Aera Energy LLC v. Federal Energy Regulatory Commission

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued February 9, 2015 Decided June 16, 2015
No. 13-1138
AERA ENERGY LLC, ET AL.,
PETITIONERS
v.
FEDERAL ENERGY REGULATORY COMMISSION,
RESPONDENT
ANADARKO ENERGY SERVICES COMPANY, ET AL.,
INTERVENORS
Consolidated with 13-1303
On Petitions for Review of Orders of
the Federal Energy Regulatory Commission
James F. Moriarty argued the cause for Petitioner Kern
River Gas Transmission Company. With him on the briefs
were Thomas E. Knight, Jennifer Brough, Matthew T.
Eggerding, and J. Gregory Porter.
2
Katherine B. Edwards argued the cause for petitioners
Aera Energy LLC, et al. and supporting intervenors. With her
on the joint briefs were John Paul Floom, Erica L. Rancilio,
and Norman A. Pedersen.
Lona T. Perry, Deputy Solicitor, Federal Energy
Regulatory Commission, argued the cause for respondent.
With her on the brief were David L. Morenoff, General
Counsel, and Robert H. Solomon, Solicitor.
James F. Moriarty, Thomas E. Knight, Jennifer Brough,
Matthew T. Eggerding, and J. Gregory Porter were on the
brief for intervenor Kern River Gas Transmission Company in
support of respondent.
Andrea J. Chambers, Katharine E. Leesman, Thomas C.
Woodworth, Norman A. Pedersen, Katherine B. Edwards,
John Paul Floom, Erica L. Rancilio, Keith A. Layton, John R.
Ellis, Jonathan J. Newlander, and Richard P. Bonnifield were
on the joint brief for intervenors Aera Energy, LLC, et al. in
support of respondent.
Before: BROWN, Circuit Judge, and SILBERMAN and
SENTELLE, Senior Circuit Judges.
Opinion for the Court filed by Senior Circuit Judge
SENTELLE.
Concurring statement filed by Senior Circuit Judge
SILBERMAN.
SENTELLE, Senior Circuit Judge: Petitioner Kern River
Gas Transmission Company owns and operates an interstate
pipeline that transports natural gas from its production area in
Wyoming to markets in Utah, Nevada, and California.
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Petitioners Aera Energy LLC and several other natural gas
and transportation companies (collectively “Shippers”) ship
natural gas using Kern River’s pipeline. In their consolidated
petitions, Kern River and the Shippers seek review of
different aspects of seven orders issued by the Federal Energy
Regulatory Commission during rate proceedings. We
conclude that the Commission complied with the Natural Gas
Act and our precedents. The Commission responded
meaningfully to petitioners’ objections and articulated a
rational explanation for its decisions under the particularly
deferential standard of review we apply to ratemaking
decisions. We therefore deny the petitions for review.
I.
A. Factual Background
To construct a pipeline, a natural gas company must first
obtain a certificate from the Commission. See 15 U.S.C.
§ 717f(c). When Kern River applied for its certificate, then-
existing regulations allowed it to obtain an optional certificate
and assume the economic risks of the project. FERC
approved Kern River’s optional certificate and permitted Kern
River to charge separate rates during three periods: (1) Period
One, the 15-year term of the original contracts; (2) Period
Two, the period from the expiration of those contacts to the
end of the pipeline’s 25-year depreciation life; and (3) Period
Three, the period thereafter. Kern River Gas Transmission
Co., 50 FERC ¶ 61,069, at 61,150–51 (1990). The
Commission also allowed “Kern River to utilize a levelized
cost of service” during Period One. Id. at 61,150. Using
levelized rates, Kern River planned to “recover all of its debt
service during the first 15 years, and to recover its return of
equity primarily during the second period.” Id.
4
Unlike a traditional rate structure, in which a pipeline
charges higher rates during the early years of its life, Kern
River’s levelized rate plan provided lower rates during the
early years of operation. Lower initial rates help new
pipelines market their capacity and compete with other
established pipelines. There is, however, a trade-off. By
charging lower rates during the first half of the levelization
period, Kern River defers the recovery of costs that it would
otherwise recover during the early years of operation if it had
used a traditional rate structure. Kern River therefore entered
into long-term contracts with the Shippers, which extend
beyond the initial period of lower rates, to ensure that it will
adequately recover its costs.
With respect to calculating Kern River’s return on capital
investment, FERC recognized that Kern River would not
maintain its original ratio of 70 percent debt and 30 percent
equity over the course of the pipeline’s life. Kern River Gas
Transmission Co., 60 FERC ¶ 61,123, at 61,347 (1992). In
accordance with its optional certificate, Kern River would
instead retire the debt principal during the first 15 years of the
project (i.e., during Period One) and operate with a 100
percent equity capital structure thereafter (i.e., Periods Two
and Three). Id. FERC noted “that in the latter years of the
projects, the rate of return on equity . . . may not be
appropriate as the overall rate of return.” Id. Thus, FERC
reserved its right to reexamine the issue in future general rate
proceedings. Id.
