 United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT




Argued March 22, 2016                   Decided July 1, 2016

                        No. 11-1479

              UNITED AIRLINES, INC., ET AL.,
                     PETITIONERS

                             v.

 FEDERAL ENERGY REGULATORY COMMISSION AND UNITED
                STATES OF AMERICA,
                   RESPONDENTS

          BP WEST COAST PRODUCTS LLC, ET AL.,
                    INTERVENORS



       Consolidated with 12-1069, 12-1070, 12-1073,
           12-1086, 15-1101, 15-1105, 15-1107



          On Petitions for Review of Orders of the
          Federal Energy Regulatory Commission



    Thomas J. Eastment argued the cause for Shipper
Petitioners. With him on the briefs were Gregory S. Wagner,
Richard E. Powers, Jr., Melvin Goldstein, and Steven A.
                             2

Adducci. Frederick G. Jauss and Marcus W. Sisk Jr. entered
appearances.

   Charles F. Caldwell argued the cause for Petitioner SFPP
L.P. With him on the briefs were Dean Lefler and Daniel W.
Sanborn. Deborah R. Repman entered an appearance.

    Ross R. Fulton and Lisa B. Luftig, Attorneys, Federal
Energy Regulatory Commission, argued the causes for
respondents. On the brief were William J. Baer, Assistant
Attorney General, U.S. Department of Justice, James J.
Fredricks and Robert J. Wiggers, Attorneys, Robert H.
Solomon, Solicitor, Federal Energy Regulatory Commission,
Beth G. Pacella, Deputy Solicitor, and Elizabeth E. Rylander,
Attorney.

   Steven A. Adducci, Thomas J. Eastment, Gregory S.
Wagner, Richard E. Powers Jr., and Melvin Goldstein were
on the brief for Shipper Intervenors in support of Federal
Energy Regulatory Commission.

   Charles F. Caldwell, Dean H. Lefler, and Daniel W.
Sanborn were on the brief for intervenor SFPP, L.P. in
support of respondents. Elizabeth B. Kohlhausen entered an
appearance.

   Before: GRIFFITH and KAVANAUGH, Circuit Judges, and
SENTELLE, Senior Circuit Judge.

   Opinion for the Court filed by Senior Circuit Judge
SENTELLE.

    SENTELLE, Senior Circuit Judge: Petitioners SFPP, L.P.
(“SFPP”) and several shippers—“i.e., firms that pay to
transport petroleum products over SFPP’s pipelines,”
                              3

ExxonMobil Oil Corp. v. FERC, 487 F.3d 945, 947 (D.C. Cir.
2007)—challenge aspects of three orders from the Federal
Energy Regulatory Commission (“FERC”) related to filings
by SFPP for cost-of-service tariffs on its pipelines. SFPP
disputes FERC’s choice of data for calculating SFPP’s return
on equity and the Commission’s decision to grant only a
partial indexed rate for the 2009 index year. The shipper-
petitioners (the “Shippers”) claim that FERC’s tax allowance
policy for partnership pipelines, such as SFPP, is arbitrary or
capricious and results in unjust and unreasonable rates. We
grant-in-part and deny-in-part SFPP’s petition and grant the
Shippers’ petition for review.

I.     BACKGROUND

    SFPP is a Delaware limited-partnership, common-carrier
oil pipeline. The pipeline transports refined petroleum
products from California, Oregon, and Texas to various
locations throughout the southwestern and western United
States. On June 30, 2008, SFPP filed tariffs to increase rates
on its West Line, which transports petroleum products
throughout California and Arizona. These new tariffs had an
effective date of August 1, 2008. Also on June 30, 2008,
SFPP made a separate tariff filing to decrease the rates on its
East Line, which runs from West Texas to Arizona. The
purported impetus for these filings was increased throughput
on SFPP’s East Line due to a recently completed expansion,
which accordingly decreased throughput on the West Line.
Several shippers protested the West Line tariff filing by
raising challenges to SFPP’s cost of service.

   On December 2, 2009, an administrative law judge issued
an Initial Decision addressing the shippers’ arguments.
FERC reviewed the Initial Decision in Opinion 511, 134
FERC ¶ 61,121 (2011), considered a request for rehearing of
                               4

that opinion in Opinion 511-A, 137 FERC ¶ 61,220 (2011),
and then reviewed a request for rehearing of Opinion 511-A
in Opinion 511-B, 150 FERC ¶ 61,096 (2015). Both SFPP
and the Shippers 1 petition this Court for review of these three
FERC orders.

    SFPP makes two arguments in its petition. First, it claims
that FERC arbitrarily or capriciously failed to utilize the most
recently-available data when assessing its so-called real return
on equity. Second, SFPP asserts that FERC erred when it
declined to apply the full value of the Commission’s
published index when setting SFPP’s rates for the 2009 index
year. We grant SFPP’s petition with respect to the first issue
but deny the petition with respect to the second.

    The Shippers raise a separate challenge to FERC’s current
policy of granting to partnership pipelines an income tax
allowance, which accounts for taxes paid by partner-investors
that are attributable to the pipeline entity. Specifically, the
Shippers claim that because FERC’s ratemaking methodology
already ensures a sufficient after-tax rate of return to attract
investment capital, and partnership pipelines otherwise do not
incur entity-level taxes, FERC’s tax allowance policy permits
partners in a partnership pipeline to “double recover” their
taxes. We agree that FERC has not adequately justified its
tax allowance policy for partnership pipelines and grant the
Shippers’ petition.



