Highway to the Danger Zone - Pipelines with Rising ROEs

Hopefully, many of you were able to join our Webinar on Wednesday with other experts from Wright & Talisman and Brown, Williams, Moorhead & Quinn, which was focused on how the recent federal tax cut may play out at the Federal Energy Regulatory Commission (FERC). LawIQ provided an overview of its data-driven analysis describing how different FERC approaches may impact the tariff rates and revenue of the natural gas pipelines it regulates.
Today this topic gained mainstream media attention, as the Wall Street Journal published an article that used our data to analyze the impact of the tax cut on the larger public companies that own these pipelines. The Journal's article focuses on the percentage of a pipeline's revenue that is generated from negotiated rate agreements. While we agree that such an approach is a key indicator of the potential impact on a pipeline's revenue, a more robust, quantitative analysis based on additional financial characteristics of the pipeline assets is necessary. LawIQ has prepared a white paper that provides such an analysis, based on these additional characteristics:

Is the pipeline subject to a rate moratorium, which is an agreement with its shippers that neither the shippers nor the pipeline will seek a change in rates for a set period of time?
Is the pipeline subject to a comeback requirement, which is an agreement obligating the pipeline to file a rate case by a date certain?
Is the pipeline's return on equity (ROE) above a rate that may make it particularly prone to being subject to a rate case and a rate adjustment in any such case?

In our white paper, we analyzed these three factors, plus the percentage of negotiated rate revenue discussed in the Wall Street Journal article, to calculate an individual "Revenue Resilience Score" for over 60 pipelines. We then combined those individual pipeline scores to obtain an aggregated Revenue Resilience Score for the 11 public companies that hold an interest in those pipelines:

Berkshire Hathaway
Boardwalk Pipeline Partners
Dominion Energy
Enable Midstream
Enbridge
Energy Transfer
EQT
Kinder Morgan
Tallgrass Energy
TransCanada
Williams

The chart below shows the range of scores for these 11 public companies. As you can see, there is quite a difference in the aggregated Revenue Resilience Score among the companies. How does this analysis measure up?
Public Company Revenue Resilience

Today we would like to focus on just a couple of key aspects of our analysis, ROE and comeback requirements. As Joe Koury of Wright & Talisman noted during the Webinar, the one certainty about how FERC will handle the tax cut issue is that any pipeline that needs to come before FERC on a tariff rate issue this year will be expected to adjust its rates to account for the change in the corporate tax rate. In fact, this has already happened to TransCanada's

Changing the assumed tax rate from 35% to 21% on 100% of a pipeline's revenue results in a 21.5% increase in that pipeline's ROE. Thus, pipelines with an ROE, prior to the tax cut, in the 11.5% to 14% range may not have been required to reduce their rates, but, after the tax cut, could have a revised ROE that puts the pipelines in the danger zone for a rate reduction. For purposes of calculating our Revenue Resilience Score, we used a 14% ROE as the threshold above which pipelines begin running the risk of having to reduce their rates. We used this rate because it has become a fairly standard rate for the approved ROE used to calculate initial rates for a new pipeline, given their higher risk profile.

Our data shows that there are nine such pipelines, which as a result of the tax cut may have moved into this zone. Interestingly, three of them, Williams Companies' Transcontinental Pipeline and Northwest Pipeline , and Kinder Morgan's Southern Natural Pipeline, are obligated under prior settlement agreements to file Section 4 rate cases this year. So, even if FERC takes no industry-wide action, these three pipelines, with total revenues exceeding 10% of the industry's entire annual revenue, may well be required to adjust their rates this year as a result of the tax cut.