In 1992, FERC issued the certificate order, and Kern
River started operating its pipeline. Eight years later, Kern
River proposed to lower its shipping rates by refinancing its
debt. All existing customers, referred to as “original
shippers,” extended the terms of their contracts in exchange
for lower rates. Some original shippers agreed to new 10-year
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contracts (2001 to 2011), while others agreed to new 15-year
contracts (2001 to 2016). FERC approved the proposal,
allowing levelized rates to continue and permitting Kern
River, consistent with its original certificate order, to recover
its debt “by the end of the new debt repayment period.” Kern
River Gas Transmission Co., 92 FERC ¶ 61,061 at 61,157
(2000).
A few years later, Kern River sought to increase the
capacity of its pipeline. Because of the unique nature of its
existing levelized rate plan, Kern River could not use typical
roll-in methodology to recover its expansion costs. Kern
River therefore proposed to roll the costs of the proposed
expansion into the cost of the original system by adjusting the
rates for all “rolled-in” shippers (i.e., existing customers and
new expansion customers). Kern River Gas Transmission
Co., 96 FERC ¶ 61,137, at 61,576–77 (2001). In 2002, Kern
River allowed new expansion customers to choose 10-year or
15-year terms to pay for the additional capacity, and FERC
approved the plan. Id. at 61,582. In 2003, Kern River again
expanded the pipeline and offered its new expansion
customers 10-year or 15-year contracts. Kern River thus had
six groups of customers paying levelized Period One rates
following its second expansion:
• Original shippers with 10-year contracts
(2001 to 2011)
• 2002 expansion shippers with 10-year contracts
(2002 to 2012)
• 2003 expansion shippers with 10-year contracts
(2003 to 2013)
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• Original shippers with 15-year contracts
(2001 to 2016)
• 2002 expansion shippers with 15-year contracts
(2002 to 2017)
• 2003 expansion shippers with 15-year contracts
(2003 to 2018).
B. Procedural Background
In 2004, Kern River filed a general rate case pursuant to
Section 4 of the Natural Gas Act, 15 U.S.C. § 717c, seeking
to adjust Period One rates (at that time, all customers were
paying Period One rates). Kern River Gas Transmission Co.,
Initial Decision, 114 FERC ¶ 63,031 P 1 (2006). Kern River
submitted proposed rates based on a 12-month test period
ending in January 2004, “as adjusted for known and
measurable changes occurring through October 31, 2004.” Id.
In May 2004, the Commission conditionally accepted Kern
River’s proposed rates subject to refund and the outcome of
further proceedings. Id. P 2. After considering testimony and
evidence submitted by the parties, an administrative law judge
found that Kern River had carried its burden under Section 4
of the Natural Gas Act to prove “that its levelized cost-of-
service/ratemaking methodology can produce just and
reasonable rates.” Id. P 253. “However,” the administrative
law judge concluded that “Kern River ha[d] not proven that
its levelized methodology will produce just and reasonable
rates if all of its proposed cost-of-service and cost-allocation
elements are approved.” Id.
In a series of orders, the Commission affirmed the
administrative law judge’s finding that Kern River’s adjusted
Period One rates should continue to be based on its levelized
7
methodology and addressed Kern River’s subsequent
compliance filings with revised cost-of-service and cost-
allocation elements. Kern River Gas Transmission Co.,
Opinion No. 486, Order on Initial Decision, 117 FERC
¶ 61,077 (2006), order on reh’g, Opinion No. 486-A, 123
FERC ¶ 61,056 (2008), order on reh’g, Opinion No. 486-B,
126 FERC ¶ 61,034 (2009), order on reh’g, Opinion No. 486-
C, 129 FERC ¶ 61,240 (2009), order on reh’g, Opinion No.
486-D, 133 FERC ¶ 61,162 (2010). Relevant here, the
Commission conditionally accepted Kern River’s compliance
filings for Period One rates and set the effective date of those
rates as December 17, 2009, the date it issued Opinion No.
486-C. 129 FERC ¶ 61,240 P 14. In the same decision,
FERC concluded that it would be “unjust and unreasonable
for Kern River to use different reservation billing
determinants for allocating costs” to its rolled-in shippers, id.
P 167, so it “direct[ed] Kern River to use the actual
reservation billing determinants of 639,570 [dekatherms] for
allocating costs” to its rolled-in shippers, id. P 171, and
required Kern River “to file revised tariff sheets for Period
One Rates within 45 days of the date of [its] order,” id.
P 266(C).
