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

S70 77/ Co.

35 | ‘Ak i «2006

Ce OF THE SLES

34(p _ Nos. 06-1457 and 06-1462 " COUA Ne

IN THE

Supreme Court of the Anited States

MORGAN STANLEY CAPITAL GROUP INC., PETITIONER,

Vv.

PUBLIC UTILITY DISTRICT NO. 1 OF SNOHOMISH COUNTY,

WASHINGTON, ET AL., RESPONDENTS.

CALPINE ENERGY SERVICES, L.P., ET AL., PETITIONERS,

V.

PUBLIC UTILITY DISTRICT NO. 1 OF SNOHOMISH COUNTY,

WASHINGTON, E£7'AL., RESPONDENTS.

On Writ of Certiorari to the

United States Court of Appeals

for the Ninth Circuit

BRIEF OF THE LARGE PUBLIC POWER

COUNCIL AS AMICUS CURIAE

IN SUPPORT OF RESPONDENTS

JONATHAN D. SCHNEIDER

Counsel of Record

HARVEY L. REITER

M. DENYSE ZOSA

STINSON MORRISON HECKER LLP

1150 18th Street, N.W., 800

Washington, DC 20036

(202) 785-9100

Counsel for the Large Public Power

Council

January 14, 2008

i

QUESTION PRESENTED BY

LARGE PUBLIC POWER COUNCIL

The Federal Power Act declares that, whenever

the Federal Energy Regulatory Commission finds,

upon complaint, that “any rate, charge ... or

contract” for a sale for resale of energy in interstate

commerce is “unjust [or] unreasonable,” it must

“determine the just and reasonable rate, charge, .. .

or contract” and “fix the same by order,” id. §

824e(a). Did the Federal Energy Regulatory

Commission (“FERC” or “Commission”) err ‘in

determining that long-term market-based rate

agreements formed during a period of severe spot

market dysfunction are presumptively to be just and

reasonable under the Federal Power Act pursuant to

United Gas Pipe Line Co. v. Mobile Gas Serv. Corp.,

350 U.S. 332 (1956), and FPC v. Sierra Pacific Power

Co., 350 U.S. 348 (1956).

ll

TABLE OF CONTENTS

QUESTION PRESENTED BY LARGE PUBLIC

EE ns iantinnssciscicntounainsisiiirtiinusnnnienitonsii i

ae III sentirictecenconsnssnnpenaicernnninessiinniiesieas i

ee Br I cin vicercsscistcsetereennsonteenticis iil

TE Se? GI ectincccrnsinncssnenicesinstinnitenicsciniidi l

SUMMARY OF ARGUMENT. ............... 0. eeeeeeeeees 3

TE iicisinieesitcsniiinieniitetayiieiicn ieiiteiamaliniiideieuniitanntiindte 7

1. MARKET-BASED RATE AGREEMENTS

FORMED DURING A PERIOD OF MARKET

DYSFUNCTION CANNOT BE PRESUMED

TO BE JUST AND REASONABLE UNDER

THE MOBILE-SIERRA DOCTRINE..................... 8

A. The Ninth Circuit is Right that a

Functional Market is an Essential

Prerequisite for Application of the Mobile-

Sierra Presumption that Contract Rates

are Just and Reasonable in a Market-

Re a a OE 8

B. Market-Based Rate Contracts Formed

During a Period of Market Dysfunction

Cannot Be Presumed to be Just and

a celal 13

II.

III.

ill

PETITIONER’S CONCERN OVER THE

IMPACT OF CONTRACT

MODIFICATION ON THE INVESTMENT

CLIMATE ARE OVERSTATED AND, IN

ANY EVENT, NO BASIS FOR REFUSING

TO REMEDY UNLAWFUL RATEB................ 21

CHEVRON IS INAPPLICABLE WHERE, AS

HERE, THE AGENCY'S DECISION IS

BASED, NOT ON ITS INTERPRETATION OF

THE STATUTE IT ADMINISTERS, BUT ON

A MISTAKEN INTERPRETATION OF THIS

COURT'S PRECEDENTG..................sseseseeee 24

I itiiiccisinistcticnsiiedatictinntiapnienimidieaneniin 26

iv

TABLE OF AUTHORITIES

CASES

American Paper Inst. v. American Elec. Power,

ee ee ee csmasenesouabensoncnses 24

Atlantic City Elec. Co. v FERC,

I Oe, Oe ee Cs SD ccvevcivccscccossccrsesecses 9

California ex rel. Lockyer v. FERC,

383 F.3d 1006 (9th Cir. 2004).............. 6, 12, 16

Chevron USA v. Natural Res. Defense Council,

Ge Pe Fe I wrcicckcscccccescnccccesscscacoves 24, 25

Elizabethtown Gas Co. v. FERC,

10 F. 3d 866 (D.C. Cir. 1993) ......... 5, 11, 12, 16

Farmers Union Cent. Exch., Inc. v. FERC.

734 F.2d 1486 (D.C. Cir. 1984) 0.0000... 5, 12, 16

FPC v. Sierra Pacific Power Co.,

ee cousssevaboadidanbe i, 5

FPC v. Texaco, Inc.,

I ccsicenle 20, 24

Maine Pub. Util. Comm'n v. FERC,

454 F.3d 278 (D.C. Cir. 2006) 0.00.0... 9

Maislin Indus. US v. Primary Steel, Inc.,

re I os ccasudtansuonnooees 12, 20

MCI Telecomm. Corp. v. AT&T.

Re Br, EOD vceccncccccesececseveseressesseces 12, 20

Meyers Indus., Inc. v. Prill,

is calaiamnennainiiianintens 25

Vv

New England Motor Rate Bureau, Inc. v. Fed. Trade

Comm'n,

908 F.2d. 1064 (1%t Cir. 1990).......00 ccc eee. 25

Northeast Utils. Serv. Co. v. FERC.

