Opinion ID: 721438
Heading Depth: 2
Heading Rank: 1

Heading: Background to Transition Costs

Text: 242 Order No. 436 began the natural gas pipeline industry's transition from its historic role as gas merchant to gas transporter. The Order authorized interstate gas pipelines to convert to blanket-certificated open-access transportation service. See supra Part I.B. In exchange, however, customers of those pipelines that did convert were permitted both(1) to convert their firm sales obligations into firm transportation contracts and also (2) to reduce their obligations to purchase gas from the pipelines. Pipeline customers in large numbers exercised their right under the Order to buy less gas from the pipelines, and secured gas supplies from less expensive sources. The pipelines themselves were then left with massive obligations to purchase high-priced gas at the wellhead: 243 [T]he conditions under which the NGPA began to relax wellhead price controls--namely acute gas shortage and sharply rising prices for alternative fuels--tended to divert pipeline attention from the hazards of incurring long-term obligations to buy high-priced gas. Under pressure from the Commission, the pipelines had typically purchased gas under contracts for very long terms. Besides incorporating high prices (and provisions for escalation upward), the contracts commonly included take-or-pay provisions, requiring the pipeline to pay for some specified percentage, say 75%, of the deliverable gas even if it took less. While usually subject to recoupment later, and while a perfectly natural allocation of risk between producer and purchaser, the take-or-pay provisions effectively committed the pipelines to high gas costs in what by 1982 proved to be a time of falling prices, both for competing fuels and for substitute supplies of gas not covered by contract. 244 AGD I, 824 F.2d at 995-96 (citations omitted) (emphasis added). 245 Thus arose the take-or-pay liabilities addressed by the Commission in Order No. 436 and its successors, as well as by this court in a variety of opinions. See supra Part I.B. Specifically, because most customers could purchase gas more cheaply from other sources, pipelines essentially were unable to pass through the costs of their own supply obligations. With purchases sharply reduced, pipelines owed massive take-or-pay liabilities to gas producers, which they had to either buydown--i.e., reduce--or buyout--i.e., eliminate. In Order No. 436, the Commission refused to set a general policy on whether or how pipelines could attempt to recover these costs. We vacated and remanded the Order, concluding that, in this regard, it was not based on reasoned decisionmaking, primarily because it appeared to grossly underestimate the financial impact of take-or-pay liability on pipelines. Id. at 1021-30. Of great concern to the court was the likelihood that even higher gas prices [319 U.S.App.D.C. 114] would simply cause more customers to switch suppliers, thereby exacerbating the take-or-pay crisis. This cycle of ever increasing prices and ever shrinking customer base--a phenomenon that petitioners label the death spiral--made it very unlikely that the pipelines would in fact recoup their take-or-pay liabilities absent some mechanism for separately passing those costs through to their customers. 246 In subsequent proceedings, the Commission adopted and this court approved various measures designed to address that concern and allow pipelines to pass through some of their take-or-pay liabilities to a broader range of customers. See supra Part I.B. Most pertinent to our analysis here, under Commission policy, a pipeline could agree to absorb between 25% and 50% of its take-or-pay costs in exchange for the right to bill customers an equal share through a fixed charge, and recover the remaining amount through a volumetric surcharge based on total throughput. Customers, and in turn the consuming public, ultimately reimbursed pipelines for approximately $6.4 billion in take-or-pay costs, while the pipelines themselves absorbed $3.6 billion. 247
248 After Order No. 436, all of the major interstate pipelines converted to open-access transportation. Not all customers on those pipelines, however, exercised their right to unbundle their sales agreements and reduce their gas purchase obligations. Several years later in Order No. 636, the Commission mandated unbundling and authorized sales customers to reduce their pipeline gas purchases. When customers exercised that right and secured gas supplies from other sources, the pipelines once again incurred substantial take-or-pay liabilities; though the Commission labeled these liabilities gas supply realignment costs in Order No. 636, they arose from the same type of producer-pipeline contract provisions as the take-or-pay costs considered in Order No. 436. Cf. Order No. 636-A, p 30,950, at 30,649 n.466 (Any costs that would qualify for recovery as GSR costs could be filed for recovery under [the successor to Order No. 436,] Order No. 528.). 249 In allocating recovery of GSR costs, however, the Commission adopted a policy more advantageous to the pipelines. Instead of refusing to establish a mechanism for pipelines to recover their take-or-pay costs, as it originally had in Order No. 436, FERC authorized pipelines to bill their customers separately for 100% of their GSR costs. This policy was, in fact, a substantial change from even Order No. 500, which permitted pipelines to surcharge their transportation customers for take-or-pay costs only if they agreed to absorb between 25 and 50% of those costs. The Commission set forth the mechanisms available to pipelines under Order No. 636 as follows: 250 ... The Commission will permit pipelines full cost recovery of prudently incurred gas supply realignment costs deemed to be eligible under this rule. To recover those costs, a pipeline will be permitted to use either a negotiated exit fee, or a reservation fee surcharge recoverable from Part 284 firm transportation customers. 251 Under this rule, a firm entitlement holder has options as to how to react to gas supply realignment costs: it may remain a sales customer of the pipeline; otherwise, it may take an assignment of the pipeline's existing contracts or pay an exit fee/reservation fee surcharge for costs approved by the Commission. 252 Order No. 636, p 30,939, at 30,458. On rehearing, FERC modified this ruling somewhat, and required pipelines to bill 10% of their GSR costs to interruptible transportation customers. See infra Part V.E.3.b.2. 253 Pipelines also face three other types of significant transition costs under Order No. 636: (1) unrecovered gas costs or credits remaining in the purchased gas adjustment (PGA) account when a pipeline terminates its PGA mechanism; (2) costs of pipeline assets (such as storage facilities) currently used to provide bundled sales service which are not directly assignable to customers of the unbundled services (stranded costs); and (3) costs for equipment required to physically implement the rule (new facility costs). [319 U.S.App.D.C. 115] Order No. 636, p 30,939, at 30,457. FERC determined in Order No. 636 that pipelines would generally be allowed to recover 100% of these costs. Id. at 30,457-60. 254 Petitioners raise several challenges to FERC's treatment of transition costs. First, they claim that FERC erred in allowing pipelines to recover 100% of their stranded costs, arguing that such recovery violates applicable legal standards. Second, they contend that FERC failed to adequately address the problem of LDC bypass, which occurs when large industrial customers bypass LDCs, thereby avoiding transition costs properly attributable to them. Third, they oppose Order No. 636's passthrough of above-market prices paid by pipelines for synthetic natural gas from the Great Plains Gasification Plant. Finally, they challenge in several respects FERC's treatment of GSR costs. 255