November 20, 2013 Articles

FERC's Capacity-Release Program: Financial Indifference and Reasonableness

Increasing pipeline efficiency by allowing shippers to use interstate capacity that would otherwise sit idle.

By John Hutchings and Bret Reich – November 20, 2013

Interstate pipelines and shippers often enter into long-term firm transportation-services agreements (TSA). These contracts benefit both parties: Firm TSAs guarantee shippers capacity on the pipeline to serve their customers, and pipelines secure predictable revenues through reservation charges, regardless of whether gas is actually shipped on the pipeline. Firm TSAs typically range from 5 to 15 years. As can be expected, as a result of changing market conditions and other factors, shippers often cease to need the capacity secured by the firm TSA. The shipper has a remedy in as the capacity-release program administered by the Federal Energy Regulatory Commission (FERC). The capacity-release program allows the transfer of interstate pipeline capacity from a shipper who no longer needs or wants the capacity on a long- or short-term basis to the shipper who places the greatest value on the capacity. Nw. Pipeline Corp., 111 FERC ¶ 61,231, ¶ 62,048 (May 20, 2005). The program increases the efficiency of the national pipeline system by allowing shippers to use interstate capacity that would otherwise sit idle. Promotion of a More Efficient Capacity Release Market, 73 Fed. Reg. 37,072, 37,059–61 (June 30, 2008) (codified at 18 C.F.R. § 284).


The commission instituted its capacity-release program in 1992 through Order No. 636. Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation, 57 Fed. Reg. 13,267 (Apr. 16, 1992) (codified at 18 C.F.R. § 284). The purpose of the program was to allow holders of firm capacity to assign unused capacity to a party who needs the capacity. The capacity-release program ended the prior practice of capacity brokering. Now, all capacity-release transactions must be conducted through the pipeline in an open, transparent, and nondiscriminatory manner. When a releasing shipper seeks to release capacity, the replacement shipper must enter into a contract directly with the pipeline, and the pipeline must post information regarding the contract, including any special conditions. A shipper must also have title to any gas that it ships on the pipeline. There is a ceiling equal to the FERC-approved monthly maximum tariff rates. FERC requires that all capacity releases greater than 31 days be posted for bidding, and the pipeline must allocate the capacity “to the person offering the highest rate not over the maximum tariff rate.” FERC also prohibits tying the release of capacity to any extraneous conditions. These rules set the framework for the transfer of interstate pipeline capacity in a transparent and nondiscriminatory manner through FERC’s capacity-release program.

Although the capacity-release program creates efficiencies, it also creates uncertainty for the pipeline and threatens the loss of its bargain under the original firm TSA. No two shippers are created equal; each presents different financial circumstances and default risks. The pipeline company entered into the firm TSA based on certain expectations. If the original shipper (releasing shipper) decides to conduct a capacity release, the pipeline must contract with a second shipper (replacement shipper), who will present different financial circumstances and default risks. The greater the risk of default of a shipper, the greater the risk to the pipeline that the shipper will be unable to fulfill its obligations under the firm TSA. For this reason, for the pipeline to obtain the benefit of its bargain under the firm TSA, FERC allows a pipeline to refuse a capacity release if it believes that it will not remain financially indifferent to the capacity-release transaction. Algonquin Gas Transmission, LLC, 112 FERC ¶ 61,262, ¶ 62,221 (Sept. 9, 2005). According to FERC, if an interstate pipeline is not financially indifferent to a capacity release, depending on the circumstances, it is reasonable for the pipeline to either (1) deny the capacity release; or (2) permit the capacity release and refuse to release the releasing shipper from the firm TSA. FERC emphasized it does not have a bright-line policy for when a pipeline is financially indifferent to a capacity release.Nw. Pipeline Corp., 111 FERC at ¶ 62,049.

