240 7-18-85 Commission Opinions, Orders and Notices

61,831

American Petrofina Company of Texas and Petrofina Delaware, Inc ., Docket

No. CI85-41-002 ;

Diamond Shamrock Exploration Company, Docket No. CI85-50-001 ;

Union Texas Petroleum Company, Docket No . CI85-99-001 ;

Conoco, Inc ., Docket No. C185-156-001 ;

Yankee Resources, Inc ., Docket No. CI84-565-001 ;

Chevron USA, Inc ., Docket No. CI85-167-001 ;

Marathon Oil Company, Docket No . CI85-173-001 ;

Kerr-McGee Corporation, Docket No . CI85-176-001 ;

Samson Resources Company, Docket No . C185-239-001

Order Dismissing Request for Rehearing in Certain Dockets

(Issued June 27, 1985)

Before Commissioners : Raymond J . O'Connor, Chairman; Georgiana Sheldon,

A. G . Sousa and Charles G . Stalon.

On May 29, 1985, the Maryland People's

Counsel (MPC) filed in the above-captioned

dockets a request for rehearing of the

Commission's May 17, 1985 order [31 FERC

¶61,171] issued in Docket No. CI83-269-038,

,et aL, MPC, however, did not intervene in the

above-captioned dockets as provided for in

Rule 214 (18 C .F .R . § 385 .214) of the

Commission's Rules of Practice and Procedure .

[161,376]

Regulation of Electricity Sales-for-Resale and Transmission Services, Docket

No. RM85-17-000 (Phase II)

Notice of Inquiry

(Issued June 28, 1985)

By Direction of the Commission : Lois D . Cashell, Acting Secretary.

[This rule was published in 50 Fed . Reg. 27604, on July 5, 1985, and appears at

FERC Statutes and Regulations 135,519. ]

[161,377]

Williams Pipe Line Company, Docket Nos. OR79-1-000 and 022 (Phase I)

Opinion No. 154-B; Opinion and Order on Remand

(Issued June 28, 1985)

Before Commissioners : Raymond J . O'Connor, Chairman ; Georgiana Sheldon,

A. G. Sousa and Charles G . Stalon .

[Note: Opinion No. 154-A, Opinion and Order Denying Rehearing, issued

January 31, 1983, appears at 22 FERC 161,086 .1

FERC Reports161,377

050-24

Therefore, MPC is not a party, as defined in 18

C.F .R. § 385 .102(c) of the Regulations, in

these proceedings. Thus, pursuant to § 385 .713

of the Regulations, MPC has no standing to

request rehearing of the May 17, 1985 order in

the above-captioned dockets .

Accordingly, Maryland People's Counsel's

request for rehearing in the above-captioned

dockets is dismissed .
61,832

Cited as "31 FERC ¶ . . . .

[Opinion No. 154-B Text]

Introduction

On March 9, 1984, the United States Court of Appeals for the District of

Columbia Circuit affirmed in part and remanded in part the Commission's' opinion in

Phase I of this proceeding .'

The purpose in Phase I of this proceeding is to devise generic principles for the

setting of just and reasonable oil :pipeline rates . One essential ingredient in this task is

to adopt rate base and rate of return methodologies which will operate together to

produce a just and reasonable return allowance . In making this determination the

Commission must also determine the proper method for computing the tax expense

component of an oil pipeline's cost-of-service . 2

Background

This proceeding began in 1972 when various shippers (Mid-Continent Shippers)

using the Williams Pipe Line Company (Williams) challenged the lawfulness of

Williams' rates before the Interstate Commerce Commission (ICC) . The ICC found

those rates to be just and reasonable under its traditional criteria of an overall rate of

return of .10 percent on a valuation rate baser s The Mid-Continent Shippers appealed

to the United States Court of Appeals for the .District of Columbia Circuit .

In 1977, while that appeal was pending, Congress transferred regulatory

authority over oil pipelines to this Commission. 4 In 1978, at the Commission's request

so that it could begin its "regulatory duties . . . with a clean slate," the court remanded

the case to the Commission for reconsideration . a The court wanted to allow the

Commission "to build a viable modern precedent . . . that not only reaches the right

result, but does so by way of ratemaking criteria free of the problems that appear to

exist in the ICC'.s approach." 6

In 1982, the Commission issued Opinion No . 154 .

