Opinion ID: 777086
Heading Depth: 2
Heading Rank: 1

Heading: Five-year matching cap and regulatory right of first refusal

Text: 136 Section 7(b) of the Natural Gas Act generally prohibits natural-gas compan[ies] from ceasing to provide service to their existing customers unless, after due hearing, FERC finds that the present or future public convenience or necessity permit such abandonment. 15 U.S.C. § 717f(b). Seeking to streamline the regulatory process, the Commission in Order No. 436 attempted to dispense with these individualized hearings by giving pipelines broad prospective authority to refuse shippers continued service on the expiration of their contracts (in the absence of a contractual right of renewal). See American Gas Ass'n v. FERC, 912 F.2d 1496, 1513-14 (D.C.Cir.1990) ( AGA ). Under this mechanism, the Commission makes ex ante generic findings of public convenience and necessity, and issues a blanket certificate that allows a pipeline to terminate service at the end of the shipper's contract term. See 18 C.F.R. § 284.221(d); cf. Mobil Oil Exploration & Producing Southeast, Inc. v. United Distrib. Cos., 498 U.S. 211, 227, 111 S.Ct. 615, 625, 112 L.Ed.2d 636 (1991) (allowing the Commission to issue general, prospective, and conditional abandonment approvals under § 7(b)). 137 When this court addressed the merits of the issue in AGA, we remanded the rule for lack of an adequate explanation of how it could be squared with the Commission's basic duty to protect gas customers from pipeline exercise of monopoly power. AGA, 912 F.2d at 1518. But we noted that all parties recognized that such a procedure made sense for at least some transactions, most notably interruptible services and short-term contracts. See id. 138 In Order No. 636, the Commission responded to AGA and modified its earlier approach by supplementing pre-granted abandonment authority with a right of first refusal for those shippers the Commission considered to be captive and thus in need of protection — those operating under a firm contract longer than one year. Order No. 636 at 30,446-48. The right entitled a protected shipper with an expiring contract to retain its service from the pipeline under a new contract by matching the rate and duration offered by the highest competing bid — up to the maximum just and reasonable rate approved by FERC. On reconsideration, the Commission also adopted a 20-year cap on the length of the term that existing shippers may be required to match. Order No. 636-A at 30,631. 139 On review, though we generally upheld pre-granted abandonment as supplemented with the right of first refusal, see UDC, 88 F.3d at 1140, we thought that the 20-year cap was not justified by the record and remanded it for further explanation. Id. at 1140-41. We expressed concern that contract duration could become a surrogate for price (which, of course, is capped), thereby allowing new customers to outbid existing ones by offering longer terms than they would in a truly competitive market. Id. at 1140. In addition, while FERC had picked 20 years in reliance on actual contracts, we questioned whether the subset of contracts relied on — involving the construction of new facilities — was properly representative. Id. at 1141. But because the selection of any duration for the matching cap would be necessarily somewhat arbitrary, we said we would defer to the Commission's expertise if it provides substantial evidence to support its choice and responds to substantial criticisms of that figure. Id. at 1141 n. 45. 140 On remand, FERC decided to reduce the 20-year cap to one of five years, pointing to what it perceived as the current industry trend in favor of shorter term shipping contracts. Order No. 636-C, Order on Remand, Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation Under Part 284 of the Commission's Regulations, 78 FERC ¶ 61,186 at 61,773-74 (1997) (Order No. 636-C). Despite objections from the pipelines, FERC summarily affirmed its decision in Order No. 636-D, Order on Rehearing, Pipeline Service Obligations and Revisions to Regulations Governing Self-Implementing Transportation Under Part 284 of the Commission's Regulations, 83 FERC ¶ 61,210 at 61,925, 1998 WL 327106 (1998). 141 In Order No. 637 the Commission again confirmed the five-year period. See id. at 31,339. And it made clear that right of first refusal includes the right of the existing shipper to elect to retain a volumetric portion of its capacity subject to the right of first refusal, and permit the pipeline's pregranted abandonment to apply to the remainder of the service. Id. at 31,341. Moreover, it said that the regulatory right of first refusal (i.e., the right supplied by this Commission mandate) was a minimum right, usable by an eligible shipper regardless of whether its contract provides a comparable right (by means, for example, of an evergreen clause), and that the shipper might exercise the regulatory right for part of the contract volume and any contract right for the rest. Id. ; Order No. 637-A at 31,647. It also specified, most clearly in Order No. 637-A, that the right trumped any inconsistent provision in a pipeline's tariff. 142 A group of interstate gas pipelines, led by INGAA (collectively INGAA), attack both retention of the five-year period and the Commission's explicit statement that the right of first refusal applies regardless of tariff provisions. 143 1. Five-year cap. In selecting a five-year cap on remand from UDC, the Commission gave little indication of why it thought that this new figure would appropriately balance the protection of captive customers with the furtherance of market values (putting capacity in the hands of those who value it most). It relied entirely on the fact that five years was about the median length of all contracts of one year or longer between January 1, 1995 and October 1, 1996. See Order No. 636-C at 61,774, 61,792. This contrasted with average durations of about 10 years in the period from April 8, 1992 to October 1, 1996. 