[Federal Register Volume 65, Number 245 (Wednesday, December 20, 2000)]
[Rules and Regulations]
[Pages 79711-79718]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32340]



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  Federal Register / Vol. 65, No. 245 / Wednesday, December 20, 2000 / 
Rules and Regulations  

[[Page 79711]]



DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 342

[Docket No. RM00-11-000]


Five-Year Review of Oil Pipeline Pricing Index

Issued December 14, 2000.
AGENCY: Federal Energy Regulatory Commission.

ACTION: Order concluding initial five-year review of the oil pipeline 
pricing index.

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SUMMARY: The Federal Energy Regulatory Commission (Commission) is 
issuing this final order concluding its five-year review of the oil 
pricing index, established in Order No. 561, Revisions to Oil Pipeline 
Regulations Pursuant to the Energy Policy Act of 1992, FERC Stats. & 
Regs. [Regs. Preambles, 1991-1996] para. 30,985 (1993). After 
consideration of all the initial and reply comments, the Commission has 
concluded that the PPI-1 index has reasonably approximated the actual 
cost changes in the oil pipeline industry during the preceding five 
year period, and that it should be continued for the subsequent five 
year period. At the end of this period, in July 2005, the Commission 
will once again review the index to determine whether it continues to 
measure adequately the cost changes in the oil pipeline industry.

FOR FURTHER INFORMATION CONTACT:  Harris S. Wood, Office of the General 
Counsel, Federal Energy Regulatory Commission, 888 First Street, NE., 
Washington, DC 20426. (202) 208-0224.

SUPPLEMENTARY INFORMATION:

Order Concluding Initial Five-Year Review of the Oil Pipeline 
Pricing Index

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

    Issued December 14, 2000.

    On July 27, 2000, the Commission issued a notice of inquiry (NOI) 
in this proceeding on its five-year review of the oil pricing index.\1\ 
The oil pricing index was established in Order No. 561, Revisions to 
Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992.\2\ 
The Commission invited comments regarding the results of its review of 
the Producer Price Index for Finished Goods minus one percent (PPI-1) 
as an index to measure actual cost changes in the oil pipeline 
industry.\3\
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    \1\ FERC Stats. & Regs. [Notices] para. 35,536 (2000).
    \2\ Revisions to Oil Pipeline Regulations Pursuant to the Energy 
Policy Act, FERC Stats. & Regs. [Regs. Preambles, 1991-1996] para. 
30,985 (1993), 58 F.R. 58753 (Nov. 4, 1993); order on reh'g, Order 
No. 561-A, FERC Stats. & Regs. [Regs. Preambles, 1991-1996] para. 
31,000 (1994), 59 F.R. 40243 (Aug. 8, 1994), affirmed, Association 
of Oil Pipelines v. FERC, 83 F.3d 1424 (D.C. Cir. 1996).
    \3\ Excluding the Trans-Alaska Pipeline System (TAPS).
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    For the reasons appearing below, the Commission affirms that the 
PPI-1 index has closely approximated the actual cost changes in the oil 
pipeline industry as reported in FERC Form No. 6, and concludes that 
this index continues to satisfy the mandates of the Energy Policy Act 
of 1992.\4\
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    \4\ 42 U.S.C.A. 7172 note (West Supp. 1993).
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Background

    This is the first of the Commission's five-year reviews of the 
effectiveness of the oil price index established in Order No. 561. As 
the Commission stated in Order No. 561, the selection of the PPI-1 was 
not necessarily a choice for all time. The Commission recognized that 
its responsibilities, to both shippers and pipelines, required it to 
monitor the relationship between the change in the PPI-1 index and the 
actual cost changes experienced by the industry. The Commission 
undertook to review the effectiveness of the index every five years.
    In Order No. 561-A, the Commission reaffirmed its decision to use 
the annual change in the PPI-1 index to establish rate ceilings under 
the indexing system, and renewed its commitment to review this decision 
every five years, beginning with the year 2000.\5\ The Commission's 
adoption of the PPI-1 was affirmed by the U.S. Court of Appeals for the 
District of Columbia Circuit on May 10, 1996.\6\ Wide-ranging arguments 
were raised by both pipelines and shippers with respect to the 
Commission's determination to use the PPI-1 index as the proper index. 
For example, the Association of Oil Pipelines (AOPL) argued that the 
Gross Domestic Product--Implicit Price Deflator (GDP-IPD) should be 
used. The court determined that AOPL had failed to show why the 
Commission's rejection of the GDP-IPD in any way was arbitrary or 
capricious.\7\ AOPL also challenged the Commission's decision to use 
the PPI-1 rather than simply the PPI. The court found that the 
Commission had ample evidence to support its determination.\8\ 
Shippers, on the other hand, argued that the Commission erred in 
deciding to index all pipeline costs without adequately considering the 
option of selectively indexing only those costs driven by inflation. 
The court determined that the Commission had fully articulated reasoned 
grounds for its choice of a full rather than a selective indexing 
scheme.\9\ As the Commission found in Order No. 561, application of the 
PPI-1 to the total rate was a better measure of pipelines' cost 
experience.\10\ Moreover, the Commission found that selective indexing 
would be more complex and difficult to administer.\11\ Finally, the 
Commission stated that selective indexing could create incentives for 
pipelines to reduce their capital investments in pipelines.\12\ The 
court upheld the Commission in all respects on its choice of an index 
and the application of that index to the total rate of the pipelines, 
and cited with approval the Commission's determination to review the 
index formula after five years' experience.\13\
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    \5\ FERC Stats. & Regs. [Regs. Preambles, 1991-1996] para. 
31,000 (1994) at 31,009.
    \6\ Association of Oil Pipelines v. FERC, 83 F.3d 1424 (1996).
    \7\ 83 F.3d at 1435.
    \8\ Id.
    \9\ 83 F.3d at 1436.
    \10\ Order No. 561 at 30,951-52.
    \11\ Id. at 30,952.
    \12\ Id.
    \13\ 83 F.3d at 1437, 1445.

