United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued February 19, 2010 Decided April 13, 2010
No. 09-1121
MISSOURI PUBLIC SERVICE COMMISSION,
PETITIONER
v.
FEDERAL ENERGY REGULATORY COMMISSION,
RESPONDENT
MUNICIPAL GAS COMMISSION OF MISSOURI, ET AL.,
INTERVENORS
On Petition for Review of Orders
of the Federal Energy Regulatory Commission
Lera L. Shemwell argued the cause for petitioner. With her
on the briefs were Samuel D. Ritchie, Kathleen L. Mazure, and
Jason T. Gray.
Holly E. Cafer, Attorney, Federal Energy Regulatory
Commission, argued the cause for respondent. With her on the
brief were Thomas R. Sheets, General Counsel, and Robert H.
Solomon, Solicitor.
Before: HENDERSON and GARLAND, Circuit Judges, and
EDWARDS, Senior Circuit Judge.
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Opinion for the Court filed by Senior Circuit Judge
EDWARDS.
EDWARDS, Senior Circuit Judge: In June 2006, Missouri
Interstate Gas, LLC (“MIG”), along with two state-regulated
intrastate pipelines, Missouri Gas Company, LLC (“MGC”) and
Missouri Pipeline Company, LLC (“MPC”), applied to the
Federal Energy Regulatory Commission (“FERC” or
“Commission”) for a certificate of public convenience and
necessity (“certificate”) pursuant to § 7 of the Natural Gas Act
(“NGA”), 15 U.S.C. § 717f(c), to reorganize into one interstate,
federally regulated natural gas company called MoGas Pipeline,
LLC (“MoGas”). After approving the merger and issuing the
certificate, the Commission authorized initial rates for service on
the combined facilities of the new entity. The Missouri Public
Service Commission (“MoPSC”) challenged MoGas’s proposed
initial rates on a number of grounds. These included claims that
the proposed rates passed on to consumers contained certain
“acquisition premium” costs associated with asset purchases by
MIG as well as acquisition premiums associated with MGC and
MPC. Under established FERC precedent, such premiums are
disallowed, unless the agency applies the so-called “benefits
exception.” See Rio Grande Pipeline Co. v. FERC, 178 F.3d
533, 536-37 (D.C. Cir. 1999); Kan. Pipeline Co., 81 F.E.R.C. ¶
61,005 (1997).
FERC sustained MoPSC’s objections to the acquisition
premiums embedded in the costs associated with MGC and
MPC. However, the Commission initially declined to address
MoPSC’s challenge to the alleged acquisition premium
embedded in the costs associated with the MIG pipeline. See
Mo. Interstate Gas, LLC, 119 F.E.R.C. ¶ 61,074 (2007) (“2007
Order”). Later, upon denying a request for rehearing on this
issue, see Mo. Interstate Gas, LLC, 122 F.E.R.C. ¶ 61,136
(2008) (“2008 Order”), FERC clarified its intention to allow
MoGas’s initial rates to stand, relying on an earlier order issued
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in 2002 in which FERC allowed MIG to include the disputed
costs in its own initial rates, see Mo. Interstate Gas, LLC, 100
F.E.R.C. ¶ 61,312 (2002) (“2002 Order”).
In its petition for review before this court, MoPSC argues
that FERC’s decision regarding the inclusion of acquisition
premium costs in MoGas’s initial rates is arbitrary and
capricious. We agree. FERC’s action is plainly inconsistent
with its own precedents. It is also inconsistent with the agency’s
treatment of the acquisition premiums embedded in the costs
associated with MGC and MPC, with respect to which MoPSC’s
objections were sustained. FERC’s claim that it properly
deferred consideration of the disputed acquisition premium issue
to an NGA § 4, 15 U.S.C. § 717c, proceeding is unavailing.
MoPSC submitted evidence to FERC during the § 7 proceeding
to demonstrate the existence of an improper acquisition
premium and MoGas did not contest it or otherwise attempt to
justify the alleged acquisition premium. “[B]oth the Supreme
Court and this circuit have made clear that the Commission has
a duty to use its § 7 power to protect consumers. . . . Indeed, the
Commission’s ‘usual practice in Section 7 certificate
proceedings’ is to ‘apply[], to the extent practicable, the same
ratemaking policies that it applies in Section 4 rate cases.’” Mo.
