Appendix — Morgan Stanley Capital Group Inc. v. Public Util. Dist. No. 1 of Snohomish Cty.

O61457 Ay 03 2007

(2) OFFICEOFTHECLERK

No. 06- .

IN THE

Supreme Court of the United States

MORGAN STANLEY CAPITAL Group INC.,

Petitioner,

Vv.

PuBLtic UTiLity District No. |

OF SNOHOMISH COUNTY WASHINGTON, et al,

and

FEDERAL ENERGY REGULATORY COMMISSION,

Respondents.

On Petition for a Writ of Certiorari to the

United States Court of Appeals for the Ninth Circuit

APPENDIX

ERIC GROSSMAN WALTER DELLINGER

ZACHARY STERN Counsel of Record

MORGAN STANLEY CaPiITAL MARKS. DAVIES

Group O’MELVENY & MYERS LLP

1633 Broadway 1625 Eye Street, NW

New York, NY 10019 Washington, DC 20006

(202) 383-5300

PAUL J. PANTANO, JR.

MICHAEL A. YUFFEE

MCDERMOTT WILL & EMERY LLP

600 Thirteenth Street, NW

Washington, DC 20005

Attorneys for Petitioner

f—_ ______

i

TABLE OF CONTENTS

Page(s)

Appendix A:

Opinion & Order on Petition for Review of an Order

of the Federal Energy Regulatory Commission,

United States Court of Appeals for the Ninth Circuit,

Nos. 03-72511, 03-74757, 04-70712,

03-74617, 03-74208,

Appendix B:

Initial Decision of the Federal Energy

Regulatory Commission,

I savesiituidinonseneibel 68a

Appendix C:

Order on Initial Decision, Rehearing

Requests, and Motions,

SS NR mee CE Teme 246a

Appendix D:

Opinion & Order on Petition for Review of an Order

of the Federal Energy Regulatory Commission,

United States Court of Appeals for the Ninth Circuit,

Nos. 03-74207, 03-74246,

Le A eS 314a

Appendix E:

Provisions of the Federal Power Act,

codified at 16 U.S.C. §§ 791 ef S€q.........ccscceeseeseeeeneeeeees 33l1a

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APPENDIX A

UNITED STATES COURT OF APPEALS,

FOR THE NINTH CIRCUIT

PUBLIC UTILITY DISTRICT NO. 1 OF SNOHOMISH

COUNTY WASHINGTON, Petitioner,

Reliant Energy Services Inc., Jntervenor,

v.

FEDERAL ENERGY REGULATORY COMMISSION,

Respondent.

Southern California Water Company, Petitioner,

Enron Power Marketing Inc., Intervenor,

Vv.

Federal Energy Regulatory Commission, Respondent.

Attorney General, State of Nevada, Petitioner,

BP Energy Company;

Mirant Americas Energy Marketing, L.P., Intervenors,

v.

4 Federal Energy Regulatory Commission, Respondent.

§ Nevada Power Company; Sierra Pacific Power Company,

b Petitioners,

:

Federal Energy Regulatory Commission, Respondent.

; Public Utility District No. 1

of Snohomish County Washington, Petitioner,

; Calpine Energy Services, L.P.;

: El Paso Merchant Energy L.P.;

Morgan Stanley Capital Group, Inc.;

: Mirant Americas Energy Marketing, LP;

BP Energy Co.; Allegheny Energy Supply Co., LLC;

American Electric Power Service Corporation, /ntervenors,

; v

;

Federal Energy Regulatory Commission, Respondent.

Nos. 03-72511, 03-74757, 04-70712, 03-74617, 03-74208.

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;

Argued and Submitted Dec. 8, 2004.

Filed Dec. 19, 2006.

On Petition for Review of an Order of the Federal Energy

Regulatory Commission.

FERC Nos. EL02-26 et al., EL-02-28,

EL02-28-004, EL02-26-000.

Before: BROWNING, PREGERSON, and BERZON, Circuit

Judges.

BERZON, Circuit Judge:

The energy crisis in 2000-2001 resulted in extreme

power shortages and price volatility in California and other

western states. This consolidated appeal raises several

interrelated issues concerning a series of wholesale energy

contracts for future energy supplies--known as "forward"

contracts--entered into by power companies in California,

Nevada, and Washington during the energy crisis.

Petitioners, including retail power companies and state

agencies’, contended before the Federal Energy Regulatory

Commission (FERC) that the contracts should be modified,

but FERC concluded that they should not be.

Petitioners (the “local utilities”) now allege that

FERC, in so deciding, did not appropriately apply the just

and reasonable standard set by section 206(a) of the Federal

Power Act (FPA).” They allege that FERC erred in applying

' Petitioners are Public Utility District No. 1 of Snohomish County,

Washington (Snohomish); Southern California Water veo

(Southern Cal Water); Nevada Power Company (Nevada Power); and

Sierra Pacific Power Company (Sierra Pacific); and the Office of the

cri ples aes: Bureau of Consumer Protection.

? Although the statute was amended slightly in 2005, this opinion

exclusively refers to, and quotes from, the 2000 version. Section 206(a)

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the Mobile-Sierra "public interest" mode of review’ to

contracts that were (1) not subject to meaningful initial

review or approval, and (2) formed during one of the most

erratic and bizarre periods of activity for the western energy

market.

We hold that FERC erred both in its procedural

reliance on Mobile-Sierra * and in the substantive standard it

used in determining that the contracts at issue did not affect

the public interest. FERC's reliance on Mobile-Sierra was

misplaced because its grant of market-based rate authority

lacked a mechanism to provide effective, timely relief from

unjust and unreasonable rates due to market dysfunction,

thereby creating a gap in the FPA's protection against

excessive energy prices. Although we would remand to

FERC solely because its application of Mobile-Sierra was

provided:

Whenever the Commission, after a hearing had upon its

own motion or upon complaint, shall find that any rate,

charge, or classification, demanded, observed, charged, or

collected by any public utility for any transmission or sale

subject to the jurisdiction of the Commission, or that any

rule, regulation, practice, or contract affecting such rate,

charge, or classification is unjust, unreasonable, unduly

discriminatory or preferential, the Commission shall

determine the just and reasonable rate, charge, classification,

rule, regulation, practice, or contract to be thereafter

observed and in force, and shall fix the same by order.

16 U.S.C. § 824e(a) (2000) (emphasis added). Notably, this provision

expressly applied to “any ... contract,” as well as to rates unilaterally set.

> This shorthand takes its name from two Supreme Court cases decided

on the same day, United Gas Pipe Line Co. v. Mobile Gas Service Corp.

(Mobile ), 350 U.S. 332 (1956), and Federal Power Commission v.

Sierra Pacific Power Co. (Sierra ), 350 U.S. 348 (1956).

* We use the term “Mobile-Sierra " throughout this opinion to refer both

to the two original Supreme Court cases and to the doctrine derived from

them.

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therefore procedurally improper, we further hold that the

agency's finding that the challenged contracts do not affect

the public interest was based on a substantively erroneous

mode of analysis. A remand is therefore necessary to allow

FERC the opportunity to review these complaints in the first

instance in light of these holdings and determine whether the

challenged rates meet the statutory standard.

I. The Federal Power Act and Mobile-Sierra

The FPA governs the actions of public utilities,

defined as “any person who owns or operates facilities

subject to the jurisdiction of the [Federal Energy Regulatory]

Commission." 16 U.S.C. § 824(e). The Commission's

jurisdiction covers the "transmission of electric energy in

interstate commerce and the sale of such energy at wholesale

in interstate commerce." /d. § 824(a). This definition

encompasses activities carried out by all of the Intervenor-

Respondent companies.

The FPA requires FERC to regulate public utilities

for the benefit of consumers. See Pa. Water & Power Co. v.

Fed. Power Comm'n, 343 U.S. 414, 418 (1952) ("A major

purpose of the whole [Federal Power] Act is to protect power

consumers against excessive prices."); California ex rel.

Lockyer v. FERC (Lockyer), 383 F.3d 1006, 1017 (9th Cir.

2004) (describing “protecting consumers” as the FPA's

“primary purpose”); see also All. Ref. Co. v. Pub. Serv.

Comm'n, 360 U.S. 378, 388 (1959) ("The [Natural Gas] Act

was so framed as to afford consumers a complete, permanent

and effective bond of protection from excessive rates and

charges.").

Two FPA provisions, sections 205 and 206, 16

U.S.C. §§ 824d, 824e, govern FERC's authority and establish

its obligation to regulate rates for the interstate sale and

transmission of electricity. Through these provisions, the

FPA empowers FERC to regulate wholesale electricity rates

but not the rates charged directly to consumers by local

utilities. See 16 U.S.C. § 824(a), (b)(1). The protection the

FPA accords consumers is therefore indirect: By assuring

that wholesale purveyors of electric power charge fair rates

to retailers, the FPA protects against the need to pass

excessive rates on to consumers. At the same time, by

assuring that wholesale purveyors of electric power receive a

fair rate of return, the FPA assures that such sellers have the

incentive to continue to produce and supply power.

The First Circuit has aptly described the interaction

of sections 205 and 206:

In regulating electncity rates, the Federal Power

Act follows (with variations) a well-developed model:

the utility sets the rates in the first instance, 16 U.S.C.

§ 824d(a), subject to a basic statutory obligation that

rates be just and reasonable and not unduly

discriminatory or preferential, id. §§ 824d(a)-(b).

FERC, which inherited the powers of its predecessor

(the Federal Power Commission), can investigate a

newly filed rate (section 205, id. § 824d(e)), or an

existing rate (section 206, id. § 824e(a)), and, if the

rate is inconsistent with the statutory standard, order a

change in the rate to make it conform to that standard,

id. §§ 824d(e), 824e(a)-(b).

The procedural incidents and FERC's ability to

provide refunds vary depending on whether the

proceeding is one to investigate a new rate filing or an

existing rate. For example, in the former case, the

burden is on the utility to show that its rate is lawful,

16 U.S.C. § 824d(e), and, in the latter, the burden is on

the FERC staff or the customer to show that the rate is

unlawful, id. § 824e(b). In both circumstances,

however, the statutory test of lawfulness is phrased in

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the same terms.

Boston Edison Co. v. FERC, 233 F.3d 60, 64 (1st Cir. 2000)

(footnote omitted). Additionally, when utilities set rates in

the first instance, they may do so via privately-negotiated

contracts, filed pursuant to section 205(c)- (d), 16 U-S.C. §

824d(c)-(d).° Thus, the FPA, by its terms, creates a role for

privately negotiated wholesale power contracts, balanced by

FERC's obligation to ensure that those contracts rates, like

unilaterally filed rates, are "just and reasonable."

* Section 205(c)-(d), 16 U.S.C. § 824d(c)-(d), provides:

(c) Schedules

Under such rules and regulations as the Commission may

prescribe, every public utility shall file with the Commission,

within such time and in such form as the Commission may

designate, and shall keep open in convenient form and place

for public imspection schedules showing all rates and charges

for any transmission or sale subject to the jurisdiction of the

Commission, and the classifications, practices, and

regulations affecting such rates and charges, together with all

contracts which in any manner affect or relate to such rates,

charges, classifications, and services.

(d) Notice required for rate changes

Unless the Commission otherwise orders, no change shall

be made by any public utility in any such rate, charge,

classification, or service, or in any rule, regulation, or

contract relating thereto, except after sixty days’ notice to the

Commission and to the public. Such notice shall be given by

filing with the Commission and keeping open for public

inspection new schedules stating plainly the change or

changes to be made in the schedule or schedules then in

force and the time when the change or changes will go into

effect. The Commission, for good cause shown, may allow

changes to take effect without requiring the sixty days’ notice

herein provided for by an order specifying the changes so to

be made and the time when they shall take effect and the

manner in which they shall be filed and published.

(Emphases added).

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Two Supreme Court decisions, announced on the

same day in 1956, explain the approach that federal

regulators must apply in certain circumstances when

reviewing challenges maintaining that contracted rates are

too low to be just and reasonable. See United Gas Pipe Line

Co. v. Mobile Gas Serv. Corp. (Mobile ), 350 U.S. 332

(1956);° Fed. Power Comm'n v. Sierra Pac. Power Co.

(Sierra ), 350 U.S. 348 (1956). These decisions explain

how, in the context of the energy industry as it existed in

1956, FERC was to ensure that wholesale contracts were

“just and reasonable."

In Mobile, a seller agreed to a long-term fixed rate

contract with another business, and the agency accepted it

for filing under section 205. The Court held that the seller

could not unilaterally increase a contracted rate by filing a

new rate under section 205(d), reasoning that the statute

“evinces no purpose to abrogate private rate contracts,”

Mobile, 350 U.S. at 338, and recognizing the need for

“individualized arrangements" between suppliers and

distributors, id. at 339. The Court emphasized that the public

is served by the negotiation and enforcement of private

contracts: "By preserving the integrity of contracts, [the

Natural Gas Act] permits the stability of supply

arrangements which all agree is essential to the health of the

... industry." Jd. at 344. At the same time, the Court made

clear that while “permit[ting}] the relations between the

parties to be established initially by contract," the Natural

Gas Act provided for "the protection of the public interest ...

by supervision of the individual contracts, which to that end

must be filed with the Commission and made public." /d. at

* Mobile related to the Nawural Gas Act, and so did not involve a FPA

claim. The Supreme Court, however, referred in Mobile to “the virtually

identical provisions of the Federal Power Act,” 350 U.S. at 346, and the

doctrine derived from Mobile always has been understood to be fully

applicable to FPA section 206(a) cases.

8a

339.

Sierra took up where Mobile left off, echoing the

principle that a unilateral filing of a new rate cannot

supersede a contract rate, even if the new rate is just and

reasonable. Sierra, 350 U.S. at 352-53. The Court then

extended Mobile to section 206 cases, holding that when a

public utility agrees "by contract to a rate affording less than

a fair return," then the "sole concern" of the Federal Power

Commission (FERC's predecessor) in section 206(a) review

is "whether the rate is so low as to adversely affect the public

interest." Jd. at 355 (emphases added). As the emphasized

language indicates, Sierra dealt only with whether a

challenged contract rate was too low to serve the public

interest. It did not deal with a contract rate alleged to be too

high. In these low-rate cases, the Court declared, "the

purpose of the power given the Commission by § 206(a) is

the protection of the public interest, as distinguished from

the private interests of the utilities," as "a contract may not

be said to be either ‘unjust ' or ‘unreasonable’ simply because

it is unprofitable to the public utility." /d. (emphasis added).

Sierra thus did not purport to abandon the "just and

reasonable" standard in the statute. Rather, it gave substance

to that standard in circumstances in which the contention is

that the seller of energy finds a long-term contract it entered

into no longer profitable. Relying on section 201 of the FPA

and reciting that "the scheme of regulation imposed by [the

FPA] is necessary in the public interest," the Court held that

when a seller seeks to raise rates after a contract has gone

into effect, only “public interest" factors are pertinent to the

"just and reasonable” inquiry, including whether the rate

“might impair the financial ability of the public utility to

continue its service, cast upon other consumers an excessive

burden, or be unduly discriminatory." /d. (internal quotation

marks omitted).

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Mobile-Sierra, then, stands for the proposition that in

certain circumstances, a presumption applies that private

parties to a wholesale electric power contract have negotiated

a "just and reasonable” contract over a designated period of

time, lawful under the FPA throughout that period.’ That

presumption can be rebutted by establishing that the contract

adversely affects the public interest--that is, the interests of

the consuming public that the FPA protects.*

As we explain in Part II of this opinion, Mobile and

Sierra arose in a regulatory context in which there was an

opportunity for traditional cost-based just and reasonable

review before the energy contracts at issue became effective.

The regulatory regime evolved, however, and FERC shifted

its inquiry from the permissible cost-basis of rates to the

determination of a seller's market power. We therefore

confront here, for the first time, the intersection of two

doctrines--one, the Mobile-Sierra doctrine, the product of the

courts; the other, market-based rate authorization, the

product of recent agency policy--as they affect the

application of the just and reasonable standard. No case that

’ The parties and some of the cases speak as if two alternative standards

for reviewing wholesale electricity rates exist--the statutory “just and

reasonable" standard and the Mobile-Sierra public interest standard. We

do not find this way of viewing the statutory terrain useful. The FPA

establishes a single, albeit general, standard for FERC's adjudication of

contract challenges like the present one: whether the challenged contract

is “just and reasonable." 16 U.S.C. § 824e(a). The question therefore

cannot be not whether the Mobdile-Sierra or the "just and reasonable"

standard of review applies. Instead, we understand Mobile-Sierra to

establish presumptions regarding whether certain electricity contracts

meet the statutory standard, and hold that lack of profitability alone is not

a basis for deeming a contract unreasonable when the seller has agreed to

the rate that proves unprofitable.

* As already noted, the specific factors mentioned in Sierra as rebutting

this presumption apply to cases challenging a contract rate for being too

low. Mobile and Sierra had no occasion to determine what factors must

be shown in other situations.

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we have found concerns the intersection of these two

doctrines.

