Master Limited Partnership

RBC Natural Resources MLP Subsector PyramidNatural Resources MLP Subsector PyramidCommodityRisksEnergy MLPs cover a range of energy businesses, each of whichhas a unique risk profileFertilizerImportantly, not all MLPs are pipelines, nor do all MLPsgenerate predictable fee based revenues/cash flowChemicalsUpstreamEnergy MLPs can provide investors with both aggressive anddefensive assets and cash flowOffshore RigsFrac SandGathering & ProcessingPotential Risk Factors Include:Commodity Price ExposureVolume SensitivityRefinery UtilizationMacroeconomic SensitivityDepleting Asset BaseWeatherCoalPropaneShippingDiversified Natural Gas/NGLCrude/Refined Product PipelineSource: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com9

Understanding MLP TaxationTaxation is Unique for MLPs, Which are Tax-Advantaged SecuritiesNo double taxation – no federal level corporate taxes at the MLP; taxes paid by unitholdersThe distribution is considered a return of capital and is not taxed when received (100% tax deferred)Unitholders are allocated a share of the MLP’s income and depreciation; the net of which is taxed at ordinary income rates in theyear it was earnedAlthough income and distribution are not the same, the income that is taxed on average equates to 20% of the distribution;consequently, investors typically view 80% of the distribution as “tax deferred”A unitholder’s cost basis declines each year by the amount of the distribution less the unitholder’s allocated net incomeWhen units are sold, depreciation recapture is taxed at ordinary income tax ratesThe Downside to MLP TaxationSchedule K-1 filings (instead of 1099s) may represent an administrative burdenEventual income recapture when units are soldIRAs, mutual funds, foreign owners, and pension funds have difficulty holding MLP units (directly) due to unrelated business taxableincome (UBTI), nonresident state taxes, and timing of K-1 tax formAre MLPs Suitable for an IRA?IRAs or other retirement plans are tax-exempt, so investors do not realize the full benefits of an MLP’s tax advantagesIncome allocated to an IRA may be considered unrelated business taxable income (UBTI) subject to taxIt will not be taxed as long as the amount of this income (and all other sources of UBTI), minus the IRA's share of partnershipdeductions, does not exceed 1,000 in any yearEven if there is some tax on the IRA's allocated share of partnership income, the partnership distributions should generally be highenough to provide a favorable return on an after-tax basisThe IRA custodian is responsible for filing an IRS Form 990T (unitholder does not pay tax directly)Source: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com10

An MLP Tax ExampleAn MLP Tax ExampleMLP Investor Buys Units at 20/Unit and Sells at 22/Unit Five Years Later (yielding 6%) Capital gain is the 2.00/unit difference between original cost basis and final selling price Tax deferral (80%) totals 4.80/unit ( 0.96 annually for five years)Source: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com11

Owning MLPs Without a K-1There are Several Ways to Gain MLP Exposure Without UBTI GenerationI-Shares (KMR and EEQ)Closed End Funds (CEFs)Exchange Traded Notes (ETNs)Exchange Traded Funds (ETFs)Shipping MLPs that Generate 1099sC-Corp General PartnersOpen Ended Mutual FundsThe most tax efficient means to invest in MLPs is through direct ownership of the securitiesI-Shares are equivalent to owning the MLP, with some differences: (1) Investors receive additional units rather than cash distributions,(2) Distributions are not taxable when received – shareholders only pay tax when I-Shares are sold, (3) I-Shares issue Form 1099, notSchedule K-1, and do not generate UBTI, (4) I-Shares are subject to capital gains tax when soldC-Corp general partners are high-growth due to IDRs but investors sacrifice current yield and lose tax advantages As cash distributions per LP unit rise through different tiers (or splits), the GP is entitled to an increasing percentage of theincremental cash distributed by the partnership (commonly up to 50%)Shipping MLPs are based offshore and not subject to US Federal Income Taxes, but can be more volatile than traditional MLPs (and lessliquid)CEFs, ETNs ETFs and Mutual Funds exhibit some tax leakageSource: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com12

Valuation of MLPsDifferent ValuationsDCF Calculation Starting With Net IncomeRecurring Partnership Net IncomeYield or Yield Spreads (does not capture excess cashflow)plusDepreciation & AmortizationEV/EBITDA (need to adjust for GP take)plus/minusNon-cash ItemsP/DCFminusMaintenance Capital ExpenditureEqualsAvailable Cash Flow for DistributionminusCash Flow to General PartnersEqualsDistributable Cash FlowDistribution Discount Model (DDM).Distributable Cash Flow (DCF) Is Key MetricEarnings not importantDCF Free Cash Flow (similar to FFO for REIT industry).Distribution Growth Key Driver For MLPsDCF Calculation Starting With EBITDAWe derive our price targets through DDMKey inputs: Debt leverage, distribution coverage andgrowth, IDRs, and risk-free rate.EBITDAminusInterest ExpenseminusMaintenance Capital ExpenditureEqualsAvailable Cash Flow for DistributionminusCash Flow to General PartnersEqualsDistributable Cash FlowWe calculate DCF after the general partner’s stake.Source: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com13

