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Energy Advisory Bulletin
Ninth Circuit Gives Purchasers Greater Ability To Challenge Wholesale Power Contracts
By Brian Gish
[Jan. 2007]
In two significant related decisions, upsetting years of precedent by the Federal Energy Regulatory Commission (FERC), the U.S. Court of Appeals for the Ninth Circuit sent back to FERC for reconsideration the issue of whether wholesale power contracts entered into during the California energy crisis should be modified as contrary to the Federal Power Act (FPA). Public Utility District No. 1 of Snohomish County, et al v. FERC, No. 03-72511 et al. (Dec. 19, 2006); Public Utilities Commission of the State of California, et al. v. FERC, No. 03-74207 et al. (Dec. 19, 2006). In doing so, the Court redefined FERC’s statutory obligations with respect to power contract rates under Sections 205 and 206 of the FPA, and gave a new interpretation to the "Mobile-Sierra doctrine" that FERC has long used to determine its authority to modify power contract terms. The application of the Mobile-Sierra doctrine over the years has been the subject of considerable dispute and even the current FERC Commissioners have differing views on it.
The cases arose out of complaints to FERC by certain local utilities in the West (Snohomish County PUD, Southern California Water Co., Nevada Power/Sierra Pacific Power) and the California Department of Water Resources alleging that the power purchase contracts they entered into during the California power market price spikes in 2000-2001 were unreasonable. These purchasers contended, among other matters, that the distortions in the short-term spot market affected the power purchasers’ ability to negotiate reasonable long-term contracts. FERC decided that the contracts did not reserve the rights for any party to unilaterally seek to change the contracts under Sections 205 and 206, and therefore held that a Mobile-Sierra analysis was applicable. The Mobile-Sierra analysis had its genesis in two 1956 Supreme Court cases and has been refined by FERC and the courts over the past half century. As currently applied, a party must demonstrate that the contract adversely affects the "public interest" as a condition to seeking to reform a contract price, which has proven to be a difficult standard that was rarely met. If a contract is not subject to the exacting "public interest" test, FERC has the authority to reform it if it were "unjust and unreasonable," which is a lower standard. After applying its Mobile-Sierra public interest test in the present cases, FERC held that the complaining parties had failed to meet the high burden necessary to change the contracts.
The Ninth Circuit reversed the FERC, and in doing so, created a new framework for determining the extent to which power contracts are subject to regulatory revision under Section 206 of the FPA. The Court used two rationales to justify its new approach: first, it noted the recent changes in regulation now allows "market-based" prices, rather than traditional cost-based rates, to determine just and reasonable rates; and second, it stated that the original Mobile-Sierra Supreme Court cases addressed complaints by sellers that the contract price was too low, and a different analysis should be applied when buyers complain that a contract price is too high.
The Court redefined the Mobile-Sierra doctrine as a "presumption" of just and reasonable rates that applies in circumstances the Court delineated, and also redefined how the Mobile-Sierra test must be used when it is applied. It held that three prerequisites are necessary for the Mobile-Sierra analysis to apply: (1) the contract does not expressly allow unilateral changes; (2) the regulatory scheme must provide FERC with an effective and timely review of the contract prices; and (3) if market-based prices are its test of just and reasonable rates, FERC’s review must permit consideration of all factors relevant to the propriety of the contract’s formation. If any one of these three prerequisites are not satisfied, the lower unjust and unreasonable standard must be used to determine if the contract should be modified.
Under the facts at issue, the Court affirmed FERC’s finding that the contracts did not allow unilateral changes because there was no express reservation of the right to seek modification of the contracts. However, the Court held that its second prerequisite for using the Mobile-Sierra standard was not met, finding that FERC did not employ sufficient regulatory oversight to ensure that the contracts were just and reasonable when made. As to the third prerequisite, the Court held that it was error for FERC to apply the Mobile-Sierra standard when it did not consider whether the contract prices were unduly influenced by factors such as the distortions in the spot markets. Although the Court remanded to FERC to decide whether a Mobile-Sierra review is appropriate in these cases, it seems the Court has already provided FERC substantial guidance that two of the prerequisites cannot be met in these cases.
Even if the Mobile-Sierra standard were applicable, the Court held FERC’s application of that test was incorrect because consumer protection needs to be accorded greater weight. The Court held that, at least in the case where purchasers are challenging prices as too high, the "public interest" standard must consider how consumers’ electricity bills have been affected by the challenged contracts, and a contract could be modified under the Mobile-Sierra analysis if its prices are outside the "zone of reasonableness." Thus, the Court has modified the Mobile-Sierra "public interest" standard of review to be more analogous to the lower-threshold unjust and unreasonable standard of review.
The Court’s new interpretation of the FPA, if followed, would portend that wholesale power sales contracts will be subject to more challenges from purchasers alleging that the prices are too high. The Court’s decisions may be subject to rehearing in the Ninth Circuit, and/or Supreme Court review. Unless stayed or reversed, these decisions will serve as precedent for other cases arising in the Ninth Circuit, which includes Western states. The extent to which this new interpretation of Sections 205 and 206 will be followed in other circuit courts cannot be predicted.
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This Advisory is a publication of the Energy Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in energy law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.
Copyright © 2007, Davis Wright Tremaine LLP.
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