UNITED STATES COURT OF APPEALS FOR THE D.C. CIRCUIT


EXXON CORP

v.

FERC


97-1092a

D.C. Cir. 2000


*	*	*


Williams, Circuit Judge: This case arises out of the Feder- al Energy
Regulatory Commission's "unbundling" of inter- state gas pipelines'
sales and transportation service. As part  of that unbundling, parties
with firm rights to buy natural gas  in the downstream areas served by
Transcontinental Gas Pipe  Line Corporation ("Transco") were given the
right to convert  their gas purchase entitlements into transportation
service  rights. They evidently all did so, and are known as the "FT 
conversion shippers." When Transco reached an unbundling  settlement
with its customers, these conversion shippers  sought assurance that
their rights to use of the pipeline  upstream would be sufficiently
firm. FERC responded affir- matively, insisting that Transco give the
service a priority  that rendered it "essentially firm."
Transcontinental Gas  Pipe Line Corp., 55 FERC p 61,446 at 62,345-46
(1991)  ("Settlement Order").


Ranged against the conversion shippers are "Indicated  Shippers," led
by Exxon, who are gas producers in Transco's  production areas. They
contend that if the conversion ship- pers are to enjoy firm
transportation service in the produc- tion areas, they should pay for
it in the way that is predomi- nant for firm transportation service,
i.e., by a two-part 


charge--first a reservation charge for the right to use the  service,
and second a usage charge covering the costs of  actual usage.


Transco filed tariffs under s 4 of the Natural Gas Act, 15  U.S.C. s
717c, proposing such two-part rates, designating  them
"firm-to-the-wellhead" or "FTW" rates. (Petitioners  note that this is
technically a misnomer; the rates in fact  would go only as far as
producers' gathering systems. But,  as have all the participants, we
use the FTW label.) The  Commission rejected the FTW rates,
Transcontinental Gas  Pipe Line Corp., 76 FERC p 61,021 ("Opinion No.
405"),  denied rehearing, 77 FERC p 61,270 (1996) ("Opinion No. 
405-A"), and finally issued a further "Order on Rehearing  and Request
for Clarification," 79 FERC p 71,205 (1997),  adhering to the
rejection. The Indicated Shippers petition  for review.


The Indicated Shippers also attack prior decisions in which  the
Commission rejected two-part FTW rates that Transco  had proposed
under s 5 of the Act, 15 U.S.C. s 717d, Trans- continental Gas Pipe
Line Corp., 63 FERC p 61,194, rehear- ing denied, 65 FERC p 61,023
(1993). We do not address  those decisions directly. In the s 4 cases,
we find no rea- soned decisionmaking to support the Commission's
rejection  of Transco's filings. If on remand the Commission adheres
to  that rejection and justifies it, the Indicated Shippers' ability 
to secure relief under s 5 will probably be remote; if on  remand the
Commission accepts the Indicated Shippers' posi- tion under s 4, then
of course they will need no relief under  s 5.


* * *


At stake are rates governing gas transportation on "later- als" linking
gas producers' gathering systems with Transco's  main pipelines.
Transco was an early unbundler, reaching an  unbundling settlement
with its customers in 1991. When  FERC reviewed the settlement,
representatives of the FT  conversion shippers sought assurance of
high priority for  their use of these laterals. (The service is dubbed


service"; nominally interruptible, it feeds the conversion ship- pers'
entitlements to mainline capacity.) FERC agreed, or- dering that


Transco's tariff should specifically set forth the capacity  priority
of Rate Schedule IT feeder service, i.e., that such  service is not
firm but that it has priority over any other  interruptible service
regardless of the date of the service  agreement.


Settlement Order, 55 FERC at 62,377. As everyone under- stood at the
time, including FERC, this grant of priority  made Transco's IT-feeder
service for the FT conversion  shippers "essentially firm." Id. at
62,346. But the Commis- sion did not direct two-part rates for this
"essentially firm"  service, and it has been subject to only a single
volumetric  usage charge.


