Home Page

[The Oil Patch]

Trans-Alaska Pipeline System: Economics

Trans-Alaska Pipeline System: Environment

Reports and Research Memoranda

Archives

About
Richard A. Fineberg

Contact Information

Federal Energy Regulatory Commission (FERC)
and State Supreme Court Confirm TAPS
Overcharges, Hand Pipeline Owners
Their Sixth Successive Defeat Since 2002

After 30 Years, FERC Rules Owners' Attempts
To Justify High TAPS Tariffs Lacking in Merit;
State Supreme Court Finds Nothing
In Owners' Appeal Worthy of Discussion

News and Comment

By RICHARD FINEBERG *
July 1, 2008

The sixth shoe fell on the owners of the Trans-Alaska Pipeline System (TAPS) June 20, when the Federal Energy Regulatory Commission (FERC) confirmed that the owners of the 800-mile pipeline have reaped unjust profits by overcharging for shipping North Slope oil, most of it their own. The FERC ordered the TAPS owners to pay limited refunds and reduce future shipping charges (tariffs) for TAPS oil bound for destinations outside Alaska - about 90% of TAPS shipments.

Transportation charges are subtracted from the market price of oil to determine the basis for calculating state royalties and production taxes. Three major North Slope producers control approximately 95% of North Slope production and own a similar percentage of TAPS, creating a strong incentive for the TAPS owners to set high transportation rates, thereby reducing their royalty and production tax payments to the state.

The TAPS owners are expected to take their case to the holder of the seventh shoe, the U.S. Supreme Court. But the record to date indicates that prospects for the TAPS owners are not good. The FERC decision June 20 was the sixth successive significant government determination since 2002 to conclude that the TAPS owners' arguments attempting to justify their TAPS tariffs were essentially without merit. Three of the rejections came on the state side; three were federal. Here's a short summary:

• On the federal side, the June 20 FERC decision affirmed the findings of a FERC administrative law judge (ALJ), issued in May 2007 (shoe number five). As reported previously on this web site (see links to past articles on the TAPS tariff case in blue box, below), the FERC law judge recommended the lower tariffs sought by independent North Slope producer-shipper Anadarko Petroleum and independent shipper Tesoro Petroleum, endorsing most of the February 2007 findings of the commission's trial staff (shoe number four).
  
  
• The other three shoes fell on the state side, where the Regulatory Commission of Alaska (RCA) administers tariffs for the 10% of TAPS oil used in-state. In February 2008, the state Supreme Court affirmed the 2006 ruling of an Anchorage superior court judge which, in turn, upheld a 2002 finding and decision by the Regulatory Commission of Alaska (RCA) that the TAPS owners' overcharged shippers. The 50-page superior court decision upheld the 162-page RCA decision"in all respects." The state's high court found nothing in the TAPS owners' appeal worthy of additional comment.

In light of an unblemished record of regulatory and court defeats, why would Alaska's "Big Three" transnational oil companies prolong this process? The answer is simple: Money.

State and federal regulatory agency orders reducing TAPS tariffs mean that the North Slope producers will share a greater percentage of future revenue with the state and must pay partial refunds for past overcharges. In the FERC case, refunds are estimated at approximately $600 million, which is only a portion of what the appropriate tariff would have required them to pay, had it been in place. In short, when you own the pipeline, it pays to overcharge for shipping and drag out the correction process for as long as you can. And for a large corporation, when big bucks and competitive advantage are involved, it ain't over 'til it's over.

The Independent Shippers' Victory at FERC

In the arcane world of pipeline ratemaking, tariffs are designed to allow the owners to collect revenue sufficient to cover their costs, including a reasonable rate of return on investment. The tariff is supposed to be determined by actual expenditures, or cost-based; the statutory target is a just and reasonable tariff. While it may sound simple in theory, in practice tariff collection and accounting procedures can be quite complicated. In the case of TAPS, those mechanisms were set in place in 1985 - eight years after North Slope oil started flowing through the pipeline - in the controversial 1985 TAPS Settlement Methodology (TSM), which was established by agreement between the state and the TAPS owners.

