
[Federal Register Volume 75, Number 245 (Wednesday, December 22, 2010)]
[Rules and Regulations]
[Pages 80300-80313]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-32062]


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DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 342

[Docket No. RM10-25-000]


Five-Year Review of Oil Pipeline Pricing Index

Issued December 16, 2010.
AGENCY: Federal Energy Regulatory Commission, DOE.

ACTION: Order establishing index for oil price change ceiling levels.

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SUMMARY: The Federal Energy Regulatory Commission (Commission) is 
issuing this Final Order concluding its third five-year review of the 
oil pricing index, established in Order No. 561. After consideration of 
the initial, reply and supplemental comments, the Commission has 
concluded that an index level of Producer Price Index for Finished 
Goods plus 2.65 percent (PPI-FG+2.65) should be established for the 
five-year period commencing July 1, 2011. At the end of this five-year 
period, the Commission will once again initiate review of the index to 
determine whether it continues to measure adequately the cost changes 
in the oil pipeline industry.

ADDRESSES: Secretary of the Commission, Federal Energy Regulatory 
Commission, 888 First Street, NE., Washington, DC 20426.

FOR FURTHER INFORMATION CONTACT: 

Andrew Knudsen (Legal Information), Office of the General Counsel, 888 
First Street, NE., Washington, DC 20426, (202) 502-6527;
Michael Lacy (Technical Information), Office of Energy Market 
Regulation, 888 First Street, NE., Washington, DC 20426, (202) 502-
8843.


SUPPLEMENTARY INFORMATION:

Before Commissioners: Jon Wellinghoff, Chairman; Marc Spitzer, 
Philip D. Moeller, John R. Norris, and Cheryl A. LaFleur.

Order Establishing Index for Oil Price Change Ceiling Levels

    1. On June 15, 2010, the Commission issued a Notice of Inquiry 
(NOI),\1\ in which it proposed to continue using the Producer Price 
Index for Finished Goods plus 1.3 percent (PPI-FG+1.3) for the next 
five-year period beginning July 1, 2011. The Commission applies the 
index to existing oil pipeline transportation rates to establish new 
annual rate ceiling levels for pipeline rate changes. The NOI invited 
interested persons to submit comments on the continued use of PPI-
FG+1.3 and to propose, justify, and fully support, any alternative 
indexing proposals. Comments and reply comments were due August 20, 
2010, and September 20, 2010, respectively. Based upon full 
consideration of the comments and reply comments received, and for the 
reasons discussed below, the Commission finds that an index of PPI-FG 
plus 2.65 percent (PPI-FG+2.65) should be established for the five-year 
period commencing July 1, 2011.
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    \1\ Five-Year Review of Oil Pipeline Pricing Index, 75 FR 34959 
(June 21, 2010), FERC Stats. & Regs. ] 35,566 (2010) (NOI).
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I. Background

A. Establishment of the Indexing Methodology

    2. Congress in the Energy Policy Act of 1992 (EPAct 1992) required 
the Commission to establish a ``simplified and generally applicable'' 
ratemaking methodology for oil pipelines \2\ that was consistent with 
the just and reasonable standard of the Interstate Commerce Act 
(ICA).\3\ On October 22, 1993, the Commission issued Order No. 561,\4\ 
promulgating regulations pertaining to the Commission's jurisdiction 
over oil pipelines under the ICA and fulfilling the requirements of the 
EPAct 1992. In Order No. 561, the Commission developed an indexing 
methodology for the purpose of allowing oil pipelines to change rates 
without making cost-of-service filings. The Commission found that the 
indexing methodology adopted in the final rule simplified and expedited 
the process of changing rates. The Commission further determined that 
the indexing methodology would ensure compliance with the just and 
reasonable standard of the ICA by subjecting the chosen index to 
periodic monitoring and, if necessary, adjustment. After extensive 
analysis of proposals from interested parties, the Commission adopted 
an index of PPI-FG minus 1 percent (PPI-FG-1), which was supported by a 
methodology developed by Dr. Alfred E. Kahn (Kahn Methodology) on 
behalf of a group of shippers. The Commission also committed to review 
every five years the continued appropriateness of the index in relation 
to industry costs.
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    \2\ Public Law 102-486, 106 Stat. 3010, Sec.  1801(a) (Oct. 24, 
1992). The EPAct 1992's mandate of establishing a simplified and 
generally applicable method of regulating oil transportation rates 
specifically excluded the Trans-Alaska Pipeline System (TAPS), or 
any pipeline delivering oil, directly or indirectly, into it. Id. 
Sec.  1804(2)(B).
    \3\ 49 U.S.C. app. 1 (1988).
    \4\ Revisions to Oil Pipeline Regulations Pursuant to the Energy 
Policy Act, Order 561, FERC Stats. & Regs. ] 30,985 (1993), order on 
reh'g, Order No. 561-A, FERC Stats. & Regs. ] 31,000 (1994), aff'd, 
Association of Oil Pipe Lines v. FERC, 83 F.3d 1424 (D.C. Cir. 1996) 
(AOPL I).
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    3. In the first five-year review, which established the index level 
for 2001-2006, the Commission deviated from the Kahn Methodology, and, 
based upon a different analysis, concluded that the index should be 
retained as PPI-FG-1.\5\ The U.S. Court of Appeals for the District of 
Columbia (D.C. Circuit) reviewed and remanded the Commission's order 
because the Commission failed to justify a departure from the Kahn 
Methodology used in Order No. 561.\6\ On remand, the Commission used 
the Kahn Methodology to set an index level of an unadjusted PPI-FG for 
the five-year period beginning July 2001. This order on remand was 
upheld by the D.C. Circuit.\7\
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    \5\ Five-Year Review of Oil Pipeline Pricing Index, 93 FERC ] 
61,266 (2000) (First Five-Year Review), aff'd in part and remanded 
in part sub nom. AOPL v. FERC, 281 F.3d 239 (DC Cir. 2002) (AOPL 
II).
    \6\ AOPL II, 281 F.3d 239.
    \7\ Five-Year Review of Oil Pipeline Pricing Index, 102 FERC ] 
61,195 (2003) (First Five-Year Review Remand Order), aff'd sub nom. 
Flying J Inc. v. FERC, 363 F.3d 495 (DC Cir. 2004).
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    4. In the second five-year review, the Commission proposed to 
retain the rate of an unadjusted PPI-FG. However, based upon the data 
presented during that proceeding, the Commission adopted an index of 
PPI-FG+1.3, which was again calculated using the Kahn Methodology.\8\
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    \8\ Five-Year Review of Oil Pipeline Pricing Index, 114 FERC ] 
61,293 (2006) (Second Five-Year Review).
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B. The Kahn Methodology

    5. The Kahn Methodology measures changes in operating and capital 
costs

[[Page 80301]]

on a per barrel-mile basis using Form No. 6 data from the prior five-
year period (for example, between 2004 and 2009 in this proceeding).\9\ 
The Kahn Methodology does not include direct measures of the capital 
costs related to rate of return on investment or income taxes; as a 
proxy for this data, the Kahn Methodology relies upon changes over the 
five year period in net carrier property per barrel-mile.
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    \9\ Specifically, this data is drawn from the Form No. 6: 
Carrier Property, page 110; Accrued Depreciation, page 111; 
Operating Revenues and Operating Expenses, page 114; Crude and 
Products Barrel-Miles, page 600. To the extent this information is 
incomplete, alternate data reported in the Form No. 6 has been 
substituted.
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    6. The Kahn Methodology assigns a weight to the Form No. 6 
operating expenses relative to the net plant using an ``operating 
ratio.'' \10\ The weighted operating expense and the weighted net plant 
are then added together to establish the cumulative cost change for 
each pipeline.\11\
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    \10\ The ``operating ratio'' = ((Operating Expense at Year 1/
Operating Revenue at Year 1) + (Operating Expense at Year 5/
Operating Revenue at Year 5))/2. If the operating ratio is greater 
than one, then it is assigned the value of 1 under the Kahn 
Methodology.
    \11\ Cumulative Cost Change = (1-operating ratio) * net plant + 
operating ratio * operating expenses.
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    7. Once these cumulative cost changes have been calculated for each 
pipeline with sufficient Form No. 6 data, the Kahn Methodology culls a 
data set consisting of pipelines with cumulative per-barrel-mile cost 
changes in the middle 50 percent of all pipelines. Later applications 
of the index also culled a data set consisting of pipelines with 
cumulative cost changes in the middle 80 percent of all pipelines. This 
trimming is done to remove statistical outliers, or spurious data 
points that could bias the sample in either direction.
    8. For each of the two data sets (the middle 50 percent and the 
middle 80 percent), the Kahn Methodology considers three different 
measures of central tendency. One measure is the median of each data 
set. Another measure, the weighted mean, calculates an average barrel-
mile cost change in which each pipeline's cost change is weighted by 
its barrel-miles. A third measure, the un-weighted average, calculates 
the simple average of the percentage cost change per barrel-mile for 
each pipeline. For each data set, a composite, is calculated by taking 
the simple average of the median, the weighted mean, and the un-
weighted mean. Table 1 provides a description of the statistical values 
of central tendency used by parties to develop the index.

                                 Table 1
------------------------------------------------------------------------
            Line                Middle 80 percent     Middle 50 percent
------------------------------------------------------------------------
A...........................  Median..............  Median.
B...........................  Weighted Mean.......  Weighted Mean.
C...........................  Un-weighted Mean....  Un-weighted Mean.
D...........................  Composite of 80       Composite of 50
                               percent = (A+B+C)/3.  percent = (A+B+C)/
                                                     3.
------------------------------------------------------------------------

    In the most recent index review, the industry-wide cost index 
differential was calculated by averaging the middle 50 composite and 
the middle 80 composite on Line D and then comparing that value to the 
PPI-FG index data over the same period. The index level was then set at 
PPI-FG plus (or minus) this differential.
    9. The Kahn Methodology has evolved during the course of prior 
index reviews. In Order Nos. 561 and 561-A, the Commission only 
considered the middle 50 percent and did not consider the middle 80 
percent. In the first and second five-year index reviews, the 
Commission considered both the middle 50 percent and the middle 80 
percent. Also, in Order Nos. 561 and 561-A, as well as the first 
review, the Commission merely cited Kahn's Methodology to demonstrate 
that it produced index levels that were close, although not exactly the 
same as, the proposed index levels of PPI-FG-1 (in Order Nos. 561 and 
561-A) and an unadjusted PPI-FG (in the first review). In the second 
five-year review, the Commission used the Kahn Methodology itself to 
set the precise index levels by averaging the middle 50 and middle 80 
composites relative to PPI-FG over the prior five-year period.

II. Comments From Industry

    10. Comments were filed by the American Trucking Associations, 
National Propane Gas Association (NPGA), Tesoro Refining and Market 
Company and Sinclair Oil Corporation (Sinclair/Tesoro, collectively), 
Air Transport Association of America (ATA), Society for the 
Preservation of Oil Pipeline Shippers (SPOPS), the Association of Oil 
Pipe Lines (AOPL), Valero Marketing and Supply (Valero), and Navajo 
Refining Company, L.L.C. (Navajo).
    11. Reply Comments were filed by the Canadian Association of 
Petroleum Producers (CAPP), the Pipeline Safety Trust, Sinclair/Tesoro, 
Platte Pipe Line Company (Platte), ATA, Navajo, AOPL, and SPOPS.
    12. On September 24, 2010, the U.S. Department of Transportation, 
Pipeline and Hazardous Materials Safety Administration (PHMSA) filed a 
Motion for Leave to File Out-of-Time and Comments and NPGA filed late 
Reply Comments.
    13. On October 8, 2010, Valero filed Supplemental Reply Comments 
and on October 20, 2010, AOPL filed a Response (October 20 Response).