55 F.3d 686 (18t Cir. 1995)........... cece eeeeeee eee 23

Phillips Petroleum Co. v. FERC,

792 F.2d 1165, (D.C. Cir. 1986) ....00... ce. 25

Potomac Elec. Power Co. v. FERC.

210 F. 3d 403, (D.C. Cir. 2000) ...........00.0cce. 9

Prill v. NLRB,

755 F.2d 941 (D.C. Cir. 1985) ........c ee 25

Sierra Pacific Power Co.v. FPC,

BD TE, BD Ge nccescossdcvccesscccccsesccesvess i, 5,13

Texaco, Inc. v FPC,

417 U.S. 380, 397-98 (1974)... 20, 24

Town of Norwood v. FERC,

587 F. 2d 1306 (D.C. Cir. 1978) 0.0.0... 9

United Gas Pipe Line Co. v. Mobile Gas Serv. Corp.,

tos Bl Ens reer i, 5, 13, 20

Verizon Communications, Inc. v. FCC,

Ie Be St I cs scinercncinshnmnmncioeunteaaiasenaale 20

ADMINISTRATIVE GRDERS

AEP Power Mktg., Inc.,

97 FERC 4 61,219 (2000) ..........0cccc eee 14

vi

Californians for Renewable Energy, Inc. v. California

Pub. Utils. Comm'n,

119 FERC 4 61,058 (2007) .................ccceceeeee. 3

Enron Power Mktg., Inc.,

106 FERC 4 61,024 (2004) ...............cccccceeeeees 15

Nevada Power Co. and Sierra Pacific Power Co. v.

Enron Power Mktg., et al.,

103 FERC 4 61,353 (2003) «00000000... 10

Northeast Utils. Serv. Co.,

66 FERC 4 61,332 (1994). oo... 9, 23

San Diego Gas & Elec. Co. v. Sellers of Energy &

Ancillary Servs.,

93 FERC 4 61,121 (2000). ..............ccccccceeeeeees 14

San Diego Gas & Elec. Co.,

96 FERC 4 61,120 (2004) .......... eee eens 15

Tenneco Oil Co.,

26 FERC 4 61,030 (194) .....................0000...... 20

ADMINISTRATIVE MATERIALS

FERC

Alternatives to Traditional Cost-of-Service

Ratemaking for Natural Gas Pipelines,

74 FERC 4 61,076 (1996) .........0000000. 16, 17

Final Report on Price Manipulation in Western

Markets (Mar. 3, 2003), available at http://

a aia anrniadcenensonensens 4

vi

STATUTES, REGULATIONS, AND RULES

§ 205(a), 16 U.S.C.A. § 824d(a).............. 7, 11, 13, 17

I scsi iacisiniictniaeneeipeiiabiiienideinesiliais 20

SI HES UII 0 cnenrienadiionondnnnidinisisninaneddibiils 1

OTHER MATERIALS

Public Power, Volume 56, No. 3, “The False Promise

of Restructuring” (May-June 2007). ............... 7

David Cay Johnston, “A New Push to Regulate

Power Costs,” N.Y. Times, Sept. 4. 2007 at C1.7

David Cay Johnston, “Competitive Priced Electricity

Costs More, Studies Show,” N.Y. Times, Nov. 6,

2007 at C4, corrected Nov. 15. 2007 ................ 7

l

INTEREST OF AMICUS!

The Large Public Power Council (“LPPC”) is an

association of twenty-four of the nation’s largest

municipal and state-owned utilities.2 LPPC members

provide reliable, low-cost electric service to most of

the more than 40 million people served by public

power. Together, LPPC members own and operate

over 75,000 megawatts of generation and

' Pursuant to Supreme Court Rule 37.6, counsel for amicus

represents that no counsel for a party authored this brief in

whole or in part, and that no counsel or party other than amicus,

its members, or its counsel, made a monetary contribution

intended to fund the preparation or submission of this brief.

Counsel discloses that another member of the law firm in which

counsel is a member represents the Nevada Attorney General,

Bureau of Consumer Protection, a Respondent herein, and that

Snohomish County Public Utility District is a member of LPPC,

although no special assessment of costs for preparation of this

brief was made to LPPC members. Pursuant to Supreme Court

Rule 37.3(a), counsel for amicus further represents that all

parties have consented to the filing of this brief. Letters

reflecting this consent have been filed with the Clerk.

2 LPPC’s members joining this brief are: Austin Energy, Clark

Public Utilities, Colorado Springs Utilities, CPS Energy (San

Antonio), IID Energy (Imperial Irrigation District), JEA

(Jacksonville, FL), Long Island Power Authority, Los Angeles

Department of Water and Power, Lower Colorado River

Authority, MEAG Power, Massachusetts Municipal Wholesale

Electric Company, Nebraska Public Power District, New York

Power Authority, Omaha Public Power District, Orlando

Utilities Commission, Platte River Power Authority, Puerto Rico

Electric Power Authority, Sacramento Municipal Utility District,

Salt River Project, South Carolina Public Service Authority

(Santee Cooper), Seattle City Light. Snohomish County Public

Utility District No. 1, and Tacoma Public Utilities. Public Utility

District No. 1 of Chelan County is an LPPC member but does not

join this brief.

2

approximately 34,000 circuit miles of transmission

line. LPPC members are governed by state and local

laws establishing that their core obligations are to

provide reliable service to native load customers at

the least possible cost.

