MO Pub Svc Cmsn v. FERC

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued May 6, 2003 Decided August 12, 2003

No. 02-1132

MISSOURI PUBLIC SERVICE COMMISSION,

PETITIONER

v.

FEDERAL ENERGY REGULATORY COMMISSION,

RESPONDENT

ENBRIDGE PIPELINES, ET AL.,

INTERVENORS

On Petition for Review of an Order of the

Federal Energy Regulatory Commission

John E. McCaffrey argued the cause for petitioner. With

him on the brief was David W. D’Alessandro. Kelly A. Daly

entered an appearance.

Lona T. Perry, Attorney, Federal Energy Regulatory

Commission, argued the cause for respondent. With her on

Bills of costs must be filed within 14 days after entry of judgment.

The court looks with disfavor upon motions to file bills of costs out

of time.

2

the brief were Cynthia A. Marlette, General Counsel, and

Robert H. Solomon, Deputy Solicitor.

James P. White and William A. Williams were on the

brief for intervenor Enbridge Pipelines.

Before: EDWARDS, SENTELLE, and GARLAND, Circuit Judges.

Opinion for the court filed by Circuit Judge GARLAND.

GARLAND, Circuit Judge: For the second time, petitioner

Missouri Public Service Commission seeks review of initial

rates approved by the Federal Energy Regulatory Commis-

sion (FERC) for natural gas transportation by the Kansas

Pipeline Company. On the last occasion, we rejected as

arbitrary and capricious the reasons FERC gave for approv-

ing the challenged rates. On remand, the Commission reaf-

firmed the same rates, albeit emphasizing different rationales.

We once again find FERC’s reasoning arbitrary and capri-

cious. Accordingly, we vacate its orders and remand the case

for further proceedings consistent with this opinion.

I

The lengthy and complex procedural history of this case is

explained in detail in the FERC orders under review, and in

our previous opinion, Missouri Public Service Commission v.

FERC, 234 F.3d 36 (D.C. Cir. 2000) [hereinafter Missouri I].

We provide only a brief summary here.

The Natural Gas Act (NGA) grants FERC jurisdiction over

the transportation of natural gas in interstate commerce. 15

U.S.C. § 717(b); see also 42 U.S.C. § 7172(a)(1)(C). Section

7 of the NGA bars the ‘‘transportation or sale of natural gas[ ]

subject to the jurisdiction of [FERC],’’ except under a ‘‘certif-

icate of public convenience and necessity issued by the Com-

mission.’’ 15 U.S.C. § 717f(c)(1)(A). The section further

gives the Commission the ‘‘power to attach to the TTT certifi-

cate TTT such reasonable terms and conditions as the public

convenience and necessity may require.’’ Id. § 717f(e). Un-

der that authority, FERC employs a ‘‘public interest’’ stan-

dard to determine the initial rates that a pipeline may charge

for newly certificated service. See Atlantic Refining Co. v.

3

Public Serv. Comm’n, 360 U.S. 378, 391 (1959). Those initial

rates ‘‘offer a temporary mechanism to protect the public

interest until the regular rate setting provisions’’ of § 4 of the

NGA, 15 U.S.C. § 717c, come into play. Algonquin Gas

Transmission Co. v. Federal Power Comm’n, 534 F.2d 952,

956 (D.C. Cir. 1976); see Atlantic Refining, 360 U.S. at 391–

92. Section 4 requires rates to be ‘‘just and reasonable,’’ 15

U.S.C. § 717c, rather than merely in the ‘‘public interest’’ as

required by § 7. See Atlantic Refining, 360 U.S. at 390–91.

In 1995, FERC determined that three affiliated and inter-

connected natural gas pipelines of the Kansas Pipeline Com-

pany system (KPC or ‘‘Kansas Pipeline’’) constituted a single

interstate pipeline system subject to FERC jurisdiction under

the NGA. KansOk P’ship, 73 F.E.R.C. ¶ 61,160 (1995). The

Commission ordered KPC to file an application for § 7 certifi-

cation to operate the pipeline system and transport gas in

interstate commerce. In 1998, FERC approved KPC’s exist-

ing contractual rates (the ‘‘Motion Rates’’) as the pipeline’s

initial rates for service under NGA § 7, pending completion of

a rate case under NGA § 4 to determine just and reasonable

rates. See Kansas Pipeline Co., 83 F.E.R.C. ¶ 61,107 (1998)

[hereinafter 1998 Order]. The Missouri Public Service Com-

mission (‘‘Missouri PSC’’) — a Missouri agency with jurisdic-

tion to regulate rates and charges for the sale of natural gas

to consumers within the State of Missouri — sought rehear-

ing. FERC denied the rehearing request, reaffirming its

approval of the existing rates. See Kansas Pipeline Co., 87

F.E.R.C. ¶ 61,020 (1999) [hereinafter 1999 Rehearing Order].

