[Federal Register Volume 85, Number 102 (Wednesday, May 27, 2020)]
[Notices]
[Pages 31760-31773]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11406]
[[Page 31760]]
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DEPARTMENT OF ENERGY
Federal Energy Regulatory Commission
[Docket No. PL19-4-000]
Inquiry Regarding the Commission's Policy for Determining Return
on Equity
AGENCY: Federal Energy Regulatory Commission, DOE.
ACTION: Policy statement on determining return on equity for natural
gas and oil pipelines.
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SUMMARY: On March 21, 2019, the Federal Energy Regulatory Commission
issued a notice of inquiry seeking information and stakeholder views
regarding whether, and if so how, it should modify its policies
concerning the determination of the return on equity (ROE) to be used
in designing jurisdictional public utility rates and whether any
changes to the Commission's policies concerning public utility ROEs
should be applied to interstate natural gas and oil pipelines.
Concurrently with this Policy Statement, the Commission is issuing
Opinion No. 569-A adopting changes to its policies concerning public
utility ROEs. The Commission finds that, with certain exceptions to
account for the statutory, operational, organizational and competitive
differences among the industries, the policy changes adopted in Opinion
No. 569-A should be applied to natural gas and oil pipelines.
Accordingly, the Commission revises its policy and will determine
natural gas and oil pipeline ROEs by averaging the results of the
Discounted Cash Flow model and the Capital Asset Pricing Model, but
will not use the Risk Premium model. In addition, the Commission
clarifies its policies governing the formation of proxy groups and the
treatment of outliers in proceedings addressing natural gas and oil
pipeline ROEs. Finally, the Commission encourages oil pipelines to file
revised FERC Form No. 6, page 700s for 2019 reflecting the revised ROE
policy.
DATES: This Policy Statement takes effect May 27, 2020.
Evan Steiner (Legal Information), Office of the General Counsel, 888
First Street NE, Washington, DC 20426, (202) 502-8792,
Evan.Steiner@ferc.gov
Monil Patel (Technical Information), Office of Energy Market
Regulation, 888 First Street NE, Washington, DC 20426, (202) 502-8296,
Monil.Patel@ferc.gov
Seong-Kook Berry (Technical Information), Office of Energy Market
Regulation, 888 First Street NE, Washington, DC 20426, (202) 502-6544,
Seong-Kook.Berry@ferc.gov
SUPPLEMENTARY INFORMATION:
1. On March 21, 2019, the Commission issued a Notice of Inquiry
(NOI) seeking information and stakeholder views to help the Commission
explore whether, and if so how, it should modify its policies
concerning the determination of the return on equity (ROE) to be used
in designing jurisdictional rates charged by public utilities.\1\ The
Commission also sought comment on whether any changes to its policies
concerning public utility ROEs should be applied to interstate natural
gas and oil pipelines.\2\ On November 21, 2019, the Commission issued
Opinion No. 569 \3\ establishing a revised methodology for determining
just and reasonable base ROEs for public utilities under the Federal
Power Act (FPA). Concurrently with the issuance of this Policy
Statement, the Commission is issuing Opinion No. 569-A adopting changes
to the base ROE methodology established in Opinion No. 569.\4\
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\1\ Inquiry Regarding the Commission's Policy for Determining
Return on Equity, 166 FERC ] 61,207, at P 1 (2019).
\2\ Id.
\3\ Ass'n of Bus. Advocating Tariff Equity v. Midcontinent
Indep. Sys. Operator, Inc., Opinion No. 569, 169 FERC ] 61,129
(2019).
\4\ Ass'n of Bus. Advocating Tariff Equity v. Midcontinent
Indep. Sys. Operator, Inc., Opinion No. 569-A, 171 FERC ] 61,154
(2020).
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2. As explained below, we revise our policy for analyzing
interstate natural gas and oil pipeline ROEs to adopt the methodology
established for public utilities in Opinion Nos. 569 and 569-A, with
certain exceptions to account for the statutory, operational,
organizational and competitive differences among the industries.
Specifically, we will determine just and reasonable natural gas and oil
pipeline ROEs by averaging the results of Discounted Cash Flow model
(DCF) and Capital Asset Pricing Model (CAPM) analyses, according equal
weight to both models. In contrast to our methodology for public
utilities, we retain the existing two-thirds/one-third weighting for
the short-term and long-term growth projections in the DCF and will not
use the risk premium model discussed in Opinion No. 569 and modified in
Opinion No. 569-A (Risk Premium). In addition, we clarify our policies
governing the formation of proxy groups and the treatment of outliers
in natural gas and oil pipeline proceedings. Finally, as discussed
below, we encourage oil pipelines to file updated FERC Form No. 6, page
700 data for 2019 to reflect the revised ROE policy established herein.
I. Background
A. Natural Gas and Oil Pipeline ROE Policy
3. The Supreme Court has stated that ``the return to the equity
owner should be commensurate with the return on investments in other
enterprises having corresponding risks. That return, moreover, should
be sufficient to assure confidence in the financial integrity of the
enterprise, so as to maintain its credit and to attract capital.'' \5\
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\5\ Fed. Power Comm'n v. Hope Nat. Gas Co., 320 U.S. 591, 603
(1944) (citing Missouri ex rel. Sw. Bell Tel. Co. v. Pub. Serv.
Comm'n of Mo., 262 U.S. 276, 291 (1923) (Brandeis, J., concurring)).
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4. Since the 1980s, the Commission has determined natural gas and
oil pipeline ROEs using the DCF model.\6\ The DCF model is based on the
premise that ``a stock's price is equal to the present value of the
infinite stream of expected dividends discounted at a market rate
commensurate with the stock's risk.'' \7\ The Commission uses the DCF
model to estimate the return necessary for the pipeline to attract
capital based upon the range of returns that the market provides
investors in a proxy group of publicly traded entities with similar
risk profiles. The Commission estimates the required rate of return for
each member of the proxy group using the following formula:
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\6\ Composition of Proxy Groups for Determining Gas and Oil
Pipeline Return on Equity, 123 FERC ] 61,048, at P 3 (2008) (2008
Policy Statement).
\7\ Canadian Ass'n of Petroleum Producers v. FERC, 254 F.3d 289,
293 (D.C. Cir. 2001) (CAPP v. FERC).
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k = D/P (1+.5g) + g
where k is the discount rate (or investors' required return), D is the
current dividend, P is the price of stock at the relevant time, and g
is the expected growth rate in dividends based upon the weighted
averaging of short-term and long-term growth estimates (referred to as
the two-step procedure). The Commission multiplies the dividend yield
(dividends divided by stock price or D/P) by the expression (1+.5g) to
account for the fact that dividends are paid on a quarterly basis. For
purposes of the (1+.5g) adjustment, the Commission uses only the short-
term growth projection.\8\
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\8\ Seaway Crude Pipeline Co. LLC, Opinion No. 546, 154 FERC ]
61,070, at PP 198-200 (2016).
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5. In the two-step DCF model, the Commission computes the expected
growth rate (g) by giving two-thirds weight to a short-term growth
projection and one-third weight to a long-term
[[Page 31761]]
growth projection.\9\ For the short-term growth projection, the
Commission uses security analysts' five-year forecasts for each company
in the proxy group, as published by the Institutional Brokers Estimated
System (IBES).\10\ The long-term growth projection is based on
forecasts, drawn from three different sources,\11\ of long-term growth
of the economy as a whole as reflected in the Gross Domestic Product
(GDP).\12\ For proxy group members that are master limited partnerships
(MLPs), the Commission adjusts the long-term growth projection to equal
50% of GDP.\13\
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\9\ 2008 Policy Statement, 123 FERC ] 61,048 at P 6.
\10\ Id.
\11\ The three sources used by the Commission are Global
Insight: Long-Term Macro Forecast--Baseline (U.S. Economy 30-Year
Focus); Energy Information Agency, Annual Energy Outlook; and the
Social Security Administration.
\12\ 2008 Policy Statement, 123 FERC ] 61,048 at P 6 (citing Nw.
Pipeline Co., Opinion No. 396-B, 79 FERC ] 61,309, at 62,383 (1997);
Williston Basin Interstate Pipeline Co., 79 FERC ] 61,311, at 62,389
(1997), aff'd, Williston Basin Interstate Pipeline Co. v. FERC, 165
F.3d 54, 57 (D.C. Cir. 1999)).
\13\ Id. P 96.
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6. Because most natural gas and oil pipelines are wholly owned
subsidiaries and their common stocks are not publicly traded, the
Commission must use a proxy group of publicly traded firms with
corresponding risks to set a range of reasonable returns.\14\ The firms
in the proxy group must be comparable to the pipeline whose ROE is
being determined, or, in other words, the proxy group must be ``risk-
appropriate.'' \15\ The range of the proxy group's returns produces the
zone of reasonableness in which the pipeline's ROE may be set based on
specific risks. Absent unusual circumstances showing that the pipeline
faces anomalously high or low risks, the Commission sets the pipeline's
cost-of-service nominal ROE at the median of the zone of
reasonableness.\16\
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\14\ Petal Gas Storage, L.L.C. v. FERC, 496 F.3d 695, 697 (D.C.
Cir. 2007) (explaining that the purpose of a DCF proxy group is to
``provide market-determined stock and dividend figures from public
companies comparable to a target company for which those figures are
unavailable. Market-determined stock figures reflect a company's
risk level and when combined with dividend values, permit
calculation of the `risk-adjusted expected rate of return sufficient
to attract investors.' '' (quoting CAPP v. FERC, 254 F.3d at 293)).
\15\ Id. at 699; see also Portland Nat. Gas Transmission Sys.,
Opinion No. 524, 142 FERC ] 61,197, at P 302 (2013), reh'g denied,
Opinion No. 524-A, 150 FERC ] 61,107 (2015).
\16\ El Paso Nat. Gas Co., Opinion No. 528, 145 FERC ] 61,040,
at P 592 (2013), order on reh'g, Opinion No. 528-A, 154 FERC ]
61,120 (2016), order on compliance & reh'g, Opinion No. 528-B, 163
FERC ] 61,079 (2018) (citing Transcontinental Gas Pipe Line Corp.,
Opinion No. 414-A, 84 FERC ] 61,084 (1998), reh'g denied, Opinion
No. 414-B, 85 FERC ] 61,323 (1998), aff'd, CAPP v. FERC, 254 F.3d
289).
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B. Other Financial Models
7. In the NOI, the Commission sought comment on other financial
models the Commission has considered when determining ROE for public
utilities, including the CAPM, Risk Premium model, and an expected
earnings analysis (Expected Earnings).\17\
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\17\ NOI, 166 FERC ] 61,207 at PP 35, 38.
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1. CAPM
8. Investors use CAPM analysis as a measure of the cost of equity
relative to risk.\18\ The CAPM is based on the theory that the market-
required rate of return for a security is equal to the ``risk-free
rate'' plus a risk premium associated with that security. The CAPM
estimates cost of equity by adding the risk-free rate to the ``market-
risk premium'' multiplied by ``beta.'' The formula for the CAPM is as
follows:
\18\ Opinion No. 569, 169 FERC ] 61,129 at P 229.
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R = rf + [beta]a(rm-rf)
rf = risk free rate (such as yield on 30-year U.S. Treasury bonds)
rm = expected market return
[beta]a = beta, which measures the volatility of the security compared
to the rest of the market.
The risk-free rate is represented by a proxy, typically the yield
on 30-year U.S. Treasury bonds. The market-risk premium is calculated
by subtracting the risk-free rate from the ``expected return,'' which,
in a forward-looking CAPM analysis, is based on a DCF analysis of a
large segment of the market, such as the dividend paying companies in
the S&P 500.\19\ Betas measure the volatility of a particular stock
relative to the market and are published by several commercial
sources.\20\ An entity may also seek to apply a size premium adjustment
to the CAPM zone of reasonableness to account for the difference in
size between itself and the dividend paying companies in the S&P
500.\21\
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\19\ Id.
