133 FERC ¶ 61,228 

UNITED STATES OF AMERICA 

FEDERAL ENERGY REGULATORY COMMISSION 

18 CFR Part 342 

[Docket No. RM10-25-000] 

Five-Year Review of Oil Pipeline Pricing Index 

(Issued December 16, 2010) 

AGENCY: Federal Energy Regulatory Commission. 

ACTION: Order Establishing Index for Oil Price Change Ceiling Levels 

SUMMARY: The Federal Energy Regulatory Commission (Commission) is issuing this 

Final Order concluding its third five-year review of the oil pricing index, established in 

Order No. 561. After consideration of the initial, reply and supplemental comments, the 

Commission has concluded that an index level of Producer Price Index for Finished Goods 

plus 2.65 percent (PPI-FG+2.65) should be established for the five-year period commencing 

July 1, 2011. At the end of this five-year period, the Commission will once again initiate 

review of the index to determine whether it continues to measure adequately the cost changes 

in the oil pipeline industry. 

ADDRESS: Secretary of the Commission 

Federal Energy Regulatory Commission 

888 First Street, NE 

Washington, DC 20426
Docket No. RM10-25-000 - 2 - 

FOR FURTHER INFORMATION CONTACT: 

Andrew Knudsen (Legal Information) 

Office of the General Counsel 

888 First Street, NE 

Washington, DC 20426 

(202) 502-6527 

Michael Lacy (Technical Information) 

Office of Energy Market Regulation 

888 First Street, NE 

Washington, DC 20426 

(202) 502-8843 

SUPPLEMENTARY INFORMATION: 
133 FERC ¶ 61,228 

UNITED STATES OF AMERICA 

FEDERAL ENERGY REGULATORY COMMISSION 

Before Commissioners: Jon Wellinghoff, Chairman; 

 Marc Spitzer, Philip D. Moeller, 

 John R. Norris, and Cheryl A. LaFleur. 

Five-Year Review of Oil Pricing Index Docket No. RM10-25-000 

ORDER ESTABLISHING INDEX FOR OIL PRICE CHANGE CEILING LEVELS 

(Issued December 16, 2010) 

1. On June 15, 2010, the Commission issued a Notice of Inquiry (NOI),1

 in which it 

proposed to continue using the Producer Price Index for Finished Goods plus 1.3 percent 

(PPI-FG+1.3) for the next five-year period beginning July 1, 2011. The Commission 

applies the index to existing oil pipeline transportation rates to establish new annual rate 

ceiling levels for pipeline rate changes. The NOI invited interested persons to submit 

comments on the continued use of PPI-FG+1.3 and to propose, justify, and fully support, 

any alternative indexing proposals. Comments and reply comments were due August 20, 

2010, and September 20, 2010, respectively. Based upon full consideration of the 

comments and reply comments received, and for the reasons discussed below, the 

Commission finds that an index of PPI-FG plus 2.65 percent (PPI-FG+2.65) should be 

established for the five-year period commencing July 1, 2011. 

 1 Five-Year Review of Oil Pipeline Pricing Index, 75 FR 34959 (June 21, 2010), 

FERC Stats. & Regs. ¶ 35,566 (2010) (NOI). 
Docket No. RM10-25-000 - 2 - 

I. Background 

A. Establishment of the Indexing Methodology

2. Congress in the Energy Policy Act of 1992 (EPAct 1992) required the 

Commission to establish a "simplified and generally applicable" ratemaking methodology 

for oil pipelines2

 that was consistent with the just and reasonable standard of the 

Interstate Commerce Act (ICA).3

 On October 22, 1993, the Commission issued Order 

No. 561,4

 promulgating regulations pertaining to the Commission's jurisdiction over oil 

pipelines under the ICA and fulfilling the requirements of the EPAct 1992. In Order 

No. 561, the Commission developed an indexing methodology for the purpose of 

allowing oil pipelines to change rates without making cost-of-service filings. The 

Commission found that the indexing methodology adopted in the final rule simplified and 

expedited the process of changing rates. The Commission further determined that the 

indexing methodology would ensure compliance with the just and reasonable standard of 

the ICA by subjecting the chosen index to periodic monitoring and, if necessary, 

adjustment. After extensive analysis of proposals from interested parties, the 

 2

 Pub. L. No. 102-486, 106 Stat. 3010, § 1801(a) (Oct. 24, 1992). The EPAct 

1992's mandate of establishing a simplified and generally applicable method of regulating 

oil transportation rates specifically excluded the Trans-Alaska Pipeline System (TAPS), 

or any pipeline delivering oil, directly or indirectly, into it. Id. § 1804(2)(B). 

3

 49 U.S.C. app. 1 (1988). 

4 Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act, Order 

561, FERC Stats. & Regs. ¶ 30,985 (1993), order on reh'g, Order No. 561-A, FERC 

Stats. & Regs. ¶ 31,000 (1994), aff’d, Association of Oil Pipe Lines v. FERC, 83 F.3d 

1424 (D.C. Cir. 1996) (AOPL I). 
Docket No. RM10-25-000 - 3 - 

Commission adopted an index of PPI-FG minus 1 percent (PPI-FG-1), which was 

supported by a methodology developed by Dr. Alfred E. Kahn (Kahn Methodology) on 

behalf of a group of shippers. The Commission also committed to review every five 

years the continued appropriateness of the index in relation to industry costs. 

3. In the first five-year review, which established the index level for 2001-2006, the 

Commission deviated from the Kahn Methodology, and, based upon a different analysis, 

concluded that the index should be retained as PPI-FG-1.5

 The U.S. Court of Appeals for 

the District of Columbia (D.C. Circuit) reviewed and remanded the Commission’s order 

because the Commission failed to justify a departure from the Kahn Methodology used in 

Order No. 561.6

 On remand, the Commission used the Kahn Methodology to set an 

index level of an unadjusted PPI-FG for the five-year period beginning July 2001. This 

order on remand was upheld by the D.C. Circuit.7

4. In the second five-year review, the Commission proposed to retain the rate of an 

unadjusted PPI-FG. However, based upon the data presented during that proceeding, the 

 5 Five-Year Review of Oil Pipeline Pricing Index, 93 FERC ¶ 61,266 (2000) (First 

Five-Year Review), aff’d in part and remanded in part sub nom. AOPL v. FERC, 281 

F.3d 239 (D.C. Cir. 2002) (AOPL II).

6 AOPL II, 281 F.3d 239.

7 Five-Year Review of Oil Pipeline Pricing Index, 102 FERC ¶ 61,195 (2003) 

(First Five-Year Review Remand Order), aff’d sub nom. Flying J Inc. v. FERC, 363 F.3d 

495 (D.C. Cir. 2004). 
Docket No. RM10-25-000 - 4 - 

Commission adopted an index of PPI-FG+1.3, which was again calculated using the 

Kahn Methodology.8

B. The Kahn Methodology 

5. The Kahn Methodology measures changes in operating and capital costs on a per 

barrel-mile basis using Form No. 6 data from the prior five-year period (for example, 

between 2004 and 2009 in this proceeding).9

 The Kahn Methodology does not include 

direct measures of the capital costs related to rate of return on investment or income 

taxes; as a proxy for this data, the Kahn Methodology relies upon changes over the 

five year period in net carrier property per barrel-mile. 

6. The Kahn Methodology assigns a weight to the Form No. 6 operating expenses 

relative to the net plant using an “operating ratio.”10 The weighted operating expense and 

the weighted net plant are then added together to establish the cumulative cost change for 

each pipeline.11 

 8

 Five-Year Review of Oil Pipeline Pricing Index, 114 FERC ¶ 61,293 (2006) 

(Second Five-Year Review). 

 

9 Specifically, this data is drawn from the Form No. 6: Carrier Property, page 

110; Accrued Depreciation, page 111; Operating Revenues and Operating Expenses, page 

114; Crude and Products Barrel-Miles, page 600. To the extent this information is 

incomplete, alternate data reported in the Form No. 6 has been substituted. 

10 The “operating ratio” = ((Operating Expense at Year 1 / Operating Revenue at 

Year 1) + (Operating Expense at Year 5 / Operating Revenue at Year 5))/2. If the 

operating ratio is greater than one, then it is assigned the value of 1 under the Kahn 

Methodology. 

 

11 Cumulative Cost Change = (1-operating ratio) * net plant + operating ratio * 

operating expenses. 
Docket No. RM10-25-000 - 5 - 

7. Once these cumulative cost changes have been calculated for each pipeline with 

sufficient Form No. 6 data, the Kahn Methodology culls a data set consisting of pipelines 

with cumulative per-barrel-mile cost changes in the middle 50 percent of all pipelines. 

Later applications of the index also culled a data set consisting of pipelines with 

cumulative cost changes in the middle 80 percent of all pipelines. This trimming is done 

to remove statistical outliers, or spurious data points that could bias the sample in either 

direction. 

8. For each of the two data sets (the middle 50 percent and the middle 80 percent), 

the Kahn Methodology considers three different measures of central tendency. One 

measure is the median of each data set. Another measure, the weighted mean, calculates 

an average barrel-mile cost change in which each pipeline’s cost change is weighted by 

its barrel-miles. A third measure, the un-weighted average, calculates the simple average 

of the percentage cost change per barrel-mile for each pipeline. For each data set, a 

composite, is calculated by taking the simple average of the median, the weighted mean, 

and the un-weighted mean. Table 1 provides a description of the statistical values of 

central tendency used by parties to develop the index. 

Line Middle 80 percent Middle 50 percent 

A Median Median 

B Weighted Mean Weighted Mean 

C Un-weighted Mean Un-weighted Mean 
Docket No. RM10-25-000 - 6 - 

D 

Composite of 80 

percent = (A+B+C)/3 

Composite of 50 

percent = (A+B+C)/3 

Table 1 

In the most recent index review, the industry-wide cost index differential was calculated 

by averaging the middle 50 composite and the middle 80 composite on Line D and then 

comparing that value to the PPI-FG index data over the same period. The index level 

was then set at PPI-FG plus (or minus) this differential. 

9. The Kahn Methodology has evolved during the course of prior index reviews. In 

Order Nos. 561 and 561-A, the Commission only considered the middle 50 percent and 

did not consider the middle 80 percent. In the first and second five-year index reviews, 

the Commission considered both the middle 50 percent and the middle 80 percent. Also, 

in Order Nos. 561 and 561-A, as well as the first review, the Commission merely cited 

Kahn’s Methodology to demonstrate that it produced index levels that were close, 

although not exactly the same as, the proposed index levels of PPI-FG-1 (in Order 

Nos. 561 and 561-A) and an unadjusted PPI-FG (in the first review). In the second 

five-year review, the Commission used the Kahn Methodology itself to set the precise 

index levels by averaging the middle 50 and middle 80 composites relative to PPI-FG 

over the prior five-year period. 

II. Comments from Industry

10. Comments were filed by the American Trucking Associations, National Propane 

Gas Association (NPGA), Tesoro Refining and Market Company and Sinclair Oil 
Docket No. RM10-25-000 - 7 - 

Corporation (Sinclair/Tesoro, collectively), Air Transport Association of America 

(ATA), Society for the Preservation of Oil Pipeline Shippers (SPOPS), the Association of 

Oil Pipe Lines (AOPL), Valero Marketing and Supply (Valero), and Navajo Refining 

Company, L.L.C. (Navajo). 

