AEP Texas North Co, et al v. Hudson

United States Court of Appeals
Fifth Circuit
F I L E D
December 21, 2006
Charles R. Fulbruge III
Clerk
REVISED JANUARY 16, 2007
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 05-51755
AEP TEXAS NORTH CO.,
Plaintiff-Appellee,
versus
TEXAS INDUSTRIAL ENERGY CONSUMERS,
Intervenor-Defendant,
versus
CITIES OF ABILENE, BALLINGER, CISCO, SAN ANGELO and
VERNON, TEXAS,
Intervenor-Defendants-Appellants,
versus
THE PUBLIC UTILITY COMMISSION OF TEXAS, ET AL,
Defendants,
PAUL HUDSON, CHAIRMAN OF THE PUBLIC UTILITY
COMMISSION OF TEXAS; JULIE PARSLEY, COMMISSIONER
OF THE PUBLIC UTILITY COMMISSION OF TEXAS; and
BARRY T. SMITHERMAN, COMMISSIONER OF THE PUBLIC
UTILITY COMMISSION OF TEXAS,
Defendants-Appellants.

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2
Appeals from the United States District Court for
the Western District of Texas
(USDC No. 1:04-CV-1069)
_________________________________________________________
Before REAVLEY, STEWART, and CLEMENT, Circuit Judges.
REAVLEY, Circuit Judge:
The issue before us is whether a state regulatory agency may set retail rates
based on its own determination that a utility has not complied with a Federal Energy
Regulatory Commission (“FERC”) tariff. We hold that pursuant to the filed rate
doctrine, federal law preempts state regulators from making a final determination as
to whether a FERC tariff has been violated and from imposing a remedy for an
alleged violation. We therefore affirm.
I.
A. The Merger
Appellee Texas North Company (“TNC”) provides retail electric service
solely in Texas. In 1999, TNC's parent, the Central and South West Company,
merged with the American Electric Power Company (“AEP”). TNC is now one of
nine public utilities owned by AEP.
Before the merger, AEP submitted a merger plan, termed the System

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Integration Agreement (the “SIA”), for approval to FERC. FERC approved the
plan. The SIA is the tariff, or rate schedule, currently filed with FERC.
When the AEP system has an excess of generating capacity, an affiliate of the
utilities, called the AEP Service Corporation (“AEPSC”) sells the excess power at
wholesale. The SIA requires that AEPSC determine the profits from such sales,
called Trading and Marketing Realizations (“TMRs”), “on an hourly basis." The
SIA defines TMRs as "the difference between i) the revenues collected from
Trading and Marketing Activities and ii) the Out-of-Pocket Cost of such Trading
and Marketing Activities and any transmission cost related to such activities."
The SIA then mandates that from sales made by all, AEPSC will distribute
the TMRs between two zones in the AEP system, according to a specific formula.
The distribution occurs in two stages. First, the SIA provides that all TMRs up to a
certain amount (equaling the amount of TMRs that were recorded in a Base Year,
the twelve month period preceding the merger) will be allocated between the former
Central and South West company (now called AEP West) and the former AEP
company (now called AEP East) as they were in the Base Year. This first allocation
favors AEP East. Second, all remaining TMRs are allocated between AEP East and
AEP West in proportion to generating capacity. This allocation favors AEP West.
Therefore, TNC is favored in the second stage of the allocation process.

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4
B. The Commission’s Review
Immediately before Texas moved to a deregulated electricity market in 2002,
the Texas Legislature mandated that the successors of the former public utilities
seek a final reconciliation of their regulated fuel expenses and revenues before the
Public Utility Commission of Texas (the “Commissioners”). According to Texas
law, after costs and revenues are reconciled, the utilities must refund any
over-recovery to the utility's retail ratepayers. 16 Tex. Admin. Code Ann. §
25.236(e) (2002). TNC filed a petition for a final reconciliation in June 2002.
In the first proceeding related to this appeal, the Commissioners found that
the TMR allocations were correctly calculated pursuant to the SIA. On rehearing,
however, the Commissioners disagreed with AEPSC's calculation of TMRs in the
Base Year. AEPSC credited the AEP East companies with the values of "open"
transactions that had not yet been completed, as well as the profits from completed
sales. The Commissioners determined that including the "open" transactions (a
method of accounting known as "mark-to-market") in the Base Year calculations
was not consistent with the SIA, which defined TMRs as the difference between
revenues collected and out-of-pocket costs.
The Commissioners then proceeded to rectify the alleged error in
calculations. The parties in the reconciliation proceeding stipulated that the

