                                             Volume 1 of 2

                  FOR PUBLICATION
  UNITED STATES COURT OF APPEALS
       FOR THE NINTH CIRCUIT

PUBLIC UTILITY DISTRICT NO. 1 OF       
SNOHOMISH COUNTY WASHINGTON,
                         Petitioner,
RELIANT ENERGY SERVICES INC.,              No. 03-72511
                        Intervenor,        FERC No.
                v.                         EL02-26 et al.
FEDERAL ENERGY REGULATORY
COMMISSION,
                       Respondent.
                                       

SOUTHERN CALIFORNIA WATER              
COMPANY,
                      Petitioner,
ENRON POWER MARKETING INC.,                No. 03-74757
                     Intervenor,           FERC No.
               v.                           EL-02-28
FEDERAL ENERGY REGULATORY
COMMISSION,
                    Respondent.
                                       




                            19539
19540         PUBLIC UTILITY DISTRICT v. FERC



ATTORNEY GENERAL, STATE OF          
NEVADA,
                      Petitioner,
BP ENERGY COMPANY; MIRANT
AMERICAS ENERGY MARKETING,                No. 04-70712
L.P.,
                    Intervenors,
                                          FERC No.
                                          EL02-28-004
              v.
FEDERAL ENERGY REGULATORY
COMMISSION,
                    Respondent.
                                    

NEVADA POWER COMPANY; SIERRA        
PACIFIC POWER COMPANY,
                     Petitioners,         No. 03-74617
               v.                         FERC No.
FEDERAL ENERGY REGULATORY                 EL02-26-000
COMMISSION,
                    Respondent.
                                    
               PUBLIC UTILITY DISTRICT v. FERC         19541



PUBLIC UTILITY DISTRICT NO. 1 OF       
SNOHOMISH COUNTY WASHINGTON
                         Petitioner,
CALPINE ENERGY SERVICES, L.P.; EL
PASO MERCHANT ENERGY L.P.;
MORGAN STANLEY CAPITAL GROUP,
INC.; MIRANT AMERICAS ENERGY                No. 03-74208

                                       
MARKETING, LP; BP ENERGY CO.;                FERC No.
ALLEGHENY ENERGY SUPPLY CO.,                EL02-26, et al
LLC; AMERICAN ELECTRIC POWER
                                              OPINION
SERVICE CORPORATION,
                       Intervenors,
                v.
FEDERAL ENERGY REGULATORY
COMMISSION,
                       Respondent.
                                       
         On Petition for Review of an Order of the
          Federal Energy Regulatory Commission

                 Argued and Submitted
          December 8, 2004—Pasadena, California

                  Filed December 19, 2006

     Before: James R. Browning, Harry Pregerson, and
             Marsha S. Berzon, Circuit Judges.

                 Opinion by Judge Berzon
               PUBLIC UTILITY DISTRICT v. FERC            19545


                         COUNSEL

Stephen M. Ryan, Manatt, Phelps & Phillips LLP, Washing-
ton, DC, argued the case and was on the briefs of petitioners
Nevada Power Company and Sierra Pacific Power Company.
Roger A. Berliner, Manatt, Phelps & Phillips LLP, Washing-
ton, DC, and C. Stanley Hunterton, Hunterton & Associates,
Las Vegas, Nevada, were also on the briefs as attorneys for
the same parties.

Randolph Lee Elliot, Miller, Balis & O’Neil PC, Washington,
DC, argued the case and was on the briefs of petitioner South-
ern California Water Company. Christopher M. Lyons was
also on the briefs as attorney for the same party.

Eric L. Christensen, Assistant General Counsel, argued the
case and was on the briefs of petitioner Public Utility District
No. 1 of Snohomish County, Washington. Howard M. Good-
friend, Edwards, Sieh, Smith & Goodfriend PS, Seattle,
Washington, and Michael J. Gianunzio, General Counsel,
were also on the briefs as attorneys for the same party.
19546           PUBLIC UTILITY DISTRICT v. FERC
Timothy Hay, Chief Deputy Attorney General and Consumer
Advocate, John E. McCaffrey, Stinson, Morrison, & Hecker
LLP, Washington, DC, and Eric Witkowski, Senior Deputy
Attorney General, were on the briefs of petitioner Office of
the Nevada Attorney General, Bureau of Consumer Protec-
tion.

