[Federal Register: April 29, 2008 (Volume 73, Number 83)]
[Notices]
[Page 23222-23240]
[DOCID:fr29ap08-56]

-----------------------------------------------------------------------

DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

[Docket No: PL07-2-000]

Composition of Proxy Groups for Determining Gas and Oil Pipeline
Return on Equity; Policy Statement

Issued April 17, 2008.
Before Commissioners: Joseph T. Kelliher, Chairman; Suedeen G.
Kelly, Marc Spitzer, Philip D. Moeller, and Jon Wellinghoff.

    1. On July 19, 2007, the Commission issued a proposed policy
statement concerning the composition of the proxy groups used to
determine gas and oil pipelines' return on equity (ROE) under the
Discounted Cash Flow (DCF) model.\1\ Historically, in determining the
proxy group, the Commission required that pipeline operations
constitute a high proportion of the business of any firm included in
the proxy group. However, in recent years, there have been fewer gas
pipeline corporations that meet that standard, in part because of the
greater trend toward Master Limited Partnerships (MLPs) in the gas
pipeline industry. Additionally, there are no oil corporations
available for use in the oil pipeline proxy group. These trends have
made the MLP issue one of particular concern to the Commission and are
the reason that the Commission issued the Proposed Policy Statement.\2\
---------------------------------------------------------------------------

    \1\ Composition of Proxy Groups for Determining Gas and Oil
Pipeline Return on Equity, 120 FERC ] 61,068 (2007) (Proposed Policy
Statement).
    \2\ After an initial round of comments and reply comments, the
Commission concluded that it required additional comment on the
issue of the growth rates of MLPs. After notice to this effect and
the receipt of a round of initial and reply comments, staff held a
technical conference involving an eight member panel on January 23,
2008 that was transcribed for the record. Comments and reply
comments were filed thereafter.
---------------------------------------------------------------------------

    2. After review of an extensive record developed in this
proceeding, the Commission concludes: (1) MLPs should be included in
the ROE proxy group for both oil and gas pipelines; (2) there should be
no cap on the level of distributions included in the Commission's
current DCF methodology; (3) the Institutional Brokers Estimated System
(IBES) forecasts should remain the basis for the short-term growth
forecast used in the DCF calculation; (4) there should be an adjustment
to the long-term growth rate used to calculate the equity cost of
capital for an MLP; and (5) there should be no modification to the
current respective two-thirds and one-third weightings of the short-
and long-term growth factors. Moreover, the Commission will not explore
other methods for determining a pipeline's equity cost of capital at
this time. The Commission also concludes that this Policy Statement
should govern all gas and oil rate proceedings involving the
establishment of ROE that are now pending before the Commission,
whether at hearing or in a decisional phase at the Commission.

I. Background

A. The DCF Model

    3. The Supreme Court has stated that ``the return to the equity
owner should be commensurate with the return on investments in other
enterprises having corresponding risks. That return, moreover, should
be sufficient to assure confidence in the financial integrity of the
enterprise, so as to maintain its credit and to attract capital.'' \3\
Since the 1980s, the Commission has used the DCF model to develop a
range of returns earned on investments in companies with corresponding
risks for purposes of determining the ROE to be awarded natural gas and
oil pipelines.
---------------------------------------------------------------------------

    \3\ FPC v. Hope Natural Gas Co., 320 U.S. 591 (1944). Bluefield
Water Works & Improvement Co. v. Public Service Comm'n, 262 U.S. 679
(1923).
---------------------------------------------------------------------------

    4. The DCF model was originally developed as a method for investors
to estimate the value of securities, including common stocks. It is
based on

the premise that ``a stock's price is equal to the present value of the
infinite stream of expected dividends discounted at a market rate
commensurate with the stock's risk.'' \4\ With simplifying assumptions,
the DCF model results in the investor using the following formula to
---------------------------------------------------------------------------
determine share price:

    \4\ CAPP v. FERC, 254 F.3d 289, 293 (2001) (CAPP).
---------------------------------------------------------------------------

    P = D/(r-g)

where P is the price of the stock at the relevant time, D is the
current dividend, r is the discount rate or rate of return, and g is
the expected constant growth in dividend income to be reflected in
capital appreciation.\5\
---------------------------------------------------------------------------

    \5\ Id. National Fuel Gas Supply Corp., 51 FERC ] 61,122, at
61,337 n.68 (1990). Ozark Gas Transmission System, 68 FERC ] 61,032,
at 61,104 n.16. (1994).
---------------------------------------------------------------------------

    5. Unlike investors, the Commission uses the DCF model to determine
the ROE (the ``r'' component) to be included in the pipeline's rates,
rather than to estimate a stock's value. Therefore, the Commission
solves the DCF formula for the discount rate, which represents the rate
of return that an investor requires in order to invest in a firm. Under
the resulting DCF formula, ROE equals current dividend yield (dividends
divided by share price) plus the projected future growth rate of
dividends:
r = D/P + g

    6. Over the years, the Commission has standardized the inputs to
the DCF formula as applied to interstate gas and oil pipelines. The
Commission averages short-term and long-term growth estimates in
determining the constant growth of dividends (referred to as the two-
step procedure). Security analysts' five-year forecasts for each
company in the proxy group (discussed below), as published by IBES, are
used for determining growth for the short term. The long-term growth is
based on forecasts of long-term growth of the economy as a whole,\6\ as
reflected in the Gross Domestic Product (GDP which are drawn from three
different sources.\7\ The short-term forecast receives a two-thirds
weighting and the long-term forecast receives a one-third weighting in
calculating the growth rate in the DCF model.\8\
---------------------------------------------------------------------------

    \6\ Northwest Pipeline Company, 79 FERC ] 61,309, at 62,383
(1997) (Opinion No. 396-B). Williston Basin Interstate Pipeline
Company, 79 FERC ] 61,311, at 62,389 (1997) (Williston I), aff'd,
Williston Basin Interstate Pipeline Co. v. FERC, 165 F.3d 54, 57 (DC
Cir. 1999) (Williston v. FERC).
    \7\ The three sources used by the Commission are Global Insight:
Long-Term Macro Forecast--Baseline (U.S. Economy 30-Year Focus);
Energy Information Agency, Annual Energy Outlook; and the Social
Security Administration.
    \8\ Transcontinental Gas Pipe Line Corp., 84 FERC ] 61,084, at
61,423-4 (Opinion No. 414-A), reh'g denied, 85 FERC ] 61,323, at
62,266-70 (1998) (Opinion No. 414-B), aff'd sub nom. North Carolina
Utilities Commission v. FERC, 203 F.3d 53 (DC Cir. 2000)
(unpublished opinion). Northwest Pipeline Co., 88 FERC ] 61,057,
reh'g denied, 88 FERC ] 61,298 (1999), aff'd CAPP v. FERC, 254 F.3d
289 (DC Cir. 2001).
---------------------------------------------------------------------------

    7. Most gas pipelines are wholly-owned subsidiaries and their
common stocks are not publicly traded. This is also true for some
jurisdictional oil pipelines. Therefore, the Commission must use a
proxy group of publicly traded firms with corresponding risks to set a
range of reasonable returns for both natural gas and oil pipelines. For
both oil and gas pipelines, after defining the zone of reasonableness
through development of the appropriate proxy group for the pipeline,
the Commission assigns the pipeline a rate within that range or zone,
to reflect specific risks of that pipeline as compared to the proxy
group companies.\9\ The Commission has historically presumed that
existing pipelines fall within a broad range of average risk. A
pipeline or other litigating party has to show highly unusual
circumstances that indicate anomalously high or low risk as compared to
other pipelines to overcome the presumption.\10\
---------------------------------------------------------------------------

    \9\ Williston v. FERC, 165 F.3d at 57 (citation omitted).
    \10\ Transcontinental Gas Pipe Line Corp., 90 FERC ] 61,279, at
61,936 (2000).
---------------------------------------------------------------------------

    8. The Commission historically required that each company included
in the proxy group satisfy the following three standards.\11\ First,
the company's stock must be publicly traded. Second, the company must
be recognized as a natural gas or oil pipeline company and its stock
must be recognized and tracked by an investment information service
such as Value Line. Third, pipeline operations must constitute a high
proportion of the company's business. Until 2003, the Commission's
policy was that the third standard could only be satisfied if a
company's pipeline business accounted for, on average, at least 50
percent of a company's assets or operating income over the most recent
three-year period.\12\
---------------------------------------------------------------------------

    \11\ Id. at 61,933.
    \12\ Williston Basin Interstate Pipeline Company, 104 FERC ]
61,036, at P 35 n.46 (2003) (Williston II).
---------------------------------------------------------------------------

    9. However, in recent years fewer corporations have satisfied the
Commission's standards for inclusion in the gas and oil pipeline proxy
groups. Mergers and acquisitions have reduced the number of publicly
traded corporations with natural gas pipeline operations. Most of the
remaining corporations are engaged in such significant non-pipeline
business that their pipeline business accounts are significantly less
than 50 percent of their assets or operating income. At the same time,
there has been a trend toward MLPs owning natural gas pipelines. This
trend has been even more pronounced in the oil pipeline industry, with
the result that there are now no purely oil pipeline corporations
available for inclusion in the oil pipeline proxy group and virtually
all traded oil pipeline equity interests are owned by MLPs. Thus, for
both oil and gas pipeline rate cases, the composition of the proxy
group has become a significant issue, and the central question is
whether, and how, to include MLPs in the proxy group.

B. The MLP Business Model

    10. MLPs consist of a general partner, who manages the partnership,
and limited partners, who provide capital and receive cash
distributions, but have no management role. The units of the limited
partners are traded on public exchanges, just like corporate stock
shares. In order to be treated as an MLP for Federal income tax
purposes, an MLP must receive at least 90 percent of its income from
certain qualifying sources, including natural resource activities.
Natural resource activities include exploration, development, mining or
production, processing, refining, transportation, storage and marketing
of any mineral or natural resource, including gas and oil.\13\
---------------------------------------------------------------------------

    \13\ See Wachovia Securities, Master Limited Partnerships: A
Primer, November 10, 2003, (Wachovia Primer 1) at 1, 3-4, reproduced
in full in Docket No. OR96-2-012, Ex. SEP ARCO-22 and also in Kern
River Gas Transmission Company, Docket No. RP04-274-000, Ex. No. BP-
19 filed October 25, 2005; J.P. Morgan, Industry Analysis, Energy
MLPS, dated March 28, 2002 (J.P. Morgan 2002 Energy MLPs) at 5-6,
reproduced in full in Docket No. OR92-8-025, Ex. No. SWST-18, filed
October 20, 2005; Wachovia Capital Markets, LLC, Equity Research
Department, Master Limited Partnerships: Primer 2nd Edition, A
Framework for Investment dated August 23, 2005 (Wachovia 2nd Primer)
at 8-9, reproduced in full in Docket No. RP06-72-000 at Ex. S-36,
filed May 31, 2006); Coalition of Publicly Traded Partnerships,
Publicly Traded Partnerships: What they are and how they work
(undated) (Publicly Traded Partnerships) at 1-3, reproduced in full
in Docket No. RP06-72-000 at Ex. S-35, filed May 31, 2006, and
Docket No. OR96-2-012, Ex. No. BP-19, filed October 25, 2005; CAPP
Reply Comments, Attachment A at 2-3; APGA Additional Comments dated
December 21, 2007.
---------------------------------------------------------------------------

    11. MLPs generally distribute most available cash flow to the
general and limited partners in the form of quarterly distributions. At
their inception, MLPs establish agreements between the general and
limited partners, which define cash flow available for distribution and
how that cash flow is

to be divided between the general and limited partners. Most MLP
agreements define ``available cash flow'' as (1) net income (gross
revenues minus operating expenses) plus (2) depreciation and
amortization, minus (3) capital investments the partnership must make
to maintain its current asset base and cash flow stream.\14\
Depreciation and amortization may be considered a part of ``available
cash flow,'' because depreciation is an accounting charge against
current income, rather than an actual cash expense. Thus, depreciation
does not reduce the MLP's current cash on hand. The MLP agreement may
provide for the general partner to receive increasingly higher
percentages of the overall distribution if it raises the quarterly
distribution. This gives the general partner incentives to increase the
partnership's business and cash flow.\15\
---------------------------------------------------------------------------

    \14\ The definition of available cash may also net out short
term working capital borrowings, the repayment of capital
expenditures, and other internal items.
    \15\ Wachovia Primer 1 at 6-7; J.P. Morgan 2002 Energy MLPs at
5, 14; Wachovia 2nd Primer at 9, 15-19.
---------------------------------------------------------------------------

