Energy-related master limited partnerships (MLPs), such as Kinder Morgan Energy Partners (KMP) and Enterprise Products Partners LP, may see an upsurge in business once tax changes passed by Congress this month take effect.

The so-called MLP Mutual Fund Amendment, part of the American Jobs Creation Act (HR 4520), was signed into law by President Bush on Friday (see related story). The bill, which cleared Congress earlier this month, offers more flexibility for mutual funds to invest in MLPs, and it would take effect Jan. 1.

The new law amends the Internal Revenue Code of 1986, which was written before MLPs existed. Mutual funds now have to obtain 90% of their income from specific qualifying sources identified in the tax code. MLPs and publicly traded partnerships (PTPs) did not exist when the mutual fund rules were written, and their income is not on the list of qualifying sources, so MLPs rely heavily on individual and niche investors.

If enacted, the MLP provision “could provide significant favorable effects on the sector…if mutual funds could more freely buy MLP’s, it would add additional sources of capital,” said Motley Fool analysts in a research note. “Large-cap MLP valuations would likely move up first, due to income funds seeking diversification and alternatives to utility stocks, which carry 4% yields and only marginal growth.”

Merrill Lynch analysts noted that KMP and Enterprise “have had a nice run lately, perhaps suggesting a bit of near-term froth… At the same time, anticipation of this legislation, coupled with the arrival of new investment products focused on the MLP sector, have created fresh demand that might prove a bit temporary.”

The legislative changes would be a “key positive development for the MLPs,” said Merrill analysts. “We believe tight natural gas and crude oil markets heighten the value of midstream logistics, whether it’s hooking up new wells, or moving/storing increasingly valuable fuel and petrochemical feedstocks. Midstream offers more upside than regulated pipes, without the commodity exposure of E&P. Given our bullish stance on energy, we like those fundamentals.”

Goldman Sachs analysts wrote in a research note that for KMP and its peers, the MLP provision will provide the sector a “short-term psychological positive,” but it may not be a sustained valuation improvement. “We believe institutional interest will grow in the MLP space, but do not view the provision as a catalyst for the large inflow of mutual funds into PTPs.”

Likewise, Wachovia Capital Markets LLC analyst Yves Siegel noted that the mutual fund provision “will boost long-term demand for MLPs,” but other requirements still could stifle mutual funds’ long-term interest.

Along with the tax changes, KMP also will benefit from the decision by Kinder Morgan Inc. (KMI), majority owner, to sell TransColorado to KMP by the end of the year (see NGI, July 26). KMI will sell TransColorado for up to $300 million, which will coincide with TransColorado’s $33 million expansion project.

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