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UPDATE: FERC strips income tax allowance for interstate pipeline MLPs

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UPDATE: FERC strips income tax allowance for interstate pipeline MLPs

The Federal Energy Regulatory Commission will no longer allow interstate natural gas and oil pipelines operating as master limited partnerships to recover an income tax allowance in their cost-of-service rates, stripping many pipelines of a mechanism that had boosted the amount of pretax income passed through to unit holders.

The FERC announcement, made at its monthly public meeting on March 15, came after a federal appeals court ruled that the agency failed to demonstrate that there had not been "double recovery" of income tax costs when it allowed a Kinder Morgan Inc. liquid pipeline company, SFPP LP, to recover both an income tax allowance and a return on equity that was determined by the discounted cash flow methodology. FERC launched a notice of inquiry on the subject of tax allowances and rate-of-return policies in December 2016.

The official order was not yet available on FERC's website. (FERC dockets PL17-1, et al.)

The Alerian MLP index was down 4.2% at 3:30 p.m. ET. Williams Cos. Inc. share prices dropped 5.8%, Energy Transfer Partners LP fell 6.9% and Spectra Energy Partners LP plunged more than 9.6% on the news.

In initial notes, analysts said the new policy will likely have a significant impact on MLPs, especially when coupled with write-downs driven by a reduction in the corporate tax rate.

"We believe the same partnerships that were impacted by the reduction in corporate taxes are going to be exposed to FERC's announcement," B. Riley FBR Inc.'s Benjamin Salisbury said in a report. "This leads us to believe that names without interstate pipeline exposure and limited FERC regulated tariffs should not be materially impacted." He singled out Boardwalk Pipeline Partners LP as a name that could see more significant impacts, while Sunoco LP and Martin Midstream Partners LP should be largely spared.

Jefferies analysts said FERC's announcements on taxes and rates "leave ambiguous" the impact to pipelines held within partnerships that are wholly owned by taxable C-corporations, such as Kinder Morgan and ONEOK Inc. "We believe the most impacted entities are those that lack an obvious C-corp vehicle into which these assets may pivot," an analyst team led by Christopher Sighinolfi said.

Stifel pointed out that the income tax line is just one component of the cost of service rate, which also includes maintenance, depreciation and other costs associated with operating a pipeline, Selman Akyol and other analysts said. "This adds a layer of uncertainty to the group, and we do not expect it to be cleared soon," they said.

SL Advisors LLC Managing Partner Simon Lack said in an email that there are "many reasons" to expect a limited impact to MLPs. For one thing, the commission's decision does not affect other parts of partnerships' businesses, such as gathering, processing, storage, LNG and other sectors. Lack also noted that many interstate pipeline contracts are negotiated based on market rates, rather than FERC rates.

But the change is another strike against MLPs. "It's possible this could be another justification to shift energy infrastructure ownership from MLPs to corporations," Lack said.

Research firm ClearView Energy Partners LLC said it expects complex rate cases over the next year and that FERC's action sends a clear message: "tax reform and [the effects of the SFPP case] will be lowering rates across electricity, natural gas and liquids pipeline sectors."