Public Utility Law Section Seminar August 3, 2012 Update on Gas Utility Regulation

1. Public Utility Law Section SeminarAugust 3, 2012Update on Gas Utility Regulation Glenn E. Johnson Kelly Hart & Hallman LLP 301 Congress Ave. Suite 2000 Austin, Texas 78701 (512) 495-6423 glenn.johnson@kellyhart.com

2. Summary of Railroad Commission Sunset Process • The Railroad Commission issued its report to the Sunset Commission in September 2009. • The Sunset Commission recommended establishing the Texas Oil and Gas Commission, governed by a single, elected Commissioner, to assume the regulatory role currently served by the Railroad Commission. • Senate Bill 655, as passed by the Senate, included all of the Sunset Commission’s recommendations, as well as a provision to suggest that the first Governor-appointed Oil and Gas Commissioner be the last elected Railroad Commissioner. • The House amended S.B. 655, maintaining many of the Sunset Commission’s recommendations, but significantly modifying the provisions relating to governance. Notably, the House altered the bill to maintain a three-member, elected commission and establish an elected chairman. The House also removed the provisions in the bill that transferred certain hearings to SOAH, and added a number of provisions, including limiting campaign contributions and requiring a commissioner to resign before seeking another elected office. • The bill went to conference committee, but the committee did not come to an agreement regarding the bill’s provisions. As a result, the Legislature did not pass S.B. 655. • Senate Bill 652, 82nd Legislature, Regular Session, continues the agency until 2013, and provided for the Sunset Commission to re-examine the Railroad Commission in full and make recommendations to the 83rd Legislature regarding its continuation and functions.

3. RecentCommissionerChanges

4. Tara Partners, Ltd.v.Centerpoint Energy Resources CorporationCourt of Appeals of Texas,Houston (1st Dist.)April 19, 2012

5. Tara Partners Case BasisofSuit Tara Partners sued “CenterPoint Energy” for breach of contract, alleging CenterPoint billed Tara Partners for more natural gas than it actually used.

6. Tara Partners Case PleatotheJurisdiction CenterPoint plea to the jurisdiction was that the trial court lacked jurisdiction because Texas Utilities Code established a regulatory scheme that confers exclusive jurisdiction for claims regarding rate disputes and refunds for overcharges on the Railroad Commission or on the municipality involved.

7. Tara Partners Case RailroadCommissionActiononComplaint Tara Partners attempted to file a complaint with the Railroad Commission, which dismissed the complaint.

8. Tara Partners Case RailroadCommissionActiononComplaint Railroad Commission advised that “consumer bill complaints [are handled] through the Market Oversight Section's consumer complaint function,” but it concluded, “Since the dispute is the subject of a lawsuit, the matter has proceeded beyond this Division's ability to facilitate a resolution.”

9. Tara Partners Case LegislativeIntent The statutory description of GURA as “comprehensive” demonstrates Legislature's intent that GURA encompass all or virtually all pertinent considerations involving gas utilities operating in Texas. Sections 102.001 and 103.001 grant “exclusive original jurisdiction” over the rates and services to the municipality or to the Railroad Commission when no municipality is involved.

10. Tara Partners Case Claimis aRateIssue Tara Partners' claim that CenterPoint incorrectly charged for natural gas falls under the statutory definitions of “rate” or “service” over which the municipality or Railroad Commission has exclusive original jurisdiction.

11. Tara Partners Case AdministrativeRemediesnotExhausted Tara Partners was required to exhaust all administrative remedies before seeking review of the agency's action in the district court.

12. Tara Partners Case Holding:Suitongasutilitychargesis arateandnot acontractmatter Tara Partners argued that GURA does not apply to its private contract claim. However, the plain language of GURA defines a “rate” over which the municipality or Railroad Commission has exclusive original jurisdiction as including a “contract affecting the compensation, tariff, charge, fare, toll, rental, or classification” charged by a gas utility.

13. Atmos Energy Corporationv.The Cities of Allen, et al., and Railroad Commission of TexasSupreme Court of Texas,353 S.W.3d 156 (MRH filed)November 18, 2011

14. Atmos Energy Case DeclarationSoughtonValidityofGRIPRule Cities filed declaratory judgment action against Railroad Commission, seeking declaration that rule promulgated by Commission governing gas utilities' filings for interim rate adjustments under Gas Utility Regulatory Act (GURA) was void to extent it prohibited cities from intervening and obtaining an evidentiary hearing on appeals to the Commission from cities' denials of filings. Gas utilities intervened in support of validity of rule.

15. Atmos Energy Case StatutoryBackground In 2003, the Texas Legislature amended the Gas Utility Regulatory Act (GURA) to allow gas utilities an opportunity to recover capital investments in Texas' gas pipeline infrastructure made during the interim period between rate cases. The amendment and rules became known as the Gas Reliability Infrastructure Program (GRIP).

16. Atmos Energy Case StatutoryBackground The GRIP statute permits a gas utility to file a new tariff adjusting its base rates to recover the costs of new capital investment made in the preceding calendar year, without the necessity of filing a rate case.

