Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-98-01115/USCOURTS-caDC-98-01115-0/pdf.json

Parties Involved:
Federal Energy Regulatory Commission
Respondent
Nebraska Public Power District
Petitioner

Document Text:

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 3, 1999 Decided June 30, 2000

As Amended Nov. 14, 2000

No. 97-1715

Transmission Access Policy Study Group, et al.

Petitioner

v.

Federal Energy Regulatory Commission,

Respondent

Vermont Department of Public Service, et al.,

Intervenors

USCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 1 of 109
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Consolidated with

98-1111, 98-1112, 98-1113, 98-1114, 98-1115, 98-1118,

98-1119, 98-1120, 98-1122, 98-1124, 98-1125, 98-1126,

98-1127, 98-1128, 98-1129, 98-1131, 98-1132, 98-1134,

98-1136, 98-1137, 98-1139, 98-1140, 98-1141, 98-1142,

98-1143, 98-1145, 98-1147, 98-1148, 98-1149, 98-1150,

98-1152, 98-1153, 98-1154, 98-1155, 98-1156, 98-1159,

98-1162, 98-1163, 98-1166, 98-1168, 98-1169, 98-1170,

98-1171, 98-1172, 98-1173, 98-1174, 98-1175, 98-1176,

98-1178,98-1180

On Petitions for Review of Orders of the

Federal Energy Regulatory Commission

Sherilyn Peterson, John T. Miller, Jr., Robert C. McDiarmid, Stanley C. Fickle, Sara D. Schotland, Jeffrey L. Landsman, Lawrence G. Malone, Jeffery D. Watkiss, Richard M.

Lorenzo, Isaac D. Benkin, Wallace E. Brand, Daniel I.

Davidson, Cynthia S. Bogorad, Harvey L. Reiter and Randolph Lee Elliott argued the causes for petitioners. With

them on the briefs were William R. Maurer, Ben Finkelstein, David E. Pomper, Ronald N. Carroll, John Michael

Adragna, Sean T. Beeny, Wallace F. Tillman, Susan N.

Kelly, Craig W. Silverstein, A. Hewitt Rose, Bryan G. Tabler,

James D. Pembroke, David C. Vladeck, Robert F. Shapiro,

Lynn N. Hargis, Wallace L. Duncan, Richmond F. Allan,

Alan H. Richardson, Michael A. Mullett, C. Kirby Mullen,

Robert A. Jablon, Sara C. Weinberg, John F. Wickes, Jr.,

Todd A. Richardson, Brian A. Statz, John P. Cook, Charles

F. Wheatley, Jr., Christine C. Ryan, Robert S. Tongren,

Joseph P. Serio, Barry E. Cohen, Carrol S. Verosky, Jennifer

S. McGinnity, Jonathan D. Feinberg, Charles D. Gray, Robert Vandiver, Cynthia Miller, Helene S. Wallenstein, William H. Chambliss, C. Meade Browder, Jr., Mary W. Cochran, Paul R. Hightower, Brad M. Purdy, Gisele L. Rankin,

Robert D. Cedarbaum, Edward H. Comer, Edward Berlin,

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Robert V. Zener, Elizabeth W. Whittle, James H. McGrew,

Donald K. Dankner, Frederick J. Killion, Joseph L. Lakshmanan, Stephen C. Palmer, Michael E. Ward, Steven J.

Ross, Marvin T. Griff and Thomas C. Trauger. Leja D.

Courter, Robert E. Glennon, Jr., Neil Butterklee, Zachary D.

Wilson, Sheila S. Hollis, Janice L. Lower and James B.

Ramsay entered appearances.

John H. Conway, Deputy Solicitor, Federal Energy Regulatory Commission, and Timm L. Abendroth and Larry D.

Gasteiger, Attorneys, argued the causes for respondent.

With them on the brief was Jay L. Witkin, Solicitor. Susan J.

Court, Special Counsel, and Edward S. Geldermann, Attorney, entered appearances.

Edward Berlin argued the cause for intervenors. With

him on the briefs were J. Phillip Jordan, Robert V. Zener,

Edward H. Comer, William M. Lange, Deborah A. Moss,

James H. McGrew, Steven J. Ross, Elizabeth W. Whittle,

Richard M. Lorenzo, David M. Stahl, D. Cameron Findlay,

Peter Thornton, J. Phillip Jordan, Robert V. Zener, Robert C.

McDiarmid, Cynthia S. Bogorad, Ben Finkelstein, Peter J.

Hopkins, Margaret A. McGoldrick, Jeffery D. Watkiss, Ronald N. Carroll, Sara D. Schotland, Alan H. Richardson,

Wallace L. Duncan, Richmond F. Allan, A. Hewitt Rose,

Wallace F. Tillman, Susan N. Kelly, John M. Adragna, Sean

T. Beeny and Randolph Lee Elliott. Edward J. Twomey,

Richard P. Bonnifield, Frederick H. Ritts, David L. Huard,

Dan H. McCrary, Mark A. Crosswhite, John N. Estes, III,

Kevin J. McIntyre, John S. Moot, Clark E. Downs, Martin V.

Kirkwood, Robert S. Waters, John T. Stough, Jr., Bruce L.

Richardson, Floyd L. Norton, IV, William S. Scherman,

Douglas F. John, Gary D. Bachman, Nicholas W. Fels,

Robert Weinberg, Robert A. Jablon, Peter G. Esposito, Christine C. Ryan, Sheila S. Hollis, Stephen L. Teichler, James K.

Mitchell, Gordon J. Smith, Edward J. Brady, Kevin F.

Duffy, Michael P. May, Barbara S. Brenner, Michael J.

Rustum, Sandra E. Rizzo, Kirk H. Betts, Pierre F. de Ravel

d'Esclapon, Glen L. Ortman and William D. DeGrandis

entered appearances.

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Before: Sentelle, Randolph and Tatel, Circuit Judges.

Opinion for the Court filed Per Curiam1:

Table of Contents

I. Introduction 7

II. FERC's Authority to Require Open Access 11

A. Statutory Challenges: FPA ss 205 and

206 14

1. ss 205 and 206 and Otter Tail Power

Company 15

2. s 206(a) Procedural and Evidentiary

Requirements 18

3. Discriminatory Effect of Order 888 21

B. Constitutional Challenge: Fifth Amendment Takings Clause 23

III. Federal versus State Jurisdiction over Transmission Services 24

A. Bundled Retail Sales 

26

B. Local Distribution Facilities 31

IV. Reciprocity 

35

A. Indirect Regulation of Non-Jurisdictional Utilities 36

B. Limitation on Reciprocity 37

V. Stranded Cost Recovery Provisions 39

A. Wholesale Stranded Costs 40

1. FERC's Authority to Provide for

Stranded Cost Recovery 44

a. Reasonable expectation of continued service 

44

__________

1 Following our normal practice in complex cases, we shared the

writing of this opinion. Judge Sentelle wrote Section II, Section

III, and Section VII. Judge Randolph wrote Section IV, Section

VI, and Section VIII. Judge Tatel wrote Section I, Section V, and

Section IX.

b. Sections 206 and 212 of the FPA 46

c. Implications of Cajun 

48

2. Natural Gas Precedent and Conformance to Cost Causation Principles 

49

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a. Natural gas precedent: AGD, K

N Energy, and UDC 50

b. Conformance to cost causation

principles 54

3. FERC's Mobile-Sierra Findings 57

a. FERC's authority to make a generic public interest finding 59

b. FERC's stranded cost public interest finding 61

c. FERC's public interest finding

regarding customers 62

4. Availability of Stranded Cost Recovery to Nonjurisdictional Utilities

and G & T Cooperatives 63

5. Challenges to Technical Aspects of

Order 888's Stranded Cost Recovery Provisions 65

a. POSCR's challenges to the

stranded cost formula 66

b. Inclusion of known and measurable costs 68

c. Treatment of energy costs in the

market option 68

d. Rescission of notice of termination provision 70

e. Provision for benefits lost 71

B. Retail Stranded Costs 72

1. Stranded Costs Arising from Retail

Wheeling 72

a. FERC's jurisdiction over

retail stranded costs 

73

b. FERC's refusal to assert jurisdiction over all retail stranded

costs 

76

2. Stranded Costs Relating to RetailTurned-Wholesale Customers 80

VI. Credits for Customer-Owned Facilities and

Behind-The-Meter Generation 85

.

VII. Liability, Interface Allocation, and Discounting 

90

A. Liability and Indemnification 

90

B. Interface Allocation 94

C. Delivery-Point-Specific Discounting 96

VIII. Tariff Terms and Conditions 

100

A. Headroom Allocation 100

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B. Headroom Prioritization 101

C. Duplicative Charges 

102

D. Multiple Control Areas 

103

E. Right-of-First-Refusal 

104

IX. National Environmental Policy Act and Regulatory Flexibility Act Compliance 105

A. NEPA Compliance 105

1. Adequacy of Base Case 

105

2. Failure to Adopt Mitigation Measures 

107

B. Regulatory Flexibility Act Compliance 

108

----------

Following two notices of proposed rulemaking, the Federal

Energy Regulatory Commission issued Orders 888 and 889 on

April 24, 1996.2 Reflecting the Commission's effort to end

__________

2 Promoting Wholesale Competition Through Open Access Nondiscriminatory Transmission Services by Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Order No. 888, FERC Stats. & Regs. p 31,036, 61 Fed. Reg.

21,540 (1996), clarified, 76 FERC p 61,009 and 76 FERC p 61,347

(1996) ("Order 888"), on reh'g, Order No. 888-A, FERC Stats. and

Regs. p 31,048, 62 Fed. Reg. 12,274, clarified, 79 FERC p 61,182

(1997), on reh'g, Order No. 888-B, 81 FERC p 61,248, 62 Fed. Reg.

64,688 (1997), on reh'g, Order No. 888-C, 82 FERC p 61,046 (1998);

discriminatory and anticompetitive practices in the national

electricity market and to ensure that electricity customers

pay the lowest prices possible, these orders represent, as the

Commission described in a later order not before us, "the

foundation necessary to develop competitive bulk power markets...." Regional Transmission Organizations, Order No.

2000, 65 Fed. Reg. 810, 812 (2000).

Open access is the essence of Orders 888 and 889. Under

these orders, utilities must now provide access to their transmission lines to anyone purchasing or selling electricity in the

interstate market on the same terms and conditions as they

use their own lines. By requiring utilities to transmit competitors' electricity, open access transmission is expected to

increase competition from alternative power suppliers, giving

consumers the benefit of a competitive market. Most fundamentally, FERC's open access policies, combined with parallel action now occurring on the state level, are intended to

create a market in which customers may purchase power

from any of a number of suppliers. A municipality or factory

in Florida, for example, will no longer have to purchase power

from its local utility but instead may seek cheaper power

anywhere in the country. A customer in Vermont may

purchase electricity from an environmentally friendly power

producer in California or a cogeneration facility in Oklahoma.

All key players in the electricity market have challenged

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various provisions of Orders 888 and 889. Their claims range

from the hypertechnical to arguments that FERC lacks authority to order open access transmission at all. Finding few

defects in the orders, we uphold them in nearly all respects.

I. Introduction

Historically, vertically integrated utilities owned generation, transmission, and distribution facilities. They sold gen-

__________

Open Access Same-Time Information System and Standards of

Conduct, Order No. 889, FERC Stats. & Regs. p 31,035, 61 Fed.

Reg. 21,737 (1996) ("Order 889"), on reh'g, Order No. 889-A, FERC

Stats. & Regs. p 31,049, 62 Fed. Reg. 12,484 (1997), on reh'g, Order

No. 889-B, 81 FERC p 61,253 (1997).

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eration, transmission, and distribution services as part of a

"bundled" package. Due to technological limitations on the

distance over which electricity could be transmitted, each

utility served only customers in a limited geographic area.

And because of their natural monopoly characteristics, utilities have been heavily regulated at both the federal and state

levels.

Since enactment of the Federal Power Act in 1935, the

electricity industry has undergone significant change, both

economically and technologically. Economies of scale have

justified the construction of large (greater than 500 MW)

generation facilities, such as nuclear power plants. Technological advances in the 1970s and 1980s have permitted small

plants to operate efficiently as well. See Notice of Proposed

Rulemaking, Promoting Wholesale Competition Through

Open Access Non-discriminatory Transmission Services by

Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, FERC Stats. & Regs.

p 32,514 at 33,059-60, 60 Fed. Reg. 17,662 (1995) ("Open

Access NOPR"). Technological improvements also made

feasible the transmission of electric power over long distances

at high voltages. See id. p 32,514 at 33,060. Alternative

power suppliers, such as cogenerators, small power producers, and independent power producers emerged in response

to these developments. Constructing and operating generation capacity at prices lower than the embedded generation

costs of traditional utilities, these alternative suppliers have

created a wholesale market for low-cost power.

The growth of this new wholesale market faced a serious

obstacle. "As entry into wholesale power generation markets

increased," FERC explained, "the ability of customers to gain

access to the transmission services necessary to reach competing suppliers became increasingly important." Id. at

33,062. Yet the owners of transmission lines, the traditional

utilities that had built the high-cost generation capacity,

denied alternative producers access to their transmission

lines on competitive terms and conditions. FERC therefore

began requiring utilities to file open access transmission

tariffs that permitted other suppliers to transmit power over

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their lines under certain circumstances, such as when a utility

sought authorization to merge with another utility or to sell

power at market-based rather than cost-based rates.

Then, in 1992, Congress enacted the Energy Policy Act,

which amended sections 211 and 212 of the FPA to authorize

FERC to order utilities to "wheel" power--i.e., transmit

power for wholesale sellers of power over the utilities' transmission lines--on a case-by-case basis. Pub. L. No. 102-486,

106 Stat. 2776, 2915-16 (1992) (codified at 16 U.S.C. ss 824jk). FERC "aggressively implemented" amended sections 211

and 212 to " 'facilitate the development of competitively

priced generation supply options, and to ensure that wholesale purchasers of electric energy can reach alternative power

suppliers and vice versa.' " Open Access NOPR, p 32,514 at

33,064 (quoting Notice of Proposed Rulemaking, Recovery of

Stranded Costs by Public Utilities and Transmitting Utilities, FERC Stats. & Regs. p 32,507 at 32,866, 59 Fed. Reg.

35,274 (1994) ("Stranded Cost NOPR")).

Despite these efforts, a persistent barrier to the development of a competitive wholesale power sale market remained.

The Commission found that "utilities owning or controlling

transmission facilities possess substantial market power;

that, as profit maximizing firms, they have and will continue

to exercise that market power in order to maintain and

increase market share, and will thus deny their wholesale

customers access to competitively priced electric generation;

and that these unduly discriminatory practices will deny

consumers the substantial benefits of lower electricity prices."

Open Access NOPR, p 32,514 at 33,052. Power generators

not permitted to use utilities' transmission lines on reasonable

terms have no way to transmit their power to customers.

Invoking its authority under sections 205 and 206 of the

FPA to remedy unduly discriminatory or preferential rules,

regulations, practices, or contracts affecting public utility

rates for transmission in interstate commerce, 16 U.S.C.

ss 824d-e, and building on its experience in restructuring the

natural gas industry, see Associated Gas Distribs. v. FERC,

824 F.2d 981 (D.C. Cir. 1987), the Commission issued Orders

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888 and 889 to "prevent this discrimination by requiring all

public utilities owning and/or controlling transmission facilities to offer non-discriminatory open access transmission

service." Open Access NOPR, p 32,514 at 33,052. Orders

888 and 889 mandate what FERC terms "functional unbundling," i.e., separating utilities' wholesale transmission functions from their wholesale electricity merchant functions.

Specifically, the orders require utilities to (1) file open access

nondiscriminatory tariffs that contain the minimum terms and

conditions of nondiscriminatory services prescribed by FERC

through its pro forma tariff; (2) take transmission service for

their own new wholesale sales and purchases of electric

energy under the same terms and conditions as they offer

that service to others; (3) develop and maintain a same-time

information system that will give potential and existing transmission users the same access to transmission information

that the utility enjoys (called the "Open Access Same-Time

Information System" or "OASIS"); and (4) state separate

rates for wholesale generation, transmission, and ancillary

services. See Order 888, p 31,036 at 31,635-36.

In requiring utilities to provide open access transmission,

FERC acknowledged the dramatic change the orders would

bring about, explaining that "[t]he most critical transition

issue that arises as a result of the Commission's actions in

this rulemaking is how to deal with the uneconomic sunk

costs that utilities prudently incurred under an industry

regime that rested on a regulatory framework and a set of

expectations that are being fundamentally altered." Order

888-A, p 31,048 at 30,346. Known as "stranded costs," these

"uneconomic sunk costs" are costs that utilities incurred not

only with regulatory approval, but with the expectation of

continuing to serve their current customers. These costs will

become "stranded" when customers take advantage of open

access transmission to purchase cheaper power from suppliers other than their historic utilities. Order 888 affords

utilities an opportunity to recover stranded costs from their

wholesale requirements customers, but only from those customers who use their utility's transmission service to purchase power from new suppliers, and only if the utility can

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prove that it had a reasonable expectation of continued service to that customer.

After three rehearing orders, the Commission denied any

further rehearing. All petitions for review of Orders 888 and

889 were consolidated and transferred to this circuit. We

consider these petitions in this opinion. Section II considers

challenges to FERC's authority to require utilities to file

open access tariffs as a remedy for undue discrimination.

Section III evaluates FERC's conclusion that it lacked jurisdiction to order retail unbundling yet has jurisdiction over

transmission where state commissions have unbundled retail

sales. Section IV addresses FERC's authority to require

nonpublic utilities to provide reciprocal open access transmission service. Section V considers challenges to Order 888's

stranded cost recovery provisions. Section VI evaluates petitioners' arguments relating to credits for customer-owned

facilities and behind-the-meter generation. Section VII addresses discounting, interface allocation, and liability. Section VIII evaluates other arguments relating to the terms and

conditions of the pro forma tariff. Section IX assesses

FERC's compliance with the National Environmental Policy

Act and the Regulatory Flexibility Act.

In the end, we affirm the orders in all respects except two:

we remand for FERC to explain its treatment of energy costs

in the stranded cost market option (Section V.A.5.c) and to

provide a reasonable cap on contract extensions under existing customers' right-of-first-refusal (Section VIII.E).

II. FERC's Authority to Require Open Access

Although FERC asserts that "mounting claims of undue

discrimination in transmission access" prompted its movement toward open access, the open access requirement of

Order 888 is premised not on individualized findings of discrimination by specific transmission providers, but on

FERC's identification of a fundamental systemic problem in

the industry. Generally, those entities that own or control

interstate transmission facilities are vertically-integrated public utilities that also generate and sell electricity. In its 1995

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notice of proposed rulemaking, FERC observed that there

were at that time approximately 328 public utilities, marketers, and wholesale generation entities with transmission

needs, and that approximately 137 of those owned or controlled the transmission facilities. See Open Access NOPR,

p 32,514 at 33,051. Entry into the transmission market is

difficult and restricted, so those utilities that already own

transmission facilities enjoy a natural monopoly over that

field. The transmission-owning utilities can use their position

to favor their own generated electricity and to exclude competitors from the market, whether by denying transmission

access outright, or by providing transmission services to

competitors only at comparatively unfavorable rates, terms,

and conditions. Utilities that own or control transmission

facilities naturally wish to maximize profit. The transmission-owning utilities thus can be expected to act in their own

interest to maintain their monopoly and to use that position to

retain or expand the market share for their own generated

electricity, even if they do so at the expense of lower-cost

generation companies and consumers.

Even before Order 888, some transmission-owning utilities

voluntarily opened their transmission facilities to third party

suppliers and purchasers of electricity; and FPA s 211 explicitly gives FERC the authority to order involuntary wheeling on a case-by-case basis. The Commission decided, however, that relying upon voluntary arrangements and s 211

orders would not remedy the fundamentally anti-competitive

structure of the transmission industry. Instead, the Commission concluded, such a piecemeal approach would result in an

inefficient "patchwork" of transmission systems nationwide.

"The ultimate loser in such a regime is the consumer." Open

Access NOPR, p 32,514 at 33,071.

As an alternative, the Commission interpreted the antidiscrimination language of FPA ss 205 and 206, 16 U.S.C.

ss 824d, 824e (1994), as giving it the authority to impose open

access as a generic remedy for its findings of systemic anticompetitive behavior. Invoking that broad authority, in Order 888, FERC requires every transmission-owning public

utility within FERC's jurisdiction to file an Open Access

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Transmission Tariff (OATT) containing minimum terms and

conditions for non-discriminatory service and to take transmission service for their own wholesale sales and purchases of

electric energy under those filed OATTs. In other words,

this order requires the public utilities to provide the same

transmission services to anyone purchasing or selling wholesale power--other public utilities, federal power suppliers and

marketers, municipalities, cooperatives, independent power

producers, qualifying facilities, or power marketers--as they

provide to themselves. The Board of Water, Light and

Sinking Fund Commissioners of the City of Dalton (Dalton)

operates a municipally-owned utility system which provides

electric power to residential, commercial, and industrial consumers in the city of Dalton, Georgia. Dalton obtains transmission services from the Georgia Integrated Transmission

System (ITS), which it owns along with public utility Georgia

Power Company (GPC) and two other utilities that are not

subject to FERC's jurisdiction, and which GPC operates

according to the terms of various filed agreements. Puget

Sound Energy, Inc. (Puget) is a public utility in the Pacific

Northwest, where Bonneville Power Administration, which is

not a public utility subject to Order 888's requirements,3

__________

3 Bonneville Power Administration (BPA) "is a power marketing

agency in the Pacific Northwest that markets power from thirty

federal hydroelectric projects constructed and operated by the

Corps of Engineers and the Bureau of Reclamation." In re Bonneville Power Administration, Power Sale and Transmission Rates,

54 F.E.R.C. p 62,143 (1991). In Order 888, FERC concluded that

BPA is not a public utility as defined by Federal Power Act (FPA)

s 201(e), and thus is not subject to Order 888's requirements.

Order 888, p 31,036 at 31,858. FERC admitted, however, to three

circumstances under which it might review BPA's transmission

access and pricing policies: (1) if BPA files an open access tariff for

review and confirmation under the Northwest Power Act and asks

FERC to find that the tariff meets FERC's open access policies;

(2) to the extent that BPA "is a transmitting utility subject to a

request for mandatory transmission services" under FPA s 211;

and (3) to the extent that BPA receives open access transmission

from a public utility and is thereby subject to the reciprocity

provision in that public utility's pro-forma tariff. Id.

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dominates the electricity transmission market. These two

industry petitioners challenge the open access requirement of

Order 888 on various statutory, constitutional, and other

grounds.

Turning first to the FPA itself, Puget and Dalton argue

that ss 205 and 206 do not give the Commission the authority

to order open access as a generic remedy; and even if the

FPA does give the agency such authority, FERC has failed to

satisfy the statutory requirements for invoking it. Dalton

also argues that Order 888 itself violates the FPA by discriminating against transmission facility owners who have invested in those assets. Shifting to constitutional concerns, Puget

and Dalton, along with amicus curiae Pacific Legal Foundation, maintain that Order 888 violates the Takings Clause of

the Fifth Amendment. Finally, Dalton argues that the open

access requirements of the OATT interfere with the antitrust

conditions of outstanding nuclear licenses, and thus are unlawful. While we consider each of these challenges separately,4 we hold that Order 888's open access requirement is

authorized by and consistent with the FPA and the Takings

Clause. We conclude also that Dalton has not yet suffered

injury from the alleged conflict between open access and the

nuclear license antitrust conditions, and that its complaint on

that issue is therefore not yet ripe for judicial review.

A. Statutory Challenges: FPA ss 205 and 206

Section 205 of the FPA broadly precludes public utilities, in

any transmission or sale subject to FERC's jurisdiction, from

"mak[ing] or grant[ing] any undue preference or advantage to

__________

4 The Commission and various intervenors on its behalf argue

extensively against our jurisdiction over these issues on the grounds

that the petitioners failed, in various ways, adequately to raise their

concerns before the agency and to preserve the issues for judicial

review. Upon careful review of the record, we can safely conclude

without further elaboration that these jurisdictional arguments are

without merit, that the Commission has had ample notice and

opportunity to address all of the petitioners' various statutory,

constitutional, and other challenges to Order 888's open access

requirement, and that we have jurisdiction to consider these issues.