11. Reply Comments were filed by the Canadian Association of Petroleum Producers 

(CAPP), the Pipeline Safety Trust, Sinclair/Tesoro, Platte Pipe Line Company (Platte), 

ATA, Navajo, AOPL, and SPOPS. 

12. On September 24, 2010, the U.S. Department of Transportation, Pipeline and 

Hazardous Materials Safety Administration (PHMSA) filed a Motion for Leave to File 

Out-of-Time and Comments and NPGA filed late Reply Comments. 

13. On October 8, 2010, Valero filed Supplemental Reply Comments and on 

October 20, 2010, AOPL filed a Response (October 20 Response). 

A. Proposals for New Index Rates

14. In comments and reply comments, several parties proposed departures from 

existing index levels. AOPL proposes an index of PPI-FG plus 3.64 percent (PPIFG+3.64) as the oil pipeline pricing index for the five-year period beginning July 1, 

2011. AOPL states that its witness, Dr. Ramsey Shehadeh, applied the Kahn 
Docket No. RM10-25-000 - 8 - 

Methodology to a data set including an initial sample of 110 pipelines,12 calculating the 

following data regarding pipeline cost changes for the 2004-2009 period: 

Line Middle 80 percent Middle 50 percent 

Median 4.26 4.26 

Weighted Mean 9.91 7.07 

Un-weighted Mean 8.81 5.74 

Composite 7.66 5.69 

Table 213

15. AOPL calculated an average annual pipeline cost growth rate of 6.68 percent 

based upon the middle 50 composite growth rate and the middle 80 composite growth 

rate. AOPL notes that the PPI-FG geometric mean rate of growth for the years 2004 

through 2009 is 3.04 percent. AOPL concludes actual oil pipeline cost increases during 

the years 2004 through 2009 exceeded PPI-FG at a rate of 3.64 percent (6.68 minus 

3.04). Thus, Dr. Shehadeh proposes an index rate for the five-year period beginning 

July 1, 2011, of PPI-FG+3.64. 

16. In contrast, Valero and its expert, Mr. Matthew O’Loughlin, contend that an index 

equal to an unadjusted PPI-FG more accurately reflects pipelines’ actual cost changes. 

 12 AOPL states that Dr. Shehadeh began his analysis using cost data reported by 

the oil pipelines in the Form No. 6 for the years 2004 through 2009. According to AOPL, 

Dr. Shehadeh then removed from this data set any pipelines that did not report data for 

any year in that period, as well as the Trans Alaska Pipeline System carriers and any 

pipelines that had FERC Form No. 6 reporting errors or incomplete FERC Form No. 6 

data. 

13 Shehadeh August 20 Decl. at Exhibit A5. 
Docket No. RM10-25-000 - 9 - 

Valero states that Mr. O’Loughlin applies a modified version of the Kahn Methodology. 

First, Mr. O’Loughlin proposes to exclude pipelines that experienced large rate base 

changes from the data set used to calculate index levels. Second, to determine cost 

changes between 2004 and 2009, Mr. O’Loughlin measures the cost change per barrelmile between 2004 and 2009 using the “Total Cost of Service” and barrel-miles reported 

on page 700. Unlike the other Form No. 6 data used in the Kahn Methodology, the page 

700 data includes an interstate total cost of service calculated under the Opinion 

No. 154-B Methodology used to determine oil pipeline rates. Following these 

procedures, Mr. O’Loughlin derives the following data: 

 Line Middle 80 percent Middle 50 percent 

Median 2.6 2.6 

Weighted Mean 4.9 3.3 

Unweighted Mean 3.9 2.9 

Composite 3.8 2.9 

Table 314

17. Mr. O’Loughlin notes that the middle 50 composite of 2.9 percent is very close to 

the PPI-FG of 3.0 percent over the last five years and supports an index of an unadjusted 

PPI-FG. In Mr. O’Loughlin’s view, the middle 50 is the most appropriate for 

 14 O’Loughlin August 20 Aff. ¶ 6. Mr. O’Loughlin explains that he only reports 

data to the nearest tenth because, in his view, more precision is not useful given the wide 

ranging distribution of annual percentage cost changes experienced by the pipelines in the 

measurement group. O’Loughlin September 20 Aff. ¶ 5 n.3. 

 
Docket No. RM10-25-000 - 10 - 

determining index levels, and should be used instead of the composite of the middle 50 

and the middle 80. 

18. Other parties endorsed either the views expressed by AOPL or Valero. Platte 

states that it is a member of AOPL and filed to provide further support for AOPL’s 

request of an index of PPI-FG+3.64. On the other hand, NPGA states that it supports the 

arguments and recommendations espoused by Mr. O’Loughlin on behalf of Valero, 

including the use of a PPI-FG without any adjustment. Navajo states that it prefers 

Valero’s proposal to establish an index level of PPI-FG. 

19. Other parties also proposed differing index levels. In reply comments, CAPP and 

its expert Mark Pinney state that if AOPL’s analysis is reproduced using constant 2004 

barrel-miles instead of the recession-influenced 2009 data, the annual cost increase 

between 2004 and 2009 is PPI-FG plus 1.62 percent (PPI-FG+1.62), which CAPP 

observes is much closer to the current PPI-FG+1.3 than the index level proposed by 

AOPL. SPOPS asserts that the index should be set at zero until all pipeline overrecoveries are at just and reasonable levels and Navajo proposes to deny index increases 

to pipelines that are currently over-recovering. Navajo also proposes to base the index 

upon changes in operating and maintenance costs and to allow indexed increases only to 

the proportion of the pipeline’s rate that can be attributed to such operating and 

maintenance costs. 

20. Other parties, as discussed below, without proposing particular index levels, urge 

the Commission to reassess the index methodology to avoid over-recoveries. Some 
Docket No. RM10-25-000 - 11 - 

parties also raised procedural concerns and argued for various changes to the 

Commission’s Form No. 6 reporting requirements. 

III. Discussion

21. The Commission adopts an index level of PPI-FG+2.65. The Commission rejects 

the procedural challenges to the validity of the NOI and to consideration of any 

modifications to the Kahn Methodology. The Commission’s proposed index level of 

PPI-FG+2.65 is supported by the Kahn Methodology as applied by AOPL, except that the 

Commission adopts Valero’s proposal to calculate the index using only the middle 

50 percent and not the middle 80 percent of the data set. 

 A. Procedural Arguments

 1. The Validity of the Notice of Inquiry

 a. Comments

22. The American Trucking Association and Sinclair/Tesoro challenge the validity of 

the NOI. These parties state that the NOI contains no justification for the index of PPIFG+1.3 specified in the NOI. Sinclair/Tesoro emphasizes that an agency must reveal an 

adequate explanation of the basis for its proposal and that the rulemaking is procedurally 

defective and should be withdrawn. Sinclair/Tesoro avers that the Commission provided 

no data analysis or support showing that it has evaluated the reasonableness of PPIFG+1.3 as the appropriate index for determining rate ceilings. 

23. AOPL asserts that these criticisms of the NOI are baseless. AOPL posits that the 

Commission’s methodology for calculating its index is well-known to industry 

participants and that there exists an “opportunity for interested parties to participate in a 
Docket No. RM10-25-000 - 12 - 

meaningful way in the discussion and final formulation of rules.”15 AOPL further 

emphasizes that Dr. Shehadeh has provided data supporting his result pursuant to the 

established methodology and states the Commission can rely upon these calculations and 

data. 

b. Commission Determination

24. The Commission rejects the assertion that the NOI is procedurally defective. The 

Commission inaugurated its five-year review of the indexation methodology proposing to 

continue the existing indexing level of PPI-FG+1.3 while inviting interested parties “to 

propose, justify, and fully support, any alternative indexing proposals.”16 By soliciting 

comments on the current index level, the Commission follows the same procedure that it 

used in the previous five-year review proceeding for allowing parties to present evidence 

that the index level should be modified.17 

25. Moreover, the Commission subsequently received extensive on-the-record 

comments and workpapers from AOPL, Valero, and other parties. The analysis 

contained within these findings is based upon Form No. 6 data, which is publically 

available on the Commission website and was utilized extensively by both AOPL and 

 15 AOPL Reply Comment at 38 (quoting Connecticut Light and Power Co. v. 

Nuclear Regulatory Commission, 673 F.2d 525, 528 (D.C. Cir.)). 

16 NOI, FERC Stats. & Regs. ¶ 35,566 at P 4.

17 The current indexing level of PPI-FG+1.3 was developed in the Commission’s 

prior five-year review proceeding. Second Five-Year Review, 114 FERC ¶ 61,293. 

This proceeding involved extensive record evidence and comments from shippers, 

and the record from that proceeding remains available on the Commission website. 
Docket No. RM10-25-000 - 13 - 

Valero. Furthermore, although the Commission’s mechanisms for assessing revisions to 

the index may evolve over time, the parties are familiar with the types of data that have 

been considered by the Commission in the past, including the variants of the Kahn 

Methodology. The Commission has considered comments, reply comments, 

supplemental reply comments, and an even later response, giving each party more than 

adequate opportunity to respond. Both the data used in this proceeding and any potential 

changes from the methodology used in the past index review have been subject to ample 

opportunity for examination and comment. It is clear that the technical support for the 

index level adopted in this proceeding has been provided to the parties with adequate 

opportunity for analysis and comment. 

2. Scope of this Proceeding

 a. Comments

26. In reply comments, AOPL argues that the Commission must adhere to the 

methodology applied in prior proceedings, and AOPL contends that the changes proposed 

by Valero and its expert Mr. O’Loughlin (using page 700 data, excluding pipelines with 

large rate base changes, and using only the middle 50 percent) are beyond the scope of 

the five-year review initiated by the NOI. 

27. AOPL contends that in the prior five year review, the Commission limited the 

purpose of the review to adjustments to the index, not whether the index should be 

changed. AOPL adds that because the existing methodology was promulgated as part of 

a Commission rulemaking, replacing that methodology requires a new rulemaking. 

AOPL asserts that in the NOI, the Commission requested comments on the appropriate 
Docket No. RM10-25-000 - 14 - 

index level, but gave no indication it was changing its methodology. Moreover, AOPL 

adds that to the extent the Commission departs from its prior methodology, the 

Commission must establish that the methodology is justified. In contrast to Mr. 

O’Loughlin’s proposal, AOPL states that Dr. Shehadeh derived the index of PPI-FG 

+3.64 with the same methodology used by Dr. Kahn and adopted by the Commission in 

prior proceedings and accepted by the D.C. Circuit. 

28. In supplemental reply, citing FCC v. Fox Television Stations, Inc.,

18 Valero states 

that the Commission only needs to establish that the new policy is permissible under the 

statute, that there are good reasons for the new policy, and that the agency believes it to 

be a better policy. Valero emphasizes that the most reasonable course of action available 

to an agency is not always to maintain its current policy unchanged. 

29. Valero also dismisses AOPL’s argument that a new rulemaking process is required 

to adopt Mr. O’Loughlin’s proposals. Valero reiterates that it is not proposing a change 

to this legislative rule embodied in the regulations, but only a change in data inputs to 

that methodology. Valero also contends that all parties, including AOPL, are on notice of 

the alternative proposals before the Commission. 

