A Fresh Look at FERC's Market Need Analysis

The Commission's approach to determining market need for new pipeline capacity stands at a critical juncture. Recent judicial decisions and evolving market dynamics may reshape how FERC evaluates demand, particularly when evaluating capacity subscribed by affiliates or local distribution companies (LDCs).

Project developers and stakeholders face increasing uncertainty about what constitutes sufficient evidence of market need. Understanding how FERC evaluates market need—and how this evaluation is evolving—is crucial for project developers, shippers, and investors in today's complex energy market.

Litigation has shown that FERC generally only needs to look behind affiliate contracts if there is some evidence of “self-dealing.” However, there are open questions about the probative value of precedent agreements with LDCs generally, and while a relatively small percentage of affiliates are contracting for firm capacity on major pipelines, a significant portion are contracted by LDCs and utilities.

Understanding the Evolution of Market Need Analysis

The Natural Gas Act mandates that FERC establish whether proposed pipelines serve the public interest. FERC’s methodology for making this determination has evolved, but a central consideration has always been the extent of market demand for natural gas. FERC has consistently viewed private companies' willingness to enter into long-term contracts as a strong indicator of market demand because they are driven by market factors rather than by other motivations outside the Commission's purview. Advocates of this approach argue that FERC should avoid interfering in private contractual relations, emphasizing that state regulators often scrutinize agreements made by natural gas shippers.

Before the issuance of the Certificate Policy Statement, which governs FERC’s current public interest analysis, FERC required pipeline projects to secure contractual commitments for at least 25% of proposed capacity, relying solely on long-term contracts with shippers to measure market demand. In the midstream sector, a "shipper" can be any entity holding a contract, or precedent agreement, to transport natural gas through a pipeline. Shippers may include producers moving their own gas, marketers who buy from producers or aggregators and resell, LDCs delivering gas to end users, or end-use consumers like LNG facilities or gas-fired power plants.

The Certificate Policy Statement reframed the Commission’s analysis to balance the public benefits against the potential adverse consequences of a project and expanded FERC's approach. It also allows applicants to use various metrics to establish need, such as demand projections, potential consumer cost savings, or assessments of projected demand compared to existing capacity. Nonetheless, precedent agreements remain a critical piece of evidence, with FERC generally giving "equal weight" to contracts with both affiliate and non-affiliate entities without delving into the underlying market dynamics.

This framework faced significant scrutiny when former Chairman Glick proposed revising the Certificate Policy Statement to prioritize an analysis of end-use demand over precedent agreements. Although his proposal was quickly withdrawn, it underscored rising concerns about whether precedent agreements—especially those with affiliates and LDCs—accurately reflect genuine market need.

Key Market Need Issues and the Recent Judicial Framework

Litigation has also shaped this landscape. Several fundamental issues arise when FERC evaluates market need; chief among these is the concern that pipeline companies — motivated by attractive returns on equity for pipeline development — may use affiliate relationships to fabricate the appearance of market demand, especially if the affiliated entities are LDCs that can pass the costs on to captive ratepayers. This concern is at least as old as the Certificate Policy Statement, but FERC’s analysis has evolved in response to litigation.

For example, in June 2021, the DC Circuit vacated FERC's certificate approval for the Spire STL project that relied on a single precedent agreement with an affiliated shipper in a market with no new demand growth. Critically, the court concluded that commenters had identified “plausible evidence of self-dealing” which required FERC to "look behind" affiliate agreements to determine whether there was market need.

In April of 2024, the Commission distinguished its authorization of the Great Basin Transmission Company’s 2024 Expansion Project from the Spire STL decision. The Commission noted that Great Basin’s project was a discrete expansion of existing pipeline capacity to meet incremental demand of its existing LDC shippers, unlike Spire's new greenfield pipeline serving a single affiliated shipper in an area with flat demand.

Most recently, in vacating the certificate for the Regional Energy Access Expansion project (REAE), the DC Circuit directed the Commission to address an argument that questioned whether precedent agreements with LDCs truly demonstrate market need given their ability to pass costs on to captive ratepayers. In a footnote, the court mentioned its acceptance of FERC’s reliance on precedent agreements with LDCs when approving the certificate for the NEXUS Project, but distinguished the REAE decision based on the issue raised, asking whether precedent agreements with LDCs serving captive ratepayers are generally probative of market need.

In its recent filing supporting the petitions for rehearing of the REAE vacatur, FERC focuses on the Spire STL reasoning and defends its conclusion that there was no probative value to the general assertions of self-dealing that were presented. The issue may turn on whether the court sees LDCs serving captive ratepayers alone as sufficient basis to question the contracts, in spite of FERC’s assertion that states have jurisdiction over LDC contracts and state regulations limit LDCs from passing on costs of unneeded capacity to captive ratepayers.

Beyond these affiliate issues, arguments about the percentage of capacity subscribed and the proximity to existing regional pipeline infrastructure also arise occasionally in market need litigation. The DC Circuit upheld FERC’s approval of the NEXUS project even though it only had a 42% domestic subscription rate, with an additional 17% coming from Canadian export agreements. Notably, the opinion stated that “there is no floor on the subscription rate needed for FERC…” to approve a project. Regarding regional infrastructure concerns, proximity to multiple existing pipelines was also a factor in the Spire STL vacatur.

It is worth noting that LNG projects are also occasionally challenged on affiliate grounds, but as the Commission recently noted in its June 2024 authorization of Venture Global’s CP2 project, “it is not an uncommon model” for affiliate pipelines to provide feedstock transportation to LNG terminals, and terminals, unlike affiliated LDCs, have no captive customers to whom they can pass costs.

Current Shipper Snapshot

Against this backdrop, we surveyed the current landscape of shippers on six major pipeline operators to provide a baseline snapshot of the current midstream marketplace, highlighting the percentage of contracted volumes held by affiliates, LDCs or utilities. We also looked back to see how these have changed. As seen in the chart below, affiliated shippers typically do not hold a significant amount of volume on their associated pipelines. The 22 total affiliate shippers across six major pipeline operators hold 4.28% of the contracted firm capacity across these pipe families.

LDCs and utilities currently hold 50.5% of the contracted firm capacity across the same six families of pipelines. As seen in the chart below, most of the volume on the longest-standing contracts is held by these shippers. LDC and utility shippers have shown consistent demand for additional natural gas capacity, adding an average of just over ten million dekatherms per day in new firm capacity each year since 2020.

Looking forward, whether the DC Circuit grants rehearing in the REAE project will determine whether FERC gets another chance to convince the court that its LDC analysis was correct. Otherwise, FERC will need to better explain why precedent agreements with LDCs generally do not present a risk of self-dealing. It’s important to remember that the court did not fault the Commission’s response substantively, but rather faulted its failure to respond to the argument. The high number of LDC and utility contracts shown in the sample pipelines demonstrate the prominent role they play in the midstream marketplace. If rehearing is denied, we will be watching how FERC responds closely, with an eye towards any resulting precedent it may set for future projects.

If you would like to discuss the evolving issues surrounding FERC’s market need analysis or other litigation, please contact us.