Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-05-01052/USCOURTS-caDC-05-01052-0/pdf.json

Parties Involved:
Federal Energy Regulatory Commission
Respondent
Interstate Natural Gas Association of America
Petitioner

Document Text:

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued September 11, 2006 Decided November 17, 2006

No. 04-1183

NATIONAL FUEL GAS SUPPLY CORPORATION,

PETITIONER

v.

FEDERAL ENERGY REGULATORY COMMISSION,

RESPONDENT

PUBLIC SERVICE COMMISSION OF THE STATE OF NEW YORK,

ET AL.,

INTERVENORS

Consolidated with

04-1302, 04-1318, 04-1338, 05-1042, 05-1048, 05-1051,

05-1052, 05-1055

On Petitions for Review of Orders of the

Federal Energy Regulatory Commission

Howard L. Nelson argued the cause for Interstate Gas

Pipeline Company Petitioners. With him on the briefs were

Joan Dreskin, Timm Abendroth, Janice A. Alperin, Mark C.

Schroeder, David W. Reitz, and Kenneth B. Driver. Richard D.

Avil, Jr. entered an appearance.

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 1 of 26
2

Christopher J. Barr argued the cause for Local Distribution

Company Petitioners. With him on the briefs were Anne K.

Kyzmir, Jeffrey M. Petrash, William A. Williams, and David W.

Reitz. Michael A. Reville entered an appearance.

Lawrence G. Acker argued the cause for petitioner Calypso

U.S. Pipeline, LLC. With him on the briefs was Brett A. Snyder.

Samuel Soopper, Attorney, Federal Energy Regulatory

Commission, argued the cause for respondent. With him on the

brief were John S. Moot, General Counsel, and Robert H.

Solomon, Solicitor.

Before: GINSBURG, Chief Judge, and GRIFFITH and

KAVANAUGH, Circuit Judges.

Opinion for the Court filed by Circuit Judge KAVANAUGH.

KAVANAUGH, Circuit Judge: The Natural Gas Act of 1938

provides that “[n]o natural-gas company shall, with respect to

any transportation or sale of natural gas . . . make or grant any

undue preference or advantage to any person or subject any

person to any undue prejudice or disadvantage.” 15 U.S.C.

§ 717c(b)(1). The Act’s fundamental purpose is to protect

natural gas consumers from the monopoly power of natural gas

pipelines. See Associated Gas Distribs. v. FERC, 824 F.2d 981,

995 (D.C. Cir. 1987). Congress has directed the Federal Energy

Regulatory Commission to enforce the statute and regulate the

pipelines. Since the 1980s, FERC has done so primarily through

open-access rules that require pipelines to carry gas on equal

terms and not to grant undue preferences or discriminate in favor

of gas sold by the pipeline itself. See id. at 996; United

Distribution Cos. v. FERC, 88 F.3d 1105, 1123-27 (D.C. Cir.

1996).

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 2 of 26
3

In 1988, acting pursuant to its statutory authority, FERC

issued Standards of Conduct to regulate natural gas pipelines’

interactions with their “marketing affiliates.” (Marketing

affiliates are the separate affiliates of pipelines that sell natural

gas; the affiliates arrange to purchase gas at the wellhead and to

transport and distribute it to buyers.) The Standards required

pipelines and their marketing affiliates to function independently

and imposed restrictions on the sharing of information between

them. FERC promulgated those rules because of (i) the

theoretical threat that pipelines would favor their marketing

affiliates by selectively divulging information about pipeline

operations, thereby impeding market competition; and (ii) a

factual record consisting of complaints by other sellers who

were competing with pipelines’ marketing affiliates and of

documented abuses by pipelines and their marketing affiliates.

The pipelines petitioned for review, but we denied the

petition in relevant part. We recognized that FERC must take

into account the substantial efficiencies and benefits of vertical

integration. We nonetheless upheld the Order because FERC

had sufficiently demonstrated both a theoretical threat of

pipelines granting undue preferences to their marketing affiliates

and substantial record evidence of actual abuse. See Tenneco

Gas v. FERC, 969 F.2d 1187, 1197 (D.C. Cir. 1992). 

In 2004, FERC significantly revised and extended the

Standards so that they would apply to pipelines’ relationships

not only with marketing affiliates but also with other entities in

the industry (such as producers, gatherers, processors, and

traders) that are affiliated with pipelines. In vastly expanding

the reach of the Standards, FERC again relied on both a claimed

theoretical threat – this time, of pipelines granting undue

preferences to those non-marketing affiliates – and record

evidence that, according to FERC, indicated that abuse by

pipelines and non-marketing affiliates was a real problem in the

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 3 of 26
4

industry. The two dissenting FERC Commissioners objected,

however, that the factual record on which FERC relied was

barren and did not contain a single example of abuse involving

non-marketing affiliates, much less evidence of an industry-wide

problem.

 

Several pipelines petitioned for review in this court. We

conclude that FERC’s asserted factual premises do not withstand

scrutiny and that the Order does not reflect the reasoned

decisionmaking required by the Administrative Procedure Act.

We therefore hold that the Order is arbitrary and capricious as

applied to natural gas pipelines. We will grant the petition,

vacate the Order as applied to natural gas pipelines, and remand.

Because of our disposition, we need not consider the separate

arguments against the Order raised by Calypso U.S. Pipeline and

the local natural gas distribution companies.

I

1. The natural gas supply chain consists of a variety of

entities. Some of them, such as producers, gatherers, processors,

pipelines, and local distribution companies, perform the physical

processes required to extract, refine, transport, and distribute

gas. Other entities, such as marketers and traders, operate on the

financial side, coordinating sales and trading in the natural gas

commodity market.

