Case Information
*2 R OGERS , Circuit Judge
: Bеfore the court is a challenge to the regulatory mechanism for the recovery by an investor-owned public utility of the cost of three transmission projects in its transmission rates. In 2007, the Federal Energy Regulatory Commission granted various rate incentives to encourage the construction of three projects by the Southern California Edison Company (“SoCal Edison”). The beneficial rate treatment included incentives to be added to a base rate of return for the projects. Later that year, SoCal Edison filed revisions to its transmission tariff, pursuant to section 205 of the Federal Power Act (“FPA”), 16 U.S.C. § 824d, to reflect changes to its transmission revenue requirements and rates, implementing the rate incentives and proposing a base return on equity (“ROE”).
The Commission concluded that SoCal Edison’s base ROE should be set at the median, rather than the midpoint as SoCal Edison proposed, of the range established by a proxy group of publicly-traded companies, and that the ROE for the locked-in period (March 1, 2008 to December 31, 2008, when the rate at issue was in effect) should be updated to reflect the most recently available financial data, based on the average yields on ten-year U.S. Treasury bonds. SoCal Edison challenges the Commission’s use of the median as contrary to FPA § 205, its updating without considering proffered evidence as contrary to 5 U.S.C. § 556(e), and both its use of the median and its updating of the ROE for the locked-in period as arbitrary and capricious. We deny the petition as to the Commission’s methodology for measuring the ROE, and we grant the petition and remand in view of the Commission’s failure to comply with 5 U.S.C. § 556(e) when it updated the ROE with information outside the record.
I.
In order to attract capital investment for construction of
transmission facilities, a utility must offer a risk-adjusted
expected ROE sufficient to attract investors.
See Canadian
Ass’n of Petroleum Producers v. FERC
, 254 F.3d 289, 293
(D.C. Cir. 2001). To calculate the ROE, the Commission
“measures the rеturn 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.”
Id.
When a utility is not publicly traded,
key values needed to calculate the ROE are missing, and the
Commission must resort to more roundabout estimations,
including relying on the ROEs of comparable publicly-traded
companies, termed a proxy group.
See Pub. Serv. Comm’n of
Ky. v. FERC
, 397 F.3d 1004, 1006–07 (D.C. Cir. 2005)
(“
Midwest ISO
”);
Canadian Ass’n
, 254 F.3d at 293–94.
Adjusting that range by applying screens to exclude
unrepresentative high or low rates of return,
see Canadian
Ass’n
,
In November 2007, the Commission approved incentive rate
treatment for SoCal Edison’s construction of three transmission
projects, including rate adders of 0.75% for the Rancho Vista
Project, 1.25% for the Devers-Palo Verde II (“DPV2”) and
Tehachapi Projects; 0.50% across the board for joining the
California Independent System Operator; and 100% recovery for
Constructiоn Work In Progress (“CWIP”) for the projects.
S.
Cal. Edison Co.
, Order Granting Petition for Declaratory Order,
The Commission accеpted the tariff revisions subject to
conditions, preliminarily determined (using a different proxy
group and screening criteria than in SoCal Edison’s application)
that the zone of reasonableness ranged from 7.97% to 13.67%
(putting SoCal Edison’s proposed overall ROEs within the upper
end), and ordered a paper hearing to allow all parties to “present
evidence to rebut the proposed ROE determination.”
S. Cal.
Edison Co.
, Order Accepting Tariff Revisions, Subject to
Conditions and Establishing Paper Hearing,
The Commission was not persuaded by SoCal Edison’s
arguments. Upon consideration of comments submitted at the
Paper Hearing, the Commission determined the appropriate
рroxy group, found that the zone of reasonableness was between
7.80% and 16.19%, and set SoCal Edison’s base ROE at the
median of that zone, 10.55%.
S. Cal. Edison Co.
, Order on
Paper Hearing and Request for Rehearing,
II.
SoCal Edison’s challenge to the Commission’s use of the
median, instead of the midpoint, to measure the base ROE of a
single electric utility of average risk includes a statutory
argument that effectively devolvеs into an argument that the
Commission’s use of the median was arbitrary and capricious.