30. Additionally, Valero disagrees with AOPL’s contention that the NOI does not 

contemplate an analysis such as the O’Loughlin approach. Valero states that the 

Commission invited parties to submit comments proposing, among other things, 

alternative indexing proposals. Valero argues that AOPL mistakes Mr. O’Loughlin’s 

 18 129 S.Ct. 1800 (2009). 
Docket No. RM10-25-000 - 15 - 

improvements to data sources as a change in the methodology itself. Rather, Valero 

contends Mr. O’Loughlin’s approach constitutes a better approach to utilizing the same 

methodology. 

31. Similarly, on reply, Navajo avers that FERC adopted the Kahn Methodology only 

upon the express caveat that its initial conclusions were not necessarily “a choice for all 

time” and that the ICA required monitoring of the index. Navajo adds that an agency 

may depart from past policy or precedent so long as the Commission acknowledges the 

change and supports its new decision with reasoned decision-making and substantial 

evidence. SPOPS also emphasizes that the Commission has the flexibility to modify its 

indexing methodology. 

32. In its response, AOPL reiterates that Mr. O’Loughlin’s methodology is a 

fundamental departure from the established methodology and would require a new 

rulemaking initiated by a Notice of Proposed Rulemaking. AOPL states that Fox 

Television also made clear that an agency must still provide a reasoned explanation for its 

decisions and that a more detailed justification is required when the prior policy 

engendered serious reliance interest. Valero, according to AOPL, downplays this 

reliance inappropriately. AOPL states that the reliance interest was not a reliance on any 

precise pricing index, but rather that the pipelines have a continued expectation that the 

Commission will apply the established methodology in calculating the index. 

b. Commission Determination

33. The Commission rejects AOPL’s assertion that modifications to the methodology 

for evaluating changing pipeline costs are beyond the scope of this proceeding. The NOI 
Docket No. RM10-25-000 - 16 - 

invited “interested persons to submit comments on the continued use of PPI+1.3 and to 

propose, justify, and fully support, any alternative indexing proposals.”19 Thus, by 

inviting parties to submit “to propose, justify, and fully support any alternative indexing 

proposals,” the Commission provided notice to AOPL and others that the Commission 

would consider different methodologies for calculating the Index, such as the proposals 

advanced by Valero, among others.20 Although the D.C. Circuit rejected in 2003 

proposed changes to the Kahn Methodology for assessing changing pipeline costs, the 

Court rejected this proposal because the Commission had neither addressed concerns 

regarding the new methodology nor justified its methodological shift.21 The Court did 

not hold that the Commission cannot make justified modifications to the Kahn 

Methodology. As the Commission did in prior five-year reviews of the indexing level, 

the Commission will give consideration to alternative methodologies for calculating the 

index.22 

 19 NOI, FERC Stats. & Regs. ¶ 35,566 at P 4. 

20 AOPL has been given an opportunity to respond to these proposals, and AOPL 

has filed reply comments and an October 20 Response that vigorously critique the 

proposed alterations to the Kahn Methodology. 

21 AOPL II, 281 F.3d at 248. 

22 AOPL argues that in the last indexing review, the Commission stated that the 

purpose of the five-year review was to determine “what extent the PPI-FG should be 

adjusted to better reflect those cost changes, not whether the method for 

determining pipeline costs should be changed.” Second Five-Year Review, 114 FERC 

¶ 61,293 at P 46 (emphasis added). However, in that passage, the Commission was 

referring to a proposal by the shipper parties for an entirely new rulemaking to re-assess 

the means for tracking pipeline costs justified, in part, by criticism of the data in Form 

No. 6. Id. See also ATA, Lion Oil Company, National Cooperative Refinery 
Docket No. RM10-25-000 - 17 - 

 B. Proposed Changes to the Kahn Methodology 

 1. Rate Base Screening Methodology

 a. Valero Initial and Reply Comments

34. To develop the data set for the Index, Valero urges the Commission to apply a 

“rate base screening” methodology that excludes pipelines experiencing both: (a) a rate 

base increase (through expansion) or decrease (through divestiture) greater than 50 

percent during the 2004-2009 period and (b) recovery of cost changes during the 2004-

2009 period through some means other than incremental rate increases via the index, such 

as a cost-of-service filing or a settlement agreement.23 For pipelines with rate base 

changes greater than 50 percent, Valero also excluded (a) any pipeline with a major 

divestiture or (b) any pipeline that acquired another pipeline where the pipeline divesting 

the assets continued to exist after the divestiture. In conducting the assessment of 

 

Association, Sinclair/Tesoro, Response, Docket No. RM05-22, at 13-14 (filed 

January 23, 2006). However, elsewhere in Second Five-Year Review, when parties did 

not propose a new rulemaking and instead proposed changes using the existing 

information reported to the Commission, as Mr. O’Loughlin has done here, the 

Commission evaluated those changes and did not find them to be beyond the scope of the 

five-year review process. Second Five-Year Review, 114 FERC ¶ 61,293 at P 30-36 

(rejecting proposal to use “the arithmetic average of the geometric mean of each 

pipeline's cumulative unit cost change, as opposed to Dr. Kahn's method of calculating 

the geometric mean of the arithmetic average of cumulative unit cost change.”). 

23 Using the rate base screening methodology, Mr. O’Loughlin excluded 25 

pipelines that he states experienced major rate base changes during the 2004-2009 period. 

O’Loughlin August 20 Aff. ¶ 10. Twelve pipelines with rate base changes of more than 

50 percent remained in the data set because, according to Mr. O’Loughlin, they did not 

appear to have requested alternative ratemaking treatment and no major acquisition or 

divestiture was identified. O’Loughlin October 8 Aff. ¶ 15.
Docket No. RM10-25-000 - 18 - 

pipelines with major rate base changes, Mr. O’Loughlin also excluded pipelines with 

what he concluded were unreliable data. 

35. Valero justifies the rate base screening methodology because, citing Order 

Nos. 561 and 561-A, Valero avers that the index is intended for normal, not 

extraordinary, changes. Valero contends that large rate base changes are “extraordinary” 

and that cost changes of this nature are typically recovered by a cost-of-service filing or 

settlement, not incremental rate changes pursuant to the index. 

36. Thus, if the index level reflects cost data from the pipelines experiencing rate base 

changes, Valero argues that pipelines receiving annual index increases that did not 

construct major expansions would obtain a windfall due to an index inflated for cost 

changes not experienced by normal pipelines. Furthermore, Valero argues that pipelines 

that constructed major expansions would receive double compensation, first, through a 

cost-of-service or other rate changing methodology related to the expansion and, second, 

through an inflated index. Furthermore, regarding divestitures and acquisitions, Valero 

and its witness O’Loughlin also aver that comparisons between the period before the 

divestitures or acquisitions and after those transactions are meaningless because the 

systems being compared are different. 

37. Valero argues that measures taken by the Commission in prior proceedings do not 

fully correct the biases caused by the inclusion of these pipelines. For example, Valero 

asserts the usage of the middle 80 percent or middle 50 percent of the sample data set in 

the prior rate proceedings does not adequately mitigate the effect of the inclusion of the 

pipelines with major rate base changes. 
Docket No. RM10-25-000 - 19 - 

38. Valero states that otherwise applying Dr. Shehadeh’s methodology, while using 

Valero’s rate base screening methodology reduces his recommended index from PPIFG+3.64 to PPI-FG+2.6. Valero also states that excluding the pipelines with large rate 

base expansions would not frustrate expectations because these pipelines do not typically 

use indexing to recover increased costs, and the index has never previously been set at 

PPI-FG+3.64 and there could have been no expectation that this index level would be 

approved. 

b. AOPL Reply Comments 

39. AOPL states that if a pipeline experiencing a rate base change is truly a statistical 

outlier, it will be excluded by using the middle 50 and middle 80 data sets as applied in 

the Kahn Methodology. AOPL states that Mr. O’Loughlin’s “rate screening 

methodology” is a highly subjective, results-driven attempt to eliminate pipelines with 

higher cost changes. This, AOPL argues, biases the data set downward before any 

application of statistical measures. AOPL emphasizes that an appropriate statistical 

method for excluding outliers must be systematic and objective. 

40. AOPL contends Mr. O’Loughlin’s “double-recovery” argument lacks consistency 

with the structure of the index methodology. According to AOPL, under the 

Commission’s regulations, if a pipeline files a cost-of-service rate increase, those rates 

form the ceiling for that year, but in the next index year, the pipeline must apply the 

applicable index, whether it is higher or lower. AOPL asserts that, rather than reflecting 

“double recovery,” this merely follows the appropriate operation of the index under the 

Commission’s regulations, which permit annual changes in rate ceilings due to actual 
Docket No. RM10-25-000 - 20 - 

industry-wide cost changes as compared to PPI-FG. AOPL further argues that Mr. 

O’Loughlin’s double-recovery argument would also discourage pipeline expansions and 

improvements by excluding pipelines that would undertake significant expansion projects 

or that incur significant expenses in compliance with safety regulations. 

41. AOPL also contends that the inclusion of pipelines with large rate base changes in 

the data set does not create a windfall because, under the indexing methodology, pipeline 

costs are merely increasing to reflect increased costs across the industry. AOPL’s 

witness Dr. Shehadeh states that whether a pipeline “used a rate mechanism other than 

indexation is irrelevant to the value of the information that these pipelines can provide as 

evidence for indexing pipeline costs.”24

42. AOPL further claims that in Order No. 561, the Commission established the Index 

level at PPI-FG-1 to account for a wave of asset retirements that resulted in significant 

rate base changes. AOPL states that it would now be inconsistent to exclude rate base 

changes when those changes relate to pipeline expansions. AOPL states that the 

disqualification from the data set pipelines that undertake significant expansion will 

discourage pipeline expansions and improvements. 

c. Other Shipper Reply Comments 

43. In reply comments, NPGA, ATA and Navajo expressed support for Valero’s rate 

base screening methodology. 

 24 Shehadeh September 20 Decl. at 11. 
Docket No. RM10-25-000 - 21 - 

d. Valero Supplemental Reply Brief

44. Responding to AOPL, Valero disputes the assertion that the rate base screening 

methodology understates cost changes experienced by a typical pipeline operator. Valero 

states that Mr. O’Loughlin’s analysis applied an objective filter which removed pipelines 

experiencing cost increases and cost decreases of more than 50 percent. Valero notes that 

pipelines that underwent expansions and major capital investments often sought to 

recover those costs by means other than the price index; to Valero, this suggests that the 

cost increases were extraordinary. 

45. In response to AOPL’s and Dr. Shehadeh’s argument that volume increases offset 

the cost increases, Valero states that it would not have been necessary or cost-justified to 

adopt increased cost-based rates if increased volumes fully offset any new costs. Valero 

adds that if volumes had increased commensurately with costs on these pipelines, then 

the pipelines with large rate base changes would not be at the high end of the 

measurement group in terms of cost-of-service per barrel-mile changes. 

