Opinion ID: 721438
Heading Depth: 1
Heading Rank: 5

Heading: Transition Costs

Text: 241 In this part of the opinion, we briefly review the history behind the transition cost issue and consider each of the petitioners' challenges to FERC's treatment of transition costs.

242 Order No. 436 began the natural gas pipeline industry's transition from its historic role as gas merchant to gas transporter. The Order authorized interstate gas pipelines to convert to blanket-certificated open-access transportation service. See supra Part I.B. In exchange, however, customers of those pipelines that did convert were permitted both(1) to convert their firm sales obligations into firm transportation contracts and also (2) to reduce their obligations to purchase gas from the pipelines. Pipeline customers in large numbers exercised their right under the Order to buy less gas from the pipelines, and secured gas supplies from less expensive sources. The pipelines themselves were then left with massive obligations to purchase high-priced gas at the wellhead: 243 [T]he conditions under which the NGPA began to relax wellhead price controls--namely acute gas shortage and sharply rising prices for alternative fuels--tended to divert pipeline attention from the hazards of incurring long-term obligations to buy high-priced gas. Under pressure from the Commission, the pipelines had typically purchased gas under contracts for very long terms. Besides incorporating high prices (and provisions for escalation upward), the contracts commonly included take-or-pay provisions, requiring the pipeline to pay for some specified percentage, say 75%, of the deliverable gas even if it took less. While usually subject to recoupment later, and while a perfectly natural allocation of risk between producer and purchaser, the take-or-pay provisions effectively committed the pipelines to high gas costs in what by 1982 proved to be a time of falling prices, both for competing fuels and for substitute supplies of gas not covered by contract. 244 AGD I, 824 F.2d at 995-96 (citations omitted) (emphasis added). 245 Thus arose the take-or-pay liabilities addressed by the Commission in Order No. 436 and its successors, as well as by this court in a variety of opinions. See supra Part I.B. Specifically, because most customers could purchase gas more cheaply from other sources, pipelines essentially were unable to pass through the costs of their own supply obligations. With purchases sharply reduced, pipelines owed massive take-or-pay liabilities to gas producers, which they had to either buydown--i.e., reduce--or buyout--i.e., eliminate. In Order No. 436, the Commission refused to set a general policy on whether or how pipelines could attempt to recover these costs. We vacated and remanded the Order, concluding that, in this regard, it was not based on reasoned decisionmaking, primarily because it appeared to grossly underestimate the financial impact of take-or-pay liability on pipelines. Id. at 1021-30. Of great concern to the court was the likelihood that even higher gas prices [319 U.S.App.D.C. 114] would simply cause more customers to switch suppliers, thereby exacerbating the take-or-pay crisis. This cycle of ever increasing prices and ever shrinking customer base--a phenomenon that petitioners label the death spiral--made it very unlikely that the pipelines would in fact recoup their take-or-pay liabilities absent some mechanism for separately passing those costs through to their customers. 246 In subsequent proceedings, the Commission adopted and this court approved various measures designed to address that concern and allow pipelines to pass through some of their take-or-pay liabilities to a broader range of customers. See supra Part I.B. Most pertinent to our analysis here, under Commission policy, a pipeline could agree to absorb between 25% and 50% of its take-or-pay costs in exchange for the right to bill customers an equal share through a fixed charge, and recover the remaining amount through a volumetric surcharge based on total throughput. Customers, and in turn the consuming public, ultimately reimbursed pipelines for approximately $6.4 billion in take-or-pay costs, while the pipelines themselves absorbed $3.6 billion. 247
248 After Order No. 436, all of the major interstate pipelines converted to open-access transportation. Not all customers on those pipelines, however, exercised their right to unbundle their sales agreements and reduce their gas purchase obligations. Several years later in Order No. 636, the Commission mandated unbundling and authorized sales customers to reduce their pipeline gas purchases. When customers exercised that right and secured gas supplies from other sources, the pipelines once again incurred substantial take-or-pay liabilities; though the Commission labeled these liabilities gas supply realignment costs in Order No. 636, they arose from the same type of producer-pipeline contract provisions as the take-or-pay costs considered in Order No. 436. Cf. Order No. 636-A, p 30,950, at 30,649 n.466 (Any costs that would qualify for recovery as GSR costs could be filed for recovery under [the successor to Order No. 436,] Order No. 528.). 249 In allocating recovery of GSR costs, however, the Commission adopted a policy more advantageous to the pipelines. Instead of refusing to establish a mechanism for pipelines to recover their take-or-pay costs, as it originally had in Order No. 436, FERC authorized pipelines to bill their customers separately for 100% of their GSR costs. This policy was, in fact, a substantial change from even Order No. 500, which permitted pipelines to surcharge their transportation customers for take-or-pay costs only if they agreed to absorb between 25 and 50% of those costs. The Commission set forth the mechanisms available to pipelines under Order No. 636 as follows: 250 ... The Commission will permit pipelines full cost recovery of prudently incurred gas supply realignment costs deemed to be eligible under this rule. To recover those costs, a pipeline will be permitted to use either a negotiated exit fee, or a reservation fee surcharge recoverable from Part 284 firm transportation customers. 251 Under this rule, a firm entitlement holder has options as to how to react to gas supply realignment costs: it may remain a sales customer of the pipeline; otherwise, it may take an assignment of the pipeline's existing contracts or pay an exit fee/reservation fee surcharge for costs approved by the Commission. 252 Order No. 636, p 30,939, at 30,458. On rehearing, FERC modified this ruling somewhat, and required pipelines to bill 10% of their GSR costs to interruptible transportation customers. See infra Part V.E.3.b.2. 253 Pipelines also face three other types of significant transition costs under Order No. 636: (1) unrecovered gas costs or credits remaining in the purchased gas adjustment (PGA) account when a pipeline terminates its PGA mechanism; (2) costs of pipeline assets (such as storage facilities) currently used to provide bundled sales service which are not directly assignable to customers of the unbundled services (stranded costs); and (3) costs for equipment required to physically implement the rule (new facility costs). [319 U.S.App.D.C. 115] Order No. 636, p 30,939, at 30,457. FERC determined in Order No. 636 that pipelines would generally be allowed to recover 100% of these costs. Id. at 30,457-60. 254 Petitioners raise several challenges to FERC's treatment of transition costs. First, they claim that FERC erred in allowing pipelines to recover 100% of their stranded costs, arguing that such recovery violates applicable legal standards. Second, they contend that FERC failed to adequately address the problem of LDC bypass, which occurs when large industrial customers bypass LDCs, thereby avoiding transition costs properly attributable to them. Third, they oppose Order No. 636's passthrough of above-market prices paid by pipelines for synthetic natural gas from the Great Plains Gasification Plant. Finally, they challenge in several respects FERC's treatment of GSR costs. 255
