United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued May 9, 2005 Decided July 12, 2005

No. 02-1374

SOUTHERN CALIFORNIA EDISON COMPANY AND

PACIFIC GAS AND ELECTRIC COMPANY,

PETITIONERS

v.

FEDERAL ENERGY REGULATORY COMMISSION,

RESPONDENT

SAN DIEGO GAS & ELECTRIC COMPANY, ET AL.,

INTERVENORS

Consolidated with

02-1376, 02-1381, 02-1385, 02-1388

On Petitions for Review of Orders of the

Federal Energy Regulatory Commission

Nicholas W. Fels argued the cause for Utility Petitioners.

With him on the briefs were Mark D. Patrizio, Stuart K.

Gardiner, Carolyn F. Corwin, Stuart J. Evans, E. Gregory

Barnes, Jennifer L. Key, and Michael D. Mackness.
2

Harvey L. Reiter argued the cause for petitioners

Sacramento Municipal Utility District, et al. With him on the

briefs were Glen L. Ortman, Wallace L. Duncan, James D.

Pembroke, Michael Postar, and Sean M. Neal.

Anthony J. Ivancovich, J. Phillip Jordan, and Michael E.

Ward were on the brief for intervenor California Independent

System Operator Corporation in support of petitioners.

Dennis Lane, Solicitor, Federal Energy Regulatory

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

brief was Cynthia A. Marlette, General Counsel.

Before: GINSBURG, Chief Judge, and SENTELLE and

ROGERS, Circuit Judges.

Opinion for the Court filed by Circuit Judge SENTELLE.

SENTELLE, Circuit Judge: The Federal Energy Regulatory

Commission (“FERC” or “the Commission”) in the order before

us disallowed tariff provisions proposed by Southern California

Edison, Pacific Gas & Electric, and San Diego Gas & Electric

(“Utility Petitioners,” transmission operators, or “TOs”) in

which Utility Petitioners had proposed a rate designed to recover

from two classes of customers cost differentials from additional

expenses arising out of the formation and maintenance of an

independent system operator (“ISO”). Utility Petitioners

proposed a tariff term passing costs through both to customers

under existing contracts and to new customers. FERC

disallowed the pass-through as to the new customers. Both the

Utility Petitioners and municipal customers (customers under

pre-existing contracts) petition for review, challenging the

FERC decision as arbitrary and capricious in violation of section

706 of the Administrative Procedure Act (“APA”). Because the

order by FERC contravenes the explicit language of the FERC-
3

1According to the Utility Petitioners, “transmission losses” are

the small portion of energy that is lost “when electricity is scheduled

over transmission lines . . . due principally to electrical resistance of

the conductors transmitting the energy from generators to consumers”

and “ancillary servic es” means “the maintenance of generation at

various stages of readiness . . . in order to assure the continued

reliability of the grid.”

approved ISO tariff schedule to which the tariffs must conform,

we find the order to have been arbitrary and capricious and grant

the petitions for review.

I. Background

A. Creation of ISO Tariff Schedule 

In March 1998, as part of a FERC-instigated restructuring

of the California energy system, Utility Petitioners transferred

control over their electricity transmission to the newly formed

California ISO. (For background on the formation of ISOs in

general, and this ISO in particular, see California Independent

System Operator Corp. v. FERC, 372 F.3d 395, 396-97 (D.C.

Cir. 2004)). When they merged into the ISO, Utility Petitioners

retained obligations to provide transmission to existing

wholesale customers under pre-existing contracts. See FERC

Electric Tariff, original vol. 1 of Cal. Ind. Sys. Operator Corp.

