United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued September 11, 1998 Decided October 23, 1998
No. 97-1607
Amoco Production Company and
Amoco Energy Trading Corporation,
Petitioners
v.
Federal Energy Regulatory Commission,
Respondent
City of Winfield, Kansas, et al.,
Intervenors
On Petition for Review of Orders of the Federal
Energy Regulatory Commission
Katherine B. Edwards argued the cause for petitioners.
With her on the briefs were Nancy J. Skancke, Frederick T.
Kolb and Mickey J. Lawrence.
Susan J. Court, Special Counsel, Federal Energy Regula-
tory Commission, argued the cause for respondent. With her
on the brief were Jay L. Witkin, Solicitor, John H. Conway,
Deputy Solicitor, and Edward S. Geldermann, Attorney.
Richard D. Avil, Jr. argued the cause for intervenor
NorAm Gas Transmission Company. With him on the brief
were Martin V. Kirkwood, Jason F. Leif and Sherrie N.
Rutherford.
Before: Silberman, Ginsburg, and Randolph, Circuit
Judges.
Opinion for the Court filed by Circuit Judge Silberman.
Opinion concurring in part and dissenting in part filed by
Circuit Judge Randolph.
Silberman, Circuit Judge: Petitioners, a group of natural
gas shippers who are customers of Intervenor NorAm Gas
Transmission Company's pipeline, seek review of an order
issued by FERC approving proposed tariffs filed by NorAm.
Those tariffs increase certain penalties on shippers and allow
NorAm to retain the revenues resulting from the pipeline's
assessment of these and other penalties. We deny the peti-
tion with regard to increased penalty rates, but remand to the
Commission for a more adequate explanation of its refusal to
require penalty revenue to flow-through to the pipeline's
customers.
I.
As we recently explained, in Pennsylvania Office of Con-
sumer Advocate (Pennsylvania) v. FERC, 131 F.3d 182, 184-
85 (D.C. Cir. 1997), modified on other grounds, 134 F.3d 422
(D.C. Cir. 1998), the revolutionary Order 636, requiring pipe-
lines to unbundle their transportation and sales services,
created certain operational problems for pipelines. Under
the new regime, shippers may contract with pipelines for
transportation services; a shipper typically contracts with a
pipeline to reserve capacity for a maximum daily volume of
gas that the shipper may tender to and remove from the
system, and in turn, the pipeline agrees to ensure that it has
the capacity to transport the agreed upon quantities. In
order to reduce the cost of reserving transportation capacity,
however, shippers may set their maximum volume levels
lower than anticipated, hoping that at peak times they can get
transportation service on an interruptible basis. In those
situations, however, interruptible service may not be avail-
able, and shippers then might choose to take more gas from
the system than the maximum volume allowed under their
contracts. Because the operational integrity of the pipeline
can be threatened by imbalances between the volume of gas
tendered to the pipeline and the volume taken by shippers,
pipelines seek to deter shippers from abusing the system by
issuing Operational Flow Orders (OFOs)--which direct ship-
pers to take specific actions to help keep the system in
balance--and by imposing penalties. When a shipper takes
more gas from the system than the maximum volume allowed
under the shipper's contract, the pipeline imposes an unau-
thorized overrun penalty. Penalties are also imposed for
violations of OFOs.
In the winter previous to NorAm's filing when the spot
market price for gas increased substantially, NorAm's ship-
pers on 250 occasions took overruns and thus incurred penal-
ties. The cost of taking gas out of the pipeline, even with the
penalties added, was apparently less than the shippers would
have incurred from alternative sources. Although NorAm, in
the previous year, did not impose any penalties for shippers'
failure to comply with OFOs, NorAm proposed in a section 4
rate filing under the Natural Gas Act to increase penalties for
both unauthorized overruns and failures to comply with
OFOs. The Commission, over the objection of petitioners,
approved the filings as "just and reasonable."
II.
Although petitioners' objected below to the increase in both
penalties, before us they challenge only the OFO increase and
argue that it is unjustified. The existing penalty level, it is
claimed, was obviously adequate, since no penalties were
incurred. Their more fundamental challenge, however, is to
the destination of any penalty revenue. Petitioners argue
that under cost of service pricing a pipeline is not entitled to
pocket that money; it must be passed on to its customers.
We have little difficulty in rejecting petitioners' claim that
the Commission acted unreasonably in permitting NorAm's
increase in OFO penalties. The Commission explained that
NorAm's increase in OFO penalties merely brought NorAm
into line with OFO penalties on nearby pipelines, such har-
monization being reasonable to ensure adequate deterrence of
abuses on NorAm's line. Moreover, there is an apparent
functional relationship between OFO penalties and the unau-
thorized overrun penalty, since both penalties aim at deter-
ring shipper abuse.
