Monday Mailbag: FERCalicious

06/30/15 | Emily Hsieh

How much will tariffs increase on interstate liquids pipelines beginning July 1, 2015?

July 1st means different things to different people. For Dallasites, it’s when you start counting the number of consecutive days it’s above 100 degrees. For Type A people, it means you have half a year left to achieve your New Year’s resolutions. For energy infrastructure companies operating interstate liquids pipelines, July 1st is the day that you adjust your pipeline tariffs by an inflation-adjusted, federally-mandated rate.

Currently, the Federal Energy Regulatory Commission (FERC) methodology allows companies operating interstate liquids pipelines to increase the tariffs on such pipelines each year on July 1st by the Producer Price Index (PPI) + 2.65%. Starting Wednesday, these companies can get a 4.58% bump to their tariffs, composed of a 1.93% value for PPI in calendar year 2014, plus 2.65%. As noted in our 2014 FERC tariff adjustment post, interstate means across states. Liquid means crude oil, natural gas liquids, and refined products like diesel or jet fuel. The methodology does not apply to natural gas pipelines or intrastate (within one state) pipelines.

If you’ve ever rented an apartment, think of the tariff adjustment in the same way that an apartment complex would adjust (read: raise) your rent once your one-year lease is nearly up, but with less egregiousness.  Apartment property companies want to make sure their rents reflect current market rates and allow them to earn a reasonable return; likewise, the FERC aims to ensure that interstate liquids pipelines generate a fair return on investment based on market conditions. Apartment properties may look at how many other apartments are in the area, how much home prices have increased, or how much their maintenance expenses have increased over the past year to determine new rents. The FERC looks at the cost of running and maintaining the pipeline as well as the cost of building new pipelines. One reason the escalator is so generous is to keep pace with the increased costs to maintain the integrity and safety of our nation’s pipeline network.

Apartment properties run their “market conditions” data daily, whereas the FERC reevaluates the formula for the oil pricing index factor (the “PPI plus” part) every five years. The current five-year period will end next July 1, 2016. If the methodology release timing is similar to the last review, we should learn what the new “PPI plus” escalator for July 1, 2016 to July 1, 2021 will be by mid-December 2015.

Now, not all companies will increase their pipeline tariff rates by 4.58% this year. Some may voluntarily keep rates lower in order to maintain or increase market share in a competitive region. Or, in the same way that a renter can negotiate with the apartment property before the new lease term begins, pipeline companies and their customers can negotiate lower tariffs. Over time, the tariff adjustments do add up. Over the past five years, a pipeline operator would have been able to increase tariffs to its customers by 23.4% based on the federally mandated amount, or 4.3% annualized. Sometimes it may be more important to maintain strong customer relationships than to make an extra few cents per barrel.

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Historical tariff increase amounts are available on the FERC website.

If you’re a company with a significant amount of liquids pipelines—the three largest being Plains All American Pipeline (PAA), Magellan Midstream Partners (MMP), and Enbridge Energy Partners (EEP)—or an investor in a company with liquids pipelines, you’ve got a pretty nice inflation hedge built into your business model. If you’re a pipeline customer and aren’t happy with the tariff increases, you’re more than welcome to move your product to another pipeline. But as any apartment renter can tell you, sometimes moving just isn’t worth it.