Opinion ID: 527537
Heading Depth: 2
Heading Rank: 2

Heading: The D-2 Charge

Text: 43 In Opinion No. 265, 38 F.E.R.C. at 61,452-53, the Commission ordered Panhandle to adopt the MFV rate design approved in Texas Eastern Transmission Corp., 32 F.E.R.C. p 61,056, modifying 30 F.E.R.C. p 61,144 (1985). Although the MFV method is complicated (see supra section I.B), its key change for present purposes may be expressed simply: a pipeline must shift certain fixed costs from the commodity component to a two-part demand component in order to make recovery more dependent on its ability to compete in the market-place. Texas Eastern, 32 F.E.R.C. at 61,149-53; 30 F.E.R.C. at 61,282-84. The first demand charge (D-1) is intended to enable a pipeline to recover 50% of its demand costs based on a customer's contract demand (i.e., entitlement to receive gas service on any given day); the D-2 charge seeks to ensure recovery of the remaining 50% based on a customer's maximum annual service entitlement. See Texas Eastern, 32 F.E.R.C. at 61,149, 61,152-54; see also Opinion No. 265, 38 F.E.R.C. at 61,452-53. Acknowledging that the D-2 billing determinant used here--customers' yearly service entitlements set forth in their contracts with Panhandle--might be based on historical figures that did not accurately reflect current needs, FERC urged affected customers to 44 renegotiate their contracts ... to include realistic reservations of the amount of annual service to be provided. If [they] are unable to reach a satisfactory resolution with [the pipeline] they should so inform us. We will then determine what, if any, adjustments should be made to the contracts. 45 Opinion No. 265, 38 F.E.R.C. at 61,453 (quoting Texas Eastern, 32 F.E.R.C. at 61,154). 46 In Opinion No. 265-A, however, the Commission ruled that the D-2 charge should be based not on renegotiated annual entitlement ceilings, but rather on a customer's unilateral renominations; FERC required Panhandle to accept any level nominated ... that is equal to or less than the level which would be reached if the customer took its existing contract demand every day. 40 F.E.R.C. at 61,596-97. The Commission justified this change by noting that Panhandle has no procedures in its tariffs for making changes to the D-2 level and asserting that independent customer renominations were consistent with Columbia Gas Transmission Corp., 37 F.E.R.C. p 61,068 (1986), reh'g granted in part, 38 F.E.R.C. p 61,342 (1987). Opinion No. 265-A, 40 F.E.R.C. at 61,596. FERC also concluded that a customer's deliberate undernomination of its actual annual needs (to reduce its D-2 charges) would be deterred by allowing Panhandle to impose substantial overrun penalty charges. Id. at 61,597 & n. 17 (citing ANR Pipeline Co., 37 F.E.R.C. p 61,263, at 61,747 (1986)). 47 In its November 4, 1987 order on rehearing, the Commission reiterated this rationale, and added that 48 the renomination of billing determinants may affect the rate the customer pays, but will not affect Panhandle's service obligation.... [T ]he pipeline still [must ] stand ready to serve its customers at the certificated level regardless of the change in entitlements. The only consequence [is] a possible increase in rates due to penalties for taking above the entitlement. 49 41 F.E.R.C. at 61,307 (emphasis added) (citing Columbia Gas, 37 F.E.R.C. p 61,068). 50 On appeal, Panhandle does not seriously dispute FERC's authority to command adoption of the MFV rate design and use of a two-part demand charge. We have previously upheld the Commission's determination that this new methodology was necessary to help pipelines cope with an increasingly competitive environment. See East Tenn. Natural Gas Co. v. FERC, 863 F.2d 932, 939 (D.C.Cir.1988) (FERC's policy judgment that MFV method would promote competitiveness among pipelines by placing certain fixed costs at risk was well within its discretion); see also Texas Eastern, 32 F.E.R.C. at 61,149-52 (explaining why MFV procedure would replace traditional method of cost classification, allocation, and rate design formulated in Atlantic Seaboard Corp., 11 F.P.C. 43 (1952), and method of distributing cost responsibility outlined in United Gas Pipe Line Co., 50 F.P.C. 1348 (1973), reh'g denied, 51 F.P.C. 1014 (1974), aff'd sub nom. Consolidated Gas Supply Corp. v. FPC, 520 F.2d 1176 (D.C.Cir.1975)). 51 Rather, Panhandle argues that FERC failed to provide an adequate rationale for changing the basis of the D-2 charge from renegotiated contractual entitlements (Opinion No. 265) to customers' unilateral nominations (Opinion No. 265-A). Indeed, Panhandle asserts that the latter procedure, coupled with the Commission's November 4 order requiring the pipeline to continue providing customers with the full certificated service level regardless of the amount each customer nominates, is indefensible because it undercuts Texas Eastern's rationale for D-2 charges. 