Jet Fuel: From
Well to Wing
JANUARY 2018
Abstract
Airlines for America (A4A) is the nation’s oldest and largest U.S. airline industry trade association. Its members
1
and their
affiliates account for more than 70 percent of the passenger and cargo traffic carried by U.S. airlines. According to the
Energy Information Administration, U.S.-based jet fuel demand averaged 1.6 million barrels per day in 2016. Generally, fuel
is supplied to airports through a combination of interstate multiproduct pipelines, third-party and off-airport terminals, and
dedicated local pipelines. The last few years have continued to demonstrate the fragility of this complex system and the
threat it poses to air-service continuity.
The current interstate refined products pipeline system, constructed many decades ago, is both capacity-constrained
and vulnerable to disruptions that typically require a patchwork of costly, inadequate fixes. New shippers have difficulty
obtaining line space and long-established shippers have difficulty shipping all of their requirements. It is likely that demand
will continue to outpace the capacity of our outdated distribution system for liquid fuels.
Given the increasing demand to transport liquid fuels, it is imperative that we take steps to overcome existing bottlenecks
and prevent future ones. These fuels are essential to aviation, trucking and rail, among others, which help power our twenty-
first century economy. As shippers and consumers of significant quantities of refined products on pipelines throughout the
country, airlines and other users of liquid fuels have a substantial interest in addressing the nationwide deficiency in pipeline
investment.
1 Alaska Airlines, Inc.; American Airlines Group Inc.; Atlas Air, Inc.; Federal Express Corporation; Hawaiian Airlines; JetBlue Airways Corp.; Southwest Airlines Co.; United Continental Holdings, Inc.; and
United Parcel Service Co. Air Canada is an associate member.
Surely, expedited permitting for fuel distribution-related infrastructure projects could help pave the
way to upgrade existing pipeline assets and expand throughput capacity into key markets. But this
deficiency is largely tied to a ratemaking system that lacks both transparency and effective regulatory
oversight, resulting in a lack of incentives for pipelines to upgrade or expand their existing networks.
Accordingly, A4A calls on the Federal Energy Regulatory Commission
(FERC) to increase the transparency of pipeline data submissions,
strengthen oversight of over-recoveries and excessive returns and
recognize fuel shippers and consumers as key constituents.
3
I. Introduction
• Jet Fuel Pricing
• Refining and Distribution
• Fuel Efficiency and Environmental Performance
II. Fuel Supply Risk
• Primary Types of Supply-Chain Risk
• Operational Remedies
• Pipeline Capacity Constraints
III. Pipeline Economic Oversight
• Increase Transparency of Pipeline Data Submissions to FERC
• Strengthen Oversight of Over-recoveries and Excessive Returns
• Recognize Fuel Shippers and Consumers as Key Constituents
IV. Conclusion
Appendix A. Economic Oversight of Pipelines and Ratemaking Methodology
Appendix B. Case Studies in Pipeline Regulation and Infrastructure Development
• The Wrong Incentives Are in Place
• Excessive Returns on Existing Capital Base Discourage Investment
• Critical Infrastructure Has Been Carved Out From FERC Oversight
• Addressing Excessive Recoveries Encourages Investment
Contents
4
Jet Fuel Pricing
The price of jet fuel is linked to the commodities markets
principally through ultra-low sulfur diesel (ULSD), a
refined product that is similar in consistency and traded
on public exchanges. The price of ULSD is highly
correlated to the price of jet fuel and therefore is oen
used as a reference point for supply contracts. In addition
to the ULSD market, other factors impacting the price
of jet fuel may include: inventory levels; transportation
costs; refinery dynamics; environmental regulations;
surges in regional demand; seasonality; and supply
disruptions caused by natural disasters, military conflict
or geopolitical events.
Just as motorists pay different prices for gasoline in
different parts of the country, airlines pay different prices
regionally for jet fuel. Generally the Gulf Coast has the
lowest prices in the country as the region produces more
than it needs. Other areas trade at a premium that mostly
represents the transportation costs from the Gulf Coast.
However, the premium in some regions is higher than
this as pipelines don’t exist or do not have adequate
capacity to meet demand. Although the United States
has become a net exporter of jet fuel, the West Coast,
Florida, and the northeast typically require imports due
to expensive domestic freight options.
Introduction
In 2016, U.S. passenger and cargo airlines consumed more than 19 billion gallons of jet fuel, powering
some 27,000 daily flights carrying 2.2 million passengers and 50,000 tons of cargo across
hundreds of airports worldwide. Globally, airlines consumed 81 billion gallons of jet fuel.
2
According
to the Energy Information Administration, U.S.-based jet fuel demand averaged 1.6 million barrels per
day in 2016.
3
2 http://www.iata.org/publications/economics/Pages/industry-performance.aspx
3 http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MKJUPUS2&f=M
4 Hedging requires a willing counterparty and, at times, a sizable upfront transaction cost. An airline also must consider whether it could find itself at a competitive disadvantage if its competitors have not
hedged and the energy market price drops below what it has agreed to pay in a hedge contract.
Air carriers buy fuel from multiple suppliers at differing
rates and in different locations. Not every supplier
operates at every domestic airport that a carrier may
serve, so multiple arrangements are necessary, including
transporting fuel from a market center to the airport.
Historically, the price of jet fuel has been very volatile,
and due to the airline industry’s dependence on fuel,
the industry is particularly susceptible to fuel price risk.
An airline may choose to hedge a portion of its jet fuel
requirements to mitigate financial uncertainty caused by
pricing volatility.
4
5
At the refinery, crude oil is separated into usable petroleum products, including gasoline, distillates such as diesel and
jet fuel, petrochemical feedstocks, waxes, lubricating oils and asphalt. Jet fuel represents less than 10 percent of U.S.
refinery yield, but could be as much as 25 percent at a specific refinery depending on its configuration and source of
feedstock.
5
Specifically, commercial aviation turbine fuel used in the United States is a kerosene-based product meeting
the requirements of the applicable ASTM International specification (e.g., composition, volatility, fluidity, combustion,
corrosion, thermal stability, contaminants, additives).
6
5 https://www.eia.gov/Energyexplained/index.cfm?page=oil_refining
6 https://www.astm.org/Standards/D1655.htm; other standards may apply outside the United States
Note: A 42-gallon (U.S.) barrel of crude oil yields about 45 gallons of petroleum products because of refinery processing gain.
