Morgan Stanley Capital Group Inc. v. Public Utility District No. 1 of Snohomish County – Oral Argument – February 19, 2008

Media for Morgan Stanley Capital Group Inc. v. Public Utility District No. 1 of Snohomish County

Audio Transcription for Opinion Announcement – June 26, 2008 in Morgan Stanley Capital Group Inc. v. Public Utility District No. 1 of Snohomish County

del

John Paul Stevens:

I’ll repeat myself.

I didn’t have the mike on.

The Court will hear argument in Morgan Stanley Capital Group, Inc., against Snohomish Public Utility District No. 1, or Public District… Snohomish County No. 1.

Mr. Kneedler.

Edwin S. Kneedler:

Thank you, Justice Stevens, and may it please the Court: The Federal Energy Regulatory Commission in this case reasonably denied Respondent’s request to modify the wholesale contracts that the purchasing power companies had entered into in 2000 and 2001.

The Commission reasonably concluded that Respondents had not made the requisite showing under the Federal Power Act and under this Court’s decisions in Mobile and Sierra that modification of the contracts was necessary in the public interest.

In reaching that conclusion, FERC first drew on three factors that this Court had identified in Sierra and found that they were not satisfied.

Thus, it found that Respondents had failed to show that the contracts would impose financial strain on the purchasing companies; that it would impose excessive burdens on the customers; or that they were unduly discriminatory.

But FERC also looked–

Ruth Bader Ginsburg:

But FERC thought it could live with the Ninth Circuit’s decision, because the government recommended that we deny cert in this case; isn’t that so?

Edwin S. Kneedler:

–That is… that is correct, and FERC thought that perhaps the decision could be limited to the circumstances arising out of the California energy crisis in the years 2000 to 2001, and that it could channel its concerns about contract stability through those other factors.

But, nonetheless, FERC believes, as its decisions make clear and as our position in this Court makes clear, that the Ninth Circuit’s reformulation of the Mobile-Sierra doctrine or interpretation of the act was incorrect.

And, now that the Court has granted review, we urge affirmance of FERC’s decision in this case.

Antonin Scalia:

Wasn’t it clear to the government that the Ninth Circuit, which is what, about 10 percent of the country, was going to continue this interpretation of the act, and that was not a matter of any consequence to FERC or to the government?

Edwin S. Kneedler:

It was of consequence, but FERC still believed it had some interpretive authority after the decision.

Maybe this was a wrong judgment at the time, but FERC thought that it still had some interpretive authority under the decision, and that it could–

Ruth Bader Ginsburg:

But, Mr. Kneedler, this is a decision, the Ninth Circuit decision, that empowers FERC.

FERC says: Oh, we don’t have that authority.

And the Ninth Circuit said: Yes, you do.

So this is an agency arguing that it can’t do what the Ninth Circuit says it can.

And why can it not?

Because of two decisions of this Court.

Is that right?

Edwin S. Kneedler:

–Well, two decisions of this Court and 50 years of intervening FERC, before that Federal Power Commission, practice.

Antonin Scalia:

Well, wait, wait, wait.

It didn’t just say the agency may do it.

It said the agency must do it.

I don’t… I don’t consider “must” to be an empowerment.

I consider that to be a direction.

Edwin S. Kneedler:

Right.

Edwin S. Kneedler:

That… that is correct.

I mean it, I think… I took the question to be that it might give FERC broader flexibility, but at a very substantial cost to the stability of contracts, which was the underlying point that this Court stressed in its decision in Sierra: That the Federal Power Act, unlike… and the Natural Gas Act, unlike the Interstate Commerce Act, contemplates that rates will be set by contract, or at least can be set by contract; and that therefore, like in most situations, a party to a contract cannot unilaterally walk away from that contract or insist upon its modification because it may become disadvantageous over time.

Ruth Bader Ginsburg:

I thought… let’s go back a step.

I thought FERC’s position was: We could not decide as a matter of discretion to do this because we are limited by those Supreme Court decisions.

Edwin S. Kneedler:

Well, FERC–

Ruth Bader Ginsburg:

So it’s not what FERC… FERC independently interpreting the statute to reach the conclusion, which it might, to reach the conclusion the Ninth Circuit did.

It’s FERC saying: We can’t do that because we have our marching orders from the Supreme Court.

Edwin S. Kneedler:

–No.

I think… I mean there are… there are two interpretive questions here: When does the public interest standard identified in this Court’s decisions in Mobile and Sierra apply?

And then there is the further question of what is necessary to satisfy the public interest standard for modifying a contract.

We think on both points the Commission’s decision in this case reflects an interpretive judgment that the Court’s decision, or the interpretation reflected in the Court’s decision, in Sierra applies equally in the market based rate system without any of the… either of the two prerequisites that the Ninth Circuit formulated as a precondition to applying the public interest standard.

And I would point the Court’s attention, in the joint appendix in the Commission’s decision, to joint appendix 1244 and 1245, repeated again at 1572 and 1573; and also the passage quoted in the Morgan Stanley brief at page 17, reflects a determination of what the Commission’s longstanding policy has been that, contracts once entered into, their integrity must be protected and should not be lightly set aside.

And also, the Commission specifically rejected at pages 1564 and 1565 of the joint appendix the prerequisites that the Ninth Circuit came up with in this case, that there must be an opportunity to determine whether the rates were within a zone of just and reasonableness at the time the contracts were entered into in order for Mobile and Sierra to apply.

Under a market based rate system, what FERC does is determine at the outset when an applicant applies for a market based tariff whether that company has market power and if so, whether it’s mitigated.

Only in those circumstances is the company granted the authority to market… to set prices by the market.

Samuel A. Alito, Jr.:

What happens if that approval is given and then a seller enters into contracts and then it’s later discovered that, contrary to what FERC thought when it granted the approval, the seller has exercised market power or has otherwise manipulated the market?

Is there any remedy in that situation?

Edwin S. Kneedler:

Well, what the Commission determined in this case is that there was… there was no manipulation or exercise of market power identified with respect to these specific contracts.

And what the Commission decided was that the importance of the integrity of contracts in that circumstance required that the contract be maintained.

If the Respondents had shown bad faith or something like that in the connection… or fraud in connection with the formation of these particular contracts, that would have been quite a different matter.

