FERC Regulation: Natural Gas and Oil

Presented:

October 3, 2017

© 2017 Concentric Energy Advisors, Inc. All rights reserved.

Agenda

• FERC Overview• Natural Gas

• Regulation Overview• Pipelines and Transportation• Storage• LNG• Local Distribution

• Oil• Regulation Overview• Carrier/Non-carrier pipelines• Pipeline lifecycle• Tariffs• Reporting Requirements

• Sample company: Kinder Morgan

2 © 2017 Concentric Energy Advisors, Inc.

What FERC Does

Federal Energy Regulatory Commission (FERC)

Electric

Interstate transmission

and wholesale sales

Certain M&A and corporate transactions

Non-federal hydroelectric

projects

Natural Gas

Interstate Transmission

and sale

Pipelines and storage facilities

LNG terminals

Oil

Interstate Transportation of

oil by pipeline

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What FERC Does Not Do• Retail electricity and natural gas sales (regulated by state public utility commissions)

• Physical construction of electric generation facilities (regulated by state public utility commissions)

• Municipal power systems, federal power marketing agencies (regulated by state public utility commissions)

• Nuclear power plants (regulated by Nuclear Regulatory Commission)

• M&A as related to natural gas and oil companies

• Pipeline safety (regulated by Pipeline and Hazardous Materials Safety Administration)

Interstate/Intrastate Natural Gas Pipeline Network

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Interstate Crude/Products Pipeline Network

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Increased Natural Gas Production

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Natural Gas - Overview

FERC Regulates:• Interstate natural gas

transportation/storage• Construction of pipelines, storage

facilities, LNG facilities• Rates for transportation/storage

services• Facility abandonment• Gathering

FERC Does Not Regulate:• Intrastate transportation• Delivery to customers• Natural gas prices• Production• Safety aspects• Gathering

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• Aspects not regulated by FERC are regulated by state utility regulatory agencies or the Pipeline and Hazardous Materials Safety Administration (PHMSA), within the Department of Transportation

Natural Gas Value Chain Regulation

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Production

•Wellhead•Gathering facilities????

Transportation

•Pipeline construction•Interstate transportation•Intrastate transportation•Rates for transportation services•Storage facility construction•Safety

Delivery

•Delivery to consumers•Natural gas prices•Facility abandonment

FERC regulates

Natural Gas: Pipelines

• FERC regulates the approval, permitting, and siting for new pipelines, as well as the transmission rates charged for interstate shipments

• The Natural Gas Act (NGA) of 1938 enables FERC to:• Review proposed interstate natural gas pipeline

• Coordinate environmental and land use permitting with other agencies

• Determine if pipeline meets public convenience and necessity

• Specify conditions under which pipeline is constructed (e.g. route used)

• Once built, FERC can monitor rates and approve a maximum allowable rate

• ‘Gathering’ and ‘transportation’ are not defined in the NGA, so FERC uses a few physical and geographic factors to determine if the facility is under their jurisdiction

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Natural Gas Pipeline Application Process

1. Company submits application to FERC to build or modify interstate pipeline

2. FERC evaluates all aspects of project, accepts comments from public

3. FERC issues analysis for further public comment

4. Approves or denies application after evaluating reviews and comments

5. Parties can ask for rehearing or new decision

6. FERC considers this request and makes a decision

7. Final decisions can be appealed to federal courts

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Natural Gas Storage

• FERC has jurisdiction over underground storage projects that are owned by interstate pipelines and integrated into their systems

• Also has jurisdiction over independently operated projects that offer storage services in interstate commerce

• The Energy Policy Act of 2005 added a new section to the Natural Gas Act, stating that FERC can authorize natural gas companies to provide storage services at market-based rates for new storage capacity

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LNG

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• FERC responsibilities• Siting and construction of onshore

and near-shore LNG import/export facilities

• Assessing environmental impacts, security

• Issuing certificates of public convenience and necessity for facilities involved in interstate transportation

• PHMSA responsibilities• Peak-shaving, LNG satellite,

vehicular fuel LNG plants connected to intrastate pipelines

• Establishing and enforcing safety regulations

*can recreate this map if we want to include it

Natural Gas Local Distribution

• Regulation of local distribution has many similar objectives, but is overseen by state utility commissions rather than FERC

• State commissions regulate rates, construction, and maintenance of supply to customers

• From 15 U.S. Code Chapter 15B – Natural Gas § 717:• The provisions of this chapter shall not apply to any person engaged in or legally

authorized to engage in the transportation in interstate commerce or the sale in interstate commerce for resale, of natural gas received by such person from another person within or at the boundary of a State if all the natural gas so received is ultimately consumed within such State, or to any facilities used by such person for such transportation or sale, provided that the rates and service of such person and facilities be subject to regulation by a State commission. The matters exempted from the provisions of this chapter by this subsection are declared to be matters primarily of local concern and subject to regulation by the several States.

