ExxonMobil Oil Corp v. FERC

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued December 12, 2006 Decided May 29, 2007
No. 04-1102
EXXONMOBIL OIL CORPORATION,
PETITIONER
v.
FEDERAL ENERGY REGULATORY COMMISSION AND
UNITED STATES OF AMERICA,
RESPONDENTS
WESTERN REFINING COMPANY, L.P., ET AL.,
INTERVENORS
Consolidated with
04-1103, 04-1104, 04-1140, 04-1142, 04-1143, 04-1160,
05-1204, 05-1217, 05-1218, 05-1219, 05-1223, 05-1226,
05-1232, 05-1245, 05-1303
______
On Petitions for Review of Orders of the
Federal Energy Regulatory Commission
Thomas J. Eastment and R. Gordon Gooch argued the cause
for Shipper Petitioners. With them on the briefs were Joshua B.
Frank, Elisabeth R. Myers, George L. Weber, Walter Lowry
Barfield, III., Steven A. Adducci, Richard E. Powers, Jr., Marcus
W. Sisk, Jr., and Frederick G. Jauss IV.
2
Charles F. Caldwell and Christopher J. Barr argued the
cause for petitioners SFPP, L.P. and the Association of Oil Pipe
Lines. With them on the briefs were Albert S. Tabor, Jr.,
Catherine O’Harra, Sabina K. Dugal, Steven H. Brose, Timothy
M. Walsh, Daniel J. Poynor, and Michele F. Joy. Erin M.
Murphy, Neil Patten, Judith M. Andrade, Kevin B. Bedell, Glenn
S. Benson, and Michael J. Manning entered appearances.
Lona T. Perry, Attorney, Federal Energy Regulatory
Commission, argued the cause for respondent. With her on the
brief were R. Hewitt Pate, Assistant Attorney General, U.S.
Department of Justice, John J. Powers, III., and Robert J.
Wiggers, Attorneys, John S. Moot, General Counsel, Federal
Energy Regulatory Commission, and Robert H. Solomon,
Solicitor. Robert B. Nicholson, Attorney, U.S. Department of
Justice, entered an appearance.
Charles F. Caldwell argued the cause for intervenors SFPP,
L.P. and the Association of Oil Pipe Lines in support of
respondent. With him on the brief were Christopher J. Barr,
Albert S. Tabor, Jr., Catherine O’Harra, Steven H. Brose,
Timothy M. Walsh, and Daniel J. Poynor.
Steven A. Adducci, R.Gordon Gooch, Elisabeth R. Myers,
Marcus W. Sisk, Jr., Frederick G. Jauss IV., and George L.
Weber were on the brief of Shipper Intervenors in support of
respondent with respect to arguments of SFPP, L.P. and the
Association of Oil Pipe Lines.
Before: SENTELLE, GRIFFITH and KAVANAUGH, Circuit
Judges.
Opinion for the Court filed PER CURIAM.
3
PER CURIAM: SFPP, L.P., operates pipelines that transport
petroleum products through Arizona, California, Nevada, New
Mexico, Oregon, and Texas. This case is the latest chapter in a
long-running dispute over SFPP’s tariffs.
The consolidated petitions for review challenge three orders
of the Federal Energy Regulatory Commission (“FERC”):
1. ARCO Products Co. v. SFPP, L.P., 92 FERC ¶ 61,244(2000) (“Order Consolidating Proceedings”);
2. ARCO Products Co. v. SFPP, L.P., 106 FERC ¶ 61,300(2004) (“Order on Initial Decision”); and
3. SFPP, L.P., 111 FERC ¶ 61,334 (2005) (“Remand
Order”).
Several shippers – i.e., firms that pay to transport petroleum
products over SFPP’s pipelines – seek review of these three
orders. The shipper petitioners are BP West Coast Products,
Chevron Products, ConocoPhillips, ExxonMobil Oil, Navajo
Refining, Ultramar, Valero Marketing and Supply, and Western
Refining. The shippers raise several challenges to the
Commission’s orders. In particular, they argue that: (1) the
Commission unlawfully granted an income tax allowance to
SFPP; (2) the Commission applied the wrong standard and
relied upon faulty data in its analysis of whether SFPP’s rates
should be “de-grandfathered” under the Energy Policy Act of
1992; and (3) the Commission erroneously held that certain
shippers were not entitled to reparations for rates charged on
SFPP’s East Line after August 1, 2000. SFPP and the
Association of Oil Pipe Lines have intervened on behalf of the
Commission with respect to these issues.
4
SFPP and the Association of Oil Pipe Lines have also cross-
petitioned for review of the three challenged orders. They argue
that the Commission incorrectly interpreted the Energy Policy
Act and made several computational errors in determining
whether SFPP’s rates should be de-grandfathered. The shippers
have intervened on behalf of the Commission regarding these
issues.
We deny the petitions for review with respect to the income
tax allowance issues and the Energy Policy Act issues. We hold
that the Commission’s income tax allowance policy was not
arbitrary or capricious or contrary to law. We also hold that
FERC’s interpretation of the Energy Policy Act was reasonable.
We need not consider several of the arguments raised by SFPP
and the shippers regarding FERC’s calculations because the
parties failed to raise those arguments before the Commission in
the first instance. However, we grant the shippers’ petition for
review with respect to the reparations issue. FERC acted
contrary to law when it held that the Arizona Grocery doctrine
precluded the Commission from awarding reparations to East
Line shippers for rates paid after August 1, 2000.
I. FERC’S INCOME TAX ALLOWANCE POLICY
The first issue in these petitions for review is whether it was
lawful for FERC to grant an income tax allowance to pipelines
operating as limited partnerships. In the Remand Order, FERC
held that SFPP is entitled to an income tax allowance to the
extent that its partners incur “actual or potential income tax
liability” on the income they receive from the partnership.
SFPP, L.P., 111 FERC ¶ 61,334 at 62,456 (2005). The shipper
petitioners contend that this order is arbitrary and capricious and
contrary to our decision in BP West Coast Products, LLC v.
FERC, 374 F.3d 1263 (D.C. Cir. 2004), because it grants a tax
5
allowance to entities that do not actually pay income taxes.
While we agree that the orders under review and the policy
statement upon which they are based incorporate some of the
troubling elements of the phantom tax we disallowed in BP West
Coast, FERC has justified its new policy with reasoning
sufficient to survive our review. We therefore deny the petitions
for review with respect to this issue.
A.
FERC’s income tax allowance (“ITA”) policy for pipelines
that operate as limited partnerships has a tortuous history. In
1995, the Commission adopted the “Lakehead policy,” under
which pipelines’ ITA eligibility turned on whether the partners
were corporations or individuals. Lakehead Pipe Line Co., 71
FERC ¶ 61,338 at 62,313-15 (1995). In Lakehead, FERC held
that a pipeline was entitled to an ITA only for income taxes that
were “attributable to its corporate partners.” Id. at 62,314. The
Commission reasoned:
When partnership interests are held by corporations, the
partnership is entitled to a tax allowance in its cost-of-
service for those corporate interests because the tax cost
will be passed on to the corporate owners who must pay
corporate income taxes on their allocated share of income
directly on their tax returns. The partnership is in essence
a division of each of its corporate partners because the
partnership functions as a conduit for income tax purposes.
Id. at 62,314-15. In contrast, FERC held that pipelines were not
entitled to an ITA with respect to income attributable to
partnership interests held by individuals because “those
individuals do not pay a corporate income tax.” Id. at 62,315.
The Commission noted that its holding “comports with the
principle that there should not be an element in the cost-of-
6
service to cover costs that are not incurred.” Id.In the Opinion No. 435 proceedings, FERC applied the
Lakehead policy to SFPP’s rates, holding that SFPP could
include an income tax allowance in its cost-of-service for the
share of the partnership’s income that was attributable to
corporate partners. SFPP, L.P., 86 FERC ¶ 61,022 at 61,102-04
(1999). Several parties petitioned for review of this order. The
shipper petitioners argued – as they do in the instant case – that
SFPP should not be entitled to any income tax allowance
because it is a limited partnership that pays no income tax at the
entity level. In contrast, SFPP argued that it should have been
granted a full income tax allowance, even on the share of
income attributable to non-corporate partners.
In BP West Coast, we granted the shippers’ petition for
review and vacated the income tax allowance provisions of
Opinion No. 435. 374 F.3d at 1285-93. We held that:
[T]he Commission’s opinions in Lakehead do not evidence
reasoned decisionmaking for their inclusion in cost of
service of corporate tax allowances for corporate unit
holders, but denial of individual tax allowances reflecting
the liability of individual unit holders.
Id. at 1290. In other words, the Commission did not reasonably
explain why corporate partners and individual partners were
treated differently under the Lakehead policy. Id. at 1288-90.
We acknowledged that corporate income is taxed twice – while
other income is taxed only once – but we emphasized that this
discrepancy is simply “a product of the corporate form.” Id. at
1290-91. FERC may not attempt to compensate for the double
taxation of corporations by creating a “phantom” tax allowance.
As we explained:
7
[W]here there is no tax generated by the regulated entity,
either standing alone or as part of a consolidated corporate
group, the regulator cannot create a phantom tax in order to
create an allowance to pass through to the rate payer.