1
  The Shippers are: United Airlines, Inc.; Delta Air Lines,
Inc.; Southwest Airlines Co.; US Airways, Inc.; BP West
Coast Products LLC; Chevron Products Co.; ExxonMobil Oil
Corporation; Valero Marketing and Supply Company; and
Tesoro Refining and Marketing Company LLC.
                              5

II.    ANALYSIS

    Under the standard dictated by the Administrative
Procedure Act, we will vacate FERC ratemaking decisions
that are arbitrary or capricious. See 5 U.S.C. § 706(2)(A).
Conversely, “FERC’s decisions will be upheld as long as the
Commission has examined the relevant data and articulated a
rational connection between the facts found and the choice
made.” ExxonMobil, 487 F.3d at 951. “In reviewing FERC’s
orders, we are ‘particularly deferential to the Commission’s
expertise’ with respect to ratemaking issues.” Id. (quoting
Ass’n of Oil Pipe Lines v. FERC, 83 F.3d 1424, 1431 (D.C.
Cir. 1996)). While we have not expressly stated whether we
review for substantial evidence FERC’s factual findings
within orders under the Interstate Commerce Act, “in their
application to the requirement of factual support the
substantial evidence test and the arbitrary or capricious test
are one and the same.” Butte Cty. v. Hogen, 613 F.3d 190,
194 (D.C. Cir. 2010) (citation omitted); cf. Farmers Union
Cent. Exch., Inc. v. FERC, 734 F.2d 1486, 1499 n.39 (D.C.
Cir. 1984) (noting the uncertainty surrounding whether the
substantial evidence standard applies to FERC’s ratemaking
decisions under the Interstate Commerce Act).

    The statutory regime governing FERC’s ratemaking for
oil pipelines is unique. In 1906, as an amendment to the
Interstate Commerce Act (the “ICA”), Congress delegated
regulatory authority over oil pipelines to the Interstate
Commerce Commission. Pub. L. No. 59-337, § 1, 34 Stat.
584, 584. But in 1977, Congress transferred regulatory
authority over oil pipelines to FERC. Department of Energy
Organization Act, Pub. L. No. 95-91, § 402(b), 91 Stat. 565,
584 (1977); see also 49 U.S.C. § 60502. Congress then
repealed the ICA in 1978 except as related to FERC’s
regulation of oil pipelines. Pub. L. No. 95-473, § 4(c), 92
                               6

Stat. 1337, 1470. For such regulation, the ICA continues to
apply “as [it] existed on October 1, 1977 . . . .” Id. The
relevant provisions of the ICA were last reprinted in the
appendix to title 49 of the 1988 edition of the United States
Code, to which we refer as necessary. Cf. BP West Coast
Prods., LLC v. FERC, 374 F.3d 1263, 1271 n.1 (D.C. Cir.
2004).

    Substantively, the ICA requires that all rates be “just and
reasonable.” 49 U.S.C. app. § 1(5)(a) (1988). Just and
reasonable rates are “rates yielding sufficient revenue to cover
all proper costs, including federal income taxes, plus a
specified return on invested capital.” ExxonMobil, 487 F.3d
at 951 (citation omitted).

   A. FERC’S CHOICE OF DATA FOR ASSESSING SFPP’S
      REAL RETURN ON EQUITY WAS ARBITRARY OR
      CAPRICIOUS

    SFPP challenges as arbitrary or capricious FERC’s
reliance on cost-of-equity data from September 2008 when
calculating SFPP’s so-called “real” return on equity and the
Commission’s rejection of more recent data from April 2009.
FERC argues in response that the more recent cost-of-equity
data “encompassed the stock market collapse beginning in
late 2008,” and was therefore anomalous. FERC’s Br. 31-32.
We agree that FERC had substantial evidence to support its
determination that the 2009 data did not reflect SFPP’s long-
term cost of equity. However, because the Commission
provided no reasoned basis to justify its decision to rely on
the September 2008 data, we hold that it engaged in arbitrary
or capricious decision-making and therefore grant SFPP’s
petition on this issue.
                                7

    The Supreme Court stated in Federal Power Commission
v. Hope Natural Gas Co., that “the return to the equity owner
[of a pipeline] should be commensurate with returns on
investments in other enterprises having corresponding risks.”
320 U.S. 591, 603 (1944). Further, “[t]hat return . . . should
be sufficient to assure confidence in the financial integrity of
the enterprise, so as to maintain its credit and to attract
capital.” Id. In accordance with these principles, FERC uses
a so-called “discounted cash flow” model to determine a
pipeline’s rate of return on equity. See Composition of Proxy
Groups for Determining Gas and Oil Pipeline Return on
Equity, 123 FERC ¶ 61,048, at 61,271-73 ¶¶ 3-9 (2008)
(discussing the mechanics of the discounted cash flow
model). “The premise of the [discounted cash flow] model is
that the price of a stock is equal to the stream of expected
dividends, discounted to their present value.” Williston Basin
Interstate Pipeline Co. v. FERC, 165 F.3d 54, 57 (D.C. Cir.
1999). Under the discounted cash flow model, FERC
“examin[es] the percentage returns on equity the market
requires for members of a proxy group.” Opinion 511, 134
FERC ¶ 61,121, at ¶ 242. “The members of the proxy group
must fall with[in] a reasonable range of comparable risks and
have publically traded securities.” Id. Based on the stock
prices of securities within the proxy group, FERC “calculates
the yield (the percentage return) by dividing the dollar
amount of the distribution by the stock price.” Id. ¶ 243.
After applying the distribution over the long-term, FERC
“discount[s] back at the first year’s percentage yield to obtain
the return on equity required to attract capital to the firm.” Id.
The resulting figure is the “nominal” return on equity.

