[BETA] Fortnightly

On May 31, 1995, the Federal Energy Regulatory Commission (FERC) issued its Statement of Policy in Docket No. PL94-4-000, Pricing Policy for New and Existing Facilities Constructed by Interstate Natural Gas Pipelines.1 In that decision, the FERC sought to provide upfront rate certainty, thereby giving pipelines and shippers a firm basis for making decisions on large-scale investments.

But is that objective realistic?

A comprehensive review of the ratemaking consequences of the new policy (em primarily the consequences for the biggest projects that will result in vintage rates2 (em reveals that the FERC's objective may be impossible. The barrier to providing upfront certainty lies in the fact that cost allocation for the many nonplant-related accounts can only be decided in a rate case, after the certificate has been issued. As for certainty, a barrier arises because cost allocation of these accounts in a vintage environment can call upon little in the way of precedent or established practice, thereby prompting controversy. The future can best be characterized as a mixed bag. On the one hand, there is no quick fix, in terms of process improvements, that would move the necessary cost-allocation decisions up front. On the other hand, more experience with cost-allocation issues in a

vintage environment should lead over time to an established practice. The cost-allocation challenge will come in developing methods that provide an appropriate basis for ratemaking (em that is, methods that enhance economic efficiency, rather than methods that allocate costs simply because they exist.

Background: PL94-4 in Context

The issues associated with vintage rates are new. Prior to FERC Opinions 3673 and 368,4 vintage rate issues were not common because the Battle Creek5 standard was applied. That standard favors roll-in of facility costs, especially in the case of expansions on integrated systems. Starting with Opinions 367 and 368 and continuing with PL94-4, vintage cost allocation is required unless rates for existing customers increase less than 5 percent, allaying concerns that "rolling in the costs could result in dramatic increases in rates faced by existing customers that might be disproportionate to the benefits they receive from the expansion."6 Now, several years after this change in cost allocation, pipelines have just begun to deal with the repercussions of vintage cost allocation on all costs, particularly nonplant costs, in their rate cases. This lagged adjustment is hindering the objectives of PL94-4.

Vintage Cost Allocation: The Timing Issue

Cost allocation for facilities that do not meet the roll-in standard in PL94-4 will change many times over the life of the facilities. The first cost allocation (in the certificate application) will assign plant-related costs by vintage and a small amount of other costs specific to the expansion facilities, such as property insurance. The second cost allocation (in the general rate case) will add an allocation of operations and maintenance (O&M) and other "overhead" types of expenses to the expansion facilities. Cost allocation will then be adjusted in every subsequent rate case, reflecting the decreasing plant-related costs so that the bulk of the costs will become overhead costs. Likewise, costs and hence rates for pre-expansion facilities