American Electric Power Service Corporation, et al. v. Public Utility 1

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Authorship: Rachel Lee

Contents

[edit] Briefs and Documents

Docket: 06-1457

Argument Transcript

Merits Briefs

Amicus briefs

Certiorari Filings

[edit] Pre-Argument Articles

[edit] Grant write-up

The following section originally appeared as a post on SCOTUSblog. It was written by Jerry E. Rothrock, a partner in the energy division at Akin Gump.

The Supreme Court has granted certiorari in two cases involving regulatory and contract disputes growing out of the western energy crisis of 2000-01. In each case, a purchaser of wholesale electric energy filed a complaint with the Federal Energy Regulatory Commission (“FERC” or “the Commission”) seeking reformation of a long term contract with a market based rate that was entered into during the western energy crisis. In their FERC complaints, the purchasers argued that their contracts were tainted by market power or dysfunction, resulting in contract terms and conditions that were not “just and reasonable” within the meaning of the Federal Power Act (“FPA”), 16 U.S.C. 791a et seq.

In response, FERC denied the complaints. According to the Commission, the appropriate standard for review of the contracts was not the FPA’s “just and reasonable” standard but rather the “public interest” standard established by the Supreme Court in United Gas Pipe Line Co. v. Mobile Gas Service Corp. (1956) (Mobile) and FPC v. Sierra Pacific Power Co. (1956) (Sierra). Since the purchasers had not shown that the contracts were contrary to the public interest, FERC denied the complaints.

On appeal, the Ninth Circuit found both procedural and substantive errors in FERC’s application of the Mobile-Sierra doctrine. According to the court, the Mobile-Sierra doctrine is simply one means of review under the “just and reasonable” standard of the FPA and is applicable in only certain limited circumstances. Specifically, the Court concluded that, in the case of a contract with a market based rate, Mobile-Sierra applies only when the following three conditions are met: (1) the terms of the contract must not preclude its application; (2) the regulatory scheme in which the contract is formed must provide FERC with an opportunity for initial review of the contracted rate; and (3) the scope of review by FERC must permit consideration of the factors relevant to the contract’s formation.

The court of appeals concluded that FERC erred in its application of the Mobile-Sierra doctrine to market based rate the contracts at issue in these cases. After agreeing with the Commission that the contracts did not preclude review under the Mobile-Sierra standard, the Court held that FERC did not have an opportunity for the timely review of the contract rates. The Court also held that FERC failed to consider evidence concerning the market conditions in which the contracts were formed, including findings in a FERC staff report concerning price manipulation and dysfunction in western power markets.

The court of appeal went on to conclude that, even if Mobile-Sierra applied, the Commission had used an erroneous standard for determining whether the challenged contracts affected the “public interest.” Specifically, the Court found that FERC improperly applied the public interest factors in Sierra because that case involved a challenge that the contract rates were too low rather than a challenge that the contract rates were too high. FERC should have instead considered whether the contract terms were outside the “zone of reasonableness” and resulted in retail rates that were higher than would be the case if that zone were not exceeded. Under that revised “public interest” standard, the purchaser might be entitled to reformation of its contract even if it resulted in lower rates than the purchaser had been paying.

The court remanded both cases to the Commission to determine, first, whether Mobile-Sierra review of the challenged contracts is appropriate; second, if so, to apply the modified form of Mobile-Sierra review outlined in its opinion; and finally, if not, to apply full just and reasonable review to the challenged contracts. Thereafter, each seller filed a petition for certiorari. In general, the sellers argued that the court of appeals’ decision was inconsistent with both Mobile and Sierra. The petitions also argued that the Ninth Circuit’s decision conflicted with the decisions of the other circuits concerning market based rates.

The petitions for certiorari were opposed by the purchasers and by FERC. In opposing review, FERC argued that the court of appeals decision was not inconsistent with Mobile or Sierra but instead applies the principles of those cases to the highly unusual context of the western energy crisis of 2000-01. The Commission also argued that, taken as a whole, the decision of the court of appeals allows the Commission sufficient discretion on remand to consider all relevant factors in determining whether the market based rate contracts at issue should be upheld or reformed. The Commission further argued that review was premature because the agency had not yet applied the decision to any of the disputed contracts. Similar arguments were made by the purchasers.

On Sept. 25, the Supreme Court granted the petitions for certiorari filed by Morgan Stanley (No. 06-1457) and Calpine Energy Services, (No. 06-1462). The Court also consolidated these petitions for briefing and argument.