§ 2.4.3.1 (“ISO Tariff”) (providing that existing contracts should

be honored such that, “to the extent possible, [doing so] imposes

no additional financial burden on either the Participating TO or

the contract rights holder . . . .”). But at the same time,

according to Utility Petitioners, they faced higher costs from the

ISO–in the form of transmission losses and ancillary service

requirements1–than those they could recover under existing

contracts with their wholesale customers. 
4

Just before the ISO went into operation, FERC approved the

final version of the ISO Tariff agreed to by the various parties

to the restructuring that established a roadmap governing the

operation of the ISO, including principles governing the

individual TO Tariffs that Utility Petitioners could charge to

their customers. During the process of negotiating this

agreement, Utility Petitioners asked that a provision be included

to allow them to recover the excess transmission and ancillary

service provision costs. This was done in section 7.1 of a revised

version of the ISO Tariff, issued in August 1997, which called

for including a “Transmission Revenue Credit” in the Access

Charge to be collected by the ISO on behalf of the TOs; the

definition of “Transmission Revenue Credit” was revised to

include “the shortfall or surplus resulting from any cost

differences between Transmission Losses and Ancillary Service

requirements associated with Existing Rights or Non-Converted

Rights and the ISO’s rules and protocols.” ISO Tariff, Master

Definitions Supplement, original sheet no. 350. Further, after

and pursuant to an October 30, 1997 FERC Order providing

interim and conditional authorization to the ISO to start

operations, Pacific Gas & Electric Co. et al, Order

Conditionally AuthorizingLimited Operation of an Independent

System Operator and Power Exchange, 81 FERC 61,122

(“October 1997 Order”), the ISO submitted a revision to the

language of section 2.4.4.4.4.5, which provided that the ISO

“will provide the parties to the Existing Contracts with details of

its Transmission Losses and Ancillary Services calculations to

. . . enable the parties to the Existing Contracts to settle the

differences bilaterally or through the relevant TO Tariff.” ISO

Tariff § 2.4.4.4.4.5 (emphasis added). 

FERC accepted the ISO’s proposed Access Charge,

including the revised definition of “Transmission Revenue

Credit” in its order of October 30, 1997. It accepted the

proposed revision to the language of section 2.4.4.4.4.5 “for
5

2The term “new customers” includes all customers taking

service under contracts entered after the assumption of service by the

ISO, without regard to whether a particular customer may have

previously had service under some preexisting contract.

filing . . . to become effective on the date that ISO operations

commence” in December 1997. Order Conditionally Accepting

for Filing Certain Pro Forma Agreements, 81 FERC 61,322,

62,477 (Dec. 17, 1997). Utility Petitioners argue that, under this

final version of the ISO Tariff, they would be permitted to

recover the cost differentials either (a) by bilaterally negotiating

with existing contract holders, or (b) by adding them to the

Access Charge (through the Transmission Revenue Credit)

charged by the ISO to the TOs’ new customers,2 paying ISO

tariff rates.

B. Administrative Proceedings

After the above-described negotiations were complete,

FERC set the individual TO Tariffs for administrative hearings,

as required by FPA § 205(e), 16 U.S.C. § 824d(e) (“Whenever

any new schedule is filed the Commission shall have authority,

. . . to enter upon a hearing concerning the lawfulness of such

rate, charge, classification, or service.”). In a consolidated

hearing addressing the proposed TO Tariffs of all three Utility

Petitioners, the administrative law judge (“ALJ”) decided that,

despite the above-cited language of the ISO Tariff, the cost

differentials could not be passed on to the TO’s tariff customers

via the Transmission Revenue Credit in the Access Charge,

holding that such a pass-through would amount to impermissible

cross-subsidization. Pacific Gas & Electric Co., Initial

Decision, 88 FERC 63,007, 65,051 (Sept. 1, 1999). Specifically,

the ALJ noted, “[a]ll other [TO] customers [aside from the

existing contract holders] would be responsible for costs

incurred on their own behalf as well as those incurred on behalf
6

of the Existing Contract customers.” Id. To make up the cost

differentials, the ALJ concluded, Utility Petitioners must either

(a) reform their contracts with existing contract holders, to the

extent permitted by those contracts and upon completion of a

FPA § 205 or FPA § 206 filing, or (b) “shoulder th[e] cost

burden” themselves, given that “they accepted the risk of

potential cost increases at the time they negotiated the Existing

Contracts.” Id. at 65,052. 

Both Utility Petitioners and Municipal Petitioners filed

exceptions to the ALJ’s decision to the Commission. FERC

affirmed, holding that the definition of Transmission Credit

Revenue in the ISO Tariff did not control, and that the language

concerning reforming existing contracts in section 2.4.3.1 was

“essentially precatory.” Pacific Gas & Electric Co. et al,

Opinion No. 458, Opinion and Order Affirming Initial Decision,

100 FERC 61,156, 61,573-74 (August 5, 2002) (“Order 458”).

FERC further held that the ALJ had correctly read the ISO

Tariff to require Utility Petitioners to recover the cost

differential by reforming existing contracts (or else absorb the

costs themselves), because “the costs are associated with service

provided under the existing contracts, not the TO Tariffs . . . .”

Id. at 61,574.