While the object of the Mobile-Sierra doctrine was

an individual contract, the markei-based rate authorization

inquiry applies to an individual selier, with regard to any

covered contract for electrical energy it enters into. The

former inquiry occurred contemporaneoucly with a contract's

formation, while the latter inquiry transpires before each

contract is formed. This dual shift distinguishes the

regulatory context here from that present in Mobile and

Sierra in two material respects: (1) the timing of the

agency's initial review has moved to a point before contract

formation, and (2) the substance of that review no longer

‘ocuses on the terms of the contract. In other words, since

Mobile and Sierra were decided, both the questions that

FERC asks in its initial regulatory review of rates and when

it asks them have changed. -

Although this regulatory evolution does not render

Mobile-Sierra a dead letter, it reinforces the need to

delineate carefully the prerequisites for its application in the

present environment. Our principal question is therefore

whether the circumstances that trigger the Mobile-Sierra

presumption are present in this case. As we explain in Part

IV of this opinion, we conclude from the context of Mobile-

Sierra and from later cases that three prerequisites are

necessary to establish the Mobile-Sierra presumption: (1) the

contract by its own terms must not preclude the limited

Mobile-Sierra review; (2) the regulatory scheme in which

the contracts are formed must provide FERC with an

opportunity for effective, timely review of the contracted

rates; and (3) where, as here, FERC is relying on a market-

based rate-setting system to produce just and reasonable

rates, this review must permit consideration of all factors

relevant to the propriety of the contract's formation.

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Taken together, the satisfaction of these three

conditions justifies a presumption that parties have

negotiated a contract that is just and reasonable between

them and therefore triggers the Mobile-Sierra public interest

mode of review, adjusted to account for the circumstance in

which it is the buyer rather than the seller that is challenging

the existing contract. When the prerequisites have not been

met, however, the Mobile-Sierra presumption cannot apply,

and FERC must find another method of evaluating whether

the challenged rates are just and reasonable.

To explain the orgins of these Mobile-Sierra

prerequisites and illuminate the current role of the doctrine,

we begin by considering the historical and regulatory context

in which Mobile-Sierra developed and the changes in that

context since those cases were decided. We then turn to the

facts and proceedings underlying the current dispute and,

finally, to the derivation and application of the Mobile-Sierra

prerequisites and standards.

II. Evolution of Power Utility Regulation

A. Early Regulation of Utility Monopolies

Congress passed the Federal Power Act in 1920,

establishing the statutory framework described above. Ch.

285, 41 Stat. 1063 (1920). This framework emerged from a

wider body of state and federal regulation that revolved

around the by-then "familiar mandate” that rates in various

industries be “just and reasonable." Verizon Commc'ns Inc. v.

FCC, 535 U.S. 467, 477 (2002).? Before Congress had

. Verizon concerned the Telecommunications Act of 1996, which is not

relevant to the present case. Verizon did, however, include a broader

historical discussion of utility regulation, see 535 US. at 477-89, that

directly relates to energy regulation.

12a

passed many laws regulating national industries, state

legislatures created specialized agencies "to set and regulate

rates." Jd. In the electric power industry, this effort began in

the first decade of the twentieth century. By 1914, forty-five

states had enacted electricity regulation laws. Richard F.

Hirsh, Power Loss: The Origins of Deregulation and

Restructuring in the American Electric Utility System 19-26

(1999).

The national government's first substantial foray into

rate regulation occurred in 1887, with the passage of the

Interstate Commerce Act. Ch. 104, 24 Stat. 379 (1887). This

statute, primarily concerned with interstate railroad rates,

formed “the model for subsequent federal public-utility

statutes like the Federal Power Act." Verizon, 535 U.S. at

478. Under the Interstate Commerce Act, railroad carriers

would first propose rate schedules, termed "tariffs." Then,

interested parties could comment to the agency, which would

accept the tariff so long as it was "just and reasonable." Jd.

at 478.

The states and Congress applied this structure to the

electric power industry on the basis of two widely-siared

assumptions:

First, policymakers assumed that public utilities were

“natural monopolies” because, among other reasons, it would

be inefficient for competing utilities to string parallel] power

lines. Timothy P. Duane, Regulation's Rationale: Learning

from the California Energy Crisis, 19 Yale J. On Reg. 471,

: 476-77 (2002). Also, utilities could benefit from economies

of scale, making a monopoly more efficient than a

competitive market. See Hirsh, supra, at 17-18.

Second, these monopolies, like 2:1y monopoly, would

be tempted to abuse their market power. Moreover, because

electricity cannot be stored, it needed to be produced at the

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same time consumers demanded it. Shortages anywhere on

an interconnected electricity grid could threaten the entire

system. The factors unique to the electric power industry

made it particularly susceptible to abuse of market power: A

local utility could withhold power, demand higher rates, and

credibly threaten to disrupt a regional or national market.

Regulation would keep local utilities in check. Duane,

supra, at 477-78.

Early state and federal agencies created two

categories of regulated rates: "retail rates charged directly

to the public and wholesale rates charged among businesses

involved in providing” the regulated good or service.

Verizon, 535 U.S. at 478. Under the FPA, the federal

government regulates only interstate wholesale electric

power sales and interstate electric power transmission,

leaving to the states the regulation of rates charged to

consumers. See 16 U.S.C. § 824(a), (b)(1). State and local

governments, therefore, generally focused on rates "as

between businesses and the public," while the federal

government regulated rates "as between businesses.”

Verizon, 535 U.S. at 479.

As a result of these differences in their regulatory

focus, important differences in methodology developed

between federal and state energy rate regulation. Knowing

that state regulators focused on rates charged directly to the

public and following Congress's "acknowledg[ment] that

contracts between commercial buyers and sellers could be

used in rate-setting,” id. (citing section 205(d) and Mobile,

350 U.S. at 338-39, the Federal Power Commission (FPC)

: and, later, FERC--both bound by Mobile-Sierra--became less

inclined to step in and alter filed rates charged among

businesses in the energy industry. Even if those agencies

wanted to change contract rates, courts, applying Mobile-

Sierra, woul4 generally assume that those rates were just and

reasonable and would probably not harm the public interest. |

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The underlying assumption was that "[iJn wholesale markets,

the party charging the rate and the party charged were often

sophisticated businesses enjoying presumptively equal

bargaining power, who could be expected to negotiate a ‘just

and reasonable’ rate as between the two of them." /d. The

equal market power of those businesses and the role of state

regulation of rates charged to consumers allowed the federal

government to set a relatively high bar for proving that a

wholesale contract was unjust or unreasonable based on

impact on the public. Federal agencies, including the FPC

and its successor agency FERC, thus saw their "principal

regulatory responsibility" as preventing discrimination "by

favorable contract rates between allied businesses" as

compared to other businesses. Jd. At the same time, Sierra's

admonition that federal regulators should reform contracts if

that was "necessary in the public interest," Sierra, 350 U.S.

at 355 (internal quotation mark omitted), confirmed a

continuing federal responsibility to review the impact of

wholesale contracts on the public, even though the federal

government did not directly regulate rates charged to

consumers.

In contrast to federal regulators, state regulators

"focused more on the demand for ‘just and reasonable’ rates

to the public than on the perils of rate discrimination."

Verizon, 535 U.S. at 480. In California, for instance, the

Public Utilities Commission ensured that rates charged by

the state's three primary utilities--Pacific Gas & Electric,

Southern California Edison, and San Diego Gas & Electric--

were just and reasonable to the consuming public. See Cal.

Const. art. XII, § 6; Duane, supra, at 480.

Within this two-tiered regulatory structure, case law

developed an evolving definition of the "just and reasonable”

standard. See Verizon, 535 U.S. at 481-89. After decades-

long debates not relevant here, courts and regulators settled

on a system that attempted to match rates to the cost to the

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utility of providing the service, including "the cost of

prudently invested capital used to provide the service." Jd. at

485. This “prudent-investor rule" was designed to provide

incentives for utilities to invest in necessary capacity-

building by allowing them to charge rates that would provide

a fair rate of return on those investments while at the same

time "protect[ing] ratepayers from supporting excessive

capacity, or abandoned, destroyed, or phantom assets.” Jd. at

486. These competing elements of cost of service regulation

were intended to "mimic natural incentives in competitive

markets." Jd.; see also Farmers Union Cent. Exch., Inc. v.

FERC, 734 F.2d 1486, 1510 (D.C. Cir. 1984). As a result,

cost of service regulation would, in theory, lead to the same

rates that would exist in a properly functioning unregulated

market.

B. Federal and State Regulatory Reform

Our description thus far covers the regulatory

landscape through the mid-1990s. Beginning then, the

electric power industry saw "complementary initiatives by

the FERC and state agencies” to shift from a cost-based rate

regulation regime to a market-based regime. Carmen L.

Gentile, The Mobile-Sierra Rule: Its Illustrious Past and

Uncertain Future, 21 Energy L.J. 353, 373 (2000).

This move toward energy regulation reform was

premised on a new set of widely-shared assumptions:

First, cost-based regulation did not effectively check

public utilities’ market power. See Verizon, 535 U.S. at 486,

("[T}he prudent-investment rule in practice often [was] no

match for the capacity of utilities having all the relevant

information to manipulate the rate base...."); Promoting

Wholesale Competition Through Open Access Non-

Discriminatory Transmission Services by Public Utilities;

Recovery of Stranded Costs by Public Utilities and

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Transmitting Utilities, FERC Order 888-A, 62 Fed. Reg.

12,274, 12,275 (Mar. 14, 1997) ("[A]bsent open access,

undue discrimination will continue ...."); Hirsh, supra, at 33-

54 (describing how ‘"[uJtility [mJanagers [g]ain[ed]

{djominance" within the earlier regulatory scheme). Also,

local utilities would often deny competitors access to their

transmission networks, protecting their monopoly status

within a geographic area. See Atl. City Elec. Co. v. FERC,

295 F.3d 1, 4 (D.C. Cir. 2002).

Second, with technological changes, public power

utilities no longer needed to be monopolies. Technological

innovations now permitted transmission of power over

longer distances, allowing consumers to obtain power from

beyond the geographic range of their local utility. See

Transmission Access Policy Study Group v. FERC, 225 F.3d

667, 681 (D.C. Cir. 2000) (per curiam) (upholding FERC's

1996 reform orders), aff'd sub nom. New York v. FERC, 535

U.S. 1 (2002).

Third, the newly feasible market competition could

drive down wholesale prices and measure the cost of service,

including the cost of long-term investments, more accurately

than did the previous regulatory regime. Competition, this

thesis posits, "at least over the long pull,” will lead to prices

that “approximate [marginal] cost," including a return on

capital sufficient to ensure that companies have financial

incentives to provide power. Interstate Natural Gas Ass'n of

Am. v. FERC (INGAA ), 285 F.3d 18, 31 (D.C. Cir. 2002).

Based on these assumptions, FERC decided in 1996

to fundamentally reform its regulation of the nation's

interstate wholesale electricity markets. FERC's orders

implementing this electrical power reform, Orders 888 and

889, required each utility that operates transmission lines to

allow any other utility in the interstate energy market to use

its transmission lines on the same terms applicable to the

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operating utility itself.'° Transmission Access, 225 F.3d at

681-82; Promoting Wholesale Competition Through Open

Access Non-Discriminatory Transmission Services by Public

Utilities; Recovery of Stranded Costs by Public Utilities and

Transmitting Utilities, FERC Order No. 888, 61 Fed. Reg.

21,540, 21,541 (May 10, 1996).

Taking advantage of the newly available “open

access,” utilities would, in theory, have both the market

incentives and the legal right to compete with each other.

This competition would provide retail consumers with the

opportunity to purchase power from a wide variety of

producers at relatively lower rates. Transmission Access,

225 F.3d at 683. A factory in Albany, California, for

example, could, in theory, purchase power from a power

plant in Albany, New York, no longer limited in its options

to whatever the local utility would sell. Local energy

utilities, could, rather than producing their own power to sell

to the public, choose between various competing producers

and then transfer the expected savings from this competition

to the public. FERC estimated that, as a result of such

competition, consumers would benefit from annual savings

of $3.8 billion to $5.4 billion. Order 888-A, 62 Fed. Reg. at

12,276.

A crucial element of FERC's 1996 "open access"

reforms was the connection between "open access” and an

“open access" utility's authority to charge whatever rates the

market would bear. "“{Aljpproximately a decade ago,

'© According to FERC, open access is the first of “two central

components.” Order 888-A, 62 Fed. Reg. at 12,276. The second central

component of the 1996 Orders is their mechanism for allowing utilities to

recover “stranded costs," that is, costs which they incurred under the

previous regulatory regime based upon an expectation of repayment that

may not occur in newly competitive markets. /d.

18a

companies began to file market-based tariffs that did not

specify the precise rate to be charged," and instead indicated

that they would charge market-based rates. Lockyer, 383

F.3d at 1012. FERC would approve those tariffs if the public

utility proved that it lacked, or had adequately mitigated, any

ability to significantly affect market prices. La. Energy &

Power Auth. v. FERC, 141 F.3d 364, 365 & n. 1 (D.C. Cir.

1998); see also Sw. Pub. Serv. Co., 72 F.E.R.C. ¥ 61,208, at

{ 61,966 (1995) (summarizing criteria for approving market-

based rate tariffs). Such grants of market-based rate

authorization were open-ended. See, e.g., So. Co. Servs.,

Inc., 87 F.E.R.C. J 61,214, at J 61,847 n. 3.

FERC's 1990s reforms specified open access as one

criteria necessary to demonstrate the lack, or adequate

mitigation, of market power. When a public utility

implemented an "open access" policy, it demonstrated that it

lacked market power regarding "sales from its existing

[power generation] capacity" and was thus entitled to

market-based rate authority--that is, the ability to charge

whatever rates the market would bear--when it sold power

over open access transmission grids. See Order No. 888, 61

Fed. Reg. at 21,553; see Lockyer, 383 F.3d at 1013

(describing FERC's test for granting market-based rate

authority as "consist[ing] of a finding that the applicant lacks

market power (or has taken sufficient steps to mitigate

market power)"); cf Edward Kahn, Electric Utility

Planning and Regulation 319 (1991) (describing the lack of

open access as allowing "market power(to] interfere with

market efficiency”).

FERC thus based its 1996 reform--and, as this case

makes clear, much of its subsequent regulation--on the belief

that “open access” would create market forces helping to

ensure that no utility could exercise market power when

selling wholesale power. See Order No. 888, 61 Fed. Reg. at

21,554 ("{I}jncreased competition resulting from open access

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transmission may reduce or even eliminate generation-

related market power in the short-run market ...."); id. at

21,555 ("[T]he Commission expects this Rule to facilitate the

development of competitive bulk power markets...."). FERC

tempered this expectation by promising to “continue our

case-by-case approach" to granting market-based rate

authority. Jd. FERC's “case-by-case approach" includes

ensuring that sellers seeking market-based rate authority

lack, or have sufficiently mitigated, market power and that

FERC has a sufficient "means of monitoring the market in

which [the seller's] sales will take place.” Entergy Servs.,

Inc., 58 F.E.R.C. J 61,234, 7 61,753-54 (1992); see also

Lockyer, 383 F.3d at 1016 (requiring a market-based regime

to include “implied enforcement mechanisms sufficient to

provide substitute remedies for the obtaining of refunds");

Transwestern Pipeline Co., 43 F.E.R.C. J 61,240, at J 61,650

(1988) (requiring a iinding that “competition in the relevant

markets will operate as a meaningful constraint on the

exercise of market power"). Following the Entergy

approach, FERC also promised to “modify our market rate

criteria if and when appropriate,” but specified that any such

modification would “not upset transactions entered into

pursuant to existing market-based rate authority." Order

888, 61 Fed. Reg; at 21,555.

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Like FERC, California challenged the monopoly

; power of electric power utilities. California's efforts to foster

competition between utility monopolies had begun after the

energy crises of the 1970s. See Duane, supra, at 482-87.

Federal law then allowed a “qualifying small power

production facility" to compete in wholesale power markets.

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

| No. 95-617, §§ 201, 210, 92 Stat. 3117, 3134-35, 3144-47 |

’ (codified at 16 U.S.C. §§ 796(17)(C), 824a-3). California i

pursued these new options particularly aggressively so that, |

by 1991, California received a third of its energy from

producers other than the monopolies held by local utilities.

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Hirsh, supra, at 93. Those producers demonstrated that a

utility could efficiently produce power without taking

advantage of economies of scale that supposedly made

electricity monopolies "natural." Through these reforms and

market changes, the monopoly status of local utilities and the

methodology of state regulation of monopoly utilities was

eroding.

California A.B. 1890, passed in 1996, sought to

accelerate this breakup of local utility monopolies by

requiring them to divest a substantial amount of their

electricity generation facilities. Act of Sept. 23, 1996, ch.

854, 1996 Cal. Legis. Serv. 854 (West). Local utilities also

were required to sell power generated by remaining facilities

to the California Power Exchange Corporation (CalPX),

which was to serve as an auction market for wholesale

electricity sales. Lockyer, 383 F.3d at 1008-09."

