Week Ending February 26, 2016

FERC Opinion 528-A Fully Airs Rate Issues and El Paso Natural Gas Co.’s Compliance With and Interpretation of Two Decades-Old Settlement

This Article Appears as Published in Foster Report No 3088
FERC Opinion 528-A Fully Airs Rate Issues and El Paso Natural Gas Co.’s Compliance With and Interpretation of Two Decades-Old Settlement

On February 18 FERC issued Opinion No. 528-A — giving marching orders to El Paso Natural Gas Co. (RP10-1398) and acting on requests for rehearing, an Initial Decision on remand and a compliance filing made in response to Opinion No. 528 issued on 10/17/13.   With one exception, FERC denied the requests for rehearing of Opinion 528 and clarification of the order filed by El Paso and other parties.  The Commission granted rehearing with respect to its decision that El Paso should follow a policy favoring allocation of costs based on unadjusted billing determinants, with the result that discount adjustment costs would be allocated within the zone in which the discount was granted.  The rate data provided in the compliance filing shows unreasonable rate disparities when the policy is applied to the existing El Paso zonal rate structure, this new Opinion concluded.

While the Commission generally affirms its holdings in the prior order, “in light of the updated rate information provided in El Paso’s Compliance Filing …, the Commission grants rehearing and reverses its decision to require El Paso to use unadjusted billing determinants to allocate costs among zones.”

In addition, the Commission “summarily rejects rehearing on the treatment of debt costs.”

El Paso also had requested rehearing of the Commission’s application of its determination from Opinion 517, that a loan to El Paso’s parent corporation should be deducted from its equity capitalization.  In Opinion 528, the Commission verified the outstanding loan amount, which was deducted from the equity ratio, and otherwise adopted the position in Opinion 517 subject to rehearing.  Here now, FERC affirmed the decision in Opinion 528 to apply the Opinion 517 approach to the outstanding dollar amounts derived at hearing subject to the outcome of the proceeding in Docket No. RP08-426 on the controlling issue of whether the loan and undistributed subsidiary earnings should be removed from the pipeline’s capital structure.

In addition, the Commission adopted the Presiding Judge’s determination in the Initial Decision issued on 9/17/14 finding the methodology proposed by Trial Staff to be a just and reasonable remedy to ensure that El Paso’s rates are consistent with Article 11.2(b) of the 1996 Settlement, and addressed arguments raised in the briefs on and opposing exceptions on the remanded issue.

The Unsettled Settlement.

The issues relating to El Paso’s rates have never been anything but complex,  some addressing events dating back over 20 years, and so this 400-plus page new Opinion does not spare any effort to set matters right.

El Paso’s interstate pipeline system transports natural gas from areas in the southwestern U.S. through the States of Texas, New Mexico, Colorado, and Arizona, to two points of termination near the California border at Ehrenberg and Topock, Arizona.  El Paso also delivers gas to numerous on-system delivery points and off-system eastern markets.   El Paso’s system consists of the South System and North System mainlines, which can deliver natural gas from the San Juan, Permian, and Anadarko Basins to various delivery points on a system that includes several “crossovers,” delivering natural gas between the North and South Systems.

FERC related that the last fully litigated El Paso rate proceeding was in 1959.   El Paso subsequently filed several Natural Gas Act (NGA) general section 4 rate cases, which resulted in settlements, including the 1996 Settlement, the 2006 Rate Case Settlement, and the 2008 Rate Case Settlement.  The 1996 Settlement, among other things, established a rate cap for certain shippers, in exchange for up front risk-sharing payments, and also entitled settling customers to a portion of remarketing revenues for the term of the settlement.

Specifically, Article 11.2(a) of that settlement provided that rates for capacity then under contract by eligible shippers would be capped, subject to inflation, and that the rate cap would continue to apply until the termination of shippers’ transportation service agreements (TSAs).   Article 11.2(b) provided that even if eligible shippers entered into new service agreements in the future, their rates would never include costs attributable to capacity, up to the level in existence on El Paso at the time of the 1996 settlement, that becomes unsubscribed or is subscribed at less than the maximum applicable tariff rate.