In 1992 the Commission adopted Order No. 636, extending  its
restructuring of the gas industry. See Pipeline Service  Obligations
and Revisions to Regulations Governing Self- Implementing
Transportation under Part 284 of the Com- mission's Regulation of
Natural Gas Pipelines after Partial  Wellhead Decontrol, FERC Stats. &
Regs. p 30,939 (1992).  One of its goals was the creation of a
"national gas market"  with "head-to-head, gas-on-gas competition
where the firm  transportation rate structure is not a potentially
distorting  factor in the competition among merchants for gas
purchasers  at the wellhead and in the field." Id. at 30,434. To this
end,  FERC ordered that when pipelines provide firm transporta- tion
with a two-part fee structure, all fixed costs are allocated  to the
reservation charge so that the usage charge is based  only on variable
costs. This new rate design was called  "straight fixed variable"
("SFV"). It replaced "modified fixed  variable" ("MFV") pricing, under
which the usage charge for  any two-part rate included a portion of a
pipeline's fixed  costs. See United Distribution Cos. v. FERC, 88 F.3d
1105,  1167-68 (D.C. Cir. 1996) (upholding FERC's abandonment of 
modified fixed variable pricing); see also 18 CFR s 284.8(d).  With
MFV the pipelines had varied in their allocation of fixed  costs to


MFV rate design distorted the unit delivered prices of gas,  and
thereby hindered the development of an efficient national  market for
gas." Municipal Defense Group v. FERC, 170  F.3d 197, 199 (D.C. Cir.
1999). With SFV the Commission  hoped "to promote competition at the
natural gas wellhead by  increasing the transparency of natural gas
pricing." Texaco  Inc. v. FERC, 148 F.3d 1091, 1094 (D.C. Cir.


Because conversion from MFV to SFV often contradicted  contracts
between pipelines and purchasers, the Commission  could require SFV
only by invoking its authority to modify  private contracts under the
so-called "Mobile-Sierra doc- trine." See Texaco Inc., 148 F.3d at
1096-97; see also  United Gas Pipe Line Co. v. Mobile Gas Corp., 350
U.S. 332  (1956); FPC v. Sierra Pacific Power Co., 350 U.S. 348
(1956).  Under Mobile-Sierra, FERC may modify a contract rate 
provision if (but only if) the "public interest" so requires, a 
standard understood by all to demand more of a showing by  FERC, in
rejecting rates, than is needed to reject rates under  the "just and
reasonable" standard of s 5. See Papago  Tribal Utility Auth. v. FERC,
723 F.2d 950, 953 (D.C. Cir.  1983); Northeast Utilities Service Co.
v. FERC, 993 F.2d 937,  960 (1st Cir. 1993). In part because of FERC's
insistence  that the MFV rate design will "distort gas market pricing
to  the detriment of the 'integrated national gas sales market,' "  we
have upheld FERC's abrogation of private contracts to  convert natural
gas pricing to SFV. See Texaco, 148 F.3d at  1097. Nonetheless, in the
s 5 proceeding alluded to at the  outset of the opinion, the
Commission rejected Transco's  effort to establish a two-part SFV rate
for the IT-feeder  service enjoyed by Transco's conversion shippers.


Following a Commission suggestion, Transco made a s 4  filing that
proposed two-part SFV rates in the production  areas. An
administrative law judge to whom the Commission  referred the matter
rejected the rates on various grounds.  Transcontinental Gas Pipe Line
Corp., 72 FERC p 63,003  (1995). Transco and Indicated Shippers filed
exceptions with  the Commission, which in its decision dropped nearly
every  aspect of the ALJ's analysis save the conclusion--that the 
proposed rates were unjust and unreasonable. See Opinion 


No. 405, 76 FERC p 61,021 (1996). The Commission began  by repudiating
the ALJ's highly critical view of two-part rates  and SFV. First, "[a]
reservation charge helps ration capaci- ty, whether in the market area
or in the production area."  Id. at 61,060. Second, rebutting the
ALJ's belief that a two- part rate with reserved capacity was an
anticompetitive "ty- ing" practice, it said there was nothing
anticompetitive about  putting shippers to a choice regarding whether
or not to  reserve capacity: "These are the types of choices that con-
sumers are constantly required to make in a competitive  marketplace."
Id. Finally, any concerns regarding a tying  effect once the choice to
reserve was made were "tempered"  by capacity holders' rights,
established in Order No. 636, to  release their capacity entitlements
and thereby at least in  part to offset the reservation costs. Id. at
61,061. In fact,  "this flexibility is enhanced on Transco's system by
the right  of firm shippers to release capacity in segments in order
to  tailor their capacity needs and alternatives to fit their needs." 
Id. Indeed, the Commission had little choice but to defend  two-part
SFV rates; as it acknowledges, they are the pre- dominant method of
pricing firm service in the wake of Order  636, Resp. Br. at 39, so a
FERC repudiation would have  risked regulatory upheaval.