C. Shifting Authority to FERC

When combined with federal preemption law, one

crucial result of these energy market regulatory reforms has

been “a massive shift in regulatory jurisdiction from the

states to the FERC.” Gentile, supra, at 373. As noted, a

"bright line” exists between state and federal jurisdiction,

with wholesale power sales--the type of sales at issue in the

challenged contracts in this case--falling on the federal side

of the line. Nantahala Power & Light Co. v. Thornburg, 476

U.S. 953, 966 (1986) (quoting Fed. Power Comm'n v. S. Cal.

Edison Co., 376 U.S. 205, 215 (1964)). FERC's jurisdiction

to determine the reasonableness of wholesale rates is

exclusive. Miss. Power & Light Co. v. Mississippi ex rel.

Moore, 487 U.S. 354, 371 (1988). Prior to 1996, vertically-

” The details of A.B. 1890 are discussed below.

2la

integrated state monopolies would charge public consumers

rates regulated by state entities and would purchase power

from interstate utilities at rates regulated by FERC. The 1996

FERC reforms opened up local monopolies to competition

among suppliers in the wholesale power market, resulting in

a sharp increase in wholesale power sales--subject to FERC's

exclusive jurisdiction--as utilities shopped among suppliers.

See Gentile, supra, at 373; Pub. Util. Dist. No. 1 v. Idacorp

Inc. (Grays Harbor ), 379 F.3d 641 (9th Cir. 2004).

Additionally, state regulatory reform laws, like California's

A.B. 1890, resulted in a less active role for state regulators

and a more active one for FERC, as the breakup of vertically

integrated utilities created the need for many more wholesale

transactions. In California, for example, regulators “ceded

most of their authority for regulating generator or trader

behavior to FERC through A.B. 1890." Duane, supra, at

507.

The upshot of these federal and state innovations in

electricity regulation is that state regulators, despite their

continued authority over rates charged directly to consumers,

have much less actual authority over those rates than they

did when Mobile and Sierra were decided. Local utilities

now obtain power largely through wholesale contracts

subject to FERC's exclusive regulation, rather than through

self-generated and self-transmitted power. As a result, state

regulators ordinarily must set retail rates with the wholesale

rates as an established cost factor. FERC recognized this

dynamic when issuing its reform orders, noting that

customers will obtain more power delivered via "unbundled"

wholesale transactions--in which the generation and

transmission are separately traded rather than provided by an

integrated local utility monopoly--making "[t]he exercise of

our jurisdiction over rates, terms and conditions of

unbundled retail transmission ... more important." Order

888-A, 62 Fed. Reg. at 12,279.

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Accordingly, while the state and federal regulatory

reforms of the 1990s did not end regulation of the electric

energy industry, they did begin a new regulatory era.

Although state regulators formerly took an extremely active

role so as to ensure the just and reasonable retail power rates,

FERC has exclusive jurisdiction over the wholesale rates that

now drive the electric power market and, as a practical

matter, largely determine the rates ultimately charged to the

public. These changes profoundly affect this case and

require us to ensure that FERC's application of the Mobile-

Sierra doctrine reflects both the historical and regulatory

purpose of the doctrine and contemporary regulatory reality.

With the history of electric rate regulation thus in

mind, we now tur to the facts of the particular contracts at

issue and then consider whether FERC applied the correct

legal standard to review of these challenged contracts.

III. Factual and Procedural Background

A. The Western Energy Crisis of 2000-2001

This is not the first case, and it will not be the last,

that requires this court to address the western energy crisis of

2000-2001, the basic facts of which are outlined elsewhere.

See Pac. Gas & Elec. Co. v. FERC, 464 F.3d 861, 863-66

(9th Cir. 2006); Pub. Utils. Comm'n of Cal. v. FERC, 462

F.3d 1027, 1035-46 (9th Cir. 2006); Bonneville Power

Admin. v. FERC, 422 F.3d 908, 911-14 (9th Cir. 2005);

Lockyer, 383 F.3d at 1008-11; California ex rel. Lockyer v.

Dynegy, Inc., 375 F.3d 831, 835-36 (9th Cir. 2004), cert.

denied, 544 U.S. 974 (2005); S. Cal. Edison Co. v. Lynch,

307 F.3d 794, 800-01 (9th Cir. 2002); Duke Energy Trading

& Mktg., L.L.C. v. Davis, 267 F.3d 1042, 1045-46 (9th Cir.

2001); Cal. Power Exch. Corp. v. FERC (CalPX ), 245 F.3d

23a

1110, 1114-19 (9th Cir. 2001); see also Duane, supra, at

511-24; Michael A. Yuffee, California's Electricity Crisis:

How Best To Respond to the "Perfect Storm," 22 Energy L.J.

65, 65-84 (2001). Accordingly, we summarize here only

those facts most relevant to this case.

As noted, in 1996, the California legislature

deregulated the power industry in California through passage

of A.B. 1890. The bill froze residential and small

commercial consumer retail rates '? and required that the

three largest California investor-owned utilities!’ divest most

of their electricity generation facilities. See CalPX, 245 F.3d

at 1114-15. Additionally, the bill created the CalPX, which

operated a single-day auction for day-ahead and day-of

trading in wholesale electricity, known as the "spot market."

Id. at 1114."

In the summer of 1999, CalPX also opened up a

"forward market" to facilitate long-term wholesale electricity

contracts. Jd. The California Public Utilities Commission,

however, allowed the investor-owned utilities to purchase

only a limited amount of electricity from the CalPX forward

markets. The great bulk of their load still had to be

purchased from the CalPX spot markets. /d. at 1115.

"2 The legislature froze rates at a level utilities expected to be far above

rates utilities were likely to have to pay, thus allowing them to recoup

“stranded costs" as California's energy market shifted to a new regulatory

era. See Duane, supra, at 501.

'3 The three largest investor-owned utilities were San Diego Gas and

Electric Company, Southern California Edison, and Pacific Gas and

Electric Company (PG & E). CalPX, 245 F.3d at 1114.

'4 The term “spot market” refers to deals for energy provided over

periods generally not exceeding 24 hours and entered into the day of or

day prior to delivery. It contrasts with the term "forward market,” in

which energy is delivered some time beyond 24 hours after the sale.

24a

In the summer of 2000, there was a dramatic spike in

the price of wholesale electricity in the spot markets. /d. For

example, “[t]he CalPX's constrained day-ahead price peaked

at $1,099/MWh [megawatts/hour] on June 28, 2000--an

astounding 15-fold increase over the pre-restructuring average

cost of $74/MWh.” Jd. at 1115 n. 2.

On November 1, 2000, FERC issued an order

explaining that, in its view, this dramatic increase was

primarily the result of three factors:

First, “competitive market forces played a major role

in the run-up of prices through significantly increased power

production costs combined with increased demand due to

unusually high temperatures and a scarcity of available

generation resources throughout the West and California in

particular." San Diego Gas & Elec. Co., 93 F.E.R.C. {

61,121, at J 61,354, 2000 WL 1637060 (2000).

Second, “{mjany of the market dysfunctions in

California and the exposure of California consumers to high

prices can be traced directly to an over reliance on spot

markets." Jd. 4 61,359. The rules requiring investor-owned

utilities to purchase primarily through the spot markets

precluded any significant reliance on forward markets. “And

other retail suppliers who would have been free to implement

appropriate risk management strategies could not be induced

to participate in California's market because the low retail

rate, frozen at 10 percent below historical levels, thwarted

competitive opportunities for new participants to enter the

market." /d.

Third, FERC suggested that there was the

opportunity for abuse of the markets through the exercise of

market power, but could not point to specific instances. /d.

61,376. FERC's staff later issued a report concluding that

the spot market was dysfunctional, partially due to market

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manipulation by sellers; that conclusion is assumed by all

parties here. See Staff of the Federal Energy Regulatory

Commission, Final Report on Price Manipulation in

Western Markets: Fact Finding Investigation of Potential

Manipulation of Electric and Natural Gas Prices, ("Staff

Report"] (2003), available at www.ferc.gov/legal/maj-ord-

reg/land-docs/PART-I-3-26-03.pdf.

California is part of a single integrated electricity

market in the West. Its energy problems therefore created a

"dysfunctional marketplace both in California and the

remainder of the West." See San Diego Gas & Elec. Co.

(June 19 Order), 95 F.E.R.C. J 61,418, at J 62,556, 2001

WL 1910052 (June 19, 2001). For example, in the Pacific

Northwest, prices have historically averaged approximately

$24/MWh. During this period, short term prices spiked to

unprecedented levels, peaking at $3,300/ MWh in early

December of 2000, and during the summer and fall of 2000

averaged between $200/MWh and $500/MWh. Markets were

also marked by unprecedented levels of price volatility. In

response to this volatility, between August 2000 and

December 19, 2001, FERC issued iwarly 75 orders providing

for spot market mitigation mear res, see, e.g., id, most

aimed at reducing the size of the zpot market. San Diego

Gas & Elec. Co., 97 F.E.R.C. J 61,275, at 62,171 (Dec. 19,

d2001).

The order issued on December 15, 2000, is of

particular relevance to the issues here. See San Diego Gas &

Elec. Co. (December 15 Order ), 93 F.E.R.C. 4 61,294, 2000

WL 1840337 (Dec. 15, 2000). That order strongly urged

investor-owned utilities to move to long-term contracts of

two years or more. /d. J 61,993. "To address concerns about

potentially unjust and unreasonable rates in the long-term

markets,” FERC agreed to “monitor prices in those markets"

and established a “benchmark” rate of $74/MWh to “use as a

reference point in addressing any complaints regarding the

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26a

priciag of long-term contracts negotiated over the next year."

Id. § 61,994-95. In response to the contention that such a

shift would only transform the forward market into another

strong sellers' market resembling the then-dysfunctional spot

market, FERC declared that it would "be vigilant in

monitoring the possible exercise of market power" in the

forward market. Jd. 4 61,994. FERC's monitoring, the

agency promised, would “also provide customers protection

by providing early review of as-bid prices that may not be

just and reasonable and prompt rate relief for prices that are

mitigated." Jd. J 61,997.

B. Contracts at Issue Here

This consolidated appeal involves three separate sets

of contracts, all of which were made pursuant to the Western

Systems Power Pool Agreement (Power Pool Agreement),

an umbrella agreement that established standardized terms

for wholesale energy transactions. All the utilities involved

in this case are signatories to that agreement.

1. Snohomish

In response to the extreme spike of spot market

prices (reaching as high as $3,300/MWh) during December

2000, Snohomish, a public utility for Snohomish County in

Washington, determined that it was no longer viable to rely

on the spot markets. On December 22, 2000, Snohomish

issued a request for proposals to 17 power suppliers, seeking

bids for one-to-three year contracts, providing a total of

approximately 75-100 megawatts of electricity for 2001.

Snohomish received five bids, but two were

unresponsive to Snohomish's needs. Of the three responsive

bids, no supplier would offer more than 25 MW, so

Snohomish accepted all three bids and negotiated contracts

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27a

with each supplier.'° That year, Snohomish's Board of

Commissioners had previously approved an unprecedented

thirty-five percent increase in retail rates, allowing for an

average contract price of $125/ MWh. Unfortunately, none

of the three offers would allow Snohomish to meet this price,

and Snohomish chose not to ask its ratepayers for another

double-digit rate increase in the same year.

Consequently, Snohomish asked Morgan Stanley--an

electrical energy commodities dealer--what term would be

necessary to secure a $100/MWh price for its contract;

Morgan Stanley demanded a ten-year term. The parties

ultimately agreed to a nine-year term at $105/MWh.

Additionally, Morgan Stanley required Snohomish to accept

credit terms articulated in a contractual provision termed the

"Collateral Annex."'®

Snohomish claims that it suffered losses between

January 2001 and March 2002 in excess of $25.7 million and

that those losses will escalate over the term of the contract as

market rates remain close to traditional levels. FERC

specifically found that the Morgan Stanley contracts

accounted for an eight percent increase for retail ratepayers

over 2001 rates, and other contracts accounted for a fifty-one

percent increase. Nev. Power Co. (November 10 Order ),

105 F.E.R.C. J 61,185, at 9 61,986, 2003 WL 22628184

'S One of the three contracts, signed with Enron Corporation, was

terminated in November 2001, as Enron's credit deteriorated. Snohomish

sought reform of the other contract, with American Electric Power, and

the parties settled that case. The remaining contract, here at issue, is with

Morgaa Stanley Capital Group (“Morgan Stanley”).

Among other requirements, the “Collateral Annex" required

Snohomish to post, on two days notice, specified collateral. This

requirement has required Snohomish to post as much as $101 million in

collateral.

28a

(Nov. 10, 2003). Snohomish here challenges the term of the

contract and the imposition of the Collateral Annex.

2. Southern Cal Water

Southern Cal Water owns and operates an electric

utility distribution system that serves approximately 21,600

customers in San Bemadino County, California. Southern

Cal Water purchases, subject to regulation by the California

Public Utilities Commission, an average electric load of

about 16.3 MW.

The A.B. 1890 requirements that investor-owned

utilities purchase in the spot market did not apply to

Southern Cal Water, which owned no transmission lines and

generated no electricity. To avoid relying entirely on the

spot markets, which it viewed as significantly risky,

Southern Cal Water executed a one-year contract with

Illinova in April 1999, providing for purchase of 12 MW of

uninterruptible around-the-clock energy at a price of

$28/MWh. One year later, Southern Cal Water renewed the

contract with Dynegy (Illinova's successor), to run from May

1, 2000, to May 1, 2001, for the same load, at the increased

price of $35.50/MWh.

California enacted A.B. 1 on February 1, 2001,

allowing the California Department of Water Resources to

purchase energy for the then-collapsing large investor-owned

utilities and power suppliers. See Act of Feb. 1, 2001, 2001

Cal. Legis. Serv. Ist Ex. Sess. 4 (West). At that point,

Dynegy informed Southern Cal Water that it was not

interested in renewing its contract with Southern Cal Water,

because it could sell its entire generation output to the State

of California. With the present contract expiring at the end

of April 2001, Southern Cal Water engaged in a hurried

29a

bidding process.'”

On March 7, 2001, Southern Cal Water issued a

request for proposals for 15 MW of power to six power

companies operating in California and requested bids by

March 14, 2001. The company requested bids of one to

seven years, without specifying a preferred or maximum

price. The three bids submitted ranged from $194.50/MWh

for a one-year contract to $84/ MWh for a seven-year

contract. After receiving firm offers at higher prices,

Southern Cal Water accepted Mirant's offer of $95/MWh for

five years, as the offer that best balanced price against

contract length. In light of this increase in Southern Cal

Water's wholesale electricity costs, the California Public

Utilities Commission allowed the company to recover a

portion of the costs of the contract, resulting in a weighted

average retail rate of $77/MWh.

Southern Cal Water maintains that its ratepayers have

seen an overall thirty-eight percent increase in their electric

bills. FERC found that there was no rate increase for

Southern Cal Water's ratepayers who are permanent

residents, and that the other group of Southern Cal Water

ratepayers, those with second homes in certain areas, paid an

average monthly electric bill of only $35.13. Order on

'7 Noting that, in October 2000, Southern Cal Water rejected an offer by

Dynegy to extend ins contract on a “blend and extend" basis of between

$46.50/MWh to $54.50/MWh depending on the length of the proposed

contract, Order on Rehearing, 105 F.E.R.C. at $ 61,988 (internal

quotation marks omitted), FERC found that Southern Cal Water chose to

wait until March 2001 to solicit bids. This statement is misleading.

Southern Cal Water could only have become aware that Dynegy would

not renew its contract on any terms because of the disincentive tc doing

so created by A.B. | after that law was passed, which was in February of

2001. As noted above, it was Dynegy's pullout that induced Southern

Cal Water's frenzied bidding process.

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3. Nevada Power Companies: Nevada Power and Sierra

Pacific

The challenge brought by Nevada Power and Sierra

Pacific seeks to modify over two hundred forward market

contracts with various >_mnerey sellers for supply of 25-100

MW blocks of power.'® These contracts range in price from

$33/MWh to $290/MWh, and were entered into in 2000-

2001 with ten energy companies. FERC found that these

contracts were standard products arranged through

independent third-party brokers, and concluded that Nevada

Power and Sierra Pacific were price-takers, meaning that

those utilities took the price the market yielded rather than

bargaining or demanding a certain price. Nev. Power Co.

(June 26 Order ), 103 F.E.R.C. J 61,353, at J 62,398, 2003

WL 21485862 (June 26, 2003). According to FERC, the

Nevada companies did not pursue purchase of a diverse mix

of products and therefore failed to hedge the risk that spot

market prices might fall. /d.

FERC also found that the Nevada companies pursued

an aggressive procurement strategy, purchasing more power

than necessary to serve the expected load of their local

customers. Jd. FERC suggests that the Nevada companies

were trying to buy as much power as they could before

sellers discovered their precarious financial situation. /d.

FERC found that if these contracts are not modified,

the resulting increase to ratepayers would be no more than

five percent. /d. J 62,397. The Nevada companies recognize

'8 The Nevada companies recently settled their disputes with Morgan

Stanley, E] Paso Merchant Energy, and Enron Power Marketing. These

settlements have no bearing on the legal issues we address.

