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US FERC will disallow tax allowance cost recovery for MLPs

The US Federal Energy Regulatory Commission no longer intends to allowoil and natural gas pipelines organized as master limited partnerships torecover an income tax allowance in cost-of-service rates.

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The agency was acting in response to a federal appeals court ruling thatfound FERC's rate policies could allow oil pipelines to set uppartnerships to unfairly profit from their tax structure. The DC CircuitCourt of Appeals in July 2016 -- in United Airlines v. FERC, a caseinvolving the pipeline SFPP -- held that the commission failed to showthere is no double recovery of taxes for partnership entities thatreceive an income tax allowance in addition to a discounted cash flowmethodology used to set returns on equity.

In response to the ruling and to comments it subsequently collected, FERCsaid it will revise its 2005 policy statement for recovery of incometaxes to no longer allow MLPs to recover an income tax allowance tocompensate for investors' taxes on the partnership income.

Passthrough entities are not subject to corporate income taxes, but theowners face taxes individually on the entity's income.

FERC Chairman Kevin McIntyre said the court ruling gave FERC "very clearmarching orders."

"In the United Airlines case, the court did not mince its words. It notonly vacated the commission's prior orders with respect to this doublerecovery issue , but it stated in no uncertain terms that granting anincome tax allowance to master limited partnerships results in'inequitable returns.'"

To carry out the change, FERC commissioners voted Thursday to issue apolicy statement directing oil pipelines set up as MLPs to reflect thechanges in their Form. 6, page 700 reporting. It said the policy changeswill be reflected in FERC's 2020 five-year review of the oil pipelineindex level.

While all passthrough entities claiming an income tax allowance will needto address the double recovery issue in United Airlines, Glenna Riley ofFERC's Office of General Counsel said the commission will address theissue for other passthrough forms in subsequent proceedings. FERC TO ADDRESS IMPACT AS PART OF NOPR

For interstate gas pipelines organized as MLPs, FERC is consideringimpacts of the revised policy as part of its notice of proposedrulemaking on effects of recent tax law changes (RM18-11).

In addition, a separate broad FERC inquiry (RM18-12) on tax cut reformsinvites comment on how the elimination of the income tax allowance forMLPs affects accumulated deferred incomes taxes. For those entitieslosing their allowances it will ask whether previously accumulated sumsfrom ADIT should be eliminated entirely from cost of service, or placedin a regulatory liability account and returned to ratepayers.

Implementing the new policy on remand, FERC also issued an order denyingSFPP an income tax allowance (IS08-390 et., al.), finding a real returnon equity of 10.24%. It also accepted an SFPP compliance filing in aseparate case (IS09-437), while seeking a further filing removing the taxallowances in SFPP's East Line cost of service.

Commissioner Cheryl LaFleur said she believed the commission's actionsoffer the "correct response," dictated by court remand and the recordFERC developed in response to its notice of inquiry.

"I know that is not the answer that the companies were hoping for," sheadded.

The Association of Oil Pipe Lines said it "is surprised and disappointedthat FERC did not take the option given to it by the court to demonstratethere is no double recovery by MLP pipelines."

"Much of the growth in pipeline capacity to serve American workers andconsumers is by partnership pipelines, and this choice by FERC makes thatexpansion harder," the group said.

The Interstate Natural Gas Association of America also pronounced itself"extremely disappointed" that FERC departed with its longstandingapproach.

Pipeline companies had previously argued that FERC's policies in factresulted in a parity of treatment between pipes owned by corporateentities and those owned by partnerships. Cathy Landry, a spokeswoman forINGAA said the trade group believes it offered convincing and detailedevidence to back a finding that MLP's are not double recovering taxes.

Benjamin Salisbury of B. Riley FBR, in a research note midday, said theMLP sector had sold off about 6.5% on news that FERC is no longerallowing MLPs to recover income tax allowance in cost-of-service rates.

"Our initial thoughts are that the broad market is being pulled down by[exchange-traded fund] selling in an effort to reduce exposure to namesexposed to interstate regulated pipelines," he said. "Over the pastquarter, we have seen individual MLPs such as Williams Partners andSpectra Energy Partners indicate some writedowns driven by the impacts oftax reform. We believe the same partnerships that were impacted by thereduction in corporate taxes are going to be exposed to FERC'sannouncement."

At the close, the Alerian MLP index, a gauge of energy MLPs, was down4.56%.

Lori Ziebart, executive director of the Master Limited PartnershipAssociation, cautioned that "the degree to which this decision impactsany particular MLP varies depending on the magnitude of their interstatepipeline business as well as the rate structure under which that portionof their business operates."

"Many interstate pipelines owned by MLPs are operated under contractswith negotiated rates that will not be impacted by this decision,"particularly newer assets where negotiated rates predominate. Interstatepipelines with index and other rate structures "are similarly notimpacted," she said.

Michael Grande of S&P Global Ratings said the FERC decision would"negatively impact credit ratios, but it's not fully clear how severethat will be at this time."

Enterprise Products Partners said FERC's altered policy is "not expectedto have a material impact to the earnings and cash flow of Enterprise."Tallgrass Energy similarly said FERC's tax policy revisions are likely tobe immaterial to that company's revenues, since both Rockies Express andPony Express have negotiated rate contracts.

ClearView Energy Partners in a note said the impact for natural gaspipelines "appears significant and may occur more quickly," than for oiland product lines, because FERC has directed gas pipes to file limitedcost and revenue studies, potentially triggering challenges fromshippers. -- Maya Weber, maya.weber@spglobal.com

-- Edited by Jim Magill, newsdesk@spglobal.com