Opinion ID: 3219375
Heading Depth: 2
Heading Rank: 1

Heading: ferc’s choice of data for assessing sfpp’s

Text: 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. IS08390-002, at 1 (FERC June 2, 2009), and one for the six-month period ending April 2009, see Exhibit SFP-323, No. IS08390-002, 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.