Colorado Interstate Gas Co. v. Federal Energy Regulatory Commission

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued May 11, 1998 Decided June 23, 1998

No. 97-1214

Colorado Interstate Gas Company and

ANR Pipeline Company,

Petitioners

v.

Federal Energy Regulatory Commission,

Respondent

UGI Utilities, Inc., et al.,

Intervenors

Consolidated with

No. 97-1215

On Petitions for Review of Orders of the

Federal Energy Regulatory Commission

Richard W. Miller argued the cause for petitioners. With
him on the briefs was Daniel F. Collins.

Edward S. Geldermann, Attorney, Federal Energy Regula-
tory Commission, argued the cause for respondent. With
him on the brief was Jay L. Witkin, Solicitor, and Susan J.
Court, Special Counsel.

Before: Wald, Williams and Tatel, Circuit Judges.

Opinion for the Court filed by Circuit Judge Williams.

Williams, Circuit Judge: Under the regulatory regime
now applicable to interstate pipelines, not only pipelines but
other actors in the gas industry (such as independent market-
ers) may hold entitlements to pipeline capacity. Non-pipeline
actors are free to acquire additional capacity entitlements
without advance approval by the Federal Energy Regulatory
Commission. But in the decisions under review here, the
Commission ruled that an interstate pipeline seeking to ac-
quire capacity rights on another pipeline ("offsystem capaci-
ty") could do so only with the advance approval of the
Commission. Because the Commission failed to offer a rea-
soned explanation for this difference in treatment, we remand
the case for further proceedings.

* * *

Historically, natural gas pipelines bought natural gas at the
wellhead and carried it to various markets for resale. As
part of its effort to shift to "light-handed regulation" of the
gas industry under the Natural Gas Act, the Commission in
its Order No. 636 required interstate pipelines to "unbundle"
their sales role from their transportation role. The Commis-
sion's purpose was to ensure that pipelines' natural monopoly
over the transportation grid did not give them an unfair
advantage over non-pipeline sellers of gas. See generally
United Distribution Companies v. FERC, 88 F.3d 1105,
1125-27 (D.C. Cir. 1996) (describing Order No. 636). To
facilitate the unbundling process, Order No. 636 required
pipelines to assign the capacity rights they held on upstream
pipelines (i.e., on pipelines closer to the point of production) to
their existing firm transportation customers, except for a

limited amount of capacity needed for operational purposes
such as keeping line pack in balance.1 See Order No. 636-A,
FERC Stats. & Regs. p 30,950, at 30,566-67 (Aug. 3, 1992).
FERC reasoned that if pipelines were allowed to retain
upstream capacity on other pipelines, they could inhibit the
development of a competitive sales market by favoring their
sales function or otherwise making it more difficult for down-
stream customers to buy from producers at competitive
prices. See UDC, 88 F.3d at 1136.

Texas Eastern Transmission Company asked FERC for a
declaration that Order No. 636 did not establish a per se rule
prohibiting interstate pipelines from holding capacity on other
pipelines. On January 31, 1996 the Commission issued an
order agreeing with Texas Eastern. Texas Eastern Trans-
mission Corp., 74 FERC p 61,074, at 61,220 (1996) ("January
Order"). It observed that Order No. 636's rationale for
requiring pipelines to assign upstream capacity had lost much
of its force, since most pipelines had already implemented the
unbundling requirement. Id. "The transition to unbundled
sales is now complete," the Commission found, "and pipelines
and their shippers have become more accustomed to doing
business in the unbundled environment." Id. Further,
FERC recognized that "pipelines and their shippers face a
dynamic and rapidly changing market," in which "acquisition
of new upstream or downstream capacity may offer a mecha-
nism for interstate pipelines to provide shippers with access
to new supply and market areas." Id. A per se ban on
acquisition of offsystem capacity would force pipelines inter-
ested in serving new markets to physically expand their own
capacity, a decision that "could result in duplicative and
unnecessary facilities contrary to the Commission's goal of
meeting new demand with both the least cost and least
environmental impact." Id. Allowing pipelines to acquire
offsystem capacity could also produce benefits for the acquir-

__________
1 Line pack is defined as the quantity of natural gas that is
necessary to fill the pipeline itself, so as to maintain the necessary
operating pressures. Kern River Gas Transmission Company, 50
FERC p 61,069, at 61,156 (1990).

ing pipeline's shippers, the Commission concluded, allowing
them to deal with a single pipeline and thus "avoid the
administrative burdens of contracting, billing, scheduling,
nominating, balancing, and dealing with penalties on multiple
pipelines." Id.

