On Oсtober 1, 1992 Northwest Pipeline Corporation (“Northwest”) filed for a general rate increase under § 4 of the Natural Gas Act, 15 U.S.C. § 717c, to cover costs associated with a previously authorized expansion of its natural gas pipeline facilities. The Federal Energy Regulatory Commission rejected certain proposed tariffs, accepted and suspended other proposed tariffs subject to refund, and set an evidentiary hearing. Almost a decade later, in two different consolidated cases, petitioners are seeking review of the relevant rate increase, which because of later filings by Northwest was in effect only from April 1, 1993 through October 31, 1994.
One of the cases involves issues that were resolved before we remanded to the Commission to consider the effect of a Commission policy change, the other involves issues resolved in the course of that remand. The first, Nos. 96-1336 and 97-1343 concerns five ordеrs, the last of which issued in 1997.
The later consolidated case, No. 99-1488 et al., involves the five orders issued after the remand.
Two parties, Northwest Natural Gas Company (“Northwest Natural”), a buyer of Northwest’s gas, and the Canadian Association of Petroleum Producers (“CAPP”), a representative of buyers, assert a variety of errors in the Commission’s decisions. We review the Commission’s determinations under the Administrative Procedure Act’s arbitrary and capricious standard. See Missouri Public Service Comm’n v. FERC,
The “just and reasonable” rates calculated by the Commission under 15 U.S.C. § 717c(a) are typically based on a pipeline’s costs. Because several of the issues here revolve around one component, the cost of equity capital, we pause briefly to explаin it. Each year that a durable utility asset is in use imposes on the utility the annual cost of the capital used for its construction (net of amounts already recovered in depreciation charges). In order to attract capital, a utility must offer a risk-adjusted expected rate of return sufficient to attract investors. This return to investors is the cost to the utility of raising capital. For the portion of capital acquired through bonds, the cost is comparativеly easy to compute — the interest the company must pay its bondholders. Common equity is more complicated, for equity investors do not have a legally fixed return. To calculate the rate of return necessary to attract them, the Commission measures the return enjoyed by the company’s equity investors by the discounted cash flow (“DCF”) model, which assumes that a stock’s price is equal to the present value of the infinite stream of expected dividends discounted at a market rate commensurate with the stock’s risk. With simplifying assumptions, this can be summarized by the formula
P = D/if-g)
where P is the price of the stock at the relevant time, D is the dividend to be paid at the end of the first year, r is the rate of return and g is the expected growth rate of the firm. See Illinois Bell Telephone Co. v. FCC,
r = D/P + g
Illinois Bell,
For a company that is not publicly traded, market-determined figures for P and D
1. Inclusion of Over-Run Costs in Rate Base
In its expansion project Northwest added considerable mainline pipeline and compressor fаcilities and services. Its original filing included $371.2 million in project costs but it ultimately persuaded the Commission to include about $61 million more. Because of decisions adverse to Northwest on other issues, the rates approved were lower than those for which it had originally filed. See
Northwest Natural claims that Northwest should not be permitted to incorporate into its rate base costs that were not included in its original filing. Its backup position is that even if consideration of those costs was proper, the Commission should have reopened proceedings to consider its claim that about $48 million in costs was not actually paid within the “test period” (twelve consecutive months used, with adjustments, in estimating a pipeline’s costs) and should have been excluded.