\20\ NOI, 166 FERC ] 61,207 at P 14.
\21\ See Opinion No. 569, 169 FERC ] 61,129 at P 298; see also
Coakley v. Bangor Hydro-Elec. Co., Opinion No. 531-B, 150 FERC ]
61,165, at P 117 (2015) (citing Roger A. Morin, New Regulatory
Finance, 187 (Public Utilities Reports, Inc. 2006) (Morin) (finding
that use of a size premium adjustment is ``a generally accepted
approach to CAPM analyses'')).
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2. Risk Premium
9. Risk premium methodologies are ``based on the simple idea that
since investors in stocks take greater risk than investors in bonds,
the former expect to earn a return on a stock investment that reflects
a `premium' over and above the return they expect to earn on a bond
investment.'' \22\ This difference reflects the greater risk of a stock
investment.\23\ The risk premium return is calculated as follows:
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\22\ Opinion No. 569, 169 FERC ] 61,129 at P 304 (quoting
Coakley v. Bangor Hydro-Elec. Co., Opinion No. 531, 147 FERC ]
61,234, at P 147 (2014)).
\23\ Ass'n of Bus. Advocating Tariff Equity v. Midcontinent
Indep. Sys. Operator, Inc., 165 FERC ] 61,118, at P 36 (2018) (MISO
Briefing Order).
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R = I + RP
where I represents current applicable bond yield and RP represents the
risk premium, which consists of the difference between (a) applicable
annual common equity premiums and (b) applicable bond yields.
10. Although there are multiple approaches to determining an
entity's equity risk premium (RP), the Risk Premium model addressed in
Opinion Nos. 569 and 569-A ``examin[es] the risk premiums implied in
the returns on equity allowed by regulatory commissions for utilities
over some past period relative to the contemporaneous level of the
long-term U.S. Treasury bond yield.'' \24\ This approach develops the
equity risk premium using Commission-allowed ROEs for public utilities
minus the long-term bond yield.
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\24\ Opinion No. 569, 169 FERC ] 61,129 at P 305.
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3. Expected Earnings
11. A comparable earnings analysis is a method of calculating the
earnings an investor expects to receive on the book value of a
particular stock.\25\ The analysis can be either backward-looking using
the company's historical earnings on book value, as reflected on the
company's accounting statements, or forward-looking using estimates of
earnings on book value, as reflected in analysts' earnings forecasts
for the company. The latter approach is often referred to as an
``Expected Earnings analysis.'' The Expected Earnings analysis provides
an accounting-based approach that uses investment analyst estimates of
return (net earnings) on book value (the equity portion of a company's
overall capital, excluding long-term debt).\26\ Algebraically, Expected
Earnings can be expressed as follows:
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\25\ Id. P 172.
\26\ Opinion No. 569, 169 FERC ] 61,129 at P 172.
R = E/B
E = Earnings during Current Year
B = Book Value at the End of the Prior Year
[[Page 31762]]
C. Public Utility ROE Proceedings Following Emera Maine v. FERC
1. Briefing Orders and Trailblazer
12. Following the decision of the United States Court of Appeals
for the District of Columbia Circuit (D.C. Circuit) in Emera Maine v.
FERC,\27\ the Commission issued two briefing orders \28\ in the fall of
2018 proposing a new methodology for analyzing public utility ROEs
under FPA section 206.\29\ The Commission preliminarily found that ``in
light of current investor behavior and capital market conditions,
relying on the DCF methodology alone will not produce a just and
reasonable ROE.'' \30\ The Commission found that investors appear to
base their decisions on numerous financial models \31\ and may give
greater weight to models other than the DCF in estimating the expected
returns from a utility investment.\32\ As such, the Commission proposed
to determine ROE for public utilities by averaging the results of DCF,
CAPM, Expected Earnings, and Risk Premium analyses, giving equal weight
to each analysis. The Commission established paper hearings and
directed the parties in those proceedings to file briefs in response.
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\27\ 854 F.3d 9 (D.C. Cir. 2017).
\28\ MISO Briefing Order, 165 FERC ] 61,118; Coakley v. Bangor
Hydro-Elec. Co., 165 FERC ] 61,030 (2018) (Coakley Briefing Order,
and together with MISO Briefing Order, Briefing Orders).
\29\ 16 U.S.C. 824e (2018).
\30\ Coakley Briefing Order, 165 FERC ] 61,030 at P 32; MISO
Briefing Order, 165 FERC ] 61,118 at P 34.
\31\ Coakley Briefing Order, 165 FERC ] 61,030 at P 40; MISO
Briefing Order, 165 FERC ] 61,118 at P 42.
\32\ Coakley Briefing Order, 165 FERC ] 61,030 at P 35; MISO
Briefing Order, 165 FERC ] 61,118 at P 37.
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13. On February 21, 2019, while the paper hearings were pending,
the Commission found in Trailblazer Pipeline Company LLC that
``investor reliance upon multiple methodologies presumably applies to
investments in natural gas pipelines'' as well as public utilities.\33\
The Commission therefore permitted parties in that natural gas pipeline
cost-of-service rate proceeding to address the four alternative
financial models at hearing.\34\
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\33\ 166 FERC ] 61,141, at P 48 (2019).
\34\ Thereafter, participants in natural gas pipeline rate
proceedings in Docket Nos. RP19-352-000, RP19-1353-000, RP19-1523-
000, and RP20-131-000 filed testimony applying the alternative
models.
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2. Opinion No. 569
14. On November 21, 2019, the Commission issued Opinion No. 569
adopting the proposal from the Briefing Orders, with several
revisions.\35\ The Commission explained that it would use the DCF model
and CAPM in its ROE analyses under FPA section 206 \36\ and give equal
weight to both models.\37\ However, contrary to the proposal in the
Briefing Orders, the Commission declined to use either the Expected
Earnings analysis or Risk Premium model.\38\ The Commission also made
findings as to the DCF model and the CAPM and adopted specific low and
high-end outlier tests.
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\35\ Opinion No. 569, 169 FERC ] 61,129 at P 18.
\36\ Id. PP 1, 18.
\37\ Id. PP 276, 425.
\38\ Id. PP 18, 31, 200, 340.
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3. Opinion No. 569-A
15. In Opinion No. 569-A, the Commission modified the methodology
established in Opinion No. 569 in several respects. First, as to the
DCF model, the Commission reduced the weighting of the long-term growth
projection from one-third to 20% and modified the high-end outlier test
adopted in Opinion No. 569.\39\ Second, as to the CAPM, the Commission
clarified that it will modify the high-end outlier test adopted in
Opinion No. 569 \40\ and that it will consider, based on evidence
provided in future proceedings, use of Value Line data, instead of IBES
data, as the source of the short-term growth projection in the DCF
component of the CAPM.\41\ Third, the Commission adopted a modified
version of the Risk Premium model.\42\ The Commission explained that it
would afford equal weighting to the DCF, CAPM, and Risk Premium
analyses and denied requests for rehearing of its decision to exclude
Expected Earnings.\43\
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\39\ Opinion No. 569-A, 171 FERC ] 61,154 at PP 57, 154.
\40\ Id. P 154.
\41\ Id. P 78.
\42\ Id. PP 104-114.
\43\ Id. P 141.
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D. NOI
16. In the NOI, the Commission requested comment on whether uniform
application of the Commission's base ROE policy across the electric,
natural gas pipeline, and oil pipeline industries is appropriate and
advisable \44\ and whether the Commission, if it departed from its sole
use of a two-step DCF methodology for public utilities, should also use
its new method or methods to determine natural gas and oil pipeline
ROEs.\45\ The Commission also sought comment on its guidelines for
proxy group formation, including proxy group screening criteria and
appropriate high and low-end outlier tests.\46\
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\44\ NOI, 166 FERC ] 61,207 at P 29.
\45\ Id. P 32.
\46\ Id. P 34.
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17. Numerous entities and individuals submitted comments in
response to the NOI. Below, we discuss the comments that are relevant
to the revised policy for natural gas and oil pipeline ROE
methodologies that we adopt herein.
II. Discussion
18. Upon review of the comments and based on the Commission's
findings in Opinion Nos. 569 and 569-A, we revise our policy for
determining natural gas and oil pipeline ROEs. Under this revised
policy, we will (1) determine ROE by averaging the results of DCF and
CAPM analyses while retaining the existing two-thirds/one-third
weighting of the short and long-term growth projections in the DCF; (2)
give equal weight to the DCF and CAPM analyses; (3) consider using
Value Line data as the source of the short-term growth projection in
the CAPM; (4) consider proposals to include Canadian companies in
pipeline proxy groups while continuing to apply our proxy group
criteria flexibly until sufficient proxy group members are obtained;
(5) exclude Risk Premium and Expected Earnings analyses; and (6)
continue to address outliers in pipeline proxy groups on a case-by-case
basis and refrain from applying specific outlier tests.
19. We are not persuaded to adopt any additional policy changes at
this time and will address all other issues concerning the
determination of natural gas and oil pipeline ROEs as they arise in
future proceedings.
A. Revised Policy for Determining Natural Gas and Oil Pipeline ROEs
1. Use of the DCF and CAPM
a. Background
20. In the Briefing Orders, the Commission preliminarily found that
since it began relying primarily on the DCF model to determine ROE in
the 1980s, investors have increasingly used a diverse set of data
sources and models to inform their investment decisions.\47\ Because
investors consider more than one financial model when making investment
decisions, the Commission reasoned that relying on multiple models
makes it more likely that the Commission's decision will accurately
reflect how investors are making their
[[Page 31763]]
investment decisions.\48\ The Commission later determined in
Trailblazer that investor reliance on multiple methodologies presumably
applies to investments in natural gas pipelines as well as public
utilities.\49\
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\47\ Coakley Briefing Order, 165 FERC ] 61,030 at P 40; MISO
Briefing Order, 165 FERC ] 61,118 at P 42.
\48\ See Coakley Briefing Order, 165 FERC ] 61,030 at PP 36, 44;
MISO Briefing Order, 165 FERC ] 61,118 at PP 38, 46.
\49\ Trailblazer, 166 FERC ] 61,141 at P 48.
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21. The Commission departed from sole reliance on the DCF model for
public utilities in Opinion No. 569, finding that investors have
varying preferences as to which of the various methods for determining
cost of equity they may use to inform their investment decisions and
that the DCF and CAPM are among the primary methods that investors use
for this purpose.\50\ Thus, the Commission concluded that expanding its
methodology for determining public utility ROEs to use the CAPM in
addition to the DCF model will make it more likely that its decisions
will accurately reflect how investors make their investment decisions
and produce cost-of-equity estimates that more accurately reflect what
ROE a utility must offer to attract capital.\51\ The Commission further
explained that using the CAPM will also mitigate the model risk that
the DCF model may perform poorly in certain circumstances.\52\
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\50\ Opinion No. 569, 169 FERC ] 61,129 at PP 34, 171.
\51\ Id. PP 31, 34, 452.
\52\ Id. PP 39, 171.
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b. NOI Comments
22. Commenters are divided on whether the Commission should expand
its methodology for determining natural gas and oil pipeline ROEs to
consider multiple models. Commenters representing natural gas and oil
pipeline shipper interests \53\ urge the Commission to continue relying
solely on the DCF model to determine pipeline ROEs.\54\ These
commenters contend that the DCF model is a standardized approach that
promotes predictability for pipelines and shippers and assert that
there is no reason to consider additional models.\55\
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\53\ These commenters include: Airlines for America; Liquids
Shippers Group; Natural Gas Supply Association (NGSA); American
Public Gas Association (APGA); Process Gas Consumers Group and
American Forest & Paper Association (PGC/AF&PA); and the Canadian
Association of Petroleum Producers (CAPP).
\54\ Airlines for America Initial Comments at 5-7; Liquids
Shippers Group Initial Comments at 12-17, 22-25; NGSA Initial
Comments at 3-6, 25, 27; APGA Comments at 3; PGC/AF&PA Joint
Comments at 1-2, 6-8; see also CAPP Initial Comments at 27-28
(lauding the DCF as superior and stating that investors most likely
view the CAPM as a supplementary model).