7 In that opinion, the

Commission retained the valuation rate base but adopted a new rate of return

methodology. 8 The Mid-Continent Shippers and the United States Department 'of

Justice (Justice), among others, challenged the opinion .

Upon review of the opinion, the court remanded certain aspects of it . In its

opinion, the ' court concluded that none of the Commission's explanations for 'its

rejection of an original ,cost rate base was satisfactory, 9 that the Commission "did not

offer a reasoned explanation for adhering to an .admittedly antiquated and inaccurate

formula [valuation], but rather a host of unconvincing excuses that fail to add up to a

rational choice," 10 that it could not "locate the rhyme nor reason of [the] rate of

return methodology" 11 and that the Commission "made no attempt to estimate the

risks involved with oil pipeline operations ." 1 2 Finally, the court asked the Commission

to once again inquire into the proper ratemaking method for oil pipelines . To help

make that inquiry, the court furnished the Commission with some "important and

basic guideposts ." Is In sum, it advised :

Most fundamentally, FERC's statutory mandate under the Interstate Commerce

Act requires oil pipeline rates to be set within the "zone of reasonableness" ;

presumed market forces may not comprise, the principal regulatory constraint.

Departures from cost-based rates must be made, if at all, only when the non-cost

factors are clearly identified and the , substitute or supplemental ratemaking

methods ensure that the resulting rate levels are justified by those factors . In

240 7-18-85

161,377 Federal Energy Guidelines

002-23
240 7-18-85

Commission Opinions ; Orders and Notices61,833

.addition, the rate of return methodology should take account of the risks

associated with the regulated enterprise . It should not be forgotten, too, that the

choice of a proper rate of return is only part of what should be an integrated

ratemaking method, and accordingly FERC must carefully scrutinize the rate

base and rate of return methodologies to see that they will operate together to

produce a just and reasonable rate .

14

Summary of the Commission's Decision

It is evident that oil pipeline rates as a general rule must be cost-based. After reexamining the record in this proceeding, the Commission concludes that with the

exception of the starting rate base, as discussed below, a rate base methodology derived

from original cost rate making models should be adopted . As the court observed,

original cost is a "proven alternative ." 15 Its obvious advantage, as the Commission

has observed, is that "the language of American finance is an .original cost language"

for American industry reports its earnings on net book investment . 16 Hence, original

cost is the best yardstick to compare an oil pipeline to other oil pipelines, to other

industrial companies, to other industries, and to the entire American economy in order

to approximate the oil pipeline's cost of capital . 17 For oil pipelines, for the reasons

given below, the Commission adopts net depreciated trended original cost (TOC) as the

model for calculating rate bases, and therefore, determining revenue requirements .

Next, the Commission concludes that rate of return should be determined on a

case-specific basis with reference to the particular pipeline's risks and its

corresponding cost of capital . Moreover, as discussed below, the Commission shall use

the usual approach of using embedded debt costs and setting a rate of return on equity

capital . And the Commission shall use a pipeline's or its parent's actual capital

structure but will allow participants on a case-specific basis to urge the use of some

other capital structure . Lastly, for the reasons given below, the Commission shall adopt

a starting rate base for existing assets consisting of the sum of a pipeline's debt ratio

times book net depreciated original cost and the equity ratio times the reproduction

cost portion of the valuation rate base depreciated by the same percentage as the book

original cost rate base has been depreciated .

With respect to taxes, the Commission adopts normalization for oil pipelines

rather than flow-through of the benefits of income tax deferrals .

The Association of Oil Pipe Lines (AOPL), supported by Texas Eastern

Transmission Corporation and Sun Pipe Line Company, asks that the Commission

reopen the Phase I record to receive more evidence on several topics . The Marathon

Pipe Line Company in a petition also indicates a desire to submit more evidence . None

of that supplemental evidence requested by those parties is required for the

Commission to reach its decision herein . Hence, the AOPL's motion and Marathon's

petition are denied .

Rate Base-General

As stated earlier, the Commission adopts TOC as the form of a cost-based rate

base rather than net depreciated original cost . 18 Thus, all new pipeline assets will be

added to the rate base at original cost and trended as described below . However, for

existing assets that are currently valued under the valuation formula, a one time

adjustment will be necessary to arrive at an appropriate base to be trended for the

future . The formula the Commission has decided to employ for this one time

adjustment to bridge the transition from valuation to TOC is described below in the

FERC Reports

003-23

¶ 61,377
61;834

Cited as "31 FERC ¶ . . . ."

section called "Starting Rate Base ." Before discussing the reasons for the decision, the

Commission shall describe the TOC model .