    12. The general partner has discretion not to distribute the entire
amount of available cash flow for the proper exercise of the business,
to create reserves for capital expenditures, for the payment of debt,
and for future distributions. However, pipeline MLPs have typically
distributed 90 percent or more of available cash flow. As a result, the
MLP's cash distributions normally include not only the operating profit
component of ``available cash flow,'' but also the depreciation
component. This means that, in contrast to a corporation's dividends,
an MLP's cash distributions generally exceed the MLP's reported
earnings. The pipeline MLP's ability to distribute a high percentage of
available cash flows reflects the stable cash flows underpinning its
businesses.\16\
---------------------------------------------------------------------------

    \16\ J.P. Morgan 2002 Energy MLPs at 11-13; Wachovia 2nd Primer
at 24-25; Enbridge Initial Comments Attachment A, Wachovia Capital
Markets, LLC, MLPs: Safe to Come Back Into the Water (Wachovia MLPs)
dated August 20, 2007, at 2-4.
---------------------------------------------------------------------------

    13. Because of their high cash distributions, MLPs have financed
capital investments required to significantly expand operations or to
make acquisitions through debt or by issuing additional units rather
than through retained cash, although the general partner has the
discretion to do so. These expansions financed through external debt
are intended to provide a return equal to the cost of the capital plus
some additional return for the existing unit holders, i.e., it is
accretive. Thus, the return on any newly issued units is expected to be
sufficiently high to avoid dilution of the current distributions to the
existing unit holders.\17\
---------------------------------------------------------------------------

    \17\ Id.
---------------------------------------------------------------------------

    14. MLPs may also provide significant tax advantages to their unit
holders. Some MLPs allocate depreciation, amortization, and tax credits
to the limited partners and away from the general partner. In some
cases, the limited partner may have no net taxable income reported on
the income tax information document (the K-1) the limited partner
receives from the partnership each year, a pattern that may continue
for years. In that case, the limited partner will not pay any taxes on
the cash received from the partnership in the year of the distribution.
To the extent a limited partner is allocated items of depreciation,
credit, or losses that exceed the limited partner's ownership
percentage, income taxes will be due on the difference when the unit is
sold. However, this may not occur for many years. Over time the real
cost of the future taxes declines while the future return of any tax
savings that is reinvested increases. This can significantly increase
the return to the investor over the holding period of the limited
partnership unit.\18\
---------------------------------------------------------------------------

    \18\ See PSCNY Initial Comments at 12-13 and Attachment 1
thereto at 2; Wachovia Primer at 4-5; Publicly Traded Partnerships
at 2-3; Wachovia 2nd Primer at 1, 5, 20-22; J.P. Morgan 2002 Energy
MLPs at 18-19.
---------------------------------------------------------------------------

    15. Moreover, distributions in excess of earnings are not taxed as
long as the limited partner has a tax basis. Rather, the limited
partner's tax basis is reduced and again any taxes are deferred until
the unit is sold. By this tax deferral, the cash flow distributed in
excess of earnings can be made available for reinvestment much earlier
than would be the case of a corporate share.\19\ This reduces the
limited partner's risk because the limited partner's cash basis in the
unit is reduced, but the distribution would not normally reduce the
market price of the unit nor, if the firm has access to external
capital, would this necessarily reduce its long term growth potential.
---------------------------------------------------------------------------

    \19\ Id.
---------------------------------------------------------------------------

C. The Recent Cases on the Shrinking Proxy Group

1. Natural Gas Pipeline Cases
    16. The Commission first addressed the problem of the shrinking
natural gas pipeline proxy group in Williston II, 104 FERC ] 61,036 at
P 34-43. In that NGA section 4 rate case, the Commission relaxed the
requirement that natural gas business account for at least 50 percent
of the corporation's assets or operating income. Instead, the
Commission approved the pipeline's proposal to use a proxy group based
on the corporations listed in the Value Line Investment Survey's list
of diversified natural gas firms that own Commission-regulated natural
gas pipelines, without regard to what portion of the company's business
comprises pipeline operations. The proxy group approved in that case
included four corporations that satisfied the Commission's historic
standards \20\ and five corporations with less pipeline business and
more local distribution business than the Commission had previously
allowed. The Commission set Williston's ROE at the median of this proxy
group.
---------------------------------------------------------------------------

    \20\ The Commission noted that two of those four companies were
in the process of merging so that in the future there would be only
three pipeline corporations that satisfied our historic proxy group
standards. Williston II, 104 FERC ] 61,036 at P 35.
---------------------------------------------------------------------------

    17. The Commission next addressed the proxy group issue in a 2004
order in Petal Gas Storage, LLC, 97 FERC ] 61,097 (2001), reh'g granted
in part and denied in part, 106 FERC ] 61,325 (2004) (Petal). In that
case, a jurisdictional storage company with market-based rates had
applied for a certificate under NGA section 7 to construct pipeline
facilities to transport gas from its existing storage facility to a new
interconnection with Southern Natural Gas Co. The Commission found that
Petal was not a new entrant in the jurisdictional gas transportation
business, but was simply expanding its existing business and had not
shown that it faced any unusual risks. Ordinarily in such circumstances
the Commission would use the pipeline's own currently approved ROE for
its existing services in determining an initial incremental rate for
the expansion. However, because Petal had market-based rates for its
existing services, there was no such currently approved ROE to use.
Therefore, the Commission calculated the initial rate for Petal's
expansion using the same median ROE which it had approved in Williston,
which was the most recent litigated gas pipeline section 4 rate case.
    18. When the Commission next addressed the proxy group issue, in
High Island Offshore System, LLC (HIOS),\21\ and Kern River Gas
Transmission Company (Opinion No. 486),\22\ the Williston II proxy
group had shrunk to six corporations. Moreover, the Commission found
that two of those

corporations should be excluded from the proxy group on the ground that
their financial difficulties had lowered their ROEs to such a low level
as to render them unrepresentative.\23\ This left only four
corporations eligible for the proxy group under the standards adopted
in Williston II, three of whom derived more revenue from the
distribution business than the pipeline business. The two pipelines
contended that, in these circumstances, the Commission should include
natural gas pipeline MLPs in the gas pipeline proxy group. They
asserted that MLPs have a much higher percentage of their business
devoted to pipeline operations than most of the corporations eligible
for the proxy group under Williston II, and therefore are more
representative of the risks faced by pipelines.
---------------------------------------------------------------------------

    \21\ 110 FERC ] 61,043, reh'g denied, 112 FERC ] 61,050 (2005).
    \22\ 117 FERC ] 61,077 (2006), reh'g pending.
    \23\ HIOS, 110 FERC ] 61,043 at P 118. Opinion No. 486, 117 FERC
] 61,077 at P 140-141.
---------------------------------------------------------------------------

    19. In HIOS and Opinion No. 486, the Commission rejected the
proposals to include MLPs in the proxy group, and approved proxy groups
using the four corporations still available under the Williston II
approach of basing the proxy group on the Value Line Investment
Survey's group of diversified natural gas corporations that own
Commission-regulated pipelines. In HIOS, the Commission set the
pipeline's ROE at the median of the four-corporation proxy group. In
Opinion No. 486, the Commission took the same general approach as in
HIOS, but set the pipeline's ROE 50 basis points above the median to
account for the fact its pipeline operations have a higher risk than
its distribution business.\24\
---------------------------------------------------------------------------

    \24\ Id. at P 171-176.
---------------------------------------------------------------------------

    20. In rejecting the proposals to include MLPs in the proxy group
in both cases, the Commission made clear that it was not making a
generic finding that MLPs cannot be considered for inclusion in the
proxy group if a proper evidentiary showing is made.\25\ However, the
Commission pointed out that data concerning dividends paid by the proxy
group members is a key component in any DCF analysis, and expressed
concern that an MLP's cash distributions to its unit holders may not be
comparable to the corporate dividends the Commission uses in its DCF
analysis. In Opinion No. 486, the Commission explained its concern as
follows:
---------------------------------------------------------------------------

    \25\ Id. at P 147. See also HIOS, 110 FERC ] 61,043 at P 125.

    Corporations pay dividends in order to distribute a share of
their earnings to stockholders. As such, dividends do not include
any return of invested capital to the stockholders. Rather,
dividends represent solely a return on invested capital. Put another
way, dividends represent profit that the stockholder is making on
its investment. Moreover, corporations typically reinvest some
earnings to provide for future growth of earnings and thus
dividends. Since the return on equity which the Commission awards in
a rate case is intended to permit the pipeline's investors to earn a
profit on their investment and provides funds to finance future
growth, the use of dividends in the DCF analysis is entirely
consistent with the purpose for which the Commission uses that
analysis. By contrast, as Kern River concedes, the cash
distributions of the MLPs it seeks to add to the proxy group in this
case include a return of invested capital through an allocation of
the partnership's net income. While the level of an MLP's cash
distributions may be a significant factor in the unit holder's
decision to invest in the MLP, the Commission uses the DCF analysis
solely to determine the pipeline's return on equity. The Commission
provides for the return of invested capital through a separate
depreciation allowance. For this reason, to the extent an MLP's
distributions include a significant return of invested capital, a
DCF analysis based on those distributions, without any adjustment,
will tend to overstate the estimated return on equity, because the
'dividend' would be inflated by cash flow representing return of
equity, thereby overstating the earnings the dividend stream
purports to reflect.\26\
---------------------------------------------------------------------------

    \26\ Opinion No. 486, 117 FERC ] 61,077 at P. 149-150.

    21. The Commission stated that it could nevertheless consider
including MLPs in the proxy group in a future case, if the pipeline
presented evidence addressing these concerns. The discussion in the
order suggested that such evidence might include some method of
adjusting the MLPs' distributions to make them comparable to dividends,
a showing that the higher ``dividend'' yield of the MLP was offset by a
lower long-term growth projection, or some other explanation why
distributions in excess of earnings do not distort the DCF results for
the MLP in question.\27\ However, the Commission concluded that Kern
River had not presented sufficient evidence to address these issues,
and that the record in that case did not support including MLPs in the
proxy group.
---------------------------------------------------------------------------

    \27\ Proposed Policy Statement at P 10-11
---------------------------------------------------------------------------

    22. In addition, Opinion No. 486 pointed out that the traditional
DCF model only incorporates growth resulting from the reinvestment of
earnings, not growth arising from external sources of capital.\28\
Therefore, the Commission stated that if growth forecasted for an MLP
comes from external capital, it is necessary either (1) to explain why
the external sources of capital do not distort the DCF results for that
MLP or (2) propose an adjustment to the DCF analysis to eliminate any
distortion.
---------------------------------------------------------------------------

    \28\ Id. at P 152.
---------------------------------------------------------------------------

2. Oil Pipeline Cases
    23. In some oil pipeline rate cases decided before HIOS and Opinion
No. 486, the Commission included MLPs in the proxy group used to
determine oil pipeline return on equity on the ground that there were
no corporations available for use in the oil proxy group.\29\ In those
cases, no party raised any issue concerning the comparability of an
MLP's cash distribution to a corporation's dividend. However, that
issue did arise in the first oil pipeline case decided after HIOS and
Opinion No. 486, which involved SFPP's Sepulveda Line.\30\ The
Commission approved inclusion of MLPs in the proxy group in that case
on the grounds that the included MLPs in question had not made
distributions in excess of earnings. The order found these facts
sufficient to address the concerns expressed in HIOS and Opinion No.
486.
---------------------------------------------------------------------------

    \29\ SFPP, L.P., 86 FERC ] 61,022, at 61,099 (1999).
    \30\ SFPP, L.P., 117 FERC ] 61,285 (2006) (SFPP Sepulveda
Order), rehearing pending.
---------------------------------------------------------------------------

D. Court Remand of Petal and HIOS

    24. Both Petal and HIOS appealed the Commission's orders in their
cases to the United States Court of Appeals for the District of
Columbia Circuit. The court considered the appeals together, and it
vacated and remanded the proxy group rulings in both cases.\31\ The
court emphasized that the Commission's ``proxy group arrangements must
be risk-appropriate.'' \32\ The court explained that this means that
firms included in the proxy group should face similar risks to the
pipeline whose ROE is being determined, and any differences in risk
should be recognized in determining where to place the pipeline in the
proxy group range of reasonable returns.
---------------------------------------------------------------------------

    \31\ Petal Gas Storage, LLC v. FERC, 496 F.3d 695 (DC Cir. 2007)
(Petal v. FERC).
    \32\ Petal v. FERC, 496 F.3d at 697, quoting Canadian
Association of Petroleum Producers v. FERC, 254 F.3d 289 (DC Cir.
2001).
---------------------------------------------------------------------------

    25. The court recognized that changes in the gas pipeline industry
compel a change in the Commission's traditional approach to determining
the proxy group, and the court stated that ``controversy about how it
should change has been bubbling up in a number of recent cases,''
citing both Williston II and Opinion No. 486. But the court found that
the cases on appeal ``seem[] to represent an arrival point of sorts for
the Commission,'' pointing out that Opinion No. 486 had reversed an

administrative law judge for deviating from the HIOS proxy group.\33\
---------------------------------------------------------------------------

    \33\ Opinion No. 486 reversed the ALJ's inclusion of the two
financially troubled pipelines in the proxy group.
---------------------------------------------------------------------------

    26. The court held that the Commission had not shown that the proxy
group arrangements it approved in Petal and HIOS were risk-appropriate.
The court pointed out that the Commission had rejected the inclusion of
MLPs in the proxy group on the ground that MLP distributions, unlike
dividends, might provide returns of equity as well as returns on
equity. While stating that this proposition is not ``self-evident,''
the court accepted it for the sake of argument. Nonetheless, the court
stated that nothing in the Commission's decision explained why the
companies selected by the Commission for inclusion in the proxy group
are risk-comparable to HIOS. The court stated that when the goal is a
proxy group of comparable companies, it is not clear that natural gas
companies with highly different risk profiles should be regarded as
comparable.
    27. The court further stated that in placing Petal and HIOS in the
middle of the proxy group in terms of return on equity, the Commission
expressly relied on the assumption that pipelines generally fall into a
broad range of average risk as compared to other pipelines. However,
the court stated, this assumption is decisive only given a proxy group
composed of other pipelines. Thus, the court reasoned that if gas
distribution companies generally face lower risk than gas
pipelines,\34\ a risk-appropriate placement would be at the high end of
the group. The court stated that the Commission erred by failing to
explain how its proxy group arrangements were based on the principle of
relative risk.
---------------------------------------------------------------------------

    \34\ The court noted that this seems likely.
---------------------------------------------------------------------------

    28. Therefore, the court vacated the Commission's orders with
respect to the proxy group issue. The court stated that on remand, it
did not require any particular proxy group arrangement, but stated that
the overall arrangement must make sense in terms of the relative risk
and in terms of the statutory command to set just and reasonable rates
that are commensurate with returns on investments in other enterprises
having corresponding risks.

