April 25, 2018, by Naureen S. Malik
Pipeline owners led by Enbridge Inc. and Williams Cos. could be forced to refund as much as $18.5 billion to drillers, utilities and even United Airlines Inc. for upfront payments they charged customers before new U.S. tax rules cut the corporate rate.
Natural gas conduits include the cost of future tax payments in customer fees. Because the Trump administration lowered the tax rate 21 percent from 35 percent earlier this year, pipelines have effectively been overcharging customers, according to East Daley Capital Management Inc. The sides now await a U.S. ruling on whether refunds must be made, and how quickly.
The outcome could be particularly damaging to master limited partnerships aligned with pipeline companies. In March, MLPs — whose shares are down 21 percent from a year ago –lost the ability to collect any taxes, after regulators issued a ruling following a federal court decision involving United Airlines. Now, they face the prospect of paying back funds charged in the past.
“The worst-case scenario is pretty draconian,” for pipeline owners, said Matthew Lewis, director of financial analysis at East Daley in Centennial, Colorado. “FERC has left pretty much every option open: You don’t have to pay back any or you have to pay it all back,” or something in between.
Among the companies with the most to lose: Enbridge may have to refund customers a portion of $3.5 billion, while Williams could owe a percentage of $2.3 billion in excess charges, Lewis said. Representatives for Enbridge and Williams didn’t immediately respond to requests for comment.
Companies disclose their so-called accumulated deferred income taxes for individual pipelines to regulators annually. To arrive at $18.5 billion, East Daley added up the 40 pipelines with the highest ADIT liabilities as of 2016, the most recent data. Of that total, 78 percent was funneled up to eight parent companies.
The Federal Energy Regulatory Commission hasn’t yet said how much pipelines will have to reimburse customers, though it’s unlikely that a full refund will be required, Lewis said. Still, Trump’s tax overhaul essentially wipes out an MLP subsidy that helped the industry access cheap capital and allowed the nation’s gas network to expand at a rapid clip amid the shale boom.
Timing will be key. Spreading reimbursements out over decades could minimize the blow to the industry. At the same time, an outright refund may be the best option for some pipeline owners because it would resolve the tax question and create goodwill with customers, who will push for lower rates when existing agreements expire, Jay Rhame, portfolio manager at W.H. Reaves & Co., said in an interview in New York.
And cutting customers’ rates could result in lower dividends for investors. Regulators typically limit gas networks’ returns on equity to 10 to 14 percent, but the corporate tax cut means those numbers may rise, Lewis said.
“This makes it easier to show pipelines are over-earning,” Lewis said.
Regulators’ scrutiny of pipeline tax issues came after a U.S. appeals court in 2016 held that FERC failed to show that a Kinder Morgan Inc. oil products pipeline wasn’t doubling up on the recovery of its income taxes from United Airlines. For MLPs, the government’s recent moves limit the companies’ appeal as an investment vehicle.
“It’s crazy,” Rhame said. “A lot of companies view MLPs as piggy banks” and while the government’s move won’t wipe out this investment vehicle, “it’ll probably last a long time as a zombie industry.”
Though FERC has so far barred only gas MLPS from collecting taxes, the agency has said that it will look at oil partnerships in 2020 when it conducts its five-year review.
Along with Enbridge, TC Pipelines LP, TransCanada Corp.’s publicly traded U.S. MLP, also has “significant exposure” to the tax overhaul on its interstate gas lines, Bloomberg Intelligence analyst Michael Kay said in a report last month. TransCanada declined to comment, but spokesman Grady Semmens said executives will provide updates during the company’s earnings call on Friday.
For more on the end of the MLP tax allowance, click here
The tax revamp may prompt more corporations to buy out their MLPs to limit their potential liability. Pipeline owners that have moved to streamline in recent years include Kinder Morgan Inc., Tallgrass Energy Partners LP and Oneok Inc. Among the companies that could follow are Williams Cos., which owns 73 percent of Williams Partners LP, and Enbridge, the majority owner of Spectra Energy Partners LP, Lewis said.
Companies won’t likely see an earnings hit from the tax change, but reduced cash flows could strain pipeline owners that are “right on the edge of investment grade,” Rhame said.
FERC will consider comments from the industry and other interested parties before making a decision on potential refunds to pipeline customers. Until then, analysts and investors are looking to pipeline owners for clues on how they may respond to future rulings.
“Right now we are really reassessing how much long-term impairment is really happening here,” Rhame said.