Learning from SemGroup Energy Partners

It’s been a rough year for the markets,  as major equity indexes suffered significant losses in the wake of subprime lending, rising inflation, and slowing economic growth.  So it’s no surprise that publicly traded MLPs have also had their share of bad luck lately.  However, as with any investment, there is risk involved.  SemGroup Energy Partners is a good example of why investors should always understand the potential downside involved when investing in MLPs.

Risk vs. Reward

One of the most appealing advantages of the public MLP is tax structure.  MLPs have the benefit of pass-through taxation which, unlike publicly traded equities, allows them to avoid tax at the entity level.  In addition, MLP investors can defer taxes on the majority of cash distributions paid to them.  However, in exchange for a higher yield as a result of these benefits, investors lose a key component which public shareholders have: a say in who manages the organization.

How SemGroup Lost Control

In the wake of severe trading losses related to oil derivatives, the general partner (GP) of the SemGroup MLP lost control of the partnership when it was forced to file for bankruptcy.  As a result, two major creditors exercised their right (outlined in documentation related to the loan) to act as solitary voting members of the GP.  What did LP unitholders have to say about it?  It doesn’t really matter – they don’t have a choice in this particular situation.  Unfortunately, those are the rules – the price of the LP units has since plunged.

Lessons Learned

Keep in mind that, while MLPs have many advantages that can give them an edge over other securities, they also have associated risks.  Investors need to fully understand these risks before investing.  And, at the risk of sounding like a broken record, investors should always consult a tax advisor beforehand as well.  You can learn more about the benefits and risks of MLPs here.