TOC works as follows . 19 First, TOC, just like net depreciated original cost,

requires the determination of a nominal (inflation-included) rate of return on, equity

that reflects the pipeline's risks and its corresponding cost of capital . Next, the

inflation component of that rate of return is extracted . This leaves what economists

call a "real" rate of return . The real rate of return times the equity share of the rate

base yields the yearly allowed equity return in dollars . The inflation factor times the

equity rate base yields the equity rate base write-up . That write-up, like depreciation,

is written-off or amortized over the life of the property.

20

The following example illustrates TOC . Assume a new pipeline with an original

equity investment of $1,000 . Also assume that a just and reasonable overall rate of

return on equity would be 16 percent and that 7 percent of that represents inflation.

This leaves 9 percent as the so-called "real" rate of return . In its first year of service,

the pipeline would be entitled to earn $90 (9 percent times $1,000) and $70 (7 percent

times $1,000) would be capitalized into its equity rate base to be amortized over the

life of the property starting in the first year, along with the depreciation on the $1,000 .

If that life were twenty years, in addition to the return of $90, the pipeline would be

entitled to recover, in the first year, $3 .50 as amortization ($70 divided by 20), $50 as

depreciation ($1,000 divided by 20), its embedded debt cost, and depreciation

associated with debt investment . 21 This process would continue over the life of the

property until the rate base (assuming no salvage value) hit zero . Unless changed in a

rate case, the real rate, which should be relatively stable, would be 9 percent each year .

The inflation rate would vary as the chosen inflation index varies . 22

It is important to emphasize that TOC and net depreciated original cost are, as

recognized by justice, essentially the same except for their treatment of inflation . 23

TOC reflects inflation through an automatic adjustment to rate base . Net depreciated

original cost reflects estimated inflation in the nominal rate of return . This difference

between them results in a different timing of the recovery of the cost of equity capital,

when inflation exists, over the life of the property . 24 But, and this is crucial, as justice

admits, "[t]heoretically, TOC results in the same discounted value of the earning

stream for the investor as does 'untrended' original cost ." 25 The Commission concludes

that TOC is an acceptable cost-based rate base alternative to net depreciated original

cost . True, Justice and the Mid-Continent Shippers raise objections to TOC . They state

that there could be problems with developing a rate of return, including selecting an

inflation factor to be extracted from the nominal rate . As discussed below, those

objections are really aimed at the mechanics of TOC and are not impediments to the

adoption of TOC .

The Commission adopts TOC over net depreciated original cost because it is a

theoretically acceptable alternative that after the switch from valuation will help

newer pipelines with higher rate bases to compete with older pipelines with lower rate

bases and will help them compete with other modes of oil transport and so will tend to

foster competition generally . 26 This is so because TOC mitigates the front-end load

problem for new pipelines .

The Commission discussed in detail the front-end load problem in Opinion No .

154 27 and reaffirms what was said there . In brief, a front-end load occurs under net

depreciated original cost because under that approach rate base declines over time .

Hence, the company's allowed return for its equity cost of capital declines over time .

1611 377

240 7-18-85

Federal Energy Guidelines

004-24
Commission Opinions, Orders and Notices

61,835

This means that the company's allowed equity return is bunched in the early years of

its property's life when its rate base is still large . The problem is that owing to

competition a pipeline may not be able to charge rates high enough to recover that

bunched income . 28 And those lost revenues are gone forever . TOC, on the other hand,

defers income until later years by capitalizing the inflation factor into the equity rate

base . As time goes by and competitors' prices rise because of inflation, the company

under TOC can raise its rates to recover the deferred income and still compete . In

Opinion No. 154, the Commission recognized the front-end load problem but retained

valuation as the inflation-sensitive rate base . But, the Commission stated that a rate

base linked to inflation, such as- . TOC, would . be the simplest and perhaps best

approach. 29 The Commission now takes that approach .

Moreover, TOC's different time pattern for the recovery of the cost of equity

capital also has other advantages . TOC comes closer to duplicating pricing in

unregulated enterprises, 30 and provides for greater intergenerational equity by

providing relatively constant cost of equity capital charges in real terms (adjusted for

inflation) to ratepayers over the life of the regulated property . $ 1 Under TOC, the

successive generations of ratepayers will be paying more in dollars but they are paying

in cheaper dollars because of inflation .

