiple Estimate 18.5x 6.2x 19.7x 2.9x 9.5x 9.5x 9.0x 2.7x 10.0x 13.5x 3.2x 12.6x 15.5x NE 8.7x 14.5x 32.1x 18.7x 14.1x 23.6x 12.6x 26.6x 25.1x 26.1x 17.0x 20.2x NA 20.7x 24.1x 22.4x 19.2x 28.6x 18.4x 58.4x 20.5x 12.0x -
Mar-96 Buckeye Partners, LP May-99 Suburban Propane Partners, LP Jun-01 Jun-03 Oct-03 Plains All-American Pipeline, LP Magellan Midstream Partners, LP GulfTerra Energy Partners, LP
Dec-03 GulfTerra Energy Partners, LP Dec-03 GulfTerra Energy Partners, LP Dec-03 Natural Resource Partners, LP Jan-04 Jan-04 Heritage Propane Partners, LP Crosstex Energy, Inc.
Mar-04 Plains All-American Pipeline, LP Mar-04 Buckeye Partners, LP Nov-04 Northern Border Partners, LP Nov-04 Kaneb Pipe Line Partners, LP Jan-05 Enterprise Products Partners, LP
Feb-05 TEPPCO Partners, LP Mar-05 Pacific Energy Partners, LP Jun-05 Inergy Holdings, L.P.
Aug-05 Plains All-American Pipeline, LP Aug-05 Enterprise GP Holdings, LP Feb-06 Energy Transfer Equity, LP Feb-06 Magellan Midstream Holdings, LP May-06 Alliance Holdings GP, L.P. Jun-06 Jul-06 Jul-06 Jul-06 Pacific Energy Partners, LP Valero GP Holdings, LLC Atlas GP Holdings Suburban Propane Partners, LP
Aug-06 Buckeye GP Holdings, L.P. Sep-06 TransaMontaigne Partners, L.P. Sep-06 Hiland Holdings GP, L.P. Dec-06 Penn Virginia GP Holdings, L.P. Apr-07 Buckeye GP Holdings, L.P. May-07 TEPPCO Partners, LP Jun-07 Regency Energy Partners, L.P.
Sep-07 MarkWest Hydrocarbon Mar-09 Magellan Midstream Holdings, LP Apr-09 Hiland Holdings GP, L.P. Jun-10 Buckeye GP Holdings, L.P.
$61.0 $98.5 $369.6 $64.3
22.3x 19.7x 19.9x 14.8x 15.1x 17.6x 18.4x
Aug-10 Inergy Holdings, L.P. Sep-10 Enterprise GP Holdings, LP Sep-10 Penn Virginia GP Holdings, L.P. Sep-10 Natural Resource Partners, GP Mean Multiple Median Multiple
Note: FTM is forward 12 months Source: Company reports and Wells Fargo Securities, LLC estimates
126
MLP Primer -- Fourth Edition Figure 148. States With MLP Pipeline Assets
BWP Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming X
BPL
EPB X
EEP X
ETP X X X X X X X X X X X
EPD X X X X X X X X X X X X X X X X X X X X X X X X
Large Cap Pipeline MLPs KMP MMP NKA NS X X X X X X X
OKS
PNG
PAA X X X X X
SEP X
SXL
WPZ X
X X X X X X X X
X X X X X X
X X X
X X X X
X X
X X
X X
X X
X X
X X
X X
X X
X X X X X X
X X X X X X X X X X X X X X X X X X X X X X X X X X X X X
X X X X X X X X X X X X X X X X X X X X X X X X X X
X X X X
X X X X X X
X X X X X X
X X X X X X
X X X X X X X X X
X X X X X X X X X X
X X X X X
X X X X X X X X X X X
X X X X X X X X X
X X X
X X X X X
X X
X X X X X X X X X X X X
X X X X
X X X X X X X
X X X X
X X X X
X X
X X X X X X X X X X
X X X
X X X X
X X X X X X
X X X X
X X X X
X X X
X X
X X X X
X X
X X X X X
X X X X
X X X X
X X
Source: National Association of Publically Traded Partnerships
127
Master Limited Partnerships Figure 149. States With MLP Pipeline Assets, Continued
Small Cap Pipeline MLPs EXLP GEL HEP X X X X X X X X X
BKEP Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming
CQP
DEP
MMLP X X X X
TCLP
TLP X
X X X X
X X X
X X X X X X X X X X
X X X X X X X X X
X X
X X
X X X
X X
X X X X X X
X X X X X X X
X X X X X X X X X X
X X
X X X X X X
X X X
X X X X X X
X X X X
X X
X X X X X
X X X X X X X
X X X X
X X
X X
X X
X X
128
MLP Primer -- Fourth Edition Figure 150. States With MLP Gathering And Processing Assets
APL Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming
CHKM
CLMT
CMLP
Gathering And Processing MLPs CPNO XTEX DPM EROC X
MWE
RGNC
NGLS X X X X X
WES
X X X X X X X X
X X X X
X X
X X
X X X X X X X
X X X X X X X X X X X X X
X X X X X X X X
X X X X X
X X X X X X X X X X X X X X X X X X X X X X
X X X X X X X X X X X X X X X X X X X X X X X X X X X
X X X
X X X X
X X
X X
X X
X X
X X X X
129
Master Limited Partnerships Figure 151. States With MLP Coal And Upstream Assets
Coal MLPs NRP OXF X X X X X X
ARLP Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming
PVR
BBEP
CEP X
ENP
Upstream MLPs EVEP LGCY X
LINE
PSE
VNR
X X X
X X
X X X
X X
X X
X X X X X X X X X X X X X
X X
X X X X X X X X X X
X X X X X
X X
X X
X X X X X X X X X X X X X X X X X
X X X X X X X X X X
X X
X X X
X X X X X X X X X
X X
X X
X X X X
X X X
X X
130
MLP Primer -- Fourth Edition Figure 152. States With MLP Propane And Shipping Assets
Propane MLPs GLP NRGY X
APU Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X
FGP X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X
SGU
SPH
CPLP
KSP X
Shipping MLPs NMM TGP
TOO
X X X X X X X X
X X
X X
X X X X X X X X X
X X X
X X X X X X X
X X
X X X
X X
X X X X X X
X X
X X X X X
X X X X X
X X
131
Master Limited Partnerships Figure 153. MLP Market Data

