[Federal Register Volume 65, Number 32 (Wednesday, February 16, 2000)]
[Notices]
[Pages 7862-7870]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3598]


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DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

[Docket No. PL99-3-001]


Certification of New Interstate Natural Gas Pipeline Facilities; 
Order Clarifying Statement of Policy

Issued February 9, 2000.

Before Commissioners: James J. Hoecker, Chairman; William L. Massey, 
Linda Breathitt, and Curt Hebert, Jr.

    On September 15, 1999, the Federal Energy Regulatory Commission 
(Commission) issued a Statement of Policy (Policy Statement) revisiting 
its policy for certificating new construction not covered by the 
optional or blanket certificate authorizations. The purpose of the 
Policy Statement was to provide the industry with guidance as to the 
analytical framework the Commission will use to evaluate proposals for 
certificating new construction.
    The Policy Statement sets out the analytical steps the Commission 
will use. It provides that when a certificate application is filed, the 
threshold question applicable to existing pipelines is whether the 
project can proceed without subsidies from their existing customers. 
The next step is to determine whether the applicant has made efforts to 
eliminate or minimize any adverse effects the project might have on the 
existing customers of the pipeline proposing the project, existing 
pipelines in the market and their captive customers, or landowners and 
communities affected by the route of the new pipeline. If the proposed 
project will not have any adverse effect on the existing customers of 
the expanding pipeline, existing pipelines in the market and their 
captive customers, or the economic interests of landowners and 
communities affected by route of the new pipeline, then no balancing of 
benefits against adverse effects would be necessary. The Commission 
would proceed to a preliminary determination or a final order. If 
residual adverse effects on the three interests are identified, after 
efforts have been made to minimize them, then the Commission will 
proceed to evaluate the project by balancing the evidence of public 
benefits to be achieved against the residual adverse effects. The 
Policy Statement sets forth in detail the considerations that the 
Commission will apply to each of these steps. At the end of the 
analysis, the Commission will approve an application for a certificate 
only if the public benefits from the project outweigh any adverse 
effects. This policy approach strives to advance development of a 
sustainable energy infrastructure that supports economic growth, 
environmental protection and other social benefits over the life of the 
projects.
    Twelve parties sought rehearing or clarification of the Policy 
Statement. The issues raised by these parties include application of 
the Policy Statement to optional certificates, the application of the 
threshold no-subsidy requirement, issues relating to some of the 
factors to be considered in the balancing text, and the application of 
the policy to projects preceding its issuance. These issues are 
discussed in turn below.

Application of Policy Statement to Optional Certificates

    The Policy Statement indicated that this policy does not apply to 
construction authorized under 18 CFR Part 157, Subparts E and F 
(optional and blanket certificates).
    The Coastal Companies request that the Commission clarify that the 
Policy Statement will apply the public interest balancing factors to 
pipeline projects that are filed under the optional certificate 
regulations. The Coastal Companies contend that this clarification is 
necessary to ensure that there is no major policy gap in the 
Commission's administration of section 7 of the NGA between traditional 
and optional certificate applicants, and that both types of applicants 
will be entitled to a certificate of public convenience and necessity 
only to the extent that such applicants clearly demonstrate that the 
project's benefits exceed its economic and social costs.
    Public Service Company of Colorado (PSCO) and El Paso concur that 
the Policy Statement should apply to projects filed under the optional 
certificate regulations, as well as to traditional applicants. It notes 
that the overarching standard applicable to all requests for 
certificate authority under NGA section 7, regardless of whether the 
certificate is sought under traditional or optional certificate 
procedures, is the requirement that a certificate applicant show that 
its proposal is required by the present or future public convenience 
and necessity.
    Enron requests that the Commission either require that optional 
certificates make the same showing of public benefits and mitigation of 
adverse effects that is required of traditional section 7(c) 
applicants, or eliminate this requirement for traditional certificates.
    The optional certificate regulations establish procedures whereby 
an eligible applicant may obtain, for the purposes of providing new 
service, a certificate authorizing: the transportation of natural gas; 
sales of natural gas; the construction and operation of natural gas 
facilities; the acquisition and operation of natural gas facilities; 
and conditional pre-granted abandonment of such activities and 
facilities. If an applicant complies with the requirements set forth in 
the Commission's regulations for optional certificates, it is presumed, 
subject to rebuttal, that the proposed new service is or will be 
required by the present or future public convenience and necessity.
    The optional certificate procedures were established to provide 
expedited treatment of applications for service under section 7 of the 
NGA. A certificate and pre-granted abandonment are available under the 
optional certificate procedures to allow any applicant to institute 
jurisdictional service and to construct and operate facilities for such 
services. To qualify, the applicant must agree to comply with certain 
terms and conditions, the most important of which is that the applicant 
must accept the full risk of the proposed venture. The applicant's 
willingness to assume the full risk of the project is critical to the 
presumption that the project is in the public interest.
    In the Policy Statement, the Commission explained that as the 
natural gas marketplace has changed, the Commission's traditional 
factors for

[[Page 7863]]

establishing the need for a project, such as contracts and precedent 
agreements, may no longer be a sufficient indicator that a project is 
in the public convenience and necessity. The Commission, therefore, 
changed its policy regarding the pricing of construction projects so 
that market decisions by pipelines and shippers, as opposed to 
regulatory tests, would better reveal whether there is sufficient 
support for the project and whether the project is financially viable. 
The Commission established a threshold requirement that the pipeline 
must be prepared to financially support the project without subsidy 
from its existing shippers. This will usually mean that the pipeline 
would have to price the project using incremental rates in which the 
full costs of the project are recovered solely from the shippers 
subscribing to the new capacity. Under this policy, the pipeline and 
its expansion customers could share the risks of the project, but they 
could not shift any of those risks onto existing customers.
    Upon further review of the issue, the Commission concludes that the 
policies set forth in the Policy Statement have converged with the 
policies underlying the optional certificate program. Specifically, 
both the Policy Statement and the optional certificate procedures are 
intended to place the risk of a new project on the pipeline and the 
customers for the new project and to protect existing customers from 
bearing the risk of a project that was not designed for their benefit. 
Accordingly, the Commission is issuing a notice of proposed rulemaking 
in Docket No. RM00-5-000 contemporaneously with this order that 
proposes to remove the optional certificate procedures from the 
Commission's regulations. Pending a final rule on that issue, however, 
the Commission concludes that the balancing outlined in the Policy 
Statement should apply to any new applications for optional 
certificates.
    Section 157.104(c) of the Commission's Regulations provides:

    (c) Presumption. If an application complies fully with the 
requirements of Sec. 157.102 and Sec. 157.103, it is presumed, 
subject to rebuttal, that:
    (1) The applicant is qualified to perform all the activities for 
which certificate authorization is requested;
    (2) The applicant is willing and able to perform acts and 
provide service, as proposed, and to comply with the Natural Gas Act 
and any applicable regulations thereunder; and
    (3) The proposed new service is or will be required by the 
present or future public convenience and necessity.

    Until the Commission issues a rule in Docket No. RM00-5-000, 
applications for optional certificates filed after the issuance of this 
order will continue to have the regulatory presumption. However, if the 
record shows that under the Policy Statement analysis, the adverse 
effects of the proposed project outweigh the benefits of the project, 
then the presumption that the proposed new service is or will be 
required by the present or future public convenience and necessity will 
be deemed to have been rebutted and the certificate will not issue.

II. The Threshold Requirement of No Financial Subsidies

    The Policy Statement changed the Commission's previous policy of 
giving a presumption for rolled-in rate treatment for pipeline 
expansions. The Commission found that rolled-in pricing sends the wrong 
price signals by masking the true cost of capacity expansions to the 
shippers seeking the additional capacity. Sending the wrong price 
signals to the market can lead to inefficient investment and 
contracting decisions which can cause pipelines to build capacity for 
which there is not a demonstrated market need. Such overbuilding, in 
turn, can exacerbate adverse environmental impacts, distort competition 
between pipelines for new customers, and financially penalize existing 
customers of expanding pipelines and customers of the pipelines 
affected by the expansion.
    The Commission noted, however, that its new policy would not 
eliminate the possibility that some or all of a project's costs could 
be included in determining existing shippers' rates. The Commission 
stated that rolled-in pricing could still be appropriate when initial 
costly expansion results in cheap expansibility. The Commission 
indicated that project expansion costs could still be included in 
existing shippers' rates when construction projects are designed to 
improve service for existing customers. The Commission also stated that 
a form of rolled-in pricing could be applied as shippers exercise their 
right of first refusal, although the Commission did not describe 
specifically the process that would be followed.\1\
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    \1\ Under the right of first refusal, a shipper is entitled to 
continue service by matching the highest bid for that capacity up to 
the maximum rate.
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    While the new policy initially places the pipeline at risk for the 
financial consequences of an expansion decision, expansion customers 
may agree to share the risk with the pipeline by specifying what will 
happen to rates under certain circumstances, such as anticipated 
volumes that do not develop or cost overruns. The Commission encouraged 
pipelines not to rely on standard ``Memphis clauses,'' \2\ but to reach 
agreement with new shippers concerning specific elements of risk.
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    \2\ A ``Memphis clause'' refers to an agreement between a 
shipper and a pipeline providing that the pipeline may change a rate 
during the term of the contract by making a rate filing under 
section 4 of the NGA. See United Gas Pipeline Co. v. Memphis, 358 
U.S. 103 (1958).
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    Requests for rehearing and clarification were filed with respect to 
a number of these issues: the adoption of the no-subsidy test for 
pricing expansions, the pricing of capacity during the right of first 
refusal, and the policy regarding Memphis clauses.

A. Adoption of the No-Subsidy Test

    American Forest and Paper Association (AFPA), Indicated Shippers, 
and Paiute Pipeline Company (Paiute) sought rehearing and clarification 
regarding the adoption of the no-subsidy test for pipeline expansion 
projects. They contend the Commission should continue to apply its 
current policy permitting rolled-in pricing, particularly in situations 
when the increase in price to existing customers will not amount to a 
greater than 5% increase in their rates. AFPA and Indicated Shippers 
contend that the Commission's prior policy is correct because under 
this policy existing shippers' rates increase only when they receive 
some benefit from the construction project. They also contend that 
permitting rolled-in pricing sends accurate price signals and avoids 
discrimination because rolled-in pricing ensures that all customers 
receiving the same transportation service pay the same rates for that 
service. AFPA maintains that rolled-in pricing will better promote 
competition by ensuring a level playing field among competitors 
purchasing natural gas supplies. AFPA and Paiute maintain that 
incremental pricing is not needed to protect against overbuilding 
because the Commission can exercise its oversight role to ensure that 
there is sufficient market need for a project.
    AFPA and Paiute argue that if the Commission does not retain its 
current pricing policy, it should at least modify that policy. AFPA and 
Paiute argue that the Commission should not establish the no-subsidy 
criteria as a threshold test, but consider a proposal for rolled-in 
rates in the context of the second prong of the test in which the 
Commission weighs all the benefits of the construction and the adverse 
impacts. As another alternative, AFPA argues the Commission could adopt 
a