II. The Proposed Policy Statement

    29. A month before the court's decision in Petal v. FERC, the
Commission reached a similar conclusion that its proxy group
arrangements for gas and oil pipelines must be reexamined. Accordingly,
on July 19, 2007, the Commission issued a Proposed Policy Statement, in
which it proposed to modify its policy to allow MLPs to be included in
the proxy group. The Proposed Policy Statement found that:

    Cost of service ratemaking requires that firms in the proxy
group be of comparable risk to the firm whose equity cost of capital
is being determined in a particular rate proceeding. If the proxy
group is less than clearly representative, this may require the
Commission to adjust for the difference in risk by adjusting the
equity cost-of-capital, a difficult undertaking requiring detailed
support from the contending parties and detailed case-by-case
analysis by the Commission. Expanding the proxy group to include
MLPs whose business is more narrowly focused on pipeline activities
would help provide a more representative proxy group.\35\
---------------------------------------------------------------------------

    \35\ Proposed Policy Statement, 120 FERC ] 61,068 at P 17.

    30. However, the Commission proposed to cap the cash distribution
used to determine an MLP's return under the DCF method at the MLP's
reported earnings. The Commission found that this was necessary to
exclude that portion of an MLP's distributions constituting return of
equity. The Commission provides for the return of equity through a
depreciation allowance. Therefore, the Commission stated that the cash
flows used in the DCF analysis should be limited to those which reflect
a return on equity. The concern was the pipeline could double recover
its depreciation expense. The Commission also proposed to require a
showing that the MLP has had stable earnings over a multi-year period,
so as to justify a finding that it will be able to maintain the current
level of cash distributions in future years. The Proposed Policy
Statement found that these requirements should render the MLP's cash
distribution comparable to a corporation's dividend for purposes of the
DCF analysis.
    31. Under the Proposed Policy Statement, the Commission would leave
to individual cases the determination of which specific MLPs and
corporations should be included in the proxy group. The Commission
proposed to apply its final policy statement to all gas and oil cases
that have not completed the hearing phase as of the date the Commission
issues its final policy statement. The Commission stated that it would
consider on a case-by-case basis whether to apply the final policy
statement in cases that have completed the hearing phase.

III. The Record in the Policy Statement Proceeding

A. Pre-Technical Conference Comments

    32. Twenty-two initial comments and thirteen reply comments were
filed in response to the Proposed Policy Statement \36\ and fall into
two categories: (1) Those of gas and oil pipelines and the related
trade associations (Pipeline Interests),\37\ and (2) those of gas and
oil producers and shippers, public and municipal utilities, state
public service commissions, and related trade associations (Customer
Interests).\38\ Two comments were also submitted by individuals in
their business or personal capacity.\39\
---------------------------------------------------------------------------

    \36\ Comments related to the technical conference are discussed
infra and are characterized as conference comments or conference
reply comments.
    \37\ The Pipeline Interests include: the Association of Oil Pipe
Lines (AOPL); El Paso Corporation (El Paso); Enbridge Energy
Partners, L.P. (Enbridge); the Interstate Natural Gas Association of
America (INGAA); MidAmerican Energy Pipeline Group (MidAmerican);
the National Association of Publicly Traded Partnerships (NAPTP);
Panhandle Energy Pipelines (Panhandle); Spectra Energy Transmission,
LLC (Spectra); TransCanada Corporation (TransCanada); and Williston
Basin Interstate Pipeline Company (Williston).
    \38\ The Customer Interests include: The American Gas
Association (AGA); the America Public Gas Association (APGA); the
Air Transport Association of America; the Canadian Association of
Petroleum Producers (CAPP); Indicated Shippers (consisting of Area
Energy, LLC, Anadarko E&P Company LP, Anadarko Petroleum
Corporation, Chevron USA Inc., Coral Energy Resources LP, Occidental
Energy Marketing Inc., and Shell Rocky Mountain Production, LLC);
the Natural Gas Supply Association (NGSA); the Process Gas Consumers
Group; the Public Service Commission of New York (PSCNY); Tesoro
Refining and Marketing Company (Tesoro); the Northern Municipal
Distributors Group (NMDG) and the Midwest Region Gas Task Force
Association filing jointly; and the Society for the Preservation of
Oil Shippers (Society).
    \39\ The individual comments include Crowley Energy Consulting,
supporting the Customer Interests, and Barry Gleicher, supporting
the Pipeline Interests.
---------------------------------------------------------------------------

    33. The comments focus on three issues: (1) Whether MLPs should be
included in the gas pipeline proxy group at all; (2) whether the
proposed cap on the MLP cash distributions used in the DCF analysis is
necessary or adequate; and (3) whether the short- and long-term growth
component of the DCF model should be modified given the financial
practices of MLPs. Secondary points include the potential distorting
effects of: MLP tax treatment, the large payouts by MLPs, the general
partner's incentive distribution rights (IDRs), and the relative
returns to the limited and general partners.
    34. All parties recognize that MLPs are the only available entities
for inclusion in the oil pipeline proxy group. The Pipeline Interests
also all assert that the Commission correctly

proposed to include MLPs in the gas pipeline proxy group. In contrast,
most of the Customer Interests assert that there are enough
corporations available for inclusion in the gas pipeline proxy group
and that there is no need to include MLPs.
    35. Both the Pipeline and Customer Interests question the proposed
earnings cap on MLP distributions, with the Pipeline Interests
asserting the cap is unnecessary and the Customer Interests asserting
the cap should be lower. The Pipeline Interests assert that an MLP's
share price reflects investors' projection of all cash flows it will
receive from the MLP, including distributions in excess of earnings.
Therefore, any cap on the distributions while still using a dividend
yield reflecting the full share price would lead to distorted
results.\40\ The Customer Interests agree that the adjustment to MLP
distributions is necessary to remove a double count attributed to
depreciation, but they also uniformly assert that the proposed
adjustment is inadequate to compensate for a wide range of financial
factors that distinguish MLPs from Schedule C corporations.
---------------------------------------------------------------------------

    \40\ AOPL initial comments at 8, 10; INGAA initial comments at
13-14; Spectra initial comments at 4; NAPTP initial comments at 4;
NAPTP initial comments at 4.
---------------------------------------------------------------------------

    36. On the growth rate issue, the Pipeline Interests in their
initial comments generally agree that, if MLPs have greater
distributions than a corporation, then the MLP may have less growth
potential than a corporation. However, they argue that this fact does
not require any additional adjustment, since any lower growth potential
would be reflected in a reduced IBES growth forecast. The Pipeline
Interests also state that distributions in excess of earnings do not
prevent reinvestment or organic growth. They assert that pipeline MLPs
have ready access to capital markets given their stable cash flows and
the projected expansion of the pipeline system, which can be the basis
for organic growth.\41\
---------------------------------------------------------------------------

    \41\ AOPL comments at 21-24 and attachments; Enbridge Energy
reply comments at 5; INGAA comments at 22-24; TransCanada reply
comments at 8-10.
---------------------------------------------------------------------------

    37. In contrast, the Customer Interests assert that MLPs have
significantly lower growth potential than corporations due to their
distributions in excess of earnings, particularly over the long
term.\42\ They cite studies by established investment firms suggesting
that the long term growth potential of MLPs is less than the long term
growth factor now included in the DCF model. Moreover, they argue that
given the high level of MLP distributions and declining opportunities
for acquisitions with high returns, MLP growth must now come from
investment of external funds in projects that will enhance organic
growth of existing business lines.\43\
---------------------------------------------------------------------------

    \42\ APGA reply comments at 11-15; CAPP initial comments at 1;
CAPP reply comments at 6-7, and attachment at 3-4; NYPSC initial
comments at 19-21, 23, including attachments of financial materials
from major investment houses; NYPSC reply comments at 4-7; Tesoro
reply comments at 25-27.
    \43\ Id.
---------------------------------------------------------------------------

    38. Some of the Customer Interests further argue that there are
inadequate investment opportunities to support capital investment, and
in the relatively near future the present level of MLP distributions
will be maintained only by borrowing or issuing additional limited
partners' units.\44\ Therefore, they argue, sustainability of MLP
growth is a major issue that must be examined in rate proceedings as
this implies a lower equity cost-of-capital component in the pipeline's
rate structure.\45\ The Customer Interests also assert that the
Commission's traditional DCF model has never permitted the inclusion of
externally generated funds in the growth component of the model. Thus,
to the extent the IBES projections include such external funds, they
assert that this compromises the forecasts.
---------------------------------------------------------------------------

    \44\ Crowley Energy Consultant initial comments; Society at 5-6.
    \45\ Id.
---------------------------------------------------------------------------

    39. Finally, NGSA urge the Commission to initiate a new proceeding
to consider alternatives to the DCF methodology for determining gas
pipeline ROEs. AGA requests a technical conference to discuss the
issues further, which as noted, the Commission granted with regard to
the growth factors.\46\ Two commenters assert that any change in policy
should apply prospectively and should not apply to proceedings for
which the hearing record is completed, e.g., the Kern River
proceeding.\47\
---------------------------------------------------------------------------

    \46\ AGA initial comments at 8.
    \47\ Id. at 8, 25; NGSA initial comments at 3, 11.
---------------------------------------------------------------------------

B. Technical Conference and Post-Technical Conference Comments

    40. After review of the initial comments summarized above, the
Commission issued a supplemental notice on November 15, 2007,
requesting additional comments solely on the issue of MLP growth rates,
and establishing a technical conference to discuss that issue. The
technical conference was held on January 23, 2008. The Commission
concluded that supplementing the record before the Commission could
resolve the issue of how to project MLP growth rates assuming that the
Commission ultimately decides to permit the use of MLPs in the proxy
group. The Commission focused the technical conference on the
appropriate method for determining MLP growth and, in particular, that
which should be used if the Commission did not cap the distributions
used to determine the dividend yield. Thus, whether to include MLPs in
the proxy group or to limit the distributions to earnings were not
issues before the technical conference. The technical conference was
transcribed for use in the record herein.
    41. Thirteen parties submitted comments in response to the November
15 notice, on three main topics: (1) The short-term growth component;
(2) the long-term growth component; and (3) the weighting of these two
components.\48\ Of these, eight parties requested to participate on the
panels and the Commission accepted all of the individuals proffered by
these parties.\49\ To summarize, two of the panelists represented
parties that continued to assert that MLPs should not be included in
the ROE proxy group.\50\ More consistent with the premise of the
conference, three panelists stated that there needed to be an
adjustment to the long term GDP component the Commission currently uses
in its DCF model.\51\ Two stated that MLPs would grow at a slower rate
than corporations in the long-term phase of growth. However, six other
panelists asserted that an MLP as a whole could grow as fast as a
corporation in the terminal phase, but most conceded that the use of
incentive distribution rights (IDRs) \52\ would cause the limited
partnership interests to grow at slower rate than the

MLP as a whole.\53\ In addition, three panelists questioned the
reliability of the IBES forecasts for use in developing the short-term
projection\54\ and one stated that the longer term growth component of
the formula should be weighted at no greater than 10 percent.\55\
---------------------------------------------------------------------------