It’s also important to note that the Commission found in this case that there was no dysfunction in the forward market, which is what we have here.

What was going on is that there was dysfunction in the spot market in 2000, 2001 for a variety of reasons, some of them going to market fundamentals such as a shortage of generation capacity, a shortage of hydropower.

Anthony M. Kennedy:

Just so I understand your answer to Justice Alito’s question, the Commission has retroactive authority to alter the permission to engage in these contracts only if there is fraud–

Edwin S. Kneedler:

No it can… I’m sorry–

Anthony M. Kennedy:

–or something similar?

Edwin S. Kneedler:

–Once it has granted market based rate authority, FERC can revoke that.

And in fact, companies… there is a triennial review of that–

Anthony M. Kennedy:

Retroactive?

Edwin S. Kneedler:

–Pardon?

Anthony M. Kennedy:

Retroactively?

Edwin S. Kneedler:

No.

It would be revoked–

Anthony M. Kennedy:

But Justice Alito’s question, I think as I understood it, or at least a question in my mind that followed upon it, was whether or not… what’s the basis for any retroactive revocation of that or–

Edwin S. Kneedler:

–No, it wouldn’t be retroactive.

It would be from the date of the complaint that was filed.

Antonin Scalia:

Would it be a public interest finding, a finding that because of the market manipulation by the seller that affected this very contract, the public interest demands that we not hold the–

Edwin S. Kneedler:

Yes.

In that situation there is an important public interest in eliminating fraud.

Antonin Scalia:

–I didn’t say fraud.

I said market manipulation.

Edwin S. Kneedler:

Or market manipulation.

David H. Souter:

Isn’t the remedy for the finding of market manipulation the abrogation of the contract, which is a separate process from, from the revocation of market based tariff?

Edwin S. Kneedler:

There are.

And this is the point I was going to make–

David H. Souter:

The same reason may support each, but–

Edwin S. Kneedler:

–Right.

I was going to make that point in response to Justice Kennedy’s question.

If it turns out that subsequent evidence shows that a particular company has acquired market based power, then FERC can revoke that authority on a going forward basis to continue to sell on that basis.

And in fact, companies are required to report any changes in their circumstances that might affect their market power, and there is a triennial review of that.

But as long ago the market–

Ruth Bader Ginsburg:

Did the companies who were involved in this case make those reports?

I mean, there was something about during this energy crisis there was rampant noncompliance with the filing, with the quarterly report filing.

Edwin S. Kneedler:

–There was, and the Ninth Circuit found that in the Lockyer decision.

But that is the sort of flaw and market oversight that should be addressed directly by FERC.

It shouldn’t be… it shouldn’t be addressed by collateral attacks on contracts that were entered into under the regulatory regime as it existed.

Antonin Scalia:

Mr. Kneedler, I’m not entirely understanding you.

Why should the fact that the seller later acquired market power have anything to do with whether the initial contract, when he did not have market power, was a fair one?

The contracts are already down in black and white, his later acquisition of market power cannot affect–

Edwin S. Kneedler:

No, that is certainly correct.

I think the question, what concerned the Ninth Circuit… actually, the Ninth Circuit wasn’t addressing market power.

Edwin S. Kneedler:

It was addressing the possibility of market dysfunction.

Antonin Scalia:

–I understand.

But later acquisition of market power would result in a cancellation of the permission for this particular firm to enter into contracts for the future, but I don’t see why it would affect the past contracts.

Edwin S. Kneedler:

And we don’t think it should, except to the extent the public interest standard is met.

David H. Souter:

–Maybe I think I led us into this, Mr. Kneedler.

The situation that I was positing was a situation in which the power marketer had engaged in market manipulation in the context of which, at the time of which, it made this contract.

And my suggestion to you, which I think you took, was that in a situation like that there would be a basis for public interest review and abrogation of this contract because of the market manipulation in fact.

And the market manipulation would also be a reason to say market power had been acquired.

It had not been mitigated, and hence, the market based tariff authority would also be revoked.

And that was the, that was the limit of my question.

And I take it your answer there is it could do each of those things?

Edwin S. Kneedler:

Yes.

It could revoke the market based power going forward.

And with respect to manipulation, especially if there was manipulation affecting the particular contract, that would be a basis for finding that the public interest required the contract to be modified.

If I may, I’d like to reserve the balance of my time.

Ruth Bader Ginsburg:

Mr. Kneedler, I do have one question.

It was the position that FERC took in December of 2000, when it was encouraging the entrance into the long term contracts rather than using the spot market, and in that order FERC said that it would monitor long term contracts vigorously for rate reasonableness and that buyers could challenge rates through 206 proceedings.

What happened to that position?

Edwin S. Kneedler:

This is such a challenge, but what FERC has concluded is that the public interest standard has to be satisfied in that situation.

FERC encouraged parties to go into the long term market in order to diminish the market volatility and it would frustrate that encouragement of policy–

Ruth Bader Ginsburg:

And how did FERC monitor the rates vigorously to make sure they were reasonable?

Edwin S. Kneedler:

–There was extensive staff studies and monitoring in subsequent decisions that are, that are shown and that are in the joint appendix, in April… in January and April and June when FERC came up with its final program to mitigate the problems in the spot market.

John Paul Stevens:

Mr. Dellinger.

Walter E. Dellinger, III:

Justice Stevens, good morning, and may it please the Court: Justice Ginsburg began by asking whether the Ninth Circuit decision did not in fact empower rather than restrict the authority of the Commission.

The answer is that the Ninth Circuit decision fundamentally precludes the Commission from carrying out what the Commission believes is essential to its mandate to assure an abundancy of electrical energy at the lowest possible cost.

And that is to encourage a market based approach to recognize that if you’re going to have, as the Commission has said, the kind of investment in the building of infrastructure to produce energy, people are going to have to be able to rely upon long term contracts.

In this case, what the Ninth Circuit’s decision did is to take away a very important option that the Commission believes is essential in times of market volatility and dysfunction.

And that is the option for parties to get out of the spot market and to enter into a long term contract of a secure supply.

