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


AL POWER CO

v.

FERC


98-1214a

D.C. Cir. 2000


*	*	*


Karen LeCraft Henderson, Circuit Judge: Petitioners  Alabama Power
Company, Georgia Power Company, Gulf  Power Company, Mississippi Power
Company, Savannah  Electric and Power Company and Southern Company
Ser- vices, Inc. (collectively, the Southern Companies, petitioners) 
seek review of two orders of the Federal Energy Regulatory  Commission
(FERC, Commission) rejecting two components  of the rates they had
proposed for supplying electric power to  the City of Tallahassee,
Florida (City).1 The first component  is "turbine assembly costs" and
the second is "heating loss  costs." With regard to the former, the
Southern Companies  argue that FERC's policy as applied here is
inconsistent with  a recent FERC decision allowing recovery of such
costs.  With regard to the Commission's denial of recovery for 
heating loss, the Southern Companies argue that the method  they used
to calculate loss, yielding results FERC deemed  unreliable, is used
by FERC for related purposes. They also  argue that the Commission's
concern over double recovery of  heating loss costs is misplaced.


For the reasons set forth below, we grant the petition for  review and
remand to the Commission for proceedings consis- tent with this
opinion and with its recent decision approving  recovery of turbine
costs to determine whether the Southern  Companies justified this
component of its rate. 


__________

n 1 The City filed an intervenor brief in support of FERC's deci-
sions.


I.


In 1990 the Southern Companies filed a Unit Power Sales  (UPS)
Agreement between themselves and the City propos- ing the sale of
certain electric power capacity to the City for a  term of ten years.
The UPS Agreement prescribed transmis- sion charges for various
support services, including a monthly  reactive control charge for the
costs associated with  generator-supplied reactive power. The Southern
Companies  then faced the task of satisfying FERC that their proposed 
reactive power charge was just and reasonable. Hearings  before an
administrative law judge yielded an Initial Decision  largely
approving the Southern Companies' proposal, conclud- ing that "the
proposed reactive power charges, with modifica- tion to certain
component allocations and [the Southern Com- panies'] reactive power
credits, are just and reasonable."  Southern Co. Servs., Inc., 61 FERC
p 63,009 at 65,024 (1992).  The Commission affirmed in part and
reversed in part, taking  issue with certain aspects of the Southern
Companies' meth- odology. See Southern Co. Servs., Inc., 80 FERC p
61,318  (1997). The Commission's two modifications at issue here, on 
which the Commission stood firm in denying rehearing, see 82  FERC p
61,168 (1998), are the exclusion of turbine assembly  costs and the


The Commission described reactive power and its role in  the provision
of electric power as follows:


Electric power consists of two components. The first  component, "real"
power (expressed in terms of watts), is  the active force that causes
electrical equipment to per- form work. The second component,
"reactive" power,  (expressed in terms of volt-amperes reactive
(VARs)) is  necessary to maintain adequate voltages so that "real" 
power can be transmitted.


Failure to provide the correct amount of reactive pow- er at various
points on the transmission system can cause  deviations from desired
voltage levels and disruption in  the flow of power on the system. In
order to maintain  desired voltage levels, reactive power must be
supplied 


or absorbed by generators (or transmission equipment)  at various
points on the transmission system.


Southern Co. Servs., Inc., 80 FERC at 62,080 (footnotes  omitted).


The Southern Companies utilize generators to produce  reactive power
and the production of reactive power causes  heating loss that
increases fuel consumption and demand on  the generators. See Brief of
Commission at 36.2 The South- ern Companies factored the heating loss
into its costs equa- tion, seeking to recoup for the required use of
additional fuel  and for a portion of the generators' real power
capacity. To  calculate costs, the Southern Companies combined the
cost of  reactive power "impacts" on their energy system with the 
heating loss cost to arrive at a control charge. Brief of  Petitioners
at 12. They determined the cost of the reactive  power impacts through
use of two load flow studies. One  study measured the "base-case" load
flow conditions and  quantified the reactive power requirement of all
generators in  the transmission system. The other, a
"transaction-case"  load flow study, measured the effect on the system
of an  energy transaction similar to those proposed in the UPS 
Agreement with the City. A comparison of the studies  demonstrated the
impact (measured in megavolt ampere reac- tives (MVARs)) of individual
transactions under the UPS  Agreement, allowing the petitioners to
determine the amount  of generating capacity lost in each transaction
and then to  multiply that figure by an average energy rate and thus 
quantify the heating loss resulting from production of reactive  power