A Pipeline May Prevent a Capacity Release if It Is Not Financially Indifferent
FERC’s capacity-release regulations state “[F]irm shippers must be permitted to release their capacity, in whole or in part, on a permanent or short-term basis, without restriction on the terms or conditions of the release.” 18 C.F.R. § 284.8(b)(1) (2013). Through its opinions, however, FERC has construed this regulation to allow pipelines to deny a shipper’s request if the capacity release will leave the pipeline in a different economic position: “The Commission only requires a pipeline to allow a permanent capacity release where the pipeline will be financially indifferent to the release.” Rockies Express Pipeline LLC, 141 FERC ¶ 61,061, 61,332 (Oct. 24, 2012).

FERC has refused to narrowly define “financial indifference.” Instead, “the pipeline must have flexibility in this regard and does not have to set out in its tariff every extenuating circumstance or condition that would lead the pipeline to determine it would not be financially indifferent to the release transaction.” Algonquin Gas Transmission, LLC, 112 FERC ¶ 61,262, ¶ 62,221 (Sept. 9, 2005). For example, a pipeline may not be financially indifferent where there is a difference in credit rating between the releasing and replacement shipper. In Algonquin, FERC denied a request to require the pipeline to include “objective criteria” in its tariff for determining whether it is “financially indifferent.” Citing its decisions in prior cases, FERC denied this request and said “the financial indifference of the pipeline in a capacity release is a reasonable factor to consider in deciding whether to permit a capacity release.” Under this rationale, even if a replacement shipper is otherwise creditworthy, the pipeline may not necessarily be financially indifferent to the transaction.

Even if a pipeline allows a release, it can refuse to relieve the releasing shipper from the firm TSA if it determines it would be reasonable to do so.

A Pipeline May Hold a Releasing Shipper Liable under the Contract if Reasonable
When a shipper has permanently released its capacity through the capacity-release program, FERC uses a “reasonableness” test to determine whether the pipeline may continue to hold the releasing shipper liable under the firm TSA. The applicable regulation provides: “Unless otherwise agreed by the pipeline, the contract of the shipper releasing capacity will remain in full force and effect, with the net proceeds from any resale to a replacement shipper credited to the releasing shipper’s reservation charge.” 18 C.F.R. § 284.8(f). FERC has construed this regulation to mean that the pipeline’s consent may not be unreasonably withheld.

In El Paso Natural Gas Co., FERC construed its regulation to mean “the pipeline may notunreasonably refuse to relieve a releasing shipper of liability under the contract where there is a permanent release of capacity.” 61 FERC ¶ 61,333, ¶ 61,312 (Dec. 17, 1992) (emphasis added). FERC “examines whether it would be reasonable” for the pipeline to relieve the releasing shipper from liability under the firm TSA “given the circumstances before it.” Nw. Pipeline Corp., 111 FERC at ¶ 62,049. In El Paso, FERC provided guidance in the form of examples to illustrate its “reasonableness” standard:

[I]f the release is permanent, that is for the remaining term of the contract, and the replacement shipper offers to pay the maximum rates, it would be unreasonable for El Paso to refuse to relieve the releasing shipper from the service agreement to reflect the release. On the other hand, it would be reasonable for the pipeline to refuse to release the shipper from its continued liability when the replacement shipper has not agreed to pay the maximum rate. In any event, the pipeline’s discretion must be exercised in a non-discriminatory manner.

61 FERC at ¶ 62,312.

After El Paso, shippers attempted to hold FERC true to its hypothetical scenarios and argued that whenever there is a permanent capacity release at maximum rates, the releasing shipper must be released from the firm TSA. FERC, however, has consistently declined to adopt such a narrow interpretation.

For example, in Texas Eastern Transmission Corp., 83 FERC ¶ 61,092, ¶ 61,446 (Apr. 29, 1998), the replacement shipper offered to pay maximum rates for the remaining term of the firm TSA. Yet this was not the end of the analysis. “[T]o conclude that a [pipeline] must, in all cases, relieve a releasing shipper of liability when the replacement shipper had agreed to pay the maximum rate for the remaining term of the contract would be to read the Commission’s policy too narrowly.” FERC considered evidence that the replacement shipper posed a risk of default. Given the risk of default, FERC found that the pipeline “would not expect to receive the same revenue subsequent to the release, and therefore, would have a reasonable basis to refuse to relieve the releasing shipper of liability.” It is therefore reasonable for the pipeline to refuse to release the releasing shipper of liability when there is a concern that the replacement shipper might default on its contract, regardless of whether the replacement shipper agrees to pay the maximum rates.

