BP W Coast Prod v. FERC

Notice: This opinion is subject to formal revision before publication in the
Federal Reporter or U.S.App.D.C. Reports. Users are requested to notify
the Clerk of any formal errors in order that corrections may be made
before the bound volumes go to press.
United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued November 12, 2003 Decided July 20, 2004
No. 99-1020
BP WEST COAST PRODUCTS, LLC,
PETITIONER
v.
FEDERAL ENERGY REGULATORY COMMISSION AND
UNITED STATES OF AMERICA,
RESPONDENTS
SFPP, L.P., ET AL.,
INTERVENORS
Consolidated with
99-1051, 00-1221, 00-1240, 00-1256, 01-1413, 01-1453,
01-1469, 01-1475, 02-1008, 02-1011, 02-1321
On Petitions for Review of Orders of the
Federal Energy Regulatory Commission
R. Gordon Gooch argued the cause for West Line Shippers.
With him on the briefs were Elisabeth R. Myers, D. Jane
Bills of costs must be filed within 14 days after entry of judgment.
The court looks with disfavor upon motions to file bills of costs out
of time.
2
Drennan, George L. Weber, Marcus W. Sisk, Jr., Steven A.
Adducci, and Richard E. Powers, Jr.
Steven H. Brose argued the cause for petitioner SFPP, L.P.
With him on the briefs were Timothy M. Walsh, Daniel J.
Poynor, Alice E. Loughran, Albert S. Tabor, Jr., and Charles
F. Caldwell.
Thomas J. Eastment argued the cause for East Line
Shippers on Cost Allocation Issues. With him on the briefs
were Joshua B. Frank, Michael J. Manning, and Glenn S.
Benson.
Thomas J. Eastment, Joshua B. Frank, Michael J. Man-
ning, George L. Weber, R. Gordon Gooch, Elisabeth R.
Myers, Richard E. Powers, Jr., Steven A. Adducci, and
Marcus W. Sisk, Jr. were on the brief for petitioners and
intervenors supporting petitioners on Rate and Reparations
Issues.
Dennis Lane, Solicitor, Federal Energy Regulatory Com-
mission, and Lona T. Perry, Attorney, argued the causes for
respondents. With them on the brief were Robert H. Pate
III, Assistant Attorney General, U.S. Department of Justice,
John J. Powers, III and Robert J. Wiggers, Attorneys, Cyn-
thia A. Marlette, General Counsel, Federal Energy Regulato-
ry Commission. Jay L. Witkin, Solicitor, and Susan J.
Court, Special Counsel, entered appearances.
Thomas J. Eastment, Joshua B. Frank, Michael J. Man-
ning, George L. Weber, R. Gordon Gooch, Elisabeth R.
Myers, Richard E. Powers, Jr., Steven A. Adducci, and
Marcus W. Sisk, Jr. were on the brief of Shipper intervenors
in support of respondents.
Steven H. Brose, Timothy M. Walsh, Daniel J. Poynor,
Alice E. Loughran, Albert S. Tabor, Jr. and Charles F.
Caldwell were on the brief of SFPP, L.P. as intervenor in
support of respondents.
3
Before: SENTELLE, ROGERS, and ROBERTS, Circuit Judges.
Opinion for the Court filed PER CURIAM.
INTRODUCTION
The consolidated petitions before us seek review of four
opinions of the Federal Energy Regulatory Commission
(‘‘FERC’’ or ‘‘the Commission’’):
1. SFPP, L.P., Opinion No. 435, 86 FERC ¶ 61,022 (1999)
(‘‘Opinion No. 435’’);
2. SFPP, L.P., Opinion No. 435–A, 91 FERC ¶ 61,135
(2000) (‘‘Opinion No. 435–A’’);
3. SFPP, L.P., Opinion No. 435–B, 96 FERC ¶ 61,281
(2000) (‘‘Opinion No. 435–B’’); and
4. SFPP, L.P., 97 FERC ¶ 61,138 (2001) (‘‘Clarification
and Rehearing Order’’).
In these opinions FERC considered the tariffs of SFPP, L.P.,
and complaints and other filings by shipper customers of
SFPP. SFPP, L.P., both a petitioner and an intervenor-
respondent in the consolidated dockets, operates pipelines
that transport petroleum products in Texas, New Mexico,
Arizona, California, Nevada, and Oregon. SFPP’s operation
includes a West Line and an East Line. The West Line
consists of pipelines extending from Watson Station in Los
Angeles, California, into Arizona to Phoenix and Tucson, and
connects at Colton, California, with another pipeline system
extending to Las Vegas. SFPP’s East Line consists of
pipelines from El Paso, Texas to Tucson and Phoenix. The
orders under review consider, set, and otherwise govern rates
on both lines. We consider three separate sets of petitions:
the petition of SFPP, L.P.; the petition of the West Line
Shippers (‘‘WLS’’); and the petition of the East Line Ship-
pers (‘‘ELS’’). Petitioners and Intervenors include the fol-
lowing: BP West Coast Products LLC (‘‘BP WCP’’; formerly
ARCO Products Company); Chevron Products Company
(‘‘Chevron’’; including the former Texaco Refining and Mar-
keting, Inc.); ConocoPhillips Company (‘‘ConocoPhillips’’);
ExxonMobil Oil Corporation (‘‘ExxonMobil’’; formerly Mobil
Oil Corporation); Navajo Refining Company, L.P. (‘‘Navajo’’);
4
Western Refining Company, L.P. (‘‘Western’’); Ultramar Inc.
(‘‘Ultramar’’); Valero Energy Corporation (‘‘VEC’’); Valero
Marketing and Supply Company (‘‘Valero’’); and SFPP, L.P.
(‘‘SFPP’’).
The administrative proceedings before FERC began with
tariff filings by SFPP for both East and West Lines. The
lengthy, complex, and convoluted proceedings that followed
included complaints and/or protests filed by shippers on the
two lines, as well as investigation into SFPP’s tariff filings by
FERC’s Oil Pipeline Board. The issues are further compli-
cated by novelty in that this is the first oil pipeline case in
which the ‘‘changed circumstances’’ standard of the Energy
Policy Act of 1992 (‘‘EPAct’’) has arisen for litigation. Ener-
gy Policy Act of 1992, Pub. L. No. 102–486, 106 Stat. 2776
(codified as 42 U.S.C. §§ 1320–556 (2003)). While we will not
detail the administrative proceedings before FERC’s adminis-
trative law judge and the full Commission as we discuss them
at length in the analyses that follow, we note that issues
presented for review include, among other things, the impor-
tant question of application of the grandfathering principle
under the new EPAct, the allocation of litigation costs be-
tween the East and West Lines, tax pass-through problems
involving non-taxed subsidiaries of taxable entities, the pay-
ment of reparations after a finding of unjust or unreasonable
rates, and the correct determination of capital structure to
determine a starting rate base. The reader is duly warned.
For reasons set forth more fully below, we are able to
affirm many of FERC’s answers to specific issues, but be-
cause we find error in several fundamental areas, we order
the decisions under review vacated and remand the matter
for further proceedings consistent with this opinion.
I. The West Line
A. Grandfathering of Rates under the EPAct
Section 1803 of the EPAct limits the ability of shippers to
challenge pipeline rates in effect at the time of the enactment
of the EPAct. Section 1803 provides that any oil pipeline
5
rate that was ‘‘in effect’’ for a full year before the EPAct’s
enactment on October 24, 1992, and was not subject to
‘‘protest, investigation, or complaint’’ during that 365–day
period, is ‘‘deemed to be just and reasonable.’’ EPAct
§ 1803(a)(1). These ‘‘grandfathered’’ rates are categorically
immune from challenge in a complaint proceeding under
Section 13 of the Interstate Commerce Act (‘‘ICA’’), 49 U.S.C.
app. § 13(1) (1988) (repealed),1 except when:
(1) evidence is presented to the Commission which estab-
lishes that a substantial change has occurred after
the date of the enactment of this Act–
(A) in the economic circumstances of 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; or
(2) the person filing the complaint was under a contrac-
tual prohibition against the filing of a complaint
which was in effect on the date of enactment of this
ActTTTT
Id. § 1803(b). In the post-EPAct world, the analysis of a
pipeline rate challenge thus proceeds in two steps: first,
FERC determines whether the rate in question is grandfa-
thered; if it is, FERC then asks whether the rate falls within
either of the exceptions outlined in Section 1803(b). The
Commission may not alter a grandfathered rate that does not
fall within an exception.
1 Although the ICA was repealed in 1978, see Pub. L. No. 95–473
§ 4(b), (c), 92 Stat. 1466, 1470 (Oct. 17, 1978), FERC has ‘‘the duties
and powers related to the establishment of a rate or charge for the
transportation of oil by pipeline or the valuation of that pipeline that
were vested on October 1, 1977, in the Interstate Commerce
Commission.’’ 49 U.S.C. § 60502 (2003). The relevant version of
the ICA was, but is no longer, reprinted in the appendix to title 49
of the United States Code. Therefore, when we refer to FERC’s
authority under the ICA, we cite to the 1988 edition of the U.S.
Code, the last such edition that reprinted the ICA as it appeared in
1977.
6
B. Grandfathering of West Line Rates
The WLS contend that none of the West Line rates are
grandfathered, and further argue that even if the rates are
grandfathered, their challenges fall within the exceptions set
out in Section 1803(b). We examine each of these contentions
in turn.
1. Rate ‘‘In Effect’’ for One Year
To be eligible for grandfathering, a pipeline rate must have
been ‘‘in effect for the 365–day period ending on the date of
the enactment of this Act [October 24, 1992].’’ EPAct
§ 1803(a)(1). Thus, to be grandfathered, a rate must have
been ‘‘in effect’’ on October 25, 1991, and have remained in
effect at least until the enactment of the EPAct.
The WLS do not contest this element with regard to the
bulk of the West Line rates. Nor could they; the West Line
rates became effective in 1989 pursuant to a settlement
terminating a 1985 rate proceeding. See Opinion No. 435, 86
FERC at 61,057; Southern Pac. Pipe Lines, Inc., 45 FERC
¶ 61,242 (1988) (order approving settlement). The WLS do,
however, challenge the eligibility for grandfathering of cer-
tain improvements to the West Line made after October 1991.
a. East Hynes Origination Point
In July 1992, SFPP made revisions to its Tariffs Nos. 15,
16, and 17 to add a new origination point on its West Line —
the East Hynes station in Los Angeles County, California —
and to add a rate for shipping services from that new
origination point to Arizona. The rate came into effect in
October 1992. The rate, however, was not new; it was the
same as the rates from SFPP’s two other source points in the
Los Angeles area. Examining this situation, the Commission
concluded that the rates from the East Hynes station quali-
fied for grandfathering because the July 1992 ‘‘filing did not
involve a change to a rate or service SFPP was providing at
the time the EPAct was enacted.’’ Opinion No. 435, 86
FERC at 61,063. SFPP’s revision to its tariffs ‘‘only added
another tap within an existing rate clusterTTTT No rate TTT
7
was changed, and there was no change in the products
transported or the services provided.’’ Id.
The question essentially boils down to the Commission’s
interpretation of the term ‘‘rate’’ in Section 1803. As this is
the first case to be litigated under the new standards of the
EPAct, we must consider the level of deference — if any —
to which FERC’s interpretations of the EPAct are entitled.
It is true, as some petitioners have noted, that the EPAct
does not expressly confer rulemaking authority on the Com-
mission. Section 1803 of the EPAct does, though, clearly
contemplate that the Commission will enforce the terms and
conditions of the statute through formal adjudications. See
EPAct § 1803(b) (referencing ‘‘proceeding instituted as a
result of a complaint’’). When Congress authorizes an agency
to adjudicate complaints arising under a statute, the agency’s
interpretations of that statute announced in the adjudications
are generally entitled to Chevron deference. See United
States v. Mead Corp., 533 U.S. 218, 229 (2001) (‘‘[A] very good
indicator of delegation meriting Chevron treatment [is] ex-
press congressional authorizations to engage in the process of
rulemaking or adjudication that produces regulations or rul-
ings for which deference is claimed.’’); see also Trans Union
Corp. v. FTC, 81 F.3d 228, 230 (D.C. Cir. 1996) (‘‘[W]e have
expressly held that Chevron deference extends to interpreta-
tions reached in adjudications as much as to ones reached in a
rulemaking.’’ (citing Midtec Paper Corp. v. United States, 857
F.2d 1487, 1497 (D.C. Cir. 1988))). We see no reason to
accord any less deference to FERC’s interpretations of the
EPAct.
Under the familiar Chevron two-part inquiry, we first ask
whether Congress has directly spoken to ‘‘the precise ques-
tion at issue.’’ Chevron U.S.A. Inc. v. Natural Res. Def.
Council, Inc., 467 U.S. 837, 842 (1984). If it has, that is the
end of the inquiry; we ‘‘must give effect to the unambiguous-
ly expressed intent of Congress.’’ Id. at 843. If Congress
has not spoken so precisely, though, we reach the second
step, and will defer to any reasonable interpretation of the
statute by the agency. Id. Not surprisingly, Congress did
not have occasion to confront the specific question of whether
8
the addition of a new source point on an existing rate cluster
would constitute a new rate. We thus proceed to the second
step of Chevron, and inquire whether the Commission’s con-
struction is a reasonable one. It is. It is certainly permissi-
ble to conclude that the addition of a tap to an existing rate
structure, completed without any change in the existing ship-
ping rates, does not constitute a new rate. To employ an
analogy that we find helpful, in adding the East Hynes
station to its West Line, SFPP merely added an on-ramp to
its existing expressway. We think that the Commission’s
conclusion reflects a permissible interpretation of the statute
and thus affirm its holding that the rate for shipping from
East Hynes is eligible for grandfathering.
b. Watson Station Enhancement Facility
Watson is the primary origin point for West Line ship-
ments to Phoenix and Tucson. In 1989, SFPP notified its
shippers that, starting in 1991, the minimum pumping rate
and pressure from Watson Station would increase. SFPP
gave its shippers the option of providing their own pressuriza-
tion facilities by a date certain, or using, for a surcharge, a
facility built by SFPP. By late 1991, most of SFPP’s ship-
pers had contracted to use SFPP’s new enhancement facility,
and on November 1, 1991, SFPP initiated the enhancement
services. See Opinion No. 435, 86 FERC at 61,074; In re
SFPP, L.P., 80 FERC ¶ 63,014, 65,156 & n.405 (1997) (‘‘ALJ
Decision’’). SFPP, though, never filed those contracts with
the Commission, because it believed its enhancement services
were beyond the reach of FERC’s jurisdiction. See Opinion
No. 435, 86 FERC at 61,074. The Commission, however,
concluded otherwise and ordered SFPP ‘‘to file a rate equal
to the historic charge in the shipper contracts.’’ Id. at 61,076.
Despite FERC’s concession that ‘‘Section 1803 only ad-
dresses rates that were on file with the Commission,’’ Opinion
No. 435–A, 91 FERC at 61,502, and its acknowledgment that
the enhancement rates had never before been filed, FERC
nevertheless concluded that, because ‘‘the charges for the
Watson Station facilities are part of enforceable contracts,’’
the rates were ‘‘the equivalent of a lawful, effective rate.’’
9
Opinion No. 435, 86 FERC at 61,076. The Commission
reasoned that because all the Watson enhancement rate
contract charges ‘‘were in effect before October 24, 1992,’’ the
shippers challenging those charges had to establish ‘‘substan-
tially changed circumstances.’’ Id. at 61,075, 61,076. The
fact that no statute permitted a shipper to challenge an
unfiled rate before the Commission did not matter. For ‘‘if
[the rates] had been filed TTT, it is clear that they would have
been grandfathered because there was no challenge to them
during the 12 months proceeding [sic] the enactment of the
Act.’’ Opinion No. 435–A, 91 FERC at 61,502.
We find the Commission’s reasoning on this point to be
fundamentally flawed, and vacate this portion of its order.
First, if FERC is indeed correct in its interpretation that
Section 1803 applies only to filed rates, the Commission may
not grandfather unfiled rates on the assumption that if the
rates had been filed, no challenge would have been brought.
The Commission may not regulate rates as if they existed in a
world that never was. It must take the rates as it finds
them, and here, FERC found them unfiled. If FERC inter-
prets Section 1803 to apply only to filed rates, then it may not
extend the benefits of that provision to unfiled rates based on
speculation about what would have happened had they in fact
been filed. Invoking the so-called ‘‘filed rate’’ doctrine —
which ‘‘forbids a regulated entity to charge rates for its
services other than those properly filed with the appropriate
federal regulatory authority,’’ Arkansas Louisiana Gas Co. v.
Hall, 453 U.S. 571, 577 (1981) — the WLS argue that the
pipeline’s failure to file a Watson enhancement rate tariff with
the Commission precludes the Commission’s treatment of the
unfiled rate as grandfathered. Our disposition of this is-
sue — which is based on the Commission’s flawed reasoning,
and not a flawed conclusion — does not require us to decide
definitively whether Section 1803 of the EPAct applies only to
filed rates.
Second, Opinion No. 435 suggests that any rate agreed
upon before the EPAct’s enactment on October 24, 1992 could
be grandfathered. See Opinion No. 435, 86 FERC at 61,075
(‘‘The clear purpose of the EPAct’s grandfathering provisions
10
is to insulate pipelines from challenges to TTT rates TTT if
those charges were in effect before October 24, 1992.’’).
