A new FERC decision veers away from congressional intent not to burden intrastate pipelines with interstate policies.

State commissions can set intrastate natural gas pipeline transportation rates except when the intrastate pipeline moves gas in interstate commerce. Then, the Federal Energy Regulatory Commission (FERC) regulates the rates under evolving Natural Gas Policy Act of 1978 (NGPA) standards. Two recent FERC orders in a GulfTerra Texas Pipeline L.P. (GulfTerra, formerly EPGT Texas Pipeline L.P.)¹ rate case make new precedent for NGPA intrastate pipelines providing interstate transportation.²

The GulfTerra orders advance several FERC-favored techniques to propose NGPA intrastate pipeline rates for interstate transportation service. FERC takes care not to burden the intrastate pipeline with some aspects of interstate, Natural Gas Act (NGA) regulation. On other matters, however, FERC either requires conformity to interstate pipeline rate policies or adopts state rate approaches for federal purposes.

NGPA vs. NGA

With the NGPA, Congress encouraged intrastate pipelines to move gas into the interstate grid without burdening them with full federal jurisdiction, including the need for prior certification of services and facilities, found in the NGA.³ That is, NGPA Section 311 gives FERC power to facilitate a national natural gas transportation network without trying to subject intrastate pipelines, which already are regulated by the states, to FERC regulation over all of their operations.⁴ NGPA intrastate pipeline transportation in interstate commerce must have fair and equitable ratemaking, which is purposefully, as well as semantically, a different standard from the NGA's just-and-reasonable rates standard for interstate gas pipelines.

NGPA intrastate rates also must be reasonably comparable to interstate rates. Deferring to the federal system's delicate balance between state and national authorities, NGPA Section 311 declares that fair and equitable rates for intrastate pipeline transportation in interstate commerce may not exceed amounts FERC determines to be "reasonably comparable" to the rates and charges that any interstate pipeline would be permitted to charge for providing similar service.⁵ Plainly, the inherent state/federal tension of such reasonably comparable FERC rate regulation of intrastate pipelines engaged in interstate transportation raises questions of the extent such ratemaking should be done at all, and, if done, further questions of which rate techniques should control. These two GulfTerra orders give FERC's up-to-date answers, providing lessons for those rate planners trying to maximize their options.

GulfTerra's Rate Case Raises Important Issues

FERC effectively does not litigate NGPA rate cases. Since 1978, FERC has held only one NGPA Section 311 rate hearing,⁶ with testimony and trial examination of expert witnesses. FERC prefers instead to proceed without hearings, using staff panel advisory procedures, with the participants filing papers on the issues. FERC used that advisory procedure for GulfTerra, which is a substantially sized system in Texas.

GulfTerra's more than 6,200 miles of intrastate gathering and transportation lines impact the operation of the national transmission grid significantly by connecting all major Texas hubs and markets except the Katy Hub, including 11 interstate pipelines and 20 intrastate pipelines.⁷ Regulated by the Railroad Commission of Texas (RRC), GulfTerra apparently is a bona fide NGPA intrastate pipeline constructed within the state's borders and delivering gas produced in-state to end users or local distribution companies for in-state consumption.⁸ GulfTerra already had NGPA rates for interruptible service when, in late 1999, over intervenor opposition,⁹ it proposed two-part NGPA rates for firm transportation service.

With its June 11, 2002, and Feb. 25, 2004, orders on reasonably comparable interstate ratemaking for GulfTerra's NGPA firm rates, FERC in part applies its NGA rate policies to NGPA intrastate pipeline interstate ratemaking and in part does not. Over one commissioner's dissent, and in keeping with past practice, FERC also directs GulfTerra to file, within three years of the order on rehearing, to justify its existing rates or to establish new maximum rates, so that FERC can obtain information to determine whether GulfTerra's intrastate pipeline rates remain fair and equitable for interstate transportation purposes.¹⁰

Interstate Regulation Unexercised

FERC accepts GulfTerra's two-part rate for firm service as a typical rate design used for decades in the gas industry. Also, FERC does not require GulfTerra to follow policies made to protect firm shippers when interstate pipelines were required to provide open access to their transportation capacity, including interstate pipeline capacity release, any electronic bulletin board (EBB), flexible receipt and delivery points, and seasonal maximum daily quantities.

