On November 22, 2017, the Federal Energy Regulatory Commission ("Commission") issued an Order on Petition for Declaratory Order denying a petition filed by Magellan Midstream Partners, L.P. ("Magellan") and finding that certain arrangements for marketing companies to ship crude oil on an affiliated company’s pipeline would violate the Interstate Commerce Act ("ICA"). The much-anticipated order has the potential to disrupt existing crude oil and liquids product marketing arrangements and shines a spotlight on issues that previously remained behind the scenes of the Commission’s ICA regulation.
Specifically, the Commission found that commercial arrangements in which a marketing affiliate ships crude oil (or other products subject to ICA jurisdiction) on an affiliated pipeline at an economic loss, i.e., where the pipeline’s tariff rate for transportation service is greater than the difference in price between the origin and destination markets, violate “various provisions of the ICA, primarily the ICA’s prohibition on rebates.”1 The practice of having an integrated company with a marketing entity that transports on an affiliated pipeline is common in the industry, and the Magellan Order is likely to have an effect on a number of these integrated companies as well as some producers, who now must analyze the effect the order has on existing and future marketing arrangements. As that analysis unfolds, it will be important to understand what the Commission found and what it did not find in Magellan, as well as ways in which marketing arrangements could be modified going forward in order to account for the issue identified in Magellan.
Magellan’s Petition for Declaratory Order
On November 14, 2016, Magellan filed a petition asking the Commission to declare that establishment of a marketing affiliate to buy, sell, and ship crude oil on Magellan’s pipeline system at the applicable tariff rate would comply with the ICA. Magellan further requested the Commission approve specific interactions between the marketer and affiliated pipeline, as well as transactions in which the marketing affiliate could incur a profit or loss on shipments of crude oil on the Magellan System while still providing overall benefits to the integrated company. Magellan explained that such an arrangement would provide an overall benefit to the integrated company even when the price differentials between the origin and destination points were lower than the published tariff rates paid by the affiliate, so long as the price differential exceeds the variable costs of the movement. Magellan also argued that its competitors have similar marketing affiliate arrangements, placing Magellan at a disadvantage, and that granting the petition would allow Magellan to compete more effectively for shipper volumes, increase usage of underutilized pipeline capacity, and provide greater flexibility for producers and marketers.
Several entities filed comments in the Commission proceeding, both in support of and in opposition to the petition. A number of intervenors supported the petition, arguing that it is well-established in Commission precedent that ICA-jurisdictional pipelines can be affiliated with marketing entities and those entities can ship on their affiliated pipelines. Intervenors further argued, however, that the Commission does not have jurisdiction over a common carrier’s decision to establish a marketing affiliate or over the marketing affiliate itself or its activities. Opponents of the petition in turn argued that granting the petition could allow Magellan to evade the ICA’s requirements concerning just, reasonable and non-discriminatory rates and that the proposed transactions violate the Elkins Act, which makes it “unlawful for any person, persons, or corporation to offer, grant, give, or to solicit, accept, or receive any rebate, concession, or discrimination to the transportation of any property in interstate commerce…”2
The Commission's Findings in the Magellan Order
The Commission denied Magellan's petition, noting that while several aspects of Magellan's request related to well-established Commission precedent (such as the creation of a marketing affiliate by an oil pipeline) or issues outside the scope of the Commission's jurisdiction (including sales of petroleum products), Magellan's proposal as a whole would violate various provisions of the ICA, primarily its prohibition on rebates. The Commission concluded that the transactions at issue were unlawful for several reasons:
- First, the proposed transactions were barred under Section 6(7) of the ICA, which prohibits a carrier from providing rebates of the filed rates. Direct or indirect payments back to a shipper constitute prohibited rebates from the filed tariff rate, and even though the affiliated shipper would facially pay the pipeline’s tariff rate, the integrated nature of the companies coupled with the intentional loss on the marketer’s buy/sell arrangement would act as an indirect payment back to the affiliated marketer to support that loss. The prohibitions on rebates therefore prevents marketing affiliates from shipping in situations where the price differential between the origin and destination markets is insufficient to cover the filed tariff rate on an affiliated pipeline and the pipeline subsidizes those loses.