\55\ Airlines for America Initial Comments at 1-2, 5-7; Liquids
Shippers Group Initial Comments at 12-17; NGSA Initial Comments at
3-4, 10, 25; PGC/AF&PA Joint Comments at 6-8.
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23. In contrast, natural gas and oil pipelines and trade
associations \56\ argue that it would be reasonable to consider other
models in addition to the DCF, subject to modifications in recognition
of the unique risks and regulatory framework applicable to the natural
gas and oil pipeline industries.\57\ Generally, these entities contend
that the Commission's findings that investors rely upon multiple
financial models in making investment decisions also apply to investors
in pipelines.\58\
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\56\ These commenters include: Association of Oil Pipe Lines
(AOPL); Interstate Natural Gas Association of America (INGAA);
Magellan Midstream Partners, L.P., Plains Pipeline L.P.; SFPP, L.P.
and Calnev Pipe Line LLC; and Tallgrass Energy, LP.
\57\ AOPL Initial Comments at 3, 8-9, 11-12; INGAA Initial
Comments at 40-41; Magellan Initial Comments at 8-13; Plains
Comments at 3-4; SFPP-Calnev Comments at 3-4; Tallgrass Initial
Comments at 1, 11.
\58\ E.g., AOPL Initial Comments at 4, 11; Tallgrass Initial
Comments at 2.
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c. Commission Determination
24. Based on the Commission's findings in Opinion No. 569, we
revise our methodology for determining natural gas and oil pipeline
ROEs to rely on multiple financial models, rather than relying solely
on the DCF model. Specifically, we will determine pipeline ROEs using
the DCF model and CAPM, but in contrast to our methodology for public
utilities, we will not use the Risk Premium model.
25. As an initial matter, we note that the D.C. Circuit has
repeatedly observed that the Commission is not required to rely upon
the DCF model alone or even at all.\59\ As such, the Commission may
``change its past practices,'' such as relying exclusively on the DCF
model, ``with advances in knowledge in its given field or as its
relevant experience and expertise expands,'' provided that it supplies
``a reasoned analysis indicating that prior policies and standards are
being deliberately changed, not casually ignored.'' \60\
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\59\ E.g., Tenn. Gas Pipeline Co. v. FERC, 926 F.2d 1206, 1211
(D.C. Cir. 1991) (explaining that the Commission is free to reject
the DCF, provided that it adequately explains its reasons for doing
so); NEPCO Mun. Rate Comm. v. FERC, 668 F.2d 1327, 1345 (D.C. Cir.
1981) (``FERC is not bound `to the service of any single formula or
combination of formulas.' '' (quoting FPC v. Nat. Gas Pipeline Co.
of Am., 315 U.S. 575, 586 (1942))).
\60\ Opinion No. 569, 169 FERC ] 61,129 at P 32 (quoting Nuclear
Energy Inst., Inc. v. EPA, 373 F.3d 1251, 1296 (D.C. Cir. 2004) (per
curiam)) (internal citations and quotation marks omitted).
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26. In Hope, the Supreme Court held that ``the return to the equity
owner should be commensurate with returns on investments in other
enterprises having corresponding risks. That return, moreover, should
be sufficient to assure confidence in the financial integrity of the
enterprise, so as to maintain its credit and to attract capital.'' \61\
Thus, a key consideration in determining just and reasonable utility
ROEs is determining what ROE an entity must offer in order to attract
capital, i.e., induce investors to invest in the entity in light of its
risk profile.\62\ As the Commission stated in Opinion No. 414-B,\63\
``the cost of common equity to a regulated enterprise depends upon what
the market expects not upon precisely what is going to happen.'' \64\
Thus, in determining what ROE to award a utility, we must look to how
investors analyze and compare their investment opportunities.
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\61\ Hope, 320 U.S. at 603; see also CAPP v. FERC, 254 F.3d at
293 (``In order to attract capital, a utility must offer a risk-
adjusted expected rate of return sufficient to attract
investors.'').
\62\ See Bluefield Waterworks & Improvement Co. v. Pub. Serv.
Comm'n of W. Va., 262 U.S. 679, 692-93 (1923) (discussing factors an
investor considers in making investment decisions).
\63\ Transcontinental Gas Pipe Line Corp., Opinion No. 414-B, 85
FERC ] 61,323 (1998).
\64\ Opinion No. 414-B, 85 FERC at 62,268; see also Kern River
Gas Transmission Co., Opinion No. 486-B, 126 FERC ] 61,034, at P 120
(2009), order on reh'g and compliance, Opinion No. 486-C, 129 FERC ]
61,240 (2009).
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27. We find that the rationale set forth in the Briefing Orders and
Opinion No. 569 for relying on CAPM in addition to the DCF applies
equally to natural gas and oil pipelines. In those proceedings, the
Commission found that investors employ various methods for determining
cost of equity and that the DCF and CAPM are among the primary methods
investors use for this purpose.\65\ In addition, the Commission found
in Opinion No. 569 that both record evidence and academic literature
\66\ indicated that CAPM is
[[Page 31764]]
widely used by investors.\67\ These findings apply to investors
generally, and we do not see, nor do the NOI comments identify, any
basis for distinguishing between investors in public utilities and
investors in natural gas and oil pipelines in this context. We
therefore find that investors in pipelines, like investors in public
utilities, consider multiple models for measuring cost of equity,
including the DCF model and CAPM, in making investment decisions.\68\
---------------------------------------------------------------------------
\65\ Opinion No. 569, 169 FERC ] 61,129 at PP 34, 236; Coakley
Briefing Order, 165 FERC ] 61,030 at P 35; MISO Briefing Order, 165
FERC ] 61,118 at P 37.
\66\ See, e.g., Jonathan B. Berk and Jules H. van Binsbergen,
Assessing Asset Pricing Models Using Revealed Preference, 119(1)
Journal of Financial Economics 1, 2 (2016) (``We find that the CAPM
is the closest model to the model that investors use to make their
capital allocation decisions . . . investors appear to be using the
CAPM to make their investment decisions.''); Brad M. Barber, et al.,
Which Factors Matter to Investors? Evidence from Mutual Fund Flows,
29(10) The Review of Financial Studies 2600, 2639 (2016) (``[W]hen
we ran a horse race between six asset-pricing models, the CAPM is
able to best explain variation in flows across mutual funds.''); id.
at 2624 (``[T]he CAPM does the best job of predicting fund-flow
relations.''); see also John R. Graham and Campbell R. Harvey, The
Theory and Practice of Corporate Finance: Evidence from the Field,
60(2) Journal of Financial Economics 187, 201 (2001) (explaining
that ``the CAPM is by far the most popular method of estimating the
cost of equity capital.'').
\67\ Opinion No. 569, 169 FERC ] 61,129 at P 236.
\68\ See Trailblazer, 166 FERC ] 61,141 at P 48 (citing Coakley
Briefing Order, 165 FERC ] 61,030 at PP 34-36). We note that with
the exception of commenters supporting sole reliance on the DCF
model, commenters generally do not oppose use of the CAPM for
natural gas and oil pipelines. See CAPP Initial Comments at 28;
INGAA Initial Comments at 41 (supporting use of DCF, CAPM, and
Expected Earnings); AOPL Initial Comments at 8-9 (endorsing use of
the proposed four-model methodology, which includes CAPM, as a
reasonable approach for oil pipelines); Plains Comments at 4 (same);
SFPP-Calnev Comments at 4 (same).
---------------------------------------------------------------------------
28. Accordingly, under the rationale set forth in Opinion No. 569,
we will expand our methodology for determining natural gas and oil
pipeline ROEs and will consider the CAPM in addition to the DCF
model.\69\ We conclude that as with public utilities, expanding the
methodology we use to determine ROE for natural gas and oil pipelines
to include the CAPM in addition to the DCF model will better reflect
how investors in those industries measure cost of equity while tending
to reduce the model risk associated with relying on the DCF model
alone. This should result in our ROE analyses producing cost-of-equity
estimates for natural gas and oil pipelines that more accurately
reflect what ROE a pipeline must offer in order to attract capital.
---------------------------------------------------------------------------
\69\ Opinion No. 569, 169 FERC ] 61,129 at P 236.
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2. DCF
29. We decline to adopt any changes to the two-step DCF model that
we apply to natural gas and oil pipelines under our existing policy. We
will therefore continue to base the long-term growth projection on
forecasts of long-term growth of GDP, adjust the long-term growth
projection of MLPs to equal 50% of GDP consistent with the 2008 Policy
Statement,\70\ and use only the short-term growth projection for
purposes of the (1+.5g) adjustment to dividend yield. As discussed
below, in contrast to our revised base ROE methodology for public
utilities as adopted in Opinion No. 569-A, we will retain the existing
two-thirds/one-third weighting for the short and long-term growth
projections.
---------------------------------------------------------------------------
\70\ The Commission adopted the 50% long-term growth rate
adjustment for MLPs in the 2008 Policy Statement in part because
MLPs have limited investment opportunities and face pressure to
maintain a high payout ratio. See 2008 Policy Statement, 123 FERC ]
61,048 at PP 95-96. Commenters state that MLPs no longer face the
same pressure to maintain a high payout ratio and often now generate
growth internally through retained earnings, which will cause their
growth rates to increase. See, e.g., INGAA Initial Comments at 58-
59. While the Commission continues to favor the 50% long-term growth
adjustment for MLPs, parties may present empirical evidence for an
alternative adjustment in cost-of-service rate proceedings. Natural
gas and oil pipelines that are MLPs may not use alternative
adjustments to support their annual forms.
---------------------------------------------------------------------------
a. NOI Comments
30. Commenters that address the weighting of the growth projections
in the DCF model are divided on whether the Commission should retain
the existing weighting, with AOPL and NGSA not proposing any
adjustments \71\ and CAPP and INGAA proposing alternative weighting
schemes. CAPP contends that the Commission should accord the growth
projections equal weighting.\72\ INGAA, on the other hand, proposes to
increase the weighting of the short-term projection to four-fifths and
reduce the weighting of the long-term projection to one-fifth.\73\
---------------------------------------------------------------------------
\71\ AOPL Initial Comments at 41; NGSA Initial Comments at 32-
33; see also Magellan Initial Comments at 23-24 (supporting two-
thirds/one-third weighting should Commission retain existing two-
step DCF).
\72\ CAPP Initial Comments at 40.
\73\ INGAA Initial Comments at 55.
---------------------------------------------------------------------------
b. Commission Determination
31. The D.C. Circuit has recognized that the Commission has
discretion regarding its growth projection weighting choices.\74\
Although the Commission is reducing the weighting of the long-term
growth projection in public utility proceedings to one-fifth, we find
that distinctions between public utilities and natural gas and oil
pipelines support exercising this discretion to continue affording one-
third weighting to the long-term growth projections in our analyses of
pipeline ROEs.
---------------------------------------------------------------------------
\74\ See CAPP v. FERC, 254 F.3d at 297 (holding that the
Commission did not abuse its discretion in reducing the weighting of
the long-term growth projection from one-half to one-third).
---------------------------------------------------------------------------
32. The Commission adopted the existing two-thirds/one-third
weighting scheme in Opinion No. 414-A.\75\ As explained in Opinion No.
569-A, reducing the weighting of the long-term growth projection in DCF
analyses of public utilities is appropriate because the short-term
growth projections of public utilities have declined relative to GDP
since the issuance of Opinion No. 414-A.\76\ As a result, investors may
reasonably consider current public utility short-term growth
projections to be more sustainable than when the Commission adopted the
existing weighting policy in 1998. It is therefore reasonable to afford
greater weight to the short-term growth projection and lesser weight to
the long-term growth projection in determining cost of equity for
public utilities.\77\
---------------------------------------------------------------------------
\75\ Opinion No. 414-A, 84 FERC ] 61,084 (1998).
