INNOVATIONS IN TARIFF METHODOLOGY IN CROSS BORDER AND TRANSIT OIL AND GAS PIPELINES

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Group No:13 2010-14 Pandit Deendayal Petroleum University

CERTIFICATE
This is to certify that this report on Innovations in Tariff Methodology in cross border and transit oil and gas pipelines is submitted by the following students, in partial fulfillment of the requirement for the Bachelor of Technology degree in Petroleum Engineering, Session 20132014. This work is done under my guidance.

NAME OF STUDENT
Viral Patel Brijesh Bhalodia Sagar Vaghasia Nishant Parate Prakhar Jain Arpan Rathod

ROLL NO.
10BPE015 10BPE088 10BPE144 10BPE145 10BPE221 10BPE236

SIGNATURE

Date: 18/11/2013 Place: PDPU, Gandhinagar (Dr.Bhawanisingh Desai)

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ACKNOWLEDGEMENT
First of all we would like to thank our Dr.Bhawanisingh Desai for his guidance and support throughout the course of completion of this project. Without their endless encouragement, support and trust at all levels we could not have accomplished the research project. His ingenious perspective into tariff methodology fueled out interest in the study of project and provided us with useful insights into how to proceed about this work. We would like to thank Director Dr. Anirbid Sircar for providing us this opportunity and thanks a lot PDPU.

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Table of Contents
ACKNOWLEDGEMENT ................................................................................................................................... 2 Summary ....................................................................................................................................................... 5 General findings ............................................................................................................................................ 5 Technical factors ............................................................................................................................... 5 Economic factors............................................................................................................................... 5 Legal and regulatory factors ............................................................................................................. 5 Other factors ..................................................................................................................................... 6

Chapter 1: The Cross-Border Pipelines of the Former Soviet Union........................................................... 7 Introduction .............................................................................................................................................. 7 1.1. The Significance of Pipeline Transport and Transit ........................................................................ 7 1.2. Transit in International Law ........................................................................................................... 7 2 Oil Transport Tariff Methodologies for Cross-Border and Transit Flows ............................................... 9 2.1. Introduction ................................................................................................................................... 9 2.2. Allowed Profitability..................................................................................................................... 11 2.3. Cost-of-Service Methodology ...................................................................................................... 12 2.4. Negotiated Tariff .......................................................................................................................... 12 2.5. Transit Tariffs ............................................................................................................................... 13 3 Transport Tariff Methodologies for Domestic, Cross-Border and Transit Pipelines in Russia............. 13 4 Transit .................................................................................................................................................. 19 Chapter 2: Rockies Express Pipeline ........................................................................................................... 20 1.1 Introduction ...................................................................................................................................... 20 2 Technical Description ........................................................................................................................... 20 2.1 REX Entrega .............................................................................................................................. 20 2.2 REX West................................................................................................................................... 20 2.3 REX East .................................................................................................................................... 20 3 Traffic, Tolls, and Tariffs ....................................................................................................................... 22 4 Issues .................................................................................................................................................... 22 4.1 Market-based Toll Methodology .................................................................................................. 22 4.2 Form of Regulation........................................................................................................................ 26 4.3 Common Carrier Obligations ........................................................................................................ 28

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4.4 Impact of Express on IPL Apportionment ..................................................................................... 29 5 Transportation Agreements and Open Season Results ....................................................................... 30 Chapter 3: The Bolivia-to-Brazil (BTB) gas pipeline .................................................................................... 33 Introduction ............................................................................................................................................ 33 2 Oil Transport Tariff Methodologies for Cross-Border and Transit Flows ............................................. 34 2.1Background .................................................................................................................................... 34 2.2Project Leaders .............................................................................................................................. 34 2.3Finance ........................................................................................................................................... 35 2.4Engineering .................................................................................................................................... 37 2.5 Tariff .............................................................................................................................................. 42 2.6Regulatory framework ................................................................................................................... 47 Conclusion ................................................................................................................................................... 50 General findings: ..................................................................................................................................... 50 What Is Next? .......................................................................................................................................... 50 Bibliography ................................................................................................................................................ 52

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Summary
The international energy economy depends on the reliable operation of oil and gas pipeline networks; in many parts of the world, these pipelines are the arteries that bring energy supplies from wellhead to market, and any interruption to flows of energy can quickly have repercussions along the energy chain. Recent events have again demonstrated the importance of reliable transit both for oil and for gas, and it is therefore vital to minimize the risks that can affect cross-border energy supply and energy flows in transit. The key problems for the pipeline transport are the tariffs and the rules for access. The objectives of this study are to describe and analyze existing crude and oil product transport tariffs and methodologies as well as rules for access where relevant for existing and new cross-border oil pipeline systems across countries. Essential technical and economic elements influencing costs of oil and products pipeline transportation are described, as well as typical tariff methodologies. Amounts and methodologies of oil pipeline tariffs are examined and, where relevant, cross-border tariff regimes are compared with those for domestic transport.

General findings
Transit tariffs across the countries examined show a wide range of variations. Cost-reflective tariffs and negotiated tariffs are the two methodologies used. Transit tariffs are typically subject to negotiations. Specific requirements of a pipeline project may require the setting of tariffs for short or a longer term. The analysis of existing tariffs (i.e. transit, export and domestic tariffs) and underlying methodologies involves detailed examination of various factors, including a number of technical, economic, financial, geographical and legal / regulatory parameters. This would include, among others:

Technical factors:
1. Pipeline design parameters such as capacity, diameter, length, pressure; 2. Actual utilisation rate (load factor); 3. Composition / density.

Economic factors:
1. Costs, including financing cost (premium for political / country risks); 2. Valuation of assets by replacement costs vs. book value; 3. External factors such as fluctuations in world steel prices, labour cost, inflation, and currency rate.

Legal and regulatory factors:

1. Negotiated systems vs. regulated systems; 2. Pipeline access rules; 3. Transparency rules;

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4. Access to congested pipelines; 5. Cost allocation in case of establishment of additional capacity.

Other factors:
1. Climatic and natural conditions, including terrain, of the pipeline route and the associated costs; 2. Types of transit system: Pure transit line with no supply to transit country; transit line with some supply to transit country; 3. Pipeline ownership: Ownership and operation by state / state companies, by private investors or joint ownership; 4. Quality management (commingled stream vs. batch operations and related investment costs).

Among various cost elements included in the tariff calculation, the two essential factors that have a significant impact on transportation / transit tariffs are pipeline throughput capacity (which is a function of pipe diameter) and utilisation rate. Different tariffication methodologies may be chosen by governments at the national level, taking into account of the particularities of the countrys transportation and transit system. Application of different methodologies and particularities of each case may lead to differences, sometimes by significant margins, at the tariff levels between two transit cases or between domestic transport and transit of comparable movements. Varying aspects of a particular movement can create a wide range of tariffs, even under a methodology which is compatible with efficient system operation and adequate profits. With respect to comparison of transit and export / domestic tariffs, it is difficult to find comparable flows. Each case requires detailed assessment of particular transit and domestic transport under different approaches and circumstances. Lack of transparency of transit tariffs is an important challenge. In most of the countries, such tariffs are negotiated at the state level and set through intergovernmental agreements. Such negotiations are often conducted under strict confidentiality and the outcomes are often not revealed to the public. In the countries where pipeline transport of oil is regarded as natural monopoly, access and tariffs for domestic transport are regulated by the state and they are often published. In the Western Europe, oil transport activities are commercially driven among private actors without state interference and only subject to general competition rules of the EU and the country itself. But the information on tariffs is then considered to be confidential and is not publicly available. The lack of transparency makes a thorough assessment of the degree of cost-reflectiveness of transit tariffs difficult. The peculiarities of each transit case associated with its technical, economic, geographical, legal / regulatory and other characteristics would result in a range of possible costreflective tariffs. 6|Page

Chapter 1: The Cross-Border Pipelines of the Former Soviet Union

Introduction
1.1. The Significance of Pipeline Transport and Transit
Most of internationally traded oil is delivered by marine tankers. This transportation option allows for high flexibility in delivery routes, distances, volumes and quality needed. Compared to tankers the pipeline represents a much more rigid transportation option, usually locked down to an oil production site / region or a final consumer, a refinery or a sea port terminal. It may have less options to deliver different quality grades of the crude desired by the consumers, can only deliver volumes limited by the throughput capacity, requires a line fill quantity (which can be significant) to enable the operation. Such demanding requirements notwithstanding, pipelines play a significant role in the international crude oil logistics. They allow exploring remote oil fields and are a much cheaper and convenient option, for instance, compared to railway. This is especially important for landlocked territories with no or limited access to the sea. Thanks to the construction of pipelines, the last two decades have seen the emergence of new suppliers on the world oil market. For the latter secure and economical transit through third countries in order to access world markets is of critical importance. This explains their interest in binding multilateral rules to govern energy transit. This study analyses the methodology for oil pipeline tariffs and the actual rates with a special emphasis on the phenomenon of transit. The findings will be used to provide the reader with an understanding in how far energy in transit is treated in a non-discriminatory way in comparison to domestic flows. The background for this interest is the binding provisions of the Energy Charter Treaty of 1994 on transit and the specific rules of the draft Transit Protocol requiring non-discriminatory treatment of energy in transit.

1.2. Transit in International Law

From GATT to the Energy Charter Treaty Reliable transit of energy is a critical issue for regional and global energy security, as energy is increasingly transported across multiple borders on their way from producer to consumer. Common rules and close cooperation among states and private companies are required to secure energy flows in transit, to develop and operate energy transport facilities and to make transit of energy commercially viable. Such rules may serve the interests of all stakeholders in the energy supply chain: energy producers and consumers in securing and diversifying sales and purchases, and transit countries in increasing the attractiveness of supply routes through their territory. The findings of this study on transit of oil and oil products will be assessed against the background of international law. 1.2.1. Transit in GATT The general international rules on transit are set out in Article V of the General Agreement on Tariffs and Trade (GATT 1947). The article stipulates the following principles: 7|Page

Freedom of transit through the territory of a member country via the routes most convenient for international transit; Non-discrimination based on nationality, ownership, origin / destination, or entry / exit; Transit without any unnecessary delays or restrictions; Most-Favoured-Nation (MFN) treatment to goods in transit; and Transit traffic shall not be a source of fiscal revenue.

In particular, Article V sets out specific requirements regarding charges on transit. According to Paragraph 3 of the article, traffic in transit is exempt from customs duties, and except for transportation and administrative expenses no transit duties or other charges may be levied in respect of transit. All charges have to be reasonable, having regard to the conditions of the traffic (Para 4), and nondiscriminatory (Para 5). 1.2.2. Transit in the Energy Charter Treaty The Energy Charter Treaty (ECT), which entered into force in 1998, further developed international transit rules in energy sector. The ECTs transit provisions establish in Article 7 an obligation for the contracting parties to facilitate the transit of energy materials and products consistent with the principle of freedom of transit from GATT. Furthermore, they explicitly cover grid-bound energy transport facilities, including: High-pressure gas transmission pipelines; High-voltage electricity transmission grids and lines; Crude oil transmission pipelines; Coal slurry pipelines; Oil product pipelines; and Other fixed facilities handling energy materials and products.

Under the ECT the parties shall treat in their provisions energy materials and products in transit no less favorable than those originating in or destined for their own area. They shall not place obstacles in the way of new capacity being established in energy transport facilities if transit cannot be achieved on commercial terms. The ECT furthermore provides for a conciliation procedure in the event of transit disputes. Negotiations on a specific Transit Protocol under the ECT resulted in draft binding provisions related to the utilisation of available capacity for transit, transit tariffs and the construction, expansion, and operation of energy transport facilities used for transit. Due to fact that regulation first and foremost of the gas sector has developed at different pace in the Energy Charter member states a final text could however not be agreed. Important basic provisions of the draft Transit Protocol however remained generally undisputed. This may be said about Article 10 on transit tariffs, which is relevant for the subject of this study. According to this draft Article, transit tariffs and other conditions shall be objective, reasonable, transparent and 8|Page

non-discriminatory and based on operational and investment costs, including a reasonable rate of return. They shall not be affected by market distortions resulting from transit countries abuse of their dominant positions. The Energy Charter Conference, the governing body of the Energy Charter, further pursues the objective of developing specific binding rules on energy transit to the benefit of existing and future energy corridors. In parallel, it has developed Model Agreements to facilitate cooperation between states and private entities in developing cross-border oil and gas pipelines as well as electricity projects. The texts of these Model Agreements can be found on the Charters website www.encharter.org.

