Nw. Corp. v. Fed. Energy Regulatory Comm'n

• Decision Date: 16 March 2018
• Docket Number: No. 16-1176,16-1176
• Citation: 884 F.3d 1176
• Parties: NORTHWESTERN CORPORATION, Petitioner v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent Montana Consumer Counsel, et al., Intervenors
• Court: U.S. Court of Appeals — District of Columbia Circuit

884 F.3d 1176

NORTHWESTERN CORPORATION, Petitioner

v. FEDERAL ENERGY REGULATORY COMMISSION, RespondentMontana Consumer Counsel, et al., Intervenors

No. 16-1176

United States Court of Appeals, District of Columbia Circuit.

Argued December 1, 2017

Decided March 16, 2018

John Lee Shepherd, Jr. argued the cause for petitioner. With him on the briefs were Clifford M. Naeve, Washington, DC, James P. Danly, Washington, DC, Heather H. Grahame, Sioux Falls, SD, M. Andrew McLain, and Timothy T. Mastrogiacomo, Washington, DC.

Holly E. Cafer, Senior Attorney, Federal Energy Regulatory Commission, argued the cause for respondent. With her on the brief were David L. Morenoff, General Counsel, and Robert H. Solomon, Solicitor.

Christina F. Gomez, Denver, CO, argued the cause for intervenors. With her on the brief were Kathleen L. Mazure, Washington, DC, Thorvald A. Nelson, Greenwood Village, CO, and Michelle Brandt King, Greenwood Village, CO. John P. Coyle, Natalie M. Karas, Washington, DC, and Justin W. Kraske entered appearances.

Before: Kavanaugh and Wilkins, Circuit Judges, and Randolph, Senior Circuit Judge.

Kavanaugh, Circuit Judge:

The Federal Energy Regulatory Commission requires utilities that transmit electricity to supply extra power generation in order to balance moment-to-moment variations in demand for electricity. Utilities must add power to, or withdraw power from, the grid in real time as actual demand for electricity exceeds or falls short of projected demand. That extra power generation is known as regulation service.

FERC allows utilities to recover costs associated with the provision of regulation service. Utilities may recover those costs by charging them to customers, as long as the utilities charge rates that are "just and reasonable." 16 U.S.C. § 824d(a).

NorthWestern is an electric utility that is subject to FERC's regulation-service requirement. Before 2011, NorthWestern lacked the generating capacity to provide its own regulation service, so it met the requirement by purchasing regulation service from other utilities. With FERC's approval, NorthWestern then passed on the cost of that purchased regulation service to its wholesale and retail customers. But purchasing regulation service from other utilities eventually became too expensive, so NorthWestern built a new generating station dedicated to providing regulation service. NorthWestern then proposed to revise the rate that it charges customers for regulation service in order to recover the costs of providing that service from the new station.

FERC determined that NorthWestern's proposed rate was not just and reasonable. FERC therefore modified NorthWestern's proposed rate and ordered NorthWestern to refund its customers the difference between the proposed rate and the modified rate. NorthWestern challenges FERC's decision as arbitrary and capricious under the Administrative Procedure Act. The arbitrary and capricious standard requires that an agency's decision be reasonable and reasonably explained. We conclude that FERC's decision in this case was reasonable and reasonably explained, and we therefore deny the petition for review.

I

In 1996, FERC issued Order 888. 61 Fed. Reg. 21,540 (May 10, 1996). Among other things, Order 888 requires electric utilities to provide their customers with certain ancillary services—services that supplement the basic service of transmitting electricity. Id. at 21,579 –80. One such ancillary service is "regulation service." Regulation service is extra power generation that responds to "moment-to-moment variations" in demand for electricity in a given area. Id. at 21,582. In other words, regulation service is "the injection or withdrawal of real power" into or from the electric grid in response to fluctuations in demand for electricity. Order No. 755, 76 Fed. Reg. 67,260, 67,260 –61 (Oct. 31, 2011). Regulation service helps to prevent blackouts and equipment damage by keeping the frequency of the electric current at close to 60 Hertz, the standard frequency in the United States. Id. If a utility fails to maintain that frequency, FERC may impose civil penalties on the utility. See 16 U.S.C. § 825o -1.

