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Energy Law Exchange

February 7, 2018 - Source: King & Spalding Energy Newsletter

FERC Comes Under Pressure to Reduce Pipeline and Other Regulated Rates to Reflect Changes in the Corporate Income Tax Rate

Late last year, Congress passed the Tax Cuts and Jobs Act of 2017, which the President signed into law on December 22, 2017.1Tax Cuts and Jobs Act, Pub. L. No. 115-97, 131 Stat. 2054 (2017). A central feature of the Act is the reduction of the maximum corporate income tax rate from 35% to 21% effective January 1, 2018. The Federal Energy Regulatory Commission (FERC) is coming under mounting pressure from pipeline customer groups and state officials to reduce interstate natural gas pipeline and other regulated rates to reflect the new, lower tax rate.

In a January 3, 2018 letter to the FERC Chairman, the American Public Gas Association (APGA) encouraged FERC to institute proceedings under Section 5 of the Natural Gas Act (NGA) to reduce interstate natural gas pipeline cost-based rates, claiming that the change in the corporate income tax rate is “a known and measurable change of a ‘substantial nature.’”2Letter from Bert Kalisch (APGA) to Chairman McIntyre, re: Need for Immediate FERC Action in Response to Corporate Tax Reduction (Jan. 3, 2018), APGA states that it represents “nearly 1,000 communities that own their own gas system and are paying interstate pipeline rates.”

Virtually all of the cost-of-service calculations underlying natural gas pipeline cost-based rates include allowances for federal income taxes. These tax allowances are designed to allow a pipeline to receive its return on equity on an after-tax basis, and are a significant component of regulated cost-based rates. APGA estimates that reflecting the lower 21% federal income tax rate in pipeline rate calculations should lower cost-based rates by 5-9%. APGA also points out that the federal income tax rate is used by pipelines to calculate deferred income taxes, an amount that the pipeline retains to reflect the tax effects of the difference between depreciation used in ratemaking and tax depreciation. APGA points out that pipelines’ deferred tax amounts are now overstated as a result of the tax rate reduction and recommends that pipeline rates be further reduced to compensate for this overstatement.

APGA suggests that FERC undertake some form of “universal” proceeding, applicable to all interstate natural gas pipelines, under NGA Section 5. It notes, however, that there may be impediments to such a generic approach because of differences among pipelines and FERC’s “general reluctance to adjust rates to reflect discrete cost-of-service changes.” Pursuit of a “generic” approach might also be complicated by the proliferation of “black box” settlements in recent pipeline rate cases, which do not identify the components of the cost-of-service underlying the settlement rates. Absent the type of universal proceeding APGA advocates, FERC would likely have to initiate individual Section 5 proceedings against the pipelines, each of which could be as complex as a general rate case.

In a January 9, 2018 letter, representatives of sixteen states echoed APGA’s call for FERC to lower pipeline rates (the letter is signed by state utility commissioners, Consumer Advocate Offices and/or Attorneys General for California, Connecticut, Florida, Illinois, Kentucky, Maine, Massachusetts, Maryland, Nevada, New Hampshire, New York, North Carolina, Rhode Island, Texas, Vermont and Virginia).3Letter from Maura Healey, Mass. Att’y Gen., et al., to FERC Commissioners re: Request to Open an Investigation into the Justness and Reasonableness of Jurisdictional Utilities’ Rates and to Adjust Revenue Requirements to Reflect the Reduction in their Federal Income Taxes, FERC eLibrary Accession No. 20180109-5229 (submitted Jan. 9, 2018). This letter also requests that FERC reduce the cost-based rates of regulated electric transmission companies and oil pipelines. It notes that some state utility commissions have acted sua sponte to initiate proceedings to effect similar rate reductions for state-regulated electric and natural gas distribution utilities. Representatives of Michigan submitted separate letters to FERC advocating rate reductions.4Letter from Sally A. Talber, Norman J. & Rachael A. Eubanks (Mich. Pub. Serv. Comm’n) to FERC Commissioners, re: Corporate Tax Reduction and Interstate Natural Gas Pipeline Rates, FERC eLibrary Accession No. 20180111-5205 (submitted Jan. 11, 2018); Letter from Valerie Brader (Mich. Agency for Energy) to FERC Commissioners, re: Corporate Tax Reduction and Interstate Natural Gas Pipeline Rates, FERC eLibrary Accession No. 20180116-5273 (submitted Jan. 16, 2018).

Not surprisingly, the Interstate Natural Gas Association of America (INGAA), an organization representing interstate natural gas pipelines, has issued a statement asking FERC to move cautiously. INGAA advocates that pipeline rates be considered in the context of the circumstances faced by individual pipelines and any settlements that may govern a pipeline’s rates.

Calls for FERC to reduce rates to reflect corporate tax rate reductions come at a time when FERC’s approach to income tax allowances is already controversial. In a Policy Statement issued in 2005, FERC stated that it will allow a pass-through entity to include an allowance for income taxes in its cost-of-service if the entity demonstrates that its owners would incur actual or potential income tax liability on the basis of the pass-through entity’s income.5Inquiry Regarding Income Tax Allowances, Policy Statement on Income Tax Allowances, 111 FERC ¶ 61,139 (2005). Pass-through entities, including limited liability companies and master limited partnerships, do not themselves pay income taxes; however, their owners may be subject to income taxes on distributions of the pass-through entities’ income. Opponents of FERC’s income tax allowance policy argue that pass-through entities are over-recovering their costs because, with such allowances, a pass-through entity charges its customers for the cost of income taxes that the entity itself does not pay.

