United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued March 22, 2016 Decided July 1, 2016

No. 11-1479

UNITED AIRLINES, INC., ET AL.,

PETITIONERS

v.

FEDERAL ENERGY REGULATORY COMMISSION AND UNITED 

STATES OF AMERICA,

RESPONDENTS

BP WEST COAST PRODUCTS LLC, ET AL.,

INTERVENORS

Consolidated with 12-1069, 12-1070, 12-1073, 

12-1086, 15-1101, 15-1105, 15-1107

On Petitions for Review of Orders of the 

Federal Energy Regulatory Commission

Thomas J. Eastment argued the cause for Shipper 

Petitioners. With him on the briefs were Gregory S. Wagner, 

Richard E. Powers, Jr., Melvin Goldstein, and Steven A. 
2

Adducci. Frederick G. Jauss and Marcus W. Sisk Jr. entered 

appearances.

Charles F. Caldwell argued the cause for Petitioner SFPP 

L.P. With him on the briefs were Dean Lefler and Daniel W. 

Sanborn. Deborah R. Repman entered an appearance.

Ross R. Fulton and Lisa B. Luftig, Attorneys, Federal 

Energy Regulatory Commission, argued the causes for 

respondents. On the brief were William J. Baer, Assistant 

Attorney General, U.S. Department of Justice, James J. 

Fredricks and Robert J. Wiggers, Attorneys, Robert H. 

Solomon, Solicitor, Federal Energy Regulatory Commission, 

Beth G. Pacella, Deputy Solicitor, and Elizabeth E. Rylander, 

Attorney.

Steven A. Adducci, Thomas J. Eastment, Gregory S. 

Wagner, Richard E. Powers Jr., and Melvin Goldstein were 

on the brief for Shipper Intervenors in support of Federal 

Energy Regulatory Commission.

Charles F. Caldwell, Dean H. Lefler, and Daniel W. 

Sanborn were on the brief for intervenor SFPP, L.P. in 

support of respondents. Elizabeth B. Kohlhausen entered an 

appearance.

Before: GRIFFITH and KAVANAUGH, Circuit Judges, and 

SENTELLE, Senior Circuit Judge.

Opinion for the Court filed by Senior Circuit Judge

SENTELLE.

SENTELLE, Senior Circuit Judge: Petitioners SFPP, L.P. 

(“SFPP”) and several shippers—“i.e., firms that pay to 

transport petroleum products over SFPP’s pipelines,” 
3

ExxonMobil Oil Corp. v. FERC, 487 F.3d 945, 947 (D.C. Cir. 

2007)—challenge aspects of three orders from the Federal 

Energy Regulatory Commission (“FERC”) related to filings 

by SFPP for cost-of-service tariffs on its pipelines. SFPP 

disputes FERC’s choice of data for calculating SFPP’s return 

on equity and the Commission’s decision to grant only a 

partial indexed rate for the 2009 index year. The shipperpetitioners (the “Shippers”) claim that FERC’s tax allowance 

policy for partnership pipelines, such as SFPP, is arbitrary or 

capricious and results in unjust and unreasonable rates. We 

grant-in-part and deny-in-part SFPP’s petition and grant the 

Shippers’ petition for review.

I. BACKGROUND

SFPP is a Delaware limited-partnership, common-carrier 

oil pipeline. The pipeline transports refined petroleum 

products from California, Oregon, and Texas to various 

locations throughout the southwestern and western United 

States. On June 30, 2008, SFPP filed tariffs to increase rates 

on its West Line, which transports petroleum products 

throughout California and Arizona. These new tariffs had an 

effective date of August 1, 2008. Also on June 30, 2008, 

SFPP made a separate tariff filing to decrease the rates on its 

East Line, which runs from West Texas to Arizona. The 

purported impetus for these filings was increased throughput 

on SFPP’s East Line due to a recently completed expansion, 

which accordingly decreased throughput on the West Line. 

Several shippers protested the West Line tariff filing by

raising challenges to SFPP’s cost of service. 

On December 2, 2009, an administrative law judge issued 

an Initial Decision addressing the shippers’ arguments. 

FERC reviewed the Initial Decision in Opinion 511, 134 

FERC ¶ 61,121 (2011), considered a request for rehearing of 
4

that opinion in Opinion 511-A, 137 FERC ¶ 61,220 (2011), 

and then reviewed a request for rehearing of Opinion 511-A 

in Opinion 511-B, 150 FERC ¶ 61,096 (2015). Both SFPP 

and the Shippers1 petition this Court for review of these three 

FERC orders. 

SFPP makes two arguments in its petition. First, it claims 

that FERC arbitrarily or capriciously failed to utilize the most 

recently-available data when assessing its so-called real return 

on equity. Second, SFPP asserts that FERC erred when it 

declined to apply the full value of the Commission’s 

published index when setting SFPP’s rates for the 2009 index 

year. We grant SFPP’s petition with respect to the first issue 

but deny the petition with respect to the second.

The Shippers raise a separate challenge to FERC’s current 

policy of granting to partnership pipelines an income tax 

allowance, which accounts for taxes paid by partner-investors 

that are attributable to the pipeline entity. Specifically, the 

Shippers claim that because FERC’s ratemaking methodology 

already ensures a sufficient after-tax rate of return to attract 

investment capital, and partnership pipelines otherwise do not 

incur entity-level taxes, FERC’s tax allowance policy permits 

partners in a partnership pipeline to “double recover” their 

taxes. We agree that FERC has not adequately justified its 

tax allowance policy for partnership pipelines and grant the 

Shippers’ petition.