Section 1803, though, allows grandfathering of only those
rates that were in effect (and unchallenged) for at least 365
days prior to the date of enactment of EPAct. EPAct
§ 1803(a). Even if we assume as a general proposition that
Section 1803 applies to unfiled rates, other statements sprin-
kled throughout Opinion No. 435 suggesting that some of the
rates were contracted for after the 365–day window had
closed would remain problematic. See Opinion No. 435, 86
FERC at 61,075 (‘‘the contracts were entered into voluntarily
by the parties, mostly before the end of 1991’’); id. (‘‘all the
relevant contracts were required to be, and had been, execut-
ed well before June 1, 1992’’). If the Commission allows
Section 1803 to apply to unfiled rates, those rates, to be
grandfathered, must be in effect for at least 365 days prior to
the EPAct’s enactment. The reasoning of Opinion No. 435
gives us no comfort that this was the case. Without such an
assurance, we cannot affirm the Commission’s conclusion that
the Watson enhancement rate is subject to grandfathering.
c. Turbine Fuel Service
In December 1992, SFPP filed its Tariff No. 18, proposing
the transportation on its West Line of a new product, turbine
fuel (also known as jet fuel). The rate for the new turbine
fuel service was equal to other grandfathered rates in Tariff
No. 18 that had been in effect since 1989. The shippers
argue that because the turbine fuel rate was not initiated
until 1992 — long after the grandfathering window had closed
(indeed, after the EPAct had been enacted) — the rate
cannot be grandfathered. The Commission does not contest
this; it recognized that the turbine fuel service was new, and
therefore could not be grandfathered. Id. at 61,063. It
nevertheless foreclosed further challenge to the turbine fuel
rate, concluding, as a substantive matter, that the turbine fuel
rate was just and reasonable. Id. at 61,078. The Commis-
sion reasoned that because the turbine fuel rate was equal to
other Tariff No. 18 rates that had been deemed just and
reasonable, ‘‘there is no basis for providing a different rate
level for turbine fuel at this time.’’ Id.
11
That analysis falls far short of the mark. The fact that the
Tariff No. 18 rates were deemed just and reasonable does not
mean that the rates actually are just and reasonable. Per-
haps if the Commission had undertaken a substantive review
of the reasonableness of the West Line rates listed in Tariff
No. 18, then its conclusion that the turbine fuel rate is
reasonable — because it is equal to those rates — might be
supportable. But here, the West Line rates had been
‘‘deemed just and reasonable’’ by operation of law — solely
because they had persisted without challenge for one year
prior to the enactment of the EPAct. The turbine fuel rate,
not itself eligible for grandfathering, cannot simply piggyback
on the grandfathered status of other rates. The Commis-
sion’s contrary conclusion reflects a fundamental misappre-
hension of the nature and purpose of the grandfathering
provisions of the EPAct. The requirements for grandfather-
ing — the rate must be in effect and not subject to challenge
for the year prior to the EPAct’s enactment — are not
proxies for actual reasonableness. Those requirements in-
stead operate principally as a means to constrain litigation
over pre-EPAct pipeline rates. The fact that the turbine fuel
rate is equal to other Tariff No. 18 rates thus says nothing
about that turbine fuel rate’s substantive reasonableness.
The Commission’s declaration that, as a substantive matter,
the turbine fuel rate was just and reasonable — a conclusion
reached without the benefit of any substantive review of the
underlying cost of service and rate of return — was an
arbitrary and capricious exercise of the Commission’s authori-
ty and cannot stand.
2. Complaints, Protests, or Investigations
While the WLS concede that most of the West Line rates
were in effect for the required year prior to the EPAct’s
enactment, they contend that no West Line rate is eligible for
grandfathering because each of them was ‘‘subject to protest,
investigation, or complaint’’ during that same one-year win-
dow. In support of their argument, the WLS point principal-
ly to protests filed by shippers El Paso Refinery, L.P.
(‘‘EPR’’) and Chevron, and an investigation opened by the Oil
Pipeline Board (‘‘OPB’’) pursuant to those protests. In Octo-
12
ber 1993, the Commission rejected these arguments, holding
that the West Line rates were ‘‘presumed just and reason-
able’’ and, therefore, a successful challenge had to ‘‘prove the
existence of the extraordinary circumstances set forth in
section 1803 of the Energy Policy Act.’’ SFPP, L.P., 65
FERC ¶ 61,028, 61,378 (1993); see also SFPP, L.P., 66 FERC
¶ 61,210 (1994) (denying rehearing).
What does it mean for ‘‘the rate’’ to be ‘‘subject to protest,
investigation, or complaint’’? EPAct § 1803(a). The WLS
maintain that a general attack on a tariff is sufficient to
challenge all the rates and activities described therein. See
WLS Br. 14 (‘‘a protest of a tariff filing did subject all rates in
the tariff to review’’). The Commission, though, in ruling
that the shippers’ pleadings did not challenge the West Line
rates, interpreted this clause of Section 1803 to require that
the protest, investigation, or complaint specifically challenge
the reasonableness of the rate in question. See SFPP, L.P.,
65 FERC at 61,378 n.14 (while Chevron’s protest did include
‘‘a request for suspension of revised tariff no. 16, which
contains TTT only west line rates,’’ the protest ‘‘pled no
concerns with the existing rates set forth in this tariff’’). The
WLS object to FERC’s interpretation on a general level,
arguing that it grafts onto the statute a particularity require-
ment not found in its text. Here, too, we find the Chevron
deference that we must accord to the agency’s interpretation
to be dispositive. Because we cannot say that the Commis-
sion’s adjudicative interpretation is an impermissible reading
of the statute — the statute provides, after all, that it is ‘‘the
rate’’ (not the tariff) that must be subject to ‘‘protest, investi-
gation, or complaint’’ — we defer to the Commission’s inter-
pretation. And with that interpretation in mind, we turn to
the particular contentions of the WLS.
a. West Line Shipper Protests
On September 4, 1992, EPR, an East Line shipper, filed a
protest to SFPP’s Tariffs Nos. 15 and 16, and followed with
three supplements that same month, one of which requested
the suspension of Tariffs Nos. 15 and 16 and that the Oil
Pipeline Board (‘‘OPB’’ or ‘‘Board’’) open an investigation into
13
the same. That same month, Chevron, which shipped on both
the East and the West Line, filed a protest to Tariffs Nos. 15
and 16, also calling for their suspension and investigation.
The WLS contend that because EPR’s and Chevron’s
protests challenged Tariff No. 16 — which listed only West
Line rates — those protests had challenged the West Line
rates. The Commission rejected this contention, looking
beyond the relief requested by the protests to the shippers’
substantive arguments for that relief. Examining the rele-
vant pleadings, the Commission concluded that the protesting
shippers ‘‘raised concerns with only three matters — flow
reversal, prorationing, and existing rates on SFPP’s east
line.’’ Id., 65 FERC at 61,378. As ‘‘[n]othing within the four
corners of these protests indicate[d] a concern with the
existing rates on SFPP’s west line,’’ the Commission rejected
those protests as a basis for denying grandfathered status to
the West Line rates. Id.
Our examination of the relevant pleadings convinces us that
the Commission correctly concluded that EPR and Chevron
did not challenge the reasonableness of the West Line rates
in their protests to SFPP’s Tariffs No. 15 and 16. The EPR
and Chevron pleadings scarcely mention the West Line at all,
let alone mount an attack on the reasonableness of its rates.
The only mention of the West Line rates is found in EPR’s
first supplement to its protest: ‘‘Santa Fe’s proposed Tariff
Nos. 15 and 16 retain Santa Fe’s previously effective rates for
service on its East Line and West Line systems, but repre-
sent the first tariffs under which product will flow in a
reversed direction on the ‘Six–Inch Line’ portion of the East
Line system from Phoenix to Tucson.’’ In re SFPP, L.P.,
Supplement to Protest of El Paso Refinery, L.P., 1–2 (Sept. 9,
1992) (emphasis omitted). This statement obviously concerns
the flow reversal on the Phoenix–Tucson pipe — not the
reasonableness of West Line rates. Chevron’s protest, as the
Commission noted, ‘‘simply fails to contain any statement
indicating a challenge to existing rates on SFPP’s west line.’’
SFPP, L.P., 65 FERC at 61,378. The Commission thus
reasonably concluded that these protests by East Line ship-
14
pers were insufficient to render the West Line rates ‘‘subject
to protest.’’ EPAct § 1803(a).2
b. Oil Pipeline Board Investigation
On September 29, 1992, in response to the protests filed by
EPR and Chevron, the OPB, pursuant to its authority under
Section 15(7) of the ICA, 49 U.S.C. app. § 15(7) (1988),
opened an investigation of SFPP’s rates listed in revised
Tariffs Nos. 15, 16, and 17, suspended the tariffs for one day,
and imposed refund obligations on SFPP. SFPP, L.P., 60
FERC ¶ 62,252 (1992).3 In April 1993, the Commission vacat-
ed the suspension orders and the refund obligations. SFPP,
L.P., 63 FERC ¶ 61,014 (1993). Observing that the protests
against the tariffs did not challenge any change in a listed
rate or practice (such as the addition of the East Hynes
origination point or the turbine fuel service), but rather
attacked only existing, unchanged rates and policies (the East
Line rates and the flow reversal and prorationing practices),
the Commission concluded that the OPB lacked authority to
2 In August 1993, Chevron filed a complaint that did specifically
challenge the reasonableness of the West Line rates. See ALJ
Decision, 80 FERC at 65,121. The WLS maintain that this 1993
complaint should ‘‘relate back’’ to its 1992 protest. We do not
agree. Relation back is a concept born in the context of statutes of
limitations. Amendments to complaints are said to relate back to
the date of the original complaint. See Fed. R. Civ. P. 15(c). Even
assuming that this suggested use of the relation back doctrine could
supersede the Commission’s own time limitations governing amend-
ments of protests, the WLS concede that to relate back ‘‘the claim
TTT in the amended pleading [must have] ar[isen] out of the
conduct, transaction, or occurrence set forth TTT in the original
pleading.’’ Fed. R. Civ. P. 15(c)(2). That clearly is not the case
here. As the Commission found, Chevron’s initial protest ‘‘simply
fails to contain any statement indicating a challenge to existing
rates on SFPP’s west line.’’ SFPP, L.P., 65 FERC at 61,378.
3After SFPP filed Tariff No. 18, adding the turbine fuel service
on the West Line, the OPB, acting pursuant to a protest by
Chevron to Tariff No. 18, instituted an investigation and consolidat-
ed that case into the open investigation and suspension of SFPP’s
Tariffs Nos. 15, 16, and 17. SFPP, L.P., 62 FERC ¶ 62,060 (1993).
15
open an investigation under Section 15(7) of the ICA, which
permits the Board only to investigate newly filed rates or
practices. Id. at 61,125 (‘‘It was not appropriate for the
Board to suspend the proposed tariff changes and initiate an
investigation under section 15(7) when the focus of the protest
was existing, unchanged, portions of the tariff.’’); 49 U.S.C.
app. § 15(7) (1988) (limiting application to ‘‘any schedule
stating any new individual or joint rate TTT or charge’’)
(emphasis added). The Commission held that the case should
continue as a complaint proceeding before the Commission
under ICA Section 13(1), id. § 13(1), and be limited to the
issues properly raised by EPR, Chevron, and the intervenors.
SFPP, L.P., 63 FERC at 61,125. But as the Board ‘‘does not
possess delegated authority to order initiation of a section
13(1) proceeding,’’ the Commission vacated the tariff suspen-
sions and the refund obligations. Id. The Commission even-
tually terminated the Board’s suspension docket entirely,
stating that matters would proceed only in the instant com-
plaint docket. SFPP, L.P., 63 FERC ¶ 61,275 (1993). And
based on its conclusion that the OPB’s investigation had been
unlawfully initiated, the Commission determined that SFPP’s
West Line rates were not ‘‘subject to investigation’’ for
grandfathering purposes. SFPP, L.P., 66 FERC at 61,480.
Parsing with care the words of the Commission’s counter-
mand of the Board, the WLS argue that the Commission
never formally vacated the Board’s investigation of the
SFPP’s Tariffs Nos. 15–18, and thus the rates within those
tariffs — including the West Line rates — remained subject
to investigation in 1992, precluding grandfathered status.
We, like the Commission, are unpersuaded. First, while the
WLS are quite right that the Commission did not, in its
ordering clauses, vacate the Board’s investigation, the ship-
pers’ interpretation of the Commission’s action runs head-on
into the Commission’s statement that it was inappropriate ‘‘to
suspend the proposed tariff changes and initiate an investi-
gation under section 15(7).’’ SFPP, L.P., 63 FERC at 61,125
(emphasis added). Moreover, the shippers offer no explana-
tion how such an investigation by the Board could proceed in
light of the Commission’s order that the case would continue
16
as a Section 13(1) complaint. But even if common sense
bowed to formalism and the Board’s investigation remained
technically open, the scope of the Board’s investigation —
lawful only insofar as it enforces ICA Section 15(7) — must
be limited to newly tariffed rates or practices. See 49 U.S.C.
app. § 15(7) (1988). As SFPP’s tariffs made no changes to
the West Line rates (except to add the Watson enhancement
and the turbine fuel services), the Board could not have
investigated the West Line rates.
We therefore conclude that FERC reasonably determined
that the West Line rates (except, as noted above, for the
Watson Station enhancement and turbine fuel rates) were
grandfathered and therefore deemed just and reasonable
under the terms of Section 1803(a) of the EPAct.
C. Exceptions to Grandfathering
We turn now to the WLS’ contention that the rates fall
within the exceptions outlined in Section 1803(b) and there-
fore are still open to challenge under the ICA. Section
1803(b) permits a shipper to challenge a grandfathered rate if
the shipper establishes either that (1) there has been a
‘‘substantial change’’ in the economic circumstances or ser-
vices provided that ‘‘were a basis for the rate’’; or (2) ‘‘the
person filing the complaint’’ was under ‘‘a contractual prohibi-
tion against the filing of a complaint’’ on the date of the
enactment of the EPAct. EPAct § 1803(b). The complain-
ing shipper bears the burden of proving the existence of one
of the circumstances triggering an exception. The Commis-
sion concluded that the WLS had not met either requirement.
See SFPP, L.P., 68 FERC ¶ 61,105, 61,581 (1994) (contractual
prohibition); Opinion No. 435, 86 FERC at 61,064–71
(changed circumstances). The shippers were therefore
barred by the EPAct from challenging the grandfathered
West Line rates. The WLS appeal both rulings.
1. Substantially Changed Circumstances
Before the ALJ and the Commission, the WLS argued that
there were five circumstances that had substantially changed
so as to permit a challenge to the grandfathered West Line
17
rates, including increased throughput on the West Line and
the impact of the Commission’s Lakehead decisions on
SFPP’s income tax cost allocation. The ALJ rejected all the
substantial change arguments. See ALJ Decision, 80 FERC
at 65,192–96. Concerning the claim based on throughput, the
ALJ concluded that the evidence of a forty-percent increase
in throughput from EPAct’s enactment in October 1992 to
1995 (the last year for which data was obtained), by itself,
could not prove a change in economic circumstances. Id. at
65,194. Missing, according to the ALJ, was any evidence
demonstrating that the increase in throughput produced high-
er revenues and profits for SFPP. Id.
The Commission affirmed the holdings of the ALJ on each
of the WLS’ claims of substantial change, see Opinion No.
435, 86 FERC at 61,064–71, but, with respect to the through-
put claim, did so on somewhat different reasoning, see id. at
61,067–69. The Commission found that the ALJ had erred by
measuring change from the date of enactment of the EPAct,
and by using data generated after the filing of the shippers’
complaint. Id. Determining whether there has been a sub-
stantial change in economic circumstances providing the basis
for the rate, the Commission held, requires comparing (a) the
period before the rate first became effective (the basis for the
rate) with (b) the period starting on the date of enactment
and ending on the date of the complaint. Id. The WLS’
substantial change claim based on increased throughput failed
because the shippers measured changed circumstances
against the ‘‘wrong base period’’ and with post-complaint
evidence. Id. at 61,069. To establish a substantial change,
FERC held, the shippers should have compared the period
before the West Line rates became effective in 1989 to the
period between October 24, 1992 (EPAct’s enactment) and
August 7, 1993 (the date of Chevron’s complaint).
The shippers contest neither the Commission’s interpreta-
tion of the substantial change provision of EPAct, nor its
conclusion that the shippers failed to demonstrate a substan-
tial change under that standard. The WLS do, however,
maintain that the Commission’s ruling employed a ‘‘newly
articulated standard’’ and that they are, therefore, entitled to
18
a remand so that they may have an opportunity to litigate
under the Commission’s ‘‘new’’ evidentiary requirements.
WLS Br. 23. We reject this contention.
Even before the Commission announced this interpretation,
the correct points of comparison in a substantial change
analysis were clear from the face of the statute. The statute
requires a shipper to show a change in economic circum-
stances ‘‘which were a basis for the rate.’’ EPAct § 1803(b).
As the Commission noted in its Opinion No. 435, this phrase
could only mean ‘‘the basis upon which the rate was last
considered to be just and reasonable, either as a filed rate, a
settlement rate, or one for which the Commission has made a
legal determination.’’ Opinion No. 435, 86 FERC at 61,068.
Any other moment in time would lack ‘‘correlation to the
economic circumstances that were the basis of the rate at the
time it was designed.’’ Id.
The textual clues to the second point of comparison are
perhaps less obvious but no less certain. The statute pro-
vides that ‘‘[n]o person may file a complaint TTT unless TTT
evidence is presented TTT which establishes that a substantial
change has occurred after the date of TTT enactment.’’
EPAct § 1803(b). From the ‘‘after the date of enactment’’
language we are given the earliest point at which a shipper
may show a substantial change. The closing date for evi-
dence is the day the complaint is filed; this conclusion follows
from the language providing that no ‘‘complaint’’ may be filed
unless ‘‘evidence is presented’’ with the complaint that dem-
onstrates that a substantial change ‘‘has occurred.’’ As the
Commission stated, ‘‘[i]t is difficult to see how language that
so explicitly uses the past tense could apply to evidence that
would be developed at some indeterminate time after the
complaint is filed.’’ Opinion No. 435, 86 FERC at 61,069.
