United States: Should The FERC Change Its Approach For Licensing New Gas Infrastructure?

Former Chairman and Commissioner Norman Bay gave the natural gas industry a surprise his last day at the Federal Energy Regulatory Commission ("FERC" or "Commission"), February 3, 2017, in opening a debate about whether the Commission should modify critical aspects of its pipeline infrastructure review process under Section 7(c) of the Natural Gas Act ("NGA").1

In a statement accompanying the Commission's order in National Fuel Gas Supply Corp.,2 Commissioner Bay advocated that the Commission explore adjusting its approach to authorizing new pipelines both in terms of evaluating the need for new facilities and the scope of environmental analysis to support such projects.

Bay maintains that these changes are prompted by the twin forces of "increased controversy" surrounding pipeline infrastructure, as evidenced by a recent paper from the Sierra Club3 advocating a stop to all new pipelines in favor of investment in renewable energy, and the "considerable public interest" associated with concerns over the production of gas, methane emissions and the use of fracking (none of which the FERC has authority to regulate, as Bay readily admits).

Bay recommends that the Commission look beyond executed precedent agreements to determine the need for new projects and that, "in light of heightened public interest and in the interests of good government,"4 the Commission expand its environmental inquiry into areas that he concedes are not required by the National Environmental Policy Act of 1969 ("NEPA").5 This would entail performing a programmatic review of gas production from the Marcellus and Utica Shales and, in connection with each new pipeline project, performing an assessment of the downstream impacts of gas use and a life-cycle greenhouse gas ("GHG") emissions study.

Does Controversy Alone Justify Changing the Commission's Approach?

The controversy cited by Bay is real and immediate.  Well-funded environmental groups like the Sierra Club that back a climate change, anti-fracking and renewable energy agenda are locked in what seems like an existential struggle with the Commission over the authorization of new gas projects.  Their agenda of blocking all new pipelines is fundamentally at odds with the Commission's responsibility under the NGA to assure interstate consumers "an adequate and reliable supply of gas at reasonable prices."6 Because Congress has directed the Commission to address the needs of the interstate gas market and has not empowered it to regulate gas production, fracking or GHG emissions,7 the Commission's job regarding new gas projects is clear -- to authorize such projects if they are shown to be in the public convenience and necessity (i.e., demonstrated need for the project, no subsidies and an acceptable route). 

But by no means is the Commission's job easy.  The opposition by environmental groups has gone far beyond the expected vigorous debate presented in pleadings and filings to the Commission and reviewing courts.  It has also included demonstrations inside and outside the Commission's headquarters, sit-ins at Commission's meetings, and even picketing individual Commissioners' homes.

Nonetheless, the mere existence of controversy -- without some showing that the Commission's decisional approach is demonstrably flawed -- does not justify changing the Commission's longstanding reliance on the 1999 Certificates Policy Statement to decide pipeline certificate cases. 

Bay has not made the case that the Policy Statement is flawed.  Nor has he shown that taking on additional environmental reviews not required by NEPA and covering areas where the Commission has no authority to regulate is prudent given the nature of the environmental opposition.  Although the Commission already prepares upper-bound estimates of upstream and downstream environmental effects,8 voluntarily performing the other reviews cited by Bay would serve no purpose other than to unreasonably delay final project approval,9 add significant costs and supply the Commission's environmental adversaries with additional targets to question the Commission's orders in the courts of appeals. 

Adequacy of the Policy Statement to Evaluate the Need and Public Benefit of Projects

The Certificates Policy Statement has guided the Commission's review of new pipeline applications for over 17 years, a period of record additions to gas infrastructure. It sets forth a multi-step review process that an applicant must satisfy to demonstrate that the construction and operation of its proposed project is in the public convenience and necessity.

The first step involves allocation of risk and lack of subsidies, requiring an existing pipeline applicant to demonstrate that its current customers will not subsidize the new project, a requirement typically satisfied by use of incremental rates for service over the new facilities.