Producers establish new wells and extract natural gas from

the ground. Gatherers transport the gas from the wellhead to a

processing plant. From there, processors distill “pipeline

quality” natural gas by removing various hydrocarbons and

fluids (some processing is done initially at the wellhead or later

in the supply chain). Natural gas pipelines (either intrastate or

interstate) carry gas to local distribution companies and to large

industrial and commercial customers. Finally, local distribution

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 4 of 26
5

companies deliver gas to retail consumers, subject to price

regulation by state utility commissions. 

Natural gas marketers sell natural gas and oversee the steps

needed to arrange transportation of gas from the wellhead to the

end-user. Frequently affiliated with another entity (such as a

producer or pipeline), marketers identify customers, arrange gas

transportation and storage, and ensure that adequate supplies are

available to satisfy the purchasers’ demand. 

In recent years, entities referred to as natural gas traders

have actively participated in the natural gas spot market and the

natural gas derivatives market. In the spot (or physical) market,

traders enter into contracts for the near-term delivery of natural

gas. In the derivatives market, traders buy and sell derivative

instruments like futures that are based on the underlying natural

gas commodity. Traders participate in those markets primarily

to hedge against risk or to profit from speculation on future price

changes. 

2. Like railroads, water pipelines, cable television lines,

and telephone lines, natural gas pipelines traditionally have been

considered natural monopolies. In other words, the costs of

entering the market are so high (because of the large fixed cost

of building a pipeline) that it is most efficient for only one firm

to serve a given geographical region. See RICHARD A. POSNER,

ECONOMIC ANALYSIS OF LAW § 12.1, at 343-46 (4th ed. 1992);

see also United Distribution Cos. v. FERC, 88 F.3d 1105, 1122

& n.4 (D.C. Cir. 1996); Associated Gas Distribs. v. FERC, 824

F.2d 981, 1010 (D.C. Cir. 1987). As natural monopolies,

pipelines if unregulated would possess the ability to engage in

monopolistic pricing for transportation services and discriminate

against unaffiliated entities that seek to transport gas.

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 5 of 26
6

As this court has explained, federal regulation of the natural

gas industry is “designed to curb pipelines’ potential monopoly

power over gas transportation.” United Distribution Cos., 88

F.3d at 1122. Federal regulation began in 1938 after Congress

passed and President Franklin Roosevelt signed the Natural Gas

Act. 52 Stat. 821 (codified as amended at 15 U.S.C. §§ 717 et

seq.). That Act conferred jurisdiction on FERC’s predecessor,

the Federal Power Commission, to regulate the interstate

transportation and sale of natural gas. See 15 U.S.C. §§ 717(b),

717d(a). The Act also established a certification system and

required the Commission to ensure that all rates were “just and

reasonable” and that natural gas companies did not grant “undue

preference[s].” See id. §§ 717c, 717d, 717f(c)(1)(a). Under this

system, the Commission for decades regulated both the wellhead

price and the “city gate price” (the price charged by pipelines to

end-users and local distribution companies). See generally

STEPHEN G. BREYER & PAUL W. MACAVOY, ENERGY

REGULATION BY THE FEDERAL POWER COMMISSION 56-88

(1974). 

In 1978, Congress passed and President Carter signed the

Natural Gas Policy Act, Pub. L. No. 95-621, 92 Stat. 3350. That

Act began the gradual deregulation of prices at the wellhead. In

the aftermath of the Act and as a result of other legal and

economic developments in the early 1980s, FERC launched a

new regulatory approach. The Commission concluded that it

could best fulfill the statutory purposes by allowing customers

to purchase gas at the wellhead free from regulation and by

preventing pipelines from abusing their monopoly power over

the transportation of gas. At the time, pipelines served not just

as transporters of gas but also as the primary gas marketers:

They would purchase gas at the wellhead themselves, transport

it over their systems, and sell it to local distribution companies

or other end-users. See Associated Gas Distribs., 824 F.2d at

993. The problem was that pipelines could exclude third parties

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 6 of 26
7

from using the transmission facilities when pipelines wanted to

favor the pipelines’ own sales. See id. 

To achieve its regulatory goals, FERC issued its landmark

Order 436 in 1985. See Regulation of Natural Gas Pipelines

After Partial Wellhead Decontrol, Order No. 436, F.E.R.C.

Stats. & Regs. ¶ 30,665, 50 Fed. Reg. 42,408 (1985) (rehearing

orders omitted). Order 436 declared the bundling of

transportation and marketing services “unduly discriminatory”

and conditioned “blanket certification” (which allowed pipelines

to avoid costly individual certifications) on non-discriminatory

“open access” to pipelines’ transmission facilities. The Order

served to help deregulate the sales market, where there are no

natural barriers to market competition, while simultaneously

preventing anti-competitive activity by the monopolistic

pipelines in the transportation market. This court upheld the

regulatory scheme as consistent with FERC’s authority to

prevent natural gas companies from granting undue preferences.

See Associated Gas Distribs., 824 F.2d at 1044 (approving bulk

of Order); Regulation of Natural Gas Pipelines After Partial

Wellhead Decontrol, Order No. 500, F.E.R.C. Stats. & Regs.

¶ 30,761, 52 Fed. Reg. 30,334 (1987) (readopting in large part

Order 436); Am. Gas Ass’n v. FERC, 888 F.2d 136, 153 (D.C.

Cir. 1989) (remanding record of Order 500); Am. Gas Ass’n v.