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1 16 U.S.C. § 824(b)(1).
5
mark-to-market accounting resulted in $7.9 million less in revenues for TNC. The
Commissioners ordered that TNC reduce its retail rates as if it had received this
revenue. However, AEPSC did not change its method of calculating TMRs.
Because of the lower retail rates, TNC was forced to absorb the difference between
the actual allocation of revenues and the lower retail rates. TNC filed a motion for
rehearing, which was overruled.
TNC filed this action in federal court, challenging the order on preemption
grounds. The district court granted TNC's motion for summary judgment, finding
that the Commissioners' ruling violated the Federal Power Act and the Supremacy
Clause of the U.S. Constitution.
II.
A.
The Federal Power Act (“FPA”) gives FERC exclusive jurisdiction to
regulate the transmission and wholesale sale of electric energy in interstate
commerce.1 The filed rate doctrine, which governs this case, derives from that
jurisdictional grant. "The filed rate doctrine requires ‘that interstate power rates
filed with FERC or fixed by FERC must be given binding effect by state utility

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2 Entergy Louisiana, Inc., v. Louisiana Pub. Serv. Comm'n, 539 U.S. 39, 47, 123 S.Ct.
2050, 2056 (2003) ("Entergy") (quoting Nantahala Power & Light Co. v. Thornburg, 476 U.S.
953, 962, 106 S. Ct. 2349, 2354 (1986)).
3 Entergy, 539 U.S. at 47, 123 S. Ct. at 2056.
4 Nantahala, 467 U.S. at 955, 106 S. Ct. at 2351.
5 Mississippi Power & Light Co. v. Moore, 487 U.S. 354, 357, 108 S. Ct. 2428, 2431
(1988).
6 Nantahala, 467 U.S. at 970, 106 S. Ct. at 2358–59.
7 Entergy, 539 U.S. at 42, 123 S. Ct. at 2053.
6
commissions determining intrastate rates.'"2 The FPA and the Supremacy Clause,
U.S. Const. art. VI, § 2, preempt any state action modifying or overruling a filed
rate.3 Pursuant to the doctrine, the Supreme Court has determined that federal law
preempts states from second-guessing FERC's allocations of electric power4 and
from conducting prudence inquiries into FERC's cost allocations, even when FERC
has not conducted such an inquiry.5 In addition, states are prohibited from “trapping
costs” by setting retail sales at a level that would prevent a utility “from recovering
the costs of paying the FERC-approved rate.”6
In Entergy, the most recent Supreme Court case dealing with the filed rate
doctrine, the Court considered “whether a FERC tariff that delegates discretion to
the regulated entity to determine [a] precise cost allocation. . . preempts a [state
commission’s] order that adjudges those costs imprudent.”7 The Entergy

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8 Id. at 42–43, 123 S. Ct. at 2053–54.
9 Id. at 43, 123 S. Ct. at 2054.
10 The Louisiana Public Service Commission looked only at the time period after August
5, 1997, as FERC had already found that categorizing the ERS units as "available" was reasonable
prior to August 5, 1997. Id. at 44, 123 S. Ct. at 2054.
7
Corporation owned five different public utilities, which could use each other's
excess capacity. The costs of keeping excess capacity available were shared among
the utilities according to a provision in a system agreement, filed with FERC, that
Entergy's operating committee administered. The provision at issue was an
automatic adjustment clause, which under § 205(f) of the FPA allows for increases
or decreases in a utility's paid costs without prior hearings.8 In determining costs,
the operating committee designated certain generating units (called Extended
Reserve Shutdown, or ERS, units) as "available" when those units were actually
shut down, but could be activated in emergencies.9 This designation caused Entergy
Louisiana, Inc., a utility with ERS units, to pay a higher percentage of costs. The
Louisiana Public Service Commission found that although it was preempted from
determining whether the system agreement was violated, it could determine that
Entergy’s expenditures were imprudent because Entergy paid more for possessing
ERS units.10 Thus, the Louisiana Commission did not allow Entergy to increase

