Sithe/Independence Power Partners, L.P. v. Federal Energy Regulatory Commission

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 8, 2002 Decided April 9, 2002

No. 00-1092

Sithe/Independence Power Partners, L.P.,
Petitioner

v.

Federal Energy Regulatory Commission,
Respondent

Public Service Commission of the State of New York, et al.,
Intervenors

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

Richard P. Bress argued the cause for petitioner. With
him on the briefs were David L. Schwartz and Minh N. Vu.

Beth G. Pacella, Attorney, Federal Energy Regulatory
Commission, argued the cause for respondent. With her on

the brief were Cynthia A. Marlette, Acting General Counsel,
and Dennis Lane, Solicitor.

Elias G. Farrah, Rebecca J. Michael and Arnold H. Quint
were on the brief for intervenors New York Independent
System Operator, Inc. and New York Transmission Owners.

Before: Edwards and Sentelle, Circuit Judges, and
Silberman, Senior Circuit Judge.

Opinion for the Court filed by Senior Circuit Judge
Silberman.

Silberman, Senior Circuit Judge: Sithe petitions for re-
view of two orders by the Federal Energy Regulatory Com-
mission, one conditionally accepting a proposal to restructure
wholesale electricity sales and transmission services in New
York State, the second denying Sithe's application for rehear-
ing. Because FERC failed to explain adequately its decision
to depart from its longstanding cost-causation principle in
approving a component of the proposal, we grant Sithe's
petition for review in part.

I.

Sithe describes itself as a non-utility generator that owns
and operates an electric generation facility in New York. Its
facility interconnects with the utility Niagara Mohawk Power
Corporation's transmission system. Petitioner sells energy,
on a wholesale basis, to Niagara and Consolidated Edison
Company of New York, Inc. under privately negotiated power
purchase agreements. Sithe challenges the Commission's
approval of new tariff provisions governing charges for so-
called transmission losses. In Order 888,1 FERC generally

__________
1 Promoting Wholesale Competition Through Open Access
Non-Discriminatory Transmission Servs. by Pub. Utils.; Recov-
ery of Stranded Costs by Pub. Utils. & Transmitting Utils., Order
No. 888, FERC Stats & Regs. p 31,036 (1996), order on reh'g, Order
No. 888-A, FERC Stats & Regs. p 31,048, order on reh'g, Order
888-B, 81 FERC p 61,248 (1997), order on reh'g, Order No. 888-C,
82 FERC p 61,046 (1998), affirmed in relevant part, remanded in
part on other grounds sub nom. Transmission Access Policy Study

required each public utility to file tariffs for open access
transmission services to remedy undue discrimination in ac-
cess to their monopoly-owned transmission wires and re-
quired certain power pools, including the New York Power
Pool (comprising eight utilities, including Niagra and Con Ed,
referred to as the "Member Systems"), to file reformed
pooling agreements by December 31, 1996. Under the Order,
open access transmission tariffs were to contain at least
equivalent terms and conditions for non-discriminatory ser-
vice to those set out in a Commission-prescribed pro forma
tariff. It also encouraged the formation of independent sys-
tem operators (ISOs) to administer transmission services and
new markets for wholesale electricity transactions. These
ISOs were to adopt transmission (and ancillary services)
pricing policies to promote the efficient use of, and invest-
ment in, generation, transmission, and consumption. In re-
sponse, the Member Systems filed a proposal to replace the
existing New York power pool structure with a newly created
ISO: the New York Independent System Operator. Accord-
ing to the proposal, the NYISO would be an independent,
non-profit administrator of transmission services and of the
new markets for wholesale electricity transactions in New
York--the accompanying tariff was intended to provide a
single open access tariff over the entire New York State
transmission system.

This case involves the propriety of the Member Systems'
proposed transmission services pricing, specifically the pric-
ing for transmission losses. Transmission losses refer to the
amount of electric energy lost when electricity flows across a
transmission system: it is a function of the square of the
amount of the current flowing on the wire and of the resis-
tance it encounters. In general, the current on a given
transmission line remains a constant, and the loss associated
with a single transmission of electricity is primarily a function
of the distance the electricity is transmitted. Northern
States Power Co. (Minn) v. FERC, 30 F.3d 177, 179-80 (D.C.

__________
Group v. FERC, 225 F.3d 667 (D.C. Cir. 2000), aff'd sub nom. New
York v. FERC, 122 S. Ct. 1012 (2002).

Cir. 1994). Utilities (who control the transmission lines) must
deliver to the electricity customer the entire amount contract-
ed for, regardless of the inevitable loss, so a transmission
customer (an entity such as Sithe who pays a utility to
transmit electricity across its lines) generally compensates a
utility for lost energy either by providing more energy at the
injection point than the electricity customer receives at the
withdrawal point, or by providing energy in-kind to the
transmitting utility.

