Today, pipelines are by a wide margin the safest, fastest, and cheapest means of moving crude oil and refined petroleum products. There are currently more than 190,000 miles of liquids pipelines in the United States, delivering some 9.3 billion barrels of crude oil per year. Include refined products and natural gas liquids moved by pipeline and that figure jumps to 16.2 billion barrels. Roughly 70% of crude oil and refined products are shipped by pipeline; by comparison, trucking and rail shipments together account for only 7% of total deliveries.1
While those numbers demonstrate an impact that far exceeds the pipeline industry of 100 years ago, the physical similarities between pipelines then and now are striking. In 1917, oil moved in pipes, propelled by pumps, over long distances. The material traveled from crude oil production fields to refineries, then to terminals, and finally to end markets. In 2017, oil moves in pipes, propelled by pumps, over long distances; it still travels from crude oil production fields to refineries, then to terminals, and finally to end markets. And so an observer from 1917 teleported through time to view an oil pipeline today would readily understand what he or she was seeing (assuming, of course, that the pipeline wasn’t buried, as the vast majority of pipelines are today).
To be sure, the 2017 pipeline viewed by our observer would exhibit marked improvements over its 1917 counterpart: higher-quality steel, turbine-driven motors rather than diesel-fueled pumps, and an array of computer technology enabling the pipeline operator to monitor the inside of the pipe and control the oil’s flow, even from the comfort of a remote office. Nevertheless, the basic purpose of oil pipelines, and the fundamental ways in which pipeline companies achieve that purpose, has remained remarkably unchanged over the past century. The same cannot be said about almost any other infrastructure industry. Imagine, for example, a telephone user from 1917 trying to understand, much less operate, an iPhone 7 (but that’s a topic for someone else’s essay).
In many ways, today’s regulation of oil pipelines would also be recognizable to our early 20th century observer. The Interstate Commerce Act, which still governs oil pipelines, was passed in 1887 to regulate railroads (and later telegraph companies). It was extended to oil pipelines by the Hepburn Act of 1906, which declared interstate oil pipelines, like railroads, to be common carriers (not public utilities), and required their rates and terms of service to be just and reasonable and not unduly discriminatory or preferential. Those statutory mandates still control today. The Hepburn Act also required that tariffs be publicly filed with the Interstate Commerce Commission (ICC), with any deviation from the published terms of the tariff subject to penalty, including imprisonment in some instances. Today, tariffs must be filed with the Federal Energy Regulatory Commission (FERC), a federal regulatory agency similar to the ICC. Also like the ICC, FERC can and does punish entities for deviating from the terms of their filed rates and for other violations of the statute.
Why did Congress decide that oil pipelines needed to be regulated at all? In a landmark decision 76 years after passage of the Hepburn Act, FERC gave its view of the answer to that question: “Nineteen Hundred and Six was a great Progressive year. And John D. Rockefeller and his Standard Oil combine were Progressivism’s primary targets.”2 Rockefeller, of course, was then the world’s richest individual, and Standard Oil was the source of the great bulk of his wealth. Standard dominated the oil industry in the late 19th century, at one time owning or leasing more than 90 percent of the nation’s refining capacity.3 Rockefeller readily understood the importance of pipelines in a completely unregulated environment. He maneuvered Standard into a position of virtually unchallenged domination of the pipeline side of the petroleum industry, either by building better pipelines than a competing operator had in place (such as in Standard’s battle with the Tide Water Pipe Line Company), or by simply buying the competition (as Standard did with Empire Transportation Company).4 The Hepburn Act was designed to break that stranglehold.
