Mobil Pipe Line Company v. FERC

Filing

OPINION filed [1369158] (Pages: 13) for the Court by Judge Kavanaugh [11-1021]

USCA Case #11-1021

Document #1369158

Filed: 04/17/2012

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 17, 2011

Decided April 17, 2012

No. 11-1021
MOBIL PIPE LINE COMPANY,
PETITIONER
v.
FEDERAL ENERGY REGULATORY COMMISSION AND UNITED
STATES OF AMERICA,
RESPONDENTS
CANADIAN NATURAL RESOURCES LIMITED, ET AL.,
INTERVENORS

On Petition for Review of an Order of the
Federal Energy Regulatory Commission

Joseph Guerra argued the cause for petitioner. On the
briefs were James F. Bendernagel, Jr., Lorrie M. Marcil,
Christopher M. Lyons, and Eric D. McArthur.
Lona T. Perry, Senior Attorney, Federal Energy
Regulatory Commission, argued the cause for respondents.
With her on the brief were Robert H. Solomon, Solicitor, and
Judith A. Albert, Senior Attorney. Robert J. Wiggers and
John J. Powers, III, Attorneys, U.S. Department of Justice,
entered appearances.

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Marcus W. Sisk, Jr., Frederick G. Jauss IV, and James H.
Holt were on the brief for intervenors Canadian Natural
Resources Limited, et al. in support of respondents.
Before: SENTELLE, Chief Judge, and GRIFFITH and
KAVANAUGH, Circuit Judges.
Opinion for
KAVANAUGH.

the

Court

filed

by

Circuit

Judge

KAVANAUGH, Circuit Judge: Congress has directed the
Federal Energy Regulatory Commission to ensure that oil
pipeline rates are “just and reasonable.” When the market in
which a pipeline operates is not competitive, the Commission
caps the pipeline’s rates. When the market in which a
pipeline operates is competitive, however, the Commission
generally allows the pipeline to charge market-based rates.
Mobil owns and operates the Pegasus crude oil pipeline,
which runs from Illinois to Texas. The pipeline transports
mostly Western Canadian crude oil. Out of the 2.2 million
barrels of Western Canadian crude oil produced each day,
Pegasus transports only about three percent – about 66,000
barrels each day.
In light of the competitiveness of the Western Canadian
crude oil market and Pegasus’s minor role in it, Mobil applied
to FERC for permission to charge market-based rates on
Pegasus. FERC’s expert staff examined the market and
deemed this case a “slam dunk” for allowing Mobil to charge
market-based rates. But the Commission itself came out the
other way and denied Mobil’s application on the ground that
Pegasus possessed market power.

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We conclude that the Commission’s decision was
unreasonable in light of the record evidence. The record
shows that producers and shippers of Western Canadian crude
oil have numerous competitive alternatives to Pegasus for
transporting and selling their crude oil. Pegasus does not
possess market power. We grant Mobil’s petition for review,
vacate FERC’s order, and remand to the Commission for
further proceedings consistent with this opinion.
I
A
Congress has directed FERC to ensure that oil pipelines
charge “just and reasonable” rates. 49 U.S.C. app. § 1(5)
(1988); see Frontier Pipeline Co. v. FERC, 452 F.3d 774, 776
(D.C. Cir. 2006).
To implement that command, the Commission regulates
rates via an indexing system. See Revisions to Oil Pipeline
Regulations Pursuant to the Energy Policy Act of 1992 (Order
No. 561), 58 Fed. Reg. 58,753, 58,754 (Nov. 4, 1993). Under
FERC’s indexing system, an oil pipeline must establish an
initial baseline rate with the Commission. 18 C.F.R.
§ 342.1(a). That rate is usually determined by a pipeline’s
cost of providing service, including a reasonable return on
investment. 18 C.F.R. § 342.2; see also 58 Fed. Reg. at
58,758. After FERC accepts a pipeline’s initial baseline rate,
the pipeline may increase that rate up to a ceiling set by the
Commission’s indexing formula. 18 C.F.R. § 342.3. FERC’s
indexing system allows oil pipelines to adjust their rates to
account for inflation, while protecting shippers from large rate
increases. 58 Fed. Reg. at 58,758.

