United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued December 1, 2017 Decided March 16, 2018

No. 16-1176

NORTHWESTERN CORPORATION,

PETITIONER

v.

FEDERAL ENERGY REGULATORY COMMISSION,

RESPONDENT

MONTANA CONSUMER COUNSEL, ET AL.,

INTERVENORS

On Petition for Review of Orders of the

Federal Energy Regulatory Commission

John Lee Shepherd, Jr. argued the cause for petitioner. 

With him on the briefs were Clifford M. Naeve, James P. 

Danly, Heather H. Grahame, M. Andrew McLain, and Timothy 

T. Mastrogiacomo.

Holly E. Cafer, Senior Attorney, Federal Energy 

Regulatory Commission, argued the cause for respondent. 

With her on the brief were David L. Morenoff, General 

Counsel, and Robert H. Solomon, Solicitor.

Christina F. Gomez argued the cause for intervenors. With 

her on the brief were Kathleen L. Mazure, Thorvald A. Nelson,
2

and Michelle Brandt King. John P. Coyle, Natalie M. Karas, 

and Justin W. Kraske entered appearances.

Before: KAVANAUGH and WILKINS, Circuit Judges, and 

RANDOLPH, Senior Circuit Judge.

Opinion for the Court filed by Circuit Judge KAVANAUGH.

KAVANAUGH, Circuit Judge: The Federal Energy 

Regulatory Commission requires utilities that transmit 

electricity to supply extra power generation in order to balance 

moment-to-moment variations in demand for electricity. 

Utilities must add power to, or withdraw power from, the grid 

in real time as actual demand for electricity exceeds or falls 

short of projected demand. That extra power generation is 

known as regulation service.

FERC allows utilities to recover costs associated with the 

provision of regulation service. Utilities may recover those 

costs by charging them to customers, as long as the utilities 

charge rates that are “just and reasonable.” 16 U.S.C. 

§ 824d(a).

NorthWestern is an electric utility that is subject to 

FERC’s regulation-service requirement. Before 2011, 

NorthWestern lacked the generating capacity to provide its 

own regulation service, so it met the requirement by purchasing 

regulation service from other utilities. With FERC’s approval, 

NorthWestern then passed on the cost of that purchased

regulation service to its wholesale and retail customers. But 

purchasing regulation service from other utilities eventually 

became too expensive, so NorthWestern built a new generating 

station dedicated to providing regulation service. 

NorthWestern then proposed to revise the rate that it charges 
3

customers for regulation service in order to recover the costs of 

providing that service from the new station.

FERC determined that NorthWestern’s proposed rate was 

not just and reasonable. FERC therefore modified

NorthWestern’s proposed rate and ordered NorthWestern to 

refund its customers the difference between the proposed rate 

and the modified rate. NorthWestern challenges FERC’s 

decision as arbitrary and capricious under the Administrative 

Procedure Act. The arbitrary and capricious standard requires 

that an agency’s decision be reasonable and reasonably 

explained. We conclude that FERC’s decision in this case was 

reasonable and reasonably explained, and we therefore deny 

the petition for review.

I

In 1996, FERC issued Order 888. 61 Fed. Reg. 21,540

(May 10, 1996). Among other things, Order 888 requires 

electric utilities to provide their customers with certain 

ancillary services – services that supplement the basic service 

of transmitting electricity. Id. at 21,579-80. One such ancillary 

service is “regulation service.” Regulation service is extra 

power generation that responds to “moment-to-moment 

variations” in demand for electricity in a given area. Id. at 

21,582. In other words, regulation service is “the injection or 

withdrawal of real power” into or from the electric grid in

response to fluctuations in demand for electricity. Order No. 

755, 76 Fed. Reg. 67,260, 67,260-61 (Oct. 31, 2011). 

Regulation service helps to prevent blackouts and equipment 

damage by keeping the frequency of the electric current at close 

to 60 Hertz, the standard frequency in the United States. Id. If 

a utility fails to maintain that frequency, FERC may impose 

civil penalties on the utility. See 16 U.S.C. § 825o-1.
4

A utility charges customers for regulation service under 

Schedule 3 of the utility’s Open Access Transmission Tariff,

which is filed with FERC. FERC must examine the rate that a 

utility proposes to charge Schedule 3 customers in order to 

ensure that the rate is “just and reasonable.” 16 U.S.C. 

