Amicus Brief — American Paper Institute, Inc. v. American Elec. Power Service Corp.

No. 82-226

No. 82-34

In the Supreme

United States

Ocroser Tax, 1982

FeperaL Enercy Recutatory Commission,

Petitioner,

vs.

Auna Execrnic Power Service Coar., et al.,

Respondents.

Amenican Paper Inetrrvte Inc.,

Petitioner,

vs.

Amenicay Evectraic Power Szrvice Corp., et al.,

Respondents.

On Writs of Certiorari

to the United States Court of Appeals

For the District of Columbia

BRIEF OF AMICI CURIAE

NATURAL RESOURCES DEFENSE COUNCIL, INC.

NATIONAL AUDUBON SOCIETY

THE SOLAR LOBBY

IN SUPPORT OF PETITIONERS

Au S. Mun Gaecory A. Tuomas

Natural Resources Defense Natural Resources Defense

Council, Inc. Council, Inc.

1725 I Street, N. W., 25 Kearny Street

Suite 600 San Francisco, CA 94108

Washington, D.C. 20006 Telephone: (415) 421-6561

Telephone: (202) 223-8219 Counsel of Record for

Wuuuo A. Buri Amici

National Audubon Society

645 Pennsylvania Avenue, S. E.

Washington, D. C. 20003

Telephone: (202) 547-9009

Of Counsel

TABLE OF CONTENTS

Interest of the amici curiae

Summary of argument

Argument

I

II

The full avoided cost rule is flexible, operating only

where market forces do not

A. The avoided cost rule fosters private bargaining

on purchase rates

B. The full avoided cost rule induces competition in

the generation of electricity

III

The full avoided cost rule is mandated by the obliga-

gation to encourage QF’s without subjecting them to

plenary regulatory scrutiny

A. Full avoided costs are necessary for optimal de-

ployment of QF’s .

B. Alternatives — by the court of —

entail impermissible regulatory scrutiny ..............

IV

The full avoided cost rule, by moderating electric rates,

is just and reasonable to ratepayers

A. The full avoided cost rate induces maximal dis.

placement of high cost electric generation

B. The full avoided cost rate induces utility cost re-

ductions through more efficient use of resources

om nl

nw

7

10

18

ii

TaB_e or ConTENTS

Page

V

The full avoided cost rule is in the public interest .......... 22

A. The full avoided cost rate produces important

environmental benefits 22

B. The full avoided cost rate enhances energy secu-

rity 23

VI

The full avoided cost rule, as a rate innovation, war-

rants greater than ordinary judicial deferene 25

A. The avoided cost rule is valid under the special

deference due ratemaking 26

B. Judicial deference is also appropriate here in

view of the congressional command for a novel

and unprecedented regulatory initiative 28

Conclusion 30

Appendix: Description of amici A-l

iii

TABLE OF AUTHORITIES CITED

Cases

American Public Gas Ass’n. v. FPC, 567 F.2d 1016

(D.C. Cire.), cert. denied, 435 U.S. 907 (1977) .......... 25, 29

Associated Industries of New York v. Dept. of Labor,

OU 25

Atchison, Topeka & Santa Fe Ry. v. Wichita Bd. of

? 26

Ayrshire Collierres Corp. v. United States, 335 U.S.

573 (1949) 27

Board of Trade of Kansas City v. United States, 314

I .—ääKK—H21K2—2łfVu T 26

Citizens to Preserve Overton Park v. Volpe, 401 U.S.

— — 25

E. I. du Pont de Nemours & Co. v. Train, 430 U.S. 112

8 —.—.ñ᷑ 30

EPA v. National Crushed Stone, 449 U.S. 64 (1980) — 27

FERC v. Mississippi. U.S. , 102 S.Ct. 2126

77 ²˙ se RS ie NN Eee 3,4

FPO v. Hope Natural Gas Co., 320 U.S. 591 (1944) — 27

Illinois v. Gorsuch, 530 F.Supp. 340 (D. D. C. 1981) 29

Kennecott Copper v. EPA, 462 F. 2d 846 (D.C. Cir.

1972) — 29

Manufacturers R. Co. v. United States, 246 U.S. 457

9 —————————95ĩ 26

Mobil Oil Corp. v. FPC, 417 U.S. 283 (1974) 27

Permian Basin Area Rate Cases, 390 U.S. 747 (1968) 27

San Antonio, Texas ex rel. City Public Service Board v.

United States, 631 F.2d 831 (D.C. Cir. 1980) 26

iv

Takt or Autuorities CrTep

Cases

Page

Shell Oil Co. v. FPC, 520 F.2d 1061 (5th Cir. 1975)

cert. denied sub nom. California Co. v. FPC, 426 U.S.

941 (1976) ...... , 29

Train v. Natural Resources Defense Council, 421 U.S.

60 (1975) .................... — 30

Weyerhauser Co. v. Costle, 590 F.2d 1011 (D.C. Cir.

1978) = 30

Statutes

Public Utility Regulatory Policies Act of 1978, Pub. L.

No. 95-617, 92 Stat. 3117 (1977 passim

Section 201, 16 U.S.C. 796 (17) (Supp. IV, 1980) ........ 1

Section 210, 16 U.S.C. § 824a-3 (Supp. ITI, 1979) ..passim

Regulations

18 C. F. R. $§ 292.201-292.207 (1980) 1

18 C. F. R. 6 292.301 (b) (1) (19800) ————.———— 9

e 8

e . 7, 9

16 C.F.B. § BBB.408 (106600 ———7—7—j———j7v—7Nꝙ«⁶ 7

44 Fed. Reg. 38863, 38865 (July 3, 19797 8

Miscellaneous

Cal. P. U. C., Dec. No. 82-01-103, OIR2 (Jan. 21, 1982) ... 18

123 Cong. Rec. 23848 (daily ed. Aug. 1, 19777 28

123 Cong. Rec. 32403 (Oct. 5,1977 28

124 Cong. Rec. 817528, (daily ed. Oct. 7, 1978 s

Congressional Budget Office, The World Oil Market in

the 1980's: Implications for the United States (1980) 24

Vv

TaxLx or AutTHorities Crrep

MISCELLANEOUS

Deese and Nye, Energy and Security (Ballinger 1981)

—

R. Deb and J. Mulvaney, “Economie and Engineer-

ing Factors Affecting Generating Unit Size,” IEEE

Trans. on Power Apparatus and Systems, V. PAS-

101, No. 10 (October, 1982) —— 21

DOE, Energy Information Administration, 1981

Annual Report to Congress, DOE/EIA-0173 (81)/3

OF ee 12

3 DOE Industrial Potential Cogeneration Source Book,

Geographical/Industrial Sector Profile, “Targeting

Opportunities at the Plant Site (TOPS)” (1982) ...... 11

DOE, Monthly Energy Review (July 1982) ...................... 11

DOE, Monthly Energy Review (Sept. 1982) .................... 4

FERC, Draft Environmental Impact Statement, “Rule-

making for Small Power Production and Cogenera-

tion Facilities—Qualifying Status/Rates and Ex-

emption,” Docket No. RM-79-54, RM-55 (June 1980)

TOTES 12, 22, 23

H. Rep. No. 543, 95th Cong., 2nd Sess. (1978) .................. 22

H. Conf. Rep. No. 1750, 95th Cong., 2d Sess. reprinted

in 1978 U.S. Code Cong. & Ad. News 7832 ................ 5, 8, 15

Iowa State Commerce Commission, In re Iowa Illinois

Gas and Electric Company, RPLI-81-5 (May 18,

1982) 21

Lock, Encouraging Decentralized Generation of Elec-

tricity: Implementation of the New Statutory

Scheme, 2 Solar L. Rep. 705, 717 (1980) 9

Lock, Statewide Purchase Rates Under Section 210 of

PURPA, 3 Solar L. Rep. 419 (1981) 8

vi

Tas_e or AutnHorities Crrep

MIscELLANEOUS

V. Loose and T. Flaim, Economies of Seale and Relia-

bility : The Economics of Large vs. Small Generating

Units,” 4 Energy Systems and Policy, Nos. 1 and 2

x= „%

E. Meyer, “New Directions of Utility Resource and Fi-

nancial Planning,” Energy Efficiency and the Utili-

ties, California Public Utilities Commission Sympo-

21

sium Proceedings (July, 1980 —— 18, 19

Missouri Publie Service Commission, Re Kansas City

Power and Light Co., Case No. ER-80-48, 38 PUR

.— — —

National Economie Research Associates, Inc., An Eco-

nomic Evaluation of the Marble Hill Nuclear Proj-

ect, Indiana Public Service Commission Cause No.

eee

Nichols, WPPSS—A Postcript, Pub. Util. Fort. (June

5 ener

North Dakota Public Service Commission, Re Otter

Tail Power Co., Docket No. 10,124, 44 PUR 4th

(July 20, 1981) ........................