Lona T. Perry, Attorney, Federal Energy Regulatory Commis-
sion, Washington, DC, argued the case and was on the briefs
of the respondent. Cynthia A. Marlette, General Counsel, and
Dennis Lane, Solicitor, were also on the briefs as attorneys for
the respondent.

Richard L. Hinckley, General Counsel, was on the brief of
intervenor Public Utilities Commission of Nevada.

William J. Kayatta, Jr., Jared S. des Rosiers, Louise K.
Thomas, Deborah L. Shaw, Christopher T. Roach, Pierce
Atwood, Portland, Maine, and Erik N. Saltmarsh, Erin Koch-
Goodman, California Electricity Oversight Board, Sacra-
mento, California, were on the joint brief of the intervenors,
as attorneys for California Electricity Oversight Board. Aro-
cles Aguilar, Sean Gallagher, Jonathan Bromson, Public Utili-
ties Commission of the State of California, San Francisco,
California, were on the joint brief of the intervenors, as attor-
neys for the Public Utilities Commission of the State of Cali-
fornia.

Richard P. Bress, Michael J. Gergen, Jared W. Johnson,
David G. Tewksbury, Stephanie S. Lim, Latham & Watkins
LLP, Washington, DC, were on the brief of intervenor Mirant
Americas Energy Marketing LP.

Paul J. Pantano, Jr. and Catherine M. Krupka, McDermott,
Will & Emery LLP, Washington, DC, were on the brief of
intervenor Morgan Stanley Capital Group Inc.

Kenneth W. Irvin, Morrison & Foerster LLP, Washington,
DC, argued the case and was on the joint brief of the interve-
               PUBLIC UTILITY DISTRICT v. FERC            19547
nors in support of the respondent, as attorney for El Paso Mer-
chant Energy, LP. Edward J. Twomey and Bruce Barnard
were also on the joint brief as attorneys for the same party.

Merrill L. Kramer, Robert Shapiro, and Robin D. Ball, Chad-
bourne & Park LLP, Washington, DC, were on the joint brief
of the intervenors in support of the respondent, as attorneys
for Allegheny Energy Supply Company, LLC.

Clark Evans Downs, Martin V. Kirkwood, Kenneth B. Driver,
Jonathan F. Christian, Jones Day, Washington, DC, were on
the joint brief of the intervenors in support of the respondent,
as attorneys for American Electric Power Service Corp.

Mark R. Haskell, Morgan, Lewis & Bockius LLP, Washing-
ton, DC, was on the joint brief of the intervenors in support
of the respondent, as attorney for BP Energy Company.

Sarah G. Novosel, Calpine Corporation, Washington, DC,
was on the joint brief of the intervenors in support of the
respondent, as attorney for Calpine Energy Services, LP.

Charles A. Moore, Leboeuf, Lamb, Greene & MacRae, LLP,
Houston, Texas, was on the joint brief of the intervenors in
support of the respondent, as attorney for Enron Power Mar-
keting, Inc.

Randoplph Q. McManus and Melissa E. Maxwell, Baker
Botts LLP, Washington, DC, were on the joint brief of the
intervenors in support of the respondent, as attorney for Reli-
ant Energy Services, Inc.
19548               PUBLIC UTILITY DISTRICT v. FERC
                                  OPINION

BERZON, Circuit Judge:

   The energy crisis in 2000-2001 resulted in extreme power
shortages and price volatility in California and other western
states. This consolidated appeal raises several interrelated
issues concerning a series of wholesale energy contracts for
future energy supplies — known as “forward” contracts —
entered into by power companies in California, Nevada, and
Washington during the energy crisis. Petitioners, including
retail power companies and state agencies,1 contended before
the Federal Energy Regulatory Commission (FERC) that the
contracts should be modified, but FERC concluded that they
should not be.