Current Yield
($MM, except per unit data) NISKA GAS STORAGE PARTNERS ENERGY TRANSFER PARTNERS -LP KINDER MORGAN MANAGEMENT LLC ENBRIDGE ENERGY PRTNRS -LP ENBRIDGE ENERGY MGMT LLC NUSTAR ENERGY LP BOARDWALK PIPELINE PRTNRS-LP KINDER MORGAN ENERGY -LP PLAINS ALL AMER PIPELNE -LP WILLIAMS PARTNERS LP SUNOCO LOGISTICS PARTNERS LP BUCKEYE PARTNERS LP ONEOK PARTNERS -LP PAA NATURAL GAS STORAGE LP ENTERPRISE PRODS PRTNER -LP MAGELLAN MIDSTREAM PRTNRS LP SPECTRA ENERGY PARTNERS LP EL PASO PIPELINE PARTNERS LP Large Cap Pipeline MLP Median CHENIERE ENERGY PARTNERS LP MARTIN MIDSTREAM PARTNERS LP EXTERRAN PARTNERS LP TRANSMONTAIGNE PARTNERS LP GENESIS ENERGY -LP GLOBAL PARTNERS LP HOLLY ENERGY PARTNERS LP TC PIPELINES LP DUNCAN ENERGY PARTNERS LP BLUEKNIGHT ENERGY PRTNRS LP Small Cap Pipeline MLP Median CALUMET SPECIALTY PRODS -LP COPANO ENERGY LLC CROSSTEX ENERGY LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP DCP MIDSTREAM PARTNERS LP CRESTWOOD MIDSTREAM PTNRS LP MARKWEST ENERGY PARTNERS LP ATLAS PIPELINE PARTNER LP WESTERN GAS PARTNERS LP CHESAPEAKE MIDSTREAM PRTNRS EAGLE ROCK ENERGY PARTNRS LP Gathering & Processing MLP Median ENCORE ENERGY PARTNERS LP VANGUARD NATURAL RESOURCES EV ENERGY PARTNERS LP BREITBURN ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC PIONEER SOUTHWEST ENERGY -LP CONSTELLATION ENERGY PRTNRS Upstream MLP Median FERRELLGAS PARTNERS -LP INERGY LP SUBURBAN PROPANE PRTNRS -LP AMERIGAS PARTNERS -LP STAR GAS PARTNERS -LP Propane MLP Median CAPITAL PRODUCT PARTNERS LP NAVIOS MARITIME PARTNERS LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP K-SEA TRANSPORTATION -LP Shipping MLP Median OXFORD RESOURCE PARTNERS LP RHINO RESOURCE PARTNERS LP NATURAL RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP ALLIANCE RESOURCE PTNRS -LP Coal MLP Median PENN VIRGINIA GP HOLDINGS LP ENERGY TRANSFER EQUITY LP NUSTAR GP HOLDINGS LLC ALLIANCE HOLDINGS GP LP BUCKEYE GP HOLDINGS LP ENTERPRISE GP HOLDINGS LP CROSSTEX ENERGY INC ATLAS PIPELINE HOLDINGS LP General Partnership MLP Median All MLPs Average All MLPs Median All MLPs Median (Excluding GPs)
Ticker NKA ETP KMR EEP EEQ NS BWP KMP PAA WPZ SXL BPL OKS PNG EPD MMP SEP EPB CQP MMLP EXLP TLP GEL GLP HEP TCLP DEP BKEP CLMT CPNO XTEX NGLS RGNC DPM CMLP MWE APL WES CHKM EROC ENP VNR EVEP BBEP LGCY LINE PSE CEP FGP NRGY SPH APU SGU CPLP NMM TGP TOO KSP OXF RNO NRP PVR ARLP PVG ETE NSH AHGP BGH EPE XTXI AHD
Price 11/16/10 $19.70 $50.40 $63.00 $60.27 $60.40 $65.77 $31.65 $69.42 $61.25 $45.42 $79.55 $66.85 $79.36 $24.41 $42.55 $55.31 $33.85 $32.75 $19.65 $34.99 $23.23 $34.76 $23.24 $25.35 $52.04 $47.91 $31.90 $6.95 $21.28 $29.15 $13.71 $30.17 $25.23 $34.65 $26.12 $41.82 $23.38 $28.91 $27.84 $7.41 $19.71 $25.14 $37.59 $19.55 $26.34 $35.08 $28.16 $2.84 $26.20 $38.51 $55.30 $47.09 $5.09 $8.19 $18.42 $34.98 $28.13 $4.85 $21.01 $22.84 $29.67 $26.96 $60.16 $24.50 $38.83 $35.35 $43.01 $46.96 $63.49 $9.17 $14.90
Current Distribution $1.40 $3.58 $4.44 $4.11 $4.11 $4.30 $2.06 $4.44 $3.80 $2.75 $4.68 $3.90 $4.52 $1.35 $2.33 $2.98 $1.76 $1.64 $1.70 $3.00 $1.87 $2.40 $1.55 $1.98 $3.30 $3.00 $1.81 $0.00 $1.84 $2.30 $1.00 $2.15 $1.78 $2.44 $1.68 $2.56 $1.20 $1.48 $1.35 $0.00 $2.00 $2.20 $3.03 $1.56 $2.08 $2.64 $2.00 $0.00 $2.00 $2.82 $3.40 $2.82 $0.29 $0.93 $1.68 $2.40 $1.90 $0.00 $1.75 $1.78 $2.16 $1.88 $3.32 $1.56 $2.16 $1.92 $2.00 $1.88 $2.30 $0.28 $0.20
52-Week Low $17.01 $40.06 $44.94 $38.02 $39.08 $51.49 $14.49 $55.85 $44.12 $26.06 $50.37 $45.00 $25.57 $22.25 $29.05 $39.25 $22.58 $22.18 $10.15 $25.51 $18.66 $10.66 $15.47 $18.00 $36.26 $33.51 $21.20 $6.55 $14.00 $19.00 $5.25 $19.35 $18.70 $24.90 $16.08 $20.96 $7.04 $17.84 $21.25 $4.45 $9.50 $16.89 $21.24 $9.85 $16.76 $12.60 $19.46 $2.59 $19.05 $30.35 $39.16 $35.00 $3.71 $5.31 $12.17 $19.75 $16.80 $3.80 $15.87 $21.10 $18.00 $10.01 $37.51 $13.56 $27.25 $24.38 $22.74 $26.45 $35.99 $3.98 $3.11 High $20.35 $52.00 $64.82 $63.39 $64.39 $68.48 $34.23 $71.72 $65.20 $48.95 $81.80 $71.67 $81.67 $26.68 $44.32 $57.43 $36.31 $35.74 $20.96 $35.99 $26.62 $35.52 $26.45 $27.79 $53.74 $49.44 $33.39 $11.85 $23.93 $30.00 $14.66 $31.39 $26.58 $36.66 $27.16 $43.33 $24.82 $31.35 $28.29 $7.58 $21.80 $26.75 $39.60 $20.89 $27.59 $37.24 $29.74 $5.05 $27.19 $43.95 $57.24 $48.18 $5.84 $10.06 $20.17 $36.56 $29.30 $15.36 $23.50 $24.86 $31.20 $28.65 $62.91 $27.17 $40.46 $36.20 $46.28 $48.90 $66.29 $10.05 $15.44
Market Cap $1,332 $9,385 $7,174 $4,249 $6,096 $20,990 $8,391 $11,832 $2,542 $3,446 $8,087 $1,087 $27,285 $6,168 $2,718 $5,030 $6,132 $3,179 $650 $661 $502 $920 $429 $1,149 $2,213 $1,841 $238 $790 $751 $1,914 $687 $2,172 $3,239 $1,247 $744 $2,988 $1,246 $1,989 $3,846 $617 $1,581 $894 $556 $1,091 $1,042 $1,056 $5,138 $932 $70 $987 $1,820 $2,537 $1,957 $2,688 $348 $1,957 $203 $797 $1,879 $1,279 $93 $797 $432 $566 $2,311 $1,410 $2,209 $1,410 $957 $8,657 $1,503 $2,575 $1,329 $8,837 $430 $413 $1,416 $3,117 $1,503 $215,046
Enterprise Value $2,138 $15,425 $12,395 $6,098 $9,348 $32,679 $12,997 $18,055 $3,890 $4,887 $11,236 $1,308 $39,230 $8,061 $3,098 $6,749 $8,704 $5,254 $964 $1,096 $610 $1,346 $1,180 $1,651 $2,795 $2,495 $652 $1,263 $1,160 $2,497 $1,406 $3,605 $4,235 $1,860 $983 $4,204 $1,753 $2,724 $3,846 $1,133 $2,178 $1,134 $727 $1,425 $1,558 $1,346 $7,879 $1,006 $260 $1,240 $3,052 $3,432 $2,305 $3,557 $386 $3,052 $658 $1,023 $3,443 $2,771 $379 $1,023 $551 $680 $2,948 $2,075 $2,631 $2,075 $957 $10,457 $1,522 $2,575 $1,329 $9,932 $430 $447 $1,426 $4,463 $2,305 $307,917
3-Month Avg. Vol. 156,128 751,418 272,141 377,509 43,678 169,928 229,303 534,454 317,104 502,301 98,008 122,251 120,719 65,179 1,119,362 291,703 66,986 653,670 250,722 193,324 62,385 150,848 37,673 222,952 64,292 50,190 76,480 83,783 56,288 70,386 136,786 375,466 216,952 376,400 575,743 119,417 54,886 258,601 486,903 196,863 152,506 298,974 237,777 200,410 273,134 182,769 282,338 132,064 868,822 64,112 62,061 191,589 120,592 556,883 101,893 48,105 140,215 120,592 207,626 339,810 94,655 305,792 116,162 207,626 172,969 63,618 190,468 146,738 100,789 146,738 218,589 278,976 100,026 50,816 65,067 167,570 379,759 158,568 163,069 230,013 167,570
Est. Tax Deferred 80% 80% 100% 80% 80% 95% 70% 80% 80% 75% 80% 80% 90% 80% 80% 80% 80% 80% 80% 80% 80% 90% 70% 75% 80% 90% 80% 80% 75% 80% 80% 80% 80% 70% 80% 65% 80% 75% 80% 80% 80% 80% 60% 65% 100% 70% 90% 70% 70% 70% 90% 80% 80% 75% 80% 80% 60% 44% 70% 30% 80% 60% 75% 60% 70% 80% 70% 70% 80% 60% 80% 50% 90% 90% 0% 75% 78% 76% 80%
7.1% 7.1% 7.0% 6.8% 6.8% 6.5% 6.5% 6.4% 6.2% 6.1% 5.9% 5.8% 5.7% 5.5% 5.5% 5.4% 5.2% 5.0% 6.1% 8.7% 8.6% 8.0% 6.9% 6.7% 7.8% 6.3% 6.3% 5.7% 0.0% 6.8% 8.6% 7.9% 7.3% 7.1% 7.1% 7.0% 6.4% 6.1% 5.1% 5.1% 4.8% 0.0% 7.0% 10.1% 8.8% 8.1% 8.0% 7.9% 7.5% 7.1% 0.0% 8.0% 7.6% 7.3% 6.1% 6.0% 5.7% 6.1% 11.4% 9.1% 6.9% 6.8% 0.0% 8.0% 8.3% 7.8% 7.3% 7.0% 5.5% 7.3% 6.4% 5.6% 5.4% 4.7% 4.0% 3.6% 3.1% 1.3% 4.3% 6.2% 6.5% 6.8%
Coal
Shipping
Propane
Upstream MLPs
Small & Mid Cap Pipeline
All MLPs Sum:
Note: Median yields exclude MLPs that have suspended their distributions Source: Partnership reports and FactSet
132
MLP Primer -- Fourth Edition Figure 154. Credit Metrics