A 2016 Court of Appeals decision (in response to United Airlines’ challenge to a FERC oil pipeline rate decision) held that FERC had failed to demonstrate that there is no “double recovery” of taxes under its policy permitting pass-through entities to include income tax allowances in their cost-of-service.6United Airlines Inc. v. FERC, 827 F.3d 122, 134, 136 (D.C. Cir. 2016). The Court in United Airlines seemed sympathetic to arguments against income tax allowances for pass-through entities, holding that FERC’s policies resulted in disparate treatment of corporations and pass-through entities because such policies do not consider investor-level taxes for companies organized as corporations.

In response to the United Airlines remand, FERC issued a Notice of Inquiry (Docket No. PL17-01) seeking comments on its income tax allowance policies. Various entities and organizations filed comments and reply comments during the first half of 2017; however, nothing happened in the proceeding thereafter because FERC lacked a quorum. Now FERC is faced with a second tax-related rate issue with the recent push to recognize reductions in corporate tax rates. FERC may find it necessary to consider the treatment of pass-through entities and the question of whether to require or encourage pipelines to reduce their rates to reflect the recent corporate tax rate reductions at the same time given the large number of pipelines that are now organized as pass-through entities.

On January 2, 2018, Mr. R. Gordon Gooch, acting pro se as a consumer, filed in the FERC Notice of Inquiry a motion for partial summary judgment in which he urges FERC to require that all pass-through entities reduce their income tax allowance claims to reflect the lower tax rates.7R. Gordon Gooch (Pro Se), First Motion for Partial Summary Judgment, Docket No. PL17-1-000 (filed Jan. 2, 2018). Separate pleadings supporting Mr. Gooch’s motion were filed by groups of natural gas pipeline and oil pipeline shippers.8Answer of Natural Gas Indicated Shippers in Support of Motion for Partial Summary Disposition, Docket No. PL17-1-000 (filed Jan. 17, 2018); Answer of the Liquids Shippers Group in Support of Motion for Partial Summary Disposition, Docket No. PL17-1-000 (filed Jan. 17, 2018); see also Answer of the American Public Gas Association in Support of Motion for Partial Summary Judgment, Docket No. PL17-1-000 (filed Jan. 17, 2018). These groups seek lower rates for the pipeline transportation services their members purchase, although one group states that it does not advocate changes to any pipeline’s rates that are the subject of a rate case settlement which includes a moratorium prohibiting NGA Section 5 challenges. On January 26, 2018, INGAA filed an answer opposing Mr. Gooch’s motion and requesting that FERC dismiss the motion because (1) substantive motions are prohibited in informal rulemaking proceedings; (2) the relief sought falls outside the limited scope of a Notice of Inquiry; and (3) the motion is untimely because it raises new issues outside the scope of the Notice of Inquiry well after the close of the comment period.9Answer of INGAA in Opposition to Motions for Summary Disposition, Docket No. PL17-1-000 (filed Jan. 26, 2018).

Interstate natural gas pipelines with expansion projects pending before FERC may not need to wait for rate proceedings to see how FERC addresses the reduction in corporate tax rates. In mid-January, FERC staff sent data requests to a number of pipelines directing them to recalculate their expansion project incremental rates to reflect the change in tax rates.10See, e.g., Texas Eastern Transmission, LP, Docket No. CP15-499-001 (Jan. 16, 2018) (unpublished delegated order).

FERC may be planning to act quickly to promote rate reductions reflecting reduced corporate tax rates. Chairman McIntyre told reporters following FERC’s January 18, 2018 open meeting that the Commission is considering the matter and could pursue a combination of generic action and a case-by-case approach.11The Chairman’s comments suggest that FERC might act in a matter similar to its response to the 1986 reduction in the corporate income tax rate from 46% to 35%. FERC issued Final Rule adopting a voluntary, abbreviated rate filing procedure that allowed electric public utilities to file for rate decreases to reflect the decreased tax rate. FERC noted its intent to undertake a review under Section 206 of the Federal Power Act for utilities which elected not to voluntarily reduce their rates. Rate Changes Relating to Federal Corp. Income Tax Rates for Pub. Utils., Order No. 475, FERC Stats. & Regs. ¶ 30,752,re h’g denied, Order No. 475-A, 41 FERC ¶ 61,029 (1987) (in limiting the Final Rule to electric public utilities, FERC reasoned that natural gas pipeline companies’ rates would automatically be adjusted since tax trackers had been included in the majority of the natural gas pipeline companies’ rate settlements then in effect; changes in oil pipeline rates would be made on a case-by-case basis). Commissioner Powelson underscored the urgency of the situation from his perspective, stating that consumers should not be penalized by slow regulatory reviews that could delay the flow of savings.

It appears that FERC can be expected in the near future, in one way or another, to initiate rate proceedings to reflect the Tax Cuts and Jobs Act’s tax rate decrease. Cutting the corporate income tax rate has been touted by the President and his party as an economic stimulation and jobs creation measure. If pressure being brought to bear upon FERC is successful in forcing action, the Tax Cuts and Jobs Act may also result in reduced consumer prices for energy.