October 18, 2019
The best defense is a good offense, or so the saying goes. So when FERC announced a Section 5 rate investigation against Panhandle Eastern and Northern Natural Gas, each of them complied with the requirements of that proceeding, but also prepared to file their own rate case under Section 4. Northern Natural filed its case on July 1 and Panhandle filed its case at the end of August. Both are proceeding along parallel tracks with a schedule that calls for initial decisions in November 2020 for Northern Natural and in January 2021 for Panhandle, while the parties also meet regularly with a settlement judge.
Today we review the testimony filed in the Panhandle case to look at two key issues, tax allowances and return on equity (ROE), that could impact other cases. Panhandle restructured itself to eliminate its tax allowance and relied on a variety of methods for calculating its ROE to boost its proposed return from 13.2% to 14.67%. In particular, it used two of the three methods FERC has recently started using to calculate the ROE for electric transmission providers, but rejected the third measure as being inappropriate for pipelines. We then provide an update on the status of the other rate cases that seem to be following the usual path toward settlement.
Panhandle filed its Form 501-G on October 11, 2018. It filed an addendum on November 5, 2018. Based on a review of those filings, responsive comments filed by others and publicly available information filed with the Commission, the Commission concluded that Panhandle may be substantially over-recovering its cost of service, causing Panhandle’s existing rates to be unjust and unreasonable. Therefore, on January 16, 2019, the Commission initiated an investigation pursuant to Section 5, simultaneously setting the matter for hearing and requiring Panhandle to file a cost and revenue study within 75 days of the issuance of the hearing order. That Section 5 proceeding resulted in testimony being filed by both Panhandle and FERC Staff. In addition, on August 30, Panhandle filed testimony as part of the Section 4 case it commenced. Two key issues that could impact other cases are in dispute between FERC and Panhandle. The first is whether Panhandle should be entitled to a tax allowance and whether it needs to pass back to customers any excess accumulated deferred income taxes (ADIT). The second is the ROE that Panhandle is entitled to based on FERC’s methodology for calculating ROE.
Tax Allowance and ADIT
As anyone who has been following FERC’s pronouncements over the last eighteen months knows, FERC reversed its longstanding policy that allowed all pipeline companies to include a tax allowance in their cost of service and began prohibiting such allowances for companies that were owned by master limited partnerships (MLP). This led to a number of corporate restructurings by the corporate affiliates of MLPs to eliminate the MLP from their corporate structure in order to maintain a right to include an income tax allowance. The benefit to MLPs that existed on the date FERC changed its policy is that FERC also decided that those pipelines could wipe off their books the ADIT balances that had accrued while they were entitled to a tax allowance. The elimination of ADIT causes the asset base of a pipeline to increase because the ADIT balance reduces a company’s asset base.
The interesting twist presented in the Panhandle case is that Panhandle completed an internal restructuring in July 2019 to eliminate any corporate entities from its ownership structure, apparently in an effort to eliminate its income tax allowance and the related ADIT balance. The benefit of doing this can be seen in the asset base Panhandle reported in its cost of service study filed in the Section 5 case, which was $877,251,688 as compared to the rate base filed in support of its Section 4 case of $1,131,344,865, with that $250,000,000 increase being caused almost entirely by the elimination of $215,000,000 in ADIT.
FERC Staff has taken the position in its testimony that the Commission’s precedent has not yet addressed the question presented in this case. According to the Staff’s reasoning, FERC’s prior decision makes clear that had Panhandle been structured as it currently is when FERC made the announcement to eliminate the tax allowance for MLPs, it would be entitled to eliminate its ADIT, but that because it “became” an MLP-owned pipeline after that date, it is not entitled to eliminate its ADIT and must keep the ADIT as a reduction in its rate base and ratably pass that excess ADIT back to its shippers. The impact of this argument is seen in the three cost of service calculations that FERC Staff proposes that differ solely on how to address this question of whether Panhandle is entitled to an ITA and whether it must retain its ADIT and pass it back to its customers. As detailed by FERC Staff, the cost of service would vary as follows:
As can be seen, this one issue can cause an almost 20% increase in the pipeline’s cost of service even using FERC’s much lower ROE discussed in the next section.
ROE Methodology - - The New Way is Great When it Helps
As we discussed in FERC Asks for Input on ROEs for Pipelines and the Opinions Roll In , FERC has asked for input on whether it should change its methodology for calculating the ROE granted to pipelines in rate cases. FERC has proposed extending to pipelines the process it adopted for electric transmission providers that takes the mathematical average of four different calculations of ROE rather than relying solely on the results from its traditional Discounted Cash Flow (DCF) methodology. A struggle FERC is having with many of these methodologies, however, is that there are simply not enough companies that meet FERC’s standards for inclusion in what is called the “proxy group” for calculating the market’s ROE requirements. The Panhandle and Northern Natural cases are prime examples of this problem where all of the experts were required to relax FERC’s proxy group standards to come up with a proxy group with at least five members. The list of companies used by each expert is instructive:The difference in proxy group members and time period used for calculating the returns caused the results to vary:
Apparently, the median of the DCF range was not acceptable to Panhandle because it chose to use two of the three other methods currently being used by FERC to calculate ROEs for electric transmission providers. By including these other methodologies, Panhandle was able to increase the median ROE to FERC’s high ROE of 14.67%. Panhandle’s expert refused to use the risk premium analysis methodology, because she didn’t think it appropriately reflected the risk that pipelines face. She argued that the methodology required her to include gas distribution companies in her analysis because of the limited number of gas transmission companies and that there was no appropriate way to adjust the result for the difference in risks faced by gas distribution companies and gas transmission companies. While Northern Natural discussed the other measures, its expert ended up recommending the median of the range based on the DCF method of 14.2%.
Most Cases Eventually Settle
We have said this before in Rate Cases Settle, But FERC Struggles With Impact of Its MLP Ruling , but most rate cases, whether filed under Section 4 or Section 5 of the Natural Gas Act, usually settle. The following cases have recently followed that path:In addition to these companies that have settled, three other companies have recently announced that they intend to settle:Finally, five other cases are proceeding along with settlement discussions:
National Fuel Gas Supply;
Tallgrass Interstate Gas Transmission;
Transcontinental Gas Pipe Line; and
Viking Gas Transmission.
We will continue to follow these cases and report on any items that we see as having a broader impact on the industry.