Week Ending August 21, 2020

Shippers, Pipelines Square Off in Comments on Oil Pipeline Rate Index NOI

This Article Appears as Published in Foster Report No 3313

The tussle between oil pipelines and their shippers over FERC’s five-year review of pipeline costs and setting the pipeline rate index level began in earnest August 17, with comments from both sides that the calculations the Commission used in the June 18 Notice of Inquiry (NOI) need to be changed.

Shippers pointed to reduced risks for pipelines based on contracts that have shippers committing to pay for costs of pipeline expansions ahead of time and changes to FERC policies for return on equity (ROE) calculations. Those and other arguments were made for asserting that the index level in the NOI should be adjusted lower.

Pipelines, on the other hand, referred to higher costs associated with pipeline safety requirements and other factors in claiming that the index level should be higher than what was proposed in the NOI (RM20-14). The Association of Oil Pipe Lines (AOPL) and a group of pipelines dubbed Designated Carriers[1] filed comments representing liquids pipeline owners.

Both shippers and pipelines agreed that FERC should not use any 2020 data or effects of the COVID-19 pandemic in the factors used to reach a final index level, since the five-year review is a look backwards that covers 2015-2019. However, they differed in how hard that line should be drawn, with shippers adamant that pipeline usage and oil demand declines should be pushed to the next review and pipelines suggesting an index level for the upcoming period would underestimate the actual cost experience of liquids pipelines.

“While AOPL does not propose that the Commission adjust the index methodology in the review to account for these [pandemic] issues, it is important for the Commission to be aware of the economic challenges oil pipelines are facing as it determines the index level and the impact on the application of the rate index in upcoming years,” AOPL said.

When FERC last adjusted the oil pipeline rate index level in 2015, it promised to examine cost adjustments for pipelines that reflect reduced risks for pipeline owners, shippers told FERC. Then, in 2018, FERC declined to adjust oil pipeline cost factors following a tax law change – unlike adjustments made for natural gas pipelines and electric utilities – while vowing to do so in the five-year review of oil and natural gas liquids pipeline rates. Yet in the NOI that initiated the latest five-year review, FERC did not follow through on those steps to a degree that left shippers seeking changes in the index level.

In separate comments, the Liquids Shippers Group[2] (LSG) and the Canadian Association of Petroleum Producers (CAPP) said FERC, in its Income Tax Policy Statement issued following the 2017 tax law change, vowed to include the effect of zeroing out the income tax allowance for master limited partnerships (MLPs) in the index calculation as part of the five-year review. “Having deferred its regulatory responsibilities to this proceeding, the Commission now has an obligation to ensure that the index accurately captures the 2018 tax changes, including the Income Tax Policy Statement,” LSG said.

That change, and others suggested in the comments of LSG, would result in an index level below what was proposed in the NOI.

As part of that NOI, FERC sought comments on the proposal to use the Producer Price Index for Finished Goods (PPI-FG) plus 0.09% as the index level starting July 1, 2021.

LSG’s witness testimony said the use of different cost data and other return on equity (ROE) calculations would produce an index level of PPI-FG minus 1.58%, which more accurately reflects the pipeline sector as a whole.

Conversely, AOPL said FERC should bump the index level up to PPI-FG plus 0.79%. AOPL’s position was seconded by a group of Designated Carriers, who filed separate comments and witness testimony with a few tweaks from AOPL’s calculations. The Designated Carriers advocated for an index level of PPI-FG plus 0.82%.

AOPL and the Designated Carriers said FERC should include a larger segment of the liquids pipeline industry to capture a true reflection of the sector. They also suggested FERC adjust calculations for income tax allowances and accumulated deferred income taxes (ADIT) for MLPs to be consistent with past policy decisions incorporated into the liquids pipeline index methodology.

The proceeding is a key part of FERC’s regulation of liquids pipelines, consistent with the light-handed ratemaking approach mandated by Congress in the Energy Policy Act, commissioners said when the NOI was issued in June. The Commission will select a final index level at the conclusion of the proceeding, which will be used to calculate annual changes to liquids pipeline rate ceilings for the subsequent five years, beginning July 1, 2021.

FERC annually applies an index to oil pipeline rate ceilings to establish new rate ceiling levels, and the Commission reconsiders the index level every five years. The indexed rate methodology allows pipelines to change their tariff rates as long as they remain at or below certain ceiling levels.

The current five-year review marks the fifth such effort since FERC Order 561 was issued to carry out statutory changes in the Commission’s oil pipeline ratemaking methodology. Five years ago, FERC’s final order settled on an index level of PPI-FG plus 1.23% that has been in effect since the middle of 2016.

When it issued the NOI, FERC said parties will have an opportunity to include new data that has not yet been filed in their Form 6 page 700 informational filings. Stakeholders also could include alternative methodologies for calculating the index level, such as changes FERC has made in cost-of-service ratemaking and ROE calculations in different dockets.

