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MLPs Plunge On FERC Proposal To Bar 'Double Recovery' Of Tax Costs

This article is more than 6 years old.

President Trump's tariffs on imported steel were the first bit of bad news for investors in America's pipeline infrastructure. A worse surprise came today, sending MLP investors into a panic. Recovering some after steep declines, Energy Transfer Partners closed the day down 6.25%, Williams Companies off 5%, Enbridge down 5% and Enterprise Products Partners down 3%. The Alerian MLP exchange traded fund ended off 5% after being down more than 10%.

The huge moves are the result of this staff presentation today by the Federal Energy Regulatory Commission, which signals dramatic changes ahead in how MLPs are allowed to account for income taxes.

Master Limited Partnerships are pass-through entities -- distributing pre-tax income to unit holders, who then are responsible for paying taxes on it according to their individual situations. For more than a decade MLPs have been able, in the FERC's words, "to recover an income tax allowance in their cost of service" -- effectively boosting the amount of pre-tax income to be passed through.

That perk is likely over, due to a D.C. circuit court decision in United Airlines vs. FERC, which found a pipeline operator to be enjoying a "double recovery" of income tax costs, vacated FERC's orders and remanded the issue back to the commission. FERC says that it will issue a notice of proposed rule making, which will address the impact of eliminating the income tax allowance on interstate pipeline rates. Pipeline operators that rely on a cost-of-service pricing model would presumably have to reduce by the amount of their allowances the rates they charge customers to ship oil, gas and refined products around the country.

Investors clearly shot first, then asked questions later, which created good opportunities for dip-buying. Sam Margolin at Cowen & Co., emphasized in a note this afternoon that the FERC rule applies only to interstate pipeline assets, not to those that originate and terminate within the same state. Such is the case with pipeline assets in held by Cheniere Energy Partners (CQP, -2%), which feed the Gulf Coast liquefied natural gas export facility operated by its parent Cheniere Energy.

The FERC move may not result in much if any rate relief for customers paying negotiated or market-based rates. Enterprise Products Partners said in a statement this afternoon that it anticipated no material effect on its posted tariffs. Andeavor, the refining company formerly known as Tesoro, said its midstream MLP, Andeavor Logistics (ANDX), would see a hit to Ebitda of no more than $10 million.

The rule is not expected to go into effect until 2020, so immediate restructuring plans are unlikely -- though in extreme cases we could end up seeing refining companies reversing years of spin outs and buying back assets currently held in MLPs. Portfolio manager Simon Lack at SL Advisors notes today that the change could lead the likes of Williams Companies to work with affiliate Williams Partners to create a new corporate structure to hold long-haul assets like its Transco gas pipeline. Kinder Morgan famously scrapped its MLP structures in 2014, consolidating four publicly traded entities into a single C-corp.

To better understand these tricky beasts I recommend reading Forbes' 2018 Tax Guide To MLPs as well as our 2018 Tax Guide To MLP Funds.

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