To ensure that the Shippers would benefit from lower
Period Two rates, the Commission expanded the scope of the
rate proceedings to include Period Two rates. See Opinion
No. 486, 117 FERC ¶ 61,077 P 37. An administrative law
judge held hearings to address, among other things, whether
Kern River’s return on equity in Period Two should be
reduced because of its 100 percent equity capital structure in
Period Two. See Opinion No. 486-D, 133 FERC ¶ 61,162
P 196. Since “Period Two rates must be designed based on
data from the 2004 test period,” FERC explained that “any
testimony supporting any adjustment above or below the
median [return on equity] should similarly be based on 2004
8
test period information.” Id. P 197. In other words, “any
deviation from the median return on equity for Period Two
must be based upon risks that informed investors in 2004
would have perceived concerning Kern River’s risks during
the 2011 to 2018 time period (the range of expiration dates for
Period One contracts).” FERC Br. 47 (citing Kern River Gas
Transmission Co., Opinion No. 486-E, Order on Initial
Decision, 136 FERC ¶ 61,045 P 201 (2011), and Opinion No.
486-F, 142 FERC ¶ 61,132 P 254 (2013)). Kern River sought
to increase its return on equity, while the Shippers argued that
it should be reduced. In his initial decision, the administrative
law judge found “no persuasive evidence, one way or the
other,” that justified changing Kern River’s return on equity
from the median 11.55 percent. Kern River Gas Transmission
Co., Initial Decision, 135 FERC ¶ 63,003 P 1026 (2011).
In Opinion No. 486-D, FERC stated that it would
consider “circumstances unique to the transition from Period
One to Period Two rates that justify an adjustment to the cost
of service underlying the Period One rates.” 133 FERC
¶ 61,162 P 194. Relying on this statement, Kern River
introduced evidence during the Period Two evidentiary
hearing to support its proposed cost-of-service adjustment for
Period One rates. In his initial decision, the administrative
law judge rejected Kern River’s proposed cost-of-service
adjustment as “not part of this proceeding” because “Period
One rates were finalized by Opinion 486-D.” 135 FERC
63,003 P 346.
The Commission affirmed the administrative law judge’s
initial decision on all matters, except one issue not relevant
here, and denied rehearing. Opinion No. 486-E, 136 FERC
¶ 61,045, order on reh’g, Opinion No. 486-F, 142 FERC
¶ 61,132. The Commission explained that “a party must
make a very persuasive case” to overcome its “strong
9
presumption” in favor of the median return on equity
developed by the proxy group. Opinion No. 486-E, 136
FERC ¶ 61,045 P 201. Concluding that neither Kern River
nor the Shippers overcame its strong presumption, FERC
affirmed the administrative law judge’s decision to maintain
Kern River’s return on equity at 11.55 percent. Id. P 206; see
also Opinion No. 486-F, 142 FERC ¶ 61,132 P 263. The
Commission further explained that all issues related to Period
One rates had been finalized by Opinion No. 486-D. See
Opinion No. 486-E, 136 FERC ¶ 61,045 P 8 (“In Opinion No.
486 and the subsequent four orders in the Opinion No. 486
series, the Commission has finally resolved all issues
concerning Kern River’s Period One rates . . . .”); Opinion
No. 486-F, 142 FERC ¶ 61,132 P 8 (same). As a result, it did
not address Kern River’s argument related to an adjustment to
the cost of service underlying the Period One rates.
Kern River filed a timely petition for review of Opinion
Nos. 486 through 486-F. It raises two issues: (1) whether
FERC erred in setting the effective date for Period One rates;
and (2) whether FERC erred by refusing to consider its
proposed cost-of-service adjustment for Period One rates after
Opinion No. 486-D. The Shippers filed a timely petition for
review of Opinion Nos. 486-E and 486-F. They argue that
FERC erred when it did not reduce Kern River’s return on
equity in Period Two. We consolidated the petitions.
II.
Under the Administrative Procedure Act, we will set
aside FERC’s orders if they are arbitrary, capricious, an abuse
of discretion, or otherwise not in accordance with the law.
5 U.S.C. § 706(2)(A). “[W]e afford great deference to the
Commission in its rate decisions.” Morgan Stanley Capital
Grp. Inc. v. Pub. Util. Dist. No. 1, 554 U.S. 527, 532 (2008);
10
see also E. Kentucky Power Co-op, Inc. v. FERC, 489 F.3d
1299, 1306 (D.C. Cir. 2007) (“We are particularly deferential
when FERC is involved in the highly technical process of
ratemaking.”) (internal quotation marks omitted). If FERC
“has considered the relevant factors and articulated a rational
connection between the facts found and the choice made,” we
will uphold its decision. Transcontinental Gas Pipe Line
Corp. v. FERC, 518 F.3d 916, 919 (D.C. Cir. 2008) (internal
quotation marks omitted).
A. Kern River’s Petition
Kern River advances several arguments as to why it
thinks FERC’s orders are arbitrary, capricious, an abuse of
discretion, or otherwise not in accordance with the law. None
have merit.
1. Setting the Effective Date of Period One Rates
Kern River contends that FERC’s decision to fix the
prospective Period One rates as of December 17, 2009, the
date it issued Opinion No. 486-C, is contrary to the plain
language of the Natural Gas Act and controlling precedent.