If the Ninth Circuit’s decision stood, literally parties, buyers and sellers, would both be precluded from entering into that, because you would know if there were dysfunction that nothing you could say in the contract could mean that you could buy power for the next eight years at $105 at a time, as was the case here, when the spot market was $300.

It would take away the option.

Walter E. Dellinger, III:

And sellers would know they couldn’t enter into a contract they could rely upon subject only to being overridden in the public interest, which FERC does.

And that would be very damaging to the very processes which the Commission has used consistent with this Court’s decision of 50 years ago to encourage development in this industry.

Ruth Bader Ginsburg:

Well, those decisions are puzzling transposed to this setting, because in those decisions it was the seller who had made a bad bargain; the price was too low; and the seller wanted to get out, right?

Walter E. Dellinger, III:

Yes.

Ruth Bader Ginsburg:

And now we are transposing that.

And one of the main themes I think of Justice Harlan’s decision was this Act was meant to protect the consumer, to make sure that the consumer wasn’t going to be overcharged.

And that runs through those two 1956 decisions, at a time when there was no market based authority, or any such, right?

Walter E. Dellinger, III:

Well, yes.

Justice Ginsburg, that is correct.

That was a case where a seller was seeking to get out of a contract that was paying too low.

But the fundamental purpose… the Court recognized even in Justice Harlan’s opinion that maintaining the stability and expectation of contracts was going to be important to consumers, to buyers as well as to sellers.

In this… and FERC has adopted that position.

In this case you have a situation where the Commission decided that instability in the spot markets was being partly caused by the fact that the State regulatory process had discouraged people from entering into longer term contracts; and FERC said in its 2000 San Diego order, we strongly urge utilities to move their load to long term contracts of two years or more.

Ruth Bader Ginsburg:

That’s the same order where they said we are going to monitor the rates for reasonableness.

Walter E. Dellinger, III:

That is true.

And when they did indeed undertake a review of this, they decided that with respect to these contracts there was no evidence of bad faith.

There was no evidence of unfairness.

There was no evidence of duress.

There was no evidence of any market manipulation that affected the contracts specifically in these long term cases.

The long term contracts were part of the solution or the mitigation of the problem.

It was a long term contract that allowed the utilities in this case to get out from under $300 a megawatt prices and to enter into a contract at 105, in one of the cases.

John Paul Stevens:

Can I ask this question?

Assuming there is absolutely no bad faith or fraud or anything like that, but there is just a general conclusion that the market was such… in such turmoil that there could not be made reasonable or long term contracts, because the predicate for that kind of negotiation just didn’t exist.

Would that be a basis for setting aside the contract?

Walter E. Dellinger, III:

No; and it’s very important that not be a basis, because if that were the case, parties would know and parties… both… all parties were aware that there was volatility, and the Commission had announced that the conditions were conducive to manipulation of the spot markets.

That would mean that a seller would say to a buyer, we know you would like to get out of this volatility and get a regular supply guaranteed at a… at a much lower price for long term.

We can’t enter into that contract, because the fact that we know there has been this problem in the market means that our contract won’t be upheld.

Now, the Ninth Circuit decision says that contract terms are not binding if they were influenced by a dysfunctional market; and that is the very most important circumstance in which having long term contracting is most valuable.

Anthony M. Kennedy:

Is volatile the same as dysfunctional?

Walter E. Dellinger, III:

Justice Kennedy, I don’t know precisely what the Ninth Circuit means by dysfunctional.

Walter E. Dellinger, III:

There is volatility.

I think the difference would be is there manipulation, is one factor; there were a number of factors that caused the volatility here–

John Paul Stevens:

Mr. Dellinger, does that mean that it is your position that no matter how dysfunctional the market was, just complete turmoil, as long as the contract was made in good faith without any fraud or abuse of power, it’s a binding contract?

Walter E. Dellinger, III:

–That is correct, unless… and this is an important unless… the Commission reviews those contract terms and finds that the public interest necessitates a revision of the contract.

They have that discretion.

They have that authority.

They are prepared to and have exercised it, but in… in this case–

Antonin Scalia:

For example–

Walter E. Dellinger, III:

–For example–

Antonin Scalia:

–For example, if the prices down the road turn out to be so high for the utility, that the utility would go out of business?

Walter E. Dellinger, III:

–That is an example that the Court gave in Mobile and… and Sierra.

But the Court… but what the Commission would know is that the circumstances would have to be rather extraordinary.

Because whenever you were to modify the terms of a contract that the sellers have been relying upon, the sellers became buyers.

They also went out on the market.

They are buying and selling.

So unraveling all of these buying and selling would itself be… would be dysfunctional; but what sellers would know thereafter is that they couldn’t rely upon the contracts.

They would either have to stay out of that market or they would have to charge a risk premium, which would raise prices to buyers and consumers.

So that long run harm of making it less reliable to engage in contracting would have to be overcome by a fairly severe showing of what the short term harms would be to one particular set of buyers.

The Commission has made those findings.

They found circumstances where the contracts gave first priority to commercial uses of power, and at a time of shortage that meant that residential customers would be cut off.

The Commission ordered that done.

The Commission has been on the job here.

They have… the process by which they grant market based rate authority is an elaborate one.

They get assurances that the sellers lack transmission market power, generation market power, that there are no barriers to entry, that if they have transmission facilities there is open access.

They… any party can challenge that.

And any party in this case, any party in this case–

Ruth Bader Ginsburg:

You said the Commission is on the job, but one of the pieces of information here is that the Commission staff said that the dysfunction in the spot market carried over into the forward market, such that prices in the forward market were inflated.

Walter E. Dellinger, III:

–That is correct.

But what the Commission realized is that the parties were aware of what was going on in the spot market.

They were able to contract on that basis.

Walter E. Dellinger, III:

They could have asked for what’s called a Memphis clause, giving either party the right to seek modification based on some administrative determination of what a right price would be at some later point.

They did not.

They kept in the clauses that allowed only joint approaches to the Commission, and indeed in one contract said that the rates are fixed and shall remain in effect for the terms of this agreement.

That language is illustrative of how you could not enter into a long term contract and assure that the terms were binding.

The fact that–

Antonin Scalia:

I don’t understand what that statement means, anyway.

The current dysfunction carries over into… into the future market?

What does that mean?

