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Midstream Energy Master Limited Partnerships

Economic Analysis – Contributions to Employment and Income

Prepared for the National Association of Publicly Traded Partnerships

By

John F. O’Hare Judy A. Xanthopoulos

Quantria Strategies, LLC www.quantria.com

301.322.9780 p 301.322.9781 f

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MIDSTREAM ENERGY MLP EMPLOYMENT AND INCOME ESTIMATES

CONTENTS

EXECUTIVE SUMMARY .....................................................................................................1 I. Overview .......................................................................................................................2

II. Economic Footprint of the Midstream Energy MLP Sector ...................................3

A. Organizational Structure ................................................................................3 B. Midstream Energy Pipelines ..........................................................................4 C. Current Investment ........................................................................................5 D. Current Employment (Direct) ........................................................................6 E. Economic Outlook ............................................................................................7

III. Cost of Capital and Changes in Investment ............................................................10 IV. I-O Analysis – Impact on Employment and Income ..............................................11

A. Economic Impact Multipliers .......................................................................11 B. Income and Jobs in the Midstream Energy Sector .....................................12 C. Forecast of the Cumulative Economic Impact ............................................13 D. Impact on the Industry from Imposing a Corporate-Level Tax ...............14

V. Summary and Conclusions .......................................................................................17 APPENDIX A – Detailed Economic Impact Estimates ......................................................18 APPENDIX B – NAICS Code Descriptions ........................................................................22 APPENDIX C – Technical Description of the Cost of Capital ..........................................24 APPENDIX D – Technical Description of the I-O Analysis ..............................................26 REFERENCES .......................................................................................................................30

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LIST OF TABLES Table 1 – Total Pipeline Miles, by Energy Source ..................................................................4 Table 2 – Employment and Earnings in the Midstream Energy Sector, 2005 to 2010 .............7 Table 3 – Type II Employment Multipliers for the midstream energy MLP Sector ...............12 Table 4 – Total Contribution of the Midstream Energy MLP Sector to Employment and Income, 2012 ...........................................................................................................13 Table 5 – Economic Impact of the Midstream Energy MLPs, 2012 to 2016 .........................14 Table 6 – Estimated Impact on Midstream Energy MLPs from Imposing a Corporate Level Tax, 2012-2016 .............................................................................................15 Table 7 – Detailed Economic Impact of the Midstream Energy MLPs, 2012 to 2016 ...........17 Table 8 – Detailed Estimated Impact on Midstream Energy MLPs from Imposing a Corporate Level Tax, 2012-2016 ............................................................................19 Table 9 – Equipment and Structures Classes for Present-Value of Depreciation Estimates

Supporting the User-Cost of Capital Estimates .......................................................25 LIST OF GRAPHS Graph 1 – Capacity Additions from Natural Gas Pipeline Investment, 2001 through 2011 ..................................................................................................5 Graph 2 – Economic Impact on Midstream Energy Employment from Imposing a Corporate Level Tax, 2012 to 2016 ......................................................................16 Graph 3 – Economic Impact on Midstream Energy Income from Imposing a Corporate Level Tax, 2012 to 2016 .......................................................................................16 LIST OF FIGURES Figure 1 – Lower 48 States Shale Plays ....................................................................................8

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MLP EMPLOYMENT AND INCOME ESTIMATES

EXECUTIVE SUMMARY

� Midstream energy MLPs form the backbone of our energy infrastructure, serving as the link between exploration and production and end-use consumers.

� In order to meet the nation’s energy needs, the midstream energy sector must reinvest

continually in this pipeline infrastructure through expansion and development.

� Midstream energy companies added approximately 2,400 miles of new pipeline to the existing infrastructure in 2011.

� Imposing a new tax on the income of energy MLPs will increase the cost of capital facing

these firms and in response to these higher costs, firms will reduce investments in plant and equipment – investment that is fundamental to production, employment and growth in the sector.

� Investment and employment by energy MLPs affect the U.S. economy directly by offering

wages that far exceed the national average; indirectly through jobs and employment in industries that supply equipment and services to the midstream sector; and through induced employment from household spending.

� For 2012, we estimate that the energy MLP sector supports approximately 323,000 jobs in

the United States. Of this total, about 63,000 result from direct employment in the sector while the remaining employment offer support through the supply chain linkages.

� Over the next five years, our figures show modest but steady growth in the sector with a total

(direct, indirect and induced), average level of employment supported by the industry of about 330,000 thousand jobs and cumulative wages totaling $147 billion.

� If midstream energy MLPs are subject to a new, corporate-level tax, our analysis indicates

that total annual employment will decrease by more than 27,000 jobs over the next five years and wages paid to workers directly and indirectly by the sector will decrease by about $2 billion.

� On an annual equivalent basis, the MLP industry will support more than 1.6 million jobs over the next 5 years or about 330,000 per year1. If a new corporate level tax is imposed, we estimate that annual equivalent employment will decrease by about 88,000 over the next five years or about 17,000 per year, with a corresponding annual equivalent decrease in direct and indirect wages of approximately $6 billion.

1 We define annual equivalent employment as the number of full-time jobs supported over a 12-month period. Annual equivalent income is the amount of wage and salary income supported over a 12-month period.

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I. Overview Master limited partnerships (MLPs) in the midstream energy sector directly employ over 63,000 workers who build our nation’s infrastructure of pipelines, storage tanks and delivery systems for oil and natural gas. These MLPs comprise an important component of the delivery system for oil and natural gas. Their organizational structure provides a lower cost of capital to the MLPs and a steady, reliable stream of earnings to retail investors and retirees. In this report, we examine the likely economic effects that will occur if the tax treatment of midstream energy MLPs changes fundamentally. In particular, imposing an additional layer of tax on the income of this sector will likely have profound effects on the viability of the present MLP business model and future infrastructure investments in the United States. Most economists agree that imposing a new tax on the income of energy MLPs will increase the cost of capital facing these firms.2 According to economic theory, an increase in the cost of capital will result in lower capital investment. In response to these higher costs, it is likely that firms will reduce investments in plant and equipment that is fundamental to production, employment and growth in the sector. Reduced capital results in a concomitant reduction in output and employment in the sector. Economists refer to this reduction as the direct effect of the initial decrease in investment. Furthermore, this reduction will have an indirect effect – ripple effects across other industrial sectors linked with the midstream energy sector through the supply chain with other related industries. To estimate these effects, we implemented two distinct, but closely related modeling strategies. In the first stage, we employed Quantria Strategies’ cost of capital model to estimate the investment costs firms face under present law – that is, in the absence of a corporate level tax. Next, we estimated how this would change under a tax regime where MLPs are subject to tax as corporations. To estimate the effect on income and employment of this reduced investment, in the second stage we used a specific type of macroeconomic model – an Input-Output (I-O) model – one especially favorable to identifying the inter-industry changes in final demand.

2 For general changes in taxes on investment, see Congressional Budget Office (2006), Computing Effective Tax Rates on Capital Income, Background Paper, December. For energy MLPs specifically, see the recent paper by Swagel, Phillip and Robert Carroll, The Impact of Changes to the Tax Treatment of Master Limited Partnerships, report delivered to the National Association of Publicly Traded Partnerships, 2012.