    Under its so-called “trended original cost” methodology,
FERC splits the nominal return on equity into an inflation
component and the so-called “real” return on equity, defined
as the difference between the nominal return on equity and
                              8

inflation. See Williams Pipe Line Co., 31 FERC ¶ 61,377, at
61,833-34 (1985). While the pipeline can recover its real
return on equity in its current annual rates, inflation “is
written-off or amortized over the life of the property.” Id. at
61,834; see also Ass’n of Oil Pipe Lines, 83 F.3d at 1429.

     When assessing the pipeline’s cost structure, FERC “uses
a ‘test year’ methodology to determine a pipeline’s annual
cost of service.” BP West Coast, 374 F.3d at 1298. This
method starts with a “base period” that “consist[s] of 12
consecutive months of actual experience” with some specified
adjustments. 18 C.F.R. § 346.2(a)(1)(i). FERC then defines a
“test period” that generally “must consist of a base period
adjusted for changes in revenues and costs which are known
and are measurable with reasonable accuracy at the time of
[rate] filing and which will become effective within nine
months after the last month of available actual experience
utilized in the filing.” Id. § 346.2(a)(1)(ii). In this case,
FERC used a base period from January 1, 2007, through
December 31, 2007, meaning that the “nine-month
adjustment period for test period changes [wa]s from January
1, 2008, through September 30, 2008.” Opinion 511, 134
FERC ¶ 61,121, at ¶ 8.

    However, for the discounted cash flow analysis, “the
Commission prefers the most recent financial data in the
record,” id. ¶ 208, “because the market is always changing
and later figures more accurately reflect current investor
needs,” Trunkline Gas Co., 90 FERC ¶ 61,017, at 61,117
(2000). In other words, FERC may use post-test period data
for purposes of the discounted cash flow analysis,
“recognizing that updates are not permitted once the record
has been closed and the hearing has concluded.” Opinion
511, 134 FERC ¶ 61,121, at ¶ 208.
                              9

    SFPP initially submitted return-on-equity data for the six-
month period ending with the test period, i.e., through
September 2008.        See Exhibit SFP-1, Prepared Direct
Testimony of J. Peter Williamson on Behalf of SFPP, L.P.,
No. IS08-390-002, at 3-22 (FERC June 2, 2009). However,
the pipeline later provided two updates, one for the six-month
period ending January 2009, see Exhibit SFP-76, No. IS08-
390-002, at 1 (FERC June 2, 2009), and one for the six-month
period ending April 2009, see Exhibit SFP-323, No. IS08-
390-002, at 1 (FERC June 2, 2009). From the September
2008 data, the nominal return on equity was 12.63 percent,
with 7.69 percent representing the real return on equity and
4.94 percent as inflation. 2 Opinion 511-A, 137 FERC
¶ 61,220, at ¶ 255. From the January 2009 data, the nominal
return on equity was 14.33 percent, distributed between 14.30
percent real return on equity and 0.03 percent inflation.
Exhibit SFP-76, at 1. The April 2009 data showed a nominal
return on equity of 14.09 percent with a 14.83 percent real
return on equity and -0.74 percent inflation. Exhibit SFP-323,
at 1. FERC also “incorporated into the . . . record” SFPP
cost-of-equity data for the six-month periods ending in
February 2010 and March 2010. Opinion 511, 134 FERC
¶ 61,121, at ¶ 209 & n.339. The nominal return on equity
from the February 2010 data was 11.24 percent, 2.14 percent

2
   There is some ambiguity in the record regarding the
September 2008 return on equity data. SFPP’s initial filings
show that the nominal return on equity for this period was
13.01 percent with 5.37 percent inflation and 7.64 percent real
return on equity. See Exhibit SFP-1, at 21; Exhibit SFP-5,
No. IS08-390-002, at 9 (FERC June 2, 2009); Opinion 511-A,
137 FERC ¶ 61,220, at ¶ 252. As the exact numbers do not
affect our holding and the parties otherwise agree that 7.69
percent was the real return on equity for the September 2008
period, we refer to that figure. See SFPP’s Br. 8; FERC’s Br.
33-34.
                              10

of which was inflation with a 9.09 percent real return on
equity. SFPP’s Br. App. A. From the March 2010 data, the
nominal return on equity was 11.03 percent, inflation was
2.31 percent, and the real return on equity was 8.72 percent.
Id.

    SFPP argues that FERC acted arbitrarily or capriciously
when it relied on the September 2008 data, instead of the
April 2009 data, in setting SFPP’s real return on equity. In
particular, SFPP contends that FERC ignored its own “policy
of using the most recent equity rate of return data in the
record” and provided no explanation for its choice of the
September 2008 data. SFPP’s Br. 22-23. In FERC’s view,
the April 2009 data is not “representative of SFPP’s cost of
capital during the future periods the rates proposed in this
case may be in effect.” Opinion 511, 134 FERC ¶ 61,121, at
¶ 209. Specifically, that data “reflects the collapse of the
stock market in late 2008 and early 2009” and a “minimal or
negative inflation rate” not likely to continue into the future.
Id.

