Going With the Flow: Changes in the Directional Flow of Natural Gas Due to Increased Shale Gas Supply May Lead to Increased Fuel Charges for Pipeline Customers

            The shale natural gas boom has presented tremendous opportunities for the U.S. to compete in the global energy market.  The increased supply of natural gas boasts the potential for cleaner electricity generation, lower domestic fuel prices, increased job opportunities, and a seat for the U.S. at the table of global natural gas exporters.  When it comes down to the details that will drive the realization of this potential, we are in the beginning stages of developing policy that will have a very real impact on the natural gas and electricity providers doing business at either end of the nation’s extensive network of natural gas pipelines.  One issue that will garner more attention in the coming months is the change in the direction that natural gas has historically flowed as a result of the increased availability of gas in the Northern and Eastern regions of the country.  In our two-part series Going With the Flow, we will highlight several of the consequences that will flow from this shift.  In this post, we look at the traditional backhaul transportation of natural gas and impending policy changes surrounding the assessment of fuel charges against pipeline customers seeking to transport natural gas from the North to the South and the East to the West.  In our next post, we will discuss issues that have arisen due to the transportation of excess gas that exceeds optimal quality standards against the historical flow pattern, including the impact on electric generators at the receiving end of the higher quality gas.  The Federal Energy Regulatory Commission (“FERC”) recently considered these issues in dockets involving Texas Eastern Transmission, LP (“Texas Eastern”), which operates a pipeline system that runs from Texas and offshore Louisiana north into Philadelphia and New York.  These Texas Eastern proceedings foreshadow larger scale reversals in gas flow on other pipelines, which have the potential for a substantial financial impact on pipeline customers throughout the country.

Texas Eastern Pipeline from http://www.spectraenergy.com/Operations/US-Natural-Gas-Pipelines/Texas-Eastern-Transmission/

            Backhaul Transportation of Natural Gas:  Natural gas historically has flowed from the Gulf to the North, creating a paradigm in which gas flowing north is considered to flow “downstream.”  Under this historical paradigm, gas did not physically flow “upstream” in the reverse direction (north to south).  To transport gas from north to south, gas would be taken out upstream (in the South) and the same quantity of gas would be put back into the pipeline downstream (in the North).  This displacement of gas known as backhaul transportation also takes place in the transportation of gas from east to west on pipelines like Algonquin, which historically transport gas from west to east.  Because no gas physically flows in reverse during backhaul transportation, pipelines historically would not charge the shipper fuel costs, which are designed to cover the extra gas required to create enough pressure to move gas being transported.  This exemption from fuel charges for backhaul transactions is provided for by FERC regulations and in many cases a pipeline’s tariffs.

            The Paradigm Shift to Bi-Directional Gas Flows:  The increased supply of natural gas in the North, generated largely through fracking in the Marcellus Shale, has led to more and more gas entering pipelines from the North.  On certain pipelines, like Texas Eastern, this results in gas actually flowing both downstream and upstream.  What historically was a backhaul transaction to send gas upstream from north to south through displacement, is now a true reverse-flow transaction in some cases.  The question then arises – what, if any, fuel charges should pipelines now assess for upstream gas transportation?

            Developing Policy on Fuel Charges: The optimal answer for shippers of natural gas would be that backhaul transactions conducted through displacement should continue to be exempted from fuel charges, while true reverse-flow transactions that use fuel arguably could be assessed a fuel charge like traditional downstream transactions.  Texas Eastern has posed the question to FERC and the July 18, 2013 FERC Texas Eastern Order (Docket RP13-237-000) is an indication that natural gas shippers should prepare themselves for the possibility of less than optimal policy on this issue.  In November 2012, Texas Eastern filed a revision to its tariff proposing that it no longer treat any transportation transactions in its Access Area as backhauls exempt from fuel charges, since it was experiencing bi-directional flows of natural gas.  Texas Eastern historically treated all north to south transactions in its Access Area as backhauls that were exempt from fuel charges.  According to the FERC Order, Texas Eastern submitted:

significant new sources of supply have emerged, particularly in the Marcellus Shale area, which is located in the Market Area of Texas Eastern’s system.  Texas Eastern claimed these new supply sources have precipitated a material shift in customer sourcing patterns across its system.  According to Texas Eastern, these shifts in nomination patterns for gas sourced in, or moving into, the Access Area have rendered customer-nominated flows that are counter to historical flows in the Access Area as likely to occur as customer-nominated flows in the same direction as historical flows.  Texas Eastern thus argued that because it is no longer feasible under these circumstances to make case-by-case determinations of actual flows in order to establish which individual transactions should be assessed fuel, it would assess a fuel charge on all transactions in the Access Area.

