Originally published for customers July 28, 2023
What’s the issue?
Liquids pipeline indexes took effect July 1, 2023, so we’re taking a look at who took the full increase.
Why does it matter?
Not all companies did, and that can impact the competitive landscape for shippers and pipelines.
What’s our view?
Just over half of liquids pipelines took the full index this year, based on our analysis of origin and destination pairs for FERC-regulated lines. Two primary drivers for this decision are likely the desire of certain pipelines to be more attractive to shippers, and risk aversion to possible shipper complaints when exceeding the Percentage Comparison Test.
It’s late July, and that means the dust has settled following the 2023 indexing season. As a reminder, most pipeline companies adjust their tariff rates for indexed liquids pipelines effective July 1. This timing is based on when FERC releases its Oil Pipeline Index, which comes out in mid-May, once the prior year’s PPI-FG figures are finalized. From there, regulatory teams at pipeline companies file their updated rates by the end of May to take effect July 1. You can read more about that process and our thoughts on how this season would look in 2023 Rates Look Poised to Be an Uninspired Sequel to 2022. At this point, the big question on everyone’s mind is what did everyone else do?
Before diving into the data to see how things shook out, here’s a refresher on how the Oil Pipeline Index works: FERC releases an escalation rate that effectively sets a ceiling on how much pipeline companies can increase their rates for that season. This year’s escalation was a whopping 13.3194%. To calculate the new ceiling rate for this year, simply multiply 1.133194 against your previous tariff (e.g., if your tariff had been $1.00, your new ceiling for your escalation would be $1.1331). The thing to keep in mind is that the escalation sets your ceiling, but you do not have to take the full index adjustment.
Liquids tariffs typically contain unique origin points and possible destinations from those origin points — with a corresponding tariff rate tied to each specific movement. On the graph below, we plotted the percentage of the full index taken for each unique origin and destination pair. For this exercise, we are specifically looking at index rates that fall under FERC’s jurisdiction, so this analysis will not apply to settlement or market-based rate filings. As the chart below shows, the full index was applied on rates for just over half the movements in our dataset. Of those that did not take the full index, most took 65% or more of their overall escalation.
At first glance, it may seem surprising that more companies did not take the full escalation this year. Who wouldn’t seize any opportunity to max out their tariff revenue? There are two primary considerations for pipelines’ decisions on escalation.
The first is, out of an abundance of caution, to avoid the risk of a rate case. In our article Neither End of the Pipe Is Immune to Inflation, we described FERC’s use of the Percentage Comparison Test as a simple method to keep pipeline companies’ returns in check. Based on this year’s Page 700 data, just under half of pipeline companies would have failed that initial 10% threshold test by taking the full index. When comparing the list of those companies with our updated FERC jurisdiction index data, we see that roughly 70% of them did not take the full index. We can see a correlation here, and can likely conclude pipeline companies do not want to draw protests from shippers who might be maintaining and tracking their own threshold tests.
Another major decision factor is centered around market positioning. Pipeline companies may opt to take less than the full index in order to entice shippers to move more volume on their pipes. In this case, the company retains the ability to bank the remainder of that rate increase for sometime in the future (e.g. timing rate increases for capex projects or keeping headroom in their rates if there is ever a negative index in the future).
Likely correlated to this desire for competitive market position, our review of the data revealed regional trends. For the origin states of Texas, New Mexico and Louisiana, we saw more origin/destination pairs that did not take the full index. Meanwhile, for origins in North Dakota, Michigan and Wyoming, it was more common to take the full index. This is likely due in part to the prevailing asset bases and available capacity in these regions.
Like many aspects of the energy industry, the world of liquids tariffs seems to be increasingly complex. The result of July 2023’s indexing season is less cut and dry than you might think, with many pipelines opting to not simply take the full index this year and move on. Two of the key drivers behind this choice stems from being conservative when it comes to rate case risk after two years of record high rate increases, and positioning pipes against their competitors to attract more volume. For midstream companies and shippers, it is more important than ever to monitor and understand their competitors’ behaviors. Pulling together the data necessary to perform any kind of tariff benchmarking can be a grueling process, but Arbo’s dataset can be leveraged to skip that step and jump right into analysis. If you are interested in learning more about our liquids tariff data and how you might put it to use, please reach out and we would be happy to help.