Opinion ID: 3040019
Heading Depth: 2
Heading Rank: 5

Heading: Application of Mobile-Sierra

Text: Having established the prerequisites to Mobile-Sierra review under the current regulatory regime, we address first whether the contracts at issue permit Mobile-Sierra review. 19590 PUBLIC UTILITY DISTRICT v. FERC In this case, FERC determined that there was no express reservation of unilateral modification. As FERC noted, “[f]or all but one of the contracts identified by the complainants, Section 6.1 of the umbrella [Power Pool] Agreement appears to be the only specific contractual provision which may affect parties’ rights to make changes to contracts entered into under the [Power Pool] agreement.” April 11 Order, 99 F.E.R.C. at ¶ 61,190.21 The relevant portion of section 6.1 states: Nothing contained herein shall be construed as affecting in any way the right of the Parties to jointly make application to FERC for a change in the rates and charges, classification, service, terms, or conditions affecting [Power Pool] transactions under Section 205 of the Federal Power Act and pursuant to FERC rules and regulations promulgated thereunder. Id. ¶ 61,190 n.10. Applying the interpretive doctrine of expressio unius est exclusio alterius,22 FERC viewed the reservation of joint section 205 rights as confirming the parties’ intention otherwise to abide by the contractual terms for the time period covered. Order on Initial Decision, 103 F.E.R.C. at ¶ 62,388. 21 FERC found that Section 39B of the Snohomish-Morgan Stanley Confirmation Agreement expressly restricts the parties’ rights to amend under both FPA sections 205 and 206. April 11 Order, 99 F.E.R.C. at ¶ 61,190 & n.11. FERC noted, however, that even if Snohomish could overcome the restriction in Section 39B, it would still be restricted by Section 6.1 of the Power Pool agreement. Order on Initial Decision, 103 F.E.R.C. at ¶ 62,389. Because we hold the Power Pool agreement, both standing alone and taking Section 6.1 into account, is consistent with Mobile-Sierra review, we have no need to consider Section 39B of the SnohomishMorgan Stanley Confirmation Agreement. 22 The Latin phrase means the “express[ion] or inclu[sion of] one thing implies the exclusion of the other.” BLACK’S LAW DICTIONARY 620 (8th ed. 1999). PUBLIC UTILITY DISTRICT v. FERC 19591 [5] “FERC is entitled to some deference in construing contracts where the sales are subject to FERC regulation.” Boston Edison, 233 F.3d at 66 (citing Memphis, 358 U.S. at 114); see also City of Seattle v. FERC, 923 F.2d 713, 716 (9th Cir. 1991) (granting FERC deference in the interpretation of contracts). With or without that deference, we agree with FERC that these contracts do not preclude Mobile-Sierra review, but we do not rely on the expressio unius precept in so concluding. Instead, like the D.C. Circuit in Texaco II, 148 F.3d at 1096, we hold that private long-term contracts can be generally governed by Mobile-Sierra if such review is otherwise appropriate, unless there is a specific indication in the contract that section 205 or 206 rights have been reserved. Texaco II considered a boilerplate clause that said that the contract “shall comply with all applicable laws, statutes, ordinances, safety codes and rules and regulations of governmental authorities having jurisdiction.” Id. The D.C. Circuit held that such a general clause does not reserve compliance with section 206 standards. In so deciding, the D.C. Circuit stated, in essence, a default rule, explaining: “The law is quite clear: absent contractual language ‘susceptible to the construction that the rate may be altered while the contract[ ] subsist[s],’ the Mobile-Sierra doctrine applies.” Id. (alterations in original) (quoting Appalachian Power Co. v. Fed. Power Comm’n, 529 F.2d 342, 348 (D.C. Cir. 1976)). After Texaco II, the prevailing rule of contract interpretation with regard to the preservation of limited Mobile-Sierra review, according to the First Circuit, is that general statements that the law will “otherwise be binding” do not “negate the ordinary, default rule that Mobile-Sierra govern[s] FERC-proposed changes.” Boston Edison, 233 F.3d at 67 (citing Texaco II, 148 F.3d at 1096). The trio of authorities cited by the local utilities, all from the D.C. Circuit and all pre-Texaco II, are not inconsistent with this interpretive principle. See Union Pac. Fuels, Inc. v. FERC, 129 F.3d 157 (D.C. Cir. 1997); Papago Tribal Util. 19592 PUBLIC UTILITY DISTRICT v. FERC Auth. v. FERC, 723 F.2d 950 (D.C. Cir. 1983); Kansas Cities v. FERC, 723 F.2d 82 (D.C. Cir. 1983). In two of these cases, the court inferred an intent to permit full FERC review from a provision restricting review in narrow circumstances. See Papago, 723 F.2d at 954; Kansas Cities, 723 F.2d at 86-90. To infer from a narrow restriction on unilateral changes an intent otherwise to allow such changes, as Kansas Cities and Papago permitted, is quite different from inferring from a narrow authorization of joint authority to make changes an intent to allow unilateral changes, as the local utilities here insist FERC was required to do. By contrast with Papago, Kansas Cities, and this case, the disputed contracts in Union Pacific Fuels did include a Memphis clause. See Union Pac. Fuels, 129 F.3d at 161. The contracts, however, also included a clause restricting the ability of the parties to seek a change to the “modified fixed variable rate design.” Id. (internal quotation mark omitted). In these unusual circumstances, the D.C. Circuit upheld FERC’s order requiring a provider to file proposed changes to its rate structure under section 5 of the Natural Gas Act despite that narrow restriction and noted: Nothing in the contracts expressly exempted the private agreement from rate changes initiated by FERC under NGA § 5. . . . While Petitioners protest that boilerplate language acknowledging rate changes by FERC