FERC held a technical conference on the proposed tariff revision in January, 2013. Texas Eastern’s proposal was met with opposition on the grounds that assessing fuel charges for transactions that have historically been characterized as backhaul transportation had not been shown to be just and reasonable.

            In considering Texas Eastern’s proposed tariff revision, FERC started with a baseline premise that may prove to be an obstacle to pipeline customers opposing the imposition of fuel charges in similar proceedings: “[b]ecause the presumption is that all transactions consume fuel, pipelines are not required to demonstrate that specific transactions consume fuel.”  The Commission explained that it has allowed pipelines to exempt backhaul transactions from fuel charges only because no fuel is used in those transactions and all transportation service transactions should be assessed a fuel charge unless the pipeline can demonstrate that transactions do not consume fuel.  From this standpoint, it was enough for FERC that “Texas Eastern has demonstrated that it is experiencing bi-directional flows in its Access Area to the extent that it is no longer feasible for it to ascertain whether certain individual transactions consist solely of backhaul transportation, which would thus qualify for an ASA of zero under its tariff.”  FERC held that because “Texas Eastern can no longer demonstrate that any transactions in the Access Area are accomplished solely by backhaul transportation, Commission policy and Texas Eastern’s tariff require it to assess a fuel charge on all transactions in the Access Area.”

            Despite objections, FERC also found that it is just and reasonable to assess a fuel charge on all upstream transactions even though the pipeline may experience true reverse flows only periodically and therefore consume fuel only on certain days. FERC reasoned “the fuel used for transportation and other services on a pipeline benefits all the pipeline’s shippers, even those who rely on backhaul deliveries, because a pipeline cannot physically deliver gas by displacement absent a corresponding forward haul.” Therefore, it is just and reasonable to assess a fuel charge on transportation flows that use fuel on some days but not on others.  FERC concluded that Texas Eastern’s “proposal to assess fuel on all transactions it cannot now demonstrate are purely backhauls would not subsidize one set of shippers to the detriment of another.”

            The Potential Moving Forward: The nation’s network of natural gas pipelines is extensive. And the Texas Eastern docket is just the tip of the iceberg in the filing of similar tariff revisions.  On the same day it issued its Texas Eastern Order, FERC issued an Order in a similar proceeding involving the Algonquin pipeline (Docket No. RP13-1040-000) requiring a hearing on “whether Algonquin’s tariff provisions concerning fuel-exemptions are unjust, unreasonable, or otherwise unlawful” with respect to the potential imposition of fuel charges on backhaul transactions (in that case from east to west).  On August 15, 2013, the Administrative Law Judge in the Algonquin matter issued a Scheduling Order which set forth the schedule for the proceedings and May 7, 2014 hearing.

Most recent map of U.S. network of pipelines available at http://www.eia.gov/pub/oil_gas/natural_gas/analysis_publications/ngpipeline/ngpipelines_map.html

            FERC’s Texas Eastern decision established a low threshold for imposing fuel charges on traditional backhaul transactions – that the pipeline need only demonstrate that it is experiencing bi-directional flows in the Access Area.  However, the Commission’s conclusion to assess fuel charges on all contract paths based upon such a showing arguably is overly broad and may result in unjust and unreasonable results.   While natural gas shippers should be aware of the possibility that fuel charges may be assessed for all upstream transactions, regardless of whether they are backhauls, they should be equally anticipative of their ability to shape developing policy in this area. Each pipeline’s particular tariff regarding fuel assessment may impact FERC’s analysis of the issue, and the facts of each proceeding may vary.  These future proceedings present pipeline customers the opportunity to intervene, to successfully challenge the imposition of fuel charges on backhaul transactions and to propose alternatives to the all-or-nothing approach that FERC took in the Texas Eastern docket.  We will be watching developments in this area and will keep you posted.