On April 16, 2015, the Federal Energy Regulatory Commission (FERC) issued a Policy Statement regarding Cost Recovery Mechanisms for Modernization of Natural Gas Facilities (Docket No. PL15-1-000). The Policy Statement affords interstate natural gas pipelines the opportunity to propose surcharge mechanisms providing for the recovery of costs incurred to comply with certain government mandated programs.

FERC recognized that natural gas pipelines may be required to make significant expenditures to comply with pending pipeline safety and environmental emissions rulemakings. In particular, under the Pipeline Safety, Regulatory Certainty and Jobs Creation Act of 2011, the Department of Transportation's Pipeline and Hazardous Materials Safety Administration (PHMSA) is expected to promulgate rules addressing pipeline integrity and internal inspection, which could require pipelines to upgrade or replace significant portions of their systems. The Environmental Protection Agency (EPA) is also considering new regulations concerning greenhouse gas emissions, including methane emissions from pipeline facilities.

Although FERC generally disfavors rate surcharges to recover specifically identified costs, it noted that traditional ratemaking would not be an effective means of enabling pipelines to recover these compliance costs in a timely manner. Further, denying pipelines a meaningful opportunity to recover the costs of compliance might jeopardize achievement of the public safety benefits promoted by the rulemakings.

Comments on the proposed Policy Statement were predictably split. Pipeline companies strongly favored the use of surcharges and encouraged FERC to adopt an expansive view of the expenditures that might be recovered via a surcharge. Customers of pipelines, on the other hand, generally opposed the use of surcharges, but argued that, if adopted, the Policy Statement should narrowly constrain the potential scope of recoverable costs. In consideration of these diverse comments, FERC adopted a five-step process intended to balance the needs of pipelines and their customers:

• Review of Existing Rates - The pipeline's base rates must have been recently reviewed, either by means of an Natural Gas Act general section 4 rate proceeding or through a collaborative effort between the pipeline and its customers.
• Eligible Costs – The eligible costs must be limited to one-time capital costs incurred to modify the pipeline's existing system to comply with safety or environmental regulations issued by PHMSA, EPA, or other federal or state government agencies, and other capital costs shown to be necessary for the safe or efficient operation of the pipeline. The pipeline must specifically identify each capital investment to be recovered by the surcharge.
• Avoidance of Cost Shifting – The pipeline must design the proposed surcharge in a manner that will protect the pipeline's captive customers from cost shifts if the pipeline loses shippers or must offer increased discounts to retain business.
• Periodic Review of the Surcharge and Base Rates – The pipeline must include some method to allow a periodic review to determine whether the surcharge and the pipeline's base rates remain just and reasonable.
• Shipper Support – The pipeline must work collaboratively with shippers to seek shipper support for any surcharge proposal.

Obtaining approval for a modernization surcharge will be a daunting task for pipelines. Nonetheless, many pipelines will entertain the possibility of pursuing such surcharges given the magnitude of compliance expenditures, which are estimated in the hundreds of millions of dollars for certain pipeline systems.

Perhaps the most notable pronouncement in the Policy Statement is that customer support for a proposed surcharge does not have to be unanimous. Thus, a pipeline may pursue a surcharge at FERC that might be unpopular with one or more of its customer groups.

The Cost Recovery Policy Statement goes into effect on October 1, 2015.

William Rice
Washington, D.C.
+1 202 626 9602
wrice@kslaw.com
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