East Tennessee Natural Gas Co. v. F.E.R.C.

• Decision Date: 09 December 1988
• Docket Number: No. 87-1765,87-1765
• Parties: EAST TENNESSEE NATURAL GAS COMPANY, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 932

863 F.2d 932

274 U.S.App.D.C. 243

EAST TENNESSEE NATURAL GAS COMPANY, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.

No. 87-1765.

United States Court of Appeals, District of Columbia Circuit.

Argued Oct. 14, 1988.

Decided Dec. 9, 1988.

James T. McManus, with whom Maria M. Jackson, Washington, D.C., and Thomas E. Midyett, Jr., Knoxville, Tenn., were on the brief, for petitioner. Terence J. Collins, Washington, D.C., also entered an appearance for petitioner.

Dwight C. Alpern, Attorney, F.E.R.C., with whom Catherine C. Cook, Gen. Counsel, and Jerome M. Feit, Sol., F.E.R.C., Washington, D.C., were on the brief, for respondent.

Glenn W. Letham and Kenneth M. Albert, Washington, D.C., were on the brief, for intervenor.

Before WALD, Chief Judge, and MIKVA and SENTELLE, Circuit Judges.

Opinion for the court filed by Chief Judge WALD.

WALD, Chief Judge:

Petitioner East Tennessee Natural Gas Company ("East Tennessee") seeks review of an order of the Federal Energy Regulatory Commission ("FERC") requiring East Tennessee to eliminate its minimum commodity bill from its partial requirements rate schedule. We find substantial evidence to support the Commission's determination that the bill is unjust and unreasonable.

East Tennessee's petition raises the further question of whether FERC can order the elimination of the minimum bill retroactively to the effective date of the pipeline's most recent rate filing although the pipeline itself proposed no change in the bill at that time. To answer that question, we reexamine Secs. 4 and 5 of the Natural Gas Act, 15 U.S.C.A. Secs. 717-717w (1976), as they relate to changes ordered by FERC in existing rates because of their interaction with changes proposed in the pipeline's filing. We determine that the FERC-ordered changes in East Tennessee's minimum bill did not come within the Commission's Sec. 4 retroactivity authority. Consequently, we reverse the retroactive application of the Commission's order eliminating the minimum commodity bill.

I. BACKGROUND

A. Factual Context

East Tennessee operates a natural gas pipeline system in Tennessee and Virginia. Although most of East Tennessee's customers are full requirements customers who purchase natural gas solely from East Tennessee, two ¹ of its customers are partial requirements customers who can choose to purchase gas either from East Tennessee or from alternative suppliers. ² The service provided to East Tennessee's partial requirements customers is known as "firm sales service". Under this service, partial requirements customers are entitled to purchase on demand a designated quantity of gas over a certain period of time.

To provide this firm service, East Tennessee incurs both fixed and variable costs. Fixed costs are those costs that do not vary with the amount of gas that East Tennessee actually sells. ³ They include not only up-front expenditures in making investments, but also an approved return on such investments (equity return) and related taxes. Variable costs, on the other hand, are those costs that do vary with the quantity of gas sold; the principle source of variable cost is the cost of gas purchased by East Tennessee for delivery to its customers. The essential difference between the two kinds of costs from East Tennessee's point of view is that once it incurs fixed costs, it risks not recovering these costs unless it sells gas; variable costs on the other hand are risk-free: if East Tennessee does not sell gas, it incurs no such costs. The issue in this case involves East Tennessee's attempt to recover through a minimum bill some fixed costs of providing firm sales service to partial requirement customers.

Historically, East Tennessee's fixed costs have been recovered in two ways. First, it has charged its partial requirements customers a demand charge: a flat charge which is based on the entitlement reserved but collected regardless of the quantity of gas actually purchased by the customer. Second, East Tennessee has a per-unit charge, known as a commodity charge, which is collected for each unit of gas actually sold to a customer. In designing rates, East Tennessee adds up the fixed costs of reserving an entitlement quantity for a customer and then collects part of that total through the demand charge and part through the commodity charge.

The demand charge guarantees that the fixed costs allocated to it will be recovered regardless of how much gas East Tennessee actually sells. The fixed costs allocated to the commodity charge, however, are only recovered to the extent that sales are made. Historically, East Tennessee has protected itself from underrecovery of the portion of fixed costs allocated to the commodity charge by including a minimum bill requirement in its partial requirements rate schedule. The minimum bill obligates a customer to pay the commodity charge for 60% of its entitlement whether or not that quantity of gas is actually purchased. The minimum bill thus guarantees further recovery of fixed costs.