    We hold that it was reasonable for FERC to conclude that
the April 2009 data was not representative of SFPP’s long-
term cost of capital. SFPP’s argument that FERC has a
bright-line policy of relying on the most recently available
data to determine the real return on equity is incorrect. As
FERC stated in Trunkline Gas Co., the Commission “seeks to
find the most representative figures on which to base rates.”
90 FERC ¶ 61,017, at 61,049 (emphasis added). Therefore,
FERC “may adopt test period estimates, or it may adopt other,
more representative figures of historical costs . . . if it
determines that these other figures are the best, most
representative evidence of the pipeline’s experience for the
test period.” Id. The real return on equity from the April
2009 data, 14.83 percent, is the highest among each of the
                              11

periods FERC considered, and only this data includes
negative inflation. Had FERC decided to use the April 2009
data, SFPP would have been able to recoup essentially its
entire nominal return on equity in its current rates, see
Williams Pipe Line Co., 31 FERC ¶ 61,377, at 61,833-34,
despite the fact that the February 2010 and March 2010 data
indicated that negative inflation was a short-term
phenomenon.       Substantial evidence therefore supported
FERC’s finding that the April 2009 data was not the most
representative data for assessing SFPP’s real return on equity,
meaning that FERC did not engage in arbitrary-or-capricious
decision-making by rejecting that data. See Opinion 511, 134
FERC ¶ 61,121, at ¶¶ 208-09; Opinion 511-A, 137 FERC
¶ 61,220, at ¶¶ 256-59.

    However, this conclusion does not end the inquiry. In lieu
of the more recently available April 2009 data, FERC relied
instead on the September 2008 data to fix SFPP’s real return
on equity. See Opinion 511, 134 FERC ¶ 61,121, at ¶ 209.
Because we agree with SFPP that FERC provided no
reasoned explanation for its choice of the September 2008
data, we grant SFPP’s petition for review and vacate FERC’s
orders with respect to this issue.

    While there may be evidence to support the conclusion
that the nominal return on equity for September 2008 was in
line with historical trends, this evidence does not show that
the real return on equity for that time period was
representative of SFPP’s costs. See Request for Rehearing of
SFPP, L.P., No. IS08-390-002, at 11-12 (FERC Apr. 11,
2011) (SFPP conceding that the September 2008 nominal
return on equity is “consistent with historical periods”); see
also Opinion 511, 134 FERC ¶ 61,121, at ¶ 209; Opinion
511-A, 137 FERC ¶ 61,220, at ¶¶ 252-59. To the contrary,
FERC provides only a cursory comparison of real returns on
                             12

equity from the September 2008 through the March 2010 time
periods, and otherwise appears to have chosen the smallest
real return on equity from the data available. See Opinion
511, 134 FERC ¶ 61,121, at ¶ 209. FERC was further unable
to identify any such explanation in the record when pressed to
do so at oral argument. See Oral Arg. Tr. 44:6-45:14. While
“we are particularly deferential to the Commission’s expertise
with respect to ratemaking issues,” ExxonMobil, 487 F.3d at
951 (citation and internal quotation marks omitted), FERC
cannot rely in conclusory fashion on its knowledge and
expertise without adequate support in the record. See, e.g.,
Int’l Union, United Mine Workers of Am. v. Mine Safety &
Health Admin., 626 F.3d 84, 93 (D.C. Cir. 2010).

    Because we agree that FERC engaged in arbitrary-or-
capricious decision-making by adopting the September 2008
real return on equity without reasoned explanation, we need
not reach SFPP’s alternative argument that FERC improperly
rejected SFPP’s proposal to adopt an average real return on
equity. We grant SFPP’s petition on this issue.

   B. FERC’S INDEXING ANALYSIS WAS NOT ARBITRARY
      OR CAPRICIOUS

    SFPP also argues that FERC engaged in arbitrary-or-
capricious decision-making when it declined to apply the full
amount of the 2009 rate index adjustment in calculating
SFPP’s rates and refunds for the period from July 1, 2009,
through June 30, 2010. FERC responds that it complied with
the plain text of its regulations when it found that granting
SFPP a full indexed rate adjustment would result in unjust
and unreasonable rates. We agree with FERC and deny
SFPP’s petition on this issue.
                              13

    As part of the Energy Policy Act of 1992, Congress
required FERC to “issue a final rule which establishes a
simplified and generally applicable ratemaking methodology
for oil pipelines in accordance with section 1(5) of part I of
the [ICA].” Pub. L. No. 102-486, § 1801(a), 106 Stat.
2776, 3010.      Congress     also     mandated     that   “the
Commission . . . issue a final rule to streamline procedures of
the Commission relating to oil pipeline rates in order to avoid
unnecessary regulatory costs and delays.” Id. § 1802(a). In
response, FERC released a notice of proposed rulemaking on
July 2, 1993, which set forth an indexing scheme for setting
oil pipeline rates. See Revisions to Oil Pipeline Regulations
Pursuant to the Energy Policy Act of 1992; Proposed
Rulemaking, 58 Fed. Reg. 37,671, at 37,672 (1993). FERC
then issued on November 4, 1993, its final rule implementing
the indexing scheme. Revisions to Oil Pipeline Regulations
Pursuant to the Energy Policy Act of 1992, 58 Fed. Reg.
58,753, at 58,754 (1993).

