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BP West Coast Products, LLC v. Federal Energy Regulatory Commission and United States of America [Part I]

By:
Date:
Location: Court of Appeals, DC Circuit


BP West Coast Products, LLC v. Federal Energy Regulatory Commission and United States of America

Part I of III

R. Gordon Gooch argued the cause for West Line Shippers. With him on the briefs were Elisabeth R. Myers, D. Jane Drennan, George L. Weber, Marcus W. Sisk, Jr., Steven A. Adducci, and Richard E. Powers, Jr.

Steven H. Brose argued the cause for petitioner SFPP, L.P. With him on the briefs were Timothy M. Walsh, Daniel J. Poynor, Alice E. Loughran, Albert S. Tabor, Jr., and Charles F. Caldwell.

Thomas J. Eastment argued the cause for East Line Shippers on Cost Allocation Issues. With him on the briefs were Joshua B. Frank, Michael J. Manning, and Glenn S.
Benson.

Thomas J. Eastment, Joshua B. Frank, Michael J. Manning, George L. Weber, R. Gordon Gooch, Elisabeth R. Myers, Richard E. Powers, Jr., Steven A. Adducci, and
Marcus W. Sisk, Jr. were on the brief for petitioners and intervenors supporting petitioners on Rate and Reparations Issues.

Dennis Lane, Solicitor, Federal Energy Regulatory Commission, and Lona T. Perry, Attorney, argued the causes for respondents. With them on the brief were Robert H. Pate III, Assistant Attorney General, U.S. Department of Justice, John J. Powers, III and Robert J. Wiggers, Attorneys, Cynthia A. Marlette, General Counsel, Federal Energy Regulatory Commission. Jay L. Witkin, Solicitor, and Susan J. Court, Special Counsel, entered appearances.

Thomas J. Eastment, Joshua B. Frank, Michael J. Manning, George L. Weber, R. Gordon Gooch, Elisabeth R. Myers, Richard E. Powers, Jr., Steven A. Adducci, and
Marcus W. Sisk, Jr. were on the brief of Shipper intervenors in support of respondents.

Steven H. Brose, Timothy M. Walsh, Daniel J. Poynor, Alice E. Loughran, Albert S. Tabor, Jr. and Charles F. Caldwell were on the brief of SFPP, L.P. as intervenor in support of respondents.

Before: SENTELLE, ROGERS, and ROBERTS, Circuit Judges.

Opinion for the Court filed PER CURIAM.

INTRODUCTION

The consolidated petitions before us seek review of four opinions of the Federal Energy Regulatory Commission (''FERC'' or ''the Commission''):
1. SFPP, L.P., Opinion No. 435, 86 FERC ¶ 61,022 (1999) (''Opinion No. 435'');
2. SFPP, L.P., Opinion No. 435-A, 91 FERC ¶ 61,135 (2000) (''Opinion No. 435-A'');
3. SFPP, L.P., Opinion No. 435-B, 96 FERC ¶ 61,281 (2000) (''Opinion No. 435-B''); and
4. SFPP, L.P., 97 FERC ¶ 61,138 (2001) (''Clarification and Rehearing Order'').

In these opinions FERC considered the tariffs of SFPP, L.P., and complaints and other filings by shipper customers of SFPP. SFPP, L.P., both a petitioner and an intervenorrespondent in the consolidated dockets, operates pipelines that transport petroleum products in Texas, New Mexico, Arizona, California, Nevada, and Oregon. SFPP's operation includes a West Line and an East Line. The West Line consists of pipelines extending from Watson Station in Los Angeles, California, into Arizona to Phoenix and Tucson, and connects at Colton, California, with another pipeline system extending to Las Vegas. SFPP's East Line consists of pipelines from El Paso, Texas to Tucson and Phoenix. The orders under review consider, set, and otherwise govern rates on both lines. We consider three separate sets of petitions: the petition of SFPP, L.P.; the petition of the West Line Shippers (''WLS''); and the petition of the East Line Shippers (''ELS''). Petitioners and Intervenors include the following: BP West Coast Products LLC (''BP WCP''; formerly ARCO Products Company); Chevron Products Company (''Chevron''; including the former Texaco Refining and Marketing, Inc.); ConocoPhillips Company (''ConocoPhillips''); ExxonMobil Oil Corporation (''ExxonMobil''; formerly Mobil Oil Corporation); Navajo Refining Company, L.P. (''Navajo''); Western Refining Company, L.P. (''Western''); Ultramar Inc. (''Ultramar''); Valero Energy Corporation (''VEC''); Valero Marketing and Supply Company (''Valero''); and SFPP, L.P. (''SFPP'').

The administrative proceedings before FERC began with tariff filings by SFPP for both East and West Lines. The lengthy, complex, and convoluted proceedings that followed included complaints and/or protests filed by shippers on the two lines, as well as investigation into SFPP's tariff filings by FERC's Oil Pipeline Board. The issues are further complicated by novelty in that this is the first oil pipeline case in which the ''changed circumstances'' standard of the Energy Policy Act of 1992 (''EPAct'') has arisen for litigation. Energy Policy Act of 1992, Pub. L. No. 102-486, 106 Stat. 2776 (codified as 42 U.S.C. §§ 1320-556 (2003)). While we will not detail the administrative proceedings before FERC's administrative law judge and the full Commission as we discuss them at length in the analyses that follow, we note that issues presented for review include, among other things, the important question of application of the grandfathering principle under the new EPAct, the allocation of litigation costs between the East and West Lines, tax pass-through problems involving non-taxed subsidiaries of taxable entities, the payment of reparations after a finding of unjust or unreasonable rates, and the correct determination of capital structure to determine a starting rate base. The reader is duly warned.

For reasons set forth more fully below, we are able to affirm many of FERC's answers to specific issues, but because we find error in several fundamental areas, we order the decisions under review vacated and remand the matter for further proceedings consistent with this opinion.

