On October 20, 2022, the Federal Energy Regulatory Commission ("FERC") issued a Policy Statement providing guidance on how it will evaluate complaints against liquids energy pipeline index-based rate adjustments.1 In doing so, FERC resolved long-standing concerns with its prior policy, some dating back to 2007. As described in greater detail, below, the Policy Statement rejects FERC's problematic Substantial Exacerbation Standard for complaints against index-based rates and adopts in its place the Percentage Comparison Test it currently uses to assess other rate protests.
The Indexing Regime and the Policy Statement
Liquids pipelines are regulated by FERC pursuant to the Interstate Commerce Act of 1887. Generally, liquids pipeline rates must be just and reasonable, and their rates and terms and conditions of service must not be unduly discriminatory or preferential. Under the Energy Policy Act of 1992, Congress directed FERC to create a "simplified, generally applicable ratemaking methodology" for liquids pipelines. In following this directive, FERC established its indexing methodology whereby liquids pipelines are permitted to adjust their rates annually (typically in July of each year) by an index based on industry-wide cost changes (currently the Producer Price Index for Finished Goods minus 0.21%).2 Generally, application of this index each year to the pipeline's agreed-upon or cost-based rate will generate the pipeline's ceiling rate level, and the pipeline has the flexibility to charge a rate at or below this index ceiling.3
FERC's regulations permit shippers to challenge a pipeline's index-based rate adjustments by protest or complaint. A challenge filed against the indexing component of a rate:
must allege reasonable grounds for asserting that the rate violates the applicable ceiling level, or that the rate increase is so substantially in excess of the actual cost increases incurred by the carrier that the rate is unjust andunreasonable, or that the rate decrease is so substantially less than the actual cost decrease incurred by the carrier that the rate is unjust and unreasonable.4
Prior to the Policy Statement, FERC used one standard for evaluating protests and a different standard for complaints against index rate adjustments. With the Policy Statement, FERC reverses its problematic Substantial Exacerbation Standard for assessing these complaints and instead finds that the Percentage Comparison Test it uses to assess protests should also apply to its assessment of complaints.
The Percentage Comparison Test
Under the Percentage Comparison Test, FERC compares the annual change in the index (as a percentage) to the percentage change in the year-over-year cost of service of the pipeline as shown on Page 700 of the pipeline's FERC Form No. 6 (the pipeline's financial report filed annually with FERC). If the two figures are within ten percent, FERC - typically - will not accept a protest against an indexing adjustment. For example, if the pipeline's cost of service goes down by five percent, and the index goes up by five percent, the divergence of 10 percent is acceptable and the protest should be rejected. As another example, if the pipeline's cost of service goes down by six percent and the index goes up by five percent, the divergence of eleven percent is not acceptable and the protest should be accepted.5However, as noted below, the pipeline may elect to take a partial index increase to stay within the ten percent threshold.
The Substantial Exacerbation Standard
In 2007, FERC created the Substantial Exacerbation Standard in analyzing a complaint against SFPP's index-based rates. FERC found that it would accept such a complaint when: "(1) the pipeline is substantially over-recovering its costs," and (2) the application of the index would substantially exacerbate that over-recovery due to the additional revenue that would be generated by application of the index. Since that time, SFPP and others have pointed out to FERC that this standard creates irrational results; under this test, the smaller the over-recovery, the larger the "exacerbation" of the over-recovery due to application of the index.
Policy Statement in Docket No. AD20-10
In Docket No. AD20-10, following FERC's proposal inHollyFrontier Refining & Marketing LLC v. SFPP, L.P.6 to eliminate the Substantial Exacerbation Standard, FERC invited public comments on this proposal and also on whether the ten percent threshold under the Percentage Comparison Test should be applied to both protests and complaints. Its proposal inHollyFrontierfollowed a remand from the United States Court of Appeals for the District of Columbia Circuit inSouthwest Airlines Co. v. FERC,7 where the court took issue with FERC's inconsistent standard for evaluating protests and complaints against indexing adjustments and directed FERC to "explain its action in a way that coheres withthe rest of its indexing scheme" and "provide a reasoned explanation that treats like cases alike."8 InHollyFrontier, FERC stated that the Substantial Exacerbation Standard, among other things: (1) is undefined and lacks clear standards; (2) suffers from an inherent mechanical flaw that yields irrational results (see above); and (3) is inconsistent with Section 343.2(c)(1) (see above). Therefore, FERC sought comments on a variety of topics, including what standard to apply in evaluating complaints and whether the ten percent threshold (under the Percentage Comparison Test) should be used if FERC were to adopt that test for evaluating complaints as well as protests.
Following the submission of various comments and reply comments, FERC issued the Policy Statement adopting the Percentage Comparison Test and the ten percent threshold for evaluating both protests and complaints against index-based rate adjustments. The Policy Statement remains subject to rehearing and appeal.
Implications of the Policy Statement
In order to assess the risk of a protest or a complaint against an index rate adjustment, pipelines should evaluate - in advance of their tariff filings - the percentage change in their costs of service against the percentage change in the index. If pipelines are over the ten percent threshold, they should consider filing for only a partial index increase so that they can reduce the risk of complaints or protests or rejection of their tariff filings by FERC. However, it is important to consider in the first instance whether the pipeline is over- or under-recovering its cost of service as that may mitigate the risk of challenges.
Pipelines should also consider this issue when preparing Page 700 of their FERC Form Nos. 6. Under some circumstances, a pipeline may have extraordinary, non-recurring expenses that distort the year-over-year comparison and that would therefore distort application of the Percentage Comparison Test. Following advice of counsel and/or regulatory accounting experts, pipelines should consider the appropriate Page 700 treatment for such extraordinary expenses.
Pipelines with contract rates should consider whether their contracts permit them to take a set percentage annual rate increase irrespective of any over-recovery or ten percent threshold. If that is the case, the pipeline should assess whether and to what extent this issue should be raised in its transmittal letter accompanying its tariff filing.
Finally, because the Policy Statement remains subject to rehearing and appeal, pipelines should monitor Docket No. AD20-10 going forward until FERC's policy is final.
Please contact the Baker Botts Energy Regulatory team noted below with any questions you may have about the Policy Statement or if you have questions regarding FERC's indexing methodology.
Footnotes
1 Standard Applied to Complaints Against Oil Pipeline Index Rate Changes, 181 FERC ¶ 61,057 (2022) ("Policy Statement").
2 SeeOil Pipeline Index | Federal Energy Regulatory Commission (ferc.gov). The current indexing methodology is pending review before the D.C. Circuit, upon transfer from the Fifth Circuit in May 2022.
3 When liquids pipelines use this flexibility, they must nevertheless assess whether doing so in the manner proposed will result in undue discrimination or preference, which are still prohibited.
4 18 C.F.R. § 343.2(c)(1) (2022).
5 FERC will likely permit a pipeline to take the full index increase, irrespective of the Percentage Comparison Test, if the pipeline is under-recovering its cost of service.SeePolicy Statement at PP 30 n.59, 45, 61 nn.134-135.
6 170 FERC ¶ 60,133 (2020) ("HollyFrontier").
7 926 F.3d 851 (D.C. Cir. 2019).
8 Id.at 859.
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