    \48\ APGA, AOPL, CAPP, Enbridge, INGAA, MidAmerica, NAPTP, NGSA,
PSNYC, State of Alaska, Tesoro, TransCanada, and Williston.
    \49\ Professor J. Peter Williamson on behalf of the Association
of Oil Pipelines, Mr. J. Bertram Solomon on behalf of the American
Public Gas Association, Mr. Michael J. Vilbert on behalf of the
Interstate Natural Gas Association of America, Mr. Park Shaper and
Mr. Yves Siegel on behalf of the National Association of Publicly
Traded Partnerships, Mr. Patrick Barry on behalf of the Public
Service Commission of New York, Mr. Thomas Horst on behalf of the
State of Alaska, and Mr. Paul Moul on behalf of TransCanada
Corporation.
    \50\ PSCNY and APGA. CAPP, NGSA, and Tesoro supported this
position but did not participate on the panel.
    \51\ PSCNY, APGA, and State of Alaska as well as the NGSA.
    \52\ As discussed further below, an incentive distribution
provision in an MLP partnership agreement provides for an increasing
large percentage of distributions to the general partner as the cash
distributions per limited partnership share increase over time. The
maximum incentive distribution to the general partner varies with
the partnership agreement, but may be as high as 47 percent.
    \53\ Two spoke for NAPTP and one each for AOPL, INGAA, the State
of Alaska, and TransCanada. Williston, Enbridge, and MidAmerican
also asserted that there is no reason to conclude the growth would
not at least equal GDP. They did not speak to the issue of the
limited partner growth rate that might be lower as a result of the
incentive distributions to the general partner.
    \54\ APGA, PSCNY, and State of Alaska.
    \55\ TransCanada, Additional Comments dated December 21 at 12.
---------------------------------------------------------------------------

IV. Discussion

    42. Based on its review of all the comments and the record of the
technical conference, the Commission is adopting the following policy
concerning the composition of the natural gas pipeline and oil pipeline
proxy groups: (1) Consistent with the Proposed Policy Statement, the
Commission will permit MLPs to be included in the proxy group for both
gas and oil pipelines; (2) the proposed earnings cap on the MLPs'
distributions will not be adopted; and (3) the Commission will use the
same DCF analysis for MLPs as for corporations, except that the long-
term growth projection for MLPs shall be 50 percent of projected growth
in GDP.

A. Whether To Include MLPs in the Gas and Oil Pipeline Proxy Groups

1. Comments
    43. The first issue is whether to include MLPs in the proxy group
used to determine a pipeline's return on equity. No commenter contests
the Commission's statement that, in oil pipeline proceedings, MLPs are
the only firms available for inclusion in the proxy group.\56\ In
addition, the Pipeline Interests all assert that the Commission
correctly proposed to include MLPs in the gas pipeline proxy group.
They agree with the Commission that this will result in a more
representative proxy group that reflects long-term trends within the
gas pipeline industry and assert that the resulting returns will
encourage further investment in both the gas and oil pipeline
industries. Including MLPs in the proxy group would reduce the need for
difficult adjustments to projected equity returns to accommodate
differences in risk among the different types of firms that might
reasonably be included in the proxy group.
---------------------------------------------------------------------------

    \56\ AOPL initial comments at 5. Tesoro initial comments at 2.
See also Society initial comments addressing the possible inclusion
of oil pipeline MLPs in the proxy group.
---------------------------------------------------------------------------

    44. In contrast, most of the commenters representing the Customer
Interests assert that there are enough corporations available for
inclusion in the gas pipeline proxy group that there is no need to
include MLPs. They further argue that the differences between the MLP
and corporate business model render any use of MLPs inconsistent with
the DCF model. APGA expressly states that the Commission should abandon
the Proposed Policy Statement.\57\
---------------------------------------------------------------------------

    \57\ APGA initial comments at 14.
---------------------------------------------------------------------------

    45. The NMDG asserts that the Commission has not established that
there is any reason to issue the Policy Statement or to relieve a
pipeline applicant of the burden of establishing why any MLPs should be
included in the proxy group. In this vein, Indicated Shippers assert
that the Commission should consider alternative procedures for defining
the proxy group, and that the improvement in El Paso Natural
Corporation's and the William Company's financial situation and the
creation of the Spectra Group suggest that the corporate gas proxy
group is becoming more representative.
    46. Finally, NGSA urges the Commission to initiate a new proceeding
to consider alternatives to the DCF methodology for determining gas
pipeline ROEs. NGSA generally supports including MLPs in the proxy
group, subject to adjustments, as a means of continuing to use the DCF
method on a temporary basis. But it argues that a better long-term
solution to determining gas pipeline ROEs would be to stop using the
DCF method, and instead adopt a risk premium approach to determining
ROE. It asserts that the risk premium approach is used in Canada and
does not require adjustments to account for variations in corporate
structure.\58\ INGAA states in its reply comments that the DCF
methodology is not necessarily the only financial model that may be
used, and asks the Commission to clarify that parties may propose other
approaches in individual rate cases.\59\
---------------------------------------------------------------------------

    \58\ NGSA initial comments at 13-15.
    \59\ INGAA reply comments at 18.
---------------------------------------------------------------------------

2. Discussion
    47. As the Commission pointed out in the proposed policy statement,
the Supreme Court has held that ``the return to the equity owner should
be commensurate with the return on investment in other enterprises
having corresponding risks. That return, moreover, should be sufficient
to assure confidence in the financial integrity of the enterprise, so
as to maintain its credit and to attract capital.'' \60\ In order to
attract capital, ``a utility must offer a risk-adjusted expected rate
of return sufficient to attract investors.'' \61\ In other words, the
utility must compete in the equity markets to obtain capital.
---------------------------------------------------------------------------

    \60\ FPC v. Hope Natural Gas Co., 320 U.S. 591, 603 (1044).
    \61\ CAPP, 254 F.3d at 293.
---------------------------------------------------------------------------

    48. The Commission performs a DCF analysis of publicly-traded proxy
firms to determine the return on equity that markets require a pipeline
to give its investors in order for them to invest their capital in the
pipeline. As the court explained in Petal Gas Storage, LLC v. FERC, the
purpose of the proxy group is to ``provide market-determined stock and
dividend figures from public companies comparable to a target company
for which those figures are unavailable. Market-determined stock
figures reflect a company's risk level and when combined with dividend
values, permit calculation of the `risk-adjusted expected rate of
return sufficient to attract investors.' '' \62\ It is thus crucial
that the firms in the proxy group be comparable to the regulated firm
whose rate is being determined. In other words, as the court emphasized
in Petal, the proxy group must be ``risk-appropriate.'' \63\
---------------------------------------------------------------------------

    \62\ Petal, 496 F.3d at 697, quoting Canadian Association of
Petroleum Producers v. FERC, 254 F.3d 289 (DC Cir. 2001).
    \63\ Id. 6.
---------------------------------------------------------------------------

    49. The Commission continues to believe that including MLPs in the
gas and oil proxy groups will, as required by Petal, make those proxy
groups more representative of the business risks of the regulated firm
whose rates are at issue. While there has been some modest expansion of
the number of publicly-traded diversified natural gas companies that
could be included in the proxy group, this does not change one basic
fact. This is that more and more gas pipeline assets are being
transferred to publicly-traded MLPs, whose business is narrowly focused
on pipeline activities. As a result, these MLPs are likely to be more
representative of predominantly pipeline firms than the diversified gas
corporations still available for inclusion in a proxy group. As such,
including MLPs in the gas pipeline proxy group should render the proxy
group more ``risk-appropriate,'' consistent with Petal. Moreover, MLPs
are the only publicly traded ownership form for oil pipelines and are
the most representative group for determining the equity cost of
capital for oil pipelines.

    50. As the court also emphasized in Petal, when a proxy group is
less than clearly representative, there may be a need for the
Commission to adjust for the difference in risk by adjusting the equity
cost-of-capital, a difficult undertaking requiring detailed support
from the contending parties and detailed case-by-case analysis by the
Commission. Expanding a proxy group to include MLPs whose business is
more narrowly focused on pipeline activities should help minimize the
need to make adjustments, because the proxy group should be more
representative of the regulated firms whose rates are at issue.
    51. While this Policy Statement modifies Commission policy to
permit MLPs to be included in the proxy group, the Commission is making
no findings at this time as to which particular corporations and/or
MLPs should be included in the gas or oil proxy groups. The Commission
leaves that determination to each individual rate case. In order to
assist the Commission in determining the most representative possible
proxy group in those cases, the parties and other participants should
provide as much information as possible regarding the business
activities of each firm they propose to include in the proxy group,
including their recent annual SEC filings and investor service analyses
of the firms. This information should help the Commission determine
whether the interstate natural gas or oil pipeline business is a
primary focus of the firm and whether investors view an investment in
the firm as essentially an investment in that business. While the
Commission is not precluding use of diversified corporations or MLPs in
the proxy group, the probable difference in the risk of the natural gas
pipeline business and the risk profile of a diversified gas corporation
with substantial local distribution activities has been highlighted by
the parties and specifically recognized by the court in Petal.\64\
---------------------------------------------------------------------------

    \64\ Id. at 6-7.
---------------------------------------------------------------------------

    52. As discussed further below, the Commission recognizes that
there are significant differences in the cash flows to investors and
growth rates of corporations and MLPs. However, as discussed below, the
Commission believes that those issues may be accounted for in a
correctly performed DCF analysis, and therefore these differences do
not preclude inclusion of MLPs in the proxy group.
    53. Finally, the Commission has concluded that it will not explore
other methods of determining the equity cost of capital at this time.
The DCF model is a well established method of determining the equity
cost of capital,\65\ and other methods such as the risk premium model
have not been used by the Commission for almost two decades. In the
Commission's judgment, the uncertainty that would be created by
reopening its procedures to include other approaches outweighs any
limitations in its current pragmatic approach to the financial
characteristics of MLPs. Therefore the alternatives suggested by
certain of the parties will not be pursued further here. Nothing
submitted at the January 23rd technical conference warrants different
conclusions.
---------------------------------------------------------------------------

    \65\ See Illinois Bell Telephone Co. v. FCC, 988 F.2d 1254, 1259
n. 6 (DC Cir. 1993), stating, ``The DCF method `has become the most
popular technique of estimating the cost of equity, and it is
generally accepted by most commissions. Virtually all cost of
capital witnesses use this method, and most of them consider it
their primary technique.' '' quoting J. Bonbright et al., Principles
of Public Utility Regulation 318 (2d ed. 1988).
---------------------------------------------------------------------------

B. The Proposed Adjustment to MLP Cash Distributions

1. Comments
    54. Both the Pipeline and Customer Interests attack the proposed
earnings cap on MLP distributions, with the Pipeline Interests
asserting the cap is unnecessary and the Customer Interests asserting
the cap should be lower. The Pipeline Interests assert that there is no
need to adjust the distributions included in the DCF model. They argue
that investors include all cash flows that are generated by an MLP in
applying a DCF model and do not distinguish between a return of
investment and a return on investment \66\ since depreciation is an
accounting concept that is used to calculate an MLP's earnings that is
not relevant to determining the cash flows included in a DCF
analysis.\67\ The Pipeline Interests further assert that an unadjusted
DCF calculation does not result in the double recovery of the
depreciation component of an MLP's cost-of-service.\68\
---------------------------------------------------------------------------

    \66\ AOPL initial comments at 16, 18; Spectra Energy initial
comments at 14; NAPTP initial comments at 3.
    \67\ INGAA initial comments at 5-6, 15-18; NAPTP initial
comments at 4-5; MidAmerican initial comments at 5; Panhandle
initial comments at 3 and attachment; Williston initial comments at
11.
    \68\ INGAA initial comments at 15-17 and 20-21.
---------------------------------------------------------------------------

    55. Moreover, the Pipeline Interests assert that, because all parts
of the DCF model are linked, if the distribution component is reduced,
this will necessarily affect the growth component of the model. They
assert that any adjustment limiting the distributions used to earnings
will result in below market returns to investors and thus any such
adjustment is arbitrary.\69\ As an alternative, they suggest that if an
MLP's distributions are unrepresentative, it is wiser to exclude that
MLP from the sample as an outlier.\70\ They further assert there have
been corporations in the proxy group that have distributed dividends in
excess of earnings for years and the Commission has never required an
adjustment.\71\ They claim that in any event there are practical
problems with an earnings cap because earnings are reported quarterly
(unlike distributions which are reported monthly) and such reports are
unedited and may require seasonal adjustments.\72\
---------------------------------------------------------------------------

    \69\ AOPL initial comments at 8, 10; INGAA initial comments at
13-14; Spectra initial comments at 4; PAPTP initial comments at 4.
    \70\ INGAA initial comments at 13; Spectra Energy initial
comments at 5, 19-20.
    \71\ INGAA initial comments at 18; MidAmerica initial comments
at 6.
    \72\ AOPL initial comments at 24-25; Spectra Energy initial
comments at 17-18.
---------------------------------------------------------------------------

