Risks From Filing Form 501G - How the Major Pipelines Stack Up

Next month, the Form 501Gs will start rolling in. And, as we discussed in 501G Calculator & Consultation Available from LawIQ, our team has pre-populated a Form 501G, specific to each of the 126 companies required to file the form, to illustrate each pipeline's particular circumstances: ROE, revenue by rate structure, and optimal filing scenarios considering ADIT, ITA and rate case moratoria.

Based on LawIQ's 501G analytics, we expect a significant number of filings for "major pipelines" (which we define as those with more than $100 million of annual revenue in 2017), will show high ROEs (above 16%) by FERC standards, and will have "indicated rate reductions" exceeding 8%. The graph below for the 46 major pipeline companies shows why the calculations that the 501G forms generate can create risks for pipelines.
Major Pipelines Ranked by Post-Tax-Cut ROE and Indicated Rate Reduction

This analysis used the following assumptions that all pipelines: file Form 501G as a C corporation; pass back excess ADIT on a ratable basis over 25 years; use the FERC default capital structure of 43/57 debt to equity. 
Some pipeline companies are skeptical (Kinder Morgan's CEO called the form "flawed") about whether a standard form is too blunt an approach to capture the complexities of a case-by-case analysis. Nonetheless, pipeline companies should have a plan in place to rebut any "inaccurate" expectations that the form may create.

Whether you are a pipeline seeking to benchmark to your competitors, an investor assessing the risk to the total revenue of a pipeline and its parent company, or a shipper hoping to benefit from a rate reduction, understanding where a pipeline falls on this chart is critical. And, of course, details matter. So let's take an initial look at the chart's four quadrants.

Upper Right - Double-Barreled Risk Profile

The sixteen pipelines in the chart's upper right quadrant will likely be primary targets for rate reductions by FERC and the shipper community, because both their post-tax-cut ROE, over 16%, and the indicated rate reduction, over 8%, are higher than most of the other pipelines. The pipelines in this group will likely need to explain why their ROEs are high and be able to rebut the expectation that a rate cut of the calculated magnitude is appropriate. We fully expect pipelines in this group to focus on at least three key elements to thwart any demand that they immediately file to reduce rates:

• Two of the pipelines in this category have a moratorium in place from a prior settlement that should exempt them from filing to reduce rates until those moratoria end.
• Five of these pipelines generated over 80% of their 2017 revenue from negotiated rate contracts and will likely argue that any rate reduction will not benefit anyone. Of course, the up to 20% of shippers not under negotiated rate agreements and FERC may disagree with this argument.
• Pipelines with a substantial number of expansion projects in recent years that were incrementally priced for rate purposes will likely argue the contracts supporting those projects are creating their high ROE, and once the rate base is adjusted for these projects, their current rates remain appropriate or are even too low.

If these arguments are not persuasive, this group of major pipelines face the double-barreled risk arising from filing the Form 501G: 1) they will be the focus of FERC and the shipper community; and 2) if they need to reduce their rates, the magnitude of those rate reductions may be substantial.

Upper Left - Regulatory Risk, But Will Anyone Care?

The ten pipelines in the chart's Upper Left Quadrant face the same regulatory risk as those in the upper right, because their post-tax-cut ROE is also higher than most, but their indicated rate reduction is lower than the upper right quadrant pipelines. However, a quick review shows their post-tax-cut ROEs are not substantially lower; they all have an indicated rate reduction of at least 6%. Interestingly, this group of ten includes seven pipelines currently subject to a rate moratorium under prior settlements. This should, at least temporarily, protect them from any rate reductions. The remaining three pipelines generate a significant portion of their revenue from recourse rate contracts and may need to focus their arguments on recent changes to their systems that create the false impression of an unusually high ROE.

Lower Right - A Healthy Rate Reduction, If It's Real

The Form 501G filings by the thirteen pipelines in the chart's lower right quadrant are expected to show a substantial rate reduction due to their customers, ranging from 8% to almost 14%. However, these pipelines all have less than a 16% ROE (an ROE comparable to that recently asserted by Transcontinental Pipeline as being the median rate of return needed to attract capital) and many of them have less than a 12% ROE, which is what FERC indicated they need to achieve after any rate reduction to obtain a three-year moratorium.

We expect the pipelines in this quadrant to assert that even after the tax cut, they still are not earning an allowed rate of return and should not be obligated to make any rate reduction. In addition, three of them are currently subject to a moratorium on rate changes from prior rate cases. However, if their filings show that the expected rate reduction is this high, they should expect pressure from their shippers to share at least some of the calculated rate reduction. These pipelines could be candidates for making a rate reduction to reduce their ROE to less than 12%, and then seeking a three-year moratorium on any future rate cases in exchange.

Lower Left - Help, I am Drowning

The seven pipelines in the chart's lower left quadrant are likely candidates for taking the fourth option FERC has offered to pipelines when they file - to simply file the Form 501G and leave well enough alone. These pipelines not only have post-tax-cut ROEs lower than their peers, but will also show a lower indicated rate reduction. If you assume FERC and shippers have limits on the resources needed to bring Section 5 cases against pipelines that don't adjust their rates, the pipelines in this quadrant are prime candidates for taking that risk and simply filing the Form 501G and moving on with their business.

LawIQ has created a 501G analytics and advisory product that allows our customers to calculate the Form 501G results for all 126 pipelines using alternative scenarios.
Note: GIF animation will not display in MS Outlook

We have developed the graphic at the beginning of this write-up by using this product and will make available to our customers who have access to the product the full list of companies included in the graphic. If you haven't yet asked us about getting access to this product, please contact James Cahalin at jcahalin@lawiq.com , or call us anytime at (202) 505-5296.

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