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[[Page 79712]]

Comments and Reply Comments

    Comments on the NOI were filed by AOPL, an unincorporated trade 
association of 56 common carrier oil pipelines, whose member companies 
transport nearly 80 per cent of the crude oil and petroleum products 
that moves by pipeline in the United States; jointly by Sinclair Oil 
Corporation, Crown Central Petroleum Corporation, Lion Oil Company and 
Tesoro Petroleum Company, Inc. (Sinclair); the Canadian Association of 
Petroleum Producers, a trade association representing approximately 165 
producers in Canada; Equilon Pipeline Company LLC (Equilon); Williams 
Pipeline Company (Williams); and Platte Pipe Line Company. Reply 
comments were filed by AOPL, Sinclair, the Canadian Association of 
Petroleum Producers and Alberta Department of Resource Development 
(jointly, CAPP), and by Colonial Pipeline Company (Colonial). The 
issues raised in these comments are discussed below.

Issues

    Staff's study presented a review of the effectiveness of the change 
in the PPI-1 index \14\ as an index to measure actual cost changes in 
the oil pipeline industry. The Commission stated in the NOI, it 
appeared that, based on Staff's review, the changes in the PPI-1 index 
have closely approximated the changes in the reported cost data for the 
oil pipeline industry during the five-year period covered by this 
review. In light of Staff's review, the Commission elicited comments 
from interested parties on this review.
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    \14\ The PPI represents the Producer Price Index for Finished 
Goods, also written PPI-FG. The PPI-FG is determined and issued by 
the Bureau of Labor Statistics, U.S. Department of Labor. Pursuant 
to 18 CFR Section 342.3(d)(2), ``The index will be calculated by 
dividing the PPI-FG for the calendar year immediately preceding the 
index year by the previous calendar year's PPI-FG, and then 
subtracting 0.01.'' Multiplying the rate ceiling on June 30 of the 
index year by the resulting number gives the rate ceiling for the 
year beginning the next day, July 1.
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    AOPL presented comments and a study and testimonial declaration by 
Dr. Alfred E. Kahn, and recommended that the Commission utilize the 
PPI, rather than PPI-1, as the index to govern oil pipeline rate 
changes in the next five years.\15\ Sinclair, on the other hand, 
presented comments and a study by Professor F.M. Sherer, and concluded 
that the appropriate index should be PPI-2.\16\
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    \15\ AOPL Initial Comments, p.17. AOPL's recommendation was 
supported by Colonial, Equilon, Platte and Williams.
    \16\ Sinclair Reply Comments, p. 22.
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    Several of the commenters raised miscellaneous issues which are not 
relevant to the inquiry in this proceeding. Such miscellaneous issues 
include the extent of exceptions to the indexing methodology, 
constraints proposed in considering cost-of-service and market-based 
ratemaking, revision and simplification of complaint procedures, and 
the effectiveness of the index to deal with anticipated but unknown 
future cost changes in the industry. These issues are for other 
proceedings and will not be discussed herein.
    The primary issues raised by the commenters and replies to those 
comments are set forth in detail, followed by the Commission's 
discussion and conclusions. In summary, those issues are:

1. Study Methodology Using Year-to Year Changes in Annual Weighted 
Average Cost

2. Adequacy of the Number of Pipelines Included in the Study

3. Adequacy of Costs Considered in Staff's Study

4. The Index of Choice

Discussion

    This discussion begins by reciting AOPL's initial comments, 
including the testimony of Dr. Alfred E. Kahn, and Sinclair's reply 
comments, including the testimony of Professor F.M. Sherer, regarding 
use of the PPI-1 as the oil pipeline index. All other parties who 
commented on the relevant issue made essentially the same points or 
made comments that were not relevant in our review of the adequacy of 
the index to reflect industry cost changes.\17\ The initial comments of 
Sinclair are essentially the same as contained in its reply comments. 
Likewise, the reply comments of AOPL reflect its views expressed in its 
initial comments. Issues raised concerning the choice of the PPI-1 
index and the timing of future review of the index in the initial and 
reply comments of CAPP, Colonial, Platte, Williams and Equilon are also 
discussed.
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    \17\ Some of these comments are discussed in connection with 
Issue No. 4 below.
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1. Study Methodology Using Year-to Year Changes in Annual Weighted 
Average Cost

    In its review Staff examined the year-to-year percent changes in 
the annual weighted average cost of the oil pipeline industry, each 
pipeline firm's cost being weighted by its share of the total barrel-
miles shipped during that year. Staff compared those changes with the 
year-to-year percent changes in the PPI-1 index. Staff made the 
comparison after adjusting the period during which the index changes 
occurred to match the period for which the cost data were 
available.\18\ Staff then computed a simple average of those year-to-
year percent changes and compared the two averages.
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    \18\ Converting the PPI to the twelve-month period from July1 to 
June 30.
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    AOPL argues that Staff erred in focusing on the year-to-year 
changes in the annual weighted average cost of the entire pipeline 
industry. AOPL maintains this is the main error in Staff's analysis, 
accounting for most of the difference between AOPL's and Staff's 
results. AOPL asserts that the correct measure of costs to be examined 
is the (weighted or unweighted) average of the year-to-year changes in 
each pipeline firm's annual costs.\19\ AOPL claims that the 
determination must be made between the two methods as to which provides 
the better measure of industry costs: change in the average of the 
entire industry, or the average of the cost changes of the individual 
members of the industry.\20\ AOPL supports its position by presenting a 
hypothetical example in which each pipeline firm's costs increase from 
one year to the next but the industry weighted average cost goes 
down.\21\
---------------------------------------------------------------------------

