Energy Legal Blog

High Cash Distributions of Master Limited Partnerships May Set Regulated Equity Return to Natural Gas Pipelines

In a July 19 proposed Policy Statement, the Federal Energy Regulatory Commission (FERC) floats the idea of substituting cash distributions that natural gas pipelines, organized as master limited partnerships (MLP), make to their partners for the corporate dividends that the agency uses in discounted cash flow (DCF) analyses to set regulated equity returns for natural gas pipeline companies.  The industry has long requested and anticipated this policy development since, increasingly, natural gas pipelines (like their oil pipeline cousins) have switched from traditional C-corporations to lower-taxed MLPs — from twice-taxed corporate dividends to once-taxed MLP cash distributions that tend to be higher.  If the Policy Statement is adopted, it may also affect equity returns of electric transmission systems, a number of which are considering switching from C-corporations to (MLP-comparable) real estate investment trusts (REIT).  To be considered, public comments on the proposed Policy Statement must be submitted within 30 days of publication in the Federal Register — sometime in late August.  A final Policy Statement is expected before year’s end.

Since corporate dividends distribute a portion of earnings, dividends have traditionally been a dependable indicator of where regulated returns on equity should be set, namely at a level that permits utility investors to earn a reasonable return on investment while also providing adequate funds for future growth.  Use of MLP cash distributions instead of corporate dividends is controversial in that those distributions can, and not infrequently do, exceed earnings and provide not only a return on investment but also a return of investment, which, if used in a DCF analysis, would award higher equity returns to natural gas pipelines, and possibly double recovery of some investments in the form of both equity return and depreciation.    (Presumably the same would be true if the cash distributions of an electric transmission REIT were used in a DCF analysis to set a transmission utility’s equity return.)

To address these concerns, FERC proposes two limitations on the use of MLP cash distributions in DCF analyses.  First, in order to be eligible for use in a DCF analysis, MLP cash distributions would be capped so that they could not exceed the reported earnings of an MLP natural gas pipeline — a return on, but not of, investment.  Second, a proponent of using MLP cash distributions in a DCF analysis would be required to produce and analyze multi-year data on the selected MLPs to show that cash distributions were not excessive and that earnings and growth were sustainable over time.