256 A separate class of Order No. 636 transition costs are stranded costs, which are those incurred by pipelines in connection with their bundled sales services that cannot be directly allocated to customers of the unbundled services. Order No. 636, p 30,939, at 30,460. To be denominated stranded, an investment (1) must have been prudently made, Order No. 636-A, p 30,950, at 30,662, but (2) must be no longer used and useful after Order No. 636, Order No. 636-B, p 61,272, at 62,041. Examples include upstream pipeline capacity for which a downstream pipeline cannot find a buyer, and storage capacity that a pipeline no longer needs when the volume of its sales service shrinks. Order No. 636, p 30,939, at 30,460. According to the Commission, pipelines can recover their stranded costs in NGA § 4 rate filings. Id.; see also Order No. 636-B, p 30,950, at 62,042 (The Commission will allow pipelines to make limited section 4 filings to recover ... the costs of stranded facilities that are currently incrementally priced.... However, pipelines must file to recover the costs of most, if not all other stranded facilities in general section 4 rate proceedings.). 257 The PUCs challenge the Commission's ruling, see Order No. 636-B, p 61,272, at 62,041, that pipelines may recover 100% of their stranded costs. Their presentation is straightforward: items that are not currently used and useful may not be included in a utility's rates. In support, the PUCs invoke the Commission's statement in New England Power Co., 42 F.E.R.C. p 61,016, at 61,078 (1988), that [i]n general, the used and useful standard provides that an asset may be included in a utility's rate base only when the item is used and useful in providing service. They also cite to this Court's statement in Tennessee Gas Pipeline v. FERC, 606 F.2d 1094, 1109 (D.C.Cir.1979), that the precept endures that an item may be included in a rate base only when it is 'used and useful' in providing service. 258 In its brief, the Commission replies along two fronts. First, it contends that the PUCs' objection is premature, given that in Order No. 636, the Commission stated that, in subsequent restructuring proceedings, it would consider arguments about whether particular facilities are used and useful, or whether the costs should be recoverable as transition costs in § 4 rate proceedings. Order No. 636-A,p 30,950, at 30,662. Second, the Commission contends that the used and useful principle invoked by the PUCs, while generally sound, does not apply to facilities that have been stranded only because of the Commission's own action. In other words, the pipelines should recover on their investments as they would have had Order No. 636 never been promulgated. 259 While we ultimately affirm the position taken by the Commission in the administrative proceedings, we believe that both the PUCs and the Commission itself may have overlooked a relevant distinction on appeal: the difference between a utility's rates and its rate base. The rate allowed a utility is the sum of (1) its cost of service, and (2) its rate base multiplied by its rate of return. Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168, 1172 (D.C.Cir.1987) (en banc). Generally, the rate base is comprised of total capital invested in facilities minus depreciation plus cash working capital. The rate of return, on the other hand, is a [319 U.S.App.D.C. 116] weighted average of different rates applied to debt, preferred stock and common stock. Id. at 1203 (Mikva, J., dissenting). Calculation of rate base is a critical step in establishing maximum rates, since the product of rate base multiplied by allowed rate of return is the total sum of money the agency allows to investors in the firm. RICHARD J. PIERCE, JR. & ERNEST GELLHORN, REGULATED INDUSTRIES 102 (3d ed.1994). 260 The cases cited by the PUCs, and not challenged by the Commission, stand for the proposition that the items in a utility's rate base generally should currently be used and useful to consumers. As a result, investors generally profit only from those investments that presently benefit consumers. However, that principle does not answer the question whether investments that are not used and useful may nonetheless be included in the utility's rates, i.e., still treated as part of the utility's cost of service. 90 261 Viewed in this light, the general statement in Order No. 636 that pipelines will recover 100% of their stranded costs still leaves the Commission with a number of options in the § 4 rate proceedings. For example, the Commission could decide that stranded costs should merely be included in the pipeline's cost of service, recoverable through amortization over time. In such an instance, FERC has already moved somewhat in the direction of balancing competing interests by permitting recovery of the costs of building the plant in the cost of service. Investor interests have not, therefore, been entirely ignored. Jersey Central, 810 F.2d at 1192 (Starr, J., concurring). The Commission might also allow the pipeline to recover not only the amortization, but also interest, i.e., the cost of the unamortized portion of the investment. The Commission could further decide to include stranded investments in the utility's rate base and thereby generate a profit for investors. 262 In the administrative proceedings, the Commission assiduously avoided announcing a general standard that would control the manner in which stranded costs may be recovered. Thus, Order No. 636, at 30,460 (emphasis added), states that while most of the costs of new facilities would be includable in rate base, ... there is no way of anticipating the nature and amount of the stranded costs, and thus no way at this time of devising an appropriate billing mechanism on a generic basis. Similarly, in Order No. 636-B, p 61,272, at 30,662, the Commission deferred until individual rate cases a party's objection that costs associated with physical plant that is no longer used and useful ... should ... no longer be includable in the rate base. 263 The PUCs' objection therefore is ripe for review only to the extent that they contend that pipelines should not recover 100% of their Order No. 636 stranded costs in any fashion. We cannot at this point address the specific question of whether pipelines should be permitted to include stranded costs in their rate base, and thereby receive a profit on the investment, because Order No. 636 adopted no such rule. Accord, e.g., Columbia Gas Trans. Corp., 64 F.E.R.C.p 61,060 (1993) (deferring determination of rate base treatment of stranded cost recovery to § 4 proceeding); National Fuel Gas Supply Corp., 63 F.E.R.C. p 61,291 (1993) (same). In fact, in at least one NGA section 4 rate proceeding, the Commission expressly refused to permit such treatment of stranded costs, explaining: 264 Included in [the pipeline's] claim for stranded cost treatment for the production facilities, is a pretax return allowance on the unamortized balance.... As discussed above, in order for [the pipeline] to receive stranded cost treatment for these facilities, they must no longer be used and useful. It is long standing Commission policy that when facilities are not used and useful, they do not qualify for rate base treatment. In addition, the recovery of stranded costs is designed to compensate pipelines for out-of-pocket costs that they [319 U.S.App.D.C. 117] have no other means of recovering. While the costs of facilities are out-of-pocket costs, equity return and related income taxes are not. Therefore, [the pipeline] should not be allowed a pretax return allowance on the unamortized balance. The Commission will limit [the pipeline's] recovery to interest on the unamortized amount.... 265 This is consistent with the way the Commission has treated other costs of a transitional nature that are being amortized over a period of years to reduce the rate impact on customers, e.g., GSR cost amortizations or take-or-pay buyout and buydown cost amortizations. The interest treatment prescribed above adequately compensates the pipeline for the time value of the outstanding unamortized balance, but recognizes the nature of the costs being amortized. 266 Equitrans, Inc., 64 F.E.R.C. p 61,374, at 63,601 (1993); cf. National Fuel Gas Supply Corp., 71 F.E.R.C. p 61,031, at 61,138 (1995) (A rate of return on the amount of written down facilities would be inappropriate since this allows a return on facilities that are not economically viable, and may also result in a competitive advantage for the pipeline. The pipeline would, however, be allowed to recover interest on the unamortized portion of its written-down plant over a reasonable amortization period, as this will keep the pipeline whole for the direct cost of its investment in the facilities.). 267 We reject the PUCs' claim (now properly limited to the argument that the used and useful principle per se prohibits pipeline recovery of stranded costs even when merely amortized as part of the cost of service), because it was previously rejected in NEPCO Municipal Rate Committee v. FERC, 668 F.2d 1327, 1333 (D.C.Cir.1981) (NEPCO). In NEPCO, we considered whether FERC's refusal to include project expenditures in the rate base, while allowing their recovery as costs over time, is a valid approach to allocating the risks of project cancellation. We found such an approach acceptable because, in that case, the Commission's decision was based on substantial evidence and had adequately balanced the interests of investors and ratepayers. Id.; see also Jersey Central, 810 F.2d at 1183 (rejecting claim that NEPCO adopted per se bar to including in rate base items not currently used and useful). So long as the Commission's decisionmaking in the individual § 4 proceedings satisfies that standard, it will survive any subsequent challenge brought on used and useful grounds.
268 Order No. 636 creates new opportunities for large retail customers to bypass LDCs and connect directly to pipelines. Problems of scale and efficiency preclude other customers from taking advantage of such options, however. State regulators and LDCs argued before FERC that it is unfair to force an LDC's remaining customers to pay the transition costs that they contend are fairly allocatable to the departed customers of the LDC. Order No. 636, p 30,939, at 30,461; Order No. 636-A, p 30,950, at 30,658-59. FERC, however, refused to adopt a generic rule to address this problem, determining instead that it would consider requests for relief on a case-by-case basis. The Commission believes that it is reasonable to require that an LDC seeking relief in a bypass situation ... show that there is a direct nexus between the bypass and the pipeline, so that the costs it seeks to avoid should be reallocated to the bypassing customer. Order No. 636-A, p 30,950, at 30,659. 269 The PUCs protest that the burden placed on LDCs of demonstrating the nexus between the bypass and the pipeline is nearly impossible to meet because of its specificity. They accordingly argue that the pipeline and the bypassing customer should have to explain why they shouldn't bear the bypassing customer's share of transition costs. FERC counters that it has made no statement as to the ultimate burden of proof in such situations but has left resolution of LDC bypass claims to individual proceedings. However, as noted above, FERC did find it fair to require an LDC seeking bypass relief to show a direct nexus between the bypass and the pipeline. While arguably it may not constitute a burden of proof in a technical sense, it does constitute a hurdle of [319 U.S.App.D.C. 118] causation which LDCs seeking relief must clear in individual proceedings. Therefore, in contrast to the Intervenors' argument, FERC's direct nexus requirement is ripe for review. 270 We find the PUCs' arguments unpersuasive. First, we note that the burden LDCs face in these cases is not impossible to meet. As FERC notes, it has already made it clear that at least one bypassing customer still must bear its fair share of GSR costs. See Arcadian Corp. v. Southern Natural Gas Co., 67 FERC p 61,176, at 61,538 (1994). Second, FERC reasonably determined that the factual circumstances surrounding LDC bypasses differ sufficiently that the Commission cannot justify a generic rule [apart from the direct nexus requirement] that would be appropriate in all circumstances. Order No. 636-A, p 30,950, at 30,659. We accordingly reject the PUCs' challenges on this issue. 271
272 The Great Plains Gasification Plant was constructed to convert coal into synthetic natural gas (SNG). In Order No. 636-A, FERC noted that in Transcontinental Gas Pipe Line Corp., 55 FERC p 61,446, reh'g denied, 57 FERC p 61,345 (1991) (Transco), it had approved a settlement that provided for a volumetric surcharge on system throughput to recover the above-market gas costs and associated transportation costs related to Transco's obligations to purchase synthetic gas from Great Plains. Order No. 636-A, p 30,950, at 30, 657-58. Several petitioners complained that this arrangement was in substantial conflict with the competition-enhancing purposes of Order No. 636. FERC admitted as much in Order No. 636-A, but determined that the volumetric surcharge is consistent with the Commission's goal of providing a smooth transition from the prior regulatory environment to the new market-oriented environment. Id. at 30,658. Furthermore, FERC followed its reasoning in Transco, concluding that it is 'reasonable for all [the pipeline's] customers to share in the above-market costs of the nation's first large-scale synthetic fuels plant, whose technological benefits would have redounded to all future gas users ... by increasing the supply of available gas.'  