In Missouri I, we reviewed the 1998 Order and 1999

Rehearing Order. Counsel for FERC defended the orders’

approval of the existing rates on five grounds, arguing that:

(1) approval of the existing rates ended the dispute over

whether the pipeline was properly subject to FERC’s inter-

state jurisdiction; (2) the existing rates had been negotiated

among the parties; (3) the existing rates had been approved

by KPC’s prior state regulator; (4) the existing rates pre-

served KPC’s financial integrity and prevented KPC’s bank-

ruptcy; and (5) the existing rates were lower than the rates

FERC would otherwise have approved on rehearing (the

4

‘‘Rehearing Rates’’). See Missouri I, 234 F.3d at 40. We

found that the second and third rationales (that the existing

rates had been negotiated by the parties and had been

approved by KPC’s prior regulator) could not sustain FERC’s

determination because FERC had not actually relied on those

grounds in its orders. Id. at 41 (citing SEC v. Chenery Corp.,

332 U.S. 194, 196 (1947)). We further held that, although

FERC had mentioned the first and fourth rationales (that

approval of the rates would end the jurisdictional dispute and

would preserve KPC’s financial integrity), it had done so only

in a ‘‘passing reference’’ that was ‘‘not sufficient to satisfy the

Commission’s obligation to carry out ‘reasoned’ and ‘princi-

pled’ decisionmaking.’’ Id.

That left only the fifth rationale, which we regarded as the

Commission’s ‘‘primary reason’’ for approving the existing

rates: the argument that those rates were lower than the

rates that FERC would otherwise have approved had it

granted a rehearing. Id. at 42. We rejected that rationale

as well, finding that the Commission had not even attempted

to defend its computation of the rates it would otherwise have

approved — a fact that made it impossible for us to accept

the use of those rates as a benchmark for comparing the

existing rates. Id. Ruling that ‘‘FERC ha[d] not adequately

explained how the rationales, alone or together, satisfy the

‘public interest’ standard of section 7,’’ we remanded to the

agency for further proceedings. Id. We noted, however,

that with proper support, some of the rationales found want-

ing in Missouri I might serve as justifications for § 7 rates in

an appropriate case. Id.

On remand, the Commission reaffirmed the rates that it

had initially approved in its 1998 Order. See Kansas Pipe-

line Co., 97 F.E.R.C. ¶ 61,168 (2001) [hereinafter 2001 Re-

mand Order]. In so doing, FERC abandoned the primary

justification it had offered in Missouri I and turned to an

array of other rationales. 2001 Remand Order, 97 F.E.R.C.

at 61,779, 61,784–85. Missouri PSC sought rehearing, which

FERC denied in 2002. See Kansas Pipeline Co., 98 F.E.R.C.

¶ 61,343, at 62,457 (2002) [hereinafter 2002 Rehearing Order].

The 2002 Rehearing Order clarified the Commission’s reason-

5

ing, listing three supporting rationales. According to the

Commission, approval of the existing rates: (1) preserved

KPC’s financial integrity, by ensuring compliance with a

condition of a major loan agreement; (2) was fair to KPC’s

shippers because those rates had been negotiated by the

shippers and approved under the prior state regulatory re-

gime; and (3) would resolve the jurisdictional issue, because

KPC had agreed to drop its challenge to FERC’s jurisdiction

if the existing rates were adopted. See 2002 Rehearing

Order, 98 F.E.R.C. at 62,457.

Missouri PSC filed a timely petition for review, and En-

bridge Pipelines, the successor to KPC, intervened in support

of FERC’s decision. In the meantime, FERC has completed

§ 4 proceedings for the pipeline, and the § 4 rates — which

are substantially lower than the rates that FERC approved

under § 7 — have gone into effect. Our decision in this case,

therefore, will have no prospective effect; it will determine

only whether KPC’s customers were overcharged and wheth-

er FERC should consider a refund for the rates assessed

during the interim period.

II

We review FERC’s orders under the arbitrary or capri-

cious standard of the Administrative Procedure Act, 5 U.S.C.

