Master Limited Partnerships - Summary Description of MLPs

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1 Suzanne Hannigan, CFA February 28, 2011 Master Limited Partnerships - Summary Description of MLPs INVESTMENT CONCLUSION: Tax accounting for MLP ownership is somewhat complicated, and filings can be delayed, by the pass-through nature of partnership income and the use of the K-1 tax form. We strongly recommend consulting with a tax accountant regarding the federal and state filing requirements for MLP investors prior to investing. We introduce coverage of Master Limited Partnerships (MLPs) with a cautiously optimistic view on the group and its potential for continued strong total returns. MLPs have enjoyed a long period of outperformance relative to most equity indices. Until the financial crisis, correlation to other equities was low. That relationship broke down during the crisis when the group sold off in tandem. Many high-quality operators were able to maintain distribution payments, though access to capital was severely strained. While we may see less impressive price appreciation from MLPs in an environment of rising interest rates, the group s well above market and tax advantaged yields argues for an allocation to the sector. It is particularly attractive for buy-and-hold income oriented investors. Master Limited Partnerships (MLPs) are tax advantaged investment vehicles. Distributions are, for the most part, issued as a tax-deferred return of capital with no taxes due until the units are sold. Like Real Estate Investment Trusts (REITs) and Business Development Corps (BDCs), MLPs are attractive for their above-market yields. MLPs have the added attraction of enjoying a tax advantaged status. Any change to the tax code, however, would very likely cause a significant sell-off in the group. KEY POINTS: MLPs must generate 90% of income from activities related to natural resources. Common units trade on exchanges and in the secondary markets just as common stocks do. MLPs generally have yields well in excess of the market average. Quarterly distributions (akin to quarterly common stock dividends) are tax deferred and reduce the cost basis. K-1s are issued to unit holders for tax filing. A K-1 is the tax form used to report pro-rata income and expenses to each partner in any partnership. Partnerships are not subject to double taxation. MLPs units are primarily owned by retail investors (about 2/3 of the float). Owning units in an IRA or a pension fund may reduce or eliminate the tax advantage. Equity Research Industry Report Research Analyst Certifications and Important Disclosures are on pages of this report

2 Mutual funds can count MLP income as qualifying. General Partners (GPs) typically receive a fee of 2% of distributable income. GPs often receive Incentive Distribution Rights (IDRs) as well. MLP unit holders have no voting rights

3 A master limited partnership, like all partnerships, is not subject to federal income taxes at the organization level. Income and expenses are distributed, or passed through, to the partners. In the case of MLPs, much of this income is tax deferred. That is, distributions are not taxed until the limited partner unit holder sells those ownership units. To understand MLP s and their tax treatment it is helpful to review partnerships in various formations. Partnerships: A partnership is an organization of co-owners. A general partnership (one that is not a limited partnership) is a legal entity in which the individual partners share in the ownership and profits based on their respective level of investment, financial or other. Each partner, however, is fully personally liable for the obligations of the firm. This is a high risk structure. A limited partnership will have at least one general partner and at least one limited partner. The entity enjoys the same tax status as a full partnership, but each limited partner is liable only to the extent of his own investment. He can lose his entire investment and accumulated profits, but not more. In bankruptcy or other proceedings there is no recourse to the personal assets of the limited partners. It is possible, however, for creditors to seek a return of distributed income if their claim arose prior to the payment. The general partner typically runs the business and is fully liable for the obligations of the business. Because of this unlimited liability, the General Partner is often structured as an LLC or corporation. Publicly Traded Partnerships and Master Limited Partnerships: A Publicly Traded Partnership (PTP) has ownership units that trade on exchanges and in the secondary market, just as common stocks do. A PTP can retain its partnership tax status if at least 90% of its income is derived from activities related to natural resources, such as minerals and other commodities, or from passive sources including interest, dividends, rents, gains on asset sales or proceeds from sales. If it does not meet the 90% rule, it is taxed as a corporation. A Master Limited partnership is a PTP that generates at least 90% of its income from mineral, energy or commodity related businesses. The parameters for determining distributable income allow firms to retain earnings sufficient for the maintenance and growth of the business. MLPs were granted their tax advantaged status in large part to encourage investment in the country s resource production and services and the build-out of needed infrastructure, particularly in energy. This explains the dominance of energy companies, particularly energy pipeline companies, among the list of publicly traded MLPs. The general partner (GP) of an MLP typically receives 2% of distributable income. Often the GP is also entitled to Incentive Distribution Rights (IDRs) when specified distribution thresholds are reached. These levels are referred to as splits. Incentive Distributions Rights: The splits are defined in the partnership agreement and can only be altered by a modification to the agreement. Several MLPs either have taken or plan to take the necessary steps to eliminate IDRs as their profitability grows, thus lowering the partnerships cost of capital and allowing investors to fully participate in income growth. IDRs give the GP a larger portion of distributable income at each split. For example, if the first split is 25%/75% at 50 cents then, when the MLP s quarterly distribution exceeds 50 cents, the GP receives 2% on the distribution up to 50 cents and 25% on the distribution in excess of that level. The next split may be 50%/50% at 60 cents. When the quarterly distribution reaches 60 cents per share, the GP will receive - 3 -