A. Proposals for New Index Rates

    14. In comments and reply comments, several parties proposed 
departures from existing index levels. AOPL proposes an index of PPI-FG 
plus 3.64 percent (PPI-FG+3.64) as the oil pipeline pricing index for 
the five-year period beginning July 1, 2011. AOPL states that its 
witness, Dr. Ramsey Shehadeh, applied the Kahn Methodology to a data 
set including an initial sample of 110 pipelines,\12\ calculating the 
following data regarding pipeline cost changes for the 2004-2009 
period:
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    \12\ AOPL states that Dr. Shehadeh began his analysis using cost 
data reported by the oil pipelines in the Form No. 6 for the years 
2004 through 2009. According to AOPL, Dr. Shehadeh then removed from 
this data set any pipelines that did not report data for any year in 
that period, as well as the Trans Alaska Pipeline System carriers 
and any pipelines that had FERC Form No. 6 reporting errors or 
incomplete FERC Form No. 6 data.

                              Table 2 \13\
------------------------------------------------------------------------
                                                 Middle 80    Middle 50
                     Line                         percent      percent
------------------------------------------------------------------------
Median........................................         4.26         4.26
Weighted Mean.................................         9.91         7.07
Un-weighted Mean..............................         8.81         5.74
Composite.....................................         7.66         5.69
------------------------------------------------------------------------


[[Page 80302]]

    15. AOPL calculated an average annual pipeline cost growth rate of 
6.68 percent based upon the middle 50 composite growth rate and the 
middle 80 composite growth rate. AOPL notes that the PPI-FG geometric 
mean rate of growth for the years 2004 through 2009 is 3.04 percent. 
AOPL concludes actual oil pipeline cost increases during the years 2004 
through 2009 exceeded PPI-FG at a rate of 3.64 percent (6.68 minus 
3.04). Thus, Dr. Shehadeh proposes an index rate for the five-year 
period beginning July 1, 2011, of PPI-FG+3.64.
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    \13\ Shehadeh August 20 Decl. at Exhibit A5.
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    16. In contrast, Valero and its expert, Mr. Matthew O'Loughlin, 
contend that an index equal to an unadjusted PPI-FG more accurately 
reflects pipelines' actual cost changes. Valero states that Mr. 
O'Loughlin applies a modified version of the Kahn Methodology. First, 
Mr. O'Loughlin proposes to exclude pipelines that experienced large 
rate base changes from the data set used to calculate index levels. 
Second, to determine cost changes between 2004 and 2009, Mr. O'Loughlin 
measures the cost change per barrel-mile between 2004 and 2009 using 
the ``Total Cost of Service'' and barrel-miles reported on page 700. 
Unlike the other Form No. 6 data used in the Kahn Methodology, the page 
700 data includes an interstate total cost of service calculated under 
the Opinion No. 154-B Methodology used to determine oil pipeline rates. 
Following these procedures, Mr. O'Loughlin derives the following data:

                              Table 3 \14\
------------------------------------------------------------------------
                                                 Middle 80    Middle 50
                     Line                         percent      percent
------------------------------------------------------------------------
Median........................................          2.6          2.6
Weighted Mean.................................          4.9          3.3
Unweighted Mean...............................          3.9          2.9
Composite.....................................          3.8          2.9
------------------------------------------------------------------------

    17. Mr. O'Loughlin notes that the middle 50 composite of 2.9 
percent is very close to the PPI-FG of 3.0 percent over the last five 
years and supports an index of an unadjusted PPI-FG. In Mr. 
O'Loughlin's view, the middle 50 is the most appropriate for 
determining index levels, and should be used instead of the composite 
of the middle 50 and the middle 80.
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    \14\ O'Loughlin August 20 Aff. ] 6. Mr. O'Loughlin explains that 
he only reports data to the nearest tenth because, in his view, more 
precision is not useful given the wide ranging distribution of 
annual percentage cost changes experienced by the pipelines in the 
measurement group. O'Loughlin September 20 Aff. ] 5 n.3.
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    18. Other parties endorsed either the views expressed by AOPL or 
Valero. Platte states that it is a member of AOPL and filed to provide 
further support for AOPL's request of an index of PPI-FG+3.64. On the 
other hand, NPGA states that it supports the arguments and 
recommendations espoused by Mr. O'Loughlin on behalf of Valero, 
including the use of a PPI-FG without any adjustment. Navajo states 
that it prefers Valero's proposal to establish an index level of PPI-
FG.
    19. Other parties also proposed differing index levels. In reply 
comments, CAPP and its expert Mark Pinney state that if AOPL's analysis 
is reproduced using constant 2004 barrel-miles instead of the 
recession-influenced 2009 data, the annual cost increase between 2004 
and 2009 is PPI-FG plus 1.62 percent (PPI-FG+1.62), which CAPP observes 
is much closer to the current PPI-FG+1.3 than the index level proposed 
by AOPL. SPOPS asserts that the index should be set at zero until all 
pipeline over-recoveries are at just and reasonable levels and Navajo 
proposes to deny index increases to pipelines that are currently over-
recovering. Navajo also proposes to base the index upon changes in 
operating and maintenance costs and to allow indexed increases only to 
the proportion of the pipeline's rate that can be attributed to such 
operating and maintenance costs.
    20. Other parties, as discussed below, without proposing particular 
index levels, urge the Commission to reassess the index methodology to 
avoid over-recoveries. Some parties also raised procedural concerns and 
argued for various changes to the Commission's Form No. 6 reporting 
requirements.

III. Discussion

    21. The Commission adopts an index level of PPI-FG+2.65. The 
Commission rejects the procedural challenges to the validity of the NOI 
and to consideration of any modifications to the Kahn Methodology. The 
Commission's proposed index level of PPI-FG+2.65 is supported by the 
Kahn Methodology as applied by AOPL, except that the Commission adopts 
Valero's proposal to calculate the index using only the middle 50 
percent and not the middle 80 percent of the data set.

A. Procedural Arguments

1. The Validity of the Notice of Inquiry
a. Comments
    22. The American Trucking Association and Sinclair/Tesoro challenge 
the validity of the NOI. These parties state that the NOI contains no 
justification for the index of PPI-FG+1.3 specified in the NOI. 
Sinclair/Tesoro emphasizes that an agency must reveal an adequate 
explanation of the basis for its proposal and that the rulemaking is 
procedurally defective and should be withdrawn. Sinclair/Tesoro avers 
that the Commission provided no data analysis or support showing that 
it has evaluated the reasonableness of PPI-FG+1.3 as the appropriate 
index for determining rate ceilings.
    23. AOPL asserts that these criticisms of the NOI are baseless. 
AOPL posits that the Commission's methodology for calculating its index 
is well-known to industry participants and that there exists an 
``opportunity for interested parties to participate in a meaningful way 
in the discussion and final formulation of rules.'' \15\ AOPL further 
emphasizes that Dr. Shehadeh has provided data supporting his result 
pursuant to the established methodology and states the Commission can 
rely upon these calculations and data.
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    \15\ AOPL Reply Comment at 38 (quoting Connecticut Light and 
Power Co. v. Nuclear Regulatory Commission, 673 F.2d 525, 528 (DC 
Cir.)).
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b. Commission Determination
    24. The Commission rejects the assertion that the NOI is 
procedurally defective. The Commission inaugurated its five-year review 
of the indexation methodology proposing to continue the existing 
indexing level of PPI-FG+1.3 while inviting interested parties ``to 
propose, justify, and fully support, any alternative indexing 
proposals.'' \16\ By soliciting comments on the current index level, 
the Commission follows the same procedure that it used in the previous 
five-year review proceeding for allowing parties to present evidence 
that the index level should be modified.\17\
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    \16\ NOI, FERC Stats. & Regs. ] 35,566 at P 4.
    \17\ The current indexing level of PPI-FG+1.3 was developed in 
the Commission's prior five-year review proceeding. Second Five-Year 
Review, 114 FERC ] 61,293. This proceeding involved extensive record 
evidence and comments from shippers, and the record from that 
proceeding remains available on the Commission Web site.
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    25. Moreover, the Commission subsequently received extensive on-
the-record comments and workpapers from AOPL, Valero, and other 
parties. The analysis contained within these findings is based upon 
Form No. 6 data, which is publically available on the Commission Web 
site and was utilized extensively by both AOPL and Valero. Furthermore, 
although the Commission's mechanisms for assessing revisions to the 
index may evolve over time, the parties are familiar with the types of 
data that have been considered by the Commission in the past, including 
the variants of the Kahn

[[Page 80303]]