On the first claim, Northwest Natural argues that an earlier Commission decision, Natural Gas Pipeline Co. of America, 38 FPC 1136 (1967), governs how the Commission must deal with cost figures that differ from those of the initial filing. It places special rеbanee on a phrase of that decision saying that the regulations “bind Natural to its case-in-chief as submitted.” Id. at 1148. The phrase is indeed there, but the Commission went on to make clear that there was no flat rule against new data; instead it performed a contextual analysis. There (1) the evidence did not fit the very limited subject of the hearing; (2) because of that disjuncture there was a risk that other parties would reasonably assume that the evidence would not be considered (and accordingly these parties would lack effective notice); and (3) the new cost evidence in fact did not meet the Commission’s requirement that changes in costs after the test period be “known and measurable.” Id. at 1148-50 (internal quotation omitted). None of these characteristics was present here. The Commission found that because Northwest’s revised costs were disclosed prior to the filing of direct testimony in the hearing before the Administrativе Law Judge, that the parties had ample notice of the cost claims, and that such claims, though estimates, were known and measurable. See Opinion No. 396-A,
In its second claim Northwest Natural argues that the Commission unlawfully refused to reopen proceedings to hear its claim that Northwest had not actually paid all of the expansion costs within
Nоrthwest Natural also claims discriminatory treatment in the Commission’s reopening refusal, as the Commission did reopen proceedings to consider the long-term growth projections. But it did so exclusively in light of its own intervening decision in Ozark Gas Transmission System, 68 FERCT 61,032 at 61,105 (1994), announcing a new policy to include such projections. Such an effort by the Commission to assure that it applies similar principles in simultaneously pending cases may be obligatory. See Williston Basin,
2. Assessment of Northwest’s Business Risk
As part of its process to determine Northwest’s rate, the Commission assessed Northwest’s costs of capital. This estimation required, under the DCF method that the Commission used, calculating the implicit equity rate of return for a proxy group of supposedly similar corporations, and then determining where Northwest belonged within that group, in large part on the bаsis of Northwest’s business risk. CAPP complains that the Commission didn’t adequately consider evidence suggesting that Northwest’s business risk was in fact lower than the average of the proxy group, so that it erred in assigning Northwest a rate based on the middle of the proxy group range. CAPP’s theory was that Northwest was more like the “pure” pipeline companies within the proxy group, which had lower rates of return, than like the companies with more diversified operations. We do not review the merits of CAPP’s petition because it is proeedurally barred.
Four of the Commission’s orders prior to our remand are relevant. We start with a very simple summary of each relevant order, what it did, and the nature of CAPP’s petition for rehearing in the instances where it filed one.
Opinion No. 896. The Commission rejected CAPP’s contention that Northwest’s business risk was below the average of the proxy group.71 FERC ¶ 61 ,-253 at 61,992 (1995). CAPP petitioned for rehearing, raising the issue of business risk.
Opinion No. 396-A. The Commission remanded the matter to thе ALJ for development of a record on longterm*296 growth rates.76 FERC ¶ 61,068 at 61,-419 (1996). It said nothing at all about the business-risk issue. CAPP did not seek rehearing, but petitioned for review in this court of both Opinion No. 396 and Opinion No. 396-A.
Opinion No. 396-B. Following the proceedings before the ALJ, the Commission identified a new range of rates for the proxy companies and selected the mid-point of that range as appropriate for Northwest.79 FERC ¶ 61,309 at 62,384-86 (1997). Northwest sought rehearing in a petition that did not mention the business risk issue.
Opinion No. 396-C. The Commission disposed of the petitions for rehearing.81 FERC ¶ 61,036 (1997). Northwest petitioned for review here.
The Commission arguеs that neither of the first two opinions, No. 396 or No. 396-A, was final, which is a prerequisite to our review. See Transwestern Pipeline Co. v. FERC,
CAPP did, however, seek review of Opinion No. 396-C, thereby bringing up issues properly preserved from Opinion No. 396-B. But was the business risk issue, raised only on rehearing of Opinion No. 396, preserved? Section 19(b)’s rehearing requirement itself applies “not to the issue involved, but to the order that comes before us for review.” Kansas Cities v. FERC,
In the present case, however, several stages of agenсy review and modification separate Opinion No. 396-B from CAPP’s petition for rehearing of Opinion No. 396— proceedings before the ALJ on the long-term/short-term weighting issue, followed by Commission resolution of that issue and its selection of a new equity rate of return for Northwest. Enforcement of the rehearing requirement in this context serves not merely to inform the Commission of issues that may be appealed, but ensures certainty in the dispute process, apprising potentially settling parties of what issues remain contested. See ASARCO, Inc. v. FERC, 111 F.2d 764, 773-74 (D.C.Cir.1985). We note, moreover, that CAPP does not argue, nor do we see any basis for finding, that its failure to preserve its right to appeal was justified under the “reasonable ground” exception to Section 19(b)’s rehearing requirement. Accordingly, CAPP’s petition is dismissed for lack of jurisdiction.