Nonetheless, the Commission said that any pipeline intend-
ing to acquire upstream or downstream capacity must secure
advance Commission approval of the proposed service. Id. at
61,221. The Commission justified this requirement by refer-
ence to a variety of concerns. There appeared to be four
basic ones. First, the acquiring pipeline might control cus-
tomer choices or tie use of the acquired capacity to other
pipeline or pipeline affiliate services. Second, depending on
the treatment of the costs, rate changes might result that had
adverse impacts on customers of the acquiring pipelines, on
firms competing with the acquiring pipeline's marketing affili-
ate, or on customer choices among supply basins. Third,
there might be preferential treatment of the acquiring pipe-
line over the customers of the selling pipeline (presumably by
the selling pipeline, but the Commission does not identify the
actor). Fourth, some adverse effects might flow from the
way the capacity would be managed or otherwise integrated
into the existing open access operations of the acquiring
pipeline. Here the Commission expressed particular concern
about access to receipt and delivery points on the acquired
capacity. Id. at 61,220-21.

Two interstate pipelines, Colorado Interstate Gas Company
and ANR Pipeline Company, petitioned for rehearing. They
contended that the Commission's case-by-case authorization
requirement discriminated against pipelines, since the Com-
mission permits non-pipeline shippers to acquire capacity and
ship gas on any pipeline without prior approval. They point-
ed to existing regulatory safeguards by which the Commis-
sion can guard against the concerns that purportedly justify
the prior authorization requirement, arguing that these safe-
guards already place greater controls on pipelines than on
non-pipeline shippers. The delay and uncertainty engen-
dered by the pre-approval requirement, they said, would
inflict a competitive disadvantage on the pipelines, hobbling
their efforts to make prompt commitments to firm deals.

In the second order under review the Commission denied
the rehearing petition, repeating many of the arguments on
which it relied in its initial order. Texas Eastern Transmis-
sion Corp., 78 FERC p 61,277, at 62,161-62 (1997) ("Rehear-
ing Order"). In addition, it reasoned that because a pipeline's
acquisition of offsystem capacity was an alternative to con-
struction of duplicate facilities, Commission review was ap-
propriate for the reasons justifying advance review of such
construction. Id. at 62,161. CIG and ANR petitioned for
review in this court.

* * *

The Commission does not seriously contest that the delay
associated with case-by-case authorization practically elimi-
nates any opportunity for pipelines to compete in the increas-
ingly important market for short-term transportation ser-
vices. Even for long-term transactions, the requirement
hinders pipelines' efforts to make prompt and reliable com-
mitments. And it generally hampers their ability to partici-
pate in the Commission's "capacity release" program, under
which shippers who hold firm transportation capacity can
release it to others when it is unneeded. See 18 CFR
s 284.243.

The Commission's justification of the prior authorization
requirement presents two difficulties. First, in pointing to
the various possible hazards of pipeline acquisitions of offsys-
tem capacity, the Commission never explains why these con-
cerns are more severe when the acquisitions are made by a
pipeline than by a non-pipeline--so much more severe that
advance application and approval are needed only for the
former. For example, the Commission said that a pipeline
acquiring offsystem capacity might manipulate customer
choices, perhaps by conditioning access to the acquired capac-
ity on the customer's use of the pipeline's services or those of
its affiliates. The scale of this risk would seem to turn on the
extent to which, for any origin-and-destination pair, the ac-
quired link afforded its holder market power. The risk may
be substantial, but the Commission has not explained--and
nothing in the record indicates--why it is more severe when
pipelines rather than gas marketers get hold of the capacity.

Particularly in light of the Commission's own finding that the
"transition to unbundled sales is now complete," January
Order, 74 FERC at 61,220, it must give a fuller explanation of
why these unbundled pipelines nonetheless continue to pose
greater hazards to competition than do other holders of
transportation capacity.

Second, the Commission fails to address the petitioners'
argument that regulatory mechanisms already exist to control
any hazards that might arise when a pipeline is the acquiring
entity. This failure to address existing controls on pipeline
behavior applies to all of the risks identified by the Commis-
sion. Its concern about the rate impact of capacity acquisi-
tion is especially puzzling, since a pipeline can only charge
rates stated in a Commission-approved tariff. So far as rates
for the service itself are concerned, we infer that the pipeline
would have to charge according to some previously approved
formula (including whatever flexibility is available under
Commission rules, such as its authorization of discount rates,
see 18 CFR s 284.7(c)(5)(ii)(A)). As for possible rate effects
on customers not using the acquired capacity, any attempt to
shift the costs of the acquired capacity apparently has to run
the gauntlet of a rate change filing under s 4 of the Act,
which would enable the Commission to protect any otherwise
adversely affected customers. The Commission seemed to
recognize this fact in its Rehearing Order, only to brush it
aside without discussion:

Conceivably, these types of [anticompetitive] issues, to
the extent they implicate subsidization or improper allo-
cation of costs, could be addressed when the pipeline
filed a rate case to recover the costs of offsystem capaci-
ty. Still, we believe the public interest is best served if
proposals by pipelines to acquire capacity, like proposals
to construct it, are reviewed beforehand.

Rehearing Order, 78 FERC at 62,162.

At oral argument Commission counsel seemed to suggest
that it might be difficult for the Commission to say no in a
s 4 proceeding once the pipeline had incurred the costs of
acquisition. Why the Commission would be so tender-

hearted to the pipeline is unclear. In any event, rather than
singling out pipelines for the competitive disadvantage of
preclearance, the Commission could establish a general rule
that pipelines must bear the risk of loss from capacity acquisi-
tions. Cf. Associated Gas Distributors v. FERC, 824 F.2d
981, 1033-38 (upholding "optional expedited certification" pro-
cess establishing rebuttable presumption of Section 7 approv-
al for pipelines willing to assume full economic risk of new
ventures).