Because the foregoing requirements of the statute are clear
from its face, the shippers had adequate notice of the stan-
dard they were required to meet. See, e.g., Midtec Paper
Corp., 857 F.2d 1487, 1510 (D.C. Cir. 1988) (rejecting petition-
er’s argument that it had inadequate notice specific evidence
was required to support its complaint where the text of the
19
regulations at issue ‘‘clearly indicates’’ that such evidence was
to be considered).4
The WLS also argue that the Commission erred in reject-
ing their argument that the Commission’s decision in Lake-
head Pipe Line Co., L.P., 71 FERC ¶ 61,338 (1995) (Lake-
head), reh’g denied, 75 FERC ¶ 61,181 (1996) (‘‘Lakehead
II’’), insofar as it changed the ability of limited partnerships
like SFPP to include certain income tax allowances in their
cost of service, represented a substantial change in SFPP’s
economic circumstances. The Commission reasoned that the
mere existence of the Lakehead policy, without any showing
how the application of that policy affects the economic basis
for the rates, cannot constitute substantially changed circum-
stances. See Opinion No. 435, 86 FERC 61,070–71. In light
of our conclusion below that aspects of the Commission’s
Lakehead policy are arbitrary and capricious, we think the
best course is to remand this claim to the Commission for
further consideration in light of our disposition in this case.
4 Consolidated Edison Co. v. FERC, 315 F.3d 316 (D.C. Cir. 2003)
and the other cases cited by the shippers (see WLS Br. 23) are
distinguishable. Those cases stand for the unremarkable proposi-
tion that when an agency abandons its own precedent in the course
of an adjudication, the new rule may be applied retroactively to the
parties only ‘‘so long as the parties TTT are given notice and an
opportunity to offer evidence bearing on the new standard.’’ 315
F.3d at 323 (citing Hatch v. FERC, 654 F.2d 825, 835 (D.C. Cir.
1981)). Here, FERC did not abandon its own precedent. Shippers
point to Santee Distrib. Co. v. Dixie Pipeline Co., 71 FERC
¶ 61,205 (1995), reh’g denied, 75 FERC ¶ 61,254 (1996), but that
ruling — issued nearly two years after Chevron’s complaint was
filed, and several months after the parties had submitted their
direct cases to the ALJ, see ALJ Decision, 80 FERC at 65,121 —
stands solely for the proposition that, to make out a substantial
change under EPAct Section 1803, the complainant must show some
change in circumstances since the enactment of the EPAct. See
Santee Distrib. Co., 71 FERC at 61,754 (‘‘Comparisons of data for
1987 to data for 1993 cannot be the basis for showing a change in
economic circumstances since enactment of the EPAct.’’). That
holding is entirely consistent with the holding of Opinion No. 435.
20
2. Contractual Prohibition
The WLS next contend that they may challenge the grand-
fathered West Line rates because they fit within the ‘‘contrac-
tual prohibition’’ exception. That exception allows a shipper
to challenge a grandfathered rate when ‘‘the person filing the
complaint was under a contractual prohibition against the
filing of a complaint which was in effect on the date of
enactment of [the EPAct] and had been in effect prior to
January 1, 1991.’’ EPAct § 1803(b)(2). Navajo, as a part of
an earlier settlement with SFPP, was subject to such a
prohibition and thus was permitted to file a complaint against
the West Line rates without demonstrating substantially
changed circumstances. See SFPP, L.P., 67 FERC ¶ 61,089,
61,254 (1994). Navajo, however, reached another settlement
with SFPP and withdrew its complaint against the pipeline.
SFPP, L.P., 79 FERC ¶ 63,014 (1997). The Commission then
terminated the Navajo complaint proceeding. SFPP, L.P., 80
FERC ¶ 61,088 (1997).
The WLS nevertheless argue that they, too, should not
have to show substantially changed circumstances. First,
they assert that Navajo’s invocation of the contractual prohi-
bition exception effectively vitiated the West Line rates’
grandfathered status as to all complaining shippers. See
WLS Br. 18 (‘‘The ‘grandfathered’ status of the West Line
rates TTT was thus revoked.’’). Alternatively, the WLS argue
that because the ALJ conditioned Navajo’s ‘‘withdrawal of the
complaint’’ on ‘‘not prejudic[ing] in any way the status and
rights of any other participants in this proceeding,’’ SFPP,
L.P., 79 FERC at 65,176, the other complaining shippers
should be able to pursue their complaint as if Navajo had not
withdrawn — that is, without showing substantially changed
circumstances. The Commission rejected both of these argu-
ments. From the first, the Commission recognized that the
contractual prohibition exception is party-specific. ‘‘Because
neither Chevron nor ARCO/Texaco was subject to a contrac-
tual bar [as was Navajo], it follows, under the plain meaning
of the language of the statutory provision, that the complaints
of Chevron and ARCO/Texaco [must show substantially
changed circumstances].’’ SFPP, L.P., 68 FERC at 61,581.
21
As for the shippers’ claim that they had been prejudiced by
Navajo’s withdrawal, the Commission concluded that the con-
dition on Navajo’s settlement applied only to ‘‘the integrity of
the record.’’ Opinion No. 435, 86 FERC at 61,073.
We agree with the Commission. The language of Section
1803(b)(2) is quite obviously party-specific. EPAct
§ 1803(b)(2) (‘‘the person filing the complaint was under a
contractual prohibition’’) (emphasis added). An interpreta-
tion, like that suggested by the WLS, that would allow other
shippers to piggyback on the status of a contractually-
prohibited shipper, conflicts not only with the plain language
of the statute, but also with Section 1803’s overarching pur-
pose of limiting litigation over pre-EPAct rates. On the
other hand, the Commission’s interpretation — limiting the
exception to those parties actually contractually prohibited
from complaining — is entirely consistent with the statute
and therefore reasonable. We also find no merit to the WLS’
claim that they were somehow prejudiced by Navajo’s settle-
ment. After examining the relevant proceedings, see SFPP,
L.P., 79 FERC at 65,176, we think it clear that the ALJ, in
implicitly promising that Navajo’s withdrawal would not
‘‘prejudice TTT the status and rights of any other participants
in proceeding,’’ was referring only to the evidence that Nava-
jo had placed into the administrative record.
II. The East Line
SFPP’s East Line rates were not grandfathered under
§ 1803 of the EPAct, as EPR, as an ELS, had challenged
them in the same September 1992 complaint in which it had
protested SFPP’s flow-reversal on the six-inch line. They
were therefore ‘‘subject to protest, investigation, or com-
plaint’’ within the year prior to the EPAct’s enactment.
Navajo later filed its own complaint against the East Line
rates, and the Commission proceeded under the ICA, which,
in Section 15, empowers the Commission to set aside rates it
finds ‘‘unjust or unreasonable,’’ and to ‘‘determine and pre-
scribe what will be the just and reasonable TTT rates, fares or
charges to be thereafter observed.’’ 49 U.S.C. app. § 15(1)
22
(1988). The ALJ evaluated SFPP’s East Line rates pursuant
to its cost of service regulations, 18 C.F.R. § 346.2 (2004),
found them unjust and unreasonable, and proceeded to set
new ones in their place. ALJ Decision, 80 FERC at 65,122–
191. The Commission substantially affirmed the ALJ’s deter-
mination in Opinion No. 435. 86 FERC at 61,084–111. Un-
der the Commission’s rate-of-return methodology, this in-
volved determinations of SFPP’s embedded capital costs, its
yearly operating expenses, allowances for other costs, and its
appropriate rate of return. See 18 C.F.R. § 346.2(c).
The proceedings before the Commission were complex, and
many of the issues it decided in setting new East Line rates
(and in determining that the previous rates were unjust or
unreasonable) have not been challenged. As relevant to our
review, the parties dispute only four discrete issues regarding
the Commission’s East Line rate-setting: (1) the starting rate
base to which SFPP was entitled; (2) what tax allowance, if
any, should be factored into rates; (3) the proper means of
recovery, if any, of SFPP’s litigation expenses; and (4) the
treatment of SFPP’s claimed expenses for reconditioning
portions of the East Line.
The court reviews the Commission’s ratemaking decision to
determine whether it was arbitrary and capricious, see Asso-
ciation of Oil Pipelines v. FERC, 83 F.3d 1424, 1431 (D.C.
Cir. 1996) (‘‘AOPL’’), according special deference to the Com-
mission’s expertise, id. at 1431; see also In re Permian Basin
Area Rate Cases, 390 U.S. 747, 790 (1968). The court thus
examines the Commission’s ratemaking decisions to deter-
mine whether the Commission has examined the relevant
data and articulated a rational connection between the facts
found and the choice made. AOPL, 83 F.3d at 1431. 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) (quoting Motor Vehicle Mfrs.
Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463
U.S. 29, 48–49 (1983)).
A. Starting Rate Base
The Commission decided that to measure SFPP’s overall
investment upon which it is entitled to a return, SFPP should
23
use its December 19, 1988 capital structure. Opinion No.
435–A, 86 FERC at 61,503–06. In assessing the value of a
pipeline’s invested capital, the Commission’s approach —
stemming from its opinion in Williams Pipeline Co., 31
FERC ¶ 61,377 (1985) (‘‘Opinion No. 154–B’’) — weighs equi-
ty and debt-financed capital investments made prior to 1985
differently, and SFPP contends that the Commission used the
wrong historical ratio between the two in setting the starting
rate base.
Some explanation of the ‘‘starting rate base’’ concept and
its history is necessary. Prior to June 28, 1985, the rate base
to be included in oil pipeline cost of service analysis was
calculated under an Interstate Commerce Commission
(‘‘ICC’’) valuation method, which combined elements of origi-
nal and reproduction cost. In Farmers Union Central Ex-
change, Inc. v. FERC, 584 F.2d 408, 417–20 (D.C. Cir. 1978)
(‘‘Farmers I’’), the court expressed concerns about the ICC’s
valuation methodology, particularly its tendency to overvalue
assets so as to ‘‘exceed[ ] investment by a substantial
amount.’’ Id. at 415. After the Commission proposed to
continue to use the ICC’s valuation method in Williams
Pipeline Co., 21 FERC ¶ 61,260 (1982), the court, on review
from that decision, remanded the case in Farmers Union
Central Exchange, Inc. v. FERC, 734 F.2d 1486, 1510–14
(D.C. Cir. 1984) (‘‘Farmers II’’), and directed the Commission
to consider alternatives, noting the widespread agreement
among many experts that the ICC’s method ‘‘lacks any
economic rationale.’’ Id. at 1511 (internal citation omitted).
On remand from Farmers II, the Commission developed its
current ‘‘trended original cost’’ method. Opinion No. 154–B,
31 FERC at 61,833–35. This method starts from the original
cost of a pipeline’s assets but smooths out depreciation and
equity recovery over the life of the pipeline, thereby avoiding
the front-loading problems associated with a depreciated orig-
inal cost methodology. Making the switch to this ‘‘trended
original cost’’ method required the Commission to account for
investments in existence at the time of the change. Under
the ICC’s valuation rate base methodology, many of these had
been valued substantially above investment cost. See Farm-
24
ers I, 584 F.2d at 415. Setting their value to depreciated
original cost would, in many cases, have significantly de-
creased their valuation for rate-setting purposes. See Opin-
ion No. 154–B, 31 FERC at 61,836. To mitigate any abrupt
reduction in pipeline earnings resulting from the change, the
Commission permitted a one-time rate base adjustment —
creating a so-called starting rate base — calculated by par-
tially continuing the ICC’s valuation method to the extent of a
pipeline’s equity ratio, but assessing its rate base at depreci-
ated original cost to the extent of its debt ratio. Opinion No.
154–B, 31 FERC at 61,835–37. Because the stated purpose
of this approach was to protect the expectations of investors
who had invested prior to the switch, the Commission deter-
mined that the relevant debt-to-equity ratio would be a
pipeline’s capital structure as of the date of Opinion 154–B,
June 28, 1985, rather than its capital structure at the time
rates are set. See Williams Pipeline Co., 33 FERC ¶ 61,327,
61,640 (1985) (‘‘Opinion No. 154–C’’).
The court has never reviewed the reasonableness of the
Commission’s Opinion No. 154–B methodology, nor need we
do so now, as no party has challenged whether that approach
is faithful to the court’s remand order in Farmers II, 734
F.2d at 1511–21. The ELS support the Commission’s appli-
cation of the Opinion No. 154–B methodology, and SFPP
contends only that the Commission’s use of December 19,
1988 rather than June 28, 1985 as the relevant snapshot of
the pipeline’s capital structure is not faithful to Opinion No.
154–B and its progeny. We turn, then, to SFPP’s contention
that the Commission acted arbitrarily and capriciously, and
departed from past precedent without adequate explanation,
in rejecting use of the actual June 28, 1985 capital structure
of the Santa Fe Southern Pacific corporation (‘‘SFSP’’), the
pipeline’s then-parent.
SFPP did not yet exist in 1985, and its predecessor corpo-
ration, Southern Pacific Pipelines, Inc. (‘‘SPPL’’), was a whol-
ly-owned corporate subsidiary of SFSP. SPPL therefore had
a 100% equity structure, and no party urged the Commission
to use that capital structure to calculate SFPP’s starting rate
base. SPPL’s parent, SFSP, was capitalized at 78.29% equity
25
and 21.71% debt at the time, and SFPP urged the Commis-
sion to follow Opinion No. 154–B’s instruction to use the
parent’s capital structure to calculate the starting rate base.
Initially, in Opinion No. 435, 86 FERC at 61,089–90, the
Commission took the position that the 1988 settlement agree-
ment between SPPL and several of its shippers, which had
last set the pipeline’s rates, required the use of SFSP’s
capital structure in the starting rate base. On rehearing in
Opinion No. 435–A, however, the Commission decided that
the settlement did not preclude it from independently examin-
ing SFPP’s capital structure after the rates set by the
settlement expired. The Commission determined that
SFSP’s capital structure should not be used in the starting
rate base calculation because SFSP’s high equity component
in June 28, 1985 did not ‘‘accurately reflect[ ] the risks of
SFPP’s underlying operations,’’ and there was a ‘‘significant
difference in the nature of the pipeline’s operations and those
of its parent company on June 28, 1985.’’ Opinion No. 435–A,
91 FERC at 61,504–05.
SFPP contends that Opinion No. 154–B requires, in cases
where a pipeline is owned by a parent company and therefore
does not issue debt in its own name, the use of a parent
company’s capital structure as of June 28, 1985. Opinion No.
154–C, which clarified Opinion No. 154–B, does contain the
instruction that ‘‘the capital structure to be used in determin-
ing the starting rate base is as of the date of Opinion No.
154–B (June 28, 1985).’’ 33 FERC at 61,640. The Commis-
sion qualified that approach, however, in ARCO Pipeline Co.,
52 FERC ¶ 61,055, 61,233–34 (1990), where it began applying
its precedents from the rate-of-return context — in which it
first examines whether a parent company’s capital structure
is representative of its subsidiary’s risk level before imputing
it to the subsidiary — to the capital structure used in the
starting rate base calculation. While the Commission in
ARCO ended up using the corporate parent’s actual capital
structure, it indicated that its decision to do so hinged on
‘‘whether the capital structure is representative of the pipe-
line’s risks.’’ Id. at 61,233.
 26
ARCO did not contain much by way of explanation about
why the representativeness of a parent’s capital structure to
the pipeline’s risks should matter; its relevance to the start-
ing rate base, where the equity component is standing in as a
measure of investor reliance on the old ICC valuation method,
appears less obvious than in the rate-of-return context, where
pipelines receive different returns on debt and equity to
compensate for their different risk levels, see, e.g., Kuparuk
Transportation Co., 55 FERC ¶ 61,122, 61,375–78 (1991);
Alabama-Tennessee Natural Gas Co., 25 FERC ¶ 61,151,
61,417–18 (1983). But the Commission’s basic premise that a
capital structure representative of a pipeline’s risks must be
used in the starting rate base calculation is not at issue, for
SFPP concedes that the Commission can depart from a
parent’s actual capital structure if it is ‘‘not TTT representa-
tive of the pipeline’s risks.’’ SFPP Pet. Br. 17. SFPP’s
challenge goes only to whether the Commission made a
reasoned decision applying that standard, and nothing about
the Commission’s determination of SFPP’s, SPPL’s, and
SFSP’s relative risk levels was arbitrary or capricious.
The Commission noted that the bulk of SFSP’s business
was in the railroad, trucking, and mineral exploration indus-
tries, which faced substantially higher amounts of competition
than the pipeline, a regulated ‘‘monopoly for the entire peri-
od’’ guaranteed a fair rate of return and ‘‘sufficiently secure
that it proposed to undertake a major expansion beginning in
1985.’’ Opinion No. 435–B, 96 FERC at 62,067. Most impor-
tantly, the Commission had a powerful piece of evidence of
the pipeline’s relatively low risk level: its initial public offer-
ing. When it first became a stand-alone entity on December
19, 1988, SFPP was able to adopt a capital structure financed
with 60.74% debt and 39.26% equity. This strongly suggests
a market judgment that the pipeline was significantly less
risky than SFSP, which was financed with 78.29% equity and
21.71% debt. The Commission’s view that SFPP’s equity
level as of its initial public offering more ‘‘accurately re-
flect[ed] the pipeline’s risk’’ than that of its previous parent
was based upon a reasoned view that ‘‘the financial market’s
perceptions of the pipeline’s risk,’’ as demonstrated through
27
an ‘‘arms length public offering,’’ provide an accurate esti-
mate of an entity’s risk level. 96 FERC at 62,068. SFPP
misses the mark when it states that there is no single capital
structure dictated by the market, for although other reason-
able debt-equity ratios might have been adopted for SFPP,
none would have market imprimatur. The reasonableness of
the Commission’s position is confirmed by the very different
nature of the respective entities’ business operations and the
stark contrast between the capital structures each adopted.
