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ASSOCIATION OF OIL PIPE LINES (AOPL)

AOPL represents liquids pipeline owners
and operators transporting crude oil,
petroleum products like gasoline, diesel,
jet fuel, and home heating fuels
and industrial products like ethane
Table of Contents

Executive Summary ................................................................... 5

Introduction .............................................................................. 6

Oil Pipelines – The Business Landscape .................................... 8

Public Benefits from Oil Pipelines ....................................... 9

Competition ....................................................................... 10

“Common Carrier” vs. “Contract Carrier” .......................... 11
An Important Difference

Rapidly Shifting Markets and Risks .................................... 11

Project Development – Commercial ................................. 14
and Regulatory Issues

Oil Pipelines – The Regulatory Landscape ............................... 16

Liquid Pipelines are Not Public Utilities ............................. 16
or Natural Monopolies

ICA Compliance Includes No Undue .................................. 17
Discrimination and Protecting Confidentiality
of Shipper Information

Cost-of-Service Regulation: Lessons from History ............ 18
and Congressional Direction

Oil Pipeline Ratemaking...................................................... 18

What is Page 700 and How Should it Be Used? ................. 20

The Regulatory Construct Has Been Working .................... 20

Conclusion ............................................................................... 22

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 Executive Summary

v Pipeline transportion of crude oil, refined products, and natural gas liquids is safe and low cost,
accounting for a small fraction of consumer prices. In addition, FERC has explained that prices
paid by consumers for petroleum products are determined by market forces, “not by regulatory
concepts.”

v Oil pipelines operate in a more competitive and higher risk environment than the other FERC-
regulated industries, competing with each other, and trains, barges, and trucks with more
operational flexibility and little to no economic regulation.

v Volatility in both throughput volumes and financial performance reflect the dynamic markets in
which oil pipelines operate.

v Common carrier status for oil pipelines creates unique risks, because in most cases shippers lack a
contract commitment and can leave a pipeline system at any time.

v Oil pipelines are not public utilities or natural monopolies, as FERC, courts, and the Department of
Justice recognize. Competitive pressures discipline pipeline rates, and many pipelines operate
under market-based rates because of that competition.

v New pipeline projects are becoming even more expensive and challenging, lack long-term shipper
commitments, and have high re-contracting risk. FERC policies have a significant influence on
whether pipelines invest to expand.

v A series of statutory mandates apply to oil pipelines, including prohibitions on undue
discrimination and disclosure of shipper information. FERC audits demonstrate oil pipelines’
compliance with these requirements.

v Widespread cost-of-service regulation is ill-suited to the oil pipeline industry, and its use many
years ago led Congress to require “streamlined” and “simplified” FERC regulation, without
imposing “unnecessary regulatory costs.” Cost-of-service regulation is rightfully the “exception,
rather than the rule,” for oil pipelines.

v Page 700 of the oil pipeline annual report is a simplified cost-of-service presentation used as a
“preliminary screening tool” for rates. FERC has rightly rejected proposals to turn Page 700
perilously close to an annual cost-of-service rate case presentation.

v FERC regulation works well as is. The oil pipeline rate index pushes pipelines to operate efficiently,
benefitting shippers through lower rates. Industry data shows more efficient pipelines earn higher
returns and charge lower rates than less efficient ones.

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Oil Pipelines: The Business and Regulatory Landscape

Introduction carriers, and not public utilities. Unlike a traditional

utility with natural monopoly characteristics (e.g.,
defined service territory, steady returns on investment,
From the initial use of a pipeline to transport regulated entry into the market, customers who lack a
oil after the first commercial well was drilled in 1859, choice of transportation or transmission options, and
to today’s modern web of lines that traverse our ultimate end users that are captive to their retail
nation, the oil pipeline industry has been characterized distributor), the oil pipeline industry is rooted in risk
by dynamism. After a period of steady growth during taking and investments that lack any assurance of a
the early years, the network of oil pipelines we have long-term revenue stream. Oil pipelines operate in an
today largely results from specific periods of big environment with swift market changes and a
investment, including in the 1920s with the growth of customer base comprised of large commercial
the automobile industry. During World War II when enterprises that can use transportation alternatives.
our country’s oil tankers were vulnerable to attack and
supplies were needed from producing regions to serve Another key distinction between oil pipelines
markets and the military along the eastern seaboard, and traditional utilities is that the rates charged by oil
pipelines expanded to meet the needs of national pipelines have little, if any, discernable impact on
security and people on the east coast. In the late consumers. This is because the price of transportation
1960s, new pipelines were added to serve growing generally accounts for only a small fraction of the price
population on the west coast. that consumers pay for refined petroleum products,
and the price of petroleum products distributed to end
In this decade, we are in another period of use consumers is unregulated.1 On average, only a few
expansion to bring the benefits of increased North cents of the cost of a gallon of gasoline to an end-user
American energy production to more Americans. The can be attributed to pipeline transportation.
“oil pipeline” industry today has 212,000 miles of pipe
carrying crude oil to refineries, natural gas liquids to As the Federal Energy Regulatory Commission
fractionators, carbon dioxide to oil fields, and products (FERC) has explained, regulation of pipeline
like gasoline, diesel, jet fuel, and propane to American transportation is a small part of a “vast unregulated
consumers, farms, and businesses, making American whole,” and the prices paid by ultimate end users “are
lives better and supporting millions of American jobs. determined not by regulatory concepts, but by market
forces.”2 Ultimately, the primary interests of the public
The oil pipeline industry’s story is not a tale of with respect to oil pipelines are ensuring adequate
constant growth and success. Industry participants capacity so that sufficient motor gasoline and other
have dealt with downturns and periods of declines in fuels are delivered to market, and pipeline safety and
domestic production and regional demand. The North integrity.
American energy renaissance is expected to continue
for years to come, causing shifts in transportation Significant competitive pressures at play in the
needs and thus winners and losers in the midstream oil pipeline industry have been recognized for many
sector. While most Americans will continue to use years, as evidenced by the seminal 1986 Department of
fossil fuels for a long time, oil pipelines and their Justice study which found that most oil pipelines could
shippers are again in dynamic times. There is be deregulated without harm to shippers or
uncertainty driven by the possibility of alternative fuels consumers.3 As a result, in comparison to the more
and electric powered vehicles seizing market share, traditional network industries regulated by FERC –
and a well-funded movement challenging energy interstate electric transmission and natural gas
infrastructure which makes expanding pipelines more pipelines – the oil pipeline industry is characterized by
difficult and costly than ever before. substantial market volatility, which results in
commercial winners and losers.
The oil pipeline industry is like no other
network industry in America. Oil pipelines are common