\76\ In Opinion No. 414-A, the short-term growth projections of
the proxy group members averaged 11.33%, almost twice the long-term
GDP growth projection of 5.45%. See id. at app. A. As explained in
Opinion No. 569-A, the average short-term growth projections for the
proxy group in one of the public utility proceedings addressed
therein had declined to 5.03%, as compared to a long-term GDP growth
projection in that proceeding of 4.39%. Opinion No. 569-A, 171 FERC
] 61,154 at P 57.
\77\ Opinion No. 569-A, 171 FERC ] 61,154 at PP 57-58.
---------------------------------------------------------------------------
33. This reasoning does not apply with equal force to natural gas
and oil pipelines. Although the short-term growth projections of
natural gas and oil pipelines are lower than in 1998, they have not
declined to the same extent as those of public utilities.\78\ As such,
investors could reasonably view pipelines' short-term growth
projections as less sustainable than the projections of public
utilities. Moreover, the shale gas revolution has caused the natural
gas and oil pipeline industries to become more dynamic and less mature,
which could undermine the reliability of pipelines' short-term growth
projections.
---------------------------------------------------------------------------
\78\ For example, using data from February 2020, the short-term
growth projections of a hypothetical natural gas pipeline proxy
group consisting of Enbridge Inc., TC Energy, National Fuel Gas
Company, Kinder Morgan Inc., and Williams Companies, Inc., average
5.92% relative to a GDP growth projection of 4.22%. By comparison,
in one of the public utility proceedings addressed in Opinion No.
569-A, the short-term growth projections of the proxy group averaged
5.03% relative to a projected growth in GDP of 4.39%. Id. P 57.
---------------------------------------------------------------------------
34. For these reasons, we exercise our discretion to maintain our
existing weighting scheme and will continue to accord two-thirds
weighting to the short-term growth projection and one-third weighting
to the long-term growth projection in natural gas and oil pipeline
proceedings.
3. CAPM
35. We now turn to how we will apply the CAPM to natural gas and
oil pipelines. As discussed below, with regard to the calculation of
the market risk premium and the use of Value Line adjusted betas in
pipeline proceedings, we adopt the policy established in Opinion No.
569.
[[Page 31765]]
a. Calculation of Market Risk Premium
36. As described above, the CAPM market risk premium is calculated
by subtracting the risk-free rate, which is typically represented by a
proxy such as the yield on 30-year U.S. Treasury bonds, from the
expected market return. The expected market return can be estimated
either using a backward-looking approach based upon realized market
returns during a historical period, a forward-looking approach applying
the DCF model to a representative market index, such as the S&P 500, or
a survey of academic and investment professionals.\79\
---------------------------------------------------------------------------
\79\ Opinion No. 569, 169 FERC ] 61,129 at P 239 (citing Morin
at 155-162).
---------------------------------------------------------------------------
i. Background
37. In Opinion No. 569, the Commission adopted the use of the 30-
year U.S. Treasury average historical bond yield over a six-month
period as the risk-free rate.\80\ The Commission explained that the
six-month period should correspond as closely as possible to the six-
month financial study period used to produce the DCF study in the
applicable proceeding.\81\ For the expected market return, the
Commission adopted a forward-looking approach based upon a one-step DCF
analysis of the dividend paying members of the S&P 500.\82\ The
Commission rejected proposals to use a two-step DCF analysis for this
purpose, finding that the rationale for incorporating a long-term
growth projection in conducting a two-step DCF analysis of a specific
group of utilities does not apply when conducting a DCF study of the
companies in the S&P 500 because (i) the S&P 500 is regularly updated
to ensure that it only includes companies with high market
capitalization and remains representative of the industries in the
economy of the United States and (ii) the dividend paying members of
the S&P 500 constitute a large portfolio of stocks and therefore
include companies at all stages of growth.\83\ Furthermore, the
Commission found that S&P 500 companies with growth rates that are
negative or in excess of 20% should be excluded from the CAPM analysis
\84\ and approved the use of a size premium adjustment in the CAPM
analysis.\85\ The Commission affirmed these conclusions on
rehearing.\86\
---------------------------------------------------------------------------
\80\ Id. P 237.
\81\ Id. PP 237-238.
\82\ Id. P 260. Because the rationale for including a long-term
growth estimate in the DCF analysis of a specific utility does not
apply to the DCF analysis of a broad, representative market index
with a wide variety of companies that is regularly updated, the
Commission held that the DCF analysis of the dividend paying members
of the S&P 500 should be a one-step DCF analysis that uses only
short-term growth projections. Id. PP 261-266.
\83\ Id. PP 263-265.
\84\ Id. PP 267-268.
\85\ Id. PP 296-303.
\86\ Opinion No. 569-A, 171 FERC ] 61,154 at PP 75-77, 85.
---------------------------------------------------------------------------
ii. NOI Comments
38. INGAA, CAPP, and NGSA address how the Commission should
determine the CAPM market risk premium in pipeline proceedings.
Regarding the risk-free rate, INGAA states that although the Commission
could use either the 20-year or 30-year U.S. Treasury bond rate, it
supports using the 20-year rate.\87\ As to the expected market return,
INGAA supports using a one-step DCF analysis of dividend paying
companies in the S&P 500.\88\ CAPP and NGSA, by contrast, support using
a two-step DCF analysis that uses both short-term and long-term growth
rates.\89\
---------------------------------------------------------------------------
\87\ INGAA Initial Comments at 61. INGAA states that unlike 30-
year bonds, which were not issued for a period of time, 20-year bond
yields are available back to 1926 and will therefore allow the use
of a full historical data set covering a longer period. Id.
\88\ Id. (citing Ass'n of Bus. Advocating Tariff Equity v.
Midcontinent Indep. Sys. Operator, Inc., Opinion No. 551, 156 FERC ]
61,234, at PP 166-168 (2016)).
\89\ CAPP Initial Comments at 41; NGSA Initial Comments at 33.
---------------------------------------------------------------------------
iii. Commission Determination
39. We adopt the policy established in Opinion No. 569. Thus, in
determining the CAPM market risk premium for natural gas and oil
pipelines, we will (1) use, as the risk-free rate, the 30-year U.S.
Treasury average historical bond yield over a six-month period
corresponding as closely as possible to the six-month financial study
period used to produce the DCF study in the applicable proceeding, (2)
estimate the expected market return using a forward-looking approach
based on a one-step DCF analysis of all dividend paying companies in
the S&P 500,\90\ and (3) exclude S&P 500 companies with growth rates
that are negative or in excess of 20%.
---------------------------------------------------------------------------
\90\ The appropriate data source for the short-term growth
projection in the DCF component of the CAPM is addressed infra.
---------------------------------------------------------------------------
40. First, as the Commission recognized in Opinion No. 531-B, 30-
year U.S. Treasury bond yields are a generally accepted proxy for the
risk-free rate in a CAPM analysis.\91\ We are not persuaded to adopt
INGAA's proposal to use the 20-year U.S. Treasury bond yield for this
purpose. The Commission determined in Opinion No. 569 that factors
supporting the use of the 30-year U.S. Treasury average historical bond
yield over a six-month period outweigh factors supporting the use of
the 20-year U.S. Treasury yield, including any potential benefit that
may come from using a data set covering a longer period.\92\ We affirm
that conclusion here.
---------------------------------------------------------------------------
\91\ Opinion No. 531-B, 150 FERC ] 61,165 at P 114 (citing Morin
at 151-152).
\92\ Opinion No. 569, 169 FERC ] 61,129 at P 237.
---------------------------------------------------------------------------
41. Second, we will determine the expected market return using a
one-step DCF analysis of the dividend paying members of the S&P 500. As
explained in Opinion No. 569, using a DCF analysis of the dividend
paying members of the S&P 500 is a well-recognized method of estimating
the expected market return for purposes of the CAPM,\93\ and we find
that this method is likewise reasonable for purposes of applying the
CAPM to natural gas and oil pipelines. We also find that the reasons
set forth in Opinion No. 569 for using a one-step DCF analysis, instead
of a two-step analysis, in estimating the expected market return are
equally valid in the context of natural gas and oil pipelines.\94\
Accordingly, for the reasons stated in Opinion No. 569,\95\ we will use
a one-step DCF analysis of the dividend paying companies in the S&P 500
as the expected market return in applying the CAPM under our revised
ROE methodology for natural gas and oil pipelines.
---------------------------------------------------------------------------
\93\ Id. P 260.
\94\ Id. PP 262-266.
\95\ See id. PP 260-276.
---------------------------------------------------------------------------
42. Third, consistent with Opinion No. 569, we will screen from the
CAPM analysis of natural gas and oil pipelines S&P 500 companies with
growth rates that are negative or in excess of 20%. The Commission has
explained that such low or high growth rates are highly unsustainable
and unrepresentative of the growth rates of public utilities.\96\ We
find that these growth rates are likewise not representative of
sustainable growth rates for companies in pipeline proxy groups. We
will therefore apply this growth rate screen as part of the CAPM
analysis in natural gas and oil pipeline proceedings.
---------------------------------------------------------------------------
\96\ Id. P 268.
---------------------------------------------------------------------------
b. Betas and Size Premium
i. Background
43. The Commission found in Opinion Nos. 569 and 569-A that Value
Line adjusted betas are reasonable for use in the CAPM analysis for
public utilities.\97\ The Commission explained that there was
substantial evidence that investors rely on Value Line betas and
[[Page 31766]]
observed that Dr. Morin supports the use of adjusted betas in the CAPM.
---------------------------------------------------------------------------
\97\ Id. P 297; Opinion No. 569-A, 171 FERC ] 61,154 at PP 75-
76.
---------------------------------------------------------------------------
44. Moreover, the Commission also accepted the use of a size
premium adjustment derived using Duff & Phelps raw betas based on a
regression of the monthly returns on the stock index that are in excess
of a 30-year U.S. Treasury yield over the period of 1926 through the
most recent period.\98\ The Commission affirmed that the use of such an
adjustment was ``a generally accepted approach to CAPM analyses'' and
determined that application of size premium adjustments based on the
New York Stock Exchange (NYSE) to dividend paying members of the S&P
500 is acceptable.\99\ The Commission acknowledged that there is
imperfect correspondence between the size premia being developed with
different betas, but concluded that the size premium adjustments
improve the accuracy of CAPM results and cause the CAPM to better
correspond to the cost-of-capital estimates used by investors.\100\ The
Commission also found that sufficient academic literature exists to
indicate that many investors rely on size premia.\101\
---------------------------------------------------------------------------
\98\ Opinion No. 569, 169 FERC ] 61,129 at PP 279, 296.
\99\ Id. P 296 (quoting Opinion No. 531-B, 150 FERC ] 61,165 at
P 117).
\100\ Id. P 298.
\101\ Id. PP 299-300.
---------------------------------------------------------------------------
ii. NOI Comments
45. A variety of commenters, including AOPL, INGAA, Magellan, CAPP,
and NGSA, support use of Value Line adjusted betas in applying the
CAPM.\102\ INGAA adds that although Value Line betas, which are based
on five years of historical data, may be appropriate in most cases, it
is possible that using betas based on five years of data may not
reflect more recent events that have substantially changed the risk
characteristics of the natural gas pipeline industry. INGAA therefore
states that in such circumstances, the Commission should consider beta
estimates calculated over shorter periods.\103\
---------------------------------------------------------------------------
\102\ AOPL Initial Comments at 42; INGAA Initial Comments at 62;
Magellan Initial Comments at 27; CAPP Initial Comments at 42; NGSA
Comments at 34; see also Maryland Office of People's Counsel
(Maryland OPC) Initial Comments at 21-22 (``Value Line is the most
detailed and most trusted investment source currently available in
the industry. The Value Line beta is calculated over a long-term
time period that dampens volatility and, as such, is the most
representative source now available in the marketplace.'').
\103\ INGAA Initial Comments at 62.