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any person or subject[ing] any person to any undue prejudice

or disadvantage...." 16 U.S.C. s 824d(b). Section 206 of

the FPA further provides in relevant part that

[w]henever the Commission, after a hearing had upon its

own motion or upon complaint, shall find that any rate,

charge, or classification, demanded, observed, charged,

or collected by any public utility for any transmission or

sale subject to the jurisdiction of the Commission, or that

any rule, regulation, practice, or contract affecting such

rate, charge, or classification is unjust, unreasonable,

unduly discriminatory or preferential, the Commission

shall determine the just and reasonable rate, charge,

classification, rule, regulation, practice, or contract to be

thereafter observed and in force, and shall fix the same

by order.

16 U.S.C. s 824e(a). The statutory issues before us are

whether these provisions give FERC the authority to order

involuntary wheeling as a generic remedy, and if they do,

whether FERC satisfied the procedural and evidentiary requirements imposed by these provisions.

1. ss 205 and 206 and Otter Tail Power Company

The Commission did not write on a blank slate when it

interpreted FPA ss 205 and 206 as giving it the authority to

order involuntary wheeling as a generic remedy for systemic

anti-competitive behavior. Puget and Dalton argue principally that the Supreme Court's decision in Otter Tail Power Co.

v. United States, 410 U.S. 366 (1973), controls the disposition

of this issue. Otter Tail was an antitrust case in which the

Supreme Court addressed whether the district court could

require Otter Tail Power Company to wheel power for its

competitors as a remedy for monopolistic practices. Contrary to the company's arguments, the Supreme Court concluded that the district court's order did not impermissibly

conflict with the authority of the Federal Power Commission,

FERC's predecessor, because the agency did not have the

power itself to order involuntary wheeling under Part II of

the FPA, which includes ss 205 and 206. Puget and Dalton

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cite various circuit court precedents, including one from this

circuit, as construing Otter Tail to prevent the Commission

from ordering involuntary wheeling as a generic remedy.

See, e.g., Florida Power & Light Co. v. FERC, 660 F.2d 668

(5th Cir. Unit B Nov. 1981); New York State Electric & Gas

Corp. v. FERC, 638 F.2d 388 (2d Cir. 1980); Richmond

Power & Light v. FERC, 574 F.2d 610 (D.C. Cir. 1978).

Finally, Puget and Dalton note that subsequent to Otter Tail,

Congress enacted FPA s 211, 16 U.S.C. s 824j, giving FERC

the authority to impose open access on a case-by-case basis to

remedy a broad range of problems. The petitioners argue

that, if FPA ss 205 and 206 authorize the Commission to

impose open access, and if Otter Tail does not prohibit such

action, then there was no reason for Congress to enact s 211.

In response, the Commission contends that we should not

read Otter Tail as limiting its authority under FPA s 206 to

remedy discriminatory behavior, since Otter Tail was an

antitrust case and not an undue discrimination case. The

Commission also maintains that the circuit court cases cited

by the petitioners are not on point and do not prohibit a

generic open access remedy. The Commission points instead

to our decision in Associated Gas Distributors v. FERC, 824

F.2d 981, 998 (D.C. Cir. 1987) (AGD), in which we upheld a

similar open access transportation requirement imposed by

FERC on natural gas transmission, as the controlling precedent. Finally, FERC argues that Congress enacted FPA

s 211 to broaden its already existing authority to order

involuntary wheeling, as FPA ss 205 and 206 authorize such

action only as a remedy for undue discrimination.

We agree with FERC that our decision in AGD controls

the disposition of this issue. In AGD, we reviewed a FERC

order imposing open access conditions on pipelines transporting natural gas. See 824 F.2d at 997-1001. Considering

arguments quite similar to those made by the petitioners

here, we concluded that Otter Tail does not constrain FERC

from mandating open access where it finds circumstances of

undue discrimination to exist. See id. at 998-99. Turning to

relevant circuit precedent, we construed Richmond Power &

Light as supporting only the proposition that a refusal to

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provide transmission services to another utility was not per se

unduly discriminatory and we noted that the court in Florida

Power & Light expressly left open the question of whether

FERC could impose open access conditions as a remedy for

anti-competitive behavior. See id. at 999. Further, we pointed out that our reading of Richmond is consistent with other

precedent, specifically Central Iowa Power Coop. v. FERC,

606 F.2d 1156 (D.C. Cir. 1979), in which we upheld FERC's

use of its authority to prevent undue discrimination to condition its approval of a power-pooling agreement upon removal

of membership criteria which denied certain privileges to

some but not all participants. See AGD, 824 F.2d at 999.

Indeed, in AGD, we noted that open access relies upon the

very same principles that we upheld in Central Iowa. See id.

Although AGD addressed open access under the antidiscrimination provisions of the Natural Gas Act (NGA) rather than FPA ss 205 and 206, we have repeatedly recognized

the similarity of the two statutes and held that they should be

interpreted consistently. See Environmental Action v.

FERC, 996 F.2d 401, 410 (D.C. Cir. 1993); Tennessee Gas

Pipeline Co. v. FERC, 860 F.2d 446, 454 (D.C. Cir. 1988); see

also Arkansas La. Gas Co. v. Hall, 453 U.S. 571, 577 n.7

(1981). Thus, AGD counsels the conclusion that, while Otter

Tail may represent a general rule that FERC's authority to

order open access is limited, the FPA, like the NGA, makes

an exception to that rule where FERC finds undue discrimination.

Moreover, as in AGD, the deferential standard of Chevron

U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S.

837 (1984), governs our review of FERC's interpretation of

FPA ss 205 and 206. See AGD, 824 F.2d at 1001. If we

agreed with Puget and Dalton that the Supreme Court's Otter

Tail opinion dictates a particular construction of ss 205 and

206, then the Commission's contrary interpretation would not

be entitled to Chevron deference. See Maislin Indus., U.S.,

Inc. v. Primary Steel, Inc., 497 U.S. 116, 131 (1990) ("Once

we have determined a statute's clear meaning, we adhere to

that determination under the doctrine of stare decisis, and we

judge an agency's later interpretation of the statute against

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our prior determination of the statute's meaning."). But

having concluded that Otter Tail does not govern the disposition of this case, we are faced solely with considering the

validity of FERC's interpretation of the FPA, a statute that

the Commission administers. In AGD, we concluded that

FERC reasonably interpreted the NGA's ambiguous antidiscrimination provisions as giving it broad authority to remedy unduly discriminatory behavior through a generic open

access requirement. See AGD, 824 F.2d at 1001. Given the

FPA's similar language, we can only reach the same conclusion with respect to Order 888. For all of these reasons, we

find that the Commission has the authority under FPA

ss 205 and 206 to require open access as a generic remedy to

prevent undue discrimination.

2. s 206(a) Procedural and Evidentiary Requirements

Puget and Dalton next argue that, even if FPA ss 205 and

206 authorize FERC to impose open access generically,

s 206(a) imposes certain procedural and evidentiary requirements for action which the Commission failed in two separate

but related ways to satisfy. First, the petitioners claim that

FPA s 206(a) requires substantial evidence of contemporaneous "unjust, unreasonable, unduly discriminatory or preferential" behavior before the Commission can act. The Commission made no finding of discrimination or monopoly control on

the part of Georgia Power Company or Puget. None of the

applications or complaints filed with the Commission accused

these petitioners of unduly discriminatory or anti-competitive

behavior. Instead, the Commission premised Order 888 on a

generic finding that public utility holders as a group have

sufficient monopoly power over the transmission of electricity

to engage in unduly discriminatory and anti-competitive practices, and that this condition will worsen in the future. To

support its finding, the Commission relied upon unsubstantiated allegations of discriminatory conduct in public comments, its own experience in reviewing applications and complaints, and its own understanding of the incentives for

monopolists to behave discriminatorily.

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Puget and Dalton additionally assert that FPA s 206(a)

requires that the requisite findings of undue discrimination be

made in the context of a hearing. Although they concede

that a rulemaking proceeding can satisfy the statute's hearing

requirement, Puget and Dalton maintain that the rulemaking

proceeding nevertheless must clearly identify the challenged

activities and actors, and give the accused actors the opportunity to demonstrate that their activities were not unlawful.

The petitioners protest that the Commission's notice-andcomment rulemaking process did not afford them such opportunity.

FERC claims the discretion under NLRB v. Bell Aerospace

Co., 416 U.S. 267, 293 (1974), to choose between rulemaking

and case-by-case adjudication; and FERC contends that its

generic rulemaking process fully satisfied the requirements of

FPA s 206(a). FERC concedes that it relied upon general

findings of systemic monopoly conditions and the resulting

potential for anti-competitive behavior, rather than evidence

of monopoly and undue discrimination on the part of individual utilities. Citing our opinion in Wisconsin Gas Co. v.

FERC, 770 F.2d 1144, 1166 (D.C. Cir. 1985), however, FERC

maintains that such findings are sufficient to substantiate its

decision to impose the open access requirement. Finally,

FERC observes that we rejected these same arguments in

AGD. See 824 F.2d at 1008 (citing Wisconsin Gas, 770 F.2d

at 1165-68).

Again, we must agree with the Commission. In American

Public Gas Ass'n v. FPC, we held that the Commission could

exercise its authority under NGA s 5(a), the provision parallel to FPA s 206, through rulemaking as well as adjudication.

See 567 F.2d 1016, 1064-67 (D.C. Cir. 1977); see also Wisconsin Gas, 770 F.2d at 1153 (articulating the American Public

Gas holding). Congress subsequently ratified the American

Public Gas holding when it enacted the Department of Energy Organization Act, 42 U.S.C. s 7173(c) (1994). See Wisconsin Gas, 770 F.2d at 1153 n.8 (acknowledging the Act). That

statute provides that "the establishment of rates and charges

under the Federal Power Act [16 U.S.C. 791a et seq.] or the

Natural Gas Act [15 U.S.C. 717 et seq.], may be conducted by

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rulemaking procedures." 42 U.S.C. s 7173(c) (brackets in

original). By passing a statute adopting the holding of

American Public Gas, and explicitly applying that rule to the

FPA as well as the NGA, Congress signaled its intent that

the hearing requirements of NGA s 5(a) and FPA s 206(a)

be interpreted similarly.

Interpreting the hearing requirement of NGA s 5(a), we

have said that, while the Commission cannot rely solely on

"unsupported or abstract allegations," the agency is also not

required to make "specific findings," so long as the agency's

factual determinations are reasonable. See Wisconsin Gas,

770 F.2d at 1158. In AGD, we applied Wisconsin Gas in

holding that the Commission was not required to make

specific findings that individual rates charged by individual

pipelines were unlawful, or to offer empirical proof for all the

propositions upon which its order depended, before promulgating a generic rule to eliminate undue discrimination. See

AGD, 824 F.2d at 1008-09. Upon comparison of the order

considered in AGD with Order 888, if anything, FERC more

thoroughly documented the reasons for its actions in Order

888 than in the earlier natural gas order.

Puget claims that AGD and Wisconsin Gas are distinguishable, and that this case is governed by Electricity Consumers

Resource Council v. FERC, 747 F.2d 1511 (D.C. Cir. 1984), in

which we reversed FERC's adoption of a rate based on an

economic theory in the absence of a discussion of the practical

applications of that theory. See 747 F.2d at 1514. As the

AGD court recognized, however, the court in Electricity

Consumers was persuaded that the Commission had distorted

the economic theory it claimed to apply. See AGD, 824 F.2d

at 1008. Just as the pipelines in AGD did, Puget has failed to

articulate exactly how FERC has distorted the theories on

which it relies in Order 888. Additionally, the AGD court

rejected the idea that "Electricity Consumer's reference to

'economic theory' was intended to invalidate agency reliance

on generic factual predictions merely because they are typically studied in the field called economics." Id. Following

the rationale of Wisconsin Gas and AGD, we conclude that

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FERC has satisfied the requirements for invoking its authority under FPA s 206(a).

3. Discriminatory Effect of Order 888

Dalton charges that, even if the FPA permits FERC to

impose involuntary wheeling generally, the open access requirement of Order 888 causes rather than remedies discrimination, and therefore violates FPA s 206(a)'s express requirement that FERC act against undue discrimination.

Specifically, Dalton and the other non-jurisdictional owners of

the Georgia ITS facilities invested millions of dollars in those

facilities in order to use the facilities each owns and receive

reciprocal open access transmission services from the other

owners. Under the Open Access Transmission Tariff

(OATT), other customers do not have to make such investments to use the Georgia ITS facilities. FERC responds

that Order 888 does not unduly discriminate between old and

new customers of integrated transmission systems like the

Georgia ITS; and that if Dalton has evidence that the tariff

results in undue discrimination in its individual circumstances, Dalton remains free to file a petition under FPA

s 206 for redress, and FERC will consider its claim.

FERC's conclusion that its open access requirement is not

unduly discriminatory is subject only to arbitrary and capricious review. See 5 U.S.C. s 706(2)(A) (1994); Sithe/

Independence Power Partners, LP v. FERC, 165 F.3d 944,

948 (D.C. Cir. 1999); Union Pacific Fuels, Inc. v. FERC, 129

F.3d 157, 161 (D.C. Cir. 1997). We conclude that FERC has

adequately explained why its open access requirement is not

unduly discriminatory. Relying upon extensive commentary

as well as its own experiences, FERC concluded that, as a

general matter, transmission industry conditions were conducive to discriminatory practices and anti-competitive behavior,

such that case-by-case adjudication could not adequately address the problem. FERC also recognized that its generic

findings may have exceptions, and thus that Order 888 may in

individual circumstances have a different result than that

intended. Therefore, Order 888 does not preclude facilities

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stances in their OATT filings or, as with Dalton, in their own

petitions for relief under FPA s 206(a). Rather, Order 888

merely shifts from a regulatory norm in which a user of

transmission services must demonstrate to FERC an individualized need for open access to one in which a provider of

transmission services must present to FERC individualized

circumstances requiring relief from open access. As the

petitioners have a mechanism by which they can seek relief

for their particular concerns, we find nothing arbitrary or

capricious about FERC's conclusion that its approach to open

access is not unduly discriminatory.

In another stab at demonstrating the discriminatory effect

of Order 888's open access requirement, Dalton alerts us to

an agreement entered into between it and Georgia Power

Company (GPC) in partial implementation of antitrust conditions contained in operating licenses issued by the Nuclear

Regulatory Commission for jointly owned nuclear facilities

connected to the Georgia ITS. Those antitrust conditions

require GPC to provide Dalton with transmission services

until the nuclear licenses expire, long after the ITS Agreement terminates. Dalton alleges that limitations imposed by

Order 888 on Dalton's rights upon termination of the ITS

Agreement are inconsistent with GPC's obligations under the

nuclear licenses, and that the interference will result in

discrimination against Dalton. FERC maintains that it

agreed in addressing GPC's Order 888 compliance filing to

treat the ITS Agreements separately.

Ultimately, Dalton has offered no present injury from the

alleged conflict, so this issue is not ripe for review. Dalton

will only be injured if, upon termination of the ITS Agreement, Order 888 interferes with Dalton's right to transmission services. Dalton's own argument suggests as much,

observing that FERC "left to GPC the decision whether it

'must, but cannot, comply with separate orders' of NRC and

FERC and whether it will present evidence of such conflict to

either Commission," and complaining that even if GPC does

act, "the orders under review provide no assurance that the

competitive transmission and other service rights provided by

the nuclear licenses will be respected under the OATT." Br.

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of Petitioner Dalton at 23 (quoting Order 888-A, p 31,048 at

30,452). In short, GPC and FERC are still in the process of

determining whether the antitrust provisions even conflict

with Order 888, as well as how to deal with any such

inconsistency.5 Accordingly, this issue is not appropriate for

judicial review at this time.

B. Constitutional Challenge: Fifth Amendment Takings

Clause

Puget and amicus curiae Pacific Legal Foundation (Pacific)

contend that Order 888 violates the Takings Clause of the

Fifth Amendment. These petitioners maintain that Order

888's open access requirement engineers a "taking" in two

ways: First, that FERC's open access requirement effects a

regulatory taking by arbitrarily changing pricing methodology in a way that excessively deprives transmission owners of

their investments in facilities; and, second, that the open

access requirement allows a physical invasion, a permanent

physical occupation, by taking away the transmission owners'

right to exclude competitors from their transmission property. We cannot grant relief on either ground.

When the action of the federal government effects a "taking" for Fifth Amendment purposes, there is no inherent

constitutional defect, provided just compensation is available.

At bottom, both of the petitioners' Fifth Amendment claims

turn not on whether open access effects a taking, but whether

FERC's cost-based transmission pricing policies in the end

provide just compensation. The remedy of just compensation

is not within our jurisdiction but that of the United States

Court of Federal Claims, under the Tucker Act, 28 U.S.C.

s 1491. See Bell Atlantic Tel. Cos. v. Federal Communications Comm'n, 24 F.3d 1441, 1444 n.1 (D.C. Cir. 1994);

Railway Labor Executives' Ass'n v. United States, 987 F.2d

806, 815-16 (D.C. Cir. 1993).

We recognize that our jurisdiction to review an agency's

construction of a statute necessarily involves an exercise of

__________

5 GPC's management of the Georgia ITS is subject to the direction of a committee that includes Dalton representatives.

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the policy of avoiding constitutional issues where possible,

even though the issues may concern arguable takings amenable to Tucker Act remedy, "when 'there is an identifiable

class of cases in which application of a statute will necessarily

constitute a taking.' " Bell Atlantic, 24 F.3d at 1445 (D.C.

Cir. 1994) (quoting United States v. Riverside Bayview

Homes, Inc., 474 U.S. 121, 128 n.5 (1985)). We need not

decide whether this case falls within that category, however,

because even if it did, any takings problem created by Order

888 does not raise such significant constitutional doubt as to

require us to construe the FPA to prohibit FERC from

ordering open access. If there is a taking, and a claim for

just compensation, then that is a Tucker Act matter to be

pursued in the Court of Federal Claims, and not before us.

III. Federal versus State Jurisdiction

over Transmission Services

Vertically integrated utilities use their own facilities to

generate, transmit, and distribute electricity to their customers. Traditionally, the customer paid one combined rate for

both the power and its delivery, thus the industry refers to

such sales as "bundled." To the extent that bundled sales are

made directly to the end user of the electricity, they are also

recognized as retail sales. Utilities may also sell the electricity they generate at wholesale to other utilities or other

resellers of power, which then resell that power to their own

customers. Thus, the same utility may use its facilities to

serve both retail and wholesale customers. Vertically integrated utilities use their transmission facilities to move electricity over long distances, and use local distribution lines to

deliver the electricity to the end user.

Even before Congress enacted the FPA, the Supreme

Court held that states could not regulate wholesale sales of

electricity. See Public Utils. Comm'n of R.I. v. Attleboro

Steam & Elec. Co., 273 U.S. 83 (1927). A few years later in

1935, Congress included in the FPA a provision giving the

Federal Power Commission, FERC's predecessor agency, the

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sale," as well as "the transmission of electric energy in

interstate commerce." FPA s 201(a), 16 U.S.C. s 824(a)

(1994). Congress also limited federal regulation "to those matters which are not subject to regulation by the States," id.,

and reserved to the states "jurisdiction ... over facilities

used for the generation of electric energy or over facilities

used in local distribution or only for the transmission of

electric energy in intrastate commerce...." FPA s 201(b),

16 U.S.C. s 824(b). Pursuant to these provisions, FERC has

regulated wholesale power sales and interstate transmissions,

and state agencies have retained jurisdiction over bundled

retail transactions, including service issues and the intrastate

sale and distribution of electricity through local distribution

facilities.

Initially, as most transactions involved either a wholesale or

a retail sale, and correspondingly transmission or local distribution facilities, this regulatory division of labor was straightforward in application. Indeed, in 1935, when Congress

enacted the FPA, the networks of high-voltage, long-distance

transmission lines which today crisscross the United States

did not exist. Instead, vertically integrated utilities individually built facilities sufficient to meet the power needs of their

customers. Over time, however, the landscape of the electric

industry changed.

Utilities decided to cover demand spikes by sharing power,

rather than by building more generation capacity. The transmission grid developed from these arrangements. Eventually, nonutility generators started producing electricity; and

power marketers began to buy and resell electricity to other

power marketers, utilities, or even directly to consumers.

These industry participants do not own transmission lines, so

they rely upon the utilities that own such facilities to provide

transmission services. In addition to their traditional bundled sales activity, vertically integrated utilities started "unbundling" their own services and developing their own power

marketing units to buy and sell electricity at wholesale.

Some states even mandate unbundling of retail services. As

a result of these changes, facilities once used solely for local

distribution of bundled retail sales now engage regularly in

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unbundled wholesale transmissions and retail delivery as well.

Thus, while the electricity world once neatly divided into

spheres of retail versus wholesale sales, and local distribution

versus transmission facilities, such is no longer the case.

In Order 888, FERC reinterpreted FPA s 201 to accommodate the new industry practices and conditions. FERC

left the regulation of bundled retail transmissions to the

states, concluding that "when transmission is sold at retail as

part and parcel of the delivered product called electric energy, the transaction is a sale of electric energy at retail."

Order 888, p 31,036 at 31,781. Nevertheless, FERC asserted

jurisdiction over all unbundled retail transmissions, and left

to the states only the sales portion of unbundled retail

transactions, on the ground that FPA s 201 gives it jurisdiction without qualification over all transmission by public

utilities in interstate commerce. See id. Also, while acknowledging that FPA s 201(b) explicitly places retail transmissions by "facilities used in local distribution" beyond the

Commission's jurisdiction, FERC adopted a seven factor jurisdictional test for determining which facilities fall within that

category, and claimed exclusive authority over those that do

not. See id. at 31,780, 31,784. In the present litigation, each

of these changes is challenged, with some petitioners claiming

that FERC went too far, and others contending that the

Commission did not go far enough in asserting jurisdiction.

A. Bundled Retail Sales

Several state regulatory commissions complain that FERC

exceeded the boundaries of its statutory authority by asserting jurisdiction over unbundled retail transmissions. These

state petitioners argue that the plain meaning and history of

FPA s 201(a) gives FERC the authority to regulate only

transmissions of electricity consumed in a state other than

that in which the electricity was generated, if the transmission was not otherwise subject to state regulation. The

states historically have regulated retail transmissions as part

of bundled retail sales of electricity, while FERC has regulated wholesale transmissions; and the division of regulatory

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tions have now been unbundled into separate generation,

transmission, and sales components.

Two groups of transmission dependent utilities, TAPS and

TDU Systems, and the nation's largest power wholesaler,

Enron Power Marketing (collectively the "unbundling and

discounting" or "U&D" petitioners), both intervene on the

side of FERC with respect to the states' claim, and separately challenge FERC's interpretation of its jurisdiction on

different grounds. The U&D petitioners contend that FERC

impermissibly limited its jurisdiction by leaving the regulation

of bundled retail transmissions to the states. These parties

maintain that FERC has the authority to regulate both

bundled and unbundled retail transmissions, and that FERC

violates FPA s 206 by limiting the scope of Order 888 to the

latter. To establish that bulk transmission by utilities is

transmission in interstate commerce regardless of whether

the power is sold at wholesale or retail, the U&D petitioners

cite particularly FPC v. Florida Power & Light Co., 404 U.S.

453 (1972), and Jersey Central Power & Light Co. v. FPC, 319

U.S. 61 (1943), two of the cases relied upon by FERC in the

Notice of Proposed Rulemaking, p 32,514 at 33,135-42. As

further support that FERC's jurisdiction extends to all interstate transmissions, the U&D petitioners offer NGA precedent recognizing FERC's authority over all interstate gas

transportation, if not the gas being transported. See, e.g.,

FPC v. Louisiana Power & Light Co., 406 U.S. 621, 636

(1972); United Distribution Cos. v. FERC, 88 F.3d 1105, 1153

(D.C. Cir. 1996) (UDC); Mississippi River Transmission

Corp. v. FERC, 969 F.2d 1215 (D.C. Cir. 1992). These

petitioners contend that excluding bundled retail transmissions from the OATT will permit discrimination and give

owners a competitive advantage, contrary to the mandate of

FPA s 206(a) that FERC eliminate undue discrimination.

Accordingly, the U&D petitioners claim that FERC erred

when it declined to mandate functional unbundling for an

owner's transmissions to bundled retail customers of (1) its

own generated power or (2) power purchased at wholesale.

