Regulatory Basics for Oil Pipelines

September 16, 2009

AOPL Workshop
Discussion Outline

 Part I: Who regulates oil pipelines?

 Part II: Procedures for filing tariffs.

 Part III: The two major rate-setting methodologies.
Part I

Federal Energy Regulatory Commission

The federal authority 

responsible for 

regulating oil pipelines
FERC

Introduction

 Also regulates the electric, hydro, gas industries.

 Part of the Executive Branch.

 An independent agency.

 Extensive Congressional oversight.

 Funded by the fees charged to the entities it regulates 

 As of 2009, regulated 141 oil pipelines. 

 FERC departments important to oil pipeline industry:

 Office of Energy Markets & Reliability

 Office of Enforcement

 Office of Administrative Litigation
FERC

Organizational Chart
FERC

Commissioners as of Sept. 2009 

Marc 

Spitzer

R

Philip 

Moeller

R

Jon 

Wellinghoff 

Chairman

D

Suedeen 

Kelly 

D
FERC

Commissioners

 Appointed by the President with the consent of 

the Senate.

 Serve 5-Year Terms.

 Equal vote on regulatory matters.

 No more than 3 Commissioners of the same 

political party. 
FERC

Office of Energy Markets & Reliability

 Principal advisor to the Commission on regulatory 

issues.

 Oversees energy market structure and performance.

 Oversight of compliance of market participants with the 

Commission's rules. 

 Conducts analytical studies of energy markets.

 OEMR Division Key to Oil Pipelines:

 Division of Tariffs and Market Development (Central Group)

 1 of 6 divisions under OEMR
FERC

Tariffs and Market Development (Central Group)

 Analyzes oil pipeline tariff and rate change filings. 

 Advises Commission on filings, initial decisions, 

rehearings, complaints, & declaratory orders.

 Directs companies to perform oil pipeline statutory 

depreciation studies.

 Analyzes oil pipeline market-based rate applications.

 Often assists pipelines in complying with regulations 

(e.g. ensuring tariffs meet all of the pertinent 

requirements).
FERC

Office of Enforcement

 Oversees compliance of market participants with the 

Commission’s rules for market activity.

 Reports on the state of the energy markets, analyzing 

market activities and trends.

 Advises the Commission on accounting and financial 

matters affecting energy markets.

 Oversees compliance with the Uniform System of 

Accounts.

 OE Divisions Key to Oil Pipelines:

 Division of Financial Regulation

 Division of Audits
FERC

OE: Division of Financial Regulation

 Provides guidance to the Commission concerning its 

financial accounting

 Reviews new or proposed accounting standards 

made by authoritative accounting bodies to 

determine effect on regulated industries.

 Prepares and coordinates necessary revisions 

and/or amendments to the Commission’s Uniform 

System of Accounts.

 Administers financial forms Nos. 1, 2, 2-A, 6, 3Q, 

6Q, etc.
FERC

Form No. 6

 What is the Form 6?

Required Annual Report of Oil Pipeline Companies who are 

regulated by the Federal Energy Regulatory Commission as set forth 

in the Interstate Commerce Act

 Who uses the Form 6?

FERC and Other Regulatory Commissions, Shippers, Carriers, AOPL, 

Bureau of Economic Analysis

 Purpose of the Form 6:

To collect comprehensive financial and operational information 

about oil pipeline companies subject to the jurisdiction of the FERC

 General Corporate Information 

 Financial Statements

 Plant Statistical Data

 Allowed Cost-of-Service (Page 700)

 Filing Dates

 Year-End (Form 6)- April 18th

 Quarterly (Form 6-Q) (70 days after the quarter ends)
FERC

OE: Division of Audits

 Performs financial and operational audits of industry 

participants.

 Performs audits on a random basis.

 Authority to audit all FERC regulation related records

 Represents the Commission and explains and advocates 

its legal and policy positions.

 Advises the Commission on compliance related matters.
FERC

Offices Involved in Rate Cases

 Office of Administrative Litigation (OAL)

 Resolves disputes through settlement.

 Litigates unresolved issues at hearing.

 Commission Staff and lawyers represent the public interest.

 Office of Administrative Law Judges (OALJ)

 Resolves contested cases as directed by the Commission, 

either through impartial hearing and decision or through 

negotiated settlement. 

 Conducts fair and impartial investigations as directed by 

the Commission. 

 Performs various alternative dispute resolution (ADR) as 

directed by the Commission.
Part II

Rate-Setting Procedures

Initial Rates

Indexed Rates

Grandfathered Rates

Settlement Rates

Market-Based Rates

Cost-of-Service Rates
Rate-Setting Procedures

Introduction

 Where are regulations pertaining to oil pipelines located?

 Code of Federal Regulations, Title 18 - Conservation of Power and 

Water Recourses (CFR 18)

 FERC & DOE regulations: Volume I, parts 1 to 399.

 Chapters pertinent to oil pipelines:

 Subchapter P – Regulations under the Interstate Commerce Act 

(ICA), Parts 340-350

 Subchapter Q – Accounts under the ICA, Parts 351-352

 Subchapter R – Approved Forms, ICA, Parts 356-357

 Where are regulations specific to tariff filings located?

