Special Report: Tax Changes - What to Expect for Oil Pipelines
The markets are focused on how the FERC's actions in response to the Tax Cuts and Jobs Act and FERC's revised MLP Tax Allowance policy will impact natural gas pipelines. Yesterday, the FERC's Notice of Proposed Rulemaking, "Interstate and Intrastate Natural Gas Pipelines; Rate Changes Relating to Federal Income Tax Rate" (NOPR), was published in the Federal Register. This action starts the time frame for comments, due by April 25. This NOPR describes how FERC proposes to implement tax changes for natural gas pipelines, but does not address the process for interstate liquids pipelines (which FERC refers to as "oil pipelines," although such pipelines include crude oil, refined products and natural gas liquids pipelines).
The timing and significance of any impact on oil pipelines, like that on natural gas pipelines, will be highly dependent on each pipeline's particular circumstances. Our review of Form 6 data for the 207 oil companies in the LawIQ web platform can help identify pipelines that could be singled out for individual rate action between now and 2021, when FERC proposes to address the tax changes on an industry-wide basis for oil pipelines. In summary, there is relatively little risk of rate action for the vast majority of oil pipelines, 125 of the 207, until 2021. Among the remaining 82 pipeline companies, we believe the ten highest interstate revenue pipeline companies (which, in many cases,include multiple pipelines) that could potentially face specific rate actions initiated by their shippers before 2021 include:
Marathon Pipe Line LLC
Tallgrass Pony Express Pipeline, LLC
Buckeye Pipe Line Company, L.P.
Zydeco Pipeline Company LLC
Express Pipeline LLC
Phillips 66 Carrier LLC
NuStar Logistics, L.P.
EnLink NGL Pipeline, LP
NuStar Pipeline Operating Partnership L.P.
Holly Energy Partners
Getting Up-to-Speed on Oil Pipeline Regulations
As we have discussed in prior customer notes, including last week's report and the pending Colonial Pipeline rate case, the regulatory framework for oil pipelines is very different from the framework for natural gas pipelines. In its press release on March 15, FERC acknowledged this difference with its simple statement that, for oil pipelines, it would address the tax changes in its 2020 five-year review of the oil pipeline index. As a result, many stakeholders have assumed that there will be no impact on oil pipelines' index rates until 2021, when the new index referenced in this statement would take effect. While these changes will have an industry-wide impact in 2021, FERC did adopt some changes that could impact the rates of MLP-owned pipelines as early as 2018, and the rates of Non-MLP owned pipelines in 2019.
FERC regulates oil pipeline rates under the Interstate Commerce Act (ICA). In response to the Energy Policy Act of 1992 (EPAct 1992), FERC issued Order 561, which created FERC's methodology for indexing oil pipeline rates and allows oil pipelines to annually change their rates, subject to certain ceiling levels.
Every five years, FERC reviews how the industry's costs have changed since the prior review and establishes a base rate to be used for the following five-year period, which, when combined with an inflation-based index, is used each July to calculate the new ceiling level. The last review was conducted in 2015 and established the base rate for the years 2016 through 2020. The next review will be conducted in 2020 and will take effect on July 1, 2021. This is why conventional wisdom is that FERC's actions will not impact an oil pipelines' rates until July 1, 2021.
Page 700 - A Screening Tool for Shippers
In Order 561, FERC determined that EPAct 1992 did not completely remove FERC's authority to investigate an oil pipeline's rates, but made clear that it would rely primarily upon shipper challenges to a pipeline's rates. To aid shippers in this effort, FERC added page 700 to Form 6 to serve as a preliminary screening tool. Page 700 provides a simplified presentation of an oil pipeline company's jurisdictional cost-of-service and revenues. In its present form, page 700 reflects only total company data, which may involve a single pipeline asset, but oftentimes includes multiple pipelines and does not provide separate costs-of-service for different parts of a pipeline system.
Shippers can use the data in page 700 to support a preliminary claim against a pipeline's rates, which can result in a FERC rate investigation, by satisfying one of two tests. The first, the "percentage comparison test," compares the change in the prior two years' total cost-of-service data reported on page 700 with a pipeline's proposed indexed rate change. FERC has historically investigated the proposed index rate change if the percentage comparison test differential is greater than 10%. The second test, the "substantially exacerbate" test, may lead to a FERC rate investigation if the pipeline is "substantially over-recovering" and the index increase would "substantially exacerbate" that over-recovery. As indicated by the word "substantially," there is currently no numerical criteria for this second test.