The Commission established a presumption that the Article 11.2(b) requirement would not be triggered if El Paso had subscribed service of at least 4,000 MMcf/d (representing capacity El Paso had under subscription in 1995) priced at the Article 11.2(a) rate or above.  The Commission later explained that the 1995 capacity presumption “ensures that El Paso must have subscribed capacity at maximum rates that is equivalent to the capacity that existed on its system in 1995 before it can propose to include the cost of unsubscribed or discounted capacity in the rates of eligible shippers.”

Then FERC Opinion No. 517 clarified that the presumption threshold was established to “simplify compliance” and that it is “not the only method for determining compliance with Article 11.2(b).”  The Commission found: “[A]n Article 11.2(b) analysis includes two parts: (1) a calculation of whether El Paso’s firm contracts at or above the rate cap exceed 4,000 MMcf/d and (2) a determination of whether El Paso proposes to shift the costs of unsubscribed or discounted capacity to the rates of Article 11.2(b) shippers.”

Consequently, “if the presumption is not met, other evidence might show that Article 11.2(b) is otherwise satisfied.”

Opinion 517 said that in addition to firm maximum rate contracts, it is appropriate to count non-forward haul firm services, maximum rate firm contracts that are not counted as billing determinants (maximum rate short-term firm, short haul, backhaul, east flow, and production area contracts), and CRNs (capacity reserved for hourly services) in determining whether the presumption had been met.  The Commission further found that the “maximum rate equivalent of discounted contracts” cannot be counted toward the presumption.

2011 Rate Case.

The subject of the Opinion 528 orders began with El Paso’s filing on 9/30/10 of a general section 4 rate increase for existing services and changes to certain terms and conditions of service.  In the ensuing suspension order, the Commission (1) accepted El Paso’s proposed primary tariff records subject to refund, hearing, and the outcome of the 2006 Rate Case, 2008 Rate Case, and Fuel Complaint Case proceedings; (b) rejected the alternate tariff records; and (c) suspended the effectiveness of the proposed rate increase and other tariff records until 4/1/11.

In an order on rehearing of the 2011 suspension order, FERC stated that the purpose of making the 2011 Rate Case filing subject to the outcome of the 2008 Rate Case proceeding was, in part, to “give the Commission the opportunity to make its decision based on a completed hearing record.”  The Presiding Judge issued an Initial Decision addressing the 2011 case on 6/18/12.

Opinion No. 528.

FERC’s October 2013 Opinion 528 ( an Opinion and Order on Initial Decision) affirmed in part and modified in part the Initial Decision and set for a supplemental hearing the appropriate remedy for El Paso’s failure to meet the requirements of Article 11.2(b) of the 1996 Settlement.  That Opinion also reviewed evidence and exceptions relating to El Paso’s return on equity (ROE) and affirmed the Judge’s proxy group selection and rejection of El Paso’s proposal to change the Commission’s discounted cash flow (DCF) methodology.  In addition, the Commission reversed the finding that El Paso should be placed well above the median return on equity and found that El Paso’s return on equity should be at the median of the proxy group (at 10.55%) because its risk does not reflect highly unusual circumstances.  The Commission found that El Paso must exclude costs related to the abandoned Tucson and Deming Compressor Stations from its cost of service and approved rates for premium flexible services, generally affirming the depreciation determinations in the ID, but reversing the ruling to use contract length to establish useful life for the Willcox lateral facility.

With respect to cost allocation and rate design, the Commission had affirmed El Paso’s zone of delivery/contract path methodology, but rejected use of adjusted billing determinations, and rejected the alternatives including El Paso’s proposals to equalize rates in California and bordering states and a new “within basin” production zone rate methodology.  In addition, the Commission rejected shippers’ proposed postage-stamp rate proposal and automatic daily balancing provisions.

The Commission then also affirmed El Paso’s discount adjustment, and rejected cost-sharing for unsubscribed capacity.

