Week Ending February 5, 2016

FERC vs. Presiding ALJ in Seaway Crude Pipeline Rate Case – FERC Wins

This Article Appears as Published in Foster Report No 3085
FERC vs. Presiding ALJ in Seaway Crude Pipeline Rate Case – FERC Wins

FERC issued Opinion No. 546 on February 1 that both affirmed in part and in many cases reversed an Initial Decision on Remand issued 5/9/14 by Presiding Administrative Law Judge Karen V. Johnson.  The remand decision followed the issuance of a Commission’s order on Initial Decision and remand for further action.  Here the Commission found that the Presiding Judge failed to follow the mandate of the remand order concerning committed rates posed by Seaway Crude Pipeline Co. LLC[1] (IS12-226) and “erred in other rulings” concerning Seaway’s initial rates.

In this proceeding, FERC conceded, among other things, “we are presented with a question as to the extent to which the law requires the Commission to owe deference to administrative law judges when a Presiding Judge disagrees with, and therefore does not implement, well-established Commission policy.” The Presiding Judge argues that administrative law judges (ALJs) are independent, and must be completely free from any influence from the Commission.  However, this ruling concluded, “the Commission was well within its authority to remand the decision back to the Presiding Judge, along with clarification of Commission and legal precedent, with the expectation that the Presiding Judge will follow the law and policy.”

The Opinion roundly rejected numerous elements of the Judge’s implication that the Commission had ill-used the ALJ process and unfairly negated her prerogatives.  However, the Commission in this order also offered a conciliatory conclusion, specifically:  “Disagreements over law and policy are bound to occur from time to time between the Commission and Administrative Law Judges.  While the Commission may disagree with a Presiding Judge’s particular course of action, and expect that all decisions follow the relevant law as well as precedent and policy, such actions are not meant to impugn the professionalism or motives of an individual ALJ.”

Background.  Seaway in 2012 sought to establish initial rates agreed to in writing by a non-affiliated shipper who intended to use the service set forth in the filed tariff.  Several parties lodged motions to intervene, including Cenovus Energy Marketing Services Ltd., Apache Corp., Chevron Products Co. and Noble Energy Inc. (ACN), Nexen Energy Marketing U.S.A. Inc.; MEG Energy Corp., the Canadian Association of Petroleum Producers (CAPP); Suncor Energy Marketing Inc., Canadian Natural Resources Ltd., and Denbury Onshore LLC (Suncor); the Independent Petroleum Association of America (IPAA); and EnCana Marketing USA.  One party, Chesapeake Energy Marketing, Inc., filed a comment in support of the tariff.  Five protests were filed by various interested parties.

FERC’s suspension order in May that year established hearing procedures to address all issues.  Separately, on 12/12/12  Seaway (OR13-10) filed a petition for declaratory order (PDO) requesting the Commission declare that Seaway’s committed rates be governed by the pipeline’s Transportation Service Agreement (TSA). The Commission denied this request on procedural grounds, yet reaffirmed its policy of upholding negotiated rates.

An Initial Decision (ID) followed on 9/13/13, following an evidentiary hearing.  Among other rulings, the ID found that Seaway’s committed shipper rates, as established in the TSA, were unjust and unreasonable.  Among other rulings, the Presiding Judge found that Seaway’s committed rates were unjust and unreasonable.  The Judge also eliminated a substantial portion of Seaway’s proposed uncommitted rates associated with the costs of acquiring the Seaway pipeline.  But on 2/28/14, the Commission issued its Remand Order, reversing the ID and remanding it for further action.

Committed Shipper Rates in the ID.  The Initial Decision on Remand concluded that the circumstances of this proceeding merit the Commission’s exercising its discretion and modifying Seaway’s committed rates because, according to the Presiding Judge, the Commission’s hearing order required that all of Seaway’s rates be cost-based.  The Judge further stated that Seaway’s committed rates were unjust and unreasonable because the committed rates “are not based on cost-of-service data; rather they were determined through an open season process.”  According to the Judge, the committed rates will allow Seaway to “substantially over-recover its cost-of-service” and such an over-recovery is “inconsistent with the concept of just and reasonable rates that are required by the Commission’s cost-based rate regulation.”