should not render [the] Mobile-Sierra doctrine inapplicable, . . . they do not explain why they could not have adopted language that would simply and clearly have invoked Mobile-Sierra. Id. at 161-62. Texaco II, issued by the same court a year later, explained that this language in Union Pacific Fuels does not have application beyond the situation there presented, in which the contract contains a clause that does, generally, negate the default Mobile-Sierra rule. See Texaco II, 148 F.3d at 1096 (noting that in Union Pacific Fuels, the court “inadPUBLIC UTILITY DISTRICT v. FERC 19593 vertently lent support to the inference” that absent express language invoking Mobile-Sierra, FERC ordinarily is free to review rates without regard to the Mobile-Sierra presumption (emphasis added)). [6] We agree with the D.C. and First Circuits that the Mobile-Sierra presumptions are, in essence, self-executing. Adoption of a Memphis clause permitting a party to an energy contract to modify its terms unilaterally demonstrates that the parties were not seeking to establish the stability of energy contracts the Mobile-Sierra doctrine seeks to foster. Absent such a clause, the Mobile-Sierra balance between preserving the stability of private contracts and protecting the public interest in just and reasonable rates prevails. Preserving joint modification does not negate the default application of the Mobile-Sierra presumption when that presumption is otherwise appropriate, as the Mobile-Sierra presumption applies to unilateral, not joint, rate changes. Indeed, parties to energy contracts, like parties to any other contract, are free, by agreement, to vary the terms of the contract mid-term, with or without a prior pact allowing them to do so. When parties to an energy contract do so vary an agreement, sections 205 and 206 apply according to their express terms. [7] We therefore uphold FERC’s interpretation of section 6.1 of the Power Pool agreement as reasonable.
As the parties intended Mobile-Sierra review to apply, we next consider whether, as FERC maintains, its blanket grant of market-based rate authority qualifies as sufficient prior review and approval of all contracts made under that authorization to trigger the Mobile-Sierra presumption in any later section 206 challenge. If not, then the contracts here were not subject to “first review” by FERC under the FPA and do not trigger the Mobile-Sierra doctrine. We hold that although market-based rate authority can qualify as sufficient prior 19594 PUBLIC UTILITY DISTRICT v. FERC review to justify limited Mobile-Sierra review, it can only do so when accompanied by effective oversight permitting timely reconsideration of market-based authorization if market conditions change. [8] Two fairly recent decisions of this circuit considered the role of market-based rate authority under the FPA. In Grays Harbor, we held that a contract entered into during the California energy crisis pursuant to the market-based rate regime was protected under the “filed rate doctrine.”23 See 379 F.3d at 651-52. We relied heavily on FERC’s contention that the regime offered continued and ongoing oversight and thereby “assured that the market-based rates charged comply with the FPA’s requirement that rates be just and reasonable.” Id. at 651. On that basis, Grays Harbor concluded that, “while market-based rates may not have historically been the type of rate envisioned by the filed rate doctrine, . . . they do not fall outside the purview of the doctrine.” Id. [9] More recently, we again stressed the need for oversight in a market-based rate regime in holding “that market-based tariffs do not, per se violate the FPA.” Lockyer, 383 F.3d at 1014. Lockyer held the initial grant of market-based rate authority alone was not enough to assure just and reasonable rates, as FERC recognized when it “affirmed in its presentation before us that it is not contending that approval of a market-based tariff based on market forces alone would comply with the FPA or the filed rate doctrine.” Id. at 1013 (emphasis added). The court clarified further that “a marketbased tariff cannot be structured so as to virtually deregulate an industry and remove it from statutorily required oversight.” Id. at 1014. 23 The filed rate doctrine provides that state law and some federal law (e.g. antitrust) may not be used to strike down a rate subject to FERC’s exclusive jurisdiction. See Grays Harbor, 379 F.3d at 650; see also Davel Commc’ns, Inc. v. Qwest Corp., 460 F.3d 1075, 1084-86 (9th Cir. 2006) (discussing the filed rate doctrine). PUBLIC UTILITY DISTRICT v. FERC 19595 Lockyer’s emphasis on the need for continued oversight of contract rates is critically important to our current inquiry. In Lockyer, California sought relief under section 205 from rates established by wholesale energy companies (many of whom are Intervenor-Respondents here) while there were dysfunctions in the spot market during the California energy crisis. The Court made the following observation regarding FERC “oversight” at the time: Despite the promise of truly competitive market- based rates, the California energy market was subjected to artificial manipulation on a massive scale. With FERC abdicating its regulatory responsibility, California consumers were subjected to a variety of market machinations, such as “round trip trades” and “hockey-stick bidding,” coupled with manipulative corporate strategies, such as those nicknamed “FatBoy,” “Get Shorty,” and “Death Star.” Id. at 1014-15 (emphasis added) (footnotes omitted). Under these circumstances, the court concluded, “[t]o cabin FERC’s section 205 refund authority . . . would be manifestly contrary to the fundamental purpose and structure of the FPA . . . . The FPA cannot be construed to immunize those who overcharge and manipulate markets in violation of the FPA.” Id. at 1017. The requirement of continued oversight in a market-based rate regime applies equally to the section 206 context, and to the application of the Mobile-Sierra doctrine in section 206 review. Lockyer flatly stated that the FPA does not allow a market-based regime absent “implied enforcement mechanisms sufficient to provide substitute remedies for the obtaining of refunds for the imposition of unjust, unreasonable and discriminatory rates.” Id. at 1016. Furthermore, Lockyer indicates that even in a properly approved market-based rate regime, section 206 remedies are still fully available. See id. at 1017 (noting that the “only remedies [under section 206] are prospective”). 