Methodology. The Commission has considered comments, reply comments, 
supplemental reply comments, and an even later response, giving each 
party more than adequate opportunity to respond. Both the data used in 
this proceeding and any potential changes from the methodology used in 
the past index review have been subject to ample opportunity for 
examination and comment. It is clear that the technical support for the 
index level adopted in this proceeding has been provided to the parties 
with adequate opportunity for analysis and comment.
2. Scope of This Proceeding
a. Comments
    26. In reply comments, AOPL argues that the Commission must adhere 
to the methodology applied in prior proceedings, and AOPL contends that 
the changes proposed by Valero and its expert Mr. O'Loughlin (using 
page 700 data, excluding pipelines with large rate base changes, and 
using only the middle 50 percent) are beyond the scope of the five-year 
review initiated by the NOI.
    27. AOPL contends that in the prior five year review, the 
Commission limited the purpose of the review to adjustments to the 
index, not whether the index should be changed. AOPL adds that because 
the existing methodology was promulgated as part of a Commission 
rulemaking, replacing that methodology requires a new rulemaking. AOPL 
asserts that in the NOI, the Commission requested comments on the 
appropriate index level, but gave no indication it was changing its 
methodology. Moreover, AOPL adds that to the extent the Commission 
departs from its prior methodology, the Commission must establish that 
the methodology is justified. In contrast to Mr. O'Loughlin's proposal, 
AOPL states that Dr. Shehadeh derived the index of PPI-FG +3.64 with 
the same methodology used by Dr. Kahn and adopted by the Commission in 
prior proceedings and accepted by the D.C. Circuit.
    28. In supplemental reply, citing FCC v. Fox Television Stations, 
Inc.,\18\ Valero states that the Commission only needs to establish 
that the new policy is permissible under the statute, that there are 
good reasons for the new policy, and that the agency believes it to be 
a better policy. Valero emphasizes that the most reasonable course of 
action available to an agency is not always to maintain its current 
policy unchanged.
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    \18\ 129 S.Ct. 1800 (2009).
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    29. Valero also dismisses AOPL's argument that a new rulemaking 
process is required to adopt Mr. O'Loughlin's proposals. Valero 
reiterates that it is not proposing a change to this legislative rule 
embodied in the regulations, but only a change in data inputs to that 
methodology. Valero also contends that all parties, including AOPL, are 
on notice of the alternative proposals before the Commission.
    30. Additionally, Valero disagrees with AOPL's contention that the 
NOI does not contemplate an analysis such as the O'Loughlin approach. 
Valero states that the Commission invited parties to submit comments 
proposing, among other things, alternative indexing proposals. Valero 
argues that AOPL mistakes Mr. O'Loughlin's improvements to data sources 
as a change in the methodology itself. Rather, Valero contends Mr. 
O'Loughlin's approach constitutes a better approach to utilizing the 
same methodology.
    31. Similarly, on reply, Navajo avers that FERC adopted the Kahn 
Methodology only upon the express caveat that its initial conclusions 
were not necessarily ``a choice for all time'' and that the ICA 
required monitoring of the index. Navajo adds that an agency may depart 
from past policy or precedent so long as the Commission acknowledges 
the change and supports its new decision with reasoned decision-making 
and substantial evidence. SPOPS also emphasizes that the Commission has 
the flexibility to modify its indexing methodology.
    32. In its response, AOPL reiterates that Mr. O'Loughlin's 
methodology is a fundamental departure from the established methodology 
and would require a new rulemaking initiated by a Notice of Proposed 
Rulemaking. AOPL states that Fox Television also made clear that an 
agency must still provide a reasoned explanation for its decisions and 
that a more detailed justification is required when the prior policy 
engendered serious reliance interest. Valero, according to AOPL, 
downplays this reliance inappropriately. AOPL states that the reliance 
interest was not a reliance on any precise pricing index, but rather 
that the pipelines have a continued expectation that the Commission 
will apply the established methodology in calculating the index.
b. Commission Determination
    33. The Commission rejects AOPL's assertion that modifications to 
the methodology for evaluating changing pipeline costs are beyond the 
scope of this proceeding. The NOI invited ``interested persons to 
submit comments on the continued use of PPI+1.3 and to propose, 
justify, and fully support, any alternative indexing proposals.'' \19\ 
Thus, by inviting parties to submit ``to propose, justify, and fully 
support any alternative indexing proposals,'' the Commission provided 
notice to AOPL and others that the Commission would consider different 
methodologies for calculating the Index, such as the proposals advanced 
by Valero, among others.\20\ Although the DC Circuit rejected in 2003 
proposed changes to the Kahn Methodology for assessing changing 
pipeline costs, the Court rejected this proposal because the Commission 
had neither addressed concerns regarding the new methodology nor 
justified its methodological shift.\21\ The Court did not hold that the 
Commission cannot make justified modifications to the Kahn Methodology. 
As the Commission did in prior five-year reviews of the indexing level, 
the Commission will give consideration to alternative methodologies for 
calculating the index.\22\
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    \19\ NOI, FERC Stats. & Regs. ] 35,566 at P 4.
    \20\ AOPL has been given an opportunity to respond to these 
proposals, and AOPL has filed reply comments and an October 20 
Response that vigorously critique the proposed alterations to the 
Kahn Methodology.
    \21\ AOPL II, 281 F.3d at 248.
    \22\ AOPL argues that in the last indexing review, the 
Commission stated that the purpose of the five-year review was to 
determine ``what extent the PPI-FG should be adjusted to better 
reflect those cost changes, not whether the method for determining 
pipeline costs should be changed.'' Second Five-Year Review, 114 
FERC ] 61,293 at P 46 (emphasis added). However, in that passage, 
the Commission was referring to a proposal by the shipper parties 
for an entirely new rulemaking to re-assess the means for tracking 
pipeline costs justified, in part, by criticism of the data in Form 
No. 6. Id. See also ATA, Lion Oil Company, National Cooperative 
Refinery Association, Sinclair/Tesoro, Response, Docket No. RM05-22, 
at 13-14 (filed January 23, 2006). However, elsewhere in Second 
Five-Year Review, when parties did not propose a new rulemaking and 
instead proposed changes using the existing information reported to 
the Commission, as Mr. O'Loughlin has done here, the Commission 
evaluated those changes and did not find them to be beyond the scope 
of the five-year review process. Second Five-Year Review, 114 FERC ] 
61,293 at P 30-36 (rejecting proposal to use ``the arithmetic 
average of the geometric mean of each pipeline's cumulative unit 
cost change, as opposed to Dr. Kahn's method of calculating the 
geometric mean of the arithmetic average of cumulative unit cost 
change.'').
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B. Proposed Changes to the Kahn Methodology

1. Rate Base Screening Methodology
a. Valero Initial and Reply Comments
    34. To develop the data set for the Index, Valero urges the 
Commission to apply a ``rate base screening'' methodology that excludes 
pipelines experiencing both: (a) A rate base increase (through 
expansion) or decrease (through divestiture) greater

[[Page 80304]]

than 50 percent during the 2004-2009 period and (b) recovery of cost 
changes during the 2004-2009 period through some means other than 
incremental rate increases via the index, such as a cost-of-service 
filing or a settlement agreement.\23\ For pipelines with rate base 
changes greater than 50 percent, Valero also excluded (a) any pipeline 
with a major divestiture or (b) any pipeline that acquired another 
pipeline where the pipeline divesting the assets continued to exist 
after the divestiture. In conducting the assessment of pipelines with 
major rate base changes, Mr. O'Loughlin also excluded pipelines with 
what he concluded were unreliable data.
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    \23\ Using the rate base screening methodology, Mr. O'Loughlin 
excluded 25 pipelines that he states experienced major rate base 
changes during the 2004-2009 period. O'Loughlin August 20 Aff. ] 10. 
Twelve pipelines with rate base changes of more than 50 percent 
remained in the data set because, according to Mr. O'Loughlin, they 
did not appear to have requested alternative ratemaking treatment 
and no major acquisition or divestiture was identified. O'Loughlin 
October 8 Aff. ] 15.
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    35. Valero justifies the rate base screening methodology because, 
citing Order Nos. 561 and 561-A, Valero avers that the index is 
intended for normal, not extraordinary, changes. Valero contends that 
large rate base changes are ``extraordinary'' and that cost changes of 
this nature are typically recovered by a cost-of-service filing or 
settlement, not incremental rate changes pursuant to the index.
    36. Thus, if the index level reflects cost data from the pipelines 
experiencing rate base changes, Valero argues that pipelines receiving 
annual index increases that did not construct major expansions would 
obtain a windfall due to an index inflated for cost changes not 
experienced by normal pipelines. Furthermore, Valero argues that 
pipelines that constructed major expansions would receive double 
compensation, first, through a cost-of-service or other rate changing 
methodology related to the expansion and, second, through an inflated 
index. Furthermore, regarding divestitures and acquisitions, Valero and 
its witness O'Loughlin also aver that comparisons between the period 
before the divestitures or acquisitions and after those transactions 
are meaningless because the systems being compared are different.
    37. Valero argues that measures taken by the Commission in prior 
proceedings do not fully correct the biases caused by the inclusion of 
these pipelines. For example, Valero asserts the usage of the middle 80 
percent or middle 50 percent of the sample data set in the prior rate 
proceedings does not adequately mitigate the effect of the inclusion of 
the pipelines with major rate base changes.
    38. Valero states that otherwise applying Dr. Shehadeh's 
methodology, while using Valero's rate base screening methodology 
reduces his recommended index from PPI-FG+3.64 to PPI-FG+2.6. Valero 
also states that excluding the pipelines with large rate base 
expansions would not frustrate expectations because these pipelines do 
not typically use indexing to recover increased costs, and the index 
has never previously been set at PPI-FG+3.64 and there could have been 
no expectation that this index level would be approved.
b. AOPL Reply Comments
    39. AOPL states that if a pipeline experiencing a rate base change 
is truly a statistical outlier, it will be excluded by using the middle 
50 and middle 80 data sets as applied in the Kahn Methodology. AOPL 
states that Mr. O'Loughlin's ``rate screening methodology'' is a highly 
subjective, results-driven attempt to eliminate pipelines with higher 
cost changes. This, AOPL argues, biases the data set downward before 
any application of statistical measures. AOPL emphasizes that an 
appropriate statistical method for excluding outliers must be 
systematic and objective.
    40. AOPL contends Mr. O'Loughlin's ``double-recovery'' argument 
lacks consistency with the structure of the index methodology. 
According to AOPL, under the Commission's regulations, if a pipeline 
files a cost-of-service rate increase, those rates form the ceiling for 
that year, but in the next index year, the pipeline must apply the 
applicable index, whether it is higher or lower. AOPL asserts that, 
rather than reflecting ``double recovery,'' this merely follows the 
appropriate operation of the index under the Commission's regulations, 
which permit annual changes in rate ceilings due to actual industry-
wide cost changes as compared to PPI-FG. AOPL further argues that Mr. 
O'Loughlin's double-recovery argument would also discourage pipeline 
expansions and improvements by excluding pipelines that would undertake 
significant expansion projects or that incur significant expenses in 
compliance with safety regulations.
    41. AOPL also contends that the inclusion of pipelines with large 
rate base changes in the data set does not create a windfall because, 
under the indexing methodology, pipeline costs are merely increasing to 
reflect increased costs across the industry. AOPL's witness Dr. 
Shehadeh states that whether a pipeline ``used a rate mechanism other 
than indexation is irrelevant to the value of the information that 
these pipelines can provide as evidence for indexing pipeline costs.'' 
\24\
---------------------------------------------------------------------------

    \24\ Shehadeh September 20 Decl. at 11.
---------------------------------------------------------------------------

    42. AOPL further claims that in Order No. 561, the Commission 
established the Index level at PPI-FG-1 to account for a wave of asset 
retirements that resulted in significant rate base changes. AOPL states 
that it would now be inconsistent to exclude rate base changes when 
those changes relate to pipeline expansions. AOPL states that the 
disqualification from the data set pipelines that undertake significant 
expansion will discourage pipeline expansions and improvements.
c. Other Shipper Reply Comments
    43. In reply comments, NPGA, ATA and Navajo expressed support for 
Valero's rate base screening methodology.
d. Valero Supplemental Reply Brief
    44. Responding to AOPL, Valero disputes the assertion that the rate 
base screening methodology understates cost changes experienced by a 
typical pipeline operator. Valero states that Mr. O'Loughlin's analysis 
applied an objective filter which removed pipelines experiencing cost 
increases and cost decreases of more than 50 percent. Valero notes that 
pipelines that underwent expansions and major capital investments often 
sought to recover those costs by means other than the price index; to 
Valero, this suggests that the cost increases were extraordinary.
    45. In response to AOPL's and Dr. Shehadeh's argument that volume 
increases offset the cost increases, Valero states that it would not 
have been necessary or cost-justified to adopt increased cost-based 
rates if increased volumes fully offset any new costs. Valero adds that 
if volumes had increased commensurately with costs on these pipelines, 
then the pipelines with large rate base changes would not be at the 
high end of the measurement group in terms of cost-of-service per 
barrel-mile changes.
    46. Valero also avers that Dr. Shehadeh's claim that the rate base 
screening methodology would have increased the index adjustment factor 
established in Order No. 561 contradicts his claim that Mr. 
O'Loughlin's methodology biases results downward and leads to an 
inappropriately low index.