Explaining that it never has required intrastate pipelines to introduce to their systems all the features of interstate pipeline open access service, FERC points to its Order Nos. 636, et al., specific exemption of intrastates¹¹ from the open access policy requirements (including capacity release, EBBs, and point flexibility) for interstates. FERC's apparent GulfTerra purpose, consistent with the NGPA, is that if FERC refrains from unduly burdening intrastate pipelines, the intrastate pipelines will provide interstate transportation services on the grid, thereby developing that transportation network as Congress intended. In that way also, FERC believes duplication of facilities between interstate and intrastate pipelines will be lessened or avoided.

Finding no harm to any party or to its goal to foster a national pipeline grid, FERC also approves GulfTerra's assignment of only 50 percent of its fixed costs to the reservation charge. That allocation plainly deviates from the straight fixed-variable rate design FERC requires for interstate pipelines by which all, not just half, of fixed costs are assigned to the reservation charge. From the perspective of NGPA intrastate pipeline rate planning to avoid FERC regulation if possible, those are the non-intrusive parts of the GulfTerra orders.

The Good, the Bad, and the Ugly

FERC decides the following precedent-making cost-of-service matters, among others, in the GulfTerra orders:

• Circumstances not unusual enough to support proposed equity return. FERC reduces GulfTerra's requested 14 percent equity return to 13.01 percent, which FERC finds to be the median among four interstate pipelines GulfTerra had included in a larger proxy group. Rejecting GulfTerra's proposed, larger proxy group of 15 regulated gas and electric energy companies, FERC instead uses a proxy group consisting solely of four companies operating gas pipelines that are publicly traded, engaged largely in gas transmission, and that own FERC-regulated interstate gas pipelines. Unconvinced GulfTerra has above-average risk, FERC says that its interstate pipeline risk analysis presumes, absent highly unusual circumstances indicating anomalously high or low risk, that pipelines fall into a broad range of average risk. Without considering any risk differences between interstate and intrastate markets, FERC uses such analysis to derive GulfTerra's NGPA intrastate pipeline cost of service.
• Depreciation rate records inadequate. FERC rejects GulfTerra's proposed cost-of-service depreciation rate levels for gathering (4 percent), transmission (2.5 percent), and general plant (14.29 percent). FERC finds inadequate GulfTerra's response to a staff data request for the basis of the depreciation rates proposal and faults GulfTerra for neither providing life-of-reserves studies to design the gathering rate, nor breaking down different general plant categories. To correct that paucity of record information, FERC orders GulfTerra to turn to its Texas regulatory history and use the last RRC-approved intrastate depreciation rates for its NGPA interstate ratemaking in this case. FERC maintained those depreciation rulings on rehearing.¹²
• Donations treated uncharitably. Following NGA interstate pipeline policy that charitable donations cannot be included in cost of service,¹³ and thus removing $22,734 annually, a FERC majority rejects GulfTerra's argument that FERC should apply Texas's rule allowing recovery of charitable donations in cost of service. Stating that their reasoning is more important than the mere fact that a state agency did or did not come to a certain policy decision, FERC's majority holds that such contributions do not constitute a valid operating cost in offering interstate service. FERC applies its holding equally to all pipelines, interstate or intrastate, offering service subject to FERC jurisdiction. FERC also declares its respect for state regulation and does not conclude that state regulators should follow its lead ("We will not vary our policy depending on where the pipeline is located. [However,] ... we take no position on whether charitable donations should be allowed in the cost of service for purposes of intrastate service ratemaking.")¹⁴ The FERC commissioner dissenting from such "unnecessarily harsh ... systematic exclusion … without regard to any possible ratepayer benefit" either would have allowed the charitable costs or at a minimum would have conducted a ratepayer benefit analysis.¹⁵
  The GulfTerra orders also set precedents on certain rate design issues thus:¹⁶