Ohio Public Utilities Commission, Re Dayton Power

and Light Co., Case No. 81-#L-AIR, 45 PUR 4th

eee

Pacific Gas and Electric Company, Statement of Key

Corporate Goals and Direction, Long Term Planning

Results 1982-2000 (June, 1982)

Public Utility Regulatory Policies Act Amendments:

Hearings on Amendment No. 1452 to S. 1885 Before

the Subcommittee on Energy Regulation of the Sen-

ate Comm. on Energy and Natural Resources, Part 2,

?

21

19

19

21

21

19

vii

Tal or AutTHorities Crrep

MISCELLANEOUS

Page

Resource Planning Associates, Inc., The Potential for

Cogeneration Development in Six Major Industries

by 1985, U.S. Department of Energy Contract No.

CR-04-60172-00, December 1977 13

Ross, Energy Consumption by Industry, 6 Ann. Rev.

. 11

Statistical Abstract of the United States (19817 14

R. Stobaugh and D. Yergin, Energy Future: Report of

the Energy Project at the Harvard Business School

(Ballantine ed. 1980) 4

Testimony of William A. Hawkins of Consolidated

Edison Company of New York before the New York

Public Service Commission in Case 27574 (1980) 20

R. Williams, Industrial re 3 Ann. Rev. En-

GHEE TED 00 23

No. 82-226

No. 82-34

In the Supreme Court

OF THE

United States

Ocroser Term, 1982

FeperaL Enercy Recuiatory Commission,

Petitioner,

VS.

American ELxC TRIO Power Service Con. , et al.,

Respondents.

American Paper Institute Ixc.,

Petitioner,

VS.

American ELxC TRI Power Service Corp., et al.,

Respondents.

On Writs of Certiorari

to the United States Court of Appeals

For the District of Columbia

BRIEF OF AMICI CURIAE

NATURAL RESOURCES DEFENSE COUNCIL, INC.

NATIONAL AUDUBON SOCIETY

THE SOLAR LOBBY

IN SUPPORT OF PETITIONERS

This brief in support of petitioners is submitted with the

written consent of counsel to all parties filed with the Clerk

of Court.

INTEREST OF THE AMICI CURIAE

This brief is submitted by three national environmental

organizations dedicated to protection of the environment,

to prudent use and responsible management of natural

resources, and to the economic, esthetic, and social advan-

tages that flow from decreased dependence on nonrenew-

able sources of energy. These organizations have a com-

bined membership of over 550,000 contributors. A more de-

tailed description of each amicus appears in the Appendix

to this brief.

Amici have an interest in this case because both section

210 of PURPA and the Federal Energy Regulatory Com-

mission’s implementing rules are important steps toward

amici’s goals of creating more equitable utility rate struc-

tures and reducing the nation’s dependence upon nonrenew-

able energy sources. In particular, the rules challenged in

this case promote the deployment of renewable energy tech-

nologies which are environmentally benign compared to

the conventional electrical energy generators which they

displace. The amici consider vindication of the FERC rules

to be crucial to a sound energy future for the nation.

SUMMARY OF ARGUMENT

In order to tap the vast reservoir of electric power po-

tentially available from wasted heat and renewable energy

sources (denominated “qualifying facilities” or “QF’s”),*

Congress commanded the Federal Energy Regulatory Com-

This term, as used herein, means “qualifying small power pro-

duction facilities” and “qualifying cogeneration facilities” as de-

fined by section 201 of the Public Utilities Regulatory Policies

Act of 1978 (PURPA), 16 U.S.C. 796 (17) (Supp. IV 1980) and

under 18 C.F.R. 56 292.201-292.207 (1980).

2

mission (“FERC”) to establish an incentive purchase rate

in section 210 of the Public Utility Regulatory Policies Act

of 1978 (“PURPA”).

The full avoided cost rule operates only where markets

do not. It is not a universal rule; it applies only in the

absence of an agreement between a QF and a purchasing

utility and only in the absence of a determination by a state

regulatory commission that a lower rate provides a suf-

ficient incentive.

The full avoided cost rule permits market mechanisms,

where they exist, to establish prices for QF power. Where

market forces are sufficient to make the full avoided cost

tariff unnecessary, the states are free to prescribe another

rate. Where the purchase of power from QF results in no

cost advantage to the utility, it is not obliged to pay for

the unneeded capacity. QF power elicited under the rule

actually fosters competition with the purchasing utility that

would not otherwise exist. The rule merely establishes an

equitable bargaining framework under which negotiations

between buyer and seller can proceed.

Nothing less than full avoided cost rates maximize cost-

effective power production by QF’s without raising elec-

tric rates. QF’s can potentially provide the equivalent of

twenty-five percent of current electrical consumption. Any

lower purchase rates will retard development of these

resources.

Full avoided cost rates are “just and reasonable to con-

sumers” because they will moderate electricity prices. The

resulting power from QF’s will displace the most costly

generators, induce utility cost reductions through competi-

tion, and reduce the costs of utility reserve margins through

dispersed siting of QF’s.

The rule also provides important benefits to the general

public by substituting environmentally preferable power

generation technologies and by decreasing the nation’s reli-

ance on foreign sources of oil.

3

The Court of Appeals erred in declining to accord sub-

stantial deference to the judgment of the expert agency on

these points. Special deference was in order because the

rule is a rate established by the agency under a novel

congressional mandate and within strict limitations of time.

ARGUMENT

I

BACKGROUND

The full avoided cost rule is based on important prin-

ciples of consumer equity and the public interest. This

amicus brief is confined to that issue.

PURPA was a product of a widely-perceived national

energy crisis.* The exigencies of the time were appreciated

by this Court in upholding the constitutionality of PURPA

last term in FERC v. Mississippi. U. S. , 102 S. Ct.

2126 (June 1, 1982):

At the time [PURPA was enacted] it was said that the

generation of electricity consumed more than 25% of

all energy resources used in the United States. S. Rep.

No. 95-442, p. 7 (1977). Approximately one-third of

the electricity in this country was generated through

use of oil and natural gas, and electricity generation

was one of the fastest growing segments of the Na-

tion's economy. S. Rep. No. 95-361, p. 32 (1977). In

part because of their reliance on oil and gas, electricity

utilities were plagued with increasing costs and de-

creasing efficiency in the use of their generating capac-

ities; each of these factors had an adverse effect on

rates to consumers and on the economy as a whole.

“PURPA is one of five parts of a National Energy Act enacted

by the Ninety-Fifth Congress as a top domestic priority of the

Carter Administration. The cornerstone of the President's “National

Energy Plan” was the maximum cost-effective conservation of

energy in the economy, as reflected in the purposes of each of the

five Energy Act components.

4

S. Rep. No. 95-442, at 9. Congress accordingly deter-

mined that conservation by electricity utilities of oil

and natural gas was essential to the success of any

effort to lessen the country’s dependence on foreign

oil, to avoid a repetition of the shortage of natural gas

that had been experienced in 1977, and to control con-

sumer costs.

Id. at 2130. The nation’s energy supply picture has not

brightened appreciably during the intervening years.“

In partial response, Congress enacted section 210 of

PURPA to unlock the tremendous reservoir of untapped

domestic energy that is potentially available from waste

heat from industrial processes (cogeneration) and renew-

able energy sources.* Section 210 commanded the FERC

to prescribe “such rules as it determines necessary to en-

courage cogeneration and small power production,” includ-

ing incentive rates governing the purchase of this power

by electrical utilities. Section 210 and its legislative history

prescribe four rate design parameters. The rates must:

1. Be just and reasonable to the electric consumers

of the utility (§ 210(b)(1));

2. Be in the public interest (Id.);

3. Not discriminate against qualifying facilities

(§¢ 210(b) (2)) ; and

See DOE, Monthly Energy Review, at 8, 27 (Sept. 1982); R.

