4. Request for Public Utilities Code Section 854 Authority

4.1. Nature of the Proposed Change of Control

Section 854 Applicants ask the Commission to authorize a proposed change of control over the intrastate portions of SFPP and Calnev. Under the proposal, KMI, the publicly-traded corporation which effectively controls the pipelines now, would be acquired by a group of private investors through Knight Holdco, a private limited liability company. As the Applicants succinctly state, "[t]he proposed acquisition of KMI would result in the transfer of KMI from public to private ownership and the transfer of direct and indirect control of all of KMI's subsidiaries and business interests, including SFPP and Calnev." (Section 854 Application at 7.)

The Section 854 Application relates that on August 28, 2006, KMI's Board of Directors announced that it had accepted a buyout offer from a group of investors led by Richard Kinder, and comprised of other members of KMI management as well as affiliates of Goldman Sachs, AIG, The Carlyle Group, and Riverstone Holdings. Collectively referred to as the KMI Investor Group, these individuals and entities offered to buy all outstanding shares of KMI at $107.50 share, or about US $15 billion -- a 27% premium over the closing price of KMI shares as of May 26, 2006, the last trading day before the KMI Investor Group's initial proposal was made. The KMI Investor Group also agreed to assume about $7 billion in existing KMI debt.

Ex. 210, which consists of selected pages of the Schedule 13D/A proxy statement filed with the SEC, breaks the $22 billion cost of the deal down into four components: up to $5 billion in new equity from Goldman Sachs and the three other financial institutions; up to $2.9 billion in rollover equity from the KMI Investor Group; approximately $7.3 billion of new debt; and acquisition of outstanding debt, estimated to be approximately $7.2 billion.

The public version of Ex. 11, the December 11, 2006 commitment letter by which Goldman Sachs and other lenders (Citigroup Global Markets Inc., Deutsche Bank Securities Inc., Wachovia Capital Markets, LLC and Merrill Lynch Capital Corporation) agree to provide $17.2 billion of the necessary financing, includes a statement of the rationale for the transaction:

The purpose of the merger is to enable KMI's public stockholders to immediately realize the value of their investment in Kinder Morgan, Inc. through their receipt of the per share merger price of $107.50 in cash, without interest ...

The management group participants ("Rollover Investors") believe that the merger will provide Kinder Morgan with the flexibility to pursue alternatives that it would not have as a public company, including the ability to execute transactions and focus on long-term value creation outside of public market constraints. Additionally, following consummation of the merger, the Investor Group plans to offer to sell the Trans Mountain Pipeline system to KMP as well as consider whether Kinder Morgan, Inc. ought to undertake a variety of additional possible transactions, including the spin-off, sale, joint venture or public offering of all or a portion of NGPL, Terasen Gas, its power operations, the Express/Platte pipeline system, the general partner of KMP, the sale of units in KMP owned by KMI, the sale of listed shares of KMR owned by KMI, or any combination of the foregoing transactions taken individually or in concert. (Ex. 11 at 6.)

Upon consummation of the deal, all outstanding shares of KMI, whether contributed by Kinder and other members of KMI management participating in the deal or repurchased from nonparticipating shareholders, will be held by Knight Holdco or one of its subsidiaries. This transfer of all KMI shares will vest ownership and control of KMI in Knight Holdco, which will have an eleven-member Board of Managers. Kinder will be entitled to designate four members and the four financial institutions will be entitled to six, with Knight Holdco's Chief Executive Officer (Kinder) serving as the eleventh member. Thus, Kinder will control five of the eleven members of the Board of Managers, at least initially. The Section 854 Application represents that the "expected allocation" of the other six seats is: Goldman Sachs - 2, AIG - 2, Carlyle Partners IV - 1, and Carlyle/Riverstone III - 1. (Section 854 Application at 8.)

Kinder will not only be Knight Holdco's CEO, but also Chief Manager of the Board of Managers. He can be removed as Chief Manager for cause or for failure to meet the business plan's financial performance targets by at least 90%. Ex. 9 reports the targets for each of the five years from 2006 (approximately $1.1 billion) to 2010 (approximately $2.0 billion); the targets increase by roughly $200 million from year-to-year, nearly doubling from 2006 to 2010.

The day-to-day operations of SFPP and Calnev will not be affected, according to the Section 854 Application. "[C]ontrol will continue to remain in the hands of KMEP's management and Board of Directors" or in other words, the Board of Directors of KMR, since this board, "as delegate of KMEP's general partner, serves as the board of directors of KMEP." (Ibid.) Under cross-examination, Thomas A. Bannigan, President of Products Pipelines for KMEP, whose oversight includes SFPP and Calnev, testified that the boards of directors of KMEP, KMGPI and KMR are identical. Each board consists of the same five individuals -- Kinder, another KMI associate, and three others who are not employees or officers of KMI.

Ex. 1, Bannigan's prepared testimony, expands upon Section 854 Applicants' claim that the proposed transfer will have no effect upon SFPP and Calnev:

There will be no change in the employees of SFPP and Calnev, the Board of Directors of Kinder Morgan Management, or any other officers or managers responsible for the pipelines' financial and operating conditions. There will be no change in the operations, as well as no change in the regulatory, accounting, engineering, planning or any other function of the SFPP, Calnev or the people performing those functions as a result of the proposed transaction. (Ex. 1 at 2.)

