Impact of Form 501G on Pipeline Rates - Transco as an Example

FERC's final rule implementing the requirement that pipelines file the new Form 501G could come any day now, although FERC originally estimated it wouldn't be issued until late summer. We expect that it will be issued before the typical summer vacation period here in Washington, which starts in earnest in early August. Pipelines will begin to file their forms within 28 days following the issuance of the final rule. A common perception seems to be that completion of the Form 501G by the submitting pipeline company is merely a ministerial task involving limited decisions that could impact important pipeline financial metrics, such as ROE. That is decidedly not the case.

Below is a Form 501G using calendar year 2017 data that we have completed for Williams' Transcontinental Gas Pipe Line Company (Transco). Far from being a simple calculation, there are key decisions that Transco must make that can result in drastic changes to the three outputs that the form is designed to calculate: Indicated Rate Reduction (aka Indicated Cost of Service Reduction), ROE before the Tax Changes and ROE after the Tax Changes. By changing just one or two inputs, Transco could cause the result for the Indicated Rate Reduction to be zero or as high as 9%, and the Pre-ROE to range from as low as 11% to as high as 25%, and the Post-ROE to vary between 15% and 25%. The choices that each pipeline makes when it files the Form 501G will have a significant impact on the likelihood and extent of any reduction in the pipeline's rates and, therefore, its overall revenue.

We have extracted the data necessary to complete the Form 501Gs for 2017, and we are in the process of completing the form for all 133 companies required to file the forms, which information will be a benefit to almost all stakeholders. Our version of the 501G forms will give shippers and investors an early window into the impact the filing may have on an individual pipeline's rates and revenues, including the ability to roll that impact up to the public company level. Pipelines will be able to compare their anticipated rate reduction and calculated ROE to other pipelines before they are required to file their own form.

Transco's 501G Form

Transco is required to file a rate case by August 1 of this year. Below is: (i) a copy of Page 1 of 501G form, as we have created it; (ii) an explanation of choices pipelines will be expected to make when they file the form; and (iii) our analysis of the choices we expect pipeline companies to make and the assumptions we will use in our analysis of the entire industry's forms.

Calculating the Rate Reduction

The purpose of page 1 of the Form 501G is to calculate the "Indicated Rate Reduction" that a pipeline would be required to adopt if it chose to file a voluntary limited Section 4 rate proceeding. However, the calculation of this reduction is dependent on choices the pipeline makes as to how to complete other sections of the form, as we discuss in Items 1 through 4 below.

1.   "Is the pipeline a separate income taxpaying entity?" - The answer to this simple question in the form determines the federal income tax rate for the time period before and after the tax cut. If the answer is yes, the form fixes the rates at 35% and 21%, respectively. If the answer is no, the form reverts to 0% for both before and after the tax cut, unless the pipeline completes the information on Page 5 of the form. Pipelines may simply answer no and leave Page 5 blank, because FERC would not otherwise have that data and the pipelines may assert that this is a section that FERC may not require them to complete. For Transco, we have assumed that it will answer yes to this question since Transco has indicated that its rate case will be based on the assumption that it has eliminated the MLP from its corporate structure and that Transco will be owned by a C corporation.
   
2. What is the pipeline's Return on Capital? - This value is driven by how the pipeline completes page 4 of the form, which allows the pipeline to essentially choose between four different capital structures. While many pipelines complained about the fourth structure in that section, which assumes a 50/50 debt to equity ratio with a 5% cost of debt and 10.55% return on equity, we believe almost every pipeline will elect this option because doing so will almost certainly result in the lowest indicated rate reduction when compared to the other three choices. For Transco, we have assumed it will choose this option because if it were to use the capital structure set forth under Option 1, the indicated rate reduction rises from 5.5% to 6.6%.
   
3. What is the pipeline's blended State Income Tax Rate? - This value is driven by how the pipeline completes Page 5. As with the other information on pages 4 and 5, by not completing this section, the pipeline can minimize the indicated rate reduction. For Transco, we have assumed that it will leave the state rate section blank, which reduces the indicated rate reduction to 5.5% versus the 5.8% rate that would have resulted if Transco had completed this section consistent with our understanding of Transco's actual state tax rate.
   
4. How does the pipeline amortize ADIT? - In the 2017 Form 2 that Transco filed in April, the company calculated the excess ADIT that it views will ultimately be returned to customers by establishing a regulatory liability of over $840 million. We expect most other pipelines will take a similar approach. The key issue in completing this entry will be whether, and how quickly, the pipeline will be required to amortize that regulatory liability. For Transco specifically, we have assumed that it will assert that none of this balance needs to be returned to customers because the regulatory liability will be eliminated when Williams completes a roll-up of the MLP. This is similar to the treatment FERC allowed for Kinder Morgan following its elimination of its MLP structure. Assuming instead that this liability is amortized over a 20-year period, would cause the indicated rate reduction to jump from 5.5% to 8.2%.
   

Calculating the ROE Pre and Post Tax Changes

The purpose of Pages 2 and 3 of the Form 501G, as set forth below, is to calculate the return on equity before and after the tax changes. The results are driven by the same issues that impact Page 1, but the choices that minimize the results on Page 1 increase the indicative rate of return in this section. For example, if Transco optimizes the form so that the indicated rate reduction goes to 0%, it would increase the calculation of both the pre- and post-ROE to 25%. Conversely, if Transco were to take the positions that would result in a 9.4% indicated rate reduction, the pre- and post-ROEs would fall to 11.5% and 15.1%, respectively. We believe that Transco and other pipelines will select a path between these two extremes.

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