The second step entails a general identification of the need/benefits of the project and its potential adverse effects on three discrete interests: (i) the applicant's existing customers, (ii) competing pipelines and their captive customers, and (iii) affected landowners and surrounding communities.

The final step involves balancing the need/benefits of the project, including identifiable public benefits, against the adverse effects to determine whether the benefits outweigh the adverse effects taking into account mitigation measures. Upon determining that project benefits outweigh adverse effects, the Commission then evaluates environmental effects under NEPA.

Bay identifies essentially three categories of concerns with the Policy Statement, labeled here as (i) "balance" concerns, (ii) "crystal ball" concerns, and (iii) "fairness" concerns.

His principal "balance" concern is that the Commission's practice of relying on executed precedent agreements to show project need might exclude consideration of other factors indicative of project benefit like "whether the capacity is needed to ensure deliverability to new or existing gas-fired generators," or "whether there is a significant reliability or resiliency benefit."10

His "crystal ball" concerns deal with the level of confidence or knowledge the Commission can have regarding how a project it approves will be affected by future events, such as the extent to which the markets supporting the project will actually materialize, thus avoiding potential stranded investment or, even more speculative, "[w]hat happens to infrastructure developed to ship Marcellus and Utica gas west, if gas is cheaper to produce in Texas and Oklahoma?" 

Bay's single "fairness" issue deals with the possible impact a project can have on the captive customers of a competing pipeline that loses other existing customers to the new pipeline project. 

Although Bay raises a host of questions about the Commission's approach to pipeline certificates, nowhere does he identify specific flaws with the Policy Statement or provide examples where reliance on the Policy Statement has produced a result at odds with the NGA's purpose, which the Commission demonstrably could have avoided using a different approach.

To the extent Bay's concerns can reasonably be addressed without a crystal ball, they are all adequately addressed in the Policy Statement.  His concern about possible overreliance on executed precedent agreements appears to overlook the array of project benefits that can and should be taken into account in the second and third steps of the Policy Statement review.  The Policy Statement contemplates that all relevant benefits, including those identified by Bay, should be presented for consideration in the balancing process.11

Avoiding stranded investment is an important concern in the Commission's authorization of long-lived projects like pipelines and LNG terminals.  Having no crystal ball, the Commission relies on what is probably the next best alternative to validate the long-term need for new facilities -- the commercial arrangements (executed precedent agreements and firm service agreements) between project developers and their customers.

Given the significant financial commitments associated with new gas projects, project sponsors are incentivized, even required, to off-load all risk of under-utilization of the proposed facilities onto their customers, who, in turn, must back their contractual payment commitments with appropriate credit support instruments from A-grade banks or investment grade parent firms to cover the fixed charges under the project service agreements.  In this context, the Commission can reasonably assume that project sponsors, customers and their respective financial backers derive no benefit from building or contracting for more capacity than they can reasonably expect to use.

Even though Bay cites the US LNG import terminals approved during the first decade of this century as an example of stranded investment, he doesn't fault the Commission for that result or in any way suggest that the Commission could and should have avoided it.12 A measure of risk-taking is essential to a healthy natural gas industry and should not be discouraged. 

What is critical is the proper allocation of risk so that the financial effects of failed projects are not socialized or passed on to parties who have no contractual stake in potential project benefits.  The collapse of the market for LNG imports has in fact had little effect on the industry at large and essentially no effect on interstate consumers.  Most of the import terminals are being re-purposed for LNG exports, the financial hit is being absorbed by large energy merchant off-takers experienced in the global game of LNG arbitrage, and US gas consumers are enjoying the bounty of the shale gas boom (low energy prices, significantly reduced GHG emissions and stable supply).

The other crystal ball issues Bay raises, such as "what happens if basis differentials largely disappear at major gas trading hubs across the United States"13 are essentially imponderables, too speculative to address outside the concrete setting of a specific certificate case.  But if the implication of these questions is that the Commission should assume a greater "central planning" role in overseeing the interstate gas market, the Commission should decline the invitation.  Central planning has largely been disastrous in the gas industry, whereas the market-oriented approach of the Policy Statement has served the Commission and the industry well, supporting a competitive, robust and dynamic market. 