Walter E. Dellinger, III:

–Right.

Well–

Antonin Scalia:

Does it mean that because of the current dysfunction, you can’t predict for sure what the rates are going to be down the road?

Of course it means that.

But doesn’t a dysfunction always mean that?

Walter E. Dellinger, III:

–Yes.

Dysfunction–

Antonin Scalia:

And isn’t that why you enter into long term contracts?

Walter E. Dellinger, III:

–Yes.

Yes.

Antonin Scalia:

Because given the current dysfunction you have no idea what the price is going to be down the road.

Walter E. Dellinger, III:

That’s exactly right.

Ruth Bader Ginsburg:

Mr. Dellinger, wasn’t the staff saying something more than that in that… in that report?

Walter E. Dellinger, III:

I don’t… I don’t know what you’re intimating, but what the conclusion was of the Commission was, for example, that there was no basis to support a finding that the Respondents exercised market–

Ruth Bader Ginsburg:

But the Commission didn’t… didn’t respond to the staff report, right?

Didn’t say anything one way or another about it.

Walter E. Dellinger, III:

–Well, the Commission expressly said with respect to the… to the staff report that there was no evidence of any manipulation.

Ruth Bader Ginsburg:

Did they say it with respect to the staff report?

Or… I thought they thought the staff report was irrelevant?

Walter E. Dellinger, III:

Yes.

The aspect of the staff report that said that forward prices were influenced by prices in the spot market and that there had been dysfunction was irrelevant precisely because it would have been relevant were the Commission making its own bureaucratic determination of a right price.

But the parties made the determination of the prices that they wanted to agree to, the terms they wanted to agree to, and they did so with full knowledge both that they knew there had been some manipulation, that there was volatility and that they knew they didn’t know, as Justice Scalia, said the extent of it; and, therefore, that’s precisely why you want to be involved in a contract that guarantees you today that, no matter what happens to prices in the next year or next summer, one of these… one of these utilities has a guarantee of power at $105.

Walter E. Dellinger, III:

I will reserve my time for Mr. Kneedler, unless there are questions.

No, I’m not.

He is going to do a rebuttal, whatever amount of time we have, Justice Stevens–

John Paul Stevens:

All right.

Walter E. Dellinger, III:

–unless there are further questions.

Thank you.

John Paul Stevens:

Mr. Wright.

Christopher J. Wright:

Thank you, Justice Stevens, and may it please the Court: I’d like to start off by picking up on Justice Ginsburg’s observation that FERC understood itself to be without discretion here, and add the point that this is an extremely unusual case where FERC thought it lacked discretion to apply the statute.

In the briefs, there is now agreement that the just and reasonable standard applies to all rates under the Act and couldn’t be more clear that the just and reasonable standard applies.

FERC–

Samuel A. Alito, Jr.:

Among your arguments, and the arguments of the Respondent, seems to be in some tension… seems to me in some tension to FERC’s market based rate program.

Do you… do you acknowledge that that is permissible interpretation of the Federal Power Act or not?

Christopher J. Wright:

–I… there is much that we don’t disagree with about the market based rate program.

I suppose we do think that there are two things that FERC has to make sure that it does as part of that program.

First, in… in approving the market based rate program, Judge Douglas Ginsburg said when there is a competitive market, FERC may rely upon market based rates in lieu of cost of service regulations.

That makes perfect sense to us, but when there is a competitive market.

So we think a critical part of a market based rate program is that there must be an inquiry into whether or not the market was competitive when the contract was entered into.

Of course, we have the unusual circumstance here where Professor Kahn and nine other deregulatory economists wrote a letter in May 2001 saying markets are out of control, this is the unusual circumstance where FERC should enter a price cap.

Samuel A. Alito, Jr.:

Isn’t it… isn’t it a central requirement of a market based rate program that FERC cannot, except perhaps in very limited circumstances, go back and undo contracts that had been entered into under that program, based on a retrospective determination that the rates are not just and reasonable, in the same sense that [= FERC] would have applied that term if the utility had simply filed a tariff?

Christopher J. Wright:

Justice Alito, all rates must be just and reasonable.

We are not arguing that FERC needs to go back to a cost of service ratemaking approach; but an agency that sees just and reasonable and thinks it’s applying a just and reasonable standard, for 70 years has thought it’s either going to do a cost of service approach, or more recently it’s going to rely on the market to make rates just and reasonable, our modest point is that it can’t ignore the market.

It–

David H. Souter:

No, but I guess this is what’s bothering us.

Your point does not seem, at least to me, to be a modest point, because if I understand where you’re going, you’re saying that in a market with the degree of volatility of this one at the time these contracts were made, no contract is enforceable.

It will last only so long as… as one party does not complain about a disadvantage, and the minute it does, it’s back in front of FERC.

And the argument is being made that in fact a market based rate cannot be enforced through contract because the very premise… i.e., what you call and what was called a competitive… Judge Ginsburg called a competitive market… was absent.

Isn’t that the consequence of what you’re arguing?

Christopher J. Wright:

–Yes.

Let me make four points here, though, that I think make absolutely clear that it would not set a broad precedent to revisit the contracts here.

And the four points are first, the Government acknowledges in its brief at page 16, this was the worst electricity market crisis in history.

Christopher J. Wright:

Second–

David H. Souter:

Well, how do we know when we’re only in the second worst?

[Laughter]

Christopher J. Wright:

–Well–

David H. Souter:

Well, but I mean the problem is–

Christopher J. Wright:

–No, no–

David H. Souter:

–And I don’t see any… and I realize that you’re giving me limiting principles to what seems to me in effect a general rule that says no contracts are enforceable, if they are made during periods of market volatility, however sensible they may be given the premise of that volatility.

And your first proposal for a limiting principle is this is the worst of times, and I don’t see how that’s going to help because somebody is always going to claim, well, these times are… are almost as bad.

Christopher J. Wright:

–Well, Your Honor, of course the Federal Power Act instructs a Federal agency to ensure that rates are just and reasonable.

A… the Federal Power Act–

David H. Souter:

Look–

Christopher J. Wright:

–The FERC, FERC needs to grapple with this.

David H. Souter:

–That’s a good… I mean that’s a fine general phrase, but the question is, is it possible to make an enforceable contract under these circumstances?

