[Federal Register Volume 75, Number 245 (Wednesday, December 22, 2010)]
[Rules and Regulations]
[Pages 80300-80313]
[FR Doc No: 2010-32062]

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DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 342

[Docket No. RM10-25-000]

Five-Year Review of Oil Pipeline Pricing Index

Issued December 16, 2010.
AGENCY: Federal Energy Regulatory Commission, DOE.

ACTION: Order establishing index for oil price change ceiling levels.

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SUMMARY: The Federal Energy Regulatory Commission (Commission) is
issuing this Final Order concluding its third five-year review of the
oil pricing index, established in Order No. 561. After consideration of
the initial, reply and supplemental comments, the Commission has
concluded that an index level of Producer Price Index for Finished
Goods plus 2.65 percent (PPI-FG+2.65) should be established for the
five-year period commencing July 1, 2011. At the end of this five-year
period, the Commission will once again initiate review of the index to
determine whether it continues to measure adequately the cost changes
in the oil pipeline industry.

ADDRESSES: Secretary of the Commission, Federal Energy Regulatory
Commission, 888 First Street, NE., Washington, DC 20426.

FOR FURTHER INFORMATION CONTACT:

Andrew Knudsen (Legal Information), Office of the General Counsel, 888
First Street, NE., Washington, DC 20426,<PHONE_NUMBER>;
Michael Lacy (Technical Information), Office of Energy Market
Regulation, 888 First Street, NE., Washington, DC 20426, (202) 502-
8843.

SUPPLEMENTARY INFORMATION:

Before Commissioners: Jon Wellinghoff, Chairman; Marc Spitzer,
Philip D. Moeller, John R. Norris, and Cheryl A. LaFleur.

Order Establishing Index for Oil Price Change Ceiling Levels

    1. On June 15, 2010, the Commission issued a Notice of Inquiry
(NOI),\1\ in which it proposed to continue using the Producer Price
Index for Finished Goods plus 1.3 percent (PPI-FG+1.3) for the next
five-year period beginning July 1, 2011. The Commission applies the
index to existing oil pipeline transportation rates to establish new
annual rate ceiling levels for pipeline rate changes. The NOI invited
interested persons to submit comments on the continued use of PPI-
FG+1.3 and to propose, justify, and fully support, any alternative
indexing proposals. Comments and reply comments were due August 20,
2010, and September 20, 2010, respectively. Based upon full
consideration of the comments and reply comments received, and for the
reasons discussed below, the Commission finds that an index of PPI-FG
plus 2.65 percent (PPI-FG+2.65) should be established for the five-year
period commencing July 1, 2011.
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    \1\ Five-Year Review of Oil Pipeline Pricing Index, 75 FR 34959
(June 21, 2010), FERC Stats. & Regs. ] 35,566 (2010) (NOI).
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I. Background

A. Establishment of the Indexing Methodology

    2. Congress in the Energy Policy Act of 1992 (EPAct 1992) required
the Commission to establish a ``simplified and generally applicable''
ratemaking methodology for oil pipelines \2\ that was consistent with
the just and reasonable standard of the Interstate Commerce Act
(ICA).\3\ On October 22, 1993, the Commission issued Order No. 561,\4\
promulgating regulations pertaining to the Commission's jurisdiction
over oil pipelines under the ICA and fulfilling the requirements of the
EPAct 1992. In Order No. 561, the Commission developed an indexing
methodology for the purpose of allowing oil pipelines to change rates
without making cost-of-service filings. The Commission found that the
indexing methodology adopted in the final rule simplified and expedited
the process of changing rates. The Commission further determined that
the indexing methodology would ensure compliance with the just and
reasonable standard of the ICA by subjecting the chosen index to
periodic monitoring and, if necessary, adjustment. After extensive
analysis of proposals from interested parties, the Commission adopted
an index of PPI-FG minus 1 percent (PPI-FG-1), which was supported by a
methodology developed by Dr. Alfred E. Kahn (Kahn Methodology) on
behalf of a group of shippers. The Commission also committed to review
every five years the continued appropriateness of the index in relation
to industry costs.
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    \2\ Public Law 102-486, 106 Stat. 3010, Sec.  1801(a) (Oct. 24,
1992). The EPAct 1992's mandate of establishing a simplified and
generally applicable method of regulating oil transportation rates
specifically excluded the Trans-Alaska Pipeline System (TAPS), or
any pipeline delivering oil, directly or indirectly, into it. Id.
Sec.  1804(2)(B).
    \3\ 49 U.S.C. app. 1 (1988).
    \4\ Revisions to Oil Pipeline Regulations Pursuant to the Energy
Policy Act, Order 561, FERC Stats. & Regs. ] 30,985 (1993), order on
reh'g, Order No. 561-A, FERC Stats. & Regs. ] 31,000 (1994), aff'd,
Association of Oil Pipe Lines v. FERC, 83 F.3d 1424 (D.C. Cir. 1996)
(AOPL I).
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    3. In the first five-year review, which established the index level
for 2001-2006, the Commission deviated from the Kahn Methodology, and,
based upon a different analysis, concluded that the index should be
retained as PPI-FG-1.\5\ The U.S. Court of Appeals for the District of
Columbia (D.C. Circuit) reviewed and remanded the Commission's order
because the Commission failed to justify a departure from the Kahn
Methodology used in Order No. 561.\6\ On remand, the Commission used
the Kahn Methodology to set an index level of an unadjusted PPI-FG for
the five-year period beginning July 2001. This order on remand was
upheld by the D.C. Circuit.\7\
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    \5\ Five-Year Review of Oil Pipeline Pricing Index, 93 FERC ]
61,266 (2000) (First Five-Year Review), aff'd in part and remanded
in part sub nom. AOPL v. FERC, 281 F.3d 239 (DC Cir. 2002) (AOPL
II).
    \6\ AOPL II, 281 F.3d 239.
    \7\ Five-Year Review of Oil Pipeline Pricing Index, 102 FERC ]
61,195 (2003) (First Five-Year Review Remand Order), aff'd sub nom.
Flying J Inc. v. FERC, 363 F.3d 495 (DC Cir. 2004).
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    4. In the second five-year review, the Commission proposed to
retain the rate of an unadjusted PPI-FG. However, based upon the data
presented during that proceeding, the Commission adopted an index of
PPI-FG+1.3, which was again calculated using the Kahn Methodology.\8\
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    \8\ Five-Year Review of Oil Pipeline Pricing Index, 114 FERC ]
61,293 (2006) (Second Five-Year Review).
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B. The Kahn Methodology

    5. The Kahn Methodology measures changes in operating and capital
costs

on a per barrel-mile basis using Form No. 6 data from the prior five-
year period (for example, between 2004 and 2009 in this proceeding).\9\
The Kahn Methodology does not include direct measures of the capital
costs related to rate of return on investment or income taxes; as a
proxy for this data, the Kahn Methodology relies upon changes over the
five year period in net carrier property per barrel-mile.
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    \9\ Specifically, this data is drawn from the Form No. 6:
Carrier Property, page 110; Accrued Depreciation, page 111;
Operating Revenues and Operating Expenses, page 114; Crude and
Products Barrel-Miles, page 600. To the extent this information is
incomplete, alternate data reported in the Form No. 6 has been
substituted.
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    6. The Kahn Methodology assigns a weight to the Form No. 6
operating expenses relative to the net plant using an ``operating
ratio.'' \10\ The weighted operating expense and the weighted net plant
are then added together to establish the cumulative cost change for
each pipeline.\11\
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    \10\ The ``operating ratio'' = ((Operating Expense at Year 1/
Operating Revenue at Year 1) + (Operating Expense at Year 5/
Operating Revenue at Year 5))/2. If the operating ratio is greater
than one, then it is assigned the value of 1 under the Kahn
Methodology.
    \11\ Cumulative Cost Change = (1-operating ratio) * net plant +
operating ratio * operating expenses.
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    7. Once these cumulative cost changes have been calculated for each
pipeline with sufficient Form No. 6 data, the Kahn Methodology culls a
data set consisting of pipelines with cumulative per-barrel-mile cost
changes in the middle 50 percent of all pipelines. Later applications
of the index also culled a data set consisting of pipelines with
cumulative cost changes in the middle 80 percent of all pipelines. This
trimming is done to remove statistical outliers, or spurious data
points that could bias the sample in either direction.
    8. For each of the two data sets (the middle 50 percent and the
middle 80 percent), the Kahn Methodology considers three different
measures of central tendency. One measure is the median of each data
set. Another measure, the weighted mean, calculates an average barrel-
mile cost change in which each pipeline's cost change is weighted by
its barrel-miles. A third measure, the un-weighted average, calculates
the simple average of the percentage cost change per barrel-mile for
each pipeline. For each data set, a composite, is calculated by taking
the simple average of the median, the weighted mean, and the un-
weighted mean. Table 1 provides a description of the statistical values
of central tendency used by parties to develop the index.

                                 Table 1
------------------------------------------------------------------------
            Line                Middle 80 percent     Middle 50 percent
------------------------------------------------------------------------
A...........................  Median..............  Median.
B...........................  Weighted Mean.......  Weighted Mean.
C...........................  Un-weighted Mean....  Un-weighted Mean.
D...........................  Composite of 80       Composite of 50
                               percent = (A+B+C)/3.  percent = (A+B+C)/
                                                     3.
------------------------------------------------------------------------

    In the most recent index review, the industry-wide cost index
differential was calculated by averaging the middle 50 composite and
the middle 80 composite on Line D and then comparing that value to the
PPI-FG index data over the same period. The index level was then set at
PPI-FG plus (or minus) this differential.
    9. The Kahn Methodology has evolved during the course of prior
index reviews. In Order Nos. 561 and 561-A, the Commission only
considered the middle 50 percent and did not consider the middle 80
percent. In the first and second five-year index reviews, the
Commission considered both the middle 50 percent and the middle 80
percent. Also, in Order Nos. 561 and 561-A, as well as the first
review, the Commission merely cited Kahn's Methodology to demonstrate
that it produced index levels that were close, although not exactly the
same as, the proposed index levels of PPI-FG-1 (in Order Nos. 561 and
561-A) and an unadjusted PPI-FG (in the first review). In the second
five-year review, the Commission used the Kahn Methodology itself to
set the precise index levels by averaging the middle 50 and middle 80
composites relative to PPI-FG over the prior five-year period.