 1 The Shippers are: United Airlines, Inc.; Delta Air Lines, 

Inc.; Southwest Airlines Co.; US Airways, Inc.; BP West 

Coast Products LLC; Chevron Products Co.; ExxonMobil Oil 

Corporation; Valero Marketing and Supply Company; and 

Tesoro Refining and Marketing Company LLC.
5

II. ANALYSIS

Under the standard dictated by the Administrative 

Procedure Act, we will vacate FERC ratemaking decisions 

that are arbitrary or capricious. See 5 U.S.C. § 706(2)(A). 

Conversely, “FERC’s decisions will be upheld as long as the 

Commission has examined the relevant data and articulated a 

rational connection between the facts found and the choice 

made.” ExxonMobil, 487 F.3d at 951. “In reviewing FERC’s 

orders, we are ‘particularly deferential to the Commission’s 

expertise’ with respect to ratemaking issues.” Id. (quoting 

Ass’n of Oil Pipe Lines v. FERC, 83 F.3d 1424, 1431 (D.C. 

Cir. 1996)). While we have not expressly stated whether we 

review for substantial evidence FERC’s factual findings 

within orders under the Interstate Commerce Act, “in their 

application to the requirement of factual support the 

substantial evidence test and the arbitrary or capricious test 

are one and the same.” Butte Cty. v. Hogen, 613 F.3d 190, 

194 (D.C. Cir. 2010) (citation omitted); cf. Farmers Union 

Cent. Exch., Inc. v. FERC, 734 F.2d 1486, 1499 n.39 (D.C. 

Cir. 1984) (noting the uncertainty surrounding whether the 

substantial evidence standard applies to FERC’s ratemaking 

decisions under the Interstate Commerce Act).

The statutory regime governing FERC’s ratemaking for 

oil pipelines is unique. In 1906, as an amendment to the 

Interstate Commerce Act (the “ICA”), Congress delegated 

regulatory authority over oil pipelines to the Interstate 

Commerce Commission. Pub. L. No. 59-337, § 1, 34 Stat. 

584, 584. But in 1977, Congress transferred regulatory 

authority over oil pipelines to FERC. Department of Energy 

Organization Act, Pub. L. No. 95-91, § 402(b), 91 Stat. 565, 

584 (1977); see also 49 U.S.C. § 60502. Congress then 

repealed the ICA in 1978 except as related to FERC’s 

regulation of oil pipelines. Pub. L. No. 95-473, § 4(c), 92 
6

Stat. 1337, 1470. For such regulation, the ICA continues to 

apply “as [it] existed on October 1, 1977 . . . .” Id. The 

relevant provisions of the ICA were last reprinted in the 

appendix to title 49 of the 1988 edition of the United States 

Code, to which we refer as necessary. Cf. BP West Coast 

Prods., LLC v. FERC, 374 F.3d 1263, 1271 n.1 (D.C. Cir. 

2004). 

Substantively, the ICA requires that all rates be “just and 

reasonable.” 49 U.S.C. app. § 1(5)(a) (1988). Just and 

reasonable rates are “rates yielding sufficient revenue to cover 

all proper costs, including federal income taxes, plus a 

specified return on invested capital.” ExxonMobil, 487 F.3d 

at 951 (citation omitted).

A. FERC’S CHOICE OF DATA FOR ASSESSING SFPP’S 

REAL RETURN ON EQUITY WAS ARBITRARY OR 

CAPRICIOUS

SFPP challenges as arbitrary or capricious FERC’s 

reliance on cost-of-equity data from September 2008 when 

calculating SFPP’s so-called “real” return on equity and the 

Commission’s rejection of more recent data from April 2009. 

FERC argues in response that the more recent cost-of-equity 

data “encompassed the stock market collapse beginning in 

late 2008,” and was therefore anomalous. FERC’s Br. 31-32. 

We agree that FERC had substantial evidence to support its 

determination that the 2009 data did not reflect SFPP’s longterm cost of equity. However, because the Commission 

provided no reasoned basis to justify its decision to rely on 

the September 2008 data, we hold that it engaged in arbitrary 

or capricious decision-making and therefore grant SFPP’s 

petition on this issue.
7

The Supreme Court stated in Federal Power Commission 

v. Hope Natural Gas Co., that “the return to the equity owner 

[of a pipeline] should be commensurate with returns on 

investments in other enterprises having corresponding risks.” 

320 U.S. 591, 603 (1944). Further, “[t]hat return . . . should 

be sufficient to assure confidence in the financial integrity of 

the enterprise, so as to maintain its credit and to attract 

capital.” Id. In accordance with these principles, FERC uses 

a so-called “discounted cash flow” model to determine a 

pipeline’s rate of return on equity. See Composition of Proxy 

Groups for Determining Gas and Oil Pipeline Return on 

Equity, 123 FERC ¶ 61,048, at 61,271-73 ¶¶ 3-9 (2008) 

(discussing the mechanics of the discounted cash flow 

model). “The premise of the [discounted cash flow] model is 

that the price of a stock is equal to the stream of expected 

dividends, discounted to their present value.” Williston Basin 

Interstate Pipeline Co. v. FERC, 165 F.3d 54, 57 (D.C. Cir. 

1999). Under the discounted cash flow model, FERC 

“examin[es] the percentage returns on equity the market 

requires for members of a proxy group.” Opinion 511, 134 

FERC ¶ 61,121, at ¶ 242. “The members of the proxy group 

must fall with[in] a reasonable range of comparable risks and 

have publically traded securities.” Id. Based on the stock 

prices of securities within the proxy group, FERC “calculates 

the yield (the percentage return) by dividing the dollar 

amount of the distribution by the stock price.” Id. ¶ 243. 