4 2% of distributions up to 50 cents, 25% of distributions from cents to 60 cents and 50% of distributions in excess of 60 cents. It is common for splits to reach 50%. Table 1: Incentive Distribution Rights Example of Incentive Distribution Rights Payments Based on the Above Splits: Quarterly Distribution % to % to per unit Common Unit Holders General Partner $ $ % 2% $ $ % 25% (on distributions > 50 cents) $ $ % 50% (on distributions > 60 cents) Source: JMS Research I-Shares: or Institutional Shares are offered by the management companies of both Kinder Morgan Energy Partners LP (KMP; NR) and Enbridge Energy Partners, LP (EEP; BUY). In each case, the management company, Kinder Morgan Management, LLC (KMR) and Enbridge Energy Management, LLC (EEQ), owns only its stake in the MLP. I-Share holders receive distributions in the form of additional shares. The additional shares reduce the cost basis per share. I-share holders receive neither a K-1 nor a 1099 tax form. There are no tax complications and no ownership restrictions. These shares are less liquid than the MLP units as they receive no cash distribution. As such, they trade at a discount to the MLP units. Limited Liability Corporations (LLC) may also trade as a PTP. An LLC, as its name suggests, is a cross between a corporation and a limited partnership. Owners/Investors in an LLC enjoy the limited liability of a corporate shareholder and the pass-through income of a partnership. Properly structured LLCs may trade as PTPs and are subject to the same rules and tax treatment. From an investor s perspective, a publicly traded LLC has the advantage of having no general partner to whom a management fee and IDRs are paid, and common holders do have voting rights. Table 2: Comparison of MLPs, LLCs, I-Shares, and Corporations MLP LLC I-Shares Corporation Taxable at Firm Level Yes Tax Form K-1 K-1 N/A 1099 Distributions Tax Deferred Tax Deferred Additional Shares Taxable Pass Through Income Yes Yes General Partner Yes --- Yes --- IDRs Some --- Yes --- Common Holder Voting Rights --- Yes --- Yes Source: NAPTP and JMS Research - 4 -

5 Tax Treatment: MLP unit holders receive a form K-1 for tax filing purposes. The K-1 allocates each limited partner s pro-rata share of income, expenses, depreciation, etc. The deadline for issuing a K-1 is April 15 though many MLPs commit to getting them out by March 15. This can delay tax filings for investors. The additional paperwork may also add to the cost of tax preparation. The high yield paid by most MLPs generally compensates for these added costs to retail investors. For institutional investors, the added tax complications including, for some, the allocation of unrelated business income (UBIT) limits the appeal of this asset class. An MLP s distribution qualifies as a tax deferred return of capital. A return of capital reduces the cost basis of the ownership units. As such, no tax is due on distributions unless and until the units are sold. If and when the adjusted cost basis goes to $0.00, the quarterly distributions become taxable in the year earned (as capital gains). Purchasing more units would bring your coast basis back above $0.00. Appreciation above the distribution adjusted cost basis is taxed at the capital gains rate. Partners pay tax on pass-through earnings, regardless of (tax-deferred) cash distributions received. The unit-holders allocated share of income or loss is not the same as the Cash Distribution. MLP income or losses are classified as passive because the holder has no active role in managing the business. His allocated share of income and expenses will be reported annually on the form K-1. Taxes are due in the year received, at the holder s ordinary income rate. An allocation of partnership income will increase your cost basis. An allocation of partnership expenses, such as depreciation, will decrease your basis. Any reduction in cost basis resulting from a net loss allocation is taxed at sale as ordinary passive income. An allocated loss from MLPs may be carried forward to offset income in future years from the same MLP only. The loss may not be used to offset income of a different MLP in any year. RECAPTURE OF ALLOCATED DEPRECIATION AND DEPLETION: We state above that when units are sold, appreciation above the adjusted cost basis is taxed at the capital gains rate. An adjustment is made, however, for any gain that results from an allocation of depreciation or depletion. That portion is taxed as ordinary income. As a general rule, the greater the level of deductions from depreciation, depletion, and amortization per unit, the more attractive the MLP units. These reduce the level of currently taxable income relative to distributions. This is referred to as the tax shield. Tables 3: Impact of Distributions and Allocations on Cost Basis Impact of Allocations on the Cost Basis of Common MLP Units: Quarterly Distribution Allocation of Income Allocation of Expenses Source: JMS Research - 5 -