LPPC members own distribution, transmission

and generating assets and_ generally supply

substantial portions of their load through generation

they own themselves. To supplement that supply,

LPPC members are active in purchasing electric

supply in competitive markets regulated by the

Federal Energy Regulatory Commission. LPPC

members have, accordingly, an avid interest in

ensuring that rates in these markets are just and

reasonable.

The Western energy crisis of 2000-2001 badly

shook LPPC members’ confidence in _ federally

regulated competitive markets for wholesale electric

service. While the FERC has taken certain steps to

rectify prospectively those market conditions that

FERC itself described as “dysfunctional,” the

Commission's refusal in the orders on review to

protect customers exposed to market dysfunction

serves as an ongoing warning that reliance on federal

wholesale markets may be inconsistent with LPPC

members’ core obligations to their customers to

provide least cost reliable service. LPPC’s

participation in this appeal reflects an effort to

restore confidence in the competitive wholesale

market. Consumer confidence is essential to

partic pation in, and ultimately the health of, the

marke. for competitive power.

3

SUMMARY OF ARGUMENT

By FERC’s own account, the Western energy crisis

of 2000-2001 was the “worst in the Nation’s history.”3

Just two years into the Commission’s large-scale

experiment with market-based rates, the West

experienced “unprecedented market dysfunction.”4

The Western energy crisis resulted from a

combination of regulatory misjudgment, unique

natural events, the exercise of market power and

market abuse. The Commission described events

contributing to the crisis as a confluence of “flawed

market rules; inadequate addition of generating

capacity facilities in the preceding years; a drop in

available hydropower due to drought conditions; a

rupture of a major pipeline supplying natural gas into

California; strong growth in the economy and

electricity demand; unusually high temperatures; an

increase in unplanned outages of extremely old

generating facilities; and market manipulation.”

Californians for Renewable Energy, Inc. v. California

Pub. Utils. Comm’n, 119 FERC 4 61,058 at para. 30

(2007). As the Commission further commented, these

actions and events conspired “to place California and

the entire West in an electricity crisis that had never

before been experienced.” Jd.

At the height of this crisis, in sometimes desperate

efforts to ameliorate the exposure of their customers

to these markets, wholesale customers, including

LPPC members, sought what they hoped would be the

3 Brief of the Federal Energy Regulatory Commission In

Opposition to Certiorari at 22, filed in these proceedings on

August 6, 2007 (“FERC Br.”)

4 Jd. at 13

4

relatively safe harbors of long-term electric supply

agreements. As FERC Commissioner Massey noted

in his dissent below, FERC encouraged customers to

enter into these contracts, and “assured buyers that

they would be protected from the exercise of market

power.” Further, Commissioner Massey noted that

the Commission “set a $74 Mwh benchmark” which it

said it “would expect to use in assessing any

complaints regarding the justness and reasonableness

of pricing such long-term contracts negotiated under

current market conditions.” JA 1308a (citing 93 FERC

para 91,294 at 61,982 (2000)).

Thus, it is quite clear that dysfunction in FERC-

administered spot market had a dramatic adverse

impact on prices available to these customers in long:

term forward markets. FERC’s Staff so concluded in

its “Final Report on Price Manipulation in Western

Markets,” issued on March 3, 2003 in Docket No.

PA02-2-000 (“Staff Report”). JA 209sa. And while

prices in the spot market eventually responded

favorably to the Commission's ministrations (thereby

revealing the extent of the dysfunction), prices set in

long-term agreements have continued to reflect the

impact of the dysfunctional market during the 2000-

2001 energy crisis.

In the orders on review, the Commission expressly

stated the finding that the spot market at the time

the contracts at issue were negotiated was

“dysfunctional” and that the rates for sales of power

in the short-term spot market were “unjust and

unreasonable,” as that term is understood in the

Federal Power Act (“FPA”). JA 1222a — 1299a at JA

1275a; JA 1554a. Further, the Commission

acknowledged the conclusion of its Staff Report that

spot market distortions flowed through to forward

power prices, and thus directly affected contracts

entered into for future delivery.

Nevertheless, the Commission went on to hold

that such evidence was not “relevant” under the

"public interest” standard applicable to the

agreements under the Mobile-Sierra_ doctrine.5

According to the Commission, “[a] finding that unjust

and unreasonable spot market prices caused forward

market prices to be unjust and unreasonable would be

relevant to contract modification only where there is a

‘just an reasonable’ standard of review.” JA 1275a-JA

1276a. “Under the ‘public interest standard,” FERC

held, “to justify contract modification it is not enough

to show that forward prices became unjust and

unreasonable due to the impact of spot market

dysfunctions; it must be shown that the rates, terms

and conditions are contrary to the public interest.” Jd.

Rates under the agreements were instead presumed

to be just and reasonable.

The Commission’s decision to presume under the

Mobile-Sierra doctrine that contract rates entered

into during this period of acknowledged market

dysfunction are just and reasonable is clear error.

While the courts have agreed with the Commission

that competitive forces may be relied on to achieve

just and reasonable rates,® it is axiomatic that when

5 The Mobile Sierra doctrine refers to this Court's companion

decisions in United Gas Pipe Line Co. v. Mobile Gas Service

Corp., 350 U.S. 332 (1956) (“Mobile”), and FPC v. Sierra Pacific

Power Co., 350 U.S. 348 (1956) (“Sierra”) (together, “Mobile-

Sierra”)

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

1501-09 (D.C. Cir. 1984); Elizabethtown Gas Co. v. FERC, 10 F.

6

such markets break down, the rates they produce

cannot be presumed to be just and reasonable, as the

Commission decisions on review concede. When that

happens — when markets become dysfunctional (to

use the Commission’s own description) — it is wrong to

conclude that rates in contracts entered into in such a

period can be presumed to be just and reasonable.

