Argument Preview

In its merits brief, Morgan Stanley argued that the contracts at issue in this case are governed by Mobile-Sierra, under which the rates in an energy contract are "just and reasonable" in the absence of circumstances requiring the contract to be modified for an unequivocal public necessity. Morgan Stanley challenged the Ninth Circuit's holding that the Mobile-Sierra framework applies only to contracts originally negotiated in a "functional marketplace" with an opportunity for FERC to initially review the contracted rate. A post-hoc assessment of market dysfunction should not invalidate a contract, because such dysfunction is merely one of the risks that the contracting parties allocate in their agreement. Moreover, the "dysfunction" standard is vague and would introduce uncertainty into the market. In this case, although there was evidence of distortion in the "spot market" (contracts for power to be delivered within twenty-four hours), the market for longer-term contracts was competitive and efficient. Contrary to the Ninth Circuit's suggestion, FERC did not approve the contract rates at issue in Mobile or Sierra. It would be duplicative and senseless for FERC to review a contract rate both initially and after a challenge, particularly because FERC already determines that a seller lacks market power or has mitigated its market power before authorizing it to enter into contracts, and the rates negotiated by sophisticated parties with equal bargaining power can be expected to be just and reasonable.

According to Morgan Stanley, the contract it made with Snohomish PUD is valid under Mobile and Sierra because it met none of the Sierra criteria for adverse effect on the public interest (which include impairing the financial ability of the utility to continue service, casting on other consumers an excessive burden, or being unduly discriminatory). Indeed, the contract had only a small impact on consumer rates. Furthermore, by locking in a price for power, the long-term contract protected Snohomish PUD consumers against fluctuations in the spot market, thus serving the public interest. Morgan Stanley also argued that the Ninth Circuit erred in holding that FERC should apply a looser standard for customers complaining of a high rate than when a low rate is challenged.

The brief by Calpine presented arguments similar to those in the Morgan Stanley brief, but also emphasized the connection between predictable enforcement of long-term power contracts and stable energy markets. The Ninth Circuit's decision would discourage the formation of long-term contracts, thus increasing reliance on the volatile spot market and undermining incentives for generators to provide additional power or invest in power generation capacity"”especially during times of scarcity, when markets are mostly likely to be deemed dysfunctional. Calpine also noted that the costs of the inevitable increase in litigation under the Ninth Circuit's approach would fall on consumers.

Despite being named respondent in the case (and having opposed the grant of certioriari), the Federal Energy Regulatory Commission (FERC) filed a merits brief in support of the petitioners. In addition to making arguments similar to those of the petitioners, FERC argued that its original decision to uphold the contracts was entitled to Chevron deference, as an acceptable interpretation of the Federal Power Act's "just and reasonable" standard. FERC suggested that the Energy Policy Act of 2005 ratified the market-based rate system, and also noted that the Energy Policy Act created new tools for FERC to reduce manipulative behavior by energy market participants.

Five amicus briefs were filed in support of Morgan Stanley and Calpine, with several highlighting the undesirable consequences that would stem from undermining the enforceability of long-term power contracts.

Note: Two months after petitioners filed their merits brief, the writ of certiorari was dismissed as to Calpine alone, with the agreement of the other parties. Calpine emerged from bankruptcy proceedings contemporaneously with the dismissal of certiorari.

The respondents PUD of Snohomish County, the Nevada Power Company, the Sierra Pacific Power Company, and the Office of the Nevada Attorney General Bureau of Consumer Protection filed a joint brief. It begins by arguing that Morgan Stanley and the other petitioners have cast the holdings of Mobile and Sierra too broadly and that those cases cannot override either FERC's statutory mandate to ensure just and reasonable rates or its duty to modify any rate found to fail that standard. When FERC applied the Sierra "public interest" standard to the challenged rates instead, it did so without establishing that it had the discretionary authority to do so. Moreover, FERC presumes that the rates arrived at in contracts between sophisticated parties predetermined to lack market power will be just and reasonable. However, this assumption is unreasonable given the pervasive dysfunctions in the western electricity markets at the time, which artificially inflated prices in both the spot market and segments of the forward market. Therefore, to comply with the statutory scheme, there must be at least an opportunity for ex post review of the contract rates to determine if they are just and reasonable, an opportunity which did exist in Mobile and Sierra. Furthermore, contract rates cannot be shielded from this regulatory oversight merely by the terms of the contract. Finally, the policy concerns raised by the petitioners are both insufficient to trump FERC's statutory mandate and misguided: action by FERC to correct market dysfunction and remedy tainted contracts will create greater stability in the market and bolster support for electricity deregulation.

Golden State Water Company (GSWC) also filed a brief as respondent. (Although its contract is not among those included in the grants of certiorari, it was a party below and is thus entitled to file documents at the Supreme Court.) GSWC argued along similar lines as the other respondents that FERC had neglected its statutory obligation to assure just and reasonable rates when it chose to analyze the contracts under its interpretation of Mobile and Sierra. GSWC highlighted that in December 2000, FERC urged utilities to enter into long-term contracts and specifically announced that it would be "vigilant" in monitoring for exercise of market power and would use a benchmark price as a reference point in handling complaints regarding those contracts. Despite entering into a contract similar to the benchmark but for a much higher price, GSWC was denied relief by FERC. FERC concluded that GSWC's customers were not subject to an "excessive burden" "“ a finding that, GSWC argues, was unreasonable given that its customers experienced an average rate increase of thirty-eight percent as a direct result of the disputed contract.

The Public Utility Commission of California and the California Electricity Oversight Board also filed a respondents' brief as intervenors of right, representing the interests of the California public. They argue that FERC is required to allow at least opportunity for determining if a rate is just and reasonable, and neither the ex ante approval of sellers as lacking (or having mitigated) market power nor the formation of the disputed contracts constitutes such an opportunity. Here, the rates were unjust and unreasonable at the time of contract formation (rather than becoming so later, due to changes in market conditions), but FERC refused to provide any opportunity for review of their reasonableness. Moreover, having disputed below that the "just and reasonable" standard even applied, only in its filings before the Supreme Court does FERC claim to have applied that standard, and an agency decision can only be evaluated on appeal by the reasoning originally used.

Eight amicus briefs were filed in support of the respondents, many of which argued that FERC's approach to reviewing these contracts is not entitled to Chevron deference.

In their reply briefs, FERC and the petitioners argued that although FERC used language carelessly in describing its standard of review for the contract rates, it had applied the Mobile-Sierra public interest standard, which is one version of the statutory "just and reasonable" standard. They reiterated that a contract rate negotiated by the parties is likely to be just and reasonable, without the need for ex ante review of the rate by FERC. As to ex post review, it would both undermine the market-based rate system to modify these contracts and would not be appropriate when there was no evidence that these particular contracts were formed in a dysfunctional market.

Chief Justice Roberts and Justice Breyer took no part in the consideration of the petitions for certiorari in this case. It is therefore likely that they will recuse themselves from the decision on the merits as well.

Posted in Morgan Stanley Capital Group, et al. v. Public Utility 1, Everything Else