---------------------------------------------------------------------------
iii. Commission Determination
46. We adopt the reasoning in Opinion Nos. 569 and 569-A and find
reasonable the use of Value Line adjusted betas in the CAPM analysis as
applied to natural gas and oil pipelines. As the Commission has
explained, there is substantial evidence indicating that investors rely
on Value Line betas in making their investment decisions, and this
finding presumably applies equally to investors in natural gas and oil
pipelines. Although we recognize that the distinct risks facing
interstate natural gas and oil pipelines may in some cases bear upon
whether an alternative beta source would be more appropriate, we will
address such issues as they arise in specific proceedings.
47. Likewise, we find reasonable the use of the size premium
adjustment based on the NYSE, as discussed in Opinion Nos. 531-B \104\
and 569.\105\ The use of such adjustments is ``a generally accepted
approach to CAPM analyses'' that improves the accuracy of the CAPM
results and causes such results to better correspond to the cost-of-
capital estimates that investors use in making investment
decisions.\106\ As such, we find that use of these adjustments will
improve the accuracy of cost-of-equity estimates for natural gas and
oil pipelines under our revised ROE methodology.
---------------------------------------------------------------------------
\104\ Opinion No. 531-B, 150 FERC ] 61,165 at P 117.
\105\ Opinion No. 569, 169 FERC ] 61,129 at P 296.
\106\ Id. PP 296-297 (quoting Opinion No. 531-B, 150 FERC ]
61,165 at P 117).
---------------------------------------------------------------------------
4. Weighting of Models
a. Background
48. In Opinion No. 569, the Commission held that it would give
equal weight to the DCF model and CAPM in analyzing ROE for public
utilities.\107\ The Commission found that the evidence indicated that
neither model was conclusively superior to the other and reasoned that
giving each model equal weight will reduce the model risk associated
with any particular model more than giving one model greater weight
than the other.\108\ After expanding its public utility base ROE
methodology in Opinion No. 569-A to include the Risk Premium model, the
Commission held that it would accord equal weight to all three
models.\109\
---------------------------------------------------------------------------
\107\ Id. PP 425, 427.
\108\ Id. P 426.
\109\ Opinion No. 569-A, 171 FERC ] 61,154 at P 141.
---------------------------------------------------------------------------
b. NOI Comments
49. Commenters propose various approaches to weighting the models
used to determine ROE. CAPP states that the Commission should give the
DCF model at least 50% weighting while giving the remaining weight to
any other models the Commission decides to use.\110\ The Maryland OPC
states that if the Commission uses multiple models, it should accord
the DCF model the majority of the weighting while giving the other
models a minority weighting.\111\ INGAA and Tallgrass oppose equal
weighting and assert that the Commission should adopt a flexible
weighting approach that allows it to exclude or give appropriate weight
to any model in light of prevailing financial conditions and the facts
and circumstances of each case.\112\ The New York State Public Service
Commission (NYPSC) submits that the Commission should give two-thirds
weighting to the DCF model and one-third weighting to the CAPM.\113\
---------------------------------------------------------------------------
\110\ CAPP Initial Comments at 30.
\111\ Maryland OPC Initial Comments at 12.
\112\ INGAA Initial Comments at 8-9; Tallgrass Initial Comments
at 12.
\113\ NYPSC Initial Comments at 18.
---------------------------------------------------------------------------
c. Commission Determination
50. We adopt the rationale of Opinion Nos. 569 and 569-A and will
give equal weight to the DCF model and CAPM in determining natural gas
and oil pipeline ROEs. As stated in Opinion No. 569, we find that
neither the DCF model nor the CAPM is conclusively superior and that
giving both models equal weight will mitigate the risks associated with
the potential errors or flaws in any one model. The comments proposing
alternative weighting schemes do not refute these concerns and are
therefore unpersuasive.
5. Data Sources
a. Background
51. The Commission has historically preferred IBES data as the
source of the short-term growth projection in the DCF model.\114\ By
contrast, because less precision was required of the CAPM when the
Commission used it only to corroborate the results of the DCF analysis,
the Commission allowed parties to average IBES and Value Line growth
projections in the DCF component of the CAPM.\115\
---------------------------------------------------------------------------
\114\ E.g., Nw. Pipeline Corp., 92 FERC ] 61,287, at 62,001-02
(2000) (quoting Opinion No. 396-B, 79 FERC at 62,385).
\115\ Opinion No. 551, 156 FERC ] 61,234 at P 169.
---------------------------------------------------------------------------
52. In Opinion 569, the Commission affirmed that it would use IBES
projections as the sole source of the short-term growth projections in
the DCF model.\116\ The Commission also required the sole use of IBES
projections for the DCF component of the CAPM, explaining that because
it would be weighting the CAPM equally with the
[[Page 31767]]
DCF model in setting just and reasonable ROEs, the CAPM must be
implemented with the same degree of precision as the DCF model.\117\
The Commission explained that IBES data was preferable to Value Line
data because unlike Value Line projections, which represent the
estimates of a single analyst at a single institution, IBES projections
generally represent consensus growth estimates by a number of analysts
from different firms.\118\ In addition, the Commission noted that IBES
growth projections are generally timelier than the Value Line
projections because IBES updates its database on a daily basis as
participating analysts revise their forecasts, whereas Value Line
publishes its projections on a rolling quarterly basis.\119\
---------------------------------------------------------------------------
\116\ Opinion No. 569, 169 FERC ] 61,129 at P 120.
\117\ Id. P 276.
\118\ Id. P 125.
\119\ Id. P 128.
---------------------------------------------------------------------------
53. In Opinion No 569-A, the Commission affirmed its preference for
IBES data for the short-term growth projection in the DCF model but
granted rehearing of its decision to require sole use of IBES data for
the DCF component of the CAPM.\120\ Acknowledging its concerns about
Value Line data as discussed in Opinion No. 569, the Commission
nonetheless concluded that use of these estimates will bring value to
its revised ROE methodology. The Commission found that although Value
Line estimates come from a single analyst, they include the input of
multiple analysts because they are vetted through internal processes
including review by a committee composed of peer analysts. Similarly,
the Commission found that there is value in including Value Line
estimates because they are updated on a more predictable basis than
IBES estimates. The Commission therefore concluded that IBES and Value
Line growth estimates both have advantages and that it is appropriate
to consider both data sources in determining public utility ROEs. In
light of the Commission's longstanding use of IBES data in the DCF
model, the Commission determined that it was appropriate to consider
using Value Line in the newly adopted CAPM.
---------------------------------------------------------------------------
\120\ Opinion No. 569-A, 171 FERC ] 61,154 at PP 78-83.
---------------------------------------------------------------------------
b. NOI Comments
54. Commenters are divided on the data source the Commission should
use for the short-term growth projection in pipeline proceedings. AOPL
states that the Commission should allow oil pipelines to use Value Line
projections because they do not overlap with or duplicate IBES
projections.\121\ INGAA likewise supports use of Value Line growth
estimates to supplement the IBES three to five-year growth
projections.\122\ In contrast, Magellan, NGSA, and CAPP support the
sole use of IBES growth forecasts, with CAPP asserting that Value Line
is inferior to IBES because it reflects the estimate of a single
analyst.\123\
---------------------------------------------------------------------------
\121\ AOPL Initial Comments at 38.
\122\ INGAA Initial Comments, Attachment A at 28-33 (Affidavit
of Dr. Michael J. Vilbert).
\123\ Magellan Initial Comments at 20; NGSA Initial Comments at
29-30; CAPP Initial Comments at 36-37, 39.
---------------------------------------------------------------------------
c. Commission Determination
55. With regard to the short-term growth projections in our DCF and
CAPM analyses of natural gas and oil pipelines, we adopt the policy set
forth in Opinion No. 569-A. Therefore, in natural gas and oil pipeline
proceedings we will (1) continue to prefer use of IBES three to five-
year growth projections as the short-term growth projection in the two-
step DCF analysis and (2) allow participants to propose using Value
Line growth projections as the source of the short-term growth
projection in the one-step DCF analysis embedded within the CAPM.
56. We reiterate our belief that both IBES and Value Line growth
estimates have advantages and that it is appropriate to include both
data sources in determining ROEs. As in public utility proceedings, it
is beneficial to diversify the data sources used in our revised natural
gas and oil pipeline ROE methodology because doing so may better
reflect the data sources that investors consider and mitigate the
effect of any unusual data in either source. Although we have not
previously used Value Line growth estimates in determining natural gas
and oil pipeline ROEs, we believe that including these estimates in our
methodology will bring value to our analysis because they are updated
on a more predictable basis than IBES estimates and reflect the
consensus growth estimates of multiple analysts. By contrast, IBES
projections are updated on an irregular basis as analysts revise their
forecasts.
57. Consistent with our policy for public utilities, we consider
using Value Line growth estimates in our revised natural gas and oil
pipeline ROE methodology in the CAPM while continuing our longstanding
use of IBES three to five-year growth estimates as the source of the
short-term growth projection in the DCF. As discussed in Opinion No.
569-A, because we are newly adopting the CAPM, we find that it is
appropriate to consider using a new data source within the CAPM.
6. Proxy Group Construction
a. Background
58. As discussed above, the companies included in a proxy group
must be comparable in risk to the pipeline whose rate is being
determined. To ensure that companies included in pipeline proxy groups
are risk-appropriate, the Commission has required that each proxy group
company satisfy three criteria: (1) The company's stock must be
publicly traded; (2) the company must be recognized as a natural gas or
oil pipeline company and its stock must be recognized and tracked by an
investment information service such as Value Line; and (3) pipeline
operations must constitute a high proportion of the company's
business.\124\ In determining whether a company's pipeline operations
constitute a high proportion of its business, the Commission has
historically applied a 50% standard requiring that the pipeline
business account for, on average, at least 50% of the company's assets
or operating income over the most recent three-year period.\125\
Furthermore, in addition to the foregoing criteria, the Commission has
declined to include Canadian companies in pipeline proxy groups.\126\
---------------------------------------------------------------------------
\124\ 2008 Policy Statement, 123 FERC ] 61,048 at P 8.
\125\ Opinion No. 486-B, 126 FERC ] 61,034 at PP 8, 59.
\126\ For example, in Opinion No. 486-B, the Commission excluded
TransCanada Corporation from the proxy group in a natural gas
pipeline proceeding based in part on the fact that its Canadian
pipeline ``was subject to a significantly different regulatory
structure that renders it less comparable to domestic pipelines
regulated by the Commission.'' Id. P 60. The Commission again
affirmed the exclusion of TransCanada Corporation in Opinion No.
528, finding that it was ``subject to the vagaries of Canadian
regulation and Canadian capital markets, thereby making it difficult
to establish comparable risk.'' Opinion No. 528, 145 FERC ] 61,040
at P 626.
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59. The Commission has explained that proxy groups ``should consist
of at least four, and preferably at least five members'' \127\ and that
pipeline proxy groups should only exceed five members if each
additional member satisfies the 50% standard.\128\ At the same time,
the Commission has also explained that although ``adding more members
to the proxy group results in greater statistical accuracy, this is
true
[[Page 31768]]
only if the additional members are appropriately included in the proxy
group as representative firms.'' \129\
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\127\ Opinion No. 486-B, 126 FERC ] 61,034 at P 104.
\128\ See Portland Nat. Gas Transmission Sys., Opinion No. 510,
134 FERC ] 61,129, at P 215 (2011) (declining to include company
that failed 50% standard because proxy group had more than five
members).
\129\ Opinion No. 486-B, 126 FERC ] 61,034 at P 104.
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60. The number of companies satisfying the Commission's historical
proxy group criteria in pipeline proceedings has declined in recent
years, resulting in inadequately sized proxy groups. Consolidation in
the natural gas and oil pipeline industries has resulted in the
absorption of many natural gas and oil pipeline companies into larger,
diversified energy companies that own a variety of energy-related
assets in addition to interstate pipelines. In addition, major
companies in the oil pipeline industry have recently acquired natural
gas pipeline assets.\130\ The proliferation of these diversified energy
companies has reduced the number of companies satisfying the 50%
standard. Recent acquisitions of pipeline companies by private equity
firms have further reduced the number of eligible natural gas and oil
pipeline proxy group members by converting those pipeline companies
from publicly traded to privately held entities.
