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Give former President Ronald Reagan credit for the American energy boom we’re currently living through.
In 1986, President Reagan took a decisive step toward advancing America’s energy independence. 27 years later, some investors are still reaping the profits of this landmark policy decision.
Let me explain…
High oil prices and gas rationing of the 1970s were still a recent memory. And the Reagan Administration decided that from happening ever again.
The solution was a special deal for select U.S. companies. His goal was to encourage massive amounts of capital investment to secure America’s energy future. How?
Reagan’s Plan to Revive the American Energy Sector
Simple. The President decided to provide a tax exemption to companies in the oil and gas infrastructure business.
A company had to meet stringent guidelines to qualify for this special status. For instance, at least 90% of sales had to come from America’s energy infrastructure.
But if a business met those requirements, it received a huge tax break. Specifically, it no longer had to pay federal or state taxes on its profits.
These companies are known as Master Limited Partnerships, or MLPs. And because of their tax benefits, they can be extremely lucrative for their shareholders.
Since these companies are technically “partnerships,” their shareholders are essentially “partners.” Unlike most business partnerships though, MLPs are publicly traded companies.
Perhaps the best aspect of these partnerships is the fact that they are required – by law – to pay 90% of their profits to the partners. Called distributions, these payouts are very similar to dividends.
The result is very high dividend yields. The average yield from MLPs over the past decade is more than 7%. And some currently pay more than 10%.
Today, almost all MLPs are in the business of oil and gas pipelines. There really isn’t a more profitable aspect of the energy business.
Pipeline operators are paid based upon the volume of fuel moved – not the commodity price. So the price of oil or gas doesn’t really matter. All that counts is the amount of oil or gas moving down the line. This is important – because it means these companies aren’t as sensitive to price fluctuations as other types energy stocks.
The pipeline business lucrative, and also capital intensive – which is a good thing for existing MLPs. Pipelines are so expensive to build, few startups are coming along to threaten the old guard. That’s what Warren Buffet calls a “moat.”
Once put in place, pipes are relatively cheap to maintain. So after the initial outlay of capital, a huge percentage of all future income is pure profit.
And since pipes are just pipes, this isn’t exactly an industry that requires much investment in R&D. Today, pipelines remain the far and away the cheapest method to move vast amounts of petroleum across land.
It all adds up to an extremely attractive sector for income investors. MLPs are an indispensable component of America’s booming energy infrastructure, and they’re able to legally avoid taxes.
You know that America’s domestic oil and gas production is surging, thanks to a new technology called fracking. New discoveries and increased production are good news for the oil industry. And investors in MLPs can expect many years of healthy dividend payments.