Kern River asks us to set the effective date of the Period One
rates as November 18, 2010, the date FERC accepted Kern
River’s supplemental compliance filing in Opinion No. 486-
D. We reject Kern River’s arguments and deny its petition for
review.
Before it can fix a new rate, FERC must find the
prospective rates “just and reasonable.” 15 U.S.C. § 717d(a).
Because FERC found an aspect of the prospective Period One
rates unjust and unreasonable and ordered Kern River to
submit “a substantively new compliance filing,” Kern River
argues that FERC could not have fixed the rates under
11
Section 5 of the Natural Gas Act as of the date of Order No.
486-C. Kern River Br. 20. In support of its argument, Kern
River relies on Electrical District No. 1 v. FERC, where we
explained “that the statute means what it says”—when fixing
a rate, it is not enough for FERC “to prescribe the legal and
accounting principles which, properly applied, will yield one
particular rate” because the statute “requires the rate itself to
be specified.” 774 F.2d 490, 492 (D.C. Cir. 1985)
(interpreting the Federal Power Act). In accordance with
Electrical District, Kern River argued that FERC could not
fix Period One rates because the rates were indeterminable as
of the date of Opinion No. 486-C. See Opinion No. 486-D,
133 FERC ¶ 61,162 PP 16–18. FERC reasonably rejected
Kern River’s arguments. Id. PP 19–31. So do we.
In Electrical District, we considered the effective “date
of an order setting forth no more than the basic principles
pursuant to which the new rates are to be calculated.” 774
F.2d at 493. We vacated the order because it fixed the
effective date of the prospective rates as of the date FERC
ordered the utility to make a new compliance filing. Id. at
491–93. We concluded that the order lacked “necessary
predictability” and thus required FERC to fix the date once
the “numerical rate is specified.” Id. at 492–93. Even though
Electrical District “adopted a bright-line insistence that a
numerical rate be ‘specified’” before it can be fixed,
Transwestern Pipeline Co. v. FERC, 897 F.2d 570, 577 (D.C.
Cir. 1990), another decision, Public Service Co. of New
Hampshire v. FERC, 600 F.2d 944, 954 (D.C. Cir. 1979),
permitted FERC to fix rates subject to adjustments. We
“reconciled” those decisions in Transwestern and explained:
The Commission need not confine rates to specific,
absolute numbers but may approve a tariff containing
a rate “formula” or a rate “rule” (as Public Service Co.
12
of New Hampshire assumed); it may not, however,
simply announce some formula and later reveal that
the formula was to govern from the date of
announcement (as it had done in Electrical District).
897 F.2d at 578 (emphasis in original).
The circumstances here, FERC correctly determined, are
unlike those in Electrical District. See Opinion No. 486-D,
133 FERC ¶ 61,162 PP 24–25. When it fixed Kern River’s
Period One rates as of the date of Opinion No. 486-C, “the
Commission had done much more than set forth the basic
principles of [those] rates.” Id. P 26. Indeed, by the time the
Commission fixed Period One rates, they had already been the
subject of a full hearing before an administrative law judge, a
post-hearing decision, and three FERC orders (Opinion Nos.
486, 486-A, and 486-B). Id. P 24. Moreover, FERC had
previously directed Kern River to submit compliance filings
with revised Period One rate calculations. See Opinion
No. 486-B, 126 FERC ¶ 61,304 P 192. “On March 2, March
27, and September 22, 2009, Kern River submitted the
required compliance filings, and the Commission accepted
those filings, subject to conditions in Opinion No. 486-C.”
Opinion No. 486-D, 133 FERC ¶ 61,162 P 24. Those
conditions, FERC concluded, are analogous to the
circumstances in Transwestern because, like a formula or
rule, FERC’s order gave Kern River no discretion to make
further changes to its rates. Id. P 28.
Kern River suggests, however, that Transwestern is
inapplicable because its tariff contains neither a formula nor a
rule; instead, it contains “rate models.” See, e.g., Kern River
Br. 21, 26–27, 29. Since its rate models are so complex, Kern
River points out that “no party (not Kern River, FERC, nor
any shipper) knew the effective prospective Period One rates
13
until all levelized rate models had been rerun with the
changed components.” Kern River Br. 27; see also Opinion
No. 486-D, 133 FERC ¶ 61,162 P 18 (same). FERC
reasonably rejected this argument because “the rate
uncertainty that concerned the court in Electrical District was
not present here to the same degree.” Id. P 26. We agree.
FERC’s conditional acceptance of Period One rates in
Opinion No. 486-C simply required Kern River to substitute
one number for another when allocating costs to the rolled-in
shippers. See 129 FERC ¶ 61,240 P 171 (directing Kern
River to use 639,570 dekatherms as the billing determinant).
Because this mechanical change gave Kern River no
discretion to adjust its rate models, FERC provided sufficient
notice to ratepayers. See W. Deptford Energy, LLC v. FERC,
766 F.3d 10, 22 (D.C. Cir. 2014) (recognizing that FERC
need not confine rates to specific numbers when ratepayers
have notice of the formula or rule that will be applied).