    \19\ AOPL Comments, p. 6.
    \20\ Kahn Declaration, p. 8.
    \21\ Kahn Declaration, p. 7.
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    AOPL further asserts that Staff should have used the geometric 
(also known as cumulative) average for calculating average annual rates 
of change rather than the arithmetic average. AOPL argues that what 
really matters is the change over the five-year period, represented by 
the geometric average, rather than the simple, or arithmetic, average 
of year-to-year changes. It supports this with a simple example showing 
how the two measures differ.\22\
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    \22\ AOPL Comments, p. 7.
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    In reply, Sinclair states that AOPL's study focuses mainly on 
individual company cost index changes that happened between two 
discrete years, from the 1994 base year to the 1999 terminal year, in 
effect ignoring everything that happened in the intervening years. 
Sinclair contends that by doing so, AOPL overlooks the multi-year 
averaging process that occurs under a price cap regulation scheme.\23\ 
Sinclair claims that the AOPL study applies fixed original year (1994) 
barrel mileage for computing the barrel-mile-weighted averages for 
purposes or computing how

[[Page 79713]]

costs have changed between 1994 and 1999. Sinclair states that as a 
result, AOPL ignores the cost savings that occur as volume moves away 
from high-cost pipelines and to lower-cost pipelines.\24\ Further, 
Sinclair states that AOPL computes averages of the percentage changes 
of each individual company's costs from one time period to another, 
rather than computing the average changes in cost levels across the 
industry as the Commission Staff and Sinclair have done. Sinclair 
states that AOPL's approach places equal weight on the pipelines that 
experience large year-to-year cost changes as compared to pipelines 
with more modest cost changes and as a result AOPL accords relatively 
high weight to the pipelines that have been the least successful in 
controlling costs.\25\ Sinclair claims that if it were to replicate 
AOPL's analysis of average changes in operating costs experienced by 
companies filing data in every year from 1994 to 1999, but exclude the 
extreme 5 percent of reporting companies and substitute 1999 weights in 
place of 1994 weights, the weighted average cost increase would be 
substantially closer to PPI-1 than to AOPL's suggested PPI.\26\
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    \23\ Sinclair Reply Comments, p. 7, Scherer Testimony, pp. 5 and 
9-11.
    \24\ Sinclair Reply Comments, pp. 7-8, Scherer Testimony, pp. 5 
and 11-12.
    \25\ Sinclair Reply Comments, p. 8, Scherer Testimony, pp. 5 & 
13-14.
    \26\ Sinclair Reply Comments, p. 9.
---------------------------------------------------------------------------

Discussion
    AOPL argues that Staff's use of a weighted average of operating 
costs is not the appropriate measure of industry costs by which to 
evaluate the index's performance. The choice between Staff's method and 
AOPL's method depends on the meaning of ``actual cost changes 
experienced by the oil pipeline industry.'' \27\ Staff has interpreted 
this phrase to mean actual year-to-year changes in the industry's 
average operating cost of transporting one barrel of oil or oil 
products one mile.\28\ Comparing this with the index changes emphasizes 
the index's efficiency-promoting (i.e., cost controlling) property, one 
of the characteristics the Commission cited as a benefit of using an 
indexing system.\29\ In addition, an index that tracks reasonably well 
the industry's weighted average cost provides assurance that pipelines' 
prices to shippers are not rising faster or falling slower than the 
cost of shipping a substantial portion of all crude oil or products 
being transported. This protection of shippers from rate increases 
greater than a measure of the rate of inflation is another benefit of 
indexing cited by the Commission.\30\
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    \27\ Order No. 561 at 30,941, 30,950.
    \28\ Staff actually scaled its analysis to report average cost 
per thousand barrel-miles rather than one barrel-mile.
    \29\ Order No. 561 at 30,948 and n. 37.
    \30\ Order No. 561 at 30,948-49.
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    AOPL has interpreted the objective of indexing to be choosing ``the 
indexation formula that appears, on the basis of past experience, best 
to reflect the changes in costs that individual pipeline companies 
might most reasonably be able to achieve.'' \31\ Dr. Kahn also claims 
that the appropriate measure for indexing changes ``is not the change 
in industry costs'' despite the Commission's repeated use in Order No. 
561 of the phrase ``actual cost changes experienced by the oil pipeline 
industry.'' \32\ This interpretation provides the basis for AOPL's 
assertion that the correct measure of changes in the industry costs 
considers central tendencies in year-to-year changes in the costs of 
individual firms.\33\
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    \31\ AOPL Initial Comments, p. 6; Kahn Declaration, p. 8. 
Emphasis added.
    \32\ See, e.g., Order No. 561 at pages 30,941 and 30,950. 
Emphasis added.
    \33\ Id.
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    AOPL also objects to Staff's use of the average of year-to-year 
changes in costs and the PPI-1 index to compare the index changes with 
the cost changes. AOPL argues that the change between the first and 
last years of the period being examined is better for comparing the 
index to industry costs than is the average used by Staff. As Sinclair 
has pointed out, however, AOPL has used 1994 barrel-miles weights in 
computing the weighted average costs for 1999 that it uses to measure 
the change between the two years. In addition, Sinclair notes that 
AOPL's method is a fixed-weight approach formerly used in the 
calculation of the Consumer Price Index but recently discarded. This 
change occurred because the fixed-weight approach ignored consumer 
substitution from high-priced goods to low-priced goods, consequently 
overestimating the amount of price inflation in the economy.\34\
---------------------------------------------------------------------------