[[Page 80305]]

e. AOPL October 20, 2010 Response
    47. AOPL states that once an initial rate is set for a pipeline 
expansion, indexing becomes the primary method for changing oil 
pipeline rates. According to AOPL, there is no reason to exclude 
pipelines filing a cost-of-service or settlement rate when examining 
industry-wide cost changes and that the presence of ratemaking 
alternatives do not justify setting the index below overall industry 
levels. AOPL avers that if pipelines undertaking significant 
infrastructure investment are excluded from the measurement of cost 
changes, the index will be inappropriately low, causing more pipelines 
to use other ratemaking methods and undermining the purpose of the 
index.
f. Commission Determination
    48. The Commission will not adopt Valero's proposal to exclude 
pipelines experiencing major rate base changes from the data set. To 
determine which pipelines should be trimmed from the data sample, the 
Commission has relied upon the level of the cost changes, not the 
reasons why a particular pipeline's changing costs might be anomalous. 
Thus, in assessing Form No. 6 data in prior index proceedings, the 
Commission has trimmed the data sets to remove outliers, such as the 25 
percent of pipelines with the greatest cost increases per barrel-mile 
and the 25 percent with the greatest decreases. As discussed below, the 
Commission in this proceeding will trim the data set to pipelines in 
the middle 50 percent of cost changes. To the extent that a particular 
pipeline's cost change is an anomalous outlier compared to the changes 
on other pipelines, using the middle 50 percent of cost changes, should 
remove any distorting impact resulting from the pipeline's presence in 
the index.\25\
---------------------------------------------------------------------------

    \25\ To the extent that large rate base changes are associated 
with disproportionately large cost shifts, AOPL's expert Dr. 
Shehadeh explains that 18 of the 25 pipelines removed by Mr. 
O'Loughlin due to rate base changes were excluded when the data set 
was reduced to the middle 50 percent using Dr. Shehadeh's 
methodology. Shehadeh September 20 Decl. at 12.
---------------------------------------------------------------------------

    49. In contrast to this simplified methodology, the rate base 
screening methodology proposed by Valero selectively emphasizes one 
factor that may cause a substantial change in pipeline costs per 
barrel-mile while ignoring other factors. There is no doubt that 
substantial changes in rate base can alter the per barrel-mile costs of 
a particular pipeline. However, costs per barrel-mile can also be 
altered by shifting customer demand, increased competition, economic 
changes, or changing product supplies. As Valero's expert Mr. 
O'Loughlin notes, there is a wide range in the changes in pipeline per 
barrel-mile costs,\26\ and much of this variability \27\ is unrelated 
to the significant rate base changes cited for exclusion by Mr. 
O'Loughlin. By selectively modifying the data set based upon one 
potential cause for cost changes, Mr. O'Loughlin risks distorting the 
index calculation.
---------------------------------------------------------------------------

    \26\ O'Loughlin August 20 Aff. ]] 44-45, Figure 14.
    \27\ For example, Mr. O'Loughlin explains that, using his own 
methodology, of the 97 pipelines in his data set, which has been 
culled pursuant to the rate base screening methodology, there ``are 
20 pipelines that experienced average cost increases greater than 
10% per year and 10 pipelines that experienced average cost 
decreases of more than 10% per year over the five-year period.'' 
O'Loughlin August 20 Aff. ] 45.
---------------------------------------------------------------------------

    50. Moreover, the index is pursuant to a Congressional mandate to 
develop a ``simplified and generally applicable ratemaking methodology* 
* *.'' \28\ Consistent with this mandate of general applicability, the 
Commission is reluctant to inquire into the particular circumstances of 
every pipeline and selectively remove pipelines that experienced cost 
changes due to one particular factor from the data set used to 
calculate the index.\29\
---------------------------------------------------------------------------

    \28\ Energy Policy Act of 1992 Public Law 102-486 Sec. 1801(a), 
106 Stat. 3010 (Oct. 24, 1992).
    \29\ The D.C. Circuit has previously recognized the importance 
of an index that is relatively simple to derive. AOPL II, 281 F.3d 
at 247 (quoting EPAct 1992, at Sec.  1801(a)). The complexity of Mr. 
O'Loughlin's rate base screening methodology is demonstrated by 
Appendix F of his September 20 Affidavit, in which Mr. O'Loughlin 
examines the circumstances of 37 pipelines that experienced rate 
base changes greater than 50 percent. To apply the rate base 
screening methodology, for each pipeline with a change in rate base 
exceeding 50 percent, Mr. O'Loughlin examined tariff filings, 
assessed acquisition and divestiture activity, probed into the 
reliability of the pipeline's reported data, researched whether the 
pipeline had sought rate increases pursuant to the index, and 
generally sought to determine why the rate base changes occurred.
---------------------------------------------------------------------------

    51. Furthermore, large rate base changes can reflect changing 
pipeline costs. The cost of new investment associated with rate base 
increases reflects industry cost experience related to pipeline 
infrastructure on a barrel-mile basis. These rate base changes also 
provide important information regarding industry capital requirements. 
A rate base change, like any other change in the business circumstances 
of a pipeline, is only an outlier if a pipeline's per barrel costs 
change in a manner disproportionate to those changes experienced by 
other pipelines.
    52. Moreover, the index serves as a means of recovery for some 
pipelines with significant rate base changes. According to data 
provided by Mr. O'Loughlin, several of the pipelines that Mr. 
O'Loughlin identified as experiencing significant rate base changes 
relied upon indexed rates (or at least did not seek some other form of 
recovery, such as a cost-of-service filing).\30\ The fact that a non-
trivial number of pipelines experiencing rate base changes continued to 
use the indexing methodology reinforces the inclusion of pipelines with 
rate base changes in the data set.
---------------------------------------------------------------------------

    \30\ O'Loughlin September 20 Aff. ] 54 n.75, Appendix F at 8-10.
---------------------------------------------------------------------------

    53. Additionally, merely because a pipeline seeks recovery of rates 
outside the indexing methodology, for example through a cost-of-
service, does not establish that the pipeline should be excluded from 
the data set used to develop the index. The changing costs that 
compelled the pipeline to seek recovery outside the indexing 
methodology nonetheless reflect industry cost experience. Moreover, for 
those pipelines with significant rate base increases, Mr. O'Loughlin's 
decision to include only those pipelines where the pipeline opted to 
continue to use the index could skew the index downward; this is 
because the pipelines continuing to use the index are more likely to be 
the pipelines where the rate base change decreased per-barrel mile 
costs.
    54. Valero repeatedly cites language in Order Nos. 561 and 561-A 
that the index accounts only for ``normal,'' not ``extraordinary'' 
changes.\31\ However, this language does not support Valero's proposal 
to exclude pipelines experiencing major rate changes from the data set 
used to determine the index level. In these passages, ``extraordinary'' 
referred to pipelines experiencing changed per barrel-mile costs that 
were greater than the changing costs experienced by other pipelines 
regardless of the causes underlying any particular pipeline's cost 
changes. Thus, even though a rate base change of 50 percent is a 
significant occurrence, it is only ``extraordinary'' as Order Nos. 561 
and 561-A used that term to the extent that it causes an anomalous 
change in costs per barrel-mile.
---------------------------------------------------------------------------

    \31\ Valero Supplemental Reply Comment at 14-15 (citing Order 
No. 561-A, FERC Stats. & Regs. ] 31,000 at 31,097).
---------------------------------------------------------------------------

    55. Valero's contention that including pipelines with rate base 
changes in the data set used to determine index will lead to double-
recovery is without merit. After making a cost-of-service filing, the 
cost-of-service rate becomes the ceiling rate for that year \32\ and 
pipelines are authorized to increase their rates pursuant to the index 
in

[[Page 80306]]

subsequent years.\33\ Valero's argument ultimately rests upon the 
contention that the index is inflated by the inclusion of pipelines 
experiencing rate base changes. However, as noted previously, such 
inflation of the index only occurs if the rate base changes lead to 
changes in per barrel-mile costs that are anomalous. To the extent that 
the rate base change leads to an anomalous cost increase or decrease, 
it will be excluded by the data set trimming as discussed below.
---------------------------------------------------------------------------

    \32\ 18 CFR 342.3(d)(5).
    \33\ However, further undermining Valero's double-recovery 
argument, the Commission has denied an increase pursuant to the 
index when the cost-of-service filing supporting the existing rate 
already incorporated the cost changes covered by the index. See 
SFPP, L.P., 117 FERC ] 61,271 (2006) (denying an index increase 
because the cost-of-service rate, which used a 2005 base period, 
already reflected the 2005 cost changes covered by the index).
---------------------------------------------------------------------------

2. Data Trimming and the Middle 50
a. Valero Initial and Reply Comments
    56. Valero urges the Commission to calculate the index using a data 
sample trimmed to the middle 50 percent, i.e. removing the 25 percent 
of pipelines with the greatest cost increases and the 25 percent of 
pipelines with the greatest cost decreases. Although Valero 
acknowledges that recent index proceedings have considered both the 
middle 50 and middle 80 percent, Valero contends that trimming the data 
set to the middle 80 percent inadequately accounts for outliers due to 
the widely varying average annual cost changes. Valero adds that the 
middle 80 includes pipelines with anomalous characteristics, such as 
very high costs per barrel-mile or the absence of rate base.
b. AOPL Reply Comments
    57. AOPL opposes trimming the sample data set to the middle 50 
percent of pipelines. Dr. Shehadeh responds to Mr. O'Loughlin's 
proposal by stating that the wide distribution of pipeline cost changes 
(as opposed to a normalized bell curve) does not support ignoring the 
middle 80 percent in favor of the middle 50 percent. Rather, Dr. 
Shehadeh claims that the wide distribution supports the use of the 
middle 80 percent, rather than the middle 50 percent because it would 
be more inclusive and represent a larger number of pipelines.
c. Valero Supplemental Reply Comments
    58. Valero contends, contrary to AOPL's assertions, that Mr. 
O'Loughlin's use of the middle 50 percent data set is justified and 
consistent with Commission policy. Valero asserts that the Commission's 
methodology has varied over the years, and in Order Nos. 561 and 561-A, 
the Commission used an analysis of only the middle 50 percent of the 
data set, not a composite of the middle 50 percent and middle 80 
percent of the data set. Valero's Mr. O'Loughlin emphasizes that the 
middle 50 percent better serves the goal of excluding extraordinary 
data points. Mr. O'Loughlin also identifies an additional three 
pipelines in the middle 80 percent that he states have unusual 
characteristics, such as a cost of capital under two percent or, in 
another case, no rate base yet a positive depreciation expense.
d. AOPL's October 20, 2010 Response
    59. In its response, AOPL reiterates its position that both the 
middle 50 percent and middle 80 percent should be used. AOPL reiterates 
its contention that the wide distribution of pipeline cost changes does 
not support assigning no weight to the middle 80 percent. AOPL also 
challenges the three pipelines Mr. O'Loughlin identified as anomalous, 
noting that one was excluded from Dr. Shehadeh's data set and that the 
others showed overall cost changes that were not all that different 
from other pipelines. AOPL states that as the Form No. 6 data has 
improved, there is no merit to limiting the data set.
e. Commission Determination
    60. The Commission will use the middle 50 percent of the data set 
to determine the appropriate index level. This use of the middle 50 
percent is consistent with the Commission's approach when it adopted 
the indexing methodology. In Order Nos. 561 and 561-A, the initial 
rulemaking establishing the indexing methodology, the Commission used 
only the middle 50 percent of the data set to determine the appropriate 
indexation level. In that proceeding, neither the Commission nor Dr. 
Kahn considered the middle 80 percent. In the second review, Dr. Kahn 
introduced the middle 80 percent to his analysis.\34\ Given that the 
two data sets supported the same resulting index-level of an unadjusted 
PPI-FG, using both (as opposed to just the middle 50) was not discussed 
or contested, as there was little substantive impact from this 
departure from the Order No. 561 methodology.\35\ In the second and 
most recent 5-year review, the composite usage of the middle 50 and the 
middle 80 reoccurred, but again the relative merits of the middle 50 
and middle 80, and the departure from the prior Order No. 561 
methodology were not weighed or discussed.
---------------------------------------------------------------------------

