A federal appeals court in Washington, DC, last Tuesday upheld FERC's 2005 policy statement that limits interstate pipelines' collateral requirements for non-creditworthy shippers to an amount equal to three months of reservation charges.

Two California pipelines -- Gas Transmission Northwest Corp. (GTN) and North Baja Pipeline -- challenged the policy statement and subsequent FERC orders in the U.S. Court of Appeals for the District of Columbia Circuit, arguing that they were unreasonable, arbitrary and capricious.

In the June 2005 policy statement, the Federal Energy Regulatory Commission (FERC) reaffirmed its traditional policy of permitting pipelines to collect no more than the equivalent of three months of reservation charges as collateral from current shippers on existing facilities. FERC said it would consider on a case-by-case basis pipeline requests to collect more than three months of charges as collateral from shippers who are bidding for available capacity on a pipe's system. For new mainline construction, FERC noted that it would permit larger collateral requirements that reasonably reflect the risk of the project (see NGI, June 20, 2005).

GTN and North Baja, stung by recent shipper defaults, sought to amend their tariffs to require non-creditworthy shippers (those who have below-investment grade bond ratings) to post 12 months of reservation charges as collateral to maintain capacity on their systems. FERC's policy statement allowed for exceptions to the three-month collateral policy in two cases -- if there are no protests filed to a pipeline's request for larger collateral requirements, and when the collateral request involves newly constructed facilities.

"We think that [FERC's] position is eminently reasonable" with respect to larger collateral requirements (up to 12 months of reservation charges) for unchallenged filings, the three-judge panel ruled. While the court agreed with the pipelines' argument that FERC's initial explanation for treating new facilities differently was "economically faulty," the agency in its rehearing order "explained reasonably that pipelines and their financing institutions' reliance interests for new investment justify the longer collateral requirement," the court said.

GTN and North Baja further argued that the three months' collateral requirement did not cover the risk of remarketing the capacity of defaulting shippers. FERC acknowledged that pipelines have that risk, but it concluded that it was an "ordinary business risk and, therefore, should be factored into the pipeline's rate of return -- which is another way of saying the cost of that risk should be spread over all the pipeline's customers," the appellate court noted.

"Some remarketing risk may be spread to creditworthy shippers, but the Commission believes its policy is justified by the beneficial effects on open access, and the resulting increase in the supply of natural gas. That strikes us as the sort of policy call entrusted to the Commission -- not to us."

The court further cited a case in which FERC considered the effects of remarketing risk while determining a rate of return for Ozark Gas Transmission. "The Commission was willing to increase Ozark's rate of return to compensate the pipeline for its relatively high credit risk and remarketing risk," it said.

GTN reported that it has faced 12 defaults in recent years, and its primary markets -- northern California and the Pacific Northwest -- are likely to experience slower growth in the future. But FERC countered that the pipeline "has failed to show that northern California markets will not be steady or continue to grow over time, regardless of the isolated bankruptcies of a handful of shippers." The court gave FERC the benefit of the doubt, saying "we see no reason to second guess these factual determinations."

North Baja Pipeline said it faced default from one out of five shippers, or 20% of its customer base. But despite this default rate, the Commission noted that North Baja was 95% subscribed for long-term firm capacity. "Given that the pipeline was operating at nearly full capacity, FERC rejected reasonably North Baja's assertion that it was in a 'tenuous position' with respect to credit risk," the court said.

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