Even as Oil & Gas Prices Increase, MLP Values Decline

When the Federal Energy Regulatory Commission (“FERC”) evaluates tariff rates on regulated pipelines, they target a “just and reasonable” return on equity (“ROE”) to compensate pipeline operators.  To determine these rates, operators calculate their expenses associated with running their pipelines and are allowed to charge a certain amount over and above those expenses. Previously, MLPs1  included an income tax allowance (“ITA”) as one of these expenses.2

On March 15th, FERC announced it would no longer allow MLPs to recover ITAs from their expense calculations.  The impact of this ruling is that FERC-regulated cost-of-service pipelines may need to adjust their prices downwards to prevent over-earning their “just and reasonable” ROE.  Natural gas pipelines have been directed to review their rates by the end of this year, while oil pipelines will face a review of their pricing in 2020.

In a second announcement, FERC issued a Notice of Proposed Rulemaking (“NOPR”) for natural gas pipelines, regardless of whether MLP or a C-Corporation own them.  This NOPR requires MLPs to review their tariff rates by year-end to adjust for the corporate tax rate falling from 35% to 21% as a result of the Tax Cuts and Jobs Act of 2017.

Does this signal a buying opportunity for investors?  According to a recent Wells Fargo research report:3

“Compelling valuations are not enough of a reason to overweight MLPs.  We remain neutral (even weight).  A positive fundamental or technical trigger would be needed for us to become more optimistic toward MLPs.”

Crude Oil Outlook

While futures markets aren’t a crystal ball, their price levels and related options are useful for estimating future ranges, or “confidence intervals,” for crude oil and natural gas prices.

The graphic below shows crude oil price as of April 16, 2018 and predicted crude oil prices based on options on oil futures contracts (ticker /CL).

On the graphic below, the blue lines are within one standard deviation (σ) of the settlement price (green line) and the red lines are within two standard deviations for each month (for a refresher on standard deviations, see the January 2016 blog).

Based on April 16, 2018, pricing, the futures markets indicate that in mid-July 2018 the expected strip price is $65.74, with a 68% chance that oil prices will be between $57.50 and $75.50 per barrel.  Likewise, there is about a 95% chance that prices will be between $48.00 and $90.50.  For a longer-term view, by mid-November 2018 the approximate one standard deviation price range is between $52.00 to $78.50 per barrel with an expected value of $63.50.  As of last month, oil futures are still in “backwardation.”

Natural Gas Outlook

The natural gas futures contracts are currently trading at $2.77 per MMBtu for the Henry Hub (ticker /NG).  Although more affected by seasonal factors than crude oil, in July 2018, the expected price is $2.83 with a +/- 1σ price range of $2.55 to $3.15 per MMBtu, and the 2σ range (95%) of $2.15 to $3.65 per MMBtu.  For a longer-term view, by mid-Oct 2018 the expected price is $2.85 per MMBtu with a +/- one standard deviation price range is between $2.45 to $3.35 per MMBtu.

1. A Master Limited Partnership (“MLP”), is a limited partnership that is traded publicly on an exchange.  An MLP combines the tax benefits of a limited partnership with the liquidity that publicly traded securities offer.

2. Seeking Alpha, April 11, 2018, https://seekingalpha.com/article/4162472-ferc-ruling-impact-mlps

3. Wells Fargo Investment Institute, Real Asset Strategy, “Where We Stand on Master Limited Partnerships,” April 2, 2018

Tags: Oil & Gas Price Outlook April 2018, Gas Price Outlook April 2018, Oil Price Outlook April 2018

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