The Shippers, moreover, could have calculated the rates
on their own. See Kern River Gas Transmission Co., 119
FERC ¶ 61,106 P 9 (2007) (requiring Kern River to furnish
all Shippers “with electronic copies of each model, with cells,
links, formulae and data intact”). Because the Shippers could
“supply their own inputs to the [models] and thereby know
the numerical rates,” FERC reasonably fixed the rates “within
the meaning of Natural Gas Act § 5” as of the date it accepted
Kern River’s compliance filings in Opinion No. 486-C. City
of Anaheim v. FERC, 558 F.3d 521, 524 (D.C. Cir. 2009)
(citing Transwestern, 897 F.2d at 578). In light of the great
deference we give FERC in rate decisions, FERC’s order
setting the effective date of Period One rates as December 17,
2009 was not arbitrary, capricious, or otherwise not in
accordance with law.
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2. Adjusting the Period One Rate Credit
Kern River argues that FERC failed to respond
meaningfully to its objections, and the Commission’s
nonresponse rendered its decisions arbitrary and capricious.
See, e.g., PSEG Energy Res. & Trade LLC v. FERC, 665 F.3d
203, 210 (D.C. Cir. 2011). Under Kern River’s approved
rolled-in methodology, it recovers Period One costs by
adjusting the credit that it gives to different groups of rolled-
in shippers. As rolled-in shippers transition from Period One
to Period Two rates, Kern River loses revenue because Period
Two rates are lower than Period One rates. Kern River
contends that FERC ignored its request to adjust the credit
that it gives to rolled-in shippers paying Period One rates as
rolled-in shippers transition to Period Two rates. Kern River
also argues that FERC abused its discretion by not reopening
the evidentiary record. These arguments lack merit.
At the outset, FERC suggests that we need not consider
Kern River’s argument because it “twice waived” any
contention that Opinion No. 486-D was not final—Kern River
never raised the argument on rehearing before the
Commission or in its opening brief here. Xcel Energy Servs.
Inc. v. FERC, 510 F.3d 314, 318 (D.C. Cir. 2007); see also 15
U.S.C. § 717r(b) (“No objection to the order of the
Commission shall be considered by the court unless such
objection shall have been urged before the Commission in the
application for rehearing unless there is reasonable ground for
failure to do so.”). In response, Kern River characterizes
FERC’s waiver argument as a post-hoc rationalization and
reminds us that the “agency’s order must be upheld . . . on the
same basis articulated in the order by the agency itself.”
PSEG Energy Res. & Trade, 665 F.3d at 210 (internal
quotation marks omitted).
15
We uphold FERC’s decisions because “the agency’s path
may reasonably be discerned” from the record. Motor Vehicle
Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co.,
463 U.S. 29, 43 (1983) (quoting Bowman Transp. Inc. v.
Arkansas-Best Freight Sys., 419 U.S. 281, 286 (1974)).
FERC did not address Kern River’s proposed cost-of-service
adjustment because the Commission was satisfied with the
administrative law judge’s reasoning that Period One rates
had already been finalized. Moreover, FERC reasonably
refused to adjust Period One rates in a Period Two hearing
because the cribbed language from Opinion No. 486-D relied
on by Kern River only addressed Period Two rates.
FERC acknowledges that it did not reiterate the
administrative law judge’s analysis related to Kern River’s
proposed cost-of-service adjustment for Period One rates in
Opinion Nos. 486-E and 486-F. However, “[t]he Commission
is not required to recapitulate the reasoning of the
[administrative law judge] if it is satisfied that the initial
decision and the reasoning underlying it are sound.”
Boroughs of Ellwood City v. FERC, 731 F.2d 959, 967 (D.C.
Cir. 1984). Here, the administrative law judge rejected Kern
River’s proposed cost-of-service adjustment because “Period
One rates were finalized by Opinion 486-D.” Kern River Gas
Transmission Co., 135 FERC 63,003 P 346. Satisfied with
this reasoning, FERC twice reiterated that all issues related to
Period One were finalized by Opinion No. 486-D; even Kern
River acknowledges that. See Kern River Br. 37 (citing
Opinion No. 486-E, 136 FERC ¶ 61,045 P 8, and Opinion No.
486-F, 142 FERC ¶ 61,132 P 8 (same)). Under these
circumstances, FERC’s failure to address Kern River’s
specific argument was neither arbitrary nor capricious.
Kern River misreads Opinion No. 486-D as an invitation
to reopen the Period One evidentiary record to adjudicate its
16
proposed cost-of-service adjustment for Period One rates. As
we have previously explained: “Reopening an evidentiary
hearing is a matter of agency discretion, and is reserved for
extraordinary circumstances.” Cities of Campbell v. FERC,
770 F.2d 1180, 1191 (D.C. Cir. 1985) (citations omitted).
Kern River nonetheless contends that FERC abused its
discretion because the adjustment to the rolled-in rate credit is
an extraordinary circumstance. We disagree.