    \34\ Kahn Decl. at 13 (August 31, 2000) (Docket No. RM00-11-
000).
    \35\ The composite of the middle 50 and middle 80 were very 
similar in that proceeding at 1.32 percent and 1.2 percent, 
respectively. Id.
---------------------------------------------------------------------------

    61. Given the more fully developed record presented here, the 
Commission returns to its approach in Order Nos. 561 and 561-A to use 
the middle 50 percent as the most appropriate method for trimming the 
data sample. The purpose of the index is to permit a simplified 
recovery for normal cost changes, not to enable recovery for 
extraordinary cost increases or decreases.\36\ The middle 50 percent 
more appropriately adjusts the index levels for ``normal'' cost changes 
as opposed to the middle 80 percent, which, by definition, includes 
pipelines relatively far removed from the median. Furthermore, some of 
these more dramatic cost changes may be due to circumstances on a 
particular pipeline that are not broadly shared across the industry. 
Even when accurate data is reported, pipelines in the middle 80, as 
opposed to the middle 50, are more likely to have cost changes 
resulting from factors particular to that pipeline, such as a rate base 
expansion, plant retirement, or localized changes in supply and demand. 
Using the middle 50 ensures that pipelines with relatively large cost 
increases or decreases do not distort the index.
---------------------------------------------------------------------------

    \36\ Order No. 561-A, FERC Stats. & Regs. ] 31,000 at 31,097 
(noting that the purpose of the Index is to ensure recovery of 
``normal'' cost changes, not ``extraordinary'' cost changes).
---------------------------------------------------------------------------

    62. The Commission further observes that our adoption of the middle 
50 provides a better remedy for some of the concerns Mr. O'Loughlin 
used to justify his rate base screening methodology. Of the 25 
pipelines Mr. O'Loughlin seeks to exclude via the rate base screening 
methodology, 18 are excluded by using the middle 50 percent in the Kahn 
Methodology as applied by Dr. Shehadeh.\37\ More generally, the 
adoption of the middle 50 is a less subjective and more simplified 
method (consistent with the EPAct 1992) of removing potentially 
anomalous data than selective removal of certain pipelines with 
particular characteristics from the data sample. The middle 50 also is 
preferable to such selective screening methods because it avoids the 
risk that the index is skewed because certain cost changes (such as 
rate base changes) are selectively excluded while

[[Page 80307]]

other significant changes (changes in local supply and demand) are 
incorporated.
---------------------------------------------------------------------------

    \37\ Shehadeh September 20 Decl. at 12. Only 13 of the 25 are 
excluded in the middle 80 percent. Id. The number of excluded 
pipelines include four companies that Dr. Shehadeh removed due to 
missing data. Shehadeh September 20 Decl. at 12 n.15.
---------------------------------------------------------------------------

    63. The Commission accordingly concludes that the middle 50 
provides a robust data sample for determining changing barrel-mile 
costs. The middle 50 percent of pipelines represents 76 percent of 
total barrel-miles in 2004 subject to the index,\38\ and thus for this 
index calculation, the Commission finds it unnecessary to include the 
middle 80 percent to obtain a representative sample of the data. 
Finally, the use of the middle 50 minimizes the risk of including 
pipelines that experienced either large increases or decreases in cost 
(or errant data) that may be included in an 80 percent sample, while 
still capturing changes from a broad spectrum of the pipeline industry.
---------------------------------------------------------------------------

    \38\ AOPL Comments at 14-15; Dr. Shehadeh August 20 Decl. at 10 
n.23.
---------------------------------------------------------------------------

3. Page 700 Data
a. Valero's Initial and Reply Comments
    64. Valero and Mr. O'Loughlin aver that the Commission should adopt 
page 700, which uses the Opinion No. 154-B methodology to derive a 
total cost-of-service for interstate pipeline companies. Valero states 
there are several advantages to using the page 700 data as opposed to 
the other Form No. 6 data relied upon by the Commission in the past.
    65. Valero asserts that by relying upon page 700 data, the 
Commission can avoid using net carrier property as a proxy for actual 
changes in allowed return and income tax. Valero notes that the 
Commission has previously questioned the effectives of net carrier 
property as a proxy for changes in capital costs. Valero further states 
that Mr. O'Loughlin's analysis shows that the change in net plant is 
typically greater than the change in allowed return and income tax. 
Additionally, Valero argues that net plant data reported on Form No. 6 
can also include purchase accounting adjustments (PAAs), which the 
Commission does not allow for ratemaking purposes absent a showing of 
substantial benefits to ratepayers.
    66. Valero also contends that the ``operating ratio'' weighting 
methodology as applied by Dr. Shehadeh leads to a distorted analysis. 
The operating ratio is set between zero and one based upon the ratio of 
operating expenses to revenues. If operating expenses exceed revenues, 
then the operating ratio is set to one, meaning that no weight is 
assigned to capital costs (net plant under the prior methodology) in 
the formula. Thus, Valero contends that for fifteen pipelines in Dr. 
Shehadeh's data set, the weight for the index of changes in net plant 
is zero percent, making the index of changes in net plant irrelevant. 
Valero contends that its proposed methodology using data from page 700 
obviates the need for the operating ratio because the total cost of 
service on page 700 incorporates both operating and capital costs.
    67. Valero explains that operating expense, net carrier property, 
and barrel-mile data, which are reported on pages 110-111, 300-303, and 
600-601 of the Form No. 6, include intrastate, as well as interstate, 
pipeline information. The solution, Valero contends, is to use the data 
on page 700 of the Form No. 6, which includes only interstate 
information.
b. Other Shipper Comments
    68. In their comments, other parties addressed Valero's proposal to 
use page 700. ATA emphasized that any analysis of costs should be based 
on the interstate costs reported on page 700. ATA emphasizes that page 
700 contains the information available to shippers to provide a 
screening tool to determine whether a ``pipeline's cost of service or 
per-barrel/mile costs'' are so divergent from revenues as to warrant a 
challenge to the rates. ATA stresses that it is appropriate to use the 
same data to develop the index as is used to determine whether a 
pipeline is recovering its costs.
    69. NPGA likewise submits that any proper analysis of operating 
costs should be based on interstate operations and costs and not on 
costs that reflect intrastate operations. Thus, NPGA urges the use of 
page 700 data.
    70. In reply comments, SPOPS urges that to the extent the 
Commission continues to apply its methodology, the Commission should 
use the primary source for the jurisdictional costs of service for the 
pipelines, the page 700 and the underlying workpapers, not the 
secondary source methodology demanded by AOPL.
c. AOPL's Reply Comments
    71. AOPL opposes the use of page 700 data. AOPL argues that the 
page 700 data is more volatile due to the return element underlying the 
page 700 total cost-of-service data. Specifically, AOPL contends that 
stock market fluctuations make the rate of return highly sensitive to 
the end-year selected by the Commission (i.e., 2008 versus 2009) for 
calculating the index. According to AOPL, the Form No. 6 net carrier 
property data is preferable because it reflects actual changes in 
capital costs while assuming that the competitive cost of capital 
remains constant.
    72. AOPL also argues that if rate of return from page 700 is used 
to measure cost increases, increases in pipeline efficiency will not 
result in lower indexation levels. AOPL explains that pipeline returns 
are based on a proxy group and as the profitability increases for 
companies in the proxy group, returns will likely increase. As a 
result, using return from page 700 will tend to increase, as oppose to 
decrease, future index levels.
    73. AOPL also disagrees with Mr. O'Loughlin's claim that page 700 
data is superior to Form No. 6 data because page 700 data does not 
include intrastate costs. AOPL counters that oil pipelines often make 
intrastate and interstate movements through the same pipeline segments. 
Thus, AOPL believes that it is reasonable to assume that both 
interstate and intrastate cost changes are likely to be representative 
of interstate cost changes.
    74. AOPL argues that Mr. O'Loughlin mistakenly describes the page 
700 data as new and instead suggests that the information Mr. 
O'Loughlin proposes to use has been available to the Commission for 
many years.
d. Valero Supplemental Reply
    75. Responding to AOPL, Valero asserts that pipeline efficiency 
gains will not distort the return information from page 700 because 
basic finance theory provides that an increase in a company's current 
and future cash flow increases the equity value of the company. 
Regarding AOPL's contention that volatility in the page 700 return data 
will skew results, Valero argues that Dr. Shehadeh, by analyzing the 
rate of return in isolation from the allowed return and income tax 
allowance, obtained a result that is not fully indicative of a 
pipeline's capital costs. Valero further argues that recessionary 
declines in petroleum demand increased the average cost of service per 
barrel mile for 2009. Valero concludes that if the recessionary 
volatility in barrel-miles is reflected in developing unit costs, the 
prevailing rates of return as reported in the cost-of-service 
calculations on page 700 of the Form No. 6, must also be used.
    76. Valero disputes AOPL's contention that an interstate cost-of-
service value was reflected on page 700 as early as 1994. Valero states 
that a reliable total interstate-only cost-of-service data and the 
specific line items composing the interstate cost of service, including 
jurisdictional rate base, were not available until 2000. Valero states 
that the Commission has not previously

