BP W Coast Prod v. FERC

Notice: This opinion is subject to formal revision before publication in the

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 12, 2003 Decided July 20, 2004

No. 99-1020

BP WEST COAST PRODUCTS, LLC,

PETITIONER

v.

FEDERAL ENERGY REGULATORY COMMISSION AND

UNITED STATES OF AMERICA,

RESPONDENTS

SFPP, L.P., ET AL.,

INTERVENORS

Consolidated with

99-1051, 00-1221, 00-1240, 00-1256, 01-1413, 01-1453,

01-1469, 01-1475, 02-1008, 02-1011, 02-1321

On Petitions for Review of Orders of the

Federal Energy Regulatory Commission

R. Gordon Gooch argued the cause for West Line Shippers.

With him on the briefs were Elisabeth R. Myers, D. Jane

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

Drennan, George L. Weber, Marcus W. Sisk, Jr., Steven A.

Adducci, and Richard E. Powers, Jr.

Steven H. Brose argued the cause for petitioner SFPP, L.P.

With him on the briefs were Timothy M. Walsh, Daniel J.

Poynor, Alice E. Loughran, Albert S. Tabor, Jr., and Charles

F. Caldwell.

Thomas J. Eastment argued the cause for East Line

Shippers on Cost Allocation Issues. With him on the briefs

were Joshua B. Frank, Michael J. Manning, and Glenn S.

Benson.

Thomas J. Eastment, Joshua B. Frank, Michael J. Man-

ning, George L. Weber, R. Gordon Gooch, Elisabeth R.

Myers, Richard E. Powers, Jr., Steven A. Adducci, and

Marcus W. Sisk, Jr. were on the brief for petitioners and

intervenors supporting petitioners on Rate and Reparations

Issues.

Dennis Lane, Solicitor, Federal Energy Regulatory Com-

mission, and Lona T. Perry, Attorney, argued the causes for

respondents. With them on the brief were Robert H. Pate

III, Assistant Attorney General, U.S. Department of Justice,

John J. Powers, III and Robert J. Wiggers, Attorneys, Cyn-

thia A. Marlette, General Counsel, Federal Energy Regulato-

ry Commission. Jay L. Witkin, Solicitor, and Susan J.

Court, Special Counsel, entered appearances.

Thomas J. Eastment, Joshua B. Frank, Michael J. Man-

ning, George L. Weber, R. Gordon Gooch, Elisabeth R.

Myers, Richard E. Powers, Jr., Steven A. Adducci, and

Marcus W. Sisk, Jr. were on the brief of Shipper intervenors

in support of respondents.

Steven H. Brose, Timothy M. Walsh, Daniel J. Poynor,

Alice E. Loughran, Albert S. Tabor, Jr. and Charles F.

Caldwell were on the brief of SFPP, L.P. as intervenor in

support of respondents.

3

Before: SENTELLE, ROGERS, and ROBERTS, Circuit Judges.

Opinion for the Court filed PER CURIAM.

INTRODUCTION

The consolidated petitions before us seek review of four

opinions of the Federal Energy Regulatory Commission

(‘‘FERC’’ or ‘‘the Commission’’):

1. SFPP, L.P., Opinion No. 435, 86 FERC ¶ 61,022 (1999)

(‘‘Opinion No. 435’’);

2. SFPP, L.P., Opinion No. 435–A, 91 FERC ¶ 61,135

(2000) (‘‘Opinion No. 435–A’’);

3. SFPP, L.P., Opinion No. 435–B, 96 FERC ¶ 61,281

(2000) (‘‘Opinion No. 435–B’’); and

4. SFPP, L.P., 97 FERC ¶ 61,138 (2001) (‘‘Clarification

and Rehearing Order’’).

In these opinions FERC considered the tariffs of SFPP, L.P.,

and complaints and other filings by shipper customers of

SFPP. SFPP, L.P., both a petitioner and an intervenor-

respondent in the consolidated dockets, operates pipelines

that transport petroleum products in Texas, New Mexico,

Arizona, California, Nevada, and Oregon. SFPP’s operation

includes a West Line and an East Line. The West Line

consists of pipelines extending from Watson Station in Los

Angeles, California, into Arizona to Phoenix and Tucson, and

connects at Colton, California, with another pipeline system

extending to Las Vegas. SFPP’s East Line consists of

pipelines from El Paso, Texas to Tucson and Phoenix. The

orders under review consider, set, and otherwise govern rates

on both lines. We consider three separate sets of petitions:

the petition of SFPP, L.P.; the petition of the West Line

Shippers (‘‘WLS’’); and the petition of the East Line Ship-

pers (‘‘ELS’’). Petitioners and Intervenors include the fol-

lowing: BP West Coast Products LLC (‘‘BP WCP’’; formerly

ARCO Products Company); Chevron Products Company

(‘‘Chevron’’; including the former Texaco Refining and Mar-

keting, Inc.); ConocoPhillips Company (‘‘ConocoPhillips’’);

ExxonMobil Oil Corporation (‘‘ExxonMobil’’; formerly Mobil

Oil Corporation); Navajo Refining Company, L.P. (‘‘Navajo’’);

4

Western Refining Company, L.P. (‘‘Western’’); Ultramar Inc.

(‘‘Ultramar’’); Valero Energy Corporation (‘‘VEC’’); Valero

Marketing and Supply Company (‘‘Valero’’); and SFPP, L.P.

(‘‘SFPP’’).

The administrative proceedings before FERC began with

tariff filings by SFPP for both East and West Lines. The

lengthy, complex, and convoluted proceedings that followed

included complaints and/or protests filed by shippers on the

two lines, as well as investigation into SFPP’s tariff filings by

FERC’s Oil Pipeline Board. The issues are further compli-

cated by novelty in that this is the first oil pipeline case in

which the ‘‘changed circumstances’’ standard of the Energy

Policy Act of 1992 (‘‘EPAct’’) has arisen for litigation. Ener-

gy Policy Act of 1992, Pub. L. No. 102–486, 106 Stat. 2776

(codified as 42 U.S.C. §§ 1320–556 (2003)). While we will not

detail the administrative proceedings before FERC’s adminis-

trative law judge and the full Commission as we discuss them

at length in the analyses that follow, we note that issues

presented for review include, among other things, the impor-

tant question of application of the grandfathering principle

under the new EPAct, the allocation of litigation costs be-

tween the East and West Lines, tax pass-through problems

involving non-taxed subsidiaries of taxable entities, the pay-

ment of reparations after a finding of unjust or unreasonable

rates, and the correct determination of capital structure to

determine a starting rate base. The reader is duly warned.

For reasons set forth more fully below, we are able to

affirm many of FERC’s answers to specific issues, but be-

cause we find error in several fundamental areas, we order

the decisions under review vacated and remand the matter

for further proceedings consistent with this opinion.

I. The West Line

A. Grandfathering of Rates under the EPAct

Section 1803 of the EPAct limits the ability of shippers to

challenge pipeline rates in effect at the time of the enactment

of the EPAct. Section 1803 provides that any oil pipeline

5

rate that was ‘‘in effect’’ for a full year before the EPAct’s

enactment on October 24, 1992, and was not subject to

‘‘protest, investigation, or complaint’’ during that 365–day

period, is ‘‘deemed to be just and reasonable.’’ EPAct

§ 1803(a)(1). These ‘‘grandfathered’’ rates are categorically

immune from challenge in a complaint proceeding under

Section 13 of the Interstate Commerce Act (‘‘ICA’’), 49 U.S.C.

app. § 13(1) (1988) (repealed),1 except when:

(1) evidence is presented to the Commission which estab-

lishes that a substantial change has occurred after

the date of the enactment of this Act–

(A) in the economic circumstances of the oil pipeline

which were a basis for the rate; or

(B) in the nature of the services provided which

were a basis for the rate; or

(2) the person filing the complaint was under a contrac-

tual prohibition against the filing of a complaint

which was in effect on the date of enactment of this

ActTTTT

Id. § 1803(b). In the post-EPAct world, the analysis of a

pipeline rate challenge thus proceeds in two steps: first,

FERC determines whether the rate in question is grandfa-

thered; if it is, FERC then asks whether the rate falls within

either of the exceptions outlined in Section 1803(b). The

Commission may not alter a grandfathered rate that does not

fall within an exception.

1 Although the ICA was repealed in 1978, see Pub. L. No. 95–473

§ 4(b), (c), 92 Stat. 1466, 1470 (Oct. 17, 1978), FERC has ‘‘the duties

and powers related to the establishment of a rate or charge for the

transportation of oil by pipeline or the valuation of that pipeline that

were vested on October 1, 1977, in the Interstate Commerce

Commission.’’ 49 U.S.C. § 60502 (2003). The relevant version of

the ICA was, but is no longer, reprinted in the appendix to title 49

of the United States Code. Therefore, when we refer to FERC’s

authority under the ICA, we cite to the 1988 edition of the U.S.

Code, the last such edition that reprinted the ICA as it appeared in

1977.

6

B. Grandfathering of West Line Rates

The WLS contend that none of the West Line rates are

grandfathered, and further argue that even if the rates are

grandfathered, their challenges fall within the exceptions set

out in Section 1803(b). We examine each of these contentions

in turn.

1. Rate ‘‘In Effect’’ for One Year

To be eligible for grandfathering, a pipeline rate must have

been ‘‘in effect for the 365–day period ending on the date of

the enactment of this Act [October 24, 1992].’’ EPAct

§ 1803(a)(1). Thus, to be grandfathered, a rate must have

been ‘‘in effect’’ on October 25, 1991, and have remained in

effect at least until the enactment of the EPAct.

The WLS do not contest this element with regard to the

bulk of the West Line rates. Nor could they; the West Line

rates became effective in 1989 pursuant to a settlement

terminating a 1985 rate proceeding. See Opinion No. 435, 86

FERC at 61,057; Southern Pac. Pipe Lines, Inc., 45 FERC

¶ 61,242 (1988) (order approving settlement). The WLS do,

however, challenge the eligibility for grandfathering of cer-

tain improvements to the West Line made after October 1991.

a. East Hynes Origination Point

In July 1992, SFPP made revisions to its Tariffs Nos. 15,

16, and 17 to add a new origination point on its West Line —

the East Hynes station in Los Angeles County, California —

and to add a rate for shipping services from that new

origination point to Arizona. The rate came into effect in

October 1992. The rate, however, was not new; it was the

same as the rates from SFPP’s two other source points in the

Los Angeles area. Examining this situation, the Commission

concluded that the rates from the East Hynes station quali-

fied for grandfathering because the July 1992 ‘‘filing did not

involve a change to a rate or service SFPP was providing at

the time the EPAct was enacted.’’ Opinion No. 435, 86

FERC at 61,063. SFPP’s revision to its tariffs ‘‘only added

another tap within an existing rate clusterTTTT No rate TTT

7

was changed, and there was no change in the products

transported or the services provided.’’ Id.

The question essentially boils down to the Commission’s

interpretation of the term ‘‘rate’’ in Section 1803. As this is

the first case to be litigated under the new standards of the

EPAct, we must consider the level of deference — if any —

to which FERC’s interpretations of the EPAct are entitled.

It is true, as some petitioners have noted, that the EPAct

does not expressly confer rulemaking authority on the Com-

mission. Section 1803 of the EPAct does, though, clearly

contemplate that the Commission will enforce the terms and

conditions of the statute through formal adjudications. See

EPAct § 1803(b) (referencing ‘‘proceeding instituted as a

result of a complaint’’). When Congress authorizes an agency

to adjudicate complaints arising under a statute, the agency’s

interpretations of that statute announced in the adjudications

are generally entitled to Chevron deference. See United

States v. Mead Corp., 533 U.S. 218, 229 (2001) (‘‘[A] very good

indicator of delegation meriting Chevron treatment [is] ex-

press congressional authorizations to engage in the process of

rulemaking or adjudication that produces regulations or rul-

ings for which deference is claimed.’’); see also Trans Union

Corp. v. FTC, 81 F.3d 228, 230 (D.C. Cir. 1996) (‘‘[W]e have

expressly held that Chevron deference extends to interpreta-

tions reached in adjudications as much as to ones reached in a

rulemaking.’’ (citing Midtec Paper Corp. v. United States, 857

F.2d 1487, 1497 (D.C. Cir. 1988))). We see no reason to

accord any less deference to FERC’s interpretations of the

EPAct.

Under the familiar Chevron two-part inquiry, we first ask

whether Congress has directly spoken to ‘‘the precise ques-

tion at issue.’’ Chevron U.S.A. Inc. v. Natural Res. Def.

Council, Inc., 467 U.S. 837, 842 (1984). If it has, that is the

end of the inquiry; we ‘‘must give effect to the unambiguous-

ly expressed intent of Congress.’’ Id. at 843. If Congress

has not spoken so precisely, though, we reach the second

step, and will defer to any reasonable interpretation of the

statute by the agency. Id. Not surprisingly, Congress did

not have occasion to confront the specific question of whether

8

the addition of a new source point on an existing rate cluster

would constitute a new rate. We thus proceed to the second

step of Chevron, and inquire whether the Commission’s con-

struction is a reasonable one. It is. It is certainly permissi-

ble to conclude that the addition of a tap to an existing rate

structure, completed without any change in the existing ship-

ping rates, does not constitute a new rate. To employ an

analogy that we find helpful, in adding the East Hynes

station to its West Line, SFPP merely added an on-ramp to

its existing expressway. We think that the Commission’s

conclusion reflects a permissible interpretation of the statute

and thus affirm its holding that the rate for shipping from

East Hynes is eligible for grandfathering.

b. Watson Station Enhancement Facility

Watson is the primary origin point for West Line ship-

ments to Phoenix and Tucson. In 1989, SFPP notified its

shippers that, starting in 1991, the minimum pumping rate

and pressure from Watson Station would increase. SFPP

gave its shippers the option of providing their own pressuriza-

tion facilities by a date certain, or using, for a surcharge, a

facility built by SFPP. By late 1991, most of SFPP’s ship-

pers had contracted to use SFPP’s new enhancement facility,

and on November 1, 1991, SFPP initiated the enhancement

services. See Opinion No. 435, 86 FERC at 61,074; In re

SFPP, L.P., 80 FERC ¶ 63,014, 65,156 & n.405 (1997) (‘‘ALJ

Decision’’). SFPP, though, never filed those contracts with

the Commission, because it believed its enhancement services

were beyond the reach of FERC’s jurisdiction. See Opinion

No. 435, 86 FERC at 61,074. The Commission, however,

concluded otherwise and ordered SFPP ‘‘to file a rate equal

to the historic charge in the shipper contracts.’’ Id. at 61,076.

Despite FERC’s concession that ‘‘Section 1803 only ad-

dresses rates that were on file with the Commission,’’ Opinion

No. 435–A, 91 FERC at 61,502, and its acknowledgment that

the enhancement rates had never before been filed, FERC

nevertheless concluded that, because ‘‘the charges for the

Watson Station facilities are part of enforceable contracts,’’

the rates were ‘‘the equivalent of a lawful, effective rate.’’

9

Opinion No. 435, 86 FERC at 61,076. The Commission

reasoned that because all the Watson enhancement rate

contract charges ‘‘were in effect before October 24, 1992,’’ the

shippers challenging those charges had to establish ‘‘substan-

tially changed circumstances.’’ Id. at 61,075, 61,076. The

fact that no statute permitted a shipper to challenge an

unfiled rate before the Commission did not matter. For ‘‘if

[the rates] had been filed TTT, it is clear that they would have

been grandfathered because there was no challenge to them

during the 12 months proceeding [sic] the enactment of the

Act.’’ Opinion No. 435–A, 91 FERC at 61,502.

We find the Commission’s reasoning on this point to be

fundamentally flawed, and vacate this portion of its order.

First, if FERC is indeed correct in its interpretation that

Section 1803 applies only to filed rates, the Commission may

not grandfather unfiled rates on the assumption that if the

rates had been filed, no challenge would have been brought.

The Commission may not regulate rates as if they existed in a

world that never was. It must take the rates as it finds

them, and here, FERC found them unfiled. If FERC inter-

prets Section 1803 to apply only to filed rates, then it may not

extend the benefits of that provision to unfiled rates based on

speculation about what would have happened had they in fact

been filed. Invoking the so-called ‘‘filed rate’’ doctrine —

which ‘‘forbids a regulated entity to charge rates for its

services other than those properly filed with the appropriate

federal regulatory authority,’’ Arkansas Louisiana Gas Co. v.

Hall, 453 U.S. 571, 577 (1981) — the WLS argue that the

pipeline’s failure to file a Watson enhancement rate tariff with

the Commission precludes the Commission’s treatment of the

unfiled rate as grandfathered. Our disposition of this is-

sue — which is based on the Commission’s flawed reasoning,

and not a flawed conclusion — does not require us to decide

definitively whether Section 1803 of the EPAct applies only to

filed rates.

Second, Opinion No. 435 suggests that any rate agreed

upon before the EPAct’s enactment on October 24, 1992 could

be grandfathered. See Opinion No. 435, 86 FERC at 61,075

(‘‘The clear purpose of the EPAct’s grandfathering provisions

10

is to insulate pipelines from challenges to TTT rates TTT if

those charges were in effect before October 24, 1992.’’).