II. Comments From Industry

    10. Comments were filed by the American Trucking Associations,
National Propane Gas Association (NPGA), Tesoro Refining and Market
Company and Sinclair Oil Corporation (Sinclair/Tesoro, collectively),
Air Transport Association of America (ATA), Society for the
Preservation of Oil Pipeline Shippers (SPOPS), the Association of Oil
Pipe Lines (AOPL), Valero Marketing and Supply (Valero), and Navajo
Refining Company, L.L.C. (Navajo).
    11. Reply Comments were filed by the Canadian Association of
Petroleum Producers (CAPP), the Pipeline Safety Trust, Sinclair/Tesoro,
Platte Pipe Line Company (Platte), ATA, Navajo, AOPL, and SPOPS.
    12. On September 24, 2010, the U.S. Department of Transportation,
Pipeline and Hazardous Materials Safety Administration (PHMSA) filed a
Motion for Leave to File Out-of-Time and Comments and NPGA filed late
Reply Comments.
    13. On October 8, 2010, Valero filed Supplemental Reply Comments
and on October 20, 2010, AOPL filed a Response (October 20 Response).

A. Proposals for New Index Rates

    14. In comments and reply comments, several parties proposed
departures from existing index levels. AOPL proposes an index of PPI-FG
plus 3.64 percent (PPI-FG+3.64) as the oil pipeline pricing index for
the five-year period beginning July 1, 2011. AOPL states that its
witness, Dr. Ramsey Shehadeh, applied the Kahn Methodology to a data
set including an initial sample of 110 pipelines,\12\ calculating the
following data regarding pipeline cost changes for the 2004-2009
period:
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    \12\ AOPL states that Dr. Shehadeh began his analysis using cost
data reported by the oil pipelines in the Form No. 6 for the years
2004 through 2009. According to AOPL, Dr. Shehadeh then removed from
this data set any pipelines that did not report data for any year in
that period, as well as the Trans Alaska Pipeline System carriers
and any pipelines that had FERC Form No. 6 reporting errors or
incomplete FERC Form No. 6 data.

                              Table 2 \13\
------------------------------------------------------------------------
                                                 Middle 80    Middle 50
                     Line                         percent      percent
------------------------------------------------------------------------
Median........................................         4.26         4.26
Weighted Mean.................................         9.91         7.07
Un-weighted Mean..............................         8.81         5.74
Composite.....................................         7.66         5.69
------------------------------------------------------------------------

    15. AOPL calculated an average annual pipeline cost growth rate of
6.68 percent based upon the middle 50 composite growth rate and the
middle 80 composite growth rate. AOPL notes that the PPI-FG geometric
mean rate of growth for the years 2004 through 2009 is 3.04 percent.
AOPL concludes actual oil pipeline cost increases during the years 2004
through 2009 exceeded PPI-FG at a rate of 3.64 percent (6.68 minus
3.04). Thus, Dr. Shehadeh proposes an index rate for the five-year
period beginning July 1, 2011, of PPI-FG+3.64.
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    \13\ Shehadeh August 20 Decl. at Exhibit A5.
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    16. In contrast, Valero and its expert, Mr. Matthew O'Loughlin,
contend that an index equal to an unadjusted PPI-FG more accurately
reflects pipelines' actual cost changes. Valero states that Mr.
O'Loughlin applies a modified version of the Kahn Methodology. First,
Mr. O'Loughlin proposes to exclude pipelines that experienced large
rate base changes from the data set used to calculate index levels.
Second, to determine cost changes between 2004 and 2009, Mr. O'Loughlin
measures the cost change per barrel-mile between 2004 and 2009 using
the ``Total Cost of Service'' and barrel-miles reported on page 700.
Unlike the other Form No. 6 data used in the Kahn Methodology, the page
700 data includes an interstate total cost of service calculated under
the Opinion No. 154-B Methodology used to determine oil pipeline rates.
Following these procedures, Mr. O'Loughlin derives the following data:

                              Table 3 \14\
------------------------------------------------------------------------
                                                 Middle 80    Middle 50
                     Line                         percent      percent
------------------------------------------------------------------------
Median........................................          2.6          2.6
Weighted Mean.................................          4.9          3.3
Unweighted Mean...............................          3.9          2.9
Composite.....................................          3.8          2.9
------------------------------------------------------------------------

    17. Mr. O'Loughlin notes that the middle 50 composite of 2.9
percent is very close to the PPI-FG of 3.0 percent over the last five
years and supports an index of an unadjusted PPI-FG. In Mr.
O'Loughlin's view, the middle 50 is the most appropriate for
determining index levels, and should be used instead of the composite
of the middle 50 and the middle 80.
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    \14\ O'Loughlin August 20 Aff. ] 6. Mr. O'Loughlin explains that
he only reports data to the nearest tenth because, in his view, more
precision is not useful given the wide ranging distribution of
annual percentage cost changes experienced by the pipelines in the
measurement group. O'Loughlin September 20 Aff. ] 5 n.3.
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    18. Other parties endorsed either the views expressed by AOPL or
Valero. Platte states that it is a member of AOPL and filed to provide
further support for AOPL's request of an index of PPI-FG+3.64. On the
other hand, NPGA states that it supports the arguments and
recommendations espoused by Mr. O'Loughlin on behalf of Valero,
including the use of a PPI-FG without any adjustment. Navajo states
that it prefers Valero's proposal to establish an index level of PPI-
FG.
    19. Other parties also proposed differing index levels. In reply
comments, CAPP and its expert Mark Pinney state that if AOPL's analysis
is reproduced using constant 2004 barrel-miles instead of the
recession-influenced 2009 data, the annual cost increase between 2004
and 2009 is PPI-FG plus 1.62 percent (PPI-FG+1.62), which CAPP observes
is much closer to the current PPI-FG+1.3 than the index level proposed
by AOPL. SPOPS asserts that the index should be set at zero until all
pipeline over-recoveries are at just and reasonable levels and Navajo
proposes to deny index increases to pipelines that are currently over-
recovering. Navajo also proposes to base the index upon changes in
operating and maintenance costs and to allow indexed increases only to
the proportion of the pipeline's rate that can be attributed to such
operating and maintenance costs.
    20. Other parties, as discussed below, without proposing particular
index levels, urge the Commission to reassess the index methodology to
avoid over-recoveries. Some parties also raised procedural concerns and
argued for various changes to the Commission's Form No. 6 reporting
requirements.

III. Discussion

    21. The Commission adopts an index level of PPI-FG+2.65. The
Commission rejects the procedural challenges to the validity of the NOI
and to consideration of any modifications to the Kahn Methodology. The
Commission's proposed index level of PPI-FG+2.65 is supported by the
Kahn Methodology as applied by AOPL, except that the Commission adopts
Valero's proposal to calculate the index using only the middle 50
percent and not the middle 80 percent of the data set.

A. Procedural Arguments

1. The Validity of the Notice of Inquiry
a. Comments
    22. The American Trucking Association and Sinclair/Tesoro challenge
the validity of the NOI. These parties state that the NOI contains no
justification for the index of PPI-FG+1.3 specified in the NOI.
Sinclair/Tesoro emphasizes that an agency must reveal an adequate
explanation of the basis for its proposal and that the rulemaking is
procedurally defective and should be withdrawn. Sinclair/Tesoro avers
that the Commission provided no data analysis or support showing that
it has evaluated the reasonableness of PPI-FG+1.3 as the appropriate
index for determining rate ceilings.
    23. AOPL asserts that these criticisms of the NOI are baseless.
AOPL posits that the Commission's methodology for calculating its index
is well-known to industry participants and that there exists an
``opportunity for interested parties to participate in a meaningful way
in the discussion and final formulation of rules.'' \15\ AOPL further
emphasizes that Dr. Shehadeh has provided data supporting his result
pursuant to the established methodology and states the Commission can
rely upon these calculations and data.
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    \15\ AOPL Reply Comment at 38 (quoting Connecticut Light and
Power Co. v. Nuclear Regulatory Commission, 673 F.2d 525, 528 (DC
Cir.)).
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b. Commission Determination
    24. The Commission rejects the assertion that the NOI is
procedurally defective. The Commission inaugurated its five-year review
of the indexation methodology proposing to continue the existing
indexing level of PPI-FG+1.3 while inviting interested parties ``to
propose, justify, and fully support, any alternative indexing
proposals.'' \16\ By soliciting comments on the current index level,
the Commission follows the same procedure that it used in the previous
five-year review proceeding for allowing parties to present evidence
that the index level should be modified.\17\
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    \16\ NOI, FERC Stats. & Regs. ] 35,566 at P 4.
    \17\ The current indexing level of PPI-FG+1.3 was developed in
the Commission's prior five-year review proceeding. Second Five-Year
Review, 114 FERC ] 61,293. This proceeding involved extensive record
evidence and comments from shippers, and the record from that
proceeding remains available on the Commission Web site.
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    25. Moreover, the Commission subsequently received extensive on-
the-record comments and workpapers from AOPL, Valero, and other
parties. The analysis contained within these findings is based upon
Form No. 6 data, which is publically available on the Commission Web
site and was utilized extensively by both AOPL and Valero. Furthermore,
although the Commission's mechanisms for assessing revisions to the
index may evolve over time, the parties are familiar with the types of
data that have been considered by the Commission in the past, including
the variants of the Kahn