Side-stepping the issue of just and reasonable

rates, the Commission, other Petitioners, and

supporting Amici, have made much of the potential

adverse impact that reversal of the Commission may

have on the climate for investment.’ Yet, the

circumstances presented on appeal in which contracts

would be subject to review under a just and

reasonable standard are narrowly confined to those in

which the agency has itself determined that markets

are dysfunctional. In its brief opposing certiorari,

referencing reforms which FERC says will help it

ensure that markets function properly, FERC itself

commented that these circumstances are unique and

unlikely to be repeated.

Moreover, to the extent the investment climate is

taken into account, LPPC also urges the Court to

weigh the impact on the marketplace of a decision

frustrating consumers legitimate expectation of

regulatory protection from dysfunctional markets.

While FERC has recently taken steps to police

competitive markets prospectively, the assurance that

adequate remedies are available when markets go

3d 866 (D.C. Cir. 1993); California ex rel. Lockver v. FERC, 383

F.3d 1006, 1009 (9th Cir. 2004), cert. denied, 127 S. Ct. 2972

(2007) (“Lockyer’).

7 See infra note 18.

awry provides confidence in market outcomes.

Consumer confidence in the market is as important a

factor as investor confidence in creating a sound

market structure and, ultimately, a firm basis for

investment. Consumer confidence has been badly

shaken,’ and without it, those consumers who can

will vote with their feet. Surely, the climate for

competitive investment cannot be benefited by this.

Ultimately, the Court must direct the Commission

to comply with its governing statute. FPA section

205(a) stipulates that “[aJll rates and charges made,

demanded, or received by any public utility for or in

connection with....the sale of electric energy subject to

the jurisdiction of the Commission....shall be just and

reasonable, and any such rate or charge that is not

just and reasonable is hereby declared unlawful.” 16

U.S.C.A. § 824d(a). In a dysfunctional market,

adopting a presumption that contract prices affected

by such dysfunction are just and reasonable conflicts

with the agency’s statutory responsibility and

common sense.

8 See Public Power, Volume 56, No. 3, “The False Promise of

Restructuring.” See David Cay Johnston, “A New Push to

Regulate Power Costs, “ N.Y. Times, Sept. 4. 2007, at Cl. See

David Cay Johnston, “Competitive Priced Electricity Costs More,

Studies Show,” N.Y. Times, Nov. 6, 2007, at C4, corrected Nov.

15, 2007.

8

ARGUMENT

I. MARKET-BASED RATE AGREEMENTS

FORMED DURING A PERIOD OF

MARKET DYSFUNCTION CANNOT BE

PRESUMED TO BE JUST AND

REASONABLE UNDER THE MOBILE-

SIERRA DOCTRINE.

A. The Ninth Circuit is Right that a

Functional Market is an Essential

Prerequisite for Application of the

Mobile-Sierra Presumption that

Contract Rates are Just and

Reasonable in a Market-Based Rate

Setting.

FERC and Petitioners are wrong to attack the

Ninth Circuit for establishing what are said to be

unprecedented “prerequisites” to application of the

Mobile-Sierra doctrine. While the Court in Mobile

and Sierra did not speak of conditions or

“prerequisites” to the application of the doctrine,

those decisions addressed the question whether rates

were just and reasonable in the context of a tightly

regulated, cost-based rate regime. In that historical .

setting, with the regulated, cost-based rate serving as

recourse for both buyer and seller, it is entirely

reasonable to presume that rates and terms derived

by mutual agreement of the parties are just and

reasonable, absent a significant showing why it would

be otherwise. By contrast, in a market-based rate

9 FERC Br. at 25-26; Brief of Calpine Energy Services, L.P., et

al, at 48-52 (“Calpine Br.”).

9

setting, there is no basis for a presumption that —

negotiated rates are just and reasonable unless there

is reasonable assurance that the market is

functioning appropriately.

In cases subsequent to Mobile and Sierra, in which

more novel terms and conditions of service have been

at issue, with judicial blessing, FERC has in fact been

more jealous of its initial prerogative to review

agreements ab initio, and not simply to allow parties

the benefit of a presumption that their bargain is in

the public interest without substantive review. See,

e.g., Maine Public Utils Comm'n v. FERC, 454 F.3d

278, 283 (D.C. Cir. 2006), in which the court

comments that the Mobile-Sierra presumption has no

place when a contract (in that case, regarding

formation of a Regional Transmission Organization)

is submitted to FERC for the first time. See also

Potomac Elec. Power Co. v. FERC, to 210 F. 3d 403,

409 (D.C. Cir. 2000) (applying the doctrine in “first

review cases would mean that [the agency's] ability to

protect the public interest would be negligible and

public regulation would consist of little more than

rubber-stamping private contracts.” (quoting

Northeast Utils. Serv. Co., 66 FERC 4 61,332 at p.

62,087 (1994)). Further, the courts have been clear

that that the Mobile-Sierra presumption applies only

so long as “there is no reason to question what

transpired at the contract formation stage.” See e.g.,

Atlantic City Elec. Co. v FERC, 295 F.3d 1, 14 (D.C.

Cir. 2002); Town of Norwood v. FERC, 587 F. 2d

1306, 1312 (D.C. Cir. 1978).

On Brief, FERC now eschews the need to review

what at transpired at the contract formation stage,

and disputes its practicality, asserting that its order

10

granting a utility market-based rate authority

provides blanket approval of rates under contracts

entered into subsequently. 103 FERC 4 61,353 at

para. 37. JA 1246a. FERC asserts that a requirement

to approve each agreement would fundamentally

conflict with the market-based rate framework. /d.