Stobaugh and D. Yergin, Energy Future: Report of the Energy

Project at the Harvard Business School ( Ballantine ed. 1980).

‘See FERC v. Mississippi, supra at 2136, where this Court

focussed specifically upon section 210:

Congress also determined that the development of cogener-

ation and small power production facilities would conserve

energy. The evidence before Congress showed the potential

contribution of these sources of energy: it was estimated that

if proper incentives were provided, industrial cogeneration

alone could account for seven to ten percent of the Nation’s

electrical generating capacity by 1987. Sen. Rep. No. 95-442

at 21, 23.

5

4. Be predicated upon an examination of the costs

of generation experienced by the utility rather than

those of the qualifying facility.’

Within these parameters, the Congress left to the FERC

the design of appropriate rates, subject only to the fur-

ther limitation that the rate not “exceed the incremental

The fourth critical parameter is derived from the Conference

Report which elaborates on the “just and reasonable” standard. It

evinces a congressional intent that the rate governing purchases of

power from QF’s not burden the OFs with the type of detailed

examination of the costs of generating power that is typically ap-

plied to regulated utilities. The Conferees explain that:

It is not the intention of the conferees that cogenerators and

small power producers become subject, by virtue of this lan-

guage, and the rules promulgated under this section, to the type

of examination that is traditionally given to electric utility rate

applications to determine what is the just and reasonable rate

that they should receive for their electric power. The conferees

recognize that cogenerators and small power producers are dif-

ferent from electric utilities, not being guaranteed a rate of re-

turn on their activities generally or on the activities vis-a-vis

the sale of power to the utility and whose risk in proceeding

forward in the cogeneration of small power production enter-

prise is not guaranteed to be recoverable.

The conferees wish to make clear that cogeneration is to be

under this section and therefore the examination

of the level of rates which should apply to the purchase by the

utility of the cogenerators or small power producers power

Ü — cy ge pg et —U—

but rather in a less burdensome manner. The

—— — ones thane eonld ent

as a significant disincentive to firms interested in cogeneration

and small power production.

H. Conf. Rep. No. 1750, 95th Cong., 2d Sess. 97-98 (1978), re.

printed in 1978 U.S. Code Cong. & Ad. News 7831-7832.

cost to the electric utility of alternative electric energy.”

(§ 210(b)).°

No dispute exists that the full avoided cost formula pro-

vides an ample incentive to qualifying facilities and prop-

erly avoids subjecting them to utility-type regulatory seru-

tiny. The Court of Appeals vacated the rule because it was

not satisfied that the standard was just and reasonable to

electric consumers and in the public interest.’ The essence

of the court’s reasoning was:

By ordering that the purchase rate be equal to the

full avoided cost in every case, FERC has, without con-

vineing explanation, simply adopted as a uniform rule

the maximum purchase rate specified in the statute.

Congress made a clear distinction between a ‘just and

reasonable rate’ and a rate based on the full avoided

cost though the two may coincide. It has long been

held that the essence of the just and reasonable stand-

ard is a balancing of the interests of the affected par-

ties. Although FERC was not to subject cogenerators

to complex, traditional utility-type regulation, it was

compelled to consider the hard questions which the

standard necessarily raises.

B-10 (footnotes omitted, emphasis added).

The “incremental cost of alternative electric energy” is defined to

mean “the cost to the electric utility of the electric energy which,

but for the purchase from such cogenerator or small power pro-

ducer, such utility would generate or purchase from another source.”

(§210(d)). This “incremental cost” is equivalent to the “full

avoided cost” in the FERC rule.

All citations herein to the opinion and order of the Court of

Appeals will be made to Petitioner's Appendix B. (E.g. B-1.) The

court’s opinion is reported at 675 F.2d 1226 (D.C. Cir. 1982). Cita-

tions to the Commission record which was before the Court of Ap-

peals will be preceded by the letter K-.

7

The Court of Appeals acknowledged that the Com-

mission may be right in its conclusion, but it needs to make

its reasoning and findings explicit.” B-11. Yet the court

summarily dismissed the very “reasoning and findings” re-

cited by the agency, not because they were without support

in the record, but because of the court’s factual and

ideological prejudices concerning rate structure and utility

economics.

On remand, the court asked the FERC to take competi-

tive forces into account “in determining the degree and

type of regulation necessary.” B-15. This statement is

astonishing because the full avoided cost rate does exactly

that.

THE FULL AVOIDED COST RULE IS FLEXIBLE,

OPERATING ONLY WHERE MARKET FORCES DO

NOT

The Court of Appeals misread the full avoided cost rule

in concluding that it is a “uniform rule” which applies “in

every case.” Indeed, it operates more as a guarantee, ap-

plying only in those cases where a state regulatory author-

ity or self-regulating utility does not determine that some

other rate is sufficient to encourage small power produc-

tion.* Moreover, section 210 places no obligation on a utility

to buy unusable capacity. Capacity payments are required

*Rates at less than full avoided cost are authorized for purchases

of electric energy “if the state regulatory authority . . or the non-

regulated electric utility determines that a lower rate is consistent

with [the statutory criteria for establishing purchase rates], and

is sufficient to encourage cogeneration and small power produc-

tion.” 18 C.F.R. § 292.304(b)(3) (1980) B-111. Other provisions

permit state regulatory authorities or non-regulated electric utilities

to apply for a waiver from any of the FERC rules under section

210 by showing that compliance is not necessary to encourage co-

and small power production and is not otherwise re-

quired under section 210 of PURPA. See 18 C.F.R. § 292.403 ( 1980)

B-118.

only when a utility “avoids costs” by virtue of the QF’s

capacity. The rules impose no requirement on the purchas-

ing utility to deliver unusable energy or capacity to another

utility for subsequent sale. See Section-By-Section Analy-

sis accompanying 18 C. F. R. § 292.303 (1980), B-53.

In these respects, the FERC rule is more a guideline

than a specific rate. Congress explicitly left a role for the

states in defining and implementing the FERC rules, re-

jecting a more intrusive House bill. See 124 Cong. Ree.

817528 (daily ed. Oct. 7, 1978) (remarks of Sen. Jackson).

The Conference Report refers repeatedly to action by “the

Commission and the States.” H. Conf. Rep. No. 1750, 95th

Cong., 2d Sess. 98, reprinted in 1978 U.S. Code Cong. & Ad.

News 7832. States were given substantial discretion to de-

fine and calculate avoided costs; the regulations refer to the

need for “flexibility for experimentation and accommoda-

tion of special circumstances . . .” “Staff Discussion Paper,”

44 Fed. Reg. 38863, 38865 (July 3, 1979). This discretion

has in fact resulted in widespread variation in choices of

methodology and, ultimately, in rates—variations much

greater than would result from reducing avoided cost pay-

ments by five or ten percent. See Lock, Statewide Purchase

Rates Under Section 210 of PURPA, 3 Solar L. Rep. 419

(1981).

Where the market pricing system is functioning to pro-

vide reasonable prices of QF’s, the full avoided cost tariff

becomes unnecessary and may be disregarded by the states.

It must be noted, however, that section 210 was enacted in

response to the perception that utilities were refusing to

bargain reasonably with QF’s for interconnection and the

purchase of power; it is thus predicated upon a congres-

sional assumption that market forces alone were not

enough.

A. The Avoided Cost Rule Fosters Private Bargaining On

Purchase Rates

The Court of Appeals overlooked the fact that full

avoided cost rates do not prevent but in fact facilitate pri-

vate transactions between the QF and the utility. Under 18

C.F.R. § 292.304 (1980), the full avoided cost rate is elec-

tive; the QF can either elect to receive payment based on

the utility’s avoided cost at the time of delivery or pursu-

ant to an enforceable contract.’ Section 292.301(b)(1) of

the rule specifically contemplates that private bargaining

will occur between qualifying facilities and electric utili-

ties. The tariff merely establishes a framework within

which bargaining can take place.

In fact, QF’s have a strong incentive to negotiate agree-

ments. Decentralized producers often lack the technical

and administrative expertise that the utilities can furnish.