However, Bannigan also confirmed projections that SFPP and Calnev pipeline revenues will increase over the next four to five years by 4% to 4½% per year and admitted that such revenues could not be obtained through an increase in volumes alone, since "intrastate volumes have grown about an average of 2% per year." (Tr. 122.) Asked about Ex. 109, a January 12, 2006 letter from KMEP to BP West Coast Products LLC (and other pipeline shippers) which solicits advance agreement to a KMEP-specified rate increase on the proposed expansion between Colton and Las Vegas as a condition of construction, Bannigan conceded that KMEP might decide not to build "if we cannot get the appropriate rate certainty around this investment." (Tr. 109.)

Ex. 3, the prepared testimony of Joesph Listengart, Vice President, General Counsel and Secretary of KMI, KMEP and KMR, describes the distribution of revenues from SFPP, Calnev and other KMEP subsidiaries to KMEP's limited partners, KMGPI, and KMR, the latter through i-units. The i-units in KMR are additional ownership units distributed in lieu of cash - the actual cash is not paid to unit holders, but held elsewhere according to Ex. 102, the prepared testimony of Indicated Shippers' witness Ashton. This entire arrangement is expected to continue post-transfer.

KMEP's partnership agreement requires that it distribute 100% of "Available Cash," as defined in the partnership agreement, to its partners within 45 days following the end of each calendar quarter in accordance with their respective percentage interests. "Available Cash" consists generally of all of KMEP's cash receipts, including cash received by its operating partnerships and net reduction in reserves, less cash disbursements and net additions to reserves. Available Cash is calculated after taking into account all cash disbursements from SFPP and Calnev in the operation of their respective businesses, including amounts payable to the former general partner of SFPP in respect of its remaining 0.5% interest in SFPP and satisfaction of liabilities, which would include the payment of rate refunds, if any are awarded. (Ex. 3 at 4-5.)

Our search of the record has located the definition of "Available Cash" in four documents: Ex. 14, the Limited Liability Agreement for KMR; Ex. 15, the Limited Liability Agreement for KMEP; Ex. 16, the Limited Partnership Agreement of OLP-D; and Ex. 19, the Limited Partnership Agreement for SFPP.9

Listengart testified that KMEP pays out more cash than it earns in income, partially funding distributions by "regularly" borrowing money. (Tr. 314.) Listengart explained that money to fund pipeline maintenance or expansions "is not sitting in a bank account in a reserve. It is raised by cash from operations, or it is raised by capital-market transactions." (Tr. 317.) Likewise, no actual reserves have been established for potential pipeline rate refunds. Ex. 101, the prepared testimony of Indicated Shippers' witness Kellye Jennings, CPA, together with Ashton's Ex. 102, essentially posit that the enterprise's cash distribution policy has rendered both pipelines insolvent as stand-alone entities. These witnesses rely upon various data including Federal Energy Regulatory Commission (FERC) Form 6 filings which show the pipelines' liabilities exceeding assets.

Ex. 2 and Ex. 4, respectively the prepared and rebuttal testimony of Section 854 Applicants' witness James Volkman, a principal of Corporate Valuation Advisors, Inc., state that SFPP's asset base would provide significant borrowing capacity. Ex. 2 includes Volkman's solvency opinion, together with a January 22, 2007 letter to Volkman from Wachovia Securities which states, "Wachovia is confident that a financing total of $1 billion is financeable." (Ex. 2, Attachment.) Indicated Shippers' Ashton calculates SFPP's maximum borrowing capacity at a lower sum of about $820 million. He argues that Volkman has underestimated SFPP's outstanding and potential liabilities (including potential rate refunds in California and at FERC) and has overestimated its future rate revenues. Ashton concludes that SFPP's borrowing capacity is insufficient to fund all of its potential liabilities.

Ex. 110, selected pages from KMEP's Prospectus Supplement dated January 2007, advises that "Credit rating agencies have announced that the ratings assigned to KMI will be reduced to below investment grade upon completion of its going private transaction" and report bond downgrades by Standard & Poor's - to below investment grade for KMI and to BBB for KMEP. (Ex. 110, S-3.) Both Moody's and Fitch have announced that they also are likely to issue downgrades, the Supplement reports.10 It also states:

As previously disclosed, the credit rating agencies have discussed with our management and KMI that if certain steps were taken, our credit rating would remain investment grade. Discussions with the rating agencies centered around an additional $1 billion of equity being committed to KMI upon the occurrence of certain specified events, KMI's existing regular quarterly dividends being discontinued, an independent minority investment in our general partner being obtained from an unaffiliated third party, and various steps, such as changing KMI's name following the transaction to emphasize KMI's separate nature from us. Though no assurance can be given, we expect our senior unsecured indebtedness, including the notes, to continue to be rated investment grade. (Ibid.)