While LPPC does not disagree that blanket approval

for market-based agreements may be provided, the

ensuing presumption that contract rates are just and

reasonable can only attach if the market place in

which these agreements are executed is functional.

In its Brief in Opposition to certiorari at 24, FERC

observed that neither this Court, nor any other, has

had reason to consider the application of the Mobile-

Sierra doctrine in the context of a market-based rate

regime. Addressing petitioners seeking certiorari,

FERC commented that none of the cases applying

Mobile-Sierra “concerned a market-based contract,

much less one entered into during the Nation’s worst

power crisis.” Jd.

Stepping into the breach, the Ninth Circuit

concluded that the Commission’s blanket approval of

market-based rate contracts would be an acceptable

predicate for invoking the Mobile-Sierra presumption

if (1) procedures had been put in place for timely

reconsideration of market-based rate authority when

warranted; and (2) consideration is given to the

market conditions at issue when contracts are

formed. !°

Put slightly differently, the Ninth Circuit correctly

held that in view of the fluid operation of the

marketplace, the Commission must assure on a

10 Pet. App. 38a, 46a, 56a - 58a.

11

current basis that market-based rates continue to be

just and reasonable if contracts entered into under

this regime are to enjoy a presumption that they meet

the statutory standard. FERC itself acknowledges

that the circumstances at the time a seller is granted

market-based rate authority can change

unpredictably. FERC Br. At 34. Without the

assurance that markets are not dysfunctional at the

time contracting parties enter into their agreements,

it simply cannot be presumed that the agreements are

just and reasonable. If, as the Commission concedes

was the case here, markets at the time of contract

formulation were dysfunctional, customers must be

permitted an opportunity to prove that their

agreements are unjust and unreasonable.

The Ninth Circuit’s approach reasonably delivers

on the statutory assurance that rates will be just and

reasonable in a market-based rate setting, while

honoring the Mobile-Sierra presumption favoring

freely negotiated contracts.?! While courts

considering the question have generally agreed that

the just and reasonable standard may be met by

reliance on a market-based rate regime, the decisions

have been equally clear that this regime carries with

it an obligation on FERC’s part to provide the ongoing

assurance that the conditions justifying market-based

rates will continue to be met. In, e.g., Elizabethtown

Gas Co. v. FERC, 10 F.3d 866 (D.C. Cir. 1993), while

satisfied that the Commission had demonstrated

'! FPA section 205(a) stipulates that “la]ll rates and charges

made, demanded, or received by any public utility for or in

connection with....the sale of electric energy subject to the

jurisdiction of the Commission....shall be just and reasonable....”

16 U.S.C.A. § 824d (2005).

12

initially that the applicants’ markets’ were

“sufficiently competitive to preclude it from exercising

significant market power,” the court further relied on

FERC’s guarantee that “it will exercise its [Natural

Gas Act) § 5 authority (upon its own motion or upon

that of a complainant) to assure that a market...rate

is just and reasonable.” /d. at 870. In Farmers Union

Cent. Exch. Inc. v. FERC, 734 F.2d 1486 (D.C. Cir.

1984), while positing the potential] for market forces

to bring rates within a just and reasonable level, the

court faulted the Commission for its “largely

undocumented reliance on market forces.” Jd. at

1508.

Similarly, in California ex rel. Lockyer v. FERC,

383 F.3d 1006, 1014 (9th Cir. 2004), cert. denied, 127

S. Ct. 2972 (2007) (‘Lockyer’), while upholding the

Commission’s reliance on market forces in order to

establish just and reasonable rates, the court faulted

the Commission for failing to administer its quarterly

reporting requirement, a mechanism that the court

concluded would have enabled the Commission to

ensure that the statutory standard is met, thereby

avoiding the charge that it effectively deregulated

prices, in violation of the statutory requirement that

rate. be filed and continue to be just and reasonable.

As the court in Lockyer pointed out, in failing to

provide a mechanism for monitoring and remedying

prices where needed, the Commission had effectively

deregulated prices administratively, in contravention

of the statute and this Court’s decisions in MC/

Telecomm. Corp. v. AT&T, 512 U.S. 218 (1994) and

Maislin Indus. US v. Primary Steel, Inc., 497 U.S. 116

(1990). Jd. at 1014.

13

The Commission is capable, as it states, of

remedying dysfunctional markets on a prospective

basis. But, as FERC itself observes, market

dysfunction may arise after the execution of a

contract and can occur unpredictably. FERC Br. at

34. Thus, unless a functioning market is held to be a

predicate for application of the Mobile-Sierra

presumption, the promise of prospective correction

essentially cuts adrift from statutory protection those

customers who have entered into long-term

agreements. This is a poor result as a matter of

policy, because it discourages parties from entering

into long-term agreements.'2 As a matter of law, it

violates the assurance in FPA section 205(a) that

“[aJll rates and charges made, demanded, or received

by any public utility for or in connection with....the

sale of electric energy subject to the jurisdiction of the

Commission....shall be just and reasonable, and any

such rate or charge that is not just and reasonable is

hereby declared unlawful.” 16 U.S.C.A. § 824d.

B. Market-Based Rate Contracts

Formed During a Period of Market

Dysfunction Cannot Be Presumed to

be Just and Reasonable.

“The California ISO and PX spot markets,” FERC

stated below, “were dysfunctional during the relevant

period” and “the rates in those markets were unjust

and unreasonable. JA 1275a. FERC further

acknowledged that its Staff Report concluded that

spot market distortions flowed through to forward

'2 This point was made by dissenting Commissioner Massey. See

JA 1308a — 1309a.

