National Fuel Gas Supply Corp. v. F.E.R.C., 04-1183.

• Citation: 468 F.3d 831
• Decision Date: 17 November 2006
• Docket Number: No. 05-1048.,No. 04-1318.,No. 04-1302.,No. 04-1183.,No. 05-1052.,No. 05-1042.,No. 05-1051.,No. 04-1338,,No. 05-1055.,04-1183.,04-1302.,04-1318.,04-1338,,05-1042.,05-1048.,05-1051.,05-1052.,05-1055.
• Parties: NATIONAL FUEL GAS SUPPLY CORPORATION, Petitioner v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent Public Service Commission of the State of New York, et al., Intervenors.
• Court: United States Courts of Appeals. United States Court of Appeals (District of Columbia)

468 F.3d 831

NATIONAL FUEL GAS SUPPLY CORPORATION, Petitioner v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent Public Service Commission of the State of New York, et al., Intervenors.

No. 04-1183.

No. 04-1302.

No. 04-1318.

No. 04-1338,

No. 05-1042.

No. 05-1048.

No. 05-1051.

No. 05-1052.

No. 05-1055.

United States Court of Appeals, District of Columbia Circuit.

Argued September 11, 2006.

Decided November 17, 2006.

On Petitions for Review of Orders of the Federal Energy Regulatory Commission.

Howard L. Nelson argued the cause for Interstate Gas Pipeline Company Petitioners. With him on the briefs were Joan Dreskin, Timm Abendroth, Janice A. Alperin, Mark C. Schroeder, David W. Reitz, and Kenneth B. Driver. Richard D. Avil, Jr. entered an appearance.

Christopher J. Barr argued the cause for Local Distribution Company Petitioners. With him on the briefs were Anne K. Kyzmir, Jeffrey M. Petrash, William A. Williams, and David W. Reitz. Michael A. Reville entered an appearance.

Lawrence G. Acker argued the cause for petitioner Calypso U.S. Pipeline, LLC. With him on the briefs was Brett A. Snyder.

Samuel Soopper, Attorney, Federal Energy Regulatory Commission, argued the cause for respondent. With him on the brief were John S. Moot, General Counsel, and Robert H. Solomon, Solicitor.

Before: GINSBURG, Chief Judge, and GRIFFITH and KAVANAUGH, Circuit Judges.

Opinion for the Court filed by Circuit Judge KAVANAUGH.

KAVANAUGH, Circuit Judge.

The Natural Gas Act of 1938 provides that "[n]o natural-gas company shall, with respect to any transportation or sale of natural gas . . . make or grant any undue preference or advantage to any person or subject any person to any undue prejudice or disadvantage." 15 U.S.C. § 717c(b)(1). The Act's fundamental purpose is to protect natural gas consumers from the monopoly power of natural gas pipelines. See Associated Gas Distribs. v. FERC, 824 F.2d 981, 995 (D.C.Cir.1987). Congress has directed the Federal Energy Regulatory Commission to enforce the statute and regulate the pipelines. Since the 1980s, FERC has done so primarily through open-access rules that require pipelines to carry gas on equal terms and not to grant undue preferences or discriminate in favor of gas sold by the pipeline itself. See id. at 996; United Distribution Cos. v. FERC, 88 F.3d 1105, 1123-27 (D.C.Cir.1996).

In 1988, acting pursuant to its statutory authority, FERC issued Standards of Conduct to regulate natural gas pipelines' interactions with their "marketing affiliates." (Marketing affiliates are the separate affiliates of pipelines that sell natural gas; the affiliates arrange to purchase gas at the wellhead and to transport and distribute it to buyers.) The Standards required pipelines and their marketing affiliates to function independently and imposed restrictions on the sharing of information between them. FERC promulgated those rules because of (i) the theoretical threat that pipelines would favor their marketing affiliates by selectively divulging information about pipeline operations, thereby impeding market competition; and (ii) a factual record consisting of complaints by other sellers who were competing with pipelines' marketing affiliates and of documented abuses by pipelines and their marketing affiliates.

The pipelines petitioned for review, but we denied the petition in relevant part. We recognized that FERC must take into account the substantial efficiencies and benefits of vertical integration. We nonetheless upheld the Order because FERC had sufficiently demonstrated both a theoretical threat of pipelines granting undue preferences to their marketing affiliates and substantial record evidence of actual abuse. See Tenneco Gas v. FERC, 969 F.2d 1187, 1197 (D.C.Cir.1992).

In 2004, FERC significantly revised and extended the Standards so that they would apply to pipelines' relationships not only with marketing affiliates but also with other entities in the industry (such as producers, gatherers, processors, and traders) that are affiliated with pipelines. In vastly expanding the reach of the Standards, FERC again relied on both a claimed theoretical threat—this time, of pipelines granting undue preferences to those non-marketing affiliates—and record evidence that, according to FERC, indicated that abuse by pipelines and non-marketing affiliates was a real problem in the industry. The two dissenting FERC Commissioners objected, however, that the factual record on which FERC relied was barren and did not contain a single example of abuse involving non-marketing affiliates, much less evidence of an industry-wide problem.