The captive customer/"fairness" concern flagged by Bay was also raised in the Policy Statement as a potential issue that might warrant special treatment if ever presented in a pipeline certificate case.14 Yet despite the passage of 17 years, it has never come up, most likely because new gas facilities are much more expensive than facilities installed 20-30 years ago, providing customers little economic incentive to switch pipelines.

Voluntarily Assuming Additional Environmental Reviews under NEPA

The only support Bay offers for his suggestion that the Commission voluntarily take on additional environmental studies not required by NEPA is that such action would be "in the interests of good government."15 But that skirts the more fundamental issue that the Commission lacks authority to regulate the environmental effects of fracking in the gas supply basins or GHG emissions in the gas consumption markets linked by pipelines.16

Other agencies are tasked by Congress or the states with those responsibilities.  In contrast, the Commission's job under the NGA is to assure gas service to the interstate market, and discharging that responsibility effectively is not helped if the Commission devotes its resources to preparing unnecessary and speculative environmental studies that will only delay and drive up the costs of new projects found in the public convenience and necessity. 

True, Congress can change the law and direct the Commission to deny projects in the name of climate change.  But unless and until it does, the Commission must reasonably accommodate the needs and wants of interstate gas consumers.

Additionally, the nature of the environmental opposition, coupled with the Commission's winning track record in the courts of appeals, suggests caution -- not haste-- on any proposed departure from current practice on pipeline certificates. 

If the environmental opposition cannot win at the Commission because of Congress' choice supporting interstate gas service, they know that they can at least delay projects, serving their purposes, and take the Commission to task on any and all NEPA reviews in the hope of creating issues before the courts of appeals. 

The courts of appeals are the prize, because if the Commission's environmental adversaries can overturn certificate approvals there, the resulting project complications, delay and expense can potentially kill a project.  Realistically, voluntarily adding environmental reviews would not likely end the current intractable controversy but only play into the hands of the Commission's environmental adversaries, delaying project approvals even more and supplying the opposition with even more targets to shoot at in court. 

Because the Commission is now winning its cases in court, prudence would counsel that it stay the course and be wary of increasing its exposure.

Footnotes

1 15 U.S.C. § 717f(c).

2 National Fuel Gas Supply Corp., 158 FERC ¶ 61,145 (2017) (statement of Commissioner Bay, hereinafter "Statement").

3 The Gas Rush, Locking America Into Another Fossil Fuel For Decades, Sierra Club (Jan. 26, 2017), http://content.sierraclub.org/sites/content.sierraclub.org.coal/files/1466-Gas-Rush-Report%2004_web.pdf.

4 Statement at 5.

5 Statement at 4-5, citing 42 U.S.C. §§ 4321, et seq.

6 California v. Southland Royalty Co., 436 U.S. 519, 523 (1978).

7 Columbia Gas Transmission, LLC, 158 FERC ¶ 61,046, at P 23 (2017) ("Columbia") (acknowledging that without a directive from Congress, the Commission lacks authority to deny new pipelines in the name of advancing national climate change goals).

8 E.g., Columbia at PP 116-23.

9 Where 10 years ago a pipeline certificate case could typically get through FERC within a year after the filing of the application, cases can now take 16-24 months to clear the Commission.  Because time is money for developers, each added procedure that extends the review process carries significant cost, especially if it affects a project's ability to make tree-clearing windows or other seasonal limitations on pre-construction activity in areas of affected species habitat.

10 Statement at 3.

11 Policy Statement, 88 FERC at 61,749-51.

12 Not all LNG import terminals that were licensed were actually built.  A number of licensed projects couldn't attract the commercial support and financing to go forward.

13 Statement at 4.

14 Policy Statement, 88 FERC at 61,743.

15 Statement at 5.

16 Section 1(b) of the NGA expressly excludes from the Commission's jurisdiction "the production or gathering of natural gas" at the upstream end of interstate pipelines and "the local distribution of natural gas" at the downstream end of such pipelines. 15 U.S.C. § 717(b).

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