Academic journal article Energy Law Journal

Report of the Finance and Transactions Committee

Academic journal article Energy Law Journal

Report of the Finance and Transactions Committee

Article excerpt

I. PUBLIC UTILITY HOLDING COMPANY ACT OF 2005/FEDERAL POWER ACT SECTION 203

In light of the significant developments under Federal Power Act section 203 and the Public Utility Holding Company Act of 2005 over the past year, members of the Finance and Transactions Committee and the Electricity Regulation Committee have worked together to provide a comprehensive presentation of these matters in the Corporate/Affiliate and Section 203/Merger Developments sections of Electricity Regulation Committee Report. For a discussion of these developments, to which the Finance and Transactions Committee contributed, please see the Electricity Regulation Committee Report in this issue.

Provided below is a report of significant financing and transactional developments that have occurred in the past year in the energy and utility industries.

II. NATURAL GAS PIPELINES

A. Kern River Gas Transmission Company

On October 19, 2006, the Commission (FERC or the Commission) issued Opinion No. 486 in the Kern River Gas Transmission Company rate case. ' The proceeding was closely watched by stakeholders in the gas pipeline industry particularly with respect to the rate of return on equity issue. In Opinion No. 486, which Commissioner Suedeen Kelly described as the "roadmap" for pipeline rate cases for the foreseeable future, the Commission allowed Kern River a return on equity of 11.2%, reversing the administrative law judge's March 2, 2006, initial decision recommending a 9.34% return on equity for the pipeline.2

The Commission's decision stems from an April 30, 2004, rate filing in which Kem River proposed a return on equity of 15.1%. Kern River proposed a proxy group that included master limited partnerships (MLPs) and claimed that a return on equity of 15.1%, which was the highest in the zone of reasonableness, was appropriate because of its high level of risk.3 Arguing against the inclusion of MLPs in the proxy group, other parties in the case proposed a return on equity in the nine to ten percent range at the median of the zone of reasonableness. In the initial decision, the judge rejected Kern River's proposal to include MLPs in the proxy group, finding that the result was an artificial inflation to the returns.4 The judge also rejected the Commission Staffs proposal to include electric utilities in the proxy group. Instead, the judge used a proxy group consisting of El Paso Corp., Equitable Resources Inc., Kinder Morgan Inc., National Fuel Gas Co., Questar Gas Co., and the Williams Cos. to determine an appropriate return on equity for Kern River. This proxy group had returns on equity ranging from 7.31% to 13.62%.5 The judge also adopted the proposal of several parties to place Kern River at the median of the zone, which resulted in a return on equity of 9.34%.6

B. Proxy Group

In Opinion No. 486, the Commission upheld the judge's decision to exclude MLPs and electric utilities from the proxy group, but modified the proxy group chosen by the judge. Instead, the Commission used the same four-company proxy group that it adopted in High Island Offshore System, L.L.C.,7 and which excluded El Paso and Williams, and concluded that the median return on equity for Kern River should be 10.7%.8

The Commission reaffirmed its use of the discounted cash flow (DCF) methodology to determine return on equity for natural gas pipelines. The DCF method calculates an investor's expectation of income from the investment in the future (based on current yield and expected growth). In order to determine a reasonable return for the pipeline in question, the DCF calculation is applied to the yields of a proxy group consisting of similarly situated publicly traded entities. This results in a zone of reasonableness of expected returns for those companies. Then, depending on whether the pipeline in question is of average risk, more risky than average, or less risky than average, it will be assigned a return on equity somewhere within this zone of reasonableness. …

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