2 Oil Transport Tariff Methodologies for Cross-Border and Transit Flows

2.1. Introduction
Before looking into oil pipeline access regime in the countries that form the object of investigation, this section briefly describes history of regulatory developments in the US, where oil pipeline has been under the federal regulatory oversight since 1906. In early days of modern oil industry in the US, Standard Oil, founded by John D. Rockefeller in 1870, was establishing a monopoly by controlling refineries and oil transportation. There was public outrage against Standard Oils monopoly (which ultimately led to break-up of the company in an anti-trust suit in 1911) and then president Theodore Roosevelt enacted the Hepburn Act of 1906. The act brought oil pipelines under the Interstate Commerce Act of 1887. Under the coverage of the Interstate Commerce Act: Interstate oil pipelines must be common carriers, Tariffs must be just and reasonable, Undue discrimination and preferences are prohibited, and Carriers must report to the federal authority and post tariffs publicly.

However, the act left the following unregulated: Construction and abandonment of oil pipelines, Sales and leases of oil pipeline assets, and Securities transaction of pipeline companies.

Most former Soviet Union countries have chosen to adopt the natural monopoly model on oil pipelines in their countries. These governments have established rules of non-discriminatory access to services and tariffs. In the rules the main specific features of the economic mechanism in oil transportation system are equal access and control of pipeline tariffs. It is also important that the systems be open and transparent, in order for the pipeline capacities to be allocated fairly and for the shippers and public to be informed.

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As earlier mentioned there is no unanimity in considering oil and products pipelines as natural monopolies or not. This heavily impacts the concept of the tariff setting regulation in different countries. If there is no monopoly there is no need in special tariff regulation and commercial relations between pipeline operator and a supplier are covered by civil law. Thus the tariff is the product of commercial negotiations or there can be no tariff at all, if the pipeline serves the needs of its owners. In the latter case the costs of service are merely distributed among suppliers. Analyzing costs of service a deeper look into pipeline economics is necessary. There are several factors impacting the cost of transportation. 2.1.1. Capacity Utilization and Pipe Diameter The pipeline diameter makes a significant impact on the value of a unit delivery cost(per metric ton of oil). There is a formula that capacity of a pipe is equal to the square of its radius. However according to the existing technology regulations the optimum throughput capacity is rather proportional to the diameter for the power of 2.5: Optimal D 2.5 The excerpt from the existing technology regulations is shown below.
Table 1: Existing Technology Regulation

Throughput capacity, mb/d (MT/Y) 0.08-0.18 (4-9) 0.14-0.26 (7-13) 0.22-0.38 (11-19) 0.30-0.54 (15-27) 0.46-1.00 (23-50) 0.82-1.56 (41-78)

Diameter(outer), mm 530 630 720 820 1020 1220

Unit variable cost is lower when the diameter is larger. On fixed costs, depreciation is proportional to the square of the diameter. Although maintenance costs depend on the diameter, they are insignificant at the beginning of operations. Taking into account the share of depreciation in fixed costs, the tariffs decrease quickly when the diameter is larger. Thus the pipelines have significant economies of scale. The interrelation of the level of capacity utilisation and pipe diameter is as follows: In cases of comparable average capacity utilisation, delivery costs are less in those pipelines that have a larger hydraulic diameter. Considering the fact that the fixed costs constitute about 75% of the delivery cost, the level of capacity utilisation becomes critical. The less the utilisation rate of the pipeline, the more costs are attributed to a unit of oil or product moved through the system. Thus level of capacity utilisation is a decisive factor in the delivery cost. In view of the predominant share of fixed costs in the structure of delivery cost, a reduction in capacity utilisation will result in an increase in tariffs. 10 | P a g e

2.1.2. Impact of Other Technical Parameters Climatic and natural conditions, including terrain, affect construction costs and, subsequently, depreciation. Northern conditions significantly increase construction costs and make operation more costly requiring heating of facilities and in some cases of the crude oil. The terrain profile can also impact both construction and operations cost requiring for example more pump stations in mountainous regions and higher energy consumption. Quality control (except for quality control of petroleum product pipelines, which are primarily designed for transmission of different types of product) does not affect the tariffs significantly. Normally quality management issues are solved at the initial stage of the project. Pipelines are designed for either batch or commingled stream operation. Batch operation is the most natural solution. In this case the pipeline operates as it is designed and no extra expenditures are necessary. In case of commingled stream operation, quality management is usually aimed at stabilising oil quality at the output. Transneft is an example for this. Designed to serve the needs of the centralised economy of the former Soviet Union, it carries out distribution of quality within the centralised management of the pipeline system to the extent that production capacity and oil storage capacity allow. Other economic factors, such as prices for metal and fuel / power, have impacts on the cost of the fixed assets and expenses for delivery. The depreciation rate and depreciation policy are most significant. Another very important factor is the cost of financing. The service of borrowings made to facilitate construction works can significantly impact the economic performance of the pipeline company thus leading to tariff increase to cover financial expenses. The exchange rates fluctuations can also impact the economics of the pipeline if for example the currency of the tariff differs from the currency of the main expenditures.

2.2. Allowed Profitability

As earlier mentioned if the pipeline transportation is considered to be a natural monopoly the tariff setting issue is always in regulatory focus. Basically there are two main approaches in the methods of tariff setting: allowed profitability and cost-of-service. The allowed profitability methodology can be better understood with references to methodologies in the US. Legal basis of oil pipeline tariffs are the Interstate Commerce Act and Energy Policy Act of 1992. Interstate Commerce Act stipulates that oil pipeline tariffs should be just and reasonable. The methodology of setting oil pipeline tariffs has seen many revisions since 1906. The main issues were about establishing appropriate profit levels and defining a base for profit calculation. Tariffs are set at a level so that pipeline operations generate just and reasonable profits. Technically profit limitation is based on the rate-of-return methodology. The profit levels refer to dividend of companies in the competitive market. Discussions about the basis for profit calculation were what to include in the basis initial cost of fixed assets with or without depreciation, whether to consider inflation or not, to include a cost of the right to use land or not, whether to include current assets or not, etc. 11 | P a g e

2.3. Cost-of-Service Methodology

The easiest way to calculate a tariff is to sum up the real costs of oil delivery per section, their overheads and also rate of profit. The difficulty, however, is that cost accounting is undertaken in a company as a whole, but not by section. Therefore obtaining real costs per section is problematic. The accurate calculation of a pattern of transportation costs based on theoretical assumptions is virtually impossible because there is an established level of costs which differs according to the pipeline. These cost differences are not always explained by physical and technical aspects but often as a consequence of social, political, geographic and other factors, which are difficult to take into account. Experience shows that the planned costs at a particular section, whilst based on accurate assumptions, do not necessary coincide with real costs, and often significantly divert from them. The specific features of the Russian tax system can be taken as an example. They have resulted in strict regulations on the list of costs that can be included into the delivery cost. A number of required production costs, for example expenses for maintenance of inhabited areas at oil transfer stations, remote from residential areas, expenses for insurance of environmental damage, are allowed to be covered from net profit only. High inflation in Russia (in years 1992-1995 and 1998) and associated deposit banking rates prevented a sizeable profit in the regulated tariffs to occur. Consequently the Russian methodology of tariff setting incorporates a justified need for technical upgrading of the equipment, social development of a company and insurance into planned tariff proceeds. In all subsequent Russian tariff calculations for oil transportation this approach has been adopted. Thus, the pipeline tariffs must provide a company with tariff proceeds that are sufficient to reimburse operational costs. Additionally justified net profits required for normal production, economic activity and payment of taxes are required by law. The usual way of calculating the specific tariff is by division of tariff proceeds by the turnover.

2.4. Negotiated Tariff

An example of a negotiated tariff is an agreement between the pipeline operator and a customer. This is often the case in the countries that do not consider crude oil pipelines as natural monopolies. Although the negotiated tariff should also cover the costs of operation and provide for an amount of profit, there are known situations, when the negotiated tariff does not cover the actual expenses. This is to explain by the fact that not everything can be foreseen when agreeing to a formula-based or fixed tariff rate. The change in the business-environment like exchange rates or interest rates can easily make the economics of a pipeline unprofitable with tariff rates already agreed for a long term. This tariff type is also used in regulated environments when, for example, the transmission capacity of either a pipeline system or its separate section has to be expanded. The users of the system who do not use the services in particular (for example, a narrow section) will continue to pay an old tariff rate. The users, who need expansion, pay, in addition to the old tariff, a negotiated new tariff. The funds that a pipeline company gains from the negotiated tariffs are used to finance expansion arrangements of transmission capacity of the system (e.g., expansion of the narrow sections).

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The validity period of the negotiated tariff can vary from one to three or more years. This is quite obvious for a common law agreement, but extremely unusual for regulated tariff setting, as the general practice of regulated tariff setting is to revise the tariffs periodically, usually on an annual basis. This can be an obstacle for the financing of a new project where fixed rates are desirable. To mitigate this problem a methodology for long-term tariffs was developed. Long-term tariffs are established for shippers who presented guarantees to oil pipeline companies for transportation of minimum volumes of oil for the time period of pipeline capacity expansion or new construction. The period of validity of the long-term tariffs can be 5, 10 or even 15 years. Stable, transparent long-term tariffs fully correspond to the interests of the oil producing, oil processing and oil transmitting companies because they attract investments and significantly decrease the impact of inflation when transporting oil to the export terminals. They ensure investment gains and the repayment of investment-related credits.

2.5. Transit Tariffs

A tariff is the fee that is paid by a shipper for the use of a pipeline and is meant to cover the costs of investment and financing, operating and maintaining the pipeline as well as an element of profit for the operator. A transit tariff as understood in this study is a tariff paid for the use of a pipeline for transit. The tariffs are derived on the basis of cost of service and cover the required revenue of the pipeline operator which is normally subject to business tax. In addition or alternatively, some countries levy a government charge for transit essentially as a fee for the right of way through that countrys territory, as compensation for taxes not levied and for service rendered by the country (e.g. protection of pipeline, political / administrative resources, environmental risks). In the draft Transit Protocol of the Energy Charter it had been recalled that government charges need to be in line with Art. 5 GATT and be commensurate with administrative expenses entailed by transit or with the cost of services rendered. Whether a simple royalty payment to the transit country without any link to the cost of service would be in line with this requirement is questionable. This does not mean that the host country may not gain a profit from the construction of a pipeline through its territory. In addition to justified government charges or business tax (no customs duties) it could do so by becoming a party of the enterprise constructing and operating the pipeline. Payments are usually determined as a result of commercial negotiations on a governmental level as part of the Intergovernmental Agreement on Transit or in a Host Government Agreement with the pipeline owners.

