United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued September 9, 2002 Decided October 15, 2002
No. 01-1187
Pacific Gas and Electric Company,
Petitioner
v.
Federal Energy Regulatory Commission,
Respondent
Enron Power Marketing, Inc., et al.,
Intervenors
Consolidated with
No. 01-1190
On Petitions for Review of Orders of the
Federal Energy Regulatory Commission
---------
Stuart K. Gardiner and Richard L. Roberts argued the
causes for utility petitioners. With them on the briefs was
Jennifer L. Key.
Lona T. Perry, Attorney, Federal Energy Regulatory
Commission, argued the cause for respondent. With her on
the brief were Cynthia A. Marlette, General Counsel, and
Dennis Lane, Solicitor, Federal Energy Regulatory Commis-
sion.
Channing D. Strother, Jr. was on the brief for intervenor
City of Vernon, California.
Before: Edwards, Sentelle and Rogers, Circuit Judges.
Opinion for the Court filed by Circuit Judge Rogers.
Rogers, Circuit Judge: The principal issue in this appeal is
whether the review conducted by the Federal Energy Regu-
latory Commission ("FERC") of the revenue requirements of
a non-jurisdictional entity that is part of a jurisdictional
independent system operator ("ISO") was sufficient to ensure
that the ISO's rates will be just and reasonable under s 205
of the Federal Power Act ("FPA"), 16 U.S.C. s 824d. South-
ern California Edison Company ("Edison") and Pacific Gas
and Electric Company (collectively, "PG&E"), petition for
review of three Orders in which FERC approved the trans-
mission revenue requirement of Vernon, a municipally owned
utility and non-jurisdictional entity, for use in the California
ISO's ("CAISO") transmission access charge. PG&E con-
tends that FERC did not properly evaluate, consistent with
its duty under s 205, Vernon's revenue requirements, and
arbitrarily and capriciously approved Vernon's requirements
based on findings that are unsupported by substantial evi-
dence. We hold that, although FERC has considerable dis-
cretion in choosing how to implement its statutory duty, its
approach in the Orders on review fails to ensure that the
CAISO's rates will be just and reasonable under s 205.
Accordingly, we grant the petition and remand the case for
further proceedings.
I.
In Order No. 2000, FERC encouraged the formation of
regional transmission organizations. See Regional Transmis-
sion Organizations, Order No. 2000, FERC Stats. & Regs.
p 31,089 (1999), 65 Fed. Reg. 810 (2000), on reh'g, Order No.
2000-A, FERC Stats. & Regs. p 31,092, 65 Fed. Reg. 12,088
(2000) (codified at 18 C.F.R. s 35.34), aff'd, Pub. Util. Dist.
No. 1 v. FERC, 272 F.3d 607 (D.C. Cir. 2001). The State of
California created a regional transmission organization, the
CAISO, to operate transmission facilities within California.
The CAISO is subject to FERC's regulatory authority, see
Cal. Indep. Sys. Operator Corp., 91 F.E.R.C. p 61,205, at
61,724 (2000), including the statutory requirement under
ss 205 and 206 of the FPA that a utility's rates must be "just
and reasonable." 16 U.S.C. ss 824d, 824e. The CAISO
originally consisted of three investor-owned utilities (PG&E,
Edison, and San Diego Gas & Electric Company), each of
which is subject to FERC's jurisdiction. Each of the utilities
is compensated by the CAISO for the use of its facilities
through a transmission revenue requirement ("TRR"), which
consists of the costs and rate of return to which the utilities
are entitled as participating transmission owners. FERC
independently examines each of these jurisdictional utilities'
TRRs to ensure that they are just and reasonable. See Cal.
Indep. Sys. Operator, 91 F.E.R.C. at 61,723 n.11. Initially,
the CAISO's rates, or transmission access charge ("TAC"),
reflected the TRRs of the participating transmission owners
in each of three TAC areas. Id. at 61,720.