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II. Economic Footprint of Midstream Energy MLPs

Midstream energy MLPs form the backbone of our energy infrastructure, serving as the link between exploration and production and end-use consumers. For the 66 energy MLPs traded on public exchanges at the time this report was written,3 this organizational structure lowers the cost of capital for energy infrastructure assets while at the same time offering reliable returns to individual investors.4 As an investment vehicle, MLPs derive much of their popularity from the fact that they provide their investors, mostly individuals, with a reliable income stream through quarterly cash distributions. For 30 years, MLPs have offered an effective and efficient means of meeting our domestic energy needs. Midstream energy companies are responsible for moving the majority of energy products through oil and gas pipelines. These energy products provide resources needed for national defense, to generate power for homes and businesses (for heating, cooling, lighting and business production), as well as to fuel our vast transportation system. The midstream energy sector is responsible for transporting oil and gas resources through a highly integrated transmission and distribution grid in the lower 48 states. They are the critical link between energy developers and local distributors. A. Organizational Structure Under current law, an MLP is a publicly traded partnership (PTP): a partnership or LLC whose interests trade on an established securities market, or are readily tradable on a secondary market. In general, a PTP is subject to tax as a corporation, but the tax code provides an exception from corporate treatment, if 90 percent or more of the PTP’s gross income is interest, dividends, real property rents, or certain other types of qualifying income. Under this exception, income and gains from certain activities with respect to minerals or natural resources are qualifying income.5 The term MLP as popularly used generally refers to publicly traded partnerships and LLCs that operate active businesses, primarily energy related.6 An MLP is a pass-through entity (like all partnerships) which is not subject to Federal income tax. Income earned by the partnership is allocated to the collection of partners (referred to as unitholders) and is taxed at their relevant tax rate. The unitholders treat income allocated to them by the MLP as if the unitholder earned

3 For purposes of this analysis, we exclude 6 MLPs whose principal line of business is the mining of coal and other minerals and 5 MLPs that organized in a foreign country. The remaining 66 MLPs operate in 4 North American Industrial Classification System (NAICS) categories – pipeline transportation (486), petroleum bulk stations and terminals (424710), water transportation (483), and oil and gas extraction (211). 4 Refer to Wells Fargo Equity Research, MLP Primer, Fourth Edition, November 19th, 2010. 5 Section 7704(d)(1)(E) states that “income and gains derived from the exploration, development, mining or production, processing, refining transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber), industrial source carbon dioxide, or the transportation, or storage of any fuel described in subsections (b), (c), (d), or (e) of section 6426, or any alcohol fuel defined in section 6426(b)(4)(A) or any biodiesel fuel as defined in section 40A(d)(1).” 6 A substantial number of PTPs operate as investment funds, usually commodity funds, but generally, these are not considered MLPs. Refer to the National Association of Publicly Traded Partnerships (NAPTP), Master Limited Partnerships 101, available at http://www.naptp.org/documentlinks/Investor_Relations/MLP_101.pdf.

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(directly) the MLP’s income.7 MLPs make regular cash distributions to the unitholders, which they can use to pay tax on the allocated amounts. The equity market capitalization for these 66 energy MLPs was approximately $270 billion as of March 22, 2012. B. Midstream Energy Pipelines Throughout the United States, there are approximately 475,000 miles of midstream energy pipeline distributing energy resources. 8 Midstream energy firms generally provide fee-based services to the producers and consumers of energy. Virtually all natural gas consumed in the United States flows through facilities owned by midstream energy MLPs. Pipelines owned by MLPs account for just over half of the total pipeline-miles used for crude oil transportation and more than 30 percent of the pipeline-miles involved in the transportation of refined petroleum products such as gasoline and other fuels.9 Midstream energy MLPs collect products through gathering lines from sources such as land or offshore wells and shipping tankers. They build and operate the oil and gas pipeline network – transmission lines – that move the energy products throughout the country.

Table 1 – Total Pipeline Miles, by Energy Source

Energy Source Pipeline Miles

Hazardous Liquids (includes petroleum and refined petroleum products, including chemicals and hydrogen) 170,000 Natural Gas (includes natural gas and liquefied natural gas)

Interstate Pipelines Intrastate Pipelines

205,000 100,000

Total 475,000 Source: Pipeline-mile estimates for hazardous liquid are available from the Pipeline and Hazardous Materials Safety Administration (PHMSA) of the Department of Transportation and pipeline-mile estimates for natural gas are available from Energy Information Administration of the Department of Energy. These transmission lines pass through compressor stations that maintain the pipeline pressure. Ultimately, midstream energy companies deliver the energy sources to delivery points, underground storage facilities, export pipelines, and liquefied natural gas (LNG) peaking facilities. According to the Energy Information Administration (EIA), the 305,000 pipeline miles in the U.S. natural gas network consists of more than 210 separate pipeline systems. These pipeline systems, owned and maintained by the midstream energy companies, include over 1,400 compressor stations that maintain pressure within the pipelines. These compressors deliver continuously the natural gas to 17,400 delivery points.10 In addition, the midstream energy sector maintains over 400 7 Each unitholder receives annually a K-1 form that reports the unitholder’s proportionate share of the MLP’s income, gain, deductions, losses, and credits. 8 Refer to the Department of Transportation, PHMSA and Department of Energy, Energy Information Administration. 9 Refer to Swagel, Phillip and Robert Carroll, The Impact of Changes to the Tax Treatment of Master Limited Partnerships, report delivered to the National Association of Publicly Traded Partnerships, 2012. 10 This total includes the 11,000 delivery points, 5,000 receipt points, and 1,400 interconnection points that enable the transfer of natural gas throughout the country.

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underground natural gas storage facilities, 49 import/export locations, and approximately 100 liquefied natural gas peaking facilities.11 The importance of this pipeline transportation system cannot be overstated. This network of midstream energy pipelines ensures that the nation’s energy supplies reach energy consumers. In order to meet the nation’s energy needs, the midstream energy sector must reinvest continually in this pipeline infrastructure through expansion and development. This expansion and development means that midstream energy companies must maintain and increase the pipeline capacity. This may require companies to build new pipelines or convert an existing oil pipeline to a natural gas pipeline. Often, they will install a parallel or adjacent pipeline along an existing pipeline. In addition, the midstream energy companies must maintain and improve the existing capacity by improving or expanding existing facilities or compressor stations along existing pipeline routes. C. Current Investment The EIA estimates that midstream energy companies added approximately 2,400 miles of new pipeline to the existing infrastructure in 2011. These pipeline miles were part of over 25 separate construction projects that increased transportation capacity by approximately 40,000 billion cubic feet of natural gas per day.12 As shown in Graph 1, midstream energy companies have increased the country’s natural gas transportation capacity throughout the past ten years.

11 Peaking facilities or peak shaving facilities provide system design to permit a natural gas pipeline to meet short-term surges in customer demands with minimal infrastructure. Through the peaking facility, changes in demand are addressed by using gas from storage or by short-term line packing. 12 Refer to the U.S. EIA, GasTran Natural Gas Transportation Information System, Natural Gas Pipeline Projects Database.