Id. at 1291. Income tax costs are “no different” than any other
costs, such as bookkeeping expenses. Id. We noted that just as
a pipeline does not receive an allowance for the bookkeeping
costs of its investors, neither may it receive an allowance for
income taxes paid by “corporate unit holders” (i.e., investors).
Id. In sum, our per curiam decision in BP West Coast vacated
FERC’s Lakehead policy because the Commission did not
provide a reasoned explanation for distinguishing between
individual and corporate partners, and because the Commission
appeared to be granting income tax allowances to regulated
entities that did not actually pay income taxes.
In response to our decision in BP West Coast, the
Commission issued a notice of inquiry seeking comments from
interested parties on the question when, if ever, it is appropriate
to provide an income tax allowance for partnerships or similar
pass-through entities that hold interests in a regulated public
utility. Inquiry Regarding Income Tax Allowances; Request for
Comments, 69 Fed. Reg. 72,188 (Dec. 13, 2004). On May 4,
2005, the Commission issued a policy statement that provided
guidance about how it planned to address the ITA issue going
forward. Policy Statement on Income Tax Allowances, 111
FERC ¶ 61,139 (2005) (“Policy Statement”). In the Policy
Statement, the Commission concluded that “such an allowance
should be permitted on all partnership interests, or similar legal
interests, if the owner of that interest has an actual or potential
income tax liability on the public utility income earned through
the interest.” Id. at 61,736. In response to its request for
comments, the Commission received 42 responses. Id. at
61,737. After review of the comments, the Commission
8
determined that it should choose one of four possible
approaches:
(1) provide an income tax allowance only to corporations,
but not partnerships; (2) give an income tax allowance to
both corporations and partnerships; (3) permit an allowance
for partnerships owned only by corporations; and (4)
eliminate all income tax allowances and set rates based on
a pre-tax rate of return.
Id. at 61,741. The Commission ultimately selected the second
option, stating that it would “permit an income tax allowance for
all entities or individuals owning public utility assets, provided
that an entity or individual has an actual or potential income tax
liability to be paid on that income from those assets.” Id. After
weighing the relevant policy concerns, FERC concluded that
this policy “serves the public because it allows rate recovery of
the income tax liability attributable to regulated utility income,
facilitates investment in public utility assets, and assures just
and reasonable rates.” Id. at 61,736.
The Commission applied its new policy and reiterated its
reasoning in the Remand Order. 111 FERC at 62,454-56. In
that order, FERC ruled that SFPP was entitled to an ITA to the
extent that the pipeline’s partners – both individual and
corporate – paid taxes on the income they received from the
partnership. Id. at 62,455-56. The Commission acknowledged
that “the pass-through entity does not itself pay income taxes,”
but nonetheless granted the ITA because “the owners of a pass-
through entity pay income taxes on the utility income generated
by the assets they own via the device of the pass-through entity.”
Id. at 62,455. FERC reasoned that:
9
[J]ust as a corporation has an actual or potential income tax
liability on income from the public utility assets it controls,
so do the owners of a partnership or limited liability
corporation (LLC) on the assets and income that they
control by means of the pass-through entity.
Id. Thus, the Commission concluded that “SFPP, L.P. should be
afforded an income tax allowance on all of its partnership
interests to the extent that the owners of those interests had an
actual or potential income tax liability during the periods at
issue.” Id. at 62,456.
ExxonMobil Oil, BP West Coast Products, Navajo Refining
Company, and other shippers have petitioned for review of the
Remand Order, arguing that FERC’s decision to grant SFPP an
income tax allowance was arbitrary and capricious and contrary
to our decision in BP West Coast. The Policy Statement is not
directly challenged in these petitions for review. However, in
the Remand Order – which is challenged in the instant case – the
Commission expressly relied upon the conclusions and
reasoning of the Policy Statement. See 111 FERC at 62,456
(“Given the Commission’s Policy Statement and the application
of its policy in this opinion, the Commission concludes that
SFPP, L.P. should be afforded an income tax allowance . . . .”).
Thus, in determining whether the Remand Order was arbitrary
and capricious or contrary to BP West Coast, we necessarily
review the Commission’s conclusions and reasoning in the
Policy Statement.
B.
In the Remand Order, FERC resolved the principal defect
of the Lakehead policy, which was the inadequately explained
differential treatment of the tax liability of individual and
corporate partners. The Commission concluded that regulated
10
pipelines operating as limited partnerships should be eligible for
income tax allowances to the extent that all partners incur actual
or potential tax liability on the income they receive from the
partnership. FERC’s explanation in support of this policy
choice is reasonable, and the Commission’s Remand Order is
not inconsistent with BP West Coast. Accordingly, we deny the
petitions for review with respect to this issue.
We review the Commission’s ratemaking decisions under
the “arbitrary and capricious” standard. Ass’n of Oil Pipe Lines
v. FERC, 83 F.3d 1424, 1431 (D.C. Cir. 1996) (“AOPL”).
Under this test, FERC’s decisions will be upheld as long as the
Commission has examined the relevant data and articulated a
rational connection between the facts found and the choice
made. Id. (quoting Motor Vehicle Mfrs. Ass’n v. State Farm
Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)). In other words, the
Commission must “cogently explain why it has exercised its
discretion in [the] given manner.” Exxon Corp. v. FERC, 206
F.3d 47, 54 (D.C. Cir. 2000) (internal quotation marks omitted)
(alteration in original). In reviewing FERC’s orders, we are
“particularly deferential to the Commission’s expertise” with
respect to ratemaking issues. AOPL, 83 F.3d at 1431; see also
FPC v. Hope Natural Gas Co., 320 U.S. 591, 602 (1944) (noting
that a party challenging a natural gas rate order “carries the
heavy burden of making a convincing showing that it is invalid
because it is unjust and unreasonable”).
The Commission must ensure that the rates charged by
jurisdictional pipelines are “just and reasonable.” BP West
Coast, 374 F.3d at 1286 (citation omitted). We have held that
“just and reasonable” rates are “rates yielding sufficient revenue
to cover all proper costs, including federal income taxes, plus a
specified return on invested capital.” City of Charlottesville v.
FERC, 774 F.2d 1205, 1207 (D.C. Cir. 1985). Of course, this
canonical principle of ratemaking begs the question of which
11
costs are “proper.” In the challenged Remand Order, FERC
concluded that it was proper to grant SFPP an income tax
allowance to the extent that its partners – both individual and
corporate – incurred actual or potential tax liability on their
distributive share of the partnership income. In light of the
deference we extend to the Commission’s judgments regarding
ratemaking issues, we cannot hold that this conclusion was
arbitrary or capricious.
On remand from BP West Coast, the Commission
considered four different options for its income tax allowance
policy. First, the Commission considered – and rejected – a
proposal to adopt a modified version of the Lakehead policy. As
FERC explained in the Policy Statement, “the Commission
agrees with the court’s conclusion in BP West Coast that . . .
Lakehead did not articulate a rational ground for concluding that
there should be no tax allowance on partnership interests owned
by individuals, but that there should be one for partnership
interests owned by corporations.” 111 FERC at 61,743. Given
our holding in BP West Coast, the Commission was certainly
permitted – if not required – to reject the comments that
proposed a modified Lakehead policy. Second, FERC
considered a proposal that would grant income tax allowances
only to partnerships that are “owned wholly by corporations
filing a consolidated return.” Id. at 61,738. FERC reasonably
rejected this for the same reason it rejected the first alternative
– because it found no rational reason for differentiating between
corporate and non-corporate partnership interests. Id. at 61,744.
The two remaining policy options considered by the
Commission were polar opposites. One proposal would have
categorically prohibited limited partnerships from taking income
tax allowances, while the other would have granted partnerships
a full income tax allowance to the extent that the partners incur
actual or potential tax liability. Id. at 61,739-41. The
12
Commission chose to adopt a policy of full income tax
allowances for limited partnerships, and we cannot conclude that
this choice was unreasonable. Most importantly, FERC
determined that income taxes paid by partners on their
distributive share of the pipeline’s income are “just as much a
cost of acquiring and operating the assets of that entity as if the
utility assets were owned by a corporation.” Id. at 61,742. In
other words, the Commission found no good reason to limit the
income tax allowance to corporations, given that “both partners
and Subchapter C corporations pay income taxes on their first
tier income.” Id. at 61,744.
Moreover, the Commission determined that income taxes
paid on the partners’ distributive share of the pipeline’s income
were properly “attributable” to the regulated entity because such
taxes must be paid regardless of whether the partners actually
receive a cash distribution. See United States v. Basye, 410 U.S.
441, 453 (1973) (“[I]t is axiomatic that each partner must pay
taxes on his distributive share of the partnership’s income
without regard to whether that amount is actually distributed to
him.”). Based on this aspect of partnership law, FERC
concluded that income taxes paid by investors in a limited
partnership are “first-tier” taxes that may be allocated to the
regulated entity’s cost-of-service. The shipper petitioners argue
that these taxes are ultimately paid by individual investors – not
the pipeline – and thus it was improper for FERC to grant an
ITA to the regulated entity. However, the Commission
reasonably addressed this concern, explaining:
Because public utility income of pass-through entities is
attributed directly to the owners of such entities and the
owners have an actual or potential income tax liability on
that income, the Commission concludes that its rationale
here does not violate the court’s concern that the
Commission had created a tax allowance to compensate for
13
an income tax cost that is not actually paid by the regulated
utility.
