Town of Norwood, Mass. v. F.E.R.C.

• Decision Date: 03 February 1993
• Docket Number: No. 91-1134,91-1134
• Citation: 962 F.2d 20
• Parties: TOWN OF NORWOOD, MASSACHUSETTS, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent, New England Power Company, Intervenor.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 20

962 F.2d 20

295 U.S.App.D.C. 211

TOWN OF NORWOOD, MASSACHUSETTS, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent New England Power Company, Intervenor.

No. 91-1134.

United States Court of Appeals District of Columbia Circuit.

Argued Jan. 10, 1992.

Decided April 14, 1992.

As Amended May 15, 1992.

Rehearing and Rehearing En Banc

Denied Feb. 3, 1993.

Petition for Review of Orders of the Federal Energy Regulatory Commission.

Philip B. Malter, with whom Charles F. Wheatley, Jr., Annapolis, Md., was on the brief, for petitioner.

Randolph Lee Elliott, Atty., F.E.R.C., with whom William S. Scherman, Gen. Counsel, Jerome M. Feit, Solicitor, and Joseph S. Davies, Deputy Sol., F.E.R.C., Washington, D.C., were on the brief, for respondent.

Kenneth G. Jaffe, Washington, D.C., with whom Cynthia A. Arcate, Westborough, Mass., was on the brief, for intervenor.

Before BUCKLEY, D.H. GINSBURG, and RANDOLPH, Circuit Judges.

Opinion for the Court filed by Circuit Judge D.H. GINSBURG.

D.H. GINSBURG, Circuit Judge:

The Town of Norwood seeks review of a Federal Energy Regulatory Commission order approving the New England Power Company's adoption of a marginal cost approach to setting wholesale electric rates. This is the first marginal cost rate design that the FERC has approved since we instructed the agency on the need for record support in Electricity Consumers Resource Council v. FERC, 747 F.2d 1511 (D.C.Cir.1984) (ELCON ). Because the FERC has this time given adequate reasons for its decision to approve the proposed rate design, based upon evidence in the record, we deny the petition for review.

I. BACKGROUND

The rate design before us, like most wholesale electric rates, consists of separate monthly demand and energy charges. The demand component is calculated to recover NEPCO's fixed (or capacity-related) costs, such as construction and debt service, which it incurs regardless of how much electricity it produces. The energy charge is designed to recover the company's variable costs, which it incurs only in the course of actually producing electricity; fuel is a prime example.

In NEPCO's proposed rate design, the demand and the energy charge are each divided into two rates, one applicable to the customer's so-called "initial block" and the other to its "tail block." Each customer's initial block is an amount equal to 80% of its average monthly maximum demand and energy use during a base year. The rate for the initial block is based upon NEPCO's average cost, derived as usual from its historical or "embedded" costs. Demand and energy use in excess of that level is to be billed at the tail block rate, calculated on the basis of NEPCO's estimated long-run marginal cost (LRMC) for future capacity and energy.

In addition, NEPCO proposed to change the way it determines each customer's demand charge: whereas the demand charge had previously been calculated on the basis of each customer's actual peak usage during the month, it would now be calculated on the basis of the customer's usage at the time that total demand on NEPCO's system peaks each month. This switch from non-coincident to coincident peak billing was designed to impose upon each customer the cost of its contribution to NEPCO's need for increased capacity, which must be added in order to supply any increase in peak demand.

The ALJ approved these features, as well as other aspects of NEPCO's proposal that are no longer in controversy. See 49 FERC p 63,007 (1989). The Commission affirmed, approving and to some degree supplementing the opinion of the ALJ, 52 FERC p 61,090 (1990), and denied the petitioner's request for rehearing, see 54 FERC p 61,055 (1991).

If as expected NEPCO's marginal costs exceed its historical costs, then the proposed use of block billing will increase the price of electricity to customers whose demand is increasing. The Town of Norwood is foremost among these; from 1985 through 1988 (when NEPCO filed the proposed rate design), Norwood's consumption rose almost 30% while that of all other NEPCO customers grew by 18.75%. In fact, the petitioner stands alone among NEPCO's seven unaffiliated wholesale customers in experiencing a rate increase by reason of the change in rate structure.

