*1 United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued March 22, 2016 Decided July 1, 2016
No. 11-1479 U NITED A IRLINES , I NC ., ET AL ., P ETITIONERS v.
F EDERAL E NERGY R EGULATORY C OMMISSION AND U NITED
S TATES OF A MERICA , R ESPONDENTS BP W EST C OAST P RODUCTS LLC, ET AL .,
I NTERVENORS Consolidated with 12-1069, 12-1070, 12-1073, 12-1086, 15-1101, 15-1105, 15-1107
On Petitions for Review of Orders of the Federal Energy Regulatory Commission
Thomas J. Eastment argued the cause for Shipper Petitioners. With him on the briefs were Gregory S. Wagner , Richard E. Powers , Jr. , Melvin Goldstein , and Steven A. Adducci . Frederick G. Jauss and Marcus W. Sisk Jr. entered appearances.
Charles F. Caldwell argued the cause for Petitioner SFPP L.P. With him on the briefs were Dean Lefler and Daniel W. Sanborn . Deborah R. Repman entered an appearance.
Ross R. Fulton and Lisa B. Luftig , Attorneys, Federal Energy Regulatory Commission, argued the causes for respondents. On the brief were William J. Baer , Assistant Attorney General, U.S. Department of Justice, James J. Fredricks and Robert J. Wiggers , Attorneys, Robert H. Solomon , Solicitor, Federal Energy Regulatory Commission, Beth G. Pacella , Deputy Solicitor, and Elizabeth E. Rylander , Attorney.
Steven A. Adducci , Thomas J. Eastment , Gregory S. Wagner , Richard E. Powers Jr. , and Melvin Goldstein were on the brief for Shipper Intervenors in support of Federal Energy Regulatory Commission.
Charles F. Caldwell , Dean H. Lefler , and Daniel W. Sanborn were on the brief for intervenor SFPP, L.P. in support of respondents. Elizabeth B. Kohlhausen entered an appearance.
Before: G RIFFITH and K AVANAUGH , Circuit Judges , and S ENTELLE , Senior Circuit Judge .
Opinion for the Court filed by Senior Circuit Judge S ENTELLE .
S ENTELLE ,
Senior Circuit Judge
: Petitioners SFPP, L.P.
(“SFPP”) and several shippers—“
i.e.
, firms that pay to
transport petroleum products over SFPP’s pipelines,”
ExxonMobil Oil Corp. v. FERC
,
I. BACKGROUND
SFPP is a Delaware limited-partnership, common-carrier oil pipeline. The pipeline transports refined petroleum products from California, Oregon, and Texas to various locations throughout the southwestern and western United States. On June 30, 2008, SFPP filed tariffs to increase rates on its West Line, which transports petroleum products throughout California and Arizona. These new tariffs had an effective date of August 1, 2008. Also on June 30, 2008, SFPP made a separate tariff filing to decrease the rates on its East Line, which runs from West Texas to Arizona. The purported impetus for these filings was increased throughput on SFPP’s East Line due to a recently completed expansion, which accordingly decreased throughput on the West Line. Several shippers protested the West Line tariff filing by raising challenges to SFPP’s cost of service.
On December 2, 2009, an administrative law judge issued
an Initial Decision addressing the shippers’ arguments.
FERC reviewed the Initial Decision in Opinion 511, 134
SFPP makes two arguments in its petition. First, it claims that FERC arbitrarily or capriciously failed to utilize the most recently-available data when assessing its so-called real return on equity. Second, SFPP asserts that FERC erred when it declined to apply the full value of the Commission’s published index when setting SFPP’s rates for the 2009 index year. We grant SFPP’s petition with respect to the first issue but deny the petition with respect to the second.
The Shippers raise a separate challenge to FERC’s current policy of granting to partnership pipelines an income tax allowance, which accounts for taxes paid by partner-investors that are attributable to the pipeline entity. Specifically, the Shippers claim that because FERC’s ratemaking methodology already ensures a sufficient after-tax rate of return to attract investment capital, and partnership pipelines otherwise do not incur entity-level taxes, FERC’s tax allowance policy permits partners in a partnership pipeline to “double recover” their taxes. We agree that FERC has not adequately justified its tax allowance policy for partnership pipelines and grant the Shippers’ petition.
