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May 12, 2016

Washington State Court Nixes Recovery Of Out-Of-State PURPA Costs

PacifiCorp is an investor-owned utility that operates in six western states, including Washington, Oregon and California. A portion of its power supply needs in those states is met by purchases from so-called Qualifying Facilities (QFs), i.e., cogenerators and small power producers that qualify to sell power to utilities under the Public Utility Regulatory Policies Act of 1978 (PURPA).  PURPA required utilities to pay rates to QFs based on “avoided costs,” which are the costs the utilities would incur in supplying the power themselves or acquiring it from another source but for the purchase from the QF. It left the responsibility for computing avoided costs with the states.[1]

In a decision issued on April 27, 2016, a state appellate court in Washington upheld an order of the Washington Utilities and Transportation Commission (WUTC) preventing PacifiCorp from charging its Washington customers for costs of purchases from QFs located in California and Oregon on the ground that those customers should not be responsible for wholesale power costs reflecting the relatively generous avoided cost determinations of other states.[2] While acknowledging a Congressional mandate that the Federal Energy Regulatory Commission (FERC) issue and enforce regulations ensuring that utilities recover all prudently incurred PURPA costs, the court concluded that the mandate did not apply in PacifiCorp’s case because FERC found that “the recovery of [PURPA] costs was a matter of state discretion.”

WUTC’s desire to protect in-state customers from the economic effects of decisions of regulators in other states is understandable, and PacifiCorp’s position may have been  undermined by an agreement it made with respect to inter-jurisdictional cost allocation when it merged with Utah Power Company in 1986. Nonetheless, the court’s decision to affirm the WUTC order rests on a questionable interpretation of the Congressional mandate, and may result in “trapping” of wholesale power costs that is inconsistent with Supreme Court doctrine.

The court order arises out of a proposal by PacifiCorp in a 2013 rate case to revise the formula, known as the “WCA methodology,”[3] for allocating system costs between PacifiCorp operating entities. Previously, the WUTC had approved a version of that methodology under which PacifiCorp was required to charge customers in each state for the costs attributable to QF purchases physically located in that state. In other words, “Washington customer rates include[d] 100 percent of the costs PacifiCorp incur[red] in buying power from Washington QFs, regardless of whether that cost [was] higher or lower than market rates, even though power from Washington QFs arguably also serve[d] loads in Oregon and California.”[4] The formula imputed market rates, instead of the higher contract rates, to out-of-state QF power used to serve Washington load.

In proposing to change the methodology, PacifiCorp argued that Washington customers should pay for their share of out-of-state QF power at the actual PPA rates, which was consistent with the way the WCA methodology allocated costs of power from non-QF sources.  PacifiCorp argued that this was appropriate because the California and Oregon QF PPAs benefitted Washington customers; the Oregon and California avoided cost determinations on which the PPAs were based were reasonable and comparable to Washington QF PPAs; Washington’s energy policies were “substantially aligned with Oregon and California”; and cost recovery was consistent with PURPA.[5]

In response, WUTC staff and a major industrial intervenor argued that the purpose of the existing allocation methodology was to “recognize that the three states’ approaches to implementing PURPA’s QF requirements are different, having different policy goals, achieving different ends, and resulting in different costs. ….  Washington ratepayers should not be made responsible for the higher costs of QF power in Oregon and California that are the result of those states’ environmental policies and their choices in implementing PURPA to promote those policies.”[6]

The WUTC agreed with staff, stating that

the approaches of the three states are different.  Oregon and California have implemented PURPA to carry out policies favoring renewable energy that has resulted in 74 percent of PacifiCorp’s QF power for 2014 coming from contracts PacifiCorp entered in the last 5 years at avoided cost rates for Oregon and California.  Washington policy makers have relied less on PURPA and more on renewable portfolio standards and greater use of tax-related incentives to promote renewable energy development in this state.  Washington’s policies are paid for by Washington taxpayers or ratepayers, as this state’s policy makers determine.  Absent a regionally negotiated alternative arrangement, Oregon’s and California’s renewable energy policies should be paid for by the taxpayers and ratepayers of those states, as determined by their policy makers.[7]