    56. The Customer Interests support the Commission's initial
conclusion that an adjustment to MLP distributions is necessary to
remove a double count attributed to depreciation, but they also
uniformly assert that the proposed adjustment is inadequate to
compensate for a wide range of financial factors that distinguish MLPs
from Schedule C corporations. Thus, they assert that further
adjustments to the distributions should be made to reflect the tax
advantages that flow to MLPs,\73\ the alleged distortions that result
from incentive distributions to the general partner,\74\ and the fact
that distributions may also include cash derived from the sale of
assets, bond issues, and the issuance of further limited partnership
units.\75\ Several also assert that for an MLP's distribution to be
comparable to that of a corporation, the percentage of the MLP's
distribution included in the DCF model should be no higher than the
percentage of earnings corporations typically include in their dividend
payments, or about 60 percent.\76\ Finally, to the extent that INGAA
and others assert that depreciation is not a direct source of cash flow
for distribution, the Customer Interests cite to investor literature
and MLP filings

with the SEC disclosure that state exactly the opposite.\77\
---------------------------------------------------------------------------

    \73\ Crowley Energy at 2; Indicated Shippers initial comments at
24; PSCNY initial comments at 12-13; Society initial comments,
passim.
    \74\ APGA at 7-8; Crowley Energy at 2; Indicated Shippers
comments at 24; NGSA at 6; Society initial comments passim.
    \75\ Crowley Energy initial comments; Society, passim; Tesoro
reply comments at 26.
    \76\ CAPP initial comments at 3, 6; Indicated Shippers initial
comments at 23; PSCNY initial comments at 6; Tesoro initial comments
at 15.
    \77\ APGA initial comments at 11; CAPP reply comments at 3-4;
NGSA reply comments at 9-10; Tesoro reply comments at 19-21.
---------------------------------------------------------------------------

2. Discussion
    57. The Commission concludes that a proposed earnings cap on the
MLP distributions that would be included in the DCF model should not be
adopted. On further review, the Commission concludes that its concern
with the distinction between return on capital and return of capital
improperly conflates cost-of-service rate-making techniques with the
market-driven DCF method used for determining the pipeline's cost of
obtaining capital in the equity markets. This is inconsistent with the
DCF model's internal structure.
    58. The fundamental premise of the DCF model is that a firm's stock
price should equal the present value of its future cash flows,
discounted at a market rate commensurate with the stock's risk. No
commenter seriously contends that an investor would distinguish between
cash flows attributable to return on capital, and those attributable to
return of capital, in performing a DCF analysis. In short, under the
DCF model, all cash flows, whatever their source, contribute to the
value of stock. The Commission agrees that, since the DCF model uses
the total unadjusted cash flows to determine a stock's value, it is
theoretically inconsistent to use lower adjusted cash flows when using
the DCF model to determine the return required by investors purchasing
the stock.
    59. More specifically, the investor first determines what risk
should be attributed to a prospective investment and the related return
that would be required in order to make the investment. For example,
the investor may conclude that the minimum return from the investment
must be 10 percent on equity. The investor then looks at the total cash
flows from all sources over time, including the current distribution
(or dividend) and its projected growth. The DCF model yields a price
for the share that reflects the present value of those cash flows at
the discount rate.
    60. In contrast, the Commission solves the DCF formula for the
return required by the investor, not the price of the stock. This
results in the Commission calculating the proxy firm's ROE as the sum
of (1) the proxy firm's dividend yield and (2) the projected growth
rate. The Commission determines dividend yield by dividing the proxy
firm's cash distribution (or dividend) by its current stock price. As
the court in Petal pointed out, both the stock price and distribution
(or dividend) figures of the proxy firms are market-determined.
Moreover, an investor's projection of the MLP's growth prospects would
be affected by the actual level of its distributions, with
distributions in excess of earnings generally perceived as reducing the
growth projection because less cash flow is available for reinvestment
in the firm.\78\ The pipeline industry generally acknowledged this fact
in earlier rate proceedings as well as in this proceeding, or at least
until its later phases.\79\ As illustrated in Appendix B to this Policy
Statement, a DCF analysis using market-determined inputs for each of
the variables in the DCF formula appropriately determines, consistent
with Petal, the percentage return on equity a pipeline must offer in
the equity market in order to attract investors, whether the proxy
firms are corporations or MLPs.
---------------------------------------------------------------------------

    \78\ Because a corporation typically retains a portion of its
earnings, general financial theory suggests that it is able to use
internally generated funds to obtain a higher growth rate. An MLP's
higher level of distributions theoretically produces a lower
projected growth rate. In fact, the most recent IBES projections for
the four corporations included in the gas pipeline proxy group in
Appendix A average 10.5 percent, while the IBES growth projections
for the six MLPs average only 6.67 percent.
    \79\ See AOPL Initial Comments, Williamson Aff. at 6-7; AOPL
Reply Comments at 6-7; Panhandle Initial Comments, Attachment dated
August 30, 2007, Analysis of the Use of MLPs in the Group of Proxy
Companies Used For Determining Gas and Oil Pipeline Return on Equity
at 10-11; Transwestern Pipeline Company, LLC, Docket No. RP06-614-
000, Ex. TW-56 filed September 29, 2006, at 23-24; High Island
Offshore System, LLC, Docket No. RP96-540-000, Ex. HIO-73 filed
August 26, 2006 at 28-29; Texaco Refining and Marketing Inc, et al.
v. SFPP, L.P., Docket No. OR96-2-012, Ex. SEP SFPP-56 dated February
14, 2005 at 9-10; Mojave Pipeline Company, Docket No. RP07-310-000,
Ex. MPC-70 dated February 2, 2007 at 28-32 (including tables and
charts on the relative growth rates of corporations and MLPs); Kern
River Gas Transmission Company, Docket No. RP04-274-000, Ex. KR-107
at 17.
---------------------------------------------------------------------------

    61. If the Commission were to cap the distribution used to
determine an MLP's dividend yield at below the market-determined level,
but use the actual market price of the MLP's publicly traded units and
a growth projection reflecting the actual level of distributions, the
DCF analysis would fail to achieve its intended purpose of determining
the return the equity market requires in order to justify an investment
in the pipeline. That is because there would be a mismatch among the
inputs the Commission used for the variables in the DCF formula. The
DCF analysis presumes that the market value of an MLP's units is a
function of the entire present and future cash flow provided by an
investment in those units. Given this interlocking nature of the
variables in the DCF formula, INGAA and the other pipeline commenters
are correct that limiting the distribution input to earnings, while
using market values for the other inputs to the DCF formula, would
result in the calculation of a return below that implied in the share
price.\80\
---------------------------------------------------------------------------

    \80\ The earnings cap on the distribution would artificially
reduce an MLP's dividend yield below that assumed by the investor in
valuing the stock. Adding the artificially reduced dividend yield to
a growth projection that reflects the MLP's reduced growth prospects
due to its high actual distributions would inevitably result in an
ROE lower than that actually required by the market.
---------------------------------------------------------------------------

    62. In addition, use of a proxy MLP's full distribution in
determining ROE will not cause a double recovery of the depreciation
component included in the pipeline's cost-of-service rates. In a rate
case, the Commission determines the dollar amount of the ROE component
of the cost-of-service of the pipeline filing the rate case by
multiplying (1) the percentage return on equity required by the market
by (2) the actual rate base of the pipeline in question. Having found
that use of a proxy MLP's full distribution is necessary for the DCF
analysis to accurately determine the percentage return on equity
required by the equity markets, it necessarily follows that the same
percentage should be used in determining the dollar amount of the ROE
component of the pipeline's cost of service. Awarding the pipeline an
ROE allowance based on that percentage of its own rate base will give
the pipeline an opportunity to provide its investors with the return on
their investment required by the market. Such an ROE allowance does not
implicate the separate depreciation allowance the Commission also
includes in a pipeline's cost of service to provide for return of
investment.
    63. The Commission therefore concludes that it is not analytically
sound to cap the distributions to be included in the DCF model by the
MLP's earnings. As discussed below, the record is more convincing that
if any adjustment is required, this issue centers on the projected
growth of the MLPs. Given this, it is not necessary to discuss the
appropriate level for any earnings cap.
    64. Having concluded that an earnings cap adjustment would be
inappropriate, the Commission also concludes that it is not necessary
to address the long term sustainability of MLPs as a whole, or those of
the particular MLP whose rates are under review. As has been discussed,
the DCF model has two components. One is the cash distribution in the
current period and

the second is the discounted value of the anticipated growth in that
distribution. The increase in distribution is driven by the anticipated
growth in earnings that generates the cash to be used for the
distribution. If projected earnings suggest that the distribution
cannot be sustained, this will be reflected in the projected cash flow
for the firm and ultimately the MLP unit price.\81\ In this regard,
some MLPs will inevitably do better and others not as well, and from
the Commission's point of view, this will be reflected in the required
rate of return developed by the DCF model.
---------------------------------------------------------------------------

    \81\ The investor requires a minimum return that reflects the
perceived risk of the investment. Thus, if the cash flows decline,
so will the price of the stock assuming the percentage return
required remains the same.
---------------------------------------------------------------------------

    65. For this reason, as the Pipeline Interests suggest, if an MLP's
financial condition or growth rate is outside the norm for the
industry, or is unrepresentative, the best way to deal with this issue
is to exclude that particular MLP from the proxy group sample, just as
the Commission has done with unrepresentative diversified gas
corporations. Finally, the Commission has previously held that the
issue of whether MLPs are an appropriate investment vehicle for the
pipeline industry as a whole is a matter that is best left for
Congress, the body that authorized MLPs in the first instance. Thus the
Commission will not address that issue, or the appropriateness of the
tax deferral aspects of MLPs further in this proceeding.\82\ Nothing
presented at the technical conference warrants different conclusions.
---------------------------------------------------------------------------

    \82\ See SFPP, L.P., 121 FERC ] 61,240, at P 20-61 (2007) for an
extensive discussion of these income tax allowance and tax deferral
policy issues relating to MLPs. Moreover, any tax advantages are
normally reflected in the MLP unit price. See also INGAA Reply
Comments at 12-13; MidAmerica, Reply Comments at 4-5; AOPL Reply
Comments at 11-12; Tr. 121-22; AOPL Post-Technical Conference
Comments at 14.
---------------------------------------------------------------------------

    66. The Commission now turns to the issue of how to project the
growth rates of MLPs. For the reasons discussed below, the Commission
finds that the differences between MLPs and corporations, and
particularly the MLPs' lower growth prospects due to their
distributions in excess of earnings, are appropriately accounted for in
the growth projection component of the DCF model.

C. The Short-Term Growth Component

    67. This section of the Policy Statement discusses whether changes
should be made to the short-term growth component of the DCF model. For
the short-term growth estimate the Commission currently uses security
analysts' five-year forecasts for each company in the proxy group, as
published by IBES. IBES is a service that monitors the earnings
estimates on over 18,000 companies of interest to institutional
investors. More than 850 firms contribute data to IBES to be used in
its projections and the information is provided on a subscription
basis.
1. Comments
    68. The Pipeline Interests support the continued use of five-year
IBES forecasts for short-term growth projections in the DCF model with
regard to MLPs. In general, they argue that, while no growth forecast
is perfect, IBES provides the best available information regarding what
investors expect in companies. They state that IBES estimates are
unbiased and publicly available. They add that since IBES estimates are
company-specific, they already adjust for any differences among the
entities analyzed, including whether the company is organized as an MLP
or corporation.
    69. For example, NAPTP supports the IBES estimates because the
various items that may affect the growth rate expected by the market,
such as the effect of IDRs to the general partner, are already factored
into IBES projections.\83\ Williston Basin argues that since IBES data
is drawn from many financial analysts, and since the information is
widely accepted in the financial industry, use of IBES helps reduce
subjectivity when estimating appropriate short-term growth
forecasts.\84\ TransCanada acknowledges that IBES may underestimate
short-term growth for MLPs, but argues that modifying IBES would only
further understate short-term growth rates and compound any problems
brought on by trying to estimate growth for MLPs.\85\ The AOPL
similarly argues that studies have shown that IBES estimates understate
short-term growth rates for MLPs and therefore the growth projections
are conservative.\86\
---------------------------------------------------------------------------

    \83\ NAPTP, Initial Technical Conference Comments at 3.
    \84\ Williston, Additional Comments dated December 21 at 2.
    \85\ TransCanada, Additional Comments dated December 21 at 12-
13.
    \86\ AOPL, Initial Technical Conference Comments at 5,
Williamson Post-Technical Conference Aff. at 3, 8.
---------------------------------------------------------------------------