§ 706(2)(A). Missouri I, 234 F.3d at 40.1 To satisfy that

1 We reject at the outset Enbridge Pipeline’s contention that we

are without jurisdiction to consider Missouri PSC’s argument that

FERC erred in ‘‘depart[ing] from cost-based ratemaking policies,’’

because the petitioner failed ‘‘to urge the issue’’ adequately in its

request for rehearing before the Commission. Intervenor’s Br. at

8; see 15 U.S.C. § 717r(b) (‘‘No objection TTT shall be considered by

the court unless such objection shall have been urged before the

Commission in the application for rehearing unless there is reason-

able ground for failure so to do.’’). Examination of petitioner’s

application for rehearing makes clear that it did adequately raise

the issue. See, e.g., Joint Req. for Reh’g, at 1 (Dec. 10, 2001) (J.A.

at 1125) (protesting the Commission’s ‘‘extraordinary’’ departure

‘‘from its cost-based ratemaking policies’’); id. at 2 (J.A. at 1126)

6

standard, there must be ‘‘a rational connection between the

facts found and the choice made’’ by the Commission. Id.

(internal quotation marks omitted). FERC must ‘‘articulate

the critical facts upon which it relies,’’ and when it ‘‘finds it

necessary to make predictions or extrapolations from the

record, it must fully explain the assumptions it relied on to

resolve unknowns and the public policies behind those as-

sumptions.’’ Id. (quoting Columbia Gas Transmission Corp.

v. FERC, 628 F.2d 578, 593 (D.C. Cir. 1979)). Similarly,

when ‘‘the Commission balances competing interests in arriv-

ing at its decision, it must explain on the record the policies

which guide it.’’ Id. (quoting Columbia Gas, 628 F.2d at 593).

Finally, the Commission’s factual findings are ‘‘conclusive’’ if,

but only if, they are ‘‘supported by substantial evidence’’ in

the record. NGA § 19(b), 15 U.S.C. § 717r(b).

There is no dispute that the ‘‘public interest’’ standard of

NGA § 7 is less exacting than the ‘‘just and reasonable’’

requirement of § 4. See Atlantic Refining, 360 U.S. at 390–

91. But both the Supreme Court and this circuit have made

clear that the Commission has a duty to use its § 7 power to

protect consumers. See id. (‘‘[T]he inordinate delay TTT in

the processing of § 5 proceedings requires a most careful

scrutiny and responsible reaction to initial price proposals of

producers under § 7.’’); Consumer Fed’n of Am. v. Federal

Power Comm’n, 515 F.2d 347, 356 (D.C. Cir. 1975) (declaring

that ‘‘preservation of the statutory scheme depends on dili-

gent enforcement of the § 7 certification requirement as a

holding operation on initial rates’’). Indeed, the Commis-

sion’s ‘‘usual practice in Section 7 certificate proceedings’’ is

to ‘‘apply[ ], to the extent practicable, the same ratemaking

policies that it applies in Section 4 rate cases in determining

just and reasonable rates on a cost of service basis.’’ 2001

Remand Order, 97 F.E.R.C. at 61,785; see Maritimes &

Northeast Pipeline, L.L.C., 84 F.E.R.C. ¶ 61,130, at 61,683

(1998).

(arguing that ‘‘[n]one of [FERC’s arguments] TTT justify the Com-

mission’s admitted departure’’ from these policies).

7

FERC correctly noted that ‘‘ ‘non-cost’ public interest fac-

tors may justify the Commission’s departure from its usual

cost-based approach to setting rates.’’ 2001 Remand Order,

97 F.E.R.C. at 61,786–87 (citing FERC v. Pennzoil Prods.

Co., 439 U.S. 508, 517–18 (1979)). ‘‘The mere invocation of a

non-cost factor, however, does not alleviate a reviewing court

of its duty to assure itself that the Commission has given

reasoned consideration to each of the pertinent factors.’’

Farmers Union Cent. Exch., Inc. v. FERC, 734 F.2d 1486,

1502 (D.C. Cir. 1984) (citing Pennzoil, 439 U.S. at 518). ‘‘On

the contrary,’’ deviations from the Commission’s customary

cost-based approach, like departures from any agency’s usual

policy, must be ‘‘found not to be unreasonable and to be

consistent with the Commission’s TTT responsibility.’’ Id. In

short, FERC ‘‘must specify the nature of the relevant non-

cost factor and offer a reasoned explanation of how the factor

justifies the resulting rates.’’ Id.

Missouri PSC contends, and FERC does not dispute, that

in this case the Commission did depart from its customary

practice of basing § 7 rates on cost-based principles. See

Petitioner’s Br. at 25; 2001 Remand Order, 97 F.E.R.C. at

61,784–85. The Commission argues that it did so, however,

because KPC’s pipeline presented ‘‘unique circumstances’’:

unlike the pipelines in typical § 7 cases, ‘‘the Kansas Pipeline

[was] neither a [newly constructed] pipeline, nor an existing

company operating under a FERC-regulated tariff.’’ 2002

Rehearing Order, 98 F.E.R.C. at 62,456. According to

FERC, the three rationales set forth in its 2002 Rehearing

Order respond to these unique circumstances and justify its

decision to grandfather KPC’s existing rates rather than

adhere to its usual cost-based ratemaking principles. Id. at

62,457.

