The spotlight will be on FERC Thursday as it takes up the controversial case involving return on equity (ROE) for the Wyoming-to-California Kern River Gas Transmission pipeline.

Assuming the case is not stricken from the agenda at the last moment, the Federal Energy Regulatory Commission will have the option to approve or reject in full or in part a March decision by an agency administrative law judge (ALJ) that recommended an ROE of 9.34% for the Kern River system, considerably below the pipeline’s request of 15.1% and its current ROE of 13.25% [RP04-274].

The initial decision of ALJ Charlotte J. Hardnett sent shivers through the interstate gas pipeline industry, with the Interstate Natural Gas Association of America (INGAA) and energy analysts predicting that a single-digit ROE, if approved by the full Commission, could be harbinger of things to come industrywide (see Daily GPI, March 21). Lower ROEs, they contend, would make it more difficult for gas pipelines to attract investors to their new projects.

INGAA, which represents interstate gas pipes, released a report in late August that concluded that ROEs in the single-digit range would likely have a “chilling effect” on investment in new pipeline infrastructure. The group commissioned Chicago-based Navigant Consulting Inc. to do the report following Hardnett’s initial ruling (see Daily GPI, Aug. 25).

In comments filed Friday, the New York Public Service Commission (PSC) was highly critical of the INGAA report, saying that the pipeline group was relying on past ROEs to support its position that forward ROEs should fall within the range of 12% to 14%. “The Commission should resist INGAA’s proposal to use historical allowed ROEs as the ‘true market test’ of reasonableness because such an approach would untether the ROE analysis from an objective measurement of capital cost under existing market conditions,” the PSC said.

Moreover, the 12-14% range cited by INGAA is “arbitrary,” the state regulatory agency noted. “Allowed ROEs generally have not approached 13% in the post-Order 636 environment upon which INGAA focuses most specifically. In only two of the eleven decisions since Order 636 has the Commission authorized ROE above 13%, and as INGAA notes, the average for this period is 12.43%.” It further noted that FERC’s predecessor, the Federal Power Commission, “routinely approved ROEs significantly lower than the 12% to 14% range.”

The PSC also took issue with INGAA’s proposal to include master limited partnerships (MLPs) in the discounted cash flow (DCF) proxy group to determine pipeline ROEs. “INGAA opportunistically seizes upon the issue of including MLPs (which currently tend to produce higher DCF results) in the proxy group…The Commission has previously recognized that there are fundamental problems with including MLPs in the DCF proxy group to derive an ROE estimate for a natural gas pipeline, and nothing in the [INGAA report] warrants revisiting the Commission’s established policy on this issue,” the state agency said.

Kern River proposed several MLPs for its proxy group to determined its ROE. Its proxy group, which was ultimately rejected by Hardnett, included Enterprise Products Partners, GulfTerra Energy Partners LP, Kinder Morgan Energy Partners, Kinder Morgan Inc., Northern Border Partners and The Williams Companies.

Producers and industrial gas consumer groups also asked FERC to not make any changes to its current ROE policies at this time. “We urge the Commission not to alter its rate of return ratemaking policies in the Kern River proceeding. The Commission’s existing policies have served the industry well over time. We see no reason for the Commission to revise the MLP issue” in the Kern River rate case, wrote the Process Gas Consumers Group (PGC), the Independent Petroleum Association of America (IPAA) and the Natural Gas Supply Association (NGSA) in a letter to Chairman Joseph Kelliher last Thursday.

“However, it would be more appropriate if the Commission did so [examine the MLP issue] in the context of a generic, public proceeding that addressed a broad spectrum of ratemaking policies with an opportunity for comment by all industry participants,” they said.

The three groups disputed INGAA’s claims that the current FERC policy on ROEs is affecting investment in interstate gas pipelines. “We see no evidence that there is a lack of investment under the Commission’s existing policy. In fact, one only needs to look at the large number of proposed pipelines and recently constructed projects to know that the industry continues to be a very attractive prospect.”

The PGC, IPAA and NGSA called on the Commission to decide the case expeditiously based on the “full and very complete record,” and ignore the “extra-record considerations” raised by the INGAA report.

The rate case involving Kern River dates back to May 2004, when FERC accepted and suspended for five months a $40.1 million rate hike on the pipeline’s system. As part of the proceeding, the pipeline sought the 15.1% ROE.

Kern River’s system extends about 900 miles from Wyoming through Utah and Nevada to the San Joaquin Valley near Bakersfield, CA. The pipeline, which began service in 1992, had an initial transportation capacity of 700 MMcf/d. A $1.2 billion expansion in 2003 more than doubled Kern River’s firm delivery capacity to 1.7 Bcf/d.

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