In November 2014, the Federal Energy Regulatory Commission (“FERC”) proposed a PolicyStatement on Cost Recovery Mechanisms for Modernization of Natural GasFacilities in Docket No. PL15-1 that would allow interstate pipelines to recover the costs of modernizing their facilities through an approved cost tracker or surcharge mechanism. Following its review of substantial initial and replycomments, FERC issued an order on April 15, 2015 implementing the Policy Statement effective October 1, 2015.

The various filed comments demonstrated a sharp disagreement between the pipelines and their customers regarding: (1) whether pipelines should receive a financial incentive for complying with EPA and PHMSA safety and environmental regulations; (2) whether the proposed policy was premature, since EPA and PHMSA have not implemented any regulations and there is considerable uncertainty about the effects of this type of tracker; and (3) whether the tracker would contravene the need for traditional Section 4 rate cases. Despite the contrasting views within the industry, FERC approved the Policy Statement with little modification.

In the final Policy Statement, FERC recognized that although its general policy is to prohibit cost trackers, this tracker was justified in order for pipelines to have a mechanism by which to recover costs of replacing “aging, unsafe and leak-prone facilities.” Under the Policy Statement, FERC will require each pipeline requesting a tracker to satisfy five standards:

  1. Review of Existing Rates: The pipeline must demonstrate that its existing rates are just and reasonable. FERC declined to require that the rate review be conducted through a Section 4 proceeding. It instead stated that pipelines could propose alternative approaches for rate justification. FERC encouraged a full exchange of information with the pipeline’s customers to ensure justification of its base rates, and stated that it will establish appropriate procedures on a case-by-case basis to resolve any issues of material fact based on the substantial evidence on the record.
  2. Defined Eligible Costs: The pipeline must specifically define the costs that it intends to recover through the tracker mechanism. However, this list of costs could be modified at a later date. FERC found that by requiring pipelines to clearly define their included costs, rate transparency will be ensured. The pipeline must also demonstrate that the costs that it seeks to recover are limited to one-time capital costs that are either necessary to comply with federal or state regulations or are necessary to improve pipeline facility efficiency. Reoccurring maintenance costs or testing costs to identify upgrades must be excluded from the mechanism. FERC suggested, however, that a pipeline could include a provision in its proposed tracker that explicitly excludes an amount representing its ordinary system costs.
  3. Avoidance of Cost Shifting: A pipeline must design its mechanism to protect its captive customers from cost shifts in the event that shippers leave the system. To do so, FERC suggested that a pipeline might agree to set a floor on the billing determinants that it uses to design the surcharge. FERC stated that it would review the billing determinants used by each pipeline on a case-by-case basis.
  4. Periodic Review: A pipeline must provide for periodic review of its mechanism to ensure that it and the underlying base rates remain just and reasonable. To meet this goal, FERC suggested that pipelines make their trackers temporary. If the mechanism terminates before recovering its costs, the pipeline could either seek to recover remaining costs in its next Section 4 rate case or file to extend the tracker. FERC stated that it will not require pipelines to file a full Section 4 rate case to review the mechanism; rather that it “remains open” to reasonable proposals for achieving such review.
  5. Shipper Support: A pipeline must work collaboratively with its shippers to seek support for its cost recovery proposal, but FERC declined to require a minimum level of customer support to warrant implementation. Instead FERC found that, as long as a pipeline demonstrates that its proposed mechanism is just and reasonable under Section 4 and meets the Policy Statement guidelines, the proposal may be accepted, even if some customers voice opposition.

Although FERC found that compliance with these five factors should protect shippers from being exposed to excessive costs, the final Policy Statement clearly sided with the pipelines’ requests for flexibility. Thus, affected shippers will need to be vigilant in reviewing the justness and reasonableness of a pipeline’s proposal beginning at the pre-filing collaborative stage. Given the ability of pipelines to submit their tracker mechanism filings on October 1, 2015, we expect that some pipelines will commence pre-filing discussions with their shippers as early as this summer.