[Federal Register Volume 61, Number 153 (Wednesday, August 7, 1996)]
[Notices]
[Pages 41135-41138]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-20051]


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DEPARTMENT OF ENERGY
[Docket Nos. EL94-45-001 and QF88-84-006]


LG&E-Westmoreland Southampton; Order Granting Rehearing in Part 
and Denying Rehearing in Part, and Announcing Policy Concerning Non-
Compliance With the Commission's QF Regulations

Issued July 31, 1996.
    On August 9, 1994, LG&E-Westmoreland Southampton (Southampton) 
filed a request for rehearing of the Commission's order issued in this 
proceeding on July 7, 1994. LG&E-Westmoreland Southampton, 68 FERC 
para. 61,034 (1994). In that order, the Commission denied the request 
by Southampton, the owner of a topping-cycle cogeneration facility, for 
waiver of the Commission's operating standard applicable to qualifying 
cogeneration facilities, see 18 CFR Sec. 292.205 (1995), for calendar 
year 1992.
    We will deny rehearing to the extent Southampton asks us to upset 
our decision to deny its request for waiver of section 205 of the 
Federal Power Act (FPA) to excuse its non-compliance during calendar 
year 1992 with the Commission's requirements for qualifying facility 
(QF) status. We will grant rehearing to the extent Southampton asks us 
to allow it to remain exempt during that year from the other 
requirements of the FPA, as well as certain other federal and state 
regulation. Because this is just one of several pending cases that 
present the Commission with the question of how to regulate previously 
certificated (or self-certificated) QFs that have been found to be in 
non-compliance with the Commission's QF regulations during some past 
period of operation, and in order to encourage respect for and 
compliance with those regulations, we take this opportunity to announce 
a policy of general application concerning the consequences of failing 
to retain QF status.

Background

    We discuss the background of this proceeding in detail in the 
previous order. In brief, Southampton owns a 62.6 MW topping-cycle 
cogeneration facility located in Franklin, Virginia that failed to meet 
the Commission's operating standard for qualifying cogeneration 
facilities during calendar years 1991 and 1992. Southampton previously 
was granted limited waiver to excuse non-compliance for calendar year 
1991. In this proceeding, Southampton requested an additional waiver to 
excuse non-compliance for calendar year 1992. Southampton sought to 
justify a second waiver on the fact that, among other things, the 
facility was engaged in start-up and testing operations during a 
portion of 1992, and that the third-party plant operator mistakenly 
delivered (without Southampton's knowledge) steam produced in a non-
sequential manner to the thermal host.
    The Commission, after balancing all relevant considerations, found 
this explanation to be insufficient to justify a second waiver of its 
QF requirements. The Commission found particularly troubling the fact 
that Southampton, in justifying waiver for calendar year 1991, 
previously represented to the Commission that it expected to comply 
with all applicable QF requirements during calendar year 1992 and later 
years. The Commission also found that the circumstances leading to 
Southampton's second waiver request were not entirely outside of its 
control: ``We believe that the Commission should not, through its 
waiver authority, insulate a QF from the risks of non-performance due 
to operator error or poor management.'' 68 FERC at 61,113.
    Finally, the Commission noted that Southampton may have operated as 
a public utility within the meaning of the Federal Power Act (FPA) 
during the period of time in which it failed to comply with the 
Commission's operating standard. For this reason, the Commission 
directed Southampton to ``show cause why it should not be required to 
file appropriate rate schedules with the Commission reflecting sales 
for resale'' to its utility-purchaser. 68 FERC at 61,113 n.9.

Request for Rehearing and Responses

    On rehearing, Southampton argues that the Commission should have 
granted waiver for calendar year 1992.1

[[Page 41136]]

