Village of Bethany, Illinois v. Federal Energy Regulatory Commission

In the
United States Court of Appeals
For the Seventh Circuit
No. 99-1840
Village of Bethany, Illinois, et al.,
Petitioners,
and
Amoco Production Co., et al.,
Intervenors-Petitioners,
v.
Federal Energy Regulatory Commission,
Respondent,
and
Natural Gas Pipeline Co. of America,
Intervenor-Respondent.
On Petition for Review of Orders of the
Federal Energy Regulatory Commission
Argued April 18, 2001--Decided January 11, 2002
Before Harlington Wood, Jr., Diane P. Wood,
and Williams, Circuit Judges.
Diane P. Wood, Circuit Judge. The
petitioners in this case are small
municipalities (to which we refer
collectively as the Municipalities) that
buy natural gas transportation services
from the Natural Gas Pipeline Company of
America (Natural). In 1997, Natural filed
tariffs with the Federal Energy
Regulatory Commission (the Commission)
proposing to change the way that it
allocates capacity that becomes available
on its pipeline. After several rounds of
negotiations and comments, the Commission
issued orders approving Natural’s new
capacity allocation plan. The
Municipalities have filed a petition for
review of those orders, challenging two
aspects of the plan. Although we are not
unsympathetic to their concerns, we find
that those concerns should be addressed
during the Commission’s next ratemaking

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proceeding regarding Natural’s pipeline
and were not relevant to the Commission’s
decision in this capacity allocation
case. We therefore enforce the
Commission’s orders.
I
Much of our decision in this case turns
on the distinction between two types of
proceedings before the Commission. In a
ratemaking proceeding, the Commission
sets the maximum and minimum rates that a
pipeline can charge its customers,
essentially by determining the total cost
of operation, adding a fair profit for
the pipeline company, and then deciding
on a fair allocation of the total costs
among the pipeline’s customers. The
overriding policy concern in a ratemaking
proceeding is to establish rates that
require each customer to bear a fair and
proportional share of the pipeline’s
costs. This case, however, does not
involve ratemaking. Instead, this case
involves the general terms and conditions
under which Natural operates--
specifically, the procedure by which it
allocates available capacity on its
pipeline among its customers. As we shall
see, theinterests and policy goals at
issue in such a proceeding differ
markedly from those involved in a
ratemaking case.
A
Before we proceed to the specific
disputes before us, a bit of background
on the basic concepts at issue is in
order. First, a few of the issues that
commonly arise in ratemaking cases are
relevant here. Natural, like most other
pipeline companies, sells the gas it
transports to various types of customers,
including industrial users, large
intrastate gas companies, and the
Municipalities, which in turn provide
residential and small business gas
service in their areas. The
Municipalities are captive customers of
Natural’s pipeline because no other
pipeline reaches their areas. Many of
Natural’s other customers, however, have
a choice between using Natural and using
competing suppliers. Because the
customers’ capacity needs vary widely and
because some but not all of the customers
are captive, determining each customer’s
fair share of the pipeline’s fixed costs

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can be difficult.
Since the 1980s, the Commission has had
a general policy of encouraging
competition among natural gas pipelines.
In furtherance of this general goal, the
Commission a decade ago undertook a
rulemaking procedure that resulted in Or
der 636, which is its latest major policy
statement on how it will set rates for
interstate pipelines. See Order No. 636,
FERC para. 30,939 (1992). Pipelines
generally offer two basic types of
service. First, pipelines sell "firm
capacity," which represents a guarantee
that a certain amount of gas will be
available for the buyer. Second,
pipelines sell interruptible service,
which allows customers to buy additional
gas as long as capacity is actually
available on the pipeline, but does not
guarantee capacity availability. In Order
636, the Commission determined that
pipelines should price their services
based on two-part rates, so that each
customer would pay both a "reservation
charge" based on the amount of firm
capacity committed to the customer and a
usage charge based on the actual amount
of gas the customer consumed. The
Commission believed this two-part
structure would aid competition between
pipelines, because it would reduce price
distortions inherent in a one-part rate
based only on consumption.
When the Commission issued Order 636,
however, it realized that switching from
one-part rates to two-part rates could
shift some costs from large industrial
users to smaller users. In general, users
such as the Municipalities, which serve
primarily residential customers, have a
high seasonal variation between their
peak demand and their average usage.
Because these users need a firm capacity
commitment that will cover their peak
demand, they often are not using their
entire firm capacity. Industrial users,
on the other hand, tend to have fairly
constant rates of usage, so that their
average usage is much closer to their
peak demand. In the industry, a
customer’s average usage divided by its
peak demand is called that customer’s
"load factor." A low load factor
indicates a wide disparity between
average and peak usage, while a high load
factor indicates a fairly constant rate
of usage. Separating out reservation

