United States: Court of Appeals Holds that SMUD Has No Contractual Right to Transmission Service

A recent case arising out of the California electricity transmission industry presented an important question for California electricity municipalities. In Sacramento Mun. Util. Dist. v. F.E.R.C., ---- F.3d ----, No. 04-1171, 2005 WL 2848964 (D.C. Cir. Nov.1, 2005), the legal issue was whether the Sacramento Municipal Utility District (SMUD) had a right of first refusal to extend current electricity transmission capacity contracts with California utilities pursuant to FERC Order 888, or whether that right was effectively eliminated when FERC approved the California ISO Tariff in 1996.¹ FERC denied SMUD’s request for relief, holding that such a right was superseded when the California ISO Tariff failed to include such a provision. See id. at *1. SMUD sought judicial review in the United States Court of Appeal for the District of Columbia Circuit. The Court affirmed FERC, ruling that the Commission engaged in a straightforward application of the relevant Tariffs and orders. Id. at *3.

Dating back to 1967, SMUD has been meeting its customers’ demand by purchasing electricity from outside its control area. Id. at *1. To ensure adequate transmission capacity to deliver the power, SMUD signed contracts with utilities guaranteeing two hundred megawatts of firm transmission capacity at any time during the duration of the contract. Id.

This arrangement changed in 1996 when FERC issued Order 888 requiring the utilities to grant competing generators "open access" to the utilities’ transmission lines. Id. at *1. FERC, however, recognized that power purchasers like SMUD might be at a bargaining disadvantage under "open access" rules since they had an obligation to provide electricity to their customers. See Order No. 888, F.E.R.C. Stats. & Regs. at 31,662-63. So the Commission required the utilities to adopt provisions in their Tariffs granting SMUD a right of first refusal to continue service upon termination of the contracts. SMUD, 2005 WL 2848964 at *1. This guaranteed SMUD access to the same transmission capacity after its contract ended so long as it would pay the current "just and reasonable" market rate. Id.

Meanwhile, California deregulated its energy sector and created the California ISO to oversee the state’s transmission grid. Id. at *2. The ISO changed the way transmission rights were allocated by moving away from the system of long-term capacity contracts and instead opting for a system that allocated transmission capacity in real-time transactions. Id. FERC approved the ISO Tariff, finding it consistent with the broad non-discrimination goals of Order 888, and ordered all existing contract holders to accept the new ISO transmission allocation rules upon termination of their contracts. Id.; see Pacific Gas & Elec. Co., 81 F.E.R.C. ¶ 61,122, 61,435 (1997). Of critical importance was the fact that those new rules included no right of first refusal provision for entities like SMUD. SMUD, 2005 WL 2848964 at *2. Finding that discrete transmission contracts would be inconsistent with a system of allocation of transmission rights in real time, FERC struck the provision in the California utilities’ Tariffs granting SMUD a right of first refusal. Id. FERC did, however, recognize that the real-time system posed a risk of increased prices for long-term contract holders. Id. at *3. It therefore required the ISO to submit a proposal to hedge this risk but took no final action before wrapping the proceeding into a market redesign proceeding after the energy crisis. Id.

When SMUD’s contract was set to expire, it sought to exercise its right of first refusal to continue to use its two hundred megawatts of transmission capacity. Id. The utilities refused, prompting SMUD to file a complaint with FERC. Id. FERC denied relief, holding that the California ISO Tariff superseded the right of first refusal contained in the utilities’ Tariffs. Id. Since the California ISO Tariff included no such provision, SMUD no longer had such a right and would have to take transmission under the real-time transmission allocation system. Id.

The Court of Appeals denied SMUD’s petition for review and affirmed FERC, holding that FERC’s decision was not arbitrary and capricious. Id. Rather, FERC had "engaged in a straightforward application of the relevant Tariffs and orders. Even before the ISO commenced operations, the California utilities’ open access Tariffs had been stripped of their right of first refusal provisions." Id. The Court found that SMUD was ultimately challenging the validity of the California ISO Tariff, by asserting that the California ISO Tariff’s system of congestion pricing failed to provide a service "that is as good as or superior to that under the Order No. 888 pro forma Tariff." The Court rejected this argument as "an impermissible collateral attack on the previously approved California ISO Tariff." Id. at *4.

This decision makes it clear that SMUD and other California municipal utilities must use the California ISO’s system of real-time transmission allocation to acquire transmission capacity rights.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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