D.C. Circuit Interprets Incentives for Natural Gas Storage Operators

The D.C. Circuit recently rejected an appeal that would have significantly expanded an incentive intended to spur the development of additional gas storage capacity.  The decision upholds a FERC interpretation and soundly preserves the contours of what was already a potentially generous exception to market regulation.

The Nebraska-based Northern Natural Gas Company had appealed a 2010 FERC interpretation of a provision from the Energy Policy Act of 2005.  That provision, 15 U.S.C. § 717c(f), authorizes FERC to allow a gas company to negotiate market-based rates for storage and storage-related services at facilities placed into service after August 8, 2005, even absent a showing that the company does not have market power, if the company satisfies two conditions.

First, the market-based rates must be in the public interest and “necessary to encourage the construction of storage capacity in the area needing storage services.”  Second, adequate measures must be taken to protect customers.

Northern Natural argued that facilities that have already qualified under Section 717c(f) and sold storage capacity at market-based rates should be able to resell at market-based rates once original contracts have expired.  In other words, a facility should qualify for Section 717c(f) in perpetuity rather than merely for the duration of its initial sales contracts.

This contention ignored the policy goal behind Section 717c(f) – encouraging companies to expand storage capacity – and treated the provision like a gateway to relatively unfettered market pricing.  As the D.C. Circuit asked: “How can a benefit be an incentive to specific conduct if the conduct has already occurred.”

The court did clarify that, if facilities change hands as the result of an event like bankruptcy or default, new owners can continue to charge market-based rates under replacement contracts that fill out the terms of original contracts.  And the court left open the possibility that if, after a facility has entered service, “(previously unforeseeable) circumstances” require its owner to make “heavy additional investment[s],” those investments could be eligible for market-based rates under Section 717c(f).

The section has been the subject of a previous FERC clarification and applied to several facilities in FERC orders but has not been litigated before.  The D.C. Circuit opinion does not transform the section into a more expansive regulatory but ensures that the section continues to provide a potentially attractive benefit.

In the time since the adoption of Section 717(c), nationwide storage capacity has increased considerably, probably due to many factors, including the shale revolution and the growing preference for gas generation over more environmentally harmful coal generation.

In 2005, as FERC was promulgating its implementing regulation, Chairman Joseph Kelliher justified the regulation by pointing to the inadequacy of storage capacity at that time: “Natural gas storage capacity has remained relatively static for many years while demand has increased sharply.  Since 1988, gas storage capacity has expanded only 1.4% while demand has risen 24%.  Significantly, the volatility of gas prices has risen sharply during this period.  One possible cause of greater volatility in gas prices is inadequate gas storage capacity.”  The National Petroleum Council had estimated that the United States and Canada would need to add 700 Bcf by 2025 to meet projected storage needs.

Compare this assessment to post-2005 developments: The Energy Information Administration estimates storage capacity in the U.S. increased 14 percent between April 2006 and April 2012 and another 3 percent between April 2011 and April 2012.

Some industry watchers worried this spring that aggressive gas production and a warmer-than-usual winter would strain storage facilities.  The Wall Street Journal even noted that limits on capacity could prompt the industry to reign in production.  Capacity proved sufficient this injection season and – barring a collision of factors like a blistering winter and spiking production – should prove so next season.

The true challenge lay further ahead, in ensuring that capacity supply keeps pace with demand as gas becomes an even bigger part of the energy economy.

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