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FERC Adopts Final Rule Addressing Natural Gas Pipeline Tax Changes

FERC has given unanimous approval to a final rule to address changes in income tax rates for natural gas pipeline companies resulting from last year's federal tax reform bill.

The 202-page final rule, approved by the Federal Energy Regulatory Commission late Wednesday as Order 849, modifies a notice of proposed rulemaking (NOPR) issued in March.

The rule, according to the Commission, would allow it to determine which pipelines under the Natural Gas Act (NGA) may be collecting unjust and unreasonable rates in light of the corporate tax reduction and changes to FERC’s income tax allowance policies following the United Airlines v. FERC (827 F.3d 122 [D.C. Cir. 2016]) case.

The NOPR was issued in response to the $1.5 trillion Tax Cuts and Jobs Acts bill signed by President Trump in December. The rule would require interstate gas pipelines to file a one-time report (FERC 501-G) on the rate of the new tax law and changes to FERC's income tax allowance policies. In addition, FERC said pipelines would have four options:

  • Make a limited section 4 filing to reduce rates by the percentage reduction in cost of service shown in FERC 501-G;
  • Commit to file either a prepackaged uncontested rate settlement or a general NGA section 4 rate case if using the limited section 4 option will not result in a just and reasonable rate;
  • If it does not believe it has to change its rates, file a statement explaining why; or
  • File the new form without taking any other action.

Based on which option a pipeline selects, and the contents of the pipeline's FERC 501-G, the Commission would consider whether to initiate a Section 5 investigation of the pipeline's rates if it appears those rates may be unjust and unreasonable.

"Although the final rule maintains the requirement to file the FERC 501-G, the final rule makes adjustments to the proposed form, including automatically eliminating the accumulated deferred income tax (ADIT) from a pipeline's cost of service when the form enters a federal and state income tax of zero for pipelines that are nontax paying entities," FERC said.

That adjustment is consistent with an order on rehearing of the revised policy statement in Docket PL17-1-001, which was issued concurrently with the final rule.

The final rule also encourages pipelines to file an addendum to FERC 501-G to reflect their individual financial situations, and adopts with clarifying modifications procedures proposed for Natural Gas Policy Act section 311 and Hinshaw pipelines to reflect in their jurisdictional rates any rate reductions from the new tax law and changes to FERC's income tax allowance policies.

Flowing Benefits To Customers ASAP

The Tax Cuts and Jobs Act, which went into effect Jan. 1, reduced the corporate tax rate from a maximum 35% to a flat 21%, said FERC Chairman Kevin McIntyre.

"We recognize that reductions in rates are not appropriate for every pipeline, as many pipelines are in a state of underrecovery and many have settlements with their shippers that include rate change moratorium provisions, and may need significant discounted and negotiated rates," McIntyre said. "However, when a pipeline is overrecovering, it is imperative that tax reduction benefits that should be expected are addressed and are flowed to customers as soon as possible, given that the Natural Gas Act does not permit retroactive ratemaking.

"My goal is for us to do our statutory job here, which is to ensure that we identify the regulatory construct that would work best and most efficiently and flow through to consumers the benefits of this historic and dramatic reduction in the income tax rate in an an open and transparent manner. I believe the final rule that we issued yesterday, which carefully considered the thoughtful and valid concerns that commenters raised, did just that, in a deliberate and expedient manner."

Incentives To Reduce Rates

The final rule provides power incentives for pipelines to voluntarily reduce their rates, according to Commissioner Neil Chatterjee.

"In particular, it provides for a three-year moratorium on Commission-initiated Section 5 investigations should a pipeline voluntarily agree to reduce its rates to reflect the Tax Cuts and Jobs Act or the United Airlines decision so that its total ROE [return on equity] is at or below a 12% threshold value," Chatterjee said.

Commissioners Cheryl LaFleur and Richard Glick voted for the orders. However, in a joint statement, the two Democrats expressed "some frustration" that rate benefits customers and shippers might have expected could be significantly reduced by FERC's treatment of ADIT.

"As a matter of equity, we believe that the arguments for applying previously accrued ADIT balances to reduce future rate base where a tax allowance is eliminated are compelling," they said.

"However, based on the arguments presented in this docket regarding the Commission's authority to mandate those reductions on a generic basis, it appears that such a directive would run afoul of the rule against retroactive ratemaking, as interpreted by the D.C. Circuit in Public Utilities Commission of State of California v. FERC. Nonetheless, we note that today’s order is simply guidance, and to the extent that customers or shippers in individual proceedings argue that such a reduction is legal in specific cases, we will consider those arguments on the appropriate record."

LaFleur and Glick also said a legislative fix is needed to address the lack of refund authority in Section 5 of the Natural Gas Act.

"Under current law, the Commission’s ability to protect natural gas customers against unjust and unreasonable rates is compromised by its inability to set a refund date. We believe that current law provides a perverse incentive for protracted litigation and creates an asymmetry of leverage between pipelines seeking a rate increase under Section 4 of the NGA and complainants or the Commission under Section 5."

The revised policy statement issued by FERC earlier this year included an income tax allowance for master limited partnerships (MLP) that is not included in Order 849.

MLP Ownership Structures Now Beneficial?

"We would characterize FERC's stance as a shift from what appeared to be a categorical 'no' in March for MLP income tax recovery to 'maybe some,'" said ClearView Energy Partners LLC. "The wording in both...orders indicates to us that while the revised policy statement is guidance and not legally binding in terms of forcing rate reductions, the Commission's order on remand in the United Airlines v. FERC case prohibits double recovery of tax obligations.

“Between the two orders, we believe FERC has opened the door to retaining income tax allowances in pipeline rates in cases where a corporation owns MLP partnership units, as we thought possible."

Eliminating the ADIT from cost of service can significantly lower ROE, making it beneficial for some natural gas pipelines to stay in MLP ownership structures, according to East Daley Capital analysts.

"The impact of the new FERC rulings on MLPs is sure to send a shockwave through the U.S. oil and gas midstream sector, and the market is already responding positively," said East Daley’s Justin Carlson, managing director of research. "When the FERC originally issued ADIT guidelines in March of this year, there was concern that the new guidelines would negatively impact MLP earnings, and as a result we saw the movement of midstream companies converting from an MLP structure to a C-Corp. Now that the FERC has clarified the policy, swinging the pendulum back the other way."

The final rule takes effect 45 days after publication in the Federal Register. The deadline for the first group of pipelines to file FERC 501-Gs will be 28 days after the effective date of the final rule; deadlines for the second and third groups will each be 28 days after the previous group's deadline.

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