On July 1, 2016, the United States Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) rendered an opinion affecting the return-on-equity and cost-of-service components of oil pipeline ratemaking. Specifically, the D.C. Circuit ordered FERC to either justify or amend its practice of granting income tax allowances for limited partnership pipelines, questioned FERC’s rationale in deciding what financial data should be used to calculate real rate of return on equity, and upheld FERC’s determination that a pipeline’s cost-of-service rates can already account for changes in costs associated with rate indexes. The D.C. Circuit remanded the case back to FERC on the income tax allowance and real rate of return on equity issues.
The D.C. Circuit’s opinion addressed multiple appeals brought by both shippers (the “Shippers”) on SFPP, L.P.’s (“SFPP”) pipelines, and SFPP. The Shippers’ appeal challenged FERC’s prior decision to authorize income tax allowances for limited partnership pipelines, while SFPP challenged FERC’s decision regarding real rate of return and SFPP’s rate index adjustment.
With regard to income tax allowances, the Shippers claimed that a pipeline organized as a partnership is not taxed at the entity level, and that FERC’s discounted cash flow methodology already provides for a sufficient after-tax return on equity to attract investment to the pipeline. Furthermore, the Shippers argued that the combination of the discounted cash flow return on equity and FERC’s tax allowance results in double recovery of taxes for SFPP’s partners. The D.C. Circuit agreed, finding that FERC failed to provide sufficient evidence that granting the tax allowance to oil pipelines organized as partnerships does not result in double recovery. The D.C. Circuit remanded the case back to FERC, ordering FERC to demonstrate that the allowance does not permit double recovery, remove any instances of duplicative tax recovery by adjusting the discounted cash flow return on equity, or eliminate the income tax allowances for SFPP.
With regard to rate of return, SFPP challenged FERC’s prior decision to calculate SFPP’s real rate of return on equity based on financial data from September 2008, rather than the most recent data at the time of filing, from April 2009. SFPP argued that FERC arbitrarily departed from its established preference for relying on the most recent financial data in the record to determine a pipeline’s real rate of return on equity. While the D.C. Circuit agreed with FERC that the April 2009 data was not representative of SFPP’s long-term cost of capital, it nonetheless found that “FERC provided no reasoned explanation for its choice of the September 2008 data.” The D.C. Circuit noted that the September 2008 data yielded the lowest real return on equity of all data on the record. The D.C. Circuit remanded to FERC to provide a reasoned explanation for the financial data it used, or to use financial data for which it can provide a reasoned explanation.
Finally, SFPP challenged FERC’s prior decision on its rate index adjustment, arguing that FERC erred in failing to apply the full amount of the 2009 rate index adjustment in calculating SFPP’s rates and refunds for the period from July 1, 2009, through June 30, 2010. FERC argued in response that SFPP’s cost-of-service rates for 2008 already partially accounted for the changes in costs associated with the index increase, thus applying the full amount of the 2009 rate index adjustment would allow SFPP to double recover. The D.C. Circuit denied SFPP’s appeal on the index adjustment issue, concluding that “FERC provided sufficient justification for its decision to reduce SFPP’s 2009 index to one-quarter of the published value.”
The D.C. Circuit opinion is available here.