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FERC Ends Income Tax Allowance Cost Recovery in MLP Pipeline Rates

FERC said Thursday it will no longer allow master limited partnership (MLP) interstate natural gas and oil pipelines to recover income tax allowances in cost of service rates.

Commissioners said the decision came in response to a decision of the U.S. Court of Appeals for the District of Columbia Circuit in United Airlines v. FERC (827 F.3d 122 [D.C. Cir. 2016]). The court held that the Federal Energy Regulatory Commission failed to demonstrate that there was no double-recovery of income tax costs when permitting SFPP LP, an MLP, to recover both an income tax allowance and a return on equity determined by the discounted cash flow methodology.

“As the United Airlines decision stated, the discounted cash flow methodology ‘determines the pre-tax investor return required to attract investment,’” said FERC’s Glenna Riley of the Office of General Counsel. “Given that the return is a pre-tax investor return, permitting a master limited partnership such as SFPP to recover both an income tax allowance for the partner’s tax costs and a discounted cash flow return on equity leads to a double recovery of income tax costs.”

According to the revised policy statement, while all partnerships seeking to recover an income tax allowance will need to address the double-recovery concern, the application of the United Airlines court case to non-MLP partnerships “will be addressed as those issues arise in subsequent proceedings,” FERC said.

The change could be a stumbling block for some exploration and production (E&P) companies, which found tax hedges in MLPs.

"MLP equity prices got hit hard last year, from the combination of concerns that the new mantra among U.S. E&P companies to focus more on returns and less on production growth at all costs will slow the rate of cash generating asset growth at MLPs, general concerns about the rising cost of capital at the MLP level, concerns about U.S. tax reform, and perhaps to a lesser extent, worries about rising interest rates, which historically have sent MLP prices lower,” said NGI’s Patrick Rau, director of Strategy & Research.

In December 2016, FERC issued a notice of inquiry and received comments about how to address any double recovery of income tax resulting from its income tax allowance and rate of return policies [PL17-1].

By its vote Thursday, FERC also instructed oil pipelines organized as MLPs to reflect the elimination of the income tax allowance in their Form No. 6, page 700 reporting. FERC will use the data to incorporate the effects of the revised policy on industry-wide oil pipeline costs in the 2020 five-year review of the oil pipeline index level.

But the impact “appears significant” and may occur more quickly for natural gas pipelines, ClearView Energy Partners LLC said. In a separate but interrelated action Thursday, FERC issued a notice of proposed rulemaking that addresses the effects of the revised income tax policy on the rates of interstate natural gas pipelines as MLPs. 

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