Do You Want to Know a Secret? - A Downside for Many Midstreamers in New Tax Law

While the recently enacted federal tax cuts have been widely viewed as a boon to corporate America, including businesses in the energy sector, a new report by our friends at East Daley Capital finds a major drawback in the law for midstream companies. By slashing the corporate tax rate from 35% to 21% — and by allowing partnerships and “pass-through” entities to take a 20% deduction on their income pre-tax — the new law will increase the return on equity that midstreamers earn on their crude oil, NGL and natural gas pipelines. That may well lead the Federal Energy Regulatory Commission (FERC) to re-set its formula rates for at least some gas pipelines, and also is likely to heighten regulatory scrutiny of the rates charged by the owners of oil and NGL pipelines. Today, we continue our review of East Daley’s new “Dirty Little Secrets” report with a look at the tax law, the higher pipeline ROEs resulting from the tax cuts, and the midstream companies that may be affected most.

The 2018 edition of “Dirty Little Secrets” shines a bright light on the assets and prospects of 28 U.S. midstream companies. As we said in Part 1 of our blog series on the report’s highlights, accurately assessing the relative value of specific midstream energy companies requires a deep, detailed analysis — not all midstreamers are winners, even in a period of rebounding crude oil prices. We also noted some of the key takeaways from the new report, including:

  • $7.2 billion (15%) in cash-flow growth from midstream companies in 2018 will be transformational for an industry beaten down in 2017.
  • 17 of the 28 companies covered in this report are expected to outperform market consensus, highlighting a positive outlook for midstream growth.
  • Coverage and leverage are key metrics but they can mask insight into future company performance that is only exposed through detailed asset-level analysis — Boardwalk Pipeline Partners and Energy Transfer Partners being two prime examples.
  • Gas and oil production is expected to surge across the country, bolstering earnings across the sector.
  • Supply growth has been underappreciated in basins like the Bakken, the Powder River and the Marcellus.

The report also provides a number of thematic insights that are helpful when considering individual midstreamers’ pros and cons. In Part 1, we discussed one theme — namely, that while greenfield pipeline projects grab the headlines, a big focus of midstream companies in 2018 will be on repurposing existing pipelines, either by reversing their flows or switching the hydrocarbons that flow through them (from NGLs to crude oil or vice versa, for example).

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