Devon Energy (NYSE:DVN) shares traded up more than 4% after announcing that it will form a master limited partnership (MLP) in the third quarter of 2007 by issuing partnership units in the company’s U.S. midstream and onshore marketing assets. The chief asset is Devon’s gathering and pipeline system around the Barnett Shale natural gas play near Ft. Worth, Texas. All told, DVN owns midstream assets including 2,700 miles of pipeline, two gas processing plants with a total capacity of 680 MMcf/d, and an NGL fractionater with a capacity of 15,000 b/d.

Devon’s Fiscal 2006 margin from its marketing and midstream operations totalled $448 million, essentially flat with FY2005. It expects the margins to be roughly the same in 2007, from revenue of $1.71B – $2.1B, and expenses of $1.31B – $1.67.

This is pretty small beer, as pipeline MLPs go. But investors seem to like them because an MLP’s tax advantage: income is not taxed at the corporate level, only the individual partner pays income tax. Current shareholders also get a nice present from the sale of partnership units.

Still, the company directors and officers are the ones who really score.  Devon will retain ownership of its new MLP’s general partner (GP) and a majority stake in it. The GP typically gets a 2% distribution and, on top of that, what are called "incentive distributions" that could equal as much as 50% of the MLP’s income. All that will be spelled out in the registration documents that Devon files with the SEC later this quarter.

In its announcement, Devon said it would use a "significant portion" of the proceeds from the sale of partnership units to pay down the parent company’s debt and to repurchase shares of DVN’s common stock. It’s pretty easy to see why company officers and directors like MLPs, and even company shareholders get a nice one-time dividend.

But why do other investors buy in? The tax benefit is surely attractive, and MLPs do offer guaranteed returns because pipelines are subject to federal and state rate regulation.  Unitholders often pay dearly for these benefits and the secondary supply of shares or units is somewhat limited, so anyone wanting in on new MLP usually tries to get in early.  If you don’t believe it, take a look at how well SemGroup Energy Partners, L.P. (NASDAQ:SGLP) did in its trading debut today.

Paul Ausick
July 18, 2007

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