3 Transport Tariff Methodologies for Domestic, Cross-Border and Transit Pipelines in Russia
Cross-Border and Domestic Crude Oil and Products PipelinesRussia was the first FSU country to have introduced methodological bases to define tariffs for oil delivery. Other FSU and even some East European countries followed suit taking the systems adopted in Russia as a model or a starting point. However the tariff methodology in Russia has undergone several changes and models borrowed by

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other FSU countries differ depending on the methodology version being active in the particular timeframe. That is why it is important to trace the developments in the Russian regulatory framework. Formally, the regulation of trunk oil and oil products transportation systems was to be started by the approval of corresponding Federal laws. Nevertheless, the Federal Law No.147-FZ On Natural Monopolies was approved only in August 17, 1995. But the Resolution No. 555 (dated by October 18, 1991) On the formation of Rosneftegaz Russian State oil-and-gas Corporation commissioned Rosneftegaz (an entity which included Glavtransneft) to introduce payment for trunk oil transportation services based on tariffs already in 1992. Within a short period of time the document entitled Methodology of Tariffs Calculation for oil transfer, reloading and filling-in trunk oil pipelines was worked out and agreed by the Price Committee under the Ministry of Economics of Russia. In December 1991 it was approved by the Minister of Fuel and Power of the Russian Federation. During the period 1992 to 1994 tariffs for oil transportation services were sanctioned by the Price Committee under the Ministry of Economics of Russia; then by the Committee for Pricing Policy, followed by the Ministry of Economics of Russia and Mintopenergo (Ministry of Fuel and Power) of Russia. In 1995-1996 tariffs were under the approval of Mintopenergo of Russia, and since October 1996 the Federal Energy Committee (later transformed into the Federal Tariff Service FTS of Russia), which was established as the body to control natural monopolies in the energy sector, has been in charge. The first domestic methodology of tariff calculation, which was developed in an extremely short period of time for various reasons, was unable to completely adopt the principles of profit formation, used in the countries with advanced market economies. The main provisions of the first Russian methodology of tariff calculation were based on the following concepts: Tariffs should provide a transport company with the means to cover objectively essential levels of costs for oil transportation, reloading and loading operations, and standard profits; Tariff proceeds should include appropriate amounts to cover all kinds of operational expenses, insurance charges for oil loss and ecological damage as well as profits to provide self-financing of the oil-pipeline transportation system, including investment requirements.

Significant differences between Russian and Western methodological approaches towards tariffs calculation (discussed in Chapter 2) created dissatisfaction among international investors and international organisations. The latter argued that these differences made Russian tariffs unpredictable, and the method used for profit calculation in tariff structure was not sufficiently transparent. This was one of the obstacles for the Russian oil industry to attract foreign investment. Discussions in 1997 aimed at developing a new (second) tariff methodology started. Subsequently, the adoption of this methodology became one of the obligations of the Russian party under the Third Loan for Structural Reorganisation of the Economy (SAL-3) from the World Bank. The new methodology was approved on 30 October 1998. According to the second methodology:

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The control of tariffs is based on the limitation of natural monopolists net profits through the profitability norm established under the ratio of allowed net profit; Tariffs are the only type of payment to be collected from a user of a trunk-oil-pipeline system for oil transportation services; Planned tariff proceeds should not provide an opportunity to accumulate cash for investment funds or development funds, aimed at the subsequent financing of new projects.

The development and introduction of the new calculation methodology of oil pipeline tariffs undoubtedly became a step forward both in theory and practice. The new methodological approach did not arouse objections from users, was supported by international organisations, and met conventional standards of world practices. However, due to a number of reasons (including the financial crisis in 1998), the compulsory introduction of the second methodology tariff calculation was not followed through. Attempts to adapt this methodology in day-to-day activities were not successful. It also failed to attract credits to fund new construction projects. Eventually, the second methodology was abandoned. In truth, it was a situation in which the methodology declared one thing, but practices did not correspond. In view of the situation the third methodology (Resolution of July 10, 2002 No. 42-/5) was worked out and approved by the Russian authorities. It legitimated tariff setting practices which had already been developed and used. These include: A two-tier tariff structure (the first for oil transfer and the second for services provided for order performance and dispatching) which had in practice been in place since May, 1999; Special tariffs (the Suhodolnaya-Rodionovskaya route, (2001, etc.); Limitation of the planned net profit which included the amount required to finance upgrading, reconstruction and trunk oil pipeline system development programmes and for other economically justified expenses; Negotiated and long-term tariffs (a long-term tariff had been working since 2001 in the trunk oil pipeline system for TOTAL of France, which had been working under a product sharing agreement).

This third methodology does not exclude an opportunity to use several methods of tariffs calculation such as indexing, cost-based, and competitive. However, the subsequent implementation under the third methodology revealed some shortcomings: Currency risks: tariff rates for dispatching and export orders were denominated in US dollars. The regulation body makes calculations based on the forecasted rate accepted in the federal budget. The official forecasts tend to be more optimistic than the reality turns out to be. Application of negotiated and long-term tariffs was not necessary successful. It became necessary to have more studies and detailed regulation.

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Taking into account the above, development of a new methodology was undertaken and on August 17, 2005 the FTS of Russia in its Order No. 380-/2 approved the Provisions on Definition of Services Tariffs for Trunk-Oil-Pipeline Transportation to replace the third tariffs calculation methodology. The fourth revision was a quite sophisticated document providing very detailed specifications of tariff calculations procedures of all possible tariff types. The summary of the methodology can be given as follows. The unit tariff rate is calculated as the Planned tariff proceeds divided by the Planned turnover. The Planned tariff proceeds are a sum of Allowed costs, Profit limit and Taxes. The Planned tariff proceeds are determined by two methods. In the first case, the amount required for financing of modernisation, reconstruction and development programmes, purchases of land and other economically justified expenditures are defined in the net profit. The essence of the second method is to set up the profitability norm, which is determined as a ratio of the planned net profit to the profitability base. Regulation of tariffs requires a separate account for expenses of the controlled activities. In other words, the net profit includes: Financing of economically justified programmes of technical modernisation and reconstruction of basic production assets which are not covered by depreciation charges; Reserves for dividend payments; Financing of other justified expenses.

While calculating tariffs, the following factors are taken into account: expenses for the materials used for production and economic needs; for electric power and heat power consumed; for labour payments basing on predicted number of the personnel; social allocations (uniform social tax); depreciation; rent; expenses for services of all types of transport; services rendered by other agencies (expenses for payment of communication services, departmental and outside security, legal, information, auditing, consulting, marketing and other services); expenses for capital repairs; for diagnostics; for personnel training; for labour safety and safety precautions; for insurance, including voluntary medical but not state pension insurance; for carrying out research and development studies, and technology improvement, including the development of branch standards, regulations and documents; balance of operational and non-merchandising incomes and expenses of regulation subject in the part referred to rendering of oil transportation services; other expenses in accordance with the laws of the Russian Federation. Tariffs for oil transportation services are set in ruble and, according to the decision of the FTS of Russia, tariffs can be fixed per 100 t/km, or, per 1 ton, or, per 100 ton. The following different tariff rates can be applied based on the type of operation: A tariff rate for performance order and dispatching of oil deliveries to refineries of the Russian Federation and participants of the Customs Union Agreement; A tariff rate for performance order and dispatching of oil deliveries across the borders of customs territories of the Russian Federation and participants of the Customs Union Agreement; A tariff rate for oil transfer;

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A tariff rate for oil reloading, discharging / loading, acceptance / release in each point of oil reloading; The rate of coordinated tariff; The rate of long-term tariff; The rate of competitive tariff; The rate of network tariff.

Coordinated tariffs can be set as an additional rate to working tariffs, in case of the necessity to undertake actions aimed at the expansion of throughput of a trunk oil pipeline system or increasing the reliability of its functioning when the expenses for such activities have not been taken into account in the planned tariff rates. Long-term tariffs can be set with the consent of trunk pipelines system users and under regulatory consents to conclude long-term contracts for oil transportation under the fixed tariff rate, depending on the current and perspective load of the tariff route. A long-term tariff is fixed for three-year period as minimum. Long-term tariffs can be established in foreign currencies. In the case when a certain tariff route has alternative ways of oil transportation, competitive tariffs can be set for the route in the form of the maximum tariffs rates or in the form of correlation with the cost of oil transportation along the alternative route as long as it does not contradict the principle of equal accessibility to trunk pipeline systems. Network tariffs can be set with a view of optimisation of freight traffic on separate routes of trunk pipelines, if there is more than one terminal point of oil delivery. Network tariffs are calculated per ton of oil shipped. This fourth methodology was adopted in the same year when the Law on Natural Monopolies was amended the way that it should be the responsibility of the government to issue methodology regulation on tariffs, which the FTS should follow. However the fourth FTS methodology remained in force for about two years, till in 2007 a decision was taken to align the legislation. The new methodology was adopted by a Resolution of the Government #980 dated 29.12.2007. It basically doesnt alter the previous FTS methodology. It makes it more generalised, less detailed and focuses only on main principles of the tariff settings. The Resolution of the Government #980 defines four methods of tariff setting: Economically justified costs of service; Economically justified return on invested capital; Maximum percentage ratio of transportation costs to alternative types of transport of the similar nomenclature of oil or oil products on similar directions; Indexing.

The essence of the mentioned principles is the same as was specified by the last FTS regulation. A new addition was made in 2009 to incorporate the possibility of a tariff that includes a combination of 17 | P a g e

transportation legs. This was necessary due to commissioning of the first stage of the ESPO pipeline. The first stage reached only till Skovorodino from where oil is loaded into railway tank cars and delivered by rail to Kozmino port. The amendment of 2009 made it possible to set a tariff for the whole route including the transportation by railway. Another important issue introduced by the 2009 amendment is the provision for network tariff implementation. It stipulates that tariff setting can consider the necessity to provide shippers from same region with equal conditions for crude oil transportation to different international markets taking into account the current pricing at those markets. This provision gives ground for implementation of a network tariff system, which can be constructed in different ways. A shipper will have a single tariff no matter the route he takes or the shipper will get tariffs, that will be calculated the way he gets the same revenue irrespective the route he takes. There is one more important novelty in the new methodology introduced by the Resolution of the Government #980. It covers products pipelines as well. The previous practice was to issue separate methodologies for oil and products pipelines. The preceding revision of basic principles and methods of tariffs calculation for oil products transportation by trunk pipelines was established by the Methodology approved under Federal Energy Commission (currently FTS) Resolution No. 314 of 16.10.2002. No. 70/5. The main principle of definition of the tariffs for oil products transportation by trunk pipelines is the conformity between planned incomes and expenses of products pipeline transportation companies. The expenses of products pipeline transportation companies are planned separately for each type of operations. The expenses cover: Economically justified expenses, including taxes and duties; Economically justified operational and non-merchandising expenses required for maintenance of normal industrial and economic activities; Expenses of a capital character; Payments of profit tax of the enterprise.

Expenses include material inputs, labour expenses, deductions for social needs, depreciation, other expenses (communication services; transport services; services of external security; expenses for technical diagnostics of a trunk-pipelines systems; deductions to repair fund; rent of the ground and land tax; expenses for insurance; taxes and duties; expenses for personnel training; deductions for scientific and research activities, experimental and design works and other expenses). To define tariffs for oil products transportation, the FTS of Russia approves the following maximum tariffs by type of operation for each products pipeline transportation company. The maximum cost of oil products transportation by trunk pipelines is defined in ruble per ton of oil products, if the stabilisation of oil products markets is necessary. The maximum specific rates of tariffs For oil products transfer services, these rates are defined in ruble per 100 t/km, dividing planned tariff proceeds for oil products transfer services by the planned value of commodity transportation work (freight turnover).

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For oil products discharge, reloading, filling and release services, these rates are defined in ruble per ton for each point of discharging, reloading, filling and release, dividing planned tariff proceeds for oil products discharge (reloading, filling and release) services by the planned volume of work for each terminal or tank farm. Maximum percentage ratio of transportation costs to alternative types of transport of the similar nomenclature oil products on similar directions.It should be noted, that despite the mentioned variety of tariff setting opportunities only the last method has actually been in use for all these years. The main alternative and competitor to the products pipelines is the railway thus the pipeline tariffs are set at approximately 70% of the related railway tariff. This has not changed with the adoption of the new Resolution #980.

It is worth to note that the principles of tariffs regulation and calculation are not necessarily applied in case of transit services.