This case arises out of California's efforts to encourage
non-jurisdictional, municipal utilities to join the CAISO. Id.
at 61,720-21. As a general matter, publicly-owned utilities
are not subject to FERC's ss 205 and 206 jurisdiction, see
FPA s 201(f), 16 U.S.C. s 824(f), although FERC may ana-
lyze and consider the rates of non-jurisdictional utilities to the
extent that those rates affect jurisdictional transactions, see
S.C. Pub. Serv. Auth., 75 F.E.R.C. p 61,209, at 61,696 & n.7
(1996); see also Pub. Utils. Comm'n v. FERC, 660 F.2d 821,
826 (D.C. Cir. 1981). The CAISO proposed to amend its
tariff to allow non-jurisdictional utilities or governmental
entities that joined the CAISO to recover their TRRs through
the CAISO's transmission access charge. See Cal. Indep.
Sys. Operator, 91 F.E.R.C. at 61,720. Once a new transmis-
sion owner ("TO") joined the CAISO, the TAC would reflect
the combined TRRs of the owners in each of the three TAC
areas, and then, over a ten-year period, a single ISO grid-
wide TAC would be phased-in. Id. However, the CAISO's
original tariff proposal did not allow for any FERC review of
the TRRs of governmental entities; instead, review was
limited to a CAISO Revenue Review Panel. Id. at 61,721. In
a May 31, 2000 Order, FERC concluded that the CAISO's
proposal was inconsistent with FERC's statutory responsibili-
ty to ensure that jurisdictional utilities' rates, namely the
CAISO's TAC, be just and reasonable. Id. at 61,729. In
compliance with the May 31, 2000 Order, the CAISO submit-
ted a revised tariff proposal which provided:
If the Participating TO is not FERC jurisdictional, the
Participating TO shall at its sole option: (1) file its High
Voltage TRR and Low Voltage TRR for those facilities
and Entitlements under the Operational Control of the
ISO directly with the Commission in accordance with the
rules and requirements established by the Commission;
or (2) submit to the ISO its TRR.... The decision of
the [Revenue Review] panel shall be subject to review
and acceptance by the FERC.
Cal. Indep. Sys. Operator Corp., 93 F.E.R.C. p 61,104, at
61,287 (2000) [hereinafter "TAC Order"] (alterations in the
original). In an October 27, 2000 Order, FERC accepted this
revision. Id. at 61,288-89.
Pursuant to the CAISO's revised tariff, Vernon, a munici-
pally-owned utility located in the same TAC area as Edison,
voluntarily submitted its TRR for FERC review. With cer-
tain revisions, FERC "accept[ed] Vernon's use of the rate
methodology utilized by [Edison] (an [investor-owned utility]
that has determined its TRR) which is a methodology familiar
to [FERC]" and approved Vernon's TRR. City of Vernon, 93
F.E.R.C. p 61,103, at 61,285 (2000) [hereinafter "Vernon Or-
der"]. PG&E sought rehearing, which was denied in an
order dated February 21, 2001. Cal. Indep. Sys. Operator
Corp., 94 F.E.R.C. p 61,148, at 61,565 (2000) [hereinafter
"Rehearing Order"]. PG&E now seeks review of the TAC
Order, Vernon Order, and Rehearing Order.
II.
PG&E contends that FERC's review of Vernon's TRR was
insufficient to ensure that the CAISO's rates remained just
and reasonable because it was based on an inadequate stan-
dard of review and contrary to FERC precedent. PG&E also
contends that FERC violated s 205 by relying solely on a
review of Vernon's rate methodology in order to approve
Vernon's TRR. PG&E further contends that by not requir-
ing the CAISO to file cost support for the part of its
transmission rate resulting from use of Vernon's facilities or
requiring Vernon to meet the CAISO's s 205 obligation,
FERC chose an impermissible course and the court should
remand with directions for a s 205 inquiry of Vernon's TRR.
The court reviews FERC's Orders under the arbitrary and
capricious standard. 5 U.S.C. s 706(2)(A); Pub. Utils.