3. Weighting of Short- and Long-Term Growth Rates.
On remand, the Commission changed the weighting of short- and long-term growth rates, now giving short-term rates twice the weight of long-term ones, rather than weighting them еqually as before. The petitioners claim that the Commission failed to explain its decision generally or to distinguish Ozark Gas Transmission System, 68 FERCT 61,032 (1994), where the Commission approved an equal weighting of all years of an 18-year period. Id. at 61,107 n. 46. To explain its decision, the Commission quoted its reasoning in Transcontinental Gas Pipe Line Corp.,
[W]hile determining the cost of equity nevertheless requires that a long-term evaluation be taken into account, long-term projections are inherently more difficult to make, and thus less reliable, than short-term projections. Over a longer period, there is a greater likelihood for unanticipated developments to occur affecting the projection. Given the greater reliability of the short-term projection, we believe it is appropriate to give it greater weight. However, continuing to give some effect to the long-term growth projection will aid in normalizing any distortions that might be reflected in short-term data limited to a narrow segment of the еconomy.
Initial Post Remand Order,
4. Choice of the Median Rate of Return on Equity.
On remand the Commission also changed its method of selecting an equity rate of return from the array of rates of the proxy group. Before the remand it
We remanded to the Commission to enable it “to reconsider its decisions in light of Williston Basin v. FERC,
The Commission’s orders and brief speak only to the choice between median and midpoint. Its orders pointed to the Transcontinental decision, where, besides changing the weighting of short- and long-term growth factors, it also selected the median instead of the midpoint. But it supplied only the most limited reasoning there. See Transcontinental Gas Pipe Line Corp.,
[U]se of the median gives consideration to more of the proxy company numbers. The median is the point at which half of the numbers are higher and half are lоwer. The midpoint, on the other hand, merely represents an average of the highest and lowest of the numbers and completely disregards the middle three numbers.
Median Rate Order on Rehearing,
To a large extent this “explanation” merely describes the differences in calculating the median and the midpoint. Insofar as it seeks to justify on the basis of the number of numbers considered, it is not wholly accurate. The midpoint doesn’t “completely disregard!] the middle three numbers”; the highest and lowest numbers achievе their status by reference to all five numbers. But even if acceptable as an explanation for choosing the median over the midpoint, it fails as an explanation for rejecting petitioners’ proposal that the Commission use the simple arithmetic mean (either of all five, or of the middle three companies of the proxy group). See No. 99-1488 et al., J.A. at 105, 171,192-93.
The Commission simply dismissed the alternative proposal in conclusory terms. See Median Rate Order,
The Commission’s failure to respond meaningfully to calls for using an average rate of all or of three of the proxy group companies renders its decision to use the median rate arbitrary and capricious. See City of Brookings Municipal Telephone Co. v. FCC,
5. Imposition of Surcharges
The Commission determined on remand that it had improperly reduced Northwest’s rates in its first series of orders and consequently ordered Northwest to impose surcharges to recover those excess refunds from its shippers. Petitioners claim that the surcharges violated the filed ratе doctrine, “which forbids a regulated entity to charge rates for its services other than those properly filed with the appropriate federal regulatory authority,” Arkansas Louisiana Gas Co.,
Petitioners rely on Natural Gas Clearinghouse v. FERC,
CAPP’s petition for review is dismissed for want of jurisdiction on the business-risk issue. The case is reversed and remanded to the Commission for further consideration of the selection of the median rate of return on equity from the proxy group. Otherwise, the petitions are denied.
So ordered.
Notes
. The five are: Opinion No. 396,
.