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(i.e. firm) charges from usage charges
will generally increase the total bill
for customers with low load factors and
decrease the total bill for high-load-
factor customers.
In order to mitigate this effect on
small, low-load-factor consumers, the
Commission in Order 636 allowed pipelines
to continue using one-part rates for
these customers. These one-part rates
were calculated in a way that would
incorporate both the customer’s portion
of the pipeline’s fixed costs and the
customer’s actual usage into a single
rate that would be applied to the volume
of gas the customer consumed. The rates
were not intended to reflect the exact
amount the small customers would have
paid under the two-part rates. Rather, in
calculating the one-part rates, the
pipelines and the Commission imputed to
the small customers a load factor higher
than their actual load factors. The
combined effect of these adjustments was
to charge the small customers a smaller
percentage of the pipeline’s fixed costs
than they would have paid under the two-
part rate. The Municipalities buy gas
from Natural under one of these special
one-part rates.
As we have noted, the ratemaking process
results in a range of rates that a
pipeline is allowed to charge. The
important question in this case relates
to the next stage of the process: how the
pipelines determine the rate they will
charge to individual customers. The rate
schedules the Commission sets for a
pipeline can vary according to geography,
and most pipelines also have different
rate schedules for different types of
service or classes of customers. Each of
these rate schedules incorporates a set
minimum and maximum rate. Most pipelines
are free to charge a customer any rate
between the minimum and the maximum set
for that customer’s area and class of
service, with the qualification that
pipelines may not unduly discriminate
between similarly situated customers. See
15 U.S.C. sec. 717c(b).
Despite the rule against unreasonable
discrimination, pipelines are generally
allowed to offer discount rates (below
the maximum rate but above the minimum)
to attract customers in competitive
markets. See, e.g., 18 C.F.R. sec.

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284.10(c)(5). The Commission believes
that allowing discount rates is good for
end-users in competitive markets, because
it drives down prices, and that allowing
discount rates is also good for all
customers on a pipeline, even for those
who are not in competitive markets,
because discount rates can prevent the
pipeline from losing business to other
pipelines or to other types of energy.
More business on the pipeline, the
Commission reasons, means each customer
pays a smaller percentage of the
pipeline’s fixed costs. For these
reasons, the fact that one customer
receives a discount to meet market
competition while another customer, in a
captive market, does not, is not
necessarily considered "undue"
discrimination between customers. See
Associated Gas Distrib. v. FERC, 824 F.2d
981, 1009-12 (D.C. Cir. 1987). The
Commission’s discount policy is one of
the key points of contention in this
case.
B
With this background in mind, we turn to
the function of the Commission that is
more directly relevant in this case: the
regulation of the process by which
pipelines allocate their capacity.
Pipelines have long-term contracts with
many of their customers for firm
capacity, and customers such as the
Municipalities generally have the right
to renew their firm capacity contracts
indefinitely. When firm capacity
contracts expire and are not renewed or
when the pipeline expands its capacity,
the pipeline has new firm capacity to
allocate among its customers.
Until the 1990’s, pipelines generally
allocated available firm capacity on a
first-come, first-serve basis. More
recently, however, the Commission has
turned to an auction system, under which
pipelines are encouraged to auction
available capacity in a way that limits
their discretion while maximizing their
total revenues. According to the
Commission, the new system fosters
efficiency by ensuring that the customer
willing to pay the most for the firm
capacity (within the allowable rates) is
the one who receives it. This approach
also benefits all users of the pipeline,
because it ensures that customers who are

