A new twist on an old doctrine.
Stephen L. Teichler is the head of the Duane Morris energy practice group. Contact him at SLTeichler@duanemorris.com. Ilia Levitine is an energy partner at Duane Morris.
The D.C. Circuit once observed that the Mobile-Sierra doctrine is “refreshingly simple”: “Rate filings consistent with contractual obligations are valid; rate filings inconsistent with contractual obligations are invalid.” In fact, however, the doctrine has become incredibly nuanced and complex over time.
Since the late 1950s, the courts and the Federal Energy Regulatory Commission (FERC) have struggled with the appropriate standard for reviewing initiatives that may abrogate the terms of bilateral contracts providing for wholesale sales of natural gas and electricity. Heretofore, the prescriptions of the Mobile-Sierra doctrine could be overcome only upon a showing that the “public interest” required existing agreements to be changed by regulatory fiat. The heart of this standard was that the requisite showing could not be made easily by either the commission or the party requesting a contract modification. Now, the 9th Circuit Court of Appeals has rewritten the rules.
In two concurrently issued decisions, the court has discovered new prerequisites to the initial application of the Mobile-Sierra doctrine, changed the independent “public interest” review standard into a presumption, and has jettisoned that presumption entirely when contract prices are too high as opposed to too low.2 Just as the commission slowly reached consensus on the issue, the doctrinal controversy arose anew with undiminished vehemence.
In Mobile,3 a seller agreed to a long-term, fixed-rate contract that was filed with, and accepted by, the Federal Power Commission, FERC’s regulatory predecessor. Thereafter, the seller attempted to increase prices under the contract by filing higher rates pursuant to Section 4 of the Natural Gas Act (NGA).4 The Supreme Court held that the seller could not unilaterally increase its contract price through a regulatory filing because the NGA “evinces no purpose to abrogate private rate contracts.”5 A filing to increase prices pursuant to the NGA could be made only if the underlying contract provided authority for either party to increase the price unilaterally.
In Sierra,6 the court held that when a public utility agrees to a contract that provides less than a fair return, the commission may interdict the contract under Section 206 of the Federal Power Act (FPA)7 only if “the rate is so low as to adversely affect the public interest.”8 The court stated that: “The purpose of the power given the commission by [Section] 206(a) is the protection of the public interest, as distinguished from the private interests of the utilities,” as “a contract may not be said to be either ‘unjust’ or ‘unreasonable’ simply because it is unprofitable to the public utility.”9 In determining the “public interest,” the court identified three indicative factors of whether the rate: (1) might impair the financial ability of the public utility; (2) would impose an excessive burden on other consumers; and (3) would be unduly discriminatory.10
The extent to which the commission itself is subject to the “public interest” standard, described by one court as “practically insurmountable,”11 has been the subject of lively controversy. Some have held to the view that when the commission is acting sua sponte or in a generic policy role, it may abrogate contracts or terms thereof upon a finding that they have become unjust and unreasonable. Others, however, aver that the commission itself must demonstrate that abrogation is required by the public interest no matter how generically it may be acting.
The Ninth’s PUD Opinion
At issue before the Ninth Circuit were a number of forward contracts that voluntarily had been entered into at the height of the California energy crisis. In most cases, the purchaser relinquished any unilateral right to seek revisions to the contract. When the crisis passed, however, purchasers entreated the commission to abrogate these contracts on the basis that fraud and abuse tainted the contract-formation process. The commission declined to grant relief on the basis that petitioners had failed to show that the “public interest” required contract abrogation.12
In Public Utility District No. 1 of Snohomish County, Wash. v. FERC (PUD), the Ninth Circuit prefaced its opinion with the observation that it was confronting, for the first time, “the intersection of two doctrines—one, the Mobile-Sierra doctrine, the product of the courts; the other, market-based rate authorization, the product of recent agency policy—as they affect the application of the just and reasonable standard.”13 The phenomenon of market-based rate authority adds a new dimension to the analysis, according to the court, because in the prior regime, the commission made a just and reasonable determination when an individual contract was filed, while market-based rate authority is granted before each contract is formed.