Section 1803, though, allows grandfathering of only those

rates that were in effect (and unchallenged) for at least 365

days prior to the date of enactment of EPAct. EPAct

§ 1803(a). Even if we assume as a general proposition that

Section 1803 applies to unfiled rates, other statements sprin-

kled throughout Opinion No. 435 suggesting that some of the

rates were contracted for after the 365–day window had

closed would remain problematic. See Opinion No. 435, 86

FERC at 61,075 (‘‘the contracts were entered into voluntarily

by the parties, mostly before the end of 1991’’); id. (‘‘all the

relevant contracts were required to be, and had been, execut-

ed well before June 1, 1992’’). If the Commission allows

Section 1803 to apply to unfiled rates, those rates, to be

grandfathered, must be in effect for at least 365 days prior to

the EPAct’s enactment. The reasoning of Opinion No. 435

gives us no comfort that this was the case. Without such an

assurance, we cannot affirm the Commission’s conclusion that

the Watson enhancement rate is subject to grandfathering.

c. Turbine Fuel Service

In December 1992, SFPP filed its Tariff No. 18, proposing

the transportation on its West Line of a new product, turbine

fuel (also known as jet fuel). The rate for the new turbine

fuel service was equal to other grandfathered rates in Tariff

No. 18 that had been in effect since 1989. The shippers

argue that because the turbine fuel rate was not initiated

until 1992 — long after the grandfathering window had closed

(indeed, after the EPAct had been enacted) — the rate

cannot be grandfathered. The Commission does not contest

this; it recognized that the turbine fuel service was new, and

therefore could not be grandfathered. Id. at 61,063. It

nevertheless foreclosed further challenge to the turbine fuel

rate, concluding, as a substantive matter, that the turbine fuel

rate was just and reasonable. Id. at 61,078. The Commis-

sion reasoned that because the turbine fuel rate was equal to

other Tariff No. 18 rates that had been deemed just and

reasonable, ‘‘there is no basis for providing a different rate

level for turbine fuel at this time.’’ Id.

11

That analysis falls far short of the mark. The fact that the

Tariff No. 18 rates were deemed just and reasonable does not

mean that the rates actually are just and reasonable. Per-

haps if the Commission had undertaken a substantive review

of the reasonableness of the West Line rates listed in Tariff

No. 18, then its conclusion that the turbine fuel rate is

reasonable — because it is equal to those rates — might be

supportable. But here, the West Line rates had been

‘‘deemed just and reasonable’’ by operation of law — solely

because they had persisted without challenge for one year

prior to the enactment of the EPAct. The turbine fuel rate,

not itself eligible for grandfathering, cannot simply piggyback

on the grandfathered status of other rates. The Commis-

sion’s contrary conclusion reflects a fundamental misappre-

hension of the nature and purpose of the grandfathering

provisions of the EPAct. The requirements for grandfather-

ing — the rate must be in effect and not subject to challenge

for the year prior to the EPAct’s enactment — are not

proxies for actual reasonableness. Those requirements in-

stead operate principally as a means to constrain litigation

over pre-EPAct pipeline rates. The fact that the turbine fuel

rate is equal to other Tariff No. 18 rates thus says nothing

about that turbine fuel rate’s substantive reasonableness.

The Commission’s declaration that, as a substantive matter,

the turbine fuel rate was just and reasonable — a conclusion

reached without the benefit of any substantive review of the

underlying cost of service and rate of return — was an

arbitrary and capricious exercise of the Commission’s authori-

ty and cannot stand.

2. Complaints, Protests, or Investigations

While the WLS concede that most of the West Line rates

were in effect for the required year prior to the EPAct’s

enactment, they contend that no West Line rate is eligible for

grandfathering because each of them was ‘‘subject to protest,

investigation, or complaint’’ during that same one-year win-

dow. In support of their argument, the WLS point principal-

ly to protests filed by shippers El Paso Refinery, L.P.

(‘‘EPR’’) and Chevron, and an investigation opened by the Oil

Pipeline Board (‘‘OPB’’) pursuant to those protests. In Octo-

12

ber 1993, the Commission rejected these arguments, holding

that the West Line rates were ‘‘presumed just and reason-

able’’ and, therefore, a successful challenge had to ‘‘prove the

existence of the extraordinary circumstances set forth in

section 1803 of the Energy Policy Act.’’ SFPP, L.P., 65

FERC ¶ 61,028, 61,378 (1993); see also SFPP, L.P., 66 FERC

¶ 61,210 (1994) (denying rehearing).

What does it mean for ‘‘the rate’’ to be ‘‘subject to protest,

investigation, or complaint’’? EPAct § 1803(a). The WLS

maintain that a general attack on a tariff is sufficient to

challenge all the rates and activities described therein. See

WLS Br. 14 (‘‘a protest of a tariff filing did subject all rates in

the tariff to review’’). The Commission, though, in ruling

that the shippers’ pleadings did not challenge the West Line

rates, interpreted this clause of Section 1803 to require that

the protest, investigation, or complaint specifically challenge

the reasonableness of the rate in question. See SFPP, L.P.,

65 FERC at 61,378 n.14 (while Chevron’s protest did include

‘‘a request for suspension of revised tariff no. 16, which

contains TTT only west line rates,’’ the protest ‘‘pled no

concerns with the existing rates set forth in this tariff’’). The

WLS object to FERC’s interpretation on a general level,

arguing that it grafts onto the statute a particularity require-

ment not found in its text. Here, too, we find the Chevron

deference that we must accord to the agency’s interpretation

to be dispositive. Because we cannot say that the Commis-

sion’s adjudicative interpretation is an impermissible reading

of the statute — the statute provides, after all, that it is ‘‘the

rate’’ (not the tariff) that must be subject to ‘‘protest, investi-

gation, or complaint’’ — we defer to the Commission’s inter-

pretation. And with that interpretation in mind, we turn to

the particular contentions of the WLS.

a. West Line Shipper Protests

On September 4, 1992, EPR, an East Line shipper, filed a

protest to SFPP’s Tariffs Nos. 15 and 16, and followed with

three supplements that same month, one of which requested

the suspension of Tariffs Nos. 15 and 16 and that the Oil

Pipeline Board (‘‘OPB’’ or ‘‘Board’’) open an investigation into

13

the same. That same month, Chevron, which shipped on both

the East and the West Line, filed a protest to Tariffs Nos. 15

and 16, also calling for their suspension and investigation.

The WLS contend that because EPR’s and Chevron’s

protests challenged Tariff No. 16 — which listed only West

Line rates — those protests had challenged the West Line

rates. The Commission rejected this contention, looking

beyond the relief requested by the protests to the shippers’

substantive arguments for that relief. Examining the rele-

vant pleadings, the Commission concluded that the protesting

shippers ‘‘raised concerns with only three matters — flow

reversal, prorationing, and existing rates on SFPP’s east

line.’’ Id., 65 FERC at 61,378. As ‘‘[n]othing within the four

corners of these protests indicate[d] a concern with the

existing rates on SFPP’s west line,’’ the Commission rejected

those protests as a basis for denying grandfathered status to

the West Line rates. Id.

Our examination of the relevant pleadings convinces us that

the Commission correctly concluded that EPR and Chevron

did not challenge the reasonableness of the West Line rates

in their protests to SFPP’s Tariffs No. 15 and 16. The EPR

and Chevron pleadings scarcely mention the West Line at all,

let alone mount an attack on the reasonableness of its rates.

The only mention of the West Line rates is found in EPR’s

first supplement to its protest: ‘‘Santa Fe’s proposed Tariff

Nos. 15 and 16 retain Santa Fe’s previously effective rates for

service on its East Line and West Line systems, but repre-

sent the first tariffs under which product will flow in a

reversed direction on the ‘Six–Inch Line’ portion of the East

Line system from Phoenix to Tucson.’’ In re SFPP, L.P.,

Supplement to Protest of El Paso Refinery, L.P., 1–2 (Sept. 9,

1992) (emphasis omitted). This statement obviously concerns

the flow reversal on the Phoenix–Tucson pipe — not the

reasonableness of West Line rates. Chevron’s protest, as the

Commission noted, ‘‘simply fails to contain any statement

indicating a challenge to existing rates on SFPP’s west line.’’

SFPP, L.P., 65 FERC at 61,378. The Commission thus

reasonably concluded that these protests by East Line ship-

14

pers were insufficient to render the West Line rates ‘‘subject

to protest.’’ EPAct § 1803(a).2

b. Oil Pipeline Board Investigation

On September 29, 1992, in response to the protests filed by

EPR and Chevron, the OPB, pursuant to its authority under

Section 15(7) of the ICA, 49 U.S.C. app. § 15(7) (1988),

opened an investigation of SFPP’s rates listed in revised

Tariffs Nos. 15, 16, and 17, suspended the tariffs for one day,

and imposed refund obligations on SFPP. SFPP, L.P., 60

FERC ¶ 62,252 (1992).3 In April 1993, the Commission vacat-

ed the suspension orders and the refund obligations. SFPP,

L.P., 63 FERC ¶ 61,014 (1993). Observing that the protests

against the tariffs did not challenge any change in a listed

rate or practice (such as the addition of the East Hynes

origination point or the turbine fuel service), but rather

attacked only existing, unchanged rates and policies (the East

Line rates and the flow reversal and prorationing practices),

the Commission concluded that the OPB lacked authority to

2 In August 1993, Chevron filed a complaint that did specifically

challenge the reasonableness of the West Line rates. See ALJ

Decision, 80 FERC at 65,121. The WLS maintain that this 1993

complaint should ‘‘relate back’’ to its 1992 protest. We do not

agree. Relation back is a concept born in the context of statutes of

limitations. Amendments to complaints are said to relate back to

the date of the original complaint. See Fed. R. Civ. P. 15(c). Even

assuming that this suggested use of the relation back doctrine could

supersede the Commission’s own time limitations governing amend-

ments of protests, the WLS concede that to relate back ‘‘the claim

TTT in the amended pleading [must have] ar[isen] out of the

conduct, transaction, or occurrence set forth TTT in the original

pleading.’’ Fed. R. Civ. P. 15(c)(2). That clearly is not the case

here. As the Commission found, Chevron’s initial protest ‘‘simply

fails to contain any statement indicating a challenge to existing

rates on SFPP’s west line.’’ SFPP, L.P., 65 FERC at 61,378.

3After SFPP filed Tariff No. 18, adding the turbine fuel service

on the West Line, the OPB, acting pursuant to a protest by

Chevron to Tariff No. 18, instituted an investigation and consolidat-

ed that case into the open investigation and suspension of SFPP’s

Tariffs Nos. 15, 16, and 17. SFPP, L.P., 62 FERC ¶ 62,060 (1993).

15

open an investigation under Section 15(7) of the ICA, which

permits the Board only to investigate newly filed rates or

practices. Id. at 61,125 (‘‘It was not appropriate for the

Board to suspend the proposed tariff changes and initiate an

investigation under section 15(7) when the focus of the protest

was existing, unchanged, portions of the tariff.’’); 49 U.S.C.

app. § 15(7) (1988) (limiting application to ‘‘any schedule

stating any new individual or joint rate TTT or charge’’)

(emphasis added). The Commission held that the case should

continue as a complaint proceeding before the Commission

under ICA Section 13(1), id. § 13(1), and be limited to the

issues properly raised by EPR, Chevron, and the intervenors.

SFPP, L.P., 63 FERC at 61,125. But as the Board ‘‘does not

possess delegated authority to order initiation of a section

13(1) proceeding,’’ the Commission vacated the tariff suspen-

sions and the refund obligations. Id. The Commission even-

tually terminated the Board’s suspension docket entirely,

stating that matters would proceed only in the instant com-

plaint docket. SFPP, L.P., 63 FERC ¶ 61,275 (1993). And

based on its conclusion that the OPB’s investigation had been

unlawfully initiated, the Commission determined that SFPP’s

West Line rates were not ‘‘subject to investigation’’ for

grandfathering purposes. SFPP, L.P., 66 FERC at 61,480.

Parsing with care the words of the Commission’s counter-

mand of the Board, the WLS argue that the Commission

never formally vacated the Board’s investigation of the

SFPP’s Tariffs Nos. 15–18, and thus the rates within those

tariffs — including the West Line rates — remained subject

to investigation in 1992, precluding grandfathered status.

We, like the Commission, are unpersuaded. First, while the

WLS are quite right that the Commission did not, in its

ordering clauses, vacate the Board’s investigation, the ship-

pers’ interpretation of the Commission’s action runs head-on

into the Commission’s statement that it was inappropriate ‘‘to

suspend the proposed tariff changes and initiate an investi-

gation under section 15(7).’’ SFPP, L.P., 63 FERC at 61,125

(emphasis added). Moreover, the shippers offer no explana-

tion how such an investigation by the Board could proceed in

light of the Commission’s order that the case would continue

16

as a Section 13(1) complaint. But even if common sense

bowed to formalism and the Board’s investigation remained

technically open, the scope of the Board’s investigation —

lawful only insofar as it enforces ICA Section 15(7) — must

be limited to newly tariffed rates or practices. See 49 U.S.C.

app. § 15(7) (1988). As SFPP’s tariffs made no changes to

the West Line rates (except to add the Watson enhancement

and the turbine fuel services), the Board could not have

investigated the West Line rates.

We therefore conclude that FERC reasonably determined

that the West Line rates (except, as noted above, for the

Watson Station enhancement and turbine fuel rates) were

grandfathered and therefore deemed just and reasonable

under the terms of Section 1803(a) of the EPAct.

C. Exceptions to Grandfathering

We turn now to the WLS’ contention that the rates fall

within the exceptions outlined in Section 1803(b) and there-

fore are still open to challenge under the ICA. Section

1803(b) permits a shipper to challenge a grandfathered rate if

the shipper establishes either that (1) there has been a

‘‘substantial change’’ in the economic circumstances or ser-

vices provided that ‘‘were a basis for the rate’’; or (2) ‘‘the

person filing the complaint’’ was under ‘‘a contractual prohibi-

tion against the filing of a complaint’’ on the date of the

enactment of the EPAct. EPAct § 1803(b). The complain-

ing shipper bears the burden of proving the existence of one

of the circumstances triggering an exception. The Commis-

sion concluded that the WLS had not met either requirement.

See SFPP, L.P., 68 FERC ¶ 61,105, 61,581 (1994) (contractual

prohibition); Opinion No. 435, 86 FERC at 61,064–71

(changed circumstances). The shippers were therefore

barred by the EPAct from challenging the grandfathered

West Line rates. The WLS appeal both rulings.

1. Substantially Changed Circumstances

Before the ALJ and the Commission, the WLS argued that

there were five circumstances that had substantially changed

so as to permit a challenge to the grandfathered West Line

17

rates, including increased throughput on the West Line and

the impact of the Commission’s Lakehead decisions on

SFPP’s income tax cost allocation. The ALJ rejected all the

substantial change arguments. See ALJ Decision, 80 FERC

at 65,192–96. Concerning the claim based on throughput, the

ALJ concluded that the evidence of a forty-percent increase

in throughput from EPAct’s enactment in October 1992 to

1995 (the last year for which data was obtained), by itself,

could not prove a change in economic circumstances. Id. at

65,194. Missing, according to the ALJ, was any evidence

demonstrating that the increase in throughput produced high-

er revenues and profits for SFPP. Id.

The Commission affirmed the holdings of the ALJ on each

of the WLS’ claims of substantial change, see Opinion No.

435, 86 FERC at 61,064–71, but, with respect to the through-

put claim, did so on somewhat different reasoning, see id. at

61,067–69. The Commission found that the ALJ had erred by

measuring change from the date of enactment of the EPAct,

and by using data generated after the filing of the shippers’

complaint. Id. Determining whether there has been a sub-

stantial change in economic circumstances providing the basis

for the rate, the Commission held, requires comparing (a) the

period before the rate first became effective (the basis for the

rate) with (b) the period starting on the date of enactment

and ending on the date of the complaint. Id. The WLS’

substantial change claim based on increased throughput failed

because the shippers measured changed circumstances

against the ‘‘wrong base period’’ and with post-complaint

evidence. Id. at 61,069. To establish a substantial change,

FERC held, the shippers should have compared the period

before the West Line rates became effective in 1989 to the

period between October 24, 1992 (EPAct’s enactment) and

August 7, 1993 (the date of Chevron’s complaint).

The shippers contest neither the Commission’s interpreta-

tion of the substantial change provision of EPAct, nor its

conclusion that the shippers failed to demonstrate a substan-

tial change under that standard. The WLS do, however,

maintain that the Commission’s ruling employed a ‘‘newly

articulated standard’’ and that they are, therefore, entitled to

18

a remand so that they may have an opportunity to litigate

under the Commission’s ‘‘new’’ evidentiary requirements.

WLS Br. 23. We reject this contention.

Even before the Commission announced this interpretation,

the correct points of comparison in a substantial change

analysis were clear from the face of the statute. The statute

requires a shipper to show a change in economic circum-

stances ‘‘which were a basis for the rate.’’ EPAct § 1803(b).

As the Commission noted in its Opinion No. 435, this phrase

could only mean ‘‘the basis upon which the rate was last

considered to be just and reasonable, either as a filed rate, a

settlement rate, or one for which the Commission has made a

legal determination.’’ Opinion No. 435, 86 FERC at 61,068.

Any other moment in time would lack ‘‘correlation to the

economic circumstances that were the basis of the rate at the

time it was designed.’’ Id.

The textual clues to the second point of comparison are

perhaps less obvious but no less certain. The statute pro-

vides that ‘‘[n]o person may file a complaint TTT unless TTT

evidence is presented TTT which establishes that a substantial

change has occurred after the date of TTT enactment.’’

EPAct § 1803(b). From the ‘‘after the date of enactment’’

language we are given the earliest point at which a shipper

may show a substantial change. The closing date for evi-

dence is the day the complaint is filed; this conclusion follows

from the language providing that no ‘‘complaint’’ may be filed

unless ‘‘evidence is presented’’ with the complaint that dem-

onstrates that a substantial change ‘‘has occurred.’’ As the

Commission stated, ‘‘[i]t is difficult to see how language that

so explicitly uses the past tense could apply to evidence that

would be developed at some indeterminate time after the

complaint is filed.’’ Opinion No. 435, 86 FERC at 61,069.