The Commission reviewed the latest exceptions relating to the continued effectiveness and applicability of El Paso’s 1996 Settlement and affirmed that Article 11.2 remains in effect, consistent with the public interest, and upheld the Article 11.2 rate caps.  As to implementing the terms of the 1996 Settlement, the Commission affirmed that El Paso may not reallocate shortfalls to non-settlement recourse customers, and rejected El Paso’s proposed bifurcated cost of service.  The Commission reversed the Judge’s finding that El Paso met the 4,000 MMcf/d threshold to demonstrate that Article 11.2(b) rate protections were not triggered.   Using more current contract data, it found that El Paso has not met the threshold and remanded the issue for determination of the appropriate remedy.

Because El Paso failed to satisfy the requirements of Article 11.2(b) of the 1996 Settlement, the Commission found that it was necessary to determine an appropriate means to ensure compliance with that article.  And so the Commission remanded the remedy to the Office of Administrative Law Judges for a Supplemental Hearing to determine the extent to which El Paso may be recovering costs of unsubscribed or discounted 1995 capacity through Article 11.2(b) contracts in violation of Article 11.2(b); and, if so, to develop revisions to the applicable rates to ensure that Article 11.2(a) shippers do not bear the cost of unsubscribed or discounted 1995 capacity through contracts protected by Article 11.2(b).

FERC directed El Paso to file pro forma recalculated rates, consistent with Opinion 528, within 60 days. The compliance filing should use the approved rate design, a single cost of service instead of El Paso’s bifurcated cost of service and a single billing determinant data set for the 12-month period ending 3/31/11.

Requests for rehearing and/or clarification were filed in 2013 by El Paso; Arizona Corporation Commission and Southwest Gas Corp. (ACC/Southwest Gas); the California Public Utilities Commission (CPUC); El Paso Electric Co.; Hourly Services Shipper Group; Indicated Shippers (BP Energy Co. and Shell Energy North America (US), LP); Sempra Global and Golden Spread Electric Cooperative, Inc.; Southern California Edison Co.; Southern California Gas Co. and San Diego Gas & Electric Co. (SoCal Gas/San Diego); and UNS Gas, Inc. and Tucson Electric Power Co.[1]

The hearing on the remanded issue, conducted in June 2014 addressed: (1) Whether, under El Paso’s rate proposal as modified in Opinion 528, shippers protected by Article 11.2(b) would be charged costs of unsubscribed or discounted capacity as defined in the 1996 Settlement and (2) If so, what is an appropriate remedy.  The Presiding Judge issued the Remand Decision on 9/17/14.

Rehearing Issues.

This Opinion 528-Ais lengthy and the issues are overlapping and sometimes complicated.  What follows is a brief summary of most of the Commission’s determinations:

  1. Depreciation and Negative Salvage — El Paso does not challenge the rejection of the variable depreciation proposal, but argues that the Commission erred by failing to accept the higher depreciation rates calculated by Trial Staff, which exceeded the currently effective transportation rate (2.20%) and storage rate (1.09%). The Commission denied El Paso’s request for rehearing.  In its request, stated the Commission, “El Paso fails to recognize the Commission’s affirmation of the Presiding Judge’s core finding that the only rates proposed and properly supported were El Paso’s existing depreciation rates.”  The Commission affirmed its finding that El Paso’s case for new depreciation rates was “poorly defined” and “seriously hampered by the confusion injected into the proceeding by El Paso’s proposed variable scale of depreciation rates.”

The Commission also here reaffirmed its order that the depreciation rate for the Willcox Lateral be set at the 2.20% depreciation rate for El Paso’s mainline facilities.  In reversing the Initial Decision, the Commission had explained earlier that Willcox does not qualify as an exception to the general policy that contract term (or contract life) should not be used to establish depreciation rates.  And despite El Paso’s arguments to the contrary, “the Commission’s long-standing policy is to not allow depreciation rates based on length of contract, including depreciation rates for laterals.”

The Commission also denied rehearing of its decision on El Paso’s negative net salvage rate.  El Paso initially proposed increasing its negative salvage rate to 0.18% from the current rate of 0.12%, citing increased retirement costs and lower salvage values as a result of environmental and safety regulations.  But in Opinion 528, the Commission had affirmed the ruling of the Judge in rejecting proposed increases to El Paso’s current negative salvage rate of 0.12%.