After applying the distribution over the long-term, FERC 

“discount[s] back at the first year’s percentage yield to obtain 

the return on equity required to attract capital to the firm.” Id. 

The resulting figure is the “nominal” return on equity. 

Under its so-called “trended original cost” methodology, 

FERC splits the nominal return on equity into an inflation 

component and the so-called “real” return on equity, defined 

as the difference between the nominal return on equity and 
8

inflation. See Williams Pipe Line Co., 31 FERC ¶ 61,377, at 

61,833-34 (1985). While the pipeline can recover its real 

return on equity in its current annual rates, inflation “is 

written-off or amortized over the life of the property.” Id. at 

61,834; see also Ass’n of Oil Pipe Lines, 83 F.3d at 1429. 

When assessing the pipeline’s cost structure, FERC “uses 

a ‘test year’ methodology to determine a pipeline’s annual 

cost of service.” BP West Coast, 374 F.3d at 1298. This 

method starts with a “base period” that “consist[s] of 12 

consecutive months of actual experience” with some specified 

adjustments. 18 C.F.R. § 346.2(a)(1)(i). FERC then defines a 

“test period” that generally “must consist of a base period 

adjusted for changes in revenues and costs which are known 

and are measurable with reasonable accuracy at the time of 

[rate] filing and which will become effective within nine 

months after the last month of available actual experience 

utilized in the filing.” Id. § 346.2(a)(1)(ii). In this case, 

FERC used a base period from January 1, 2007, through 

December 31, 2007, meaning that the “nine-month 

adjustment period for test period changes [wa]s from January 

1, 2008, through September 30, 2008.” Opinion 511, 134 

FERC ¶ 61,121, at ¶ 8. 

However, for the discounted cash flow analysis, “the 

Commission prefers the most recent financial data in the 

record,” id. ¶ 208, “because the market is always changing 

and later figures more accurately reflect current investor 

needs,” Trunkline Gas Co., 90 FERC ¶ 61,017, at 61,117 

(2000). In other words, FERC may use post-test period data 

for purposes of the discounted cash flow analysis, 

“recognizing that updates are not permitted once the record 

has been closed and the hearing has concluded.” Opinion 

511, 134 FERC ¶ 61,121, at ¶ 208. 
9

SFPP initially submitted return-on-equity data for the sixmonth period ending with the test period, i.e., through 

September 2008. See Exhibit SFP-1, Prepared Direct 

Testimony of J. Peter Williamson on Behalf of SFPP, L.P., 

No. IS08-390-002, at 3-22 (FERC June 2, 2009). However, 

the pipeline later provided two updates, one for the six-month 

period ending January 2009, see Exhibit SFP-76, No. IS08-

390-002, at 1 (FERC June 2, 2009), and one for the six-month 

period ending April 2009, see Exhibit SFP-323, No. IS08-

390-002, at 1 (FERC June 2, 2009). From the September 

2008 data, the nominal return on equity was 12.63 percent, 

with 7.69 percent representing the real return on equity and 

4.94 percent as inflation.2

 Opinion 511-A, 137 FERC 

¶ 61,220, at ¶ 255. From the January 2009 data, the nominal 

return on equity was 14.33 percent, distributed between 14.30 

percent real return on equity and 0.03 percent inflation. 

Exhibit SFP-76, at 1. The April 2009 data showed a nominal 

return on equity of 14.09 percent with a 14.83 percent real 

return on equity and -0.74 percent inflation. Exhibit SFP-323, 

at 1. FERC also “incorporated into the . . . record” SFPP 

cost-of-equity data for the six-month periods ending in 

February 2010 and March 2010. Opinion 511, 134 FERC 

¶ 61,121, at ¶ 209 & n.339. The nominal return on equity 

from the February 2010 data was 11.24 percent, 2.14 percent 

 2 There is some ambiguity in the record regarding the 

September 2008 return on equity data. SFPP’s initial filings 

show that the nominal return on equity for this period was 

13.01 percent with 5.37 percent inflation and 7.64 percent real 

return on equity. See Exhibit SFP-1, at 21; Exhibit SFP-5, 

No. IS08-390-002, at 9 (FERC June 2, 2009); Opinion 511-A, 

137 FERC ¶ 61,220, at ¶ 252. As the exact numbers do not 

affect our holding and the parties otherwise agree that 7.69 

percent was the real return on equity for the September 2008 

period, we refer to that figure. See SFPP’s Br. 8; FERC’s Br. 

33-34.
10

of which was inflation with a 9.09 percent real return on 

equity. SFPP’s Br. App. A. From the March 2010 data, the 

nominal return on equity was 11.03 percent, inflation was 

2.31 percent, and the real return on equity was 8.72 percent. 

Id.

SFPP argues that FERC acted arbitrarily or capriciously 

when it relied on the September 2008 data, instead of the 

April 2009 data, in setting SFPP’s real return on equity. In 

particular, SFPP contends that FERC ignored its own “policy 

of using the most recent equity rate of return data in the 

record” and provided no explanation for its choice of the 

September 2008 data. SFPP’s Br. 22-23. In FERC’s view, 

the April 2009 data is not “representative of SFPP’s cost of 

capital during the future periods the rates proposed in this 

case may be in effect.” Opinion 511, 134 FERC ¶ 61,121, at 

¶ 209. Specifically, that data “reflects the collapse of the 

stock market in late 2008 and early 2009” and a “minimal or 

negative inflation rate” not likely to continue into the future. 