[[Page 7864]]

commensurate benefits test in which rolled-in pricing is permitted when 
the increase in rates to existing customers is commensurate with the 
benefits they receive.
    The Commission concludes that, in the current market, its threshold 
requirement that pipeline expansions should not be subsidized by 
existing customers is necessary to enable a finding of a market need 
for a project. There are three different types of projects: an 
expansion project to provide additional service, a project to improve 
service to existing customers by replacing existing facilities, 
improving reliability, or providing additional flexibility, and a 
project that combines an expansion for new service with improvements 
for existing customers.\3\ Under the Commission's no-subsidy policy, 
existing shippers should not have the rates under their current 
contracts changed because the pipeline has built an expansion to 
provide service to new customers. Existing customers' rates can be 
increased for projects that improve their service. And, as explained 
below, where a project combines an expansion with improvements to 
existing services, a pipeline can file to increase existing customers' 
rates when the pipeline can demonstrate that the new facilities are 
needed to improve service to existing customers.
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    \3\ The term expansion as used here includes the extension of 
existing facilities to serve new customers.
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    The Commission has a two-step process for determining whether the 
market finds an expansion project economically viable. The first step, 
which occurs prior to the certificate application, is for the pipeline 
to conduct an open season in which existing customers are given an 
opportunity to permanently relinquish their capacity.\4\ This first 
step ensures that a pipeline will not expand capacity if the demand for 
that capacity can be filled by existing shippers relinquishing their 
capacity. The open season policy was not changed by the recent Policy 
Statement. The second step is that the expansion shippers must be 
willing to purchase capacity at a rate that pays the full costs of the 
project, without subsidy from existing shippers through rolled-in 
pricing.
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    \4\ Pricing Policy for New and Existing Facilities Constructed 
by Interstate Natural Gas Pipelines, 71 FERC para. 61,241, at 61,917 
(1995), reh'g denied, 75 FERC para. 61,105 (1996).
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    The removal of the subsidy is necessary to ensure that the market 
finds the project is viable because either the pipeline or its 
expansion shippers are willing to fully fund the project. Having lower 
prices subsidized by existing customers can lead to overbuilding as new 
customers are willing to subscribe to the capacity only because the 
price of the capacity is subsidized.
    This no-subsidy requirement also is needed to ensure existing 
pipelines do not receive unfair advantage in competition for new 
construction projects with new entrant pipelines. The new entrant, by 
virtue of having no existing customers, must fully support a proposed 
project. In contrast, if the existing pipeline can receive a partial 
subsidy from its existing customers, this would create a bias favoring 
the expansion of existing facilities even where the pipeline of the new 
entrant would be more efficient. A rolled-in subsidy paid by the 
customers of the existing pipeline, therefore, may result in potential 
shippers favoring the less efficient project over the more efficient 
one.
    AFPA and Paiute contend that the Commission need not rely on 
incremental pricing to establish market need, but can continue to rely 
upon its current regulatory requirements, such as relying on executed 
long-term contracts or binding precedent agreements for the capacity. 
But, as the Commission found in the Policy Statement, reliance on 
contractual agreements cannot be a substitute for reliance on proper 
pricing signals. A pipeline, for instance, may be able to provide 
precedent agreements for 100% of a project when it offers new shippers 
rolled-in rates subsidized by existing shippers. But that level of 
support could well disappear if the subsidy were removed and the new 
shippers had to fully support the costs of the project.
    Indicated Shippers, AFPA, and Paiute contend that incremental 
pricing creates price discrimination because the existing and expansion 
shippers are paying different rates for the same service. Indicated 
Shippers maintain that all shippers should pay the same rate because 
both existing and expansion shippers are responsible for the demand 
creating the need for the expansion. Indicated Shippers quotes 
Southeastern Michigan Gas Company v. FERC, to the effect that:

    Because every shipper is economically marginal the costs of 
increased demand may equitably be attributed to every user, 
regardless when it first contracted with the pipeline.\5\
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    \5\ 133 F.3d 34, 41 (D.C. Cir. 1998).

    There are legitimate bases for charging existing and expansion 
shippers different rates. One of the Commission's regulatory goals is 
to protest captive customers from rate increases during the terms of 
their contracts that are unrelated to the costs associated with their 
service. The existing shippers sign long-term contracts with the 
pipelines with the expectation that increases in their rates will be 
related to the costs and usage of the system for which they subscribe 
and not based on construction needed to serve other shippers. One of 
the benefits generally associated with long-term contracts is that they 
reduce the buyer's risk by providing greater price certainty. Raising 
the rates of existing shippers during the term of their long-term 
contracts in order to subsidize expansions for new shippers reduces 
rate certainty and increases contractual risk. Existing shippers, 
therefore, should not be subject to increases in rates during the term 
of their existing contracts to reduce the rates faced by new shippers 
subscribing to expansion capacity.
    It is not necessarily true, as AFPA suggests, that all companies 
should pay the same prices for the same good or service regardless of 
when they contract for the good or service. In an unregulated market, 
an established firm may be able to lock-in a low price for goods or 
services through a long-term contract when demand is weak relative to 
available supply, while a new entrant contracting for the same good or 
service at a later time when supply and demand conditions have changed, 
may have to pay higher prices. \6\
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    \6\ By the same token, during periods when demand is greater 
relative to available supply, customers may enter into high priced 
contracts for the future, while customers entering the market later 
when conditions have changed pay lower prices.
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    Moreover, charging expansion customers rolled-in prices at the 
onset of a project is not, as AFPA and Indicated Shippers suggest, the 
most efficient pricing solution because rolled-in pricing may result in 
undervaluing the costs of the expansion, which in turn, results in 
overbuilding. An alternative to the approach adopted in the Policy 
Statement would be for the Commission to revamp its current pricing 
system so that all shippers pay incremental prices or prices based on 
replacement as opposed to historic costs. Such an approach would avoid 
the pricing distortions that accompany rolled-in pricing for new 
facilities while charging both expansion and existing shippers the same 
rate. But moving to such a pricing system would require a complete 
reevaluation of the Commission's current ratemaking method, while the 
Commission is not prepared to make at this point. Indeed, neither AFPA 
nor Indicated Shippers