In support, Southampton states that the Commission may have 
misunderstood the circumstances of its failure to satisfy the 
Commission's operating standard for QF status. Southampton explains 
that its non-compliance was due not to the actions of any of its own 
employees, but rather those of an entirely separate corporate entity, 
UC Operating Services. Southampton states that the third-party operator 
of its facility during the time in question was an experienced operator 
of generating facilities. For this reason, Southampton argues that it 
was entitled to rely on UC Operating Services to operate the QF in 
compliance with the Commission's technical requirements.
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    \1\ Also on August 9, 1994, when it filed its rehearing request, 
Southampton filed a motion to treat its request for rehearing as if 
it had been filed on time, i.e., on August 8, 1994. Southampton 
explains that, due to ``photocopying equipment malfunctions,'' its 
courier did not arrive at the Commission to file its rehearing until 
5:02 p.m. on August 8, 1994, after the close of business. On August 
23, 1994, Virginia Electric & Power Company (Virginia Power), the 
utility-purchaser of Southampton-generated power, filed an answer in 
opposition to Southampton's motion.
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    Southampton argues that in the past the Commission has granted 
waiver of its technical QF requirements except where there has been a 
willful or knowing violation of the Commission's QF standards. 
Southampton argues that here there was no such willful or knowing 
violation. Southampton also points out that both the Commission and 
Virginia Power would have remained unaware of the failure to comply 
with the operating standard absent Southampton's application for 
waiver; Southampton argues that this fact should have been considered 
in its favor.
    In the alternative, Southampton asks the Commission to grant it a 
conditional waiver. Specifically, Southampton asks that it be allowed 
to refund to Virginia Power the difference between the avoided cost 
rates it charged during the period of non-compliance and the cost-based 
rates which otherwise would have been permitted under the FPA. 
Southampton argues that such a refund represents an appropriate remedy 
for its non-compliance and that there is no compelling reason to 
compound its ``punishment'' by also withholding the regulatory 
exemptions--from most sections of the FPA, from the Public Utility 
Holding Company Act (PUHCA) and from certain state laws and regulations 
(pertaining to electric utility rates and financial and organizational 
regulation)--otherwise available to QFs under the Commission's 
regulations, see 18 CFR Secs. 292.601, 292.602 (1995). Southampton 
expresses particular concern with the possible loss of its PUHCA 
exemption, explaining that such a loss may undermine the ability of 
affiliates of its owners to remain in compliance with the QF ownership 
requirements, see 18 CFR Sec. 292.206 (1995).
    On August 24, 1994, Virginia Power filed a response to 
Southampton's request for rehearing, as well as a motion for leave to 
respond to the request for rehearing. Virginia Power argues, among 
other things, that the Commission did not apply a new policy in denying 
Southampton's request for waiver. Virginia Power also argues that the 
requested ``conditional'' waiver is based on speculative claims as to 
the dire consequences of an outright denial of waiver, and should not 
be granted to the economic detriment of Virginia Power's ratepayers.
    On September 8, 1994, Westmoreland Coal Company, Westmoreland 
Energy, Inc. and Westmoreland-Franklin, Inc. (together, the 
Westmoreland Companies) filed a pleading in support of Southampton's 
request for rehearing or conditional waiver. The three Westmoreland 
entities state that they have an indirect partnership interest in 
Southampton and, accordingly, could be subjected to a host of federal 
and state regulations and liabilities for a past period of non-
compliance if waiver is denied.
    On October 18, 1994 and on October 24, 1994, respectively, the 
Electric Generation Association (EGA) and the National Independent 
Energy Producers (NIEP) filed letters in this proceeding in support of 
the alternative request for conditional waiver.
    On November 7, 1994, the California Public Utilities Commission 
(California Commission) filed a letter in response to the letters of 
EGA and NIEP. The California Commission argues, among other things, 
that the only remedy for QF non-compliance that would fairly protect 
ratepayers is to require the non-complying QF to refund with interest 
the difference between the avoided cost rate paid by the utility to the 
non-complying QF and the market rate that the utility would have paid 
for the energy had it not been required to purchase power from the QF 
during the period of the QF's non-compliance. The California Commission 
states that a cost-based rate for the period of non-compliance that 
exceeds what the utility would have paid had it been able to respond to 
competitive market opportunities would not be reasonable to utility 
ratepayers.
    Finally, on December 21, 1995, Southampton filed a motion for 
settlement conference. Southampton states that it believes that the 
arguments set forth in its request for rehearing are compelling. It 
nevertheless suggests that the convening of a settlement conference, at 
which it is prepared to present a proposal ``which it believes would 
accommodate the interests of all concerned, including Virginia Power, 
its ratepayers and the public'' (Motion at 4), would speed Commission 
resolution of this case.

Discussion

    Under the circumstances presented herein, we will accept 
Southampton's request for rehearing as if it had been timely filed on 
August 8, 1994. In addition, we will consider all supplemental 
pleadings and letters filed in this proceeding (which we have added to 
the public record in these proceedings), in order to complete the 
arguments of the parties and to assist in our resolution of the issues 
presented.