  Petitioners (the “local utilities”) now allege that FERC, in
so deciding, did not appropriately apply the just and reason-
able standard set by section 206(a) of the Federal Power Act
(FPA).2 They allege that FERC erred in applying the Mobile-
  1
     Petitioners are Public Utility District No. 1 of Snohomish County,
Washington (Snohomish); Southern California Water Company (Southern
Cal Water); Nevada Power Company (Nevada Power); and Sierra Pacific
Power Company (Sierra Pacific); and the Office of the Nevada Attorney
General, Bureau of Consumer Protection.
   2
     Although the statute was amended slightly in 2005, this opinion exclu-
sively refers to, and quotes from, the 2000 version. Section 206(a) pro-
vided:
      Whenever the Commission, after a hearing had upon its own
      motion or upon complaint, shall find that any rate, charge, or
      classification, demanded, observed, charged, or collected by any
      public utility for any transmission or sale subject to the jurisdic-
      tion of the Commission, or that any rule, regulation, practice, or
      contract affecting such rate, charge, or classification is unjust,
      unreasonable, unduly discriminatory or preferential, the Com-
      mission shall determine the just and reasonable rate, charge,
      classification, rule, regulation, practice, or contract to be thereaf-
      ter observed and in force, and shall fix the same by order.
16 U.S.C. § 824e(a) (2000) (emphasis added). Notably, this provision
expressly applied to “any . . . contract,” as well as to rates unilaterally set.
                  PUBLIC UTILITY DISTRICT v. FERC                  19549
Sierra “public interest” mode of review3 to contracts that were
(1) not subject to meaningful initial review or approval, and
(2) formed during one of the most erratic and bizarre periods
of activity for the western energy market.

   We hold that FERC erred both in its procedural reliance on
Mobile-Sierra4 and in the substantive standard it used in
determining that the contracts at issue did not affect the public
interest. FERC’s reliance on Mobile-Sierra was misplaced
because its grant of market-based rate authority lacked a
mechanism to provide effective, timely relief from unjust and
unreasonable rates due to market dysfunction, thereby creat-
ing a gap in the FPA’s protection against excessive energy
prices. Although we would remand to FERC solely because
its application of Mobile-Sierra was therefore procedurally
improper, we further hold that the agency’s finding that the
challenged contracts do not affect the public interest was
based on a substantively erroneous mode of analysis. A
remand is therefore necessary to allow FERC the opportunity
to review these complaints in the first instance in light of
these holdings and determine whether the challenged rates
meet the statutory standard.

       I.   The Federal Power Act and Mobile-Sierra

   The FPA governs the actions of public utilities, defined as
“any person who owns or operates facilities subject to the
jurisdiction of the [Federal Energy Regulatory] Commission.”
16 U.S.C. § 824(e). The Commission’s jurisdiction covers the
“transmission of electric energy in interstate commerce and
  3
     This shorthand takes its name from two Supreme Court cases decided
on the same day, United Gas Pipe Line Co. v. Mobile Gas Service Corp.
(Mobile), 350 U.S. 332 (1956), and Federal Power Commission v. Sierra
Pacific Power Co. (Sierra), 350 U.S. 348 (1956).
   4
     We use the term “Mobile-Sierra” throughout this opinion to refer both
to the two original Supreme Court cases and to the doctrine derived from
them.
19550           PUBLIC UTILITY DISTRICT v. FERC
the sale of such energy at wholesale in interstate commerce.”
Id. § 824(a). This definition encompasses activities carried out
by all of the Intervenor-Respondent companies.

   The FPA requires FERC to regulate public utilities for the
benefit of consumers. See Pa. Water & Power Co. v. Fed.
Power Comm’n, 343 U.S. 414, 418 (1952) (“A major purpose
of the whole [Federal Power] Act is to protect power consum-
ers against excessive prices.”); California ex rel. Lockyer v.
FERC (Lockyer), 383 F.3d 1006, 1017 (9th Cir. 2004)
(describing “protecting consumers” as the FPA’s “primary
purpose”); see also Atl. Ref. Co. v. Pub. Serv. Comm’n, 360
U.S. 378, 388 (1959) (“The [Natural Gas] Act was so framed
as to afford consumers a complete, permanent and effective
bond of protection from excessive rates and charges.”).

   Two FPA provisions, sections 205 and 206, 16 U.S.C.
§§ 824d, 824e, govern FERC’s authority and establish its
obligation to regulate rates for the interstate sale and transmis-
sion of electricity. Through these provisions, the FPA empow-
ers FERC to regulate wholesale electricity rates but not the
rates charged directly to consumers by local utilities. See 16
U.S.C. § 824(a), (b)(1). The protection the FPA accords con-
sumers is therefore indirect: By assuring that wholesale pur-
veyors of electric power charge fair rates to retailers, the FPA
protects against the need to pass excessive rates on to con-
sumers. At the same time, by assuring that wholesale purvey-
ors of electric power receive a fair rate of return, the FPA
assures that such sellers have the incentive to continue to pro-
duce and supply power.