Since 1996, Tesoro Petroleum has argued that the TSM formula has been manipulated to allow the TAPS owners to file excessive tariffs that overcharge independent shippers (their own costs are merely transfer payments) and reduce their payments to the state by a variety of mechanisms that include plain old double-counting of costs. Twelve years later, the language of the June 20 FERC decision clearly indicates FERC's determination that Tesoro has been right all along. "There is no merit to the TAPS Carriers' [owners'] claim that the TSM is a cost-based methodology," the commission wrote. "They refer to their proxy . . . presentations as support for the specific rates at issue. Clearly, a number of elements within the TSM are unrelated to costs of providing service, or are otherwise inappropriate for cost-based ratemaking." A footnote to this statement listed seven specific TSM tariff elements the commission staff found to be "inconsistent with cost-based ratemaking."

The following excerpts from the commission's June 20 decision are representative of the strong, declarative language the commission used in rejecting the arguments of the TAPS owners:

• "Accepting the TAPS Carriers' position would render the just and reasonable standard meaningless, which we decline to do."
• "We find no merit in the exceptions filed" (by the TAPS owners in opposition to the ALJ's opinion).
• "Furthermore, the Commission finds that the ALJ properly found the TAPS Carriers' witnesses not credible since they espoused positions that were inconsistent with the TAPS Carriers' annual rate filing, the facts of the case and Commission policy and precedent."
• "As the ALJ noted, this appears to be another attempt by the TAPS Carriers to overstate elements of their cost-based rate filing to justify recovery of returns more than once."

The FERC's almost complete rejection of the TAPS owners' arguments, discussed above, is reflected in this extraordinary fact: Where judges are notorious for decisions that split the baby, in this case the ALJ and the commission adopted the basic tariff numbers recommended by the Anadarko/Tesoro expert witnesses in their entirety.

Where Was the State?

In view of the state's clear interest in assuring appropriate tariffs to maximize state revenue and to promote competition, during this period one might expect that the state was arguing vigorously at Tesoro's side. .

Not so.

One can read page after page of the ALJ and commission decisions without finding any reference to state arguments. The following paragraphs will explain how the state, under the uncertain stewardship of the Department of Law, spent decades going in the wrong direction and, more recently, managed to marginalize itself.

Despite the importance of pipeline tariffs to state revenues and to North Slope development, when Tesoro challenged the intrastate tariff at the Alaska Public Utilities Commission (predecessor to the RCA) in 1996, the state sided with the TAPS owners in defending the 1985 settlement tariff framework. After the RCA ruled against the state and the TAPS owners in 2002, the state joined the pipeline owners in an unsuccessful court appeal of the RCA ruling against them. Through Tesoro's efforts the RCA tariff was reduced for in-state shipments. However, the TAPS owners continued to increase their shipping charges for the 90% of TAPS oil destined for the Lower 48 and therefore regulated by FERC.

As the de facto manager of state tariff interests, the Alaska Department of Law based its failure to support the state's clear interests in low tariffs on TAPS on an obscure, boiler-plate clause in the 1985 settlement agreement. In the process of negotiating the 1985 settlement, Alaska's attorneys agreed to a "duty to defend" clause, which they subsequently interpreted to mean they could not challenge the settlement terms. As a result of this contractual agreement, when the TAPS owners used creative accounting techniques to inflate their tariffs, the Department of Law felt that the state's hands were tied. Over the next two decades, the state challenged the TAPS owners on relatively minor tariff issues concerned with implementation of the settlement without questioning the terms themselves or the bottom-line results.