    \34\ Scherer Testimony, p. 12.
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    Upon reviewing the initial and reply comments, the Commission 
concludes that the methodology used by Staff as reflected in the NOI is 
correct. Staff's approach gives more weight to the volumes and 
distances products are shipped by the pipeline industry, whereas AOPL 
gives equal weight to the year-to-year cost changes of each individual 
firm, regardless of the volume and distances products are shipped. 
Indeed, as Sinclair noted, AOPL's approach, when applied to a larger 
set of firms, yields results that more reasonably approximate the PPI-1 
than the PPI as the proper index to use in determining the annual price 
ceiling.
    AOPL attempts to support its use of pipeline-specific cost 
experience, as opposed to industry-wide, barrel-mile, weighted average 
costs, with a hypothetical example. In AOPL's hypothetical, a high cost 
pipeline, which inexplicably has much higher volumes than a less costly 
competitor, finds that its business naturally migrates to the lower 
cost competitor. Thus, even though both companies' costs may increase 
somewhat over time, the industry-wide, barrel-mile weighted costs will 
decrease as more business is now flowing to the more efficient firm. 
This is simply the natural working of the market forces at play, and 
does not show any distortion resulting from Staff's methodology for 
calculating the industry's cost experience in support of the PPI-1 
index choice. In fact, such behavior is exactly the type that an 
appropriately chosen index would be expected to encourage.
    The Commission finds that the barrel-mile, weighted average cost 
approach, is fully consistent with determining an industry-wide, 
generally applicable index mechanism that is fair to both transporters 
and shippers alike. In fact, to use AOPL's approach would 
inappropriately skew the index by giving unreasonable weight to higher 
cost, less efficient transporters that move only a fraction of the 
industry-wide volumes. It is natural that such less efficient, more 
costly individual firms may experience higher costs than the vast 
majority of companies for which the general index, supported by a 
weighted-average barrel-mile analysis, is appropriate.\35\
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    \35\ Any outlier company, which experiences higher costs than 
the vast majority for whom the index is appropriate, always has the 
option, however, of filing for a cost of service increase to 
initiate a general rate proceeding, if it can demonstrate that there 
is a substantial divergence between the actual costs experienced by 
the pipeline and the indexed ceiling rate such that the indexed 
ceiling rate would preclude the pipeline from being able to charge a 
just and reasonable rate. See 18 CFR Sec. 342.4 (2000).
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    By emphasizing cost changes of individual firms rather than 
industry average cost changes, AOPL would raise the price ceiling and 
thereby enable more high-cost pipelines to become or remain profitable. 
In its comments on Order No. 561, AOPL supported a more generous index 
than the PPI-1 on the grounds that it would cover even the largest 
changes in costs and allow even the highest cost pipelines to cover 
their costs. In response to this argument we noted that ``[t]he role of 
an index is to accommodate normal cost changes. Its purpose is not to 
guarantee recovery of

[[Page 79714]]

all costs at any time and in full, regardless of other circumstances. 
Even competitive markets do not do this.'' \36\
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    \36\ Order No. 561-A, p. 31,097. Footnote 25 on that page quotes 
Dr. Kahn saying essentially the same thing in his original testimony 
that case.
---------------------------------------------------------------------------

    Sinclair, on the other hand, argued that the Commission should 
adopt the PPI-2 or at most PPI-1.5 as the index for determining oil 
pipeline rates for the next five years.\37\ Support for that assertion 
appears weak, however. In fact, Sinclair's own expert, Professor 
Scherer, is lukewarm on the idea. Professor Sherer in fact concludes 
his initial statement by saying,'' ``[A]lthough aggregate expense per 
barrel-mile fluctuated from year to year, in part because of changes in 
the volume of crude oil or product transported, the PPI(FG)-1 approach 
performed well in relating operators' costs to automatically authorized 
rate increases.''\38\ He then states, ``From the industry's recent 
experience in raising pipeline throughput and labor productivity, an 
argument might be sustained for twisting the ratchet a bit tighter--
e.g., increasing the annual PPI offset from 1.0 to, e.g., 1.5 
percentage points.''\39\ He provides no facts to support why the 
ratchet should be twisted tighter. In fact, in his reply comments, he 
repeats ``the conclusion of my previous statement--that the PPI-1 
approach performed well in relating operators' costs to automatically 
authorized rate increases.''\40\ Sinclair therefore does not have a 
sufficient basis for increasing the -1 factor to -1.5 or -2. Therefore, 
we conclude that the study methodology contained in the Staff's review 
is appropriate.
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    \37\ See Sinclair Initial Comments, p. 37.
    \38\ Scherer Initial Testimony, p. 16.
    \39\ Id.
    \40\ Sherer Further Testimony, p. 25.
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2. Adequacy of the Number of Pipelines Included in the Study

    Staff's review uses as much information as possible from the 
available data based on FERC Form No. 6. Data were unavailable for some 
firms in some years. For example, a missing barrel-miles report for a 
particular firm in one year would drop that firm out of the data set 
for that year. However, Staff included that firm in its computations 
for each year containing valid data for the firm. As a result, Staff's 
data set contained a varying number of firms during the years 1994 
through 1999.
    AOPL argues that Staff, in its review, should not use pipeline 
firms for which data were available for some years and missing for 
others. AOPL limited its analysis to pipeline firms for which data were 
available for the entire period being examined.\41\ AOPL asserts that 
Staff's review fails to account for the possibility of outliers, 
namely, pipeline firms whose costs or cost changes are much too low or 
much too high because of some anomaly, such as a reporting error, an 
extraordinary expense or a shift of costs from one year to the next. 
AOPL adjusts its data set (year-to-year changes in each individual 
firm's cost) to account for possible outliers by using both the middle 
80 percent and the middle 50 percent of pipeline firms (excluding the 
10 percent and 25 percent, respectively, of pipelines having the 
largest cost changes and the 10 percent and 25 percent, respectively, 
of pipelines having the smallest cost changes).\42\
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    \41\ AOPL Comments, p. 7.
    \42\ Kahn Declaration, pp. 11-12.
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    Sinclair asserts in reply that because AOPL's study is based 
entirely on those companies that filed Form No. 6 data in every single 
year from 1994 to 1999, its data base is seriously flawed.\43\ Sinclair 
states that AOPL's database does not include previously existing 
companies that merged into other companies or new companies that have 
come about as a result of mergers or sell-offs. Sinclair states that 
the companies that disappeared as a result of a merger were smaller 
higher cost operators that were not included in the database until 
after the merger as part of a pipeline that existed over the entire 
1994-1999 period. As a result, Sinclair contends that this overstates 
the weighted average change experienced by post-merger pipelines when 
compared to the same pipelines before the merger. Sinclair states that 
pipelines carrying 97.8 percent of pre-merger barrel-mile traffic 
acquired pre-merger companies with costs 4.26 times of the acquiring 
pipeline companies, resulting in the acquiring companies' post-merger 
barrel-mile weighted costs increasing 7.2 percent.\44\
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    \43\ Sinclair Reply Comments, pp. 5-6.
    \44\ Sinclair Reply Comments, p. 6, Scherer Testimony pp. 4-5 
and 7.
---------------------------------------------------------------------------