Listengart testified that in response to the credit agencies' concern about increased bankruptcy risk, KMEP plans to create an independent investor in KMGPI (that is, an investor with no interest in Knight Holdco). The sole power of this new interest in KMGPI will be to hold veto power over any determination to place KMEP and its subsidiaries, including SFPP and Calnev, into bankruptcy. The position has not been established yet, nor has it been determined what percentage of the general partner interest will be sold, nor what the price will be. Listengart testified that the "expectation" is that the interest will sell for "$100 million." (Tr. 309.) After the transaction has been approved, according to post-hearing information from Joint Applicants, both the KMGPI Articles of Incorporation and the Bylaws will be amended to create this new interest in the general partner and its bankruptcy veto power. 11

Indicated Shippers contend that the purported safeguard created by this new interest in the general partner is of limited value for three reasons. First, since the new general partner interest will receive a share of KMEP's cash distributions and income, "this stockholder has every incentive to put SFPP and Calnev into bankruptcy so that cash flow can be increased by wiping out" pipeline liabilities such as future potential rate refunds or environmental damages. (Indicated Shippers' Reply Brief at 26.) They point out that KMGPI receives about half of the cash flow from KMEP's subsidiaries. Second, they argue that under the Delegation of Control Agreement (Ex. 13), KMGPI has delegated to KMR full authority over KMEP's subsidiaries and "so the "watchdog" in KMGPI is toothless." (Ibid.) Three, they underscore that absent anything in writing, the proposal remains conceptual.

Section 854 Applicants respond that the notion that KMI would wish to force the pipeline utilities into bankruptcy to escape rate refund liability and therefore forgo $250 million or more in annual revenues makes no sense. As for the authority of the new general partner interest, Section 854 Applicants merely state, without citation, that "[t]he record reflects that post-transaction a passive minority investor in KMEP's general partner, KMGPI, will have veto authority over any contemplated bankruptcy of SFPP or Calnev." (Joint Applicants' Reply Brief at 18.)

Indicated Shippers point out repeatedly that the current KMEP, KMGPI and KMR governing structure (identical, five-member boards) means that the two "inside" directors need only obtain the vote of one "outside" director to form a majority; and that the two outside directors can be removed without cause at any time. Listengart agreed that a majority of directors can revise the partnership agreements and other documents which govern each of these entities. Indicated Shippers also argue that through the Knight Holdco Limited Liability Company Agreement, Ex. 8, the financial institutions who collectively will own over 60% of KMI will have will have the ability to compel the restructuring of existing arrangements below.

In response Listengart testified:

This agreement [Ex. 8] cannot unilaterally amend the KMR agreement and the KMEP partnership agreement. Those remain unaffected by this. There is nothing that this contract can do without the participation ... of KMR or KMGP[I] or Kinder Morgan Energy Partners governed by their governing documents. (Tr. 370.)

The Knight Holdco Limited Liability Company Agreement is an unexecuted document that will not be executed until the transaction has been fully approved.

4.2. Standard of Review

The applicable law is Section 854 and the body of decisions interpreting it. As we have already noted (see footnote 5 and accompanying text, above) Section 854(a) requires Commission authorization before the finalization of any transaction that results in a change of control, whether direct or indirect, over a public utility in this state. The purpose of Section 854 and related statutes is to enable the Commission, before any transfer of public utility authority is consummated, to review the situation and to take such action, as a condition of the transfer, as the public interest may require.12 Absent prior Commission approval, Section 854(a) provides that the transaction is "void and of no effect."

The standard traditionally applied by the Commission to determine if a transaction should be approved under Section 854(a) is whether the transaction will be "adverse to the public interest."13 On occasion the Commission has inquired whether a transfer will provide positive benefits and such an examination is expressly required under Section 854(b) when one or more parties to the proposed transaction has gross annual California revenues exceeding U.S. $500 million. Likewise, Section 854(c) requires the Commission to review such transactions for other, enumerated impacts (on financial condition of the utility, quality of service, etc.). The Section 854 Application represents that no Applicant meets this financial threshold but recognizes that even when Section 854(b) and (c) do not expressly apply to a transaction, the Commission has used the criteria set forth in those statutes to provide context for a public interest assessment.14

4.3. Discussion

We focus our public interest review of the Section 854 Application on three central issues, which the Scoping Memo and Ruling of Assigned Commissioner, January 23, 2007 (Scoping Memo) articulates, in a slightly different order, as follows:

· Will the proposed change of control have any impact on future rates, terms, and conditions of service, including service quality?

· Will the proposed change of control have any impact on Commission or Shipper access to the books and records of SFPP and Calnev? What access will the Commission or Shippers have to the books and records of Knight Holdco and how does this differ from the access presently available?

· Shippers' refunds. The Commission need not determine in this consolidated docket whether Shippers are entitled to a refund in C.97-04-024 et al. and if so, in what sum. However, should approval of A.06-09-016 be conditioned on measures to ensure collection of a refund order or to provide some alternative remedy?