Christopher J. Wright:

Well–

David H. Souter:

I haven’t heard a limiting principle yet.

You have three others.

Christopher J. Wright:

–I have three others.

There was rampant noncompliance with the reporting requirements.

The Government concedes that, too: FERC’s market based rate program, however well it might work today after it’s been improved, as the Government said in its opposition to cert, however well it’s been improved on account of the 2005 amendments–

David H. Souter:

Did these… did… did the Petitioners here… do you claim that the Petitioners here were guilty of failure to report?

Christopher J. Wright:

–Yes.

They… they were not… they were not complying with the… we contend that the reporting requirements that were in effect in 2001 were inconsistent with the statute and not–

David H. Souter:

That’s… that’s a different issue.

That… that may be that the Commission was derelict in… in having a nonstatutory condition.

But did these… did these Petitioners… do you claim, is it a basis for your claim before FERC, that these Petitioners failed to follow the reporting requirements that were in effect?

Christopher J. Wright:

–Our… our basic argument is the rates weren’t just and reasonable–

David H. Souter:

That’s what I thought.

Christopher J. Wright:

–And the rates weren’t just and reasonable on the day the contracts were signed.

And let me make clear–

David H. Souter:

Okay, but here I just want to make sure I understand.

David H. Souter:

You’re saying one… one limiting principle is the re examination of contract might be limited or at least only prompted by a… a failure to follow reporting requirements.

I can understand that and that offhand seems to me perfectly fair.

It may not cover this case, but I can understand that.

What are your other two reasons?

Christopher J. Wright:

–My third is, as Commissioner Massey stated in his dissent, without contradiction by the majority, that if the just and reasonable standard were… would be applied, these rates would be declared unlawful, because they were multiples of traditional prices.

David H. Souter:

Okay, but that seems to me consistent with the problem that I have with your argument.

And that is, if you make a contract in a period of high volatility, and it seems reasonable to the two parties to come up with a rate that is certainly a higher rate than anybody would come up with if they were going through cost plus return ratemaking, the contract is vulnerable.

And it seems to me that Commissioner Massey’s argument is consistent with the conclusion that all those contracts are vulnerable.

So I don’t see that as any limiting principle.

What’s your fourth one?

Christopher J. Wright:

The fourth one is, as Justice Ginsburg has noted, that FERC said in December 2000, before all of the contracts at issue were negotiated, that it would monitor and… and would… deems rates above $74 suspect.

All the contracts in here have rates above that benchmark.

So it’s the worst crisis in history; there’s rampant noncompliance; rates were multiples of traditional pricings, and FERC had said it was going to study these rates closely.

David H. Souter:

Okay, I can understand… under your fourth point, I could understand the position if the argument were this is above $74, and therefore it is suspect; but the claim you’re making, as I understand it, is a much broader claim.

You’re saying the entire contract ought to be abrogated in the public interest, not merely above 74 but below 74.

Isn’t that correct?

Christopher J. Wright:

Well, I’m sorry, Your Honor.

We want this case to be sent back to FERC.

David H. Souter:

And when you get there, you’re saying abrogate this contract.

Christopher J. Wright:

We are saying reduce the rates, and–

David H. Souter:

Are you saying… have you at any point said reduce the rates to $74?

Christopher J. Wright:

–I’m sure different… there are many different parties on my side.

I’m sure we have many different theories.

Could I tell you what FERC ‘s done with respect to the–

David H. Souter:

I will… I will stop the cross examination, but I just wanted to get the four points.

Christopher J. Wright:

–I appreciate the cross examination.

It’s helped me get out what I think our four points–

Anthony M. Kennedy:

If… if your theory prevails and you go back to the Commission, does the Morgan Stanley contract, where the lower rate seller was, does that get reevaluated, too?

You reevaluate all the contracts back down the line?

Christopher J. Wright:

–Well, I… does Morgan Stanley’s… well, Morgan Stanley actually… a number of parties in Morgan Stanley’s situation chose to file protective actions, and Morgan Stanley didn’t.

Christopher J. Wright:

So I don’t know whether it has waived its rights or not.

But I think FERC ought to grapple with that.

Anthony M. Kennedy:

Let me say that, consistent with your theory, that everybody… that this whole unwinding process backs up all the way down to the original seller?

Christopher J. Wright:

Right.

Well, Your Honor, the way these markets work, there is every reason to think that Morgan Stanley doesn’t have the sort of claim that they have suggested without telling us they have.

And, of course, they know what their portfolio is.

There is every reason to think they bought power before the big spike came, and that they bought power since then, and that they’re not… they’re not buying power at 104 and selling it to Snohomish at 105, Your Honor.

Antonin Scalia:

Well, good for them.

[Laughter]

I mean you’re suggesting they should be punished for that?

I don’t understand what… what follows?

I mean–

Christopher J. Wright:

We’re not, Your Honor, but I would remind you this is a plain language case.

The statute requires rates to be just and reasonable.

That… for 70 years, that’s meant something to administrative agencies.

The reason–

Ruth Bader Ginsburg:

But how would you… how would you go about determining in this case?

You said it’s not the traditional cost of service, return on investment.

So how… if you prevail, what should FERC do to determine whether this rate was fair and reasonable?

Christopher J. Wright:

–Thank you, Your Honor.

We expect that, ultimately, it will do, or should do, what it’s done with respect to the spot market.

With respect to the spot market, it has provided relief to parties who bought at the same time.

And what it has done is it has… it has determined what it calls a mitigated market clearing price.

It has done this with great elaborate… elaboration for periods as low as 10 minutes for the period in 2000… 2001, when it is now conceded manipulation raised rates on the spot market.

And it has taken the prices that were paid, and it has… it has reduced them to what it calls the “mitigated market clearing price”.

This is… this is described in painful detail in the… in the Ninth Circuit’s 2006 CPUC versus FERC opinion.

Antonin Scalia:

–Didn’t your clients know that the market was chaotic at the time they entered into this long term contract?

I mean does this come as a surprise that after the fact, now that you’re paying more than the market price is, you want to kick over a long term contract you entered into?

What has changed?

Did you not know that the market was chaotic?

Antonin Scalia:

Wasn’t that the very reason you entered into the long term contract.

