Court Opinion

ID: 4255498
Source: CourtListenerOpinion
Date Created: 2018-03-16 15:00:49.365436+00
Date Added: 2024-06-11T14:44:32.582377
License: Public Domain

United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued December 1, 2017               Decided March 16, 2018

                        No. 16-1176

              NORTHWESTERN CORPORATION,
                     PETITIONER

                              v.

       FEDERAL ENERGY REGULATORY COMMISSION,
                    RESPONDENT

           MONTANA CONSUMER COUNSEL, ET AL.,
                    INTERVENORS

           On Petition for Review of Orders of the
           Federal Energy Regulatory Commission

    John Lee Shepherd, Jr. argued the cause for petitioner.
With him on the briefs were Clifford M. Naeve, James P.
Danly, Heather H. Grahame, M. Andrew McLain, and Timothy
T. Mastrogiacomo.

    Holly E. Cafer, Senior Attorney, Federal Energy
Regulatory Commission, argued the cause for respondent.
With her on the brief were David L. Morenoff, General
Counsel, and Robert H. Solomon, Solicitor.

     Christina F. Gomez argued the cause for intervenors. With
her on the brief were Kathleen L. Mazure, Thorvald A. Nelson,
                               2
and Michelle Brandt King. John P. Coyle, Natalie M. Karas,
and Justin W. Kraske entered appearances.

   Before: KAVANAUGH and WILKINS, Circuit Judges, and
RANDOLPH, Senior Circuit Judge.

    Opinion for the Court filed by Circuit Judge KAVANAUGH.

     KAVANAUGH, Circuit Judge:           The Federal Energy
Regulatory Commission requires utilities that transmit
electricity to supply extra power generation in order to balance
moment-to-moment variations in demand for electricity.
Utilities must add power to, or withdraw power from, the grid
in real time as actual demand for electricity exceeds or falls
short of projected demand. That extra power generation is
known as regulation service.

    FERC allows utilities to recover costs associated with the
provision of regulation service. Utilities may recover those
costs by charging them to customers, as long as the utilities
charge rates that are “just and reasonable.” 16 U.S.C.
§ 824d(a).

     NorthWestern is an electric utility that is subject to
FERC’s regulation-service requirement.           Before 2011,
NorthWestern lacked the generating capacity to provide its
own regulation service, so it met the requirement by purchasing
regulation service from other utilities. With FERC’s approval,
NorthWestern then passed on the cost of that purchased
regulation service to its wholesale and retail customers. But
purchasing regulation service from other utilities eventually
became too expensive, so NorthWestern built a new generating
station dedicated to providing regulation service.
NorthWestern then proposed to revise the rate that it charges
                               3
customers for regulation service in order to recover the costs of
providing that service from the new station.

     FERC determined that NorthWestern’s proposed rate was
not just and reasonable.          FERC therefore modified
NorthWestern’s proposed rate and ordered NorthWestern to
refund its customers the difference between the proposed rate
and the modified rate. NorthWestern challenges FERC’s
decision as arbitrary and capricious under the Administrative
Procedure Act. The arbitrary and capricious standard requires
that an agency’s decision be reasonable and reasonably
explained. We conclude that FERC’s decision in this case was
reasonable and reasonably explained, and we therefore deny
the petition for review.

