July 2020 Vol. 75 No. 7

Washington Watch

FERC Policy Statement on ROE Favors Pipelines

By Stephen Barlas, Contributing Editor, Washington, D.C.

Interstate gas and oil pipelines got a couple of big boosts from the Federal Energy Regulatory Commission (FERC) policy statement published on May 21. Changes in the way the FERC calculates a pipeline’s return on equity (ROE) generally mean the higher the ROE, the higher the rates a pipeline can charge. 

FERC established a new ROE policy for electric utilities in 2019 and then undertook another examination to determine whether that policy should be applied to interstate gas and oil pipelines. The Interstate Natural Gas Association of America (INGAA) opposed doing so and suggested a number of changes FERC could make to existing pipeline policy, some of which were incorporated in the Commission’s May 20,2020 gas and oil pipeline ROE policy statement.

While the Commission applied the utility policy generally to pipelines, it made several exceptions for the pipelines to account for statutory, operational, organizational and competitive differences among the industries. Specifically, the Commission will determine “just and reasonable” natural gas and oil pipeline ROEs by averaging the results of Discounted Cash Flow (DCF) model and Capital Asset Pricing Model (CAPM) analyses, according equal weight to both models.

In contrast to its methodology for public utilities, FERC will retain the existing two-thirds/one-third weighting for the short-term and long-term growth projections in the DCF and will not use the risk premium model, which pipelines opposed. In addition, the rules for formation of proxy groups are changed.

According to Paul Korman, an attorney for Van Ness Feldman, the addition of the CAPM to FERC’s framework for determining ROE is likely to produce ROEs that are approximately 30 to 50 basis points higher, because the CAPM ROE tends to be higher than the DCF model ROE.

“However, as the composition of proxy groups and the underlying market data change, so will the results,” Korman wrote in commentary on the website “Lexology.” “There is no guarantee that the CAPM ROE will continue to be higher than the DCF ROE.”

INGAA did not respond to a query regarding the new policy statement.

But pipelines are undoubtedly mostly satisfied, given the statement rebuffs the demands of environmentalists and shippers. Environmental groups argued that, based on statistics from the Edison Electric Institute, the utility trade group, FERC in 2017 granted 52 utilities an average ROE of 9.7 percent. That is considerably lower than the 14 percent the groups alleged FERC has been granting pipelines for 20 years. The Natural Resources Defense Council (NRDC) and others claimed the 14 percent ROE led to overbuilding of pipelines.

The Natural Gas Supply Association told FERC it should continue to rely exclusively on the DCF methodology for determining natural gas pipeline ROEs. Casey Gold, director of regulatory affairs for NGSA, says her group is nonetheless pleased the DCF methodology “will still be used for calculating ROEs, and pleased that FERC provided clarity on proxy group formation.”

She stressed the policy statement was not a complete loss for the NGSA adding, “While FERC did broaden the policy to include CAPM, it did not adopt the pipelines’ proposal to apply different weights or models in setting ROEs and, instead, took a balanced approach that will average and give equal weight to both models.”

“Proxy” groups are similarly situated interstate pipelines with business and financial situations that are comparable to a pipeline whose ROE is being established by FERC. INGAA had pressed FERC to expand its proxy group eligibility criteria by continuing to consider additional energy entities of comparable risk, even if those entities do not meet the “high proportion” of natural gas pipeline threshold. INGAA specifically mentioned the need to include in proxy groups Canadian companies Enbridge and TC Energy, both of which now have significant U.S. natural gas pipeline assets.

In the policy statement, the Commission clarified its policies governing the formation of proxy groups, stating that it would continue to apply a flexible approach if needed to obtain a proxy group of at least five members. This would permit companies to relax the general criteria that the pipeline business account for at least 50 percent of a proxy group member’s assets or operating income over the last three years. In addition, the Commission noted it will consider proposals to include otherwise-eligible Canadian entities in the proxy group in future proceedings.

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