However viewed, SoCal Edison’s contentions face an uphill
battle. As the Supreme Court has observed, “[t]he statutory
requirement that rates be ‘just and reasonable’ is obviously
incapable of precise judicial definition, and we afford great
deference to the Commission in its rate decisions.”
Morgan
Stanley Capital Grp., Inc.
,
Under FPA § 205(e), 16 U.S.C. § 824d(e), “the burden of proof to show that the increased rate or charge is just and reasonable shall be upon the public utility.” The Commission, however, must “approve th[e increase] as long as the new rates are ‘just and reasonable.’” Wis. Pub. Power, Inc. v. FERC , 493 F.3d 239, 254 (D.C. Cir. 2007) (citation omitted); see Atl. City Elec. Co. v. FERC , 295 F.3d 1, 9 (D.C. Cir. 2002). SoCal Edison therefore contends that “if a utility proposes use of the midpoint in a Section 205 filing and the use of the midpoint is just and reasonable, then under the statute [the Commission] must accept it.” Pet’r’s Br. 25. By SoCal Edison’s reading, the Commission did not conclude in the challenged orders that it had failed to prove the midpoint was just and reasonable, and under the FPA without so concluding the Commission could not reject its proposed rate. See id . at 25–28.
The Commission rejected SoCal Edison’s midpoint-based
ROE upon concluding that for a single electric utility of average
risk “the best measure of central tendency is the median,”
Paper
Hearing Order
, 131 FERC at ¶ 61,147, and stating that it was
“not persuaded that our established procedures for determining
a[] ROE for a utility of average risk are not just and reasonable
for setting SoCal Edison’s ROE,”
Rehearing Order
, 137 FERC
at ¶ 61,068. SoCal Edison correctly points out that the
Commission did not expressly state that its use of the midpoint
was not just and reasonable, but neither has this court required
the Commission to do so with respect to a component of a
proposed rate. To the extent SoCal Edison maintains that a “just
and reasonable” rate is a zone and not a point, suggesting that
there is room for both the midpoint and the median to meet the
statutory standard,
see
Pet’r’s Br. 26, whether any space exists
between the median being just and reasonable and the midpoint
not
being so is a subset of the question of what rate is “just and
reasonable.” And SoCal Edison’s counsel understandably
acknowledged that the Commission has discretion regarding the
methodology by which it determines whether a rate is just and
reasonable.
See
Oral Arg. Tr. at 5;
Fed. Power Comm’n v. Hope
Natural Gas Co.
,
Despite SoCal Edison’s use of cherry picked phrases from the Paper Hearing Order to imply that the Commission simply chose the median as “preferable,” 131 FERC at ¶ 61,145, and not because the midpoint-based ROE SoCal Edison proposed was not “just and reasonable,” Reply Br. 4, the Commission did not hold SoCal Edison to a higher standаrd than the FPA requires. Rather, the Commission concluded that the median methodology was preferable and it may, consistent with the FPA, reject a utility’s proposed methodology without assessing the justness or reasonableness of that methodology. In order to discharge its statutory duty of ensuring that “[a]ll rates . . . [are] just and reasonable,” 16 U.S.C. § 824d(a), the Commission may require the use of a particular ratemaking methodology so long as its embrace of that methodology is not arbitrary and capricious. The Supreme Court explained in Hope Natural Gas , “[u]nder the statutory standard of ‘just and reasonable’ it is the result reached not the method employed which is сontrolling” and “infirmities” in Commission methodology are “not . . . important,” provided that “the total effect of the rate order cannot be said to be unjust and unreasonable.” 320 U.S. at 602 (citations omitted). Indeed, SoCal Edison essentially concedes in footnote 2 of its Reply Brief that its statutory argument collapses into its argument that the Commission’s use of the median for a single electric utility of average risk is arbitrary and capricious because the Commission has previously determined, and this court has affirmed, that the midpoint is a just and reasonable measure of the ROE for a group of electric utilities with diverse risk profiles. This it fails to show, in part because the Commission’s “endorsement of the median of the proxy group results produced by the DCF methodology to determine an individual electric utility’s ROE represents the logical development of [the Commission’s] ROE policy over the past fifteen years.” Intervenors’ Br. 9.