                                I

     In 1996, FERC issued Order 888. 61 Fed. Reg. 21,540
(May 10, 1996). Among other things, Order 888 requires
electric utilities to provide their customers with certain
ancillary services – services that supplement the basic service
of transmitting electricity. Id. at 21,579-80. One such ancillary
service is “regulation service.” Regulation service is extra
power generation that responds to “moment-to-moment
variations” in demand for electricity in a given area. Id. at
21,582. In other words, regulation service is “the injection or
withdrawal of real power” into or from the electric grid in
response to fluctuations in demand for electricity. Order No.
755, 76 Fed. Reg. 67,260, 67,260-61 (Oct. 31, 2011).
Regulation service helps to prevent blackouts and equipment
damage by keeping the frequency of the electric current at close
to 60 Hertz, the standard frequency in the United States. Id. If
a utility fails to maintain that frequency, FERC may impose
civil penalties on the utility. See 16 U.S.C. § 825o-1.
                                 4
      A utility charges customers for regulation service under
Schedule 3 of the utility’s Open Access Transmission Tariff,
which is filed with FERC. FERC must examine the rate that a
utility proposes to charge Schedule 3 customers in order to
ensure that the rate is “just and reasonable.” 16 U.S.C.
§ 824d(a), (e). A just and reasonable rate must be fair both to
the utility and to its customers: It “should be based on the costs
of providing service to the utility’s customers, plus a just and
fair return on equity.” Alabama Electric Cooperative, Inc. v.
FERC, 684 F.2d 20, 27 (D.C. Cir. 1982); see also FPC v. Hope
Natural Gas Co., 320 U.S. 591, 603 (1944).

     This case concerns an attempt by petitioner NorthWestern
to revise its Schedule 3 rate. NorthWestern is an electric utility
subject to FERC’s regulation-service requirement. As relevant
here, NorthWestern transmits electricity to wholesale and retail
customers in Montana. 1 When NorthWestern first began
operations in 2002, NorthWestern did not possess sufficient
generating capacity to provide its own regulation service. So
NorthWestern complied with Order 888 by purchasing
regulation service from other utilities.          NorthWestern
contracted with those other utilities for a set amount of
regulation service and passed the cost of that regulation service
on to customers under Schedule 3. From 2002 to 2010,
NorthWestern purchased, and passed on the cost of, 60

    1
       The record is not clear about the precise makeup of
NorthWestern’s customer base.               According to FERC,
NorthWestern’s customers – presumably its wholesale customers –
include generators and “load-serving entities.” Respondent’s Brief
at 1. Load-serving entities are utilities that supply electricity to
homes and businesses. NorthWestern’s retail customers appear to
include industrial energy customers such as refining companies, see
Intervenors’ Brief at ii, 1, but may also include commercial and
residential customers. Regardless, the exact makeup of each
customer class does not affect the resolution of this case.
                                5
megawatts of regulation service each year to its Schedule 3
customers.

     But NorthWestern eventually decided that purchasing
regulation service from other utilities was inefficient. So
NorthWestern built the Dave Gates Generating Station, a
station dedicated to providing regulation service to
NorthWestern’s customers. The Gates Station has three
generators, each with a maximum capacity of 50 megawatts,
for a total nominal or “nameplate” capacity of 150 megawatts.
The Gates Station began operating in January 2011.

     Whereas NorthWestern had previously passed on to its
Schedule 3 customers the cost of purchasing regulation service
from other utilities, NorthWestern now wanted to recover from
its customers the cost of providing regulation service from the
Gates Station. So NorthWestern filed a proposed revised
Schedule 3 rate for FERC’s approval. NorthWestern filed its
rate pursuant to Section 205 of the Federal Power Act, which
places the burden on the utility to show that its proposed
revised rate is just and reasonable. 16 U.S.C. § 824d(e).

     Here is how NorthWestern proposed to recover the cost of
providing regulation service from the Gates Station. First,
NorthWestern calculated the Gates Station’s revenue
requirement – the station’s costs plus an allowed rate of return.
NorthWestern then divided the Gates Station’s revenue
requirement between two different groups of customers. The
first group of customers included retail customers only. In
Montana, retail customers pay for wind-generated electricity in
addition to fuel-generated electricity. Retail customers pay for
wind-generated electricity at state-approved rates; FERC does
not enter into the picture, and utilities do not use Schedule 3 to
recover the cost of regulation service associated with wind-
generated electricity. Because NorthWestern calculated that
                               6
retail customers would need 45 megawatts of regulation service
just to support wind-generated electricity, NorthWestern
intended to charge retail customers alone for 45 megawatts of
regulation service, and to do so at the state-approved rate –
separate from Schedule 3.