    Sinclair contends that the AOPL study suffers from another major 
flaw in that AOPL's conclusions regarding changes in operating costs 
are based on companies that transported as little as 67 percent of the 
total miles transported by the industry in 1999. Sinclair states that 
this is the result of AOPL excluding 50 percent of the industry from 
its study.\45\
---------------------------------------------------------------------------

    \45\ Sinclair Reply Comments, pp. 8-9.
---------------------------------------------------------------------------

    Sinclair states that it replicated AOPL's analysis with variations 
in sample size and barrel-mile coverage to show the sensitivity of the 
AOPL study to these variables and how with minor changes in these 
variables AOPL's methodology produces operating cost changes that are 
far closer to PPI-1 than to PPI. In the first of three computations, 
Sinclair states that it followed AOPL and used the average changes in 
operating costs experienced by companies filing data in every year from 
1994 to 1999, but excluded only the extreme 5 percent of reporting 
companies and substituted 1999 weights in place of 1994 weights. As a 
result, 89.8 percent of the barrel miles transported by the industry in 
1999 were included. The study resulted in a weighted average annual 
percentage change in operating costs of 0.28 percent. Sinclair contends 
this result is substantially closer to the PPI-1 (0.17 percent) than to 
the PPI (1.17 percent).\46\
---------------------------------------------------------------------------

    \46\ Sinclair Reply Comments, pp. 9-10.
---------------------------------------------------------------------------

    In its second analysis, Sinclair used all companies that reported 
data in both 1994 and 1999, added Unocal Pipeline Company (Unocal) and 
Exxon Pipeline Company (Exxon) to its database because both companies 
conducted much of their business in the continental U.S. in addition to 
Alaska (and therefore were not subject to the TAPS exclusion), and used 
100 percent of the companies rather than 95 percent. This analysis 
captures 94.2 percent of the barrel-miles and results in a weighted 
average annual percentage change in operating costs of 0.19 
percent.\47\ Sinclair's third analysis, was the same as its second 
except for omitting the 5 percent most extreme values. This included 
93.7 percent of the barrel miles and resulted in a weighted average 
annual percentage change in operating costs of 0.22 percent.\48\
---------------------------------------------------------------------------

    \47\ Sinclair Reply Comments, p. 10.
    \48\ Sinclair Reply Comments, pp.10-11.
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Discussion
    In its review, Staff considered all firms having valid data for at 
least one year during 1994 through 1999. The resulting data set differs 
from that used by AOPL in two important ways. First, it uses much more 
of the information available from the entire Oil Pipeline Research 
Institute (OPRI)\49\ data set than does AOPL's. Second, the number of 
firms whose costs are used varies from year to year. AOPL criticizes 
Staff for including firms that do not have cost-per-barrel-mile figures 
for every year from 1994 through 1999.
---------------------------------------------------------------------------

    \49\ See NOI at 35,765, n. 16.
---------------------------------------------------------------------------

    AOPL's concern with Staff's use of firms for whom cost data are not 
reported in all years between 1994 and 1999 inclusive is misplaced. 
Exclusion

[[Page 79715]]

of a number of firms who are absent in one or more years is ignoring 
valuable information. As Sinclair has noted, AOPL has failed to account 
for mergers, spin-offs and new entrants during the period. This may 
lead, for example, to an existing firm's costs being ignored prior to 
its acquisition by another firm, the consequence being that industry 
average costs may appear to change when in fact they have not. 
Regardless, the exclusion of firms biases upward AOPL's reported cost 
changes.
    AOPL has ignored information in a second way. So as to avoid being 
influenced by outliers (data that are extreme and thus may unduly 
affect the outcome), after AOPL has limited its data set as described 
above, it limits its review to the ``middle fifty percent'' and the 
``middle eighty percent'' of its sample by excluding the ``upper and 
lower'' observations.\50\ AOPL apparently did so symmetrically, 
removing as many firms from the upper side of the distribution as from 
the lower. As we describe below, narrowing the data set as AOPL has 
done and using its cost-change method dramatically increases the 
resultant cost changes from those determined by using a complete or 
nearly complete data set.
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    \50\ Kahn, Declaration, p. 12.
---------------------------------------------------------------------------