   The First Circuit has aptly described the interaction of sec-
tions 205 and 206:

    In regulating electricity rates, the Federal Power Act
    follows (with variations) a well-developed model:
    the utility sets the rates in the first instance, 16
    U.S.C. § 824d(a), subject to a basic statutory obliga-
                      PUBLIC UTILITY DISTRICT v. FERC                  19551
       tion that rates be just and reasonable and not unduly
       discriminatory or preferential, id. §§ 824d(a)-(b).
       FERC, which inherited the powers of its predecessor
       (the Federal Power Commission), can investigate a
       newly filed rate (section 205, id. § 824d(e)), or an
       existing rate (section 206, id. § 824e(a)), and, if the
       rate is inconsistent with the statutory standard, order
       a change in the rate to make it conform to that stan-
       dard, id. §§ 824d(e), 824e(a)-(b).

          The procedural incidents and FERC’s ability to
       provide refunds vary depending on whether the pro-
       ceeding is one to investigate a new rate filing or an
       existing rate. For example, in the former case, the
       burden is on the utility to show that its rate is lawful,
       16 U.S.C. § 824d(e), and, in the latter, the burden is
       on the FERC staff or the customer to show that the
       rate is unlawful, id. § 824e(b). In both circum-
       stances, however, the statutory test of lawfulness is
       phrased in the same terms.

Boston Edison Co. v. FERC, 233 F.3d 60, 64 (1st Cir. 2000)
(footnote omitted). Additionally, when utilities set rates in the
first instance, they may do so via privately-negotiated con-
tracts, filed pursuant to section 205(c)-(d), 16 U.S.C.
§ 824d(c)-(d).5 Thus, the FPA, by its terms, creates a role for
  5
   Section 205(c)-(d), 16 U.S.C. § 824d(c)-(d), provides:
      (c) Schedules
         Under such rules and regulations as the Commission may pre-
      scribe, every public utility shall file with the Commission, within
      such time and in such form as the Commission may designate,
      and shall keep open in convenient form and place for public
      inspection schedules showing all rates and charges for any trans-
      mission or sale subject to the jurisdiction of the Commission, and
      the classifications, practices, and regulations affecting such rates
      and charges, together with all contracts which in any manner
      affect or relate to such rates, charges, classifications, and ser-
      vices.
19552             PUBLIC UTILITY DISTRICT v. FERC
privately negotiated wholesale power contracts, balanced by
FERC’s obligation to ensure that those contracts rates, like
unilaterally filed rates, are “just and reasonable.”

   Two Supreme Court decisions, announced on the same day
in 1956, explain the approach that federal regulators must
apply in certain circumstances when reviewing challenges
maintaining that contracted rates are too low to be just and
reasonable. See United Gas Pipe Line Co. v. Mobile Gas Serv.
Corp. (Mobile), 350 U.S. 332 (1956);6 Fed. Power Comm’n
v. Sierra Pac. Power Co. (Sierra), 350 U.S. 348 (1956).
These decisions explain how, in the context of the energy
industry as it existed in 1956, FERC was to ensure that whole-
sale contracts were “just and reasonable.”

  In Mobile, a seller agreed to a long-term fixed rate contract
with another business, and the agency accepted it for filing

    (d)   Notice required for rate changes
       Unless the Commission otherwise orders, no change shall be
    made by any public utility in any such rate, charge, classification,
    or service, or in any rule, regulation, or contract relating thereto,
    except after sixty days’ notice to the Commission and to the pub-
    lic. Such notice shall be given by filing with the Commission and
    keeping open for public inspection new schedules stating plainly
    the change or changes to be made in the schedule or schedules
    then in force and the time when the change or changes will go
    into effect. The Commission, for good cause shown, may allow
    changes to take effect without requiring the sixty days’ notice
    herein provided for by an order specifying the changes so to be
    made and the time when they shall take effect and the manner in
    which they shall be filed and published.
(Emphases added).
   6
     Mobile related to the Natural Gas Act, and so did not involve a FPA
claim. The Supreme Court, however, referred in Mobile to “the virtually
identical provisions of the Federal Power Act,” 350 U.S. at 346, and the
doctrine derived from Mobile always has been understood to be fully
applicable to FPA section 206(a) cases.
                PUBLIC UTILITY DISTRICT v. FERC            19553
under section 205. The Court held that the seller could not
unilaterally increase a contracted rate by filing a new rate
under section 205(d), reasoning that the statute “evinces no
purpose to abrogate private rate contracts,” Mobile, 350 U.S.
at 338, and recognizing the need for “individualized arrange-
ments” between suppliers and distributors, id. at 339. The
Court emphasized that the public is served by the negotiation
and enforcement of private contracts: “By preserving the
integrity of contracts, [the Natural Gas Act] permits the stabil-
ity of supply arrangements which all agree is essential to the
health of the . . . industry.” Id. at 344. At the same time, the
Court made clear that while “permit[ting] the relations
between the parties to be established initially by contract,” the
Natural Gas Act provided for “the protection of the public
interest . . . by supervision of the individual contracts, which
to that end must be filed with the Commission and made pub-
lic.” Id. at 339.