Review of these issues, together with the necessary assessment of any impact under the California Environmental Quality Act (CEQA), will provide a thorough public interest review given the circumstances the Section 854 Application presents. As the evidentiary record and briefs clearly demonstrate, each of these issues is of great concern to Shippers.15 Their underlying contention is that the status quo has given rise to problems which the change of control will only exacerbate. Shippers argue that Section 854 Applicants have failed to meet their burden of proof that the proposed transaction will not further endanger the public interest and that accordingly, the Commission cannot approve the transfer without imposing conditions to protect that interest. CFC shares Shippers' concerns but argues for a wider array of conditions, including structural changes within the enterprise's general partner/master limited partnership/limited liability company organization. CFC also argues that we should impose on SFPP, Calnev and their owners and affiliates the Affiliate Transaction Rules for Large California Energy Utilities adopted in D.06-12-029. Finally, CFC urges the Commission to defer approving the transfer until all structural changes and other conditions have been implemented.

Joint Applicants' initial brief argues that the evidentiary record emphatically supports findings that the proposed transfer of control is not adverse to the public interest and that it should be approved free of any conditions. As we discuss below, however, their reply brief appears to make certain concessions on both future rates and future access to books and records.

4.3.1. Impact on Future Rates, Terms, and Conditions of Service

While oil pipelines tend to be less in the public eye than energy, communications, or water utilities, they are subject to this Commission's regulation, including rate regulation, under Section 216. It is undisputed that SFPP and Calnev transport significant quantities of refined petroleum products (gasoline, diesel fuel and jet fuel) on an intrastate basis. Ex. 202, a California Energy Commission map entitled "West Coast Petroleum Flows," identifies 22 separate flows into, across and out of California, one half of them controlled by "Kinder Morgan." Several private pipelines also exist, and transportation by ship/barge along the coast and by truck elsewhere provides some limited competition for SFPP and Calnev.

Though Section 854 Applicants resist Shippers' characterization of SFPP and Calnev as natural monopolies and while no market power studies have been introduced in this record, neither can obscure the reality that SFPP and Calnev are the primary common carriers of refined petroleum products in this state. Indicated Shippers, referencing the pipelines' FERC Form 6 report for 2005, state that SFPP transported 263,729,529 barrels in California that year and Calnev, 6,478,705 barrels. A barrel is 42 gallons. The prepared testimony of their witness Ashton represents that the pipelines move "over one-third of the total volume of refined products consumed in California." (Ex. 102 at 3.)

While it is always germane to inquire how a proposed change of control may affect a Commission-regulated public utility's rates, terms and conditions of service, the inquiry becomes increasingly more critical to the degree that utility customers have few effective alternatives. Even large, sophisticated entities like the oil companies who ship refined petroleum products over SFPP and Calnev are entitled to the assurance of fair and reasonable rates, terms and conditions of service.16

The greatest problem the evidentiary record poses for Section 854 Applicants is the complexity, coupled with lack of transparency, of their chosen form of business organization. Post-transaction, with a private Knight Holdco at the head, complexity and obscurity will increase. Indicated Shippers' witness Daniel Wm. Fessler, described the master limited partnership and limited liability company arrangement as highly "plastic." (Tr. 42.) As operated by Section 854 Applicants, this business organization permits the funneling of large amounts of cash upstream from SFPP, Calnev and other KMEP subsidiaries through regular, quarterly distributions. The cash flow from SFPP and Calnev (about $250 million annually) constitutes a substantial portion of the cash distributed to KMEP. Ashton reports that "KMI received approximately 42% of all quarterly cash distributions in 2005 in its role as general partner and 9% in its role as a limited partner for a total of 51%." (Ex. 102 at 26.) Section 854 Applicants state they do not plan to change this practice post-transfer.

Witnesses Bannigan and Listengart, both affiliated with KMI, testified repeatedly that the transaction is not intended to have any effect on SFPP or Calnev. But the record contains sufficient evidence, some direct and some circumstantial, to raise questions about whether the transaction, in fact, will be neutral over either the short-term or long-term. The conflicting record fails to establish that Knight Holdco and its investors cannot influence the management and operations of KMEP's subsidiaries, including the bankrupting of them. Neither is the record clear about the respective, legally binding powers of KMGPI and KMR, among others. This situation is partly due to the late production of many of the operative agreements, partly due to the wholly executory nature of the Knight Holdco Limited Liability Company Agreement, partly due to the complex interrelationship of that draft with the operative agreements, and partly due to the absence of any written agreement governing the new general partner interest. What the record does establish is that SFPP and Calnev provide a regular and substantial revenue stream and that the impetus exists at every level within the organization to maximize its distribution upward. Furthermore, though Joint Applicants insist it would be contrary to their best interests to do so - and presuming no ill intent whatsoever - one can conceive of scenarios (however unanticipated at present, they are far from fanciful) where future pipeline liabilities, such as those attributable to environmental disasters, could make recourse to bankruptcy a preferred economic option.