"CaN

3la

that the retail rates have decreased since they agreed to the

challenged contracts, but they maintain that Nevada

pay if the contracts were modified to reflect just and

reasonable rates. Order on Rehearing, 105 F.E.R.C. at ¥

61,986. Nevada Power and Sierra Pacific therefore seek to

modify their contracts with the energy sellers. Nev. Power

Co. (April 11 Order ), 99 F.E.R.C. 4 61,047, at 4 61,185,

2002 WL 32126219 (Apr. 11, 2002). Nevada Power is

seeking relief for contracts that had not yet gone to delivery

at the refund effective dates set by FERC (between late

January and April of 2002, depending on docket number).'?

Id. F] 61,185, 61,192.

C. Agency Proceedings

The agency actions challenged here arise from a

series of orders issued by FERC with regard to the

complaints filed by the local utilities.

1. Order Setting the Local Utilities’ Complaints for Hearing

(April 11 Order)

On April 11, 2002, pursuant to section 206 of the

FPA, FERC set a hearing concerning the contracts "entered

into during the time period from November 1, 2000 through

June 20, 2001, and that have not yet concluded," because

FERC has “no authority to order refunds for contracts or

'? Upon setting a section 206 complaint for hearing, FERC establishes a

“refund effective date," which is a date establishing the period from

which complainants may attain relief should the proceedings extend

beyond that established date. In other words, if a party makes a

complaint on January 1, 2004, but FERC does not set the complaint for

hearing until July 1, 2004, FERC may establish a "refund effective date"

of March 1, 2004, so that the complainant will not suffer from the

agency's delay or from continued agency proceedings.

|

iy

:

:

’

32a

transactions that conclude prior to the refund effective date."

Id. ¥ 61,191 (footnote omitted). FERC also set refund

effective dates for each of the complaints. Jd. J 61,192.

FERC explained in its April 2002 order that it did not

have enough information yet to address the Mobile-Sierra

issues definitively. The agency clarified that "[flor all but

one of the contracts identified by the complainants, Section

6.1 of the umbrella [Power Pool] agreement appears to be the

only specific contractual provision which may affect parties’

rights to make changes to contracts." /d. § 61,190. The

remaining contract, between PUD and Morgan Stanley, has a

separate provision addressing both FPA sections 205 and

206. Id. J 61,190 & n.11. FERC also noted a key dispute

between the parties: whether the “spot markets had an

adverse effect on the long-term, bilateral markets in

California, Nevada and Washington." /d. J 61,191. The

hearing, designed to illuminate these questions, was to

address "whether the dysfunctional California spot markets

adversely affected the long-term bilateral markets, and, if so,

whether modification of any individual contract at issue is

warranted." Jd. (footnote omitted). FERC specifically

excluded "issues concerning the Commission's policies on

granting market-based rate authority or on regulation of

sellers with such authority.” /d.

2. Initial Decision of the Administrative Law Judge

(Initial Decision)

On December 19, 2002, after an extensive hearing,

Administrative Law Judge Carmen Cintron issued a lengthy

initial decision on the complaints. Nev. Power Co., 101

F.E.R.C. ¥ 63,031, 2002 WL 31889939 (Dec. 19, 2002). She

ultimately concluded that (1) the Mobile-Sierra “public

interest" standard is the applicable standard of review, id. ]

65,277, and (2) the complainants failed to demonstrate that

the spot market sufficiently adversely affected the forward

33a

market to merit revision of the contracts under the Mobile-

Sierra doctrine, id. J 65,295.

3. Order on Initial Decision

On June 26, 2003, FERC issued a lengthy opinion in

which it affirmed the Initial Decision. Order on Initial

Decision, 103 F.E.R.C. at J 62,400. FERC's primary findings

included: (1) Section 6.1 of the Power Pool

express reservation of joint modification under section 205

of the FPA impliedly waived the right to seek unilateral

modification, id. J 62,388; (2) this waiver meant that review

was limited to the Mobile-Sierra "public interest" standard,

id. {7 62,388-89; (3) applying the three factors articulated

in Sierra and considering “the totality of the circumstances,"

complainants failed to meet the "public interest" standard

because "(t]he fact that a contract becomes uneconomic over

time does not render it contrary to the public interest," id.

62,384; and (4) the totality of the circumstances evidence

analyzed by the ALJ further demonstrated that “the

challenged transactions were the result of {the local utilities’]

voluntary choices," and there was "no evidence of

unfairness, bad faith, or duress in the original negotiations,”

id. J] 62,399-62,400. Because modification was therefore

not warranted, FERC denied the complaints. Jd. J 62,400.

Although FERC acknowledged that it had set the

ALJ hearing in large part to decide “whether the

dysfunctional California ISO and PX spot markets adversely

affected Western long-term bilateral markets," /d. J 62,385,

FERC concluded that evidence showing the spot market's

effect on the forward market--including that reviewed in the

Staff Report”? "would be relevant to contract modification

FERC at first stated that it “t{ook] into consideration the findings of the

Staff Report,” Order on Initial Decision, 103 F.E.R.C. at 4 62,396, but

: = <x

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only where there is a ‘just and reasonable’ standard of

review." Id. 462,397. FERC further explained, applying the

contract modification it is not enough to show that forward

prices became unjust and unreasonable due to the impact of

spot market dysfunctions; it must be shown that the rates,

terms, and conditions are contrary to the public interest," a

showing the local utilities failed to make. /d.

Commissioner Massey issued a vigorous dissent,

disagreeing with all of the Commission's major findings and

analysis. He explained that "{oJur primary calling under the

Federal Power Act is to ensure that prices are just and

reasonable 24 hours a day, seven days a week." /d. 4 62,403

(Massey, Comm'r, dissenting). Furthermore, even under a

"public interest" standard, which he maintained was not

applicable to these contracts, Commissioner Massey

determined there was

“simply no persuasive public interest rationake for

_. It would simply defy logic to conclude thet the

high prices im these contracts were not adversely

influenced by market conditions that included the

exercise of market power and widespread market

Id. 4 62,408.

4. Order on Requests for Rehearing and Clarification

Complainants applied for rehearing. On November

10, 2003, FERC reaffirmed its previous holdings. Order on

later stated its conclusion that those findings weie not “relevant” under

Mobile-Sierra, the standard FERC determined appropriate. /d. | 62,397.

Rehearing, 105 F.E.R.C. at J 61,980. FERC, however,

revised its previous factual findings to recognize that the

customers of Snohomish and Southern Cal Water did

experience a retail rate increase. FERC concluded, however,

that these increases either were not significant or were not

of the increases. Jd. 4] 61,986-87. FERC also rejected

petitioners’ claims that two of the Commissioners violated

procedural requirements and the Sunshine Act by engaging

in ex parte communications. Jd. FJ 61,991-94. The local

utilities then filed this petition for review of FERC's

decision.

‘

We review FERC's orders to ensure that they are not

"arbitrary, capricious, an abuse of discretion, or otherwise

not in accordance with law.” 5 U.S.C. § 706(2)(A). We

review de novo the question whether FERC complied with

and understood its statutory mandate. City of Fremont v.

FERC, 336 F.3d 910, 914 (9th Cir. 2003); Am. Rivers v.

FERC, 201 F.3d 1186, 1194 (9th Cir. 1999). We “defer to

the Commission's interpretations of the statutory provisions

it administers, but we remain ‘the final authority on issues of

statutory construction and must reject administrative

constructions which are contrary to clear congressional

intent." Am. Rivers, 201 F.3d at 1194 (quoting Natural Res.

Def. Council v. U.S. Dep't of the Interior, 113 F.3d 1121,

1124 (9th Cir. 1999)). FERC's factual findings are

conclusive so long as they are “supported by substantial

evidence.” 16 U.S.C. § 8251 (b).

IV. Prerequisites To Applyimg Moljile-Sierra

As explained above, there is but one statutory

standard addressing the lawfulness of wholesale electricity

: rates. That standard requires that ai/ rates be “just and

: reasonable." While there is language im some cases

36a

suggesting otherwise,” ' we are convinced that Mobile-Sierra

one means of review under the just and

reasonable standard, applicable in certain limited

circumstances. The statute will admit of no other

conclusion, and the Supreme Court case law supports it.

Sierra framed its analysis as a determination as to

whether the Federal Power Commission met its "condition

precedent" to a section 206 remedy, a "finding that the

or preferential.' " 350 U.S. at 353. It then faulted the

Commission's finding that the established rate was invalid

not because it applied the usual section 206(a)

“unreasonable” standard, but because “the Commission holds

that the contract rate is unreasonable solely because it yields

less than a fair return on the net invested capital." /d. at 354-

55. As the Sierra Court explained,

[While it may be that the Commission may not

normally impose upon a public utility a rate which

would produce less than a fair return, it does not

follow that the public utility may not itself agree

by contract to a rate affording less than a fair

return or that, if it does so, it is entitled to be

relieved of its improvident bargain... [T)he

purpose of the power given the Commission by §

206(a) is the protection of the public interest, as

distinguished from the private interests of the

utilities... When § 206(a) is read in the light of

this purpose, it is clear that a contract may not be

said to be either ‘unjust or ‘unreasonable’ simply

*" Boston Edison Co., 233 F.3d at 65, for example, refers to Mobile-

Sierra as establishing a “public interest standard,” separate from the

statutory just and reasonable requirement, and referring to that standard

as having been "created out of whole cloth.”

a

37a

because it is unprofitable to the public utility.

Id, at 355. Sierra, then, simply held that considerations as to

what is “unjust” or “unreasonable” differ in the context of an

established bilateral contract, not that the statutory standards

no longer govern. The Supreme Court confirmed this

understanding in Verizon, explaining that "[iJn wholesale

markets, the party charging the rate and the party charged

were often sophisticated businesses enjoying presumptively

equal bargaining power, who could be expected to negotiate

a ‘just and reasonable’ rate as between the two of them." 535

U.S. at 479.

Beginning with that understanding of Modile-Sierra,

we turn to the limited circumstances in which its

presumption applies. Although no case has outlined these

conditions succinctly, we derive three prerequisites from the

context of Mobile-Sierra and from later cases employing the

doctrine.

A. Contractual Waiver

As an initial matter, the contested contract by its own

terms must not preclude the limited Mobile-Sierre mode of

review. See Texaco Inc. v. FERC (Texaco II), 148 F.3d

1091, 1096 (D.C. Cir. 1998); Ne. Utils. Serv. Co. v. FERC

(Ne. Utils. I), 993 F.2d 937, 960 (ist Cir. 1993). Mobile-

Sierra presumes that private parties have negotiated an

agreement that they view as just and reasonable over the

time period covered. If, by the very terms of their

agreement, the parties indicate otherwise, FERC cannot

assume the mutual satisfaction of the parties.

For example, parties can include in a contract an

express reservation of a right to make changes unilaterally,

known as a “Memphis clause." See United Gas Pipe Line

Co. v. Memphis Light, Gas & Water Div., 358 U.S. 103, 105,

38a

112 (1958). Such a clause will preclude application of the

Mobile-Sierra presumption. The rationale for enforcing such

clauses is that if the contract does not settle rates as between

the parties for the term of the agreement or call for limited,

Mobile-Sierra review, then application of Mobile-Sierra

does not stabilize or protect the sanctity of contract. See id.

at 112 (noting that the “decisive difference" between

Memphis and Mobile was that "in Mobile one party to a

contract was asserting that the Natural Gas Act somehow

gave it the right unilaterally to abrogate its contractual

undertaking, whereas here petitioner seeks simply to assert,

in accordance with the procedures specified by the Act,

rights expressly reserved to it by contract") (emphasis

added). In other words, Mobile-Sierra serves to protect

contracts from unilateral change, but that purpose is not

served when the parties expressly have permitted such

change.

B. Regulatory Context

Even if it is established that the parties contracted

with the intent that Mobile-Sierra apply, a further barrier

remains: The regulatory context in which the contracts were

initially formed must provide a sound basis to believe that

the resulting rates are just and reasonable. Absent such

assurances, FERC's reliance on the presumption would

amount to a complete abdication of its statutory

responsibility under the FPA. As the following sub-sections

explain, two related conditions operate to ensure that a

foundation for the presumption exists: (1) timely and

precedurally effective review of rates--which in the

contemporary regulatory regime can be limited to review of

a utility's market-based rate authority in the first instance,

and (2) meaningful substantive standards for review of the

circumstances of contract formation.

1. Timely and Effective Review of Rates

39a

To justify the Mobile-Sierra mode of review, the

regulatory scheme in which the contracts are formed must

provide FERC with an opportunity for initial review of the

contracted rate. In Mobile and Sierra, for example, the rates

had been submitted to the agency previously under section

205 and allowed to remain in effect. See Mobile, 350 U.S. at

336; Sierra, 350 U.S. at 352. Such an initial review is an

important precondition to Mobile-Sierra because, as FERC

has explained, applying the doctrine in "first review cases

would mean that '[the agency's] ability to protect the public

interest would be negligible and public regulation would

consist of little more than rubber-stamping private

contracts."" Potomac Elec. Power Co. v. FERC (PEPCO),

210 F.3d 403, 409 (D.C. Cir. 2000) (quoting Ne. Utils. Serv.

Co., 66 F.E.R.C. J 61,332, at J 62,087, 1994 WL 92839

(1994), aff'd, 55 F.3d 686 (1st Cir. 1995)); see also PEPCO,

210 F.3d at 406 (noting that challenged contracts had "been

found to be just and reasonable when originally approved"

by FERC).

Consistent with its previous rulings, FERC concedes

here that an opportunity for initial review of whether a rate is

just and reasonable is necessary for Mobile-Sierra to apply.

The Intervenor-Respondents, however, cite to a thirty-year

old D.C. Circuit decision, see Borough of Lansdale v. Fed.

Power Comm'n, 494 F.2d 1104, 1112-14 (D.C. Cir. 1974),

and argue that an opportunity for initial review is not

necessary to trigger the Mobile-Sierra presumption. We

disagree.

The analysis in Lansdale is not applicable to this

case. In Lansdale, a seller, joined by the Commission,

sought to ignore a rate in a contract to which it had

previously agreed but which it had not properly filed with

the Commission, and instead file a higher rate, "as if the

contract had never been negotiated.” /d. at 1112; see also

40a

id. at 1107-08. The D.C. Circuit refused to allow this

unilateral revision of an agreement, holding that the

Commission could not permit the higher rate of the second

contract to go into effect unless and until it found that the

original rates were unlawful. See id. at 1117.

Lansdale did not allow the seller to “convert its

statutory duty to file into a vehicle for breaching the 1971

contract with Lansdale." Jd. at 1112. In other words,

Lansdale focused on whether Mobile-Sierra review allows

the adoption of a second contract with a higher rate when the

first was never correctly filed with the Commission. As

such, Lansdale primarily reflected concern over a seller's

abuse of the rate-filing requirement. Lansdale did not

decide, because the question was not before it, that the

Mobile-Sierra presumption always applies to the filing of an

initial rate, regardless of the circumstances.

In this case, the answers to the questions presented

turn in part upon whether Mobile-Sierra applies to the rate

first set in a contract entered into under a seller's market-

based rate authority, rather than only to a later challenge

maintaining that earlier-established rates are no longer just

and reasonable. The local utilities do not maintain that the

original contract is void because it was never filed, but rather

that the rates set were unjust and unreasonable when

established and should be modified. Lansdale’s position that

a seller may not profit by failing properly to file a rate-

setting contract it freely entered into is hardly remarkable,

but is also not particularly pertinent to the questions at issue

here.

Indeed, just a year before Lansdale was decided, the

Supreme Court recognized the importance of an opportunity

for an initial just and reasonableness review to the overall

statutory scheme. In Federal Power Commission v. Texaco,

Inc. (Texaco I), 417 U.S. 380 (1974), the Court struck down

4la

an indirect regulatory scheme adopted by the Commission

that would have provided a "blanket certificate procedure for

small producers of natural gas." See id. at 382, 395. One of

the primary reasons for the decision was that "[t]here was no

finding that these contemplated increased rates for flowing

gas would be just and reasonable. The Commission merely

asserts in its brief here that it was familiar with the existing

contracts and must have considered the rates reserved to be

acceptable under the Act." Jd. at 396.

In short, FERC is correct to recognize that the

Mobile-Sierra doctrine apples only if a newly-entered

contract remains in effect after there is an opportunity for

plenary, "just and reasonable" agency review.

2. Meaningful Review of the Circumstances

of Contract Formation

Not only must FERC have an opportunity for some

initial review of rates, but the scope of that review must

permit consideration of the factors relevant to the propriety

of the contract's formation. See Ati. City Elec. Co., 295 F.3d

at 14 (holding that Mobile-Sierra applies "assuming that

there was no reason to question what transpired at the

contract formation stage") (citing Town of Norwood v.

FERC, 587 F.2d 1306, 1312 (D.C. Cir. 1978)). The original

premise of Mobile-Sierra was that as long as the rate was

just and reasonable when the contract was formed, there

would be a presumption-- based on both the need to protect

stability of contract and the likelihood that market

participants entering into long-term contracts can protect

their own interests--that the reasonableness continued

throughout the term of the contract. See Verizon, 535 U.S. at

479 ("In wholesale markets, the party charging the rate and

the party charged were often sophisticated businesses

enjoying presumptively equal bargaining power, who could

be expected to negotiate a ‘just and reasonable’ rate as

42a

between the two of them."). In the present regulatory

regime, these relevant factors focus on whether the original

negotiations occurred in a functional marketplace such that

we may presume the contracted rates were originally just and

reasonable.