Policy Statement, 111 FERC at 61,742.
FERC also emphasized that “the return to the owners of
pass-through entities will be reduced below that of a corporation
investing in the same asset if such entities are not afforded an
income tax allowance on their public utility income.” Id. The
Commission determined that “termination of the allowance
would clearly act as a disincentive for the use of the partnership
format,” because it would lower the returns of partnerships vis-
a-vis corporations, and because it would prevent certain
investors from realizing the benefits of a consolidated income
tax return. Id. We cannot hold that these conclusions were
unreasonable. It has long been established that “the return to the
equity owner should be commensurate with returns on
investments in other enterprises having corresponding risks.”
Hope Natural Gas, 320 U.S. at 603. In the Policy Statement,
FERC concluded that it would be inequitable to grant a full
income tax allowance to corporations while denying a similar
allowance to limited partnerships. 111 FERC at 61,740, 61,742.
For example, if the corporate tax rate is 35%, then a pipeline that
operates as a corporation is permitted to charge a rate of $154 in
order to earn after-tax income of $100. As several commenters
pointed out, “if an income tax allowance is not allowed the
partnership, then the partners must pay a $35 income tax on
$100 of utility income, leaving them with only an after-tax
return of $65.” Id. Based on these comments, the Commission
determined that pipelines operating as limited partnerships
should receive a full income tax allowance in order to maintain
parity with pipelines that operate as corporations. This
conclusion was not unreasonable, and we defer to FERC’s
expert judgment about the best way to equalize after-tax returns
for partnerships and corporations.
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In sum, policy choices about ratemaking are the
responsibility of the Commission – not this Court. See AT&T
Corp. v. FCC, 220 F.3d 607, 631 (D.C. Cir. 2000) (noting that
“policy judgment[s]” are “for the agency – not this court – to
make”). Our role as a reviewing court is limited to ensuring that
“the Commission’s decisionmaking is reasoned, principled, and
based upon the record.” So. Cal. Edison Co. v. FERC, 443 F.3d
94, 98 (D.C. Cir. 2006) (quoting Williston Basin Interstate
Pipeline Co. v. FERC, 165 F.3d 54, 60 (D.C. Cir. 1999)). Here,
the conclusions reached in the Policy Statement and the Remand
Order were within the scope of the Commission’s discretion
with respect to ratemaking issues. We held in City of
Charlottesville that regulated entities are entitled to recover all
“proper” costs from their ratepayers. 774 F.2d at 1207.
Obviously, “proper” is not a self-defining term, and the
Commission thus has broad discretion to determine which costs
may be recovered through a pipeline’s rates. Here, FERC has
reasonably explained why income taxes paid on partnership
income are properly allocated to the regulated entity for
ratemaking purposes, and the shipper petitioners have offered no
compelling reason to second-guess the agency’s policy choices.
***
Petitioners argue that regardless of whether FERC’s new
ITA policy is reasonable, the Remand Order must be set aside
because it is inconsistent with our opinion in BP West Coast.
We disagree.
At the outset, we note that BP West Coast did not
categorically prohibit the Commission from granting income tax
allowances to pipelines that operate as limited partnerships. We
granted the shippers’ petition for review in that case primarily
because of the Commission’s inadequately justified differential
treatment of individual partners and corporate partners. As we
15
explained, “the Commission’s opinions in Lakehead do not
evidence reasoned decisionmaking for their inclusion in cost of
service of corporate tax allowances for corporate unit holders,
but denial of individual tax allowances reflecting the liability of
individual unit holders.” BP West Coast, 374 F.3d at 1290. The
Commission has now chosen to treat all income taxes alike,
regardless of whether they are incurred by individual partners or
corporate partners. See Remand Order, 111 FERC at 62,455
(conceding that “Lakehead mistakenly focused on who pays the
taxes rather than on the more fundamental cost allocation
principle of what costs, including tax costs, are attributable to
regulated service, and therefore properly included in a regulated
cost of service”). BP West Coast did not pass upon the specific
question at issue in the instant case – whether FERC may grant
an ITA to limited partnerships for the income taxes paid by all
partners on the income they receive from the partnership. It is
a basic tenet of administrative law that when an agency action
is found to be arbitrary and capricious because of a failure to
exercise reasoned decisionmaking, the agency is free to adopt a
new policy on remand, provided it supplies a reasoned
explanation for its actions. See SEC v. Chenery Corp., 332 U.S.
194, 200-01 (1947) (holding that when a court sets aside an
agency order as “unsupportable for the reasons supplied by that
agency,” the agency is “bound to deal with the problem afresh”
on remand).
Petitioners also argue that limited partnerships do not pay
entity-level income taxes, and thus FERC’s new ITA policy
disregards our statement in BP West Coast that “the regulator
cannot create a phantom tax in order to create an allowance to
pass through to the rate payer.” 374 F.3d at 1291. While not
without force, this argument cannot ultimately prevail, for two
reasons. First, as FERC explained in the Policy Statement and
the Remand Order, the income taxes for which SFPP will
receive an income tax allowance are real, albeit indirect. SFPP
16
will be eligible for a tax allowance only to the extent it can
demonstrate – in a rate proceeding – that its partners incur
“actual or potential” income tax liability on their respective
shares of the partnership income. Remand Order, 111 FERC at
62,456. Second, when we used the term “phantom tax” in BP
West Coast, we were reviewing a very different set of orders
than the ones at issue here. In BP West Coast, we vacated the
Lakehead policy because the Commission had offered no
reasoning to support its distinction between corporate partners
and individual partners. 374 F.3d at 1290 (“This does not
supply reasoning for differentiating between individual and
corporate tax liability. It is merely restating the proposition that
the Commission is so differentiating.”). However, in the instant
case FERC has gone to great lengths to explain why the taxes in
question are not “phantom” and are properly attributed to the
regulated entity. And there is at least one aspect of partnership
law that supports FERC’s conclusion but was not advanced by
the Commission in BP West Coast – investors in a limited
partnership are required to pay tax on their distributive shares of
the partnership income, even if they do not receive a cash
distribution. See Basye, 410 U.S. at 454. As explained above,
this supports FERC’s determination that taxes on the income
received from a limited partnership should be allocated to the
pipeline and included in the regulated entity’s cost-of-service.
In this sense, petitioners’ likening of partnership tax to
shareholder dividend tax is inapposite because a shareholder of
a corporation is generally taxed on the amount of the cash
dividend actually received. In sum, in the Policy Statement and
the Remand Order, FERC has reasonably explained why its new
ITA policy does not result in the creation of “phantom” tax
liability for regulated pipelines that operate as limited
partnerships. The same cannot be said for the Lakehead policy
that we vacated in BP West Coast.
17
Shipper petitioners also emphasize that in BP West Coast
we rejected SFPP’s argument that the Commission should have
adopted a full income tax allowance for limited partnerships.
Petitioners argue that this holding is now the “law of the case,”
because the instant case involves the same issue that was
litigated – and resolved in the shippers’ favor – in the earlier
proceeding. Again, we disagree. In BP West Coast, SFPP
cross-petitioned for review of the Lakehead policy. Like the
shipper petitioners, SFPP argued that the Commission’s
distinction between corporate partners and individual partners
was unsupportable. 374 F.3d at 1291. However, while the
shipper petitioners argued that FERC should not have permitted
any income tax allowance, SFPP argued that FERC should have
granted a full ITA to pipelines operating as limited partnerships.
We rejected SFPP’s argument in BP West Coast, but petitioners
now read too much into our holding with respect to this issue.
All we held in BP West Coast is that the Commission was not
required to grant a full income tax allowance to pipelines that
operate as limited partnerships. Petitioners’ argument assumes
that “not required” is synonymous with “prohibited.” To the
contrary, when an agency has broad discretion to choose among
different policy options, the fact that any one option is not
required certainly does not mean that it is prohibited. Arguably,
a fair return on equity might have been afforded if FERC had
chosen the fourth alternative of computing return on pretax
income and providing no tax allowance at all for the pipeline
owners. This, however, is a policy decision rejected by FERC.
As we noted above, policy decisions are for the Commission and
not the court.
***
In conclusion, we deny the petitions for review with respect
to the income tax allowance issue. Under the arbitrary and
capricious test, our standard of review is “only reasonableness,
18
not perfection.” Kennecott Greens Creek Min. Co. v. MSHA,
476 F.3d 946, 954 (D.C. Cir. 2007). We need not decide
whether the Commission has adopted the best possible policy as
long as the agency has acted within the scope of its discretion
and reasonably explained its actions. In the Policy Statement
and the Remand Order, the Commission resolved the principal
defect of the Lakehead policy, which was the unexplained
differential treatment of individual and corporate partners.
