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TRANSCONTINENTAL GAS PIPE LINE CORPORATION v. FEDERAL ENERGY REGULATORY COMMISSION </h1> <p class="docCourt"> </p> <p> June 9, 1995 </p> <p class="case-parties"> <b>TRANSCONTINENTAL GAS PIPE LINE CORPORATION, PETITIONER<br><br>v.<br><br>FEDERAL ENERGY REGULATORY COMMISSION, RESPONDENT<br><br>PUBLIC SERVICE ELECTRIC & GAS COMPANY, ET AL., INTERVENORS</b><br><br> </p> <div class="caseCopy"> <div class="facLeaderBoard"> <script type="text/javascript"><!-- google_ad_client = "ca-pub-1233285632737842"; /* FACLeaderBoard */ google_ad_slot = "8524463142"; google_ad_width = 728; google_ad_height = 90; //--> </script> <script type="text/javascript" src=""> </script> </div class="facLeaderBoard"> <div class="numbered-paragraph"><p><br> Before: Williams, Sentelle and Rogers, Circuit Judges.</p></div> <div class="numbered-paragraph"><p> Williams, Circuit Judge</p></div> <div class="numbered-paragraph"><p> FOR PUBLICATION</p></div> <div class="numbered-paragraph"><p> FOR THE DISTRICT OF COLUMBIA CIRCUIT</p></div> <div class="numbered-paragraph"><p> Argued March 24, 1995</p></div> <div class="numbered-paragraph"><p> On Petition for Review of an Order of the Federal Energy Regulatory Commission</p></div> <div class="numbered-paragraph"><p> Opinion for the Court filed by Circuit Judge Williams.</p></div> <div class="numbered-paragraph"><p> The Federal Energy Regulatory Commission certified Transcontinental Gas Pipe Line's Southern Expansion service, subject to a condition altering its proposed rate design; on rehearing, it reversed course and accepted Transco's proposed design; thereafter, it twice modified the order, ultimately ruling that the approved rates should become effective only a year after the start of service. Transcontinental Gas Pipe Line Corp., 51 FERC Para(s) 61,173 (1990); 56 FERC Para(s) 61,037 (1991); 57 FERC Para(s) 61,331 (1991); 62 FERC Para(s) 61,211 (1993); 64 FERC Para(s) 61,099 (1993). Transco argues that the rates should be made effective as of the start of service. Although we disagree with Transco's contention that the Commission was jurisdictionally barred from its various tinkerings with the effective date, we find its arguments on the merits in substantial part persuasive. We thus reverse the orders below in part and remand for further proceedings consistent with this opinion.</p></div> <div class="numbered-paragraph"><p> On September 2, 1988, Transco filed an application with the Commission pursuant to Section 7(c) of the Natural Gas Act, 15 U.S.C. Section(s) 717f(c) (1988), requesting a certificate to provide transportation service to 25 existing customers during the peak and shoulder demand months, November through March. To implement the service, Transco proposed construction of 27.22 miles of gas pipeline looping and some related facilities. Transco calls this project "Southern Expansion" service.</p></div> <div class="facAdFloatLeft"> <script type="text/javascript"><!-- google_ad_client = "ca-pub-1233285632737842"; /* FACContentLeftSkyscraperWide */ google_ad_slot = "1266897617"; google_ad_width = 160; google_ad_height = 600; //--> </script> <script type="text/javascript" src=""></script> </div class="facLeaderBoard"> <div class="numbered-paragraph"><p> The application grew out of extensive negotiations between Transco and the 25 customers, who needed access to additional natural gas during the winter months to accommodate "a steady addition of new temperature-sensitive customers". 51 FERC at 61,467. As in most agreements, each side bargained away some possible advantages in exchange for others it deemed more valuable. Transco, for example, allowed the customers "maximum flexibility and the opportunity to secure the most economically priced gas available". Id. at 61,468. The customers would be allowed to contract with third parties for the purchase of gas and upstream transportation with virtually no limitations.</p></div> <div class="numbered-paragraph"><p> For their part, the customers agreed that the initial rate for Southern Expansion service would utilize the straight fixed-variable ("SFV") rate design methodology. Under SFV, a pipeline recovers all of its fixed costs through a demand charge and all of its variable costs through a commodity charge. Pipeline customers pay the demand charge each month based on their entitlement to service, regardless of whether or how much they actually use it. They pay the commodity charge only for their actual shipments through the pipeline. <a href="#D*fn1" name="S*fn1">*fn1</a> Use of the SFV methodology guaranteed Transco recovery of all of its fixed costs, no matter how little its customers used the Southern Expansion service. Because all parties had agreed to SFV methodology, Transco's application incorporated throughput levels projected by the customers on the basis of SFV rates.