Will phillips 66 roll-up its mlp – phillips 66 partners lp (nyse psxp) seeking alpha gas emoji

Last week’s announcement by Enbridge ( ENB) to acquire all of its MLPs, including the golden goose from the Spectra Energy merger – Spectra Energy Partners (NYSE: SEP), was yet another blow to the beleaguered MLP sector. That is especially true considering there was little or no premium paid to the MLP unit-holders. While Enbridge cited the need to simplify its corporate and capital structure under one listed entity, it also mentioned risks related to the FERC MLP tax allowance elimination.

"The Federal Energy Regulatory Commission (FERC) today responded to a federal court remand by stating it no longer will allow master limited partnership ("MLP") interstate natural gas and oil pipelines to recover an income tax allowance in cost of service rates."

Today, I want to take a look at Phillips 66 Partners ( PSXP) and see if it would make sense for its GP – Phillips 66 (NYSE: PSX) – to consolidate the MLP into the corporate level. After all, PSXP has interest in some large-scale interstate pipelines:

"One final topic that I would like to address is the recent FERC ruling that MLPs can no longer include an income tax allowance in the cost of service calculation. Phillip 66 Partners expects little to no impact from this decision due to our limited exposure to cost of service rates. Most of our pipelines fall into three categories, pipelines that are not FERC regulated; FERC regulated pipelines where Phillips 66 is the sole shipper; and pipelines that have negotiated rates."

While it certainly is true most of PSXP’s pipelines are not FERC regulated, I would argue that most of the largest pipelines that PSXP has interests in are FERC regulated (see list above) and a significant percentage of the company’s total number of barrels transported are via those pipelines. As for being a "sole shipper", that is also not the case on the pipelines listed above. In addition, it is not clear – at least not to me – that the pipelines listed above are not "cost of service" oriented pipes. It appears to me they are. But of course, as usual, none of the analysts attending the conference call pressed PSXP management on these issues.

"The recent FERC income tax allowance policy reversal and the regulatory rate impact from the U.S. Tax Cuts and Jobs Act (TCJA), as well as the market reactions across the MLP landscape, have challenged the standalone viability of SEP, EEP and EEQ as reliable and cost effective sources of capital to support Enbridge’s growth."

In other words, it wasn’t just the FERC income tax allowance reversal that figured into Enbridge’s decision to roll-up its MLPs. It was also the significant cut in the US corporate tax rate (from 35% to 21%). That lower tax-rate makes holding pipeline assets at the corporate level much more desirable.

The MLP sector is obviously unloved. That said, while PSXP’s unit-price performance has been a laggard as compared to the overall market, this is likely less of a consideration for PSX because PSXP is still investment grade and has excellent access to capital. Summary & Conclusion

PSXP has been a great vehicle for PSX to monetize its midstream assets. The MLP has been performing well (other than its unit price) and has met its goal of a 30% CAGR in distribution growth. If you own the units, I wouldn’t sell them here. At the same time, I wouldn’t buy PSXP here either (I’d buy PSX instead). That said, income oriented investors may find PSXP’s 5.8% yield attractive – even with the 10-year slightly over 3%.

Me, I am underwater in PSXP and would love to see PSX roll-up the MLP so that I would own more PSX instead. However, given how successful the MLP has been from PSX’s standpoint, I don’t see that happening. Meantime, investors deserve more disclosure on the impact of the FERC decision on PSXP’s interstate pipeline interests.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for investment decisions you make.