The Member Systems propose tariffs that would charge
transmission customers for transmission losses predicted on a
"locational based marginal pricing" (LBMP) method, which
would take into account costs imposed by congestion on the
system. As its name implies, the methodology has both a
marginal and a locational element. We gather from the
parties' submissions that it predicts costs taking into account
location, because the efficiency of a given electricity with-
drawal or injection location may depend on the relative
crowdedness of a transmission route at that time. It also
projects costs on the margin, meaning that it takes into
account how much electricity is already on the system when
an additional unit is added, because the more electricity on
the system at a given time the higher the costs. For
example, in the event of ten consecutive transactions each
adding one unit of electricity to the system, the tenth transac-
tion imposes a greater cost than the first additional unit. The
parties do not make clear whether the LBMP method also
includes traditional cost factors such as the distance load
traveled. Previously, losses had been calculated using either
a "rolled-in" rate or through modeling techniques that allocat-
ed charges to each transmission customer based on average
(or approximate) system-wide costs imposed by the addition
of load. When utilities allocated losses through a "rolled-in"
average system transmission loss factor, system-wide losses
were divided pro rata, and each customer paid a standard,
per-unit amount. Similarly, utilities have previously allocated
losses based on their transmission customers' incremental
usage, using load flow models and prioritization systems to
approximate the marginal losses caused by each transmission
customer. The Member Systems asserted that their pro-

posed LBMP-based tariff would be an improvement. It
would send efficient price signals to market participants
because it could calculate the actual marginal losses transmis-
sion customers impose on the system.

But in its tariff, the Member Systems did not propose to
rely on a straight LBMP methodology; instead, they added a
"simplifying assumption" that is the crux of this case. Every
Mwh of energy injected into the system is treated as the
"last" Mwh of energy on the system, and therefore this
assumption would lead to the systematic overcollection of the
amount of revenue needed to offset the transmission system's
actual losses. The record indicates that the overcollection
would be as high as 31%. The Member Systems proposed
using the excess amounts to offset the NYISO's Scheduling,
System Control and Dispatch Service charge (the "Scheduling
Charge"), before allocating such costs among transmission
customers. Generally, the total Scheduling Charge paid by a
particular transmission customer is the product of the Sched-
uling Charge rate and the amount of power withdrawn by the
customer from the system. That rate equals the NYISO's
monthly overhead and other costs and expenses, minus cer-
tain credits such as overcollections for transmission losses,
divided by the total number of billing units in the system.
The Member Systems proposed to provide a sort of indirect
refund of overcollections to those transmission customers
subject to the Scheduling Charge. Unfortunately, as dis-
cussed below, FERC has never established that each entity
that would be overcharged by the LBMP methodology is
subject to and would benefit from a reduced Scheduling
Charge.

In relevant part, FERC conditionally accepted the Member
Systems' proposal; summarily rejected Sithe's objections to
the proposed treatment of transmission losses; and set re-
maining issues for hearing. Sithe petitioned for rehearing,
which the Commission denied.

II.

Petitioner challenges as arbitrary and capricious both
FERC's approval of the LBMP methodology--with its simpli-

fying assumption--as well as the agency's endorsement of the
proposed refund mechanism. FERC disputes our jurisdiction
over the first issue; section 313(b) of the Federal Power Act,
16 U.S.C. s 825l(b), provides that "[n]o objection to the order
of the Commission shall be considered by the court unless
such an objection shall have been urged before the Commis-
sion in the application for rehearing unless there is a reason-
able ground for failure to do so."

And in its rehearing request, Sithe made the following
statement:

Sithe does not seek rehearing of the Commission's deter-
mination that the ISO may charge for losses using a
marginal methodology. However, Sithe requests that
the Commission reconsider its decision permitting the
ISO to re-allocate to all loads (through the Scheduling
charge) the amount of revenue that the ISO admittedly
overcharged customers for transmission losses. (Em-
phasis added.)

Sithe, rather unpersuasively, contends that its statement
below should be construed as not challenging the concept of
"a" LBMP charge but as raising a challenge to this particular
application of the methodology. Nice try--but no cigar.
Although the record provides some indication that Sithe was
unhappy with the simplifying assumption (for example, it
submitted expert testimony as to different methodologies for
assessing transmission loss costs), it is also clear that Sithe
limited its challenge to the refund mechanism.