II. ANALYSIS
Under the standard dictated by the Administrative
Procedure Act, we will vacate FERC ratemaking decisions
that are arbitrary or capricious.
See
5 U.S.C. § 706(2)(A).
Conversely, “FERC’s decisions will be upheld as long as the
Commission has examined the relevant data and articulated a
rational connection between the facts found and the choice
made.”
ExxonMobil
,
The statutory regime governing FERC’s ratemaking for oil pipelines is unique. In 1906, as an amendment to the Interstate Commerce Act (the “ICA”), Congress delegated regulatory authority over oil pipelines to the Interstate Commerce Commission. Pub. L. No. 59-337, § 1, 34 Stat. 584, 584. But in 1977, Congress transferred regulatory authority over oil pipelines to FERC. Department of Energy Organization Act, Pub. L. No. 95-91, § 402(b), 91 Stat. 565, 584 (1977); see also 49 U.S.C. § 60502. Congress then repealed the ICA in 1978 except as related to FERC’s regulation of oil pipelines. Pub. L. No. 95-473, § 4(c), 92 Stat. 1337, 1470. For such regulation, the ICA continues to apply “as [it] existed on October 1, 1977 . . . .” The relevant provisions of the ICA were last reprinted in the appendix to title 49 of the 1988 edition of the United States Code, to which we refer as necessary. Cf. BP West Coast Prods., LLC v. FERC , 374 F.3d 1263, 1271 n.1 (D.C. Cir. 2004).
Substantively, the ICA requires that all rates be “just and reasonable.” 49 U.S.C. app. § 1(5)(a) (1988). Just and reasonable rates are “rates yielding sufficient revenue to cover all proper costs, including federal income taxes, plus a specified return on invested capital.” ExxonMobil , 487 F.3d at 951 (citation omitted).
A. FERC’ S C HOICE OF D ATA FOR A SSESSING SFPP’ S R EAL R ETURN ON E QUITY W AS A RBITRARY OR C APRICIOUS
SFPP challenges as arbitrary or capricious FERC’s reliance on cost-of-equity data from September 2008 when calculating SFPP’s so-called “real” return on equity and the Commission’s rejection of more recent data from April 2009. FERC argues in response that the more recent cost-of-equity data “encompassed the stock market collapse beginning in late 2008,” and was therefore anomalous. FERC’s Br. 31-32. We agree that FERC had substantial evidence to support its determination that the 2009 data did not reflect SFPP’s long- term cost of equity. However, because the Commission provided no reasoned basis to justify its decision to rely on the September 2008 data, we hold that it engaged in arbitrary or capricious decision-making and therefore grant SFPP’s petition on this issue.
The Supreme Court stated in
Federal Power Commission
v. Hope Natural Gas Co.
, that “the return to the equity owner
[of a pipeline] should be commensurate with returns on
investments in other enterprises having corresponding risks.”
320 U.S. 591, 603 (1944). Further, “[t]hat return . . . should
be sufficient to assure confidence in the financial integrity of
the enterprise, so as to maintain its credit and to attract
capital.”
Id.
In accordance with these principles, FERC uses
a so-called “discounted cash flow” model to determine a
pipeline’s rate of return on equity.
See Composition of Proxy
Groups for Determining Gas and Oil Pipeline Return on
Equity
, 123 FERC ¶ 61,048, at 61,271-73 ¶¶ 3-9 (2008)
(discussing the mechanics of the discounted cash flow
model). “The premise of the [discounted cash flow] model is
that the price of a stock is equal to the stream of expected
dividends, discounted to their present value.”
Williston Basin
Interstate Pipeline Co. v. FERC
, 165 F.3d 54, 57 (D.C. Cir.
1999). Under the discounted cash flow model, FERC
“examin[es] the percentage returns on equity the market
requires for members of a proxy group.” Opinion 511, 134
Under its so-called “trended original cost” methodology,
FERC splits the nominal return on equity into an inflation
component and the so-called “real” return on equity, defined
as the difference between the nominal return on equity and
inflation.
See Williams Pipe Line Co.
,
When assessing the pipeline’s cost structure, FERC “uses
a ‘test year’ methodology to determine a pipeline’s annual
cost of service.”