FERC then determined that it would be “just and reasonable” to
grant regulated pipelines an income tax allowance to the extent
that all of the pipeline’s partners – whether individual or
corporate – incur actual or potential tax liability. The
Commission reasonably determined that such taxes are
“attributable” to the regulated entity, given that partners must
pay tax on their share of the partnership income regardless of
whether they actually receive a cash distribution. Additionally,
the Commission reasonably relied upon evidence that a full
income tax allowance is necessary to ensure that corporations
and partnerships of like risk will earn comparable after-tax
returns. Lastly, in the income tax allowance Policy Statement,
FERC explained in detail why it chose to reject the other three
policy options proposed by commenters. We cannot hold that
the Commission’s policy choices were arbitrary and capricious.
Accordingly, we deny the petitions for review with respect to
this issue.
II. ENERGY POLICY ACT ISSUES
Both sets of petitioners argue that FERC misinterpreted §
1803 of the Energy Policy Act of 1992. This provision
grandfathers certain oil pipeline rates as they existed at the time
of the Act’s enactment. Under this statute, shippers can
challenge these grandfathered rates when “a substantial change
has occurred after the date of the enactment of [the EPAct] . . .
19
in the economic circumstances of the oil pipeline which were a
basis for the rate.” FERC interpreted § 1803 to allow rate
challenges when there has been a substantial change in a
pipeline’s overall rate of return. Shipper petitioners argue that
this interpretation grandfathers too many rates; they contend that
a substantial change in any one cost element, even if offset by
other changes such that the overall rate of return is unaffected,
subjects a rate to challenge under § 1803. From the other
direction, pipeline petitioners contend that FERC’s
interpretation grandfathers too few rates; they argue that the
correct standard should take account of factors in addition to a
pipeline’s costs. FERC has rejected the diametrically opposed
arguments of the petitioners and interpreted the statutory text to
establish a middle ground between those two competing
positions. We hold that FERC’s interpretation is reasonable.
A.
Federal regulation of oil pipelines began in 1906, when
Congress passed the Hepburn Act. That statute applied the
Interstate Commerce Act (ICA) to oil pipelines and gave the
Interstate Commerce Commission jurisdiction over the
pipelines. Pub. L. No. 59-337, § 1, 34 Stat. 584, 584. In 1977,
Congress transferred responsibility for oil pipeline regulation to
the newly created FERC. Department of Energy Reorganization
Act, Pub. L. No. 95-91, § 402(b), 91 Stat. 565, 584. The
following year, Congress comprehensively revised the ICA but
provided that its 1977 provisions would continue to govern
FERC’s regulation of oil pipelines.1 Act of Oct. 17, 1978, Pub
L. No. 95-473, § 4(c), 92 Stat. 1337, 1470.
1
As a result, the older version of the ICA was reprinted in the
appendix to Title 49 of the United States Code. Because newer
editions of the Code do not include the ICA, however, all citations to
the ICA in this opinion refer to the 1988 U.S. Code.
20
The ICA prohibits pipelines from charging rates that are
“unjust or unreasonable” and permits shippers to challenge both
pre-existing and newly filed rates. 49 U.S.C. app. §§ 13(1),
15(1), (7). FERC has generally approved just and reasonable
rates based primarily on a pipeline’s costs. See Frontier
Pipeline Co. v. FERC, 452 F.3d 774, 776 (D.C. Cir. 2006)
(citing Ass’n of Oil Pipe Lines v. FERC, 83 F.3d 1424, 1428-29
(D.C. Cir. 1996); Farmers Union Cent. Exch. v. FERC, 734 F.2d
1486, 1495-96 (D.C. Cir. 1984); Farmers Union Cent. Exch. v.
FERC, 584 F.2d 408, 412-22 (D.C. Cir. 1978)). In Opinion No.
154-B, issued in 1985, FERC adopted the “trended original cost”
(or “TOC”) method for ratemaking, in which asset depreciation
and equity recovery are smoothed out over the lifetime of a
pipeline in order to avoid excessively high rates at the front end,
thereby encouraging new market entrants. See Williams Pipe
Line Co., 31 FERC ¶ 61,377 at 61,833 (1985); BP West Coast
Prods., LLC v. FERC, 374 F.3d 1263, 1282-83 (D.C. Cir. 2004).
In 1992, Congress enacted the Energy Policy Act (EPAct).
Pub. L. No. 102-486, 106 Stat. 2776. In Title 18 of that Act,
called “Oil Pipeline Regulatory Reform,” Congress sought to
simplify ratemaking procedures for oil pipelines; this would
reduce administrative and litigation costs for pipelines and
shippers. See id. at 3010-12 (codified at 42 U.S.C. § 7172 note);
Ass’n of Oil Pipe Lines v. FERC, 83 F.3d 1424, 1429 (D.C. Cir.
1996). Section 1801 of the EPAct directed FERC to “issue a
final rule which establishes a simplified and generally applicable
ratemaking methodology for oil pipelines” within one year of
the passage of the Act. 106 Stat. at 3010. Section 1802 required
FERC to “issue a final rule to streamline procedures . . . relating
to oil pipeline rates in order to avoid unnecessary regulatory
costs and delays” within 18 months. Id. The goal of these
provisions was to decrease the costs associated with
administrative proceedings and litigation involving oil pipeline
rates.
21
FERC implemented those mandates in Order No. 561 by
establishing an indexed cap system, in which the maximum
permissible rates for pipelines are adjusted annually to reflect
predictions of industry-wide changes in costs. See Revisions to
Oil Pipeline Regulations Pursuant to the Energy Policy Act of
1992, Order No. 561, FERC Stats. & Regs. ¶ 30,985, 58 Fed.
Reg. 58,753 (1993); Order No. 561-A, FERC Stats. & Regs. ¶
31,000, 59 Fed. Reg. 40,243 (1994). A pipeline may charge a
rate above the applicable cap only if there is a “substantial
divergence” between the cap and its actual costs, if it shows that
it lacks “significant market power,” or if all of its customers
consent. 18 C.F.R. § 342.4.
We upheld this scheme in Association of Oil Pipe Lines v.
FERC. 83 F.3d at 1428. We have explained that the primary
benefits of the cap system are that it “dispenses with intricate
calculations of specific pipeline costs” and encourages pipelines
to develop “cost-reducing innovations” because any given
pipeline’s cost-cutting is unlikely to affect the industry-wide
cap. Frontier Pipeline Co., 452 F.3d at 777.
In keeping with its general purpose to reduce costs from
administrative proceedings and litigation associated with the
regulation of oil pipelines, the EPAct also includes a
“grandfathering” provision that insulates certain pre-existing
pipeline rates from challenge even if the rates exceed the
appropriate indexed cap. Section 1803(a) provides that any rate
in effect for the full year ending on the date of the enactment of
the EPAct (October 24, 1992) is just and reasonable unless it
had been subject to protest, investigation, or complaint during
that one-year period. Under § 1803(b), a grandfathered rate can
be challenged as not just and reasonable – “de-grandfathered” –
if “evidence is presented to the Commission which establishes
that a substantial change has occurred after the date of the
enactment of this Act – (A) in the economic circumstances of
22
the oil pipeline which were a basis for the rate; or (B) in the
nature of the services provided which were a basis for the rate”
(emphasis added). Thus, under § 1803, “the analysis of a
pipeline rate challenge . . . proceeds in two steps: first, FERC
determines whether the rate in question is grandfathered; if it is,
FERC then asks whether the rate falls within either of the
exceptions outlined in Section 1803(b).” BP West Coast, 374
F.3d at 1272.
The background to this litigation is complex. Since the
EPAct went into effect in 1992, shippers have asked FERC to
declare that SFPP’s lines either did not qualify for
grandfathering or should be de-grandfathered due to
substantially changed circumstances.
Docket No. OR92-8 (1992-1995). In Docket No. OR92-8,
addressing complaints filed between 1992 and August 1995,
FERC determined that SFPP’s West Line rates were (with one
exception) grandfathered, but that its East Line rates were not.
SFPP, L.P., Opinion No. 435-A, 91 FERC ¶ 61,135 at 61,499
(2000); BP West Coast, 374 F.3d at 1281. We affirmed FERC’s
conclusion with respect to the West Line in BP West Coast
Products, LLC v. FERC (the East Line analysis was not
challenged). 374 F.3d at 1278, 1282. In that same docket,
FERC also determined that the West Line had not experienced
substantially changed circumstances necessary to de-grandfather
its rates, despite the fact that FERC’s new Lakehead policy had
altered the income tax allowances SFPP could include in its
rates. See Lakehead Pipe Line Co., L.P., 71 FERC ¶ 61,338(1995); Opinion No. 435-A, 91 FERC at 61,499; BP West Coast,
374 F.3d at 1280. In BP West Coast, we did not need to reach
the question of substantially changed circumstances on the West
Line because we held that the Lakehead policy itself was
defective. 374 F.3d at 1280. We therefore remanded the issue
to FERC.
23
Docket No. OR96-2 (1995-2000). While the BP West Coast
appeal was pending, FERC consolidated in Docket No. OR96-2
shipper complaints filed between August 1995 and August 2000.
