Midstream companies are facing more legal and regulatory risks, while also seeing higher returns on equity (ROE) in natural gas pipeline rate cases at FERC, speakers concluded at an Arbo (fka LawIQ) online event November 10. [The webinar recording is embedded below.] Legal challenges for new pipeline projects, longer reviews at FERC before receiving a certificate order, higher costs for projects and a new makeup of FERC commissioners were among the risk factors cited by Arbo staff. Pressure for increased transparency on environmental, social and governance (ESG) issues also is a trend worth watching as midstream companies are considering how they show progress on ESG matters, said Chip Moldenhauer, founder and CEO of Arbo. At the same time, the increased frequency of rate cases for gas pipelines and the revised methodology used by FERC to calculate the return on equity (ROE) appears to show higher returns for pipelines, noted Gary Kruse, managing director of research. The revised methodology, combining the discounted cash flow (DCF) methodology and the capital asset pricing model (CAPM), was adopted in May. It drew a partial dissent and harsh comments from Commissioner Richard Glick, who may become chairman in an administration of President-elect Joe Biden, said Kruse. The situation at FERC, where Commissioner Neil Chatterjee was recently demoted by President Donald Trump and James Danly was named chairman, with a minimum three members needed for a quorum, “is very fluid” and subject to change in a Biden administration if the Senate does not confirm Trump nominees Mark Christie and Allison Clements by the end of the current session of Congress, Kruse said.
Chatterjee, a Republican, has vowed to fill out his term at the Commission, which ends June 30, 2021, and he can continue to serve past that date if a replacement is not confirmed. Danly also is a Republican, with a term that ends June 30, 2023. Danly has not indicated if he will stay at FERC or step down if Biden gains the White House and names a Democrat as chairman. Trump nominees Christie, a Republican, and Clements, a Democrat, could be left to languish if the Senate does not confirm them in 2020, and new nominees would have to come from a Biden White House in 2021.
That would present the opportunity for Biden to nominate two Democrats for open FERC seats, with a Democrat as chairman and the ability to drive the agenda, Kruse said. “The control of FERC will be critical on a number of issues going forward,” Kruse said, noting that Chatterjee has indicated he expects to be able to work with Glick on pipeline certificate matters and reach an accommodation, since Glick has often dissented on pipeline and LNG export project orders due to what he views as insufficient consideration of greenhouse gas (GHG) emission issues.
If Glick becomes chairman, he could instruct FERC staff to examine GHG emissions in an environmental review for gas pipeline projects that are pending at the Commission, Kruse said. Glick has also suggested that when a court issues a stay of permits in legal challenges, it should be FERC commissioners, not FERC staff, who issue orders on halting construction or resuming construction, and that dynamic could broaden the effect of a stay from a court, Kruse suggested.
The environmental reviews at FERC are getting shorter in recent years, but it is taking longer to reach a decision for a certificate order under Natural Gas Act Section 7 pipeline applications, said Moldenhauer. He used public data compiled by Arbo showing FERC is taking 75% longer for a certificate order than in 2013.
Following a wave of pipeline project applications in 2014-2016, Moldenhauer said the days of big pipeline projects are no longer the norm, and even smaller projects simply adding compressor stations are taking longer to gain FERC approval. “We weren’t expecting to see that trend,” since such projects usually involve land owned by the pipeline and a review that is more straightforward, he said.
While material costs are not affected by timing issues, labor costs and other pipeline expenses have increased as it takes longer for projects to move from application to approval and through construction, Moldenhauer said. Some of those higher costs are tied to legal reviews in courts, and pipeline opposition groups are learning what works to slow down projects in different parts of the country, such as watercrossing permits at federal agencies and a host of other challenges, Kruse asserted. Midstream companies need to pay attention to court cases and legal challenges beyond their footprint, because “arguments that gain traction in one case can spread like a virus to challenges filed against others,” Kruse said.
A Biden administration position on the U.S. Army Corps of Engineers Nationwide Permit 12 program for the Keystone XL project will be closely watched, along with whether Biden seeks to have Congress undo the corporate tax cut passed under the Trump administration, Kruse said.
Any corporate tax change could be included in a pipeline rate case for those midstream companies operating as corporations, Kruse added. The days of pipelines rarely filing rate cases “came to a screeching halt” in 2018, following the tax cut change and FERC calling for filings from nearly all pipelines under Form 501-G proceedings, he pointed out. A lot of pipelines have mandatory rate case filing deadlines included in past settlements, so rate cases will be more frequent.
When FERC’s methodology for setting pipeline ROE was changed to average the results of the DCF and CAPM analyses, Glick accused the majority of trying to drive up returns for pipelines “and based on the early returns, it would appear that it is doing just that,” Kruse said. He referred to data showing higher ROEs using the average of the DCF and CAPM models.
Source: Arbo (fka LawIQ) from pipeline rate case filings at FERC with testimony on CAPM and DCF
The trend could lead to higher returns for pipelines that are filing rate cases, with an ROE in the range between 14% and 16%. A return to using the DCF methodology alone is possible, which would push returns lower, though the makeup of the Commission will affect how it decides to address ROE matters.
“We would expect this issue to be revisited under a Biden-led FERC,” Kruse said.
When Glick wrote separately on the new policy adopted in May, he bemoaned the changes made by FERC following Opinion No. 569. “The Commission must stop the endless fiddling with its ROE methodology,” he said.
Click here to download the Webinar presentation slides.