Source: U.S. Energy Information Administration
Refining and Distribution
PRODUCTS MADE FROM A BARREL OF
CRUDE OIL IN THE UNITED STATES, 2016
6
From the refinery, jet fuel typically travels by pipeline or oceangoing vessel to storage terminals, from which it is further
transported by truck, barge or pipeline to airports. From the airport storage tanks, fuel is distributed to aircra via truck or
via an underground hydrant system that carries fuel to the airport apron, where hoses span the final distance to the wing of
the airplane.
JET FUEL SUPPLY CHAIN
7
With demand to transport refined products such as gasoline, diesel and jet fuel on the rise,
steps must be taken to avoid bottlenecks. These fuels are essential to aviation, trucking and rail,
among others, which help power our twenty-first century economy. Expedited permitting and/
or a streamlined approval process for related infrastructure projects could help pave the way to
upgrade existing pipeline assets and expand throughput capacity into key markets.
MAJOR U.S. REFINED PRODUCTS
PIPELINES CARRYING JET FUEL
8
Simply put, environmental excellence and sustainability
are a vital part of the airlines’ business model. Even as the
number of passengers has tripled since the mid-1970s,
U.S. airlines have improved fuel efficiency by
120%
and reduced aircra noise exposure by
95%
They have achieved this level of environmental
performance by relentlessly pursuing and implementing
technological, operational and infrastructure-related
measures to minimize environmental impacts.
With the price of jet fuel significantly impacting route
profitability, airlines constantly strive to improve jet fuel
efficiency. Fuel conservation measures include reducing
and more accurately measuring onboard weight,
cruising longer at higher altitudes, employing greater
use of flight-management systems, and conducting more
in-depth analyses of weather conditions. In addition,
airlines are modernizing their fleets and investing in
drag-reducing winglets.
7
Use of twenty-first century
satellite-based navigation systems to direct
aircraft, across the globe, is also a critical means of
minimizing fuel burn for airline flight operations.
7 https://en.wikipedia.org/wiki/Wingtip_device, https://www.grc.nasa.gov/www/k-12/airplane/winglets.html
8 Domestic transportation only, from “Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2015,” Table A-116, U.S. Environmental Protection Agency
The most recent data available from the U.S.
Environmental Protection Agency (EPA) shows that less
than 2 percent of domestic greenhouse gas (“GHG”)
emissions is attributable to commercial aviation and the
sector exhibits much lower growth from 1990 levels (8
percent) — and from a much smaller base — compared
to the transportation sector (16 percent) and on-road
sources in particular (23 percent).
8
Lastly, through the International Civil Aviation
Organization’s Committee on Aviation Environmental
Protection, A4A and its member airlines continue to
support the development of economically reasonable,
technologically feasible international aircra-and-engine
standards governing noise, oxides of nitrogen (NOx),
particulate matter (PM) and carbon dioxide (CO
2
).
As a result of the successive, increasingly stringent NOx
standards, aircra engines produced today must be about
50%
cleaner
than under the initial standard adopted in 1997.
Fuel Efficiency and Environmental Performance
9
Fuel Supply Risk
Given the 24/7 nature of flight operations, the continuity of air service is highly dependent on an
uninterrupted supply of on-time, on-specification jet fuel at large, medium and small airports around the
world. Passengers and shippers depend on our industry for global connectivity, and the airlines in turn
depend on a fragile supply chain.
Primary Types of Supply-Chain Risk
Airports may experience disruptions on-airport and off-airport. While an on-airport disruption can have an immediate
impact because it may prevent the airlines from accessing their stored fuel, the exposure is low since most issues can be
controlled. The primary off-airport threats to fuel supply are 1) loss of use of a fuel terminal or pipeline that feeds the airport
and 2) systemic unavailability of fuel caused by the catastrophic loss of refining capacity as a result of natural disasters or
geopolitical shocks.
PHYSICAL CONSTRAINTS
The last few years have continued to demonstrate the
fragility of this complex system and the threat it poses to
air-service continuity. For example, pipeline explosions
caused stoppages that threatened to shut down airports
that were dangerously close to running out of fuel.
Another fuel supply chain risk involves product terminals,
where scarcity of storage oen leads to cancellation of
fuel shipments – placing airports in a precarious fuel
shortage situation.
THIRD-PARTY ARRANGEMENTS
Additionally, bulk fuel supplies can be sourced from
intermediary fuel purchasers or directly from refiners.
Intermediary fuel suppliers purchase fuel from refiners
and can be responsible for the transport of fuel to the
airport where it is then purchased by the airline. These
third-party arrangements eliminate the airline’s burden
to secure transportation and quality control of the fuel.
However, the lack of direct control of the supply chain
oen leaves the airlines in the dark when disruptions
occur.
To mitigate the risk of supply chain disruptions,
whenever practicable, many airlines source fuel directly
from the refinery, take title of the fuel at the refinery gate
and ship it to where it is needed, therefore omitting third
parties. Having direct access to capacity on pipelines
is an important fuel-disruption mitigation strategy; for
example, if a pipeline goes off-line, the airline receives
direct notification of a potential problem, allowing the
longest possible time to react. However, this can also be
expensive since all costs to redirect the fuel are typically
borne by the shipping airline.
10
In the event of an off-airport fuel disruption, the airline industry responds quickly to ensure minimal impact on flight
operations. Impacted suppliers and airlines will first seek alternate supply. If alternate supply cannot be acquired, each
airline serving the affected airport would have to consider the following options:
Tankering can be a very effective means of supplementing inventory and alternative supplies. However, it is expensive and
environmentally inefficient to carry more fuel than otherwise needed to reach the destination. Accordingly, airlines strive to
avoid operational tankering whenever possible.
9 See http://www.maritimelawcenter.com/html/the_jones_act.html and https://www.marad.dot.gov/ships-and-shipping/domestic-shipping/
When pipeline operations are disrupted,
alternative means of transporting jet fuel to
airports are generally inadequate. Oceangoing
vessels or barges have finite capacity and require
airports to be located near a waterway. Additionally,
the Jones Act
9
requires that those vessels be U.S.-built,
-owned and -operated to ship fuel within the United
States, further limiting the volume of fuel that can be
transported over the water, and are dependent on
terminals that cannot easily handle additional volumes
of jet fuel on short notice unless already serving the jet
market.
