FERC Abandons Tax Allowance in MLP Pipeline Rate Setting and Signals Changes Due to Tax Act Rate Drop

On Thursday, March 15, 2018, the Federal Energy Regulatory Commission (“FERC” or “Commission”) issued a series of orders and notices to address changing the treatment of income tax costs in rate setting for oil and natural gas companies and public utilities.^[1]  These orders and notices are, in part, a response to the reduction in the federal corporate income tax rate to 21 percent under the Tax Cuts and Jobs Act of 2017.  The immediate effect differs by industry.

MLPs No Longer to Receive Income Tax Allowance in Cost-of-Service Rate Setting

FERC issued a Revised Policy Statement on Treatment of Income Taxes (“Revised Policy Statement”) announcing that it will no longer allow natural gas and oil pipelines organized as master limited partnerships (“MLPs”) to recover an income tax allowance in their cost-of-service rates. The stock market reacted promptly causing a drop in MLP unit prices on March 15th by, on average, almost 10 percent, although there has been some recovery in prices since then.  The policy change is significant and will undoubtedly have an impact in the long run, but there are many reasons why the revenue effect of the policy change may be quite muted.  In fact, a number of MLPs have already commented that they do not expect the ruling to have a significant impact on their earnings.

The MLP policy change was issued as a result of the July 2016 remand to FERC of a rate case by the D.C. Circuit Court of Appeals in United Airlines.^[2]  In that case, the petitioners, shippers on an interstate oil pipeline, asserted that cost-of-service rates should not include an allowance for income tax costs when the pipeline is held by an entity, such as a partnership or LLC, that is transparent for tax purposes and all the income taxes of which are borne by the partners (or, in the case of MLPs, their unitholders).  The petitioners argued that including income tax costs to the partnerships in their cost of service for purposes of setting FERC-approved rates was a double recovery if the partnership did not in fact bear entity-level tax costs.

The Court of Appeals remanded the issue to FERC to determine the basis for including an income tax cost recovery in the rates of a partnership and FERC has had an open inquiry on this point for the last 15 months.  A number of stakeholders submitted comments on the issue asserting that the tax costs of MLP unitholders affect their return on investment in the same manner that the tax costs of a corporation affect corporate shareholders and thus should equally figure in to a cost of service calculation.  The Revised Policy Statement provides that FERC will no longer allow an MLP to recover income taxes in its rates.  FERC stated that it will address non-MLP partnership forms in the future as the issue arises in subsequent pipeline proceedings. 

However, the impact of the new policy may not be immediate or significant for a number of MLPs.  For example, the new policy only applies to those pipelines that are under FERC jurisdiction, while many MLPs have intrastate pipelines that are not affected by FERC’s rate-setting rules.  Second, if the MLP’s rates are subject to FERC regulation but have been determined by a negotiated rate agreement with the shipper, the policy change may not have an impact until the agreement is no longer in effect.  Similarly, if the pipeline’s rates are fixed under a settlement agreement with its shippers and there is a moratorium on proposing rate changes for a specified period of time or the settlement is a “black-box” settlement which includes little if any cost and revenue information, an adjustment in rates pursuant to the new policy may be delayed.  For further discussion, see our earlier alert on this topic.

Notice of Inquiry Solicits Comments on Tax Costs After Tax Reform

On March 15, 2018, FERC simultaneously issued a Notice of Inquiry regarding the effect of the Tax Cuts and Jobs Act on all rates under FERC jurisdiction, which would include those charged by public utilities, interstate natural gas pipelines, and oil pipelines.^[3]  Although the Notice of Inquiry solicits comments on the effects of the tax law changes generally, the Commission is particularly interested in possible responses to changes regarding accumulated deferred income taxes and bonus depreciation.  Comments are due 60 days after the Notice of Inquiry is published in the Federal Register.

The Tax Cuts and Jobs Act reduces the federal corporate income tax rate to a flat 21 percent rate, effective January 1, 2018, from a prior maximum rate of 35 percent, thereby reducing the tax liability of public utilities, interstate natural gas pipelines and oil pipelines. FERC is soliciting comments on the impact the changes in tax law will have on cost-of-service based rates (which include income taxes among other expenses) and indexed rates.