Total Debt ($MM, except per unit data) BUCKEYE PARTNERS LP BOARDWALK PIPELINE PRTNRS-LP ENBRIDGE ENERGY PRTNRS -LP EL PASO PIPELINE PARTNERS LP ENTERPRISE PRODS PRTNER -LP ENERGY TRANSFER PARTNERS -LP KINDER MORGAN ENERGY -LP MAGELLAN MIDSTREAM PRTNRS LP NISKA GAS STORAGE PARTNERS NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP PAA NATURAL GAS STORAGE LP SPECTRA ENERGY PARTNERS LP SUNOCO LOGISTICS PARTNERS LP WILLIAMS PARTNERS LP Large Cap Pipeline MLP Median BLUEKNIGHT ENERGY PRTNRS LP DUNCAN ENERGY PARTNERS LP EXTERRAN PARTNERS LP GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP MARTIN MIDSTREAM PARTNERS LP TC PIPELINES LP TRANSMONTAIGNE PARTNERS LP Small Cap Pipeline MLP Median ATLAS PIPELINE PARTNER LP CHESAPEAKE MIDSTREAM PRTNRS CRESTWOOD MIDSTREAM PTNRS LP COPANO ENERGY LLC DCP MIDSTREAM PARTNERS LP EAGLE ROCK ENERGY PARTNRS LP MARKWEST ENERGY PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP WESTERN GAS PARTNERS LP CROSSTEX ENERGY LP Gathering & Processing MLP Median BREITBURN ENERGY PARTNERS LP ENCORE ENERGY PARTNERS LP EV ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC PIONEER SOUTHWEST ENERGY -LP VANGUARD NATURAL RESOURCES Upstream MLP Median AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP INERGY LP SUBURBAN PROPANE PRTNRS -LP Propane MLP Median K-SEA TRANSPORTATION -LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP Shipping MLP Median ALLIANCE RESOURCE PTNRS -LP ARLP NRP OXF PVR AHD AHGP BGH EPE ETE NSH PVG XTXI Ticker BPL BWP EEP EPB EPD ETP KMP MMP NKA NS OKS PAA PNG SEP SXL WPZ BKEP DEP EXLP GEL HEP MMLP TCLP TLP APL CHKM CMLP CPNO DPM EROC MWE NGLS RGNC WES XTEX BBEP ENP EVEP LGCY LINE PSE VNR APU FGP NRGY SPH KSP TGP TOO (At Q3'10) $1,441 $3,252 $5,220 $1,719 $11,945 $6,040 $11,689 $1,892 $806 $1,848 $3,149 $4,606 $222 $380 $1,348 $6,223 $2,520 $414 $655 $436 $426 $502 $314 $582 $108 $431 $508 None $239 $583 $613 $515 $1,216 $1,433 $995 $735 $718 $665 $516 $240 $334 $290 $2,742 $74 $171 $290 $868 $1,232 $895 $348 $881 $285 $1,564 $1,493 $1,493 $422 $637 $119 $665 $530 $34 None None $1,095 $1,800 $20 None None $565 $1,582 $660 None None None BBNone None None None No No No No No No No No None None None None No No No No None None None No No No None B+ None BB No No No No None None None None B+ None None No No No No No No No BNone None BBBBBNone BB BBBBNone None No No No No Yes No No No No No No None None None None BBNone None None No No No No No No No No S&P Debt Rating BBB BBB BBB BB BBBBBBBBB BBB BB BBBBBB BBBNone None BBB BBBInvestment Grade Yes Yes Yes No Yes Yes Yes Yes No Yes Yes Yes No No Yes Yes
Ship Coal General Partnerships
Propane
Upstream MLPs
Small Cap Pipelines
NATURAL RESOURCE PARTNERS LP OXFORD RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Coal MLP Median ATLAS PIPELINE HOLDINGS LP ALLIANCE HOLDINGS GP LP BUCKEYE GP HOLDINGS LP ENTERPRISE GP HOLDINGS LP ENERGY TRANSFER EQUITY LP NUSTAR GP HOLDINGS LLC PENN VIRGINIA GP HOLDINGS LP CROSSTEX ENERGY INC General Partnership MLP Median All MLPs Average All MLPs Median
Source: Partnership reports and FactSet
133
Master Limited Partnerships Figure 155. Annual Distribution Growth
Estimated Distribution CAGRs 1999A BPL BWP EEP EPB EPD ETP KMP MMP NKA NS OKS PAA PNG SEP SXL WPZ Median BKEP DEP EXLP GEL HEP MMLP TCLP TLP Median APL CHKM CMLP CPNO DPM EROC MWE NGLS RGNC WES XTEX Median BBEP ENP EVEP LGCY LINE PSE VNR Median APU FGP NRGY SPH Median KSP TGP TOO Median ARLP NRP OXF PVR Median AHD AHGP BGH EPE ETE NSH PVG XTXI Median Median (All MLPs) 3.6% 0.5% 4.8% 3.6% 5.0% 7.4% 0.0% 0.0% 5.0% 26.7% 3.0% 5.0% 27.4% 15.4% 5.0% 15.4% 24.1% 17.2% 21.2% 21.2% 0.0% 0.0% 1.3% 0.0% 0.0% 0.0% 4.3% 0.0% 0.0% 0.0% 4.1% 0.0% 0.0% 0.0% 3.4% 0.0% 0.0% 0.0% 10.5% 2.7% 1.4% 0.0% 0.0% 13.2% 4.3% 2.1% 1.8% 0.0% 19.8% 0.5% 1.2% 3.6% 0.0% 7.3% 6.1% 4.8% 11.5% 12.1% 11.8% 20.5% 15.2% 16.4% 16.4% 3.6% 3.7% 2000A 10.3% 0.4% 13.5% 0.5% 23.4% 2001A 2.1% 0.0% 13.7% 5.4% 25.5% 2002A 2.0% 3.6% 13.9% 5.2% 13.3% 20.3% 2003A 2.0% 2.1% 8.1% 1.0% 8.0% 16.9% 7.3% 0.0% 3.5% 2004A 4.9% 0.0% 4.8% 22.3% 9.1% 11.1% 8.5% 0.0% 6.3% 2005A 7.5% 0.0% 10.2% 27.0% 9.1% 17.0% 5.2% 0.0% 12.6% 2006A 7.0% 0.0% 7.5% 37.2% 4.2% 13.3% 7.0% 18.1% 12.5% 2007A 6.5% 14.5% 1.4% 6.7% 18.9% 6.7% 9.1% 6.5% 6.5% 11.7% 2008A 6.1% 6.2% 4.5% 6.5% 8.8% 15.5% 8.8% 6.5% 5.8% 6.2% 13.1% 11.9% 16.0% 6.5% (68.6%) 3.5% 16.4% 26.1% 5.8% 10.4% 7.0% 17.1% 8.7% (9.2%) 2009A 5.8% 4.2% 1.0% 13.5% 5.8% 0.7% 4.5% 2.4% 3.9% 2.1% 3.4% 13.0% 11.2% 1.8% 4.1% (100.0%) 4.3% 4.2% 10.1% 5.3% 1.4% 2.8% 1.3% 3.5% (95.4%) 9.7% 2.9% 0.4% (93.9%) 2.0% 5.3% 1.4% 5.0% (100.0%) 1.7% (100.0%) (13.9%) 6.8% 1.5% 0.0% 0.0% 7.1% 0.0% 4.7% 0.0% 6.3% 3.6% 4.1% (35.2%) 2.7% 5.9% 2.7% 13.2% 4.3% 1.6% 4.3% (100.0%) 21.1% 20.6% 13.4% 11.8% 9.5% 4.1% (100.0%) 10.6% 3.6% 2010E 5.2% 4.1% 3.2% 17.9% 5.5% 0.0% 4.8% 4.1% 0.8% 3.4% 3.5% 11.5% 9.4% 7.1% 4.4% NA 3.1% 0.8% 9.7% 5.1% 0.0% 2.2% 2.5% 2.5% NM 9.9% 0.0% 1.7% 125.0% 0.0% 2.9% 0.0% 15.1% NA 2.3% NA (4.2%) 0.5% 0.0% 2.4% 0.0% 7.9% 0.3% 5.2% 0.0% 5.2% 2.7% 4.0% -100.0% 5.3% 6.4% 5.3% 9.0% 0.0% 0.0% 0.0% NA 13.1% 20.2% 11.8% 1.2% 8.1% 2.6% NA 10.0% 3.4% 1-Yr ('11E) 3.0% 5.0% 2.1% 12.4% 5.6% 2.1% 3.9% 6.9% 0.0% 1.6% 3.6% 5.0% 3.9% 9.2% 5.4% 7.9% 4.4% 2.6% 4.8% 16.3% 4.8% 5.0% 4.7% 5.0% 4.8% 4.4% 12.6% 0.0% 5.7% 2.3% 7.5% 5.6% 21.4% 5.7% 7.8% (6.2%) 2.3% 2.9% 4.7% 1.5% 5.3% 2.9% 5.0% 2.5% 5.1% 5.7% 5.1% 7.5% 8.1% 7.8% 11.7% 2.3% 2.3% 3.2% 2.8% 17.1% 3-Yr ('11-13E) 3.4% 4.5% 0.8% 11.1% 5.6% 3.2% 3.9% 5.8% 2.1% 3.1% 4.5% 5.0% 8.0% 8.5% 6.0% 6.5% 4.7% 4.2% 6.6% 11.6% 4.9% 4.7% 5.6% 4.6% 4.9% 9.8% 10.5% 3.6% 5.5% 56.4% 5.0% 7.0% 5.8% 14.3% 7.0% 6.3% (1.7%) 3.3% 3.8% 4.6% 3.4% 4.3% 3.8% 4.5% 3.3% 5.2% 5.6% 4.9% 6.0% 7.0% 6.5% 10.6% 3.0% 6.1% 2.6% 4.5% 14.6% Acquired Acquired 7.9% 5.4% Merger Pending 7.9% 5.3% 5-Yr ('11-15E) 3.3% 3.9% 2.0% 10.1% 5.4% 3.4% 3.5% 4.9% 3.1% 3.3% 4.7% 5.0% 7.5% 7.4% 6.0% 5.2% 4.8% 4.4% 6.5% 9.7% 4.4% 3.8% 5.5% 4.2% 4.4% 10.2% 9.1% 4.2% 4.8% 30.8% 5.6% 6.4% 5.1% 10.4% 6.4% 5.3% 0.4% 3.8% 4.0% 4.4% 3.8% 3.9% 3.9% 4.7% 3.6% 4.8% 5.6% 4.8% 4.6% 5.8% 5.2% 9.2% 3.1% 5.6% 2.3% 4.4% 12.5%
9.6% 11.4%
6.2%
8.9% (0.3%)
13.0% 8.8%
4.9% 6.9%
11.6% 6.2% 8.9% 8.8% 6.0% 5.4%
16.8% 7.4%
9.6% 9.3%
19.2% 10.0%
8.1% 24.6% 7.4%
Small Cap Pipelines
0.0%
(15.0%)
(64.7%)
(66.7%)
50.0%
100.0% 4.2% 5.8% 0.0% 5.0% 11.9%
5.0% 7.3% 1.1% 0.0% 3.0% 18.4%
6.8% 0.0% (15.0%) (28.9%) 27.2%
5.1% (30.8%) (14.6%)
4.9% 27.4% 11.7%
23.8% 12.3% 8.2% 2.2% 7.5% 8.2% 7.6%
28.8% 7.4% 9.4% 11.9% 15.7% 11.9% 5.0%
Gathering & Processing
47.1%
30.3% 35.6% 14.9%
62.5%
20.2%
9.1%
16.0%
21.5% 13.0% 9.8% 16.2% 39.4% 13.2% (14.2%) 13.1% 19.1% 33.1% 19.9% 10.0%
27.2%
(14.6%)
37.1%
32.0% 20.2%
13.5% 13.5%
13.0% 14.5%
6.9% 14.9%
Upstream MLPs
30.9%
30.9% 5.2% 0.0% 6.8% 12.5% 6.0% 12.7% 10.9% 11.8% 12.3% 12.6% 11.5% 12.3%
19.5% 4.9% 0.0% 6.8% 9.1% 5.8% 8.1% 8.2% 14.5% 8.2% 18.5% 10.1% 8.8% 10.1% 29.1% 34.2% 21.2% 15.5% 22.6% 14.5% 25.9% 21.1% 21.9% 10.4%
Coal
Shipping
Propane
0.0%
0.0%
19.7% 43.0%
3.5% 5.1% 5.1% 5.0%
8.3% 5.4% 8.3% 4.9%
35.8% 35.8% 9.1%
35.5% 35.5% 12.1%
13.1% 19.7% 11.7%
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MLP Primer -- Fourth Edition Figure 156. MLP IDR Tiers