FERC, 912 F.2d 1496, 1503, 1520 (D.C. Cir. 1990) (largely

upholding additional Orders 500-H and 500-I). 

In 1992, FERC followed up on Order 436 by issuing Order

636, which fully mandated the unbundling of transportation and

marketing by directly requiring pipelines to offer transportation

service on a non-discriminatory basis. See Pipeline Service

Obligations and Revisions to Regulations Governing SelfImplementing Transportation; and Regulation of Natural Gas

Pipelines After Wellhead Decontrol, Order No. 636, F.E.R.C.

Stats. & Regs. ¶ 30,939, 57 Fed. Reg. 13,267 (1992) (rehearing

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 7 of 26
8

orders omitted). We upheld that Order in large part. See United

Distribution Cos., 88 F.3d at 1191. 

3. In the 1980s, as FERC unbundled interstate pipelines’

marketing and transportation functions by requiring pipelines to

transport gas on equal terms, pipelines began to withdraw from

the sales market for a variety of legal and economic reasons.

See Tenneco Gas v. FERC, 969 F.2d 1187, 1193 (D.C. Cir.

1992). Instead of selling gas directly, pipelines established

marketing affiliates that would sell gas in a competitive market

free from regulation. Before long, however, non-affiliated

marketers objected that pipelines – while providing equal and

open access to sellers – were violating that principle in spirit by

granting their marketing affiliates undue preferences, such as by

divulging inside information regarding future capacity that

would provide competitive benefits to pipelines’ affiliates. See

id. at 1194. 

In response to pipelines’ undue favoritism toward their

marketing affiliates, FERC promulgated Order 497, which set

out Standards of Conduct to govern the relationship between

pipelines and their marketing affiliates. See Inquiry Into

Alleged Anticompetitive Practices Related to Marketing

Affiliates of Interstate Pipelines, Order No. 497, F.E.R.C. Stats.

& Regs. ¶ 30,820, 53 Fed. Reg. 22,139 (1988) (rehearing orders

omitted). Order 497 required pipelines to provide equal

treatment to sellers in areas such as scheduling, transportation,

and speed of service; ordered contemporaneous disclosure of

transportation information to all potential shippers if disclosed

to an affiliate; and required independent functioning of pipeline

and marketing affiliate employees. See Tenneco, 969 F.2d at

1194-95. 

Order 497 was narrowly targeted in certain important

respects. First, FERC chose not to extend the Standards to

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 8 of 26
9

relationships with non-marketing affiliates, such as producers,

gatherers, and processors. FERC concluded that imposing the

Standards on relationships with non-marketing affiliates was

unnecessary because of “the absence of evidence of abusive

practices” between pipelines and non-marketing affiliates and

“in light of the availability of complaint procedures for

aggrieved persons.” Order 497, at 31,130. Second, the Order

did not apply to pipelines that do not conduct any transactions

with their marketing affiliates. FERC found that “there is no

possibility for abuse of the pipeline-marketing affiliate

relationship where the pipeline and marketing affiliate do not

conduct any transactions with each other.” Id. at 33,131. 

Pipelines and other entities filed petitions in this court

challenging the contemporaneous disclosure and independent

functioning requirements of Order 497. See Tenneco, 969 F.2d

at 1195-96. We began by stating that vertical integration in the

natural gas industry produces benefits for consumers and that

FERC must take those benefits into account when regulating the

pipelines. See id. at 1197-99. We nonetheless upheld the

contemporaneous disclosure requirement with respect to

transportation information because the record demonstrated both

a straightforward theoretical threat of abuse and substantial

record evidence that pipelines had been granting their marketing

affiliates undue preferences. See id. In light of the theoretical

threat and the record of abuse, we also upheld the independent

functioning requirement, noting that it preserved some benefits

of vertical integration, particularly in contrast to the more

draconian possibilities of complete physical separation,

divorcement, or divestiture. Id. at 1204, 1209. 

4. Some nine years later, in 2001, FERC considered

taking a step it had rejected in Order 497. FERC issued a notice

of proposed rulemaking announcing its plan to broaden “the

definition of an affiliate covered by the standards of conduct” to

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 9 of 26
10

include non-marketing affiliates. See Notice of Proposed

Rulemaking, Standards of Conduct for Transmission Providers,

F.E.R.C. Stats. & Regs. ¶ 32,555, at 34,079, 66 Fed. Reg. 50,919

(Sept. 27, 2001); id. at 34,090. FERC cited its concern “that a

transmission provider’s market power could be transferred to its

affiliated businesses because the existing rules do not cover all

affiliate relationships” and pointed to “[s]ignificant changes” in

the range of services offered by various companies in the natural

gas industry. Id. at 34,081-34,082. The notice of proposed

rulemaking indicated that the industry-wide costs of compliance

with the Standards could be $240 million per year – a cost that

eventually would be borne in part by consumers. See id. at

34,090.

In their comments, the pipelines suggested that the proposal

was “perhaps a solution in search of a problem.” Comments of

Interstate Natural Gas Association of America (Dec. 20, 2001)

at 1. After receiving input from the pipelines, other industry

participants, and various organizations, FERC went ahead and

promulgated Order 2004 in November 2003. See Standards of

Conduct for Transmission Providers, Order No. 2004, F.E.R.C.

Stats. & Regs. ¶ 31,155, 68 Fed. Reg. 69,134 (Nov. 25, 2003).

FERC conducted four more rounds of notice and comment to

clarify various aspects of the new regulations. See Order No.