Under the Natural Gas Act, the Commission has long used
the median to set the ROE. In
Transcontinental Gas Pipe Line
Corp.
,
By contrast, until 2008, the Commission used the midpoint
to establish the ROE for both individual electric utilities of
average risk,
see, e.g.
,
Consumers Energy Co
., 98 FERC ¶
61,333 (2002), and diverse-risk electric utilities filing jointly,
see, e.g.
,
Midwest Indep. Transmission Sys. Operator, Inc.
, 106
In 2008, the Commission announced in
Golden Spread
Electric Coop., Inc.
,
This is the first time a challenge to the Commission’s use of
the median for an individual electric utility of average risk has
сome before the court. SoCal Edison contends that the
Commission still has provided an inadequate justification for its
policy change. Essentially, SoCal Edison maintains that it is
arbitrary and capricious for the Commission to “treat[] the same
utility—with the same risk profile—differently, depending upon
the context in which the utility files a[] ROE application” (singly
or as part of a group) since “this context does not in any way
affect the ROE that a utility needs to earn in order to attract
investors, maintain a reliable energy infrastructure, and serve its
customers.” Pet’r’s Br. 19. The record shows that the
Commission has not “glosse[d] over or swerve[d] from prior
prеcedents without discussion [so as to] cross the line from
tolerably terse to intolerably mute.”
W & M Props. of Conn.,
Inc. v. NLRB
,
In the Paper Hearing Order , the Commission explained why it had changed its policy for an individual electric utility:
[W]hile SoCal Edison is correct that the Commission has traditionally used the midpoint for setting the ROE in electric proceedings and the median in gas proceedings, as the electric and gas industries have evolved, the Commission finds that, when establishing the ROE of an individual utility, there is no longer a sufficient basis for divergent approaches to determining the middle оf the range of reasonable returns in the gas and electric industries. Rather, the Commission finds that here, the median is appropriate because it is the most accurate measure of central tendency for a single utility of average risk, such as SoCal Edison.
131 FERC at ¶ 61,147 (emphases added). (As intervenors note,
the gas industry restructuring preceded the electric industry
restructuring by a number of years.
See
Intervenors’ Br. 11–12
& n.10 (citing
Transmission Access Policy Study Grp. v. FERC
,
225 F.3d 667, 681–83 (D.C. Cir. 2000),
aff’d sub nom. New
York v. FERC
,
“The laws of statistics support the Commission’s use of the median in setting [the] ROE for a company facing average risk because it has important advantages over the mean and midpoint approaches in determining central tendency. The median best represents central tendency in a skewed distribution over the mean because the latter is drawn in the direction of the skew more than the median. That is, in а very positively skewed distribution, the mean will be higher than the median. In a very negatively skewed distribution, the mean will be lower than the median. These statistical facts make the median an appropriate average to use to represent the typical observation in a skewed distribution because it is less affected by extreme numbers than the mean. Similarly, the median is also less affected by extreme numbers than the midpoint in a skewed distribution. Since the midpoint is the average of the highest and lowest numbers in the group, it is clearly subject to distortion by extremely high or low values.”
Id. at ¶¶ 61,145–46 (quoting Northwest Pipeline , 99 FERC at ¶ 62,276). The Commission stated as well that “the median is preferаble to the midpoint or mean because it aids the Commission in its effort to treat all companies that face average risk equally.” Id . at ¶ 61,145.
Given these reasons and the evolution of the gas and
electric industries, the Commission concluded in the
Paper
Hearing Order
that “when establishing the ROE of an individual
utility, there is no longer a sufficient basis for divergent
approaches to determining the middle of the range of reasonable
returns in the gas and electric industries.”
Id
. at ¶ 61,147. The
Commission distinguished cases cited by SoCal Edison as
involving either a diverse group of utilities,
id
. ¶ 61,146 (citing,
e.g.,
Devon Power Co.