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But rates set by indexing “do not function well to signal
individuals how to efficiently respond to changes in market
conditions.” Market-Based Ratemaking for Oil Pipelines
(Order No. 572), 59 Fed. Reg. 59,148, 59,150 (Nov. 16,
1994). To address that shortcoming, FERC may authorize
pipelines to charge rates established by market competition
instead of indexing. See 18 C.F.R. §§ 342.4(b), 348.1, 348.2.
Market-based rates “can result in pricing that is both efficient
and just and reasonable.” 59 Fed. Reg. at 59,150.
A pipeline does not have a unilateral right to charge
market-based rates. Rather, in order to charge market-based
rates, a pipeline must obtain approval from the Commission.
See 18 C.F.R. §§ 342.4(b), 348.1, 348.2.
FERC Order No. 572 guides the Commission’s
consideration of applications for market-based rate authority.
59 Fed. Reg. at 59,149. Under Order No. 572, FERC’s
inquiry centers on whether a pipeline possesses market power.
Id. at 59,150. To qualify for market-based rate authority, a
pipeline must demonstrate that it lacks market power in its
product and geographic markets. 18 C.F.R. §§ 342.4(b),
348.1(c)(1), (2). FERC has said that market power is “the
ability profitably to maintain prices above competitive levels
for a significant period of time.” See Department of Justice &
Federal Trade Commission, Horizontal Merger Guidelines
§ 0.1 (rev. ed. 1997); see also Mobil Pipe Line Co., 133
FERC ¶ 61,192, at 61,950-51 (2010); Explorer Pipeline Co.,
87 FERC ¶ 61,374, at 62,392 (1999); SFPP, L.P., 84 FERC
¶ 61,338, at 62,497 (1998). As that standard formulation
suggests, FERC has decided to adhere to well-settled
economic and competition principles in determining whether
an oil pipeline possesses market power.

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B
Pegasus is an 858-mile, 20-inch-diameter crude oil
pipeline owned and operated by Mobil. Until April 2006,
Pegasus transported about 66,000 barrels of crude oil per day
from Nederland, Texas, to Patoka, Illinois.
Rapid
development of the Western Canadian oil sands, however,
made transportation of Western Canadian crude oil to new
markets an attractive proposition. To take advantage of that
opportunity, in April 2006, Mobil reversed the direction of the
flow of crude oil on Pegasus so that it could transport Western
Canadian crude oil southward.
Pegasus now transports almost entirely Western
Canadian crude oil from Illinois to Texas. The crude oil
comes to the Pegasus pipeline in Illinois by pipelines from
Western Canada. Importantly, Pegasus transports only about
66,000 barrels of Western Canadian crude oil each day –
which is only about three percent of the 2.2 million barrels of
Western Canadian crude oil produced each day.
Mobil filed an application with FERC to charge marketbased rates on Pegasus. The Commission scheduled an initial
hearing before an administrative law judge to determine
whether Pegasus possessed market power. At the hearing,
FERC’s expert staff strongly supported Mobil’s application
for market-based rate authority, concluding that Pegasus’s
origin and destination markets were plainly competitive.
The contested issue here concerns Pegasus’s origin
market. 1
FERC’s expert staff defined that market as
1

FERC recognized that Pegasus’s Gulf Coast destination
market is extremely competitive. Refineries and other entities in
the Gulf Coast that want to obtain crude oil obviously have

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consisting of the competitive alternatives available for
producers and shippers of Western Canadian crude oil to
transport and sell their crude oil. Those alternatives include
local refineries in Western Canada and refineries throughout
Canada and the United States that can be reached by
pipelines.
In arguing that Mobil should be allowed to charge
market-based rates on the Pegasus pipeline, FERC’s expert
staff did not think this a close case. To get a flavor of the
expert staff’s views, we here quote some of their
observations:
•