Because the foregoing requirements of the statute are clear

from its face, the shippers had adequate notice of the stan-

dard they were required to meet. See, e.g., Midtec Paper

Corp., 857 F.2d 1487, 1510 (D.C. Cir. 1988) (rejecting petition-

er’s argument that it had inadequate notice specific evidence

was required to support its complaint where the text of the

19

regulations at issue ‘‘clearly indicates’’ that such evidence was

to be considered).4

The WLS also argue that the Commission erred in reject-

ing their argument that the Commission’s decision in Lake-

head Pipe Line Co., L.P., 71 FERC ¶ 61,338 (1995) (Lake-

head), reh’g denied, 75 FERC ¶ 61,181 (1996) (‘‘Lakehead

II’’), insofar as it changed the ability of limited partnerships

like SFPP to include certain income tax allowances in their

cost of service, represented a substantial change in SFPP’s

economic circumstances. The Commission reasoned that the

mere existence of the Lakehead policy, without any showing

how the application of that policy affects the economic basis

for the rates, cannot constitute substantially changed circum-

stances. See Opinion No. 435, 86 FERC 61,070–71. In light

of our conclusion below that aspects of the Commission’s

Lakehead policy are arbitrary and capricious, we think the

best course is to remand this claim to the Commission for

further consideration in light of our disposition in this case.

4 Consolidated Edison Co. v. FERC, 315 F.3d 316 (D.C. Cir. 2003)

and the other cases cited by the shippers (see WLS Br. 23) are

distinguishable. Those cases stand for the unremarkable proposi-

tion that when an agency abandons its own precedent in the course

of an adjudication, the new rule may be applied retroactively to the

parties only ‘‘so long as the parties TTT are given notice and an

opportunity to offer evidence bearing on the new standard.’’ 315

F.3d at 323 (citing Hatch v. FERC, 654 F.2d 825, 835 (D.C. Cir.

1981)). Here, FERC did not abandon its own precedent. Shippers

point to Santee Distrib. Co. v. Dixie Pipeline Co., 71 FERC

¶ 61,205 (1995), reh’g denied, 75 FERC ¶ 61,254 (1996), but that

ruling — issued nearly two years after Chevron’s complaint was

filed, and several months after the parties had submitted their

direct cases to the ALJ, see ALJ Decision, 80 FERC at 65,121 —

stands solely for the proposition that, to make out a substantial

change under EPAct Section 1803, the complainant must show some

change in circumstances since the enactment of the EPAct. See

Santee Distrib. Co., 71 FERC at 61,754 (‘‘Comparisons of data for

1987 to data for 1993 cannot be the basis for showing a change in

economic circumstances since enactment of the EPAct.’’). That

holding is entirely consistent with the holding of Opinion No. 435.

20

2. Contractual Prohibition

The WLS next contend that they may challenge the grand-

fathered West Line rates because they fit within the ‘‘contrac-

tual prohibition’’ exception. That exception allows a shipper

to challenge a grandfathered rate when ‘‘the person filing the

complaint was under a contractual prohibition against the

filing of a complaint which was in effect on the date of

enactment of [the EPAct] and had been in effect prior to

January 1, 1991.’’ EPAct § 1803(b)(2). Navajo, as a part of

an earlier settlement with SFPP, was subject to such a

prohibition and thus was permitted to file a complaint against

the West Line rates without demonstrating substantially

changed circumstances. See SFPP, L.P., 67 FERC ¶ 61,089,

61,254 (1994). Navajo, however, reached another settlement

with SFPP and withdrew its complaint against the pipeline.

SFPP, L.P., 79 FERC ¶ 63,014 (1997). The Commission then

terminated the Navajo complaint proceeding. SFPP, L.P., 80

FERC ¶ 61,088 (1997).

The WLS nevertheless argue that they, too, should not

have to show substantially changed circumstances. First,

they assert that Navajo’s invocation of the contractual prohi-

bition exception effectively vitiated the West Line rates’

grandfathered status as to all complaining shippers. See

WLS Br. 18 (‘‘The ‘grandfathered’ status of the West Line

rates TTT was thus revoked.’’). Alternatively, the WLS argue

that because the ALJ conditioned Navajo’s ‘‘withdrawal of the

complaint’’ on ‘‘not prejudic[ing] in any way the status and

rights of any other participants in this proceeding,’’ SFPP,

L.P., 79 FERC at 65,176, the other complaining shippers

should be able to pursue their complaint as if Navajo had not

withdrawn — that is, without showing substantially changed

circumstances. The Commission rejected both of these argu-

ments. From the first, the Commission recognized that the

contractual prohibition exception is party-specific. ‘‘Because

neither Chevron nor ARCO/Texaco was subject to a contrac-

tual bar [as was Navajo], it follows, under the plain meaning

of the language of the statutory provision, that the complaints

of Chevron and ARCO/Texaco [must show substantially

changed circumstances].’’ SFPP, L.P., 68 FERC at 61,581.

21

As for the shippers’ claim that they had been prejudiced by

Navajo’s withdrawal, the Commission concluded that the con-

dition on Navajo’s settlement applied only to ‘‘the integrity of

the record.’’ Opinion No. 435, 86 FERC at 61,073.

We agree with the Commission. The language of Section

1803(b)(2) is quite obviously party-specific. EPAct

§ 1803(b)(2) (‘‘the person filing the complaint was under a

contractual prohibition’’) (emphasis added). An interpreta-

tion, like that suggested by the WLS, that would allow other

shippers to piggyback on the status of a contractually-

prohibited shipper, conflicts not only with the plain language

of the statute, but also with Section 1803’s overarching pur-

pose of limiting litigation over pre-EPAct rates. On the

other hand, the Commission’s interpretation — limiting the

exception to those parties actually contractually prohibited

from complaining — is entirely consistent with the statute

and therefore reasonable. We also find no merit to the WLS’

claim that they were somehow prejudiced by Navajo’s settle-

ment. After examining the relevant proceedings, see SFPP,

L.P., 79 FERC at 65,176, we think it clear that the ALJ, in

implicitly promising that Navajo’s withdrawal would not

‘‘prejudice TTT the status and rights of any other participants

in proceeding,’’ was referring only to the evidence that Nava-

jo had placed into the administrative record.

II. The East Line

SFPP’s East Line rates were not grandfathered under

§ 1803 of the EPAct, as EPR, as an ELS, had challenged

them in the same September 1992 complaint in which it had

protested SFPP’s flow-reversal on the six-inch line. They

were therefore ‘‘subject to protest, investigation, or com-

plaint’’ within the year prior to the EPAct’s enactment.

Navajo later filed its own complaint against the East Line

rates, and the Commission proceeded under the ICA, which,

in Section 15, empowers the Commission to set aside rates it

finds ‘‘unjust or unreasonable,’’ and to ‘‘determine and pre-

scribe what will be the just and reasonable TTT rates, fares or

charges to be thereafter observed.’’ 49 U.S.C. app. § 15(1)

22

(1988). The ALJ evaluated SFPP’s East Line rates pursuant

to its cost of service regulations, 18 C.F.R. § 346.2 (2004),

found them unjust and unreasonable, and proceeded to set

new ones in their place. ALJ Decision, 80 FERC at 65,122–

191. The Commission substantially affirmed the ALJ’s deter-

mination in Opinion No. 435. 86 FERC at 61,084–111. Un-

der the Commission’s rate-of-return methodology, this in-

volved determinations of SFPP’s embedded capital costs, its

yearly operating expenses, allowances for other costs, and its

appropriate rate of return. See 18 C.F.R. § 346.2(c).

The proceedings before the Commission were complex, and

many of the issues it decided in setting new East Line rates

(and in determining that the previous rates were unjust or

unreasonable) have not been challenged. As relevant to our

review, the parties dispute only four discrete issues regarding

the Commission’s East Line rate-setting: (1) the starting rate

base to which SFPP was entitled; (2) what tax allowance, if

any, should be factored into rates; (3) the proper means of

recovery, if any, of SFPP’s litigation expenses; and (4) the

treatment of SFPP’s claimed expenses for reconditioning

portions of the East Line.

The court reviews the Commission’s ratemaking decision to

determine whether it was arbitrary and capricious, see Asso-

ciation of Oil Pipelines v. FERC, 83 F.3d 1424, 1431 (D.C.

Cir. 1996) (‘‘AOPL’’), according special deference to the Com-

mission’s expertise, id. at 1431; see also In re Permian Basin

Area Rate Cases, 390 U.S. 747, 790 (1968). The court thus

examines the Commission’s ratemaking decisions to deter-

mine whether the Commission has examined the relevant

data and articulated a rational connection between the facts

found and the choice made. AOPL, 83 F.3d at 1431. The

Commission must ‘‘cogently explain why it has exercised its

discretion in [the] given manner.’’ Exxon Corp. v. FERC, 206

F.3d 47, 54 (D.C. Cir. 2000) (quoting Motor Vehicle Mfrs.

Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463

U.S. 29, 48–49 (1983)).

A. Starting Rate Base

The Commission decided that to measure SFPP’s overall

investment upon which it is entitled to a return, SFPP should

23

use its December 19, 1988 capital structure. Opinion No.

435–A, 86 FERC at 61,503–06. In assessing the value of a

pipeline’s invested capital, the Commission’s approach —

stemming from its opinion in Williams Pipeline Co., 31

FERC ¶ 61,377 (1985) (‘‘Opinion No. 154–B’’) — weighs equi-

ty and debt-financed capital investments made prior to 1985

differently, and SFPP contends that the Commission used the

wrong historical ratio between the two in setting the starting

rate base.

Some explanation of the ‘‘starting rate base’’ concept and

its history is necessary. Prior to June 28, 1985, the rate base

to be included in oil pipeline cost of service analysis was

calculated under an Interstate Commerce Commission

(‘‘ICC’’) valuation method, which combined elements of origi-

nal and reproduction cost. In Farmers Union Central Ex-

change, Inc. v. FERC, 584 F.2d 408, 417–20 (D.C. Cir. 1978)

(‘‘Farmers I’’), the court expressed concerns about the ICC’s

valuation methodology, particularly its tendency to overvalue

assets so as to ‘‘exceed[ ] investment by a substantial

amount.’’ Id. at 415. After the Commission proposed to

continue to use the ICC’s valuation method in Williams

Pipeline Co., 21 FERC ¶ 61,260 (1982), the court, on review

from that decision, remanded the case in Farmers Union

Central Exchange, Inc. v. FERC, 734 F.2d 1486, 1510–14

(D.C. Cir. 1984) (‘‘Farmers II’’), and directed the Commission

to consider alternatives, noting the widespread agreement

among many experts that the ICC’s method ‘‘lacks any

economic rationale.’’ Id. at 1511 (internal citation omitted).

On remand from Farmers II, the Commission developed its

current ‘‘trended original cost’’ method. Opinion No. 154–B,

31 FERC at 61,833–35. This method starts from the original

cost of a pipeline’s assets but smooths out depreciation and

equity recovery over the life of the pipeline, thereby avoiding

the front-loading problems associated with a depreciated orig-

inal cost methodology. Making the switch to this ‘‘trended

original cost’’ method required the Commission to account for

investments in existence at the time of the change. Under

the ICC’s valuation rate base methodology, many of these had

been valued substantially above investment cost. See Farm-

24

ers I, 584 F.2d at 415. Setting their value to depreciated

original cost would, in many cases, have significantly de-

creased their valuation for rate-setting purposes. See Opin-

ion No. 154–B, 31 FERC at 61,836. To mitigate any abrupt

reduction in pipeline earnings resulting from the change, the

Commission permitted a one-time rate base adjustment —

creating a so-called starting rate base — calculated by par-

tially continuing the ICC’s valuation method to the extent of a

pipeline’s equity ratio, but assessing its rate base at depreci-

ated original cost to the extent of its debt ratio. Opinion No.

154–B, 31 FERC at 61,835–37. Because the stated purpose

of this approach was to protect the expectations of investors

who had invested prior to the switch, the Commission deter-

mined that the relevant debt-to-equity ratio would be a

pipeline’s capital structure as of the date of Opinion 154–B,

June 28, 1985, rather than its capital structure at the time

rates are set. See Williams Pipeline Co., 33 FERC ¶ 61,327,

61,640 (1985) (‘‘Opinion No. 154–C’’).

The court has never reviewed the reasonableness of the

Commission’s Opinion No. 154–B methodology, nor need we

do so now, as no party has challenged whether that approach

is faithful to the court’s remand order in Farmers II, 734

F.2d at 1511–21. The ELS support the Commission’s appli-

cation of the Opinion No. 154–B methodology, and SFPP

contends only that the Commission’s use of December 19,

1988 rather than June 28, 1985 as the relevant snapshot of

the pipeline’s capital structure is not faithful to Opinion No.

154–B and its progeny. We turn, then, to SFPP’s contention

that the Commission acted arbitrarily and capriciously, and

departed from past precedent without adequate explanation,

in rejecting use of the actual June 28, 1985 capital structure

of the Santa Fe Southern Pacific corporation (‘‘SFSP’’), the

pipeline’s then-parent.

SFPP did not yet exist in 1985, and its predecessor corpo-

ration, Southern Pacific Pipelines, Inc. (‘‘SPPL’’), was a whol-

ly-owned corporate subsidiary of SFSP. SPPL therefore had

a 100% equity structure, and no party urged the Commission

to use that capital structure to calculate SFPP’s starting rate

base. SPPL’s parent, SFSP, was capitalized at 78.29% equity

25

and 21.71% debt at the time, and SFPP urged the Commis-

sion to follow Opinion No. 154–B’s instruction to use the

parent’s capital structure to calculate the starting rate base.

Initially, in Opinion No. 435, 86 FERC at 61,089–90, the

Commission took the position that the 1988 settlement agree-

ment between SPPL and several of its shippers, which had

last set the pipeline’s rates, required the use of SFSP’s

capital structure in the starting rate base. On rehearing in

Opinion No. 435–A, however, the Commission decided that

the settlement did not preclude it from independently examin-

ing SFPP’s capital structure after the rates set by the

settlement expired. The Commission determined that

SFSP’s capital structure should not be used in the starting

rate base calculation because SFSP’s high equity component

in June 28, 1985 did not ‘‘accurately reflect[ ] the risks of

SFPP’s underlying operations,’’ and there was a ‘‘significant

difference in the nature of the pipeline’s operations and those

of its parent company on June 28, 1985.’’ Opinion No. 435–A,

91 FERC at 61,504–05.

SFPP contends that Opinion No. 154–B requires, in cases

where a pipeline is owned by a parent company and therefore

does not issue debt in its own name, the use of a parent

company’s capital structure as of June 28, 1985. Opinion No.

154–C, which clarified Opinion No. 154–B, does contain the

instruction that ‘‘the capital structure to be used in determin-

ing the starting rate base is as of the date of Opinion No.

154–B (June 28, 1985).’’ 33 FERC at 61,640. The Commis-

sion qualified that approach, however, in ARCO Pipeline Co.,

52 FERC ¶ 61,055, 61,233–34 (1990), where it began applying

its precedents from the rate-of-return context — in which it

first examines whether a parent company’s capital structure

is representative of its subsidiary’s risk level before imputing

it to the subsidiary — to the capital structure used in the

starting rate base calculation. While the Commission in

ARCO ended up using the corporate parent’s actual capital

structure, it indicated that its decision to do so hinged on

‘‘whether the capital structure is representative of the pipe-

line’s risks.’’ Id. at 61,233.

26

ARCO did not contain much by way of explanation about

why the representativeness of a parent’s capital structure to

the pipeline’s risks should matter; its relevance to the start-

ing rate base, where the equity component is standing in as a

measure of investor reliance on the old ICC valuation method,

appears less obvious than in the rate-of-return context, where

pipelines receive different returns on debt and equity to

compensate for their different risk levels, see, e.g., Kuparuk

Transportation Co., 55 FERC ¶ 61,122, 61,375–78 (1991);

Alabama-Tennessee Natural Gas Co., 25 FERC ¶ 61,151,

61,417–18 (1983). But the Commission’s basic premise that a

capital structure representative of a pipeline’s risks must be

used in the starting rate base calculation is not at issue, for

SFPP concedes that the Commission can depart from a

parent’s actual capital structure if it is ‘‘not TTT representa-

tive of the pipeline’s risks.’’ SFPP Pet. Br. 17. SFPP’s

challenge goes only to whether the Commission made a

reasoned decision applying that standard, and nothing about

the Commission’s determination of SFPP’s, SPPL’s, and

SFSP’s relative risk levels was arbitrary or capricious.

The Commission noted that the bulk of SFSP’s business

was in the railroad, trucking, and mineral exploration indus-

tries, which faced substantially higher amounts of competition

than the pipeline, a regulated ‘‘monopoly for the entire peri-

od’’ guaranteed a fair rate of return and ‘‘sufficiently secure

that it proposed to undertake a major expansion beginning in

1985.’’ Opinion No. 435–B, 96 FERC at 62,067. Most impor-

tantly, the Commission had a powerful piece of evidence of

the pipeline’s relatively low risk level: its initial public offer-

ing. When it first became a stand-alone entity on December

19, 1988, SFPP was able to adopt a capital structure financed

with 60.74% debt and 39.26% equity. This strongly suggests

a market judgment that the pipeline was significantly less

risky than SFSP, which was financed with 78.29% equity and

21.71% debt. The Commission’s view that SFPP’s equity

level as of its initial public offering more ‘‘accurately re-

flect[ed] the pipeline’s risk’’ than that of its previous parent

was based upon a reasoned view that ‘‘the financial market’s

perceptions of the pipeline’s risk,’’ as demonstrated through

27

an ‘‘arms length public offering,’’ provide an accurate esti-

mate of an entity’s risk level. 96 FERC at 62,068. SFPP

misses the mark when it states that there is no single capital

structure dictated by the market, for although other reason-

able debt-equity ratios might have been adopted for SFPP,

none would have market imprimatur. The reasonableness of

the Commission’s position is confirmed by the very different

nature of the respective entities’ business operations and the

stark contrast between the capital structures each adopted.

