Concerned about what they see as an interstate natural gas pipeline overbuild, consumer and environmental advocates are urging federal regulators to take a stand against a ratemaking formula that they said encourages unnecessary projects.
While those groups have not yet successfully overturned the status quo, their efforts might pave the way for state utilities commissions to effectively challenge the Federal Energy Regulatory Commission.
To calculate the compensation due pipeline companies for building energy infrastructure, FERC uses a ratemaking formula that includes a reasonable return on equity to investors. FERC has historically used a two-step discounted cash flow methodology to establish a gas pipeline's authorized return on equity, or ROE. The two-step analysis looks at short-term and long-term growth measures. Oil Change International, Public Citizen and the Sierra Club argued in a recent report that the 14% ROE that FERC typically uses incentivizes developers to build greenfield infrastructure, encouraging more gas transportation capacity than is needed to satisfy consumption.
The Sierra Club and Public Citizen have not specified what the ideal ROE for interstate gas pipelines should be, but they would like it to be lower. It is "probably far less than 14%," Public Citizen's Tyson Slocum said.
Industry experts and FERC, however, contend that the ratio of net income to shareholder equity accurately reflects the demand for such projects. NERA Economic Consulting's Managing Director Jeff Makholm called the 14% ROE "probably in the ballpark of being reasonably fair," even though he acknowledged that it might not always be sustainable.
The U.S. Court of Appeals for the District of Columbia Circuit is looking at pipeline return on equity.
Source: Associated Press
"[The rate] would change if either equity costs ... rise or fall significantly from where they are now, or there's some level of risk in the interstate pipeline market that we don't have today," Makholm said. "But we don't foresee any of those things changing."
Still, pipeline opponents and state utilities commissions are making inroads. After successfully petitioning FERC to change Enbridge Inc.-led Sabal Trail pipeline's capital structure of 40% debt and 60% equity to a structure of 50% of each, groups including the Sierra Club filed for a review of the rate at the U.S. Court of Appeals for the District of Columbia Circuit in September 2016. They protested the modified 14% rate for the 1.1-Bcf/d pipeline, set when FERC authorized the project in February 2016, as excessive.
In August, the D.C. Circuit Court ruled in favor of FERC's ROE, but the court said it was "skeptical that a bare citation to precedent, derived from another case and another pipeline, qualifies as the requisite 'substantial evidence'" for the commission's decision on the issue. (U.S. Court of Appeals for the D.C. Circuit, docket 16-1329)
A challenge to a FERC-approved 15.34% ROE for Williams Cos. Inc. subsidiary Transcontinental Gas Pipe Line Co. LLC for its 1.7-Bcf/d Atlantic Sunrise pipeline could have a better chance if the North Carolina Utilities Commission and the New York State Public Service Commission decide to petition the D.C. Circuit. The state commissions in March filed a request for rehearing at FERC regarding the pipeline's certificate authorization, contending that the gas transportation rates were unreasonable based on the "significant changes in the financial markets" since the 2001 rate case Transco used to justify Atlantic Sunrise's ROE. The project has entered the construction phase.
"Using this excessive pretax return from fifteen years ago does not reflect current market conditions and, consequently, results in excessive recourse rates which do not provide the necessary check on the market power of the pipeline in negotiating rates for service on the new Atlantic Sunrise project," the commissions stated.
FERC has not yet decided whether to grant the state commissions' request. If FERC wraps up the proceeding without a rehearing, the parties may take their case to the D.C. Circuit, which could be more sympathetic to the petitioners after the Sabal Trail decision.