READINGS
1. MORGAN STANLEY CAPITAL GROUP INC., Petitioner v. PUBLIC UTILITY DISTRICT NO. 1 OF SNOHOMISH COUNTY, WASHINGTON, Respondent
128 S. Ct. 2733 (2008)
[The respondents were western utilities that purchased power under long-term contracts during 2000 and 2001. Although the respondents were are not located in California, the high prices in California energy market spilled over into other Western States. The energy contracts between the parties included rates that were very high by historical standards. After the energy crisis passed, the respondents asked the Federal Energy Regulatory Commission (FERC) to modify the contracts.
In two cases decided in 1956, the Supreme Court had addressed the authority of FERC’s predecessor agency to modify rates set bilaterally by contract. In United Gas Pipe Line Co. v. Mobile Gas Service Corp., 350 U.S. 332 (U.S. 1956), the Court rejected a natural-gas utility’s argument that, under the Natural Gas Act, it could abrogate a contract with a purchaser simply by filing a new tariff. In Federal Power Comm'n v. Sierra Pac. Power Co., 350 U.S. 348 (U.S. 1956), the Court applied Mobile to the analogous provisions of the FPA. In Sierra, however, the Commission had also found that the contract rate itself was too low to be just and reasonable -- yielding less than a fair return on the net invested capital of the utility. The Supreme Court concluded that while the Commission may not normally impose upon a public utility a rate that would produce less than a fair return, if the public utility itself contracts for such a rate, the utility is not entitled to be relieved of its improvident bargain. The Commissions focus is then on whether the rate is so low as to adversely affect the public interest (e.g., impairing the financial ability of the public utility to continue its service and thus place on other consumers an excessive burden).
These principles:
(1) that public utilities are presumed to be bound by contracts that they entered into voluntarily, but (2) if the rates produced by the contract adversely affect the public interest, not just one of the parties, the Commission can vacate the contract, are known as the “Mobile-Sierra doctrine,” and have been applied by the federal courts many times.
In its orders below, FERC found that the Mobile-Sierra presumption did apply to the contracts at issue. Although FERC agreed that the presumption applies only where FERC has had an initial opportunity to review a contract, FERC maintained that the granting of market-based authority to the petitioners was that initial opportunity for review. FERC furthermore found that the respondents had not overcome the Mobile-Sierra presumption, despite a FERC Staff Report that had found that distortions in the spot market flowed through to forward market for power. FERC concluded that under the public interest standard, to justify contract modification, the challengers must have shown that forward prices became unjust and unreasonable due to the impact of spot market dysfunctions. FERC held that a party must show that rates, terms, and conditions are contrary to the public interest. Using this standard, FERC determined that, under the factors identified in Sierra, inter alia, the respondents had not demonstrated that the contracts threatened the public interest.
The Ninth Circuit, in Public Utility District No. 1 v. FERC, 471 F.3d 1053 (9th Cir. Cal. 2006), granted the petitions for review and remanded to the proceeding back to FERC, citing two basic flaws with FERCs analysis: . First, the Ninth Circuit agreed with respondents that rates set by contract are presumptively reasonable only where FERC has had an initial opportunity to review the terms of contracts after their formation and modify those that do not appear to be just and reasonable; this initial review must include an inquiry into the market conditions under which the contracts formed. Additionally, market dysfunction is a ground for finding a contract not to be just and reasonable. Second, the Ninth Circuit found the even assuming that the Mobile-Sierra presumption applied, the standard for overcoming that presumption is different for a purchasers challenge to a contract, as compared to a sellers challenge. According to the Ninth Circuit, the standard in the case of a purchasers challenge is whether the contract rate exceeds a zone of reasonableness.]