The combination of congressional action and the breakup of Standard Oil following the historic 1911 Supreme Court decision applying the Sherman Act5 transformed the pipeline industry into a market much like what we know today (albeit on a much smaller scale). The deconstruction of Standard produced ten common carrier pipeline companies, plus three integrated companies with pipeline affiliates. In relatively short order, market forces compelled these new entities to compete with one another and thereby created a more robust marketplace. Nevertheless, even by 1917 (more than a decade after the Hepburn Act was passed), rail remained the dominant method by which crude oil and refined products were shipped.6
World War I, along with the economic boom of the 1920s, created an ever-increasing demand for petroleum products and the consequent increased demand for means to transport them. By 1930, pipeline mileage had roughly tripled in a decade, totaling approximately 115,000 miles. Intense competition in the gasoline market, as well as high rail rates, stimulated demand for pipelines to carry finished products from refineries to end markets, and so refined products pipelines emerged as a significant component of the pipeline industry. Once pipeline operators were able to overcome various technological issues—such as how to avoid major contamination of batches of different products— refined products pipelines became even more common, especially since they were able to offer rates as much as 90 percent below those of railroads moving products between the same points.7
The pipeline industry continued to expand throughout the 1930s. From 1931 to 1940, the number of pipeline companies reporting their results to the ICC increased from 49 to 66. By 1940, pipelines transported more than 300 million barrel miles of crude oil and refined products per year. Then came World War II. Only months after the Japanese attack at Pearl Harbor, German U-boats sailed to the east coast and began sinking U.S. merchant vessels, including, by mid-1942, 55 oil tankers. In response, in one of the first large-scale examples of what is now known as a Public Private Partnership, the government and private industry developed what were at that time the nation’s largest pipelines: the “Big Inch,” a 24-inch diameter crude oil line from Longview, Texas, to Philadelphia, and the “Little Big Inch,” a 20-inch diameter refined products line from Beaumont, Texas, to Linden, New Jersey. While it took a world war and significant government backing, the development of these two lines indicated the security and substantial economies of scale resulting from moving oil through large, long-distance pipelines.8
The dynamic transformation of the pipeline industry during this period was by no means matched by the industry’s regulators. In reality, the ICC did little to oversee oil pipelines in the first three decades after it was tasked with the job (and not much more than that in the 40 years that followed that early period). The ICC did create a uniform annual reporting form, adopted a system of depreciation accounting, and took other modest steps mostly to allow it to monitor the financial health and reach of the pipeline industry. Active rate regulation, however, was not a priority for the Commission, which did not entertain any action approximating a rate case until 1920, nearly 15 years after passage of the Hepburn Act.9
A burst of activity then ensued, beginning in the late 1930s and continuing until the start of World War II. In 1940, the ICC adopted a rule that the rate of return for a crude oil pipeline should not exceed 8 percent on the pipeline’s Commission-determined valuation,10 and in 1941 determined that a return not to exceed 10 percent was appropriate for a products pipeline.11 These rulings led to significant litigation over how the ICC would value pipelines. The ICC’s first pipeline valuation report was issued in 1937 and included a generalized “Statement of Methods” that the ICC would apply.12 In 1949, the ICC issued a revised valuation report in Ajax Pipe Line Co.,13 which became the ICC’s definitive—if generalized—description of its valuation standard for this integral part of the methodology used in setting pipeline rates. Amazingly, however, the ICC declined to share its recipe: the weights given to various factors in the Ajax calculation remained undisclosed for decades. Indeed, it was not until 1977, when the ICC submitted testimony in a proceeding that was reconsidering the Ajax approach, that the agency publicly disclosed the relationships embodied in its valuation calculation.14 It was indeed a different time.
An even more consequential development was initiated not by the ICC but by the Department of Justice’s Antitrust Division. In 1940, DOJ commenced litigation against a number of integrated oil companies and their pipeline subsidiaries, alleging that dividends paid by pipelines to their shipper-parents constituted unlawful “rebates” in violation of the Interstate Commerce Act and Elkins Act. The action was consuming an immense amount of industry time and expense, all of which came to a halt in the immediate aftermath of the attack on Pearl Harbor. Both the oil companies and DOJ recognized the need to devote full attention to the war effort, and a mere sixteen days after Pearl Harbor they entered a consent decree that terminated the complaint in exchange for the companies’ agreement that a shipper-parent would not be paid earnings or dividends in excess of seven percent of the pipeline’s ICC-calculated valuation. While the consent decree technically applied only to its original signatories, the industry as a whole adopted it:15 from the 1940s through the early 1970s, pipeline companies generally abided by the terms of the consent decree, even if they were not signatories to it.
Active pipeline regulation entered into another roughly thirty-year lull while the consent decree governed. This hiatus came to an abrupt end, however, in the 1970s, with the initiation of two seminal cases: the Williams case and the protest of the initial rates for the Trans Alaska Pipeline System. Williams presented the first major challenge to the ICC’s approach to oil pipeline rates. The saga began in the early 1970s when Williams Brothers Pipe Line Company (the linear predecessor of what is now Magellan Midstream) filed for a rate increase and a number of parties objected, not only to the rate change but also to the underlying methodology itself. The ICC addressed these challenges both by initiating a Williams-specific rate and by commencing an industry-wide rulemaking proceeding to consider whether the long-prevailing ratemaking methodology should be modified. While these proceedings were pending, Congress passed the Department of Energy Organization Act, which created FERC as the replacement for the Federal Power Commission and also transferred regulatory responsibility over oil pipelines from the ICC to the new agency.16 The ICC’s decision in the Williams case was then pending in the court of appeals, prompting FERC to request that the court remand the matter so that FERC could evaluate for itself whether to approach oil pipeline ratemaking in a different manner than the ICC had.