14

power prices, and to contracts entered into for future

delivery. JA 1275a. And during this same period

FERC made two commonsense observations about the

relationship between the spot markets and prices in

the long term markets. “Maintaining an accurately

priced spot market,” it said in AEP Power Mktg., Inc.,

97 FERC 4 61,219 at 61,972 (2000), is the single most

important element for disciplining longer term

transactions.” “Higher spot market prices,” it also

observed, “in turn affect the prices in forward

markets.” San Diego Gas & Elec. Co. v Sellers of Elec.

and Ancillary Servs., 93 FERC 4 61,121 at 61,367

(2000).

The Commission nevertheless held that, under the

Mobile-Sierra doctrine, none of this was relevant to

the question whether to modify contracts entered into

during this period. Denying even the need to

ascertain whether its Staff was right in determining

that spot market distortions affected prices in forward

contracts, or the conclusion that the markets were

subject to market manipulation and gaming, the

Commission held:

[Elven if we were to assume that these

allegations and/or findings were true, they

would not be determinative of the issues in the

instant proceeding. | mmissi

already concluded that the California ISO and

PX spot markets were dysfunctional during

vant peri those

mark wi ust unre. ble.'3

13 Citing San Diego Gas & Elec. Co. v. Sellers of Energy &

Ancillary Servs., 93 FERC 4 61,121 at pp. 61,359-60, 72 (2000),

order on reh®g and clarification, 97 FERC 4 61,275 at p. 62,225

(2002).

15

Evidence of market manipulation merely

suggests another cause of the spot market

dysfunctions and the unjust and unreasonable

rates in the spot markets. However, a finding

that unjust _ and unreasonable spot market

prices caused forward bilateral prices to be

unjust and unreasonable would be relevant to

nee ye pny yore Se pe peer

we wn previously concluded, the contracts om

issue in this proceeding do not have such a

standard but rather evidence an intent that

the contract may be changed only pursuant to

the “public interest” standard of review.”'4

JA 1274a - 1275a (emphasis added).

Putting aside the fact that there is only one

standard of review — a just and reasonable standard —

FERC’s orders squarely present the question whether

a presumption that contractual rates are just and

reasonable attaches to contracts executed under a

market-based rate regime regardless of whether

FERC itself has concluded that markets at the time of

contract formation are dysfunctional.

LPPC urges the Court to conclude resoundingly

that the answer is “no.” While the Commission has

determined, and the courts have agreed, that

‘4 The Commission later determined that these markets were

subject to gaming and manipulation. See Enron Power Mktg.,

Inc., 106 FERC 4 61,024 at paras. 26, 29 (2004). Further, the

Commission required refunds of sellers in the spot market in

order to constrain rates to just and reasonable levels for the

period precisely coincident with the formation of the contracts

here at issue. See San Diego Gas & Elec. Co., 96 FERC 4 61,120

(2001).

16

competitive forces may be relied on to achieve just

and reasonable rates,'5 the rates they produce cannot

be just and reasonable if the markets break down, as

the decisions on review concede. When that happens

— when markets become dysfunctional (to use the

Commission’s own description) — it is wrong to

conclude that rates in contracts entered into in such a

period can be presumed, much less conclusively

presumed to be just and reasonable.

The Commission’s decision to ignore the necessity of a

just and reasonable backstop before presuming that

negotiated agreements meet the statutory standard

stands in marked contrast to its earlier conclusion

that, in circumstances where market-based rates

cannot be justified, utilities may be permitted to

charge individually negotiated rate agreements only

where viable cost of service recourse service is

available. Alternatives to Traditional Cost-of-Service

Ratemaking for Natural Gas Pipelines, 74 FERC 4

61,076 at 61,240 (1996), clarified, 74 FERC 4 61,194

(1996), order on rehg, 75 FERC 4 61,024 (1996)

(emphasis added). There, the Commission commented

that it was

...particularly concerned about maintaining the

integrity of the recourse service. In order to be

successful, the recourse service must remain a

viable alternative to negotiated service. Otherwise,

if the recourse service remains stagnant, in time,

the recourse service will become outmoded and

'5 See Farmers Union Central Exch., Inc. v. FERC. 734 F.2d

1486, 1501-09 (D.C. Cir. 1984): Elizabethtown Gas Co. v. FERC.

10 F. 3d 866 (D.C. Cir. 1993): California ex rel. Lockver v. FERC.

383 F.3d 1006, 1009 (9th Cir. 2004), cert. denied, 127 S. Ct. 2972

(2007) (* Lockyer’).

17

will cease to be a viable alternative to negotiated

service. minen Sn pomansee Af, Win. seamenee. setzion ie

to act

re It is i ‘ssible.

74 FERC 4 61,076 at 61,240 (emphasis added).

The competitive market may provide similar

recourse for customers in a market-based setting if

the market functions correctly, a matter that the

Court in Mobile-Sierra had no reason to consider. It

would be reasonable to conclude, as urged by the

Commission and supporting Petitioners, that parties

may be held to the benefits and burdens of

agreements freely executed in a competitive market.

However, where the competitive market does not

exist — i.e., where the market is dysfunctional and the

Commission itself holds that the market has broken

down -- customers have no such backstop and there is

no assurance that the rate agreements customers

may be required to enter into are just and reasonable.

Put slightly differently, without giving customers

recourse to a rate the Commission can determine to

be just and reasonable, there is no possible way for

the Commission to provide the assurance required

under the FPA that all rates will be just and

reasonable. FPA section 205(a) states that “[aJll rates

and charges made, demanded, or received by any

public utility for or in connection with....the sale of

electric energy subject to the jurisdiction of the

Commission....shall be just and reasonable, and any

such rate or charge that is not just and reasonable is

hereby declared unlawful.” 16 U.S.C.A. § 824d(a)

(2005).