On the other hand, FERC reads Sithe's waiver too broadly.
The Commission would have us accept for purposes of this
case the LBMP methodology with the simplifying assumption
as if it were graven in stone, and therefore in judging its
response to Sithe's objection to the refund mechanism that
methodology must be regarded as sacrosanct. But although
its challenge was directed to the refund mechanism, petition-
er did clearly say that "[u]ntil [the member systems] can
deliver a means of assessing losses on a marginal basis that
permits refunds of overcharges to the customer that over-
pays, the Commission should reject [the] proposal." Al-

though Sithe ostensibly has grabbed hold only of the tariff's
tail, the tariff cannot go forward so long as petitioner's legal
hold on its tail is sufficient. And FERC cannot justify a
perfunctory response to petitioner's refund complaint on
grounds that the basic tariff methodology justifies it.

It will be recalled that the proposed refund mechanism
would reduce the Scheduling Charge for transmission custom-
ers. Sithe objects on two grounds. It contends that it does
not even pay a Scheduling Charge because that charge is not
imposed on transmission customers, such as itself, that
"schedule" wholesale bilateral transactions within New York
State and do not serve end-use consumers. The Commis-
sion's counsel thought otherwise but could point to nothing in
the record to support her belief.

Assuming arguendo that Sithe is correct, it would be part
of a class of transmission customers who have been over-
charged for transmission losses. The Federal Power Act
provides that a utility may not charge rates that "make or
grant any undue preference or advantage to any person or
subject any person to any undue prejudice or disadvantage."
16 U.S.C. s 824d(b); see also Electricity Consumers Re-
source Council v. FERC ("ECRC"), 747 F.2d 1511 (D.C. Cir.
1984) (remanding a marginal rate scheme that resulted in
cross-subsidization of certain customers by other customers).
Similarly, under section 205(a) of the Federal Power Act, a
utility may charge only rates that are "just and reasonable."
16 U.S.C. s 824d(a).2 Interpreting that mandate, we have

__________
2 When assessing whether rate tariffs are just and reasonable,
we apply a standard akin to the APA's substantial evidence inquiry,
ECRC, 747 F.2d at 1513, which is a subset of the APA's arbitrary
and capricious standard. Memorial Hospital/Adair County Health
Ctr., Inc. v. Bowen, 829 F.2d 111, 116-17 (D.C. Cir. 1987). Similar-
ly, approval of an unreasonable rate is arbitrary and capricious.
MCI Telecommunications Corp. v. FCC, 842 F.3d 1296, 1303-04
(D.C. Cir. 1988). Arbitrary and capricious simply means unreason-
able. Detroit Typographical Union No. 18 v. NLRB, 216 F.2d 109,
118 (D.C. Cir. 2000); Association of Data Processing Serv. Orgs.,
Inc. v. Board of Governors of the Fed. Reserve Sys., 745 F.2d 677,
684 (D.C. Cir. 1984).

explained that such rates "should be based on the costs of
providing service to the utility's customers, plus a just and
fair return on equity." Alabama Elec. Coop. v. FERC, 684
F.2d 20, 27 (D.C. Cir. 1982). We have consistently upheld
rates based on such a cost-causation principle, see, e.g., id.;
K N Energy, Inc. v. FERC, 968 F.2d 1295, 1300 (D.C. Cir.
1992).

Even if Sithe gains some benefit from the refund mecha-
nism, it also claims that it would be entitled to a refund that
is equivalent to the amount it has been overcharged.
FERC's response in its order on rehearing was merely that
the tariffs and refund mechanism produced "efficient price
signals," and that petitioner's requested refunds would some-
how disrupt that price signaling, would be "infeasible," and a
matter of "unending controversy." To be sure, we have
acknowledged that feasibility concerns play a role in approv-
ing rates, indicating that FERC is not bound to reject any
rate mechanism that tracks the cost-causation principle less
than perfectly, see, e.g., Tejas Power Corp. v. FERC, 908 F.2d
998, 1005 (D.C. Cir. 1990). But the Commission's cursory
response simply will not do. At no point did the Commission
explain how these considerations applied. Why, we wonder,
would a different method of refunds, based more closely on
cost-causation principles, jeopardize desirable price signaling
or be infeasible?

It may well be that the Commission's refusal to consider
petitioner's refund proposal is really attributed to a desire to
protect the simplifying assumption. It could be thought that
a more precise refund mechanism--matching the refunds to
overpayments--would render the simplifying assumption use-
less. But we do not see how the Commission can justify its
refusal to insist on equitable refunds, based on its approval of
a presumably discriminatory tariff, just because petitioner
challenged squarely only the refund mechanism. If FERC's
position were to be that the refund mechanism is inextricably
intertwined with the simplifying assumption, then petitioner's
challenge to the refund mechanism would perforce question
the simplifying assumption.

 * * * *

Accordingly, the petition for review is granted in part and
we remand the case to the Commission to more adequately
respond to petitioner's contentions.

So ordered.