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 Oil Pipelines: The Business and Regulatory Landscape

This unique oil pipeline delivery system is The oil pipeline regulatory construct mandated
governed by a regulatory construct designed to by Congress, and implemented by FERC, is working as
optimize the benefits of competitive pressures by envisioned. Oil pipelines have responded by operating
encouraging efficient economic performance for the efficiently and cutting costs for the benefit of shippers,
benefit of shippers and pipelines alike. In contrast to while providing safe, reliable transportation services.
electric utilities and natural gas pipelines, cost-of- This is reflected in the Form 6, Page 700 preliminary
service ratemaking is a rarely used “safety valve” in the rate screening data. An analysis of that data shows
oil pipeline industry. Most rates are set by price cap that higher return pipelines exhibit more effective cost
regulation (i.e., the oil pipeline rate index), and the control than lower return pipelines: 1) they have lower
remaining rates are commonly set through operating and maintenance costs, and 2) comparatively
negotiations and market-based rate authority. lower average prices (lower revenues per barrel-mile).
In other words, more efficient pipelines both earn
Indeed, Congress, in the Energy Policy Act of higher returns and charge customers lower rates than
1992 (EPAct 1992),4 mandated that oil pipeline rates be those that are less efficient. Further, the data show
set by “simplified” ratemaking and “streamlined” that the oil pipeline industry as a whole has been
procedures, rather than a cumbersome, utility-type under-earning its cost-of-service going back at least to
regulatory model. Congress required that the 1993.
regulatory approach avoid “unnecessary regulatory
costs,” in recognition of the dynamic business
landscape in which oil pipelines operate. In fact, the
United States Court of Appeals for the D.C. Circuit has
made clear that an oil pipeline regulatory construct
based largely on the use of cost-of-service rates “would
be inconsistent with Congress’s mandate.”5

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Oil Pipelines: The Business and Regulatory Landscape

Oil Pipelines – The Business Transportation of energy liquids requires careful

system planning and engineering expertise as products
Landscape are delivered in multiple batches6 back-to-back through
pipelines (up to 20 gasoline and 10 distillate types may

be shipped on the same line).
America depends on the more than 212,000

miles of oil pipelines to move energy and raw materials
Pipelines take special care to ensure that
our country relies on. Oil pipelines bring crude oil to
distinct products meet market specifications upon
the nation’s refineries and important petroleum
delivery. At those places where any incompatible
products to our communities, including all grades of
products interface during transportation, a product
gasoline, diesel, jet fuel, home heating oil, kerosene,
mixture called “transmix” is created. This transmix is
propane, and biofuels. In addition to transportation,
removed at the receiving facility, reprocessed, and
many other industries receive raw materials or energy
then sold or blended back into compatible products.
by pipeline, including food, drugs and pharmaceuticals,

plastics, chemicals, and road construction.
For example, pipelines employ additional fuel

filtering and quality testing to ensure that jet fuel
Pipeline transportation continues to be the
quality standards are satisfied. Jet fuel has a high
preferred mode for transporting crude and refined
sulfur content, with up to 3,000 parts per million (ppm)
products, because of its low cost, safety and efficiency.
maximum, in contrast to 15 ppm maximum
Approximately 68 percent of domestic petroleum
for most other distillates. Jet fuel is normally shipped
moves by pipeline, with marine movements accounting
next to distillates and the transmix that is generated
for 25 percent and rail and truck the balance.
from these movements typically has a high sulfur
Significant competition among oil pipelines and with
content. The market for high sulfur distillates is limited
other transportation modes helps to keep pipeline
and getting smaller due to increasing restrictions on
rates reasonable.
sulfur content. The current market for transmix with a

high sulfur content is $3 to $4/barrel less than for
Oil pipelines transport dozens of different
lower sulfur content transmix.
energy liquids today. These products are shipped over

a number of days from origin to delivery points
This special treatment of jet fuel increases the
specified by shippers. Pipelines do not own the
pipeline’s costs, and in some cases may impact the
commodities shipped, and have every incentive to
ability of the pipeline to move other products.
maximize throughput since in most cases they earn
revenue only for shipments made.

Sequencing of Product Batches in a Liquids Pipeline

Interface




Home
Premium Regular
Gasoline Gasoline
Heating Jet Fuel Diesel Fuel
Fuel




Transmix

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 Oil Pipelines: The Business and Regulatory Landscape

Transmix disposal fees are generally paid for safely. Oil pipelines make significant efforts to ensure
by the shipper through a variety of mechanisms. In the safety of their systems, employing a range of
some cases, pipelines that operate a fungible pipeline programs including the use of sophisticated in-line
system can substantially reduce transmix costs by inspection tools and other means to assess safety. In
blending transmix directly into other products. The 2016 alone, AOPL member pipelines spent more than
ability to blend the high sulfur transmix into fungible $1.65 billion
products, gas or distillate, is limited but can lower the
disposal cost of transmix for jet fuel shippers. The on pipeline integrity management, which included
volume of high sulfur transmix normally exceeds the more than 44,000 miles inspected, more than 1,700
volume that may be blended, forcing pipelines’ reliance tool runs, and more than 9,600 integrity-related digs.
on other parties to receive and process the remaining The oil pipeline industry has many industry-initiated
high sulfur transmix volume. safety programs and also must comply with
comprehensive regulatory requirements of the
The industry’s over-riding focus is on pipeline Department of Transportation’s Pipeline and
safety. Pipelines are the safest mode of transporting Hazardous Materials Safety Administration.
energy liquids, with 99.999% of products delivered

Public Benefits From Oil
Pipelines

• Pipeline expansions benefit the consumer and
shippers by making markets work better.
For example, retail gasoline prices are lower in
regions where there is sufficient pipeline
access to lower costing crude oil and gasoline,
compared to where there is not. An expert
study showed that when the SFPP East Line
expansion project from El Paso into Phoenix
was completed, which almost doubled the
pipeline’s capacity, savings to consumers more
than paid back the $300 million cost of the
project in just 18 months.