Indicated Shippers' initial brief (with extensive citations) provides a useful summary of their view of the evidentiary record and the several ways that the proposed transaction could affect the rates, terms and conditions of service on SFPP and Calnev. We further summarize their points as follows:

Section 854 Applicants continue to contest most of these assessments in their reply brief; however they conclude with the following promise:

[T]he Section 854 Applicants unreservedly commit that they will not seek recovery in utility rates of any cost associated with the proposed transaction, including that relatively small portion of the increase in KMEP's debt (caused by the transaction-related, ratings downgrade) that might otherwise be allocated to SFPP and Calnev for ratemaking purposes. (Section 854 Applicants' Reply Brief at 14.)

To ensure that no pass through of any transaction-related costs occurs, we require as a condition of our approval, that both SFPP and Calnev file general rate applications with this Commission for a test year 2009. Each filing shall be made within 12 months of the effective date of today's decision. We note that the Commission has three complaints and five rate applications involving SFPP pending before it in another consolidated docket, Case (C). 97-04-024 et al. (see Section 3.3.3 of today's decision). 17 Resolution of C.97-04-024 et al. will eliminate or at least minimize the major rate disputes that have plagued SFPP and Calnev over the last decade. That, together with the ALJ Division's current familiarity with the issues presented in A.06-09-016 et al., should enable the Commission to process a new rate case in an efficient and timely manner.

However, given the complexity of the business organization now and the increased complexity and lack of transparency under private limited liability company ownership, the substantial debt now and increased debt post-transfer, and the ongoing reliance upon regular cash infusions from the pipeline utilities, we place several other conditions on our approval. We draw some of the conditions from the recommendations of Shippers or CFC (though we do not accept everything they propose). In particular, on this record we decline to impose the detailed Affiliate Transaction Rules adopted in D.06-12-029, given the many differences between the oil pipeline and energy utility regulatory frameworks.

Several of the conditions we have developed, ourselves, to establish safeguards we deem necessary or to obtain information required for ongoing monitoring. The conditions manifest our concern, based upon the entirety of the record, for the future of SFPP and Calnev if we take no action. They also manifest our determination to exercise our jurisdictional authority to ensure provision of safe, reliable, environmentally sound products pipeline services at just and reasonable rates.

Section 854 Applicants make two, general arguments against imposition of most of the conditions. They contend that some conditions simply are unnecessary because SFPP, Calnev and their current owners already comply. Where we impose such conditions anyhow, we do so to make clear that we expect compliance to continue post-transfer. (We make no findings about the degree or adequacy of compliance at present.) Section 854 Applicants also argue, broadly, that some conditions are beyond the scope of this proceeding. This argument not only interprets the Scoping Memo exceedingly narrowly but fails to recognize the Commission's broad general and remedial regulatory authority under Sections 701 and 761.18 The prepared testimony of Indicated Shippers' witness Fessler and their initial brief, as well as the initial brief of DRA, and the initial and reply briefs of ConocoPhillips provide a comprehensive review of the Commission's jurisdictional authority in areas "cognate and germane" to its regulation of public utilities, including the imposition of appropriate controls on utility parent holding companies.19

Accordingly, we further condition our approval of the change of control upon the following:

Section 854 Applicants particularly oppose imposition of a first priority condition or a ring-fencing requirement. With respect to the latter, they argue that the existing structural separation between KMI/Knight Holdco and the pipeline utilities effectively constitutes a ring fencing arrangement. If this is the case, then it should not prove difficult for them to obtain a non-consolidation opinion. If a non-consolidation opinion cannot be obtained, then Knight Holdco, KMI, Kinder Morgan (Delaware), KMGPI, KMR, KMEP, OLP-D, Kinder Morgan Pipeline, and any other intermediate entities will need to make changes in their business organization and operational arrangements in order to remedy the defects that prevent issuance of the opinion.

A primary problem with a first priority condition, Section 854 Applicants argue, is that it will undermine the existing ring fencing "equivalent" protections they have in place. But Section 854 Applicants do not provide any analysis or authority to substantiate how a parent company guarantee of pipeline utility debts (whether rate refunds or other obligations, including environmental liabilities) risks involving the utility in the parent's bankruptcy. ConocoPhillips, citing authority to the contrary, argues:

In fact, the types of indebtedness more likely to cause consolidation in bankruptcy are upstream guarantees, where a subsidiary guarantees the debts of a parent. See In re Bonham, 229 F.3d 750, 764 (9th Cir. 2000). In contrast, downstream guarantees, as proposed here, are rarely questioned by bankruptcy courts. Robert J. Rosenberg, Intercorporate Guarantees and the Law of Fraudulent Conveyances: Lender Beware, 125 U. Pa. L. Rev., 235, 238 (1976). In the final analysis, SFPP could be forced into bankruptcy only if the pipeline were not generally paying its debts as they come due, which would be no more likely to occur with the proposed parent company guarantees. (ConocoPhillips' Reply Brief at 8.)

Given that as much as $250 million in annual pipeline revenues is designated as "Available Cash" and sent up through OLP-D and KMEP to KMI and its investors - and post-transfer will be available to Knight Holdco's private investors - we think a first priority condition is absolutely critical to responsible regulation of the pipeline utilities. In Sections 3.3.2 and 3.3.3 we discuss other conditions more directly related to the two remaining Section 854 Scoping Memo issues.