Understanding GP Incentive Distribution Rights (IDRs)Declared DistributionMinimum Quarterly DistributionTotal Distribution PaidTotal Distribution Paid Per UnitAnnualDist Per 1.50 1.50Declared DistributionMinimum Quarterly DistributionFirst Target DistributionTotal Distribution PaidTotal Distribution Paid Per Unit 2.00 1.50 2.00Declared DistributionMinimum Quarterly DistributionFirst Target DistributionSecond Target DistributionTotal Distribution PaidTotal Distribution Paid Per Unit 2.50 1.50 2.00 2.50Declared DistributionMinimum Quarterly DistributionFirst Target DistributionSecond Target DistributionThird Target DistributionTotal Distribution PaidTotal Distribution Paid Per Unit 3.00 1.50 2.00 2.50 3.00Declared DistributionMinimum Quarterly DistributionFirst Target DistributionSecond Target DistributionThird Target DistributionGreater than Third Target DistributionTotal Distribution PaidTotal Distribution Paid Per Unit 3.50 1.50 2.00 2.50 3.00 3.50UnitO/SLPGP LP Dist. in GP Dist. Total Dist. CumulativeTake Take MMin MM in MMGP 2%2%15%2%2%15%25%2%2%15%25%50%750750 1.501515 0.03765765 1.532%2%7502501,000 2.0015520 0.047652551,020 2.042%2%7502502501,250 2.501554465 0.137652552941,315 2.635%5%7502502502501,500 3.001554483148 0.307652552943331,648 3.309%9%7502502502502501,750 3.501554483250398 0.807652552943335002,148 4.3019%19%General Partners (GPs) can be entitled to IncentiveDistribution Rights (IDRs). IDRs provide incentive for theGP to grow the distributions at the MLP. As theunderlying MLP grows its distribution and exceedscertain target distribution tiers, the GP is entitled to ahigher percentage of the incremental distributions.In the adjacent exhibit, we provide an example of IDRs.As the target distribution increases, the GP receives ahigher proportion of the cash. Note that the increasedproportion is on the incremental distribution (not thetotal distribution).Since the GP is entitled to an increasing percentage ofthe incremental distribution, distributions to the GPgrow faster than distributions to the LPs. For example,when the distribution increases from 2.00 per unit to 2.50 per unit, cash distributions to LP unitholdersincrease 25% from the previous distribution target butthe cash distributions to the GP increase 216%.Consequently, GPs are commonly called a “levered playon the growth of the underlying MLP”.While IDRs serve as an incentive to grow the underlyingMLP, IDRs increase the cost of capital for the underlyingMLP as the underlying MLP has generate sufficient cashto cover the distributions to both LPs and the GP.Source: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com14

Understanding Cost of CapitalCalculation of Cost of CapitalWith IDRIn the adjacent table, we show how to estimate the costof capital for two MLPs, one with IDRs and the otherwithout IDRs. The table demonstrates that IDRs increasean MLP’s cost of capital.Without IDRCost of EquityAnnualized Distribution Current Unit PriceCurrent Yield GP TakeCost of EquityPercent of EquityEquity Component of Cost of Capital 5.0085.05.9%50.0%11.8%50.0%5.9%Cost of EquityAnnualized Distribution Current Unit PriceCurrent Yield GP TakeCost of EquityPercent of EquityEquity Component of Cost of Capital 5.0085.05.9%0.0%5.9%50.0%2.9%Cost of DebtInterest Rate % of Short-term Debt of Total DebtShort-Term Floating RateInterest Rate % of Long-term Debt of Total DebtLong-Term Fixed Rate Short-Term Floating RateCost of Debt Percent of DebtDebt Component of Cost of Cost of DebtInterest Rate % of Short-term Debt of Total DebtShort-Term Floating RateInterest Rate % of Long-term Debt of Total DebtLong-Term Fixed Rate Short-Term Floating RateCost of Debt Percent of DebtDebt Component of Cost of Cost of CapitalEquity Component of Cost of Capital Debt Component of Cost of CapitalCost of Capital5.9%2.5%8.4%Cost of CapitalEquity Component of Cost of Capital Debt Component of Cost of CapitalCost of Capital2.9%2.5%5.4%As the declared distribution of the limited partner moveshigher through the distribution tiers, cash received by GPincreases, which consequently increases the cost ofequity capital. When this happens, the underlying MLPneeds to identify projects that provide returns adequateenough to cover distributions to both LP units and GP.In an effort to attain a competitive cost of capital, someMLPs have acquired their General Partners in the past.In addition, although not included in our example, webelieve it is important to incorporate distribution growthwhen analyzing equity cost of capital. If ignored, a projector acquisition that may be accretive to distributable cashflow growth in the early years may actually be dilutive inthe later years.Source: RBC Capital MarketsElvira Scotto, CFA (212) 905-5957 elvira.scotto@rbccm.comTJ Schultz, CFA (512) 708-6385 tj.schultz@rbccm.comJohn Ragozzino, CFA (Analyst) (512) 708-6335 john.ragozzino@rbccm.com15

Capital Markets AccessibleAnnual MLP Equity Issuance (IPO & FO) bnAnnual Equity Issuance - IPOs and Follow-onsSince MLPs pay out the majority of their cash flow asdistributions, th

Phillips 66 Partners LP PSXP Plains All American Pipeline, L.P. PAA Plains GP Holdings, L.P. PAGP PVR Partners, L.P. Energy/Natural Resources MLPs. There are other publicly PVR QEP Midstream Partners, LP QEPM Regency Energy Partners LP services etc