2004-A, F.E.R.C. Stats. & Regs. ¶ 31,161, 69 Fed. Reg. 23,562

(Apr. 16, 2004); Order No. 2004-B, F.E.R.C. Stats. & Regs.

¶ 31,166, 69 Fed. Reg. 48,371 (Aug. 2, 2004); Order No.

2004-C, F.E.R.C. Stats. & Regs. ¶ 31,172, 70 Fed. Reg. 284

(Dec. 21, 2004); Order No. 2004-D, 110 FERC ¶ 61,320 (Mar.

23, 2005). (For ease of reference, we will refer to these Orders

collectively as “Order 2004.”)

FERC based the new Standards on the same principles of

non-discrimination and independent functioning as the old

Standards. See Standards of Conduct for Transmission

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 10 of 26
11

Providers, 18 C.F.R. § 358.2 (2006); Tenneco, 969 F.2d at 1194-

95. The central provisions are:

(a) Independent Functioning. A pipeline’s employees who

engage in transmission operations ordinarily “must function

independently of [its] Marketing or Energy Affiliates’

employees,” with an exception for “emergency circumstances.”

18 C.F.R. § 358.4(a)(1)-(2). Further, a pipeline generally may

not permit its affiliates’ employees to engage in transmission

system operations or reliability functions or to access the system

control center. Id. § 358.4(a)(3)(i)-(ii). 

(b) Non-discrimination. A pipeline must ensure that its

affiliates’ employees have access only to the information

available to all transmission customers and that such employees

are prevented from obtaining non-public information about the

pipeline’s transmission system. Id. § 358.5(a). 

(c) Posting Requirements. A pipeline must post online such

information as the names and addresses of its affiliates, the

organizational structure of its parent corporation, a list of

facilities shared with affiliates, a list of business units and job

descriptions, a schedule for implementing the Standards, and a

written log “detailing the circumstances and manner in which

[the pipeline] exercised its discretion under any terms of [its]

tariff.” Id. §§ 358.4(b)(1)-(3), (e)(1), 358.5(c)(4). 

Order 2004 ushers in two fundamental changes from Order

497. First, it extends the Standards beyond pipelines’

relationships with their marketing affiliates to govern also

pipelines’ relationships with numerous non-marketing affiliates

– processors, gatherers, producers, local distribution companies,

and traders. See Order 2004, at 30,825-30,827. The Order

includes a broad, multipart definition of Energy Affiliate as an

affiliate that “(1) Engages in or is involved in transmission

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 11 of 26
12

transactions in U.S. energy or transmission markets; or (2)

Manages or controls transmission capacity of a Transmission

Provider in U.S. energy or transmission markets; or (3) Buys,

sells, trades or administers natural gas or electric energy in U.S.

energy or transmission markets; or (4) Engages in financial

transactions relating to the sale or transmission of natural gas or

electric energy in U.S. energy or transmission markets.” 18

C.F.R. § 358.3(d)(1)-(4). The definition also includes local

distribution companies, other than those that make only onsystem sales (where the point of delivery is on or directly

interconnected with the local distribution company’s distribution

system). Id. § 358.3(d)(5), (d)(6)(v). 

Second, the new Standards cover a pipeline’s relationships

even with those affiliates that do not hold or control any

capacity on the pipeline. See id. §§ 358.1(a), 358.3(d). For

example, a pipeline is subject to the Standards in its relationship

with an affiliated producer that transports gas only on other

pipelines. FERC’s apparent rationale was that pipelines could

communicate information to affiliates who in turn could profit

in the natural gas financial markets. FERC believed that a

pipeline could, for instance, inform its affiliate of an upcoming

transmission constraint that would affect the price of the

commodity in the New York Mercantile Exchange, enabling the

affiliate to enter into a profitable futures contract and gain a

competitive advantage. See Order 2004, at 30,827-30,828.

 

Two FERC Commissioners strongly disagreed with

FERC’s new intervention in the natural gas market.

Commissioner Kelliher stated that “the flaw in the Standards of

Conduct Final Rule is the lack of record evidence to support

expanding the scope beyond Marketing Affiliates.” Order 2004-

A, at 31,225 (statement of Kelliher, Comm’r, dissenting in part).

In his view, “suspicion is not a sufficient basis for expanding the

scope of Standards of Conduct beyond Marketing Affiliates.”

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 12 of 26
13

Id. He explained that the record evidence of abuse related to

marketing affiliates, not non-marketing affiliates, and stated: “I

do not see how a record of affiliate abuse limited to Marketing

Affiliates argues in favor of expanding the scope of the rule

beyond Marketing Affiliates. To my mind, it argues in favor of

keeping the scope of the rule where it was. Indeed, there

appears to be no factual basis to support expanding the scope

beyond Marketing Affiliates.” Id. Finally, citing this court’s

decision in Dominion Resources, Inc. v. FERC, 286 F.3d 586

(D.C. Cir. 2002), Commissioner Kelliher expressed his concern

that the Order would diminish industry efficiencies without

advancing the FERC policy of preventing unduly discriminatory

behavior. Order 2004-A, at 31,226 (statement of Kelliher,

Comm’r, dissenting in part). Commissioner Brownell also

dissented. She stated that there was “insufficient evidence to

support eliminating the exemption for affiliated producers,

gatherers, and processors.” Order 2004, at 30,860 (statement of

Brownell, Comm’r, dissenting in part).

