The Ruling May Revitalize the Discussion Surrounding MLPs Changing Corporate Structure
The Federal Energy Regulatory Commission (FERC) recently announced changes to the way certain Master Limited Partnerships (MLPs) set rates, or prices, for their services. Partnerships that transport crude oil or natural gas, and also operate on a cost of service basis, specifically are impacted by this ruling. Cost of service contracts allow an MLP to set rates and provide a constant return to equity and debt holders.
Historically, a component of this return comprised a tax allowance that all midstream companies could take. The ruling by FERC reversed this allowance, stating that parent companies can only use the allowance if they are actually paying those taxes. The market responded unfavorably to this news. While the announcement and ruling surprised the market, we suspect the hasty market reaction resulted in many investors selling first and asking questions later. Below are our key points and takeaways from the announcement.
• Who is Impacted? The FERC ruling only impacts FERC regulated interstate oil and gas pipelines which operate cost of service contracts. MLPs that do not operate these types of contracts or those that do not transport across state lines are not impacted. Additionally, the rules are unlikely to affect pipelines transporting liquids until 2020. It’s important to note, this will not affect negotiated rate pipelines, market-based pipelines, pipelines held in C-corps, and gathering and processing assets. Harvest Fund Advisors estimates suggest the EBITDA at risk for the Alerian MLP Index is merely 3.1%.
• What is the Impact? The tax allowance makes up approximately 5-10% of the whole tariff for regulated pipelines. While this will materially impact a limited number of names in the space, other assets will remain unaffected by the announcement. Given the unexpected nature of the announcement, information is still being collected. However, many major MLP companies have provided press releases around the materiality, or lack thereof, for their business.
• Does this Change the Nature of MLP Contracts? No. There will be no material follow-on effects of how contracts are set between pipelines and their counterparties. Pipelines operating a cost of service model are generally at least 10 years old. Given the market has already shifted away from this type of pricing, the ruling will not create a fundamental disruption to companies’ business models.
• What is Our Outlook? Our assessment of value in the asset class remains unchanged. While the group has been out of favor, it remains an area that provides diversification from traditional stocks and bonds, protection from inflation and higher forward-looking return expectations.
We will continue to monitor developments as more details emerge and additional commentary is provided on potential impact at a company-specific level. This ruling is likely to revitalize the discussion surrounding the MLPs changing corporate structure to a C-corp. While the C-corp midstream companies are untouched in this ruling, it remains a single point of consideration for a long-term decision by company management. As details and clarity emerge, we will continue to assess the overall long-term impacts.
Please feel free to contact any of our professional advisors at Fi3 for more information.
Harvest Fund Advisors, March 2018