Rate Base (Tucson/Deming Compressor Station Abandonment) — Opinion 528-A denied rehearing and reaffirmed the earlier holding that the expenses associated with the Tucson and Deming Compressor Stations should be excluded from El Paso’s cost of service.   El Paso filed to abandon these stations on 9/28/10, two days before filing the 2011 rate application, but the Commission order authorizing the abandonment was not issued until 9/11/11, after the end of the test period.  The Commission here explained that it can reach beyond the test period if changes occurring after the test period are of a substantial nature and would correct estimates that were substantially in error.  El Paso believes that standard was not met.  FERC disagreed.

Rehearing Granted – Cost Allocation and Rate Design — The only zonal rate design issue upon which El Paso seeks rehearing is Opinion 528’s requirement that costs should be allocated across zones based on the contract demands of shippers in each zone unadjusted for discounting, and in this Opinion the Commission granted El Paso’s request for rehearing on that issue.   In these circumstances, “we find that our actions with respect to El Paso’s zone of delivery rate design fall within the ambit of our NGA section 4 authority.”

After calculating rates for each zone, however, El Paso had proposed to “equilibrate” the rates for the California, Arizona, and Nevada rate zones by averaging the rates for the three zones into a single rate, while maintaining separate zonal rates for New Mexico and Texas.  Edison and SoCal Gas/San Diego argued that if the Commission does not adopt postage-stamp rates for El Paso, it should at least approve El Paso’s zone equilibration proposal.

In Opinion 528, the Commission affirmed the Presiding Judge’s approval of El Paso’s zone-of-delivery methodology for allocating mileage-related costs as just and reasonable, and his rejection of El Paso’s proposal to “equilibrate” the rates.  Opinion 528 also affirmed the Judge’s finding that El Paso’s proposed contract-path methodology for allocating mileage-related costs is just and reasonable.  Opinion 528 found that it is appropriate to use contract paths because they represent specific routes along El Paso’s pipeline system by which natural gas can be transported from the shipper’s receipt point (or pool) to its delivery point.

However, the Commission had reversed the Presiding Judge on one issue concerning El Paso’s Dth-mileage study.  While the Presiding Judge accepted El Paso’s proposal to use discount adjusted billing determinants in that study, the Commission rejected that proposal and required El Paso to use unadjusted billing determinants.

Edison contended on rehearing that the Commission’s acceptance of El Paso’s zone-of-delivery rate design proposal, while rejecting its zone equilibration proposal, incorrectly, and unlawfully, blurred the lines between sections 4 and 5 by imposing a rate design that was not proposed by El Paso.  As noted above, Opinion 528-A rejected this objection.

Along this line, the Commission re-affirmed its finding before that El Paso’s zone-of-delivery methodology is appropriate for allocating mileage-related costs and that the proposed contract-path methodology for allocating mileage-related costs is just and reasonable.  Among other things, the Commission “disagrees with the arguments that the contract paths should not be used for allocating distance-based costs because contract paths do not reflect cost incurrence or actual/average activity on El Paso’s system.”  El Paso’s proposal results in rates that reasonably reflect material variations in the cost of providing service due to distance.

El Paso, however, did seek rehearing of the Commission’s application of its policy favoring use of unadjusted billing determinants to reject El Paso’s section 4 proposal to use discount-adjusted billing determinants for cost allocation purposes.  The holding of Opinion 528 required El Paso to allocate costs among zones using unadjusted billing determinants, following the policy reflected in Williston Basin.  However, pursuant to Opinion 528-A the Commission granted rehearing on this issue, and affirmed the Presiding Judge’s conclusion accepting El Paso’s proposal to use discount-adjusted volumes in its Dth-mileage study for purposes of allocating costs among rate zones.

Continuing with regard to peripherally related contests  on rate design matters following Opinion 528, the Commission here again rejected a contention of  SoCal Gas/San Diego it had  erred in rejecting both “El Paso’s primary zone equilibration proposal” and what they describe as El Paso’s “alternative postage stamp rate design proposal.”  FERC disagreed with SoCal Gas/San Diego and Edison’s contentions that “we should treat El Paso as having made an alternative proposal under NGA section 4 to adopt a single system-wide postage-stamp rate applicable to all rate zones, if we reject El Paso’s primary rate design proposal.”