In response to these challenges, FERC maintains that the

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tion over all interstate transmissions without qualification,

while at the same time limiting jurisdiction over sales to

wholesale sales. Relying particularly on Florida Power &

Light and Jersey Central Power & Light, FERC asserts

broad jurisdiction over all transmission activities in interstate

commerce. As for bundled retail sales, FERC's position is

that once the transmission service is bundled with generation

and local distribution, it becomes merely a component of the

retail sale itself, over which FERC has no jurisdiction.

FERC maintains that natural gas jurisprudence is inapplicable because the language of the NGA and FPA differ on this

issue, and the natural gas cases turned on the existence of a

regulatory gap that does not exist in the electricity field.

FERC also asserts that its interpretation of the FPA's jurisdictional grant is entitled to deference under Chevron U.S.A.

Inc. v. Natural Resources Defense Council, 467 U.S. 837

(1984).

Both FPA s 201(a) and (b) clearly and unambiguously

confer upon FERC jurisdiction over the "transmission of

electric energy in interstate commerce." FPA s 201(c) further provides that "electric energy shall be held to be transmitted in interstate commerce if transmitted from a State and

consumed at any point outside thereof." 16 U.S.C. s 824(c).

In both Florida Power & Light and Jersey Central Power &

Light, the Supreme Court considered whether certain indirect

transmissions of electrical power across state lines represented transmissions in interstate commerce.

Jersey Central Power & Light involved the transmission of

energy generated by Jersey Central in New Jersey. Jersey

Central transmitted electricity to the New Jersey transmission facilities of another company, Public Service, which then

transmitted the power first to another of its New Jersey

facilities, and then on to a facility owned by yet a third

company and located in the middle of a body of water

separating New Jersey from Staten Island, New York. The

third company in the chain then transmitted the energy first

to its own facilities in New York, then finally and ultimately

to consumers in New York. Jersey Central's own transmission facilities were located solely in New Jersey, as were

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the facilities used by Public Service to receive the transmissions from Jersey Central.

The Supreme Court recognized that Jersey Central had no

control over the transmissions' destination once the electricity

was delivered to Public Service, see Jersey Central, 319 U.S.

at 65, and that the total flow of electricity from Jersey

Central to New York was small. See id. at 66. Nevertheless,

because some electricity generated by Jersey Central in New

Jersey was consumed in New York, the Court upheld

FERC's jurisdiction under FPA s 201 over Jersey Central's

transmission facilities as utilized for transmissions in interstate commerce. See id. at 67. The Court said that, under

FPA s 201(a) and (b), FERC's power extends over all facilities "which transmit energy actually moving in interstate

commerce." Id. at 72. The Court emphasized, however, that

"mere connection" of one utility's transmission facilities to

those of another transmitting in interstate commerce was

insufficient for jurisdiction under FPA s 201. Id.

The Court revisited the issue in Florida Power & Light,

which involved certain Florida and Georgia utilities who

voluntarily connected their transmission facilities to coordinate their activities and exchange power as required to meet

temporary needs. Like Jersey Central, FP&L's transmission

facilities were confined to Florida, and none of FP&L's

transmission lines directly connected with those of out-ofstate companies. Nevertheless, because FP&L was a member of a group of interconnected utilities, its transmission

lines connected with those of other Florida utilities; and the

lines of one of those other utilities, Florida Power Corp.,

interconnected just short of Florida's northern border with

those of Georgia Power Co. Records indicated that power

transfers between FP&L and Florida Power coincided with

transfers between Florida Power and Georgia Power.

In Jersey Central, logs of the relevant companies demonstrated at least a dozen occasions when facilities in New York

drew power from certain lines at times when Jersey Central

was the only supplier of electricity to those lines. See

Florida Power & Light, 404 U.S. at 459. By way of contrast,

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there was no similar evidence that power generated by FP&L

specifically passed through Florida Power to Georgia Power,

with Florida Power serving as a mere conduit. See id. At

best, company records demonstrated instances when transfers between FP&L and Florida Power occurred at or about

the same time as transfers between Florida Power and

Georgia Power. See id. at 457.

Instead, the Court considered two theories by which

FP&L's power could be deemed transmitted across state

lines. The first posited a cause and effect relationship by

which every flick of a light switch would cause every generator on a multi-state interconnected system to produce some

quantity of additional electricity to maintain the system's

balance, and thus to transmit electric energy throughout the

system and across state lines. The second theory suggested

that where the transmission lines of two utilities interconnect,

their energy commingles, such that inevitably some energy

transmitted by FP&L to Florida Power was then transmitted

to Georgia Power and across state lines.

Despite its statement in Jersey Central that "mere connection determines nothing," 319 U.S. at 72, the Court relied on

the second of these theories to conclude that FP&L's facilities

were transmitting energy in interstate commerce, and left

open the possible validity of the cause and effect theory. See

404 U.S. at 462-63. Writing in dissent, Justice Douglas

characterized the Court's opinion as "mean[ing] that every

privately owned interconnected facility in the United States

... is within the [Federal Power Commission's] jurisdiction,"

such that otherwise local utilities would now be subject to the

mandates of the federal bureaucracy. Id. at 471 (Douglas, J.,

dissenting).

The Supreme Court has interpreted the language in FPA

s 201 regarding FERC's jurisdiction over transmissions in

interstate commerce. We are bound by the High Court's

dictates to conclude that the FPA gives FERC the authority

to regulate the transmissions at issue here, whether retail or

wholesale. Even if the Court had not so spoken, however,

and even if we independently concluded that the statute's text

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was less than clear, it is the law of this circuit that the

deferential standard of Chevron U.S.A. Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984), applies to an

agency's interpretation of its own statutory jurisdiction. See

Oklahoma Natural Gas Co. v. FERC, 28 F.3d 1281, 1283-84

(D.C. Cir. 1994). As guided by Chevron, unless Congress has

directly spoken to the contrary, or FERC has unreasonably

or impermissibly interpreted the statute, we must defer to

the Commission's construction of ambiguous provisions of the

FPA. See Chevron, 467 U.S. at 842-43. In this age of

interconnected transmission grids, and given the accompanying technological complexities, we would be hard pressed to

conclude that FERC's interpretation of s 201(c) as giving it

jurisdiction over both wholesale and retail transmissions is

unreasonable or impermissible.

Nevertheless, we are not persuaded that this conclusion

requires FERC to mandate unbundling and assert jurisdiction over all retail transmissions. Just as FPA s 201 gives

FERC jurisdiction over transmissions in interstate commerce

and sales at wholesale, the statute also clearly contemplates

state jurisdiction over local distribution facilities and retail

sales. The statute is much less clear about exactly where the

lines between those activities are to be drawn. A regulator

could reasonably construe transmissions bundled with generation and delivery services and sold to a consumer for a single

charge as either transmission services in interstate commerce

or as an integral component of a retail sale. Yet FERC has

jurisdiction over one, while the states have jurisdiction over

the other. FERC's decision to characterize bundled transmissions as part of retail sales subject to state jurisdiction

therefore represents a statutorily permissible policy choice to

which we must also defer under Chevron. Accordingly, we

affirm FERC's decisions in Order 888 to assert jurisdiction

over unbundled retail transmissions while leaving regulation

of bundled retail transmissions to the states.

B. Local Distribution Facilities

FPA s 201(b) explicitly excludes from FERC jurisdiction

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sion of electric energy in intrastate commerce." 16 U.S.C.

s 824(b)(1). Historically, wholesale sales have not for the

most part involved local distribution facilities. FERC claims

that increased unbundling gives resellers the opportunity to

reconfigure the wholesale sales so that they might now occur

on those facilities which traditionally have been treated as

local distribution facilities. Moreover, FERC's assertion of

jurisdiction over the transmission component of unbundled

retail sales blurred the line between local distribution facilities and facilities used for transmission in interstate commerce.

In Order 888, FERC claimed exclusive authority over the

regulation of facilities which sell and transmit electricity at

wholesale to customers who will resell the electricity to end

users. With respect to unbundled retail sales, FERC acknowledged that transmissions by "facilities used in local

distribution" are beyond the Commission's jurisdiction, while

facilities engaged in interstate transmission are subject to

FERC jurisdiction under FPA s 201(a). Thus FERC

adopted a seven factor jurisdictional test to identify whether a

facility is a local distribution facility subject to state jurisdiction or a facility engaged in interstate transmission subject to

FERC jurisdiction.6 In short, under Order 888, when a

__________

6 The Commission's seven factor test involves evaluating on a

case-by-case basis whether the activities of the facilities in question

correspond with seven specific indicators of local distribution:

(1) Local distribution facilities are normally in close proximity

to retail customers.

(2) Local distribution facilities are primarily radial in character.

(3) Power flows into local distribution systems; it rarely, if

ever, flows out.

(4) When power enters a local distribution system, it is not

reconsigned or transported on to some other market.

(5) Power entering a local distribution system is consumed in a

comparatively restricted geographical area.

(6) Meters are based at the transmission/local distribution

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public utility is engaged in wholesale transmission, FERC has

jurisdiction regardless of the nature of the facility; but when

the public utility is engaged in unbundled retail transmission,

the facts and circumstances will determine whether the facilities are subject to FERC or state jurisdiction.

The state petitioners argue that FERC's dual approach

radically expands its jurisdiction and violates Congress' explicit directive in FPA s 201(b) that regulation of local distribution facilities be left to the states. The states contend that

Congress clearly intended to preserve state jurisdiction over

local distribution facilities, regardless of whether the energy

comes from out of state or the sale is a wholesale sale. The

states maintain that, by claiming jurisdiction over any facility

transporting energy for resale, regardless of whether the

facility might otherwise be a local distribution facility under

the seven factor test, FERC has adopted the circular reasoning that wholesale sales do not occur on local distribution

facilities, so any facility that engages in wholesale activities is

not a local distribution facility. The states contend further

that FERC offers no reasoned analysis of why local distribution should be defined differently for wholesale versus retail

sales. The states finally charge that, under Order 888, nearly

identical facilities would be under federal jurisdiction and

state jurisdiction for different customers receiving indistinguishable service. Such a situation, they contend, will only

encourage energy marketers to choose their regulator by

using middlemen to shift the point at which title to the power

transfers, and thus undermine the jurisdictional certainty that

Order 888 states is necessary for competition.

FERC responds that it is not asserting jurisdiction over

local distribution facilities, but asserts that when a public

utility delivers unbundled energy at wholesale to a supplier

for the purpose of resale to an end user, FPA s 201 gives

FERC unqualified authority to assert jurisdiction over the

facility used to effect that transaction. When the public

utility is engaged in unbundled retail transmission, however,

__________

interface to measure flows into the local distribution system.

(7) Local distribution systems will be of reduced voltage.

Order 888, p 31,036 at 31,981.

the circumstances of a specific case will determine whether

the facilities used are subject to FERC or state jurisdiction.

The arguments by the states do no more than raise policy

concerns which are for FERC and not the court. See Arent

v. Shalala, 70 F.3d 610 (D.C. Cir. 1995).

Intervening again on FERC's behalf on this issue, the

U&D petitioners add that FERC's use of different tests is

appropriate given the differences in the two separate jurisdictional grants of FPA s 201. The intervenors argue that,

given the statute's clear grant to FERC of jurisdiction over

all aspects of wholesale sales, FERC is fully justified in

employing a functional test to identify wholesale transmissions. In contrast, because FERC's jurisdiction over retail

sales is limited to transmissions in interstate commerce, the

seven factor test is more appropriate.

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We agree that FERC's dual approach to assessing its

jurisdiction stems from the fact that FPA s 201 contains

more than one jurisdictional grant. FPA s 201(b) denies

FERC jurisdiction over local distribution facilities "except as

specifically provided in this subchapter and subchapter III."

16 U.S.C. s 824(b)(1) (emphasis added). FPA s 201(a)

makes clear that all aspects of wholesale sales are subject to

federal regulation, regardless of the facilities used. FERC's

assertion of jurisdiction over all wholesale transmissions,

regardless of the nature of the facility, is clearly within the

scope of its statutory authority. Moreover, various cases

support the proposition that FERC regulates all aspects of

wholesale transactions. See, e.g., Duke Power Co. v. FPC,

401 F.2d 930, 935-36 (D.C. Cir. 1968) (noting that the FPC

regulates public utility facilities used in wholesale transmissions or sales in interstate commerce); Arkansas Power &

Light Co. v. FPC, 368 F.2d 376, 383 (8th Cir. 1966) (stating

that the functional use of the transmission lines--wholesale

versus retail--controls); Wisconsin-Michigan Power Co. v.

FPC, 197 F.2d 472, 477 (7th Cir. 1952) (finding that transmission facilities used at wholesale are not "local distribution

facilities").

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The seven factor test applies only to unbundled retail sales,

where FERC seeks to regulate pursuant to the separate

grant of jurisdictional authority over transmissions in interstate commerce. In this context, the definition of "facilities

used in local distribution" becomes relevant. The statute

does not define "facilities used in local distribution," but

instead leaves that task to FERC. As Chevron counsels us,

FERC's interpretation of undefined and ambiguous statutory

terms is entitled to deference. See Chevron, 467 U.S. at 842-

43.

FERC has adopted a multi-factor test to determine the

nature of transmission facilities. In a footnote, Order 888

says that distribution-only facilities which sell only at retail

will still be considered local distribution facilities. See Order

888, p 31,036 at 31,981 n.99. This is consistent with the fact

that states historically have regulated bundled retail sales to

end users. However, Order 888 implicitly recognizes the

current reality that many primarily retail utilities engage in

both local distribution and interstate transmissions, and seeks

through the seven factors to discern each facility's primary

function. We cannot agree with the state petitioners that this

approach is unreasonable or otherwise impermissible.

IV. Reciprocity

Section 6 of the Tariff contains a reciprocity provision

resting on the principle that any public utility offering "nondiscriminatory open access transmission for the benefit of

customers should be able to obtain the same nondiscriminatory access in return." Order 888, p 31,036 at

31,760. Non-public utilities--those outside the Commission's

jurisdiction because, for instance, they are state-owned, see 16

U.S.C. s 824(f)--would otherwise not have to offer openaccess. Under the Tariff, a public utility does not have to

offer them access unless they reciprocate. In order to avoid

controversies between public and non-public utilities regarding reciprocal service, the Commission adopted a voluntary

"safe harbor" provision pursuant to which non-public utilities

could submit a transmission tariff to the Commission for a

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determination whether it satisfied the reciprocity condition.

If it did, the public utility would have to offer service; if it did

not, the public utility could refuse service (although it had the

option of waiving the reciprocity condition, as did the Commission itself).

A. Indirect Regulation of Non-Jurisdictional Utilities

Nebraska Public Power District (NPPD), a state entity,

provides electrical generation, transmission and distribution

service to wholesale and retail customers throughout Nebraska.7 It claims that the Commission, through the reciprocity

provision, has reached beyond its statutory authority and is

illegally attempting to regulate entities, including NPPD, over

which the Commission has no jurisdiction, in violation of the

Federal Power Act and the Tenth Amendment to the Constitution. NPPD admits that pursuant to Nebraska law, all

state power districts are obligated to provide open access

transmission service. They have been doing so for years.

This is doubtless why, after Order No. 888 issued, another

Nebraska public power district so easily obtained a safe

harbor declaration. See Omaha Pub. Power Dist., 81

F.E.R.C. p 61,054 (1997). In light of this, the Commission

argues--and we agree--that NPPD's petition is unripe.

Since NPPD already offers open access transmission, it is far

from certain that the reciprocity provision will have any effect

on it.8 It certainly has not demonstrated any particular

hardship that it would suffer if we refused to engage in preenforcement judicial review. See AT&T Corp. v. Iowa Utils.

Bd., 525 U.S. 366, 386 (1999). From all that appears, no

public utility has refused, or even threatened to refuse, to

give NPPD access to its transmission system in the wake of

__________

7 "Nebraska is unique among the States in the Union in that all

generation, transmission and distribution service is provided by

public entities, municipalities and cooperatives whose governing

boards are responsible to, and serve at the voting pleasure of, the

rate-payers they serve." NPPD Brief at 2.

8 The Commission made clear that existing contracts will not be

affected. See Order 888-A, p 31,048 at 30,181.

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Order No. 888.9 Given the fact that public utilities may waive

the reciprocity provision anyway, and that NPPD has the

same option of obtaining a safe harbor as did the Omaha

Public Power District, we are not persuaded that the provision is currently altering NPPD's conduct of its affairs or that

withholding judicial review will cause it any hardship whatever. "Unlike the drug manufacturers in Abbott Laboratories

[v. Gardner, 387 U.S. 136 (1967)], but like the cosmetics

companies in Toilet Goods Ass'n v. Gardner, 387 U.S." 158,

164 (1967), NPPD need not change its "behavior or risk costly

sanctions." Clean Air Implementation Project v. EPA, 150

F.3d 1200, 1205 (D.C. Cir. 1998). Furthermore, exactly how

the Commission will fill in the contours of the reciprocity

provision remains to be seen. That it may defer to state

commissions, as it indicated in Houston Lighting & Power

Co., 81 F.E.R.C. p 61,015 (1997), order on reh'g, 83 F.E.R.C.

p 61,181 (1998), affects NPPD's contention that the Commission is seeking to bring about nationwide uniformity by

forcing non-public utilities to comply with its "detailed mandates." NPPD Brief at 5. We therefore believe the issues

raised would benefit from a more concrete setting in which

NPPD can demonstrate exactly how the reciprocity provision

has affected its primary conduct. See Clean Air Implementation Project, 150 F.3d at 1204. For all these reasons,

NPPD's challenge to the reciprocity provision is not ripe for

judicial review.

B. Limitation on Reciprocity

The Investor Owned Utilities (IOUs) challenge the following limitation on reciprocity: non-public utilities owe reciprocal open access only to the public utility from which they take

open access service--not to all utilities. See IOU Brief at 40-

44; IOU Reply Brief at 18-20. These petitioners argue that

the Commission has left open the door for non-public utilities

__________

9 For this reason we find unpersuasive NPPD's claim that the

Tariff's reciprocity provision places it at a disadvantage in negotiations because a public utility may simply refuse to provide service

without any fear of a Commission enforcement action. See NPPD

Reply Brief at 4-5.

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to discriminate against all other utilities and that it has done

so solely because of tax considerations that no longer apply.

We agree with Commission counsel that tax considerations

were not the only basis on which the Commission's limitation

rested. The Commission stated that "the reciprocity requirement strikes an appropriate balance by limiting its application

to circumstances in which the non-public utility seeks to take

advantage of open access on a public utility's system." Order

888, p 31,036 at 31,762. The Commission also explained that

it "do[es] not have the authority to require non-public utilities

to make their systems generally available." Id. at 31,761.

The Commission stated also that it did not want broad open

access reciprocity to jeopardize the tax-exempt financing nonpublic utilities enjoy,10 that the IRS was then reexamining the

question, id. at 31,762, and that if the tax issue is favorably

resolved, it will reconsider the matter. Order 888-A,

p 31,048 at 30,287. The IRS has now acted. See Temporary

Regulations s 1.141-7T(f), in 63 Fed. Reg. 3256 (1998). The

IOUs argue that we must therefore remand for reconsideration. See IOU Brief at 44 (citing Panhandle Eastern Pipeline v. FERC, 890 F.2d 435, 439 (D.C. Cir. 1989); National

Fuel Gas Supply Corp. v. FERC, 899 F.2d 1244, 1249-50

(D.C. Cir. 1990); Ciba-Geigy v. EPA, 46 F.3d 1208 (D.C. Cir.

1995)).

We think not. So far as we know, the IRS has not finalized

its temporary and proposed regulations. The IRS acknowledges that its temporary regulations "raise[ ] a number of

complex technical issues" many of which "may need to be

addressed legislatively" and it anticipates that the finalization

process will take three years to accomplish. 63 Fed. Reg. at

3258-59. Second, as the Commission indicates, the possible

tax consequences of requiring open access from nonjurisdictional utilities was its secondary concern. The Commission's greater concern was its lack of jurisdiction to do

what the IOUs ask. And lastly the Commission should be

__________

10 See 26 U.S.C. ss 141, 142 (permitting "private activity" bonds

and "local furnishing" bonds, respectively).

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taken at its word that it will reconsider the scope of reciprocity when and if the temporary tax regulations are finalized.

V. Stranded Cost Recovery Provisions

Ordering open access transmission, Order 888-A explains

that "[t]he most critical transition issue that arises as a result

of the Commission's actions in this rulemaking is how to deal

with the uneconomic sunk costs that utilities prudently incurred under an industry regime that rested on a regulatory

framework and a set of expectations that are being fundamentally altered." Order 888-A, p 31,048 at 30,346. "If a

former wholesale requirements customer or a former retail

customer uses the new open access to reach a new supplier,"

FERC said, "we believe that the utility is entitled to recover

legitimate, prudent and verifiable costs that it incurred under

the prior regulatory regime...." Order 888, p 31,036 at

31,789.

According to FERC, these "stranded" costs consist predominantly of costs of building generation capacity, which

utilities incurred with the expectation that they would use the

additional capacity to serve existing customers. See Notice of

Proposed Rulemaking, Recovery of Stranded Costs by Public

Utilities and Transmitting Utilities, FERC Stats. & Regs.

p 32,507 at 32,863-64, 59 Fed. Reg. 35,274 (1994) ("Stranded

Cost NOPR"). Because of the increased competition in the

generation market that will result from open access, this

capacity may become underutilized or uneconomical, i.e.,

"stranded." Stranded costs also include nonrecurring costs

approved by regulators that, in order to avoid rate increases,

were recovered over a period of years instead of at the time

the expenditures were made. Known as "regulatory assets,"

these costs include deferred income taxes, deferred pension

and other employee benefit and retirement costs, research

and development, extraordinary property losses, and the

phase-in of new plant costs. Nuclear decommissioning costs

and costs to buy out high-priced fuel and power contracts

may also become stranded as a result of open access.

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Exercising its exclusive jurisdiction over wholesale power

sales, FERC through Order 888 gave utilities the opportunity

to recover their stranded costs from former wholesale customers who take advantage of open access transmission to

purchase power from other suppliers. Order 888, p 31,036 at

31,810. With respect to stranded costs resulting from stateordered retail wheeling, Order 888 provides that FERC will

consider stranded cost claims only when state regulatory

agencies lack authority to do so. Id. at 31,824-25. Order 888

also designated FERC as the primary forum for stranded

cost claims stemming from what are known as new municipalizations and municipal annexations. See Order 888-A,

p 31,048 at 30,404; Order 888-B, 81 FERC at 62,104.

Stranded costs in these situations result from retail (as

opposed to wholesale) power sales.

Petitioners challenge nearly every aspect of FERC's

stranded cost policy as set forth in Order 888, from the

mechanics of calculating customers' stranded cost obligations

to whether FERC has authority to address stranded costs at

all. We begin with those challenges that relate to the recovery of wholesale stranded costs (Section V.A), then turn to

challenges to Order 888's treatment of retail stranded costs

(Section V.B). We affirm FERC's stranded cost policy in all

respects, except we vacate that portion of the orders dealing

with the treatment of energy costs in the market option and

remand to FERC for further explanation. See Section

V.A.5.c.

A. Wholesale Stranded Costs

In requiring nondiscriminatory open access transmission as

a remedy for undue discrimination, FERC recognized that it

"cannot change the rules of the game without providing a

mechanism for recovery of the costs caused by such

regulatory-mandated change." Order 888-A, p 31,048 at

30,346. Under the pre-open access regulatory regime, utilities entered into long-term contracts to make wholesale power sales to municipal, cooperative, and investor-owned utilities. See Stranded Cost NOPR, p 32,507 at 32,862. Because

these customers had no source of power supply other than

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their historic utility, these contracts were typically extended

at the end of their term. This produced an implicit obligation

by the utilities to continue satisfying their customers' power

needs, as well as a reciprocal expectation by customers of

continued service. See id. at 32,863-64. To satisfy expected

customer demand, utilities invested money, built facilities, and

entered into long-term fuel or power contracts, relying on the

"regulatory compact" under which utility shareholders accepted lower rates of return on their investment in exchange for

the certainty of regulated rates and resulting ability to recover prudently incurred costs. See Notice of Proposed Rulemaking, Promoting Wholesale Competition Through Open

Access Non-discriminatory Transmission Services by Public

Utilities; Recovery of Stranded Costs by Public Utilities and

Transmitting Utilities, FERC Stats. & Regs. p 32,514 at

33,049, 60 Fed. Reg. 17,662 (1995).

Order 888 fundamentally undermines utilities' expectation

of continued service and cost recovery. A utility's requirements customers may now use the utility's open access transmission service to purchase power from other suppliers at the

end of their contract terms. If customers leave before paying

their share of costs the historic utility incurred on their

behalf, the utility will be left with stranded costs, which it will

either absorb or shift to remaining customers.