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\130\ Examples of such transactions include Enbridge Inc.'s
acquisition of Spectra Energy Corp., TC Energy Corporation's
acquisition of Columbia Pipeline Group, Inc., and IFM Investors'
acquisition of Buckeye Partners LP.
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61. To address the problem of the shrinking natural gas and oil
pipeline proxy groups, the Commission has relaxed the 50% standard when
necessary to construct a proxy group of five members.\131\ The
Commission has emphasized, however, that it will only include firms not
satisfying the 50% standard until five proxy group members are
obtained.\132\
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\131\ E.g., Opinion No. 528, 145 FERC ] 61,040 at P 635; Opinion
No. 486-B, 126 FERC ] 61,034 at PP 67-75, 94-96 (including two firms
not satisfying the 50% standard in natural gas pipeline proxy group
after application of the Commission's traditional criteria resulted
in a proxy group of only three members); Williston Basin Interstate
Pipeline Co., 104 FERC ] 61,036, at PP 35-37, 43 (2003), order on
reh'g and compliance, 107 FERC ] 61,164 (2004).
\132\ Opinion No. 528-A, 154 FERC ] 61,120 at P 236 (``[W]e will
relax the [50 percent] standard only if necessary to establish a
proxy group consisting of at least five members''); Opinion No. 510,
134 FERC ] 61,129 at P 167 (``[I]n order to achieve a proxy group of
at least five firms, a diversified natural gas company not
satisfying the historical [50 percent] standard could be included in
the proxy group, but only if there is a convincing showing that an
investor would view that firm as having comparable risk to a
pipeline.'').
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b. NOI Comments
62. Commenters recognize the ongoing difficulties in forming
pipeline proxy groups of sufficient size and support the Commission's
policy of relaxing the 50% standard when necessary to obtain five proxy
group members.\133\ AOPL, INGAA, and Tallgrass assert that the
Commission should not apply the 50% standard as a rigid screen and
continue to allow the inclusion of companies that do not satisfy the
50% standard but are nonetheless significantly involved in
jurisdictional natural gas and oil pipeline operations.\134\ NGSA and
PGC/AF&PA likewise support continued flexibility in the construction of
pipeline proxy groups.\135\
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\133\ E.g., CAPP Initial Comments at 19; AOPL Initial Comments
at 35; NGSA Initial Comments at 11.
\134\ See AOPL Initial Comments at 15, 17-18, 35; INGAA Initial
Comments at 24, 29-30; Tallgrass Initial Comments at 9.
\135\ NGSA Initial Comments at 11, 17; PGC/AF&PA Joint Comments
at 9-10.
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63. Other commenters urge the Commission to adopt more drastic
changes to its proxy group formation policies. For example, Magellan
states that the Commission should allow the inclusion of risk-
appropriate non-energy companies in natural gas and oil pipeline proxy
groups \136\ while APGA recommends permitting the inclusion of natural
gas distributors.\137\ INGAA proposes several additional changes to the
Commission's natural gas pipeline proxy group policy,\138\ including
allowing for the inclusion of risk-comparable Canadian companies with
significant U.S. interstate natural gas pipeline assets in natural gas
pipeline proxy groups.\139\ NGSA also supports this proposal.\140\
Moreover, INGAA and Tallgrass propose using the financial metric
``beta'' to assist in determining whether potential proxy group members
are comparable in risk to the pipeline at issue.\141\
---------------------------------------------------------------------------
\136\ Magellan Initial Comments at 15; see also NextEra
Transmission, LLC Initial Comments at 5-6. Most commenters oppose
including non-energy companies in pipeline proxy groups. E.g., AOPL
Initial Comments at 32; Tallgrass Initial Comments at 9; CAPP
Initial Comments at 21; NGSA Initial Comments at 19; PGC/AF&PA Joint
Comments at 10.
\137\ APGA Comments at 10.
\138\ INGAA Initial Comments at 24-25, 29-37, 40; INGAA Reply
Comments at 6-12.
\139\ INGAA Initial Comments at 30.
\140\ NGSA Initial Comments at 11.
\141\ INGAA Initial Comments at 24-25, 34-35; Tallgrass Initial
Comments at 6-7.
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c. Commission Determination
64. Based on our review of our current policy and upon
consideration of the comments to the NOI, we will maintain a flexible
approach to forming natural gas and oil pipeline proxy groups and
continue to relax the 50% standard when necessary to obtain a proxy
group of five members. In addition, we clarify that in light of
continuing difficulties in forming sufficiently sized natural gas and
oil pipeline proxy groups, we will consider proposals to include
otherwise-eligible Canadian entities.\142\ We recognize that
difficulties in forming a proxy group of sufficient size may be
enhanced under current market conditions, including those resulting
from the COVID-19 pandemic. In light of these conditions, the
Commission will consider adjustments to our ROE policies where
necessary.\143\
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\142\ While the Commission has preferred screens and methods for
selecting companies that will compose a proxy group, parties may
continue to propose alternative screens and methods in cost-of-
service rate proceedings.
\143\ See, e.g., SFPP, L.P., Opinion No. 511, 134 FERC ] 61,121,
at P 209 (2011) (departing from the Commission's general policy to
determine ROE using the most recent data in the record and
determining nominal ROE using earlier data where the most recent
data reflected the collapse of the stock market in late 2008 and
thus was not representative of the pipeline's long-term equity cost
of capital), order on reh'g, Opinion No. 511-B, 150 FERC ] 61,096
(2015) remanded on other grounds sub nom. United Airlines, Inc. v.
FERC, 827 F.3d 122 (D.C. Cir. 2016), order on remand and compliance
filing, Opinion No. 511-C, 162 FERC ] 61,228, at PP 46-53 (2018);
see also Trunkline Gas Co., Opinion No. 441, 90 FERC ] 61,017, at
61,049 (2000) (``The Commission seeks to find the most
representative figures on which to base rates.'').
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65. As discussed above, the problem of the shrinking pipeline proxy
groups persists due to, among other issues, the consolidation of pure
play natural gas and oil pipelines into diversified energy companies
and acquisitions of pipeline companies by private firms. These
developments have reduced the number of publicly traded companies
eligible for inclusion in a proxy group under the Commission's
historical criteria, making it difficult for the Commission to develop
an adequate sample of representative firms to estimate a pipeline's
required cost of equity. As such, we will continue to apply the 50%
standard flexibly, based on the record evidence and in accordance with
the Commission's past practice, when necessary to construct a proxy
group of at least five members.
66. In addition, we find that the NOI comments advance credible
reasons why it may be appropriate to permit the inclusion of Canadian
entities in natural gas and oil pipeline proxy groups. Extending proxy
group eligibility to such entities could alleviate the shrinking proxy
group problem by adding new potential proxy group members. As explained
above, the Commission has previously excluded companies from pipeline
proxy groups based on concerns that the fact that such entities are
subject to Canadian regulation and Canadian capital markets makes it
difficult to establish whether
[[Page 31769]]
they are comparable in risk to Commission-regulated pipelines.\144\ We
note, however, that considerations underlying those decisions may have
changed since the Commission established that policy.\145\ Therefore,
in future natural gas and oil pipeline proceedings, we will consider
proposals to include in the proxy group risk-appropriate Canadian
entities that otherwise satisfy the Commission's proxy group
eligibility requirements.
---------------------------------------------------------------------------
\144\ Opinion No. 528, 145 FERC ] 61,040 at P 626; Opinion No.
486-B, 126 FERC ] 61,034 at P 60.
\145\ For instance, a 2009 rate case decision by the National
Energy Board of Canada (NEB) may be instructive. National Energy
Board of Canada, RH-1-2008 Reasons for Decision, Trans Qu[eacute]bec
& Maritimes Pipelines Inc., March 2009, available at http://www.regie-energie.qc.ca/audiences/3690-09/RepDDRGM_3690-09/B-29_GM_Reasons-Decision-RH-1-2008_3690_30juin09.pdf (Trans
Qu[eacute]bec). In that decision, the NEB revised its ratemaking
policy by adopting an after-tax weighted average cost-of-capital
approach to determining pipeline cost of capital. Id. at 18-19. The
NEB also accepted evidence that the Canadian and U.S. financial
markets are integrated and, as a result, Canadian pipelines and U.S.
pipelines compete for capital. Id. at 66-68 (finding that ``Canadian
and U.S. pipelines operate in what the Board views as an integrated
North American natural gas market.''). The NEB also found that
although the risks facing U.S. and Canadian pipelines are not
identical, those risks ``are not so different as to make them
inappropriate comparators'' and in fact share ``many similarities.''
Id. at 68. As such, the NEB found that U.S. pipelines ``have the
potential to act as a useful proxy'' for use in determining the
appropriate ROE for Canadian pipelines. Id. at 67.
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B. Excluded Financial Models
1. Risk Premium
a. Background
67. In Opinion No. 569, the Commission excluded the Risk Premium
model from its revised ROE methodology for public utilities.\146\ The
Commission found that the Risk Premium model is largely redundant with
the CAPM because, although they rely on different data sources to
determine the risk premium, both models use indirect measures (i.e.,
past Commission orders in the Risk Premium model and S&P 500 data in
the CAPM) to ascertain the risk premium that investors require over the
risk-free rate of return.\147\ The Commission also found that the Risk
Premium model is likely to provide a less accurate current cost-of-
equity estimate than the DCF model or CAPM because whereas those models
apply a market-based method to primary data, the Risk Premium model
relies on previous ROE determinations whose resulting ROE may not
necessarily be directly determined by a market-based method.\148\
---------------------------------------------------------------------------
\146\ Opinion No. 569, 169 FERC ] 61,129 at P 340.
\147\ Id. P 341.
\148\ Id. P 342.
---------------------------------------------------------------------------
68. In Opinion No. 569-A, the Commission granted rehearing and
adopted a modified Risk Premium model for use in ROE analyses under FPA
section 206. Unlike the Risk Premium model discussed in Opinion No.
569, the modified Risk Premium model excludes problematic cases from
the analysis, such as those where an entity joined a Regional
Transmission Organization (RTO), and the Commission, without
reexamination, allowed adoption of the existing RTO-wide ROE. The
Commission explained that, as modified, the Risk Premium model adds
benefits to the ROE analysis through model diversity and reduced
volatility that outweigh the disadvantages identified in Opinion No.
569.\149\
---------------------------------------------------------------------------
\149\ Opinion No. 569-A, 171 FERC ] 61,154 at PP 104-114.
---------------------------------------------------------------------------
b. NOI Comments
69. INGAA, AOPL, NGSA, and CAPP assert that the Risk Premium model
cannot be applied to natural gas and oil pipelines in light of the lack
of stated allowed ROEs from settlements or Commission decisions in
pipeline proceedings. Because the Risk Premium model relies upon
Commission-allowed ROEs to estimate the equity risk premium, these
commenters state that it would be difficult, if not impossible, to
apply this model in pipeline cases.\150\
---------------------------------------------------------------------------
\150\ INGAA Initial Comments at 41-42; AOPL Initial Comments at
12, 27-28; NGSA Initial Comments at 10-11, 24; CAPP Initial Comments
at 11-12.
---------------------------------------------------------------------------
c. Commission Determination
70. We will not use the Risk Premium model in our revised ROE
methodology. As commenters observe, there is insufficient data to apply
the Risk Premium models considered in Opinion Nos. 569 and 569-A to
natural gas or oil pipelines. That model relies upon stated ROEs
approved in past Commission orders, such as orders on settlements, to
ascertain the risk premium that investors require. In recent years,
however, natural gas and oil pipeline cost-of-service rate proceedings
have frequently resulted in ``black box'' settlements instead of a
fully litigated Commission decision. Unlike public utility proceedings,
where ROE may be addressed on a standalone basis as a component of
formula rates, settlements in pipeline proceedings typically do not
enumerate a stated ROE.
