Opinion ID: 436086
Heading Depth: 1
Heading Rank: 2

Heading: the ferc opinion

Text: 9 FERC heralded its Opinion No. 154 (the Williams opinion) as the longest and most elaborate decision it had ever issued. 14 The Williams opinion announces FERC's intended approach to future oil pipeline ratemaking; thus it is of great importance to oil producers, refiners, and pipeline owners. 10 FERC's essential conclusion in Williams is that ratemaking for oil pipelines should serve only to restrain gross overreaching and unconscionable gouging 15 in order to keep rates within the zone of commercial reasonableness, not public utility reasonableness. 16 As FERC said in a related order issued the same day as Williams: 11 Williams says that oil pipeline rate regulation should be relatively unobtrusive. It finds competition (both actual and potential) a far more potent force in this industry than in the others we regulate. Accordingly, it proposes to rely in the main on market forces. It views oil pipeline rate regulation as a modest supplement to rather than a pervasive substitute for the market. The supplement, Williams tells us, is in the nature of a check on gross abuse. 12 Trans Alaska Pipeline System, 21 FERC (CCH) p 61,092, at 61,285 (Nov. 30, 1982). The following summary describes how FERC reached that conclusion, and how it translated that conclusion into a particular ratemaking methodology. 13
14 In 1906, Congress adopted the Lodge Amendment to the Hepburn Act, which extended the definition of common carrier in the Interstate Commerce Act 17 to encompass interstate oil pipelines, and, as a consequence, required pipeline rates to be just and reasonable. 18 In Williams, FERC embarked on a close study of the climate of opinion that existed when Congress passed the Lodge Amendment. In doing so, FERC primarily examined the works of Ida Tarbell, a progressivist of the turn of the century, who has been credited with inflam[ing] the public's long-standing hostility to the [Standard Oil] combination as nothing before had. 19 FERC concluded that the Lodge Amendment was motivated by the desire to bust the Standard Oil trust. 20 15 FERC also found that in the early twentieth century the Standard Oil Company maintained its dominance over the entire American oil business by setting its pipeline rates at such extraordinarily high levels that access to the pipelines (and hence to important downstream markets) was cut off. See 21 FERC at 61,597. From this observation, FERC concluded that the Congress, in mandating that oil pipeline rates be just and reasonable, intended to outlaw only outrageously high rates: Prohibitive rates were a means to that end [of dominating American oil markets]. Congress wanted to forbid both the use of the means and the attainment of the end. The policy at which it fired was a policy of 'prohibitive' pricing. Id. In the belief that [t]he phrase in question, 'just and reasonable,' is a high-level abstraction[,] ... a mere vessel into which meaning must be poured, id. at 61,594, and considering numerous differences in the reasons for the establishment of a regulatory scheme over public utilities, such as electric companies, as opposed to transportation companies, such as oil pipelines, id. at 61,591-96, FERC determined that: 16 the authors of the Hepburn Act's oil pipeline provisions did not use the words just and reasonable in the sense in which public utility lawyers have used them since the 1940's. 17 We think that what was meant was not public utility reasonableness, but ordinary commercial reasonableness. To be specific, we discern no intent to limit these carriers' rates to barebones cost. What we perceive is an effort to restrain gross overreaching and unconscionable gouging. 18 Id. at 61,597. Thus, on the basis of this historical survey, FERC interpreted the statutory mandate that oil pipeline rates be just and reasonable to require only the most lighthanded regulation, with no necessary connection between revenue recoveries and the cost of service.
