Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

PL94-4: Pricing for New Pipeline Construction

Fortnightly Magazine - April 15 1996

primary purpose of vintage cost allocation (em namely, that subsidies should be eliminated. As noted by several scholars, a general method like full-cost apportionment that pays no attention to cost responsibility is destined to produce subsidies:

"To make sure that no subsidies are involved, one must look to stand-alone or incremental costs . . . and not fully distributed costs."8

While it is true that PL94-4 intends only to prevent existing customers from subsidizing new customers, there is no justification for condoning subsidies of existing customers while prohibiting subsidies of new customers.

Lastly, full-cost apportionment negates any economic-efficiency benefit that might flow from vintage cost allocation. Vintage allocation of plant costs, premised on eliminating subsidies, can provide the first step toward marginal cost pricing (em the costs caused by adding capacity are segregated and, thus, accurately measure the change in costs caused by that added capacity.9 And since these segregated costs have no depreciation at the time of certification, they represent the true marginal cost of new capacity, not depreciated or embedded costs. As noted by economist Alfred Kahn, the idea of applying full-cost apportionment to the other cost categories in this context has no grounds if economic efficiency is desired:

"Quite simply, the basic defect of fully distributed costs as a basis for ratemaking is that they do not necessarily measure marginal-cost responsibility in a causal sense."10

The other possibility is to allocate costs based on cost causation. That is, costs caused by an expansion should be assigned to the expansion. The cost-causation standard is consistent with vintage allocation for plant costs (and therefore could be accurately termed "incremental-cost allocation"), ensures against subsidies, and provides a basis for marginal-cost pricing of new capacity.


In light of its policy and theoretical advantages, the second possibility can only be challenged on the grounds of practicality. Pipelines and regulators will have to undertake the analysis necessary to determine the costs caused by an expansion. This task should not prove insurmountable in the environment of a general rate case, however.

Such analysis should provide a practical benefit. Ultimately, cost-allocation methods will be developed based on cost incurrence and made applicable to all pipelines. Analysis, then, may well be the only approach that will yield a basis for precedent and a means of reducing controversy and uncertainty.

The result, rational cost allocation, is not insignificant in the circumstances faced today by pipeline customers. Typically, shippers obtaining expansion capacity that receives vintage treatment of plant costs are paying rates two to three times higher than existing system rates. Adding on a variety of other costs simply because no one is willing to do the required analysis, becomes difficult to defend. Mindful of the goal, the additional work is time well spent:

"No approach to utility pricing can be considered truly rational which does not give an important and even a major weight to marginal-cost considerations."11 t

Jeffrey Hitchings is director of regulatory affairs at Pacific Gas Transmission Co. This article is based on PGT's recent experience in FERC Docket No. RP94-149, but does not necessarily represent