FERC made three small but significant changes to its pipelinerate of return policy this week, winning the praise of theInterstate Natural Gas Association of America (INGAA), whichrepresents the pipelines. INGAA President Jerald V. Halvorsen saidthe Commission’s action “should help pipelines compete in theincreasingly competitive financial markets for the capital to buildprojects that are necessary to meet projections of a 30 Tcf naturalgas economy by 2010.”

The changes, which were introduced in four orders affectingTranscontinental Gas Pipeline, Williams Natural Gas, Iroquois GasTransmission and Williston Basin, include giving more weight toshort-term earnings growth rate forecasts than to long-term growthrate forecasts in establishing reasonable returns on equity forpipelines. The draft orders give two-thirds weight to short-termprojections because of their greater reliability and one-thirdweight to long-term projections rather than weighting them equallyas was done previously.

Secondly, in order to provide financial incentives for pipelinesto manage their businesses efficiently the draft orders say theCommission no longer will reduce a low-risk pipeline’s equityreturn if its lower risk is a result of its efficiencies inconducting its business. Thirdly, on the capital structure issue,the draft orders would eliminate the requirement established lastyear that a pipeline’s own capital structure can only be used inrate of return calculations if it is within the range of equityratios of the proxy companies selected. Rather the draft orderspermit use of a pipeline’s own capital structure if the pipelineissues its own nonguaranteed debt, has its own bond rating and ifthe pipeline’s equity ratio is reasonably comparable to otherequity ratios approved by the Commission and those of the othercompanies in the selected proxy group.

Based on the revised policies, the draft orders allow Transco areturn on equity of 12.49%, and Williams Natural Gas a return onequity of a 13.46%. Both pipelines are permitted to use their owncapital structures in calculating their returns.

“While the upward adjustments in allowed returns are notdramatic, in my mind they represent a reasonable response to manyof the concerns raised before, at and after the January conference[on financial conditions of pipelines],” said Commissioner VickyBailey. “I am satisfied that use of actual capital structures,weighting of growth projections, and flexibility regarding risk andperformance issues will go a long way toward achieving reasonableallowed return levels while the Commission continues to explorerate setting in the future, particularly in the context of the[notice of inquiry] we just approved. Additionally I believe theopportunity to achieve higher returns-if pipelines maximize theopportunities offered by the [notice of proposed rulemaking] -should go a long way toward insuring that capacity will be able tomeet the 30 Tcf demand [projected].”

Using the previous methodology, Commissioner Curt Hebert said,the Commission had “inappropriately foreclosed a more studiedplacement of a pipeline within the range of reasonable returns.”Hebert admitted, however, he fears the increased ability ofpipelines to maneuver for better rates of return might promptparties that “might normally have settled the capital structureissue” to litigate to gain a greater ROR and to set a precedent.

Chairman James Hoecker agreed the previous methodology was “fartoo rigid and didn’t allow pipelines to plead their uniquecircumstances in a rate case.” He believes the changes willnecessitate little additional litigation, however, while givingpipelines the greater latitude in arguing the reasonableness oftheir capital structure as well as their relative risk.

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