BP West Coast
, 374 F.3d at 1298. This
method starts with a “base period” that “consist[s] of 12
consecutive months of actual experience” with some specified
adjustments. 18 C.F.R. § 346.2(a)(1)(i). FERC then defines a
“test period” that generally “must consist of a base period
adjusted for changes in revenues and costs which are known
and are measurable with reasonable accuracy at the time of
[rate] filing and which will become effective within nine
months after the last month of available actual experience
utilized in the filing.” § 346.2(a)(1)(ii). In this case,
FERC used a base period from January 1, 2007, through
December 31, 2007, meaning
that
the “nine-month
adjustment period for test period changes [wa]s from January
1, 2008, through September 30, 2008.” Opinion 511, 134
However, for the discounted cash flow analysis, “the
Commission prefers the most recent financial data in the
record,”
id.
¶ 208, “because the market is always changing
and later figures more accurately reflect current investor
needs,”
Trunkline Gas Co.
, 90 FERC ¶ 61,017, at 61,117
(2000). In other words, FERC may use post-test period data
for purposes of
the discounted cash flow analysis,
“recognizing that updates are not permitted once the record
has been closed and the hearing has concluded.” Opinion
511,
SFPP initially submitted return-on-equity data for the six- month period ending with the test period, i.e., through September 2008. See Exhibit SFP-1, Prepared Direct Testimony of J. Peter Williamson on Behalf of SFPP, L.P., No. IS08-390-002, at 3-22 (FERC June 2, 2009). However, the pipeline later provided two updates, one for the six-month period ending January 2009, see Exhibit SFP-76, No. IS08- 390-002, at 1 (FERC June 2, 2009), and one for the six-month period ending April 2009, see Exhibit SFP-323, No. IS08- 390-002, at 1 (FERC June 2, 2009). From the September 2008 data, the nominal return on equity was 12.63 percent, with 7.69 percent representing the real return on equity and 4.94 percent as inflation. [2] Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 255. From the January 2009 data, the nominal return on equity was 14.33 percent, distributed between 14.30 percent real return on equity and 0.03 percent inflation. Exhibit SFP-76, at 1. The April 2009 data showed a nominal return on equity of 14.09 percent with a 14.83 percent real return on equity and -0.74 percent inflation. Exhibit SFP-323, at 1. FERC also “incorporated into the . . . record” SFPP cost-of-equity data for the six-month periods ending in February 2010 and March 2010. Opinion 511, 134 FERC ¶ 61,121, at ¶ 209 & n.339. The nominal return on equity from the February 2010 data was 11.24 percent, 2.14 percent of which was inflation with a 9.09 percent real return on equity. SFPP’s Br. App. A. From the March 2010 data, the nominal return on equity was 11.03 percent, inflation was 2.31 percent, and the real return on equity was 8.72 percent. Id.
SFPP argues that FERC acted arbitrarily or capriciously
when it relied on the September 2008 data, instead of the
April 2009 data, in setting SFPP’s real return on equity. In
particular, SFPP contends that FERC ignored its own “policy
of using the most recent equity rate of return data in the
record” and provided no explanation for its choice of the
September 2008 data. SFPP’s Br. 22-23. In FERC’s view,
the April 2009 data is not “representative of SFPP’s cost of
capital during the future periods the rates proposed in this
case may be in effect.” Opinion 511,
We hold that it was reasonable for FERC to conclude that the April 2009 data was not representative of SFPP’s long- term cost of capital. SFPP’s argument that FERC has a bright-line policy of relying on the most recently available data to determine the real return on equity is incorrect. As FERC stated in Trunkline Gas Co. , the Commission “seeks to find the most representative figures on which to base rates.” 90 FERC ¶ 61,017, at 61,049 (emphasis added). Therefore, FERC “may adopt test period estimates, or it may adopt other, more representative figures of historical costs . . . if it determines that these other figures are the best, most representative evidence of the pipeline’s experience for the test period.” The real return on equity from the April 2009 data, 14.83 percent, is the highest among each of the periods FERC considered, and only this data includes negative inflation. Had FERC decided to use the April 2009 data, SFPP would have been able to recoup essentially its entire nominal return on equity in its current rates, see Williams Pipe Line Co. , 31 FERC ¶ 61,377, at 61,833-34, despite the fact that the February 2010 and March 2010 data indicated that negative inflation was a short-term phenomenon. Substantial evidence therefore supported FERC’s finding that the April 2009 data was not the most representative data for assessing SFPP’s real return on equity, meaning that FERC did not engage in arbitrary-or-capricious decision-making by rejecting that data. See Opinion 511, 134 FERC ¶ 61,121, at ¶¶ 208-09; Opinion 511-A, 137 FERC ¶ 61,220, at ¶¶ 256-59.