   Sierra took up where Mobile left off, echoing the principle
that a unilateral filing of a new rate cannot supersede a con-
tract rate, even if the new rate is just and reasonable. Sierra,
350 U.S. at 352-53. The Court then extended Mobile to sec-
tion 206 cases, holding that when a public utility agrees “by
contract to a rate affording less than a fair return,” then the
“sole concern” of the Federal Power Commission (FERC’s
predecessor) in section 206(a) review is “whether the rate is
so low as to adversely affect the public interest.” Id. at 355
(emphases added). As the emphasized language indicates,
Sierra dealt only with whether a challenged contract rate was
too low to serve the public interest. It did not deal with a con-
tract rate alleged to be too high. In these low-rate cases, the
Court declared, “the purpose of the power given the Commis-
sion by § 206(a) is the protection of the public interest, as dis-
tinguished from the private interests of the utilities,” as “a
contract may not be said to be either ‘unjust’ or ‘unreason-
able’ simply because it is unprofitable to the public utility.”
Id. (emphasis added).
19554             PUBLIC UTILITY DISTRICT v. FERC
   Sierra thus did not purport to abandon the “just and reason-
able” standard in the statute. Rather, it gave substance to that
standard in circumstances in which the contention is that the
seller of energy finds a long-term contract it entered into no
longer profitable. Relying on section 201 of the FPA and
reciting that “the scheme of regulation imposed by [the FPA]
is necessary in the public interest,” the Court held that when
a seller seeks to raise rates after a contract has gone into
effect, only “public interest” factors are pertinent to the “just
and reasonable” inquiry, including whether the rate “might
impair the financial ability of the public utility to continue its
service, cast upon other consumers an excessive burden, or be
unduly discriminatory.” Id. (internal quotation marks omit-
ted).

   Mobile-Sierra, then, stands for the proposition that in cer-
tain circumstances, a presumption applies that private parties
to a wholesale electric power contract have negotiated a “just
and reasonable” contract over a designated period of time,
lawful under the FPA throughout that period.7 That presump-
tion can be rebutted by establishing that the contract adversely
affects the public interest — that is, the interests of the con-
suming public that the FPA protects.8
  7
     The parties and some of the cases speak as if two alternative standards
for reviewing wholesale electricity rates exist — the statutory “just and
reasonable” standard and the Mobile-Sierra public interest standard. We
do not find this way of viewing the statutory terrain useful. The FPA
establishes a single, albeit general, standard for FERC’s adjudication of
contract challenges like the present one: whether the challenged contract
is “just and reasonable.” 16 U.S.C. § 824e(a). The question therefore can-
not be not whether the Mobile-Sierra or the “just and reasonable” standard
of review applies. Instead, we understand Mobile-Sierra to establish pre-
sumptions regarding whether certain electricity contracts meet the statu-
tory standard, and hold that lack of profitability alone is not a basis for
deeming a contract unreasonable when the seller has agreed to the rate that
proves unprofitable.
   8
     As already noted, the specific factors mentioned in Sierra as rebutting
this presumption apply to cases challenging a contract rate for being too
low. Mobile and Sierra had no occasion to determine what factors must
be shown in other situations.
                PUBLIC UTILITY DISTRICT v. FERC            19555
   As we explain in Part II of this opinion, Mobile and Sierra
arose in a regulatory context in which there was an opportu-
nity for traditional cost-based just and reasonable review
before the energy contracts at issue became effective. The
regulatory regime evolved, however, and FERC shifted its
inquiry from the permissible cost-basis of rates to the determi-
nation of a seller’s market power. We therefore confront here,
for the first time, the intersection of two doctrines — one, the
Mobile-Sierra doctrine, the product of the courts; the other,
market-based rate authorization, the product of recent agency
policy — as they affect the application of the just and reason-
able standard. No case that we have found concerns the inter-
section of these two doctrines.