The Commission also denied Edison and SoCal Gas/San Diego’s request for rehearing of its rejection of El Paso’s zone equilibration proposal.   And the Commission clarified for Edison’s sake that “the Commission has not found that a postage stamp rate design would be just and reasonable for El Paso’s system.  We have simply found that it is not necessary for us to reach that issue in this case, because El Paso’s existing zone of delivery rate design, including its contract path method of allocating mileage-based rates, is just and reasonable and therefore there is no basis to consider alternative rate designs under NGA section 5.”

Discount Adjustments — El Paso had proposed a discount adjustment to the billing determinants it proposed to use both to allocate its cost of service among services and rate zones and to design its per unit rates.  El Paso also proposed to include the costs of its unsubscribed capacity in its rate design so that its rates would recover 100% of its cost of service.   The Commission had agreed with the Presiding Judge that El Paso had satisfied the burden of proof ordinarily required to show that a full discount adjustment to rate design billing determinants is just and reasonable.  The Commission agreed with the Judge’s findings that mere claims that El Paso’s rates had gone up over the last few rate cases, and that discounts were mainly responsible for those increases, were speculative and unsupported, and thus not enough to show that the resulting rates were unjust and unreasonable.

In Opinion 528-A, the Commission denied rehearing on this issue, and also provided clarification.  The Commission “did not intend in Opinion No. 528 to alter in any manner its policy concerning discount adjustments, as set forth in the Selective Discounting Policy Statement or other Commission orders.”  However, while the Commission has consistently approved discount adjustments in section 4 rate cases, nothing in the Selective Discounting Policy orders establishes a rule or mandates that pipelines have a right to a full discount adjustment in all instances.   The Commission considers the impact of any discount adjustment on captive customers in specific proceedings, and may not permit a full discount adjustment in situations where that would lead to an inequitable result.

However, the Commission “continues to find that this case does not present circumstances warranting disallowance of a full discount adjustment, despite our decision above to grant rehearing of Opinion No. 528’s rejection of El Paso’s proposal to use discount-adjusted billing determinants to allocate costs among rate zones.”  El Paso should be permitted to design its rates using a full discount adjustment and the shippers’ various risk sharing proposals should be rejected, the Commission concluded.

Variable Cost Allocation — In its 2010 filing, El Paso classified all variable costs as mileage-based and proposed to continue to recover these costs through its zone-of-delivery usage charges.  In the Initial Decision, the Judge adopted the SoCal Gas/San Diego view to treat compressor station costs as non-mileage-related.  Opinion 528 affirmed the Presiding Judge’s finding and classified El Paso’s storage compressor station cost as non-mileage related, including costs for those compressor stations whose purpose is to increase the pressure of pooled natural gas supplies to the pressure level of mainline facilities.  And based on SoCal Gas/San Diego’s detailed analysis, the Commission had found that El Paso’s proposal to continue to classify costs associated with these compressor stations as mileage-based was no longer just and reasonable.  Rather, SoCal Gas/San Diego’s proposal to classify those costs as non-mileage-based is just and reasonable.

Attempting to carry the argument further, Edison argues that if El Paso is not required to adopt postage-stamp reservation rates, it should be required to calculate postage-stamp usage rates to reflect non-mileaged treatment of all its non-fuel variable costs.  Edison further argues that the record supported the classification of all of El Paso’s variable costs as non-mileage based.  On rehearing, FERC concluded that Edison offers no new arguments on rehearing.

Rate Design for Premium Rate Schedules (FT-H and IHSW) —  Denying hearing, first, the Commission affirmed its prior determination that using weighted premium factors based on the full distance of the contract path is appropriate and consistent with El Paso’s contract-path methodology.   Second, the Commission affirmed its prior determination that including hourly service non-mileage costs is appropriate and consistent with the overall weighted premium factor methodology.

FERC also reaffirmed El Paso’s proposal to derive its IHSW rate from the Rate Schedule FTH-16 rate at a 100% load factor.  The Commission found that the 100 percent load factor FTH-16 service most closely approximates the hourly flexibility provided by IHSW service.   Policy “allows interruptible transportation rates to be derived from comparable firm service.”  The Commission found that FTH-16 service, which is a 16-hour firm service, is a better match for the IHSW service, which is a 15-hour swing service.

