CHAPTER 4 RATEMAKING FOR JURISDICTIONAL OIL PIPELINES
| Jurisdiction | United States |
(Jan 1995)
RATEMAKING FOR JURISDICTIONAL OIL PIPELINES
Andrews & Kurth
Washington, D.C.
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TABLE OF CONTENTS
INTRODUCTION
DISCUSSION
I. The Valuation Method
II. Current Methods
A. Opinion Nos. 154-B and C/Trended Original Cost
B. Litigation/Decisions Implementing Opinion 154-B/TOC
C. Light-handed Regulation
D. The Energy Policy Act of 1992
E. Order Nos. 561 and 561-A
1) The Indexing Methodology
a) Procedures Relating to the Indexing Methodology
b) Filing the Rates
c) Challenges to the Index Related Rate Changes
2) Settlement Rates
3) Establishment Of Initial Rates
4) Judicial Review Of Order Nos. 561, et al
F. Order No. 571 -- Cost of Service Filing Requirements
1) Cost of Service Rates
2) Filing the Rates
3) Revisions to Form 6
G. Market Based Rates and Order No. 572
III. An Overview Of How To Qualify For Market-Based Rates
A. Overview Of Competition
1) Competition in General
2) Role of Market Equilibrium
3) Competition From New Pipeline Construction
4) Major Shippers—Price Makers Not Takers
5) The Role Of Exchanges
6) Excess Capacity
B. Economic Issues
1) Market Definition
a) The BEA as a Geographic Market
b) The Product Market: All Pipelineable Petroleum Products
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2) Market Concentration
a) Measurement: The Role of HHIs
b) Measurement of Market Concentration: Capacity Versus Deliveries
C. Conclusion
IV. Procedures For Expediting Commission Action On Rates
A. New Procedures
1) Information to Accompany a Tariff Filing
2) Procedures Related to the Filing of, And Responding to, Complaints and Protests
3) Complaints Against Grandfathered Rates
4) Staff Initiated Investigations
5) Elimination of the Oil Pipeline Board
V. Alternative Dispute Resolution
A. Required Negotiation
B. Arbitration
APPENDIX
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INTRODUCTION
Under the current rules of the Federal Energy Regulatory Commission ("Commission"), pipeline rates may be changed and justified using one of three methods — indexing, cost of service, or a market-based approach. The purpose of this paper is to discuss briefly each of these methods, the circumstances under which they may be applied and generally how to implement each approach. Before a company determines which methodology it will utilize, however, one of the first questions a company must ask is whether the rates it is currently charging, and is seeking to adjust, have been deemed just and reasonable under the Energy Policy Act of 1992 (the "Energy Act").1 In that regard, if a pipeline is seeking to increase existing rates which have been deemed just and reasonable, the pipeline is required to utilize the Commission's indexing methodology prescribed by Order Nos. 561 and 561-A.2 As discussed below (at pp. 20-25), there are circumstances where a company is not required to follow the Commission's indexing methology. For example, a second method — a cost of service based approach — may be utilized to justify rates in either of two situations. First, to the extent a pipeline seeks to establish rates for a new service, a cost of service or a negotiated (settlement) rate approach may be utilized. Second, the cost of service or negotiated approach may be utilized if a pipeline finds that the indexing methodology results in a rate which would not produce sufficient revenue to enable the company to recover its prudently incurred costs. With regard to the third possible approach — market based rates — under the Commission's rules a
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pipeline has the "opportunity" to demonstrate to the Commission that competitive pressures in the markets it serves are sufficient to restrain rates to just and reasonable levels. Assuming the pipeline can carry its burden and demonstrates that the necessary level of competition exists, on a prospective basis only the pipeline will be permitted to charge rates which arguably are not "cost based." As discussed in more detail at pp. 24-32, the opportunity to charge so-called "market based" rates, however, is very limited.
