Court affirms FERC ROE policy, but faults FERC for not applying official notice

By David Poe and Rachael Marsh, Bracewell & Giuliani

The U.S. Court of Appeals for the D.C. Circuit this month remanded a Federal Energy Regulatory Commission (FERC) order establishing the rate of return for three transmission projects of Southern California Edison Co. (SoCal Edison).

The court's decision is noteworthy not only for its affirmance of FERC's decision to adopt and apply a new approach to setting rates of return for individual electric utilities, but also for its finding that the case should be remanded due to FERC's misuse of the official notice provisions of the Administrative Procedure Act (APA).

In SoCal Edison v. FERC, issued May 10, 2013, the D.C. Circuit considered SoCal Edison's challenge of FERC's decision to change its method for calculating returns on equity (ROE) that are used as input values in rate formulas for transmission projects.

For a number of years FERC had determined ROEs for individual electric companies by looking to a proxy group of comparable publicly traded companies and using the arithmetic mean of the highest and lowest ROEs in that group.

In the orders under review, however, FERC rejected SoCal Edison's proposed use of that approach for its three transmission projects, and instead required SoCal Edison to use the median of the proxy-group range — i.e., the ROE value at the middle of the group.

FERC found the median to be a mathematically preferable "measurement of the central tendency" of the calculation. FERC has long used the median to set ROEs for natural gas pipelines. In the orders under review, FERC decided that there was no longer any reason to treat the gas and electric industries differently for these purposes.

An interesting aspect of the decision was SoCal Edison's protest that FERC did not expressly find that its proposal, which was to use the arithmetic mean of the highest and lowest ROEs in a proxy group, did not meet the "just and reasonable" standard that transmission rates have to meet under Section 205 of the Federal Power Act (FPA).

On review, the D.C. Circuit affirmed that FERC can reject a company's proposed rate component without making a finding on its justness or reasonableness. FERC may require companies to use a specific rate methodology so long as the agency's requirement is not arbitrary and capricious.

The court found that FERC had "provided principled reasons for using the median to establish SoCal Edison's base ROE" and quoted U.S. Supreme Court precedent as holding that FERC was not obligated to demonstrate "that the reasons for the new policy are better than the reasons for the old one"; rather, it is sufficient that FERC's new policy is permissible under the statute and that FERC believes it to be a better policy.

The broad deference the D.C. Circuit afforded to FERC's decision making in SoCal Edison v. FERC is consistent with a Supreme Court opinion issued just ten days later considering a challenge to a ruling by another independent agency, the Federal Communications Commission.

In that case, the high court said that when a court reviews an agency's interpretation of a statute it administers, if the agency's determination is permissible under the statute, then "that is the end of the matter."

Nonetheless, despite affirming the substance of FERC's reasoning, in SoCal Edison v. FERC the D.C. Circuit overturned the FERC order and remanded the matter back to the commission because of a failure to follow proper procedures. The court decided that FERC had failed to follow the requirements of Section 556(e) of the APA, which permits an agency to take official notice of a publicly known fact generally not subject to dispute.

But the agency may only do so when the party against whom the fact would be used is given a reasonable opportunity to either contradict it or temper its use in the context of the particular case. With respect to SoCal Edison, the court noted that, after the record had closed, FERC had taken official notice of the average ten-year U.S. Treasury bond yields for the period, March 1, 2008 to December 31, 2008, and had used that information to reduce the allowed ROE.

Thereafter, SoCal Edison had submitted an affidavit of an expert who explained that during the free-fall of the U.S. economy during that period, the normal relationship between treasury yields and the private cost of capital had been disrupted, undercutting the proxy relationship between the two values. FERC refused to consider the affidavit on the grounds that the record had closed. The court held that refusal to be error, and remanded the case to FERC.

The D.C. Circuit decision is Southern California Edison Co. v. FERC, No. 11-1471 (D.C. Cir. May 10, 2013).

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