The same reasoning explains the Commission’s choice to use
December 19, 1988, the date of SFPP’s initial public offering,
as the relevant snapshot of its equity level, hardly an arbi-
trary date given its reliance on the judgment of the financial
markets.
SFPP maintains, however, that by adopting SFPP’s De-
cember 19, 1988 capital structure for purposes of the starting
rate base calculation, the Commission improperly applied it
‘‘retroactively,’’ thereby denying the pipeline a fair chance to
bring itself in line with the capital structure hypothesized.
The Commission’s use of the December 19, 1988 capital
structure was predicated on the conclusion that it was repre-
sentative of the pipeline’s risks in 1988, and that there were
‘‘no rational grounds here to believe that SPPL’s operations
or business substantially changed between June 28, 1985 and
December 19, 1988.’’ Opinion No. 435–B, 96 FERC at 62,067.
SFPP points to nothing that suggests otherwise. The start-
ing rate base is an element of the determination of the
prospective rates ‘‘in dispute in this proceeding,’’ and the
Commission was neither altering past rates nor seeking to
recover the pipeline’s past losses in future rates; rather, it
was determining a just and reasonable valuation of the pipe-
line’s investment for the purpose of setting present rates. As
such, there was nothing ‘‘retroactive’’ about the Commission’s
setting of the starting rate base.
Because the record contained sufficient evidence on which
the Commission could find that SPPL faced significantly
lower risks than SFSP in 1985, and SFPP concedes that the
Commission may depart from an actual capital structure in
the starting rate base formula where it is not representative
28
of a pipeline’s risks, the court has no occasion to decide
whether the Commission improperly relied on non-record
material from Moody’s Transportation Manual regarding the
poor financial condition of the Southern Pacific Railroad
during the relevant period. Nor need we decide whether the
Commission’s other basis for departing from SFSP’s 1985
capital structure—its concern that SFSP’s 78.29% equity
component would yield an exorbitantly high starting rate
base—would suffice to uphold its decision. Accordingly, we
affirm the Commission’s starting rate base decision.
B. Cost Issues
1. Income Tax Allowance
As one element of the cost of service allowable to SFPP,
FERC included a 42.7% income tax allowance reflecting the
interest in the regulated entity held by a subchapter C
corporation. All petitioners assigned this tax allowance as
error. The shipper petitioners, and intervenors supporting
them, allege as error the recognition of any income tax
allowance as SFPP is a limited partnership that pays no
income taxes. SFPP alleges as error the denial of a full
income tax allowance. Because FERC has not established
that its 42.7% allowance is the product of reasoned decision-
making and indeed has provided no rational basis for this
part of its order, we find that allowance to have been errone-
ous and we vacate.
There is no question that as a general proposition a pipe-
line that pays income taxes is entitled to recover the costs of
the taxes paid from its ratepayers. We explained this propo-
sition thoroughly in City of Charlottesville v. FERC, 774 F.2d
1205 (D.C. Cir. 1985) (Scalia, J.). While we will not fully
discuss the analysis set forth in that decision, we will briefly
review the basic principles as background for the current
controversy.
The Commission must ensure that the rates of jurisdiction-
al pipelines are ‘‘just and reasonable.’’ Id. at 1207 (quoting
15 U.S.C. § 717c(a) (1982)). This means that using the
principles of cost of service ratemaking, Commission-
29
approved rates must yield ‘‘sufficient revenue to cover all
proper costs,’’ and provide an appropriate return on capital.
Id. (citing Pub. Serv. Co. of New Mexico v. FERC, 653 F.2d
681, 683 (D.C. Cir. 1981)). Taxes, including federal income
taxes, are costs. See id. at 1207. The difficulty in the
application of this seemingly straightforward principle arises
when ‘‘the utility is part of a consolidated group,’’ only a
portion of which is regulated. Id. Historically, the Commis-
sion has employed two differing methodologies for attribution
of tax costs in dealing with this difficulty. Again, City of
Charlottesville provides the background for understanding
the two methodologies. Under the older, ‘‘flow-through’’
methodology, the Commission ‘‘derive[d] an effective tax rate
by determining the ratio of each [regulated] pipeline’s taxable
income to the total taxable income of all affiliates, multipl[ied]
this fraction by the group’s consolidated tax liability, and
divide[d] this figure by the pipeline’s taxable income.’’ Id. at
1207. Under the more recently derived ‘‘stand-alone’’ meth-
odology, the Commission has sought to segregate the regulat-
ed utility, then determine ‘‘the taxable income and deductions
TTT specifically attributable to the utility’s jurisdictional activ-
ities.’’ Id. Under this approach, the Commission then ap-
plies ‘‘the statutory tax rate TTT to the tax base to yield the
stand-alone tax allowance.’’ Id. The present controversy
arises from the fact that neither of these historic methods can
by its terms be literally applied to the rates of SFPP.
The name of the jurisdictional pipeline operator explains
the origin of the difficulty. SFPP, L.P., is a limited partner-
ship — specifically a publicly-traded one. Both the flow-
through and stand-alone methodologies presume taxable in-
come generated by the regulated entity. Each arose in the
context of corporate ownership of a jurisdictional pipeline by
a tax-paying corporation which is part of an affiliated group.
Shipper petitioners concede that were SFPP a subchapter C
corporation, a tax allowance would be appropriate in order ‘‘to
insure that the regulated entity has the opportunity to earn
its allowed return on equity.’’ Lakehead, 71 FERC at 62,314.
But a limited partnership operating jurisdictional pipelines
incurs no income tax liability. 26 U.S.C. § 7704(d)(1)(E).
30
Therefore, shipper petitioners contend there is no rational
basis for FERC to approve an income tax allowance for a
limited partnership that incurs no income taxes. Thus, ship-
pers argue, FERC erred in allowing even a 42.7% tax allowance
in the rates of SFPP.
Shippers raised this argument before the Commission and
the Commission discussed it in Opinion No. 435. See 86
FERC at 61,101–07; see also Opinion No. 435–A, 91 FERC at
61,508–09; Opinion No. 435–B, 96 FERC at 62,077–78. In all
of its iterations, FERC’s discussion of the issue has been in
terms of the ‘‘Lakehead policy.’’ FERC first announced that
policy in Lakehead, 71 FERC ¶ 61,338, and offered certain
clarifications of the policy in Lakehead II, 75 FERC ¶ 61,181.
That case also involved ratemaking of a limited partnership.
In Lakehead, the Commission declared that where a regulat-
ed pipeline is a non-taxed limited partnership, it will not be
permitted the same tax allowance as it would if the pipeline
company were a corporation. However, FERC further ruled
that where the limited partnership includes corporate part-
ners, it would treat the partnership as being ‘‘in essence a
division of each of its corporate partners’’ for purposes of
determining an income tax component in the partnership’s
cost of service computation. Lakehead, 71 FERC at 62,315.
Importantly, FERC’s opinion in Lakehead was never subject-
ed to judicial review, and neither this court nor any other
circuit has ever passed on the validity of the Lakehead policy.
Therefore, while FERC may deem itself bound to follow that
policy, we are not so bound and consider its validity for the
first time in this application. All petitioners urge us to reject
it in whole or in part, though for differing reasons.
Commencing with the assumption that it should apply the
Lakehead policy to SFPP’s ratemaking, FERC considered
the question before it to be the determination of how that
policy applied to a limited partnership composed of one
partner (or partners) that is a subchapter C (taxpaying)
corporation and other partners that are not subchapter C
corporations but rather individuals, subchapter S corpora-
tions, trusts, or other entities that do not incur corporate
31
income tax. FERC’s analysis is rooted in the rationale
offered in Lakehead, discussed in the ALJ Decision, see 80
FERC at 65,179, and adopted by the Commission in Opinion
No. 435, see 86 FERC at 61,102. The Commission bases that
rationale on the ‘‘double taxation’’ incurred in the context of
subchapter C corporations, in which the profitmaking corpo-
ration is liable for corporate income tax and the shareholders
of the corporation are individually liable for their individual
income tax on dividends generated by the profitmaking corpo-
rations.5 The Commission in Lakehead ruled that ‘‘because
the corporate tax is an extra layer of taxation, the Commis-
sion includes an element for the corporate taxes in the cost-
of-service to insure that the regulated entity has the opportu-
nity to earn its allowed return on equity.’’ 71 FERC at
62,314. This same rationale guided the Commission’s compu-
tation of tax allowance for the nontaxpaying limited partner-
ship, including one or more subchapter C partners, through-
out the Lakehead administrative litigation and the SFPP
ratemaking now before us. Because SFPP, Inc., a subchap-
ter C corporation, held a 42.7% interest6 in the SFPP limited
partnership, the Commission included in the cost of service
computation for SFPP, L.P., a 42.7% allowance for income
taxes that would have been incurred had the pipeline’s juris-
dictional earnings been subject to corporate taxation. 86
FERC at 61,103.
Shippers contend that FERC erred in including this income
tax allowance, arguing that the ALJ was correct that because
no income taxes have been or will be paid on SFPP’s partner-
ship income, the inclusion of an income tax allowance in the
cost of service constitutes allowance for ‘‘phantom taxes.’’ Id.
SFPP, on the other hand, contends that the 42.7% allowance
5 In our discussion of the double-taxation rationale, we are adver-
tent to actual and proposed changes in corporate and dividend
taxation occurring after the ratemaking we now review. In view of
the timing of the ratemaking, and of our resolution of this issue, no
such changes are germane to our further analysis.
6 A 41.7% limited partnership interest and a 1% general partner-
ship interest.
32
is in fact inadequate to reflect cost of service. It argues that
the Lakehead policy results in an understatement of the
appropriate income tax allowance, and that the Commission
should have applied a version of the ‘‘stand-alone’’ methodolo-
gy discussed above, treating the regulated entity as if it alone
were responsible for taxes which would have been incurred on
the same income had the jurisdictional pipeline been a taxable
corporation.
Because we conclude that FERC’s rationale does not sup-
port its conclusion, we hold that inclusion of the 42.7% income
tax allowance in the cost of service computation was errone-
ous and we vacate FERC’s order to that effect. We further
conclude that SFPP’s arguments are not well-taken and
reject the proposition that FERC should have included the
100% allowance that SFPP seeks. We further conclude that
the shipper petitioners offer a convincing analysis consistent
with ratemaking principles and governing law, and that on
the record before us SFPP is entitled to no allowance for the
phantom income taxes it did not pay.
We cannot conclude that FERC’s inclusion of the income
tax allowance in SFPP’s rates is the product of reasoned
decisionmaking. In Lakehead, as re-adopted in the opinion
before us, the ‘‘reasoning’’ consists of a recitation of separate-
ly unassailable statements that do not together constitute a
syllogism leading to the conclusion purportedly based on
them. The Commission in Lakehead reasoned that:
l. Under cost-of-service ratemaking principles a regu-
lated company is entitled to rates that yield sufficient
revenue to cover its appropriate costs.
2. Income tax allowance is no different from the allow-
ance for any other costs.
3. When the regulated entity is organized as a corpora-
tion, its revenues are taxed at the corporate tax rate and
the earnings of the owners (shareholders) of the corpora-
tion are then taxed on dividends at their particular rate.
71 FERC at 62,314.
To that point the Commission’s statements are unassaila-
ble. However, the Commission follows these statements with
33
a rather cryptic statement. ‘‘Because the corporate tax is an
extra layer of taxation, the Commission includes an element
for the corporate taxes in the cost-of-service to ensure that
the regulated entity has the opportunity to earn its allowed
return on equity. However, there is no allowance for the
taxes paid by the owners of the corporation.’’ Id. Again, the
second of these two sentences is inarguable, but it is not at all
clear what the Commission means by the first. It would
seem to follow from the Commission’s own reasoning in the
preceding elements of analysis, as well as fundamental princi-
ples of ratemaking, that if the corporate tax is to be included
in the cost-of-service, it is not because it is ‘‘an extra layer of
taxation,’’ but rather because it is a cost. Id. In the Com-
mission’s own words, a tax allowance is ‘‘no different from the
allowance for any other costs.’’ Id. Presumably whatever
tax rate was applicable to a tax-paying regulated entity would
be included in the cost-of-service analysis, nor does anything
said by the Commission in Lakehead or in the opinions before
us dispute that presumption. From this line of ‘‘reasoning,’’
FERC proceeded to conclude that the limited partnership
operating a jurisdictional pipeline ‘‘is entitled to an income tax
allowance with respect to income attributable to its corporate
partners.’’ Id. The only further explanation that FERC
offers for this conclusion is ‘‘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 costs will be passed on to the corporate
owners who must pay corporate income taxes on their allocat-
ed share of income directly on their tax returns.’’ Id.
The Commission then goes on to ‘‘conclude[ ] that [the
limited partnership pipeline] should not receive an income tax
allowance with respect to income attributable to the limited
partnership interests held by individuals TTT because those
individuals do not pay a corporate income tax.’’ Id. at 62,315.
Presumably, however, the individual owners pay individual
income taxes. Also, presumably many owners (shareholders)
of corporate holders of limited partnership interests will not
be paying taxes on dividends as corporations often do not
34
generate dividends.7 In the original Lakehead opinion, the
Commission had little further to say about why it distin-
guished between the corporate taxes of corporate unit holders
and the individual income taxes of individual unit holders. In
Lakehead II, and in the opinions we review today, the Com-
mission did offer some attempt to explain the distinction.
In Lakehead II, FERC considered the argument of the
Lakehead limited partnership that the Commission’s refusal
to grant a tax allowance reflecting the tax liabilities of all
limited partnership unit holders, whether or not each holder
was a subchapter C corporation, did not comport with the
Commission’s own ‘‘actual taxes paid’’ rationale, because the
Commission, under the ‘‘stand-alone’’ tax policy discussed
above, would permit ‘‘a regulated entity to collect a fair tax
allowance even where no actual tax liability is incurred.’’
Lakehead II, 75 FERC at 61,594. Lakehead II went on to
argue that under this rationale, even if the jurisdictional
entity is a non-taxed limited partnership, ‘‘rate payers should
be responsible for the tax liability otherwise associated with
the revenue generated from the jurisdictional activities, with-
out regard to any actual amount paid to the IRS.’’ Id. In
rejecting the argument, the Commission stated, no doubt
correctly, that in the case of a jurisdictional corporate subsid-
iary of a corporate group, ‘‘the allowed equity return gener-
ates an actual tax liability for the pipeline that must be paid
to the IRS, either in cash or through the use of another
member’s deductionsTTTT [E]ither way, the tax liability of
the jurisdictional company is a real cost of providing service.’’
Id. at 61,595 (citing Northern Border Pipeline Co., 67 FERC
¶ 61,194, 61,110–11 (1994)). As applied to tax liability gener-
ating corporate subsidiaries engaged in jurisdictional activi-
ties, the Commission’s statement is again quite defensible,
when such a subsidiary does not itself incur a tax liability but
generates one that might appear on a consolidated return of
7 As noted in n.5, supra, changes in tax laws subsequent to the
Commission’s opinion herein may further affect the asymmetry of
including in ratemaking allowance for the corporate tax of corporate
unit holders but not the individual tax of individual unit holders.
35
the corporate group. The difficulty arose when the Commis-
sion attempted to take the next step and explain why this
reasoning applied to an entity that is a non-taxable limited
partnership and to justify discriminating between allowances
for the tax liability of corporate unit holders and the tax
liability of those unit holders who are individuals or otherwise
not subchapter C corporations. The Commission’s reasoning
on that point extends for two more paragraphs, but is sum-
marized in the following statement immediately following the
last quoted language from Lakehead II:
In contrast, there is no corporate tax liability associated
with individual partners’ equity return and therefore it is
not appropriate to allow Lakehead to collect for such
amounts in its cost-of-service.
Id. This does not supply reasoning for differentiating be-
tween individual and corporate tax liability. It is merely re-
stating the proposition that the Commission is so differentiat-
ing. Otherwise stated, the Commission is once again simply
declaring: we are including a tax allowance for corporate tax
liability; we are not allowing a deduction for individual in-
come tax liability. To re-phrase a proposition is not the same
as supplying supporting reasoning. In short, the Commis-
sion’s opinions in Lakehead do not evidence reasoned deci-
sionmaking for their inclusion in cost of service of corporate
tax allowances for corporate unit holders, but denial of indi-
vidual tax allowances reflecting the liability of individual unit
holders.
Nonetheless, we could sustain the Commission’s decision if
the opinions we review had added the reasoned decisionmak-
ing lacking in Lakehead. They do not. Before the court, the
Commission’s counsel argues that the distinction is justified
in the reasoning offered by the ALJ in the portion of his
decision affirmed by the Commission. The ALJ, attempting
to apply the Lakehead policy, had reasoned that ‘‘investors in
a regulated pipeline are entitled to a return ‘commensurate
with returns on investments in other enterprises having
corresponding risk.’ ’’ ALJ Decision, 80 FERC at 65,177
(quoting FPC v. Hope Natural Gas Co., 320 U.S. 591, 603
36
(1944)). Still struggling with the Lakehead policy which had
permitted a corporate income tax allowance but not an allow-
ance for the tax liability of other investors in the limited
partnership, the ALJ concluded ‘‘because there is no dual
taxation, a tax allowance is not necessary to ensure that an
individual limited partner obtains a ‘commensurate return.’ ’’
Id. We agree that the ALJ’s invocation of the Hope Natural
Gas Co. principle was apt, but unlike the Commission, we
agree that the conclusion he based it on was sound.
