FERC Issues Final Rule on Pipeline Tax Policy
On July 18, 2018, well after market close, the U.S. Federal Energy Regulatory Commission (FERC) announced updated policy guidance related to master limited partnership (MLP) treatment of the Income Tax Allowance (ITA). In this blog, we summarize the changes, assess the impact, and provide guidance on the outlook for midstream companies.

FERC Updates its Stance

In March 2018, FERC announced that it would no longer allow MLPs to recover an ITA in its cost-of-service for FERC-regulated assets (e.g., interstate natural gas pipelines). This initial decision roiled the entire MLP space and especially affected certain MLPs with a high composition of FERC-regulated assets. In the months that followed, MLPs with limited FERC exposure have recovered to various extents; however, the regulatory uncertainty introduced confusion and hurt overall sentiment.

Blog: Assessing FERC’s Decisions on Pipeline Tariffs

On the evening of July 18, FERC updated its policy guidance related to the ITA. In essence, FERC will allow MLPs to recover an ITA in a pipeline's cost-of-service so long as the pipeline lowers the tariff to reflect the new lower corporate tax rate of 21%. MLPs negatively impacted by the March 2018 FERC decision may benefit meaningfully from this updated policy guidance because it reverses to some extent the ITA that FERC took away from MLPs in March. The updated FERC policy guidance also gives both pipelines and shippers future recourse to justify further cost-of-service changes to support reasonable rates and fair returns. Further, FERC provided favorable guidance about how MLPs would treat Accumulated Deferred Income Taxes (ADIT).

MLPs with a high composition of impacted FERC-regulated assets include TC Pipelines, LP (NYSE: TCP), Spectra Energy Partners LP (NYSE: SEP), and Dominion Energy Midstream Partners, LP (NYSE: DM).

Note that SteelPath formally filed comments with FERC regarding its initial ITA decision. We also offered solutions intended to assist FERC as it considered rehearing requests for the revised policy statement.

Assessing the Potential Impact

We anticipate that MLP unit prices will have a materially positive reaction to FERC’s decision in the near-term and going forward, especially for MLPs with the highest composition of FERC-regulated assets. We believe that this will also improve sentiment for MLPs broadly given the recent encouraging regulatory backdrop.

Further, 2Q18 earnings for MLPs will be released over the next few weeks. Midstream fundamentals are very constructive. Kinder Morgan was the first midstream company to report earnings for the quarter, and its results generally reflect the strong underlying fundamentals we have been observing.

MLP valuation metrics are well below historical levels. For example, Price-to-Distributable Cash Flow (DCF) multiples for the Alerian MLP Infrastructure Index (AMZI) are close to trough levels and well below historical averages. The AMZI currently yields 7.8%, which is well above the historical average of 6.5% over the prior eight years. In addition, the recent wave of organizational simplifications and removal of incentive distribution rights (IDRs) should allow these MLPs to benefit even more from strong underlying operating and financial fundamentals.

With this FERC policy update, strong operating and financial fundamentals, simplified organizational structures, and attractive valuation levels, we believe the backdrop for investing in MLPs is as strong as it has been in the last four years.