• Pipeline projects boost state and local tax
revenues, as well. For example, North Dakota
state revenues increased by more than $6
million per month when the Dakota Access
Pipeline went into service. This supports
community benefits like better schools.

• Pipeline projects create good-paying jobs.

Experts estimate the Keystone XL pipeline will
create 42,000 U.S. jobs and $2.1 billion in U.S.
worker payroll. Construction will drive 6,800 of
those jobs and with a further 35,200 jobs
supporting the project in manufacturing, trade,
finance, and hospitality.
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Oil Pipelines: The Business and Regulatory Landscape

Competition

Strong competitive forces are at work in the

oil pipeline industry. First, there is competition DOJ Confirms Competition
among oil pipelines, including direct competition in
the same markets from existing pipelines, new
pipelines, and pipelines that have modified their
The seminal study by the
operations through a capacity expansion, product Department of Justice (“DOJ”)
conversion, or flow reversal. Pipeline-to-pipeline on Oil Pipeline Deregulation in
competition is intense with many alternative pipelines 1986 detailed the highly
operating in most origin and destination markets. An competitive nature of the oil
oil pipeline is very rarely the only supplier in a market.
pipeline industry. The DOJ
Second, there is competition from other
study concluded that most
modes of transportation, including waterborne, refined products pipelines and
railroad and truck transportation alternatives. Ships, all lower-48 crude oil pipelines
railroads, and trucks are highly competitive on their could be safely deregulated
own, and collectively they place significant without harm to shippers or
competitive pressure on oil pipelines. These consumers because oil
industries have significant competitive advantages
over pipelines. They are not limited to shipping in a
pipelines faced sufficient
single direction and to fixed points, as are pipelines. competition, and that it was
Other modes of transportation can deliver the not necessary to impose
commodity more quickly than can pipelines. They are economic regulation on any
more flexible in that smaller batches of petroleum new pipeline.
products can be moved on these modes of
transportation than can be moved on pipelines. In
addition, the waterborne and truck transportation
Since that time, the
industries are not subject to rate regulation, and intensity of oil pipeline
railroads are subject to virtually no rate regulation, competition has increased
which allows for greater commercial flexibility to with the addition of even more
respond to changing market conditions. market entrants. Further,
market-based rate authority
Third, refineries compete with outbound crude
has been granted by FERC for a
oil pipelines and inbound refined petroleum products
pipelines. A crude oil producer can now export its oil number of oil pipelines, unlike
via an outbound crude oil pipeline or refine it in the in the natural gas and electric
U.S. if the market conditions are right and transmission industries. Also,
transportation is available. Similarly, U.S. refineries competitive pressures
must compete with imported refined petroleum discipline pipeline rates more
products.
generally even for those
Additionally, as common carriers, most oil
pipelines that have not sought
pipelines do not have customers with firm contract market-based rate authority.
commitments, and competitors can respond to
market changes to offer additional services to
shippers.7 An oil pipeline’s competitors, such as

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 Oil Pipelines: The Business and Regulatory Landscape

“Common Carrier” vs “Contract Carrier”: An Important Difference


Oil pipelines have been regulated under the ICA as common carriers for more than 110 years.
In contrast, interstate natural gas pipelines regulated by FERC are contract carriers. This creates
unique risks for oil pipelines in comparison to natural gas pipelines and electric transmission
companies. Unlike contract carriers, in most cases oil pipelines do not have customers with firm
contract commitments. Whereas natural gas pipelines collect substantially all of their revenue
through fixed demand charges, oil pipelines, for the most part, have no fixed charges. As such, oil
pipeline revenue is mostly collected only when there are shipments on the system. Oil pipelines
are therefore at greater risk to recover costs and have every incentive to maximize throughput.

Under this common carrier framework, with a lack of ship or pay commitment, shippers can walk
away at any time. A shipper is free to leave the pipeline system at will without any liability.
Because oil pipelines are capital-intensive, immobile assets that lack a franchised monopoly, and
given the competition from other pipelines and other transportation modes, oil pipelines are at
risk that changing market dynamics will render them unprofitable. Oil pipeline shippers are large
enterprises, with significant bargaining power and alternatives to choose from, which changes the
dynamic from a utility-type regulated industry.





barges, tankers, rail and trucks, can easily enter the primary ratemaking methodology for the other FERC-
market, and they can respond quickly to market regulated industries, which allows them an opportunity
conditions. Conversely, natural gas pipelines and to seek rate adjustments to make up for lost volumes
electric transmission facilities are typically lower risk or uncontrollable cost increases or to obtain such
assets, as they generally do not face competition from adjustments automatically by means of formula rates.
other modes of transportation and serve a
comparatively less volatile customer base that The oil pipeline industry also faces greater
commonly takes service under long-term firm market risk associated with the dynamic nature of the
contracts with fixed demand charges that provide petroleum industry, including: (1) changes in the
greater assurance of cost recovery. location and amount of refined petroleum products,
crude oil and NGL production; (2) the volatility of the
Rapidly Shifting Markets and Risks demand for service in these markets, including due to
shifts in market demand caused by changes in global
supply, expansions and closures of refineries; and (3)
The oil pipeline industry, with shippers that are
the changes in regulations that affect the demand for
free to come and go from the system, operate in a
and supply of refined petroleum products (e.g., ultra-
higher risk environment than the other industries FERC
low sulfur diesel and heating oil sulfur reductions,
regulates. Because tariff rates are mostly determined
biofuel and fuel economy mandates).
based on indexation and competition, oil pipelines face

uncertainty regarding revenues (e.g., lost volume due
The dynamic markets in which oil pipelines
to competition or commodity market changes) and
operate can cause large swings in pipeline throughput
costs (e.g., increased safety or security regulations),
and, consequently, profitability. These circumstances
which makes their return on investment less certain.
are evidence of competitive markets at work.
Conversely, cost-of-service-based ratemaking is the