Quarterly Distribution Thresholds 15% Ticker BUCKEYE PARTNERS LP BOARDWALK PIPELINE PRTNRS-LP ENBRIDGE ENERGY PRTNRS -LP EL PASO PIPELINE PARTNERS LP ENTERPRISE PRODS PRTNER -LP ENERGY TRANSFER PARTNERS -LP KINDER MORGAN ENERGY -LP MAGELLAN MIDSTREAM PRTNRS LP NISKA GAS STORAGE PARTNERS NUSTAR ENERGY LP ONEOK PARTNERS -LP PLAINS ALL AMER PIPELNE -LP PAA NATURAL GAS STORAGE LP SPECTRA ENERGY PARTNERS LP SUNOCO LOGISTICS PARTNERS LP WILLIAMS PARTNERS LP Large Cap Pipeline MLP Median BLUEKNIGHT ENERGY PRTNRS LP DUNCAN ENERGY PARTNERS LP EXTERRAN PARTNERS LP GENESIS ENERGY -LP HOLLY ENERGY PARTNERS LP MARTIN MIDSTREAM PARTNERS LP TC PIPELINES LP TRANSMONTAIGNE PARTNERS LP Small Cap Pipeline MLP Median ATLAS PIPELINE PARTNER LP CHESAPEAKE MIDSTREAM PRTNRS CRESTWOOD MIDSTREAM PTNRS LP COPANO ENERGY LLC DCP MIDSTREAM PARTNERS LP EAGLE ROCK ENERGY PARTNRS LP MARKWEST ENERGY PARTNERS LP TARGA RESOURCES PARTNERS LP REGENCY ENERGY PARTNERS LP WESTERN GAS PARTNERS LP CROSSTEX ENERGY LP Gathering & Processing MLP Median BREITBURN ENERGY PARTNERS LP ENCORE ENERGY PARTNERS LP EV ENERGY PARTNERS LP LEGACY RESERVES LP LINN ENERGY LLC PIONEER SOUTHWEST ENERGY -LP VANGUARD NATURAL RESOURCES Upstream MLP Median AMERIGAS PARTNERS -LP FERRELLGAS PARTNERS -LP INERGY LP SUBURBAN PROPANE PRTNRS -LP Propane MLP Median K-SEA TRANSPORTATION -LP TEEKAY LNG PARTNERS LP TEEKAY OFFSHORE PARTNERS LP Shipping MLP Median ALLIANCE RESOURCE PTNRS -LP ARLP NRP OXF PVR $0.28 $0.28 $0.50 $0.28 $0.31 $0.33 $0.55 $0.33 $0.38 $0.38 $0.66 $0.38 $0.83 $0.54 $0.44 $0.47 BPL BWP EEP EPB EPD ETP KMP MMP NKA NS OKS PAA PNG SEP SXL WPZ BKEP DEP EXLP GEL HEP MMLP TCLP TLP APL CHKM CMLP CPNO DPM EROC MWE NGLS RGNC WES XTEX BBEP ENP EVEP LGCY LINE PSE VNR APU FGP NRGY SPH KSP TGP TOO Tier $0.33 $0.40 $0.59 $0.33 $0.25 $0.28 $0.15 $0.29 $0.40 $0.60 $0.61 $0.45 $0.34 $0.35 $0.50 $0.40 $0.10 $0.40 $0.25 $0.55 $0.55 $0.45 $0.44 $0.42 $0.39 $0.35 $0.40 $0.42 $0.28 $0.39 $0.40 $0.35 $0.25 $0.46 $0.61 $0.55 $0.33 $0.55 $0.55 $0.46 $0.40 25% Tier $0.35 $0.44 $0.70 $0.36 $0.31 $0.32 $0.18 $0.33 $0.44 $0.66 $0.72 $0.50 $0.37 $0.38 $0.58 $0.44 $0.11 $0.44 $0.28 $0.63 $0.63 $0.88 $0.50 $0.52 $0.42 $0.38 $0.44 $0.45 $0.31 $0.42 $0.44 $0.38 $0.31 $0.50 $0.70 $0.63 $0.38 $0.63 $0.54 $0.44 50% Tier $0.53 $0.53 $0.99 $0.43 $0.41 $0.23 $0.39 $0.53 $0.94 $0.68 $0.51 $0.45 $1.58 $0.53 $0.14 $0.53 $0.33 $0.75 $0.75 $0.88 $0.60 $0.60 $0.51 $0.45 $0.53 $0.54 $0.38 $0.51 $0.53 $0.45 $0.38 $0.90 $0.82 $0.45 $0.75 $0.65 $0.53
Current Quarterly Distribution $0.98 $0.52 $1.03 $0.41 $0.58 $0.89 $1.11 $0.75 $0.35 $1.08 $1.13 $0.95 $0.34 $0.44 $1.17 $0.69 $0.00 $0.45 $0.47 $0.39 $0.83 $0.75 $0.75 $0.60 $0.30 $0.34 $0.42 $0.58 $0.61 $0.00 $0.64 $0.54 $0.45 $0.37 $0.25 $0.39 $0.50 $0.76 $0.52 $0.66 $0.50 $0.55 $0.71 $0.50 $0.71 $0.85 $0.00 $0.60 $0.48
Current IDR Split 50% 25% 50% 25% 25% 50% 50% 50% 2% 25% 50% 50% 2% 25% 25% 50% 38% 2% 2% 25% 50% 50% 25% 15% 25% 25% 2% 2% 25% 2% 50% 2% 50% 50% 25% 15% 2% 15% 0% 0% 25% 0% 0% 0% 0% 0% 25% 2% 50% 15% 20% 2% 25% 25% 25% 50% 50% 2% 50% 50%
Ship Coal
Propane
Upstream MLPs
Small Cap Pipelines
NATURAL RESOURCE PARTNERS LP OXFORD RESOURCE PARTNERS LP PENN VIRGINIA RES PRTNR LP Coal MLP Median
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Master Limited Partnerships Figure 157. Distribution Growth CAGR Since IPO
NRGP ETE AHGP C PNO EVEP WPZ NGLS PVG EPB ENP KMP DPM MWE SXL C MLP ARLP LINE NRP MMP SEP NSH C LMT VNR NRGY ETP WES HEP TOO BWP EPD EXLP PVR KMR TGP NMM NS PAA LGC Y RGNC TLP BPL MMLP TC LP OKS GLP SPH DEP EEP APU EEQ C QP FGP PSE 0% 0% 0% 5% 10% 15% 20% 25% 2% 2% 14% 14% 13% 13% 12% 12% 12% 12% 11% 11% 11% 11% 11% 11% 11% 10% 10% 9% 9% 9% 8% 8% 8% 8% 8% 8% 7% 7% 7% 7% 7% 6% 6% 6% 5% 5% 5% 5% 4% 4% 4% 4% 3% 17% 19% 20% 23%
30%
0%
30%
35%
Note: MLPs who cut or suspended their distribution are excluded Note: Distribution CAGRs based on annualized quarterly distribution growth rate since IPO Source: Partnership reports
136
MLP Glossary Of Terms