Similarly, in Northwest Pipeline, FERC repeated its policy of evaluating all the circumstances in determining whether a pipeline’s refusal to release a shipper from liability is reasonable. The pipeline proposed a revision to its capacity-release tariff mechanism, which provided: “Transporter may refuse to allow a permanent release if it has a reasonable basis to conclude that it will not be financially indifferent to the release.” 111 FERC at ¶ 62,049. In approving the revised tariff, FERC rejected protests that the proposed language was overly broad and lacked “objective parameters.” FERC emphasized that its “reasonableness” policy requires a consideration of all relevant factors:

all factors, such as the financial indifference of the pipeline, on a reasonable basis is a necessary and proper manner in which to evaluate whether the pipeline must relieve the releasing shipper from liability.” Moreover, the Commission intended that the pipeline have flexibility in this regard and not every extenuating circumstance or condition that would define a “reasonable basis” to refuse to relieve the releasing shipper from liability needs to be set out in a pipeline’s tariff.

Id. (emphasis added) (footnotes omitted) (citations omitted) (quoting Texas E., 83 FERC at ¶¶ 61,448, 61,449).

FERC has also made clear that factors other than the ones considered in El Paso (i.e., permanent release at maximum rates) and Texas Eastern (i.e., default of the replacement shipper) should be taken into account when determining whether a pipeline would be financially indifferent to a capacity release such that it should release the releasing shipper of liability under the original service contract.

In Overthrust Pipeline Co., 64 FERC ¶ 61,380 (Sept. 30, 1993), for example, FERC considered a project-financed pipeline’s lending agreements when considering whether relieving the releasing shipper’s liability in a capacity release was warranted. FERC said, “If Overthrust’s credit agreement with its lenders prohibits relieving the releasing shipper of liability and the lenders will not sanction a change, it would be reasonable for Overthrust to deny such a request by the releasing shipper.” Therefore, even lending agreements are relevant in the analysis of whether it is reasonable to release the releasing shipper of liability under a firm TSA.

FERC has made clear that interstate pipelines must have the flexibility to consider numerous factors when deciding whether it is reasonable to refuse to relieve a releasing shipper of its liability under a firm TSA even if the shipper is being permanently released at maximum rates.

Conclusion 
In conclusion, “[T]he examples given are premised upon the idea that the pipeline would be financially indifferent to the substitution because it would expect to recover at least the same revenues for the same contract demand and would find itself in a revenue neutral position after the capacity release.” Texas E. Corp., 83 FERC at ¶ 61,447 (emphasis added). Financial indifference is not bare revenue neutrality. Instead, a pipeline’s expectations for the recovery of revenues for the contracted capacity are also integral to the analysis. It is important for interstate natural-gas pipelines to recognize FERC’s strong support of its capacity-release program and the transfer of unwanted interstate pipeline capacity to those who desire it most. Accordingly, if a pipeline takes the position that it will not be financially indifferent to a capacity release, depending on the degree of financial indifference, FERC will likely find it more reasonable for a pipeline to refuse to relieve the releasing shipper of liability under the firm TSA as opposed to denying the capacity release altogether. It is equally important for releasing shippers to recognize that pipelines are not financially indifferent to a capacity release even if a replacement shipper has agreed to execute a firm TSA with the pipeline on the same terms as the releasing shipper’s firm TSA and complies with the creditworthiness provisions of a pipeline’s FERC-approved gas tariff. The pipeline’s expectations for the recovery of revenue for the contracted capacity may not be met despite a replacement shipper’s willingness to take the capacity permanently at maximum rate at the time of the release.


Keywords: energy litigation, FERC, natural gas, capacity release, pipeline, interstate


John Hutchings is a senior attorney and Bret Reich is the vice president and assistant general counsel and chief compliance officer at Kern River Gas Transmission Company in Salt Lake City, Utah. The opinions and analyses in this article are those of the authors and not of Kern River Gas Transmission Company or Northern Natural Gas Company.


Copyright © 2013, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).