§ 824d(a), (e). A just and reasonable rate must be fair both to 

the utility and to its customers: It “should be based on the costs 

of providing service to the utility’s customers, plus a just and 

fair return on equity.” Alabama Electric Cooperative, Inc. v. 

FERC, 684 F.2d 20, 27 (D.C. Cir. 1982); see also FPC v. Hope 

Natural Gas Co., 320 U.S. 591, 603 (1944). 

This case concerns an attempt by petitioner NorthWestern 

to revise its Schedule 3 rate. NorthWestern is an electric utility 

subject to FERC’s regulation-service requirement. As relevant

here, NorthWestern transmits electricity to wholesale and retail 

customers in Montana.1

 When NorthWestern first began 

operations in 2002, NorthWestern did not possess sufficient 

generating capacity to provide its own regulation service. So 

NorthWestern complied with Order 888 by purchasing 

regulation service from other utilities. NorthWestern 

contracted with those other utilities for a set amount of 

regulation service and passed the cost of that regulation service

on to customers under Schedule 3. From 2002 to 2010, 

NorthWestern purchased, and passed on the cost of, 60 

 1 The record is not clear about the precise makeup of 

NorthWestern’s customer base. According to FERC, 

NorthWestern’s customers – presumably its wholesale customers –

include generators and “load-serving entities.” Respondent’s Brief 

at 1. Load-serving entities are utilities that supply electricity to 

homes and businesses. NorthWestern’s retail customers appear to 

include industrial energy customers such as refining companies, see

Intervenors’ Brief at ii, 1, but may also include commercial and 

residential customers. Regardless, the exact makeup of each 

customer class does not affect the resolution of this case.
5

megawatts of regulation service each year to its Schedule 3

customers.

But NorthWestern eventually decided that purchasing 

regulation service from other utilities was inefficient. So 

NorthWestern built the Dave Gates Generating Station, a 

station dedicated to providing regulation service to 

NorthWestern’s customers. The Gates Station has three 

generators, each with a maximum capacity of 50 megawatts, 

for a total nominal or “nameplate” capacity of 150 megawatts. 

The Gates Station began operating in January 2011.

Whereas NorthWestern had previously passed on to its 

Schedule 3 customers the cost of purchasing regulation service 

from other utilities, NorthWestern now wanted to recover from 

its customers the cost of providing regulation service from the 

Gates Station. So NorthWestern filed a proposed revised 

Schedule 3 rate for FERC’s approval. NorthWestern filed its 

rate pursuant to Section 205 of the Federal Power Act, which 

places the burden on the utility to show that its proposed 

revised rate is just and reasonable. 16 U.S.C. § 824d(e).

Here is how NorthWestern proposed to recover the cost of 

providing regulation service from the Gates Station. First, 

NorthWestern calculated the Gates Station’s revenue 

requirement – the station’s costs plus an allowed rate of return. 

NorthWestern then divided the Gates Station’s revenue 

requirement between two different groups of customers. The 

first group of customers included retail customers only. In 

Montana, retail customers pay for wind-generated electricity in 

addition to fuel-generated electricity. Retail customers pay for 

wind-generated electricity at state-approved rates; FERC does 

not enter into the picture, and utilities do not use Schedule 3 to 

recover the cost of regulation service associated with windgenerated electricity. Because NorthWestern calculated that 
6

retail customers would need 45 megawatts of regulation service 

just to support wind-generated electricity, NorthWestern 

intended to charge retail customers alone for 45 megawatts of 

regulation service, and to do so at the state-approved rate –

separate from Schedule 3. 

The second group of customers included both retail and 

wholesale customers. Both retail and wholesale customers pay 

for regulation service associated with fuel-generated electricity 

at FERC-approved rates under Schedule 3. NorthWestern 

determined that this second group of customers would need 60 

megawatts of regulation service – the amount that 

NorthWestern had historically purchased from other utilities. 