Trucks are another mode of delivering fuel to airports;
however, the relatively small volumes a truck can carry
require an unreasonably large number of trucks to supply
major airports. There are neither enough fuel trucks
to supply the needed volumes of fuel to U.S. airports
nor capacity at airports to unload them. Finally, there
is transportation by rail; while rail can offer sufficient
volumes, the U.S. rail infrastructure and the available rail
cars for transporting jet fuel are not sufficient to meet the
airline industry need. In short, operational remedies are
extremely limited and costly.
Technical Stops
Stopping at an intermediate
airport to refuel
Tankering
Carrying extra fuel on
inbound aircra to reduce
the amount needed at the
affected airport
Schedule Reductions
Canceling flights and
rerouting passengers
through other airports
Operational Remedies
11
Pipeline Capacity Constraints
10 https://www.eia.gov/dnav/pet/pet_cons_psup_dc_nus_mbblpd_a.htm and https://www.eia.gov/analysis/projection-data.cfm#annualproj
11 https://www.faa.gov/data_research/aviation/
As indicated above, the airline industry — and the
air travelers and shippers who rely on it — is heavily
dependent on interstate pipelines to deliver jet fuel for
daily operations. Ensuring a reliable supply of jet fuel
at the nation’s commercial airports is a critical element
of reliable, cost-effective flight operations and is
inextricably tied to the logistics and costs of transporting
jet fuel across pipelines.
Jet-fuel demand in the United States — driven by U.S. and
foreign airlines, business aviation and military aviation
— has grown substantially over the past few decades.
Although significant fuel-efficiency gains slowed the
rate of consumption growth from 2000 to 2016, the
underlying economic demand for air travel and shipping
have boosted daily U.S. jet-fuel demand to a level more
than double what it was just four decades earlier, when
multiproduct pipelines were relatively new on the scene.
The vast majority of this fuel is disseminated to airports via
pipeline, but many major pipelines are already shipping
the maximum amount of fuel that their system’s physical
constraints allow. Today, new shippers can have difficulty
obtaining line space and long-established shippers have
difficulty shipping all of their requirements.
The Federal Aviation Administration
expects passenger traffic to grow
2.5%
annually over the next 20 years and
cargo traffic to grow
2.8%
annually.
11
It is thus quite likely that demand will continue to outpace
the capacity of our outdated pipeline distribution system.
Daily Jet Fuel Consumption in the United States
10
12
WEST COAST
• Kinder Morgan Pipeline to San Francisco is limited
to existing infrastructure under San Francisco Bay;
installing a new pipe is essential to future growth at
the airport
• Olympic Pipeline is at full capacity; to Portland,
Seattle and Vancouver
• Kinder Morgan Pipeline capacity to San Diego is
barely adequate for current needs, restricting future
growth; although the pipeline could alter the delivery
schedule, they choose not to due to concerns for
other shippers
• Shippers in Phoenix are oen limited, seemingly at
random, with respect to the amount of jet fuel they
can send via pipeline
MID-CONTINENT
• Explorer Pipeline is at full capacity north of Tulsa,
Oklahoma, most months at all destinations except
Wood River, Illinois; Explorer chooses to allow jet fuel
shipments only every other cycle
• Badger Pipeline to Chicago has been at full capacity
most months except winter
• Buckeye Pipeline has been at full capacity every
month to Indianapolis and Pittsburgh
• Enterprise Pipeline stopped shipping jet fuel to
Chicago
EAST COAST
• Plantation Pipeline is at full capacity to the
Washington, DC area, forcing some users to buy half
their volume from resellers and opportunistic sellers
exploiting the market
• Colonial Pipeline’s main line and several spur lines are
at full capacity
• Buckeye Pipeline to New York City airports is
periodically at full capacity
• Florida is disconnected from U.S. pipeline
infrastructure and wholly reliant on waterborne imports
The current interstate pipeline system, constructed many decades ago, cannot meet current demand and is vulnerable to
disruptions. Following are selected issues across the country:
Pipeline
Economic
Oversight
Per the Interstate Commerce Act (ICA),
12
as natural
monopolies,
13
interstate pipelines are regulated by
the Federal Energy Regulatory Commission (“the
Commission” or FERC), which in turn has a statutory
responsibility to ensure that rates are “just and
reasonable.”
14
As shippers and consumers of significant
quantities of jet fuel on pipelines throughout the
country, airlines have a substantial interest in ensuring
that pipeline tariffs are derived and maintained on a just
and reasonable basis and in a manner that is not unduly
discriminatory or preferential.
13
Moving jet fuel from the Gulf Coast to the Midwest costs
nearly $2.50 per barrel, a 72 percent increase over
the past 10 years. Even before the products are moved
on those pipelines there are costs associated with the
movement of crude oil to the refineries – a cost passed-
on to end users.
The pipeline industry has consolidated substantially since
1995 when the Commission began allowing automatic
index-based rate increases and market-based rates,
but there has been no systematic review of individual
carrier rates and costs. Meanwhile, the cumulative index
increase from 1995 to 2017 exceeded 80 percent.
During this period pipelines have consistently reported
excessive returns on existing assets. A4A considers a
pipeline company’s annual return to be “excessive”
or reflecting an “over-recovery” when it reports to the
Commission total interstate operating revenues greater
than total cost of service (which cost of service already
includes an allowed return). To address this issue, if any
pipeline has an “excessive” return or an “over-recovery”
exceeding 7.5 percent for two consecutive years, the
Commission should require the company to show cause
as to why its rates are just and reasonable.
15
Perversely, because the current regulatory framework —
now in place for more than two decades — effectively
allows pipeline owners to systematically charge rates that
over-recover costs on existing assets, they have little,
if any, incentive to invest in expansion and/or upgrade
of existing interstate pipeline networks. The pipeline
perspective is that such projects or investments dilute
the return from existing pipeline assets, making new
investments comparatively unattractive. This is another
reason why a systematic review of pipeline rates and
costs and a show cause process are needed. These
disincentives would be eliminated if the Commission
addressed the “over-recoveries” that exist under a
structure that has been in place for more than two
decades.