In October 2016, FERC issued an Advance Notice of Proposed Rulemaking (ANOPR) in which it proposed changes to both the percentage comparison test and the substantially exacerbate test. FERC proposed replacing its somewhat vague "substantially exacerbate" test with a new "exacerbate" test, which would deny any ceiling level increase or indexed rate increases for pipelines in which a pipeline's page 700 revenues exceed page 700 total costs by 15% for each of the prior two years. The change to the "percentage comparison" test would deny a proposed increase to a pipeline's rate or ceiling level greater than 5% of the barrel-mile cost changes reported on page 700.
FERC's March 15 Actions on Oil Pipelines
While FERC did not take any direct action on March 15 to address over earning by oil pipelines, its new policy on income tax allowance contained two footnotes that require changes to how oil pipelines are to complete their page 700 filings for this year and next. In the first footnote, FERC directed that any pipeline owned by an MLP should remove from its page 700 filing to be made on April 18, 2018, any income tax allowance for both calendar years 2016 and 2017. In the second footnote, FERC directed all other pipelines to reduce the tax allowance for calendar year 2018 to the new 21% corporate rate for the page 700 filing to be made on April 18, 2019.
Under FERC's directive for MLP pipelines, this year's page 700 filing will not trigger the percentage comparison test because both years will have no tax allowance. However, the removal of any tax allowance for both years could lead to a pipeline showing revenues that exceed their costs by at least 15% for 2016 and 2017, which could trigger the "exacerbate" test in the ANOPR or the more subjective "substantially exacerbate" test. In such a situation, shippers may challenge a particular pipeline's proposed index increase that would otherwise occur in July of this year, which could lead to a rate investigation by FERC.
Assessing Risk for Individual Oil Pipelines
While FERC has yet to act on its ANOPR, the 15% "exacerbate" test provides a tool that can be applied to each pipeline's Form 6 filings for 2016 to gauge the risk that a shipper may challenge a pipeline's rates, either this year or next, depending on whether the pipeline is owned by an MLP or not.
To screen for pipelines that have some risk for such a claim, we reduced the 2016 reported tax allowance for MLP-owned pipelines to zero and tested to see whether the pipeline would have revenue that exceeded 115% of its costs for 2016. The vast majority of pipelines, 125 out of 207, even after these adjustments, did not have revenue that exceeded their costs by 15%. The following pipelines were the ten largest MLP-owned pipelines by Interstate Operating Revenue that would have 2016 revenue that exceeded their costs by at least 15%:
Respondent name
Unadjusted Percentage Overearning
Adjusted Percentage Overearning at Zero Tax Allowance
Marathon Pipe Line LLC
11%
24%
Tallgrass Pony Express Pipeline, LLC
12%
34%
Buckeye Pipe Line Company, L.P.
10%
23%
Zydeco Pipeline Company LLC
97%
114%
Express Pipeline LLC
59%
83%
Phillips 66 Carrier LLC
20%
34%
NuStar Logistics, L.P.
26%
51%
EnLink NGL Pipeline, LP
136%
185%
NuStar Pipeline Operating Partnership L.P.
10%
23%
Holly Energy Partners
37%
64%
The mere fact that an MLP-owned pipeline may have 2016 revenues that exceed their costs by 15% does not mean there will be any impact to that pipeline company's anticipated revenue for 2018. For there to be an impact on an MLP-owned pipeline company's revenue, the following four criteria would need to apply:
The filing for 2017 would need to show that there were not other changes to their revenues or costs that would reduce the excess revenues to a level less than 15%;
A shipper would have to file a complaint against a particular company;
FERC would need to approve the shipper challenge; and
Any change would most likely only impact the pipeline's rates that are subject to the index.
LawIQ is analyzing these and the other 72 companies that met this initial screen to determine (i) if they are owned by an MLP and will be required to adjust their page 700 this year or (ii) if they are owned by a non-MLP and will only be required to adjust their page 700 in 2019.
This communication has been prepared by LawIQ, LLC. The information contained in this communication has been obtained from publicly available data, but we do not represent or warrant that it is accurate or complete. This communication is for informational purposes only and not for the purpose of providing legal advice. Your receipt or use of this communication is not provided in the course of and does not create or constitute an attorney-client relationship. LawIQ, LLC, its affiliates, and their respective officers, directors, partners, and employees do not accept any liability for any direct or consequential loss arising from any use of this communication or its contents.