Methodology. The Commission has considered comments, reply comments,
supplemental reply comments, and an even later response, giving each
party more than adequate opportunity to respond. Both the data used in
this proceeding and any potential changes from the methodology used in
the past index review have been subject to ample opportunity for
examination and comment. It is clear that the technical support for the
index level adopted in this proceeding has been provided to the parties
with adequate opportunity for analysis and comment.
2. Scope of This Proceeding
a. Comments
    26. In reply comments, AOPL argues that the Commission must adhere
to the methodology applied in prior proceedings, and AOPL contends that
the changes proposed by Valero and its expert Mr. O'Loughlin (using
page 700 data, excluding pipelines with large rate base changes, and
using only the middle 50 percent) are beyond the scope of the five-year
review initiated by the NOI.
    27. AOPL contends that in the prior five year review, the
Commission limited the purpose of the review to adjustments to the
index, not whether the index should be changed. AOPL adds that because
the existing methodology was promulgated as part of a Commission
rulemaking, replacing that methodology requires a new rulemaking. AOPL
asserts that in the NOI, the Commission requested comments on the
appropriate index level, but gave no indication it was changing its
methodology. Moreover, AOPL adds that to the extent the Commission
departs from its prior methodology, the Commission must establish that
the methodology is justified. In contrast to Mr. O'Loughlin's proposal,
AOPL states that Dr. Shehadeh derived the index of PPI-FG +3.64 with
the same methodology used by Dr. Kahn and adopted by the Commission in
prior proceedings and accepted by the D.C. Circuit.
    28. In supplemental reply, citing FCC v. Fox Television Stations,
Inc.,\18\ Valero states that the Commission only needs to establish
that the new policy is permissible under the statute, that there are
good reasons for the new policy, and that the agency believes it to be
a better policy. Valero emphasizes that the most reasonable course of
action available to an agency is not always to maintain its current
policy unchanged.
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    \18\ 129 S.Ct. 1800 (2009).
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    29. Valero also dismisses AOPL's argument that a new rulemaking
process is required to adopt Mr. O'Loughlin's proposals. Valero
reiterates that it is not proposing a change to this legislative rule
embodied in the regulations, but only a change in data inputs to that
methodology. Valero also contends that all parties, including AOPL, are
on notice of the alternative proposals before the Commission.
    30. Additionally, Valero disagrees with AOPL's contention that the
NOI does not contemplate an analysis such as the O'Loughlin approach.
Valero states that the Commission invited parties to submit comments
proposing, among other things, alternative indexing proposals. Valero
argues that AOPL mistakes Mr. O'Loughlin's improvements to data sources
as a change in the methodology itself. Rather, Valero contends Mr.
O'Loughlin's approach constitutes a better approach to utilizing the
same methodology.
    31. Similarly, on reply, Navajo avers that FERC adopted the Kahn
Methodology only upon the express caveat that its initial conclusions
were not necessarily ``a choice for all time'' and that the ICA
required monitoring of the index. Navajo adds that an agency may depart
from past policy or precedent so long as the Commission acknowledges
the change and supports its new decision with reasoned decision-making
and substantial evidence. SPOPS also emphasizes that the Commission has
the flexibility to modify its indexing methodology.
    32. In its response, AOPL reiterates that Mr. O'Loughlin's
methodology is a fundamental departure from the established methodology
and would require a new rulemaking initiated by a Notice of Proposed
Rulemaking. AOPL states that Fox Television also made clear that an
agency must still provide a reasoned explanation for its decisions and
that a more detailed justification is required when the prior policy
engendered serious reliance interest. Valero, according to AOPL,
downplays this reliance inappropriately. AOPL states that the reliance
interest was not a reliance on any precise pricing index, but rather
that the pipelines have a continued expectation that the Commission
will apply the established methodology in calculating the index.
b. Commission Determination
    33. The Commission rejects AOPL's assertion that modifications to
the methodology for evaluating changing pipeline costs are beyond the
scope of this proceeding. The NOI invited ``interested persons to
submit comments on the continued use of PPI+1.3 and to propose,
justify, and fully support, any alternative indexing proposals.'' \19\
Thus, by inviting parties to submit ``to propose, justify, and fully
support any alternative indexing proposals,'' the Commission provided
notice to AOPL and others that the Commission would consider different
methodologies for calculating the Index, such as the proposals advanced
by Valero, among others.\20\ Although the DC Circuit rejected in 2003
proposed changes to the Kahn Methodology for assessing changing
pipeline costs, the Court rejected this proposal because the Commission
had neither addressed concerns regarding the new methodology nor
justified its methodological shift.\21\ The Court did not hold that the
Commission cannot make justified modifications to the Kahn Methodology.
As the Commission did in prior five-year reviews of the indexing level,
the Commission will give consideration to alternative methodologies for
calculating the index.\22\
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    \19\ NOI, FERC Stats. & Regs. ] 35,566 at P 4.
    \20\ AOPL has been given an opportunity to respond to these
proposals, and AOPL has filed reply comments and an October 20
Response that vigorously critique the proposed alterations to the
Kahn Methodology.
    \21\ AOPL II, 281 F.3d at 248.
    \22\ AOPL argues that in the last indexing review, the
Commission stated that the purpose of the five-year review was to
determine ``what extent the PPI-FG should be adjusted to better
reflect those cost changes, not whether the method for determining
pipeline costs should be changed.'' Second Five-Year Review, 114
FERC ] 61,293 at P 46 (emphasis added). However, in that passage,
the Commission was referring to a proposal by the shipper parties
for an entirely new rulemaking to re-assess the means for tracking
pipeline costs justified, in part, by criticism of the data in Form
No. 6. Id. See also ATA, Lion Oil Company, National Cooperative
Refinery Association, Sinclair/Tesoro, Response, Docket No. RM05-22,
at 13-14 (filed January 23, 2006). However, elsewhere in Second
Five-Year Review, when parties did not propose a new rulemaking and
instead proposed changes using the existing information reported to
the Commission, as Mr. O'Loughlin has done here, the Commission
evaluated those changes and did not find them to be beyond the scope
of the five-year review process. Second Five-Year Review, 114 FERC ]
61,293 at P 30-36 (rejecting proposal to use ``the arithmetic
average of the geometric mean of each pipeline's cumulative unit
cost change, as opposed to Dr. Kahn's method of calculating the
geometric mean of the arithmetic average of cumulative unit cost
change.'').
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B. Proposed Changes to the Kahn Methodology

1. Rate Base Screening Methodology
a. Valero Initial and Reply Comments
    34. To develop the data set for the Index, Valero urges the
Commission to apply a ``rate base screening'' methodology that excludes
pipelines experiencing both: (a) A rate base increase (through
expansion) or decrease (through divestiture) greater

than 50 percent during the 2004-2009 period and (b) recovery of cost
changes during the 2004-2009 period through some means other than
incremental rate increases via the index, such as a cost-of-service
filing or a settlement agreement.\23\ For pipelines with rate base
changes greater than 50 percent, Valero also excluded (a) any pipeline
with a major divestiture or (b) any pipeline that acquired another
pipeline where the pipeline divesting the assets continued to exist
after the divestiture. In conducting the assessment of pipelines with
major rate base changes, Mr. O'Loughlin also excluded pipelines with
what he concluded were unreliable data.
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    \23\ Using the rate base screening methodology, Mr. O'Loughlin
excluded 25 pipelines that he states experienced major rate base
changes during the 2004-2009 period. O'Loughlin August 20 Aff. ] 10.
Twelve pipelines with rate base changes of more than 50 percent
remained in the data set because, according to Mr. O'Loughlin, they
did not appear to have requested alternative ratemaking treatment
and no major acquisition or divestiture was identified. O'Loughlin
October 8 Aff. ] 15.
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    35. Valero justifies the rate base screening methodology because,
citing Order Nos. 561 and 561-A, Valero avers that the index is
intended for normal, not extraordinary, changes. Valero contends that
large rate base changes are ``extraordinary'' and that cost changes of
this nature are typically recovered by a cost-of-service filing or
settlement, not incremental rate changes pursuant to the index.
    36. Thus, if the index level reflects cost data from the pipelines
experiencing rate base changes, Valero argues that pipelines receiving
annual index increases that did not construct major expansions would
obtain a windfall due to an index inflated for cost changes not
experienced by normal pipelines. Furthermore, Valero argues that
pipelines that constructed major expansions would receive double
compensation, first, through a cost-of-service or other rate changing
methodology related to the expansion and, second, through an inflated
index. Furthermore, regarding divestitures and acquisitions, Valero and
its witness O'Loughlin also aver that comparisons between the period
before the divestitures or acquisitions and after those transactions
are meaningless because the systems being compared are different.
    37. Valero argues that measures taken by the Commission in prior
proceedings do not fully correct the biases caused by the inclusion of
these pipelines. For example, Valero asserts the usage of the middle 80
percent or middle 50 percent of the sample data set in the prior rate
proceedings does not adequately mitigate the effect of the inclusion of
the pipelines with major rate base changes.
    38. Valero states that otherwise applying Dr. Shehadeh's
methodology, while using Valero's rate base screening methodology
reduces his recommended index from PPI-FG+3.64 to PPI-FG+2.6. Valero
also states that excluding the pipelines with large rate base
expansions would not frustrate expectations because these pipelines do
not typically use indexing to recover increased costs, and the index
has never previously been set at PPI-FG+3.64 and there could have been
no expectation that this index level would be approved.
b. AOPL Reply Comments
    39. AOPL states that if a pipeline experiencing a rate base change
is truly a statistical outlier, it will be excluded by using the middle
50 and middle 80 data sets as applied in the Kahn Methodology. AOPL
states that Mr. O'Loughlin's ``rate screening methodology'' is a highly
subjective, results-driven attempt to eliminate pipelines with higher
cost changes. This, AOPL argues, biases the data set downward before
any application of statistical measures. AOPL emphasizes that an
appropriate statistical method for excluding outliers must be
systematic and objective.
    40. AOPL contends Mr. O'Loughlin's ``double-recovery'' argument
lacks consistency with the structure of the index methodology.
According to AOPL, under the Commission's regulations, if a pipeline
files a cost-of-service rate increase, those rates form the ceiling for
that year, but in the next index year, the pipeline must apply the
applicable index, whether it is higher or lower. AOPL asserts that,
rather than reflecting ``double recovery,'' this merely follows the
appropriate operation of the index under the Commission's regulations,
which permit annual changes in rate ceilings due to actual industry-
wide cost changes as compared to PPI-FG. AOPL further argues that Mr.
O'Loughlin's double-recovery argument would also discourage pipeline
expansions and improvements by excluding pipelines that would undertake
significant expansion projects or that incur significant expenses in
compliance with safety regulations.
    41. AOPL also contends that the inclusion of pipelines with large
rate base changes in the data set does not create a windfall because,
under the indexing methodology, pipeline costs are merely increasing to
reflect increased costs across the industry. AOPL's witness Dr.
Shehadeh states that whether a pipeline ``used a rate mechanism other
than indexation is irrelevant to the value of the information that
these pipelines can provide as evidence for indexing pipeline costs.''
\24\
---------------------------------------------------------------------------

    \24\ Shehadeh September 20 Decl. at 11.
---------------------------------------------------------------------------

    42. AOPL further claims that in Order No. 561, the Commission
established the Index level at PPI-FG-1 to account for a wave of asset
retirements that resulted in significant rate base changes. AOPL states
that it would now be inconsistent to exclude rate base changes when
those changes relate to pipeline expansions. AOPL states that the
disqualification from the data set pipelines that undertake significant
expansion will discourage pipeline expansions and improvements.
c. Other Shipper Reply Comments
    43. In reply comments, NPGA, ATA and Navajo expressed support for
Valero's rate base screening methodology.
d. Valero Supplemental Reply Brief
    44. Responding to AOPL, Valero disputes the assertion that the rate
base screening methodology understates cost changes experienced by a
typical pipeline operator. Valero states that Mr. O'Loughlin's analysis
applied an objective filter which removed pipelines experiencing cost
increases and cost decreases of more than 50 percent. Valero notes that
pipelines that underwent expansions and major capital investments often
sought to recover those costs by means other than the price index; to
Valero, this suggests that the cost increases were extraordinary.
    45. In response to AOPL's and Dr. Shehadeh's argument that volume
increases offset the cost increases, Valero states that it would not
have been necessary or cost-justified to adopt increased cost-based
rates if increased volumes fully offset any new costs. Valero adds that
if volumes had increased commensurately with costs on these pipelines,
then the pipelines with large rate base changes would not be at the
high end of the measurement group in terms of cost-of-service per
barrel-mile changes.
    46. Valero also avers that Dr. Shehadeh's claim that the rate base
screening methodology would have increased the index adjustment factor
established in Order No. 561 contradicts his claim that Mr.
O'Loughlin's methodology biases results downward and leads to an
inappropriately low index.