In March 2004, three months before we announced our decision
in BP West Coast, FERC held that the West Line had
experienced substantially changed circumstances and thus its
rates were de-grandfathered. ARCO Prods. Co. v. SFPP, L.P.,
106 FERC ¶ 61,300 at 62,148 (2004) (“Order on Initial
Decision”). In the same order, FERC held that SFPP’s North
and Oregon Lines had not experienced substantially changed
circumstances, reversing an ALJ decision to the contrary. Id. at
62,153. FERC explained that the ALJ had wrongly found
substantially changed circumstances solely because SFPP’s tax
allowance – only one factor in its total costs – had changed due
to the Lakehead policy. Id. at 62,144. Instead, the Commission
explained, the ALJ should have considered whether SFPP’s total
costs on those lines had substantially changed. Id. In other
words, even if SFPP’s tax liability had significantly decreased,
if its overall cost of service remained roughly the same due to
other cost increases, there would not be substantially changed
circumstances. FERC analyzed the change in total costs on the
West, North, and Oregon Lines, and found that only the West
Line had experienced substantially changed circumstances. Id.
at 62,148-50.
June 2005 Remand Order. In June 2005, eleven months
after our remand order in BP West Coast, FERC issued an order
that served both as a remand order from BP West Coast
(addressing Docket No. OR92-8) and as a decision on appeal in
Docket No. OR96-2. SFPP, L.P., 111 FERC ¶ 61,334 (2005)
(“Remand Order”). In that order, FERC re-calculated whether
there had been substantially changed circumstances on SFPP’s
lines in light of its new adoption of a full income tax allowance
policy (see Part I above). After making these calculations,
24
FERC reaffirmed its determinations that the West Line was
de-grandfathered but that the North and Oregon Lines were not.
Id. at 62,458-59.
Both SFPP (with the Association of Oil Pipe Lines) and its
shippers petitioned this Court for review, each believing that the
Commission’s standard for determining substantially changed
circumstances is incorrect. Both sets of petitioners also allege
in their petitions that FERC erred in some of its calculations for
determining whether SFPP’s lines had experienced substantially
changed circumstances. We have jurisdiction under 49 U.S.C.
app. § 17(10) (1988).
B.
Both sets of petitioners challenge FERC’s interpretation of
the statutory phrase “a substantial change has occurred after the
date of the enactment of this Act . . . in the economic
circumstances of the oil pipeline which were a basis for the
rate.” FERC interpreted that phrase to mean a change in a
pipeline’s total cost of service. Remand Order, 111 FERC at
62,458-59. The shippers believe that the phrase must mean that
any substantial change in one rate element – for example, a
pipeline’s tax allowance – suffices to de-grandfather the rate,
even if that change is offset by another change, such that there
is virtually no change in the pipeline’s overall cost of service.
For their part, SFPP and the Association of Oil Pipe Lines
believe that the phrase must be interpreted to encompass factors
in addition to a pipeline’s cost of service because many pipelines
did not set the rates initially under the current cost-of-service
method. For example, FERC approved some pipeline rates on
the basis that a pipeline faced competition sufficient to allow the
market, rather than a cost-of-service formula, to determine the
rates.
25
Because Congress authorized FERC to adjudicate
complaints arising out of § 1803, the Commission’s
interpretation of § 1803 in an adjudication is entitled to Chevron
deference. BP West Coast, 374 F.3d at 1272-73.
FERC interprets the phrase “a substantial change has
occurred after the date of the enactment of this Act . . . in the
economic circumstances of the oil pipeline which were a basis
for the rate” as requiring a substantial change in the overall rate
of return of the pipeline, rather than in one cost element, such as
a tax allowance. That is because, as the Commission explained,
“there can be a very large reduction in income tax allowance . . .
even if many of the other principal cost factors, and in fact the
total cost-of-service, increased.” Order on Initial Decision, 106
FERC at 62,144. In other words, it makes little sense to
de-grandfather a rate when the pipeline is no more profitable –
or perhaps even less profitable – than it was when the rate was
grandfathered.
FERC’s interpretation easily fits within the bounds of the
statutory text. The word “circumstances” plausibly invokes a
composite of several variables. One definition of
“circumstances” is “the total complex of essential attributes and
attendant adjuncts of a fact or action: the sum of essential and
environmental characteristics.” WEBSTER’S THIRD NEW
INTERNATIONAL DICTIONARY 410 (1976). Another is “the
logical surroundings or ‘adjuncts’ of an action; the time, place,
manner, cause, occasion, etc., amid which it takes place.” 3
OXFORD ENGLISH DICTIONARY 241 (2d ed. 1989). When
modified by the word “economic,” the word “circumstances”
could reasonably mean the total economic outlook of a pipeline
– its profitability. In that case, it would be a change only in that
overall picture, rather than in any individual part of that picture,
that would constitute a change in “economic circumstances.” A
straightforward reading of the statutory text, therefore,
26
substantially validates FERC’s interpretation.
Moreover, FERC’s reading meshes with the purpose of the
EPAct, as gleaned from its text and structure. The
grandfathering provision of § 1803 is intended to insulate
pre-existing rates from attack by ordaining them to be
necessarily “just and reasonable.” The most natural
understanding of § 1803 is that Congress believed that the
then-existing rates of return were not so large as to justify the
added litigation costs of subjecting the rates to agency
evaluation and judicial review. This inference comports with
the streamlining goals of § 1801 and § 1802. It makes good
sense, then, to de-grandfather rates only when the rate of return
itself has changed. It is unclear why Congress would care if the
underlying composition of a pipeline’s costs has changed so
long as the pipeline’s rate of return has remained constant or
decreased.
The shippers focus on a different word in § 1803: the
indefinite article “a” before the phrases “substantial change” and
“basis for the rate.” They claim that the presence of the singular
indefinite article indicates that any substantial change in a single
cost element must qualify as a substantial change in economic
circumstances, even if that change is offset by other changes
such that the pipeline’s overall return is unaffected. We
disagree that such an interpretation is required by the text.
FERC could reasonably conclude that the phrase “a substantial
change . . . in the economic circumstances” means a change in
the overall economic circumstances, not a change in one
economic circumstance. And the phrase “a basis for the rate”
indicates nothing more than the fact that there are other bases for
a rate besides a pipeline’s economic circumstances. The EPAct
even identifies another basis for a rate: “the nature of services
provided.” EPAct, § 1803(b)(1)(B). Neither use of the
indefinite article undermines the reasonable inference that the
27
term “economic circumstances” refers to a composite of several
variables rather than any individual variable – which might be
the case if, for instance, the statute said “an economic
circumstance.”
The shippers also contend that the Order on Initial Decision
unreasonably departed from FERC’s precedent in Opinion No.
435. Of course, FERC may not depart from its own precedent
without a reasoned explanation. See Dominion Res., Inc. v.
FERC, 286 F.3d 586, 592 (D.C. Cir. 2002). In Opinion No. 435,
FERC wrote that a substantial change “could be established by
one or a number of rate elements” and that it is unnecessary to
“establish that there has been a substantial change to every rate
design element.” 86 FERC ¶ 61,022 at 61,066 (1999). The
shippers believe this means that FERC concluded that a change
in a single cost element – even absent a change in the overall
rate of return – would qualify as a change in economic
circumstances. It is doubtful, however, that FERC was
considering the possibility that two or more changes could offset
each other, which would explain why FERC discussed changes
in terms of a single rate element. Nowhere in Opinion No. 435
does FERC mention the possibility of offsetting. In the Order
on Initial Decision, in contrast, FERC became aware that using
single cost factors “could lead to anomalous results and result
[in] a threshold that does not adequately discourage challenges
to grandfathered oil pipeline rates.” 106 FERC at 62,151. The
Commission therefore explained that offsetting changes would
not count as changes in economic circumstances. See Remand
Order, 111 FERC at 62,458-59. This decision does not appear
to be a departure from precedent at all, but rather a clarification
of an issue that was not on the Commission’s radar at the time
of Opinion No. 435.
The shippers also argue that FERC inexplicably ascribes a
different quantitative level to the word “substantial” in
28
determining substantially changed circumstances under § 1803
than it does in determining whether a pipeline’s costs have
increased so much that the pipeline may charge a rate exceeding
the appropriate index level. In the de-grandfathering context,
the word “substantial” connotes a greater percentage change it
does in the indexing context. See Texaco Refining & Marketing,
Inc., 103 FERC ¶ 63,055 at 65,151 n.29 (2003); FERC
Supplemental Br. at 36-37. Even assuming this argument is not
waived (as it is unclear where in the record the petitioners raised
this point), it has no merit. The two regulatory contexts that the
shippers seek to equate – de-grandfathering and indexing –
implicate different regulatory interests. With indexing, FERC
must ensure that pipelines can survive economically by
recovering their costs. Even a small divergence between the
index level and actual costs might thwart this goal. In contrast,
in fleshing out the de-grandfathering standard under § 1803,
FERC is attempting to determine when a pipeline’s costs
diverge so much from those of the original rates that the benefits
of grandfathering (e.g., less litigation, more certainty) no longer
outweigh the costs to consumers. It is hardly irrational to
ascribe different meanings to the general term “substantial” in
those very different contexts.
