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FERC reaches beyond current model for setting oil, gas pipeline ROE

Highlights

New policy averages DCF, capital asset methods

Use of Canadian pipelines in proxy groups possible

Washington — The Federal Energy Regulatory Commission voted unanimously to broaden the methods that can be used to calculate oil and natural gas pipelines' rate of return on equity. It put a capital asset pricing model (CAPM) on equal footing with the discounted cash flow (DCF) method used historically.

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The shift away from reliance on the DCF methodology, announced in a policy statement Thursday, comes in time to impact a batch of significant gas pipelines rate cases expected to be queued up at FERC in 2020. FERC also encouraged oil pipelines to submit updated information on FERC Form 6, a financial and operational data filing, to reflect the new approach.

FERC had already moved away from historical reliance primarily on the DCF model in decisions affecting electric transmission owners in an effort to bring its methodology into closer alignment with how investors inform their decisions. But it was still unclear before Thursday's policy statement the degree to which FERC would take a similar step for oil and gas pipelines.

Under the policy announced Thursday, FERC said it will determine ROE for oil and gas companies by averaging the results of the DCF and capital asset methods, giving equal weight to both models and using a single zone of reasonableness.

Proxy groups

FERC also took a step to expand the proxy group of companies that can be weighed in oil and gas pipeline cases by considering proposals including Canadian companies. Consolidation in the oil and gas sector has over time diminished the eligible proxy companies that can be used to establish pipeline ROEs.

The policy step is intended to bring greater stability to ROE determinations that have fluctuated over a fairly wide range in various cases, observers suggested.

In the run-up to the policy decision, gas pipelines urged FERC to differentiate among industry segments in setting the methodology, particularly among gas pipelines and utilities. The Interstate Natural Gas Association of America discouraged FERC from adopting a formulaic approach, preferring flexibility in the weighting of each of several models.

Distinctions for oil, gas

Chairman Neil Chatterjee, during FERC's virtual open meeting Thursday, discussed some of the differences in approaches FERC is taking for public utilities versus oil and gas pipelines to account for statutory, operational, organizational and competitive differences.

"In contrast to the methodology for public utilities, we will retain the existing two-thirds, one-third weighting for the short-term and long-term growth projections in the DCF and will not use the risk premium model," Chatterjee said.

The commission chose not to use a risk premium model for oil and gas pipelines because there was too little data to estimate cost of equity using that data, according to a statement from the commission. Both the DCF and CAPM models use proxy groups of similarly situated companies to determine a range of reasonable returns, while the risk premium model incorporates interest rates as a direct input.

FERC also failed to adopt specific outlier tests for oil and gas pipeline proxy groups.

The action came the same day FERC revised a two-step model for a calculating a just and reasonable base return on equity for power transmission projects by adding a third financial model it abandoned six months earlier.

Responding to concerns raised by Midcontinent Independent System Operator transmission owners, FERC granted partial rehearing and clarification in a pair of contested proceedings that saw the commission in November 2019 slash MISO's existing 12.38% ROE for transmission to 9.88%.

FERC established a method based on three models: a risk premium model, the DCF model and the CAPM model.

While Commissioner Richard Glick faulted FERC's reasoning in the MISO order for reversing course with the effect, in his view, of raising ROE for transmission owners, he voted in favor of the oil and gas pipeline ROE policy.

In a telephone interview, Glick said that while it is too soon to tell the precise effect of the oil and gas policy on levels of ROE, it has the potential to add stability, and suggested that should be the goal.