    70. However, certain parties recommend that the Commission
discontinue using IBES estimates for MLPs to project short-term growth
rates in its DCF model. These parties argue there is considerable
uncertainty of whether the individual forecasts IBES is reporting
reflect earnings growth or distribution growth. The State of Alaska
asserts that IBES growth estimates of distributions per share are
incomplete and unreliable for use in the DCF calculation. It argues
that there are not a sufficient number of stock analysts providing IBES
with distribution per share growth estimates to get a reliable estimate
for the purposes of calculating the cost of equity for pipeline
companies. Speaking for the State of Alaska, Dr. Thomas Horst notes
that of the 37 gas and oil companies he examined data for, there was
not a single case where IBES received two or more estimates of
distributions per share growth rates.\87\
---------------------------------------------------------------------------

    \87\ State of Alaska, Reply Comments dated February 20 at 5.
---------------------------------------------------------------------------

    71. APGA states that through communications with personnel at
Thompson Financial, the owner of IBES and the publisher of its
forecasts, it verified that the five-year analysts' growth rate
projections reported by IBES for MLPs are projections of earnings per
unit, and not distributions per unit.\88\ PSCNY also considers IBES
projections unreliable, since they do not account for such parameters
as IDRs. It questions whether analysts can truly estimate MLP growth
beyond two years. It also questions whether lower earnings retention
necessarily would translate into lower short-term IBES growth rates
relative to corporations.\89\ CAPP expresses concerns that the analysts
that produce IBES growth estimates continue to be concentrated within
the same financial institutions that also underwrite the securities of
the subject companies, invest in those securities, and furnish other
financial services to the subject enterprises \90\ and also notes the
uncertainty of whether the forecasts are for earnings or
distributions.\91\
---------------------------------------------------------------------------

    \88\ APGA, Reply Technical Conference Comments at 5-6.
    \89\ NYPSC Initial Technical Conference Comments at 5-6.
    \90\ CAPP Supplemental Comments dated December 21 at 3-4.
    \91\ CAPP Initial Technical Conference Comments at 7.
---------------------------------------------------------------------------

    72. However AOPL maintains that historical records confirm that
what analysts actually report to IBES is distribution growth. It adds
that Yves Siegel, Wachovia's representative, confirmed that Wachovia
provides projected MLP distribution growth to IBES, and not earnings
growth.\92\ NAPTP asserts that, for projecting the short-term growth
rates of MLPs, the Commission should use analysts'

forecasts of growth in the MLP's distributable cash flow for all of its
equity holders and that, while not perfect, this is the best
information that is available.\93\
---------------------------------------------------------------------------

    \92\ AOPL Initial Technical Conference Comments at 4-5.
    \93\ NAPTP Post-Technical Conference Comments at 1-3.
---------------------------------------------------------------------------

2. Discussion
    73. The Commission's longstanding policy is to use security
analysts' five-year growth forecasts as reported by IBES to determine
the short-term growth rates for each proxy company. In Opinion No 414-
A,\94\ the Commission explained that the growth rate to be used in the
DCF model is the growth rate expected by the market. Thus, the
Commission seeks to base its growth projections on ``the best evidence
of the growth rates actually expected by the investment community.''
\95\ Moreover, the Commission stated, the growth rate expected by the
investment community is not, quoting a Transco witness, ``necessarily a
correct growth forecast; the market may be wrong. But the cost of
common equity to a regulated enterprise depends upon what the market
expects not upon precisely what is going to happen.'' \96\
---------------------------------------------------------------------------

    \94\ 85 FERC ] 61,323 at 62,268-9.
    \95\ Id. at 62,269.
    \96\ Id.
---------------------------------------------------------------------------

    74. The Commission held that the IBES five-year growth forecasts
for each company in the proxy group are the best available evidence of
the short-term growth rates expected by the investment community. It
cited evidence that (1) those forecasts are provided to IBES by
professional security analysts, (2) IBES reports the forecast for each
firm as a service to investors, and (3) the IBES reports are well known
in the investment community and used by investors. The Commission has
also rejected the suggestion that the IBES analysts are biased and
stated that ``in fact the analysts have a significant incentive to make
their analyses as accurate as possible to meet the needs of their
clients since those investors will not utilize brokerage firms whose
analysts repeatedly overstate the growth potential of companies.'' \97\
---------------------------------------------------------------------------

    \97\ Transcontinental Gas Pipe Line Corp., 90 FERC ] 61,279, at
61,932 (2000).
---------------------------------------------------------------------------

    75. Based on the comments, the Commission concludes that the IBES
five-year growth forecasts should also be used for any MLP included in
the proxy group. While the Commission recognizes that there may be some
statistical limitations to the IBES projections, the record here
demonstrates that it remains the best and most reliable source of
growth information available. IBES publishes security analysts' five-
year growth forecasts for MLPs in the same manner as for corporations.
No party questions the Commission's findings in past cases that
investors rely on the IBES projections in making investment decisions,
because they are widely available and generally reflect the input of a
number of financial analysts. Also, since IBES projections are company-
specific, they should already adjust for any differences among the
entities analyzed, including any reduced growth prospects investors
expect due to the fact an MLP makes distributions in excess of
earnings. In fact, the most recent IBES projections for the seven MLPs
included in the gas pipeline proxy group in Appendix A, Table 1,
average 6.86 percent, while the IBES growth projections for the four
corporations average 10.75 percent. Thus, those MLP growth projections
are about 400 basis points below those for the corporations.
    76. As discussed above, several parties assert that the security
analysts' five-year growth forecasts appear generally to be forecasts
of growth in earnings, rather than distributions. They point out that
the relevant cash flows for the DCF model are the MLP's distributions
to the limited partners, and therefore the growth projections used in
the DCF analysis should be growth in distributions, not earnings.
Despite these concerns, the Commission again concludes that the IBES
short-term growth projections provide the best estimate of short-term
growth rates for MLP distributions. Professor J. Peter Williamson, on
behalf of AOPL, reviewed historical IBES five-year growth forecasts for
five oil pipeline MLPs since the mid-1990s. IBES had published five to
nine growth forecasts for each of the MLPs, with a total of 39
forecasts. Williamson compared each of these 39 forecasts to the MLP's
actual growth in earnings and distributions during the subsequent five-
year period. He found that 29 of the 39 IBES five-year forecasts, or 74
percent, were closer to the actual average distribution growths over
that time span than the actual earnings growths. In his study,
Williamson also found that historical records fail to support any
claims that the IBES forecasts are biased or tend to overstate future
growth.\98\ In fact, 22 of the 39 forecasts were lower than the actual
distribution growth, and 17 were higher. Thus, far from showing a
pattern of overestimating actual growth in distributions, the IBES
growth projections underestimated growth in distributions 56 percent of
the time, a conservative result. Accordingly, regardless of whether
financial analysts stated they are reporting projected earnings growth
or projected distribution growth for MLPs, the Commission finds the
five-year growth rates that IBES reports are acceptable since they
closely approximate distribution growth for MLPs, which is the short-
term input for the DCF model.
---------------------------------------------------------------------------

    \98\ AOPL, Post-Technical Conference Comments, Williamson Aff.
at 2-6.
---------------------------------------------------------------------------

    77. As noted, the State of Alaska expresses concerns that there are
an insufficient number of stock analysts providing IBES with estimates
which are expressly identified at forecasts of MLP distribution per
share growth to obtain reliable short-term growth projections for MLPs.
At the technical conference, Mr. Horst presented a chart showing the
number of IBES report counts for 37 oil and gas pipeline companies--
both corporations and MLPs. The chart breaks the analyst report counts
down into earnings reports and distribution reports. It shows that
analysts made an average of 3.1 earnings reports for each MLP and an
average of 0.8 distribution reports for each MLP.\99\ However, as
discussed above, Williamson's analysis of a historical period suggests
that actual MLP growth in the short term tracks IBES earnings
projections better than distribution projections. Moreover, Mr. Horst's
averages include many smaller, less frequently traded MLPs and thus
understate the number of analysts that are likely to follow the larger,
more established pipeline MLPs likely to be included in a proxy group.
The Commission therefore concludes that the number of reports made by
analysts for oil and gas companies MLPs is acceptable for use in the
DCF model.
---------------------------------------------------------------------------

    \99\ State of Alaska, Comments dated December 21, Second Horst
Aff. at 4-5; Reply Comments dated February 20 at 5, Third Horst Aff.
at 16-17, 21.
---------------------------------------------------------------------------

    78. Some of the Customer Interests are agreeable to the continued
use of IBES forecasts, but only under certain conditions. Specifically,
PSCNY contends that, should the Commission continue to use IBES
forecasts in its DCF model, any MLP the Commission allows in a proxy
group must be market-tested and representative of a natural gas
pipeline company. PSCNY contends that IBES would be acceptable if the
MLP is tracked by Value Line, has been in operation for at least five
years as an MLP, and derives 50-percent of its operating income from,
or has 50 percent of its assets devoted to, interstate natural gas
transportation operations. PSCNY also contends that the Commission
should exclude MLPs from proxy groups when their growth

projections are illogical or anomalous.\100\
---------------------------------------------------------------------------

    \100\ PSCNY Supplemental Comments dated Dec. 21 at 3-5.
---------------------------------------------------------------------------

    79. The Commission agrees in principle with PSCNY's position that
IBES forecasts should only be used for an MLP that is tracked by Value
Line, has been in operation for at least five years as an MLP, and
derives at least 50 percent of its operating income from, or 50 percent
of its assets devoted to, interstate operations. Thus, when developing
its proxy group, a pipeline should select MLPs that are well
established and have assets that are predominantly gas and oil
pipelines. Such pipelines are those most likely to have risk comparable
to the pipeline seeking to justify its rates. However, there may be
particular MLPs that do not satisfy these criteria, but are still
appropriate for inclusion in the proxy group. The pipeline must justify
including such an MLP in its proxy group. Thus, while the Commission
encourages pipelines to follow the guidelines suggested by PSCNY, it
will not make them a condition of including a particular MLP in the
proxy group. As suggested by the parties, the Commission will continue
to exclude an MLP from the proxy groups if its growth projection is
illogical or anomalous.
    80. Two parties state that, should the Commission continue to use
IBES projections to estimate short-term growth rates in its DCF model
for MLPs, it must modify the estimated rates. Tesoro states that, if
the Commission makes no adjustments to dividend distributions of MLPs,
it should significantly reduce its IBES short-term growth estimates to
recognize the fact that an MLP cannot indefinitely sustain its
operations when distributions consistently exceed earnings. It argues
that, if the Commission caps MLP distributions at earnings, it would
still have to reduce IBES rates in order to recognize the fact that
proxy group members would not be reinvesting retained earnings in
ongoing operations, thereby achieving lower growth rates. Tesoro only
recommends no adjustments to short-term growth estimates if the
Commission caps distributions at a level below earnings, offering 65-
percent of earnings as an example.\101\
---------------------------------------------------------------------------

    \101\ Tesoro, Comments on Growth dated December 21 at 3-4, 5-7.
---------------------------------------------------------------------------

    81. The State of Alaska recommends that if a pipeline company's
distributions per share exceed its earnings per share (as is frequently
the case with pipeline MLPs), then the expected growth rate of the
pipeline's distributions per share should be adjusted to equal (1) the
expected growth of its earnings per share, multiplied by (2) the ratio
of the pipeline's earnings per share to its distributions per share.
According to Alaska, if a pipeline company distributes more cash than
its current earnings, then the projected growth in earnings per share
should also be adjusted by the ratio of the pipeline's earnings per
share to its distributions per share.\102\
---------------------------------------------------------------------------

    \102\ State of Alaska, Comments dated Dec. 21 at 3-4; Second
Horst Aff. at 2-3, 5-11.
---------------------------------------------------------------------------

    82. The Commission rejects these proposals by Tesoro and the State
of Alaska. As already discussed, to the extent investors expect an
MLP's distributions in excess of earnings to reduce its growth
prospects, that fact should be reflected in the IBES five-year growth
projections themselves, without the need for any further adjustment.
MLPs must publicly report their earnings and distribution levels.
Therefore, the security analysts are aware of the degree to which each
MLP is making distributions in excess of earnings. The security
analysts presumably take that information, together with all other
available information concerning the MLP, into account when making
their projections. Moreover, these proposals would have a similar
effect as capping the distributions used to calculate dividend yield at
or below the level of the MLP's earnings. For the reasons previously
discussed, the Commission finds that any cap on an MLP's distributions
used in the DCF model at a level below the actual distribution is
inconsistent with the basic operation of the DCF model. Thus, using a
straight IBES five-year projection without modification presents the
best method of estimating an MLP's short-term growth rate.
    83. APGA further suggests revising IBES growth rates by averaging
them with the comparable growth forecasts reported by Zacks Investment.
It states that this averaging could help remove anomalous or outlying
growth rates. It offers as an example, on December 10, 2007, IBES
projected a five-year growth rate of 7.60 percent for Kinder Morgan
Energy Partners (KMEP), whereas Zacks Investment projected a 33.70
percent growth rate for that company. APGA argues that the Commission
should also use Value Line reports to test the reasonableness of
projected growth rates for MLPs.\103\
---------------------------------------------------------------------------