6 Tables 4: Impact of Allocations on Taxes Year 1: 1,000 units $ Basis is: $30,000 Investor receives total cash distributions of $2.50/unit Investor is allocated and pays tax on net taxable income of $.50/unit, including $2.00 of income and $1.50 of depreciation - $2,500 + $ 500 Adjusted Basis $28,000 Year 2: All units $32.00 $32,000 Gain per unit: $ $28.00 = $4.00 $ 4,000 Depreciation recapture-taxed at ordinary income rates $1,500 Taxed at capital gain rates* $2,500 *Assumes MLP has no ordinary income assets Source: National Association of Publicly Traded Partnerships TAX SHIELD: This is the portion of the annual distribution that is truly tax deferred because it is shielded from a currently taxable allocation of income. Many MLPs have tax shields above 80%. Using an example from the National Association of Publicly Traded Partnerships (NAPTP) website: Assume that an investor acquires a PTP unit and expects distributions of around $100 per unit annually. The investor expects its share of the PTP s taxable income to be around $15 i.e., the individual expects to have to include an amount that is equal to 15 percent of the expected $100 distribution in its income. Thus, the tax shield would be 0.85 (i.e., $100 - $15). STATE TAX FILINGS: Following the letter of the tax code, an MLP and its investors must file a state tax return in every state in which the MLP operates. From conversations with accountants, we believe that this requirement is less onerous than it seems. We reiterate, though, that a tax accountant should be consulted prior to investing. TAX EXEMPT ENTITIES: If owned in an IRA or other retirement account or in a pension fund, a large part of the tax advantage may be lost. Pension and retirements funds may incur taxes due if the income allocation is above the $1000 exclusion for unrelated income. IRA custodians, not individual tax payers, are responsible for paying taxes from the account (on form 990). They may, however, charge the account for the additional service

7 MUTUAL FUNDS: A mutual fund must receive 90% of its income from qualifying sources such as interest and dividends. Since the enactment of a tax law change in 2004, MLP and other PTP income is considered qualifying income. Mutual funds are subject to certain diversification requirements that may limit MLP/PTP holdings. OTHER INSTITUTIONAL INVESTORS: If a money manager purchases MLPs for clients in separately managed accounts (SMAs), his client(s) will receive K-1s for each MLP held. INHERITANCE: As with common stock, the cost basis of MLP units is stepped-up to current market value at the time of the owner s death. In effect, any prior distributions are wiped clean. No tax will be due on them. Should heirs sell the units at or near the time of inheritance, little or no capital gains tax will be due. The cost basis will be adjusted downward by the amount of distributions that occur after they inherit. Why Own MLPs: Above market yield Tax deferred income Benefits of partnership with greater liquidity and low minimum investment Exposure to growth of energy infrastructure Exposure to new, unconventional energy sources Diversification Estate planning Risks to MLP Ownership: Any change to the tax code that limits or eliminates the favorable tax treatment of MLPs would likely have a significant negative impact on the valuation of MLP units and on the group s access to capital. The pass-through nature of partnership income typically results in low retained earnings and frequent debt and equity offerings. Market disruptions, such as occurred in negatively impact access to capital. This is more disruptive to the average MLP than to the average corporation. GPs and related entities tend to own large percentages of outstanding units, reducing the liquidity of many MLPs. Incentive Distribution Rights increase the cost of capital and reduce returns to common holders as high splits are reached. A high-interest rate environment could decrease the relative attractiveness of MLPs. The majority of MLPs are in the energy sector. Increased regulation is being debated, which could negatively impact profitability for the group. Over-building of energy infrastructure could lead to poor asset utilization and poor returns. In their early years MLPs were something of a niche product. Tax complexities and the low-growth, cash focused model of many MLPs limited their appeal in high interest rate environments or when the stock markets were especially strong. In the last decade choppy markets, declining rates and a renewed focus on growth at many MLPs has spurred investor interest in the instruments