 18 C.F.R. § 340

 Tariffs must be filed 30 days prior to taking effect, 18 C.F.R. §341.2

 Neither the filing date nor the effective date are counted in the 30 

days 

 Short notice exception

 Tariff must be formatted in conformance with regulations, 18 C.F.R. 

§341.3
Tariff Rate Types

Initial Rates (18 C.F.R. §342.2)

 A carrier must justify an initial rate for a new service by:

a) Filing a cost-of-service to support such rate, or

b) Filing a sworn affidavit that the rate is agreed to by 

at least one non-affiliated shipper who intends to 

use the service in question (a negotiated rate).
Tariff Rate Types

Indexed Rates 18 C.F.R. §342.3

 A rate may be changed, at any time, to a level not to 

exceed the ceiling level.

 The current period ceiling level equals the product of the 

previous index year’s ceiling level and the most recent 

index published by the Commission.

 Index published prior to June 1 of each year.
Tariff Rate Types

Grandfathered Rates

 Section 1803(a) of the Energy Policy Act of 1992

(“EPAct”) deems just and reasonable “any rate in effect

for the 365-day period ending on the date of the

enactment of this Act ... if the rate in effect... has not

been subject to protest, investigation or complaint during

such period.

 A grandfathered rate can be challenged if:

 “a substantial change has occurred after” October 24, 

1992, “in the economic circumstances of the oil 

pipeline which were a basis for the rate,” or

 “a substantial change has occurred after” October 24, 

1992, “in the nature of the services provided which 

were the basis of the rate.”
Tariff Rate Types

Settlement Rates 18 C.F.R. §342.4

 A carrier may change a rate without regard to the ceiling 

level if the proposed change has been agreed to, in 

writing, by each person who, on the day of the filing of 

the proposed rate change, is using the service covered 

by the rate.
Tariff Rate Types

Market-Based Rates 18 C.F.R. §342.3

 Carrier must demonstrate that it lacks significant market 

power in the in the origin market and the destination 

market.

 Filing requirements established in 18 C.F.R. §348.

 These filing requirements require a relatively lengthy 

application.

 If the application is approved, the carrier may set rates 

at whatever level the market will bear.

 Chris Lyons and I will be giving a presentation discussing 

market-based rates in significant depth at XX
Tariff Rate Types

Cost-of-Service Rates 18 C.F.R. §342.4

 Carrier must show that there is a substantial divergence 

between the actual costs experienced by the carrier and 

the rate resulting from the application of the index such 

that the rate at the ceiling level would preclude the 

carrier from being able to charge a just and reasonable 

rate within the meaning in the Interstate Commerce Act.

 Filing requirements established in 18 C.F.R. §346

 More on cost-based rates to come...
PART III

Cost-of-Service Rates
Cost-of-Service

Introduction

 Types of Cost-of-Service Methodologies:

 Depreciated Original Cost (“DOC”)

 Trended Original Cost (“TOC”)

 COS Methodology Prescribed by the Commission: The 

Opinion No. 154-B Cost-of-Service Methodology

 Issued June, 1985

 Utilizes a TOC rate base

 Has been modified and clarified by subsequent 

decisions.
Cost-of-Service

Depreciated Original Cost

Operating Expenses

+ Return of Rate Base (Depreciation)

+ Return on Rate Base

+ Amortization of Allowance for Funds Used 

During Construction (“AFUDC”) 

+ Income Tax Allowance

= Cost of Service (Revenue Requirement)
Cost-of-Service

Operating Expenses

 Salaries and Wages

 Materials and Supplies

 Outside Services

 Fuel and Power

 Pensions and Benefits

 Insurance 

 Oil Losses and Shortages

 Taxes other than Income Taxes

 Allocated Overhead
Allocated Overhead

 For pipelines that are subsidiaries of a larger 

corporation, allocated overhead can represent a 

significant component of the COS.

 The Commission generally uses a three factor 

approach consisting of revenue, plant and payroll to 

allocate overhead.

 Other approaches are permissible.

 The critical issue is that the allocation methodology 

match cost with causation. 
Cost-of-Service 

Depreciation 

 Depreciation Example:

 Beginning of Year 1 Rate Base = 1000

 Estimated Life = 20 years

 Year 1 Depreciation Expense = (1000 / 20) = 50

 Group Method of Depreciation: a number of similar or 

related assets are included in a group to which a single 

composite depreciation rate is applied.
Cost-of-Service

Rate Base

Carrier Property in Service

- Accumulated Depreciation

+ Allowance for Funds Used During Construction 

(“AFUDC”) 

- Accumulated Amortization of AFUDC

+ Working Capital Allowance

- Accumulated Deferred Income Taxes (“ADIT”)

= DOC Rate Base
Cost-of-Service

Accumulated Deferred Income Tax

Calculation of ADIT Year 1 Year 2 Year 3 Year 4

Tax Depreciation 33.3 33.3 33.3 -

Book Depreciation 25.0 25.0 25.0 25.0

Timing Difference 8.3 8.3 8.3 (25.0)