Even apart from rate matters, existing regulations appear
to guard more thoroughly against the risks of anticompetitive
behavior by pipeline holders of offsystem capacity than
against similar risks posed by non-pipeline holders of capaci-
ty. Interstate pipelines are governed by the terms of their
blanket certificates of public convenience and necessity,
granted under s 7 of the Natural Gas Act. See 18 CFR
s 284.221. These require the pipeline to make its transporta-
tion service available on a nondiscriminatory basis under open
access tariffs determined by the Commission. 18 CFR
s 284.8. By contrast, non-pipeline shippers are not limited
by the non-discrimination and open access requirements of
the blanket certificate regulations.

Thus, if the Commission is concerned that a pipeline selling
capacity might favor an acquiring pipeline over its other
customers, it can address the issue by enforcing the selling
pipeline's obligation to comply with the blanket certificate
regulations and its open access tariff. Likewise, if it is
concerned about whether the acquired capacity will be man-
aged or integrated into existing open access operations in a
manner harmful to shippers, it can enforce the open access
tariff of the acquiring pipeline.

Perhaps the Commission reasonably fears that, even taking
these safeguards into account, pipeline acquisitions of offsys-
tem capacity pose such grave threats that without preclear-
ance it will be unable to perform its protective mission. If so,
the Commission must explain the basis of that fear. Alterna-
tively, given the pipelines' wish to participate flexibly and
responsively in the market, especially in the emerging spot

markets, the Commission may explain itself on remand by
identifying ways the pipelines can satisfy the pre-approval
requirement and still achieve that goal.

We can find no merit in the Commission's theory that,
because pipeline arrangements for acquiring existing capacity
on other systems are substitutes for new construction, such
acquisitions similarly require advance review. Mere trans-
fers of existing capacity rights do not raise the issues that
justify FERC review of construction certificate applications--
avoiding duplication of facilities, environmental disturbance,
and waste of resources.

We reject, however, CIG and ANR's claim that 18 CFR
s 284.223(a) independently confers on pipelines a right to
acquire offsystem capacity without prior Commission approv-
al. That regulation provides that "any interstate pipeline
issued [a blanket certificate] ... is authorized, without prior
notice to or approval by the Commission, to transport natural
gas for any duration for any shipper for any end-use by that
shipper or any other person." CIG and ANR read this
language in conjunction with the January Order's observation
that once a downstream pipeline has acquired capacity on an
upstream pipeline it "will be the shipper on the upstream
pipeline." January Order, 74 FERC at 61,220. From this, as
we understand it, they infer that the downstream pipeline is a
"shipper" for purposes of s 284.223(a), so that when a pipe-
line moves gas on capacity acquired from an upstream pipe-
line, the latter is in effect exercising its authority under the
regulation "to transport natural gas ... for any shipper,"
here the downstream pipeline.

The Commission's answer, in effect, is that there are
shippers and shippers. In s 284.223(a) the term "shipper,"
read against the backdrop of FERC's Order 636-A, refers
only to an entity that holds title to gas while it is being
transported. And the January Order, in the same passage
cited by CIG and ANR, specifically noted that downstream
pipelines holding capacity on upstream pipelines would occu-
py a "limited exception" to this dominant understanding of
the term "shipper," since they would "not hold title when the

gas is being shipped." January Order, 74 FERC at 61,221
(emphasis added).

We of course "afford substantial deference to the Commis-
sion's interpretations of its own regulations, deferring to the
agency unless its interpretation is plainly erroneous or incon-
sistent with the regulations." Northern Border Pipeline Co.
v. FERC, 129 F.3d 1315, 1318 (D.C. Cir. 1997) (citation and
internal quotation marks omitted). Here the reasonableness
of the Commission's interpretation of s 284.223(a) seems no
different from that of its overall differential treatment of
pipelines and non-pipelines with respect to pre-approval. Put
another way, on FERC's view a downstream pipeline only
becomes a "shipper" (in a limited, non-titleholding sense) once
it has satisfied the Commission through the prior authoriza-
tion process that acquisition of upstream capacity is permissi-
ble. Assuming that the Commission on remand can provide
adequate reasons for its decision to impose this process on
pipelines alone, those reasons should also suffice to deny
pipelines, alone among "shippers," the benefits of
s 284.223(a).

In summary, although FERC enjoys broad discretion in
establishing procedures to cope with issues presented by
deregulation, see Mobil Oil Exploration & Producing South-
east, Inc. v. United Distribution Companies, 498 U.S. 211,
230 (1991), it must state reasoned justifications for the proce-
dures it establishes. Because it has not adequately explained
its decision to treat pipelines and non-pipelines differently in
a context where they appear similarly situated, we remand
the case to the Commission for a fuller explanation.

So ordered.