Id. 

We hold that it was reasonable for FERC to conclude that 

the April 2009 data was not representative of SFPP’s longterm cost of capital. SFPP’s argument that FERC has a 

bright-line policy of relying on the most recently available 

data to determine the real return on equity is incorrect. As 

FERC stated in Trunkline Gas Co., the Commission “seeks to 

find the most representative figures on which to base rates.” 

90 FERC ¶ 61,017, at 61,049 (emphasis added). Therefore, 

FERC “may adopt test period estimates, or it may adopt other, 

more representative figures of historical costs . . . if it 

determines that these other figures are the best, most 

representative evidence of the pipeline’s experience for the 

test period.” Id. The real return on equity from the April 

2009 data, 14.83 percent, is the highest among each of the 
11

periods FERC considered, and only this data includes 

negative inflation. Had FERC decided to use the April 2009 

data, SFPP would have been able to recoup essentially its 

entire nominal return on equity in its current rates, see 

Williams Pipe Line Co., 31 FERC ¶ 61,377, at 61,833-34, 

despite the fact that the February 2010 and March 2010 data 

indicated that negative inflation was a short-term 

phenomenon. Substantial evidence therefore supported 

FERC’s finding that the April 2009 data was not the most 

representative data for assessing SFPP’s real return on equity, 

meaning that FERC did not engage in arbitrary-or-capricious 

decision-making by rejecting that data. See Opinion 511, 134 

FERC ¶ 61,121, at ¶¶ 208-09; Opinion 511-A, 137 FERC 

¶ 61,220, at ¶¶ 256-59.

However, this conclusion does not end the inquiry. In lieu 

of the more recently available April 2009 data, FERC relied 

instead on the September 2008 data to fix SFPP’s real return 

on equity. See Opinion 511, 134 FERC ¶ 61,121, at ¶ 209. 

Because we agree with SFPP that FERC provided no 

reasoned explanation for its choice of the September 2008 

data, we grant SFPP’s petition for review and vacate FERC’s 

orders with respect to this issue. 

While there may be evidence to support the conclusion 

that the nominal return on equity for September 2008 was in 

line with historical trends, this evidence does not show that 

the real return on equity for that time period was 

representative of SFPP’s costs. See Request for Rehearing of 

SFPP, L.P., No. IS08-390-002, at 11-12 (FERC Apr. 11, 

2011) (SFPP conceding that the September 2008 nominal 

return on equity is “consistent with historical periods”); see 

also Opinion 511, 134 FERC ¶ 61,121, at ¶ 209; Opinion 

511-A, 137 FERC ¶ 61,220, at ¶¶ 252-59. To the contrary, 

FERC provides only a cursory comparison of real returns on 
12

equity from the September 2008 through the March 2010 time 

periods, and otherwise appears to have chosen the smallest 

real return on equity from the data available. See Opinion 

511, 134 FERC ¶ 61,121, at ¶ 209. FERC was further unable 

to identify any such explanation in the record when pressed to 

do so at oral argument. See Oral Arg. Tr. 44:6-45:14. While 

“we are particularly deferential to the Commission’s expertise 

with respect to ratemaking issues,” ExxonMobil, 487 F.3d at 

951 (citation and internal quotation marks omitted), FERC 

cannot rely in conclusory fashion on its knowledge and 

expertise without adequate support in the record. See, e.g., 

Int’l Union, United Mine Workers of Am. v. Mine Safety & 

Health Admin., 626 F.3d 84, 93 (D.C. Cir. 2010). 

Because we agree that FERC engaged in arbitrary-orcapricious decision-making by adopting the September 2008 

real return on equity without reasoned explanation, we need 

not reach SFPP’s alternative argument that FERC improperly 

rejected SFPP’s proposal to adopt an average real return on 

equity. We grant SFPP’s petition on this issue.

B. FERC’S INDEXING ANALYSIS WAS NOT ARBITRARY 

OR CAPRICIOUS

SFPP also argues that FERC engaged in arbitrary-orcapricious decision-making when it declined to apply the full 

amount of the 2009 rate index adjustment in calculating 

SFPP’s rates and refunds for the period from July 1, 2009, 

through June 30, 2010. FERC responds that it complied with 

the plain text of its regulations when it found that granting 

SFPP a full indexed rate adjustment would result in unjust 

and unreasonable rates. We agree with FERC and deny 

SFPP’s petition on this issue.
13

As part of the Energy Policy Act of 1992, Congress 

required FERC to “issue a final rule which establishes a 

simplified and generally applicable ratemaking methodology 

for oil pipelines in accordance with section 1(5) of part I of 

the [ICA].” Pub. L. No. 102-486, § 1801(a), 106 Stat. 

2776, 3010. Congress also mandated that “the 

Commission . . . issue a final rule to streamline procedures of 

the Commission relating to oil pipeline rates in order to avoid 

unnecessary regulatory costs and delays.” Id. § 1802(a). In 

response, FERC released a notice of proposed rulemaking on 

July 2, 1993, which set forth an indexing scheme for setting 

oil pipeline rates. See Revisions to Oil Pipeline Regulations 

Pursuant to the Energy Policy Act of 1992; Proposed 

Rulemaking, 58 Fed. Reg. 37,671, at 37,672 (1993). FERC 

then issued on November 4, 1993, its final rule implementing 

the indexing scheme. Revisions to Oil Pipeline Regulations 

Pursuant to the Energy Policy Act of 1992, 58 Fed. Reg. 

58,753, at 58,754 (1993). 

