There are certain fears in the MLP sector that need to be addressed in the wake of the Federal Energy Regulatory Commission’s (FERC) income tax ruling. The myths include:
The decision affects all MLPs—The FERC ruling only directly impacts a portion of MLPs, namely those with interstate natural gas pipelines with cost-of-service rates. To avoid double-recovery of taxes, an income tax allowance will no longer be permitted for those pipelines.
This ruling has no bearing on revenues from gathering and processing businesses, storage facilities, intrastate pipelines, or interstate liquids (crude, refined product or NGL) pipelines.
Interstate natural gas pipelines with negotiated rates will have to file paperwork to ensure their rates are not unjust or unreasonable, but there is no immediate impact.
In 2020, FERC will conduct the scheduled five-year review of its oil pipeline index level. The decreased corporate tax rate, as well as all other costs and industry changes, will be reviewed at that time. This is consistent with previous practice.
Within 24 hours of the decision, many MLPs had issued press releases clearly stating that the decision had no impact on their business or that it would only have a de minimis impact. Only one—Enbridge Energy Partners—indicated a need to reduce EBITDA guidance, although it would still be able to maintain distributions at current levels.
Despite the overall minimal fundamental impact, in the days and weeks that followed, the entire MLP and energy infrastructure space traded down. While the initial market reaction can be understood as “sell first, ask questions later,” the following weeks showed that fear went beyond the initial impact and misconceptions were widespread.
FERC has the power to eliminate the MLP structure and tax advantage—Only Congress has the power to eliminate the MLP structure. However, Congress reaffirmed the MLP structure through an amendment to the recent tax reform bill. While the IRS does have limited power to restrict which businesses can be included in an MLP, the power remains with Congress.
MLPs will now convert to C corps—MLPs are neither required to, nor likely to, convert en masse to C corps. However, this fear arose due to timing. For example, the Tallgrass Energy family of companies had previously announced its intention to simplify its structure in order to improve its cost of capital to fund future growth. The final announcement came soon after the FERC announcement, despite this ruling being immaterial to the company as it has primarily negotiated rate contracts.
MLPs pursuing simplifications is neither a new phenomenon nor a harbinger of failure. While weak unit prices have driven up the cost of equity, they do not mean the business or structure is unsustainable. In at least two instances, the MLP will be the surviving entity in some announced transactions.
In fact, eliminating incentive distribution rights not only reduces the cost of equity, which can broaden the set of available opportunities, but it can also improve corporate governance and encourage generalist investors to participate in the MLP space.
The reality is it will take time to see the final fundamental impact the FERC policy statement has on the MLP space. Contrary to many beliefs, the MLP structure remains an efficient way to own and operate most midstream assets.
Maria Halmo is the director of research at Alerian, an independent provider of MLP and energy infrastructure market intelligence. As of the end of March, over $13 billion is directly tied to the Alerian Index Series. For additional commentary and research, please visit www.alerian.com/alerian-insights.
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