4 Transit
Since 1996 the transit tariff for Azerbaijan oil, set under the inter-governmental agreement and corresponding transit contract between the Russian Federation and the Azerbaijan Republic, is in force. The tariff was fixed at a rate of US$15.67 per mt which is still in force. It has never been reviewed. Transit tariffs for Kazakhstan oil have been introduced since 1 January 1999. Originally, the logic of introducing special transit tariffs for oil producers of the Republic of Kazakhstan was based on the following circumstances. The Atyrau-Samara oil pipeline section served by Privolzhsknefteprovod (a Transneft daughter company) does not transfer any other oil but that from Kazakhstan. This oil pipeline is equipped with advanced heating facilities specific for Kazakhstan oils. Consequently, the expenses of Privolzhsknefteprovod for this oil pipeline constitute a significant part of the companys total expenses. Thus, actually Russian oil shippers were contributing to expenses of the Kazakhstan producers. Therefore these expenses were included into the tariff of the pipeline company. The volumes of Kazakhstan oil loaded through the system of Transneft grew steadily (from 0.18 mb/d (9 MT/Y) to 0.38 mb/d (19 MT/Y). In this connection Transneft had to expand the bottlenecks of its trunk oil pipelines system on a regular basis in order to allow the delivery of increasing Kazakhstan oil volumes. Taking into account these circumstances and based on current tariff calculation methodology the Federal Energy Commission (currently FTS) approved in Resolution No. 46/9 of 4 December 1998 a transit tariff. The amount of tariff (0.37 US dollars per 100 t/km) was calculated based on the expenses to be made to guarantee the transfer of Kazakhstan oil volumes. All revenues received by Transneft from transit of Kazakhstan oil are considered by the FTS of Russia as the additional financial sources during the following annual tariff setting session while calculating the domestic tariffs of Transneft. With the establishing in 2010 of the Customs Union of Russia, Belarus and Kazakhstan the rates for transportation of Kazakhstan oil were aligned with rates used for domestic producers. 19 | P a g e

Chapter 2: Rockies Express Pipeline

1.1 Introduction
The Rockies Express Pipeline is a 1,679-mile (2,702 km) long high-speed natural gas pipeline system from the Rocky Mountains, Colorado to eastern Ohio. The pipeline system consists of three sections running through eight states. It is the largest natural gas pipeline built in the United States in more than 20 years, and one of the largest natural gas pipelines ever built in North America. The pipeline is operated by Rockies Express Pipeline, LLC, a partnership between Tallgrass Energy Partners, Phillips 66 and Sempra Energy. In February 2006, Kinder Morgan Energy Partners and Sempra Energy acquired Entrega Gas Pipeline Inc., from EnCana Corporation. In June 2006, ConocoPhillips acquired 24% of the project. ConocoPhillips spun off the downstream part of its business in May 2012.

2 Technical Description
The diameter of 1,679-mile (2,702 km) long pipeline system varies between 36 and 42 inches (910 and 1,100 mm). The capacity of the pipeline is 16.5 billion cubic meter (bcm) of natural gas per year. The whole pipeline costs around US$5 billion. The final section of the pipeline was completed on 12 November 2009.

2.1 REX Entrega

REX Entrega is the 328-mile (528 km) long former Entrega Pipeline between the Meeker Hub in Rio Blanco County, Colorado, and the Cheyenne Hub in Weld County, Colorado. Construction of this pipeline was authorized in August 2005. The pipeline project was acquired by Rockies Express Pipeline, LLC in February 2006. The 136 miles (219 km) long segment from the Meeker Hub to the Wamsutter Hub in Sweetwater County, Wyoming, is of 36 inches (910 mm) pipeline, which is in service since February 2006. The 192-mile (309 km) long segment from the Wamsutter Hub to the Cheyenne Hub in Weld County, Colorado, is of 42 inches (1,070 mm) pipeline, which is in service since February 2007.

2.2 REX West

REX west is a 713-mile (1,147 km) long 42 inches (1,070 mm) pipeline from Weld County, Colorado, to Audrain County, Missouri. It has a 5-mile (8.0 km) long 24 inches (610 mm) branch connecting pipeline with the Williams Energy owned Echo Springs Processing Plant. On 31 May 2006, the Rockies Express Pipeline filed an application to construct and operate this section. The construction approval was issued by the Federal Energy Regulatory Commission (FERC) on 20 April 2007. The first 503-mile (810 km) long segment of this pipeline was commissioned on 27 December 2007, and the second 214-mile (344 km) long segment was commissioned on 16 May 2008. It is in full service since 16 May 2008.

2.3 REX East

REX east is a 638-mile (1,027 km) long 42 inches (1,070 mm) pipeline from Audrain County, Missouri, to Clarington in Monroe County, Ohio. The Rockies Express Pipeline filed an application to construct and operate this section on 30 April 2007 and the FERC issued approval on 30 May 2008. There are seven new compressor stations and 19 meter stations along this section, as well as 13 interconnections to 19 other inter and intra-state pipelines. To transport the gas towards the north-east, 20 | P a g e

several expansion projects were suggested. A north-east express project that will extend 604km (375 miles) from Clarington and Lebanon, Ohio to Princeton, New Jersey, will be completed by late 2010. A separate project, Time III, will connect the Rockies Express pipeline with the Texas Eastern Transmission pipeline, which is owned by Spectra Energy.Scheduled to start by November 2010, this project will expand the annual capacity of the Texas Eastern Transmission pipeline by 4bcm and carry Rocky Mountains gas to Pennsylvania.

Figure 1: Express Pipeline Project

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3 Traffic, Tolls, and Tariffs

Express applied for an order approving a market-based toll methodology as well as an order designating Express as a Group 2 company for purposes of NEB toll and tariff regulation. The Company filed a draft crude petroleum tariff which included toll schedules and pro forma transportation service agreements. The proposed initial tolls for the Canadian portion of the Express Pipeline are as follows

Table 2: Proposed Initial Tolls on Express Hardisty to Wild Horse CRUDE TYPE LIGHT MEDIUM HEAVY 3.461 (0.550) 3.738 (0.594) 4.153 (0.660) UNCOMMITED 5 YEARS 2.921 (0.464) 3.155 (0.501) 3.505 (0.557) COMITTED 10 YEARS 2.704 (0.430) 2.920 (0.464) 3.245 (0.516) 15 YEARS 2.380 (0.378) 2.570 (0.408) 2.856 (0.454)

$US Per Cubic Metre ($US per Barrel) These tolls represent a pro rata share by pipeline length of the full tolls from Hardisty, Alberta to Casper, Wyoming. The tolls appearing in Table 1 for light crude were drawn directly from the tariff documentation, while the tolls for medium and heavy crude were calculated by the Board based on the 8 percent and 20 percent surcharges cited in the tariff. Express noted that these surcharge levels match those of IPL. The draft tariff also provides that Express can escalate the contract tolls by up to 2 percent per year1. As further explained in next section, the uncommitted toll is planned to vary in response to market conditions. As further detailed in Chapter 6, during the autumn of 1995, Express conducted an open season whereby all potential shippers were given an opportunity to submit bids for capacity. The open season resulted in shippers entering into long-term transportation service agreements for approximately 85 percent of the available capacity. 4 Issues 4.1 Market-based Toll Methodology Express proposes to have its tolls set on a market basis rather than derived using a traditional cost-of service approach. The Company argued that the concept of rate base and cost-of-service recovery on 22 | P a g e

an annual basis is therefore not relevant to its project and, accordingly, did not provide toll information in the format contemplated by the Boards Filing Guidelines. Express indicated that the notional cost-ofservice toll for the first year of operation would have been in the $1.70-$1.75 (U.S.) per barrel range for transportation of light crude from Hardisty to Casper. This initial toll was considered by Express to be higher than what the market would bear and led the Company to explore alternate approaches. In developing its proposed tolling structure, Express sought to balance a number of sometimes competing objectives, as follows: Fairness to both tollpayers and project sponsors, in the context of a new pipeline; The legislative requirement to establish "just and reasonable" tolls; The need to develop tolls which are market responsive, reflect service enhancements offered by Express, and are competitive with alternate pipeline delivery systems; The need to bring an element of stability and predictability to the tolls, while at the same time being responsive to the competitive market; The necessity of charging rates that would yield an acceptable return to the pipeline sponsors over the economic life of the facilities given the level of risk assumed; and The desire to obtain a degree of firm support from third party shippers and the corresponding need for a toll incentive to promote longer term commitments. In its evaluation of the appropriate levels at which its tolls should be set, Express examined: Tolls and other service factors impacting shippers transporting Canadian crude oil from Hardisty to Casper/Guernsey in PADD IV and from Hardisty to Wood River/Patoka in southern PADD II; The level of tolls required to provide an acceptable level of return to Express over the life of the Project; and The requirement for Express to obtain firm shipper support for the Project. In making its evaluation, Express was aware that, if its tolls were not competitive, prospective shippers would seek out other transportation alternatives. Express was of the view that shippers willing to commit to term service should receive secure access to the markets served. Express also considered that longer term shipper commitments provide critical support for the financing of the pipeline and therefore justify lower tolls. In order to provide a range of options, Express chose to offer shippers term contracts of 5, 10, and 15 years with corresponding tolls of $1.35, $1.25 and $1.10 U.S. per barrel for shipment of light crude from Hardisty, Alberta to Casper, Wyoming. Express offered shippers who chose not to enter into term service agreements an apportioned month to month service with a competitive toll at the upper end of the range of competitive tolls ($1.60 U.S. per barrel for light crude). The complete toll schedule follows:

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Table 3: Proposed Initial Tolls on Express Hardisty to Casper CRUDE TYPE LIGHT MEDIUM HEAVY 10.063 (1.60) 10.868 (1.73) 12.076 (1.92) UNCOMMITED 5 YEARS 8.492 (1.35) 9.171 (1.46) 10.190 (1.62) COMITTED 10 YEARS 7.862 (1.25) 8.491 (1.35) 9.434 (1.50) 15 YEARS 6.919 (1.10) 7.473 (1.19) 8.303 (1.32)

$US Per Cubic Metre ($US per Barrel) Express argued that its proposed toll design meets the standards set out in Part IV of the NEBA of "just and reasonable tolls" and "no unjust discrimination"1 as described below: All potential shippers had an equal opportunity to subscribe to each level of service and, accordingly, would be charged equally for services of the same description; The differentials in tolls between levels of services are rationally based; therefore, there is no unjust discrimination; All services are to be provided on a tariff basis; The process of offering term arrangements is open and transparent; and all shippers would be treated equally within each level of service. Express stated that although the level of return initially achieved may not be commensurate with the risk assumed, on a full life-cycle basis the expected return on the Express Pipeline would be acceptable, provided that Express was allowed to charge the market-based rates over the full life-cycle of the pipeline. Express also stated that the applied-for toll design was critical to the success of the Project, as the standard cost-of-service approach would fail to compensate investors for the risks taken. Accordingly, Express proposed this market-based toll design which provided a reasonable balance between the needs of shippers and Express's investors. As evidence of the Boards willingness in the past to be innovative with respect to tolling methodology, Express referred to the recent approval of the IPL/Canadian Association of Petroleum Producers ("CAPP") incentive tolling proposal. Express also noted that in the case of Cochin Pipe Lines Ltd. ("Cochin"), the Board accepted tolls based on a semi-depreciated rate base, in order to provide a tariff profile consistent with market constraints. Likewise, in the case of Interprovincial Pipe Line (NW) Ltd. ("IPL (NW)"), the Board approved a tolling methodology negotiated between the carrier and its shippers.