The petitioners also sought to recoup, through the pro- posed reactive
power charge at issue, costs incurred from use  of their generators to
supply or absorb reactive power. Hav-




__________

n 2 See also Joint Appendix (JA) 180 (testimony of FERC staff  member)
("Producing or absorbing reactive power at a generator  results in
real power heating losses in the generator and [this]  heating loss
requires that fuel be burned [and] causes a portion of  the real
capacity of [sic] generator to be consumed producing the  heating


ing determined the amount of MVARs the transactions under  the UPS
Agreement demanded, their next step in calculating  the charge was to
identify the six major generator compo- nents associated with reactive
power production.3 Relying on  the connection between the turbines and
the production of  reactive power,4 the Southern Companies included
the "tur- bine assembly"5 as one of the six major components in its 
costs calculation. Using these components, they estimated  the plant
investment associated with production of reactive  power. Because the
turbine assembly is involved with the  production of both real power
and reactive power, the South- ern Companies included in their
estimate, and thus in the  reactive power charge, only that portion of
the turbine assem- bly cost allocated to reactive power based on the
ratio of total  power to reactive power. See 80 FERC at 62,083.


The Commission concluded the Southern Companies' calcu- lations
suffered from "erroneous modeling assumptions and 




__________

n 3 They identified the (1) exciter, (2) exciter cooling system, (3) 
generator stator, (4) rotor, (5) turbine assembly and (6) step-up 
transformers. See 80 FERC at 62,083.


4 Turbines are mechanical devices with fan-like blades that rotate 
when steam, for example, is forced though them. The resulting 
mechanical energy powers a connected instrument like a generator  (or,
more specifically, a generator's exciter): "The turbine produces  the
mechanical [or real] power to turn the generator, which, in turn, 
produces both real and reactive power." 80 FERC at 62,090 n.65;  see
82 FERC at 61,611. A turbine is essential to the production of 
reactive power. See JA 212-13 (testimony of petitioners' witness) 
("Without the turbine, there would be no production of real or 
reactive power[;] the exciter is driven by the rotor and turbine 
assembly, and thus that equipment is directly involved in the 


5 The turbine assembly is "the device [or motor] that turns the 
exciter within the magnetic field" and includes "all of the equipment 
that is on the same shaft," described as "a lot of equipment." See  JA
248-49 (testimony of petitioners' witness). "Turbine assembly"  is
used interchangeably with "turbine(s)," see, e.g., 80 FERC at  62,091;
Brief of Commission at 17-18, and there is "not generally" a 
difference between the two terms. JA 248.


flawed rate design." Id. at 62,084. The load flow studies  used to
calculate heating loss costs came under attack first.  The base-case
load flow study reflected a hypothetical operat- ing condition that,
as the Southern Companies' expert con- ceded, is not typical or
desirable. See id. at 62,084-85. The  Commission disapproved the
transaction cases as well be- cause the Southern Companies'
calculations did not account  for possible generator responses that
benefit the system by  either absorbing or producing fewer MVARs. For
example,  some transactions cause a decrease in the absorption of 
MVARs, a benefit to the transmission system, but the peti- tioners'
calculations reflected this reduction of demand on the  system as an
increase in demand for reactive power service.  As the Commission
phrased its concern, "[j]ust as one would  expect not to be charged
more for consuming less energy, one  would expect not to be charged
more for reducing reactive  power support." Id. at 62,086. In addition
to disapproving  the petitioners' methodology, FERC concluded that
they had  not explained why their fuel adjustment clause, designed to 
enable a utility to recover from its power customers the fuel  expense
associated with producing power, see Brief of Com- mission at 39, did
not already ensure recovery of these costs.  The Commission concluded
that, absent such a showing, the  petitioners' proposed rate would
result in a prohibited double  recovery of costs. See 80 FERC at


Turning to the turbine assembly costs, the Commission  disallowed their
inclusion in the petitioners' reactive power  charge because, in its
words, "turbines produce only real  power." Id. at 62,091. In
contrast, it noted that the genera- tors, in addition to producing
real power, produce (or absorb)  reactive power. Accordingly, the
Commission agreed that  costs of the generator and its parts are
appropriately included  in the reactive power charge. The Commission
also noted  that reactive power can be produced by a generator discon-
nected from its turbine and operated as a "synchronous  condenser."6
In the end, the Commission determined that 




__________

n 6 As the Commission notes, the Southern Companies do not use  these
self-powered generators. See Brief of Commission at 7 n.2.


the Southern Companies failed to establish that their rates  were just
and reasonable.