,
The Commission also explained that its decision to apply the midpoint in Midwest ISO occurred in the “unique circumstances” in which “the ROE was going to apply to a diverse group of comрanies, rather than to a single company of average risk, [and so] it was important to consider the entire range of results yielded by the proxy group.” Id . In those circumstances, it was “less concerned about distortions that may occur because of the highest or lowest number,” and “instead, it must ensure that the base ROE sufficiently supports the entities that have ventured into the [Regional Transmission Organization] membership and that [the base ROE] results in a reasonable rate of return as applied to all the companies in the group.” Id . The Commission emphasized that “the median places more weight on the middle values of a range of values than does the midpoint, and thus, it potentially produces a value that is not appropriate for a diverse group of utilities.” Id . It underscored that “it was not seeking the most refined measure of central tendency, which might be achieved with the median, because it was not establishing a[] ROE for a single company of average risk.” Id . ¶ 61,147.
On rehearing, the Commission reaffirmed that its approach of using the median “recognizes important differences in the purpose of the analysis that the Commission conducts when it sets a[] ROE for an individual utility rather than for a group comprising all of the utilities within an [Independent System Operаtor].” Rehearing Order , 137 FERC at ¶ 61,068. That is, when setting the “ROE for an individual utility, [its] analysis is designed to address the risks of the individual utility,” id . whereas with a group of utilities with differing risks and business profiles, see id. ¶ 61,069, the goal is “not to select the most refined measure of central tendency, as is the case when . . . setting a[] ROE for a single utility of average risk,” id . The Commission emphasized that in explaining its use of the midpoint in Midwest ISO , it had stated that it was not considering “what constitutes the best overall method for determining ROE generically (i.e., the midpoint versus the median or mean),” but only in the unique circumstances of setting the ROE for a diverse group of transmission owners. Id . (citation and quotation marks omitted).
Absent continuing reasons to treat the electric and gas
industries differently, thе Commission identified its changed
policy and provided principled reasons for using the median to
establish SoCal Edison’s base ROE. The Commission was
under no obligation to “demonstrate . . . that the reasons for the
new policy are
better
than the reasons for the old one; it suffices
that the new policy is permissible under the statute, that there are
good reasons for it, and that the agency
believes
it to be better,
which the conscious change of course adequately indicates.”
Fox Television
,
Contrary to SoCal Edison’s position, the Commission did
not apply “different standards to similarly situated entities and
fail[] to support this disparate treatment with a reasoned
explanation and substantial evidence in the record.”
Burlington
N. & Santa Fe Ry. Co. v. Surface Transp. Bd.
,
Likewise, SoCal Edison’s assertion that it and individually filing electric utilities generally are disadvantaged by the Commission’s use of the median instead of the midpoint does not withstand scrutiny. In Midwest ISO , the court stated:
If FERC’s orders premised a policy of using the midpoint on an effort to obtain the highest rate of return, the orders could nоt withstand APA review. This is because there would be no logical connection between the rationale and the result: nothing about the midpoint ensures it will be higher than the median or the mean in any particular case. Of course, FERC could have explained that it would always choose the measure that yields the highest result, and tried to defend that rationale here. But the Commission cannot justify a commitment to the midpoint on the ground that it produced the highest return, because that is pure happenstance.
SoCal Edison’s more technical arguments fare no better. Its suggestion that because the Commission screens the proxy group for atypically high or low ROEs, the Commission is not justified in using the median to lessen the impact of extreme data points is flawed. Although the use of screening parameters lessens the effect of high or low data points, the Commission’s basic point is that use of the median, as a mathematical principle, reduces the influence of extremes, see Northwest Pipeline , 99 FERC at ¶ 62,276 (citing Robert D. Mason, S TATISTICAL T ECHNIQUES IN B USINESS AND E CONOMICS 86–87 (3d ed. 1974); A.J. Jaffe & Herbert F. Spirer, M ISUSED S TATISTICS S TRAIGHT T ALK FOR T WISTED N UMBERS 90 (1987)). SoCal Edison is also incorrect when it suggests that in Canadian Association the court “rejected” the view that the median is preferable because it shows consideration of more companies in the proxy group, see Pet’r’s Br. 34. The court concluded only that the midpoint does not “completely disregard” the central data points, 254 F.3d at 298, which does not undermine the Commission’s embrace of the median here. Indeed, the court stated that the median’s consideration of more data points might be “acceptable as an explanation for choosing the median over the midpoint.” Id .