I. The West Line

A. Grandfathering of Rates under the EPAct
Section 1803 of the EPAct limits the ability of shippers to challenge pipeline rates in effect at the time of the enactment of the EPAct. Section 1803 provides that any oil pipeline rate that was ''in effect'' for a full year before the EPAct's enactment on October 24, 1992, and was not subject to ''protest, investigation, or complaint'' during that 365-day period, is ''deemed to be just and reasonable.'' EPAct § 1803(a)(1). These ''grandfathered'' rates are categorically immune from challenge in a complaint proceeding under Section 13 of the Interstate Commerce Act (''ICA''), 49 U.S.C. app. § 13(1) (1988) (repealed), except when:

(1) evidence is presented to the Commission which establishes that a substantial change has occurred after the date of the enactment of this Act-
(A) in the economic circumstances of the oil pipeline which were a basis for the rate; or
(B) in the nature of the services provided which were a basis for the rate; or

(2) the person filing the complaint was under a contractual prohibition against the filing of a complaint which was in effect on the date of enactment of this Act....

Id. § 1803(b). In the post-EPAct world, the analysis of a pipeline rate challenge thus proceeds in two steps: first, FERC determines whether the rate in question is grandfathered; if it is, FERC then asks whether the rate falls within either of the exceptions outlined in Section 1803(b). The Commission may not alter a grandfathered rate that does not fall within an exception.

B. Grandfathering of West Line Rates
The WLS contend that none of the West Line rates are grandfathered, and further argue that even if the rates are grandfathered, their challenges fall within the exceptions set out in Section 1803(b). We examine each of these contentions in turn.

1. Rate ''In Effect'' for One Year
To be eligible for grandfathering, a pipeline rate must have been ''in effect for the 365-day period ending on the date of the enactment of this Act [October 24, 1992].'' EPAct § 1803(a)(1). Thus, to be grandfathered, a rate must have been ''in effect'' on October 25, 1991, and have remained in effect at least until the enactment of the EPAct.

The WLS do not contest this element with regard to the bulk of the West Line rates. Nor could they; the West Line rates became effective in 1989 pursuant to a settlement terminating a 1985 rate proceeding. See Opinion No. 435, 86 FERC at 61,057; Southern Pac. Pipe Lines, Inc., 45 FERC ¶ 61,242 (1988) (order approving settlement). The WLS do, however, challenge the eligibility for grandfathering of certain improvements to the West Line made after October 1991.

a. East Hynes Origination Point
In July 1992, SFPP made revisions to its Tariffs Nos. 15, 16, and 17 to add a new origination point on its West Line -the East Hynes station in Los Angeles County, California -and to add a rate for shipping services from that new origination point to Arizona. The rate came into effect in October 1992. The rate, however, was not new; it was the same as the rates from SFPP's two other source points in the Los Angeles area. Examining this situation, the Commission concluded that the rates from the East Hynes station qualified for grandfathering because the July 1992 ''filing did not involve a change to a rate or service SFPP was providing at the time the EPAct was enacted.'' Opinion No. 435, 86 FERC at 61,063. SFPP's revision to its tariffs ''only added another tap within an existing rate cluster.... No rate ... was changed, and there was no change in the products transported or the services provided.'' Id.

The question essentially boils down to the Commission's interpretation of the term ''rate'' in Section 1803. As this is the first case to be litigated under the new standards of the EPAct, we must consider the level of deference - if any -to which FERC's interpretations of the EPAct are entitled. It is true, as some petitioners have noted, that the EPAct does not expressly confer rulemaking authority on the Commission.

Section 1803 of the EPAct does, though, clearly contemplate that the Commission will enforce the terms and conditions of the statute through formal adjudications. See EPAct § 1803(b) (referencing ''proceeding instituted as a result of a complaint''). When Congress authorizes an agency to adjudicate complaints arising under a statute, the agency's interpretations of that statute announced in the adjudications are generally entitled to Chevron deference. See United States v. Mead Corp., 533 U.S. 218, 229 (2001) (''[A] very good indicator of delegation meriting Chevron treatment [is] express congressional authorizations to engage in the process of rulemaking or adjudication that produces regulations or rulings for which deference is claimed.''); see also Trans Union Corp. v. FTC, 81 F.3d 228, 230 (D.C. Cir. 1996) (''[W]e have expressly held that Chevron deference extends to interpretations reached in adjudications as much as to ones reached in a rulemaking.'' (citing Midtec Paper Corp. v. United States, 857 F.2d 1487, 1497 (D.C. Cir. 1988))). We see no reason to accord any less deference to FERC's interpretations of the EPAct.

Under the familiar Chevron two-part inquiry, we first ask whether Congress has directly spoken to ''the precise question at issue.'' Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842 (1984). If it has, that is the end of the inquiry; we ''must give effect to the unambiguously expressed intent of Congress.'' Id. at 843. If Congress has not spoken so precisely, though, we reach the second step, and will defer to any reasonable interpretation of the statute by the agency. Id. Not surprisingly, Congress did not have occasion to confront the specific question of whether the addition of a new source point on an existing rate cluster would constitute a new rate. We thus proceed to the second step of Chevron, and inquire whether the Commission's construction is a reasonable one. It is. It is certainly permissible to conclude that the addition of a tap to an existing rate structure, completed without any change in the existing shipping rates, does not constitute a new rate. To employ an analogy that we find helpful, in adding the East Hynes station to its West Line, SFPP merely added an on-ramp to its existing expressway. We think that the Commission's conclusion reflects a permissible interpretation of the statute and thus affirm its holding that the rate for shipping from East Hynes is eligible for grandfathering.

b. Watson Station Enhancement Facility
Watson is the primary origin point for West Line shipments to Phoenix and Tucson. In 1989, SFPP notified its shippers that, starting in 1991, the minimum pumping rate and pressure from Watson Station would increase. SFPP gave its shippers the option of providing their own pressurization facilities by a date certain, or using, for a surcharge, a facility built by SFPP. By late 1991, most of SFPP's shippers had contracted to use SFPP's new enhancement facility, and on November 1, 1991, SFPP initiated the enhancement services. See Opinion No. 435, 86 FERC at 61,074; In re SFPP, L.P., 80 FERC ¶ 63,014, 65,156 & n.405 (1997) (''ALJ Decision''). SFPP, though, never filed those contracts with the Commission, because it believed its enhancement services were beyond the reach of FERC's jurisdiction. See Opinion No. 435, 86 FERC at 61,074. The Commission, however, concluded otherwise and ordered SFPP ''to file a rate equal to the historic charge in the shipper contracts.'' Id. at 61,076.

