Enbridge Inc., like rival TransCanada Corp., seems headed for a tough decision on its struggling U.S. pipeline partnerships as fallout from a federal tax ruling prompts some big players in the sector to question whether stashing U.S. assets in drop-down partnerships is still financially viable.
After the Federal Energy Regulatory Commission's March 15 decision that oil and gas pipeline master limited partnerships would no longer be able to recover an income tax allowance in cost-of-service rates, TransCanada announced that TC PipeLines LP was no longer an appropriate financial vehicle for its U.S. pipeline assets. Lacking any growth prospects from TransCanada asset dropdowns, the MLP introduced a 35% distribution cut to mitigate its high exposure to cost-of-service rates, which could cost TC PipeLines up to $100 million in annualized cash flow.
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That move not only sent TC PipeLines stock into a tailspin but also depressed Enbridge Energy Partners LP's and Spectra Energy Partners LP's market values, stoking concerns that those partnerships could meet a similar fate. Roughly 40% of Spectra's business is based on cost-of-service rates, which could mean an annual revenue impact of $110 million to $125 million, the partnership reported in an SEC filing. Enbridge Energy Partners is also exposed to those rates and adjusted its 2018 distributable cash flow guidance range to $650 million to $700 million from $720 million to $770 million.
With no growth trajectory in sight, Morningstar Equity Research analyst Joe Gemino said, both MLPs may be left to fend for themselves. "Enbridge said in its [first-quarter] earnings that neither vehicle is an option for new growth projects, so I expect them to follow that strategy," he said in an interview. "What Enbridge Energy Partners holds is the U.S. portion of the Canadian Mainline system, and outside of this current Line 3 project, there really isn't another ... opportunity."
Enbridge slashed Enbridge Energy Partners' distribution to 35 cents per unit from 58.3 cents per unit in 2017, and Gemino said another cut would make sense. The company took a different path with the recently acquired Spectra partnership, eliminating the MLP's required cash contributions to its general partner to alleviate a growing cost of capital.
Given funding constraints and taxation consequences for shareholders, Enbridge is not ready to outright acquire both partnerships. "Their access to capital markets was being questioned because they'd been downgraded by Moody's in the back half of last year, and the capital that they would require to roll all those entities up to have just one regular corporation ... likely isn't a funding endeavor that they would want to add to the cloud of uncertainty they have right now," Veritas Investment Research Corp. Vice President Darryl McCoubrey said in an interview.
McCoubrey also emphasized that a roll-up would trigger higher taxes for limited partners due to the corporate structure and the fact that the transaction itself is also taxable, similar to a potential TransCanada buyout of TC PipeLines.
The option to consolidate Spectra and Enbridge Energy Partners does not seem to appeal to Enbridge, either, as it seeks to separate its liquids and gas segments, Gemino said.
Still, some industry observers say FERC's ruling should further convince Enbridge to simplify what CreditSights analysts called "the most complicated midstream [organization] chart" in a May 10 note to clients. Barclays analysts wrote in a March 16 note that the company "would be somewhat incentivized" to roll up Spectra and Enbridge Energy Partners due to their exposure to cost-of-service rates.
Enbridge Energy Partners units closed the May 15 session at $9.94, down 24% since the FERC tax ruling, while Spectra's stock fell 17% in the same period, finishing March 15 at $33.18 per unit.

