Colonial Pipeline – A Bellwether?

Financials Oil
December 21, 2016

As if the liquids pipeline industry was not facing enough backlash with the growing protests surrounding the Dakota Access Pipeline, an explosion in Alabama — the second incident in two months — on the Colonial Pipeline system has escalated concerns. On October 31, a crew working on Colonial’s gasoline pipeline (Line 1) in Shelby County experienced an incident when a trackhoe struck the pipeline, causing a fire. The work being conducted on Line 1 was in response to an incident about a month earlier when a leak was discovered, and which resulted in the release of 7,370 barrels of gasoline. Colonial Pipeline supplies about one-third of the gas consumed on the East Coast, so the markets scrambled immediately following the reports of the explosion.

With the need to expand the pipeline capacity by another 300,000 – 500,000 bpd, Colonial had considered, but decided against, building a new pipeline, primarily due to uncertainty as to cost, customer commitments, and regulatory hurdles. And other pipelines, such as Kinder Morgan’s Palmetto Pipeline, have tried to offer competing services, but have run into state based political headwinds. Was this just a bad month for Colonial, which has been operating since 1964? Or, with an increasingly risky regulatory permitting process, are these type of incidents a bellwether of issues that are here to stay?

Interstate liquids pipelines, similar to natural gas pipelines, are subject to the regulation of the Pipeline and Hazardous Materials Safety Administration (PHMSA), which requires incident reporting for events such as Colonial’s. But the agency also pursues violations through routine inspections, incident investigations, and other oversight activity. The PHMSA Regional Director will determine if probable violations have occurred with regard to the explosion in Alabama, and, if appropriate, will issue a Notice to the operator, alleging specific regulatory violations and, where applicable, propose appropriate remedial action and/or civil penalties in a Compliance Order. For example, just this week, PHMSA issued Orders and Civil Penalties against Kinder’s Natural Gas Pipeline Company and Sunoco’s West Texas Gulf Pipeline Company for alleged violations.Pipeline operators are forced into a difficult balancing act. How much do you spend on maintenance, replacements, and upgrades to prevent PHMSA actions, while maintaining appropriate cost and revenue for the purposes of FERC financial filings and rate determinations? 

Liquids pipeline operators have benefited from limited transparency, when compared to their gas pipeline counterparts, in their financial filings, particularly the maintenance and revenue reported in filings to the FERC. The FERC issued an Advanced Notice of Proposed Rulemaking (ANOPR), proposing changes to Form No. 6, specifically a section that details the pipeline’s cost of service. The Form No. 6 captures in depth financial, operational, and maintenance data on a quarterly and annual basis but concerns have been voiced regarding the depth of data provided in one key section, the Annual Cost of Service Based Analysis Schedule. If this seems familiar to our customers, it is. In 2015, the Liquids Shippers Group, a consortium of the country’s largest shipper/producers, Airlines for America, and the National Propane Gas Association filed a petition for rulemaking seeking additional cost information. More specifically, the Group asserted the need for greater insight into interstate liquids pipelines’ costs and revenues in order to create a level playing field for shippers to challenge oil pipeline rates that may be unjust and unreasonable. In particular, the petitioners aimed to gain segment specific values for liquids pipeline systems that see unique costs and revenues by segment but which currently report systemwide values. Why the renewed interest by FERC? 

Under the Interstate Commerce Act, the FERC is obligated to regulate the operations of interstate liquids pipelines, in particular their rate setting, which is largely established by indexing (as discussed in our Liquids Pipeline Rates and Terms of Service – Unlocking the Black Box, Weekly Insights). The FERC has asserted that through its ongoing monitoring of how the index affects pipeline rates, it has observed that some pipelines continue to obtain additional index rate increases despite reporting revenues on the Form No. 6, that significantly exceed costs. According to FERC, additional insight into annual cost of services values would assist them in evaluating liquids pipeline operations and minimize costly and time-consuming litigation regarding pipeline rates. 

Operations and maintenance expenses are one of the line items included in the Annual Cost of Service Based Analysis Schedule, which, along with all pipeline financial and operational data, is distilled in LawIQ’s Oil Financials Page. And greater clarity into these expenses on a segment basis may raise questions regarding whether a pipeline operator’s rates are just and reasonable. This new data may also shed additional light on a company’s commitment to safety and the likely longevity of its system. With many systems nearing a century in age, and with only 12% of pipelines having been built since 2010, it may be a telltale sign of troubles ahead for some operations.