It is in the interest of all consumers of liquid fuels —
including the flying, driving and shipping public —
for the Commission to increase the transparency of
pipeline filings, tariffs and rate-making processes. Such
transparency is especially critical within a regulatory
framework that relies almost exclusively on the shippers
to police pipeline rates and initiate administrative actions
to ensure that rates and services are provided on a just
and reasonable basis. But consumers of gasoline, diesel,
propane and home heating oil, for example, typically
lack the resources to monitor and contest pipeline rates
and services, so airlines are in the forefront of policing
them.
Further, the pipeline’s routine excess recoveries distort
market forces and create barriers — not incentives — to
needed infrastructure investment. Additional and more
transparent information will enable effective regulation of
the nation’s interstate pipelines and promote investment
in the infrastructure required to support a thriving,
efficient pipeline industry and a thriving, affordable
commercial aviation system. For more detail on pipeline
regulatory issues, see Appendix A.
Congress and or/federal agencies could take the
following steps to improve the reliability of our nation’s
jet-fuel supply: establish incentives to increase refined
product pipeline capacity, increase the transparency of
pipeline data submissions to regulators, and increase
oversight of pipeline over-recoveries and excessive
returns.
12 See ICA sections 1(4) and 1(5) and https://www.ferc.gov/industries/oil/indus-act/handbooks/volume-III/8.pdf
13 Per “Regulation of Natural Monopoly” (Ben W.F. Depoorter, Center for Advanced Studies in Law and Economics, University of Ghent, Faculty of Law): “Under perfect competition prices of goods equal
marginal cost, as firms engage in a competitive bidding process. Under conditions of monopoly, the profit-maximizing behavior of the incumbent firm will lead to a higher price charged to consumers and a
lower output. It enables the seller to capture much of the value that would otherwise be attained by consumers. Monopoly pricing thus results in a wealth transfer from consumers of a product to the seller.”
14 Ibid. “Allowing regulated firms to acquire a total sum that consist of annual expenditure plus a reasonable profit on capital investment, the so-called ‘fair’ rate of return, was constructed by American
courts and the regulating bodies in order to meet constitutional demands of utilities to set prices on a ‘just and reasonable’ level.”
15 See Joint comments of Airlines for America, National Propane Gas Association and Valero Marketing and Supply Company and Affidavit of Daniel S. Arthur, Principal of The Brattle Group, Docket No.
RM17-1-000, “Revisions to Indexing Policies and Page 700 of FERC Form No. 6” (Jan. 19, 2017)
14
15
As noted above, under the ICA the Commission is responsible for regulating the rates, terms and conditions
that oil pipelines charge for interstate transportation. The ICA prohibits oil pipelines from charging rates that
are unjust and unreasonable and permits shippers and the Commission to challenge both pre-existing and
newly filed rates. To assist in the administration of its jurisdictional responsibilities, the ICA authorizes the
Commission to prescribe annual or other periodic reports. Through Form 6, the Commission collects annual
financial information from crude and refined product pipelines subject to the Commission’s jurisdiction.
Page 700 (Annual Report of Oil Pipeline Companies) of Form 6 provides a simplified presentation of an oil
pipeline’s jurisdictional cost-of-service and serves as a preliminary screening tool to evaluate oil pipeline
rates. To increase the transparency of pipeline data submissions, the Commission should take the following
two actions:
Increase the Transparency of Pipeline Data Submissions to FERC
2
Require pipelines to make available to shippers (upon
request) work papers that fully support the data
reported on Form 6, Page 700, including the total
cost-of-service calculations. Despite shipper requests,
the Commission recently declined to make Page 700
work papers available to shippers when revising its
Page 700 reporting rules, meaning that pipelines are
still only required to make this information available
to Commission staff on a confidential basis. Without
access to these work papers, shippers cannot verify the
information reported on Page 700 or determine whether
accounting and allocation gimmicks have obscured the
pipeline’s true cost of service.
1
Require pipelines to file separate financial and rate data
(i.e., data on Page 700) if they have (a) both crude oil
and petroleum product systems, and/or (b) multiple
established and unrelated recognized segments
within a crude oil or petroleum product system which
correspond to how a pipeline’s rates are established or
designed. In addition to enhancing transparency and
preventing cross-subsidization, requiring pipelines to
disaggregate costs and revenues by pipeline, system or
distinct segment will ensure that Form 6 requirements
are internally consistent. Specifically, this change would
conform the reporting requirements for total cost,
revenue and throughput information to the practice of
requiring pipelines to segregate information on carrier
property, depreciation rates and crude-oil and product
movements. Additionally, this change should require
that pipelines with market-based and nonmarket-based
rates provide separate Page 700s for each set of rates
in order for shippers and the Commission to determine
whether there is any cross-subsidization.
16
Strengthen Regulatory
Oversight of Over-Recoveries
and Excessive Returns
As in the natural gas industry, the Commission should
require pipelines showing over-recoveries or excessive
returns on their Form 6 to show cause why their rates
should not be considered unjust and unreasonable.
For many years, dozens of pipelines that have filed for
index rate increases reported cost over-recoveries or
excessive returns on their Form 6 annual/quarterly
reports. And, a number of other companies that did
not file for an index adjustment, or which maintain
market-based rates, are reporting cost over-recoveries
or excessive returns. This is a clear signal that the rates
are excessive, or market-rates are ill-defined, and
warrant investigation. Under circumstances like these,
the Commission should exercise its authority under the
Interstate Commerce Act to require pipelines to show
cause why their rates should not be found unjust and
unreasonable. The Commission should do this on its
own and not require shippers to file review petitions
or complaints.
Also, the Commission should require pipelines to
file a complete Form 6 before they file for an index
rate increase. In the past, pipelines who “qualified”
for automatic index rate increases did not file or filed
incomplete annual reports. Further, the Commission
should revise the FERC interest rate for refunds and
reparations as provided in 18 CFR §340.1(c)(2)(i) to
reflect, at a minimum, the pipeline’s rate of return (i.e.,
weighted average cost of capital) as reported on Form 6,
Page 700 [or preferably a rate that reflects the shipper’s
cost of capital, almost certainly higher than the pipeline’s
cost of capital]. Otherwise, the pipeline will continue to
be rewarded for charging unreasonable rates and for
delaying final Commission action by all means available.
