The FERC helps MLPs attain a certain rate of return at a fair cost

Market Realist

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

(Continued from Part 1)

Stability of returns and cash flows

As we’ve seen, the FERC (Federal Energy Regulatory Commission) regulates the amount that midstream companies can charge shippers to use their natural gas and oil transportation assets, which essentially means the agency has much control over these assets’ rate of return.

Pipeline assets in themselves are generally already relatively low beta. That means their profitability is less sensitive to changes in the broader economic environment than other sectors, which could make certain MLPs (master limited partnerships) good defensive investments in times of market volatility. Lower beta also technically translates into lower cost of capital. In plain terms, companies with assets that generate more stable and predictable cash flows generally can raise money at cheaper rates, as investors perceive these assets to be less risky and require less return from them. FERC regulation over pipelines’ rates of return and maximum service fee escalation provides an additional layer of stability over the returns and cash flows of interstate pipeline assets, which are relatively low beta. Generally speaking, the FERC acts to help pipelines attain a certain rate of return while providing service at a fair cost to customers.

A measure of regulatory risk

Because these interstate pipeline tariffs are generally governed by the FERC and not the marketplace, there’s a layer of regulatory risk involved if, for example, the FERC were to change its methodology for approving rates. Plus, as we’ve seen, customers could file challenges to pipelines’ rates and the FERC could rule against the pipelines and require downward rate adjustments.

Whom does this affect?

Not all master limited partnerships own interstate pipeline assets. Generally, the larger-cap midstream names have these pipelines. These companies include Kinder Morgan Energy Partners (KMP), Enbridge Energy Partners (EEP), Plains All American Pipeline (PAA), Energy Transfer Partners (ETP), Magellan Midstream Partners (MMP), Oneok Partners (OKS), Williams Partners (WPZ), and El Paso Pipeline Partners (EPB). These names are major constituents of MLP exchange-traded funds such as the Alerian MLP ETF (AMLP) and the AMJ JPMorgan Alerian MLP (ETN).

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