Pub. Serv. Comm’n v. FERC, 337 F.3d 1066, 1070-71 (D.C. Cir.
2003) (quoting Kan. Pipeline Co., 97 F.E.R.C. ¶ 61,168 at
61,785 (2001)); see also Maritimes & Ne. Pipeline, LLC, 84
F.E.R.C. ¶ 61,130 at 61,683 (1998). There is nothing in FERC’s
decision to suggest that it would have been impracticable to
address the MIG acquisition premium issue in the § 7
proceeding, yet FERC failed to do so. Because the agency’s
decision is the antithesis of “reasoned decisonmaking,”
Allentown Mack Sales & Serv., Inc. v. NLRB, 522 U.S. 359, 375
(1998), we grant the petition for review, vacate FERC’s order
with respect to the alleged acquisition premium issue regarding
MIG, and remand the case for a prompt resolution of the
question of the alleged acquisition premium.
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I. BACKGROUND
A. Statutory and Regulatory Background
Under the NGA, 15 U.S.C. § 717 et seq., FERC closely
supervises the sale and transport of natural gas in interstate
commerce. Under § 7 of the NGA, natural gas companies must
obtain a certificate of public convenience and necessity from
FERC before constructing, acquiring, or operating interstate
natural gas pipelines. In the context of granting such a
certificate, FERC sets initial rates governing the sale price of
natural gas transported in the pipeline. Initial rates proposed by
a new pipeline are approved if the agency finds that they are in
the “‘public interest.’” See Mo. Pub. Serv. Comm’n, 337 F.3d
at 1068 (quoting Atl. Ref. Co. v. Pub. Serv. Comm’n, 360
U.S. 378, 390-91 (1959)). “Initial rates ‘offer a temporary
mechanism to protect the public interest until the regular rate
setting provisions’ [of the NGA] . . . come into play.”
Id. (quoting Algonquin Gas Transmission Co. v. Fed. Power
Comm’n, 534 F.2d 952, 956 (D.C. Cir. 1976)). These regular
rate setting provisions are codified under § 4 and § 5 of the
NGA. Section 4 allows pipelines to initiate proceedings to set
or modify permanent rates, while § 5 allows FERC to do so on
its own authority. Permanent rates established under § 4 and § 5
proceedings are governed by the “just and reasonable” standard.
See 15 U.S.C. §§ 717c, 717d; see also Mo. Pub. Serv. Comm’n,
337 F.3d at 1068 (comparing “just and reasonable” and “public
interest” standards).
B. Creation and Certification of MIG
MIG was first created in 2002 pursuant to a plan to convert
a decommissioned oil pipeline into an interstate natural gas
pipeline. When MIG sought certification from FERC, MoPSC
challenged the pipeline’s proposed initial rates, arguing that they
contained an improper acquisition premium. “Generally, when
establishing the cost of service upon which a pipeline’s
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regulated rates are based, FERC employs ‘original cost’
principles” to determine what costs should be passed on to
consumers. Rio Grande Pipeline Co., 178 F.3d at 536. “Under
these principles, when a facility is acquired by one regulated
entity from another, the seller’s depreciated original cost is
included in the cost-of-service computations, even though the
price paid by the purchaser may exceed that amount.” Id. Any
cost above the depreciated original cost (a term that is
alternately referred to as the “net book value”) is known as an
acquisition premium. Under established FERC precedent, such
premiums are disallowed, unless the agency applies its so-called
“benefits exception” to this general rule. See id.; Kan. Pipeline
Co., 81 F.E.R.C. at ¶ 61,005. As the agency explained in its
Kansas Pipeline case:
The Commission has, with limited exception, considered
amounts in excess of the net book value to be an acquisition
premium that should be absorbed by the shareholders. The
original cost policy is an old and accepted concept of public
utility regulation. The Commission has allowed exceptions
to this rule but, only when the purchaser has demonstrated
specific dollar benefits resulting directly from the sale.
However, the benefits must be tangible, non-speculative,
and quantifiable in monetary terms. The burden of proof
for a utility seeking to demonstrate specific dollar amounts
is heavy.