Southampton's Request for Rehearing

    As an initial matter, we will deny Southampton's request for 
rehearing to the extent we decline to upset our prior decision to deny 
its request for waiver for calendar year 1992. Southampton has not 
presented any arguments on rehearing that suggest to our satisfaction 
that our balancing of relevant factors improperly tilted in favor of a 
denial of waiver.
    We are not persuaded by Southampton's argument on rehearing that 
the waiver decision should be motivated by whether the operators of its 
facility were its own employees or those employed by ``an experienced'' 
third-party contractor. In either event, the QF owner cannot abdicate 
its ongoing obligation to ensure compliance with the Commission's QF 
requirements. This is especially true where, as here, the QF owner 
already has received a Commission waiver to excuse non-compliance 
during a previous period of non-compliance (here, calendar year 1991). 
In light of Southampton's representation to the Commission, in support 
of waiver for calendar year 1991, that it expected to be back in 
compliance for calendar year 1992 and later periods, we believe that 
Southampton had a responsibility--which it failed to exercise--to be 
especially vigilant in ensuring QF compliance. In these circumstances, 
we believe it is no excuse for Southampton to claim that its non-
compliance was neither willing nor knowing; it should have taken 
appropriate steps in these circumstances to understand the operation of 
its facility at all relevant times to ensure compliance.
    We will, however, grant rehearing to the extent that we will grant 
Southampton's request that it retain most of the exemptions from 
federal and state regulation otherwise available to

[[Page 41137]]

QFs under the Commission's regulations. The one exemption we will deny 
is the obligation that Southampton file for Commission review, under 
section 205 of the FPA, the rates it charged Virginia Power during 
calendar year 1992 for wholesale power sales in interstate commerce.
    We base this latter decision on a general policy we now announce to 
guide our resolution of all pending and future cases of QF non-
compliance. We believe it is important at this time to explain the 
consequences of a denial of QF status. We take this action at this 
juncture to encourage QFs to be as vigilant as possible in promptly 
detecting possible non-compliance and in alerting the Commission as to 
possible non-compliance. Our concern is that if we do not articulate a 
clear policy as to the consequences of unexcused non-compliance, QFs 
will not exercise such vigilance.
    Below, we explain this general policy. We then apply it to the 
circumstances of this particular case.

General Policy With Respect to Non-Compliance With the Commission's QF 
Regulations

