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Devil in the details Alaska legislators learn how tariffs for natural gas pipelines are determined Kristen Nelson Petroleum News Editor-in-Chief
How are natural gas tariffs set? How would such a tariff be set for a proposed natural gas pipeline from the Alaska North Slope? That was the focus of a hearing held June 16-17 in Anchorage by the Legislative Budget and Audit Committee and the Senate Resources Committee.
There are tariff rates set by the Federal Energy Regulatory Commission, called recourse rates, “and there can be negotiated rates,” said Mark Myers, director of the Alaska Division of Oil and Gas. Rates can vary between shippers, based on things like length of contract, he said, but rates “cannot be unduly discriminatory.”
Bob Loeffler, a Washington, D.C., senior partner with the law firm of Morrison & Foerster, said in an overview of permissible tariff methodologies that many in the audience would remember when tariffs were set for the trans-Alaska oil pipeline.
At that time “there was a huge controversy over what’s the proper way to set the rates… The good news is, there is no such overarching issue here,” Loeffler said. “Gas pipeline rates are set on standard utility ratemaking basis, which is original cost rate basis…” On the other hand, he noted, “there are details, and the devil is in the details,” which can have “some real dour consequences.” Different regulatory regime The regulatory regimes are different for oil and gas pipelines, Loeffler said. For oil, the FERC shares regulatory authority with the Regulatory Commission of Alaska, which sets rates for shipments within Alaska, while the FERC sets rates for shipments that go outside of Alaska.
“That does not happen with gas pipelines. The FERC sets the rates for the gas … outside of Alaska and for any gas that’s taken off in Alaska, as far as that gas travels on the main pipeline.”
There is a second big difference between oil and gas, he said. You don’t need permission from FERC to go into the oil pipeline business or to exit the business, but for gas pipelines you do. For gas pipelines FERC “regulates the size, pressure, whether it serves the public interest — and there is a huge environmental impact process.”
Gas pipeline regulation is the FERC’s bread and butter, Loeffler said, while a FERC staffer once described oil regulation “as the crazy aunt in the attic.” For every hundred gas pipeline cases at the FERC, he said, you’d probably only find one or two oil cases, which holds true for the rate area as well as the regulatory area.
“You’ve got to remember this framework when you think about fighting the last war which was the Taps war and fighting the wars that are to come on the gas,” he said. Original cost The FERC has used different methodologies over the years, Loeffler said, but original cost remains the basis. “That’s not true for oil pipelines. Sometimes it’s original cost, sometimes it’s indexing, sometimes it’s this trended original cost.”
But, he said, gas pipeline ratemaking is different.
“The objective is to strike a balance between rates that protect consumers from excessive rates and that reward investors for the risks of investing in a pipeline,” Loeffler said.
The pipeline will put out proposed rates in the open season and file proposed rates with FERC, which will review them.
Gas pipeline rates are a “cost-plus system,” he said: “The rates are designed to recover the operating costs, depreciation, taxes and a return on capital investment.”
Most of the effort in ratemaking is spent on three things, Loeffler said: profit, depreciation and rate design.
Profit is the rate of return the pipeline will be allowed to earn, and the commission is concerned about determining the cost of capital. There are two large steps, he said: how much investment is debt and how much is equity; and what is the cost of each.
Debt is what is borrowed and the market rate on that debt.
Equity, and the return on equity, is determined by looking at “what other pipelines in the industry are earning.” What determines how high the return is on equity is how risky the pipeline is. Pipelines will argue, “I’m not an average pipeline, I’m more risky than anyone else, so I deserve more. And of course the shippers on the pipeline argue, they’re not risky at all…”
Loeffler said in closing that, while the FERC has established ways of looking at gas pipelines, “Alaska is the biggest thing that will go through the commission and it will set its own rules.” Rates can be levelized One difference in how rates are set comes from how depreciation is handled. Myers said one of the biggest differences between recourse rates, set by FERC, and negotiated rates is that under negotiated rates, the rate can be levelized.
FERC-set recourse rates, typical cost-of-service rates, reflect depreciation: the line is worth more at the beginning of its life and hence the tariff is higher. As the line is depreciated, it is worth less, and the tariff drops.
In negotiated rates, however, the tariff could be levelized and would be the same throughout: It will be lower in the beginning than a FERC-set recourse rate, but higher at the end. And, because the FERC is only asked for new recourse rates periodically, Myers said, the recourse rate tends to stair-step down and to be “somewhat sticky in adjustments downward,” so “the shippers are going to pay more, generally, under the recourse rate than they would” under a negotiated rate.
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