Unless utilities are able to recover stranded costs, FERC

reasoned, their ability to compete and attract investor capital

in a deregulated market may be seriously impaired. FERC

therefore decided that it had to "address recovery of the

transition costs of moving from a monopoly-regulated regime

to one in which all sellers can compete on a fair basis and in

which electricity is more competitively priced." Order 888,

p 31,036 at 31,635. In reaching this conclusion, FERC relied

on its experience in restructuring the natural gas industry,

where this court faulted it for failing to provide transitional

mechanisms such as stranded cost recovery. FERC explained: "We have learned from our experience in the natural

gas area the importance of addressing competitive transition

issues early and with as much certainty to market participants as possible." Id.

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In shaping its stranded cost recovery mechanism, FERC

had to balance two competing interests: speeding the transition to competition versus protecting utilities that had incurred costs with the expectation that their customers would

remain and eventually pay those costs through electricity

rates. Allowing recovery of stranded costs, FERC acknowledged, would delay full realization of the benefits of open

access--lower electricity rates--because customers facing

stranded cost liability might continue purchasing power from

their historic utility even though competitors are selling

power at lower rates. See Order 888-A, p 31,048 at 30,355.

Indeed, a customer would only switch suppliers if the competitor offered a rate less than the historic utility's rate plus the

customer's stranded cost liability. But given the highly regulated nature of the electricity industry, in which utilities

incurred costs with the expectation of recouping them, FERC

concluded that the delay was a necessary component of its

open access program. See id. Mindful of its ultimate goal of

converting the electricity industry into a competitive market,

however, FERC fashioned the stranded cost recovery provisions to be transitional, allowing utilities to recover stranded

costs only in connection with wholesale requirements contracts entered into on or before July 11, 1994 (the date of the

stranded cost notice of proposed rulemaking). See 18 C.F.R.

s 35.26(b)(8), 35.26(c)(1)(v)-(vi).

As to precisely who should pay for stranded costs, utilities

and customers not surprisingly had dramatically different

positions. Customers argued that utilities should absorb

most, if not all, stranded costs. Utilities (and their investors)

argued that customers should pay.

Facing an enormously difficult task in balancing these

sharply conflicting positions, FERC crafted a rule that requires customers to pay stranded costs but only in certain

circumstances. Most important, in order to recover stranded

costs from a customer, the historic utility must prove that it

had a reasonable expectation of continued service to that

particular customer for a certain number of years beyond the

end of the contract term; a utility unable to prove such an

expectation may not recover stranded costs under Order 888.

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See 18 C.F.R. s 35.26(c)(2)(i). Moreover, a utility able to

demonstrate a reasonable expectation of continued service

may recover stranded costs only if its wholesale customer

actually takes advantage of the utility's open access tariff to

obtain access to a new generation supplier at the end of its

contract term (i.e., the former customer continues to use the

historic utility's transmission service but no longer purchases

power from it). See 18 C.F.R. s 35.26(b)(1)(i). Through

these two limitations, FERC balanced the interests of utilities

and customers by allowing utilities to recover their stranded

costs only if they can demonstrate a reasonable expectation of

continued service and requiring customers to pay those costs

only if they take advantage of their historic utility's open

access transmission to reach cheaper sources of power. And

of course, no customer will have to pay stranded costs at all if

it continues purchasing power from its historic utility

throughout the period during which the utility has a reasonable expectation of continued service--precisely what the

customer would have done in the absence of Order 888's open

access requirement.

Under Order 888, stranded costs are calculated on a "revenues lost" basis. A departing customer's stranded cost obligation equals the estimated revenue it would have paid had it

continued to purchase power from the historic utility minus

the current market value of the power it would have purchased, calculated over the period the utility is determined to

have a reasonable expectation of continued service to that

customer. See 18 C.F.R. s 35.26(c)(2)(iii). In other words,

the stranded cost formula is not tied to particular stranded

assets or contractual commitments, but rather awards utilities

the difference between the pre-open access cost-based rate

and the post-open access market rate. Once a customer's

stranded cost liability is calculated, it may pay through a

lump-sum payment, installment payments, or a surcharge to

the transmission rate charged by the historic utility. See

Order 888, p 31,036 at 31,799.

Before turning to petitioners' arguments, we emphasize

what should be obvious from the foregoing summary of Order

888: Order 888 awards stranded costs to no one. It does

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nothing more than establish a mechanism by which utilities

may seek to recover stranded costs. To recover stranded

costs, a utility must demonstrate its continued expectation of

service at an evidentiary hearing. The customer may appear

at that hearing and, through evidentiary submissions of its

own, attempt to demonstrate that the utility had no such

expectation. Only after such a hearing may FERC decide

whether a utility can recover stranded costs and, if so, how

much.

Petitioners mount many challenges to Order 888's stranded

cost recovery provisions. For purposes of analysis, we group

these challenges into five categories: (1) challenges to

FERC's authority to provide for stranded cost recovery

(section V.A.1); (2) claims that Order 888 conflicts with cost

causation principles and case law developed under the Natural Gas Act (section V.A.2); (3) challenges to FERC's MobileSierra findings (section V.A.3); (4) claims that FERC arbitrarily and capriciously failed to provide for stranded cost

recovery by certain entities, such as transmission dependent

utilities and generation and transmission cooperatives (section

V.A.4); and (5) challenges to various technical aspects of

Order 888's stranded cost recovery provisions (section V.A.5).

1. FERC's Authority to Provide for Stranded Cost Recovery

A group called Petitioners Opposing Stranded Cost Recovery ("POSCR") advances three challenges to FERC's authority to provide for stranded cost recovery: (1) as a factual

matter, utilities could never have had a reasonable expectation of continued service to wholesale customers beyond the

contract term; (2) sections 206 and 212 of the Federal Power

Act ("FPA") forbid stranded cost recovery; and (3) our

decision in Cajun Elec. Power Coop., Inc. v. FERC, 28 F.3d

173 (D.C. Cir. 1994), holds that stranded cost recovery is

anticompetitive. We consider each argument in turn.

a. Reasonable expectation of continued service

To recover stranded costs relating to a specific departing

wholesale requirements customer, a utility must show that it

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had a reasonable expectation of service to that customer

beyond the term of its existing contract. See 18 C.F.R.

s 35.26(c)(2)(i). Pointing out that contracts define the extent

of the parties' obligations and that customers have long

exercised their rights to purchase power from other suppliers

at the end of their contract terms, POSCR contends that

utilities could never have had an expectation of service beyond their contract terms. In considering this argument it is

important to remember that Order 888 does not itself award

stranded costs; it merely establishes a procedure by which

utilities may petition FERC in individual proceedings to

recover stranded costs from a specific customer based on a

specific evidentiary showing. Utilities failing to show an

expectation of continued service will be unable to recover

stranded costs. POSCR's challenge thus amounts to a claim

that no utility could ever, under any circumstances, have had

a reasonable expectation to serve a wholesale customer beyond the term of its contract. We review this claim under

the APA's familiar arbitrary and capricious standard. See 5

U.S.C. s 706(2)(A); Williams Field Services Group, Inc. v.

FERC, 194 F.3d 110, 115 (D.C. Cir. 1999).

Responding to this same challenge in Order 888-A, FERC

explained that utilities historically had an implicit obligation

to serve customers beyond the contract term for a simple

reason: Customers had no means of reaching alternative

suppliers. See Order 888-A, p 31,048 at 30,354. As part of

that obligation to serve, FERC found, a local utility "had a

concomitant obligation to plan to supply [its] customers'

continuing needs, and planned its system taking account of

the wholesale load. In many cases the wholesale customers

participated by supplying load forecasts." Id. In making

capital decisions and predicting future demand, utilities frequently consulted with their wholesale requirements customers. For these reasons, FERC concluded, utilities may have

a reasonable expectation of continued service to particular

customers. See id. at 30,354-55.

Not only is FERC's judgment about utilities' reasonable

expectations precisely the type of policy assessment to which

we owe great deference, but POSCR points to nothing sugUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 45 of 109
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gesting that FERC's reasoning is arbitrary and capricious.

In fact, POSCR's argument completely ignores the highly

regulated nature of the electricity industry prior to Order

888. Unlike competitive markets, where buyers may freely

purchase from many sellers, the monopolistic character of the

electricity industry, combined with the congressionally imposed regulatory structure, left requirements customers highly dependent on a single supplier--their historic utility. Indeed, as intervenors point out, utilities were even unable to

choose not to renew an expiring wholesale requirements

contract without first notifying FERC. See 18 C.F.R. s 35.15

(1995) (repealed by Order 888). Although it may well be

true, as POSCR argues, that some wholesale customers have

long been able to purchase unbundled transmission service,

we think such evidence is best reserved for individual proceedings, where a departing customer can attempt to refute

the utility's claim that it had an expectation of continued

service.

b. Sections 206 and 212 of the FPA

Section 206(a) of the FPA gives FERC authority to "determine the just and reasonable rate, charge, classification, rule,

regulation, practice, or contract to be thereafter observed and

in force" if it finds that any existing arrangement "is unjust,

unreasonable, unduly discriminatory or preferential." 16

U.S.C. s 824e(a). Relying on section 206(a) as the basis for

Order 888, FERC found that utilities had used their monopoly transmission power to discriminate against potential competitors and that such practices would increase as competitive

pressures in the industry increased. Order 888, p 31,036 at

31,676, 31,682.

POSCR contends that Order 888's stranded cost recovery

provisions themselves violate FERC's own construction of

section 206, the construction FERC relied on as the basis for

the open access rule. According to POSCR, "[t]he stranded

cost rule perpetuates the very 'discrimination' FERC found

unlawful, and subjects the same victims--customers held

hostage to uneconomic electric generation by transmission

monopolists--to continued abuse."

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In challenging FERC's policy decision to provide for

stranded cost recovery, POSCR conflates the violation

(FERC's generic determination that utilities' practice of prohibiting access to their transmission lines on reasonable terms

was unduly discriminatory) with the remedy (FERC's more

limited finding that recovery of stranded costs in particular

circumstances would not be unduly discriminatory). FERC

has not, as POSCR contends, given "unduly discriminatory"

different meanings; rather, it has applied the term in different contexts.

POSCR's argument thus boils down to a challenge to

FERC's conclusion that the stranded cost recovery prescribed in Order 888 is not unduly discriminatory, a challenge

meriting arbitrary and capricious review. Viewed through

this lens, we think FERC more than adequately explained

why it concluded that stranded cost recovery is not unduly

discriminatory--stranded cost recovery, FERC said, is transitional only, follows cost causation principles, and requires

utilities to prove that they had a reasonable expectation of

continued service. FERC faced an enormously difficult task.

It had to balance the transition to competitive markets

against the need to maintain the competitiveness of utilities

that had incurred costs based on a reasonable expectation

that they would recoup them. We find nothing either arbitrary or capricious in how FERC struck this balance.

POSCR next contends that stranded cost recovery violates

section 212 of the FPA, which governs the rates for transmission ordered by FERC pursuant to section 211. 16 U.S.C.

ss 824j-k. Section 212

allows FERC to order "rates, charges, terms, and conditions

which permit the recovery by [a transmitting] utility of all the

costs incurred in connection with the transmission services

and necessary associated services, including, but not limited

to, an appropriate share, if any, of legitimate, verifiable and

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economic costs, including taking into account any benefits to

the transmission system of providing the transmission service, and the costs of any enlargement of transmission facilities." 16 U.S.C. s 824k(a). Contending that "economic

costs" cannot be read to include payment of stranded costs,

which by definition relate to generation (not transmission)

services, POSCR reads section 212 to preclude stranded cost

recovery.

Straightforward application of the Chevron doctrine demonstrates the lack of merit in this argument. See Chevron,

U.S.A., Inc. v. Natural Resources Defense Council, 467 U.S.

837 (1984). Because Congress has not "directly spoken to the

precise question at issue"--do "economic costs" include

stranded costs?--and because nothing in the statute precludes recovering through transmission rates costs that were

traditionally recovered through generation rates, the term

"economic costs" is ambiguous. Id. at 842.

Proceeding to Chevron's second step, we ask whether

FERC has reasonably interpreted the term "economic costs."

See id. at 843. We have no doubt that it has. As FERC

explained, but for section 211 wheeling orders, there would be

no stranded costs. Stranded costs, according to FERC, are

therefore economic costs of section 211 wheeling. See Order

888-A, p 31,048 at 30,390. POSCR offers nothing to undermine this eminently reasonable interpretation of the statute.

c. Implications of Cajun

Next, POSCR contends that our decision in Cajun Elec.

Power Coop., Inc. v. FERC, 28 F.3d 173 (D.C. Cir. 1994),

condemns stranded cost recovery as anticompetitive. A preOrder 888 decision, Cajun reviewed two tariffs allowing a

utility, Entergy Corporation, to sell power at market rates,

and a third tariff providing for open access to Entergy's

transmission services at cost-based rates. The third tariff

gave Entergy an opportunity to recover stranded costs from

customers who no longer purchase power from Entergy but

use its transmission lines to reach other suppliers--exactly

the circumstances in which Order 888 provides for stranded

cost recovery. Under the tariff, the stranded cost charge was

included in Entergy's transmission rate. See id. at 175-77.

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Characterizing the stranded cost provision as a "tying

arrangement" under antitrust law, Cajun explained that under the tariff, Entergy could charge a former customer for

the cost of generation services when the customer wished to

purchase only transmission services; because Entergy has a

monopoly over transmission, customers would have no choice

but to pay costs relating to generation they no longer wanted

from Entergy. Id. at 177-78. Thus, because "Entergy could

use its monopoly over transmission services to eliminate

competition in the market for generation services," the net

effect of the tariffs may be anticompetitive. Id. at 176.

Of significance to this case, however, we did not strike

down the tariffs. Instead, we remanded the case for FERC

to determine "how much competition in fact is dampened" by

the stranded cost provision. Id. at 178. Thus, contrary to

POSCR's suggestion, Cajun does not represent a blanket

condemnation of stranded cost recovery; rather, recognizing

that such recovery could be anticompetitive, Cajun directed

FERC to evaluate and justify the potential anticompetitive

impact. This is precisely what FERC has done in Order 888.

It expressly considered the anticompetitive effects of stranded cost recovery. See Order 888-A, p 31,048 at 30,372-74.

Then, stressing the transitional nature of the recovery and

the fact that recovery was compelled by the open access

requirement, which utilities could not have anticipated, FERC

concluded that the limited anticompetitive effects of stranded

cost recovery were both a necessary and acceptable consequence of the transition to competition. See id. Not only

has POSCR offered no evidence that would lead us to question FERC's conclusion, but such judgments about anticompetitive effects are "the kind of reasonable agency prediction

about the future impact of its own regulatory policies to which

we ordinarily defer." Louisiana Energy and Power Auth. v.

FERC, 141 F.3d 364, 370 (D.C. Cir. 1998).

2. Natural Gas Precedent and Conformance to Cost Causation Principles

Having rejected POSCR's arguments that FERC lacks

authority to authorize stranded cost recovery, we turn to its

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argument that FERC has failed adequately to explain why

Order 888 requires departing customers to pay one-hundred

percent of stranded costs. In support of this argument,

POSCR claims that our decisions reviewing FERC's restructuring of the natural gas industry require cost sharing; it also

argues that Order 888's stranded cost recovery conflicts with

the cost causation principles that traditionally govern allocation of costs.

a. Natural gas precedent: AGD, K N Energy, and UDC

In introducing competition into the electricity industry,

FERC has taken essentially the same path that it took in

restructuring the natural gas industry, although what FERC

has done in a single order in the electricity industry (Order

888) it did in a series of orders in the natural gas industry.

Because POSCR relies so heavily on FERC's natural gas

orders and our decisions reviewing them, we begin by summarizing them in some detail.

Finding practices in the natural gas industry "unduly discriminatory" in violation of the Natural Gas Act, FERC

began by issuing Order 436, which "unbundled" pipeline

transportation and merchant functions. Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol, Order

No. 436, FERC Stats. & Regs. p 30,665, 50 Fed. Reg. 42,408

(1985) (rehearing orders omitted). At the time of Order 436,

pipelines were facing enormous liabilities under long-term

"take-or-pay" contracts. Entered into when gas prices were

expected to rise, these contracts obligated pipelines to purchase minimum quantities of gas from wellhead producers at

fixed prices that turned out to be well in excess of market

prices. See Associated Gas Distributors v. FERC, 824 F.2d

981, 1021 (D.C. Cir. 1987) ("AGD"). Although FERC estimated take-or-pay liabilities at billions of dollars, and although Order 436 would exacerbate the take-or-pay problem

by providing incentives to pipeline customers to purchase gas

from cheaper suppliers, FERC declined to take any action

with respect to the contracts. In AGD, we found that

FERC's decision to do nothing failed to meet the requirements of reasoned decisionmaking, citing FERC's "seeming

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blindness to the possible impact of Order No. 436 on take-orpay liability" and permanent market distortions that may

result from FERC's inaction. Id. at 1021-23, 1025. Specifically, we noted, in words echoed by FERC years later in

Order 888, that consumers who purchased from the "least

nimble" local distribution companies would "be stuck with the

burden of the overpriced gas." Id. at 1023.

In response to AGD, FERC issued Order 500. Regulation

of Natural Gas Pipelines After Partial Wellhead Decontrol,

Order No. 500, FERC Stats. & Regs. p 30,761, 52 Fed. Reg.

30,334 (1987) (rehearing orders omitted). Recognizing that

no one segment of the gas industry was wholly responsible

for the take-or-pay problem, Order 500 allowed pipelines to

recover take-or-pay costs through "equitable sharing." Pipelines that willingly absorbed twenty-five to fifty percent of

their costs could require sales customers to match that

amount through a fixed charge. Pipelines could recover any

balance through commodity rates or volumetric surcharges,

borne by both sales and transportation customers. For an

overview of these components of Order 500, see K N Energy,

Inc. v. FERC, 968 F.2d 1295, 1297-98 (D.C. Cir. 1992). We

sustained this approach in K N Energy, holding that even

though Order 500 replaced traditional "cost causation" principles with cost spreading and value-of-service concepts, it did

not violate Natural Gas Act section 4's requirement that rates

be just and reasonable. Id. at 1301-02. Citing statements in

AGD that "all actors in the natural gas industry" are "candidates" for absorbing take-or-pay liability, we relied on "the

unusual circumstances surrounding the take-or-pay problem,

and the limited nature--both in time and scope--of the

Commission's departure from the cost-causation principle."

Id. at 1301.

Concluding that Order 436 had been only partially successful in introducing competition into the natural gas industry,

FERC issued its third major restructuring order, Order 636.

Pipeline Service Obligations and Revisions to Regulations

Governing Self-Implementing Transportation; and Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol, Order No. 636, FERC Stats. & Regs. p 30,939, 57 Fed.

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Reg. 13,267 (1992) (rehearing orders omitted). That order

imposed mandatory unbundling of sales and transportation

services and allowed sales customers to reduce the amount of

gas they had to purchase pursuant to existing contracts.

When customers took advantage of this option and purchased

gas from sources other than the pipelines, the pipelines were

once again left with substantial take-or-pay liabilities. Labeling the costs of reducing these liabilities gas supply realignment or GSR costs, Order 636 authorized pipelines to bill

current transportation customers for one-hundred percent of

their GSR costs by charging either a negotiated exit fee or

reservation fee surcharge. Order 636 also authorized pipelines to recover all stranded costs in rate filings. In the

natural gas industry, stranded costs represented the costs of

pipeline assets (such as storage facilities) used to provide

bundled sales services that were not directly assignable to

transportation customers. For an overview of these components of Order 636, see United Distribution Cos. v. FERC, 88

F.3d 1105, 1125-27, 1176-78 (D.C. Cir. 1996) ("UDC").

In UDC, we affirmed FERC's determination that pipelines

could recover all stranded costs through filed rates, so long as

FERC "adequately balanced the interests of investors and

ratepayers." Id. at 1180. Reaffirming the appropriateness

of the cost spreading and value-of-service principles approved

in K N Energy, we found that FERC's allocation of GSR

costs to pipeline transportation customers, as opposed to the

pipelines themselves, properly applied those principles. Id.

at 1182. Although recognizing that GSR costs stemmed from

pipeline sales customers, not transportation customers, we

found that FERC appropriately imposed the costs on transportation customers because these customers benefitted from

the availability of lower-priced transportation and also because FERC could not spread costs to the pre-Order 636

sales customers since those customers no longer purchased

gas from the pipelines. Id. at 1185-86. We remanded for

FERC to explain more fully why pipelines should not have to

pay some of the costs, noting an inconsistency in the Commission's analysis: While FERC applied cost spreading principles to justify imposing costs on transportation customers, it

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invoked cost causation principles in concluding that pipelines

should not have to pay any of these costs. Id. at 1188-89.

We explicitly stated, however, that we were not saying that

"it is impossible, or even improbable, that the Commission on

remand can establish a convincing rationale for exempting the

pipelines." Id. at 1189.

POSCR reads this history to require FERC to order cost

sharing, but it ignores Order 888's explanation of the difference between natural gas restructuring and the situation in

the electricity industry. Most fundamentally, Order 888 explains, stranded cost recovery in the electricity industry

conforms to cost causation principles, which normally govern

the allocation of costs and require customers to pay the costs

they caused. See Order 888, p 31,036 at 31,798. Cost causation principles could not be applied in natural gas restructuring, Order 888 explains, because many customers had already

begun purchasing gas from other suppliers before FERC had

addressed the take-or-pay problem on remand from AGD,

and because the filed rate doctrine prohibits assessing

charges against former customers. Id. at 31,800-01. Order

888 also explains that unlike stranded costs in the electricity

industry, the take-or-pay liabilities in the gas industry were

extraordinary. The billions of dollars of take-or-pay liabilities

resulted not from Order 636, but from earlier regulatory

policies that had encouraged pipelines to enter into long-term,

fixed-price gas purchase contracts, combined with declining

gas prices that made those contracts uneconomical. See

Order 888-A, p 31,048 at 30,380. Under all of these circumstances, "[t]o have allocated these costs solely to any one

segment of the industry would have imposed a crushing new

burden on that segment." Id. at 30,380-81.

Stranded costs in the electricity industry, Order 888 explains, are quite different. Resulting directly from Order

888, they represent "ordinary costs that have always been,

and are currently, included in the utility's rates for electric

generation approved by the Commission." Id. at 30,382.

Moreover, wholesale customers may avoid stranded cost liability by continuing to purchase power from their historic

utility, precisely what they probably would have done in the

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absence of Order 888. In other words, in contrast to the

natural gas industry, where customers would have faced

enormous new burdens had FERC forced them to pay takeor-pay costs, customers in the electricity industry face no new

burdens; instead, Order 888 requires them to pay nothing

more than costs they would have had to pay in the absence of

Order 888. In the electricity industry, the only effect of

stranded cost recovery is delayed realization of the full benefits of a competitive market.

In light of these differences between the natural gas and

electricity industries and FERC's exhaustive treatment of the

natural gas restructuring in Order 888, POSCR's contention

that FERC has failed "to offer a coherent rationale, rising to

the level of reasoned decisionmaking" for not imposing cost

sharing is wholly without merit. Equally without merit is

POSCR's assertion that UDC "teaches that, where customers

and utilities benefit from an open access rule/order that leads

to early contract termination and where anticompetitive conduct by utilities has given rise to the need for the open access

order, utilities must share transition costs." POSCR ignores

three important points. First, FERC, not this court, determined that cost sharing was appropriate with respect to takeor-pay liabilities. UDC merely affirmed FERC's decision.

Second, K N Energy recognized that cost sharing in the

natural gas industry was a departure from the cost causation

principles that normally apply, a departure justified by extraordinary circumstances in the natural gas industry. K N

Energy, 968 F.2d at 1301-02. And finally, as to stranded

costs that more closely resemble those at issue in this case--

for example, pipeline assets that would no longer be fully

employed when customers took advantage of unbundling to

purchase gas from alternative suppliers--FERC ordered, and

UDC affirmed, that pipelines recover one-hundred percent of

those costs.

b. Conformance to cost causation principles

Having established that the natural gas cases impose no

obligation on FERC to order cost sharing, we next consider

POSCR's argument that the inclusion of stranded costs in

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transmission rates does not conform to cost causation principles. This is so, POSCR asserts, because Order 888's stranded cost provisions require customers to pay through transmission rates for costs the utility previously incurred to provide

generation services.

