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Stock Analyst Update

Tax Impact on Pipelines Likely Overblown

We would be looking to purchase quality midstream firms at a discount.

A Feb. 8 Wall Street Journal article suggested that all regulated pipelines would be negatively affected by lower tax rates, as regulators would force pipeline operators to cut rates and pass the savings on to customers. We think fears over the issues raised in the article are generally overstated, and we would be looking to purchase quality midstream firms at a discount, including Enbridge, Spectra Energy Partners, Enterprise Products Partners, and Plains All American Pipeline. We do not plan to adjust our fair value estimates or moat ratings for the industry.

The issue at hand is that for pipelines operating under a cost-of-service pricing model, rates are tied to operational costs, which include taxes. With lower tax rates, the Federal Energy Regulatory Commission has asked 13 pipeline operators to review their rates. We think it is important to understand that the cost-of-service pricing model is not the dominant rate model, as FERC also allows market-based or negotiated rate setting, as well as index-based rate setting. The latter two approaches are the most common rate-setting models in the industry and would not be affected by changes in tax rates. For example, Enterprise Products Partners has most of its pipelines on market-based rates. Further, FERC only regulated interstate pipelines, meaning intrastate assets, including Energy Transfer Partners’ large Texas system, would not be affected. Energy Transfer has been able to negotiate rates for its Texas assets without regulatory hearings. Other pipeline operators such as Spectra Energy Partners have not filed a rate case in more than a decade, and unless they do so, they are unlikely to be affected.

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