      Under the final rule, FERC required that oil pipelines
utilize the indexing system for rate changes unless specified
circumstances permit use of an alternative methodology. Id.
at 58,757. “First, a cost-of-service showing may be utilized
to change a rate whenever a pipeline can show that it has
experienced uncontrollable circumstances that preclude
recoupment of its costs through the indexing system.” Id.; see
also 18 C.F.R. § 342.4(a). “Second, whenever a pipeline can
secure the agreement of all existing customers, it may file a
rate change based on such a settlement.” 58 Fed. Reg. at
58,757; see also 18 C.F.R. § 342.4(c). Finally, FERC permits
market-based ratemaking if the pipeline can show that it
“lacks significant market power in the markets in question
. . . .” 58 Fed. Reg. at 58,757; see also 18 C.F.R. § 342.4(b).
                                14

     At a general level, FERC’s indexing methodology directs
pipelines to file initial rates, usually reflecting their costs-of-
service. 58 Fed. Reg. at 58,758. Based on the initial rate
filings, FERC then calculates rate ceilings for future years
based on the change in the Producer Price Index for Finished
Goods. Id. at 58,760; see also 18 C.F.R. § 342.3(d)(2).
Importantly, “the index establishes a ceiling on rates—it does
not establish the rate itself.” 58 Fed. Reg. at 58,759. In other
words, “a company is not required to charge the ceiling rate,
and if it does not, it may adjust its rates upwards to the ceiling
at any time during the year upon filing of the requisite
data . . . and upon giving the appropriate notice.” Id. at
58,761. For future years, the index “is cumulative[, meaning
that] . . . the index applies to the applicable ceiling rate, which
is required to be calculated each year, not to the actual rate
charged.” Id. at 58,762. The stated purpose of this regime is
to “preserve[] the value of just and reasonable rates in real
economic terms [by] . . . tak[ing] into account inflation, thus
allowing the nominal level of rates to rise in order to preserve
their real value in real terms.” Id. at 58,759.

    In this case, SFPP filed cost-of-service rates, effective
August 1, 2008, proposing to increase the rates charged on its
West Line “based upon the cost of providing the service
covered by the rate . . . .” 18 C.F.R. § 342.4(a). Because this
rate took effect during the 2008 index year—i.e., between
July 1, 2008, and June 30, 2009—it also “constitute[d] the
applicable ceiling level for that index year.”              Id.
§ 342.3(d)(5); see also id. § 342.3(c) (defining the index year
as “the period from July 1 to June 30”). Therefore, to
compute the ceiling level for the 2009 index year—i.e.,
between July 1, 2009, and June 30, 2010—SFPP
“multipl[ied] the previous index year’s [2008’s] ceiling level
by the most recent index published by [FERC].” Id.
§ 342.3(d)(1). The index for 2009 was 7.6025 percent.
                               15

Revisions to Oil Pipeline Regulations Pursuant to the Energy
Policy Act of 1992, 127 FERC ¶ 61,184 (2009). SFPP
therefore contends that it has the right to apply this full index
when calculating its 2009 rates. FERC argues that, because
SFPP’s cost-of-service rates for 2008 already partially
“accounted for the changes in costs associated with the index
increase,” Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 407,
SFPP can only apply that portion of the 2009 index “not
reflected in the cost of service adopted by Opinion No. 511 or
the rates SFPP must establish [in Opinion No. 511-A],” id.
¶ 405. In particular, FERC permitted SFPP to use an index of
1.9006 percent, “correspond[ing] to the three months of 2008
cost changes that are outside” the period of costs already
covered by SFPP’s proposed rates. Id. In other words, FERC
limited SFPP’s 2009 index to twenty-five percent of the
published value for that index year.

     Were this information all that the Court had to consider,
SFPP’s argument that FERC “ignore[d] its regulations, which
have the force of law,” SFPP’s Br. 35, might be plausible in
light of the plain text of FERC’s indexing regulations, see 18
C.F.R. § 342.3. But the analysis is only half-complete.
“[M]erely because the Commission regulations permit SFPP
to request the index increase does not mean that the
Commission is bound to accept the indexed rate increase.”
Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 407. In particular,
“persons with a substantial economic interest in the tariff
filing may file a protest to a tariff filing pursuant to the
Interstate Commerce Act.” 18 C.F.R. § 343.2(b). A protest
to a proposed rate under 18 C.F.R. § 343.2 must allege
“reasonable grounds for asserting that the rate violates the
applicable ceiling level, or that the rate increase is so
substantially in excess of the actual cost increases incurred by
the carrier that the rate is unjust and unreasonable, or that the
rate decrease is so substantially less than the actual cost
                              16