Rate Base-the Mechanics

Dr. Myers recommended that the inflation index for TOC be the actual change in

the construction price index used in the ICC's valuation formula . S2 Justice suggested

that the Commission look to the U .S . Treasury bill rate or some other long-term

corporate bond index . 33 The Mid-Continent Shippers see problems with all indices . 34

Justice and the Mid-Continent Shippers also point out that the derivation of real rates

of returnn will bee difficult . The Commission concludes that the choice of index should be

resolved on a case-specific basis .

35 What is important is that the index used to

decrease the nominal equity rate of return is also used to increase the equity rate

base . 36 Finally, as to the determination of the initial real rate of return, all that

involves is the finding of the nominal rate- and the extraction of the inflation

component . The Commission sees nothing unusual about the determination of nominal

rates. This is the standard practice for gas pipeline and electric companies . Moreover,

changes in the real rate will also be determined by reference to changes in the nominal

rate .

As noted, Dr. Myers recommended the setting of an overall real rate of return and

the trending of the entire rate base . We have chosen to trend only the equity portion of

the rate base . We have done this in order to ensure that the equity holder_ will not

benefit from a write-up of the rate base with respect to assets financed by debt . 37 The

equity holder will only be compensated for the inflation to the extent that assets are

financed by equity .

Starting Rate Base

Because the Commission is switching oil pipelines ., from a valuation rate base to a

TOC rate base, it must adopt a starting or transition rate base in dollars for existing

plant. 38 The industry argues that the starting rate base should be a pipeline's most

recent valuation . The industry's adversaries argue that book net depreciated original

cost should be the starting rate base .

In selecting a starting rate base, the Commission gave consideration to the rate

base which is minimally disruptive but comports with the newly adopted ratemaking

approach. The Commission also gave much weight to its previously stated view that

FERC Reports

¶ 61,377

000-16

240 7-18-85
61,836

Cited as "31 FERC ¶ . . .

the valuation rate base is flawed . 39 However, the Commission is concerned about the

long reliance of pipeline investors on the previous rate base method and, as a result,

has sought a middle ground that is fair in light of investor expectations but without

perpetuating the serious flaws of the previous method . The Commission believes that

the appropriate starting rate base should be the sum of a pipeline's debt ratio times net

depreciated original cost and the equity ratio times the reproduction portion of the

valuation rate base depreciated by the same percentage as the book original cost rate

base has been depreciated . 40 The Commission believes this formula, which is a middle

ground between valuation and net depreciated original cost, is fair in view of pipeline

investor reliance on a rate base which has . been adjusted for inflation . The starting rate

base will more closely approximate the TOC rate base that would have existed had the

ICC not written-up debt. It will ensure that the equity holder does not benefit from the

write-up of debt financed assets, as was the case with the ICC valuation rate base . It

will also eliminate from valuation the unjustified 6 percent write-up for "going concern

value." The Commission observes that it regulates around ninety pipelines and the

factual situation of each can be expected to differ . Hence, a participant in a rate case

may raise this issue and attempt to prove that a particular company is not entitled to

the instant starting rate base. 41

Capital Structure

The Commission must decide on the appropriate capital structure to use to

determine a pipeline's starting rate base and to thereafter compute the pipeline's

allowed return . The Commission recently expressed for gas pipelines a general policy of

using actual capital structures rather than hypothetical capital structures .

42 The

Commission believes that this approach is appropriate for oil pipelines . The actual

capital structure could be the actual capital structure of either the pipeline or its

parent. 43 The Commission concludes that a pipeline which has issued no long-term

debt or which issues long-term debt to its parent or which issues long-term debt

guaranteed by its parent to outside investors should use its parent's actual capital

structure . 44 However, a pipeline which issues long-term debt- to outside investors

without any parent guarantee should use its (the pipeline's) own capital structure . 4s

Relationship of Rate Base and Capital Structure

We describe the relationship between rate base and capital structure by an

illustration . Assume a starting rate base of $1,200, a debt ratio of 70%, a debt cost of

8%, an equity ratio of 30%, a nominal equity cost of 16%, an inflation rate of 7%, and a

real equity cost of 9% . A debt equity chart would be :

240 7-18-85

Allowed earnings would be $99.60 . The rate base write-up would be $25 .20 minus the

amount amortized . 46 Depreciation would still be taken on original cost .