•

•

•
•

“Staff’s competitive story is that of a competitive
origin market with a small pipeline – the Pegasus
straw – through which producers or shippers can
access refiners in a competitive destination market.”
J.A. 787.
“[T]here is little difference between the destination
market for Pegasus and the origin market. . . . What
we have are two competitive markets . . . .” J.A. 78889.
“[I]f one excludes Pegasus from the analysis and
finds the origin market competitive, then logic
suggests that adding a small player such as Pegasus to
the competitive market will not render the market less
competitive.” J.A. 618.
“[H]ow can a small pipeline exert market power over
a large origin market?” J.A. 617.
“Pegasus clearly cannot be a monopolist for the
transportation” of “Western Canadian crude . . . as the

numerous alternatives to Pegasus-transported crude oil. The
competitiveness of Pegasus’s destination market is not disputed in
this litigation.

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•

•

•

•

•

supply of such products . . . vastly exceeds Pegasus’s
capacity.” J.A. 825.
“[I]t is clear that Pegasus is not a monopolist, nor
does it possess significant market power. It makes no
economic sense for Pegasus to be considered a
monopolist . . . in an expansive geographic market
. . . . Nor does it make economic sense to claim that a
new entrant to a market is a monopolist . . . .” J.A.
714.
“There are no allegations or evidence that the market
associated with the Alberta producing area was not
competitive prior to 2006. The reversal of the
Pegasus line (in 2006) effectively created a new
supplier of crude oil transportation service out of
[that] origin market . . . .” J.A. 628.
“As Staff developed its analysis, it seemed illogical
that when we looked at the competitive alternatives
that Western Canadian producers had to dispose of
their crude oil, they faced a very unconcentrated set
of destinations until Pegasus reversed its flow. How
can these same producers (or producer-shippers) be
said to face a less competitive set of alternatives when
they have an additional outlet, albeit small, for their
crude oil?
Logic would dictate the opposite
conclusion.” J.A. 791.
“[T]hese very alternatives were available to the
Western Canadian . . . shippers prior to the 2006
reversal of the Pegasus line, and are still being used.
It is difficult to believe that these alternatives, given
current usage, are no longer viable or competitive
. . . .” J.A. 728.
“[I]t is literally impossible for a recent entrant to be a
monopolist if it is entering an already established
market.” J.A. 640.

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Despite the force of the conclusions reached by FERC’s
expert staff, the Commission denied Mobil’s application for
market-based rate authority. FERC reasoned that Pegasus
possessed market power in its origin market. Indeed, FERC
actually concluded that Pegasus had a 100 percent market
share in that market.
Mobil timely petitioned for review in this Court. We
assess FERC’s order under the Administrative Procedure
Act’s arbitrary and capricious standard. That standard
requires that FERC’s decision be reasonable and reasonably
explained.
II
FERC denied Mobil’s application for market-based rate
authority on the ground that Pegasus possessed market power
in its origin market. Indeed, FERC reached the rather
extraordinary conclusion that Pegasus possessed a 100
percent market share in that market. We find FERC’s
decision unsustainable.
The Pegasus pipeline transports almost exclusively
Western Canadian crude oil. The proper question, therefore,
is whether producers and shippers of Western Canadian crude
oil must rely so heavily on Pegasus for transportation of their
crude oil that Pegasus can be said to possess market power –
that is, whether Mobil could profitably raise rates on Pegasus
above competitive levels for a significant period of time
because of a lack of competition. The answer is an emphatic
no: Pegasus transports only about 66,000 of the 2.2 million
barrels – about three percent – of Western Canadian crude oil
produced each day.