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Oil Pipelines: The Business and Regulatory Landscape

Depending on market dynamics, during some time For example, the production surge was not
periods an oil pipeline may be favorably affected by immediately matched by new transportation
changing markets and be able to earn a higher return infrastructure. As a consequence, a major oversupply
that offsets diminished returns in other periods. of crude oil occurred in the Upper Midwest and at

Cushing, Oklahoma, which caused a dramatic drop in
the price of WTI crude oil at Cushing relative to the
price of Brent crude oil (i.e., from an average WTI-Brent
This volatility demonstrates and emphasizes
differential of $1.43 per barrel during 1996-2010, to an
the need to review oil pipeline earnings and average differential of -$12.60 per barrel during 2011-
rate levels over a substantially longer time 2014).
horizon than less competitive industries
with more predictable markets and revenue This oversupply caused sharp reductions in
streams. throughput and profitability for pipelines that
transported crude oil from the Gulf Coast to Cushing
and the Upper Midwest, and substantial opportunities
for new pipelines and other modes to transport crude
The build-out of the oil pipeline network in
oil from Cushing and the Upper Midwest to the Gulf
response is the North American energy renaissance is
Coast, the West Coast, or to the U.S.-Canadian East
emblematic of the opportunities and challenges faced
Coasts. In large part due to the new transportation
by pipelines. Significant investments have been made
infrastructure, the WTI-Brent price differential has
in new pipeline construction, and in expanding
been largely eliminated at this time.
capacity, flow reversals, and converting pipelines to

transport different commodities (e.g., natural gas to
Likewise, new production in regions like the
crude oil). During the period 2006-2016, overall
Bakken in North Dakota and Montana has increased
refinery receipts grew eight percent, with pipeline
the need for new pipeline and rail transportation
deliveries to refineries rising by 36%, but also with very
capacity. Consequently, some pipelines transporting
substantial increases of deliveries by the other
crude oil out of the Bakken region into the Midwest
transportation modes – a 40% increase by barge, 184%
refinery areas experienced sharp increases in volumes
by truck, and 2575% by rail.
and, because rail transportation has proven to be a

strong competitor, some crude oil pipelines
As would be expected, some pipelines
experienced significant decreases in throughput.
experienced significant increases in flows, while
.
volumes decreased for others.

Throughput Volatility on Crude Oil Pipelines
150

Millions of Barrels of Throughput

120

90



60


30


0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Mid-Valley Pipeline Company Enbridge Pipelines (North Dakota) LLC Butte Pipe Line Company

Source: FERC Form 6, page 700.

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 Oil Pipelines: The Business and Regulatory Landscape

Shifts in demand for petroleum products also improved motor vehicle fuel efficiency, higher fuel
cause considerable volatility in markets for refined prices, and increased production of refined petroleum
products pipelines. For example, the demand for products by the Midwest refineries. Centennial
refined products pipeline delivery to the Midwest Pipeline, Explorer Pipeline, and Enterprise TE Products
declined due to reduced consumption as a result of Pipeline are three such pipelines.


Throughput Volatility on Refined Products Pipelines

Enterprise TE Products Pipeline & Explorer Pipeline

250 75

Millions of Barrels of Throughput

200
Millions of Barrels of Throughput

60

Centennial Pipeline
150
45

100

30

50

15
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
0

Enterprise TE Products Pipeline Company LLC Explorer Pipeline Company Centennial Pipeline LLC (Right Axis)


Source: FERC Form 6, page 700.


Increased production of oil and “wet” natural from the Marcellus region, the need to transport NGLs
gas has produced a corresponding dramatic increase in to the region has dissipated.
NGLs. In addition, domestic and global use of NGLs is
expanding. This creates a need for new pipeline Growth in NGL production has caused
capacity to transport the raw “mixed NGLs” from the challenges in finding outlets for the increased
natural gas production areas to NGL fractionation production and in building the necessary infrastructure.
plants and then to transport the individual NGL Pipeline capacity to move NGLs from new and growing
products (e.g., propane, butane, ethane) from these production basins to consuming areas and export
fractionation plants to truck distribution terminals markets is being expanded on the U.S. East Coast, from
(e.g., propane) or to industrial end-users (e.g., ethane). the Marcellus area to the U.S. Gulf Coast, U.S. East
Coast, and Eastern Canada, and from the Bakken to
New sources of NGL supply have also led to Colorado and Alberta, Canada. New supply and
substantially less throughput on certain systems. For demand centers for NGLs create a dynamic scenario for
example, with the significant upswing in production NGL pipelines that experience changing transportation
requirements in different geographic regions.

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Oil Pipelines: The Business and Regulatory Landscape

Project Development – Commercial and The risks of not covering project costs are
heightened in certain regions, where a combination of
Regulatory Issues capacity expansion and low commodity prices can
result in over-capacity. Additionally, because of the
Development of oil pipeline projects is a risky competition among pipelines and with other
and costly proposition. New greenfield construction is transportation modes, companies may invest
estimated to cost $2.5 million to $3.5 million per mile significant capital to develop a project, only to see
on average. Oil pipeline projects are typically those plans never implemented because of other
supported by volumetric commitments. In many cases, options perceived to be more favorable by prospective
these commitments represent materially less than the shippers. For example, due to the competitiveness of
full capacity of the pipeline, as shippers subscribe to rail, in May 2013, Kinder Morgan Energy Partners LP
capacity during open season processes based on a canceled plans for its proposed Freedom Pipeline, a $2
review of competitive options. billion crude oil pipeline intended to transport West
Texas crude to refiners on the West Coast.8
Also, the terms of shipper commitments are
typically not long enough to ensure an acceptable rate The commercial environment for oil pipeline
of return on the capital employed and, consequently, projects differs substantially from that of a typical
the pipeline assumes recontracting risk to generate the regulated industry, given that oil pipeline projects are
forecasted rate of return. It is common for contracts to not supported by comparably long-term contracts and
be of five to ten years in duration, which is insufficient operate under a regulatory construct that provides no
to guarantee a revenue stream that covers project assurance of an opportunity to recover invested capital
costs. and earn a reasonable rate of return.