144 Before confirming the five-year figure, the Commission itself raised doubt about its wisdom. In Order No. 636-D, it acknowledged that the pipelines have raised legitimate concerns about the practical effects of the five year term matching cap on the restructured market as it continues to evolve. Order No. 636-D at 61,926. At that point the Commission decided to defer a final decision about the length of the cap until a new gas policy initiative (which proved to be Order No. 637), because at the time it had no information concerning current conditions in the natural gas industry. Order No. 636-D at 61,926. In its NOPR for Order No. 637, FERC raised what it perceived were further problems with the five-year term, suggesting that it provides a disincentive for an existing shipper to enter into a contract of more than five years, and results in a bias toward short-term contracts. Notice of Proposed Rulemaking, Regulation of Short-Term Natural Gas Transportation Services, FERC Stats. & Regs. [Proposed Regulations 1988-1998] (CCH) ¶ 32,533 at 33,486 (1998). The Commission apparently was concerned that the cap would foster an imbalance of risks between pipelines and existing shippers, allowing shippers indefinite control over pipelines' capacity, but giving the pipelines no corresponding protection. Id. at 33,486-87. Thus, it suggested, elimination of the cap would foster efficient competition. Id. at 33,487. Moreover, as the pipeline petitioners point out, an artificial, regulation-induced shift toward shorter contracts increases risk for the pipelines; this tends to raise their costs of capital and thus the overall cost of pipeline transportation. And, they note, it is odd — or at least requires explanation — why FERC should choose a median to function as a ceiling. 145 But when FERC ultimately elected to retain the five-year period, it addressed none of the difficulties that it (or the pipelines) had previously invoked. Instead, it simply referred back to Order No. 636-C's evidence about median contract lengths and remarked that [n]one of the commenters presented evidence to support the conclusion that a five year contract is atypical in the current market. Order No. 637 at 31,339; see also Order No. 637-A at 31,664 (concluding simply that there is no evidentiary basis at this time for changing the 5-year matching cap). Thus the only evidence supporting FERC's final decision to choose a five-year cap was the original record — which on the Commission's own view was incomplete. There is neither an affirmative explanation for the selection of five years, nor a response to its own or the pipelines' objections. 146 We therefore vacate the five-year cap and remand the issue back to the agency. The Commission may appear to be, vis-à-vis the court, like mankind to the gods: As flies to wanton boys, they kill us for their sport. Pick 20 years, and get reversed for failing to explain the length; pick five, and get reversed for failing to explain the brevity. But our acknowledgment of the difficulty of the policy choice, see UDC, 88 F.3d at 1141 n. 45, is fully intended. The record simply lacks indicators of the Commission's seriously tackling that choice. 147 2. Right of first refusal trumping tariff provisions. Pipeline counsel accuse the Commission of wrongfully creating a regulatory right of first refusal in Order No. 637. We think their claim can better be comprehended as saying that the Commission in that order transformed its requirement of a right of first refusal, ensconced in the Commission's regulations since April of 1992, see Order No. 636 at 30,446-48; see also § 284.221(d)(2)(ii), into a self-executing requirement. That is, their argument is comprehensible only as a claim that before Order No. 637 the right of first refusal had legal effect only to the extent that it was expressly embodied in a pipeline tariff. In fact, Order No. 637 and Order No. 637-A appear to be the Commission's first express articulations of the idea that the regulatory right of first refusal trumps tariff provisions. The first declares that eligible shippers have the right of first refusal as provided in the Commission's regulations, Order No. 637 at 31,341, and the second expressly says that the regulatory right of first refusal is effective regardless of the terms of any tariff, Order No. 637-A at 31,646-47. 148 The Commission says this was old hat, pointing to its statement back in August 1992, in the Order No. 636 series, when it said that shippers were assured the right to continued service even if the parties do not include an evergreen or rollover clause in their contract. Order No. 636-A at 30,628. But the language makes no mention of tariffs, and thus appears not inconsistent with a view that tariff language, mandated by the Commission's regulations, is necessary to effect the right, or at least that inconsistent tariff language trumps. More confusing is the Commission's decision in Algonquin Gas Transmission Co., 94 FERC ¶ 61,383, 2001 WL 323207 (2001). There it first pointed to the language quoted above from Order No. 637, see 94 FERC at 62,439; then, when its attention was called to contradictions between the regulatory right of first refusal as it conceived it, and the pipelines' tariff provisions (which had been approved as just and reasonable), it said that the solution was proceedings under § 5 of the NGA to consider forward-looking modification of the tariffs, see id. at 62,446. Were the regulatory right self-executing, we do not understand why § 5 proceedings would be needed. The Commission's brief on the issue sheds no light. 149 Accordingly, though not vacating this aspect of Order No. 637 or Order No. 637-A, we remand to the Commission for it to explain its current position, and, to the extent that language in the orders under review is legally unsustainable, to modify it.