e. AOPL October 20, 2010 Response
    47. AOPL states that once an initial rate is set for a pipeline
expansion, indexing becomes the primary method for changing oil
pipeline rates. According to AOPL, there is no reason to exclude
pipelines filing a cost-of-service or settlement rate when examining
industry-wide cost changes and that the presence of ratemaking
alternatives do not justify setting the index below overall industry
levels. AOPL avers that if pipelines undertaking significant
infrastructure investment are excluded from the measurement of cost
changes, the index will be inappropriately low, causing more pipelines
to use other ratemaking methods and undermining the purpose of the
index.
f. Commission Determination
    48. The Commission will not adopt Valero's proposal to exclude
pipelines experiencing major rate base changes from the data set. To
determine which pipelines should be trimmed from the data sample, the
Commission has relied upon the level of the cost changes, not the
reasons why a particular pipeline's changing costs might be anomalous.
Thus, in assessing Form No. 6 data in prior index proceedings, the
Commission has trimmed the data sets to remove outliers, such as the 25
percent of pipelines with the greatest cost increases per barrel-mile
and the 25 percent with the greatest decreases. As discussed below, the
Commission in this proceeding will trim the data set to pipelines in
the middle 50 percent of cost changes. To the extent that a particular
pipeline's cost change is an anomalous outlier compared to the changes
on other pipelines, using the middle 50 percent of cost changes, should
remove any distorting impact resulting from the pipeline's presence in
the index.\25\
---------------------------------------------------------------------------

    \25\ To the extent that large rate base changes are associated
with disproportionately large cost shifts, AOPL's expert Dr.
Shehadeh explains that 18 of the 25 pipelines removed by Mr.
O'Loughlin due to rate base changes were excluded when the data set
was reduced to the middle 50 percent using Dr. Shehadeh's
methodology. Shehadeh September 20 Decl. at 12.
---------------------------------------------------------------------------

    49. In contrast to this simplified methodology, the rate base
screening methodology proposed by Valero selectively emphasizes one
factor that may cause a substantial change in pipeline costs per
barrel-mile while ignoring other factors. There is no doubt that
substantial changes in rate base can alter the per barrel-mile costs of
a particular pipeline. However, costs per barrel-mile can also be
altered by shifting customer demand, increased competition, economic
changes, or changing product supplies. As Valero's expert Mr.
O'Loughlin notes, there is a wide range in the changes in pipeline per
barrel-mile costs,\26\ and much of this variability \27\ is unrelated
to the significant rate base changes cited for exclusion by Mr.
O'Loughlin. By selectively modifying the data set based upon one
potential cause for cost changes, Mr. O'Loughlin risks distorting the
index calculation.
---------------------------------------------------------------------------

    \26\ O'Loughlin August 20 Aff. ]] 44-45, Figure 14.
    \27\ For example, Mr. O'Loughlin explains that, using his own
methodology, of the 97 pipelines in his data set, which has been
culled pursuant to the rate base screening methodology, there ``are
20 pipelines that experienced average cost increases greater than
10% per year and 10 pipelines that experienced average cost
decreases of more than 10% per year over the five-year period.''
O'Loughlin August 20 Aff. ] 45.
---------------------------------------------------------------------------

    50. Moreover, the index is pursuant to a Congressional mandate to
develop a ``simplified and generally applicable ratemaking methodology*
* *.'' \28\ Consistent with this mandate of general applicability, the
Commission is reluctant to inquire into the particular circumstances of
every pipeline and selectively remove pipelines that experienced cost
changes due to one particular factor from the data set used to
calculate the index.\29\
---------------------------------------------------------------------------

    \28\ Energy Policy Act of 1992 Public Law 102-486 Sec. 1801(a),
106 Stat. 3010 (Oct. 24, 1992).
    \29\ The D.C. Circuit has previously recognized the importance
of an index that is relatively simple to derive. AOPL II, 281 F.3d
at 247 (quoting EPAct 1992, at Sec.  1801(a)). The complexity of Mr.
O'Loughlin's rate base screening methodology is demonstrated by
Appendix F of his September 20 Affidavit, in which Mr. O'Loughlin
examines the circumstances of 37 pipelines that experienced rate
base changes greater than 50 percent. To apply the rate base
screening methodology, for each pipeline with a change in rate base
exceeding 50 percent, Mr. O'Loughlin examined tariff filings,
assessed acquisition and divestiture activity, probed into the
reliability of the pipeline's reported data, researched whether the
pipeline had sought rate increases pursuant to the index, and
generally sought to determine why the rate base changes occurred.
---------------------------------------------------------------------------

    51. Furthermore, large rate base changes can reflect changing
pipeline costs. The cost of new investment associated with rate base
increases reflects industry cost experience related to pipeline
infrastructure on a barrel-mile basis. These rate base changes also
provide important information regarding industry capital requirements.
A rate base change, like any other change in the business circumstances
of a pipeline, is only an outlier if a pipeline's per barrel costs
change in a manner disproportionate to those changes experienced by
other pipelines.
    52. Moreover, the index serves as a means of recovery for some
pipelines with significant rate base changes. According to data
provided by Mr. O'Loughlin, several of the pipelines that Mr.
O'Loughlin identified as experiencing significant rate base changes
relied upon indexed rates (or at least did not seek some other form of
recovery, such as a cost-of-service filing).\30\ The fact that a non-
trivial number of pipelines experiencing rate base changes continued to
use the indexing methodology reinforces the inclusion of pipelines with
rate base changes in the data set.
---------------------------------------------------------------------------

    \30\ O'Loughlin September 20 Aff. ] 54 n.75, Appendix F at 8-10.
---------------------------------------------------------------------------

    53. Additionally, merely because a pipeline seeks recovery of rates
outside the indexing methodology, for example through a cost-of-
service, does not establish that the pipeline should be excluded from
the data set used to develop the index. The changing costs that
compelled the pipeline to seek recovery outside the indexing
methodology nonetheless reflect industry cost experience. Moreover, for
those pipelines with significant rate base increases, Mr. O'Loughlin's
decision to include only those pipelines where the pipeline opted to
continue to use the index could skew the index downward; this is
because the pipelines continuing to use the index are more likely to be
the pipelines where the rate base change decreased per-barrel mile
costs.
    54. Valero repeatedly cites language in Order Nos. 561 and 561-A
that the index accounts only for ``normal,'' not ``extraordinary''
changes.\31\ However, this language does not support Valero's proposal
to exclude pipelines experiencing major rate changes from the data set
used to determine the index level. In these passages, ``extraordinary''
referred to pipelines experiencing changed per barrel-mile costs that
were greater than the changing costs experienced by other pipelines
regardless of the causes underlying any particular pipeline's cost
changes. Thus, even though a rate base change of 50 percent is a
significant occurrence, it is only ``extraordinary'' as Order Nos. 561
and 561-A used that term to the extent that it causes an anomalous
change in costs per barrel-mile.
---------------------------------------------------------------------------

    \31\ Valero Supplemental Reply Comment at 14-15 (citing Order
No. 561-A, FERC Stats. & Regs. ] 31,000 at 31,097).
---------------------------------------------------------------------------

    55. Valero's contention that including pipelines with rate base
changes in the data set used to determine index will lead to double-
recovery is without merit. After making a cost-of-service filing, the
cost-of-service rate becomes the ceiling rate for that year \32\ and
pipelines are authorized to increase their rates pursuant to the index
in

subsequent years.\33\ Valero's argument ultimately rests upon the
contention that the index is inflated by the inclusion of pipelines
experiencing rate base changes. However, as noted previously, such
inflation of the index only occurs if the rate base changes lead to
changes in per barrel-mile costs that are anomalous. To the extent that
the rate base change leads to an anomalous cost increase or decrease,
it will be excluded by the data set trimming as discussed below.
---------------------------------------------------------------------------

    \32\ 18 CFR 342.3(d)(5).
    \33\ However, further undermining Valero's double-recovery
argument, the Commission has denied an increase pursuant to the
index when the cost-of-service filing supporting the existing rate
already incorporated the cost changes covered by the index. See
SFPP, L.P., 117 FERC ] 61,271 (2006) (denying an index increase
because the cost-of-service rate, which used a 2005 base period,
already reflected the 2005 cost changes covered by the index).
---------------------------------------------------------------------------

2. Data Trimming and the Middle 50
a. Valero Initial and Reply Comments
    56. Valero urges the Commission to calculate the index using a data
sample trimmed to the middle 50 percent, i.e. removing the 25 percent
of pipelines with the greatest cost increases and the 25 percent of
pipelines with the greatest cost decreases. Although Valero
acknowledges that recent index proceedings have considered both the
middle 50 and middle 80 percent, Valero contends that trimming the data
set to the middle 80 percent inadequately accounts for outliers due to
the widely varying average annual cost changes. Valero adds that the
middle 80 includes pipelines with anomalous characteristics, such as
very high costs per barrel-mile or the absence of rate base.
b. AOPL Reply Comments
    57. AOPL opposes trimming the sample data set to the middle 50
percent of pipelines. Dr. Shehadeh responds to Mr. O'Loughlin's
proposal by stating that the wide distribution of pipeline cost changes
(as opposed to a normalized bell curve) does not support ignoring the
middle 80 percent in favor of the middle 50 percent. Rather, Dr.
Shehadeh claims that the wide distribution supports the use of the
middle 80 percent, rather than the middle 50 percent because it would
be more inclusive and represent a larger number of pipelines.
c. Valero Supplemental Reply Comments
    58. Valero contends, contrary to AOPL's assertions, that Mr.
O'Loughlin's use of the middle 50 percent data set is justified and
consistent with Commission policy. Valero asserts that the Commission's
methodology has varied over the years, and in Order Nos. 561 and 561-A,
the Commission used an analysis of only the middle 50 percent of the
data set, not a composite of the middle 50 percent and middle 80
percent of the data set. Valero's Mr. O'Loughlin emphasizes that the
middle 50 percent better serves the goal of excluding extraordinary
data points. Mr. O'Loughlin also identifies an additional three
pipelines in the middle 80 percent that he states have unusual
characteristics, such as a cost of capital under two percent or, in
another case, no rate base yet a positive depreciation expense.
d. AOPL's October 20, 2010 Response
    59. In its response, AOPL reiterates its position that both the
middle 50 percent and middle 80 percent should be used. AOPL reiterates
its contention that the wide distribution of pipeline cost changes does
not support assigning no weight to the middle 80 percent. AOPL also
challenges the three pipelines Mr. O'Loughlin identified as anomalous,
noting that one was excluded from Dr. Shehadeh's data set and that the
others showed overall cost changes that were not all that different
from other pipelines. AOPL states that as the Form No. 6 data has
improved, there is no merit to limiting the data set.
e. Commission Determination
    60. The Commission will use the middle 50 percent of the data set
to determine the appropriate index level. This use of the middle 50
percent is consistent with the Commission's approach when it adopted
the indexing methodology. In Order Nos. 561 and 561-A, the initial
rulemaking establishing the indexing methodology, the Commission used
only the middle 50 percent of the data set to determine the appropriate
indexation level. In that proceeding, neither the Commission nor Dr.
Kahn considered the middle 80 percent. In the second review, Dr. Kahn
introduced the middle 80 percent to his analysis.\34\ Given that the
two data sets supported the same resulting index-level of an unadjusted
PPI-FG, using both (as opposed to just the middle 50) was not discussed
or contested, as there was little substantive impact from this
departure from the Order No. 561 methodology.\35\ In the second and
most recent 5-year review, the composite usage of the middle 50 and the
middle 80 reoccurred, but again the relative merits of the middle 50
and middle 80, and the departure from the prior Order No. 561
methodology were not weighed or discussed.
---------------------------------------------------------------------------

