As reported in our prior blogs, on November 2014, the Federal Energy Regulatory Commission (FERC) proposed a Policy Statement on Cost Recovery Mechanisms for Modernization of Natural Gas Facilities in Docket No. PL15-1 that would allow interstate pipelines that meet certain criteria to recover the costs of modernizing their facilities through an approved cost tracker or surcharge mechanism. On April 15, 2015, following its review of substantial initial and reply comments, FERC issued an order implementing the Policy Statement, effective October 1, 2015. By order issued November 30, 2015 in Tallgrass Interstate Gas Transmission, LLC (“Tallgrass”), Docket No. RP16-137, FERC took the opportunity to preliminarily address the first cost recovery tracker proposed under the Policy Statement, one heavily contested by the pipeline’s shippers.

Tallgrass’ Proposal

On October 30, 2015, Tallgrass filed a general rate case under Section 4 of the Natural Gas Act. 15 U.S.C. 717c. As part of the filing, Tallgrass proposed a commodity surcharge to recover one-time system integrity costs pursuant to the Policy Statement. Through this mechanism, Tallgrass would recover “system safety, integrity, reliability, and environmental-related costs” in a volumetric surcharge to its usage rates. The revised General Terms & Conditions of its Tariff would define costs eligible for recovery through the Cost Recovery Mechanism as both capital costs and operation and maintenance (O&M) costs related to projects designed to comply with the regulations of  the Pipeline and Hazardous Materials Safety Administration, Environmental Protection Agency, and other governmental agencies.

FERC’s Reactions

In its November 30 suspension order, FERC was “encouraged that Tallgrass submitted a comprehensive proposal” that included “detailed testimony and exhibits explaining how its proposed Cost Recovery Mechanism charge satisfies the five standards set forth in the Modernization Cost Recovery Policy Statement.” FERC found that “Tallgrass’ filing of a general section 4 rate case in conjunction with its proposed Cost Recovery Mechanism will allow a thorough review of the justness and reasonableness of the base rates to which the Cost Recovery Mechanism will be attached, consistent with the policy statement.” Nevertheless, FERC determined that the proposal raised “numerous significant issues” of material fact that, along with the traditional rate case issues presented, should be addressed in an evidentiary hearing.

First, FERC found that protestors raised valid questions as to whether the specific projects included in the Cost Recovery Mechanism are consistent with the Policy Statement’s requirement precluding recovery in the Cost Recovery Mechanism of ordinary capital costs routinely incurred as part of regular system maintenance, costs that should continue to be recovered in the pipeline’s base rates.

Second, protestors pointed out that Tallgrass failed to include a mechanism for ensuring that a representative level of ordinary system maintenance capital costs are excluded from the tracker, as suggested by the Policy Statement.

Third, FERC found that the protestors raised “serious concerns” that Tallgrass included ordinary, recurring O&M costs in its Cost Recovery Mechanism charge (e.g., in-line inspections and hydrostatic testing), contrary to the Policy Statement.

In addition to the issues set for hearing, FERC summarily rejected Tallgrass’ proposed design of its Cost Recovery Mechanism charge, finding it in violation of FERC Order No. 636, which requires pipelines to use a Straight Fixed Variable (SFV) rate design that assigns all fixed costs to a pipeline’s reservation charges. While Tallgrass proposed to continue to design its base rates using an SFV rate design, its proposed Cost Recovery Mechanism is a volumetric surcharge through which Tallgrass impermissibly seeks to recover fixed costs. FERC ordered Tallgrass to revise its Cost Recovery Mechanism to be consistent with an SFV rate design.

Looking Ahead

Responding to the first pipeline Cost Recovery Mechanism proposal under the Modernization Policy Statement, it is not surprising that absent a comprehensive settlement offer the Commission would apply a strict interpretation to the Policy Statement’s underlying rate design criteria; nor is it surprising that the Commission would set all aspects of Tallgrass’ heavily contested Cost Recovery Mechanism proposal for hearing to determine their justness and reasonableness. Time will tell whether, and to what extent, the record in this proceeding will seek to test the scope of the Policy Statement’s criteria and require FERC to provide additional guidance to the industry regarding its proper implementation. For this reason, we will continue to monitor this case and report out any significant developments.