Much more troublesome, however, is petitioners' fundamen-
tal claim that the pipeline will enjoy a "windfall" if it is
permitted to keep penalty revenue. In Pennsylvania, we
rejected a similar analytic challenge (in a section 5 proceed-
ing).1 But in that case, the penalty rate had been in existence
for the previous year yet no penalties had been imposed. We
thus thought that the Commissioner was warranted in con-
cluding that "the mere possibility of revenue gains" did not
"justif[y] a prospective requirement that the [penalty] reve-
nues be credited to customers." Pennsylvania, 131 F.3d at
187 (emphasis added). The Commission, moreover, assured
us that it was monitoring any revenues generated by the
penalties and that it could revisit the issue in future rate
filings if "significant" revenues were generated.2 Important-
ly, we did say that "[t]here appears to be no doubt that if [the
pipeline] were to collect substantial penalties, those revenues
would not be justified by the pipeline's cost of service." Id.
at 187.
__________
1 Although this case involves a section 4 proceeding, the analysis
regarding revenue retention is the same. The difference is that the
remedy in section 5 actions is prospective only.
2 The Commission made the same pledge here; however, as
petitioners point out, NorAm is not obligated to make a section 4
filing in the future, and as we explained, relief under section 5 is
prospective only.
In this case, NorAm, by contrast, has collected, in the year
prior to the section 4 filing, 1.8 million dollars in overrun
penalty revenues. (Indeed, the Commission decision in this
case was noted in Pennsylvania because NorAm's penalties--
at least to us--appeared significant. See id. at 186.) The
Commission, nevertheless, predicted that future penalty reve-
nue would not be significant because the increase in penalty
rates would deter shippers from taking unauthorized gas or
violating OFOs. The difficulty with FERC's logic is that it
does not follow that NorAm's revenue will decrease merely
because the penalties are raised. Even if a lesser number of
penalties are imposed, the increased penalty rate might result
in a gross increase in penalty revenue. Moreover--and this
is the key imponderable--whether a shipper will be willing to
incur the penalty depends on his cost in securing alternative
supplies in a tight market. Although we were willing to defer
to FERC's predictive judgment in Pennsylvania because past
experiences supported that judgment, its prediction here is so
speculative that we cannot treat it, without more, as a suffi-
cient explanation. In any event, the Commission never even
explains how much revenue should be regarded as significant.
The Commission forthrightly asserts that as a matter of
policy it does not want to require pipelines to flow through
penalty rates to their customers. But FERC neither ade-
quately explains nor seeks to justify that policy in terms of
the statute. The Commission does not suggest that to pass
the penalties through to all customers would undermine any
deterrent effect. (It could easily provide that the customers
paying the penalty would be denied participation if that were
thought to be a problem.) Nor does the Commission claim
(as does the intervenor) that to do so would be administra-
tively burdensome. The Commission is content to assert,
somewhat mechanically, that it does not expect the revenues
to be "significant," so presumably we should think the prob-
lem is de minimis.
Under these circumstances, we are obliged to remand to
the Commission for a more adequate explanation for its
order.
Randolph, Circuit Judge, concurring in part and dissent-
ing in part: In Pennsylvania Office of Consumer Advocate v.
FERC, we faced the same question we face here regarding a
pipeline's proposal to assess penalties on those customers
whose actions threatened the pipeline's operational integri-
ty--namely, whether "as a policy matter, the mere possibility
of revenue gains [from a natural gas pipeline's collection of
penalties] justifies a prospective requirement that the reve-
nues be credited to customers." 131 F.3d 182, 187 (D.C. Cir.
1997). We there sustained the Commission's refusal to im-
pose such a requirement, in part because "the record failed to
demonstrate that such revenue gains would occur." The
same is true here, as are the other reasons we gave for
upholding the Commission. Yes, NorAm collected $1.8 mil-
lion in overrun penalties (but nothing in penalties for viola-
tions of Operational Flow Orders) the year before its filing.
If NorAm had proposed continuing the same level of penalties
for the future, I would be with my colleagues. But NorAm
proposed, and the Commission approved, an increase in pen-
alties in order to prevent shippers from taking more gas from
the system than they were entitled to take. Given the
increase in penalties, there is no evidence in the record that
"revenue gains would occur" in the future; past experience
shows nothing of the sort. In the Commission's expert
judgment, based partly on the experience of other pipelines
having the same level of penalties, little or no penalty revenue
will be generated under the new penalty regime. As in
Pennsylvania Office of Consumer Advocate, the Commis-
sion's prediction may turn out to be right, or it may turn out
to be wrong, but this "is an accepted feature of the rate-
setting regime." Id. at 187. The sort of certainty about the
future my colleagues want from the Commission is unattaina-
ble, depending as it does on many unknowables, not the least
of which is how cold the winters will be.
Although I therefore dissent from the majority's opinion
insofar as it orders the Commission to explain more fully its
decision not to require penalty revenue crediting, I concur in
the portion of the opinion upholding the increase in penalties.