    AOPL's own work suggests that as more and more of those omitted 
observations are included, the weighted-average change in operating 
cost declines.\51\ Sinclair confirms that decline by expanding the set 
of observations to include ninety-five percent of the appropriate firms 
and finding cost changes much closer to the changes in PPI-1 than in 
PPI.\52\
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    \51\ Kahn, Declaration, Table 4.
    \52\ Sinclair Reply Comments, pp.10-11.
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    Dropping outliers from a data distribution is a common technique to 
deal with the possible distortion they might impart to measures of its 
central tendency. The median of a data distribution is unchanged by 
dropping the same number of observations from the high end of the 
distribution as from the low end. Looking at the median, then, suggests 
that increasing or decreasing the number of outliers has little effect 
on the information available from the data set. In this case, however, 
the information available from the narrowed distribution varies 
substantially with the number of observations that are discarded as 
outliers.
    In its analysis presented in the NOI, Staff excluded TAPS pipelines 
from its data set, including pipeline activity of Exxon and Unocal in 
the lower forty-eight states. To account for this omission, Staff 
included the operating costs and barrel-miles for those two companies 
in the contiguous forty-eight states and recalculated its results. The 
only resultant change appeared in the industry average cost per barrel-
mile, which rose slightly from -0.47 percent to -0.43 percent.
    Staff has redone its analysis using AOPL's method of excluding 
observations from the analysis on a data set enlarged to include every 
firm for which two consecutive years of cost data appeared at least 
once. Staff considered four cases: the entire distribution of changes 
for each of the five two-year periods, the middle 90 percent, the 
middle 80 percent and the middle 50 percent of the five distributions. 
These four cases provide two significant results regarding the effects 
of narrowing the data sets under consideration. First, reducing the 
initial data set to only those firms present in all years causes the 
weighted average of cumulative cost changes to increase. Second, as the 
number of observations dropped from the available distribution 
increases (i.e., the number of observations remaining for analysis 
decreases), the weighted average of cumulative cost changes increases. 
This effect is particularly strong as the observations available for 
analysis decline from 90 percent to 80 percent of all observations, 
although AOPL's initial comments demonstrate this for the change from 
80 percent to 50 percent.\53\
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    \53\ Kahn Declaration, Table 4, rows (1) and (5), column (d).
---------------------------------------------------------------------------

    We are persuaded that taking full advantage of the available 
information is the proper path to take. Narrowing the set of 
observations may be appropriate if it is not possible to quantify the 
entire population in the analysis, so that a sample must be drawn to 
make the needed calculations. For example, the pollution levels in a 
contaminated landfill site are determined through sampling, not by 
analyzing every cubic yard of dirt in the landfill. In the present 
case, however, we are not required to sample. We can work with the 
complete data set without sampling. Using all available data is 
consistent with Order No. 561 to review the experience of the entire 
oil pipeline industry and not limit the review to some portion of it. 
In addition, the systematic changes that arise from narrowing the data 
set are troubling. We see no compelling reason to engage in a practice 
that is unnecessary and appears not to be neutral in its effect on our 
review.

3. Adequacy of Costs Considered in Staff's Review

    In completing its review of historical changes in industry costs, 
the Staff used operating expenses as reported by pipelines in FERC Form 
No. 6.\54\ Operating expenses consist of operations expenses (i.e., 
salaries and wages, supplies and expenses, outside services, operating 
fuel and power, and oil losses and shortages); maintenance expenses 
(i.e., salaries and wages, supplies and expenses, outside services, and 
maintenance materials); and general expenses (i.e., salaries and wages, 
supplies and expenses, outside services, rentals, depreciation and 
amortization, pensions and benefits, insurance, casualty and other 
losses and pipeline taxes). Staff used these costs in its review 
because they include both operating expenses incurred during the 
relevant year and charges for amortization and depreciation for that 
year.\55\
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    \54\ Operating expenses were taken from FERC Form No. 6, page 
304, line 22, column m.
    \55\ NOI at 35,765.
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    AOPL points out that the data Staff uses are operating costs as 
reported in FERC Form No. 6, which includes depreciation but excludes 
other capital costs, especially return on investment and income taxes. 
AOPL argues that this is an important omission.\56\
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    \56\ AOPL Comments, p. 8.
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    Sinclair argues that the AOPL study computes a new index of costs 
that include not only operating expenses as defined in FERC Form No. 6, 
but also the current year's net additions to the depreciated book value 
of plant and equipment. Sinclair contends this approach violates 
generally accepted accounting principles.\57\
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    \57\ Sinclair Reply Comments, p. 8, Scherer Testimony pp. 5 and 
16-17.
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Discussion
    AOPL contends that Staff should have recognized return on 
investment and income taxes. AOPL itself, however, did not include a 
cost component that was associated with return on investment and income 
taxes. Rather AOPL's witness Dr. Kahn used an alternate method to 
approximate the costs associated with return on investment and income 
taxes. To account for these two components of cost, Dr. Kahn calculated 
the change in the net plant account for petroleum pipelines (i.e., 
computing the change in carrier property less accrued depreciation). 
This computation was used in addition to the change in operating costs 
to arrive at the change in costs from one year to another. Neither AOPL 
nor Dr. Kahn

[[Page 79716]]

support why using the change in net plant would approximate an oil 
pipeline's cost associated with return on investment and income taxes.
    Order No. 561 required that the FERC Form No. 6 information be used 
to determine the cost changes experienced by the industry. However, 
FERC Form No. 6 does not include any cost figures associated with a 
pipeline's return on investment and income taxes. A pipeline's cost-of-
service is made up of costs associated with operation, maintenance, 
depreciation and amortization, taxes, and return on rate base of which 
undepreciated value of carrier plant, or net plant, is the major 
component. However, only operation and maintenance and general expense 
(which includes depreciation and amortization) are included in FERC 
Form No. 6. AOPL proposes to approximate the other two cost-of-service 
items by measuring the change in net plant. Unlike the four cost-of-
service items, net plant represents an asset account rather than an 
expense account item.
    AOPL recognizes that depreciation and amortization is a measure of 
capital costs. The amortization and depreciation amounts listed in FERC 
Form No. 6 are based upon the carrier property used by Dr. Kahn in his 
calculation to approximate return on investment and taxes. As a result, 
an increase in net plant from one year to another should be matched by 
an increase in the depreciation expense and amortization associated on 
that plant. Likewise a decrease in net plant from one year to the next 
should be matched by a decrease in depreciation expense and 
amortization associated on that plant. Net plant is also the main 
component used to determine a pipeline's rate base that is used to 
compute return and taxes associated with return. As a result, an 
increase or decrease in a company's net plant would be reflected in the 
return on investment and associated taxes. Thus, depreciation expense 
and amortization, return, and taxes all measure a pipeline's capital 
investment. All three of these capital cost components differ from net 
plant in that: (1) they represent an expense amount rather than an 
asset amount, and (2) each represents only a fraction of the amounts 
represented by net plant. Depreciation and amortization expense 
represents the portion of depreciable assets allocated to expense each 
year. This allocation process is done over the estimated service lives 
of assets. Return is the cost associated with a pipeline's investment 
in rate base, of which net plant is the major component. Return is 
derived by multiplying rate base by a rate of return expressed as a 
percentage. Taxes are computed based upon the return.
    The Commission is not persuaded by AOPL's arguments. The Commission 
finds that AOPL has not supported why a change in a pipeline's net 
plant can approximate a change in costs associated with return on 
investment and income taxes. Further, the Commission does not believe 
it appropriate to consider a pipeline's change in net plant from one 
year to another as a reasonable approximation of the change in costs 
associated with return on investment and income taxes. As discussed 
above the three capital cost components associated with net plant 
represent a small portion of this asset account. Thus, including net 
plant in an equation to determine a change in pipeline costs could 
unfairly weight any change in the capital portion of a pipeline's total 
costs. Therefore, the Commission finds that by using FERC Form No. 6 
reported costs for operation and maintenance expenses (including 
depreciation expense), the majority of the dollars associated with a 
pipeline's cost-of-service components are being captured for the 
determination of the change in costs from year to year. This represents 
a more reasonable method than trying to approximate return and related 
income taxes based upon changes in net plant.

