Interstate natural gas pipelines expressed support for the direction of FERC's proposed policy statement that would allow the use of master limited partnerships (MLP) in proxy groups to determine oil and gas pipelines' return on equity (ROE). But they had some concerns with the particulars. Local distribution companies (LDCs), on the other hand, urged FERC to move cautiously, while major producers viewed the policy statement as a short-term patch..
The Federal Energy Regulatory Commission issued the draft policy statement in late July, conceding that a change in the type of companies allowed to be included in proxy groups was warranted in light of the decline in publicly traded companies with substantial pipeline assets and the rise in the number of MLPs in the pipeline sector (see NGI, July 23).
While pipes favor the shift in policy, they are opposed to FERC's proposal to cap the cash distributions used to determine an MLP's return under the discounted cash flow (DCF) methodology at an MLP's reported earnings. The Commission said this action would render MLP cash distributions comparable to corporate dividends for the purpose of a DCF analysis.
"The Commission is clearly heading in the right direction by recognizing that 'firms engaged in the pipeline business are increasingly organized as MLPs,'" said Spectra Energy Transmission LLC, which owns a number of interstate gas pipelines and storage facilities. But "the Commission should not adopt its proposed cap on MLP distributions," it said.
Instead of a cap, FERC should eliminate any "outlier MLP proxy candidate that either 1) distributes more cash flow than is internally generated by the MLP, or 2) fails to demonstrate a sustained level of cash distributions over a set period," Spectra Energy said.
If there are "outliers" in a prospective proxy group that present clearly anomalous distributions, "the Commission's approach should be to exclude them from the final proxy group rather than perform an across-the-board subtraction from the distributions above earnings of all MLPs," the company noted.
Spectra Energy warned that capping MLP distributions at earnings would ignore the market and chill investment in the pipeline industry.
El Paso Corp., which owns El Paso Natural Gas pipeline, echoed those sentiments. "The Commission's proposal to cap an MLP's distributions at the level of its earnings is inconsistent with [the] market-based theory of the DCF methodology and would result in an understatement of the return component of pipeline rates," it said.
The Houston-based energy company said it also agreed with the Interstate Natural Gas Association of America, which represents interstate gas pipes, that "the Commission's concern about the sustainability of an MLP's distributions [is] unfounded and [is] not supported by either financial theory or historical experience." Thus, "the burden should be on any party opposing the inclusion of an MLP in the proxy group to demonstrate that a particular MLP's distributions are not sustainable and that such MLP is not suitable for inclusion in the proxy group."
El Paso called on FERC to adopt a final policy that would allow MLPs to be included in pipeline proxy groups without 1) limiting cash distributions to the MLP's earnings or 2) requiring a demonstration from a sponsoring pipeline that an MLP's distributions are sustainable.
The American Gas Association (AGA), which represents LDCs, recommended that FERC convene a technical conference "to address [the] uncertainties so that the Commission as well as industry participants can have the confidence that the Commission's proxy group policy will produce rates consistent with the statutory mandate" of the Natural Gas Act.
"AGA believes that before allowing MLPs to be included in a proxy group, the Commission should exercise care (including making appropriate adjustments) to ensure that use of MLP cash distributions in the calculation of rates of return will not overstate or misrepresent the required return on equity," the utility group said.
Unlike interstate pipelines, the AGA said it believes capping the distributions at earnings is "appropriate" to eliminate the potential for double recovery of return of capital.
The Natural Gas Supply Association (NGSA), which represents major producers, believes the proposed MLP proxy group policy should be implemented on an interim basis. "As more adjustments are made to force MLPs into the DCF model, the method becomes increasingly less intellectually pure, making this proposal, at best, a temporary solution. Thus, in order to develop a more valid long-term solution, a new proceeding should be initiated to devise a more straight-forward and transparent approach that departs from the long-held DCF model," the NGSA said.
During the interim period, the producer group said a cap on MLP distributions was "imperative." It further noted that in order to be included in MLPs, companies should have pipeline operations that constitute a higher proportion of their businesses. And the NGSA said the policy should not be applied retroactively in cases where the hearing phase has been completed and the record has been closed.
Interstate gas pipelines have repeatedly called on FERC to recognize the growing role of MLPs in the pipeline industry, and the need to include them in proxy groups to determine pipe ROEs. The exclusion of MLPs from proxy groups triggers wide shifts in ROEs that can affect the profits pipelines make each year and their ability to attract investors for projects, they said.
The issue of MLPs in proxy groups came to the forefront last year in a rate case involving Kern River Gas Transmission. A FERC judge recommended a 9.34% ROE for the Wyoming-to-California pipeline, significantly below what it had requested, based largely on the exclusion of MLPs from its proxy group. In October 2006, FERC voted to increase Kern River's ROE to 11.2%, but it ruled that the pipeline had not met the burden to support its proposal to include MLPs in its proxy group (see NGI, Oct. 23, 2006).
Kern River's proposed proxy group included Enterprise Products Partners, GulfTerra Energy Partners LP, Kinder Morgan Energy Partners, Kinder Morgan Inc. and Northern Border Partners. But the proxy group ultimately adopted by FERC was composed of companies with a relatively low proportion of pipeline businesses and substantial distribution operations.
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