Federal Appeals Court Allows FERC to Continue Pipeline Policy that Encourages Overbuilding

Several weeks ago, we reported on a new Federal Energy Regulatory Commission (FERC) Notice of Inquiry (NOI) seeking comments on whether its existing return on equity (ROE) policy should be revamped. A recent federal court of appeals ruling enhances the importance of this new FERC NOI for those concerned that the current policy encourages pipeline overbuilding.

Under its existing policy, FERC grants virtually all new gas pipeline expansions an ROE of 14 percent regardless of perceived investment risk. FERC’s decision to reexamine this policy comes almost a year after it issued, to much fanfare, a still pending NOI seeking comments on whether its Certificate Policy Statement – which governs all aspects of how it evaluates pipeline expansions – should be revised. Under its Certificate Policy Statement, FERC will approve a proposed gas pipeline expansion as long as the pipeline can show there is a need for the new service and that the facilities can be constructed without subsidization by its existing customers. Due to recent changes at the FERC Commissioner level, it is uncertain whether FERC will move ahead with its Certificate Policy Statement NOI.

FERC’s policy on certificating new pipeline facilities coupled with its practice of granting a 14 percent ROE to new pipeline expansions raises concerns that pipelines will have the incentive to overbuild, thereby increasing costs to gas consumers and greenhouse gas emissions.

For those seeking a policy change, a recent federal court of appeals decision only heightens the importance of FERC’s ROE NOI. In an unreported order issued April 3, 2019, a panel of the United States Court of Appeals for the District of Columbia Circuit dismissed a challenge by the North Carolina Utilities Commission and the New York State Public Service Commission to FERC orders granting certificates to Transcontinental Gas Pipe Line Company, L.L.C. to construct three gas projects, each with approved ROEs of 14 percent. The state commissions challenged as unlawful FERC’s long-standing policy allowing expansion rates to be designed using the approved ROE from the pipeline’s most recent general rate case, here an ROE established 15 years ago. They contended that this policy led to ROEs that were outdated and overstated, and that the resulting recourse rates unlawfully failed to constrain the pipeline’s ability to exercise market power in its rate negotiations with customers.

However, the court did not reach the merits of these claims. It found that the state commissions lacked standing because they had failed to establish “injury in fact,” explaining that they failed to establish either that the gas to be made available by these new projects will enter their states or that any end-users within their states will pay higher rates as a result of these projects. It therefore dismissed the appeal.

Although this unpublished ruling is not precedential, it exemplifies the difficulty of changing a long-established FERC policy via litigation. However, commenters on the ROE NOI may attempt to persuade FERC that it doesn’t make sense to grant 14 percent ROEs for pipeline expansions when other economic indicators such as corporate bond rates that fluctuate with economic risk rarely, if ever, offer a 14 percent return on investment.