4.3.2. Impact on Access to Books and Records

The record contains somewhat inconsistent representations by Section 854 Applicants regarding their view of the Commission's legal right to inspect the books and records of any entities above SFPP and Calnev.

However, Section 854 Applicants' reply brief states: "There is no real controversy ..." and continues:

No action is necessary to enhance the existing level of complete Commission or shipper access to the books and records of SFPP and Calnev.

....

No specific action is required to preserve the Commission's existing statutory authority governing access to the books and records of Knight Holdco and subjecting Knight Holdco's officers and employees to Commission process. (Section 854 Applicants' Reply Brief at 25-26.)

Thus, Section 854 Applicants concede the Commission's jurisdiction to demand the production of such documents that we consider cognate and germane to our regulation of the pipelines, whether these documents are held at the pipeline or holding company level. They also recognize our jurisdiction to order production to Shippers and other customers. However, Section 854 Applicants fail to mention our right to witnesses or to the books and records of Kinder Morgan Pipeline, OLP-D, KMEP, KMGPI, KMR, Kinder Morgan (Delaware), or KMI - entities which now hold - and will continue to hold - various degrees of authority over either the management and operation of the pipelines or the dispersal upward in the organization of the substantial revenues they generate.

To avoid any confusion in the future, we deem it prudent to condition our approval upon such access as the Commission, itself, may determine to be necessary, consistent with established precedent.23 The situation before the Commission here, further complicated by Section 854 Applicants' complex choice of business forms and that fact that these entities are organized out-of-state, warrants such clarity.

4.3.3. Impact on Any Refunds Owed by SFPP

The central issue in the consolidated complaint/rate application docket, C.97-04-024 et al., is what constitutes just and reasonable rates for SFPP. Like Calnev, SFPP traditionally has provided pipeline common carriage under cost-based ratemaking principles, and numerous contested issues in these proceedings may affect whether rate increases SFPP has levied over the past 10 years are allowed to stand or are determined to be excessive.24 If the Commission finds against SFPP, the utility may be liable for substantial refunds. Shippers argue that they expect a favorable resolution, including a refund order of about $100 million. If the Commission should order rate refunds, Shippers want to be sure to collect them and they ask us to condition any approval of the change of control upon the establishment by SFPP of liquid collateral, such as a letter of credit, for that purpose.

Section 854 Applicants state that though they do not expect any refund liability for SFPP, the utility has adequate borrowing capacity to pay refunds, if ordered to do so. They clearly view any Commission order as unnecessary micromanagement of their business preferences; in response to ConocoPhillip's request for a reserve of cash or cash equivalents, they argue:

ConocoPhillips asks the Commission to reform the existing KMEP partnership agreement and dilute the rights of existing unit holders by restricting the amount of cash available for distribution to them ... (Section 854 Applicants' Reply Brief at 34-35.)

There is no need to discuss the somewhat "apples and oranges" presentations put forward by the parties on SFPP's ability to meet its current obligations or its borrowing ability (the record on Calnev's status is very slim). After reviewing all of the evidence on this subject, we conclude that Section 854 Applicants have not fully rebutted Shipper's claims that SFPP's borrowing capacity will be insufficient to enable it to discharge all near-term liability, including intrastate and interstate rate refunds. We are obliged to ensure that SFPP is able to honor and timely discharge any refund liability that may be determined in C.97-04-024 et al.

Under the circumstances presented here, we agree with Shippers that sound policy militates against using one potential mechanism we asked the parties to examine - a credit on future rates as the method of funding any past overcharges. Not only might such method fail to reach those Shippers due refunds if any are ordered, but potentially it could reduce the monies available for necessary, ongoing maintenance and safety. No other party supports a rate credit and we do not pursue it here.

Instead, exercising our broad general and remedial regulatory authority under Sections 701 and 761, we require as a condition of our approval of the transfer that within 60 days of the effective date of today's decision SFPP demonstrate that it holds a letter of credit for $100 million from a national bank. The letter of credit should be designed, in form and in substance, to convey the direct obligation of the bank to any Shippers entitled to refunds, notwithstanding the insolvency or credit risk of the entity or entities legally responsible for repayment of the letter of credit. Shippers ask that we have the letter of credit served on them and permit comments. We decline to hold this proceeding open to do so, though we recognize Shippers' interest in the terms of a legal document created for their potential benefit. Therefore, we will require SFPP to submit the letter of credit in C.97-04-024 et al., by means of a motion to reopen the record of that proceeding to receive the letter of credit as a late-filed exhibit. The assigned ALJ and Assigned Commissioner, or either of them, may determine whether to allow any further proceedings in that docket in connection with the letter of credit. We think that SFPP should be able to obtain a letter of credit for less than $500,000 in the current economic climate. No costs associated with the financing shall be recovered in future rates charged to pipeline customers.

