Assume for a moment that KMP has 100 LP unitholders and declared a $0.15 distribution per unit. LP unitholders would, in aggregate, receive $15, and the GP would receive $0.31. The total cash payout of $15.31 would go 98% to the LP unitholders and 2% to the GP.

That doesn't amount to much, but incentives kick in as the LP distribution increases. As the distribution level reaches $0.17 per LP unit, the LP unitholders receive $17 in aggregate, while the GP gets $0.64. Again this isn't much, but look at the percent increase: the LP distribution increased 13.3%, while the GP distribution increased by 106%, and the GP now receives 4% of the total cash payout.

Moving up the splits, the same math plays out until you get to the high splits. For KMP, any LP distribution above $0.23375 is in the high splits. Let's assume KMP declared a $0.34 distribution, twice the level of the last example. LP unitholders would get $34, a 200% increase, while the GP would receive $13.25, nearly 20 times as high a payout.

You can see how this math works out against KMP's actual distribution history in the chart below. As the LP distribution increased each year, the GP's share of total distributions increased very rapidly at first, and since about 2002 it has been asymptotically closing on 50%. Currently the GP's share of total distributions is about 44%.

The other variable to consider is that the incentive is based on total cash payout. In the example above we kept KMP's hypothetical units outstanding set at 100. But as the unit count increases, the total cash payout also increases. This means that the GP's cash distribution increases whenever KMP issues more units, even if the LP's distribution does not.

It's a Drag
In our view, high distribution splits create a real drag on LP distribution growth. Deep in the high splits, IDRs burden an MLP with a high claim on the cash flow it generates. By our calculations, KMP must increase its distributable cash flow by around 10% annually to be able to raise LP distributions at a 5% clip. Since it's challenging for a partnership as large as KMP to grow cash flows by 10% or more, year after year, high splits translate into lower LP distribution growth over time. We think we're seeing that play out now.

As you can see in the chart below, we anticipate KMP will be able to increase its LP distributions by around 4.5% a year over the next five years. But based on the math we've just walked through, the general partner's distributions will grow a little bit more than twice as fast.

This math underscores the great strength--and the potential weakness--of KMI as an investment option. Clearly, KMI's ownership of KMP's general partner and incentive distribution rights provides for strong cash flow growth, which in turn should allow KMI to grow its own dividend payments at a healthy clip. However, high incentive splits place a sizable burden on KMP's ability to raise its LP distributions over the long run. Over time, we would not be surprised to see a move to reduce or eliminate KMP's incentive distribution rights, as several other MLPs have done in the recent past. We see this as the greatest risk to KMI's long-term growth story. As the old saying goes, if something can't continue forever, it won't.

Jason Stevens is a senior stock analyst with Morningstar.