Comm'n v. FERC, 254 F.3d 250, 253-54 (D.C. Cir. 2001)
[hereinafter "CPUC"]. FERC therefore "must be able to
demonstrate that it has made a reasoned decision based upon
substantial evidence in the record." Sithe/Independence
Power Partners, L.P. v. FERC, 165 F.3d 944, 948 (D.C. Cir.
1999) (quotations omitted). Because of the highly technical
and policy-based nature of rate design, the court's review of
whether a particular rate design is just and reasonable is
highly deferential. CPUC, 254 F.3d at 254. Absent proce-
dural or methodological flaws, the court may only set aside a
rate that is outside a zone of reasonableness, bounded on one
end by investor interest and the other by the public interest
against excessive rates. Jersey Cent. Power & Light Co. v.
FERC, 810 F.2d 1168, 1176-77 (D.C. Cir. 1987) (describing
the standard in FPC v. Hope Natural Gas Co., 320 U.S. 591
(1944)). Pertinent here, the Supreme Court explained:
The court's responsibility is not to supplant the Commis-
sion's balance of these interests [investor and public
interest] with one more nearly to its liking, but instead to
assure itself that the Commission has given reasoned
consideration to each of the pertinent factors. Judicial
review of the Commission's orders will therefore function
accurately and efficaciously only if the Commission indi-
cates fully and carefully the methods by which, and the
purposes for which, it has chosen to act, as well as its
assessment of the consequences of its orders for the
character and future development of the industry.
In re Permian Basin Area Rate Cases, 390 U.S. 747, 792
(1968). FERC's findings of facts are conclusive if supported
by substantial evidence. FPA s 313(b), 16 U.S.C. s 825l(b).
The CAISO's TAC methodology is a formula rate through
which the TRR of each participating transmission owner is
collected. See generally CPUC, 254 F.3d at 254. As such,
the TRR of each participating transmission owner can be
conceptualized not as its own rate but rather as a cost of the
CAISO. Understood this way, Vernon's TRR need not be
independently subjected to the just and reasonable standard
of s 205, as PG&E contends. While FERC does subject the
TRRs of jurisdictional participating transmission owners to
an independent s 205 just and reasonable review, FERC may
take a different approach as to Vernon, over which FERC
lacks independent jurisdiction, so long as FERC can ensure
by examining Vernon's TRR that the CAISO's rates will
ultimately be just and reasonable.
FERC's approach is to allow a non-jurisdictional entity to
file its costs directly with the FERC, in effect reducing
paperwork and speeding the regulatory process. See Public
Utils. Comm'n, 660 F.2d at 824. FERC then uses its review
of Vernon's filed costs--i.e., its TRR--to evaluate whether
the CAISO's jurisdictional rates are permissible, a form of
indirect regulation. An analogous approach was upheld as to
small natural gas producers in FPC v. Texaco, Inc., 417 U.S.
380 (1974). In Texaco, FERC allowed small gas producers to
sell gas at market prices even if those prices were above the
maximum area rates set by FERC, id. at 384, inasmuch as it
could indirectly regulate the rates of the small producers by
regulating them as costs of the large producers, id. at 384,
386-87. The Supreme Court held that "the Commission is
free to engage in indirect regulation of small producers by
reviewing pipeline costs of purchased gas, providing that it
insures that the rates paid by pipelines, and ultimately borne
by the consumer, are just and reasonable." Id. at 401.
In principle, then, there is no objection to the general
approach taken by FERC. Neither FERC nor Vernon sug-
gest that FPA s 201, exempting "a State or any political
subdivision of a State ... from the review provisions of
s 205," 16 U.S.C. s 824(f), bars FERC's review of Vernon's
TRR to the extent necessary to ensure that the CAISO's
rates are just and reasonable. However, the only place
where FERC described this approach--the approach it now
relies upon in its brief--was in its Rehearing Order. Its
explanation there of the standard it applied in implementing
that approach is limited to the statement: "[W]e evaluated
Vernon's proposed TRR as a means of ensuring that the costs
ultimately charged by the ISO are just and reasonable."