52 In Texas Eastern, FERC justified the new two-part demand charge on two grounds. First, creating a separate demand component would mitigate the cost-shifting from high to low load factor customers that resulted from adoption of the MFV rate design, which reduced the fixed costs to be recovered through the commodity charge and increased those to be recouped through the demand charge. 32 F.E.R.C. at 61,152. 53 Second, the demand charge would enable a pipeline to recover the costs both of building facilities adequate to provide service during peak demand periods and of acquiring gas supplies sufficient to meet overall consumer demand. Id. Although the latter sales service function had become increasingly important because demand had replaced capacity as the principal market constraint, the Commission noted that pipelines persisted in obtaining gas supplies based on customers' reservations of the amount of service they desired, rather than on actual market demand. Id. at 61,152-53. In FERC's view, the D-2 charge would rectify this situation: it would recognize that pipelines incur costs when customers reserve the right to receive a specified amount of service, and it would give customers the incentive to make realistic reservations by tying their D-2 payment rate explicitly to the amount of service they reserved. Id. 54 Thus, in Texas Eastern the Commission concluded that the determinants used to allocate costs in the D-2 charge should reflect a customer's reservations; conversely, a customer's right to receive service should be limited to those amounts. Id. at 61,153. The determinants would initially be established by using a customer's historical maximum annual entitlement. Where this figure no longer reflected the amount of service desired, however, FERC instructed customers to renegotiate their contracts with the pipeline to include accurate reservations of service, with intractable disputes referred to the Commission for final resolution. Id. at 61,153-54. 55 Panhandle argues that FERC's orders here contradict Texas Eastern because customers lack any incentive to make realistic reservations of annual service: the amount of service they nominate unilaterally does not constitute the limit they may receive; rather, customers retain the right to take the quantity of annual service set forth in Panhandle's certificate, without paying for this security. Panhandle claims that its customers (especially those with alternative suppliers) will deliberately undernominate in order to lower their demand charges, thereby shifting fixed costs to full requirements customers. 56 We conclude that the Commission properly exercised its discretion in resolving the D-2 charge issue in Opinions No. 265 and No. 265-A, but erred in its November 4, 1987 order on rehearing. In its first two opinions, FERC simply chose different means to achieve the same legitimate objective: to induce Panhandle's customers to make accurate reservations. Panhandle apparently concedes that the Commission's use of the Texas Eastern method of determining D-2 charges by reference to annual entitlements, as in Opinion No. 265, would have been appropriate. Panhandle cites nothing in Texas Eastern, however, to suggest that FERC bound itself to use this procedure in every succeeding case. Rather, the Commission had the discretion in Opinion No. 265-A to choose the Columbia Gas procedure based on customers' unilateral nominations. See Columbia Gas, 38 F.E.R.C. at 62,076 (approving customer's unilateral nominations of seasonal entitlements). 57 Furthermore, FERC could properly rely on overrun penalties to protect against customers' deliberate under-estimation of their actual service needs. See ANR Pipeline Co., 37 F.E.R.C. p 61,263, at 61,747 (1986). Panhandle argues that the penalty charge, which is the sum of the commodity rate plus the unit charges of the two demand components calculated at a 100% load factor rate, will be an ineffective deterrent because it represents the ordinary per unit cost that a firm sales customer would incur if it used its full entitlement. As the Commission stated in its November 4 order, however, this excess charge has proven useful in other proceedings because it effectively imposes the D-1 charge twice on any customer taking more than its D-2 nominated level. 