1P Reserves (Proved): Proved reserves indicate there is at least a 90% probability or reasonable certainty that the reserves will be producing in the future. 2P Reserves (Proved + Probable): Probable reserves indicate there is at least a 50% probability or more likely than not chance that the reserves will be producing in the future. 3P Reserves (Proved + Probable + Possible): Possible reserves indicate there is at least a 10 % probability or less likely than probable chance that the reserves will be producing. Adjusted Yield: A MLPs current yield adjusted for the percent of cash flow going to the general partner (GP). For example, if the GP is receiving 15% of the underlying MLPs total distributions and the underlying MLPs unit trades at a 6.0% yield, the adjusted yield is approximately 7.1% (i.e. the current yield [1 - % of cash flow to GP]). Amine: Amine is a type of chemical used to remove impurities from natural gas in order to make the natural gas suitable for pipeline transport. Aquifers: Natural gas can be stored underneath the ground in depleted reservoirs, salt caverns, or aquifers. Aquifers are underground rock formations that act as natural water reservoirs, which can be used to store natural gas. Associated Gas: Associated or casinghead gas is raw natural gas that has become dissolved in oil accumulations and is produced as a by-product along with crude oil. If the gas is in contact, but not in solution with crude oil, it called associated free gas. Associated gas is typically rich with heavier NGLs. Available Cash Flow: Available cash flow is the cash flow available to the common unit holders and the general partner. Figure 158. Available Cash Flow Calculation
Net income (+) depreciation and amortization (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow OR EBITDA (-) interest expense (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow
Backwardation: A market condition in which future commodity prices are lower than spot prices. A backwardated market usually occurs when demand exceeds supply. Figure 159. Backwardated Market
Backwardated Market Conditions
$150 Commodity price $125 $100 $75 $50 $25 $0 Spot price
Future price
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Base Gas: All underground gas storage must contain a certain amount of base gas, or cushion gas. This base gas is the amount of gas that the storage facility must hold to provide the desired pressurization to extract natural gas. Basis differential: The difference between the Henry Hub spot natural gas price and the corresponding cash natural gas spot price in another location (e.g. Carthage, Katy, Waha, etc.). The differential relates to factors like product quality, location, and available takeaway capacity (options). Benzene (C4H6): Benzene is an intermediary product used in the synthesis of styrene/polystyrene. Polystyrene has many uses including disposable cutlery, CD and DVD cases, and Styrofoam (a trademark of Dow Chemical), which is used to create disposable cups, plates, packaging, etc. To note, benzene is a natural constituent of crude oil, and hence natural gas-based steam cracker feeds such as ethane and propane do not produce benzene as a byproduct. Blendstocks: A blendstock is a liquid compound that is mixed with petroleum products to improve the petroleums characteristics. For example, blendstocks are mixed with motor gasoline to increase the gasolines octane or oxygen content. British Thermal Unit (Btu): A Btu is a unit of energy used to describe the energy (heat) content of a fuel (natural gas). Butadiene (C4H6): Butadiene is an important building block of synthetic rubber. Butadiene is produced primarily as a by-product of stream cracking. Compound Annual Growth Rate (CAGR). CAGR is the measure of the average annual growth rate of a financial metric (e.g. distributions) over a certain time period. Capital Asset Pricing Model (CAPM): The CAPM maps the relationship between risk and expected return, and provides an alternate definition of the required rate of return (or cost of equity) of a given asset. It is defined as the risk-free rate (typically the 10-year treasury) plus (+) beta multiplied () by the expected market return (typically the historical return of a given market index), minus the risk-free rate. Casinghead Gas: See definition for associated gas. Cash Yield: We define cash yield as an MLPs current yield adjusted for its GP share of cash flow. For example, if the GP is receiving 10% of an MLPs total distributions and the partnerships units trade at a 7% yield, the cash yield would be 7.8% (current yield / [1 - % of cash distributions paid to GP]). Compression: Midstream companies utilize compression equipment to compact or compress natural gas to a higher pressure in order to increase the delivery capacity of a pipeline. Condensate: Condensate or lease condensate refers to a specific portion of the NGL stream. Some of the heavier NGL components (i.e., iso-butane and natural gasoline) exist as a gaseous state only at underground pressures. These molecules will immediately condense to a liquid state when brought to atmospheric conditions, hence the name condensate.
138
Contango: A market condition in which future commodity prices are greater than spot prices. The higher future price is often due to the cost associated with storing and insuring the underlying commodity. Figure 160. Contango Market
Contango Market Conditions
$150 Commodity price $125 $100 $75 $50 $25 $0 Spot price
Future price
Conventional Natural Gas Production: Conventional production typically relates to natural gas that is produced from underground formations composed of sandstone or carbonate rock. Conventional deposits are easier to produce from relative to unconventional deposits. Corporation: A corporation (C Corp.) is a distinct legal entity, separate from its shareholders and employees. As a separate legal standing entity, a corporation protects its owners from being personally liable in the event that the company is sued (i.e. limited liability). The shareholders contribute capital, but have no liability to business creditors, tax authorities, or any other parties, which may have a claim on corporate earnings and assets. Cryogenic Expander Process: The cryogenic expansion process is one of the primary techniques (the other being lean oil absorption) used for methane separation, that is, the actual separation of methane (i.e., natural gas) from NGL components, which is the last step in natural gas processing. Cryogenic expansion involves the rapid cooling of natural gas via expansion to approximately negative 120 degrees Fahrenheit. At this temperature, ethane and the other NGL components condense out of the natural gas stream, while methane remains in its gaseous form. Most modern processing plants use the cryogenic expander process to extract NGLs. Current Yield: The annualized quarterly distribution divided by the MLPs current unit price. Cycle: This refers to the complete withdrawal and injection of a storage facilitys working gas capacity. Dehydration: Dehydration is the process of removing water found in saturated natural gas. If left in the natural gas stream during long-haul transportation, water can form ice and corrosion inside pipelines. To meet transportation standards, natural gas is dehydrated to remove any water from the natural gas stream. Depleted Reservoir: Natural gas can be stored underneath the ground in depleted reservoirs, salt caverns, or aquifers. Depleted reservoirs are naturally occurring formations wherein all recoverable natural gas or oil has been produced, leaving a void capable of holding natural gas. Dirty Hedge: A company can use crude oil derivatives to hedge its natural gas liquids (NGL) exposure.
139
Distributable Cash Flow (DCF): DCF is the cash flow available to the common unit holders after the cash flow is paid to the GP. Figure 161. Distributable Cash Flow Calculation
Net income (+) depreciation and amortization (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow OR EBITDA (-) interest expense (-) maintenance capex Available cash flow (-) Cash flow to general partner Distributable cash flow
Distribution: MLPs typically distribute all available cash flow (i.e. cash flow from operations less maintenance CAPEX) to unit holders in the form of distributions (similar to dividends). Distribution Coverage Ratio: The coverage ratio indicates the cash available for distribution for every dollar to be distributed. The ratio is calculated by dividing available cash flow by distributions paid. Investors typically associate as the cushion a partnership has in paying its cash distribution. In this context, the higher the ratio, the greater the safety of the distribution. Figure 162. Distribution Coverage Ratio Calculation
Distribution coverage ratio =
Available cash flow (to GP and LP) Distributions paid (to GP and LP)
Distribution Tiers: Distribution tiers indicate the percentage allocations (and the associated thresholds) of available cash flow between common unit holders and the general partner based on specified target distribution levels. Figure 163. Hypothetical Distribution Tiers
Percent of cash flow to: Distribution tiers Tier 1 LP 98% 85% 75% 50% GP 2% 15% 25% 50% LP distr. up to: $1.00 $2.00 $3.00 $4.00 Thresholds Thresholds
Distribution Distribution tiers
Tier 2 Tier 3 Tier 4 (high splits)
Percent Percent allocations allocations