19596 PUBLIC UTILITY DISTRICT v. FERC [10] Taken together, these recent circuit decisions support the following conclusion: Market-based rate authority provides a meaningful opportunity for prior review and approval of rates under the FPA, an essential prerequisite to the Mobile-Sierra mode of rate review, only insofar as FERC implements and uses an effective oversight mechanism after the market-based rate authorization is initially granted. Only then can FERC meet its statutory duty to ensure that all rates are “just and reasonable.” This conclusion is bolstered by the judicial treatment of two similar regimes instituted by FERC in the past. In Texaco I, the Supreme Court considered the Federal Power Commission’s attempt to utilize a “blanket certificate procedure for small producers of natural gas” that would “relieve[ ] them of almost all filing requirements.” 417 U.S. at 382. The Federal Power Commission’s rationale was that small producers would be subject to the forces of the market and could therefore only charge what the market would bear. See id. at 390. The Federal Power Commission’s rationale in Texaco I thus was essentially the same as FERC’s rationale here: That case’s “small producers,” like the market-based rate authority producers here, were asserted to lack market power and were therefore authorized to set rates with no further oversight. The assumption was that the rates set would necessarily be competitive and would therefore tend to reflect the cost of production, including the cost of attracting investment. The Court affirmed that such a system of “indirect regulation” was permissible under the Natural Gas Act, see id., but struck down the order because it did not sufficiently assure oversight to meet the statutory requirement of “just and reasonable” review. See id. at 395-96. The Court so held despite the FPC’s assurances that it would review the prices of contracts made pursuant to this authority, see id. at 396-97, stating: [W]e should also stress that in our view the prevailing price in the marketplace cannot be the final meaPUBLIC UTILITY DISTRICT v. FERC 19597 sure of “just and reasonable” rates mandated by the Act. It is abundantly clear from the history of the Act and from the events that prompted its adoption that Congress considered that the natural gas industry was heavily concentrated and that monopolistic forces were distorting the market price for natural gas. . . . In subjecting producers to regulation because of anticompetitive conditions in the industry, Congress could not have assumed that “just and reasonable” rates could conclusively be determined by reference to market price. Id. at 397-99 (emphasis added) (footnotes omitted). The D.C. Circuit followed Texaco I’s approach when considering a FERC regulation for the oil industry based on the premise that “competitive market forces should be relied upon in the main to assure proper rate levels.” See Farmers Union, 734 F.2d at 1490. That court was adamant in holding “FERC’s largely undocumented reliance on market forces as the principal means of rate regulation to be . . . misplaced. It is of course elementary that market failure and the control of monopoly power are central rationales for the imposition of rate regulation.” Id. at 1508 (citing STEPHEN BREYER, REGULATION AND ITS REFORM 15-16 (1982)) (footnote omitted). Indeed, the “fundamental flaw in the Commission’s scheme” was that “nothing in the regulatory scheme itself acts as a monitor to see if [competition drives rates into the ‘zone of reasonableness’] or to check rates if it does not.” Id. at 1509. [11] Here, FERC failed to adopt any monitoring mechanism before applying deferential Mobile-Sierra review to the challenged contracts. When FERC encouraged the local utilities to purchase power in the forward market, the agency promised to oversee the forward market contracts to ensure their justness and reasonableness. See December 15 Order, 93 F.E.R.C. at ¶ 61,994. FERC later held, however, that its approval of energy sellers’ market-based rate authority — 19598 PUBLIC UTILITY DISTRICT v. FERC long prior to the market failures that gave rise to the December 15 Order — allowed it to apply the Mobile-Sierra doctrine without any direct inquiry into whether the resulting rates were in fact “just and reasonable,” and also without any inquiry into the actual state of the market at the time contracts were negotiated. See Order on Initial Decision, 103 F.E.R.C. at ¶ 62,388-89. In light of the foregoing discussion, we must answer the crucial question: Did FERC provide sufficient oversight for contracts made under market-based rate authority to ensure that the resulting rates were within the statutory “just and reasonable” range in the first instance, thereby permitting reliance on the Mobile-Sierra doctrine as to the continuing effectiveness of those contracts? We hold that it did not. FERC asserted in its Order on Initial Decision that the grant of market-based rate authority is sufficient predetermination, so that it was “not required specifically to review each agreement” made pursuant to the grant of market-based rate authority. Id. ¶ 62,389. In other words, FERC contends that because it requires, before granting market-based rate authority, a showing of