71. Consequently, for natural gas and oil pipelines, there is
insufficient data to estimate cost of equity using the Risk Premium
models discussed in Opinion Nos. 569 and 569-A. In light of this lack
of data, we will not use these models in determining pipeline ROEs.
While we do not adopt the Risk Premium model in our revised methodology
here for the reasons discussed above, we do not necessarily foreclose
its use in future proceedings if parties can demonstrate that the
concerns discussed above have been addressed.
2. Expected Earnings
a. Background
72. In Opinion No. 569, the Commission excluded the Expected
Earnings model from its revised base ROE methodology for public
utilities because the record did not support departing from the
Commission's traditional use of market-based approaches to determine
base ROE.\151\ The Commission also found that the record did not
demonstrate that investors rely on Expected Earnings when making
investment decisions.\152\
---------------------------------------------------------------------------
\151\ Opinion No. 569, 169 FERC ] 61,129 at PP 200-201.
\152\ Id. PP 212-218.
---------------------------------------------------------------------------
73. The Commission explained that in determining a just and
reasonable ROE under Hope, it must analyze the returns that are earned
on ``investments in other enterprises having corresponding risks.''
\153\ In contrast to market-based models, the accounting-based Expected
Earnings model uses estimates of return on an entity's book value to
estimate the earnings an investor expects to receive on the book value
of a particular stock.\154\ As investors cannot invest in an enterprise
at book value, the Commission concluded that the expected return on a
utility's book value does not reflect ``returns on investments in other
enterprises'' because in most circumstances book value does not reflect
the value of any investment that is available to an investor in the
market.\155\ The Commission thus found that return on book value is not
indicative of what return an investor requires to invest in the
utility's equity or what return an investor receives on the equity
investment.\156\
---------------------------------------------------------------------------
\153\ Id. P 201 (quoting Hope, 320 U.S. at 603).
\154\ Id. P 172.
\155\ Id. P 201.
\156\ Id. PP 202, 211.
---------------------------------------------------------------------------
74. On rehearing, the Commission affirmed the exclusion of the
Expected Earnings model in those proceedings for the reasons stated in
Opinion No. 569.\157\ The Commission found, moreover, that the Expected
Earnings model does not accurately measure the returns that investors
require to invest in public utilities because the current market values
of utility stocks
[[Page 31770]]
substantially exceed utilities' book value. As a result, a utility's
expected earnings on its book value will inevitably exceed the return
that investors require in order to purchase the utility's higher-value
stock.\158\
---------------------------------------------------------------------------
\157\ Opinion No. 569-A, 171 FERC ] 61,154 at PP 125-131.
\158\ Id. P 127.
---------------------------------------------------------------------------
b. NOI Comments
75. Commenters that support expanding the Commission's pipeline ROE
methodology to consider models in addition to the DCF \159\ do not
oppose using the Expected Earnings model. INGAA supports use of the
Expected Earnings model to determine natural gas pipeline ROEs,\160\
and AOPL states that the Expected Earnings model can be applied to oil
pipelines if the Commission adopts an appropriate approach to
outliers.\161\ Among the commenters that oppose applying the Expected
Earnings model to natural gas and oil pipelines, NGSA criticizes the
Expected Earnings model for ignoring capital markets \162\ while CAPP
asserts that the Expected Earnings model appears to be confined to
academic uses and, in any event, there is likely an insufficient number
of pipelines to implement the Expected Earnings model.\163\
---------------------------------------------------------------------------
\159\ As noted above, several commenters, including Airlines for
America, Liquids Shippers Group, NGSA, APGA, and PGC/AF&PA assert
that the Commission should continue relying solely on the DCF model
in analyzing pipeline ROEs.
\160\ INGAA Initial Comments at 8, 41, 63; INGAA Reply Comments
at 1-2.
\161\ AOPL Initial Comments at 28l; see also Plains Initial
Comments at 4; Magellan Initial Comments at 12-13, 28-29 (stating
that Expected Earnings should be used only in conjunction with other
models such as the DCF, CAPM, and Risk Premium).
\162\ NGSA Initial Comments at 34.
\163\ CAPP Initial Comments at 13, 27.
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c. Commission Determination
76. We will not use the Expected Earnings model to determine ROE
for natural gas and oil pipelines for the reasons stated in Opinion No.
569. We conclude that the findings underlying the Commission's decision
to exclude the Expected Earnings model from our analysis of public
utility ROEs also support excluding that model from our analysis of
natural gas and oil pipeline ROEs.
77. As discussed above, the Commission must ensure that the
``return to the equity owner'' is ``commensurate with returns on
investments in other enterprises having corresponding risks.'' \164\ As
with public utilities, under the market-based approach the Commission
performs this analysis by setting a pipeline's ROE to equal the
estimated return that investors would require in order to purchase
stock in the pipeline at its current market price. However, the return
on book value measured under the Expected Earnings model does not
permit such an analysis. Like investors in utilities, investors in
natural gas and oil pipelines cannot invest at the pipeline's book
value and must instead pay the prevailing market price. As such, the
expected return on the pipeline's book value does not reflect the value
of an investment that is available to an investor in the market and
thus does not reflect the ``returns on investments in other enterprises
having corresponding risks'' that we must analyze under Hope.\165\
Likewise, the return on a pipeline's book value does not reflect ``the
return to the equity owner'' that we must consider under Hope because
the return that an investor requires to invest in the pipeline's equity
and the return an investor receives on the equity investment are
determined based on the current market price the investor must pay in
order to invest in the pipeline's equity.\166\
---------------------------------------------------------------------------
\164\ Hope, 320 U.S. at 603.
\165\ See Opinion No. 569, 169 FERC ] 61,129 at P 201.
\166\ See id. P 202.
---------------------------------------------------------------------------
78. Accordingly, based on the record in this proceeding, we
conclude that at this time relying on the Expected Earnings model to
determine pipeline ROEs would not satisfy the requirements of Hope. We
will therefore exclude the Expected Earnings model from our revised
methodology for determining natural gas and oil pipeline ROEs. While we
do not adopt the Expected Earnings model in our revised methodology
here for the reasons discussed above, we do not necessarily foreclose
its use in future proceedings if parties can demonstrate that the
concerns discussed above have been addressed.
C. Outlier Tests
1. Background
79. Generally, the Commission has not applied a specific low-end or
high-end outlier test in natural gas and oil pipeline proceedings.
Rather, the Commission has used a fact-specific analysis to select
proxy group members. In constructing pipeline proxy groups, the
Commission excludes anomalous and illogical proxy group returns that do
not provide meaningful indicia of the return a pipeline requires to
attract capital.\167\
---------------------------------------------------------------------------
\167\ See Opinion No. 546, 154 FERC ] 61,070 at P 196; 2008
Policy Statement, 123 FERC ] 61,048 at P 79 (``[T]he Commission will
continue to exclude an MLP from the proxy groups if its growth
projection is illogical or anomalous.'').
---------------------------------------------------------------------------
80. Conversely, the Commission has applied specific outlier screens
to public utilities. Prior to Opinion No. 569, the Commission excluded
as low-end outliers companies whose ROEs failed to exceed the average
10-year bond-yield by approximately 100 basis points on the ground that
investors generally cannot be expected to purchase a common stock if
debt, which has less risk than a common stock, yields essentially the
same expected return.\168\ In the Briefing Orders, the Commission
proposed to treat as high-end outliers any proxy company whose cost of
equity estimated under the model in question is more than 150% of the
median result of all of the potential proxy group members in that model
before any high-end or low-end outlier test is applied.\169\
---------------------------------------------------------------------------
\168\ Opinion No. 569, 169 FERC ] 61,129 at P 379 (citing
Pioneer Transmission, LLC, 126 FERC ] 61,281, at P 94 (2009), reh'g
denied, 130 FERC ] 61,044 (2010); S. Cal. Edison Co., 131 FERC ]
61,020, at PP 54-56 (2010)).
\169\ MISO Briefing Order, 165 FERC ] 61,118 at P 54; Coakley
Briefing Order, 165 FERC ] 61,030 at P 53.
---------------------------------------------------------------------------
81. In Opinion No. 569, the Commission adopted a revised low-end
outlier test that eliminates proxy group ROE results that are less than
the yields of generic corporate Baa bond plus 20% of the CAPM risk
premium.\170\ The Commission explained that it was necessary to include
a risk premium in the low-end outlier test to account for the fact that
declining bond yields have caused the ROE that investors would consider
to yield ``essentially the same expected return as a bond'' to
increase.\171\ The Commission concluded that the 20% risk premium was
reasonable because it is sufficiently large to account for the
additional risks of equities over bonds, but not so large as to
inappropriately exclude proxy group members whose ROE is
distinguishable from debt.\172\
---------------------------------------------------------------------------
\170\ Opinion No. 569, 169 FERC ] 61,129 at P 387.
\171\ Id.
\172\ Id. P 388.
---------------------------------------------------------------------------
82. In addition, Opinion No. 569 adopted the high-end outlier test
proposed in the Briefing Orders.\173\ The Commission reasoned that
because the Commission will continue to use the midpoint as the measure
of central tendency for region-wide public utility ROEs, a high-end
outlier test was necessary to eliminate proxy group members whose ROEs
are unreasonably high.\174\
---------------------------------------------------------------------------
\173\ Id. P 375.
\174\ Id.
---------------------------------------------------------------------------
83. The Commission explained that both the low-end and high-end
outlier tests would be subject to a natural-break analysis, which
determines whether
[[Page 31771]]
proxy group companies screened as outliers, or those almost screened as
outliers, truly reflect non-representative data and should thus be
removed from the proxy group.\175\ The Commission noted that the
natural break analysis provides the Commission with flexibility to
reach a reasonable result based on the particular array of ROEs
presented in a particular case.\176\
---------------------------------------------------------------------------
\175\ Id. P 396. Typically, this involves examining the distance
between that proxy group company and the next closest proxy group
company and comparing that to the dispersion of other proxy group
companies. As explained in Opinion No. 569, the natural break
analysis may justify excluding companies whose ROEs are a few basis
points above the low-end outlier screen if their ROEs are far lower
than other companies in the proxy group, and a similar analysis
could apply with regard to high-end outliers. Id.
\176\ Id. P 397.
---------------------------------------------------------------------------
84. In Opinion No. 569-A, the Commission denied requests for
rehearing as to the low-end outlier test. The Commission rejected
challenges to the threshold based on 20% of the CAPM risk premium and
similarly rejected claims that the low-end outlier test is inconsistent
with Commission precedent.\177\
---------------------------------------------------------------------------
\177\ Opinion No. 569-A, 171 FERC ] 61,154 at P 161.
---------------------------------------------------------------------------
85. Moreover, the Commission modified the high-end outlier test
adopted in Opinion No. 569 to increase the exclusion threshold to 200%
of the median result of all the potential proxy group members in the
model in question before any high or low-end outlier test is applied.
The Commission recognized that a high-end outlier test with a bright-
line threshold could inappropriately exclude rational ROEs that are not
anomalous for the subject utility and found that increasing the
threshold to 200% will reduce the risk that such rational results are
inappropriately excluded.\178\
---------------------------------------------------------------------------
\178\ Id. P 154.
---------------------------------------------------------------------------
2. NOI Comments
86. Most commenters agree that the outlier tests proposed in the
Briefing Orders are not appropriate for natural gas or oil
pipelines.\179\ These commenters assert that outlier tests are
unnecessary because the Commission sets natural gas and oil pipeline
ROEs at the median of the proxy group results, which reduces the
distortion that high-end cost of equity estimates may cause when the
ROE is set at the midpoint of the proxy group results.\180\ CAPP, by
contrast, states that the outlier tests proposed in the Briefing Orders
would be useful in forming proxy groups.\181\ Similarly, although it
opposes use of a high-end outlier test, INGAA states that there is
theoretical support for applying a low-end outlier test.\182\ However,
INGAA opposes the proposed low-end outlier test's 20% threshold and
proposes two alternative approaches.\183\
---------------------------------------------------------------------------
\179\ AOPL Initial Comments at 4, 15-17; INGAA Initial Comments
at 10-11, 65-69; Plains Comments at 1-2, 5-6.