18

In his’ dissenting opinion below, FERC

Commissioner Massey made precisely this point,

commenting that

[t]he tainted atmosphere in which these contracts

were negotiated was unprecedented § and

extraordinary. The mivst influential benchmark

used in negotiating forward contacts — the spot

market and expectations of future spot prices —

was wildly dysfunctional. When these contracts

were negotiated, the Commission had already

declared that conditions in the California markets

allowed the exercise of market power and rates

were unjust and unreasonable....Those market

conditions certainly tainted any _ contracts

negotiated during this time frame. It would

simply defy logic to conclude that the high prices

in these contracts were not adversely influenced

by market conditions that included the exercise of

market power and wide spread market

manipulation.

JA 1317a —- JA 1318a.

The Commission's earlier conclusion that effective

recourse service is an essential check on pipeline

market power (and the threat to just and reasonable

rates) also serves to rebut Petitioners who have

argued that the Commission and the Court have no

reason to intervene in what amounts to a commercial

dispute among “sophisticated” parties well-aware of

the risks they took when entering into the relevant

agreements.'® To the same effect, FERC argues:

6 See, e.g., Brief for Petitioner Morgan Stanley Capital Group at

12- 14, 31 — 32 (““MSCG Br.”).

19

Once dysfunction in the spot market occurred,

it was inevitable that it would impose costs on

someone. The parties to these contracts

presumptively had equal access to information

about the functioning of the spot markets, and

they made a knowing and intelligent choice

about how to allocate risks and costs. Had the

purchasers believed that the rates in their

contracts might become unjust and

unreasonable...they could have insisted on a

clause preserving their right to seek

Commission modification of the contracts.

FERC Br. at 45.

But it may only be assumed that customers have

bargaining power equal to their utility suppliers when

customers are operating with an effective safety net

assuring that they have recourse to just and

reasonable rates. While market-based spot market

rates may supply such a safety net, dysfunction in the

market undermines that protection. With the

Commission’s concession that just and reasonable

rates were unavailable to customers as of the time

they entered into the agreements at issue, the

decision to apply a presumption that the resulting

rates are just and reasonable is directly at odds with

the FPA.

In this connection, it is particularly jarring that

Petitioners argue that the Court should adjudge

utility customers’ rights in this case just as it would

any counterparties to a commercial agreement.!’ But

“17 At 34, Morgan Stanley invokes Uniform Commercial Code

provisions stipulating that market fluctuations “are exactly the

type of business risk which business contracts made at fixed

|

20

the unqualified presumption that buyers of wholesale

power have bargaining strength equal to that of

regulated sellers has no grounding in the statute.'8

The FPA establishes an entirely different framework

for determining the parties’ rights than does an

unregulated commercial setting. It reflects “a

reasonable accommodation between the conflicting

interests of contract stability on the one hand and

public regulation on the other.” Mobile, supra, 350

U.S. at 344. To use FERC’s own words, [t]he fact that

[utilities] can dictate the terms of their contracts

entered into with their customers forms at least one

of the premises for regulation.” Tenneco Oil Co., 26

FERC 4 61,030 at 61,069 (1984). And while market

forces may play a role in satisfying the statutory

requirement that rates be just and reasonable, the

Commission abdicates its statutory responsibility in

simply entrusting customer welfare to the

marketplace without a determination that the market

is capable of ensuring just and reasonable rates. MCI

Telecomm. Corp. v. AT&T, supra; Maislin Indus. US

v. Primary Steel, Inc., supra. In the circumstances in

this case, with the Commission’s own determination

that rates in the market are unjust and unreasonable,

prices are intended to cover [citing U.C.C. § 2-615(a)].”

18 Citing dicta in this Court's decision in

Verizon Communications, Inc. v. FCC, 535 U.S. 467. 479 (2002),

Petitioners assert that buyers and sellers of wholesale electricity

have presumptively equal bargaining power. MSCG Br. at 30-

31; Calpine Br. at 34, 39; FERC Br. at 22, 34. But the statutory

presumption is exactly the opposite. The parallel provisions of

the Natural Gas Act, for example, were enacted to regulate

"monopolistic forces” controlling the sale of natural gas. FPC v.

Texaco, Inc. 417 U.S. 380, 397-98 (1974).

21

it simply cannot presume that the resulting contracts

satisfy the statutory standard.

It does not help Petitioners to argue that the term

“market dysfunction” has no defined meaning and

therefore lacks significance on appeal. See Brief of

William Baumol, et a/. as Amici Curiae in Support of

Petitioners at 21, et seg. (“Market ‘dysfunction’ is

particularly pernicious basis for abrogation because it

has no well-defined meaning.”)(“Baumol Br.”). In

fact, the orders on review make clear that the

Commission very well understood the import of its

conclusion that markets in the relevant period were

dysfunctional; it meant that rates did not meet the

statutory just and reasonable standard. The

Commission expressly “concluded that the California

ISO and PX spot markets were dysfunctional during

the relevant period and that rates in those markets

were unjust and unreasonable. JA 1275a. With

that, the Commission’s determination that the

market in all relevant periods was dysfunctional

meant that rates were unlawful during this period.

For purposes of the issues on appeal, that is all the

Court needs to know.

Il. Petitioner's Concern Over the Impact of

Contract Modification on the

Investment Climate are Overstated

and, In Any Event, No Basis for

Refusing to Remedy Unlawful Rates.