Id. 273 The PUCs challenge FERC's treatment of Great Plains gas, contending that it conflicts with the goal which forms the heart of Order [No.] 636--providing consumer access to competitively priced supply. They also cite Commissioner Langdon's partial dissent in Order No. 636, in which he stated that every comma, word, sentence and paragraph of the order is internally inconsistent with respect to Great Plains gas. Order No. 636, p 30,939, at 30,472 (Langdon, C., concurring in part and dissenting in part). I fail to see how the [volumetric surcharge] will ultimately benefit the consumer, or transmit accurate pricing signals. Id. The PUCs also claim that FERC's decision requires gas consumers to subsidize Great Plains, an outcome the Commission has previously rejected with respect to failed SNG plants. 274 FERC responds to the PUCs' claims by arguing that Elizabethtown III, 10 F.3d at 873-74, has already settled this issue. Elizabethtown III reviewed FERC's orders approving restructuring agreements between Transco and its customers. The petitioners challenged Transco's passthrough of its above-market cost of SNG from Great Plains on the basis that customers should pay rates based only upon the costs they cause the pipeline to incur. Id. at 873. We rejected that argument, however, concluding that the departure from cost-causation principles was justified because, had the Great Plains plant succeeded in increasing the supply of natural gas, it would have contributed also to reducing the price of natural gas, to the benefit of all natural gas consumers. Id. at 874. 275 The PUCs argue that Elizabethtown III is inapposite because it did not consider the treatment of Great Plains gas in a restructuring proceeding in light of the overall purposes of Order No. 636. Although the PUCs are correct that Elizabethtown III does not address Great Plains gas in light of Order No. 636, we note that the case was both argued (February 23, 1993) and decided (December 17, 1993) after the issuance of Order No. 636 (April 16, 1992), Order No. 636-A (August 12, 1992), Order No. 636-B [319 U.S.App.D.C. 119] (November 27, 1992), and even Order No. 636-C (January 8, 1993). The Elizabethtown III court thus had ample opportunity to consider the consistency of the Great Plains volumetric surcharge with the overall policy objectives of the Order No. 636 regime. Petitioners point to no developments since the Elizabethtown III decision that effectively distinguish that case from the issue before us, and we are accordingly constrained by Elizabethtown III 's treatment of the Great Plains issue. We therefore reject petitioners' challenges to FERC's treatment of Great Plains gas.
276 In this part of the opinion, we consider petitioners' challenges to the GSR costs that arose from the modification of producer-pipeline contracts. Order No. 636 both (1) required pipelines to unbundle their firm sales contracts into separate transportation and gas sales arrangements and (2) permitted customers to reduce or eliminate their obligations to buy gas from pipelines under the sales component. The pipelines, with fewer sales customers, were in turn forced by market pressures to buy their way out of many costly supply contracts with gas producers, thereby incurring some $1.7 billion in gas supply realignment (GSR) costs. In Order No. 636, the Commission authorized pipelines to recover 100% of their prudently incurred GSR costs from their blanket-certificated transportation customers. 91 277 Petitioners raise several objections to this recovery policy, all of which we conclude are ripe for review. First, they argue that FERC should have used its NGA § 5 authority to require gas producers to bear part of the GSR costs. We conclude that FERC reasonably declined to exercise the limited authority it possessed over producer-pipeline contracts. Second, petitioners contend that the Commission erred in its assignment of GSR costs to two classes of pipeline transportation customers. By and large, we conclude that the Commission's allocation of GSR costs among customers was an acceptable application of cost spreading and value of service principles. We do conclude, however, that the Commission has failed to explain adequately its decision in all instances to allocate 10% of GSR costs to the pipelines' interruptible transportation customers. Third, petitioners contend that the pipelines themselves should have been required to absorb some portion of their GSR costs. After carefully reviewing the issue, we conclude that the Commission did not engage in reasoned decisionmaking such that we can sustain its decision to exempt the pipelines altogether. We do not hold that the Commission was required to assign a particular portion of GSR costs to pipelines, however, but instead remand this question (along with the 10% interruptible transportation figure) for further consideration. 278
279 Settled principles of ripeness require that [a court] postpone review of administrative decisions where (1) delay would permit better review of the issues while (2) causing no significant hardship to the parties. Northern Indiana Public Service Co. v. FERC, 954 F.2d 736, 738 (D.C.Cir.1992) (NIPSCO). FERC argues that none of the petitioners' challenges to its allocation of GSR costs are ripe for review. It notes that, under Order No. 636, a pipeline may file ... to recover GSR costs only after it has restructured its system in full compliance with the rule and argues that disputes over GSR cost recovery are therefore better left to individual restructuring proceedings. See Order No. 636, p 30,939, at 30,460; Order No. 636-B, p 61,272, at 62,042. Additionally, FERC noted in Order No. 636-B that the Order No. 636 series transition cost policies are not incorporated in the regulations, but are policy statements. Order No. 636-B, p 61,272, at 62,034-35. It further explained [319 U.S.App.D.C. 120] that it would review specific proposals for recovering transition costs with reference to the particular circumstances of each pipeline system and the degree of support those proposals enjoy from the affected parties. Id.; see also Order No. 636-A,p 30,950, at 30,648-49 (Guidelines and policies will be developed ... in concrete cases to address concerns about GSR cost recovery.). FERC thus compares this case to AGA I, 888 F.2d 136, which held unripe challenges to Order No. 500's equitable sharing policy in light of the strong norm against reviewing policy statements and other tentative agency positions where no hardship will result to the parties. 