Last Wednesday, November 22, the Federal Energy Regulatory Commission acted on a Petition for Declaratory Order (PDO) by Magellan Midstream Partners in which the midstreamer asked for FERC’s blessing to establish a marketing affiliate to “buy, sell and ship” crude oil on pipelines owned by Magellan as well as pipes owned by other companies. Today Magellan does not have such an affiliate, although many of its competitors do. Most of those competitors use their affiliates to generate incremental throughput on their pipelines, sometimes by doing transactions that result in losses for the marketing affiliate, but that are still profitable for the overall company because the marketing arm pays its affiliated pipeline the published tariff transportation rate. FERC denied Magellan’s request, coming down hard on such transactions as “rebates” specifically prohibited by the law governing interstate oil pipelines. In today’s blog, we take a preliminary look at FERC’s Magellan order and what it could mean for U.S. crude oil markets.
The FERC finding spells out aspects of crude oil pipeline regulation that have been in place for over 100 years, but have been subject to varying degrees of interpretation and enforcement and are very different from the rules that cover natural gas and gas pipelines. As we discussed in Hey Crude – The Costs and Challenges of Building Crude Oil Pipelines, although crude and gas pipelines that cross state lines are both regulated by FERC, the laws and rules governing crude oil pipelines are based on an entirely different statute — the Interstate Commerce Act (ICA) instead of the Natural Gas Act (NGA) — and the evolution of FERC regulation of oil pipelines has a pretty tortured history ever since FERC took over this area of regulation from the Interstate Commerce Commission.
These oil pipeline regulations have been around since the Hepburn Act of 1906, which made oil pipelines subject to the ICA of 1887. Up until that time, the ICA had applied only to railroads (which turns out to be relevant to the Magellan order). Under the ICA, crude oil pipelines became “common carriers” subject to all sorts of rules related to who gets access to what services (but not whether or not a pipeline can be built, which remains in the purview of the states for crude pipes). There are two important aspects of these ICA-based regulations relevant to the Magellan PDO. First, the rules for setting crude oil pipeline tariffs are somewhat ambiguous, to say the least. The tariffs aren’t necessarily based on costs, the approach to setting rates can vary over the life of a pipeline, and the rules have pragmatically mutated from time to time, to the extent that they can change without a lot of warning. All this provides both opportunities and risks that don’t exist to the same degree for gas pipelines. Second, the rules governing permissible transactions on crude pipes are quite different than those for gas pipelines, and are even more ambiguous than the crude oil pipeline tariff rules. For example, gas pipes are subject to highly structured mechanisms for any transaction that would move gas on a pipeline for a rate lower than the published tariff. Whether the transactions are between the pipeline and a shipper or between two shippers (one “renting” its capacity from another), the gas deals are subject to rules covering what is legal, and how the transactions must be broadcast to the marketplace (via the gas pipeline’s “Electronic Bulletin Board” — or EBB — websites). No such structured mechanisms exist for oil pipelines.