DISCUSSION
Before examining each of the current ratemaking methods in more detail, I believe that it is helpful and, therefore, appropriate to examine briefly the historical course ratemaking in our industry has traveled to bring us to our present state of rate regulation. Therefore, I begin this paper with some information regarding the valuation methodology which historically was utilized to justify rates. This discussion naturally includes some information regarding the origin of that method and its eventual evolution to the current rate methodologies. For your convenience, in order to impart the maximum amount of relevant information in the shortest period of time and yet convey to the reader a general understanding of the nature of each case dealing with one of the rate methodologies covered in this paper, each decision including ARCO 3 and Kuparuk 4 have been summarized and included in the Appendix attached hereto.
I. The Valuation Methodology
Between 1906 and 1978, the Interstate Commerce Commission ("ICC") was charged with exercising regulatory authority over oil pipelines, including transportation rates, pursuant to the Interstate Commerce Act5 and, in general, until
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the early to mid-1980s rates were based upon the so-called "valuation" methodology. This methodology, generally, reflected a compromise between the original and reproduction cost doctrines and enabled the pipeline carrier to charge rates which allowed it to earn a return based on the present "fair value" of all property which was dedicated to public use.
The basis for the ICC's use of the valuation methodology can be traced to the Valuation Act of 1913, which was adopted as an amendment to the Interstate Commerce Act at a time when it appeared the Supreme Court required ratemaking to follow a so-called "fair value" approach.6 In Smyth v. Ames7 the Supreme Court explained the general weighting process that was utilized in setting rates under this so-called "fair value" method. The Court stated:
the basis of all calculations as to the reasonableness of rates to be charged ... must be the fair value of the property being used ... for the convenience of the public.... [I]n order to ascertain that value, the original cost of construction, the amount expended in permanent improvements, the amount and market value of ... bonds and stock, the present as compared with the original cost of construction, the probable earning capacity of the property under particular rates ... and the sum required to meet operating expenses, are all matters for consideration....8
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Although the Valuation Act makes no reference to the appropriate method for ascertaining the "fair value" of carrier property in service, the ICC obviously was influenced by the Supreme Court's decision and permitted the pipelines to develop a hybrid rate base which weighted the original cost and the cost of reproduction new of the pipeline's rate base related assets.9 The resulting weighted average was then adjusted for depreciation. Under this method, the resulting rate base was an integral part of justifying a company's rates because a pipeline's rates generally were deemed to be just and reasonable if the rate of return it earned on its "valuation rate base" did not exceed the guideline of 8% for crude oil lines and 10% for products pipeline. The valuation rate base approach was applied by the ICC until its oversight authority for the oil pipeline industry was transferred to FERC in 1978.10 Although this methodology has been termed "bizarre" by its critics,11 and has been criticized by the courts,12 certain writers believe that this approach was comprehensible within the legal and economic context of the time period.13 However, the ICC offered little justifiation as to the reasoning behind its selection of the valuation methodology as the appropriate ratemaking guideline for the oil pipeline industry.14
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Prior to losing its jurisdictional authority over pipeline rates, the ICC's valuation methodology for determining whether rates were just and reasonable was challenged by a group of shippers on the Williams system. The challenge was the result of an ICC decision upholding this approach when applied to rate increases which were implemented by Williams. The shippers sought judicial review which ultimately resulted in the U.S. Court of Appeals for the D.C. Circuit's decision in Farmers Union I.15 Before the D.C. Circuit reached its decision, however, the proceedings before the D.C. Circuit were complicated by the transfer of regulatory authority over oil pipelines from the ICC to the Commission. As a result, during the pendency of the appeal,16 before the D.C. Circuit could render a decision on the merits, the Commission requested that the court remand the matter to allow the Commission to formulate a new ratemaking method, independent of the ICC methodology.17 Although the Court granted the Commission's request to remand the matter, the Court openly criticized the ICC valuation methodology, stating that "significant changes in the relevant legal environment since the ICC's 1940's decisions [and] important economic transformations..." cast doubt on the reasonableness of the ICC-determined rate at issue.18
In response to the Court remand, after 46 months of "consideration", the Commission issued Opinion No. 154,19 which generally retained the ICC valuation approach to measure whether rates were "just and reasonable". The Commission did, however, adopt a new rate of return methodology. In its decision, the Commission determined that ratemaking for oil pipelines and its oversight of that activity needed only to "restrain gross overreaching and unconscionable gouging" in order to keep rates within a zone of "commercial...
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