Nearly four years later, after being presented with extensive presentations from carriers, shippers, and government entities, the Commission issued Opinion No. 154, which concluded that there was no good reason to make more than minor changes to the ICC’s methodology.17 It reached that result for three main reasons: (1) FERC saw the principal rationale for oil pipeline regulation as the prevention of discrimination among shippers, not the protection of the ultimate consumers of petroleum products; (2) it found oil pipeline rates to have a minuscule impact on ultimate consumers; and (3) it viewed the oil pipeline industry as being generally subject to competitive market conditions.
On review, the D.C. Circuit quickly and vigorously disagreed and again remanded the case so that FERC could develop a methodology that would more closely reflect modern economic theory and regulatory practice.18 The result was FERC’s Opinion No. 154-B, which created the essence of today’s cost-of-service methodology for oil pipelines.19 The Opinion No. 154-B methodology is based on “trended original cost,” which resembles traditional depreciated cost ratemaking (FERC’s approach to natural gas pipeline and electric utility rates) but differs in the way it deals with inflation. Details aside, and except for a transition component to ease the change from the ICC’s methodology to the new approach, Opinion No. 154-B represented a complete break with the decades-long basis for evaluating oil pipeline rates. And more than that, it portended a considerably more hands-on regulatory scheme than the oil pipeline industry had experienced since passage of the Hepburn Act.
Around the same time that the Williams drama was unfolding, the Commission also confronted a dispute over the initial tariff rates for the Trans Alaska Pipeline System (TAPS). TAPS was designed to move crude oil from the recently discovered (and massive) Prudhoe Bay oil fields, which became a national priority given the Arab oil embargo that was materially endangering Americans’ access to petroleum products. TAPS was built at breakneck speed, a challenge compounded by its remoteness and the extreme harshness of much of its route. The result was the most expensive pipeline ever constructed (and reportedly the most expensive private construction project in U.S. history), which in turn engendered challenges to the prudence of much of the nearly $8 billion (mostly in 1974–1977 dollars) in costs. FERC was essentially paralyzed by the scale, complexity, and stakes of the case, leading ultimately to an innovative and long-term settlement some eight years after the proceeding had begun. Even with that settlement, the significance of the pipeline system (not least to the State of Alaska) and the immense number of barrels that travel through the pipeline has meant that TAPS rates have been in nearly non-stop litigation for the entire 40 years of the system’s existence.
The years following issuance of Opinion No. 154-B (1985) saw a number of highly contentious rate challenges that led to growing dissatisfaction among all interested players about the time, expense, and uncertainty required to litigate matters to conclusion. (In one notable instance, the pipeline and its protesting shipper settled the case but the Commission Staff nonetheless elected to continue on in order to resolve some of the details that the Opinion No. 154-B guidelines had left unanswered.) Congress finally stepped in and, with passage of the Energy Policy Act of 1992 (EPAct), created the next watershed moment for oil pipeline regulation.20
The mandate of EPAct was straightforward: FERC was to devise a “simplified and generally applicable ratemaking methodology” for oil pipelines.21 The first step in that effort was to “grandfather”—that is, to declare just and reasonable as a matter of statute —all rates that had been in existence without challenge for one year prior to enactment of EPAct. That measure alone removed the considerable uncertainty that was hanging over the rates of companies throughout the industry. The second step was FERC’s creation of a system in which most oil pipeline rates would then be adjusted annually by an inflation-based index without the need (except in what were expected to be unusual circumstances) for cost-of-service filings. Under the rate indexing approach, every five years FERC re-examines what its benchmark index standard should be. Since its inception, that standard has been the Producer Price Index for Finished Goods, plus or minus a component to reflect how pipeline cost changes have varied from cost changes in the broader economy.22 Based on that measure, FERC then publishes a specific annual inflation index before June 1 of each year that is used to establish a ceiling level for the ensuing July 1 to June 30 index year. The pipeline computes the ceiling level for each of its published rates by multiplying the previous index year’s ceiling rate by the new index. If the ceiling level goes up (which it has in most years), the pipeline can raise its rates to that level without having to cost-justify the revised rate.23 Challenges to the index change are permissible, but only under relatively narrow conditions.