As an initial matter, we note that payment through transmission rates is only one of three ways that a departing

customer may pay its stranded cost obligation; the customer

also has the option of making a lump-sum payment or installment payments. Thus POSCR's challenge seems aimed only

at the method of payment, not at the fact that payment is

required. But even viewing POSCR's challenge more broadly, as a claim that stranded cost recovery no matter what the

method of payment violates cost causation principles, we

think it lacks merit.

We have explained the cost causation principle as follows:

"Simply put, it has been traditionally required that all approved rates reflect to some degree the costs actually caused

by the customer who must pay them." K N Energy, 968 F.2d

at 1300. Given this definition, we are puzzled by POSCR's

claim that because inclusion of stranded costs in transmission

rates requires customers to pay currently for costs incurred

in the past, it violates cost causation principles. To some

degree, all utility rates reflect past costs; utilities typically

expend funds today (for example, constructing generation

facilities), fully expecting to recover those costs through

future rates. In fact, current rates often include past costs

that utilities deferred in order to avoid rate increases. Cost

causation requires not that costs be incurred at the same time

they are included in rates, but that the rates "reflect to some

degree the costs actually caused by the customer who must

pay them." Id.

In fashioning Order 888's stranded cost recovery provisions, FERC went to great lengths to ensure that customers

would be responsible for only those costs they caused.

[T]he Rule is consistent with the traditional cost causation principle because it recognizes the link between the

incurrence of the stranded costs and the decision of a

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particular generation customer to use open-access transmission on the utility's system to leave the utility's

generation system and shop for power, and bases the

utility's ability to recover stranded costs on its ability to

demonstrate that it incurred costs with the reasonable

expectation that the customer would remain on its generation system beyond the term of the contract.

Order 888-A, p 31,048 at 30,382.

We cannot see how including stranded costs in transmission

rates instead of lump sum payments changes this analysis.

To the extent POSCR is arguing that including in a transmission rate costs incurred to provide generation services violates cost causation principles, we reiterate that stranded

costs are not costs of providing the physical transmission

services but, as Order 888-A explains, they are utilities' cost

of open access transmission. See Order 888-A, p 31,048 at

30,389 & n.634. More generally, given the fundamental

changes wrought by Order 888 and the unprecedented opportunity for customers to purchase power from alternative

suppliers, we are quite comfortable deferring to FERC's

judgment that stranded cost recovery--through transmission

rates or otherwise--conforms to cost causation principles. In

fact, FERC may have violated cost causation principles had it

failed to assign stranded costs to customers who caused them.

POSCR next argues that Order 888 is unduly discriminatory because including stranded costs in transmission rates

forces transmission customers who previously used a utility's

generation capacity to pay higher costs than new transmission customers. Disagreeing, FERC determined that requiring customers receiving similar services to pay different rates

is necessitated by Order 888's open access requirement. See

Order 888-A, p 31,048 at 30,388-90. Cf. AGD, 824 F.2d at

1009 ("[T]he mere fact of a rate disparity is not enough to

constitute unlawful discrimination.") (internal quotation

marks omitted). Moreover, FERC concluded, the application

of cost causation principles justifies this different treatment.

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ing unreasonable (let alone arbitrary or capricious) in

FERC's policy judgment, we reject POSCR's challenge.

Nor do we agree with POSCR's argument that stranded

cost recovery violates the 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." Western Resources, Inc. v. FERC, 72 F.3d 147,

149 (D.C. Cir. 1995). In Western Resources, we held that

FERC's assignment to current customers of costs relating to

take-or-pay liabilities did not violate the filed rate doctrine.

Recognizing that "a central purpose of the doctrine is to

enable purchasers to know in advance the consequences of

the purchasing decisions they make," we determined that the

doctrine was satisfied where customers received "adequate

notice of a rate in advance of the service to which it relates."

Id. at 149-50 (internal quotation marks omitted). Order 888's

stranded cost policy satisfies this requirement because customers electing to purchase power generation from a source

other than the transmitting utility from which they had

purchased power in the past will be aware of the costs when

making that decision.

3. FERC's Mobile-Sierra Findings

Under the Supreme Court's Mobile-Sierra doctrine, where

parties have negotiated a contract that sets firm prices or

dictates a specific method of computing charges and includes

a clause denying either party the right to change such prices

or charges unilaterally, "FERC may abrogate or modify the

contract only if the public interest so requires." Texaco, Inc.

v. FERC, 148 F.3d 1091, 1095 (D.C. Cir. 1998); see also FPC

v. Sierra Pacific Power Co., 350 U.S. 348, 353-55 (1956);

United Gas Pipe Line Co. v. Mobile Gas Serv. Corp., 350 U.S.

332, 344-45 (1956). We have recognized that "the 'public

interest' that permits FERC to modify private contracts is

different from and more exacting than the 'public interest'

that FERC seeks to serve when it promulgates its rules."

Texaco, 148 F.3d at 1097.

FERC usually makes Mobile-Sierra determinations on a

case-by-case basis. A party seeking to modify a contract

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containing a Mobile-Sierra clause petitions FERC. That

party bears the burden of convincing FERC that the modification is in the public interest.

Order 888 departs from this normal case-by-case practice

by making two generic public interest findings, one focused

on utilities, the other on customers. These generic findings

relieve utilities and customers of the burden of demonstrating

in individual proceedings that the proposed modifications are

in the public interest. As to utilities, Order 888 ruled that it

was in the public interest to allow them to add stranded cost

amendments to their contracts if they could demonstrate, in

accordance with Order 888, that they had a reasonable expectation of continued service. See Order 888-A, p 31,048 at

30,394-95. This finding rested on two considerations: that

the burden of unrecoverable stranded costs could impair

utilities' access to capital markets, which could in turn precipitate the departure of other customers, thus worsening the

utilities' financial condition and threatening its ability to

provide reliable service; and that allowing customers to leave

a utility without paying their share of costs would shift those

costs to other customers who lack alternative power sources.

See Order 888, p 31,036 at 31,811. For its second generic

finding, FERC concluded that it was in the public interest to

allow customers to modify their wholesale requirements contracts in any way upon a showing that the terms are no

longer just and reasonable. See Order 888-A, p 31,048 at

30,189. Observing that the contracts in question "were entered into during an era in which transmission providers

exercised monopoly control over access to their transmission

facilities," FERC based this finding on the unequal bargaining power between utilities and customers. Id. at 30,193.

Because "[m]any of these contracts were the result of uneven

bargaining power between customers and monopolist transmission providers," FERC reasoned, "the unprecedented

competitive changes that have occurred (and are continuing to

occur) in the industry may render their contracts to be no

longer in the public interest or just and reasonable." Id.

Challenging the first finding, POSCR argues that FERC

lacks authority to make a generic public interest finding that

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allows for contract modification in an entire class of cases.

POSCR insists that FERC can only proceed on a case-bycase basis, determining in each case whether a particular

contract modification is in the public interest. Even if FERC

has authority to make generic findings, POSCR goes on to

argue, FERC's Order 888 finding is unsupported by substantial evidence. The investor owned utilities ("IOUs") challenge

the second finding, arguing that allowing customers to seek

modification of all contract terms, while limiting utilities to

stranded cost provisions, fails adequately to balance competing interests.

a. FERC's authority to make a generic public interest finding

POSCR correctly observes that FERC has pointed to no

case in which a court affirmed a generic Mobile-Sierra finding. At the same time, POSCR has cited no case prohibiting

FERC from making a generic finding, nor have we found one.

In the absence of definitive authority in either direction, and

given the unique circumstances of this case and our traditional deference to FERC's expertise, we find no fault with

FERC's generic determination.

The Mobile-Sierra doctrine "represents the Supreme

Court's attempt to strike a balance between private contractual rights and the regulatory power to modify contracts

when necessary to protect the public interest." Northeast

Utilities Serv. Co. v. FERC, 55 F.3d 686, 689 (1st Cir. 1995).

In Mobile, the Supreme Court recognized that intervening

circumstances may create a situation in which contractual

terms and conditions that were just and reasonable at the

time the contract was executed are no longer just and reasonable. 350 U.S. at 344-45. But concluding that a utility is not

typically "entitled to be relieved of its improvident bargain,"

the Sierra Court required that FERC's predecessor, the

Federal Power Commission, show more than that the contract was unjust and unreasonable--the Commission had to

find that contract modification was in the public interest. 350

U.S. at 355.

In most cases, intervening circumstances are unique to the

relationship between contracting parties. See, e.g., Northeast

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Utilities, 55 F.3d 686 (affirming FERC's modification to the

rate schedule of a contract as a condition for approval of a

merger between two parties to the contract). But where

intervening circumstances--in this instance, FERC-mandated

open access transmission--affect an entire class of contracts

in an identical manner, we find nothing in the Mobile-Sierra

doctrine to prohibit FERC from responding with a public

interest finding applicable to all contracts of that class.

Moreover, in providing for stranded cost recovery, FERC has

not relieved utilities of "improvident bargains," the concern of

the Sierra Court; rather, it has recognized that open access

affects all utilities in the same manner, namely, leaving them

vulnerable to potentially unrecoverable stranded costs. In

fact, to deny FERC authority to make generic findings in

such a case would simply impose on it and the parties the

repetitive burden of proving the public interest in each and

every case.

In sustaining FERC's generic finding, we are influenced by

the fact that before recovering stranded costs, a utility must

prove that it had a reasonable expectation of continued service to a particular customer. As the IOUs invervening on

behalf of FERC explain, the need to make this showing adds

a particularized element to FERC's generic public interest

finding. Viewed this way, Order 888's generic finding is more

precisely stated as follows: It is in the public interest to allow

utilities to recover stranded costs if they can prove that they

had a reasonable expectation of continued service to particular customers. If a utility can demonstrate that it had a

reasonable expectation of continued service to a particular

customer, and incurred costs based on that expectation, then

it would be against the public interest to require other

customers or shareholders to bear those costs. As Order 888

explains, "the case-by-case findings that some commenters

seek will, in effect, be made when the Commission determines

whether to approve a proposed stranded cost amendment to a

particular contract." Order 888, p 31,036 at 31,813.

We stress that generic Mobile-Sierra findings are appropriate only in rare circumstances. Order 888 is just such a

circumstance. It fundamentally changes the regulatory enviUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 60 of 109
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ronment in which utilities operate, introducing meaningful

competition into an industry that since its inception has been

highly regulated and affecting all utilities in a similar way.

b. FERC's stranded cost public interest finding

Having concluded that the Mobile-Sierra doctrine permits

a generic finding in this case, we turn to POSCR's claim that

the finding was unsupported by substantial evidence.

POSCR faults FERC for failing to adduce evidence to support its conclusion that denying stranded cost recovery would

put particular utilities in financial peril. POSCR also thinks

that the impact on customers of failing to provide for stranded cost recovery is insufficient to support a public interest

finding.

With respect to POSCR's first point, it is certainly true

that Sierra identified impairment of "the financial ability of

the public utility to continue its service" as one factor supporting a public interest finding. Sierra, 350 U.S. at 355.

Relying on this, POSCR challenges FERC's public interest

finding on the ground that the record contains no individual

assessments of the financial condition of public utilities.

Although public interest findings made on a case-by-case

basis necessarily evaluate the harm to the particular utility

seeking modification, that is not true where, as here, FERC

implements a generic change in the industry. Just as that

change can support a generic public interest finding, that

generic finding can be supported by generic industry-wide

evidence. FERC has produced such evidence. The record

contains estimates of stranded costs amounting to $200 billion

or more. See Stranded Cost NOPR, p 32,507 at 32,866. It

also includes comments from representatives of the financial

community stating that "the prospect of not recovering

stranded costs could erode a utility's ability to attract capital."

POSCR points out that eighty-five to ninety percent of the

estimated $200 billion of stranded costs relates to retail sales,

not wholesale sales. True enough, but we find no basis for

questioning FERC's conclusion that unrecovered stranded

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costs of even ten percent of $200 billion--the low end of the

wholesale stranded cost estimate--could have serious consequences for utilities. See Order 888, p 31,036 at 31,790. In

any event, if POSCR turns out to be correct about the

absence of a wholesale stranded cost problem, few utilities

will avail themselves of Order 888's stranded cost recovery

provisions.

POSCR's second argument focuses on FERC's finding that

"if some customers are permitted to leave their suppliers

without paying for stranded costs, this may cause an excessive burden on the remaining customers who, for whatever

reason, cannot leave and therefore may have to bear those

costs." Order 888, p 31,036 at 31,811. POSCR does not

agree with FERC that the failure to recover stranded costs

will create an "undue burden" on remaining customers. But

disagreeing with FERC is not enough. To prevail in this

court, POSCR must demonstrate that FERC's prediction that

failure to recover stranded costs will create an undue burden

on remaining customers is unsupported by substantial evidence, see 16 U.S.C. s 825l(b), which is another way of saying

it is arbitrary and capricious. See Michigan Consolidated

Gas Co. v. FERC, 883 F.2d 117, 124 (D.C. Cir. 1989) ("[M]aking ... predictions is clearly within the Commission's expertise and will be upheld if rationally based on record evidence.") (internal quotation marks omitted). This POSCR

has failed to do.

c. FERC's public interest finding regarding customers

The IOUs mount two challenges to FERC's second public

interest finding--that it was in the public interest to allow

customers to seek modification of their wholesale requirements contracts. Unlike POSCR, the IOUs make no claim

that the finding lacks substantial evidence; rather, they

contend that FERC's decision to allow customers to seek

modification of all contract terms, while limiting utilities to

adding stranded cost provisions, fails to balance FERC's

competing concerns: respecting existing contractual commitments and accelerating the transition to competition. They

also complain that FERC has failed adequately to explain

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why affording customers this broad ability to modify their

contracts is in the public interest.

FERC gave two justifications for affording customers a

broader opportunity than utilities to modify their contracts,

both of which seem perfectly rational to us. First, Order

888-A explains, "these contracts were entered into during an

era in which transmission providers exercised monopoly control over access to their transmission facilities." Order

888-A, p 31,048 at 30,193. Also, the "unprecedented competitive changes.... may affect whether such contracts continue

to be just and reasonable or not unduly discriminatory both

as to the direct customers of the contracts, as well as to

indirect, third-party consumers...." Id. at 30,193-94. In

fact, Order 888 rests on the very premise that by denying

competitors access to their transmission lines, utilities engaged in undue discrimination. Confined to purchasing power from their local utilities, customers suffered from this lack

of access. In the natural gas restructuring, we affirmed

FERC's decision to allow customers to seek to modify their

sales contracts because those contracts "necessarily reflect

the pipelines' monopoly power." AGD, 824 F.2d at 1017.

The same reasons call for affirming FERC's decision here.

In addition, as FERC has explained, the harm to third parties

(i.e., customers of the wholesale requirements customers) that

may result from adherence to uneconomical contracts further

justifies its conclusion. See Order 888-A, p 31,048 at 30,194.

Remedying potential unfairness to utilities by allowing them

to seek stranded cost recovery if a customer shortens the

term of a contract, FERC struck a balance between customers and utilities that can hardly be characterized as arbitrary

or capricious.

4. Availability of Stranded Cost Recovery to Nonjurisdictional Utilities and G&T Cooperatives

Section 201 of the FPA gives FERC jurisdiction over

"public utilities" but not over federal and state utilities. 16

U.S.C. s 824. Although FERC required utilities not subject

to its jurisdiction ("nonjurisdictional utilities") to provide reciprocal open access transmission when they use a jurisdicUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 63 of 109
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tional utility's open access tariff, it declined to provide a

mechanism for them to recover stranded costs. Explaining

that it promulgated its reciprocity provision pursuant to

fairness concerns, not statutory authority, FERC reasoned

that it lacked jurisdiction to provide stranded cost recovery

for nonjurisdictional utilities. See Order 888-A, p 31,048 at

30,364. FERC recommended that these utilities include

stranded cost provisions in their open access tariffs; those

tariffs would be reviewed not by FERC but by the appropriate regulatory authority. See id.

Dairyland petitioners contend that FERC acted arbitrarily

and capriciously in denying nonjurisdictional utilities stranded

cost recovery, arguing that the same "fairness" concerns

invoked by FERC to require reciprocal open access transmission require the award of stranded costs. To be sure, FERC

may have had authority to include stranded cost recovery as a

provision of Dairyland's open access tariff. But Dairyland

has offered no reason for thinking that FERC's refusal to do

so was arbitrary and capricious. Given the limited scope of

FERC's stranded cost provisions, its lack of jurisdiction over

entities like Dairyland, and the ability of nonjurisdictional

utilities to include stranded cost provisions in their open

access tariffs, we see no reason to question FERC's judgment

on this issue.

The same is true with respect to the transmissiondependent utilities ("TDUs"). Like the Dairyland petitioners,

they claim that FERC acted arbitrarily and capriciously by

failing to provide a mechanism for them to recover stranded

costs. Owning few or no transmission facilities, TDUs serve

their loads using other utilities' transmission systems. Not

only are TDUs nonjurisdictional utilities, but, as Order 888-A

explains, open access does not cause their costs to become

stranded--their customers have always had an option to use

other utilities' transmission services to purchase power. See

Order 888-A, p 31,048 at 30,365.

Dairyland also contends that FERC acted arbitrarily and

capriciously when it declined to treat a generation and transmission ("G&T") cooperative and its member distribution

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cooperatives as a single economic unit for stranded cost

purposes. G&T cooperatives provide bundled wholesale power to their member distribution cooperatives, who in turn sell

the power to the members' retail customers. Observing that

cooperatives, unlike traditional utilities, are not vertically

integrated but instead function as single economic units,

Dairyland claims that G&T cooperatives have reasonable

expectations of continued service to retail customers of their

member cooperatives that differ substantially from the expectations public utilities have with respect to retail customers of

their wholesale customers. This difference, Dairyland argues, requires FERC to allow G&T cooperatives to recover

stranded costs from their member cooperatives' customers.

Rejecting Dairyland's petition for rehearing on this point,

FERC noted that treating a G&T cooperative and its members as a single economic unit for purposes of stranded cost

recovery would conflict with its treatment of these same

cooperatives as distinct entities in its reciprocity provisions.

Order 888-A, p 31,048 at 30,366. There, FERC agreed with

Dairyland's proposal that if a G&T cooperative seeks open

access transmission from a public utility, "then only the G&T

cooperative, and not its member distribution cooperatives,

would be required to offer [reciprocal] transmission service."

Order 888, p 31,036 at 31,763. Moreover, FERC reasoned,

recovering from a retail customer of a member cooperative is,

in effect, recovering from an indirect customer, a situation

that FERC declined to include in its stranded cost rule. See

Order 888-A, p 31,048 at 30,366.

It is true that FERC could have treated G&T cooperatives

and their members as single economic units for stranded cost

purposes. But FERC's explanation of why it chose not to do

so, particularly the fact that G&T cooperatives and their

members were treated as distinct entities for reciprocity

purposes, is entirely reasonable.

5. Challenges to Technical Aspects of Order 888's Stranded

Cost Recovery Provisions

Several petitioners mount challenges to various technical

aspects of the stranded cost recovery provisions. Before

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addressing these challenges, we emphasize the very limited

scope of our review. For us to undo what FERC has done,

petitioners must persuade us that FERC's actions were arbitrary or capricious. "Highly deferential," the arbitrary and

capricious standard "presumes the validity of agency action."

National Mining Ass'n v. Mine Safety and Health Admin.,

116 F.3d 520, 536 (1997). Where, as here, the issue before us

"requires a high level of technical expertise, we must defer to

the informed discretion of the responsible federal agencies."

Marsh v. Oregon Natural Resources Council, 490 U.S. 360,

377 (1989) (internal quotation marks omitted). It is not

enough for petitioners to convince us of the reasonableness of

their views, see UDC, 88 F.3d at 1169 ("The existence of a

second reasonable course of action does not invalidate an

agency's determination."); those arguments should be presented to FERC, whose commissioners are appointed by the

President and confirmed by the Senate with the expectation

that they, not Article III courts, will make policy judgments.

To prevail in this court, petitioners must demonstrate that

FERC's policy judgments are arbitrary or capricious, a heavy

burden indeed. See National Treasury Employees Union v.

Hefler, 53 F.3d 1289, 1292 (D.C. Cir. 1995) ("The 'scope of

review under the "arbitrary and capricious" standard is narrow and a court is not to substitute its judgment for that of

the agency.' ") (quoting Motor Vehicles Mfrs. Ass'n v. State

Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)). With this

very deferential scope of review in mind, we turn to petitioners' arguments.

a. POSCR's challenges to the stranded cost formula

Reasoning that it would be burdensome to identify each

and every asset that would become underutilized as a result

of Order 888, FERC adopted a "revenues lost" formula to

determine a departing customer's stranded cost obligation.

Order 888, p 31,036 at 31,839. For each year a utility can

prove that it had a reasonable expectation of continued service to a particular customer, the formula calculates the

customer's stranded cost obligation by subtracting the comUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 66 of 109
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petitive market value of the power the customer would have

purchased from the utility (as estimated by the utility) from

the amount the customer would have paid had it remained a

generation customer of the utility (based on FERC-approved

rates that the customer paid the prior three years). Id. at

31,839-40.

POSCR claims that this formula gives utilities no incentive

to mitigate their stranded costs. Not so. The formula

automatically provides such an incentive by subtracting from

utilities' recovery the market price of the power--utilities

that fail to sell the power at market prices will not recover

their full costs. POSCR also claims that the formula fails

accurately to measure stranded costs because it is based on

an estimate of those costs at one point in time. Responding,

FERC explained why it rejected a "true-up" provision that

would have made adjustments to the amount the customer

owed to reflect market conditions over the reasonable expectation period. According to FERC, such an approach would

have created enormous uncertainty, outweighing any potential increase in accuracy. See Order 888-A, p 31,048 at

30,427-28. POSCR has offered no basis for us to question

this reasoning.

POSCR's claim that the formula gives utilities an incentive

to minimize their estimate of the market value of the power

the customer would have purchased is similarly groundless.

To avoid precisely this result, Order 888 gives customers an

option to either market or broker the capacity and associated

energy they would have purchased from their historic utility,

effectively reducing their stranded cost obligations by the

difference between the actual market value of the power and

the utility's estimate of the market value. See Order 888,

p 31,036 at 31,844. Order 888 also gives customers an option

to substitute the price of power under the customer's contract

with a new supplier for the utility's estimate of the market

value. See id.

One final point. Throughout its brief and at oral argument,

POSCR consistently referred to stranded costs as "imprudently incurred costs." Although it never developed this

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argument, we think it worth noting that all costs included in

customers' stranded cost obligations are based on FERCapproved rates and were included in utility rate bases as

assignable to particular customers. To us, this means that

these costs are legitimate, prudent, and verifiable.

b. Inclusion of known and measurable costs

The IOUs take issue with Order 888's stranded cost recovery formula because the estimate of the price the customer

would have paid for the power is based on rates for the prior

three years; according to the IOUs, this approach fails to

consider known and measurable costs resulting from regulatory mandates that may have been deferred pursuant to filed

rate schedules and FERC-approved settlements. The costs

they cite include deferred costs of generation that have

already been approved for inclusion in the rate base, costs

relating to approved qualifying facility contracts, and government-imposed costs such as deferred taxes and nuclear decommissioning.

Although it is true that the revenue calculation measures

only current rates and not deferred costs, Order 888 allows

customers and utilities to file for a change in the rates before

the customer's requirements contract terminates; in such

cases, FERC will calculate the customer's stranded cost

obligation based on those new rates. See Order 888-A,

p 31,048 at 30,427. While seeking to avoid detailed listings of

specific costs that may become stranded, FERC has adequately preserved utilities' ability to include known, measurable costs in revenue estimates through a ratemaking proceeding.

c. Treatment of energy costs in the market option

The IOUs challenge FERC's treatment of energy costs in

the market option. To mitigate utilities' incentives to minimize their estimates of the market value of the power (the

competitive market value estimate or "CMVE"), Order 888

affords customers an option to buy the power stranded by

their departure from the utility and resell it. Order 888,

p 31,036 at 31,844. Customers would purchase generation

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capacity at the utility's estimated market value of the capacity

and associated energy at average system variable cost. Id. at

31,845. Thus if a customer believes that a utility is underestimating the price at which it could sell the power, the customer can buy the power and then resell it. While customers

exercising this option would still have to pay their stranded

cost obligation as calculated under the formula, they would

effectively offset the obligation by keeping the profit on the

resale of the power. Id. at 31,845 n.879.