As of this date, the Supreme Court has taken no action with respect to the petitions for certiorari filed by Sempra Generation (No. 06-1454) and Dynegy Power Marketing, Inc. (No. 06-1468) with respect to a companion decision that was issued by the Ninth Circuit on the same day and involved long term contracts with the California Department of Water Resources. It appears that these two cases may remain pending until the Court resolves the two petitions that were granted.

[edit] Argument Preview

In its merits brief, Morgan Stanley argued that the contracts at issue in this case are governed by Mobile-Sierra, under which the rates in an energy contract are “just and reasonable” in the absence of circumstances requiring the contract to be modified for an unequivocal public necessity. Morgan Stanley challenged the Ninth Circuit’s holding that the Mobile-Sierra framework applies only to contracts originally negotiated in a “functional marketplace” with an opportunity for FERC to initially review the contracted rate. A post-hoc assessment of market dysfunction should not invalidate a contract, because such dysfunction is merely one of the risks that the contracting parties allocate in their agreement. Moreover, the “dysfunction” standard is vague and would introduce uncertainty into the market. In this case, although there was evidence of distortion in the “spot market” (contracts for power to be delivered within twenty-four hours), the market for longer-term contracts was competitive and efficient. Contrary to the Ninth Circuit’s suggestion, FERC did not approve the contract rates at issue in Mobile or Sierra. It would be duplicative and senseless for FERC to review a contract rate both initially and after a challenge, particularly because FERC already determines that a seller lacks market power or has mitigated its market power before authorizing it to enter into contracts, and the rates negotiated by sophisticated parties with equal bargaining power can be expected to be just and reasonable.

According to Morgan Stanley, the contract it made with Snohomish PUD is valid under Mobile and Sierra because it met none of the Sierra criteria for adverse effect on the public interest (which include impairing the financial ability of the utility to continue service, casting on other consumers an excessive burden, or being unduly discriminatory). Indeed, the contract had only a small impact on consumer rates. Furthermore, by locking in a price for power, the long-term contract protected Snohomish PUD consumers against fluctuations in the spot market, thus serving the public interest. Morgan Stanley also argued that the Ninth Circuit erred in holding that FERC should apply a looser standard for customers complaining of a high rate than when a low rate is challenged.

The brief by Calpine presented arguments similar to those in the Morgan Stanley brief, but also emphasized the connection between predictable enforcement of long-term power contracts and stable energy markets. The Ninth Circuit’s decision would discourage the formation of long-term contracts, thus increasing reliance on the volatile spot market and undermining incentives for generators to provide additional power or invest in power generation capacity—especially during times of scarcity, when markets are mostly likely to be deemed dysfunctional. Calpine also noted that the costs of the inevitable increase in litigation under the Ninth Circuit’s approach would fall on consumers.

Despite being named respondent in the case (and having opposed the grant of certioriari), the Federal Energy Regulatory Commission (FERC) filed a merits brief in support of the petitioners. In addition to making arguments similar to those of the petitioners, FERC argued that its original decision to uphold the contracts was entitled to Chevron deference, as an acceptable interpretation of the Federal Power Act’s “just and reasonable” standard. FERC suggested that the Energy Policy Act of 2005 ratified the market-based rate system, and also noted that the Energy Policy Act created new tools for FERC to reduce manipulative behavior by energy market participants.

Five amicus briefs were filed in support of Morgan Stanley and Calpine, with several highlighting the undesirable consequences that would stem from undermining the enforceability of long-term power contracts.

Note: Two months after petitioners filed their merits brief, the writ of certiorari was dismissed as to Calpine alone, with the agreement of the other parties. Calpine emerged from bankruptcy proceedings contemporaneously with the dismissal of certiorari.

The respondents PUD of Snohomish County, the Nevada Power Company, the Sierra Pacific Power Company, and the Office of the Nevada Attorney General Bureau of Consumer Protection filed a joint brief. It begins by arguing that Morgan Stanley and the other petitioners have cast the holdings of Mobile and Sierra too broadly and that those cases cannot override either FERC’s statutory mandate to ensure just and reasonable rates or its duty to modify any rate found to fail that standard. When FERC applied the Sierra “public interest” standard to the challenged rates instead, it did so without establishing that it had the discretionary authority to do so. Moreover, FERC presumes that the rates arrived at in contracts between sophisticated parties predetermined to lack market power will be just and reasonable. However, this assumption is unreasonable given the pervasive dysfunctions in the western electricity markets at the time, which artificially inflated prices in both the spot market and segments of the forward market. Therefore, to comply with the statutory scheme, there must be at least an opportunity for ex post review of the contract rates to determine if they are just and reasonable, an opportunity which did exist in Mobile and Sierra. Furthermore, contract rates cannot be shielded from this regulatory oversight merely by the terms of the contract. Finally, the policy concerns raised by the petitioners are both insufficient to trump FERC’s statutory mandate and misguided: action by FERC to correct market dysfunction and remedy tainted contracts will create greater stability in the market and bolster support for electricity deregulation.