While indexing was anticipated to be the most commonly used method of changing and justifying oil pipeline rates, the rulemakings that followed EPAct also created three alternatives. One is the availability of market-based ratemaking authority, which is granted when FERC finds that the pipeline lacks significant power in both the relevant origin and destination markets.24 That authority has been granted to a number of refined products pipelines and more recently to one crude oil pipeline as well. A second alternative is settlement rates, which typically require the agreement of all shippers currently using the service.25 And finally, the Opinion No. 154-B cost-of-service methodology is there for any pipeline that wants it (although usually it is the option of last resort).26 In some circumstances, the Opinion No. 154-B methodology is also available as the basis for a shipper challenge to the pipeline’s underlying rates.
Those ratemaking approaches surely would have been a mystery to our 1917 observer, but no more so than another, and even newer, addition to the oil pipeline regulatory landscape. Recent years have seen the growing use, through the declaratory order process, of pre-approval of contract rates and terms of service to support oil pipeline infrastructure development. Although for many years that approach was widely considered inconsistent with a pipeline’s common carrier obligations, FERC has come to the conclusion that as long as the terms of service are made available on a non-discriminatory basis through a legitimate open season process, then many forms of contract rates and other terms—including in some circumstances priority (or firm) service—are permissible under the Interstate Commerce Act. FERC’s issuance of declaratory orders approving such arrangements has enabled pipelines to obtain regulatory certainty before undertaking large capital investments to build new pipelines, and at the same time enabled shippers to gain assurance that the benefits important to them—such as priority service or discounted rates tied to volume commitments—will be honored by the Commission.
In short, despite long periods of regulatory inactivity prior to the mid-1970s, oil pipeline regulation has now evolved to the point where it would be much less recognizable to the 1917 observer than would the pipeline’s operation itself. So, for that matter, would be the increasingly common form of pipeline organization. For much of the past century, most pipelines were part of large integrated oil companies; in fact, they typically were created to serve the oil fields and refineries of their sister companies and operated as common carriers mainly because they were required to by statute. Over the past few decades, that model has changed; many major oil pipelines today are independent entities, organized as master limited partnerships, with far less reliance on a single shipper (much less an affiliated one). That structure is largely the product of the tax laws—which, of course, can change dramatically—so predicting what the formal structure of the industry might look like in the years ahead is a fool’s errand.
But that is the errand we’re on. There is not much apparent value in trying to predict what oil pipeline regulation will look like in 2117 (by far the easiest prediction is that no one will think to look back at this essay to see how the guesses made here actually turned out). So let’s instead take on a more modest challenge: what will oil pipeline regulation look like 20 years from today.
Most predictable is that the cornerstone of oil pipeline regulation, the Interstate Commerce Act and its “just and reasonable” and “non-discrimination” directives, will continue to be the bedrock on which the industry is required to operate. Given the increasing separation of the interests of pipelines and their shippers, it can also be expected that controversies involving rates and terms of service will proliferate. In turn, it seems more likely than not that FERC will take an increasingly active role in overseeing and regulating pipelines. One indication that this may be a near-term development is seen in FERC’s Advanced Notice of Proposed Rulemaking issued last year.27 In the ANOPR, FERC proposed significant modifications to the indexing procedure, including the possibility of requiring pipelines to submit substantial amounts of additional data when applying for an indexed rate adjustment and limiting the circumstances in which pipelines can increase their rates under the indexing methodology. While these proposals remain just that, they do signal an agency that wants oil pipelines to be more closely regulated and for their rate approval process to more closely resemble that of electric utilities and natural gas pipelines.
In addition to increased FERC oversight, pipelines will likely continue to face increasing resistance from both states and individuals when attempting to build new pipelines. In late 2016, the Dakota Access Pipeline faced significant public backlash over its proposed routing. In that year and earlier, the Keystone XL pipeline faced similar challenges due to growing environmental concerns. Others, such as the Utopia East pipeline, have faced significant backlash at the state level, with some state courts refusing to grant the necessary rights of way. Given ever increasing environmental concerns, it seems that such hurdles will likely continue. Whether this will translate into greater federal control of the oil pipeline permitting process is one of the great unknowables.
Whatever direction the details may take, oil pipelines will certainly continue to be a vital part of the American petroleum industry and the economy as a whole. And while technical advances are a certainty, there is no reason to doubt that the pipelines of 2037 will bear a striking physical resemblance to their 120-year old counterparts. Our 1917 observer will surely still understand how they work, why they are there, and the important function that they serve, even if the regulatory structure will be a source of wonderment.