In denying rehearing, the Commission again addressed the  recovery of
turbine assembly and heating loss costs. While  the Southern Companies
compared the costs associated with  the turbine that powers a
generator to the cost of electricity  that powers a synchronous
condenser, which the Commission  agreed would be recoverable under a
reactive power charge,  the Commission again concluded that recovery
of turbine  assembly costs was not appropriate because turbines
produce  only real power notwithstanding their contribution to the 
generators' production of reactive power. See 82 FERC at  61,611. With
regard to heating loss costs, FERC again  rejected the load flow
studies and also declined to accept the  summary of actual meter
readings,7 which the Southern Com- panies submitted with their
rehearing request, because the  readings "represent[ ] a moving
target" and use of actual data  was inconsistent with FERC's approach
"not to adjust esti- mates for actuals." Id. at 61,612. Finally, the
Commission  remained unconvinced that the petitioners' revenue
crediting  mechanism prevented double recovery of heating loss costs. 


II.


We review FERC's orders under the arbitrary and capri- cious standard
of the Administrative Procedure Act (APA).  See 5 U.S.C. s 706(2)(A)
(1994); Sithe/Independence Power  Partners v. FERC, 165 F.3d 944, 948
(D.C. Cir. 1999). We  explained the applicable standard of review in
Northern  States Power Co. v. FERC, 30 F.3d 177, 180 (D.C. Cir.


The Federal Power Act requires that rates for "the  transmission ... of
electric energy subject to the juris-




__________

n 7 The Southern Companies submitted the actual meter readings  showing
the system's total MVAR production for 1991 and the  "Reactive Power
Effects on Southern Company Generators," JA  425. The total MVAR
production was greater than they had  estimated. See id. at 419-20,
423 (5897 MVARs versus 4954  MVARs).


diction of the Commission ... be just and reasonable."  16 U.S.C. s
824d(a). Because "[i]ssues of rate design  are fairly technical and,
insofar as they are not technical,  involve policy judgments that lie
at the core of the  regulatory mission," our review of whether a
particular  rate design is "just and reasonable" is highly
deferential.  Town of Norwood v. Federal Energy Regulatory Com-
mission, 962 F.2d 20, 22 (D.C. Cir. 1992). Our review is  not,
however, an empty gesture: the Commission must  be able to demonstrate
that it has "made a reasoned  decision based upon substantial evidence


The Southern Companies argue that the Commission's  exclusion of
turbine assembly costs from the reactive power  charge was arbitrary
and capricious because the real power  created by the turbine is
essential to the generator's produc- tion of reactive power. In
producing reactive power, the  generator derives power from the
turbine, the generator's  "prime mover." Brief of Commission at 7; see
JA 177; 80  FERC at 62,091. Although FERC allows recovery of genera-
tor costs, it disallowed recovery of the petitioners' turbine 
assembly costs. In fact, FERC allows recovery of costs of  electric
power serving as the prime mover of a synchronous  condenser generator
producing reactive power, that is, a  generator disconnected from the
turbine assembly. See 82  FERC at 61,611 & n.6. The Southern Companies
contend  that the recoverability of costs for the prime mover of a 
generator should not depend on whether the generator's  prime mover is
electric power, as with a synchronous con- denser, or a turbine. FERC
chose to draw the costs recov- ery line at the generator and its
integral parts rather than at  its prime mover. We need not decide
whether the line is  reasonably so drawn, however, because FERC's
treatment of  the Southern Companies' turbine costs compared with its 
treatment of turbine costs in American Electric Power Ser- vice Corp.,
80 FERC p 63,006 (1997), aff'd in relevant part, 88  FERC p 61,141


In AEP FERC allowed recovery of turbine costs as part of  the
investment required for the production of real power 


necessary to drive the generator. In the AEP initial decision,  which
the Commission affirmed summarily, see 88 FERC at  61,439-40, the
administrative law judge (ALJ) approved the  amount of production
plant investment that American Elec- tric Power Service Corporation
(AEPSC) allocated to reactive  power production and sought to recover
through the reactive  power charge. AEPSC divided its charge into
three compo- nents: "(1) the generator and its exciter, (2) accessory
elec- tric equipment that supports the operation of the generator-
exciter, and (3) the remaining total production investment  required
to provide real power and operate the exciter." 80  FERC at 65,074.
Although AEPSC omitted its investment in  turbines from its generator
and exciter costs, the ALJ recog- nized its turbine investment as a
legitimate cost, see id. at  65,076-77, and therefore included turbine
costs in the residual  category of "the remaining total production
investment re- quired to provide real power and operate the exciter,"
id. at  65,074, which the ALJ labeled "Other Power Production 
Investment."8 Id. at 65,079-80. FERC's allowance of recov- ery of
turbine costs in AEP and its failure to explain its  disallowance of
the Southern Companies' turbine costs re- quires us to remand to FERC
for reconsideration in light of  its holding in AEP.


