Alabama Power Co. v. Federal Energy Regulatory Commission

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued March 24, 2000 Decided June 30, 2000

No. 98-1214

Alabama Power Company, et al.,
Petitioners

v.

Federal Energy Regulatory Commission,
Respondent

Florida Power & Light Company and
The City of Tallahassee, Florida,
Intervenors

On Petition for Review of Orders of the
Federal Energy Regulatory Commission

Dan H. McCrary argued the cause for the petitioners.
Andrew W. Tunnell was on brief. Rodney O. Mundy en-
tered an appearance.

 Monique Penn-Jenkins, Attorney, Federal Energy Regu-
latory Commission, argued the cause for the respondent.
John H. Conway, Acting Solicitor, Federal Energy Regulato-
ry Commission, and Timm L. Abendroth, Attorney, Federal
Energy Regulatory Commission, were on brief.

Gary D. Bachman and Cheryl M. Feik were on brief for
intervenor City of Tallahassee, Florida.

Steven Jay Ross entered an appearance for intervenor
Florida Power & Light Company.

Before: Edwards, Chief Judge, Henderson, Circuit Judge
and Buckley, Senior Circuit Judge.

Opinion for the court filed by Circuit Judge Henderson.

Karen LeCraft Henderson, Circuit Judge: Petitioners
Alabama Power Company, Georgia Power Company, Gulf
Power Company, Mississippi Power Company, Savannah
Electric and Power Company and Southern Company Ser-
vices, Inc. (collectively, the Southern Companies, petitioners)
seek review of two orders of the Federal Energy Regulatory
Commission (FERC, Commission) rejecting two components
of the rates they had proposed for supplying electric power to
the City of Tallahassee, Florida (City).1 The first component
is "turbine assembly costs" and the second is "heating loss
costs." With regard to the former, the Southern Companies
argue that FERC's policy as applied here is inconsistent with
a recent FERC decision allowing recovery of such costs.
With regard to the Commission's denial of recovery for
heating loss, the Southern Companies argue that the method
they used to calculate loss, yielding results FERC deemed
unreliable, is used by FERC for related purposes. They also
argue that the Commission's concern over double recovery of
heating loss costs is misplaced.

For the reasons set forth below, we grant the petition for
review and remand to the Commission for proceedings consis-
tent with this opinion and with its recent decision approving
recovery of turbine costs to determine whether the Southern
Companies justified this component of its rate.
__________
1 The City filed an intervenor brief in support of FERC's deci-
sions.

I.

In 1990 the Southern Companies filed a Unit Power Sales
(UPS) Agreement between themselves and the City propos-
ing the sale of certain electric power capacity to the City for a
term of ten years. The UPS Agreement prescribed transmis-
sion charges for various support services, including a monthly
reactive control charge for the costs associated with
generator-supplied reactive power. The Southern Companies
then faced the task of satisfying FERC that their proposed
reactive power charge was just and reasonable. Hearings
before an administrative law judge yielded an Initial Decision
largely approving the Southern Companies' proposal, conclud-
ing that "the proposed reactive power charges, with modifica-
tion to certain component allocations and [the Southern Com-
panies'] reactive power credits, are just and reasonable."
Southern Co. Servs., Inc., 61 FERC p 63,009 at 65,024 (1992).
The Commission affirmed in part and reversed in part, taking
issue with certain aspects of the Southern Companies' meth-
odology. See Southern Co. Servs., Inc., 80 FERC p 61,318
(1997). The Commission's two modifications at issue here, on
which the Commission stood firm in denying rehearing, see 82
FERC p 61,168 (1998), are the exclusion of turbine assembly
costs and the exclusion of heating loss costs.

The Commission described reactive power and its role in
the provision of electric power as follows:

Electric power consists of two components. The first
component, "real" power (expressed in terms of watts), is
the active force that causes electrical equipment to per-
form work. The second component, "reactive" power,
(expressed in terms of volt-amperes reactive (VARs)) is
necessary to maintain adequate voltages so that "real"
power can be transmitted.

Failure to provide the correct amount of reactive pow-
er at various points on the transmission system can cause
deviations from desired voltage levels and disruption in
the flow of power on the system. In order to maintain
desired voltage levels, reactive power must be supplied

 or absorbed by generators (or transmission equipment)
at various points on the transmission system.

Southern Co. Servs., Inc., 80 FERC at 62,080 (footnotes
omitted).