Article 11.2 — El Paso raises three arguments on rehearing.  First, El Paso argues that, by rejecting its proposal to reallocate the Article 11.2 shortfall (the difference between maximum recourse rates and Article 11.2(a) rates), the Commission unreasonably departed from numerous prior orders that stated that El Paso would have a reasonable opportunity to recover all of its expansion costs.  Second, El Paso argues that the Commission erred in remanding the Article 11.2(b) issues for hearing because the record demonstrates that it complied with Article 11.2(b) and has not proposed to shift 1995 discounted or unsubscribed capacity costs to eligible shippers.  Finally, El Paso argues that the Commission erred by not finding that Article 11.2 is contrary to the public interest and/or produces unjust and unreasonable rates.  Here, in Opinion 528-A, the Commission denied rehearing.

The Commission repeated earlier explanations that “there is no guarantee” that a pipeline will fully recover its costs if rolled-into system rates.  The Commission denied rehearing consistent with the determination in Opinion 517 that the Commission did not count maximum rate equivalents when it established the threshold.  El Paso has not provided data and analysis to demonstrate that customers are not being charged 1995 system costs in violation of Article 11.2(b).

FERC asserted that many of El Paso’s other arguments are similar to those rejected on rehearing in Opinion 517-A.

Return On Equity and El Paso’s Placement in the Proxy Group — In Opinion 528, the Commission affirmed the Judge’s rulings regarding the composition of the proxy group and the application of the customary two-step discounted cash flow (DCF) analysis to that group.  Based on that DCF analysis, and a five member proxy consisting of Boardwalk Pipeline Partners, LP; TC Pipelines, LP; Spectra Energy Partners, LP; Spectra Energy Corp.; and Williams Partners, LP, the Commission determined that the range of reasonableness for El Paso’s return on equity (ROE) is 10.39% to 11.08%, with a median of 10.55%.  In arriving at this determination, the Commission upheld the Presiding Judge’s finding that the long-term growth rate for master limited partnerships (MLPs) should be one-half of gross domestic product (GDP), instead of El Paso’s full GDP proposal based on its proposed “Benchmark Model.”  The Commission also reversed the Judge’s finding that El Paso’s relative risk justified an ROE “well above the median,” finding instead that El Paso’s allowed ROE should be set at the median of the range of reasonableness, or 10.55%.

El Paso challenges the Commission’s approval of the proxy group, the finding that one-half GDP should be used as the MLP long term growth component in the two-step DCF analysis, and the decision to place El Paso at the median of the range of reasonable returns.  On rehearing, FERC denied El Paso’s requests on all three accounts.  FERC specifically denied rehearing of the determination to exclude KMEP, ONEOK and Enterprise from the proxy group.

The only issue raised on rehearing of Opinion 528 concerning the two-step DCF analysis of the proxy group members relates to the long-term growth projection of the MLPs in the proxy group, Boardwalk, TC Pipelines, Spectra Partners, and Williams.   In these circumstances, the Commission repeated, the two-step analysis of the proxy group MLPs must be based on market-determined data for the limited partner units of those MLPs, consistent with the court’s holding in Petal Gas v. FERC that the purpose of a proxy group is to “provide market-determined stock and dividend figures from public companies comparable to a target company for which those figures are unavailable.”

Thus, the DCF analysis of each MLP must be based on the stock price of its limited partner units, the amount of its limited partner distributions, and its IBES[2] growth projection.  That leaves only the question of what long-term growth projection to use.   In the only previous natural gas pipeline case where the issue of a long-term growth projection for MLPs was litigated, Opinion No. 486-B, FERC held that the reasonable long-term growth projection was 50 percent of GDP.

FERC next turned to the issue of where in the zone of reasonableness to set El Paso’s ROE.  The Commission’s traditional assumption with regard to relative risk is that natural gas pipelines “generally fall into a broad range of average risk absent highly unusual circumstances that indicate an anomalously high or low risk as compared to other pipelines.”  In El Paso’s case, the Commission reaffirmed the finding in Opinion 528 that El Paso failed to overcome the presumption of average risk, and thus that its ROE should be set at the median of the zone of reasonable returns.