280 The problem with FERC's ripeness argument is that it fails to meet NIPSCO's two criteria for declaring a case unripe. The Commission claims that it intended in the Order No. 636 series to merely announce a general policy approach to GSR costs and leave analysis of specific GSR cost disputes to individual pipeline restructuring proceedings. Where the language and context of [an agency] statement are inconclusive, we have turned to the agency's actual applications. Public Citizen, Inc. v. NRC, 940 F.2d 679, 682 (D.C.Cir.1991). In this case, FERC's treatment of the GSR cost issue in subsequent proceedings is inconsistent with a general policy approach. For example, in restructuring proceedings for Texas Eastern Transmission Corporation, petitioners challenged FERC's allocation of GSR costs, but FERC determined that [b]ecause the Commission has addressed all of the Industrial Groups' arguments in Order No. 636 et seq., the Industrial Groups' request for rehearing is denied. Texas Eastern Transmission Corp., 63 FERC p 61,100, at 61,512 (1993). In Texas Eastern's NGA § 4 filing for the recovery of GSR costs, FERC again refused to consider these arguments. See Texas Eastern Transmission Corp., 63 FERC p 61,254, at 63,245-46 (1993). In Columbia Gas Transmission Corp., 64 FERC p 61,365, at 63,588 (1993), FERC refused to consider certain GSR cost arguments because they were essentially a request for rehearing of Order No. 636. There is no need to revisit these arguments again. We deny rehearing. In ANR Pipeline Co., 64 FERC p 61,140, at 62,083-84 (1993), FERC rejected arguments about GSR costs for the same reasons stated in Order No. 636-B. 281 Unlike the situation in Papago Tribal Utility Authority v. FERC, 628 F.2d 235, 240 (D.C.Cir.1980), where we found that FERC might resolve the claims of the parties and obviate any injury to them if we allow it to complete its proceedings, FERC has demonstrated that it does not plan to offer any significant justifications for its treatment of GSR costs as outlined in the Order No. 636 series other than those presented in the Order No. 636 series itself. We therefore hold that FERC's treatment of GSR costs does not constitute an unreviewable general policy statement but rather a final determination ripe for judicial review. Because FERC continually relies on the Order No. 636 series' treatment of GSR costs, it is not reasonable to conclude that a delay in review would permit better review of the issue. 282 The second part of the NIPSCO test asks whether delay in review would cause significant hardship to the parties. Put another way, the petitioners must show a direct and immediate effect on their primary conduct. Tenneco Gas v. FERC, 969 F.2d 1187, 1211 (D.C.Cir.1992). FERC admits that Order No. 636 GSR costs as of February 7, 1996, totaled almost $1.7 billion without interest, hardly an insignificant amount. In any case, it is unlikely that FERC would have gone to such lengths to assure that pipelines recover 100% of GSR costs if those costs were unlikely to have an immediate effect on the conduct of the parties having to pay them. Furthermore, to the extent that pipelines and gas producers continue to renegotiate contracts, such negotiations will undoubtedly be affected by FERC's treatment of GSR costs in the Order No. 636 series (and in the individual restructuring proceedings). We accordingly conclude that FERC's treatment of GSR costs causes a direct and immediate effect on the petitioners' primary conduct, and that the petitioners' claims are ripe for review.
283 In the Order No. 636 series proceedings, petitioners presented several alternative [319 U.S.App.D.C. 121] solutions to the transition cost problems, some of which would have required that FERC abrogate existing contractual obligations between pipelines and gas producers. These alternative solutions would have forced gas producers to bear part of the transition costs. FERC declined to adopt these proposals on the grounds that, among other things, it lacked § 5 authority to abrogate producer-pipeline contracts. Order No. 636-A, p 30,950, at 30,643. The Commission is correct that it lacks such authority. We have already said as much in AGA II, 912 F.2d at 1505, where we concluded that Congress unambiguously restricted FERC's § 5 powers to jurisdictional contracts. And FERC's jurisdiction over wellhead contracts began to decline as soon as Congress eliminated such jurisdiction over new wellhead contracts. See NGPA § 601(a)(1)(A), (B), 15 U.S.C. § 3431(a)(1)(A), (B); Pennzoil Co. v. FERC, 645 F.2d 360, 380 (5th Cir.1981). The PUCs' claims that FERC's authority to regulate pipeline rates for the benefit of consumers gives it implicit authority over nonjurisdictional contracts crumble against the wall of the AGA II holding. 284 The PUCs also argue that, even if AGA II applies, FERC still retained jurisdiction over some old gas contracts when it issued Order No. 636 and that it should have used its § 5 authority to reform those contracts. (In AGA II we recognized that FERC still had jurisdiction over some wellhead contracts, noting that [t]he proportion of wellhead sales that is subject to FERC jurisdiction steadily declines ... as old gas is exhausted. AGA II, 912 F.2d at 1505.) But exercising such jurisdiction would have conflicted with Congress' clear intent that FERC get out of the business of regulating wellhead gas prices, making such an approach a questionable vehicle for addressing the petitioners' concerns. Furthermore, as FERC noted in Order No. 636-A, its jurisdiction over most producer/pipeline supply contracts has already been removed under the NGPA. As of January 1, 1993, there will be no remaining vestiges of such jurisdiction by virtue of the Decontrol Act. Order No. 636-A, p 30,950, at 30,643 n.460. In light of these concerns, it would be unreasonable to conclude that FERC should have reformed any producer-pipeline contracts to force producers to bear part of the GSR costs. We accordingly decline to accept the petitioners' invitation to remand this issue to the Commission. 285
286 Order No. 636 authorizes pipelines to recover their GSR costs from all of their blanket-certificated transportation customers. Petitioners contend that the Commission erred in allocating costs to two specific classes of customers: customers that were not directly responsible for GSR costs under Order No. 636 (i.e., those that did not reduce their pipeline gas purchases in response to mandatory unbundling); and interruptible transportation customers. FERC defends its allocation of GSR costs based on the principles of cost spreading and value of service. It is there that we begin. 287
288 Order No. 500, the immediate successor to Order No. 436, authorized pipelines to recover take-or-pay costs from both their customers that were blanket certificated under the Commission's open-access regime and customers that were individually certificated under NGA § 7(c). The § 7(c) shippers objected that they were merely transportation customers of pipelines, and were therefore not in any way responsible for the fact that the pipelines, in preparing to accommodate their anticipated sales obligations, had incurred take-or-pay liabilities. According to the § 7(c) shippers, the Commission's allocation of take-or-pay costs therefore violated accepted principles of cost causation, under which [p]roperly designed rates should produce revenues from each class of customers which match, as closely as practicable, the costs to serve each class or individual customer, Alabama Electric Coop. v. FERC, 684 F.2d 20, 27 (D.C.Cir.1982) (citation and internal quotation marks omitted). 