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 Oil Pipelines: The Business and Regulatory Landscape

U.S. Liquids Pipeline Mileage


215,000
210,000
205,000
200,000
195,000
190,000
185,000
180,000
175,000
170,000
165,000
2010 2011 2012 2013 2014 2015 2016

The pipeline response to the surge in

production has meant substantial investment in
Because their returns on investment are pipeline projects. New entry has occurred in the form
more risky, oil pipelines require a relatively of newly built pipelines, expanded pipelines, reversal of
higher expected return on investment when pipeline flows and a change of products transported by
pipelines. All of these developments substantially
competing to attract capital to finance the
enhance competition in oil pipeline markets, which
significant investment needed in oil pipeline benefits shippers and consumers by providing access to
infrastructure. In the oil pipeline industry, more economic resources.
there is more risk-taking and more
opportunities for greater gains and losses. In addition to commercial risks, oil pipeline
infrastructure development faces high regulatory
hurdles. While the Keystone XL pipeline saga, with
over a decade of regulatory review, has been well
The oil pipeline regulatory construct has
played a critical role in encouraging significant capital publicized, numerous other projects have been delayed
investment. Price cap and competition-based or even canceled due to regulatory and legal
ratemaking provide oil pipelines with the flexibility to challenges. For example, in 2016 Kinder Morgan halted
respond to market changes and help to ensure that work on its proposed $1 billion Palmetto Pipeline
long-run economic signals encourage timely entry and project, which would have carried gasoline, diesel and
exit, thereby improving market efficiencies. ethanol across 360 miles from South Carolina through
Georgia and into Florida, after pipeline opponents,
Further, FERC’s petition for declaratory order including non-pipeline competitors, encouraged the
process provides the necessary certainty for pipelines Georgia legislature to enact a moratorium on permits
and shippers to agree to transportation service for petroleum pipelines. A pipeline project today can
agreements with committed rates that are crucial to face more difficulty in permitting and higher costs in
allow for financing of new projects. approvals and easements than ever before.

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Oil Pipelines: The Business and Regulatory Landscape

Oil Pipelines – The Regulatory

Landscape Liquid Pipelines are Not Public
Utilities or Natural Monopolies


Oil pipelines have been regulated for more
An oil pipeline is far different than a
than 110 years as common carriers, in recognition of
public utility with characteristics of a
the commercial environment in which they operate,
natural monopoly. The D.C. Circuit has
particularly that they lack many of the key
said it would “be especially loath
characteristics of regulated public utilities (e.g.,
uncritically to import public utility

franchised territories and the ability to dictate prices to
notions into this area.”TB1 The FERC also
customers in the absence of regulation). FERC
recognizes the unique dynamics in
regulates the rates, terms and conditions of oil pipeline
which oil pipelines operate, and the
transportation, but does not regulate such matters as
limited influence of pipeline rates on
pipeline construction or siting, corporate transactions,
ultimate consumers, explaining "the
or abandonment of facilities or services. As the
“market price for petroleum products,
Commission has observed, under the ICA “[m]any
such as motor gasoline, is influenced by
constraints commonly associated with utility-type
a variety of factors, and the relatively
regulation … were not imposed on oil pipelines,” which
insignificant influence of marginal
“has been interpreted as reflecting a Congressional
changes in pipeline rates can be
intent to allow market forces freer play within the oil
subsumed by other market forces.”TB2
pipeline industry than was allowed for other common
In recognition of the competitive forces
carrier industries.”9
at play, Congress passed provisions in

EPAct 1992 that “streamlined” and
In contrast to FERC’s regulation of other
“simplified” oil pipeline regulation.
industries where consumer protection is paramount,

oil pipeline regulation under the ICA “is not a
There is good reason oil pipelines are
consumer-protection measure.” The focus of oil
not subject to traditional utility
pipeline regulation is on the relationship between
regulation. Oil pipelines face intense
business enterprises, carrier and shipper, which “differs
and sustained competition from other
fundamentally” from the relationship “between
pipelines and other modes of
utilities and their customers.”10 Oil pipeline regulation
transporting energy liquids, and most
is “primarily designed to promote equity among
pipeline shippers lack any commitment
entrepreneurs,” rather than consumer protection.11
to pay for pipeline capacity so are free

to use other transportation options.
Under the ICA, oil pipelines have a series of
The Department of Justice found long
compliance obligations that are taken very seriously by
ago that most refined products
the industry, including the prevention of undue
pipelines and all lower-48 crude oil
discrimination and protecting the confidentiality of
pipelines could be safely deregulated
information relating to shippers’ activities.
without harm to shippers or consumers

because oil pipelines faced sufficient
For example, ICA Section 3(1) prohibits undue
competition, and that it was not
preferences for shippers, whether affiliated or not,
necessary to impose economic
Section 2 prohibits certain differences in rates to
regulation on any new pipeline. Since
similarly situated shippers, and Section 41 prohibits any
that time, competition in this arena has
rebate or device to provide a rate lower than the
increased with more market entrants.
published tariff rate either directly or indirectly.
Further, the FERC has granted market-

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 Oil Pipelines: The Business and Regulatory Landscape

The industry focus on protection of shippers Further, liquids pipelines face powerful
and the competitive environment in which shippers incentives to avoid undue discrimination due to the
operate is heightened by the unique, “bright line” potential for shipper reparations for damages arising
restriction in Section 15(13) of the ICA on prohibiting from undue discrimination (or other violations) after a
disclosure of shipper information to any person – not successful complaint – reparations that can be
just to affiliated shippers. The ICA confidentiality requested for events two years in the past. Moreover,
requirement is fitting for an industry with unregulated in the past several years the Commission has
commodity markets and intense competition for completed a series of audits of some of the largest oil
transportation of those commodities. pipelines. The narrow findings in those audits reflects
the industry’s strong focus on regulatory compliance.