• State gathering rates apart from transmission rates. Rejecting both GulfTerra's inclusion of gathering costs in its transportation cost of service, and GulfTerra's statement that Texas law does not require the gathering service rate to be stated separately, FERC requires GulfTerra prospectively to conform to interstate pipeline policy favoring separately stated gathering and transmission rates. The NGA interstate concern, which FERC unhesitatingly applies also to NGPA intrastate pipelines performing interstate service,¹⁷ is that a pipeline including gathering costs in transportation rates unfairly disadvantages those customers desiring to purchase gas off-system because such customers need only a separate transmission service rate, not the gathering rate as well. FERC also does not want to inhibit market center transmission service development. Denying rehearing to GulfTerra, FERC continued to emphasize its pro-competitive goals to allow shippers to choose and pay for only those services they want, and to assure that GulfTerra's transportation service is of equal quality for all gas supplies regardless of the gas supplier.¹⁸
  However, in order not to burden GulfTerra or cause it to opt out of interstate transportation markets, FERC requires that GulfTerra refunctionalize its plant only before its next NGPA Section 311 rate filing, and not that it do so in this case. FERC continued to find that requirement not unduly burdensome on rehearing.¹⁹ GulfTerra now is to use existing data to develop gathering rates based on a gathering cost of service, with a gathering rate base including allocated amounts for general plant, working capital, and accumulated deferred income tax. That FERC-initiated, separate gathering rate change has only prospective effect. Past refund period rates are to be calculated on GulfTerra's as-filed, bundled basis.
• Mileage-based rates required. FERC rejects GulfTerra's postage stamp rate proposal, and instead applies interstate pipeline rate-design cost-causation principles (i.e., that rates reflect costs actually caused by customers paying the rates) and policy that rates reasonably should reflect any material variation in cost of providing service due to distance of haul. To design NGPA rates, FERC requires GulfTerra to turn to Texas regulation and use its previously effective, RRC-established methodology, which was based on mileage traversed (incorporating distance sensitivity) as well as line diameter. FERC concludes that GulfTerra's 6,200-mile extent suggests it is a long-line system where cost of service varies with distance. FERC also says, unless GulfTerra demonstrates otherwise, that the previous RRC intrastate service rate design creates a presumption for NGPA intrastate pipeline provision of interstate service that distance-sensitive rates are appropriate. On rehearing, FERC also confirmed, notwithstanding such cost updating and rate redesign, that fair and equitable ratemaking requires that GulfTerra's rates be capped at its originally filed, 1999 postage-stamp levels.²⁰
• Affiliate discounts unjustified. FERC allows GulfTerra no downward rate-design throughput adjustment for affiliate discounts (while allowing such adjustment for non-affiliates), thereby decreasing the maximum rate and reducing GulfTerra's opportunity to collect its full cost of service. Applying longstanding interstate pipeline discounting policy rulings,²¹ FERC finds GulfTerra did not justify the affiliate discounts it awarded on substantial affiliate throughput of about 55 percent of 1998 volumes.

Observing that all pipelines have problematic incentives to offer discounts to their affiliates not required by competition, FERC points to the much heavier pipeline rate applicant burden to justify discount levels for affiliates. GulfTerra needed to show why affiliate discounts were necessary, such as by identifying alternatives available to the affiliate or by showing that GulfTerra routinely was unable to collect its maximum rate on a particular segment (so that the affiliate only received the same discount as non-affiliates). FERC faults GulfTerra's failure to compare details of affiliate receipt and delivery points and non-affiliate receipt and delivery points (to support GulfTerra's statement that affiliates pay a higher average rate than non-affiliates). GulfTerra also failed, FERC asserts, to examine each contract's rate and relationship to basis differentials (to support GulfTerra's statement that basis differentials generally determine rates).

Balancing Goals

With the NGPA, Congress sought to encourage intrastate pipelines to provide interstate transportation services in part by not burdening them unnecessarily with NGA rate policies. FERC's GulfTerra orders would balance that goal not to burden intrastate pipelines against the additional purpose that NGPA intrastate pipeline transportation rates must not exceed reasonably comparable rates for similar NGA interstate pipeline services.