Moreover, agreements that assure a long-term revenue flow

are often indispensible to the QF in procuring financing.

The avoided cost tariff guarantees a certain level of reve-

nue for only a limited time, until the cost incidence of the

utility changes. It is therefore in the interest of small

The effect of PURPA is simply to improve the bargaining posi-

tion of QF’s relative to the monopsony power of utilities. Section

210 shifts the burden of non-agreement from the QF to the utility,

providing the QF a tariff rate to which it can resort if it believes the

utility is not negotiating reasonably. See Lock, Encouraging Decen-

tralized Generation of Electricity: Implementation of the New Stat-

utory Scheme, 2 Solar L. Rep. 705, 717 (1980).

Small power producers testified in the rulemaking record that the

monopsony power of the utilities and the lack of bargaining power

possessed by developers discouraged small power production.

R 2443, 2843-44, Vol. 1, 38Col. R 1186-87, 1523, Vol. 1, 186DC1,

219DCl1. FERC expressly took this into account in the rules: “the

ability of a qualifying cogeneration or small power producer to ne-

gotiate with an electric utility is buttressed by the existence of

rights and protection of these rules.” B-49.

10

power developers to trade away some percentage of the

guaranteed tariff for a longer term commitment from the

utility to purchase at an agreed rate.“

The full avoided cost rate provides a firm and reason-

able starting point for these negotiations. Any lesser rate

would simply erode the basis of the negotiations and pro-

duce a rate less optimal for QF development.

B. The Full Avoided Cost Rule Induces Competition in

the Generation of Electricity

The full avoided cost rule not only allows market forces

to function where they exist, it also creates a market which

would not exist otherwise. Utilities traditionally have been

the sole source of power for their customers. The full

avoided cost rule changes this situation by encouraging

alternative, private sources.

The FERC regulations explicitly recognize that the debt serv-

ice obligations of qualifying facilities may require the latitude

of contractual arrangements in lieu of tariff- like mechanisms.

A facility which enters into a long-term contract to provide

energy or capacity to a utility may wish to receive a greater

percentage of the total purchase price during the beginning

of the obligation. For example, a level payment schedule from

the utility to the qualifying facility may be used to match more

closely the structure of debt service of the facility. So long as

the total payment over the duration of the contract term does

not exceed the estimated avoided costs, nothing in these rules

would prohibit a state regulatory authority or non-regulated

electric utility from approving such an arrangement.

B-73.

In recent Senate hearings on section 210 of PURPA, Dr. Glenn

J. Bjorklund, the Vice-President of Southern California Edison Com-

pany stated that his company has signed 60 contracts with QF’s

since the beginning of 1981, “nearly all of which have been nego-

tiated at a rate below full avoided cost.” Public Utility Regulatory

Policies Act Amendments: Hearings on Amendment No. 1452 to

S. 1885 Before the Subcommittee on Energy Regulation of the Sen-

ate Comm. on Energy and Natural Resources, Part 2, 97th Cong.,

2d Sess. 110, 114, 131 (1982) (Statement of Dr. Glenn J. Bjorklund).

11

In effect, qualifying facilities compete with the purchas-

ing utility itself as a source of power. To the extent that a

utility can lower its own costs of generating power at the

margin, it is obliged to pay qualifying facilities that much

less under the “avoided cost” formula. If the utility can

lower its marginal costs below a QF’s costs of generating

power, it can recapture that share of the marginal market

for itself. If the purchase rate is established below the full

avoided cost level, however, the utility is not subject to the

same competitive pressure. The full avoided cost rule, in

this way, unleashes the very market forces which the Court

of Appeals feared were being fettered.

THE FULL AVOIDED COST RULE IS MANDATED

BY THE OBLIGATION TO ENCOURAGE CF’s WITH-

OUT SUBJECTING THEM TO PLENARY REGULA-

TORY SCRUTINY

A. Full Avoided Costs Are Necessary for Optimal De-

ployment of QF’s

With the rapid rise in electricity costs during the last

decade,“ the potential for cost-effective cogeneration in

industry has become very large.“ The potential for indus-

trial cogeneration at existing plants exceeds twenty-five

percent of electrical demand in the United States—equiva-

lent to 93 large (1,000 MW) coal or nuclear power plants.”

Despite the slowdown in general inflation, electricity prices are

still rising at an eleven percent annual rate. DOE, Monthly Energy

Review, July 1982.

“This is particularly true in the petroleum, chemical, paper,

food, and steel industries. See 3 DOE Industrial Potential Cogen-

eration Source Book, Geographical/Industrial Sector Profile, “Tar-

geting Opportunities at the Plant Site (TOPS)” (1982).

See Ross, Energy Consumption by Industry, 6 Ann. Rev. Energy

409 (1981).

12

The Department of Energy (DOE) projects the additional

potential for cogeneration in future industrial facilities at

6, 11 and 14 percent of the total United States electricity

consumption for the years 2000, 2010 and 2020 respec-

tively.“

The potential contribution of small-scale renewable en-

ergy systems is also impressive. Several forms, including

hydropower, wind electric systems, and municipal waste

combusters are now technically and economically mature.

Several other technologies including generators using bio-

mass fuels, photovoltaic cells, and solar thermal devices

show great promise for the future.“

The amount of power from QF’s that will be produced

for external consumption at any time is directly a function

of the price for which it can be sold to the connecting

utility. As the price offered the QF is decreased from full

avoided costs, the rate of return diminishes disproportion-

ately, since the rate of return depends on the difference

between revenue and cost.“ Since the last few percentage

"See DOE, Energy Information Administration, 1981 Annual

Report to Congress, DOE/EIA-0173 (81)/3 at 174, 177 (1981).

The Draft Environmental Impact Statement for the rulemaking

process projects the following levels of small power production

nationwide by 1995: Wind generation, 1900 MW; Municipal waste

electricity generation, 360 MW, and Small scale hydropower gen-

eration, 3500 MW. FERC, Draft Environmental Impact Statement,

“Rulemaking for Small Power Production and Cogeneration Facil-

ities—Qualifying Status/Rates and Exemption,” Docket No. RM-

79-54, RM-55, at VII-12 (June 1980) (“DEIS”).

That full avoided cost rates provide the necessary investment

certainly was made apparent to the FERC in the rulemaking pro-

ceedings. See R 1291, 2423, Vol. 1, 213 DCI, 57-58DC4. Potential

investors and lenders are reluctant to commit funds unless a project

demonstrates financial viability. (R 1311, 2882, Vol. 1, 86SF.) The

more innovative the technology, the greater the risks to the devel-

oper. (R Vol. 1, 134Col.) If innovative projects are to be under-

taken, some reward must be provided for the risk takers. (R 1309-

II. Vol. 1, 181-82DCl, 185DCl. See, e.g., Comments of the Ha-

waiian Sugar Planters Association, “the avoided costs’ pricing stan-

dard . . . will constitute a necessary incentive for the production of

i3

points of profit over operating costs will determine whether

a facility is constructed and operated, a purchase rate

below the utility’s full avoided costs will discourage QF’s

that are only marginally profitable at the full avoided cost

rate.

FERC’s finding on this point was amply justified and

clearly articulated:

. in most instances, if part of the savings from

cogeneration and small power production were allo-

cated among the utilities’ ratepayers, any rate reduc-

tions will be insignificant for any individual customer.

On the other hand, if these savings are allocated to the

relatively small class of qualifying cogenerators and

small power producers, they may provide a significant

incentive for a higher growth rate of these technologies.

B-65.

Any “savings” to ratepayers must come out of a QF’s

revenues at the margin, directly and profoundly affecting

the rate of return on investment. For example, if FERC

were to adopt a purchase rate at 80 percent of avoided

costs (one of the alternatives suggested by the Court of

Appeals), the rate of return on a cogenerator’s investment

would fall 40 percent for an 80 MW facility, according to

a Department of Energy study.“ This decrease in return on

investment would cause an estimated reduction in cogener-

ation development of 50-70%, compared to the level antici-

pated under a purchase rate based on full avoided costs.“

additional biomass power by Hawaiian sugar factories.” (R 1334);

testimony of the American Wind Energy Association, “payment of

full avoided costs could be necessary to bring any significant

amount of generation stock on line soon.” (R Vol. 1, 134Col.)