Power-Up Project Phase III Prudence —  El Paso claims the Commission erred by failing to reverse the Presiding Judge’s determination that that parties are not estopped from challenging the prudence of Phase III of the Power-Up Project.  While El Paso acknowledges that the Judge rejected the prudence challenges, it nevertheless objects to the ruling as an impermissible “advisory” opinion.  The Commission denied rehearing, explaining that “because the Commission did not decide against El Paso on the Phase III Power Up issue in Opinion No. 528 the issue is moot and El Paso is not aggrieved by the Presiding Judge’s dicta on that issue.”

Remand Proceeding, Article 11.2(b). 

In Opinion 528, as indicated, the Commission found that El Paso failed to demonstrate that it satisfied the requirements of Article 11.2(b) of the 1996 Settlement which provides that the rates charged to certain settlement shippers may not include unsubscribed or discounted capacity costs related to capacity on El Paso in 1995.  To ensure that the terms of the settlement were met, the Commission remanded this proceeding to hearing to determine an appropriate means to ensure that the protected shippers do not bear the disallowed costs in their rates for service not otherwise covered by the 1996 Settlement.  The Commission stated that the parties should use the compliance filing that El Paso submits to comply with the directives of Opinion 528 as the basis from which to determine the appropriate level of costs reflected in contracts protected under Article 11.2(b) for which El Paso has agreed to assume responsibility and the adjusted rates applicable to those contracts.

The Presiding Judge conducted a hearing on June 4 and June 5, 2014, addressing whether shippers protected by Article 11.2(b) would be charged the costs of unsubscribed or discounted 1995 capacity under El Paso’s 2011 rate proposal in violation of the 1996 Settlement and, if so, what is an appropriate remedy.  And the Judge eventually agreed with Trial Staff and Rate Protected Shippers that El Paso has proposed to shift costs related to the 1995 capacity in a manner that is inconsistent with Article 11.2(b) of the 1996 Settlement.

In Opinion 528-A, FERC affirmed the Presiding Judge’s finding that El Paso’s filed 2011 rate proposal would shift costs of 1995 capacity to protected shippers in a manner that is inconsistent with Article 11.2(b).  Due to the fact that El Paso operates an integrated system, the Commission had established a presumption threshold that if El Paso has 4,068,000 Dth/d (the thermal equivalent of 4,000 MMcf/d) of capacity subscribed at the Article 11.2(a) rate cap or above, then El Paso has no 1995 stranded or discounted capacity.

In Opinion No. 517, however, the Commission stated that the presumption is not the only way to determine compliance with Article 11.2(b).

In both the main 2011 rate case proceeding reviewed in Opinion 528 and the remand proceeding established to address issues related specifically to Article 11.2(b), El Paso provides a cost and revenue study and claims that comparing the 1995 cost of facilities with system revenues should be an appropriate and acceptable approach to determine whether it has shifted costs to Article 11.2(b) shippers.  In the alternative, El Paso proposes to use cost and revenue data to demonstrate that it has met the 4,000 MMcf/d threshold if certain revenues are treated as proportionate stand-ins for firm, maximum recourse rate equivalents.

But the Commission said El Paso’s Certificate Policy Statement analogy does not support its use of a cost and revenue study.  In the certificate proceedings, the Commission’s findings are only predeterminations.  The analysis is based on estimated figures which may change and are not binding on any party.  The instant proceeding is not a certificate proceeding but a proceeding to determine compliance with a settlement provision.

Furthermore, the Commission noted it has rejected El Paso’s prior attempts to separate its capacity “by vintage” for Article 11.2 purposes.

And the Commission found that El Paso’s cost and revenue study is flawed in many ways.  For instance, El Paso incorrectly interprets the costs of 1995 capacity as consisting exclusively of the cost of facilities comprising El Paso’s 1995 system.

Because service volumes have fallen below the 4,000 MMcf/d threshold for the time period covered by this proceeding, coupled with the fact that El Paso’s requested discount adjustment would transfer costs to non-Article 11.2 maximum rate contracts, “it is necessary to develop a remedy to ensure that the discount costs are not borne by shippers protected by Article 11.2(b).”