Under the final rule, FERC required that oil pipelines 

utilize the indexing system for rate changes unless specified 

circumstances permit use of an alternative methodology. Id.

at 58,757. “First, a cost-of-service showing may be utilized 

to change a rate whenever a pipeline can show that it has 

experienced uncontrollable circumstances that preclude 

recoupment of its costs through the indexing system.” Id.; see 

also 18 C.F.R. § 342.4(a). “Second, whenever a pipeline can 

secure the agreement of all existing customers, it may file a 

rate change based on such a settlement.” 58 Fed. Reg. at 

58,757; see also 18 C.F.R. § 342.4(c). Finally, FERC permits 

market-based ratemaking if the pipeline can show that it 

“lacks significant market power in the markets in question

. . . .” 58 Fed. Reg. at 58,757; see also 18 C.F.R. § 342.4(b).
14

At a general level, FERC’s indexing methodology directs 

pipelines to file initial rates, usually reflecting their costs-ofservice. 58 Fed. Reg. at 58,758. Based on the initial rate 

filings, FERC then calculates rate ceilings for future years 

based on the change in the Producer Price Index for Finished 

Goods. Id. at 58,760; see also 18 C.F.R. § 342.3(d)(2). 

Importantly, “the index establishes a ceiling on rates—it does 

not establish the rate itself.” 58 Fed. Reg. at 58,759. In other 

words, “a company is not required to charge the ceiling rate, 

and if it does not, it may adjust its rates upwards to the ceiling 

at any time during the year upon filing of the requisite 

data . . . and upon giving the appropriate notice.” Id. at 

58,761. For future years, the index “is cumulative[, meaning 

that] . . . the index applies to the applicable ceiling rate, which 

is required to be calculated each year, not to the actual rate 

charged.” Id. at 58,762. The stated purpose of this regime is 

to “preserve[] the value of just and reasonable rates in real 

economic terms [by] . . . tak[ing] into account inflation, thus 

allowing the nominal level of rates to rise in order to preserve 

their real value in real terms.” Id. at 58,759.

In this case, SFPP filed cost-of-service rates, effective 

August 1, 2008, proposing to increase the rates charged on its 

West Line “based upon the cost of providing the service 

covered by the rate . . . .” 18 C.F.R. § 342.4(a). Because this 

rate took effect during the 2008 index year—i.e., between 

July 1, 2008, and June 30, 2009—it also “constitute[d] the 

applicable ceiling level for that index year.” Id.

§ 342.3(d)(5); see also id. § 342.3(c) (defining the index year 

as “the period from July 1 to June 30”). Therefore, to 

compute the ceiling level for the 2009 index year—i.e., 

between July 1, 2009, and June 30, 2010—SFPP 

“multipl[ied] the previous index year’s [2008’s] ceiling level 

by the most recent index published by [FERC].” Id.

§ 342.3(d)(1). The index for 2009 was 7.6025 percent. 
15

Revisions to Oil Pipeline Regulations Pursuant to the Energy 

Policy Act of 1992, 127 FERC ¶ 61,184 (2009). SFPP 

therefore contends that it has the right to apply this full index 

when calculating its 2009 rates. FERC argues that, because 

SFPP’s cost-of-service rates for 2008 already partially 

“accounted for the changes in costs associated with the index 

increase,” Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 407, 

SFPP can only apply that portion of the 2009 index “not 

reflected in the cost of service adopted by Opinion No. 511 or 

the rates SFPP must establish [in Opinion No. 511-A],” id.

¶ 405. In particular, FERC permitted SFPP to use an index of 

1.9006 percent, “correspond[ing] to the three months of 2008 

cost changes that are outside” the period of costs already 

covered by SFPP’s proposed rates. Id. In other words, FERC 

limited SFPP’s 2009 index to twenty-five percent of the 

published value for that index year.

Were this information all that the Court had to consider, 

SFPP’s argument that FERC “ignore[d] its regulations, which 

have the force of law,” SFPP’s Br. 35, might be plausible in 

light of the plain text of FERC’s indexing regulations, see 18 

C.F.R. § 342.3. But the analysis is only half-complete. 

“[M]erely because the Commission regulations permit SFPP 

to request the index increase does not mean that the 

Commission is bound to accept the indexed rate increase.” 

Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 407. In particular, 

“persons with a substantial economic interest in the tariff 

filing may file a protest to a tariff filing pursuant to the 

Interstate Commerce Act.” 18 C.F.R. § 343.2(b). A protest 

to a proposed rate under 18 C.F.R. § 343.2 must allege 

“reasonable grounds for asserting that the rate violates the 

applicable ceiling level, or that the rate increase is so 

substantially in excess of the actual cost increases incurred by 

the carrier that the rate is unjust and unreasonable, or that the 

rate decrease is so substantially less than the actual cost 
16

decrease incurred by the carrier that the rate is unjust and 

unreasonable.” Id. § 343.2(c)(1). In this case, the Shippers 

did file protests to SFPP’s indexed rates for the 2009 index 

year. See Protest and Comments of Chevron Products 

Company, ConocoPhillips Company, Continental Airlines, 

Inc., Northwest Airlines, Inc., Southwest Airlines Co., US 

Airways, Inc., and Valero Marketing and Supply Company on 

SFPP, L.P. Compliance Filing (“Protest I”), Nos. IS08-390-

002, IS08-390-006, IS11-338-000 (FERC June 15, 2011); 

Protest of ExxonMobil Oil Corporation and BP West Coast 

Products LLC of Compliance Filing Implementing Opinion 

No. 511 (“Protest II”), No. IS08-390-006 (FERC June 15, 

2011). Therein, they argued that because “[t]he 2009 index is 

based on [FERC’s] computation of industry-wide cost 

increases between 2007 and 2008[,]” SFPP should not be 

permitted to double-recover its costs by combining its 2008 

cost-of-service rates with proposed 2009 indexed rates. 