Given likely FERC disinclination to give intrastate pipelines a pass on significant interstate pipeline ratemaking policies, and the likely FERC inclination to apply such policies to intrastate pipelines where possible, many of the GulfTerra rate rulings do not readily appear wholeheartedly to encourage NGPA intrastate pipeline interstate transportation. In the future, prudent NGPA intrastate pipeline rate planning for interstate service will consider and proceed consistently, and more cautiously, given the ratemaking decisions in the two GulfTerra orders.

Endnotes

1. , 99 FERC 61,295 (2002); order on reh'g, , L.P.,106 FERC 61,184 (2004) (EPGT changed its name to GulfTerra in 2003).
2. FERC allows intrastate pipelines either to base their NGPA rates on any rates they may have on file with the appropriate state regulatory agency or to apply for FERC approval of their filed NGPA rate proposals. 18 C.F.R. § 284.123 (b). These orders concern the latter election.
3. H.R. Conf. Rep. No. 95-1752, 96th Cong., 1st Sess. 107-09 (1978); 15 U.S.C. §§717-717w.
4. , 899 F.2d 1250, 1255-56 (D.C. Cir. 1990).
5. 15 U.S.C. § 3371 (a)(2); , supra, 899 F.2d at 1255-56.
6. , 42 FERC 61,015 (1988).
7. , supra, 106 FERC 61,184, [text para.] P.14 & n.10; EPGT , L.P., 103 FERC 61,181, P. 4 (2003) (order granting market-based rate authority for NGPA storage services).
8. , 84 FERC 61,238, 62,208 (1998); see generally J.M. Marcoux, "Too Easily Overlooked: Three Rivers Intrastate Pipeline Exemption," 16 , No. 11, 25-28 (2000).
9. Southern Union Gas Co., not a current GulfTerra Section 311 customer, is a firm intrastate shipper that is reflected in intrastate/interstate cost allocations (GulfTerra proposed two-part rates to the RRC for firm intrastate service).
10. , supra, 106 FERC 61,184, P. 33.
11. 61 FERC 61,272, 61,992 n.26 (1992); GulfTerra, supra, 106 FERC 61,184, P. 13 & n.7.
12. , supra, 106 FERC 61,184, PP. 29-32.
13. , 90 FERC 61,017, 61,064-65 (2000).
14. , supra, 99 FERC 61,295 at 62,249-50.
15. at 62,256.
16. FERC also accepts GulfTerra's proposal to charge a fuel rate percentage based on an engineering matrix of costs to move gas, requires a GulfTerra plan for making customer refunds and accepts a proposed allocation of $50,000 to GulfTerra's parking and lending (PAL) service, with which GulfTerra had no experience, allowing GulfTerra to use its interruptible transportation rate as the PAL rate. EPGT, supra, 99 FERC 61,295, 62,256.
17. FERC cites an earlier order rejecting the anti-competitiveness of blended rates in interstate transportation service. , 85 FERC 61,080, 61,281-84 (1998).
18. , supra, 106 FERC 61,184, PP. 11-13, 15-18.
19. , PP. 21-25.
20. , PP. 10, 26-28.
21. , supra, 99 FERC 61,295 at 62,255 & nn. 36-42.

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NGPA Intrastate Pipeline Interstate Transportation Rate Guidelines

Cost-of-Service Issues

• Presume average risk for your ROE. Using a proxy group of publicly traded interstate gas pipelines largely engaged in transmission service and owning FERC-regulated pipelines, seek to show highly unusual circumstances to prove anomalously high risk.
• Support depreciation rates. Intrastate pipelines may be ordered to use their intrastate depreciation rates when FERC finds NGPA depreciation proposals inadequately supported.
• Remove charitable contributions. Intrastate policy notwithstanding, charitable donations are not valid operating costs for NGPA interstate service.

Rate Design Issues

• State gathering separately. FERC's lodestar is to avoid disadvantaging customers wanting to buy gas off-system that only need to pay the transmission service rate.
• Reflect cost variations for distance of haul. Previous mileage-sensitive intrastate ratemaking can create a presumption for NGPA interstate service rates.
• Meet the heavier burden to justify affiliate discounts. Identify service alternatives for affiliates. Compare rates at affiliate and non-affiliate receipt and delivery points. Show that basis differentials determine contract rates.

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