</p></div> <div class="numbered-paragraph"><p> On May 14, 1990 FERC issued an order granting Transco certificate authority for the Southern Expansion service, subject to certain conditions and modifications. 51 FERC Para(s) 61,173 (1990). Only one modification is relevant here: FERC rejected the application's proposed use of the SFV rates and substituted a modified fixed-variable ("MFV") rate design. Under MFV, a portion of the pipeline's fixed costs-return on equity and related income taxes-is included in the commodity charge, not the demand charge. The Commission explained its rejection only by observing that under the SFV methodology Transco would bear none of the risk of facility underutilization and that it had required MFV on a Transco expansion project three years earlier. Id. at 61,472. It noted, however, that it found MFV appropriate only as an initial rate and that in Transco's next rate filing any party or FERC staff could "propose new rates based on different methodologies, principles, or concepts". Id. at 61,473. FERC also recognized one factor that we think helps to explain the parties' contractual risk allocation: although the customers wanted the insurance provided by additional capacity, many were unsure whether or how much they would use the additional service, particularly in the near term. Id. at 61,470. If one viewed the service as an insurance policy for the customers, SFV would make perfect sense: persons who buy insurance pay the premium even if the risk insured against-here, an excess of demand over otherwise available supplies-fails to materialize.</p></div> <div class="numbered-paragraph"><p> Before proceeding further, we must explain an important detail of the MFV methodology and its application by the Commission here. Because a portion of the MFV commodity rate is designed to permit recovery of a fixed sum (the pipeline's return on equity plus related taxes), that portion of the rate is determined by dividing the fixed sum by the estimated throughput. Thus, if the fixed cost to be recovered were $1 million, and estimated throughput 2,000,000 units, the unit commodity rate would include 50 cents for that recovery. As a matter of simple arithmetic, the higher the estimated throughput, the lower the unit commodity rate. Here, in determining the commodity rate under the imposed MFV rate design, the Commission used the throughput levels estimated by the customers on the basis of the SFV methodology that they and Transco had agreed on. This was somewhat incongruous, for if there was any elasticity of demand, the customers would use less of the service at a high (MFV) commodity rate than at a low (SFV) rate.</p></div> <div class="numbered-paragraph"><p> Transco filed a timely request for rehearing, challenging FERC's imposition of MFV for its initial rate. The Commission on July 13, 1990 granted the request solely for purposes of securing more time for its consideration. On November 1, 1990, while the issue was still pending, Transco started service. Not knowing which rate structure FERC would ultimately adopt, customers presumably made decisions about whether (and how much) to use the service at least in part on the basis of their guesses as to whether SFV or MFV would more likely prevail. North Carolina Natural Gas decided against usage in the first season, while others decided in favor. See 64 FERC at 61,907.</p></div> <div class="numbered-paragraph"> <p> On July 5, 1991 FERC granted rehearing on Transco's rate design claim and approved an "initial rate" based on SFV principles. 56 FERC 61,037 (1991). It found that "as a general matter, agreements among the pipeline and its customers regarding rate design should be given significant weight and implemented, absent a determination by the Commission that it would be unreasonable to do so...." Id. at 61,136. It gave examples of factors that would render acceptance of the agreement unreasonable-mentioning specifically pipeline market power that could deny the customers "a meaningful choice" and an absence of arm's length bargaining-and found neither problem present here. Id. Accordingly, Transco made a "compliance filing" that (if accepted) would implement the SFV rate "effective November 1, 1990", the start of service. 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