The Southern Companies utilize generators to produce
reactive power and the production of reactive power causes
heating loss that increases fuel consumption and demand on
the generators. See Brief of Commission at 36.2 The South-
ern Companies factored the heating loss into its costs equa-
tion, seeking to recoup for the required use of additional fuel
and for a portion of the generators' real power capacity. To
calculate costs, the Southern Companies combined the cost of
reactive power "impacts" on their energy system with the
heating loss cost to arrive at a control charge. Brief of
Petitioners at 12. They determined the cost of the reactive
power impacts through use of two load flow studies. One
study measured the "base-case" load flow conditions and
quantified the reactive power requirement of all generators in
the transmission system. The other, a "transaction-case"
load flow study, measured the effect on the system of an
energy transaction similar to those proposed in the UPS
Agreement with the City. A comparison of the studies
demonstrated the impact (measured in megavolt ampere reac-
tives (MVARs)) of individual transactions under the UPS
Agreement, allowing the petitioners to determine the amount
of generating capacity lost in each transaction and then to
multiply that figure by an average energy rate and thus
quantify the heating loss resulting from production of reactive
power necessary to supply the City.

The petitioners also sought to recoup, through the pro-
posed reactive power charge at issue, costs incurred from use
of their generators to supply or absorb reactive power. Hav-

__________
2 See also Joint Appendix (JA) 180 (testimony of FERC staff
member) ("Producing or absorbing reactive power at a generator
results in real power heating losses in the generator and [this]
heating loss requires that fuel be burned [and] causes a portion of
the real capacity of [sic] generator to be consumed producing the
heating loss.").

ing determined the amount of MVARs the transactions under
the UPS Agreement demanded, their next step in calculating
the charge was to identify the six major generator compo-
nents associated with reactive power production.3 Relying on
the connection between the turbines and the production of
reactive power,4 the Southern Companies included the "tur-
bine assembly"5 as one of the six major components in its
costs calculation. Using these components, they estimated
the plant investment associated with production of reactive
power. Because the turbine assembly is involved with the
production of both real power and reactive power, the South-
ern Companies included in their estimate, and thus in the
reactive power charge, only that portion of the turbine assem-
bly cost allocated to reactive power based on the ratio of total
power to reactive power. See 80 FERC at 62,083.

The Commission concluded the Southern Companies' calcu-
lations suffered from "erroneous modeling assumptions and

__________
3 They identified the (1) exciter, (2) exciter cooling system, (3)
generator stator, (4) rotor, (5) turbine assembly and (6) step-up
transformers. See 80 FERC at 62,083.

4 Turbines are mechanical devices with fan-like blades that rotate
when steam, for example, is forced though them. The resulting
mechanical energy powers a connected instrument like a generator
(or, more specifically, a generator's exciter): "The turbine produces
the mechanical [or real] power to turn the generator, which, in turn,
produces both real and reactive power." 80 FERC at 62,090 n.65;
see 82 FERC at 61,611. A turbine is essential to the production of
reactive power. See JA 212-13 (testimony of petitioners' witness)
("Without the turbine, there would be no production of real or
reactive power[;] the exciter is driven by the rotor and turbine
assembly, and thus that equipment is directly involved in the
production of reactive power.").

5 The turbine assembly is "the device [or motor] that turns the
exciter within the magnetic field" and includes "all of the equipment
that is on the same shaft," described as "a lot of equipment." See
JA 248-49 (testimony of petitioners' witness). "Turbine assembly"
is used interchangeably with "turbine(s)," see, e.g., 80 FERC at
62,091; Brief of Commission at 17-18, and there is "not generally" a
difference between the two terms. JA 248.

flawed rate design." Id. at 62,084. The load flow studies
used to calculate heating loss costs came under attack first.
The base-case load flow study reflected a hypothetical operat-
ing condition that, as the Southern Companies' expert con-
ceded, is not typical or desirable. See id. at 62,084-85. The
Commission disapproved the transaction cases as well be-
cause the Southern Companies' calculations did not account
for possible generator responses that benefit the system by
either absorbing or producing fewer MVARs. For example,
some transactions cause a decrease in the absorption of
MVARs, a benefit to the transmission system, but the peti-
tioners' calculations reflected this reduction of demand on the
system as an increase in demand for reactive power service.
As the Commission phrased its concern, "[j]ust as one would
expect not to be charged more for consuming less energy, one
would expect not to be charged more for reducing reactive
power support." Id. at 62,086. In addition to disapproving
the petitioners' methodology, FERC concluded that they had
not explained why their fuel adjustment clause, designed to
enable a utility to recover from its power customers the fuel
expense associated with producing power, see Brief of Com-
mission at 39, did not already ensure recovery of these costs.
The Commission concluded that, absent such a showing, the
petitioners' proposed rate would result in a prohibited double
recovery of costs. See 80 FERC at 62,089.