9,262 12,848

10,423 7,661 8,198

12,705 14,859

44,589

19,035

24,469

40,357

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011p

Billi

on c

ubic

feet

per

day

Graph 1 Capacity Additions from Natural Gas Pipeline Investment, 2001 through 2011

Source: U.S. Energy Information Administration, GasTran Natural Gas Transportation Information System, Natural Gas Pipeline Projects Database

Capacity Additions

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This 2011 capacity investment was below the levels for 2008, when midstream energy companies increased transportation capacity by approximately 45,000 billion cubic feet of natural gas per day.13 However, it is important to recognize the lag structure inherent in this form of investment, as companies must embark in long planning and approval processes before placing in service the pipeline capacity. These capacity increases, in any given year, reflect a 2 to 3 year planning and construction process before realization. In order to meet the ongoing investment in new capacity, midstream energy companies must first estimate demand and market interest for the pipeline project. After announcing publicly the project, the midstream energy company must obtain the appropriate regulatory approval. Once these requirements are met, construction of the pipeline may begin. Following construction, the pipeline undergoes rigorous testing and inspection before being placed in service. D. Current Employment (Direct) At present, the midstream energy sector provides direct employment for approximately 136,000 individuals in the United States.14 The Economic Census classifies these workers in four North American Industrial Classification System (NAICS) categories – pipeline transportation (486), petroleum bulk stations and terminals (424710), water transportation (483), and oil and gas extraction (211). While the focus of this study is on midstream energy and petroleum MLPs, it is useful to consider the entire U.S. midstream energy and petroleum sectors.15 First, it is important to consider the size of the sector relative to the U.S. economy. Second, it serves as a guide to allocate employment and wages to energy MLPs. Table 2 provides an industry snapshot for 2005 to 2010 for the four NAICS sectors that are the focus of this study.16 Several important facts emerge from this data. Each of these factors plays an important role in the economic impact analysis of the midstream energy MLPs for the near to mid-term. These facts include:

� Total employment in each sector has been flat or in decline since the 2008 recession.

� Oil and gas extraction is by far the largest sector, but very few midstream energy MLPs operate in this sector.

� Average wages across all the energy sectors are substantially above the average wages of all U.S. workers (approximately $46,000 for private workers in 2010).17

13 2011 values are preliminary figures from the U.S. Energy Information Administration. 14 We include Oil & Gas Exploration and Production (E&P), or the “upstream” sector, in these figures because there are presently 14 MLPs that operate in this sector. 15 We include a portion of the upstream sector, because a few midstream MLPs report activities included in this industry classification. Any tax law change would affect these MLPs as well. 16 The data are from the Bureau of Labor Statistics, Quarterly Census of Employment and Wages. 17 This will have important impacts when measuring the induced effects for the industry in the I-O framework.

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� The cumulative growth in employment over the period has been substantially higher in the oil and gas extraction and water transportation sectors than in the pipeline transportation sector.

Table 2 – Employment and Earnings in the Midstream Energy Sector, 2005 to 2010

NAICS Code Industry 2005 2006 2007 2008 2009 2010

Number of Employees 211 Oil and Gas Extraction 125,818 134,858 146,081 160,081 160,688 158,423

23712 Petroleum Bulk Stations and Terminals 32,516 32,556 32,232 32,492 32,067 31,781

483 Water Transportation 58,779 61,038 62,923 64,595 62,738 62,401 486 Pipeline Transportation 37,910 38,676 40,303 41,116 41,384 42,265 Total Employees 255,023 267,128 281,539 298,284 296,877 294,870

Total Wages (in millions) 211 Oil and Gas Extraction 14,739 17,689 19,357 23,038 21,605 23,080

23712 Petroleum Bulk Stations and Terminals 1,811 1,971 2,012 2,038 2,082 2,099

483 Water Transportation 3,459 3,795 4,286 4,568 4,473 4,552 486 Pipeline Transportation 3,179 3,567 4,019 4,053 4,164 4,451 Total Wages 21,371 23,188 27,023 29,675 33,698 32,325

Average Wages (in dollars) 211 Oil and Gas Extraction $117,147 $131,165 $132,510 $143,914 $134,456 $145,684

23712 Petroleum Bulk Stations and Terminals $48,074 $54,205 $61,647 $68,245 $67,653 $65,649

483 Water Transportation $58,847 $62,181 $68,119 $70,722 $71,298 $72,941 486 Pipeline Transportation $83,848 $92,233 $99,732 $98,587 $100,618 $105,314 Source: Quarterly Census on Employment and Wages (QCEW), Bureau of Labor Statistics

E. Economic Outlook During the past several years, the EIA began recognizing shale gas as a “game changer” for the U.S. natural gas market. Within shale formations, exploration has identified dry shale gas, wet shale gas, and shale oil. The increase in production of new shale plays increased dry shale gas production in the United States from 1.0 to 4.8 trillion cubic feet between 2006 and 2010. This increased production represents 23 percent of total 2010 U.S. dry natural gas production.18 In addition to dry shale gas, wet shale gas reserves increased to about 60.64 trillion cubic feet by 2009, when the EIA estimates that they comprised about 21 percent of overall U.S. natural gas reserves. In addition, oil production from shale plays, notably the Bakken Shale in North Dakota and Montana, has grown rapidly in recent years. The following figure shows the location of the shale plays in the lower 48 states.

18 Refer to U.S. Department of Energy, Energy Information Administration, Review of Emerging Resources: U.S. Shale Gas and Shale Oil Plays, July 2011.

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Figure 1

Source: U.S. Department of Energy, EIA, 2011 To gain a better understanding of the potential U.S. domestic shale gas and shale oil resources, EIA commissioned INTEK, Inc. to develop an assessment of onshore technically recoverable shale gas and shale oil resources in the lower 48 States. The INTEK shale resources report estimates shale gas and shale oil resources for the undeveloped portions of 20 shale plays.19 INTEK estimates that 750 trillion cubic feet of natural gas resources are available in these undeveloped plays.20 These estimates exclude three components: proven reserves, inferred reserves in actively developed areas, and un-discovered resources.21 Of the total 750 trillion cubic feet of technically recoverable shale gas, approximately 86 percent are in the Northeast, Gulf Coast, and Southwest regions (which account for 63 percent, 13 percent, and 10 percent of the total, respectively). In these regions, the largest shale gas plays are the Marcellus (410.3 trillion cubic feet, 55 percent of the total), Haynesville (74.7 trillion cubic feet, 10 percent of the total), and Barnett (43.4 trillion cubic feet, 6 percent of the total) plays. The report estimates that 23.9 billion barrels of recoverable shale oil resources are available in the lower 48 states. The largest shale oil formation is the Monterey/Santos play in southern California.

19 With subdivisions of certain plays, this creates 29 separate resource assessments. 20 The 750 trillion cubic feet of shale gas resources in the INTEK shale report is a subset of the AEO2011 onshore lower 48 states natural gas shale recoverable resource estimate of 862 trillion cubic feet (details may not add due to rounding). The remainder of the AEO2011 includes 35 trillion cubic feet of proven reserves reported to the Securities and Exchange Commission and the EIA, 20 trillion cubic feet of inferred reserves not included in the INTEK shale report, and 56 trillion cubic feet of undiscovered resources estimated by the USGS. 21 The U.S. Geological Survey estimates separately the undiscovered reserves.

