Enbridge’s Quiet $4 Billion Spat With Its Shippers

Following the passage of the Tax Cuts and Jobs Act at the end of last year, FERC has been on an adventure to make sure the benefits of the tax cut are passed through to natural gas pipeline customers. The twists and turns of FERC’s efforts reverberated through the equities market and led a number of companies to announce that they were ending their participation in the master limited partnership (MLP) market, often by buying all of the outstanding shares of the interests held by the public in the MLP found in their corporate family tree. One such company that announced its abandonment of the MLP marketplace is Enbridge, which on August 24 announced a merger in which it would acquire all of the publicly held common units in its MLP, Spectra Energy Partners (SEP).

Following its announcement, Enbridge sought FERC approval of its proposed accounting treatment for its accumulated deferred income taxes (ADIT), one of the most arcane areas of the tax accounting process. Normally, such accounting entry applications draw little attention and are routinely approved by FERC’s Chief Accountant. However, Enbridge’s filing caught the eye of its customers, maybe because the proposed entries have the potential to add almost $4 billion in assets to the SEP pipeline companies’ balance sheets, and over $5 billion when combined with separate filings made by other pipelines partially owned by SEP. Then, last Thursday, FERC issued a Policy Statement regarding the treatment of ADIT for both accounting and ratemaking purposes for all Commission-jurisdictional public utilities, natural gas pipelines, and oil pipelines. This new policy may impact the current spat between Spectra and its shippers, and appears to favor the shippers in that fight.

The Enbridge Request

Enbridge’s request involves a number of accounting entries concerning the treatment of its pipelines’ ADIT balances resulting from FERC’s decision to no longer allow a pipeline owned by an MLP to include an income tax allowance (ITA) in the cost of service used to justify its tariff rates. The primary purpose of the accounting entries proposed by Enbridge is to remove from the books of the SEP pipelines both the ADIT and Excess ADIT that were on the company’s books as of the end of 2017. The entries result in an almost $4 billion difference in the asset base of the SEP pipelines and potentially eliminate the need to pass back the Excess ADIT to the pipeline companies’ shippers.

The total ADIT balances are substantial. The Excess ADIT equates to approximately two-thirds of the ADIT balance as of December 31, 2017, as shown in the chart below. For some of the SEP pipelines, the combined ADIT balances exceed 40% of the value of the company’s net plant.

FERC’s Winding Path for ADIT

Since March 15 of this year, when FERC started down the path to address both the Tax Cuts and Jobs Act and its surprise announcement changing the ITA policy for MLPs, the path has been anything but clear or linear with respect to ADIT. The surprise announcement ending MLPs’ right to an ITA led to a precipitous decline in their stock values.

The initial understanding of FERC’s announcement was that FERC would no longer allow an MLP to include an ITA in its cost of service. But, FERC would still require the ADIT and Excess ADIT balances to be included on the pipeline’s balance sheet, and the Excess ADIT balance would need to be returned to shippers over the remaining useful life of the assets. This was a triple whammy for MLPs, because the ADIT and Excess ADIT balances are deductions from the Net Plant of the pipeline, which reduces the pipeline’s cost of service. The discontinuance of an ITA further reduces the pipelines’ cost of service, and the pass-back of the Excess ADIT also reduces the pipelines’ cost of service. This triple whammy is what led to the steep market decline of MLPs, and caused many companies with MLPs in their structures to reassess their continuing viability.

In July, FERC announced its “final” rules and policies regarding the ITA for MLPs. With this announcement, it appeared FERC reversed course on two of the whammies included in its March announcement. FERC announced that because an MLP was no longer entitled to an ITA, the MLP would no longer need to keep either the ADIT or Excess ADIT on its books, and would not be required to pass back the Excess ADIT to its customers. This was a great relief to the MLP market, although many companies had already decided to eliminate their MLP’s. In fact, Loews Corporation had completed its corporate restructuring that terminated its Boardwalk MLP just days before FERC’s announcement in July. Enbridge continued with its decision to acquire the publicly held common units of SEP and announced that decision on August 24.

Based on FERC’s July announcement, the petition Spectra filed with FERC in September seems very straightforward. In essence, Spectra is simply asking FERC to allow it to reflect on its books the treatment provided under FERC’s Form 501G, namely, that for an MLP owned pipeline, the ADIT balances and Excess ADIT balances are removed, and the need to pass-back the Excess ADIT balance over time is eliminated. However, a number of Spectra’s shippers objected to the proposed accounting treatment on various grounds, including:

The request is premature, because FERC’s policy only allows elimination of the ADIT and Excess ADIT balances once the ITA is removed from a pipeline’s cost of service.
In the rate case that Texas Eastern has announced it intends to file, the shippers should have the opportunity to argue whether the pipeline’s proposed cost of service, revenue requirement, income tax allowance, and ADIT are calculated properly and result in just and reasonable rates. The approval of these accounting changes prior to Texas Eastern’s rate filing could prejudge some of these determinations and put shippers at a serious disadvantage during that proceeding.
A pipeline’s accounting entry proceeding does not provide shippers with the due process rights to challenge the accounting changes as required by FERC’s new ITA policy.

FERC’s New Policy

In the midst of this spat, FERC, last Thursday, issued a new “policy” that may impact restructured MLPs like the SEP pipelines, although this is far from clear. This newest policy indicates that any Excess ADIT associated with post-December 31, 2017 asset dispositions should be treated differently for ratemaking purposes. According to the November policy, for an entity that continues to receive an ITA, there are two associated balances following a taxable sale: (1) the ADIT balance based on the 21 percent tax rate that will be owed to the IRS; and (2) Excess ADIT balances resulting from the reduced tax liability that will not be payable to the IRS upon the sale or retirement of the asset. While ADIT balances that need to be settled with the IRS would be extinguished following a sale, Excess ADIT balances are more reflective of a regulatory liability and need not be extinguished.

This policy can be read to reinstate one of the whammies eliminated after the July decisions, at least for pipelines that are restructured from being owned by an MLP to being owned by a C corporation, and would require the Excess ADIT to remain on the books of the pipeline and passed back to the customers through a reduction in a pipeline’s ITA. The reason this may apply to the SEP pipelines is because the transaction which Enbridge chose to eliminate the MLP from its structure appears to be considered a taxable sale under the tax code; thus, the “sale” treatment set forth in the policy may well apply, since, following the transaction, these pipelines will continue to be entitled to an ITA.

A Very Simplified View of the Impact on Texas Eastern

While the above chart is oversimplified, there is enough impact here for the parties to continue to fight over the tax treatment of the ADIT.
Given the substantial impact of the changes and the parties agreeing that an accounting proceeding is not the place to dispute a major rate issue, we would expect FERC to not rule on Enbridge’s accounting treatment request and defer it to the expected Texas Eastern rate case, or potentially, the pending Saltville rate proceeding.

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