Rate of Return

The Commission has concluded that the equity rate of return should be

determined on a case-specific basis with reference to the risks and corresponding cost of

capital associated with the oil pipeline whose rates are in issue .

47 Of course, one factor

which may be included in any risk analysis is the competition faced by the pipeline . 48

161,377Federal Energy Guidelines

007-23

Debt 70%

. 8% 5 .6

Equity 30% 9% 2 .7

8 .3
240 7-18-85 Commission Opinions, Orders and Notices

61,837

Any pipeline may try to prove that it is entitled to additional compensation to reflect

increased risk or other non-cost factors such as incentives to investment . 4s This

endeavor will yield a nominal rate of return on equity which will then be translated

into a real rate by the extraction of inflation pursuant to an index determined in the

particular case . 50 The Commission observes again that rate base and rate of return

must "operate together to produce a just and reasonable rate," consequently, the

Commission will pay particluar attention to the operation of the two elements together

in each case . 51

Taxes

Two tax issues require attention . The first tax issue is the determination of the

interest expense deduction to use in calculating a pipeline's tax allowance . The usual

method is to multiply the company's weighted cost of debt times its rate base . This will

not work for oil pipelines . This is so because under the TOC methodology adopted in

this opinion the rate base includes an equity write-up . The Commission holds,

therefore, that oil pipelines should use their actual interest expense .

The court suggested that the Commission reexamine the . next tax issue : the proper

ratemaking treatment of book and tax timing differences in the . recognition of certain

expenses. For example, oil pipelines may depreciate their properties for federal income

tax purposes faster than they depreciate those properties for book . or cost-of-service

expense purposes. 52 The issue is whether their cost-of-service tax component should be

calculated using the cost-of-service depreciation expense as a deduction from gross

income (normalization) or using the greater tax depreciation expense (flow-through of

tax savings). Opinion No . 154 permitted the pipelines to use normalization on the

ground that "normalization facilitates the comparable analyses basic to the

determination of appropriate rates of return ." 53 The court questioned this decision

because it found we had "effectively abandoned comparable earnings analysis" and

thus had no further justification for using normalization . 54 The Commission has

concluded in this opinion that an oil pipeline's rate of return on equity should be

determined with reference to its risk and corresponding cost of capital . The

Commission has hence made comparable risks and earnings basic to the determination

of rate of return . Accordingly, it adopts normalization rather than flow-through to

accommodate its earnings analysis . 55 The Commission repeats what was said in

Opinion No . 154 :

[W]e opt . . . for normalization . The essential reason for that is that normalization

facilitates the comparable earnings analyses basic to the determination of

appropriate rates of return on oil pipeline . . . investments . Throughout the

economy rates of return . . . are reported on a normalized basis . 56 This means

that after-tax earnings are computed as though the "deferred taxes" had actually

been paid. Hence the taxpayer's actual after tax rate of return is higher than the

version of that return given in its financial statements, reported to the Securities

and Exchange Commission, and used by the financial community . 57

So a flow through rule for this field will make for mismatched rate of return

comparisons between oil pipelines and other industries .Were we to insist on actual

cash basis, after tax rates of return here, elaborate adjustments would be needed

in order to compare those returns with actual cash basis, after tax rates of return

elsewhere . That would be administratively difficult . And those difficulties would

be pointless . Nothing of substance would be accomplished . S8

FERC Reports

015-23 ¶ 61,377
61,838

Cited as "31 FERC ¶ .

The Commission still finds this reasoning sound . 59

Other Matters

. The Commission reaffirms its policies set forth in Opinion No. 154 with respect to

(1) test periods, throughput variations, and developmental losses, 80 (2) holding

company problems, 81 and (3) working capital . 62 The Commission reverses its

administrative policies set forth in Opinion No . 154 with respect to oil pipeline rate

filings . 83 The limitations imposed upon the Commission and staff in oil pipeline cases

before the Commission is being removed to help the Commission fulfill its statutory

mandate under the Interstate Commerce Act to set oil pipeline rates that are just and

reasonable .