Christopher J. Wright:

Your Honor, we had a sort of a Henry Ford choice.

Any… we had a choice of a variety of rates as long as they were unjust and unreasonable.

We didn’t have any alternative, because of the market manipulation, that allowed us to get a just and reasonable rate on the spot market, on long term markets–

David H. Souter:

You were saying that the most… the most reasonable thing for us to do was to enter into a long term contract in order to mitigate the effects of the chaotic spot market.

You understood that.

Christopher J. Wright:

–In large part, because FERC had told us they were going to monitor these contracts and use the $74 benchmark.

Antonin Scalia:

In fact, you did very well under these contracts.

Initially, you were even reselling some of the energy that you got.

You got it at a price so much below what was then the market that you made a profit by reselling it.

But now that things have changed, you don’t like the long term contract.

Christopher J. Wright:

Your Honor, it’s our position that we have to prove these were just and reasonable on the day they were entered.

And the way these markets work, local utilities like Snohomish buy energy, and they always sell a little bit.

They’re going to lose 153 million over the life of this contract.

And it’s always been the life of the contract that FERC has thought was the… the real benchmark.

David H. Souter:

Mr. Wright, may I go back to your answer to Justice Ginsburg’s question?

She asked you: What do you want FERC to do if it does what you want them to do?

And you said: We want them to make the same kind of adjustments ex post that they made to the spot prices.

Isn’t there one big difference here to… between readjusting spot prices and rewriting or abrogating a contract like this?

In the case of adjusting the spot prices, in effect.

What they are saying is: Somebody isn’t going to make the killing that he thought he was making.

It was… a spot price indicates it was a snap decision.

People were reacting to… to changes in the market from hour to hour.

And the Commission is going to go back and say, you know, you’re out of luck on the killing you thought you made.

When, on the other hand, the Commission, in effect, rewrites or abrogates a contract, it is saying something very different.

It is saying: You may not engage in long term reliance on the agreements that you make.

And isn’t that a huge difference?

Christopher J. Wright:

Your Honor, we think that FERC could, and it seems clear that it will, distinguish between the spot market and long term contracts on these bases.

Our point there is that we probably, if it does, then have to overcome a hurdle and show that there wasn’t effective competition at the time the long term contracts were entered into.

FERC might rationally, once it grapples with this, decide that that’s the way the just and reasonable standard applies.

David H. Souter:

Yes, but with respect, doesn’t that, in effect, mean… going back to your answer to Justice Ginsburg… that what you really want is to say there wasn’t effective competition.

There wasn’t effective competition because the market was chaotic.

And, therefore, in a chaotic market, including this one, a long term contract which later turns out to be disadvantageous to one side is unenforceable.

Isn’t that what you… your real answer to Justice Ginsburg is.

Christopher J. Wright:

Well, Your Honor, again, I don’t think we should prevail, and it’s not our position that we prevail, unless we show that we didn’t have just and reasonable alternatives at the time we entered into the contract.

We don’t think we can–

David H. Souter:

No, but I mean… that’s where I don’t think that, at least with me, helps your argument.

We all know that there is a broad umbrella standard of justness and reasonableness.

One index of justness is the set of conditions under which the parties operate.

The conditions in this case were conditions of chaos.

And what the other side is saying, I think, is: We each tried to make the most reasonable deal we could, the most advantageous for us that we could, under these conditions of chaos.

They certainly produced a rate that wouldn’t have been produced in a calm time either by market based tariffs or by cost plus return ratemaking.

But under the circumstances that we did operate in, this is what it produced.

And we were dealing at arm’s length.

Nobody was engaging in fraud, et cetera.

So that’s just.

And I think when you say, as you did a minute ago, there is an overarching obligation or standard of justness and reasonableness, I think you’re saying that that reasoning that I just tried to outline is not sufficient reasoning for sustaining the contract.

Now, if I’m wrong, tell me.

If I’m right, it seems to me you’re really saying ditch the contracts if they were entered into in a period of high volatility.

Christopher J. Wright:

–Well, Your Honor, let me make clear what… what we mean by “chaos” or “high volatility”.

We think we have to show that manipulation was affecting the market.

We don’t… we don’t think we are entitled to relief if it was the weather that was affecting the market.

FERC’s 2003 staff–

David H. Souter:

Are you entitled to relief if there was manipulation, but these people were not engaging in the manipulation?

In other words, they are, in effect, innocent of the manipulation; but they, as sellers, are in a chaotic market.

Are you entitled to relief against them under those circumstances?

Christopher J. Wright:

–We… we don’t think that a statute that protects consumers and says that consumers get just and reasonable rates was enacted to prevent… to overcome contracts only when there is fraud in the contract.

David H. Souter:

The trouble is that justness is a relational category, and you are… I think you are saying we don’t have to consider justness to the parties who were doing… we will assume for the sake of the question… the best that they could under bad circumstances.

You are saying justness only goes to the ultimate retail ratepayer.

Christopher J. Wright:

Again, Your Honor, we don’t need the statute.

Christopher J. Wright:

The statute is superfluous insofar as it affects contracts, and that is its main effect, if it requires fraud in the negotiation of the contract.

And, again, if Morgan Stanley can show that it was a victim of manipulation, too, then it is entitled to relief.

There has certainly been some of that with respect to some of these spot market deals where there are occasionally intervening parties.

Antonin Scalia:

Mr. Wright, I really don’t understand why you would… why you say, you know, if… if the chaos is due to the weather or maybe, you know, an Arab oil embargo or whatever, that that’s perfectly okay.

But if it’s due to manipulation, it’s bad.

I can understand if you added manipulation by one of the parties, by the sellers, that I could understand.

But so long as it’s a factor extrinsic to the parties to the contract, what difference does it make to the buyer whether the flukishness of the market is caused by the weather or by manipulation by somebody other than the seller?

In other words, I think it’s not enough to show manipulation.

That’s what’s going on in the market.

And you’re trying to save yourself from it.

So long as it’s not manipulation by the seller, I don’t see how you have a… I don’t know… an equitable case.

Christopher J. Wright:

It… on the equities, if the local utilities end up bearing the brunt of making bad judgments about the weather, that’s one thing.