41 F.E.R.C. at 61,308. Moreover, in the event Panhandle could later demonstrate that the overrun penalty was not preventing abusive undernominations by its customers, Panhandle could propose a higher charge. Id. 58 In short, we conclude that although FERC could have based the D-2 charges on renegotiated entitlements, as it did in Texas Eastern and Opinion No. 265, the Commission had the discretion to devise a system featuring unilateral customer specifications with overrun penalties for undernominations, as in Opinion No. 265-A. The agency did not depart from its Texas Eastern policy of ensuring realistic reservations merely by determining that a different method would better effectuate that policy in this particular case. 59 The Commission erred, however, in its November 4, 1987 order by allowing customers to specify unilaterally their annual demand, while simultaneously requiring Panhandle to stand ready to provide each customer with its full requirements at the certificated level, even where this is higher than the renominated level. 41 F.E.R.C. at 61,307. This requirement unreasonably whipsaws Panhandle and totally vitiates FERC's repeated rationale that Panhandle remains free to protect itself through cost-cutting and other measures to attract additional customers. See, e.g., Opinion No. 265, 38 F.E.R.C. at 61,455-56, 61,470; Opinion No. 265-A, 40 F.E.R.C. at 61,598. If a pipeline must set aside an amount of gas equal to the difference between the customer-nominated and certificated levels, it obviously cannot prudently offer this same gas for sale to third parties. See Texas Eastern, 32 F.E.R.C. at 61,152-53 (D-2 charge acknowledges that pipelines incur costs by agreeing to provide a certain quantity of service to customers). 60 Neither of the Commission's two justifications offered in support of this requirement withstands scrutiny. First, FERC's argument that the penalty for under-nomination will discourage customer abuse is simply irrelevant to the issue of the reasonableness of forcing Panhandle to freeze a portion of its gas supply while receiving no corresponding economic benefit. Moreover, even assuming that the threat of penalties will result in a customer's nomination approximating its actual use, if that use happens to fall below the certificated level, the Commission's November 4, 1987 order indicates that the pipeline must hold excess capacity available to meet the customer's contingent future needs at no cost to the customer. This cannot be reconciled with the free market principles reflected in Texas Eastern. If a customer miscalculates actual needs and has not paid for the availability of standby reserves, it must be prepared to bear the risk and cost of looking to the marketplace for additional supplies. 61 Second, the Commission relied on Columbia Gas, 38 F.E.R.C. p 61,342 (1987). That case, however, involved a unique arrangement whereby a pipeline sought to reduce a large portion of its annual service obligation by imposing seasonal gas entitlement limits on each customer: if a customer purchased gas at its ordinary load factor over the course of the year, it would exceed these seasonal limitations and be subject to penalties. FERC concluded that the pipeline's tactics did not constitute a partial abandonment of service because the pipeline remained obligated to serve customers at existing certificated levels, notwithstanding the change to seasonal entitlements at levels below existing contract demand for 365 days. Id. at 62,076. The only consequence, said the agency, was that a customer might pay increased charges due to the penalty provision. Nonetheless, as the pipeline had imposed seasonal limitations in a tariff that was being challenged as unjust and unreasonable, the Commission would allow customers to unilaterally renominate seasonal entitlements. Id. 62 Reading Columbia Gas in its factual context indicates that FERC was attempting to prevent a pipeline from using the seasonal limitations device to shirk its duty to provide its customers with the certificated level of annual service. To the extent that Columbia Gas suggests that a pipeline must always stand ready to serve a customer at the certificated level--even where this quantity exceeds the customer's renominated level of service used to calculate D-2 charges--we reject it. 63 In conclusion, although the Commission's disposition of the D-2 charge issue in Opinions No. 265 and No. 265-A represented permissible exercises of FERC's discretion, we reject as unreasonable the Commission's subsequent decision to require Panhandle to serve its customers at the certificated level regardless of the customers' unilateral changes in their entitlements. We therefore remand the demand charge issue for further consideration.