Finally, the Commission should monitor the rates
charged by pipelines with market-based rate authority
to ensure these rates remain within a just and reasonable
range. The Commission grants pipelines the authority
to charge market-based rates on the theory that,
where there are sufficient alternatives to the services
provided by a pipeline, competitive forces will restrict
the pipeline’s ability to increase its rates above just and
reasonable levels. But because the nature and effect
of competition within a market cannot be predicted in
advance with perfect accuracy, it is important to continue
to monitor market-based rates to ensure that the market
forces are having the effect the Commission expected
when it allowed the pipeline to charge market-based
rates. In the absence of such regular oversight and cost-
based regulations, pipelines may increase their rates far
above just and reasonable levels. These increases are
particularly problematic as a pipeline with market power
has the incentive to under-develop or restrict capacity in
order to sustain higher rates. In addition, the Commission
has not clarified the reparations available to shippers
associated with the significantly higher burden imposed
by filing a complaint against market-based rates.
17
Recent positions by FERC stating that it will not review the reasonableness of committed shipper rates on oil pipelines and
the Commission’s method for evaluating whether oil pipelines possess market power provide another incentive for oil
pipelines to under-develop capacity and maintain or create capacity constraints. First, because airlines are supply-sensitive,
restrained capacity induces airlines to enter into committed shipper contracts to ensure a reliable supply of jet fuel. Because
the rates associated with committed shipper contracts will not be reviewed by FERC, and the shippers entering into the
contracts are bound to support the rates, the pipeline is incentivized to limit capacity expansion to a level less than it would
in a competitive market because the pipeline can capture higher committed rates. Second, if a pipeline is applying for
market-based rates, or has market-based rates, the Commission’s approach to used alternatives also incentivizes pipelines
to limit capacity development. In this case, if the applicant pipeline is constrained, shippers are likely to use less attractive
alternatives as well as the applicant pipeline. The Commission has in the past presumed that “used” alternatives are always
competitive alternatives to the pipeline even though, in reality, there are many instances in which such alternatives would
not be used if adequate pipeline capacity were available. It has also fallen into the “Cellophane Fallacy” of equating the
competitive price in a market with the highest cost of any “used” alternative. While the Commission has recently recognized
some flaws in this reasoning – including that the Supreme Court has expressly warned agencies not to fall into the
“Cellophane Fallacy” – it still has not fully reconciled its past precedents, and the potential for future erroneous decisions on
market-based rate applications remains.
To ensure adequate investment in our pipeline
infrastructure and fair costs for shippers, the Commission
needs to be proactive on issues affecting airlines and
other shippers/consumers. It should expedite review of
pipeline rates where over-recoveries or excessive returns
persist and, like the Commission’s policy with respect
to complaints against rates charged by natural-gas
pipelines, it should treat all complaints against oil and
product pipeline rates on an expedited basis.
The Commission also should use its oversight jurisdiction
to determine whether pipelines have improperly
disaggregated certain pipeline transportation in
functions such as terminaling and storage to generate
significant additional revenues to the detriment of
shippers/consumers. Overall, the Commission should
factor into its actions the reality that many shippers and
consumers, as a practical matter, simply are not capable
of monitoring and challenging rates, and recognize that
middlemen do not adequately protect most consumers.
Importantly, the Commission should focus on terms and
conditions of service that affect the airlines and other
shippers/consumers. It is critical that the Commission
recognize the real operational and financial impact that
these issues have on airlines, as well as on the customers
and communities they serve.
Recognize Fuel Shippers
and Consumers as Key
Constituents
18
Conclusion
Jet Fuel Infrastructure
Is Essential for Safe,
Reliable and Cost-Effective
Commerce
Pipelines play a critical role in supplying our nation’s jet
fuel and ensuring air service — for passengers and cargo
— to small and large communities. Unfortunately, our
national pipeline system today is fragile. It lacks adequate
capacity for future growth to efficiently transport critical
fuels around the country and address the nation’s
increasing demands. Shippers, including airlines and
their suppliers, among others, continue to pay more, in
the form of higher tariffs, while receiving less in the form
of transparency, quality data, timeliness and security
of supply.
In the highly competitive airline industry, we depend on
regulators to ensure that cost inputs for critical and finite
resources are just and reasonable. Given the fact that fuel
is among the airline industry’s largest expenses (along
with employee wages and benefits) and that the U.S.
air-service network is so dependent on pipelines, the
actions and inactions of the Federal Energy Regulatory
Commission have a significant impact on the airlines’
everyday business.
The Majority of Pipelines
Are True Monopolies and
Should Not Be Subject to
“Market Based Rates”
The Commission today has an opportunity to recognize
and adapt to the substantial consolidation in the pipeline
industry that has occurred since the 1995 inception of
19
indexing rules. Pipelines have consistently reported
excessive returns on existing assets and yet there has
been no systematic review of individual rates and
services. Further, since 1995 pipelines have removed
many assets and services from their FERC jurisdictional
rates and drastically increased the costs for use of those
assets and services, with little or no review.
Accordingly, in the interest of the flying and shipping
public and all consumers of liquid fuels, Airlines for
America calls on FERC to increase pipeline oversight to
eliminate and prevent over-recoveries and excessive
returns. It also should increase the transparency of
pipeline data submissions and recognize the airlines and
other shippers/consumers as key constituents.
Pipelines Are the Safest,
Most Efficient Mode of
Transporting Liquid Fuels
16
As set forth in this document, it is in the interest of all
consumers of liquid fuels for the Commission to increase
the transparency of pipeline filings, tariffs and ratemaking
processes. Such transparency is especially critical
within a regulatory framework that relies heavily on the
shippers themselves to ensure that and services are
provided on a “just and reasonable” basis. The current
regulatory framework, as applied by the Commission,
creates a disincentive for pipeline companies to invest
in the infrastructure needed to ensure that airlines and
airports can meet the needs of the traveling and shipping
public. It also shows that some pipelines are excluding
critical infrastructure from regulatory oversight. These
cases illustrate why FERC should play a more active role
in ensuring that pipelines earn just and reasonable — not
excessive — returns.