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Market-power analysis focuses on whether there are
alternatives to a firm’s services that constrain its ability to
profitably charge prices above competitive levels for a
significant period of time. The inquiry examines the
alternatives reasonably available to consumers and the crosselasticity of demand – that is, the extent to which consumers
will respond to an increase in the price of one good by
substituting or switching to another. See, e.g., Eastman
Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451,
469 (1992); United States v. Microsoft Corp., 253 F.3d 34,
51-52 (D.C. Cir. 2001) (en banc) (per curiam); FTC v. H.J.
Heinz Co., 246 F.3d 708, 718 (D.C. Cir. 2001); 2B PHILLIP E.
AREEDA, HERBERT HOVENKAMP & JOHN L. SOLOW,
ANTITRUST LAW ¶ 506a (3d ed. 2007); Department of Justice
& Federal Trade Commission, Horizontal Merger Guidelines
§ 1.11 (rev. ed. 1997).
In the crude oil context, because “crude oil in an area
may either be exported out of the area or consumed, i.e.,
refined, in the area,” a pipeline “transporting crude oil out of
an area therefore competes with local crude refineries as well
as with other crude transportation facilities.” DEPARTMENT
OF JUSTICE, OIL PIPELINE DEREGULATION 16 (1986) (footnote
omitted). The competitive alternatives in crude oil pipeline
origin markets thus include: (1) pipelines that transport crude
oil out of the area and (2) local refineries. Id.
Here, in considering the relevant market, FERC’s expert
staff identified many local refineries that process Western
Canadian crude oil, as well as several pipelines that move
Western Canadian crude oil to other refineries in Canada and
the United States. As the staff noted, the critical statistic is
that about 97 percent of Western Canadian crude oil gets to
refineries by means other than Pegasus.

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Given that eye-opening 97 percent figure, Mobil rightly
asks: How can Pegasus be said to possess market power over
producers and shippers of Western Canadian crude oil when
Pegasus transports only about three percent of Western
Canadian crude oil? FERC has no good answer to that simple
question. And the absence of a good answer is why FERC’s
expert staff concluded that this case was a “slam dunk” for
market-based rates. Tr. of Administrative Hearing at 2216. 2
The hole in the Commission’s analysis is highlighted by
the fact that Pegasus is a new entrant into a previously
competitive market. Before Pegasus started transporting
Western Canadian crude oil in 2006, producers and shippers
of Western Canadian crude oil had numerous competitive
alternatives for transporting and selling their crude oil. When
Pegasus came onto the scene, it simply provided an additional
alternative for Western Canadian crude oil producers and
shippers. Basic economic logic dictates that the introduction
of a new alternative into a highly competitive market further
increases competition; it does not suddenly render a
previously competitive market uncompetitive. 3
2

The Commission, of course, is by no means obliged to heed
the advice of its expert staff. It is “our well-established view that
an agency is not bound by the actions of its staff if the agency has
not endorsed those actions.” Comcast Corp. v. FCC, 526 F.3d 763,
769 (D.C. Cir. 2008) (quoting Vernal Enterprises, Inc. v. FCC, 355
F.3d 650, 660 (D.C. Cir. 2004)); see also Community Care
Foundation v. Thompson, 318 F.3d 219, 227 (D.C. Cir. 2003);
MacLeod v. ICC, 54 F.3d 888, 891 (D.C. Cir. 1995). In this case,
we cite the economic and legal analysis of FERC’s expert staff only
because we find it so persuasive.
3
To be sure, the effect on competition can depend on the new
entrant’s size. But that is not an issue here, as shown by the
statistics on Pegasus’s market share.