On appeal, PacifiCorp argued that the UTC violated PURPA by (a) disallowing recovery of out-of-state QF PPAs when it was undisputed that they were priced at PacifiCorp’s avoided costs; (b) re-pricing out of state QF PPAs in Washington at market rates; and (c) ignoring PURPA’s specific cost recovery mandate.[8] The court rejected all three points.[9]

The court stated that, as to PacifiCorp’s first point, the relevant inquiry was “whether the Commission is required to adopt Oregon’s and California’s determination of PacifiCorp’s avoided costs and include those avoided costs in PacifiCorp’s Washington customer rates.”[10] Answering in the negative, the court explained that the case on which PacifiCorp relied, State ex rel. Utilities Comm’n v. North Carolina Power Corp., 338 N.C. 412, 450 S.E. 2d 896 (1994), had actually ruled contrary to PacifiCorp’s position, holding that North Carolina was not required to accept Virginia’s avoided cost determinations and to include those costs in North Carolina customer rates.[11]

The court summarily rejected PacifiCorp’s second argument, holding that PacifiCorp had not provided factual support, meaningful argument, or relevant authority to support its position.[12]

As to the third point, the court noted that PacifiCorp relied on the Energy Policy Act of 2005 (EPAct 2005), which added section 210(m) to PURPA, codified at 16 U.S.C. §824a-3(m)(7). That section provides that FERC “shall issue and enforce such regulations as are necessary to ensure that an electric utility that purchases electric energy or capacity from a [QF] under this section recovers all prudently incurred costs associated with the purchase.”

The court observed that in a rulemaking to implement that provision, utilities had argued that FERC should adopt regulations to “permit complete and timely recovery of the utility’s prudently-incurred QF purchase costs… because the states and the Commission often use different methodologies for allocating costs between the jurisdictions.”[13] FERC rejected that argument, stating that it was “reluctant to review an issue that should be handled by the states in the first instance.”[14] The court interpreted this ruling as a holding by FERC that recovery of PURPA cost was “a matter of state discretion,” and, on that basis, concluded that PacifiCorp’s reliance on EPAct 2005 was misplaced.[15]

This conclusion is unquestionably a weak link in the court’s decision. Given the direction in Section 210(m) that FERC “shall issue and enforce such regulations as are necessary to ensure that [a utility] …recovers all prudently incurred costs associated with the purchase [of QF power],” it is unreasonable to interpret FERC’s statement that the issue of inconsistent methodologies for allocating costs between jurisdictions “should be handled by the states in the first instance” to mean that cost recovery was a matter of state discretion. A far more plausible reading of FERC’s intent was simply that it did not wish to intrude prematurely on states’ authority to make inter-jurisdictional cost allocations because those allocations might turn out to allow full cost recovery of QF costs, removing the need for FERC to act.[16]

To be sure, the WUTC was correct that it is unfair for Washington customers to be saddled with the economic consequences of other states’ energy policies that favored reliance on QF contracts to meet renewable energy goals, especially where Washington was already using renewable portfolio standards and tax incentives to achieve similar results. In that respect, however, Washington’s situation is similar to that of states that are disadvantaged by FERC allocations of wholesale power costs. In those situations, states are unquestionably obligated to respect FERC’s allocations in setting retail rates, lest some of those costs become “trapped” by inconsistent state decisions. Mississippi Power & Light Co. v. Mississippi ex rel. Moore, 487 U.S. 354, 372 (1988); Nantahala Power  & Light Co. v. Thornburg, 476 U.S. 953, 970 (1986).

Had FERC directly blessed the rates paid to QFs in Oregon and California, it is clear that the WUTC would have been required to flow through to retail rates the costs incurred by PacifiCorp’s Washington utility for its share of their output. PacifiCorp has a reasonable argument that the result should be no different under the division of authority over QF rates established in PURPA, i.e., FERC adopts rules that state must follow in determining avoided costs, and state commissions control QF rates through those determinations. Cf. Mississippi Power & Light Co. v. Mississippi ex rel. Moore, supra, 487 U.S. at 374 (preemptive effect of FERC jurisdiction does not turn own whether a particular matter was actually determined in the FERC proceedings). [17]

In setting forth the background of the dispute between PacifiCorp and the WUTC, the court mentioned that PacifiCorp had agreed, when it merged with Utah Power Corp., that “its shareholders will assume all risks that may result from less than full system cost recovery if interdivisional allocation methods differ among the merged company’s jurisdictions.”[18] In the decision below, the WUTC said that that agreement, dating from three decades earlier,  “remains significant today.”[19] While the court did not say how that agreement affected its decision on the merits, it could have made the court less receptive to PacifiCorp’s arguments.

