MLPs trade on the major exchanges just like common stocks and you will pay normal broker commissions. However, MLPs aren’t corporations.

They pay no corporate tax; instead, these partnerships pass through their profits to holders in the form of quarterly distributions and individuals pay taxes on those payouts. In other words, MLPs avoid the problem of double taxation.

And MLPs are able to pass along significant tax shelters to unitholders. As much as 80 to 100 percent of all distributions you receive from an MLP will be treated as return of capital, allowing you to defer paying taxes on the income you receive until you sell the MLP units.

Even better, President Obama’s preliminary budget proposed a number of new taxes but there are no proposals to change the taxation of MLPs.

In fact, these new taxes make MLPs’ tax-deferral advantages even more valuable, especially if you’re taxed at the highest income tax bracket.

Congress recently expanded the range of businesses MLPs can participate in to include renewable fuels–the tax-advantaged MLP structure is one way the government will attempt to encourage alternative energy development.

There’s far more to MLPs than just beneficial tax treatment. As “S&P KO’d By MLPs” illustrates, the industry benchmark Alerian MLP Index has handily outperformed the broader market averages since the beginning of 1998, beating the broader average in 8 of the past 10 years.

The current market environment offers the most compelling buying opportunity for the group since the mid-1990s. As “A Fistful of Income” illustrates, the Alerian index yields close to 11 percent right now, about double the average yield since 2000. And despite the weak economy and paralyzed credit markets, only three out of 46 MLPs in the index cut their payouts. In fact, the average MLP in the Alerian index boosted its distribution by more than 18 percent during the past year.

Shifting Gas

The US natural gas market is changing rapidly. Older fields that were once the mainstay of US production are now in a state of decline. Meanwhile, US producers have begun to exploit “unconventional” shale plays all over the US.

Through a combination of modern drilling technologies, these fields have become among the most prolific and largest gas plays in the world today. The US could easily overtake Russia as the world’s largest gas producer within five years.

But there’s a problem with unconventional plays: There’s insufficient pipeline and storage infrastructure to move natural gas from wellhead to consumer. The transportation bottleneck is why gas prices in hot producing regions such as the Rocky Mountains trade at a huge discount to US gas futures. (See “Drawn Down.”)

The most common business for MLPs is the ownership of midstream energy assets including pipelines, storage facilities and gas processing facilities. MLPs will play a key role in building the infrastructure needed to handle America’s gas production boom.

Kinder Morgan Energy Partners (NYSE: KMP) owns a network of crude oil and refined products pipelines capable of transporting 2 million barrels of oil equivalent per day–Kinder is the largest operator of such pipelines in the US.

Like most pipeline operators, Kinder isn’t paid based on the value of crude or gasoline flowing through its pipelines but on the volumes; rates are also adjusted annually to account for cost inflation. The end result: Pipelines offer steady returns on investment with no real leverage to commodity prices.

More promising from a growth perspective is Kinder’s natural gas pipeline and storage business. The company’s Rockies Express pipeline will carry natural gas from the Rockies east to the Pennsylvania/Ohio border; the line is already partly completed and is scheduled for completion by midyear.

And Kinder’s Midcontinent Express pipeline is a 50/50 joint venture between Kinder and Energy Transfer Partners (NYSE: ETP). This pipe passes adjacent to at least four major unconventional fields.

With a yield above 9 percent and the financial strength to undertake large-scale projects in spite of the credit crunch, Kinder Morgan Energy Partners is a buy under 55.

If you’re interested in exposure to Kinder inside a retirement or tax-advantaged account, consider Kinder Morgan Management (NYSE: KMR) instead of Kinder Morgan Energy Partners.

Instead of paying out distributions in cash, Kinder Morgan Management pays holders in additional units. The benefit is that Kinder Morgan Management eliminates concerns about unrelated business taxable income, an issue we explained in the January 28, 2009 issue of PF. Kinder Morgan Management is a buy under 51.

Growth Portfolio bellwether Enterprise Products Partners (NYSE: EPD) is a purer play on natural gas-related infrastructure. The company owns more than 36,000 miles of pipeline that transports natural gas and natural gas liquids (NGL)–products such as propane and butane that naturally occur with gas.

In addition to pipelines, Enterprise owns 27 billion cubic feet (bcf) of gas storage, six production platforms in the Gulf of Mexico and 24 processing plants designed remove NGLs from raw natural gas.

Unlike the pipeline and storage business, investors should be wary of MLPs involved in gas processing because this business can have exposure to natural gas price swings. But Enterprise has a conservative base of contracts and a well-diversified mix of businesses, so we don’t see its processing exposure as a negative.

The company recently completed two major new projects, the Meeker gas processing facility and the Sherman extension pipeline. The former is a gas processing facility located in Colorado; where gas demand outstrips processing capacity.

The Sherman Extension pipeline is in Texas near a prolific gas-producing unconventional play known as the Barnett Shale. It’s largely secured by transportation agreements with major producers. With a yield of more than 10 percent, Enterprise Products Partners is a buy under 27.

For a more aggressive play on natural gas, consider Regency Energy Partners (NSDQ: RGNC). Regency is a relatively small MLP with exposure to gas processing and gathering lines, small diameter pipelines that connect individual wells to the pipeline grid.

Both businesses have some exposure to commodity prices, but Regency has cut back this exposure in recent quarters while boosting its straight fee-based revenue stream.

But by far its most exciting project is the Haynesville Expansion Project, a 1.1 bcf per day line that will transport gas out of Louisiana’s prolific Haynesville Shale gas play. The Haynesville is emerging as the lowest-cost and highest potential natural gas play in the US. Total reserves in the field are estimated at as high as five times the current largest gas field in the US.

Chesapeake Energy (NYSE: CHK), Petrohawk Energy (NYSE: HK) and a number of smaller producers are actively drilling the play and have plans to continue development despite weak gas prices. However, the one major issue facing the Haynesville is a lack of pipeline capacity to transport gas from the region.

By partnering with GE Financial Services and private equity firm Alinda, Regency has secured financing for the new pipe. Management believes strong cash flows from the new project will allow it to maintain its 15 percent-plus yield regardless of the path of commodity prices. Regency Energy Partners is a buy for more aggressive income investors under 15.

Swimming Upstream

Until the beginning of 2006, all energy-related MLPs were involved in the midstream energy business. But Growth Portfolio bellwether Linn Energy (NSDQ: LINE) is involved in upstream energy operations, the production of oil and natural gas from fields across the Mid-Continent and Southern California. 

Linn’s distributions should remain safe whether gas is at $3 per million British thermal units or $13 thanks to the company’s extensive hedge position. Linn is 100 percent hedged through fiscal year 2011 and has hedged more than two-thirds of its 2012 production.

Even with gas prices at current levels, management estimates it will cover its 2009 distributions 1.1 times. There is room for upside when gas prices recover as Linn has some low-risk drilling opportunities on its existing properties. With a yield over 16 percent, Linn Energy is a buy under 20.

Finally, for investors seeking broad exposure to the MLP group or looking to hold MLPs inside a tax-advantaged account, consider Growth Portfolio holding Tortoise Energy Infrastructure (NYSE: TYG).

This closed-end fund holds some of our favorite MLPs and sports a yield near 11 percent. Tortoise Energy Infrastructure is a buy under 27.

Elliott H. Gue is editor of Personal Finance, The Energy Strategist and the complementary e-zines Pay Me Weekly and The Energy Letter.