It’s quite another thing if there is rampant non compliance, hiding the fact that there’s been massive withholding of energy, and driving… and these spikes were not accidental, by any means.

That seems to us to be, you know, a… a sort of distinction that the… that the law draws all the time.

And let me say the example came–

John Paul Stevens:

I’m still puzzled by your answer to Justice Scalia.

If, say, it is something like an atom bomb or terrorism or something totally innocent, where the parties are… but it causes the same economic consequence, namely: That the rates are a lot higher than they otherwise would be, why do you draw the distinction that he says doesn’t make sense?

Christopher J. Wright:

–Well, I guess the ultimate distinction is that there isn’t somebody making a whole lot of money on account of market manipulation somewhere.

John Paul Stevens:

No, but in each case the rates would be higher than they otherwise would, and you’d have to say they’re high enough to be no longer just and reasonable.

Christopher J. Wright:

Well, “just and reasonable”, again, has always… has traditionally first meant a sort of cost of service inquiry and more recently means a market inquiry.

But, again, a market inquiry doesn’t… means a competitive market, an effective market, as Professor Kahn said, not a market totally infected by manipulation.

And then, in any case–

John Paul Stevens:

Even if infected by an act of God, it seems to me the same consequence.

Christopher J. Wright:

–I guess consumers bear the brunt of acts of God, but don’t… shouldn’t bear the brunt of market manipulation that was unlawful and now is–

Anthony M. Kennedy:

I think you could argue that it should be just the obverse.

David H. Souter:

Aren’t you really arguing… no, but aren’t you really making the argument that the notion of justness does have an equitable component that looks to the source of the trouble; and if the source of the chaos in the market are the very people who are trying to make a profit on your contract, that is a reason to say that that market based rate is not a just one, because they created the conditions that gave them the leverage to get you to make the deal that you made?

But if they are not guilty of improper conduct in making it, then, you know, everybody has to take his lumps.

Aren’t you saying something like that?

Christopher J. Wright:

–We don’t know because FERC hasn’t looked at it, what… who Morgan Stanley paid and what they paid and who made the money here.

David H. Souter:

No, but just as a general premise, in your answer to Justice Scalia weren’t you assuming something like that?

Christopher J. Wright:

We certainly think that the best result would be that whoever was manipulating the market ought to be the one who ends up getting their return cut; and that the local utilities and any innocent middlemen should be made whole, too.

That’s fine.

It was brought up earlier in discussing the market based rate program sort of what sorts of remedies were allowed.

And let me say that… well, I think this came out, but the Enron example shows very well.

Enron got market based rate authority in 1993.

Enron was not the only player, but was a leading player in the market manipulation in 2000-2001.

FERC didn’t get around to lifting their market based rate authority until 2003, and they did it strictly prospectively.

It is a core point of our argument today that that shouldn’t be allowed.

And I think the answer was: Well, market based rate authority only results in lifting the market based rate authority; a 206 action under the Federal Power Act is where consumers get relief.

That’s right, and we’re here to get relief, and we think that ultimately the parties that manipulated the market and made too much money on account of the manipulation ought to… ought to lose what they paid; and, certainly, the ratepayers shouldn’t bear the costs; and if there are innocent middlemen they shouldn’t bear the cost, either.

David H. Souter:

And, to the extent that you make that argument, that’s an answer, sort of, to the question that I put to you a couple of times: Why, why isn’t your argument anything less broad than the fact that you can’t make a contract in a chaotic market?

And you are, at least as a subset of what you are saying, telling us that if the contract… if the chaos in the market was caused by the impropriety of one contracting party, that party should not profit from it.

And I understand that answer.

That if… to the extent that that is your position, it is an answer to my question.

Christopher J. Wright:

Thank you, Your Honor.

And let me remind the Court that one case that the other side I don’t think has acknowledged sufficiently is this Court’s 1974 Texaco decision.

That was a situation where FERC… well, the Federal Power Commission attempted… attempted to do what the other side is asking this Court to rule today, to essentially make contracts sacrosanct and not subject to any challenge.

FERC had told small producers that it wouldn’t… that they could enter into contracts and they didn’t have to file the contracts, and the Commission wouldn’t review the contracts to see if they were just and reasonable.

This Court very clearly held, quote,

“The Commission lacks authority to place exclusive reliance on market prices. “

unquote.

Under this statute, which requires just and reasonable rates, there must be coexistence between contracts and a regulatory backstop.

And, again, in the situation here that you helped me review… the worst electricity market crisis in history, rampant non compliance, rates that were multiples of traditional levels, and couldn’t be justified under anything FERC has ever called a just and reasonable standard, and FERC had said it was going to examine a benchmark… this is a case that FERC has to go back and explain why, at least explain why it thinks these rates are just and reasonable.

Antonin Scalia:

Just and reasonable when?

Christopher J. Wright:

On the day they were made.

Antonin Scalia:

On the day they were agreed to.

Christopher J. Wright:

And we think they weren’t, because they were the product of market manipulation that made all of the rates available–

Antonin Scalia:

They were just and reasonable–

Christopher J. Wright:

–that made all rates unjust and unreasonable on that date, Your Honor.

David H. Souter:

But I think… and here I want to be clear on this… you’re saying they were not just and reasonable on the date they were made, number one, if the market manipulation that caused the chaos was manipulation by these Petitioners.

David H. Souter:

That at least is part of your argument.

But I think you’re also saying that the rates were not just and reasonable if they were the result of market manipulation by others, not these Petitioners.

Am I correct that your argument is broad enough to encompass the second alternative?

Christopher J. Wright:

Absolutely, Your Honor.

David H. Souter:

Okay.

Samuel A. Alito, Jr.:

And even that argument is much narrower than what the Ninth Circuit held, isn’t it?

The Ninth Circuit just referred to “dysfunction in the market”.

They didn’t say: And dysfunction means manipulation by anybody.

They seemed to have included all sorts of other things: The California regulatory program, the weather, and a number of other factors.

Christopher J. Wright:

Your Honor, we certainly agree that the test can’t be dysfunction; that FERC has to grapple with this issue and give it a concrete meaning.

I’m sure there would be disagreement on remand as to exactly what it means, and there are lines to be drawn.

But FERC needs to do that.