Despite FERC's concession that ''Section 1803 only addresses rates that were on file with the Commission,'' Opinion No. 435-A, 91 FERC at 61,502, and its acknowledgment that the enhancement rates had never before been filed, FERC nevertheless concluded that, because ''the charges for the Watson Station facilities are part of enforceable contracts,'' the rates were ''the equivalent of a lawful, effective rate.'' Opinion No. 435, 86 FERC at 61,076. The Commission reasoned that because all the Watson enhancement rate contract charges ''were in effect before October 24, 1992,'' the shippers challenging those charges had to establish ''substantially changed circumstances.'' Id. at 61,075, 61,076. The fact that no statute permitted a shipper to challenge an unfiled rate before the Commission did not matter. For ''if [the rates] had been filed …, it is clear that they would have been grandfathered because there was no challenge to them during the 12 months proceeding [sic] the enactment of the Act.'' Opinion No. 435-A, 91 FERC at 61,502.

We find the Commission's reasoning on this point to be fundamentally flawed, and vacate this portion of its order. First, if FERC is indeed correct in its interpretation that Section 1803 applies only to filed rates, the Commission may not grandfather unfilled rates on the assumption that if the rates had been filed, no challenge would have been brought. The Commission may not regulate rates as if they existed in a world that never was. It must take the rates as it finds them, and here, FERC found them unfiled. If FERC interprets Section 1803 to apply only to filed rates, then it may not extend the benefits of that provision to unfiled rates based on speculation about what would have happened had they in fact been filed. Invoking the so-called ''filed rate'' doctrine - which ''forbids a regulated entity to charge rates for its services other than those properly filed with the appropriate federal regulatory authority,'' Arkansas Louisiana Gas Co. v. Hall, 453 U.S. 571, 577 (1981) - the WLS argue that the pipeline's failure to file a Watson enhancement rate tariff with the Commission precludes the Commission's treatment of the unfiled rate as grandfathered. Our disposition of this issue - which is based on the Commission's flawed reasoning, and not a flawed conclusion - does not require us to decide definitively whether Section 1803 of the EPAct applies only to filed rates.

Second, Opinion No. 435 suggests that any rate agreed upon before the EPAct's enactment on October 24, 1992 could be grandfathered. See Opinion No. 435, 86 FERC at 61,075 (''The clear purpose of the EPAct's grandfathering provisions is to insulate pipelines from challenges to ... rates ... if those charges were in effect before October 24, 1992.''). Section 1803, though, allows grandfathering of only those rates that were in effect (and unchallenged) for at least 365 days prior to the date of enactment of EPAct. EPAct § 1803(a). Even if we assume as a general proposition that Section 1803 applies to unfiled rates, other statements sprinkled throughout Opinion No. 435 suggesting that some of the rates were contracted for after the 365-day window had closed would remain problematic. See Opinion No. 435, 86 FERC at 61,075 (''the contracts were entered into voluntarily by the parties, mostly before the end of 1991''); id. (''all the relevant contracts were required to be, and had been, executed well before June 1, 1992''). If the Commission allows Section 1803 to apply to unfiled rates, those rates, to be grandfathered, must be in effect for at least 365 days prior to the EPAct's enactment. The reasoning of Opinion No. 435 gives us no comfort that this was the case. Without such an assurance, we cannot affirm the Commission's conclusion that the Watson enhancement rate is subject to grandfathering.

c. Turbine Fuel Service
In December 1992, SFPP filed its Tariff No. 18, proposing the transportation on its West Line of a new product, turbine fuel (also known as jet fuel). The rate for the new turbine fuel service was equal to other grandfathered rates in Tariff No. 18 that had been in effect since 1989. The shippers argue that because the turbine fuel rate was not initiated until 1992 - long after the grandfathering window had closed (indeed, after the EPAct had been enacted) - the rate cannot be grandfathered. The Commission does not contest this; it recognized that the turbine fuel service was new, and therefore could not be grandfathered. Id. at 61,063. It nevertheless foreclosed further challenge to the turbine fuel rate, concluding, as a substantive matter, that the turbine fuel rate was just and reasonable. Id. at 61,078. The Commission reasoned that because the turbine fuel rate was equal to other Tariff No. 18 rates that had been deemed just and reasonable, ''there is no basis for providing a different rate level for turbine fuel at this time.'' Id.

That analysis falls far short of the mark. The fact that the Tariff No. 18 rates were deemed just and reasonable does not mean that the rates actually are just and reasonable. Perhaps if the Commission had undertaken a substantive review of the reasonableness of the West Line rates listed in Tariff No. 18, then its conclusion that the turbine fuel rate is reasonable - because it is equal to those rates - might be supportable. But here, the West Line rates had been ''deemed just and reasonable'' by operation of law - solely because they had persisted without challenge for one year prior to the enactment of the EPAct. The turbine fuel rate, not itself eligible for grandfathering, cannot simply piggyback on the grandfathered status of other rates. The Commission's contrary conclusion reflects a fundamental misapprehension of the nature and purpose of the grandfathering provisions of the EPAct. The requirements for grandfathering - the rate must be in effect and not subject to challenge for the year prior to the EPAct's enactment - are not proxies for actual reasonableness. Those requirements instead operate principally as a means to constrain litigation over pre-EPAct pipeline rates. The fact that the turbine fuel rate is equal to other Tariff No. 18 rates thus says nothing about that turbine fuel rate's substantive reasonableness. The Commission's declaration that, as a substantive matter, the turbine fuel rate was just and reasonable - a conclusion reached without the benefit of any substantive review of the underlying cost of service and rate of return - was an arbitrary and capricious exercise of the Commission's authority and cannot stand.