Proposed Rule Calls for Informational Filing and Action Regarding Rate Adjustment

In addition to the Revised Policy Statement and the Notice of Inquiry, FERC issued a Notice of Proposed Rulemaking (“NOPR”)^[4] proposing a process that will allow it to determine which jurisdictional natural gas pipelines may be collecting unjust and unreasonable rates in light of the recent reduction in the corporate income tax rate in the Tax Cuts and Jobs Act and changes to the Commission’s income tax allowance policies following the United Airlines decision.  The NOPR includes a requirement that interstate natural gas pipelines make a one-time informational filing with the Commission to evaluate the effect of both the Tax Cuts and Jobs Act and the Revised Policy Statement on interstate natural gas pipelines’ revenue (“One-time Report”).  A new form (FERC Form No. 501-G) and guide that sets out the information to be submitted in the One-time Report is included as part of the NOPR. Comments are due 30 days after the NOPR is published in the Federal Register.

Under the proposed regulation, in addition to, and simultaneously with, filing the required One-time Report, each interstate natural gas pipeline, regardless of whether it is a partnership or a corporation, would be required to do one of the following:

• reduce its rates by filing a limited Natural Gas Act (“NGA”) section 4 filing, reflecting the decrease in federal corporate income tax liability and the elimination of the MLP tax allowance,
• commit to file either a pre-packaged uncontested settlement or, if that is not possible, a general NGA section 4 rate case by December31, 2018,
• file a statement explaining why no change in its rates is necessary, or
• take no action other than filing the One-time Report.

However, the rule proposes that if the interstate gas pipeline does not pick either option 1 or 2, FERC will consider issuing an order under the NGA “requiring the pipeline either to reduce its rates to reflect the income tax reduction or explain why it should not be required to do so.”  Interstate natural gas pipelines that file general NGA section 4 rate cases or pre-packaged uncontested rate settlements before the deadline for their One-time Report will be exempted from making the One-time Report.

Oil Pipelines

At this juncture, FERC has chosen not to take action to alter oil pipeline rates, which are typically set based on an industry-wide index.  According to a Staff Presentation on March 15, 2018, FERC believes that the cost data informing the industry-wide index during the 2014-2019 period will reflect the changes in tax law and the Revised Policy Statement.^[5] FERC has, however, sought additional information to inform its 2020 five-year review of the oil pipeline index level. For example, oil pipelines organized as MLPs must reflect the elimination of the income tax allowance under the Revised Policy Statement in their next Form No. 6, page 700, due April 18, 2018, to allow FERC to review the effects for the 2020 five-year review.  This information will be used in future rate setting for oil pipelines, regardless of whether rates are set annually through FERC indexing^[6] or through cost-of-service ratemaking. 

Electricity:  Public Utilities Must Explain or Adjust by May 13, 2018

FERC issued two show-cause orders,^[7] requiring each of 48 public utilities in total “(1) to propose revisions to its transmission formula rates under its open access transmission tariff or transmission owner tariff to reflect the recent change in the federal corporate income tax rate, or (2) to show cause why it should not be required to do so” by May 13, 2018. These orders were issued to address public utilities that incorporated the former 35 percent federal corporate income tax rate into their transmission rates.  Additionally, FERC issued two orders approving waivers for a Midwest transmission-owning utility^[8] and certain Midcontinent Independent System Operator, Inc. (“MISO”) Transmission Owners^[9] for the 2018 rate year. The waivers requested in each case were to change certain provisions to reflect the Tax Cuts and Jobs Act, including the reduction in the federal corporate income tax rate.   

In the first case, the utility had argued in its request that the waiver would facilitate a reduction in cost for its customers, as a result of the lower federal corporate tax rate, not reflected in the projected net revenue requirements it had submitted before the Tax Cuts and Jobs Act was enacted. Similarly, the MISO Transmission Owners had argued that the waiver would allow them to “avoid relying on the true-up for Rate Year 2018 to return the money [from the reduced federal corporate tax rate] to customers.” They also argued that approval of the waiver would “remove regulatory uncertainty” with regard to the impact of the tax law changes on their transmission rates.

Summary

FERC is seeking a reevaluation of rates to the extent that the federal corporate income tax rate is included in the rate-setting analysis, whether through a line-item in public utilities’ transmission formula rates or interstate natural gas pipelines’ stated rates. At the same time, FERC is soliciting information to inform future industry-wide decisions for interstate natural gas pipelines and oil pipelines. These decisions reflect a desire to ensure that rates reflect any savings accruing to companies due to the changes in tax law and do not permit double recovery with respect to tax costs.  The immediacy of the impact of these actions on MLP revenues may, however, have been overestimated by the market.