Coming from the other direction, SFPP and the Association
of Oil Pipe Lines argue that FERC’s approach does not provide
enough protection to grandfathered rates. They argue that
because many of the grandfathered rates were not established
using a cost-of-service method, that method was not a “basis”
for those rates, and that therefore it is improper to
de-grandfather a rate based simply on a change in its cost of
service. SFPP points out that “[m]any rates were effectively set
according to the informal consent or formal agreement of the
shippers.” SFPP’s Br. at 36. Even rates that were computed
through a cost-of-service method often utilized formulas
different from the current method – for example, without the
29
income tax allowance. Moreover, beginning in the late 1980’s,
FERC offered pipelines a market-based alternative to the
cost-of-service method if they could demonstrate that they did
not possess significant market power.
A flaw in SFPP’s argument, so FERC could reasonably
conclude, is that § 1803 does not necessarily depend on the
method used to compute the grandfathered rate. Rather, § 1803
assumes that the “economic circumstances” of a pipeline were
a basis for its rate, regardless of how the rate was actually
established. It is certainly reasonable for FERC to use a
cost-of-service computation as an approximation for a pipeline’s
economic circumstances; the purpose of a cost-of-service rate,
after all, is to simulate what a pipeline’s economic behavior
would be in a competitive market. Merely because some
grandfathered rates were set according to non-regulated
agreements with shippers does not mean that the pipeline’s costs
did not indirectly influence the rate. Consequently, FERC’s
choice appears to be a perfectly reasonable means of interpreting
and applying § 1803.
C.
Both the shipper and pipeline petitioners raise a number of
technical challenges to the method by which FERC calculated
whether SFPP’s West, North, and Oregon lines had experienced
substantially changed circumstances: (1) The shippers argue
that FERC erred in using volumes as a proxy for revenues. (2)
The shippers argue that FERC should have apportioned costs
among different delivery points on the West Line. (3) The
shippers argue that FERC incorrectly determined that SFPP’s
North and Oregon Lines had not experienced substantially
changed circumstances because FERC employed an
inappropriate cost-of-service method. (4) SFPP and the
Association of Oil Pipe Lines argue that the figure FERC used
30
for 1992 costs is erroneous. (5) SFPP and the Association of Oil
Pipe Lines argue that FERC made an arithmetic error in
summing percentages of changes in rate elements to compute
the total change in return. Petitioners failed, however, to raise
any of those challenges in the proceedings before the
Commission.
A party must first raise an issue with an agency before
seeking judicial review. United States v. L.A. Tucker Truck
Lines, Inc., 344 U.S. 33, 36-37 (1952). This requirement serves
at least two purposes. It ensures “simple fairness” to the agency
and other affected litigants. It also provides this Court with a
record to evaluate complex regulatory issues; after all, the scope
of judicial review under the APA would be significantly
expanded if courts were to adjudicate administrative action
without the benefit of a full airing of the issues before the
agency. See Advocates for Highway & Auto Safety v. Fed.
Motor Carrier Safety Admin., 429 F.3d 1136, 1150 (D.C. Cir.
2005).
Petitioners believe that the absence of a rehearing
requirement in the ICA means that they were not required to
raise their complaints with FERC. Compare 49 U.S.C. app. §
17(9)(h) (1988) (Interstate Commerce Act) with 15 U.S.C. §
717r(b) (Natural Gas Act) and 16 U.S.C. § 825l(b) (Federal
Power Act). Petitioners miss the point: Their error was not
failing to seek rehearing, but rather failing to raise the issue at
all. See Sims v. Apfel, 530 U.S. 103, 108-110 (2000); L.A.
Tucker Truck Lines, Inc., 344 U.S. at 36-37; Hormel v.
Helvering, 312 U.S. 552, 556 (1941); Frontier Pipeline Co., 452
F.3d at 793; cf. 47 U.S.C. § 405(a) (“The filing of a petition for
reconsideration shall not be a condition precedent to judicial
review of [an FCC decision] except where the party seeking
such review . . . relies on questions of law or fact upon which
the Commission . . . has been afforded no opportunity to pass.”).
31
We need not consider the merits of those arguments because
none of them was raised below.
D.
In sum, we hold that FERC’s interpretation of § 1803 as
requiring a substantial change in a pipeline’s cost of service is
a reasonable interpretation of the statute. We need not address
the petitioners’ challenges to FERC’s technical calculations
because those arguments were not raised before the
Commission.
III. REPARATIONS
Shipper petitioners also challenge the Commission’s denial
of their claim for reparations for the service rates they have paid
to use SFPP’s East Line since August 1, 2000. The ICA permits
reparations for successful challenges to the justness and
reasonableness of existing rates, see 49 U.S.C. app. § 16(3)
(1988). If the Commission determines that the pipeline rates are
not “just and reasonable,” shippers who file complaints – and
only those shippers – are entitled to the difference between the
rates they paid and the rates the Commission retrospectively
determines to be just and reasonable. Id. The period for
potential reparations generally includes two years prior to the
filing date of the complaint. See id.; BP West Coast, 374 F.3d
at 1305-06.
In this case, the Commission determined that reparations
were not warranted for the challenged rates that went into effect
on August 1, 2000 because (1) they were proposed by SFPP in
response to a FERC order, (2) FERC had accepted them (albeit
on an interim basis), and (3) at the time the rates were accepted,
FERC explicitly recognized shippers’ right to appropriate
32
refunds pending the Commission’s finalization of just and
reasonable rates. Because reparations are precluded where the
Commission has “approved or prescribed” a reasonable rate, see
Arizona Grocery Co. v. Atchison, T. & S. F. Ry. Co., 284 U.S.
370 (1932), FERC argued that shippers were not entitled to
reparations for these rates. In challenging the Commission’s
ruling, shippers argue, inter alia, that Arizona Grocery does not
apply because the final rate has not been prescribed even as of
the time briefs were filed and argument was made to this Court.
The Commission and intervenors respond that this Court in BP
West Coast affirmed an earlier Commission ruling that upon
completion of refund calculations, the East Line’s rates are
considered final and effective as of August 1, 2000; therefore,
they argue, BP West Coast essentially permits Arizona Grocery
protection of the final rate once it is determined.
At the outset, we note that in this case the Commission
accepted SFPP’s proposed rate subject to refund as an interim
rate to compensate pipelines before the final just and reasonable
rate was to be determined. The question before us is whether we
should therefore consider the August 2000 rates minus potential
refunds to be FERC-prescribed and thus immune to reparation
claims. Critical to our analysis is the fact that when FERC
accepted this interim rate, its methodology had not yet been
established for determining the final rate. Because we agree
with petitioners that the Commission could not have “approved
or prescribed” just and reasonable rates as of August 1, 2000, we
conclude that these yet-to-be-finalized rates, which the shippers
paid to use SFPP’s East Line, do not receive Arizona Grocery
protection. The Commission’s ruling in denying these shippers
reparations was thus contrary to law.
33
A.
To determine whether the challenged rates were FERC-
prescribed, we must review their provenance. SFPP proposed
the August 1, 2000 rates in response to a FERC order, which
was the result of the proceedings now referred to as the OR92-8
proceedings. We briefly describe the relevant portion of those
proceedings.
As we discussed in Part II, § 1803(a) of the EPAct
grandfathered any rate in effect for the full year ending on the
date of the enactment of the EPAct (October 24, 1992) unless it
had been subject to protest, investigation, or complaint during
that year. SFPP was unable to benefit from this protection for
its East Line rates because one month before passage of the
EPAct, a shipper filed a complaint challenging those rates. See
BP West Coast, 374 F.3d at 1281. Following passage, numerous
shippers filed complaints challenging the East Line rates that
were not protected by the EPAct.
The Commission grouped those complaints into two
dockets: one docket included complaints filed between
November 1992 and August 1995 (Docket No. OR92-8) and
another docket included complaints filed between August 1995
and August 2000 (Docket No. OR96-2). Although the petition
before us challenges only FERC’s determination with respect to
the complaints in the OR96-2 proceedings, because that
determination rested in part on FERC’s action with respect to
the complaints in the OR92-8 proceedings, we describe each
docket in turn. The OR92-8 proceedings involved three steps by
which FERC determined that “the East Line rates between Texas
and Arizona were not just and reasonable and ordered them to
be modified and directed SFPP to make reparations
accordingly.” Opinion No. 435, 86 FERC ¶ 61,022 at 61,055
(1999) (citing SFPP, L.P., 80 FERC ¶ 63,014 (1997)). Once the
34
initial determination of unreasonableness had been made, the
Commission initiated proceedings to calculate the appropriate
modification so that reparations could be paid to East Line
shippers that had filed complaints. To calculate the appropriate
modification, the Commission employed a “test-year”
methodology. See 86 FERC at 61,113-14; see also BP West
Coast, 374 F.3d at 1307 (approving “test-year” methodology).