Distribution Yield: The distribution yield is synonymous to a dividend yield. Downstream: This refers to the refining and marketing sectors of the energy industry. It is also associated with the distribution (i.e. post refining/processing) of products to the end-user market for consumption. Dropdown: A dropdown is the sale of an asset from the parent company (or sponsor company) to the underlying partnership. Dropdowns can also be defined as a transaction between to affiliated companies. Dry Natural Gas: Natural gas is classified as dry or wet depending on the amount of NGLs present. Dry or lean natural gas contains less than 1 gallon of recoverable NGLs per Mcf of gas (GPM) and is composed primarily of methane. The amount of NGLs contained in the natural gas stream can vary depending upon the region, depth of wells, proximity to crude oil, and other factors.
140
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): EBITDA is a nonGAAP measure used to provide an approximation of a companys profitability. This measure excludes the potential distortion that accounting and financing rules may have on a companys earnings; therefore, EBITDA is a useful tool when comparing companies that incur large amounts of depreciation expense because it excludes these non-cash items which could understate the companys true performance. Earnings Per Unit (EPU): An MLPs EPU is synonymous with a C corp.s earnings per share (EPS). EPU is calculated by dividing net income allocated to the limited partners divided by the weighted average units outstanding at the end of the period. EBITDA Multiple: An EBITDA multiple is the expected return an acquisition or organic growth project is estimated to generate. For example, a $100 million investment at an 8x EBITDA multiple, would be expected to generate approximately $12.5 million on an annual basis (or a 12.5% return). Energy Information Administration (EIA): The EIA is an independent statistical agency of the U.S. Department of Energy (DOE). The EIA provides energy data (e.g. pricing, supply, and reserves), short- and long-term forecasts (e.g. supply and demand), and analyses that can be used to understand energy usage in the U.S. Its publications cover petroleum, natural gas, electricity, coal, renewable and alternative fuels, and nuclear energy. Ethane: Ethane is typically the second-largest component of natural gas (methane is the largest). It is primarily used as a feedstock for ethylene production by the petrochemical industry. Thus, the demand for ethane is tied closely to ethylene production, which, in turn, is tied to demand for plastics, or more broadly speaking, the health of the overall economy. Ethane Extraction: Natural gas processors will choose to extract (i.e. separate) ethane from the natural gas stream when processing economics are favorable (i.e. when ethane is worth more as a distinct product than as part of the natural gas stream). Ethane Rejection: A natural gas processor will likely choose, if given the option, to reject ethane (i.e., leave it in the natural gas stream) rather than extract it, when the processing margin (specifically the ethane margin) turns negative or uneconomic (i.e., below a plants fixed operating costs). If the processor is unable to reject ethane under this scenario, the company would likely incur a loss. To note, the remainder of the NGL stream (i.e., propane+) is still processed. Most modern processing plants have the ability extract heavier NGL components, but leave ethane in the natural gas stream when processing economics are unfavorable. Ethylene: Ethylene is a building block for polyethylene, which is the most popular plastic in the world. Ethylene is the simplest olefin produced by the petrochemical industry. Excess Cash Flow: Excess cash flow is the cash flow that remains after distributions have been paid to common and subordinated unit holders and general partner. Expansion Capital Expenditures (CAPEX): See definition for Organic CAPEX. Fee-Based: An example of a fee-based processing contract is when a MLP receives a fee for the volume of natural gas that flows through its processing plant. Gross margin is directly related to the volume, not the price, of the commodity flowing through the system and the contracted fixed rate. Federal Energy Regulatory Commission (FERC): The FERC is an independent agency that regulates the interstate transmission of electricity, natural gas, and oil. FERC also reviews proposals to build liquefied natural gas (LNG) terminals and interstate natural gas pipelines as well as licensing hydropower projects. (Definition source www.ferc.gov) Feedstock: This is the raw material used by steam cracker plants in the production of ethylene, propylene, and butadiene (also known as olefins). Feedstock is also commonly referred to as feedslate. Firm Storage: Type of service offered by storage operators in which contracts consist primarily of take-orpay agreements, with minimal price or volumetric risk. Forward Yield: We define forward yield as a MLPs next four quarterly distributions (i.e., total distributions received over the next 12 months) divided by an MLPs current yield. Frac Spread: See definition for Processing Margin.
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Fractionation: Fractionation is the process that involves the separation of the NGLs into discrete NGL purity products (i.e. ethane, propane, normal butane, iso-butane, and natural gasoline). Fracturing: Fracturing is a process that typically involves the pumping of water (at very high pressures) to create an extensive crack in the rock formation. The crack in the rock exposes an increased surface area that allows a greater amount of natural gas to be produced. Fuel Oil: Fuel oil refers to the heaviest commercial fuel that can be obtained from crude oil. Its weight exceeds that of natural gasoline or naphtha. For example, diesel is a type of fuel oil. Full Recovery: Full recovery refers to normal operating conditions when a processing plant is extracting both ethane and the heavier NGL components. Gallons of Recoverable NGLs per Mcf (GPM): GPM refers to the amount of NGLs contained in the natural gas stream and is dependent upon the region, depth of wells, proximity to crude oil, and other factors. Gas Oil: Gas oil is considered a heavy feedstock used in ethylene production. Gas oils include diesel fuel, heating fuel, and light fuel oils. General Partner (GP): The GP (1) manages the day-to-day operations of the partnership, (2) generally has a 2% ownership stake in the partnership, and (3) is eligible to receive an incentive distribution (through the ownership of the MLPs incentive distribution rights). Header System: A header system is the primary pipeline in a natural gas storage facility that transports gas from the storage caverns to and from each interconnecting pipeline. Heavy Feedstock: Heavy feedstock consists primarily of hydrocarbons derived from crude oil sources such as heavy naphtha and gas oil. If a heavy feedstock is used in the production of ethylene, the byproducts (excluding ethylene) include propylene and butadiene as well as heavier hydrocarbons known as aromatics (i.e., C5+) suitable for gasoline blending. Heavy Naphtha: Heavy naphtha, which is composed of heavier hydrocarbons found at the bottom of the naphtha splitter, is classified as heavy feedstock. Held by Production (HBP): If an oil or gas well successfully produces during the primary term of the lease, the lease is automatically extended and considered held by production. The lease will remain valid as long as the property keeps producing a minimum quantity of oil or gas as previously negotiated in the lease. Incentive Distribution Agreement: At inception, MLPs establish agreements between the GP and LP that outline the percentage of total cash distributions that are to be allocated between the GP and LP unit holders. Incentive Distribution Rights (IDRs): IDRs allow the holder (typically the general partner) to receive an increasing percentage of quarterly distributions after the MQD and target distribution thresholds have been achieved. In most partnerships, IDRs can reach a tier wherein the GP is receiving 50% of every incremental dollar paid to the LP unit holders. This is known as the 50/50 or high splits tier. Injection Rate: Injection rate, or injection capacity, refers to the amount of gas that can be injected into the facility. Both of these measurements are usually expressed in billion or million cubic feet per day. Injection Season: This refers to the time period (usually from April to October) when producers and pipelines inject natural gas into storage for use during the winter months (November to March). Interruptible Service: The customer contracts for storage capacity on a spot market basis at prevailing rates. Capacity is not guaranteed and is offered only if available. Interstate Pipelines: An interstate pipeline is a pipeline that transports product across state lines. Interstate pipelines are regulated by the FERC. Intrastate Pipelines: An intrastate pipeline is a pipeline that operates within one state. Intrastate pipelines are regulated by state, provincial or local jurisdictions.
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Isobutane: Isobutane has the same molecular formula as normal butane, but a different structural formula (i.e., atoms are rearranged). Isobutane is used in refinery alkylation to enhance the octane content of motor gasoline. I-Shares: I-shares are equivalent to MLP units in most aspects, except the payment of distributions is in stock instead of cash. I-shares are not required to file K-1 statements and do not generate UBTI. K-1 Statement: The K-1 form is the statement that an MLP investor receives each year from the partnership that shows his/her share of the partnerships income, gain, loss, deductions, and credits. A K-1 is similar to Form 1099 received by shareholders of a corporation. Keep-Whole: In a keep-whole arrangement, the processor retains title to the NGLs produced from the natural gas stream to sell at market prices. By extracting the NGLs, the volume and BTU content of the dry gas is reduced. This is referred to as shrinkage. The processor must then replace the BTUs that it extracts from the natural gas stream (via the extraction of NGLs) with equivalent BTUs of natural gas. A holder of a keepwhole contract would be long on NGL prices and short on natural gas prices. Lean Natural Gas: Dry or lean natural gas contains less than 1 gallon of recoverable NGLs per Mcf of gas (GPM) and is composed primarily of methane. Lean Oil Absorption Method: The lean oil absorption method is one of the primary techniques (the other being cryogenic expander process) used for methane separation, that is, the actual separation of methane (i.e., natural gas) from NGL components, which is the last step in natural gas processing. The absorption method uses specially formulated oils to absorb heavier NGL components from the incoming gas stream. As natural gas passes through the absorption tower, NGLs are captured by the absorption oil, which has an affinity to NGLs. The absorption oil is then fed into oil stills where the mixture is heated above the boiling point of NGLs but below that of oil, thereby separating the NGLs from the absorption oil. Light Feedstock: Light feedstock is commonly defined as hydrocarbon feeds derived from natural gas sources (i.e., ethane, propane, and butane); however, it can also refer to light naphtha. Light feedstock produces lighter olefins including ethylene, propylene, and butadiene. Light Naphtha: Light naphtha, which is composed primarily of C5 hydrocarbons (i.e., natural gasoline) is generally classified as a light feedstock. Limited Partner (LP): The LP (1) provides capital, (2) has no role in the MLPs operations or management, and (3) receives cash distributions. Liquefaction: This is the process that changes natural gas from a gaseous state to a liquid state. Liquefied Natural Gas (LNG): LNG is natural gas that has been condensed into liquid form (via either pressure or refrigeration). Liquid Petroleum Gases (LPGs): LPGs are created (as a byproduct) during the refining of crude oil or from natural gas production. LPGs are typically in some form of mix of propane and butane. Long: If a holder is long natural gas, they expect the price of natural gas price to increase. Looping: This refers to the installation of additional pipeline next to an existing pipeline system in order to increase the systems capacity. Marketed Natural Gas Production: Marketed natural gas production refers to gross natural gas withdrawals from reservoirs less the natural gas used for re-pressuring, quantities vented and flared, and nonhydrocarbon gases removed in treating or processing operations. Maintenance Capital Expenditures (CAPEX): Maintenance CAPEX is the investment required to maintain the partnerships existing operating capacity and operating income over the long-term. Maximum Potential Distribution (MPD): MPD represents the maximum distribution a partnership could, in theory, pay if it distributed all of its sustainable cash flow. Alternatively, it is the distribution that could be paid such that he distribution coverage ratio equals 1.0x (no excess cash flow).
