FERC Hastens Modifications in Oil Pipeline Regulatory Approach

by | Jan 15, 2013

In the past year, FERC continued to provide increased flexibility to oil pipelines seeking to expand their facilities.  In 2012, oil pipelines received FERC approval to use net present value (NPV) to allocate new pipeline capacity and to permit certain shippers to release their capacity.

Historically, oil pipelines have been regulated as non-discriminatory common carriers with ease of entry and exit into the business. FERC, therefore, regulates oil pipelines’ rates and tariffs, but has no direct jurisdiction over facilities or construction.  In the late 1980s and early 1990s, a number of regulatory developments, such as the Buckeye Pipeline case and the Energy Policy Act of 1992, led to simplified regulation of oil pipelines.

More recently, the need for development of and investment in oil pipeline facilities has resulted in significant changes to their regulatory structure.  While FERC lacks jurisdiction over the construction of oil pipeline facilities, its jurisdiction over rates and tariffs offer FERC a manner to enhance the construction of oil pipeline infrastructure.  Oil pipelines have been reluctant to commit substantial resources to the construction of facilities without a fairly certain means to recover the investment.  Common carriers, with published rates, have not historically had a means to ensure that any facilities they construct will be used and will become profitable.  FERC has addressed this problem through use of petitions for declaratory order by oil pipelines.  Specifically, FERC has permitted oil pipelines to obtain advance approval of rates and tariffs by filing petitions for declaratory order.

Express Pipeline

Express Pipeline was the first oil pipeline to file a request for declaratory order.  Express was a greenfield project and sought advance approval of tariffs provided for in agreed-upon contracts — of varying lengths and containing discounted rates — with particular shippers.  FERC initially concluded that use of a petition for declaratory order was appropriate.  Express Pipeline Partnership, 75 FERC ¶ 61,303, order on reh’g, 76 FERC ¶ 61,245 (1996).  On rehearing, FERC approved Express’ specific proposals, noting that although shippers that obtain capacity during the open season received different rates and terms than those that did not, all shippers had the opportunity to particular in the open season.  Express Pipeline, 76 FERC at p. 62,254.  Following Express Pipeline, FERC has issued declaratory orders permitting oil pipelines to obtain pre-approval of various rates and terms of service agreed to by oil pipelines and shippers through non-discriminatory open seasons.

Houston-to-Houma Pipeline System

This year, FERC issued additional orders that further increase the flexibility afforded oil pipelines to obtain pre-approval of rates and tariff provisions associated with new facilities.  In one case, Shell sought a declaratory order for a proposal to reverse the flows on an existing pipeline, called the Houston-to-Houma (“Ho-Ho”) Pipeline System.  According to Shell, the Ho-Ho Reversal was needed to permit the increased volumes of light, sweet crude from shale production and other production regions in the western United States and Canada to flow to refineries in Port Arthur, Texas and Louisiana.  Shell claimed that those refineries prefer light, sweet crude, while refineries in Houston prefer heavier crude oil.  Shell estimated the costs of the Ho-Ho Reversal at $100 million and claimed that multi-year, firm commitments from shippers were required to support this level of investment.  Shell held an open season that resulted in binding requests for service.  Committed shippers participating in the open season will execute three- or five-year contracts to ship (or pay for) specific volumes at tiered rates depending upon the volume selected.  Committed shippers also received priority rights to 90 percent of the Ho-Ho Reversal in the event of prorationing.  Uncommitted shippers would pay different rates and would be subject to Shell’s historical method of prorationing.  In addition, if the Ho-Ho Reversal was oversubscribed during the open season, Shell proposed to allocate capacity using an NPV methodology.  Unlike the Express Pipeline proceeding, no party objected to Shell’s proposals.

FERC issued the requested declaratory order on June 21, 2012.  Shell Pipeline Co., L.P., 139 FERC ¶ 61,228 (2012).  FERC reasoned that as all shippers had been offered the opportunity to participate in the open season, the differences in rates and terms afforded committed and uncommitted shippers render shippers “not similarly situated by choice.”  Id. at P 20.  FERC went on to note that Shell’s proposal to use an NPV methodology to allocate capacity in the event of an over-subscribed open season was unprecedented.  Id. at P 22.  Nonetheless, FERC noted that Shell had made clear to potential shippers that NPV would be used and, as a result, “[t]here is no issue of discrimination” because all shippers could structure their open season bids accordingly.  Id.  FERC also pointed out that natural gas pipelines have used NPV to allocate capacity during open seasons.  Id.

In a subsequent case, also involving Shell, FERC issued a declaratory order granting preapproval of proposed rates and terms of service, including a proposal allowing committed shippers to assign their contracts along with their shipping history.  Shell Pipeline Co., L.P., 141 FERC ¶ 61,017 (Oct. 5, 2012).  FERC stated that the assignment rights will permit new shippers to “step into the shoes of the original shipper and . . . be responsible for providing the continued long term financial support of the pipeline.”  Id. at P 16.  In addition, the inclusion of the assignment rights was an important point of the bargain that induced the committed shippers to purchase new capacity.  Id.  Again, Shell’s filing drew no opposition.

These recent orders indicate FERC’s continued willingness to provide oil pipelines with the flexibility needed to construct new infrastructure.  FERC’s actions, along with the lack of shipper objections, indicate that oil pipelines may become more creative in the rates and services they offer to new shippers.

Debra Ann Palmer is a partner with Schiff Hardin.

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