Justice Scalia delivered the opinion of the court:
In recent decades, the Commission has undertaken an ambitious program of market-based reforms. Part of the impetus for those changes was technological evolution. Historically, electric utilities had been vertically integrated monopolies. For a particular geographic area, a single utility would control the generation of electricity, its transmission, and its distribution to consumers. Since the 1970's, however, engineering innovations have lowered the cost of generating electricity and transmitting it over long distances, enabling new entrants to challenge the regional generating monopolies of traditional utilities.
To take advantage of these changes, the Commission has attempted to break down regulatory and economic barriers that hinder a free market in wholesale electricity. It has sought to promote competition in those areas of the industry amenable to competition, such as the segment that generates electric power, while ensuring that the segment of the industry characterized by natural monopoly--namely, the transmission grid that conveys the generated electricity--cannot exert monopolistic influence over other areas.
Against this backdrop of technological change and market-based reforms, the Commission over the past two decades has begun to permit sellers of wholesale electricity to file "market-based" tariffs. These tariffs, instead of setting forth rate schedules or rate-fixing contracts, simply state that the seller will enter into freely negotiated contracts with purchasers. FERC will grant approval of a market-based tariff only if a utility demonstrates that it lacks or has adequately mitigated market power, lacks the capacity to erect other barriers to entry, and has avoided giving preferences to its affiliates. In addition to the initial authorization of a market-based tariff, FERC imposes ongoing reporting requirements. A seller must file quarterly reports summarizing the contracts that it has entered into, even extremely short-term contracts. It must also demonstrate every four months that it still lacks or has adequately mitigated market power.
In 1996, California enacted Assembly Bill 1890 (AB 1890), which massively restructured the California electricity market…. It required [California electric utilities] to purchase and sell the bulk of their electricity from and to the CalPX [California Power Exchange’s] spot market, permitting only limited leeway for them to enter into long-term contracts. That diminishment of the role of long-term contracts in the California electricity market turned out to be one of the seeds of an energy crisis. In the summer of 2000, the price of electricity in the CalPX's spot market jumped dramatically--more than fifteenfold.
The principal respondents in these cases are western utilities that purchased power under long-term contracts during that tumultuous period in 2000 and 2001. Although they are not located in California, the high prices in California spilled over into other Western States. Petitioners are the sellers that entered into the contracts with respondents.
The contracts between the parties included rates that were very high by historical standards. For example, respondent Snohomish signed a 9-year contract to purchase electricity from petitioner Morgan Stanley at a rate of $105/megawatt hour (MWh), whereas prices in the Pacific Northwest have historically averaged $24/MWh. The contract prices were substantially lower, however, than the prices that Snohomish would have paid in the spot market during the energy crisis, when prices peaked at $3,300/MWh.
After the crisis had passed, buyer's remorse set in and respondents asked FERC to modify the contracts. They contended that the rates in the contracts should not be presumed to be just and reasonable under Mobile-Sierra because, given the sellers' market-based tariffs, the contracts had never been initially approved by the Commission without the presumption. Respondents also argued that contract modification was warranted even under the Mobile-Sierra presumption because the contract rates were so high that they violated the public interest.
There is only one statutory standard for assessing wholesale electricity rates, whether set by contract or tariff--the just-and-reasonable standard. The plain text of the FPA states that "[a]ll rates . . . shall be just and reasonable." … Sierra was grounded in the commonsense notion that "[i]n wholesale markets, the party charging the rate and the party charged [are] often sophisticated businesses enjoying presumptively equal bargaining power, who could be expected to negotiate a 'just and reasonable' rate as between the two of them." Therefore, only when the mutually agreed-upon contract rate seriously harms the consuming public may the Commission declare it not to be just and reasonable.
By enabling sophisticated parties who weathered market turmoil by entering long-term contracts to renounce those contracts once the storm has passed, the Ninth Circuit's holding would reduce the incentive to conclude such contracts in the future. Such a rule has no support in our case law and plainly undermines the role of contracts in the FPA's statutory scheme.