Rate Review
    As to the rates for power sales during a period of non-compliance 
with the Commission's QF requirements, we believe it is appropriate to 
distinguish between the following circumstances: (1) where the parties 
contemplated in the power sales agreement that QF status would be 
maintained during the entire term of the agreement; and (2) where the 
parties contemplated in the power sales agreement that QF compliance 
might not be maintained during the entire term of the agreement, e.g., 
by negotiating an alternative non-compliance rate. In the former (more 
common) circumstance, we believe that the just and reasonable rate for 
such sales should be no higher than the price the buyer would have paid 
for energy had it not been required to purchase from the QF under our 
mandatory purchase requirements and instead had made an economic 
decision to purchase power from the QF in the hour. This places the 
buyer in the same position it would have faced had it known that it was 
not required to purchase the QF's power. Accordingly, with one 
exception, we will use the utility buyer's economy energy (incremental) 
cost during the period of non-compliance. 2 The one exception will 
be where the QF contract rate was less than the utility buyer's economy 
energy cost. 3
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    \2\ We believe that in the majority of cases any attempt to 
replicate actual market conditions during past periods would be a 
difficult and time consuming procedure. Moreover, data about the 
actual economic decisions of the buyer can be found in its dispatch 
logs. Except for its must run generating units and mandatory 
purchases including QF purchases, a utility will evaluate its 
economic options in each hour (energy purchases and generating unit 
running costs) and select a combination of resources sufficient to 
meet its load at the lowest overall cost. To set a rate for sales 
made during a period of non-compliance, we will adopt the highest 
cost option actually selected by the buyer in the hour, e.g., the 
most expensive energy purchase or unit running cost. This is because 
the highest cost option represents the utility's incremental cost in 
that hour. Such costs represent a reasonable proxy for the market 
rate the buyer would have paid during the period of non-compliance. 
To the extent an investigation is necessary, it would be limited to 
determining the purchaser's actual energy costs during the period of 
non-compliance.
    \3\ To the extent the contract rate was less than the economy 
energy costs over all the hours of the period of noncompliance, the 
just and reasonable rate will be the contract rate. Any other result 
would penalize ratepayers due to the facility's non-compliance with 
QF requirements. Such a perverse result would not comply with the 
requirements of section 210(b) of the Public Utility Regulatory 
Policies Act of 1978 (PURPA), 16 U.S.C. 824a-3(b) (1994).
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    As the Commission explained in Medina Power Company, 72 FERC para. 
61,224 at 62,038-39 (1995), there is no reason to presume that the 
utility-purchaser would have agreed to purchase QF power at an avoided 
cost rate if, freed of the perceived obligation to purchase QF-
generated power under PURPA, it could have purchased equivalent amounts 
of power from alternative sources at lower prices. An economy energy 
rate, in our judgment, places the utility-purchaser (and its 
ratepayers) in no worse a position than if it had known at the time of 
purchase that its ``QF'' supplier would be adjudged to be out of 
compliance with the Commission's QF requirements. Similarly, such a 
rate places the ``QF'' in the same position as if it had known at the 
relevant time that it would not be eligible for QF status during a 
particular period of non-compliance and would not be entitled to compel 
a purchase at the purchasing utility's avoided cost.
    We agree with the California Commission that a fully allocated 
cost-based rate is not appropriate during the period of non-compliance 
when the parties were operating under the assumption that the seller 
would remain a QF during the entire term of their power purchase 
agreement (and thus did not contractually provide for an alternative 
non-compliance rate).
    Further, a QF should not be able to charge a fully allocated cost-
based rate if it represented to the Commission and to the utility-
purchaser that it would operate in accord with the Commission's QF 
requirements. Such an opportunity, if successful, would act only to 
undermine compliance with the Commission's QF requirements. While the 
Commission is subject to the PURPA directive to ``encourage'' 
cogeneration and small power production, 16 U.S.C. 824a-3(a), it also 
is obligated to ensure that the rate charged by the QF ``shall be just 
and reasonable to the electric consumers of the electric utility and in 
the public interest'' and does not ``exceed[] the incremental cost to 
the electric utility of alternative electric energy.'' 4 16 U.S.C. 
824a-3(b) (1994).
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    \4\ As noted, the utility-purchaser's economy energy costs 
during the period of non-compliance are, in effect, a measure of the 
utility's ``incremental costs.''
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    Finally, an economy energy rate is a market-driven (as opposed to 
fully allocated cost-based) rate that is more likely to reflect market 
conditions at the time of non-compliance than would the ``old'' avoided 
cost rate. Accordingly, an economy energy rate will better protect 
electric utility purchasers from uneconomic mandatory purchases from 
non-complying QFs.
    We recognize that a substitute rate based on the purchasing 
utility's economy energy costs may not be appropriate in situations in 
which the parties in their contract have contemplated the possibility 
of non-compliance with the Commission's QF regulations. We are aware of 
QF power purchase contracts that do not require the seller to remain a 
QF throughout the term of the power purchase agreement and contemplate 
continued power sales during periods of non-compliance at a negotiated 
default rate. See Medina Power Company (Medina), 71 FERC para. 61,264, 
reh'g denied, 72 FERC para. 61,224 (1995) (instituting a hearing to 
determine the reasonableness of the seller's rates on a cost basis, 
where the seller never has complied with the Commission's QF 
regulations).
    We believe that it is appropriate to continue to consider cases 
like the Medina case, in which the parties contractually provided for 
continuing service during periods of QF non-compliance at a different 
rate, on a case-by-case basis. 5
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    \5\ In such cases, the ``QF'' should file its proposed rate, 
with appropriate support, with the Commission.
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Regulatory Exemptions
    Turning to the continuing availability of the regulatory 
exemptions, see 18 C.F.R. Secs. 292.601, 292.602 (1995), we agree with 
Southampton that, as a general matter, there is no compelling reason to 
eliminate all of the exemptions from federal and state