A utility charges customers for regulation service under Schedule 3 of the utility's Open Access Transmission Tariff, which is filed with FERC. FERC must examine the rate that a utility proposes to charge Schedule 3 customers in order to ensure that the rate is "just and reasonable." 16 U.S.C. § 824d(a), (e). A just and reasonable rate must be fair both to the utility and to its customers: It "should be based on the costs of providing service to the utility's customers, plus a just and fair return on equity." Alabama Electric Cooperative, Inc. v. FERC , 684 F.2d 20, 27 (D.C. Cir. 1982) ; see also FPC v. Hope Natural Gas Co. , 320 U.S. 591, 603, 64 S.Ct. 281, 88 L.Ed. 333 (1944).

This case concerns an attempt by petitioner NorthWestern to revise its Schedule 3 rate. NorthWestern is an electric utility subject to FERC's regulation-service requirement. As relevant here, NorthWestern transmits electricity to wholesale and retail customers in Montana.¹ When NorthWestern first began operations in 2002, NorthWestern did not possess sufficient generating capacity to provide its own regulation service. So NorthWestern complied with Order 888 by purchasing regulation service from other utilities. NorthWestern contracted with those other utilities for a set amount of regulation service and passed the cost of that regulation service on to customers under Schedule 3. From 2002 to 2010, NorthWestern purchased, and passed on the cost of, 60 megawatts of regulation service each year to its Schedule 3 customers.

But NorthWestern eventually decided that purchasing regulation service from other utilities was inefficient. So NorthWestern built the Dave Gates Generating Station, a station dedicated to providing regulation service to NorthWestern's customers. The Gates Station has three generators, each with a maximum capacity of 50 megawatts, for a total nominal or "nameplate" capacity of 150 megawatts. The Gates Station began operating in January 2011.

Whereas NorthWestern had previously passed on to its Schedule 3 customers the cost of purchasing regulation service from other utilities, NorthWestern now wanted to recover from its customers the cost of providing regulation service from the Gates Station. So NorthWestern filed a proposed revised Schedule 3 rate for FERC's approval. NorthWestern filed its rate pursuant to Section 205 of the Federal Power Act, which places the burden on the utility to show that its proposed revised rate is just and reasonable. 16 U.S.C. § 824d(e).

Here is how NorthWestern proposed to recover the cost of providing regulation service from the Gates Station. First, NorthWestern calculated the Gates Station's revenue requirement—the station's costs plus an allowed rate of return. NorthWestern then divided the Gates Station's revenue requirement between two different groups of customers. The first group of customers included retail customers only. In Montana, retail customers pay for wind-generated electricity in addition to fuel-generated electricity. Retail customers pay for wind-generated electricity at state-approved rates; FERC does not enter into the picture, and utilities do not use Schedule 3 to recover the cost of regulation service associated with wind-generated electricity. Because NorthWestern calculated that retail customers would need 45 megawatts of regulation service just to support wind-generated electricity, NorthWestern intended to charge retail customers alone for 45 megawatts of regulation service, and to do so at the state-approved rate—separate from Schedule 3.

The second group of customers included both retail and wholesale customers. Both retail and wholesale customers pay for regulation service associated with fuel-generated electricity at FERC-approved rates under Schedule 3. NorthWestern determined that this second group of customers would need 60 megawatts of regulation service—the amount that NorthWestern had historically purchased from other utilities. So NorthWestern proposed to recover the cost of 60 megawatts of regulation service from this second group of customers under Schedule 3.

In other words, NorthWestern planned to use the Gates Station to supply a total amount of 105 megawatts of regulation service to all of its customers. Retail customers alone would pay for 45 megawatts of that total—43%—at a state-approved rate, separate from Schedule 3. Retail and wholesale customers together would pay for the remaining 60 megawatts of that total—57%—under Schedule 3. NorthWestern calculated its proposed Schedule 3 rate by multiplying the Gates Station's revenue requirement by .57, which is the ratio of 60/105.

Three other components of NorthWestern's proposed Schedule 3 rate also matter here. First, NorthWestern planned to use Schedule 3 to recover fuel costs associated with operating the Gates Station, but also planned to credit customers for any revenue that the Gates Station might bring in from anything other than providing regulation service, such as from "off-system sales"—sales of energy to third parties. NorthWestern indicated, however, that it did not actually plan to use the Gates Station for anything other than regulation service. Second, NorthWestern proposed to recover costs associated with a three-month outage of the Gates Station that occurred in 2012. During that outage, NorthWestern once again had to buy regulation service from other utilities. NorthWestern planned to pass the cost of that purchased regulation service on to its customers under Schedule 3. Third, NorthWestern also sought approval to pass on to customers the cost of any regulation service that NorthWestern might need to purchase in the future in the event of another Gates Station outage.

In sum, NorthWestern asked FERC to approve a revised Schedule 3 rate that: (1) charged customers for regulation service by...