V. Application of Mobile-Sierra

A. Contractual Waiver of Section 206 Rights

Having established the prerequisites to Mobile-Sierra

review under the current regulatory regime, we address first

whether the contracts at issue permit Mobile-Sierra review.

In this case, FERC determined that there was no express

reservation of unilateral modification. As FERC noted,

"(flor all but one of the contracts identified by the

complainants, Section 6.1 of the umbrella [Power Pool]

Agreement appears to be the only specific contractual

provision which may affect parties’ rights to make changes to

contracts entered into under the [Power Pool] agreement."

April 11 Order, 99 F.E.R.C. at J 61,190.”

The relevant portion of section 6.1 states:

‘Nothing contained herein shall be construed as

affecting in any way the nght of the Parties to

jointly make application to FERC for a change in

22 FERC found that Section 39B of the Snohomish-Morgan Stanley

Confirmation Agreement expressly restricts the parties’ nghts to amend

under both FPA sections 205 and 206. April //] Order, 99 F.E.R.C. at

61,190 & n.11. FERC noted, however, that even if Snohomish could

overcome the restriction in Section 39B, it would still be restricted by

Section 6.1 of the Power Pool agreement. Order on Initial Decision, 103

F.E.R.C. at J 62,389. Because we hold the Power Pool agreement, both

standing alone and taking Section 6.1 into account, is consistent with

Mobile-Sierra review, we have no need to consider Section 39B of the

Snohomish-Morgan Stanley Confirmation Agreement.

43a

the rates and charges, classification, service, terms,

or conditions affecting [Power Pool] transactions

under Section 205 of the Federal Power Act and

pursuant to FERC rules and_ regulations

promulgated thereunder.”

Id. ¥ 61,190 n.10. Applying the interpretive doctrine of

expressio unius est exclusio alterius,?? FERC viewed the

reservation of joint section 205 nghts as confirming the

parties’ intention otherwise to abide by the contractual terms

for the time period covered. Order on Initial Decision, 103

F.E.R.C. at J 62,388.

"FERC is entitled to some deference in construing

contracts where the sales are subject to FERC regulation."

Boston Edison, 233 F.3d at 66 (citing Memphis, 358 U.S. at

114; see also City of Seattle v. FERC, 923 F.2d 713, 716

(9th Cir. 1991) (granting FERC deference in the

interpretation of contracts). With or without that deference,

we agree with FERC that these contracts do not preclude

Mobile-Sierra review, but we do not rely on the expressio

unius precept in so concluding. Instead, like the D.C. Circuit

in Texaco II, 148 F.3d at 1096, we hold that private long-

term contracts can be generally governed by Mobile-Sierra if

such review is otherwise appropriate, unless there is a

specific indication in the contract that section 205 or 206

rights have been reserved.

Texaco II considered a boilerplate clause that said

that the contract “shall comply with all applicable laws,

statutes, ordinances, safety codes and rules and regulations

of governmental authorities having jurisdiction." /d. The

D.C. Circuit held that such a general clause does not reserve

® The Latin phrase means the “express[ion] or inclu{sion of] one thing

implies the exclusion of the other." Black’s Law Dictionary 620 (8th

ed.1999).

44a

compliance with section 206 standards. In so deciding, the

D.C. Circuit stated, in essence, a default rule, explaining:

"The law is quite clear: absent contractual language

‘susceptible to the construction that the rate may be altered

while the contract[ } subsist[s],' the Mobile-Sierra doctrine

applies." Jd. (alterations in orginal) (quoting Appalachian

Power Co. v. Fed. Power Comm'n, 529 F.2d 342, 348 (D.C.

Cir. 1976)). After Texaco II, the prevailing rule of contract

interpretation with regard to the preservation of limited

Mobile-Sierra review, according to the First Circuit, is that

general statements that the law will "otherwise be binding"

do not "negate the ordinary, default rule that Mobile-Sierra

govern{s] FERC-proposed changes." Boston Edison, 233

F.3d at 67 (citing Texaco IJ, 148 F.3d at 1096).

The trio of authorities cited by the local utilities, all

from the D.C. Circuit and all pre-Zexaco Ji, are not

inconsistent with this interpretive principle. See Union Pac.

Fuels, Inc. v. FERC, 129 F.3d 157 (D.C. Cir. 1997); Papago

Tribal Util. Auth. v. FERC, 723 F.2d 950 (D.C. Cir. 1983);

Kansas Cities v. FERC, 723 F.2d 82 (D.C. Cir. 1983). In

two of these cases, the court inferred an intent to permit full

FERC review from a provision restricting review in narrow

circumstances. See Papago, 723 F.2d at 954; Kansas Cities,

723 F.2d at 86-90. To infer from a narrow restriction on

unilateral changes an intent otherwise to allow such changes,

as Kansas Cities and Papago permitted, is quite different

from inferring from a narrow authorization of joint authority

to make changes an intent to allow unilateral changes, as the

local utilities here insist FERC was required to do.

By contrast with Papago, Kansas Cities, and this

case, the disputed contracts in Union Pacific Fuels did

include a Memphis clause. See Union Pac. Fuels, 129 F.3d

at 161. The contracts, however, also included a clause

restricting the ability of the parties to seek a change to the

"modified fixed variable rate design." /d. (internal quotation

45a

mark omitted). In these unusual circumstances, the D.C.

Circuit upheld FERC's order requiring a provider to file

proposed changes to its rate structure under section 5 of the

Natural Gas Act despite that narrow restriction and noted:

Nothing in the contracts expressly exempted the

private agreement from rate changes initiated by

FERC under NGA § 5.... While Petitioners protest

that boilerplate language acknowledging rate

changes by FERC should not render [the] Mobile-

Sierra doctrine inapplicable, ... they do not explain

why they could not have adopted language that

would simply and clearly have invoked Mobile-

Sierra.

Id. at 161-62. Texaco IJ, issued by the same court a year

later, explained that this language in Union Pacific Fuels

does not have application beyond the situation there

presented, in which the contract contains a clause that does,

generally, negate the default Mobile-Sierra rule. See Texaco

IT, 148 F.3d at 1096 (noting that in Union Pacific Fuels, the

court "inadvertently lent support to the inference" that absent

express language invoking Mobile-Sierra, FERC ordinarily is

free to review rates without regard to the Mobile-Sierra

presumption (emphasis added)).

We agree with the D.C. and First Circuits that the

Mobile-Sierra presumptions are, in essence, self-executing.

Adoption of a Memphis clause permitting a party to an

energy contract to modify its terms unilaterally demonstrates

that the parties were not seeking to establish the stability of

energy contracts the Mobile-Sierra doctrine seeks to foster.

Absent such a clause, the Mobile-Sierra balance between

preserving the stability of private contracts and protecting

the public interest in just and reasonable rates prevails.

Preserving joint modification does not negate the default

application of the Mobile-Sierra presumption when that

46a

presumption is otherwise appropriate, as the Mobile-Sierra

presumption applies to unilateral, not joint, rate changes.

Indeed, parties to energy contracts, like parties to any other

contract, are free, by agreement, to vary the terms of the

contract mid-term, with or without a prior pact allowing

them to do so. When parties to an energy contract do so vary

an agreement, sections 205 and 206 apply according to their

express terms.

We therefore uphold FERC's interpretation of section

6.1 of the Power Pool agreement as reasonable.

B. Timely and Effective Review of Rates

As the parties intended Mobile-Sierra review to

apply, we next consider whether, as FERC maintains, its

blanket grant of market-based rate authority qualifies as

sufficient prior review and approval of all contracts made

under that authorization to tngger the Mobile-Sierra

presumption in any later section 206 challenge. If not, then

the contracts here were not subject to "first review" by FERC

under the FPA and do not tngger the Mobile-Sierra doctrine.

We hold that although market-based rate authority an

qualify as sufficient prior review to justify limited Mobi/e-

Sierra review, it can only do so when accompanied by

effective oversight permitting timely reconsideration of

market-based authorization if market conditions change.

Two fairly recent decisions of this circuit considered

the role of market-based rate authority under the FPA. In

Grays Harbor, we held that a contract entered into during the

California energy crisis pursuant to the market-based rate

regime was protected under the "filed rate doctrine."** See

24 The filed rate doctrine provides that state law and some federal law

(¢.g.antitrust) may not be used to strike down a rate subject to FERC's

exclusive jurisdiction. See Grays Harbor, 379 F.3d at 650; see also

47a

379 F.3d at 651-52. We relied heavily on FERC's contention

that the regime offered continued and ongoing oversight and

thereby "assured that the market-based rates charged comply

with the FPA's requirement that rates be just and

reasonable." Jd. at 651. On that basis, Grays Harbor

concluded that, "while market-based rates may not have

historically been the type of rate envisioned by the filed rate

doctrine, ... they do not fall outside the purview of the

doctrine.” Id.

More recently, we again stressed the need for

oversight in a market-based rate regime in holding “that

market-based tanffs do not, per se violate the FPA.”

Lockyer, 383 F.3d at 1014. Lockyer held the initial grant of

market-based rate authority alone was not enough to assure

just and reasonable rates, as FERC recognized when it

“affirmed in its presentation before us that it is not

contending that approval of a market-based tariff based on

market forces alone would comply with the FPA or the filed

rate doctrine." Jd. at 1013 (emphasis added). The court

clarified further that "a market-based tariff cannot be

structured so as to virtually deregulate an industry and

remove it from statutorily required oversight." Jd. at 1014.

Lockyer's emphasis on the need for continued

oversight of contract rates is critically important to our

current inquiry. In Lockyer, California sought relief under

section 205 from rates established by wholesale energy

companies (many of whom are Intervenor-Respondents here)

while there were dysfunctions in the spot market during the

California energy crisis. The Court made the following

observation regarding FERC "oversight" at the time:

Davel Commc'ns, Inc. v. Qwest Corp., 460 F.3d 1075, 1084-86 (9th Cir.

2006) (discussing the filed rate doctrine).

48a

Despite the promise of truly competitive market-

based rates, the California energy market was

subjected to artificial manipulation on a massive

scale. With FERC abdicating its regulatory

responsibility, California consumers were

subjected to a variety of market machinations,

such as “round trip trades" and “hockey-stick

bidding,” coupled with manipulative corporate

strategies, such as those nicknamed "Fat-Boy,”

"Get Shorty," and "Death Star."

Id. at 1014-15 (emphasis added) (footnotes omitted). Under

these circumstances, the court concluded, "[t]o cabin FERC's

section 205 refund authority ... would be manifestly contrary

to the fundamental purpose and structure of the FPA.... The

FPA cannot be construed to immunize those who overcharge

and manipulate markets in violation of the FPA." /d. at 1017.

The requirement of continued oversight in a market-

based rate regime applies equally to the section 206 context,

and to the application of the Mobile-Sierra doctrine in

section 206 review. Lockyer flatly stated that the FPA does

not allow a market-based regime absent “implied

enforcement mechanisms sufficient to provide substitute

remedies for the obtaining of refunds for the imposition of

unjust, unreasonable and discriminatory rates." Jd. at 1016.

Furthermore, Lockyer indicates that even in a properly

approved market-based rate regime, section 206 remedies are

still fully available. See id. at 1017 (noting that the “only

remedies [under section 206] are prospective").

Taken together, these recent circuit decisions support

the following conclusion: Market-based rate authority

provides a meaningful opportunity for prior review and

approval of rates under the FPA, an essential prerequisite to

the Mobile-Sierra mode of rate review, only insofar as FERC

implements and uses an effective oversight mechanism after

49a

the market-based rate authorization is initially granted. Only

then can FERC meet its statutory duty to ensure that ai/ rates

are "just and reasonable."

This conclusion is bolstered by the judicial treatment

of two similar regimes instituted by FERC in the past. In

Texaco I, the Supreme Court considered the Federal Power

Commission's attempt to utilize a “blanket certificate

procedure for small producers of natural gas" that would

"relieve [ ] them of almost all filing requirements." 417

US. at 382. The Federal Power Commission's rationale

was that smal] producers would be subject to the forces of

the market and could therefore only charge what the market

would bear. See id. at 390, 94 §.Ct. 2315. The Federal

Power Commission's rationale in Texaco 7] thus was

essentially the same as FERC's rationale here: That case's

"small producers,” like the market-based rate authority

producers here, were asserted to lack market power and were

therefore authorized to set rates with no further oversight.

The assumption was that the rates set would necessarily be

competitive and would therefore tend to reflect the cost of

production, including the cost of attracting investment.

The Court affirmed that such a system of "indirect

regulation” was permissible under the Natural Gas Act, see

id., but struck down the order because it did not sufficiently

assure oversight to meet the statutory requirement of "just

and reasonable" review. See id. at 395-96. The Court so

held despite the FPC's assurances that it would review the

prices of contracts made pursuant to this authority, see id. at

396-97, stating:

[W]e should also stress that in our view the

prevailing price in the marketplace cannot be the

final measure of "just and reasonable” rates

mandated by the Act. It is abundantly clear from

the history of the Act and from the events that

50a

prompted its adoption that Congress considered

that the natural gas industry was heavily

concentrated and that monopolistic forces were

distorting the market price for natural gas.... In

subjecting producers to regulation because of

anticompetitive conditions in the industry,

Congress could not have assumed that "just and

reasonable” rates could conclusively be

determined by reference to market price.

Id. at 397-99 (emphasis added) (footnotes omitted).

The D.C. Circuit followed Texaco I's approach when

considering a FERC regulation for the oil industry based on

the premise that "competitive market forces should be relied

upon in the main to assure proper rate levels." See Farmers

Union, 734 F.2d at 1490. That court was adamant in holding

"FERC's largely undocumented reliance on market forces as

the principal means of rate regulation to be ... misplaced. It

is of course elementary that market failure and the control of

monopoly power are central rationales for the imposition of

rate regulation.” /d. at 1508 (citing Stephen Breyer,

Regulation and Its Reform 15-16 (1982)) (footnote omitted).

Indeed, the "fundamental flaw in the Commission's scheme"

was that "nothing in the regulatory scheme itself acts as a

monitor to see if [competition drives rates into the 'zone of

reasonableness'] or to check rates if it does not." /d. at 1509.

Here, FERC failed to adopt any monitoring

mechanism before applying deferential Mobile-Sierra review

to the challenged contracts. When FERC encouraged the

local utilities to purchase power in the forward market, the

agency promised to oversee the forward market contracts to

ensure their justness and reasonableness. See December 15

Order, 93 F.E.R.C. at J 61,994. FERC later held, however,

that its approval of energy sellers’ market-based rate

authonity--long prior to the market failures that gave nse to

Sla

the December 15 Order--allowed it to apply the Mobile-

Sierra doctrine without any direct inquiry into whether the

resulting rates were in fact "just and reasonable," and also

without any inquiry into the actual state of the market at the

time contracts were negotiated. See Order on Initial

Decision, 103 F.E.R.C. at J 62,388-89.

In light of the foregoing discussion, we must answer

the crucial question: Did FERC provide sufficient oversight

for contracts made under market-based rate authority to

ensure that the resulting rates were within the statutory "just

and reasonable" range in the first instance, thereby

permitting reliance on the Mobile-Sierra doctrine as to the

continuing effectiveness of those contracts? We hold that it

did not.

FERC asserted in its Order on Initial Decision that

the grant of market-based rate authority is sufficient

predetermination, so that it was "not required specifically to

review each agreement" made pursuant to the grant of

market-based rate authority. /d. J 62,389. In other words,

FERC contends that because it requires, before granting

market-based rate authority, a showing of lack of market

power and regular reporting, it has therefore fulfilled its

oversight role, and no further oversight is necessary. FERC

asserted the same position on rehearing, maintaining that its

decision in Lockyer supports that result. Order on

Rehearing, 105 F.E.R.C. at J 61,982-83.

In FERC's Lockyer decision, the agency held that

once market-based rate authority is granted, additional

oversight is a “compliance issue." California ex rel.

Lockyer, 99 F.E.R.C. 9 61,247 at 4 62,063, 2002 WL

32035504 (2002); see also Lockyer, 383 F.3d at 1015. We

rejected this aspect of FERC's Lockyer decision, however,

because without active oversight, “effective federal

regulation is removed altogether." Lockyer, 383 F.3d at

52a

1015. We reject FERC's reliance on that same proposition as

a pillar of FERC's invocation of the Mobile-Sierra mode of

review in this case.

FERC's position here, as in Lockyer, is that it fulfills

its monitoring obligation by imposing on sellers with

market-based rate authority the requirement that they file

Quarterly Transaction Reports, make the Reports available

for public review, and submit data on a triennial basis to

confirm the continued lack (or mitigation) of market power.

This data collection activity, however, was insufficient to

fulfill FERC's statutory obligation with respect to the

contracts challenged here. As demonstrated by what actually

happened during the California energy crisis, this sporadic

data collection approach is pragmatically unlikely to expose

in a timely manner the impact of market changes--in this

instance, the impact on the forward market of acknowledged

severe market changes within the dysfunctional spot market.