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Estimates suggest that this formation holds 15.4 billion barrels or 64 percent of the total available shale oil resources.22 Estimates of technically recoverable shale gas resources are certain to change over time as new wells go into production and new technologies are developed. As a result, individual well production rates and recovery rates can vary by as much as a factor of 10. There is considerable uncertainty regarding the ultimate size of recoverable shale gas and oil reserves. These factors work in opposite directions, some increasing or decreasing the potential energy recovery.23 Therefore, we moderated our estimates of the growth to consider the following factors:

� Long-term production profiles of shale wells and their estimated ultimate recovery of oil and natural gas are uncertain, because most formations are new and untested;

� The current production from emerging shale plays may overstate the potential reserves, because production concentrates in areas with the highest known production rates;24

� The larger shale plays (e.g., the Marcellus shale) have not undergone extensive production testing;

� Technological change could advance the productive capacity through less costly well drilling and completion;

� Currently untested shale plays may prove to offer greater productive capacity than originally estimated; and

� Midstream MLPs will be the primary builders of infrastructure to take the natural gas and oil out of the shale plays and on to processing and transportation.25

22 The Monterey shale play is the primary source rock for the conventional oil reservoirs found in the Santa Maria and San Joaquin Basins in southern California. The next largest shale oil plays are the Bakken and Eagle Ford, which hold approximately 3.6 billion barrels and 3.4 billion barrels of oil, respectively. 23 Refer to U.S. Department of Energy, Energy Information Administration, Review of Emerging Resources: U.S. Shale Gas and Shale Oil Plays, July 2011. 24 The INTEK shale report for the EIA attempts to mitigate this problem by differentiating the productivity of a play’s sweet spot from the productivity for rest of that play. 25 The Interstate Natural Gas Association of America (INGAA) estimates that we will need to invest an additional $250 billion in pipelines and related facilities to meet the needs of the developing shale production through 2035.

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III. Cost of Capital and Changes in Investment Over the past 25 years, Federal tax policy has offered an important incentive to midstream energy MLPs. The goal of this tax policy is to encourage investment in the capital intensive, low return assets characterizing this important industry. Tax policy directed at influencing investment opportunities may alter the effective prices of capital goods, making investment more attractive as the tax-adjusted price falls and less attractive as it rises. When tax policy increases the relative prices of capital assets such as pipelines, misallocation of capital investment may occur across capital assets. In other words, changing the existing tax policy framework will alter the incentives to invest in midstream assets. A tax-induced increase in the price of pipeline assets relative to other investment capital encourages substitution away from pipeline assets. We employ the most widely used measure of investment costs (including taxes) facing businesses – the Hall-Jorgenson formula for the user cost of capital.26 The derivation of this formula is from a model that equates asset cost to the discounted future earnings flowing from the asset. This formula, also referred to as the “rental price” or “rental value of capital services,” represents the marginal cost of $1 of investment. Estimates of the user cost of capital vary by industry and depend on the mix of investment made within each sector. For example, industrial sectors that invest proportionately more in equipment than in structures (see Table 9 in Appendix C) will face a higher cost of capital. This analysis calculated the user cost of capital for each industry in the midstream energy sector, under two scenarios: (1) under present law where there is no corporate level tax and (2) under the assumption that MLPs are subject to corporate taxes.27 This difference in the cost of capital under each tax regime will change total investment in the midstream energy assets. A change in the tax on capital often alters the relative cost of capital assets, particularly in the case of long- and short-lived assets. For instance, a ten percent increase in the statutory tax rate will have a greater impact on assets with longer service lives. Pipeline assets are such assets, as they are likely to remain in service indefinitely following construction. Our analysis finds that this tax change would increase the user cost of capital by approximately 8.5 percent. The higher cost of capital would alter the investment decisions of the MLPs that build pipelines, leading them to build fewer pipelines and/or take longer to get to the level needed to transport projected oil and gas supplies. In addition, a corporate level tax would affect investment in MLPs, as corporate taxation would most likely force MLPs to reduce their distributions, which are the primary attraction for investors. This will generate not only more expensive but also less available capital for these important investments in the midstream energy industries. The following sections incorporate our cost of capital measures in our estimates of the impact on investment of this tax change. This investment change then passes to our I-O model of the U.S. economy to measure the total effect on employment and income.

26 Hall, R.E and D.W. Jorgenson (1967), “Tax Policy and Investment Behavior”, American Economic Review, June, pp. 391-414. 27 Refer to Appendix B for a discussion of our methodology.

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IV. I-O Analysis – Impact on Employment and Income

Our underlying I-O model reports inter-industry transactions and output by NAICS codes. We examined publicly available financial information (i.e., 10-Ks) for the approximately 66 energy MLPs presently trading on public exchanges to map properly energy MLPs into the major industry groupings. We identified the following four industry groups that comprise most, if not all, of the energy MLPs:28 NAICS subsector 211 (oil and gas extraction), subsector 424710 (petroleum bulk stations and terminals), subsector 483 (water transportation) and subsector 486 (pipeline transportation).29 With these industries identified, the next step was to segregate the MLPs from other types of entities (e.g., C corporations). This was necessary because the I-O data represents all U.S. economic activity and is not specific to any type of business organization. In performing this allocation, again we relied on publicly available financial reports to estimate the size of the MLP sector. A listing of the 66 MLPs used in this analysis is contained in Appendix C along with relevant financial information that helped guide the allocations. A. Economic Impact Multipliers I-O models allow the calculation of three different effects as production moves through the supply chain:30

� Direct effects represent those impacts that occur within a particular industry. For example, the number of workers employed by energy MLPs would represent a direct effect;

� Indirect effects refer to those economic impacts that occur in other industries as a direct result of supplying inputs to the energy MLPs. Many economists refer to indirect effects as “ripple” effects; and

� Induced effects capture the additional impact on income and employment as workers spend the earnings they receive, either directly or indirectly, on goods and services produced for final consumption.

The sum of the direct, indirect and induced effects represents the total effect of an industry’s impact. The multiplier calculations are industry-specific “multipliers” that capture the inter-industry linkages and the flow of goods and services through the economy. This analysis relies on “Type II” multipliers (i.e., multipliers that identify direct, indirect and induced effects of employment). We

28 These descriptions come from the NAICS website at www.census.gov. 29 These NAICS industrial sectors conform to the following MLP industrial classes: (1) Oil & Gas E&P, (2) Propane and Refined Fuel Distribution, (3) Marine Transportation and (4) Midstream Operations, Compression and Refining, respectively. Some midstream energy companies have secondary operations in such areas as gathering pipeline construction. However, for this analysis these secondary operations are not shown separately from their primary business classification. After eliminating those MLPs in Marine Transportation that organized in foreign countries, there was one remaining Marine MLP. For confidentiality purposes, data for this Marine MLP has been included in the Pipeline Transportation sector.,. 30 Several of the midstream energy MLPs have downstream operations, and these are included in the estimates.

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accomplish this by extending the conventional I-O framework by making the household sector part of the interrelated or endogenous sectors – referred to by economists as “closing the model.”31 Historically, I-O analysis allows the calculation of several types of multipliers, the most common relating to output, income, employment and value added. Table 3 shows the direct, indirect, induced and total effect for each industry in our study calculated as a Type II employment multiplier.