Procedural Posture of This Opinion

On March 7, 1985, the Commission approved a settlement which resolved all

issues in Phase II of this proceeding . 64 The AOPL is concerned about the procedural

posture of this case in light of that settlement . In particular, it states that "in the

absence of any continuing case or controversy over Williams' rates, this adjudicatory

proceeding may no longer provide a proper vehicle for the resolution of the generic

issues . . . pending in Phase I ." 85 It believes the Commission should convert Phase I

into a formal rulemaking under the Administrative Procedure Act . 86 The Commission

sees no reason to do that . Whatever its label, the Commission views this opinion as a

statement in compliance with the court's mandate that it fashion a "proper

ratemaking method for oil pipelines ." 87 The Commission is providing a guide to its

action in future and pending oil pipeline cases . The Commission is establishing a

methodology pursuant to which it will test the reasonableness of oil pipeline rates on a

case-by-case basis. At that time, the Commission will determine whether the "end

result" of this methodology produces just and reasonable rates . 88 The Commission is

not persuaded that at this late date in these proceedings any person's rights will be

prejudiced in such a way as to necessitate turning Phase I into a formal rulemaking .

Hence, the AOPL's motion is denied .

-Footnotes -

I Farmers Union Central Exchange, Inc . v.

F.E.R.C., 734 F .2d 1486 (D.C . Cir. 1984), cert .

denied sub nom., Williams Pipe Line Co. v. Farmers

Union Central Exchange, Inc., 105 S .Ct . 507 (1984)

(hereinafter FARMERS) . The Commission's opinion

appears at 21 FERC 161,260 (1982) reh g denied, 22

FERC 161,086 (1983) (hereinafter Opinion No . 154) .

2 The FARMERS court stated that the

Commission could consider the issue of cost allocation

in Phase I . FARMERS at 1529 . The Commission

elects not to do that . That issue, also known as rate

design, is best suited for case-specific treatment .

s The 10 percent rate of return was used for

refined products pipelines such as Williams . The rate

of return for crude oil pipelines was 8 percent . The

Mid-Continent Shippers lost before the full ICC .

Petroleum Products, Williams Brothers Pipe Line Co .,

355 ICC 479 (1976) .

4 Section 402 of the Department of Energy

Organization Act transferred the ICC's oil pipeline

jurisdiction to this Commission . Department - of

Energy Organization Act, Pub . L . No . 95-91, 91 Stat .

565, 584 (1977) (codified at 42 U .S.C. § 7172(b)),

effectuated, Exec . Order No . 12,009, 42 Fed . Reg .

161,377

240 7-18-85

46,267 (Sept . 13, 1977), implemented, 42 Fed. Reg .

55,534 (Oct . 17, 1977) .

5 Farmers Union Central Exchange v. F.E.R .C.,

584 F .2d 408, 421 (D .C . Cir . 1978), cert . denied sub

nom. Williams Pipe Line Co. v. F.E.R.C., 439 U.S.

995 (1978) .

e Id.

7 Supra note 1 .

s The valuation rate base formula is set out in

Opinion No. 154, 21 FERC at p . 61,696 n .295 and in

FARMERS at 1495 n .28 . The rate of return

methodology appears in Opinion No . 154 at 21 FERC

at pp . 61,636-50 and in FARMERS at 1521-23 .

9 FARMERS at 1512 .

20 Id. at 1518 .

11 Id. at 1522 .

12 Id.

Is Id. at 1530.

14 Id.

15 Id. .

16 Opinion No . 154, 21 FERC at p . 61,618 for the

quote .

Federal Energy Guidelines

025-37
240 7-18-85

Commission Opinions, Orders and Notices

61,839

17 Id. at p . 61,619.

18 The court upheld the Commission's

determination that rate base should be determined on

a system-wide basis . FARMERS at 1529 n .79.

19 The Commission's description is based on the

testimony of Dr . Stewart Myers except that Dr.

Myers would trend the entire rate base and set an

overall return . Our description is simplified by

assuming an equity rate base . See our discussion

under the heading Relationship of Rate Base and

Capital Structure, infra .

20 Dr . Myers viewed the capitalized inflation

amount as reinvested income . Exhibit 21-1 at 18, 24.

The Commission disagrees and finds that the rate

base write-up represents deferred earnings on capital

and not a return of capital . Justice's expert witness

agrees that a pipeline is entitled to collect those

deferred earnings . Exhibit 201-5 at 19.

21 The equity rate base at the start of year two

would be $1,016 .50 ($1,000 - 50 + 66.50) .

22 The Commission recognizes that in some

situations TOC might present problems for new

pipelines . The Commission is willing in such

situations to consider any innovative solutions which

are presented to it .