The Commission’s basis for refusing to consider Kern
River’s rolled-in rate credit argument can be reasonably
discerned from the record. See Motor Vehicle Mfrs. Ass’n,
463 U.S. at 43. Starting with Opinion No. 486, FERC
determined that Period Two rates would be based on the same
cost-of-service adjustment used for Period One rates. 117
FERC ¶ 61,077 P 54 (directing Kern River to file proposed
Period Two rates “based upon the instant cost of service” used
for Period One rates). As FERC explained in Opinion No.
486-D, “The only exception to this general approach to
developing Kern River’s Period Two rates is where there are
circumstances unique to the transition from Period One to
Period Two rates that justify an adjustment to the cost of
service underlying the Period One rates.” 133 FERC ¶ 61,162
P 194 (emphasis added); see also id. P 202 (“In general, this
should lead to the use of the same cost of service for the
Period Two rates as for the Period One rates, except where
circumstances unique to the transition from Period One to
Period Two rates justify projecting different costs or volumes
than used in developing the Period One rates.” (emphasis
added)). Kern River misreads Opinion No. 486-D because
FERC only considered making adjustments that would affect
Period Two rates; it did not reopen the Period One
evidentiary record to adjudicate Kern River’s proposed cost-
of-service adjustment for Period One rates. Indeed, even
Kern River acknowledges that FERC acted consistent with the
17
Commission’s reading of Opinion No. 486-D. See Kern
River Br. 44 (explaining how FERC only approved
“adjustments to the Rolled-In Rate Credit for Period Two”).
In sum, FERC correctly set the effective date of Period
One rates as December 17, 2009, and FERC did not abuse its
discretion by refusing to reopen the Period One evidentiary
record after it issued Opinion No. 486-D. Kern River
advances additional arguments, but none warrant relief or
compel further discussion.
B. Shippers’ Petition
Because of the reduced financial risk associated with
being debt free in Period Two, the Shippers urged FERC to
lower Kern River’s return on equity for Period Two rates.
FERC refused. The Shippers argue that FERC failed to
engage in reasoned decision making after it: (1) failed to
address the reduced financial risk associated with 100 percent
equity in Period Two; (2) relied on an irrational composite
capital structure; (3) assumed increased business risk would
offset decreased financial risk; and (4) failed to follow its
precedent, which requires a reduction in the return on equity.
The Shippers ask us to reverse Opinion Nos. 486-E and 486-F
and remand with instructions for FERC to reduce Kern
River’s return on equity in Period Two. We deny the
Shippers’ petition under the deferential standard of review we
apply to FERC’s ratemaking decisions.
1. Financial Risk
In general, “the higher the proportion of equity capital,
the lower the financial risk . . . and thus, in this respect, the
lower the necessary rate of return” on equity. Missouri Pub.
Serv. Comm’n v. FERC, 215 F.3d 1, 2 (D.C. Cir. 2000).
18
During Period Two rate proceedings, FERC confirmed: “It
goes without saying that a 100 percent equity structure would
be perceived by informed investors to lessen substantially a
company’s financial risk.” Opinion No. 486-F, 142 FERC
¶ 61,132 P 255. That is common sense. See Missouri Pub.
Serv. Comm’n, 215 F.3d at 4. Because Kern River has lower
financial risk than the members of the 2004 proxy group
(based on Kern River’s 100 percent equity structure), the
Shippers maintain that FERC should have set Kern River’s
return on equity lower than the proxy group’s median 11.55
percent return.
FERC reasonably explained why the Shippers’ argument
lacks merit. When it set Kern River’s return on equity for
Period Two, FERC considered how investors in 2004 would
have viewed the transition from a 30 percent equity structure
in Period One to the 100 percent equity structure in Period
Two. See Opinion No. 486-E, 136 FERC ¶ 61,045 P 204–05.
FERC explained how an informed investor would have
noticed that the transition toward less financial risk is not
abrupt. See id. Instead, the “100 percent equity structure
would come on line gradually from 2011 through 2018.” Id.
P 205. For example, through the end of 2015 (more than
halfway into the transition period), 88 percent of the Period
One contracts would still be in effect. See id. Thus, FERC
explained that an investor in 2004 would have likely
perceived that, during the initial four years of transition to
Period Two rates, Kern River’s financial risk would be about
the same as Period One. See id. The investor’s perception of
the gradual transition, FERC determined, “would trend the
required [return on equity] toward the median rather than the
lower end of the range in absence of highly persuasive
information (evidence) to the contrary.” Id.; see also id.
P 206 (noting that the Shippers “have not presented
compelling evidence based on the 2004 test period that Kern
19
River’s return on equity should be reduced below the
median”). That is not an arbitrary conclusion.
2. Composite Equity
The Shippers contend that FERC unjustifiably abandoned
the notion of separate capital structures in Period One and
Period Two when it referred to a “composite equity” standard.