    \34\ Kahn Decl. at 13 (August 31, 2000) (Docket No. RM00-11-
000).
    \35\ The composite of the middle 50 and middle 80 were very
similar in that proceeding at 1.32 percent and 1.2 percent,
respectively. Id.
---------------------------------------------------------------------------

    61. Given the more fully developed record presented here, the
Commission returns to its approach in Order Nos. 561 and 561-A to use
the middle 50 percent as the most appropriate method for trimming the
data sample. The purpose of the index is to permit a simplified
recovery for normal cost changes, not to enable recovery for
extraordinary cost increases or decreases.\36\ The middle 50 percent
more appropriately adjusts the index levels for ``normal'' cost changes
as opposed to the middle 80 percent, which, by definition, includes
pipelines relatively far removed from the median. Furthermore, some of
these more dramatic cost changes may be due to circumstances on a
particular pipeline that are not broadly shared across the industry.
Even when accurate data is reported, pipelines in the middle 80, as
opposed to the middle 50, are more likely to have cost changes
resulting from factors particular to that pipeline, such as a rate base
expansion, plant retirement, or localized changes in supply and demand.
Using the middle 50 ensures that pipelines with relatively large cost
increases or decreases do not distort the index.
---------------------------------------------------------------------------

    \36\ Order No. 561-A, FERC Stats. & Regs. ] 31,000 at 31,097
(noting that the purpose of the Index is to ensure recovery of
``normal'' cost changes, not ``extraordinary'' cost changes).
---------------------------------------------------------------------------

    62. The Commission further observes that our adoption of the middle
50 provides a better remedy for some of the concerns Mr. O'Loughlin
used to justify his rate base screening methodology. Of the 25
pipelines Mr. O'Loughlin seeks to exclude via the rate base screening
methodology, 18 are excluded by using the middle 50 percent in the Kahn
Methodology as applied by Dr. Shehadeh.\37\ More generally, the
adoption of the middle 50 is a less subjective and more simplified
method (consistent with the EPAct 1992) of removing potentially
anomalous data than selective removal of certain pipelines with
particular characteristics from the data sample. The middle 50 also is
preferable to such selective screening methods because it avoids the
risk that the index is skewed because certain cost changes (such as
rate base changes) are selectively excluded while

other significant changes (changes in local supply and demand) are
incorporated.
---------------------------------------------------------------------------

    \37\ Shehadeh September 20 Decl. at 12. Only 13 of the 25 are
excluded in the middle 80 percent. Id. The number of excluded
pipelines include four companies that Dr. Shehadeh removed due to
missing data. Shehadeh September 20 Decl. at 12 n.15.
---------------------------------------------------------------------------

    63. The Commission accordingly concludes that the middle 50
provides a robust data sample for determining changing barrel-mile
costs. The middle 50 percent of pipelines represents 76 percent of
total barrel-miles in 2004 subject to the index,\38\ and thus for this
index calculation, the Commission finds it unnecessary to include the
middle 80 percent to obtain a representative sample of the data.
Finally, the use of the middle 50 minimizes the risk of including
pipelines that experienced either large increases or decreases in cost
(or errant data) that may be included in an 80 percent sample, while
still capturing changes from a broad spectrum of the pipeline industry.
---------------------------------------------------------------------------

    \38\ AOPL Comments at 14-15; Dr. Shehadeh August 20 Decl. at 10
n.23.
---------------------------------------------------------------------------

3. Page 700 Data
a. Valero's Initial and Reply Comments
    64. Valero and Mr. O'Loughlin aver that the Commission should adopt
page 700, which uses the Opinion No. 154-B methodology to derive a
total cost-of-service for interstate pipeline companies. Valero states
there are several advantages to using the page 700 data as opposed to
the other Form No. 6 data relied upon by the Commission in the past.
    65. Valero asserts that by relying upon page 700 data, the
Commission can avoid using net carrier property as a proxy for actual
changes in allowed return and income tax. Valero notes that the
Commission has previously questioned the effectives of net carrier
property as a proxy for changes in capital costs. Valero further states
that Mr. O'Loughlin's analysis shows that the change in net plant is
typically greater than the change in allowed return and income tax.
Additionally, Valero argues that net plant data reported on Form No. 6
can also include purchase accounting adjustments (PAAs), which the
Commission does not allow for ratemaking purposes absent a showing of
substantial benefits to ratepayers.
    66. Valero also contends that the ``operating ratio'' weighting
methodology as applied by Dr. Shehadeh leads to a distorted analysis.
The operating ratio is set between zero and one based upon the ratio of
operating expenses to revenues. If operating expenses exceed revenues,
then the operating ratio is set to one, meaning that no weight is
assigned to capital costs (net plant under the prior methodology) in
the formula. Thus, Valero contends that for fifteen pipelines in Dr.
Shehadeh's data set, the weight for the index of changes in net plant
is zero percent, making the index of changes in net plant irrelevant.
Valero contends that its proposed methodology using data from page 700
obviates the need for the operating ratio because the total cost of
service on page 700 incorporates both operating and capital costs.
    67. Valero explains that operating expense, net carrier property,
and barrel-mile data, which are reported on pages 110-111, 300-303, and
600-601 of the Form No. 6, include intrastate, as well as interstate,
pipeline information. The solution, Valero contends, is to use the data
on page 700 of the Form No. 6, which includes only interstate
information.
b. Other Shipper Comments
    68. In their comments, other parties addressed Valero's proposal to
use page 700. ATA emphasized that any analysis of costs should be based
on the interstate costs reported on page 700. ATA emphasizes that page
700 contains the information available to shippers to provide a
screening tool to determine whether a ``pipeline's cost of service or
per-barrel/mile costs'' are so divergent from revenues as to warrant a
challenge to the rates. ATA stresses that it is appropriate to use the
same data to develop the index as is used to determine whether a
pipeline is recovering its costs.
    69. NPGA likewise submits that any proper analysis of operating
costs should be based on interstate operations and costs and not on
costs that reflect intrastate operations. Thus, NPGA urges the use of
page 700 data.
    70. In reply comments, SPOPS urges that to the extent the
Commission continues to apply its methodology, the Commission should
use the primary source for the jurisdictional costs of service for the
pipelines, the page 700 and the underlying workpapers, not the
secondary source methodology demanded by AOPL.
c. AOPL's Reply Comments
    71. AOPL opposes the use of page 700 data. AOPL argues that the
page 700 data is more volatile due to the return element underlying the
page 700 total cost-of-service data. Specifically, AOPL contends that
stock market fluctuations make the rate of return highly sensitive to
the end-year selected by the Commission (i.e., 2008 versus 2009) for
calculating the index. According to AOPL, the Form No. 6 net carrier
property data is preferable because it reflects actual changes in
capital costs while assuming that the competitive cost of capital
remains constant.
    72. AOPL also argues that if rate of return from page 700 is used
to measure cost increases, increases in pipeline efficiency will not
result in lower indexation levels. AOPL explains that pipeline returns
are based on a proxy group and as the profitability increases for
companies in the proxy group, returns will likely increase. As a
result, using return from page 700 will tend to increase, as oppose to
decrease, future index levels.
    73. AOPL also disagrees with Mr. O'Loughlin's claim that page 700
data is superior to Form No. 6 data because page 700 data does not
include intrastate costs. AOPL counters that oil pipelines often make
intrastate and interstate movements through the same pipeline segments.
Thus, AOPL believes that it is reasonable to assume that both
interstate and intrastate cost changes are likely to be representative
of interstate cost changes.
    74. AOPL argues that Mr. O'Loughlin mistakenly describes the page
700 data as new and instead suggests that the information Mr.
O'Loughlin proposes to use has been available to the Commission for
many years.
d. Valero Supplemental Reply
    75. Responding to AOPL, Valero asserts that pipeline efficiency
gains will not distort the return information from page 700 because
basic finance theory provides that an increase in a company's current
and future cash flow increases the equity value of the company.
Regarding AOPL's contention that volatility in the page 700 return data
will skew results, Valero argues that Dr. Shehadeh, by analyzing the
rate of return in isolation from the allowed return and income tax
allowance, obtained a result that is not fully indicative of a
pipeline's capital costs. Valero further argues that recessionary
declines in petroleum demand increased the average cost of service per
barrel mile for 2009. Valero concludes that if the recessionary
volatility in barrel-miles is reflected in developing unit costs, the
prevailing rates of return as reported in the cost-of-service
calculations on page 700 of the Form No. 6, must also be used.
    76. Valero disputes AOPL's contention that an interstate cost-of-
service value was reflected on page 700 as early as 1994. Valero states
that a reliable total interstate-only cost-of-service data and the
specific line items composing the interstate cost of service, including
jurisdictional rate base, were not available until 2000. Valero states
that the Commission has not previously

