A recent Ninth Circuit decision could have serious consequences for sellers of wholesale electric energy operating under market-based tariffs approved by the Federal Energy Regulatory Commission (“FERC” or “Commission”).  In California, ex rel. Lockyer v. FERC, a three-judge panel reached two important holdings regarding FERC’s market-based rate policy.  First, in one of the most searching reviews of FERC’s market-based rate policy issued from a U.S. court, the Ninth Circuit concluded that FERC’s current market-based framework did not violate the statutory requirements of the Federal Power Act of 1935 (“FPA”).  Second, contrary to FERC’s own interpretation of its authority under the FPA, the court held that FERC had broad discretion to employ its refund authority to penalize a regulated company for failing to comply with the conditions imposed on its market-based rate authority.  According to the court, FERC’s authority to order refunds for such non-compliance reached beyond the 60-day, refund-effective date set forth in the FPA, to include any period during which the company failed to satisfy the conditions and representations upon which FERC relied in granting the company market-based authority.  If the Ninth Circuit opinion is allowed to stand, wholesale electricity sellers with market-based rate authority may be confronted with potential refund liability at FERC for any period of time in which their operations do not conform to the material circumstances and conditions under which they obtained market-based rate authority.  Consequently, wholesale electricity sellers may need to develop more sophisticated methods for monitoring market behavior and regulatory compliance to ensure both conform to their market-based tariffs.

Procedural History of California, ex rel. Lockyer v. FERC:

California, ex rel. Lockyer v. FERC is an appeal from a FERC order addressing possible refunds from the “California Energy Crisis,” a period of significant price volatility in Western wholesale electricity prices between the years of 2000 and 2001.   On March 20, 2002, the State of California filed a complaint at FERC against all sellers of power and ancillary services subject to FERC jurisdiction in California’s organized markets and sellers to the California Energy Resources Scheduler (“CERS”) (collectively, “California Wholesalers”).  The complaint challenged FERC’s market-based rate quarterly-filing requirements as inconsistent with the FPA and alleged that, irrespective of their validity, electricity sellers had failed to comply with the quarterly-filing requirements by submitting aggregated quarterly data instead of transaction-specific data.  Among other remedies, the State of California asked FERC to order California Wholesalers to refund with interest any amounts obtained through short-term power transactions in the California market.

With respect to the prima facie challenge to FERC’s quarterly-filing requirements, FERC determined that the State of California’s complaint constituted an impermissible collateral attack on previous orders establishing and refining its market-based rate policy.  FERC also addressed the substance of the challenge, concluding that the FPA provided the regulatory flexibility to support market-based regulation generally and the mechanics of FERC’s market-rate regime specifically.  This included permitting FERC to rely on post-transaction reporting to satisfy the filing requirements under the FPA.  However, FERC did find that the aggregated data submitted by many of the regulated entities operating with market-rate authority had failed to satisfy the quarterly-reporting requirements.  Consequently, FERC ordered the identified wholesalers to file appropriate transaction-specific data for the period October 2, 2000 to the date of the order.

In the same order, FERC also addressed the scope of its authority to grant refunds under the FPA.  FERC noted that in a proceeding commenced by private complaint, it could only order a company to refund amounts collected after the “refund-effective date,” which the FPA set as the date sixty (60) days following the filing of the relevant complaint.  According to FERC, the FPA prohibited FERC from considering refunds for transactions that occurred prior to sixty days after the filing of the State of California complaint. 

The Ninth Circuit Opinion in California, ex rel. Lockyer v. FERC:

On review, the Ninth Circuit reversed FERC’s determination of its refund authority under the FPA.  First, however, the court affirmed the legality of FERC’s policy of market-based rate regulation.  Following legal precedent set down in a line of opinions from the D.C. Circuit, the court concluded that the FPA did not prohibit FERC from granting market-rate authority to regulated entities in cases where FERC determined competitive market forces would prevail.  Therefore, conditioning market-based rate authority on a finding that an applicant could not exert market power fulfilled FERC’s statutory obligation to ensure a marketplace that would generate wholesale electricity transactions at just and reasonable rates.  Furthermore, the court noted that FERC’s quarterly-reporting requirements allowed the sort of continuing regulatory surveillance absent in cases where the Supreme Court had rejected administrative attempts to introduce market forces into regulated industries.  The combination of a preliminary market-power test and post-approval reporting requirements fulfilled FERC’s regulatory responsibilities under the FPA and insulated FERC’s market-based rate policy from a prima facie challenge.