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Put simply, we fail to understand how the entry of
Pegasus, which transports only about 66,000 barrels per day,
into a previously competitive 2.2 million barrel per day
market makes that market suddenly uncompetitive. As
FERC’s expert staff explained, “If you evaluate the market
with no Pegasus, and it’s clearly competitive, adding one
more option can’t possibly make the market less
competitive.” Tr. of Administrative Hearing at 2216. The
Commission’s contrary conclusion is analogous to saying that
a new shoe store in a city has monopoly power even though
there are already numerous shoe stores in the same city. That
doesn’t make much sense.
The Commission may have been led astray by its
assessment that Mobil, if granted market-based rate authority,
could raise rates on Pegasus by 15 percent or more. But the
Commission calculated that figure by using Pegasus’s
regulated rate as the baseline. As FERC’s expert staff
explained, the 15 percent figure demonstrates only that
Pegasus’s regulated rate is below the competitive rate. The
regulated rate does not reflect Pegasus’s full value to Western
Canadian crude oil producers and shippers. Therefore, the
possibility that the market rate might be higher than the
regulated rate does not show that Pegasus possesses market
power.
FERC also seemed concerned that producers and shippers
of Western Canadian crude oil could obtain higher prices on
the Gulf Coast, thereby giving Pegasus undue leverage over
producers and shippers of Western Canadian crude oil who
sought that particular outlet. It is true that Pegasus is the
primary avenue for producers and shippers of Western
Canadian crude oil to get their crude oil to Gulf Coast
refineries. But from the perspective of producers and shippers
of Western Canadian crude oil, there is nothing unique about

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Gulf Coast refineries, as distinct from other refineries
available to them in Canada and the United States. See
Williams Pipe Line Co., 71 FERC ¶ 61,291, at 62,131 (1995)
(“the real economic concern of shippers is the delivered
product and its price rather than whether the product travels
between specific locations via pipeline”). The overall picture
here, as FERC’s expert staff emphasized, is one of robust
competition for Western Canadian crude oil: Producers and
shippers of Western Canadian crude oil have numerous
competitive alternatives to get their crude oil to refineries. If
Pegasus raised its rates above competitive levels, then
producers and shippers of Western Canadian crude oil would
choose one of the many alternative outlets available to them.
Those other outlets thereby constrain the rates that Pegasus
can charge. There is thus no plausible way, as we see it and
as FERC’s expert staff saw it, to say that Pegasus holds a
hammer over Western Canadian crude oil producers and
shippers.
Moreover, contrary to FERC’s suggestion, short-term
price variations – which may temporarily make Gulf Coast
refineries (and thus Pegasus) an attractive outlet for Western
Canadian crude oil producers and shippers – are consistent
with competition. See Blumenthal v. FERC, 552 F.3d 875,
883 (D.C. Cir. 2009); Edison Mission Energy, Inc. v. FERC,
394 F.3d 964, 969 (D.C. Cir. 2005); Interstate Natural Gas
Ass’n of America v. FERC, 285 F.3d 18, 32 (D.C. Cir. 2002);
see also Explorer Pipeline Co., 87 FERC ¶ 61,374, at 62,392,
62,394 (1999); Longhorn Partners Pipeline, L.P., 83 FERC
¶ 61,345, at 62,380 (1998); Williams Pipe Line Co., 71 FERC
at 62,145; Williams Pipe Line Co., 68 FERC ¶ 61,136, at
61,658 (1994). As FERC has previously explained, shortterm price variations that result in regional price differentials
do not establish market power. See Explorer Pipeline Co., 87
FERC at 62,394 (“Differential pricing, when constrained by

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effective competition, can materially improve the efficiency
of transportation markets by allocating capacity to those
shippers who value it the most, particularly in markets
involving different degrees of geographic or seasonal
variation.”); Longhorn Partners Pipeline, L.P., 83 FERC at
62,380 (“[A]ny price differential between the origin and
destination markets does not confer monopolistic power upon
[the pipeline], but rather it promotes competition.”).
In sum, when an agency is statutorily required to adhere
to basic economic and competition principles – or when it has
exercised its discretion and chosen basic economic and
competition principles as the guide for agency
decisionmaking in a particular area, as FERC did in Order No.
572 – the agency must adhere to those principles when
deciding individual cases. Here, 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. As we have explained, the
record thoroughly undermines FERC’s conclusion. The
Commission’s decision thus cannot stand.
***
We conclude that the Commission’s denial of Mobil’s
application for market-based rate authority was unreasonable
on the facts and evidence before it. We grant Mobil’s petition
for review, vacate FERC’s order, and remand for further
proceedings consistent with this opinion.
So ordered.

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