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

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0538%3A03

## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 2008
- **Citation:** 554 U.S. 527

## Text

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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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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22a

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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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
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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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Rehearing, 105 F.E.R.C. at J 61,986.

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.

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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

: = 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 a settlement in this case as
a result of this process.

* Tr at 4513-16; Ex. S-1. :

86a

30. The unrebutted testimony of Dr. Perillo is entitled to
substantial weight. Dr. Perillo testified that contracts
formed by the Transaction Confirmations and the WSPPA
do not permit either party to make unilateral applications to
FERC to modify the rates, terms or conditions of service. He
states that under the maxim "expressio unius est exclusio
alterius," (the expression of one thing is the exclusion of the
other), the only interpretation of Section 6.1 of the WSPPA
is that the parties thought about, contemplated, and provided
for applications to FERC, excluding all applications not
specifically provided for in the contracts. In other words, the
parties agreed that unilateral applications to FERC would not
be permitted under the contracts.*' According to Dr. Perillo,
due to the fact that the parties chose not to modify or
supplement Section 6.1 (which only allows joint application
to FERC) it is clear, as a matter of contract law, that there
was no intent on the part of the parties to the Transaction
Confirmations to allow unilateral applications for contract
modification.”

31. | The WSPPA contains no contractual language which
may be construed as permitting parties to alter the fixed-rate
contracts by means of a unilateral filing. Consequently, the
contracts are governed by the public interest standard. The
Commission has held that it will not read into the parties’
agreements provisions that the parties did not include and
courts have held that fixed-rate contracts fall under the
Mobile-Sierra public interest standard if they omit express
language granting a party the mght to unilaterally seek

© Ex. MAEM-1 at 7:8-10.
*' Ex. MAEM-1 at 10:8-12.

® Ex. MAEM-] at 13:5-9.

87a
contractual modifications.”

32. | Complainants argue that other contracts have specific
reference to Section 206. Complainants’ arguments are not
persuasive. These contracts are not part of this proceeding.
The contract is clear, it contains specific language
concerning the rights of the parties to seek contract
modifications. Therefore, the only rationale interpretation of
Section 6.1 of the WSPPA is that it precluded unilateral
contract modification. Moreover, Dr. Perillo's testimony
concerning parole evidence is persuasive. When parties
"have foreseen an event or action, such as application to
FERC to change the rates, terms or conditions of service
under transactions pursuant to the WSPPA, and have made
some provision for it,” as was done in the WSPPA with
regard to applications to the Commission for contract
modification, parole evidence may not be introduced
regarding the parties intent as to unilateral application for
contract modifications.”

33. Even though the above resolves this issue, the
Commission in its Rehearing Order stated that it wanted a
record developed "to interpret section 6.1 of the WSPP
Agreement and to ascertain the .atent of the parties at the
time the contracts were signed. Consequently, intent will

® City of Lebanon Ohio v. Cincinnati Gas and Elec. Co., 64 FERC
61,341 at 63,445 (1993); Power Authority of New York v. Long Island
Lightning Co., 60 FERC 61,069 at 61,234 (1992). See Boston-Edison,
supra at 65; Union Pac. Fuels, Inc. v. FERC, 129 F.3d 157 (D.C. Cir.
1997). See also San Diego, 91 FERC at 61,851-53.

Ex. MAEM-I at 12:15-20. In their reply brief, the Nevada Companies
concede the point that since there is no ambiguity in the contracts, resort
to extrinsic evidence of intent is not necessary. Nevada Companies RB at
10, 0.6.

*° Nevada Power Company v. Enron Power Marketing, Inc., 100 FERC
at 62,047 (2002) (Rehearing Order).

