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US tax cuts to raise gas pipelines ROE

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Energy Global,

East Daley Capital Advisors, Inc., advises that recent federal tax cuts have raised natural gas pipeline return on equity (ROE), increasing the risk of significant revenue cuts via upcoming FERC action.

East Daley Capital Advisors, Inc., an energy assets research firm redefining how markets view risk in midstream energy companies, has announced that ‘Dirty Little Secrets – The Naked Truth: Uncovering Opportunities in the Midstream Sector,’ is now available.

The 165 page report details the risk for 28 companies in the midstream sector by subdividing their cash flow at an asset-level, providing key insights and EBITDA forecasts for 2018 and beyond.

“The newest risk to midstream earnings from natural gas pipelines in 2018 is undoubtedly the new federal tax cuts,” said Justin Carlson, VP and Managing Director, Research at East Daley Capital.

“The passage of the new tax legislation was a major shoe to drop on the regulatory front and it potentially has major direct and indirect effects on the rates and revenues earned by regulated pipelines. The most obvious of these effects is the massive cut to the corporate tax rate which will increase pipeline return on equity for those with significant corporate ownership.”

Under the new tax plan, East Daley has identified twenty natural gas pipelines that will have ROEs well above the typically allowed range.

The FERC typically targets return on equity for interstate pipelines to fall anywhere between 10 - 14%, depending on asset-specific risks. EDC views the risk of significant rate and revenue downside as quite high for many natural gas pipelines under these new tax laws. Investors should have a solid grasp on pipeline specific ROEs and potential mitigating factors for the companies they own as FERC considers next steps for rate reductions.

“Due to the sweeping tax changes, it’s possible the FERC could take industrywide action and investors should take notice as it could bring down rates swiftly and significantly,” said Carlson. “Given the precedent that the FERC has done this before in the late 80s and given FERC Commissioner Powelson’s recent rate reduction comments, this may be the route the FERC ends up taking. However, the FERC could take a more targeted approach by using Section 5 rate cases to launch investigations on specific pipelines where ROE may be too high.”

East Daley’s analysis on the impacts of the new tax laws on the midstream sector is detailed in a new report titled ‘Dirty Little Secrets – The Naked Truth: Uncovering Opportunities in the Midstream Sector.’ The report analyses the ROE for over 40 natural gas pipelines, indicating that half of those pipelines are at risk to lower rates over the next few years via FERC action.

Key findings include:

  • Tax cuts have raised return on equity for natural gas pipelines, oil, and NGL lines, increasing the risk of significant revenue cuts via rate cases or rate freezes.
  • US$7.2 billion (15%) in cash-flow growth from midstream companies in 2018 will be transformational for an industry beaten down in 2017.
  • 17 of 28 companies covered in this report are expected to outperform market consensus, highlighting East Daley’s positive outlook for midstream growth.
  • Coverage and leverage are key metrics but they can mask insight into future company performance that is only uncovered from detailed asset-level analysis, such as the case with BWP and ETP.
  • Gas and oil production is expected to surge across the country, boosting oil output by 1.3 million bpd and gas extraction by 5.6 billion ft3/d y/y, bolstering earnings across the sector.
  • Supply growth has been underappreciated in basins such as the Bakken, Powder River and Marcellus. Growth in those basins is contrary to market sentiment for rate and volume risk.
  • The infrastructure of tomorrow could be in the ground today with old infrastructure finding new life in the Permian, Bakken and DJ.

East Daley Capital is an energy assets data and analysis research firm that is redefining how markets view risk for midstream and exploration and production (E&P) companies. In addition to using top-level financial data to predict a company’s performance, East Daley delivers asset-level analysis that provides comprehensive, fact-based intelligence.

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