Protest II, at 12. Equivalently, the Shippers alleged that 

SFPP’s 2009 indexed rate increase was “substantially in 

excess of the actual cost increases incurred by [SFPP]” during 

2008. 18 C.F.R. § 343.2(c)(1). FERC agreed. See Opinion 

511-A, 137 FERC ¶ 61,220, at ¶ 411; Opinion 511-B, 150 

FERC ¶ 61,096, at ¶¶ 27-33. “Because the subject of our 

scrutiny is a ratemaking—and thus an agency decision 

involving complex industry analyses and difficult policy 

choices—the court will be particularly deferential to the 

Commission’s expertise.” Ass’n of Oil Pipe Lines, 83 F.3d at 

1431. With this principle in mind, we discern no error in 

FERC’s decision-making.

SFPP’s principal retort to this otherwise straightforward 

application of FERC’s regulations is that the alleged purpose 

of FERC’s indexing procedures is to permit a pipeline to 

capture future inflation-based cost adjustments, not prior-year 

cost-of-service changes. FERC responds, somewhat 
17

cryptically, that indexing “allows rates to track inflation in the 

general economy, essentially preserving pipelines’ existing 

rates in real economic terms.” FERC’s Br. 43.

SFPP’s argument is irrelevant to this case. Admittedly, 

whether FERC’s indexing mechanism is retrospective or 

prospective is unclear. For example, FERC has previously 

described the purpose of indexing as “preserv[ing] the value 

of just and reasonable rates in real economic terms . . . [by] 

tak[ing] into account inflation, thus allowing the nominal 

level of rates to rise in order to preserve their real value in 

real terms.” Revisions to Oil Pipeline Regulations Pursuant 

to the Energy Policy Act of 1992, 58 Fed. Reg. at 58,759; see 

also SFPP, L.P., 117 FERC ¶ 61,271, at 62,337 (2006). By 

contrast, we have stated that indexing “enable[s] pipelines to 

recover costs by allowing pipelines to raise rates at the same 

pace as they are predicted to experience cost increases.” 

Ass’n of Oil Pipe Lines, 83 F.3d at 1430. However, once a 

party files a protest to a pipeline’s proposed rates, FERC’s 

regulations state that the Commission will compare the 

“actual cost increases incurred by the carrier” with the 

proposed rate increase. 18 C.F.R. § 343.2(c)(1) (emphasis 

added). FERC made this comparison when it noted that SFPP 

would effectively double-recover its 2008 costs were it to 

receive the full 2009 index. See Opinion 511-A, 137 FERC 

¶ 61,220, at ¶¶ 409-11; Opinion 511-B, 150 FERC ¶ 61,096, 

at ¶¶ 27-33. While admittedly FERC’s analysis was less 

quantitative than in prior rate proceedings, we hold that FERC 

provided sufficient justification for its decision to reduce 

SFPP’s 2009 index to one-quarter of the published value. See 

Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 411 n.687; SFPP, 

L.P., 135 FERC ¶ 61,274, at 62,513 ¶¶ 11-12 (2011) 

(describing the so-called “percentage comparison test”); see 

also SFPP, L.P., 117 FERC ¶ 61,271, at 62,337 ¶ 5 (denying 

indexed rate increase to SFPP’s East Line rates where base 
18

rates already “recover[ed] all the relevant operating and 

capital costs”). 

SFPP’s reliance on prior FERC proceedings involving 

indexing, see, e.g., Opinion 435, 86 FERC ¶ 61,022, at 61,085 

(2000); Opinion 435-A, 91 FERC ¶ 61,135, at 61,516 (2000), 

is inapposite. As SFPP admitted during oral argument, those 

proceedings at most permitted FERC to apply the full index to 

SFPP’s rates but did not compel it. See Oral Arg. Tr. 22:12-

:15. Notably, FERC did not address in those cases whether 

the indexed rates were “so substantially in excess of the actual 

cost increases incurred by the carrier,” 18 C.F.R. 

§ 343.2(c)(1), which it has done here. We otherwise agree 

with FERC that SFPP “has failed to demonstrate that 

[FERC’s] determination . . . is inconsistent with precedent.” 

FERC’s Br. 48. 

We therefore deny SFPP’s petition on this issue.

C. FERC MUST DEMONSTRATE THAT THERE IS NO 

DOUBLE RECOVERY OF TAXES FOR PARTNERSHIP 

PIPELINES

The Shippers argue that FERC engaged in arbitrary-orcapricious decision-making when it granted an income tax 

allowance to SFPP. Specifically, the Shippers note that, as a 

partnership pipeline, SFPP is not taxed at the pipeline level. 

Because FERC’s discounted cash flow return on equity 

already ensures a sufficient after-tax return to attract 

investment to the pipeline, they argue, the tax allowance 

results in “double recovery” of taxes to SFPP’s partners. In 

FERC’s view, we already decided this issue in ExxonMobil, 

where we held that FERC’s policy of permitting partnership 

pipelines to receive a tax allowance was “not unreasonable” 

in light of “FERC’s expert judgment about the best way to 
19

equalize after-tax returns for partnerships and corporations.” 