88a

be considered. The evidence in this case does not support
Complainants’ allegations concerning intent. Complainants’
witnesses’ testimony in this regard is not credible. Substantial
evidence supports Respondents’ arguments concerning this
issue. To wit, Calpine witness Posoli, stated that there is an
understanding among traders in the electricity business that
once agreed to, prices and other terms are fixed and not
subject to later modification.” In particular, in brokered
transactions, involving standard products, the discussions are
limited to the basic economic terms such as t,
quantity, price, delivery period and delivery point.° This is
corroborated by a number of trader telephone conversations
played at the hearing.” Further, corroboration appears in the
testimony of AEP witness William Reed, who testified that
discussions regarding standards of review for future changes
to the contract would have been highly irregular for traders
or brokers.” Even Nevada Companies’ trader Perry stated
that he never considered section 206 and it never came up
during negotiations. ”

34. Furthermore, the arguments that Mobile-Sierra does
not apply to the Nevada Companies contracts because they
were shorter-term forward contracts’' or SCWC's argument

© CES.1 at 9-10.
®’ Tr. 3171-72.

68 Exs. MSC 11; 135;136; 178.

® Ex AEP-1 at 4-5. See also, Tr. 2734-39; 3166; 3181-82; 3260-62;
3334; 3500; 4155-56; Ex. MSC-21 at 10-12.

”® Tr. 2337.

”' The delivery terms of the Nevada Companies’ contracts, in many cases
were for a three-month period. However, the majority of the contracts
would be in force for much longer periods, several months to several
years. Under the terms of the WSPP, only agreements of one year or
longer need be filed. Several of the challenged contracts had terms longer

89a

that Mobile-Sierra applies only to a "low rate” case, are not
persuasive. Mobile-Sierra does not distinguish the length of
the contracts, whether the rates are low or high or whether
the complaint is filed by the buyer or the seller. The PUCN's,
SCWC's and the Nevada Companies’ arguments that Mobile-
Sierra does not apply because the Confirmation Agreements
were not filed with the Commission are not persuasive.” The
Commission has held that, in the case of market-based rates,
the Section 205 requirements are satisfied by the
Commission's determination, prior to the effectiveness of
those rates, that the utility (and its affiliates) lacks market
power or has taken sufficient steps to mitigate market
power.” In this case, an initial review has already occurred
under Section 205 when the Commission approved the
WSPPA and found that all Respondents are authorized to sell
power at market-based rates and that Respondents did not
possess the ability to exercise market power in the WSPP.”*
Thus, the rates under the WSPPA are presumed just and
reasonable. ’° Finally, the Nevada Companies’ and PUCN's
argument that Mobile-Sierra should not apply because the

than one year and were filed with and accepted by the Commission.
Respondents’ IB at 5, n.12.

” The Nevada Companies cite Florida Power and Light Company, 67
FERC 61, 141 (1994). This case is inapposite since it applies to initial
Commission review under Section 205. This is not the case here.

” See, e.g. San Diego Gas and Electric Company, 91 FERC at 61,853
(applied the public interest standard to a "high rate" case where the buyer
was seeking to decrease the rate). ("California Refund Proceeding")

“The WSPPA and pro forma Confirmation Agreements set guidelines
for the development of contract prices, setting market based rates or rates
under established price caps. As Staff appropriately points out, as long as
the contract prices at issue fall within these guidelines, which they did,
they are entitled to a presumption of justness and reasonableness. Staff
RB at 4.

"> California v. British Columbia Power Exch. Corp., 99 FERC 61,247 at
62,063 (2002).

90a

market was dysfunctional is without merit. This is indeed the
issue in this case, whether the dysfunctions in the Cal PX
and ISO spot markets adversely affected the forward
markets.