17. Atmos Energy Case FilingofAtmos After passage of the GRIP statute, Atmos Energy Corporation (“Atmos”) filed interim rate adjustments, or GRIP filings, with the Commission and several municipalities to charge adjusted rates. The Commission approved Atmos' GRIP filings, but numerous municipalities denied Atmos' filings.

18. Atmos Energy Case AppealtoRailroadCommission • Atmos appealed the Cities' denials to the Commission. • Cities sought to intervene in the appeals and to require the Commission to hold contested case proceedings in the appeals. • Commission denied interventions and requests for evidentiary hearings on the ground that neither the GRIP statute nor the GRIP rule authorizes contested case proceedings in GRIP filings.

19. Atmos Energy Case DeclaratoryJudgment Because 102.001(b) purports to give the Commission “exclusive appellate jurisdiction” to review the matter and the Cities could not appeal the Commission's rulings because they were not parties, the Cities did not believe they had a way to appeal the Commission's rulings.

20. Atmos Energy Case DeclaratoryJudgmentAction Fifty-one Texas cities then pursued a declaratory judgment action in district court against the Commission, challenging the validity of Commission Rule 7.7101, the GRIP rule.

21. Atmos Energy Case TrialCourt • The trial court issued a final judgment denying the Cities' request for declaratory relief, but issued findings of fact and conclusions of law stating that subsections 7.7101(g)(2)(B) and (g)(2)(C) of the Commission's GRIP rule were void. • The trial court held that the Legislature did not intend to authorize municipalities to conduct a substantive review of GRIP filings, only a “ministerial review of the compliance with basic requirements.” • The trial court held that the Cities have no authority to deny utilities' interim filings under section 104.301(a).

22. Atmos Energy Case TrialCourt The trial court also held that a utility does not have the authority to appeal an improper denial to the Railroad Commission because the Legislature did not provide an appellate mechanism in the GRIP Amendment (section 104.301(a)), and the Railroad Commission does not have the authority to apply its Rule 7.7101 to the action of a city.

23. Atmos Energy Case CourtofAppeals The court of appeals affirmed the judgment of the trial court, holding that a ministerial review for compliance “is all that is required.” The court of appeals also affirmed that GRIP rule subsections 7.7101(g)(2)(B) and (g)(2)(C) are only void to the extent the Commission attempts to reject a GRIP filing over which it holds regulatory authority for any reason other than failure to comply with the statutory requirements.

24. Atmos Energy Case CourtofAppeals The court of appeals also held that appellate review by the Commission is “not available when a municipality denies a GRIP filing after conducting a ministerial review for compliance with the statute” because there is “no indication that a municipality's denial of a GRIP filing for failure to comply with the statutory requirements is considered ‘an order or ordinance of a municipality’ as contemplated by section 102.001.”

25. Atmos Energy Case SupremeCourt • Commission had appellate jurisdiction over municipal denials of gas utilities' requests for interim rate increases, and • Commission's appellate jurisdiction was limited to review of utilities' filings for compliance with GURA and applicable administrative rule.

26. Atmos Energy Case SupremeCourt Section 102.001(b) of the Texas Utilities Code provides: “The railroad commission has exclusive appellate jurisdiction to review an order or ordinance of a municipality exercising exclusive original jurisdiction as provided by this subtitle.” This grant of appellate authority clearly gives the Commission jurisdiction to review the Cities' denials of the interim rate increases.

27. Atmos Energy Case SupremeCourt The view that the Legislature had withheld appellate jurisdiction in this case from the Commission could frustrate GRIP's purpose. The Legislature designed GRIP to incentivize gas utilities to expand infrastructure and empowered them to file interim rate adjustments in between rate cases.

28. Atmos Energy Case SupremeCourt The Legislature intended a streamlined process, and an evidentiary review beyond a compliance check could frustrate that purpose.

29. Atmos Energy Case SupremeCourt Legislature implemented protections for the ratepayers when a utility makes a GRIP filing. A utility may not avail itself of the interim rate adjustment unless that utility brought a rate case pursuant to Chapter 104, Subchapter C, within the two years prior to its GRIP filing.

30. Atmos Energy Case SupremeCourt A utility that makes interim rate adjustments is also required to undergo another rate case within five years and six months after implementing its first amended tariff or rate schedule.

31. Atmos Energy Case SupremeCourt A gas utility seeking to implement an interim rate adjustment must electronically file with the Commission an annual earnings monitoring report as part of the application describing the investment projects completed and placed in service.

32. Atmos Energy Case SupremeCourt Any amounts collected as interim rate adjustments are subject to a full refund to the extent the interim recovery of infrastructure investments are later disallowed at the next rate case.

33. Atmos Energy Case SupremeCourt Under GURA the Commission or a municipality retains authority to institute a proceeding, either on its own or at the complaint of a party, to determine if a utility's rates are unreasonable or in violation of the law. A municipality could file a rate case on its own motion whenever it perceives the need after a GRIP filing.

