Policy Changes Won't Dent Midstream Moats
We may modestly decrease our fair value estimates after proposed policy changes, but we think the market is overly punishing high-quality midstream energy firms.
A D.C. Circuit Court decision prompted the Federal Energy Regulation Commission, or FERC, to propose policy changes on Thursday that could have a negative impact on our midstream coverage. The policy changes could eliminate MLPs' ability to recover a tax allowance, potentially leading to lower tariffs, revenue, and earnings.
We are reviewing Williams Partners (WPZ), Enbridge (ENB), Enbridge Energy Partners LP (EEP), Energy Transfer (ETE), and Spectra Energy Partners (SEP) for potential modest fair value estimate cuts. The relative winners here are corporations and market-based pipelines, primarily NGLs and refined products partnerships where the agreements are negotiated between child and parent. However, we don’t plan any moat changes for the industry. We reiterate that investors should be purchasing the highest-quality midstream firms that are deeply undervalued, including Enterprise Product Partners, Spectra Energy Partners, Enbridge, and Plains All American Pipelines and its general partner.
For natural gas pipelines that charge cost-of-service rates at maximum allowed levels, we expect a drop in EBITDA approximating 1%-5%. We expect a similar potential impact for oil pipelines operating under an index rate methodology. However, with the exception of Williams Partners, we believe many pipelines are actually underearning their allowed rates, meaning there will not be a material impact. Many pipelines charge negotiated or settled rates that also would not be impacted.
Despite the elimination of the double-recovery benefit, the MLP model remains sound, as taxes are still passed through to unitholders. FERC’s action merely eliminates a loophole that allowed MLPs to benefit twice from taxes. This has been debated in FERC filings and court cases going back more than a decade. Given the considerable number of pipelines that appear to be underearning their allowed rates, we think pipeline owners might already have anticipated FERC's move.
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Stephen Ellis does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.