Table 3 – Type II Employment Multipliers for the

Midstream Energy MLP Sector

NAICS Code Industry Direct Indirect Induced Total

211 Oil and Gas Extraction 1.0000 1.5075 4.4143 6.9218

424710 Petroleum Bulk Stations and Terminals 1.0000 0.5129 2.6634 4.1764

483 Water Transportation 1.0000 1.6587 4.6806 7.3393 486 Pipeline Transportation 1.0000 0.9060 3.3555 5.2616

These multipliers form the starting point of our economic impact analysis and measure the combined effect of an additional job in each energy sector. For example, the figures indicate that for the pipeline transportation sector (NAICS 486) every job results in about 0.9 additional jobs in sectors supplying goods and services and about 3.4 additional jobs related to spending the income earned directly by employees and indirectly by those employees supporting the pipeline transportation industry through the supply chain. Alternatively expressed as each job in the pipeline transportation industry results in about 4.3 additional jobs (indirect plus induced or 5.2616 – 1.0000) through indirect and induced effects. The Type II multipliers reported in Table 3 are consistent with those reported in other studies of the Energy Sector.32 The induced effect dominates the total impact, because of the relatively high wages paid in the industry. B. Income and Jobs in the Midstream Energy MLP Sector For 2012, we estimate that the midstream energy MLP sector will support approximately 322,000 jobs and generate income of approximately $26 billion in the United States. Of this total employment, about 63,000 result directly from employment in the sector, while the remaining employment offer support through the supply chain linkages. Most of these jobs are from the induced effect of workers spending their earnings on consumption items. Of this total income, about

31 Refer to Appendix D for additional details on this methodology. 32 Jobs and Economic Benefits of Midstream Infrastructure Development: U.S. Impacts through 2035, Black & Veatch for the INGAA Foundation, February 2012.

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$3.2 billion results directly from the sector, while the indirect and induced effects generate the remaining income. Table 4 shows our estimate of the total impact on employment and income for the midstream energy MLP sector in 2012. Most of the direct employment and income effects come from the pipeline transportation sector (NAICS 486). In recent years, firms in this sector have tended to organize as MLPs.33

Table 4 – Total Contribution of the Midstream Energy MLP Sector to Employment and Income, 2012

(Income expressed in thousands of dollars) Employment

Industry Direct Indirect Induced Total Oil and Gas Extraction 4,040 6,090 17,835 27,965 Petroleum Bulk Stations and Terminals 17,831 9,146 47,492 74,468 Pipeline Transportation 41,025 38,842 140,603 220,470 Total 62,896 54,078 205,929 322,903

Income Industry Direct Indirect Induced Total

Oil and Gas Extraction 654,440 739,908 1,877,784 3,272,132 Petroleum Bulk Stations and Terminals 1,309,559 503,768 2,267,159 4,080,487 Pipeline Transportation 4,723,855 3,311,701 10,458,360 18,493,917 Total $6,687,854 $4,555,378 $14,603,303 $25,846,535

C. Forecast of the Economic Impact To determine the combined effect on the midstream energy MLP sector over the next several years, we relied on several sources to extrapolate, or age, the underlying data in our I-O model. These data sources include:

� Macroeconomic forecasts of the Congressional Budget Office (CBO) that provide estimates of income, employment and corporate profits out to 2022;

� Industry specialists and the near-term outlook for the midstream energy sector;

� Shale plays and how this may affect economic growth in the sector; and

� Industry estimates of miles of pipeline to be built in the next few years. Table 5 shows our year-by-year estimates of employment and income for the period 2012 to 2016.34

33 Conversely, economy-wide, the gas & oil extraction sector (NAICS 211) is quite large; however, most of these larger companies are organized as C corporations. Many of the smaller oil and gas extraction companies organize as non-publicly traded partnerships or LLCs. Neither of these two types of companies is part of this analysis. 34 Refer to Appendix A for the supporting details of the economic impact estimates.

14

Our figures show modest but steady growth in the sector over the next five years consistent with growth in new sources of energy production in the midstream energy sector.

Table 5 –Economic Impact of the Midstream Energy MLPs, 2012 to 2016

(Income expressed in thousands of dollars)

2012 2013 2014 2015 2016 Employment

All Energy MLPs Direct 62,896 63,525 64,160 64,802 65,450 Indirect 54,078 54,619 55,165 55,717 56,274 Induced 205,929 207,989 210,069 212,169 214,291 Total Impact 322,903 326,132 329,394 332,687 336,014 Cumulative Impact All Energy MLPs Direct 62,896 126,421 190,581 255,383 320,833 Indirect 54,078 108,697 163,862 219,579 275,853 Induced 205,929 413,918 623,987 836,156 1,050,447 Total Impact 322,903 649,035 978,429 1,311,116 1,647,130

Income All Energy MLPs Direct 6,687,854 7,122,565 7,585,531 8,078,591 8,603,699 Indirect 4,555,378 4,851,477 5,166,823 5,502,667 5,860,340 Induced 14,603,303 15,552,517 16,563,431 17,640,054 18,786,658 Total Impact 25,846,535 27,526,560 29,315,786 31,221,312 33,250,697 Cumulative Impact All Energy MLPs Direct 6,687,854 13,810,419 21,395,950 29,474,541 38,078,240 Indirect 4,555,378 9,406,855 14,573,678 20,076,345 25,936,685 Induced 14,603,303 30,155,820 46,719,251 64,359,305 83,145,963 Total Impact 25,846,535 53,373,095 82,688,881 113,910,193 147,160,890

D. Impact on the Industry from Imposing a Corporate Level Tax There is no doubt that legislation that imposes a corporate-level tax on the midstream energy MLP sector will have a negative effect on industry growth as the cost of capital the industry faces will rise substantially and investments that might have been profitable under the current tax regime are no longer cost effective. It is difficult to say just what the industry response might be to the higher tax rate, as this involves questions as to who bears the ultimate tax burden. In preparing our estimates, we assumed the following:

� Midstream energy MLPs will pass to their customers the higher taxes in the form of higher prices (i.e., the tax is shifted forward); and

15

� In response to the higher cost of capital, firms will reduce investments in plant and equipment.

Table 6 shows the combined impact in the output, employment and income in the midstream energy MLP sector.35 Our estimates indicate that if midstream energy MLPs are subject to a corporate-level tax, they will reduce employment by over 27,000 jobs over the 5-year period. Similarly, wages paid to workers directly and indirectly employed by the sector will decrease by about $2 billion, or about 4 percent, from their current level. As before, most of the job and income loss occurs in sectors other than midstream energy MLPs through the indirect and induced effects and primarily through the pipeline transportation sector (NAICS 486).

Table 6 – Cumulative Economic Impact on Midstream Energy MLPs, From

Imposing a Corporate Level Tax, 2012 to 2016 (Income expressed in thousands of dollars)

2012 2013 2014 2015 2016

Employment All Energy MLPs Direct -1,572 -2,508 -3,448 -4,393 -5,344 Indirect -1,352 -2,156 -2,965 -3,778 -4,594 Induced -5,148 -8,211 -11,290 -14,385 -17,495 Total Impact -8,073 -12,876 -17,703 -22,556 -27,433

Income All Energy MLPs Direct -167,196 -243,271 -327,876 -421,765 -525,748 Indirect -113,884 -165,702 -223,330 -287,282 -358,109 Induced -365,083 -531,195 -715,936 -920,947 -1,147,999 Total Impact -646,163 -940,168 -1,267,143 -1,629,993 -2,031,856

Graphs 2 and 3 present the economic impact on employment and income in the midstream energy sector from imposing a corporate level tax. As the graphs indicate, the change would have a significant direct and indirect impact on the industry.

