REIT tax advantage is an illusion

REIT tax advantage is an illusion ||

One advantage of converting a utility into a real estate investment trust (REIT) is the supposed tax advantage in that the REIT no longer pays taxes but through rates, taxes continue to be collected.
One argument that was put forth to justify for collecting money for taxes that are not paid by the company from consumers is that regulators routinely allow for collection of taxes that are not paid by other forms of pass-through entities such as limited partnerships.
We are of the opinion that taxes being collected by other pass-through entities is for the taxes that would be paid by the recipients of the distribution to ensure after-tax equivalency across corporate structures.
We would also argue that the after-tax “return-on” portion of the pass-through distributions is competitive with other forms of business entities, but the “tax-advantage” comes in the form of the “return-of” capital portion, which, by definition, would be free from tax burdens.
Therefore, we’d argue that taxes collected by the Oncor-REIT would be to allow for tax-equivalency as compared to other business structures, but not to reward investors with cash that they did not earn.

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Corp. tax cut from 35% to 15% leads to 20%-30% upside; 2017 Outlook

• President-elect Trump has promised a corporate tax cut from 35% to 15%; if this tax cut is enacted, we believe that share prices should rise by some 20%-30%, but not likely for utilities
• Even if non-utility companies don’t change their growth/investment plans, we believe that the change in tax rate would accelerate their growth profile by giving these companies the ability to take the excess cash to pay-down debt faster or by earning interest income on the higher cash balance; however, we feel that it would be difficult to quantify the acceleration in growth profile unless specific plans are known
• If companies invest more than their depreciation expense then their P/E-multiple are likely to increase with a cut in tax rate, while investing less than their depreciation expense looks to reduce their P/E-multiple with a cut in tax rate; however, we feel that it would be difficult to quantify the actual change without knowing specific investment plans and depreciation expenses
• We set up a simple example to demonstrate our thesis:

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What we think Trump Presidency means; energy industry give & take

• In a historical upset Donald J. Trump will be our 45th president of the United States (POTUS) of America
• Energy industry is likely to see some benefits but also incur some detriments, in our opinion
• We believe that a Trump presidency is bad for commodity prices (except coal), so good for consumers
• We look for some specific energy policies to be instituted that would drastically change US energy policy instituted over the last 8 years, in particular, we believe that Clean Power Plan (CPP) is dead
• Infrastructure spending looks to be increasing
• We look for Yucca Mountain to be relicensed to accept nuclear waste

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Natural gas: Tailwind; Interest rate: Mild headwind; Election: Tornado

• As expected, natural gas prices started to rally, but about a month ahead of expectations in June
• We expect natural gas prices to generally move upward through 2H2016 and for 2017
• The impact of 1-3 rate increases should not be significant for valuations, but the portend for further rate increases is what would drive valuations down, in our opinion
• We expect that the global migration towards using more natural gas will continue and favor US energy companies, including energy infrastructure companies
• Power industry move towards renewables and natural gas is unlikely to abate, but there are a plethora of issues that would determine whether this is good or bad for investors depending on the industry, pricing mechanism, use of storage and back-up power, and development of new or refurbishment/replacement of old infrastructures
• Regardless, we look for heat rates to become more central in determining power economics moving forward, and likely grows in importance with higher percentage of generation delivered from intermittent renewable power sources

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Somewhat surprise BRXIT vote has little long-term consequences

Somewhat surprise BRXIT vote has little long-term consequences || Having lived in England for over six years during my early years, it’s not surprising that UK voted to exit the European Union (EU)
However, this has little consequences for the US utility, power, energy infrastructure, and LNG in the long-term
If the US and UK come to a quick free trade agreement (impossible with current administration) in 2017 under a new administration, there may not even be short-term negativity

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Supreme Court Stays Implementation of the Clean Power Plan; a New Plan May Already Be in the Works

On February 9, 2016, the Supreme Court of the US (SCOTUS), in a 5-4 verdict, stayed the implementation of the Clean Power Plan (CPP) until the DC Circuit Court could review the plan.

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The Myriad of Changes Are not Challenges, but Rather Opportunities

First time in almost 15 years, the electricity industry is facing rapid changes. Not since the separation of generation from transmission and distribution (T&D) businesses has the industry faced so many changes. Some of these include renewable portfolio standards (RPS), greenhouse gas (GHG) regulations, other regulatory and legislative changes, and the proliferation of distributed generation, energy storage, smart meters and smart grids, electric vehicles, and renewable power. Many view these changes as challenges and hurdles, but we believe that these changes should not be viewed as challenges, but opportunities, particularly for the utility sector and conditionally for the independent power producers (IPP).

Some of the more difficult issues involve RPS, and GHG regulations on the regulatory/legal side and the proliferation of distributed generation, renewable power, energy storage and electric vehicles from a commercial viewpoint. Many of these issues are interrelated and entangled and one change cannot be properly accommodated without integrating another change properly. From a high level, we believe that challenges encompassing these changes are as follows:

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Barring abnormal weather, we expect stronger commodity prices

NATURAL GAS
• As expected, due to mild weather, gas prices dipped below $3/MMBTU and continues to languish
• However, the strange turn in March weather has alleviated the downward pressure on gas prices
• Our forward-looking forecast on commodity prices does not consider the possibility of additional strange weather patterns occurring, i.e., we assume normal weather for the rest of 2017
• We believe that two factors will contribute to higher demand that will drive gas prices up in 2017 and 2018, which would keep gas prices mean-reverting above $3.50/MMBTU levels, in our view:
o Higher economic growth conditioned on reductions in both corporate and personal tax rates, and
o Accelerating liquefied natural gas (LNG) exports
• We believe that higher economic growth should eclipse the approximately 1.9% growth in supply (some 1.4BCF/Day) in 2017 projected by the EIA
o Our optimism wouldn’t be warranted under the economic environment of the last 6 years or so, which saw annual average economic growth of just above some 1.5%
o Our optimism is based on the expected accelerating economic activity brought on by the expectant reduction in corporate tax rates and enhanced by an expectant cut in personal income tax rates as well; we believe that these new economic and tax policies will create a positive virtuous economic cycle that would propel GDP growth beyond 3%, which should quickly absorb a 1.9% growth in natural gas supply, in our opinion

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