addressed the possibility of using this interstate, page 700 data in
the index.
    77. Valero also challenges Dr. Shehadeh's claim that the
interstate-only operating and maintenance expense and depreciation
expense data reported on page 700 are unsuitable for the rate index
methodology because the data contain various accounting, allocation,
and normalizing assumptions. Rather, Valero contends that because the
calculations of operating and maintenance expense must be consistent
with the Commission's Opinion No. 154-B methodology and because changes
in those components impact the costs a pipeline can recover in rates,
those considerations are appropriate for determining the price index.
    78. Valero states that Dr. Shehadeh's preferred data source, the
operating and maintenance expense data on page 114 of the Form No. 6,
can contain accounting reserves that are not permitted for ratemaking.
Valero states that carriers should not be permitted to use these
discretionary changes in accounting reserves to influence the change in
unit costs used to determine the level of index to be used for annual
adjustments.
e. AOPL October 20, 2010 Response
    79. AOPL renews its arguments that (a) intrastate costs are
representative of interstate costs; (b) inclusion of the rate of return
from page 700 would make the index more volatile; (c) net plant is a
preferable measure of return for the purposes of establishing the index
than the page 700 data; and (d) the page 700 data has been available
during prior indexing proceedings.
    80. AOPL also argues that Valero's proposed usage of page 700
ignores serious accounting issues. AOPL states that, in order to derive
a unit cost for each carrier, Mr. O'Loughlin divides the total cost-of-
service reported on page 700 by the total throughput reported on page
700. AOPL states that the page 700 cost-of-service figure provides each
carrier's interstate cost-of-service using an Opinion No. 154-B
methodology. However, AOPL states that the barrel-mile data on page 700
includes interstate and intrastate volumes. AOPL explains that the
instructions on page 700 indicate that the barrel-mile figure should be
the same as that reported on page 600, and the barrel-mile figure on
page 600 includes ``all oils'' received by the pipeline, not just
interstate oils. AOPL contends that there could be a mismatch between
the interstate only costs and the interstate and intrastate volumes.
    81. AOPL defends the data in Form No. 6. AOPL states that while
PAAs reflected in Form No. 6 are generally not allowed to be reflected
in regulated rates, these adjustments are appropriate when calculating
cost changes because the PAAs reflect the opportunity cost of capital.
Moreover, AOPL states that PAAs do not create the perverse incentives
in the calculation of an industry-wide index that they do when
calculating an individual pipeline's rates. Also, AOPL also contends
that although the accounting reserves in Form No. 6 present timing
issues for the purposes of a ratemaking proceeding, they also represent
real costs of doing business that are properly reflected in the
calculation of the rate index.
    82. AOPL also defends the usage of the operating ratio. AOPL states
that applying a weight of one to operating expenses and zero to net
plant is appropriate for a company where operating costs are greater
than revenue.
f. Commission Determination
    83. The Commission does not adopt Mr. O'Loughlin's proposal to use
page 700 data because there is a mismatch between the page 700 total
cost-of-service, which includes only interstate data, and the page 700
throughput data, which includes interstate and intrastate data.
    84. As the shipper parties emphasize, the total cost of service
data on page 700 relates solely to interstate costs. However, the
throughput data used by Mr. O'Loughlin from page 700 reports a
combination of interstate and intrastate volumes. As AOPL explains in
its October 20 Response, the barrel-mile information listed on page 700
provides that the barrel-mile figure should be the same as that
reported on line 33a of page 600 of the Form No. 6. The instructions
for page 600 refer to the inclusion of ``all oils received'' by the
pipeline and makes no distinction between interstate and intrastate
volumes. Consequently, pipelines may be reporting both interstate and
intrastate volumes on page 700.
    85. Thus, Mr. O'Loughlin's calculations compare one set of costs
(interstate costs) with a different set of throughput (combined
interstate and intrastate). Changes in transported throughput on a
particular movement cause changes in the costs related to the very same
movement. Thus, it is an axiomatic rule of ratemaking that the same set
of costs and volumes must be used to determine rates. To obtain an
accurate measurement of changing per barrel-mile costs for purposes of
establishing an index level, the methodology must match the throughput
used in the methodology to the costs incurred to transport the
throughput used in the methodology. Given that page 700 does not match
interstate costs with interstate volumes, the Commission rejects its
usage in the methodology.
4. Adjustments for Declining Throughput
a. Comments
    86. In reply comments, CAPP asserts that the index should not be
inflated by the decline in throughput between 2004 and 2009. CAPP
contends that the widespread recession caused the reduction in 2009
barrel miles and that such throughput declines cannot be expected to
continue for another five years. CAPP states that its expert Mark
Pinney replicated AOPL's analysis using constant 2004 barrel miles and
the resulting increase equated to PPI-FG plus 1.62 percent. CAPP argues
that it is inconsistent with the purpose of an inflation adjusted index
to allow changes in volumes to affect index levels and that increasing
the index due to declining volumes will be self-perpetuating. CAPP also
argues that allowing a generic index increase based on 2009 barrel-mile
data contradicts Commission ratemaking policy for new pipeline
facilities by using barrel-mile data instead of capacity as billing
determinants.
    87. Also in reply, ATA states that U.S. Energy Information
Administration (EIA) estimates project an increase in total crude oil
and petroleum consumption from 2010 to 2011. ATA thus advocates
establishing an index using constant 2009 volumes for 2011 through 2016
as a ``conservative'' approach more favorable to pipelines.
    88. In its October 20 Response, AOPL contends that adjusting actual
historical throughput to assume constant volume levels is speculative
and directly contrary to the Commission's established methodology. AOPL
also challenges CAPP's suggestion that the Commission uses capacity to
measure costs instead of actual throughput, stating that because the
oil pipeline industry is a highly capital intensive industry, when
throughput declines, costs do not decline proportionally. AOPL adds
that CAPP treats volumes as remaining constant but makes no attempt to
adjust for fuel and power costs that are dependent upon volume levels.
Moreover, AOPL adds that contrary to CAPP's assertion that the decline
resulted from the 2009 recession, more than 60 percent of the
throughput decline occurred between 2004 and 2005. Thus, AOPL states
that

capacity should not be used to measure costs.
b. Commission Determination
    89. The Commission rejects CAPP's and ATA's proposal to use
constant barrel-miles in the Kahn Methodology rather than the actual
barrel-mile levels.
    90. The Commission finds it appropriate to continue to rely upon
historical data in applying the Kahn Methodology. The DC Circuit has
upheld the Commission's reliance upon historical data finding that the
usage of historical data is consistent with the mandate to apply ``a
simplified and generally applicable ratemaking methodology.'' \39\
---------------------------------------------------------------------------

    \39\ AOPL II, 281 F.3d at 247 (2003) (quoting EPAct 1992, at
Sec.  1801(a)).
---------------------------------------------------------------------------

    91. Moreover, CAPP's and ATA's analysis of cost changes assuming
constant volumes are problematic because they utilize asynchronous
data. Regarding CAPP's proposal to use constant 2004 barrel-miles, the
2009 costs reflect the expenses associated with the lower 2009 volume
levels. Since certain costs (such as fuel and power) increase and
decrease with volume levels, using 2004 data volume data with 2009
operating costs will not present an accurate depiction of the change in
per barrel-mile costs. By applying an upward adjustment to 2009 volumes
without adjusting for the costs that would have been incurred as a
result of those higher volumes, CAPP imposes a downward distortion on
the change in pipeline costs calculated under the Kahn Methodology.
Similarly, ATA's proposal to assume constant 2009 volumes is defective
because it does not adjust 2004 costs so that the 2004 costs reflect
the lower 2009 volumes.
    92. The Commission further rejects CAPP's argument that it is
inappropriate to allow the indexing methodology to be calculated based
upon declining volumes. Declining volumes require pipelines to increase
rates in order to meet revenue needs and, for existing oil pipelines,
the Commission uses existing volumes, not capacity, to determine
rates.\40\ Thus, much as in a cost-of-service, such declining volumes
should lead to increased pipeline recovery levels in the indexing
methodology.
---------------------------------------------------------------------------

    \40\ See 18 CFR 346.2(b)(2). Moreover, it is not clear how this
capacity information could be obtained in the application of the
index, since pipelines report throughput in Form No. 6, not
capacity.
---------------------------------------------------------------------------

    93. Finally, CAPP fails to demonstrate that the declining
throughput for the 2004-2009 period resulted primarily from the unusual
economic conditions in 2008 and 2009 as opposed to changes reflected
throughout the prior five-year period. As Dr. Shehadeh demonstrates,
more than 60 percent of the decline in barrel-miles during the 2004-
2009 period recorded on Form 6 occurred between 2004 and 2005,\41\ and
was unrelated to the recession in 2008 and 2009. Thus, it is not the
case that the index level has been distorted by the recession in 2008
and 2009.
---------------------------------------------------------------------------

    \41\ Shehadeh October 20 Decl. at 29.
---------------------------------------------------------------------------

5. Applying the Index Only to Operations and Maintenance Costs
a. Comments
    94. In its comments and reply comments, Navajo urges the Commission
to apply the index only to operating and maintenance costs and not to
costs attributable to depreciation, return, and income tax allowances.
Navajo asserts that depreciation is not affected by inflation because
depreciation is based upon equity investment, a historical cost. Navajo
further contends that the two components of return--return on equity
(in the form of increased deferred return) and cost of debt--already
incorporate an inflation component. Thus, Navajo asserts that
automatically granting pipelines an additional inflation-based index
increase would enable pipelines to ``double-dip'' the inflation
element. Third, Navajo asserts that the income tax allowance should not
be increased automatically by an index, because one of its two
components (the tax rate) generally is fixed by law and does not vary
based on inflation, and the second component (rate of return on equity)
already accounts for inflation.
    95. Instead, Navajo avers that the index should only be applied to
operating and maintenance (operating and maintenance expense) costs.
Navajo acknowledges that the Commission previously rejected this
approach as too complicated in Order Nos. 561 and 561-A, but Navajo
notes that the Commission now collects categorical cost data from
pipelines on page 700 of Form No. 6 and the Commission could apply the
index only to operating and maintenance costs as recorded on page 700.
Thus, Navajo states that the Commission could use the change in
operating and maintenance expense costs identified by O'Loughlin to
develop the indexed rate.\42\ Navajo explains that under its proposal,
for each pipeline seeking an annual index increase, the index rate
could be applied to the part of the rate attributable to operating and
maintenance expense. Navajo elaborates that if the operating and
maintenance expense costs were 40 percent of a pipeline's cost of
service on page 700 of its Form No. 6, the index-based rate increase
should equal the pre-existing ceiling rate times the index multiplied
by ``0.4.''
---------------------------------------------------------------------------

    \42\ To derive this rate, Navajo relies upon Mr. O'Loughlin's
showing a change in the O&M costs for the middle 50 percent of oil
pipelines of 5.0 percent and a change for the composite of the 50
and 80 percent of 5.4 percent. O'Loughlin August 20 Aff. ] 49,
Figure 15.
---------------------------------------------------------------------------

    96. In reply comments, ATA states that it agrees that applying an
index adjustment to items not subject to inflation misaligns cost
recovery with cost increases. ATA also alleges this provides a
disincentive to invest in infrastructure.
    97. In reply comments and its October 20 Response, AOPL asserts
that the Commission has twice rejected the selective indexing proposal
advocated by Navajo. AOPL states that Navajo's proposal is beyond the
scope of this proceeding. Moreover, AOPL asserts that because the
Commission measures capital cost changes by comparing changes in net
carrier property, the Kahn Methodology does not incorporate inflation
for either return or income tax allowance as alleged by Navajo. Rather,
AOPL asserts, the methodology is based upon the assumption that the
competitive rate of return on capital does not change.
    98. AOPL adds that the Commission has twice previously rejected
Navajo's proposal, first in Order No. 561 and in the first five year
review on the basis that it would be difficult to administer and create
perverse incentives. AOPL states that Navajo has provided the
Commission with no valid reason to reverse its prior rulings.
Furthermore, AOPL asserts that under Navajo's proposal, each pipeline
would be required to perform calculations to determine its own pipeline
specific index, a fundamental change from the ``generally applicable''
ratemaking methodology required by the EPAct 1992.
b. Commission Determination
    99. The Commission rejects Navajo's proposal. The Commission has
twice rejected proposals similar to the one advocated by Navajo. In
Order No. 561 as affirmed by the D.C. Circuit, the Commission concluded
that limiting index increases to operating and maintenance costs would
create perverse incentives for pipelines to direct a disproportionate
amount of their spending to operating and maintenance costs and to
neglect capital expenditures.\43\ Moreover, because new

investment may be substantial and would not be covered by the index,
many companies would be required to file cost-of-service cases to
recover significant increases in cost.\44\
---------------------------------------------------------------------------