8 Tax protected yield, above average yield, limited correlation to other equities, liquid exposure to energy and the build-out of needed infrastructure all make MLPs worthy of an asset allocation. MLPs are particularly attractive for buy-and-hold investors as the bulk of the tax due is deferred until the units are sold. If you never sell, you will pay only minimal taxes. MLP s offer the tax benefits of partnerships with the liquidity and smaller minimum investment of a common stock. Also, partnership income is not double taxed. A handful of companies have restructured to reduce or eliminate fees and IDRs to their General Partners. We applaud these moves as they reduce the partnerships cost of capital and increase funds available for investing in growth or for distributions to unit holders. The MLPs that have effectively eliminated their GPs are Buckeye Partners, LP (BPL; NR), Eagle Rock Energy Partners, LP (EROC; NR), Enterprise Products Partners, LP (EPD; BUY), Inergy LP (NRGY; NR), and Magellan Midstream Partners LP (MMP; NR). Sunoco Logistics, LP (SXL; BUY significantly restructured its GPs IDRs. Linn Energy (LINE), as an LLC, has no GP. Liquidity has improved along with the growth in Market Cap: Though MLPs still tend to have lower daily trading volume than a typical common stock of the same market cap due to high percentage ownership by GPs and the buy-and-hold strategy of many MLP investors, liquidity had improved due increased institutional investor participation and the emergence of MLP based ETNs and ETFs. With further investment needed to develop unconventional reserves (shales and oil sands), the number of traded MLPs is likely to grow while existing MLPs continue to issue both debt and equity to fund expansion

9 Energy Focus of MLPS: There are currently about 90 MLPs with a combined market capitalization of more than $240 bn. The vast majority, about 75%, of MLPs operate in the energy sector. Further, roughly 44% of publicly ly traded MLPs are in the midstream portion of the oil and gas sectors. In terms of market capitalization, those numbers are even higher- 90% and 72% respectively. A few are in other energy and mineral businesses, real estate, and investment management. Still fewer are in the cemetery (StoneMor) and entertainment businesses. Table 5: MLP Market Capitalization Distribution PTP Market Capitalization by Industry Gas & Oil Midstream Operations - 72% Oil & Gas E&P -5% Propane & Refined Fuel -4% Coal Marine Transportation -2% Investment/Financial -9% Other Minerals, Timber -1% Real Estate -0.6% Other -1% Source: National Association of Publicly Traded Partnerships The predominance of midstream energy companies, to some extent, reflects investor preference. The relatively stable cash generation without commodity risk is attractive. From the partnerships perspective, ready access to capital provides funding for ongoing infrastructure build-out and/or growth through acquisition. Upstream, Midstream, Downstream explained: Upstream- This is the exploration and production portion of the crude or natural gas chain. Identifying energy reserves and drilling, on or off-shore, to extract them from the earth are the key upstream functions. A portion of the gathering process may be included here as well to move - 9 -

