FERC rules mainly for shippers in lingering Santa Fe product pipeline case

Maureen Lorenzetti
Washington Editor

WASHINGTON, DC, Mar. 29 -- The US Federal Energy Regulatory Commission unanimously affirmed most of an earlier administrative law judge's ruling that shippers on Kinder Morgan Energy Partners' (KMEP) Santa Fe Pacific Pipelines (SFPP) could challenge rates being charged on the system.

The commission's decision is the latest legal twist in a 6-year rate dispute, and a final resolution could take months or even years unless the parties decide to settle.

FERC is not likely to determine refund amounts until first quarter 2005, industry sources said.

Eventually, SFPP's potential liability could be as high as $200 million, but Wall Street analysts did not seem to think the Mar. 24 decision would impact the stock of the independent oil pipeline, especially in the near term.

Standard & Poor's Ratings Services, for example, said that KMEP's BBB+/Stable/A-2 rating and outlook would not be affected by FERC's ruling.

"Although the FERC's decision did not establish prospective rates or determine the amount of reparations that should be paid to complaining shippers, the previously announced maximum judgment (with an annual cash value of $45 million) had already been factored into [KMEP's] current rating and outlook," S&P said.

Similarly, Wachovia Securities International Ltd. saw the mixed FERC decision as a buy opportunity for its clients. "We would be buyers of the stock as the potential impact to earnings will be minimal, in our view. Under a worst-case scenario (which this is not), the ruling would have reduced [KMEP's] earnings per share by 10-15¢ in 2005. While the actual refund amount in not yet quantifiable, we believe the impact to EPS will certainly be less that that," the analyst said.

Process ahead
An administrative law judge still must decide what refunds that diesel, jet fuel, and gasoline shippers deserve. Then, the commission will either affirm or change the judge's decision. A federal appeals court also might get involved. Further delaying the outcome is the fact that in its most recent action, FERC did not offer an opinion on what future rates should be.

FERC staff only told the commission that shippers met the legal burden to challenge grandfathered rates on the company's "West Lines" from southern California to Arizona. That line represents about 70% of the overcharges that may have taken place during 1997-2003. It also agreed that shippers could challenge rates on the company's East Line. But shippers failed to make their case on the pipeline's North and Oregon lines, according to FERC staff, and the commission agreed.

"Bottom line, the shippers prevailed on the bulk of their complaints. The excluded rates represent comparatively smaller liabilities," said Schwab Soundview Capital Markets energy analyst Christine Tezak in a written report to clients.

When Congress passed the Energy Policy Act of 1992, it grandfathered most existing interstate oil pipeline rates; however, lawmakers stipulated a rate review could occur if shippers could show that the basic assumptions used to calculate the original tariff had substantially changed. Soon after the law passed some shippers challenged SFPP; they argued the pipeline rates were unfair and should not be grandfathered.

In the Mar. 24 decision, the commission quantified the "substantial change" definition to a number of about 16%. Tezak called that number a relatively high figure that represents an important incremental benchmark.

Further, she suggested that FERC's decision that changes in tax obligations are insufficient on a stand-alone basis to prove "substantial change" is an important policy articulation, particularly for independent operators using the limited partnership structure.

Kinder Morgan inherited the case when it bought the pipeline in 1998. Under the commission's latest decision it also must apply for FERC's permission to include its "acquisition premium" for the Santa Fe pipeline in its rate base.

Tezak noted in a Mar. 29 note to clients that FERC directed that the purchase premium be excluded from any refund calculations, and it is not yet clear that it will be included in the calculation of new rates.

Although pipeline operators and shippers today appear divided about FERC's recent decision, both indicated the commission gave interested parties some badly needed legal clarity.

"The commission's ruling certainly clarifies how it intends "changed circumstances" be shown and broadens the rates that may be challenged. It is too early to judge the impact on the industry but it has the potential to be significant," said the Association of Oil Pipe Lines.

Meanwhile, KMEP Chairman and CEO Richard D. Kinder warned that the FERC order could represent a "major" policy shift for petroleum pipelines.

"We are pleased the commission upheld the grandfathered status of SFPP's North Line and Oregon Line interstate rates, which is an improvement over the initial ALJ decision issued last June, which would have 'ungrandfathered' all of SFPPs grandfathered rates. However, we are disappointed in the ruling that the West Line rates should be 'ungrandfathered' for certain years.

"We believe the commission's order represents a major shift in public policy governing US petroleum pipelines, undermining the intent of Congress when it mandated grandfathered rates in the Energy Policy Act of 1992. We will review the decision in detail when it becomes available and evaluate our options before the Commission and the US Court of Appeals," Kinder said.

One legal expert who represents shipper interests said that the FERC's decision illustrates that the agency will step into what has been a largely deregulated industry if it decides rates are too high.
"The FERC has clearly decided that it will not abandon its statutory duty to ensure that oil and even gas pipeline rates are "just and reasonable," said attorney Gordon Gooch.

"The bottom line, in my view, is that significant reductions in rates and significant reparations with respect to not only SFPP, but other
similarly situated public utilities, can reasonably be expected, eliminating any excess and unlawful overcharges that have crept into the system."

Shippers have alleged that SFPP overall is collecting excess profits of $30 million/year.
"We are talking about a lot of unlawfulness under the Interstate Commerce Act for oil pipelines and potentially under the Natural Gas Act for gas pipelines," said Gooch.

Future trends
The oil and gas industry in general has been closely watching the case for spillover into other rate issues, according to Schwab's Tezak. Oil and product pipelines are regulated under the Interstate Commerce Act while natural gas pipelines are regulated under the Natural Gas Act.

But both types of pipelines have rates that assume recovery of taxes based on a formula FERC uses based on a 1995 decision involving the Canadian Lakehead crude oil and natural gas liquids pipeline.

FERC established then that for ratemaking purposes a regulated limited partnership is entitled to a combined federal-state income tax allowance only with respect to income attributable to its corporate partners. But that is provided such partners are subject to an income tax liability regarding their respective shares of partnership income.

Contact Maureen Lorenzetti at Maureenl@ogjonline.com.

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