lack of market power and regular reporting, it has therefore fulfilled its oversight role, and no further oversight is necessary. FERC asserted the same position on rehearing, maintaining that its decision in Lockyer supports that result. Order on Rehearing, 105 F.E.R.C. at ¶ 61,982-83. In FERC’s Lockyer decision, the agency held that once market-based rate authority is granted, additional oversight is a “compliance issue.” California ex rel. Lockyer, 99 F.E.R.C. ¶ 61,247 at ¶ 62,063 (2002); see also Lockyer, 383 F.3d at 1015. We rejected this aspect of FERC’s Lockyer decision, however, because without active oversight, “effective federal regulation is removed altogether.” Lockyer, 383 F.3d at 1015. We reject FERC’s reliance on that same proposition as a pillar of FERC’s invocation of the Mobile-Sierra mode of review in this case. PUBLIC UTILITY DISTRICT v. FERC 19599 [12] FERC’s position here, as in Lockyer, is that it fulfills its monitoring obligation by imposing on sellers with marketbased rate authority the requirement that they file Quarterly Transaction Reports, make the Reports available for public review, and submit data on a triennial basis to confirm the continued lack (or mitigation) of market power. This data collection activity, however, was insufficient to fulfill FERC’s statutory obligation with respect to the contracts challenged here. As demonstrated by what actually happened during the California energy crisis, this sporadic data collection approach is pragmatically unlikely to expose in a timely manner the impact of market changes — in this instance, the impact on the forward market of acknowledged severe market changes within the dysfunctional spot market. That such impacts can occur without affecting FERC’s continuing approval of market-based rate authority undercuts FERC’s assertion that initial just and reasonableness review occurred with regard to the challenged contracts sufficient to trigger the MobileSeirra mode of review. In particular, the quarterly reporting requirement, standing alone, permits review of the grounds for market-based rate authority only with regard to contracts entered into after the impact of the market dysfunction or market power on longterm bilateral contracts has already occurred, affecting the likelihood that the contracts in fact set rates within the statutory “just and reasonable” range. There is a crucial difference between this review — that is, purely prospective review, affecting only future contracts — and one that permits consideration of the market conditions at the time a challenged forward contract was entered. See El Paso Elec. Co., 108 F.E.R.C. ¶ 61,071, at ¶ 61,370 n.10 (2004) (“A revocation of market-based rates . . . would not void contracts that parties may have signed . . . .”). The latter kind of remedy is the kind the local utilities ask for here: They seek modification of the contracts here at issue, prospectively from the refund effective date but based on the market circumstances that prevailed at the times the contracts were negotiated. 19600 PUBLIC UTILITY DISTRICT v. FERC A hypothetical explains the dilemma with FERC’s present “oversight scheme”: Seller A receives market-based rate authority in Year 1. In Year 5, prices increase dramatically in short-term markets. Buyer B, needing to escape these markets, agrees to long-term contracts X, Y, and Z to buy wholesale energy from Seller A. Buyer B agrees to the contract terms because in a frantic market Seller A is one of the only suppliers willing to enter into a long-term contract, and Buyer B needs to ensure that its supply is able to meet the load required by its retail customers. In its next required quarterly report in Year 6, Seller A dutifully transfers the proper information about its rates to FERC. FERC — perhaps reviewing contracts X, Y, and Z — discovers that the assumption of a functioning market underlying its approval of market-based rate authority for Seller A does not accord with the rates being charged in forward contracts generally, or in those entered by Seller A in particular. FERC therefore revokes Seller A’s market-based rate authority. FERC’s action, however, will do nothing to reform those troubling contracts. The problem raised by this hypothetical is that FERC has no opportunity to review whether contracts X, Y, and Z are just and reasonable before they are entered. As FERC recognizes, revocation of market-based rate authority in Year 6 in the above hypothetical can only provide relief for contracts made thereafter. See id. If a contract is entered into in Year 5, FERC cannot consider whether the basis for market-based rate authority had so atrophied by this time that the economic basis for assuming the rates established would be within the statutorily mandated “just and reasonable” range had evaporated. Instead, FERC applies the most-forgiving version of review, the Mobile-Sierra presumption that long-term bilateral contracts will reflect just and reasonable rates, without any opportunity for initial review of such contractual rates, whether cost or market based. This case is precisely parallel to the above hypothetical. For example, Enron, an Intervenor-Respondent in this case, did PUBLIC UTILITY DISTRICT v. FERC 19601 have its market-based rate authority revoked, because of the actions it took during the time period in which the contracts at issue here were entered into. Enron Power Mktg., Inc., 103 F.E.R.C. ¶ 61,343, at ¶ 62,302 (2003). By revoking that power, FERC restricted Enron’s prospective power to enter into contracts. Id. ¶¶ 62,307-10. The very day after revoking Enron’s market-based rate authority, however, FERC denied Nevada Power’s request to reform its contracts with Enron even though they were made during the very period FERC identified Enron as grossly abusing and violating its marketbased rate authority. See Order on Initial Decision, 103 F.E.R.C. at ¶ 62,397. FERC accomplished this result by applying a Moble-Sierra “public interest” standard to the contract reformation proceedings. See id. By doing so, FERC neither performed the full scope of “just and reasonable” review nor revisited the market circumstances in which the agreements were entered to determine whether those circumstances were sufficiently functional that they were likely to yield long-term contracts within the “just and reasonable” range. This approach to section 206 review simply cannot be squared with the statutory scheme. Section 206 commands prospective revision of rates that, as of the refund effective date, are not just and reasonable: When FERC determines that a rate is unjust or unreasonable, “the Commission shall determine the just and reasonable rate, charge, classification, rule, regulation, practice, or contract to be thereafter observed and in force, and shall fix the same by order.” 16 U.S.C. § 824e(a). By layering Mobile-Sierra review on top of a market-based rate authority that can be revoked only prospectively from the refund effective date, FERC abdicates its statutory responsibility to provide such rate revision when appropriate. FERC represents in its post-argument submission that the local utilities could have challenged the sellers market-based rate authority at the time they entered into the challenged contracts. That representation is true, but beside the point. Any 19602 PUBLIC UTILITY DISTRICT v. FERC such challenge, even if successful, could not have been a basis for reforming the challenged contracts, even if the excessively high rates established by the contracts were strong indications that market-based rate authority should be revoked. Rescission of market-based rate authority still would have affected only later contracts, leaving the challenged agreements subject to limited Mobile-Sierra public interest review. As a result of FERC’s refusal to consider the abrogation of market-based rate authority except with respect to future contracts, and given the dramatic and sudden nature of the onset of the California energy crisis and the limited period of time that the local utilities had to respond to it, the local utilities here had no meaningful opportunity to institute a challenge to these sellers’ market-based rate authority before entering the disputed agreements. For example, in February 2001, California enacted legislation allowing its Department of Water Resources to purchase power on behalf of its deteriorating investor-owned utilities. Southern Cal Water’s previous supplier, Dynegy promptly told Southern Cal Water that it was “not interested in extending or renegotiating” its previous one year contract with Southern Cal Water that expired in April 2001, as Dynegy “could sell its generation output to the State of California.” Southern Cal Water was thus left with less than two months to obtain power for the following year and only three “choices”: (1) immediately negotiate a long-term contract that could take effect in April 2001; (2) shift to the spot markets, by then recognized by FERC as manipulated and dysfunctional markets that had already caused hyper-pricing and bankrupted several utility companies; or (3) shut down operation and fail to provide electricity for its retail customers. Faced with these choices, Southern Cal Water entered into a forward contract based on a bidding period of little more than two weeks. Under these time constraints, Southern Cal Water could not have challenged the seller’s market-based rate authority, obtained an order from FERC, and then negotiated PUBLIC UTILITY DISTRICT v. FERC 19603 a forward agreement and signed a contract with the very seller whose market-based rate authority it had just challenged. There was simply no realistic way that Southern Cal Water could continue to participate in the forward market while assuring meaningful “just and reasonable” review. Ultimately, the fatal flaw in FERC’s approach to “oversight” is that it precludes timely consideration of sudden market changes and offers no protection to purchasers victimized by the abuses of sellers or dysfunctional market conditions that FERC itself only notices in hindsight. For example, on December 15, 2000, FERC issued an order encouraging the adoption of long-term contracts and establishing a benchmark price of $74/Mwh. See December 15 Order, 93 F.E.R.C. at ¶¶ 61,994-95. FERC promised that it would “be vigilant in monitoring the possible exercise of market power . . . [t]o address concerns about potentially unjust and unreasonable rates in the long-term markets.” Id. ¶ 61,994. In fact, because of its flawed processes, FERC was never able to “address concerns about potentially unjust and unreasonable rates in the long-term markets,” because it had no means to revoke market-based rate authority before the precipitously entered contracts went into effect and became, in FERC’s view, no longer subject to cost-based “just and reasonable” review. As a result, FERC failed to detect that, according to its own benchmarks, something was awry in the forward markets that produced these contracts. As in Lockyer, we do not dispute that FERC may adopt a regulatory regime that differs from the historical cost-based regime of the energy market, or that market-based rate authority may be a tenable choice if sufficient safeguards are taken to provide for sufficient oversight. FERC, however, cannot use that choice to excuse its duty to maintain effective oversight and then invoke Mobile-Sierra as a ground for precluding ordinary rate review, including review of the propriety of market-based rate authority at the time the contracts became effective. Any other conclusion would permit FERC to abdi19604 PUBLIC UTILITY DISTRICT v. FERC cate entirely its statutory responsibility under the FPA to ensure that all rates, including bilateral contract rates, are “just and reasonable.”