10 the oil or gas to pipelines. Companies and partnerships operating in this portion of the supply chain generally have direct exposure to changes in the price of the commodities. Midstream- Encompasses gathering, processing, fractionating gas, transportation, and storage. Midstream operators are typically paid on a fee-for-service or capacity leasing basis and do not bear the risk of commodity price fluctuation. Contracts tend to be long-term. Ultimately, they are impacted by demand. o Gathering- The collection of crude or natural gas from the well. o Processing- Removing impurities that reduce the quality of the commodity and cause pipeline corrosion. o Fractionation- After natural gas liquids (NGLs) are separated from the raw natural gas, fractionation can occur. It is the process of breaking down natural gas into its base components-- ethane, propane, butane, isobutane, and natural gasoline. o Transportation- The movement of processed crude, gas, petrochemicals, or refined products through pipelines to oil refineries or to distribution centers throughout the US or to export terminals. o Storage- Holding customers gas or oil in storage facilities. Downstream- The downstream sector includes oil refineries, petrochemical plants, petroleum distribution and retail outlets, and natural gas distribution companies. The end products of the downstream segments include petrol, diesel, jet fuel, heating oil, asphalt, lubricants, synthetic rubber, plastics, fertilizers, antifreeze, pesticides, pharmaceuticals, natural gas and propane. * Retail Sales (gas station revenues) are not qualifying income. Shale Plays: There is a lot of investor excitement surrounding the potential of the various shale reserves, particularly the Eagle Ford in Texas and the Marcellus in Pennsylvania, as these are much less developed than the others. Several MLPs are positioning to participate in the infrastructure build-out and energy production of these Shales. Shales are fine-grained, sedimentary rock formations that can contain stores of natural gas and/or petroleum. Until just a few years ago, it was not economically viable to develop these deposits. Experience and technological advances, gained in the development of the Barnett Shale, combined with the discovery that Shale reserves are much greater than recently believed, have altered the economics. The US Energy Information Administration (EIA) doubled its estimate of shale deposits from the 2009 level. Updated estimates on the Marcellus are a large part of the increase. EIA now estimates that, at the current rate of consumption, the US has 110 years of natural gas reserves in all known sources. The Bakken, Eagle Ford (primarily oil), and Marcellus Shales especially are in the early stages of development. They will require investment and infrastructure build-out over the next several years. As such they represent meaningful long-term growth opportunities for energy firms. The MLP structure is well-suited to execute the needed build-out due to its favorable access to capital and tax advantaged status. As demonstrated above, depreciation serves as an offset to allocated income, thus improving the tax shield ratio. The dramatic increase in proven reserves coincided with the onset of the recession. The chart below shows the steep drop in natural gas prices. While oil also endured a steep decline in , it has recovered meaningfully from its trough. Natural gas remains near historic lows. While pricing is not projected to recover in the near or intermediate term, the improved economics of extracting reserves makes increased production feasible, particularly from unconventional sources

11 Table 6: Projections of Natural Gas Production from Shales Shale Plays Natural Gas Production Forecasts Source: Wood Mackenzie Table 6: Shale formations throughout the US Source: Energy Information Administration (EIA)

12 Table 7 & 8: Long Term Charts of Natural Gas and Crude Oil Prices

13 5 Year Performance of the Alerian MLP Index versus the S&P 500 Source: Capital IQ 6 Months Performance of the Alerian MLP Index versus the S&P 500 Source: Capital IQ

14 Glossary of Terms - The following list contains terms commonly used in discussion of MLPs and/or energy enterprises. Not all of these terms are used in this report. Associated Gas: raw natural gas that is dissolved in oil and produced as a by-product along with crude. Associated gas generally has a high concentration of heavier natural gas liquids (NGLs). Available Cash Flow: cash flow available to the common unit holders and to the general partner. Backwardation: a market condition in which future commodity prices are lower than spot prices. This usually occurs when demand exceeds supply. Base Gas: the amount of gas a storage facility must hold to provide sufficient pressure to extract natural gas. Basis differential: The difference between the Henry Hub spot natural gas price and the corresponding cash price in another location. British Thermal Unit (Btu): a unit of energy used to describe the heat content of a fuel. Compression: a process used by Midstream companies to condense natural gas to a higher pressure to increase the delivery capacity of a pipeline. Contango: a market condition in which future commodity prices are greater than spot prices. This is a normal condition which reflects the cost of carrying the commodity. Conventional Natural Gas Production: natural gas produced from underground formations composed of sandstone or carbonate rock. These are typically more economical to access than unconventional deposits. Depleted Reservoir: The cavern left when all gas or oil has been extracted from a site. These are often used as natural gas storage facilities. Dirty Hedge: an imperfect hedge, (e.g. using crude oil products to hedge natural gas liquids exposure). Distributable Cash Flow (DCF): the cash flow available to the common unit holders after the payments to the GP. Distribution: cash payment to unit holders, akin to stock dividends. Distribution Coverage Ratio: cash available for distribution divided by the distribution. A higher ratio implies greater safety of the distribution. Distribution Yield: distribution divided by unit price akin to dividend yield