But after 2002, when the TAPS owners began sharply increasing tariffs at FERC after the RCA ordered the tariff on shipments under its jurisdiction reduced, the Department of Law's position on tariffs became awkward, if not untenable. By 2005, the RCA tariff was $1.96 per barrel and the FERC tariff was over $5.00. At that point, the $3.00 per barrel difference was costing state approximately $0.75 per barrel in reduced royalty and production tax payments. When Tesoro, victorious at the RCA, took its tariff challenge to FERC and was joined by independent producer Anadarko Petroleum, the Department of Law finally changed course, arguing at FERC that the disparity between state and federal tariffs for the same service was inequitable and that the FERC should reduce the tariff to the RCA level.

Still stuck with its self-imposed duty to defend the 1985 settlement, the state did not offer the FERC specific, cost-based information that would support the independent shippers' arguments that the TAPS owners were charging too much for TAPS shipments. Instead of arguing in clear, cost-based terms that the TAPS owners were over-charging, the state's arguments were based on hypothetical data and legal abstractions. Not surprisingly, the state's convoluted arguments were rejected by the FERC law judge and, finally, by the Commission itself.

In 2006, when Superior Court Judge John Suddock upheld the RCA decision reducing TAPS tariffs to $1.96 per barrel "in all respects," the Department of Law found itself facing another problem: On the federal side, the state was petitioning the FERC to reduced its tariffs to the RCA level by challenging the TAPS owners'$5.00 per barrel tariff filings under TSM on legalistic grounds, without challenging the settlement itself. Meanwhile, on the state side, to adhere to its "duty to defend" obligation, would the state have to join the TAPS owners in supporting the TSM tariff level before the state Supreme Court? In February 2006, the Department of Law quietly resolved this dilemma by serving notice that the state would not participate in the appeal to the high court.

If the Department of Law could withdraw the state from the TAPS owners' defense of the 1985 settlement in 2006, why couldn't the state have taken a similar action when Tesoro filed its initial state challenge in 1996? By doing so, the state might have expedited the regulatory process that is finally extricating the state from the 1985 settlement that has costing the state billions of dollars in reduced royalty and production tax payments while hindering competition on the North Slope.

As reported previously on this web site, the Department of Law refuses to respond to inquiries about past pipeline tariff policies and practices. But when Governor Sarah Palin and agency officials chortle happily about the June 20 FERC decision, it must be remembered that this victory has come only after three decades of TAPS tariff overcharges. Moreover, it is the Anadarko/Tesoro legal team - not the state's legal team - that did the heavy lifting.

Lost Refunds

While the FERC's June 20 TAPS opinion and order brings future tariffs down to the RCA tariff level, the refunds awarded by the FERC fail to make the state whole for overcharges since 2002 for two basic reasons:

• Under FERC procedures, refunds are tied to the last filed tariff before the tariff under protest. Since Tesoro and the state did not file their TAPS protests at FERC until 2005, the refunds for 2005 and 2006 cover only the difference between the tariff for those years and the filed tariff for 2004, which averaged about $3.11 per barrel - more than $1.00 per barrel above the RCA-level tariff the FERC has set for the future. While the filings pursuant to the order have yet to be made, the it appears that the state will only get about half of the additional revenue it would have received had the lower tariff been in place in 2004.
  
  
• Since the state and the shippers had not filed protests in 2003 and 2004, there are no refunds for those years. The lost refunds for those years simply disappear into the huge hopper with state revenue lost due to tariff overcharges since TAPS began operating in 1977.

As reported previously on this web site, over the life of TAPS it appears that tariff overcharges have enabled the pipeline owners to pocketed approximately $3 billion in off-book profits (more than $4.5 billion in today's dollars). Although Department of Law personnel decline to reflect on their past performance, the magnitude of the state's revenue losses due to pipeline tariff overcharges compels consideration of this unfortunate history. The maxim that those who do not learn from history are condemned to repeat it suggests that examination of the causes and consequences of past tariff policies are indeed worthy of consideration.

