On April 17, 2012, the United States Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) found unreasonable FERC’s decision to deny Mobil Pipeline Company’s (“Mobil”) application to charge market-based rates on its crude oil pipeline, Pegasus.  The D.C. Circuit rejected the Commission’s determination that Pegasus had market power. The court found that producers and shippers of Western Canadian crude oil have “numerous alternatives to Pegasus” in order to transport and sell crude oil.   The D.C. Circuit granted Mobil’s petition for review, vacated FERC’s order and remanded the case to the Commission for further proceedings.

FERC must ensure that oil pipelines charge “just and reasonable rates.”  In addition to traditional cost-based rate regulation (which, for oil pipelines, is based on an indexing system), FERC can authorize oil pipelines to charge market-based rates pursuant to FERC Order No. 572.  In order to obtain market-based rate authority, the oil pipeline must demonstrate that it lacks market power in the relevant product and geographic markets.  FERC views market power as “the ability to profitably to maintain prices above competitive levels for a significant period of time” and applies “well-settled economic and competition principles in determining whether an oil pipeline possesses market power.” 

In this case, Pegasus transports roughly three percent of the Western Canadian crude oil produced each day.  In the market-based rate proceeding, FERC staff strongly supported Mobil’s application for market-based rate authority on behalf of Pegasus finding that “Pegasus’s origin and destination markets were plainly competitive.” Staff characterized this conclusion as a “slam dunk.”  Notwithstanding this assessment, the Commission denied Mobil’s application on grounds that Pegasus possessed market power in its origin market.  The Commission further found Pegasus had 100 percent market share in its origination market.  In order to reach this determination, the Commission engaged in a series of analyses concerning: (1) the price incurred by shippers after all costs of delivery (“netbacks”); and (2) whether shipper alternatives were comparable in the defined origination market.  

On appeal, the D.C. Circuit found FERC’s decision “unsustainable.”  The court reasoned that “97 percent of Western Canadian crude oil gets to refineries by means other than Pegasus.” The court noted that when Pegasus began transporting crude oil in 2006, it became another alternative for Western Canadian crude oil producers and shippers.  The Commission had expressed concern that Pegasus is the “primary avenue” for shippers and producers of Western Canadian crude oil to get their product to Gulf Coast refineries.  The D.C. Circuit reasoned that there is nothing distinct about these refineries as compared to others available in Canada and the United States.  The D.C. Circuit also concluded that short-term price variations associated with the Gulf Coast refineries “are consistent with competition.”  Finally, the court stated that the Commission “jumped the rails by treating the Pegasus pipeline as the rough equivalent of a bottleneck or essential facility for transportation of Western Canadian crude oil.” 

A copy of the DC Circuit opinion is available here.