    \103\ APGA, Additional Comments dated Dec. 21 at 3, 9-10.
---------------------------------------------------------------------------

    84. The Commission will not require that IBES growth rates be
averaged with the corresponding company's growth rates as reported for
Zacks Investment at this time, or that Value Line reports be used to
test the reasonableness of projected growth rates for MLPs. Finally,
PSCNY requests that the Commission clarify that Thomson Financial Data
posted on Yahoo.com may be used in the DCF formula, since Thomson
Financial owns IBES.\104\ The Commission clarifies that the growth
projections to be used in the DCF model are those reported by IBES. If
they are the same growth projections posted by Thomson Financial Data
on Yahoo.com, then they are acceptable for the DCF model.
---------------------------------------------------------------------------

    \104\ PSCNY, Supplemental Comments dated Dec. 21 at 5.
---------------------------------------------------------------------------

D. The Long Term Growth Component

1. Comments
    85. At this point the critical issue is whether the long term
growth component of the Commission's DCF methodology should be modified
in determining the equity cost of capital for an MLP. As has been
discussed, for more than a decade the Commission has required that
projected long-term growth in GDP be used as the corporate long term
(terminal) growth component of the DCF calculation. The discussion at
the technical conference disclosed four general positions. The
AOPL,\105\ NAPTP,\106\ INGAA,\107\ and TransCanada \108\ asserted that
the use of long term GDP is equally applicable to MLPs as to
corporations.\109\ However, the APGA,\110\ PSCNY,\111\ and the State of
Alaska \112\ all made suggestions for a reduction to the GDP growth
projection to reflect the different retention and investment practices
of MLPs.\113\ In a different vein, INGAA suggested the use of the
average of the projected long term inflation rate and projected long
term

GDP as a proxy for the lower growth rate of the limited partnership
interests, but only if the Commission concluded that some reduction in
the MLP long term growth rate was warranted.\114\ NAPTP further argued
that there must be an upward adjustment of the limited partnership
growth rate to reflect the equity cost of capital of the limited and
general partners, and thus that of the entire firm.\115\
---------------------------------------------------------------------------

    \105\ AOPL, Post-Technical Conference Comments at 7-9, 13.
    \106\ NAPTP Additional Comments dated Dec. 21 at 1, 10-11; Post-
Technical Conference Comments at 4-8.
    \107\ INGAA, Additional Initial Comments dated Dec. 21 at 2-3;
Post-Technical Conference Reply Comments at 3-6.
    \108\ TransCanada Post-Technical Comments at 2-5.
    \109\ MidAmerican and Williston supported this position.
    \110\ APGA Additional Comments dated Dec. 21 at 4, 7-8; Initial
Post-Technical Comments at 2, J. Bertram Solomon Aff. at 4-8.
    \111\ PSCNY, Supplemental Comments dated Dec. 21 at 5, 8-9 and
appended Prepared Statement of Patrick J. Barry for the January 23,
2008 Technical Conference; Initial Post-Technical Conference
Comments at 14-16.
    \112\ State of Alaska, Comments dated Dec. 21 at 3-4 and Second
Horst Aff. at 3, 5-7. Reply Comments dated February 20, 2008 at 6.
    \113\ NGPA and Tesoro also supported a lower long term growth
rate for MLPs.
    \114\ INGAA Additional Initial Comments dated Dec. 21 at 3-4 and
Vilbert Report attached thereto, passim.
    \115\ NAPTP Reply Comments dated Sept. 19 at 2-4; Additional
Comments dated Dec. 21 at 9-12.
---------------------------------------------------------------------------

    86. The Pipeline Interests also generally assert that an MLP's
terminal growth can be at least equal to that of a corporation, and
perhaps exceed it. They assert that MLPs are able to raise external
capital in a tax efficient manner. Because an MLP does not retain cash
it does not immediately need and can distribute without the tax
penalty, it is under less pressure to invest idle capital. Rather, an
MLP can wait until sounder investment opportunities are available and
pursue them more discreetly, which results in a more consistent return
from the projects selected.\116\ Moreover, while the computation is
very complicated, the tax-deferral aspects of MLP limited partnership
interest normally result in a higher per unit price when issued and
thus a lower cost of equity capital to the issuing MLP. For these
reasons the Pipeline Interests conclude that MLPs should readily find
profitable investment opportunities despite their lower retention
ratios.\117\
---------------------------------------------------------------------------

    \116\ NAPTP Post-Technical Conference Comments at 9; TransCanada
Post Technical Conference Comments at 8-9.
    \117\ NAPTP, id. 2, 5-6. TransCanada, id.
---------------------------------------------------------------------------

    87. The Pipeline Interests further assert that the record
demonstrates that MLPs have a long term history of growing
distributions and an overall growth rate that has at times been higher
than that of corporations.\118\ They cite to the example of KMEP in
particular and that KMEP has been able to grow its distributions in
good or poor financial environments.\119\ They therefore conclude that
there is no reason to conclude that MLPs cannot continue to grow at
least as fast as corporations or that the relatively high distribution
growth rate for the industry as a whole will not be sustained.\120\
However, INGAA concedes that even if an MLP as a whole can grow as fast
as a corporation, the limited partnership interests would grow less
rapidly than the MLP as a whole because of the IDRs \121\ most MLPs
have granted their general partners.\122\ The Pipeline Interests also
argue that investors will not invest in enterprises that have a
projected growth rate that is less than GDP and that such firms are
likely to fail.\123\
---------------------------------------------------------------------------

    \118\ NAPTP Additional Comments dated Dec. 21 at 4-8.
    \119\ NAPTP Additional Comments dated December 21 at 8.
    \120\ NAPTP and Post-Technical Conference Comments at 11-12 AOPL
Post-Technical Conference at 9-10 and Williamson Post Technical
Conf. Aff. Ex. at 1 and 2.
    \121\ IDRs operate as follows. Most MLP agreements provide that
the limited partners own 98 percent of the equity when the firm is
first created and the general partner 2 percent. Thus, given a
distributable cash of $1,000, the limited partners would obtain $980
(98 percent) and the general partner $20.00 (2 percent). The
partnership agreement also provides that as the total cash available
for distribution increases, a greater share goes to the general
partner, including that which would be available in liquidation. For
example, the partnership agreement may provide that once
distributable cash is $3,000, the general partner will receive 2
percent based on its partnership interest and 48 percent based on
the IDRs.
    At that point the limited partners' share of the distribution is
$1,500 (50 percent) and the general partner's share is also $1,500
(50 percent). Thus, while the limited partners' distribution has
grown in the relevant time frame (by 50 percent), it has not grown
as fast as it would have absent the general partner's IDR. Absent
the IDR the general partner's share would only be $60. Since a
proportionately smaller share of future value flows to the limited
partners in the initial years, the projected long term growth rate
for a limited partnership interest will be lower. Therefore the
limited partnership interests have lower return than that of the
general partner.
    \122\ INGAA Additional Initial Comments dated December 21 at 5;
TransCanada.
    \123\ AOPL, Post-Technical Comments at 7-8. TransCanada,
Additional Comments dated Dec. 21 at 2, 4-5.
---------------------------------------------------------------------------

2. Discussion
    a. Should the MLP long-term growth projection be lower than
projected growth in GDP?
    88. As discussed in the previous section, in determining the
appropriate growth projections to use in its DCF analysis, the
Commission seeks to approximate the growth projections investors would
rely upon in making their investment decisions. This principle applies
equally to the long-term growth projection, as to the short-term growth
projection. When the Commission first established its policy of basing
the long-term growth projections on projected growth in GDP in Opinion
No. 396-B and Williston I, the Commission stated in both cases, ``The
purpose of using the DCF analysis in this proceeding is to approximate
the rate of return an investor would reasonably expect from a pipeline
company.'' \124\ The Commission found, ``the record shows that Merrill
Lynch and Prudential Bache do not attempt to make long-term growth
projections for specific industries or companies in doing DCF analyses.
Instead they use the long-term growth of the United States economy as a
whole as the long-term growth forecast for all firms, including
regulated businesses.'' \125\ The Commission thus relied heavily on
evidence concerning investment house long-term growth projections in
deciding to base its long-term growth projections for corporations that
were properly included in the proxy group on the long-term growth of
GDP. In affirming this aspect of Williston I, the DC Circuit similarly
relied on the fact that the record ``demonstrated that major investment
houses used an economy-wide approach to projecting long-term growth * *
* and that existing industry-specific approaches reflected investor
expectations and many unfounded economic assumptions.'' \126\
---------------------------------------------------------------------------

    \124\ Opinion No. 396-B, 79 FERC ] 61,309 at 62,383. Williston
I, 79 FERC at 62,389.
    \125\ Opinion No. 396-B, 79 FERC ] 61,309 at 62,382. Williston
I, 79 FERC ] 61,311 at 62,389. As the Commission pointed out in a
subsequent case, the exhibits in both the Opinion No. 396-B
proceeding and Williston I, describing Prudential Bache's
methodology stated that it used a lower long-term growth projection
for electric utilities, because of their high payout ratios. System
Energy Resources, Inc., 92 FERC ] 61,119, at 61,445 n.23 (2000).
    \126\ Williston Basin Interstate Pipeline Co. v. FERC, 165 F.3d
54 (DC Cir. 1999).
---------------------------------------------------------------------------

    89. Consistent with this precedent, the key question in deciding
what long-term growth projection the Commission should use in its DCF
analysis of MLPs is whether investors expect MLP long-term growth rates
to be less than projections of growth in GDP. The record established
here shows that at least two major investment houses project terminal
growth rates for MLPs that are notably lower than the current 4.43
percent projected growth in GDP. Citicorp Smith Barney (Citicorp) \127\
projects a 1 percent terminal growth rate for pipeline MLPs. Wachovia
projects terminal growth rates for individual MLPs that vary from zero
to 3.5 percent.\128\ The Wachovia projection for each MLP which the
Commission is likely to include in a proxy group \129\ is for a 2.5
percent terminal growth rate.\130\

The Pipeline Interests did not submit any evidence of a major
investment house projecting long-term growth rates for MLPs equal to or
above the growth in GDP. Thus, applying the same approach as that in
Opinion No. 396-B and Williston I, the record supports a finding that
investors project MLP growth rates significantly below the growth in
GDP.
---------------------------------------------------------------------------

    \127\ Society, Reply Comments at 11, citing: Citicorp Master
Limited Partnership Monitor and Reference Book, Citigroup Investment
Research (March 2007) at 28, Figure 24.
    \128\ Comments of Enbridge Energy Partners, L.P., Attachment A,
Wachovia Equity Research Paper dated August 20, 2007 at 9-12;
Wachovia Equity Research dated January 30, 2008, MLP Outlook 2008:
Cautious Optimism at 39-44.
    \129\ These are the MLPs listed in Tables 1 and 2.
    \130\ NAPTA, in its Post-Technical Conference Comments, provided
a publication by Morgan Stanley Research which, among other things,
reported on our January 23, 2008 technical conference. That
publication, at page 3, states, ``At Morgan Stanley, we assume an
MLP will increase its cash flow--1.5%-3.0% per year beyond 2012.
Importantly we make the same assumption in forecasting long-term
growth for our C-Corp companies.'' Pipeline MLPs: What's in the
Pipeline, Morgan Stanley Research at 3. These projections are also
less than the current projection of 4.43 percent long-term growth in
the economy as a whole. However, we give greater weight to the
Citigroup and Wachovia publications, because those publications
include specific long-term growth projections for individual MLPs,
whereas the Morgan Stanley publication simply sets forth a general
range it uses without specifying how that range is distributed among
individual firms. Also, the Citigroup and Wachovia analyses were not
issued in response to the technical conference.
---------------------------------------------------------------------------

    90. To counter this conclusion, the Pipeline Interests argue that
these lower figures reflect the investment houses' desire to use
``conservative'' estimates in order to prevent unrealistic investor
expectations. However, as discussed above, the Commission has found in
earlier cases that investment houses try to give the most accurate
information to their investors. In any event, it is appropriate for the
Commission to use growth estimates that reflect the investment houses'
view of what investors should realistically expect from an investment
in an MLP. Moreover, the fact that some MLPs have grown rapidly in the
past does not mean necessarily that they will maintain the same growth
rate in the future. In fact, KMEP's projected growth rate is expected
to drop in future years.\131\ This record also demonstrates that a rate
of long term growth is dependent on the base years selected. Thus, the
Customer Interests focus on more recent years to show that the growth
rate has slowed for many MLPs.\132\
---------------------------------------------------------------------------

    \131\ APGA, Post-Technical Conference Reply Comments, Solomon
Aff. at 4.
    \132\ APGA, Post-Technical Conference Reply Comments at 4-5 and
attached Solomon Aff. at 4-9.
---------------------------------------------------------------------------