[[Page 7865]]

support such an approach, and AFPA, in fact, objects to any approach 
that would permit a pipeline to overrecover its cost-of-service based 
on historic costs. Thus, while no ratemaking policy is perfect, the 
Commission concludes that, within the confines of the existing 
ratemaking policy, the no-subsidy policy is superior to the use of 
roll-in pricing in establishing the proper pricing signals for new 
construction, without creating undue discrimination between pipeline 
customers.
    Several of the comments raise questions about the application of 
the Commission's policy to expansion projects which may provide some 
benefit to existing customers. AFPA contends that roll-in pricing 
should be permitted if the existing customer receives some benefit from 
the project. Paiute similarly contends that intergrated expansions 
generally provide a positive benefit to all shippers and, therefore, 
should be priced on a rolled-in bases. Indicated Shippers contends that 
roll-in pricing creates no subsidy when existing shippers bear a 
portion of the expansion costs reflective of the benefits they receive 
from the expansion. Indicated Shippers, in particular, contend that the 
construction of supply laterals should qualify for roll-in pricing, 
because supply laterals frequently benefit all shippers on a system by 
providing access to new gas supply sources. Amoco \7\ asks the 
Commission to clarify what constitutes a subsidy. Amoco maintains there 
may be some projects, such as the addition of compression, that have 
the effect of both expanding system capacity and also improving the 
reliability of and flexibility to existing customers at a cost lower 
than could be achieved without the capacity expansion.
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    \7\ Amoco Energy Trading Corporation, Amoco Production Company, 
and Burlington Resources Oil and Gas Company.
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    The Commission's no-subsidy policy recognizes that existing 
customers should pay the cost of projects designed to improve their 
service by replacing existing capacity, improving reliability, or 
providing additional flexibility. An example of the application of that 
policy is Great Lakes Gas Transmission,\8\ in which the Commission 
permitted the pipeline to raise rates for all customers for a looping 
project where the pipeline demonstrated that the project provided 
increased reliability and flexibility and was not tied to the provision 
of service to specific customers. But this approach does not justify 
rolling-in the entire costs of an expansion simply because the existing 
customers receive ``some benefit from the construction of the new 
facilities,'' as AFPA suggests \9\ or because shippers receive some 
positive benefit as Paiute recommends. Nor is there a presumption 
favoring rolled-in rates. Pipelines can file to include additional 
costs in calculating the rates charged existing customers if the 
facilities are needed to improve service for existing customers, the 
increase in rates is related to the improvements in service, and 
raising existing customers' rates does not constitute a subsidy of an 
expansion by the existing customers.
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    \8\ 80 FERC para. 61,105 (1997)
    \9\ AFPA Rehearing, at 6.
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B. Right of First Refusal

    Process Gas Consumers,\10\ Florida Cities,\11\ and Amoco raise 
questions about the statement in the Policy Statement which would 
permit a form of rolled-in pricing when the contracts of existing 
shippers expire and they seek to exercise their right of first refusal 
(ROFR). Process Gas Consumers and Florida Cities maintain that the 
Commission cannot legally permit a pipeline to change the maximum rate 
for ROFR in a policy statement and that such an action must take place 
through either a rulemaking or a section 4 filing. Both Florida Cities 
and Process Gas Consumers request clarification that pipelines cannot 
incorporate the ROFR policy sua sponte without making a general section 
4 rate filing.
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    \10\ Process Gas Consumers Group, American Iron and Steel 
Institute, Georgia Industrial Group, United States Gypsum Company, 
and Alcoa, Inc.
    \11\ Orlando Utilities Commission, Cities of Lakeland and 
Tallahassee, Flroida, City of Gainesville d/b/a Gainesville Regional 
Utilities, Jacksonville Electric Authority, and Florida Gas Utility.
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    Florida Cities further contends that charging shippers whose 
contracts expire a rate higher than the current maximum rate for that 
capacity fails to provide sufficient protection to existing shippers. 
They contend that an existing shipper is no less an existing shipper 
when its contract expires and that it should, accordingly, be entitled 
to the same rate protection. Florida Cities also contends that raising 
existing shippers' rates upon contract renewal would run afoul of an 
existing rate settlement on Florida Gas. If the Commission determines 
to continue with its policy, Florida Cities proposes that existing 
shippers should not be subject to the policy until they have had at 
least one opportunity to recontract for capacity at their existing rate 
so that they can choose a contract term with full appreciation for the 
pricing risks attendant to signing a short-term contract.
    While supporting the policy, Amoco requests clarification of the 
rate that existing customers would have to match. Amoco maintains that 
existing shippers should not have to match a bid up to the highest 
incremental rate, but instead should be required to pay no more than 
the system-wide rolled-in rate in order to prevent the pipeline from 
overrecovering its cost-of-service.
    In the Policy Statement, the Commission did not fully describe how 
the ROFR process would operate but will clarify that process here. The 
Commission's ROFR regulations provide that a shipper whose contract is 
expiring is entitled to renew that contract by matching the highest bid 
made for the capacity up to the maximum rate.\12\ The Commission 
clarifies that under the policy described in the Policy Statement, a 
shipper exercising its ROFR could be required to match a bid up to a 
maximum rate higher than the historic maximum rate applicable to its 
capacity in certain limited circumstances: when a pipeline expansion 
has been completed and an incremental rate exists on the system; the 
pipeline is fully subscribed; and there is a competing bid above the 
maximum pre-expansion rate applicable to existing shippers.\13\ To 
adjust the maximum rate applicable to shippers exercising their ROFR in 
these circumstances, the pipeline would have to establish a mechanism 
for reallocating costs between the historic and incremental rates so 
all rates remain within the pipeline's cost-of-service.\14\ The 
mechanism can be established either through a general section 4 rate 
case or through the filing of pro forma tariff sheets which would 
provide the Commission and the parties with an opportunity to review 
the proposal prior to implementation. The Commission would review the 
proposed mechanism to determine how well it achieves the following 
objectives: capacity pricing that permits as efficient an allocation of 
capacity as is possible under cost-of-service ratemaking; protection 
against the exercise of market power by the pipeline (through 
withholding of capacity, for example, or the potential