Rehearing Order, 94 F.E.R.C. at 61,564. Nowhere does
FERC elaborate on the application of this standard to Ver-
non's TRR or to the CAISO's rates; in other words, it is
unclear under what standard FERC reviewed Vernon's TRR
to ensure that a pass through of its costs by the CAISO
would be just and reasonable. Typically, "[u]nder the Com-
mission's cost-of-service ratemaking, before a utility's costs of
providing jurisdictional service will be disallowed, those costs
must be examined and found to be excessive or improper."
Ind. & Mich. Mun. Distribs. Ass'n, 62 F.E.R.C. p 61,189, at
62,237 (1993), aff'd sub nom. Ind. Mun. Power Agency v.
FERC, 56 F.3d 247 (D.C. Cir. 1995). In its brief, FERC
recognizes that it generally judges pass-through costs using
this prudence test. But this prudence standard is nowhere to
be found in the Orders at issue.
In contrast, elsewhere in the administrative proceedings,
the most prominently stated description of the approach that
FERC undertook was as follows:
[T]he purpose of our review is to determine whether
Vernon's rate methodology, in the context of Vernon's
participation in a Commission jurisdictional public utility
ISO, will result in a just and reasonable component of the
ISO's rates.
Vernon Order, 93 F.E.R.C. at 61,285; accord Rehearing
Order, 94 F.E.R.C. at 61,563; TAC Order, 93 F.E.R.C. at
61,389. On its face, this statement suggests that FERC did
not consider Vernon's TRR only as a cost component of the
CAISO's formula rate, but rather reviewed Vernon's rate
methodology independently to determine if Vernon's TRR
was itself just and reasonable, albeit under an arguably less
strict standard of just and reasonable. This is confirmed by
other statements in the Orders that FERC concluded that
Vernon's TRR was itself just and reasonable and not merely
that, when passed through into the CAISO's formula rate, the
CAISO's rate remained just reasonable:
[T]he Commission finds that Vernon's proposed rate
methodology and resulting high voltage TRR, as modi-
fied, are just and reasonable.
Vernon Order, 93 F.E.R.C. at 61,283.
In the [Vernon Order], the Commission found that the
proposed rate methodology and resulting TRR filed by
the City of Vernon, in accordance with the ISO's alterna-
tive filing procedure, were just and reasonable as modi-
fied.
Rehearing Order, 94 F.E.R.C. at 61,562.
The filed protests by PG&E and Edison argued that all
aspects of Vernon's TRR had to be found just and reasonable
under the s 205 or comparable standard, Vernon Order, 93
F.E.R.C. at 61,284-85, and took issue with various claimed
costs of services, including the proper rate of return. Id.
The CAISO sought guidance on three aspects of Vernon's
calculation of its TRR, regarding cost deferrals and use of
Edison's rate of return and depreciation factor. Id. at 61,285.
FERC did address some of these concerns. It directed
Vernon to modify its TRR by (1) using Edison's capital
structure as well as its return on common equity as a proxy
and (2) deleting unused transmission capacity expense. Id. at
61,286. In concluding that Vernon's "resulting high voltage
TRR" was just and reasonable, see Vernon Order, 93
F.E.R.C. at 61,282, and in addressing the evidence supporting
its costs provided by Vernon, see Rehearing Order, 94
F.E.R.C. at 61,564, FERC also considered the costs that
underlay Vernon's TRR. We therefore reject PG&E's con-
tention that FERC improperly relied solely on cost methodol-
ogy. But FERC never clarified and developed either the
approach or the standard that it applied in this case.
In justifying its approach, FERC stated: "We believe that
the approach we took properly balances our duty to ensure
the justness and reasonableness of the ISO's rates with the
fact that Vernon itself is not jurisdictional for purposes of
FPA Section 205." Rehearing Order, 94 F.E.R.C. at 61,564.
In none of the Orders on review did FERC expand on this
justification for its "approach" aside from noting that it may
approve other approaches in the future, id. at 61,563.