However, this conclusion does not end the inquiry. In lieu of the more recently available April 2009 data, FERC relied instead on the September 2008 data to fix SFPP’s real return on equity. See Opinion 511, 134 FERC ¶ 61,121, at ¶ 209. Because we agree with SFPP that FERC provided no reasoned explanation for its choice of the September 2008 data, we grant SFPP’s petition for review and vacate FERC’s orders with respect to this issue.
While there may be evidence to support the conclusion
that the
nominal
return on equity for September 2008 was in
line with historical trends, this evidence does not show that
the
real
return on equity for that time period was
representative of SFPP’s costs.
See
Request for Rehearing of
SFPP, L.P., No. IS08-390-002, at 11-12 (FERC Apr. 11,
2011) (SFPP conceding that the September 2008 nominal
return on equity is “consistent with historical periods”);
see
also
Opinion 511, 134 FERC ¶ 61,121, at ¶ 209; Opinion
511-A, 137 FERC ¶ 61,220, at ¶¶ 252-59. To the contrary,
FERC provides only a cursory comparison of real returns on
equity from the September 2008 through the March 2010 time
periods, and otherwise appears to have chosen the smallest
real return on equity from the data available.
See
Opinion
511,
Because we agree that FERC engaged in arbitrary-or- capricious decision-making by adopting the September 2008 real return on equity without reasoned explanation, we need not reach SFPP’s alternative argument that FERC improperly rejected SFPP’s proposal to adopt an average real return on equity. We grant SFPP’s petition on this issue.
B. FERC’ S I NDEXING A NALYSIS W AS N OT A RBITRARY OR C APRICIOUS
SFPP also argues that FERC engaged in arbitrary-or- capricious decision-making when it declined to apply the full amount of the 2009 rate index adjustment in calculating SFPP’s rates and refunds for the period from July 1, 2009, through June 30, 2010. FERC responds that it complied with the plain text of its regulations when it found that granting SFPP a full indexed rate adjustment would result in unjust and unreasonable rates. We agree with FERC and deny SFPP’s petition on this issue.
As part of the Energy Policy Act of 1992, Congress required FERC to “issue a final rule which establishes a simplified and generally applicable ratemaking methodology for oil pipelines in accordance with section 1(5) of part I of the [ICA].” Pub. L. No. 102-486, § 1801(a), 106 Stat. 2776, 3010. Congress also mandated that “the Commission . . . issue a final rule to streamline procedures of the Commission relating to oil pipeline rates in order to avoid unnecessary regulatory costs and delays.” Id. § 1802(a). In response, FERC released a notice of proposed rulemaking on July 2, 1993, which set forth an indexing scheme for setting oil pipeline rates. See Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992; Proposed Rulemaking , 58 Fed. Reg. 37,671, at 37,672 (1993). FERC then issued on November 4, 1993, its final rule implementing the indexing scheme. Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992 , 58 Fed. Reg. 58,753, at 58,754 (1993).
Under the final rule, FERC required that oil pipelines
utilize the indexing system for rate changes unless specified
circumstances permit use of an alternative methodology.
Id.
at 58,757. “First, a cost-of-service showing may be utilized
to change a rate whenever a pipeline can show that it has
experienced uncontrollable circumstances that preclude
recoupment of its costs through the indexing system.” ;
see
also
18 C.F.R. § 342.4(a). “Second, whenever a pipeline can
secure the agreement of all existing customers, it may file a
rate change based on such a settlement.” 58 Fed. Reg. at
58,757;
see also
18 C.F.R. § 342.4(c). Finally, FERC permits
market-based ratemaking if the pipeline can show that it
“lacks significant market power in the markets in question
. . . .”
At a general level, FERC’s indexing methodology directs
pipelines to file initial rates, usually reflecting their costs-of-
service. 58 Fed. Reg. at 58,758. Based on the initial rate
filings, FERC then calculates rate ceilings for future years
based on the change in the Producer Price Index for Finished
Goods.
