In light of the decline in publicly traded companies with substantial pipeline assets and the rise in master limited partnerships (MLP) in the pipe sector, FERC Thursday issued a draft policy statement that would allow the use of MLPs in proxy groups to determine oil and natural gas pipelines’ returns on equity (ROE) for ratemaking purposes.

However, the Federal Energy Regulatory Commission proposes to cap the cash distributions used to determine an MLP’s return under the discounted cash flow (DCF) methodology at the MLP’s reported earnings. This would render MLP cash distributions comparable to corporate dividends for the purpose of a DCF analysis, staff said.

This is a “significant policy change,” said Chairman Joseph Kelliher. “Pretty striking structural changes have occurred in both the oil pipeline and natural gas pipeline sectors.”

There is no problem with FERC’s existing DCF method for determining pipeline ROEs; “the problem is the disappearing proxy group” for oil and gas pipelines, Kelliher said at the agency’s monthly meeting. It would be “perverse for us to exclude MLPs from the proxy group.”

The absence of a cap on MLP cash distributions would be a “windfall to pipelines,” said Commissioner Marc Spitzer. He noted that the cap eliminates the potential for double recovery.

The proposed policy statement is a “correction and perfection” of traditional ratemaking principles, Spitzer said. “Given the shifting financial structure of the industry, [this policy statement] is appropriate,” agreed Commissioner Jon Wellinghoff.

Interstate gas pipelines have repeatedly called on FERC to recognize the growing role of MLPs in the pipeline industry, and the need to include them in proxy groups to determine pipe ROEs. The exclusion of MLPs from proxy groups triggers wide shifts in ROEs that can affect the profits pipelines make each year and their ability to attract investors for projects, they said.

“I think it’s [the FERC action] a positive step, but the devil’s in the details” said Joan Dreskin, general counsel for the Interstate Natural Gas Association of America. The Commission showed a “recognition that the industry is increasingly moving toward the MLP structure.”

The issue of MLPs in proxy groups came to the forefront last year in a rate case involving Kern River Gas Transmission. A FERC judge recommended a 9.34% ROE for the Wyoming-to-California pipeline, significantly below what it had requested, based largely on the exclusion of MLPs from its proxy group. In October 2006, FERC voted to increase Kern River’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 (see Daily GPI, Oct. 20, 2006).

Kern River’s proposed proxy group included Enterprise Products Partners, GulfTerra Energy Partners LP, Kinder Morgan Energy Partners, Kinder Morgan Inc. and Northern Border Partners. But the proxy group ultimately adopted by FERC was composed of companies with a relatively low proportion of pipeline businesses and substantial distribution operations.

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