     The second group of customers included both retail and
wholesale customers. Both retail and wholesale customers pay
for regulation service associated with fuel-generated electricity
at FERC-approved rates under Schedule 3. NorthWestern
determined that this second group of customers would need 60
megawatts of regulation service – the amount that
NorthWestern had historically purchased from other utilities.
So NorthWestern proposed to recover the cost of 60 megawatts
of regulation service from this second group of customers
under Schedule 3.

     In other words, NorthWestern planned to use the Gates
Station to supply a total amount of 105 megawatts of regulation
service to all of its customers. Retail customers alone would
pay for 45 megawatts of that total – 43% – at a state-approved
rate, separate from Schedule 3. Retail and wholesale customers
together would pay for the remaining 60 megawatts of that total
– 57% – under Schedule 3. NorthWestern calculated its
proposed Schedule 3 rate by multiplying the Gates Station’s
revenue requirement by .57, which is the ratio of 60/105.

     Three other components of NorthWestern’s proposed
Schedule 3 rate also matter here. First, NorthWestern planned
to use Schedule 3 to recover fuel costs associated with
operating the Gates Station, but also planned to credit
customers for any revenue that the Gates Station might bring
in from anything other than providing regulation service, such
as from “off-system sales” – sales of energy to third parties.
NorthWestern indicated, however, that it did not actually plan
                               7
to use the Gates Station for anything other than regulation
service. Second, NorthWestern proposed to recover costs
associated with a three-month outage of the Gates Station that
occurred in 2012. During that outage, NorthWestern once
again had to buy regulation service from other utilities.
NorthWestern planned to pass the cost of that purchased
regulation service on to its customers under Schedule 3. Third,
NorthWestern also sought approval to pass on to customers the
cost of any regulation service that NorthWestern might need to
purchase in the future in the event of another Gates Station
outage.

     In sum, NorthWestern asked FERC to approve a revised
Schedule 3 rate that: (1) charged customers for regulation
service by multiplying the Gates Station’s revenue requirement
by the cost-calculation ratio of .57; (2) charged customers for
fuel costs, but credited customers for any revenue the Gates
Station might bring in from off-system sales and other non-
regulation-service sales; (3) charged customers for the
regulation service that NorthWestern purchased for three
months during the 2012 outage; and (4) charged customers for
any regulation service that NorthWestern might need to
purchase during future outages.

     The administrative law judge assigned to NorthWestern’s
case concluded that several aspects of the rate were not just and
reasonable. The ALJ reduced NorthWestern’s proposed rate
by: (1) multiplying the revenue requirement by a different cost-
calculation ratio of .13, which is 19/150; (2) excluding fuel
costs from the Schedule 3 rate altogether and rejecting
NorthWestern’s crediting arrangement; (3) requiring
NorthWestern to make a separate filing to recover costs
associated with the 2012 outage; and (4) requiring
NorthWestern to make separate filings before charging
                                8
customers for any regulation service that NorthWestern might
need to purchase during future outages.

    FERC affirmed the ALJ’s decision in all respects. FERC
ordered NorthWestern to refund its customers the difference
between NorthWestern’s proposed rate and the lower rate that
FERC ultimately approved as just and reasonable. FERC
denied NorthWestern’s request for rehearing.

     NorthWestern timely petitioned for review in this Court.
We review FERC’s order under the Administrative Procedure
Act’s arbitrary and capricious standard. That standard requires
that FERC’s decision be reasonable and reasonably explained.

                                II

     NorthWestern raises four challenges to the revised rate
that FERC approved.

    First, NorthWestern maintains that FERC unreasonably
reduced the numerator of NorthWestern’s proposed cost-
calculation ratio. The numerator reflects the number of
megawatts needed to serve Schedule 3 customers. FERC
reduced the proposed numerator from 60 to 19 megawatts after
determining that only 19 megawatts were needed to serve
Schedule 3 customers.

     Along with some other exclusions not at issue here, FERC
excluded the megawatts associated with “regulation-down”
capacity from the numerator. NorthWestern contends that it
was unreasonable to exclude regulation-down capacity from
the numerator. We disagree.