16 See http://www.aopl.org/wp-content/uploads/2015/10/Safety-Record-
Pipeline-Issues-Series.pdf, http://www.marketwatch.com/story/pipelines-are-the-
safest-way-to-transport-energy-2013-03-29
20
Appendix A. Economic Oversight of Pipelines and
Ratemaking Methodology
For interstate pipelines, the persistent over-recovery of ongoing costs and excessive returns on legacy assets are significant
factors reducing the flow of capital into new petroleum pipeline assets, especially for pipelines serving highly congested
urban areas. Importantly for the United States, this problem is discouraging upgrades or expansion of critical infrastructure,
a consequence that is likely antithetical to the aims of the Federal Energy Regulatory Commission (FERC).
17 See https://www.ferc.gov/industries/oil/gen-info/pipeline-index.asp and 18 CFR § 342.3
18 See https://www.ferc.gov/industries/oil/gen-info/pipeline-index/RM15-20-000.pdf
19 Bureau of Labor Statistics Producer Price Index Commodity Data Series WPUFD49207, as originally published
Since the mid-1990s, the
Commission has allowed
pipelines to adjust their rates
each year based on an inflation-
adjusted index tied to the U.S.
Producer Price Index for Finished
Goods (PPI-FG).
17
On May 23,
2011, over the objections of
many shippers, the Commission
established a new pipeline index
level of PPI plus 2.65 percent for
July 1, 2011 through June 30, 2016
(the highest percentage increase
over the PPI level ever set). This
rate increase added billions
of dollars to existing pipeline
over-recoveries and significant
additional costs to shippers and
consumers. Cumulatively, from
June 30, 2011, to June 30, 2016,
index rates rose 31.9 percent.
On December 17, 2015, the
Commission revised the annual
PPI adjustment downward, from
2.65 percent to 1.23 percent,
effective July 1, 2016.
19
LACK OF COMMISSION OVERSIGHT, CURRENT INDEXING
METHODOLOGY AND MARKET BASED RATES
21
The most fundamental problem with current regulation
of interstate pipelines is the lack of Commission oversight
combined with the current FERC indexing methodology.
The Commission has chosen to allow pipelines to
increase their rates each year through automatic indexing
adjustments while relying solely on shippers to challenge
rates. Pipelines have not been required to show that rates
are just and reasonable prior to increasing those rates by
the index – the increase is automatic. On the other hand,
to challenge an index increase, shippers must show not
only that the resulting rates are not just and reasonable
but also that there is a substantial divergence from the
last approved rate increase.
As noted earlier, this regulatory framework effectively
allows pipeline owners to systematically charge rates that
over-recover costs and consistently achieve excessive
returns on existing assets. This in turn disincentivizes
investment in expansion and/or upgrade of existing
interstate pipeline networks because such projects dilute
the return from existing pipeline assets and make new
investment look comparatively unattractive.
These effects are compounded on pipelines the
Commission has granted authority to charge market-
based rates. Once the Commission determines that a
market is competitive and allows the pipelines in that
market to charge market-based rates, it essentially
abandons oversight of those rates. While shippers may
still bring rate complaints, the Commission has not
plainly articulated the standards for evaluating such
complaints. Consequently shippers have been reluctant
to expend resources to challenge market-based rates.
Because of this limited oversight and insulation from
challenge, pipelines have increasingly sought market-
20 Per https://www.ferc.gov/docs-filing/forms/form-6/form-6.pdf, the FERC Form No. 6 (FERC Form 6) is an annual regulatory reporting requirement (18 C.F.R. §357.2), designed to collect both
financial and operational informational from oil pipeline companies subject to the jurisdiction of the Federal Energy Regulatory Commission.
21 FERC requires that each regulated oil pipeline provide certain annual information relating to cost of service and revenues as part of its annual Form 6, commonly referred to as “Page 700.” Page 700
provides data for the end of the reporting year and for the immediately preceding year including: Annual Cost of Service (as calculated under the Order No. 154-B methodology), operating revenues, and
throughput in barrels and barrel-miles.
based rate authority, oen supporting their applications
with “alternatives” that are not, in practice, viable
substitutes for the pipeline’s services. The Commission
rarely rejects an application that is not protested, so it is,
once again, incumbent on shippers to protest and point
out the deficiencies in market- based rate applications.
Shippers, however, are hindered by inadequate
disclosure of information by pipelines and conflicts of
interest.
On October 20, 2016, at the request of A4A and
others, FERC issued an Advanced Notice of Proposed
Rulemaking regarding potential modifications to its
polices for evaluating oil pipeline indexed rate changes
and regarding potential changes to FERC Form No. 6
(“Annual Report of Oil Pipeline Companies”),
20
Page 700
(“Annual Cost of Service Based Analysis Schedule”).
21
As
to indexing, FERC is considering a two-part evaluation
of index filings. FERC proposes to deny any indexed
rate increase for pipelines if (a) the Page 700 revenues
exceed total costs by 15 percent for both of the prior two
years or (b) the proposed index increases exceed by 5
percent the annual cost changes on Page 700.
22
MANY SHIPPERS LACK THE
KNOWLEDGE AND RESOURCES TO
CHALLENGE THE ESTABLISHMENT
Many shippers lack adequate and transparent information
regarding pipeline operations, financial performance,
and assets. Airlines are among few end-users that have
engaged in Commission proceedings. In effect, airlines
are the most significant voice of the shipper/consumer in
FERC proceedings involving the transportation of liquid
fuels. The Commission has entrusted to shippers the
job of ensuring that pipeline rates and services are just
and reasonable.
Unfortunately, the only publicly available information
is annual/quarterly pipeline reports, designated as
Form 6. Currently, little can be gleaned from FERC
Form 6. Page 700 of Form 6 has undergone only
minimal revisions since 2000, despite multiple shipper
requests for additional changes. In 2013, to facilitate
the determination of a pipeline’s realized return on
equity, the Commission directed pipelines to provide
some additional information regarding individual cost
elements. However, as discussed further below, shippers
do not yet have access to all the necessary information to
determine whether specific rates on individual systems or
segments are just and reasonable. Since the Commission
relies on shippers to monitor whether rates are just and
reasonable, it is only fair that the Commission facilitates
the process by providing them with all the information
and tools necessary to undertake this task.
