Oil Pipelines Take Annual Increase at TRRC and FERC, But DC Circuit Questions Methodology
Each year, oil pipelines with tariff-based rates are allowed to increase the maximum rate charged under their tariffs by an index based on the general inflation rate for the prior year. This year’s increase was 4.31% and nearly all pipelines filed the new rates effective as of July 1, 2019 for the period ending June 30, 2020. Many oil pipelines have tariffs filed with FERC and with state regulators such as the Texas Railroad Commission (TRRC). And many pipelines will note that not all of their revenue is limited by the indexing process at FERC.
Today we look at how this indexing is actually implemented by those pipelines with tariffs for movements under state and federal tariffs. We also look at a recent decision by the United States Court of Appeals for the District of Columbia Circuit (DC Circuit) which questioned whether FERC has clearly articulated a reasoned basis for its indexing process.
While state-based tariffs are not subject to the limits imposed by FERC’s indexing methodology, our review shows that most pipelines adjust their state tariffs in lockstep with their federal tariffs. We also discuss how FERC’s response to the court’s decision may require FERC to explain the principles that support the entire indexing methodology. A discussion of the fundamental principles of indexing could change how FERC will account for the tax cut and elimination of tax allowances by master limited partnerships (MLPs). FERC’s response, therefore, could have an industry-wide impact.
Oil Pipeline Indexing
LawIQ recently acquired a data platform that allows users to determine the rates charged to move liquids such as crude and refined products between any two points in the nation. Set forth below is a map showing the various paths for moving these types of liquids within and between Texas and Oklahoma.
Map of Origin Points Based on Number of Destinations
Keeping track of all the tariffs that apply to the movement of these commodities is difficult without access to a platform such as ours, which provides the currently effective tariffs, as well as data about how those tariffs have changed over the last twenty years or so.
As noted above, almost all pipelines recently increased their FERC tariff rates, effective as of July 1, 2019, by 4.31%. In addition, it appears that, at least in Texas, the pipelines were able to increase the state-regulated tariffs as well.
Our data has over 250 origin and destination point pairs in Texas and Oklahoma with tariffs for over 30 pipelines that are governed by both federal and state tariffs. Our review of these similar tariffs shows that almost two-thirds of the pipelines changed both the state and federal rates effective as of July 1, 2019, keeping them in lockstep with one another, with crude tariffs leading the way in this process.
Tariff Changes for Paths Governed by Both State and Federal Tariffs
As shown above, although FERC’s indexing methodology applies only to FERC-regulated tariffs, the pipelines regulated by the TRRC can adjust the matching state rate. This means that the indexing methodology at FERC can have a broader impact on the revenue of pipelines. That is why any changes at the FERC level need to be watched carefully.
DC Circuit Once Again Doubts FERC’s Methods
The litigation between SFPP, Inc. and its shippers has been going on for years. That litigation led to the DC Circuit decision that ultimately caused FERC to reverse its longstanding policy of allowing pipelines owned by MLPs to include a tax allowance in their rates -- a decision that has almost killed the MLP ownership structure for pipeline companies. The most recent DC Circuit decision in June of this year also arose from the continuing litigation between SFPP and its shippers. In this case, the shippers filed a complaint in 2014 challenging SFPP’s decision to increase its rates by the index in 2012 and 2013. The basis of that complaint was that SFPP was already earning more than it needed to cover its cost of service and that a further increase would only “exacerbate” the over-recovery. The complaints were based on principles FERC had used for years to review such complaints which required the shippers to show that the pipeline was already over-recovering and that the increases greatly exceeded the pipeline’s actual cost increases in the year prior to the rate increase.
The shippers showed that SFPP’s costs decreased by 4.48% between 2010 and 2011 although the index increase it was allowed in 2012 was 8.6%. Similarly, the shippers showed that between 2011 and 2012, SFPP’s costs decreased another 0.56%, but the index it was allowed to take for that year would increase its revenue by 4.6%. FERC dismissed the complaint for both years by looking at the filing SFPP had made for the year 2013, which showed that its over-recovery narrowed rather than widened, and which FERC deemed as the best evidence that the increases in 2012 and 2013 had not in fact “exacerbated” the over-recoveries shown to have occurred in 2011 and 2012.
The DC Circuit reversed FERC’s decision because the court found FERC had failed to adequately explain why SFPP’s financial results in 2013 were relevant to the increases in 2011 and 2012. The court found that FERC did not adequately explain whether the indexing is designed to be “forward-looking,” in which case the 2013 results might be relevant, or whether the indexing is “backward-looking,” in which case the 2013 results would be meaningless.
How FERC addresses the court’s reversal will, of course, impact the case against SFPP, but, like FERC’s decision that led to the demise of the MLP market, FERC’s rationale will almost certainly have a broader impact on the market. In particular, the reasoning for FERC’s decision could impact the index rate calculation in 2020 and, in particular, how the reduction in costs arising from the tax cut and elimination of a tax allowance for MLPs is handled.
If FERC determines that the indexing methodology is “backward-looking,” then it would seem that when it recalculates the index in 2020 it will take into account how the tax cut and elimination of a tax allowance for MLPs reduced the industry’s costs between 2015 and 2019. However, if FERC determines that the indexing methodology is designed to be “forward-looking,” then it may well ignore the reduction in pipeline costs arising from the tax cut and elimination of the tax allowance for MLPs because those events are not likely to occur again. This distinction could have a very significant impact on the setting of the index rate in 2020 that will apply for the period July 1, 2021 through June 30, 2026 and bears watching between now and then.
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