Shippers Br. 21 (quoting Opinion No. 486-E, 136 FERC
¶ 61,045 P 205). In their view, FERC’s reference to
composite equity is inconsistent with the design principles
underlying Kern River’s levelized rates—i.e., Kern River
must develop “individual rates based upon separately
calculated equity rate base amounts for each customer class.”
Opinion No. 486, 117 FERC ¶ 61,077 P 119. According to
the Shippers, it is irrelevant to the design of Period Two rates
that some customers might still be paying Period One rates
(based on a 30 percent equity capital structure) through 2018
because FERC must calculate Period Two rates based on a
100 percent capital structure.
We reject the Shippers’ arguments because they ignore
the context of the Commission’s reference to “composite
equity” in Opinion No. 486-E. Considering the reference in
context, we conclude that FERC did not abandon the separate
capital structures for each period when it referred to
composite equity. Rather, FERC explained how an investor
in 2004 might perceive Kern River’s “generic business risks”
during the gradual transition to Period Two rates from 2011
through 2018. Opinion No. 486-E, 136 FERC ¶ 61,045
P 205; see also Opinion No. 486-F, 142 FERC ¶ 61,132 P 254
(“[T]his language forms part of the Commission’s discussion
of what informed investors might have perceived in 2004
about Kern River’s business risk.”). By referring to
composite equity, FERC rejected the notion that “the 2004
20
investor would be considering investment in a pipeline that
would have exclusively Period Two contracts and a Period
Two all-equity capital structure.” Opinion No. 486-F, 142
FERC ¶ 61,132 P 236. This observation is rational and
consistent with FERC’s position throughout these
proceedings.
3. Business Risk
The Shippers advance several arguments suggesting that
FERC’s analysis of Kern River’s business risk is inconsistent
and not supported by the record. None are persuasive.
The Shippers urged FERC to set Kern River’s return on
equity at the lowest reasonable level because, in their view,
Kern River’s business risk is substantially reduced during
Period Two by the 100 percent equity structure. FERC
explained that a low return on equity would only be
appropriate if “Kern River’s business risk would necessarily
be so low that investors could be assured that changes in Kern
River’s capital structure would offset all of the potential
competition from new pipeline capacity or gas supply.”
Opinion No. 486-E, 136 FERC ¶ 61,045 P 204 (emphasis
added). After considering the Shippers’ arguments, FERC
concluded that “the existence of the 100 percent equity capital
structure cannot be construed to completely off-set the
potential business risks Kern River might face.” Opinion
No. 486-F, 142 FERC ¶ 61,132 P 257. That conclusion is
neither arbitrary nor capricious.
First, FERC determined the record was insufficient to
conclude that the change in capital structure over time would
completely offset “incentive[s] for entry by competing firms,”
which “would be hard to quantify in 2004.” Opinion No.
486-E, 136 FERC ¶ 61,045 P 204. FERC rejected the
21
Shippers’ retrospective analysis of Kern River’s potential
competition because it relied on “more detailed information
that . . . [became] available some seven years after the close
of the 2004 test period.” Id. In doing so, FERC engaged in
reasoned decision making because the return on equity
analysis “depends upon market perception of future risks” and
FERC, as of the 2004 test period, “reasonably factored
evidence of potential competition into its [return on equity]
calculus.” Canadian Assoc. of Petroleum Producers v.
FERC, 308 F.3d 11, 16 (D.C. Cir. 2002).
Second, FERC concluded that the record did “not provide
compelling evidence that” the gradual transition in capital
structure would completely offset Kern River’s re-contracting
risk as Period One contracts expired. Opinion No. 486-E, 136
FERC ¶ 61,045 P 204. As of the 2004 test period, no
customer had agreed to contract with Kern River for shipping
natural gas during Period Two. See Opinion No. 486-D, 133
FERC ¶ 61,162 P 198. Therefore, re-contracting risk was
“the primary reason” FERC did not adjust Kern River’s return
on equity for Period Two rates. Opinion No. 486-F, 142
FERC ¶ 61,132 P 250. The Shippers challenge FERC’s
reliance on re-contracting risk, but their arguments lack merit
because they ignore the context of FERC’s purportedly
inconsistent statements.
According to the Shippers, FERC recognized that re-
contracting risk is not unique to Kern River. The Shippers,
however, misread FERC’s statements. While rejecting Kern
River’s argument in favor of a higher “return on equity based
on evidence concerning various market changes since the
2004 test period,” FERC explained that re-contracting risk is
“not a circumstance unique to the transition from Period One
to Period Two.” Id. P 245 (emphasis added). In other words,
FERC rejected Kern River’s proposed increase because it was
22
not based on data from the 2004 test period and did not fall
within the limited “circumstances unique to the transition
from Period One to Period Two rates.” Opinion No. 486-D,
133 FERC ¶ 61,162 P 202. When put into context, FERC
reasonably explained how re-contracting risk was not an issue
unique to the transition and therefore did “not justify
consideration of post-test period market changes.” Opinion
No. 486-F, 142 FERC ¶ 61,132 P 245. FERC’s statements
about re-contracting risk are not inconsistent.