To the Judge, this was “a question of first impression” as to agency policy when the negotiated rate revenues generated by the committed shipper contracts exceed the pipeline’s overall cost of service.  The Presiding Judge called it “an interpretation of a novel question of law.”  The Judge disagreed with the Commission’s statement in the remand order that the committed TSA contract rates were not themselves an issue, but the hearing was intended to examine Seaway’s uncommitted rate structure and the fairness of the open season process.  The ALJ argued that the hearing order did not convey such an intention, and no participant understood that to be an intended purpose of the hearing.  Instead that order required Seaway’s negotiated rates to be cost-based.  And while the committed shipper contracts “must be honored,” a provision of the contract allows for the Commission to modify the committed rates.

In addition to reiterating her ruling that the committed contract rates, insofar as they were not cost-based, were therefore unjust and unreasonable, the Judge disagreed with the Commission for issuing its remand order, arguing that FERC “does not have the authority to order an administrative law judge to change her findings as to the merits of an issue” and is instead contravening the U.S. Supreme Court by “imposing external pressure” to change her independent judgment.

Not stopping there, the Presiding Judge goes on to state that the Commission’s views on its own policies regarding negotiated rates are “baseless and inaccurate” and that the Commission relied on a “post-hoc rationalization” for excluding the committed shipper rates from the Presiding Judge’s consideration.

In its brief on exceptions, Seaway criticized the Judge’s rulings concerning the validity of its committed rates and views as to the scope of independence enjoyed by administrative law judges.  Among other points, Seaway argued that the Initial Decision on Remand failed to acknowledge that not all rates are required to be set on a cost-of-service basis.  Seaway also rejected the Judge’s argument that issues concerning the open season were not viewed by any participant as being within the scope of this proceeding.

And Seaway held that the Commission has the unequivocal authority to require administrative law judges to issue decisions that comply with applicable law and policy.

Seaway also states at one point the Initial Decision on Remand reference to “the industry propaganda machine” is “unworthy of a neutral decision maker and fails to exhibit the impartiality required of a Presiding Judge by the Commission’s regulations.”

In its brief on exceptions, Trial Staff stated that it no longer maintains its earlier litigation position that the committed shipper rates are at issue.  In its brief opposing exceptions, Trial Staff again stated that committed rates are not at issue in this proceeding, yet argued that rates for uncommitted shippers should reflect the revenue earned from those committed rates.

However, Staff continued to argue that Seaway’s overall revenue is above its costs and therefore its negotiated rates are unjust and unreasonable.  Trial Staff stated that a failure to modify Seaway’s committed rates would be an abandonment of the Commission’s “traditional vigilance.”  Because it believes Seaway’s committed rates are no longer at issue, Staff suggested a crediting method is required to establish just and reasonable cost-based rates for uncommitted shippers.

Independence of a Presiding ALJ.  According to FERC in the instant order, “The decisional independence of an ALJ , as protected by the APA, encompasses issues of tenure, compensation and performance appraisal exemptions.  To the extent a larger right of decisional independence exists, such a right would belong to the claimants whose rights are adjudicated by the ALJs rather than to the ALJs themselves.”[2]  Therefore, contrary to the arguments of the Presiding Judge, the Commission holds that administrative law judges “do not enjoy unlimited independence in their decision making.”  ALJs instead have a “qualified” right of decisional independence.

There are defined limits to the extent to which ALJs may exercise this qualified right of decisional independence.  “An ALJ is a creature of statute and, as such, is subordinate to ((the Commission)) in matters of policy and interpretation of law.” Nash v. Bowen, (2nd Cir. 1989).  Administrative Law Judges “remain entirely subject to the agency on matters of law and policy.” see also Iran Air v. Kugelman (D.C. Cir. 1993), citing Antonin Scalia, The ALJ Fiasco – A Reprise, U.Chi.L.Rev. 57, 62 (1979).