FERC's efforts to defend its approach on appeal are to no
avail. First, FERC seeks to defend its vague standard under
the "end result" test identified in Hope Natural Gas, 320 U.S.
at 602. However, it is long settled that "[e]xperience has
taught that a determination of whether the result reached is
just and reasonable requires an examination of the method
employed in reaching that result." City of Charlottesville v.
FERC, 661 F.2d 945, 950 (D.C. Cir. 1981) (citing Permian
Basin Area Cases, 390 U.S. at 791-92). Second, FERC
maintains, relying on CPUC, 254 F.3d 250, that as long as the
formula rate filed by the CAISO has been approved, it need
not conduct any separate review under s 205 of the CAISO's
pass through of Vernon's TRR costs via that formula rate.
But, FERC itself acknowledged in requiring FERC review of
non-jurisdictional TRRs that it "must be able to determine
that the pass through of costs by the [CAISO] to its custom-
ers are just and reasonable." Cal. Indep. Sys. Operator
Corp., 91 F.E.R.C. at 61,724. Moreover, in CPUC, the court
held that separate s 205 review was unnecessary for "con-
tracts that merely affect jurisdictional rates" because the
CAISO used a bid-based process to ensure that it paid as
little as possible for those contracts. 254 F.3d at 255. The
Vernon TRR at issue, on the other hand, is filed directly with
FERC, and the CAISO has no authority to approve or
disapprove it, see TAC Order, 93 F.E.R.C. at 61,287, giving
Vernon "unfettered discretion to set the level of" its TRR, see
CPUC, 254 F.3d at 256 n.5. FERC also appears to have
relied on its review of Vernon's TRR to deny future "collater-
al" attacks on the justness and reasonableness of the
CAISO's pass through of Vernon's costs. See Cal. Indep.
Sys. Operator Corp., 94 F.E.R.C. p 61,147, at 61,558 (2001).
Finally, FERC's reliance for the first time on appeal on FPA
s 206, which allows FERC or consumers to retroactively
challenge rates as not just and reasonable, as affording
consumers sufficient protections, is a post-hoc rationalization
of counsel, Burlington Truck Lines, Inc. v. United States, 371
U.S. 156, 168-69 (1962), that cannot cure the deficiency of the
initial review.
The only remaining question is what standard of review
should apply, and on this point it is clear that s 205 imposes a
"just and reasonable" standard. FERC acknowledges that it
is required under s 205 to determine that the rate ultimately
charged by an ISO is "just and reasonable." See Respon-
dent's Br. at 22-23. Yet the Orders on review reveal, as
noted, no method for ensuring this, neither specifying what
approach nor defining the standard FERC applied in deter-
mining that the CAISO's rates were "just and reasonable"
after the inclusion of Vernon's TRR. On appeal FERC does
not claim that its somewhat amorphous standards ensure that
Vernon's TRR itself will be just and reasonable. While
FERC's approach might be acceptable if FERC tested the
final ISO composite rate (which included Vernon's require-
ments) to determine whether it was just and reasonable,
FERC acknowledged at oral argument that the CAISO's rate
is filed without such review. See generally CPUC, 254 F.3d
at 254. Thus, "[a]t the very least, the [approach] is so
ambiguous that it falls short of that standard of clarity that
administrative orders must exhibit," see Texaco, 417 U.S. at
395-96, and a remand is required so that FERC can articu-
late with clarity what approach and standard are governing
its review and how both ensure the CAISO's rates are just
and reasonable under s 205.
III.
In light of the remand, we briefly address PG&E's conten-
tion that FERC's method of review of Vernon's TRR was
arbitrary and capricious on several procedural and substan-
tive grounds.