2. Complaints, Protests, or Investigations
While the WLS concede that most of the West Line rates were in effect for the required year prior to the EPAct's enactment, they contend that no West Line rate is eligible for grandfathering because each of them was ''subject to protest, investigation, or complaint'' during that same one-year window. In support of their argument, the WLS point principally to protests filed by shippers El Paso Refinery, L.P. (''EPR'') and Chevron, and an investigation opened by the Oil Pipeline Board (''OPB'') pursuant to those protests. In October 1993, the Commission rejected these arguments, holding that the West Line rates were ''presumed just and reasonable'' and, therefore, a successful challenge had to ''prove the existence of the extraordinary circumstances set forth in section 1803 of the Energy Policy Act.'' SFPP, L.P., 65 FERC ¶ 61,028, 61,378 (1993); see also SFPP, L.P., 66 FERC ¶ 61,210 (1994) (denying rehearing).

What does it mean for ''the rate'' to be ''subject to protest, investigation, or complaint''? EPAct § 1803(a). The WLS maintain that a general attack on a tariff is sufficient to challenge all the rates and activities described therein. See WLS Br. 14 (''a protest of a tariff filing did subject all rates in the tariff to review''). The Commission, though, in ruling that the shippers' pleadings did not challenge the West Line rates, interpreted this clause of Section 1803 to require that the protest, investigation, or complaint specifically challenge the reasonableness of the rate in question. See SFPP, L.P., 65 FERC at 61,378 n.14 (while Chevron's protest did include ''a request for suspension of revised tariff no. 16, which contains ... only west line rates,'' the protest ''pled no concerns with the existing rates set forth in this tariff''). The WLS object to FERC's interpretation on a general level, arguing that it grafts onto the statute a particularity requirement not found in its text. Here, too, we find the Chevron deference that we must accord to the agency's interpretation to be dispositive. Because we cannot say that the Commission's adjudicative interpretation is an impermissible reading of the statute - the statute provides, after all, that it is ''the rate'' (not the tariff) that must be subject to ''protest, investigation, or complaint'' - we defer to the Commission's interpretation. And with that interpretation in mind, we turn to the particular contentions of the WLS.

a. West Line Shipper Protests
On September 4, 1992, EPR, an East Line shipper, filed a protest to SFPP's Tariffs Nos. 15 and 16, and followed with three supplements that same month, one of which requested the suspension of Tariffs Nos. 15 and 16 and that the Oil Pipeline Board (''OPB'' or ''Board'') open an investigation into the same. That same month, Chevron, which shipped on both the East and the West Line, filed a protest to Tariffs Nos. 15 and 16, also calling for their suspension and investigation.

The WLS contend that because EPR's and Chevron's protests challenged Tariff No. 16 - which listed only West Line rates - those protests had challenged the West Line rates. The Commission rejected this contention, looking beyond the relief requested by the protests to the shippers' substantive arguments for that relief. Examining the relevant pleadings, the Commission concluded that the protesting shippers ''raised concerns with only three matters - flow reversal, prorationing, and existing rates on SFPP's east line.'' Id., 65 FERC at 61,378. As ''[n]othing within the four corners of these protests indicate[d] a concern with the existing rates on SFPP's west line,'' the Commission rejected those protests as a basis for denying grandfathered status to the West Line rates. Id.

Our examination of the relevant pleadings convinces us that the Commission correctly concluded that EPR and Chevron did not challenge the reasonableness of the West Line rates in their protests to SFPP's Tariffs No. 15 and 16. The EPR and Chevron pleadings scarcely mention the West Line at all, let alone mount an attack on the reasonableness of its rates. The only mention of the West Line rates is found in EPR's first supplement to its protest: ''Santa Fe's proposed Tariff Nos. 15 and 16 retain Santa Fe's previously effective rates for service on its East Line and West Line systems, but represent the first tariffs under which product will flow in a reversed direction on the 'Six-Inch Line' portion of the East Line system from Phoenix to Tucson.'' In re SFPP, L.P., Supplement to Protest of El Paso Refinery, L.P., 1-2 (Sept. 9, 1992) (emphasis omitted). This statement obviously concerns the flow reversal on the Phoenix-Tucson pipe - not the reasonableness of West Line rates. Chevron's protest, as the Commission noted, ''simply fails to contain any statement indicating a challenge to existing rates on SFPP's west line.'' SFPP, L.P., 65 FERC at 61,378. The Commission thus reasonably concluded that these protests by East Line shippers were insufficient to render the West Line rates ''subject to protest.'' EPAct § 1803(a).