As such, the basic concept of the independent ALJ requires that she/he conduct the cases over which she/he presides with “complete objectivity and independence.”  In so operating, however, she/he is “governed, as in the case of any trial court, by the applicable and controlling precedents.  These precedents include the applicable statutes and agency regulations, the agency’s policies as laid down in its published decisions, and applicable court decisions.”

When the Commission calls on an ALJ, on remand, to accept the agency’s reading of the applicable law, the ALJ is bound to follow that instruction, FERC declared.

The Presiding Judge cites to Butz v. Economou (Initial Decision on Remand, 1978) in support of her argument that the Commission unfairly threatened her judicial independence.  However, FERC counter argued that the case does not support the argument that the Presiding Judge can ignore Commission policy and precedent.

Most relevant for the present proceeding, the Court in Butz found that the possibility of unlawful bias by a hearing examiner/ALJ was limited in the judicial process due in part to “the importance of precedent in resolving controversies” and “the correctability of error on appeal.”   To do otherwise, held the Court, would be an exhibition of bias.  It is this statement, FERC stated in the instant Opinion 546, that is the most relevant holding of Butz concerning the issues in this proceeding.  “The Court held that the likelihood of a hearing examiner exhibiting bias is minimized by the requirement that the hearing examiner follow precedent, and be subject to correction.  Instead of supporting the argument that the Presiding Judge enjoys complete decisional independence, the holding in Butz further establishes that hearing examiners/ALJs must follow precedent.”

Suncor and ACN also presented arguments in support of the Presiding Judge’s decisional independence that, instead, “undercut such claims of untrammeled independence,” the Commission continued.

The Commission, moreover, did not remand the instant case to the Presiding Judge with instructions to modify the factual findings of the case.  Instead the Judge had been directed to properly analyze those facts in accordance with well-established policy.  “It is the duty of a presiding officer to conduct a fair and impartial hearing and to determine the matters justly under the law.  The actions of the presiding officer must be consistent with applicable law and policy.”

The Commission does not dispute that the revenue from Seaway’s committed rates will exceed its overall cost of service.  But it disputed the conclusions to be drawn from this fact, primarily whether that fact alone results in committed rates that are unjust and unreasonable.  What is required here is a determination of a principle, of a rule of duty.  It is not the determination of a fact.  These words reflect the ultimate legal conclusion and opinion of the fact-finder and judge (or Commission).  They are the ultimate standard to be reached under the Act (APA).

Remand Authority.  The Opinion next singled out the Presiding Judge’s statement that while the Commission has the authority to reverse an ID, it does not have the authority to order an ALJ to change her findings as to the merits of an issue.  FERC answered, “While this argument is based primarily on the Presiding Judge’s erroneous views regarding the judicial independence of ALJs,…, it also raises the issue of the Commission’s authority to remand proceedings generally.”

Procedurally, the Commission began, remand is appropriate when it is issued in accordance with the usual administrative review process, as occurred in this proceeding.  The Commission is wholly authorized to remand an initial decision back to the Judge with instructions to correct errors.  In the uncommon instance where it considers a remand, the general rule the Commission follows is that remand is appropriate if enhancement of the record would be useful.  Where the circumstances are that no useful purpose would be served by further administrative proceedings, or where the record has been fully developed, it is appropriate for the Commission to issue an order on initial decision.

An additional purpose of a remand, relevant in the present case, is where the Commission identifies an error in analysis or understanding of well-established policy.  “The desire to ensure a reasonable degree of uniformity among ALJ decisions is not only within the bounds of legitimate agency supervision, but is also encouraged.”

In this proceeding, the Commission “did not direct the Presiding Judge to change any factual findings, and did not direct the Presiding Judge to deem Seaway’s committed rates just and reasonable.  The instructions were to follow well-established Commission policy, and to determine whether, in accordance with this policy, the committed rates should stand.”