Up front, shippers that hold contracts protected by Article 11.2(b) should not pay costs of unsubscribed or discounted 1995 capacity (through the discount adjustment or otherwise) under the 1996 Settlement.  At hearing, the Presiding Judge reviewed proposed remedies from Trial Staff, El Paso, Rate Protected Shippers and SoCal Gas/San Diego.  Trial Staff proposed a billing determinant-based approach while the other Participants proposed a revenue crediting approach.

The revenue-crediting approaches measure the difference in revenues generated from the actual discounted rate contracts as compared to revenues that would have been generated had they been priced at the Article 11.2(a) rate.  The revenue-crediting remedies each start by establishing the capacity shortfall, which is defined as the amount of additional capacity that, if sold at or above the Article 11.2(a) rate, would cause El Paso to be in compliance with Article 11.2(b).  The Participants then determine the revenue deficiency related to the capacity shortfall.  El Paso and SoCal Gas/San Diego calculate the revenue deficiency by filling the shortfall by sequencing El Paso’s discounted contracts from highest to lowest rate until the 4,000 MMcf/d capacity threshold is met, while Rate Protected Shippers use a proportionate amount of all long-term and short-term discounted contracts to fill the shortfall.

The Judge and FERC liked Trial Staff’s approach better.  Trial Staff’s billing-determinants approach imputes billing determinants to ensure that capacity costs are allocated consistent with the threshold.  To do so, Trial Staff increases the billing determinants underlying El Paso’s compliance filing recourse rates proportionately to all zones and rates, to the threshold level.  Trial Staff then derives reservation rates for eligible Article 11.2(b) shippers by dividing the reservation costs of service by the adjusted billing determinants for each period.  Trial Staff compares the revenues generated by these rates with the revenues from the compliance filing rates to calculate the revenue shortfall that El Paso is required to absorb to meet the Article 11.2(b) requirement.

After hearing, the Presiding Judge found that Trial Staff’s remedy appropriately and reasonably removes any improper shift in costs and should be adopted in full.  The Judge identified a number of factors supporting Trial Staff’s remedy.

The Commission affirmed the Judge’s choice of Trial Staff’s primary remedy, as representing an approach that is “more easily and fairly administered, neutral, and precise.”  The Commission agreed that although the revenue crediting approach can achieve the same result as Trial Staff’s billing determinant-based remedy, Trial Staff’s approach avoids the arbitrariness of the other Participants’ methods while still identifying and removing any improper cost shift to Article 11.2(b) shippers.  The Commission also agreed with Trial Staff’s use of system capacity rather than the cost of facilities for the 1995 system.  “Use of the system capacity as the starting point to calculate the remedy is consistent with the terms of the 1996 Settlement and also, the integrated nature of El Paso’s system, which cannot be physically separated into pre-1995 or post-1995 capacity.”

Otherwise, added the Commission, “[we] reject El Paso’s proposal to adopt a value for 1995 facilities based on 1995 Form No. 2 costs updated for depreciation.”  El Paso has made no attempt to demonstrate that such costs represent the current costs to provide service over 1995 capacity and provided no updated accounting reflecting current costs comparable to that typically used to establish rate base.  Such an accounting would include updated facility costs reflecting additional capital costs increased by maintenance, repair and replacement costs.  Moreover, El Paso’s criticism that Trial Staff’s approach overstates the cost of depreciated 1995 facilities supporting the 1995 capacity is “unfounded.”

The Commission concluded that “Trial Staff’s primary billing determinant remedy is just and reasonable, clear and objective in its application, and conforms to previous Commission determinations.”  The other Participants’ remedies, while achieving a similar result as Trial Staff’s primary remedy, “lack objectivity and are more difficult to administer.”

Compliance Filing.

Finally, turning to the compliance filing of El Paso, the Commission found that El Paso has complied with the directives of Opinion 528.  El Paso has properly used the rate components accepted in Opinion 528.

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[1]  ConocoPhillips Co. and Texas Gas Service Co. (ONEOK, Inc.) originally requested rehearing, but withdrew their pleadings by agreement with El Paso.

[2]   Institutional Brokers Estimate System

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