The IOUs contend that allowing customers to pay average

variable cost for the associated energy is inconsistent with

Order 888's definition of the CMVE, which equals the market

value of both the generation capacity and associated energy.

See id. at 31,839 (defining CMVE as "the utility's estimate of

the average annual revenues ... that it can receive by selling

the released capacity and associated energy, based on a

market analysis performed by the utility"). Customers could

receive a windfall, the IOUs claim, by exercising the market

option--although they will pay average variable cost for the

associated energy, they will be able to resell it at the presumably higher market price. At the same time, utilities will be

unable to recover the full market value of the power because

they will be forced to sell the associated energy at cost.

Responding to this argument in Order 888-A, FERC offered two justifications for allowing customers to purchase

the associated energy at average variable cost. First, because the capacity being marketed would not generally be

associated with a single asset, customers exercising this option are purchasing a "slice of the system" and thus should

pay average variable cost. Second, customers should be able

to purchase energy at the price they currently pay, typically

average variable cost. See Order 888-A, p 31,048 at 30,433.

But neither explanation responds to the IOUs' argument that

defining CMVE as the market price of both the capacity and

associated energy is inconsistent with allowing customers

exercising the market option to purchase associated energy at

average variable cost. In its brief in this court, FERC

continues to misapprehend the IOUs' argument, largely reitUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 69 of 109
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erating the same arguments and failing to address the inconsistency.

The market option's stated intention is to reduce a utility's

incentive to understate the CMVE. See Order 888, p 31,036

at 31,842. If it did understate the CMVE, then customers

could buy the power from the utility and resell it, keeping the

difference. But FERC's policy of allowing customers to

purchase the associated energy at cost gives customers an

incentive to exercise the market option even when a utility

has appropriately estimated CMVE because they can buy the

energy at cost and resell it at the presumably higher market

price. FERC's failure to explain whether it intended this

result and if so, the justification for permitting customers to

receive a windfall while undercompensating utilities constitutes a failure of reasoned decisionmaking. See AGD, 824

F.2d at 1030 ("We do not require that FERC reach any

particular conclusion; we merely mandate that it reach its

conclusion by reasoned decisionmaking."). We therefore vacate this portion of the orders and remand the issue to FERC

for further consideration.

d. Rescission of notice of termination provision

Until FERC issued Orders 888 and 889, it had required

parties to power sales contracts to notify it sixty days prior to

cancellation of a contract or termination of a contract by its

own terms. See 18 C.F.R. s 35.15 (repealed by Order 888).

Orders 888 and 889 eliminate the requirement that parties

notify FERC in advance when a contract terminates by its

own terms, but only with respect to contracts executed after

July 9, 1996; in other cases of contract cancellation or

termination, parties must still notify FERC in advance. See

18 C.F.R. s 35.15 (1999). TDU petitioners claim that in

rescinding the notice requirement, FERC ignored the fact

that utilities still have substantial market power. That some

utilities retain market power in generation, however, does not

undermine Orders 888 and 889. Through these orders,

FERC sought to move the electricity industry toward competition; by providing an open access mechanism through which

buyers may purchase power from suppliers other than transUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 70 of 109
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mitting utilities, FERC substantially reduced utilities' market

power. Eliminating the notice requirement furthered that

policy. Moreover, customers who believe termination of their

contracts is unjust can seek relief from FERC pursuant to

section 206 of the FPA. See Order 888-A, p 31,048 at 30,393.

e. Provision for benefits lost

The TDU petitioners claim that FERC acted arbitrarily

and capriciously by failing to provide a mechanism for customers purchasing power at below-market rates to preserve

those rates at the termination of their contract with their

historic utility. Just as utilities may have expectations of

continued service to particular customers, the TDU petitioners contend, customers may have reasonable expectations of

continuing to receive wholesale requirements service from

their historic utility at cost-based rates. Order 888-A says

that the Commission does "not have a sufficient basis on

which to make generic findings that customers under such

contracts may be entitled to extend a contract at the existing

rate." Order 888-A, p 31,048 at 30,393 (emphasis removed).

Moreover, the order explains, "the consequences of customers' expectations as a general matter would not have the

potential to shift significant costs to other customers," whereas utilities' failure to recover stranded costs could potentially

shift the costs to other customers. Id.

We think that FERC has adequately explained why it

chose not to provide for benefits-lost recovery in Order 888.

Most important, FERC has not foreclosed customers in this

situation from seeking relief: As Order 888-A explains, a

customer may "exercise its procedural rights under section

206 to show that the contract should be extended at the

existing contract rate, or [ ] make such a showing in the

context of a utility's proposed termination of a contract

pursuant to the section 35.15 notice of termination (approval)

requirement." Id. (footnote omitted). Given that agencies

"enjoy[ ] broad discretion in determining how best to handle

related, yet discrete, issues in terms of procedures ... and

priorities," we think FERC's refusal to promulgate a generic

rule on this issue was entirely reasonable. Mobil Oil ExploUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 71 of 109
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ration & Producing Southeast, Inc. v. United Distrib. Cos.,

498 U.S. 211, 230 (1990).

B. Retail Stranded Costs

Recognizing state agency authority to address stranded

costs that relate to retail power sales, Order 888 limits

FERC's role as a forum for the recovery of these costs to two

situations: when customers take advantage of state-ordered

wheeling to reach new power suppliers and when former

retail customers become wholesale customers through what is

known as municipalization or municipal annexation. See Order 888-A, p 31,048 at 30,402, 30,410. In the former scenario,

FERC will consider proposals for the recovery of stranded

costs only when the appropriate state regulatory commission

lacks authority to do so; in the latter situation, FERC will

serve as the primary forum for resolution of stranded cost

claims.

1. Stranded Costs Arising from Retail Wheeling

Stranded costs may result from state unbundling of retail

sales, where retail customers take advantage of state-ordered

retail wheeling to reach new generation suppliers. See Order

888, p 31,036 at 31,819. Observing that both FERC and the

states have authority to address these stranded costs, Order

888 explains that:

[B]ecause it is a state decision to permit or require the

retail wheeling that causes retail stranded costs to occur,

we will leave it to state regulatory authorities to deal

with any stranded costs occasioned by retail wheeling.

The only circumstance in which we will entertain requests to recover stranded costs caused by retail wheeling is when the state regulatory authority does not have

authority under state law to address stranded costs when

the retail wheeling is required.

Order 888, p 31,036 at 31,824-25 (footnote omitted). FERC

will provide for recovery of those stranded costs through the

transmission rate the former supplying utility charges the

departing customer. Order 888-A, p 31,048 at 30,410. (As

discussed in Section III supra, FERC has jurisdiction over

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the transmission component of unbundled retail sales.) In

evaluating claims for stranded cost recovery, FERC will use

the same standards as it applies with respect to wholesale

stranded costs (i.e., it will require utilities to demonstrate a

reasonable expectation of continued service). See Order 888,

p 31,036 at 31,819 n.722.

Two sets of petitioners challenge FERC's retail stranded

cost recovery provisions from opposite sides. The States and

POSCR contend that FERC exceeded its jurisdiction by

asserting rate authority over retail stranded costs. The

IOUs argue that FERC abdicated its statutory authority by

failing to agree to consider all proposals for recovery of

stranded costs that arise from retail wheeling. Because we

think FERC has appropriately exercised its jurisdiction, we

reject both claims.

a. FERC's jurisdiction over retail stranded costs

The States' and POSCR's arguments boil down to the

following: Because retail stranded costs relate primarily to

facilities used for retail generation, and because section 201(b)

of the FPA explicitly excludes these facilities from FERC's

jurisdiction, FERC may not provide for recovery of these

costs in FERC-jurisdictional rates. Unbundling electricity

sales, they argue, cannot alter the jurisdictional status of

these costs.

As an initial matter, we agree with FERC that petitioners

confuse costs and rates. Rates are jurisdictional; costs are

not. As Order 888-A explains:

[T]here are rarely separate retail and wholesale generating facilities. Retail customers and wholesale requirements customers get energy from the same facilities,

each buying a "slice of the system." Typically all generating assets go into both the retail and the wholesale rate

bases for determining retail and wholesale rates. Rates

are determined by allocating the total generating costs

among customer classes. The parties confuse the issue

before us to the extent they suggest that state commissions, not this Commission, have "jurisdiction" over cerUSCA Case #98-1115 Document #526819 Filed: 06/30/2000 Page 73 of 109
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tain "costs." Neither the state commissions nor this

Commission has exclusive jurisdiction over "costs."

Each regulatory authority has jurisdiction to determine

"rates" for services subject to its jurisdiction and, in

determining rates, may take into account all of the costs

incurred by the utility.

Order 888-A, p 31,048 at 30,414. In other words, as FERC

explained in its brief, "regulatory authorities do not carve out

so-called 'wholesale costs' that only FERC can take into

account in determining rates subject to its jurisdiction or socalled 'retail costs' that only a state commission can take into

account in determining rates subject to state jurisdiction."

Instead, "[u]nder historical cost-of-service ratemaking, each

regulatory authority, in exercising its respective ratemaking

jurisdiction, reviews the total costs incurred by a utility to

provide service and makes its separate and independent

determination of what costs may be recovered through rates

within its jurisdiction." Order 888-A, p 31,048 at 30,414.

Thus, while petitioners correctly point out that section

201(b) of the FPA denies FERC jurisdiction over "facilities

used for the generation of electric energy," that provision

does not necessarily prevent FERC from including costs

relating to generating facilities in transmission rates, over

which FERC indisputably has jurisdiction. 16 U.S.C.

s 824(b). This is so because this part of section 201(b) is

modified by the phrase "except as specifically provided in this

subchapter and subchapter III of this chapter." Id. Given

that section 201(a) grants FERC jurisdiction over "the transmission of electric energy in interstate commerce" and, therefore, over transmission rates, 16 U.S.C. s 824(a), FERC may

exercise jurisdiction over generation facilities to the extent

necessary to regulate interstate transmission.

This is exactly the construction that we gave section 201(b)

in Mississippi Industries v. FERC, 808 F.2d 1525, 1543-45

(D.C. Cir. 1987) (subsequent history omitted). There, petitioners challenged FERC's authority to reallocate costs relating to generation facilities among utilities that were parties to

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cate such costs, FERC relied on its "undisputed jurisdiction

over interstate sales of electric energy at wholesale." Id. at

1543. We agreed: "[A]lthough allocating cost does, to some

extent, result in the 'regulation of matters relating to generation,' such regulation is valid under the FPA when it is the

byproduct of a legitimate exercise of FERC's power to regulate wholesale rates." Id. In reaching this conclusion, we

rejected petitioners' argument that "the statutory prohibition

of federal regulation of [generation] facilities in section 201(b)

becomes meaningless if FERC is permitted to allocate the

costs of a plant," given FERC's undisputed responsibility to

regulate the wholesale sale of power. Id. at 1543-44. Under

Mississippi Industries, then, FERC may regulate costs relating to generation facilities if such regulation "is the byproduct

of a legitimate exercise of FERC's power to" regulate interstate transmission. Id. at 1543. Because FERC indisputably

has jurisdiction over transmission rates, Mississippi Industries also disposes of petitioners' argument that FERC's

retail stranded cost recovery provisions run afoul of section

201(a) of the FPA, which provides that "Federal regulation

[shall] extend only to those matters which are not subject to

regulation by the States." 16 U.S.C. s 824(a).

Attempting to distinguish Mississippi Industries, petitioners point out that the case "involved authority to allocate

generation costs to a wholesale sales rate (which may, of

course, include generation costs)." True, but Mississippi

Industries provides clear authority for the proposition that

there is no per se jurisdictional bar to FERC's including

generation costs in jurisdictional rates, whether wholesale

sales rates or transmission rates. Thus narrowed, the question before us is this: Is inclusion of stranded costs relating

to generation facilities in transmission rates the byproduct of

a legitimate exercise of FERC's authority over transmission

rates? In most cases the answer would be no, but given the

highly unusual circumstances of this case, we think the answer is yes. Just as FERC may include generation-related

wholesale stranded costs in transmission rates (see Section

V.A.1.b), it may include generation-related retail stranded

costs in transmission rates. That retail stranded costs were

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originally reflected in state-jurisdictional retail sales rates

does not change the analysis, for in both cases the stranded

costs can be viewed as "costs" of providing transmission

services: "While such costs are not a cost of operating the

physical transmission system, nevertheless, they are an economic cost incurred as a result of being required to provide

retail transmission." Order 888-A, p 31,048 at 30,414 n.708.

While we agree that generation-related retail costs are not

typically "costs" relating to transmission services, the fundamental changes wrought by state-ordered retail wheeling, as

well as the narrow circumstances in which FERC will consider stranded cost recovery claims, justify the conclusion that

these costs are costs of providing transmission service.

Petitioners claim that by agreeing to consider retail stranded cost recovery claims, FERC has unduly interfered with

state legislative processes and decisions. We disagree.

FERC has limited its "interference" to instances where state

commissions have no authority even to address stranded cost

recovery claims. Describing its role as limited to "fill[ing]

any regulatory gap," FERC made it clear that it will deny

consideration to any utility seeking stranded cost recovery "if

a state regulatory authority with authority to address retail

wheeling stranded costs has in fact addressed such costs,

regardless of whether the state regulatory authority has

allowed full recovery, partial recovery, or no recovery." Order 888-A, p 31,048 at 30,415. Under these circumstances, it

can hardly be said that FERC has usurped state authority.

b. FERC's refusal to assert jurisdiction over all retail

stranded costs

Contending that FERC did not go far enough, the IOUs

challenge the agency's refusal to consider claims for stranded

costs resulting from state-ordered retail wheeling unless the

relevant state regulatory commission lacks authority to address such claims. They claim that FERC should have

agreed to consider proposals for retail stranded cost recovery

whether or not the state commission had authority to address

the claim, and even whether or not a state commission with

such authority had already addressed the claim. In support

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of their position, the IOUs advance three related arguments.

They allege first that by concluding that it had jurisdiction

over retail stranded costs but declining to exercise it, FERC

abdicated its legal authority. Second, they say, FERC violated its statutory obligation to ensure just and reasonable

rates. And finally, they contend that FERC erred in concluding that stranded costs resulting from retail wheeling lack

a direct nexus to the open access transmission ordered in

Order 888.

With respect to their first argument, the IOUs claim that

once FERC determined that it had jurisdiction over retail

stranded costs, the agency had to exercise that jurisdiction.

In making this argument, the IOUs make the same mistake

POSCR made: They confuse FERC jurisdiction over costs

with its jurisdiction over rates. FERC has not "concluded

that it shares jurisdiction over retail stranded costs with the

states," as the IOUs assert. As we explained above, "costs"

are not jurisdictional. The FPA speaks not in terms of

"costs," but in terms of "rates," requiring FERC to ensure

that rates are just, reasonable, and not unduly discriminatory.

FERC indisputably has jurisdiction over interstate transmission rates. In essence, then, the IOUs claim that FERC has

no discretion to leave retail stranded cost recovery to state

authorities.

We review claims that an agency lacks discretion to follow

(or decline to follow) a certain course of action by examining

the agency's governing statute as well as its own regulations.

See, e.g., National Wildlife Federation v. Browner, 127 F.3d

1126, 1130 (D.C. Cir. 1997) (concluding that agency regulations do not require EPA to review and approve or disapprove a state's decision to maintain existing water quality

standards); NRDC v. EPA, 25 F.3d 1063, 1069-70 (D.C. Cir.

1994) (holding that neither the governing statute nor relevant

regulations impose a mandatory duty on EPA to list all

wastes that exhibit a hazardous characteristic; statute gives

EPA "substantial room to exercise its expertise in determining the appropriate grounds for listing"). The IOUs have

failed to point to any statutory provision that robs FERC of

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ry commissions should serve as the primary forum for retail

stranded cost recovery. Our own examination of the FPA

reveals no such provision either. Sections of the statute

giving FERC jurisdiction over transmission in interstate commerce, 16 U.S.C. s 824(a), and requiring FERC to ensure

that rates are just and reasonable, 16 U.S.C. s 824d(a), do

not alone create a mandatory duty to consider proposals for

retail stranded cost recovery.

The two Supreme Court cases the IOUs rely on provide no

support for their position, for in both cases the agencies,

unlike FERC in this case, failed to comply with a specific

statutory mandate. In MCI v. AT&T, 512 U.S. 218 (1994),

the Supreme Court held that the FCC could not exempt

certain communication common carriers from filing a tariff;

the statute specified that all carriers must file tariffs. Similarly, in FPC v. Texaco, Inc., 417 U.S. 380 (1974), the Supreme Court determined that the FPC could not exempt

certain producers from the statute's requirement that rates

be just and reasonable. Under these cases, FERC would

abdicate its statutory obligations if it, for example, exempted

certain utilities from the requirement that rates be just and

reasonable (as in Texaco), or if it refused to review transmission rate filings altogether. These cases do not hold that in

carrying out its statutory obligations, FERC has no discretion

to determine as a matter of policy that states are better

positioned to address costs originally included in retail rate

bases. What the IOUs suggest--that because FERC has

authority to address retail stranded costs through transmission rates, it must exercise that authority--is simply not the

law.

As an alternative to their legal argument, the IOUs claim

that FERC acted arbitrarily and capriciously in determining

that just and reasonable transmission rates include retail

stranded cost recovery in some circumstances but not in

others. Their argument goes like this: Section 201(b)(1) of

the FPA gives FERC exclusive jurisdiction over transmission

of electric energy in interstate commerce. Under section 205,

FERC must set just and reasonable rates. In addition,

sections 205 and 206 prohibit undue discrimination. Thus,

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the IOUs argue, "[b]y approving different transmission rates,

some including stranded cost recovery (e.g., municipalization),

and others without (e.g., retail wheeling or bypass), FERC is

sanctioning arbitrary and capricious differences in violation of

the FPA."

In making this argument, the IOUs ignore the wide discretion the FPA affords FERC to determine what constitute

"just and reasonable rates" and "undue discrimination," as

well as the unusual circumstances created by an industry

change as fundamental as Order 888's open access requirement. Just because some transmission rates include retail

stranded costs while others do not does not alone make Order

888 arbitrary and capricious; rather, petitioners must show

that there is no reason for the difference. Cf. AGD, 824 F.2d

at 1009 ("[T]he mere fact of a rate disparity is not enough to

constitute unlawful discrimination.") (internal quotation

marks omitted). We think FERC has provided a convincing

explanation for the difference. "Recovery of this type of cost

through a transmission rate is obviously not the norm,"

explains Order 888-A, "but is necessitated by the need to deal

with the transition costs associated with this Rule." Order

888-A, p 31,048 at 30,418. Only in situations where state

regulatory commissions lack authority to award stranded

costs will FERC include these costs in transmission rates.

Otherwise, customers would be able to avoid their stranded

cost obligations, leaving utility shareholders or remaining

customers to bear the costs.

The IOUs' reliance on the natural gas restructuring cases

is misplaced. Setting aside the extraordinary nature of takeor-pay liabilities as compared to the stranded costs at issue

here, AGD required only that FERC address the take-or-pay

liabilities that the pipelines had incurred. See AGD, 824 F.2d

at 1030 ("We do not require that FERC reach any particular

conclusion; we merely mandate that it reach its conclusion by

reasoned decisionmaking."). That is exactly what Order 888

does with respect to stranded costs. While FERC has not

agreed to serve as the forum for recovery of these costs in all

situations, neither the FPA nor the natural gas cases requires

it to do so. By ensuring that utilities have a forum in which

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to bring claims for retail stranded cost recovery, FERC has

done just what AGD requires.

Nor do we find merit in the IOUs' argument that FERC

erred in concluding that stranded costs resulting from retail

wheeling lack a direct nexus to the open access transmission

mandated by Order 888. FERC's decision that state regulatory commissions should address retail stranded costs rested

on its conclusion that state-ordered wheeling, not FERCmandated open access transmission, causes those costs to

become stranded. See Order 888-A, p 31,048 at 30,410.

Recognizing a "limited" nexus between retail stranded costs

and FERC-mandated open access stemming from FERC's

jurisdiction over transmission rates and the resulting authority to award stranded costs, FERC nonetheless found no

causal nexus between stranded costs and FERC-ordered

transmission. Id. at 30,419. The lack of a direct causal

nexus differentiates retail stranded costs from retail-turnedwholesale stranded costs (see infra Section V.B.2).

Taking issue with this reasoning, the IOUs contend that

FERC ignored "the central role played by the federal government" in shaping the electric energy industry. Because retail

wheeling, according to the IOUs, is "a direct result of a

federally created system of increased competition," FERC

must take responsibility for all retail stranded costs.

Nowhere does FERC contest the nexus between stateordered wheeling and Order 888's open access requirement.

But the existence of a nexus does not require FERC to

address retail stranded costs in light of the fact that in most

instances state regulatory commissions will have authority to

do so. Indeed, because the costs were originally included in

retail rate bases, state agencies are better positioned to

consider them. Given that it is state-ordered wheeling that

most directly causes retail costs to become stranded, we find

no reason to disturb FERC's judgment.

2. Stranded Costs Relating to Retail-Turned-Wholesale

Customers

FERC concluded that open access transmission may encourage what is known as "municipalization," where a town

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condemns a utility's distribution plant, becomes a wholesale

customer of the utility, and utilizes open access transmission

to purchase power on the competitive market. Concluding

that costs incurred to serve former retail customers may

become stranded due to the municipality's (the new wholesaler's) utilization of open access transmission, FERC decided to

serve as the primary forum for resolution of stranded costs

claims relating to new municipalizations. See Order 888-A,

p 31,048 at 30,402. FERC also decided to serve as the

primary forum "in a discrete set of municipal annexation

cases"--i.e., cases involving "existing municipal utilities that

annex retail customer service territories and, through the

availability of Commission-required transmission access, use

the transmission system of the annexed customers' former

supplier to access new suppliers to serve the annexed load."

Order 888-B, p 61,248 at 62,102. In such cases, FERC will

determine on a case-by-case basis whether there exists the

requisite nexus between municipal annexation and open access transmission. Recognizing that state regulatory authorities may be the first to address claims for stranded cost

recovery in the retail-turned-wholesale scenario (FERC's label for new municipalizations and municipal annexations),

FERC stated that it "will take into account state findings on

cost determinations ... and will give great weight in [its]

proceedings to a state's view of what might be recoverable."

Id. at 62,105 (internal quotation marks omitted).

This issue provoked the only dissents to Order 888. Although neither dissenting commissioner disputed FERC's

jurisdiction to allow recovery of these stranded costs, both

faulted FERC for second-guessing state authorities regarding

stranded costs. They thought that FERC should have acted

as the forum for adjudicating these stranded cost issues only

when state authorities failed to act altogether. See Order

888, p 31,036 at 31,904-07 (Commissioner Hoecker concurring

in part and dissenting in part); id. at 31,907 (Commissioner

Massey dissenting in part).

Unlike the dissenters, both the States and POSCR challenge FERC's assertion of jurisdiction. According to the

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States, FERC usurped their role as protectors of retail

customers by potentially undermining their rate treatment of

retail costs. POSCR makes three arguments. Advancing

claims similar to its arguments about stranded costs resulting

from state-ordered retail wheeling (see Section V.B.1.a supra), POSCR first contends, relying again on section 201(b),

that FERC lacks jurisdiction to award retail stranded costs in

the retail-turned-wholesale scenario. Second, it claims,

FERC failed to weigh properly the adverse effects of Order

888 on franchise competition between utilities and municipalities. Finally, relying on the Hoecker and Massey dissents,

POSCR argues that FERC acted arbitrarily and capriciously

by declaring itself to be the primary forum for retail-turnedwholesale stranded cost claims. For their part, the IOUs

fault FERC's failure to consider claims for recovery in the socalled "bypass" scenario. We address these arguments in

turn.

The States begin their argument by asserting that "[w]hen

retail utility customers leave the utility's system because of

municipalization, the costs stranded by the customers' migration normally are not allocable ... to whatever wholesale

utility service might be sold to the city for resale." While

this may have been true in the past, the States' argument

ignores FERC's conclusion that it is open access transmission

that makes municipalization feasible. Because FERC has

determined that it will consider proposals for stranded cost

recovery only when there is a direct nexus between municipalization and open access transmission, we see no basis for

the States' claim that FERC will "override Congress's instruction that the states be permitted to protect retail customers."