As the Commission points out, however, its inclusion of  turbine costs
in AEP does not necessarily mean it must adopt  the Southern
Companies' method of calculation. See Brief of  Commission at 29, 35.
The petitioners use "a relatively large  allocation of one component
(the turbine) to serve as a proxy  for the amount of [the] other
production plant that is attribut-




__________

n 8 In brief FERC disputes that it allowed recovery of turbine costs 
in AEP. See Brief of Commission at 34-35. In AEP, however,  FERC
allowed recovery of "the remaining total production invest- ment
required to provide real power to operate the exciter." 80  FERC at
65,074. AEPSC incurred costs for investment in tur- bines, see id. at
65,077, and the turbines provide real power to  operate the exciter.
See supra notes 4 and 5. The investment in  turbines was not included
in the first two categories, see 80 FERC  at 65,076-78, but was
instead part of AEPSC's third category of  recoverable costs. See id.


able to reactive power production" compared to the "smaller  allocation
of all components of the other production plant"  approved in AEP.
Brief of Petitioners at 31 n.18 (emphasis  in original). While they
insist that the end result of their  methodology is "virtually
identical" to that obtained with  AEPSC's methodology, see id. at
33-34, we leave that deter- mination to FERC on remand.


Although we also remand FERC's denial of heating loss  recovery, the
Commission's rejection of the Southern Compa- nies' heating loss cost
calculations survives our review under  the APA. It disallowed
recovery because the Southern Com- panies' calculations rested on
their base-case load flow study  which the Commission found flawed.
The flaw, according to  the Commission, resulted from the measurement
of VAR  output at peak operating conditions instead of normal condi-
tions. See 80 FERC at 62,085. The Southern Companies'  own witness
testified that they would not operate at the level  used in the
calculations.9 See JA 237-39, 241-42. The  Commission thus determined
that the petitioners' calculations  did not accurately quantify their
heating loss costs. See 82  FERC at 61,612; 80 FERC at 62,086.
Although they seek to  recast FERC's denial as based on their choice
of methodolo- gy, that is, the load flow study, and not on their
calculations,  we conclude that the Commission rejected, correctly,
their  calculations associated with heating loss costs. On remand, 
FERC should allow the Southern Companies to recalculate  the costs


The Commission further concluded that the heating loss  costs should
not even be reflected in the proposed rates.  According to FERC, the
fuel adjustment clause allows for  compensation for heating loss and
the Southern Companies  failed to explain why the clause did not cover
the heating loss 




__________

n 9 Before us the Commission cites only the flaw it found with the 
base-case study, see Brief of Commission at 36-37; in its original 
order, however, the Commission found the transaction-case study 
flawed because it did not accurately reflect "the benefits and 
burdens of its generators in response to the subject transactions." 
80 FERC at 62,085; see p. 6 supra.


component. The Southern Companies, however, maintained  that their
revenue-crediting mechanism prevented double re- covery and also
avoided subsidy of certain customers' rates  by other customers. But
it was the Commission that failed to  explain its rejection of the
revenue-crediting mechanism. See  82 FERC at 61,612. Thus, FERC should
reconsider whether  all heating loss costs are recovered through the
fuel adjust- ment clause and whether the revenue-crediting mechanism 
prevents double recovery of those costs that are recovered  through
the fuel adjustment clause. Assuming FERC's re- consideration of the
petitioners' revenue-crediting mechanism  discloses unrecovered10
heating loss costs, FERC should allow  the Southern Companies to
adjust the rate accordingly so  that the costs are recovered.


For the foregoing reasons, we grant the petition for review  and remand
to the Commission for reconsideration of the  turbine assembly costs
in light of its holding in American  Electric Power Service Corp., 80
FERC p 63,006 (1997), aff'd  in relevant part, 88 FERC p 61,141
(1999). The Commission  should also reconsider whether the Southern
Companies incur  unrecovered heating loss costs or heating loss costs
that could  be more equitably recovered.


So ordered.




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n 10 Even if the costs are already recovered, the Commission should 
consider if it is more appropriate to allow recovery through the 
proposed rates (with appropriate revenue-credits), that is, if the 
rates properly allocate costs among consumers.