ICA Compliance Includes No Undue Discrimination, and Protecting

Confidentiality of Shipper Information

In the late 1800s, Congress adopted strong protections in the ICA against undue
discrimination and shipper information being used for the carrier’s benefit. Liquid pipelines
were brought under these rules in 1906. There are a series of mandates to ensure that all
shippers are treated equally and to protect against improper conduct that would harm the
competitive dynamics. Through meetings and educational sessions, AOPL regularly
communicates with its members about FERC compliance.

✓ ICA prohibition on disclosing shipper information
✓ ICA prohibition on undue preferences
✓ ICA prohibition on differences in rates for similarly situated shippers
✓ ICA prohibition on rebates or devices to provide rate below tariff rate directly or
indirectly
✓ ICA allows reparations for damages for events two years in the past
✓ FERC audits have narrow findings which reflects industry’s strong compliance
focus
✓ AOPL Audits and Compliance Team allows industry to continuously improve
compliance
✓ AOPL convenes annual Audits and Compliance program for industry learning
✓ AOPL members meet annually with FERC audit staff

17
 Oil Pipelines: The Business and Regulatory Landscape
Cost-of-Service Regulation: Lessons from History and Congressional Direction

FERC applied cost-of-service regulations to oil pipelines in the 1980s and early 1990s. FERC’s failed experience
resulted in the Congress enacting EPAct 1992 and directing a “streamlined” and “simplified” approach for

regulating oil pipeline rates.

From 1906 to 1977, oil pipelines were regulated by the Interstate Commerce Commission, which used a

ratemaking methodology based largely on the “fair value” of pipeline assets (the “valuation methodology”).
After jurisdiction over oil pipelines was transferred to the new FERC in 1977, and a series of court decisions,

FERC adopted a cost-based ratemaking methodology in Opinion No. 154-B.TB3


Almost immediately, pipeline rate changes began to be protested, which led to costly and time-consuming
cases, especially relative to the amount truly at stake. One proceeding cost the pipeline at least $5 million in a

case that was estimated to be worth at most $6 million. As FERC noted in the aftermath of EPAct 1992:
“[a]djudicated proceedings for oil pipelines, though few in number, have been long, complicated and costly,
and required considerable expenditure of participants’ time and resources, including that of the

Commission.” TB4


In EPAct 1992, Congress addressed the problem of burdensome cost-of-service rate litigation “[i]n order to
reduce costs, delays, and uncertainties” with respect to oil pipeline ratemaking. Given the extensive evidence
of the strong competitiveness in the oil pipeline industry, EPAct 1992 “grandfathered” most of the oil pipeline

rates existing in 1992, making them just and reasonable as a matter of law.

EPAct 1992 further required FERC to streamline its procedures “relating to oil pipeline rates in order to avoid
unnecessary regulatory costs and delays,” and directed FERC to implement a “simplified and generally

applicable ratemaking methodology for oil pipelines.” Congress recognized that utility-type, cost-of-service
regulation did not fit the competitive landscape faced by oil pipelines. The D.C. Circuit has explained that cost-

of-service is intended to be “the exception rather than the rule,” and that widespread use of cost-of-service
“would be inconsistent with Congress’s mandate under the EPAct.”TB5




Oil Pipeline Ratemaking challenges to pipeline rates.13 On judicial review, the
D.C. Circuit concluded that the post-EPAct 1992
Consistent with Congress’s instructions, after regulations “reasonably balanced [FERC’s] dual
EPAct 1992 the Commission promulgated three major responsibilities of ensuring just and reasonable pipeline
rules (Order Nos. 561, 571, and 572) which rates and simplifying and streamlining ratemaking
comprehensively revised its oil pipeline regulations. through generally applicable procedures,” and the
procedural reforms were found to be consistent with
The Commission explained that these that necessary to ensure that oil pipeline rates are just
regulations work together to fulfill the policy objective and reasonable.14
of EPAct 1992 “to simplify and expedite the
Commission’s regulation of oil pipeline rates,” Order No. 561 established the oil pipeline rate
consistent with the ICA’s requirement that rates be just index mechanism as the “simplified and generally
and reasonable.12 Included in these reforms were applicable” ratemaking methodology for changing oil
shipper protest and complaint procedures to ensure a pipeline rates. Indexed rates promote efficient and
system of checks and balances that allows appropriate innovative operations where the benefits are shared

1
8
 Oil Pipelines: The Business and Regulatory Landscape

between the oil pipeline and its shippers. The benefits The Commission issued Order No. 571 to address in
flow through to shippers in the form of lower tariff detail the cost-of-service reporting and filing
rates, including when measuring pipeline cost changes requirements under Order No. 561.15 Order No. 571
in establishing the industry-wide rate index every five also added the Page 700 filing requirement, for the sole
years. purpose of providing a “preliminary screening tool” to
assist in the review of indexed rate changes. FERC has
Given the made clear that Page 700
competitive nature of the “is not intended to show
industry and this regulatory Oil Pipeline Rate Mechanisms what a just and reasonable
construct, oil pipelines rate should be.”16
operate in the most
efficient manner possible, 1.0% Order No. 572
and incur only those costs codified the Commission’s
needed for efficient system then-existing practice of
operations while ensuring 9.5% permitting market-based
the provision of safe, rates by promulgating
reliable transportation 13.0% requirements for market-
services. based rate applications.17
The Commission has
Under indexing, oil explained that “[u]nder the
pipelines are permitted to 76.5% market-based approach,
increase (and required to the oil pipeline will be able
decrease) their rates to engage in competitive
consistent with an annual pricing in order to react to
inflation-based rate cap. changes in market
The rate index is a form of Cost of Service Rates Market-Based Rates conditions,” which “can
price cap ratemaking used Negotiated Rates Indexed Rates result in pricing that is both
in industries where more efficient and just and
competitive forces are at reasonable.”18
play. A number of oil Estimated based on rate type in pipeline tariff filings
pipelines charge rates The Commission’s
grandfathered under post-EPAct 1992
EPAct 1992 that were deemed just and reasonable as a regulations also permit pipelines to charge settlement
matter of law and have been adjusted in accordance rates agreed to “by each person who … is using the
with the FERC’s rate index regulations. service covered by the rate.”19 As such, the
Commission has upheld contract rates commercially
The oil pipeline regulatory construct is unique negotiated between pipelines and shippers as just and
also because of the variety of ratemaking approaches reasonable. The Commission’s policy regarding
that can be relied upon. In addition to indexing, the contract rates has been extremely successful and has
Commission allows the use of market-based rates, helped to encourage expansion of pipeline
settlement rates, or cost-of-service rates where infrastructure. Given the competitive industry
demonstrated to be appropriate. In Order No. 561, landscape, and that shippers are typically large,
FERC allowed use of cost-of-service rates for new sophisticated companies that can protect their
services when an indexed rate generates inadequate interests, the number of negotiated rates is significant
revenues, or as a result of a shipper complaint. As and has been growing.
shown, cost-of-service rates are used infrequently.

