Williston Basin Interstate Pipeline Co. v. F.E.R.C., 97-1644

• Decision Date: 22 January 1999
• Docket Number: No. 97-1644,97-1644
• Citation: 165 F.3d 54
• Parties: WILLISTON BASIN INTERSTATE PIPELINE COMPANY, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent. Colorado Interstate Gas Company, et al., Intervenors.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 54

165 F.3d 54

334 U.S.App.D.C. 109

WILLISTON BASIN INTERSTATE PIPELINE COMPANY, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent Colorado Interstate Gas Company, et al., Intervenors.

No. 97-1644.

United States Court of Appeals District of Columbia Circuit.

Argued Nov. 19, 1998.

Decided Jan. 22, 1999.

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

Robert T. Hall, III argued the cause for petitioner. With him on the briefs were John R. Schaefgen, Jr., and Paul K. Sandness.

Susan J. Court, Special Counsel, Federal Energy Regulatory Commission, argued the cause for respondent. With her on the brief was Jay L. Witkin, Solicitor. John H. Conway, Deputy Solicitor, Larry D. Gasteiger and Patricia L. Weiss, Attorneys, entered appearances.

Alan J. Roth was on the brief for intervenors Public Utilities Commission of South Dakota, et al.

Before: EDWARDS, Chief Judge, WILLIAMS and RANDOLPH, Circuit Judges.

Opinion for the Court filed by Chief Judge EDWARDS.

HARRY T. EDWARDS, Chief Judge:

Petitioner Williston Basin Interstate Pipeline Company ("Williston Basin") seeks review of multiple orders of the Federal Energy Regulatory Commission ("FERC" or "Commission") in connection with a general rate increase filed by Williston Basin under § 4 of the Natural Gas Act ("NGA" or "Act"), 15 U.S.C. § 717c. The Commission found that Williston Basin had not satisfied its burden of demonstrating that various components of its proposed rate increase were lawful, and it therefore ordered certain adjustments to Williston Basin's filing. In this petition for review, Williston Basin takes issue with the Commission's findings insofar as they concern the rate of return on common equity, ad valorem tax expense, throughput projection, depreciation allowance, and cost of long-term debt. The Public Utilities Commission of South Dakota, Montana Consumer Counsel, and Montana Public Service Commission ("State Agencies") have intervened in support of the Commission's position.

We find that Williston Basin's challenges to the Commission's depreciation and cost of long-term debt determinations are plainly without merit, and, therefore, warrant no discussion. The Commission's decisions require no amplification on these two issues. However, for the reasons provided below, we grant Williston Basin's petition for review and remand to the Commission for further proceedings on the issues related to the rate of return on common equity, ad valorem tax, and throughput.

I. BACKGROUND

A. Regulatory Framework

This case involves the Commission's authority, pursuant to the NGA, to regulate "the transportation of natural gas in interstate commerce." 15 U.S.C. § 717(b) (1994). Section 4(a) of the Act requires that rates charged by natural gas pipelines within the Commission's jurisdiction be just and reasonable. See id. § 717c(a). Consistent with this mandate, pipelines must file all proposed rates with the Commission for a determination as to their reasonableness. See id. § 717c(c). The pipeline bears the burden of demonstrating that a proposed rate change is reasonable. See id. § 717c(e). The Commission may suspend the operation of a proposed new rate for up to five months pending a reasonableness determination. See id. If the Commission fails to reach a determination before the end of the suspension period, it must allow the filed rate to go into effect subject to an ultimate decision, which may be made retroactive. See id.

B. Commission Rate-Setting Practices

The Commission sets pipeline rates by dividing revenue requirements by projected demand to attain a dollar-per-unit-of-service figure. To begin, the Commission sets a pipeline's basic costs by totaling operation and maintenance expenses, depreciation, and taxes, including ad valorem taxes. As it is ordinarily impossible for a pipeline to know at the time of filing what its actual costs will be during the effective period of the filed rates, the Commission has adopted a "test period" approach for this stage of rate making. Under this approach, a pipeline submits data in support of its rate proposal that reflects actual experience over the most recent twelve consecutive months (the "base period"), adjusted for changes that are known and measurable with reasonable accuracy at the time of filing, and that will become effective within nine months after the last month of actual experience (the "adjustment period"). See 18 C.F.R. § 154.303(a)(4) (1998). (Separate test period regulations govern rate setting in the electric utility context. See id. § 35.13.) Under certain circumstances, the Commission has discretion to make adjustments in light of actual, post-test period data. See Exxon Corp. v. FERC, 114 F.3d 1252, 1263 (D.C.Cir.1997). For the most part, however, the Commission develops rates using the representative cost data available at the time of filing. The test period underlying the rates in this case consisted of a twelve-month base period ending January 31, 1992 and a nine-month adjustment period ending October 31, 1992.

