Volume 9 number 4, April 2007 TAPS Tariffs: Throwing Good Money After Bad published April 13, 2007 Everybody knows: it's not smart to throw good money after bad. But state bureaucracy sometimes lives by different rules, as the House Resources Committee discovered March 5 when it met in Juneau to learn about a legal brief by the Federal Energy Regulatory Commission (FERC) staff that excoriated the Trans-Alaska Pipeline System (TAPS) owners. Independent shippers Anadarko and Tesoro (A/T)—joined on technical grounds by the State of Alaska—are asking FERC to reduce TAPS tariffs (shipping charges). In its Feb. 16 brief, the FERC staff sided with the shippers, describing TAPS owners' defense of their tariffs in terms such as "silly," "obfuscating," and contrary to FERC precedents. According to the FERC staff brief, the TAPS owners used everything but the kitchen sink and meaningful ratemaking data to justify their high tariffs. When it convened March 5 to learn more about the FERC staff brief, the House Resources Committee walked into the latest chapter of a drama that has been playing out since before TAPS began pumping oil. Since 1996, Tesoro, which ships and refines North Slope crude oil but doesn't produce any, has been fighting to reduce TAPS tariffs set under a controversial 1985 settlement between the TAPS owners and the state of Alaska. Tesoro scored a major victory in 2002 when the Regulatory Commission of Alaska (RCA) ordered TAPS owners to reduce TAPS tariffs for in-state shipments on TAPS. The RCA decision and order—a behemoth of 168 pages (plus more than 300 pages of backup) that culminated a six-year hearing process—found that a tariff of $1.96 per barrel would enable the TAPS owners to recover all costs and earn a reasonable profit on their investment. The RCA reaffirmed that tariff in four successive years and in 2006 a superior court decision upheld the commission "in all respects." The TAPS owners have carried their appeal of the RCA's decision to the state Supreme Court, where arguments were heard March 13. The RCA TAPS tariff order applies only to the 11 percent of TAPS oil destined for in-state use. The remaining 89 percent of TAPS oil is shipped Outside and is therefore regulated by FERC. For that oil, the TAPS owners continue to charge a significantly higher tariff under the terms of the 1985 settlement agreement. The TAPS Settlement Methodology (TSM) tariff has nearly doubled since 1997, from $2.72 per barrel to $5.10 per barrel. Most of the increase in the TSM tariff being challenged at FERC has occurred since the RCA's 2002 order. But it was not until 2005 that Tesoro, together with North Slope producer Anadarko, took their TAPS tariff complaints to FERC. TAPS tariffs have direct and significant impact on state revenue and petroleum development policy. Consider these three basic facts:
Conservatively reckoned, over the three decades of North Slope operation, RCA data indicate that TAPS tariff overcharges have allowed the industry to reduce its payments to the state by approximately $4.5 billion. At present, I estimate that state revenue is hemorrhaging $404 per minute (more than $500,000 per day), based on the difference between the RCA and FERC tariffs. Between 1997 and 2004, the difference between the TSM tariff and the tariff ordered by the RCA cost the state more than $700 million in reduced royalty and production tax payments. In the last three years, TAPS tariff overcharges have cost the state an additional $470 million (all figures in 2007 dollars). But the policy consequences of TAPS overcharges may be more important than the money: When it is generally agreed that the state wants more companies to come to the North Slope to explore for oil and gas, high TAPS tariffs constitute a barrier to development by new companies. With hundreds of millions of dollars and continued North Slope development riding on the outcome, the FERC staff brief is good news for Alaska. But the state, under the aegis of the Department of Law, is not articulating—and may not be aggressively pursuing—its best interests. When it comes to TAPS tariffs, this is nothing new. (See related article for discussion of the Department of Law's dubious performance on TAPS tariff issues and its checkered record accounting for that performance during the three decades of North Slope production.) But the March 5 hearing provided the 25th Alaska State Legislature the opportunity to observe first-hand how the state has managed (or mismanaged) TAPS tariffs issues for the past quarter century. As the TAPS owners have continued to increase their filed TAPS tariffs at FERC, the Department of Law has vacillated between protesting specific alleged overcharges and pretending that the state isn't really protesting. At the March 5 hearing, the Department of Law's case manager emphasized that the state's position was very different from that of the shippers. He said that he would leave it to the A/T lawyers, who were not parties to the 1985 settlement agreement, to make their own arguments regarding the tariff rates produced under that methodology. The state's case manager went to such great lengths to differentiate the state's position from that of the shipping companies that a momentarily confused Resources Committee Chairman Carl Gatto asked, "Then the state would not ask for refunds from past charges?" As the state case manager framed the situation, possible refunds were an artifact of an unexplained difference between the RCA's determination that a "just and reasonable" TAPS tariff was $1.96 per barrel, while the recent TSM tariff was more than twice that. According to the brief the Department of Law filed at FERC, the state's sole basis for supporting the lower RCA tariff was that these disparate tariffs constituted rate discrimination against shippers paying the higher rate and therefore violated the Interstate Commerce Act. In following this line of argument, the state seemed to be relying on an abstract ratemaking principle, a set of tenuous arguments, and the mysterious difference between the RCA and TSM tariffs to secure a better deal for the state. What the Department of Law did not tell legislators was that in each of the last four years, the state had protested the TAPS owners' inclusion of specific items in the tariff. For