Id.
at 58,760;
see also
18 C.F.R. § 342.3(d)(2).
Importantly, “the index establishes a
ceiling
on rates—it does
not establish the rate itself.”
In this case, SFPP filed cost-of-service rates, effective August 1, 2008, proposing to increase the rates charged on its West Line “based upon the cost of providing the service covered by the rate . . . .” 18 C.F.R. § 342.4(a). Because this rate took effect during the 2008 index year—i.e., between July 1, 2008, and June 30, 2009—it also “constitute[d] the applicable ceiling level for that index year.” Id. § 342.3(d)(5); see also id. § 342.3(c) (defining the index year as “the period from July 1 to June 30”). Therefore, to compute the ceiling level for the 2009 index year—i.e., between July 1, 2009, and June 30, 2010—SFPP “multipl[ied] the previous index year’s [2008’s] ceiling level by the most recent index published by [FERC].” § 342.3(d)(1). The index for 2009 was 7.6025 percent.
15
Revisions to Oil Pipeline Regulations Pursuant to the Energy Policy Act of 1992 , 127 FERC ¶ 61,184 (2009). SFPP therefore contends that it has the right to apply this full index when calculating its 2009 rates. FERC argues that, because SFPP’s cost-of-service rates for 2008 already partially “accounted for the changes in costs associated with the index increase,” Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 407, SFPP can only apply that portion of the 2009 index “not reflected in the cost of service adopted by Opinion No. 511 or the rates SFPP must establish [in Opinion No. 511-A],” id. ¶ 405. In particular, FERC permitted SFPP to use an index of 1.9006 percent, “correspond[ing] to the three months of 2008 cost changes that are outside” the period of costs already covered by SFPP’s proposed rates. In other words, FERC limited SFPP’s 2009 index to twenty-five percent of the published value for that index year.
Were this information all that the Court had to consider,
SFPP’s argument that FERC “ignore[d] its regulations, which
have the force of law,” SFPP’s Br. 35, might be plausible in
light of the plain text of FERC’s indexing regulations,
see
C.F.R. § 342.3. But the analysis is only half-complete.
“[M]erely because the Commission regulations permit SFPP
to request the index increase does not mean that the
Commission is bound to accept the indexed rate increase.”
Opinion 511-A,
SFPP’s principal retort to this otherwise straightforward application of FERC’s regulations is that the alleged purpose of FERC’s indexing procedures is to permit a pipeline to capture future inflation-based cost adjustments, not prior-year cost-of-service changes. FERC responds, somewhat cryptically, that indexing “allows rates to track inflation in the general economy, essentially preserving pipelines’ existing rates in real economic terms.” FERC’s Br. 43.
SFPP’s argument is irrelevant to this case. Admittedly,
whether FERC’s indexing mechanism is retrospective or
prospective is unclear. For example, FERC has previously
described the purpose of indexing as “preserv[ing] the value
of just and reasonable rates in real economic terms . . . [by]
tak[ing] into account inflation, thus allowing the nominal
level of rates to rise in order to preserve their real value in
real terms.”
Revisions to Oil Pipeline Regulations Pursuant
to the Energy Policy Act of 1992
,
SFPP’s reliance on prior FERC proceedings involving
indexing,
see, e.g.
, Opinion 435,
We therefore deny SFPP’s petition on this issue. C. FERC M UST D EMONSTRATE THAT T HERE I S N O D OUBLE R ECOVERY OF T AXES FOR P ARTNERSHIP P IPELINES
The Shippers argue that FERC engaged in arbitrary-or- capricious decision-making when it granted an income tax allowance to SFPP. Specifically, the Shippers note that, as a partnership pipeline, SFPP is not taxed at the pipeline level. Because FERC’s discounted cash flow return on equity already ensures a sufficient after-tax return to attract investment to the pipeline, they argue, the tax allowance results in “double recovery” of taxes to SFPP’s partners. In FERC’s view, we already decided this issue in ExxonMobil , where we held that FERC’s policy of permitting partnership pipelines to receive a tax allowance was “not unreasonable” in light of “FERC’s expert judgment about the best way to equalize after-tax returns for partnerships and corporations.” 487 F.3d at 953. FERC therefore posits that the Shippers’ petition in this case is an impermissible collateral attack on our decision in ExxonMobil . Further, FERC denies that granting a tax allowance to SFPP results in a double-recovery of taxes and avers that any disparity in after-tax returns to partners or shareholders arises from the Internal Revenue Code, not from FERC’s tax allowance policy. Because we reserved the issue of whether the combination of the discounted cash flow return on equity and the tax allowance results in double recovery of taxes for partnership pipelines, we disagree with FERC’s collateral attack argument. Nonetheless, we acknowledge that our opinion in ExxonMobil stated that it may be reasonable for FERC to grant a tax allowance to partnership pipelines. However, because FERC failed to demonstrate that there is no double-recovery of taxes for partnership, as opposed to corporate, pipelines, we hold that FERC acted arbitrarily or capriciously. We therefore grant the Shippers’ petition.