23 Justice's Initial Brief at 98 ; Exhibit 201-5 at 3,

23 .

24 Justice's Initial Brief at 98 .

25 Id. ; Exhibit 21-1 at 23 .

26 See Exhibit 21-1 at 44 and n .3 .

27 Opinion No . 154,21 FERC at pp. 61,628-30.

28 See Exhibit 8-I at 46, 47 for a hypothetical

illustration .

29 Id. at 61,630-31 .

30 Exhibit 21-1 at 41, 75 .

31 Exhibit 21-1 at 42, 43 and Exhibit 21-2 at 17

on fairness to shippers and consumers .

32 Exhibit 21-1 at 45, 47 ; Transcript at 3580 .

33 Justice's Initial Brief at 105 .

34 Mid-Continent Shippers' Reply Brief at 28.

35 Other choices would be the CPI and the GNP

deflator. The inflation rate for the past year would be

used as the estimated rate for the next year. Hence,

the rate base would be written-up at the start of the

year and not at the end of the year .

36 Cf. FARMERS at 1524-25 .

37 On this point the Commission agrees with the

Mid-Continent Shippers . Mid-Continent Shippers'

Reply Brief at 26 .

38 Of course, all new plant will be recorded at

cost . Subject to reexamination in a particular case, oil

pipelines may add to their rate bases as an allowance

for funds used during construction an amount

computed using their nominal overall cost of capital .

39 Opinion No . 154, 21 FERC at p . 61,616 and

see p . 61,696 n .304 .

40 In formula form we have :

SRB = O(1-e) + R(e)

Where :

SRB = starting rate base

FERC Reports

018 60

0 = book net depreciated original cost

R = net depreciated reproduction cost

e = ratio of equity to total capitalization

The reproduction part of "R" should be taken

from the 1983 valuation when completed . "0" should

be taken from the pipeline's books on that date . The

pipeline may add to its starting rate base the original

cost of land, rights of way less book depreciation,

working capital, and plant not included in the 1983

valuation at cost less book depreciation . For purposes

of determining the depreciation to be applied to the

reproduction portion of rate base, the same ratio

should be applied as the ratio of depreciation to

original cost. For example, if original cost has been 40

percent depreciated, this reproduction cost should be

assumed to be 40 percent depreciated .

f1 A pipeline's existing book depreciated original

cost rate base shall continue for cost-of-service

depreciation expense purposes .

i2 Arkansas Louisiana Gas Co., a Division of

Arkla, Inc ., 31 FERC ¶ 61,318 (1985) .

43 Solely for the purpose of fixing the starting

rate base, actual capital structure shall be the actual

capital structure as of the date of this opinion .

44 Debt guaranteed by the parent should be

included in the parent's capital structure.

45 For cases . pending before the Commission, the

starting rate base should be determined as of the date

the filed rates in question become effective, if that

date is prior to the pipeline's 1983 valuation .

46 $1,200 x 2 .1% (30% x 7%) = $25 .20 .

47 The Commission expects the cost of equity

capital for oil pipelines will be determined by the use

of either or both of the market-oriented or comparable

earnings standards. Both focus on investor

expectations and requirements with respect to

earnings .

48 See FARMERS at 1508 n .50.

49 See id. at 1495 n .27, 1503 and 1530 .

50 Moreover, on a case-specific basis, a pipeline

will be permitted to argue that its parent company is

entitled to compensation for any guarantees of the

pipeline's debt . Id. at 1521 .

51 Id. at 1530.

52 I .R.C. § § 167 and 168 (1982) .

53 Opinion No. 154, 21 FERC at p. 61,656 .

54 FARMERS at 1530 n .80 .

55 The court affirmed the Commission's decision

that oil pipelines must exclude all deferred tax

amounts from their rate bases . FARMERS at 1529,

1530. The Commission notes that its decision that oil

pipelines are entitled to the full benefit of investment

tax credits was not appealed . Opinion No. 154, 21

FERC at p. 61,657, and p. 61,658 .

56 See Accounting Principles Board Opinion No.

11, which adopted normalization for 1968 and

subsequent years .

57 A comprehensive statistical demonstration of

this phenomenon appears in Effective Corporate Tax

Rates in 1980, A Special Supplement prepared by the

Editors of Tax Notes, Arlington, Virginia (1982) .