Utility Petitioners and Municipal Petitioners sought

rehearing. FERC affirmed its prior conclusion, along with its

justifications. See Pacific Gas & Electric Co. et al, Opinion

458-A, Order Denying Rehearing, Granting Clarification and

Approving Partial Settlement, 101 FERC 61,151, 61,620

(“Order 458-A”). At this point, FERC added new justifications

for its affirmation of the ALJ’s decision: First, FERC noted that

although the ISO Tariff defined Transmission Revenue Credit

to include the cost differential (and thus seemingly provided for

the ISO to collect the cost differential from the new customers

as part of the Access Charge), the definition “merely provided
7

that the ISO will assess these costs to the [TOs], but says

nothing about what the [TOs] can do to recover these costs.” Id.

at 61,621. Second, despite the fact that the October 1997 Order

revised section 2.4.4.4.4.5 as set forth above, FERC averred it

had not “sp[oken] to the issue in this case in the October 1997

Order.” Id. at 61,623. Instead, it said that all it had done was

provide that “‘ . . . the ISO will establish a mechanism

acceptable to the [TO] to roll any shortfall or surplus into the

ISO rates applicable to that Transmission Owner.’” Id. (quoting

October 1997 Order at 61,464 n.145). FERC went on: “This

language does not, and was not intended to, explain the next step

in the process–how the TOs would recover the costs from their

customers.” 

C. Current Petitions

Both Utility Petitioners and Municipal Petitioners petition

this court for review of Orders 458 and 458-A. Utility

Petitioners argue that FERC’s ruling that they may not recover

the cost differentials through their TO Tariffs is arbitrary and

capricious in violation of the Administrative Procedure Act

(“APA”), insofar as it ignores or misconstrues the plain

language of sections 2.4.4.4.4.5 and 7.1 of the ISO Tariff, and

relies instead on the ALJ’s “irrelevant” assertion that to allow

otherwise would shift costs from the existing contract holders to

the TO Tariff customers. Municipal Petitioners argue that it was

arbitrary and capricious for FERC to uphold the ALJ’s decision,

because (a) it ignored the ISO Tariff provisions that allowed for

recovery of the cost differentials through the TO Tariffs, and (b)

FERC “neither explains the basis for its subsidization finding

nor addresses Municipal Petitioners’ arguments that cost

causation principles require the opposite conclusion,” i.e., that

the existing contract holders were not responsible for the cost

differentials. Mun. Pet. Br. at 16.
8

After Petitioners filed their petitions in December 2002,

FERC asked for a voluntary remand of the record so that it could

consider the issues further. The Commission issued an order on

remand in May 2004, noting that it had mistakenly stated that

the ISO Tariff language established the rate the ISO collects

from (rather than for) the TOs. Order on Remand, 107 FERC

61,115 (May 6, 2004) (referring to language in Opinion No.

458-A at 61,621, mentioned above, in which FERC states that

the definition of Transmission Revenue Credit “merely provided

that the ISO will assess these costs to the [TOs], but says

nothing about what the [TOs] can do to recover these costs.”)

However, FERC maintains that that error did not affect its basic

conclusions. 

We have jurisdiction under 16 U.S.C. § 825l(b). See, e.g.,

In re American Rivers & Idaho Rivers United, 372 F.3d 413,

419 (D.C. Cir. 2004). Because we conclude that FERC cannot

disregard the definition of Transmission Revenue Credit that it

approved and included in the ISO Tariff when considering later

TO Tariff filings by TOs seeking to conform to that tariff, we

grant the petitions for review.

II. Discussion

In the tariff context, this Court generally “gives substantial

deference to [FERC's] interpretation of filed tariffs, even where

the issue simply involves the proper construction of language.”

Koch Gateway Pipeline Co. v. FERC, 136 F.3d 810, 814 (D.C.

Cir. 1998) (internal quotation marks omitted). But, “[i]f the

tariff's language is unambiguous, this court need not defer to

FERC's interpretation.” Idaho Power v. FERC, 312 F.3d 454,

461 (D.C. Cir. 2002).

The language of the ISO Tariff at issue in this case is clear.

Section 2.4.4.4.4.5 of the ISO Tariff is permissive, allowing for
9

the recovery of cost differentials through the TO Tariffs, as well

as through bilateral negotiations to reform existing contracts.

The provision for the collection of a Transmission Revenue

Credit as part of the Access Charge in section 7.1, combined

with the definition of Transmission Revenue Credit, creates an

explicit accounting mechanism for the ISO to recover the cost

differentials through the TO Tariff on the TOs’ behalf. Thus,

Utility Petitioners are correct that the ISO Tariff allows them to

recover the cost differentials associated with the formation of

the ISO through their individual TO Tariffs. 