The Hope Natural Gas decision did not itself involve
attribution of tax liability for purposes of determining allow-
ances and ratemaking. It did however, apply general princi-
ples of ratemaking that are instructive in that context. As
the Commission argues to us, that decision teaches that the
Commission’s ratemaking function involves ‘‘a pragmatic as-
sessment of whether the rates prescribed for a pipeline will
support its services and provide a reasonable return to its
investors.’’ FERC Br. 60 (citing Hope Natural Gas, 320 U.S.
at 602; Farmers II, 734 F.2d at 1502). However, the Com-
mission’s premise again does not lead to the Commission’s
conclusion. The ALJ correctly derived from Hope Natural
Gas the more specific principle that the regulating commis-
sion is to set rates in such a fashion that the regulated entity
yields returns for its investors commensurate with returns
expected from an enterprise of like risks. Were the corpo-
rate unit holders investing in a non-regulated entity of like
risk and otherwise similar return, they would of course expect
to pay their own corporate tax on any profit they might
realize from that investment. Should that profit generate
dividends from the corporations, the shareholders would ex-
pect to pay their own taxes on such dividends.8 Likewise,
individual investors in such a non-regulated enterprise would
expect to pay their individual taxes thereon. Granted, the
second group of investors would pay one level of taxation; the
first group, at least potentially, two layers of taxation. This
is a product of the corporate form, not of the regulated or
unregulated nature of the pipeline or any comparable invest-
8 See footnotes 5 and 7, supra.
37
ment or of the risks involved therein. Therefore, consistent
with Hope Natural Gas, the ALJ correctly concluded that
where 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. The
Commission erred when it rejected the ALJ’s conclusion.
As we have recited repeatedly above, and as the Commis-
sion itself has recognized in this very proceeding, under cost-
of-service principles, a regulated company is entitled to a rate
design to yield sufficient revenue to cover its appropriate
cost; income tax allowance is no different from the allowance
of any other costs. The regulated pipeline generates many
costs, for example bookkeeping expenses. Presumably those
bookkeeping expenses are recoverable in its rates. Its corpo-
rate unit holders, if any, presumably also have bookkeeping
expenses. The bookkeeping expenses of the corporate unit
holders are not recoverable in the rates of the pipeline, even
though the corporation and its shareholders each may inde-
pendently be paying bookkeepers and accountants unlike
individual unit holders who pay only for their own accounting.
All of this makes sense. It makes equal sense when applied
to income taxes.
SFPP, while raising its own objections to the Lakehead
policy, joins the Commission in opposing the shipper petition-
ers’ arguments that no income tax allowance should be includ-
ed in the ratemaking. SFPP, however, argues that the
Commission not only did not err in including the potential tax
liability of its corporate unit holders, it instead erred in not
including the potential tax liability of its individual or other
non-subchapter C corporate unit holders. That argument
serves to illustrate further why the ALJ was correct in
including no such pass-through or phantom taxes at all.
Under the Commission’s present order, the imputed tax
liability of the corporate unit holders creates an allowance
included in the making of the rate for the pipeline. The
ratepayers pay that rate for the product shipped, but the
allocation of the nontaxed profit of the limited partnership
pipeline is, so far as the record reflects, subject to division
38
among the unit holders rateably according to their interest in
the limited partnership, not affected by how their share of the
profits will ultimately be taxed. Therefore, even if the Com-
mission’s goal of changing the risk analysis of ‘‘double-taxed’’
investors were a valid one, it is not being accomplished. The
inclusion of the phantom taxes in the rate changes the profit
margin for all unit holders in the untaxed limited partnership,
not just those who are under a particular tax structure.
Therefore, SFPP may well be correct that if such an allow-
ance were allowable at all, it should have been allowed for the
imputed taxes potentially incurred by all unit holders who
realized taxable income from the untaxed profits of the
limited partnership of the pipeline. For the reasons set forth
above, we hold that the first step of this analysis is errone-
ous — that is, we hold that no such allowance should be
included.
Both FERC and SFPP argue that the position we adopt
today is inconsistent with the ‘‘stand-alone’’ methodology
approved by this court in City of Charlottesville, for reasons
related to the so-called ‘‘actual tax’’ principle discussed there-
in. City of Charlottesville, 774 F.2d at 1207, 1215. Again, we
will not rehash the full analysis of City of Charlottesville, but
simply will remind SFPP that the stand-alone principle as
approved in City of Charlottesville dealt with the imputation
of taxes within a corporate structure where the imputation
was made necessary not by the non-taxable, non-corporate
nature of the regulated entity, but by the allocation of profits
and losses among the related members maintaining separate
balance sheets within a consolidated corporate group. While
it is true that then-Judge Scalia posited the applicability of
the stand-alone methodology to a circumstance in which taxes
were ‘‘not necessarily TTT paid,’’ id. at 1215, that analysis
dealt with the use of ‘‘actual or estimated taxes paid or
incurred’’ rather than being limited to actual taxes paid. But
the part of the City of Charlottesville opinion in which that
discussion occurred dealt with the argument that the taxes,
though properly estimated and actually incurred, might not
ever be actually paid because of such factors as losses gener-
ated in the corporate structure, or the allocation of profits
39
between and among taxable years in such a fashion as to
result in a different tax actually being paid, if any at all. See
id. at 1214–15. Nothing in the City of Charlottesville opinion
suggests that it is the business of the Commission to create
tax liability when neither an actual nor estimated tax is ever
going to be paid or incurred on the income of the utility in the
ratemaking proceeding.9
Finally, SFPP argues that adopting the Lakehead policy
and applying it to this case to restrict the allowance to the
taxes of the corporate unit holders as opposed to imputing the
taxes of all unit holders ‘‘runs directly contrary to legislation
in which Congress expressly sought to encourage the publicly
traded partnership formed for oil pipelines and other selected
industries.’’ Underlying this argument is Congress’s 1987
enactment of Section 7704 of the Internal Revenue Code. 26
U.S.C. § 7704 (added by Pub L. 100–203, Title X, § 10211(a),
Dec. 22, 1987, 101 Stat. 1330–403). Under Section 7704,
Congress decreed that, in general, publicly traded limited
partnerships would be taxed as corporations. However, Con-
gress made the policy decision that for a limited number of
industries, including ‘‘pipelines transporting gas, oil, or prod-
ucts thereof,’’ limited partnerships should operate without
taxation to encourage investment in those critical industries.
Id. § 7704(d)(1)(E). SFPP argues that because Congress
singled out a narrow category of enterprises with the intent
to facilitate investment in such enterprises by providing a tax-
efficient means to raise capital, FERC’s policy is inconsistent
with congressional intent because it provides a smaller incen-
tive than would be the case if it granted an allowance for
phantom taxes based on all unit holders instead of simply the
9 At least equally inapposite is Carolina Power and Light v.
FERC, 860 F.2d 1097 (D.C. Cir. 1988). SFPP relies on Carolina
Power and Light for the proposition that ‘‘the Commission is not
obligated in prospective ratemaking proceedings to match rates
dollar for dollar with taxes paid to the Internal Revenue Service.’’
Id. at 1101 (internal quotations omitted). There, again, we dealt
with the computation of the precise amount of taxes to be passed
through, not whether the Commission could create a tax liability out
of whole cloth to pass through to rate payers of a nontaxable utility.
40
corporate ones. This is a classic case of an argument proving
too much.
SFPP’s argument would equally apply to any decision by
the Commission that caused the pipeline lower allowances
rather than higher. Unsurprisingly, SFPP is able to offer no
precedent for the proposition that we should compel the
Commission, or any other agency, to adopt a rate structure
bringing it into line with the perceived intent of Congress to
achieve objectives in general, as opposed to consistency with
the mandate adopted by Congress in furtherance of such
objectives. As we have noted in other contexts, congressional
mandates to agencies to carry out ‘‘specific statutory di-
rective[s] define[ ] the relevant functions of [the agency] in a
particular area.’’ Michigan v. EPA, 268 F.3d 1075, 1084
(D.C. Cir. 2001). Such a mandate does not create for the
agency ‘‘a roving commission’’ to achieve those or ‘‘any other
laudable goal.’’ Id. The mandate of Congress in the tax
amendment was exhausted when the pipeline limited partner-
ship was exempted from corporate taxation. It did not
empower FERC to do anything, let alone to create an allow-
ance for fictitious taxes.
For the reasons set forth above, we vacate the tax-
allowance portion of the FERC opinion and order allowing
recovery for income taxes not incurred and not paid.
2. Litigation Costs
This case has been an expensive one. At the time of the
ALJ Decision, 80 FERC ¶ 63,013, SFPP sought to recover
$15.1 million for litigation expenses and associated costs
related to Commission and certain civil litigation. This in-
cluded a $12 million litigation expenses reserve plus $3.1
million that SFPP claimed was a direct expense associated
with this rate proceeding and related civil litigation. By the
time this case reached its second rehearing in 2001, Opinion
No. 435–B, SFPP’s actual costs appear to have ballooned
much higher; the pipeline’s 2002 compliance filing places its
cumulative costs litigating this rate proceeding, as well as
litigating and settling related civil litigation, at over $48.1
million.
41
a. Rate Litigation
In keeping with Iroquois Gas Transmission Sys. v. FERC,
145 F.3d 398 (D.C. Cir. 1998), and its own precedents, the
Commission considered SFPP’s rate litigation to be ‘‘part of
its normal, ongoing operations’’ and allowed SFPP to recover
these costs from shippers. It did not, however, permit recov-
ery through a permanent rate increase. Reasoning that
SFPP’s regulatory litigation costs, if ‘‘includ[ed] in embedded
rates,’’ would ‘‘artificially inflate the level of rates between
rate cases,’’ because the rate proceeding that caused most of
the costs was now over and was not likely soon to recur, the
Commission refused to factor them into SFPP’s indexed
rates. Instead, the Commission allowed SFPP to recover its
actual regulatory litigation costs in the form of an amortized
five-year surcharge, with recovery of costs incurred after the
1994 test year offset by the amount which SFPP had collected
in excess of the just and reasonable rates from shippers that
did not file complaints within the appropriate period. The
court reviews, therefore, two distinct decisions of the Com-
mission: to use a temporary surcharge in lieu of a rate
increase to recover SFPP’s rate litigation costs, and to offset
the post–1994 surcharge by the amount of reparations that
would have been due non-complaining shippers.
No party challenges the Commission’s decision that SFPP’s
rate litigation costs are recoverable. This does not mean,
however, that SFPP was automatically entitled to have those
expenses treated as part of its indexed rates, as if the
unusually high costs it incurred in this proceeding would
regularly recur until the next rate proceeding. SFPP con-
tends that it was entitled to have a litigation reserve factored
into its cost of service, because it incurred significant regula-
tory litigation expenses in the test year, 1994, and was bound
to continue to incur costs litigating matters before the Com-
mission in the future. Yet nothing in the record suggests
that any other matters SFPP has pending before the Com-
mission will generate costs close to those in this rate proceed-
ing. A glance at SFPP’s compliance filing confirms that its
litigation expenses have dropped significantly from the levels
they reached between 1994 and 1997. The Commission’s
42
reasoning for denying the rate increase, that there was ‘‘no
assurance that SFPP’s litigation costs would exceed
$2,914,114 a year for the several years that the 1994 rates are
likely to remain in effect,’’ Opinion No. 435–B, 96 FERC at
62,075, seems quite reasonable. The Commission has not
denied all recovery of these costs but simply limited SFPP’s
recovery to its actual costs defending this proceeding and
required that those costs be removed from rates once they
were repaid.
Where the Commission took a more novel approach was in
how it implemented this surcharge. While SFPP was permit-
ted to recover its 1993 and 1994 regulatory litigation costs in
full, the Commission offset the surcharge for later years by
the amount SFPP had collected, in excess of rates ultimately
set by the Commission, from shippers that did not challenge
the rates and were therefore not entitled to reparations.
SFPP contends that this novel approach of deducting ‘‘un-
claimed reparations’’ from the surcharge deprived it of a full
recovery, because, in effect, it recovered nothing at all for
litigation costs incurred after the test year.
Although the Commission does not cite any precedent for
this offset, the apparent novelty of this approach does not
render it unreasonable. As the Commission noted, the costs
of this proceeding were ‘‘high for all parties,’’ and the issue is
‘‘how those costs can be most equitably allocated.’’ Id. at
62,074. In setting prospective rates, the Commission could
reasonably conclude that because SFPP had reaped a windfall
by charging rates in excess of those ultimately deemed just
and reasonable in the same past years for which it was
claiming supplemental expenses above those it would prospec-
tively incur as part of its cost of service, it should be required
to first fund its litigation expenses out of that pool before it
could begin charging those costs to its customers anew.
While SFPP contends that this unfairly benefits shippers that
sat on their rights by not filing complaints against SFPP’s
rates, and that Section 16 of the ICA only authorizes repara-
tions for shippers who have filed such challenges, see 49
U.S.C. app. § 16(1) (1988), it presents no justification for
being entitled to keep this windfall. The court therefore
43
affirms the Commission’s surcharge mechanism and its corre-
sponding offset, subject to the qualification that, depending
on what rates ultimately result from this proceeding on
remand, the surcharge might require recalculation.
b. Civil Litigation Expenses
SFPP also challenges the Commission’s decision to disallow
recovery in the East Line rates of significant expenses SFPP
incurred in civil litigation defending its reversal of flow on a
segment of six-inch pipe running between Phoenix and Tuc-
son. SFPP’s flow reversal removed capacity from the East
Line in order to allocate it to the West Line. While this
benefitted West Line shippers, it would be, as the Commis-
sion recognized, inequitable to include these costs in the East
Line rates, for ‘‘there appears no reason why ratepayers
should bear the expense of defending conduct that had no ex
ante prospect of benefitting them.’’ See Iroquois Gas, 145
F.3d at 401; see also Mountain States Telephone & Tele-
graph Co. v. FCC, 939 F.2d 1035, 1043 (D.C. Cir. 1991)
(‘‘Mountain States I’’). The Commission’s recognition that
litigation of this sort lacks the requisite nexus to the provision
of SFPP’s East Line service to justify inclusion in those rates
was not unreasonable.
SFPP was embroiled in lengthy litigation in Arizona and
Texas state courts with EPR and Navajo, two East Line
shippers, regarding SFPP’s reversal of flow on the six-inch
line, one of SFPP’s two pipes running between Phoenix and
Tucson. That litigation ultimately cost SFPP, according to
its 2002 compliance filing, over $23.7 million. SFPP also has
an eight-inch pipe running between the two cities. The six-
inch line had been in West Line service from 1989 to 1991.
When SFPP undertook an expansion of the eight-inch line
(which had been in East Line service) SFPP temporarily
assigned the six-inch line to the East Line. Upon completion
of the expansion project, SFPP entered an agreement with
ARCO, a West Line shipper, to return the six-inch line to
West Line service, thus restoring West Line service to Tuc-
son. EPR and Navajo sued to enjoin the reversal, alleging
that SFPP had contractually agreed to provide them the
44
extra capacity, that they had engaged in costly investments in
reliance on those agreements, and that the line reversal was
motivated by a desire to drive the two shippers out of
business. As noted, EPR also filed a complaint with the
Commission challenging both the flow reversal and SFPP’s
East Line rates, thereby initiating this rate proceeding. The
ALJ dismissed the portion of EPR’s complaint dealing with
the flow reversal for lack of jurisdiction, noting that because
the Commission has no jurisdiction to prevent SFPP from
abandoning service on the six-inch line, it also lacks authority
to adjudicate allocation disputes as between shippers serving
different markets along the line. ALJ Decision, 80 FERC at
65,161–64. No party has sought review of that ruling. The
litigation then proceeded in other courts with SFPP ultimate-
ly entering into settlements with both shippers.
The ELS’ lawsuit based on SFPP’s reallocation of capacity
from the East Line to the West Line, and the corresponding
litigation costs incurred by SFPP, while caused, in the imme-
diate sense, by ELS, were not costs of East Line service or
expenditures benefitting the SFPP system generally. They
were costs, if anything, of making capacity available to the
West Line at the East Line’s expense. SFPP did not seek to
recover its costs from West Line shippers, either in the cost
of service or by capitalizing them into the rate base, presum-
ably because of the Commission’s earlier ruling that the West
Line rates were grandfathered under Section 1803 of the
EPAct, and therefore not subject to increase in this proceed-
ing. Instead, SFPP sought to recover them from East Line
shippers.
The Commission rejected this attempt, concluding that
SFPP’s costs in settling these matters ‘‘arose out of litigation
unique to the conditions of [EPR and Navajo],’’ and, as such,
were not costs that related to the provision of East Line
service as a whole. Opinion No. 435, 86 FERC at 61,106. On
rehearing, the Commission ruled that the costs of litigating
these matters were not recoverable, because ‘‘civil litigation of
this type’’ involving ‘‘assertions of anti-competitive behavior
and breach of contract to make capacity available’’ does not
‘‘address legal costs and remedies that SFPP would normally
45
incur in the conduct of its common carrier operations.’’ Opin-
ion No. 435–A, 91 FERC at 61,513. Therefore, the Commis-
sion concluded, SFPP’s litigation expenses were ‘‘extraordi-
nary.’’ Id. On further rehearing, the Commission reaffirmed
its ruling that SFPP could not recover such litigation costs in
its rates. Opinion No. 435–B, 96 FERC at 62,070.
Under the Commission’s accounting regulations, extraordi-
nary costs are defined as costs that ‘‘possess a high degree of
abnormality and [are] of a type clearly unrelated to, or only
incidentally related to the ordinary and typical activities of
the entity’’ and are ‘‘not reasonably expected to recur in the
in the foreseeable future,’’ 18 C.F.R. pt. 352, General Instruc-
tions, 1–6(a). SFPP’s flow reversal was not itself unique, for
it had changed the direction of flow on the six-inch line a year
before during the expansion of the eight-inch line. Neverthe-
less, as none of these prior reversals had generated legal
disputes of this scope, the Commission could reasonably
conclude that this type of civil litigation, ‘‘an action that would
not arise in the normal course of the pipeline’s operations,’’
was not likely to recur. Opinion No. 435–B, 96 FERC at
62,070.