The same reasoning explains the Commission’s choice to use

December 19, 1988, the date of SFPP’s initial public offering,

as the relevant snapshot of its equity level, hardly an arbi-

trary date given its reliance on the judgment of the financial

markets.

SFPP maintains, however, that by adopting SFPP’s De-

cember 19, 1988 capital structure for purposes of the starting

rate base calculation, the Commission improperly applied it

‘‘retroactively,’’ thereby denying the pipeline a fair chance to

bring itself in line with the capital structure hypothesized.

The Commission’s use of the December 19, 1988 capital

structure was predicated on the conclusion that it was repre-

sentative of the pipeline’s risks in 1988, and that there were

‘‘no rational grounds here to believe that SPPL’s operations

or business substantially changed between June 28, 1985 and

December 19, 1988.’’ Opinion No. 435–B, 96 FERC at 62,067.

SFPP points to nothing that suggests otherwise. The start-

ing rate base is an element of the determination of the

prospective rates ‘‘in dispute in this proceeding,’’ and the

Commission was neither altering past rates nor seeking to

recover the pipeline’s past losses in future rates; rather, it

was determining a just and reasonable valuation of the pipe-

line’s investment for the purpose of setting present rates. As

such, there was nothing ‘‘retroactive’’ about the Commission’s

setting of the starting rate base.

Because the record contained sufficient evidence on which

the Commission could find that SPPL faced significantly

lower risks than SFSP in 1985, and SFPP concedes that the

Commission may depart from an actual capital structure in

the starting rate base formula where it is not representative

28

of a pipeline’s risks, the court has no occasion to decide

whether the Commission improperly relied on non-record

material from Moody’s Transportation Manual regarding the

poor financial condition of the Southern Pacific Railroad

during the relevant period. Nor need we decide whether the

Commission’s other basis for departing from SFSP’s 1985

capital structure—its concern that SFSP’s 78.29% equity

component would yield an exorbitantly high starting rate

base—would suffice to uphold its decision. Accordingly, we

affirm the Commission’s starting rate base decision.

B. Cost Issues

1. Income Tax Allowance

As one element of the cost of service allowable to SFPP,

FERC included a 42.7% income tax allowance reflecting the

interest in the regulated entity held by a subchapter C

corporation. All petitioners assigned this tax allowance as

error. The shipper petitioners, and intervenors supporting

them, allege as error the recognition of any income tax

allowance as SFPP is a limited partnership that pays no

income taxes. SFPP alleges as error the denial of a full

income tax allowance. Because FERC has not established

that its 42.7% allowance is the product of reasoned decision-

making and indeed has provided no rational basis for this

part of its order, we find that allowance to have been errone-

ous and we vacate.

There is no question that as a general proposition a pipe-

line that pays income taxes is entitled to recover the costs of

the taxes paid from its ratepayers. We explained this propo-

sition thoroughly in City of Charlottesville v. FERC, 774 F.2d

1205 (D.C. Cir. 1985) (Scalia, J.). While we will not fully

discuss the analysis set forth in that decision, we will briefly

review the basic principles as background for the current

controversy.

The Commission must ensure that the rates of jurisdiction-

al pipelines are ‘‘just and reasonable.’’ Id. at 1207 (quoting

15 U.S.C. § 717c(a) (1982)). This means that using the

principles of cost of service ratemaking, Commission-

29

approved rates must yield ‘‘sufficient revenue to cover all

proper costs,’’ and provide an appropriate return on capital.

Id. (citing Pub. Serv. Co. of New Mexico v. FERC, 653 F.2d

681, 683 (D.C. Cir. 1981)). Taxes, including federal income

taxes, are costs. See id. at 1207. The difficulty in the

application of this seemingly straightforward principle arises

when ‘‘the utility is part of a consolidated group,’’ only a

portion of which is regulated. Id. Historically, the Commis-

sion has employed two differing methodologies for attribution

of tax costs in dealing with this difficulty. Again, City of

Charlottesville provides the background for understanding

the two methodologies. Under the older, ‘‘flow-through’’

methodology, the Commission ‘‘derive[d] an effective tax rate

by determining the ratio of each [regulated] pipeline’s taxable

income to the total taxable income of all affiliates, multipl[ied]

this fraction by the group’s consolidated tax liability, and

divide[d] this figure by the pipeline’s taxable income.’’ Id. at

1207. Under the more recently derived ‘‘stand-alone’’ meth-

odology, the Commission has sought to segregate the regulat-

ed utility, then determine ‘‘the taxable income and deductions

TTT specifically attributable to the utility’s jurisdictional activ-

ities.’’ Id. Under this approach, the Commission then ap-

plies ‘‘the statutory tax rate TTT to the tax base to yield the

stand-alone tax allowance.’’ Id. The present controversy

arises from the fact that neither of these historic methods can

by its terms be literally applied to the rates of SFPP.

The name of the jurisdictional pipeline operator explains

the origin of the difficulty. SFPP, L.P., is a limited partner-

ship — specifically a publicly-traded one. Both the flow-

through and stand-alone methodologies presume taxable in-

come generated by the regulated entity. Each arose in the

context of corporate ownership of a jurisdictional pipeline by

a tax-paying corporation which is part of an affiliated group.

Shipper petitioners concede that were SFPP a subchapter C

corporation, a tax allowance would be appropriate in order ‘‘to

insure that the regulated entity has the opportunity to earn

its allowed return on equity.’’ Lakehead, 71 FERC at 62,314.

But a limited partnership operating jurisdictional pipelines

incurs no income tax liability. 26 U.S.C. § 7704(d)(1)(E).

30

Therefore, shipper petitioners contend there is no rational

basis for FERC to approve an income tax allowance for a

limited partnership that incurs no income taxes. Thus, ship-

pers argue, FERC erred in allowing even a 42.7% tax allowance

in the rates of SFPP.

Shippers raised this argument before the Commission and

the Commission discussed it in Opinion No. 435. See 86

FERC at 61,101–07; see also Opinion No. 435–A, 91 FERC at

61,508–09; Opinion No. 435–B, 96 FERC at 62,077–78. In all

of its iterations, FERC’s discussion of the issue has been in

terms of the ‘‘Lakehead policy.’’ FERC first announced that

policy in Lakehead, 71 FERC ¶ 61,338, and offered certain

clarifications of the policy in Lakehead II, 75 FERC ¶ 61,181.

That case also involved ratemaking of a limited partnership.

In Lakehead, the Commission declared that where a regulat-

ed pipeline is a non-taxed limited partnership, it will not be

permitted the same tax allowance as it would if the pipeline

company were a corporation. However, FERC further ruled

that where the limited partnership includes corporate part-

ners, it would treat the partnership as being ‘‘in essence a

division of each of its corporate partners’’ for purposes of

determining an income tax component in the partnership’s

cost of service computation. Lakehead, 71 FERC at 62,315.

Importantly, FERC’s opinion in Lakehead was never subject-

ed to judicial review, and neither this court nor any other

circuit has ever passed on the validity of the Lakehead policy.

Therefore, while FERC may deem itself bound to follow that

policy, we are not so bound and consider its validity for the

first time in this application. All petitioners urge us to reject

it in whole or in part, though for differing reasons.

Commencing with the assumption that it should apply the

Lakehead policy to SFPP’s ratemaking, FERC considered

the question before it to be the determination of how that

policy applied to a limited partnership composed of one

partner (or partners) that is a subchapter C (taxpaying)

corporation and other partners that are not subchapter C

corporations but rather individuals, subchapter S corpora-

tions, trusts, or other entities that do not incur corporate

31

income tax. FERC’s analysis is rooted in the rationale

offered in Lakehead, discussed in the ALJ Decision, see 80

FERC at 65,179, and adopted by the Commission in Opinion

No. 435, see 86 FERC at 61,102. The Commission bases that

rationale on the ‘‘double taxation’’ incurred in the context of

subchapter C corporations, in which the profitmaking corpo-

ration is liable for corporate income tax and the shareholders

of the corporation are individually liable for their individual

income tax on dividends generated by the profitmaking corpo-

rations.5 The Commission in Lakehead ruled that ‘‘because

the corporate tax is an extra layer of taxation, the Commis-

sion includes an element for the corporate taxes in the cost-

of-service to insure that the regulated entity has the opportu-

nity to earn its allowed return on equity.’’ 71 FERC at

62,314. This same rationale guided the Commission’s compu-

tation of tax allowance for the nontaxpaying limited partner-

ship, including one or more subchapter C partners, through-

out the Lakehead administrative litigation and the SFPP

ratemaking now before us. Because SFPP, Inc., a subchap-

ter C corporation, held a 42.7% interest6 in the SFPP limited

partnership, the Commission included in the cost of service

computation for SFPP, L.P., a 42.7% allowance for income

taxes that would have been incurred had the pipeline’s juris-

dictional earnings been subject to corporate taxation. 86

FERC at 61,103.

Shippers contend that FERC erred in including this income

tax allowance, arguing that the ALJ was correct that because

no income taxes have been or will be paid on SFPP’s partner-

ship income, the inclusion of an income tax allowance in the

cost of service constitutes allowance for ‘‘phantom taxes.’’ Id.

SFPP, on the other hand, contends that the 42.7% allowance

5 In our discussion of the double-taxation rationale, we are adver-

tent to actual and proposed changes in corporate and dividend

taxation occurring after the ratemaking we now review. In view of

the timing of the ratemaking, and of our resolution of this issue, no

such changes are germane to our further analysis.

6 A 41.7% limited partnership interest and a 1% general partner-

ship interest.

32

is in fact inadequate to reflect cost of service. It argues that

the Lakehead policy results in an understatement of the

appropriate income tax allowance, and that the Commission

should have applied a version of the ‘‘stand-alone’’ methodolo-

gy discussed above, treating the regulated entity as if it alone

were responsible for taxes which would have been incurred on

the same income had the jurisdictional pipeline been a taxable

corporation.

Because we conclude that FERC’s rationale does not sup-

port its conclusion, we hold that inclusion of the 42.7% income

tax allowance in the cost of service computation was errone-

ous and we vacate FERC’s order to that effect. We further

conclude that SFPP’s arguments are not well-taken and

reject the proposition that FERC should have included the

100% allowance that SFPP seeks. We further conclude that

the shipper petitioners offer a convincing analysis consistent

with ratemaking principles and governing law, and that on

the record before us SFPP is entitled to no allowance for the

phantom income taxes it did not pay.

We cannot conclude that FERC’s inclusion of the income

tax allowance in SFPP’s rates is the product of reasoned

decisionmaking. In Lakehead, as re-adopted in the opinion

before us, the ‘‘reasoning’’ consists of a recitation of separate-

ly unassailable statements that do not together constitute a

syllogism leading to the conclusion purportedly based on

them. The Commission in Lakehead reasoned that:

l. Under cost-of-service ratemaking principles a regu-

lated company is entitled to rates that yield sufficient

revenue to cover its appropriate costs.

2. Income tax allowance is no different from the allow-

ance for any other costs.

3. When the regulated entity is organized as a corpora-

tion, its revenues are taxed at the corporate tax rate and

the earnings of the owners (shareholders) of the corpora-

tion are then taxed on dividends at their particular rate.

71 FERC at 62,314.

To that point the Commission’s statements are unassaila-

ble. However, the Commission follows these statements with

33

a rather cryptic statement. ‘‘Because the corporate tax is an

extra layer of taxation, the Commission includes an element

for the corporate taxes in the cost-of-service to ensure that

the regulated entity has the opportunity to earn its allowed

return on equity. However, there is no allowance for the

taxes paid by the owners of the corporation.’’ Id. Again, the

second of these two sentences is inarguable, but it is not at all

clear what the Commission means by the first. It would

seem to follow from the Commission’s own reasoning in the

preceding elements of analysis, as well as fundamental princi-

ples of ratemaking, that if the corporate tax is to be included

in the cost-of-service, it is not because it is ‘‘an extra layer of

taxation,’’ but rather because it is a cost. Id. In the Com-

mission’s own words, a tax allowance is ‘‘no different from the

allowance for any other costs.’’ Id. Presumably whatever

tax rate was applicable to a tax-paying regulated entity would

be included in the cost-of-service analysis, nor does anything

said by the Commission in Lakehead or in the opinions before

us dispute that presumption. From this line of ‘‘reasoning,’’

FERC proceeded to conclude that the limited partnership

operating a jurisdictional pipeline ‘‘is entitled to an income tax

allowance with respect to income attributable to its corporate

partners.’’ Id. The only further explanation that FERC

offers for this conclusion is ‘‘when partnership interests are

held by corporations, the partnership is entitled to a tax

allowance in its cost-of-service for those corporate interests

because the tax costs will be passed on to the corporate

owners who must pay corporate income taxes on their allocat-

ed share of income directly on their tax returns.’’ Id.

The Commission then goes on to ‘‘conclude[ ] that [the

limited partnership pipeline] should not receive an income tax

allowance with respect to income attributable to the limited

partnership interests held by individuals TTT because those

individuals do not pay a corporate income tax.’’ Id. at 62,315.

Presumably, however, the individual owners pay individual

income taxes. Also, presumably many owners (shareholders)

of corporate holders of limited partnership interests will not

be paying taxes on dividends as corporations often do not

34

generate dividends.7 In the original Lakehead opinion, the

Commission had little further to say about why it distin-

guished between the corporate taxes of corporate unit holders

and the individual income taxes of individual unit holders. In

Lakehead II, and in the opinions we review today, the Com-

mission did offer some attempt to explain the distinction.

In Lakehead II, FERC considered the argument of the

Lakehead limited partnership that the Commission’s refusal

to grant a tax allowance reflecting the tax liabilities of all

limited partnership unit holders, whether or not each holder

was a subchapter C corporation, did not comport with the

Commission’s own ‘‘actual taxes paid’’ rationale, because the

Commission, under the ‘‘stand-alone’’ tax policy discussed

above, would permit ‘‘a regulated entity to collect a fair tax

allowance even where no actual tax liability is incurred.’’

Lakehead II, 75 FERC at 61,594. Lakehead II went on to

argue that under this rationale, even if the jurisdictional

entity is a non-taxed limited partnership, ‘‘rate payers should

be responsible for the tax liability otherwise associated with

the revenue generated from the jurisdictional activities, with-

out regard to any actual amount paid to the IRS.’’ Id. In

rejecting the argument, the Commission stated, no doubt

correctly, that in the case of a jurisdictional corporate subsid-

iary of a corporate group, ‘‘the allowed equity return gener-

ates an actual tax liability for the pipeline that must be paid

to the IRS, either in cash or through the use of another

member’s deductionsTTTT [E]ither way, the tax liability of

the jurisdictional company is a real cost of providing service.’’

Id. at 61,595 (citing Northern Border Pipeline Co., 67 FERC

¶ 61,194, 61,110–11 (1994)). As applied to tax liability gener-

ating corporate subsidiaries engaged in jurisdictional activi-

ties, the Commission’s statement is again quite defensible,

when such a subsidiary does not itself incur a tax liability but

generates one that might appear on a consolidated return of

7 As noted in n.5, supra, changes in tax laws subsequent to the

Commission’s opinion herein may further affect the asymmetry of

including in ratemaking allowance for the corporate tax of corporate

unit holders but not the individual tax of individual unit holders.

35

the corporate group. The difficulty arose when the Commis-

sion attempted to take the next step and explain why this

reasoning applied to an entity that is a non-taxable limited

partnership and to justify discriminating between allowances

for the tax liability of corporate unit holders and the tax

liability of those unit holders who are individuals or otherwise

not subchapter C corporations. The Commission’s reasoning

on that point extends for two more paragraphs, but is sum-

marized in the following statement immediately following the

last quoted language from Lakehead II:

In contrast, there is no corporate tax liability associated

with individual partners’ equity return and therefore it is

not appropriate to allow Lakehead to collect for such

amounts in its cost-of-service.

Id. This does not supply reasoning for differentiating be-

tween individual and corporate tax liability. It is merely re-

stating the proposition that the Commission is so differentiat-

ing. Otherwise stated, the Commission is once again simply

declaring: we are including a tax allowance for corporate tax

liability; we are not allowing a deduction for individual in-

come tax liability. To re-phrase a proposition is not the same

as supplying supporting reasoning. In short, the Commis-

sion’s opinions in Lakehead do not evidence reasoned deci-

sionmaking for their inclusion in cost of service of corporate

tax allowances for corporate unit holders, but denial of indi-

vidual tax allowances reflecting the liability of individual unit

holders.

Nonetheless, we could sustain the Commission’s decision if

the opinions we review had added the reasoned decisionmak-

ing lacking in Lakehead. They do not. Before the court, the

Commission’s counsel argues that the distinction is justified

in the reasoning offered by the ALJ in the portion of his

decision affirmed by the Commission. The ALJ, attempting

to apply the Lakehead policy, had reasoned that ‘‘investors in

a regulated pipeline are entitled to a return ‘commensurate

with returns on investments in other enterprises having

corresponding risk.’ ’’ ALJ Decision, 80 FERC at 65,177

(quoting FPC v. Hope Natural Gas Co., 320 U.S. 591, 603

36

(1944)). Still struggling with the Lakehead policy which had

permitted a corporate income tax allowance but not an allow-

ance for the tax liability of other investors in the limited

partnership, the ALJ concluded ‘‘because there is no dual

taxation, a tax allowance is not necessary to ensure that an

individual limited partner obtains a ‘commensurate return.’ ’’

Id. We agree that the ALJ’s invocation of the Hope Natural

Gas Co. principle was apt, but unlike the Commission, we

agree that the conclusion he based it on was sound.