b. Oil Pipeline Board Investigation
On September 29, 1992, in response to the protests filed by EPR and Chevron, the OPB, pursuant to its authority under Section 15(7) of the ICA, 49 U.S.C. app. § 15(7) (1988), opened an investigation of SFPP's rates listed in revised Tariffs Nos. 15, 16, and 17, suspended the tariffs for one day, and imposed refund obligations on SFPP. SFPP, L.P., 60 FERC ¶ 62,252 (1992).3 In April 1993, the Commission vacated the suspension orders and the refund obligations. SFPP, L.P., 63 FERC ¶ 61,014 (1993). Observing that the protests against the tariffs did not challenge any change in a listed rate or practice (such as the addition of the East Hynes origination point or the turbine fuel service), but rather attacked only existing, unchanged rates and policies (the East Line rates and the flow reversal and prorationing practices), the Commission concluded that the OPB lacked authority to open an investigation under Section 15(7) of the ICA, which permits the Board only to investigate newly filed rates or practices. Id. at 61,125 (''It was not appropriate for the Board to suspend the proposed tariff changes and initiate an investigation under section 15(7) when the focus of the protest was existing, unchanged, portions of the tariff.''); 49 U.S.C. app. § 15(7) (1988) (limiting application to ''any schedule stating any new individual or joint rate ... or charge'') (emphasis added). The Commission held that the case should continue as a complaint proceeding before the Commission under ICA Section 13(1), id. § 13(1), and be limited to the issues properly raised by EPR, Chevron, and the intervenors. SFPP, L.P., 63 FERC at 61,125. But as the Board ''does not possess delegated authority to order initiation of a section 13(1) proceeding,'' the Commission vacated the tariff suspensions and the refund obligations. Id. The Commission eventually terminated the Board's suspension docket entirely, stating that matters would proceed only in the instant complaint docket. SFPP, L.P., 63 FERC ¶ 61,275 (1993). And based on its conclusion that the OPB's investigation had been unlawfully initiated, the Commission determined that SFPP's West Line rates were not ''subject to investigation'' for grandfathering purposes. SFPP, L.P., 66 FERC at 61,480.

Parsing with care the words of the Commission's countermand of the Board, the WLS argue that the Commission never formally vacated the Board's investigation of the SFPP's Tariffs Nos. 15-18, and thus the rates within those tariffs - including the West Line rates - remained subject to investigation in 1992, precluding grandfathered status. We, like the Commission, are unpersuaded. First, while the WLS are quite right that the Commission did not, in its ordering clauses, vacate the Board's investigation, the shippers' interpretation of the Commission's action runs head-on into the Commission's statement that it was inappropriate ''to suspend the proposed tariff changes and initiate an investigation under section 15(7).'' SFPP, L.P., 63 FERC at 61,125 (emphasis added). Moreover, the shippers offer no explanation how such an investigation by the Board could proceed in light of the Commission's order that the case would continue as a Section 13(1) complaint. But even if common sense bowed to formalism and the Board's investigation remained technically open, the scope of the Board's investigation -lawful only insofar as it enforces ICA Section 15(7) - must be limited to newly tariffed rates or practices. See 49 U.S.C. app. § 15(7) (1988). As SFPP's tariffs made no changes to the West Line rates (except to add the Watson enhancement and the turbine fuel services), the Board could not have investigated the West Line rates.

We therefore conclude that FERC reasonably determined that the West Line rates (except, as noted above, for the Watson Station enhancement and turbine fuel rates) were grandfathered and therefore deemed just and reasonable under the terms of Section 1803(a) of the EPAct.

C. Exceptions to Grandfathering
We turn now to the WLS' contention that the rates fall within the exceptions outlined in Section 1803(b) and therefore are still open to challenge under the ICA. Section 1803(b) permits a shipper to challenge a grandfathered rate if the shipper establishes either that (1) there has been a ''substantial change'' in the economic circumstances or services provided that ''were a basis for the rate''; or (2) ''the person filing the complaint'' was under ''a contractual prohibition against the filing of a complaint'' on the date of the enactment of the EPAct. EPAct § 1803(b). The complaining shipper bears the burden of proving the existence of one of the circumstances triggering an exception. The Commission concluded that the WLS had not met either requirement. See SFPP, L.P., 68 FERC ¶ 61,105, 61,581 (1994) (contractual prohibition); Opinion No. 435, 86 FERC at 61,064-71 (changed circumstances). The shippers were therefore barred by the EPAct from challenging the grandfathered West Line rates. The WLS appeal both rulings.

1. Substantially Changed Circumstances
Before the ALJ and the Commission, the WLS argued that there were five circumstances that had substantially changed so as to permit a challenge to the grandfathered West Line rates, including increased throughput on the West Line and the impact of the Commission's Lakehead decisions on SFPP's income tax cost allocation. The ALJ rejected all the substantial change arguments. See ALJ Decision, 80 FERC at 65,192-96. Concerning the claim based on throughput, the ALJ concluded that the evidence of a forty-percent increase in throughput from EPAct's enactment in October 1992 to 1995 (the last year for which data was obtained), by itself, could not prove a change in economic circumstances. Id. at 65,194. Missing, according to the ALJ, was any evidence demonstrating that the increase in throughput produced higher revenues and profits for SFPP. Id.

The Commission affirmed the holdings of the ALJ on each of the WLS' claims of substantial change, see Opinion No. 435, 86 FERC at 61,064-71, but, with respect to the throughput claim, did so on somewhat different reasoning, see id. at 61,067-69. The Commission found that the ALJ had erred by measuring change from the date of enactment of the EPAct, and by using data generated after the filing of the shippers' complaint. Id. Determining whether there has been a substantial change in economic circumstances providing the basis for the rate, the Commission held, requires comparing (a) the period before the rate first became effective (the basis for the rate) with (b) the period starting on the date of enactment and ending on the date of the complaint. Id. The WLS' substantial change claim based on increased throughput failed because the shippers measured changed circumstances against the ''wrong base period'' and with post-complaint evidence. Id. at 61,069. To establish a substantial change, FERC held, the shippers should have compared the period before the West Line rates became effective in 1989 to the period between October 24, 1992 (EPAct's enactment) and August 7, 1993 (the date of Chevron's complaint).

The shippers contest neither the Commission's interpretation of the substantial change provision of EPAct, nor its conclusion that the shippers failed to demonstrate a substantial change under that standard. The WLS do, however, maintain that the Commission's ruling employed a ''newly articulated standard'' and that they are, therefore, entitled to a remand so that they may have an opportunity to litigate under the Commission's ''new'' evidentiary requirements. WLS Br. 23. We reject this contention.

