Regulatory Treatment of Recoating Costs

This paper examines current federal regulations of interstate natural gas pipelines with regard to their treatment of recoating costs. These regulations require that costs associated with recoating be expensed in the year incurred. The analysis presented in this paper concludes that permitting pipelines to capitalize recoating costs would result in a more equitable distribution of such costs between future and current customers and would reduce the financial impact on pipelines.

There are over 250,000 miles of pipelines in the interstate network. Over 75% pipeline construction occurred prior to 1970 and the average age of pipeline facilities is about 31 years. Among other factors, the age distribution of the interstate network suggests that recoating requirements could be significant in the near future. A survey of pipeline members of INGAA indicated that 13 of 22 pipeline respondents believe recoating will be required on their system in the near future and 5 pipelines project they will recoat more than 150 miles. Recoating involves many of the same tasks in the construction of the original pipeline. Because the right-of-way will be disturbed, the recoating process will likely be subject to environmental standards, many of which were not in place at the time the original pipe was installed. It is estimated that, in some cases, the cost of recoating could be as much as 60 percent of original construction costs.

The current regulatory accounting requirements require that a item be listed as a retirement unit in order for its replacement to be capitalized. Since the cost of coating the pipe was about 2 to 6.5 percent of the original cost of pipeline construction, most pipeline companies simply considered coating to be a part of the pipeline and did not list coating as a retirement unit. Unless the pipeline is able to obtain an exception to the accounting regulations, the costs associated with recoating must be expensed. This paper concludes that recoating costs are too substantial to be expensed and the requirement to expense such costs is inconsistent with sound regulatory policy because:

  • It may encourage replacement rather than recoating.
  • It has the potential of impacting the financial wealth of the pipeline industry adversely and raising the cost of capital.
  • It is not fair to different generations of ratepayers.

This paper explores a number of options that the FERC might pursue for allowing pipelines to capitalize recoating costs. The most promising method is the issuance of a policy statement by FERC that it intends to treat recoating as an addition to plant which can be depreciated over the remaining life of the recoated pipeline. To maintain the integrity of pipeline accounts, the policy statement could allow the pipeline to make a one-time adjustment to plant accounts using one of different approaches. Under one approach, the adjustment could be done on the basis of the estimated cost of the original coating. Alternately, the FERC could select a percentage of the original cost as proxy for recoating costs and permit pipelines to adjust the plant accounts on this basis or provide documentation for a different percentage.