Although FERC adopted a double-digit return on equity (ROE) of 11.2% for Kern River Gas Transmission last month — higher than the single-digit 9.34% ROE that was recommended by an administrative law judge — other actions taken by the agency in the order will make the 11.2% ROE “structurally unachievable,” the Wyoming-to-California interstate natural gas pipeline said last Monday.

While improving upon the ALJ’s recommended ROE, the Federal Energy Regulatory Commission “clearly chose not to provide Kern River with the benefit of its bargain by selectively dismantling the long-standing levelization methodology through the elimination of the integral 3% inflation adjustment factor and the 95% load factor for calculation of billing determinants on Kern River’s original system. Without these components, the balance achieved by the levelization methodology is dramatically shifted with a result that leaves Kern River unable to earn a return on equity greater than 9.88%,” the Mid-American pipeline said in a statement, which it issued last Monday after filing a request at FERC for rehearing of the Oct. 19 order [RP04-274].

Immediately following the ALJ’s initial decision in March, interstate gas pipelines said they feared that single-digit ROEs might become the norm and would have a chilling effect on investment in pipeline facilities. Wide shifts in ROEs can affect the profits that pipelines make each year and their ability to attract investors for projects. FERC was under pressure from pipelines and congressional lawmakers to adopt a higher ROE in the Kern River rate case. And while the Commission’s ROE was a step up from the ALJ’s, Kern River contends it still falls short of what it needs.

“The Commission order falls well short of providing Kern River a realistic opportunity to earn a reasonable return on its investment,” said Kern River President Kirk Morgan. “The Commission seemingly overlooks the fact that Kern River was able to complete its 2003 Expansion Project [only] after MidAmerican Energy Holdings Co. acquired the pipeline and accepted considerable risk. Had MidAmerican not stepped to the plate to guarantee completion of this $1.2 billion project and relied on the Commission’s history of approving returns on equity that fairly reflect actual business risks, this critical infrastructure would not have been built,” he noted.

In its rehearing order, Kern River said the Commission-approved 11.2% ROE for the pipeline is more than 200 basis points below the ROE of 13.25% the agency allowed for Kern River’s 2003 expansion project. That project, it noted, was placed in service on schedule, under budget and financed at rates providing immediate benefits to shippers less than two years after the worst energy crisis in the nation’s recent history.

“The Commission’s selected return on equity of 11.2% is unfair and unreasonable in the circumstances of this case,” Morgan said. Although higher than the ALJ’s recommended ROE, the FERC-approved ROE was below Kern River’s request of 15.1% and its current ROE of 13.25%. It also was below a pipeline group’s proposal of 12-14% ROE for Kern River.

“The Commission has made no attempt to reconcile its proposed return for nearly new pipeline facilities, like Kern River’s 2003 Expansion Project. The 11.2% return is also less than returns the Commission has approved for jurisdictional electric utilities and less than many returns approved by state commissions for regulated gas distribution companies,” Morgan noted.

Another key issued raised in the rehearing request was the Commission’s decision to rely on a proxy group of largely local distribution companies as the benchmark for establishing Kern River’s ROE (see NGI, Oct. 23). This produced a ROE for Kern River more than 240 basis points less than that of the only legitimate gas pipeline among FERC’s selected proxies, Kern River said.

The revised proxy group adopted in the FERC order to determine Kern River’s ROE included “companies with a relatively low proportion of pipeline business and substantial distribution operations,” agency staff noted.

The ROE controversy stems from a Section 4 rate case that Kern River filed in April 2004. Kern River’s pipeline system extends about 1,679 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. The $1.2 billion expansion in 2003 more than doubled Kern River’s firm delivery capacity to 1.7 Bcf/d.

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