While the guarantee of a $100 million potential liability would seem to be a rather small matter for KMI and Knight Holdco considering the $22 billion value of the change of control, the matter is not inconsequential from a regulatory perspective. The Commission may not adopt a cavalier attitude toward any utilities or any utility customers, even large oil companies. KMI should have entered into its acquisition of SFPP with full realization that while a public utility may provide a regular revenue stream, it also carries public service obligations. Knight Holdco must recognize the same. If SFPP lacks resources or flexibility, we are certain that KMI and Knight Holdco have both. The Commission's 2006 decision authorizing a change of indirect control over Wild Goose includes a 10-page summary of KMI's business operations, of which SFPP and Calnev are a small part.25 Moreover, Section 854 Applicants underscore the financial strength of the financial institution investors.

Though we acknowledge Indicated Shippers' claim that the potential refund liability is closer to $500 million if refunds due at FERC are included, our concern is with those amounts, if any, that represent a component of jurisdictional intrastate rates. Shippers must pursue their interstate claims at FERC.

4.3.4. Acknowledgment of Conditions

Consistent with past practice, we require the Knight Holdco Board of Managers to acknowledge the conditions upon our authorization of the transfer of control.26 Similarly, we also require the Boards of Directors or the equivalent authority of KMI, Kinder Morgan (Delaware), KMGPI, KMR, KMEP, OLP-D, Kinder Morgan Pipeline, and any other currently existing intermediate entity to submit written acknowledgment of these conditions. Though different in form from the holding company organizations that led to the major restructuring of energy utilities beginning in the 1980s, the transaction by which KMI will be taken private is significant and warrants this formality.

4.4. CEQA

Under CEQA, we must consider the environmental consequences of projects that are subject to our discretionary approval and may have an impact upon the environment. (Pub. Resources Code §§ 21065, 21080.) It is possible that a change of ownership and/or control may alter an approved project, result in new projects, or change facility operations, etc. in ways that have an environmental impact.

Section 854 Applicants affirmatively state in the Section 854 Application and Amendment to it that the proposed change in control of KMI will not result in any change in the "public utility operations or related activities or in any additional construction" for either SFPP or Calnev. (Section 854 Application at 14; Amendment at 2.) Indicated Shipper's claim that this proves that Calnev does not intend to pursue what they represent to be a needed pipeline extension from Barstow to Las Vegas, but their claim has nothing to do with CEQA.

We base our analysis on the following. One, the Barstow extension is not a reasonably foreseeable impact of approval of the Section 854 Application, but at this time remains a speculative future undertaking. Two, all review required under CEQA will occur in conjunction with future applications for all permits necessary to undertake the intrastate portion of such construction.

After review, we agree that the proposed transfer of control does not raise issues which will give rise to physical, operational changes that could affect the environment. Because the pipeline utilities will be operated as previously authorized by this Commission, the Section 854 Application is not a project pursuant to Pub. Resources Code § 21065, and furthermore, assuming arguendo that the proposed project is a project under CEQA, the proposed project qualifies for an exemption from CEQA pursuant to § 15061(b)(3) of the CEQA guidelines and the Commission need perform no further environmental review. (See CEQA Guidelines § 15061(b)(3).)

9 In response to the Administrative Law Judge's (ALJ) request at hearing that Joint Applicants produce all other material governing documents not yet provided, on March 1, 2007 Joint Applicants produced these documents, together with Ex. 13, Delegation of Control Agreement Among KMGPI, KMR, KMEP, OLP-D (and KMEP's other operating limited partnerships) and Ex. 18, the Calnev Limited Liability Company Agreement. CFC's objection, filed March 8, 2007 argues that we should require a verification that no other responsive documents exist, but we think that Rule 1.1 of the Commission's Rules of Practice and Procedure is adequate in this circumstance.

10 Fitch did so on April 11, 2007, lowering KMI's rating to B+ and KMEP's rating to BBB, reflecting "weak near-term, post-transaction credit fundamentals and the uncertainty and execution risk of [Kinder Morgan's] future structure." (Reuters, April 11, 2007.) We grant the April 17, 2007 Motion of Indicated Shippers to Reopen the Record to receive this information and reject Joint Applicants opposition, filed the same day. We find that the information is material and therefore meets the requirements of Rule 13.14 of the Commission's Rules of Practice and Procedure. We identify the one-page document as Ex. 126 and receive it in evidence as of the effective date of today's decision.

11 By email sent to all parties on April 9, 2007, the ALJ asked Joint Applicants to identify and provide copies of those documents proposed to be amended to effectuate the new general partner interest. Joint Applicants responded the same day by forwarding copies of KMGPI's Articles of Incorporation and Bylaws. We identify these documents, respectively, as Ex. 20 and Ex. 21, and receive them in evidence as of the effective date of today's decision. CFC's objection, filed April 18, 2007, argues that we should require a verification, but we think that Rule 1.1 of the Commission's Rules of Practice and Procedure is adequate in this circumstance.

12 See San Jose Water Co. (1916) 10 CRC 56.

13 See, for example, Quest Communications Corp., D.00-06-079, 2000 Cal. PUC LEXIS 645, *18. This is also the standard applied by D.03-06-069, 2002 CalPUC LEXIS 975, authorizing a transfer in control over Wild Goose to EnCana; by D.05-12-007, 2005 CalPUC LEXIS 527, authorizing the transfer of a 50% interest in the parent of Lodi Gas Storage, L.L.C.; and more recently by D.06-11-019, 2006 CalPUC LEXIS 499), authorizing the transfer in control over Wild Goose to Niska Gas Storage, as described more particularly in footnote 8, above.