    \43\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,951-52,
aff'd AOPL I, 83 F.3d at 1437. The Commission returned to the issue
in the first five year review, again rejecting the proposal on the
basis that it could cause perverse consequences. First Five-Year
Review, 93 FERC at 61,854-55.
    \44\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,952.
---------------------------------------------------------------------------

    100. In addition to creating perverse incentives, the Commission's
prior orders noted that Navajo's proposal would also undermine the
statutory mandate to establish a generally applicable and simplified
methodology.\45\ The availability of page 700 data does not change this
conclusion. Under Navajo's proposal, the index would not be generally
applicable. Each pipeline would receive its own annual index adjustment
to the ceiling rate dependent upon the pipeline's specific level of
operating costs as reported on page 700. Navajo's proposal is also
contrary to the purpose of a simplified methodology. Requiring
pipelines to multiply the index level by the ratio of ``operating and
maintenance'' expenses to ``total cost-of-service'' on page 700 before
applying the index to a pipeline's existing ceiling rate will increase
the likelihood of disputes in each annual application of the index as
parties challenge those particular components of page 700 data.
---------------------------------------------------------------------------

    \45\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,951-52;
First Five-Year Review, 93 FERC at 61,854-55.
---------------------------------------------------------------------------

    101. Furthermore, Navajo's arguments are theoretically unsound.
Capital costs are a component of a pipeline's total costs, and any
index that tracks actual cost changes must account for changing capital
costs. The Commission also rejects Navajo's argument that for income
tax and rate of return, the index double-counts inflation. The Kahn
Methodology uses net carrier property as a proxy for income tax and
rate of return, and net carrier property does not contain any internal
inflation-related adjustments.\46\
---------------------------------------------------------------------------

    \46\ Because it is not presented by the facts here, the
Commission does not address whether using rate of return data that
incorporated an inflation component would, in fact, be inappropriate
for deriving the index. Similarly, the Commission does not address
issues related to using actual page 700 tax allowance data because
the index currently uses a proxy for income tax costs.
---------------------------------------------------------------------------

6. Separate Indices for Crude and Product Pipelines
a. Comments
    102. In its comments, Valero and its witness O'Loughlin recommend
one index for crude and product pipelines. However, Valero avers that
differences in cost changes experienced between crude and product
pipelines could argue in favor of separate indices for these two
groups. Valero states that using his methodology, Mr. O'Loughlin
determined that the median annual change in unit costs is 2.1 percent
for products pipelines and 3.3 percent for crude pipelines. The
composite index for the middle 50 percent of the datasets is 2.3
percent for products pipelines and 4.3 percent for crude pipelines.
    103. In reply comments, ATA advocates the adoption of separate
indices for crude and product pipelines, asserting that separate
indices would allocate costs more equitably among shippers. ATA
emphasizes that doing otherwise would force product shippers to
subsidize crude shippers. The ATA urges that the data to produce
separate indices is readily available, noting that of the 97 pipelines
included within Mr. O'Loughlin's analysis, 31 were classified as crude
pipelines and 45 were classified as product pipelines. NPGA also states
that, as established by Mr. O'Loughlin, the disparity in cost changes
between crude pipelines and product pipelines supports the development
of separate indices.
    104. In its reply comments and October 20 Response, AOPL represents
that the Commission has previously rejected separate indices and
emphasizes that Valero witness O'Loughlin ultimately concluded that the
Commission should apply one index to all oil pipelines.
b. Commission Determination
    105. Mr. O'Loughlin has provided some evidence to indicate that
product and crude pipelines have experienced different levels of cost
change. However, neither Mr. O'Loughlin, ATA, nor NPGA offered an
explanation for why this cost disparity between crude and product
pipelines exists. ATA and NPGA rely upon Mr. O'Loughlin's testimony,
but Mr. O'Loughlin recommends using one index for all pipelines,\47\
and ATA and NPGA otherwise have failed to demonstrate that the
Commission should depart from its prior policy applying one uniform
index to all pipelines. Thus, on the record presented here, the
Commission will continue to apply one index to both crude and product
pipelines.
---------------------------------------------------------------------------

    \47\ O'Loughlin August 20 Aff. ] 61.
---------------------------------------------------------------------------

C. Allegations of Pipeline Over-Recovery

1. Comments
    106. In their comments, several shippers--Sinclair/Tesoro, the
Trucking Association, ATA, NGPA, SPOPS, and Navajo--reject the notion
that the index reflects actual pipeline cost changes. Sinclair/Tesoro
argues that it is unlikely the pipeline industry is experiencing cost
increases equal to the broader economy since the last review. In
support, Sinclair/Tesoro cites depressed cost levels in areas specific
to pipeline operation, such as labor, energy, and materials used in
pipeline construction. In contrast, Sinclair/Tesoro represents that
PPI-FG has recovered more rapidly, almost completely rebounding to its
mid-2008 peak. Thus, Sinclair/Tesoro states that it is not appropriate
to maintain the prior period rate ceiling of PPI-FG+1.3.
    107. In its comments, ATA states that, based upon a sample of 73
Commission-regulated pipelines, over 30 pipelines have reported over-
recoveries for some or all of the years from 2002-2009, and that these
pipelines reported over-recoveries of approximately $1.9 billion. ATA
asserts that this could cause parties to defer capital expenditures
because returns on depreciated assets exceed those provided by new
investments. Moreover, ATA suggests it is suspicious that pipelines
that are under-recovering by substantial amounts have not filed a cost-
of-service rate increase. In Reply Comments, ATA further emphasizes
that pipelines experience non-uniform cost changes. ATA states that the
Commission should be ``careful'' in designing any index to be applied
to pipelines generally.
    108. In addition to reiterating ATA's concerns regarding over-
recovery, NPGA states that the major propane pipelines are now
controlled by one company and that as a result shippers have
experienced a pattern of increased costs through new fees, reduced
service, sale of necessary assets to a pipeline affiliate, and
operating penalties. Although NPGA acknowledges that pipelines as a
whole are reporting an under-recovery, NPGA states that this does not
relieve the Commission of its duty to ensure that each individual
carrier's rates are just and reasonable and the existence of such a
disparity merely indicates that the index does not reflect actual
changes in pipeline cost. NPGA and ATA urge the Commission to require
pipelines showing over-recoveries to show cause why their rates should
not be considered unjust and unreasonable.
    109. Similarly, SPOPS avers that oil pipelines are consistently
over-recovering their costs. Accordingly, SPOPS proposes an index rate
of zero until pipeline profits return to a just and reasonable level.
SPOPS states that since the inception of the index the Commission has
allowed pipelines to

increase their rates by 39 percent, even though by 2009, 41 oil
pipelines reported excess profits totaling over $200 million per year.
In its comments, SPOPS includes in these profits the income tax
allowance for Master Limited Partnerships (MLP), which do not incur
income taxes. SPOPS states that it is difficult to challenge rate
increases pursuant to the index. SPOPS states, as a result, the
Commission has abdicated its responsibility under the ICA, emphasizing
that not even ``a little unlawfulness'' is permitted, and that the
Commission index as applied by the Commission tolerates unlawfulness.
    110. In reply, Navajo states that it has reservations about basing
the index on PPI-FG. Navajo states that nothing in the record
demonstrates that pipeline costs inherently correlate with general
rates of producer price inflation. In addition to claiming that
pipelines have been over-recovering, on reply, Navajo also state that
pipelines should not receive the benefit of automatically-approved rate
increases when the pipeline reports that it is over-recovering. Navajo
states that withholding the index from pipelines that are over-
recovering can be accomplished through page 700, and thus is not any
less administratively efficient than the Commission's current approach
nor, in Navajo's view, does it increase litigation.
    111. AOPL in its Reply Comments and October 20 Response states that
the Commission properly rejected similar arguments during the prior 5-
year review. AOPL notes that the Commission's rationale in past
proceedings accepts that some pipelines may over-earn while others
under-earn as an inherent attribute of the index. AOPL asserts that the
pertinent issue is not the overall level of pipeline cost, but rather
how the index compensates for changes in pipeline costs. AOPL also
states although page 700 data may show excess revenues, it does not
mean a pipeline rates are not just and reasonable. According to AOPL,
there are several other mechanisms other than an Opinion No. 154-B
methodology to establish a pipeline's rates, including market-based
rates and negotiated rates. In addition, AOPL contends the shippers'
allegations do not reflect actual pipeline cost recovery. Based on Dr.
Shehadeh's calculations, AOPL claims approximately two-thirds of
pipelines' page 700 calculations report under-earning on an Opinion No.
154-B basis. AOPL responds to Sinclair's claim that the pipeline
industry experienced cost changes in alignment with the global economic
recession by stating it is speculative and is contrary to actual
changes in costs as Dr. Shehadeh shows in his calculations using the
Kahn Methodology.
2. Commission Determination
    112. The fact that some pipelines may be over-recovering is not
contrary to the establishment of a general index level for all
pipelines. The purpose of the index is to track cost changes using a
generally applicable and simple method, and does not involve an
assessment of whether each of the various pipelines are over- or under-
recovering their costs. This can be seen in the application of the
index. When a pipeline proposes an indexed rate change, the Commission
is not subject to a statutory duty to examine the whole rate.\48\
Rather, the Commission's inquiry is limited to a comparison of the
changes in the rates and costs from year to year.
---------------------------------------------------------------------------

    \48\ Second Five-Year Review, 114 FERC ] 61,293 at P 57. This is
consistent with the grandfathering of the then-existing rates under
the EPAct 1992. EPAct 1992, at Sec.  1803.
---------------------------------------------------------------------------

    113. As the Commission explained previously, inherent to the
application of any industry-wide pipeline index, some pipelines will
over-earn while others will under-earn.\49\ However, the Kahn
Methodology ensures that that indexed changes are consistent with
recent industry-wide historical norms.\50\ To the extent that the
customers of a particular pipeline determine that the underlying rates
on a particular pipeline are unjust and unreasonable, those parties may
file a complaint against that particular pipeline's rates pursuant to
the ICA and the Commission regulations. Moreover, even when considering
pipeline over-recoveries and under-recoveries (as opposed to cost
changes), Dr. Shehadeh presented evidence that in 2009, the oil
pipeline industry as a whole was under-earning by approximately 17
percent.\51\
---------------------------------------------------------------------------