35 Refer to Appendix A for the supporting details of the economic impact estimates of imposing a corporate level tax on midstream energy MLPs.

16

-8.1

-4.8 -4.8 -4.9 -4.9

-12.9

-17.7

-22.6

-27.4 -30.0

-25.0

-20.0

-15.0

-10.0

-5.0

0.02012 2013 2014 2015 2016

Job

Loss

es in

thou

sand

s Graph 2 Economic Impact on Midstream Energy Employment from Imposing

a Corporate Level Tax, 2012 to 2016 (job losses in thousands)

Annual Job Loss Cumulative Job Loss

-$646

-$294 -$327 -$363 -$402

-$940

-$1,267

-$1,630

-$2,032

-$2,500

-$2,000

-$1,500

-$1,000

-$500

$02012 2013 2014 2015 2016

Inco

me

in m

illio

ns o

f dol

lars

Graph 3 Annual and Cumulative Impact on Midstream Energy Income from Imposing a Corporate Level Tax, 2012 to 2016

(income in millions of dollars)

Annual Job Loss Cumulative Job Loss

17

V. Summary and Conclusions Imposing a new tax on the income of midstream energy MLPs will increase the cost of capital facing these firms. In response to these higher costs, firms will reduce their investments in plant and equipment. This investment is fundamental to production, employment and growth in the sector. Investment and employment by midstream energy MLPs affect the U.S. economy directly by offering wages that far exceed the national average; indirectly through jobs and employment in industries that supply equipment and services to the midstream sector; and through induced employment from household spending. For 2012, we estimate that the midstream energy MLP sector supports approximately 323,000 jobs in the United States. Of this total, over 63,000 result directly from employment in the sector, while the remaining employment offer support through the supply chain linkages. Over the next five years, our figures show modest but steady growth in the sector with a total (direct, indirect and induced), average level of employment supported by the industry of about 330,000 jobs and cumulative wages of $147 billion. If midstream energy MLPs are subject to a new, corporate-level tax, our figures indicate that total employment will decrease by more than 27,000 jobs over the next five years and wages paid to workers directly and indirectly by the sector will decrease by more than $2 billion. On an annual equivalent basis, the MLP industry will support more than 1.6 million jobs over the next 5 years or about 330,000 per year.36 If a new corporate level tax is imposed, we estimate that annual equivalent employment will decrease by about 88,000 over the next five years or about 17,000 per year, with a corresponding annual equivalent decrease in direct and indirect wages of approximately $6 billion.

36 We define annual equivalent employment as the number of full-time jobs supported over a 12-month period. Annual equivalent income is the amount of wage and salary income supported over a 12-month period.

18

Appendix A – Detailed Economic Impact Tables Table 7 provides the supporting details of the economic impact of the midstream energy MLPs shown in Table 5. Table 8 provides the supporting details of the economic impact of imposing a corporate level tax on midstream energy MLPs shown in Table 6.

Table 7 – Detailed Economic Impact of the Midstream Energy MLPs, 2012 to 2016

(Income expressed in thousands of dollars)

2012 2013 2014 2015 2016 Employment

All Energy MLPs Direct 62,896 63,525 64,160 64,802 65,450 Indirect 54,078 54,619 55,165 55,717 56,274 Induced 205,929 207,989 210,069 212,169 214,291 Total Impact 322,903 326,132 329,394 332,687 336,014

Oil and Gas Extraction Direct 4,040 4,081 4,121 4,163 4,204 Indirect 6,090 6,151 6,213 6,275 6,338 Induced 17,835 18,013 18,193 18,375 18,559 Total Impact 27,965 28,245 28,527 28,813 29,101

Petroleum Bulk Stations and Terminals Direct 17,831 18,009 18,189 18,371 18,555 Indirect 9,146 9,237 9,330 9,423 9,517 Induced 47,492 47,967 48,446 48,931 49,420 Total Impact 74,468 75,213 75,965 76,725 77,492

Pipeline Transportation Direct 41,025 41,435 41,849 42,268 42,690 Indirect 38,842 39,230 39,623 40,019 40,419 Induced 140,603 142,009 143,429 144,864 146,312 Total Impact 220,470 222,674 224,901 227,150 229,422

Income All Energy MLPs Direct 6,687,854 7,122,565 7,585,531 8,078,591 8,603,699 Indirect 4,555,378 4,851,477 5,166,823 5,502,667 5,860,340 Induced 14,603,303 15,552,517 16,563,431 17,640,054 18,786,658 Total Impact 25,846,535 27,526,560 29,315,786 31,221,312 33,250,697

Oil and Gas Extraction Direct 654,440 696,978 742,282 790,530 841,915 Indirect 739,908 788,002 839,223 893,772 951,867 Induced 1,877,784 1,999,839 2,129,829 2,268,268 2,415,705 Total Impact 3,272,132 3,484,820 3,711,334 3,952,570 4,209,487

19

Table 7 – Detailed Economic Impact of the Midstream Energy MLPs, 2012 to 2016

(Income expressed in thousands of dollars)

2012 2013 2014 2015 2016

Petroleum Bulk Stations and Terminals Direct 1,309,559 1,394,680 1,485,334 1,581,881 1,684,703 Indirect 503,768 536,513 571,387 608,527 648,081 Induced 2,267,159 2,414,525 2,571,469 2,738,614 2,916,624 Total Impact 4,080,487 4,345,718 4,628,190 4,929,022 5,249,409

Pipeline Transportation Direct 4,723,855 5,030,906 5,357,915 5,706,179 6,077,081 Indirect 3,311,701 3,526,962 3,756,214 4,000,368 4,260,392 Induced 10,458,360 11,138,153 11,862,133 12,633,172 13,454,328 Total Impact 18,493,917 19,696,021 20,976,262 22,339,720 23,791,801

20

Table 8 – Detailed Cumulative Economic Impact on Midstream Energy MLPs, From Imposing a Corporate Level Tax, 2012 to 2016

(Income expressed in thousands of dollars)

2012 2013 2014 2015 2016 Employment

All Energy MLPs Direct -1,572 -2,508 -3,448 -4,393 -5,344 Indirect -1,352 -2,156 -2,965 -3,778 -4,594 Induced -5,148 -8,211 -11,290 -14,385 -17,495 Total Impact -8,073 -12,876 -17,703 -22,556 -27,433

Oil and Gas Extraction Direct -101 -161 -222 -282 -343 Indirect -152 -243 -334 -425 -517 Induced -446 -711 -978 -1,246 -1,515 Total Impact -699 -1,115 -1,533 -1,953 -2,376

Petroleum Bulk Stations and Terminals Direct -446 -711 -978 -1,246 -1,515 Indirect -229 -365 -501 -639 -777 Induced -1,187 -1,894 -2,604 -3,317 -4,035 Total Impact -1,862 -2,969 -4,083 -5,202 -6,327

Pipeline Transportation Direct -1,026 -1,636 -2,249 -2,866 -3,485 Indirect -971 -1,549 -2,130 -2,713 -3,300 Induced -3,515 -5,607 -7,709 -9,822 -11,945 Total Impact -5,512 -8,791 -12,087 -15,400 -18,731