289 The Commission conceded that its take-or-pay allocation could not be sustained under a narrow view of cost causation. It argued, however, that circumstances surrounding the take-or-pay crisis and the transformation [319 U.S.App.D.C. 122] of the pipeline industry necessitate and justify the crafting of new ratemaking principles. K N Energy v. FERC, 968 F.2d 1295, 1301 (D.C.Cir.1992). Specifically, the Commission defended its policy on grounds of cost spreading and value of service: 290 Under this first notion, allocating take-or-pay costs to transportation customers who admittedly may not have directly caused them is acceptable because, in the Commission's judgment, the extraordinary nature of this problem requires the aid of the entire industry to solve it; there are no other alternatives that would allow a transition to a market-based pipeline industry to be effectuated. Closely related to this rationale is FERC's second: namely that all segments of the industry--including those who may not have caused take-or-pay problems--will nonetheless ultimately benefit from their resolution and the concomitant move toward an open access regime; consequently, all segments can rightly be assessed a portion of take-or-pay costs. 291 Id. 292 In K N Energy, we sustained the Commission's invocation of cost spreading and value of service, id. at 1302, though we made clear that our approval of those principles was limited, see id. (A more searching inquiry may well prove necessary ... if the Commission should attempt to adopt these ratemaking rationales outside the take-or-pay context.). We did not, however, approve of the Commission's conclusion that application of cost spreading and value of service justified billing take-or-pay costs to § 7(c) customers. While the Commission contended that § 7(c) customers benefitted from Order Nos. 436 and 500 through lower transportation rates, the data before the court suggested that those rates had in fact increased. Id. Moreover, the Commission's Orders allocated costs to pipelines' remaining sales customers inconsistently. Id. at 1303. We therefore remanded for further consideration of the manner in which take-or-pay liabilities should be applied to § 7(c) customers. 92 293 In this case, the Commission contends that its assignment of GSR costs to all blanket-certificated shippers was an appropriate application of cost spreading and value of service principles. 294
1.) Limitation to bundled sales customers 295 The Industrial End-Users object to FERC's decision to allow recovery of transition costs from all blanket-certificated transportation customers, including those that were not pipeline sales customers at the time of the implementation of Order No. 636. The ground for their objection is straightforward: GSR costs arose from the contracts between the pipelines and those firm sales customers that they retained after Order No. 436, not from contracts with customers that had previously converted under Order No. 436. Specifically, Order No. 636 required firm sales customers to convert their sales entitlements into firm transportation entitlements. Some of those customers also exercised their option to reduce their pipeline gas purchases, leaving the pipelines with excess sales capacity, purchase obligations, and related costs: 296 Indeed, nearly 65 percent of pipeline capacity was committed to sales customers prior to Order 636 even though pipelines' sales accounted for less than 20% of deliveries by 1991. Transportation customers who had earlier converted under Order 436 and 500 from sales service to transportation service, or who had never been pipeline sales customers, had already negotiated their gas supply arrangements and had previously paid the cost of restructuring prior to Order 636. Significantly, nothing in Order 636 permits these transportation customers to reform their supply or transportation arrangements (or to pass on to others the associated costs). 297 [319 U.S.App.D.C. 123] Industrial End-Users' Br. at 18 (emphasis in original). The contracts of non-sales customers therefore did not directly give rise to Order No. 636 GSR costs. 93 The Industrial End-Users further note that even if customers that had previously converted to firm transportation service benefit from Order No. 636, the Commission made no attempt to correlate the degree of that benefit with its cost allocation decisions. 94 298 FERC's approach in Order No. 636, however, is valid under the value-of-service and cost-spreading rationales approved by this court in the K N Energy decision. Even those customers not directly responsible for GSR costs benefit from the availability of lower priced transportation in the unbundled marketplace. Moreover, the Commission's options in spreading out costs to pre-Order No. 636 firm sales customers are substantially limited by the filed rate doctrine and the bar to retroactive ratemaking; FERC simply cannot reach backwards through time in a truly equitable manner. While the Industrial End-Users correctly note that to date we have approved the Commission's departure from traditional cost-causation principles in only limited circumstances, those circumstances are squarely presented in this case. GSR costs under Order No. 636 are the functional equivalent of take-or-pay costs under Order No. 436, and the Commission has not betrayed its obligations to the NGA or precedent by employing these ratemaking principles in its attempt to bring closure to the take-or-pay drama, K N Energy, 968 F.2d at 1302. 2.) Interruptible transportation customers 299 The Industrial End-Users challenge the Commission's decision to allocate 10% of a pipeline's GSR costs to interruptible transportation customers. 95 They contend that unbundling confers no real benefit on that class of customers, who therefore should not be responsible for paying GSR costs. They further contend that interruptible transportation customers in fact may receive inferior service after Order No. 636 because the higher volume of firm transportation expected to result under the Commission's capacity release program may displace interruptible transportation services. Moreover, given that less gas is transported by interruptible than firm transportation, the GSR surcharges applied to interruptible transportation in some cases may exceed those charges applied to firm transportation. 300 The Small Distributors and Municipalities concur that FERC should have better spread the costs of restructuring throughout the industry, but take the contrary position that additional costs should have been allocated to interruptible transportation. Invoking benefit of service principles, 96 the brunt of [319 U.S.App.D.C. 124] their claim is a relatively complex economic analysis of why interruptible transportation customers stand to gain a great deal under Order No. 636. In sum, their theory is that the customers who receive the most benefit under Order No. 636 are those with elastic demands, i.e., those most likely to use interruptible transportation. 301 Our concerns here mirror those in our review of the application of take-or-pay costs to § 7(c) customers in K N Energy. The fact that interruptible transportation customers are part of the natural gas industry is not, standing alone, sufficient to assign them GSR costs; even the cost spreading and value of service principles that we have approved allow for the imposition of costs only upon those entities that either bear some responsibility for the costs or derive some benefit from the solution imposed. See K N Energy, 968 F.2d at 1302-04. We are quite sensitive to the Commission's expert conclusion that interruptible transportation customers do derive benefits from unbundling under Order No. 636; an active market for firm transportation would seem likely to drive down the cost of less desirable interruptible transportation, and while the additional use of firm transportation under Order No. 636 may crowd out some interruptible transportation, that results at least in part from customers converting from interruptible to firm service. Moreover, unlike our review of Order No. 500, we are not presented in this case with evidence that the Commission's prediction of reduced costs was wrong as a factual matter. Further still, interruptible transportation customers do clearly benefit from Order No. 636 through access to low cost transportation that is available through the Commission's capacity release mechanism. 