So NorthWestern proposed to recover the cost of 60 megawatts

of regulation service from this second group of customers

under Schedule 3.

In other words, NorthWestern planned to use the Gates 

Station to supply a total amount of 105 megawatts of regulation 

service to all of its customers. Retail customers alone would 

pay for 45 megawatts of that total – 43% – at a state-approved 

rate, separate from Schedule 3. Retail and wholesale customers

together would pay for the remaining 60 megawatts of that total 

– 57% – under Schedule 3. NorthWestern calculated its

proposed Schedule 3 rate by multiplying the Gates Station’s 

revenue requirement by .57, which is the ratio of 60/105.

Three other components of NorthWestern’s proposed 

Schedule 3 rate also matter here. First, NorthWestern planned 

to use Schedule 3 to recover fuel costs associated with 

operating the Gates Station, but also planned to credit 

customers for any revenue that the Gates Station might bring 

in from anything other than providing regulation service, such 

as from “off-system sales” – sales of energy to third parties. 

NorthWestern indicated, however, that it did not actually plan 
7

to use the Gates Station for anything other than regulation 

service. Second, NorthWestern proposed to recover costs 

associated with a three-month outage of the Gates Station that 

occurred in 2012. During that outage, NorthWestern once 

again had to buy regulation service from other utilities. 

NorthWestern planned to pass the cost of that purchased 

regulation service on to its customers under Schedule 3. Third, 

NorthWestern also sought approval to pass on to customers the 

cost of any regulation service that NorthWestern might need to 

purchase in the future in the event of another Gates Station 

outage.

In sum, NorthWestern asked FERC to approve a revised 

Schedule 3 rate that: (1) charged customers for regulation 

service by multiplying the Gates Station’s revenue requirement 

by the cost-calculation ratio of .57; (2) charged customers for 

fuel costs, but credited customers for any revenue the Gates 

Station might bring in from off-system sales and other nonregulation-service sales; (3) charged customers for the 

regulation service that NorthWestern purchased for three 

months during the 2012 outage; and (4) charged customers for 

any regulation service that NorthWestern might need to 

purchase during future outages.

The administrative law judge assigned to NorthWestern’s 

case concluded that several aspects of the rate were not just and 

reasonable. The ALJ reduced NorthWestern’s proposed rate 

by: (1) multiplying the revenue requirement by a different costcalculation ratio of .13, which is 19/150; (2) excluding fuel 

costs from the Schedule 3 rate altogether and rejecting 

NorthWestern’s crediting arrangement; (3) requiring 

NorthWestern to make a separate filing to recover costs 

associated with the 2012 outage; and (4) requiring 

NorthWestern to make separate filings before charging 
8

customers for any regulation service that NorthWestern might

need to purchase during future outages. 

FERC affirmed the ALJ’s decision in all respects. FERC 

ordered NorthWestern to refund its customers the difference 

between NorthWestern’s proposed rate and the lower rate that 

FERC ultimately approved as just and reasonable. FERC 

denied NorthWestern’s request for rehearing. 

NorthWestern timely petitioned for review in this Court. 

We review FERC’s order under the Administrative Procedure 

Act’s arbitrary and capricious standard. That standard requires 

that FERC’s decision be reasonable and reasonably explained.

II

NorthWestern raises four challenges to the revised rate 

that FERC approved.

First, NorthWestern maintains that FERC unreasonably

reduced the numerator of NorthWestern’s proposed costcalculation ratio. The numerator reflects the number of 

megawatts needed to serve Schedule 3 customers. FERC 

reduced the proposed numerator from 60 to 19 megawatts after 

determining that only 19 megawatts were needed to serve 

Schedule 3 customers. 

Along with some other exclusions not at issue here, FERC

excluded the megawatts associated with “regulation-down” 

capacity from the numerator. NorthWestern contends that it 

was unreasonable to exclude regulation-down capacity from 

the numerator. We disagree.

“Regulation down,” a component of regulation service, is 

the capacity associated with operating a generator at a set point, 
9

a steady point from which the utility can quickly ramp down if 

demand for electricity suddenly drops. The energy generated

as a by-product of operating at a set point can potentially be 

used for non-regulation-service purposes – for example, it can 

be sold to third parties in “off-system sales.” 