example, one alleged overcharge item listed in the state's 2006 tariff protest at FERC was the attempt by the pipeline owners to recover in the TSM (interstate) tariff the costs of fighting the reduced in-state rates. And in both 2005 and 2006 the state had protested alleged overcharges imprudently incurred on the TAPS strategic reconstruction engineering and construction program, whose estimated costs had reportedly doubled over initial estimates, from $250 million to $500 million. In prior years the state had occasionally challenged other items in the TSM tariff, usually for much smaller dollar amounts than the big-ticket items that produced the large 2007 tariff increase and the extraordinary gains to the TAPS owners and losses to shippers alleged by A/T. This background information raises two questions: (1) why were these alleged overcharges dropped from the 2005 and 2006 tariff protests? (2) Why would the Department of Law fail to disclose this information to state legislators? Because information about the state's original 2003–2006 protests were not discussed, this question was not asked or answered. In the absence of information about state overcharge allegations, the state's lawyers gave the impression that the state was merely riding opportunistically on a convoluted legal argument handed to the state by the TAPS shippers. The absence of the state's overcharge protests deprives the shippers of support for their case, which, if successful, would deliver significant revenue gains to the state. Instead, the state appears to be depending on an abstract legal argument that is convoluted, tenuous, and perhaps even fatally flawed. Three reasons for this disclosure failure come to mind. The first is simple oversight. The second is that the Department of Law may not have wanted the Legislature looking over its shoulder. But that's exactly what legislators are supposed to do when they hold fact-finding hearings. The third reason is that the Department of Law did not want to acknowledge publicly that it needed to wriggle out of a twenty-year-old legal straight-jacket in which it had placed itself when it negotiated the 1985 settlement. That agreement contains a clause obligating the state to cooperate, at its own expense, in defending against any litigation affecting the validity and enforceability of the agreement. Although the settlement agreement contains pages of legal definitions, the state’s obligation under this clause is not spelled out. But it is this clause that probably explains why state case manager Reeves went to such great lengths to dissociate the state from the shippers’ claims against the settlement agreement. And it might explain why the state, instead of challenging the TAPS owners on substantive grounds, focused its case brief solely on an abstract legal argument. Attesting to the fiscal importance of questions such as these, the Alaska Department of Revenue disclosed that it estimated that the outcome of the tariffs filed between 2005 and 2008 could mean more than $800 million to the Alaska state treasury. Perhaps because ADOR had combined known tariffs for 2005 through 2007 with an estimate of tariff overcharges for 2008, for which tariffs will not be filed for another eight months, the ADOR numbers were difficult to interpret. When Rep. Paul Seaton asked the department if they had anything in writing that would help the Legislature understand the basis for the $818 million estimate, Division Director Jon Iversen replied he did not have a written estimate ready because the department had only begun to work on an estimate that morning. (He provided a one-sheet summary shortly after the hearing.) The state's lawyers may not have seen fit to quantify their $800-million case prior to that morning, but one can be sure that their industry counterparts have carefully quantified the potential gains and losses riding on the outcome of this case. When legislators finally got around to asking about the sharply worded FERC staff brief that had initially grabbed their attention, they didn't get very far. Near the end of the hearing, Rep. David Guttenberg asked this important question, based on his reading of the FERC staff brief: Could charges reduced on the in-state tariff be put back into the tariff on the interstate side? If the FERC staff was correct and if this provision of the TSM were allowed to stand, that poison pill could nullify any state gains from a reduced intrastate tariff. Mr. Iversen deferred to the Department of Law's Reeves, the case manager. Silence on the teleconference line. Then a voice in the hearing room said, "He's gone." The state's case manager had left the hearing—reportedly to catch a plane—and the department had not arranged for a backstop to field questions about a case estimated to be worth up to $800 million to the state. In the Department of Law's absence, the question bounced back to the Revenue Department folks in Anchorage. They representatives of the state's economic shop repeated that they did not know the answer. While the fiscal implications of the case clearly warrant further attention, this fundamental question remains: Are the state's interests well served by an oil pipeline tariff policy that rides on the backs of the shippers instead of promoting their interests? Although the history of state TAPS tariff policy is littered with examples of withheld information and failure to pursue and attain state interests, the oil pipeline tariff issues raised here are based on current information and future considerations. The period for renegotiation of TAPS tariff terms quietly began January 1 of this year. In view of the estimated historical loss to the state treasury, this is not a problem the state can afford to bungle or continue to talk to death. If the state really wants to assure just and reasonable tariffs on TAPS that will encourage potential developers to come north to explore for oil and gas on the North Slope, oil pipeline case management requires immediate attention. To fund the Department of Law's feckless tariff maneuvers without conducting rigorous oversight and providing clear policy guidance is nothing more than throwing good money after bad. More on this topic can be found at www.finebergresearch.com.
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