The claimed procedural error concerns FERC's denial of a
hearing. PG&E maintains FERC precedent establishes that
all material, factual disputes warrant a hearing and discovery,
which were both denied to PG&E. Inasmuch as FERC may
have to consider this question anew on remand, we need only
point out that FERC may properly deny an evidentiary
hearing if the issues, even disputed issues, may be adequately
resolved on the written record, at least where there is no
issue of motive, intent, or credibility. Texaco, Inc. v. FERC,
148 F.3d 1091, 1100 (D.C. Cir. 1998). PG&E does not con-
tend that the disputed issues could not be resolved on the
written record and offers no evidence that would have re-
quired such a hearing. Its contentions pose legal and policy
disputes as to the appropriateness of the evidence provided
by Vernon, see Carnegie Natural Gas Co., 47 F.E.R.C.
p 63,025, at 65,063 (1989), and as such do not warrant a
hearing, Union Pac. Fuels, Inc. v. FERC, 129 F.3d 157, 164
(D.C. Cir. 1997). Under the circumstances, the court defers
to FERC's determination that a hearing was not required.
See Ala. Power Co. v. FERC, 993 F.2d 1557, 1565 (D.C. Cir.
1993). That said, it does not follow that legal and policy
disputes about the sufficiency of the evidence might not
require further elaboration on remand.
The substantive errors, PG&E maintains, arise because
FERC (1) failed to look for cost justification of Vernon's TRR
and improperly declined to examine certain costs because
they were de minimis, and (2) did not justify Vernon's reli-
ance on Edison's rates of return and depreciation. FERC's
threshold response, that these contentions fail because PG&E
does not claim that the CAISO's rates are not just and
reasonable, misses the mark. When PG&E contends that
FERC lacked adequate support to conclude that Vernon's
TRR was just and reasonable, PG&E is necessarily contend-
ing that the CAISO's TAC, to the extent it has as a compo-
nent Vernon's TRR, is not just and reasonable. Indeed, any
failure by PG&E to challenge explicitly the CAISO's resulting
TAC may well be a result of FERC's amorphous analysis
purporting to determine, under an unspecified standard of
review, that Vernon's TRR was a just and reasonable compo-
nent of the CAISO's rate. In the end, FERC's responsibility
appears the same: whatever standard it might apply, it must
be able to show that there was substantial evidence to sup-
port the conclusion that the CAISO's rates after the inclusion
of Vernon's TRR are just and reasonable and that this
conclusion was not arbitrarily and capriciously reached.
Regarding costs, "it has come to be well established that
electrical rates should be based on the costs of providing
service to the utility's customers, plus a just and fair return
on equity." Ala. Elec. Coop., Inc. v. FERC, 684 F.2d 20, 27
(D.C. Cir. 1982). FERC generally requires that rates be cost
supported. Id. PG&E maintains that FERC improperly
relied solely on sworn cost support and testimony and that
there is a lack of specific evidence to support FERC's conclu-
sions; according to PG&E, this prevented FERC from inves-
tigating why Vernon's costs were proportionately so much
higher than Edison's. With respect to the administrative and
general costs, PG&E contends that FERC departed from
pre-existing precedent not to disregard de minimis costs,
citing People's Elec. Coop., 84 F.E.R.C. p 61,229 (1998); N.
Ind. Pub. Serv. Co., 66 F.E.R.C. p 61,213 (1994), when it
justified its review of those costs by pointing out that Ver-
non's administrative and general expense was approximately
0.04 percent of the CAISO's rate. Rehearing Order, 94
F.E.R.C. at 61,564 n.7.