The Hope Natural Gas decision did not itself involve

attribution of tax liability for purposes of determining allow-

ances and ratemaking. It did however, apply general princi-

ples of ratemaking that are instructive in that context. As

the Commission argues to us, that decision teaches that the

Commission’s ratemaking function involves ‘‘a pragmatic as-

sessment of whether the rates prescribed for a pipeline will

support its services and provide a reasonable return to its

investors.’’ FERC Br. 60 (citing Hope Natural Gas, 320 U.S.

at 602; Farmers II, 734 F.2d at 1502). However, the Com-

mission’s premise again does not lead to the Commission’s

conclusion. The ALJ correctly derived from Hope Natural

Gas the more specific principle that the regulating commis-

sion is to set rates in such a fashion that the regulated entity

yields returns for its investors commensurate with returns

expected from an enterprise of like risks. Were the corpo-

rate unit holders investing in a non-regulated entity of like

risk and otherwise similar return, they would of course expect

to pay their own corporate tax on any profit they might

realize from that investment. Should that profit generate

dividends from the corporations, the shareholders would ex-

pect to pay their own taxes on such dividends.8 Likewise,

individual investors in such a non-regulated enterprise would

expect to pay their individual taxes thereon. Granted, the

second group of investors would pay one level of taxation; the

first group, at least potentially, two layers of taxation. This

is a product of the corporate form, not of the regulated or

unregulated nature of the pipeline or any comparable invest-

8 See footnotes 5 and 7, supra.

37

ment or of the risks involved therein. Therefore, consistent

with Hope Natural Gas, the ALJ correctly concluded that

where there is no tax generated by the regulated entity,

either standing alone or as part of a consolidated corporate

group, the regulator cannot create a phantom tax in order to

create an allowance to pass through to the rate payer. The

Commission erred when it rejected the ALJ’s conclusion.

As we have recited repeatedly above, and as the Commis-

sion itself has recognized in this very proceeding, under cost-

of-service principles, a regulated company is entitled to a rate

design to yield sufficient revenue to cover its appropriate

cost; income tax allowance is no different from the allowance

of any other costs. The regulated pipeline generates many

costs, for example bookkeeping expenses. Presumably those

bookkeeping expenses are recoverable in its rates. Its corpo-

rate unit holders, if any, presumably also have bookkeeping

expenses. The bookkeeping expenses of the corporate unit

holders are not recoverable in the rates of the pipeline, even

though the corporation and its shareholders each may inde-

pendently be paying bookkeepers and accountants unlike

individual unit holders who pay only for their own accounting.

All of this makes sense. It makes equal sense when applied

to income taxes.

SFPP, while raising its own objections to the Lakehead

policy, joins the Commission in opposing the shipper petition-

ers’ arguments that no income tax allowance should be includ-

ed in the ratemaking. SFPP, however, argues that the

Commission not only did not err in including the potential tax

liability of its corporate unit holders, it instead erred in not

including the potential tax liability of its individual or other

non-subchapter C corporate unit holders. That argument

serves to illustrate further why the ALJ was correct in

including no such pass-through or phantom taxes at all.

Under the Commission’s present order, the imputed tax

liability of the corporate unit holders creates an allowance

included in the making of the rate for the pipeline. The

ratepayers pay that rate for the product shipped, but the

allocation of the nontaxed profit of the limited partnership

pipeline is, so far as the record reflects, subject to division

38

among the unit holders rateably according to their interest in

the limited partnership, not affected by how their share of the

profits will ultimately be taxed. Therefore, even if the Com-

mission’s goal of changing the risk analysis of ‘‘double-taxed’’

investors were a valid one, it is not being accomplished. The

inclusion of the phantom taxes in the rate changes the profit

margin for all unit holders in the untaxed limited partnership,

not just those who are under a particular tax structure.

Therefore, SFPP may well be correct that if such an allow-

ance were allowable at all, it should have been allowed for the

imputed taxes potentially incurred by all unit holders who

realized taxable income from the untaxed profits of the

limited partnership of the pipeline. For the reasons set forth

above, we hold that the first step of this analysis is errone-

ous — that is, we hold that no such allowance should be

included.

Both FERC and SFPP argue that the position we adopt

today is inconsistent with the ‘‘stand-alone’’ methodology

approved by this court in City of Charlottesville, for reasons

related to the so-called ‘‘actual tax’’ principle discussed there-

in. City of Charlottesville, 774 F.2d at 1207, 1215. Again, we

will not rehash the full analysis of City of Charlottesville, but

simply will remind SFPP that the stand-alone principle as

approved in City of Charlottesville dealt with the imputation

of taxes within a corporate structure where the imputation

was made necessary not by the non-taxable, non-corporate

nature of the regulated entity, but by the allocation of profits

and losses among the related members maintaining separate

balance sheets within a consolidated corporate group. While

it is true that then-Judge Scalia posited the applicability of

the stand-alone methodology to a circumstance in which taxes

were ‘‘not necessarily TTT paid,’’ id. at 1215, that analysis

dealt with the use of ‘‘actual or estimated taxes paid or

incurred’’ rather than being limited to actual taxes paid. But

the part of the City of Charlottesville opinion in which that

discussion occurred dealt with the argument that the taxes,

though properly estimated and actually incurred, might not

ever be actually paid because of such factors as losses gener-

ated in the corporate structure, or the allocation of profits

39

between and among taxable years in such a fashion as to

result in a different tax actually being paid, if any at all. See

id. at 1214–15. Nothing in the City of Charlottesville opinion

suggests that it is the business of the Commission to create

tax liability when neither an actual nor estimated tax is ever

going to be paid or incurred on the income of the utility in the

ratemaking proceeding.9

Finally, SFPP argues that adopting the Lakehead policy

and applying it to this case to restrict the allowance to the

taxes of the corporate unit holders as opposed to imputing the

taxes of all unit holders ‘‘runs directly contrary to legislation

in which Congress expressly sought to encourage the publicly

traded partnership formed for oil pipelines and other selected

industries.’’ Underlying this argument is Congress’s 1987

enactment of Section 7704 of the Internal Revenue Code. 26

U.S.C. § 7704 (added by Pub L. 100–203, Title X, § 10211(a),

Dec. 22, 1987, 101 Stat. 1330–403). Under Section 7704,

Congress decreed that, in general, publicly traded limited

partnerships would be taxed as corporations. However, Con-

gress made the policy decision that for a limited number of

industries, including ‘‘pipelines transporting gas, oil, or prod-

ucts thereof,’’ limited partnerships should operate without

taxation to encourage investment in those critical industries.

Id. § 7704(d)(1)(E). SFPP argues that because Congress

singled out a narrow category of enterprises with the intent

to facilitate investment in such enterprises by providing a tax-

efficient means to raise capital, FERC’s policy is inconsistent

with congressional intent because it provides a smaller incen-

tive than would be the case if it granted an allowance for

phantom taxes based on all unit holders instead of simply the

9 At least equally inapposite is Carolina Power and Light v.

FERC, 860 F.2d 1097 (D.C. Cir. 1988). SFPP relies on Carolina

Power and Light for the proposition that ‘‘the Commission is not

obligated in prospective ratemaking proceedings to match rates

dollar for dollar with taxes paid to the Internal Revenue Service.’’

Id. at 1101 (internal quotations omitted). There, again, we dealt

with the computation of the precise amount of taxes to be passed

through, not whether the Commission could create a tax liability out

of whole cloth to pass through to rate payers of a nontaxable utility.

40

corporate ones. This is a classic case of an argument proving

too much.

SFPP’s argument would equally apply to any decision by

the Commission that caused the pipeline lower allowances

rather than higher. Unsurprisingly, SFPP is able to offer no

precedent for the proposition that we should compel the

Commission, or any other agency, to adopt a rate structure

bringing it into line with the perceived intent of Congress to

achieve objectives in general, as opposed to consistency with

the mandate adopted by Congress in furtherance of such

objectives. As we have noted in other contexts, congressional

mandates to agencies to carry out ‘‘specific statutory di-

rective[s] define[ ] the relevant functions of [the agency] in a

particular area.’’ Michigan v. EPA, 268 F.3d 1075, 1084

(D.C. Cir. 2001). Such a mandate does not create for the

agency ‘‘a roving commission’’ to achieve those or ‘‘any other

laudable goal.’’ Id. The mandate of Congress in the tax

amendment was exhausted when the pipeline limited partner-

ship was exempted from corporate taxation. It did not

empower FERC to do anything, let alone to create an allow-

ance for fictitious taxes.

For the reasons set forth above, we vacate the tax-

allowance portion of the FERC opinion and order allowing

recovery for income taxes not incurred and not paid.

2. Litigation Costs

This case has been an expensive one. At the time of the

ALJ Decision, 80 FERC ¶ 63,013, SFPP sought to recover

$15.1 million for litigation expenses and associated costs

related to Commission and certain civil litigation. This in-

cluded a $12 million litigation expenses reserve plus $3.1

million that SFPP claimed was a direct expense associated

with this rate proceeding and related civil litigation. By the

time this case reached its second rehearing in 2001, Opinion

No. 435–B, SFPP’s actual costs appear to have ballooned

much higher; the pipeline’s 2002 compliance filing places its

cumulative costs litigating this rate proceeding, as well as

litigating and settling related civil litigation, at over $48.1

million.

41

a. Rate Litigation

In keeping with Iroquois Gas Transmission Sys. v. FERC,

145 F.3d 398 (D.C. Cir. 1998), and its own precedents, the

Commission considered SFPP’s rate litigation to be ‘‘part of

its normal, ongoing operations’’ and allowed SFPP to recover

these costs from shippers. It did not, however, permit recov-

ery through a permanent rate increase. Reasoning that

SFPP’s regulatory litigation costs, if ‘‘includ[ed] in embedded

rates,’’ would ‘‘artificially inflate the level of rates between

rate cases,’’ because the rate proceeding that caused most of

the costs was now over and was not likely soon to recur, the

Commission refused to factor them into SFPP’s indexed

rates. Instead, the Commission allowed SFPP to recover its

actual regulatory litigation costs in the form of an amortized

five-year surcharge, with recovery of costs incurred after the

1994 test year offset by the amount which SFPP had collected

in excess of the just and reasonable rates from shippers that

did not file complaints within the appropriate period. The

court reviews, therefore, two distinct decisions of the Com-

mission: to use a temporary surcharge in lieu of a rate

increase to recover SFPP’s rate litigation costs, and to offset

the post–1994 surcharge by the amount of reparations that

would have been due non-complaining shippers.

No party challenges the Commission’s decision that SFPP’s

rate litigation costs are recoverable. This does not mean,

however, that SFPP was automatically entitled to have those

expenses treated as part of its indexed rates, as if the

unusually high costs it incurred in this proceeding would

regularly recur until the next rate proceeding. SFPP con-

tends that it was entitled to have a litigation reserve factored

into its cost of service, because it incurred significant regula-

tory litigation expenses in the test year, 1994, and was bound

to continue to incur costs litigating matters before the Com-

mission in the future. Yet nothing in the record suggests

that any other matters SFPP has pending before the Com-

mission will generate costs close to those in this rate proceed-

ing. A glance at SFPP’s compliance filing confirms that its

litigation expenses have dropped significantly from the levels

they reached between 1994 and 1997. The Commission’s

42

reasoning for denying the rate increase, that there was ‘‘no

assurance that SFPP’s litigation costs would exceed

$2,914,114 a year for the several years that the 1994 rates are

likely to remain in effect,’’ Opinion No. 435–B, 96 FERC at

62,075, seems quite reasonable. The Commission has not

denied all recovery of these costs but simply limited SFPP’s

recovery to its actual costs defending this proceeding and

required that those costs be removed from rates once they

were repaid.

Where the Commission took a more novel approach was in

how it implemented this surcharge. While SFPP was permit-

ted to recover its 1993 and 1994 regulatory litigation costs in

full, the Commission offset the surcharge for later years by

the amount SFPP had collected, in excess of rates ultimately

set by the Commission, from shippers that did not challenge

the rates and were therefore not entitled to reparations.

SFPP contends that this novel approach of deducting ‘‘un-

claimed reparations’’ from the surcharge deprived it of a full

recovery, because, in effect, it recovered nothing at all for

litigation costs incurred after the test year.

Although the Commission does not cite any precedent for

this offset, the apparent novelty of this approach does not

render it unreasonable. As the Commission noted, the costs

of this proceeding were ‘‘high for all parties,’’ and the issue is

‘‘how those costs can be most equitably allocated.’’ Id. at

62,074. In setting prospective rates, the Commission could

reasonably conclude that because SFPP had reaped a windfall

by charging rates in excess of those ultimately deemed just

and reasonable in the same past years for which it was

claiming supplemental expenses above those it would prospec-

tively incur as part of its cost of service, it should be required

to first fund its litigation expenses out of that pool before it

could begin charging those costs to its customers anew.

While SFPP contends that this unfairly benefits shippers that

sat on their rights by not filing complaints against SFPP’s

rates, and that Section 16 of the ICA only authorizes repara-

tions for shippers who have filed such challenges, see 49

U.S.C. app. § 16(1) (1988), it presents no justification for

being entitled to keep this windfall. The court therefore

43

affirms the Commission’s surcharge mechanism and its corre-

sponding offset, subject to the qualification that, depending

on what rates ultimately result from this proceeding on

remand, the surcharge might require recalculation.

b. Civil Litigation Expenses

SFPP also challenges the Commission’s decision to disallow

recovery in the East Line rates of significant expenses SFPP

incurred in civil litigation defending its reversal of flow on a

segment of six-inch pipe running between Phoenix and Tuc-

son. SFPP’s flow reversal removed capacity from the East

Line in order to allocate it to the West Line. While this

benefitted West Line shippers, it would be, as the Commis-

sion recognized, inequitable to include these costs in the East

Line rates, for ‘‘there appears no reason why ratepayers

should bear the expense of defending conduct that had no ex

ante prospect of benefitting them.’’ See Iroquois Gas, 145

F.3d at 401; see also Mountain States Telephone & Tele-

graph Co. v. FCC, 939 F.2d 1035, 1043 (D.C. Cir. 1991)

(‘‘Mountain States I’’). The Commission’s recognition that

litigation of this sort lacks the requisite nexus to the provision

of SFPP’s East Line service to justify inclusion in those rates

was not unreasonable.

SFPP was embroiled in lengthy litigation in Arizona and

Texas state courts with EPR and Navajo, two East Line

shippers, regarding SFPP’s reversal of flow on the six-inch

line, one of SFPP’s two pipes running between Phoenix and

Tucson. That litigation ultimately cost SFPP, according to

its 2002 compliance filing, over $23.7 million. SFPP also has

an eight-inch pipe running between the two cities. The six-

inch line had been in West Line service from 1989 to 1991.

When SFPP undertook an expansion of the eight-inch line

(which had been in East Line service) SFPP temporarily

assigned the six-inch line to the East Line. Upon completion

of the expansion project, SFPP entered an agreement with

ARCO, a West Line shipper, to return the six-inch line to

West Line service, thus restoring West Line service to Tuc-

son. EPR and Navajo sued to enjoin the reversal, alleging

that SFPP had contractually agreed to provide them the

44

extra capacity, that they had engaged in costly investments in

reliance on those agreements, and that the line reversal was

motivated by a desire to drive the two shippers out of

business. As noted, EPR also filed a complaint with the

Commission challenging both the flow reversal and SFPP’s

East Line rates, thereby initiating this rate proceeding. The

ALJ dismissed the portion of EPR’s complaint dealing with

the flow reversal for lack of jurisdiction, noting that because

the Commission has no jurisdiction to prevent SFPP from

abandoning service on the six-inch line, it also lacks authority

to adjudicate allocation disputes as between shippers serving

different markets along the line. ALJ Decision, 80 FERC at

65,161–64. No party has sought review of that ruling. The

litigation then proceeded in other courts with SFPP ultimate-

ly entering into settlements with both shippers.

The ELS’ lawsuit based on SFPP’s reallocation of capacity

from the East Line to the West Line, and the corresponding

litigation costs incurred by SFPP, while caused, in the imme-

diate sense, by ELS, were not costs of East Line service or

expenditures benefitting the SFPP system generally. They

were costs, if anything, of making capacity available to the

West Line at the East Line’s expense. SFPP did not seek to

recover its costs from West Line shippers, either in the cost

of service or by capitalizing them into the rate base, presum-

ably because of the Commission’s earlier ruling that the West

Line rates were grandfathered under Section 1803 of the

EPAct, and therefore not subject to increase in this proceed-

ing. Instead, SFPP sought to recover them from East Line

shippers.

The Commission rejected this attempt, concluding that

SFPP’s costs in settling these matters ‘‘arose out of litigation

unique to the conditions of [EPR and Navajo],’’ and, as such,

were not costs that related to the provision of East Line

service as a whole. Opinion No. 435, 86 FERC at 61,106. On

rehearing, the Commission ruled that the costs of litigating

these matters were not recoverable, because ‘‘civil litigation of

this type’’ involving ‘‘assertions of anti-competitive behavior

and breach of contract to make capacity available’’ does not

‘‘address legal costs and remedies that SFPP would normally

45

incur in the conduct of its common carrier operations.’’ Opin-

ion No. 435–A, 91 FERC at 61,513. Therefore, the Commis-

sion concluded, SFPP’s litigation expenses were ‘‘extraordi-

nary.’’ Id. On further rehearing, the Commission reaffirmed

its ruling that SFPP could not recover such litigation costs in

its rates. Opinion No. 435–B, 96 FERC at 62,070.

