Vermont Gas Customers May Cover Some Pipeline Costs, Even If Project Is Canceled

The fate of the $154 million Vermont Gas pipeline to Addison County will be decided in a matter of weeks, and regulators could order the company to stop building the pipeline because it mishandled cost estimates for the project.

Vermont Gas has already spent more than $80 million on the new pipeline, much of that while the future of the project was uncertain. That spending was a major risk, but a plan Vermont Gas quietly implemented last winter means its customers – not the corporation – could end up shouldering the cost of the project even if it gets canceled.

Here's how Vermont Gas did it.

Bad Math

Vermont’s utility regulation system is designed to protect customers from bad business. The state’s Public Service Board regulates the rates utilities charge to ensure Vermonters are paying a reasonable price for the service that benefits them, not covering the costs of unnecessary or overpriced investments by utilities – or mismanaged projects.

When it comes to building and paying for new infrastructure like the Vermont Gas Addison County pipeline, Vermont’s utility regulation system is designed to have four basic steps that govern the way utility infrastructure projects work:

1. A utility puts a project plan in writing and presents it to the Public Service Board.
2. The Public Service Board, after hearing from the utility, the Department of Public Service (which is tasked with representing customers’ interests) and other interested parties, determines if the project would be in the overall “public good” of the state. If it is, the board approves the utility’s plan with a certificate of public good that gives the utility permission to build the project as presented.
3. The utility builds the project in keeping with the plan.
4. Once the project is finished and in use, the utility can go back to the Public Service Board to seek permission to recover the costs of the infrastructure project from customers through their utility rates, which are regulated by the board. If the board determines that the infrastructure the rates would pay for is “used and useful,” the company is allowed to pass the costs on to customers, who are benefiting from the new “used and useful” infrastructure. 

Vermont Gas got board approval for its Addison County pipeline project in Dec. 2013. At the time, company estimates said the total cost to complete the pipeline would be $86.6 million.

Less than a year after the pipeline’s approval, the company announced it wasn’t going to be able to build the project according to the plan the Public Service Board originally approved.

Credit Taylor Dobbs / VPR

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VPR

In July, 2014, the company announced that the pipeline would instead cost $122.7 million to complete. In the wake of that price increase, the Public Service Board decided to reevaluate the pipeline’s permit, taking the new cost into consideration. Since customers are expected to foot the bill for building projects like this one, the board's job was to decide if the 41-mile pipeline was going to provide enough benefit to the state to merit Vermonters spending up to $122.7 million on it.

Ultimately, the board ruled in October of 2014 that despite the cost increase, the project would still bring an overall benefit to Vermont.

As CEO Don Rendall took over the company in the final months of of 2014, the company discovered that the revised $122.7 million cost estimate for the pipeline was also wrong.

The new cost – $154.4 million – was nearly 80 percent above the price tag regulators had approved in 2013.

This meant that Vermont Gas would have to tell the Public Service Board, and the public at large, that the company had botched cost estimates for its pipeline not once, but twice. Then it would have to convince the Public Service Board that the project is worth $154 million, and that the company hadn't messed up this estimate too.
 
This was a major problem for Rendall.

The board chose to reconsider the pipeline, which created the possibility that it could revoke the certificate of public good for the project (issued in step two of the process) because the company wasn’t able to build a project that matched what was described in the permit (as expected in step three of the process).

To complicate matters further, the company’s new $154 million cost projection could only be met, company officials said, if contractors were able to work uninhibited through the entire 2015 and 2016 construction seasons.

Vermont Gas, according to its executives' reasoning, had no choice but to continue building the pipeline before the board’s decision came down.

There was a chance, if the board decided to pull the permit for the project, that Vermont Gas would spend all or part of the 2015 construction season building a pipe to nowhere. If the board ultimately revoked the permit, all work on the pipeline up to that point would be useless – there would be a pipe in the ground that had no use, that wasn’t useful. In step four of the regulatory process, the company wouldn't be able to recover costs for infrastructure it built, because that infrastructure wouldn't be "used and useful."

In other words, if the company worked through 2015 and didn't have a finished, "used and useful" product to show for it, the company faced the costly possibility of having to absorb the costs incurred so far on the pipeline if the board revoked its permit.

Instead, as he took over in late 2014, Don Rendall developed a plan that would allow the company to continue building through the 2015 construction season and still have a chance to recover its costs if the project was canceled ($80.9 million out of the total $154.4 million as of Sept. 30, 2015, according to board filings).

Eleven Miles

The company’s plan hinges on the northernmost 11 miles of the planned 41-mile pipeline.

That section, completed this year, connects at both ends to the existing Vermont Gas system. Because of that design, Vermont Gas will be able to fill those 11 miles with gas as soon as they are done; that work is almost finished.

This loop increases the overall amount of gas in the company’s systems, which Rendall says will serve to make the company’s service more reliable.