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willing to take the largest chunks of
available capacity receive that capacity.
This reduces the system’s unused
capacity, which in turn allows the
pipeline to spread its fixed costs among
a larger customer base. Finally, awarding
capacity to the highest bidder helps the
other pipeline users, because if that
bidder pays more toward fixed costs, the
other users ultimately pay less. In this
case, the Commission approved this type
of auction system for Natural; the
Municipalities challenge various aspects
of that decision.
In 1997, Natural ran into trouble with
the Commission for unfairly awarding
available firm capacity to an affiliated
company at discounted prices. As a
result, the Commission required Natural
to develop a new system for allocating
firm capacity that would leave the
pipeline with less discretion, and thus
less opportunity to engage in undue
discrimination. When Natural filed its
new tariffs, it proposed, in keeping with
the Commission’s current policy, to
switch to an auction method for
allocating capacity. In auctioning
capacity, Natural planned to use a "net
present value" method to award capacity
to the bidder who would produce the
greatest total revenue for the pipeline.
The net present value method takes into
account only the reservation charge the
customer would pay, not the anticipated
usage charges. The Commission had
approved this auction method for several
other pipelines.
Natural also proposed that it would
establish a system of reserve prices and
that it would not be required to accept
any bids below the reserve prices. The
reserve prices would, of course, fall
between the maximum and minimum allowable
prices under Natural’s current rate
schedule. Natural believed that it needed
to set different reserve prices in
different regions, in different markets,
and for different types of customers,
because it needed to be able to take into
account both differences in its costs of
service and competition from other
suppliers in setting the price at which
it would sell to each customer. In most
cases, the Commission allows pipelines to
set an unlimited number of reserve prices
for different customers, as long as the
pipeline can justify the distinctions it

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is making. Natural’s case was different.
Because it had a history of undue
discrimination, the Commission wanted to
impose more restraints on Natural’s
reserve prices. Natural proposed a system
under which it would use a 15-market
matrix to set different reserve prices
for different markets that it identified,
based on such factors as cost-to-serve
and market competition.
Before the Commission, the
Municipalities challenged Natural’s
proposal on a number of grounds; they
renew two of those challenges here.
First, they argued that basing the
auction solely on reservation charges
discriminates against small customers
like themselves who pay a one-part rate,
because their one-part rate does not
include a reservation charge. These
customers would be forced to bid at a
two-part rate to compete with the other
bidders. Forcing them into a two-part
rate is wrong, they argued, because if
small customers on Natural’s system paid
a two-part rate, they would be
shouldering a disproportionate percentage
of the pipeline’s fixed costs and
effectively subsidizing larger users. The
Municipalities sought an evidentiary
hearing in which they hoped to prove that
the one-part rate on Natural’s system
accurately reflects their proportionate
fixed costs. Second, the Municipalities
challenged the reserve pricing proposal,
arguing that it is unduly discriminatory
for Natural to take factors other than
cost-to-serve into account in setting its
reserve prices.
The Commission rejected both of the
Municipalities’ challenges and approved
Natural’s proposal with some
modifications not relevant here. The
Commission approved the net present value
auction system as consistent with
itspolicy of awarding available capacity
to the highest bidder. In so holding, the
Commission denied the Municipalities’ re
quest for an evidentiary hearing, noting
that it had recently approved almost
identical auction systems on other
pipelines and that the evidence that the
Municipalities wanted to present was
relevant only to ratemaking, not to
capacity allocation. The Commission also
determined that Natural’s proposed
reserve pricing system struck a good
balance between allowing Natural the