Next, the Commission adds to this basic cost of service figure a reasonable profit, computed by multiplying the rate base by the rate of return. See Boston Edison Co. v. FERC, 885 F.2d 962, 964 (1st Cir.1989). The rate base, which is not at issue in the present case, represents "total historical investment minus total prior depreciation." Id. (internal quotation omitted). The rate of return, which is very much at issue in the present case, represents a weighted average of the costs of the three elements comprising the pipeline's capital structure: long-term debt, preferred stock, and common equity. See North Carolina Utils. Comm'n v. FERC, 42 F.3d 659, 661 (D.C.Cir.1994). The cost of common equity is frequently, as it is here, a point of contention in rate making. NEPCO Mun. Rate Comm. v. FERC, 668 F.2d 1327, 1335 (D.C.Cir.1981).

To calculate a pipeline's rate of return on common equity, the Commission first develops a "zone of reasonableness," which gauges returns experienced in the industry, ordinarily by reference to a proxy group of publicly-traded companies for which market data is available. North Carolina, 42 F.3d at 661-62. To arrive at this zone of reasonableness, the Commission favors a discounted cash flow ("DCF") model, which projects investor growth expectations over the long term by adding average dividend yields to estimated constant growth in dividends over the indefinite future. The premise of the DCF model is that the price of a stock is equal to the stream of expected dividends, discounted to their present value. Once the Commission has defined a zone of reasonableness in this manner, it then assigns the pipeline a rate within that range to reflect specific investment risks associated with that pipeline as compared to the proxy group companies. See id. at 661. This figure, combined with the long-term debt and preferred stock figures, represents the overall rate of return used to calculate the pipeline's profit allowance.

In the final rate-making step, the Commission divides the total revenue requirement--cost of service plus reasonable profit--by the total demand. Demand corresponds with throughput volume on the pipeline system, which, like cost of service, is computed by reference to a test period. See Exxon Corp., 114 F.3d at 1263-64. This calculation yields the per-unit price necessary to cover the pipeline's revenue requirement, which, in turn, represents a reasonable price that the Commission will permit the pipeline to recover. See Boston Edison, 885 F.2d at 964.

C. Commission Proceedings

The procedural history of this case, which spanned more than five years and spawned six Commission orders and two administrative law judge ("ALJ") decisions, does not bear exhaustive recitation here. To put the relevant issues into context, we need only summarize the Commission's determinations, as relevant to the rate of return on common equity, ad valorem tax, and throughput issues.

Williston Basin is a natural gas company that operates a pipeline system within the states of Montana, North Dakota, South Dakota, and Wyoming. On April 30, 1992, Williston Basin filed tariff sheets with the Commission in order to implement a proposed general rate increase under § 4 of the NGA, to be effective on June 1, 1992. On May 29, 1992, the Commission accepted Williston Basin's filing, suspended the rates until November 1, 1992, and made the increase subject to refund, various conditions, and the outcome of a hearing on cost-of-service and throughput issues. See Williston Basin Interstate Pipeline Co., 59 F.E.R.C. p 61,237 (1992). Subsequently, on September 30, 1992, Williston Basin filed a superceding rate increase to reflect firm service conversions, from sales to transportation, on its system. Because this filing relied on the same cost of service and allocations as the earlier rate case, the two proposals raised several identical issues. The Commission accepted the revised rates, suspended them until November 1, 1992, and consolidated the new filing with the pending proceeding. See Williston Basin Interstate Pipeline Co., 61 F.E.R.C. p 61,129 (1992). In the meantime, Williston Basin filed revised tariff sheets in connection with its restructuring pursuant to FERC Order No. 636. By order dated February 12, 1993, the Commission set various issues in the restructuring proceeding for hearing, to be addressed in the ongoing proceedings in the 1992 dockets. See Williston Basin Interstate Pipeline Co., 62 F.E.R.C. p 61,144 (1993). The Commission thereafter permitted Williston Basin to implement its restructuring as of November 1, 1993, subject to certain conditions. Consequently, the orders under review affect Williston Basin's rates from June 1, 1992 through December 31, 1995, the effective date of its next rate case.

On July 19, 1994, following an evidentiary hearing on the matters raised by the Commission, the...