While U.S. energy pipeline companies expect the recently reduced corporate tax rate to ultimately benefit their balance sheets, some midstream businesses took significant fourth-quarter 2017 earnings hits due to the diminished value of future tax breaks.
The Tax Cuts and Jobs Act of 2017 slashed the corporate tax rate to 21% from 35% starting in 2018. But because of when the law was signed, according to tax expert Greg Matlock at the business consulting firm EY, pipeline entities that are taxed as corporations had to revisit their results.
"If I have a net operating loss, which many companies in the [midstream] space have had, I have effectively a deferred tax asset because I could offset future earnings with this net operating loss, and because the tax law was signed into law before the end of the year, for financial statement purposes you have to evaluate the changes as of the enacted date," he said in an interview. "Instead of having a net operating loss that could offset income at a 35% rate, that asset is now only valuable up to a 21% rate."

One-time hits
Kinder Morgan Inc. reported the largest deferred tax expense of a group of major U.S. midstream companies and partnerships S&P Global Market Intelligence examined, with a $1.4 billion fourth-quarter loss, while Plains GP Holdings LP took a hit of $823 million.
Targa Resources Corp., on the other hand, recorded a $269.5 million deferred income tax benefit due to the lowered corporate rate applied to its deferred tax liability.
Those one-time charges, however, have not dimmed midstream companies' sunny outlook on federal taxes. Kinder Morgan CEO Steven Kean stated in the gas pipeline giant's Jan. 17 earnings release that the lower rate will be "moderately positive" for the company.
"Several of our U.S. business units (essentially all but our interstate natural gas pipelines) will be able to deduct 100 percent of their capital expenditures through 2022," he said. "The net impact results in postponing the date when [Kinder Morgan] becomes a federal cash taxpayer by approximately one year, to beyond 2024."
Anticipating
Some midstream master limited partnerships also recorded tax-related losses for the fourth quarter, but for a much different reason than their income-tax-paying peers.
MLPs transfer their income tax responsibilities through distributions paid to investors, who then pay taxes on those earnings. Through a 20% pass-through deduction that applies to both business income and MLP unit sales, along with the top individual rate being lowered from 39.6% to 37%, those tax liabilities have shrunken considerably.
At the same time, however, interstate pipeline MLPs and corporations face a risk that reduced taxes could result in cost-of-service decreases that eat into profits. "The recent federal tax cuts have raised natural gas pipeline return on equity, increasing the risk of significant revenue cuts via upcoming rate cases," a January report from research firm East Daley Capital Advisors Inc. noted. "Companies with heavy pipeline exposure like Spectra Energy Partners LP, Kinder Morgan, and TransCanada Corp. may now have assets where ROE has jumped into the high teens and even over 20%, when typically, the [Federal Energy Regulatory Commission] targets around 10 to 14%."
After pipeline customer advocates pressured the commission to take steps preventing companies from over-collecting for their cost of service, FERC asked developers to provide an adjusted cost of service and to recalculate the initial incremental rates tied to the cost of expansion.
Indeed, Spectra's $860 million fourth-quarter charge reflected "the establishment of an estimated regulatory liability," according to the partnership's annual report filed with the SEC on Feb. 16. Williams Partners LP listed a similar expense, but CEO Alan Armstrong assured investors that the new tax law will not affect existing rates.
Kinder Morgan's Kean was also optimistic that FERC will not make any near-term changes to its policy. "We do not believe that the FERC can or should isolate the tax law change for some separate immediate action," he said during the company's Feb. 17 earnings conference call. "So we think it's very well established that neither the pipeline itself nor the commission can selectively adjust one element on the cost of service without considering the overall cost of service."