302 More troubling, however, is the Commission's apparently stringent adherence to the 10% figure in all instances. FERC elected to allocate GSR costs to interruptible transportation (IT) in response to claims by some pipelines that they would not be able to recover all of their transition costs from firm customers alone. It completely failed, however, to explain why it chose 10% rather than 5% or 15%, and why that 10% figure should be applied to every pipeline; the Orders and FERC's brief simply do not attempt to defend that figure whatsoever. For example, we are presented with absolutely no explanation of why IT should contribute 10% of GSR costs even on those pipelines on which IT constitutes less than 10% of throughput. And, while the Commission correctly points out that courts have recognized the inherent ambiguities in ratemaking, that does not immunize an agency from engaging in reasoned decisionmaking that is susceptible of appellate review. As we explained in reviewing Order No. 500: 303 While we owe the Commission substantial deference in matters predictive and economic, we cannot ignore the Commission's unwillingness to address an important challenge to its stated benefit rationale for charging transportation customers. It most emphatically remains the duty of this court to ensure that an agency engage the arguments raised before it--that it conduct a process of reasoned decisionmaking. The deference we owe FERC's expert judgment does not strip us of that responsibility. Indeed, ... we will uphold an agency's decision if, but only if, we can discern a reasoned path from the facts and considerations before the [agency] to the decision it reached. 304 Id. at 1303 (citations omitted) (second emphasis added). 305 In this instance, we cannot discern the Commission's path from its view that interruptible transportation customers should bear some of the burden for GSR costs to the conclusion that the share should be 10%. Cf. WALT WHITMAN, LEAVES OF GRASS, Darest Thou Now O Soul (Darest thou now O soul, Walk out with me toward the unknown region, Where neither ground is for the feet nor any path to follow?). And, while we are sympathetic to the Commission's view that [t]he task of determining fair allocations of transition costs is ultimately thankless, even though [it] bring[s] all [its] experience and best judgment to bear on it, Order No. 636-B, p 61,272, at 62,034, the law requires more [319 U.S.App.D.C. 125] than simple guesswork. 97 We therefore remand the issue to the Commission for further consideration.
306 To this point, petitioners' objections to the distribution of GSR costs have involved the allocation of those costs among groups of pipeline transportation customers. As a separate matter, petitioners forcefully contend that the Commission erred in not requiring the pipelines themselves to absorb any GSR costs. They note the remarkable similarities between Order No. 636 GSR costs and Order No. 436 take-or-pay costs, and contend that the pipelines should absorb GSR costs just as they do take-or-pay costs. While we do not conclude that the Commission necessarily was required to assign the pipelines responsibility for some portion of their GSR costs, we do agree with petitioners that the Commission's stated reasons for exempting the pipelines do not rise to the level of reasoned decisionmaking. We therefore remand the issue to the Commission for further consideration. 307 Initially, we agree with petitioners that the Commission's stated rationale for allocating take-or-pay costs to pipelines substantially applies in the context of GSR costs as well. As we explained above, see supra Part V.A, take-or-pay and GSR costs both arise from the same provisions in producer-pipeline contracts and result from pipelines' former firm sales customers reducing their gas purchases. We therefore find it instructive that in the take-or-pay context, the Commission itself concluded that pipelines should bear some of the burden, reasoning that 308 allowing a pipeline to recover 100 percent of its settlement costs through a fixed charge would be inconsistent with the Commission's holding in Order No. 500 that all segments of the natural gas industry should share in the burden of resolving the take-or-pay problem, since no single segment of the industry was to blame for its take-or-pay problem. 309 Order No. 500-H, p 30,867, at 31,575. In Order No. 636 as well, the Commission acknowledged that GSR costs had arisen at least in part due to the conduct of the pipelines, characterizing bundled sales arrangements, which arose in substantial part from pipelines' market power, as an unreasonable and unlawful restraint of trade. Order No. 636, p 30,939, at 30,405. Moreover, according to the Commission, the pipelines benefit from Order No. 636, in that they will presumably receive more favorable prices or other valuable consideration resulting from contract reformation. Order No. 636-A, p 30,950, at 30,643; cf. id. at 30,642 ([Petitioners] generally allege that since Order No. 636 will benefit all segments of the gas industry, all segments should bear the costs. The Commission believes that the benefits of Order No. 636 indeed will be widespread.). 310 The Commission nevertheless puts forward a wide variety of arguments for exempting pipelines from paying GSR costs, which we will address on the merits seriatim. We begin, however, by noting that, as a general matter, the Commission's arguments seem directed toward proving the wrong point. FERC allocated Order No. 636 GSR costs to customers based on the principles of cost spreading and value of service discussed above, see supra Part V.E.3.a. When it exempted the pipelines from those costs, however, the Commission reverted to traditional concepts of cost causation, or to use its characterization, returned to first principles holding that a utility is entitled to the opportunity to recover all of its prudently incurred costs in providing public service. 98 It is important to emphasize that these are competing models for allocating the industry's costs of service. Cost causation correlates costs with those customers for whom a service [319 U.S.App.D.C. 126] is rendered or a cost is incurred. For example, as we noted above, see supra Part V.E.3.b.1, the Industrial End-Users argue that under a cost causation model, the only customers who should be required to pay GSR costs are those that reduced their pipeline gas purchases in response to Order No. 636. Cost spreading and value of service, in contrast, take a much wider view, assigning the costs of service to those classes of industry participants that either are at fault for the take-or-pay dilemma or benefit from its resolution. Applying these latter principles, we sustained the Commission's determination that GSR costs should be paid by all blanket-certificated transportation customers, even those that did not directly cause the pipelines to incur liabilities under their supply contracts. See supra Part V.E.3.b.1. 