46. Valero also avers that Dr. Shehadeh’s claim that the rate base screening 

methodology would have increased the index adjustment factor established in Order 

No. 561 contradicts his claim that Mr. O’Loughlin’s methodology biases results 

downward and leads to an inappropriately low index. 

e. AOPL October 20, 2010 Response

47. AOPL states that once an initial rate is set for a pipeline expansion, indexing 

becomes the primary method for changing oil pipeline rates. According to AOPL, there 

is no reason to exclude pipelines filing a cost-of-service or settlement rate when 
Docket No. RM10-25-000 - 22 - 

examining industry-wide cost changes and that the presence of ratemaking alternatives do 

not justify setting the index below overall industry levels. AOPL avers that if pipelines 

undertaking significant infrastructure investment are excluded from the measurement of 

cost changes, the index will be inappropriately low, causing more pipelines to use other 

ratemaking methods and undermining the purpose of the index. 

f. Commission Determination

48. The Commission will not adopt Valero’s proposal to exclude pipelines 

experiencing major rate base changes from the data set. To determine which pipelines 

should be trimmed from the data sample, the Commission has relied upon the level of the 

cost changes, not the reasons why a particular pipeline’s changing costs might be 

anomalous. Thus, in assessing Form No. 6 data in prior index proceedings, the 

Commission has trimmed the data sets to remove outliers, such as the 25 percent of 

pipelines with the greatest cost increases per barrel-mile and the 25 percent with the 

greatest decreases. As discussed below, the Commission in this proceeding will trim the 

data set to pipelines in the middle 50 percent of cost changes. To the extent that a 

particular pipeline’s cost change is an anomalous outlier compared to the changes on 

other pipelines, using the middle 50 percent of cost changes, should remove any 

distorting impact resulting from the pipeline’s presence in the index.25 

 25 To the extent that large rate base changes are associated with disproportionately 

large cost shifts, AOPL’s expert Dr. Shehadeh explains that 18 of the 25 pipelines 

removed by Mr. O’Loughlin due to rate base changes were excluded when the data set 

was reduced to the middle 50 percent using Dr. Shehadeh’s methodology. Shehadeh 

September 20 Decl. at 12. 

 
Docket No. RM10-25-000 - 23 - 

49. In contrast to this simplified methodology, the rate base screening methodology 

proposed by Valero selectively emphasizes one factor that may cause a substantial 

change in pipeline costs per barrel-mile while ignoring other factors. There is no doubt 

that substantial changes in rate base can alter the per barrel-mile costs of a particular 

pipeline. However, costs per barrel-mile can also be altered by shifting customer 

demand, increased competition, economic changes, or changing product supplies. As 

Valero’s expert Mr. O’Loughlin notes, there is a wide range in the changes in pipeline 

per barrel-mile costs,26 and much of this variability27 is unrelated to the significant rate 

base changes cited for exclusion by Mr. O’Loughlin. By selectively modifying the data 

set based upon one potential cause for cost changes, Mr. O’Loughlin risks distorting the 

index calculation. 

50. Moreover, the index is pursuant to a Congressional mandate to develop a 

“simplified and generally applicable ratemaking methodology....”28 Consistent with this 

mandate of general applicability, the Commission is reluctant to inquire into the 

particular circumstances of every pipeline and selectively remove pipelines that 

 26 O’Loughlin August 20 Aff. ¶¶ 44-45, Figure 14. 

27 For example, Mr. O’Loughlin explains that, using his own methodology, of the 

97 pipelines in his data set, which has been culled pursuant to the rate base screening 

methodology, there “are 20 pipelines that experienced average cost increases greater than 

10% per year and 10 pipelines that experienced average cost decreases of more than 

10% per year over the five-year period.” O’Loughlin August 20 Aff. ¶ 45. 

28 Energy Policy Act of 1992 Pub. L. No. 102-486 Sec. 1801(a), 106 Stat. 3010 

(Oct. 24, 1992). 
Docket No. RM10-25-000 - 24 - 

experienced cost changes due to one particular factor from the data set used to calculate 

the index.29 

51. Furthermore, large rate base changes can reflect changing pipeline costs. The cost 

of new investment associated with rate base increases reflects industry cost experience 

related to pipeline infrastructure on a barrel-mile basis. These rate base changes also 

provide important information regarding industry capital requirements. A rate base 

change, like any other change in the business circumstances of a pipeline, is only an 

outlier if a pipeline’s per barrel costs change in a manner disproportionate to those 

changes experienced by other pipelines. 

52. Moreover, the index serves as a means of recovery for some pipelines with 

significant rate base changes. According to data provided by Mr. O’Loughlin, several of 

the pipelines that Mr. O’Loughlin identified as experiencing significant rate base changes 

relied upon indexed rates (or at least did not seek some other form of recovery, such as a 

cost-of-service filing).30 The fact that a non-trivial number of pipelines experiencing rate 

 29 The D.C. Circuit has previously recognized the importance of an index that 

is relatively simple to derive. AOPL II, 281 F.3d at 247 (quoting EPAct 1992, at 

§ 1801(a)). The complexity of Mr. O’Loughlin’s rate base screening methodology is 

demonstrated by Appendix F of his September 20 Affidavit, in which Mr. O’Loughlin 

examines the circumstances of 37 pipelines that experienced rate base changes greater 

than 50 percent. To apply the rate base screening methodology, for each pipeline with a 

change in rate base exceeding 50 percent, Mr. O’Loughlin examined tariff filings, 

assessed acquisition and divestiture activity, probed into the reliability of the pipeline’s 

reported data, researched whether the pipeline had sought rate increases pursuant to the 

index, and generally sought to determine why the rate base changes occurred. 

30 O’Loughlin September 20 Aff. ¶ 54 n.75, Appendix F at 8-10. 
Docket No. RM10-25-000 - 25 - 

base changes continued to use the indexing methodology reinforces the inclusion of 

pipelines with rate base changes in the data set. 

53. Additionally, merely because a pipeline seeks recovery of rates outside the 

indexing methodology, for example through a cost-of-service, does not establish that the 

pipeline should be excluded from the data set used to develop the index. The changing 

costs that compelled the pipeline to seek recovery outside the indexing methodology 

nonetheless reflect industry cost experience. Moreover, for those pipelines with 

significant rate base increases, Mr. O’Loughlin’s decision to include only those pipelines 

where the pipeline opted to continue to use the index could skew the index downward; 

this is because the pipelines continuing to use the index are more likely to be the 

pipelines where the rate base change decreased per-barrel mile costs. 

54. Valero repeatedly cites language in Order Nos. 561 and 561-A that the index 

accounts only for “normal,” not “extraordinary” changes.31 However, this language does 

not support Valero’s proposal to exclude pipelines experiencing major rate changes from 

the data set used to determine the index level. In these passages, “extraordinary” referred 

to pipelines experiencing changed per barrel-mile costs that were greater than the 

changing costs experienced by other pipelines regardless of the causes underlying any 

particular pipeline’s cost changes. Thus, even though a rate base change of 50 percent is 

a significant occurrence, it is only “extraordinary” as Order Nos. 561 and 561-A used that 

term to the extent that it causes an anomalous change in costs per barrel-mile. 

 31 Valero Supplemental Reply Comment at 14-15 (citing Order No. 561-A, FERC 

Stats. & Regs. ¶ 31,000 at 31,097). 
Docket No. RM10-25-000 - 26 - 

55. Valero’s contention that including pipelines with rate base changes in the data set 

used to determine index will lead to double-recovery is without merit. After making a 

cost-of-service filing, the cost-of-service rate becomes the ceiling rate for that year32 and 

pipelines are authorized to increase their rates pursuant to the index in subsequent 

years.33 Valero’s argument ultimately rests upon the contention that the index is inflated

by the inclusion of pipelines experiencing rate base changes. However, as noted 

previously, such inflation of the index only occurs if the rate base changes lead to 

changes in per barrel-mile costs that are anomalous. To the extent that the rate base 

change leads to an anomalous cost increase or decrease, it will be excluded by the da

set trimming as dis

ta 

cussed below. 

2. Data Trimming and the Middle 50 

a. Valero Initial and Reply Comments

56. Valero urges the Commission to calculate the index using a data sample trimmed 

to the middle 50 percent, i.e. removing the 25 percent of pipelines with the greatest cost 

increases and the 25 percent of pipelines with the greatest cost decreases. Although 

Valero acknowledges that recent index proceedings have considered both the middle 50 

and middle 80 percent, Valero contends that trimming the data set to the middle 80 

 32 18 CFR § 342.3(d)(5). 

33 However, further undermining Valero’s double-recovery argument, the 

Commission has denied an increase pursuant to the index when the cost-of-service filing 

supporting the existing rate already incorporated the cost changes covered by the index. 

See SFPP, L.P., 117 FERC ¶ 61,271 (2006) (denying an index increase because the costof-service rate, which used a 2005 base period, already reflected the 2005 cost changes 

covered by the index).
Docket No. RM10-25-000 - 27 - 

percent inadequately accounts for outliers due to the widely varying average annual cost 

changes. Valero adds that the middle 80 includes pipelines with anomalous 

characteristics, such as very high costs per barrel-mile or the absence of rate base. 

b. AOPL Reply Comments 

57. AOPL opposes trimming the sample data set to the middle 50 percent of pipelines. 

Dr. Shehadeh responds to Mr. O’Loughlin’s proposal by stating that the wide distribution 

of pipeline cost changes (as opposed to a normalized bell curve) does not support 

ignoring the middle 80 percent in favor of the middle 50 percent. Rather, Dr. Shehadeh 

claims that the wide distribution supports the use of the middle 80 percent, rather than the 

middle 50 percent because it would be more inclusive and represent a larger number of 

pipelines. 

c. Valero Supplemental Reply Comments 

58. Valero contends, contrary to AOPL’s assertions, that Mr. O’Loughlin’s use of the 

middle 50 percent data set is justified and consistent with Commission policy. Valero 

asserts that the Commission’s methodology has varied over the years, and in Order 

Nos. 561 and 561-A, the Commission used an analysis of only the middle 50 percent of 

the data set, not a composite of the middle 50 percent and middle 80 percent of the data 

set. Valero’s Mr. O’Loughlin emphasizes that the middle 50 percent better serves the 

goal of excluding extraordinary data points. Mr. O’Loughlin also identifies an additional 

three pipelines in the middle 80 percent that he states have unusual characteristics, such 

as a cost of capital under two percent or, in another case, no rate base yet a positive 

depreciation expense. 
Docket No. RM10-25-000 - 28 - 

d. AOPL’s October 20, 2010 Response

59. In its response, AOPL reiterates its position that both the middle 50 percent and 

middle 80 percent should be used. AOPL reiterates its contention that the wide 

distribution of pipeline cost changes does not support assigning no weight to the middle 

80 percent. AOPL also challenges the three pipelines Mr. O’Loughlin identified as 

anomalous, noting that one was excluded from Dr. Shehadeh’s data set and that the others 

showed overall cost changes that were not all that different from other pipelines. AOPL 

states that as the Form No. 6 data has improved, there is no merit to limiting the data set. 

 e. Commission Determination

60. The Commission will use the middle 50 percent of the data set to determine the 

appropriate index level. This use of the middle 50 percent is consistent with the 

Commission's approach when it adopted the indexing methodology. In Order Nos. 561 

and 561-A, the initial rulemaking establishing the indexing methodology, the 

Commission used only the middle 50 percent of the data set to determine the appropriate 

indexation level. In that proceeding, neither the Commission nor Dr. Kahn considered 

the middle 80 percent. In the second review, Dr. Kahn introduced the middle 80 percent 

to his analysis.34 Given that the two data sets supported the same resulting index-level of 

an unadjusted PPI-FG, using both (as opposed to just the middle 50) was not discussed or 

contested, as there was little substantive impact from this departure from the Order 

 34 Kahn Decl. at 13 (August 31, 2000) (Docket No. RM00-11-000). 
Docket No. RM10-25-000 - 29 - 

No. 561 methodology.35 In the second and most recent 5-year review, the composite 

usage of the middle 50 and the middle 80 reoccurred, but again the relative merits of the 

middle 50 and middle 80, and the departure from the prior Order No. 561 methodology 

were not weighed or discussed. 