We consider the first two of FERC’s rationales below.

Because we find them insufficient to sustain FERC’s orders,

we have no reason to consider the third — that approval of

the existing rates would resolve the dispute over FERC’s

jurisdiction. The Commission made clear that it ‘‘would not

8

have approved the [existing] rates simply to resolve the

jurisdictional issue,’’ 2002 Rehearing Order, 98 F.E.R.C. at

62,460, and as a consequence we may not affirm the agency’s

orders on that basis, see SEC v. Chenery Corp., 318 U.S. 80,

87–88, 93–95 (1943).

III

In its post-Missouri I orders, FERC’s primary rationale

for concluding that the existing rates were in the public

interest was that they preserved KPC’s financial integrity by

ensuring compliance with a condition of a major loan agree-

ment. The loan in question was a $91 million loan obtained

by KPC’s affiliate, Syenergy Pipeline Company (the ‘‘Syener-

gy loan’’). See 2001 Remand Order, 97 F.E.R.C. at 61,788.

The loan agreement contained a covenant requiring KPC to

maintain a minimum Debt Service Coverage Ratio (DSCR) of

1.00 to 1.15.2 See id. at 61,785. According to FERC, the

approved rates were necessary to ensure KPC sufficient

revenues to maintain the DSCR ‘‘with a reasonable margin of

safety.’’ Id. at 61,789.

For the two reasons discussed below, we conclude that this

was an arbitrary and capricious rationale for approving

KPC’s existing rates under NGA § 7.

A

The Commission first addressed the Syenergy loan in 1998,

when it was considering KPC’s initial request for interim

rates under § 7. At that time, FERC flatly rejected KPC’s

argument that it should approve rates sufficient to cover the

debt service on the loan. FERC’s conclusion was set forth in

harshly worded language, which we quote at length because

of its importance to the present case:

2 ‘‘The DSCR is calculated by dividing the loan applicant’s net

operating income by its total debt service obligations, including

principal and interest, on all loans on the property serving as

security.’’ 2001 Remand Order, 97 F.E.R.C. at 61,785 n.37.

9

First, we can find no nexus between the value of the

facilities and the size of the Syenergy primary loanTTTT

[W]e can find nothing in the record to account for how

the $91 million was actually used. Further, TTT the main

purpose of the loan was to allow Syenergy to purchase

99.9 percent of the pipeline interests of Kansas Pipeline

Partnership, KansOk, and Riverside. Since Syenergy

[and the other three] ultimately are owned by the same

entity, it would appear that this transaction is not at

arms-length. In essence, the company borrowed $91

million to purchase itself, at a price which it set, with no

apparent nexus between the value of the facilities and

the amount of the loan. The argument put forth now is

that the rate base should be raised artificially, and rates

set accordingly, so that the applicant can make payments

on the primary loan. Absent a nexus between the loan

amount and the value of the facilities, and given the lack

of arms-length negotiations due to the affiliate nature of

those involved, we are not persuaded by the argument

that, because of the [Kansas Corporation Commission]

accounting order, we are required by law to ensure that

the rates are sufficient to sustain the loan provisions.

1998 Order, 83 F.E.R.C. at 61,507 (emphasis added; footnote

omitted). The Commission’s refusal to rest its 1998 approval

of KPC’s rates on the rationale that they were necessary to

satisfy the Syenergy loan — which had ‘‘no nexus’’ to the

value of the facilities used to provide service to the ratepay-

ers — was completely consistent with FERC’s usual cost-

based approach to ratesetting.3

3 Cf. K N Energy, Inc. v. FERC, 968 F.2d 1295, 1300–01 (D.C.

Cir. 1992) (noting that ‘‘it has been traditionally required that all

approved rates reflect to some degree the costs actually caused by

the customer who must pay them’’); Alabama Elec. Coop., Inc. v.

FERC, 684 F.2d 20, 27 (D.C. Cir. 1982) (noting that ‘‘[p]roperly

designed rates should produce revenues from each class of custom-

ers which match, as closely as practicable, the costs to serve each

class or individual customer’’); Tennessee Gas Pipeline Co. v.