4. The Index of Choice

    CAPP observes that the Energy Policy Act of 1992 required the 
Commission to establish a simplified and generally applicable 
ratemaking methodology for oil pipelines, consistent with the just and 
reasonable standards of the Interstate Commerce Act (ICA).\58\ CAPP 
recognizes that to achieve this simplicity requires some tradeoff with 
accuracy. CAPP argues that a simple aggregate index would not be 
expected to be as accurate as a more detailed index that closely 
matched and tracked prices and costs on a component by component basis. 
CAPP concludes by stating that if a ``simple'' index is required, the 
PPI-based index is the most all-encompassing, simplest index 
available.\59\
---------------------------------------------------------------------------

    \58\ 49 U.S.C. app. 1 (1988).
    \59\ CAPP Reply Comments, pp. 16-17.
---------------------------------------------------------------------------

    CAPP states, however, that it has concerns regarding the ``general 
applicability'' of a PPI-based index. CAPP questions whether one simple 
index can be ``generally applicable'' when the pipeline industry does 
not have a normal distribution of companies in terms of size and 
performance, that is, the industry structure is very concentrated by 
its representation of a small number of very large firms.\60\ CAPP 
suggests that the Commission review its constraint of having the same 
index for all pipelines. That is, the Commission could retain the same 
simple PPI-base index, but vary the reduction factor according to two 
or three broad industry groupings, to make the index more ``generally 
applicable.''\61\
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    \60\ CAPP states it has not conducted an in-dept review of the 
numerous pipelines that file FERC Form No. 6. It states that it 
conducted a review of aggregated data reported annually in the Oil & 
Gas Journal. CAPP Reply Comments, pp. 12-13.
    \61\ CAPP Reply Comments, pp. 15-20.
---------------------------------------------------------------------------

    CAPP asserts that any index-to-actual cost differences, or 
regulatory errors, should be borne by the party that also receives the 
biggest benefit--in this case, the pipeline companies. CAPP contends 
the index should err on the side that results in the pipelines 
undercharging, in order to ensure the users of the pipelines do not 
bear a disproportionate share of the regulatory cost burden.\62\
---------------------------------------------------------------------------

    \62\ CAPP Reply Comments, p. 10.
---------------------------------------------------------------------------

    CAPP argues that since a pipeline's cost structure is not fully 
impacted by inflation, the cost base should not be fully indexed to 
inflation. CAPP also argues that an index approach can instill 
incentives to capture significant gains and costs reductions and these 
savings need to be reflected in rates. CAPP suggests that reducing the 
price index by a factor can be a mechanism to help keep rates in-line 
with underlying costs, without jeopardizing the underlying rationale or 
effect of the index methodology.\63\
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    \63\ CAPP Initial Comments, p. 8.
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    CAPP asserts that a five-year period is too short to compute a 
trend analysis that is statistically sound and that provides conclusive 
findings. CAPP concludes by saying that any historical correlations or 
comparisons of pipeline costs and the PPI are as likely to reflect 
random coincidence as they are to reflect a statistically significant 
relationship. CAPP also expresses a concern that small differences can 
have significant absolute impacts since the value and volume of crude 
oil transported through oil pipelines is huge. CAPP suggests an 
alternative method for assessing the appropriateness of the PPI, i.e., 
Commission review of the underlying components and definitions of 
various indexes available for comparison with the components of 
pipeline operating costs.\64\
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    \64\ CAPP Initial Comments, pp. 6-7.
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    CAPP claims pipeline companies have experienced significant cost

[[Page 79717]]

