Silenced Partner

Thank FERC It's Friday? Not for MLPs

A regulatory warning shot deepens existential questions for pipelines.

A worker walks through the pipe yard for TransCanada's Houston Lateral Project in Mont Belvieu, Texas, about 30 miles east of Houston on Wednesday, March 5, 2014.

Photographer: Scott Dalton/Bloomberg via Getty Images
SPECTRA ENERGY PARTNERS LP
-1.82
At Closing, May 18th
31.67 USD

"What? The FERC?!" is probably a cry that went up in unison across MLP-land on Thursday.

A somewhat nuanced proposed ruling from the Federal Energy Regulatory Commission touched off a rout in master limited partnerships; at one point, the Alerian MLP Index was off by almost 10 percent (it closed down 4.6 percent). This wiped out the last vestiges of the mini-rally that got going in December, taking the index back into the sub-250 territory last visited in the panic of early 2016:

Remembrance Of Dings Past

Thursday's sell-off has taken the MLP sector back to levels last seen in the great panic of early 2016

Source: Bloomberg

Some MLPs operating interstate pipelines, usually older ones, charge customers a regulated price under a cost-of-service model. As part of that, they collect a portion to cover corporate tax charges; but, as MLPs, they don't pay these. This has been the subject of various legal wrangles over the years. Now, in response to a court judgment and the recently enacted tax cuts, the FERC is proposing taking that benefit away for gas pipelines and reviewing it in 2020 for oil pipelines.

Ergo, those operators affected would have to cut the fees they charge -- which is a thing investors do not like.

Few MLPs appear to actually face significant hits to cash flow from this. At one extreme, Enbridge Energy Partners LP has already cut its cash flow guidance; the stock fell 17 percent Thursday. TC Pipelines LP, which plunged 18 percent, hasn't revised its numbers but does have a lot of pipeline capacity of the interstate, cost-of-service variety. Williams Partners LP and Spectra Energy Partners LP, among a few others, could also face some sort of potential hit. Still, it's tough to quantify how big that hit would be; Williams and Spectra say the impact would be minimal, a line echoed by several other companies.

Yet virtually every one of the Alerian's 40 members ended Thursday in the red -- and that collateral damage is the bigger issue here.

Remember MLPs aren't strictly a sector, just a specific structure for capital-raising wrapped around an underlying business -- typically pipelines, terminals and other bits of energy infrastructure. Their attraction for companies is that their high distributions and tax advantage from being partnerships resulted in a reduced cost of capital to fund growth.

Until, that is, they didn't.

What Are You For Again?

MLPs no longer necessarily offer a cheaper cost of equity capital

Source: Bloomberg

The reasons for this fall from grace are many and varied, but they include MLP structures being extended into more volatile businesses, skewed incentives favoring founders over ordinary investors, shockingly bad acquisitions, and structurally poor governance.

Not everyone was guilty of these failings, but enough were, and the oil crash revealed all. The resulting disillusion has led many retail investors, who used to be the largest cohort holding MLPs, to abandon ship. It's also led to a shoot-first-ask-questions-later approach; something exacerbated by the leverage employed by MLP funds, as Charles Johnson of CreditSights points out.

Is this selling an irrational stampede of the herd without regard for differences in the underlying businesses? Yes it is. On the other hand, you could say the exact same thing about the boom in MLPs that preceded the crash.

The question now is whether this latest indignity pushes some MLPs to simply abandon the structure.

Consider Enterprise Products Partners LP, whose units were down 7 percent at one point Thursday afternoon for no real reason (they closed down 2.7 percent). It didn't cut its dividend in the downturn, has a swathe of good assets, including exposure to growing Permian basin production, and is committing to a self-funding model. It issued a statement Thursday afternoon to reassure investors the FERC's action isn't a big deal for its profits and cash flow. Yet its yield is getting back up there again:

Thanks Partners

Enterprise has tried resetting its relationship with MLP investors but now sees its yield climbing back toward 7 percent

Source: Bloomberg

Some companies such as Enterprise, along with The Williams Cos. (see this) and maybe even a stalwart like Magellan Midstream Partners LP -- which now yields north of 6 percent -- are surely asking themselves if the MLP designation is worth it. As I wrote here, there are plenty of institutional shareholders who avoid MLPs but might relish the chance to own steady-paying energy infrastructure via a regular C-corporation. Some MLPs, such as Oneok Inc., have converted already. And the passage of tax cuts has removed a big uncertainty around doing so.

The FERC's action chips further away at the capital-cost advantage of at least a few MLPs. Even if Friday brings a relief rally, some may be that much closer to just getting off the ride altogether.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE