Roll-Ups (Enbridge) and Rate Cases (Dominion Overthrust) - What We Can Learn Before Transco Files
Enbridge announced on Friday its roll-up of Spectra Energy Partners providing that the "significant weakening of the US Master Limited Partnership capital markets has adversely affected the growth opportunities for MLPs," including Spectra. The timing of this announcement was not a surprise for those following FERC rate cases, because Enbridge was required to file a rate case by this Friday for one of Spectra's subsidiaries, Saltville Storage. While Saltville is a small portion of the Spectra portfolio, any details revealed in that proceeding about the tax structure of Saltville would have been a key indicator of whether the Spectra roll-up was going to occur, which would impact the major Spectra subsidiaries, such as Texas Eastern and Algonquin.
Investors, shippers, and operators can gain competitive intelligence about pipelines that have filed Section 4 rate cases and how decisions in those cases may impact the rates of other pipelines. This is particularly true this year because all other pipelines will be filing Form 501Gs later this year and Williams' Transcontinental Pipeline (Transco) is required to file a full rate case by this Friday. For investors, a company's need to file form 501Gs later this year, or, for Dominion, its need to file the settlement terms for a pending Section 5 case, could hasten roll-up decisions by those MLPs that are still considering whether to join Kinder Morgan, Oneok, Boardwalk, Williams and Enbridge in eliminating the use of the MLP structure. For shippers that are anxiously awaiting rate reductions this year, they may be in for an unpleasant surprise, as many of the rate cases that have been filed are seeking increases despite the lowering of the federal tax rate, a circumstance that may be replicated when the form 501Gs are filed in the fourth quarter.
2018 Rate Cases
As we reported in Thorough Preparation Makes Its Own Luck - Section 4 Rate Cases, even before FERC filed its Section 5 investigations and required the filing of Form 501G, 2018 promised to be a big year for rate cases with seven rate cases needing to be filed because of comeback provisions in prior rate case settlements. One of those cases, Northern Border, was settled before FERC made its major tax announcements in March, which we discussed most recently in 501G Pipeline Waves are About to Break at FERC - Will Wave One Bring Rate Reductions?. While the settlement contained provisions concerning the impact of any such changes on a moratorium that extends until the end of 2023, there will likely be some disagreement about how those provisions apply to the actions FERC took in March.
Two other cases, Kinder Morgan's Southern Natural Gas and Granite State Gas Transmission, were settled after FERC's actions in March. Both settlements contain specific provisions stating that the settlement rates take into consideration the decrease in the corporate income tax rate set forth in the Tax Cuts and Jobs Act. The parties agreed that during the respective moratoria, which ends on August 31, 2021 for Southern Natural and on April 30, 2019 for Granite State, the pipelines will not be required to adjust their tariff rates to incorporate the effect of that act.
Two of the seven rate cases, Enable Mississippi River Transmission (MRT) and Trailblazer Pipeline, are currently pending, with the other two, Transcontinental Pipeline and Saltville Gas Storage, still needing to be filed by the end of this week. In addition to these two pending cases, FERC also initiated two Section 5 investigations against Midwestern Gas Transmission Company and Dominion Energy Overthrust Pipeline, which have been tentatively settled, and two other pipelines have filed voluntary Section 4 proceedings this year, MoGas Pipeline LLC and Empire Pipeline.
Rate Change Under 501G Versus Actual Rate Increase Requested
What We Can Learn From These Cases
As we await the filing of the Form 501Gs and Transco's rate case later this week, there are a number of lessons to be learned from the cases currently pending:
- Return on Equity (ROE) requested by pipelines is much higher than the 10.55% set forth in Form 501G.
- Capital structures proposed for the calculation of a tariff rate can exceed the 43/57 debt to equity ratio set forth in the default capital structure in Form 501G.
- The Tax Cut and Jobs Act does not mean that every pipeline will be reducing its rates.
- Income Tax Allowance (ITA) will still be hotly contested for any pipeline that is not either a C corporation or a pass-through entity owned entirely by a C corporation.