The nearly hysterical tone of Petitioners and amici

on the impact on the investment climate of a decision

removing the Mobile-Sierra presumption in this case.

belies the limited circumstances in which contracts

22

may indeed be reopened.'® In its brief opposing

certiorari in this case at 12, FERC commented that

the Ninth Circuit’s decision was confined to the

“narrow proposition that, if there is a credible claim

that severe market dysfunction has affected the

formation of a market-based rate contract, the

Commission must take that fact into account....” In

fact, even more narrowly, a decision reversing the

Commission would stand for the limited proposition

that where markets are dysfunctional, and cannot

constrain rates to just and reasonable levels, it may

not be presumed that contracts entered into for that

period are just and reasonable. And even then, upon

examination, the Commission may very well hold that

the contracts indeed meet the statutory standard.

It bears no small emphasis that contracting parties

have never been shielded from the _ risk of

Commission-ordered contract modification, even

under a “public interest standard.” As FERC has

stated:

[Wle have the authority under the public

interest standard to modify a contract

where: it may be unjust, unreasonable,

unduly discriminatory or preferential to

the detriment of purchasers that are not

parties to the contract; it is not the result

of arm's-length bargaining: or it reflects

circumstances where the_ seller has

exercised market power over’ the

purchaser.

19 See Calpine Br. at 36-42. See MSCG Br. at 36-40. See Baumo

Br. at 15-18, 24-25.

23

Northeast Utils. Serv. Co., 66 FERC 4 61,332 at

62,078 (1994), affd, Northeast Utils. Serv. Co. v.

FERC, 55 F.3d 686 (1st Cir. 1995)(emphasis added).

As the Commission observed in its brief at 12,

prior to its change of heart:

Taken as a whole, the decisions of the court of

appeals allow the Commission sufficient

discretion on remand to consider all relevant

factors in determining whether the contracts

at issue should be upheld or reformed.

Allowing the Commission to address these

issues will not “cause severe damage to the

wholesale energy markets.” 06-1457 Pet. 25.

The decisions have not, as petitioners suggest

caused'a flood of complaints by disgruntled

purchasers seeking to reform contracts. In

fact, there have been relatively few

complaints, and, more important,’ the

Commission promptly rejected those that lack

merit.

Equally to the point in considering the impact of

the decision on review is the importance of consumer

confidence in the competitive wholesale marketplace

in creating a sound market structure and a firm basis

for investment. LPPC members will attest that the

Western energy crisis of 2000-2001 badly shook that

confidence. Without it, those consumers who can will

vote with their feet in order to avoid FERC-regulated

markets. Municipalities will learn not to trust the

marketplace for their supply, and states will direct

utilities to withdraw from participation in the

24

competitive market.2° Surely, the climate for

competitive investment cannot be benefited by this.

In the final analysis, the Court must direct the

Commission to do what the statute requires. In a

dysfunctional market, adopting a presumption that

contracts customers are forced to enter into are just

and reasonable conflicts with common sense and the

agency's statutory responsibility. The Commission

must be reversed.

Ill. CHEVRON IS INAPPLICABLE

: WHERE, AS HERE, THE AGENCY’S

DECISION IS BASED, NOT ON ITS

INTERPRETATION OF THE

STATUTE IT ADMINISTERS, BUT ON

A MISTAKEN INTERPRETATION OF

THIS COURTS PRECEDENTS.

FERC maintains (Br., p. 20 - 21) that its decision

is entitled to deference under this Court’s decision in

Chevron USA v. Natural Res. Defense Council, 467

U.S. 837 (1984). This Court can quickly dispose of

20 The proposition that the public interest is not disadvantaged

as long as high rates do not cripple buyers who executed the

contracts at issue is also at variance with this Court's

observation that “[iJn the context of ratemaking, it is typically

the case that any increment in the rate will only make a small

dent in the consumer's pocket,” but that the statutory

requirement to establish just and reasonable rates “reflects a

congressional determination that potential savings for

consumers as a class are important even though rate changes

will generally not have any great economic significance for any

individual consumer.” American Paper Inst. v. American Elec.

Power, 461 U. S. 402, 417 n. 11 (1983)quoting FPC v. Texaco,

Inc., supra, 417 U.S. at 399).

iis

25

that claim. Under Chevron, this Court will defer to an

agency's reasonable interpretation of an ambiguous

statute it is charged to administer. /d. at 2782.

But FERC states repeatedly that its decision was

compelled by this Court's decisions in Mobile and

Sierra, not by its interpretation of an ambiguity in the

Federal Power Act. JA 1225a-1226a, JA 1229a, JA

1243a-JA 1245a; See JA 1229a (decision “dictated by

the Supreme Court under the Mobile-Sierra

doctrine.”) This Court owes no deference to FERC

when the agency’s reasoning is based upon what it

believes it is obligated to do by previous court

decisions rather than by its interpretation of an

ambiguity in the statute itself. See, e.g., Phillips

Petroleum Co. v. FERC, 792 F.2d 1165, 1169 (D.C.

Cir. 1986); (Chevron is inapplicable where FERC “did

not exercise its own judgment” but believed itself

bound by the Supreme court’s decision.”); New

England Motor Rate Bureau, Inc. v. Fed. Trade

Comm'n, 908 F.2d 1064, 1071-72 (1st Cir. 1990); Pril/

v. NLRB, 755 F.2d 941, 947-50 (D.C. Cir. 1985), cert.

denied, Meyers Indus., Inc. v. Prill, 474 U.S. 948

(1985).

26

CONCLUSION

For reasons articulated above, the Court should

affirm the judgment of the Court of Appeals.

Respectfully submitted,

JONATHAN D. SCHNEIDER

Counsel of Record

HARVEY L. REITER

M. DENYSE ZOSA

STINSON MORRISON HECKER LLP

1150 18TH STREET, N.W., 800

WASHINGTON, DC 20036

(202) 785-9100

jschneider@stinson.com

Counsel for the Large Public Power

Council

_danuary 14, 2008