311 If the Commission intends to assign GSR costs according to these cost spreading and value of service principles, it must do so consistently or explain the rationale for proceeding in another manner. 99 We approved the invocation of those principles in K N Energy because FERC had concluded that the take-or-pay crisis could be resolved only by spreading costs throughout the entire industry, 968 F.2d at 1301 (emphasis added), and because we recognized that all segments of the industry ... will benefit, id. (emphasis added), from restructuring. Cf. Order No. 636-A, p 30,950, at 30,650 ([I]n the Commission's judgment, [Order No. 636] continues the general goal of spreading the costs of industry restructuring.). 100 The Commission therefore cannot, without explanation, burden blanket-certificated transportation customers on the ground that they will benefit from Order No. 636, and then ignore that same factor as it relates to the pipelines. For example, the fact that both pipelines and customers will benefit from expanded open-access transportation is one argument in favor of applying GSR costs to both. On the other hand, it is not particularly relevant that GSR costs will total only approximately $1.7 billion, while take-or-pay costs were $10 billion, for that proves nothing about the relative responsibility of various segments of the industry for those costs. On the same footing is the Commission's recognition that pipelines have already paid $3.6 billion in take-or-pay costs; petitioners are quite right when they note that consumers have in the end paid nearly twice that amount. The relevant question is instead whether the $3.6 billion dollar figure should be even larger--recognizing that the figure for consumers is sure to grow--because the pipelines are in part responsible for GSR costs and will benefit from Order No. 636. 312 This is not to say, however, that it is impossible, or even improbable, that the Commission on remand can establish a convincing rationale for exempting the pipelines. For example, arguably, the pipelines' contribution to the costs of theindustry's transition has already been so disproportionately large vis-a-vis consumers that they are entitled to be excused from further responsibility. It also may be that unbundling under Order No. 636 benefits consumers so much more than it does the pipelines that the pipelines should bear few or no GSR costs. Such issues, however, require a fuller airing in the administrative proceedings on remand than is evident from the record developed in the initial go-round. 313 Two final arguments raised by the Commission merit separate attention. First, it notes that unbundling under Order No. 436 was voluntary while under Order No. 636 it is mandatory. It is unclear in the Order No. 636 series, however, how the voluntariness of the reduction in pipeline gas purchases correlates with the pipelines' responsibility for the resulting costs. The fact that certain [319 U.S.App.D.C. 127] pipelines made an economic choice to convert to open-access transportation and thereby almost certainly incur take-or-pay costs under Order No. 436 does not make other pipelines less responsible for the same type of costs when the Commission ultimately decided that it had to force the final stages of industry restructuring. Moreover, we rejected that very distinction when we vacated Order No. 436: 314 FERC also alludes to the voluntary character of pipeline provision of Order No. 436 transportation. There are two flaws in this. First, refusal of the option may spell bankruptcy: inability to provide blanket-certificate transportation for fuel-switchable users may in current market circumstances cause critical load loss.... 315 Second, the argument obscures distinctions between pipelines in the aggregate and alone. To be sure, Order No. 436 gives pipelines an option, blanket-certificate transportation, which ... is not available outside of Order No. 436. But as soon as a single pipeline finds it attractive enough to accept, each competing pipeline will come under competitive pressure to match the first's flexibility. 316 AGD I, 824 F.2d at 1024. 317 The Commission also notes that under Order No. 500, but not Order No. 636, those pipelines that paid take-or-pay costs received a heightened presumption that those liabilities were prudently incurred. 101 As with voluntariness, however, the Order No. 636 series does not explain how the presumption of prudence correlates with FERC's cost-spreading and value-of-service rationales. The Orders' differing treatment of prudence stems from the fact that Order No. 500 and its successors allowed pipelines to recover some, but not all, of their take-or-pay liabilities through a fixed charge on transportation if and only if they absorbed some of those costs themselves. The presumption of prudence created an incentive for the pipelines to engage in cost absorption in that it reduced expenses they might later incur in litigating the appropriateness of their take-or-pay liabilities. Order No. 636 needs no such incentive because pipelines can directly bill transportation customers for 100% of GSR costs, an option that was never available under Order No. 500. And, of course, were the Commission on remand to assign some proportion of GSR costs to pipelines, it could apply the same presumption of prudence that it used in the take-or-pay context. 318 In sum, we cannot conclude from the record now before us that the Commission's decision to exempt pipelines completely from paying GSR costs was the product of reasoned decisionmaking. Order No. 636 is based on principles of cost spreading and value of service that are, in turn, premised on the notion that all aspects of the natural gas industry must contribute to the transition to an unbundled marketplace. In addressing pipelines' liability for GSR costs, however, the Commission at the very least undervalued those considerations. We leave it to the Commission on remand to consider whether the pipelines should nonetheless continue to be exempted from such costs in light of the factors we have identified.[319 U.S.App.D.C. 128] F. Conclusion 319 With respect to stranded costs, we hold that FERC's interpretation of the used and useful doctrine is supported by substantial evidence. We reject petitioners' argument that FERC inadequately addressed the LDC bypass issue, and we also reject petitioners' challenges to the volumetric surcharge for above-market Great Plains gas. 320 Turning to GSR costs, we first conclude that petitioners' challenges are ripe for review. Next, we hold that FERC did not err by failing to exercise its NGA § 5 authority so as to force gas producers to bear part of the transition costs. Furthermore, we sustain the Commission's application of GSR costs to the full range of blanket-certificated transportation customers. We remand the case to the Commission, however, for further consideration of the appropriate share of those costs to be paid by interruptible transportation customers and the gas pipelines.