Under the Commission’s accounting regulations, extraordi-

nary costs are defined as costs that ‘‘possess a high degree of

abnormality and [are] of a type clearly unrelated to, or only

incidentally related to the ordinary and typical activities of

the entity’’ and are ‘‘not reasonably expected to recur in the

in the foreseeable future,’’ 18 C.F.R. pt. 352, General Instruc-

tions, 1–6(a). SFPP’s flow reversal was not itself unique, for

it had changed the direction of flow on the six-inch line a year

before during the expansion of the eight-inch line. Neverthe-

less, as none of these prior reversals had generated legal

disputes of this scope, the Commission could reasonably

conclude that this type of civil litigation, ‘‘an action that would

not arise in the normal course of the pipeline’s operations,’’

was not likely to recur. Opinion No. 435–B, 96 FERC at

62,070.

The remaining question is whether the Commission used

the correct standard in determining that these costs were

‘‘clearly unrelated to, or only incidentally related to the

ordinary and typical activities of the entity.’’ SFPP contends

that any reading of this portion of the Commission’s regula-

tions must comply with Iroquois Gas, 145 F.3d 398, and

Mountain States I, 939 F.2d at 1034, particularly the latter

decision’s admonition that ‘‘[i]f expenses are properly in-

curred, they must be allowed as part of the composition of

rates. Otherwise, the so-called allowance of a return upon

the investment, being an amount over and above the ex-

penses, would be a farce.’’ Id. at 1029 (internal citations

omitted).

SFPP’s position that capacity allocation litigation is an

inevitable cost of doing business with two shipper camps

competing for the same markets is not without some persua-

siveness. The court has generally taken a somewhat broad

46

view of which litigation costs entities regulated under rate-of-

return ratemaking should be permitted to recover. In Iro-

quois Gas, the court vacated the Commission’s presumptive

disallowance of a gas pipeline’s litigation costs defending

alleged environmental violations during construction, reason-

ing that the Commission must analyze whether the purported

environmental violations were for ratepayers’ benefit rather

than simply presuming the imprudence of supposedly illegal

activity. 145 F.3d at 399–403. Similarly, in Mountain States

I, 939 F.2d at 1029–35, the court vacated an FCC order

denying a carrier’s recovery of antitrust litigation expenses,

and, the same term, in Mountain States Telephone and

Telegraph Co. v. FCC, 939 F.2d 1035 (D.C. Cir. 1991) (‘‘Moun-

tain States II’’), remanded a rule presumptively denying

recovery of litigation and judgment costs resulting from

findings of illegal activity, expressing concern that such a rule

might discourage utilities from taking appropriate legal risks

that would ultimately benefit their ratepayers. Id. at 1042–

47.

The Commission stated that it did not consider Iroquois

Gas apposite because in that case, the underlying activity —

construction of the pipeline pursuant to the Commission’s

certificate authority — was something over which the Com-

mission had jurisdiction and whose prudence the Commission

could evaluate. Opinion No. 435–B, 96 FERC at 62,070–71.

By contrast, the Commission viewed SFPP’s underlying busi-

ness decision to reverse flow on the six-inch line as ‘‘beyond

the Commission’s remedial authority.’’ Proceeding on the

premise that it lacks jurisdiction over market entry and exit,

the Commission apparently takes the position that it is incap-

able of evaluating the prudence of legal expenses incurred in

the course of either, and therefore cannot include them in

common carrier rates.

The salient criterion under Iroquois Gas and Mountain

States II for the recovery of legal expenditures by regulated

entities is whether the underlying activity being defended in

the litigation serves the interests of ratepayers. See Iroquois

Gas, 145 F.3d at 401–02; Mountain States II, 939 F.2d at

1043–47. The court need not address whether the Commis-

47

sion can reasonably deny the recovery of all nonjurisdictional

litigation expenses associated with ‘‘both [market] entry and

exit by the pipeline,’’ Opinion No. 435–B, 96 FERC at 62,070,

because the issue in this proceeding is more narrow, and

arises only with regard to the inclusion of market exit costs in

the East Line rates, not market entry costs in the West Line

rates. Whatever might be a common carrier’s entitlement to

recover any nonjurisdictional litigation costs associated with

the initiation of common carrier service, it is not unreasonable

for the Commission to refuse to allow a common carrier to

charge ratepayers for the cost of taking capacity away from

them. The Commission’s initial determination that the flow-

reversal litigation at issue was unrelated to the provision of

East Line service was reasonable, and we affirm on that

basis. The Commission recognized that, unlike in Iroquois

Gas, SFPP’s litigation did not ‘‘arise[ ] under regulatory

obligations that apply to the system as a whole,’’ and noted

the ‘‘common sense observation by the East Line shippers

that the costs and awards relating to their litigation will be

borne primarily by themselves if the litigation and settlement

costs are included in the East Line rates.’’ Id. at 62,071. As

only the East Line rates were at issue, the court understands

the Commission’s statement, that SFPP’s civil legal expenses

arising from the reversal dispute are not those ‘‘that SFPP

would normally incur in the conduct of its common carrier

operations,’’ to refer narrowly to SFPP’s ‘‘common carrier

operations’’ on the East Line, and not more broadly to

SFPP’s ‘‘common carrier operations’’ generally. This ap-

proach is reasonable, because the cost of cancelling service is

not a cost of providing it.

c. Allocation of litigation costs

More problematic is the Commission’s decision that the

East Line rates should bear half of SFPP’s recoverable

litigation costs. Opinion No. 435–A, 91 FERC at 61,513.

The rate proceeding included both East Line rates and the

dispute about whether West Line rates were grandfathered.

Some litigation costs may have been exclusive to each line,

whereas others were common, but the record does not contain

precise information regarding how much of SFPP’s legal

48

expenses can be attributed to each portion of the rate litiga-

tion. The West Line accounts for roughly twice the through-

put of the East Line, and the Commission had initially

reasoned that due to the more complex nature of the West

Line issues litigated in the regulatory proceeding, costs

should be apportioned volumetrically between the lines.

Opinion No. 435, 86 FERC at 61,106. On rehearing, the

Commission reversed itself and split the costs evenly. Opin-

ion No. 435–A, 91 FERC at 61,512. The Commission stated

that the ALJ, who initially presided over the case, was ‘‘in a

position to observe complexity and flow’’ of the litigation, and

could have reasonably concluded that it was the East Line

issues, not the West Line issues, that accounted for the

‘‘greater portion’’ of costs generated in the proceeding. Id.

The ELS contend that the Commission departed from its

well-established volumetric allocation policy for general costs

without a rational basis, and thus was arbitrary and capri-

cious in basing its allocation on which shippers created higher

litigation costs. We see nothing problematic in an approach

that attributes litigation costs to those for whose benefit the

litigation is incurred, and prior Commission cases dealing

with legal expenses have allocated them similarly. See, e.g.,

Southern California Edison Co., 56 FERC ¶ 61,003, 61,021

(1991). A volumetric approach might be appropriate for the

recovery of commonly-incurred costs benefitting the entire

system, but the Commission’s focus here on who ‘‘generate[d]

the greater portion of a given litigation,’’ Opinion No. 435–A,

91 FERC at 61,513, is reasonable when litigation costs are

specific to separately priced services.

The problem with the Commission’s litigation-cost alloca-

tion is more basic: it lacks substantive analysis. The court is

unable to discern why the Commission decided that 50%, as

opposed to 40%, 30%, or any other number, fairly reflects the

portion of SFPP’s litigation expenses attributable to the East

Line. It simply claimed to rely on the ALJ Decision for the

50% figure. See 80 FERC at 65,167. The ALJ Decision, at

best, implicitly adopts the allocation suggested by a Staff

witness. Other than describing the Staff’s proposal as being

developed as a representative amount of litigation expenses

49

for inclusion in the test year cost of service, the ALJ Decision

provides no analysis of why such a distribution is warranted.

Hence, the Commission’s reliance on the ALJ as being in the

best position to observe the ‘‘complexity and flow’’ of the

litigation leaves unexplained the basis for the allocation.

While most of SFPP’s litigation cost recovery has been offset

by unpaid reparations, and the difference in rates resulting

from the allocation may ultimately not be significant, the

Commission must still explain its decision. The 50% alloca-

tion may or may not be a fair reflection of SFPP’s rate

litigation costs that were in fact attributable to the East Line.

Accordingly, we remand for the Commission to explain its

rationale for its allocation, either based on a 50–50 sharing

between the East and West Lines or any other allocation it

determines would be appropriate.

3. Reconditioning Costs

SFPP sought to have included in its East Line rates a

projected annual cost of $3 million for a 15–year pipeline

reconditioning program replacing the protective coating on

parts of the East Line. Before the Commission, SFPP

claimed to have spent upwards of $5.9 million of these recon-

ditioning costs between 1995 and 1998. While acknowledging

SFPP’s expenditures on the project, the Commission refused

to incorporate those costs, most of which were not incurred

until after 1995, into SFPP’s cost of service because they

were too uncertain at the end of the test period in 1994.

Opinion No. 435, 86 FERC at 61,106–08. On rehearing, the

Commission permitted SFPP to recover its actual expenses

from shippers as part of the temporary surcharge it created

for SFPP’s rate litigation and environmental expenses. Opin-

ion No. 435–A, 91 FERC at 61,518–19. On further rehearing,

however, the Commission reversed itself again and denied

SFPP all recovery of its refurbishing costs. Opinion No. 435–

B, 96 FERC at 62,078–79.

Under its cost of service regulations, the Commission uses

a ‘‘test year’’ methodology to determine a pipeline’s annual

cost of service. This approach looks to the actual costs the

carrier incurs in the ‘‘test year’’ and then adjusts for any

50

‘‘known and measurable with reasonably accuracy’’ costs that

‘‘will become effective within nine months after the last month

of the available actual experience utilized in the filing.’’ 18

C.F.R. § 346.2(a)(1)(ii) (2004). The test year methodology

accounts for the somewhat counterintuitive quality of these

proceedings. The Commission, in issuing decisions after 1999

setting SFPP’s cost of service for years after 1994, looked not

to SFPP’s actual costs in those years but rather to what one

could have predicted those costs to be, based on what was

known in 1994. The Commission noted in Opinion No. 435

that it considers the test year a ‘‘relatively rigid concept

simply because there must be some point at which the record

closes and there is a known, factual basis for the conclusions.’’

86 FERC at 61,108. Although this statement appears to

mark a change from Commission policy in cases preceding

the implementation of its cost of service regulations, where it

indicated that it would approach test years more flexibly, see,

e.g., Lakehead, 71 FERC at 62,313; Williams Pipe Line Co.,

21 FERC at 61,658, the Commission’s current cost of service

regulations provide that it ‘‘may allow reasonable deviation

from the test period’’ for ‘‘good cause shown.’’ 18 C.F.R.

§ 346.2(a)(1)(ii).

The ALJ, using 1993 as the base year, decided that the

refurbishing costs could not be recovered as part of SFPP’s

cost of service because the costs had not yet been incurred at

that time, and SFPP’s predictions of future costs were too

uncertain. Finding that SFPP’s board had not committed to

the refurbishing program as late as 1995 and was simply

funding the program year-by-year rather than committing

itself to the entire proposed 15–year program, the ALJ

reached a series of conclusions: that SFPP might decide to

abandon the project or scale it back in the future, that the

overall plan was subject to change, that there was little

documentation to support estimates of the costs, and that it

was uncertain whether significant amounts of the pipeline

scheduled for refurbishing might be so corroded as to require

outright replacement, which would be treated as a capital

investment and factored into the rate base, not as an expense

added to cost of service. In Opinion No. 435, the Commission

51

essentially affirmed the ALJ’s decision. 86 FERC at 61,106–

08.

SFPP contends that the Commission, which used a 1994

base period and the nine-month test period in 1995, could not

reasonably affirm the ALJ’s decision, which was based on

data from an earlier period. There is some record evidence

supporting SFPP’s claim that it had more firmly committed

to the reconditioning project, including beginning refurbish-

ment of several miles of pipeline in 1995, within ‘‘nine months

after the last month’’ of 1994. Cf. 18 C.F.R. § 346.2(a)(1)(ii).

There was testimony that SFPP’s board had approved the

project by 1994, that SFPP had recoated 13 miles of the

pipeline in 1995, and that its prospective cost estimates were

based upon its actual costs thus far.

Nonetheless, it was not unreasonable of the Commission to

continue to have doubts about locking so large an expense

into SFPP’s cost of service (or, to put it more aptly given the

test year methodology used here, it was not unreasonable for

the Commission to have thought that doubts about the scope

of the reconditioning project would still have been proper in

1995). At most the evidence before the Commission showed

that, by 1995, SFPP had begun refurbishing certain portions

of its pipeline; there was no guarantee from SFPP that the

refurbishing would be as ambitious and expensive as claimed.

Embedding SFPP’s projections into its cost of service would

have required its customers to pay for the refurbishing even

if the project ultimately resulted in far smaller expenditures

than those SFPP had projected. Indeed, given that SFPP

now claims to have spent roughly $6 million on the project

over four years, when it had predicted costs of at least $3

million a year over fifteen years, the Commission’s judgment

has been validated by hindsight.

This does not end our inquiry, however, for SFPP also

contends that having denied inclusion of reconditioning costs

in SFPP’s cost of service, it was arbitrary for the Commission

not to permit recovery in a surcharge of SFPP’s actual costs

in 1995–98, which were not found to be imprudently incurred.

The Commission’s legitimate doubts over the ultimate scope

52

and cost of the reconditioning do not explain the basis for the

Commission’s decision to deny recovery once actual costs of

the project were known. Its decision, rather, stems from a

combination of the Commission’s test year approach and its

interpretation of the filed rate doctrine. In Opinion No. 435–

A, the Commission permitted SFPP to recover its actual

reconditioning costs as part of the same surcharge whereby it

permitted recovery of SFPP’s regulatory litigation costs,

similarly offset by any unpaid reparations; any cost not so

offset could be included in a surcharge amortized over five

years. Yet in Opinion No. 435–B, presented with SFPP’s

claim that it had expended $5.9 million in actual East Line

refurbishing costs between 1995 and 1998, the Commission

denied recovery altogether because the expenditures ‘‘were

not incurred in the 1994 cost of service test period.’’ 96

FERC at 62,078. In responding to protests that its Opinion

No. 435–A ruling violated the filed rate doctrine, the Commis-

sion concluded ‘‘[u]pon further review’’ that allowing a sur-

charge for costs not incurred in the test period or with any

regularity thereafter ‘‘would permit SFPP to recover costs

after the fact which were not even present in the test year

itself and which thereafter could not be recovered in a cost of

service rate filing,’’ and that ‘‘[t]o do so after the fact raises

serious questions under the filed rate doctrine.’’ Opinion No.

435–B, 96 FERC at 62,078.

The difficulty for the court stems from three sources: the

Commission’s apparent failure in its test year approach to

articulate a clear and consistent approach for dealing with the

prudently incurred costs of providing pipeline service that do

not regularly recur, the Commission’s failure to explain ade-

quately why SFPP’s reconditioning costs would not be recov-

erable in a cost of service rate filing, and its failure to

articulate why such a surcharge would violate the filed rate

doctrine. Some prudent expenditures involved in the opera-

tion of a pipeline that are not capitalized, such as, for in-

stance, rate litigation or refurbishing, are bound to be one-

time or infrequent expenditures. A ‘‘test year’’ snapshot of a

pipeline’s operating costs, therefore, if applied too simplisti-

cally, risks over- or under-stating the ‘‘real’’ costs of providing

53

pipeline service, depending on whether such costs happen, by

chance, to fall in a test year or not. We do not understand

the Commission to apply the test year concept so simplistical-

ly; its regulations deal with the possible overstating problem

by disallowing nonrecurring costs as part of the cost of

service, see 18 C.F.R. § 346.2(a)(1)(I), and both under- and

over-stating problems by permitting deviation from the test

year ‘‘for good cause shown,’’ id. § 346.2(a)(1)(ii). Yet the

Commission’s approach in the instant case does not appear to

deal consistently with costs incurred outside the test year, as

evidenced by its different treatment of SFPP’s rate litigation

and reconditioning costs between 1995 and 1998. Both ap-

pear to be prudent, otherwise recoverable costs; both are

nonrecurring (in the sense that they will not be permanent

expenditures SFPP can be expected to incur each year); both

were incurred chiefly outside the 1994 test year; and the

Commission initially held that both past expenses could be

recovered in prospective rates through a temporary sur-

charge because of ‘‘benefits that flowed to the system when

the costs were incurred.’’ Opinion No. 435–A, 91 FERC at

61,518.

The Commission then reversed course in Opinion No. 435–

B and disallowed recovery of the reconditioning costs only.

Its reasoning for disallowing one surcharge but permitting

the other was that ‘‘unlike the [Commission] regulatory costs,

none of [SFPP’s reconditioning costs] were incurred in the

test period.’’ 96 FERC at 62,078. The rate litigation sur-

charge included SFPP’s actual costs after 1994. So the

Commission’s ruling suggests that it matters, to recovery of

costs incurred outside of the test year, whether a carrier also

incurred costs of the same general nature in the test year

itself. The logic behind this distinction, as applied to costs

that benefit the carrier’s system but are not expected to

regularly recur, is neither explained in Opinion No. 435–B

itself, nor is it obvious. Should the Commission wish to rely

on this reasoning on remand, it must articulate and justify

more carefully what its policy on the recoverability of non-

test-year expenses is.

The Commission did explain that SFPP’s rates were in-

dexed to account for cost increases after the test year, and

54

that SFPP could not meet the ‘‘substantial divergence’’ stan-

dard for showing that indexing failed to account for increases

in its cost of service due to reconditioning expenses after

1994. Cf. 18 C.F.R. § 342.4(a) (2004). Assuming that the

Commission can explain its different treatment of rate litiga-

tion and reconditioning costs incurred in years after the 1994

test year, this may be a reasonable basis for denying recov-

ery, but the Commission’s opinion provides no analysis for

why it is true. Where the Commission had found SFPP’s

cost of service to be roughly $14 million a year, SFPP was

claiming reconditioning costs of roughly $1 million a year, a

not insubstantial amount. The Commission provided no esti-

mate or analysis of how any supplemental revenues to SFPP

resulting from rate indexing, or from increased throughput in

years after 1994, compare to those expenses.