15 Downstream: the refining and marketing sectors of the energy industry including the placement of refined products with the end-user. Dropdown: the sale of an asset from the parent company to the MLP. Dry Natural Gas: natural gas containing low, or no, levels of NGL. Energy Information Administration (EIA): an independent agency of the US Department of Energy (DOE) that provides educational materials, data and analysis relating to all forms of energy. Excess Cash Flow: cash flow remaining after distributions has been paid to common and subordinated unit holders and general partner. Federal Energy Regulatory Commission (FERC): The independent agency that regulates the interstate transmission of electricity, natural gas, and oil. Feedstock: the raw material used in the production of ethylene, propylene, and butadiene. Firm Storage: storage contracts consisting primarily of take-or-pay agreements with minimal exposure, to the MLP, of price or volume risk. Fractionation: the process of separating natural gas into its base components- ethane, propane, normal butane, isobutane, and natural gasoline. Fracturing: a process by which pressurized water is pumped into rock formations to cause a fracture. The fracture allows greater access to the energy deposits contained in the rock. General Partner (GP): an individual or entity responsible for managing the operations of the partnership. The GP typically receives a management fee and Incentive Distribution Rights (IDRs) for this service. Incentive Distribution Agreement: the agreement outlined in the Partnership Agreement that establishes the percentage of total cash distributions that will be paid to the GP. Incentive Distribution Rights (IDRs): progressively higher percentage payouts (splits) to the GP as certain distribution levels (as defined in the Incentive Distribution Agreement).are reached. Interruptible Service: a contract in which the customer pays for storage capacity on a spot market basis at prevailing rates. Capacity is not guaranteed. Interstate Pipelines: transports product across state lines. Interstate pipelines are regulated by the FERC

16 Intrastate Pipelines: operates within one state. These are not FERC regulated, but are regulated by states and municipalities. I-Shares: shares in an MLP that are designed to meet the needs of institutional investors. I- Shares pay distributions in stock rather than cash. No K-1 is issued to holders and no UBTI is generated. K-1 Statement: the tax form used to allocate pro-rata income and expenses to individual partners in any partnership. Limited Partner (LP): a partner with no responsibility for the operations of the enterprise who bears only limited liability (to the extent of his investment and gains). Liquefaction: the process that transforms natural gas from a gaseous state to a liquid state. Liquefied Natural Gas (LNG): natural gas that has been condensed into liquid form. Liquid Petroleum Gases (LPGs): gases released as byproducts of the refining process. Looping: adding pipe to an existing pipeline network to increase capacity. Master Limited Partnership (MLP): a limited partnership that derives at least 90% of its revenue from activities related to natural resources. MLPs may issues publicly traded common units and receive favorable tax treatment. Methane (CH4): dry natural gas-- the primary component of natural gas. Methane Separation: the process of dividing the methane from the NGL components of natural gas. Midstream: gathering, treating, processing, transportation, and storage of energy. Minimum Quarterly Distribution (MQD): the lowest distribution the partnership intends to pay to its common and subordinated unit holders. This is not a guaranteed payment, but is based on available cash.. Natural Gasoline: a mixture of liquid hydrocarbons extracted from natural gas and mainly used in gasoline. NGL: natural gas liquids NGL Yield: the amount of natural gas liquids (NGLs) present in a given supply of natural gas. Non-Associated Gas: natural gas that is free from contact with crude oil

17 Normal Butane: a component of the natural gas chain and a petrochemical feedstock. Oil Sands: a mixture of sand, clay, water, and bitumen, an extremely viscous oil. These are considered an unconventional oil source. Partnership: a collection of partners, not an entity in its own right. Petrochemicals: chemical compounds derived from petroleum or hydrocarbons. Pipeline Quality Gas: the dry portion of natural gas (primarily methane) after the NGLs have been separated out. This can be safely transported through pipelines. Polyethylene: the world s most common and versatile plastic and the primary user of ethylene. Processing: the separation of raw natural gas into pipeline quality gas and natural gas liquids. Processing Margin: the difference between the price of natural gas and a composite price for NGLs on a BTU-equivalent basis. Propane: or C3, is the third largest component of the natural gas stream Propylene: or propene or C3H6, is a key element in plastics. Proved Developed Producing Reserves (PDP): reserves accessible through existing wells with existing infrastructure. Proved Undeveloped Reserves (PUDs): reserves that require either new wells or a major capital investment to access. Raw NGL Mix: a blend of heavier NGL components, extracted via natural gas processing. Refined Petroleum Products: end-market consumer products including gasoline, diesel, jet fuel, kerosene, and heating oil. Residue Natural Gas: the natural gas remaining after heavier NGL components have been extracted through processing-- primarily methane and ethane. Salt Caverns: depleted underground reservoirs, which are used for natural gas storage. Shale: sedimentary rock formations, which can contain crude oil or natural gas. Splits: distribution levels which trigger higher payout percentages to the GP. Subordinated Units: units which, for a specified time period, receive no distribution or receive no distribution until common holders are paid the MQD