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Oil Regulation - Overview

• Oil pipelines transport (1) Crude Oil (2) Natural Gas Liquids (3) refined petroleum products, such as:

• Hepburn Act of 1906 classified oil pipelines as common carriers under Interstate Commerce Act of 1887 (originally applied only to railroads) and began the regulation of interstate oil pipelines.

• Interstate oil pipelines were regulated by Interstate Commerce Commission (ICC) from 1906 – 1977 and by FERC from 1977 to present.

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• Liquefied petroleum gas• Chemicals• Gasoline• Jet Fuel

• Diesel Fuel• Lubricating Oil• Fuel Oil• Oil for roads and roofing

• What are FERC's responsibilities for regulating oil pipelines?1) Regulating interstate and international transportation of petroleum by common carrier

pipelines; and2) Ensuring that oil pipeline carriers file tariffs, which contain the rates, charges, and rules for

transporting the oil by pipeline.

U.S. Liquid Pipelines Map

Common Carrier & Interstate

• Oil pipelines are considered as “Common Carriers” – a term refers to all pipeline companies and all persons engaged in such transportation

• The definition of “Common Carrier” is often interpreted by state regulatory bodies. For example a) Illinois Commerce Commission defines “Common carrier by pipeline" as

• A person or corporation that owns, controls, operates, or manages, within this State, directly or indirectly, equipment, facilities, or other property, or a franchise, permit, license, or right, used or to be used in connection with the conveyance of gas or any liquid other than water for the general public in common carriage by pipeline, or

• A gas public utility that provides local distribution services is not a common carrier by pipeline, irrespective of whether the public utility transports customer-owned gas or gas owned by a third party to some of its customers. A water public utility that provides local distribution services is not a common carrier by pipeline. A unit of local government is not a common carrier by pipeline.

b) Railroad Commission of Texas overturned a Hearings Examiner’s interim ruling that the Common Carrier Act does not apply to a pipeline transporting ethylene

• Intrastate oil pipelines are not regulated by FERC. The same pipeline can provide both intra-state and interstate transportations.

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Oil Pipeline Life Cycle

FERC does not regulate:• The oversight of oil pipeline construction (regulated by states and local jurisdictions)• Abandonment of Service• Mergers and Acquisitions• Safety (regulated by PHMSA within the Department of Transportation)• Pipeline transportation on or across the Outer Continental Shelf

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Entry into Market

• Planning, siting, financing etc.• Finalizing plans and receiving approvals/permits• Oil pipeline construction

Operational Phase

• Establish tariffs (with no firm capacity)• Safety• Environment issue

Exit from Market

• Sale of pipeline asset• Mergers and acquisitions• Abandonment or abolishment

FERC Regulation

Oil Pipeline Tariffs

• Initial rates are established by the following two (2) ways:1) Cost-of-service – A pipeline must submit the applicable cost, revenue, and data supporting such a rate

as required by the FERC's regulations. At that time the FERC will review the rate and decide whether it is appropriate to set the price at that rate.

2) Sworn affidavit – A pipeline must submit a sworn affidavit that the initial rate was agreed to by at least one non-affiliated person who intends to use service. If application is protested, the pipeline must submit cost-of-service data to support the initial rate.

• Existing rates can be updated in these four (4) ways:1) Indexing – An oil pipeline determines an annual ceiling level which caps (places a maximum number

the rate can be) the rate an oil pipeline may charge. This ceiling level is adjusted annually based upon changes in the Producer Price Index minus one.

2) Cost-of-service – A pipeline must show that there is a substantial difference between the actual costs experienced by the pipeline and the rate resulting from application of the index such that the rate at the ceiling level would precluded the carrier from being able to charge a just and reasonable rate within the meaning of the ICA.

3) Settlement rate. – A pipeline secures the agreement of all its existing customers to its proposed rate change.

4) Market-based rates – A pipeline must show that it does not have significant market power in the markets it is applying for market-based rates.

