Must-know: Why government regulation stabilizes MLP cash flow

Market Realist

Why does government regulation stabilize MLP cash flow? (Part 1 of 2)

The Federal Energy Regulatory Commission regulates the interstate transmission and transportation of electricity, natural gas, and oil

The FERC, or the Federal Energy Regulatory Commission, is an independent regulatory agency that (among other mandates) oversees the interstate transportation of electricity, natural gas, and oil. Given that much of energy midstream infrastructure is involved in moving oil and gas across state lines, the FERC influences many master limited partnership (MLP) assets. (To learn more about MLPs, see Master Limited Partnership (MLP) basics.)

The FERC governs the rates pipeline companies can charge

Natural gas pipelines

For example, the FERC regulates the tariffs and rates of return on natural gas pipelines. The tariffs govern the minimum and maximum rates that pipelines can charge companies wishing to transport natural gas through their infrastructure. The FERC’s ratemaking process regulates the tariffs set. This process considers the costs of providing service, the allowed rate of return, and contract and volume throughput assumptions. It determines the allowed rate of return in each rate case. As El Paso Pipeline Partners (EPB) stated in its 10-K (an annual comprehensive summary report), “The FERC approves tariffs that establish rates, cost recovery mechanisms and other terms and conditions of service to our customers. The fees or rates established under our tariffs are a function of providing services to our customers, including a reasonable return on our invested capital.”

Pipeline companies may vary the rates within this range for reasons such as competition, as long as they offer their discounted rates to customers without undue discrimination or favoritism. Pipelines can also negotiate set rates with customers without regard to the minimum and maximum listed tariffs.

Liquids pipelines

The FERC also governs liquids pipelines, with liquids including crude oil, natural gas liquids, and refined products. Liquids pipelines must maintain tariffs on file with the FERC that are “just and reasonable.” Parties can also challenge rates, and the FERC can revise future rates and require refunds if it determines rates to be unlawful.

In some cases, the FERC will allow companies to use pricing methodologies such as cost-of-service and market-based rates. Sometimes pipelines can also directly negotiate rates with shippers if all parties find the rate acceptable. However, in many cases, the FERC requires the pipelines to adjust rates with a maximum annual adjustment at PPI-FG (the Producer Price of Finished Goods) plus 2.65% from July 1, 2011, through June 30, 2016. The PPI-FG is one of several indices that measure inflation. Given that the FERC determines tariffs and adjusts them for inflation, the real returns (also known as inflation-adjusted returns) from interstate pipelines should be relatively stable.

Note that customers are allowed to protest rate changes made within the ceiling, but they must demonstrate that the portion of the rate increase is substantially more than the pipeline’s increase in costs from the prior year.

Continue to Part 2

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