In a dramatic shift of prevailing precedent, the court characterizes the “public interest” test as a presumption as opposed to a standard of review separate and apart from the just-and-reasonable standard, and articulates two new conditions precedent for the presumption itself to arise. Under the court’s view, the “public-interest” test as a standard of review finds no support in the FPA. Instead, the Mobile-Sierra doctrine merely creates a rebuttable presumption that voluntarily negotiated prices are, and will remain for the life of the contract, just and reasonable. According to the court, Sierra “simply held that considerations as to what is ‘unjust’ or ‘unreasonable’ differ in the context of an established bilateral contract, not that the statutory standards no longer govern.”14 For the presumption that rates under bilateral contracts are just and reasonable to arise, the court held that three prerequisites must be satisfied: (1) the contract by its own terms must not preclude the limited Mobile-Sierra review (i.e., does not provide contractual authority to make unilateral rate filings); (2) the regulatory scheme in which the contracts are formed must provide FERC with an opportunity for effective, timely review of the contracted rates; and (3) in the context of market-based rates, the commission’s review must include consideration of all factors relevant to the propriety of the contract’s formation. As the court put it, “taken together, the satisfaction of these three conditions justifies a presumption that parties have negotiated a contract that is just and reasonable between them and therefore triggers the Mobile-Sierra public-interest mode of review.”15
The first condition reflects settled law that, absent contractual authority, a party to a jurisdictional contract cannot file to collect higher rates unless it can show that the abrogation of its contract is in the public interest.16 The second condition carries forward the Ninth Circuit’s holding in Lockyer17 that a market-based rate regime must include some provision by which the commission considers whether market-based rates are just and reasonable, i.e., that the assumptions upon which market-rate authority was granted were obtained when the contract was executed. The third condition is cut from whole cloth and requires the commission to examine whether anomalies were extant at the time of contract formation, which call into question whether the rates and terms of the contract reflect the outcome of a workably competitive market.
In the case at bar, the court found that none of the contested contracts authorized unilateral action, and thus held that its first Mobile-Sierra precondition was satisfied. As to the second condition, the court stated that “although market-based rate authority can qualify as sufficient prior review to justify limited Mobile-Sierra review, it can do so only when accompanied by effective oversight permitting timely reconsideration of market-based authorization if market conditions change.”18
In the instant case, as with Lockyer before it, the court found that the commission failed to adopt any monitoring mechanism before applying the deferential Mobile-Sierra review to the challenged contracts. Rather, the commission accepted the grant of market-based rate authority as conclusive proof that the terms of subsequently negotiated contracts were just and reasonable without any inquiry into the actual state of the market at the time contracts were negotiated. According to the court, “by layering Mobile-Sierra review on top of a market-based rate authority that can be revoked only prospectively ... FERC abdicates its statutory responsibility to provide such rate revision when appropriate.”19 The court found that the “fatal flaw in FERC’s approach to ‘oversight’[was] that it preclude[d] timely consideration of sudden market changes and offer[ed] no protection to purchasers victimized by the abuses of sellers or dysfunctional market conditions that FERC itself only notices in hindsight.”20 Therefore, the second prerequisite to the application of the Mobile-Sierra doctrine was unfulfilled in this case.
As to the third condition, the court held that FERC must establish that the challenged contract initially was formed free from the influence of improper factors, such as market manipulation, the leverage of market power, or an otherwise dysfunctional market. In the challenged orders, the commission acknowledged a report by its own staff finding that the flaws in the spot market artificially influenced rates in the forward markets, but found such evidence to be irrelevant to its Mobile-Sierra analysis. The court held that the FERC’s application of the Mobile-Sierra doctrine without considering contract formation issues was in error.
The Ninth Circuit went on to opine that the commission’s error in deciding whether to apply the Mobile-Sierra presumption was compounded by its use of an erroneous standard for determining whether the challenged contracts affect the public interest. The court held that the public interest factors cited by the court in Sierra only were applicable in the context of a low-rate challenge, and were not apropos to the high-rate challenge presented in the case before it. In a high-rate challenge, such as the PUD case, the FERC must give predominant weight to the impact of a challenged wholesale contract on the rates paid by the consuming public. According to the court, the narrow conception of “public interest” taken from Sierra does not suffice in this circumstance.
The court admonished that FERC must take into account the Supreme Court’s observation that even “‘a small dent in the consumer’s pocket’ is relevant to the determination of fair rates.”21 Thus, the proper test is not whether the contracted rates pose an “excessive burden” on consumers, but whether the wholesale contract is outside the “zone of reasonableness” and results in retail rates higher than would be the case if that zone were not exceeded. The “zone-of-reasonableness” test, which originated in the Supreme Court’s decision in Hope,22 is, of course, a hallmark of the “just and reasonable” analysis, which is now conflated, at least in some circumstances, with the previously distinct (and more stringent) “public-interest” review under Mobile-Sierra. Given this new standard, the court concluded that the commission did not properly assess the public interest of any of the contracts before it in the case at bar. A similar decision was reached in the companion CPUC case, where the Court applied the new standard articulated in PUD.