Criticisms of the Commission’s Impartiality.  FERC also blasted an implication in the Presiding Judge’s statements that the Commission decision was “tainted” by external influences, primarily the influx of comments from industry actors in response to the original ID that first raised the prospect of changing the Commission’s long-held policies on negotiated committed rates.  According to the new Opinion, “It is not surprising that a decision that calls into question the sanctity of committed rate contracts, which ignores long-held Commission policy, would generate interest from parties outside of the present proceeding.”  The Commission also does not generally exclude the public’s ability to appropriately comment on issues of interest.  Further, the Commission has maintained that position on negotiated committed rates consistently throughout this proceeding.

Review of Committed Rates.  In the earlier order as in the instant Opinion 546, the Commission wholly rejected the Presiding Judge’s argument that the revenue earned from Seaway’s negotiated rates cannot exceed the pipeline’s cost of service.  The Commission “also explicitly stated that the Hearing Order did not require that the committed rates be cost-based.”  The Commission rejected the Judge’s “untenable” argument that terms of the committed rate contract that allow for modification provide a justification for lowering Seaway’s committed rates to a cost-of-service level solely due to committed rate revenue exceeding Seaway’s cost of service.

On remand, the Commission reaffirmed these conclusions and again reversed the Presiding Judge. In addition, the Commission addressed “new or refined” arguments raised subsequent to the Remand Order “concerning modification of Seaway’s negotiated rates.”

On these matters, the Commission:

  • Found the Presiding Judge’s arguments concerning the scope of this proceeding are erroneous. The Commission “has been consistent throughout this proceeding that the committed rates are properly within the scope of this hearing.  It is the nature of that inquiry that is at issue.” Arguments that go beyond the “applicable law, precedent and policy,” were not proper.
  • Rejects the Judge’s argument that this proceeding presents “unprecedented factual circumstances” that render it outside of the Commission’s well-established policy on negotiated rates. There is little merit in the Judge’s statement that parties could not find a past case where the specific factual situation of committed revenue exceeding the overall revenue requirement existed.  “While there is no precedent for modifying a contract rate based on the fact that committed revenue alone exceeds a pipeline’s revenue requirement, there is extensive precedent that supports the Commission’s policy that negotiated rates need not be cost-based, and that a pipeline’s entire portfolio of rates can produce revenues that exceed its overall cost of service.”  Whether through a combination of committed and uncommitted revenue, or through committed revenue alone, “it is not at all unique that a pipeline’s cost-of-service is exceeded by its revenues.”
  • Declares the shippers’ argument that policy concerning negotiated rates for natural gas pipelines is directly applicable to oil pipelines “is erroneous.” Under the Alternative Rate Policy Statement concerning negotiated rates on natural gas pipelines, negotiated rates are defined as rates derived from the outcome of discussions with individual shippers, i.e., rates available only on a shipper-by-shipper basis.  Rates generally available under a natural gas tariff are not negotiated rates.  Under the Commission’s policies for negotiated rates on oil pipelines, and the common carriage requirements of the Interstate Commerce Act (ICA), there are no such bi-lateral rates available only on a shipper-by-shipper basis.  All rates and services must be made available to all shippers, and must be set forth in the oil pipeline’s tariffs.  Thus, “negotiated rates, as that phrase is defined by the Commission for natural gas pipelines, simply do not exist in the same way for oil pipelines.  Consequently, there is no requirement that the Commission’s policies for negotiated rates on natural gas pipelines be applied precisely in the same manner on oil pipelines.”

The rest of this lengthy Remand Order on Initial Decision addressed the rate issues in further detail as mentioned above.