**Resource Planning Associates, Inc., The Potential for Cogener-

ation Development in Six Major Industries by 1985, U.S. Depart-

ment of Energy Contract No. CR-04-60172-00, December 1977 at

Exhibit Lr.

Id. at Exhibit Lj.

14

Thus, a relatively small adjustment in the price QF’s

receive produces disproportionately large changes in the

deployment of such facilities. On the other hand, the sav-

ings experienced by the utility in purchasing QF power

at less than full avoided cost must be spread among so

many electrical consumers that it will become virtually un-

detectable.** And, because the benefits of QF power to rate-

payers will be partially foregone, any savings to them in

the short run will prove wholly illusory.”

*The triviality of any saving to ratepayers can be illustrated by

a simple hypothetical. Assume that the average price paid to Fs

is 5¢/kWh, and that this reflects only 80% of the full avoided cost.

Under the circumstances ratepayers would save 1.25¢/kWh. Assume

FERC’s estimate of 14 * 10° kWh purchased from QF’s in 1985.

See DEIS, supra note 14 at VII-17, Table VII-6. The total ratepayer

savings nationwide of $175 million are approximately 0.2 percent

of the 1980 electric utility revenues of $91.6 billion. (Statistical Ab-

stract of the United States, 1981, Table 1018.) The total number of

customers was 91.7 million in 1980. (Id.) Therefore the average

savings per customer would be less than $2.00 per year. This esti-

mated savings will result in a 50%-70% reduction in QF deploy-

ment. See text accompanying notes 16 and 17 supra.

The Court of Appeals rejected FERC’s reasoning on this point

on the ground that “if cogeneration becomes substantial, a rate

uniformly set at the statutory ceiling may be quite costly to con-

sumers” (B-11) and that “a rate which is below full avoided cost,

but still above the cogenerator's cost, could suffice to induce co-

generation... (B-14.) The court is so obviously wrong on these

assertions that the agency could not be expected to provide elab-

orate demonstrations in anticipation of them. First, the court simply

misread the rules in believing them to be uniform. (See note 8

supra and accompanying text.) Second, since avoided cost rates re-

flect the purchasi..g utility’s cost savings in purchasing power from

Fs they necessarily cannot cause costs to consumers to rise. Third,

rates set at below full avoided costs will fail to induce QF’s whose

cost is above such rates to generate.

15

B. Alternatives Suggested By the Court of Appeals

Entail Impermissible Regulatory Scrutiny

A unique merit of full avoided cost rates is that they

eliminate entirely the need to scrutinize the QF’s costs of

generation because the full avoided ecsts is based wholly

on the costs of the purchasing utility (which is already sub-

ject to regulation).

Congress viewed the prospect of utility-type regulation

as a major disincentive to QF’s. It therefore instructed the

FERC to design an incentive rate which does not entail

detailed examination of the QF’s costs. Congress observed

that, unlike electric utilities, qualifying facilities are not

protected by a regulatory blanket from business risks and

must therefore be assured a profit commensurate with

those risks. See H. Conf. Rep. No. 1750, 95th Cong. 2d

Sess. 97 (1978).

The Court of Appeals held that the FERC had correctly

rejected a “split-the-savings approach” as excessively bur-

densome on QF’s, but the court failed to rec nize that a

percentage of avoided cost approach suffers from the same

problem.” The court apparently envisioned that FERC,

20 The Court of Appeals charged FERC on remand to

allocate the benefits more evenly between the cogenerators

and the utilities if the utilities can demonstrate that under a

percentage of avoided cost approach, an allocation less heavily

favoring the cogenerators is in the public interest and the in-

terest of the utilities’ electric consumers and will not dispio-

portionately discourage cogeneration.

B-12. The utilities had the opportunity to make such a demonstra-

tion in the rulemaking proceeding. Instead they generally embraced

the full avoided cost principle and contented themselves with urg-

ing technical ana mechanical refinements:

Con Edison and Boston Edison Company are particularly

pleased that the final rules recognize that, although cogener-

ation and small power production is intended to be encouraged

under Section 210 of PURPA, that encouragement is not to be

provided at the expense of the other ratepayers of utilities, or

16

Solomon-style, would choose some percentage of avoided

costs as the basis for a rate that allocates some of the cost

savings to the utility and some to the QF. Whether the sav-

ings are to be split 50-50 (which the court correctly re-

jected) or according to some other ratio, the need to in-

quire into the qualifying facility’s costs is inescapable. The

percentage of full avoided costs that “appropriately” allo-

cates the benefits cannot be determined without knowing

how much it will cost to generate the alternative power.

Only then can FERC calculate a sufficient profit margin or

determine how much cogeneration and small power any

given percentage of full avoided cost will induce.”

Under the court’s rationale, FERC must not only seru-

tinize the mode and costs of operation of QF’s, it appar-

ently must do so separately for each technology and, per-

haps, for each individual facility. This result follows from

the fact that the costs of generation will vary widely among

through the uneconomic encouragement of investment in un-

needed generating. The final rules properly provided that util-

ities are not required to pay more than their avoided cost for

purchases for qualifying facilities (§ 292.304(a)(2), 45 Fed.

Reg. 12235) and that, where a utility has sufficient capacity to

meet its demands, and purchases from qualifying facilities will

not enable it to avuid any capacity costs, capacity credits for

purchases from qualifying facilities are not required. (5 292.304

(e)(3), 45 Fed. Reg. 12236).

Petition for Rehearing and Reconsideration on Behalf of Consoli-

dated Edison Company of New York, Inc. and Boston Edison Com-

pany, p. 686 of the Joint Appendix and p. 3750 of the record.

1L_ikewise, the lower court’s concern that FERC take into ac-

count differential pollution control standards and taxation rates

between utilities and cogeneration invites just the sort of regula-

tory scrutiny which the Congress wanted to avoid. A thorough in-

quiry into the external benefits and disbenefits of small power pro-

ductioa compared to conventional generation would lead to the

conclusion that full avoided costs rates are overly conservative in

view of the significant environmental and national security benefits

of small power, as discussed at length infra. Such was the conclu-

sion of the California Public Utilities Commision in its order im-

plementing section 210 of PURPA. See note 22, infra.

17

technologies and facilities. A different percentage, there-

fore, would presumably be appropriate for each. Indeed, no

approach other than a full avoided cost rate can be caleu-

lated wholly on the basis of the utilities’ costs, without

reference to the costs of the QF. Certainly the Court of

Appeals was not successful in its efforts to suggest one.

IV

THE FULL AVOIDED COST RULE, BY MODERATING

ELECTRIC RATES, IS JUST AND REASONABLE

TO RATEPAYERS

In holding that the four parameters established for Con-

gress for purchase rates require a “balancing of the inter-

ests of the affected parties,” B-10, the lower court invoked

an inapt metaphor which suggests that FERC should have

refereed a compromise among the stakeholders—ratepay-

ers, qualifying facilities and the general public—in order to

strike a sort of equipoise. A more ideal view, however, is

that PURPA envisions a rate which optimizes net benefits

and provides maximum rewards to all stakeholders.” This

optimization is most likely to be achieved by avoided cost

rates.

22Indeed, the California Public Utilities Commision in its Order

implementing Section 210 of PURPA is strongly of the view that

full avoided cost rates are the minimum necessary to effectuate the

purpose of the law:

Some argue that ratepayers are disadvantaged when avoided

costs are paid to qualifying facilities, because in some cases

these facilities can produce electricity at less than the avoided

cost price. While it may be true that some QFs could be

brought on line at a purchase price below avoided cost, such

a price would not be sufficient to bring in other QFs capable

of producing power at prices up to the avoided cost price. The

point of permitting avoided cost pricing is to encourage the

fullest possible efficient development of QF resources that can

effectively and economically compete with utility resources.