- Second, the transactions would be illegal under ICA Section 2, which prohibits charging different rates for identical service. The Commission concluded that Magellan’s proposed transactions implicitly offer different rates, terms, and conditions to its affiliates, as well as providing service different from that offered in its tariff. Similarly, the Commission concluded that the proposal also would violate the ICA Section 3(1)’s anti-discrimination provisions that make it unlawful for a common carrier to offer pipeline transportation pursuant to customized terms, conditions, and rates unavailable to all shippers. In its petition, Magellan reasoned that the true cost of transportation to the integrated company is the variable cost of such transportation. The Commission agreed with Magellan’s reasoning and found that "providing transportation service to affiliates at the variable cost of the movement, while requiring non-affiliated shippers to pay the filed tariff rate, would violate section 3(1)."3
- Third, the Commission found that Magellan’s proposal would circumvent the ICA’s requirements for publication and the Commission review of transportation rates. ICA section 1(5) requires that all rates must be subject to review by the Commission for a determination of whether such rates are just and reasonable, while ICA sections 6(1) and 6(3) require publication of rates for transportation service and changes in rates. Although the affiliate may on paper pay the filed tariff rate, as explained above, the Commission agreed that the actual cost of transportation to the integrated company would be the variable cost of providing transportation, which would not have been reviewed by the Commission nor, presumably, published by the pipeline.
Arrangements Approved and Issues not Resolved in the Magellan Order
While the Magellan Order was clear on its findings in response to Magellan’s specific proposal, there are a number of issues relevant to marketers and producers that were either reaffirmed by the Commission or not resolved and that remain open for future determination. Moreover, given the industry interest in the Magellan Order, it is likely that parties will seek rehearing of the order. (The deadline for rehearing requests is Friday, December 22, 2017.)
Specifically, the Commission stated that the ICA does not prohibit the creation of a marketing affiliate nor prohibit a marketing affiliate from shipping on a pipeline where the price differential between origin and destination markets equals or exceeds the filed tariff rate. The Commission also clarified that the prohibition on rebates does not serve as "a blanket restriction on integrated company financing."4 The Magellan Order also does not address the issue of whether dividends paid to affiliates constitute unlawful rebates. The rebate issue was not raised in the petition, but the Commission did distinguish the transactions proposed by Magellan from the payment of dividends on the grounds that the transactions proposed by Magellan involved “specific transaction payments that are calculated based on a comparison between price differentials and the pipeline’s filed tariff rate."5
What’s Next for Producers, Marketing Affiliates, and Pipelines?
While the Magellan Order remains subject to rehearing and is not a broad-based rulemaking affecting transactions outside of those addressed in Magellan’s petition, integrated companies as well as producers who utilize marketing entities affiliated with pipelines nevertheless have a number of issues to consider in relation to the Magellan Order. If it becomes final after rehearing requests, the Commission’s findings in the Magellan Order could trigger a wave of litigation by shippers on a pipeline competing with that pipeline’s marketing affiliate, especially if such third-party shippers seek lower rates or access to additional capacity. Marketers and producers should examine existing marketing arrangements to analyze the extent to which they are factually consistent with the marketing arrangement proposed by Magellan and found to be prohibited in the Magellan Order. Interpreted broadly, the order calls into question the legality of arrangements that allow a marketer shipping on an affiliated pipeline to continue buy/sell arrangements when the price spread on the buy/sell could move lower than the tariff rate for transportation. For producers, the order also could initially increase the cost to get to market, with purchasing marketing entities unable to help overcome tariffed transportation costs that exceed the relevant market price differentials. Marketers and affiliated pipelines, in turn, may reevaluate standard marketing arrangements and consider a number of possible contractual options to address the issues raised in the Magellan Order.