In ELCON, we reviewed the Commission's approval of a rate design that proceeded from the principle of marginal cost pricing but incorporated "substantial adjustments" made necessary in order to reconcile that principle with the utility's revenue constraint. The result was a complicated affair--the utility "would collect the entire marginal cost of energy and would consider any residual revenue collectable under the revenue constraint to be the demand charge," 747 F.2d at 1513 (emphasis in original)--that might have been entirely justifiable under the circumstances but was not recognizable as marginal cost pricing. We remanded the matter for the FERC's reconsideration, noting that "mere invocation of [marginal cost pricing] theory is an insufficient substitute for substantial evidence and reasoned explanations," particularly "where the theory has been severely compromised by the revenue constraint." Id. at 1517. We pointed out "unequivocally," however, that we were not "expressing our opposition" to the principle of marginal cost rate design; we even allowed that "[a] modified version of marginal cost pricing theory may indeed be perfectly acceptable, but not without record support and reasoned decision-making by FERC that address the particular nuances of the modified theory." Id. at 1518 (emphasis in original).

The present case brings once more before the court the issue of marginal cost pricing in a utility's rate design--this time without the Rube Goldberg-style modifications that the utility had cobbled together and the agency had approved in ELCON. Here the petitioner argues straightforwardly that (1) the proposed LRMC rate design is not just and reasonable because it is too volatile (at least relative to the stability of average cost rates), (2) marginal cost ratemaking is impermissibly retroactive, (3) the theory of marginal cost pricing supports only the use of short run marginal cost (SRMC) and not LRMC, and (4) the proposed rate structure involves an unlawful rate tilt. In addition, the petitioner argues that coincident peak demand billing is not just and reasonable and that the FERC impermissibly shifted the burden of proof from NEPCO to the petitioner on these issues.

II. ANALYSIS

Issues of rate design are fairly technical and, insofar as they are not technical, involve policy judgments that lie at the core of the regulatory mission. Not surprisingly, therefore, our review is deferential. In determining whether the FERC's decision that a rate design is "just and reasonable," 16 U.S.C. § 824d(a), we require only that the agency have made a reasoned decision based upon substantial evidence in the record.

A. The LRMC Rate Design

We find adequate justification in the record for the Commission's approval of NEPCO's proposal to move from an embedded cost to a marginal cost rate design. The ALJ correctly stated and clearly understood the conventional economic case for marginal cost pricing:

[NEPCO's marginal cost rate design applies] to public utility ratemaking ... one of the best-established precepts of classical economics: social welfare is maximized when the marginal cost of purchasing any commodity is equivalent to the marginal cost of producing it.... [T]he rate design proposed in this proceeding by NEPCO would approach that objective more closely than continued adherence to a rate design based upon embedded costs.

49 FERC at 65,032. The Commission fully embraced this rationale, remarking that "customers must face prices that reflect their supplier's incremental costs in order for them to make efficient investment decisions and efficient choices when seeking alternative supply sources." 52 FERC at 61,335.

We note the agreement as well of the leading authorities in the field of public utility regulation. See James C. Bonbright, Albert L. Danielsen, & David R. Kamerschen, Principles of Public Utility Rates 410 (2d ed. 1988) ("[M]arginal cost must play a major and even a dominant role in the elaboration of any scheme of rates or prices that seriously pretends to have as a major motive the efficient utilization of available resources and facilities") (quoting William Vickrey, Some Implications of Marginal Cost Pricing for Public Utilities, 45 Am.Econ.Rev., Papers and Proceedings 605 (1955)); Robert G. Uhler, Electric Utility Pricing Issues, in Current Issues in Public-Utility Economics 77, 81-82 (Albert L. Danielsen and David R. Kamerschen eds. 1983) ("The issue for the 1980s is not to debate the merits of marginal-cost pricing [, an idea] articulated by Bonbright two decades ago and clearly understood by the industry experts of today. The issue for the 1980s is to reaffirm Bonbright's three primary criteria for sound rate-making--revenue adequacy, optimal use of service, and fairness--and doggedly pursue marginal-cost pricing as a means to achieve those time-honored ends"); Alfred E. Kahn, 1 The Economics of Regulation: Principles and Institutions 65 (1970) [hereinafter Economics of Regulation ] ("If economic theory is to have any relevance to public utility pricing, [the equation of price and marginal cost] is the point at which the inquiry must begin"); Samuel Huntington, The Rapid Emergence of Marginal Cost Pricing in the Regulation of Electric Utility Rate Structures, 55 B.U.L.Rev. 689, 696-97 (1975) ("Marginal cost pricing ... has long been accepted by economists.... [M]any regulators and other participants in the regulatory process are beginning to bridge the gap between economic theory and regulatory practice"); J. Robert Malko and Philip R. Swensen, Pricing and the Electric Utility Industry, in Public Utility Regulation 35, 56-69 (Kenneth Nowotny et al. eds., 1989) (recounting and applauding successful...