19 FERC next surveyed the changes since 1906 in the economics of the oil pipeline industry, and determined that the modern economic environment does not manifest the same threat of monopolistic practices that bedeviled Congress in 1906. 20 Comparing the dollars spent in 1981 in America for petroleum products to the dollars spent in the same year for oil pipeline transportation, 21 FERC found that pipeline costs are not very much when viewed in relation to the nation's total oil bill. 22 Further, FERC found that any savings created by lower pipeline charges would not necessarily--or even likely--be passed on to consumers. See 21 FERC at 61,601-02. FERC therefore concluded that [f]rom the consumer's perspective, oil pipeline rate regulation is akin to efforts to do something about the high price of shoes by controlling the pricing of shoe laces [or] to contain the price of food by seeing to it that the price of spice is always 'just and reasonable.'  Id. at 61,601. 21 FERC also found that, from Congress' perspective in 1906, oil pipeline rates did in fact make a difference to the oil consuming public. Reviewing cost and revenue trends, FERC showed that in the past pipeline charges comprised as much as sixty-eight percent of what the oil producer received for crude oil. 23 Thus, FERC concluded that although Congress may in 1906 have reasonably been concerned about oil pipeline prices, today [p]rohibitive oil pipeline rate structures are now a problem for the economic historian, and the oil pipeline rate reform crusade is anachronistic ... overtaken by events so that the combatants' rhetoric is no longer in touch with reality. Id. at 61,606-07. 22 Finally, FERC found that the economic market for oil pipelines has become competitive since 1906. In contrast to the industry during the early part of this century, today [p]rohibitive pricing has become uneconomic 24 and [n]o oil company (not even the largest) is wholly self-sufficient. 25 Also, FERC appeared to conclude that the significant decline in the price of pipeline transportation from 1931-1969 manifests the existence of competition in the pipeline transportation market. 26 23 In light of all the foregoing considerations, FERC expressed its belief that the consumer's interest in low pipeline rates is submicroscopic while the real threat to the public is underinvestment in needed oil pipelines. 27 Accordingly, FERC set down as a guiding principle of oil pipeline ratemaking that it is best to err on the side of liberality because the dangers of giving too little vastly outweigh those of giving too much. Id. at 61,613. 24 FERC then turned to apply this general principle to formulate a ratemaking methodology for oil pipelines.
25 Under the old ICC method, an arcane formula, comprised chiefly of a weighted average of original cost and cost of reproduction new, 28 was used to calculate the pipelines' valuation rate base. 29 While admitting that [w]ere we beginning afresh on a clean slate we might be inclined to use something different because the ICC formula contains anomalies and inconsistencies that result in an inaccurate picture of the pipelines' cost of service, id. at 61,616, FERC nevertheless concluded that the costs of adopting another rate base formula outweighed the benefits of such a shift. It therefore chose to adhere to the formula [it] inherited from the Interstate Commerce Commission. Id. at 61,632. 26 In doing so, FERC expressly rejected two proposed alternatives to the ICC ratemaking formula. First, the Commission eschewed original cost ratemaking in the belief that the chief advantage of such an approach--the facilitation of comparable earnings analysis--was of little use in the oil pipeline context, and that the switch to original cost alternative would create unnecessary regulatory burdens and social costs. See infra at 1511-18. Second, FERC rejected specific alterations to the ICC rate base formula proposed by the Association of Oil Pipe Lines because, in FERCs view, only relatively insubstantial amounts of money would be affected, and, in any event, the ICC's methodological errors tend to compensate roughly for one another. See infra at 1518-21. 27 Thus FERC reaffirmed the ICC rate base method, admitting it to be much too blunt or too clumsy for close work, but still finding it pragmatic and usable. 21 FERC at 61,616.
28 Quoting at length from this court's opinion in Farmers Union I, FERC launched its inquiry into rate of return methods from the premise that [t]he need for reform is plain. 30 Finding the parties' arguments ... so unhelpful and the applicable historical tradition ... so palpably deficient, FERC felt left to [its] own devices to fashion a new rate of return methodology. 31 It held that a proper rate of return for oil pipelines should be comprised of three elements: (1) debt service, (2) a full compensatory suretyship premium, and (3) the  'real ' entrepreneurial rate of return on the equity component of the valuation rate base. See 21 FERC at 61,644 (emphasis in original). 29 The first component, debt service, represents the amount needed to pay interest on the debt the pipeline has accumulated. The second component, the suretyship premium, represents the additional amount that would have been needed above actual debt service in the absence of a debt guarantee from the oil pipeline company's parent. 