To be sure, FERC has ample authority to set aside a contract where there is unfair dealing at the contract formation stage--for instance, if it finds traditional grounds for the abrogation of the contract such as fraud or duress. In addition, if the "dysfunctional" market conditions under which the contract was formed were caused by illegal action of one of the parties, FERC should not apply the Mobile-Sierra presumption. But the mere fact that the market is imperfect, or even chaotic, is no reason to undermine the stabilizing force of contracts that the FPA embraced as an alternative to "purely tariff-based regulation. We may add that evaluating market "dysfunction" is a very difficult and highly speculative task--not one that the FPA would likely require the agency to engage in before holding sophisticated parties to their bargains.
[The Ninth Circuit held that FERC must determine] whether consumers' electricity bills "are higher than they would otherwise have been had the challenged contracts called for rates within the just and reasonable range," i.e., rates that equal "marginal cost." That is a misreading of Sierra and our later cases. A presumption of validity that disappears when the rate is above marginal cost is no presumption of validity at all, but a reinstitution of cost-based rather than contract-based regulation. We have said that, under the Mobile-Sierra presumption, setting aside a contract rate requires a finding of "unequivocal public necessity," or "extraordinary circumstances.” In no way can these descriptions be thought to refer to the mere exceeding of marginal cost.
Despite our significant disagreement with the Ninth Circuit, we find two errors in the Commission's analysis, and we therefore affirm the judgment below on alternative grounds.
First, it appears that the Commission may have looked simply to whether consumers' rates increased immediately upon the relevant contracts' going into effect, rather than determining whether the contracts imposed an excessive burden on consumers "down the line," relative to the rates they could have obtained (but for the contracts) after elimination of the dysfunctional market. For example, the Commission concluded that two of the respondents would experience "rate decreases of approximately 20 percent for retail service" during the period covered by the contracts. But the baseline for that computation was the rate they were paying before the contracts went into effect. That disparity is certainly a relevant consideration; but so is the disparity between the contract rate and the rates consumers would have paid (but for the contracts) further down the line, when the open market was no longer dysfunctional. That disparity, past a certain point, could amount to an "excessive burden."
The "unequivocal public necessity" that justifies overriding the Mobile-Sierra presumption does not disappear as a factor once the contract enters into force. It is entirely possible that rates had increased so high during the energy crises because of dysfunction in the spot market that, even with the acknowledged decrease in rates, consumers still paid more under the forward contracts than they otherwise would have. If that is so, and if that increase is so great that, even taking into account the desirability of fostering market-stabilizing long-term contracts, the rates impose an excessive burden on consumers or otherwise seriously harm the public interest, the rates must be disallowed.
Second, respondents alleged before FERC that the contracts were the product of market manipulation by Enron, Morgan Stanley, and other Respondents, which was established by a Commission Staff report. The Staff Report concluded that the abnormally high prices in the spot market during the energy crisis influenced the terms of contracts in the forward market. But the Commission dismissed the relevance of the Staff Report on the ground that it had not demonstrated that forward market prices were so high as to overcome the Mobile-Sierra presumption. We conclude, however, that if it is clear that one party to a contract engaged in such extensive unlawful market manipulation as to alter the playing field for contract negotiations, the Commission should not presume that the contract is just and reasonable. Like fraud and duress, unlawful market activity that directly affects contract negotiations eliminates the premise on which the Mobile-Sierra presumption rests: that the contract rates are the product of fair, arms-length negotiations.
On remand, the Commission should amplify or clarify its findings on these two points. The judgment of the Court of Appeals is affirmed, and the cases are remanded for proceedings consistent with this opinion.
It is so ordered.
Will natural gas stay this cheap?
By MARK WILLIAMS
AP Energy Writer -- Meltdown 101
September 1, 2009
Natural gas prices are at seven-year lows and it looks like heating bills may be cheap for a while. How did prices get so low, and how long are they likely to stay there? Are there ways we could be using natural gas — beyond staying warm and cooking food — to take advantage of this cheap source of energy?