[[Page 80308]]

addressed the possibility of using this interstate, page 700 data in 
the index.
    77. Valero also challenges Dr. Shehadeh's claim that the 
interstate-only operating and maintenance expense and depreciation 
expense data reported on page 700 are unsuitable for the rate index 
methodology because the data contain various accounting, allocation, 
and normalizing assumptions. Rather, Valero contends that because the 
calculations of operating and maintenance expense must be consistent 
with the Commission's Opinion No. 154-B methodology and because changes 
in those components impact the costs a pipeline can recover in rates, 
those considerations are appropriate for determining the price index.
    78. Valero states that Dr. Shehadeh's preferred data source, the 
operating and maintenance expense data on page 114 of the Form No. 6, 
can contain accounting reserves that are not permitted for ratemaking. 
Valero states that carriers should not be permitted to use these 
discretionary changes in accounting reserves to influence the change in 
unit costs used to determine the level of index to be used for annual 
adjustments.
e. AOPL October 20, 2010 Response
    79. AOPL renews its arguments that (a) intrastate costs are 
representative of interstate costs; (b) inclusion of the rate of return 
from page 700 would make the index more volatile; (c) net plant is a 
preferable measure of return for the purposes of establishing the index 
than the page 700 data; and (d) the page 700 data has been available 
during prior indexing proceedings.
    80. AOPL also argues that Valero's proposed usage of page 700 
ignores serious accounting issues. AOPL states that, in order to derive 
a unit cost for each carrier, Mr. O'Loughlin divides the total cost-of-
service reported on page 700 by the total throughput reported on page 
700. AOPL states that the page 700 cost-of-service figure provides each 
carrier's interstate cost-of-service using an Opinion No. 154-B 
methodology. However, AOPL states that the barrel-mile data on page 700 
includes interstate and intrastate volumes. AOPL explains that the 
instructions on page 700 indicate that the barrel-mile figure should be 
the same as that reported on page 600, and the barrel-mile figure on 
page 600 includes ``all oils'' received by the pipeline, not just 
interstate oils. AOPL contends that there could be a mismatch between 
the interstate only costs and the interstate and intrastate volumes.
    81. AOPL defends the data in Form No. 6. AOPL states that while 
PAAs reflected in Form No. 6 are generally not allowed to be reflected 
in regulated rates, these adjustments are appropriate when calculating 
cost changes because the PAAs reflect the opportunity cost of capital. 
Moreover, AOPL states that PAAs do not create the perverse incentives 
in the calculation of an industry-wide index that they do when 
calculating an individual pipeline's rates. Also, AOPL also contends 
that although the accounting reserves in Form No. 6 present timing 
issues for the purposes of a ratemaking proceeding, they also represent 
real costs of doing business that are properly reflected in the 
calculation of the rate index.
    82. AOPL also defends the usage of the operating ratio. AOPL states 
that applying a weight of one to operating expenses and zero to net 
plant is appropriate for a company where operating costs are greater 
than revenue.
f. Commission Determination
    83. The Commission does not adopt Mr. O'Loughlin's proposal to use 
page 700 data because there is a mismatch between the page 700 total 
cost-of-service, which includes only interstate data, and the page 700 
throughput data, which includes interstate and intrastate data.
    84. As the shipper parties emphasize, the total cost of service 
data on page 700 relates solely to interstate costs. However, the 
throughput data used by Mr. O'Loughlin from page 700 reports a 
combination of interstate and intrastate volumes. As AOPL explains in 
its October 20 Response, the barrel-mile information listed on page 700 
provides that the barrel-mile figure should be the same as that 
reported on line 33a of page 600 of the Form No. 6. The instructions 
for page 600 refer to the inclusion of ``all oils received'' by the 
pipeline and makes no distinction between interstate and intrastate 
volumes. Consequently, pipelines may be reporting both interstate and 
intrastate volumes on page 700.
    85. Thus, Mr. O'Loughlin's calculations compare one set of costs 
(interstate costs) with a different set of throughput (combined 
interstate and intrastate). Changes in transported throughput on a 
particular movement cause changes in the costs related to the very same 
movement. Thus, it is an axiomatic rule of ratemaking that the same set 
of costs and volumes must be used to determine rates. To obtain an 
accurate measurement of changing per barrel-mile costs for purposes of 
establishing an index level, the methodology must match the throughput 
used in the methodology to the costs incurred to transport the 
throughput used in the methodology. Given that page 700 does not match 
interstate costs with interstate volumes, the Commission rejects its 
usage in the methodology.
4. Adjustments for Declining Throughput
a. Comments
    86. In reply comments, CAPP asserts that the index should not be 
inflated by the decline in throughput between 2004 and 2009. CAPP 
contends that the widespread recession caused the reduction in 2009 
barrel miles and that such throughput declines cannot be expected to 
continue for another five years. CAPP states that its expert Mark 
Pinney replicated AOPL's analysis using constant 2004 barrel miles and 
the resulting increase equated to PPI-FG plus 1.62 percent. CAPP argues 
that it is inconsistent with the purpose of an inflation adjusted index 
to allow changes in volumes to affect index levels and that increasing 
the index due to declining volumes will be self-perpetuating. CAPP also 
argues that allowing a generic index increase based on 2009 barrel-mile 
data contradicts Commission ratemaking policy for new pipeline 
facilities by using barrel-mile data instead of capacity as billing 
determinants.
    87. Also in reply, ATA states that U.S. Energy Information 
Administration (EIA) estimates project an increase in total crude oil 
and petroleum consumption from 2010 to 2011. ATA thus advocates 
establishing an index using constant 2009 volumes for 2011 through 2016 
as a ``conservative'' approach more favorable to pipelines.
    88. In its October 20 Response, AOPL contends that adjusting actual 
historical throughput to assume constant volume levels is speculative 
and directly contrary to the Commission's established methodology. AOPL 
also challenges CAPP's suggestion that the Commission uses capacity to 
measure costs instead of actual throughput, stating that because the 
oil pipeline industry is a highly capital intensive industry, when 
throughput declines, costs do not decline proportionally. AOPL adds 
that CAPP treats volumes as remaining constant but makes no attempt to 
adjust for fuel and power costs that are dependent upon volume levels. 
Moreover, AOPL adds that contrary to CAPP's assertion that the decline 
resulted from the 2009 recession, more than 60 percent of the 
throughput decline occurred between 2004 and 2005. Thus, AOPL states 
that

[[Page 80309]]

capacity should not be used to measure costs.
b. Commission Determination
    89. The Commission rejects CAPP's and ATA's proposal to use 
constant barrel-miles in the Kahn Methodology rather than the actual 
barrel-mile levels.
    90. The Commission finds it appropriate to continue to rely upon 
historical data in applying the Kahn Methodology. The DC Circuit has 
upheld the Commission's reliance upon historical data finding that the 
usage of historical data is consistent with the mandate to apply ``a 
simplified and generally applicable ratemaking methodology.'' \39\
---------------------------------------------------------------------------

    \39\ AOPL II, 281 F.3d at 247 (2003) (quoting EPAct 1992, at 
Sec.  1801(a)).
---------------------------------------------------------------------------

    91. Moreover, CAPP's and ATA's analysis of cost changes assuming 
constant volumes are problematic because they utilize asynchronous 
data. Regarding CAPP's proposal to use constant 2004 barrel-miles, the 
2009 costs reflect the expenses associated with the lower 2009 volume 
levels. Since certain costs (such as fuel and power) increase and 
decrease with volume levels, using 2004 data volume data with 2009 
operating costs will not present an accurate depiction of the change in 
per barrel-mile costs. By applying an upward adjustment to 2009 volumes 
without adjusting for the costs that would have been incurred as a 
result of those higher volumes, CAPP imposes a downward distortion on 
the change in pipeline costs calculated under the Kahn Methodology. 
Similarly, ATA's proposal to assume constant 2009 volumes is defective 
because it does not adjust 2004 costs so that the 2004 costs reflect 
the lower 2009 volumes.
    92. The Commission further rejects CAPP's argument that it is 
inappropriate to allow the indexing methodology to be calculated based 
upon declining volumes. Declining volumes require pipelines to increase 
rates in order to meet revenue needs and, for existing oil pipelines, 
the Commission uses existing volumes, not capacity, to determine 
rates.\40\ Thus, much as in a cost-of-service, such declining volumes 
should lead to increased pipeline recovery levels in the indexing 
methodology.
---------------------------------------------------------------------------

    \40\ See 18 CFR 346.2(b)(2). Moreover, it is not clear how this 
capacity information could be obtained in the application of the 
index, since pipelines report throughput in Form No. 6, not 
capacity.
---------------------------------------------------------------------------

    93. Finally, CAPP fails to demonstrate that the declining 
throughput for the 2004-2009 period resulted primarily from the unusual 
economic conditions in 2008 and 2009 as opposed to changes reflected 
throughout the prior five-year period. As Dr. Shehadeh demonstrates, 
more than 60 percent of the decline in barrel-miles during the 2004-
2009 period recorded on Form 6 occurred between 2004 and 2005,\41\ and 
was unrelated to the recession in 2008 and 2009. Thus, it is not the 
case that the index level has been distorted by the recession in 2008 
and 2009.
---------------------------------------------------------------------------

    \41\ Shehadeh October 20 Decl. at 29.
---------------------------------------------------------------------------

5. Applying the Index Only to Operations and Maintenance Costs
a. Comments
    94. In its comments and reply comments, Navajo urges the Commission 
to apply the index only to operating and maintenance costs and not to 
costs attributable to depreciation, return, and income tax allowances. 
Navajo asserts that depreciation is not affected by inflation because 
depreciation is based upon equity investment, a historical cost. Navajo 
further contends that the two components of return--return on equity 
(in the form of increased deferred return) and cost of debt--already 
incorporate an inflation component. Thus, Navajo asserts that 
automatically granting pipelines an additional inflation-based index 
increase would enable pipelines to ``double-dip'' the inflation 
element. Third, Navajo asserts that the income tax allowance should not 
be increased automatically by an index, because one of its two 
components (the tax rate) generally is fixed by law and does not vary 
based on inflation, and the second component (rate of return on equity) 
already accounts for inflation.
    95. Instead, Navajo avers that the index should only be applied to 
operating and maintenance (operating and maintenance expense) costs. 
Navajo acknowledges that the Commission previously rejected this 
approach as too complicated in Order Nos. 561 and 561-A, but Navajo 
notes that the Commission now collects categorical cost data from 
pipelines on page 700 of Form No. 6 and the Commission could apply the 
index only to operating and maintenance costs as recorded on page 700. 
Thus, Navajo states that the Commission could use the change in 
operating and maintenance expense costs identified by O'Loughlin to 
develop the indexed rate.\42\ Navajo explains that under its proposal, 
for each pipeline seeking an annual index increase, the index rate 
could be applied to the part of the rate attributable to operating and 
maintenance expense. Navajo elaborates that if the operating and 
maintenance expense costs were 40 percent of a pipeline's cost of 
service on page 700 of its Form No. 6, the index-based rate increase 
should equal the pre-existing ceiling rate times the index multiplied 
by ``0.4.''
---------------------------------------------------------------------------

    \42\ To derive this rate, Navajo relies upon Mr. O'Loughlin's 
showing a change in the O&M costs for the middle 50 percent of oil 
pipelines of 5.0 percent and a change for the composite of the 50 
and 80 percent of 5.4 percent. O'Loughlin August 20 Aff. ] 49, 
Figure 15.
---------------------------------------------------------------------------

    96. In reply comments, ATA states that it agrees that applying an 
index adjustment to items not subject to inflation misaligns cost 
recovery with cost increases. ATA also alleges this provides a 
disincentive to invest in infrastructure.
    97. In reply comments and its October 20 Response, AOPL asserts 
that the Commission has twice rejected the selective indexing proposal 
advocated by Navajo. AOPL states that Navajo's proposal is beyond the 
scope of this proceeding. Moreover, AOPL asserts that because the 
Commission measures capital cost changes by comparing changes in net 
carrier property, the Kahn Methodology does not incorporate inflation 
for either return or income tax allowance as alleged by Navajo. Rather, 
AOPL asserts, the methodology is based upon the assumption that the 
competitive rate of return on capital does not change.
    98. AOPL adds that the Commission has twice previously rejected 
Navajo's proposal, first in Order No. 561 and in the first five year 
review on the basis that it would be difficult to administer and create 
perverse incentives. AOPL states that Navajo has provided the 
Commission with no valid reason to reverse its prior rulings. 
Furthermore, AOPL asserts that under Navajo's proposal, each pipeline 
would be required to perform calculations to determine its own pipeline 
specific index, a fundamental change from the ``generally applicable'' 
ratemaking methodology required by the EPAct 1992.
b. Commission Determination
    99. The Commission rejects Navajo's proposal. The Commission has 
twice rejected proposals similar to the one advocated by Navajo. In 
Order No. 561 as affirmed by the D.C. Circuit, the Commission concluded 
that limiting index increases to operating and maintenance costs would 
create perverse incentives for pipelines to direct a disproportionate 
amount of their spending to operating and maintenance costs and to 
neglect capital expenditures.\43\ Moreover, because new

