On December 20, 2005, the D.C. Circuit rejected FERC’s finding that Southern California Water Company exceeded its "forecasted incremental cost" by selling at a price that took into consideration the cost of obtaining electricity being sold.  Southern California Water Co. v. FERC,  No. 04-1324, 2005 WL 3555846, at *1 (D.C. Cir. Dec. 30, 2005).  Southern California, a public utility distributing electricity to retail customers in San Bernardino County, California, had challenged the FERC orders, arguing that the Commission misapplied the concept of "incremental cost" in finding that its sale of electricity violated statutory filing requirements for the making of jurisdictional sales. Id.

At the beginning of March 2001, Southern California had two wholesale contracts:  (1) a baseload contract with Dynegy Power Marketing for 12 megawatts (MW) of around-the-clock energy at $35.50; and (2) a contract with Illinova Energy Partners (IEP) to meet any hourly demand in excess of 12 MW at "SP15," a name given to the spot market price in the "South of Path 15" zone, a common delivery point.  As the Dynegy contract was scheduled to expire on April 30, 2001, Southern California entered into a new contract with Mirant Americas Energy Marketing to purchase 15 MW of around-the-clock energy at a price of $95/MWh.  The contract was under the WSPP Agreement, which the parties identified as the "enabling agreement." Id. at *2-3. 

Since the Mirant contract was to start April 1, 2001, the Mirant and Dynegy contracts were to overlap for the month of April.  To address this overlap, Southern California entered into a separate contract with Mirant on March 30, 2001, again under the WSPP Agreement, agreeing to sell Mirant 15 MW of around-the-clock energy for the month of April at a price of SP15 minus $20/MWh.  Id. at *2.  This one-month contract was not formally tied to or contingent on the Mirant contract.  Id.  Leading up to the March 30, 2001 contract, the SP15 price fluctuated between a peak high of $280 to a low of about $80, due to the California energy crisis.

During the April 2001 sale to Mirant, Southern California had no authority to sell energy at market-based prices.  In July 2002, it applied to the Commission for such authority.  Mirant intervened, seeking a refund and arguing that the April 2001 sale was itself at market-based rates.  Id.  FERC granted Southern California the requested authority prospectively, but initiated an inquiry into the April 2001 sale.  Southern California defended the sale on the ground that the rates were not "market-based" but "cost-based," falling within the WSPP Agreement’s cost-based limit — its provision that prices must not "exceed the Seller’s forecasted Incremental Cost" plus a so-called "adder."  Id.  The Agreement defines the term "incremental cost" as "[t]he forecasted expense incurred by the Seller in providing an additional increment of energy or capacity during a given hour."  Id. at *2-3, citing Western Systems Power Pool Agreement § 4.9, J.A. 219. 

Southern California argued that the relevant incremental cost was SP15, the price it would pay IEP for the last unit needed to meet the obligation to Mirant whenever its total sales commitments exceeded the 27 MW that it could count on from its contracts with Dynegy and Mirant. Id. at *2.  FERC rejected this argument and determined that the sale was at market-rates, and was therefore unauthorized.  The Commission ordered a refund of the difference between the revenue collected under the contract and $95/MWh (the price under Southern California’s contract with Mirant), plus interest. Id.

In denying rehearing, FERC explained that the SP15 was not the "incremental cost" under the WSPP Agreement because SP15 "would only be [Southern California’s] incremental cost once the sale to Mirant is consummated." Id., citing to Rehearing Order, 108 FERC at P 14, p. 62,022.  FERC’s decision was based on the argument that Southern California "simply resold" to Mirant the same energy that it bought, and that the incremental cost could not have been SP15 because SP15 exceeded its sale price of SP15 minus $20/MWh. Id., citing 108 FERC at P 14, p. 62,022 & P 17, p. 62,198.  In a later order, FERC reduced the refund by the amount of an "adder," which the WSPP Agreement allowed in excess of incremental costs for all sales under the Agreement that were not at market-based rates. Id.  Southern California challenged the Complaint Order and the Rehearing Order as arbitrary and capricious. Id.

Reversing FERC’s orders, the Court found that the Commission failed to adequately explain its conclusion that the price of Southern California’s April sale to Mirant exceeded the cost-based ceiling established by the WSPP Agreement — Southern California’s "forecasted Incremental Cost." Id..  First, the Court rejected FERC’s argument that Southern California "did not procure the energy it sold to Mirant from the sport market, but simply resold the energy it was contractually committed to purchase from Mirant," and that therefore the incremental cost was $95/MWh.  Id. at *4, citing Compliance Order, 106 FERC at P 17, p. 62,198.  The Court found that FERC did not explain how it reconciled this cost concept with the WSPP’s definition of "forecasted expense . . . in providing an additional increment of energy or capacity."  By attempting to attribute a fungible good to particular sources, the Court found that FERC "effectively guts the meaning of incremental cost."  Id.

Second, the Court found similarly unpersuasive FERC’s argument that the incremental cost could not have been SP15, because this would have meant that Southern California was simultaneously buying energy at SP15 while selling it at SP15 minus $20/MWh.  Id. at *5.  FERC had reasoned that if the incremental cost were SP15, a sale below SP15 was necessarily unreasonable from Southern California’s business perspective.  Finding this "transparently wrong," the Court stated that without the Mirant sale Southern California would not have come close to using the entire 27 MW capacity available to it in April under the Dynegy and Mirant contracts.   Id.  As a result of the sales, Southern California could "improve its situation by making additional sales as long as the price was right."   Id.

Finding no rational explanation for FERC’s view that the incremental cost under the WSPP Agreement for the April 2000 sale was $95/MWh, the Court reversed and remanded to the lower court.  The Court noted that if, on remand, FERC found that incremental cost was below SP15 minus $20/MWh, it must address the applicable equitable principles in calculating refunds.  Id.