US oil pipelines might rethink affiliate discounts: Fuel for Thought

US oil pipeline companies were calling their lawyers in Washington last week after regulators said a practice that has apparently become commonplace in the industry violates federal law.

The order by the Federal Energy Regulatory Commission involves marketing affiliates of pipelines that buy space on the parent company's system and then resell it -- sometimes at a lower rate than the published tariff.

FERC said it was fine for pipelines to create marketing affiliates and for them to resell line space at the same rate as the tariff or higher. But it becomes a problem when the affiliate resells the space at a lower rate than the tariff.

That represents an illegal rebate that violated the Interstate Commerce Act, FERC said.

"Buy/sell transactions by affiliates have been a very common practice in the industry, so this will cause people to think twice," said a FERC expert and lawyer for a pipeline company who asked not to be named.

Why would a pipeline want to sell space at a lower rate than its tariff?

Magellan Midstream Partners, which brought the case to FERC, proposed creating a marketing affiliate that would buy crude oil at the origin and sell it at the destination, sometimes to the same entity. The affiliate would pay the FERC-approved tariff that is often higher than the origin/destination spread.

While the pipeline company would take a loss from what it would have received from a third-party shipper, it could use the affiliate to strike shipping commitments with producers and refiners that let it survive weak spreads and keep the pipeline full, Magellan said in the petition.

But this didn't fly with FERC.

"The fact that the pipeline's parent may find the arrangement economic (because the loss incurred by the marketing affiliate is not so large as to preclude recovery of the pipelines' costs) does not remedy the problem that such transactions are not permitted under the ICA since only the affiliate can access them," Christi Tezak, a managing director of ClearView Energy Partners, said in a note.

Tezak said the law requires all similarly situated shippers have access to the same terms, rates and conditions for the same product movements.

"But here, the affiliate's access to the 'rebate' allows it to offer a rate no other party can," she said.

Several pipeline companies filed comments in support of Magellan's petition, including Marketlink, Plains Marketing, Enterprise Product Partners and Medallion Pipeline.

Marketlink, which carries crude from Cushing, Oklahoma, to the Texas Gulf Coast, urged FERC to start a rulemaking proceeding on the matter because it is an industry-wide concern.

Plains Marketing, an affiliate of Permian heavyweight Plains All American, also urged the commission to explore the question in another venue if it disagreed with Magellan's proposal.

 Unintended consequences

"Marketing affiliates in the crude oil and products sectors are common, and some of the transactions Magellan may enter into are typical in the industry," Plains lawyers wrote in comments to FERC. "For these reasons, if the commission is inclined to reject any of the requested rulings in the petition in any respect, the result would be disruptive of standard industry practice and may have unintended consequences."

The Liquid Shippers Group raised concerns that Magellan's proposal could result in undue discrimination and the release of confidential shipper information. The consortium includes Anadarko Petroleum, Apache, ConocoPhillips, Encana Marketing and Noble Energy.

Airlines for America and the National Propane Gas Association strongly opposed Magellan's petition, arguing it would allow pipelines to exercise market power and evade the law's requirement for just, reasonable and non-discriminatory rates.

Magellan spokesman Bruce Heine said the company has considered creating a crude oil marketing affiliate "from time-to-time to ensure we remain competitive to attract product to our long-haul crude oil pipelines, such as Longhorn and BridgeTex in the Permian Basin."

"We appreciate the FERC's recent response providing more clarity on the permissible activities for marketing practices on an affiliated pipeline," he said. "Magellan does not have a crude oil marketing affiliate today, and we have not assumed the creation of such a marketing affiliate in our future projections."

Bracewell lawyers said the implications of the order are not yet clear.

"While FERC's order rejected Magellan's specific proposal, the broader implications of the order are less clear, and the industry should be cautious of overly broad interpretations," lawyer Ty Johnson said in a blog post. "FERC's pronouncements in the order must be considered within the particulars of a given transaction or structure. "

While Magellan's petition had asked FERC to bless its proposal to create a marketing affiliate, many suspect the company was actually looking to call out its competitors and get FERC put in writing that it disapproves of the practice.

"I think in retrospect, [Magellan's] filing was designed to tease out of the commission the order that was received -- that a lot of what's going on in the industry is action the commission considers not to be appropriate," the FERC expert said.

"It puts Magellan back on a more level playing field," the expert said. "I think it's either going to get other companies to change their behavior or they're going to have to go into the commission and ask the commission to reconsider its order with more explanation of the facts."