Last year at this time the Federal Energy Regulatory Commission (FERC) issued its latest round of orders initiating rate investigations under Section 5 of the Natural Gas Act, a practice it began in 2009. Companies investigated last year included Tuscarora Gas Transmission, Columbia Gulf, Iroquois Gas Transmission, and Empire Pipeline. In each case, the company under investigation settled with FERC and its respective shippers — some with dramatically lower rates (e.g., 37% lower for some segments of Empire Pipeline’s system). Therefore, in some cases, these companies saw appreciable revenue stream declines (see our Insights, The Results Are In – And the Rate Investigation Winner Is…). The looming question that companies attempt to figure out this time of year is: If FERC initiates a rate investigation, will my company be a target? But what are the leading indicators? How can a company spot the risk factors that may indicate an impending case?
Typically, FERC initiates these investigations following a screening process that begins at FERC in the Office of Administrative Litigation (OAL). During this screening process, OAL staff takes several months to evaluate whether major and non-major interstate pipelines may be over-recovering, based on a painstaking manual assembly of annual Form-2 financial data — and presumably state tax data — necessary to determine a return on equity (ROE). Following this screening process, OAL staff makes recommendations to the Office of Energy Market Regulation that conducts its own evaluation process, which is not as well understood, to select the pipelines it will recommend to the Commission for investigation.
What is considered “too high,” or potentially “unjust and unreasonable?” FERC establishes a range of ROEs by relying upon an analysis of proxy companies using FERC’s discounted cashflow model of rate calculations. In theory, if FERC has indicated that a reasonable ROE range is between 9% and 12%, then an ROE value greater than 12% could increase a company’s risk of being subjected to a FERC rate investigation. But practically speaking, the median ROE for companies brought in for rate investigations is 19%.
Each new rate investigation spurs the same critiques from pipeline companies regarding defects in FERC’s evaluation process and its underlying methodology, which lead, in their viewpoint, to inaccurate ROE calculations. For starters, FERC’s ROE calculations are based on stale inputs; that is, the Form-2 financials are typically one-year out-of-date. Oftentimes, the disparity between the company’s and FERC’s ROE calculations arises because a company has additional context for the values reported to the FERC. Company studies, particularly those for non-major pipelines, incorporate actual debt to equity ratios (as opposed to the 50/50 ratio assumed by the FERC staff). Companies may also provide adjustments to revenues and other rate components that result in a much different (and sometimes much lower) ROE and revenue snapshot compared to the FERC staff’s evaluation.
But aside from company-specific information, which is not available to FERC during its screening process, does FERC have access to other data sources that might make its own calculations closer to those the company provides? Yes. One topic commonly litigated in rate investigations includes the impact on revenue of impending contract roll-offs and turnback of maximum recourse rate contracts. Other negotiated rates contracts that are set to expire could also be analyzed in order to make revenue adjustments. And should the negotiations for renewal be ongoing, the company is required to update FERC once negotiations are finalized. Nearly all of this data is reported to FERC, albeit in varied, difficult to consume formats, and could be analyzed.
Will the Trump administration have any impact on the Commission’s interest in assuring pipelines are more routinely held accountable for potentially unjust and unreasonable rates? We will see. But there is no need to wait to begin analyzing the risk factors that drive whether a company will be investigated. LawIQ’s Platform includes all of the essential ingredients to spot the pipelines at risk: pipeline financial data, contract terms, and, now, the negotiated rates. What’s more, our Platform includes ROE calculations for many pipelines based upon the same methodology utilized by FERC.