By opening this market, the supply of electricity is increased,

which should lower customers’ rates over time. Heavy utility

reliance on oil and gas fuels to generate electricity has caused

18

A. The Full Avoided Cost Rate Induces Maximal Dis-

placement of High Cost Electric Generation

Over the long run, avoided cost rates for alternative

energy are likely to be more effective in reducing or moder-

ating electrical rates than any lower rates. A utility seeks

to minimize its costs of generating power by operating or

building the most expensive plants last. Thus, the new

power purchased from QF’s will ordinarily displace the

most costly source of generation or purchased power in the

utility’s supply mix. Least-cost dispatch assumes that the

first energy source to be replaced by a QF is high-priced

imported oil, just as PURPA intended. For utilities that

are experiencing significant demand growth, the alternative

power will eventually displace new power plants that would

otherwise have to be built.** Such facilities are almost uni-

versally higher in cost than existing facilities.“

rates in California to skyrocket. Avoided cost pricing is in-

tended to stimulate development of substantial generating ca-

pacity that will reduce utility oil and gas consumption. In ad-

dition, system reliability is increased by the presence of larger

numbers of smaller facilities.

If anything, this Commission believes that the avoided cost

signal to QFs is a conservative one, as it does not include the

tangible but hard to quantify “social costs” that are associated

with new utility supplies and which are avoided through the

purchase of QF power. These “social costs” include the risks

associated with imported energy supplies and environmental

degradation related to conventional generation.

Cal. P.U.C., Dec. No. 82-01-103, OIR2, at 25 (Jan. 21, 1982).

In the unusual case where economics of scale cause the system-

wide costs of generation to decline as new conventional capacity is

added, the utility will not “avoid” capacity costs by purchasing QF

power. In these cases, the full avoided cost rate will pay Fs only

the value of the utility’s fuel savings unless the utility chooses to

wheel the power to another utility. A QF will have little incentive

to locate in the service area of such a utility or to size the facility

to generate power for external consumption. These cases are anal-

ogous to the overcapacity cases discussed at note 26 infra and ac-

companying text.

New power plants require enormous outlays of capital which

the utilities are finding increasingly difficult to raise. E Meyer,

19

To the extent that QF’s substitute for expensive fuels

and the construction of new power plants, the costs of gen-

erating power are reduced. Since these marginal sources

define the utility’s “avoided cost,” a growth in the con-

tribution of alternative energy will over time lower or

moderate the avoided or marginal costs of providing elee-

trical power, which should translate into lower rates for

consumers.“

Admittedly, the situation is different for some utilities

that already have more generating capacity than they need

“New Directions for Utility Resource and Financial Planning,” En-

ergy Efficiency and the Utilities, California Public Utilities Com-

mission Symposium Proceedings 139-144 (July, 1980). Because the

risk that the projects may prove unnecessary or obsolete. This oc-

curred with the Washington Public Power Supply System. Declin-

ing forecasts of the need for power, coupled with cost overruns,

forced the cancellation of two nuclear units on which $2.25 billion

Ar Nichols, WPPSS—A Postscript, Pub. Util.

ort. (June 24, 1982) at 54. Thus, the full avoided cost rate will

pany, Statement of Key Corporate Goals and Direction, Long Term

Planning Results 1982-2000, (June, 1982). Purchasing power under

PURPA is an element of this strategy. The economic benefit to elec-

tricity consumers of lower cost of debt and equity is significant. See

National Economic Research Associates, Inc., An Economic Eval-

uation of the Marble Hill Nuclear Project, Indiana Public Service

Commission Cause No. 36818 at IV-17, 18 (October 4, 1982).

The restraining effect on utility rates was apparently in mind

as FERC developed the full avoided cost rule:

Under the principles of economic dispatch, utilities gen-

erally turn on last and turn off first their generating units with

to meet demand in the present or near future. This situa-

tion gives rise to the theoretical problem which vexed the

Court of Appeals:

If a utility has excess capacity the additional cogen-

eration encouraged by full avoided cost payments will

result in higher costs for all remaining customers of

the utility because that cogeneration will reduce the

number of customer-purchased kilowatt hours over

which the utility can spread a share of the fixed costs

of that extra capacity.

B-13. But this hypothetical misconstrues the application

of the full avoided cost principle. If the avoided capacity

costs on a system are small or nonexistent, so will be the

incentive to QF’s. Cogenerators, for instance, will either

locate in a more conducive utility service area or size their

facilities to serve only their own internal needs, rather

than to sell power to the interconnecting utility because the

incremental cost of additional generation will not be jus-

tified by the low rates predicated upon the utility’s cost

saving.”

B. The Full Avoided Cost Rate Induces Utility Cost Re-

ductions Through More Efficient Use of Resources

We have noted above that the full avoided cost formula

stimulates competition between utilities and QF’s as to

the highest running cost. At any given time, an economically

dispatched utility can avoid operating its highest-cost units as

a result of making a purchase from a qualifying facility.

[Power from a QF can] permit the purchasing electric utility

to avoid the need to construct a generating unit, to build a

smaller, less expensive plant, or to reduce firm power pur-

chases from another utility, [and] the rates for such a purchase

will be based on the avoided capacity and energy costs.

B-44.

**See, e.g., Testimony of William A. Hawkins of Consolidated

Edison Company of New York before the New York Public Service

Commission in Case 27574 at 4 ( 1980).

21

the marginal supply of power. This competition exercises a

restraint on utilities’ resource expansion plans. The present

and prospective availability of qualifying small power

makes expensive new capital projects harder to justify

without risking excess capacity.” This salutory competition,

operating outside the usual regulatory constraints, will

lead to more efficient use of resources by utilities and lower

rates for consumers.

Small-scale dispersed generators also promote greater

system reliability, decreasing a utility’s need for reserves.

The chances of an aggregate of 1,000 MW of small gener-

ators going off line unexpectedly are negligible compared

to the chances of an unplanned outage of a single 1,000 MW

central generating station. This decreased need for stand-

by capacity translates into cost savings to z utility.”

All of these benefits to ratepayers—decreased cost of

capacity additions, greater resource efficiency through com-

petition, and decreased need for reserve capacity due to

greater reliability—are directly correlated to the degree

of penetration of cogeneration and small power production

in the nation’s electricity markets. Full avoided cost rates

provide the maximum financial incentive for the construc-

Regulatory commissions have shown an increasing propensity to

penalize utilities for unused capacity resulting from imprudent ex-

pansion decisions. See, e.g., lowa State Commerce Commission, In

re Iowa Illinois Gas and Electric Company, RPLI-81-5, May 18,

1982; Ohio Public Utilities Commission, Re Dayton Power and

Light Co., Case No. 81-#L-AIR, 45 PUR 4th (Feb. 3, 1982); North

Dakota Public Service Commission, Re Otter Tail Power Co.,

Docket No. 10,124, 44 PUR 4th (July 20, 1981); Missouri Public

Service Commission, Re Kansas City Power and Light Co., Case

No. ER-80-48, 38 PUR 4th (June 19, 1980).

R. Deb and J. Mulvaney, “Economic and Engineering Factors

Affecting Unit Size,” IEEE Trans. on Power Apparatus

and Systems, V. PAS-101, No. 10 (October, 1982) 3907-3918. V.

Loose and T. Flaim, “Economics of Scale and Reliability: The

Economics of Large vs. Small Generating Units,” 4 Energy Systems

and Policy, Nos. I and 2 at 37-55 (1980).

tion and operation of such facilities without increasing

costs to electrical consumers. Any lower rate, whether based

upon a percentage of full avoided cost or some other for-

mula, would discourage some substantial percentage of such

facilities.”

V

THE FULL AVOIDED COST RULE IS IN THE PUBLIC

INTEREST

The Court of Appeals was unconvinced that the full

avoided cost rule meets the requirement that purchase rates

be “in the public interest.” (B-9.) To be non-redundant, this

standard must comprehend public benefits beyond the rate

benefits to particular customers. Many public interests may

be affected by the emergence of alternative energy systems,

but two benefits are particularly noteworthy because they

were much on the minds of the members of Congress in

enacting PURPA. These involve environmental quality and

energy security.”

A. The Full Avoided Cost Rate Produces Important En-

vironmental Benefits

The beneficial environmental impacts of cogeneration

and small power production were discussed by the agency

in the environmental impact statement on the proposed

rules.“ The impact statement found that [olne of the

major environmental benefits brought about by the opera-

tion of facilities indueed by PURPA will be to reduce

effects that otherwise would have occurred through con-

See, e.g., H. Rep. No. 543, 95th Cong., 2d Sess. 5 (1978):

The fundamental problem for the U.S. energy policy is the

insecurity of its oil supply. . Our reliance on imported oil

is expected to increase dramatically if present practices and

policies are coritinued. .. Such an increase in our reliance on

oil imports would greatly constrain our foreign policy and

could do considerable damage to our economy.