As all parties acknowledge, this case is not the first time that we have considered FERC’s tax allowance policy for oil pipelines. Until our decision in BP West Coast , 374 F.3d at 1293, FERC relied on the so-called Lakehead policy when granting tax allowances. Named for the FERC decision in which the Commission formalized the policy, see Lakehead Pipe Line Co. , 71 FERC ¶ 61,338, at 62,314-15 (1995), the Lakehead policy addressed the situation in which a partnership pipeline has both corporate-partners and individual-partners. FERC therein concluded:
When partnership interests are held by corporations, the partnership is entitled to a tax allowance in its cost- of-service for those corporate interests because the tax cost will be passed on to the corporate owners who must pay corporate income taxes on their allocated share of income directly on their tax returns. . . . However, the Commission concludes that Lakehead should not receive an income tax allowance with respect to income attributable to the limited partnership interests held by individuals. This is because those individuals do not pay a corporate income tax.
Id.
We reviewed the Lakehead policy in BP West Coast and held that “[w]e cannot conclude that FERC’s inclusion of the income tax allowance in SFPP’s rates is the product of reasoned decisionmaking.” 374 F.3d at 1288. In that case, we started from the principle “that the regulating commission is to set rates in such a fashion that the regulated entity yields returns for its investors commensurate with returns expected from an enterprise of like risks.” Id. at 1290. Consistent with this principle, we rejected FERC’s justifications for its Lakehead policy and held that “where there is no tax generated by the regulated entity, either standing alone or as part of a consolidated corporate group, the regulator cannot create a phantom tax in order to create an allowance to pass through to the rate payer.” at 1291.
Concededly, our use of the term “phantom tax” in BP West Coast lacked precision. This was made apparent in ExxonMobil , as several shipper-petitioners challenged FERC’s revised tax allowance policy, which granted a full income tax allowance to both partnership pipelines and corporate pipelines, regardless of the identities of the partners or shareholders. 487 F.3d at 950. We rejected the petitioners’ arguments in that case, stating that because “investors in a limited partnership are required to pay tax on their distributive shares of the partnership income, even if they do not receive a cash distribution[,] . . . the income received from a limited partnership should be allocated to the pipeline and included in the regulated entity’s cost-of- service.” at 954. FERC did not create a “phantom tax” because it did not arbitrarily distinguish between corporate and individual partners in a partnership pipeline, and the Commission adequately explained why partner taxes could be considered a pipeline cost.
In this case, the Shippers challenge the same tax allowance policy at issue in ExxonMobil . Given that nothing has changed with regard to this policy, FERC’s argument that the Shippers present an impermissible collateral attack to our ExxonMobil decision is, on first consideration, conceivable. However, as the Shippers mention in their reply brief, FERC averred during briefing in ExxonMobil that it was addressing the double recovery issue in a separate proceeding. See Br. of Resp’t at 30-31, ExxonMobil Oil Corp. v. FERC , 487 F.3d 945 (D.C. Cir. 2007) (Nos. 04-1102 et al. ). While we did not expressly reserve the issue in our ExxonMobil opinion, the fact that FERC took this position both in ExxonMobil and in an accompanying case, see Br. of Resp’t at 29-30, Canadian Ass’n of Petroleum Producers v. FERC , 487 F.3d 973 (D.C. Cir. 2007) (No. 05-1382), reflects our implicit reservation of the question. To clarify, we held in ExxonMobil that, to the extent FERC has a reasoned basis for granting a tax allowance to partnership pipelines, it may do so. 487 F.3d at 955. The Shippers now challenge whether such a reasoned basis exists based on grounds that FERC agreed were not at issue in the prior case. We therefore hold that the Shippers’ petition is not a collateral attack on that decision.
