FERC Boosts MLPs

The Federal Energy Regulatory Commission (FERC) became MLP investors’ new BFF last week. Only four months ago, FERC’s revised policy on allowing imputed tax expense in setting tariffs caused a memorable intra-day 10% drop and contributed to dismal 1Q performance (see FERC Ruling Pushes Pipelines Out of MLPs). Ever since, MLP investors have regarded FERC warily, sensitive to additional market shocks. Cost-of-service pipeline contracts, historically common but rare nowadays and the source of much of this volatility, are unlikely to be employed in the future.

The clarification issued last week was unambiguously, if modestly, good. MLPs are still not allowed to include taxes paid by their equity investors as an operating cost in calculating applicable rates on interstate natural gas pipelines. But they can now include taxes paid by a corporate parent (if they have one), a feature omitted from the March announcement. Moreover, Accumulated Deferred Income Tax (ADIT), which most natural gas pipeline MLPs had built up, will no longer have to be refunded to customers. This had been recorded as an income tax liability using accelerated depreciation, offset by cash received from customers on cost-of-service contracts that relied on straight-line depreciation.

Depending on timing, some firms had accrued a significant net cash benefit and faced the prospect of returning this excess to customers. One research firm estimated the sums involved in the billions, in effect a retroactive fee adjustment. This possibility has now been eliminated.

By excluding ADIT, pipelines will show more equity invested which will in turn lower their Return on Equity (ROE). Typically, a pipeline tariff is deemed “fair and reasonable” if it generates a 10-16% ROE.  The net result will be that some contracts will fall below the threshold, reducing the likelihood of lower rates and even opening the door to bigger rate increases.

Since 2014 when Kinder Morgan (KMI) led the way, large MLPs have been converting to corporations in order to access a broader set of equity investors (see Corporations Lead the Way to American Energy Independence). More recently, Enbridge (ENB) and Williams Companies (WMB) both announced plans to roll up their MLP affiliates. TransCanada (TRPtold investors that financing assets at their MLP, TC Pipelines (TCP), was no longer viable.

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Disclosure: We are invested in ENB, KMI, TRP and WMB. We are short AMLP.

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