FERC has simplified and expedited the pipelines’
ability to obtain automatic rate increases but the
ability of shippers to determine if the resulting rates
are just and reasonable has not kept pace. Since the
indexing rules were instituted in 1995, the pipeline
industry has consolidated further, resulting in larger
and more complex entities filing (in many instances) a
single combined Form 6 for all pipelines, systems and
distinct segments operating within their company. This
information aggregation has thus, unfortunately, made
the task of monitoring and challenging rates on individual
systems more difficult and, in some cases, impossible.
The inability to determine whether rates on individual
systems are just and reasonable also creates cross-
subsidies between systems where rates on one system lie
significantly beyond any zone of reasonableness.
In that October 20, 2016 Advanced Notice of Proposed
Rulemaking, as to Page 700, FERC is considering a
requirement that pipelines file supplemental Page 700s
for (a) crude oil and product systems, (b) non-contiguous
systems and (c) certain major pipeline systems.
22
23
THE CURRENT REGULATORY
CONSTRUCT INHERENTLY FAVORS
PIPELINES
Not only has the pipeline industry consolidated and
become more complex – it also holds terminaling,
storage and other assets outside of the pipeline
entities in so-called “non-jurisdictional entities.” These
developments raise questions as to whether assets that
are an integral part of transportation, increasing the
efficiency of operation and capacity of the pipeline, are
being improperly used to create additional revenues for
the parent company of pipelines at significant additional
costs to the shippers/consumers – costs that were
previously covered by FERC-regulated rates.
Even if pipeline filings were adequate and transparent
with respect to operations, financial performance and
assets, the Commission should not be passive and leave
to shippers the responsibility to ensure that rates are just
and reasonable. Many shippers have conflicts or other
interests that prevent them from challenging rates. One
concern is that many shippers can reach settlements
that mainly benefit them through incentive rates or
new services while remaining shippers are le with
excessive rates.
Another concern is that many shippers, or their affiliates,
also have an ownership interest in interstate pipelines.
Yet another is that many shippers on petroleum-product
pipelines simply pass along pipeline costs to consumers
such as individual motorists or truckers. Furthermore, in a
given destination market, some shippers have alternative
sources of local supply, meaning that they might actually
benefit from higher rates on a given line. For instance,
if a refinery is located in an area that requires fuel to be
brought in from out of state, the local market must reach
a price equilibrium that will attract fuel from another
state. When the cost of moving fuel from another state
increases, the price equilibrium must increase, enabling
the local supplier to sell its fuel at the higher price.
Finally, small shippers and new entrants are
competitively disadvantaged because they lack the
scale, sophistication and/or financial wherewithal to
effectively monitor and challenge pipeline rates and
services. This diffusion of interests contrasts sharply
with the large integrated oil and product pipelines,
which have substantial financial wherewithal and, under
the Commission’s current rules, can recover their legal
costs through their rates. Until the shippers, who must
pay their own legal costs, can get the Commission to
act, these pipelines enjoy the benefit of unjust and
unreasonable rates.
23
24
Appendix B. Case Studies in Pipeline Regulation and
Infrastructure Development
The following four case studies help illustrate the disincentives to investment that stem from the aforementioned
shortcomings in pipeline regulation. The first three cases are real-world examples where needed investments were not
made. The fourth represents a case where addressing excessive recoveries enabled infrastructure investment. As shown,
however, the investment was made only aer a complaint by shippers against excessive rates.
An efficient and customer-focused pipeline company
is earning revenues significantly above its costs and is
at constant risk of losing these premiums if a customer
were to complain to FERC. The pipeline has achieved
these revenues partially by expanding capacity
proactively and efficiently, by creating services to enable
customers to better manage risks and by ensuring that
resources, such as over-subscribed line space on the
pipeline, are allocated fairly. Even with this positive
track record, the pipeline has invested in very few, if
any, new services. Why? Because without customer
guarantees and commitments that provide a very high,
risk-free return, the pipeline company is concerned that
1) new investments would not increase its returns given
the extraordinary returns it already earns on existing
investments, and 2) it would remain at risk of a customer
filing a complaint with FERC.
Meanwhile, another pipeline company takes the
opposite approach. Tariffs on one of the company’s
systems have been challenged multiple times in the past
decade. Rather than reduce and keep tariffs at rates that
would prevent over-recovery, the company prefers to
maintain rates well above the reported cost-of-service
levels, defend itself against complaints, and eventually
settle with the few shippers that understand the process
and can afford both the legal costs and the management
time associated with a complaint. The unintended
consequence is that shippers who simply sell their fuel at
the pipeline destination have no incentive to challenge
the rate adjustments, since these costs are oen a direct
pass- through to the customer.
They know they are paying too much to ship their fuel,
but they also know that they will be able to recover the
shipping costs through the wholesale price of fuel at
the destination. They know this because the market
frequently sets prices at the destinations based on the
wholesale price at the origin plus the existing tariff to the
destination.
Even when a shipper files a complaint that is eventually
settled – years later – for a cash refund payment, the
shipper receives its confidential portion of the over-
recovery back and is able to pocket the savings. The
purchaser of wholesale product at the destination
never receives any of the excess tariff. Even a savvy
consumer who has bulk purchasing power, but is not
a shipper, cannot fully recover its share of the over-
recovery because the settlements remain confidential
and because there is no incentive for a supplier to pass
through any settlement monies.
CASE STUDY 1: THE WRONG
INCENTIVES ARE IN PLACE
25
Despite their divergent customer policies, neither of the
above pipeline companies can make new investments in
its systems with confidence that the current regulatory
environment alone will enable it to recover its costs
and earn the kind of return its shareholders have grown
to expect. It is true that the new investment will raise
their respective cost bases and the amount that they
can earn, but their shareholders and executives expect
them to continue to achieve returns consistent with
their existing capital base and risk profile. Under that
set of expectations and the current regulatory culture,
new investments simply cannot gain approval without
the throughput-and-deficiency agreements that enable
the pipeline companies to achieve desired returns and
eliminate the risk of shipper-initiated challenges filed with
FERC. The current system provides tremendous leverage
to the pipelines based on their natural monopoly position
and the limited [cost and revenue] information pipelines
must file combined with remarkably light regulatory
oversight of rates and services.
At an airport that traditionally had depended on two
separately owned pipelines, one pipeline was required
by the U.S. Department of Transportation to shut down.