That such impacts can occur without affecting FERC's

continuing approval of market-based rate authority undercuts

FERC's assertion that initial just and reasonableness review

occurred with regard to the challenged contracts sufficient to

trigger the Mobile-Sierra mode of review.

In particular, the quarterly reporting requirement,

standing alone, permits review of the grounds for market-

based iate authority only with regard to contracts entered

into after the impact of the market dysfunction or market

power on long-term bilateral contracts has already occurred,

affecting the likelihood that the contracts in fact set rates

within the statutory "just and reasonable" range. There is a

crucial difference between this review--that is, purely

prospective review, affecting only future contracts--and one

that permits consideration of the market conditions at the

time a challenged forward contract was entered. See El Paso

Elec. Co., 108 F.E.R.C. § 61,071, at 4 61,370 n.10 (2004)

("A revocation of market-based rates ... would not void

53a

contracts that parties may have signed...."). The latter kind

of remedy is the kind the local utilities ask for here: They

seek modification of the contracts here at issue, prospectively

from the refund effective date but based on the market

circumstances that prevailed at the times the contracts were

negotiated.

A hypothetical explains the dilemma with FERC's

present "oversight scheme": Seller A receives market-based

rate authority in Year 1. In Year 5, prices increase

dramatically in short-term markets. Buyer B, needing to

escape these markets, agrees to long-term contracts X, Y,

and Z to buy wholesale energy from Seller A. Buyer B

agrees to the contract terms because in a frantic market Seller

A is one of the only suppliers willing to enter into a long-

term contract, and Buyer B needs to ensure that its supply is

able to meet the load required by its retail customers. In its

next required quarterly report in Year 6, Seller A dutifully

transfers the proper information about its rates to FERC.

FERC--perhaps reviewing contracts X, Y, and Z--discovers

that the assumption of a functioning market underlying its

approval of market-based rate authority for Seller A does not

accord with the rates being charged in forward contracts

generally, or in those entered by Seller A in particular.

FERC therefore revokes Seller A's market-based rate

authority. FERC's action, however, will do nothing to

reform those troubling contracis.

The problem raised by this hypothetical is that FERC

has no opportunity to review whether contracts X, Y, and Z

are just and reasonable before they are entered. As FERC

recognizes, revocation of market-based rate authority in Year

6 in the above hypothetical can only provide relief for

contracts made thereafter. See id. If a contract is entered

into in Year 5, FERC cannot consider whether the basis for

market-based rate authority had so atrophied by this time that

the economic basis for assuming the rates established would

54a

be within the statutorily mandated "just and reasonable"

range had evaporated. Instead, FERC applies the most-

forgiving version of review, the Mobile-Sierra presumption

that long-term bilateral contracts will reflect just and

reasonable rates, without any opportunity for initial review

of such contractual rates, whether cost or market based.

This case is precisely parallel to the above

hypothetical. For example, Enron, an Intervenor-Respondent

in this case, did have its market-based rate authority revoked,

because of the actions it took during the time period in which

the contracts at issue here were entered into. Enron Power

Mktg., Inc., 103 F.E.R.C. J 61,343, at 7 62,302 (2003). By

revoking that power, FERC restricted Enron's prospective

power to enter into contracts. Jd. J] 62,307-10. The very day

after revoking Enron's market-based rate authority, however,

FERC denied Nevada Power's request to reform its contracts

with Enron even though they were made dunng the very

period FERC identified Enron as grossly abusing and

violating its market-based rate authority. See Order on

Initial Decision, 103 F.E.R.C. at J 62,397. FERC

accomplished this result by applying a Mohile-Sierra "public

interest" standard to the contract reformation proceedings.

See id. By doing so, FERC neither performed the full scope

of "just and reasonable” review nor revisited the market

circumstances in which the agreements were entered to

determine whether those circumstances were sufficiently

functional that they were likely to yield long-term contracts

within the "just and reasonable" range.

This approach to section 206 review simply cannot

be squared with the statutory scheme. Section 206

commands prospective revision of rates that, as of the refund

effective date, are not just and reasonable: When FERC

determines that a rate is unjust or unreasonable, “the

55a

Commission shall determine the just and reasonable rate,

charge, classification, rule, regulation, practice; or contract to

be thereafter observed and in force, and shall fix the same by

order." 16 U.S.C. § 824e(a). By layering Mobile-Sierra

review on top of a market-based rate authority that can be

revoked only prospectively from the refund effective date,

FERC abdicates its statutory responsibility to provide such

rate revision when appropriate.

FERC represents in its post-argument submission that

the local utilities could have challenged the sellers market-

based rate authority at the time they entered into the

challenged contracts. That representation is true, but beside

the point. Any such challenge, even if successful, could not

have been a basis for reforming the challenged contracts,

even if the excessively high rates established by the contracts

were strong indications that market-based rate authority

should be revoked. Rescission of market-based rate

authority still would have affected only later contracts,

leaving the challenged agreements subject to limited Mobile-

Sierra public interest review.

As a result of FERC's refusal to consider the

abrogation of market-based rate authority except with respect

to future contracts, and given the dramatic and sudden nature

of the onset of the California energy crisis and the limited

period of time that the local utilities had to respond to it, the

local utilities here had no meaningful opportunity to institute

a challenge to these sellers’ market-based rate authority

before entering the disputed agreements. For example, in

February 2001, California enacted legislation allowing its

Department of Water Resources to purchase power on behalf

of its deteriorating investor-owned utilities. Southern Cal

Water's previous supplier, Dynegy promptly told Southern

Cal Water that it was "not interested in extending or

renegotiating” its previous one year contract with Southern

Cal Water that expired in Apn! 2001, as Dynegy "could sell

56a

its generation output to the State of California.”

Southern Cal Water was thus left with less than two

months to obtain power for the following year and only three

"choices": (1) immediately negotiate a long-term contract

that could take effect in April 2001; (2) shift to the spot

markets, by then recognized by FERC as manipulated and

dysfunctional markets that had already caused hyper-pricing

and bankrupted several utility companies; or (3) shut down

operation and fail to provide electricity for its retail

customers. Faced with these choices, Southern Cal Water

entered into a forward contract based on a bidding period of

little more than two weeks. Under these time constraints,

Southern Cal Water could not have challenged the seller's

market-based rate authority, obtained an order from FERC,

and then negotiated a forward agreement and signed a

contract with the very seller whose market-based rate

authority it had just challenged. There was simply no

realistic way that Southern Cal Water could continue to

participate in the forward market while assuring meaningful

"just and reasonable” review.

Ultimately, the fatal flaw in FERC's approach to

"oversight" is that it precludes timely consideration of

sudden market changes and offers no protection to

purchasers victimized by the abuses of sellers or

dysfunctional market conditions that FERC itself only

notices in hindsight. For example, on December 15, 2000,

FERC issued an order encouraging the adoption of long-term

contracts and establishing a benchmark price of $74/Mwh.

See December 15 Order, 93 F.E.R.C. at FI 61,994-95.

FERC promised that it would "be vigilant in monitoring the

possible exercise of market power ... [t]o address concerns

about potentially unjust and unreasonable rates in the long-

term markets." /d. J 61,994. In fact, because of its flawed

processes, FERC was never able to "address concerns about

potentially unjust and unreasonable rates in the long-term

57a

markets," because it had no means to revoke market-based

rate authority before the precipitously entered contracts went

into effect and became, in FERC's view, no longer subject to

cost-based “just and reasonable" review. As a result, FERC

failed to detect that, according to its own benchmarks,

something was awry in the forward markets that produced

these contracts.

As in Lockyer, we do net dispute that FERC may

adopt a regulatory regime that differs from the historical

cost-based regime of the energy market, or that market-based

rate authority may be a tenable choice if sufficient

safeguards are taken to provide for sufficient oversight.

FERC, however, cannot use that choice to excuse its duty to

maintain effective oversight and then invoke Mobile-Sierra

as a ground for precluding ordinary rate review, including

review of the propriety of market-based rate authority at the

time the contracts became effective. Any other conclusion

would permit FERC to abdicate entirely its statutory

responsibility under the FPA to ensure that ail rates,

including bilateral contract rates, are "just and reasonable."

C. Meaningful Review of Contract Formation

This fundamental procedural error was compounded

by FERC's substantive adherence to Mobile-Sierra without

regard to the market conditions in which the contracts at

issue were formed. As we have explained, Mobile-Sierra

cannot apply without a determination that the challenged

contract was initially formed free from the influence of

improper factors, such as market manipulation, the leverage

of market power, or an otherwise dysfunctional market.

The local utilities argue here that the frenzied market

conditions of the California energy crisis in the spot market

influenced the forward market in such a manner as to raise a

question about what transpired during formation of the

58a

forward contracts here at issue. The most important

evidence supporting this position is the FERC Staff Report

concerning price manipulation in the western United States

at the time these contracts were formed. The FERC staff

concluded:

Our analysis shows ... that forward power prices

negotiated during 2000-2901 in the western United

States were significantly influenced by the then-

current spot power prices. This tells us that the

trauma of the dysfunctional spot power prices at

that time so influenced buyers that they placed

great weight on these prices in forming future

expectations.

Staff Report at ES-9 (emphasis added). The report noted that

the influence was greatest for one-to-two year forward

contracts, 7> and that there is a "statistically significant

relationship" between the spot price and forward price. /d.

Although it noted the Staff's findings, FERC held

them irrelevant because they did not demonstrate that the

rates in the forward contracts affected the “public interest."

Order on Initial Decision, 103 F.E.R.C. at 4 62,397. FERC

therefore did not consider the staff findings in determining

whether the Mobile-Sierra doctrine was applicable to these

contracts; instead, FERC discarded the findings after

determining, for independent reasons, that the Mobile-Sierra

doctrine was applicable. The upshot is that FERC failed ever

to consider whether the influence of the spot markets on the

forward markets reached a level sufficient to question

whether FERC could assume that two private parties had

negotiated a "just and reasonable” contract in the first

> Most of the contracts challenged by Nevada Power and Sierra Pacific

are within that time range.

59a

instance and therefore apply the Mobile-Sierra presumption.

FERC's very limited factual findings regarding the

state of the market at the time the challenged contracts were

negotiated are thus not responsive to the theory advanced by

the local utilities here. FERC held only that because the

local utilities entered into the challenged contracts

“voluntarily” and because "there is no evidence of

unfairness, bad faith, or duress in the original negotiations

[of the forward contracts], the [local utilities} are not entitled

to change their bargains." /d. at JJ 62,399-62,400. But the

local utilities do not allege that the energy companies

manipulated their negotiations of the contracts here at issue;

the local utilities challenge the context, not the conduct, of

those negotiations. Consistently with the Staff Report's

findings, the local utilities are maintaining that factors

exogenous to the forward market, the dysfunction and

manipulation of the spot market, artificially influenced the

rates in the forward market, creating market dysfunction in

the forward market.”° The local utilities’ argument is that

when such market dysfunction occurs and there is no

opportunity to revisit the propriety of the market-based rate

authority in effect when the contract was entered, FERC

cannot assume that contractual terms were just and

reasonable as between the contracting parties when the

agreement was negotiated. As a result, FERC cannot focus

only on “public interest" considerations when the rates

established are thereafter challenged.

26 FERC's premise, never examined in its orders and opinions, is that the

spot and forward markets can and should be analyzed separately. Many

of the participants in the two markets are the same, however, as is the

product sold--electric power. The only difference is the time frame for

delivery of that product. For present purposes, we accept FERC's

assumption that the two markets are sufficiently separate that there is at

least a question as to the scope of the impact of the dysfunctional spot

market on the forward market.

all

60a

In this case, the questions raised by the Staff Report--

whether and how the manipulated spot market influenced the

forward markets--are relevant to determining whether the

Mobile-Sierra doctrine applies, because they raise questions

about the market conditions at the time of contract formation

and thus about the propriety of relying on a regime of

market-based rate authority at that time to produce just and

reasonable rates. Although FERC “is not obligated to justify

deviations from an approach suggested by its own staff,”

when "the conceptual underpinnings of the staff's approach"

are "critical to a reasoned resolution of the problem," then

FERC must address them. Pub. Utils. Comm'n v. FERC, 817

F.2d 858, 862-63 (D.C. Cir. 1987).

We conclude that FERC's decision to treat the

market-function evidence as irrelevant to the question

whether Mobile-Sierra applies, and its resulting application

of the Mobile-Sierra doctrine, was fundamental error. In a

regulatory regime predicated on the grant of market-based

rate authority, the decision whether to apply Mobile-Sierra to

subsequent contracts formed under that authority requires

FERC and reviewing courts to determine if the contracts at

issue were initially entered into in fully functioning markets.

FERC's application of the Mobile-Sierra doctrine without

considering the contract formation issues was error.

D. Effect on the "Public Interest"

FERC's error in its approach to deciding whether

to apply the Mobile-Sierra presumption was compounded by

its use of an erroneous standard for determining whether the

challenged contracts affect the public interest. As our

historical summary shows, electric utility deregulation has

made it increasingly necessary for FERC to consider

wholesale power contracts’ effect on the consuming public.

In its efforts to determine the impact on the public interest

6la

under Mobile-Sierra, however, FERC relied on the wrong

legal standard, applying factors taken from the context of a

low-rate challenge rather than those relevant to the high-rate

challenge present in this case.

As we discussed in Part II, state agencies in the past

regulated heavily the rates charged directly to the public.

Electric rate regulation reform, however, has significantly

limited the role state regulators play and simultaneously

increased the importance of federal regulation for the prices

paid by retail ratepayers. FERC's increased responsibility for

protecting the public's interest makes its obligation to ensure

that wholesale rates do not unjustifiably adversely affect the

public--always a part of FERC's statutory mandate--more

important than it was when the Mobile-Sierra doctrine first

developed. Because, at present, FERC, not state regulators,

"is perhaps in the best position to reach the most equitable

result and to act in the public interest,” Miss. Indus. v. FERC,

808 F.2d 1525, 1549 (D.C. Cir. 1987) (per curiam) (quoting

Middle S. Serv., Inc., 30 F.E.R.C. 4 63,030, at 9 65,151

(1985)), FERC must give predominant weight in determining

whether to modify a contract under section 206 to the impact

of a challenged wholesale contract on the rates paid by the

consuming public who use the energy covered by the

contract. Tested against this protocol, the agency's narrow

conception of “public interest" review does not suffice.

FERC determined that the challenged contract rates

did not impact the public interest principally because the

local utilities presented little evidence relevant to the three

public interest factors specifically mentioned in Sierra.’

27 In such circumstances{when the public interest test satisfies]

{FERC's duty to ensure just and reasonable rates} the sole concern of the

Commission would seem to be whether the rate is so low as to adversely

affect the public interest--as where it might impair the financial ability of

the public utility to continue its service, cast upon other consumers an

‘=

§2a

Order on Initial Decision, 103 F.E.R.C. at § 62,397.

Similarly, FERC's briefs in this court, assume, erroneously,

that Sierra established a three-prong public interest standard

applicable across all circumstances, an assumption with

which we do not agree. In particular, the "excessive burden"

reference in Sierra, heavily relied upon by FERC in this case

in concluding that there was no impact on the public interest,

has no application here.

As the text from Sierra, reproduced in the margins,

demonstrates, the three Sierra factors were specifically

identified as relevant to the /Jow-rate challenge presented in

that case. Rates asserted to be Jower than those FERC would

approve ab initio will not ordinarily directly affect the most

obvious “public interest" underlying the FPA--namely,

avoidance of unnecessarily high rates for the consuming

public. That Sierra does not mention such a consideration is

thus no wonder. See Ne. Utils. Serv. Co. v. FERC

(Ne. Utils IT ), 55 F.3d 686, 691 (ist Cir. 1995) (applying a

broader definition of "public interest" in a high-rate

challenge because "[i]t all depends on whose ox is gored and

how the public interest is affected"); cf Permian Basin Area

Rate Cases, 390 U.S. 747, 783-84 (1968) (approving Federal

Power Commission's setting of maximum rates because of

the impact on the public interest). Indeed, the D.C. Circuit

has characterized Sierra as establishing the rule that "a heavy

burden must be met before a customer who has negotiated a

fixed-price contract can be deprived against his will of the

benefit of his bargain." Town of Norwood, 587 F.2d at 1310

(emphases added). When a customer has negotiated a low

contract rate, FERC must meet a high burden before raising

that rate. By contrast, in this case, the customer is

complaining of a high rate. The concerns in such a high-rate

excessive burden, or be unduly discriminatory. Sierra, 350 U.S. at 355

(emphasis added).

63a

case are not entirely parallel to those in a low-rate case.