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Master Limited Partnership (MLP): MLPs are limited partnership investment vehicles consisting of units (rather than shares) that are traded on public exchanges. MLPs consist of a general partner (GP) and limited partners (LPs). MLPs are also commonly referred to as partnerships. Methane (CH4): Methane is equivalent to dry natural gas, it is the primary component of natural gas. Methane Separation: Methane separation is the actual separation of the methane (i.e., natural gas) stream from NGL components. Approximately 90% of the natural gas processing plants in the United States use one of the following techniques for methane separation: (1) absorption method or (2) cryogenic expander process. Midstream: This refers to gathering, treating, processing, transportation, or storage of a product after it has left the wellhead (i.e. upstream), but before it has been distributed to the end use market (i.e. downstream). Minimum Quarterly Distribution (MQD): MQD is the minimum distribution the partnership plans to pay to its common and subordinated unit holders, assuming the company is able to generate sufficient cash flow from its operations (after the payment of fees, expenses, maintenance capex, and cash flow to the GP). The partnership does not guarantee its ability to pay out the MQD during any quarter. Naphtha: Naphtha is considered a heavy feedstock used in ethylene production. Naphtha is also a highly flammable liquid hydrocarbon mixture that is produced through crude oil distillation (i.e., derived from crude oil). Natural Gas Liquids (NGLs): NGLs are extracted from the raw natural gas stream into a liquid mix (consisting of ethane, propane, butane, iso-butane, and natural gasoline). The NGLs are then typically transported via pipelines to fractionation facilities. Natural Gasoline: Natural gasoline is extracted from natural gas and is a mixture of liquid hydrocarbons (i.e., primarily pentanes and heavier hydrocarbons). It is primarily used as a blendstock for motor gasoline. NGL Yield: The NGL yield represents the amount of NGLs present in natural gas. Non-Associated Gas: Non-associated gas is natural gas that is free from contact with crude oil (e.g., dry natural gas is non-associated gas). Normal Butane: Normal butane is used as a petrochemical feedstock for the production of ethylene and butadiene (used to make synthetic rubber), as a blendstock for motor gasoline, and as a feedstock to create isobutane through isomerization. (The isomerization process is accomplished by heating normal butane in the presence of a catalyst to create isobutane.) Oil Sands: Oil sands or bituminous sands are a type of unconventional petroleum deposit. It is usually comprised of a mixture of sand, clay, water, and bitumen. Bitumen is an extremely viscous oil, yet after treatment it can be used by refineries to produce fuels such as gasoline and diesel. While oil sands are found throughout the world, large amounts have been discovered in Canadas Alberta providence as well as Venezuela. Olefin: An olefin is any unsaturated chemical compound containing at least one carbon double bond. The petrochemical industry produces three primary olefins: ethylene, propylene, and butadiene. Optimization and Marketing: A storage operator can keep a certain amount of storage capacity for its own account. The operator uses a marketing function to maximize the value of its storage by employing the same strategies as its customers, such as arbitraging seasonal spreads and cycling storage when market opportunities present themselves. Organic Growth Capital Expenditures (CAPEX): Organic CAPEX is investments used to expand a companys operating capacity or operating income over the long-term. Park and Loan: The storage operator will either loan gas to a market participant on a temporary basis or will park gas in its facility on a temporary basis for a fee. Again, this service is opportunistic in nature and depends upon market demand and storage capacity availability. Partnership: A partnership is not considered to be a separate entity, but rather is an aggregate of all the partners. All partners are liable for the obligations of the partnership; although limited partners enjoy limits on their liability, they are not fully shielded in the way shareholders are. Creditors generally have the right to seek
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return of capital distributed to a limited partner if the liability for which payment is sought arose before the distribution. This right survives the termination of a partner's interest. Limited partners may also be liable for substantial tax liabilities that could be determined through the audit process long after they have sold their interest. As a practical matter, however, this is unlikely to happen to a PTP investor. (Source: NAPTP) Percent of Proceeds (POP)/Liquids (POL): The processor gathers and processes natural gas on behalf of producers. The MLP sells the resulting residue gas (dry, pipeline quality gas) and NGLs at market prices and remits to the producer an agreed upon percentage of the proceeds based on an index price. A typical contract would entitle the producer to 80% of the proceeds from the sale of natural gas and NGLs through the plant, while the remaining 20% would be assigned to the processing plant operator. Accordingly, POP contracts share price risk between the producer and processor. Gross margin increases as natural gas prices and NGL prices increase and decrease as natural gas prices and NGL prices decrease. A percentage-of-liquids (POL) contract is a type of POP contract where the processor receives a percentage of the NGLs only. Petrochemicals: Petrochemicals are chemical compounds that are made from raw materials, which are derived from petroleum or hydrocarbons. Some examples of petrochemicals include: ethylene, propylene, and benzene. Pipeline Quality Gas: This is natural gas that has had all of the natural gas liquids (and impurities) removed from the natural gas stream and is considered dry natural gas. The natural gas liquids and impurities are removed from the natural gas stream because major natural gas transmission lines usually impose restrictions on the make-up of the natural gas that is allowed into the pipeline. Pipeline quality gas is typically composed of approximately 95% methane. Play: A play is a proven geological formation that contains petroleum and/or natural gas. Polyethylene: Polyethylene, which is the primary derivative of ethylene, is the most popular plastic in the world. Polyethylene comes in several different grades, depending on its density and molecular branching. The three most common grades are low density polyethylene, linear low density polyethylene, and high density polyethylene. Low density polyethylene is used to create thin film plastics such as plastic bags and film wrap. High density polyethylene is used to create sturdier plastics such as detergent bottles, garbage containers, and water pipes. Since approximately 50% of ethylene is polymerized into polyethylene, polyethylene production is an important proxy for ethylene demand, and hence ethane/NGL demand. Processing: Natural gas processing involves the separation of raw natural gas into pipeline quality gas and natural gas liquids. Producer Price Index (PPI) Adjustment: The FERC has allowed interstate natural gas and oil pipelines to increase the (maximum) rates charged to shippers based on the use of an index system. The index system is based on the Producer Price Index for Finished Goods plus 1.3%. Companies are allowed to increase their rates on an annual basis on July 1st. The current index is valid for a five-year period that began on July 1, 2006 and extends through July 1, 2011. Processing Margin: The processing margin is the difference between the price of natural gas and a composite price for NGLs on a BTU-equivalent basis. Propane: Propane (also known as C3) is the third largest component of the natural gas stream (preceded by methane and ethane). It is primarily used as a feedstock by the petrochemical industry to produce ethylene and propylene. The bulk of remaining propane consumption is related to its use as a heating fuel in the residential and commercial markets. Hence, demand for propane is closely tied to the overall health of the economy and fluctuations in weather patterns. Propylene (C3H6): Like ethylene, propylene (also known as propene) is an important chemical used in the manufacture of plastics. It is the second simplest olefin behind ethylene. Proved Developed Producing Reserves (PDP): PDPs are reserves that can be recovered via existing wells and through the use of existing equipment and operations. Proved Undeveloped Reserves (PUDs): PUDs are reserves that are recovered through new wells (on undrilled acreage) or from existing wells that require significant capital expenditures (to be recompleted). PV-10 (Standardized Measure): PV-10 is the after tax present value of estimated future cash flow of proved reserves. The calculation is based on current commodity prices and is discounted at 10%.
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Raw NGL Mix: Raw NGL mix or y grade refers to the heavier NGL components that are extracted via natural gas processing. The resulting NGL mix is commingled product consisting of ethane (depending on whether ethane rejection took place), propane, butane, iso-butane, and natural gasoline. It is not until fractionation, the next step in the NGL value chain, that the raw NGL mix is further separated into individual NGL components. Recompletion: A recompletion is the completion of an existing wellbore (i.e. had been previously completed) for production. Refined Petroleum Products: Crude oil refineries process and refine oil into refined petroleum products. These products are primarily used as fuels by consumers (gasoline, diesel, jet fuel, kerosene, and heating oil). Residue Natural Gas: Residue or dry natural gas refers to the resulting natural gas stream after heavier NGL components have been extracted through processing. Residue natural gas consists primarily of methane and ethane (depending on processing economics) and is suitable for transportation in natural gas pipelines. Royalty Payment: A royalty is type of a payment received based on either a percentage of sales revenue or a fixed price per unit sold. For example, a partnership may lease out its coal reserves to operators for the right to mine the partnerships coal reserves in exchange for royalty payments. Salt Caverns: Natural gas can be stored underneath the ground in depleted reservoirs, salt caverns, or aquifers. Salt caverns are formed out of underground salt deposits. Salt caverns are usually leached, or solution mined, by injecting fresh water via drills into the salt cavern. Shale: Shale is a form of sedimentary rock, which could contain crude oil or natural gas. Short: If a holder is short natural gas, they expect the price of natural gas price to decline. Steam Cracker: A steam cracker is a petrochemical plant that uses either light feedstock (i.e., ethane, propane, LPGs) or heavy feedstock (i.e., heavy naphtha, gas oil), depending on plant configuration and economics to create ethylene, propylene, and other petrochemicals. In order to create these petrochemicals (e.g., ethylene), saturated hydrocarbons need to be broken down (or cracked) into smaller, unsaturated hydrocarbons in a process known as stream cracking. Steam cracking is accomplished by heating the hydrocarbon feedstock diluted with steam in a furnace to approximately 650-850 degrees Celsius. Subsequently, the mixture is rapidly cooled to 400 degrees Celsius to stop the reaction. Water is then injected to further cool the mixture; thereby creating a condensate, rich in ethylene and various quantities of other byproducts (depending on the type of feedstock). Subordinated Units: Subordinated units are secondary to common units because for a period of time the subordinated units will not be entitled to receive distributions until the common units have received the MQD plus any arrearages from prior quarters. Subordinated units increase the likelihood that (during the subordinated period) there will be sufficient available cash to be distributed to the common units. In addition, subordinated units are not entitled to distribution arrearages. Subordination Period: The subordination period is the period of time that subordinated units will not be entitled to receive any distributions until the common units have received the MQD plus any arrearages from prior quarters. The subordination period typically last for three years from the date of the partnerships initial public offering. However, the subordination period could be terminated at an earlier date if the partnership achieves certain criteria. Upon expiration of the subordinated period, the units will convert to common units on a one-for-one basis. Take-or-Pay Contract: Under a take-or-pay agreement, the customer is obligated to pay for a product (e.g. natural gas, NGLs, crude oil, etc.) regardless of whether the customer takes delivery of the product. Tax Deferral Rate: A percentage of the cash distribution to the unit holder that is tax deferred until the security is sold. The tax deferral rate on distributions ranges from 40-90%. The tax deferral rate is an approximation provided by the partnership and is only effective for a certain period of time. Toluene (C7H8): Toluene is a type of petrochemical commonly used as a solvent used for paints, lacquers, printing ink, etc. The chemical is also used as an octane booster in gasoline.
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Treating: Natural gas gathered with impurities higher than what is allowed by pipeline quality standards is treated with liquid chemicals (i.e. amine) to remove the impurities. The natural gas is treated at a separate facility before being processed. Unconventional Natural Gas Production: Unconventional production relates primarily to natural gas that is produced from tight formations (i.e., low porosity and permeability), gas shales, and coal bed methane. Natural gas produced from unconventional sources is typically more difficult to extract and thus, is more expensive than conventional production. Units: MLP units are synonymous with C Corp.s shares. Unrelated Taxable Business Income (UBTI): MLP income received by a tax-exempt entity (e.g. pension accounts, 401-K, and endowment funds) is considered income earned from business activities unrelated to the entitys tax-exempt purpose or UBTI. A tax-exempt entity that receives more than $1,000 per year of UBTI may be held liable for the tax on the UBTI. Upstream: This refers to the production of oil and natural gas from the wellhead (i.e. exploration and production). Weighted Average Cost of Capital (WACC): WACC is the hurdle rate for new investments. As it relates to MLPs, it is the proportional weight of equity and debt in a partnerships capital structure. Unlike C Corps, MLPs do not realize a tax benefit on their debt (since they do not pay corporate taxes). Well Bore: A well bore is the hole created by a drill bit. Wellhead: The equipment at the surface of a crude oil or natural gas well used to control the pressure of the well. The wellhead is also the point at which natural gas or crude oil leaves the ground. Wet Natural Gas: Natural gas is classified as dry or wet depending on the amount of NGLs present. Wet or rich natural gas contains at least 1 gallon of recoverable NGLs per Mcf of gas (GPM) and up to as much as 5-6 GPM. The amount of NGLs contained in the natural gas stream can vary depending upon the region, depth of wells, proximity to crude oil, and other factors. Wheeling: A storage operator will move gas across its facilities from one pipeline interconnect or another, which enables customers to deliver their gas to the desired market. The storage operator collects a fee for this service; however, this service is performed on a spot basis and is driven by market factors. Winter-To-Summer Spread: The winter-to-summer spread is simply the difference between the highest natural gas price on the NYMEX 12-month forward curve and lowest price, less the carrying costs of storage. The spread represents effectively the value of storage in any given year because a user of storage can buy natural gas in the summer (when prices are seasonally low due to less demand), inject it into storage and sell forward on the NYMEX at the higher winter price, locking in a margin. Withdrawal Rate: Withdrawal rate, or deliverability capacity, is the amount of natural gas that can be extracted from the storage facility on a daily basis. Withdrawal Season: This refers to the time period (usually from November through March), when natural gas supplies are withdrawn from storage for use during the heating season. Working Gas: is the volume of natural gas that can be injected or withdrawn during normal storage operations and is what most facilities quote their storage capacity as. Workover: A workover is the operations on a producing well to resume or increase production.
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Energy Industry Abbreviations