Recovery of QF PPA costs has long been a concern of utilities, especially after declining fossil fuel costs and deregulation rendered many of the PPAs uneconomic.[20] In practice, most regulatory commissions have allowed utilities to recover those costs, through stranded cost charges or otherwise.[21] The Washington court decision is one of a small few that have put recovery of those costs at risk. While the decision reflects the understandable interest of a state to shield its citizens from shouldering the economic consequences of sister states’ renewable energy policies in addition to their own, its conclusion that the cost recovery mandate of EPAct 2005 did not apply rests on shaky ground.

[1] In the Energy Policy Act of 2005 (EPAct 2005), Congress exempted utilities from the requirement to buy power at avoided cost rates from QFs under certain circumstances. However, there is no indication in the WUTC order or the court’s decision that that exemption applied to PacifiCorp’s purchases from Oregon and California QFs during the relevant time period.

[2] PacifiCorp d/b/a Pacific Power & Light Co. v. Washington Utils. and Transp. Comm’n, No. 46009-2-II (Wash. Ct. App. Div. 2, April 27, 2016)(PacifiCorp).

[3] “WCA” is an acronym for the Western Control Area, which comprises California, Oregon and Washington.

[4] PacifiCorp, Slip op. 3.

[5] PacifiCorp, Slip op. 3.

[6] WUTC Order at P 101.

[7] WUTC Order at P 111; footnote omitted.

[8] PacifiCorp, Slip op. 6-7.

[9] The court also rejected arguments by PacifiCorp that the WUTC’s findings were unsupported by substantial evidence, and that denial of cost recovery violated the dormant Commerce Clause. PacifiCorp, Slip op. 9-15.

[10] PacifiCorp, Slip op. 8.

[11] PacifiCorp, Slip op. 8.

[12] PacifiCorp, Slip op. 9.

[13] PacifiCorp, Slip op. 7, quoting from New PURPA Section 210(m) Regulations, 71 Fed. Reg. 64, 342 at ¶ 215 (2006).

[14] PacifiCorp, Slip op. 7, quoting from New PURPA Section 210(m) Regulations, 71 Fed. Reg. 64, 342 at ¶ 216.

[15] PacifiCorp, Slip op. 9.

[16] FERC routinely declines to use its preemptive authority where it finds that state or local regulation may make use of that authority unnecessary. See, e.g., Project No. 2342-018, PacifiCorp, Order on Petition for a Declaratory Order, PP8-9 (May 18, 2006).

[17] The recent Supreme Court decision striking down a Maryland program that had the effect of requiring load-serving entities to subsidize in-state generation is not to the contrary. Hughes v. Talen Energy Marketing, LLC, No. 14-614 (April 19, 2016). There the Court held that it was acting only because the state program “disregard[ed] a wholesale rate required by FERC. We therefore need not and do not address the permissibility of other measures States might employ to encourage new or clean generation, including tax incentives, land grants, direct subsidies, construction of state-owned generation facilities, or re-regulation of the energy sector…”

[18] PacifiCorp, Slip op. 2, quoting from WUTC Docket UE 050684, Order 05 at ¶ 56 (April 17, 2006).

[19] WUTC  Order at P 81.

[20] See generally Congressional Budget Office White Paper, “Electric Utilities: Deregulation and Stranded Costs” (October 1998).

[21] See Raskin, D., “The Regulatory Challenge of Distributed Generation,” Harvard Business Law Rev. Online, Vol. 4: 38, 47 (2013), accessible at http://www.hblr.org/2013/12/the-regulatory-challenge-of-distributed-generation/.

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