NorthWestern operates its Gates Station generators at a set 

point in order to reserve capacity for regulation down. But 

NorthWestern does not sell the energy thereby generated. 

NorthWestern nonetheless proposed to recover from its 

Schedule 3 customers the costs of reserving regulation-down 

capacity. The ALJ rejected NorthWestern’s proposal and 

subtracted the megawatts associated with regulation-down 

capacity from NorthWestern’s proposed numerator after 

determining that NorthWestern had neither produced adequate 

data to show how much regulation-down capacity the Gates 

Station would need to reserve, nor explained why 

NorthWestern could not recover its costs in some other way, 

such as by selling the energy.

FERC affirmed the ALJ’s decision and added some further 

analysis, focusing primarily on NorthWestern’s failure to 

demonstrate that it could not recover its costs through means 

such as off-system sales. Drawing on other cases excluding

regulation-down capacity from cost calculations, FERC 

applied the principle that animated those cases: Customers 

should not pay for what is essentially a backup service if the

utility can recover its costs by using or selling the energy that 

it generates as a by-product. See NorthWestern Corp., 155 

FERC ¶ 61,158, at ¶¶ 33-36 (2016); see also Kentucky Utilities 

Co., 85 FERC ¶ 61,274 (1998); Allegheny Power Service 

Corp., 85 FERC ¶ 61,275 (1998). NorthWestern, FERC 

acknowledged, might be in a different situation: It was 

possible, for example, that the location of the Gates Station

might make off-system sales infeasible. If so, then 
10

NorthWestern might be able to show the justness and 

reasonableness of charging Schedule 3 customers for the costs

of reserving regulation-down capacity. But FERC concluded 

that NorthWestern had failed to produce sufficient evidence to

support such a showing. See NorthWestern Corp., 147 FERC 

¶ 61,049, at ¶ 48 (2014). And because it was NorthWestern’s

burden under Section 205 to show that its proposed rate was 

just and reasonable, that failure was fatal. FERC therefore 

reasonably excluded the megawatts associated with regulationdown capacity from the cost-calculation ratio.

NorthWestern’s several rejoinders miss the mark. 

NorthWestern maintains that FERC lacked authority under 

Section 205 to reduce the numerator of NorthWestern’s 

proposed cost-calculation ratio. Because NorthWestern 

previously passed on the cost of 60 megawatts of purchased 

regulation service with FERC’s approval, NorthWestern 

argues that the 60-megawatt amount was “embedded” in 

NorthWestern’s original rate. Petitioner’s Brief at 40. And 

because FERC (i) must act under Section 206 of the Federal 

Power Act in order to modify an existing rate component and 

(ii) may modify an existing rate component under Section 206 

only after showing that the existing rate component is not just 

and reasonable, NorthWestern contends that FERC made an 

“end-run” around Section 206 by (i) modifying an existing rate 

component in a Section 205 proceeding and (ii) placing the 

burden of proof on NorthWestern. Id. at 41; see 16 U.S.C. 

§ 824e; Public Service Commission of New York v. FERC, 642 

F.2d 1335, 1345 (D.C. Cir. 1980) (utility bears burden of proof 

on those parts of its proposed rate that depart from status quo, 

but not on those parts that are “constant elements” of the 

previous rate).

NorthWestern is mistaken. The 60-megawatt amount was 

never “embedded” in any rate formula that FERC previously 
11

approved because it was never a component of a traditional 

cost-of-service rate. Rather, FERC previously allowed 

NorthWestern – as a temporary expedient – to pass on what it 

cost NorthWestern to procure a set amount (60 megawatts) of 

regulation service from third parties. NorthWestern’s proposed 

revised rate, which is structured as a traditional cost-of-service 

rate, departs from the previous status quo. NorthWestern 

therefore had to justify its entire revised and redesigned rate, 

including all of the rate’s components, as FERC explained. 

