The U.S. Court of Appeals for the District of Columbia Circuit has remanded the natural gas pipeline rates for Petal Gas Storage and High Island Offshore System (HIOS) after concluding that FERC had mistakenly based the rates on a proxy group to include local distribution companies (LDC). The three-judge panel ruled that the Commission’s decision to include the LDCs, which carry less risk than interstate pipes, compromised the outcome of the rate cases.
The ruling in Petal Gas Storage LLC v. Federal Energy Regulatory Commission was decided on Tuesday (No. 04-1166). The Interstate Natural Gas Association of America and ExxonMobil Gas & Power Marketing were intervenors in the case, which was consolidated with Case No. 06-1064.
Circuit Judge Janice Rogers Brown, who wrote the opinion, said “the chief issue — the only one Petal and HIOS share in common… — is whether the Commission erred in its selection of the ‘proxy groups’ used to calculate petitioners’ gas transmission rates, along with its placement of petitioners within those proxy groups. We hold that the Commission did err, by failing to explain how its proxy group arrangements were based on the principle of relative risk.”
In the Petal Gas case, the panel noted that FERC traditionally relied on a proxy group of publicly traded companies with a high proportion of their business in pipeline operations to estimate gas pipeline rates.
“But the industry is changing,” said the panel. “Acquisitions, financial mishaps and other factors have left, by one count, just three companies that fit the old requirements (too few for a proxy group)…and all parties to this case agree the Commission’s traditional approach must change…Controversy about how it should change has been bubbling up in a number of recent cases…but this case seems to represent an arrival point of sorts for the Commission…”
The panel referred to the draft policy issued by FERC in July to allow the use of master limited partnerships (MLP) in proxy groups to determine oil and natural gas pipelines’ returns on equity for ratemaking purposes (see Daily GPI, July 20). The ruling also referred to the petition filed by Williston Basin Interstate Pipeline that sought a judicial review of FERC’s decision to reject the pipe’s proposed rate increase (see Daily GPI, Dec. 27, 2006). The Williston Basin petition was dismissed without reaching a proxy group issue.
Petal and HIOS disputed FERC’s proxy groups in their cases on three grounds that claimed:
“On the record before us, we do not find adequate support for the contention that the Commission’s proxy group arrangements were risk-appropriate,” the panel concluded. It noted that “when the goal is a proxy group of comparable companies, it is not clear natural gas companies with highly different risk profiles should be regarded as comparable.”
FERC “expressly relies on the ‘assumption that pipelines generally fall into a broad range of average risk…as compared to other pipelines’ — an assumption that is decisive only given a proxy group composed of other pipelines…If gas distribution companies generally face lower risks than gas pipeline companies (as seems likely), a risk-appropriate placement would be at the high end of the group.”
The panel vacated FERC’s orders with respect to the proxy group issue, and on remand said it did not require any particular proxy group arrangement.
“Perhaps it would be best to include gas distribution companies and exclude MLPs, but to put petitioners’ rates of return on equity at the top of the range,” Brown wrote. “Or perhaps including MLPs and excluding gas distribution companies, while putting Petal and HIOS in the middle of the range, would be best.” FERC “might even acceptably return to this court with just the same arrangements it has chosen, albeit explained and justified in very different terms. What matters is that the overall proxy group arrangement makes sense in terms of relative risk and, even more importantly, in terms of the statutory command to set ‘just and reasonable’ rates’…”
In a related action, the panel rejected three separate claims by HIOS that argued FERC should have approved a rate settlement it presented; selected a faster depreciation rate for its pipeline system; and awarded it a higher management fee. Brown said FERC “was well within the considerable deference we show it in ratemaking cases.”
In 2002, HIOS sought to raise its shipping rates, but an administrative law judge rejected the rate increase in 2004. HIOS appealed, but while the appeal was pending, HIOS completed a settlement with at least some of its shippers and filed the settlement with FERC for approval.
FERC rejected the settlement in 2005 (see Daily GPI, Jan. 26, 2005) and, on the merits, depreciated HIOS’s pipeline system at a slower rate than HIOS favored, awarded HIOS a smaller management fee than it requested, and “of course, used a proxy group to determine HIOS’s rate of return on equity.”
HIOS claimed that FERC should have accepted its settlement proposal. Failing that, HIOS disputed FERC’s choice of depreciation rate and management fee. The panel said that “arbitrary and capricious standard governs our review.”
FERC rejected the settlement for two reasons, the panel noted. The settlement “dictated rates half again as high as the administrative law judge had approved. Second, it awarded a $3 million payment from HIOS to the active parties to the settlement — a payout that the Commission concluded would…undermine the usual assumption that the settlement’s active parties will protect the interests of its inactive parties.”
The judges said FERC’s rejection was “only the independent consideration of fairness, reasonableness, and the public interest the Commission is duty-bound to give.” They noted, “FERC is not required to choose the best solution, only a reasonable one.”
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