[[Page 80310]]

investment may be substantial and would not be covered by the index, 
many companies would be required to file cost-of-service cases to 
recover significant increases in cost.\44\
---------------------------------------------------------------------------

    \43\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,951-52, 
aff'd AOPL I, 83 F.3d at 1437. The Commission returned to the issue 
in the first five year review, again rejecting the proposal on the 
basis that it could cause perverse consequences. First Five-Year 
Review, 93 FERC at 61,854-55.
    \44\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,952.
---------------------------------------------------------------------------

    100. In addition to creating perverse incentives, the Commission's 
prior orders noted that Navajo's proposal would also undermine the 
statutory mandate to establish a generally applicable and simplified 
methodology.\45\ The availability of page 700 data does not change this 
conclusion. Under Navajo's proposal, the index would not be generally 
applicable. Each pipeline would receive its own annual index adjustment 
to the ceiling rate dependent upon the pipeline's specific level of 
operating costs as reported on page 700. Navajo's proposal is also 
contrary to the purpose of a simplified methodology. Requiring 
pipelines to multiply the index level by the ratio of ``operating and 
maintenance'' expenses to ``total cost-of-service'' on page 700 before 
applying the index to a pipeline's existing ceiling rate will increase 
the likelihood of disputes in each annual application of the index as 
parties challenge those particular components of page 700 data.
---------------------------------------------------------------------------

    \45\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,951-52; 
First Five-Year Review, 93 FERC at 61,854-55.
---------------------------------------------------------------------------

    101. Furthermore, Navajo's arguments are theoretically unsound. 
Capital costs are a component of a pipeline's total costs, and any 
index that tracks actual cost changes must account for changing capital 
costs. The Commission also rejects Navajo's argument that for income 
tax and rate of return, the index double-counts inflation. The Kahn 
Methodology uses net carrier property as a proxy for income tax and 
rate of return, and net carrier property does not contain any internal 
inflation-related adjustments.\46\
---------------------------------------------------------------------------

    \46\ Because it is not presented by the facts here, the 
Commission does not address whether using rate of return data that 
incorporated an inflation component would, in fact, be inappropriate 
for deriving the index. Similarly, the Commission does not address 
issues related to using actual page 700 tax allowance data because 
the index currently uses a proxy for income tax costs.
---------------------------------------------------------------------------

6. Separate Indices for Crude and Product Pipelines
a. Comments
    102. In its comments, Valero and its witness O'Loughlin recommend 
one index for crude and product pipelines. However, Valero avers that 
differences in cost changes experienced between crude and product 
pipelines could argue in favor of separate indices for these two 
groups. Valero states that using his methodology, Mr. O'Loughlin 
determined that the median annual change in unit costs is 2.1 percent 
for products pipelines and 3.3 percent for crude pipelines. The 
composite index for the middle 50 percent of the datasets is 2.3 
percent for products pipelines and 4.3 percent for crude pipelines.
    103. In reply comments, ATA advocates the adoption of separate 
indices for crude and product pipelines, asserting that separate 
indices would allocate costs more equitably among shippers. ATA 
emphasizes that doing otherwise would force product shippers to 
subsidize crude shippers. The ATA urges that the data to produce 
separate indices is readily available, noting that of the 97 pipelines 
included within Mr. O'Loughlin's analysis, 31 were classified as crude 
pipelines and 45 were classified as product pipelines. NPGA also states 
that, as established by Mr. O'Loughlin, the disparity in cost changes 
between crude pipelines and product pipelines supports the development 
of separate indices.
    104. In its reply comments and October 20 Response, AOPL represents 
that the Commission has previously rejected separate indices and 
emphasizes that Valero witness O'Loughlin ultimately concluded that the 
Commission should apply one index to all oil pipelines.
b. Commission Determination
    105. Mr. O'Loughlin has provided some evidence to indicate that 
product and crude pipelines have experienced different levels of cost 
change. However, neither Mr. O'Loughlin, ATA, nor NPGA offered an 
explanation for why this cost disparity between crude and product 
pipelines exists. ATA and NPGA rely upon Mr. O'Loughlin's testimony, 
but Mr. O'Loughlin recommends using one index for all pipelines,\47\ 
and ATA and NPGA otherwise have failed to demonstrate that the 
Commission should depart from its prior policy applying one uniform 
index to all pipelines. Thus, on the record presented here, the 
Commission will continue to apply one index to both crude and product 
pipelines.
---------------------------------------------------------------------------

    \47\ O'Loughlin August 20 Aff. ] 61.
---------------------------------------------------------------------------

C. Allegations of Pipeline Over-Recovery

1. Comments
    106. In their comments, several shippers--Sinclair/Tesoro, the 
Trucking Association, ATA, NGPA, SPOPS, and Navajo--reject the notion 
that the index reflects actual pipeline cost changes. Sinclair/Tesoro 
argues that it is unlikely the pipeline industry is experiencing cost 
increases equal to the broader economy since the last review. In 
support, Sinclair/Tesoro cites depressed cost levels in areas specific 
to pipeline operation, such as labor, energy, and materials used in 
pipeline construction. In contrast, Sinclair/Tesoro represents that 
PPI-FG has recovered more rapidly, almost completely rebounding to its 
mid-2008 peak. Thus, Sinclair/Tesoro states that it is not appropriate 
to maintain the prior period rate ceiling of PPI-FG+1.3.
    107. In its comments, ATA states that, based upon a sample of 73 
Commission-regulated pipelines, over 30 pipelines have reported over-
recoveries for some or all of the years from 2002-2009, and that these 
pipelines reported over-recoveries of approximately $1.9 billion. ATA 
asserts that this could cause parties to defer capital expenditures 
because returns on depreciated assets exceed those provided by new 
investments. Moreover, ATA suggests it is suspicious that pipelines 
that are under-recovering by substantial amounts have not filed a cost-
of-service rate increase. In Reply Comments, ATA further emphasizes 
that pipelines experience non-uniform cost changes. ATA states that the 
Commission should be ``careful'' in designing any index to be applied 
to pipelines generally.
    108. In addition to reiterating ATA's concerns regarding over-
recovery, NPGA states that the major propane pipelines are now 
controlled by one company and that as a result shippers have 
experienced a pattern of increased costs through new fees, reduced 
service, sale of necessary assets to a pipeline affiliate, and 
operating penalties. Although NPGA acknowledges that pipelines as a 
whole are reporting an under-recovery, NPGA states that this does not 
relieve the Commission of its duty to ensure that each individual 
carrier's rates are just and reasonable and the existence of such a 
disparity merely indicates that the index does not reflect actual 
changes in pipeline cost. NPGA and ATA urge the Commission to require 
pipelines showing over-recoveries to show cause why their rates should 
not be considered unjust and unreasonable.
    109. Similarly, SPOPS avers that oil pipelines are consistently 
over-recovering their costs. Accordingly, SPOPS proposes an index rate 
of zero until pipeline profits return to a just and reasonable level. 
SPOPS states that since the inception of the index the Commission has 
allowed pipelines to

[[Page 80311]]

increase their rates by 39 percent, even though by 2009, 41 oil 
pipelines reported excess profits totaling over $200 million per year. 
In its comments, SPOPS includes in these profits the income tax 
allowance for Master Limited Partnerships (MLP), which do not incur 
income taxes. SPOPS states that it is difficult to challenge rate 
increases pursuant to the index. SPOPS states, as a result, the 
Commission has abdicated its responsibility under the ICA, emphasizing 
that not even ``a little unlawfulness'' is permitted, and that the 
Commission index as applied by the Commission tolerates unlawfulness.
    110. In reply, Navajo states that it has reservations about basing 
the index on PPI-FG. Navajo states that nothing in the record 
demonstrates that pipeline costs inherently correlate with general 
rates of producer price inflation. In addition to claiming that 
pipelines have been over-recovering, on reply, Navajo also state that 
pipelines should not receive the benefit of automatically-approved rate 
increases when the pipeline reports that it is over-recovering. Navajo 
states that withholding the index from pipelines that are over-
recovering can be accomplished through page 700, and thus is not any 
less administratively efficient than the Commission's current approach 
nor, in Navajo's view, does it increase litigation.
    111. AOPL in its Reply Comments and October 20 Response states that 
the Commission properly rejected similar arguments during the prior 5-
year review. AOPL notes that the Commission's rationale in past 
proceedings accepts that some pipelines may over-earn while others 
under-earn as an inherent attribute of the index. AOPL asserts that the 
pertinent issue is not the overall level of pipeline cost, but rather 
how the index compensates for changes in pipeline costs. AOPL also 
states although page 700 data may show excess revenues, it does not 
mean a pipeline rates are not just and reasonable. According to AOPL, 
there are several other mechanisms other than an Opinion No. 154-B 
methodology to establish a pipeline's rates, including market-based 
rates and negotiated rates. In addition, AOPL contends the shippers' 
allegations do not reflect actual pipeline cost recovery. Based on Dr. 
Shehadeh's calculations, AOPL claims approximately two-thirds of 
pipelines' page 700 calculations report under-earning on an Opinion No. 
154-B basis. AOPL responds to Sinclair's claim that the pipeline 
industry experienced cost changes in alignment with the global economic 
recession by stating it is speculative and is contrary to actual 
changes in costs as Dr. Shehadeh shows in his calculations using the 
Kahn Methodology.
2. Commission Determination
    112. The fact that some pipelines may be over-recovering is not 
contrary to the establishment of a general index level for all 
pipelines. The purpose of the index is to track cost changes using a 
generally applicable and simple method, and does not involve an 
assessment of whether each of the various pipelines are over- or under-
recovering their costs. This can be seen in the application of the 
index. When a pipeline proposes an indexed rate change, the Commission 
is not subject to a statutory duty to examine the whole rate.\48\ 
Rather, the Commission's inquiry is limited to a comparison of the 
changes in the rates and costs from year to year.
---------------------------------------------------------------------------

    \48\ Second Five-Year Review, 114 FERC ] 61,293 at P 57. This is 
consistent with the grandfathering of the then-existing rates under 
the EPAct 1992. EPAct 1992, at Sec.  1803.
---------------------------------------------------------------------------

    113. As the Commission explained previously, inherent to the 
application of any industry-wide pipeline index, some pipelines will 
over-earn while others will under-earn.\49\ However, the Kahn 
Methodology ensures that that indexed changes are consistent with 
recent industry-wide historical norms.\50\ To the extent that the 
customers of a particular pipeline determine that the underlying rates 
on a particular pipeline are unjust and unreasonable, those parties may 
file a complaint against that particular pipeline's rates pursuant to 
the ICA and the Commission regulations. Moreover, even when considering 
pipeline over-recoveries and under-recoveries (as opposed to cost 
changes), Dr. Shehadeh presented evidence that in 2009, the oil 
pipeline industry as a whole was under-earning by approximately 17 
percent.\51\
---------------------------------------------------------------------------