This fundamental procedural error was compounded by FERC’s substantive adherence to Mobile-Sierra without regard to the market conditions in which the contracts at issue were formed. As we have explained, Mobile-Sierra cannot apply without a determination that the challenged contract was initially formed free from the influence of improper factors, such as market manipulation, the leverage of market power, or an otherwise dysfunctional market. The local utilities argue here that the frenzied market conditions of the California energy crisis in the spot market influenced the forward market in such a manner as to raise a question about what transpired during formation of the forward contracts here at issue. The most important evidence supporting this position is the FERC Staff Report concerning price manipulation in the western United States at the time these contracts were formed. The FERC staff concluded: Our analysis shows . . . that forward power prices negotiated during 2000-2001 in the western United States were significantly influenced by the thencurrent spot power prices. This tells us that the trauma of the dysfunctional spot power prices at that time so influenced buyers that they placed great weight on these prices in forming future expecta- tions. Staff Report at ES-9 (emphasis added). The report noted that the influence was greatest for one-to-two year forward contracts,24 and that there is a “statistically significant relationship” between the spot price and forward price. Id. 24 Most of the contracts challenged by Nevada Power and Sierra Pacific are within that time range. PUBLIC UTILITY DISTRICT v. FERC 19605 Although it noted the Staff’s findings, FERC held them irrelevant because they did not demonstrate that the rates in the forward contracts affected the “public interest.” Order on Initial Decision, 103 F.E.R.C. at ¶ 62,397. FERC therefore did not consider the staff findings in determining whether the Mobile-Sierra doctrine was applicable to these contracts; instead, FERC discarded the findings after determining, for independent reasons, that the Mobile-Sierra doctrine was applicable. The upshot is that FERC failed ever to consider whether the influence of the spot markets on the forward markets reached a level sufficient to question whether FERC could assume that two private parties had negotiated a “just and reasonable” contract in the first instance and therefore apply the Mobile-Sierra presumption. FERC’s very limited factual findings regarding the state of the market at the time the challenged contracts were negotiated are thus not responsive to the theory advanced by the local utilities here. FERC held only that because the local utilities entered into the challenged contracts “voluntarily” and because “there is no evidence of unfairness, bad faith, or duress in the original negotiations [of the forward contracts], the [local utilities] are not entitled to change their bargains.” Id. at ¶¶ 62,399-62,400. But the local utilities do not allege that the energy companies manipulated their negotiations of the contracts here at issue; the local utilities challenge the context, not the conduct, of those negotiations. Consistently with the Staff Report’s findings, the local utilities are maintaining that factors exogenous to the forward market, the dysfunction and manipulation of the spot market, artificially influenced the rates in the forward market, creating market dysfunction in the forward market.25 The local utilities’ argu25 FERC’s premise, never examined in its orders and opinions, is that the spot and forward markets can and should be analyzed separately. Many of the participants in the two markets are the same, however, as is the product sold — electric power. The only difference is the time frame for delivery of that product. For present purposes, we accept FERC’s assumption that the two markets are sufficiently separate that there is at least a question as to the scope of the impact of the dysfunctional spot market on the forward market. 19606 PUBLIC UTILITY DISTRICT v. FERC ment is that when such market dysfunction occurs and there is no opportunity to revisit the propriety of the market-based rate authority in effect when the contract was entered, FERC cannot assume that contractual terms were just and reasonable as between the contracting parties when the agreement was negotiated. As a result, FERC cannot focus only on “public interest” considerations when the rates established are thereafter challenged. [13] In this case, the questions raised by the Staff Report — whether and how the manipulated spot market influenced the forward markets — are relevant to determining whether the Mobile-Sierra doctrine applies, because they raise questions about the market conditions at the time of contract formation and thus about the propriety of relying on a regime of market-based rate authority at that time to produce just and reasonable rates. Although FERC “is not obligated to justify deviations from an approach suggested by its own staff,” when “the conceptual underpinnings of the staff’s approach” are “critical to a reasoned resolution of the problem,” then FERC must address them. Pub. Utils. Comm’n v. FERC, 817 F.2d 858, 862-63 (D.C. Cir. 1987). [14] We conclude that FERC’s decision to treat the marketfunction evidence as irrelevant to the question whether Mobile-Sierra applies, and its resulting application of the Mobile-Sierra doctrine, was fundamental error. In a regulatory regime predicated on the grant of market-based rate authority, the decision whether to apply Mobile-Sierra to subsequent contracts formed under that authority requires FERC and reviewing courts to determine if the contracts at issue were initially entered into in fully functioning markets. FERC’s application of the Mobile-Sierra doctrine without considering the contract formation issues was error.