61. Given the more fully developed record presented here, the Commission returns to 

its approach in Order Nos. 561 and 561-A to use the middle 50 percent as the most 

appropriate method for trimming the data sample. The purpose of the index is to permit a 

simplified recovery for normal cost changes, not to enable recovery for extraordinary cost 

increases or decreases.36 The middle 50 percent more appropriately adjusts the index 

levels for “normal” cost changes as opposed to the middle 80 percent, which, by 

definition, includes pipelines relatively far removed from the median. Furthermore, some 

of these more dramatic cost changes may be due to circumstances on a particular pipeline 

that are not broadly shared across the industry. Even when accurate data is reported, 

pipelines in the middle 80, as opposed to the middle 50, are more likely to have cost 

changes resulting from factors particular to that pipeline, such as a rate base expansion, 

plant retirement, or localized changes in supply and demand. Using the middle 50 

ensures that pipelines with relatively large cost increases or decreases do not distort the 

index. 

 35 The composite of the middle 50 and middle 80 were very similar in that 

proceeding at 1.32 percent and 1.2 percent, respectively. Id. 

36 Order No. 561-A, FERC Stats. & Regs. ¶ 31,000 at 31,097 (noting that the 

purpose of the Index is to ensure recovery of “normal” cost changes, not “extraordinary” 

cost changes). 
Docket No. RM10-25-000 - 30 - 

62. The Commission further observes that our adoption of the middle 50 provides a 

better remedy for some of the concerns Mr. O’Loughlin used to justify his rate base 

screening methodology. Of the 25 pipelines Mr. O’Loughlin seeks to exclude via the rate 

base screening methodology, 18 are excluded by using the middle 50 percent in the Kahn 

Methodology as applied by Dr. Shehadeh.37 More generally, the adoption of the middle 

50 is a less subjective and more simplified method (consistent with the EPAct 1992) of 

removing potentially anomalous data than selective removal of certain pipelines with 

particular characteristics from the data sample. The middle 50 also is preferable to such 

selective screening methods because it avoids the risk that the index is skewed because 

certain cost changes (such as rate base changes) are selectively excluded while other 

significant changes (changes in local supply and demand) are incorporated. 

63. The Commission accordingly concludes that the middle 50 provides a robust data 

sample for determining changing barrel-mile costs. The middle 50 percent of pipelines 

represents 76 percent of total barrel-miles in 2004 subject to the index,38 and thus for this 

index calculation, the Commission finds it unnecessary to include the middle 80 percent 

to obtain a representative sample of the data. Finally, the use of the middle 50 minimizes 

the risk of including pipelines that experienced either large increases or decreases in cost 

(or errant data) that may be included in an 80 percent sample, while still capturing 

changes from a broad spectrum of the pipeline industry. 

 37 Shehadeh September 20 Decl. at 12. Only 13 of the 25 are excluded in the 

middle 80 percent. Id. The number of excluded pipelines include four companies that 

Dr. Shehadeh removed due to missing data. Shehadeh September 20 Decl. at 12 n.15. 

38 AOPL Comments at 14-15; Dr. Shehadeh August 20 Decl. at 10 n.23. 
Docket No. RM10-25-000 - 31 - 

 3. Page 700 Data

a. Valero’s Initial and Reply Comments

64. Valero and Mr. O’Loughlin aver that the Commission should adopt page 700, 

which uses the Opinion No. 154-B methodology to derive a total cost-of-service for 

interstate pipeline companies. Valero states there are several advantages to using the 

page 700 data as opposed to the other Form No. 6 data relied upon by the Commission in 

the past. 

65. Valero asserts that by relying upon page 700 data, the Commission can avoid 

using net carrier property as a proxy for actual changes in allowed return and income tax. 

Valero notes that the Commission has previously questioned the effectives of net carrier 

property as a proxy for changes in capital costs. Valero further states that Mr. 

O’Loughlin’s analysis shows that the change in net plant is typically greater than the 

change in allowed return and income tax. Additionally, Valero argues that net plant data 

reported on Form No. 6 can also include purchase accounting adjustments (PAAs), which 

the Commission does not allow for ratemaking purposes absent a showing of substantial 

benefits to ratepayers. 

66. Valero also contends that the “operating ratio” weighting methodology as applied 

by Dr. Shehadeh leads to a distorted analysis. The operating ratio is set between zero and 

one based upon the ratio of operating expenses to revenues. If operating expenses exceed 

revenues, then the operating ratio is set to one, meaning that no weight is assigned to 

capital costs (net plant under the prior methodology) in the formula. Thus, Valero 

contends that for fifteen pipelines in Dr. Shehadeh’s data set, the weight for the index of 
Docket No. RM10-25-000 - 32 - 

changes in net plant is zero percent, making the index of changes in net plant irrelevant. 

Valero contends that its proposed methodology using data from page 700 obviates the 

need for the operating ratio because the total cost of service on page 700 incorporates 

both operating and capital costs. 

67. Valero explains that operating expense, net carrier property, and barrel-mile data, 

which are reported on pages 110-111, 300-303, and 600-601 of the Form No. 6, include 

intrastate, as well as interstate, pipeline information. The solution, Valero contends, is to 

use the data on page 700 of the Form No. 6, which includes only interstate information. 

b. Other Shipper Comments

68. In their comments, other parties addressed Valero’s proposal to use page 700. 

ATA emphasized that any analysis of costs should be based on the interstate costs 

reported on page 700. ATA emphasizes that page 700 contains the information available 

to shippers to provide a screening tool to determine whether a “pipeline’s cost of service 

or per-barrel/mile costs” are so divergent from revenues as to warrant a challenge to the 

rates. ATA stresses that it is appropriate to use the same data to develop the index as is 

used to determine whether a pipeline is recovering its costs. 

69. NPGA likewise submits that any proper analysis of operating costs should be 

based on interstate operations and costs and not on costs that reflect intrastate operations. 

Thus, NPGA urges the use of page 700 data. 

70. In reply comments, SPOPS urges that to the extent the Commission continues to 

apply its methodology, the Commission should use the primary source for the 
Docket No. RM10-25-000 - 33 - 

jurisdictional costs of service for the pipelines, the page 700 and the underlying 

workpapers, not the secondary source methodology demanded by AOPL. 

c. AOPL’s Reply Comments

71. AOPL opposes the use of page 700 data. AOPL argues that the page 700 data is 

more volatile due to the return element underlying the page 700 total cost-of-service data. 

Specifically, AOPL contends that stock market fluctuations make the rate of return highly 

sensitive to the end-year selected by the Commission (i.e., 2008 versus 2009) for 

calculating the index. According to AOPL, the Form No. 6 net carrier property data is 

preferable because it reflects actual changes in capital costs while assuming that the 

competitive cost of capital remains constant. 

72. AOPL also argues that if rate of return from page 700 is used to measure cost 

increases, increases in pipeline efficiency will not result in lower indexation levels. 

AOPL explains that pipeline returns are based on a proxy group and as the profitability 

increases for companies in the proxy group, returns will likely increase. As a result, 

using return from page 700 will tend to increase, as oppose to decrease, future index 

levels. 

73. AOPL also disagrees with Mr. O’Loughlin’s claim that page 700 data is superior 

to Form No. 6 data because page 700 data does not include intrastate costs. AOPL 

counters that oil pipelines often make intrastate and interstate movements through the 

same pipeline segments. Thus, AOPL believes that it is reasonable to assume that both 

interstate and intrastate cost changes are likely to be representative of interstate cost 

changes. 
Docket No. RM10-25-000 - 34 - 

74. AOPL argues that Mr. O’Loughlin mistakenly describes the page 700 data as new 

and instead suggests that the information Mr. O’Loughlin proposes to use has been 

available to the Commission for many years. 

d. Valero Supplemental Reply 

75. Responding to AOPL, Valero asserts that pipeline efficiency gains will not distort 

the return information from page 700 because basic finance theory provides that an 

increase in a company’s current and future cash flow increases the equity value of the 

company. Regarding AOPL’s contention that volatility in the page 700 return data will 

skew results, Valero argues that Dr. Shehadeh, by analyzing the rate of return in isolation 

from the allowed return and income tax allowance, obtained a result that is not fully 

indicative of a pipeline’s capital costs. Valero further argues that recessionary declines in 

petroleum demand increased the average cost of service per barrel mile for 2009. Valero 

concludes that if the recessionary volatility in barrel-miles is reflected in developing unit 

costs, the prevailing rates of return as reported in the cost-of-service calculations on page 

700 of the Form No. 6, must also be used. 

76. Valero disputes AOPL’s contention that an interstate cost-of-service value was 

reflected on page 700 as early as 1994. Valero states that a reliable total interstate-only 

cost-of-service data and the specific line items composing the interstate cost of service, 

including jurisdictional rate base, were not available until 2000. Valero states that the 

Commission has not previously addressed the possibility of using this interstate, page 700 

data in the index. 
Docket No. RM10-25-000 - 35 - 

77. Valero also challenges Dr. Shehadeh’s claim that the interstate-only operating and 

maintenance expense and depreciation expense data reported on page 700 are unsuitable 

for the rate index methodology because the data contain various accounting, allocation, 

and normalizing assumptions. Rather, Valero contends that because the calculations of 

operating and maintenance expense must be consistent with the Commission’s Opinion 

No. 154-B methodology and because changes in those components impact the costs a 

pipeline can recover in rates, those considerations are appropriate for determining the 

price index. 

78. Valero states that Dr. Shehadeh’s preferred data source, the operating and 

maintenance expense data on page 114 of the Form No. 6, can contain accounting 

reserves that are not permitted for ratemaking. Valero states that carriers should not be 

permitted to use these discretionary changes in accounting reserves to influence the 

change in unit costs used to determine the level of index to be used for annual 

adjustments. 

e. AOPL October 20, 2010 Response

79. AOPL renews its arguments that (a) intrastate costs are representative of interstate 

costs; (b) inclusion of the rate of return from page 700 would make the index more 

volatile; (c) net plant is a preferable measure of return for the purposes of establishing the 

index than the page 700 data; and (d) the page 700 data has been available during prior 

indexing proceedings. 