“DEIS, note 14 supra.

ventional utility power generation.” DEIS at VI-30.“ This

statement projects that between 1980 and 1995, the full

avoided cost rule will defer 5400 MW of coal-fired genera-

ation, 1200 MW of nuclear power, 3300 MW of oil and gas-

fired generation, and 290 MW of large-scale hydropower.

Id. at VI-18. Each of these generating technologies imposes

substantial and controversial environmental costs at each

step of its fuel cycle, from fuel extraction through combus-

tion and waste disposal. The DEIS shows that for each new

1000 MW coal plant, 200,000-300,000 pounds per day of air

pollution will be produced, depending upon the region in

which it is located. Jd. at VII-32, Table VII-13. Again, de-

pending on the regiom, such a plant will produce between

1000 and 3700 tons of solid waste per day. Jd. at VII-33,

Table VII.

These substantial) environmental costs detract from

human health and quality of life. Small power production

avoids or greatly reduces these costs“ creating public ben-

efits that militate strongly in favor of maximum stimula-

tion of QF development.

B. The Full Avoided Cost Rate Enhances Energy

Security

The other public benefit foremost in the minds of the

Congress in enacting PURPA was the effect upon the

The advantages of cogeneration include the enhanced efficiency

with which it uses fuel reserves compared to conventional genera-

tion. Cogeneration requires but one-half as much fuel to produce

the same electricity as is required in a single purpose electricity

generating station R. Williams, Industrial Cogeneration, 3 Ann.

Rev. Energy 313 (1978).

To be sure, small power produces some untoward environ-

mental effects as well. Cogenerators, for instance, cause a certain

amount of air pollution. However, these effects were judged by the

Commission to be sufficiently small compared to the important en-

vironmental |benefits of small power to lead the Commission to con-

clude that “(tle overall development of QFs will not have a sig-

nificant effect on the of the human environment within the

meaning of Section 102 of NEPA.” DEIS at I- G.

24

nation’s vulnerability to supply interruptions and price

escalations from foreign sources of energy. As PURPA

was being debated, the nation was importing 8.5 million

barrels of oil per day—nearly half our needs—at fifteen

times the price charged only a few years before, and domes-

tic oil production was in decline.* The vulnerability asso-

ciated with this extermal dependence can be measured by

assessing the consequemces to the national economy should

the supply be preemptorily terminated. The Congressional

Budget Office estimates that the loss of oil from one foreign

supplier alone, Saudi Arabia, would cost the United States

$272 billion, increase the unemployment rate by two per-

cent, and boost the inflation rate by twenty percentage

points.” The disruption of America’s chief military allies

would be even greater. This concern has given rise to open

discussion of war to secure oil routes out of the Persian

Gulf. President Carter called the situation “a clear and

present danger to our national security.”

While we do not maintain that PURPA, however vigor-

ously implemented, can eliminate oil imports alone or im-

mediately, the public benefit of enhanced energy security is

furthered in direct proportion to the rate of deployment

of qualifying facilities. The maximum finaneial incentive

permitted under PURPA—full avoided cost—is the rate

that best satisfies the “public interest” design parameter.

This conclusion is too apparent to require extensive analy-

sis in the decision-making record or explicit discussion in

the Section-by-Section Analysis of the rules. It would be

absurd to remand this case to the agency for it to state

what no one ean credibly dispute.

“See Deese and Nye, Energy and Security 3 (Ballinger 1981).

**Congressional Budget Office, The World Oil Market in the

1980's: Implications for the United States (1980).

VI

THE FULL AVOIDED COST RULE, AS A RATE IN-

NOVATION, WARRANTS GREATER THAN OR-

DINARY JUDICIAL DEFERENCE”

In a typical case of judicial review of agency rule-

making, a “thorough, probing, in-depth review” is proper

under the instructions set forth by this Court in Citizens

to Preserve Overton Park v. Volpe, 401 U.S. 402, 415

(1971).“ In conducting such a review, the Court of Appeals

failed to appreciate the unique features of this case. Judi-

cial review of rate cases proceeds subject to a rule of spe-

cial deference to the expert judgment of the decision-

Much debate has been joined in this litigation over the proper

standard of review. See FERC Petition for Cert. at 22; American

Paper Institute Petition for Cert. at 4, 16-20; Opposition to Petition

for Cert. at 9-12. No real difference exists between the “substantial

evidence standard and the arbitrary and capricious standard” in

practice, especially in regard to informal rulemaking, as both the

District of Columbia Circuit and the Second Circuit have recog-

nized. See American Public Gas Association v. Federal Power Com-

mission, 567 F.2d 1016, 1026-29 (D.C.Cir.) cert. denied, 435 U.S.

907 (1977); Associated Industries of New York v. Dept. of Labor,

487 F.2d 342, 348-350 (2d Cir. 1973).

“Overton Park, supra, established a three-part test. First, the

court is “required to decide whether the Secretary acted within the

scope of his authority.” Id. at 415. Involved in this inquiry is “a

determination of whether the Secretary's decision can reasonably

be said to be within that range set forth by Congress.” Id. Section

210 of PURPA established a range within which the rate for pur-

chases of power is to be set, namely that it shall not “exceed the in-

cremental cost to the electric utility of alternative energy.” Clearly,

the awoided cost rule does not exceed this point.

Secondly, a finding must be made that “the actual choice made

was mot ‘arbitrary, capricious, an abuse of discretion, or ctherwise

not in accordance with law. Id. at 417. An examination of the over

4,000 pages of the record below amply illustrates that the decision

was “based on relevant factors” and that “there has been [no] clear

error of judgment.” Id. The Court of Appeals could only conclude

that the legislation “could” fail to induce additional cogeneration

and “might” leave customers worse off. At the same time, the Court

making agency. This principle applies a fortiori where, as

here, the rate is developed in response to a novel and ex-

perimental congressional mandate and subjected to tight

and strict time constraints.

A. The Avoided Cost Rule is Valid Under the Special

Deference Due Ratemaking

The instant case is steeped in the economics of rate-

setting. This Court and many others have recognized that

FERC’s regulation of rates under the “just and reason-

able” standard is due considerable deference. See Atchison,

Topeka & Santa Fe Ry. v. Wichita Bd. of Trade, 412 US.

800, 806 (1973) (quoting Manufacturers R. Co. v. United

States, 246 U.S. 457, 481 (1918) and Board of Trade of

Kansas City v. United States, 314 U.S. 534, 546 (1942)).

See also San Antonio, Texas ex rel. City Public Service

Board v. United States, 631 F.2d 831, 836 (D.C. Cir. 1980).

Justice Douglas recognized the special status of rate-

making, from the standpoint of judicial review, in a case

involving an order setting rates on coal:

Rate structures are not designed merely to favor the

revenues of producers and carriers. The Commission

has the consumer interest to safeguard as well. And

when it undertakes to rationalize the interests of the

three, great complexities are often encountered. The

economics of the bituminous coal industry have baffled

even experts. We would depart from our competence

and our limited function in this field if we undertook to

accommodate the factors of transportation conditions,

distance and competition differently than the Commis-

sion has done in this case. That is a task peculiarly

for it. In fashioning what the Commission called a dif-

admitted that the Commission “may be right in its conclusion.

B-38, B-11.

Third, “the final inquiry is whether the Secretary's action fol-

lowed the necessary procedural requirements.” Whether the proper

were followed is not at issue in this case which inval-

idated the avoided cost rule on substantive, not procedural, grounds.

27

ferentially related and finely balanced rate structure

for this coal, there is no place fur dogma or rigid

formulae. The problem calls for an expert, informed

judgment on a multitude of facts. The result is that

the administrative rate-maker is left with broad dis-

cretion as long as no statutory requirement is over-

looked. Yet that is, of course, precisely the nature of

the administrative process in this field.

Ayrshire Collierres Corp. v. United States, 335 U.S. 573,

592-93 (1949).