Several entities timely filed petitions for review in this

court. They include the Interstate Natural Gas Association of

America, a trade group that represents interstate pipelines. (No

electric utilities petitioned for review of the Standards as applied

to them.) Invoking the standards in the Administrative

Procedure Act, 5 U.S.C. §§ 701 et seq., the petitioners challenge

multiple aspects of the Orders: (1) the extension of the Standards

to non-marketing affiliates; (2) the extension of the Standards to

entities that do not hold or control capacity on their affiliated

pipelines, including the elimination of the exemption for local

distribution companies that make off-system sales only on

non-affiliated pipelines; (3) the favorable treatment of local

distribution companies as compared to producers, gatherers, and

processors with respect to the exemption for local distribution

companies that make only on-system sales; (4) the restriction of

the activities of risk management employees and lawyers; and

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 13 of 26
14

(5) the waiver log requirement. In addition, petitioner Calypso

U.S. Pipeline challenges the application of the Standards to a

certificate holder that has not commenced the transportation of

natural gas but has begun soliciting business. We have

jurisdiction under 15 U.S.C. § 717r(b). 

II

1. The Administrative Procedure Act governs our analysis.

We review FERC’s Order to determine whether it is “arbitrary,

capricious, an abuse of discretion, or otherwise not in

accordance with law.” 5 U.S.C. § 706(2)(A). An agency’s

“policy decisions are entitled to deference so long as they are

reasonably explained.” Covad Communications Co. v. FCC,

450 F.3d 528, 539 n.6 (D.C. Cir. 2006). Under the arbitrary and

capricious prong of the standard, we must ensure that FERC has

“examine[d] the relevant data and articulate[d] a satisfactory

explanation for its action including a rational connection

between the facts found and the choice made.” Motor Vehicle

Mfrs. Ass’n of U.S. v. State Farm Mut. Auto. Ins. Co., 463 U.S.

29, 43 (1983) (internal quotation marks omitted). “Normally, an

agency rule would be arbitrary and capricious if the agency has

. . . offered an explanation for its decision that runs counter to

the evidence before the agency.” Id. The APA “establishes a

scheme of ‘reasoned decisionmaking.’” Allentown Mack Sales

& Serv., Inc. v. NLRB, 522 U.S. 359, 374 (1998) (quoting State

Farm, 463 U.S. at 52).

We also adhere to the principle set out in SEC v. Chenery

Corp., 318 U.S. 80, 95 (1943): “[A]n administrative order

cannot be upheld unless the grounds upon which the agency

acted in exercising its powers were those upon which its action

can be sustained.” See also La. Pub. Serv. Comm’n v. FERC,

184 F.3d 892, 898 (D.C. Cir. 1999); Consol. Edison Co. of N.Y.

v. FERC, 823 F.2d 630, 641 (D.C. Cir. 1987). We will neither

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 14 of 26
15

supply our own justifications for an order nor uphold an order

based on FERC’s post hoc rationalizations. See EchoStar

Satellite, L.L.C. v. FCC, 457 F.3d 31, 36 (D.C. Cir. 2006). An

important corollary is that where FERC has relied on multiple

rationales (and has not done so in the alternative), and we

conclude that at least one of the rationales is deficient, we will

ordinarily vacate the order unless we are certain that FERC

would have adopted it even absent the flawed rationale. See

Consol. Edison Co. of N.Y., 823 F.2d at 641-42; Allied-Signal,

Inc. v. U.S. Nuclear Regulatory Comm’n, 988 F.2d 146, 150-51

(D.C. Cir. 1993). 

To justify Order 2004, FERC has relied on both an asserted

theoretical threat of undue preferences and a claimed record of

abuse. The Commission did not seek to justify the Order based

solely on the theoretical danger. Therefore, if we find that the

claimed record evidence does not support the Order, we cannot

uphold it. See Chenery, 318 U.S. at 95. 

2. In Tenneco, we carefully examined FERC’s adoption of

Standards of Conduct to govern relationships between pipelines

and their marketing affiliates. Our analysis in that case guides

our evaluation of Order 2004’s extension of the Standards of

Conduct to relationships between pipelines and their nonmarketing affiliates. 

We began by emphasizing that vertical integration creates

efficiencies for consumers. See Tenneco Gas v. FERC, 969 F.2d

1187, 1197 (D.C. Cir. 1992) (“In a competitive market, the

efficiencies of the pipeline-affiliate relationship should produce

benefits for consumers.”) (citing 3 P. AREEDA & D. TURNER,

ANTITRUST LAW ¶ 725d, at 201 (1978)). See generally ROBERT

H. BORK, THE ANTITRUST PARADOX 225-31 (2d ed. 1993). As

to vertical information sharing, we stated that “the sharing of

information between pipelines and their marketing affiliates has

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 15 of 26
16

efficiency benefits.” 969 F.2d at 1197. In considering structural

separation requirements, we similarly recognized that “there are

efficiencies to be derived from such integration and any

separation reduces those benefits to some extent.” Id. at 1205.

We pointed out that the Commission, by contrast,

“appear[ed] to believe that any advantage a pipeline gives its

marketing affiliate is improper.” Id. at 1201. We rejected this

theory and explained that “advantages a pipeline gives its

affiliate are improper only to the extent that they flow from the

pipeline’s anti-competitive market power. Otherwise vertical

integration produces permissible efficiencies that ‘cannot by

themselves be considered uses of monopoly power.’” Id.

(quoting Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d

263, 276 (2d Cir. 1979)).

Tenneco thus stands for the proposition that FERC cannot

impede vertical integration between a pipeline and its affiliates

without “adequate justification.” See 969 F.2d at 1199. We

upheld Order 497 in relevant part because FERC presented an

adequate justification – by advancing both (i) a plausible

theoretical threat of anti-competitive information-sharing

between pipelines and their marketing affiliates and (ii) vast

record evidence of abuse. 