But the Commission found a catch in Transco's proposal,  the 1991
settlement:


Transco proposes, in effect, to unilaterally modify those  [1991]
contracts so that the customer will pay a two-part  rate for
essentially the same firm service on the supply  laterals. This is
unacceptable. The customers must be  given an opportunity to choose
between firm or interrup- tible service.


Opinion No. 405, 76 FERC at 61,061. Thus the Commission  offered its
support for an "open season" where Transco's  customers would be
allowed to choose between firm and truly  interruptible service (i.e.,
service that can and will be inter- rupted at times). Id. at


Indicated Shippers petitioned for rehearing. On the con- tract
abrogation argument, they argued that "[a] change from 


IT-feeders to FTW is a change in rate structure that changes  the
apportionment of costs, just as costs are shifted upon the  adoption
of a change in rate design or cost allocation method.  Such a change
does not constitute an abrogation of existing  contracts." In other
words, they said, Transco had proposed  nothing different from the
MFV-SFV shift that the Commis- sion had routinely endorsed--had,
indeed, imposed on parties  by overriding contracts in the name of the
public interest  under Mobile-Sierra. The Commission, however, was
reso- lute in defense of the prevailing rates. Transco had proposed 
"a fundamental change to the rate design, not a mere cost 
reallocation." Opinion No. 405-A, 77 FERC p 61,270 at 62,- 127. "A
cost reallocation will not change a one-part rate into  a two-part
rate; it will only change the level of existing  charges." Id.


* * *


Under s 4 of the Natural Gas Act a pipeline proposing a  rate change
has the burden of showing that the proposed rate  is just and
reasonable. If it meets that burden, FERC  approves the rate
regardless of whether there may be other  rates that would also be
just and reasonable. See Western  Resources, Inc. v. FERC, 9 F.3d
1568, 1578 (D.C. Cir. 1993);  Public Serv. Comm'n v. FERC, 866 F.2d
487, 488 (D.C. Cir.  1989). The Commission is afforded a "narrow
section 4 range  of acceptance or disapproval of a pipeline's proposed
 changes." Public Serv. Comm'n, 866 F.2d at 491 (quoting  Sea Robin
Pipeline Co. v. FERC, 795 F.2d 182, 183 (D.C. Cir.  1986)).


The Commission concedes that "two-part rates are permis- sible for firm
service in the production area." Opinion No.  405, 76 FERC at 61,061;
see also 18 CFR s 284.8(d). In  fact, FERC informs us that such rates
are "predominant" for  firm service in the production area. Resp. Br.
at 39. Thus a  logical first question might be: is Transco's IT-feeder
service  "firm service" of the sort for which SFV rates are, in FERC's
 words, "permissible" and "predominant"?


FERC and the parties call the IT-feeder service "firm" or  at least
"essentially firm." The term "essentially firm" de- rives from the
1991 settlement, see Settlement Order, 55  FERC at 62,346, and FERC
still agrees with that character- ization. Opinion No. 405-A, 77 FERC
at 62,129. The qualifi- er--"essentially"--appears to derive from
certain grandfa- thered firm service that predated the 1991
settlement. See  Settlement Order, 55 FERC at 62,345-46. The qualifier
 might also derive from the paradoxical characterization of IT- feeder
service in the Settlement Order, that it is "not firm"  but also not
to be interrupted. See id. at 62,377. FERC at  times returns to this
apparent doublespeak in Order No. 405,  referring to "high priority,
interruptible service." Order No.  405, 76 FERC at 61,061. In this
proceeding, FERC has at no  time rested its decision on any claim that
the qualifier "essen- tially" is material. Accordingly, we treat the
service as firm  and the qualifier as immaterial, subject, of course,
to the  possibility that on remand the Commission may breathe life 


