PREFERENCE CUSTOMERS AHEAD ON POINTS? THE NINTH CIRCUIT UPHOLDS BPA-ALCOA CONTRACTS, BUT DISSENT CASTS DOUBT ON FUTURE DSI DEALS

October 16, 2012

The U.S. Court of Appeals for the Ninth Circuit today upheld the Bonneville Power Administration's ("BPA") current contract with Alcoa's Intalco Works aluminum smelter near Ferndale, Washington. While providing some short-term comfort to Intalco, the decision, Alcoa, Inc. v. BPA is notable for the pall it casts on future DSI contracts, especially through Judge Carlos T. Bea's strongly-worded partial dissent.

The Alcoa decision is the latest skirmish in a long-running legal war between Direct Service Industries ("DSIs"), the large industrial power users eligible to receive power directly from BPA under the Northwest Power Act, and BPA's other customers, especially "preference customers." BPA's preference customers are publicly-owned utilities such as PUDs, municipal power agencies, and rural electric coops entitled to receive power from BPA at its lowest cost-based rates, referred to as the "PF rate." At base, the preference customers believe that, to the extent BPA offers subsidized power to the DSIs, those subsidies raise BPA's cost, and the PF rates based on those costs.

Today's Ninth Circuit decision arises on the backdrop of several significant litigation victories preference customers have scored in recent years in the DSI wars. Most notably, in a 2009 decision, Pacific Northwest Generating Cooperative v. BPA, which was substantially amended in 2010, the Ninth Circuit found that BPA is prohibited from providing cash subsidies to the DSIs. In those decisions, the Court considered contracts which provided "monetized" benefits to the DSIs -- that is, cash payments in lieu of physical power -- and concluded that those contracts amounted to subsidies to the DSIs, violating BPA's statutory obligation to operate in accordance with "sound business principles."

Today's decision provides some limited clarification to the PNGC decisions. Specifically, the decision upholds BPA's decision to sell power to Intalco in the short term. In determining that it should enter the short-term contracts, BPA projected it would make a modest profit by selling to Intalco. The court found "sound business principles" do not require BPA to maximize profits by selling into the market rather than selling to the DSIs, even though BPA likely would have generated greater profit by selling into the market. With respect to the longer-term contract originally contemplated by BPA at the outset of the litigation, the majority's decision concludes that, because the events triggering BPA's obligation to enter into the long-term contract have not occurred and BPA does not currently have a proposed contract on the table, the petitioners' challenges to the longer-term contract are speculative and not ripe for judicial resolution.

In parting company with the majority, Judge Bea's partial dissent provides considerable fodder for those seeking to limit BPA's authority to enter future of DSI contracts. At the outset, Judge Bea concludes that, even though a long-term contract is not currently on the table, the court should nonethless address the challenges raised by the petitioners. This is so, Judge Bea concludes, because BPA's long course of conduct suggests BPA will offer contracts to the DSIs on concessionary terms, and, in the Record of Decision underlying the litigation, BPA estimated that the long-term contract it was then considering could increase BPA's costs by $66 million annually for five years, resulting in a 4% rate increase for BPA's preference customers. Further, in Judge Bea's view, the preference customers should not be forced to wait until BPA actually executes such a contract because those customers would then be left without an effective remedy. Remedies available to the preference customers are limited because BPA's DSI contracts now contain a clause absolving the DSIs from any obligation to return overpayments from BPA, an approach upheld by the Alcoa majority. Hence, even if preference customers launched a successful challenge to a future DSI contract, they would be stuck paying for the subsidies created by the contract up until the court ruled.

Judge Bea then explains at length why he would conclude that the long-term DSI contract on terms originally considered by BPA violate the Northwest Power Act. First, in Judge Bea's view, the Northwest Power Act requires that, if BPA elects to sell power to the DSIs, it must sell power at the "IP rate," a rate based on BPA's costs with an additional margin to reflect the costs incurred by industrial customers who purchase from distribution utility rather than directly from BPA. This means that BPA cannot offer a contract to DSIs at a rate lower than the IP rate, and the IP rate must always recover BPA's cost plus the premium required to even the playing field between the DSIs and other industrial customers who do not purchase directly from BPA.

Second, Judge Bea concludes, the phrase "sound business principles" in the statute is intended to limit BPA's authority to sell power at below-cost rates. The statute states that BPA must sell power at "the lowest possible rates to consumers consistent with sound business principles." When read this context, Judge Bea concludes, the phrase limits BPA's authority to sell at below-cost rates rather than expanding its authority to act in any way that can be defended as a "sound" business decision.

Third, Judge Bea concludes, if BPA were to sell power to the DSIs at below-cost rates, the costs would have to be paid by BPA's other customers, in this case resulting in a 4% increase to PF rates. This result, Judge Bea concludes, is also contrary to the Northwest Power Act.

Judge Bea's opinion can be read as a warning shot to BPA. If, in the future, BPA elects to sell power to the DSIs at anything below the IP rate, Judge Bea's opinion provides a statutory roadmap to attack BPA's action. Similarly, if BPA sets the IP rate at anything below what is sufficient to recover its costs and meet the other requirements of the Northwest Power Act, Judge Bea's reasoning would require BPA's action to be overturned.

If you have any questions about the Ninth Circuit's opinion, please contact a member of GTH's Energy, Telecommunications and Utilities practice group. We have years of experience in BPA matters, the Northwest's energy industry, complex administrative matters, appellate litigation, and related fields.