SEP Spectra Energy Partners, LP Common Units Representing Limited Partner Interests (delisted)

By Alison Sider and Christopher M. Matthews 

A federal tax ruling dealt a new blow to a group of pipeline firms that had helped finance a massive build-out of energy infrastructure, intensifying questions on Wall Street about the sector's survival.

The decision Thursday by the Federal Energy Regulatory Commission to disallow certain income-tax allowances could hasten the demise of many so-called master limited partnerships, which were already on a lengthy losing streak.

The stocks of several pipeline-partnership companies plummeted after the announcement. Shares of Enbridge Energy Partners LP fell 17%, Spectra Energy Partners LP shares dropped 10%, while Williams Cos. and Energy Transfer Equity shares were down more than 10% before rebounding.

Once the darlings of the energy sector because they essentially pay no corporate tax, such pipeline companies, or MLPs, have lost their luster in recent years as they've struggled to keep up with demand for growing payouts to investors and their parent companies. In response, some pipeline companies have begun converting older partnerships into traditional corporate structures.

The regulator's decision will chip away at some of the tax benefits that made these partnerships attractive in the first place. FERC voted to reverse a longstanding policy that allowed interstate natural gas and oil pipelines configured as pass-through companies to collect corporate income-tax expenses from customers.

The FERC policy has been litigated for years because customers claim it allowed pipeline owners to essentially recover income-tax costs twice because regulators already allow partnerships to structure rates to ensure a sufficient after-tax return. A federal appeals court agreed with customers in 2016 and told FERC to examine the policy.

Some analysts said the reaction by investors was overblown. Many newer pipelines have negotiated rates with customers that won't be affected by the change and a handful companies that own pipelines but aren't structured as partnerships also will be unaffected. The majority of pipeline companies are MLPs, with a total market capitalization of about $350 billion.

Enterprise Products Partners LP, one of the largest of these partnerships, said the change won't hurt its bottom line. "We do not expect the revisions to the FERC's policy on the recovery of income taxes to materially impact our earnings and cash flow," the company said Thursday.

Still, FERC's decision was the latest blow for a group of companies that investors had started to sour on.

"The sentiment in the group is terrible and this does not help," said Ethan Bellamy, an analyst at Robert W. Baird & Co.

The firms' tax-advantaged structure and promises of large and ever-increasing payouts helped draw billions of dollars of investment in pipelines and other energy infrastructure that was sorely needed at height of the shale boom, when companies were racing to bring the output from newly discovered oil and gas fields to market.

But the tide has started to shift.

The partnerships were marketed as the toll roads of the energy industry, and investors expected that their payouts would be insulated from volatile commodity prices.

It didn't work out that way. Partnerships slashed their dividend-like payouts during the oil rout that began in 2014. Investors who owned a portfolio of MLPs in 2014 would have had their distributions cut by a third since then, said Mr. Bellamy.

Retail investors who bought MLPs in the boom times are "fed up," said Tyler Rosenlicht, who manages a portfolio of MLPs and infrastructure investments at Cohen & Steers, an investment firm.

Oil prices have stabilized at above $60 a barrel and companies are getting back to work drilling new wells, creating a need for more pipes. But the partnerships have languished. The Alerian MLP Index was one of the worst performing assets last year -- losing 6.5% on a total return basis compared with the nearly 22% that the S&P 500 returned.

Investors have pulled more than $500 million from mutual funds and exchange-traded products that specialize in energy partnerships in recent weeks, in contrast to the heady days of the shale boom.

"It's hard for me to remember an environment when sentiment was this lousy despite the fundamental outlook improving," said Adam Karpf, managing director at CIBC Atlantic Trust Private Wealth Management.

Thursday's decision by FERC is likely to force many older natural gas and oil pipelines to lower their rates, say analysts, potentially making it even more difficult to fund the hundreds of billions in planned infrastructure projects.

Some companies, including Kinder Morgan Inc. and Oneok Inc. have done away with their partnerships converting them to traditional corporations, hoping the simplified structure will please investors and make it easier to raise cash.

In 2014, partnerships accounted for 63% of the market value of "midstream" energy infrastructure companies, according to Hinds Howard, a portfolio manager at CBRE Clarion. Now that's 54%, after some large companies converted into regular corporations.

The FERC decision will accelerate the conversion of older partnerships into traditional corporations, according to Height Securities analyst Katie Bays. "No question about it, for older MLPs you're going to see a more fast-paced transition," she said.

Others say that even if retail investors maintain their chilly stance, the MLP structure isn't going anywhere. More MLPs can now live within their means without infusions of cash from equity markets. Institutional investors and private equity backers have funneled money into the space.

"I don't think the model is going away. I still think it's an effective way to build critical infrastructure," said Rob Thummel, who manages a portfolio of MLPs and other energy investments at Tortoise Capital Advisors. "If you have more production, you need more pipelines."

Write to Alison Sider at alison.sider@wsj.com and Christopher M. Matthews at christopher.matthews@wsj.com

(END) Dow Jones Newswires

March 15, 2018 19:46 ET (23:46 GMT)

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