FERC persuasively responds that it did review the costs
underlying Vernon's proposed rate methodology and that in
large part they were "objectively verifiable." Although the
supporting data for Vernon's TRR costs do not meet the
requirements of 18 C.F.R. s 35.13, which apply to the rate
filings of jurisdictional utilities, PG&E never specifically rais-
es this as a challenge to the Orders and, more importantly,
for reasons discussed in Part II, FERC need not apply to
non-jurisdictional utilities the requirements of its regulations
applicable to jurisdictional utilities. In the Rehearing Order,
FERC discussed each element of Vernon's costs, noting that
most of its costs were specified in work papers from various
"transmission projects" in which Vernon had ownership inter-
ests and came from expenses paid to other utility corpora-
tions for transmission of Vernon's electricity, expenses that
were "a pass through of verifiable transmission expenses"
paid to those utilities. Rehearing Order, 94 F.E.R.C. at
61,564. With respect to Vernon's administrative and general
costs, FERC reviewed this cost, indicating that it was approx-
imating 0.04 percent of the CAISO's rate, a sufficient analysis
to defeat PG&E's contention that FERC departed from pre-
existing precedent not to disregard de minimis costs. Given
our deferential standard of review, FERC's review of Ver-
non's costs was not arbitrary and capricious. Rather, the
more fundamental problem is the amorphous standard by
which FERC has reviewed the impact of Vernon's TRR on
the CAISO's rates.
Regarding Vernon's use of Edison as a proxy for the rate
of return on common equity and the depreciation rate, the
Orders on review provide only an inadequate conclusory
statement that FERC thought use of Edison as a proxy was
appropriate because Edison and Vernon were in the same
TAC area. Vernon Order, 93 F.E.R.C. at 61,286. Not only
does the record reflect that Vernon itself sought to distin-
guish itself from Edison, at least for the purposes of being
allowed to include unused transmission expense in its TRR,
the filed protests presented unanswered challenges to allow-
ing Vernon to use Edison's rates. Vernon Order, 93 F.E.R.C.
at 61,284; see also Rehearing Order, 94 F.E.R.C. at 61,563.
While use of a surrogate capital structure or return on equity
may be appropriate for a governmental entity, FERC did not
explain why such a proxy was necessary nor justify the
selection of Edison as a surrogate by considering and examin-
ing, for example, whether Vernon and Edison share common
risks. Cf. S. Cal. Edison Co., 92 FERC p 61,070, at 61,264-67
(2000). Vernon's use of Edison's rate-making methodology
bears no obvious correlation to an appropriate return on
equity for Vernon, and mere geographical proximity hardly
appears, absent further explanation, a sufficient warrant for
the same return on equity or the same capital structure. A
similar problem exists with regard to FERC's explanation of
its approval of Vernon's reliance on Edison's 3.2% rate of
depreciation. FERC's conclusion that its choice is "reason-
able," Rehearing Order, 94 F.E.R.C. at 61,565, is thus insuffi-
cient to survive arbitrary and capricious review.
Perhaps on remand FERC may be able to provide an
adequate explanation for allowing Vernon to use Edison as a
proxy. FERC did adequately explain in the Rehearing Order
that the "alternative proposal to use a cost of capital equiva-
lent to the debt costs of other California municipals does not
represent a superior proxy for Vernon[, because] Vernon's
facilities were not financed with tax-exempt debt or bonds of
any kind." Rehearing Order, 94 F.E.R.C. at 61,565. Howev-
er, the rejection of a single alternative does not alone warrant
adoption of Edison as a proxy. On appeal, FERC maintains
that it was necessary for Vernon to rely on Edison's capital
structure and overall return as a proxy because Vernon's
return could only be measured indirectly, and Vernon and
Edison had the same risks because they provide services in
the same TAC area. The Orders on review do not provide
that explanation and the court cannot rely on FERC's post
hoc justifications for its action. Burlington Truck Lines, 371
U.S. at 168-69.
Accordingly, because the Orders on review provided no
explanation as to how or why FERC's review of Vernon's
TRR produced the necessary result, namely, just and reason-
able rates for the CAISO, we grant the petition and remand
the case for further proceedings. In doing so we are not
unmindful of the complexities underlying Order No. 2000 and
FERC's regional approach, and that FERC may wish to
retain flexibility regarding the nature of its review of the
TRRs of individual non-jurisdictional entities. Vernon Order,
93 F.E.R.C. at 61,285. Nevertheless, while FERC has discre-
tion in formulating its approach with respect to a non-
jurisdictional utility, the choice it makes must ensure that the
CAISO's rates meet the just and reasonable standard of
s 205.