Report: New U.S. Tax Laws Increase Rate Case Risk on Natural Gas Pipelines
East Daley Capital Advisors, Inc., an energy assets research firm redefining how markets view risk in midstream energy companies, today released “Dirty Little Secrets – The Naked Truth: Uncovering Opportunities in the Midstream Sector.” The 165-page report details the risk for 28 companies in the midstream sector by subdividing their cash flow at an asset-level providing key insights and EBITDA forecasts for 2018 and beyond.
“The newest risk to midstream earnings from natural gas pipelines in 2018 is undoubtedly the new federal tax cuts,” said Justin Carlson, VP and Managing Director, Research at East Daley Capital. “The passage of the new tax legislation was a major shoe to drop on the regulatory front and it potentially has major direct and indirect effects on the rates and revenues earned by regulated pipelines. The most obvious of these effects is the massive cut to the corporate tax rate which will increase pipeline return on equity for those with significant corporate ownership.”
Under the new tax plan, East Daley Capital has identified twenty natural gas pipelines that will have return on equity’s (ROEs) well above the typically allowed range. FERC typically targets return on equity for interstate pipelines to fall anywhere between 10-14%, depending on asset-specific risks. East Daley Capital views the risk of significant rate and revenue downside as quite high for many natural gas pipelines under these new tax laws. Investors should have a solid grasp on pipeline specific ROEs and potential mitigating factors for the companies they own as FERC considers next steps for rate reductions.
“Due to the sweeping tax changes, it’s possible FERC could take industrywide action and investors should take notice as it could bring down rates swiftly and significantly,”added Carlson. “Given the precedent that FERC has done this before in the late 80’s and given FERC Commissioner Powelson’s recent rate reduction comments, this may be the route the FERC ends up taking. However, FERC could take a more targeted approach by using Section 5 rate cases to launch investigations on specific pipelines where ROE may be too high.”
Key findings from the report include:
- Tax cuts have raised return on equity for natural gas, oil, and NGL pipelines, increasing the risk of significant revenue cuts via rate cases or rate freezes.
- $7.2 billion (15%) in cash-flow growth from midstream companies in 2018 will be transformational for an industry beaten down in 2017.
- Gas and oil production is expected to surge across the country, boosting oil output by 1.3 million bpd and gas extraction by 5.6 Bcf.
- Supply growth has been underappreciated in areas like the Bakken Shale, Powder River Basin and Marcellus Shale. Growth in those regions is contrary to market sentiment for rate and volume risk.
- The infrastructure of tomorrow could be in the ground today with old infrastructure finding new life in the Permian Basin, Bakken Shale and DJ Basin.
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