[[Page 7866]]

for skewed bidding); protection against the pipeline's overrecovery of 
its revenue requirement; and equity of treatment between shippers with 
expiring contracts and new shippers to the system seeking comparable 
service.
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    \12\ 18 CFR Sec. 284.221(d) (1999).
    \13\ Under this procedure, the pipeline cannot require the 
existing shipper to pay a rate higher than that of the competing 
bidder. For example, if the historic maximum rate is $1/MMBtu, the 
maximum rate the existing shipper has to match is $2/MMBtu, and the 
competing bid is $1.50/MMBtu, the pipeline must sell the capacity to 
the existing shipper if it is willing to match the $1.50 bid.
    \14\ Cf. Viking Gas Transmission, 89 FERC para. 61,204 (1999) 
(rejecting tariff filing to raise matching rates under a ROFR where 
the filing did not readjust existing and expansion rates and was 
inconsistent with a rate settlement).
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    Application of this approach could lead to rates for shippers 
exercising their ROFR that are higher than their existing vintaged 
rate. But this will occur only if the preconditions are met--the 
pipeline is full and there is a competing bid higher than the pre-
expansion rate so that a higher rate is needed to allocate available 
capacity--and the Commission has accepted the pipeline's mechanism for 
determining rates as just and reasonable.
    The Commission recognizes there is tension between sending 
efficient pricing signals to expansion customers and to customers whose 
contracts are expiring, while remaining within the pipeline's revenue 
requirement. There may be a number of ways to recompute rates to 
effectively balance these interests. Amoco, for example, has suggested 
that the maximum matching rate for shippers exercising a ROFR should be 
the system average rate. The Appendix to this order provides two 
examples of potential approaches to the recomputation of rates, one in 
which the expansion rate is recomputed to establish the maximum 
matching rate and the other where the system average rate is used as 
the matching rate. Under these approaches, as contracts of existing 
shippers expire, the costs and contract demand represented by these 
contracts are reallocated between the existing and expansion service 
without changing the pipeline's overall revenue requirement.
    The rehearing requests question the appropriateness of requiring an 
existing customer to pay a rate higher than its historic rate to 
continue service beyond the term of its contract. As discussed above, 
there is a reasonable basis for not having existing shippers subsidize 
expansion projects during the remaining term of their current 
contracts. However, when the existing customer's contract expires, the 
existing customer could be treated similarly to new customers for 
pipeline capacity, who face rates higher than the pre-expansion 
historic rate.\15\ Under the policy conditions established by the 
Commission (fully subscribed expansion, at least one bid above the 
existing rate, and a rate mechanism established in advance), there 
would be insufficient capacity to satisfy all the demands for service 
on the system. When insufficient capacity exists, a higher matching 
rate will improve the efficiency and fairness of capacity allocation, 
within the limits imposed by cost-of-service ratemaking, by allowing 
new shippers who place greater value on obtaining capacity than the 
existing shipper to better compete for the limited capacity that is 
available.
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    \15\ Cf. PG&E Gas Transmission, Northwest Corporation, 82 FERC 
para. 61,289, at 62, 124-26 (1998), affirmed, Washington Water Power 
Co. v. FERC, No. 98-1245 (D.C. Cir., February 1, 2000) (for 
permanent releases of capacity taking place after an expansion, the 
replacement shippers should pay the same rate as the expansion 
shippers).
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    The Commission does not agree with Florida Cities that an existing 
customer must be provided with one opportunity to renew at its current 
maximum rate. When there is insufficient capacity to satisfy all 
demands for capacity, an efficient system of capacity allocation would 
award the capacity to the shipper placing the greatest value on 
obtaining capacity. Adoption of Florida Cities' proposal for a one-time 
mandatory renewal would conflict with that policy by permitting the 
existing shipper to continue service at a rate less than the highest 
rate bid.
    Process Gas Consumers maintains that the restructuring of rates 
should be implemented in a general section 4 rate case in which the 
Commission could examine all the pipeline's costs and revenues. A full 
section 4 rate case is one option a pipeline can use to establish the 
reallocation mechanism. However, a full section 4 rate case can be a 
cumbersome way of implementing this mechanism because it examines cost 
and revenue items and other issues unrelated to the more limited cost 
allocation and rate design changes needed to readjust rates at contract 
expiration. Pipelines, therefore, also can establish the reallocation 
mechanism by filing pro forma tariff sheets, which will provide the 
Commission and the parties with sufficient opportunity to review the 
filing prior to implementation. Once the review is completed, the 
pipeline can then implement the mechanism through a limited section 4 
rate filing. Issues regarding case-specific settlement conditions, such 
as those referenced by Florida Cities, can be addressed in the section 
4 rate case or pro forma tariff proceeding.

C. Memphis Clause

    El Paso Energy Corporation Interstate Pipelines (El Paso) requests 
clarification of the Commission's policy towards the use of Memphis 
clauses. Under the Policy Statement, the pipeline is responsible for 
financially supporting the project unless it contracts with new 
customers to share that risk. Similarly, the risks of construction cost 
overruns would rest with the pipeline unless apportioned between the 
pipeline and the new customers by contract. In apportioning such risks, 
the Commission stated that pipelines should not rely on standard 
Memphis clauses which would permit the pipeline to change the rate 
during the term of a contract by making a new rate filing under section 
4 of the NGA. Instead, the Commission stated that pipelines should 
reach more explicit agreements with new shippers concerning who will 
bear the risks of underutilization of capacity and cost overruns and 
the rate treatment for cheap expansibility.\16\
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    \16\ Cheap expansibility refers to the fact that pipeline 
construction projects sometimes make further expansion relatively 
inexpensive, for instance, because all that is needed to create 
extra capacity is the addition of greater compression.
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    El Paso requests clarification that the Commission's comment on 
Memphis clauses does not signify that Memphis clauses will no longer be 
considered a viable contractual method to allocate risk between 
pipelines and shippers. El Paso maintains that a Memphis clause 
evidences the customer's agreement to an increase in rates, but only if 
the pipeline can satisfy the burden of showing that the increase is 
just and reasonable.
    Memphis clauses can continue to be used in expansion contracts if 
the pipelines and shippers choose to use this method for allocating 
risk. While Memphis clauses may be an acceptable means of allocating 
the risks of difficult to predict events, the Commission does not find 
them a good method of allocating the risks of anticipated events such 
as cost overruns, underutilization of capacity, and cheap 
expansibility. The parties are in the best position to allocate these 
risks at the time of contracting, rather than leaving such issues for 
litigation at the Commission.\17\ The Commission strongly encourages 
pipelines and shippers to specifically provide in their contracts for 
the allocation of such anticipated risks even if they choose to include 
a Memphis clause to deal with unanticipated risks.
---------------------------------------------------------------------------