The answer to POSCR's first argument--that section

201(b) precludes FERC from awarding stranded costs in the

retail-turned-wholesale context--appears in our discussion of

FERC's jurisdiction to address retail stranded costs resulting

from state-ordered retail wheeling. See Section V.B.1.a supra. Because a town becomes a wholesale customer of the

historic supplying utility when it municipalizes, FERC's exclusive jurisdiction over all aspects of wholesale sales gives

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FERC all the authority it needs to include generation-related

costs in rates, including even costs originally incurred to

provide retail service. We find no reason to question FERC's

decision to allocate stranded costs caused by retail-turnedwholesale customers to the cost of providing wholesale service

subject to its jurisdiction. As in the retail wheeling context,

these stranded costs are properly viewed as "costs" of the

former supplying utility's provision of open access transmission service. With respect to new municipalizations, the

retail-turned-wholesale customer is able to reach a new generation supplier only because of open access transmission.

And with respect to municipal annexations, FERC will require utilities to demonstrate a nexus between the annexation

and open access transmission.

POSCR's second argument relates to what is known as

"franchise competition." According to POSCR, franchise

competition occurs "when a privately-owned utility is threatened by the prospect that a municipality may exercise powers

of eminent domain to take over the utility's operations."

POSCR argues that stranded cost recovery could impede

franchise competition, which it says FERC has always encouraged. Although this might well be true, the possibility

that potential stranded cost liability could deter municipalities

from taking advantage of open access does not undermine

Order 888. As Order 888-A explains, "the purpose of the

stranded cost policy is neither to encourage nor to discourage

municipalization, but rather to facilitate a fair transition to

competition and to ensure stability in the industry during that

transition." Order 888-A, p 31,048 at 30,405.

We turn finally to POSCR's claim that FERC acted arbitrarily and capriciously by declaring itself the primary forum

for recovery of retail-turned-wholesale stranded costs. Asserting that FERC's action implicitly undermines state decisionmaking and encourages forum shopping, POSCR claims

that Order 888's treatment of the retail-turned-wholesale

scenario contravenes agency precedent and conflicts with the

agency's decision to leave to the states the consideration of

those stranded costs resulting from state-ordered wheeling.

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While FERC did leave resolution of claims for wholesaleturned-retail stranded costs to the states in United Illuminating Co., 63 FERC p 61,212 (1993), a pre-Order 888 case

addressing a particular utility's application for stranded cost

recovery, Order 888-A explains that, after reanalyzing the

stranded cost problem, FERC concluded that "where such

costs are stranded as a direct result of Commission-mandated

wholesale transmission access, these costs should be viewed

as costs of the transition to competitive wholesale bulk power

markets and this Commission should be the primary forum

for addressing their recovery." Order 888-A, p 31,048 at

30,407. In our view, this explanation adequately distinguishes between recovery of stranded costs from retail customers and recovery from retail-turned-wholesale customers.

In the former situation customers remain retail customers

subject to state jurisdiction; in the latter situation, customers

become wholesale customers subject to FERC's exclusive

jurisdiction. This very different result justifies FERC's different treatment of the two situations.

The IOUs argue that FERC should have provided for

stranded cost recovery from a retail-turned-wholesale customer who ceases to purchase power from a utility but does not

use that utility's transmission service to reach another power

supplier--the so-called "bypass" scenario. This argument

requires little discussion. In declining to provide a mechanism for the recovery of bypass stranded costs, FERC explained that "Order No. 888 does not by its terms bar the

recovery of costs that do not result from the use of Commission-required transmission access. Utilities may, as before,

seek recovery of such non-open-access-related costs on a

case-by-case basis in individual rate proceedings. The Commission will not prejudge those issues here." Id. at 30,409.

Given FERC's discretion to proceed through adjudication

rather than by generic rule, see SEC v. Chenery Corp., 332

U.S. 194, 201-03 (1947), the IOUs' challenge is without merit.

* * *

As evidenced by the numerous petitions for review, FERC

faced an enormously difficult task in fashioning a stranded

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cost recovery mechanism that fairly compensates utilities for

past investments while transitioning the electricity industry

to competition. FERC has done an admirable job. Producing a comprehensive, evenhanded record and carefully considering all commenters' claims, it adopted a stranded cost

recovery policy that accomplishes its stated objectives, complies with the FPA, conforms to our case law, and reasonably

accommodates all competing interests. No doubt, there were

alternative approaches to stranded cost recovery--petitioners

have pointed to several. No doubt some aspects of Order 888

could have been better supported. But given the extremely

technical nature of these issues, as well as our highly deferential standard of review, we find no basis for questioning

FERC's approach. Although Order 888 may be characterized in many ways, it can hardly be said to be either arbitrary

or capricious.

VI. Credits for Customer-Owned Facilities

and Behind-The-Meter Generation

The Commission's Open Access Tariff requires that public

utilities--or "transmission providers"--offer "network integration transmission service." This requirement is one of the

key elements in the Commission's attempt to "remove impediments to competition in the wholesale bulk power marketplace," Order 888, p 31,036 at 31,634. Network service allows

a customer--for instance, a municipal utility--to use a transmission system in a manner comparable to the way the

transmission provider utilizes its system to move power from

its generators to its native load customers.11 See Order 888,

__________

11 "Load" may be defined as "[t]he total demand for service on a

utility system at any given time." Public Utilities Reports Glossary for Utility Management 84 (1992); see also Carl Pechman,

Regulating Power: the Economics of Electricity in the Information Age 11 (1993). The Tariff defines "native load customers" as

the "wholesale and retail power customers of the Transmission

Provider on whose behalf the Transmission Provider, by statute,

franchise, regulatory requirement, or contract, has undertaken an

obligation to construct and operate the Transmission Provider's

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p 31,036 at 31,736; id. at 31,751; Order 888-A, p 31,048 at

30,260 n.247; id. at 30,325.12 With network service, resources

located throughout the system serve loads dispersed throughout the system. For this, the transmission provider incorporates the network customer's resources and loads (projected

over a minimum ten-year period) into its own long term

planning. Because network service ultimately provides the

customer with the same full system ability for transmitting

power as the transmission owner, the Commission required

that costs be allocated on the basis of a ratio of the network

customer's load to the transmission provider's entire load on

its transmission system. A group of petitioners, led by

Florida Municipal Power Agency (FMPA), challenge the

Commission's use of this "load-ratio pricing."

The FMPA petitioners do not object to load-ratio pricing as

such. In fact they think it "is a good method to allocate the

costs of a transmission network among network owners or

users," Brief of Credits for Customer-Owned Facilities, etc.,

at 3-4 ("Credits Brief"). Their principal complaint, repeated

many times and in many ways throughout their briefs, stems

from their view that as a practical matter the Commission

required that the network customer's total load be used in

calculating the ratio,13 even though some customers "sell

power from local, 'behind the meter' generation and transmission, or ... obtain power from more than one transmission

system...." Id. at 8.14 The FMPA petitioners say this

__________

system to meet the reliable electric needs of such customers."

Order 888-A, p 31,048 at 30,508.

12 Public utilities must also offer point-to-point service, that is,

transmission service reserved and/or scheduled between specified

points of receipt and delivery. Order 888-A, p 31,048 at 30,508.

13 The Commission did not actually require a customer to designate its total load to obtain network service: a customer may

exclude all--not merely part--of its load at a discrete delivery

point. See Order 888-A, p 31,048 at 30,256-62.

14 "Behind the meter generation [and transmission] means generation [or transmission] located on the customer's side of the point of

delivery." Order 888-A, p 31,048 at 30,254 n.230.

allows "transmission providers to charge wholesale customers

for network transmission that they do not want, need or use

to provide electric power service to their customers." Id. at

18.

The Commission provided some relief in response to these

complaints, but not enough to satisfy the FMPA petitioners.

"Because of the diverse concerns raised by the commenters,"

the Commission wrote in the preamble to Order No. 888, "we

are unable to resolve on the basis of this record the extent to

which, or under what circumstances, cost credits related to

customer-owned facilities would be appropriate under an

open-access transmission tariff." Order 888, p 31,036 at

31,742. Rather, this will be done on a case-by-case basis.

The Commission warned, however, that mere interconnection

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er's facilities will not be sufficient to warrant a cost credit.

Relying on Florida Municipal Power Agency v. Florida

Power & Light Co., 67 F.E.R.C. p 61,167 (1994) (FMPA I),

modified, 74 F.E.R.C. p 61,006 (1996) (FMPA II), the Commission required the customer to demonstrate that its "transmission facilities are integrated with the transmission system

of the transmission provider" and "provide additional benefits

to the transmission grid in terms of capability and reliability,

and [are] relied upon for the coordinated operation of the

grid." Order 888, p 31,036 at 31,742; Order 888-A, p 31,048

at 30,271. The Commission did, however, guarantee credits

for new, integrated transmission facilities built by a customer

if jointly planned with the transmission provider.

We detect nothing in the arguments of the FMPA petitioners to warrant setting aside this aspect of the Commission's

rule. It is true that as the owners of generation and transmission facilities, any one of these petitioners can satisfy

some of its needs. But network service, as the Commission

defined it, means that network customers can call upon the

transmission provider to supply not just some, but all of their

load at any given moment, when for instance they experience

blackouts or brownouts. The Commission decided that if a

customer does not desire such full network service for its

entire load, it may exclude loads at discrete delivery points

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and purchase point-to-point service instead. What it cannot

do is split loads at delivery points. The FMPA petitioners

object to the Commission's refusal to allow a split system, but

their objection is not well-taken. They ignore the technical

problems with a split system, stemming partly from the

manner in which electrons flow and the impossibility of

isolating loads from the transmission provider's system. See

FPC v. Florida Power & Light, 404 U.S. 453 (1972). Furthermore, "such a split system creates the potential for a

customer to 'game the system' thereby evading some or all of

its load-ratio cost responsibility for network services." Order

888-A, p 31,048 at 30,259.15 The FMPA petitioners label this

prospect a "fiction," but offer neither evidence nor reasoning

to counter the Commission's expert judgment.16

As to credits, these petitioners maintain that if the Commission is going to use total "load-ratio pricing with Network

Load defined as total customer load, simultaneous credits are

required." Credits Brief at 41. What they mean by credits

is reduced prices for any and all behind-the-meter facilities

they own. The Commission's rejection of this blanket approach is well-supported. Credit may be given, but not

automatically. The question can only be determined on a

case-by-case basis because it depends on whether the customer's facilities are truly integrated with the transmission system, rather than merely interconnected. Only if they are

__________

15 Load-ratio cost responsibility is based on the customer's contribution to the transmission system peak each month. With a split

system a customer could, at the time of the monthly system peak,

increase its behind-the-meter generation in order to decrease its

load-ratio cost responsibility, while making significant use of the

transmission system throughout the rest of the month. See Order

888-A, p 31,048 at 30,259 & nn.244 & 245.

16 Petitioners claim that Florida Power Co., 81 F.E. R. C. p 61,247

(1997), decided after Order No. 888, shows that it is not "necessary

for customers to purchase amounts of network transmission equal

to their entire load behind a delivery point." Credits Brief at 30.

It shows no such thing. The case involved not network integration

transmission service, but a sort of hybrid service called "network

contract demand transmission service."

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integrated will the transmission system benefit and only then,

the Commission decided, should credits--which shift the costs

of the customer's facilities to the transmission provider's

customers--be allowed. Order 888-A, p 31,048 at 30,271.

Petitioners call the Commission's rule in this regard "an

unexplained and inexplicable retreat from FMPA v. FPL."

Credits Brief at 42. It is nothing of the sort. The Commission made this abundantly clear. In FMPA I the Commission said that "if [a customer] has transmission facilities that

will operate as part of the integrated transmission system, a

credit would be reasonable." 67 F.E.R.C. at 61,482 n.76.

And in FMPA II the Commission said that mere interconnection does not equal integration and that integration must be

determined case by case. 74 F.E.R.C. at 61,010. This is

completely consistent with the Commission's resolution of the

credits issue in the proceedings before us.

The FMPA petitioners' next objection deals with new customer facilities--that is, those built after network service

begins under the Tariff. The Commission determined that

"the Network customer shall receive a credit where such

facilities are jointly planned and installed in coordination with

the Transmission Provider." Order 888-A, p 31,048 at

30,534. Petitioners begin by reading this as some sort of

"limitation," they expand it into a "condition precedent for

customers to receive credit for new facilities," and they end

by treating it as a bar to "credits for new customer-facilities

unless they are jointly planned," Credits Brief at 43, 44, 45.

Commission counsel rightly points out that petitioners have

completely misread the rule: "simply put, the Rule does not

speak to the situation of new facilities built outside a joint

planning effort." Commission Brief at 104. The Commission

did determine that a joint planning mandate was "beyond the

scope of this proceeding," Order 888-A, p 1,048 at 30,311.

Using their mistaken premise, petitioners insist that the

Commission acted arbitrarily in this regard, giving transmission providers the power to block all customer credits for new

facilities. See Credits Brief at 45. Since their premise is

mistaken, their conclusion must be rejected. The balance of

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the FMPA petitioners' arguments have been considered and

rejected.

VII. Liability, Interface Allocation, and Discounting

As part of Order 888, FERC adopted a pro forma Open

Access Transmission Tariff (OATT), containing minimum

terms and conditions for non-discriminatory service, which

every transmission-owning public utility must file with the

Commission and by which it must abide in providing transmission services to itself and others. Various petitioners

have challenged isolated provisions of the OATT--specifically

the provisions governing liability and indemnification, interface allocation, and delivery-point specific discounting. We

reject each of these challenges.

A. Liability and Indemnification

Prior to unbundling, retail tariffs were primarily a matter

for state regulation, and most states had approved tariff

provisions permitting utilities to limit their liability for service

interruptions to instances of gross negligence or willful misconduct. Courts upheld these limitations on the public policy

grounds that they balanced lower rates for all customers

against the burden of limited recovery for some, and that the

technological complexity of modern utility systems and resulting potential for service failures unrelated to human errors

justified liability limitations. In the past, FERC also has

allowed electric utility tariffs to explicitly limit a utility's

liability for service interruptions to instances of gross negligence or willful misconduct.

One of the pro forma tariffs included in the Notice of

Proposed Rulemaking contained a provision explicitly limiting

the liability of transmission providers to circumstances of

gross negligence or intentional wrongdoing. See Open Access

NOPR, p 32,514 at App. C s 15.0. Section 10.2 of the OATT

requires the transmission customer to "at all times indemnify,

defend, and save the Transmission Provider harmless from,

any and all damages ... except in cases of negligence or

intentional wrongdoing by the Transmission Provider." Order 888, p 31,036 at 31,936-37 (emphasis added). In Order

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888, FERC justified the change with a single statement: "We

find that this new indemnification provision would be too

strict if it required customers to indemnify transmission

providers even in cases where the transmission provider is

negligent." Order 888, p 31,036 at 31,765.

The investor owned utility petitioners (IOUs) challenge the

OATT's indemnification provision on the ground that FERC

adopted the lesser ordinary negligence standard in Order 888

without first notifying interested parties that it was contemplating such a major policy change. The IOUs claim that the

change in the provision's language represents a significant

shift in indemnification policy, in that it leaves transmission

providers open to claims of ordinary negligence for the first

time. The courts consistently have relied upon explicit tariff

provisions to enforce the gross negligence standard for liability, see, e.g., Southwestern Bell Tel. Co. v. Rucker, 537 S.W.2d

326, 330-32, 334 (Tex. App. 1976); and if the tariffs do not

explicitly limit liability for ordinary negligence, the IOUs

claim, the courts will assess such matters differently. Because FERC's notice was not clear that the liability standard

was a subject or issue of the rulemaking, the IOUs claim that

FERC denied their right to comment on the change. See,

e.g., AFL-CIO v. Donovan, 757 F.2d 330 (D.C. Cir. 1985);

McLouth Steel Prods. Corp. v. Thomas, 838 F.2d 1317 (D.C.

Cir. 1988). Citing principally our opinion in Air Transport

Association of America v. DOT, 900 F.2d 369, 379 (D.C. Cir.

1990), the IOUs contend that the fact that they were able to

raise their concerns in their petition for rehearing is not a

substitute for pre-issuance notice and comment.17

FERC responds by denying that the indemnification provision adopts a particular liability standard at all. FERC

claims that it has merely distinguished liability from indemnification, and that the change to the pro forma tariff does not

establish a new, simple negligence standard of liability for

transmission providers. Citing its own statements in Order

__________

17 We recognize that Air Transport has been vacated. See Air

Transport Association of America v. DOT, 933 F.2d 1043 (1991)

(per curiam).

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888-A, FERC asserts that the tariff's indemnification provision should not be construed as preempting state liability

standards. See Order 888-B, p 61,248 at 62,080-81. FERC

maintains that, since the change to the indemnification provision does not represent a substantive alteration in policy or

the standards governing legal liability, the Commission was

not obligated to notify interested parties and seek comment.

FERC accuses the petitioners of wanting FERC to impose a

federal gross negligence liability standard, which FERC contends that it properly declined to do pursuant to United Gas

Pipe Line Co. v. FERC, 824 F.2d 417 (5th Cir. 1987) (rejecting the need for a federal liability standard for pipelines).

The IOUs charged that FERC has deleted a limitation of

liability to gross negligence from the existing background of

utilities liability law and has done so without substantial

evidence and without exercising reasoned decision making.

See Mid-Tex Elec. Coop., Inc. v. FERC, 773 F.2d 327, 338

(D.C. Cir. 1985) (the Commission's decision must be supported by substantial evidence and be the result of reasoned

decision making). The Commission denies that it has established a standard of liability nearly so sweeping as the IOUs

fear. We agree with FERC's reading of the rule. While the

petitioners argue that the rule works a "dramatic change"

regarding the liability of electric utilities by imposing an

ordinary negligence rather than a gross negligence standard

that previously prevailed, in fact, the rule does not establish a

new simple negligence standard of liability for transmission

providers. While we read FERC's interpretation of its own

rule deferentially, see Jersey Shore Broad. Corp. v. FERC, 37

F.3d 1531, 1536 (D.C. Cir. 1994), by any standard, its construction is correct in the present controversy. In the

preamble to the regulations before us, FERC plainly describes the disputed provision as an "indemnification" provision, and recites reasoning supporting the particular indemnification provision it adopted. "[T]his new indemnification

provision would be too strict if it required customers to

indemnify transmission providers even in cases where the

transmission provider is negligent." Order 888, p 31,036 at

31,765. In the preamble to Order 888-A, in a section concededly headed "Liability and Indemnification" (emphasis

added), FERC explains the later version of the relevant

provisions in terms consistent with the Order 888 preamble.

See generally Order 888-A, p 31,048 at 30,299-302. Finally,

in Order 888-B, FERC summarizes its reasoning for its

indemnification and liability decisions, again both adequately

and in ways not amounting to the adoption of the universal

standard as asserted by the IOUs. See generally Order

888-B, p 61,248 at 62,079-81. In short, FERC's rule does not

work so sweeping a change in the legal landscape as the IOUs

assert, and FERC has exercised reasoned decisionmaking in

support of such pronouncements as it has made.

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Insofar as the IOUs challenge the adequacy of FERC's

notice in the NOPR that it was contemplating a change in the

indemnification and liability provisions of pro forma tariffs,

that challenge also fails. It is well established that a final

rule need not be identical to the original proposed rule. See,

e.g., AFL-CIO v. Donovan, 757 F.2d at 338; Trans-Pacific

Freight Conference v. Federal Maritime Comm'n, 650 F.2d

1235, 1249 (D.C. Cir. 1980). Were the change between the

proposed and final rule an important one, we would have to

ask whether the final rule is a logical outgrowth of the

proposed one. See, e.g., National Mining Ass'n v. Mine

Safety & Health Admin., 116 F.3d 520, 531 (D.C. Cir. 1997).

Not all changes are sufficiently important to warrant such

scrutiny and concern, however. "An agency, after all, must

be free to adopt a final rule not described exactly in the

[notice of proposed rulemaking] where the difference is sufficiently minor, or agencies could not change a rule in response

to valid comments without beginning the rulemaking anew."

National Cable Television Ass'n v. FCC, 747 F.2d 1503, 1507

(D.C. Cir. 1984).

We agree with FERC that its indemnification provision

does not preclude the states from shielding utilities from

liability for ordinary negligence. States did so before,

through both their regulatory commissions and their courts;

and they remain free to do so under Order 888. The deletion

of the gross negligence language from the pro forma tariff's

indemnification provision does not significantly change the

petitioners' legal position. Therefore, contrary to the IOUs'

challenge, the deviation of the final rule from the proposed

one is not a major one; and FERC's failure to notify interested parties that it was considering the change does not render

the provision arbitrary or capricious under the APA. Accordingly, we affirm this portion of the pro forma tariff.

B. Interface Allocation

The IOUs also challenge FERC's treatment of interface

allocation as unsupported by the record and contrary to

reasoned decision making. Section 30.8 of the pro forma

tariff addresses how much of a transmission provider's interface capacity a network customer can use. See Order 888,

p 31,036 at 31,954-55. Interface capacity represents the capability of a transmission facility to transfer power between

two utilities. Section 30.8 permits a network customer to use

a transmission provider's capacity to the extent of the network customer's total load without limitation.

In the rulemaking process, several parties argued that a

fair method of interface allocation would be the use of a load

ratio, under which the transmission provider and each network customer would be allocated a share of each specific

interface based upon their respective loads. Nevertheless, in

Order 888, FERC ruled that network customers could use

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any of the transmission providers' interfaces to import up to

their full load on a first-come, first-served basis. The IOUs

maintain that this ruling does not promote an equitable

allocation of a transmission provider's interfaces.

The IOUs also note that, responding to the IOUs petition

for rehearing on this issue in Order 888-A, FERC merely

referenced Florida Municipal Power Agency v. Florida Power & Light Co., 74 F.E.R.C. p 61,006 (1996) (hereinafter

FMPA II), to support its conclusion, without addressing

either the comments or the rehearing petitions. FERC

meanwhile maintains it found the load ratio share method

advocated by some transmission owners to be unreasonable

for the same reasons discussed at length in FMPA II.

Intervenors add that the IOUs' challenge of the aggregate,

first-come, first-served approach adopted by FERC as inequitable merely reflects a disagreement with FERC's policy

choice.

Whether to adopt a load ratio share approach or an aggregate, first-come, first-served approach to capacity allocation is

a matter of policy. Again, the IOUs have not challenged

FERC's legal authority to select a particular interface allocation method, but rather whether FERC's choice was based

upon reasoned decision making. Accordingly, we evaluate

FERC's treatment of interface capacity allocation under the

APA's arbitrary and capricious standard. See 5 U.S.C.

s 706(2)(A) (1994).

FERC's analysis of the issue in the present rulemaking

consists solely of a reference to and quotation from its earlier

decision in FMPA II. See Order 888-A, p 31,048 at 30,304-

05. That proceeding involved an application by Florida Municipal Power Agency for open access to Florida Power &

Light Company's transmission facilities pursuant to FPA

ss 211 and 212. See FMPA II, 74 F.E.R.C. p 61,006 at

61,004; see also Florida Mun. Power Agency v. Florida

Power & Light Co., 67 F.E.R.C. p 61,167 (1994) (hereinafter

FMPA I). In FMPA I and FMPA II, FERC justified its

choice of policies as follows:

[T]here are no restrictions on the use of other parts of

the transmission system. If the interfaces are constrained, Florida Power and FMPA should simply redispatch and share the redispatch costs and, ultimately,

Florida Power will build new facilities when needed.

The interfaces are just another part of the transmission

grid, and Florida Power must plan and operate the grid,

including the interfaces, to meet the combined needs of

Florida Power and FMPA on an equal basis. When

there are conflicting needs to use the same interface

capacity, the parties have already agreed that the combined Florida Power and FMPA systems will be redispatched and the costs shared. When the grid, including

interfaces, needs to be expanded, Florida Power will

undertake the expansion on behalf of the combined system.

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FMPA II, 74 F.E.R.C. p 61,006 at 61,018 (quoting FMPA I,

67 F.E.R.C. p 61,167 at 61,484). While FERC's recognition of

the petitioners' concerns was certainly cursory, and its language in FMPA II is slightly oblique, FERC has adequately

demonstrated that it gave full consideration before rejecting

load ratio share in favor of aggregate, first-come, first-served

capacity allocation. Accordingly, we uphold FERC's ruling

on the interface capacity allocation issue.