Notwithstanding its legality, the novelty of FERC’s market-based rate regime offered the court a new challenge: determining the scope of FERC’s refund authority.  Because the quarterly-filing requirements were crucial to distinguishing relevant Supreme Court precedent, the court reasoned that the filing requirements represented an integral part of a company’s market-based tariff.  The court noted the Commission’s own emphasis on transaction-specific reporting as “necessary so that the [seller’s] rates will be on file as required by section 205(c) of the FPA, to evaluate the reasonableness of the charges, and to provide for ongoing monitoring of the [seller’s] ability to exercise market power.”  Accordingly, a company’s failure to comply with the filing requirements constituted a violation of the market-based tariff itself.  The consequence for FERC’s refund authority was that “the power to order retroactive refunds when a company’s non-compliance has been so egregious that it eviscerates the tariff is inherent in FERC’s authority to approve a market-based tariff in the first instance.”  As a result, the court ruled that FERC had abused its discretion by relying on the refund-effective provision in the FPA to reject the State of California’s complaint as it related to a request for refunds.  However, the court also noted that while it was within FERC’s discretion to grant refunds in such cases, FERC’s obligation extended to entertaining the substance of the State of California’s complaint, not to automatically ordering refunds.  The court reversed and remanded the matter to FERC for further consideration.

The Consequences of the Ninth Circuit’s Opinion:

The Ninth Circuit’s opinion raises a set of serious concerns for wholesale electricity sellers operating under market-based rate authority.  First, there are no clear boundaries on the reasoning adopted by the court.  Essentially, the question becomes which compliance issues, in the Ninth Circuit’s words, “completely eviscerate[] the tariff.”  Besides non-compliance with FERC’s quarterly-reporting requirements, the most logical possibility might be the failure to report circumstances that have led to a company’s assumption of market power.  Market-based rate authority is explicitly conditioned on the company’s lack of market power, and each company with such authority is obligated to inform FERC promptly if it can thereafter exert market power.  The Ninth Circuit opinion clearly identified this aspect of FERC’s market-based rate policy, in conjunction with the quarterly-filing requirements, as fundamental to satisfying the FPA.  Therefore, it appears likely that this sort of non-compliance would empower FERC with refund authority for prior periods.

Furthermore, the Ninth Circuit’s construction of the market tariff could also comprehend the conditions unique to a company’s authorization order or even the representations made in the company’s application for market-based rate authority.  Refusing to abide by these conditions or failing to report material changes in the circumstances represented in the application for market-based rate authority could trigger FERC’s refund authority.  In ruling that FERC had authority to order refunds for violations of the market-based tariff, the court referred to an order in which the Commission caused a power marketer to refund amounts from a power sale in part because the transaction conflicted with representations made in the power marketer’s application for market-based rate authority.  The court referred to this case as support for its ultimate conclusion that FERC had abused its discretion by not taking up the substantive merits of the State of California’s refund request.  Accordingly, a broad reading of the Ninth Circuit’s opinion suggests that FERC’s refund authority could extend to these extremes.

To the extent any of the non-compliance issues identified above are in fact fundamental to the market tariff, their occurrence would appear to give FERC carte blanche to review a regulated entity’s rates for conformity to the just and reasonable standard, subjecting wholesale electricity sellers to liability for their market activities in a fashion not contemplated when they applied for market-based rate authority.  It is also worth noting that in light of the Ninth Circuit’s opinion, the scope of FERC’s discretion to order refunds appears to extend to enforcement of general compliance.  The Ninth Circuit did not condition FERC’s authority to order refunds on a finding of market abuse; under a plain reading of the opinion, refund authority is triggered solely upon a finding of non-compliance with the reporting procedures themselves.

Sellers of wholesale electricity operating under market-based rate authority are among the most directly affected by the possible consequences of the Ninth Circuit’s decision.  At the very least, the possibility that FERC will exercise the broad remedial power identified by the Ninth Circuit brings a new layer of uncertainty to market-based transactions.  If FERC does in fact adopt the Ninth Circuit’s reasoning, it is likely to be some time before clear defining lines emerge around this aspect of FERC’s refund authority.  Although the Ninth Circuit’s opinion suggests that the power to order refunds has always been inherent in market-based rate authorization, FERC will be writing on what is essentially a clean slate because it has not chosen to rely on this power in the past.  Meanwhile, industry participants will have to guard against unforeseen regulatory gaps resulting from the decision.  To minimize potential refund liability, wholesale electricity sellers may be required to monitor their activities in the marketplace and their compliance with the procedural aspects of FERC’s market-rate policy more vigorously.  For example, sellers with market-based rate authority may want to develop mechanisms to monitor their market behavior for evidence of market power and to ensure intra-corporate compliance with market rules.  Furthermore, companies may also want to scrutinize the representations made in their applications for market-based rate authority to determine their compliance with the assumptions under which FERC granted their applications.  With the Ninth Circuit’s decision announced and no clear indication from FERC regarding its current position, these steps may be necessary to protect market-based transactions against future challenge.