Choppy Waters Again
Just when the commission believed it had found its way under the Mobile-Sierra doctrine, the waters are roiled again. If the court’s PUD decision is good law, then the “public-interest” standard as we have known it is a dead letter. Instead, existing contracts merely carry a presumption that the rates and terms thereunder will remain just and reasonable over the term of the contract. If the seller is challenging the contract, the presumption is strong. If the buyer is challenging a contract on the basis that the price is too high, the presumption appears to conflate to little more, if any, than the standard burden under Section 206 to show that the rates are unjust and unreasonable.
In a market-based regime, the commission may be hard pressed to show that it is maintaining an oversight role that is applicable at the time of contract formation. Even with market monitors and a newly invigorated enforcement function, the commission’s detection and remediation of temporal or systemic market flaws or abuse becomes effective only after objectionable circumstances have occurred. There is nothing in FERC’s arsenal of regulatory arms that would allow it to conduct meaningful oversight of contracts executed under the blanket market-based rate authority of a seller. As a result, the FERC’s ability to authorize market-based rates may be seriously affected.
The final condition articulated in PUD is a mere catch-all. If hindsight suggests that contract formation was flawed due to market irregularities, the Mobile-Sierra presumption does not apply and the inquiry is guided solely by the unjust and unreasonable standard of Section 206 of the FPA. The court suggests that if wholesale prices are any higher than they would have been absent the market irregularities, then they are ipso facto unjust and unreasonable, warranting contract abrogation retroactive to the date of execution. How this result comports with the filed-rate doctrine and the rule against retroactive rulemaking is yet to be seen.23
At the very least, the commission is now relieved of its internal dispute as to the meaning and application of the “public-interest” standard to its own conduct since that concept appears to be either dead or on its way back to the Supreme Court.
1. Richmond Power & Light v. FPC, 481 F.2d 490, 493 (D.C. Cir. 1973).
2. Pub. Util. Dist. No. 1 of Snohomish County, Washington v. FERC, No. 03-72511, et al., 2006 U.S. App. LEXIS 31297 (9th Cir. Dec. 19, 2006) (PUD); Pub. Utils. Comm’n of the State of California v. FERC, No. 03-74207, 2006 U.S. App. LEXIS 31140 (9th Cir. Dec. 19, 2006)(“CPUC”). This article focuses on the PUD decision, as the new standard was developed therein.
3. United Gas Pipe Line Co. v. Mobile Gas Serv. Corp., 350 U.S. 332 (1956) (Mobile).
4. 15 U.S.C. § 717c.
5. Mobile, 350 U.S. at 338.
6. FPC v. Sierra Pacific Power Co., 350 U.S. 348 (1956) (Sierra).
7. 16 U.S.C. § 824e.
8. Sierra, 350 U.S. at 355.
11. Papago Tribal Util. Auth. v. FERC, 723 F.2d 950, 954 (D.C. Cir. 1983).
12. For a discussion of these decisions, see Stephen L. Teichler & Ilia Levitine, Long-term Power Purchase Agreements in a Restructured Electricity Industry, 40 Wake Forest L. Rev. 677, 697-701 (2005).
13. PUD, 2006 U.S. App. LEXIS 31297, at *16.
14. Id. at *58.
15. Id. at *18.
16. See, e.g., Pennzoil Co. v. FERC, 645 F.2d 360 (5th Cir. 1981).
17. California ex rel. Lockyer v. Dynegy Inc., 375 F.3d 831 (9th Cir. 2004).
18. PUD, 2006 U.S. App. LEXIS 31297, at *75.
19. Id. at *89.
20. Id. at *91.
21. Id. at *104 (quoting FPC v. Texaco Inc., 417 U.S. 380, 399 (1974)).
22. FPC v. Hope Natural Gas Co., 320 U.S. 591 (1944).
23. The filed-rate doctrine forbids a regulated entity to charge rates for its services other than those properly filed with the appropriate federal regulatory authority. See Arkansas Louisiana Gas Co. v. Hall, 453 U.S. 571 (1981). The related rule against retroactive ratemaking prohibits the commission from adjusting current rates to make up for a utility's over- or under-collection in prior periods.