Even before the Commission announced this interpretation, the correct points of comparison in a substantial change analysis were clear from the face of the statute. The statute requires a shipper to show a change in economic circumstances ''which were a basis for the rate.'' EPAct § 1803(b). As the Commission noted in its Opinion No. 435, this phrase could only mean ''the basis upon which the rate was last considered to be just and reasonable, either as a filed rate, a settlement rate, or one for which the Commission has made a legal determination.'' Opinion No. 435, 86 FERC at 61,068. Any other moment in time would lack ''correlation to the economic circumstances that were the basis of the rate at the time it was designed.'' Id.

The textual clues to the second point of comparison are perhaps less obvious but no less certain. The statute provides that ''[n]o person may file a complaint ... unless ... evidence is presented ... which establishes that a substantial change has occurred after the date of ... enactment.'' EPAct § 1803(b). From the ''after the date of enactment'' language we are given the earliest point at which a shipper may show a substantial change. The closing date for evidence is the day the complaint is filed; this conclusion follows from the language providing that no ''complaint'' may be filed unless ''evidence is presented'' with the complaint that demonstrates that a substantial change ''has occurred.'' As the Commission stated, ''[i]t is difficult to see how language that so explicitly uses the past tense could apply to evidence that would be developed at some indeterminate time after the complaint is filed.'' Opinion No. 435, 86 FERC at 61,069. Because the foregoing requirements of the statute are clear from its face, the shippers had adequate notice of the standard they were required to meet. See, e.g., Midtec Paper Corp., 857 F.2d 1487, 1510 (D.C. Cir. 1988) (rejecting petitioner's argument that it had inadequate notice specific evidence was required to support its complaint where the text of the regulations at issue ''clearly indicates'' that such evidence was to be considered).

The WLS also argue that the Commission erred in rejecting their argument that the Commission's decision in Lakehead Pipe Line Co., L.P., 71 FERC ¶ 61,338 (1995) (Lakehead), reh'g denied, 75 FERC ¶ 61,181 (1996) (''Lakehead II''), insofar as it changed the ability of limited partnerships like SFPP to include certain income tax allowances in their cost of service, represented a substantial change in SFPP's economic circumstances. The Commission reasoned that the mere existence of the Lakehead policy, without any showing how the application of that policy affects the economic basis for the rates, cannot constitute substantially changed circumstances. See Opinion No. 435, 86 FERC 61,070-71. In light of our conclusion below that aspects of the Commission's Lakehead policy are arbitrary and capricious, we think the best course is to remand this claim to the Commission for further consideration in light of our disposition in this case.

2. Contractual Prohibition
The WLS next contend that they may challenge the grandfathered West Line rates because they fit within the ''contractual prohibition'' exception. That exception allows a shipper to challenge a grandfathered rate when ''the person filing the complaint was under a contractual prohibition against the filing of a complaint which was in effect on the date of enactment of [the EPAct] and had been in effect prior to January 1, 1991.'' EPAct § 1803(b)(2). Navajo, as a part of an earlier settlement with SFPP, was subject to such a prohibition and thus was permitted to file a complaint against the West Line rates without demonstrating substantially changed circumstances. See SFPP, L.P., 67 FERC ¶ 61,089, 61,254 (1994). Navajo, however, reached another settlement with SFPP and withdrew its complaint against the pipeline. SFPP, L.P., 79 FERC ¶ 63,014 (1997). The Commission then terminated the Navajo complaint proceeding. SFPP, L.P., 80 FERC ¶ 61,088 (1997).

The WLS nevertheless argue that they, too, should not have to show substantially changed circumstances. First, they assert that Navajo's invocation of the contractual prohibition exception effectively vitiated the West Line rates' grandfathered status as to all complaining shippers. See WLS Br. 18 (''The 'grandfathered' status of the West Line rates ... was thus revoked.''). Alternatively, the WLS argue that because the ALJ conditioned Navajo's ''withdrawal of the complaint'' on ''not prejudic[ing] in any way the status and rights of any other participants in this proceeding,'' SFPP, L.P., 79 FERC at 65,176, the other complaining shippers should be able to pursue their complaint as if Navajo had not withdrawn - that is, without showing substantially changed circumstances. The Commission rejected both of these arguments. From the first, the Commission recognized that the contractual prohibition exception is party-specific. ''Because neither Chevron nor ARCO/Texaco was subject to a contractual bar [as was Navajo], it follows, under the plain meaning of the language of the statutory provision, that the complaints of Chevron and ARCO/Texaco [must show substantially changed circumstances].'' SFPP, L.P., 68 FERC at 61,581. As for the shippers' claim that they had been prejudiced by Navajo's withdrawal, the Commission concluded that the condition on Navajo's settlement applied only to ''the integrity of the record.'' Opinion No. 435, 86 FERC at 61,073.

We agree with the Commission. The language of Section 1803(b)(2) is quite obviously party-specific. EPAct § 1803(b)(2) (''the person filing the complaint was under a contractual prohibition'') (emphasis added). An interpretation, like that suggested by the WLS, that would allow other shippers to piggyback on the status of a contractually-prohibited shipper, conflicts not only with the plain language of the statute, but also with Section 1803's overarching purpose of limiting litigation over pre-EPAct rates. On the other hand, the Commission's interpretation - limiting the exception to those parties actually contractually prohibited from complaining - is entirely consistent with the statute and therefore reasonable. We also find no merit to the WLS' claim that they were somehow prejudiced by Navajo's settlement. After examining the relevant proceedings, see SFPP, L.P., 79 FERC at 65,176, we think it clear that the ALJ, in implicitly promising that Navajo's withdrawal would not ''prejudice ... the status and rights of any other participants in proceeding,'' was referring only to the evidence that Navajo had placed into the administrative record.