    91. The Pipeline Interests also argue that investors will not
invest in entities with a projected long term growth rate that is less
than the long-term growth in GDP.\133\ However, the fact is that,
despite major investment houses advising their clients that MLPs will
have long-term growth rates below GDP, investors have continued to
invest in MLPs, and in increasing amounts through 2007. Historically
this was true even though the Commission's analyses continue to
indicate that the IBES five-year growth projections for MLPs are lower
than those for corporations.\134\
---------------------------------------------------------------------------

    \133\ TransCanada, Additional Comments at 5; AOPL Post-Technical
Conference Comments at 8.
    \134\ See Appendix A, which displays in part the comparative
corporate and MLP short term growth projections. Cf. PSCNY Post
Technical Conference Comments at 7-8.
---------------------------------------------------------------------------

    92. At bottom, the key financial assumption advanced by the
Pipeline Interests is that MLPs and corporations have equal access to
capital. However, the Customer Interests advance credible reasons why
MLPs may not have as ready access to capital markets in the future
given the MLPs' unique financial structure. This would reduce the total
capital pool available to the MLPs, thus reducing their growth
prospects. These include a greater exposure to interest rate risk,\135\
the increased cost of capital that a high level of IDRs imposes on an
MLP,\136\ and lower future returns from either acquisitions or organic
investments as the MLP industry matures.\137\ This latter point is of
greater importance to MLPs because they are limited by law to a
narrower range of investment opportunities than a schedule C
corporation. These arguments suggest why the long term forecasts by
investment houses investors rely on could conclude that the long term
growth rate for MLPs would be less than the long term GDP the
Commission uses for corporations. Each addresses the consistency of
investment opportunities and as such consistency of access to capital
markets that MLPs are dependent on to maintain long term growth.
---------------------------------------------------------------------------

    \135\ Indicated Shippers Initial Comments at 21, citing Citicorp
Smith Barney; AGPA Reply Comments at 5; Wachovia August 20, 2007
Report, supra, at 1-2;
    \136\ PSCNY Supplemental Comments at 3, n. 8 and Initial Post-
Technical Conference Comments at 12.
    \137\ PSCNY Initial Post-Technical Conference Comments at 9-10
and cited Value Line attachments; Reply Comments at 5-6 citing
Merrill Lynch, n. 16.
---------------------------------------------------------------------------

    93. In particular, the Commission concludes that corporations (1)
have greater opportunities for diversification because their investment
opportunities are not limited to those that meet the tax qualifying
standards for an MLP and (2) are able to assume greater risk at the
margin because of less pressure to maintain a high payout ratio. It is
a corporation's higher retention ratio that allows this greater
flexibility. This is consistent with the fact that Prudential Bache
projected the long-term growth rates of electric utilities to be less
than that of the economy as a whole because of their greater dividend
payouts and lower retention ratios.\138\ Therefore, investors would
quite reasonably conclude that MLP long term growth rates would be
lower than that of tax paying corporations, because MLPs have fewer
opportunities to participate in the broad economy that underpins the
Commission's current use of long-term growth in GDP.
---------------------------------------------------------------------------

    \138\ System Energy Resources, Inc., 92 FERC ] 61,119, at 61,445
n. 23 (2000).
---------------------------------------------------------------------------

    94. Thus, while it is true that the Commission uses GDP as a proxy
for long term growth, the point here is not whether some firms,
including MLPs may have a growth rate that is more or less than the
proxy over time. The issue is whether MLPs have the same relative
potential as the corporate based economy that has been the basis for
the Commission's assumption that a mature firm will grow at the same
rate as the economy as a whole. For the reasons stated, the Commission
concludes that the collective long term growth rate for MLPs will be
less than that of schedule C corporations regardless of the past
performance of MLPs the Pipeline Interests have inserted in the record.
    b. What specific projection should be used for MLPs?
    95. We now turn to the issue of exactly what long-term growth
projection below GDP should be used in MLP pipeline rate cases. As the
Commission recognized when it established its policy of giving the
long-term growth projection only one-third weight, while giving the
short-term growth projection two-thirds weight, ``long-term growth
projections are inherently more difficult to make, and thus less
reliable, than short-term projections.'' \139\ Thus, as the Commission
has stated with respect to the other aspects of its long-term growth
projection policy, the Commission is ``required to choose from among
imperfect alternatives'' \140\ in deciding what specific long-term
growth projection should be used for MLPs.
---------------------------------------------------------------------------

    \139\ Transcontinental Gas Pipe Line Corp., 84 FERC ] 61,084, at
61,423 (1998).
    \140\ Northwest Pipeline Corp., 88 FERC ] 61,298, at 61,911
(1999).
---------------------------------------------------------------------------

    96. The technical conference panelists advanced four methods of
determining long-term growth projections for MLPs which are less than
the growth in GDP. After reviewing all four, the Commission adopts the
APGA proposal to use a long-term growth projection for MLPs equal to 50
percent of long term GDP.\141\ At present, that proposal results

in a long-term growth projection of 2.22 percent. This is within the
range of long-term growth projections used by investment houses for
MLPs discussed in the preceding section. For example, Wachovia projects
terminal growth rates for individual MLPs that vary from zero to 3.5
percent,\142\ and its projection for each MLP which the Commission is
likely to include in a proxy group is for a 2.5 percent terminal growth
rate.\143\ Therefore, in light of the inherent difficulty of projecting
long-term growth, the 50 percent of GDP proposal would appear to result
in a long-term growth projection that falls within any reasonable
margin of error for such projections, while giving recognition to the
fact that investors expect MLPs' long-term growth to be less than that
of GDP.\144\
---------------------------------------------------------------------------

    \141\ APGA Additional Comments dated Dec. 21 at 2-3, 8; Outline
for the Presentation of Bertrand Solomon on the Behalf of APGA dated
January 23, 2008 at 3; Initial Post-Technical Conference Comments.
J. Bertrand Solomon Aff. at 3-4, 6-7 and supporting exhibits.
    \142\ Comments of Enbridge Energy Partners, L.P., Attachment A,
Wachovia Equity Research Paper dated August 20, 2007 at 9-12;
Wachovia Equity Research dated January 30, 2008, MLP Outlook 2008:
Cautious Optimism at 39-44.
    \143\ The Commission will not use the specific long-term MLP
growth projections of the investment houses to determine the cost of
equity for specific firms for the same reasons we have not done so
with respect to the projections of long-term growth in GDP the
Commission uses for corporations. As the Commission explained in
Michigan Gas Storage Co., 87 FERC ] 61,038, at 61,162-5 (1999) and
Williston Basin Interstate Pipeline Co., 87 FERC ] 61,264, at
62,005-6 (1999), there is no evidence as to how the investment house
figures were derived which limits their utility in determining the
cost of equity for an individual firm. However, as here, the
Commission has relied on the perceptions of the investment community
in developing a generic long term growth rate. See also Opinion No.
396-B, 79 FERC ] 61,309 at 62,384.
    \144\ As the DC Circuit stated with respect to our choice of the
relative weighting of the short- and long-term growth projections,
the choice of the long-term growth component is also an exercise
``hard to limit by strict rules.'' CAPP v. FERC, 254 F.3d at 290.
---------------------------------------------------------------------------

    97. The Commission also concludes that the other three proposed
methods of projecting MLP long-term growth rates all have flaws
justifying their rejection. The State of Alaska and the NYPSC propose
methods which would result in varying long-term growth projections for
each MLP, based upon financial information for each of the MLPs to be
included in a proxy group. These proposals are contrary to the
Commission's policy of using a single long-term growth projection for
all corporations, based on the fact that it is not possible to make
reliable company-by-company long-term growth projections.\145\ The
State of Alaska and NYPSC have provided no basis to conclude that they
have provided a more reliable way to make long-term growth projections
for individual MLPs. Their difficulty in doing so reinforces the
Commission's traditional practice in this regard.
---------------------------------------------------------------------------

    \145\ Opinion No. 396-B, 79 FERC ] 61,309 at 62,382.
---------------------------------------------------------------------------

    98. The State of Alaska suggests adjusting the GDP long term growth
projection used for each MLP based on its current positive or negative
retention ratio.\146\ Thus, if an MLP's retention ratio was positive,
then 100 percent of long term growth in GDP would be used. If the
retention ratio was less than one, then the long term growth in GDP
would be reduced accordingly. This theory essentially caps the long
term growth rate at the earnings of the entities involved. As such, it
suffers from the same weakness as the original proposal to cap the
distribution component included in the model at earnings. Consistent
with the premise of the DCF model that a stock is worth the present
value of all future cash flows to be received from the investment,
investors base their DCF analyses on the MLP's entire cash
distributions, including projected cash flows generated by external
investments, which to date is the bulk of the investment for the MLP
model. In addition, because MLPs rely substantially on external capital
to finance growth, the fact one MLP currently pays out more of its
earnings than another MLP does not necessarily mean that the first
MLP's long-term growth prospects are less than the second MLP's.
Moreover, Alaska's proposed method assumes each MLP's current retention
ratio will continue indefinitely into the future, without any support
for the accuracy of such an assumption.
---------------------------------------------------------------------------

    \146\ State of Alaska, Comments dated December 21 at 3-4 and
Second Horst Aff. at 3, 5-7. Reply Comments dated February 20, 2008
at 6.
---------------------------------------------------------------------------

    99. The NYPSC recommends use of a modified form of the sustainable
growth model the Commission uses to determine electric return on
equity.\147\ Under that method, the Commission determines growth based
on a formula under which growth = br + sv, where b is the expected
retention ratio, r is the expected earned rate of return on common
equity, s is the percent of common equity expected to be issued
annually as new common stock, and v is the equity accretion rate. The
br component of this formula projects a utility's growth from the
investment of retained earnings, and the sv component estimates growth
from external capital raised by the sale of additional units. The NYPSC
would assume zero growth from investment of retained earnings (the br
component) and then base the long-term growth projection for each MLP
on projected growth from external capital resulting from the sv
component of the br + sv formula.
---------------------------------------------------------------------------

    \147\ PSCNY, Supplemental Comments dated Dec. 21 at 5, 8-9 and
appended Prepared Statement of Patrick J. Barry for the January 23,
2008 Technical Conference; Initial Post-Technical Conference
Comments at 14-16.
---------------------------------------------------------------------------

    100. A fundamental problem with this approach is that the
Commission has consistently held that the br + sv formula only produces
a projection of short-term growth, similar to the IBES
projections.\148\ This follows from the fact that the inputs used in
the formula are all drawn from Value Line data and projections reaching
no more than five years into the future. In addition, there would be
great uncertainties in projecting any of the inputs to the formula,
such as the retention ratio, the amount and timing of equity sales, and
the projected price of the sale for any longer period. Moreover,
setting the br component at zero assumes that an MLP can only grow
through the use of external capital. This does not reflect accurately
the retention and investment flexibility vested in an MLP's general
partners or the fact that some MLPs may reinvest a fairly high
proportion of the free cash available. Therefore this methodology does
not appropriately adjust the long term GDP component that the
Commission now uses for corporations.
---------------------------------------------------------------------------

    \148\ See Southern California Edison Co., 92 FERC ] 61,070, at
61,262-3 (2000).
---------------------------------------------------------------------------

    101. Finally, INGAA provided a complex model designed to calculate
the equity cost of capital for an MLP as a whole.\149\ This model was
developed by Mr. Vilbert and attempts to calculate the equity cost of
capital for both the limited and the general partners. At their
inception, MLPs establish agreements between the general and limited
partners, which define how the partnership's cash flow is to be divided
between the general and limited partners. Such agreements give the
general partners IDRs, which provide for them to receive increasingly
higher percentages of the overall distribution, if the general partners
are able to increase that distribution above defined levels. The INGAA
model recognizes that, as a result of these incentive distribution
rights, a DCF analysis of the MLP as a whole should (1) include higher
projected growth rates for the general partner interest than for the
limited partner interest and (2) a correspondingly higher value for
general partner interests than the MLP units which would, in turn,
reduce the

general partner's current ``dividend'' yield. However, since there are
relatively few publicly traded general partner interests, in most cases
the estimated equity cost of capital for the general partner can only
be derived through various assumptions that markup the limited
partner's cost of capital.
---------------------------------------------------------------------------

    \149\ INGAA, Additional Initial Comments dated Dec. 21 at 4-5
and Report on the Terminal Growth Rate for MLPs for Use in the DCF
Model by Michael J. Vilbert dated December 21, 2007 (Vilbert
Report), particularly at 10.
---------------------------------------------------------------------------

    102. INGAA drew two significant conclusions from Mr. Vilbert's
analysis. First, application of the Commission's existing DCF
methodology solely to the limited partner interest in the MLP would
generate returns relatively close to those that would be required to
reflect the growth rate, and cost of equity capital, for the MLP as a
whole. Second, if the Commission remains concerned that a DCF analysis
using data solely for the limited partner interest,\150\ together with
a long-term growth rate equal to the growth in GDP, may overstate the