 

As to the theoretical threat, we accepted FERC’s

explanation “that there is at least a theoretical danger that

pipelines will favor their marketing affiliates in providing

information, and that the result would be anti-competitive.” Id.

at 1197. FERC had relied on a Department of Justice report that

stated: “The affiliate relationship . . . creates an incentive for the

pipeline to withhold information that otherwise would be made

available to the affiliate’s competitors. Withholding this

information from non-affiliated shippers reduces their ability to

arrange transactions efficiently.” Id. (quoting Comments of the

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 16 of 26
17

United States Department of Justice in Response to the Notice

of Inquiry (Dec. 29, 1986) at 15). The threat of pipelines

enabling their affiliates to secure capacity sooner than their

competitors or otherwise to benefit from non-public knowledge

about the transmission system was readily apparent – and this

threat stemmed from the pipelines’ monopoly position.

As to record evidence, we explained that “[t]he record also

contains evidence that the discriminatory and anti-competitive

distribution of information is not just a theoretical danger, but a

real one.” Id. at 1197 (emphasis added); see also id. (recounting

representative example of non-affiliated marketer that lost out

on capacity when pipeline apprised affiliate of availability of

capacity before disclosing that information to affiliate’s rivals);

id. (citing pipeline’s disclosure in record that it had provided

information to its marketing affiliate, which may have allowed

the affiliate to displace existing sales). The rulemaking had

been prompted by “unaffiliated marketers [that] complained to

FERC that pipelines were granting unfair preferences to their

affiliates by, among other things, providing inside information

on pipeline capacity.” Id. at 1194. Order 497 also relied upon

“instances of abuse actually adjudicated by the Commission.”

Order 497, at 31,128. 

3. In issuing Order 2004, as well as in defending that Order

before this court, FERC has relied on what it asserts is a record

of abuse between pipelines and their non-marketing affiliates.

FERC has asserted that the record here is similar to the record

of abuse found in Order 497 between pipelines and their

marketing affiliates. See Order 2004, at 30,821 (responding to

comments arguing that there have been few cases of abuse by

citing agency investigations uncovering unfairly preferential

treatment toward marketing affiliates); Order No. 2004-A, at

31,179 (“In the past, agency arrangements have been abused.”);

id. at 31,181 (“Unduly preferential behavior can and does harm

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 17 of 26
18

customers.”); Respondent’s Br. at 27 (“[The] suggestion that the

Commission in this proceeding based its Energy Affiliate rule

on mere conjecture [is] totally unfounded. In fact, the record

contains numerous supporting comments . . . identifying affiliate

relationships with natural gas pipelines as a breeding ground for

undue discrimination.”); id. at 8 (“The Standards of Conduct

proposed by the Commission in 2001 relied on the same general

principles as those upheld by this court in Tenneco.”); id. at 16

(asserting that Order 2004 is based on “substantial evidence in

the record”); id. at 20 (Order 2004 must be and is “based upon

the record” and supported by “substantial evidence.”). 

At the outset, we take note of the assessment of the two

dissenting FERC Commissioners. They claimed that FERC was

relying on a record of abuse that in fact did not exist.

Commissioner Kelliher stated that “the flaw . . . is the lack of

record evidence to support expanding the scope beyond

Marketing Affiliates.” Order 2004-A, at 31,225 (statement of

Kelliher, Comm’r, dissenting in part). He added: “I do not see

how a record of affiliate abuse limited to Marketing Affiliates

argues in favor of expanding the scope of the rule beyond

Marketing Affiliates. To my mind, it argues in favor of keeping

the scope of the rule where it was. Indeed, there appears to be

no factual basis to support expanding the scope beyond

Marketing Affiliates.” Id. Commissioner Brownell similarly

stated that there was “insufficient evidence to support

eliminating the exemption for affiliated producers, gatherers,

and processors.” Order 2004, at 30,860 (statement of Brownell,

Comm’r, dissenting in part). 

Our review of the record on which FERC relied reveals that

Commissioners Kelliher and Brownell were plainly correct:

Unlike in Order 497, FERC here has provided no evidence of a

real problem with respect to pipelines’ relationships with nonmarketing affiliates. Indeed, Order 2004 does not include a

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 18 of 26
19

single example of abuse by non-marketing affiliates. Nor does

the record disclose complaints from competitors of pipelines’

non-marketing affiliates. Rather, FERC relied on either

examples of abuse by marketing affiliates (already covered by

the old Standards) or comments from the rulemaking that merely

reiterated a theoretical potential for abuse. 

A review of some of the primary evidence cited by FERC

helps demonstrate the flaws in its reasoning. 

• FERC explained that the Enforcement Division of its

Office of Market Oversight and Investigations had “uncovered

affiliate abuse activity that reveals that some Transmission

Providers are giving their affiliates undue preferences and

violating the standards of conduct.” Order 2004, at 30,821; see

also Order 2004-A, at 31,179-31,180. That supposed “activity”

provides no support for Order 2004 for the simple reason that all

of the cases listed addressed undue preferences granted to

marketing affiliates. See Transcon. Gas Pipe Line Corp., 102

FERC ¶ 61,302 (2003); Nat’l Fuel Gas Supply Corp., 103 FERC

¶ 61,192 (2003); Idaho Power Corp., 103 FERC ¶ 61,182

(2003); Cleco Corp., 104 FERC ¶ 61,125 (2003). Those

decisions have no bearing on whether the Standards should be

extended to relationships with non-marketing affiliates. Like

Commissioner Kelliher, we do not see how “a record of affiliate

abuse limited to Marketing Affiliates argues in favor of

expanding the scope of the rule beyond Marketing Affiliates.”