[[Page 41138]]

regulation otherwise applicable to QFs, assuming the non-compliance was 
not marked by long duration or frequent recurrence. We believe that the 
prospect of a lower, substitute economy energy rate during a period of 
non-compliance (in conjunction with whatever contractual remedies are 
appropriate for non-compliance), or the possibility of case-specific 
scrutiny to determine a just and reasonable rate where the parties' 
contract provides for a non-compliance default rate, should provide 
ample incentive for QFs to retain their QF status. Similarly, these 
rate remedies also should provide ample incentive for QFs, to the 
extent uncertain as to their continuing compliance, to take the 
initiative to seek Commission guidance as soon as possible.
    This approach is entirely consistent with the explicit language of 
PURPA which provides in section 210 that the Commission has the 
authority to grant such exemptions ``in whole or part.'' 16 U.S.C. 
Sec. 824a-3(e) (1994). The same section provides that the Commission 
may grant exemptions from ``any combination of'' FPA, PUHCA and state 
regulation ``if the Commission determines such exemption is necessary 
to encourage cogeneration and small power production.'' Id. (emphasis 
added).
    Accordingly, in all cases in which a QF failed to comply with our 
QF regulations during some past period of time, fails to receive a 
waiver to excuse such non-compliance, and is now back in compliance, we 
will continue to grant all of the exemptions otherwise applicable to 
QFs except for the FPA section 205 exemption. 6 As explained 
above, such QFs must commit to FPA section 205 rate regulation for the 
period of non-compliance.
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    \6\ We will issue orders in the near future that apply this 
policy to pending cases raising the non-compliance issues. Of 
course, we retain the discretion to resolve any individual cases on 
any peculiar facts presented, such as those resolved through 
negotiated settlement.
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    For pending cases as well as future cases, we will grant all of the 
regulatory exemptions (other than FPA rate review) unless the non-
compliance is marked by long duration or frequent recurrence. In 
circumstances where the QF has engaged in more than one period of non-
compliance, the QF will assume a heavy burden in demonstrating that the 
non-compliance merits a second waiver.
Determination of Southampton's Rates
    Applying this policy to Southampton's circumstances, we will grant 
its request for continued exemption during calendar year 1992 from 
regulation under PUHCA and state utility laws and most sections of the 
FPA, consistent with 18 C.F.R. Secs. 292.601, 292.602 (1995). However, 
as explained above, the extension of QF regulatory exemptions is 
subject to Southampton's obligation to submit for Commission rate 
review, under section 205 of the FPA, the rates it charged to Virginia 
Power during calendar year 1992. It also must refund to Virginia Power 
the difference between the contract rate during that year and the 
Commission-approved rate, with interest calculated pursuant to the 
Commission's regulations, see 18 C.F.R. Sec. 35.19a (1995).
    We have decided above that the just and reasonable rate for 
wholesale power service provided during each hour of the period of non-
compliance (1992) should be no higher than what Virginia Power would 
have paid for energy had it made an economic decision to purchase power 
from Southampton in these hours. 7 For this reason, we direct 
Virginia Power to compile data from its dispatch logs showing the 
highest cost option actually selected by Virginia Power in the hour, 
e.g., the most expensive energy purchase or unit running cost 8 
for each hour during 1992 and to submit a report of such costs to us 
within 45 days of the date of this order. To avoid questions about the 
source of such cost data, we direct personnel from both Southampton and 
Virginia Power to compile the data jointly from Virginia Power's system 
dispatch logs. We strongly encourage the parties to reach agreement as 
to this remaining rate issue. After we receive the required report, we 
will determine whether further proceedings are necessary.
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    \7\ See supra at 6 & n. 2.
    \8\ The highest cost in the hour is the incremental cost for 
that hour.
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    In light of these procedures, we see no need to undertake 
additional ``settlement judge'' procedures as recommended by 
Southampton.

The Commission Orders

    (A) Southampton's request for rehearing is hereby accepted as if it 
were timely filed.
    (B) Southampton's request for rehearing is hereby granted in part 
and denied in part, as discussed in the body of this order.
    (C) Virginia Power is hereby directed to file with the Commission, 
within 45 days of the date of this order, a report compiling its hourly 
economy energy costs for 1992, as discussed in the body of this order.
    (D) The Secretary is hereby directed to publish a copy of this 
order in the Federal Register.

    By the Commission.
Lois D. Cashell,
Secretary.
[FR Doc. 96-20051 Filed 8-6-96; 8:45 am]
BILLING CODE 6717-01-P