¶ 61,377
61,840

58 21 FERC at p. 61,656.

59 On the issue of consolidated taxes, the

Commission reaffirms for now the use of its

traditional stand-alone approach . See Opinion No.

154, 21 FERC at p. 61,652, p . 61,653 and Columbia

Gulf Transmission Co ., Opinion No . 173, 23 FERC

¶61,396 (1983), petition for review filed sub nom .

City of Charlottesville v. F.E.R.C., No. 83-2059 (D.C . Cir . Oct . 6, 1983).

60 Opinion No . 154, 21 FERC at p. 61,658, and

p . 61,659 .

81 Id. at p . 61,651, and p . 61,652 .

Cited as "31 FERC ¶ .1 . . ."

240 7-18-85

62 Id. at p . 61,704 n . 386.

63 Id. at p . 61,612 .

64 Williams Pipe Line Co ., 30 FERC 161,262

(1985) .

65 AOPL's Motion at 2 .

86 5 U .S.C . § 551, et seq .

87 FARMERS at 1530.

88 F.P.C. v. Hope Natural Gas Co., 320 U .S . 591,

603 (1944) .

[¶ 61,378]

New England Power Company, Docket Nos . ER85-475-000, ER85-476-000, and

ER85-493-000

Order Accepting for Filing and Suspending Rates, Granting Withdrawal,

Noting and Granting Interventions, Granting and Denying Waivers,

Granting and Denying Motions for Summary Disposition, Consolidating

Dockets, and Disapproving Automatic Equity Clauses

(Issued June 28, 1985)

Before Commissioners: Raymond J. O'Connor, Chairman ; Georgiana Sheldon,

A. G . Sousa and Charles G . Stalon.

On May 1, 1985, New England Power

Company (NEPCO) tendered for filing a

proposed superseding Transmission and

Interconnection Agreement providing for

transmission service to the Vermont Electric

Power Company, Inc . (VELCO) that would

result in an increase of approximately

$650,000 (Docket No. ER85-475-000) . On the

same date, NEPCO also tendered for filing a

revision to its FERC Electric Tariff Original

Volume No . 3 that would result in an increase

of approximately $690,000 for transmission of

nonfirm energy entitlements to tariff

customers (Docket No. ER85-476-000). On

May 8, 1985, NEPCO tendered for filing an

agreement to begin transmission service to its

affiliate, Narragansett Electric Company

(Docket No. ER85-493-000) that would result

in annual revenues of approximately $7,000.

NEPCO requests a waiver of the 60-day notice

requirement in order to allow the proposed

rates in Docket No. ER85-475-000 to become

effective May 1, 1985 . It requests an effective

date of July 1, 1985 for the proposed rates in

Docket Nos. ER85-476-000 and ER85-493-

000.1

Notice of NEPCO's filing in Docket Nos .

ER85-475-000 and ER85-476-000 was

published in the Federal Register 2 with

comments due on or before May 2, 1985 .

Notice of NEPCO's filing in Docket No . ER85-

493-000 was published in the FederalRegister 3

with comments due on or before May 31, 1985 .

¶ 61,377

ELCO filed a timely motion to intervene

in Docket No. ER85-475-000. It requested that

the filing be suspended for one day and that a

hearing be ordered to permit NEPCO to file

additional evidence in support of its positions

on several issues . It objected to waiver of the

60-day notice provision and requested

summary dismissal of NEPCO's filing only if a

hearing is not set . VELCO raises a variety of

cost of service and rate design issues . 4 Central

Vermont Public Service Corporation (Central

Vermont) also filed a timely motion to

intervene in this docket .

On June 6, 1985, NEPCO filed an answer.

While not opposing the motions to intervene,

the request for a one-day suspension, or the

request for a hearing, NEPCO argued that

there is good cause to waive the 60-day notice

provision . NEPCO asserts that each of

VELCO's objections lacks merit .

NEPCO's municipal customers (Municipal

Customers) filed a timely motion to intervene

in Docket No . ER85-476-000. They requested

a five-month suspension . They also requested'

summary rejection of NEPCO's proposed

treatment of Investment Tax Credits (ITCs) .

On May 24, 1985, Boston Edison Company

(Boston Edison) filed an untimely motion to

intervene in this docket, stating that there was

good cause for the late filing because it was not

served with a copy of NEPCO's filing. The

Municipal Customers and Boston Edison raise

Federal Energy Guidelines

031-48