For the first time since Order 636 laid out open access transportation FERC has called the pipeline industry to account, setting three of its members for rate investigations, saying that preliminary study shows they may be over-recovering costs and their rates may no longer be just and reasonable.

The Federal Energy Regulatory Commission (FERC) has initiated formal Natural Gas Act (NGA) Section 5 investigations of Natural Gas Pipeline Co. of America LLC (NGPL), Northern Natural Gas and Great Lakes Gas Transmission Ltd. Partners, citing returns on equity (ROE) for the three of between 20% and 25% in 2008, well above the 12% ROE that FERC usually finds acceptable. The Commission used the more extensive data it started receiving last year from the pipelines in its revised Form 2 to conduct its preliminary review.

That data indicates NGPL may have achieved a return on equity (ROE) of 24.5% based on an over-recovery of $149 million (RP-10-147), while Northern Natural's estimated ROE was 24.36% (RP10-148) with an over-recovery of $167 million and Great Lakes ROE was 20.83% with a FERC-estimated over-recovery of $56 million (RP10-149).

Since FERC rules do not permit retroactive refunds, Chairman Jon Wellinghoff said the order called for completion of the cases against the three companies as quickly as possible, with an initial decision by an administrative law judge within 47 weeks. The pipelines are required to file a cost and revenue study within 45 days including actual data for the latest 12-month period ending with the date of the order.

While outside sources estimate a number of other pipelines have ROEs in those upper ranges, FERC staff said that after a preliminary review it had excluded from further investigation those pipelines operating under settlement agreements with their customers that involved moratoriums on rate filings, or pipelines that are scheduled to file new proposed rates under NGA Section 4 in the near future. Also excluded were pipelines that had added infrastructure in 2008 or with infrastructure investments that would have clouded the revenue figures. The examination of rates will affect only recourse rates, not negotiated rates, staff said.

Commissioner Suedeen Kelly commended the staff for making good use of the broader data sets coming in through the updated Section 2 form.

Alex Strawn, chairman of the Process Gas Consumers (PGC) said his organization of natural gas end users "has been relentless in seeking action to address pipeline over-recoveries. It has been a long process, but today our persistence paid off." PGC's General Counsel Dena Wiggins, a partner in the Energy and Finance Group in the Washington, DC, office of Ballard Spahr LLP said, "We are very pleased that our concerns have been heard and that FERC has initiated these investigations."

William Hederman, a senior vice president at Concept Capital's Washington Research Group, said FERC's action "does appear, in our opinion, likely to increase regulatory risks for interstate natural gas pipelines, especially those above Northern Natural, which is No. 15 on the Natural Gas Supply Association (NGSA) list of 'actual pipeline rate of return' for a five-year average ending in 2007."

In the NGSA list NGPL was No. 1 with a five year average ROE of 34%; Great Lakes was No. 6 with an average of 20%, and Northern Natural had an average of 14%. Other pipelines with five-year averages above 20% according to NGSA, included Kinder Morgan Interstate Gas Transmission, Panhandle Eastern Pipe Line, Dominion Transmission, Mojave Pipeline, and Transwestern Pipeline. Eighteen pipelines had five year average ROEs above 13%.

FERC said NGPL also appears to be over-recovering fuel and lost and unaccounted for gas from its customers. The staff calculated an over-recovery of 30.9 million Dth of gas. NGPL's reports also show that for the fourth quarter of 2008 and the first quarter of 2009, it received $59.6 million and $48.7 million, respectively, in revenues from the sale of excess gas.

Overall NGPL collected adjusted revenue of $656 million while its cost of service was $506 million giving it a cost over-recovery of $149 million, according to an appendix to the FERC order.

NGPL is 20% owned and operated by Kinder Morgan Inc., a private company separate from publicly held Kinder Morgan Energy Partners, a spokesperson said, with the other 80% ownership held by an investment group. She said management would respond after it had had time to study the order.

FERC said the adjusted revenue reported by Northern Natural was $726 million and the cost of service calculated by the Commission was $558 million, giving Northern Natural an over recovery of $167 million for 2008.

Northern Natural Gas management "was surprised by this unexpected development." The company had no advance notice. Spokesperson Mike Loeffler said Northern Natural, which is a subsidiary of MidAmerican Energy Co., has the lowest rates in the Midwest and is the pipeline company rated highest by its customers. Management will have a "thorough and comprehensive response" to the Commission order after study of the order, he said. It was noted that Northern's five year average according to NGSA was only 14.1%.

Great Lakes' adjusted revenue was $290 million, and the cost of service calculated by the Commission was $233 million indicating an over recovery of $56 million for 2008. A spokesperson for Great Lakes Gas Transmission, a subsidiary of TransCanada, said management would comment after study of the decision.

FERC staff said its best institutional memory was that there had not been a case filed under Section 5 of the NGA by the Commission since "about 1989." The three items were a surprise last minute addition to FERC's Thursday meeting agenda.

Commissioner Marc Spitzer filed a concurring opinion saying he would have preferred allowing some time at the outset for the parties to reach a settlement. He noted that part of the bargain in the landmark Order 636, which in 1992 opened the pipelines to competition, was that pipelines would no longer be required to file periodic rate cases, a major exercise which pre-636 resulted in a regular thorough examination by the Commission and customers of a pipeline's financial information. This generally has meant that post-636 only pipelines that wanted to raise their rates filed rate cases. Pipelines that curtailed operations or otherwise lowered their costs were able to make a higher return.

However, the Commission, state or local governments or local distribution companies are empowered to challenge the rates under Section 5. The challengers bear the burden of proving the rates unjust and unreasonable.

During its review of the sufficiency of FERC Form No. 2, the Commission heard from many shippers that the old Form 2 did not contain enough information to provide a solid basis for a NGA Section 5 complaint. "We therefore revised Form 2 to provide a level of information that would enhance the ability of the Commission and the pipeline customers to assess the justness and reasonableness of pipeline rates."

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