Id. at 61,018 (footnotes omitted).
In 2002, when it approved MIG’s proposed initial rates, see
2002 Order, 100 F.E.R.C. at 61,312, FERC noted that MIG
“represent[ed] that the acquisition cost [reported by MIG for use
in FERC’s initial rate calculation was] the depreciated net book
value of” the idled oil pipeline and its related assets as charged
by the pipeline’s seller, UtiliCorp United, Inc., id. at 62,396.
After highlighting the fact that MoPSC had approved the sale of
the decommissioned oil pipeline assets to MIG as an “arms-
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length sale transaction between . . . non-affiliated parties” and
the fact that “the facilities will be devoted to gas utility service
for the first time,” FERC declined to further evaluate whether
MIG’s initial rates should be reduced due to the alleged
acquisition premium. Id. However, FERC directed MIG to file
a cost and revenue study assuming the burden of proof on a
number of issues, including the acquisition premium issue,
related to the permanent rates that would govern MIG’s
operations going forward. Id. at 62,400. On March 17, 2006,
after MIG submitted the required study, see 2007 Order, 119
F.E.R.C. at 61,474-75 (describing MIG’s 2006 filing under
FERC Docket No. RP06-274-000 (“2006 Docket Entry”)),
MoPSC filed a protest, contesting, among other things, the
continuation of the alleged acquisition premium.
C. Creation and Certification of MoGas
In June 2006, before the contested issues relating to the
2006 Docket Entry could be resolved, MIG applied – along with
two state-regulated intrastate pipelines, MGC and MPC – to
reorganize into MoGas, a single, new federally regulated
interstate natural gas company. MoPSC filed an opposition to
MoGas’s application in the § 7 proceeding, challenging
MoGas’s proposed initial rates on a number of grounds.
MoPSC’s objections included, inter alia, claims that MoGas’s
proposed initial rates included an improper acquisition premium
carried over from the initial MIG rates established in 2002.
MoPSC further claimed that the proposed initial rates also
included improper acquisition premiums embedded in the costs
associated with MGC and MPC.
In 2007, FERC approved initial rates for MoGas. See 2007
Order, 119 F.E.R.C. at 61,074. The agency sustained MoPSC’s
objections to the acquisition premiums embedded in the costs
associated with MGC and MPC. In rejecting these acquisition
premiums, FERC noted that, under the benefits exception, “the
pipeline has the burden of establishing the dollar amount of the
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benefits alleged to have been conferred upon the consumers,”
and that MoGas “provided no evidence in support of the benefits
of the[se two] acquisition premium[s].” Id. at 61,467 (internal
quotation marks omitted).
FERC, however, declined to direct MoGas to remove the
alleged acquisition premium embedded in the costs associated
with the MIG pipeline. The agency asserted that the issues
regarding MIG which had been raised by MoPSC in the context
of the 2006 Docket Entry were now “moot.” Id. at 61,474. In
other words, FERC noted that, with the issuance of a certificate
to the merged entity, “Missouri Interstate will cease to exist as
a separate interstate pipeline and will no longer charge separate
rates.” Id. Thus, the Commission saw no imperative to resolve
the MIG acquisition premium issue pending in the 2006 Docket
Entry in the context of MoGas’s § 7 proceeding. FERC said
nothing else regarding this issue in its 2007 Order, though it did
direct MoGas to file a § 4 rate case proceeding within 18 months
to finalize its rates. Id. at 61,471-72.
On May 21, 2007, MoPSC filed a request for rehearing,
asking FERC to reconsider several issues, including the alleged
acquisition premium embedded in the MIG component of the
new pipeline’s initial rates. Request for Rehearing, or, in the
Alternative, Clarification of the Missouri Public Service
Commission (May 21, 2007), reprinted in Joint Appendix
(“J.A.”) 197-236. In its rehearing order of February 19, 2008,
FERC granted rehearing with respect to certain issues but denied
rehearing on the MIG acquisition premium issue. See 2008
Order, 122 F.E.R.C. at 61,136. The Commission contended that
(1) addressing the issue would “turn this certificate proceeding
into a rate proceeding” requiring more time-consuming
procedures; (2) that MoPSC wanted FERC to “cherry pick one
issue from [MIG]’s cost and revenue study and expend
resources here to scrutinize” it; and (3) that initial rates are
approved “based on estimates.” Id. at 61,704. The agency
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further relied on its 2002 Order, which had addressed the
inclusion of MIG’s cost estimates in the initial rates for MIG.