The Shippers suggest that FERC cited lower Period Two
rates as a factor that would reduce re-contracting risk.
Again, context matters. While addressing the return on equity
for Period One rates, FERC noted: “Kern River’s
competitive position should be enhanced” as the reduced
Period Two rates become effective. Opinion No. 486-B, 126
FERC ¶ 61,034 P 148. Thus, in the context of analyzing
Period One risk, FERC concluded that “Kern River
exaggerates its financial risk,” while the Shippers “understate
Kern River’s contract risk given its relative dependence on
the more competitive generating market.” Id. The Shippers
also cite language from Opinion No. 486-E where FERC
considered adjusting the “load factor” for Period Two rates.
136 FERC ¶ 61,045 P 169. The parties updated the “record
with market information for the period of 2004–2009,” id.,
and FERC acknowledged that Kern River “has been quite
effective at competing” for market capacity based on its lower
Period Two rates, id. P 171. When put into context, neither
this statement nor FERC’s statement about Period One risk is
inconsistent with FERC’s analysis of re-contracting risk as
perceived by an investor in 2004.
The Shippers further contend that re-contracting risk
during the transition period “‘would unlikely have been
visible even to the most discerning [2004] investor.’”
23
Shippers’ Reply Br. 6 (quoting Opinion No. 486-E, 136
FERC ¶ 61,045 P 200). Once again, the Shippers ignore
context because FERC made this statement while referring to
“events that actually occurred in 2010 and 2011,” which were
“not properly before the Commission.” Opinion No. 486-E,
136 FERC ¶ 61,045 P 200. FERC never concluded that a
2004 investor would be unlikely to perceive re-contracting
risk. Instead, FERC reasonably explained that it would be
“unlikely” for a 2004 investor to perceive “the specifics
underpinning” Kern River’s argument in favor of a “higher
risk environment”—i.e., the 2004 investor would not be able
to predict circumstances based on updated data from actual
events in 2010 and 2011. Id. (emphasis added). When
viewed in its proper context, FERC’s statement about the
visibility of re-contracting risk is consistent with its analysis
of Kern River’s business risk as perceived by a 2004 investor.
Because FERC rejected re-contracting risk as a basis for
decreasing rate design volumes, the Shippers argue it is
inconsistent for FERC to refuse to lower Kern River’s return
on equity based on re-contracting risk. Their argument misses
the mark because the rate design analysis for volume takes
post-2004 test period data into account, whereas the return on
equity analysis does not. Simply put, FERC has not advanced
inconsistent positions while analyzing how a 2004 investor
would view Kern River’s re-contracting risk.
4. Precedent
The Shippers contend that FERC departed from its
precedent without providing a reasoned explanation. We
disagree.
FERC acknowledged that Kern River’s 100 percent
equity capital structure is “unique” and “anomalous.” See,
24
e.g., Opinion No. 486-F, 142 FERC ¶ 61,132 P 262. In other
unique situations involving atypically high equity ratios,
FERC has adjusted the rate of return on equity downward.
See, e.g., Williams Natural Gas Co., 77 FERC ¶ 61,277, at
62,192 (1996) (adjusting the pipeline’s return on equity “to
account for the [reduced] financial risk associated with a high
equity ratio”); Gateway Pipeline Co., 55 FERC ¶ 61,488, at
62,677 (1991) (rejecting the pipeline’s “atypical and unduly
costly” 100 percent equity capitalization and proposed rate of
return in favor of a lower rate); Tarpon Transmission Co., 41
FERC ¶ 61,044, 1987 WL 258004, at *6 (1987) (rejecting the
pipeline’s 100 percent equity structure as “beyond the norm”
and reducing the rate of return on equity). FERC reasonably
explained how these orders are not persuasive in the context
of Kern River’s rate proceedings because they involved
pipelines certified under the traditional requirements of
Section 7 of the Natural Gas Act. See Opinion No. 486-F,
142 FERC ¶ 61,132 P 262. None of the pipelines had
optional certificates similar to Kern River’s certificate. “In
this context, Kern River’s capital structure is unique, and
comparisons to other pipelines’ equity ratios do not render it
any more or less anomalous.” Id. FERC reasonably
explained that the cases relied on by the Shippers “show
nothing more than the Commission has previously adjusted
the return on equity in appropriate circumstances” that do not
apply here. FERC Br. 62.
The Shippers raise additional arguments, but none
warrant relief or compel further discussion.
25
***
Under the particularly deferential standard of review we
apply to the Commission’s ratemaking decisions, we deny the
petitions for review.
So ordered.
SILBERMAN, Senior Circuit Judge, concurring: I wish
FERC’s briefing was as clear as Judge Sentelle’s opinion.