Order 2004-A, at 31,225 (statement of Kelliher, Comm’r,

dissenting in part).

• The Commission identified one case involving a

non-marketing affiliate (a gatherer). See Order 2004, at 30,832

& n.33 (citing Shell Offshore Inc. v. Transcon. Gas Pipe Line

Corp., 100 FERC ¶ 61,254 (2002)). But that evidence does not

help FERC: This court’s subsequent review of that proceeding

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 19 of 26
20

expressly rejected the contention that the affiliate relationship

between the gatherer and a pipeline was related to the alleged

abuse. See Williams Gas Processing – Gulf Coast Co., L.P. v.

FERC, 373 F.3d 1335, 1342-43 (D.C. Cir. 2004). 

• FERC cited comments from the California Public

Utilities Commission (CPUC). The CPUC, however, did not

identify any actual examples of wrongdoing. The CPUC stated

that pipelines with affiliates are subject “to criticism as serving

not the public interest of providing competitive, open-access

transportation services . . . .” Comments of the California Public

Utilities Commission (Dec. 21, 2001) at 10. It also claimed that

it had “learned of numerous methods by which a pipeline and

affiliate can work in concert to benefit the common goal of their

parent corporation.” Id. But those remarks are mere

restatements of the theoretical threat; they do not constitute

record evidence of abuse by pipelines and their non-marketing

affiliates. The CPUC did note one complaint, but that incident

concerned a marketing affiliate. See id. at 11 (referring to a

complaint filed in Public Utilities Commission of the State of

California v. El Paso Natural Gas Co., 91 FERC ¶ 61,312 (June

28, 2000), a case that involved El Paso Natural Gas Company,

El Paso Merchant Energy-Gas, L.P., and El Paso Merchant

Energy Co.). 

• FERC pointed to comments from the Illinois Commerce

Commission, which “applauded” FERC’s approach. But the

Illinois commission similarly did not provide any examples of

misconduct with respect to non-marketing affiliates. It restated

the potential threat of abuse by marketing affiliates: “Indeed, as

a theoretical matter, an even greater degree of independence

between the transmission function and market participant

activities of the merchant function than that proposed . . . could

foster more vibrant wholesale and retail competition . . . .”

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 20 of 26
21

Comments of the Illinois Commerce Commission (Dec. 20,

2001) at 8. 

• FERC cited the submission of the National Association

of State Utility Consumer Advocates (NASUCA). But that

group simply explained that “[t]he relatively small number of

formal complaints that have been brought before [FERC] does

not necessarily indicate that there are few anti-competitive

transactions between interstate transmission providers and their

affiliates.” Comments of the National Association of State

Utility Consumer Advocates (Dec. 20, 2001) at 2. The

NASUCA mentioned state proceedings involving retail rates,

but it acknowledged that they did not “bear directly” on Order

2004 and alleged only that affiliate relationships “may have had

anti-competitive impacts in the wholesale gas and electric

markets.” Id. at 1-2 (emphasis added). The NASUCA

concluded that there exists “the potential for interstate pipelines

to engage in anti-competitive behavior” with non-marketing

affiliates and “[s]uch activities may have anti-competitive

implications for the interstate market . . . .” Id. at 4-5 (emphases

added).

• FERC referred to comments from the Federal Trade

Commission’s Bureau of Economics and Office of the General

Counsel. But those comments offered no examples or factual

evidence; they noted only that “it is possible that a transmission

provider’s market power . . . could be transferred to and

exercised by its affiliated businesses . . . .” Comments of the

Staff of the Federal Trade Commission (Dec. 20, 2001) at 3

(emphasis added). What is more, the report cited by the FTC

Staff addressed the electric power industry – not the natural gas

industry – and relied largely on FERC’s assertions, not the

FTC’s independent examination of the industry. See id. at 2-3

& nn.4-5 (citing FTC Staff Report: Competition and Consumer

Protection Perspectives on Electric Power Regulatory Reform,

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 21 of 26
22

Focus on Retail Competition (Sept. 2001) at 13, available at

http://www.ftc.gov/reports/index.htm).

• FERC referenced the comments of the American

Antitrust Institute. That organization, however, did not provide

any examples of pipelines granting undue preferences to their

non-marketing affiliates by divulging information about

transmission systems. It simply stated that “[s]uch information

sharing, if unimpeded, could allow the transmission company to

potentially frustrate or preclude its existing or prospective

downstream rivals’ access to the network.” Comments of the

American Antitrust Institute (Dec. 20, 2001) at 2 (emphases

added). Moreover, the Institute actually urged FERC to

consider more carefully the costs of the Standards: “Given the

importance of efficiencies generated by vertical integration, AAI

believes it is appropriate for FERC to make at least a cursory

attempt to scope out the costs and benefits of uniform imposition

of standards of conduct.” Id. at 4.

• FERC cited the comments of the Natural Gas Supply

Association, an organization that represents independent gas

producers and marketers. Those comments likewise did not

point to any examples of abuse involving non-marketing

affiliates. Comments of the Natural Gas Supply Association

(Dec. 20, 2001) at 5. 