The remaining question is whether the Commission used
the correct standard in determining that these costs were
‘‘clearly unrelated to, or only incidentally related to the
ordinary and typical activities of the entity.’’ SFPP contends
that any reading of this portion of the Commission’s regula-
tions must comply with Iroquois Gas, 145 F.3d 398, and
Mountain States I, 939 F.2d at 1034, particularly the latter
decision’s admonition that ‘‘[i]f expenses are properly in-
curred, they must be allowed as part of the composition of
rates. Otherwise, the so-called allowance of a return upon
the investment, being an amount over and above the ex-
penses, would be a farce.’’ Id. at 1029 (internal citations
omitted).
SFPP’s position that capacity allocation litigation is an
inevitable cost of doing business with two shipper camps
competing for the same markets is not without some persua-
siveness. The court has generally taken a somewhat broad
46
view of which litigation costs entities regulated under rate-of-
return ratemaking should be permitted to recover. In Iro-
quois Gas, the court vacated the Commission’s presumptive
disallowance of a gas pipeline’s litigation costs defending
alleged environmental violations during construction, reason-
ing that the Commission must analyze whether the purported
environmental violations were for ratepayers’ benefit rather
than simply presuming the imprudence of supposedly illegal
activity. 145 F.3d at 399–403. Similarly, in Mountain States
I, 939 F.2d at 1029–35, the court vacated an FCC order
denying a carrier’s recovery of antitrust litigation expenses,
and, the same term, in Mountain States Telephone and
Telegraph Co. v. FCC, 939 F.2d 1035 (D.C. Cir. 1991) (‘‘Moun-
tain States II’’), remanded a rule presumptively denying
recovery of litigation and judgment costs resulting from
findings of illegal activity, expressing concern that such a rule
might discourage utilities from taking appropriate legal risks
that would ultimately benefit their ratepayers. Id. at 1042–
47.
The Commission stated that it did not consider Iroquois
Gas apposite because in that case, the underlying activity —
construction of the pipeline pursuant to the Commission’s
certificate authority — was something over which the Com-
mission had jurisdiction and whose prudence the Commission
could evaluate. Opinion No. 435–B, 96 FERC at 62,070–71.
By contrast, the Commission viewed SFPP’s underlying busi-
ness decision to reverse flow on the six-inch line as ‘‘beyond
the Commission’s remedial authority.’’ Proceeding on the
premise that it lacks jurisdiction over market entry and exit,
the Commission apparently takes the position that it is incap-
able of evaluating the prudence of legal expenses incurred in
the course of either, and therefore cannot include them in
common carrier rates.
The salient criterion under Iroquois Gas and Mountain
States II for the recovery of legal expenditures by regulated
entities is whether the underlying activity being defended in
the litigation serves the interests of ratepayers. See Iroquois
Gas, 145 F.3d at 401–02; Mountain States II, 939 F.2d at
1043–47. The court need not address whether the Commis-
47
sion can reasonably deny the recovery of all nonjurisdictional
litigation expenses associated with ‘‘both [market] entry and
exit by the pipeline,’’ Opinion No. 435–B, 96 FERC at 62,070,
because the issue in this proceeding is more narrow, and
arises only with regard to the inclusion of market exit costs in
the East Line rates, not market entry costs in the West Line
rates. Whatever might be a common carrier’s entitlement to
recover any nonjurisdictional litigation costs associated with
the initiation of common carrier service, it is not unreasonable
for the Commission to refuse to allow a common carrier to
charge ratepayers for the cost of taking capacity away from
them. The Commission’s initial determination that the flow-
reversal litigation at issue was unrelated to the provision of
East Line service was reasonable, and we affirm on that
basis. The Commission recognized that, unlike in Iroquois
Gas, SFPP’s litigation did not ‘‘arise[ ] under regulatory
obligations that apply to the system as a whole,’’ and noted
the ‘‘common sense observation by the East Line shippers
that the costs and awards relating to their litigation will be
borne primarily by themselves if the litigation and settlement
costs are included in the East Line rates.’’ Id. at 62,071. As
only the East Line rates were at issue, the court understands
the Commission’s statement, that SFPP’s civil legal expenses
arising from the reversal dispute are not those ‘‘that SFPP
would normally incur in the conduct of its common carrier
operations,’’ to refer narrowly to SFPP’s ‘‘common carrier
operations’’ on the East Line, and not more broadly to
SFPP’s ‘‘common carrier operations’’ generally. This ap-
proach is reasonable, because the cost of cancelling service is
not a cost of providing it.
c. Allocation of litigation costs
More problematic is the Commission’s decision that the
East Line rates should bear half of SFPP’s recoverable
litigation costs. Opinion No. 435–A, 91 FERC at 61,513.
The rate proceeding included both East Line rates and the
dispute about whether West Line rates were grandfathered.
Some litigation costs may have been exclusive to each line,
whereas others were common, but the record does not contain
precise information regarding how much of SFPP’s legal
48
expenses can be attributed to each portion of the rate litiga-
tion. The West Line accounts for roughly twice the through-
put of the East Line, and the Commission had initially
reasoned that due to the more complex nature of the West
Line issues litigated in the regulatory proceeding, costs
should be apportioned volumetrically between the lines.
Opinion No. 435, 86 FERC at 61,106. On rehearing, the
Commission reversed itself and split the costs evenly. Opin-
ion No. 435–A, 91 FERC at 61,512. The Commission stated
that the ALJ, who initially presided over the case, was ‘‘in a
position to observe complexity and flow’’ of the litigation, and
could have reasonably concluded that it was the East Line
issues, not the West Line issues, that accounted for the
‘‘greater portion’’ of costs generated in the proceeding. Id.
The ELS contend that the Commission departed from its
well-established volumetric allocation policy for general costs
without a rational basis, and thus was arbitrary and capri-
cious in basing its allocation on which shippers created higher
litigation costs. We see nothing problematic in an approach
that attributes litigation costs to those for whose benefit the
litigation is incurred, and prior Commission cases dealing
with legal expenses have allocated them similarly. See, e.g.,
Southern California Edison Co., 56 FERC ¶ 61,003, 61,021
(1991). A volumetric approach might be appropriate for the
recovery of commonly-incurred costs benefitting the entire
system, but the Commission’s focus here on who ‘‘generate[d]
the greater portion of a given litigation,’’ Opinion No. 435–A,
91 FERC at 61,513, is reasonable when litigation costs are
specific to separately priced services.
The problem with the Commission’s litigation-cost alloca-
tion is more basic: it lacks substantive analysis. The court is
unable to discern why the Commission decided that 50%, as
opposed to 40%, 30%, or any other number, fairly reflects the
portion of SFPP’s litigation expenses attributable to the East
Line. It simply claimed to rely on the ALJ Decision for the
50% figure. See 80 FERC at 65,167. The ALJ Decision, at
best, implicitly adopts the allocation suggested by a Staff
witness. Other than describing the Staff’s proposal as being
developed as a representative amount of litigation expenses
49
for inclusion in the test year cost of service, the ALJ Decision
provides no analysis of why such a distribution is warranted.
Hence, the Commission’s reliance on the ALJ as being in the
best position to observe the ‘‘complexity and flow’’ of the
litigation leaves unexplained the basis for the allocation.
While most of SFPP’s litigation cost recovery has been offset
by unpaid reparations, and the difference in rates resulting
from the allocation may ultimately not be significant, the
Commission must still explain its decision. The 50% alloca-
tion may or may not be a fair reflection of SFPP’s rate
litigation costs that were in fact attributable to the East Line.
Accordingly, we remand for the Commission to explain its
rationale for its allocation, either based on a 50–50 sharing
between the East and West Lines or any other allocation it
determines would be appropriate.
3. Reconditioning Costs
SFPP sought to have included in its East Line rates a
projected annual cost of $3 million for a 15–year pipeline
reconditioning program replacing the protective coating on
parts of the East Line. Before the Commission, SFPP
claimed to have spent upwards of $5.9 million of these recon-
ditioning costs between 1995 and 1998. While acknowledging
SFPP’s expenditures on the project, the Commission refused
to incorporate those costs, most of which were not incurred
until after 1995, into SFPP’s cost of service because they
were too uncertain at the end of the test period in 1994.
Opinion No. 435, 86 FERC at 61,106–08. On rehearing, the
Commission permitted SFPP to recover its actual expenses
from shippers as part of the temporary surcharge it created
for SFPP’s rate litigation and environmental expenses. Opin-
ion No. 435–A, 91 FERC at 61,518–19. On further rehearing,
however, the Commission reversed itself again and denied
SFPP all recovery of its refurbishing costs. Opinion No. 435–
B, 96 FERC at 62,078–79.
Under its cost of service regulations, the Commission uses
a ‘‘test year’’ methodology to determine a pipeline’s annual
cost of service. This approach looks to the actual costs the
carrier incurs in the ‘‘test year’’ and then adjusts for any
50
‘‘known and measurable with reasonably accuracy’’ costs that
‘‘will become effective within nine months after the last month
of the available actual experience utilized in the filing.’’ 18
C.F.R. § 346.2(a)(1)(ii) (2004). The test year methodology
accounts for the somewhat counterintuitive quality of these
proceedings. The Commission, in issuing decisions after 1999
setting SFPP’s cost of service for years after 1994, looked not
to SFPP’s actual costs in those years but rather to what one
could have predicted those costs to be, based on what was
known in 1994. The Commission noted in Opinion No. 435
that it considers the test year a ‘‘relatively rigid concept
simply because there must be some point at which the record
closes and there is a known, factual basis for the conclusions.’’
86 FERC at 61,108. Although this statement appears to
mark a change from Commission policy in cases preceding
the implementation of its cost of service regulations, where it
indicated that it would approach test years more flexibly, see,
e.g., Lakehead, 71 FERC at 62,313; Williams Pipe Line Co.,
21 FERC at 61,658, the Commission’s current cost of service
regulations provide that it ‘‘may allow reasonable deviation
from the test period’’ for ‘‘good cause shown.’’ 18 C.F.R.
§ 346.2(a)(1)(ii).
The ALJ, using 1993 as the base year, decided that the
refurbishing costs could not be recovered as part of SFPP’s
cost of service because the costs had not yet been incurred at
that time, and SFPP’s predictions of future costs were too
uncertain. Finding that SFPP’s board had not committed to
the refurbishing program as late as 1995 and was simply
funding the program year-by-year rather than committing
itself to the entire proposed 15–year program, the ALJ
reached a series of conclusions: that SFPP might decide to
abandon the project or scale it back in the future, that the
overall plan was subject to change, that there was little
documentation to support estimates of the costs, and that it
was uncertain whether significant amounts of the pipeline
scheduled for refurbishing might be so corroded as to require
outright replacement, which would be treated as a capital
investment and factored into the rate base, not as an expense
added to cost of service. In Opinion No. 435, the Commission
51
essentially affirmed the ALJ’s decision. 86 FERC at 61,106–
08.
SFPP contends that the Commission, which used a 1994
base period and the nine-month test period in 1995, could not
reasonably affirm the ALJ’s decision, which was based on
data from an earlier period. There is some record evidence
supporting SFPP’s claim that it had more firmly committed
to the reconditioning project, including beginning refurbish-
ment of several miles of pipeline in 1995, within ‘‘nine months
after the last month’’ of 1994. Cf. 18 C.F.R. § 346.2(a)(1)(ii).
There was testimony that SFPP’s board had approved the
project by 1994, that SFPP had recoated 13 miles of the
pipeline in 1995, and that its prospective cost estimates were
based upon its actual costs thus far.
Nonetheless, it was not unreasonable of the Commission to
continue to have doubts about locking so large an expense
into SFPP’s cost of service (or, to put it more aptly given the
test year methodology used here, it was not unreasonable for
the Commission to have thought that doubts about the scope
of the reconditioning project would still have been proper in
1995). At most the evidence before the Commission showed
that, by 1995, SFPP had begun refurbishing certain portions
of its pipeline; there was no guarantee from SFPP that the
refurbishing would be as ambitious and expensive as claimed.
Embedding SFPP’s projections into its cost of service would
have required its customers to pay for the refurbishing even
if the project ultimately resulted in far smaller expenditures
than those SFPP had projected. Indeed, given that SFPP
now claims to have spent roughly $6 million on the project
over four years, when it had predicted costs of at least $3
million a year over fifteen years, the Commission’s judgment
has been validated by hindsight.
This does not end our inquiry, however, for SFPP also
contends that having denied inclusion of reconditioning costs
in SFPP’s cost of service, it was arbitrary for the Commission
not to permit recovery in a surcharge of SFPP’s actual costs
in 1995–98, which were not found to be imprudently incurred.
The Commission’s legitimate doubts over the ultimate scope
52
and cost of the reconditioning do not explain the basis for the
Commission’s decision to deny recovery once actual costs of
the project were known. Its decision, rather, stems from a
combination of the Commission’s test year approach and its
interpretation of the filed rate doctrine. In Opinion No. 435–
A, the Commission permitted SFPP to recover its actual
reconditioning costs as part of the same surcharge whereby it
permitted recovery of SFPP’s regulatory litigation costs,
similarly offset by any unpaid reparations; any cost not so
offset could be included in a surcharge amortized over five
years. Yet in Opinion No. 435–B, presented with SFPP’s
claim that it had expended $5.9 million in actual East Line
refurbishing costs between 1995 and 1998, the Commission
denied recovery altogether because the expenditures ‘‘were
not incurred in the 1994 cost of service test period.’’ 96
FERC at 62,078. In responding to protests that its Opinion
No. 435–A ruling violated the filed rate doctrine, the Commis-
sion concluded ‘‘[u]pon further review’’ that allowing a sur-
charge for costs not incurred in the test period or with any
regularity thereafter ‘‘would permit SFPP to recover costs
after the fact which were not even present in the test year
itself and which thereafter could not be recovered in a cost of
service rate filing,’’ and that ‘‘[t]o do so after the fact raises
serious questions under the filed rate doctrine.’’ Opinion No.
435–B, 96 FERC at 62,078.
The difficulty for the court stems from three sources: the
Commission’s apparent failure in its test year approach to
articulate a clear and consistent approach for dealing with the
prudently incurred costs of providing pipeline service that do
not regularly recur, the Commission’s failure to explain ade-
quately why SFPP’s reconditioning costs would not be recov-
erable in a cost of service rate filing, and its failure to
articulate why such a surcharge would violate the filed rate
doctrine. Some prudent expenditures involved in the opera-
tion of a pipeline that are not capitalized, such as, for in-
stance, rate litigation or refurbishing, are bound to be one-
time or infrequent expenditures. A ‘‘test year’’ snapshot of a
pipeline’s operating costs, therefore, if applied too simplisti-
cally, risks over- or under-stating the ‘‘real’’ costs of providing
53
pipeline service, depending on whether such costs happen, by
chance, to fall in a test year or not. We do not understand
the Commission to apply the test year concept so simplistical-
ly; its regulations deal with the possible overstating problem
by disallowing nonrecurring costs as part of the cost of
service, see 18 C.F.R. § 346.2(a)(1)(I), and both under- and
over-stating problems by permitting deviation from the test
year ‘‘for good cause shown,’’ id. § 346.2(a)(1)(ii). Yet the
Commission’s approach in the instant case does not appear to
deal consistently with costs incurred outside the test year, as
evidenced by its different treatment of SFPP’s rate litigation
and reconditioning costs between 1995 and 1998. Both ap-
pear to be prudent, otherwise recoverable costs; both are
nonrecurring (in the sense that they will not be permanent
expenditures SFPP can be expected to incur each year); both
were incurred chiefly outside the 1994 test year; and the
Commission initially held that both past expenses could be
recovered in prospective rates through a temporary sur-
charge because of ‘‘benefits that flowed to the system when
the costs were incurred.’’ Opinion No. 435–A, 91 FERC at
61,518.
The Commission then reversed course in Opinion No. 435–
B and disallowed recovery of the reconditioning costs only.
Its reasoning for disallowing one surcharge but permitting
the other was that ‘‘unlike the [Commission] regulatory costs,
none of [SFPP’s reconditioning costs] were incurred in the
test period.’’ 96 FERC at 62,078. The rate litigation sur-
charge included SFPP’s actual costs after 1994. So the
Commission’s ruling suggests that it matters, to recovery of
costs incurred outside of the test year, whether a carrier also
incurred costs of the same general nature in the test year
itself. The logic behind this distinction, as applied to costs
that benefit the carrier’s system but are not expected to
regularly recur, is neither explained in Opinion No. 435–B
itself, nor is it obvious. Should the Commission wish to rely
on this reasoning on remand, it must articulate and justify
more carefully what its policy on the recoverability of non-
test-year expenses is.
The Commission did explain that SFPP’s rates were in-
dexed to account for cost increases after the test year, and
54
that SFPP could not meet the ‘‘substantial divergence’’ stan-
dard for showing that indexing failed to account for increases
in its cost of service due to reconditioning expenses after
1994. Cf. 18 C.F.R. § 342.4(a) (2004). Assuming that the
Commission can explain its different treatment of rate litiga-
tion and reconditioning costs incurred in years after the 1994
test year, this may be a reasonable basis for denying recov-
ery, but the Commission’s opinion provides no analysis for
why it is true. Where the Commission had found SFPP’s
cost of service to be roughly $14 million a year, SFPP was
claiming reconditioning costs of roughly $1 million a year, a
not insubstantial amount. The Commission provided no esti-
mate or analysis of how any supplemental revenues to SFPP
resulting from rate indexing, or from increased throughput in
years after 1994, compare to those expenses.
The Commission also stated that permitting recovery of the
refurbishing costs ‘‘after the fact’’ would ‘‘raise serious ques-
tions under the filed rate doctrine.’’ Opinion No. 435–B, 96
FERC at 62,078. The filed rate doctrine ‘‘forbids a regulated
entity to charge rates for its services other than those
properly filed with the appropriate federal regulatory authori-
ty.’’ Arkansas Louisiana Gas Co. v. Hall, 453 U.S. 571, 577
(1981). The Commission did not articulate what type of
‘‘serious questions’’ it thought such recovery would raise.
