Opinion ID: 436086
Heading Depth: 3
Heading Rank: 2

Heading: The Association of Oil Pipelines' Recommendations

Text: 124 The Association of Oil Pipelines (AOPL) endorsed the ICC valuation approach to rate base calculations. See J.A. at 3870 (AOPL Opening Brief to FERC). AOPL, however, did not endorse the ICC approach in all its details. Instead, it asked FERC to make the following alterations to the ICC formula:(1) calculate reproduction costs for current expenses by reference to the current year's price index, or to an average of the indices for the most recent past year, the current year, and the next future year. Under the ICC method, costs are estimated by reference to a five-year period index consisting of the current year, one future year and three past years. APOL contended that this method understates actual current costs in times of inflation. 125 (2) increase the allowance for interest during construction employed in calculating the reproduction cost of pipeline assets. AOPL believed the six percent allowance was far too low to cover the prevailing rates to be paid during construction. 126 (3) calculate the present value of land and rights-of-way to account for their real appreciation in value over time. The ICC method calculates the present value of land at fifty percent of original cost and rights-of-way at original cost less depreciation. The AOPL claimed that such methods seriously undervalue the real present value of land and rights-of-way. 127 (4) adjust the construction damage allowance to reflect inflation up to the current year. AOPL argued that the ICC method, which adjusted the figures for inflation only from 1947 to 1953, understates actual costs. 128 (5) adjust the amounts assigned for pipe coating to reflect present prices. AOPL criticized the ICC method, which adjusted such costs for inflation only from 1947 to 1963. 129 (6) once the foregoing alterations are made, eliminate the six percent going concern value escalator to total valuation. 130 See J.A. at 3915-17 (AOPL Opening Brief). AOPL argued that these modifications would improve the accuracy of the valuation rate base. Id. at 3917. 131 FERC rejected AOPL's proposals, finding that (1) only relatively insubstantial amounts were at stake, (2) the six percent going concern value roughly compensates for methodological errors elsewhere, and (3) the old ICC method should not be altered without first engaging in a notice and comment rulemaking on the proper method of calculating depreciation. See supra at 1496. AOPL argues to this court that FERC's rejection of its proposals was arbitrary and capricious agency action because it was not supported by reasoned findings based on the evidence of record. AOPL Brief at 35-39. We agree. 132 We note at the outset that FERC failed, both in the Williams opinion and in its briefs to this court, to provide any factual basis in the record for its conclusion that the sums involved are relatively insubstantial. 21 FERC at 61,631. On the other hand, AOPL cites unrebutted testimony in the record that the use of the ICC's period indices results in consistently and substantially understated current valuations. J.A. at 1180 (testimony of John A. Jeter of Arthur Anderson & Co.). This same witness provided further unrebutted testimony that the ICC's allowance for interest during construction should be much higher in order to reflect current interest levels. See id. at 1183-85. Furthermore, in its brief, FERC states that the ICC rate base formula significantly undercounts for interest during construction, several other construction-related elements, and the value of land. 67 Indeed, in the Williams opinion FERC conceded that the AOPL proposals may well be warranted prospectively. 21 FERC at 61,631. 133 FERC, however, felt that the need for change was far from pressing because it believed that the six percent going concern value in a rough way compensated for the other flaws in the ICC methodology. Thus FERC rejected all of AOPL's objections on the grounds that the over -counting due to the going concern value--which would by itself be pure water, id.--was in effect cancelled out by the under counting created by the methodological features that gave rise to the rest of AOPL's objections. 134 In basic terms, FERC reasoned that a series of inaccuracies is permissible because another inaccuracy systematically compensates for the prior errors. Such an approach, of course, assumes that the two errors are in fact predictably related to one another so that the anticipated self-correction will actually take place. In this case, however, FERC failed to make any finding to assure that the errors will offset each other. Especially when, as here, the proposed methodological adjustments appear easy to make, and the methodological defects are discrete, clear and acknowledged, FERC indulged an unreasonable presumption that its two wrongs would in practice render a right result. In the absence of any explanation of what warrants such an assumption, we find FERC's rejection of the AOPL proposals to be arbitrary and capricious. 135 Neither did FERC explain why its decision on the AOPL proposals should be delayed until it could conduct a notice and comment rulemaking on depreciation methods. FERC merely declared that it would be wrong to alter the status quo without looking at the whole picture. Id. at 61,632. It is not at all apparent, however, why a decision on the AOPL proposals should be considered so intimately related to depreciation policy. FERC offered no rationale for its assumption that the changes proposed by AOPL should not be made separately from the decisions on depreciation policy. In fact, all of AOPL's proposals would apparently improve the accuracy of the rate base formula, regardless of the particular depreciation method employed. Thus, the adoption of the AOPL proposals would not seem to have any significant bearing on the future consideration of depreciation policy alternatives. FERC also made other similar adjustments to the rate base formula without examining the whole picture. See FERC Brief at 71 n. 81. Moreover, FERC expressly declined to commit itself to ever conducting a rulemaking on depreciation issues: 136 To be fruitful, such a rulemaking should be preceded by intensive staff studies. The whole endeavor would be costly and time-consuming. Would it be worth the cost? 137 This question calls for further reflection. This is neither the time nor the place for that. We can ponder the point on another day. 138 21 FERC at 61,632. While we recognize that an administrative agency may exercise its informed discretion in deciding whether to proceed on a given issue by way of rulemaking or adjudication, see, e.g., NLRB v. Bell Aerospace Co., 416 U.S. 267, 294, 94 S.Ct. 1757, 1771, 40 L.Ed.2d 134 (1974); SEC v. Chenery Corp., 332 U.S. 194, 203, 67 S.Ct. 1575, 1580, 91 L.Ed. 1995 (1947), we believe that in this case FERC failed entirely to make any such choice. Instead, FERC decided to delay implementation of the AOPL proposals, which it said were well taken and were deserving of a hard look, id. at 61,631, until it could conduct a seemingly unrelated depreciation rulemaking, which it then said might never take place. Such self-contradictory, wandering logic does not constitute an adequate explanation for its rejection of admittedly valuable proposals. 139 In sum, we hold that FERC failed to explain adequately its rejection of both the original cost alternative and AOPL's proposed alterations. We emphasize that this holding does not go to the wisdom or efficacy of the ICC rate base formula, although the Williams opinion does not provide a cogent defense of it. 68 Rather, our decision here turns on the inadequacies manifest in the decisionmaking process followed by FERC. 140 Even in the absence of such infirmities in FERC's method of choice among rate base methods, our review would still include scrutiny of the rate of return methodology, to see whether the selected rate of return, applied in combination with the selected rate base, leads to a reasonable result. As FERC observed, the agency must assure that the combination of rate base and rate of return provides a[n] ... acceptable end result. 21 FERC at 61,616. We now proceed to examine whether FERC engaged in reasoned decisionmaking when it chose its rates of return for use in oil pipelines ratemaking.