MLP Market Update

by: , Director, Client Portfolio Manager, Cushing Asset Management

What Happened?

Today, the Federal Energy and Regulatory Commission (FERC) announced that it will disallow income tax allowance cost recovery in MLP pipeline rates. FERC is requiring every gas pipeline to file a new form, (501-G) that either sends a pipeline into a section 4 proceeding (to lower rates) or makes the pipeline explain why they do not need to change their rates. This is against the consensus view that the FERC would do this on a pipeline-by-pipeline basis and wouldn’t issue sweeping reform that could hit all pipes at once. The FERC ruled that oil and gas pipelines housed in MLPs would no longer be able to recover an income tax allowance in their cost of service rates. This reverses prior policy.

MLPs sold off in response to the news but we’d note that this will only impact MLPs with a meaningful amount of interstate oil and gas pipelines (roughly seven securities). Furthermore, while the market was down intraday around 9.38%, by close of business the market was only down by 4.56%.1

What Does that Mean?

MLPs enjoy significant tax benefits under the guise of limited partnership. One benefit is the inclusion of an income tax allowance in determining the cost of service. Removing such allowance will reduce their after-tax income. This issue has been going back and forth in the courts for more than 20 years. We believe the pipeline industry will appeal this decision. In addition, many pipelines within MLPs operate under market-based rates (in competitive markets) and many have black box settlements for rates; meaning they would not be impacted. In the interim, we’d expect the market to eventually differentiate those MLPs with significant potential exposure and those without. This ruling does not directly impact pipelines housed in C-corps.

Looking Ahead

Today’s drop is tied to an unexpected regulatory change resulting from an adverse court ruling – difficult to foresee, but an inherent risk when investing in narrow slices of the economy like MLPs.

It is also difficult to determine how such action will shake out. All partnerships seeking to recover this allowance will have to address the double recovery concern in subsequent proceedings. In the meantime, the market will have to determine how to value these companies given the new policy and its effects on MLP’s return on equity.

The FERC ruling only directly impacts pipelines owned by businesses structured as MLPs and that are interstate pipelines. A small number of MLPs are directly impacted, this does not affect every MLP across the space. The broad selling across the space is likely driven by investors selling or shorting MLP ETFs. We view the broad- based selling as an overreaction.

1. Based on Alerian MLP Index, as of 3/15/18.

Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.

Neither New York Life Investment Management LLC, its affiliates, nor its representatives provide tax, legal, or accounting advice. Please contact your own professionals.

About Risk

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

MLPs and other natural resources sector companies are subject to certain risks, including, but not limited to, fluctuations in the prices of commodities; the highly cyclical nature of the natural resources sector may adversely affect the earnings or operating cash flows of the issuers; and a significant decrease in the production of energy commodities would reduce the revenue, operating income, and operating cash flows of MLPs and other natural resources sector companies and, therefore, their ability to make distributions or pay dividends. Energy companies are subject to certain risks, including, the proposed elimination of specific tax incentives widely used by oil and gas companies, and the imposition of new fees on certain energy producers, could adversely affect energy companies in which the Fund invests and/or the energy sector generally.

MLPs are subject to certain risks inherent in the structure of MLPs, including tax risks.  Energy companies are subject to certain risks, including, but not limited to the proposed elimination of specific tax incentives widely used by oil and gas companies, and the imposition of new fees on certain energy producers, could adversely affect energy companies in which the Fund invests and/or the energy sector generally.

The Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization, is disseminated real-time on a price-return basis (AMZ) and on a total-return basis (AMZX).

As permitted by FERC rules, in June 2011 PNM began billing at the higher. rates associated with the original filing subject to refund. The agreement is a “blackbox settlement,” meaning the parties agreed to. a specific revenue number but no specific return on equity.

A corporation is a business term that is used to distinguish this type of entity from others, as its profits are taxed separately from its owners under subchapter C of the Internal Revenue Code.

New York Life Investment Management LLC engages the services of federally registered advisors. Cushing® Asset Management, LP is unaffiliated with New York Life Investments. MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, New Jersey 07302.

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Nick Brown

Director, Client Portfolio Manager, Cushing Asset Management

Nick Brown is the Client Portfolio Manager and Business Development Director at Cushing Asset Management. Prior to joining the firm in 2013, Nick was an Analyst in Bank of America Merrill Lynch’s Investment Banking Division in Houston

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2 Comments

    1. Thank you for your question. The greatest impact will be felt directly by FERC-regulated pipelines (typically natural gas) operating under “cost of service” rate mechanisms owned by MLPs, although impacts will vary depending on a multitude of factors.

      We have posted an update on the MLP market which highlights which companies were impacted and to what extent. http://www.nylinvestments.com/polos/MSCU02j-031874122.pdf

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