As to the merits, we hold that FERC has not provided
sufficient justification for its conclusion that there is no
double recovery of taxes for partnership pipelines receiving a
tax allowance in addition to the discounted cash flow return
on equity. Despite their attempts to inundate the record with
competing mathematical analyses of whether a double
recovery of taxes for partnership pipelines exists, the parties
do not disagree on the essential facts. First, unlike a
corporate pipeline, a partnership pipeline incurs no taxes,
except those imputed from its partners, at the entity level.
See
26 U.S.C. § 7704(d)(1)(E). Second, the discounted cash flow
return on equity determines the pre-tax investor return
required to attract investment, irrespective of whether the
regulated entity is a partnership or a corporate pipeline.
See
Opinion 511,
These facts support the conclusion that granting a tax
allowance to partnership pipelines results in inequitable
returns for partners in those pipelines as compared to
shareholders in corporate pipelines. Because the Supreme
Court has instructed that “the return to the equity owner
should be commensurate with returns on investments in other
enterprises having corresponding risks,” FERC has not shown
that the resulting rates under FERC’s current policy are “just
and reasonable.”
Hope Nat. Gas Co.
,
The crux of FERC’s “gross-up” theory is that “in the
context of Commission rate design[,]” Opinion 511-A, 137
True, FERC has a justifiable basis for its attribution of partner taxes to the partnership pipeline. In ExxonMobil , we acknowledged that “investors in a limited partnership are
24
required to pay tax on their distributive shares of the
partnership income, even if they do not receive a cash
distribution.”
The remaining issue is the appropriate remedy. The Shippers do not request that we overturn our decision in ExxonMobil , which we are unable to do in any case absent an en banc decision from the Court. See LaShawn A. v. Barry , 87 F.3d 1389, 1395 (D.C. Cir. 1996). But we also believe such action is unnecessary. When questioned at oral argument, FERC conceded that it might be able to remove any duplicative tax recovery for partnership pipelines directly from the discounted cash flow return on equity. See Oral Arg. Tr. 36:3-:10. We note also that, prior to ExxonMobil , FERC considered the possibility of eliminating all income tax allowances and setting rates based on pre-tax returns. See Policy Statement on Income Tax Allowances , 111 FERC ¶ 61,139, at 61,741 (2005). To the extent that FERC can provide a reasoned basis for such a policy, we do not read our decision in ExxonMobil as foreclosing that option. See F.3d at 955 (“Arguably, a fair return on equity might have been afforded if FERC had chosen the fourth alternative of computing return on pretax income and providing no tax allowance at all for the pipeline owners.”). We therefore grant the Shippers’ petition, vacate FERC’s orders with respect to this issue, and remand for FERC to consider these or other mechanisms for which the Commission can demonstrate that there is no double recovery.
III. CONCLUSION
For the reasons stated herein, the Court: (i) grants-in-part SFPP’s petition with respect to the choice of data for assessing SFPP’s real return on equity, vacates FERC’s orders accordingly, and remands for further proceedings consistent with this opinion; (ii) denies-in-part SFPP’s petition with respect to the indexing issue; and (iii) grants the Shippers’ petition, vacates FERC’s orders with respect to the double recovery issue, and remands to FERC for further proceedings consistent with this opinion.
So ordered.
Notes
[1] The Shippers are: United Airlines, Inc.; Delta Air Lines, Inc.; Southwest Airlines Co.; US Airways, Inc.; BP West Coast Products LLC; Chevron Products Co.; ExxonMobil Oil Corporation; Valero Marketing and Supply Company; and Tesoro Refining and Marketing Company LLC.
[2] There is some ambiguity in the record regarding the September 2008 return on equity data. SFPP’s initial filings show that the nominal return on equity for this period was 13.01 percent with 5.37 percent inflation and 7.64 percent real return on equity. See Exhibit SFP-1, at 21; Exhibit SFP-5, No. IS08-390-002, at 9 (FERC June 2, 2009); Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 252. As the exact numbers do not affect our holding and the parties otherwise agree that 7.69 percent was the real return on equity for the September 2008 period, we refer to that figure. See SFPP’s Br. 8; FERC’s Br. 33-34.