NorthWestern Corp., 155 FERC ¶ 61,158, at ¶¶ 27-29; see

Kansas Gas & Electric Co. v. FERC, 758 F.2d 713, 719-20

(D.C. Cir. 1985) (utility proposing rate clause that departs from 

previous status quo bears burden of proof). So FERC properly 

assigned NorthWestern the burden of proof in this Section 205 

proceeding. 

In another burden-shifting attempt, NorthWestern 

contends that FERC failed to identify other customers who 

might bear NorthWestern’s cost of reserving regulation-down 

capacity. But it was not FERC’s burden to identify alternative 

ways for NorthWestern to recover its costs (although FERC did 

suggest some ways). Instead, it was NorthWestern’s burden to

show that its proposed rate was just and reasonable – here, for 

example, by showing that no other such customers could be 

identified.

NorthWestern also objects that, in reducing the numerator,

FERC failed to account for NorthWestern’s proposed crediting 

arrangement, which would have credited NorthWestern’s 

Schedule 3 customers the value of any off-system or other nonregulation-service energy sales that NorthWestern might 

manage to make. But FERC reasonably declined to discuss the 

crediting arrangement. The proposed crediting arrangement 

assumed the very point that NorthWestern needed to prove: 
12

that Schedule 3 customers should bear the cost of reserving

regulation-down capacity in the first place.

In short, FERC reasonably modified NorthWestern’s 

proposed cost-calculation ratio by excluding the megawatts 

associated with “regulation down” from the numerator. We 

therefore reject NorthWestern’s first challenge.

 

Second, NorthWestern contends that FERC arbitrarily 

increased the denominator of NorthWestern’s proposed costcalculation ratio from 105 megawatts to 150 megawatts. We 

disagree. 

Recall that 105 megawatts is the total amount of regulation 

service that NorthWestern planned to provide from the Gates 

Station – 45 megawatts associated with wind-generated 

electricity, plus 60 megawatts associated with fuel-generated 

electricity. NorthWestern proposed to use that 105-megawatt 

figure as the denominator of the cost-calculation ratio in order 

to charge Schedule 3 customers for their portion of the total 

amount of regulation service that NorthWestern planned to 

provide from the Gates Station.

Under FERC precedent, however, the denominator should 

reflect the nameplate capacity – here, meaning the number of 

megawatts that the Gates Station had the capacity to produce, 

not just the megawatts that NorthWestern planned to devote to 

regulation service. See Westar Energy, Inc., 130 FERC 

¶ 61,215, at ¶ 40 (2010); NorthWestern Corp., 140 FERC 

¶ 63,023, at ¶¶ 148-150 (2012). The record evidence

established that each of the three generators at the Gates Station 

had a capacity of 50 megawatts, for a total of 150 megawatts. 

FERC therefore reasonably increased the denominator to 150 

megawatts.
13

NorthWestern retorts that, because FERC’s ratio uses “the 

nameplate capacity” as the denominator “despite using 

customer demand for regulation service as the numerator,” the 

ratio is somehow unreasonable. Petitioner’s Brief at 32-33. 

We disagree. The denominator measures the Gates Station’s 

total capacity, and the numerator measures the portion of that 

total capacity that is needed to provide regulation service to 

Schedule 3 customers. 

Because FERC acted reasonably in modifying the 

denominator, we reject NorthWestern’s second challenge to 

FERC’s decision.

Third, NorthWestern maintains that FERC wrongly 

rejected NorthWestern’s proposal to recover fuel costs under 

Schedule 3. More particularly, NorthWestern argues that 

FERC inadequately explained its decision not to allow fuel 

costs, and failed to account for the fact that NorthWestern may 

not be able to recover fuel costs retroactively under Schedule 

4. FERC’s explanation, however, was adequate. 

FERC adopted the ALJ’s reasoning, which explained that 

FERC ordinarily requires utilities to recover fuel costs under 

Schedule 4, which governs “energy service,” rather than under 

Schedule 3, which governs “capacity service.” The two 

exceptional cases that NorthWestern identified both involved 

unusual circumstances, as the ALJ’s decision noted. 