Deferred Income Taxes 4.2 4.2 4.2 (12.5)

ADIT 4.2 8.3 12.5 -

Property 100

Book Depreciation 25%

Tax Depreciation 33%

Income Tax Rate 50%

Equity % 100%

ROE 10%

Assumptions
Cost-of-Service

Return on Rate Base

Debt % x Cost of Debt

+ Equity % x Nominal Equity Rate of Return

= Weighted Cost of Capital

Average DOC Rate Base

x Weighted Cost of Capital

= Return on DOC Rate Base
Cost-of-Service

Allowance for Funds Used During Construction

Average Monthly Construction Work in Progress (“CWIP”) 

Balance

x Weighted Cost of Capital

= AFUDC 

Average AFUDC Balance 

x Useful Life Factor

= Amortization of AFUDC
Cost-of-Service

Income Tax Allowance

Equity Portion of Return on DOC Rate Base

+ Amortization of Equity AFUDC

= Taxable Elements of Return

x Net-to-Tax Multiplier

= Income Tax Allowance

Income Tax Rate*

÷ (1.0 – Income Tax Rate)

= Net-to-Tax Multiplier

*Generally based on the statutory marginal tax rate for corporations
Cost-of-Service

DOC Recap

Operating Expenses

+ Return of Rate Base (Depreciation)

+ Return on Rate Base

+ Amortization of Allowance for Funds Used 

During Construction (“AFUDC”) 

+ Income Tax Allowance

= Cost of Service (Revenue Requirement)
Cost-of-Service

Trended Original Cost (TOC)

 Variation of DOC.

 Stores inflation adjustment in Rate Base and recovers as 

“Deferred Return” over life of assets.

 Applies Real Return on Equity (“ROE”)1/ to “equity” 

portion of Rate Base and Cost of Debt (“COD”) to debt 

portion of Rate Base.

 Trends portion of Rate Base funded by equity to reflect 

inflation as measured by the CPI-U.
Cost-of-Service

Nominal Equity Rate of Return

Real

Rate

of

Return

Inflation

TOC

Rate Base

TOC

Cost of

Service

DOC

Cost of

Service
Cost-of-Service

Calculation & Amortization of Deferred Return

Trending Base (Equity Rate Base)

x Inflation Factor

= Deferred Return

Deferred Return

x Useful Life Amortization Factor

= Amortization of Deferred Return
Cost-of-Service

Opinion No. 154-B

 Issued June of 1985.

 Adopts the trended original cost rate base (“TOC”) 

for oil pipelines wishing to establish or change their 

tariff rates by filing a cost-of-service.

 Provides for a transition from the previous valuation 

rate base methodology, referred to as the “starting 

rate base,” (“SRB”).

 Advocates use of the pipeline’s actual capital 

structure.

 Case-by-case determination of many issues.

* FERC Opinion No. 154-B, as modified and clarified by subsequent decisions
Cost-of-Service

Starting Rate Base

 Intended to provide transition from prior methodology.

 One-time calculation as of December 31, 1983.

 SRB Formula:

(Debt % x Net Original Cost)

+ (Equity % x Net Reproduction Cost New)

= Starting Rate Base

Starting Rate Base (“SRB”)

- DOC Rate Base

= SRB Write-Up
Cost-of-Service

Starting Rate Base Write-Up

 SRB Write-Up is included in Opinion No. 154-B 

Rate Base.

 SRB Write-Up is amortized.

 Amortization of SRB Write-Up is excluded from 

Cost of Service.

 Carrier’s Return On Rate Base includes a return 

on the unamortized SRB.

 SRB Write-Up is included in Trending Base when 

computing Deferred Return.
Cost-of-Service

Rate Base Components

DOC Rate Base

+ SRB Write-Up

- Accumulated Amortization of SRB Write-up

+ Deferred Return

- Accumulated Amortization of Deferred Return

= 154-B TOC Rate Base
Cost-of-Service

Income Tax Allowance

Equity Portion of Return on TOC Rate Base

+ Amortization of Deferred Return

= Subtotal

x Net-to-Tax Multiplier

= Income Tax Allowance
Cost-of-Service

Base & Test Periods

 A base period must consist of 12 consecutive months of 

actual experience adjusted to eliminate non-recurring 

items. Carrier may include appropriate normalizing 

adjustments in lieu of non-recurring items.

 A test period must consist of a base period adjusted for 

changes in revenues and costs which are known and 

measurable with reasonable accuracy at the time of 

filing and which become effective within nine months 

after the last month of available actual experience 

utilized in the filing. For good cause shown, the 

Commission may allow reasonable deviation from the 

prescribed test period.

 See 18 C.F.R. §346.2.
Critical Take-Aways on COS

 The calculations contain a number of variables that 

function in tandem.

 Some of the required inputs involve data going back 

over 25 years.

 The higher the quality of the data the more 

successful a cost-based rate filing will be. 
Questions?