Several pipelines petitioned for review in this court. We conclude that FERC's asserted factual premises do not withstand scrutiny and that the Order does not reflect the reasoned decisionmaking required by the Administrative Procedure Act. We therefore hold that the Order is arbitrary and capricious as applied to natural gas pipelines. We will grant the petition, vacate the Order as applied to natural gas pipelines, and remand. Because of our disposition, we need not consider the separate arguments against the Order raised by Calypso U.S. Pipeline and the local natural gas distribution companies.

I

1. The natural gas supply chain consists of a variety of entities. Some of them, such as producers, gatherers, processors, pipelines, and local distribution companies, perform the physical processes required to extract, refine, transport, and distribute gas. Other entities, such as marketers and traders, operate on the financial side, coordinating sales and trading in the natural gas commodity market.

Producers establish new wells and extract natural gas from the ground. Gatherers transport the gas from the wellhead to a processing plant. From there, processors distill "pipeline quality" natural gas by removing various hydrocarbons and fluids (some processing is done initially at the wellhead or later in the supply chain). Natural gas pipelines (either intrastate or interstate) carry gas to local distribution companies and to large industrial and commercial customers. Finally, local distribution companies deliver gas to retail consumers, subject to price regulation by state utility commissions.

Natural gas marketers sell natural gas and oversee the steps needed to arrange transportation of gas from the wellhead to the end-user. Frequently affiliated with another entity (such as a producer or pipeline), marketers identify customers, arrange gas transportation and storage, and ensure that adequate supplies are available to satisfy the purchasers' demand.

In recent years, entities referred to as natural gas traders have actively participated in the natural gas spot market and the natural gas derivatives market. In the spot (or physical) market, traders enter into contracts for the near-term delivery of natural gas. In the derivatives market, traders buy and sell derivative instruments like futures that are based on the underlying natural gas commodity. Traders participate in those markets primarily to hedge against risk or to profit from speculation on future price changes.

2. Like railroads, water pipelines, cable television lines, and telephone lines, natural gas pipelines traditionally have been considered natural monopolies. In other words, the costs of entering the market are so high (because of the large fixed cost of building a pipeline) that it is most efficient for only one firm to serve a given geographical region. See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW § 12.1, at 343-46 (4th ed.1992); see also United Distribution Cos. v. FERC, 88 F.3d 1105, 1122 & n. 4 (D.C.Cir.1996); Associated Gas Distribs. v. FERC, 824 F.2d 981, 1010 (D.C.Cir.1987). As natural monopolies, pipelines if unregulated would possess the ability to engage in monopolistic pricing for transportation services and discriminate against unaffiliated entities that seek to transport gas.

As this court has explained, federal regulation of the natural gas industry is "designed to curb pipelines' potential monopoly power over gas transportation." United Distribution Cos., 88 F.3d at 1122. Federal regulation began in 1938 after Congress passed and President Franklin Roosevelt signed the Natural Gas Act. 52 Stat. 821 (codified as amended at 15 U.S.C. §§ 717 et seq.). That Act conferred jurisdiction on FERC's predecessor, the Federal Power Commission, to regulate the interstate transportation and sale of natural gas. See 15 U.S.C. §§ 717(b), 717d(a). The Act also established a certification system and required the Commission to ensure that all rates were "just and reasonable" and that natural gas companies did not grant "undue preference[s]." See id. §§ 717c, 717d, 717f(c)(1)(a). Under this system, the Commission for decades regulated both the wellhead price and the "city gate price" (the price charged by pipelines to end-users and local distribution companies). See generally STEPHEN G. BREYER & PAUL W. MACAVOY, ENERGY REGULATION BY THE FEDERAL POWER COMMISSION 56-88 (1974).

In 1978, Congress passed and President Carter signed the Natural Gas Policy Act, Pub.L. No. 95-621, 92 Stat. 3350. That Act began the gradual deregulation of prices at the wellhead. In the aftermath of the Act and as a result of other legal and economic developments in the early 1980s, FERC launched a new regulatory approach. The Commission concluded that it could best fulfill the statutory purposes by allowing customers to purchase gas at the wellhead free from regulation and by preventing pipelines from abusing their monopoly power over the transportation of gas. At the time, pipelines served not just as transporters of gas but also as the primary gas marketers: They would purchase gas at the wellhead themselves, transport it over their systems, and sell it to local distribution companies or other end-users. See Associated Gas Distribs., 824 F.2d at 993. The problem was that pipelines could exclude third parties...