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flexibility to meet market competition
and preventing Natural from unduly
discriminating in favor of its
affiliates.
After the Commission issued its final
orders, the Municipalities filed this
appeal. Since the time the appeal was
filed, Natural has further modified its
reserve price system, with the
Commission’s approval. The 15-market-
matrix system the Commission originally
approved turned out to be unworkable, and
so the Commission permitted Natural to
change to a system under which it may set
an unlimited number of different reserve
prices for different customers, but it
must set and disclose the reserve prices
before the bidding opens. Natural’s
current auction system still bases bids
only on reservation charges, and Natural
still has the ability to set different
reserve prices on bids from customers
whose cost-to-serve is identical.
II
Our review of the Commission’s orders in
this case is deferential. "Congress has
entrusted the regulation of the natural
gas industry to the informed judgment of
the Commission, and therefore a
presumption of validity attaches to each
exercise of the Commission’s expertise."
Northern Indiana Pub. Serv. Co. v. FERC,
782 F.2d 730, 739 (7th Cir. 1986)
("NIPSCO"). Our review of the
Commission’s orders is therefore "narrow
and circumscribed" and is "limited to
assuring that [the decision] is reasoned,
principled, and based upon substantial
record evidence." Id. In conducting this
limited review, we will consider "(1)
whether the Commission abused or exceeded
its authority, (2) whether each essential
element of the Commission’s order is
supported by substantial evidence, and
(3) whether the Commission has given
reasoned consideration to each of the
pertinent factors in balancing the needs
of the industry with the relevant public
interests." Peoples Gas Light & Coke Co.
v. FERC, 742 F.2d 1109, 1111-12 (7th Cir.
1984). We find that the orders the
Municipalities challenge satisfy these
standards.
We begin our inquiry by considering the
Municipalities’ argument that a bidding
system based only on reservation charges

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impermissibly discriminates against small
customers who pay one-part rates. Recall
that under the bidding system the
Commission approved in this case,
Natural’s customers compete for capacity
on the pipeline on the basis of the "net
present value" of their bids, and that
net present value is determined with
reference only to the reservation charges
that the customer would pay on the
capacity it seeks. Because a one-part
rate has no specified reservation charge,
a bid based on a one-part rate would
result in a net present value of zero,
and the small customer would always lose
out to a larger customer bidding based on
a two-part rate (which includes a
reservation charge). The Municipalities
might be able to win new capacity based
on their one-part rates if there were no
other bidders, but otherwise the
Municipalities could only compete by
agreeing to pay two-part rates for the
new capacity.
The Commission concedes that small
customers would not be able to compete at
their one-part rates under the net
present value bidding system, but argues
that the system is consistent with the
Commission’s policy of using auctions to
increase pipeline efficiency. In its
orders in this case, the Commission noted
that the one-part rate is a form of
subsidy from the large users to the small
users, in that the small users pay less
under the one-part rate than they would
under the two-part rate. The Commission
went on to hold that, while there may be
policy reasons supporting the use of the
one-part rate for the Municipalities’
current capacity, there is no policy
reason the Commission should allow the
Municipalities to grow at their
subsidized rates, at the expense of
larger customers who are willing to pay
higher rates for the capacity. The
Commission also noted that it has reached
similar conclusions in two other recent
cases, and relied on its decisions in
those cases as evidence of its policy on
this point. Tennessee Gas Pipeline Co.,
79 FERC para. 61,297, 1997 WL 438901,
remanded on other grounds, Process Gas
Consumers Group v. FERC, 177 F.3d 995
(D.C. Cir. 1999); Texas Eastern
Transmission, 80 FERC para. 61,270, 1997
WL 579011, aff’d sub nom. Municipal
Defense Group v. FERC, 170 F.3d 197 (D.C.
Cir. 1999).