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During cross-examination, Express confirmed that FERC approval of the tolls and tariffs for the U.S. portion of the pipeline will be required prior to the commencement of service. The Company rejected the suggestion that any approval granted by the Board be made conditional on FERC approval of the rates. Several parties were concerned that Expresss tolls and its rate of return on equity under the proposed market-based methodology would be excessive. Amoco referred to the statement by one of Expresss witnesses that the 15-year contract rate would offer Express a reasonable return even if that rate applied to every barrel on the system. Amoco argued that a regulated pipeline is entitled to earn a reasonable return, and that if Express would earn a reasonable return in the case where all barrels paid the 15-year toll, then by definition, any revenue generated above that point would increase the return beyond reasonable. Amoco suggested that Express did not deserve the assurances it sought that the applied-for toll structure would not be changed by the Board over the life-cycle of the Project, since the Board is not aware of what the return to the owners will be over the life-cycle of the Project. Imperial pointed to an Express exhibit which indicated that, under a certain set of assumptions (which had been specified by Imperial), the internal rate of return would be 13.8 percent over a 20-year project life rather than the 11.0 percent figure that had been mentioned by the Company earlier in cross-examination. The Friends of Express ("FOX") argued that Express would not be free to earn excessive rates of return because the Company would continue to be subject to regulatory oversight by the Board. FOX noted that Express would have to re-appear before the Board if it expands its pipeline or if contracts are up for renewal, and would be subject to financial reporting requirements as a Group 2 company. A number of parties were of the view that Expresss tolls were not market-based and, therefore, would not be competitive in the market. These parties argued that the tolls for committed volumes were not market-based because they were simply a snapshot of what a very small portion of the market was prepared to accept, and they would not be responsive to changing market conditions, as the tolls would be fixed for long periods of time. The parties further submitted that there was no competition constraining the uncommitted toll, since there were no good alternatives to the Express Pipeline. FOX submitted that the fact that the Express shippers have signed binding agreements is evidence that the Express tolls are highly competitive in the market. FOX stated that the shippers were not interested in the cost-of-service approach, but that they were looking for a balancing of risks with Express. FOX further submitted that, although no other pipeline alternative could provide the benefits of Express, the Express Pipeline would still have to be competitive vis-a-vis other systems in the various markets it would serve. Imperial Oil Limited ("Imperial") argued that Express should be required to prove that it would not have market power in the markets that it intends to serve. Imperial argued that under the FERC rules, an oil pipeline seeking to charge market-based rates in the U.S. would be allowed to do so only if it demonstrated that it lacked market power. Imperial stated that, in order to do this, a pipeline would have to prove that there are several "good" alternatives to the pipeline seeking market-based rates. 25 | P a g e

Imperial argued that in order to be considered a good alternative, the alternative pipeline must be one that is available soon enough, at a price that is low enough, and has a quality high enough to allow customers to substitute the alternative service. Imperial also argued that market-based tolls are not appropriate for the Express Pipeline because in times of excess pipeline capacity, the cost-of-service based tolls on alternate pipeline systems would increase, thereby allowing Express to increase its tolls without any corresponding increase in its costs. Furthermore, in times of pipeline capacity shortage, Express would be able to charge whatever tolls the market would bear. Imperial argued that the Board must be convinced that a market-based toll methodology would result in just and reasonable tolls in the future before it commits to this toll methodology for the life of the pipeline. Amoco Canada Petroleum Company Ltd. ("Amoco") and Imperial had concerns regarding the lack of cost-of-service information provided by Express. Amoco referred to the statement by an Express witness that as the tolls on a cost-of-service basis would be too high in the early years of the Project, the Company decided to apply for market-based tolls. Amoco submitted that this tolling methodology had been referred to at times as a "levelized toll". This approach was used in the case of Cochins tolls application where the return to be earned by Cochin was demonstrated to be reasonable in relation to the return that would have been earned over the life-cycle of the project under the cost-ofservice tolling methodology. Amoco submitted that apart from a demonstration that the Board is usually flexible in unusual situations, the decisions by the Board with respect to Cochins and IPL (NW)s toll applications did not provide a precedent for the Express toll application. In this case, Express had not provided the Board with any cost-of-service revenue forecasts to compare with the revenue that it would receive pursuant to the applied-for toll design. FOX and the Alberta Department of Energy ("ADOE") were of the view that Express should not be required to file cost-of-service information. These parties argued that since Express did not apply for cost-of-service tolls it was not obligated to file this information. They further argued that if other intervenors wanted to compare Express against a number of benchmarks, they were free to do so by filing evidence and asking information requests. Amoco also requested that the Board consider whether there would be discrimination between the uncommitted shippers and the contract shippers on Express in terms of access to the Platte Pipeline Company ("Platte") system. Amoco stated that the contract shippers would benefit from a joint Express/Platte tariff that would result in reduced costs of transportation to Wood River, but that Express had not proposed a similar joint tariff for the uncommitted shippers. IPL argued that the Board should consider whether the right to complain is a meaningful right, or whether it is a right at all, in the light of contractual commitments. IPL further argued that Express was seeking to have the Board approve contracts and toll methodology for the term of the contracts. IPL was of the view that the Board would fetter its jurisdiction by approving the fixed-price term contracts for 5, 10, or 15 years. 4.2 Form of Regulation 26 | P a g e

As previously noted, Express applied to be designated as a Group 2 company for purposes of NEB toll and tariff regulation. Given that the tolls for transportation service regarding committed volumes are subject to commercial arrangements between Express and its shippers, Express considered the Group 2 method of regulation to be the most appropriate. Additionally, given that the Board understands the manner in which the initial level of the uncommitted toll was derived, and also has a full understanding of the way in which Express proposed to change this toll from time to time, Express considers that the need for active regulatory monitoring would be minimal. Express argued that there was no reason to expose the Company to a higher level of regulatory burden. Express stated that it was aware that certain companies are categorized as Group 1 companies, yet their tolls are regulated on a complaint basis. Express argued that while this alternative would accommodate a number of Express's objectives, it would impose an unwarranted administrative and economic burden on Express. The Company pointed out that given the agreed-upon tolls that it will charge, there would be little information that the Board did not already know. Additionally, cost-ofservice type information on an ongoing basis would be neither available nor relevant. Express stated that it did not factor Group 1 regulation into its costs when calculating its tolls; therefore, any cost impacts associated with the form of toll regulation would have to be borne by the shareholders of the owner companies. In its calculation of its return, and other costs, Express assumed that it would be regulated as a Group 2 company and therefore would not contribute as significantly to the cost recovery process as it would under a Group 1 designation. The ADOE submitted that Group 2 regulation would be appropriate under the circumstances presented by Express. It argued that a significant portion of Express's throughput is contracted by shippers who have made an assessment as to the worth of the Express proposal, including the markets it accesses and the tolls it will charge to access those markets. The shippers making those assessments, and ultimately signing transportation agreements, have indicated that they are willing to assume the risk of a term contract with Express. The ADOE concluded that under the Group 2 designation, the Board would retain a reasonable level of oversight. Amoco was opposed to a complaints-only level of scrutiny for Express, whether as a Group 1 or a Group 2 pipeline, or as a modified Group 1 pipeline, such as Cochin. Amoco was of the view that the shipper contracts would prevent the holders of 85 percent of the capacity on Express from complaining to the Board. Amoco argued that such a complaint would be a breach of the shipper's contract with Express. The uncommitted shipper may be able to complain about its toll; but having regard to the assurances that Express is seeking for its toll design, the Board would be in a very difficult position if it were to receive such a complaint. Amoco submitted that the Board should increase the level of surveillance of Express, not decrease it. It also argued that Express should be responsible for its fair share of the Boards expenses. Imperial was of the view that Express should be granted Group 2 status only after it has demonstrated to the Board and others that it lacks market power in the markets that it will serve. Once Express has demonstrated that it lacks market power, it should be required to file on an annual basis its uncommitted toll, together with full information with respect to the tolls, tariffs, and capacity of 27 | P a g e

alternate pipeline systems that serve the same markets. Imperial considered that this information should be required in order to provide shippers with some benchmark against which they could assess whether the tolls set by Express are just and reasonable. In addition, such information would provide the necessary background upon which a shipper could base its complaint, and would provide an ongoing check to ensure that Express did not subsequently acquire market power. Without such information, Imperial was concerned that the burden of proof under the toll methodology proposed by Express would be changed from the proponent having to justify its tolls to the shippers having to prove that the tolls are unjust or unreasonable. Imperial was of the view that if Express was regulated on a Group 2 basis, the Board should set out strict information filing requirements in order to ensure that Express would provide the information necessary to enable shippers to make informed decisions regarding the appropriateness of Express's tolls. 4.3 Common Carrier Obligations Subsection 71(1) of the NEBA states that "Subject to such exemptions, conditions or regulations as the Board may prescribe, a company operating a pipeline for the transmission of oil shall, according to its powers, without delay and with due care and diligence, receive, transport and deliver all oil offered for transmission by means of its pipeline". Further, section 67 of the NEBA requires that a company "not make any unjust discrimination in tolls, service or facilities against any person or locality". Together, these provisions require that an oil pipeline offer service under the same terms and conditions to any party wishing to ship oil on its line. Express submitted that there is no conflict between long-term shippers holding secure access to its system and its obligations under subsection 71(1) of the NEBA. Express referenced the Boards statement in its GHW-5-90 and RH-3-90 Reasons for Decision concerning toll design for certain natural gas liquids facilities on the IPL system that "so long as a pipeline gives all parties the same opportunity, at the same time, to participate in a project or to avail themselves of a particular service, then that pipelines common carrier status is maintained". Express submitted that this reasoning would apply in this situation, where all parties were given the opportunity to sign up for long-term secure access during the open-season period. Express further referred to the Boards decision in the GHW-5-90 and RH-3-90 Reasons for Decision that the granting of unapportioned access to parties executing a Facilities Support Agreement would not be unduly discriminatory. Given the specific circumstances of its own application, Express argued that a similar finding by the Board would be appropriate. Finally, Express cited the Boards GH-4-93 Reasons for Decision concerning the Intercoastal project as a case where the project sponsors had entered into an alternate transportation agreement with the sole shipper contracting for capacity on the pipeline. The Board found this arrangement to be acceptable and not to constitute undue discrimination2. Express argued that its open-season process could be considered analogous to Intercoastals transportation agreement. No party had been excluded from

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participation in the process and the same terms and conditions were offered to all parties at the same time. FOX agreed with Expresss view that the conditions required by subsection 71(1) of the NEBA have been met. FOX referred to Expresss testimony that it would not be undue or unreasonable for a pipeline to offer preferential treatment to shippers who had provided financial commitments to a new pipeline project. The ADOE submitted that there would be no unjust discrimination against certain shippers because of the delineation of uncommitted and 5, 10, and 15 year tolls. The ADOE noted that all parties were provided an equal opportunity to avail themselves of the unique opportunity offered by Express to shippers who were willing to commit. Amoco requested that the Board give consideration to the fact that uncommitted shippers were not provided with the same opportunity as contracted shippers to access a through-tariff on the Express and Platte pipelines from Hardisty to Wood River. IPL argued that none of the cases cited by Express as setting a precedent for allowing long-term fixed price contract holders to have unapportioned access to the pipeline were correct. IPL submitted that there has been no Board precedent for offering fixed-price long-term unapportioned access and that allowing access under these conditions may result in initial shippers being treated preferentially in the future. 4.4 Impact of Express on IPL Apportionment Amoco, Imperial, Koch, and IPL argued that the construction of the Express Pipeline and its proposed operation as a contract carrier for term volumes would allow Express shippers to potentially exacerbate or manipulate the level of apportionment on the IPL system. The scenario that was described by these parties was as follows. On the presumption that the Chicago market will continue to provide the highest netback for western Canadian crude oil producers, most WCSB volumes (including those owned or controlled by Express shippers) will be nominated on IPL to Chicago, thereby creating apportionment on IPL. To the extent that Express shippers are successful with their IPL nominations, they will receive the higher netbacks in the Chicago market. To the extent that they are unsuccessful with their IPL nominations, they can then move their volumes on Express. However, in addition to their own volumes, they would now have access to the volumes of others who are unable to ship on IPL due to the apportionment caused, in part, by the Express shippers. Express shippers could then offer to purchase the third-party crude at a discount up to the maximum of the difference between the uncommitted toll which the third party would otherwise have to pay on Express and the contract rate for the Express shipper. Amoco recommended that, if Express is approved, conditions should be included to prevent this from occurring. Imperial suggested that the Board limit committed shippers on Express to renomination on