Golden State Water Company (GSWC) also filed a brief as respondent. (Although its contract is not among those included in the grants of certiorari, it was a party below and is thus entitled to file documents at the Supreme Court.) GSWC argued along similar lines as the other respondents that FERC had neglected its statutory obligation to assure just and reasonable rates when it chose to analyze the contracts under its interpretation of Mobile and Sierra. GSWC highlighted that in December 2000, FERC urged utilities to enter into long-term contracts and specifically announced that it would be “vigilant” in monitoring for exercise of market power and would use a benchmark price as a reference point in handling complaints regarding those contracts. Despite entering into a contract similar to the benchmark but for a much higher price, GSWC was denied relief by FERC. FERC concluded that GSWC’s customers were not subject to an “excessive burden” – a finding that, GSWC argues, was unreasonable given that its customers experienced an average rate increase of thirty-eight percent as a direct result of the disputed contract.

The Public Utility Commission of California and the California Electricity Oversight Board also filed a respondents’ brief as intervenors of right, representing the interests of the California public. They argue that FERC is required to allow at least opportunity for determining if a rate is just and reasonable, and neither the ex ante approval of sellers as lacking (or having mitigated) market power nor the formation of the disputed contracts constitutes such an opportunity. Here, the rates were unjust and unreasonable at the time of contract formation (rather than becoming so later, due to changes in market conditions), but FERC refused to provide any opportunity for review of their reasonableness. Moreover, having disputed below that the “just and reasonable” standard even applied, only in its filings before the Supreme Court does FERC claim to have applied that standard, and an agency decision can only be evaluated on appeal by the reasoning originally used.

Eight amicus briefs were filed in support of the respondents, many of which argued that FERC’s approach to reviewing these contracts is not entitled to Chevron deference.

In their reply briefs, FERC and the petitioners argued that although FERC used language carelessly in describing its standard of review for the contract rates, it had applied the Mobile-Sierra public interest standard, which is one version of the statutory “just and reasonable” standard. They reiterated that a contract rate negotiated by the parties is likely to be just and reasonable, without the need for ex ante review of the rate by FERC. As to ex post review, it would both undermine the market-based rate system to modify these contracts and would not be appropriate when there was no evidence that these particular contracts were formed in a dysfunctional market.

Chief Justice Roberts and Justice Breyer took no part in the consideration of the petitions for certiorari in this case. It is therefore likely that they will recuse themselves from the decision on the merits as well.

[edit] Oral Argument

This case was argued on February 19, 2008. Walter Dellinger appeared on behalf of the petitioners, and shared a divided argument with Deputy Solicitor General Edwin Kneedler, who appeared for FERC as a respondent in support of the petitioners. Christopher Wright argued on behalf of the respondents.

[edit] Oral Argument Recap

The oral argument opened with the justices pressing FERC’s counsel about why the agency had opposed cert. but was now supporting the petitioners. Justice Ginsburg pointed out that the Ninth Circuit’s decision “empowers” FERC by recognizing authority which the agency had previously disclaimed, while Justice Scalia countered that a decision which said FERC “must” act was more of a directive than an empowerment.

After counsel provided a brief overview of FERC’s market-based rate authority program, Justice Alito inquired as to what the remedy would be if a seller were pre-approved as not having unmitigated market power, but “contrary to what FERC thought when it granted the approval, the seller has exercised market power or has otherwise manipulated the market.” Counsel responded that FERC could revoke the rate authority, but this would have no retroactive effect on contracts already formed. In addition, FERC could abrogate contracts if there was fraud or market manipulation in their formation. However, FERC had determined that there were no such problems with the specific contracts in this case.

Finally, Justice Ginsburg asked whether FERC had monitored the rates of long-term contracts vigorously, as it had announced that it would in December 2000. She was informed that FERC had indeed conducted extensive staff studies in support of its efforts to stabilize the dysfunctional spot market.

Petitioners’ counsel opened his argument by repeating the policy arguments in the briefing—that enforceable long-term contracts are essential to taming the volatility of spot markets and promoting investment in energy infrastructure. Justice Ginsburg questioned the applicability of Mobile and Sierra to the contracts in this case, since those decisions were intended to protect consumers from overcharging, but counsel repeated that enforcing contracts was in the interest of consumers, because long-term contracts are an alternative to the expensive spot market.