II. The East Line

SFPP's East Line rates were not grandfathered under § 1803 of the EPAct, as EPR, as an ELS, had challenged them in the same September 1992 complaint in which it had protested SFPP's flow-reversal on the six-inch line. They were therefore ''subject to protest, investigation, or complaint'' within the year prior to the EPAct's enactment. Navajo later filed its own complaint against the East Line rates, and the Commission proceeded under the ICA, which, in Section 15, empowers the Commission to set aside rates it finds ''unjust or unreasonable,'' and to ''determine and prescribe what will be the just and reasonable ... rates, fares or charges to be thereafter observed.'' 49 U.S.C. app. § 15(1) (1988). The ALJ evaluated SFPP's East Line rates pursuant to its cost of service regulations, 18 C.F.R. § 346.2 (2004), found them unjust and unreasonable, and proceeded to set new ones in their place. ALJ Decision, 80 FERC at 65,122-191. The Commission substantially affirmed the ALJ's determination in Opinion No. 435. 86 FERC at 61,084-111. Under the Commission's rate-of-return methodology, this involved determinations of SFPP's embedded capital costs, its yearly operating expenses, allowances for other costs, and its appropriate rate of return. See 18 C.F.R. § 346.2(c.).

The proceedings before the Commission were complex, and many of the issues it decided in setting new East Line rates (and in determining that the previous rates were unjust or unreasonable) have not been challenged. As relevant to our review, the parties dispute only four discrete issues regarding the Commission's East Line rate-setting: (1) the starting rate base to which SFPP was entitled; (2) what tax allowance, if any, should be factored into rates; (3) the proper means of recovery, if any, of SFPP's litigation expenses; and (4) the treatment of SFPP's claimed expenses for reconditioning portions of the East Line.

The court reviews the Commission's ratemaking decision to determine whether it was arbitrary and capricious, see Association of Oil Pipelines v. FERC, 83 F.3d 1424, 1431 (D.C. Cir. 1996) (''AOPL''), according special deference to the Commission's expertise, id. at 1431; see also In re Permian Basin Area Rate Cases, 390 U.S. 747, 790 (1968). The court thus examines the Commission's ratemaking decisions to determine whether the Commission has examined the relevant data and articulated a rational connection between the facts found and the choice made. AOPL, 83 F.3d at 1431. The Commission must ''cogently explain why it has exercised its discretion in [the] given manner.'' Exxon Corp. v. FERC, 206 F.3d 47, 54 (D.C. Cir. 2000) (quoting Motor Vehicle Mfrs. Ass'n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 48-49 (1983)).

A. Starting Rate Base
The Commission decided that to measure SFPP's overall investment upon which it is entitled to a return, SFPP should use its December 19, 1988 capital structure. Opinion No. 435-A, 86 FERC at 61,503-06. In assessing the value of a pipeline's invested capital, the Commission's approach -stemming from its opinion in Williams Pipeline Co., 31 FERC ¶ 61,377 (1985) (''Opinion No. 154-B'') - weighs equity and debt-financed capital investments made prior to 1985 differently, and SFPP contends that the Commission used the wrong historical ratio between the two in setting the starting rate base.

Some explanation of the ''starting rate base'' concept and its history is necessary. Prior to June 28, 1985, the rate base to be included in oil pipeline cost of service analysis was calculated under an Interstate Commerce Commission (''ICC'') valuation method, which combined elements of original and reproduction cost. In Farmers Union Central Exchange, Inc. v. FERC, 584 F.2d 408, 417-20 (D.C. Cir. 1978) (''Farmers I''), the court expressed concerns about the ICC's valuation methodology, particularly its tendency to overvalue assets so as to ''exceed[ ] investment by a substantial amount.'' Id. at 415. After the Commission proposed to continue to use the ICC's valuation method in Williams Pipeline Co., 21 FERC ¶ 61,260 (1982), the court, on review from that decision, remanded the case in Farmers Union Central Exchange, Inc. v. FERC, 734 F.2d 1486, 1510-14 (D.C. Cir. 1984) (''Farmers II''), and directed the Commission to consider alternatives, noting the widespread agreement among many experts that the ICC's method ''lacks any economic rationale.'' Id. at 1511 (internal citation omitted).

On remand from Farmers II, the Commission developed its current ''trended original cost'' method. Opinion No. 154-B, 31 FERC at 61,833-35. This method starts from the original cost of a pipeline's assets but smooths out depreciation and equity recovery over the life of the pipeline, thereby avoiding the front-loading problems associated with a depreciated original cost methodology. Making the switch to this ''trended original cost'' method required the Commission to account for investments in existence at the time of the change. Under the ICC's valuation rate base methodology, many of these had been valued substantially above investment cost. See Farmers I, 584 F.2d at 415. Setting their value to depreciated original cost would, in many cases, have significantly decreased their valuation for rate-setting purposes. See Opinion No. 154-B, 31 FERC at 61,836. To mitigate any abrupt reduction in pipeline earnings resulting from the change, the Commission permitted a one-time rate base adjustment -creating a so-called starting rate base - calculated by partially continuing the ICC's valuation method to the extent of a pipeline's equity ratio, but assessing its rate base at depreciated original cost to the extent of its debt ratio. Opinion No. 154-B, 31 FERC at 61,835-37. Because the stated purpose of this approach was to protect the expectations of investors who had invested prior to the switch, the Commission determined that the relevant debt-to-equity ratio would be a pipeline's capital structure as of the date of Opinion 154-B, June 28, 1985, rather than its capital structure at the time rates are set. See Williams Pipeline Co., 33 FERC ¶ 61,327, 61,640 (1985) (''Opinion No. 154-C'').

The court has never reviewed the reasonableness of the Commission's Opinion No. 154-B methodology, nor need we do so now, as no party has challenged whether that approach is faithful to the court's remand order in Farmers II, 734 F.2d at 1511-21. The ELS support the Commission's application of the Opinion No. 154-B methodology, and SFPP contends only that the Commission's use of December 19, 1988 rather than June 28, 1985 as the relevant snapshot of the pipeline's capital structure is not faithful to Opinion No. 154-B and its progeny. We turn, then, to SFPP's contention that the Commission acted arbitrarily and capriciously, and departed from past precedent without adequate explanation, in rejecting use of the actual June 28, 1985 capital structure of the Santa Fe Southern Pacific corporation (''SFSP''), the pipeline's then-parent.