19
Oil Pipelines: The Business and Regulatory Landscape

Advocates for expanding cost-of-service-based

regulation ignore history, law, economics and
precedent. A primary goal of both Congress and FERC What is Page 700 and How
is to minimize expensive and time-consuming cost-of- Should it Be Used?
service ratemaking. The Commission has explained

that the post-EPAct 1992 regulations provide “several
Page 700 of FERC Form No. 6 is a
ways of establishing just and reasonable rates.”20
simplified presentation of a pipeline’s

jurisdictional cost-of-service. Page 700
In adopting indexing, the Commission stated its
serves as a “preliminary screening tool”
desire to “eliminate the need for much future cost-of-
to assist the Commission and shippers
service litigation.”21 Indexing was established as the
in the review of indexed rate changes.
“ordinary scheme of rate changes,” with exceptions
FERC has made clear that Page 700 “is
permitted in “special circumstances.”22 The D.C. Circuit
not intended to show what a just and
has explained that cost-of-service rates are permitted
reasonable rate should be.”
as a “safety valve” when indexed rates prove

inadequate, and an oil pipeline regulatory construct
There have been suggestions that
based in large part on the use of cost-of-service rates
Page 700 reporting should be expanded
“would be inconsistent with Congress’s mandate under
into something more akin to an annual
the EPAct.”23 Indexing should continue to be used by
rate case presentation, with cost-of-
most pipelines, but only if the index level reflects actual
service calculations provided for each
industry cost change experience.
rate segment of pipeline systems and

shippers being provided workpapers
The Regulatory Construct Has Been underlying cost-of-service calculations.
Working
Because of the limited purpose of
As envisioned by FERC, oil pipelines have Page 700, the infrequent use of cost-of-
responded to competitive pressures and rate index service ratemaking for oil pipelines, and
regulation by operating efficiently, while providing safe, clear statements by the D.C. Circuit that
reliable transportation services. Rate indexing, Congress did not intend significant use
combined with the competitive industry landscape, of cost-of-service in the oil pipeline
incents pipelines to improve operating efficiency, as industry, FERC has repeatedly rejected
greater efficiency has a direct benefit on the bottom such proposals.
line. For example, this regulatory approach has
encouraged significant operational improvements and It has been pointed out that such
investment to enhance energy efficiency and optimize additional reporting would easily
operations to lower electricity consumption to the exceed a thousand hours of work for an
greatest degree possible,24 consistent with the benefits individual company with only two
envisioned by the regulatory construct: systems, and require, among other
things, development of new accounting
“Indexing fosters efficiency by severing the and recordkeeping systems that differ
linkage under traditional cost-of-service from the uniform systems of accounts,
ratemaking between a pipeline’s rate changes all of which would be inconsistent with
and changes in its current operating and the Congressional mandate in EPAct
investment costs. This provides the pipeline 1992 to avoid “unnecessary regulatory
with the incentive to cut costs aggressively, costs” in the regulation of oil pipelines.
since it is assured that it may retain a portion
of the savings it generates.”25

2
0
 Oil Pipelines: The Business and Regulatory Landscape

An analysis of Form 6, Page 700 data below efficient pipelines both earn higher returns and charge
shows that pipeline returns which are “higher” do not customers lower rates than those that are less efficient.
result from tariff rates that are too high. Rather, Oil pipeline earnings, consequently, are consistent with
pipelines with higher returns exhibit more effective the intended just and reasonable outcome envisioned
cost control than lower return pipelines: 1) they have when the FERC implemented a regulatory approach
lower operating and maintenance costs per barrel mile, that allows market forces to encourage economic
and 2) comparatively lower average prices (lower efficiencies.
revenues per barrel-mile). In other words, more


Pipeline Revenue & Expenses

35

cents per 100 barrel mile

30

25
20

15

10
5

0

Average Revenue Average O&M Expenses

Higher Returns Lower Returns

1. “Higher” return pipelines have on average achieved returns on rate base >10% during 2002-2016
2. Revenue from Form 6, Page 700, Line 10, for the period 2002-2016
3. Operating & Maintenance (O&M) Expenses from Form 6, Page 700, Line 1, for the period 2002-2016



Concerns about oil pipeline returns being too encourage efficiency. FERC said exactly that in its
high are often based on data for a single year or a few Review of the Oil Pipeline Pricing Index in 2010:
recent years, and fail to recognize that, overall, the “inherent to the application of any industry-wide
industry under-recovers its cost of service. As pipeline index [is that] some pipelines will over-earn
discussed above, given the substantial volatility in oil while others will under-earn.”26
pipeline throughput and earnings levels, oil pipeline
returns must be evaluated over a substantial period of Importantly, FERC Form 6 reports show the oil
time to assess their reasonableness, as there is often pipeline industry as a whole has been under-earning
significant variation in returns over time. on a cost-of-service basis every year going back to at
least 1993, and in the vast majority of those years the
Additionally, in promulgating the indexing total industry under-recovery has been more than $1
regulations, FERC recognized that indexing will cause billion annually. Aggregate industry data over the past
some pipelines to over-earn on a cost-of-service basis decade shows that the oil pipeline industry overall has
and some pipelines to under-earn. That is inherent in continued to under-recover the cost-of-service.
an indexing regime and, in fact, is necessary to

21
Oil Pipelines: The Business and Regulatory Landscape

Total Industry Revenue vs Total Industry Cost of Service

$20,000,000,000

$18,000,000,000


$16,000,000,000

$14,000,000,000

$12,000,000,000


$10,000,000,000

$8,000,000,000


$6,000,000,000

$4,000,000,000


$2,000,000,000

$-
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Total Industry Revenue Total Industry Cost of Service




FERC Form 6 reports show that the oil pipeline industry as a whole has been under-earning
every year going back to at least 1993, and in the vast majority of those years the total industry
under-recovery has been more than $1 billion annually.