Bbls: Barrels Bcf/d: One billion cubic feet per day MBtu: One thousand Btus. Mcf: One thousand cubic feet of natural gas. MBbls: One thousand barrels. MBbls/d: One thousand barrels per day. MM: In millions. MMBbls: One million barrels. MMBbls/d: One million barrels per day. MMBtu: One million Btus. MMBtu/d: One million Btus per day. MMcf: One million cubic feet of natural gas. MMcf/d: One million cubic feet of natural gas per day. Tcf: One trillion cubic feet of gas.
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STOCK RATING
1=Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the next 12 months. BUY 2=Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market over the next 12 months. HOLD 3=Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12 months. SELL
SECTOR RATING
O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. M=Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. U=Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.
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Gaming
Eric Serotta, CFA Carl Reichardt Adam Rudiger, CFA
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Restaurants
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Software
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EQUITY STRATEGY FINANCIAL SERVICES

Insurance Equity Strategy
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Gina Martin Adams, CFA, CMT Howard Park
(212) 214-8043 (212) 214-8063
MEDIA & TELECOMMUNICATIONS

Broadcasting & Cable
Marci Ryvicker, CFA, CPA (212) 214-5010 Timothy Schlock, CFA, CPA (212) 214-5011 Jess Lubert, CFA Michael Kerlan (212) 214-5013 (212) 214-8052 (312) 920-3548 (212) 214-8048 (212) 214-5012
Specialty Finance
Interactive Entertainment
Telecommunication Services - Wireless/Wireline
U.S. Banks
Jennifer M. Fritzsche Gray Powell, CFA Andrew Spinola
RETAIL RESEARCH MARKETING

Retail Research Marketing
Colleen Hansen
(410) 625-6378
November 12, 2010

WF MLP Primer IV

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November 19, 2010

Master Limited Partnerships

MLP Primer -- Fourth Edition

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

III. Who Can Own MLPs?............................................................................................................ 12

VI. The Basics............................................................................................................................. 15

VII. Key Terms ........................................................................................................................... 20

VIII. Drivers Of Performance........................................................................................................23

Master Limited Partnerships F. G.

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

XI. MLP Accounting Nuances .....................................................................................................38

XII. Sector Trends ...................................................................................................................... 40

MLP Primer -- Fourth Edition

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

XIII. Valuation Of MLPs................................................................................................................82

Master Limited Partnerships

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

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MLP Primer -- Fourth Edition

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

Introduction -- A Framework For Investment

Why Own MLPs?

10. Resilient Business Model During Periods Of Economic Weakness

A. MLP Total Return Value Proposition

3-Year Distribution Growth Estimate

Total Return Potential

Source: Wells Fargo Securities, LLC

Master Limited Partnerships

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

C. Strong Performance Track Record

45% 29% 17% 11% 5% 5% 27% 16% 12% 5% 26% 33%

2000 42.9% (9.1%) NA 57.2%

2001 41.8% (11.9%) 6.5% (30.5%)

2002 (0.3%) (22.1%) (8.8%) (30.0%)

2003 45.2% 28.7% 28.8% 26.3%

2004 16.5% 10.9% 29.2% 24.3%

2005 4.8% 4.9% 12.5% 16.8%

2006 26.6% 15.8% 41.6% 21.0%

2007 11.7% 5.5% (17.1%) 19.4%

2008 (38.2%) (37.0%) (41.2%) (29.0%)

2009 75.9% 26.5% 25.0% 11.9%

2010 TD 33.3% 7.5% 21.5% 3.4%

MLP Primer -- Fourth Edition

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

Total Return Performance

9.7% 14.3% 4.0% 16.3%

14.7% 1.0% 3.8% 8.6% 1.0% 2.1%

11.3% 2.0% 7.1%

14.7% 6.8% 9.6% 5.3% 1.2% 0.7%

15.7% Trailing 9-Year 6.9% 4.5% 5.6% 3.0% 4.5%

0% (4.8%) (5.6%) YTD Trailing 1-Year Trailing 3-Year Trailing 5-Year

Master Limited Partnerships

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

F. A Lower Risk (Beta) Way To Invest In Energy

G. MLPs Are An Effective Hedge Against Inflation

MLP Primer -- Fourth Edition

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT

Median Distribution Growth

Median Distribution Growth

H. Estate Planning Tool

Master Limited Partnerships Figure 7. U.S. Population Age Profile Projection

WELLS FARGO SECURITIES, LLC EQUITY RESEARCH DEPARTMENT