FERC, 606 F.2d 1094, 1109 (D.C. Cir. 1979) (stating that ‘‘current

10

But after Missouri I rejected the rationale upon which

FERC did rest its 1998 Order, FERC reversed course and

adopted the Syenergy loan’s DSCR provision as the primary

basis for its 2001 Remand Order. No new facts prompted the

Commission’s change of heart. To the contrary, in its re-

quest for rehearing, Missouri PSC submitted a spreadsheet

prepared by KPC that demonstrated not just the absence of a

nexus between the loan proceeds and the jurisdictional facili-

ties, but that more than $7 million of the proceeds was used

to pay stockholder and partnership distributions, and that

over $3 million was wholly unaccounted for. See Joint Req.

for Reh’g, attach. A (J.A. at 1158–59). Nor did the Commis-

sion suggest that its reversal was due to a reevaluation of any

previously considered facts. Although FERC acknowledged

its earlier concerns,4 it concluded that ‘‘[r]egardless of the

issues surrounding the underlying loan obligation, the loan

was a legally binding obligation containing a condition which,

if not met, would cause certain default.’’ Id. at 61,788–89.

The first part of this explanation, that ‘‘the loan was a

legally binding obligation,’’ can hardly be sufficient. The

point of FERC’s cost-based ratemaking policy is that pipeline

expenditures that do not benefit a pipeline’s customers —

whether or not the expenditures are legally binding — nor-

mally should not be the basis of the rates those customers

pay. Otherwise, a pipeline could embark upon a perfectly

legal and economically prudent diversification program into

non-pipeline businesses, and bill the pipeline’s customers for

the cost of those investments. Or, as here, a pipeline could

borrow money in order to make cash distributions to its

rate payers should bear only legitimate costs of providing service to

them’’).

4 See 2001 Remand Order, 97 F.E.R.C. at 61,788 (‘‘It is true that

the April 1998 Order in this proceeding found that Kansas Pipe-

line’s loan commitments did not appear to be the product of

transactions conducted at arms’ length, since they involved affili-

ates, and the loan was greater than the net depreciated value of the

pipeline facilities of the three pipelines found to constitute Kansas

Pipeline’s jurisdictional interstate system.’’).

11

partners, and recover the cost of those payments from ship-

pers and consumers.

Nor was it sufficient that the DSCR condition, ‘‘if not met,

would cause certain default,’’ because mere default — without

subsequent action by the lender — could well have no conse-

quence. Acknowledging this point, FERC further elaborated

by stating: ‘‘In that situation the lender could foreclose on

Kansas Pipeline’s pipeline facilities, since the Kansas commis-

sion had approved the lender’s placement of a lien on those

assets. Kansas Pipeline, therefore, could be forced into

bankrupty and potentially out of business.’’ Id. at 61,789

(emphasis added). But the number of qualifiers in this

theoretical chain of events renders it a weak rationale for the

imposition of the existing rates. When FERC ‘‘finds it

necessary to make predictions or extrapolations from the

record, it must fully explain the assumptions it relied on to

resolve unknowns and the public policies behind those as-

sumptions.’’ Missouri I, 234 F.3d at 40 (quoting Columbia

Gas, 628 F.2d at 593). It has not done so here.

The first link in the chain, FERC’s concern that default

‘‘could’’ lead to foreclosure, was unaccompanied by any sug-

gestion that foreclosure was likely. To the contrary, the

‘‘Commission recognize[d]’’ — just as it did in rejecting

reliance on the Syenergy loan in 1998 — ‘‘that, since long

term interest rates were in the 6 percent range when the

April 1998 Order approved Kansas Pipeline’s motion rates,

the 9.5 percent loan secured by Kansas Pipeline’s facilities

would not necessarily be recalled by the holder simply be-

cause Kansas Pipeline’s DSCR dipped below the loan[’s] TTT

DSCR default provision.’’ 2001 Remand Order, 97 F.E.R.C.

at 61,789; see 1998 Order, 83 F.E.R.C. at 61,507 n.18. Al-

though this interest rate differential was a strong reason for

concluding that violation of the DSCR alone likely would not

lead to foreclosure, FERC dismissed the point with the

statement that ‘‘there was no assurance that financial market

conditions would not change.’’ 2001 Remand Order, 97

F.E.R.C. at 61,789. But the truism that market conditions

may change in the future does not give the Commission a

license to ignore the present — at least not without some

12

assessment of the likelihood that such a change will occur.

Moreover, FERC’s 2001 decision to discount the effect of the

interest rate differential on the lender’s likely reaction was an

unexplained reversal of its reliance on precisely that differen-

tial in refusing to rest the 1998 Order on the Syenergy loan.

