Opinion ID: 2808691
Heading Depth: 3
Heading Rank: 3

Heading: Business Risk

Text: The Shippers advance several arguments suggesting that FERC’s analysis of Kern River’s business risk is inconsistent and not supported by the record. None are persuasive. The Shippers urged FERC to set Kern River’s return on equity at the lowest reasonable level because, in their view, Kern River’s business risk is substantially reduced during Period Two by the 100 percent equity structure. FERC explained that a low return on equity would only be appropriate if “Kern River’s business risk would necessarily be so low that investors could be assured that changes in Kern River’s capital structure would offset all of the potential competition from new pipeline capacity or gas supply.” Opinion No. 486-E, 136 FERC ¶ 61,045 P 204 (emphasis added). After considering the Shippers’ arguments, FERC concluded that “the existence of the 100 percent equity capital structure cannot be construed to completely off-set the potential business risks Kern River might face.” Opinion No. 486-F, 142 FERC ¶ 61,132 P 257. That conclusion is neither arbitrary nor capricious. First, FERC determined the record was insufficient to conclude that the change in capital structure over time would completely offset “incentive[s] for entry by competing firms,” which “would be hard to quantify in 2004.” Opinion No. 486-E, 136 FERC ¶ 61,045 P 204. FERC rejected the 21 Shippers’ retrospective analysis of Kern River’s potential competition because it relied on “more detailed information that . . . [became] available some seven years after the close of the 2004 test period.” Id. In doing so, FERC engaged in reasoned decision making because the return on equity analysis “depends upon market perception of future risks” and FERC, as of the 2004 test period, “reasonably factored evidence of potential competition into its [return on equity] calculus.” Canadian Assoc. of Petroleum Producers v. FERC, 308 F.3d 11, 16 (D.C. Cir. 2002). Second, FERC concluded that the record did “not provide compelling evidence that” the gradual transition in capital structure would completely offset Kern River’s re-contracting risk as Period One contracts expired. Opinion No. 486-E, 136 FERC ¶ 61,045 P 204. As of the 2004 test period, no customer had agreed to contract with Kern River for shipping natural gas during Period Two. See Opinion No. 486-D, 133 FERC ¶ 61,162 P 198. Therefore, re-contracting risk was “the primary reason” FERC did not adjust Kern River’s return on equity for Period Two rates. Opinion No. 486-F, 142 FERC ¶ 61,132 P 250. The Shippers challenge FERC’s reliance on re-contracting risk, but their arguments lack merit because they ignore the context of FERC’s purportedly inconsistent statements. According to the Shippers, FERC recognized that recontracting risk is not unique to Kern River. The Shippers, however, misread FERC’s statements. While rejecting Kern River’s argument in favor of a higher “return on equity based on evidence concerning various market changes since the 2004 test period,” FERC explained that re-contracting risk is “not a circumstance unique to the transition from Period One to Period Two.” Id. P 245 (emphasis added). In other words, FERC rejected Kern River’s proposed increase because it was 22 not based on data from the 2004 test period and did not fall within the limited “circumstances unique to the transition from Period One to Period Two rates.” Opinion No. 486-D, 133 FERC ¶ 61,162 P 202. When put into context, FERC reasonably explained how re-contracting risk was not an issue unique to the transition and therefore did “not justify consideration of post-test period market changes.” Opinion No. 486-F, 142 FERC ¶ 61,132 P 245. FERC’s statements about re-contracting risk are not inconsistent. The Shippers suggest that FERC cited lower Period Two rates as a factor that would reduce re-contracting risk. Again, context matters. While addressing the return on equity for Period One rates, FERC noted: “Kern River’s competitive position should be enhanced” as the reduced Period Two rates become effective. Opinion No. 486-B, 126 FERC ¶ 61,034 P 148. Thus, in the context of analyzing Period One risk, FERC concluded that “Kern River exaggerates its financial risk,” while the Shippers “understate Kern River’s contract risk given its relative dependence on the more competitive generating market.” Id. The Shippers also cite language from Opinion No. 486-E where FERC considered adjusting the “load factor” for Period Two rates. 136 FERC ¶ 61,045 P 169. The parties updated the “record with market information for the period of 2004–2009,” id., and FERC acknowledged that Kern River “has been quite effective at competing” for market capacity based on its lower Period Two rates, id. P 171. When put into context, neither this statement nor FERC’s statement about Period One risk is inconsistent with FERC’s analysis of re-contracting risk as perceived by an investor in 2004. The Shippers further contend that re-contracting risk during the transition period “‘would unlikely have been visible even to the most discerning [2004] investor.’” 23 Shippers’ Reply Br. 6 (quoting Opinion No. 486-E, 136 FERC ¶ 61,045 P 200). Once again, the Shippers ignore context because FERC made this statement while referring to “events that actually occurred in 2010 and 2011,” which were “not properly before the Commission.” Opinion No. 486-E, 136 FERC ¶ 61,045 P 200. FERC never concluded that a 2004 investor would be unlikely to perceive re-contracting risk. Instead, FERC reasonably explained that it would be “unlikely” for a 2004 investor to perceive “the specifics underpinning” Kern River’s argument in favor of a “higher risk environment”—i.e., the 2004 investor would not be able to predict circumstances based on updated data from actual events in 2010 and 2011. Id. (emphasis added). When viewed in its proper context, FERC’s statement about the visibility of re-contracting risk is consistent with its analysis of Kern River’s business risk as perceived by a 2004 investor. Because FERC rejected re-contracting risk as a basis for decreasing rate design volumes, the Shippers argue it is inconsistent for FERC to refuse to lower Kern River’s return on equity based on re-contracting risk. Their argument misses the mark because the rate design analysis for volume takes post-2004 test period data into account, whereas the return on equity analysis does not. Simply put, FERC has not advanced inconsistent positions while analyzing how a 2004 investor would view Kern River’s re-contracting risk.