The test year chosen for the OR92-8 proceedings was 1994.2
The Commission took that rate and, using its indexing
regulation,3 determined just and reasonable rates for the East
Line from 1994 through August 1, 2000. See Opinion No. 435-
B, 96 FERC ¶ 61,281 at 62,071 (2001). The Commission then
determined the amount of reparations due shippers that had
challenged the East Line rates for these years by calculating the
difference between the rates actually paid and the adjusted rates
based on the test-year methodology. Finally, SFPP was ordered
to pay these reparations to shippers who had filed complaints.4
As indicated in Part I, the Commission’s order requiring
SFPP to pay these reparations did not conclude the OR92-8
proceedings. The shippers that had successfully challenged
SFPP’s East Line rates also challenged the amount of
2
The ALJ had determined – and the Commission affirmed –
that 1994 was a representative year “particularly for throughput.” 86
FERC at 61,084-85.
3
The Commission’s indexing regulation permits pipelines to
adjust their rates each year based on the Producer Price Index. See 18
C.F.R. § 342.3.
4
Although shippers are entitled to reparations beginning two
years prior to the filing date of their complaints, it is not clear from the
record whether the Commission indexed the 1994 rates to claims for
prior years because the indexing regulations were not in effect prior to
1995. See Opinion No. 435-B, 96 FERC at 62,071.
35
reparations calculated by FERC, arguing that its method of
calculating SFPP’s cost of service for the test year was amiss.
In litigation that came before us in BP West Coast, these
shippers disputed whether SFPP ought to be allowed to recover
(and thus remove from the amount of reparations owed) certain
income tax allowances, litigation costs, and reconditioning costs.
See 374 F.3d at 1285-1302. Because this Court vacated the
Commission’s Lakehead policy and remanded for the
Commission to re-calculate just and reasonable rates in light of
that holding, id. at 1312, FERC had not completed proper
calculations when the instant case was heard.
Meanwhile, the Commission had never made a final
determination as to SFPP’s East Line rates going forward.
Instead, the Commission directed SFPP to propose a new tariff
for rates beginning on August 1, 2000. See Opinion No. 435-A,
91 FERC ¶ 61,135 at 61,521 (2000); Opinion No. 435-B, 96
FERC at 62,075. SFPP proposed such a tariff (“Tariff No. 60”),
which was based in large measure on the same calculations that
FERC had used to determine just and reasonable rates for 1994
through 2000. 96 FERC at 62,075.
This proposed tariff faced substantial protest from shippers.
The Commission also noted that there were “technical problems
in SFPP’s compliance filings, some of which involved clear
overreaching.” SFPP, L.P., 100 FERC ¶ 61,353 at 62,626
(2002). So the Commission accepted the rate on an interim
basis subject to later refunds if the tariff was subsequently
determined not to be just and reasonable.5 See id. at 62,625.
The Commission did so “out of equitable concern for the East
5
It is settled that the Commission had authority to direct a
pipeline to file interim rates subject to refunds if there was a
possibility that the final rates would be lower than the interim rates.
See BP West Coast, 374 F.3d at 1305.
36
Line shippers that are not eligible for reparations in this
proceeding” because they “would continue to pay rates higher
than those that might ultimately be determined to be just and
reasonable until such time as a final and definitive prospective
rate was determined.” Id. In other words, because FERC might
later deem SFPP’s proposed August 2000 rates to be not just and
reasonable, the Commission sought to give the benefit of that
subsequent determination to East Line shippers who had not
filed a complaint challenging these rates. The Commission
therefore stressed that SFPP’s interim rate for the East Line
shippers would not receive Arizona Grocery protection because
in this case “the Commission has expressly reserved its authority
in the context of an ongoing proceeding in which the
methodology for determining the rate had not even been
established.” Id. at 62,626 (emphasis added).
Since submitting Tariff No. 60 in August 2000, SFPP has
changed its rates each year pursuant to the Commission’s
indexing regulations. See Respondent’s Br. at 48-49. That is,
since August 1, 2000, all East Line shippers have been paying
interim rates, and once the final rates are determined all East
Line shippers will be entitled to refunds if the interim rates
exceed the final rates. As of the time briefs in this matter were
filed and argument was presented to this Court, SFPP and the
Commission were still working out the implications of BP West
Coast for the determination of a just and reasonable rate on the
East Line. Whatever rate is eventually determined to be just and
reasonable will be applied retroactively to August 1, 2000. See
BP West Coast, 374 F.3d at 1304; Opinion No. 435-B, 96 FERC
at 62,079. The shippers seek review of FERC’s determination
with respect to these rates.
The post-August 1, 2000 rates at issue in this case were not
directly challenged in the OR92-8 proceedings. Nevertheless,
insofar as these rates applied to all East Line shippers, and
37
insofar as the complaints filed after August 1995 had still to be
addressed, the post-August 1, 2000 rates had important
consequences on the calculation of reparations arising from any
rate proceedings that ended after August 1, 2000. This brings us
to the OR96-2 proceedings, which involved complaints filed
between late 1995 and August 2000.6 The OR96-2 proceedings
were initially completed in March 2004, see Order on Initial
Decision, 106 FERC ¶ 61,300 (2004), then in June 2005, see
Remand Order, 111 FERC ¶ 61,334 (2005), and were revisited
again in December 2005, see SFPP, L.P., 113 FERC ¶ 61,277(2005). This meant that the East Line’s post-August 1, 2000
rates and the Commission’s refund policy came under scrutiny
to the extent that reparations had to be calculated up until 2006
for the OR96-2 complainants.
In the OR96-2 proceedings, the Commission applied the
same test-year methodology it had applied in the OR92-8
proceedings, see id., but substituted 1999 for 1994 as the test
year. See 113 FERC at 62,096-97. Accordingly, FERC first
established the just and reasonable rates based on the estimated
cost of service in 1999 and then indexed these rates forward to
May 1, 2006. Based on FERC’s calculations of the test-year
rate, SFPP was directed to make compliance filings with the
proposed interim rates by February 15, 2006. Id. at 62,115. The
6
Other than the time periods in which they were filed, there
is no significant conceptual difference between the complaints in the
OR92-8 proceedings and those in the OR96-2 proceedings. The
complaints in the first docket challenged the East Line’s rates between
November 1990 (two years before the first complaint in the docket
was filed) and August 2000 (the date Tariff No. 60 went into effect).
The complaints in the second docket challenged rates between late
1993 (two years before the first complaint in the docket was filed) and
May 2006 (the effective date of SFPP’s new tariff), see SFPP, L.P.,
114 FERC ¶ 61,136 at 61,463 (2006).
38
Commission held that SFPP’s newly proposed tariff would go
into effect as of May 1, 2006. Id. As in the OR92-8
proceedings, the tariff was accepted on an interim basis and was
subject to refund if the rates are later determined to be not just
and reasonable. Id. Reparations due shippers for rates paid
between 1993 and August 1, 2000 – unless shippers have
already received reparations based on the 1994 rates by virtue of
having participated in the OR92-8 proceedings – will also be
based on the 1999 indexed rates. Id. Notably for the current
controversy, however, the Commission does not intend to use
the 1999 rates to determine the just and reasonable rates between
August 1, 2000 and May 1, 2006.
The Commission argues that as a result of the interim rate
from SFPP’s Tariff No. 60, determined according to the OR92-8
proceedings, all East Line shippers will already receive
appropriate refunds once the initial 1994 test-year analysis is
corrected and appropriate refunds are ordered. The Commission
argues, therefore, that all shippers, including those in the OR96-
2 proceedings, will eventually have paid just and reasonable
rates on the East Line from August 1, 2000 because the refund
will equal the amount between SFPP’s proposed interim rate and
the final rate eventually calculated by the Commission.
Respondent’s Br. at 39. For these reasons, in the orders under
review, the Commission denied East Line shippers reparations
for rates charged for East Line service since August 1, 2000.
See ARCO Prods. Co., 92 FERC ¶ 61,244 at 61,781 (2000);
Order on Initial Decision, 106 FERC at 62,141; Remand Order,
111 FERC at 62,462-63. Instead, shippers will be entitled to
refunds alone. Shippers petition us to vacate FERC’s orders
thereby entitling them to reparations. Before turning to our
analysis of the shippers’ petition, we pause briefly to highlight
the difference between refund and reparation.
39
When FERC has accepted interim rates subject to refund,
all shippers – not just those that file complaints – are entitled to
appropriate refunds once the final “just and reasonable” rates are
established. Where the Commission has not prescribed final
“just and reasonable” rates, refunds may be appropriate, e.g.,
where an intervening change in law alters the Commission’s
cost-of-service calculation. The BP West Coast case and the
OR92-8 proceedings are illustrative. The Commission used a
test-year methodology to calculate just and reasonable rates for
a given period, but this Court subsequently held that the
Commission, as a matter of law, erred in its income tax
allowance policy. See 374 F.3d at 1285-93. This Court
therefore remanded the case back to the Commission, and the
Commission was required to recalculate the underlying rate in
light of our holding. Upon completing the calculation, the
Commission would then have to index the new just and
reasonable rate forward, and order SFPP to refund any amount
paid in excess of the new calculations. See, e.g., 113 FERC at
62,115. Reparations, by contrast, correct the errors of rate
calculations when those calculations have never been approved
as just and reasonable, and only shippers that have filed
complaints are entitled to reparations. But under Arizona
Grocery, where the Commission has prescribed a reasonable
rate, it may not then subject a carrier to reparations based on the
Commission’s revised determination of reasonableness. See
Arizona Grocery, 284 U.S. at 390.