     “Regulation down,” a component of regulation service, is
the capacity associated with operating a generator at a set point,
                               9
a steady point from which the utility can quickly ramp down if
demand for electricity suddenly drops. The energy generated
as a by-product of operating at a set point can potentially be
used for non-regulation-service purposes – for example, it can
be sold to third parties in “off-system sales.”

     NorthWestern operates its Gates Station generators at a set
point in order to reserve capacity for regulation down. But
NorthWestern does not sell the energy thereby generated.
NorthWestern nonetheless proposed to recover from its
Schedule 3 customers the costs of reserving regulation-down
capacity. The ALJ rejected NorthWestern’s proposal and
subtracted the megawatts associated with regulation-down
capacity from NorthWestern’s proposed numerator after
determining that NorthWestern had neither produced adequate
data to show how much regulation-down capacity the Gates
Station would need to reserve, nor explained why
NorthWestern could not recover its costs in some other way,
such as by selling the energy.

      FERC affirmed the ALJ’s decision and added some further
analysis, focusing primarily on NorthWestern’s failure to
demonstrate that it could not recover its costs through means
such as off-system sales. Drawing on other cases excluding
regulation-down capacity from cost calculations, FERC
applied the principle that animated those cases: Customers
should not pay for what is essentially a backup service if the
utility can recover its costs by using or selling the energy that
it generates as a by-product. See NorthWestern Corp., 155
FERC ¶ 61,158, at ¶¶ 33-36 (2016); see also Kentucky Utilities
Co., 85 FERC ¶ 61,274 (1998); Allegheny Power Service
Corp., 85 FERC ¶ 61,275 (1998). NorthWestern, FERC
acknowledged, might be in a different situation: It was
possible, for example, that the location of the Gates Station
might make off-system sales infeasible.             If so, then
                              10
NorthWestern might be able to show the justness and
reasonableness of charging Schedule 3 customers for the costs
of reserving regulation-down capacity. But FERC concluded
that NorthWestern had failed to produce sufficient evidence to
support such a showing. See NorthWestern Corp., 147 FERC
¶ 61,049, at ¶ 48 (2014). And because it was NorthWestern’s
burden under Section 205 to show that its proposed rate was
just and reasonable, that failure was fatal. FERC therefore
reasonably excluded the megawatts associated with regulation-
down capacity from the cost-calculation ratio.

     NorthWestern’s several rejoinders miss the mark.
NorthWestern maintains that FERC lacked authority under
Section 205 to reduce the numerator of NorthWestern’s
proposed cost-calculation ratio.       Because NorthWestern
previously passed on the cost of 60 megawatts of purchased
regulation service with FERC’s approval, NorthWestern
argues that the 60-megawatt amount was “embedded” in
NorthWestern’s original rate. Petitioner’s Brief at 40. And
because FERC (i) must act under Section 206 of the Federal
Power Act in order to modify an existing rate component and
(ii) may modify an existing rate component under Section 206
only after showing that the existing rate component is not just
and reasonable, NorthWestern contends that FERC made an
“end-run” around Section 206 by (i) modifying an existing rate
component in a Section 205 proceeding and (ii) placing the
burden of proof on NorthWestern. Id. at 41; see 16 U.S.C.
§ 824e; Public Service Commission of New York v. FERC, 642
F.2d 1335, 1345 (D.C. Cir. 1980) (utility bears burden of proof
on those parts of its proposed rate that depart from status quo,
but not on those parts that are “constant elements” of the
previous rate).

    NorthWestern is mistaken. The 60-megawatt amount was
never “embedded” in any rate formula that FERC previously
                               11
approved because it was never a component of a traditional
cost-of-service rate.      Rather, FERC previously allowed
NorthWestern – as a temporary expedient – to pass on what it
cost NorthWestern to procure a set amount (60 megawatts) of
regulation service from third parties. NorthWestern’s proposed
revised rate, which is structured as a traditional cost-of-service
rate, departs from the previous status quo. NorthWestern
therefore had to justify its entire revised and redesigned rate,
including all of the rate’s components, as FERC explained.
NorthWestern Corp., 155 FERC ¶ 61,158, at ¶¶ 27-29; see
Kansas Gas & Electric Co. v. FERC, 758 F.2d 713, 719-20
(D.C. Cir. 1985) (utility proposing rate clause that departs from
previous status quo bears burden of proof). So FERC properly
assigned NorthWestern the burden of proof in this Section 205
proceeding.