See 1998 Order, 83 F.E.R.C. at 61,507 n.18. This unexplained

reversal was itself arbitrary and capricious. See Baton

Rouge Marine Contractors, Inc. v. Federal Mar. Comm’n,

655 F.2d 1210, 1214–15 (D.C. Cir. 1981).

The second link in FERC’s chain, that foreclosure could

lead to forced bankruptcy, was equally speculative. The most

the Commission could say was that ‘‘the potential TTT clearly

existed.’’ 2002 Rehearing Order, 98 F.E.R.C. at 62,456. And

the third link, that bankruptcy could put the pipeline out of

business, was similarly unaccompanied by any measure of its

likelihood. Indeed, FERC acknowledged that ‘‘a reorganiza-

tion in bankruptcy could have been beneficial for Kansas

Pipeline and its customers,’’ id., but never explained how it

balanced that potentially positive outcome against the nega-

tive possibilities upon which it relied.

The analytical weakness of FERC’s orders is made mani-

fest by contrasting them to the principal precedent upon

which the Commission relied. In Jersey Central Power &

Light Co. v. FERC, 810 F.2d 1168 (D.C. Cir. 1987) (en banc),

this court vacated a FERC order that required an electric

utility (Jersey Central) to file reduced rates based on the

Commission’s decision that the unamortized portion of the

utility’s unproductive investment in a nuclear generating sta-

tion should be excluded from the rate base.5 Unlike KPC’s

Syenergy loan, however, Jersey Central’s investment in the

generating station was concededly ‘‘prudent when made,’’ as

an effort to meet the projected needs of the utility’s custom-

ers. Id. at 1171; see also id. at 1181. Also in contrast to this

case, in which the parties cite no record evidence of the

5 Jersey Central was decided under the ‘‘just and reasonable’’

standard of § 205 of the Federal Power Act, 16 U.S.C. § 824d, a

provision analogous to NGA § 4. See Jersey Central, 810 F.2d at

1175.

13

likelihood of KPC’s financial ruin, Jersey Central had submit-

ted substantial evidence of its financial fragility and of the

fact that the requested rates were the minimum ‘‘necessary to

preserve [the] company’s TTT financial integrity.’’ Id. at

1172.6

We agree with the Commission that it was obligated ‘‘to

consider the impact the initial rates would have on Kansas

Pipeline’s financial integrity.’’ 2002 Rehearing Order, 98

F.E.R.C. at 62,458. See generally Federal Power Comm’n v.

Hope Natural Gas Co., 320 U.S. 591, 603 (1944); Jersey

Central, 810 F.2d at 1177–78, 1182. But FERC’s orders cite

no evidence regarding the effect a default on the DSCR

provision would have on the pipeline’s financial integrity.

And they are equally devoid of any indication that the Com-

mission balanced that factor against the costs of requiring

customers to pay rates to cover a loan, the size of which bears

no nexus to the value of the facilities that benefit those

customers. Accordingly, we find FERC’s determination to be

both arbitrary and unsupported by substantial evidence. See

Missouri I, 234 F.2d at 42 (‘‘In reviewing a rate order courts

must determine whether or not the end result of that order

constitutes a reasonable balancing, based on factual findings,

of the investor interest in maintaining financial integrity and

access to capital markets and the consumer interest in being

charged non-exploitative rates.’’ (quoting Jersey Central, 810

F.2d at 1177–78)).

B

FERC’s decision to approve rates sufficient to meet the

requirements of the Syenergy loan’s DSCR provision was

arbitrary for another reason: by the time the Commission

6 See also id. at 1171 (discussing testimony regarding the utility’s

low credit rating); id. at 1178 (discussing testimony on the possible

drying-up of the utility’s credit sources, and on its long-term

inability to pay common stock dividends); id. at 1188 (Starr, J.,

concurring) (noting that the utility’s ‘‘allegations of financial plight

were highly detailed and specific, indicating that the utility was

skating on the edge of bankruptcy’’).

14

offered that rationale, the Syenergy loan had been fully

repaid. Indeed, the loan was repaid in November 1999 when

Midcoast Energy Resources, Inc. acquired KPC — a full two

years before FERC relied on the DSCR provision as a

rationale for its November 2001 Remand Order. See 2002

Rehearing Order, 98 F.E.R.C. at 62,458; see also Enbridge

Pipelines, 100 F.E.R.C. ¶ 61,260, at 61,930, 61,961 (2002).7

Nonetheless, FERC argued that ‘‘whenever the Commission

sets initial rates there is always a possibility that the nature

of a loan arrangement or other financial circumstances might

change before initial rates are superceded by Section 4 rates.’’

