The much anticipated federal tax reform bill has now been passed by both chambers of Congress and the President has stated that he will sign it into law. As expected, the new law reduces the federal corporate income tax rate from 35% to 21% effective January 1, 2018. What does this mean for regulated pipelines and the rates they charge shippers? The easy answer is that income taxes are a cost of providing service and ultimately lower tax costs will be reflected in regulated rates. But how and when that will happen is not a simple matter.
The authority to address these questions lies with the Federal Energy Regulatory Commission and we expect a vigorous industry debate regarding the appropriate Commission action to reflect the tax reduction. Consumer and shipper interests will likely ask for immediate rate reductions to reflect the lower tax rate. But ratemaking is a complex process and there are plenty of arguments for moving carefully. For example, income taxes are just one of many costs underlying cost-based rates, with some costs going up over time and others going down over time. The Commission generally does not allow rate changes for movement in a single cost. Moreover, some pipelines are under rate settlements that require rate adjustments for tax rate changes, while other settlements prohibit rate changes altogether during moratorium periods.
So what’s the Commission to do? It is difficult to predict the Commission’s actions, particularly a new Commission under a new administration. Nonetheless, it is instructive to review how a prior Commission handled the last major tax rate reduction under the Tax Reform Act of 1986, which reduced the corporate tax rate from 46% to 34%.
In order to address its concern “that large overcollections on an industry-wide basis may occur unless rates are reduced promptly to reflect the new tax rate since the reduction in the tax rate affects all utilities[,]” the Commission’s Order No. 475, Electric Utilities; Rate Changes Relating to Federal Corporate Income Tax Rates for Public Utilities, Order No. 475, 1986–1990 FERC Stats. & Regs., Regs. Preambles ¶ 30,752 (1987), provided electric utilities a choice between a voluntary single-issue filing procedure to reduce rates, or the possibility of being subject to a Commission-initiated full general rate review. The Commission limited this approach to electric utilities because, at that time, “[n]atural gas pipeline companies’ rates will automatically be adjusted since tax trackers have been included in the majority of the natural gas companies’ rate settlements.” Additionally, the Commission stated that changes to oil pipeline rates would be made on a case by case basis.
Circumstances have changed for natural gas pipelines significantly since 1986. Most gas pipelines no longer have tax trackers. Additionally, gas pipelines are no longer subject to a mandatory three-year rate review, as they were in 1986 under the prior bundled service regime. Thus, the Order No. 475 procedures the Commission established for electric utilities to reflect the 1986 tax reduction could potentially serve as a model for addressing the present tax rate reduction for interstate natural gas pipelines. The key provisions of Order No. 475 were:
· A voluntary, single-issue filing procedure to reduce rates for the tax rate change, with no other rate issue allowed to be raised;
· Rate reductions made in accordance with a detailed formula based on: (1) cost inputs from the test period of last general rate change application; (2) billing determinants from the most recent 12 months; and (3) an income tax factor derived from the reduced income tax rate;
· For settlement rates, the formula called for a pro rata reduction in all costs based on a comparison of proposed revenues and settlement revenues;
· For settlement rates subject to a moratorium on rate changes, a rate reduction could be filed, but “the Commission will defer the effective date of the reduction until after the moratorium term;”
· Recognizing that the voluntary formula-based methodology for reflecting the income tax reduction might not be appropriate for all utilities, the Commission confirmed that utilities could choose to negotiate a settlement with their customers, make a general rate change filing, or “elect to do nothing[;]”and
· For utilities not using the abbreviated filing procedure, the Commission would “undertake a general review” of any non-filer’s rates and could, at its option, institute a rate investigation.
The Commission recognized that the reduction in the corporate income tax rate could affect companies and regulated rates in other ways (e.g., over-accrual of deferred income taxes, deferred tax make-up provisions, tax depreciation, and investment tax credits). The Commission deferred consideration of such other potential issues to the regulated entity’s next rate case.
While the Commission’s Order No. 475 procedures offer instructive guidance, the current Commission is not bound by those 1986 procedures, particularly given changes in industry regulation since that time. Adding to the uncertainty, the Commission has not yet taken action in its Notice of Inquiry regarding income allowances for MLP pipelines in Docket No. PL17-1.
So, what should pipelines be doing? First, pipelines should be consulting their rate and regulatory teams to fully understand their individual circumstances, including the prior cost of service underlying current tariff rates, the company’s current cost of service, any applicable settlement provision, and the extent and terms of the pipeline’s negotiated rate agreements. Second, pipelines should be preparing to participate in the industry debate regarding the appropriate Commission policy and legal standards to apply for purposes of reflecting the reduced income tax rate in the pipeline’s jurisdictional rates.