  1. The regulations reflect the concept that at the time initial rates are filed for a new pipeline that has not become operational, the pipeline must necessarily rely on projected costs, revenues, and throughput. However, once the pipeline has commenced service and has gained operating experience, actual data represents a far better depiction of its costs than mere projections. Precedent generally dictates the use of actual design capacity for initial rates on a new pipeline, and the pipeline is placed at risk for the cost of unsubscribed capacity based on actual capacity.  However, Commission policy does not support using data that is not likely to be representative of future throughput levels.  The ID on Remand adopted a post-expansion throughput that best represents future throughput levels.
  2. Seaway’s cost of service calculations were based on the Commission’s trended original cost (TOC) methodology. The Commission affirmed the use of the TOC methodology in this proceeding.
  3. FERC reversed the ALJ’s ruling that the Enbridge purchase of Seaway was not the result of an arm’s length transaction, and concluded further there is no evidence to support the contentions of the shippers or the Judge that the acquisition by Enbridge amounted to a sham transaction. Enbridge completed its purchase of Seaway for $585 million, well above the net book value of $59 million.  Enbridge sought to recover the full purchase price of the acquisition, including the acquisition premium above and beyond Seaway’s net book value. The Presiding Judge labeled the partnership between Enbridge and Enterprise a scheme orchestrated to override cost-based rate-making designed to prevent utilities buying properties from one another at a price higher than original cost in order to increase the cost of service to the customer.  The Presiding Judge stated that the transaction deserved strict scrutiny to ensure it was not a “sham transaction designed to unjustly enrich the partners in a blatant attempt to get what amounts to cost-of-service rates so elevated that they are in effect market-based rates.”  The Presiding Judge ultimately found that Seaway did not meet its burden of showing that Enbridge’s acquisition of Seaway was conducted at arm’s-length, and therefore disallowed the acquisition premium.  The Presiding Judge raised additional concerns regarding the acquisition premium.

Generally, the Commission responded here, when establishing the cost-of-service upon which a pipeline’s regulated rates are based, the Commission employs “original cost principles”, and when a facility is acquired by one regulated entity from another, only the seller’s original cost is included in the cost-of-service computations, even though the price paid by the purchaser may exceed that amount.   Original cost is defined as “the cost of such property to the person first devoting it to public service.” The Commission generally does not allow the inclusion of a facility in the rate base at more than its depreciated original cost.  “However, where the transfer at a price above book value benefits consumers, it is sometimes appropriate to permit the entire purchase price to go into the rate base.”

The “substantial benefits” requirement for a pipeline seeking rate-base treatment for an acquisition premium involves a two-prong test.  First, the pipeline must show that the facilities will be converted from one public use to a different public use, or that the assets will be placed in FERC-jurisdictional service for the first time.  Second, the pipeline must show clear and convincing evidence that its acquisition will provide substantial, quantifiable benefits to ratepayers even if the full purchase price, including the portion above depreciated original cost is included in rate base.  The Commission also considers whether the transaction at issue is an arm’s length sale between unaffiliated parties, and whether the purchase price of the asset at issue is less than the cost of constructing a comparable facility.  The Commission allows an acquisition premium to be included in a pipeline’s rate base when the purchase price is less than the cost of constructing comparable facilities, the facility is converted to a new use, and the transacting parties are unaffiliated.

The Commission rejected the argument that the mere presence of an acquisition premium indicates a transaction was a sham.  It is also not indicative of a sham transaction that benefits from the transaction extend beyond the asset being purchased. The Commission rejected the argument that the mere presence of an acquisition premium indicates a transaction was a sham.  Again, the Commission ruled, this was an arm’s length transaction that resulted in cost savings and other demonstrable benefits to Seaway’s shippers.