    \49\ Order No. 561, FERC Stats. & Regs. ] 30,985 at 30,948-49;
Second Five-Year Review, 114 FERC ] 61,293 at P 57.
    \50\ Contrary to Sinclair/Tesoro's claims and Navajo's
allegations, as discussed above, the empirical evidence presented
using the Kahn Methodology demonstrates that pipeline costs per
barrel-mile have increased at a rate exceeding changes in PPI-FG
over the past five-years. There is no indication that an adjusted
PPI-FG is inadequate for tracking cost changes.
    \51\ Shehadeh September 20 Decl. at 32-33.
---------------------------------------------------------------------------

D. Other Factors Affecting Pipeline Costs Raised by the Parties

    114. Although not linked to any particular modification of the
index methodology, the comments urged the Commission to consider
general issues related to pipeline integrity and the MLP business
structure.
1. Pipeline Integrity and Regulatory Safety Costs
AOPL Initial Comments
    115. AOPL states that costs have increased due to assessment and
re-assessment of pipeline structural integrity and remediation required
by the Pipelines and Hazardous Materials Safety Administration (PHMSA),
an agency of the United States Department of Transportation. AOPL,
supported by the Declaration of William R. Byrd, stresses that
assessment requires expensive technology (including rental of inline
inspection tools), labor intensive processes (involving excavation and
manual inspection), and remediation. Mr. Byrd represents that
``compliance with the integrity management regulations is likely to be
the largest single variable cost item for most pipelines and these
costs show no signs of decreasing.'' \52\
---------------------------------------------------------------------------

    \52\ AOPL Comment at 19 (quoting Byrd Decl. at 7).
---------------------------------------------------------------------------

    116. Mr. Byrd projects pipeline integrity costs to continue
increasing because inline inspection tools are becoming more expensive
and more likely to detect pipeline anomalies requiring correction. AOPL
states that PHMSA has imposed increasingly stringent obligations and
that new or expanded regulatory requirements may be imposed by Congress
during the reauthorization of the Pipeline Safety Act, which AOPL
expects to occur later in 2010 or 2011.
    117. AOPL and Mr. Byrd identify other regulatory obligations over
the past five years that have increased costs, including public
awareness program regulations and operator qualification regulations.
AOPL and Mr. Byrd explain that costs in the next five years are likely
to increase due to new PHMSA control room management regulations, new
PHSMA guidelines regarding land-use on or near pipeline rights-of-way,
new chemical facility anti-terrorism standards promulgated by the
Department of Homeland Security, and issues regarding greenhouse gas
emissions issued by the Environmental Protection Agency.
    118. In separate comments, PHMSA also represents that pipeline
safety and integrity regulations have imposed significant compliance
costs over the past eight years. Further, PHMSA notes the possibility
of future regulatory changes and that it anticipates the cost of these
activities will continue to impose significant financial burdens.
b. Reply Comments
    119. Several reply comments noted increased costs related to
pipeline

integrity. Platte, an interstate liquids pipeline, expects to incur
more than $2 million above historic levels of integrity related costs
for the foreseeable future. Platte notes that significant additional
costs may appear in damage prevention initiatives, valve spacing, leak
detection, and increased focus on preventing small releases. The
Pipeline Safety Trust notes that it is currently recommending that
Congress increase PHMSA's jurisdiction over hazardous liquid pipelines
and that Congress direct PHMSA to expand integrity management and other
safety-related requirements.
    120. Other parties challenged AOPL's contention that the pipeline
integrity costs supported an elevated index level. Valero notes that
accounting treatment of pipeline costs was not consistent prior to
2006, when the Commission clarified the accounting practices for
integrity programs.\53\ Thus, Valero states that AOPL, by comparing
changes in account 320 between 2004 and 2009, overstates the changes in
pipeline integrity costs. Valero also emphasizes that account 320
costs, which include both interstate and intrastate data, are only 14.4
percent of the total cost-of-service. Moreover, Valero notes that the
Commission has previously rejected adjustments to the index based upon
estimates of anticipated increases in pipeline integrity costs.\54\
Lastly, Valero asserts that claims of future increases in regulatory
expenses are speculative.
---------------------------------------------------------------------------

    \53\ Valero Reply Comment at 8 (citing Jurisdictional Public
Utilities and Licensees, Natural Gas Companies, and Oil Pipeline
Companies, 111 FERC ] 61,501 (2005)).
    \54\ Valero Reply Comment at 10 (citing AOPL II, 281 F.3d at
247).
---------------------------------------------------------------------------

    121. ATA, in its reply, states that pipeline integrity cost
increases are already appropriately accounted for in the years 2004
through 2009. ATA states that the Pipeline Integrity Management program
was established in 2002, and that the program required hazardous liquid
pipeline operators to develop a written plan to initially assess the
integrity of their pipelines over a roughly five year period with
baseline assessments to be 50 percent completed by September 30, 2004,
and 100 percent completed by March 31, 2008. After the baseline
assessment, the assessments are to be repeated every five year period.
    122. SPOPS also avers that future costs are speculative and
inconsistent with a backward looking methodology. SPOPS asserts that a
large increase rewards pipelines with unjust and unreasonable rates and
that the pipelines not recovering their costs are free to file for rate
increase. Sinclair/Tesoro also assert that more stringent safety
regulations are not unique to pipelines as environmental regulations
have also imposed costs on shippers, and that it is unfair to impose
these costs alone on shippers.
c. AOPL October 20, 2010 Response
    123. AOPL states that it relies on Mr. Byrd's declaration to
explain that Dr. Shehadeh's calculations are consistent with real-world
industry experience, and to show that establishing an index below PPI-
FG+3.64 would frustrate expectations on which past pipeline investments
have been made, among other things.
    124. AOPL also states that Mr. Byrd's testimony is consistent with
the comments of PHMSA, which state, among other things, that
regulations have imposed significant compliance costs and events,
including the Deepwater Horizon oil spill, have also caused PHMSA to
expand its integrity management regulations. AOPL disagrees with SPOPS'
suggestion that pipelines should seek to recover these safety and
integrity management costs through cost-of-service filings, arguing
that such an approach is inconsistent with the implementation of a
generally applicable ratemaking methodology. AOPL argues that if
pipelines were required to use cost-of-service filings to recover these
kinds of costs, the efficiency gains which were intended by EPAct in
implementing the generally applicable index methodology would be lost.
d. Commission Determination
    125. AOPL and other parties have submitted this information
regarding future costs for Commission consideration, but they have not
proposed to depart from the Kahn Methodology's reliance upon historic
data. Moreover, future costs projections related to regulatory changes
are speculative and inappropriate for inclusion in the index.\55\
Accordingly, the evidence presented regarding prospective regulatory
changes does not alter the Commission's determination regarding the
appropriate index level as calculated based upon historic costs.
---------------------------------------------------------------------------

    \55\ AOPL II, 281 F.3d at 247.
---------------------------------------------------------------------------

2. Master Limited Partnerships
    126. CAPP contends that the Commission should not grant an
increased allowance merely to enhance cash flow requirements that may
be attributable to the MLP form of business. CAPP states that due to
federal tax laws, MLPS generally distribute all available cash flow to
unit holders in the form of quarterly distributions. CAPP argues that
the form of business organization and operation may create a tension
between how a pipeline makes prudent safety and integrity-related
decisions without contravening cash distribution constraints. CAPP
argues that the Commission should not view the cash requirements of
MLPs as a legitimate basis for increasing the revenue flow generated by
regulated rates. SPOPS also claims that the MLP structure attracts
capital to the pipeline industry but, rather than making investments in
infrastructure, diverts the equity capital away in payouts to the
general and limited partner investors.
    127. AOPL responds in its Supplemental Reply Comments that shippers
made substantially similar arguments during the prior five-year review
period, and the Commission rejected them. Furthermore, AOPL states it
is not seeking ``an increased allowance'' to enhance MLP cash flow
requirements. AOPL asserts neither the cash flow requirements of MLPs
nor the dividend policies of corporate-owned pipelines are part of the
calculation of changes in oil pipelines costs. Nor is there any
``tension'' between pipeline safety and capital investment and MLP cash
distribution requirements, as CAPP contends. AOPL contends the issue is
not about the pipeline organizational structure, but whether pipelines
will be able to recover sufficient revenue to fund their operations.
Accordingly, AOPL argues shippers provide no valid basis to abandon the
established methodology.
a. Commission Determination
    128. All pipelines, regardless of business form, experience changes
in cost. The index is designed to enable pipelines be able to recover
sufficient revenue to fund their operations, whether or not the
pipeline's business form is as an MLP. The middle 50 Kahn Methodology
allows the Commission to appropriately exclude outliers and to track
general changes in pipeline costs whatever the form of the business.
Accordingly, the discussion regarding MLPs does not alter the
Commission's determination regarding the appropriate index level.

E. Revisions to Form No. 6

1. Comments
    129. ATA and NPGA aver that Form No. 6 should be revised to
segregate cost and revenue for each regulated common carrier and or
system and to supply separate page 700 data for each oil pipeline or
system included in the report. To enhance transparency, ATA and NPGA
also asserts that Form No. 6 should be revised to require the pipeline

to file all workpapers that fully support the data reported on Form No.
6 page 700, including a total cost-of-service. ATA and NPGA also assert
that pipelines must file Form No. 6 before initiating an index rate
increase. ATA and NPGA also argue that the Commission should change the
interest rates applicable to refunds as provided in 18 CFR Sec.
340.1(c)(2)(i) to reflect the pipeline's rate of return as reported on
Form No. 6, page 700.
    130. SPOPS urges, in its reply comments, that shippers and
customers should be allowed access to the workpapers underlying page
700. SPOPS also contends that the page 700 data should reveal both the
nominal and the real rate of return on equity, including the amount of
dollars of equity both collected in rates and dollars placed in rate
base. SPOPS states that the current rate of return on equity must be
known to determine the need for the index increase to attract capital.
    131. In reply comments, AOPL argues that the Commission has
addressed and rejected the proposal regarding segmented data and
workpapers. AOPL states the Commission in its ruling explained that
page 700 is designed to be a preliminary screening tool for pipeline
rate filings and not form the basis of a decision or demonstrates the
just and reasonableness of proposed or existing rates. AOPL asserts the
Commission has revisited this issue as recently as December 2008 and
upheld its initial views.
2. Commission Determination
    132. The Commission finds that the proposals to modify Form No. 6
are outside the scope of this proceeding, which is to set the going-
forward index level.
    The Commission orders: Consistent with our review and verification
of the sample pipeline Form No. 6 data, and the application of the
previously approved Order No. 561 methodology to that data, the
Commission determines that the appropriate oil pricing index for the
next five years, July 1, 2011 through June 30, 2016, should be PPI-
FG+2.65.

    By the Commission.
Nathaniel J. Davis, Sr.,
Deputy Secretary.
[FR Doc. 2010-32062 Filed 12-21-10; 8:45 am]
BILLING CODE 6717-01-P