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INGAA Sees 'Room for Improvement' on Pipe Issues at FERC in '07

The year 2006 was a "good year" for interstate natural gas pipelines at FERC, with the agency providing a "very positive...environment to encourage interstate pipeline construction," said the head of a major pipeline group.

But there's "room for improvement" in the year ahead, said Don Santa Jr., president of the Interstate Natural Gas Association of America (INGAA) and former FERC commissioner. He cited return-on-equity (ROE) issues and the blanket certificate program, as well as unanswered questions about the standards of conduct governing pipelines and their energy affiliates.

The top natural gas-related orders issued by FERC in 2006 were the flexible storage rule, policy statement on gas quality and interchangeability, and Kern River Gas Transmission's controversial ROE case, according to Santa..

The storage rule, released last June and upheld in November, gave FERC more flexibility to issue market-based rates to storage developers -- a move it hopes will spur the development and construction of new underground natural gas storage facilities in the United States (see Daily GPI, Nov. 17, 2006). Recipients of market-based rates can charge whatever the market will bear for their storage services. Storage developers prefer these rates over traditional cost-based rates.

The rule expanded the product market definition to allow the agency to consider nonstorage substitutes when deciding whether a storage applicant has market power and qualifies for market-based rates for storage services. The competing nonstorage substitutes could include available pipeline capacity, supplies from local gas production, liquefied natural gas (LNG) and released transportation capacity, which would be available to the same customers to be served by the new storage operations.

"The fact that the Commission...said they would consider a broader range of products" when determining market power "makes it at least theoretically easier for [storage] applicants to get market-based rates," Santa said. He noted the rule also was significant because it allows a storage applicant to seek market-based rates even if it has market power.

In deciding on a policy statement for gas quality and interchangeability, the Federal Energy Regulatory Commission "recognized as a practical matter that this was not something that lent itself well to a rulemaking or anything that would have been a requirement," Santa said. "I think it was the right level of guidance for an issue that is going to be very regional, very pipeline specific" in nature.

The decision by FERC reflected the position of interstate gas pipelines, which had called on the Commission to adopt a policy statement that would take a pipeline-by-pipeline approach to the complex gas quality and interchangeability issue. The agency's policy statement identified five principles for addressing disputes involving domestic gas quality and the interchangeability of high-Btu content LNG and traditional gas supplies (see Daily GPI, June 16, 2006).

Kern River was undoubtedly the most closely watched rate case of 2006. The controversy began last March when a FERC administrative law judge (ALJ) recommended a 9.34% ROE for the pipeline, far below its request of 15.1%. The Commission in October adopted a higher ROE for Kern River of 11.2% (see Daily GPI, Oct. 20, 2006). However, Kern River filed a rehearing request, arguing that other actions taken by the agency in the order would make the 11.2% ROE structurally unachievable.

"I think the Commission indicated a willingness to make some pragmatic adjustments to get a [ROE] number that was more realistic. I think overall the pipeline industry would prefer a better number and certainly Kern River had made that case clear in their request for rehearing. But still it was, compared to the [ALJ's] initial decision, a step in the right direction," Santa said.

"There remain interesting questions that are going to have to be addressed about the proxy group...and the extent to which the Commission will recognize master limited partnerships as part of that proxy group" used to determine an ROE, he noted. Santa believes the debate over Kern River's ROE will continue well into this year.

As FERC begins its agenda for 2007, "all eyes" will be on a notice of proposed rulemaking (NOPR) for the standards of conduct involving interstate gas pipelines and their energy affiliates. The Commission thought it settled the issue in Order 2004, which restricted interstate pipelines' interactions with an expanded sphere of energy affiliates. However, a federal appeals court in November vacated the order, saying that FERC failed to provide evidence of abuse to justify its decision to broaden the reach of its standards of conduct to include energy affiliates other than marketing affiliates (see Daily GPI, Nov. 20, 2006).

In the meantime, FERC Tuesday issued an interim rule readopting its former slimmed-down affiliate rule, Order 497, that restricts the relationship solely between interstate gas pipes and their marketing affiliates (see Daily GPI, Jan. 11). Order 2004 significantly broadened Order 497 regulations, extending the restrictions against preferential treatment, information disclosure and employee sharing to a number of other affiliates of regulated pipeline providers, including traders, producers, gatherers and processors.

The interim rule is expected to remain in effect until the agency completes a new final standards of conduct rule, a process which Santa believes could take a year or more. FERC said it plans to issue a NOPR in the very near future. "The real game is when the Commission ultimately publishes its new NOPR," he said.

Another critical court decision in 2006 involved the long-stalled Islander East Pipeline, according to Santa. In October, the U.S. Court of Appeals for the Second Circuit in New York ruled that a Connecticut agency's denial of a water quality permit for the proposed Connecticut-to-Long Island pipeline was both "arbitrary and capricious." It remanded the case to the state agency to conduct a "complete and reasoned" review that complied with federal law (see Daily GPI, Oct. 9, 2006).

However, Islander East Pipeline suffered a setback in December when the Connecticut agency denied -- for a second time -- the proposed pipeline's request for a water quality permit. The pipeline's petition for review of that decision is pending before the Second Circuit (Daily GPI, Dec. 26, 2006).

Santa did not view the rule expanding the scope of FERC's blanket certificate program as among the agency's top actions in 2006 (see Daily GPI, June 16, 2006). "I guess I kind of count that as a glass half full. We were pleased by the fact that the Commission acted on our joint petition for a rulemaking, but the Commission chose not to expand the dollar ceilings up to the level" that was awarded in the wake of Hurricanes Katrina and Rita, he said. That "detracted from the ultimate usefulness of what they did."

Also low on his list was the agency's adoption of a broad anti-manipulation rule for gas and electric power, which allowed the agency to flex its new-found enforcement powers that were authorized by Congress under the Energy Policy Act of 2005 (EPAct). "Compared to other things, it wasn't quite as bright a blip on our radar screen," Santa said.

FERC's anti-market manipulation rule made it illegal for any entity, directly or indirectly, in connection with the sale or transmission of natural gas or electricity subject to FERC regulation to engage in fraudulent or deceitful acts. The rule for the first time extended FERC's anti-market manipulation authority to energy entities that are not jurisdictional to the agency but are involved in jurisdictional transactions, such as government-owned utilities and other market participants (see Daily GPI, Jan. 20, 2006).

The rule also increased the agency's maximum civil penalty to $1 million a day per violation. However, a year after FERC adopted its final rule, it has yet to use this new penalty authority.

On Capitol Hill, "the combination of high commodity prices, high profits by some in the energy business...[and] people in the Department of Interior dropping the ball has created a political groundswell," Santa said. "By the same token, I think it's important for Congress to recognize that, as much as it may be a populist issue and as much as they may want to be punitive, it's important not to do things that are going to take away the incentives to produce energy," he noted.

"Also, it's important to bear in mind that while a lot of political attention gets focused on major integrated oil companies, a lot of those incentives benefit domestic independent producers."

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