[15] FERC’s error in its approach to deciding whether to apply the Mobile-Sierra presumption was compounded by its PUBLIC UTILITY DISTRICT v. FERC 19607 use of an erroneous standard for determining whether the challenged contracts affect the public interest. As our historical summary shows, electric utility deregulation has made it increasingly necessary for FERC to consider wholesale power contracts’ effect on the consuming public. In its efforts to determine the impact on the public interest under MobileSierra, however, FERC relied on the wrong legal standard, applying factors taken from the context of a low-rate challenge rather than those relevant to the high-rate challenge present in this case. As we discussed in Part II, state agencies in the past regulated heavily the rates charged directly to the public. Electric rate regulation reform, however, has significantly limited the role state regulators play and simultaneously increased the importance of federal regulation for the prices paid by retail ratepayers. FERC’s increased responsibility for protecting the public’s interest makes its obligation to ensure that wholesale rates do not unjustifiably adversely affect the public — always a part of FERC’s statutory mandate — more important than it was when the Mobile-Sierra doctrine first developed. Because, at present, FERC, not state regulators, “is perhaps in the best position to reach the most equitable result and to act in the public interest,” Miss. Indus. v. FERC, 808 F.2d 1525, 1549 (D.C. Cir. 1987) (per curiam) (quoting Middle S. Serv., Inc., 30 F.E.R.C. ¶ 63,030, at ¶ 65,151 (1985)), FERC must give predominant weight in determining whether to modify a contract under section 206 to the impact of a challenged wholesale contract on the rates paid by the consuming public who use the energy covered by the contract. Tested against this protocol, the agency’s narrow conception of “public interest” review does not suffice. FERC determined that the challenged contract rates did not impact the public interest principally because the local utilities presented little evidence relevant to the three public interest factors specifically mentioned in Sierra.26 Order on Initial 26 In such circumstances [when the public interest test satisfies FERC’s duty to ensure just and reasonable rates] the sole concern 19608 PUBLIC UTILITY DISTRICT v. FERC Decision, 103 F.E.R.C. at ¶ 62,397. Similarly, FERC’s briefs in this court, assume, erroneously, that Sierra established a three-prong public interest standard applicable across all circumstances, an assumption with which we do not agree. In particular, the “excessive burden” reference in Sierra, heavily relied upon by FERC in this case in concluding that there was no impact on the public interest, has no application here. As the text from Sierra, reproduced in the margins, demonstrates, the three Sierra factors were specifically identified as relevant to the low-rate challenge presented in that case. Rates asserted to be lower than those FERC would approve ab initio will not ordinarily directly affect the most obvious “public interest” underlying the FPA — namely, avoidance of unnecessarily high rates for the consuming public. That Sierra does not mention such a consideration is thus no wonder. See Ne. Utils. Serv. Co. v. FERC (Ne. Utils. II), 55 F.3d 686, 691 (1st Cir. 1995) (applying a broader definition of “public interest” in a high-rate challenge because “[i]t all depends on whose ox is gored and how the public interest is affected”); cf. Permian Basin Area Rate Case, 390 U.S. 747, 783-84 (1969) (approving Federal Power Commission’s setting of maximum rates because of the impact on the public interest). Indeed, the D.C. Circuit has characterized Sierra as establishing the rule that “a heavy burden must be met before a customer who has negotiated a fixed-price contract can be deprived against his will of the benefit of his bargain.” Town of Norwood, 587 F.2d at 1310 (emphases added). When a customer has negotiated a low contract rate, FERC must meet a high burden before raising that rate. By contrast, in this case, the customer is comof the Commission would seem to be whether the rate is so low as to adversely affect the public interest — as where it might impair the financial ability of the public utility to continue its service, cast upon other consumers an excessive burden, or be unduly discriminatory. Sierra, 350 U.S. at 355 (emphasis added). PUBLIC UTILITY DISTRICT v. FERC 19609 plaining of a high rate. The concerns in such a high-rate case are not entirely parallel to those in a low-rate case. The primary “public interest” at issue in a low-rate challenge, such as Sierra, is in keeping utilities in operation so the public is not deprived of services. Sierra also mentioned avoidance of rates “so low as to . . . cast upon other consumers an excessive burden.” 350 U.S. at 355 (emphasis added). The reason for concern with “excessive burden” on “other consumers” is that charging rates in some wholesale contracts that are too low to recoup production costs and a fair profit could lead utilities burdened with such low rate agreements to recoup their costs and profit margins by charging higher rates than are just and reasonable to other wholesale customers. Such a burden is “excessive” because it requires third parties to pay for costs, including the cost of capital, that properly should have been borne by the consumers who purchase energy covered by the challenged contract. Contrary to FERC’s supposition in this case, the reference to an “excessive” burden in Sierra did not signal that it is fine to burden customers with unjustifiably higher rates as long as those rates are not so high as to be “excessive” in some absolute sense. In contrast, the key “public interest” in a high-rate challenge, such as this one, is assuring that the consuming