2002 Rehearing Order, 98 F.E.R.C. at 62,458. Accordingly,

the Commission concluded, it was appropriate for it to rely on

remand upon ‘‘the record that the Commission had at the

time it issued its underlying TTT 1998 Order,’’ at which time

‘‘Kansas Pipeline was still subject to the Syenergy loan.’’ Id.

FERC’s argument might be persuasive if Missouri PSC’s

charge were that unanticipated financial changes had under-

cut FERC’s previous rationale — although even then FERC

would have had to articulate a nonarbitrary reason for ignor-

ing those new facts.8 Missouri’s complaint, however, was not

that new facts had undercut an old rationale, but that FERC

had adopted a new rationale premised on old facts that were

no longer true. The need to satisfy the Synergy loan’s DSCR

provision was not a rationale for the 1998 and 1999 orders

that approved KPC’s existing rates. Insofar as those orders

discussed concern over KPC’s financial integrity at all, they

did so only as a ‘‘passing reference,’’ Missouri I, 234 F.3d at

41, a reference that expressly did not rely on the DSCR

provision, see 1998 Order, 83 F.E.R.C. at 61,507 (stating that

the Commission was not relying on the DSCR provision

7 Midcoast, in turn, was purchased by the intervenor, Enbridge,

on May 11, 2001. See Enbridge Pipelines, 100 F.E.R.C. at 61,930.

8 See 18 C.F.R. § 385.716 (allowing FERC to reopen the record if

‘‘warranted by any changes in conditions of fact or of law or by the

public interest’’); see also Eastern Carolinas Broad. Co. v. FCC,

762 F.2d 95, 103 (D.C. Cir. 1985) (stating that agency decisions not

to reopen the record are normally reviewed for abuse of discretion).

15

because FERC’s approval of the existing rates rendered that

issue ‘‘effectively moot’’). The first time FERC relied on the

DSCR provision was in the post-Missouri I order that it

issued in November 2001. Thus, at the time FERC first

announced that the existing rates were necessary to prevent

both a default on the DSCR provision and the financial

disaster that might follow, the Commission knew full well that

there was no possibility that either event could occur. Reli-

ance on facts that an agency knows are false at the time it

relies on them is the essence of arbitrary and capricious

decisionmaking. Requiring Missouri consumers to pay rates

sufficient to prevent foreclosure on a loan that no longer

exists is at least equally so.9

IV

FERC’s orders offered a second, two-part rationale for

approving KPC’s rates: they ‘‘were in the public interest and

not exploitative of KPC’s shippers because those rates had

been [1] negotiated by those shippers, and [2] approved by

the prior regulatory regime.’’ Respondent’s Br. at 34. We

reject these grounds as arbitrary and capricious as well.

The fact that the existing rates had been negotiated by the

pipeline’s shippers is insufficient to support FERC’s orders

for two reasons. First, although FERC is correct that we

have ‘‘required the Commission to give weight to the con-

tracts and settlements of the parties before it,’’ Missouri I,

234 F.3d at 120 (quoting Tejas Power Corp. v. FERC, 908

F.2d 998, 1003 (D.C. Cir. 1990)), we have also made clear that

‘‘[e]ven when customer support is unanimous, TTT FERC

retains the responsibility of making an ‘independent judg-

ment,’ ’’ Laclede Gas Co. v. FERC, 997 F.2d 936, 946 (D.C.

Cir. 1993) (quoting Tejas Power, 908 F.2d at 1003). As we

9 At oral argument, counsel for the Commission suggested that,

even though the Syenergy loan had been paid off before the 2001

Remand Order, other costs might have increased in the interim.

But the Commission did not point to any evidence of such increased

costs, and counsel’s speculation cannot salvage FERC’s decision.

16

said in Tejas Power, this means that before relying on

existing contracts between a pipeline and its customers to

show that rates are reasonable, FERC must ‘‘first deter-

min[e], upon the basis of substantial evidence, that the pipe-

line lacks significant market power.’’ 908 F.2d at 1004. And

it also means that before relying on contracts between a

pipeline and its wholesale customers, FERC must ‘‘address

the question of whether’’ the interests of those customers

‘‘are sufficiently likely to be congruent with those of ultimate

consumers,’’ id. at 1004, ‘‘who, presumably, will bear the cost’’

of the agreed-upon rates in their monthly energy bills, id. at

1003. See Atlantic Refining, 360 U.S. at 390. The orders

under review in this case do not consider these relevant

factors and are therefore arbitrary and capricious. See

Northern Mun. Distribs. Group v. FERC, 165 F.3d 935, 941

(D.C. Cir. 1999).