III.
SoCal Edison also contends that, in updating its ROE, the Commission erred by taking official notice of the change in U.S. Treasury bond yields as a proxy for its private cost of capital during the loсked-in period without affording it an opportunity to show to the contrary. SoCal Edison does not contest the fact of the change in the Treasury bond yields or the Commission’s updating policy in general. Instead, because rehearing was its first opportunity to respond to the officially noticed data, SoCal Edison maintains that the Commission erred, to SoCal Edison’s prejudice, in refusing to consider proffered expert analysis of the unique conditions of the 2008 market collapse.
Section 556(e) of the Administrative Procedure Act
(“APA”) provides, “[w]hen an agency decision rests on official
notice of a material faсt not appearing in the evidence in the
record, a party is entitled, on timely request, to an opportunity
to show the contrary.” 5 U.S.C. § 556(e). In
Union Electric Co.
v. FERC
,
The Commission took official notice, after the record had closed, of the average ten-year U.S. Treasury bond yields during the locked-in period (March 1, 2008 to December 31, 2008). See Paper Hearing Order , 131 FERC at ¶¶ 61,147–48. In response, SoCal Edison proffered on rehearing an affidavit of its expert stating that those yields were not a rational proxy for its private cost of capital due to the unusual economic conditions in late 2008. In a nutshell, this was so because the spread between thе U.S. Treasury bond yields and the rates on corporate bonds increased, as investors fled from riskier corporate investments to less risky Treasury bonds, reaching proportions not seen since April 1933. See Aff. of Dr. Paul T. Hunt at 6–8 (May 17, 2010). This analysis could not have been submitted during previous proceedings because the critical economic changes occurred months after SoCal Edison’s final Paper Hearing brief was filed in May 2008.
The Commission nonetheless declined to consider the
affidavit, noting its general rule that once the record is closed it
will not be reopened and that it generally does not allow new
evidence to bе introduced at the rehearing stage.
Rehearing
Order
, 137 FERC at ¶¶ 61,066–67. The Commission explained
that its “precedent requiring updating ROEs has been applied
over the course of more than 25 years, during which time the
U.S. economy has experienced many fluctuations,”
Rehearing
Order
, 137 FERC at ¶ 61,070, and that “[r]egardless of whether
the ten-year bonds perfectly capture every short-term variation
in the costs of equity, we continue to find . . . [that] over time
the ten-year bond index continues to be a reliable barometer of
overall market conditions.”
Id
. at ¶ 61,071 (citation and
quotation marks omitted). The Commission also observes that
Union Electric
did “‘not draw in question the Commission’s
past practiсe of making post-hearing adjustments within a range
of reasonableness previously determined on the record,’”
Resp’t’s Br. 40 (quoting
Union Electric
,
Application of the updating policy without regard to SoCal
Edison’s expert affidavit illustrates how material such an
officially noticed fact can be. On the basis of the decline of the
Treasury bond rates during the locked-in period, the
Commission reduced SoCal Edison’s base ROE by 101 basis
points (1.01%), from 10.55% to 9.54%.
See Paper Hearing
Order
, 131 FERC at ¶ 61,148. This makes it somewhat odd that
the Commission would turn a blind eye to the information
SoCal Edison proffered on rehearing. The Commission does
not suggest that it has applied the updating policy in such
extreme economic circumstances as occurred in late 2008.
SoCal Edison thus made the necessary “good showing” that it
could contest the significance of the Commission’s officially
noticed information based on “a[] flaw in the evidence.”
BNSF
Ry. Co. v. Surface Transp. Bd.
,
Accordingly, we grant the petition in part and deny the petition in part, and remand the case to the Commission for further proceedings.
Notes
[1] The
Rehearing Order
also addressed SoCal Edison’s
challenges to two other Commission orders requiring it to use the
median in setting its ROE,
S. Cal. Edison Co.
, Order Accepting and
Suspending Proposed Rates and Establishing Hearing and Settlement
Judge Proceedings,