Turning to the turbine assembly costs, the Commission
disallowed their inclusion in the petitioners' reactive power
charge because, in its words, "turbines produce only real
power." Id. at 62,091. In contrast, it noted that the genera-
tors, in addition to producing real power, produce (or absorb)
reactive power. Accordingly, the Commission agreed that
costs of the generator and its parts are appropriately included
in the reactive power charge. The Commission also noted
that reactive power can be produced by a generator discon-
nected from its turbine and operated as a "synchronous
condenser."6 In the end, the Commission determined that

__________
6 As the Commission notes, the Southern Companies do not use
these self-powered generators. See Brief of Commission at 7 n.2.

the Southern Companies failed to establish that their rates
were just and reasonable.

In denying rehearing, the Commission again addressed the
recovery of turbine assembly and heating loss costs. While
the Southern Companies compared the costs associated with
the turbine that powers a generator to the cost of electricity
that powers a synchronous condenser, which the Commission
agreed would be recoverable under a reactive power charge,
the Commission again concluded that recovery of turbine
assembly costs was not appropriate because turbines produce
only real power notwithstanding their contribution to the
generators' production of reactive power. See 82 FERC at
61,611. With regard to heating loss costs, FERC again
rejected the load flow studies and also declined to accept the
summary of actual meter readings,7 which the Southern Com-
panies submitted with their rehearing request, because the
readings "represent[ ] a moving target" and use of actual data
was inconsistent with FERC's approach "not to adjust esti-
mates for actuals." Id. at 61,612. Finally, the Commission
remained unconvinced that the petitioners' revenue crediting
mechanism prevented double recovery of heating loss costs.
See id.

II.

We review FERC's orders under the arbitrary and capri-
cious standard of the Administrative Procedure Act (APA).
See 5 U.S.C. s 706(2)(A) (1994); Sithe/Independence Power
Partners v. FERC, 165 F.3d 944, 948 (D.C. Cir. 1999). We
explained the applicable standard of review in Northern
States Power Co. v. FERC, 30 F.3d 177, 180 (D.C. Cir. 1994):

The Federal Power Act requires that rates for "the
transmission ... of electric energy subject to the juris-

__________
7 The Southern Companies submitted the actual meter readings
showing the system's total MVAR production for 1991 and the
"Reactive Power Effects on Southern Company Generators," JA
425. The total MVAR production was greater than they had
estimated. See id. at 419-20, 423 (5897 MVARs versus 4954
MVARs).

 diction of the Commission ... be just and reasonable."
16 U.S.C. s 824d(a). Because "[i]ssues of rate design
are fairly technical and, insofar as they are not technical,
involve policy judgments that lie at the core of the
regulatory mission," our review of whether a particular
rate design is "just and reasonable" is highly deferential.
Town of Norwood v. Federal Energy Regulatory Com-
mission, 962 F.2d 20, 22 (D.C. Cir. 1992). Our review is
not, however, an empty gesture: the Commission must
be able to demonstrate that it has "made a reasoned
decision based upon substantial evidence in the record."
Id.

The Southern Companies argue that the Commission's
exclusion of turbine assembly costs from the reactive power
charge was arbitrary and capricious because the real power
created by the turbine is essential to the generator's produc-
tion of reactive power. In producing reactive power, the
generator derives power from the turbine, the generator's
"prime mover." Brief of Commission at 7; see JA 177; 80
FERC at 62,091. Although FERC allows recovery of genera-
tor costs, it disallowed recovery of the petitioners' turbine
assembly costs. In fact, FERC allows recovery of costs of
electric power serving as the prime mover of a synchronous
condenser generator producing reactive power, that is, a
generator disconnected from the turbine assembly. See 82
FERC at 61,611 & n.6. The Southern Companies contend
that the recoverability of costs for the prime mover of a
generator should not depend on whether the generator's
prime mover is electric power, as with a synchronous con-
denser, or a turbine. FERC chose to draw the costs recov-
ery line at the generator and its integral parts rather than at
its prime mover. We need not decide whether the line is
reasonably so drawn, however, because FERC's treatment of
the Southern Companies' turbine costs compared with its
treatment of turbine costs in American Electric Power Ser-
vice Corp., 80 FERC p 63,006 (1997), aff'd in relevant part, 88
FERC p 61,141 (1999) (AEP), requires remand.

