• FERCtastic: What MLP and Midstream Investors Should Know about the FERC

    10/15/19 | Stacey Morris

    Summary

    • Midstream investors should have some familiarity with the FERC given its oversight of interstate pipeline rates, LNG export projects, and interstate natural gas pipeline projects.
    • FERC is tasked with making sure rates on interstate pipelines are just and reasonable.
    • FERC has been criticized for delays in approving LNG export facilities but has made progress in improving its processes.

    While a regulatory body may seem like a dry topic, midstream investors should have a basic understanding of the Federal Energy Regulatory Commission (FERC), as its oversight powers and policies can have implications for midstream assets. FERC is tasked with regulating interstate pipelines, including rates, and overseeing the siting and construction of liquefied natural gas (LNG) export facilities. FERC is an independent agency, which has up to five commissioners appointed by the President to serve five-year terms. (Currently, two commissioner seats are open, with James Danly recently nominated to fill one commissioner vacancy pending Senate approval.)

    For investors, FERC became tantamount to a four-letter word in March 2018 when the Commission announced a policy revision intra-day that sent MLP equities spiraling. To say the announcement could have been better handled is an understatement. The implications of the March 2018 announcement have largely played out with greater clarity provided in the finalized rule issued in July 2018. In short, the result was not nearly as bad as initially feared. However, investors have long memories, especially when money is lost, and many maintain a negative perception of the FERC as a potential risk to MLPs and midstream. Today, we provide a brief overview of the FERC’s regulation of pipelines – where the commission has jurisdiction and how they regulate rates – and discuss FERC’s role in approving LNG export facilities.

    FERC regulates interstate pipelines.
    If a pipeline crosses state lines, it is subject to FERC regulation, with some variances depending on what the pipeline transports. FERC evaluates applications for building and operating interstate natural gas pipelines under Section 7 of the Natural Gas Act (read more). In order to build an interstate natural gas pipeline, companies must go through a multi-step process that includes notifying and soliciting feedback from stakeholders, applying for a certificate of public convenience and necessity from the FERC, and conducting environmental studies (read more). In April 2018, FERC announced a notice of inquiry to receive feedback on its policies surrounding its review of natural gas pipeline projects, but no action has been taken since then.

    FERC regulates interstate liquids pipelines under the Interstate Commerce Act, which refers to common carriers transporting oil by pipeline between different states. Oil here encompasses crude oil, refined products, and natural gas liquids, which we will refer to collectively as liquids for ease. FERC is tasked with making sure shippers receive equal service and equal access to liquids pipelines. Unlike natural gas pipelines, FERC does not approve the construction (or abandonment) of liquids pipelines.

    What does FERC not regulate when it comes to pipelines? For both liquids and natural gas pipelines, FERC has no oversight of pipeline safety, which falls to the Pipeline and Hazardous Materials Safety Administration (PHMSA). Additionally, pipelines that do not cross state lines are regulated by the relevant state. For example, pipelines in Texas are regulated by the Railroad Commission of Texas.

    How are pipeline rates regulated?
    The Office of Energy Market Regulation (OEMR) within the FERC reviews filings from natural gas and liquids pipelines to make sure rates and terms of service are just and reasonable and not unduly discriminatory or preferential. FERC is supposed to ensure that pipeline operators receive a reasonable fee for their services and reasonable returns – an important point to keep in mind for those who view the FERC negatively following the March 2018 announcement. Though the same body regulates rates for both gas and liquids pipelines, the approach for tariffs differs.

    Natural Gas Pipelines – According to the Natural Gas Act, FERC is tasked with ensuring that rates on natural gas pipelines are just and reasonable. The Natural Gas Policy Act of 1978 authorized FERC to regulate intrastate natural gas pipelines that operate in or support interstate commerce. These intrastate pipelines must have an approved tariff on record with the FERC, but the rate can be based on different methodologies as filed with the appropriate state regulatory agency (read more). Rates must be “fair and equitable.” Interstate natural gas pipelines may charge cost-of-service, market, or negotiated rates.

    A natural gas pipeline can apply to increase its rates in a Section 4 rate case, but the pipeline must prove that the new rate is just and reasonable. Once the filing has been submitted, the pipeline and its customer(s) may agree to settle a new negotiated rate, or the case could be heard by an Administrative Law Judge. If a rate is considered to be too high, FERC can require a prospective rate change under Section 5 but must prove that rates are no longer just and reasonable. FERC can initiate a rate investigation on its own or in response to a shipper complaint. As an example, FERC initiated a rate investigation of two gas pipelines in 2017, with one earning an estimated return on equity above 20% and the other earning an estimated return just shy of 20%.

    Liquids Pipelines – Most interstate liquids pipelines adjust their rates based on FERC’s Oil Pipeline Index, which sets a maximum for annual rate increases based on the Producer Price Index for Finished Goods plus an adjustment (currently PPI-FG + 1.23%). The index is reviewed every five years, with the current methodology applicable through July 2021. While most liquids pipelines use the index, rates can be based on cost of service, market rates, or negotiated rates.

    FERC making progress on improvements to LNG export project reviews.
    FERC’s review process for LNG export facilities has been criticized due to delays. FERC approves the siting and construction of LNG export facilities under Section 3 of the Natural Gas Act, reviewing the environmental impacts, safety, and engineering of facilities. In August 2018, FERC provided environmental schedules for twelve LNG facilities and announced streamlining efforts for reviewing LNG applications, which were expected to reduce reviews by 9-12 months in some cases. At the time, FERC announced other steps to improve the application process including partnering with the PHMSA for input on safety and the hiring of outside contractors to assist with reviews.

    In February 2019, FERC approved Venture Global’s Calcasieu Pass LNG export facility – its first LNG export project approval in over two years. Subsequently, additional LNG projects have been approved this year, including Tellurian’s (TELL) Driftwood LNG and Sempra Energy’s (SRE) Port Arthur LNG project (read our latest piece on LNG exports for more detail). In July 2019, FERC announced a new LNG division within its Office of Energy Projects and a new satellite office in Houston for eight staff members, complementing the twenty LNG-focused employees based in Washington, D.C. With the US expected to become the largest exporter of LNG in 2024 according to the International Energy Agency, FERC’s approval process has weighty implications for US LNG exports, and the Commission has clearly made an effort to improve its processes. For more information on LNG projects, FERC’s website includes details on the status of projects, whether they’ve been approved, approved but not built, or have merely been proposed.

    Bottom line
    An article about the FERC may seem like the ideal reading material to ease into a Sunday afternoon nap. However, FERC’s oversight of interstate pipeline rates, LNG export projects, and interstate natural gas pipeline projects means that FERC can have some bearing on midstream revenues (depending on the pipeline and rate mechanism) and project timelines. For that reason, it’s helpful to have a working knowledge of the FERC.