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A
The Municipalities argue that the
Commission erred in treating this issue
as a policy question rather than as a
factual question. They are confident that
they could have proven that, on Natural’s
system, the one-part rate is not a
"subsidy," because it accurately reflects
the small customers’ proportionate share
of the pipeline’s fixed costs. The
corollary of their argument is that, if
they are forced to bid for new capacity
at two-part rates, they will be forced to
shoulder more than their fair share of
the pipeline’s fixed costs for that
capacity. The Municipalities ask us
toremand for an evidentiary hearing, at
which they would seek to prove that the
one-part rate is not a subsidy on
Natural’s system.
After reviewing the Municipalities’
recitation of the facts they propose to
prove at an evidentiary hearing, however,
we agree with the Commission that a
hearing was unnecessary. The
Municipalities quarrel vigorously with
the Commission’s characterization of the
rate as a "subsidy." Regrettably,
however, the parties are talking past
each other, because they attach different
meanings to the term "subsidy." The
Municipalities want to prove that, even
under their one-part rates, they are
still shouldering their full proportional
share of the pipeline’s fixed costs. They
cite several cases in which they say they
have proved this factual point in the
past. See NIPSCO, 782 F.2d at 741-42;
Natural Gas Pipeline Co. of Am., 68 FERC
para. 61,388, 62,559, 1994 WL 613238.
While we express no opinion as to what
factual conclusions the courts actually
reached in these cases, we note that if
the facts the Municipalities have alleged
would have affected the issues the
Commission was considering in those
proceedings, then the Commission should
have afforded the Municipalities an
evidentiary hearing. The preliminary
question here is suggested by this
analysis: were the facts the
Municipalities proffered relevant to the
Commission’s deliberations? The answer is
no. When the Commission said in its
orders that theMunicipalities’ one-part
rate was a "subsidy," all it meant was
that the one-part rate results in a lower
total bill for the same combination of

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firm capacity and usage than a two-part
rate would. The Municipalities do not
dispute this point; in fact, they concede
as much in their reply brief. As this was
the only relevant fact on which the
Commission relied in reaching its
decision, there was no need for an
evidentiary hearing.
We also agree with the Commission’s
decision to focus only on whether the
one-part rate allowed the Municipalities
to pay less than they would under a two-
part rate, rather than on whether the
one-part rate covered their full pro rata
share of the pipeline’s costs. The reason
this focus was correct turns on the
distinction between the policy objectives
in a ratemaking case and the objectives
in a capacity auction. At the ratemaking
stage, the Commission is trying to
allocate the costs of operating the
pipeline fairly among the pipeline’s
customers. In that context, knowing
whether the one-part rate is an accurate
measure of the small customers’ fair
share of the costs, or whether it falls
below their fair share, is critical. The
Commission’s stated goals for capacity
auctions are different. In capacity
auctions, the Commission wants to
increase the overall efficiency of the
pipeline by increasing the pipeline’s
total revenues and minimizing the
unsubscribed capacity. See Tennessee Gas,
1996 WL 432428, at *8. Both of these
goals benefit all the pipeline’s
customers because they give the pipeline
a larger base among which to spread fixed
costs. In addition, the capacity auction
should ensure that the customers who most
value additional capacity (presumably,
the ones willing to pay the most for it)
are the ones who get that capacity. See
Texas Eastern, 1997 WL 432665, at *3. In
the capacity auction context, the
relevant question is not what a fair
allocation of fixed costs is, but which
customers are willing to pay the most to
win any additional capacity. Assuming the
Commission’s policy objectives in the
capacity auction context are reasonable,
it was entirely appropriate for it to
reject a two-tiered bidding system that
would have allowed the Municipalities to
win capacity even when they were not
willing to pay as much as other bidders.
B

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This conclusion leads us to the
Municipalities’ next contention, which is
that the Commission’s general policy in
favor of net present value capacity
allocation is unreasonable. As the
Municipalities point out, the
Commission’s policy favoring the net
present value system appears only in
cases such as Texas Eastern and Tennessee
Gas, not in any formal policy document,
and it has never been the subject of
notice-and-comment rulemaking. Because
the policy was not subjected to formal
rulemaking and we see no reason to assume
that Congress intended policies announced
in the Commission’s individual case
decisions to have the force of law, the
policy is not entitled to deference in
this court under the principles of
Chevron U.S.A., Inc. v. Natural Resources
Defense Council, Inc., 467 U.S. 837
(1984). See United States v. Mead Corp.,
121 S. Ct. 2164, 2172-73 (2001).
Nevertheless, as the reasoned judgment of
the federal agency charged with
administering our national energy policy,
the Commission’s view does "’constitute
a body of experience and informed
judgment to which courts and litigants
may properly resort for guidance.’" Id.
at 2171, quoting Skidmore v. Swift, 323
U.S. 134, 139-40 (1944). We will uphold
the Commission’s policy choice if it
appears that the Commission has "given
reasoned consideration to each of the
pertinent factors in balancing the needs
of the industry with the relevant public
interests." NIPSCO, 782 F.2d at 739.
In this case, the Commission’s chosen
policy meets this test. From an economic
standpoint, the Commission’s preference
for allocating available capacity to the
bidder willing to pay the most for it is
sound. It has the effect of allocating
resources to those who most value them,
and it results in lower fixed-cost
charges to everyone else on the pipeline.
The net present value approach is
consistent with these goals. It is true
that the auction approach makes it harder
for small customers to expand their firm
capacity at their special one-part rates,
but that is not enough by itself to
reject the Commission’s order. The
Commission itself recognized this burden
in its orders in this case, as it has in
previous cases in which it has approved
the net present value system. Balancing
that hardship to the small customers

