Understanding pipeline rate structures is fundamental to assessing the value of a pipeline business and the financial implications of potential or pending rate cases. And a keen understanding of rate structures can lead to a vital competitive edge. Can tariffs, rates, and the impact of rate cases be easily assessed?
Return on equity (ROE) is an indicator of financial well being and an industry standard metric for assessing interstate natural gas pipeline companies. So much so, in fact, that it serves as an indicator of financial health to regulators, particularly the Federal Energy Regulatory Commission (FERC) where it serves as the basis for launching prospective rate investigations. In some industries, an ROE calculation is a rather straightforward calculation–but not so for interstate natural gas pipelines. For these highly regulated assets, conducting this calculation can be complex, mirred in some 40 industry specific values, including rate base, or the costs of facilities that operators can pass on to customers, and complicated capitalization and tax structures involving parent – subsidiary relationships. One of the key elements of ROE, revenue, seems simple enough, right? But, it too can be tangled, especially when conducting a forward-looking investigation of a company’s finances.
The rates that a natural gas pipeline company charges its shippers can be a leading indicator of future revenue. These rates, and recourse rates in particular, are subject to the oversight of the FERC, which conducts an annual review, as well as the complaints of shippers who can instigate a federal investigation. When the FERC finds a company’s recourse rates are potentially unjust or unreasonable, a Natural Gas Act Section 5 investigation ensues. And while the investigation can lead to a trial or, more often, a settlement, the end result is generally lower recourse rates, resulting in lower future revenues. To make matters more involved, FERC may also require natural gas pipeline operators to issue refunds to shippers. But what does this mean for ROE calculations?
The results from recent Section 5 investigations are illustrative. In these investigations, the FERC evaluated the recourse rates of Iroquois Gas Transmission System, L.P. (TransCanada 50%, Dominion 50%), Columbia Gulf Transmission (TransCanada), Empire Pipeline, Inc. (National Fuel Gas Company), and Tuscarora Gas Transmission (TransCanada), each of which recently settled with FERC. What resulted was not simply a change to a single rate that would be effective immediately. Instead, rates will be changed incrementally for various segments of each company’s system, with changes implemented from year to year. This means that the impact of these lower rates largely won’t be felt until 2018 and beyond. Each settlement also included a come back provision, a term requiring the natural gas operators to revisit rates, adding an additional element of uncertainty about future revenue.
But the impact of such rate changes is only felt to the extent that the capacity on the pipeline is not subject to negotiated rates. Some systems provide firm transportation at the recourse rate, while others rely largely on negotiated rates. As shown in the below data visualization, of the four pipelines most recently subject to investigation, 60% to 100% of their total capacity was contracted under firm recourse rates. While Columbia Gulf saw a decline in it’s rates of less than 3% percent Empire saw a decline over 37% on some segments of it’s system. As a result, millions of dollars of revenues will likely be lost for those companies unwilling to negotiate with shippers. And this will likely dramatically impact the pipeline’s ROE.
Although Section 5 investigations may result in complex modifications to rates, as well as to contractual conditions and terms, these investigations can also serve to benefit not only the shippers, such as National Grid, Entergy Mississippi and Sierra Pacific Power Company, but those interested in the financial well being of the natural gas pipeline company. Delving into the modifications to rates to gain insights into revenue in coming years, while considering a company’s backlog to evaluate a potential rate base, can lead to a more informed ROE. Identification of extremely low ROEs may, alongside other factors, be an indicator that the pipeline company may initiate a Section 4 rate case to increase rates. For example, ANR Pipeline initiated a rate proceeding in January to raise system-wide rates which ANR anticipates it will begin charging shippers in August. While the parties have agreed to a settlement it has yet to be memorialized.
LawIQ provides not only existing rates for projects, but also coverage of rate cases, and we will soon provide customers with up-to-date ROE calculations, based on FERC’s methodology, for each major natural gas pipeline. Use our Platform to quickly obtain rate data from tariffs, quickly assess a pipeline’s financial health, and spot potential future rate cases and investigations.
Section 5 Rate Proceedings