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  • Emma J. Broming

Principles of Rate Making and Rate Design for Oil Pipelines

Emma J. Broming

Research Analyst Premier

Quantitative Consulting, Inc.


Shippers and pipeline owners frequently disagree over what a just and reasonable rate should be for petroleum pipeline shipments. These rates affect the bottom-line of both the pipeline and the shipper and as a result, both parties litigate frequently. Oil pipelines are critical to the transportation of petroleum products, which are consumed by virtually all Americans. According to the Association of Oil Pipelines, 71 percent of petroleum products on a ton mile basis were transported by pipeline in the United States in 2008.1 To ensure that shippers are charged just and reasonable rates and that the pipelines providing the services earn adequate returns, rates are regulated by both state (e.g., California Public Utilities Commission, CPUC) and federal (Federal Energy Regulatory Commission, FERC) agencies. Regulation is intended to prohibit shippers from being overcharged for service as well as to prevent pipelines from grossly over recovering their cost of providing service.

Section 1 (5) of the Interstate Commerce Act (ICA) requires oil pipeline rates to be just and reasonable.3 Establishing just and reasonable rates for oil pipelines requires two major steps: (1) rate making, which determines the cost of service or revenue requirement of the pipeline for cost-based rates or the use of an alternative rate making method such as market-based rates, and (2) rate design, which determines the actual rates to be charged through various methodologies, which depend on the rate making methodology employed. Although rates may be designed using a variety of methodologies including cost-based rates, market-based rates, and settlement-based rates, it is important to note that mixing rate making and rate design methodologies is not permitted by the FERC. A fundamental principle of rate design is that one set of ratepayers should not subsidize other ratepayers, and they should only be responsible for paying for the services (costs) that they consume. Because of the complexity of markets and oil pipeline operations, there is no single “one-size-fits-all” rate making and rate design methodology, and the appropriate methodology may change depending on market conditions. This paper will discuss the principles underlying petroleum pipeline regulation, the various applicable rate making methodologies, and the rate design mechanisms used to determine just and reasonable petroleum shipment rates.

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Principles of Rate Making and Rate Design for Oil Pipelines
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