The Federal Energy Regulatory Commission (FERC) ruled on two significant regulations regarding cost-of-service calculations on Thursday, sending a shockwave through the oil and gas midstream and financial sectors
Centennial, CO – March 16, 2018 – East Daley Capital Advisors, Inc., an energy assets research firm redefining risk assessment for midstream energy companies, is encouraging investors in midstream oil and gas companies to look closely to evaluate the risk to companies in the wake of new FERC rulings. On Thursday, FERC ruled on two significant regulations regarding cost-of-service calculations. The first will disallow MLP interstate natural gas and oil and pipelines to recover an income tax allowance in cost of service rates, which will prevent the “double recovery” of taxes by the MLP. The second requires natural gas pipelines, weather under the MLP or C-corp structure, to file a one-time report on the rate effect of the new tax law and changes to the Commission’s income tax policies.
“These FERC rulings have rocked midstream companies and we are getting a lot of questions about how this will impact company earnings,” said Justin Carlson, VP and Managing Director, Research at East Daley Capital. “MLPs in particular, such as Enbridge Energy Partners, TC Pipelines and Spectra Energy Partners, saw a double digit drop yesterday in their unit prices as the market reconciles the impact of these new rulings. However, it’s not all doom and gloom as many midstream companies have healthy assets and strong earnings potential, even despite this FERC action.”
This first change is significant for MLP’s holding natural gas pipeline assets, as return-on-equity (ROE) calculations on these pipelines will increase significantly without the income tax allowance, which would negatively impact earnings. The first ruling will also likely affect liquids pipelines. While FERC did delay action until 2020, the elimination of the MLP tax allowance raises the chances that a pipeline will not be able to raise its tariffs with indexing methodology and increases the pipeline’s ROE making it more susceptible to a rate case. Additionally, lower tax rates put deflationary pressure on the FERC indexing calculated adjustment that they true up every five years. This will put deflationary pressure on the next true up in 2020.
“However, as noted in our “Dirty Little Secrets” report, which analyzed the risk of lower tax rates on all the natural gas pipelines analyzed by East Daley, there are mitigating factors that also must be considered,” said Carlson. “In Transco’s case, operating costs due to their integrity program have ramped up in 2017 which will cut ROE compared to 2016 numbers. Also, Transco has a significant number of contracts with negotiated rates that may be over-earning their project specific ROEs. These contracts are unlikely to be adjusted during their term as the FERC has a longstanding policy of not changing negotiated rates.”
East Daley’s analysis on the impacts of the new tax laws on the midstream sector is detailed in a new report titled “Dirty Little Secrets – The Naked Truth: Uncovering Opportunities in the Midstream Sector.” The report analyzes the ROE for over 40 natural gas pipelines, indicating that half of those pipelines are at risk to lower rates over the next few years via FERC action.
East Daley’s largest asset database of U.S. energy infrastructure and patent-pending production allocation model, combined with in-depth analysis, brings greater transparency to the midstream energy financial market by providing investors and market participants with deeper, more accurate data to inform their investment and strategy decisions.
About East Daley Capital Advisors, Inc. is an energy assets data and analysis research firm that is redefining how markets view risk for midstream and exploration and production (E&P) companies. In addition to using top-level financial data to predict a company’s performance, East Daley delivers asset-level analysis that provides comprehensive, fact-based intelligence. Supported by a team of unbiased, experienced research analysts, East Daley provides its clients unparalleled insight into how midstream and E&P companies operate and generate cash flow. East Daley uses publicly available fundamental data and intersects that data with a company’s reported financials to asset-level adjusted-EBITDA and distributable cash flow (DCF). The result allows for more informed portfolio decisions. Founded in 2014, the company is based in Centennial, Colorado. For more information visit http://www.eastdaley.com.