Over several years, the airlines engaged in dialogue with
the owners of these two pipelines to explore numerous
alternatives. Eventually the airlines decided to rely solely
on the only existing pipeline even though it was buried
deeply below a river and could be subject to significant
interruption because it would take months to repair a
problem.
The owners of the shutdown pipeline had offered to
build a new replacement line only via a guaranteed
throughput-and-deficiency agreement of at least five
years. The airlines offered to commit 100 percent of
airport demand to the new replacement pipeline, which
exceeded the pipeline’s minimum volume commitment
and would have allowed the pipeline to earn more than
100 percent of its capital investment within five years.
At the insistence of the airlines, the pipeline company
offered to allow the airlines to buy the new pipeline aer
five years of operation. However, the pipeline’s best
offer included a premium of 80 percent of the estimated
original cost of construction at the end of five years and
ignored all of the capital recovery that would occur over
the five-year period. In short, the pipeline refused to take
on any investment risk. It could take this position because
the project would have been dilutive to its existing
capital base. In other words, since FERC policy allowed
the company to collect millions per year of tariffs on a
completely depreciated pipeline that ran from one side
of the river to the other, it was in the company’s financial
interest to do nothing rather than to take prudent risks
and earn returns below expectations set in their legacy
businesses.
CASE STUDY 2. EXCESSIVE
RETURNS ON EXISTING CAPITAL
BASE DISCOURAGE INVESTMENT
26
There are many circumstances around the country where
pipeline companies have re-classified storage and terminals as
non-jurisdictional, meaning that the rates and charges are no
longer subject to regulatory oversight even though the pipeline
cannot operate without their use. This provides the pipeline
companies with unfair leverage and the ability to shi profits
to an unregulated entity. Presumably this is allowed because,
at a minimum, potential for competition exists. However, the
following cases demonstrate instances where 1) carve outs
have been granted despite the absence of meaningful (i.e.,
economically equivalent) competition or 2) carve outs remain in
effect aer consolidation of assets has resulted in elimination of
competition.
In one circumstance, a western U.S. airport was entirely
dependent on one pipeline, which happened to be
approaching full capacity. Accordingly, the airlines serving
this particular airport agreed to pay an additional fee — above
and beyond the regulated tariffs — for two storage tanks to be
built at a nearby terminal owned by an “unregulated affiliate”
of the pipeline company. This construction would enable the
same pipeline company to use another pipeline segment to
deliver to the airport from another direction. Further blurring
the lines between the regulated and non-regulated businesses,
the pipeline charged the airlines a surcharge over 10 years to
completely reimburse the pipeline’s sister company for the cost
of the tanks. Even though the airlines had agreed to these terms,
the pipeline company nonetheless refused to allow shippers
to nominate deliveries to the two new tanks, insisting that the
pipeline would utilize the tanks only when the capacity of the
original pipeline configuration became inadequate.
The 10-year period of the airlines’ agreement with the pipeline,
and the fees charged, were negotiated to provide for the
complete reimbursement of the original cost of the two tanks.
However, upon expiration of the agreement, instead of simply
allowing the tanks to remain in service of the pipeline to access
the airport, the unregulated terminal affiliate insisted that the
CASE STUDY 3. CRITICAL INFRASTRUCTURE HAS
BEEN CARVED OUT FROM FERC OVERSIGHT
airlines would have to pay a new fee to the unregulated affiliate
to lease these same two tanks. The pipeline also refused to allow
the airlines to use the tanks as they wished. The unregulated
terminal affiliate insisted it could use the tanks for other
purposes, meaning that the airport would again be completely
dependent upon the original configuration of the pipeline
that utilized a single smaller pipeline to make deliveries to the
airport, which by this time had become both less reliable and
less efficient, taking up to three times longer to ship products the
same distance. Fearing the loss of infrastructure and recognizing
that it would take too long to build a new terminal to compete
with the existing one, the airlines agreed to pay the new lease
fees to the unregulated terminal affiliate upon expiration of the
original agreement with the pipeline company.
Meanwhile, on the opposite side of the country, an unregulated
terminal operator owned by a parent that also operates a
regulated pipeline that was the sole source of petroleum
products delivered to the unregulated terminal was allowed
to purchase the only other terminal supplied by the pipeline in
the vicinity. These terminals are located in a densely populated
corridor where there is little chance of building competing
terminals that can access the pipeline. One major U.S. airport
is completely dependent upon these terminals and pipeline for
its supply. There is no other conceivable way to deliver jet fuel
to the airport that would receive the necessary environmental
and governmental approvals in a reasonable period of time,
if ever. In order to deliver fuel to this airport, the pipeline first
delivers product to the unregulated terminal upstream of the
airport, whereby a shipper must have an agreement with the
unregulated terminal to pay fees to enable the pipeline to
restage its fuel for the last short pipeline segment to the airport.
In addition, the regulated pipeline imposes a re-injection charge
to reach the airport in addition to requiring the shipper to pay its
sister company for use of the terminal. Of course, all revenues
collected by the unregulated terminal have been treated by the
unregulated terminal as non- jurisdictional and thus beyond the
regulatory reach of FERC.
27
CASE STUDY 4: ADDRESSING EXCESSIVE
RECOVERIES ENCOURAGES INVESTMENT
At airports served by only one pipeline, shippers constituting the majority of volumes transported to these airports filed a
complaint to reduce rates and eliminate over-recoveries. At these airports demand for transportation capacity exceeded or
would shortly have exceeded the current capacity of the existing pipeline infrastructure. Although this situation was known
for some period of time, no additional infrastructure or capacity was built, in part, because the pipeline and the shippers
could not reach mutually agreeable terms, especially regarding the cost and return required on the needed infrastructure
investment.
Aer several years of litigation over rates, a settlement on rates and on providing new infrastructure was reached. Without
the pressure on rates applied through litigation to obtain more reasonable rates and return, it is doubtful that any agreement
would have been reached under which the pipeline would have agreed to add additional infrastructure to increase capacity.
Thus, in this case litigation to eliminate over-recoveries and aligned rates with reasonable return led to the development of
new infrastructure. Such litigation would not be needed if FERC had policies in place to assure that pipelines were afforded
reasonable, versus excessive, returns.
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