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Village of Bethany, Illinois v. Federal Energy Regulatory Commission

January 11, 2002


Before Harlington Wood, Jr., Diane P. Wood, and Williams, Circuit Judges.

The opinion of the court was delivered by: Diane P. Wood, Circuit Judge.

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

Argued April 18, 2001

The petitioners in this case are small municipalities (to which we refer collectively as the Municipalities) that buy natural gas transportation services from the Natural Gas Pipeline Company of America (Natural). In 1997, Natural filed tariffs with the Federal Energy Regulatory Commission (the Commission) proposing to change the way that it allocates capacity that becomes available on its pipeline. After several rounds of negotiations and comments, the Commission issued orders approving Natural's new capacity allocation plan. The Municipalities have filed a petition for review of those orders, challenging two aspects of the plan. Although we are not unsympathetic to their concerns, we find that those concerns should be addressed during the Commission's next ratemaking proceeding regarding Natural's pipeline and were not relevant to the Commission's decision in this capacity allocation case. We therefore enforce the Commission's orders.


Much of our decision in this case turns on the distinction between two types of proceedings before the Commission. In a ratemaking proceeding, the Commission sets the maximum and minimum rates that a pipeline can charge its customers, essentially by determining the total cost of operation, adding a fair profit for the pipeline company, and then deciding on a fair allocation of the total costs among the pipeline's customers. The overriding policy concern in a ratemaking proceeding is to establish rates that require each customer to bear a fair and proportional share of the pipeline's costs. This case, however, does not involve ratemaking. Instead, this case involves the general terms and conditions under which Natural operates--specifically, the procedure by which it allocates available capacity on its pipeline among its customers. As we shall see, theinterests and policy goals at issue in such a proceeding differ markedly from those involved in a ratemaking case.


Before we proceed to the specific disputes before us, a bit of background on the basic concepts at issue is in order. First, a few of the issues that commonly arise in ratemaking cases are relevant here. Natural, like most other pipeline companies, sells the gas it transports to various types of customers, including industrial users, large intrastate gas companies, and the Municipalities, which in turn provide residential and small business gas service in their areas. The Municipalities are captive customers of Natural's pipeline because no other pipeline reaches their areas. Many of Natural's other customers, however, have a choice between using Natural and using competing suppliers. Because the customers' capacity needs vary widely and because some but not all of the customers are captive, determining each customer's fair share of the pipeline's fixed costs can be difficult.

Since the 1980s, the Commission has had a general policy of encouraging competition among natural gas pipelines. In furtherance of this general goal, the Commission a decade ago undertook a rulemaking procedure that resulted in Or der 636, which is its latest major policy statement on how it will set rates for interstate pipelines. See Order No. 636, FERC para. 30,939 (1992). Pipelines generally offer two basic types of service. First, pipelines sell "firm capacity," which represents a guarantee that a certain amount of gas will be available for the buyer. Second, pipelines sell interruptible service, which allows customers to buy additional gas as long as capacity is actually available on the pipeline, but does not guarantee capacity availability. In Order 636, the Commission determined that pipelines should price their services based on two-part rates, so that each customer would pay both a "reservation charge" based on the amount of firm capacity committed to the customer and a usage charge based on the actual amount of gas the customer consumed. The Commission believed this two-part structure would aid competition between pipelines, because it would reduce price distortions inherent in a one-part rate based only on consumption.

When the Commission issued Order 636, however, it realized that switching from one-part rates to two-part rates could shift some costs from large industrial users to smaller users. In general, users such as the Municipalities, which serve primarily residential customers, have a high seasonal variation between their peak demand and their average usage. Because these users need a firm capacity commitment that will cover their peak demand, they often are not using their entire firm capacity. Industrial users, on the other hand, tend to have fairly constant rates of usage, so that their average usage is much closer to their peak demand. In the industry, a customer's average usage divided by its peak demand is called that customer's "load factor." A low load factor indicates a wide disparity between average and peak usage, while a high load factor indicates a fairly constant rate of usage. Separating out reservation (i.e. firm) charges from usage charges will generally increase the total bill for customers with low load factors and decrease the total bill for high-load-factor customers.

In order to mitigate this effect on small, low-load-factor consumers, the Commission in Order 636 allowed pipelines to continue using one-part rates for these customers. These one-part rates were calculated in a way that would incorporate both the customer's portion of the pipeline's fixed costs and the customer's actual usage into a single rate that would be applied to the volume of gas the customer consumed. The rates were not intended to reflect the exact amount the small customers would have paid under the two-part rates. Rather, in calculating the one-part rates, the pipelines and the Commission imputed to the small customers a load factor higher than their actual load factors. The combined effect of these adjustments was to charge the small customers a smaller percentage of the pipeline's fixed costs than they would have paid under the two-part rate. The Municipalities buy gas from Natural under one of these special one-part rates.

As we have noted, the ratemaking process results in a range of rates that a pipeline is allowed to charge. The important question in this case relates to the next stage of the process: how the pipelines determine the rate they will charge to individual customers. The rate schedules the Commission sets for a pipeline can vary according to geography, and most pipelines also have different rate schedules for different types of service or classes of customers. Each of these rate schedules incorporates a set minimum and maximum rate. Most pipelines are free to charge a customer any rate between the minimum and the maximum set for that customer's area and class of service, with the qualification that pipelines may not unduly discriminate between similarly situated customers. See 15 U.S.C. sec. 717c(b).

Despite the rule against unreasonable discrimination, pipelines are generally allowed to offer discount rates (below the maximum rate but above the minimum) to attract customers in competitive markets. See, e.g., 18 C.F.R. sec. 284.10(c)(5). The Commission believes that allowing discount rates is good for end-users in competitive markets, because it drives down prices, and that allowing discount rates is also good for all customers on a pipeline, even for those who are not in competitive markets, because discount rates can prevent the pipeline from losing business to other pipelines or to other types of energy. More business on the pipeline, the Commission reasons, means each customer pays a smaller percentage of the pipeline's fixed costs. For these reasons, the fact that one customer receives a discount to meet market competition while another customer, in a captive market, does not, is not ...

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