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FERC Rejects Kern River Rate Settlement with 12.5% ROE

FERC last Thursday rejected a contested Kern River Gas Transmission rate settlement, finding that the 12.50% return on equity (ROE) in the settlement rates was excessive and would result in unjust and unreasonable rates. FERC instead determined that the Wyoming-to-California pipeline's ROE should be set at 11.55%.

The decision was the first ROE issued under the Federal Energy Regulatory Commission's (FERC) 2008 policy statement, which allows the use of master limited partnerships (MLP) in proxy groups to determine oil and natural gas pipelines' ROE for ratemaking purposes (see NGI, April 21, 2008). The agency's policy statement was in recognition of the decline of publicly traded companies with substantial pipeline assets and the rise of MLPs in the pipe sector.

FERC determined that the proxy group in Kern River's case -- three MLPs and two corporations -- yielded a range of reasonable returns of 8.80% to 13%, with a median ROE of 11.55%. Anything above 11.55% for Kern River would result in unjust and unreasonable rates for the pipeline's customers, according to the Commission.

FERC directed Kern River to cancel its interim rates filed with the settlement and made effective Oct. 1, 2008, and to make a revised compliance filing within 45 days of the order, using a 11.55% ROE. It further directed Kern River to make interim refunds at the earliest practical date, as required by the settlement.

The Kern River rate case brought the issue of MLPs in pipeline proxy groups to the forefront. In March 2006 a FERC judge recommended a 9.34% ROE for Kern River (see NGI, March 27, 2006). FERC later that year voted to increase the pipeline's ROE to 11.2%, but it ruled that the pipeline had not met the burden to support its proposal to include MLPs in its proxy group.Although higher, Kern River found the FERC-approved ROE unacceptable. The ROE was below Kern River's request of 15.1% and its then-current ROE of 13.25% (see NGI, Oct. 23, 2006).

Still, in the Kern River ruling, the Commission recognized that ownership of interstate gas pipelines was changing from corporations to MLPs, and that an adjustment to its ratemaking policy was in order.

"We revised the composition of the proxy group in response to structural changes that have occurred in both the natural gas and oil pipeline sector in recent years. Our policy change was born out of a practical recognition that the size of the proxy group used under our prior approach had shrunk dramatically. We were careful in our approach. We did not revise our policies with respect to proxy group composition in order to produce higher returns. That much is borne out by our disposition of this rate proceeding," said FERC Chairman Joseph Kelliher.

"I don't think this Commission should lightly overturn settlements," said Commissioner Jon Wellinghoff, but he added he didn't think the Kern River was "much of a settlement."

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