“It will become part of our Vermont Gas transmission system,” he said at a November news conference. “That 11 miles connects to our system at both ends and it will be in service and providing reliability support to our overall system. And then in addition, we’ll build the remaining part of the pipeline next year.”

Improved reliability within the company’s system isn’t the only consequence of those 11 miles coming into service. It also allows Vermont Gas to make an argument for recovering its construction costs for that work, even if the Public Service Board doesn’t allow the full Addison County pipeline to be built. That's because the completed work could be considered “used and useful,” (as required in step 4 of the process,)  therefore eligible to be covered by customers.

In essence, the company turned the 41-mile pipeline into two projects: An 11-mile pipeline to improve reliability in the existing system and a 30-mile pipeline to Addison County.

That division only exists internally; in regulatory terms, the pipeline is one project with one permit.

In filings with the board, the company refers to the first 11-mile stretch as "Segment 1," holding it apart from the rest of the pipeline. At the board level, though, Segment 1 and the rest of the pipeline are part of the same docket - and are governed by the same imperiled permit.

Credit Taylor Dobbs / VPR

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VPR

Rendall said in November that the plan to split the work this way was developed after he came into the company.

“We did that for a variety of reasons,” Rendall said. “One was because by completing that [11-mile stretch], we could put that leg of the project into service."

He also said the company had something to prove after a year of embarrassing missed cost estimates.

"It was important to me and to our project management team that with the new budget, with all the uncertainty and challenges that the project had faced," Rendall said, "that when we reset the project that we could give ourselves a defined goal for what we could achieve and that we could demonstrate to all of you [in the press], to the public, to our regulators, to our customers that we could get this project on time and on budget and that we had a defined piece of construction to do in 2015 and that was the project that we embarked on and that’s the project we’re completing.”

Vermont Gas spokeswoman Beth Parent has repeatedly declined to make Vermont Gas executives available for interviews since Rendall’s November news conference. Parent did point out that Rendall made himself available for in-person interviews at Public Service Board hearings on the case in early December.

In an interview for this story, Parent declined to say whether Vermont Gas officials had cost recovery in mind when they decided to put Segment 1 in service before the rest of the pipeline.

“There’s nothing underhanded here,” she said. “We made a goal to be open and transparent last December, and that’s exactly what we have done. We have filed quarterly cost estimates with the board that show that this project is on time and on budget. We are so pleased with the construction season that we’ve had so far.”

Parent said keeping gas rates low is important to Vermont Gas.

"This company is committed to keeping rates competitive and affordable," she said.

Department of Public Service Commissioner Chris Recchia said the company’s plan to split the project in two didn’t require it to change the overall design of the pipeline, so no new regulatory permission was needed.

He said the strategy was the company’s way of managing the financial risk of continuing construction despite the uncertainty created by the board’s decision to reconsider the pipeline's permit.

“I think it was mainly intended to try and manage their risk with the fact that the [board process] hadn’t been resolved yet,” he said. “If the [process] had been resolved, let’s say, earlier in the summer … I think they would have continued construction beyond those 11 miles, but I think they were making a judgment call based on the fact that the decision hadn’t been made yet to hold the project at that point where at least they could make the argument that the project does have value even if they have to stop there.”

Recchia said he sees the company’s two-stage process as a smart move.

“Vermont Gas has a responsibility to prudently do this project, and to make sure that they’re doing it as efficiently and cost-effective as possible,” he said. “It would have been irresponsible, I think, in this uncertainty for them to go full speed ahead and have stranded pipe that maybe could not be used." 

Recchia said that while the plan could result in customers covering the costs of a canceled pipeline, Vermont Gas has built an improvement to its system that could genuinely benefit those customers.

"So I think it’s actually a very responsible approach for them to stop where they did based on the idea that this is a useful component to the existing system even if they are not allowed to go to Middlebury," Recchia said.

He said building beyond those first 11 miles would have risked wasting money.

"It’s one thing to build something that can serve a purpose if you stop where you are," Recchia said, "But if you start building pipe to nowhere and then the decision comes down to stop, that is a huge cost risk to the company and that would not be recoverable from rates.”

Instead, because that first 11 miles will be used to increase reliability for existing Vermont Gas customers, Vermont Gas could make the case to the Public Service Board that the costs associated with building it — more than $80 million as of Sept. 30 — could be passed along to rate payers because they are "used and useful," as required in step four of the regulatory process.

An agreement between Vermont Gas and Recchia's Department of Public Service, designed to limit the pipeline costs the company can pass to customers, is set to expire Jan. 8.

If the board decides to uphold the project permit and allow construction to continue, the agreement says the company will wait until the entire project is finished to recover construction costs. But if the board's ruling comes after that agreement's Jan. 8 expiration date - or if the board decides to cancel the project - that agreement is void, and the company can ask the board to let it get those millions back from customers through gas rates.