487 F.3d at 953. FERC therefore posits that the Shippers’ 

petition in this case is an impermissible collateral attack on 

our decision in ExxonMobil. Further, FERC denies that 

granting a tax allowance to SFPP results in a double-recovery 

of taxes and avers that any disparity in after-tax returns to 

partners or shareholders arises from the Internal Revenue

Code, not from FERC’s tax allowance policy. Because we 

reserved the issue of whether the combination of the 

discounted cash flow return on equity and the tax allowance

results in double recovery of taxes for partnership pipelines, 

we disagree with FERC’s collateral attack argument. 

Nonetheless, we acknowledge that our opinion in ExxonMobil

stated that it may be reasonable for FERC to grant a tax 

allowance to partnership pipelines. However, because FERC 

failed to demonstrate that there is no double-recovery of taxes 

for partnership, as opposed to corporate, pipelines, we hold 

that FERC acted arbitrarily or capriciously. We therefore 

grant the Shippers’ petition.

As all parties acknowledge, this case is not the first time 

that we have considered FERC’s tax allowance policy for oil 

pipelines. Until our decision in BP West Coast, 374 F.3d at 

1293, FERC relied on the so-called Lakehead policy when 

granting tax allowances. Named for the FERC decision in 

which the Commission formalized the policy, see Lakehead 

Pipe Line Co., 71 FERC ¶ 61,338, at 62,314-15 (1995), the 

Lakehead policy addressed the situation in which a 

partnership pipeline has both corporate-partners and 

individual-partners. FERC therein concluded:
20

When partnership interests are held by corporations, 

the partnership is entitled to a tax allowance in its costof-service for those corporate interests because the tax 

cost will be passed on to the corporate owners who 

must pay corporate income taxes on their allocated 

share of income directly on their tax 

returns. . . . However, the Commission concludes that 

Lakehead should not receive an income tax allowance 

with respect to income attributable to the limited 

partnership interests held by individuals. This is 

because those individuals do not pay a corporate 

income tax.

Id.

We reviewed the Lakehead policy in BP West Coast and 

held that “[w]e cannot conclude that FERC’s inclusion of the 

income tax allowance in SFPP’s rates is the product of 

reasoned decisionmaking.” 374 F.3d at 1288. In that case, 

we started from the principle “that the regulating commission 

is to set rates in such a fashion that the regulated entity yields 

returns for its investors commensurate with returns expected 

from an enterprise of like risks.” Id. at 1290. Consistent with 

this principle, we rejected FERC’s justifications for its 

Lakehead policy and held that “where there is no tax 

generated by the regulated entity, either standing alone or as 

part of a consolidated corporate group, the regulator cannot 

create a phantom tax in order to create an allowance to pass 

through to the rate payer.” Id. at 1291. 

Concededly, our use of the term “phantom tax” in BP 

West Coast lacked precision. This was made apparent in 

ExxonMobil, as several shipper-petitioners challenged 

FERC’s revised tax allowance policy, which granted a full 

income tax allowance to both partnership pipelines and 
21

corporate pipelines, regardless of the identities of the partners 

or shareholders. 487 F.3d at 950. We rejected the 

petitioners’ arguments in that case, stating that because 

“investors in a limited partnership are required to pay tax on 

their distributive shares of the partnership income, even if 

they do not receive a cash distribution[,] . . . the income 

received from a limited partnership should be allocated to the 

pipeline and included in the regulated entity’s cost-ofservice.” Id. at 954. FERC did not create a “phantom tax” 

because it did not arbitrarily distinguish between corporate 

and individual partners in a partnership pipeline, and the 

Commission adequately explained why partner taxes could be 

considered a pipeline cost. 

In this case, the Shippers challenge the same tax 

allowance policy at issue in ExxonMobil. Given that nothing 

has changed with regard to this policy, FERC’s argument that 

the Shippers present an impermissible collateral attack to our 

ExxonMobil decision is, on first consideration, conceivable. 

However, as the Shippers mention in their reply brief, FERC 

averred during briefing in ExxonMobil that it was addressing 

the double recovery issue in a separate proceeding. See Br. of 

Resp’t at 30-31, ExxonMobil Oil Corp. v. FERC, 487 F.3d 

945 (D.C. Cir. 2007) (Nos. 04-1102 et al.). While we did not 

expressly reserve the issue in our ExxonMobil opinion, the 

fact that FERC took this position both in ExxonMobil and in 

an accompanying case, see Br. of Resp’t at 29-30, Canadian 

Ass’n of Petroleum Producers v. FERC, 487 F.3d 973 (D.C. 

Cir. 2007) (No. 05-1382), reflects our implicit reservation of 

the question. To clarify, we held in ExxonMobil that, to the 

extent FERC has a reasoned basis for granting a tax 

allowance to partnership pipelines, it may do so. 487 F.3d at 

955. The Shippers now challenge whether such a reasoned 

basis exists based on grounds that FERC agreed were not at 
22

issue in the prior case. We therefore hold that the Shippers’ 

petition is not a collateral attack on that decision. 

As to the merits, we hold that FERC has not provided 

sufficient justification for its conclusion that there is no 

double recovery of taxes for partnership pipelines receiving a 

tax allowance in addition to the discounted cash flow return 

on equity. Despite their attempts to inundate the record with 

competing mathematical analyses of whether a double 

recovery of taxes for partnership pipelines exists, the parties 

do not disagree on the essential facts. First, unlike a 

corporate pipeline, a partnership pipeline incurs no taxes, 

except those imputed from its partners, at the entity level. See 

26 U.S.C. § 7704(d)(1)(E). Second, the discounted cash flow 

return on equity determines the pre-tax investor return 

required to attract investment, irrespective of whether the 

regulated entity is a partnership or a corporate pipeline. See

Opinion 511, 134 FERC ¶ 61,121, at ¶¶ 243-44; Shippers’ Br. 