To those who do not specialize in the Commission’s
proceedings, it may not be obvious why an East Line shipper
that is already entitled to refunds at the completion of
compliance proceedings would seek reparations, given that both
refunds and reparations amend unreasonable rates by
compensating those who have been subject to them by
overpayment. The difference to petitioners between refund and
reparation is simple: the two methods may, by circumstance
40
alone, reflect two different values.7
B.
The issue before us is whether Arizona Grocery precludes
reparations otherwise due East Line shippers for the rates they
have paid since August 1, 2000. We are asked to consider, in
particular, our holding in BP West Coast, which acknowledged
the Commission’s authority “to direct an oil pipeline to file
interim rates to go into effect, subject to refund, during the
suspension period for the initial rates.” 374 F.3d at 1305. The
limited question before us is whether the final rate, which will
be determined at the completion of compliance proceedings, is
entitled to Arizona Grocery protection. Put differently, the
question is whether East Line shippers can be considered to have
paid FERC–prescribed rates since August 1, 2000 if they receive
refunds at the end of yet-to-be concluded compliance
7
In a separate order, the Commission illustrates this
possibility:
By way of example only, assume that the new East Line rate
established by this order would be $1.00 on January 1, 1994,
and the indexed rate would be $1.10 on August 1, 2000 and
$1.20 on May 1, 2006 (the target date of new interim rates in
this proceeding). These levels ultimately become the January
1, 1994 indexed final rates adopted by the Commission in this
decision for the [OR92-8 Docket]. The projected final rate[s]
developed from the 1999 cost of service in [the OR96-2
Docket] are $1.05 as of August 1, 2000 and $1.15 as of May
1, 2006. This latter and lower rate of $1.15 would be effective
prospectively on May 1, 2006 because the East Line rates
previously established in [the OR92-8 Docket] are subject to
the Arizona Grocery doctrine.
113 FERC at 62,110.
41
proceedings. If so, they will not be entitled to reparations. If the
disputed rates paid since August 1, 2000 are not FERC-
prescribed rates, shippers may seek reparations.
The Arizona Grocery doctrine is essentially a prohibition
against retroactive ratemaking. The key passage from Arizona
Grocery states:
Where the Commission has upon complaint, and after
hearing, declared what is the maximum reasonable rate to
be charged by a carrier, it may not at a later time . . . by
declaring its own finding as to reasonableness erroneous,
subject a carrier which conformed thereto to the payment of
reparation measured by what the Commission now holds it
should have decided in the earlier proceeding to be a
reasonable rate.
284 U.S. at 390; see also Verizon Tel. Cos. v. FCC, 269 F.3d
1098, 1107 (D.C. Cir. 2001) (noting that Arizona Grocery
proscribes “the retroactive revision of established rates through
ex post reparations”). The purpose of the doctrine is to ensure
that when carriers – in this case, pipelines – rely on the
Commission’s determinations regarding just and reasonable
rates, they will not then be forced to pay reparations when the
Commission subsequently reconsiders its prior approval. See
Arizona Grocery, 284 U.S. at 389 (“[T]he carrier is entitled to
rely upon the declaration as to what will be a lawful, that is, a
reasonable rate[.]”). For this reason, in order for the Arizona
Grocery doctrine to apply, the Commission must have
“approved or prescribed” or “declared” a reasonable rate upon
which the carrier has relied. Id. at 381, 390.
We hold that where, as here, the Commission accepts a
pipeline’s proposed tariff subject to suspension and refund
without even establishing the methodology for determining the
42
final rate, the Commission cannot properly be considered to
have prescribed a just and reasonable rate until the proposed
tariff is approved at the completion of compliance proceedings.
Consequently, we hold that Arizona Grocery does not preclude
reparations in this case. Our holding today is motivated in large
measure by the Commission’s own acknowledgment that it was
uncertain of the methodology it would use to determine a just
and reasonable rate when it accepted Tariff No. 60. At the time
the shippers moved their gas through the East Line, the
Commission had yet to determine either a just and reasonable
rate or even the methodology of calculating it. The rates the
shippers paid were certainly not settled. The shippers, SFPP,
and FERC all accepted the rates to be interim. More
importantly, the shippers and SFPP knew that FERC had not yet
established the methodology it would use to determine a just and
reasonable rate for shipments after August 1, 2000. In such a
context, the pipeline owner’s reliance interest – which Arizona
Grocery tells us must be protected from retroactive ratemaking
– simply does not exist. The fact that once FERC had
determined how best to calculate a just and reasonable rate it
would apply that methodology retroactively to Tariff No. 60
does not help SFPP. That a rate is ultimately prescribed by
FERC is a necessary but not sufficient condition to invoke
Arizona Grocery protection. To extend Arizona Grocery
protection to such unsettled rates retroactively would itself
amount, potentially, to retroactive ratemaking. Therefore, even
after having received refunds, all East Line shippers remain
entitled to reparations to the extent that the Commission later
determines these rates (less any refunds) to be unjust and
unreasonable.
Without any approval, prescription, or declaration of (at a
minimum) a definitive methodology by which pipelines are
instructed to compute reasonable rates, it is not at all clear in
what sense the pipelines can be considered to have relied upon
43
the Commission’s determination. See Arizona Grocery, 284
U.S. at 390 (noting that the Arizona Grocery doctrine only
protects shippers that have “conformed” to FERC-prescribed
rates). Perhaps a reliance argument could be made if the
Commission had established a clear guideline for calculating
reasonable rates and still accepted SFPP’s proposed rates on an
interim basis merely because the calculation of the exact rate
had not been completed. But that is not this case and we need
not address whether this hypothetical would trigger Arizona
Grocery protection. As the record here provides, “it is clear that
the Commission had not reached a final determination on the
methodology to be used to design SFPP’s East Line rates at the
time it accepted Tariff No. 60 subject to refund or on the level
of those rates.” 100 FERC at 62,625.
At oral argument, the Commission argued that the Arizona
Grocery doctrine was “all about whether people are on notice.”
Tr. of Oral Arg. at 81. Thus, the Commission argued that where
shipments move under rates the shippers know to be interim,
these shipments can still be considered to have moved under the
FERC-prescribed just and reasonable rates upon receiving
appropriate refunds. This, we think, is an impermissibly broad
reading of Arizona Grocery that vitiates its purpose, which is to
protect the pipeline’s reasonable reliance interest. We are not
aware of any authority that supports such a sweeping application
of Arizona Grocery urged upon us by the Commission. By
contrast, we have previously cautioned against overly broad
interpretation of Arizona Grocery. See, e.g., Verizon Tel. Cos.,
269 F.3d at 1107 (“Arizona Grocery has been and should be
understood in the terms in which it was decided . . . .”).
In support of the Commission’s ruling, FERC and
intervenors SFPP and the Association of Oil Pipe Lines argue
that this Court in BP West Coast has already held that SFPP’s
post-refund rates would be considered final and prescribed
44
effective August 1, 2000. But this asks too much of our holding
in BP West Coast. In that case, SFPP challenged the
Commission’s authority to order refunds to East Line shippers
for the interim rates they had been paying since August 1, 2000.
We held as regards pre-refund interim rates that “[t]he
Commission did not establish final lawful rates where it has
expressly reserved authority to make adjustments in the context
of an ongoing proceeding in which the methodology for
determining the rate had not even been established.” 374 F.3d
at 1305 (emphasis added). We never addressed whether the
Commission’s final lawful rates would eventually be considered
to have been prescribed as of August 1, 2000 for purposes of
Arizona Grocery protection. The issue of whether shippers’
claims for reparations would be barred by the Commission’s
inability to establish the proper methodology to calculate just
and reasonable rates until the end of compliance proceedings
was not properly before us until today.
Nor are we persuaded by intervenors’ argument that
“[w]here, as here, FERC orders a carrier to make a compliance
filing or file a new tariff to be effective prospectively from the
date of the tariff, FERC is prescribing rates.” Final Joint Br. of
Intervenors SFPP, L.P. and Ass’n of Oil Pipe Lines in Support
of Respondent at 14. Such a broad statement is patently
inconsistent with the holding of BP West Coast because in that
case we specifically upheld the Commission’s authority to
accept a tariff on an interim basis.
In sum, the Commission acted contrary to law when it held
that Arizona Grocery precluded the Commission from awarding
reparations to East Line shippers for rates paid after August 1,
2000. To be sure, for East Line shippers to receive reparations,
they will still need to demonstrate that the rates they paid after
August 1, 2000 were unjust and unreasonable. Nonetheless, the
Commission erred by holding that Arizona Grocery
45
categorically barred it from granting the reparations sought by
the shippers. For the foregoing reasons, we vacate the portions
of the orders under review in which the Commission disallowed
reparations for East Line rates post-August 1, 2000.
IV.
For the aforementioned reasons, the petitions for review are
granted in part and denied in part. We deny the petitions for
review with respect to the income tax allowance issues and the
Energy Policy Act issues. We grant the petitions for review
with respect to the reparations issue, and we remand to the
Commission for further proceedings consistent with this
opinion.
So ordered.