The primary "public interest" at issue in a low-rate

challenge, such as Sierra, is in keeping utilities in operation

so the public is not deprived of services. Sierra also

mentioned avoidance of rates "so low as to ... cast upon other

consumers an excessive burden." 350 U.S. at 355 (emphasis

added). The reason for concern with "excessive burden” on

“other consumers" is that charging rates in some wholesale

contracts that are too low to recoup production costs and a

fair profit could lead utilities burdened with such low rate

agreements to recoup their costs and profit margins by

charging higher rates than are just and reasonable to other

wholesale customers. Such a burden is "excessive" because

it requires third parties to pay for costs, including the cost of

capital, that properly should have been bome by the

consumers who purchase energy covered by the challenged

contract. Contrary to FERC's supposition in this case, the

reference to an "excessive" burden in Sierra did not signal

that it is fine to burden customers with unjustifiably higher

rates as long as those rates are not so high as to be

"excessive" in some absolute sense.

In contrast, the key “public interest" in a high-rate

challenge, such as this one, is assuring that the consuming

public pays fair rates for the very energy covered by the

challenged contracts. Sierra's limitation of relief to cases

where "other" customers endure an “excessive burden” has

no application to this direct pass-through concern. Instead, if

a challenged contract imposes any significant cost on

ultimate customers because of a wholesale rate too high to be

within a zone of reasonableness, see JNGAA, 285 F.3d at 31,

that contract affect; the public interest.

To be sure, the stability of contract considerations

that underlie the Mubile-Sierra doctrine do carry over to

challenges by buyers «ther than sellers. See Mobile, 350

64a

U.S. at 344 (holding that no party may "unilaterally" change

contract because "preserving the integrity of contracts ...

permits the stability of supply arrangements"). Those

considerations, however, do not justify abnegation of FERC's

statutory responsibility to protect the public from

unjustifiably high rates in wholesale contracts.

The public interest standard, consequently, must be

adjusted to give appropriate weight to that concern. In

particular, in determining whether a challenged rate affects

the public interest, FERC must take into account the

Supreme Court's admonition that even "a small dent in the

consumer's pocket" is relevant to the determination of fair

rates. Texaco I, 417 U.S. at 399. In the context of a high-

rate challenge, consequently, a high-rate public interest

determination should focus on whether consumers’ electricity

bills have been affected by the challenged rates--not

necessarily whether the electricity bills have increased since

the signing of the contracts, but whether those bills are

higher than they would otherwise have been had the

challenged contracts called for rates within the just and

reasonable range.

This is not to say that any direct impact on consumer

rates is enough to demonstrate a public interest effect

sufficient to displace the countervailing Mobile-Sierra

concern with protecting the stability of contract. Market-

based rate regulation presumes--appropriately--that a

functioning marketplace will drive prices towards marginal

cost, and therefore toward such a reasonable range, "at least

over the long pull." JNGAA, 285 F.3d at 31. Even if a

particular rate exceeds marginal cost, however, it may still be

within this reasonable range--or "zone of reasonableness"--if

that higher-than-cost-based price results from normal market

forces and is part of a general trend toward rates that do

reflect cost. See id. at 32 (noting that brief spikes in pipeline

rates "are completely consistent with competition"). Thus,

65a

the proper standard for the Mobile-Sierra “public interest"

mode of review in a high-rate challenge is not whether the

contracted rates pose an "excessive burden" on consumers,

but whether the wholesale energy contract is outside the

"zone of reasonableness” and results in retail rates higher

than would be the case if that zone were not exceeded. This

standard mirrors that endorsed by the D.C. Circuit for

determination of a just and reasonable rate under a market-

based rate regulation regime, see INGAA, 285 F.3d at 31-36,

and provides an appropriate context for the Supreme Court's

“small dent" admonition in such a regulatory environment.

After reviewing the record carefully, we are certain

that FERC did not properly assess the public interest of any

of the contracts before it in this case.

1. Snohomish

Snohomish had already increased its retail rates by 35

percent to accommodate the payment of increased prices for

power, averaging $125/MWh. Because Snohomish could

not obtain forward contracts that allowed it to bring the retail

rates back within a normal range, it appears that the contracts

at issue did, in fact, impact Snohomish's customers.

Contrary to FERC's assertion, it does not matter whether a

rate increase occurred before or after a petitioner signed one

of the challenged contracts. See Order on Rehearing, 105

F.E.R.C. at J 61,986. In either case, the contract could cause

customers to pay higher rates than they would have without

the contract. Further, FERC specifically found that the

challenged Morgan Stanley contract accounted for an eight

percent increase for retail ratepayers over 2001 rates. /d.

2. Southern Cal Water

FERC acknowledged that the challenged contracts

led to electric bills of $35.13 per month for some Southern

66a

Cal Water customers. FERC held, however, that Southern

Cal Water had not proven that such a bill "amounts to an

excessive burden on the ratepayers." Jd. (emphasis added).

FERC's rejection of Southern Cal Water's claim because this

increase did not amount to an “excessive burden," id., is in

error because, as stated above, the "excessive burden"

standard, which referred in Sierra to the impact on third

parties of a wholesale contract so low as to necessitate that

costs be recouped from other buyers, does not apply in this

case, and did not in any event sanction impacts on consumers

as long as not in some absolute sense "excessive."

3. Nevada Power

Nevada Power's retail rates decreased after the

challenged contracts were negotiated. /d. This circumstance,

however, cannot alone determine whether those contracts

negatively affected the public interest. The decrease from

peak rates charged during the crisis does not show that the

slightly lower rates that resulted from the forward contracts

did not affect the public interest. It is entirely possible that

rates had increased so high during the energy crises because

of dsyfunction in the spot market that, even with the

acknowledged decrease in rates, consumers still paid more

under the forward contracts than they otherwise would have.

FERC should have performed a more sophisticated economic

analysis to determine if the challenged contract affected the

public interest.

For the foregoing reasons, we determine that a

remand is necessary so that FERC can apply the proper

statutory standards to determine, first, whether Mobile-Sierra

review of the challenged contracts is appropriate; second, if

so, to apply the modified form of Mobile-Sierra review

outlined in this opinion; and finally, if not, to apply full just

and reasonable review to the challenged contracts. The

petition for review is hereby granted. We remand this case

67a

to FERC for proceedings consistent with this opinion.”*

PETITION FOR REVIEW GRANTED AND

REMANDED

28 Petitioner Snohomish also claims (1) that two FERC commissioners

engaged in ex parte communications with wholesale energy sellers in

violation of Snohomish's due process rights; (2) that these same

communications violated the Sunshine Act, 5 U.S.C. § 552b; and (3) that

certain evidentiary rulings of the Administrative Law Judge violated

Snohomish's due process rights. Because our remand order requires

FERC to consider the complaints again in the first instance, we do not

reach these additional issues.

68a

APPENDIX B

FEDERAL ENERGY REGULATORY COMMISSION

ALJ Decisions and Reports

NEVADA POWER COMPANY

and

Sierra Pacific Power Company

v.

ENRON POWER MARKETING, INC.

E] Paso Merchant Energy

American Electric Power Services, Corp.

Nevada Power Company

v.

Morgan Stanley Capital Group

Calpine Energy Services

Mirant Americas Energy Marketing, L.P.

Reliant Energy Services

BP Energy Company

Allegheny Energy Supply Company, L.L.C.

Southern California Water Company

v.

Mirant Americas Energy Marketing, L .P.

Public Utility District No. 1 Snohomish County, Washington

Vv.

Morgan Stanley Capital Group, Inc.

Docket Nos. EL02-28-000, EL02-33-000, EL02-38-000

Docket Nos. EL02-29-000, EL02-30-000, EL02-31-000,

EL02-32-000, EL02-34-000,

EL02-39-000

Docket No. EL02-43-000

Docket No. EL02-56-000 (Consolidated)

69a

INITIAL DECISION

(Issued December 19, 2002)

CARMEN A. CINTRON, Presiding Administrative Law

Judge

INTRODUCTION

l. The Commission designated this case for hearing to

determine whether the dysfunctional Cal ISO and PX spot

markets adversely affected the long-term bilateral markets,

and if so, whether the effect was of a magnitude warranting

modification of contracts entered into in the bilateral markets

in California, Nevada and Washington. As discussed below,

it is found that the Mobile-Sierra public interest standard of

review applies to these contracts. Furthermore, it is

concluded that under the public interest standard,

Complainants failed to establish that the dysfunctions of the

Cal ISO and PX spot markets adversely affected the long-

term bilateral markets.

PROCEDURAL HISTORY

2. Nevada Power Company and Sierra Pacific Power

Company (collectively, "Nevada Companies") filed separate

complaints against Duke Energy Trading and Marketing,

L.L.C. ("Duke"), Morgan Stanley Capital Group, Inc.

("Morgan Stanley"), Calpine Energy Services, L-.P.

("Calpine"), Mirant Americas Energy Marketing, L.P.

("Mirant"), Reliant Energy Services, Inc. ("Reliant"), El] Paso

Merchant Energy, L.P. ("El Paso"), BP Energy Company

("BP"), American Electric Power Services Corporation

("AEP"), Enron Power Marketing, Inc. ("Enron"), and

Allegheny Energy Supply Company, L.L.C. ("Allegheny")

(collectively, "Respondents"). Southern California Water

Company ("SCWC") filed a complaint against Mirant. Public

70a

Utility District No. 1 Snohomish County, Washington

("Snohomish") filed a complaint against Morgan Stanley. '

The Nevada Companies and SCWC argued that the

dysfunctions in the Cal ISO and PX spot markets caused

long-term contracts negotiated in California, Washington,

and Nevada to be unjust and unreasonable. Snohomish

argued that the terms of its contract and the collateral annex

are unjust and unreasonable. Complainants seek modification

of their contracts.

3. On April 11, 2002, the Commission consolidated the

above complaint proceedings and set the matter for hearing.”

On April 17, 2002, the Chief Administrative Law Judge

designated a presiding judge in this proceeding.’ At a May 1,

2002, prehearing conference the parties agreed to a

procedural schedule. Discovery commenced on May 29,

2002. Numerous discovery motions were filed and numerous

discovery conferences were held in this proceeding.

4. On September 17, 2002, the Commission issued an

Order Addressing Requests for Rehearing and Clarification

of the hearing order. * In this order, inter alia, the

Commission corrected the list of contracts set for hearing.

‘In this order, the Nevada Companies, SCWC and Snohomish will be

collectively referred as ("Complainants").

? Nevada Power Company v. Duke Energy Trading and Marketing, LLC,

99 FERC 61,047 (2002) ("Hearing Order").

> Settlement procedures were initiated. The Nevada Companies and Duke

reached a settlement agreement. On June 26, 2002, the Nevada

Companies’ withdrew their complaint against Duke. On September 30,

2002, Duke's motion requesting removal of their name and case docket

number from the caption of future orders in the proceeding was granted.

Consequently, the caption is now Nevada Power Company v. Enron

Power Marketing, Inc.

* Nevada Power Company v. Enron Power Marketing, Inc., 100 FERC

61,273 (2002).

Tla

5. On June 28, 2002, the parties filed their direct

testimony. Staff filed direct testimony and answering

testimony on August 6, 2002. Respondents’ answering

testimony was filed on August 27, 2002. On September 17,

2002, Complainants filed rebuttal testimony. The hearing

was held from October 7-24, 2002. Initial briefs were

submitted on November 8, 2002 and Reply Briefs on

November 22, 2002. Initial Briefs were filed by the Nevada

Companies; SCWC and Snohomish (jointly); Snohomish;

Allegneny on one issue (real party in interest); the Public

Utilities Commission of Nevada ("PUCN") joined by the

Office of the Attorney General for the State of Nevada,

Bureau of Consumer Protection ("BCP"); Morgan Stanley

Capital Group; Commission Staff ("Staff") and Respondents

(all including Morgan Stanley). All of these entities also

filed reply briefs.

ISSUES

issue I].

Whether Nevada Power Company, Sierra Pacific

Power Company and Southern California Water Authority

must bear the burden of showing that the challenged

contracts are not just and reasonable under the Federal Power

Act or that the contracts are contrary to the public interest

under the Mobile-Sierra doctrine?

A. Parties Contentions:

6. The Nevada Companies assert that Mobile-Sierra

applies only to long-term contracts filed with and approved

by the Commission. The Confirmation Agreements (which

contain the terms of the transactions-price, duration and

delivery point) in this proceeding were not filed with or

an

72a

approved by the Commission.” As a result, these companies

argue, Mobile-Sierra does not apply since the Commission

must be granted an opportunity in every case to judge the

"reasonableness" of the rate. The Nevada Companies

distinguish their contracts from those in Mobile-Sierra since

the contracts at issue in this case are for supply from three

months to one you, not ten and fifteen year contrarts like in

Mobile-Sierra.

yA According to the Nevada Companies, the

Commission has found that there is a "potential for the

exercise of market power" and "a dysfunctional market place

both in California and the remainder of the West.” Moreover,

the Nevada Companies contend that the Commission

previously stated that any party that "believes any of its

contracts are unjust and unreasonable... [t]o file a complaint

under FPA Section 206 to seek modification of such

contracts." These companies maintain the Commission has

not applied the Mobile-Sierra public interest standard to

contracts entered into in a dysfunctional market.’ Thus, the

Commission should follow precedent and examine the

contracts here under the just and reasonable standard, the

Nevada Companies argue.

8. In addition, the Nevada Companies contend that in a

proposed policy statement the Commission made clear that,

unless an agreement specifically states that the public

interest standard applies, market-based rates will be

reviewed under the just and reasonable standard.* In this

case, the Confirmation Agreements do not include language

* The Nevada Companies Initial Brief ("IB") at 4.

* Id. at 5.

"Id.

* Id. at 6.

73a

adopting the public interest standard of review nor do they

mention the “just and reasonable" standard. The Nevada

Companies argue that their witnesses testified that they had

no intention of waiving their mght to challenge the

agreements as “unjust and unreasonable,” nor would they

have recommended waiver of this right had the issue been

raised. As a result, the Nevada Companies argue that the

Confirmation Agreements should be construed as

"demonstrating the intent of the ies to allow a just and

reasonable standard of review."” Any other interpretation

would be contrary to the Commission's proposed policy

statement clarifying its own precedent, which provides that

silence on what standard applies is to be read not against the

buyer, but in the buyer's favor.

9. Further the Nevada Companies assert that Mobile-

Sierra does not apply because the Western Systems Power

Pool Agreement (WSPPA) is an umbrella agreement which

does not contain the fundamental terms - price, duration and

delivery point - for transactions under the "Service

Schedules." The Confirmation Agreements are expressly

distinct from the WSPP itself and Section 32.3 of the WSPP

states that, in the event of a conflict between a binding and

effective Confirmation Agreement and [the WSPP], the

Confirmation Agreement shall govern.'°

10. Additionally, the Nevada Companies argue that

Section 6.1 of the WSPP limits the parties’ nghts to

unilaterally amend the WSPP by providing it can only be

amended by joint application to FERC."' If the parties had

intended to limit their Section 206 rights, they could have

* Id. at 7.

'° Id. at 8.

"Id. at 9.

74a

done so, the Nevada Companies argue and indeed have done

so with regard to some contracts. '* The fact that the

Confirmation Agreements do not include language on

Section 206 rights is substantial evidence that the parties did

not intend to limit the Nevada Companies’ rights under

Section 206 or to be bound to a public interest standard of

review."

11. _—_ In addition, the Nevada Companies maintain that the

Commission has modified “uneconomical” contracts under

the just and reasonable standard even when the contract

expressly mandates application of the Mobile-Sierra

doctrine. Moreover, case law does not indicate a "completely

consistent pattern" as to whether the doctrine of Mobile-

Sierra applies where the contract is silent in this respect.'* In

this case, because of the effect of market dysfunction, prices

for power were unjust and unreasonable, and thus, Section

206 obligates the Commission to fix a just and reasonable

price, the Nevada Companies argue.

12. | SCWC and Snohomish aver that nothing in Section

6.1 suggests that it was meant to preserve (or restrict) the

rights of an individual party to seek changes to the rates,

terms or conditions of a Confirmation Agreement for a

specific transaction.'° The Confirmation Agreements are not

part of the WSPP Agreement, by virtue of the fact that

Section 4.1, in defining “Agreement" excludes the

Confirmation Agreements. ° In executing its contract with

" For instance, Snohomish's contracts with AEPSC, Calpine and BP,

Mirant and California Department of Water Resources ("“DWR").

" The Nevada Companies IB at 10.

'* Id. at 8.

'S SCWC IB at S.

© Id. at 6.

75a

Mirant, SCWC argues that it relied on the Commission's

December 15 Order which mentioned the just and reasonable

standard.'’ In addition, Mirant's conduct, by not adding a

Mobile-Sierra clause to its contract with SCWC, indicates

that it was relying on the just and reasonable standard,

SCWC argues. '

13. The PUCN”® avers that the just and reasonable

standard is applicable to the challenged contracts at issue for

several reasons. ”° First, the Mobile-Sierra public interest

standard, developed under an entirely different set of facts, is

inapplicable to the situation at hand, involving wholesale

transactions based on market-rate authority, subject to a

dysfunctional market, which was incapable of restraining

prices at just and reasonable levels. Moreover, these

contracts were not subject to review by the Commission.”

The market dysfunction negated the presumption that the

market rates were just and reasonable, thereby invoking the

Commission's independent duty to establish a just and

reasonable rate, unconstrained by the Mobile-Sierra

doctrine.”

