A decision by the Federal Energy Regulatory Commission on the Resid formula used in Quality Bank calculations has been rejected by the U.S. Court of Appeals for the District of Columbia Circuit and remanded to FERC.
FERC initiated an investigation into Resid pricing in 2013 and during that investigation Petro Star argued that Quality Bank methodology undervalued Resid in an unjust and unreasonable manner. FERC rejected Petro Star’s argument.
Petro Star petitioned for review.
The court said in an Aug. 30 decision that FERC “failed to respond meaningfully to evidence presented by Petro Star, rendering its decision arbitrary and capricious” and also said the argument that Petro Star failed to provide a viable methodology did not provide an independent ground for FERC’s decision.
The Quality Bank, overseen by FERC, addresses the issue that the quality of crude oil shipped on the trans-Alaska oil pipeline varies, and provides a monetary adjustment for the difference in quality between oil put into the line and the oil a company receives at Valdez. Crude is valued according to the quality of components or “cuts.”
The court said Petro Star argued the methodology used by the Quality Bank undervalues Resid, one of the cuts, in an unjust and unreasonable manner. FERC rejected Petro Star’s argument.
The court said FERC “failed to respond meaningfully to evidence presented by Petro Star, rendering its decision arbitrary and capricious, and that Petro Star’s purported failure to provide a viable methodology does not provide an independent ground for the Commission’s decision.”
The court granted the petition for review and remanded the case to FERC “to reconsider the methodology used to value Resid or to provide a more reasoned explanation for its approach.”
The Resid issue
The court said that six of the nine cuts the Quality Bank uses to value crude have published market prices and can be sold following distillation and without further processing.
But three cuts - Light Distillate, Heavy Distillate and Resid - require additional processing following distillation and thus have no published market prices.
The Quality Bank methodology requires FERC to set a value for these pre-market cuts, which requires starting with published market prices for finished products that could be developed from the pre-market cuts and then deducting additional processing costs required to produce finished products, which requires, the court said, “estimating the costs associated with operating a hypothetical refinery,” with the cost deduction for Resid including a 20 percent capital recovery factor, accounting for the capital investment required to build a hypothetical refinery capable of processing pre-market cut into a marketable product, coke.
The case is a challenge to the Quality Bank’s valuation formula for Resid, adopted in 2004, the court said.
Original complaint from Flint Hills
In August 2013 Flint Hills, which then operated a refinery in North Pole, brought a complaint to FERC questioning whether the Quality Bank method was just and reasonable and suggesting that “as a result of the capital recovery factor included in Resid’s processing cost adjustment, the Quality Bank undervalued Resid relative to the other cuts.”
FERC dismissed the complaint on timeliness grounds, but initiated its own investigation into Quality Bank methodology.
Petro Star, also a refiner along the trans-Alaska oil pipeline, intervened to support Flint Hills’ position. Both argued that the 20 percent capital investment allowance should be removed from the Resid formula.
The matter was heard by an administrative law judge who rejected the argument for two reasons, saying the companies failed to propose an alternative and also failed to demonstrate it was unjust and unreasonable to include a capital investment allowance in the processing cost adjustment for Resid.
Petro Star filed exceptions.
FERC affirmed the administrative law judge’s decision in its entirety; Petro Star petitioned for review. Flint Hills had by then terminated operations at its North Pole refinery and did not join the appeal.
Petro Star claims
The court said Petro Star’s argument on the capital recovery factor “is rooted in theoretical economic principles.” The company said that published market prices for the six marketable cuts are “short-run, spot-market prices that do not reflect long-run considerations such as capital investment returns, which are regarded as sunk costs.”
But in valuing Resid, the Quality Bank calculation is based on a capital investment allowance assuming a long-term 20 percent return on capital, making the Resid valuation “incommensurate with the valuation of the six marketable cuts, infringing the essential requirement that the Quality Bank ‘assign accurate relative values’ to the cuts.”
The court said Petro Star established a case that new evidence warranted re-examination of the Resid formula.
FERC might find on remand that the existing formula is just and reasonable, the court said, but it must either answer Petro Star’s objection or change the formula.
The court also disagreed with FERC’s contention that Petro Star was required to propose a just and reasonable alternative methodology, and said that basis was not independent of FERC’s rejection of Petro Star’s argument that inclusion of the capital recovery factor in the Resid calculation is just and unreasonable. FERC must, the court said, “provide a meaningful response to the new evidence presented by Petro Star.”