decrease incurred by the carrier that the rate is unjust and
unreasonable.” Id. § 343.2(c)(1). In this case, the Shippers
did file protests to SFPP’s indexed rates for the 2009 index
year. See Protest and Comments of Chevron Products
Company, ConocoPhillips Company, Continental Airlines,
Inc., Northwest Airlines, Inc., Southwest Airlines Co., US
Airways, Inc., and Valero Marketing and Supply Company on
SFPP, L.P. Compliance Filing (“Protest I”), Nos. IS08-390-
002, IS08-390-006, IS11-338-000 (FERC June 15, 2011);
Protest of ExxonMobil Oil Corporation and BP West Coast
Products LLC of Compliance Filing Implementing Opinion
No. 511 (“Protest II”), No. IS08-390-006 (FERC June 15,
2011). Therein, they argued that because “[t]he 2009 index is
based on [FERC’s] computation of industry-wide cost
increases between 2007 and 2008[,]” SFPP should not be
permitted to double-recover its costs by combining its 2008
cost-of-service rates with proposed 2009 indexed rates.
Protest II, at 12. Equivalently, the Shippers alleged that
SFPP’s 2009 indexed rate increase was “substantially in
excess of the actual cost increases incurred by [SFPP]” during
2008. 18 C.F.R. § 343.2(c)(1). FERC agreed. See Opinion
511-A, 137 FERC ¶ 61,220, at ¶ 411; Opinion 511-B, 150
FERC ¶ 61,096, at ¶¶ 27-33. “Because the subject of our
scrutiny is a ratemaking—and thus an agency decision
involving complex industry analyses and difficult policy
choices—the court will be particularly deferential to the
Commission’s expertise.” Ass’n of Oil Pipe Lines, 83 F.3d at
1431. With this principle in mind, we discern no error in
FERC’s decision-making.

    SFPP’s principal retort to this otherwise straightforward
application of FERC’s regulations is that the alleged purpose
of FERC’s indexing procedures is to permit a pipeline to
capture future inflation-based cost adjustments, not prior-year
cost-of-service changes.        FERC responds, somewhat
                               17

cryptically, that indexing “allows rates to track inflation in the
general economy, essentially preserving pipelines’ existing
rates in real economic terms.” FERC’s Br. 43.

    SFPP’s argument is irrelevant to this case. Admittedly,
whether FERC’s indexing mechanism is retrospective or
prospective is unclear. For example, FERC has previously
described the purpose of indexing as “preserv[ing] the value
of just and reasonable rates in real economic terms . . . [by]
tak[ing] into account inflation, thus allowing the nominal
level of rates to rise in order to preserve their real value in
real terms.” Revisions to Oil Pipeline Regulations Pursuant
to the Energy Policy Act of 1992, 58 Fed. Reg. at 58,759; see
also SFPP, L.P., 117 FERC ¶ 61,271, at 62,337 (2006). By
contrast, we have stated that indexing “enable[s] pipelines to
recover costs by allowing pipelines to raise rates at the same
pace as they are predicted to experience cost increases.”
Ass’n of Oil Pipe Lines, 83 F.3d at 1430. However, once a
party files a protest to a pipeline’s proposed rates, FERC’s
regulations state that the Commission will compare the
“actual cost increases incurred by the carrier” with the
proposed rate increase. 18 C.F.R. § 343.2(c)(1) (emphasis
added). FERC made this comparison when it noted that SFPP
would effectively double-recover its 2008 costs were it to
receive the full 2009 index. See Opinion 511-A, 137 FERC
¶ 61,220, at ¶¶ 409-11; Opinion 511-B, 150 FERC ¶ 61,096,
at ¶¶ 27-33. While admittedly FERC’s analysis was less
quantitative than in prior rate proceedings, we hold that FERC
provided sufficient justification for its decision to reduce
SFPP’s 2009 index to one-quarter of the published value. See
Opinion 511-A, 137 FERC ¶ 61,220, at ¶ 411 n.687; SFPP,
L.P., 135 FERC ¶ 61,274, at 62,513 ¶¶ 11-12 (2011)
(describing the so-called “percentage comparison test”); see
also SFPP, L.P., 117 FERC ¶ 61,271, at 62,337 ¶ 5 (denying
indexed rate increase to SFPP’s East Line rates where base
                              18

rates already “recover[ed] all the relevant operating and
capital costs”).

    SFPP’s reliance on prior FERC proceedings involving
indexing, see, e.g., Opinion 435, 86 FERC ¶ 61,022, at 61,085
(2000); Opinion 435-A, 91 FERC ¶ 61,135, at 61,516 (2000),
is inapposite. As SFPP admitted during oral argument, those
proceedings at most permitted FERC to apply the full index to
SFPP’s rates but did not compel it. See Oral Arg. Tr. 22:12-
:15. Notably, FERC did not address in those cases whether
the indexed rates were “so substantially in excess of the actual
cost increases incurred by the carrier,” 18 C.F.R.
§ 343.2(c)(1), which it has done here. We otherwise agree
with FERC that SFPP “has failed to demonstrate that
[FERC’s] determination . . . is inconsistent with precedent.”
FERC’s Br. 48.

   We therefore deny SFPP’s petition on this issue.

   C. FERC MUST DEMONSTRATE THAT THERE IS NO
      DOUBLE RECOVERY OF TAXES FOR PARTNERSHIP
      PIPELINES

    The Shippers argue that FERC engaged in arbitrary-or-
capricious decision-making when it granted an income tax
allowance to SFPP. Specifically, the Shippers note that, as a
partnership pipeline, SFPP is not taxed at the pipeline level.
Because FERC’s discounted cash flow return on equity
already ensures a sufficient after-tax return to attract
investment to the pipeline, they argue, the tax allowance
results in “double recovery” of taxes to SFPP’s partners. In
FERC’s view, we already decided this issue in ExxonMobil,
where we held that FERC’s policy of permitting partnership
pipelines to receive a tax allowance was “not unreasonable”
in light of “FERC’s expert judgment about the best way to
                              19

equalize after-tax returns for partnerships and corporations.”
487 F.3d at 953. FERC therefore posits that the Shippers’
petition in this case is an impermissible collateral attack on
our decision in ExxonMobil. Further, FERC denies that
granting a tax allowance to SFPP results in a double-recovery
of taxes and avers that any disparity in after-tax returns to
partners or shareholders arises from the Internal Revenue
Code, not from FERC’s tax allowance policy. Because we
reserved the issue of whether the combination of the
discounted cash flow return on equity and the tax allowance
results in double recovery of taxes for partnership pipelines,
we disagree with FERC’s collateral attack argument.
Nonetheless, we acknowledge that our opinion in ExxonMobil
stated that it may be reasonable for FERC to grant a tax
allowance to partnership pipelines. However, because FERC
failed to demonstrate that there is no double-recovery of taxes
for partnership, as opposed to corporate, pipelines, we hold
that FERC acted arbitrarily or capriciously. We therefore
grant the Shippers’ petition.