    \49\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,948-49; 
Second Five-Year Review, 114 FERC ] 61,293 at P 57.
    \50\ Contrary to Sinclair/Tesoro's claims and Navajo's 
allegations, as discussed above, the empirical evidence presented 
using the Kahn Methodology demonstrates that pipeline costs per 
barrel-mile have increased at a rate exceeding changes in PPI-FG 
over the past five-years. There is no indication that an adjusted 
PPI-FG is inadequate for tracking cost changes.
    \51\ Shehadeh September 20 Decl. at 32-33.
---------------------------------------------------------------------------

D. Other Factors Affecting Pipeline Costs Raised by the Parties

    114. Although not linked to any particular modification of the 
index methodology, the comments urged the Commission to consider 
general issues related to pipeline integrity and the MLP business 
structure.
1. Pipeline Integrity and Regulatory Safety Costs
AOPL Initial Comments
    115. AOPL states that costs have increased due to assessment and 
re-assessment of pipeline structural integrity and remediation required 
by the Pipelines and Hazardous Materials Safety Administration (PHMSA), 
an agency of the United States Department of Transportation. AOPL, 
supported by the Declaration of William R. Byrd, stresses that 
assessment requires expensive technology (including rental of inline 
inspection tools), labor intensive processes (involving excavation and 
manual inspection), and remediation. Mr. Byrd represents that 
``compliance with the integrity management regulations is likely to be 
the largest single variable cost item for most pipelines and these 
costs show no signs of decreasing.'' \52\
---------------------------------------------------------------------------

    \52\ AOPL Comment at 19 (quoting Byrd Decl. at 7).
---------------------------------------------------------------------------

    116. Mr. Byrd projects pipeline integrity costs to continue 
increasing because inline inspection tools are becoming more expensive 
and more likely to detect pipeline anomalies requiring correction. AOPL 
states that PHMSA has imposed increasingly stringent obligations and 
that new or expanded regulatory requirements may be imposed by Congress 
during the reauthorization of the Pipeline Safety Act, which AOPL 
expects to occur later in 2010 or 2011.
    117. AOPL and Mr. Byrd identify other regulatory obligations over 
the past five years that have increased costs, including public 
awareness program regulations and operator qualification regulations. 
AOPL and Mr. Byrd explain that costs in the next five years are likely 
to increase due to new PHMSA control room management regulations, new 
PHSMA guidelines regarding land-use on or near pipeline rights-of-way, 
new chemical facility anti-terrorism standards promulgated by the 
Department of Homeland Security, and issues regarding greenhouse gas 
emissions issued by the Environmental Protection Agency.
    118. In separate comments, PHMSA also represents that pipeline 
safety and integrity regulations have imposed significant compliance 
costs over the past eight years. Further, PHMSA notes the possibility 
of future regulatory changes and that it anticipates the cost of these 
activities will continue to impose significant financial burdens.
b. Reply Comments
    119. Several reply comments noted increased costs related to 
pipeline

[[Page 80312]]

integrity. Platte, an interstate liquids pipeline, expects to incur 
more than $2 million above historic levels of integrity related costs 
for the foreseeable future. Platte notes that significant additional 
costs may appear in damage prevention initiatives, valve spacing, leak 
detection, and increased focus on preventing small releases. The 
Pipeline Safety Trust notes that it is currently recommending that 
Congress increase PHMSA's jurisdiction over hazardous liquid pipelines 
and that Congress direct PHMSA to expand integrity management and other 
safety-related requirements.
    120. Other parties challenged AOPL's contention that the pipeline 
integrity costs supported an elevated index level. Valero notes that 
accounting treatment of pipeline costs was not consistent prior to 
2006, when the Commission clarified the accounting practices for 
integrity programs.\53\ Thus, Valero states that AOPL, by comparing 
changes in account 320 between 2004 and 2009, overstates the changes in 
pipeline integrity costs. Valero also emphasizes that account 320 
costs, which include both interstate and intrastate data, are only 14.4 
percent of the total cost-of-service. Moreover, Valero notes that the 
Commission has previously rejected adjustments to the index based upon 
estimates of anticipated increases in pipeline integrity costs.\54\ 
Lastly, Valero asserts that claims of future increases in regulatory 
expenses are speculative.
---------------------------------------------------------------------------

    \53\ Valero Reply Comment at 8 (citing Jurisdictional Public 
Utilities and Licensees, Natural Gas Companies, and Oil Pipeline 
Companies, 111 FERC ] 61,501 (2005)).
    \54\ Valero Reply Comment at 10 (citing AOPL II, 281 F.3d at 
247).
---------------------------------------------------------------------------

    121. ATA, in its reply, states that pipeline integrity cost 
increases are already appropriately accounted for in the years 2004 
through 2009. ATA states that the Pipeline Integrity Management program 
was established in 2002, and that the program required hazardous liquid 
pipeline operators to develop a written plan to initially assess the 
integrity of their pipelines over a roughly five year period with 
baseline assessments to be 50 percent completed by September 30, 2004, 
and 100 percent completed by March 31, 2008. After the baseline 
assessment, the assessments are to be repeated every five year period.
    122. SPOPS also avers that future costs are speculative and 
inconsistent with a backward looking methodology. SPOPS asserts that a 
large increase rewards pipelines with unjust and unreasonable rates and 
that the pipelines not recovering their costs are free to file for rate 
increase. Sinclair/Tesoro also assert that more stringent safety 
regulations are not unique to pipelines as environmental regulations 
have also imposed costs on shippers, and that it is unfair to impose 
these costs alone on shippers.
c. AOPL October 20, 2010 Response
    123. AOPL states that it relies on Mr. Byrd's declaration to 
explain that Dr. Shehadeh's calculations are consistent with real-world 
industry experience, and to show that establishing an index below PPI-
FG+3.64 would frustrate expectations on which past pipeline investments 
have been made, among other things.
    124. AOPL also states that Mr. Byrd's testimony is consistent with 
the comments of PHMSA, which state, among other things, that 
regulations have imposed significant compliance costs and events, 
including the Deepwater Horizon oil spill, have also caused PHMSA to 
expand its integrity management regulations. AOPL disagrees with SPOPS' 
suggestion that pipelines should seek to recover these safety and 
integrity management costs through cost-of-service filings, arguing 
that such an approach is inconsistent with the implementation of a 
generally applicable ratemaking methodology. AOPL argues that if 
pipelines were required to use cost-of-service filings to recover these 
kinds of costs, the efficiency gains which were intended by EPAct in 
implementing the generally applicable index methodology would be lost.
d. Commission Determination
    125. AOPL and other parties have submitted this information 
regarding future costs for Commission consideration, but they have not 
proposed to depart from the Kahn Methodology's reliance upon historic 
data. Moreover, future costs projections related to regulatory changes 
are speculative and inappropriate for inclusion in the index.\55\ 
Accordingly, the evidence presented regarding prospective regulatory 
changes does not alter the Commission's determination regarding the 
appropriate index level as calculated based upon historic costs.
---------------------------------------------------------------------------

    \55\ AOPL II, 281 F.3d at 247.
---------------------------------------------------------------------------

2. Master Limited Partnerships
    126. CAPP contends that the Commission should not grant an 
increased allowance merely to enhance cash flow requirements that may 
be attributable to the MLP form of business. CAPP states that due to 
federal tax laws, MLPS generally distribute all available cash flow to 
unit holders in the form of quarterly distributions. CAPP argues that 
the form of business organization and operation may create a tension 
between how a pipeline makes prudent safety and integrity-related 
decisions without contravening cash distribution constraints. CAPP 
argues that the Commission should not view the cash requirements of 
MLPs as a legitimate basis for increasing the revenue flow generated by 
regulated rates. SPOPS also claims that the MLP structure attracts 
capital to the pipeline industry but, rather than making investments in 
infrastructure, diverts the equity capital away in payouts to the 
general and limited partner investors.
    127. AOPL responds in its Supplemental Reply Comments that shippers 
made substantially similar arguments during the prior five-year review 
period, and the Commission rejected them. Furthermore, AOPL states it 
is not seeking ``an increased allowance'' to enhance MLP cash flow 
requirements. AOPL asserts neither the cash flow requirements of MLPs 
nor the dividend policies of corporate-owned pipelines are part of the 
calculation of changes in oil pipelines costs. Nor is there any 
``tension'' between pipeline safety and capital investment and MLP cash 
distribution requirements, as CAPP contends. AOPL contends the issue is 
not about the pipeline organizational structure, but whether pipelines 
will be able to recover sufficient revenue to fund their operations. 
Accordingly, AOPL argues shippers provide no valid basis to abandon the 
established methodology.
a. Commission Determination
    128. All pipelines, regardless of business form, experience changes 
in cost. The index is designed to enable pipelines be able to recover 
sufficient revenue to fund their operations, whether or not the 
pipeline's business form is as an MLP. The middle 50 Kahn Methodology 
allows the Commission to appropriately exclude outliers and to track 
general changes in pipeline costs whatever the form of the business. 
Accordingly, the discussion regarding MLPs does not alter the 
Commission's determination regarding the appropriate index level.

E. Revisions to Form No. 6

1. Comments
    129. ATA and NPGA aver that Form No. 6 should be revised to 
segregate cost and revenue for each regulated common carrier and or 
system and to supply separate page 700 data for each oil pipeline or 
system included in the report. To enhance transparency, ATA and NPGA 
also asserts that Form No. 6 should be revised to require the pipeline

[[Page 80313]]

to file all workpapers that fully support the data reported on Form No. 
6 page 700, including a total cost-of-service. ATA and NPGA also assert 
that pipelines must file Form No. 6 before initiating an index rate 
increase. ATA and NPGA also argue that the Commission should change the 
interest rates applicable to refunds as provided in 18 CFR Sec.  
340.1(c)(2)(i) to reflect the pipeline's rate of return as reported on 
Form No. 6, page 700.
    130. SPOPS urges, in its reply comments, that shippers and 
customers should be allowed access to the workpapers underlying page 
700. SPOPS also contends that the page 700 data should reveal both the 
nominal and the real rate of return on equity, including the amount of 
dollars of equity both collected in rates and dollars placed in rate 
base. SPOPS states that the current rate of return on equity must be 
known to determine the need for the index increase to attract capital.
    131. In reply comments, AOPL argues that the Commission has 
addressed and rejected the proposal regarding segmented data and 
workpapers. AOPL states the Commission in its ruling explained that 
page 700 is designed to be a preliminary screening tool for pipeline 
rate filings and not form the basis of a decision or demonstrates the 
just and reasonableness of proposed or existing rates. AOPL asserts the 
Commission has revisited this issue as recently as December 2008 and 
upheld its initial views.
2. Commission Determination
    132. The Commission finds that the proposals to modify Form No. 6 
are outside the scope of this proceeding, which is to set the going-
forward index level.
    The Commission orders: Consistent with our review and verification 
of the sample pipeline Form No. 6 data, and the application of the 
previously approved Order No. 561 methodology to that data, the 
Commission determines that the appropriate oil pricing index for the 
next five years, July 1, 2011 through June 30, 2016, should be PPI-
FG+2.65.

    By the Commission.
Nathaniel J. Davis, Sr.,
Deputy Secretary.
[FR Doc. 2010-32062 Filed 12-21-10; 8:45 am]
BILLING CODE 6717-01-P