The Commission also stated that permitting recovery of the

refurbishing costs ‘‘after the fact’’ would ‘‘raise serious ques-

tions under the filed rate doctrine.’’ Opinion No. 435–B, 96

FERC at 62,078. The filed rate doctrine ‘‘forbids a regulated

entity to charge rates for its services other than those

properly filed with the appropriate federal regulatory authori-

ty.’’ Arkansas Louisiana Gas Co. v. Hall, 453 U.S. 571, 577

(1981). The Commission did not articulate what type of

‘‘serious questions’’ it thought such recovery would raise.

Because a prospective surcharge would presumably be on file

with the Commission, the court presumes that the Commis-

sion meant that an amortized surcharge, by prospectively

recovering SFPP’s expenses from past years, would violate

the related rule against retroactive ratemaking, which re-

quires that ‘‘a utility may not set rates to recoup past losses,

nor may the Commission prescribe rates on that principle.’’

Southern California Edison Co. v. FERC, 805 F.2d 1068,

1070 n.2 (D.C. Cir. 1986) (quoting Nader v. FCC, 520 F.2d

182, 202 (D.C. Cir. 1975)).

This logic, again, raises the question of why such recovery

is any more permissible for rate litigation expenses than it is

for reconditioning costs. The Commission seems to place

SFPP in a Catch–22: it cannot recover its reconditioning

costs prospectively or contemporaneously because the cost of

55

the project is too uncertain until the costs are incurred, but

then once the costs are certain it is too late because recovery

would involve retroactive charges. Absent a better explana-

tion for the Commission’s conclusion that SFPP has recov-

ered its reconditioning costs through the indexed rates, it is

unclear how the costs of any multi-year project whose cost is

not ‘‘known and measurable with reasonable certainty’’ in

advance, 18 C.F.R. § 346.2(a)(1)(ii), could ever be recovered,

were this reasoning to be consistently adopted. The Commis-

sion ruled in Opinion No. 435–A that prospective recovery of

SFPP’s reconditioning costs would be appropriate because of

‘‘benefits that flowed to the system when the costs were

incurred,’’ 91 FERC at 61,518, implying that it initially did

not view the rule against retroactive rulemaking as an obsta-

cle because the expenses provided an ongoing benefit that

would continue to accrue in future years. In light of the

Commission’s failure to explain why it now considers the rule

against retroactive rulemaking (or the filed rate doctrine) to

bar recovery, and because no party has briefed this question

in any detail, the court remands so that the Commission, if it

wishes to continue relying on this reasoning, may better

explain it.

The Commission may have answers to these concerns, but

they are not provided in the Opinions on review. SFPP’s

shippers are presently enjoying the benefits of what appears

to be an expensive pipeline reconditioning program without

sharing in any of its costs. If, in the Commission’s opinion,

they should not have to, the Commission needs to provide a

more thorough explanation of why not. Accordingly, we

remand SFPP’s request to recover its reconditioning costs for

the East Line between 1995 and 1998 to the Commission for

further consideration.

III. Reparations

A. Background and Proceedings Below

After determining that SFPP’s East Line rates were not

just and reasonable, the ALJ ordered SFPP to pay repara-

tions to the ELS which had filed complaints against the rates.

56

ALJ Decision, 80 FERC at 61,308. In Opinion No. 435, the

Commission considered various objections to the reparations

on the part of both SFPP and the shippers but reaffirmed

that SFPP was to pay reparations as determined by the

Commission. See id. at 61,111–14. Specifically, the Commis-

sion ruled that the period for the calculation of reparations

would run from the date of each complaint until March 31,

1999, the effective date of revised East Line rates required by

Opinion No. 435.

In calculating the potential reparations, the Commission

retroactively applied the test year approach it had used to set

SFPP’s prospective rates: SFPP was to develop an East Line

cost of service for a test year, 1994; design a rate that

reflected that cost of service; index that rate to December 31,

1998; and apply that indexed rate to designated volumes

adopted by Opinion No. 435 for each calendar year for which

an indexed rate had been developed. Using the new cost of

service thus established for years 1994–1998 and partial year

1999, SFPP was to determine whether the revenues for each

period resulted in an over or under-recovery of its cost of

service. FERC’s order permitted SFPP to ‘‘net out its over

and under recoveries for each year and determine that net

amount, if any, that is due its East Line Shippers.’’ Id. at

61,114. FERC ordered a similar calculation of reparations

for years prior to 1994 based on the calculation of under- or

over-recovery of cost of service in those years. As to repara-

tions in general, FERC held that no shipper was entitled to

reparations for periods prior to the filing date of a complaint.

Id. at 61,112–13.

On rehearing, FERC held that Navajo was the only com-

plainant that had filed a challenge to East Line rates. Thus,

only Navajo could recover reparations. Opinion No. 435–A,

91 FERC at 61,514. FERC granted Navajo reparations

beginning one month prior to the filing of its December 23,

1993, complaint to SFPP’s rates. FERC also noted that

Navajo had entered a settlement with SFPP in 1989. That

settlement barred Navajo from bringing action against SFPP

until November 23, 1993. With those provisos, FERC or-

57

dered SFPP to calculate the limited reparations still in order

on the East Line based on the difference between per-barrel

rates charged and per-barrel rates that would have been

charged had SFPP charged cost-based rates using a 1994 test

year, and to index such rates annually going forward — in

other words, the difference between the charged rates and

the rates that SFPP should have charged. In sum, the

Commission modified its prior order and decreed that:

SFPP will calculate the gross reparations that would be

due if all shippers that had used the East Line had filed

complaints for the applicable reparations period TTT es-

tablish[ing] the total revenue that was received in excess

of the new East Line rates established by the prior

order. Navajo will be paid its pro rata share of the

reparations for the relevant time frame.

Id. at 61,518. The Commission noted that because Navajo

was the only shipper entitled to reparations, the calculations

‘‘should leave a surplus of revenues in excess of the East Line

restated cost of service between the beginning of the repara-

tions period and the actual date on which the restated rates

began to be collected by SFPP.’’ Id.

The shippers petitioned for rehearing of FERC’s reconsid-

eration order, which FERC granted in part. This time,

FERC held that Chevron, Western, ConocoPhillips, and Exx-

onMobil were, like Navajo, entitled to reparations for over-

charges that occurred two years prior to the filing of their

complaints. Opinion No. 435–B, 96 FERC at 62,071–74.

FERC held that Valero was not entitled to reparations,

because its complaint was filed after August 7, 1995, the last

date complaints were consolidated in the proceedings. Id. at

62,072. The Commission subsequently clarified Opinion No.

435–B by stating that Chevron’s eligibility for reparations

was determined as of its August 3, 1993 complaint, not a

protest it filed September 23, 1992. Clarification and Rehear-

ing Order, 97 FERC ¶ 61,138.

SFPP now argues that the Commission ought not have

awarded any reparations whatsoever. Navajo contends that it

was improperly denied reparations prior to November 23,

58

1993. Chevron alleges that FERC improperly set the com-

mencement date for calculating its reparations. And Valero,

BP WCP, and Chevron all claim that they were improperly

denied reparations.

B. Analysis

1. SFPP

SFPP argues that the underlying orders were arbitrary

and capricious for four related reasons. First, SFPP con-

tends that awarding ELS reparations is impermissible retro-

active ratemaking, in violation of the Supreme Court’s deci-

sion in Arizona Grocery Co. v. Atchison, Topeka & Santa Fe

Railway Co., 284 U.S. 370 (1932). Second, it asserts that

FERC’s award of pre-complaint reparations violates the

EPAct. Third, SFPP advances that FERC improperly

awarded reparations based on a ‘‘test period,’’ disregarding

damages actually suffered and proved by complainants. Fi-

nally, SFPP argues that FERC failed to consider substantial

arguments — such as the novelty and complexity of SFPP’s

rate case — that militated against awarding reparations. For

the reasons stated below, we reject all four claims.

a. The Arizona Grocery Rule

Arizona Grocery proscribes ‘‘the retroactive revision of

established rates through ex post reparations.’’ Verizon Tel.

Cos. v. FCC, 269 F.3d 1098, 1107 (D.C. Cir. 2001); see also

Ala. Power Co. v. ICC, 852 F.2d 1361, 1373 (D.C. Cir. 1988).

Otherwise put, Arizona Grocery bars reparations that retro-

actively change a final Commission-approved rate. SFPP

relies on Arizona Grocery to argue that Opinion No. 435 was

a final order prescribing just and reasonable rates, and thus

FERC was barred from awarding reparations when SFPP’s

rate was effectively further lowered as a result of FERC’s

subsequent orders. SFPP argues that Opinion No. 435 was a

final order setting rates ‘‘to be thereafter observed’’ under

ICA Section 15(1), and therefore that the subsequent orders

were retroactive changes of Opinion No. 435. We disagree.

Arizona Grocery is of no help to SFPP in this case.

Arizona Grocery applies only where the Commission has

59

‘‘declared what is the maximum reasonable rate to be charged

by a carrier.’’ 284 U.S. at 390. Yet FERC did not finalize a

maximum reasonable rate in Opinion No. 435 and in fact

repeatedly stated it was not doing so. Thus Opinion No. 435

set no final rate; rather, FERC only established a final rate

at the completion of the OR92–8 proceedings. SFPP, L.P.,

100 FERC ¶ 61,353, 62,625 (2002) (‘‘September 26 Order’’).

The OR92–8 proceedings were compliance filings. SFPP’s

filing in Docket No. OR92–8–013 showed SFPP’s calculations

for determining how its East Line rates should be structured

to reflect the requirements of Opinion No. 435–B. SFPP later

amended that in Docket No. OR92–8–015 to address the

exclusion of the interest element from the calculation of the

total potential reparation pool that would be due under the

Commission’s prior orders. Id. at 62,622.

The record shows that at each point, the Commission said

that final East Line rates would not be established until the

OR92–8 proceedings were completed. September 26 Order,

100 FERC at 62,625. In response to Opinion No. 435, SFPP

filed a tariff establishing a rate, but the Commission conclud-

ed that the tariff could not be determined to be just and

reasonable until review of the Docket No. OR92–8 compliance

filing was completed. The Commission accepted the tariff for

filing and suspended it, subject to refund, pending review of

the compliance filing. SFPP, L.P., 87 FERC ¶ 61,056, 61,225–

26 (1999). Nor did FERC’s next opinion on the subject make

that rate final. Opinion No. 435–A merely reaffirmed the

suspension of the previously filed tariff based on the signifi-

cant chance that the proposed rate levels in it would change

depending on how the protests and related requests for

rehearing were resolved. 91 FERC at 61,520. It did not

finalize the rate.

FERC’s subsequent orders concerning SFPP’s proposed

rates were similarly nonfinal. FERC accepted for filing

SFPP’s Tariff No. 60, filed to comply with Opinion No. 435–A,

with a proposed effective date of August 1, 2000, but suspend-

ed it subject to refund. SFPP, L.P., 92 FERC ¶ 61,166,

61,563–64 (2000). Opinion No. 435–B approved the August 1,

2000, effective date because that was the date the Commis-

60

sion accepted SFPP’s compliance filing, and directed a fur-

ther compliance filing, also to be effective August 1, 2000. 96

FERC at 62,071, 62,079. SFPP filed Tariff No. 67 (later

corrected in Tariff No. 68), with a proposed effective date of

December 1, 2001. SFPP, L.P., 98 FERC ¶ 61,177, 61,657

(2002). The Director of the Division of Tariffs and Rates

Central rejected the tariffs because Opinion No. 435–B re-

quired an effective date of August 1, 2000. Id. FERC’s

order memorializing the rejection made clear that FERC’s

previous orders suspended, subject to refund, SFPP’s pro-

posed tariffs

pending resolution of the numerous compliance issues

that have been raised in the course of these proceedings.

In each of the prior Opinions the Commission has made

clear that SFPP must recalculate the rates to be applied

in compliance with those Opinions and that any prior

calculations of reparations and surcharges must be ad-

justed accordingly.

Id.

The Commission has thus been clear from the outset and

throughout that no final rate determination would be made

until the OR92–8 proceedings were complete. September 26

Order, 100 FERC at 62,625. As a result, the Commission’s

orders requiring reparations do not violate the prohibition in

Arizona Grocery from subjecting a carrier to payment of

reparations with respect to a final rate. The Commission did

not establish final lawful rates where it has expressly re-

served authority to make adjustments in the context of an

ongoing proceeding in which the methodology for determining

the rate had not even been established. Id. at 62,626.

SFPP contends that the Commission’s reparations orders

violate ICA Section 15(7), which authorizes refunds of ‘‘such

increased rates or charges’’ as ‘‘shall be found not justified.’’

49 U.S.C. app. § 15(7) (1988). But Section 15(7) is an author-

ization, not a prohibition, and FERC did not invoke this

provision in awarding the shippers reparations. The Com-

mission found it inappropriate for this complaint proceeding

to go forward under Section 15(7), SFPP, L.P., 63 FERC

61

¶ 61,014, 61,124 (1993), and thus no relief was awarded under

that section. Rather, FERC proceeded under ICA §§ 8, 9,

and 16(1), which specifically authorize the Commission to

award damages in a Section 13 complaint. 49 U.S.C. app.

§§ 8, 9 & 16(1) (1988). SFPP also contends that FERC lacks

authority to issue ‘‘interim’’ rates after ruling on a complaint.

Yet nothing in Section 15(1) prohibits FERC from directing a

pipeline to file an interim rate, subject to suspension and

refund, if there is a possibility that the final rates will be

lower than the interim rates. Indeed, the Supreme Court has

held that under the ICA the Commission has authority — in

response to an initial rate filing — to direct an oil pipeline to

file interim rates to go into effect, subject to refund, during

the suspension period for the initial rates. Trans Alaska

Pipeline Rate Cases, 436 U.S. 631, 654–56 (1978). See also

FPC v. Tenn. Gas Transmission Co., 371 U.S. 146, 146–57

(1962); FPC v. Natural Gas Pipeline Co., 315 U.S. 575, 585

(1942).

Therefore, we hold that when the Commission awarded

reparations, it was not constrained by Arizona Grocery’s

blanket prohibition on retroactive repeals of ratemaking.

b. Pre-Complaint Reparations

SFPP’s second contention is that the EPAct precludes pre-

complaint reparations in a Section 13 proceeding, and that

each complainant may seek reparations only for overcharges

that date from the filing of its own complaint. We disagree.

EPAct Section 1803(b) provides:

If the Commission determines pursuant to a proceeding

instituted as a result of a complaint under section 13 of

the Interstate Commerce Act that the rate is not just

and reasonable, the rate shall not be deemed to be just

and reasonable. Any tariff reduction or refunds that may

result as an outcome of such a complaint shall be pro-

spective from the date of the filing of the complaint.

EPAct § 1803(b). The ICA, however, allows reparations for

up to two years prior to the date of the filing of a complaint if

the rates paid in those two years exceed the just and reason-

62

able rate established in the complaint proceeding. See 49

U.S.C. app. § 16(3)(b) (1988).

SFPP contends that the last clause of Section 1803(b) is

applicable to any and all complaints filed under ICA Section

13, and therefore that reparations awarded for all com-

plaints — including those for East Line rates — must be

prospective from the filing of the complaints. We agree with

SFPP that EPAct Section 1803(b) prohibits retroactive rate-

making, but we think that it does so only for those rates that

were ‘‘grandfathered’’ under this section. Section 1803(b)

does not apply to complaints challenging non-grandfathered

rates. In its prefatory clause, it explicitly refers only to ‘‘a

complaint TTT against a rate deemed just and reasonable

under [Section 1803(a)].’’ The second-to-last sentence of Sec-

tion 1803(b) expressly relates only to complaints on which

FERC acts to determine grandfathered rates, otherwise

‘‘deemed to be just and reasonable,’’ to be just and reason-

able. The reference to ‘‘such a complaint’’ in the last sen-

tence of Section 1803(b) plainly refers back to the prior

references in Section 1803(b) to complaints against rates

‘‘deemed to be just and reasonable’’ under Section 1803(a).

Because the East Line rates were challenged within the

one-year period prior to enactment of the EPAct, they are

not grandfathered under Section 1803. Accordingly, relief for

East Line rate complainants is governed by ‘‘the traditional

standards of the ICA, including section 16’s provision for a

two year reparations period retroactive from the date of the

complaint.’’ SFPP, L.P., 68 FERC ¶ 61,306, 61,582 (1994).

FERC’s order tracked this interpretation of the statute

precisely. FERC found that shippers filing a complaint

against SFPP’s East Line rates may recover reparations for

the two-year period prior to the date of their complaints.

The Commission determined that the EPAct barred pre-

complaint relief only for complaints against grandfathered

rates. Thus, FERC correctly found that Section 1803(b) does

not apply to complaints challenging the East Line rates that

FERC held not to be grandfathered.

63

c. Test Period

Next, SFPP challenges the methodology FERC ordered

SFPP to use to calculate reparations. In Opinion No. 435–A,

FERC ordered SFPP to use the following method. First,

FERC said, SFPP must determine what the just and reason-

able rate would have been in each year between 1994 and

August 1, 2000 — as well as two years back from the date of

the earliest complaint — and then calculate what the appro-

priate gross revenues would have been from that rate. The

difference between the gross revenue under the new just and

reasonable rates would create the total reparations pool —

the amount SFPP would pay to all eligible shippers. SFPP

would then calculate the reparations due each eligible shipper

(including interest), leaving a residual in the pool of funds

that could not be distributed because certain shippers had not

filed a complaint within the time frame of the proceeding.