    \17\ See, e.g., El Paso Natural Gas Company, 79 FERC para. 
61,028, reh'g denied, 80 FERC para. 61,084 (1997), remanded Southern 
California Edison Company v. FERC, 162 F.3d 116 (D.C. Cir. 1999); 
Natural Gas Pipeline Company of America, 73 FERC para. 61,050, at 
61,128-29 (1995) (whether it is just and reasonable to allocate 
costs of underutilized capacity to existing shippers).
---------------------------------------------------------------------------

III. Factors To Balance in Assessing Public Convenience and 
Necessity

    After satisfaction of the threshold no-subsidy requirement, the 
Commission will determine whether a project is in the public 
convenience and necessity by

[[Page 7867]]

balancing the public benefits against the adverse effects of the 
project. The public benefits could include, among other things, meeting 
unserved demand, eliminating bottlenecks, access to new supplies, lower 
costs to consumers, providing new interconnects that improve the 
interstate grid, providing competitive alternatives, increase electric 
reliability, or advancing clean air objectives. Among the adverse 
effects the Commission will consider are the effects on existing 
customers of the applicant, the interests of existing pipelines and 
their captive customers, and the interests of landowners and the 
surrounding community, including environmental impacts. The Commission 
will approve a project where the public benefits of the project 
outweigh the project's adverse impacts.
    Several requests for rehearing raise issues relating to some of the 
factors to be considered in the balancing process: the consideration of 
effects on existing pipelines and their captive customers, the timing 
of the consideration of environmental impacts, and the ability of an 
applicant to acquire the necessary rights-of-way without the need to 
use eminent domain to obtain rights from landowners.

A. Impacts on Competing Pipelines and Customers

    In the Policy Statement, the Commission listed as one factor to be 
balanced in assessing public convenience and necessity the impact of 
the project on existing pipelines and the captive customers of these 
pipelines. The Commission stated that its focus is not on protecting 
incumbent pipelines from the risks of competition, but that the impact 
on existing pipelines and their shippers is one factor that should be 
taken into account in balancing all the relevant interests.
    Indicated Shippers maintain the Commission should not take the 
financial effect on existing pipelines into consideration because such 
a policy is at odds with the Commission's goal of allowing the market 
to decide whether an expansion is necessary and would have the effect 
of reducing competition and maintaining pipelines' market power. 
Indicated Shippers maintain that taking into account the effect on 
competing pipelines would harm, rather than help, captive customers 
because competition from alternative pipelines may be the only way to 
provide such shippers with alternatives that would free a customer from 
reliance on a single pipeline. AFPA agrees with the Commission that the 
impact of the expansion on captive customers should be taken into 
account, but it contends that the impact of a project on the revenue of 
an existing pipeline should not be part of the consideration.
    The effect of a project on an existing pipeline and its customers 
is only one factor to be considered in assessing need and will not be 
dispositve. As the commission explained in the Policy statement, it 
will be employing a proportional approach in which the quantum of 
evidence necessary to establish need will depend on an overall 
assessment of all relevant factors. In this analysis, the creation of 
greater competition would be considered a positive benefit. For 
example, as the Commission explained in the Policy Statement, a project 
that has negative impacts on an existing pipeline and its shippers may 
still be approved if it has positive public benefits, such as 
increasing competitive alternatives or lowering rates, that outweigh 
the negative impacts. Generally, this means that construction of a 
pipeline whose rates are unsubsidized will not be considered to have an 
adverse effect on an existing pipeline. The purpose of examining the 
effect of projects on existing pipelines is not to protect incumbent 
pipelines from competition, but to evaluate all relevant factors to 
determine if a project is needed. However, there may be cases in which 
service on an existing pipeline is an alternative to construction and 
the cumulative adverse impacts on an existing pipeline and its 
customers as well as on landowners and the environment are significant 
enough that the balance would tip against certification.
    AFPA asks for clarification as to whether the Commission's 
balancing policy will apply to pipeline projects that bypass LDCs or 
other pipelines. AFPA contends that bypass enhances competition and 
that the Commission should not consider the adverse effects on 
customers of the existing or expanding pipeline in determining whether 
to approve the bypass. AFPA recognizes, however, that the Commission 
previously has permitted an LDC being bypassed to reduce its contract 
demand on the bypassing pipeline so that the pipeline is not collecting 
twice for the same contract demand. \18\
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    \18\ AFPA cites to Paiute Pipeline Company, 68 FERC para. 61,064 
(1994).
---------------------------------------------------------------------------

    The same public convenience and necessity test applies to bypass 
construction as to other construction, and, therefore, the same basic 
balancing test should be applied to bypass cases. The Commission will 
need to weigh whether the benefits of a bypass, including enhanced 
competitive options, outweigh potential adverse effects of the bypass. 
It may well be that in many bypass projects, the amount of construction 
is minimal with little impact on landowners or the environment which 
would militate in favor of permitting the construction project if it 
provided additional competition or lower prices. There also may be 
other means, such as measures taken by the LDC or state regulatory 
agencies to mitigate the effect of a bypass on the bypassed pipeline or 
LDC.