Second, there is a serious problem with the factual premise

that the existing rates were those to which the shippers had

agreed. The contract of one of KPC’s principal shippers,

Missouri Gas Energy (MGE), makes clear that although that

shipper agreed to live with the contractual rates, it was

willing to do so only until FERC exercised jurisdiction in a

§ 7 order. According to the contingency provision of MGE’s

Riverside I contract, the contract rates were to be ‘‘ ‘adjusted

upwards or downwards, as may be the case, by the difference,

if any, between the rate [initially agreed to by the parties]

and the rate approved by such [Commission] order.’ ’’ Initial

Comments of MGE, at 10 (Nov. 26, 1997) (J.A. at 787)

(quoting contract). If FERC wishes to rely upon the rates

for which the parties bargained, it must consider their entire

bargain.10

10Missouri PSC does not argue, as FERC charges, that ‘‘a

contingency provision in a customer contract TTT could limit

FERC’s discretion in setting initial § 7 rates.’’ Respondent’s Br. at

18. Rather, it argues that if FERC wants to rely on an existing

contract to establish the reasonableness of a rate, it may not ignore

a contingency provision of the same contract. We agree.

17

Finally, the Commission’s decision is not rescued by the

fact that the rates FERC adopted had been approved by the

Kansas Corporation Commission (KCC) under the regulatory

regime that governed the pipeline prior to FERC’s assertion

of jurisdiction. Again, we do not disagree that ‘‘this Court

has directed that FERC consider the role of state regulators

in protecting the ultimate consumer.’’ Respondent’s Br. at 35

(citing Tejas Power, 908 F.2d at 1004). But the Commission

must nonetheless determine ‘‘in its independent judgment,’’

whether the terms approved by the KCC meet the public

convenience and necessity. Tejas Power, 908 F.2d at 1003

(emphasis added).

When FERC relies upon a state agency’s prior approval to

support the conclusion that rates are in the public interest,

the Commission must at least say something about the prior

regulator’s rationale for approving those rates. In this case,

FERC said nothing. And to the extent that we know any-

thing about the KCC’s views, what we know is not helpful to

the Commission. First, although we know that the KCC

approved the Syenergy loan, FERC’s 1998 Order expressly

rejected Kansas Pipeline’s argument that such approval justi-

fied FERC approval as well:

Kansas Pipeline argues that the Commission must ap-

prove rates which are sufficient to cover the debt service

[on the Syenergy loan], since these cost and debt instru-

ments were approved by the KCC. The Commission is

not persuaded by the applicant’s argumentsTTTT While

the KCC accounting order states that portions of the

funds would be used to upgrade pipeline assets, TTT we

can find nothing in the record to account for how the $91

million was actually used.

1998 Order, 83 F.E.R.C. at 61,506–07. Second, we also know

that in the request for rehearing below, the KCC joined

Missouri PSC in arguing against approval of the existing

rates, insisting that FERC ‘‘should not have relied on [the]

DSCR loan provision in approving initial rates in this case in

light of the facts that there was no nexus between the amount

of the loan and the cost of the Kansas Pipeline facilities, and

18

that Kansas Pipeline had not adequately accounted for the

loan proceeds.’’ 2002 Rehearing Order, 98 F.E.R.C. at

62,458.

In sum, FERC may not brandish a state’s prior approval of

a set of existing rates as if it were independently sufficient to

satisfy the Commission’s own regulatory obligations. Section

7 imposes a duty on FERC to determine for itself whether

the rates it approves are in the public interest. The Commis-

sion has not complied with that responsibility.

V

For the foregoing reasons, we conclude that the challenged

FERC orders are arbitrary and capricious. As this is the

second time that FERC has failed to justify its approval of

KPC’s existing rates, we vacate those orders.

Missouri Public Service has requested that we also ‘‘direct

the Commission to refund, with interest, the difference be-

tween properly calculated initial rates and the [approved]

rates,’’ from December 2, 1997, through the date the NGA

§ 4 rates went into effect. Petitioner’s Br. at 58. At oral

argument, FERC counsel did not dispute that the Commis-

sion would have authority to require such a refund if we

vacated its orders. See also United Gas Improvement Co. v.

Callery Props., 382 U.S. 223, 229–30 (1965); Public Serv.

Comm’n v. Federal Power Comm’n, 329 F.2d 242, 250 (D.C.

Cir. 1964). Although we do not see any reason why a refund

would not be in order at this point, the Commission has not

yet addressed the question. And we could not, in any event,

calculate the appropriate amount of a refund on our own.

Accordingly we vacate FERC’s 2001 Remand Order and 2002

Rehearing Order, and remand with directions that the Com-

mission address the question of an appropriate refund.

So ordered.