What happened
Oil and gas pipeline master limited partnerships sold off on Thursday, with several dropping by double digits. Leading the downdraft were Energy Transfer Partners (ETP), Spectra Energy Partners (SEP), and Enbridge Energy Partners (EEP), which were all down at least 10% by the mid-afternoon. Fueling the sell-off was a policy change by the Federal Energy Regulatory Commission (FERC), which will no longer allow oil and gas pipeline MLPs to recover an income tax allowance as part of their cost-of-service rates.
So what
FERC's policy revision came in response to a ruling from the U.S. Court of Appeals that it "failed to demonstrate there was no double recovery of income tax costs" when it permitted an MLP to "to recover both an income tax allowance and a return on equity" in setting pipeline rates. Because of that, FERC has revised its earlier policy that allowed MLPs to recover an income tax allowance in their cost-of-service fees.
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The net effect of this ruling is that the tariffs that pipeline companies charge on regulated oil and gas pipelines will fall, likely cutting into their cash flow. The decision is weighing heaviest on MLPs that make most of their money by operating regulated pipelines. The additional cash flow from this allowance had been substantial in some cases. For example, Enbridge Energy Partners noted earlier this year that the tax cuts enacted last year would result in the company earning less money on its Lakehead system because it had to reduce the income tax allowance component of the tolls charged to reflect the reduction in the U.S. corporate tax rate from 35% to 21%. Consequently, the company's forecast for distributable cash flow declined from a range of $775 million-$825 million down to $720 million-$770 million. However, since it will no longer be allowed to include any tax allowance as part of its tolls, cash flow will likely fall further this year. That's the same concern weighing on Spectra Energy Partners and Energy Transfer Partners since both operate vast FERC-regulated pipeline systems.
That said, not all MLPs will face the same impact. Enterprise Products Partners (EPD 0.18%), for example, had fallen as much as 9% on the day due to the FERC ruling. However, the company said, "We do not expect the revisions to the FERC's policy on the recovery of income taxes to materially impact our earnings and cash flow. The cost-based tariff rates that are in effect for all of our interstate pipelines are based on a cost of service for those pipelines whereby the disallowance for the recovery of an income tax allowance will not have a material effect, if any, to the posted tariffs.
It's also worth noting that Enterprise Products Partners, which is one of the country's largest MLPs, isn't as reliant as others on FERC-regulated oil and gas pipelines. In Enterprise's case, it makes a significant portion of its money operating oil and gas processing plants and storage terminals, which would experience no impact from this change. That statement seemed to put investors' minds at ease, enabling units of the MLP to recover most of its losses by the end of the day.
Meanwhile, natural gas pipeline company Kinder Morgan (KMI 2.53%) also said that it shouldn't see any impact to cash flow as a result of this ruling because it's not an MLP. While investors initially sold off shares of the natural gas pipeline giant -- falling more than 7.5% at one point today -- they have recovered their earlier losses.
Now what
It could take a while before the dust settles on this new FERC ruling, which appears to have hit some MLPs harder than others. Clearly, though, investors are taking a "sell first and ask questions later" approach to the severity of the impact. While that could create bargains down the road, we don't yet know the full impact this change will have on harder-hit MLPs like Enbridge Energy Partners, Energy Transfer Partners, and Spectra Energy Partners. As a result, investors might want to wait until these companies have had a chance to review their impact and release new guidance before making any investment decisions.