80. AOPL also argues that Valero’s proposed usage of page 700 ignores serious 

accounting issues. AOPL states that, in order to derive a unit cost for each carrier, 
Docket No. RM10-25-000 - 36 - 

Mr. O’Loughlin divides the total cost-of-service reported on page 700 by the total 

throughput reported on page 700. AOPL states that the page 700 cost-of-service figure 

provides each carrier’s interstate cost-of-service using an Opinion No. 154-B 

methodology. However, AOPL states that the barrel-mile data on page 700 includes 

interstate and intrastate volumes. AOPL explains that the instructions on page 700 

indicate that the barrel-mile figure should be the same as that reported on page 600, and 

the barrel-mile figure on page 600 includes “all oils” received by the pipeline, not just 

interstate oils. AOPL contends that there could be a mismatch between the interstate 

only costs and the interstate and intrastate volumes. 

81. AOPL defends the data in Form No. 6. AOPL states that while PAAs reflected 

in Form No. 6 are generally not allowed to be reflected in regulated rates, these 

adjustments are appropriate when calculating cost changes because the PAAs reflect the 

opportunity cost of capital. Moreover, AOPL states that PAAs do not create the perverse 

incentives in the calculation of an industry-wide index that they do when calculating an 

individual pipeline’s rates. Also, AOPL also contends that although the accounting 

reserves in Form No. 6 present timing issues for the purposes of a ratemaking proceeding, 

they also represent real costs of doing business that are properly reflected in the 

calculation of the rate index. 

82. AOPL also defends the usage of the operating ratio. AOPL states that applying a 

weight of one to operating expenses and zero to net plant is appropriate for a company 

where operating costs are greater than revenue. 
Docket No. RM10-25-000 - 37 - 

f. Commission Determination 

83. The Commission does not adopt Mr. O’Loughlin’s proposal to use page 700 data 

because there is a mismatch between the page 700 total cost-of-service, which includes 

only interstate data, and the page 700 throughput data, which includes interstate and 

intrastate data. 

84. As the shipper parties emphasize, the total cost of service data on page 700 relates 

solely to interstate costs. However, the throughput data used by Mr. O’Loughlin from 

page 700 reports a combination of interstate and intrastate volumes. As AOPL explains 

in its October 20 Response, the barrel-mile information listed on page 700 provides that 

the barrel-mile figure should be the same as that reported on line 33a of page 600 of the 

Form No. 6. The instructions for page 600 refer to the inclusion of “all oils received” by 

the pipeline and makes no distinction between interstate and intrastate volumes. 

Consequently, pipelines may be reporting both interstate and intrastate volumes on 

page 700. 

85. Thus, Mr. O’Loughlin’s calculations compare one set of costs (interstate costs) 

with a different set of throughput (combined interstate and intrastate). Changes in 

transported throughput on a particular movement cause changes in the costs related to the 

very same movement. Thus, it is an axiomatic rule of ratemaking that the same set of 

costs and volumes must be used to determine rates. To obtain an accurate measurement 

of changing per barrel-mile costs for purposes of establishing an index level, the 

methodology must match the throughput used in the methodology to the costs incurred to 

transport the throughput used in the methodology. Given that page 700 does not match 
Docket No. RM10-25-000 - 38 - 

interstate costs with interstate volumes, the Commission rejects its usage in the 

methodology. 

 4. Adjustments for Declining Throughput 

 a. Comments

86. In reply comments, CAPP asserts that the index should not be inflated by the 

decline in throughput between 2004 and 2009. CAPP contends that the widespread 

recession caused the reduction in 2009 barrel miles and that such throughput declines 

cannot be expected to continue for another five years. CAPP states that its expert Mark 

Pinney replicated AOPL’s analysis using constant 2004 barrel miles and the resulting 

increase equated to PPI-FG plus 1.62 percent. CAPP argues that it is inconsistent with 

the purpose of an inflation adjusted index to allow changes in volumes to affect index 

levels and that increasing the index due to declining volumes will be self-perpetuating. 

CAPP also argues that allowing a generic index increase based on 2009 barrel-mile data 

contradicts Commission ratemaking policy for new pipeline facilities by using barrelmile data instead of capacity as billing determinants. 

87. Also in reply, ATA states that U.S. Energy Information Administration (EIA) 

estimates project an increase in total crude oil and petroleum consumption from 2010 to 

2011. ATA thus advocates establishing an index using constant 2009 volumes for 2011 

through 2016 as a “conservative” approach more favorable to pipelines. 

88. In its October 20 Response, AOPL contends that adjusting actual historical 

throughput to assume constant volume levels is speculative and directly contrary to the 

Commission’s established methodology. AOPL also challenges CAPP’s suggestion that 
Docket No. RM10-25-000 - 39 - 

the Commission uses capacity to measure costs instead of actual throughput, stating that 

because the oil pipeline industry is a highly capital intensive industry, when throughput 

declines, costs do not decline proportionally. AOPL adds that CAPP treats volumes as 

remaining constant but makes no attempt to adjust for fuel and power costs that are 

dependent upon volume levels. Moreover, AOPL adds that contrary to CAPP’s assertion 

that the decline resulted from the 2009 recession, more than 60 percent of the throughput 

decline occurred between 2004 and 2005. Thus, AOPL states that capacity should not be 

used to measure costs. 

 b. Commission Determination

89. The Commission rejects CAPP’s and ATA’s proposal to use constant barrel-miles 

in the Kahn Methodology rather than the actual barrel-mile levels. 

90. The Commission finds it appropriate to continue to rely upon historical data in 

applying the Kahn Methodology. The D.C. Circuit has upheld the Commission’s 

reliance upon historical data finding that the usage of historical data is consistent with the 

mandate to apply “‘a simplified and generally applicable ratemaking methodology.’”39 

91. Moreover, CAPP’s and ATA’s analysis of cost changes assuming constant 

volumes are problematic because they utilize asynchronous data. Regarding CAPP’s 

proposal to use constant 2004 barrel-miles, the 2009 costs reflect the expenses associated 

with the lower 2009 volume levels. Since certain costs (such as fuel and power) increase 

and decrease with volume levels, using 2004 data volume data with 2009 operating costs 

 39 AOPL II, 281 F.3d at 247 (2003) (quoting EPAct 1992, at § 1801(a)). 
Docket No. RM10-25-000 - 40 - 

will not present an accurate depiction of the change in per barrel-mile costs. By applying 

an upward adjustment to 2009 volumes without adjusting for the costs that would have 

been incurred as a result of those higher volumes, CAPP imposes a downward distortion 

on the change in pipeline costs calculated under the Kahn Methodology. Similarly, 

ATA’s proposal to assume constant 2009 volumes is defective because it does not adjust 

2004 costs so that the 2004 costs reflect the lower 2009 volumes. 

92. The Commission further rejects CAPP’s argument that it is inappropriate to allow 

the indexing methodology to be calculated based upon declining volumes. Declining 

volumes require pipelines to increase rates in order to meet revenue needs and, for 

existing oil pipelines, the Commission uses existing volumes, not capacity, to determine 

rates.40 Thus, much as in a cost-of-service, such declining volumes should lead to 

increased pipeline recovery levels in the indexing methodology. 

93. Finally, CAPP fails to demonstrate that the declining throughput for the 2004-

2009 period resulted primarily from the unusual economic conditions in 2008 and 2009 

as opposed to changes reflected throughout the prior five-year period. As Dr. Shehadeh 

demonstrates, more than 60 percent of the decline in barrel-miles during the 2004-2009 

period recorded on Form 6 occurred between 2004 and 2005,41 and was unrelated to the 

recession in 2008 and 2009. Thus, it is not the case that the index level has been distorted 

by the recession in 2008 and 2009. 

 40 See 18 CFR § 346.2(b)(2). Moreover, it is not clear how this capacity 

information could be obtained in the application of the index, since pipelines report 

throughput in Form No. 6, not capacity. 

41 Shehadeh October 20 Decl. at 29. 
Docket No. RM10-25-000 - 41 - 

 5. Applying the Index Only to Operations and Maintenance Costs 

 a. Comments

94. In its comments and reply comments, Navajo urges the Commission to apply the 

index only to operating and maintenance costs and not to costs attributable to 

depreciation, return, and income tax allowances. Navajo asserts that depreciation is not 

affected by inflation because depreciation is based upon equity investment, a historical 

cost. Navajo further contends that the two components of return – return on equity (in 

the form of increased deferred return) and cost of debt – already incorporate an inflation 

component. Thus, Navajo asserts that automatically granting pipelines an additional 

inflation-based index increase would enable pipelines to “double-dip” the inflation 

element. Third, Navajo asserts that the income tax allowance should not be increased 

automatically by an index, because one of its two components (the tax rate) generally is 

fixed by law and does not vary based on inflation, and the second component (rate of 

return on equity) already accounts for inflation. 

95. Instead, Navajo avers that the index should only be applied to operating and 

maintenance (operating and maintenance expense) costs. Navajo acknowledges that the 

Commission previously rejected this approach as too complicated in Order Nos. 561 and 

561-A, but Navajo notes that the Commission now collects categorical cost data from 

pipelines on page 700 of Form No. 6 and the Commission could apply the index only to 

operating and maintenance costs as recorded on page 700. Thus, Navajo states that the 

Commission could use the change in operating and maintenance expense costs identified 
Docket No. RM10-25-000 - 42 - 

by O’Loughlin to develop the indexed rate.42 Navajo explains that under its proposal, for 

each pipeline seeking an annual index increase, the index rate could be applied to the part 

of the rate attributable to operating and maintenance expense. Navajo elaborates that if 

the operating and maintenance expense costs were 40 percent of a pipeline’s cost of 

service on page 700 of its Form No. 6, the index-based rate increase should equal the preexisting ceiling rate times the index multiplied by “0.4.” 

96. In reply comments, ATA states that it agrees that applying an index adjustment to 

items not subject to inflation misaligns cost recovery with cost increases. ATA also 

alleges this provides a disincentive to invest in infrastructure. 

97. In reply comments and its October 20 Response, AOPL asserts that the 

Commission has twice rejected the selective indexing proposal advocated by Navajo. 

AOPL states that Navajo’s proposal is beyond the scope of this proceeding. Moreover, 

AOPL asserts that because the Commission measures capital cost changes by comparing 

changes in net carrier property, the Kahn Methodology does not incorporate inflation for 

either return or income tax allowance as alleged by Navajo. Rather, AOPL asserts, the 

methodology is based upon the assumption that the competitive rate of return on capital 

does not change. 

98. AOPL adds that the Commission has twice previously rejected Navajo’s proposal, 

first in Order No. 561 and in the first five year review on the basis that it would be 

 42 To derive this rate, Navajo relies upon Mr. O’Loughlin’s showing a change in 

the O&M costs for the middle 50 percent of oil pipelines of 5.0 percent and a change for 

the composite of the 50 and 80 percent of 5.4 percent. O’Loughlin August 20 Aff. ¶ 49, 

Figure 15. 
Docket No. RM10-25-000 - 43 - 

difficult to administer and create perverse incentives. AOPL states that Navajo has 

provided the Commission with no valid reason to reverse its prior rulings. Furthermore, 

AOPL asserts that under Navajo’s proposal, each pipeline would be required to perform 

calculations to determine its own pipeline specific index, a fundamental change from the 

“generally applicable” ratemaking methodology required by the EPAct 1992. 

b. Commission Determination

99. The Commission rejects Navajo’s proposal. The Commission has twice rejected 

proposals similar the one advocated by Navajo. In Order No. 561 as affirmed by the D.C. 