    In another burden-shifting attempt, NorthWestern
contends that FERC failed to identify other customers who
might bear NorthWestern’s cost of reserving regulation-down
capacity. But it was not FERC’s burden to identify alternative
ways for NorthWestern to recover its costs (although FERC did
suggest some ways). Instead, it was NorthWestern’s burden to
show that its proposed rate was just and reasonable – here, for
example, by showing that no other such customers could be
identified.

     NorthWestern also objects that, in reducing the numerator,
FERC failed to account for NorthWestern’s proposed crediting
arrangement, which would have credited NorthWestern’s
Schedule 3 customers the value of any off-system or other non-
regulation-service energy sales that NorthWestern might
manage to make. But FERC reasonably declined to discuss the
crediting arrangement. The proposed crediting arrangement
assumed the very point that NorthWestern needed to prove:
                               12
that Schedule 3 customers should bear the cost of reserving
regulation-down capacity in the first place.

     In short, FERC reasonably modified NorthWestern’s
proposed cost-calculation ratio by excluding the megawatts
associated with “regulation down” from the numerator. We
therefore reject NorthWestern’s first challenge.

     Second, NorthWestern contends that FERC arbitrarily
increased the denominator of NorthWestern’s proposed cost-
calculation ratio from 105 megawatts to 150 megawatts. We
disagree.

     Recall that 105 megawatts is the total amount of regulation
service that NorthWestern planned to provide from the Gates
Station – 45 megawatts associated with wind-generated
electricity, plus 60 megawatts associated with fuel-generated
electricity. NorthWestern proposed to use that 105-megawatt
figure as the denominator of the cost-calculation ratio in order
to charge Schedule 3 customers for their portion of the total
amount of regulation service that NorthWestern planned to
provide from the Gates Station.

     Under FERC precedent, however, the denominator should
reflect the nameplate capacity – here, meaning the number of
megawatts that the Gates Station had the capacity to produce,
not just the megawatts that NorthWestern planned to devote to
regulation service. See Westar Energy, Inc., 130 FERC
¶ 61,215, at ¶ 40 (2010); NorthWestern Corp., 140 FERC
¶ 63,023, at ¶¶ 148-150 (2012). The record evidence
established that each of the three generators at the Gates Station
had a capacity of 50 megawatts, for a total of 150 megawatts.
FERC therefore reasonably increased the denominator to 150
megawatts.
                              13
     NorthWestern retorts that, because FERC’s ratio uses “the
nameplate capacity” as the denominator “despite using
customer demand for regulation service as the numerator,” the
ratio is somehow unreasonable. Petitioner’s Brief at 32-33.
We disagree. The denominator measures the Gates Station’s
total capacity, and the numerator measures the portion of that
total capacity that is needed to provide regulation service to
Schedule 3 customers.

    Because FERC acted reasonably in modifying the
denominator, we reject NorthWestern’s second challenge to
FERC’s decision.

     Third, NorthWestern maintains that FERC wrongly
rejected NorthWestern’s proposal to recover fuel costs under
Schedule 3. More particularly, NorthWestern argues that
FERC inadequately explained its decision not to allow fuel
costs, and failed to account for the fact that NorthWestern may
not be able to recover fuel costs retroactively under Schedule
4. FERC’s explanation, however, was adequate.

