Update: FERC Five-Year Review of Oil Pipeline Rate Indexation

Eversheds Sutherland (US) LLP

On June 30, the Federal Energy Regulatory Commission (FERC) issued a Notice of Inquiry (NOI) that proposed an adjustment to the annual indexation formula for oil pipeline rates. The NOI sought comments on a proposed indexation range between the producer price index for finished goods (PPI-FG) + 2.0% and PPI-FG + 2.4%. As in past five-year indexing review cases, FERC’s proposal uses the Kahn Methodology established in Order No. 561, which calculates cost changes using annual Form 6 data from oil pipelines. The NOI proposed an indexing range because not all pipelines had filed Form No. 6 data for 2014. A final index level for the five-year period commencing July 1, 2016, will be established at the conclusion of the proceeding.

On July 30, FERC held an informal technical conference to solicit industry participants’ views on the NOI’s proposal. Participant comments from the technical conference are summarized below.

Association of Oil Pipe Lines (AOPL). AOPL favored retaining the Kahn Methodology and recommended a level of PPI-FG + 2.55%. This suggestion differs from the NOI’s proposal (i) to account for two more pipelines having filed Form 6 data since the NOI data was compiled; and (ii) to reflect certain business combinations’ cost experiences. AOPL also recommended using the middle 50% and the middle 80% of Form 6 data rather than only the middle 50%. In the past, FERC has used the middle 50% of reported data to account for erroneous data and data outliers. AOPL contended that because data reporting has improved, it is better to use more data to establish the index level, and including the middle 80% of the Form 6 data would still account for pipeline cost anomalies.

Valero Marketing and Supply Company (VMSC). VMSC, a shipper on oil pipelines, characterized FERC’s five-year indexing review as the agency’s most important current rate case. VMSC advocated use of data from Form 6, Page 700 for the index calculation. According to VMSC, this Page 700 data would reflect interstate pipeline cost changes more accurately than the combined interstate and intrastate pipeline proxy figures FERC previously had derived from Form 6 data for use in the Kahn Methodology.

Canadian Association of Petroleum Producers (CAPP). CAPP suggested that FERC review the quality of the inputs to the Khan Methodology. CAPP maintained that Form 6 data does not reflect the differences between various non-cost-based rates, such as contract rates, negotiated rates and “customized” rates, which are more commonplace in the industry today than when the Khan Methodology was first adopted. The application of indexed rate changes to customized or surcharge-based rates raises the potential for double counting. CAPP does not intend to challenge the Khan Methodology, but requested that FERC consider that many large new projects are backed by non-cost-based alternative rates and how this, in turn, affects the indexing methodology. CAPP observed that a separate screen could be developed to account for these non-cost-based rates.

Airlines for America and National Propane Gas Association (AA/NPGA). AA/NGPA supported the use of Page 700 data to derive the index and criticized the proxies used by the Khan Methodology as inadequate and unreasonable. AA/NPGA will closely review each pipeline’s data to see if certain pipelines should be excluded from the data set due to erroneous or non-comparable data, such as data reflecting major pipeline operational changes. Only after excluding those pipelines should FERC use the middle 50% of the data. AA/NPGA will also explore (i) whether separate indexes should be used for crude and product pipelines, and (ii) whether pipelines that are reporting over-recoveries are also taking an index adjustment. AA/NPGA would deny an automatic index adjustment if a pipeline were over-recovering costs.

Liquids Shippers Group (LSG). LSG urged FERC to take a fresh look at indexing in light of major industry changes like the proliferation of committed shipper rates. If indexing is retained, LSG urged FERC to disallow an indexed rate increase to a pipeline that is over-recovering its costs. LSG noted that some 60 petitions for declaratory orders have been filed at FERC in the past five years for approval of committed shipper rates. LSG asserted that FERC policy changes during the past few years have allowed oil pipeline cost over-recoveries to proliferate and argued that indexation must be reevaluated in the context of these policy changes. LSG compared interstate oil pipeline rates with interstate gas pipeline rates, stating that in the past five years oil pipeline rates have increased 30% solely due to indexing, compared to the majority of gas pipeline rates (approximately 75%) that have remained or have decreased. In addition, gas pipeline rates have experienced a net average increase of only 1.5%. LSG questioned what differences between the two industries could justify such a discrepancy, and stated that it would oppose the Khan Methodology in its written comments.

Initial comments on FERC’s NOI proposal are due August 24, 2015, and reply comments are due September 21, 2015.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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