Dismantling Charges (DR&R)

The only significant TAPS tariff overcharge that the FERC decision did not correct relate to the amounts the TAPS owners collected for the eventual dismantling and removal of the pipeline and restoration of the right-of-way (DR&R). Dismantling funds are long-lived assets - a category of funds that have never been clearly accounted for in oil industry financial reports. The difficulty in accounting for these funds arises from the fact that the date and the costs of dismantling, as well as key factors such as estimated interim earnings, inflation and tax rates are all matters of conjecture. To prevent over-collection - penalizing the state and independent shippers - these funds should be placed in an escrow account and the collection rates should be reviewed periodically and adjusted as necessary to meet the inevitably changing conditions.

Under the TSM agreement, more than $1.5 billion - the estimated amount necessary to accomplish this task 25 years ago - was collected through the tariff on an accelerated basis. But instead of segregating these funds, the TAPS owners simply pocketed them.

Anadarko and Tesoro argued - convincingly, in this writer's estimation - that the accelerated DR&R collections through the TSM were grossly over-collected; the FERC followed its law judge in rejecting this argument. While the FERC order requires better accounting of the pre-collected DR&R sums, instead of adjusting the collected amounts periodically the commission opted to defer these considerations until the unspecified future date when dismantling actually takes place.

Snatching Defeat from the Jaws of Victory

While the regulatory agency decisions on TAPS tariffs go through the final court review process, the state has adopted legislation that would substitute an estimate of reasonable pipeline costs for reported tariff payments when the pipeline owner and shipper are affiliated and there is evidence to believe the filed tariffs are excessive. The interim effort to capture the production tax portion of the revenue lost through TAPS and other pipeline tariff overcharges is contained in the revision of the state production tax statute enacted during a special legislative session in November 2007. The Department of Revenue estimated that this correction would be worth $160 to $200 million during state fiscal year 2008. As of early June 2008, the Department of Revenue was still in the process of drafting implementing regulations.

The intent of the November 2007 legislation was clear: Despite assurances from BP (one of three major oil companies that control 95% of North Slope production and own a similar share of TAPS) that the pipeline tariff system did not need fixing, the Legislature modified the existing statute to recapture production tax revenue lost during the extended period when the regulatory process tries to cope with companies that use their overlapping ownership to game the system through excessive tariffs. (As the history of the six shoes discussed above demonstrates, the regulatory process, abetted by the state's peculiar performance, can take many years to correct this problem, and the correction may not result in full refunds.) But the state's proposed implementing regulations have run into strong opposition. At a June 4 workshop on the proposed implementing regulations, attorneys for independent shippers Tesoro and Anadarko told state drafters that the Alaska Department of Revenue's complicated proposal appeared to replace rather than backstop the regulatory process. Worse yet, Anadarko/Tesoro attorney Robin Brena commented, the complex draft regulations appeared likely to deliver a higher proxy shipping cost rather than a lower estimate, which would defeat the purpose of the statute the regulations are supposed to implement. To this observer, it seemed that an overworked state bureaucracy, preoccupied with plans for a natural gas pipeline, was bent on snatching defeat from the jaws of victory.

For reports and articles on TAPS tariff economic and management issues prepared by Richard Fineberg during 2007, see:

Feb. 28 report on impacts of excessive TAPS tariffs on state and independent shippers

Mar. 2 commentary on Department of Law handling of TAPS tariff issues

Mar. 10 commentary on Mar. 5 state House Resources Committee hearing.

April 20 and May 27, 2007 guest editorials

Prepared testimony for the June 7 House Resources Committee hearing (addressing questions on 20 tariff-related subjects to the Department of Law)

Legal Opinion Challenges TAPS Tariff Settlement Terms, July 11, 2007

Briefing for State Legislators, Aug. 20, 2007

Links to additional background information on TAPS tariff economic and management issues:

Attorney Peter Van Tuyn's June 5, 2007 memorandum on the "duty to defend" clause of the 1985 TAPS tariff settlement agreement

Department of Law's June 28 response to Representatives Carl Gatto and David Guttenberg (answering selected questions posed in this writer's June 7 testimony)

Fineberg's July 2 response to the Department of Law's June 28 letter

Discussion of tariff issues by Fairbanks Daily News-Miner staff columnist Dermot Cole