Here are some questions and answers about what is happening with natural gas prices.
Q: Where are prices now?
A: Natural gas prices fell 2.8 cents Wednesday to $2.88 per 1,000 cubic feet. That is down 80 percent from last summer, when prices spiked to nearly $14 per 1,000 cubic feet.
Q: Why have prices fallen so much?
A: It is Economics 101. There is little demand, and new drilling technology has made easy pickings of huge reserves of natural gas that was once out of reach. The Potential Gas Committee in Golden, Colo., reported in June that estimated U.S. reserves are 35 percent higher than just two years ago, thanks to new technology that has allowed producers to drill for gas in shale rock. Energy companies can now drill downward, and then sideways, for miles.
As a result, reserves are at their highest level since the group started tracking the information 44 years ago. The natural gas-backed American Clean Skies Foundation said a year ago the U.S. has a 118-year supply of natural gas at 2007 production levels. Meanwhile, the recession has crippled demand for gas. The federal government expects consumption to decline by 2.6 percent this year, driven by a huge drop in demand from the nation's factories. At the same time, summer weather for much of the country has been mild, reducing the power plant-taxing use of air conditioning, and there have been no hurricanes so far to disrupt key production areas in the U.S.
Storage levels for gas headed into the heating season are at record levels and gas has become so cheap that it has become competitive with coal for generating electricity from big power plants.
Q: With prices so low, I should get a nice break on my heating bill this winter, right?
A: Right, assuming you are in one of the 60 million homes heated by gas. The price of gas makes up about two-thirds or three-quarters of a typical gas bill. Gas prices already have started to moderate from the winter, but how much of a break you will get depends on when your distributor locks up prices. Columbia Gas of Ohio, which adjusts prices monthly, says its prices for September will be about half of what they were in September 2008.
Q: What if I heat my home with electricity?
A: You may still be in luck. Utilities generate about a fifth of the nation's electricity with gas, so those prices figure to come down. How much they'll fall depends on a whole host of factors, including whether your utility is fully regulated or deregulated, how much your utility relies on gas for power generation and how far out they locked into power contracts. Also, some utilities have been raising rates to cover costs for new power plants and pollution controls.
Q: How long will prices remain low?
A: That really depends on the wind, both economic and meteorological. Winter is on the way and the recession won't last forever. Still, most weather forecasters expect a relatively mild winter, and we are still struggling to recover from the economic downturn. Odds are, a substantial rebound in prices is not going to happen soon.
But it's not out of the question. In the summer of 2002, as the country recovered from the last recession, natural gas cost $2.66 per 1,000 cubic feet. Then it got really cold. By February, prices had doubled, and then they quickly spiked to nearly $11, in part because of one-time events — like a huge fire at an oil and gas storage facility in New York caused by an explosion of a barge carrying propane. It is difficult for energy companies to ramp up operations, but once they do, prices tend to fall — natural gas was back to $5 by August.
The difference this time is the size of the recession (a lot bigger) and the size of our reserves (also a lot bigger).
"The fundamentals weigh against the potential for $10 gas," said oil and gas trader and analyst Stephen Schork.
Q: Given that there is an abundance of natural gas, why aren't we using it to power cars and everything else? Can't we become more energy independent?
A: Natural gas is already used extensively. It heats our homes, makes our water hot and dries our clothes. It is used by industries that make, among other things, steel, plastics and chemicals, and utilities rely on gas to generate electricity.
Some people would like to see natural gas used more extensively as a transportation fuel, beyond its limited uses by some public bus systems and corporate vehicle fleets. As of yet, the infrastructure does not exist for more widespread use.
Airports and cities have built facilities where natural gas-powered buses can return for a recharge, and there are companies trying to build more natural gas stations for everyday use. If new climate regulations are enacted by the U.S., there may be an even stronger push for more such stations because natural gas produces nowhere near the emissions of gasoline.