B. Environmental Review of Projects

    The Policy Statement set forth the analytical steps the Commission 
will use to balance the public benefits against the potential adverse 
consequences of an application for new pipeline construction. In 
discussing the role that the environmental analysis of a project plays 
in the Commission's evaluation of proposals for certificating new 
construction, the Policy Statement stated that ``[o]nly when the 
benefits outweigh the adverse effects on economic interests will the 
Commission then proceed to complete the environmental analysis where 
other interests are considered.'' \19\ This statement has given rise to 
confusion about the timing of the Commission's environmental review of 
projects.
---------------------------------------------------------------------------

    \19\ Policy Statement at 19.
---------------------------------------------------------------------------

    Enron is concerned that the Policy Statement may suggest that the 
environmental review process for traditional certificate applications 
will not commence with the filing of the application. El Paso likewise 
requests clarification that the environmental and economic reviews will 
proceed concurrently, as in current practice, and that the NEPA process 
will not be postponed until the Commission reaches a resolution of the 
balance of benefits and effects. Paiute too is concerned that the 
Commission will delay its initiation of its environmental review until 
after economic tests are met. Paiute proposes merging the various steps 
for review and processing pipeline construction applications that are 
outlined in the Policy Statement to avoid delays.
    Raising a different issue, AF&PA states that in considering the 
potential adverse environmental impact of a project, the Commission 
should take into account the overall benefits to the environment of 
natural gas consumption, particularly when, as a result of the new 
facilities, natural gas will displace fuels that are more harmful to 
the environment.

[[Page 7868]]

    As has been the Commission's practice, the Commission will begin 
its environmental review at the time an application is filed with the 
Commission; environmental and economic review of a proposed project 
will continue to proceed concurrently. The Policy Statement does not 
alter this process. The quoted statement from the Policy Statement was 
only intended to indicate that if the economic analysis concluded that 
the adverse effects outweighed the benefits then there would be no need 
to complete the environmental analysis.
    Similarly, in considering the potential adverse environmental 
impact of a project, the Commission will continue to take into account 
as a factor for its consideration the overall benefits to the 
environment of natural gas consumption.

C. Eminent Domain Considerations

    The Policy Statement notes that, as part of its environmental 
review of projects, the Commission will work to take landowner's 
concerns into account, and to mitigate adverse impacts where possible 
and feasible.
    AFPA states that whether, and to what extent, new facilities may 
affect the property of landowners on the proposed route are significant 
factors for the Commission to consider in weighing public benefits 
against adverse impacts. Noting, however, that if eminent domain 
proceedings are necessary to obtain rights-of-way, the landowners will 
receive proper compensation for such rights-of-way, AFPA concludes that 
the compensation that a landowner would receive in such a proceeding 
should be considered by the Commission in its analysis of the economic 
impacts on the landowners that would result from the construction of 
new pipeline facilities.
    The Policy Statement encouraged project sponsors to acquire as much 
of the right-of-way as possible by negotiation with the landowners and 
explained how successfully doing so influences the Commission's 
assessment of public benefits and adverse consequences. The Policy 
Statement nonetheless recognized that, under section 7(h) of the NGA, a 
pipeline with a Commission-issued certificate has the right to exercise 
eminent domain to acquire the land necessary to construct and operate 
its proposed new pipeline when it cannot reach a voluntary agreement 
with the landowner. Even though the compensation received in such a 
proceeding is deemed legally adequate, the dollar amount received as a 
result of eminent domain may not provide a satisfactory result to the 
landowner and this is a valid factor to consider in balancing the 
adverse effects of a project against the public benefits.

VI. Retroactive Application of the Policy

    Northern Border, Texas Eastern, and Enron assert that the Policy 
Statement may not be applied to proposals filed before the date it 
issued. The Commission disagrees. It is within the Commission's 
discretion to determine to apply its current policies in certificate 
orders when it acts.
    PSCO, while concluding that the Policy Statement should not be 
applied retroactively where construction has begun or where a pipeline 
applicant has undertaken financial commitments necessary to proceed 
with construction, contends that the Policy Statement should be applied 
in situations where the certificates has expired and a pipeline is 
requesting an extension of the certificate. This approach could have 
harsh results depending on the circumstances. Therefore, the Commission 
will address such matters as they arise based on the facts of the 
individual case.
    El Paso requests clarification that the Policy Statement does not 
constitute a significantly changed circumstance that deprives 
certificate holders of predeterminations of rolled-in pricing in 
subsequent rate cases. The Commission clarifies the intent of the 
Policy Statement, as requested by El Paso. Issuance of the Policy 
Statement will not constitute ``changed circumstances'' for projects 
that were previously given a predetermination that rolled in rates 
would be appropriate.
    The Policy Statement is clarified in accordance with the discussion 
herein.

    By the Commission. Commissioner Hebert concurred with a separate 
statement attached.
Linwood A. Watson, Jr.,
Acting Secretary.

Appendix

Two Possible Methods for Reallocating Costs Between Existing and 
Expansion Service

Method 1--Recomputation of the Expansion Rate as the Matching Rate
    Under this method, the pipeline would recompute the expansion rate 
by applying the contract demand of the expiring contract and the costs 
represented by that demand to the expansion rates, thus reducing the 
expansion rates so the pipeline remains within its overall revenue 
requirement. Under this approach, the pipeline would add the expiring 
shipper's contract demand and its cost-of-service (in an amount 
proportionate to the contract demand) to the expansion cost-of-service 
allocated to existing customers would be decreased proportionately, so 
the historic rate would be unchanged. Because the cost-of-service 
allocated to the expiring contract is less on a per unit basis than the 
incremental cost-of-service, this approach will reduce the expansion 
rate, but, due to the larger amount of contract demand allocated to the 
expansion rate, the pipeline's revenue requirement remains the same. 
The following example shows how this method would work where a contract 
for 20,000 MMBtu of existing contract demand (CD) expires resulting in 
a reduction to the expansion rate (from $25 to $22) while the rate for 
existing customers remains the same ($10) and the pipeline recovers the 
same revenue requirement.