18 Subordination Period: the period of time during which subordinated units will not be entitled to receive distributions until the common units have been paid. Take-or-Pay Contract: the customer is obligated to pay for product even if delivery is not taken. Unconventional Natural Gas Production: gas produced from shales and coal bed methane. These are typically more expensive to develop than conventional sources. Units: limited partner equity interests in MLPs or other PTPs, akin to common shares. Unrelated Taxable Business Income (UBTI): income earned from business activities unrelated to an entity s tax-exempt purpose. A tax-exempt entity (i.e. pension fund or retirement account) that receives more than $1,000 per year of UBTI per year may incur a tax liability on that income. Upstream: the discovery and extraction of oil and natural gas (exploration and production). Wellhead: the point where oil or gas leaves the earth. Abbreviations of Energy Measurement Terms: Bbls: Bcf/d: Btu MBtu: Mcf: MBbls: MBbls/d: MMBbls: MMBbls/d: MMBtu: MMBtu/d: MMcf: MMcf/d: Tcf: Barrels One billion cubic feet per day British thermal unit One thousand Btus. One thousand cubic feet of natural gas. One thousand barrels. One thousand barrels per day. One million barrels. One million barrels per day. One million Btus. One million Btus per day. One million cubic feet of natural gas. One million cubic feet of natural gas per day. One trillion cubic feet of gas

19 IMPORTANT DISCLOSURES Research Analyst Certification I, Suzanne Hannigan, the Primarily Responsible Analyst for this research report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers. No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views I expressed in this research report. Janney Montgomery Scott LLC ("JMS") Equity Research Disclosure Legend Janney Montgomery Scott is a market maker in the securities of STON, and may at any time hold a long or short position in this security. Janney Montgomery Scott may seek compensation for investment banking services from the subject company (ies) BWP, EEP, EPD, STON and SXL securities in the next 3 months. The research analyst is compensated based on, in part, Janney Montgomery Scott's profitability, which includes its investment banking revenues. Definition of Ratings BUY: Janney expects that the subject company will appreciate in value. Additionally, we expect that the subject company will outperform comparable companies within its sector. NEUTRAL: Janney believes that the subject company is fairly valued and will perform in line with comparable companies within its sector. Investors may add to current positions on short-term weakness and sell on strength as the valuations or fundamentals become more or less attractive. SELL: Janney expects that the subject company will likely decline in value and will underperform comparable companies within its sector. Price Charts Rating and Price Target History for: Boardwalk Pipeline Partners, LP (BWP) as of Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q Created by BlueMatrix

20 Rating and Price Target History for: Enbridge Energy Partners, LP (EEP) as of Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q Created by BlueMatrix Rating and Price Target History for: Enterprise Products Partners, LP (EPD) as of Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q Created by BlueMatrix Rating and Price Target History for: StoneMor Partners L.P. (STON) as of Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q Created by BlueMatrix

21 Rating and Price Target History for: Sunoco Logistics Partners, LP (SXL) as of Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q Created by BlueMatrix Janney Montgomery Scott Ratings Distribution as of 12/31/2010 IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [B] NEUTRAL [N] SELL [S] *Percentages of each rating category where Janney has performed Investment Banking services over the past 12 months. Other Disclosures Investment opinions are based on each stock's 6-12 month return potential. Our ratings are not based on formal price targets, however our analysts will discuss fair value and/or target price ranges in research reports. Decisions to buy or sell a stock should be based on the investor's investment objectives and risk tolerance and should not rely solely on the rating. Investors should read carefully the entire research report, which provides a more complete discussion of the analyst's views. This research report is provided for informational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis.supporting information related to the recommendation, if any, made in the research report is available upon request

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