6; see also supra Part II.A (discussing the mechanics of the 

discounted cash flow methodology). Third, with a tax 

allowance, a partner in a partnership pipeline will receive a 

higher after-tax return than a shareholder in a corporate 

pipeline, at least in the short term before adjustments can 

occur in the investment market. See FERC’s Br. 29; 

Shippers’ Br. 34-35; Oral Arg. Tr. 32:17-33:2. 

These facts support the conclusion that granting a tax 

allowance to partnership pipelines results in inequitable 

returns for partners in those pipelines as compared to 

shareholders in corporate pipelines. Because the Supreme 

Court has instructed that “the return to the equity owner 

should be commensurate with returns on investments in other 

enterprises having corresponding risks,” FERC has not shown 

that the resulting rates under FERC’s current policy are “just 

and reasonable.” Hope Nat. Gas Co., 320 U.S. at 603. FERC 
23

attempts to circumvent this deduction by arguing, first, that 

there is no “gross-up” in the return rate for partnership 

pipelines to account for income taxes, and, second, that any 

disparate treatment between partners in partnership pipelines 

and shareholders in corporate pipelines is the result of the 

Internal Revenue Code, not FERC’s tax allowance policy. 

These arguments, which are two sides of the same 

metaphorical coin, are not persuasive.

The crux of FERC’s “gross-up” theory is that “in the 

context of Commission rate design[,]” Opinion 511-A, 137 

FERC ¶ 61,220, at ¶ 290, “the Commission does not gross up 

a jurisdictional entity’s operating revenues or return to cover 

the income taxes that must be paid to obtain its after-tax 

return,” id. ¶ 280. What the Commission apparently means 

by this rather obscure statement is that it imputes the income 

taxes paid by partners in a partnership pipeline to the pipeline 

itself, meaning that an income tax allowance is then necessary 

to equalize the after-tax “entity-level” rates of return for 

partnership and corporate pipelines. See Opinion 511, 134 

FERC ¶ 61,121, at ¶¶ 241-50; see also Opinion 511-A, 137 

FERC ¶ 61,220, at ¶ 319. Of course, when one then considers 

the after-tax returns to partners or shareholders, the necessary 

conclusion is that partners in a partnership pipeline receive a 

windfall compared to shareholders in a corporate pipeline, a 

point which FERC concedes. See FERC’s Br. at 29; Oral 

Arg. Tr. 32:17-33:2. FERC, in a form of Orwellian 

doublethink, attributes this disparity in returns to the Internal 

Revenue Code while simultaneously denying that doublerecovery exists. See Opinion 511-A, 137 FERC ¶ 61,220, at 

¶ 315. 

True, FERC has a justifiable basis for its attribution of 

partner taxes to the partnership pipeline. In ExxonMobil, we 

acknowledged that “investors in a limited partnership are 
24

required to pay tax on their distributive shares of the 

partnership income, even if they do not receive a cash 

distribution.” 487 F.3d at 954. By contrast, “a shareholder of 

a corporation is generally taxed on the amount of the cash 

dividend actually received.” Id. For this reason, allocation of 

partner-level taxes to a partnership pipeline may not result in 

a “phantom tax” of the type we rejected in BP West Coast. 

However, our holding in ExxonMobil did not absolve FERC 

of its obligation to ensure “commensurate . . . returns on 

investments” for “equity owner[s]” as required under Hope 

Natural Gas, 320 U.S. at 603. Even if FERC elects to impute 

partner taxes to the partnership pipeline entity, it must still 

ensure parity between equity owners in partnership and 

corporate pipelines. FERC’s failure to do so in this case is 

therefore arbitrary or capricious. 

The remaining issue is the appropriate remedy. The 

Shippers do not request that we overturn our decision in 

ExxonMobil, which we are unable to do in any case absent an 

en banc decision from the Court. See LaShawn A. v. Barry, 

87 F.3d 1389, 1395 (D.C. Cir. 1996). But we also believe 

such action is unnecessary. When questioned at oral 

argument, FERC conceded that it might be able to remove 

any duplicative tax recovery for partnership pipelines directly 

from the discounted cash flow return on equity. See Oral 

Arg. Tr. 36:3-:10. We note also that, prior to ExxonMobil, 

FERC considered the possibility of eliminating all income tax 

allowances and setting rates based on pre-tax returns. See 

Policy Statement on Income Tax Allowances, 111 FERC 

¶ 61,139, at 61,741 (2005). To the extent that FERC can 

provide a reasoned basis for such a policy, we do not read our 

decision in ExxonMobil as foreclosing that option. See 487 

F.3d at 955 (“Arguably, a fair return on equity might have 

been afforded if FERC had chosen the fourth alternative of 

computing return on pretax income and providing no tax 
25

allowance at all for the pipeline owners.”). We therefore 

grant the Shippers’ petition, vacate FERC’s orders with 

respect to this issue, and remand for FERC to consider these 

or other mechanisms for which the Commission can 

demonstrate that there is no double recovery.

 

III. CONCLUSION

For the reasons stated herein, the Court: (i) grants-in-part 

SFPP’s petition with respect to the choice of data for 

assessing SFPP’s real return on equity, vacates FERC’s 

orders accordingly, and remands for further proceedings 

consistent with this opinion; (ii) denies-in-part SFPP’s 

petition with respect to the indexing issue; and (iii) grants the 

Shippers’ petition, vacates FERC’s orders with respect to the 

double recovery issue, and remands to FERC for further 

proceedings consistent with this opinion.

So ordered.