And so we reach the central issue: if two-part rates are  permissible
and predominant for firm service in the produc- tion area, and Transco
is providing firm service in the produc- tion area, how can Transco's
proposed rate not be just and  reasonable? The Commission offers two
bases: first, the  contracts don't allow it, and second, "customers
must be given  an opportunity to choose between firm or interruptible
ser- vice," what might be termed a "customer choice policy."  Opinion
No. 405, 76 FERC at 61,061.


The Contracts


The Commission's reliance on the prior contracts seems not  to advance
the case at all. After the Supreme Court enunci- ated the
Mobile-Sierra doctrine, it approved and gave effect  to so-called
"Memphis clauses," under which a pipeline by  contract reserves the
freedom to secure rate changes by  standard filings with FERC such as
those under s 4. See  United Gas Pipe Line Co. v. Memphis Light, Gas
and Water  Div., 358 U.S. 103, 110-15 (1958); see also Union Pacific


Fuels, Inc. v. FERC, 129 F.3d 157, 160 (D.C. Cir. 1997).  Before us the
Indicated Shippers assert, and the Commission  does not dispute, that
the contracts contained Memphis claus- es. With a Memphis clause, the
contract contemplates and  allows section 4 filings and any "just and
reasonable" rates  that result from such filings. Thus we are puzzled
by the  Commission's insistence, in the opinions under review and its 
brief here, that Transco's filing was inherently an "abroga- tion" of
the contracts. For example, the Commission states  that Transco seeks
to "unilaterally modify those contracts,"  Opinion No. 405, 76 FERC at
61,061, and that "Transco's  proposed unilateral change results in an
abrogation of the  contracts," Opinion No. 405-A, 77 FERC at 62,127.
See also  Resp. Br. at 41-42.


But with a Memphis clause, where is the "abrogation"? At  this point,
one would suspect that part of FERC's theory of  "abrogation" would be
that the contracts gave rise to a  Mobile-Sierra bar on two-part
rates. Opinions No. 405 and  No. 405-A certainly imply as much
(although without discuss- ing either Mobile-Sierra or Memphis). But
FERC's brief  disclaims the presence of a Mobile-Sierra bar. Resp. Br.
at  42. Rather, FERC describes its analysis as merely "tak[ing] 
existing private contractual agreements into consideration,"  id. at
42-43, citing three cases that purportedly encourage  such
consideration, one of which is the "Mobile" of Mobile- Sierra. See id.
at 43 (citing Mobile, 350 U.S. at 338-39;  Associated Gas Distribs. v.
FERC, 824 F.2d 981, 1009 (D.C.  Cir. 1987); Cities of Bethany v. FERC,
727 F.2d 1131, 1139  (D.C. Cir. 1984)).


Associated Gas and Cities of Bethany are not similar to the  situation
Transco presents; they involve inquiries as to  whether rates reached
by private contract are discriminatory.  And the Mobile citation is
inapt because the Commission  rightly disclaims any Mobile-Sierra bar
in the contract. Giv- en the presence of Memphis clauses, observations
from these  three opinions regarding "Congress's intention in the NGA
to  allow a vital role for private contracting between parties," 
Associated Gas, 824 F.2d at 1009, provide no apparent basis 


for rejecting a proposal for rates that undeniably meet the  "just and
reasonable" standard.


Yet the Commission was ready to approve the rates under  special
circumstances; because the proposed change was too  "fundamental,"
Opinion No. 405-A, 77 FERC at 62,127, Tran- sco could apply it only
after an open season. This position  confirms that the Commission
perceives no Mobile-Sierra  bar. After such an open season, customers
will either have  firm service with a two-part rate or truly
interruptible service  with a purely volumetric rate; they will not
have their  original bargain.


And so we are left with something of a purple cow. Ac- cording to the
Commission, Transco sought an abrogation of  the contracts by
proposing a two-part rate, but the original  one-part rate is not
protected by a Mobile-Sierra bar. The  Commission must explain this
state of affairs because it  seems to defy the doctrines built upon
Memphis and Mobile- Sierra. Since Opinions No. 405 and No. 405-A do
not discuss  either of these cases, or their progeny, we safely
conclude  that there was inadequate explanation on this point.