\180\ AOPL Initial Comments at 16; INGAA Initial Comments at 67;
Plains Comments at 5-6; NGSA Comments at 20. Magellan states that it
may be unreasonable to apply an outlier test to oil pipelines
because removing outlying results could reduce the number of proxy
group companies to an unacceptable level. Magellan Initial Comments
at 17-18.
\181\ CAPP Initial Comments at 21-22.
\182\ INGAA Initial Comments at 69.
\183\ Id.
---------------------------------------------------------------------------
3. Commission Determination
87. We decline to adopt specific outlier tests for use in
determining natural gas and oil pipeline ROEs. Rather, we will continue
to address outliers in pipeline proxy groups on a case-by-case basis in
accordance with our policy to remove ``anomalous'' or ``illogical''
cost-of-equity estimates that do not provide meaningful indicia of the
returns that a pipeline needs to attract capital from the market.\184\
---------------------------------------------------------------------------
\184\ E.g., Opinion No. 546, 154 FERC ] 61,070 at P 196.
---------------------------------------------------------------------------
88. We believe that rigid outlier screens are unnecessary for
natural gas and oil pipelines for two reasons. First, as commenters
observe, the Commission's use of the proxy group median in setting
pipeline ROEs reduces the effect that low and high-end outliers may
exert on the ROE result. When the Commission sets an ROE at the
midpoint, as it does for RTO-wide ROEs in the public utility context,
the ROE is set at the average of the highest and lowest ROEs of the
proxy group members.\185\ The low and high-end returns are therefore
direct inputs into the calculation of the midpoint the Commission uses
to determine the ROE. In contrast, when the Commission uses the median
to determine the ROE of a pipeline, the presence of an outlier has a
much smaller effect.\186\
---------------------------------------------------------------------------
\185\ E.g., Midwest Indep. Transmission Sys. Operator, Inc., 106
FERC ] 61,302, at PP 8-10 (2004).
\186\ Although the decision whether to include or remove an
outlier may affect which member of the proxy group is the median
result, the outlier is not a direct part of the ROE calculation as
it is when the Commission uses the midpoint.
---------------------------------------------------------------------------
89. Second, as discussed above, the pool of entities eligible for
inclusion in natural gas and oil pipeline proxy groups has declined in
recent years and remains small. Adopting rigid outlier screens could
further reduce the number of potential proxy group members and make it
difficult to form pipeline proxy groups with at least four or five
members.
90. We also clarify that we do not anticipate applying a natural
break analysis in pipeline ROE proceedings. Unlike in the public
utility context, we are concerned that a natural break analysis could
exacerbate the difficulties in forming pipeline proxy groups by further
reducing the number of potential proxy group members. Moreover, we
believe that the natural break analysis is less useful in pipeline
proceedings. As explained in Opinion No. 569, the purpose of the
natural break analysis is to provide the Commission with flexibility to
determine whether a proxy group company ROE is truly an outlier or
contains useful information.\187\ Because there are so few members of
pipeline proxy groups, the natural break analysis is less likely to
identify outliers as this typically involves examining the distance
between a given proxy group result and the next closest result, and
comparing that to the dispersion of other proxy group results.\188\
---------------------------------------------------------------------------
\187\ Opinion No. 569, 169 FERC ] 61,129 at P 395.
\188\ Id. P 390.
---------------------------------------------------------------------------
91. We will continue to apply the general principle that
``anomalous'' or ``illogical'' data should be excluded from the proxy
group. Using this approach, the Commission will retain flexibility to
determine whether a given proxy group company is truly an outlier or
whether it contains useful information in light of the particular array
of ROEs presented by the potential proxy group companies.\189\
---------------------------------------------------------------------------
\189\ Id. P 395.
---------------------------------------------------------------------------
D. Oil Pipeline Page 700s
92. In light of the impending five-year review of the oil pipeline
index, we encourage oil pipelines to file updated FERC Form No. 6, page
700 data for 2019 reflecting the revised ROE methodology established
herein. Although the Commission will address this issue further in the
five-year review, reflecting the revised methodology in page 700 data
for 2019 may help the Commission better estimate industry-wide cost
changes for purposes of the five-year review. Pipelines that previously
filed Form No. 6 for 2019 and choose to submit updated page 700 data
should, in a footnote on the updated page 700, either (a) confirm that
their previously filed Form No. 6 was based solely upon the DCF model
or (b) provide the real ROE and resulting cost of service based solely
upon the DCF model as it was applied to oil pipelines prior to this
Policy Statement.
[[Page 31772]]
93. As discussed below, the Paperwork Reduction Act (PRA) \190\
requires each federal agency to seek and obtain the Office of
Management and Budget's (OMB) approval before undertaking a collection
of information directed to ten or more persons. Following OMB approval
of this voluntary information collection, the Commission will issue a
notice affording pipelines two weeks to file updated page 700 data
reflecting the revised ROE methodology.\191\ Before that time,
pipelines that have not filed Form No. 6 for 2019 (e.g., pipelines that
have received an extension of the Form No. 6 filing deadline) should
file page 700 data consistent with their previously-granted extensions
and such filings should be based upon the DCF model, which was the
Commission's oil pipeline ROE methodology as of April 20, 2020, the
date such filings were due.\192\
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\190\ 44 U.S.C. 3501-21.
\191\ Following OMB approval of this information collection, the
Commission will issue a notice specifying the date on which any
updated page 700 should be filed.
\192\ Upon OMB approval, these pipelines will have the
opportunity to file updated page 700 data reflecting the
Commission's revised oil pipeline ROE methodology.
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III. Information Collection Statement
94. The PRA requires each federal agency to seek and obtain OMB
approval before undertaking a collection of information directed to ten
or more persons.\193\ Upon approval of a collection of information, OMB
will assign an OMB Control Number and expiration date. The refiling of
page 700 of FERC Form No. 6 is being requested on a voluntary basis.
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\193\ OMB's regulations requiring approval of certain
collections of information are at 5 CFR 1320.
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95. The Commission is submitting this voluntary information
collection (the one-time re-filing of page 700 of FERC Form No. 6) to
OMB for its review and approval under section 3507(d) of the PRA. The
Commission solicits comments on the Commission's need for this
information, whether the information will have practical utility, the
accuracy of the burden estimates, ways to enhance the quality, utility,
and clarity of the information to be collected or retained, and any
suggested methods for minimizing respondents' burden, including the use
of automated information techniques.
96. Burden Estimate: \194\ The estimated additional one-time burden
and cost \195\ for making a voluntary filing to update page 700 of the
FERC Form No. 6 consistent with this Policy Statement is detailed in
the following table. The first row includes the industry cost of
performing cost-of-equity studies to develop an updated ROE estimate
for the period ending December 31, 2019. The second row shows the cost
of reflecting the updated ROE estimates and revised Annual Cost of
Service on page 700 of the FERC Form No. 6.
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\194\ ``Burden'' is the total time, effort, or financial
resources expended by persons to generate, maintain, retain, or
disclose or provide information to or for a Federal agency. For
further explanation of what is included in the information
collection burden, refer to 5 CFR 1320.3.
\195\ Commission staff estimates that the industry's skill set
and cost (for wages and benefits) for completing and filing FERC
Form No. 6 is comparable to the Commission's skill set and average
cost. The FERC 2019 average salary plus benefits for one FERC full-
time equivalent (FTE) is $167,091/year or $80.00/hour.
Estimated Annual Changes to Burden due to Docket No. PL19-4 \196\
[Figures may be rounded]
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Number of Annual number Total annual burden
potential of responses Total number Average burden hours & hours & total annual Cost per
respondents per respondent of responses cost ($) per response cost ($) respondent ($)
(1) (2) (1) * (2) = (4)..................... (3) * (4) = (5)........ (5) / (1) =
(3) (6)
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Updated ROE Study.................... 244 1 244 187.5 hrs.; $15,000..... 45,750 hrs.; $3,660,000 $15,000
Refile FERC Form No. 6, page 700..... 244 1 244 0.5 hrs.; $40........... 122 hrs.; $9,760....... 40
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Total Changes, Due to PL19-4..... 244 1 244 ........................ $3,669,760............. 15,040
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97. This additional one-time burden is expected to be imposed in
Year 1.
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\196\ We have conservatively assumed a 100% voluntary response
rate.
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98. Title: FERC Form No. 6, Annual Report of Oil Pipeline
Companies.
Action: Revision to FERC Form No. 6, page 700.
OMB Control No.: 1902-0022.
Respondents: Oil pipelines.
Frequency of Responses: One time.
Necessity of the Information: As established in Order No. 561,\197\
oil pipelines may increase their existing transportation rates on an
annual basis using an industry-wide index. The Commission reviews the
index level every five years.\198\ In the five-year review, the
Commission establishes the index level based upon a methodology that
calculates pipeline cost changes on a per barrel-mile basis based upon
FERC Form No. 6, page 700 data.\199\ Depending upon the record
developed in the 2020 five-year review of the oil pipeline index, the
Commission will consider using the updated FERC Form No. 6, page 700
data for 2019 in that proceeding.
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\197\ Revisions to Oil Pipeline Regulations Pursuant to the
Energy Policy Act of 1992, Order No. 561, FERC Stats. & Regs. ]
30,985 (1993), order on reh'g, Order No. 561-A, FERC Stats. & Regs.
] 31,000 (1994), aff'd, Ass'n of Oil Pipelines v. FERC, 83 F.3d 1424
(D.C. Cir. 1996).
\198\ Id. at 30,941.
\199\ Five-Year Review of the Oil Pipeline Index, 153 FERC ]
61,312, at PP 5, 12 (2015).
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99. Interested persons may obtain information on the reporting
requirements by contacting the following: Federal Energy Regulatory
Commission, 888 First Street NE, Washington, DC 20426 [Attention: Ellen
Brown, Office of the Executive Director, email: DataClearance@ferc.gov
and phone: (202) 502-8663].
100. Please send comments concerning the collection of information
and the associated burden estimates to: Office of Information and
Regulatory Affairs, Office of Management and Budget [Attention: Federal
Energy Regulatory Commission Desk Officer]. Due to security concerns,
comments should be sent directly to www.reginfo.gov/public/do/PRAMain.
Comments submitted to OMB should be sent within 30 days of publication
of this notice in the Federal Register and refer to FERC Form No. 6 and
OMB Control No. 1902-0022.
[[Page 31773]]
IV. Document Availability
101. In addition to publishing the full text of this document in
the Federal Register, the Commission provides all interested persons an
opportunity to view and/or print the contents of this document via the
internet through the Commission's Home Page (http://www.ferc.gov)). At
this time, the Commission has suspended access to the Commission's
Public Reference Room, due to the proclamation declaring a National
Emergency concerning the Novel Coronavirus Disease (COVID-19), issued
by the President on March 13, 2020.
102. From the Commission's Home Page on the internet, this
information is available on eLibrary. The full text of this document is
available on eLibrary in PDF and Microsoft Word format for viewing,
printing, and/or downloading. To access this document in eLibrary, type
the docket number excluding the last three digits of this document in
the docket number field.
103. User assistance is available for eLibrary and the Commission's
website during normal business hours from the Commission's Online
Support at (202) 502-6652 (toll free at 1-866-208-3676) or email at
ferconlinesupport@ferc.gov, or the Public Reference Room at (202) 502-
8371, TTY (202) 502-8659. Email the Public Reference Room at
public.referenceroom@ferc.gov.
V. Effective Date
104. This Policy Statement becomes effective May 27, 2020.
By the Commission.
Issued: May 21, 2020.
Nathaniel J. Davis, Sr.,
Deputy Secretary.
[FR Doc. 2020-11406 Filed 5-26-20; 8:45 am]
BILLING CODE 6717-01-P