Because a prospective surcharge would presumably be on file
with the Commission, the court presumes that the Commis-
sion meant that an amortized surcharge, by prospectively
recovering SFPP’s expenses from past years, would violate
the related rule against retroactive ratemaking, which re-
quires that ‘‘a utility may not set rates to recoup past losses,
nor may the Commission prescribe rates on that principle.’’
Southern California Edison Co. v. FERC, 805 F.2d 1068,
1070 n.2 (D.C. Cir. 1986) (quoting Nader v. FCC, 520 F.2d
182, 202 (D.C. Cir. 1975)).
This logic, again, raises the question of why such recovery
is any more permissible for rate litigation expenses than it is
for reconditioning costs. The Commission seems to place
SFPP in a Catch–22: it cannot recover its reconditioning
costs prospectively or contemporaneously because the cost of
55
the project is too uncertain until the costs are incurred, but
then once the costs are certain it is too late because recovery
would involve retroactive charges. Absent a better explana-
tion for the Commission’s conclusion that SFPP has recov-
ered its reconditioning costs through the indexed rates, it is
unclear how the costs of any multi-year project whose cost is
not ‘‘known and measurable with reasonable certainty’’ in
advance, 18 C.F.R. § 346.2(a)(1)(ii), could ever be recovered,
were this reasoning to be consistently adopted. The Commis-
sion ruled in Opinion No. 435–A that prospective recovery of
SFPP’s reconditioning costs would be appropriate because of
‘‘benefits that flowed to the system when the costs were
incurred,’’ 91 FERC at 61,518, implying that it initially did
not view the rule against retroactive rulemaking as an obsta-
cle because the expenses provided an ongoing benefit that
would continue to accrue in future years. In light of the
Commission’s failure to explain why it now considers the rule
against retroactive rulemaking (or the filed rate doctrine) to
bar recovery, and because no party has briefed this question
in any detail, the court remands so that the Commission, if it
wishes to continue relying on this reasoning, may better
explain it.
The Commission may have answers to these concerns, but
they are not provided in the Opinions on review. SFPP’s
shippers are presently enjoying the benefits of what appears
to be an expensive pipeline reconditioning program without
sharing in any of its costs. If, in the Commission’s opinion,
they should not have to, the Commission needs to provide a
more thorough explanation of why not. Accordingly, we
remand SFPP’s request to recover its reconditioning costs for
the East Line between 1995 and 1998 to the Commission for
further consideration.
III. Reparations
A. Background and Proceedings Below
After determining that SFPP’s East Line rates were not
just and reasonable, the ALJ ordered SFPP to pay repara-
tions to the ELS which had filed complaints against the rates.
56
ALJ Decision, 80 FERC at 61,308. In Opinion No. 435, the
Commission considered various objections to the reparations
on the part of both SFPP and the shippers but reaffirmed
that SFPP was to pay reparations as determined by the
Commission. See id. at 61,111–14. Specifically, the Commis-
sion ruled that the period for the calculation of reparations
would run from the date of each complaint until March 31,
1999, the effective date of revised East Line rates required by
Opinion No. 435.
In calculating the potential reparations, the Commission
retroactively applied the test year approach it had used to set
SFPP’s prospective rates: SFPP was to develop an East Line
cost of service for a test year, 1994; design a rate that
reflected that cost of service; index that rate to December 31,
1998; and apply that indexed rate to designated volumes
adopted by Opinion No. 435 for each calendar year for which
an indexed rate had been developed. Using the new cost of
service thus established for years 1994–1998 and partial year
1999, SFPP was to determine whether the revenues for each
period resulted in an over or under-recovery of its cost of
service. FERC’s order permitted SFPP to ‘‘net out its over
and under recoveries for each year and determine that net
amount, if any, that is due its East Line Shippers.’’ Id. at
61,114. FERC ordered a similar calculation of reparations
for years prior to 1994 based on the calculation of under- or
over-recovery of cost of service in those years. As to repara-
tions in general, FERC held that no shipper was entitled to
reparations for periods prior to the filing date of a complaint.
Id. at 61,112–13.
On rehearing, FERC held that Navajo was the only com-
plainant that had filed a challenge to East Line rates. Thus,
only Navajo could recover reparations. Opinion No. 435–A,
91 FERC at 61,514. FERC granted Navajo reparations
beginning one month prior to the filing of its December 23,
1993, complaint to SFPP’s rates. FERC also noted that
Navajo had entered a settlement with SFPP in 1989. That
settlement barred Navajo from bringing action against SFPP
until November 23, 1993. With those provisos, FERC or-
57
dered SFPP to calculate the limited reparations still in order
on the East Line based on the difference between per-barrel
rates charged and per-barrel rates that would have been
charged had SFPP charged cost-based rates using a 1994 test
year, and to index such rates annually going forward — in
other words, the difference between the charged rates and
the rates that SFPP should have charged. In sum, the
Commission modified its prior order and decreed that:
SFPP will calculate the gross reparations that would be
due if all shippers that had used the East Line had filed
complaints for the applicable reparations period TTT es-
tablish[ing] the total revenue that was received in excess
of the new East Line rates established by the prior
order. Navajo will be paid its pro rata share of the
reparations for the relevant time frame.
Id. at 61,518. The Commission noted that because Navajo
was the only shipper entitled to reparations, the calculations
‘‘should leave a surplus of revenues in excess of the East Line
restated cost of service between the beginning of the repara-
tions period and the actual date on which the restated rates
began to be collected by SFPP.’’ Id.
The shippers petitioned for rehearing of FERC’s reconsid-
eration order, which FERC granted in part. This time,
FERC held that Chevron, Western, ConocoPhillips, and Exx-
onMobil were, like Navajo, entitled to reparations for over-
charges that occurred two years prior to the filing of their
complaints. Opinion No. 435–B, 96 FERC at 62,071–74.
FERC held that Valero was not entitled to reparations,
because its complaint was filed after August 7, 1995, the last
date complaints were consolidated in the proceedings. Id. at
62,072. The Commission subsequently clarified Opinion No.
435–B by stating that Chevron’s eligibility for reparations
was determined as of its August 3, 1993 complaint, not a
protest it filed September 23, 1992. Clarification and Rehear-
ing Order, 97 FERC ¶ 61,138.
SFPP now argues that the Commission ought not have
awarded any reparations whatsoever. Navajo contends that it
was improperly denied reparations prior to November 23,
58
1993. Chevron alleges that FERC improperly set the com-
mencement date for calculating its reparations. And Valero,
BP WCP, and Chevron all claim that they were improperly
denied reparations.
B. Analysis
1. SFPP
SFPP argues that the underlying orders were arbitrary
and capricious for four related reasons. First, SFPP con-
tends that awarding ELS reparations is impermissible retro-
active ratemaking, in violation of the Supreme Court’s deci-
sion in Arizona Grocery Co. v. Atchison, Topeka & Santa Fe
Railway Co., 284 U.S. 370 (1932). Second, it asserts that
FERC’s award of pre-complaint reparations violates the
EPAct. Third, SFPP advances that FERC improperly
awarded reparations based on a ‘‘test period,’’ disregarding
damages actually suffered and proved by complainants. Fi-
nally, SFPP argues that FERC failed to consider substantial
arguments — such as the novelty and complexity of SFPP’s
rate case — that militated against awarding reparations. For
the reasons stated below, we reject all four claims.
a. The Arizona Grocery Rule
Arizona Grocery proscribes ‘‘the retroactive revision of
established rates through ex post reparations.’’ Verizon Tel.
Cos. v. FCC, 269 F.3d 1098, 1107 (D.C. Cir. 2001); see also
Ala. Power Co. v. ICC, 852 F.2d 1361, 1373 (D.C. Cir. 1988).
Otherwise put, Arizona Grocery bars reparations that retro-
actively change a final Commission-approved rate. SFPP
relies on Arizona Grocery to argue that Opinion No. 435 was
a final order prescribing just and reasonable rates, and thus
FERC was barred from awarding reparations when SFPP’s
rate was effectively further lowered as a result of FERC’s
subsequent orders. SFPP argues that Opinion No. 435 was a
final order setting rates ‘‘to be thereafter observed’’ under
ICA Section 15(1), and therefore that the subsequent orders
were retroactive changes of Opinion No. 435. We disagree.
Arizona Grocery is of no help to SFPP in this case.
Arizona Grocery applies only where the Commission has
59
‘‘declared what is the maximum reasonable rate to be charged
by a carrier.’’ 284 U.S. at 390. Yet FERC did not finalize a
maximum reasonable rate in Opinion No. 435 and in fact
repeatedly stated it was not doing so. Thus Opinion No. 435
set no final rate; rather, FERC only established a final rate
at the completion of the OR92–8 proceedings. SFPP, L.P.,
100 FERC ¶ 61,353, 62,625 (2002) (‘‘September 26 Order’’).
The OR92–8 proceedings were compliance filings. SFPP’s
filing in Docket No. OR92–8–013 showed SFPP’s calculations
for determining how its East Line rates should be structured
to reflect the requirements of Opinion No. 435–B. SFPP later
amended that in Docket No. OR92–8–015 to address the
exclusion of the interest element from the calculation of the
total potential reparation pool that would be due under the
Commission’s prior orders. Id. at 62,622.
The record shows that at each point, the Commission said
that final East Line rates would not be established until the
OR92–8 proceedings were completed. September 26 Order,
100 FERC at 62,625. In response to Opinion No. 435, SFPP
filed a tariff establishing a rate, but the Commission conclud-
ed that the tariff could not be determined to be just and
reasonable until review of the Docket No. OR92–8 compliance
filing was completed. The Commission accepted the tariff for
filing and suspended it, subject to refund, pending review of
the compliance filing. SFPP, L.P., 87 FERC ¶ 61,056, 61,225–
26 (1999). Nor did FERC’s next opinion on the subject make
that rate final. Opinion No. 435–A merely reaffirmed the
suspension of the previously filed tariff based on the signifi-
cant chance that the proposed rate levels in it would change
depending on how the protests and related requests for
rehearing were resolved. 91 FERC at 61,520. It did not
finalize the rate.
FERC’s subsequent orders concerning SFPP’s proposed
rates were similarly nonfinal. FERC accepted for filing
SFPP’s Tariff No. 60, filed to comply with Opinion No. 435–A,
with a proposed effective date of August 1, 2000, but suspend-
ed it subject to refund. SFPP, L.P., 92 FERC ¶ 61,166,
61,563–64 (2000). Opinion No. 435–B approved the August 1,
2000, effective date because that was the date the Commis-
60
sion accepted SFPP’s compliance filing, and directed a fur-
ther compliance filing, also to be effective August 1, 2000. 96
FERC at 62,071, 62,079. SFPP filed Tariff No. 67 (later
corrected in Tariff No. 68), with a proposed effective date of
December 1, 2001. SFPP, L.P., 98 FERC ¶ 61,177, 61,657
(2002). The Director of the Division of Tariffs and Rates
Central rejected the tariffs because Opinion No. 435–B re-
quired an effective date of August 1, 2000. Id. FERC’s
order memorializing the rejection made clear that FERC’s
previous orders suspended, subject to refund, SFPP’s pro-
posed tariffs
pending resolution of the numerous compliance issues
that have been raised in the course of these proceedings.
In each of the prior Opinions the Commission has made
clear that SFPP must recalculate the rates to be applied
in compliance with those Opinions and that any prior
calculations of reparations and surcharges must be ad-
justed accordingly.
Id.
The Commission has thus been clear from the outset and
throughout that no final rate determination would be made
until the OR92–8 proceedings were complete. September 26
Order, 100 FERC at 62,625. As a result, the Commission’s
orders requiring reparations do not violate the prohibition in
Arizona Grocery from subjecting a carrier to payment of
reparations with respect to a final rate. The Commission did
not establish final lawful rates where it has expressly re-
served authority to make adjustments in the context of an
ongoing proceeding in which the methodology for determining
the rate had not even been established. Id. at 62,626.
SFPP contends that the Commission’s reparations orders
violate ICA Section 15(7), which authorizes refunds of ‘‘such
increased rates or charges’’ as ‘‘shall be found not justified.’’
49 U.S.C. app. § 15(7) (1988). But Section 15(7) is an author-
ization, not a prohibition, and FERC did not invoke this
provision in awarding the shippers reparations. The Com-
mission found it inappropriate for this complaint proceeding
to go forward under Section 15(7), SFPP, L.P., 63 FERC
61
¶ 61,014, 61,124 (1993), and thus no relief was awarded under
that section. Rather, FERC proceeded under ICA §§ 8, 9,
and 16(1), which specifically authorize the Commission to
award damages in a Section 13 complaint. 49 U.S.C. app.
§§ 8, 9 & 16(1) (1988). SFPP also contends that FERC lacks
authority to issue ‘‘interim’’ rates after ruling on a complaint.
Yet nothing in Section 15(1) prohibits FERC from directing a
pipeline to file an interim rate, subject to suspension and
refund, if there is a possibility that the final rates will be
lower than the interim rates. Indeed, the Supreme Court has
held that under the ICA the Commission has authority — in
response to an initial rate filing — to direct an oil pipeline to
file interim rates to go into effect, subject to refund, during
the suspension period for the initial rates. Trans Alaska
Pipeline Rate Cases, 436 U.S. 631, 654–56 (1978). See also
FPC v. Tenn. Gas Transmission Co., 371 U.S. 146, 146–57
(1962); FPC v. Natural Gas Pipeline Co., 315 U.S. 575, 585
(1942).
Therefore, we hold that when the Commission awarded
reparations, it was not constrained by Arizona Grocery’s
blanket prohibition on retroactive repeals of ratemaking.
b. Pre-Complaint Reparations
SFPP’s second contention is that the EPAct precludes pre-
complaint reparations in a Section 13 proceeding, and that
each complainant may seek reparations only for overcharges
that date from the filing of its own complaint. We disagree.
EPAct Section 1803(b) provides:
If the Commission determines pursuant to a proceeding
instituted as a result of a complaint under section 13 of
the Interstate Commerce Act that the rate is not just
and reasonable, the rate shall not be deemed to be just
and reasonable. Any tariff reduction or refunds that may
result as an outcome of such a complaint shall be pro-
spective from the date of the filing of the complaint.
EPAct § 1803(b). The ICA, however, allows reparations for
up to two years prior to the date of the filing of a complaint if
the rates paid in those two years exceed the just and reason-
62
able rate established in the complaint proceeding. See 49
U.S.C. app. § 16(3)(b) (1988).
SFPP contends that the last clause of Section 1803(b) is
applicable to any and all complaints filed under ICA Section
13, and therefore that reparations awarded for all com-
plaints — including those for East Line rates — must be
prospective from the filing of the complaints. We agree with
SFPP that EPAct Section 1803(b) prohibits retroactive rate-
making, but we think that it does so only for those rates that
were ‘‘grandfathered’’ under this section. Section 1803(b)
does not apply to complaints challenging non-grandfathered
rates. In its prefatory clause, it explicitly refers only to ‘‘a
complaint TTT against a rate deemed just and reasonable
under [Section 1803(a)].’’ The second-to-last sentence of Sec-
tion 1803(b) expressly relates only to complaints on which
FERC acts to determine grandfathered rates, otherwise
‘‘deemed to be just and reasonable,’’ to be just and reason-
able. The reference to ‘‘such a complaint’’ in the last sen-
tence of Section 1803(b) plainly refers back to the prior
references in Section 1803(b) to complaints against rates
‘‘deemed to be just and reasonable’’ under Section 1803(a).
Because the East Line rates were challenged within the
one-year period prior to enactment of the EPAct, they are
not grandfathered under Section 1803. Accordingly, relief for
East Line rate complainants is governed by ‘‘the traditional
standards of the ICA, including section 16’s provision for a
two year reparations period retroactive from the date of the
complaint.’’ SFPP, L.P., 68 FERC ¶ 61,306, 61,582 (1994).
FERC’s order tracked this interpretation of the statute
precisely. FERC found that shippers filing a complaint
against SFPP’s East Line rates may recover reparations for
the two-year period prior to the date of their complaints.
The Commission determined that the EPAct barred pre-
complaint relief only for complaints against grandfathered
rates. Thus, FERC correctly found that Section 1803(b) does
not apply to complaints challenging the East Line rates that
FERC held not to be grandfathered.
63
c. Test Period
Next, SFPP challenges the methodology FERC ordered
SFPP to use to calculate reparations. In Opinion No. 435–A,
FERC ordered SFPP to use the following method. First,
FERC said, SFPP must determine what the just and reason-
able rate would have been in each year between 1994 and
August 1, 2000 — as well as two years back from the date of
the earliest complaint — and then calculate what the appro-
priate gross revenues would have been from that rate. The
difference between the gross revenue under the new just and
reasonable rates would create the total reparations pool —
the amount SFPP would pay to all eligible shippers. SFPP
would then calculate the reparations due each eligible shipper
(including interest), leaving a residual in the pool of funds
that could not be distributed because certain shippers had not
filed a complaint within the time frame of the proceeding.
The residual pool would then be credited against the total
supplemental costs permitted under Opinion No. 435–A be-
tween 1995 and 1998. Any remaining allowable costs would
then be recovered through a five-year surcharge.
To estimate what gross revenues would have been in those
years, the Commission directed that SFPP use a test year
cost of service, divided by the test year’s volumes, to replace
the previous unit rate not found to be just and reasonable.
Opinion No. 435–A, 91 FERC at 61,516. The reparations
payment due for each year would be the difference between
the revenues generated in that year under the old rates and
the revenues that would have been generated under the final
new rates. Id.
SFPP challenges the estimation methodology proposed by
FERC — specifically FERC’s direction to use a ‘‘test period’’
to estimate past gross revenues. SFPP contends that basing
the reparations calculations on a rate derived from a histori-
cal test period ‘‘makes no sense in the real world, as it
wrongly assumes SFPP’s actual cost of service did not change
appreciably over a period of eight years or more.’’ We once
again disagree.
