Responding to a court remand and revising a policy statement on the treatment of taxes by master limited partnership (MLPs) pipelines, FERC on March 15 said it will not longer allow pipelines owned by master limited partnerships to recover an income tax allowance in cost of service rates.
The ruling is in response to a remand from the U.S. Court of Appeals for the District of Columbia Circuit in an oil pipeline case (United Airlines Inc. v. FERC, 827 F.3d 122 (D.C. Cir. 2016)) involving SFPP L.P. and it will apply to oil and natural gas pipelines owned by MLPs.
Pipeline owners are assessing the impact of the decision, which can have different impacts on companies based on their ownership and rate structure. Kinder Morgan Inc., which owns the largest natural gas pipeline network in the U.S. and in 2014 changed from an MLP to a C-corporation, noted the corporate change in a March 15 statement that it would not be affected by the move.
Kinder Morgan and others also commented on a related proposed rule addressing pipeline treatment of taxes following the filing of information from the companies (see related story on page 3).
Financial analysts have said that the decision will affect MLPs with a heavy reliance on regulated pipelines and rates for their income, which could be reduced substantially by not including the tax allowance as part of the cost of service. FERC chose not to alter the discounted cash flow (DCF) methodology used to set a return on equity, providing an option to make adjustments through that ratemaking process, according to early reactions of the change.
At the Commission meeting and in a press briefing afterwards, FERC Chairman Kevin McIntyre said the directive from the D.C. Circuit was quite clear, that granting an income tax allowance and use of the DCF methodology in setting an ROE – which includes tax expenses – amounts to a double recovery of income tax costs. “The court did not mince its words” in the 2016 decision and it provided “very clear marching orders” to address the double recovery issue for MLP pipelines, McIntyre said.
The Association of Oil Pipelines (AOPL) and the Interstate Natural Gas Association of America (INGAA) expressed disappointment with the decision. The two pipeline groups are among the many entities that filed comments in a notice of inquiry (NOI) about how FERC should address the issue. Shippers and pipeline customers said the most logical step is to remove the tax allowance, while pipelines and MLP entities said FERC could demonstrate to the court that there is no double recovery of tax costs by MLPs, asserting that a change in tax treatment would erode pipelines’ ability to make investments on new infrastructure.
“AOPL is surprised and disappointed FERC did not take the option given to it by the court to demonstrate there is no double recovery by MLP pipelines,” said Andy Black, president and CEO of the pipeline group. “Much of the growth in pipeline capacity to serve American workers and consumers is by partnership pipelines, and this choice by FERC makes that expansion harder,” Black said in a statement.
INGAA “is extremely disappointed with FERC’s decision to reverse its longstanding policy by disallowing a tax allowance in cost-of-service rates for pass-through entities,” said Cathy Landry, a spokeswoman for the group.
INGAA believes it provided FERC with convincing and detailed empirical evidence to support a finding that MLPs are not recovering tax costs twice through the current structure, she said.
“The MLP structure created in tax law by the Congress has succeeded in promoting capital investment in the pipeline infrastructure needed to capitalize on America’s energy abundance. Elimination of the tax allowance for pass-through entities will blunt the effectiveness of this important incentive,” she said, adding that “INGAA is considering its next steps” in the proceeding.
In contrast, the head of the Natural Gas Supply Association (NGSA) welcomed the move. The decision to halt pipelines from recovering an income tax allowance in their cost of service is “a change we have actively pursued,” said Dena Wiggins, president and CEO of NGSA.
Because FERC’s ratemaking policy allowed MLPs to recover an income tax allowance, provided the owners can show an actual or potential tax liability to be paid on income, and its DCF methodology compensates partnerships for their tax liability, pipeline shippers have argued, and the D.C. Circuit agreed, that FERC was allowing double recovery of tax costs. The recovery occurred first when it granted SFPP a tax allowance in its cost-of-service rates and second when, using the DCF methodology, set the ROE on a before-investor-tax basis, the court said.
The Commission voted to revise its 2005 policy statement (PL17-1) based on the comments received and through the remand in the court case. When FERC issued the NOI on 12/15/16, commissioners noted that they were seeking advice from the energy industry on how to address the remand and the tax issue as part of its ratemaking policy. Even though the court case involved SFPP, commissioners said that the NOI and any resulting action from FERC could affect other entities.
In the March 15 policy statement revision, FERC said those asserting that the tax allowance should be retained failed to undermine the court’s conclusion that a double recovery of tax costs occurs through the DCF process and the tax allowance in rates and did not justify keeping the allowance notwithstanding a double recovery. None of the arguments made in response to the NOI “resolves the double-recovery concern, and accordingly, the Commission will no longer permit MLPs to recover an income tax allowance in cost-of-service rates,” FERC said.
For non-MLP pipelines, the revised policy statement leaves it to those entities to address the issues on income tax recovery as they arise in subsequent proceedings, FERC explained in the policy statement.
The policy statement change instructs MLP oil pipelines to reflect the elimination of the income tax allowance in their Form 6 page 700 reporting information, and that based on the updated data, the Commission will incorporate the effects in its five-year review of the oil pipeline index level in 2020, FERC staff explained at the meeting.
Besides the remand to the court and the policy statement, FERC addressed other proceedings involving SFPP at the meeting, including reversal of an administrative law judge decision and three complaints that had been held in abeyance pending resolution of the court remand.
By Tom Tiernan TTiernan@fosterreport.com
This article appears as published in The Foster Report No. 3190, issued on March 16, 2018
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