Id. MoPSC then petitioned this court for review, and also
petitioned FERC for rehearing on the 2008 Order. Because of
the ongoing FERC filing, the appeal before this court was
dismissed as premature. Mo. Pub. Serv. Comm’n v. FERC, No.
08-1160, slip op. at 1 (D.C. Cir. Sept. 10, 2008) (per curiam).
On April 3, 2009, FERC issued an order denying rehearing of
the 2008 Order. See Mo. Interstate Gas, LLC, 127 F.E.R.C.
¶ 61,011 (2009) (“2009 Order”). The April 3 order did not
address the acquisition premium issue. After issuance of the
2009 Order, MoPSC timely petitioned this court again for
review of the acquisition premium issue.
On appeal to this court, MoPSC raises a single issue:
Whether FERC violated 5 U.S.C. § 706 or improperly denied
due process to MoPSC when it included the alleged acquisition
premium from MIG in the initial rates of the MoGas pipeline,
deferring resolution of that issue to a future § 4 rate proceeding.
II. ANALYSIS
A. Standard of Review
Under the APA, agency action that is “arbitrary, capricious,
an abuse of discretion, or otherwise not in accordance with law”
cannot survive judicial review. See 5 U.S.C. § 706(2)(A).
FERC’s orders are reviewed under this standard. See Am. Gas
Ass’n v. FERC, 593 F.3d 14, 19 (D.C. Cir. 2010); Rio Grande
Pipeline Co., 178 F.3d at 541. FERC’s action upholding the
inclusion of an alleged acquisition premium in the initial rates
of the MoGas pipeline, as well as its decision to defer the
ultimate resolution of the acquisition premium’s validity to a
future § 4 rate proceeding, are both subject to arbitrary and
capricious review pursuant to 5 U.S.C. § 706.
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In a case such as this, the court’s role is “‘limited to
assuring that the Commission’s decisionmaking is reasoned,
principled, and based on the record.’” Rio Grande Pipeline Co.,
178 F.3d at 541 (quoting Pa. Office of Consumer Advocate
v. FERC, 131 F.3d 182, 185 (D.C. Cir. 1997)). This court has
noted, however, that FERC must “‘fully articulate the basis for
its decision,’” and that a “‘passing reference to relevant factors
. . . is not sufficient to satisfy the Commission’s obligation to
carry out reasoned and principled decisionmaking.’” Am. Gas
Ass’n, 593 F.3d at 19 (quoting Mo. Pub. Serv. Comm’n v. FERC,
234 F.3d 36, 41 (D.C. Cir. 2000) (internal quotation marks
omitted)).
B. Alleged MIG Acquisition Premium
FERC’s treatment of the MIG acquisition premium issue is
arbitrary and capricious. The benefits exception to the rule
disallowing acquisition premiums takes into account (1) whether
the acquired facility is being put to a new use, see Rio Grande
Pipeline Co., 178 F.3d at 536; Enbridge Energy Co., Inc., 110
F.E.R.C. ¶ 61,211 at 61,796 (2005); Longhorn Partners
Pipeline, 73 F.E.R.C. ¶ 61,355 at 62,112-13 (1995); and (2)
whether “the purchaser has demonstrated specific dollar benefits
resulting directly from the sale.” Kan. Pipeline Co., 81 F.E.R.C.
at 61,018; see also Enbridge Energy Co., Inc., 110 F.E.R.C. at
61,796. FERC has also considered (3) whether the transaction
at issue is an “arms length” sale between unaffiliated parties,
see, e.g., Enbridge Energy Co., Inc., 110 F.E.R.C. at 61,796; and
(4) whether the purchase price of the asset at issue is less than
the cost of constructing a comparable facility, see, e.g., Rio
Grande Pipeline Co., 178 F.3d at 536-37; Enbridge Pipelines
(Southern Lights) LLC, F.E.R.C. ¶ 61,310 at 62,688 (2007).