NorthWestern Corp., 140 FERC ¶ 63,023, at ¶ 181. In addition, 

FERC was not persuaded by NorthWestern’s argument about 

the potential difficulty of recovering past fuel costs under 

Schedule 4, because NorthWestern “admittedly never 

attempted” to recover those costs under Schedule 4. 

NorthWestern Corp., 155 FERC ¶ 61,158, at ¶ 43. FERC’s 

decision on fuel costs was reasonable and reasonably 

explained.
14

Fourth, NorthWestern argues that FERC acted arbitrarily 

by (1) requiring NorthWestern to make a separate Section 205 

filing to recover costs associated with the 2012 Gates Station 

outage, and (2) requiring NorthWestern to make separate 

Section 205 filings before charging customers for any

regulation service that NorthWestern might need to purchase 

during future outages. NorthWestern again maintains that 

FERC inadequately explained its decision and failed to 

consider the possibility that NorthWestern might not be able to 

recover costs associated with the 2012 outage retroactively. 

But FERC again adopted the ALJ’s reasoning, which justified 

the separate proceedings on reasonable grounds – the need for 

more data related to the 2012 outage, and the need for case-bycase analysis of any future contracts. FERC acted reasonably 

here as well.

In sum, we find that FERC’s decision on NorthWestern’s 

proposed rate was reasonable and reasonably explained.

III

NorthWestern also challenges FERC’s decision to order a 

refund of the difference between the higher rate that 

NorthWestern proposed and the lower rate that FERC 

approved. NorthWestern contends that FERC’s refund 

decision resulted from faulty reasoning and an inadequate 

assessment of equitable factors. We are not persuaded.

The parties agree that FERC ordinarily does not order 

refunds in cases where a utility collects the appropriate total

amount of revenue but improperly allocates it among different 

customer groups. The parties also agree that FERC ordinarily

does order refunds in cases where a utility instead overcharges 

a given customer group. See, e.g., Black Oak Energy, LLC, 139 
15

FERC ¶ 61,111, at ¶ 11 & nn. 17-18 (2012). But the parties

disagree about how to classify this case. 

FERC concluded that NorthWestern over-collected from 

its Schedule 3 customers, making this the kind of case in which 

FERC ordinarily orders refunds. That determination was 

reasonable. As FERC explained, the purpose of the Section 

205 proceeding was to decide whether the revised rate that 

NorthWestern proposed to charge its Schedule 3 customers was 

just and reasonable. The object of the proceeding was not to 

decide how to divvy up the Gates Station’s revenue 

requirement among different customer groups. NorthWestern 

Corp., 155 FERC ¶ 61,158, at ¶¶ 55-56. Because FERC 

concluded that NorthWestern’s proposed Schedule 3 rate was 

too high, FERC naturally also concluded that NorthWestern 

had overcharged, and therefore over-collected from, its 

Schedule 3 customers.

NorthWestern objects that the parties’ frequent use of the 

word “allocate” throughout the proceeding demonstrates that 

this case was really about cost allocation. True, the parties 

tossed that term around somewhat loosely. But to make the 

classification of this case turn on the parties’ imprecise use of 

the term “allocate” would be to ignore the substantive 

distinction that FERC’s precedent attempts to draw between 

“cost-allocation” and “over-collection” cases. NorthWestern’s 

other objections take too narrow a view of FERC’s relevant 

precedents and rely on comparisons to dissimilar cases. Put 

simply, FERC reasonably determined that NorthWestern overcollected from its Schedule 3 customers in this case.

Even so, NorthWestern contends that FERC did not 

adequately assess the relevant equitable factors before 

imposing the refund order. But FERC considered the argument 

that NorthWestern acted in good faith, and found it irrelevant 
16

to the question whether FERC should depart from its general 

policy of ordering refunds in over-collection cases. FERC also 

considered the fact that NorthWestern was on notice about a 

potential refund order from the start of the proceeding, when 

FERC accepted and suspended NorthWestern’s proposed rate 

subject to refund. After considering those factors, FERC 

decided to treat this case like an ordinary over-collection case 

and order a refund. That decision was reasonable and 

reasonably explained.

* * *

We deny the petition for review.

So ordered.