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Petro Star Inc. v. Federal Energy Regulatory Commission

United States Court of Appeals, District of Columbia Circuit

August 30, 2016

Petro Star Inc., Petitioner
Federal Energy Regulatory Commission and United States of America, Respondents State of Alaska, et al., Intervenors

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

          Eric F. Citron argued the cause for petitioner. With him on the briefs was Thomas C. Goldstein. Michael Diamond, Jonathan D. Simon, Angela K. Speight, and Lawrence G. Acker entered appearances.

          Bradley S. Lui, Joseph R. Palmore, Marc A. Hearron, and Craig W. Richards, Attorney General, Office of the Attorney General for the State of Alaska, were on the briefs for intervenor State of Alaska in support of petitioner.

          Susanna Y. Chu, Attorney, Federal Energy Regulatory Commission, argued the cause for respondents. With her on the brief were William J. Baer, Assistant Attorney General, Robert B. Nicholson and Robert J. Wiggers, Attorneys, and Robert H. Solomon, Solicitor, Federal Energy Regulatory Commission.

          James F. Bendernagel, Jr. argued the cause for intervenors. With him on the brief were Eugene R. Elrod, Robin O. Brena, Kelly M. Helmbrecht, Jeffrey G. DiSciullo, Andrew T. Swers, Matthew W.S. Estes, John A. Donovan, Glenn S. Benson, Barbara S. Jost, Dean H. Lefler, and Deborah R. Repman.

          Before: Tatel and Srinivasan, Circuit Judges, and Edwards, Senior Circuit Judge.



         The Trans Alaska Pipeline System is the sole means of transporting oil from Alaska's North Slope to the shipping terminal at Valdez, Alaska, roughly 800 miles to the south. Oil companies deposit crude oil extracted from their fields on the North Slope into the pipeline at its northern point. Although the companies' crude oil deposits differ in ways that affect their respective market values, the deposits necessarily become commingled in the pipeline. At the southern end of the pipeline in Valdez, the oil companies receive the same proportion of oil they initially contributed to the common stream. Because of the commingling, however, the companies generally will not receive the same quality of oil at Valdez that they initially delivered into the pipeline at the North Slope.

         Absent monetary adjustments to compensate for the difference in quality between inputs and outputs, companies depositing relatively higher-value crude oil into the pipeline would unfairly suffer a financial loss, while those depositing lower-value crudes would secure a financial windfall. To avoid that result, the Federal Energy Regulatory Commission oversees a mechanism for calibrating payments known as the Quality Bank. The Quality Bank assigns each company's crude oil a value based on the quality of its components or "cuts."

         This case concerns the formula used to value one of those cuts, called Resid. In 2013, the Commission initiated an investigation into Resid pricing. During this investigation, Petro Star argued that the Quality Bank methodology undervalues Resid in an unjust and unreasonable manner. The Commission rejected Petro Star's argument and declined to change the Resid valuation formula.

         We conclude that the Commission failed to respond meaningfully to evidence presented by Petro Star, rendering its decision arbitrary and capricious, and that Petro Star's purported failure to provide a viable methodology does not provide an independent ground for the Commission's decision. We thus grant the petition for review and remand for the Commission to reconsider the methodology used to value Resid or to provide a more reasoned explanation for its approach. We also find that Alaska lacks standing to intervene in this matter.



         Since 1984, the Federal Energy Regulatory Commission (FERC) has relied upon the Quality Bank to calculate monetary adjustments between oil companies that use the Trans Alaska Pipeline System (TAPS) to transport oil in a commingled stream. See Trans Alaska Pipeline System, 29 FERC ¶ 61, 123 (1984). The Quality Bank "charges shippers of relatively low-quality petroleum who benefit from commingling and distributes the proceeds to shippers of higher quality petroleum whose product is degraded by commingling." OXY USA, Inc. v. FERC, 6 F.3d 679, 684-85 (D.C. Cir. 1995). The Quality Bank is thus a zero-sum transfer mechanism: the goal is to "place each [company] in the same economic position it would enjoy if it received the same petroleum at Valdez that it delivered to [the pipeline] on the North Slope." Id.

         Since 1993, the Quality Bank has used the "distillation method" to calculate the monetary adjustments. See Trans Alaska Pipeline System, 65 FERC ¶ 61, 277, 62, 282 (1993). Distillation is the initial step in the oil refining process. It involves the separation of crude oil into different components or "cuts" through heating and boiling. From lightest to heaviest, the nine Quality Bank cuts are: (1) Propane, (2) Isobutane, (3) Normal Butane, (4) Light Straight Run, (5) Naphtha, (6) Light Distillate, (7) Heavy Distillate, (8) Vacuum Gas Oil, and (9) Resid. The heavier cuts at the end of the list are of lower quality.

         The Quality Bank assigns a value to each of the nine distillation cuts and determines how much of each cut makes up the crude oil streams deposited by an oil company into the TAPS. It then calculates the value of each company's crude oil contribution based on the volume-weighted value of its component cuts. The same formula determines the value of the commingled common stream.

         Before calibrating payments, the Quality Bank must also account for another variable (in addition to commingling): the impact of refineries connected to the pipeline along the route to Valdez. Those refineries divert portions of the common stream, refining the oil for their own purposes and processing other petroleum products out of the stream. The refiners then return the remaining, unused oil to the pipeline. Because the oil returned generally contains a higher percentage of lower-quality cuts (like Resid) than the common stream withdrawn by the refiners, the refining process reduces the value of the common stream.

         Accordingly, at Valdez, the Quality Bank again calculates the value of the common stream. Oil companies make payments into or receive payments from the Quality Bank based on the difference in value between the oil they deliver into the pipeline and the common stream they ultimately receive at Valdez. In order to account for the impact of the refiners, the Quality Bank "compares the value of the diverted portion of the common stream to that of the [refinery] return stream, charging the refiners and compensating other [companies] for the reduction in the common stream's value caused by the removal of the refinery products." OXY, 64 F.3d at 685. In keeping with the zero-sum methodology, the charge paid by refiners is distributed to oil companies who receive lower-quality oil at Valdez than that which they initially contributed.


         Because payments under the Quality Bank scheme are based on the difference in value between different oil streams, the proper functioning of the Quality Bank depends on assigning accurate relative values to the nine distillation cuts. "FERC must accurately value all cuts-not merely some or most of them-or it must overvalue or undervalue all cuts to approximately the same degree." Id. at 693.

         Under its current approach, the Quality Bank aims to achieve that goal by assigning a value to each cut reflecting its actual market price as closely as possible. Six of the cuts can be sold following distillation without any additional processing, and they thus have published market prices. The Quality Bank uses those prices to value the six "marketable" cuts. The published market prices for those six cuts are assumed to include the refining cost of producing the cut- i.e., distilling the individual cut out of commingled oil.

         The remaining three cuts-Light Distillate, Heavy Distillate, and Resid-cannot be sold without additional processing following distillation. Those "pre-market" cuts thus have no published market prices. The current Quality Bank methodology requires the Commission to set a value for pre-market cuts, like marketable cuts, after simple distillation but prior to any further processing. See id. at 694. Because there is no market for those three cuts without additional processing, however, there are no published market prices. In order to determine the hypothetical market price of those cuts, the Quality Bank starts with the published market prices for finished products that could be developed from the ...

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