A federal appeals court in Washington, DC, Monday rejected petitions that either directly or indirectly challenged a FERC policy statement allowing regulated energy companies, such as crude oil and natural gas pipelines and public utilities, that are partnerships to recover actual or potential income tax liability in their cost-of-service rates.

Petitioners -- BP West Coast Producers, Chevron Products, ConocoPhillips, ExxonMobil Oil, Navajo Refining, Ultramar, Valero Marketing and Supply, and Western Refining -- challenged three orders, including a 2005 remand decision that granted SFPP LP, an oil pipeline limited partnership in the Southwest, an income tax allowance for "actual or potential income tax liability" incurred by partners on income they receive from the partnership.

The petitioners argued that the SFPP remand order was "arbitrary and capricious" and ran counter to the court's 2004 ruling in BP West Coast Products LLC vs. FERC. But the U.S. Court of Appeals for the District of Columbia Circuit disagreed. "We hold that the Commission's income tax allowance policy was not arbitrary or capricious or contrary to law," the three-judge panel said.

In a separate yet related case, the appellate court also dismissed a direct challenge by the Canadian Association of Petroleum Producers (CAPP) to the Federal Energy Regulatory Commission's 2005 policy statement on income tax allowances. The court said CAPP's petition was "moot" in light of its ruling in the related case, which was styled ExxonMobil Oil Corp. vs. FERC [No. 04-1102].

Energy analyst Christine Tezak said the court ruling, while "contrary to our expectations," was a major win for pipelines that currently are owned by partnerships and companies that are planning to put their pipe assets into partnerships. The decision "makes clear that pipelines owned by partnerships will be given the opportunity to justify recovering at least a percentage of the tax allowance [they] would have recovered if [they were] a Subchapter C company," she noted.

"To the extent that this issue has been hanging over the sector, we would say a cloud has dissipated," Tezak said. The court ruling removes the threat of complaints being brought against pipelines solely on the issue of tax allowance recovery, she noted. In addition, "We would be surprised to see an appeal" of the case to a higher court.

The FERC policy statement, which was issued in May 2005, specified that a tax allowance should be allowed for all entities, including partnerships and limited liability corporations, that generate public utility income provided there is an actual or potential income tax liability on that public utility income (see Daily GPI, May 5, 2005). The Commission took this action after the D.C. Circuit in July 2004 (BP West case) remanded an agency ruling that provided for an income tax allowance in the rates of SFPP.

At issue in the case was whether partnerships, such as SFPP, should be allowed tax recovery even though they (the entity) typically do not have any tax liability. The court asked the Commission to justify on remand its reason for allowing the pipeline partnership to collect income taxes in its rates. FERC substantiated its decision by saying that income taxes are a cost of a partnership's operations that are paid by the individual partners. It further concluded that the ruling extended beyond SFPP to other capital structures involving partnerships and other forms of ownership in the regulated oil, natural gas and electricity industries.

"Even though [this] was an oil pipeline case, it had ramifications for all partnerships" that own pipelines and other energy infrastructure, said Don Santa, president of the Interstate Natural Gas Association of America, at the time."Had the Commission disallowed [the tax recovery], it would have cut the legs out from under partnerships owning pipelines." He noted that the FERC policy decision was especially important in light of the fact that more and more partnerships are owning energy pipelines.

FERC Commissioner Suedeen Kelly agreed, saying that denying partnerships the ability to reflect income tax liability in their cost-of-service rates "would chill much needed investment in additional infrastructure."

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