34. Atmos Energy Case SupremeCourt We conclude that the Railroad Commission has appellate jurisdiction under section 102.001(b) of the Texas Utilities Code over municipalities' orders or ordinances concerning interim rate adjustments, limited to the review of the Utilities' filings for compliance with the GRIP statute, section 104.301, and the GRIP rule, section 7.7101 of 16 Texas Administrative Code. This review involves examination of the statutory requirements for processing a utility's application to amend its tariff or rate schedule under the GRIP statute and rule, and whether the GRIP filing satisfies those requirements. We affirm the judgment of the court of appeals.

35. The Railroad Commission of Texasv.Texas Coast Utilities CoalitionCourt of Appeals of Texas, Austin357 S.W.3d 731October 27, 2011Motion for Rehearing OverruledDecember 21, 2011

36. Texas Coast Case Issue Whether the Legislature's statutory delegation of authority to the Railroad Commission to regulate the “rates” of gas utilities empowers it to approve or impose a rate schedule that includes a mechanism for annually adjusting customer charges based on the utility's actual operating expenses, return on investment, and franchise tax payments without the need or requirement to initiate a subsequent rate proceeding.

37. Texas Coast Case DistrictCourt Disagreeing with the Commission's view of its authority, the district court reversed the Commission's order approving CenterPoint's rate schedule. CenterPoint and the Railroad Commission appeal.

38. Texas Coast Case DistrictCourt Commission findings relating to expenses paid to affiliated companies were inadequate and that it had exceeded its authority in adopting the COSA clause. The “Commission did not have statutory authority to impose [the COSA] on the [TCUC] cities with original jurisdiction ... [or] ... to adopt the COSA in [the environs].”

39. Texas Coast Case CourtofAppeals CenterPoint and the Railroad Commission each brought a single issue asserting that the district court erred in concluding that the Commission lacked authority to adopt or impose the COSA clause within either the environs or the TCUC municipalities.

40. Texas Coast Case CourtofAppeals With the express goal of reducing volatility of cost risks and the need or impetus for “full-blown” rate proceedings in the event such risks came to fruition, the Railroad Commission approved, as part of CenterPoint's rate schedule, a version of a “cost-of-service-adjustment” (COSA) rate schedule or clause that CenterPoint had requested.

41. Texas Coast Case CourtofAppeals While we acknowledged that GURA does not explicitly mention PGA clauses, we concluded that the act's broad definition of “rate” nonetheless encompassed and contemplated this sort of adjustment mechanism.

42. Texas Coast Case CourtofAppeals We agree with appellants that GURA section 104.001—“The [R]ailroad [C]ommission is vested with all the authority and power of this state to ensure compliance with the obligations of gas utilities in [GURA]”—represents an extraordinarily broad delegation of authority to the Commission in regard to rate regulation.

43. Texas Coast Case CourtofAppeals This discretion provides sufficient flexibility to enable the Commission to effectuate the ultimate goal of “just and reasonable” rates through the use of variable or formula rates and not merely fixed charges.

44. Texas Coast Case CourtofAppeals The COSA clause would, all other things being equal, come within GURA's definition of “rate,” as it is “a rule, regulation, [or] practice ... affecting the compensation, tariff, charge, [or] fare” imposed by CenterPoint.

45. Texas Coast Case CourtofAppeals We conclude that the Railroad Commission's delegated authority under GURA encompasses the power to adopt or impose the COSA clause in both the Texas Coastal Division environs and the TCUC municipalities. We sustain appellants' sole issue on appeal.

46. Rate Treatment of Pension and Post-Employment Benefit CostsProposed Amendment to16 Tex. Admin.Code § 7.501November 11, 2011

47. Rule 7.501 RulemakingProposal The Railroad Commission of Texas (Commission) proposed to amend §7.501 to implement a new section of the Texas Utilities Code, §104.059, which purportedly required gas utilities to establish reserve accounts to track changes in pension and post-employment benefit costs, and required the Commission to allow recovery of those costs as the Commission deems reasonable and necessary.

48. Rule 7.501 RulemakingProposal The effect of the rule was to change the treatment of certain pension and post-employment benefit costs from a test year expense to an accrual-accounting-based investment. Heretofore, pension and post-employment benefit costs were treated as a test year expense, rather than as an amortized investment.

49. Rule 7.501 RulemakingProposal The Commission proposes new subsection (b) to be effective on and after January 1, 2013, one year after the establishment of reserve accounts on January 1, 2012, as required by Texas Utilities Code, §104.059. Proposed new subsection (b) authorizes a gas utility to request recovery of pension and post-employment benefits costs in the context of a general rate proceeding.

50. Rule 7.501 AtmosEnergyComments • Atmos Energy Corporation claimed that the statute gave a simple straightforward and discretionary process to establish reserve accounts to track changes in pension and post-employment benefit costs. However, the proposed rule conflicts with the plain language of the statute and imposes significant and unnecessary compliance costs ultimately to be borne by the customers. • The provisions of the statute are discretionary, yet the rule imposes mandatory requirements to establish reserve accounts as a prerequisite to recovery of any pension or post-employment benefit costs. • The proposed rule establishes disallowances not imposed or contemplated under the statute. • The proposed rule impermissibly limits recovery of pension and post-employment benefit costs to general rate proceedings.