    FERC adopted the ALJ’s reasoning, which explained that
FERC ordinarily requires utilities to recover fuel costs under
Schedule 4, which governs “energy service,” rather than under
Schedule 3, which governs “capacity service.” The two
exceptional cases that NorthWestern identified both involved
unusual circumstances, as the ALJ’s decision noted.
NorthWestern Corp., 140 FERC ¶ 63,023, at ¶ 181. In addition,
FERC was not persuaded by NorthWestern’s argument about
the potential difficulty of recovering past fuel costs under
Schedule 4, because NorthWestern “admittedly never
attempted” to recover those costs under Schedule 4.
NorthWestern Corp., 155 FERC ¶ 61,158, at ¶ 43. FERC’s
decision on fuel costs was reasonable and reasonably
explained.
                              14
     Fourth, NorthWestern argues that FERC acted arbitrarily
by (1) requiring NorthWestern to make a separate Section 205
filing to recover costs associated with the 2012 Gates Station
outage, and (2) requiring NorthWestern to make separate
Section 205 filings before charging customers for any
regulation service that NorthWestern might need to purchase
during future outages. NorthWestern again maintains that
FERC inadequately explained its decision and failed to
consider the possibility that NorthWestern might not be able to
recover costs associated with the 2012 outage retroactively.
But FERC again adopted the ALJ’s reasoning, which justified
the separate proceedings on reasonable grounds – the need for
more data related to the 2012 outage, and the need for case-by-
case analysis of any future contracts. FERC acted reasonably
here as well.

    In sum, we find that FERC’s decision on NorthWestern’s
proposed rate was reasonable and reasonably explained.

                              III

    NorthWestern also challenges FERC’s decision to order a
refund of the difference between the higher rate that
NorthWestern proposed and the lower rate that FERC
approved.    NorthWestern contends that FERC’s refund
decision resulted from faulty reasoning and an inadequate
assessment of equitable factors. We are not persuaded.

     The parties agree that FERC ordinarily does not order
refunds in cases where a utility collects the appropriate total
amount of revenue but improperly allocates it among different
customer groups. The parties also agree that FERC ordinarily
does order refunds in cases where a utility instead overcharges
a given customer group. See, e.g., Black Oak Energy, LLC, 139
                               15
FERC ¶ 61,111, at ¶ 11 & nn. 17-18 (2012). But the parties
disagree about how to classify this case.

     FERC concluded that NorthWestern over-collected from
its Schedule 3 customers, making this the kind of case in which
FERC ordinarily orders refunds. That determination was
reasonable. As FERC explained, the purpose of the Section
205 proceeding was to decide whether the revised rate that
NorthWestern proposed to charge its Schedule 3 customers was
just and reasonable. The object of the proceeding was not to
decide how to divvy up the Gates Station’s revenue
requirement among different customer groups. NorthWestern
Corp., 155 FERC ¶ 61,158, at ¶¶ 55-56. Because FERC
concluded that NorthWestern’s proposed Schedule 3 rate was
too high, FERC naturally also concluded that NorthWestern
had overcharged, and therefore over-collected from, its
Schedule 3 customers.

     NorthWestern objects that the parties’ frequent use of the
word “allocate” throughout the proceeding demonstrates that
this case was really about cost allocation. True, the parties
tossed that term around somewhat loosely. But to make the
classification of this case turn on the parties’ imprecise use of
the term “allocate” would be to ignore the substantive
distinction that FERC’s precedent attempts to draw between
“cost-allocation” and “over-collection” cases. NorthWestern’s
other objections take too narrow a view of FERC’s relevant
precedents and rely on comparisons to dissimilar cases. Put
simply, FERC reasonably determined that NorthWestern over-
collected from its Schedule 3 customers in this case.

     Even so, NorthWestern contends that FERC did not
adequately assess the relevant equitable factors before
imposing the refund order. But FERC considered the argument
that NorthWestern acted in good faith, and found it irrelevant
                              16
to the question whether FERC should depart from its general
policy of ordering refunds in over-collection cases. FERC also
considered the fact that NorthWestern was on notice about a
potential refund order from the start of the proceeding, when
FERC accepted and suspended NorthWestern’s proposed rate
subject to refund. After considering those factors, FERC
decided to treat this case like an ordinary over-collection case
and order a refund. That decision was reasonable and
reasonably explained.

                             ***

    We deny the petition for review.

                                                    So ordered.