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11 Id. at 45, 123 S. Ct. at 2055.
12 Id. at 49–50, 123 S. Ct. at 2057 (“We see no reason to create an exception to the filed
rate doctrine for tariffs of this type that would substantially limit FERC’s flexibility in approving
cost allocation arrangements.”).
13 Entergy, 539 U.S. at 49, 123 S. Ct. at 2056.
14 Id. at 50–51, 123 S. Ct. at 2058.
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retail rates to cover those costs.11
The Supreme Court reversed, holding that the Commission’s prudence inquiry
was preempted even though the proper classification of ERS units was not pursuant
to a specific mandate from FERC, but instead was within the discretion of the
operating committee.12 The Court found that the Commission’s order impermissibly
“trapped costs” by failing to allow Entergy to recoup the costs of paying for the
ERS units.13
B.
Here, we also consider a tariff which designates an agent to perform an
allocation (although Entergy involved an allocation of costs, rather than revenues).
Appellants argue that the instant case can be distinguished from Entergy because in
this case, AEPSC’s interpretation of the formula violated the language of the filed
tariff, an issue which was not before the Court in Entergy.14 They contend that the
Commissioners’ order correctly interpreted the tariff, and therefore fulfilled the

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15 Nantahala Power & Light Co. v. Thornburg, 467 U.S. 953, 966, 106 S. Ct. 2349, 2357
(1986). See also Entergy, 539 U.S. at 50, 123 S. Ct. at 2056 (“It matters. . . only whether the
FERC tariff dictates how and by whom [the] classification should be made.”).
16See Mississippi Power & Light Co. v. Moore, 487 U.S. 354, 374, 108 S. Ct. 2428, 2440
(1988) (“States may not regulate in areas where FERC has properly exercised its jurisdiction . . .
to insure that agreements affecting wholesale rates are reasonable.”).
17 See id. at 2442–43 (1988) (Scalia, J., concurring) (“[W]hether one characterizes the
questions as related to prudence, interpretation [of the basic system agreements], or cost
allocation, they are clearly matters most appropriately resolved by the Commission as part of its
overriding authority to evaluate and implement all applicable wholesale rate schedules.”) (quoting
AEP Generating Co., 36 FERC ¶ 61, 226 (1986)).
18 16 U.S.C. §§ 824d, 824e. See also Mississippi Power, 487 U.S. at 377, 108 S. Ct. at
2442 (Scalia, J., concurring) (“It is common ground that if FERC has jurisdiction over a subject,
the States cannot have jurisdiction over the same subject.”).
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state’s obligation to implement the filed rate.
Although Appellants argue the Commissioners’ order implemented the filed
rate, the entire SIA, not simply the formula in question, is filed with FERC. “[T]he
filed rate doctrine is not limited to ‘rates’ per se.”15 The states are bound to
implement a FERC-approved agreement, and the agreement authorizes only AEPSC
to implement the formula.16
Furthermore, FERC, not the state, is the appropriate arbiter of any disputes
involving a tariff’s interpretation.17 Congress has given FERC exclusive jurisdiction
to determine whether wholesale rates are just and reasonable.18 Additionally, it is
FERC’s duty under the FPA to make an assessment of the broad public interests

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19 See 16 U.S.C. § 824(a).
20 See Appalachian Power Co. v. Public Service Comm’n of West Virginia, 812 F.2d 898,
905 (4th Cir. 1987).
21 Cf. Mississippi Power, 487 U.S. at 375, 108 S. Ct. at 2241 (finding that the “only
appropriate forum” for determining the reasonableness of filed rates and agreements “is before the
Commission or a court reviewing the Commission’s order.”).
22 See 16 U.S.C. § 824e.
23 See Mississippi Power, 487 U.S. at 372, 108 S. Ct. at 2439. Appellants claim that in
this case, no costs were “trapped” because the formula at issue involved the allocation of revenue,
10
involved in determining interstate rates.19 If each state could enforce its own
findings as to the meaning of a filed tariff, in opposition to the conclusions of a
FERC-approved agent, the conflicting interpretations would undermine FERC’s
ability to ensure that a filed rate is uniform across different states, and intrude upon
its exclusive jurisdiction over interstate power transactions.20 Therefore, it is within
FERC’s jurisdiction, not the states’, to make a final determination as to whether the
tariff has been violated. If a state disputes a utility’s interpretation of a tariff, FERC
is the proper forum for resolving the disagreement.21
Finally, the FPA gives FERC exclusive jurisdiction to remedy tariff
violations by providing refunds.22 If states could remedy perceived violations by
setting retail rates based on their own calculations, states could potentially “trap”
costs by prohibiting the utility from passing on the price of FERC-mandated rates to
consumers.23 Thus, the filed rate doctrine requires that the states use AEPSC’s

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not costs. Nonetheless, the result was the same: the utility lost money.
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calculations to set retail rates until FERC resolves any dispute over the tariff’s
interpretation.
III.
We find that the Commission’s actions were preempted by the Supremacy
Clause and the Federal Power Act.
AFFIRMED.

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