14. Another reason supporting use of the just and

reasonable standard in lieu of the Mobile-Sierra doctrine is

that the Commission and entities representing third parties,

that are non-signatories to the challenged contracts, such as

"” Id. at 7.

* Id. at 10.

'? The PUCN and a number of other entities were allowed to intervene in

° PUCN IB at 3.

2! Id at 4.

2 Id.

? Id. at 4-6.

76a

the PUCN, are not necessarily bound by the doctrine.” In

addition, the Commission, pursuant to the Federal Power

Act, ("FPA") is under a duty to "make an independent

assessment of the reasonableness of wholesale rates,

regardless of the terms of the agreement between the

parties." *° Moreover, the PUCN, as representative of

Nevada in utility matters, has standing to challenge

wholesale power rates as unjust and unreasonable as applied

to the Nevada utilities and their retail customers, and thus,

the PUCN is not bound by the Mobile-Sierra public interest

standard.”° Further, the PUCN also avers that the parties

retained the right to pursue unilateral contractual changes,

pursuant to the just and reasonable standard of section 206 of

the Federal Power Act, by not expressly waiving the night to

do so under section 6.1 of the WSPPA, and thus, the parties

are not bound by the Mobile-Sierra doctrine.”’

15. | The PUCN also contends that, even if the Mobile-

Sierra public interest standard applies, “where contract relief

is sought to safeguard the interest of third parties, the

Commission is entitled to apply a more flexible standard in

evaluating whether contract modification is in the public

interest," and in this evaluation, the Commission should

assign "great weight to the possibility that Nevada customers

could be harmed by the indisputably high prices in the

challenged contracts.""* Moreover, a heavier than usual

burden should not be applied.”°

** Id. at 6.

25 Id. at 7.

8 Id.

”” Id. at 8-9.

78 Id. at 12, 14.

29 Id. at 14-15.

—

77a

16. Respondents argue that this is the first time the

Commission has ordered a hearing under Section 206 of the

FPA of a complaint against a market-based 1 rate resulting

from freely-negotiated, bilateral contracts. °° The record

supports a finding that the Nevada Companies and SCWC

agreed that contract modifications of the rates, terms and

conditions would not be sought unilaterally, but jointly under

Section 205 of the FPA pursuant to Section 6.1 of the WSPP.

The parties did not agree to any other mechanism for

contract modification and did not agree that either party

could seek future rate changes pursuant to Section 206. The

fact that parties did not agree to permit unilateral changes

means that the Nevada Companies’ and SCWC's unilateral

proposals to change the contracts through the regulatory

process are impermissible unless the Complainants can

demonstrate that contract abrogation or modification is

required by the public interest.*’ Accordingly, Respondents

argue that the Mobile-Sierra doctrine applies to the

voluntarily-negotiated contracts at issue in this proceeding.”

Respondents argue that precedent supports their

allegations.*’ Parole evidence of the parties’ intent may not

be introduced, Respondents argue. Moreover, even if

extrinsic evidence is allowed, Complainants have not

submitted affirmative evidence that the parties intended to

allow application for unilateral changes to the contracts.**

17. The reason Respondents did not specifically raise the

issue of unilateral rate filings or other special Mobile-Sierra

*° Respondent's IB at 1.

*" Respondents IB at 9.

*? Id. at 10.

° id at 9.

Id at 13.

78a

provisions is easily explained: contracting parties need not

include language explicitly restricting the nghts of a party to

file a complaint because “anyone bargaining in the shadow

of the [Mobile-Sierra] doctrine would assume that a contract

unconditionally setting a fixed rated, or a fixed rate of return,

would be governed by Mobile-Sierra. In addition, the

Commission has stated that the public-interest standard

governs where a fixed-rate contract did not provide the

moving party with the right to make a unilateral rate change

under Section 206 and the evidence showed that the parties

"did not even discuss" either Section 206 or the standard that

would apply if a complaint were filed. These are the facts

here, Respondents argue.*’ Additionally, contracts not at

issue here have no bearing on the clear intent of the parties

as expressed in Section 6.1 of the WSPP.

18. In this proceeding, Staff asserts that the appropriate

burden of proof applicable to these contracts (except for the

collateral annex in the contract between Morgan Stanley and

Snohomish) is the public interest standard. According to

Staff, this is gleaned from the terms of the WSPP and is

confirmed by the testimony of those who actually made the

deals. The participants in the WSPP intended to limit the

possibility for contract modification to very narrow

circumstances, otherwise a "deal is a deal."*®

B. Discussion/Findings:

19. The Commission in this case set for hearing the

following issue: whether complainants must bear the burden

of showing that the challenged contracts are contrary to the

public interest, or whether they will bear the burden of

showing that the contracts are not just and reasonable. The

3 Id at 14.

% Staff IB at 3.

= Saat

79a

Commission stated that even under a "just and reasonable”

standard, parties who seek to overturn market-based

contracts into which they voluntarily entered will bear a

heavy burden.’ On rehearing, tite Commission stated that

the evidentiary hearing was established to interpret Section

6.1 of the WSPPA and ascertain the parties’ intent at the time

the contracts were signed.** A short description of the

transactions is relevant to this discussion.

20. | The Nevada Companies contracts are fixed rate, over

the counter, “brokered transactions," for "standard on-peak

(6 x 16 blocks of power in 25 MW increments for delivery

hubs in the West, such as Palo Verde or Mead) products.”

Many are "locational basis swaps," and others are "sleeve

transactions.” Only two contracts with AEP are for more

than one year.“’ Most of the contracts are quarterly contracts

entered into for the third quarter of years 2002, 2003 or

2004, plus several one-year transactions. The prices of these

contracts are (varied, but all were at or below prevailing

market levels.*'

21. | Snohomish issued a Request for Proposals (RFP) on

December 22, 2000. Mor rgan Stanley was one of 17 suppliers

who received the RFP.*? Morgan Stanley was one of five

suppliers who responded to the Snohomish RFP. Snohomish

executed three separate contracts with three different sellers,

” The Nevada Companies v. Enron Power Marketing, Inc., 99 F.E.R.C .

61,047 at 61,190 (2002).

38 Id. at 100 F.E.R.C. 61,273 at 62,047 (2002).

»® Three 25 MW off-peak contracts with El Paso (2 transactions) and

Enron (1 transaction) are not standard products.

” The two-year contracts were filed with the Commission. Ex. NEV-3 at

93 and 100.

“' Tr. at 2645:14-17; 2656:16-20; 2709:9-15; 2288:3-12.

*2 Ex. SNO-4 at 5:6-8; Ex. SNO-S.

80a

including Morgan Stanley. On January 26, 2001, Snohomish

and Morgan Stanley entered into a power sales agreement

(PSA) comprised of the WSPPA, a Confirmation Agreement,

Attachment A (modifying the WSPPA) and a collateral

annex. Morgan Stanley agreed to sell Snohomish 25 MW of

around-the-clock energy for delivery at Mid-C for a period

of 105 months (8.75 years) at a price of $105/MWh.

22. | SCWC also issued an RFP sent to Mirant and five

other companies.*’ Mirant and SCWC executed a long-term

power sale contract on March 19, 2001. This consisted of

two separate transaction confirmations covering on-peak and

off-peak hours for a single, long-term sale of 15 MW of

round-the-clock firm energy ("7 x 24 energy"). The delivery

point being the Victorville substation in the South-of-Path 15

("SP 15") zone in Southern California, with delivery to occur

from April 1, 2001 through December 31, 2006, at a fixed

$95/MWh.“ After execution of the SCWC contract, on

March 30, 2001, Mirant and SCWC agreed to a one-month

transaction for April 2001, in which Mirant wouid buy back

the 15 MW of power from SCWC at the spot price of energy

at SP15 (using the Dow Jones Index) minus $20 per MWh

("SCWC Buyback Contract"). “° These contracts were

entered into pursuant to the WSPPA.

23. | The record supports the finding that the contracts at

issue in this proceeding are contracts under the WSPPA.

Moreover, the record supports the finding that the

Confirmation Agreements are part of the WSPPA.

* Tr. at 2897:19-2899:9.

“ Ex. MAEM-2 at 4:9-13.

45 Ex. MAEM-2 at 4:13-17.

*© These agreements are pro forma, the parties simply fill in the blanks to

add their names, rate, length of service, and quantities. The WSPPA

Ro.

8la

Complainants’ contentions that the Confirmation Agreements

are not part of the WSPPA are meritless. Each contract

consists of a Confirmation Agreement, the WSPPA and any

amendments, which together form a single, integrated

document. *” Section 26 of the WSPPA states that

amendments and confirmations constitute the full and

complete agreement.** Section 2.2 of the WSPPA states that

the WSPPA together with any applicable Confirmation

Agreement, sets forth the terms and conditions to implement

these services, within any applicable rate ceilings set forth in

the Service Schedules, in conformance with FERC orders,

where applicable. Additionally, Section 35 of the WSPPA

states: "The Parties acknowledge and agree that all of their

transactions, together with this Agreement and the related

Confirmation Agreement(s) form a single, integrated

agreement, and agreements and transactions are entered into

in reliance on the fact that the agreements and each

transaction form a single agreement between the Parties.*?

24. The record is clear that Section 6.1 of the WSPPA

allows parties to jointly seek modification of the rates, terms

and conditions of the contracts under Section 205 of the

FPA. However, the cited section does not have any language

regarding the parties’ nghts vis-?-vis Section 206 of the

Federal Power Act. None of the confirmation agreements,

except the Morgan Stanley-Snohomish contract, address the

contains draft Confirmation Agreements. (Sample Form for

Confirmation, Exhibit C to WSPPA). Ex. NPC-14.

*” Ex. NPC-14, Section 26.

*8 Ex. NPC-14, Section 26.

as Contrary to Complainants’ contentions, Section 38 of the WSPPA

governs changes to the WSPPA and its service schedules. Ex. NPC-14 at

56. Likewise, SCWC's contentions that Section 6.1 applies only to

changes to the WSPPA is disingenuous.

82a

parties’ rights under section 206 of the FPA.

25. | A summary of applicable law may be helpful in this

regard. In the "Mobile" case a supplier of natural gas sought

to unilaterally increase the rate of a contract filed with the

Commission. In Mobile® the Supreme Court held that the

Natural Gas Act does not empower natural gas companies

unilaterally to change their contracts. This Court went on to

say that by "preserving the integrity of contracts, it permits

the stability of supply arrangements which all agree is

essential to the health of the natural gas industry... The

contracts remain fully subject to the paramount power of the

Commission to modify them when necessary in the public

interest."

26. In "Sierra,"*' a supplier of electric power (a public

utility) tried to unilaterally increase the rate of a contract

filed with the Commission. The Supreme Court stated:

“But, while it may be that the Commission may not

normally impose upon a public utility a rate which would

produce less than a fair return, it does not follow that the

public utility may not itself agree by contract to a rate

affording less than a fair return or that, if it does so, it is

entitled to be relieved of its improvident bargain.... In such

circumstances the sole concern of the Commission would

seem to be whether the rate is so low as to adversely affect

the public interest - as where it might impair the financial

ability of the public utility to continue its service, cast upon

other consumers an excessive burden, or be unduly

discriminatory.”

© United Gas Pipeline Co. v. Mobile Gas Service Corp, 350 U.S. 332

(1956).

*' Federal Power Commission v. Sierra Pacific Power Co., 350 U.S. 348

(1956).

83a

Id. at 355.

27. Staff recites applicable law in its brief. Staff's

arguments and review of the case law is persuasive. The law

is clear: absent contractual language susceptible to the

construction that the rate may be altered while the contract

subsists, the Mobile-Sierra doctrine applies.*” In the absence

of clear contractual language allowing unilateral contract

modifications under Section 206, the party seeking change

must meet the public interest standard. In Texaco, the Court

held that Mobile-Sierra applies: "Because nothing in the

agreements suggests that the contracting parties intended to

grant Mojave unilateral authority to modify shipment rates."

Moreover, in Boston-Edison,* the Court held that "the

specification of a rate or formula by itself implicates Mobile-

Sierra (unless the parties negate the implication). The

Commission has interpreted silence in contracts concerning

section 206 rights as an implicit waiver of the buyer's nghts

to unilaterally modify contracts.”

2 Texaco Inc. v. FERC, 148 F. 3d 1091, 1096 (D.C. Cir. 1998). The

language of the contract in Texaco, was similar to the language of the

contracts in this case, and the Court held Mobile-Sierra applicable.

*? Boston Edison Company v. FERC, 233 F.3d 60 (1st Cir. 2000).

San Diego Gas & Electric Company v. Public Service Company of

New Mexico, 91 FERC 61,233 at 61,851 (2000). See also, Metropolitan

Co. v. FERC, 595 F.2d $51, 855 (D.C. Cir. 1979) (silence regarding FPA

rights invokes public interest standard). In their reply brief the Nevada

Companies cite Alabama Power Co. v. FERC, 993 F. 2d 1557, 1559

(D.C. Cir. 1993). This and other cases cited by Complainants are

inapposite. As a matter of fact, the Nevada Companies’ briefs exhibited a

disregard towards proper citation of the applicable case law. The

Alabama case is inapposite because the facts are totally different, dealing

with a “formula rate" which required Commission "agreed to" review

every three years. Moreover, the cited case is silent on the applicable

standard of proof and precedes the Texaco case cited above. In addition,

Complainants reliance on a recent Commission policy statement is not

persuasive since inter alia, it would not apply to the contracts at issue in

this case. See in general, Pacific Gas and Electric, 506 F. 2d 33, 38 (D.C.

84a

28. Accordingly, it is found that Section 6.1 of the

WSPPA does not negate Mobile-Sierra; therefore, the public

interest standard applies. Nothing in Section 6.1 of the

WSPPA, nor in the underlying confirmation agreements,

suggests that the contracting parties intended to give

unilateral authority to modify the contracts under Section

206 of the FPA. As a matter of fact, this conclusion is

bolstered by the fact that the WSPPA does indeed address

the parties' rights. Thus, Section 6.1 specifically provides

that, under Section 205, the parties may "jointly" seek rate

modifications. The inference to be made from the wording of

the contract is that by agreeing to jointly apply for

modifications, they excluded the possibility of unilaterally

seeking modifications under Section 206 of the FPA. There

is no language in the WSPPA or Confirmation Agreements

allowing unilateral rate changes. In this case, the parties

expressed their intent that the contracts could only be

changed if jointly requested under Section 205. When parties

agree to a specific, fixed rate in a contract, the Mobile-

Sierra’® doctrine applies.*° The contracts in this case contain

Cir. 1974) (a policy statement announces the agency's tentative intentions

for the future). Moreover, the Nevada Companies mischaracterize the

policy statement. To wit, in the policy statement the Commission stated

that it was proposing to hold parties bound to a public interest standard

only when both parties agreed to bind themselves in this fashion, stating

that this is a departure from past precedent. Standard of Review for

Proposed Changes to Market-Based Rate Contracts for Wholesale Sales

of Electric Energy by Public Utilities, FERC Stats & Regs P 32,563 at

34,272 (2002).

*> United Gas Pipe Line Co. v. Mobile Gas Serv. Corp., 350 U.S. 332

(1956) ("Mobile"); Federal Power Comm'n v. Sierra Pacific Power Co.,

350 U.S. 348 (1956) ("Sierra").

*© Richmond Power and Light v. FPC, 481 F.2d 490 (D.C. Cir. 1973);

Boston Edison Co. v. FERC, 233 F.3d 60 (Ist. Cir. 2000) ("Boston-

Edison")

85a

a fixed rate, thus Mobile-Sierra applies. As here, where the

contract has not preserved the rights of a party to seek

unilateral modifications, Mobile-Sierra applies in order to

preserve the contractual expectations of parties by limiting

modification only if the public interest so requires. This

furthers the policy goals of ensuring that parties’ expectations

are respected and promoting stability of contract and supply

arrangements. Mobile-Sierra applies unless the contract

states otherwise.””

29. Staff witness Forman testified that the WSPPA itself

or the rates, terms, and conditions of specific transactions

can be changed in two separate ways. First, through Section

6.1 or through Section 34 which requires that the parties

enter into Dispute Resolution before any other form of

litigation may proceed. Additionally, this witness testified

that the drafters of the WSPPA could easily have added

language to allow other ways of making changes to the

WSPPA or the rates, terms and conditions.*’ This witness

opines that the language of Section 6.1 of the WSPPA makes

clear that the parties intended that transactions could only be

modified as stated in the agreement (jointly under Section

205 or dispute resolution). Thus, the parties intended that the

rates, terms and conditions of a transaction would be final,

and not easily changed, once memorialized in a confirmation

agreement.

*’ Texaco Inc. v. FERC, 148 F.3d 1091, 1095 (D.C. Cir. 1998). See also

Town of Norwood v. FERC, 202 F.3d 392, 400 (ist Cir. 2000); Papago

Tribal Util. Auth. v. FERC, 723 F.2d 950, 953 (D.C. Cir. 1983).

* The Commission recognizing this in the hearing order, required the

parties to submit to mediation before the hearing could proceed. Nevada

Power Company v. Enron Power Marketing, Inc., 99 FERC at 61,193.

Duke Energy Trading and Marketing reached

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