  1. The Commission does not require an acquisition premium that has met the benefits test be divided between current rate base and potential future expansions. The benefits test requires that a pipeline demonstrate benefits to current shippers.  Once this test is passed, the full purchase price can be included in rate base.  As the Commission ruled in Opinion No. 525, if a group of assets are purchased together, there are a number of reasonable ways to allocate the purchase price, including a cost per mile allocation or a fair market value approach.  The Commission will require Seaway, in a compliance filing, to properly allocate all costs between jurisdictional and non-jurisdictional assets, and according to the base and test periods adopted in this order.
  2. The Commission addressed the cost allowances to be included in the cost of service (such as AFUDC, operating expense, remediation expense, depreciation expense, dismantlement, removal and restoration cost), preferring actual data over projections.
  3. The Commission reversed the Initial Decision on Remand in regards to Seaway’s capital structure. The Commission found that a capital structure based on the updated proxy group, with 51.80% debt and 48.20% equity as of 9/30/12, is appropriate.  Seaway had “met the burden of demonstrating Enbridge’s capital structure was anomalous.”  The Presiding Judge found the cost of debt is 5.31% for the period ending 12/31/11, and the cost of debt is 5.18% for the period ending 9/30/12.  The capital structure of Seaway should be based on the proposed revised oil pipeline proxy group.  As such, Seaway’s proposed cost of debt of 5.40% should be used in the cost of capital determination.

Based on the record in this proceeding, the Commission reversed and found that the just and reasonable base Return on Equity (ROE) for Seaway is 10.75% (nominal) and 9.01% (real), using Seaway’s updated DCF (Discounted Cash Flow) analysis for the six-month period ending December 2012.  For AFUDC purposes, the Commission affirmed the ID’s determination that Seaway’s nominal ROE is 11.16% and its real ROE is 8.19%.

  1. The Presiding Judge found that Seaway was entitled to a full income tax allowance based on a weighted average federal and state income tax rate of 33.7%, and the Commission agreed.
  2. The Commission rejected the argument that “the so-called unique fact” that Seaway’s committed rate revenue alone exceeds its overall cost of service is relevant in formulating a just and reasonable rate design for Seaway. The Presiding Judge “has provided no support for the notion that this factor alone results in unjust and unreasonable committed rates, or prohibits a proper calculation of cost-based uncommitted rates, aside from references to the original Hearing Order which does not support the Presiding Judge’s argument.  The Commission finds that the Presiding Judge’s rationale, if followed, would render any rate above a cost-of-service level unjust and unreasonable, not merely those committed rates that generate revenue above a pipeline’s total revenue requirement.  Such an approach is untenable.”

The Opinion specified that the Presiding Judge’s “entire argument concerning rate design is built on the fundamentally-flawed premise that the revenue generated from Seaway’s committed and uncommitted rates cannot exceed the pipeline’s cost-of-service.”  The so-called “two irreconcilable principles” the Presiding Judge references are not at all irreconcilable, and in fact present no conflict.  The Commission reiterated that the Judge’s error in seeing a conflict in these statements is “premised on a mistaken belief that the total revenue Seaway derives from both its uncommitted and committed rates cannot exceed Seaway’s cost of service.  If this were true, then yes, it would be impossible to both uphold the committed rate contracts and realistically calculate a proper uncommitted rate.”  The Commission also ruled that no true-up mechanism is necessary in Seaway’s rate design.

  1. The Commission agreed with the Judge that it is not discriminatory to charge different rates to heavy crude and light crude shippers, as their shipments have different properties and different impacts on oil pipeline operations.

Seaway’s committed rates will be upheld.  Seaway’s uncommitted, cost-based rates must be calculated based on the findings of this order and the effects of those findings on Seaway’s overall revenue requirement.

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[1]  Seaway is owned fifty percent by Enterprise Products Partners LP and fifty percent by Enbridge Inc.  Enbridge had purchased its share of Seaway from ConocoPhillips Co. in 2011.

[2]  In 1946, Congress passed the Administrative Procedure Act (APA).  With the APA, the Commission order noted, “Congress intended to make hearing examiners a special class of semi-independent subordinate hearing officers by vesting control of their compensation, promotion and tenure in the Civil Service Commission to a much greater extent than in the case of other federal employees.”

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Copyright © 2016 by Concentric Energy Publications, Inc.  All rights reserved.

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