Income All Energy MLPs Direct -167,196 -243,271 -327,876 -421,765 -525,748 Indirect -113,884 -165,702 -223,330 -287,282 -358,109 Induced -365,083 -531,195 -715,936 -920,947 -1,147,999 Total Impact -646,163 -940,168 -1,267,143 -1,629,993 -2,031,856

Oil and Gas Extraction Direct -16,361 -23,805 -32,084 -41,272 -51,447 Indirect -18,498 -26,914 -36,274 -46,662 -58,166 Induced -46,945 -68,304 -92,060 -118,421 -147,617 Total Impact -81,803 -119,024 -160,418 -206,355 -257,230

Petroleum Bulk Stations and Terminals Direct -32,739 -47,635 -64,202 -82,586 -102,947 Indirect -12,594 -18,325 -24,698 -31,770 -39,602 Induced -56,679 -82,468 -111,149 -142,977 -178,227 Total Impact -102,012 -148,428 -200,048 -257,333 -320,776

21

Table 8 – Detailed Cumulative Economic Impact on Midstream Energy MLPs, From

Imposing a Corporate Level Tax, 2012 to 2016 (Income expressed in thousands of dollars)

2012 2013 2014 2015 2016

Pipeline Transportation Direct -118,096 -171,830 -231,590 -297,907 -371,353 Indirect -82,793 -120,463 -162,358 -208,850 -260,341 Induced -261,459 -380,423 -512,728 -659,549 -822,156 Total Impact -462,348 -672,716 -906,676 -1,166,306 -1,453,850

22

Appendix B – NAICS Classes NAICS is a hierarchical classification code system offering five levels of detail via two to six digits. The NAICS classes included in the midstream energy sector consist of three NAICS subsectors (three-digit level) and one industry (five –six digit level).37 Two of the subsectors include four-digit industry groups. The Economic Census of the Census Bureau defines the applicable categories as: NAICS 211 – Oil and Gas Extraction Industries in the Oil and Gas Extraction subsector operate and/or develop oil and gas field properties. Such activities may include exploration for crude petroleum and natural gas; drilling, completing, and equipping wells; operating separators, emulsion breakers, desilting equipment, and field gathering lines for crude petroleum and natural gas; and all other activities in the preparation of oil and gas up to the point of shipment from the producing property. This subsector includes the production of crude petroleum, the mining and extraction of oil from oil shale and oil sands, and the production of natural gas, sulfur recovery from natural gas, and recovery of hydrocarbon liquids. Establishments in this subsector include those that operate oil and gas wells on their own account or for others on a contract or fee basis. This NAICS subsector does not include establishments primarily engaged in providing support services, on a fee or contract basis, required for the drilling or operation of oil and gas wells (except geophysical surveying and mapping, mine-site preparation, and construction of oil/gas pipelines). The NAICS includes these activities in Subsector 213, Support Activities for Mining. NAICS 424710 – Petroleum Bulk Stations and Terminals This industry, which is part of the Wholesale Trade sector, comprises establishments with bulk liquid storage facilities primarily engaged in the merchant wholesale distribution of crude petroleum and petroleum products, including liquefied petroleum gas. NAICS 483 – Water Transportation Industries in the Water Transportation subsector provide water transportation of passengers and cargo using watercraft, such as ships, barges, and boats. The subsector is composed of two industry groups: (1) one for deep sea, coastal, and Great Lakes; and (2) one for inland water transportation. This split typically reflects the difference in equipment used. Scenic and sightseeing water transportation services are not included in this subsector but are included in Subsector 487, Scenic and Sightseeing Transportation. Although these activities use watercraft, they are different from the activities included in water transportation. Water sightseeing does not usually involve place-to-place transportation; the passengers trip starts and ends at the same location. 37 Some midstream energy companies have secondary operations in such areas as gathering pipeline construction. However, for this analysis these secondary operations are not show separately from their primary business classification.

23

NAICS 486 – Pipeline Transportation NAICS 4861 – Industries in the Pipeline Transportation subsector use transmission pipelines to transport products such as crude oil, refined petroleum products, and slurry. This subsector includes:

� Booster pumping station, crude oil transportation � Crude oil pipeline transportation � Petroleum pipelines, crude � Pipeline transportation, crude oil

NAICS 4862 – This industry group comprises establishments primarily engaged in pipeline transportation of natural gas from processing plants to local distribution systems.

This subsector includes: � Booster pumping station, natural gas transportation � Gas, natural, pipeline operation � Natural gas pipeline transportation � Natural gas transmission (i.e., processing plants to local distribution systems) � Pipeline transportation, natural gas � Storage of natural gas � Transmission of natural gas via pipeline (i.e., processing plants to local distribution systems)

NAICS 4869 – This industry group comprises establishments primarily engaged in the pipeline transportation of products (except crude oil and natural gas).

24

Appendix C – Technical Description of the Cost of Capital Estimates Equation (1) provides the mathematical representation of the user cost of capital:

c =

��

(r �G) (1� uz� k)(1� u) . (1)

In this expression, r is the firm’s discount rate, G is rate of economic depreciation (i.e. replacement rate), u is the corporate income tax rate, z is the present value of future depreciation deductions and k is the investment tax credit. This analysis calculated the user cost of capital for each industry in the midstream energy sector, under two scenarios: (1) under present law where there is no corporate level tax and (2) under the assumption that MLPs are subject to corporate taxes.38 This difference in the cost of capital under each tax regime will change total investment in the midstream energy industries. In order to ascertain the magnitude of the response to this change, we conducted an extensive literature review to inform our modeling efforts. In addition, we calculated the present value of depreciation for those assets used in the midstream energy sector. This involved identifying the equipment and structures used in each industry, based on data from the Commerce Department’s Bureau of Economic Analysis (BEA). The BEA offers matrices of detailed equipment and structure classes by 123 NAICS industries. Table 9 provides the composition of these asset classes. The next step was to assign the appropriate service life and depreciation method (for tax purposes) based on IRS Publication 946, How to Depreciate Property. From these inputs, the analysis was able to derive the present-value of depreciation specific to the industries in the midstream energy MLP sector. Quantria’s user cost of capital model relies on investment flow data to weight the cost of capital calculations. The BEA compiles these data by detailed industry classes. These data, coupled with Quantria’s depreciation model, allow for a complete empirical expression of equation (1).39

38 Refer to Appendix B for a discussion of our methodology. 39 For this project, we modify equation (1) to accommodate personal income tax rates.

