News 
2006
| Statement: October 19, 2006 | 
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| Docket Nos: RP04-274-000 | |
Commissioner Spitzer's statement on Kern River Gas Transmission Company
"I support this Order. I believe the Return on Equity balances ratepayer and investor
interests and results in just and reasonable rates. The Kern River line provides
benefits not only to California shippers, but eases supply constraints throughout the
west.
I must address application of the discounted cash flow ("DCF") model in futuro in
light of the increasing importance of the master limited partnership entity ("MLP") in
the energy sector. A key issue in this case is the paucity of reliable proxies for
natural gas pipelines. The Order recognizes that in recent years fewer and fewer
companies have met the Commission's historical standard for inclusion in natural gas
pipeline proxy groups, particularly in which pipeline operations constitute a high
proportion of their business. The determination of the types of entities to be
included in natural gas pipeline proxy groups now squarely confronts the DCF model
and the Commission.
The pleadings reflect a general observation that natural gas pipelines are not
organized as C corporations. I pose the question "why?"
I recognize that pipelines are now rarely stand alone enterprises under any form of
business organization. However, the risk profile of the pipeline business increasingly
favors organization in partnership form, be it a general partnership, limited
partnership or MLP. Several aspects of tax and corporate law suggest this trend will
continue.
Partnerships are "tax efficient" because passthrough entities under subchapter K are
subject to one level of income taxation. Partnership income is generally taxable to
the partners based on their distributive share of income regardless of whether cash
distributions are made. Thus, the tax paid by the partner is a first-tier tax on the
income of the partnership rather than a second-tier tax on cash distributed to the
partner. C corporations, on the other hand, pay in the first instance the income tax
on the income from corporate operations (a first-tier tax), then if the corporation
distributes cash by paying a dividend, a shareholder in the corporation generally is
taxed on the amount of the dividend received (a second-tier tax). Further, upon
liquidation a C corporation is subject to entity level income tax and its shareholders
recognize a gain on the ensuing corporate distribution, unlike a partnership. There is
one incidence of tax upon realization of gains by passthrough entities.
Corporate governance matters also favor the MLP form for equity capital formation.
Sarbanes-Oxley established important disclosures for investors in publicly traded
corporations. Corporate audit and compliance fees have increased dramatically.
Private investment has become, therefore, comparatively less costly. Further, the
increasing frequency of shareholder derivative lawsuits and recent events regarding
corporate boards may accelerate the trend towards private equity. Partnerships
avoid some of these issues, and the MLP entity facilitates public equity capital
formation in a partnership form.
In summary, the MLP form of business is likely to increase, particularly in the
entrepreneurial energy sector. This argues for inclusion of MLPs in the DCF proxy
group. I understand that a potentially duplicative return of capital from MLPs is a
major concern of Staff. I also recognize the record in this proceeding did not
adequately address the extent to which MLP distributions of capital can be "backed
out" from aggregate partnership distributions. I would point out, however, that
there has been frequent litigation in the context of corporate taxation as to whether
distributions to corporate shareholders are capital redemptions or dividends. Thus,
absolute clarity in the demarcation between a capital and dividend distribution is
elusive.
In cost-of-service ratemaking the objective is to allow a fair profit, after taxes,
ascertained after taking into account a variety of factors, such as the risks of the
business and the necessity of attracting capital. The return necessary to attract
investors is measured by the return an investor could obtain from investments
bearing having commensurate risks. Further, the basic regulatory premise that a
utility must earn a comparable return refers to the after tax return to the investor,
regardless of the form of ownership. Therefore, I look forward to a more fulsome
factual record on MLP proxies in forthcoming cases."
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