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Reporting Requirements

• Annual reporting• Form No. 2 Major Natural Gas Pipeline Annual Report

- Major is defined as having combined gas transported or stored for a fee that exceeds 50 million dekatherms• Form No. 2A: Non-major Natural Gas Pipeline Annual Report

- Non-major is defined as having total gas sales or volume transactions exceeding 200 thousand dekatherms• Form No. 6: Annual Report of Oil Pipeline Companies

- Each oil pipeline carrier whose annual jurisdictional operating revenues exceed $500,000 must file FERC Form 6

• Quarterly reporting• Form No. 3-Q: Quarterly Financial Report of Electric Utilities, Licensees, and Natural Gas Companies• Form No. 6-Q: Quarterly Report of Oil Pipeline Companies

- Oil pipeline carriers submitting FERC Form 6 (annual jurisdictional operating revenues exceed $500,000) must submit FERC Form 6-Q

• Other filings• Form No. 592: Marketing Affiliates of Interstate Pipelines• Form No. 73: Oil Pipeline Service Life Data

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An Introduction-Market Based Rates

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• Crude/Product Pipelines and Natural Gas Storage—NOT Natural Gas Pipelines

• Requires a “mini-antitrust” showing (Lack of Market Power)

• Demonstrate that there is adequate competition (origin and destination markets for Crude/Product Pipelines)

• Define geographic and product market

• Identify competitive alternatives

An Introduction-Cost of Service Based Rates

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• Natural Gas Act requires “just and reasonable rates”

• Requires a balancing of the equities between the interests of the pipeline and its ratepayers

• Cost of providing service and the opportunity for the pipeline to earn a reasonable return on its investment

The Cost of Service Formula

Operation & Maintenance Expenses (O&M)

Administrative and General Expenses (A&G)

Depreciation Expense

Taxes Other Than Income

Return on Investment (Rate Base x Overall Rate of Return)

Income Taxes

Revenue Credits

Total Cost of Service

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Company Profile: Kinder Morgan Inc.

• Kinder Morgan, Inc. (NYSE: KMI) is one of the largest energy infrastructure companies in North America. It owns an interest in or operates approximately 84,000 miles of pipelines and 155 terminals.

• KMI’s pipelines transport natural gas, refined petroleum products, crude oil, condensate, CO2 and other products, and its terminals transload and store petroleum products, ethanol and chemicals, and handle such products as steel, coal and petroleum coke.

• Kinder Morgan subsidiaries:• El Paso Natural Gas Company, LLC – Midstream Natural Gas pipeline company• Kinder Morgan Cochin LLC – Midstream Oil pipeline company• SFPP, L.P.• Tennessee Gas Pipeline• Plantation Product Pipeline• Sierrita Gas Pipeline

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FERC Form No.2 – El Paso Natural Gas Company, LLC

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FERC Form No.6 – SFPP, L.P.

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Contact Information

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Ken SosnickSenior Project Manager

293 Boston Post Road West, Ste 500Marlborough, MA 01752

ksosnick@ceadvisors.com724.422.3564

Ken Sosnick has 15 years of experience with natural gas, electric and oil industry matters before the Federal Energy Regulatory Commission. DuringMr. Sosnick’s 10 years at FERC, he spent two years (2003-2004) as an auditor in the Office of Enforcement and eight years (2005-2013) in the Officeof Administrative Litigation as an expert witness and one of the lead technical staff negotiators in more than 15 major interstate natural gas pipeline,oil pipeline, and electric utility proceedings.

While in the Office of Administrative Litigation, Mr. Sosnick applied his expertise to a variety of complex issues relating to utility ratemaking. He hasconcentrated on natural gas pipeline and oil/product pipeline cost of service rates, levelized rates, incremental vs. rolled-in project costs, allocationof corporate overhead costs, master-limited partnership income taxes, throughput/system rate design quantities, cost allocation and rate design,fuel recovery mechanisms, extraordinary events surcharge trackers, NGA Section 5 rate proceedings, depreciation rate calculations, Return onEquity calculations under Discounted Cash Flow methodology as well as electric formula rates and Order No. 1000 cost allocations.

After leaving FERC in 2013, Mr. Sosnick joined MRW & Associates LLC then in 2015 joined Concentric Energy Advisors as a Senior ProjectManager. As a consultant, Mr. Sosnick constructed cost of service models and evaluated cost allocation and rate design proposals in natural gaspipeline proceedings. Mr. Sosnick has specifically worked on developing the cost of service model and/or rate design model for Southern StarCentral Pipeline, El Paso Natural Gas Company, Transcontinental Pipeline, Sea Robin Pipeline, Portland Natural Gas Transmission System, Inc.,Florida Gas Transmission, Northern Natural Gas Company, Kinder Morgan Interstate Gas Transmission, Tennessee Gas Pipeline, Tuscarora GasTransmission Company, and Wyoming Interstate Company.

Mr. Sosnick has previously taught at the New Mexico State University Center for Public Utilities Practical and Regulatory Training for the Natural GasInterstate Pipeline Industry specifically addressing FERC requirements for determining “Just and Reasonable” rates.