Endnotes
1. U.S. Liquids Pipeline Usage & Mileage Report, Ass’n of Oil Pipelines (Nov. 2015), http://www.aopl.org/wp-content/uploads/2015/11/AOPL-API-Pipeline-Usage-and-Mileage-Report-2015.pdf. The remainder moves principally by water.
2. Opinion No. 154, 21 FERC ¶ 61,260 at 61,578 (1982). Opinion No. 154 includes a lengthy and extremely colorful depiction of the oil pipeline industry and the passage of the Hepburn Act. It also is the only known agency decision to find a parallel between oil pipeline regulation and the New Testament. Id. ¶ 61,577 (“. . . [O]il pipeline owners have done nicely under the status quo. So their affection for it is unsurprising. Some may be reminded of Matthew 6:21: ‘For where your treasure is, there shall your heart be also.’”). Although ultimately overturned on appeal, Opinion No. 154 remains a treasured resource for historians of oil pipeline regulation.
3. Arthur M. Johnson, Petroleum Pipelines & Public Policy: 1906–1959 5 (1967).
4. G. Wolpert, U.S. Oil Pipe Lines 3–5 (1979).
5. Standard Oil Co. v. United States, 221 U.S. 1 (1911).
6. Wolpert, supra note 5, at 13–15.
7. Id. at 13–17.
8. Id. at 19–21. After World War II, both lines were converted to natural gas service, and the Big Inch remains in that service today. The Little Big Inch was later returned to refined products service as Texas Eastern Petroleum Products Corporation and is now part of the Enterprise Products Pipeline network.
9. See Crude Petroleum Oil from Kansas and Oklahoma to Lacy Station, Pa., 59 I.C.C. 483 (1920).
10. Reduced Pipe Line Rates and Gathering Charges, 243 I.C.C. 115 (1940).
11. Petroleum Rail Shippers’ Ass’n v. Alton & S. R.R., 243 I.C.C. 589 (1941).
12. See Atlantic Pipe Line Co., 47 Val. Rep. 541, 581–98 (1937).
13. Ajax Pipe Line Co., 50 Val. Rep. 1, 24–36 (1949).
14. The core of the formula was a weighted average of the pipeline’s original cost and cost of reproduction new. Other factors included working capital and a component for going concern value. See Testimony of Jesse C. Oak, ICC Docket No. Ex Parte 308 (1977); see also Opinion No. 154, 21 FERC ¶ 61,260n. 295, 357.
15. See United States v. Atl. Refining Co., Civil Action No. 14060 (D.D.C. Dec. 23, 1941). One element of the consent decree was that interest was treated as a “below the line” item, meaning that it would not count against the dividends the pipeline might lawfully pay. This resulted in extremely debt-heavy capital structures, which remained the norm in the industry until the consent decree was vacated in 1982.
16. 42 U.S.C. § 7155.
17. Opinion No. 154, 21 FERC ¶ 61,260 at 61,578 (1982).
18. Farmers Union Cent. Exch. v. FERC, 734 F.2d 1486 (D.C. Cir. 1984), cert. denied, 469 U.S. 1034 (1984).
19. Williams Pipe Line Co., 31 FERC ¶ 61,377 (1985), reh’g granted in part and denied in part, Opinion No. 154-C, Williams Pipe Line Co., 33 FERC ¶ 61,327 (1985). By the time Opinion No. 154-B was issued, Williams and its shippers had settled their rate controversy, making the decision a set of non-reviewable guidelines rather than a specific ruling on the Williams rate change. Order Approving Settlement, Williams Pipe Line Co., 30 FERC ¶ 61,262 (1985), reh’g denied, 31 FERC ¶ 61,108 (1985).
20. Pub. L. No. 102-486, 106 Stat. 2776 (1992).
21. Id. at §§ 1801–1802.
22. The D.C. Circuit has approved this methodology on several occasions. See, e.g., Ass’n of Oil Pipe Lines v. FERC, 83 F.3d 1424 (D.C. Cir. 1996).
23. 18 C.F.R. § 342.3.
24. See 18 C.F.R. § 342.4(b); 18 C.F.R. Part 348.
25. See 18 C.F.R. § 342.4(c).
26. See 18 C.F.R. § 342.4(a); 18 C.F.R. Part 346.
27. Revisions to Indexing Policies and Page 700 of FERC Form No. 6, 157 FERC ¶ 61,047 (2016).