FERC hasn’t done that.

FERC honestly thought… again, this is an unusual case.

FERC honestly thinks that the public interest standard, or thought that the public interest standard, is a completely different animal than the just and reasonable standard.

Antonin Scalia:

–If you are relying on the narrowest ground that Justice Souter mentioned, namely, manipulation by the seller, wasn’t it incumbent on you to demonstrate that there was manipulation by the seller?

Has that been… has that been established?

Christopher J. Wright:

We are relying on both, Your Honor.

We are… our… our main argument is that all rates in the West at this period of time–

Antonin Scalia:

Because of manipulation by somebody.

Christopher J. Wright:

–were the result of manipulation.

Antonin Scalia:

Okay.

Samuel A. Alito, Jr.:

Well, didn’t the ALJ find there wasn’t manipulation in this market, the forward market?

Christopher J. Wright:

And the ALJ found that the spot market… the ALJ found that the spot market manipulation didn’t affect the forward markets.

No one agrees to that today.

FERC has disowned it.

Morgan Stanley has disowned it.

I’m told that the ALJ has disowned it.

Samuel A. Alito, Jr.:

FERC disowned… did FERC reject the finding of the ALJ as to manipulation of this–

Christopher J. Wright:

FERC said it was irrelevant.

Christopher J. Wright:

That was the part of FERC’s first order, where it said it is irrelevant whether the manipulation of the spot markets affected manipulation in the long term markets.

That would be relevant only if the just and reasonable standard applies.

Of course, the just and reasonable standard applies.

One final point.

One remarkable aspect of this case is after FERC said that in its initial order, Morgan Stanley asked them to reconsider it, and they said we won’t do that.

Thank you.

David H. Souter:

Mr. Kneedler, in your rebuttal, will you address the state of the record with respect to evidence or findings about possible manipulation by these Petitioners?

Edwin S. Kneedler:

Yes.

On page 1589 of the joint appendix the Commission said we’ve reviewed the staff reports findings in the 100-day discovery, which were discovery occurring in other proceedings, and found no evidence to support a finding of market manipulation that specifically affected the contracts at issue.

It’s important to recognize that there were two separate markets here.

There was the spot market, which had struck in addition to all the weather and all those things, it had structural problems requiring the California investor owned utilities to trade on the spot market, which contributed to the opportunities for the manipulation.

The dysfunction and manipulation were tied together in that market, but there was… the ALJ found that the long term market was not dysfunctional.

It was functioning, it operated as it should.

Both parties–

John Paul Stevens:

–know that’s a premise in the debate.

I find it hard to accept.

How could the two be totally separate?

It was the crisis that made it necessary to engage in the long term account.

Edwin S. Kneedler:

–FERC has great discretion in deciding how to apply the public interest standard.

It’s not necessary to find that they were absolutely separate.

It’s sufficient, though, to say that the problems in the two separate markets… the situations in the two separate markets were very different.

And in the long term market, FERC concluded it was important to maintain the integrity of the contracts, indeed, under a market based system, as Justice Alito said, more important now even than at the time of Mobile, because you can’t have a functioning market based rate system without confidence that contracts would be upheld.

In that situation, as this Court suggested in Verizon, you had sophisticated buyers and sophisticated sellers dealing in a situation in which both knew that there was chaos in the spot market, that there was… there were structural problems there, and that there were allegations of manipulation.

But those allegations did not carry over to the, to the long term market.

Antonin Scalia:

May I ask, I am sure you understand that a finding that there was no manipulations that affected these contracts is not the same as a finding that there was no manipulation by these sellers in the market.

Edwin S. Kneedler:

Right.

Antonin Scalia:

And there is no such finding that there was no manipulation?

Edwin S. Kneedler:

That’s correct.

But what–

Antonin Scalia:

And there is no finding that there was by these sellers.

Edwin S. Kneedler:

–That’s correct.

And what the Commission was basically saying is we are treating the long term market situation differently.

Some of these sellers may have been engaged in manipulation in the short term market, but FERC was trying to draw a distinction between the spot market and moving forward and maintaining the integrity of markets in the long term where both the buyers and the sellers were both buyers and sellers typically.

David H. Souter:

–But, in fact, it didn’t get that articulate.

The closest it came to answering my question, I take it, is at the point to which you referred me in the joint appendix, no effect on these contracts?

Edwin S. Kneedler:

That’s correct.

We don’t think FERC should have to engage in a market based evaluation of possible manipulation in order to hold two parties, two sophisticated parties to their bargain.

David H. Souter:

Well, then what do you say about the standard of justness?

In effect, I think you’re saying it doesn’t matter whether these particular Petitioners manipulated the market creating the conditions under which these contracts were made at a price which turned out to be much higher than the spot price would be later, it’s irrelevant.

That’s your position, isn’t it?

Edwin S. Kneedler:

The manipulation in the spot market, we think FERC properly concluded, did not have to be taken into account–

David H. Souter:

I’m not talking about what FERC said.

I’m talking about your position.

I think your position is that even if these people… even if these people… Petitioners manipulated and that created the… or contributing to creating the market under which these contracts were made, that is irrelevant in looking at the contracts–

Edwin S. Kneedler:

–I think that’s something that FERC would have to decide in this case.

But I don’t believe a claim of that sort has been made here.

I believe the claim has–

David H. Souter:

–I’m not asking what claim has been made.

I want to know… I want to know what the government’s position is.

And as I understand the government’s position is that manipulation by these Petitioners would be irrelevant to a review under the public interest standard, is that right?

Edwin S. Kneedler:

–I think that’s the best way to read FERC’s decision in this case.

And I think that’s–

David H. Souter:

Is that the best way to read the government’s position.

Edwin S. Kneedler:

–Yes.

David H. Souter:

Here and now in this courtroom.

Edwin S. Kneedler:

That FERC… our position is that FERC was not required in the public interest, which looks at the market as a whole not just the two parties to the contract, it looks to the consequences for the market as a whole in unraveling particular contracts because there might have been manipulation somewhere else.

We think FERC, recognizing the importance of integrity of contracts, could decide that it was going to look no further than the particular contracts at issue in deciding whether there was market manipulation.

John Paul Stevens:

The case is undertaken.