35. | SCWC argued that the Commission in the California
Refund Proceeding asserted that the just and reasonable
standard would apply to long-term contracts. This contention
is specious. The Commission did not make a public interest
finding that Mobile-Sierra would not apply (as it did for
instance, in Order 888).’° Moreover, this hearing would be
superfluous if the Commission had made the finding that
SCWC contends. Nor is there a basis for applying a "more
flexible" standard as the PUCN argues. The cases cited in
support of the PUCN's arguments are inapposite, referring to
initial evaluations of contracts under Section 205 and not to
cases like the ones here where the parties to the contracts are
seeking to change the rates.’’ Moreover, the hearing order in
this case specifically referred to Mobile-Sierra and the just
and reasonable standard. These pronouncements are binding
in this case. Furthermore, the Commission has applied the
public interest standard to challenges brought by non-
contractual parties.”

36. Accordingly, it is found that the Mobile-Sierra public
interest standard applies to the contracts in this case. In

”® See Transmission Access Policy Study Group v. FERC, 225 F.3d 667,
709-12 (D.C. Cir. 2000).

” Southern Company Services, 67 FERC 61,080 (1994) (Commission not
bound, absent its consent, to a public interest standard of review when
the Commission reviews an agreement initially). P/M Interconnection,
LLC, 96 FERC 61,206 (2001) (a third party non-signatory to an
agreement was significantly umpacted if the agreement were to remain
unchanged).

™ See, e.g. Public Utility Commission v. Sellers of Long Term Contracts,
100 FERC 61,098, 61,396 (2002).

9la

addition, it is found that the record supports a finding that the
parties did not intend to retain for Complainants the right to
unilaterally seek changes to their contracts.

Issue I].

Whether the dysfunctional California Independent
System Operator (ISO) and Power Exchange (PX) spot
markets adversely affected the Western long-term bilateral
markets?

A. Parties Contentions:

37. |The Nevada Companies assert that its witnesses
established that prices in the Cal ISO and PX spot markets
drove prices in spot markets throughout the Western System
Coordinating Council ("WSCC"). According to the Nevada
Companies, forward market prices are based upon expected
future spot market prices. ”? The forward price will be equal
to the expected spot price for the delivered power adjusted
for the risk associated with uncertainty in the spot price, the
Nevada Companies maintain. The dysfunctional spot
markets strongly influenced forward prices in the West.”
Additionally, the Nevada Companies assert that the
dysfunctional Cal ISO and PX spot markets adversely
affected forward market prices for energy to be delivered in
years 2002 and 2003, to the extent that the dysfunction 1 in the
Cal ISO and PX spot markets was expected to persist.®

38. In addition, the Nevada Companies argue that the
forward price curves provide proof that at the time the

”? The Nevada Companies’ IB at 16.
*° id. at 18.
* Id.

92a

contracts were executed, market participants expected
dysfunction to continue at least through 2002 and possibly
into 2003." These forward price curves show that forward
market prices remained high until the Commission acted in
the spring and summer of 2001 to mitigate the impact of spot
market dysfunction through the imposition of price caps,
when market prices declined dramatically, the Nevada
Companies assert.*’ The actions taken by the Commission in
November and December 2000 did not convince market
participants that the Commission would eliminate the
dysfunction in the spot market.** According to the Nevada
Companies, statistical analysis shows that forward market
prices had lots of movement when spot market prices were
static, because the forward price changes anticipating future
mitigation began to happen before the spot price changes
took place. Thus, despite the obvious linkage, a low
correlation could show, the Nevada Companies argue.®° The
Commission found that the April 2001 Order reduced prices
in the California spot markets and, in turn, in the Western
long-term bilateral markets, confirming the actual
interdependence of prices in the two markets.

39. Both SCWC and Snohomish assert that the spot
market dysfunctions created hugely inflated expectations of
future prices, plus administered a fatal blow to the liquidity
of the forward markets. *’ Moreover, these companies
maintain that FERC's attempts to correct the spot market
dysfunctions by moving the loads of California's Investor

* Id.

© Id. at 21.

* Id. at 22.

-®’ Nevada Companies RB at 13.
* Id. at 20.

*” SCWC/Snohomish IB at 10.