Customer Choice


Perhaps intertwined with the theory of contractual abroga- tion, the
Commission concludes that as a matter of policy  Transco's customers
should get a choice as to whether they  pay a reservation charge for
their firm service. This policy is  defended as something of a
corollary of a policy that is part of  the Commission's regulations:
the choice between firm and  interruptible service.


An interstate pipeline that provides firm transportation  service under
subpart B and G of this part must also  offer transportation service
on an interruptible basis  under that subpart or subparts and
separately from any  sales service.


18 CFR s 284.9(a)(1).


Back at the time of the settlement, Transco's customers  made a choice
between firm and interruptible service; they  specifically asked FERC
to guarantee them firm rights on 


the IT-feeders, and FERC did so. The customers also  received
(temporarily, because of the Memphis clause) some- thing of a
windfall--firm service but without paying for their  entitlement to
capacity. Before these customers can be  forced to pay for their firm
service in the predominant  manner (i.e., two-part rates), FERC says
they must be given  a new choice


between purchasing a higher quality firm service with a  reservation
charge or purchasing a lower quality inter- ruptible service without a
reservation charge.


Opinion No. 405, 76 FERC at 61,060. See also Opinion No.  405-A, 77
FERC at 62,124 n.3 (speaking of the desirability of  customer "choice
of a higher quality firm service with a  reservation fee and a lower
quality interruptible service with- out a reservation fee" (emphasis
added)).


For practical purposes, the choice between firm and inter- ruptible
service will usually entail a choice between two-part  and one-part
rates. Two-part rates predominate for firm  service, and interruptible
service has only a one-part rate.  The choice made in Transco's
settlement did not correspond  to this model, but the Commission does
not make a coherent  case as to why the new choice is required, or why
a two-part  rate structure--not merely permissible but predominant for
 the service chosen--is unjust or unreasonable.


The Commission calls the imposition of a two-part rate a  "fundamental"
change in the rate structure, but a significant  chunk of the
Commission's opinion disclaims the criticism of  reservation charges
found in the ALJ opinion. See Opinion  No. 405, 76 FERC at 61,060-61.
The Commission does offer  the terse conclusion that "[a] cost
reallocation will not change  a one-part rate into a two-part rate; it
will only change the  level of existing charges." Opinion No. 405-A,
77 FERC at  62,127. We are unsure why this should be relevant. The 
basic idea of a Memphis clause is to reserve to the utility the  power
to file tariffs that can take effect if they pass Commis- sion
scrutiny under its ordinary standards: thus, if a filing  under s 4
proposes rates that are just and reasonable, as  these concededly are,
they are to be accepted--regardless of  the justness and


FERC's resistance here is especially odd in light of its 
aggressiveness in shifting pipelines with two-part rates from  MFV to
SFV. If inclusion of a few fixed costs in the usage  component of a
two-part charge was so distortive of the  market as to require the
Commission's use of the Mobile- Sierra public interest standard to
effect the MFV-SFV con- version, one would suppose a one-part charge
for firm cus- tomers, with all fixed costs in a purely volumetric
charge,  would be similarly offensive. The Commission's opinions in 
this case do not explain why Order No. 636's principles are  not at
play here on the side of the Indicated Shippers.1


The policy embedded in the regulations is a choice between  firm and
interruptible service, and Transco's customers made  that choice in
1991. They got firm service and a one-part  rate; the pipeline got a
Memphis clause. The Commission's  new policy that Transco's customers
get a second choice  (framed as one between two packages, firm service
with a  reservation charge or interruptible service without) rests on 
some heretofore unspoken reason why a reservation charge  for firm
service--concededly just and reasonable--is not just  and reasonable
because the customers had previously been  receiving firm service
under a purely volumetric charge. The  Commission's insistence that
the change can be made only by  an open season seems to amount to a
belief that customers,  having already elected firm service, must now
be asked,  "Firm service--is that your final answer?" Why this second 
bite at the apple is needed remains a mystery.


