Why Did Pipelines Drop?

Canadian investors can’t seem to catch a break with U.S. policy as of late. On Thursday, pipelines took a hit, as the U.S. Federal Energy Commission (FERC) removed a key master-limited partnerships (MLP) income tax allowance. The ruling states that MLPs can’t receive a tax credit for taxes they don’t pay and is in response to a previous court ruling that found the agency’s tax policy could result in double recover of costs. According to the earlier court ruling, “granting an income tax-allowance to MLPs results in ‘inequitable returns.’” The FERC is a five-member panel, four of which were appointed by President Donald Trump.

The changes are expected to impact natural gas pipelines as early as this summer, while oil pipelines are not expected to see any changes until 2020. What does this mean for investors? The fear is that lower taxes can lead to lower cash flows for pipelines.

Enbridge Inc. (TSX: ENB)(NYSE: ENB) was yesterday’s biggest loser north of the border. The company lost 4.2% due in large part due to its MLP exposure through Spectra Energy Partners and Enbridge Energy Partners (NYSE:EEP). Enbridge investors haven’t had much to be positive about over the past year. Its share price has lost approximately 25% of its value, and the sustainability of the dividend continues to be questioned. Further pressure on cash flows is sure to send the stock lower and supports the bear thesis.

Early Friday, the company released a statement indicating that the revised FERC policy statements will not have a material financial impact on the company. Spectra Energy Partners estimates that roughly 60% of its gas pipeline revenue comes from market-based tariffs and, as a result, would not be impacted. However, the remaining 40% could be impacted due to its cost-of-service tariffs. With respect to liquids pipelines, the company expects little impact as they are largely negotiated tariffs. As for EEP, the company estimates that the new FERC policy would result in a decrease to annual distributed cash flow of approximately $80 million.

The reason why Enbridge does not expect a material impact to financials is because the changes are expected to be a positive for Enbridge Income Fund Holdings Inc. (TSX:ENF). According to the release, the “reductions in the EEP tariff will create an offsetting revenue increase on the Canadian Mainline system owed by Enbridge Income Fund Holdings Inc.” Enbridge holds a 90% economic interest in Enbridge Income Fund and, as a result, the impacts are expected to be offsetting on a consolidated financial basis.

Interestingly, this should be a boon for Enbridge Income Fund investors, and the company appears to have been incorrectly punished by the stock market yesterday. The drop in share price appears to be overdone, and both companies present good entry points for investors.