US FERC will disallow tax allowance cost recovery for MLPs

Washington (Platts)--15 Mar 2018 728 pm EDT/2328 GMT

The US Federal Energy Regulatory Commission no longer intends to allow oil and natural gas pipelines organized as master limited partnerships to recover an income tax allowance in cost-of-service rates.

The agency was acting in response to a federal appeals court ruling that found FERC's rate policies could allow oil pipelines to set up partnerships to unfairly profit from their tax structure. The DC Circuit Court of Appeals in July 2016 -- in United Airlines v. FERC, a case involving the pipeline SFPP -- held that the commission failed to show there is no double recovery of taxes for partnership entities that receive an income tax allowance in addition to a discounted cash flow methodology used to set returns on equity.

In response to the ruling and to comments it subsequently collected, FERC said it will revise its 2005 policy statement for recovery of income taxes to no longer allow MLPs to recover an income tax allowance to compensate for investors' taxes on the partnership income.

Passthrough entities are not subject to corporate income taxes, but the owners face taxes individually on the entity's income.

FERC Chairman Kevin McIntyre said the court ruling gave FERC "very clear marching orders."

"In the United Airlines case, the court did not mince its words. It not only vacated the commission's prior orders with respect to this double recovery issue , but it stated in no uncertain terms that granting an income tax allowance to master limited partnerships results in 'inequitable returns.'"

To carry out the change, FERC commissioners voted Thursday to issue a policy statement directing oil pipelines set up as MLPs to reflect the changes in their Form. 6, page 700 reporting. It said the policy changes will be reflected in FERC's 2020 five-year review of the oil pipeline index level.

While all passthrough entities claiming an income tax allowance will need to address the double recovery issue in United Airlines, Glenna Riley of FERC's Office of General Counsel said the commission will address the issue for other passthrough forms in subsequent proceedings. FERC TO ADDRESS IMPACT AS PART OF NOPR

For interstate gas pipelines organized as MLPs, FERC is considering impacts of the revised policy as part of its notice of proposed rulemaking on effects of recent tax law changes (RM18-11).

In addition, a separate broad FERC inquiry (RM18-12) on tax cut reforms invites comment on how the elimination of the income tax allowance for MLPs affects accumulated deferred incomes taxes. For those entities losing their allowances it will ask whether previously accumulated sums from ADIT should be eliminated entirely from cost of service, or placed in a regulatory liability account and returned to ratepayers.

Implementing the new policy on remand, FERC also issued an order denying SFPP an income tax allowance (IS08-390 et., al.), finding a real return on equity of 10.24%. It also accepted an SFPP compliance filing in a separate case (IS09-437), while seeking a further filing removing the tax allowances in SFPP's East Line cost of service.

Commissioner Cheryl LaFleur said she believed the commission's actions offer the "correct response," dictated by court remand and the record FERC developed in response to its notice of inquiry.

"I know that is not the answer that the companies were hoping for," she added.

The Association of Oil Pipe Lines said it "is surprised and disappointed that FERC did not take the option given to it by the court to demonstrate there is no double recovery by MLP pipelines."

"Much of the growth in pipeline capacity to serve American workers and consumers is by partnership pipelines, and this choice by FERC makes that expansion harder," the group said.

The Interstate Natural Gas Association of America also pronounced itself "extremely disappointed" that FERC departed with its longstanding approach.

Pipeline companies had previously argued that FERC's policies in fact resulted in a parity of treatment between pipes owned by corporate entities and those owned by partnerships. Cathy Landry, a spokeswoman for INGAA said the trade group believes it offered convincing and detailed evidence to back a finding that MLP's are not double recovering taxes.

Benjamin Salisbury of B. Riley FBR, in a research note midday, said the MLP sector had sold off about 6.5% on news that FERC is no longer allowing MLPs to recover income tax allowance in cost-of-service rates.

"Our initial thoughts are that the broad market is being pulled down by [exchange-traded fund] selling in an effort to reduce exposure to names exposed to interstate regulated pipelines," he said. "Over the past quarter, we have seen individual MLPs such as Williams Partners and Spectra Energy Partners indicate some writedowns driven by the impacts of tax reform. We believe the same partnerships that were impacted by the reduction in corporate taxes are going to be exposed to FERC's announcement."

At the close, the Alerian MLP index, a gauge of energy MLPs, was down 4.56%.

Lori Ziebart, executive director of the Master Limited Partnership Association, cautioned that "the degree to which this decision impacts any particular MLP varies depending on the magnitude of their interstate pipeline business as well as the rate structure under which that portion of their business operates."

"Many interstate pipelines owned by MLPs are operated under contracts with negotiated rates that will not be impacted by this decision," particularly newer assets where negotiated rates predominate. Interstate pipelines with index and other rate structures "are similarly not impacted," she said.

Michael Grande of S&P Global Ratings said the FERC decision would "negatively impact credit ratios, but it's not fully clear how severe that will be at this time."

Enterprise Products Partners said FERC's altered policy is "not expected to have a material impact to the earnings and cash flow of Enterprise." Tallgrass Energy similarly said FERC's tax policy revisions are likely to be immaterial to that company's revenues, since both Rockies Express and Pony Express have negotiated rate contracts.

ClearView Energy Partners in a note said the impact for natural gas pipelines "appears significant and may occur more quickly," than for oil and product lines, because FERC has directed gas pipes to file limited cost and revenue studies, potentially triggering challenges from shippers. -- Maya Weber,

-- Edited by Jim Magill,

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