Circuit, the Commission concluded that limiting index increases to operating and 

maintenance costs would create perverse incentives for pipelines to direct a 

disproportionate amount of their spending to operating and maintenance costs and to 

neglect capital expenditures.43 Moreover, because new investment may be substantial 

and would not be covered by the index, many companies would be required to file costof-service cases to recover significant increases in cost.44 

100. In addition to creating perverse incentives, the Commission’s prior orders noted 

that Navajo’s proposal would also undermine the statutory mandate to establish a 

 43Order No. 561, FERC Stats. & Regs. ¶ 30,985 at 30,951-52, aff’d AOPL I, 83 

F.3d at 1437. The Commission returned to the issue in the first five year review, again 

rejecting the proposal on the basis that it could cause perverse consequences. First FiveYear Review, 93 FERC at 61,854-55. 

44 Order No. 561, FERC Stats. & Regs. ¶ 30,985 at 30,952. 

 
Docket No. RM10-25-000 - 44 - 

generally applicable and simplified methodology.45 The availability of page 700 data 

does not change this conclusion. Under Navajo’s proposal, the index would not be 

generally applicable. Each pipeline would receive its own annual index adjustment to the 

ceiling rate dependent upon the pipeline’s specific level of operating costs as reported on 

page 700. Navajo’s proposal is also contrary to the purpose of a simplified methodology. 

Requiring pipelines to multiply the index level by the ratio of “operating and 

maintenance” expenses to “total cost-of-service” on page 700 before applying the index 

to a pipeline’s existing ceiling rate will increase the likelihood of disputes in each annual 

application of the index as parties challenge those particular components of page 700 

data. 

101. Furthermore, Navajo’s arguments are theoretically unsound. Capital costs are a 

component of a pipeline’s total costs, and any index that tracks actual cost changes must 

account for changing capital costs. The Commission also rejects Navajo’s argument that 

for income tax and rate of return, the index double-counts inflation. The Kahn 

Methodology uses net carrier property as a proxy for income tax and rate of return, and 

net carrier property does not contain any internal inflation-related adjustments.46 

 

 45 Order No. 561, FERC Stats. & Regs. ¶ 30,985 at 30,951-52; First Five-Year 

Review, 93 FERC at 61,854-55. 

46 Because it is not presented by the facts here, the Commission does not address 

whether using rate of return data that incorporated an inflation component would, in fact, 

be inappropriate for deriving the index. Similarly, the Commission does not address 

issues related to using actual page 700 tax allowance data because the index currently 

uses a proxy for income tax costs. 
Docket No. RM10-25-000 - 45 - 

6. Separate Indices for Crude and Product Pipelines 

 a. Comments

102. In its comments, Valero and its witness O’Loughlin recommend one index for 

crude and product pipelines. However, Valero avers that differences in cost changes 

experienced between crude and product pipelines could argue in favor of separate indices 

for these two groups. Valero states that using his methodology, Mr. O’Loughlin 

determined that the median annual change in unit costs is 2.1 percent for products 

pipelines and 3.3 percent for crude pipelines. The composite index for the middle 

50 percent of the datasets is 2.3 percent for products pipelines and 4.3 percent for crude 

pipelines. 

103. In reply comments, ATA advocates the adoption of separate indices for crude and 

product pipelines, asserting that separate indices would allocate costs more equitably 

among shippers. ATA emphasizes that doing otherwise would force product shippers to 

subsidize crude shippers. The ATA urges that the data to produce separate indices is 

readily available, noting that of the 97 pipelines included within Mr. O’Loughlin’s 

analysis, 31 were classified as crude pipelines and 45 were classified as product 

pipelines. NPGA also states that, as established by Mr. O’Loughlin, the disparity in cost 

changes between crude pipelines and product pipelines supports the development of 

separate indices. 

104. In its reply comments and October 20 Response, AOPL represents that the 

Commission has previously rejected separate indices and emphasizes that Valero witness 
Docket No. RM10-25-000 - 46 - 

O’Loughlin ultimately concluded that the Commission should apply one index to all oil 

pipelines. 

b. Commission Determination 

105. Mr. O’Loughlin has provided some evidence to indicate that product and crude 

pipelines have experienced different levels of cost change. However, neither 

Mr. O’Loughlin, ATA, nor NPGA offered an explanation for why this cost disparity 

between crude and product pipelines exists. ATA and NPGA rely upon 

Mr. O’Loughlin’s testimony, but Mr. O’Loughlin recommends using one index for all 

pipelines,47 and ATA and NPGA otherwise have failed to demonstrate that the 

Commission should depart from its prior policy applying one uniform index to all 

pipelines. Thus, on the record presented here, the Commission will continue to apply one 

index to both crude and product pipelines. 

C. Allegations of Pipeline Over-Recovery

 1. Comments

106. In their comments, several shippers – Sinclair/Tesoro, the Trucking Association, 

ATA, NGPA, SPOPS, and Navajo –reject the notion that the index reflects actual 

pipeline cost changes. Sinclair/Tesoro argues that it is unlikely the pipeline industry is 

experiencing cost increases equal to the broader economy since the last review. In 

support, Sinclair/Tesoro cites depressed cost levels in areas specific to pipeline operation, 

such as labor, energy, and materials used in pipeline construction. In contrast, 

Sinclair/Tesoro represents that PPI-FG has recovered more rapidly, almost completely 

 47 O’Loughlin August 20 Aff. ¶ 61. 
Docket No. RM10-25-000 - 47 - 

rebounding to its mid-2008 peak. Thus, Sinclair/Tesoro states that it is not appropriate to 

maintain the prior period rate ceiling of PPI-FG+1.3. 

107. In its comments, ATA states that, based upon a sample of 73 Commissionregulated pipelines, over 30 pipelines have reported over-recoveries for some or all of the 

years from 2002 – 2009, and that these pipelines reported over-recoveries of 

approximately $1.9 billion. ATA asserts that this could cause parties to defer capital 

expenditures because returns on depreciated assets exceed those provided by new 

investments. Moreover, ATA suggests it is suspicious that pipelines that are underrecovering by substantial amounts have not filed a cost-of-service rate increase. In Reply 

Comments, ATA further emphasizes that pipelines experience non-uniform cost changes. 

ATA states that the Commission should be “careful” in designing any index to be applied 

to pipelines generally. 

108. In addition to reiterating ATA’s concerns regarding over-recovery, NPGA states 

that the major propane pipelines are now controlled by one company and that as a result 

shippers have experienced a pattern of increased costs through new fees, reduced service, 

sale of necessary assets to a pipeline affiliate, and operating penalties. Although NPGA 

acknowledges that pipelines as a whole are reporting an under-recovery, NPGA states 

that this does not relieve the Commission of its duty to ensure that each individual 

carrier’s rates are just and reasonable and the existence of such a disparity merely 

indicates that the index does not reflect actual changes in pipeline cost. NPGA and ATA 

urge the Commission to require pipelines showing over-recoveries to show cause why 

their rates should not be considered unjust and unreasonable. 
Docket No. RM10-25-000 - 48 - 

109. Similarly, SPOPS avers that oil pipelines are consistently over-recovering their 

costs. Accordingly, SPOPS proposes an index rate of zero until pipeline profits return to 

a just and reasonable level. SPOPS states that since the inception of the index the 

Commission has allowed pipelines to increase their rates by 39 percent, even though by 

2009, 41 oil pipelines reported excess profits totaling over $200 million per year. In its 

comments, SPOPS includes in these profits the income tax allowance for Master Limited 

Partnerships (MLP), which do not incur income taxes. SPOPS states that it is difficult to 

challenge rate increases pursuant to the index. SPOPS states, as a result, the Commission 

has abdicated its responsibility under the ICA, emphasizing that not even “a little 

unlawfulness” is permitted, and that the Commission index as applied by the Commission 

tolerates unlawfulness. 

110. In reply, Navajo states that it has reservations about basing the index on PPI-FG. 

Navajo states that nothing in the record demonstrates that pipeline costs inherently 

correlate with general rates of producer price inflation. In addition to claiming that 

pipelines have been over-recovering, on reply, Navajo also state that pipelines should not 

receive the benefit of automatically-approved rate increases when the pipeline reports 

that it is over-recovering. Navajo states that withholding the index from pipelines that 

are over-recovering can be accomplished through page 700, and thus is not any less 

administratively efficient than the Commission’s current approach nor, in Navajo’s view, 

does it increase litigation. 

111. AOPL in its Reply Comments and October 20 Response states that the 

Commission properly rejected similar arguments during the prior 5-year review. AOPL 
Docket No. RM10-25-000 - 49 - 

notes that the Commission's rationale in past proceedings accepts that some pipelines 

may over-earn while others under-earn as an inherent attribute of the index. AOPL 

asserts that the pertinent issue is not the overall level of pipeline cost, but rather how the 

index compensates for changes in pipeline costs. AOPL also states although page 700 

data may show excess revenues, it does not mean a pipeline rates are not just and 

reasonable. According to AOPL, there are several other mechanisms other than an 

Opinion No. 154-B methodology to establish a pipeline’s rates, including market-based 

rates and negotiated rates. In addition, AOPL contends the shippers’ allegations do not 

reflect actual pipeline cost recovery. Based on Dr. Shehadeh's calculations, AOPL claims 

approximately two-thirds of pipelines’ page 700 calculations report under-earning on an 

Opinion No. 154-B basis. AOPL responds to Sinclair's claim that the pipeline industry 

experienced cost changes in alignment with the global economic recession by stating it is 

speculative and is contrary to actual changes in costs as Dr. Shehadeh shows in his 

calculations using the Kahn Methodology. 

2. Commission Determination

112. The fact that some pipelines may be over-recovering is not contrary to the 

establishment of a general index level for all pipelines. The purpose of the index is to 

track cost changes using a generally applicable and simple method, and does not involve 

an assessment of whether each of the various pipelines are over- or under-recovering 

their costs. This can be seen in the application of the index. When a pipeline proposes an 

indexed rate change, the Commission is not subject to a statutory duty to examine the 
Docket No. RM10-25-000 - 50 - 

whole rate.48 Rather, the Commission’s inquiry is limited to a comparison of the changes 

in the rates and costs from year to year. 

113. As the Commission explained previously, inherent to the application of any 

industry-wide pipeline index, some pipelines will over-earn while others will under-earn.

49 However, the Kahn Methodology ensures that that indexed changes are consistent 

with recent industry-wide historical norms.50 To the extent that the customers of a 

particular pipeline determine that the underlying rates on a particular pipeline are u

and unreasonable, those parties may file a complaint against that particular pipeline’s 

rates pursuant to the ICA and the Commission regulations. Moreover, even when 

considering pipeline over-recoveries and under-recoveries (as opposed to cost changes), 

Dr. Shehadeh presented evidence that in 2009, the oil pipeline industry as a whole was 

under-earning by approximately 1

njust 

7 percent.51 

 48 Second Five-Year Review, 114 FERC ¶ 61,293 at P 57. This is consistent with 

the grandfathering of the then-existing rates under the EPAct 1992. EPAct 1992, at 

§ 1803. 