30 The third component, the entrepreneurial rate of return, according to FERC, follows logically from [the] basic concept that what the historical background and contemporary public policy needs call for here is a cap on gross abuse. Id. at 61,645. Accordingly, FERC offered eight different measures for the entrepreneurial rate of return. The measures included the nominal rates of return on book equity realized over the most recent one- or five-year period for (1) the oil industry generally, (2) American industry generally, or (3) the parent company or companies, excluding pipeline operations. The remaining two measures of an entrepreneurial rate of return took the total returns (dividends plus capital gains) on a diversified common stock portfolio over (1) the past five years or (2) the long run--25 years, 50 years, or more. Id. Under FERC's method, the pipeline would normally be permitted to choose the applicable rate of return from among these indices. 31 Once this rate of return is selected, it is adjusted downward [t]o avoid overcompensation for inflation. Id. at 61,646. FERC's methodology subtracts from the selected rate of return the percentage by which the valuation rate base has increased during the time period that was looked to in order to derive the appropriate nominal rate of return. 32 32 This adjusted rate of return is applied not to book equity, nor to the percentage of the valuation rate base represented by the proportion of equity relative to debt in the oil pipeline's overall capitalization structure. Rather, this rate is the allowed return on what FERC considers to be the equity component of the valuation rate base--the entire valuation rate base, less the face amount of debt. See id. at 61,647-48. 33 This method, FERC concedes, would result in handsome rate base writeups, followed by creamy returns on book equity. Id. at 61,650. FERC, however, believed that such high returns comported with its general ratemaking principles for oil pipelines: Here we are setting ceilings that will seldom be reached in actual practice. 33 Moreover, the Commission allowed generous returns in the belief that oil pipeline equityholders were entitled to the full benefit of appreciation in their leveraged assets, id. at 61,649, and that the more austere standard of fairness applied in the utility field cannot be divorced from the stringent regulatory controls on abandonment which, FERC ruled, do not apply to oil pipelines, id. at 61,650.
34 FERC made three other rulings in Williams that are challenged in this appeal. FERC held that (1) the original cost of transferred pipeline plant--and not its purchase price--should be used in ratemaking, (2) oil pipeline rate regulation should generally take place on a systemwide, rather than point-to-point, basis and (3) the tax normalization method of accounting may be employed by the oil pipeline companies if they so wish. 35 First, FERC set down as a general rule that the purchase price [for pipeline plant] is not entitled to any recognition at all for any ratemaking purpose. 34 There are two ways in which purchase price might have been used in oil pipeline ratemaking: (1) as a substitute for original cost in the rate base, and (2) in calculating the basis for depreciation expenses. FERC rejected the first use of purchase price because to do so would create a systemic incentive for the sale of pipeline plant and the consequent upward push on rates. See id. at 61,634-35. Further, to use purchase price in the rate base would contravene the principle that a mere change in ownership should not result in an increase in the rate charged for a service if the basic service rendered itself remains unchanged. 35 FERC similarly rejected the use of purchase price as the basis from which depreciation would be computed, citing this court's disapproval in Farmers Union I of the practice, 36 and finding no valid justification for what it called this nonchalant, half a loaf, split the difference policy of using original cost in the rate base, while calculating depreciation by reference to purchase prices. Id. at 61,635. 36 Second, FERC decided to regulate oil pipeline rates on a systemwide basis. FERC maintained that the alternative--ruling on the reasonableness of particular rates on specific routes--would require cost allocation inquiries that would be metaphysical inconclusive, and barren. Id. at 61,651. Also, FERC believed that systemwide regulation would give freer play to competitive forces in the oil pipeline industry. FERC restricted its ruling to pipeline systems, in contrast to pipeline companies. The rates of wholly noncontiguous pipeline systems, therefore, would not be computed by averaging companywide costs. FERC further cautioned that a showing that systemwide rates discriminated against nonowners of the pipeline would trigger strict regulatory scrutiny. Id. 37 Third, FERC permitted, but did not require, oil pipeline companies to normalize their accounts that reflect accelerated depreciation on equipment for tax purposes. 37 FERC permitted the use of the tax normalization method because normalization facilitates the comparable earnings analyses basic to the determination of appropriate rates of return on oil pipeline equity investments. Id. at 61,656. However, because [c]ompetitive considerations may lead some pipelines to prefer lower rates .... now in return for more later, FERC made the use of the method elective rather than compulsory. Id. 38 Finally, FERC prohibited pipelines that choose tax normalization from including the resulting tax reserve accounts in their rate bases. Otherwise, the rate payer who has paid higher taxes reflecting normalization accounting would be paying the carriers for earnings on the tax differential even though it was the rate payer who contributed the differential in the first place. Id. at 61,657 (quoting San Antonio v. United States, 631 F.2d 831, 847 (D.C.Cir.1980)).