How can MLPs pay out more in cash distributions than they are generating in net income?
The answer has to do with the way that depletion and depreciation expenses are treated. Depletion and depreciation expenses are a means of allocating the cost of a long-term asset, such as a coal property or a pipeline, over its useful life. They are called “noncash” expenses because cash is not actually being paid out for the depletion or depreciation of the long-term asset. A typical corporation must reinvest a substantial portion of its cash flow in order to replace its equipment, keep pace with technology, remain competitive or expand its business. After these payments are made, any remaining cash flow can be paid out to shareholders in the form of dividends. MLP assets, such as coal reserves and pipelines, however, are generally long-lived; require very little maintenance; and are not subject to major technological changes or physical deterioration. It is for these reasons that an MLP can pay out a very high level of its cash flow to unitholders without hurting the long-term basic
