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Remember (the) Maine!: Supreme Court Raises Bar in FERC Proceedings for Non-Parties Who Challenge Electric Rates Set by Contract

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In-Sites

March 12, 2010

The Federal Power Act (FPA), which gives the Federal Energy Regulatory Commission (FERC) jurisdiction over interstate electricity sales, requires that all wholesale electricity rates be “just and reasonable,” including rates set by contracts between suppliers and purchasers. In its latest decision in this area, in NRG Power Marketing, LLC v. Maine Public Utilities Commission, No. 08-674, 558 U.S. — (January 13, 2010), the Supreme Court, by an 8-1 vote, extended a doctrine first developed more than fifty years ago and made it extremely difficult for those who were not parties to the contract — even states — to challenge contractually set rates in FERC proceedings.

For years New England’s electricity generators, providers, and customers sought to improve the reliability of the region’s power grid, where demand for electricity nearly outstripped supply capacity because utilities were losing money and could not afford to build new power plants. A group of generators, called the New England Power Pool, in 2003 proposed to address the problem via “reliability must-run” agreements with the operator of the region’s transmission system. The agreements would ensure that strapped generators in areas with supply shortages could recover their full costs in order to remain in operation. The agreements went before FERC, which approved them (but allowed the generators to recover only certain maintenance costs) and simultaneously directed the operator of the transmission system to develop a new market mechanism.

In 2004, a proposed market structure was submitted to FERC. The matter was resolved by way of a 2006 settlement agreement involving 107 of the 115 negotiating parties. The agreement provided that any challenge to various payments and prices under the agreement, whether brought by a party to the agreement, by a non-party, or by FERC, would be adjudicated under the so-called Mobile-Sierra doctrine, a deferential standard of review named for the two 1956 Supreme Court decisions in which it was first articulated. Six of the eight parties who objected to the proposed market mechanism, including the Maine Public Utilities Commission, sought review of the agreement in the D.C. Circuit Court of Appeals, which held that the Mobile-Sierra doctrine, originally developed to govern challenges to contractually set rates by parties to the contract, could not apply to challenges by non-contracting parties.

The Mobile-Sierra doctrine was announced in United Gas Pipeline Co. v. Mobile Gas Service Corp., 350 U.S. 332 (1956), and Federal Power Commission v. Sierra Pacific Power Corp., 350 U.S. 348 (1956). Both cases (which were decided on the same day) involved rates set by contract, and in both cases the utility — a gas utility in Mobile, and an electric utility in Sierra — wished to get out of an unfavorable contract by filing a tariff with new rates. In addition to holding that a newly filed tariff did not automatically supersede a contract rate, the Court held that the agency’s evaluation of whether a rate was “just and reasonable” could consider only whether it would harm the public interest. Thus, in Sierra, the fact that the contract rate did not allow the selling utility to earn a fair return on its investment was not enough to make it unjust or unreasonable; the rate would have to be so low as to harm the public interest, such as by impairing the ability of the utility to continue providing service, or placing an excessive burden on other consumers, or being unjustly discriminatiory. Sierra, 350 U.S. at 354-55. As set forth in a more recent decision, under the Mobile-Sierra doctrine, FERC must presume that a rate set by “a freely negotiated wholesale-energy contract” is “just and reasonable” as required by the FPA, and the presumption may be overcome “only if FERC concludes that the contract seriously harms the public interest.” Morgan Stanley Capital Group Inc. v. Public Utility Distrcit No. 1 o Snohomish County, No. 06-1457, slip op. at 1, 554 U.S. –, — (2008).

Morgan Stanley, decided a few months after the D.C. Circuit’s decision in NRG Power Marketing, arose in the aftermath of the California energy crisis of 2000, when the price of electricity increased more than fifteen-fold due to a combination of natural, economic, and regulatory factors, including market manipulation by Enron, Morgan Stanley, and others. At the height of the crisis, FERC had stepped in to undo some of the damage wrought by California’s decision to deregulate its power industry in 1996. Encouraged to do so by FERC, utilities sought to enter into new long-term contracts. The rates under these contracts, while much lower than the rates that were prevalent before FERC acted, were still very high by historical standards. The high prices in California spilled over into other western states, where the respondents in Morgan Stanley — utilities that had entered into long-term contract to purchase electricity — were located. When the crisis was over, the purchasing utilities, like the selling utilities in Mobile and Sierra, wanted to get out of their onerous contracts. The matter went before FERC and the Ninth Circuit, and eventually reached the Supreme Court, which held that even where a challenge to the contractual rates is brought by purchasers rather than sellers, the Mobile-Sierra has to be applied. Morgan Stanley, slip op. at 15-19.