14 See for example, D.02-12-068, 2002 Cal. PUC LEXIS 909, concerning the change of control of California-American Water Company.

15 The evidentiary record consists of the following: prepared testimony by witnesses for Section 854 Applicants, Indicated Shippers and CFC; limited examination of Indicated Shippers' witnesses by the ALJ; and cross-examination and redirect of witnesses for Section 854 Applicants. Section 854 Applicants waived all cross of opposing parties' witnesses.

16 In contrast, the Commission's "light-handed" rate regulation of independent gas storage providers expressly relies upon a "let the market decide" policy based on the fact that those entities have no captive customers and must assume all market risks associated with any unused capacity. See for example, D.93-02-013, 1993 Cal. PUC LEXIS 66 at *87, Finding of Fact 37.

17 While, for various reasons, these proceedings have been pending for some time, the Commission expects to resolve them in the near future. Parties to C.97-04-025 et al. filed initial briefs on April 26, 2007 and reply briefs on May 17, 2007.

18 Section 701 provides:

Section 761 provides, in relevant part:

19 See for example, PG&E et al. v. CPUC, 118 Cal. App. 4th 1174, 2004 Cal. App. LEXIS 785. The court's decision holds that the "first priority" condition, imposed at the time of formation of a utility's holding company, is cognate and germane to aspects of the Commission's regulation and enforceable by the Commission under Section 701. The first priority condition requires a holding company's board to give first priority to the capital requirements of the utility, as determined to be necessary and prudent to meet the obligation to serve or to operate the utility in a prudent and efficient manner.

20 This condition is based upon the recommendation developed in Ex. 200, the prepared testimony of CFC's witness, Tyson Slocum, the Director of the Energy Program at Public Citizen, a consumer advocacy organization. Tyson discusses examples of market abuses by large energy traders that obtained non-public information from newly acquired energy infrastructure affiliates. Section 854 Applicants agree that the recommendation is reasonable (though they argue no condition is necessary). Listengart's prepared testimony states: "I believe it would be appropriate for KMEP to establish auditable procedures to ensure that no such information is made available to any Knight Holdco sponsor investor or their representatives." (Ex. 6 at 18.)

21 The first priority condition is fundamental to the Commission's authorization of the formation of all major utility holding companies. See for example, D.88-01-063, 1988 Cal. PUC LEXIS 2 *78 (Southern California Edison Company D.95-12-018, 1995 Cal. PUC LEXIS 931 *72 San Diego Gas & Electric Company), D.96-11-017, 1996 Cal. PUC LEXIS 1141 *74; as modified by D.99-04-068, 1999 Cal. PUC LEXIS 242 *151 (PG&E); D.98-03-073, 1998 Cal. PUC LEXIS 1 *260, *290 (Enova [Southern California Gas Company, SDG&E merger]).

22 Ring-fencing is the legal walling off of certain assets or liabilities within a corporation. Conceptually, in the context of a public utility within a holding company structure, ring-fencing includes a number of measures that may be implemented to protect the economic viability of the utility by insulating it from the potentially riskier activities of unregulated affiliates and thereby, ensuring the utility's financial stability and the reliability of its service. (See Beach Andrew N., Gunter J. Elert, Brook C. Hutton, and Miles H. Mitchell. Maryland Commission Staff Analysis of Ring-Fencing Measures For Investor-Owner Electric and Gas Utilities. The National Regulatory Research Institute-Volume 3, December 2005 at page 7). A non-consolidation opinion is not a ring-fencing measure per se, but focuses on the effect of ring-fencing. A non-consolidation opinion demonstrates that a utility has enough ring-fencing provisions to protect it from being pulled into a holding company bankruptcy.

23 See for example, D.96-11-017, 1996 Cal. PUC. LEXIS 1141 at *70-*72, in which, as a condition of approving formation of a holding company and reorganization of PG&E, the Commission required access to books and records, and officers and employees, of the holding company and its affiliates.

24 Section 455.3 governs the manner in which oil pipelines may change rates, authorizing them to charge new rates after 30-days notice but subject to the obligation to pay refunds if the rate increases subsequently are found to be excessive. The statute, enacted by Stats. 1995, Ch. 802, Sec. 1, changes the general rule, codified in Section 454, that requires Commission approval before rate changes go into effect. This increase-upon-notice authority is somewhat limited by Section 455.3(b)(5), which provides that shipping rate increases "shall not exceed 10 percent per 12-month period."

25 See D.06-11-019, Attachment 3, entitled Summary of Additional Investments in the Energy and Power Industries that Carlyle/Riverstone III and Carlyle Partners IV Will Acquire as a Result of Proposed Investment in Kinder Morgan, Inc. (referring to the Section 854 Application at issue here).

26 See for example D.96-11-017, 1996 Cal. PUC LEXIS 1141 *77.

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