FERC has been clear that the pipeline carries the burden of
proof of showing a benefits exception to justify the allowance of
an acquisition premium. In order to meet this “heavy” burden,
a pipeline must prove the existence of benefits to consumers that
10
are “tangible, non-speculative, and quantifiable in monetary
terms.” Kan. Pipeline Co., 81 F.E.R.C. at 61,018.
There is no question that FERC did not apply the “specific
dollar benefits” requirement in allowing the alleged acquisition
premium from MIG to be included in the initial rates of the
MoGas pipeline. Indeed, FERC did not directly evaluate the
MIG premium according to any of the elements of the benefits
exception test. Instead, the agency relied on its 2002 Order,
which noted (1) MIG’s original assertion that its costs reflected
net book value; (2) that the assets, which had been used as an oil
pipeline, would be converted to gas utility service for the first
time; and (3) that MoPSC had approved the underlying sales
transaction “as an arms-length sale . . . between non-affiliated
parties.” 2002 Order, 100 F.E.R.C. at 62,396. Reliance on the
2002 Order is entirely inadequate to justify the Commission’s
action in this case.
First, as noted below, MoPSC submitted uncontested
evidence showing that the assertions made by the pipeline in the
proceedings leading to the 2002 Order were suspect. This
evidence included reference to testimony from the then-
president of both MPC and MGC that the piece of pipeline that
ultimately became MIG contained an acquisition premium.
Second, FERC’s analysis in this case unequivocally does not
include any assessment of “tangible, non-speculative, and
quantifiable” benefits to consumers. Kan. Pipeline Co., 81
F.E.R.C. at 61,018. And, finally, MoGas offered nothing to
meet its burden of justifying any acquisition premium carried
over from the initial MIG rates. Indeed, during arguments
before this court, FERC’s counsel forthrightly acknowledged
that the Commission never determined that MoGas had met its
burden of establishing the dollar amount of benefits alleged to
have been conferred upon the consumers, as required by the
benefits exception test.
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It is also highly noteworthy that FERC explicitly conducted
a benefits exception inquiry with respect to the acquisition
premiums embedded in the costs associated with MGC and
MPC. The Commission rejected the inclusion of those
premiums because MoGas “provided no evidence in support of
the benefits” of the premiums. 2007 Order, 119 F.E.R.C. at
61,467.
Apparently recognizing the frailty of its position, FERC
argues in the alternative that, even if it did not apply the benefits
exception test as articulated in Kansas Pipeline, it did no less
than is required in a § 7 proceeding. Relatedly, FERC claims
that it can defer a more detailed evaluation of the alleged
acquisition premium to a § 4 rate proceeding. We reject these
claims.
It is true that the public interest standard governing the
establishment of initial rates in § 7 proceedings is not
coterminous with the just and reasonable standard governing the
establishment of permanent rates in a § 4 proceeding. See, e.g.,
Mo. Pub. Serv. Comm’n, 337 F.3d at 1070 (describing the public
interest standard as “less exacting”); 2007 Order, 119 F.E.R.C.
at 61,472 (describing the public interest standard as “somewhat
more lenient”). FERC fails, however, to provide a reasoned
explanation for why the existence of and justification for the
alleged acquisition premium here could not be evaluated in the
§ 7 proceeding in this case.
As noted at the outset of this opinion, “both the Supreme
Court and this circuit have made clear that the Commission has
a duty to use its § 7 power to protect consumers. . . . Indeed, the
Commission’s ‘usual practice in Section 7 certificate
proceedings’ is to ‘apply[], to the extent practicable, the same
ratemaking policies that it applies in Section 4 rate cases.’” Mo.
Pub. Serv. Comm’n, 337 F.3d at 1070-71 (quoting Kan. Pipeline
Co., 97 F.E.R.C. at 61,785); see also Maritimes & Ne. Pipeline,
LLC, 84 F.E.R.C. at 61,683. There is nothing in FERC’s
12
decision to suggest that it would have been impracticable to
address the MIG acquisition premium issue in the § 7
proceeding. The 2007 Order did not address the MIG
acquisition premium issue at all. Rather, the Commission
simply dismissed as “moot” any open issues from the 2006
Docket Entry due to the dissolution of MIG. 2007 Order, 119
F.E.R.C. at 61,474. But of course the acquisition premium issue
was not moot, as evidenced by FERC’s rejection of the
acquisition premiums embedded in the costs associated with
MGC and MPC.