    As all parties acknowledge, this case is not the first time
that we have considered FERC’s tax allowance policy for oil
pipelines. Until our decision in BP West Coast, 374 F.3d at
1293, FERC relied on the so-called Lakehead policy when
granting tax allowances. Named for the FERC decision in
which the Commission formalized the policy, see Lakehead
Pipe Line Co., 71 FERC ¶ 61,338, at 62,314-15 (1995), the
Lakehead policy addressed the situation in which a
partnership pipeline has both corporate-partners and
individual-partners. FERC therein concluded:
                                 20

      When partnership interests are held by corporations,
      the partnership is entitled to a tax allowance in its cost-
      of-service for those corporate interests because the tax
      cost will be passed on to the corporate owners who
      must pay corporate income taxes on their allocated
      share     of     income     directly     on   their     tax
      returns. . . . However, the Commission concludes that
      Lakehead should not receive an income tax allowance
      with respect to income attributable to the limited
      partnership interests held by individuals. This is
      because those individuals do not pay a corporate
      income tax.

Id.

     We reviewed the Lakehead policy in BP West Coast and
held that “[w]e cannot conclude that FERC’s inclusion of the
income tax allowance in SFPP’s rates is the product of
reasoned decisionmaking.” 374 F.3d at 1288. In that case,
we started from the principle “that the regulating commission
is to set rates in such a fashion that the regulated entity yields
returns for its investors commensurate with returns expected
from an enterprise of like risks.” Id. at 1290. Consistent with
this principle, we rejected FERC’s justifications for its
Lakehead policy and held that “where there is no tax
generated by the regulated entity, either standing alone or as
part of a consolidated corporate group, the regulator cannot
create a phantom tax in order to create an allowance to pass
through to the rate payer.” Id. at 1291.

    Concededly, our use of the term “phantom tax” in BP
West Coast lacked precision. This was made apparent in
ExxonMobil, as several shipper-petitioners challenged
FERC’s revised tax allowance policy, which granted a full
income tax allowance to both partnership pipelines and
                               21

corporate pipelines, regardless of the identities of the partners
or shareholders. 487 F.3d at 950. We rejected the
petitioners’ arguments in that case, stating that because
“investors in a limited partnership are required to pay tax on
their distributive shares of the partnership income, even if
they do not receive a cash distribution[,] . . . the income
received from a limited partnership should be allocated to the
pipeline and included in the regulated entity’s cost-of-
service.” Id. at 954. FERC did not create a “phantom tax”
because it did not arbitrarily distinguish between corporate
and individual partners in a partnership pipeline, and the
Commission adequately explained why partner taxes could be
considered a pipeline cost.

    In this case, the Shippers challenge the same tax
allowance policy at issue in ExxonMobil. Given that nothing
has changed with regard to this policy, FERC’s argument that
the Shippers present an impermissible collateral attack to our
ExxonMobil decision is, on first consideration, conceivable.
However, as the Shippers mention in their reply brief, FERC
averred during briefing in ExxonMobil that it was addressing
the double recovery issue in a separate proceeding. See Br. of
Resp’t at 30-31, ExxonMobil Oil Corp. v. FERC, 487 F.3d
945 (D.C. Cir. 2007) (Nos. 04-1102 et al.). While we did not
expressly reserve the issue in our ExxonMobil opinion, the
fact that FERC took this position both in ExxonMobil and in
an accompanying case, see Br. of Resp’t at 29-30, Canadian
Ass’n of Petroleum Producers v. FERC, 487 F.3d 973 (D.C.
Cir. 2007) (No. 05-1382), reflects our implicit reservation of
the question. To clarify, we held in ExxonMobil that, to the
extent FERC has a reasoned basis for granting a tax
allowance to partnership pipelines, it may do so. 487 F.3d at
955. The Shippers now challenge whether such a reasoned
basis exists based on grounds that FERC agreed were not at
                              22

issue in the prior case. We therefore hold that the Shippers’
petition is not a collateral attack on that decision.

    As to the merits, we hold that FERC has not provided
sufficient justification for its conclusion that there is no
double recovery of taxes for partnership pipelines receiving a
tax allowance in addition to the discounted cash flow return
on equity. Despite their attempts to inundate the record with
competing mathematical analyses of whether a double
recovery of taxes for partnership pipelines exists, the parties
do not disagree on the essential facts. First, unlike a
corporate pipeline, a partnership pipeline incurs no taxes,
except those imputed from its partners, at the entity level. See
26 U.S.C. § 7704(d)(1)(E). Second, the discounted cash flow
return on equity determines the pre-tax investor return
required to attract investment, irrespective of whether the
regulated entity is a partnership or a corporate pipeline. See
Opinion 511, 134 FERC ¶ 61,121, at ¶¶ 243-44; Shippers’ Br.
6; see also supra Part II.A (discussing the mechanics of the
discounted cash flow methodology). Third, with a tax
allowance, a partner in a partnership pipeline will receive a
higher after-tax return than a shareholder in a corporate
pipeline, at least in the short term before adjustments can
occur in the investment market. See FERC’s Br. 29;
Shippers’ Br. 34-35; Oral Arg. Tr. 32:17-33:2.