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against the efficiency interests of the
remaining customers, the Commission
determined that the small customers were
adequately protected by being able to
continue to pay one-part rates on their
existing capacity. Allowing the small
customers to compete for new capacity on
the basis of their one-part rates, the
Commission found, would be unfair to the
other pipeline users, who would be better
served if the new capacity was allocated
to a customer willing to pay a higher
rate. In reaching this conclusion, the
Commission considered the relevant
factors and made a policy determination
that balanced the competing interests
before it. The District of Columbia
Circuit recently approved the
Commission’s net present value policy as
a reasonable exercise of its expertise,
see Municipal Defense Group v. FERC, 170
F.3d 197, 201-03 (D.C. Cir. 1999), and we
agree with our sister circuit’s
conclusion on that point.
III
We turn finally to the Municipalities’
second major objection to Natural’s
capacity allocation scheme, which is that
the reserve pricing system permits the
pipeline unduly to discriminate against
captive customers. Under the bidding
system that the Commission approved, as
we explained above, Natural sets reserve
prices for each potential bidder before
accepting bids. It is not required to
allocate capacity at bids below the
reserve prices. Natural is permitted to
vary its reserve prices on any rational
basis, including to meet the demands of
market competition. The Municipalities
contend that Natural should be permitted
to vary its reserve prices only to
reflect differences in the cost of
providing service to each customer. Any
other variation in pricing, they argue,
violates the principle that the rates set
for a regulated commodity should track
the costs to provide the commodity to
each consumer as closely as practicable.
A
Before we reach the merits of this
contention, we must consider the
Commission’s argument that the
Municipalities lack standing to pursue
this claim. Under the Natural Gas Act, a
party has standing to seek review of any

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order of the Commission if it is
"aggrieved" by that order. 15 U.S.C. sec.
717r(b). According to the Commission, the
Municipalities’ opposition to the reserve
pricing system revolves around the
Commission’s decision to accept Natural’s
15-market-matrix proposal. Because that
system is no longer in use, the
Commission reasons, the Municipalities
cannot show that they are still aggrieved
by it. The Municipalities respond that
their quarrel is not with the 15-market-
matrix proposal in particular, but with
any system that allows Natural to vary
its reserve prices in response to market
competition rather than purely in
response to cost differentials. This is a
fair characterization of their argument,
and, as so understood, it is clear that
the Municipalities are at least as
aggrieved by the current system, which
allows Natural to set an unlimited number
of different reserve prices, as they were
by the 15-market-matrix system. Moreover,
as long as the Commission allows Natural
to vary its reserve prices based on
market competition, it is reasonable to
expect that captive customers such as the
Municipalities will face higher reserve
prices than will customers in more
competitive markets. The Municipalities
are aggrieved by the Commission’s order
and have standing to bring this claim.
B
We therefore proceed to the merits of
the argument that it is unreasonable to
allow Natural to vary its reserve prices
in response to market forces. The reserve
pricing system that the Commission
approved allows Natural the flexibility
to offer discounts to certain customers,
within the range of allowable maximum and
minimum rates, to meet market
competition. The Municipalities’
objection to this system can be
understood in two ways. First, broadly,
they contend that any system of market-
based discounts violates the Natural Gas
Act’s prohibition on "undue preferences."
See 15 U.S.C. sec. 717c(b). Second, they
argue that, even if market-based
discounts are appropriate in some cases,
this is not one of them. Under Natural’s
system, it is unduly discriminatory to
saddle the Municipalities (or perhaps all
of Natural’s captive customers) with the
additional costs associated with
providing discounts to customers in