In its 2008 Order, the Commission refused to address the
acquisition premium issue on the ground that § 7 proceedings
involve initial rates “approved . . . based on estimates” of how
pipelines will operate. 2008 Order, 122 F.E.R.C. at 61,704.
FERC has noted in other cases that, because a pipeline has no
operating history at the time when it applies for its initial
certificate, initial rates are often “based only on estimates of
what an appropriate rate for each service should be.” Maritimes
& Ne. Pipeline, LLC, 81 F.E.R.C. ¶ 61,166 at 61,726 (1997).
Therefore, it is sometimes better to defer final judgment on
certain rate issues until a § 4 proceeding when “the pipeline has
an operating history.” Id. But this rationale lends no support to
FERC’s refusal in this case to scrutinize the alleged acquisition
premium carried over from MIG. The threshold question of
whether or not an acquisition premium exists, for example,
appears to be a straightforward accounting question. In any
event, at least in this case, it seems clear that FERC easily could
have resolved the threshold issue on the basis of the uncontested
paper record before it in the § 7 proceeding. Indeed, FERC
never explains why it could not make such a determination
based wholly on the operational data from MIG’s cost and
revenue study submitted as part of the 2006 Docket Entry.
Furthermore, neither FERC nor MoGas suggest that
establishing the dollar amount of benefits – the key prong of the
13
“benefits exception” test that was ignored by FERC in this case
– requires prospective data on pipeline operating history in all
cases. In Kansas Pipeline, for example, FERC disallowed an
acquisition premium in a § 7 proceeding. Kan. Pipeline Co., 81
F.E.R.C. at 61,018. The Commission’s decision makes no
reference to any distinction between § 4 and § 7 proceedings in
this regard; nor do the cases it cites make any such distinction.
Kansas Pipeline is also consistent with FERC’s treatment of the
acquisition premiums associated with MPC and MGC in this
very case, whose inclusion in MoGas’s initial rates was rejected
because of a lack of evidence supporting tangible dollar benefits.
2007 Order, 119 F.E.R.C. at 61,467. FERC’s decision in this
case offers no meaningful distinction between the MIG
acquisition premium, on the one hand, and the Kansas Pipeline,
MPC, and MGC acquisition premiums, on the other.
In its 2008 Order, FERC claims that if MoPSC’s challenge
were addressed in the § 7 proceeding, this “potentially would
have involved procedures associated with trial-type hearings”
and would “turn th[e] certificate proceeding into a rate
proceeding.” 2008 Order, 122 F.E.R.C. at 61,704. On the
record of this case, this is an unpersuasive claim. MoPSC
submitted undisputed evidence to FERC demonstrating the
existence of an allegedly improper acquisition premium related
to MIG. This evidence included both financial data, see
UtiliCorp Pipeline Systems, Inc. Estimated Purchase Price
Certificate at 3 (2002), J.A. 250, and 2001 testimony from the
then-president of both MPC and MGC that the piece of pipeline
that ultimately became MIG contained an acquisition premium,
Missouri Public Service Commission Tr. of Hearing (Sept. 5,
2001), at 121-23, J.A. 244-46. This evidence was properly
before FERC in the § 7 proceeding, and the evidence was not
contested by the pipeline. Given this record, the Commission’s
vague suggestion that it would be inefficient “to cherry pick”
this “one issue” from the cost and revenue study is hardly
persuasive. 2008 Order, 122 F.E.R.C. at 61,704.
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Finally, FERC notes that on June 30, 2009, MoGas filed a
§ 4 rate case to establish permanent rates and points out that the
§ 4 proceeding will resolve the acquisition premium issue going
forward. However, the § 4 proceeding will simply set just and
reasonable rates prospectively. It will not address the validity of
the initial rates approved in the § 7 proceeding that are at issue
in this case.
III. CONCLUSION
We hereby grant the petition for review and vacate FERC’s
order with respect to the alleged acquisition premium issue. The
case is remanded to the Commission for a prompt resolution of
the question of the alleged acquisition premium.