In AEP FERC allowed recovery of turbine costs as part of
the investment required for the production of real power

necessary to drive the generator. In the AEP initial decision,
which the Commission affirmed summarily, see 88 FERC at
61,439-40, the administrative law judge (ALJ) approved the
amount of production plant investment that American Elec-
tric Power Service Corporation (AEPSC) allocated to reactive
power production and sought to recover through the reactive
power charge. AEPSC divided its charge into three compo-
nents: "(1) the generator and its exciter, (2) accessory elec-
tric equipment that supports the operation of the generator-
exciter, and (3) the remaining total production investment
required to provide real power and operate the exciter." 80
FERC at 65,074. Although AEPSC omitted its investment in
turbines from its generator and exciter costs, the ALJ recog-
nized its turbine investment as a legitimate cost, see id. at
65,076-77, and therefore included turbine costs in the residual
category of "the remaining total production investment re-
quired to provide real power and operate the exciter," id. at
65,074, which the ALJ labeled "Other Power Production
Investment."8 Id. at 65,079-80. FERC's allowance of recov-
ery of turbine costs in AEP and its failure to explain its
disallowance of the Southern Companies' turbine costs re-
quires us to remand to FERC for reconsideration in light of
its holding in AEP.

As the Commission points out, however, its inclusion of
turbine costs in AEP does not necessarily mean it must adopt
the Southern Companies' method of calculation. See Brief of
Commission at 29, 35. The petitioners use "a relatively large
allocation of one component (the turbine) to serve as a proxy
for the amount of [the] other production plant that is attribut-

__________
8 In brief FERC disputes that it allowed recovery of turbine costs
in AEP. See Brief of Commission at 34-35. In AEP, however,
FERC allowed recovery of "the remaining total production invest-
ment required to provide real power to operate the exciter." 80
FERC at 65,074. AEPSC incurred costs for investment in tur-
bines, see id. at 65,077, and the turbines provide real power to
operate the exciter. See supra notes 4 and 5. The investment in
turbines was not included in the first two categories, see 80 FERC
at 65,076-78, but was instead part of AEPSC's third category of
recoverable costs. See id. at 65,079-80.

able to reactive power production" compared to the "smaller
allocation of all components of the other production plant"
approved in AEP. Brief of Petitioners at 31 n.18 (emphasis
in original). While they insist that the end result of their
methodology is "virtually identical" to that obtained with
AEPSC's methodology, see id. at 33-34, we leave that deter-
mination to FERC on remand.

Although we also remand FERC's denial of heating loss
recovery, the Commission's rejection of the Southern Compa-
nies' heating loss cost calculations survives our review under
the APA. It disallowed recovery because the Southern Com-
panies' calculations rested on their base-case load flow study
which the Commission found flawed. The flaw, according to
the Commission, resulted from the measurement of VAR
output at peak operating conditions instead of normal condi-
tions. See 80 FERC at 62,085. The Southern Companies'
own witness testified that they would not operate at the level
used in the calculations.9 See JA 237-39, 241-42. The
Commission thus determined that the petitioners' calculations
did not accurately quantify their heating loss costs. See 82
FERC at 61,612; 80 FERC at 62,086. Although they seek to
recast FERC's denial as based on their choice of methodolo-
gy, that is, the load flow study, and not on their calculations,
we conclude that the Commission rejected, correctly, their
calculations associated with heating loss costs. On remand,
FERC should allow the Southern Companies to recalculate
the costs associated with heating loss.

The Commission further concluded that the heating loss
costs should not even be reflected in the proposed rates.
According to FERC, the fuel adjustment clause allows for
compensation for heating loss and the Southern Companies
failed to explain why the clause did not cover the heating loss

__________
9 Before us the Commission cites only the flaw it found with the
base-case study, see Brief of Commission at 36-37; in its original
order, however, the Commission found the transaction-case study
flawed because it did not accurately reflect "the benefits and
burdens of its generators in response to the subject transactions."
80 FERC at 62,085; see p. 6 supra.

component. The Southern Companies, however, maintained
that their revenue-crediting mechanism prevented double re-
covery and also avoided subsidy of certain customers' rates
by other customers. But it was the Commission that failed to
explain its rejection of the revenue-crediting mechanism. See
82 FERC at 61,612. Thus, FERC should reconsider whether
all heating loss costs are recovered through the fuel adjust-
ment clause and whether the revenue-crediting mechanism
prevents double recovery of those costs that are recovered
through the fuel adjustment clause. Assuming FERC's re-
consideration of the petitioners' revenue-crediting mechanism
discloses unrecovered10 heating loss costs, FERC should allow
the Southern Companies to adjust the rate accordingly so
that the costs are recovered.

For the foregoing reasons, we grant the petition for review
and remand to the Commission for reconsideration of the
turbine assembly costs in light of its holding in American
Electric Power Service Corp., 80 FERC p 63,006 (1997), aff'd
in relevant part, 88 FERC p 61,141 (1999). The Commission
should also reconsider whether the Southern Companies incur
unrecovered heating loss costs or heating loss costs that could
be more equitably recovered.

So ordered.

__________
10 Even if the costs are already recovered, the Commission should
consider if it is more appropriate to allow recovery through the
proposed rates (with appropriate revenue-credits), that is, if the
rates properly allocate costs among consumers.