More recently, in Permian Basin Area Rate Cases, 390

U.S. 747 (1968), this Court had occasion to discuss in detail

the scope of judicial review of rates set by the Federal

Power Commission, the predecessor agency to the Federal

Energy Regulatory Commission. The Court quoted the

following passage from Permian Basin in Mobil Oil Corp.

v. FPC, 417 U.S. 283, 307-308 (1974) as the “criteria gov-

erning the scope of judicial review“:

The court's responsibility is not to supplant the Com-

mission’s balance of these interests with one more

nearly to its liking, but instead to assure itself that the

Commission has given reasoned consideration to each

of the pertinent factors.

Id. at 283, quoting Permian Basin, supra at 791-92 (empha-

sis in original).

The rule set forth by this Court is that a reviewing court

is “not obliged to examine each detail of the Commission’s

decision: if the ‘total effect of the rate order cannot be said

to be unjust and unreasonable, judicial inquiry under the

Act is at an end.’” Permian Basin, supra at 767, quoting

FPC v. Hope Natural Gas Co., 320 U.S. 591, 602 (1944).

See also Mobil Oil, supra at 307. The Court has recognized

that where Congress has invested an agency with general

responsibility for administration of a complex regulatory

scheme, the agency’s interpretation of its statutory charter

is entitled to special deference. EPA v. National Crushed

Stone, 449 U.S. 64, 83 (1980).

It is clear on the face of the Court of Appeals’ opinion

that its real quarrel was not with the methods the Commis-

sion used but rather the “balance of interests” it struck.

The above discussion illustrates that the Court of Appeals

was simply mistaken on the facts and the record. Its con-

trary view was an improper substitution of its judgment

for that of the Commission.

B. Judicial Deference is Also Appropriate Here in View

of the Congressional Command for a Novel and Un-

precedented Regulatory Initiative

FERC’s decision warrants deference for another reason.

PURPA marks a substantial departure from the traditional

utility monopoly over generation of electricity. See, e.g., 123

Cong. Rec. 23848 (daily ed. Aug. 1, 1977) (remarks of Sen.

Percy) ; 123 Cong. Ree. at 32403 (Oct. 5, 1977) (remarks of

Sen. Dunkin) ; id. at 32437, (remarks of Sen. Haskell) ; id.

at 32419 (remarks of Sen. Hart). It calls for a fundamental

reordering of the traditional regulatory scheme. Uniquely,

it gives FERC authority over retail sales of power

(from utilities to qualifying facilities as back-up power).

Uniquely, it also gives states regulatory authority over

sales for resale (power sales from QF’s to utilities).

Uniquely, it requires customers (utilities) to buy power

from any QF. Incentive rates to encourage certain modes

of power consumption are familiar, (e.g., peak load pric-

ing), but here FERC is required to prescribe rates which

encourage certain types of generation. While the establish-

ment of rates for electricity on the basis of the seller's

cost is familiar regulatory terrain, Congress’ desire to have

rates based on a buyer’s avoided costs is new ground.

Congress mandated these radical departures because of

the substantial benefits of privately-financed cogeneration

and small power producers. Yet, because of the pressing

energy problems facing the country, Congress wanted the

section 210 program implemented very quickly ; FERC was

given only twelve months to promulgate regulations. See

§ 210(a). Given the scope and complexity of the issues

raised and the limited time in which to consider them,

FERC could hardly be expected to make all its determina-

tions with algebraic precision. See Illinois v. Gorsuch, 530

F.Supp. 340 (D. D.C. 1981) (Short time frame is evidence

that “Congress did not expect the agency to resolve every

conceivable problem.”).

Courts have accorded an even greater degree of judicial

deference, “[{w]hen regulation features novelty, in subject,

technique, or both,” as another panel of the Court of

Appeals for the District of Columbia stated in American

Public Gas Ass’n v. FPC, 567 F.2d 1016, 1031 (D.C. Cir.),

cert. denied, 435 U.S. 907 (1977). See also Shell Oil Co. v.

FPC, 520 F.2d 1061, 1071 (5th Cir. 1975), cert. denied sub

nom. California Co. v. FPC, 426 U.S. 941 (1976) (“kid

glove” review appropriate because of “experimental nature

of regulation”); Kennecott Copper v. EPA, 462 F.2d 846

(D.C. Cir. 1972).

Because of the novelty of this exercise, history provides

few guideposts. The amount of power that will be pro-

duced or withheld at any specific rate is a matter for edu-

cated conjecture. The effects on ratepayers of various levels

of QF penetration is necessarily speculative.“ Informed

parties may earnestly disagree concerning the point of

exact equilibrium among competing interests.

The FERC has emerged from this regulatory minefield

with a formula which is logical, workable and within the

range of options established by Congress. The full avoided

cost role is the product of extensive and well-reasoned

staff discussion papers, a formal environmental impact

review, voluminous public comments garnered in two com-

ment periods and 8 public hearings in 5 locales. All of this

The FERC was aware that, because of the time constraint and

because of the novelty of the program, the rules would of necessity

be experimental and require review and revision as data from ac-

tual experience became available. See, e.g., R 1249, 1312, 2477, 2786,

Vol. 1, 146-47 DC4.

30

was accomplished within the tight time constraint of one

year from enactment of PURPA, as required under sec-

tion 210.”

Yet the Court of Appeals was not satisfied. In demanding

absolute precision and quantification for the full avoided

cost rule, the court applied a standard which no agency

could hope to meet under comparable circumstances. Had

the FERC adopted a “percentage of avoided cost” rule,

the apparent preference of the Court of Appeals, it would

manifest the same infirmities, as would any other formula.

The only likely result of such a standard of review is reg-

ulatory paralysis and the practical demise of an important

national energy program. PURPA is a novel and experi-

mental program entrusted to FERC, and is thus entitled to

more deference than a routine delegation of rulemaking

power.

CONCLUSION

The order of the Court of Appeals for the District of

Columbia should be reversed on the full avoided cost issue.

Respectfully submitted,

Awan S. Mun Grecory A. THomas

Natural Resources Defense Natural Resources Defense

Council, Ine. Council, Ine.

Ww * Counsel of Record for

Amici

National Audubon Society

Of Counsel

Davin J. SHAFFER

Stanford Law School

Of Assistance on the Brief

(Appendix Follows)

„Courts also recognize a special deference to agency decisions

when they must be made within a short time frame. See, e.g., E. I.

du Pont de Nemours & Co. v. Train, 430 U.S. 112, 134-135 (1976);

Train v. Natural Resources Defense Council, 421 U.S. 60, 87 (1975);

Weyerhauser Co. v. Costle, 590 F.2d 1011 (D.C. Cir. 1978).

A-l

APPENDIX

DESCRIPTION OF AMICI

Natural Resources Defense Council, Inc., a national en-

vironmental organization with more than 44,000 members

residing in all states and territories, as well as abroad,

has as one of its principal goals the preservation and wise

use of the natural resources of the earth, including those

resources such as clean air and clean water held in com-

mon by all people. NRDC has sought, through the advocacy

of effective federal, state and local laws, to assure that

those commonly held resources are protected.

The National Audubon Society is one of the oldest, larg-

est and most experienced national conservation organiza-

tions. It is devoted to conservation and protection of the

natural environment which supports both humankind and

wildlife. The National Audubon Society’s 470,000 members

in 425 chapters are backed by a full-time staff of 200 work-

ing in ten regional offices. The staff includes scientists and

other professionals specialized in energy policy. In April,

1981, the Society published the Audubon Energy Plan in

which cogeneration and small-scale power production are

key elements in furthering the Society’s purpose of pro-

moting wise end efficient use of energy resources.

Solar Lobby is a not-for-profit organization with more

than 40,000 members across the United States, in the

US. verritories, and in other countries. Solar Lobby's pur-

pose is to take nationally focused political action to achieve

the rapid, substantial, and widespread use of solar energy

in an energy-efficient, environmentally sound, and equitable

society. The staff of the Solar Lobby works nationally and

through affiliate groups around the United States to en-

sure a rapid transition to a society based on renewable

energy resources and energy efficiency with an emphasis on

decentralized approaches to solving our energy needs. This

organization envisions a society that obtains twenty-five

percent of its total energy needs from renewable resources

by the year 2000. Solar Lobby’s national office is located in

Washington, D.C. The organization’s Media Project is lo-

cated in Los Angeles, California.