Conclusion pipelines invest to expand and have helped more
Americans gain from today’s energy renaissance.

Oil pipelines play a crucial role in the American FERC’s failed experience with cost-of-service
economy. Oil pipelines transport the energy Americans regulation in the 1980s and early 1990s led to
need in the safest, most reliable, environmentally Congressional action and a FERC regulatory construct
favorable, and economically efficient way, and the cost that better suits the oil pipeline industry competitive
attributed to transportation is typically just a few cents landscape, with a mix of ratemaking structures that fit
per gallon. New pipeline projects provide shippers the industry’s market dynamics. The FERC’s post-EPAct
with access to needed pipeline capacity and bring 1992 incentive- and competition-based regulation is
benefits to American workers and consumers, but they working well, by incenting market entry, driving
are expensive and entail inherent business risks efficiency, and capturing the benefits of efficiency for
because of opposition, a lack of long-term shippers.
commitments, and re-contracting risk. FERC policies
have a significant influence on whether

2
2
Oil Pipelines: The Business and Regulatory Landscape

End Notes

1
“From the consumer’s perspective, oil pipeline regulation is akin to efforts … to contain the cost of food by seeing to it that the price
of spice is always ‘just and reasonable,’ and to limit the cost of apparel by hitting hard at the price of buttons.” Williams Pipe Line Co.,
Opinion No. 154, 21 FERC ¶ 61,260 at 61,601 (1982) (footnotes omitted), reh’g denied, 21 FERC ¶ 61,086 (1983). great
2
Buckeye Pipe Line Co., 13 FERC ¶ 61,267, at 61,594 (1980); see Gooch v. Colonial, 142 FERC ¶ 61,220 at P 15 (2013) (the “market price
for petroleum products, such as motor gasoline, is influenced by a variety of factors, and the relatively insignificant influence of
marginal changes in pipeline rates can be subsumed by other market forces”).
3
Report of the U.S. Department of Justice, Oil Pipeline Deregulation (May 1986).
4
Pub. L. No. 102-486, 106 Stat. 3010 (Oct. 24, 1992).
5
AOPL v. FERC, 281 F.3d 239, 244 (D.C. Cir. 2002).
6
A batch is a quantity of petroleum product of like-specifications moved as an identifiable, individual unit.
7
An oil pipeline’s competitors, such as barges, tankers, rail and trucks, can easily enter the market, and since they either are not
subject to rate regulation (barges, tankers, and trucks), or are subject to limited regulation (rail), they can respond quickly to changing
market conditions.
8
See Ben Lefebvre, Kinder Morgan Ends Pipeline Plan For West Coast, Wall St. J., June 1, 2013, available at
http://online.wsj.com/article/SB10001424127887324866904578517371515559596.html
9
Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992, 58 Fed. Reg. 30,985 (Oct. 22, 1993), FERC Sats. & Regs.,
Regs. Preambles, 1999-1996, ¶ 30,985, at 30,942 (1993), order on reh’g., Order No. 561-A, FERC Stats. & Regs., Regs. Preambles, 1991-
1996 ¶ 31,000 (1994) (“Order No. 561”) (citing Farmers Union Central Exchange v. FERC, 584 F.2d 408, 413 (D.C. Cir. 1978) (“Farmers
Union I”), cert. denied, 439 U.S. 995 (1978)).
10
Suncor Energy Marketing Inc. v. Platt Pipe Line Company, 132 FERC ¶ 61,242 at P 104 & n.62 (2010).
11
Buckeye Pipe Line Co., 13 FERC ¶ 61,267 at 61,595 (1980).
10
Order No. 561 at 30,940.
13
Id. at 30,955 - 56.
14
AOPL v. FERC, 83 F.3d at 1443-1445 (emphasis added).
15
Order No. 571, Cost-of-Service Reporting and Filing Requirements for Oil Pipelines, FERC Stats. & Regs., ¶ 31,006 59 Fed. Reg. 59,137
(1994).
16
Order No. 571, at 31,168; Order No. 571-A at 31,254 (emphasis added).
17
Market-Based Ratemaking for Oil Pipelines, FERC Stats. & Regs., Regs. Preambles, 1991-1996, ¶ 31,007 (1994) (“Order No. 572”).
18
Id. at 31,180 (citation omitted).
19
18 C.F.R. § 342.4(c).
20
Order 561, at 30.940.
21
Id. at 30,941.
22
Order No. 571 at 31,165. For example, pipelines may file a cost-of-service rate change if they can show a “substantial divergence”
between their costs and the revenue permitted under indexing. 18 C.F.R. § 342.4(a). Shippers may also challenge a pipeline’s annual
indexing changes if they can show that the indexing increase is substantially in excess of the pipeline’s actual cost changes. 18 C.F.R. §
343.2(c)(1). Shippers may also file complaints against existing pipeline rates. 18 C.F.R. §§ 343.1.
23
AOPL v. FERC, 281 F.3d at 244 (emphasis added).
24
Oil pipelines use electric motors to power their pumping stations and, consequently, are some the largest consumers of electricity on
many utility systems. Due to the environment in which they operate and the regulatory construct that applies to the industry, oil
pipelines have strong incentives to invest in energy efficiency products and optimize operating efficiencies to lower electricity
consumption.
25
Order No. 561 at 30, 948, n. 37.
26
Review of Oil Pipeline Pricing Index, 133 FERC ¶ 61,228 at P 113 (2010).
TB1
Farmers Union I, 584 F.2d at 413.
TB2
See note 2, supra.
TB3
Williams Pipe Line Co., 31 FERC ¶ 61,377 (1985) (“Opinion No. 154-B”), opinion on reh'g, 33 FERC ¶ 61,327 (1985).
TB4
Order No. 561 at 30,943.
TB5
See note 23, supra.

23