The Daley Note: November 15, 2022
Federal regulators have curtailed shippers’ ability to contest new rate hikes on oil pipelines. The decision follows an historic increase to pipeline tolls that has just started flowing cash to operators, and with more rate hikes on the way according to our Blueprint Financial Models.
On Oct. 20, the Federal Energy Regulatory Commission (FERC) adopted a new policy statement for reviewing shipper protests on pipelines that use indexing to set rates. The new policy, unanimously approved by the Commissioners in an open meeting, will allow pipeline operators to continue collecting on rate increases posted on most liquids pipeline systems in 3Q22.
Under FERC Order 561, liquids pipelines (crude oil, NGL and refined products) have the option to set rates under tariffs that can be adjusted annually to keep pace with inflation. Pipelines may raise rates up to a ceiling level calculated from the Producer Price Index for Finished Goods (PPI-FG), plus an index set by FERC every five years.
In May, FERC set the new ceiling index at 1.087107, the highest ceiling increase ever for pipelines using indexed rates, and instructed operators to update their tariffs as of July 1, 2022. The ceiling raise reflects the soaring inflation experienced in 2021 as economic activity rebounded from Covid lockdowns. The PPI-FG rose by an average of 8.92% Y-o-Y in 2021, according to the Bureau of Labor Statistics, the fastest rate of inflation in 40 years.
For clients, we've been highlighting the future cash flow impacts to pipelines since inflation began running hot in 2021. East Daley uses forward estimates of indexed rates in our Blueprint Financial Models for pipeline owners such as DCP Midstream (DCP), Enterprise Products Partners (EPD), Energy Transfer (ET), NuStar (NS), ONEOK (OKE) and Plains All American (PAA).
Asset-level modeling often sets our company forecasts apart from the Street, and that has particularly been the case during this period of high inflation. Most recently, we reviewed the latest tariff updates to see which pipelines have passed along the full 8.7% hike allowed by FERC; clients can log in to see our Aug. 11 Midstream Navigator, “Record Rate Hike Goes Into Effect for Liquids Pipelines”. In this context, FERC’s policy will keep the spigots open for oil pipelines.
Commissioners unanimously voted to adopt a 2020 proposal that would eliminate the use of the "Substantially Exacerbate Test" for reviewing complaints. Traditionally, shippers could file protests if the rate hikes under indexing are substantially higher than actual changes in pipeline operating costs. Shippers could file these protests before new rate increases began, and then file complaints once the rate hikes took effect. Complaints were screened by FERC to examine whether (1) the pipeline was over-recovering service costs and (2) the new rate would substantially exacerbate over-recovery.
FERC adopted the new policy following a ruling by the US Court of Appeals for the District of Columbia. In Southwest Airlines Co. v. FERC, the appellate court vacated and remanded a decision by FERC applying the Substantially Exacerbate Test, finding that the agency had departed from prior policy by considering post-update data when reviewing a shipper complaint.
Under the new policy, FERC will use a "Percentage Comparison Test" to screen for a 10% change between index rates and the change over the prior two years based on the cost of service. FERC said it will use this test to screen both protests and complaints, meaning that a pipeline's current rate of over-earning will no longer be considered. Shippers can still file base rate challenges, but these complaints involve a longer process and are not viable for contesting annual index rate increases.
Inflation has yet to cool so far in 2022, and unless the PPI-FG takes a nosedive in 4Q22, the adjustment is on track for another record hike in mid-2023. Based on the latest PPI-FG data, we estimate the next adjustment will be over 13%, with no prospect for shippers to contest. Expect pipelines that are currently over-recovering in our Blueprint Financial Models to see significant upside. — Oren Pilant Tickers: DCP, EPD, ET, NS, OKE, PAA.
East Daley to Present at Nov. 17 Bank of America Securities Conference
East Daley will present our natural gas market outlook at the Bank of America Securities Conference in Miami on Nov. 17. Senior Capital Markets Analyst Zack Van Everen will present the short- and long-term outlook for natural gas supply and demand dynamics. Join us in Miami live at 10:15 am ET on Nov. 17 or watch us remotely.
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Is Midstream on the cusp of another infrastructure wave? East Daley will explore the potential in our annual Dirty Little Secrets market report in early December. Click here to learn about our 2023 Dirty Little Secrets report.
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Dirty Little Secrets is East Daley’s annual report on energy markets and the road ahead for Midstream. We share our macroeconomic outlooks for US oil, natural gas and NGLs, highlight key infrastructure opportunities, update on the state of the Energy Transition, and share our view on Midstream’s future role in energy.
3Q22 Earnings Previews and Review Now Available
East Daley has published a complete group of 3Q22 Earnings Previews and Blueprint Financial Models for midstream companies within our coverage. We also are publishing 3Q22 Earnings Reviews as companies report comparing our forecasts vs results. Quarterly Earnings Previews and Blueprints are now available for Antero Midstream (AM), Crestwood Equity (CEQP), Enbridge (ENB), EnLink Midstream (ENLC), Enterprise Products (EPD), Energy Transfer (ET), Equitrans Midstream (ETRN), Kinder Morgan (KMI), Kinetik Holdings (KNTK), Magellan Midstream (MMP), MPLX (MPLX), ONEOK (OKE), Plains All American (PAA), Summit Midstream (SMLP), Targa Resources (TRGP), TC Pipelines (TRP), Western Midstream (WES) and Williams (WMB).
Our Earnings Previews include quarterly earnings forecasts compared to Street consensus, a detailed list of the top assets that will impact the quarter, analysis of near- and long-term risks to future earnings, along with forecasts for Adj. EBITDA by segments. Please log in to access these reports.
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