    These facts support the conclusion that granting a tax
allowance to partnership pipelines results in inequitable
returns for partners in those pipelines as compared to
shareholders in corporate pipelines. Because the Supreme
Court has instructed that “the return to the equity owner
should be commensurate with returns on investments in other
enterprises having corresponding risks,” FERC has not shown
that the resulting rates under FERC’s current policy are “just
and reasonable.” Hope Nat. Gas Co., 320 U.S. at 603. FERC
                               23

attempts to circumvent this deduction by arguing, first, that
there is no “gross-up” in the return rate for partnership
pipelines to account for income taxes, and, second, that any
disparate treatment between partners in partnership pipelines
and shareholders in corporate pipelines is the result of the
Internal Revenue Code, not FERC’s tax allowance policy.
These arguments, which are two sides of the same
metaphorical coin, are not persuasive.

    The crux of FERC’s “gross-up” theory is that “in the
context of Commission rate design[,]” Opinion 511-A, 137
FERC ¶ 61,220, at ¶ 290, “the Commission does not gross up
a jurisdictional entity’s operating revenues or return to cover
the income taxes that must be paid to obtain its after-tax
return,” id. ¶ 280. What the Commission apparently means
by this rather obscure statement is that it imputes the income
taxes paid by partners in a partnership pipeline to the pipeline
itself, meaning that an income tax allowance is then necessary
to equalize the after-tax “entity-level” rates of return for
partnership and corporate pipelines. See Opinion 511, 134
FERC ¶ 61,121, at ¶¶ 241-50; see also Opinion 511-A, 137
FERC ¶ 61,220, at ¶ 319. Of course, when one then considers
the after-tax returns to partners or shareholders, the necessary
conclusion is that partners in a partnership pipeline receive a
windfall compared to shareholders in a corporate pipeline, a
point which FERC concedes. See FERC’s Br. at 29; Oral
Arg. Tr. 32:17-33:2. FERC, in a form of Orwellian
doublethink, attributes this disparity in returns to the Internal
Revenue Code while simultaneously denying that double-
recovery exists. See Opinion 511-A, 137 FERC ¶ 61,220, at
¶ 315.

    True, FERC has a justifiable basis for its attribution of
partner taxes to the partnership pipeline. In ExxonMobil, we
acknowledged that “investors in a limited partnership are
                              24

required to pay tax on their distributive shares of the
partnership income, even if they do not receive a cash
distribution.” 487 F.3d at 954. By contrast, “a shareholder of
a corporation is generally taxed on the amount of the cash
dividend actually received.” Id. For this reason, allocation of
partner-level taxes to a partnership pipeline may not result in
a “phantom tax” of the type we rejected in BP West Coast.
However, our holding in ExxonMobil did not absolve FERC
of its obligation to ensure “commensurate . . . returns on
investments” for “equity owner[s]” as required under Hope
Natural Gas, 320 U.S. at 603. Even if FERC elects to impute
partner taxes to the partnership pipeline entity, it must still
ensure parity between equity owners in partnership and
corporate pipelines. FERC’s failure to do so in this case is
therefore arbitrary or capricious.

    The remaining issue is the appropriate remedy. The
Shippers do not request that we overturn our decision in
ExxonMobil, which we are unable to do in any case absent an
en banc decision from the Court. See LaShawn A. v. Barry,
87 F.3d 1389, 1395 (D.C. Cir. 1996). But we also believe
such action is unnecessary. When questioned at oral
argument, FERC conceded that it might be able to remove
any duplicative tax recovery for partnership pipelines directly
from the discounted cash flow return on equity. See Oral
Arg. Tr. 36:3-:10. We note also that, prior to ExxonMobil,
FERC considered the possibility of eliminating all income tax
allowances and setting rates based on pre-tax returns. See
Policy Statement on Income Tax Allowances, 111 FERC
¶ 61,139, at 61,741 (2005). To the extent that FERC can
provide a reasoned basis for such a policy, we do not read our
decision in ExxonMobil as foreclosing that option. See 487
F.3d at 955 (“Arguably, a fair return on equity might have
been afforded if FERC had chosen the fourth alternative of
computing return on pretax income and providing no tax
                               25

allowance at all for the pipeline owners.”). We therefore
grant the Shippers’ petition, vacate FERC’s orders with
respect to this issue, and remand for FERC to consider these
or other mechanisms for which the Commission can
demonstrate that there is no double recovery.

III.   CONCLUSION

    For the reasons stated herein, the Court: (i) grants-in-part
SFPP’s petition with respect to the choice of data for
assessing SFPP’s real return on equity, vacates FERC’s
orders accordingly, and remands for further proceedings
consistent with this opinion; (ii) denies-in-part SFPP’s
petition with respect to the indexing issue; and (iii) grants the
Shippers’ petition, vacates FERC’s orders with respect to the
double recovery issue, and remands to FERC for further
proceedings consistent with this opinion.

                                                    So ordered.