FERC noted that since the last index review in 2015, it has adopted two major change to the cost-of-service methodology used by pipelines for their Form 6 Page 700 data. The first was in 2018 when it updated its policy in response to a court remand on the treatment of income tax allowances (ITA) and accumulated deferred income taxes (ADIT) for pipelines owned by MLPs.

The second change was in FERC’s May 21 policy statement revising its methodology for determining the ROE for natural gas and oil pipelines. In that policy statement, the Commission departed from its longstanding reliance on the discounted cash flow (DCF) model for setting ROE and said it would give equal weight to the DCF model and the capital asset pricing model, among other changes.

FERC encouraged oil pipelines to file updated Page 700 data for 2019 to reflect the revised methodology, noting that such data may help it estimate industry-wide cost changes for the five-year index review. The proposal to determine the next index level is based on the methodology developed by economist Alfred Kahn and established in Order 561, FERC explained. The Kahn methodology, which has been upheld by an appeals court, uses oil pipeline data reported on Page 700 of Form 6 from the prior five-year period to determine an adjustment to be applied to the PPI-FG.

The NOI explained that the calculations involve each pipeline’s cost change on a per barrel-mile basis over the prior five years. To remove statistical outliers and spurious data, the data set is trimmed to those pipelines in the middle 50% of cost changes. The methodology then includes calculating three measures of the middle 50% central tendency; the median, the mean, and a weighted mean.

One of the points of dispute between pipelines and shippers was the NOI’s use of the middle 50%. AOPL and the Designated Carriers said use of the middle 80% of cost changes – as was used in the past – is needed to reflect industry-wide cost factors. Use of the middle 50% would go well beyond trimming statistical outliers, and instead would exclude a large amount of meaningful data that is not “extreme and spurious,” AOPL said, referring to the U.S. Court of Appeals for the D.C. Circuit case in 2002 that upheld the data-trimming measures. Use of the middle 80% would produce a more accurate measurement of pipeline sector cost changes, while the middle 50% grouping would not capture the full industry experience and result in a downward bias in the index, the pipelines said.

LSG supported use of the median of the barrel-mile cost changes for the middle 50% of pipelines in the sample, instead of the weighted average used in the index calculation of the NOI. The weighted average gives the most weight to those pipelines with the highest barrel-miles in the middle 50% group, and FERC has never addressed the relative merits of using a weighted average – compared with some other measure of central tendency – in the index level calculations, LSG said.

Furthermore, the 50% grouping is skewed by the inclusion of two massive pipeline owners, Enbridge Energy and Colonial Pipeline Co., which account for 48% of the total barrel-miles among the 80 pipelines in the middle 50% group, LSG added. Compared with the cost data in a limited range for 78 pipelines, the cost data spikes when Enbridge and Colonial are taken into account, showing they are extreme outliers that skew the index too high, the shipper group said.

LSG also said FERC should apply a standardized ROE to the 2014 and 2019 Form 6 page 700 cost data to ensure that the index reflects then-current market conditions.

The Commission should retain the effects of zeroing out the income tax allowance for MLPs in the index calculation to bring pipeline ceiling rates more in line with their recoverable costs under FERC ratemaking policies, LSG said.

Combining the recommendations from LSG would produce the liquids pipeline index level of PPI-FG minus 1.58%.

CAPP did not provide an index level calculation in its comments, but said the NOI left out an important issue that went unresolved in the 2015 five-year review – how the cost calculations in ROE should reflect the pipeline industry trend to have contract terms with shipper commitments supporting pipeline infrastructure investments. That trend has reduced the risk associated with pipeline investments by pipeline owners, which was not captured in the NOI, CAPP said.

“The NOI leaves unclear how the use of Page 700 data, as submitted by oil pipelines, takes into account these or any other risk differentials among pipelines in the determination of ROE figures used to compile the index; yet the Commission has explicitly stated that it would do so,” the producer group said.
Besides the use of the middle 80% of pipelines for the data sample, AOPL said the index should be changed to reflect the actual costs facing pipelines owned by MLPs due to tax changes and the pipeline safety regulatory requirements that will continue for the foreseeable future. An adjustment to reflect actual tax changes, and not just FERC policy, is needed for ADIT.

“Failing to apply these normalizing adjustments would make it appear that costs changed, when all that changed was the Commission’s ratemaking policy and the resultant change in reporting of MLP pipeline income tax data in the middle of the five-year review period. In other words, the actual income tax-related costs for MLP pipelines were the same before and after the policy change – it was only the reporting of income tax data on page 700 that changed,” AOPL told FERC.

By Tom Tiernan ttiernan@fosterreport.com

[1] The Designated Carriers are Buckeye Partners LP, Colonial Pipeline Co., Energy Transfer LP, Enterprise Products Partners LP and Plains All American Pipeline LP.

[2] LSG members are Apache Corp., Cenovus Energy Marketing Services Ltd., ConocoPhillips Co., Devon Gas Services, LP, Equinor Marketing & Trading US Inc., Fieldwood Energy LLC, Marathon Oil Co., Murphy Exploration and Production Co., Ovintiv Marketing Inc. and Pioneer Natural Resources USA, Inc.

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