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Express after IPL apportionment to only those volumes which IPL rejects through the apportionment process. Express, on the other hand, suggested during cross-examination that its project may reduce apportionment on IPL by providing Canadian crude with additional markets. In reply argument, Express further submitted that the concern was hypothetical and that any apportionment problems that arise following the construction of the Express Pipeline could be addressed at that time. 5 Transportation Agreements and Open Season Results In the initial stages of assessing the viability of its project, Express determined that the project economics would not yield an acceptable return in the short term. Cost-of-service tolls would have been too high to attract shippers in the targeted markets and lower tolls would not allow Expresss sponsors to realize an acceptable return on their investment, given the project risk. To address these concerns, Express developed a tolling system whereby the risk could be shared between the project sponsors and the shippers through the use of long-term transportation contracts. These contracts offered shippers secure access to the Express Pipeline system, stable transportation costs, and lower tolls for longer term commitments in exchange for a commitment to pay tolls over the life of the contract. In exchange for offering lower tolls and secure access, Express gained a more reliable and stable revenue stream and a long-term commitment from third parties, resulting in potential savings in financing costs and a demonstration of the long-term need for the Project. Express concluded that this risk-sharing arrangement would be attractive to both shippers and the project sponsors. Express conducted an open season during the autumn of 1995 to solicit contractual support for its project from potential shippers. In exchange for signing a long-term transportation agreement, potential shippers were offered unapportioned access to the Express Pipeline for a period of 5, 10, or 15 years at progressively lower tolls (as detailed in Chapter 4). The initial open season began on 12 September 1995 and closed on 27 October 1995. On 27 November 1995, Express announced that in response to concerns raised by participants in the open season, it had made revisions to the transportation service agreements and its tariff. A supplemental open season was held between 28 and 30 November 1995. On 15 December 1995, Express filed the results of its open seasons, which are presented in Table below. In argument, Express stated that its project would not have proceeded without this contractual support. In Expresss view, the results of the open season provide real and demonstrated evidence that other parties see a need for the Project, and that they are prepared to show their support through financial commitments. Table 4: Open Season Results Term Number of Contracts Volumes

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5 Years 10 Years 15 Years

6 2 6 Total

30,000 b/d 4,000 b/d 112,000 b/d 146,000 b/d

During the hearing, Imperial made a motion to direct Express to provide specific information for each of the contracts signed. Specifically, Imperial asked Express to identify the contract term, the volume commitment, whether the shipper is a refiner, producer, or marketer and if the shipper is a refiner, where it is located, and finally, whether or not the shipper is a related party to Express, AEC, TCPL, or any of their affiliates. During argument for this motion, Imperial revised its motion by requesting that refiners who are committed shippers only be identified as being located in PADD II or PADD IV. Imperial argued that this information was necessary because the extent and nature of the commitments between Express and its shippers was a cornerstone of Expresss case that the proposed facilities are required by the present and future public convenience and necessity. Imperial noted that details of shipper contracts are routinely filed in other facilities expansion applications before the Board, and argued that the requested information would be required under section 47 of Part X of the Boards Filing Guidelines had Express not been granted an exemption from this section. Imperial also noted that the contracts themselves do not contain a confidentiality clause and that any party to a contract would have been fully aware of the possibility that the contracts could become part of the public record in a regulatory proceeding. Imperials motion was framed so that the information requested would not reveal the identity of the shipper, only the terms of the contract and the type of company. Imperial was supported in this motion by Amoco, Koch, and IPL. All parties in favour of the motion expressed the view that without this information, the Board would not be able to determine the level of actual third-party support for the proposed facilities. Express noted that the results of the open season had been filed in an aggregate fashion, along with the pro forma contracts and the open season documents, and argued that this was the appropriate way of providing information on shipper support. Express argued that the information which was requested in this motion would seriously prejudice shippers ability to negotiate commercial transactions. If a downstream buyer knew one seller of oil was committed to pay demand charges on Express, that buyer would be in a strong position because they knew the shipper had an incentive to ship the oil. When Express initiated its open season, all bidders were assured that their bids would be confidential, unless Express was otherwise directed by the Board. Express noted cases in which parties requested that the Board compel an applicant to provide confidential information but the Board protected the confidential information because of a commercial sensitivity. In Expresss view, no party to the hearing would be prejudiced if the detailed information about the results of the open season were not filed. Express was supported in its arguments by FOX and the ADOE.

31 | P a g e

After hearing argument on the question of whether or not that information should be produced, the Board asked parties to consider the applicability of the confidentiality provisions found in the NEBA and the CEAA, specifically section 16.1 and subsection 35(4) respectively. Parties were asked to address argument to that question prior to the Boards decision on whether or not it would direct that the requested information be produced. A summary of these arguments was provided in the text of the Boards ruling, reproduced in Appendix III. The Board ruled that Express should provide to the Board the information as set out in Imperials revised motion. This information was provided to the Board and, after examining it and the arguments made concerning the applicability of the confidentiality provisions of the NEBA and the CEAA, the Board came to the conclusion that Express met the onus under the NEBA for the information to be received on a confidential basis. Amoco stated that it would like to see direction from the Board with respect to the renewal rights which go along with the transportation contracts between Express and its shippers. These rights may provide shippers with an advantage in addition to unapportioned access to the pipeline. Imperial, Koch and IPL argued that there should be significant representation among committed shippers from downstream refiners. The absence of these downstream commitments would show a lack of a market pull for the Express Pipeline. Imperial submitted that if significant volumes of crude oil are contracted to affiliates of Express, thirdparty contracted shippers could be harmed. For example, an affiliate holding capacity for 15 years could help Express by reselling its capacity to an uncommitted shipper at the 15-year rate and nominating its displaced volumes to uncommitted service. IPL argued that the Board should exercise extreme caution in assessing how it views Expresss transportation contracts. It noted that despite years of development, Express has only been able to attract 12 shippers for less than 10 percent of western Canadian production to its proposed system. IPL and Koch argued that if any significant portion of the contracted space is to affiliates, the Board should consider that these agreements are not like third-party agreements. In IPLs view, these agreements should be discounted entirely. In order to assess what the contracts mean, IPL submitted that the open season should be re-opened to establish whether or not the contracted shippers would re-affirm their dedication to Express in light of recent events, such as the establishment of the Lakehead/Mobil/Shell joint tariff. FOX submitted that a re-opening of the open season would be totally unwarranted since the contracted shippers are sophisticated parties and these recent events were well known in the industry before the close of the open season.

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Chapter 3: The Bolivia-to-Brazil (BTB) gas pipeline

Introduction
The Bolivia-to-Brazil (BTB) gas pipeline is 3,150 km long including a 557 km portion from Santa Cruz de la Sierra in Bolivia, to the Bolivian border near Corumb in Brazil, which is owned and operated by the Gas Transbolivariano S.A. (GTB). On the Brazilian side, the 32-inch pipeline continues from Corumb to So Paulo, and then with a smaller diameter(24-16inch) pipeline to Porto Alegre; it is owned and operated by the Trasnportadora Brasileira Gasoduto Bolivia-Brazil S.A. (TBG). The pipeline flows through 5 Brazilian states and 135 municipalities (11 in Mato Grosso do Sul state, 70 in So Paulo, 13 in Paran, 27 in Santa Catarina and 14 in Rio Grande do Sul). Total investment is estimated at US$ 2,154 billion, of which US$ 1,719 billion corresponds to the Brazilian portion of the pipeline. The gas pipeline has 16 compressor stations, of which four are in Bolivia (Izozog, Chiquitos, Robor, Yacuses) and 12 are in Brazil (Albuquerque, Guaicurus, Anastcio, Campo Grande, Mimoso, Rio Verde, Mirandpolis, Penpolis, Ibitinga, So Carlos, Araucria and Biguau). The stations are being installed gradually to accompany the increase in the volume of gas transported. At present the transport of gas is limited to 17 million m3/day. When all of the stations are installed the Bolivia-Brazil Gas Pipeline will reach its maximum capacity of 30 million m3/day.

Section Rio Grande/Puerto Suarez Corumb/Campinas Campinas/Guararema Campinas/Curitiba Curitiba/Florianpolis Florianpolis/Cricima Cricima/Porto Alegre Brazilian Total Bolivian Total General Total

Diameter 32

Length 557

Compressor station 4

32 24 24 20 18 16 -

1258 155 469 281 178 252 2593 557 3150

10

1 1

12 4 16

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2 Oil Transport Tariff Methodologies for Cross-Border and Transit Flows

2.1Background
Bolivia had been exporting gas by pipeline to Argentina since the 1970s, but new discoveries in Argentina decreased the demand for Bolivian gas. It was critical for Bolivia to find an alternative export market, since gas sales to Argentina represented 80% of Bolivias total gas production. It was thought that future gas exports to Brazil could represent 25% of Bolivias total export earnings. In 1991, the Brazilian and Bolivian governments decided to re-examine the gas export project, which had been an unrealized dream of both countries for some 40 years. (Bolivia has been producing natural gas since the 1960s.) After making a preliminary feasibility study, the two state monopolies, Petrobras and Yacimientos Petrolferos Fiscales Bolivianos (YPFB) signed an agreement in 1993 for the sale of 8 to 16 MMcm/d (283-565 Mcf/d) of natural gas over a twenty year timeframe In 1994, Petrobras, which was still obliged to take a controlling interest in any new gas transport company under prevailing Brazilian law, selected the BTB consortium formed by British Gas (BG), Tenneco (now El Paso) and Broken Hill Petroleum (BHP, whose participation has since been aquired by TotalFinaElf) to cosponsor the Brazilian transport company. The private partners soon began to tell the government that fair access to downstream markets and good pricing policies would be important for the project.In Brazil, the Hydrocarbon Law No. 9478 intended to dismantle the monopoly of Petrobras and open the sector to private competition was approved in 1997. The Law defines the objectives of the national energy policy and creates a federal regulatory agency for the hydrocarbon sector (Agncia Nacional do Petrleo, ANP).

2.2Project Leaders
Two independent companies were constituted for the construction and operation of the gas pipeline: Gs Transboliviano S.A. (GTB), a Bolivian company, and Transportadora Brasileira Gasoduto Bolvia-Brasil S.A. (TBG), a Brazilian company. TBG, a publicly-held company constituted on April 18, 1997, has the following stockholding structure:

TBG GASPETRO Petrobras Gas BBPB Holdings (1/3 BG, 1/3 TotalfinaElf 1/3 El Paso) Transredes ( 25% Shell, 25 % Enron, 50 % Bolivian Pension Funds ) 51% 29%

GTB 11% 4%

12%

51%

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Shell Enron

4% 4%

17% 17%

GTB, also a publicly held company constituted in 1997, at present has the following stockholding structure: Transporte de Hidrocarburos S.A. (Transredes) is a privately held Bolivian company formed in May 1997 to operate the monopoly in Bolivia on the transport of hydrocarbons for forty years. The companys capital is held in equal parts by Shell, Enron and Fundos de Penso Bolivianos. BBPP Holdings Ltda is a holding company and its capital is distributed equally among British Gas Americas Inc., El Paso Energy and Broken Hill Proprietary Company (BHP). The entire BTB project comprised three components: Component 1: Construction of the pipeline on the Bolivian side from Santa Cruz de la Sierra to the Bolivian border near Corumb in Brazil. Component 2: Construction of the main trunkline from Corumb to Campinas, including the lateral extension to Guararema and two compressor stations, and the southern leg to Porto Alegre, including two compressor stations. Component 3: All the soft costs related to the Brazilian section of the pipeline, including interest during construction, development and management costs, debt service reserve fund, and working capital.

2.3Finance
The initial gas supply agreement between Petrobras and YPBF only committed YPFB to supply up to 16 MMcm/d (565 Mcf/d), the project sponsors agreed to proceed with the larger capacity pipeline on the likelihood that additional supplies would become available, recognizing that a phased increase in compression would be needed to accommodate the higher throughput volumes.

Each of the sponsors would participate in both of the national transportation companies GTB in Bolivia and TBG in Brazil. Both companies have Petrobras as partner through its subsidiary Gaspetro; the BTB Group; Enron (Bolivia) C.V.; Shell and Fundos de Penso Bolivianos. 35 | P a g e

Between 1997 and 2000, private companies invested $1.9 billion in oil and gas upstream activities in Bolivia, with a further $530 million committed in 2001. According to the World Bank, this has led to a 700% increase in Bolivias proven plus probable gas reserves to 1,324 bcm (46.8 tcf) and these reserves are currently under active development by 14 private production companies with wide international representation in ownership, including PEB (the Petrobras subsidiary in Bolivia), Total, Repsol, British Gas and Pluspetrol.