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Natural’s competitive markets. The
broader of these two arguments is
foreclosed by a long line of precedent
and the narrower one, which may well have
merit in the context of Natural’s next
ratemaking case, is not relevant in the
context of this capacity allocation case.
The Commission has long allowed market-
based discounts, on the theory that the
discounts stimulate competition, reduce
prices for consumers in competitive
markets, and increase the pipeline’s
total customer base, which helps lower
prices to both non-captive and captive
customers. This general principle was
part of the Commission’s Order 436, which
was the last major rulemaking on rate
design before Order 636. In 1987, the
District of Columbia Circuit gave
extensive consideration to the
Commission’s general policy allowing
market-based discounting and concluded
that the policy was reasonable and did
not sanction undue discrimination. See
Associated Gas Distrib. v. FERC, 824 F.2d
981, 1009-12 (D.C. Cir. 1987). The
Associated Gas decision discusses with
approval the Commission’s policy grounds
for allowing market-based discounts and
notes that market-based discounting has
long been allowed in regulated
industries. Id. at 1011. In Order 636,
the Commission again approved its policy
of market-based discounts, and the
concept is embodied in the Commission’s
regulations. See 18 C.F.R. sec.
284.10(c)(5) (entitled "Rate flexibility"
and stating that, as long as pipelines do
not discriminate in favor of affiliated
entities, "the pipeline may charge an
individual customer any rate that is
neither greater than the maximum rate nor
less than the minimum rate on file").
Thus, the general concept of market-based
discounts is firmly embedded in the
Commission’s official policies and has
been approved by the courts. We have no
inclination to reconsider the policy at
this point.
The Municipalities’ more narrow
challenge to Natural’s reserve pricing
system is that, whatever the general
status of market-based discounts, such
discounts would unfairly shift costs to
the captive customers on Natural’s
system. They correctly note that the
Associated Gas decision did not sanction
any and all market-based discounts, but

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instead held that the Commission had to
evaluate the specific discount schemes
set up by each pipeline to ensure that
captive customers were not forced to bear
a disproportionate share of the
pipeline’s costs. Associated Gas, 824
F.2d at 1011-12. The Commission should
permit pipelines to shift the costs of a
discount to their captive customers if,
but only if, the pipeline can show that
the discount benefits the captive
customers by enlarging the pipeline’s
total customer base. Id. The
Municipalities argue that Natural cannot
show that this is the case on its system,
so it should not be allowed to offer
market-based discounts.
The Municipalities are correct that the
Commission has never specifically
adjudicated whether the discounts Natural
offers in its competitive markets
actually benefit its captive customers.
Nonetheless, this capacity allocation
proceeding is not the proper place to
raise the issue. The Municipalities, as
captive customers on Natural’s pipeline,
are already paying the maximum rate
Natural is permitted to charge under its
current rate schedules (although they are
paying under the lower one-part rates
rather than the higher two-part rates).
In the short term, discounts Natural
offers to other customers will not affect
the rates the Municipalities are paying
for existing service, because their rates
cannot be raised until Natural’s next
ratemaking case. If Natural offers
discounts before its next ratemaking
case, Natural may well argue at that time
that the discounts have benefits for the
captive customers. Natural might even be
able to raise its maximum rates for those
customers to recoup some or all of the
cost of offering the discounts. At that
stage, Natural will have to show that the
benefits to the captive customers are
real, and the Municipalities will have an
opportunity to argue that the discounts
do not benefit them. If the
Municipalities are successful, Natural
will not be allowed to raise the rates it
charges captive customers. Instead, the
pipeline will be forced to swallow any
losses it is suffering from the offered
discounts, and the Municipalities’ rates
will be unaffected. The question whether
Natural’s discount scheme benefits its
captive customers can therefore be
adequately addressed in Natural’s next

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ratemaking case, and the Municipalities’
attempt to litigate the issue here is
premature.
For the foregoing reasons, we Enforce the
Commission’s orders.

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