93a

Owned Utilities (Cal IOUs) to the forward markets and a
federal order requiring power to be sold io the Cal ISO
during the crisis, led to even higher demand, less supply, aud
higher prices in the forward markets. The forward price for
a one-year contract (peak MidC) increased and by January
26, 2001, had increased by over 900 percent.®? Both SCWC
and Snohomish assert that prices available for long-term
contracts during the crisis were two to three times over the
long run marginal costs ("LRMC") and the forward price
curves during the crisis projected that prices would remain
far above LRMC for many years.” Even in periods of
shortages, long-term prices should approach LRMC within
the period necessary to construct new plants, two to three
years. Indeed, in functionally competitive markets, most of
the backwardation (i.e. the excess of spot prices over the
LRMC) disappears within the first twelve to eighteen months
of the forward price curve. However, both SCWC and
Snohomish maintain that none of this happened in the
Western markets during the crisis.”

40. The Western forward markets, during the crisis, also
suffered from a severe lack of liquidity (an adequate number
of sellers willing to conduct business), SCWC and
Snohomish maintain. ** The CalPX Block Forward and
NYMEX forward markets collapsed as a result of the
California crisis and very few sellers were willing to trade in
the forward bilateral markets, according to SCWC and
Snohomish,” thus eliminating the available choices to both

* fd. at 10.
* Id. at 11.
” Id. at 12.
" Id. at 12.
% Id. at 13.
% Id. at 13.

94a

companies. The volatility of the forward markets during the
crisis period is further evidence of the pervasive dysfunction
of those markets, according to SCWC and Snohomish. This
volatility led to untenable deals for Snohomish and SCWC,
because any delays in considering the contract terms would
result in price increases, both companies aver.”

41. Additionally, these companies argue that price
discovery in the Western forward markets was limited and
subject to manipulation. For instance, these companies argue
that California markets operated under secrecy, so that data
was not readily available from these markets. Similarly,
forward gas and electricity markets in other parts of the West
were characterized by a lack of adequate market information.
In addition, SCWC and Snohomish argue that the reported
prices for both natural gas and electricity were purposefully
manipulated and that sham trading artificially inflated
forward market prices in the Northwest by as much as
twenty-five percent. These compania; further argue that the
lack of reliable market data made it difficult or impossible
for buyers to obtain reasonable prices.”° Both SCWC and
Snohomish conclude that the Enron manipulations reached
beyond the California borders and influenced directly the
prices that Snohomish faced in the long-term market.”

42. | SCWC and Snohomish argue that the Commission
has repeatedly confirmed the relationship between spot and
forward prices.”’ In addition, they maintain that there is a
direct and well-understood economic relationship between
spot market prices and forward market prices. Spot market

™ Id. at 14.
% Id. at 14.
* Id. at 15.
” Id. at 16.

95a

prices represent the opportunity cost of selling power in the
forward markets, SCWC and Snohomish argue. As such, the
inflated prices charged in the dysfunctional California spot
market had a direct adverse effect on the prices at which
sellers offered to sell power in the forward market. As a
matter of fact, SCWC and Snohomish argue, the relationship
between spot and forward market prices tightened during the
crisis because the breakdown of ordinary market functions
made it extremely difficult to predict the movement of
forward markets based on anything other than the then
current spot market prices. “ SCWC and Snohomish
maintain that the inflated spot prices inflated sellers’
opportunity costs, pursuant to sales under long-term forward
contracts, and that during the first three months of 2001, this
caused sellers to offer inflated prices under long-term
contracts.” A seller would not forego the inflated prices
available in the spot market unless compensated by its prices
for sales in the long-term forward market.'”

43. These companies additionally maintain that the
forward prices, during the crisis period, were also artificially
inflated by the volatility and uncertainty in spot markets due
to market dysfunction and market power. '®' Thus, the
dysfunctions in the spot markets translated into dysfunctions
in the forward markets

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0538%3A03. Public record. Not legal advice.