Total investment for the project is US$ 2.154 billion, of which US$ 1.719 billion was made in Brazil and US$ 435 million in Bolivia. The project attracted domestic funding from the BNDES and Finame. Funding from outside of Brazil came from the multilateral credit institutions comprising the International Bank for Reconstruction And Development (IBRD), the Inter-American Development Bank (IADB), Corporacin Andina de Fomento (CAF) and the European Investment Bank (EIB). The International Finance Corporation (IFC) and export credit agencies (ECAs), such as Export Import Bank of Japan and others, also provided financing.

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2.4Engineering
Original Project is a 32 inches pipeline from Rio Grande (Bolivia) to the border between the two countries and from that border to Paulinia (SP). At this point, the pipeline narrowed to 24 inches to the eastern side to Guararema, where there is a connection to the Transpetro line to the metropolitan area of S.Paulo and to the State of Rio de Janeiro. The Northern line operates at 80 -100 bars. The section to Guararema operates at 50 - 75 bars. The southern section has three lines: 1. Paulinia to Araucaria (PR), 24 inches line, working gas at 70 - 80 bars; 2. Araucaria to Biguau (SC), 18 inches line, working gas at 50 - 75 bars; 3. Biguau to Canoas (RS), 16 inches line, working gas at 40 - 75 bars. The 2002 pipeline capacity 17.4 (106 )m per day was possible in the TBG side by using 4 Compressor Stations, total of 49,800 HP: 2 Compressor Stations (each has 3 compressors, 7,000HP each), one in Campo Grande (MS) and another one in Penapolis (SP), both in the northern line. In the southern section, it has 2 Compressor Stations: one in Araucaria 4 x 1200 HP, another one in Biguau 3 x 1000 HP. Both have reciprocant engines. To achieve 30.08 (106 ) m per day, TBG expansion is being completed this year 2003 in 2 stages: First, the capacity from 17.4 (106 )m per day to 24.6 (106 )m per day was done in January/2003, installing 3 new Compressor Stations in the Northern section: Miranda (MS), Trs Lagoas (MS) and S.Carlos (SP). Those Stations have, 2 compressors of 15,000 HP each one, total power of 90000 HP. Beyond that, 14,000HP were added by the fourth compressor units of Campo Grande and Penapolis, both with 7000 HP. Total power expansion: 104,000 HP.

Second, the capacity is being increased at this moment from 24.6 to 30.08 (106 )m per day, adding 5 new Compressor Stations, each composed by 2 compressors of 15,000 HP each, using turbines Mars 100 in Corumb (MS), Anastcio (MS), Ribas do Rio Pardo (MS), Mirandpolis (MS) and Iacanga (SP) Total power expansion: 150,000 HP.

So, after achieving 30.08 (106 )m per day, total Power will be 303,800 HP. There is no prediction for expansion in the Southern section. In other words, the Southern section is supposed to keep the same level of demand. There is a hypothesis under study, in which TBG could receive gas from Argentina into the State of RS. If this new project happens, TBG will offer reverse transportation service from South to North, shipping Argentinean gas from RS to SC and/or PR.

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The expansion to 34 (106 )m per day / 40 (106 )m per day has, as mentioned in item 5.2, been studied in 2 phases: 1st.phase: from 30 to 34.0 (106 )m per day, the more economical is to expand by the installation of the 5th compressor units of Campo Grande (MS) and Penapolis (SP) Stations and the 4th compressor units of the new Compressor Stations, adding more 164,000 HP to the system. 2nd phase: from 34 to 40 (106 )m per day, will require 500 km of loops with diameter of 36 inches operating at maximum pressure of 100 bars Operation of the Gas Pipeline The operation of the gas pipeline begins the moment that GTB receives natural gas from YPFB and takes it to the Brazilian border. At this point the commodity is delivered to TBG, which is responsible for its transportation to the networks of the state-level distribution companies in Brazil. These companies are responsible for the delivery of the gas to final consumers.

For all commercial purposes, the sale of the gas directly from YPFB to Petrobrs takes place at the border. YPFB is responsible for contracting the transportation company (GTB) for the Bolivian part of the journey. However, the payment to GTB for its services is made directly by Petrobrs in the name of YPFB. In Brazilian territory, Petrobrs contracts TBG and pays for the transport of the gas to the entry points (city gates) of the state networks. In addition, Petrobrs is also responsible for the sale of gas to the statelevel distributions companies.

Two types of contracts control the commercialization of Bolivian gas. The first type of contract governs the purchase and sale of the commodity and the second the transport of the commodity to the city gates in Brazil. The contracts are for blocks of transportation capacity.

The first block, called the Transportation Capacity Quantity (TCQ), is the volume of gas stipulated in the purchase and sale contract between YPFB and Petrobrs signed in 1993. In the contract YPFB agrees to sell and Petrobrs agrees to buy, on a take-or-pay basis, ever-higher volumes of gas. The level starts at 8 million m3/day and rises to 18 million m3/day in year eight, where it remains until year twenty.

In the same contract, YPFB makes available to Petrobrs a buy option for additional volumes of gas (to a maximum of 12 million m3/day) from Bolivian reserves, as long as Bolivia is able to supply this additional amount. The option links to the first 6 million m3/day a Transport Capacity Option (TCO) that can be 38 | P a g e

exercised by Petrobrs. Advance payment by Petrobrs guarantees it the right to transport 6 million m3/day of gas in excess of the TCQ amount for 20 years.

The transport capacity in excess of the TCQ and TCO volumes up to the pipelines maximum capacity of 30 million m3/day (i.e. 6 million m3/day) is referred to as the Transportation Capacity Extra (TCX). The supply contracts already signed between Petrobrs and state natural gas distributors provide for sale volumes that start at 4.1 million m3/day and rise to 22.5 million m3/day beginning in 2007. Of the total for 2007 still pending contract and sale are 3 million m3/day of TCQ, 4 million m3/day of TCO, and 0.55 million m3/day of TCX. Except for Mato Grosso do Sul, all other states that purchase Bolivian gas have closed contracts based on TCQ volumes. Of the 8.2 million contracted for 2007 by Mato Grosso do Sul, 5.45 million is for TCX volumes, 2 million for TCO and 0.75 million for TCQ.

Throughput Volumes Due to the macroeconomic difficulties experienced in Brazil during 1999, the gas market did not develop at the anticipated pace. This caused Petrobras and TBG to renegotiate the transport agreements according to revised expectations of the market. As a result,Petrobras reduced its TBG capacity commitment through 2002, while increasing its commitment for the subsequent period. Under the current signed gas transport contracts,the maximum throughput capacity of the pipeline will be reached by 2007. While this represents a speedier uptake of gas than anticipated at appraisal, current negotiations between Petrobras and TBG will further accelerate the flow ramp up and bring the fullcapacity utilization of the pipeline forward to 2003.

There were two main features in the pipeline transportation contracts. The if tenderedfeature guarantees YPFB that Petrobras will pay the agreed commodity price for specified quantities of gas that YPFB succeeds in delivering to the Brazilian border, whether or not Petrobas can market the gas. The ship or pay feature assures GTB and TBG that Petrobras or YPFB will pay the tariffs relating to specified quantities of gas to be transported on their pipelines, whether or not those quantities are actually shipped (unless the inability to ship or deliver gas results from an operational failure on the pipeline).The construction of the trunkline from Santa Cruz to Campinas to Guararema (Component 1) was completed in late March 1999, and commercial gas deliveries to Comgas commenced in June 1999. For the southern leg (Component 2) first commercial gas deliveries were made in March 2000, right after construction completion.

MARKET 39 | P a g e

The market supplied by the Bolivian Gas the Target Market is the Southeastern, Southern and Western regions of Brazil. Five States are attended directly and two others indirectly: Mato Grosso do Sul (MS), So Paulo (SP), Paran (PR), Santa Catarina (SC), Rio Grande do Sul(RS), Rio de Janeiro (RJ) the last one use the Transpetro pipeline system, which is interconnected to TBG

(Figure 1). Southern and South Eastern regions are the richest regions in Brazil, representing more than 75% of the Brazilian GDP. The reaction of the target market to the Bolivian Gas was not surprised, based on the industrial sector, vehicular natural gas and commercial users. In three years, such market absorbed around 12 (106 )m per day of Bolivian Gas, mainly the TCQ capacity and part of TCO in a daily basis. In other words, the previous estimate of demand in the MOU was very close to the real one.

The analyst says the gas price at the gathering station at Rio Grande will be $1.31/MMBTU when deliveries begin in 1999. Pipeline tariffs from Rio Grande to Sao Paulo are expected to amount to $1.60/MMBTU. "Short-term margins are expected to remain low," said Wood Mackenzie. "Major players such as Shell/Enron have invested heavily to enter into the Bolivia-Brazil gas chain because of the envisaged long-term strategic value of the assets.

These companies are willing to take the current low margins in order to reap the long-term benefits. The Brazilian market is the fastest growing market for gas in Latin America. Government controls are currently regulating the gas price in Brazil as a method to ensure rapid gas penetration of the energy market 40 | P a g e

Petrobras President Henri Philippe Reichstul recently met with Bolivian officials in a bid to persuade them to renegotiate the pricing mechanism for Bolivian gas. Currently, gas prices are tied to a basket of international fuel oil prices. However, as world oil prices have risen, the price of natural gas has risen as well, making Bolivian gas uncompetitive in Brazil. Sources say gas prices have risen from $1.13 per million Btus to a peak of $1.69 per MMBtu at the end of 2000 before easing in succeeding months.

Reichstul is asking Bolivian producers and the government to cut gas prices to around $0.90 per MMBtu, arguing that the lower price is needed to fend off competition from other companies eyeing Brazil and to assure the construction of additional generation capacity.

The Bolivian government said it would study the proposals, but local producers have flatly rejected the idea. In an apparent move to circumvent the local producers, Petrobras, recently signed a gas transportation contract with Bolivian pipeline company Transredes to move more than 210 MMcf/d of gas from its own fields in Bolivia to the Brazilian pipeline. This will enable the company to sell its own gas in Brazil, presumably at lower prices. The company would still have to pay itself the higher prices dictated by the Bolivian purchase contract, but buying its own gas for sale in Brazil would make the arrangement feasible.

TRANSPETRO involved could not make it available on time the Megawatts MW offered to the market. The electricity market was short. The industrial and domestic consumers had restrictions to consume electricity. As mentioned before, there was a fantastic saving: 2001/2002 consumptions were in the same level, 1999.

41 | P a g e

2.5 Tariff
The Original Project capacity tariff was US$ 1.21 per 106 Btu (1996), escalating 0.5% each year. When the ramp-up curve was accelerated achieving 30.08 (106 )m per day on May/2003, the tariff was reduced to US$ 1.14 per 106 Btu, in a roll in basis. Remarkable competitiveness along the Project in a long term is the fact that tariff is not escalated with the full US inflation.

For the TCQ and TCO capacities, the tariff is post-stamp, i.e., it is the same for delivery in all the citygates along the pipeline. That was a policy defined by the Federal Government to establish the competitiveness among the States within the Target Market. TCX capacity has distance basis pricing.

The Open Season tariff criteria - above 30.08 (106 )m per day established by ANP emphasized the distance from the reception point (at the border Bolivia-Brazil) as an element of costs, in order to have different capacity tariffs for different Zones of Delivery each LDC, plus 3 in Comgs area.

As the incremental tariff is lower than the Original Project capacity tariff, the ANP criteria considered one partial roll in, sharing the benefits with the Original Project and the new shippers. Besides, the Original Project shipper pays a throughput tariff of US$ 0.002 per 106 Btu, annual escalated, using the full Brazilian inflation. The shipper also pays the system use of gas (the internal consumption in the compressors operations), around 0.8% of commodity price at current flows and 6% at 30 (106 )m per day the future shippers in the Open Season also will be charged by the same throughput tariff and the system use of gas, related to their capacity. An entrance tariff was created in order to remunerate the G&A and O&M and an exit tariff to refund the city-gates investments. Both are in a post-stamp basis. For the Original Project, there is a TBG option between an exit tariff or investments paid cash to TBG in order to payback the new city-gates not previously established in the Original Project construction

However, legal restriction only allows for tariff adjustment in a 12-month period of time. Through the Transportation Contracts, TBG invoices the losses of exchange rates fluctuations, like an incremental of capacity tariff in the subsequent 12 months period. When the exchange rate changes in a highly volatile scenario, as it occurred in 1999/ 2002, the consequent TBG losses result in a lower return than it was previously estimated. Those losses also burden the Balance Sheet of TBG.