B. Procedural History

These proceedings were initiated when East Tennessee filed under Sec. 4 of the Natural Gas Act, 15 U.S.C.A. Sec. 717c (1976), to revise its rates. ⁴ Section 4 requires that FERC find proposed changes in pipeline rates to be just and reasonable. Among the changes proposed by East Tennessee was a change in its rate design. Prior to the filing, East Tennessee had been using what is known as the United ⁵ rate design, which allocates 75% of fixed costs to the demand charge and the remaining 25% to the commodity charge. In its filing, East Tennessee proposed to change to the Seaboard ⁶ method which allocates 50% of fixed costs to the demand charge and 50% to the commodity charge. East Tennessee proposed no changes to its minimum bill provision. During its review of the filing, FERC opposed East Tennessee's rate design proposal and raised questions on its own initiative about the lawfulness of the minimum bill provision in East Tennessee's partial requirements rate. ⁷

On April 6, 1984, East Tennessee filed and the Commission accepted a settlement agreement (the "1984 settlement"), Joint Appendix ("J.A.") at 29-55, which resolved most issues raised by the filing but reserved for hearing both the rate design and the minimum bill issues. This agreement contained a provision which required that any changes in the minimum bill be made prospectively only from the date on which the Commission ordered such changes. A seminal provision of the agreement indicated that except for specified clauses (not including the minimum bill), the agreement was to expire at the time that East Tennessee's next general rate filing went into effect.

A hearing was held before an Administrative Law Judge ("ALJ") on January 17-18, 1984. At the time of the hearing, East Tennessee's minimum bill was a full-cost minimum bill, collecting both the variable cost and the fixed cost components of the commodity charge. Before the ALJ rendered his decision, however, FERC issued Order No. 380, Elimination of Variable Costs From Certain Natural Gas Pipeline Minimum Commodity Bill Provisions, 49 Fed.Reg. 22778 (June 1, 1984), which disallowed the collection of the variable cost portion of commodity charges through minimum bills. As a result of Order No. 380, East Tennessee's minimum bill was significantly reduced (variable costs constituted approximately 95% of the commodity charge, Brief for Respondent at 14) to become a fixed-cost only minimum bill.

In the initial decision, issued January 23, 1985, the ALJ rejected East Tennessee's proposal to switch to the Seaboard method of rate design. The ALJ found instead that the method proposed by the staff of the Commission, the modified fixed-variable design ("MFV"), was just and reasonable and ordered East Tennessee to adopt this method prospectively. J.A. at 67-68. This method of rate design allocates all fixed costs to the demand charge except for that portion which represents a return on equity, related income taxes and fixed production costs. J.A. 135. The ALJ also found East Tennessee's minimum bill to be unjust and unreasonable ⁸ and ordered that it be eliminated, again prospectively from the date of the order. J.A. at 60-61. East Tennessee appealed both of these determinations to the Commission.

Before the Commission issued its decision, East Tennessee made another general rate filing on May 31, 1985, to become effective July 1, 1985. In this filing East Tennessee proposed to use the MFV rate design but again proposed no changes to its minimum bill. The Commission suspended the proposals until December 1, 1985, and set the case for hearing. East Tennessee, 31 F.E.R.C. p 61,383 (1985), reh'g denied, 32 F.E.R.C. p 61,456 (1985). Subsequently East Tennessee tendered another settlement agreement (the "1985 settlement") which preserved the MFV proposal, continued to reserve the minimum bill issue for hearing and again provided that any change in the minimum bill would be made prospectively only. J.A. at 180-99. On April 25, 1986, the Commission approved the 1985 settlement in all respects except for the provision regarding the effective date of changes to the minimum bill. East Tennessee, 35 F.E.R.C. p 61,113 (1986). The Commission ordered all changes, including the proposed switch to the MFV rate design and elimination of the minimum bill, to be effective retroactively to December 1, 1985. East Tennessee did not accept this modification, withdrew the 1985 settlement and filed yet another settlement on December 30, 1986 (the "1986 settlement"), which duplicated the 1985 settlement but provided that the effective date for eliminating the minimum bill would also be reserved for hearing. (J.A. at 223-52.)

On August 21, 1987, the Commission issued its Opinion No. 282, East Tennessee, 40 F.E.R.C. p 61,201 (1987) (the order on review in the instant case), in which it approved the 1986 settlement, affirmed the ALJ's determination that...