Association of Oil Pipe Lines v. F.E.R.C., 01-1066.

• Decision Date: 01 March 2002
• Docket Number: No. 01-1066.,01-1066.
• Citation: 281 F.3d 239
• Parties: ASSOCIATION OF OIL PIPE LINES, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION and United States of America, Respondents. Canadian Association of Petroleum Producers, et al., Intervenors.
• Court: U.S. Court of Appeals — District of Columbia Circuit

281 F.3d 239

ASSOCIATION OF OIL PIPE LINES, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION and United States of America, Respondents Canadian Association of Petroleum Producers, et al., Intervenors.

No. 01-1066.

United States Court of Appeals, District of Columbia Circuit.

Argued January 15, 2002.

Decided March 1, 2002.

On Petition for Review of an Order of the Federal Energy Regulatory Commission.

C. Frederick Beckner III argued the cause for petitioner. With him on the briefs were Lawrence A. Miller and Michele F. Joy.

Dennis Lane, Solicitor, Federal Energy Regulatory Commission, argued the cause for respondents. With him on the brief was Cynthia A. Marlette, Acting General Counsel. John J. Powers III and Robert J. Wiggers, Attorneys, U.S. Department of Justice, entered appearances.

James H. Holt and Melvin Goldstein were on the brief for intervenors.

Before: SENTELLE and ROGERS, Circuit Judges, and WILLIAMS, Senior Circuit Judge.

Opinion for the Court filed by Senior Circuit Judge WILLIAMS.

WILLIAMS, Senior Circuit Judge:

In December 2000 the Federal Energy Regulatory Commission established a formula for changes in the ensuing years' price caps for interstate oil pipelines. See Order Concluding Initial Five-Year Review of the Oil Pipeline Pricing Index, 93 FERC ¶ 61,266 (2000) ("Order" or "2000 Order"). To drive the annual change in the caps, it chose the Producer Price Index for Finished Goods minus one percent ("PPI-1"). Petitioner Association of Oil Pipe Lines challenges this as arbitrary and capricious, saying that the FERC Staff report justifying continuing adherence to the PPI-1 index used statistical methods that deviated from FERC's previous methodology without apparent justification, and that it also failed to account for special factors potentially altering the pattern of future changes. We find FERC's responses to the Association's criticisms inadequate — except as to the special factors — and therefore remand for further proceedings.

* * *

In prior orders FERC adopted a price cap regime for oil pipelines. See Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992, Order No. 561, F.E.R.C. Stats. & Regs. (CCH) ¶ 30,985 (1993) ("Order No. 561"); Revisions to Oil Pipeline Regulations Pursuant to Energy Policy Act of 1992, Order No. 561-A, F.E.R.C. Stats. & Regs. (CCH) ¶ 31,100 (1994) ("Order No. 561-A"); see also Association of Oil Pipe Lines v. FERC, 83 F.3d 1424, 1429-30 (D.C.Cir.1996) ("AOPL I"). After fixing as a baseline the pipeline rates that Congress deemed "just and reasonable" in the Energy Policy Act of 1992, Pub.L. No. 102-486, 106 Stat. 2776, 3010 (1992) ("EPAct"), reprinted in 42 U.S.C. § 7172 note, FERC determined to use an indexing scheme to make annual adjustments.

The index initially picked was PPI-1. FERC said that it was making this choice because, when compared to various alternatives, PPI-1 seemed to most closely track historical changes in actual pipeline costs. Order No. 561 at 30,951/2. But FERC's choice of PPI-1 was not "for all time." Order No. 561-A at 31,092-93. To ensure continuing fit between the index and actual changes in industry costs, FERC assured commentators that it would reexamine the index every five years. Order No. 561 at 30,941/2.

In 2000 FERC embarked on the first such reexamination. In its Notice of Inquiry it cited a Staff study purporting to show that "the changes in the PPI-1 Index have closely approximated the changes in the reported cost data for the oil pipeline industry during the five-year period covered by [the] review." Notice of Inquiry, Five-Year Review of Oil Pipeline Pricing Index, 65 Fed.Reg. 47,358, at 47,361 (2000) (reporting Staff study results). FERC invited comments. The Association responded, claiming that the Staff study deviated from past methodology and was otherwise flawed. Comments of the Association of Oil Pipe Lines, Five-Year Review of Oil Pipeline Pricing Index, Docket No. RM00-11-000 (Sept. 1, 2000) ("AOPL Comments"). It argued that the FERC Staff had improperly measured cost changes, had erroneously failed to remove statistical outliers, and had inexplicably altered its method for calculating capital costs. And it said that the Staff had failed to account for factors that would likely cause future cost changes to diverge from the historical trend. In fact, it said, PPI was a more appropriate index than PPI-1.