savings under deregulation but asserts the cost-savings have not been 
shared with the producer/shippers of these pipelines. CAPP suggests the 
Commission consider introducing a one-time adjustment to ensure that, 
over the next five years, rates will continue to reflect a pipeline's 
underlying cost structure and remain just and reasonable.\65\
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    \65\ CAPP Reply Comments, p. 20.
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    Platte contends that the PPI-1 index has failed to track changes in 
its individual operating costs over the past five years. Because of 
future anticipated costs, Platte argues that the PPI alone would be 
better than PPI-1, which it asserts has failed to adequately track 
pipeline cost changes during the past five years. It therefore urges 
the Commission to adopt ``the PPI index proposed by AOPL.''\66\
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    \66\ Platte Initial Comments, pp. 1-2.
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    Williams suggests that the Commission revisit the propriety of the 
index resulting from this five-year review after a period of three 
years because of the possibility that pipelines' cost will increase 
significantly in the next two or three years as measures are taken to 
mitigate health, safety and environmental risks and to comply with new 
laws and regulations.\67\ Colonial also urges the Commission to 
consider the high probability ``that pipeline costs will increase more 
rapidly in the course of the next five years because of reliabililty 
and safety issues.''\68\
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    \67\ Williams Initial Comments, p. 3
    \68\ Colonial Reply Comments, p. 1.
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    Equilon requests that an interim review of the index be performed 
prior to the 2005 review to determine whether the index has resulted in 
a revenue stream that has kept pace with increasing industry costs. In 
the absence of an interim review of the index, Equilon requests that a 
surcharge option be made available if the cost impact of pipeline 
safety legislation is both significant and pervasive.\69\
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    \69\ Equilon Initial Comments, p. 2.
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Discussion
    We will not adopt the changes in the indexing methodology suggested 
by CAPP since similar issues were previously considered in the context 
of the proceeding which resulted in Order No. 561. Nor, as discussed 
above, will we adopt AOPL's and Platte's recommendation of substituting 
PPI for PPI-1. In Order No. 561, we recognized that it is inevitable 
that an indexing system will result in some divergence between the 
actual costs changes experienced by individual pipelines and the rate 
changes permitted by the index. This is because the indexing system 
utilizes average, economy-wide costs rather than pipeline specific 
costs to establish rate ceilings.\70\
---------------------------------------------------------------------------

    \70\ Order No. 561 at 30,949.
---------------------------------------------------------------------------

    In adopting the indexing methodology, the Commission established 
``fail-safe'' procedures and exceptions to maintain a proper balance 
between the interests of pipelines and shippers under the just and 
reasonable standard of the ICA. The Commission adopted a comprehensive 
scheme which includes cost-of-service and settlement alternatives. A 
procedure was established for shippers to challenge rate changes that, 
while in compliance with applicable ceilings, are so substantially in 
excess of actual costs as to be unjust and unreasonable.\71\ In 
addition, a shipper has the ability to file a complaint when it 
believes a pipeline's rates no longer meet the just and reasonable 
standard of the ICA.
---------------------------------------------------------------------------

    \71\ Order No. 561-A at 31,101.
---------------------------------------------------------------------------

    The Commission in Order No. 561 rejected a suggestion that the 
index be applied to specific components of a rate because it could 
cause perverse and unintended consequences. The Commission concluded 
this would be complex and difficult to administer.\72\ In this 
proceeding, CAPP raises the same issue by suggesting that the index be 
applied to selected cost components, those subject to inflation. For 
the reasons we stated in Order No. 561, we will not adopt CAPP's 
suggestion. CAPP suggests varying the reduction factor according to two 
or more industry groupings. This suggestion runs counter to the mandate 
of the Energy Policy Act of 1992 to establish a simplified and 
generally applicable ratemaking methodology for oil pipelines and we 
will not adopt it. Moreover, it would be complex and administratively 
burdensome. This would require selecting appropriate classification 
criteria for establishing groups, monitoring pipelines by category to 
determine into which group each pipeline falls each year, maintaining 
records on what reduction factor each pipeline is subject to in a given 
index year, and determining whether a pipeline's maximum ceiling rate 
comports with the requirements of the applicable index reduction 
factor. Use of different index reductions for different pipelines may 
provide an incentive for a pipeline to ensure that it would be placed 
in an industry group that produced the most favorable increase or 
smallest reduction in its rate ceiling.
---------------------------------------------------------------------------

    \72\ Order No. 561 at 30,952. For example, the Commission stated 
it would likely require substantial revisions, and perhaps 
additions, to the Commission's regulations to identify and monitor 
those pipeline accounts that would be subject to the index, and 
those that would not. The additional work this would cause, to both 
the Commission and the industry, would undercut the policy of the 
Energy Policy Act of 1992, which is to reduce, not increase, 
regulatory burdens.
---------------------------------------------------------------------------

    Finally, we decline to adopt CAPP's suggestion that we require a 
one-time adjustment to ensure that rates over the next five years 
continue to reflect pipelines' costs. The purpose of our indexing 
methodology is to permit adjustment to ceiling rates based on 
historical not anticipated cost changes over some future period.
    Similarly, we decline to adopt Equilon's suggestion that we 
implement a surcharge to cover anticipated environmental and safety 
costs. A pipeline company has the option of making a cost-of-service 
filing pursuant to 18 CFR Secs. 342 and 346 upon showing that there is 
a substantial divergence between the actual costs experienced by the 
pipeline and the rate resulting from application of the index. The 
Commission's cost-of-service filing requirements provide an appropriate 
mechanism for pipelines to seek recovery in the event such costs are 
incurred. Conversely, a shipper has adequate protection during the 
five-year period because it can challenge a pipeline's indexed rate as 
excessive.
    CAPP suggests that a review period of greater than five years is 
necessary to complete ``a trend analysis that is statistically sound 
that provides conclusive results.'' On the other hand, Williams and 
Equilon suggest that the next review of the index be done in less than 
five years. Based on the experience gained in completing this five-year 
review, the Commission concludes that five years is a reasonable period 
over which to complete an assessment of the performance of the index 
and achieves a reasonable balance between the interests of pipelines 
and shippers. A pipeline has the opportunity to make a cost-of-service 
filing within the five-year period if it believes its index rate is not 
sufficient.

Conclusion

    After consideration of all the initial and reply comments, for the 
reasons set forth above, the Commission concludes that the PPI-1 index 
has reasonably approximated the actual cost changes in the oil pipeline 
industry during the preceding five year period, and that it should be 
continued for the subsequent five year period. At the end of this 
period, in July 2005, the Commission will once again review the index 
to determine whether it continues to measure adequately the cost 
changes in the oil pipeline industry.

[[Page 79718]]

    The Commission orders: The initial five-year review of the oil 
pipeline pricing index is concluded.

    By the Commission.
David P. Boergers,
Secretary.
[FR Doc. 00-32340 Filed 12-19-00; 8:45 am]
BILLING CODE 6717-01-P