- Rate cases may motivate a pipeline owner to disclose its roll-up plans as Enbridge did before it filed the Saltville rate case.
ROE and Capital Structure
| Pipeline | Equity Rate of Return | Equity Percentage of Capital | Debt/Preferred Stock Rate | Debt/Preferred Stock Percentage of Capital | Weighted Cost of Capital |
|---|---|---|---|---|---|
| Enable MRT | 14.50% | 63.355% | 4.42%/10.02% | 33.438%/3.207% | 10.99% |
| Trailblazer | 13.57% | 56.77% | 5.50%/NA | 43.23/NA | 10.08% |
| Midwestern | 13.50% | 45.99% | 5.81%/NA | 54.01%/NA | 9.35% |
| Dominion Overthrust | 14.00% | 74.37% | 3.53%/NA | 25.63%/NA | 11.32% |
| MoGas | 14.50% | 63% | 4.25%/NA | 37%/NA | 10.71 |
| Empire Pipeline | 14% | 59.63% | 5.31%/NA | 40.37%/NA | 10.49 |
| Form 501G Default | 10.55% | 57% | 5.00%/NA | 43%/NA | 8.16% |
The average ROE requested in these cases is over 14%, as compared to the 10.55% ROE default capital structure in the Form 501G. This results in the overall weighted cost of capital in these cases being between 1% to 3% higher than the default cost of capital, which, if approved by FERC, can lead to substantially higher tariff rates.
Tax Cut Does Not Equal a Rate Cut
Of the six pending cases, four of them (as seen in the graphic above) are seeking rate increases on at least a portion of their tariff rates. All of these cases provide examples of why it is necessary to understand the specific circumstances of each pipeline and not assume some generic rate decrease as a result of the reduction in a pipeline's tax rates.
- So far, only Midwestern has filed a rate decrease.
- Trailblazer's filing indicates that it will still under-recover its overall firm transportation cost of service by approximately $4 million, even after the rate increase it proposes becomes effective.
- MoGas's requested rate increase would result in a doubling or tripling of its current rates.
- Empire's filing asserts that an anchor contract that has generated a significant amount of its revenue terminates on December 21, 2018, "which will have a substantial negative impact on Empire's revenues after that date."
- Similarly, Enable MRT cites the loss of its contract with Spire STL Pipeline for 437,240 Dth/day of capacity on the MRT system. It proposes "a significant rate increase" based on the loss of the Spire STL contract and an increase in MRT's overall cost-of-service even after taking into account the tax savings.
Disputes Over ITAs for Non-taxable Entities Will Continue
As we discussed in Rate Case Rulings Clarify Which Pipelines Are Entitled To An Income Tax Allowance, these rate cases are giving FERC the opportunity to clarify which entities will be allowed to claim an ITA and which will not. Three of the currently pending pipelines, Midwestern, MoGas and Empire, did not present an issue because they either are C corporations or are wholly owned by C corporations. With respect to Enable MRT, FERC denied it the right to claim an ITA based on it being wholly owned by a master limited partnership. With respect to Trailblazer, FERC set a paper hearing to determine whether Trailblazer is entitled to an ITA.
Overthrust's Case May Require a Decision by Dominion Soon
Just as Enbridge announced its decision to roll-up Spectra Energy Partners before it filed its rate case for Saltville, the Overthrust case may require Dominion to make an announcement about its intentions with respect to the roll-up of Dominion Midstream. In a filing made on August 10, Dominion indicated that it had settled the Overthrust case in principle and that the "participants are in the process of memorializing the settlement in a formal stipulation and agreement and preparing other required settlement documents," which Dominion believed could be "drafted, discussed among participants, and filed within 30 to 60 days."
The original filing by Overthrust included a 21% federal ITA in its rate calculations. It seems unlikely that customers would agree to settle without addressing the inclusion of this ITA, especially following FERC's denial of an ITA to Enable MRT, since Overthrust, like Enable MRT, is wholly owned by an MLP, Dominion Midstream. Therefore, Dominion may choose to announce its intent for Dominion Midstream before it files the settlement document with FERC.
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