----------------------------------------------------------------------------------------------------------------
                                                                     Existing        Expansion        Revenue
                                                                      service         service      requirement.
----------------------------------------------------------------------------------------------------------------
COS.............................................................      $1,000,000      $2,000,000      $3,000,000
CD (MMBtu/year).................................................         100,000          80,000  ..............
Rate/MMBtu/year.................................................             $10             $25  ..............
New CD (MMBtu/year).............................................          80,000         100,000  ..............
New COS.........................................................        $800,000      $2,200,000      $3,000,000
New Rate/MMBtu/year.............................................             $10             $22  ..............
----------------------------------------------------------------------------------------------------------------


[[Page 7869]]

    Other details, such as the applicable rates for capacity release 
and interruptible transportation would be established as part of the 
pipeline's filing.
Method 2--System-Wide Cost-of-Service as the Matching Rate
    Under this approach, the existing shipper would have to match a bid 
only up to the system-wide average rate. The added revenue derived from 
the higher system average rate would reduce the expansion rate, with no 
change to the pipeline's revenue requirement. Using the same numbers as 
Method 1, this approach would result in the existing shipper whose 
contract is expiring having to match a rate no higher than $16.67. The 
expansion rate would decline (from $25 to $23.33), but less than what 
would occur under Method 1 ($22), and the pipeline would remain within 
its cost-of-service.

----------------------------------------------------------------------------------------------------------------
                                     Existing        Expiring        Expansion    System average      Revenue
                                      service        contract         service          rate         requirement
----------------------------------------------------------------------------------------------------------------
COS.............................      $1,000,000  ..............      $2,000,000      $3,000,000      $3,000,000
CD (MMBtu)......................         100,000  ..............          80,000         180,000  ..............
Rate/MMBtu/year.................          $10.00  ..............          $25.00          $16.67  ..............
New CD (MMBtu)..................          80,000          20,000          80,000  ..............  ..............
New COS.........................        $800,000        $333,333      $1,866,667  ..............      $3,000,000
New Rate/MMBtu/year.............          $10.00          $16.67          $23.33  ..............  ..............
----------------------------------------------------------------------------------------------------------------

    The rates paid by new shippers to the system as well as the rates 
for capacity release and interruptible transportation would have to be 
addressed as part of the filing.
    The following charts show that both methods eventually would 
converge in a system-wide average rate. The difference between the two 
is the maximum rate the shipper exercising its ROFR has to pay and how 
quickly the expansion service rate declines as contracts expire.

BILLING CODE 6717-01-M
[GRAPHIC] [TIFF OMITTED] TN16FE00.025

BILLING CODE 6717-01-C
    HEBERT, Commissioner, concurring: I write separately to explain 
briefly my position on one of the issues presented in this proceeding.
    In the Policy Statement--which I supported--the Commission stated 
explicitly that its policy on pipeline certification does not apply to 
optional certificates. 88 FERC at 61,737 & n.3. In today's clarifying 
order, however, the Commission reverses course and decides that its 
policy does indeed apply to optional certificates. Specifically, the 
Commission explains that it will apply the provisions of the Policy 
Statement to any ``applications for optional certificates filed after 
the issuance of this order'' and ``until the Commission issues a rule 
in Docket No. RM00-5-000.'' Slip op. at 4. (In a notice of proposed 
rulemaking, issued contemporaneously with this order in Docket No. 
RM00-5-000, the Commission proposes to remove the optional certificate 
procedures from the Commission's regulations.
    My preference would be to stick with our earlier decision and to 
confine the Policy Statement to traditional applications for pipeline 
certification filed under section 7 of the Natural Gas Act. I do not 
view the policies underlying the Commission's optional application 
procedures as entirely redundant to, and entirely subsumed by, the 
policies underlying the Commission's Policy Statement. As today's order 
recognizes, the optional regulations do not provide for consideration 
and weighing of public interest factors. (And for similar reasons, my 
preference would not be to proceed immediately to a rulemaking that 
proposes to abandon altogether the Commission's optional regulations.)
    But my concerns are mitigated by the Commission's decision to 
pursue a cautious approach as to the applicability of the Policy 
Statement to applications for optional certificates. Pending 
application for optional certificates will continue to be processed 
under the Commission's existing optional regulations. And the 
Commission continues to remain receptive--at least for the time being--
to applications for optional certificates. The Commission explains, 
slip op. at 4, that it will continue to presume that an application for 
an optional certificate satisfies all of the Commission's requirements, 
and that the Policy Statement is limited only to the purpose of 
rebutting that presumption.

[[Page 7870]]

    In light of this limitation, I do not view the Commission's action 
today as effectively eliminating, without prior notice, the ability of 
pipelines to apply for optional certificates.
    (As a final matter, I add that the optional certificates used to be 
commonly known as optional ``expedited'' certificates. Presumably, the 
promised speed of Commission action on applications for optional 
certificates--at least in comparison to the slower pace of Commission 
action on traditional applications--once provided much of the 
motivation to pipeline certificate applicants, filing under optional 
procedures, that were confident that there was a market for additional 
capacity. Alas, as the Commission explains in its proposed rulemaking 
in a related docket, optional certificates today provide none of the 
expedition contemplated at the time of promulgation of optional 
certificate regulations in 1985. This is because ``[e]nvironmental 
review is the driving force in total processing time, and environmental 
review requirements are the same under either program.'' Hopefully, 
there will not be a delay in the future.)
    Therefore, I respectfully concur.

Curt L. Hebert, Jr.,
Commissioner.
[FR Doc. 00-3598 Filed 2-15-00; 8:45 am]
BILLING CODE 6717-01-M