The residual pool would then be credited against the total

supplemental costs permitted under Opinion No. 435–A be-

tween 1995 and 1998. Any remaining allowable costs would

then be recovered through a five-year surcharge.

To estimate what gross revenues would have been in those

years, the Commission directed that SFPP use a test year

cost of service, divided by the test year’s volumes, to replace

the previous unit rate not found to be just and reasonable.

Opinion No. 435–A, 91 FERC at 61,516. The reparations

payment due for each year would be the difference between

the revenues generated in that year under the old rates and

the revenues that would have been generated under the final

new rates. Id.

SFPP challenges the estimation methodology proposed by

FERC — specifically FERC’s direction to use a ‘‘test period’’

to estimate past gross revenues. SFPP contends that basing

the reparations calculations on a rate derived from a histori-

cal test period ‘‘makes no sense in the real world, as it

wrongly assumes SFPP’s actual cost of service did not change

appreciably over a period of eight years or more.’’ We once

again disagree.

64

The use of test periods to set the cost of service for rates

intended to span a number of years is well established. See,

e.g., Williston Basin Interstate Pipeline Co. v. FERC, 165

F.3d 54, 56 (D.C. Cir. 1999). As we have noted, 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, and so the use of a ‘‘test period’’ for

calculating the cost of service is appropriate. Id. While use

of a test period is not perfect, it is a reasonable proxy for

actual costs. See generally American Public Power Ass’n v.

FPC, 522 F.2d 142 (D.C. Cir. 1975); see also Public Serv. Co.

v. FERC, 832 F.2d 1201, 1218 (10th Cir. 1987). It was

therefore reasonable for the Commission to base reparations

calculations on the same test period methodology it uses to

calculate prospective rates. To the extent SFPP contends

that the Commission’s reliance on the test year approach

unreasonably denied it recovery of certain expenses it in-

curred after the test period, those concerns are addressed in

Part II of our opinion.

The Commission also properly determined that rates based

on the test period could be used to calculate reparations for

the two years prior to the filing of the complaints. See ALJ

Decision, 80 FERC at 65,203. There is no basis to conclude

that test period rates that are just and reasonable for all

future years do not provide a just and reasonable basis for

determining reparations in the two years prior to the com-

plaints. Id.

SFPP further contends that it should have been allowed to

offset under-recovery of its cost of service in some years with

over-recovery of its cost of service in other years, based on

ICC decisions permitting netting of multi-year data in deter-

mining reparations. As explained, however, the Commission

reasonably found that consideration of the costs from every

year was not feasible. While the Surface Transportation

Board (formerly ICC) determines the total revenue stream

required to recover the costs of particular service over its

economic life, FERC has reasonably decided to calculate

reparations by the difference in the unit value of the old and

new rate, not the difference in gross and net revenues for the

65

operation of the pipeline as a whole. ALJ Decision, 80 FERC

at 65,203. Accordingly, the Commission reasonably found the

netting of reparations across the entire reparations period

inappropriate in these circumstances.

Moreover, this Court has previously rejected pipeline de-

mands to permit offsetting undercharges and overcharges in

different years during a refund period. As we held in Belco

Petroleum Corp. v. FERC, 589 F.2d 680, 686–87 (D.C. Cir.

1978), the NGA — like the ICA here — gives the regulated

entity no right to collect more than the just and reasonable

rate in one period simply because it collected less than the

just and reasonable rate in another.

SFPP cites a number of cases for the proposition that the

concept of netting multi-year data to assure fairness in repa-

rations is well established, but here a multi-year rate method

was not employed. It is thus reasonable to base reparations

on a year-to-year basis without netting.

d. Reasoned Decisionmaking

SFPP’s fourth contention is that the Commission abused its

discretion by failing to consider SFPP’s arguments. Al-

though SFPP acknowledges FERC’s discretion to award

reparations, it points out that it argued that SFPP’s rate case

was complex and presented issues of first impression, and

that SFPP could not have predicted what lawful rates would

have been. In sum, it argued before the Commission that it

could not have reasonably adjusted its rates. SFPP claims

that by giving no consideration to these arguments, FERC

failed to engage in reasoned decisionmaking. We reject this

contention.

FERC’s orders reasonably addressed SFPP’s concerns.

Although FERC never explicitly responded to SFPP’s point

that its case was complex, it implicitly did so by finding

SFPP’s rates unjust and unreasonable. The fact that SFPP’s

rate case was complex does not alter the Commission’s obli-

gation to make a decision as to whether SFPP’s rates were

unjust and unreasonable. The Commission reasonably re-

sponded to SFPP’s argument by simply performing its statu-

66

tory duty to pass on the reasonableness of SFPP’s rates,

rather than dwelling on the difficulty of the task at hand.

Assuming FERC’s decision to find the rates just and reason-

able was reasoned, it does not become unreasoned simply

because FERC reached its decision without explicitly com-

menting on its difficulty. In any event, it is apparent from

the length and complexity of FERC’s discussion that it

understood the complexity of SFPP’s case.

As for SFPP’s argument that it could not have predicted

the eventual rates, the Commission expressly responded to

that reliance argument by stating that SFPP was on notice

that its rates were subject to review, and that ‘‘there was a

risk that the rates could be found unjust and unreasonable

and reparations awarded.’’ Opinion No. 435, 86 FERC at

61,113.

Accordingly, the Commission engaged in reasoned decision-

making in awarding reparations. Although certain matters

were complex issues of first impression, FERC did not need

to acknowledge that complexity explicitly for its decision to

stand.

2. Navajo

Turning next to the shipper petitioners, Navajo contends

that it should be awarded reparations for the two years

preceding the filing of its complaint on December 22, 1993.

As noted above, the Commission concluded that a prior

settlement agreement between SFPP’s predecessor and Na-

vajo foreclosed Navajo from collecting reparations for this

two-year period. We find no error in FERC’s decision.

The settlement Navajo entered into with SFPP’s predeces-

sor, provided — in Section 2.3 — that:

For the five (5) year period following the effective date of

FERC Tariff No. 88 — i.e., November 23, 1988 —

Navajo shall not challenge, by complaint or any other

means, East Line rates established or increased in con-

formity with the terms and conditions of this Article, nor

shall they seek reparations or other damages with re-

spect to such rates.

67

Southern Pac. Pipe Lines, Inc., No. IS85–15–000, Stipulation

and Settlement Agreement § 2.3 (Jan. 30, 1989) (approved in

Southern Pac. Pipe Lines Partnership, L.P., 49 FERC ¶ 61,-

081 (1989)).

Navajo contends that this language permits it to seek

reparations for the two years prior to filing its complaint,

even though those two years are within the five-year settle-

ment rate moratorium. In Navajo’s view, this reading is

compelled by the contrast between Section 2.3 and Section 1.3

of the 1989 settlement concerning West Line rates. Section

1.3 provides as follows:

During the (5) year period following November 23, 1988

(the effective date of FERC Tariff No. 88), Navajo shall

not challenge, by complaint or any other means, West

Line rates established or increased in conformity with

the terms and conditions of this Article, nor shall they

seek reparations or other damages with respect to such

rates for any part of that five (5) year period.

Id. § 1.3.

According to Navajo, the last sentence ‘‘made clear that

Navajo not only agreed to refrain from filing a complaint

seeking reparations during the five-year period following

November 23, 1988, but also agreed to waive its rights to

reparations relating to that five-year period.’’ In contrast,

Navajo argues, ‘‘the provision pertaining to the East Line did

not waive the right to seek reparations for rates paid for

service on the East Line during the five-year period once the

moratorium expired.’’

The ALJ disagreed with Navajo, concluding that a ‘‘fair

reading of the settlement agreement and the Commission’s

order approving it precludes claims for reparation by Navajo

for rates charged during the period when the settlement was

in effect.’’ ALJ Decision, 80 FERC at 65,207–08. The

Commission affirmed the ALJ’s interpretation as ‘‘the only

reasonable interpretation’’ of the settlement agreement.

Opinion No. 435, 86 FERC at 61,111.

68

We find the Commission’s interpretation of the settlement

to be reasonable. Section 2.3 expressly provides that Navajo

shall not ‘‘seek reparations or other damages’’ with respect to

the East Line rates for the five-year period following Novem-

ber 23, 1988. Southern Pac. Pipe Lines, Inc., No. IS85–15–

000, Stipulation and Settlement Agreement § 2.3 (Jan. 30,

1989). While an additional phrase does appear in Section 1.3,

this does not alter the plain meaning of Section 2.3. It is

unreasonable to assume that, although obtaining agreement

to language expressly referring to a five-year moratorium

period for all rate changes, SFPP nevertheless intended to

permit Navajo to seek reparations for two of the five years.

Navajo advances a number of theories as to why SFPP

might have agreed to a shorter moratorium on East Line

reparations. However, there is no evidence that these theo-

ries played any part in the negotiations and none of them

address the fundamental point that the settlement expressly

says five years. The Commission’s interpretation of the

contract as such is therefore reasonable.

3. Valero

Valero, another shipper, contends that FERC erred by

denying it reparations in Opinion No. 435–B. Valero argues

that because FERC found that SFPP charged it unjust and

unreasonable rates in Opinion No. 435–A, FERC had an

obligation to award reparations to it as well. FERC re-

sponds that because Valero was not a party to OR92–8, the

Commission properly rejected Valero’s claim that it is entitled

to reparations ‘‘in the same manner’’ as the shippers in

OR92–8. Valero may be correct that it is entitled to repara-

tions, but we agree with FERC that it is not so entitled in

this particular proceeding.

Valero’s complaint involves distinct issues from the com-

plaints at issue in this case, and accordingly FERC reason-

ably denied it recovery in these proceedings. This case

concerns shippers who filed their claims prior to August 1995.

The timing of their complaint matters, because FERC deter-

mined that they were entitled to reparations only for over-

charges during the two years preceding the filing of their

69

complaints. In contrast, Valero — then Ultramar Diamond

Shamrock — filed its complaint in November 1997. ARCO

Products Co., 82 FERC ¶ 61,043, 61,183 (1998). That com-

plaint was docketed as OR98–2, separate from the docket at

issue here, OR92–8, consolidated with other complaints filed

after August 7, 1995, and all held in abeyance with an

opportunity to amend the complaints based on the findings in

this proceeding. The post-August 7, 1995 complaints were

consolidated in a proceeding separate from OR92–8 because

those complaints involve different test periods and cost fac-

tors from those addressed in OR92–8. Because Valero filed

its complaint in 1997 — and because, as FERC points out,

Valero’s reparations will be determined based upon a differ-

ent test period and cost factors, and will be limited to the two

years prior to the filing of Valero’s complaint — it may well

not be entitled to the same reparations as shippers who filed

in 1994. Accordingly, Valero must have its reparations claims

adjudicated in the OR98–2 proceedings.

Valero’s arguments do not convince us otherwise. Valero

alleges that FERC’s failure to provide reparations to Valero

is directly contrary to the plain language and intent of the

ICA. Under Section 8 of the ICA, injured shippers are

provided a right of action for damages. See 49 U.S.C. app.

§ 8 (1988). But FERC’s denial of reparations in Opinion No.

435–B is perfectly consistent with this provision. FERC did

not hold in that order that Valero was not entitled to repara-

tions. Rather, FERC deferred consideration of Valero’s enti-

tlement. Accordingly, FERC’s decision is consistent with the

ICA.

Valero argues that under A.J. Phillips Co. v. Grand Trunk

Western Ry. Co., 236 U.S. 662, 665 (1915), its party status in

OR92–8 ‘‘is of no moment in awarding reparations.’’ Pet.

Joint Brief on Rate and Reparations Issues 28. While A.J.

Phillips held that finding a rate unreasonable ‘‘inured to the

benefit of every person that had been obliged to pay the

unjust rate,’’ A.J. Phillips, 236 U.S. at 665, it also recognized

that a shipper’s right to reparations turns on the timely filing

of its complaint, and its rights are limited by that complaint.

Id. at 665–66 (‘‘But while every person who had paid the rate

70

could take advantage of the finding that the advance was

unreasonable, he was obliged to assert his claim within the

time fixed by law’’). Here, Valero — which filed its complaint

in 1997 — is not entitled to the same reparations as the

shippers who filed in 1994, since Valero’s reparations will be

determined upon a different test period and cost factors, and

will be limited to the two-year period prior to the filing of

Valero’s complaint. See 49 U.S.C. app. § 16(3)(b) (1988).

Thus, deferring consideration of Valero’s claim is consistent

with A.J. Phillips Co. While there is some commonality of

issues between Valero’s complaint proceeding and OR92–8,

OR92–8 is not dispositive of Valero’s reparations claims.

Therefore Valero must await adjudication of its reparations

claims in OR98–2.

4. BP West Coast Products and Chevron

Petitioners allege that because both BP WCP (formerly

ARCO Products Co.) and Chevron (formerly Texaco Refining

and Marketing, Inc.) were injured by SFPP’s East Line rates

and both jointly filed — on January 14, 1994 — a complaint,

FERC violated the ICA by denying them reparations.

FERC denied both of these entities damages from the East

Line rates because they stated no claim regarding the East

Line rates in their complaints. We again agree with FERC.

ARCO’s and Texaco’s complaint simply did not challenge

the East Line rates. While their complaint referenced Tariff

No. 15 along with other tariffs, which includes East Line

rates, that reference was not specific to any rate, but alleged

only that shippers shipped petroleum pursuant to one or

more of those tariffs. That vague reference fails to state a

cognizable complaint against the East Line rates, since other-

wise the allegations solely concerned West Line rates.

ARCO’s and Texaco’s complaint alleged, instead, that their

‘‘shipments basically originate in California and are transport-

ed by SFPP to Phoenix and Tucson.’’ Transportation from

California into Arizona occurs only on the West Line. Con-

sistent with that allegation, the complaint addressed the

grandfathering of the West Line rates, and sought repara-

tions, at the least, from the date of the filing of their

71

complaint, which is the standard for grandfathered rates.

The affidavit submitted in support of the complaint concluded

that ‘‘SFPP’s rates on its West Line System exceed the rates

that would result from an appropriate application of the

Commission’s ratemaking methodology by a significant

amount.’’ SFPP, L.P., No. OR92–8–000, Affidavit of Marsha

K. Palazzi 2 (Jan. 18, 1994). No mention of the East Line

rates is made in the complaint or the supporting affidavit.

Thus, the complaint was only applicable to the West Line

rates. See SFPP, L.P., 68 FERC at 61,582. Under these

circumstances, the Commission reasonably interpreted the

complaint to state a claim only with regard to the West Line

rates, and BP WCP and Chevron were properly denied

reparations for the East Line rates.

ARCO’s October 2, 1992, intervention in OR92–8 does not

change this result, see Rate Br. 32, since BP WCP’s stated

ground for intervention was its ‘‘direct interest’’ in the ‘‘new

origin point and applicable rates at East Hynes.’’ As the

East Hynes station is on the West Line, this intervention

likewise stated no claim with regard to the East Line rates.

5. Chevron

On September 23, 1992, Chevron filed a protest concerning

SFPP’s reversal of the flow of the ‘‘six-inch line’’ between

Tucson and Phoenix, and SFPP’s modification of its pro-

rationing policy. On August 3, 1993, Chevron filed a com-

plaint alleging that SFPP’s East Line rates were unjust and

unreasonable. Chevron demanded reparations ‘‘for the peri-

od beginning two years preceding the filing of the Com-

plaint.’’

The Commission properly calculated Chevron’s East Line

rate reparations based on Chevron’s 1993 complaint challeng-

ing those rates. See supra at 14 n.2. While Chevron argued

that its 1993 complaint should relate back to its 1992 protest,

the 1992 protest did not challenge the East Line rates, but

rather only challenged flow reversal on one of SFPP’s lines

and its capacity allocation procedures.

Chevron now contends that its East Line reparations

should be based upon the date of its 1992 protest because the

72

Commission treated the protest as a complaint. The Com-

mission, held, however, that ‘‘[t]he scope of the complaint

proceeding shall be defined by the issues raised by El Paso

and Chevron which caused these proceedings to be institut-

ed.’’ SFPP, L.P., 63 FERC ¶ 61,275, 62,769 (1993). Chev-

ron’s protest ‘‘complained against the reversal of one of

SFPP’s lines and its capacity allocation procedures, but did

not complain against the East Line rates as such.’’ Opinion

No. 435–A, 91 FERC at 61,514 n.55. Because the protest did

not complain about the East Line rates, the Commission

properly found that the protest did not trigger reparations

for the East Line rates, and dated Chevron’s right to repara-

tions from Chevron’s August 3, 1993, East Line complaint.

SFPP, L.P., 97 FERC ¶ 61,138 61,623–24 (2001) (citing

SFPP, L.P., 65 FERC ¶ 61,028); see also SFPP, L.P., 102

FERC ¶ 61,073, 61,183–84 (2003).

The ALJ’s determination that reparations demands could

relate back to earlier-filed complaints does not aid Chevron.

As the ALJ recognized, an amendment to a pleading may

relate back when it arises out of the same transaction or

occurrence set forth in the original pleading. Fed. R. Civ. P.

15(c)(2). Because the Commission found that Chevron’s orig-

inal protest did not concern the East Line rates, but rather

only the practice of prorationing and reversal of the ‘‘six inch

line,’’ however, Chevron’s claim for East Line rate repara-

tions cannot relate back to that protest. The Commission

reasonably determined that Chevron’s 1993 complaint, which

first stated a claim with regard to the justness and reason-

ableness of the East Line rates, was the proper basis for

determining Chevron’s right to reparations.

For the reasons given above, we affirm the decisions of the

Commission in awarding reparations and deny the petitions

for review in full to the extent they challenge FERC’s

reparations order.

CONCLUSION

In conclusion, we affirm the decisions of the Commission

and deny the petitions except as follows: As regards the

73

West Line rates, we grant the petition and remand with

respec

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