64
The use of test periods to set the cost of service for rates
intended to span a number of years is well established. See,
e.g., Williston Basin Interstate Pipeline Co. v. FERC, 165
F.3d 54, 56 (D.C. Cir. 1999). As we have noted, it is
ordinarily impossible for a pipeline to know at the time of
filing what its actual costs will be during the effective period
of the filed rates, and so the use of a ‘‘test period’’ for
calculating the cost of service is appropriate. Id. While use
of a test period is not perfect, it is a reasonable proxy for
actual costs. See generally American Public Power Ass’n v.
FPC, 522 F.2d 142 (D.C. Cir. 1975); see also Public Serv. Co.
v. FERC, 832 F.2d 1201, 1218 (10th Cir. 1987). It was
therefore reasonable for the Commission to base reparations
calculations on the same test period methodology it uses to
calculate prospective rates. To the extent SFPP contends
that the Commission’s reliance on the test year approach
unreasonably denied it recovery of certain expenses it in-
curred after the test period, those concerns are addressed in
Part II of our opinion.
The Commission also properly determined that rates based
on the test period could be used to calculate reparations for
the two years prior to the filing of the complaints. See ALJ
Decision, 80 FERC at 65,203. There is no basis to conclude
that test period rates that are just and reasonable for all
future years do not provide a just and reasonable basis for
determining reparations in the two years prior to the com-
plaints. Id.
SFPP further contends that it should have been allowed to
offset under-recovery of its cost of service in some years with
over-recovery of its cost of service in other years, based on
ICC decisions permitting netting of multi-year data in deter-
mining reparations. As explained, however, the Commission
reasonably found that consideration of the costs from every
year was not feasible. While the Surface Transportation
Board (formerly ICC) determines the total revenue stream
required to recover the costs of particular service over its
economic life, FERC has reasonably decided to calculate
reparations by the difference in the unit value of the old and
new rate, not the difference in gross and net revenues for the
65
operation of the pipeline as a whole. ALJ Decision, 80 FERC
at 65,203. Accordingly, the Commission reasonably found the
netting of reparations across the entire reparations period
inappropriate in these circumstances.
Moreover, this Court has previously rejected pipeline de-
mands to permit offsetting undercharges and overcharges in
different years during a refund period. As we held in Belco
Petroleum Corp. v. FERC, 589 F.2d 680, 686–87 (D.C. Cir.
1978), the NGA — like the ICA here — gives the regulated
entity no right to collect more than the just and reasonable
rate in one period simply because it collected less than the
just and reasonable rate in another.
SFPP cites a number of cases for the proposition that the
concept of netting multi-year data to assure fairness in repa-
rations is well established, but here a multi-year rate method
was not employed. It is thus reasonable to base reparations
on a year-to-year basis without netting.
d. Reasoned Decisionmaking
SFPP’s fourth contention is that the Commission abused its
discretion by failing to consider SFPP’s arguments. Al-
though SFPP acknowledges FERC’s discretion to award
reparations, it points out that it argued that SFPP’s rate case
was complex and presented issues of first impression, and
that SFPP could not have predicted what lawful rates would
have been. In sum, it argued before the Commission that it
could not have reasonably adjusted its rates. SFPP claims
that by giving no consideration to these arguments, FERC
failed to engage in reasoned decisionmaking. We reject this
contention.
FERC’s orders reasonably addressed SFPP’s concerns.
Although FERC never explicitly responded to SFPP’s point
that its case was complex, it implicitly did so by finding
SFPP’s rates unjust and unreasonable. The fact that SFPP’s
rate case was complex does not alter the Commission’s obli-
gation to make a decision as to whether SFPP’s rates were
unjust and unreasonable. The Commission reasonably re-
sponded to SFPP’s argument by simply performing its statu-
66
tory duty to pass on the reasonableness of SFPP’s rates,
rather than dwelling on the difficulty of the task at hand.
Assuming FERC’s decision to find the rates just and reason-
able was reasoned, it does not become unreasoned simply
because FERC reached its decision without explicitly com-
menting on its difficulty. In any event, it is apparent from
the length and complexity of FERC’s discussion that it
understood the complexity of SFPP’s case.
As for SFPP’s argument that it could not have predicted
the eventual rates, the Commission expressly responded to
that reliance argument by stating that SFPP was on notice
that its rates were subject to review, and that ‘‘there was a
risk that the rates could be found unjust and unreasonable
and reparations awarded.’’ Opinion No. 435, 86 FERC at
61,113.
Accordingly, the Commission engaged in reasoned decision-
making in awarding reparations. Although certain matters
were complex issues of first impression, FERC did not need
to acknowledge that complexity explicitly for its decision to
stand.
2. Navajo
Turning next to the shipper petitioners, Navajo contends
that it should be awarded reparations for the two years
preceding the filing of its complaint on December 22, 1993.
As noted above, the Commission concluded that a prior
settlement agreement between SFPP’s predecessor and Na-
vajo foreclosed Navajo from collecting reparations for this
two-year period. We find no error in FERC’s decision.
The settlement Navajo entered into with SFPP’s predeces-
sor, provided — in Section 2.3 — that:
For the five (5) year period following the effective date of
FERC Tariff No. 88 — i.e., November 23, 1988 —
Navajo shall not challenge, by complaint or any other
means, East Line rates established or increased in con-
formity with the terms and conditions of this Article, nor
shall they seek reparations or other damages with re-
spect to such rates.
67
Southern Pac. Pipe Lines, Inc., No. IS85–15–000, Stipulation
and Settlement Agreement § 2.3 (Jan. 30, 1989) (approved in
Southern Pac. Pipe Lines Partnership, L.P., 49 FERC ¶ 61,-
081 (1989)).
Navajo contends that this language permits it to seek
reparations for the two years prior to filing its complaint,
even though those two years are within the five-year settle-
ment rate moratorium. In Navajo’s view, this reading is
compelled by the contrast between Section 2.3 and Section 1.3
of the 1989 settlement concerning West Line rates. Section
1.3 provides as follows:
During the (5) year period following November 23, 1988
(the effective date of FERC Tariff No. 88), Navajo shall
not challenge, by complaint or any other means, West
Line rates established or increased in conformity with
the terms and conditions of this Article, nor shall they
seek reparations or other damages with respect to such
rates for any part of that five (5) year period.
Id. § 1.3.
According to Navajo, the last sentence ‘‘made clear that
Navajo not only agreed to refrain from filing a complaint
seeking reparations during the five-year period following
November 23, 1988, but also agreed to waive its rights to
reparations relating to that five-year period.’’ In contrast,
Navajo argues, ‘‘the provision pertaining to the East Line did
not waive the right to seek reparations for rates paid for
service on the East Line during the five-year period once the
moratorium expired.’’
The ALJ disagreed with Navajo, concluding that a ‘‘fair
reading of the settlement agreement and the Commission’s
order approving it precludes claims for reparation by Navajo
for rates charged during the period when the settlement was
in effect.’’ ALJ Decision, 80 FERC at 65,207–08. The
Commission affirmed the ALJ’s interpretation as ‘‘the only
reasonable interpretation’’ of the settlement agreement.
Opinion No. 435, 86 FERC at 61,111.
68
We find the Commission’s interpretation of the settlement
to be reasonable. Section 2.3 expressly provides that Navajo
shall not ‘‘seek reparations or other damages’’ with respect to
the East Line rates for the five-year period following Novem-
ber 23, 1988. Southern Pac. Pipe Lines, Inc., No. IS85–15–
000, Stipulation and Settlement Agreement § 2.3 (Jan. 30,
1989). While an additional phrase does appear in Section 1.3,
this does not alter the plain meaning of Section 2.3. It is
unreasonable to assume that, although obtaining agreement
to language expressly referring to a five-year moratorium
period for all rate changes, SFPP nevertheless intended to
permit Navajo to seek reparations for two of the five years.
Navajo advances a number of theories as to why SFPP
might have agreed to a shorter moratorium on East Line
reparations. However, there is no evidence that these theo-
ries played any part in the negotiations and none of them
address the fundamental point that the settlement expressly
says five years. The Commission’s interpretation of the
contract as such is therefore reasonable.
3. Valero
Valero, another shipper, contends that FERC erred by
denying it reparations in Opinion No. 435–B. Valero argues
that because FERC found that SFPP charged it unjust and
unreasonable rates in Opinion No. 435–A, FERC had an
obligation to award reparations to it as well. FERC re-
sponds that because Valero was not a party to OR92–8, the
Commission properly rejected Valero’s claim that it is entitled
to reparations ‘‘in the same manner’’ as the shippers in
OR92–8. Valero may be correct that it is entitled to repara-
tions, but we agree with FERC that it is not so entitled in
this particular proceeding.
Valero’s complaint involves distinct issues from the com-
plaints at issue in this case, and accordingly FERC reason-
ably denied it recovery in these proceedings. This case
concerns shippers who filed their claims prior to August 1995.
The timing of their complaint matters, because FERC deter-
mined that they were entitled to reparations only for over-
charges during the two years preceding the filing of their
69
complaints. In contrast, Valero — then Ultramar Diamond
Shamrock — filed its complaint in November 1997. ARCO
Products Co., 82 FERC ¶ 61,043, 61,183 (1998). That com-
plaint was docketed as OR98–2, separate from the docket at
issue here, OR92–8, consolidated with other complaints filed
after August 7, 1995, and all held in abeyance with an
opportunity to amend the complaints based on the findings in
this proceeding. The post-August 7, 1995 complaints were
consolidated in a proceeding separate from OR92–8 because
those complaints involve different test periods and cost fac-
tors from those addressed in OR92–8. Because Valero filed
its complaint in 1997 — and because, as FERC points out,
Valero’s reparations will be determined based upon a differ-
ent test period and cost factors, and will be limited to the two
years prior to the filing of Valero’s complaint — it may well
not be entitled to the same reparations as shippers who filed
in 1994. Accordingly, Valero must have its reparations claims
adjudicated in the OR98–2 proceedings.
Valero’s arguments do not convince us otherwise. Valero
alleges that FERC’s failure to provide reparations to Valero
is directly contrary to the plain language and intent of the
ICA. Under Section 8 of the ICA, injured shippers are
provided a right of action for damages. See 49 U.S.C. app.
§ 8 (1988). But FERC’s denial of reparations in Opinion No.
435–B is perfectly consistent with this provision. FERC did
not hold in that order that Valero was not entitled to repara-
tions. Rather, FERC deferred consideration of Valero’s enti-
tlement. Accordingly, FERC’s decision is consistent with the
ICA.
Valero argues that under A.J. Phillips Co. v. Grand Trunk
Western Ry. Co., 236 U.S. 662, 665 (1915), its party status in
OR92–8 ‘‘is of no moment in awarding reparations.’’ Pet.
Joint Brief on Rate and Reparations Issues 28. While A.J.
Phillips held that finding a rate unreasonable ‘‘inured to the
benefit of every person that had been obliged to pay the
unjust rate,’’ A.J. Phillips, 236 U.S. at 665, it also recognized
that a shipper’s right to reparations turns on the timely filing
of its complaint, and its rights are limited by that complaint.
Id. at 665–66 (‘‘But while every person who had paid the rate
70
could take advantage of the finding that the advance was
unreasonable, he was obliged to assert his claim within the
time fixed by law’’). Here, Valero — which filed its complaint
in 1997 — is not entitled to the same reparations as the
shippers who filed in 1994, since Valero’s reparations will be
determined upon a different test period and cost factors, and
will be limited to the two-year period prior to the filing of
Valero’s complaint. See 49 U.S.C. app. § 16(3)(b) (1988).
Thus, deferring consideration of Valero’s claim is consistent
with A.J. Phillips Co. While there is some commonality of
issues between Valero’s complaint proceeding and OR92–8,
OR92–8 is not dispositive of Valero’s reparations claims.
Therefore Valero must await adjudication of its reparations
claims in OR98–2.
4. BP West Coast Products and Chevron
Petitioners allege that because both BP WCP (formerly
ARCO Products Co.) and Chevron (formerly Texaco Refining
and Marketing, Inc.) were injured by SFPP’s East Line rates
and both jointly filed — on January 14, 1994 — a complaint,
FERC violated the ICA by denying them reparations.
FERC denied both of these entities damages from the East
Line rates because they stated no claim regarding the East
Line rates in their complaints. We again agree with FERC.
ARCO’s and Texaco’s complaint simply did not challenge
the East Line rates. While their complaint referenced Tariff
No. 15 along with other tariffs, which includes East Line
rates, that reference was not specific to any rate, but alleged
only that shippers shipped petroleum pursuant to one or
more of those tariffs. That vague reference fails to state a
cognizable complaint against the East Line rates, since other-
wise the allegations solely concerned West Line rates.
ARCO’s and Texaco’s complaint alleged, instead, that their
‘‘shipments basically originate in California and are transport-
ed by SFPP to Phoenix and Tucson.’’ Transportation from
California into Arizona occurs only on the West Line. Con-
sistent with that allegation, the complaint addressed the
grandfathering of the West Line rates, and sought repara-
tions, at the least, from the date of the filing of their
71
complaint, which is the standard for grandfathered rates.
The affidavit submitted in support of the complaint concluded
that ‘‘SFPP’s rates on its West Line System exceed the rates
that would result from an appropriate application of the
Commission’s ratemaking methodology by a significant
amount.’’ SFPP, L.P., No. OR92–8–000, Affidavit of Marsha
K. Palazzi 2 (Jan. 18, 1994). No mention of the East Line
rates is made in the complaint or the supporting affidavit.
Thus, the complaint was only applicable to the West Line
rates. See SFPP, L.P., 68 FERC at 61,582. Under these
circumstances, the Commission reasonably interpreted the
complaint to state a claim only with regard to the West Line
rates, and BP WCP and Chevron were properly denied
reparations for the East Line rates.
ARCO’s October 2, 1992, intervention in OR92–8 does not
change this result, see Rate Br. 32, since BP WCP’s stated
ground for intervention was its ‘‘direct interest’’ in the ‘‘new
origin point and applicable rates at East Hynes.’’ As the
East Hynes station is on the West Line, this intervention
likewise stated no claim with regard to the East Line rates.
5. Chevron
On September 23, 1992, Chevron filed a protest concerning
SFPP’s reversal of the flow of the ‘‘six-inch line’’ between
Tucson and Phoenix, and SFPP’s modification of its pro-
rationing policy. On August 3, 1993, Chevron filed a com-
plaint alleging that SFPP’s East Line rates were unjust and
unreasonable. Chevron demanded reparations ‘‘for the peri-
od beginning two years preceding the filing of the Com-
plaint.’’
The Commission properly calculated Chevron’s East Line
rate reparations based on Chevron’s 1993 complaint challeng-
ing those rates. See supra at 14 n.2. While Chevron argued
that its 1993 complaint should relate back to its 1992 protest,
the 1992 protest did not challenge the East Line rates, but
rather only challenged flow reversal on one of SFPP’s lines
and its capacity allocation procedures.
Chevron now contends that its East Line reparations
should be based upon the date of its 1992 protest because the
72
Commission treated the protest as a complaint. The Com-
mission, held, however, that ‘‘[t]he scope of the complaint
proceeding shall be defined by the issues raised by El Paso
and Chevron which caused these proceedings to be institut-
ed.’’ SFPP, L.P., 63 FERC ¶ 61,275, 62,769 (1993). Chev-
ron’s protest ‘‘complained against the reversal of one of
SFPP’s lines and its capacity allocation procedures, but did
not complain against the East Line rates as such.’’ Opinion
No. 435–A, 91 FERC at 61,514 n.55. Because the protest did
not complain about the East Line rates, the Commission
properly found that the protest did not trigger reparations
for the East Line rates, and dated Chevron’s right to repara-
tions from Chevron’s August 3, 1993, East Line complaint.
SFPP, L.P., 97 FERC ¶ 61,138 61,623–24 (2001) (citing
SFPP, L.P., 65 FERC ¶ 61,028); see also SFPP, L.P., 102
FERC ¶ 61,073, 61,183–84 (2003).
The ALJ’s determination that reparations demands could
relate back to earlier-filed complaints does not aid Chevron.
As the ALJ recognized, an amendment to a pleading may
relate back when it arises out of the same transaction or
occurrence set forth in the original pleading. Fed. R. Civ. P.
15(c)(2). Because the Commission found that Chevron’s orig-
inal protest did not concern the East Line rates, but rather
only the practice of prorationing and reversal of the ‘‘six inch
line,’’ however, Chevron’s claim for East Line rate repara-
tions cannot relate back to that protest. The Commission
reasonably determined that Chevron’s 1993 complaint, which
first stated a claim with regard to the justness and reason-
ableness of the East Line rates, was the proper basis for
determining Chevron’s right to reparations.
For the reasons given above, we affirm the decisions of the
Commission in awarding reparations and deny the petitions
for review in full to the extent they challenge FERC’s
reparations order.
CONCLUSION
In conclusion, we affirm the decisions of the Commission
and deny the petitions except as follows: As regards the
73
West Line rates, we grant the petition and remand with
respect to the Commission’s decisions that the Watson en-
hancement and turbine fuel rates are grandfathered under
the EPAct. We also remand with respect to the Commis-
sion’s determination that changes in tax allowance policy
constitute ‘‘substantially changed circumstances’’ under the
Act. As regards the East Line rates, we reverse the Com-
mission’s decision to rely on Lakehead insofar as it pertains
to tax allowances, and thus grant the petition and remand the
Commission’s determination regarding the proper tax allow-
ance for SFPP. We also grant the petition and remand for
the Commission to determine and explain an appropriate
allocation of the civil litigation costs between the West Line
and East Line shippers. Finally, we grant the petition and
remand for the Commission to address SFPP’s request to
recover its reconditioning costs.