public pays fair rates for the very energy covered by the challenged contracts. Sierra’s limitation of relief to cases where “other” customers endure an “excessive burden” has no application to this direct pass-through concern. Instead, if a challenged contract imposes any significant cost on ultimate customers because of a wholesale rate too high to be within a zone of reasonableness, see INGAA, 285 F.3d at 31, that contract affects the public interest. To be sure, the stability of contract considerations that underlie the Mobile-Sierra doctrine do carry over to challenges by buyers rather than sellers. See Mobile, 350 U.S. at 19610 PUBLIC UTILITY DISTRICT v. FERC 344 (holding that no party may “unilaterally” change contract because “preserving the integrity of contracts . . . permits the stability of supply arrangements”). Those considerations, however, do not justify abnegation of FERC’s statutory responsibility to protect the public from unjustifiably high rates in wholesale contracts. The public interest standard, consequently, must be adjusted to give appropriate weight to that concern. In particular, in determining whether a challenged rate affects the public interest, FERC must take into account the Supreme Court’s admonition that even “a small dent in the consumer’s pocket” is relevant to the determination of fair rates. Texaco I, 417 U.S. at 399. In the context of a high-rate challenge, consequently, a high-rate public interest determination should focus on whether consumers’ electricity bills have been affected by the challenged rates — not necessarily whether the electricity bills have increased since the signing of the contracts, but whether those bills are higher than they would otherwise have been had the challenged contracts called for rates within the just and reasonable range. [16] This is not to say that any direct impact on consumer rates is enough to demonstrate a public interest effect sufficient to displace the countervailing Mobile-Sierra concern with protecting the stability of contract. Market-based rate regulation presumes — appropriately — that a functioning marketplace will drive prices towards marginal cost, and therefore toward such a reasonable range, “at least over the long pull.” INGAA, 285 F.3d at 31. Even if a particular rate exceeds marginal cost, however, it may still be within this reasonable range — or “zone of reasonableness” — if that higher-than-cost-based price results from normal market forces and is part of a general trend toward rates that do reflect cost. See id. at 32 (noting that brief spikes in pipeline rates “are completely consistent with competition”). Thus, the proper standard for the Mobile-Sierra “public interest” mode PUBLIC UTILITY DISTRICT v. FERC 19611 of review in a high-rate challenge is not whether the contracted rates pose an “excessive burden” on consumers, but whether the wholesale energy contract is outside the “zone of reasonableness” and results in retail rates higher than would be the case if that zone were not exceeded. This standard mirrors that endorsed by the D.C. Circuit for determination of a just and reasonable rate under a market-based rate regulation regime, see INGAA, 285 F.3d at 31-36, and provides an appropriate context for the Supreme Court’s “small dent” admonition in such a regulatory environment. [17] After reviewing the record carefully, we are certain that FERC did not properly assess the public interest of any of the contracts before it in this case.
Snohomish had already increased its retail rates by 35 percent to accommodate the payment of increased prices for power, averaging $125/MWh. Because Snohomish could not obtain forward contracts that allowed it to bring the retail rates back within a normal range, it appears that the contracts at issue did, in fact, impact Snohomish’s customers. Contrary to FERC’s assertion, it does not matter whether a rate increase occurred before or after a petitioner signed one of the challenged contracts. See Order on Rehearing, 105 F.E.R.C. at ¶ 61,986. In either case, the contract could cause customers to pay higher rates than they would have without the contract. Further, FERC specifically found that the challenged Morgan Stanley contract accounted for an eight percent increase for retail ratepayers over 2001 rates. Id.
FERC acknowledged that the challenged contracts led to electric bills of $35.13 per month for some Southern Cal 19612 PUBLIC UTILITY DISTRICT v. FERC Water customers. FERC held, however, that Southern Cal Water had not proven that such a bill “amounts to an excessive burden on the ratepayers.” Id. (emphasis added). FERC’s rejection of Southern Cal Water’s claim because this increase did not amount to an “excessive burden,” id., is in error because, as stated above, the “excessive burden” standard, which referred in Sierra to the impact on third parties of a wholesale contract so low as to necessitate that costs be recouped from other buyers, does not apply in this case, and did not in any event sanction impacts on consumers as long as not in some absolute sense “excessive.”
Nevada Power’s retail rates decreased after the challenged contracts were negotiated. Id. This circumstance, however, cannot alone determine whether those contracts negatively affected the public interest. The decrease from peak rates charged during the crisis does not show that the slightly lower rates that resulted from the forward contracts did not affect the public interest. It is entirely possible that rates had increased so high during the energy crises because of dsyfunction in the spot market that, even with the acknowledged decrease in rates, consumers still paid more under the forward contracts than they otherwise would have. FERC should have performed a more sophisticated economic analysis to determine if the challenged contract affected the public interest.