25

Table 9 – Equipment and Structures Classes for Present-Value of

Depreciation Estimates Supporting the User-Cost of Capital Estimates

Equipment Structures Computers and peripheral equipment Industrial buildings Office and accounting equipment Commercial buildings Software Religious buildings Communication equipment Educational buildings Nonmedical instruments and related equipment Hospital and institutional buildings Photocopy and related equipment Other nonresidential buildings, excluding farm Fabricated metal products Railroads Engines and turbines Telecommunications Metalworking machinery Electric light and power Special industry machinery, n.e.c. Gas General industrial, including materials handling, equipment Petroleum pipelines Electrical transmission, distribution, & industrial apparatus Farm nonresidential structures Medical instruments and related equipment Petroleum and natural gas--wells Electro-medical equipment Petroleum and natural gas exploration Autos Other mining construction Aircraft Other nonresidential non-building structures Ships and boats Single-family structures - nonfarm Railroad equipment Single-family structures - farm Furniture and fixtures Multifamily structures Agricultural machinery, including tractors Manufactured homes Construction machinery, including tractors Improvements Mining and oilfield machinery Other

Service industry machinery Brokers' commissions on the sale of new residential structures

Electrical equipment, n.e.c. Other nonresidential equipment Light trucks Trucks, other than light, buses and trailers Residential (landlord durables) Source: U.S. Commerce Department, Bureau of Economic Analysis, Excel file named CFT97.xls, available at www.bea.gov

26

Appendix D – Technical Description of the I-O Model and Estimates In the late 1930’s at Harvard University, Wassily Leontief presented the first theoretical framework for I-O analysis.40 Conceptually simple, but elegant nonetheless, an I-O representation of an economy traces the inter-industry transactions necessary to produce output to satisfy the final demand of end-use consumers. These intermediate flows between industrial sectors trace-out the distribution, or supply-chain, of an industry’s product. In an I-O model of an economy, production occurs in one of many industrial sectors, or industries.41 The inter-industry transaction table records output from one industry used as an input to another industry. These intermediate transactions represent the steps, or “recipe”, used to produce products for final use by the end-use consumers. In I-O accounting, this final demand is usually treated as a separate sector and purchases are allocated across various types of end-users. For example, it is common to distinguish among the final demands of consumers, government, business investment and exports. Analytically, I-O transaction accounts represent a comprehensive depiction of the value of the products and services produced in an economy during a specific period and the interdependencies that exist among industries and consumers. Operationally, the I-O structure of an economy is represented by a system of linear equations that trace-out the sources and uses of gross output. Matrix algebra is a convenient tool for I-O analysis and is used to represent the flows of products from producers (sellers) to purchasers (buyers). To facilitate this formulation, we assume the economy can be represented by n sectors (i.e., industries) and the inter-industry transactions between two sectors, representing the flow from one industry to another is zi,j. That is, zi,j represents j’s demand for i’s product. For each industry, total output is distributed between that used to satisfy the (intermediate) demand of the other industries as well as the final demand of end-use consumers. Algebraically, for industry i:

i

jjiiniii fzfzzx � ��� ¦ ,,1, ��

, (1)

where xi is the gross output of industry i and fi is the final demand for industry i’s product. A particularly useful device in I-O analysis is the calculation of the technical coefficient of production:

��

ai, j zi, jx j . (2)

Equation (2) is sometimes referred to as the “I-O coefficient” or the direct input coefficient and represents the fraction of industry j’s output that comes from industry i.

40 For this work, Professor Leontief was awarded the Nobel Prize for Economics in 1973. The I-O approach is one of the most widely used analytical tools in economics today. 41 In most I-O formulations, the terms “sector” and “industry” are used interchangeably.

27

After some algebra, we can re-write (1) using (2) to arrive at the matrix representation of the I-O accounts:

(3)

In (3), I is the usual (n-dimensional) identity matrix with ones on the diagonal and zeros elsewhere and A is the matrix of technical coefficients embodied in (2). For a given set of final demands, the system of n equations represented by (3) has a solution if (I – A)-1 exists. If so, we can solve (3) for the total outputs required to satisfy final demand:

(4)

Equation (4) is the fundamental relationship in I-O analysis. The matrix (I – A)-1 is usually referred to as the Leontief inverse or the total requirements matrix. It plays an important role in studies that use I-O techniques to measure changes in output as they relate to changes in final demand. This is calculated directly from the Leontief inverse:

(5) In this project, we will use (5) to estimate the change in employment that results from a reduction in investment due to the imposition of a corporate level tax on MLPs. To accomplish this, we will extend the definition of final demand to include investment.42 Estimates of employment are derived from the composition of total output through value added (VA). Industry-specific wage rates will be used to translate value added to jobs. Most economic impact analyses rely upon the I-O framework to measure inter-industry transactions in order to get a more complete picture of the linkages and dependencies among industries. This aspect of I-O is captured in equation (5) which is the fundamental relationship that measures economic impacts of changes in demand and how these changes ripple through the economy. As derived here, equation (5) measures the direct and indirect components of a change in demand. It is common in economic impact analysis to also account for induced effects that result from additional rounds of spending by workers that receive wages in each industrial sector. In order to capture the induced effect of a change in demand (or output), equation (5) needs to be modified to explicitly incorporate the household sector as a producing sector that receives wages for supplying labor services. In I-O parlance, this is referred to as “closing the model” with respect to households. We accomplish this by moving the household row (compensation as a component of value added) and column (personal consumption expenditures) into the left-hand side of equation (1).43 This makes the household sector “endogenous”, or jointly determined within the business sector and allows one to calculate the induced effect as the labor income of workers flows through the economy through the purchases of goods and services that comprise final demand. 42 This is a standard assumption in most I-O formulations. 43 The left-hand side of the equation is xi, the gross output of industry i. The closed model contains an additional row (n+1) representing compensation paid to the household sector and an additional column (n+1) representing personal consumption expenditures. We also move the investment component of final demand into the processing sector in order to measure the employment effects of changes in investment.

28

An important question addressed in this study is how the current (and future) economic impact of the energy MLP sector might be altered if a corporate level tax is imposed. In order to capture this effect, the basic I-O structure (equation (1)) needs to be modified slightly to incorporate prices and taxes. In our analysis, we assume that the increased taxes are passed along in the form of higher prices to the customers. These higher prices will then result in a reduction in demand for the newly-taxed good and this reduction in demand will propagate through the economy by way of the supply chain. Incorporating taxes in the I-O framework is straightforward.44 Equation (1) needs to be rewritten: (1-a11)p1 - a21p2 - …….. = V1/X1

a12p1 + (1-a22)p2 - …….. = V2/X2

.

. (6) . a1Np1 - a2Np2 - …….. = VN/XN

In the system of equations (6), the aij’s represent the technical coefficients of production as in equation (2); pi is the (final) price of the good produced by industry i; Vi is value added in the ith industry; and Xi is total output of the industry i. Taxes can be added to (6) in a straightforward manner along the lines of Fullerton(1995)45:

(1-a11)p1(1+t1) - a21p2(1+t2) - …….. = V1/X1

a12p1(1+t1) + (1-a22)p2(1+t2) - …….. = V2/X2 (7)

.

.

. a1Np1(1+t1) - a2Np2(1+t2) - …….. = VN/XN

where the ti’s are the industry-specific tax rates. Carrying out a similar set of calculations as is the text, we can replace equation (4) by

(I – A’T)P = V or P = (I – A’T)-1V (8)

44 See, for example, Metcalf, G.E (1999), “A Distributional Analysis of Green Tax Reforms”, National Tax Journal, vol. 52, no. 4, pp. 655-681. 45 Fullerton, D. (1996), “Why Have Separate Environmental Taxes?” Tax Policy and the Economy, National Bureau of Economic Research, vol. 10, pp. 33-70.

29

Here the n x n matrix T is the diagonal “tax” matrix: (1+t1) 0 0……………..0 T = 0 (1+t2) 0 0……………..0 0 0 0 0……………..(1+tN) For this study, all the ti’s on the main diagonal will be zero except for the energy MLP sector. We then use this to calculate the direct, indirect and induced effects.

30

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