Just before the holidays, the Federal Regulatory Commission issued its final decision on the oil pipeline index rate for the next five years. The what?? Well, once rates for interstate oil pipelines are set and accepted by FERC, the rates can move around to match the market, but any increases are capped by an annual index announced by the FERC each year. The index is equal to the current year’s inflation rate, plus an “adder” that is calculated by the FERC every five years based on an examination of the industry’s results from the previous five years. In today’s blog, we explain how a few tweaks in the way FERC calculates the cost-of-service-based adder will significantly affect how much liquids pipeline rates can rise through the first half of the 2020s.
As we explained in Now Here You Go Again back in June, this indexing approach was part of FERC’s response to congressional direction in the Energy Policy Act of 1992 to simplify the regulation of oil pipeline rates. Ever since FERC took over the regulation of oil pipeline rates from the Interstate Commerce Commission in 1977, the system of regulation had been burdensome and complicated for an industry that craved simplicity. So, while FERC kept some of the onerous stuff like full cost-of-service reviews for certain situations (new services and company-specific complaints, primarily), the industry norm became indexing. These days, over 80% of all liquids-pipeline rates are capped based on the index, meaning that in markets where competition doesn’t push the rates lower than the cap, the indexed rate is what’s really charged.
In the current five-year review, FERC had proposed reducing the adder part of the index from 1.23% to 0.09%, basically eliminating the adder. (We should note that the adder can also be negative, depending on industry performance, so from the companies’ perspective, even a small positive was better than a negative.) After receiving a lot of comments and performing a lot of new calculations, FERC still reduced the adder, but by a lot less — only to 0.78%. This means that for the next five years, the cap on rates for oil pipelines (and pipes transporting other hydrocarbon liquids) can be increased each year by inflation plus 0.78%. This is good news for a midstream sector already under a lot of economic pressure, with the caveat that a higher ceiling on pipeline rates obviously doesn’t mean much if the market is demanding rates well below the ceiling.
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