42 | P a g e

Price of Imported Gas The price of natural gas delivered at the city gate, free of taxes, to be paid by distributors to Petrobrs is divided into two parts: (i) the price of the commodity; and (ii) the transport fee. The transport fee, which is the same along the entire length of the gas pipeline, is in turn divided into the capacity fee and the conveyance fee. The price formulas of the gas are as follows: PCGi = PCTi + TTi TTi = TCi + TMi where:

PCGi = Price of natural gas delivered by Petrobrs to the Distributor at the city gate and in quarter i

PCTi = Price of the Commodity at the point of delivery in Bolivia in quarter i

TTi = Transport Fee of the natural gas in quarter i

TCi = Capacity Fee in quarter i

TMi = Conveyance Fee in quarter i

Bolivian imports of gas have an adjustment mechanism that separates the price of the commodity from the actual transport.

The price of the commodity is adjusted quarterly based on a basket of U.S. and European fuel oils.

PCTi = PC0 x (basket of fuel oils)

The base price (PC0) for the first 18 million m3 43 | P a g e

/day of gas imported (TCQ) is shown below:

Year 1 to 3 4 to 5 6 7 to 8 9 10 to 11 12 13 to 14 15 to 16 17 18 to 19 20

PC0 (US$/MMBTU) 0.95 0.96 0.97 0.98 0.99 1.00 1.01 1.02 1.03 1.04 1.05 1.06

For additional volumes (TCO and TCX) up to 30 million m3/day, the PC0 is US$ 1.20/MMBTU.

The transport fee, which is the responsibility of TBG and GTB, is adjusted annually based on a U.S. inflation index.

The Capacity Fee (TC) is adjusted annually at the rate of 40% of the inflation in the U.S. dollar through 2007, and 15% of the inflation in the U.S. dollar beginning in 2008, with a minimum correction of 0.5% p.a. for the entire period. The inflation in the U.S. dollar is measured by the Consumer Price Index published by U.S. Labor Statistics. 44 | P a g e

The Conveyance Fee (TM) is adjusted annually at the rate of 100% of the inflation in the U.S. dollar, as measured by the Consumer Price Index published by U.S. Labor Statistics, with a minimum correction of 3.5% p.a. for the entire period.

The final sale price of the gas at the city gate to the distribution companies is subject to ICMS value added tax and the PIS taxes

The distribution margin of the sale price to the final consumer is determined by the amount of power granted by each state to the Distribution Companies.

Competitiveness

The tariff competitiveness must be evaluated when city-gate price (tariff plus the commodity price) is competitive to the alternative fuels and energies. City-gate price plus the Distribution margin must stimulate the decision of consumers to replace the current fuel for natural gas in the industrial, commercial and residential segments.

Natural gas to the thermal power generation must be competitive to the hydro one. This is more difficult, because there are old hydro generation plants already amortized. It is not also possible thermal power plants be competitive to the hydro ones, when the water stocks are high, during and after the rain seasons. So, the thermal power plants must have a low load factor. In other words, the TBG transportation capacity available to the thermal segment must have a low load factor as well.

Nowadays, one of the most relevant points in the natural gas chain is the gas price. This project was conceived under a very risky scenario. First the Bolivian reserves were insufficient to attend the Project demand. Therefore, aiming to stimulate exploration and new reserves discovery the concept of cost of opportunity had to be introduced, i.e., the GSA contract indicated a gas price sufficiently attractive to compensate for the risk involved. In that sense, the commodity price would vary in accordance to a basket of fuel oils the main alternative fuel. That is one reason to the investors put financial resources to discover new reserves. By the time, the feasibility studies were carried based on the crude oil price

45 | P a g e

around US$ 18.00 per barrel, and, today is above US$ 30 per barrel. Second, the Project was mainly funded in dollars, the only way for it to be feasible. That implied in a dollar based transportation tariff. The conjunction of a dollar gas price commodity plus transportation tariff in an environment that has suffered frequent exchange devaluations, and, meanwhile higher petroleum prices has seriously affected gas competitiveness.

However, if we compare the international fuel oil prices to the Bolivian gas city-gate price, since TBG begun operations in july/99 the fuel oil price has been always above city-gate prices for the gas in Brazil. For instance, until November/2002, fuel oil prices were above by an average of 15,5%, and the biggest difference reached 33% in a given month. Nevertheless this apparent competitiveness, Brazilian market has been flooded by large quantities of high viscosity fuel oil, coke and other residuals, much cheaper than regular fuel oil and, therefore, slowing the gas demand growth in the industrial sector.

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2.6Regulatory framework
Brazil is pursuing a program designed to phase out fuel subsidies and deregulate petroleum product prices by 2001. In August 1997, Brazil enacted its Hydrocarbon Law to open and liberalize the oil and gas sectors, thereby providing the basis for attracting foreign investment. In addition, in 1998, ANP was established as the Brazilian oil and gas agency to regulate, inter alia, exploration,production and transportation in the natural gas sector.

The Regulation ANP-169, of November 26, 1998 (Regulation 169), had given force to certain provisions of Brazil's Hydrocarbon Law with respect to open access of interested parties existing gas transportation pipelines and facilities. Regulation 169 guaranteed access to gas pipelines and facilities for any interested shipper that was willing to pay adequate remuneration to the owner of such facilities. It established the procedures that transporters must follow in order to offer available capacity (not contracted or under construction) in pipelines. According to Regulation 169, a pipeline operator was required to inform ANP and disclose through the media the existence of available capacity and make such capacity available to the customer offering the highest tariff. Regulation 169 also sets rules for making available unused contracted pipeline capacity on an interruptible basis, requiring, among other things, that 90% of the revenues deriving from the commercialization of such capacity is to be passed back to the original firm shipper holding contractual rights to such capacity. More recently, during 2001 and 2002, ANP willing to promote conditions to the Open Season process revoked Regulation-169 Open Access in order to improve it. Likewise, other regulatory rules were discussed as Capacity Release, Tariff Criteria, Gas Quality Specifications revoked to be improved and of course the new Open Access rule.

Additionally, the Regulation ANP - 170, dated November 26th, 1998, another one that is passing through revision, establishes that the construction and operation standards for any pipeline are subject to the approval of ANP and require the approval, among other things, of IBAMA, the Brazilian environmental Agency, which issues both installation licenses and operating licenses for pipelines. Such Regulation also establishes requirements applicable to pipeline operators relating to maintenance plans, quality control systems and periodic certificates from an independent technical entity concerning the safety and quality of pipeline installations.In 2002, ANP gathered market players and discussed the basic regulatory framework in order to give the market the transparency required, thus encouraging new players to enter the system.

Presently, the vision is that, once the regulatory risk is quantifiable and from the moment themarket can absorb more electricity and more gas, in other words, once there is an indication for a gasdemand growth, investors will be comfortable and the Open Season bidding process can go forward.This is likely to happen next year being the capacity available 24 months later, taking into account thefinancing and construction time to install compressor stations to expand the system capacity to 34 (106 )m per day. 47 | P a g e

Capacity Tariff ($/MMBtu)

Entry Point Rio Claro Limeira Americana Jaguarina Itatiba Guararema Sumar Campinas

2001 0.975 0.990 1.008 1.028 1.062 1.137 1.036 1.046

2002 0.980 0.995 1.013 1.033 1.067 1.143 1.041 1.052

CONCLUSIONS

The Project is the main driver for the development of the natural gas industry in Brazil. Actually, until the implementation of the Project, the natural gas did not constitute a reliable source of energy for Brazil. This for sure prevented the growth of the market due to insufficient domestic gas reserves. Additionally, the few existing pipelines at that time were not able to provide the required service concerning firm supply and quality. To the Project can be credited a change of paradigm in the Brazilian natural gas business. 48 | P a g e

Presently, the Bolivian gas reserves are greater than the Brazilian demand. This indicates, upon supply/demand relation analysis, that the commodity price could be reduced in order to improve the competitiveness of Bolivian gas against fuel oils, hydroelectricity and gas from other sources, thus accelerating the growth of the Target Market. The Bolivian gas is loosing competitiveness, due to the commodity price is volatile, due to its fluctuations with international oil prices. The market claims for a revaluation once it currently faces the impacts of the substantial high-level international crude oil price. Moreover, the Project capacity tariff has a competitiveness advantage, once the annual escalator is just 0.5%, which indeed represents a reduction in the real value of the tariff in the long term. Future expansions in the Open Season, based in scale gains, will reflect an increment of competitiveness on the transportation tariff, by using the roll in methodology. The new regulatory framework indicates some improvements, to encourage the players to be shippers and to invest in different segments in the gas chain. The Brazilian Government saving energy program, that brought 2001/2002 electricity consumption back to 1999 levels and a rain season that restored the hydroelectric reservoirs, frustrated the natural gas demand expectations. Therefore, the ramp-up acceleration to 30 106 m per day in 2003 is going to lead to a low load factor in the pipeline. Consequently, the Open Season above 30 106m per day was postponed.

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Conclusion
General findings:
Transit tariffs across the Energy Charter constituency show a wide range of variations: while it is as low as USD 0.47/100 tkm for a part of the Belarusian section of the Druzhba pipeline, it is up to USD 1.95/100tkm in the case of the CPC pipeline. Tariffs for the each pipeline also differ by country. Tariffs and government charges (or royalty) should not be confused. A tariff is a fee paid by the customers to a pipeline operator for the use of the pipelines. It covers the costs of investment and financing, operating and maintaining the pipe and includes an element of profit for the operator. These costs may include such items as local taxes on commercial entities. A government charge, as in the case of Baku-Supsa pipeline, is a tax by a transit country, essentially as a fee for the right of way through that countrys territory and as compensation or lump sum to compensate for taxes and freezing of taxes by Host Government Agreements and for service rendered by the country (such as protection of pipeline). But it is not related to costs of transport itself. Cost-reflective tariffs and negotiated tariffs are the two methodologies used in tariff setting in the countries examined in this study, Domestic and export tariffs are determined based on costs incurred, which also takes into account social and economic factors besides physical, technical and geographical characteristics as well as certain external parameters such as inflation. Transit tariffs are typically subject to negotiations between pipeline owner and transit parties. Specific requirements of a pipeline project may require the setting of tariffs for short-term (up to a year) or a longer term (from one to 15 years), in accordance with applicable regulatory rules.

What Is Next?
Comparison of transit and cross border tariff methodology for India, with some successful transit and cross border tariff methodology across the globe. Innovating a model transit and cross border tariff methodology for India keeping the forte of some successful methodology along with failure from some unsuccessful methodology across the globe. With respect to comparison of transit and export tariffs, it is difficult to find comparable flows. Each case requires detailed assessment of particular transit and domestic transport under different approaches and circumstances. There are few cases where national and transit flows are comparable and where tariffs are publicly available. Moreover, in the absence of sufficient transit tariff data in most cases, such an analysis cannot be based solely on a comparison of tariffs charged, but requires a detailed review and analysis of relevant legal and regulatory regime and practical implementation. Application of different methodologies and particularities of each case may lead to differences, sometimes by significant margins, at the tariff levels between two transit cases or between domestic transport and transit of comparable movements. Varying aspects of a particular movement can create a wide range of tariffs, even under a methodology which is compatible

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with efficient system operation and adequate profits. The principle of cost-reflectiveness, should not be interpreted as requiring uniform benchmarks for transit tariffs.

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Bibliography
Energy Charter Secretariat (ECS). Putting Price on Energy: International Mechanisms of Oil and Gas Price Formation. Brussels: ECS, 2007. Energy Charter Secretariat, From Wellhead to Market Oil Pipeline Tariffs and Tariff Methodologies in Selected Energy Charter Member Countries: ECS, JANUARY 2007 Energy Charter Secretariat, Bringing Oil to the Market: Transport Tariffs and Underlying Methodologies for Cross Border Crude Oil and Products Pipelines: ECS, 2012

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