C. Delivery-Point-Specific Discounting

Two groups of transmission dependent utilities, TAPS and

TDU Systems, and the nation's largest power wholesaler,

Enron Power Marketing (collectively the U&D petitioners),

challenge FERC's decision to permit delivery-point-specific

discounting. Electric utilities often offer both firm and nonfirm service. Firm service permits customers to demand

transmission at any time, while non-firm service permits the

utility to cut service when there is not enough excess capacity.

In Order 888, FERC allowed transmission providers to

offer discounted rates for non-firm service only if they gave

the same discounted rate to all customers for the same

transmission path and on all other unconstrained transmission paths. See Order 888, p 31,036 at 31,743-44. FERC

also required that the discounts be posted in advance so that

all customers could have equal opportunity to take advantage

of the discounted rate. See id. at 31,744. In Order 888-A,

FERC narrowed the requirement, so that a transmission

provider offering a discount on a particular path need only

provide the same discount to all other unconstrained paths

that go to the same delivery point on the provider's system.

See Order 888-A, p 31,048 at 30,275-76. FERC also said that

a transmission provider should discount only if necessary to

increase throughput on its system. See id. at 30,274.

The U&D petitioners contend that delivery-point-specific

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sions. Delivery-point-specific discounting permits transmission facility owners to select the delivery points for which

they will discount firm and non-firm service. The U&D

petitioners argue that this discounting method allows transmission facility owners to discriminate by denying discounts

to the delivery points used by the TDUs, thereby raising the

transmission costs of these competitors, and in turn decreasing competition at both retail and wholesale.

Additionally, because of the subordination and interruptibility of non-firm service, the U&D petitioners claim that

FERC's longstanding pricing policies utilized discounting as

the mechanism for ensuring that non-firm service was priced

below firm service. The notice of proposed rulemaking emphasized FERC's reliance on non-discriminatory discounting

to achieve higher firm service rates than non-firm rates, so

that non-firm rates would reflect the interruptibility of

transmission services and be economically efficient. The petitioners argue that FERC's decision in Order 888 to deny

discounting of non-firm rates unless firm rates are also discounted an unexplained reversal of that longstanding pricing

policy. By adopting a delivery-point-specific discounting

rule, the petitioners claim that FERC subjects TDUs to firm

rates for all non-firm service. As a result, the petitioners

contend, the price that TDUs have to pay for non-firm

service does not reflect the interruptibility of that service.

The petitioners maintain that this aspect of FERC's order

itself represents undue discrimination, and that FERC failed

to explain why it rejected a compromise position which

would restrict opportunities for discrimination and address

concerns that the new rules discourage discounting.

FERC notes that it discussed the discounting issue in

Orders No. 888, 888-A, and 888-B. See Order 888, p 31,036 at

31,743-44; Order 888-A, p 31,048 at 30,272-76; Order 888-B,

p 61,248 at 62,072-75. FERC accuses the petitioners of

wanting the Commission to require transmission providers to

discount all non-firm services below firm rates regardless of

the facts of the particular case. FERC asserts that it did not

seek to discourage discounting, but was concerned that if it

required discounting on all unconstrained paths as a condition

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for offering discounts, transmission providers would be discouraged from offering any discounts at all. Fewer discounts

could lead to decreased use of transmission services, and

therefore a decline in overall transmission revenues, and a

corresponding increase in transmission rates to enable transmission providers to recover their costs. FERC maintains

that the petitioners, like everyone else, retain the opportunity

to compete with the transmission provider for power sales to

the same delivery point at the same discounted rate. FERC

argues that its orders are consistent with its established

pricing policy of permitting flexibility to reflect interruptibility and efficient use of the transmission system, subject to the

firm price cap. In most cases, FERC expects that non-firm

transmission rates will be priced below the firm rate.

Although the petitioners hint at a statutory claim by alleging that FERC's orders result in undue discrimination and

higher rates in violation of the FPA's statutory mandate, the

petitioners generally confine themselves to arguing that

FERC's decisions to permit delivery-point-specific discounting and non-firm rates equal to firm rates represent unexplained departures from established policy. We therefore

analyze this issue under the arbitrary and capricious standard

of the APA. See 5 U.S.C. s 706(2)(A).

With respect to non-firm versus firm rates, the cases cited

by the petitioners as demonstrating a previously established

discounting policy actually establish that FERC addresses

this issue on a case-by-case basis. For example, in Kentucky

Utilities Co., 15 F.E.R.C. p 61,002 (1981), FERC said that the

utility could not allocate capacity costs to non-firm transmission service since such service did not factor into the utility's

capacity decisions. In contrast, in Central Maine Power Co.,

60 F.E.R.C. p 61,285 (1992), while FERC noted that non-firm

service generally warrants a rate lower than firm service,

FERC also upheld the utility's decision not to offer non-firm

rate discounts on several contracts. Indeed, the petitioners

acknowledge that FERC's pre-Order 888 Transmission Pricing Policy Statement, 59 Fed. Reg. 55,031 (1994), does not

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expressly require non-firm rates to be priced below firm rates

in all cases. See Br. of U&D Petitioners at 24 n.30.

The petitioners cite American Electric Power Service

Corp., 82 F.E.R.C. p 61,090 (1998), for the proposition that,

after adopting delivery-point-specific discounting, FERC has

refused to consider whether non-firm rates should be lower

than firm rates; but in that case, FERC did consider that

issue, found the rates in question to be nondiscriminatory,

and refused only to consider the petitioners' generic challenges to its broader policy of flexibility. Additionally, the

petitioners charge that FERC's acceptance of firm rates for

non-firm service conflicts with this court's decision in Fort

Pierce Utilities Authority v. FERC, 730 F.2d 778, 788-89

(D.C. Cir. 1984); but in that case, this court merely noted

that FERC had failed to reconcile its decision to allocate

capacity costs to non-firm transmission service with its previous refusal to do so in Kentucky Utilities, and remanded for

further consideration. In short, FERC does not appear to

have changed its overall pricing policy at all, except to fine

tune its guidance as to when discounting might be considered

discriminatory.

Which brings us to whether delivery-point-specific discounting in fact discriminates against the TDUs. Essentially,

FERC and the petitioners offer conflicting discounting theories, both of which seem plausible. In its request for rehearing, TAPS observed that, by allowing transmission providers

to select which delivery points merit discounts, FERC permits the providers to select for discounting those delivery

points which serve their affiliates, and not to select the

similarly situated delivery points which serve the TDUs. On

rehearing, FERC quite logically maintained that requiring

transmission providers to apply discounts to all unconstrained

transmission paths could discourage discounting generally,

resulting in higher rates for all. See Order 888-A, p 31,048 at

30,275. FERC subsequently asserted that requiring transmission providers to offer the same discount for the same

time period on all unconstrained paths that go to the same

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delivery point will achieve sufficient comparability. See Order 888-B, p 61,248 at 62,075. FERC noted that it will be

able to monitor the discounting behavior of transmission

providers for discrimination through the data posted on OASIS. See id.

The record reflects that FERC considered fully all of the

arguments, and concluded that delivery-point-specific discounting best accomplished comparability while encouraging

discounting. Thus, the discounting policies outlined in Orders

888, 888-A, and 888-B are not arbitrary or capricious. We

therefore affirm FERC's resolution of this issue.

VIII. Tariff Terms and Conditions

A. Headroom Allocation

Firm point-to-point service, as distinguished from network

service, is transmission service reserved and/or scheduled

between specified points of receipt and delivery. See Order

888-A, p 31,048 at 30,508. Point-to-point customers may not

need all the service for which they contracted. The Commission decided that they may, without extra charge, use their

excess capacity to make firm sales between the receipt and

delivery points specified in their agreement. Section 22.1 of

the Tariff gives them another option for dealing with this

"headroom." The point-to-point customer may, without

charge, have the public utility provide transmission on a nonfirm basis over receipt and delivery points other than those

specified in the service agreement (so-called "secondary"

points).

Network customers describing themselves as Transmission

Dependent Utilities (TDUs) contend that the flexibility given

to point-to-point customers to sell their unused capacity

should also be given to them. Three transmission providers18

--the CPL petitioners--want restrictions placed on point-to-

_____________

18 Carolina Power & Light Company (CPL), Florida Power &

Light Company and Niagara Mohawk Power Corporation.

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point customers in order to avoid putting the customers at a

competitive advantage. The Commission refused to adopt

these proposals for reasons we believe are sound.

As to transmission providers, the Commission noted that if

they want to make off-system sales they too must take pointto-point service; in doing so they gain the same flexibility as

regular point-to-point customers. See Order 888, p 31,036 at

31,751. For network customers, the Commission stated that

they "are not obligated to take network transmission service"

and if they "want to take advantage of the as-available, nonfirm service over secondary points of receipt and delivery

through the point-to-point service, they may elect to take firm

point-to-point transmission service in lieu of the network

service." Order 888-A, p 31,048 at 30,253. The Commission

properly insisted on maintaining its basic distinctions between

network service and point-to-point service. Unlike a point-topoint customer, a network customer's rights are defined in

terms of capacity needed, and thus "vary as the customer's

load varies," rendering them not sufficiently definite and

defined to be "reassignable in the secondary market." Id. at

30,223. At least one of the TDUs agreed with the Commission "that, because there is no fixed capacity reservation for

network customers, allowing them unrestricted use of capacity to make off-system sales without additional charge would

give such customers a competitive advantage over [point-topoint] customers." Terms and Conditions Brief at 11.19

B. Headroom Prioritization

Some petitioners complain that secondary non-firm pointto-point customers should not have been placed in a status

below non-firm point-to-point customers and that the Com-

_______________

19 These petitioners add that the Vermont Department of Public

Service (VDPS) offered a solution to the problem but the Commission overlooked it. Terms and Conditions Brief at 12. This is not

correct. The Commission did consider the Vermont proposal, finding it to be an "artifice derived from the load ratio share calculation," a "formula [that] does not result in a reassignable capacity

right." Order 888-A, p 31,048 at 30,223.

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mission offered no explanation for its doing so. See Terms

and Conditions Brief at 14-17. The Commission did explain

itself. Firm point-to-point customers are permitted to designate secondary receipt and delivery points at no extra charge

and therefore "are properly accorded a lower priority than

stand alone, non-firm transmission." Order 888-A, p 31,048

at 30,281. Furthermore, the Commission promised to reevaluate its approach in response to any "future transmission rate

proposal that is based on the concept of tradable capacity

rights," but it was moving cautiously because in the electric

utility industry (unlike the natural gas industry) such "trading

rights simply do not exist at this time." Id.

C. Duplicative Charges

The TDU petitioners argue that the new rules cause them

to be double-charged in certain transactions. They first

object to the Commission's decision that in power exchanges

(flows in one direction for a time and then flows in the

opposite direction) each party must reserve and pay for

transmission along the same path. See Terms and Conditions

Brief at 18. The Commission's response was that traditionally and "from the transmitting utility's planning and reservation perspective," the power exchange consists of two one-way

transmission services. Commission Brief at 115. Petitioners

offer no legal basis for us to prefer their treatment to that of

the agency and so we will not disturb the Commission's

approach.

Petitioners' second objection is that the Tariff double

counts network load served by two separate energy suppliers

because, "[i]f two separate suppliers purchase network service to supply a portion of the load for a particular customer,

the entire load of the customer is included in calculating the

reservation charges paid by both supplying network customers, unless each load portion is isolated electrically from the

other." Terms and Conditions Brief at 21. We confess to

some difficulty in comprehending petitioners' complaint. It

seems perfectly reasonable to answer, as the Commission's

counsel does, that "there is no rational basis for both the

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plier to designate the same load under the Tariff." Commission Brief at 115. The power supplier itself may, the Commission pointed out, purchase network service; we cannot see

why both the power supplier and the power buyer would

purchase such service when a purchase by either would

suffice. Petitioners seem to concede that in some instances

the double-counting problem could be avoided in this manner,

yet they think that in some other, ill-defined circumstance it

could not. This rulemaking set forth the standard tariff

terms. If petitioners, or any one of them, have some unique

circumstances warranting an adjustment, there will be time

enough for them to seek relief from the Commission.

D. Multiple Control Areas

Network customers may wish to serve loads in two or more

control areas. Some commenters were concerned that such

customers would have to pay a network transmission rate to

two or more transmission providers based on the customer's

total load. See supra Section VI (credits for customers).

The Commission had several responses. First, the risk could

be avoided or alleviated by the customer's purchasing pointto-point service, or a combination of network and point-topoint service at discrete delivery points (thereby reducing its

load ratio). Or the customer could purchase network service

alone in each transmission provider's control area. See Order

888-B, p 61,248 at 62,096 n.157. If the customer insists on

foregoing the last option, it can hardly expect that the

additional service it is demanding--the moving of power from

one transmission provider's system to another system--

should be free of charge. As the Commission put it:

Because the additional transmission service to nondesignated network load outside of the transmission provider's control area is a service for which the transmission provider must separately plan and operate its system beyond what is required to provide service to the

customer's designated network load [within the control

area], it is appropriate to have an additional charge

associated with the additional [point-to-point] service.

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Order 888-A, p 31,048 at 30,255, quoted in Order 888-B, 81

F.E.R.C. p 61,248 at 62,096. This is consistent with the

handling of an analogous situation involving separate transmission systems in the past. See Fort Pierce Utils. Auth. v.

FERC, 730 F.2d 778, 781-85 (D.C. Cir. 1984).20

E. Right-of-First-Refusal

In order to preserve the certainty and continuity of transmission service, the Commission granted existing customers a

right-of-first-refusal (ROFR) upon the expiration of firm contracts exceeding one year provided that the existing customer

agreed to match the contract price and term of any party

competing for that service. See Order 888, p 31,036 at 31,665.

The Commission did not set an upper limit on the terms that

a competing party could offer, but chose instead to allow the

market to determine rates and terms. Petitioners argue that

the Commission's failure to establish an upper limit should be

set aside and remanded for further consideration. The Commission conceded error on this point at oral argument in light

of United Gas Distribution Cos. v FERC, 88 F.3d 1105, 1138-

40 (D.C. Cir. 1996). We therefore remand this matter to the

Commission so that it may provide a reasonable cap on

contract extensions.21

________________

20 Petitioners claim that the Commission failed to consider a

particular proposal related to this subject. See Terms and Conditions Brief at 33. It is unnecessary to describe the proposal. All

that need be said is that the Commission rejected a nearly identical

proposal and gave its reasons for doing so. See Order 888-B,

p 61,248 at 62,096.

21 The TDU petitioners stated in their reply brief that Commission counsel's explanation of s 13.2 of the Tariff, as amended in

Order No. 888-A and as interpreted in Madison Gas & Electric Co.,

82 F.E.R.C. p 61,099 at 61,372 (1998), to apply only to short term

customers satisfies their objection. See Terms and Conditions

Reply Brief at 25. The remaining arguments of these petitioners

not discussed in this part or in part V have been considered and

rejected.

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IX. National Environmental Policy Act and

Regulatory Flexibility Act Compliance

A. NEPA Compliance

One investor-owned utility, Public Service Electric & Gas

Company ("PSE&G"), claims that FERC failed to comply

with the National Environmental Policy Act ("NEPA"), 42

U.S.C. ss 4321 et seq. It argues first that the base case

FERC adopted to evaluate the effects of open access transmission was unreasonable because it "defined away" the

effects of open access. Second, it argues, FERC acted

arbitrarily and capriciously by failing to undertake measures

to mitigate the environmental impact of Order 888.

1. Adequacy of Base Case

NEPA requires federal agencies contemplating a major

action "significantly affecting the quality of the human environment" to prepare a thorough analysis of the action's

environmental impact. 42 U.S.C. s 4332(C). The statute

requires that environmental impact studies include "a detailed

statement ... [of] alternatives to the proposed action." Id.

s 4332(C)(iii).

In its environmental impact study prepared in connection

with Order 888, FERC identified as the base case alternative

a scenario that "maintain[s] the status quo." FERC Final

Environmental Impact Statement, Promoting Wholesale

Competition through Open Access Non-discriminatory

Transmission Services by Public Utilities and Recovery of

Stranded Costs by Public Utilities and Transmitting Utilities at 2-1 (Apr. 1996) ("FEIS"). Under that scenario, FERC

would continue on a case-by-case basis to (1) condition approval of mergers and applications for sales at market rates

on the filing of open access tariffs and (2) approve open

access wheeling orders under section 211 of the FPA. Id.

Several commenters (including EPA) argued that FERC

should adopt as its base case an alternative that freezes the

status quo, i.e., assumes that no further open access transmission of any kind occurs and that efficiency in the industry

remains unchanged. See id. at 6-1. Characterizing this

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"frozen efficiency" case as unreasonable, FERC declined to

adopt it as the base case. See id. at 6-9-6-14. It nevertheless conducted sensitivity analyses comparing emissions under the frozen efficiency case with those under its base case.

This comparison revealed "modest" reductions in emissions

under the frozen efficiency case in certain circumstances. Id.

at 6-4. When market conditions favor coal versus natural

gas, NOx emissions under the base case are higher than

under the frozen efficiency case by two percent in 2000, three

percent in 2005, and five percent in 2010. Id. at 6-15. But

when market conditions favor gas, the base case produces

more favorable environmental benefits for all three years.

Id. at 6-17.

We evaluate agency compliance with NEPA under a rule of

reason standard. "[A]s long as the agency's decision is 'fully

informed' and 'well-considered,' it is entitled to judicial deference and a reviewing court should not substitute its own

policy judgment." Natural Resources Defense Council, Inc.

v. Hodel, 865 F.2d 288, 294 (D.C. Cir. 1988) (quoting North

Slope Borough v. Andrus, 642 F.2d 589, 599 (D.C. Cir. 1980)).

PSE&G argues that FERC, in adopting its base case,

"defined away" the impact of open access by comparing the

environmental effects that would result from immediate implementation through Order 888 to those that would result

from gradual implementation. Calling FERC's evaluation of

the frozen efficiency case "cursory," PSE&G contends that

the proper no action base case is not to implement open

access at all.

Given the terms of NEPA and our highly deferential

review, we think FERC's FEIS complied with the statute.

For one thing, NEPA does not require that a certain alternative be adopted as the base case. Rather, NEPA requires

that agencies include in their FEIS analysis of "alternatives

to the proposed action." 42 U.S.C. s 4332(C)(iii). Thus

there is no merit to the contention that NEPA requires

FERC to adopt the frozen efficiency case as the base case.

We agree with PSE&G that one of the alternatives NEPA

requires FERC to consider is the alternative of no action.

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But based on our own examination of the FEIS, we think that

FERC devoted sufficient attention to evaluating the frozen

efficiency case (what PSE&G calls the no action alternative)

to satisfy NEPA's requirements. In conducting sensitivity

analyses to its base case, FERC identified the changes in

both NOx and CO2 emissions that the frozen efficiency case

would produce. Given that FERC's comparison of the frozen

efficiency case to its base case yielded little difference, the

agency had no reason to conduct further analysis. By rigorously examining the frozen efficiency case, even though it

believed the case to be unreasonable, FERC ensured that its

decision was "fully informed" and "well-considered." Hodel,

865 F.2d at 294.

2. Failure to Adopt Mitigation Measures

PSE&G argues that FERC acted arbitrarily and capriciously by failing to adopt measures to mitigate the expected

harmful environmental effects of Order 888. Noting that an

agency must consider mitigation if the proposed action would

result in adverse environmental impacts, FERC considered

but ultimately rejected any mitigation measures. See FEIS

s 7. In reaching this conclusion, FERC relied on (1) the fact

that any mitigation measures it might undertake are unwarranted in view of Order 888's small impact (especially given

that its effects are as likely to be beneficial as harmful) and

(2) its lack of expertise in atmospheric chemistry, together

with the fact that any impact of open access would be

"dwarfed by the far larger existing ozone and NOx emission

issues" currently being dealt with by EPA under its Clean

Air Act authority. FEIS at 7-47-7-48.

The heart of PSE&G's challenge is this: downwind utilities,

which are subject to NOx reduction requirements, will face

increased compliance costs due to the purported increase in

emission levels resulting from Order 888; by comparison,

upwind utilities that generate the pollution but are not subject to NOx reduction requirements will experience no increased costs. PSE&G insists that FERC remedy this "undue preference" for upwind utilities.

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Given that FERC has identified only small increases in

emissions resulting from open access transmission--indeed,

under some circumstances, the Commission predicted small

decreases--we think it was entirely reasonable for FERC to

decline to adopt mitigation measures to address a problem

that it believed might not even develop. Not relying solely

on Order 888's relatively insignificant environmental impact,

however, FERC comprehensively analyzed proposed mitigation measures, explaining why it declined to require any. In

light of this thorough analysis, we think FERC's conclusion--

that NOx emission increases resulting from Order 888, if any,

are best addressed by EPA and the states through a comprehensive emissions control program--is hardly arbitrary or

capricious. We therefore have no need to resolve the parties'

debate about FERC's legal authority to order environmental

mitigation.

PSE&G also argues that FERC employed unreasonable

assumptions in the FEIS and ignored its own data showing

adverse environmental impacts. In our view, these arguments amount to an effort by PSE&G to substitute its own

analysis for FERC's. To prevail in this court, it must demonstrate that FERC's analysis is arbitrary and capricious, a

showing it has fallen far short of making.

B. Regulatory Flexibility Act Compliance

The Regulatory Flexibility Act requires agencies to conduct

a regulatory flexibility analysis for any final rule. The Act

exempts agencies from this requirement if they certify that

"the rule will not, if promulgated, have a significant economic

impact on a substantial number of small entities." 5 U.S.C.

s 605(a)-(b). Invoking this exemption, FERC certified that

both Order 888 (open access) and Order 889 (OASIS and

standard of conduct rules) would have no such impact. Order

888, p 31,036 at 31,896; Order 889, p 31,035 at 31,628.

The TDU petitioners claim that FERC failed adequately to

consider the impact of Orders 888 and 889 on nonjurisdictional entities that may have to provide open access transmission

and file open access tariffs under the orders' reciprocity

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jurisdictional utilities are classified as small entities. According to TDU petitioners, the orders impose a significant economic burden on them, requiring compliance activities as well

as alterations to their operations.

Although the RFA's judicial review provision was amended

in 1996, see Small Business Regulatory Enforcement Fairness

Act, Pub. L. No. 104-121, tit. II, 110 Stat. 857 (1996), the

TDU petitioners and FERC agree that the pre-amendment

version of the RFA applies in this case. Under that version,

our review is quite narrow. Section 611(b) provided that

"[a]ny regulatory flexibility analysis ... and the compliance

or noncompliance of the agency with the provisions of this

chapter shall not be subject to judicial review. When an

action for judicial review of a rule is instituted, any regulatory

flexibility analysis for such rule shall constitute part of the

whole record of agency action in connection with the review."

5 U.S.C. s 611(b) (1994). We have interpreted this language

to mean that " 'a reviewing court should consider the regulatory flexibility analysis as part of its overall judgment whether a rule is reasonable and may, in an appropriate case, strike

down a rule because of a defect in the flexibility analysis.'

We emphasize[ ], however, that 'a major error in the regulatory flexibility analysis may be, but does not have to be,

grounds for overturning a rule.' " Mid-Tex Elec. Co-op, Inc.

v. FERC, 773 F.2d 327, 340-41 (D.C. Cir. 1985) (quoting

Small Refiner Lead Phase-Down Task Force v. EPA, 705

F.2d 506, 537-39 (D.C. Cir. 1983)).

In this case, FERC explained that Orders 888 and 889,

considered in their entirety, do not have a "significant" impact on a "substantial" number of small entities. According

to FERC, the orders will affect nonjurisdictional utilities only

in the limited situation where they take advantage of a

jurisdictional utility's open access transmission tariff. Given

our highly deferential standard of review, and given the fact

that petitioners have offered nothing other than their own

views to the contrary, we have no basis for questioning

FERC's judgment.

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FERC, moreover, was not insensitive to the potential impact of Order 888 on small nonjurisdictional entities. Order

888 contains a waiver provision allowing these entities to seek

an exemption from compliance with the reciprocity conditions.

See 18 C.F.R. s 35.28(e)(2) (allowing nonjurisdictional utilities

to file a request for waiver "for good cause shown"). As of

March 1997, FERC had granted waivers to thirty-six small

entities. See Order 888-A, p 31,049 at 30,578.

Most important in view of our standard of review, nothing

in petitioners' arguments causes us to question the reasonableness of the reciprocity provisions themselves. See MidTex, 773 F.2d at 340-41. We therefore affirm FERC's RFA

certification.

Conclusion

In summary, we affirm Orders 888 and 889 in all respects

except as specifically provided above.

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