On March 16, 2018, the U.S. Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) affirmed FERC’s (1) reduction in NorthWestern Corporation’s (“NorthWestern”) Schedule 3 regulation service rate by removing “regulation-down” capacity from the rate’s numerator and increasing the denominator to the full nameplate capacity of NorthWestern’s generating facility and (2) decision to order NorthWestern to refund customers the difference between NorthWestern’s proposed rate and FERC’s approved rate.

Prior to 2011, NorthWestern lacked the generating capacity to self-supply regulation service –generation that maintains the frequency of the transmission system by responding to variations in demand for electricity in real time.  Instead, NorthWestern purchased regulation service from third parties and passed on the costs of these purchases to its customers.  However, after constructing a new generating facility in 2011, NorthWestern filed revisions to its Schedule 3 rate to reflect that NorthWestern would recover the costs of self-supplying regulation service from the new generating facility, rather than passing on costs of purchasing regulation service from third parties as it had previously done.  Specifically, NorthWestern proposed a cost-of-service rate, in which the numerator equaled the amount of capacity from the generating facility that NorthWestern allocated to its Schedule 3 customers (including “regulation-down” service) and the denominator equaled the amount of regulation service capacity NorthWestern planned to provide from the facility.

In affirming the Administrative Law Judge assigned to NorthWestern’s filing, FERC lowered the cost-calculation ratio for NorthWestern’s regulation service rate by (1) reducing the numerator to exclude megawatts associated with “regulation-down” capacity and (2) increasing the denominator to reflect the nameplate capacity of the generating facility.  FERC also directed NorthWestern to refund its customers the difference between its proposed rate and the rate FERC approved.

NorthWestern petitioned the D.C. Circuit for review, arguing that, among other things, FERC should not have excluded “regulation-down” capacity from the numerator of the Schedule 3 rate, and that because “regulation-down” capacity was previously “embedded” in the Schedule 3 rate when NorthWestern purchased third-party regulation service prior to 2011, FERC could only exclude the “regulation-down” capacity by acting pursuant to Federal Power Act (“FPA”) section 206.  Furthermore, NorthWestern argued that FERC’s use of the nameplate capacity as the denominator was unreasonable in light of FERC’s use of the customer demand as the numerator.  NorthWestern also argued that FERC was barred from requiring refunds because FERC does not order refunds in cases where the utility has collected the appropriate amount of revenue but improperly allocated it among customers.

The D.C. Circuit affirmed FERC in all respects.  First, the D.C. Circuit held that “regulation-down” capacity should be excluded from NorthWestern’s numerator because, among other reasons, NorthWestern failed to show why it could not recover those costs through other means, such as off-system sales.  Furthermore, the D.C. Circuit held that FERC did not need to act pursuant to FPA section 206 to remove these costs because NorthWestern’s revised cost-based rate is a departure from its previous rate design.  Moreover, the D.C. Circuit held that, under FERC precedent, the denominator for Schedule 3 rate uses the nameplate capacity for the generating facility, while the numerator measures the portion of that capacity needed to provide regulation service.  Finally, the D.C. Circuit affirmed FERC’s determination that NorthWestern in fact over-collected from its customers and thus refunds were appropriate.

A copy of the D.C. Circuit’s opinion is available here.