FERC’s primary argument in support of its decision to

uphold the ALJ’s decision disregarding the plain meaning of

these provisions of the ISO Tariff is that the ISO Tariff is not

controlling. But FERC can only support this argument with its

own statements in the administrative proceedings below: (1)

That the main purpose of those proceedings was to determine

whether the TO tariff on the table was just and reasonable, as

called for by FPA § 205(e); and (2) that it had made clear that

the Access Charges (which include the Transmission Revenue

Credit) were to be evaluated in individual tariff proceedings.

However, to hold an individual TO Tariff that conforms to the

ISO Tariff unjust and unreasonable would be to render section

7.1 and the definition of Transmission Revenue Credit nullities.

This we can not do. See, e.g., Secretary of Labor v. Twentymile

Coal Company, 2005 U.S. App. LEXIS 10797 at *11, Case Nos.

04-1292 & 04-1312 (D.C. Cir., June 10, 2005) (rejecting

agency’s interpretation of a regulation as “particularly untenable

because it would render the pertinent regulation a nullity.”)

(emphasis removed). 

FERC also argues, somewhat puzzlingly but consistent with

its statements in the Remand Order, that the ISO Tariff

provisions “leave[] open the question of who should pay the cost

differentials.” Govt. Br. at 26. In so arguing, FERC undermines
10

its own position–that the TOs cannot recover the cost

differentials through the TO Tariffs–when it notes that “the

Commission responded to that position by concluding recovery

through the TO Tariff is not the sole option,” and “recognize[d]

the TO Tariff as an option.” Govt. Br. at 29 (emphases in

original). 

Further, FERC argues that despite the plain text of the ISO

Tariff, the “cost causation principle” dictated shifting the burden

entirely over to the existing contract holders. Because FERC

has already approved the mechanism in the ISO Tariff for

collecting the cost differentials from the tariff customers, and

cannot retroactively reverse that determination in considering

individual TO Tariff filings, no argument concerning cost

causation, regardless of how compelling, would permit the

Commission to disregard the approved ISO Tariff. Should the

Commission upon further reflection consider that mechanism to

violate the cost causation principle, perhaps it may initiate

proceedings to change the ISO Tariff prospectively, but that is

not the case before us.

Thus, all of FERC’s counter-arguments fall away, leaving

us with the simple conclusion that FERC must follow its own

roadmap enunciated in the ISO Tariff, and, in rate proceedings,

affirm individual TO Tariffs that conform their rate design to the

ISO Tariff. FERC may not, as FERC staff asserted and the ALJ

agreed, “order modification of [Utility Petitioners’] TO Tariffs

irrespective of any inconsistencies that such an order might

create with the collective ISO Tariff.” Initial Decision, 88

FERC at 65,051. 

If FERC decided, after it began to look at the individual TO

Tariffs, that allowing Utility Petitioners to include the cost

differentials associated with the formation of the California ISO

in the Access Charge collected from the new customers through
11

the Transmission Revenue Credit mechanism was unjust and

unreasonable cross-subsidization, the proper course of action

was to revise sections 2.4.4.4.4.5 and 7.1 of the ISO Tariff,

including the definition of Transmission Revenue Credit also

contained therein, as it is empowered to do under FPA § 206, 16

U.S.C. § 824e. 

More generally, of course, agencies may alter regulations.

Agencies may even alter their own regulations sua sponte, in the

absence of complaints, provided they have sufficient reason to

do so and follow applicable procedures. See NRDC v. EPA, 859

F.2d 156 (D.C. Cir. 1988); see also Dana Corp. v. ICC, 703

F.2d 1297, 1305 (D.C. Cir. 1983) (“[T]he agency is entitled to

have second thoughts, and to sustain action which it considers

in the public interest upon whatever basis more mature

reflection suggests.”). But agencies may not keep regulations in

place and then disregard them in order to disapprove actions

taken by regulated entities to conform with those regulations.

Doing so is perhaps the essence of “arbitrary and capricious.”

Having so concluded, we need not reach the issue of

whether FERC was arbitrary and capricious in assigning blame

for the cost differentials to the Municipal Petitioners. 

III. Conclusion

In sum, FERC acted arbitrarily and capriciously in

upholding the ALJ’s Initial Decision that disregarded the plain

language of sections 2.4.4.4.4.5 and 7.1 of the ISO Tariff, and

the definition of Transmission Revenue Credit contained therein.

Opinions 458 and 458-A are vacated, and the case remanded for

further proceedings consistent with the ISO Tariff. 

So ordered.