4. As the dissenting Commissioners explained, FERC was

wrong to conclude that the evidence supporting Order 2004 is

similar to the evidence that supported Order 497. In Tenneco,

FERC pointed to numerous complaints by competitors and many

documented instances of abuse between pipelines and their

marketing affiliates. See 969 F.2d at 1197-98; cf. Chamber of

Commerce v. SEC, 412 F.3d 133, 140-42 (D.C. Cir. 2005)

(explaining that the SEC identified significant abuses in the

mutual fund industry and adopted rules to prevent them). We

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 22 of 26
23

relied on that record evidence in upholding FERC’s Order.

Here, by contrast, FERC has cited no complaints and provided

zero evidence of actual abuse between pipelines and their

non-marketing affiliates. FERC staked its rationale in part on a

record of abuse, but that record is non-existent. Professing that

an order ameliorates a real industry problem but then citing no

evidence demonstrating that there is in fact an industry problem

is not reasoned decisionmaking. See State Farm, 463 U.S. at 42-

43.

Perhaps recognizing the deficiency of the record evidence,

FERC’s attorneys have defended the Order before this court in

part by attempting to explain away the insubstantial nature of the

record evidence. Of course, FERC’s Order relied in part on

record evidence of abuse, so explaining away the absence of

such evidence merely underscores the need to vacate the Order

and remand. In any event, even on their own terms, the

explanations do not hold water. FERC’s brief claims, for

example, that there may have been little evidence because “the

affiliate activity in question was not yet covered by [the]

Standards of Conduct.” Respondent’s Br. at 28. But that was

also true at the time of Order 497, yet FERC had received

numerous complaints and amassed substantial evidence of abuse

arising from the relationship between pipelines and their

marketing affiliates. If abuse arising from the relationship

between pipelines and non-marketing affiliates were similarly

rampant, FERC likely would have been inundated with

complaints and evidence, as it was before issuing Order 497.

See Tenneco, 969 F.2d at 1194. 

In a separate effort to justify the absence of evidence,

FERC’s brief also resorts to a claim that “the absence of specific

documented instances of abuse by non-marketing Energy

Affiliates does not mean they have not occurred.” Respondent’s

Br. at 29. The Administrative Procedure Act does not tolerate

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 23 of 26
24

that kind of truism as the basis for the administrative action

here. 

III

On remand, FERC may decide not to proceed with rules in

this area. Alternatively, it may seek to develop a factual record

that could fully satisfy the standard of Tenneco. 

In the absence of factual evidence that satisfies Tenneco,

FERC may try to support the Standards by setting out its best

case for relying solely on a theoretical threat of abuse. In

Tenneco, of course, FERC presented both a theoretical threat

and actual evidence of abuse to justify adopting the Standards

for marketing affiliates; we express no view here whether a

theoretical threat alone would be sufficient to justify an order

extending the Standards to non-marketing affiliates. 

In Tenneco, in remanding certain provisions of Order 497,

this court provided specific guidance to FERC on what it could

do on remand if it chose to re-promulgate those provisions. See

Tenneco Gas v. FERC, 969 F.2d 1187, 1199, 1201 (D.C. Cir.

1992). We provide similar guidance here. If FERC chooses to

rely solely on a theoretical threat, it will need to explain how the

potential danger of improper communications between pipelines

and their non-marketing affiliates, unsupported by a record of

abuse, justifies such costly prophylactic rules. FERC would

need to explain why the individual complaint procedure under

Section 5 of the Natural Gas Act does not suffice to ensure that

pipelines are not abusing their relationships with non-marketing

affiliates. See 15 U.S.C. § 717d(a); cf. Order 497, at 31,130

(relying in part on complaint procedure in declining to extend

Standards to non-marketing affiliates). If FERC believes that

the nature of the alleged misconduct renders it undetectable

through normal reporting mechanisms, FERC would have to

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 24 of 26
25

say, for example, why such evidence of abuse was detected

before it adopted Order 497. If FERC points to the number of

mergers between gas and electric companies in recent years, it

must address our decision in Dominion Resources, Inc. v. FERC,

286 F.3d 586 (D.C. Cir. 2002), where we stated that “the logic

of correcting anticompetitive hazards posed by a merger

implicitly suggests remedies only between the merging

companies,” not within pre-existing entities. Id. at 593. If

FERC cites the rise of a variety of new services, mostly relating

to the commodity market, it will need to elucidate how those

developments relate to and justify the promulgation of costly

prophylactic rules governing pipelines’ relationships with their

non-marketing affiliates. If FERC relies on an increase in the

amount of pipeline capacity held by non-marketing affiliates, it

must explain how that poses a threat of actual abuse by pipelines

and their non-marketing affiliates (and why the rule should also

apply to affiliates that do not ship on their affiliated pipelines).

If FERC chooses to extend the Standards to entities that do not

hold or control capacity, the Commission would need to justify

such an extension given that a stronger theoretical threat exists

with respect to affiliates that hold or control capacity on

affiliated pipelines than to affiliates that do not hold or control

such capacity. See Comments of the Staff of the Federal Trade

Commission (Dec. 20, 2001) at 4 n.8. We cannot say that any

of these theoretical rationales, alone or in combination, would

justify adoption of the Standards of Conduct under the Tenneco

standard; they merely illustrate the kind of analysis FERC would

need to undertake if it attempts to support the Order based solely

on a theoretical threat (that is, absent record evidence of abuse).

IV

We grant the pipelines’ petition, vacate Orders 2004,

2004-A, 2004-B, 2004-C, and 2004-D as applied to natural gas

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 25 of 26
26

pipelines, and remand to the Federal Energy Regulatory

Commission. 

So ordered.

USCA Case #05-1052 Document #1005078 Filed: 11/17/2006 Page 26 of 26