Hess to Form Tax-Advantaged Unit as Profit Beats Estimates

Jul 30, 2014 4:47 pm ET

(Updates with closing share price in second paragraph.)

July 30 (Bloomberg) -- Hess Corp. soared to a five-year high after reporting better-than-expected quarterly earnings and saying it will form a tax-advantaged master-limited partnership to hold railcars, trucking, storage and processing facilities in North Dakota’s booming Bakken Shale region.

Shares of the New York-based oil producer rose 1.6 percent to $101.05 at the close in New York, the highest price since September 2008. Excluding one-time items, per-share profit for the second quarter was $1.38, exceeding the average of 24 analysts’ estimates by 20 cents.

Higher production and lower per-barrel costs in the Bakken drove the company’s results, Fadel Gheit, a New York-based analyst for Oppenheimer & Co., said today in a phone interview. “Finally, they have delivered what the market has been expecting for over a year and a half now.”

The number of tax-advantaged partnerships has proliferated because of demand from investors for cash payouts that beat debt yields. Creating the Bakken unit would reduce Hess’s tax burden for the assets, since master-limited partnerships don’t pay federal income tax. Hess is the latest to propose forming such a partnership, known as an MLP, as companies seek ways to cut the 35 percent corporate U.S. tax rate.

“Some of them doubled or tripled the value of the assets by putting them into an MLP,” said Gheit, who rates Hess a buy and doesn’t own the shares. “It’s basically financial engineering. The tax advantage is the whole idea.”

MLP Costs

Jefferies & Co. tallied more than 120 publicly traded MLPs in a July 28 note to clients. They hold assets ranging from oil and natural gas pipelines and processing facilities to refineries and petrochemical complexes.

While U.S. lawmakers debate so-called inversion, in which companies move headquarters to reduce their tax rates, MLPs will cost taxpayers about $1.5 billion from October 2010 through September of 2015, Congress’s Joint Committee on Taxation estimated in January 2012. The number of MLPs has risen since then amid Congressional proposals to expand them to include renewable energy companies.

“Any qualifying asset with free cash flow characteristics and a decent fundamental position can now be considered for MLP inclusion,” a team of Jefferies analysts led by Christopher Sighinolfi wrote. “Companies are getting IRS private letter rulings to include assets within MLPs that would not have historically qualified under the tax laws, adding further complexity to the space.”

Activist Pressure

The Alerian MLP Index, comprised of 50 partnerships, has gained 12 percent this year, beating the S&P 500’s climb by 4 percentage points. Investors have poured $1.2 billion this year into the Alerian MLP ETF, an exchange-traded fund that tracks the index, according to data compiled by Bloomberg.

MLPs controlled by a parent, such as the one planned by Hess, allow their investors no voice in management, the Jefferies analysts wrote. Conflicts can arise when the parent’s interests clash with those of investors.

Hess expects to make an initial public offering of common units in the partnership in the first quarter of 2015, the company said in a statement today. Hess will continue to control the assets by owning the general partner of the new entity after the IPO.

Monetizing Assets

Hess came under pressure to spin or sell off business units last year as its largest shareholder pushed for it to become purely an oil and gas exploration and production company. It sold or agreed to sell about $10.5 billion of assets, including its U.S. retail gasoline stations, after the proxy fight last year with activist investor Paul Singer’s Elliott Management Corp. The company agreed to “monetize” its Bakken assets in a settlement with Elliott.

The new partnership will include a natural gas processing plant in Tioga, North Dakota, as well as railcars and a loading facility for transporting oil from the region. It will also have a propane facility in Mentor, Minnesota.

Production from its Bakken fields in North Dakota rose 25 percent to the equivalent of 80,000 barrels of oil a day in the second quarter, Hess said today. The company is targeting an average of as much as 90,000 barrels a day of Bakken production for 2014, Chief Operating Officer Gregory Hill said on a conference call.

--With assistance from Alex Nussbaum in New York.