The Commission rejected the Association's arguments and issued the order now under review. See 28 U.S.C. § 2344.

1. Measurement of Cost Changes. The Association's first contention is that FERC used an improper methodology in pursuing its stated intention to measure "actual cost changes experienced by the oil pipeline industry." Order at 61,849/1; Order No. 561-A at 31,092/2; see also Order No. 561 at 30,952/2. Many methods are available. One possibility is to calculate the percentage cost change (per barrel-mile) for each individual firm and combine them in a simple average. Another is to combine the firm barrel-mile costs in an average weighted by volume, so that minor firms do not skew the result. Another is to take the median of the distribution. We will refer to these methods respectively as the unweighted average, the fixed-weight average, and the median. As we shall see, there are other candidates as well.

Orders Nos. 561/561-A substantially cited and relied on a study that reported the results of all three of the methods described above, as well as a composite figure that combined the three. See Test. of Alfred E. Kahn, Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992, Docket No. RM93-11-000 (Aug. 12, 1993), at 11 tbl.1 ("1993 Kahn Study"). The 1993-94 orders do not unambiguously show which figure held a dominant position in FERC's reasoning. The change in the composite for each of the three periods considered was fairly close to PPI-1. Of the three types of averages making up the composite, the unweighted average was closest to the composite (and thus to the PPI-1 figure ultimately selected).¹

In any event, we need not determine FERC's precise method in 1993 because the current order uses none of these previous methods. Instead of calculating cost changes by individual firm and then averaging them by any of the methods used before, the 2000 FERC Staff report used what we may call a "floating-weight" average. For each year in the period 1994-99 it took total costs for the entire industry, and divided it by the total number of barrel-miles shipped, yielding an annual average industry cost per barrel-mile. This produced an annual change, and the study found these annual changes to be a bit lower on average than the annual change in PPI-1. Notice of Inquiry, 65 Fed.Reg. 47,359-60 & tbl.1.

We call this method a "floating-weight" average because it effectively weights each pipeline's per-barrel costs by that pipeline's volume. In contrast, a fixed-weight average weights each firm's cost change by the firm's market share (in either the previous year or the current year). As was shown by the pipelines' expert witness, Professor Alfred E. Kahn (interestingly, the expert relied on by the shippers in the 1993-94 round), a floating-weight average can yield odd results. One curiosity, for example, is that such an average will include the costs of new entrants, even though, not having been in the market, they will have experienced no "change" in cost at all.

More generally, changes in market share among participants can give an arguably distorted impression of cost changes. Professor Kahn offered the following example: Suppose in Year 1, pipeline A's costs are $2 per barrel-mile, and its volume is 5 barrel-miles. Pipeline B's costs are $0.50 per barrel-mile, and its volume is 2 barrel-miles. In Year 2, B's volume remains the same, but A's volume decreases to 4. In addition, from Year 1 to Year 2, both pipelines experience an increase in cost by 12.5% (i.e., their respective costs per barrel-mile increase from $2 to $2.25 for pipeline A and from $0.50 to $0.5625 for pipeline B). Under a fixed-weight average, the average cost change is plainly 12.5%. Under a floating-weight average, however, the calculated change in cost is only 7.6%.² See Kahn Decl., Five Year Review of Oil Pipeline Pricing Index, Docket No. RM00-11-000 (Aug. 31, 2000), at 7 ("2000 Kahn Study"). One can, of course, produce a more extreme hypothetical by adjusting the numbers, creating a scenario where all pipelines experience a uniform increase in costs but the floating-weight average shows a decline.

FERC does not deny these peculiarities. Instead, it makes several collateral arguments in support of its approach, all of which are unpersuasive. First it responds that the Association's claims of underestimation are simply the consequence of competition and the move by customers from higher-cost providers to lower-cost providers. Order at 61,850 (arguing that the Association's results are "simply the natural working of the market forces at play, and does not show any distortion resulting from Staff's methodology"). Continuing, FERC argues that the Association's fixed-weight approach "would raise the price ceiling and thereby enable more high-cost pipelines to become or remain profitable." Id.

The problem with FERC's "competition" theory is that even if it were sound as a general matter (and FERC makes no effort to vindicate it), it presumes that all pipelines in the industry are close substitutes for each other. But by all indications in the record, they are not. Cf. Farmers Union Central Exchange, Inc. v. FERC, 734 F.2d 1486, 1508 n. 50 (D.C.Cir. 1984) (agreeing with the Justice Department that competition in the oil pipeline industry "must be evaluated in terms of discrete regional markets"). Indeed, if there were close competition between the pipelines, the reason for rate regulation — each pipeline's market power — would be missing. See id. at 1508 ("It is of course...