Justice Stevens asked whether a contract could be set aside because the market was in such “turmoil” that negotiation could not produce reasonable rates. Counsel for the petitioners answered that such a contract would be binding unless the public interest required a rate revision, such as when the rates would drive a utility out of business. He asserted that “[t]he Commission has been on the job here,” working diligently to administer the market-based rate program.

Justice Ginsburg then observed that the FERC staff had concluded that the dysfunction in the spot market carried over into the forward, or long-term, market. Counsel responded that the parties themselves had been aware of this and yet had signed contracts without any provision allowing the buyers to seek a rate modification from FERC. Moreover, the conclusion that the forward markets were dysfunctional was irrelevant to FERC because the agency was not attempting to determine an appropriate price—rather, it was allowing the parties to set their own rates through contract negotiations.

Counsel for the respondents began by highlighting that the “just and reasonable” standard applies to all rates. In response to a query from Justice Alito, he indicated that market-based rates could be acceptable if the market were competitive when the contracts were formed. Justice Alito then questioned whether ex post modification of contracts could be compatible with a market-based program, and Justice Souter remarked that in a volatile market no contract would be enforceable. Counsel said that there were four reasons that most contracts would be enforceable.

First, he stated that this had been “the worst electricity market crisis in history,” but Justice Souter countered that dissatisfied parties in the future would claim that “these times are almost as bad.” Second, counsel referred to the “rampant noncompliance” with FERC’s reporting requirements by market-based sellers (including the petitioners), but Justice Souter noted that non-compliance was not actually the basis for the respondents’ claims. Third, counsel stated that the rates were not just and reasonable because they were much higher than traditional prices. Justice Souter responded that this would often be true in volatile markets, thus making all contracts in those markets vulnerable to modification. Finally, counsel offered FERC’s own announcement that it would vigorously monitor the contracts and deem rates above the benchmark price suspect.

Justice Kennedy asked about what would happen if FERC modified the challenged contracts—would FERC also reevaluate the contracts in which petitioners, being middle-men, had bought that electricity? Counsel agreed that the “unwinding process” would continue back to the original power generator.

Justice Scalia attacked the idea that the respondents should be allowed to escape a long-term contract that they entered with full knowledge that the market was “chaotic.” Counsel countered that the respondents entered the contracts because they had no other alternatives—“we had a choice of a variety of rates as long as they were unjust and unreasonable.”

Justice Souter then returned to his concern that the respondents’ approach would make all long-term contracts in a chaotic market vulnerable. Counsel responded that contracts should be modified only if manipulation was affecting the market, not if weather conditions had created the volatility. Justice Souter raised the possibility that a market could be manipulated by other sellers, so that the parties to a contract would be innocent themselves. Justice Scalia observed that if extrinsic factors were to determine whether a contract should be modified, there would be no distinction from the consumer’s point of view between the weather, world market conditions, and market manipulation by other sellers. Counsel responded by arguing that it was inequitable for consumers to pay inflated prices when sellers were making huge profits, because this would not be just and reasonable. Here, the consumers were seeking relief and “any innocent middlemen should be made whole, too,” regardless of whether the market manipulation had been caused by the petitioners or by other sellers.

Justice Alito noted that the Ninth Circuit’s opinion had justified reforming the contracts based on “dysfunction in the market,” which was broad enough to include effects from weather and other factors. He also observed that the administrative law judge in the case had found that there was no manipulation in the forward market. Counsel said that “no one agrees today” with that finding, including FERC and Morgan Stanley.

In rebuttal, counsel for FERC was asked by Justice Souter to discuss possible market manipulation by the petitioners. Counsel stated that FERC had found no evidence that market manipulation had “specifically affected” the contracts in this case. Justice Scalia pointed out that a finding of no manipulation with respect to these particular contracts did not rule out other manipulations in the market by these sellers. Counsel suggested that manipulation in the spot market was sufficiently distinct from the operations of the forward market. Justice Souter pressed him for an admission that “the government’s position is that manipulation by these [p]etitioners would be irrelevant to a review under the public interest standard.” Counsel conceded this, but argued that FERC could restrict its inquiry to the specific contracts at issue, rather than looking to the market as a whole, because of the “the importance of integrity of contracts.”

[edit] Opinion Analysis

[edit] Links and further information

  • Medill has this summary of the case:

http://docket.medill.northwestern.edu/archives/004618.php.

  • A news article on the cert. grant is available at:

http://www.heraldnet.com/article/20070926/NEWS01/70926005.

(After respondent FERC filed a merits brief in support of petitioners, the chairman and another commissioner were confirmed by the Senate on December 19, 2007.)

  • An analysis of the case is available at:

http://pulpnetwork.blogspot.com/2007/09/us-supreme-court-to-decide-electricity.html.

[edit] Press

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