* * *


Because the Commission has failed to "cogently explain  why it has
exercised its discretion in [the] given manner," 




__________

n 1 FERC's regulations provide that "[w]here the customer pur- chases
firm service, a pipeline may impose a reservation fee or  charge on a
shipper as a condition for providing such service." 18  CFR s 284.8(d)
(emphasis added). This regulation did not figure  prominently in
arguments on appeal. It certainly implies that  reservation fees are
not required with firm service; it expressly  provides that they are
permissible.


Motor Vehicle Mfrs. Ass'n of U.S., Inc. v. State Farm Mut.  Auto. Ins.
Co., 463 U.S. 29, 48 (1983); 5 U.S.C. s 706(2)(A),  we reverse and
remand the case for reconsideration in light of  this opinion.


So ordered.


Randolph, Circuit Judge, dissenting: No party denies that  Transco
could exercise the Memphis clause and propose a  rate change. But the
Commission still had a statutory duty  to ensure that the company's s
4 proposal was "just and  reasonable." 15 U.S.C. s 717c. The
Commission performed  that duty and rejected Transco's filing because
it did "not  allow for a real choice of service options on Transco's
supply  laterals." 76 F.E.R.C. at 61,061. I believe the Commission 
offered a reasoned explanation for its decision.


The majority makes much of the Commission's mention of  "abrogation of
contracts," but then recognizes that this ratio- nale is "perhaps
intertwined" with the customer choice policy.  Maj. op. at 10. Indeed,
reference to the existing contracts  was not an independent ground of
the Commission's decision,  but a necessary consequence of the
customer choice policy.  If two-part rates are just and reasonable
only when custom- ers have already elected a reservation charge, then
the  Commission must ask the simple question whether the cus- tomers
have in fact chosen a reservation charge. The Com- mission indicated
that it would allow a change in rates after  an open season, which
would alter the bargain in the original  contract. See id. This
demonstrates that the Commission  was not nullifying the Memphis


Thus, the real question is whether the Commission was  arbitrary and
capricious in rejecting Transco's proposal based  on the customer
choice policy. The Commission has rejected  the idea of an outright
ban on reservation charges, noting  that such charges offer advantages
to customers. See 76  F.E.R.C. at 61,059 (citing Order No. 436, 50
Fed. Reg. 42,408  (1985)). But the Commission also recognizes that
reservation  charges tie customers to the pipeline, creating an
incentive to  use the pipeline even if more efficient service can be
obtained  elsewhere. See 76 F.E.R.C. at 61,060. The Commission thus 
decided that it is best left to individual customers to "weigh 
whether the advantages of obtaining a firm right to service on  the
pipeline are worth the limits which the reservation charge  will
inevitably impose on the desirability of its switching to  supplies on
another system." Id. Because Transco's propos- al denied conversion
shippers an opportunity to make this 


cost-benefit analysis for themselves, the Commission rejected  it.


The majority emphasizes that customers have already cho- sen firm
service. See maj. op. at 12. But the question is not  whether
customers already elected "essentially firm" service.  The question is
whether they already elected two-part rates.  It is uncontested that
they did not. The majority also finds  the Commission's decision
"especially odd" because it suppos- edly conflicts with Order 636's
principle against fixed costs in  usage charges. See id. This takes
Order 636 too far. The  Commission there decided only that "[i]f a
reservation fee is  charged, it must recover all fixed costs
attributable to the  firm service....." 18 C.F.R. s 248.8(d) (emphasis
added).  To find that fixed costs could never be included in usage 
charges would require doing away with interruptible service  (which is
necessarily a one-part rate), something the Commis- sion certainly did
not intend. According to the majority, the  Commission rejected as
unjust and unreasonable a two-part  rate that is the "predominant
manner" of "firm service."  Maj. op. at 11. This forgets that the
predominant manner of  service overall is to allow customers to choose
whether to pay  a reservation charge and receive firm service or to
reject the  reservation charge and receive lower priority service. In-
deed, the majority does not cite a single case (in either s 4 or  s 5
proceedings) in which the Commission approved two-part  rates when
customers had not previously made the calculation  that reservation


I therefore dissent.