 

49 Order No. 561, FERC Stats. & Regs. ¶ 30,985 at 30,948-49; Second Five-Year 

Review, 114 FERC ¶ 61,293 at P 57. 

50 Contrary to Sinclair/Tesoro’s claims and Navajo’s allegations, as discussed 

above, the empirical evidence presented using the Kahn Methodology demonstrates that 

pipeline costs per barrel-mile have increased at a rate exceeding changes in PPI-FG over 

the past five-years. There is no indication that an adjusted PPI-FG is inadequate for 

tracking cost changes. 

 

51 Shehadeh September 20 Decl. at 32-33. 
Docket No. RM10-25-000 - 51 - 

D. Other Factors Affecting Pipeline Costs Raised by the Parties

114. Although not linked to any particular modification of the index methodology, the 

comments urged the Commission to consider general issues related to pipeline integrity 

and the MLP business structure. 

1. Pipeline Integrity and Regulatory Safety Costs

 a. AOPL Initial Comments

115. AOPL states that costs have increased due to assessment and re-assessment of 

pipeline structural integrity and remediation required by the Pipelines and Hazardous 

Materials Safety Administration (PHMSA), an agency of the United States Department of 

Transportation. AOPL, supported by the Declaration of William R. Byrd, stresses that 

assessment requires expensive technology (including rental of inline inspection tools), 

labor intensive processes (involving excavation and manual inspection), and remediation. 

Mr. Byrd represents that “compliance with the integrity management regulations is likely 

to be the largest single variable cost item for most pipelines and these costs show no signs 

of decreasing.”52

116. Mr. Byrd projects pipeline integrity costs to continue increasing because inline 

inspection tools are becoming more expensive and more likely to detect pipeline 

anomalies requiring correction. AOPL states that PHMSA has imposed increasingly 

stringent obligations and that new or expanded regulatory requirements may be imposed 

by Congress during the reauthorization of the Pipeline Safety Act, which AOPL expects 

to occur later in 2010 or 2011. 

 52 AOPL Comment at 19 (quoting Byrd Decl. at 7). 
Docket No. RM10-25-000 - 52 - 

117. AOPL and Mr. Byrd identify other regulatory obligations over the past five years 

that have increased costs, including public awareness program regulations and operator 

qualification regulations. AOPL and Mr. Byrd explain that costs in the next five years 

are likely to increase due to new PHMSA control room management regulations, new 

PHSMA guidelines regarding land-use on or near pipeline rights-of-way, new chemical 

facility anti-terrorism standards promulgated by the Department of Homeland Security, 

and issues regarding greenhouse gas emissions issued by the Environmental Protection 

Agency. 

118. In separate comments, PHMSA also represents that pipeline safety and integrity 

regulations have imposed significant compliance costs over the past eight years. Further, 

PHMSA notes the possibility of future regulatory changes and that it anticipates the cost 

of these activities will continue to impose significant financial burdens. 

b. Reply Comments 

119. Several reply comments noted increased costs related to pipeline integrity. Platte, 

an interstate liquids pipeline, expects to incur more than $2 million above historic levels 

of integrity related costs for the foreseeable future. Platte notes that significant additional 

costs may appear in damage prevention initiatives, valve spacing, leak detection, and 

increased focus on preventing small releases. The Pipeline Safety Trust notes that it is 

currently recommending that Congress increase PHMSA’s jurisdiction over hazardous 

liquid pipelines and that Congress direct PHMSA to expand integrity management and 

other safety-related requirements. 

120. Other parties challenged AOPL’s contention that the pipeline integrity costs 
Docket No. RM10-25-000 - 53 - 

supported an elevated index level. Valero notes that accounting treatment of pipeline 

costs was not consistent prior to 2006, when the Commission clarified the accounting 

practices for integrity programs.53 Thus, Valero states that AOPL, by comparing changes 

in account 320 between 2004 and 2009, overstates the changes in pipeline integrity costs. 

Valero also emphasizes that account 320 costs, which include both interstate and 

intrastate data, are only 14.4 percent of the total cost-of-service. Moreover, Valero notes 

that the Commission has previously rejected adjustments to the index based upon 

estimates of anticipated increases in pipeline integrity costs.54 Lastly, Valero asserts that 

claims of future increases in regulatory expenses are speculative. 

121. ATA, in its reply, states that pipeline integrity cost increases are already 

appropriately accounted for in the years 2004 through 2009. ATA states that the Pipeline 

Integrity Management program was established in 2002, and that the program required 

hazardous liquid pipeline operators to develop a written plan to initially assess the 

integrity of their pipelines over a roughly five year period with baseline assessments to be 

50 percent completed by September 30, 2004, and 100 percent completed by March 31, 

2008. After the baseline assessment, the assessments are to be repeated every five year 

period. 

122. SPOPS also avers that future costs are speculative and inconsistent with a 

backward looking methodology. SPOPS asserts that a large increase rewards pipelines 

 53 Valero Reply Comment at 8 (citing Jurisdictional Public Utilities and 

Licensees, Natural Gas Companies, and Oil Pipeline Companies, 111 FERC ¶ 61,501 

(2005)). 

54 Valero Reply Comment at 10 (citing AOPL II, 281 F.3d at 247). 
Docket No. RM10-25-000 - 54 - 

with unjust and unreasonable rates and that the pipelines not recovering their costs are 

free to file for rate increase. Sinclair/Tesoro also assert that more stringent safety 

regulations are not unique to pipelines as environmental regulations have also imposed 

costs on shippers, and that it is unfair to impose these costs alone on shippers. 

c. AOPL October 20, 2010 Response 

123. AOPL states that it relies on Mr. Byrd’s declaration to explain that Dr. Shehadeh’s 

calculations are consistent with real-world industry experience, and to show that 

establishing an index below PPI-FG+3.64 would frustrate expectations on which past 

pipeline investments have been made, among other things. 

124. AOPL also states that Mr. Byrd’s testimony is consistent with the comments of 

PHMSA, which state, among other things, that regulations have imposed significant 

compliance costs and events, including the Deepwater Horizon oil spill, have also caused 

PHMSA to expand its integrity management regulations. AOPL disagrees with SPOPS’ 

suggestion that pipelines should seek to recover these safety and integrity management 

costs through cost-of-service filings, arguing that such an approach is inconsistent with 

the implementation of a generally applicable ratemaking methodology. AOPL argues 

that if pipelines were required to use cost-of-service filings to recover these kinds of 

costs, the efficiency gains which were intended by EPAct in implementing the generally 

applicable index methodology would be lost. 

d. Commission Determination

125. AOPL and other parties have submitted this information regarding future costs for 

Commission consideration, but they have not proposed to depart from the Kahn 
Docket No. RM10-25-000 - 55 - 

Methodology’s reliance upon historic data. Moreover, future costs projections related to 

regulatory changes are speculative and inappropriate for inclusion in the index.55 

Accordingly, the evidence presented regarding prospective regulatory changes does not 

alter the Commission’s determination regarding the appropriate index level as calculated 

based upon historic costs. 

2. Master Limited Partnerships 

126. CAPP contends that the Commission should not grant an increased allowance 

merely to enhance cash flow requirements that may be attributable to the MLP form of 

business. CAPP states that due to federal tax laws, MLPS generally distribute all 

available cash flow to unit holders in the form of quarterly distributions. CAPP argues 

that the form of business organization and operation may create a tension between how a 

pipeline makes prudent safety and integrity-related decisions without contravening cash 

distribution constraints. CAPP argues that the Commission should not view the cash 

requirements of MLPs as a legitimate basis for increasing the revenue flow generated by 

regulated rates. SPOPS also claims that the MLP structure attracts capital to the pipeline 

industry but, rather than making investments in infrastructure, diverts the equity capital 

away in payouts to the general and limited partner investors. 

127. AOPL responds in its Supplemental Reply Comments that shippers made 

substantially similar arguments during the prior five-year review period, and the 

Commission rejected them. Furthermore, AOPL states it is not seeking “an increased 

allowance” to enhance MLP cash flow requirements. AOPL asserts neither the cash flow 

 55 AOPL II, 281 F.3d at 247. 
Docket No. RM10-25-000 - 56 - 

requirements of MLPs nor the dividend policies of corporate-owned pipelines are part of 

the calculation of changes in oil pipelines costs. Nor is there any “tension” between 

pipeline safety and capital investment and MLP cash distribution requirements, as CAPP 

contends. AOPL contends the issue is not about the pipeline organizational structure, but 

whether pipelines will be able to recover sufficient revenue to fund their operations. 

Accordingly, AOPL argues shippers provide no valid basis to abandon the established 

methodology. 

a. Commission Determination

128. All pipelines, regardless of business form, experience changes in cost. The index 

is designed to enable pipelines be able to recover sufficient revenue to fund their 

operations, whether or not the pipeline’s business form is as an MLP. The middle 50 

Kahn Methodology allows the Commission to appropriately exclude outliers and to track 

general changes in pipeline costs whatever the form of the business. Accordingly, the 

discussion regarding MLPs does not alter the Commission’s determination regarding the 

appropriate index level. 

E. Revisions to Form No. 6

 1. Comments

129. ATA and NPGA aver that Form No. 6 should be revised to segregate cost and 

revenue for each regulated common carrier and or system and to supply separate page 

700 data for each oil pipeline or system included in the report. To enhance transparency, 

ATA and NPGA also asserts that Form No. 6 should be revised to require the pipeline to 

file all workpapers that fully support the data reported on Form No. 6 page 700, including 
Docket No. RM10-25-000 - 57 - 

a total cost-of-service. ATA and NPGA also assert that pipelines must file Form No. 6 

before initiating an index rate increase. ATA and NPGA also argue that the Commission 

should change the interest rates applicable to refunds as provided in 18 CFR 

§ 340.1(c)(2)(i) to reflect the pipeline’s rate of return as reported on Form No. 6, page 

700. 

130. SPOPS urges, in its reply comments, that shippers and customers should be 

allowed access to the workpapers underlying page 700. SPOPS also contends that the 

page 700 data should reveal both the nominal and the real rate of return on equity, 

including the amount of dollars of equity both collected in rates and dollars placed in rate 

base. SPOPS states that the current rate of return on equity must be known to determine 

the need for the index increase to attract capital. 

131. In reply comments, AOPL argues that the Commission has addressed and rejected 

the proposal regarding segmented data and workpapers. AOPL states the Commission in 

its ruling explained that page 700 is designed to be a preliminary screening tool for 

pipeline rate filings and not form the basis of a decision or demonstrates the just and 

reasonableness of proposed or existing rates. AOPL asserts the Commission has revisited 

this issue as recently as December 2008 and upheld its initial views. 

2. Commission Determination

132. The Commission finds that the proposals to modify Form No. 6 are outside the 

scope of this proceeding, which is to set the going-forward index level. 
Docket No. RM10-25-000 - 58 - 

The Commission orders:

Consistent with our review and verification of the sample pipeline Form No. 6 

data, and the application of the previously approved Order No. 561 methodology to that 

data, the Commission determines that the appropriate oil pricing index for the next five 

years, July 1, 2011 through June 30, 2016, should be PPI-FG+2.65. 

By the Commission. 

( S E A L ) 

Nathaniel J. Davis, Sr., 

Deputy Secretary.