Opinion ID: 329424
Heading Depth: 3
Heading Rank: 1

Heading: The Atlantic Seaboard Formula

Text: 15 The process of setting rates under the Natural Gas Act for jurisdictional sales of natural gas has three distinct stages. First, the total cost of service is determined at a level sufficient to embrace return (profit) and taxes payable. The different elements of the cost of service are classified to either a commodity or a demand category. This interrelates with the formation of a two-part rate: a fixed demand component related to the customer's basic entitlement to receive gas from the natural gas company; and a commodity component with a rate specified for each unit of gas received. Variable costs 8 are assigned to the commodity or volumetric component because they fluctuate according to the volume of gas delivered. Fixed costs, 9 which are incurred in advance to provide the capacity to supply customers' peak demand, as well as to service nondemand volumes, have been divided equally between demand and commodity components under the Atlantic Seaboard method. 16 In the second stage of the process, the total costs are allocated between jurisdictional and non-jurisdictional customers. Demand costs may be allocated on the basis of peak-day or peak-period demands, while commodity costs are allocated according to the percentage of test-year sales attributable to each class of customers. 17 Rates are then designed to recover the costs allocated to jurisdictional customers. 10 Commodity costs are recovered by a cents-per-mcf commodity charge, which is paid by all customers on the basis of the total volume of gas actually delivered (annual use). Under Atlantic Seaboard the commodity charge recovers all variable costs and half of the fixed costs. Demand costs are recovered by a fixed monthly demand charge paid by those who have a contractual right to demand specified quantities of gas on peak days. The demand charge may be calculated according to the maximum amount that the customer has a right to demand as specified in the service agreement, or on the basis of the highest daily take for each customer during the past twelve months. United switched from the former to the latter method in April of 1974. 18 Demand charges fall most heavily on city-gate customers, typically local distribution companies that take gas at the city gate, for sale primarily to commercial and residential customers. They usually take at a low load-factor; that is the volume of purchases of the city-gate customers tends to fluctuate considerably, between the cold winter season of high demand and the slack summer season. Because of these fluctuations the proportion they pay in demand charges is high compared to their commodity charges. In contrast, commodity charges are relatively more significant for high load-factor customers pipeline customers, who receive a relatively steady supply throughout the year, either because they service industrial customers not subject to the weather-related fluctuations characteristic of human needs, or because they have constructed storage facilities to which they can route any summer receipts in excess of their customer's summer requirements. Any shift towards the commodity component of the tariff increases the relative burden borne by the high-load customers. In the decision under review, the FPC revised its approach to cost classification and allocation and rate design, attributing only 25% of United's fixed costs to demand and 75% to commodity. 19 The decision in Atlantic Seaboard to devise a two-part formula was based on the Commission's recognition that the facilities responsible for the fixed costs perform both a capacity and a volumetric function. 11 The facilities are built to supply maximum demand, for the pipeline must always have the capacity available to meet those requirements, whether or not it is used on any given day. 12 However, the Commission pointed out that 20 pipelines are built to supply service not only on the few peak days but on all days throughout the year. In proving the economic feasibility of the project in certificate proceedings, reliance is placed upon the annual as well as the peak deliveries. Stated another way, the capital outlay for the pipeline facility is made and justified not only for service on the peak days but for service throughout the year. . . . If fixed expenses are assigned wholly to the demand or capacity function, then gas service which is interrupted on peak days will not share in any of the fixed costs. 13 21 In Atlantic Seaboard, the FPC acknowledged that the exact division of fixed costs between demand and commodity components involved a pragmatic judgment, for the facts upon which the determination must be made are not susceptible to mathematical computation. 14 The Commission pointed out that both functions are . . . significant and found that a 50%-50% weighting both recognized the higher costs of peak service and imposed some responsibility for fixed costs on off-peak service. 15 22 The Seaboard 50%-50% formula has not been adhered to rigidly. Although the Commission has not completely departed from the two-part design, it has, on an ad hoc basis, tilted the distribution of fixed costs by increasing the amount assigned to the demand component in response to competition from alternative fuel sources 16 or competition between pipelines, 17 as well as to maintain more efficient use of a pipeline's facilities by encouraging the construction of storage facilities or increasing off-peak industrial sales. 18 This practice was upheld by the Seventh Circuit as within the Commission's discretion  'to make the pragmatic adjustments which may be called for by particular circumstances.'  19 2. The Administrative Law Judge's Decision 23 In the proceeding under review, United filed a tariff essentially 20 based on the traditional Seaboard formula. The Commission's staff argued that Seaboard should be replaced by a strictly volumetric method of cost allocation and rate design, on the ground that the gas supply shortage had removed the close relationship between actual peak-day use and pipeline capacity that had existed in 1952. Two-part rates, the staff argued, encourage large-volume consumption of gas inappropriate in a time of curtailments. Administrative Law Judge (ALJ) Kaplan refused to adopt a strictly volumetric allocation on the ground that it failed to recognize both the continuing existence of some (albeit reduced) peak demand and the lower costs long recognized to be associated with high load-factor service. 21 Instead, he increased the percentage of fixed costs attributed to the commodity component from 50% to 67%, an action he deemed appropriate in the light of his finding that 17% of the total available capacity had in fact been idled because of unanticipated supply problems. 22 3. The FPC's Orders 24 The FPC agreed with ALJ Kaplan that the Seaboard method should be revised to allocate more fixed costs to the commodity component because the decrease in peak day deliveries required that greater emphasis . . . be placed upon the annual use of United's pipeline system. 23 25 The FPC went on to say that in its view a straight volumetric system could be justified under present conditions because the limiting factor in the operation of United's pipeline system is the quantity of gas available and not the capacity of the pipeline. 24 Under this approach all costs including all fixed costs would be allocated to customers solely on the basis of volume of gas used. This single rate structure could be expressed in percentage terms as assigning 100% of fixed costs to commodity and zero to demand. 26 Despite its finding that a volumetric allocation and one-part rate structure would be proper, the FPC decided that an abrupt shift of that magnitude 25 would be disruptive to United's system. 26 Since the Seaboard opinion had explicitly said that the allocation of fixed costs could not be determined by mathematical computation and had based its decision instead on a pragmatic judgment, the Commission said that the ALJ's effort to compute the proper deviation from Seaboard on the basis of a technical calculation of unanticipated unutilized capacity lacked a logical foundation. 27 Instead, the Commission chose a ratio that is midway between the Seaboard 50-50 ratio and the volumetric method, 28 that is, 75% to commodity and 25% to demand. 27