SFPP did not yet exist in 1985, and its predecessor corporation, Southern Pacific Pipelines, Inc. (''SPPL''), was a wholly-owned corporate subsidiary of SFSP. SPPL therefore had a 100% equity structure, and no party urged the Commission to use that capital structure to calculate SFPP's starting rate base. SPPL's parent, SFSP, was capitalized at 78.29% equity and 21.71% debt at the time, and SFPP urged the Commission to follow Opinion No. 154-B's instruction to use the parent's capital structure to calculate the starting rate base. Initially, in Opinion No. 435, 86 FERC at 61,089-90, the Commission took the position that the 1988 settlement agreement between SPPL and several of its shippers, which had last set the pipeline's rates, required the use of SFSP's capital structure in the starting rate base. On rehearing in Opinion No. 435-A, however, the Commission decided that the settlement did not preclude it from independently examining SFPP's capital structure after the rates set by the settlement expired. The Commission determined that SFSP's capital structure should not be used in the starting rate base calculation because SFSP's high equity component in June 28, 1985 did not ''accurately reflect[ ] the risks of SFPP's underlying operations,'' and there was a ''significant difference in the nature of the pipeline's operations and those of its parent company on June 28, 1985.'' Opinion No. 435-A, 91 FERC at 61,504-05.

SFPP contends that Opinion No. 154-B requires, in cases where a pipeline is owned by a parent company and therefore does not issue debt in its own name, the use of a parent company's capital structure as of June 28, 1985. Opinion No. 154-C, which clarified Opinion No. 154-B, does contain the instruction that ''the capital structure to be used in determining the starting rate base is as of the date of Opinion No. 154-B (June 28, 1985).'' 33 FERC at 61,640. The Commission qualified that approach, however, in ARCO Pipeline Co., 52 FERC ¶ 61,055, 61,233-34 (1990), where it began applying its precedents from the rate-of-return context - in which it first examines whether a parent company's capital structure is representative of its subsidiary's risk level before imputing it to the subsidiary - to the capital structure used in the starting rate base calculation. While the Commission in ARCO ended up using the corporate parent's actual capital structure, it indicated that its decision to do so hinged on ''whether the capital structure is representative of the pipeline's risks.'' Id. at 61,233.

ARCO did not contain much by way of explanation about why the representativeness of a parent's capital structure to the pipeline's risks should matter; its relevance to the starting rate base, where the equity component is standing in as a measure of investor reliance on the old ICC valuation method, appears less obvious than in the rate-of-return context, where pipelines receive different returns on debt and equity to compensate for their different risk levels, see, e.g., Kuparuk Transportation Co., 55 FERC ¶ 61,122, 61,375-78 (1991); Alabama-Tennessee Natural Gas Co., 25 FERC ¶ 61,151, 61,417-18 (1983). But the Commission's basic premise that a capital structure representative of a pipeline's risks must be used in the starting rate base calculation is not at issue, for SFPP concedes that the Commission can depart from a parent's actual capital structure if it is ''not … representative of the pipeline's risks.'' SFPP Pet. Br. 17. SFPP's challenge goes only to whether the Commission made a reasoned decision applying that standard, and nothing about the Commission's determination of SFPP's, SPPL's, and SFSP's relative risk levels was arbitrary or capricious.

The Commission noted that the bulk of SFSP's business was in the railroad, trucking, and mineral exploration industries, which faced substantially higher amounts of competition than the pipeline, a regulated ''monopoly for the entire period'' guaranteed a fair rate of return and ''sufficiently secure that it proposed to undertake a major expansion beginning in 1985.'' Opinion No. 435-B, 96 FERC at 62,067. Most importantly, the Commission had a powerful piece of evidence of the pipeline's relatively low risk level: its initial public offering. When it first became a stand-alone entity on December 19, 1988, SFPP was able to adopt a capital structure financed with 60.74% debt and 39.26% equity. This strongly suggests a market judgment that the pipeline was significantly less risky than SFSP, which was financed with 78.29% equity and 21.71% debt. The Commission's view that SFPP's equity level as of its initial public offering more ''accurately reflect[ ed] the pipeline's risk'' than that of its previous parent was based upon a reasoned view that ''the financial market's perceptions of the pipeline's risk,'' as demonstrated through an ''arms length public offering,'' provide an accurate estimate of an entity's risk level. 96 FERC at 62,068. SFPP misses the mark when it states that there is no single capital structure dictated by the market, for although other reasonable debt-equity ratios might have been adopted for SFPP, none would have market imprimatur. The reasonableness of the Commission's position is confirmed by the very different nature of the respective entities' business operations and the stark contrast between the capital structures each adopted. The same reasoning explains the Commission's choice to use December 19, 1988, the date of SFPP's initial public offering, as the relevant snapshot of its equity level, hardly an arbitrary date given its reliance on the judgment of the financial markets.

SFPP maintains, however, that by adopting SFPP's December 19, 1988 capital structure for purposes of the starting rate base calculation, the Commission improperly applied it ''retroactively,'' thereby denying the pipeline a fair chance to bring itself in line with the capital structure hypothesized. The Commission's use of the December 19, 1988 capital structure was predicated on the conclusion that it was representative of the pipeline's risks in 1988, and that there were ''no rational grounds here to believe that SPPL's operations or business substantially changed between June 28, 1985 and December 19, 1988.'' Opinion No. 435-B, 96 FERC at 62,067. SFPP points to nothing that suggests otherwise. The starting rate base is an element of the determination of the prospective rates ''in dispute in this proceeding,'' and the Commission was neither altering past rates nor seeking to recover the pipeline's past losses in future rates; rather, it was determining a just and reasonable valuation of the pipeline's investment for the purpose of setting present rates. As such, there was nothing ''retroactive'' about the Commission's setting of the starting rate base.

Cont'd

http://pacer.cadc.uscourts.gov/docs/common/opinions/200407/99-1020a.pdf

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