Thus, Morgan Stanley, extended the Mobile-Sierra presumption to challenges brought by purchasers as well as those brought by sellers. With NRG Power Marketing, the Court has extended the doctrine further, requiring that it be applied even where the challenge is brought by those who were not even parties to the contract. Writing for the Court, Justice Ginsburg rejected the D.C. Circuit’s view that the “public interest” standard is “independent of, and sometimes at odds with,” the “just and reasonable” standard. Instead, she wrote, the “public interest” standards “defines ‘what it means for a rate to satisfy the just-and-reasonable standard in the contract context.’” NRG Power Marketing, slip op. at 8 (quoting Morgan Stanley, slip op. at 17).

Justice Ginsburg also addressed the criticism of the lone dissenter, Justice Stevens. She defended the Mobile-Sierra doctrine as a standard that did not ignore third-party interests, but rather protected them, by directing FERC to reject a contract rate that “’seriously harms the consuming public.’” NRG Power Marketing, slip op. at 9 (quoting Morgan Stanley, slip op. at 17). She wrote further that confining the Mobile-Sierra doctrine to rate challenges by contracting parties “diminishes the animating purpose of the doctrine: promotion of ‘the stability of supply arrangements which all agree are essential to the health of the [energy] industry.’” NRG Power Marketing, slip op. at 9 (quoting Mobile, 350 U.S. at 344).

In dissent, Justice Stevens was more skeptical of the ability of the Mobile-Sierra doctrine to protect the interests of either third parties or the general public. Its requirement that a contract rate be upheld unless it “seriously harms the public interest” sets the bar too high for objectors like the Maine Public Utilities Commission, who may be able to show harm to the public interest but not serious harms. NRG Power Marketing, dissent at 5. He also found the stability of contract-based energy supply arrangements to be less important than the majority did, citing “the animating purpose of the FPA, which is ‘the protection of the public interest.’” NRG Power Marketing, dissent at 8 (quoting Sierra, 355 U.S. at 355). “That interest,” he wrote, “is ‘the interest of consumers in paying ‘the lowest possible reasonable rate consistent with the maintenance of adequate service in the public interest.’” NRG Power Marketing, dissent at 5 (quoting Morgan Stanley, dissent at 7) (additional quotation marks and citation omitted).

The issue in NRG Power Marketing, then, is not just what standard FERC should apply to a given challenge to a contract rate, but what counts, and how much, in the definition of “the public interest.” Contract stability? Consumer interests in low prices? Overall supply stability? Investors’ expectations? The interests of future generations? The debate is one that predates even Mobile and Sierra. In Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944), for example, the Supreme Court upheld a rate order of the Federal Power Commission (a predecessor of FERC) under the Natural Gas Act, finding that the rates at issue could not be held unjust and unreasonable, even if they yielded only a meager return. The Court relied in part on its undersanding of the rate-making process, which involves balancing investor and consumer interests. Concurring in the judgment, Justice Jackson agreed that the circuit court’s order should be reversed, but called for a reconsideration of the Commission’s rate-making doctrine. Under that doctrine, the Commission considered “only two ‘phases of the public interest: (1) the investor interest; (2) the consumer interest,’ which it emphasized to the exclusion of all others.” Hope Natural Gas, 320 U.S. at 656 (Jackson, J., concurring in the judgment) (quoting Federal Power Commission v. Natural Gas Pipeline Co., 315 U.S. 315 U.S. 575, 606 (YEAR). According to Justice Jackson, while such an approach may work well, for example, in setting rates for railroads, where the rates in question involved a finite substance such as natural gas, the analysis must also encompass “the long-range public interest.” Id. at 657. Rates for natural gas, said Justice Jackson, should not be set at levels that result in the impoverishment of future generations. Instead, the entity best able to cast off the cost, i.e. the industrial user, should pay the highest price, which would encourage both the search for alternative energy sources and conservation. Id. at 657-60.

The Court’s decision in NRG Power Marketing is a far cry from Justice Jackson’s somewhat prescient call for consideration of the interests of future generations in the making of federal energy policy. Without explicitly holding so, the Court appears to have made stability of contracts, and of the energy markets in which they are negotiated, an especially important aspect of “the public interest.” Future cases will determine when harms to other facets of “the public interest” are serious enough to warrant the setting aside of the rates set by those contracts.