   While the object of the Mobile-Sierra doctrine was an indi-
vidual contract, the market-based rate authorization inquiry
applies to an individual seller, with regard to any covered
contract for electrical energy it enters into. The former inquiry
occurred contemporaneously with a contract’s formation,
while the latter inquiry transpires before each contract is
formed. This dual shift distinguishes the regulatory context
here from that present in Mobile and Sierra in two material
respects: (1) the timing of the agency’s initial review has
moved to a point before contract formation, and (2) the sub-
stance of that review no longer focuses on the terms of the
contract. In other words, since Mobile and Sierra were
decided, both the questions that FERC asks in its initial regu-
latory review of rates and when it asks them have changed.

   Although this regulatory evolution does not render Mobile-
Sierra a dead letter, it reinforces the need to delineate care-
fully the prerequisites for its application in the present envi-
ronment. Our principal question is therefore whether the
circumstances that trigger the Mobile-Sierra presumption are
present in this case. As we explain in Part IV of this opinion,
we conclude from the context of Mobile-Sierra and from later
cases that three prerequisites are necessary to establish the
Mobile-Sierra presumption: (1) the contract by its own terms
19556           PUBLIC UTILITY DISTRICT v. FERC
must not preclude the limited Mobile-Sierra review; (2) the
regulatory scheme in which the contracts are formed must
provide FERC with an opportunity for effective, timely
review of the contracted rates; and (3) where, as here, FERC
is relying on a market-based rate-setting system to produce
just and reasonable rates, this review must permit consider-
ation of all factors relevant to the propriety of the contract’s
formation.

   Taken together, the satisfaction of these three conditions
justifies a presumption that parties have negotiated a contract
that is just and reasonable between them and therefore trig-
gers the Mobile-Sierra public interest mode of review,
adjusted to account for the circumstance in which it is the
buyer rather than the seller that is challenging the existing
contract. When the prerequisites have not been met, however,
the Mobile-Sierra presumption cannot apply, and FERC must
find another method of evaluating whether the challenged
rates are just and reasonable.

  To explain the origins of these Mobile-Sierra prerequisites
and illuminate the current role of the doctrine, we begin by
considering the historical and regulatory context in which
Mobile-Sierra developed and the changes in that context since
those cases were decided. We then turn to the facts and pro-
ceedings underlying the current dispute and, finally, to the
derivation and application of the Mobile-Sierra prerequisites
and standards.

         II.   Evolution of Power Utility Regulation

  A.    Early Regulation of Utility Monopolies

  Congress passed the Federal Power Act in 1920, establish-
ing the statutory framework described above. Ch. 285, 41
Stat. 1063 (1920). This framework emerged from a wider
body of state and federal regulation that revolved around the
by-then “familiar mandate” that rates in various industries be
                   PUBLIC UTILITY DISTRICT v. FERC                     19557
“just and reasonable.” Verizon Commc’ns Inc. v. FCC, 535
U.S. 467, 477 (2002).9 Before Congress had passed many
laws regulating national industries, state legislatures created
specialized agencies “to set and regulate rates.” Id. In the
electric power industry, this effort began in the first decade of
the twentieth century. By 1914, forty-five states had enacted
electricity regulation laws. RICHARD F. HIRSH, POWER LOSS:
THE ORIGINS OF DEREGULATION AND RESTRUCTURING IN THE
AMERICAN ELECTRIC UTILITY SYSTEM 19-26 (1999).

   The national government’s first substantial foray into rate
regulation occurred in 1887, with the passage of the Interstate
Commerce Act. Ch. 104, 24 Stat. 379 (1887). This statute,
primarily concerned with interstate railroad rates, formed “the
model for subsequent federal public-utility statutes like the
Federal Power Act.” Verizon, 535 U.S. at 478 n.3. Under the
Interstate Commerce Act, railroad carriers would first propose
rate schedules, termed “tariffs.” Then, interested parties could
comment to the agency, which would accept the tariff so long
as it was “just and reasonable.” Id. at 478.

   The states and Congress applied this structure to the elec-
tric power industry on the basis of two widely-shared assump-
tions:

   First, policymakers assumed that public utilities were “nat-
ural monopolies” because, among other reasons, it would be
inefficient for competing utilities to string parallel power
lines. Timothy P. Duane, Regulation’s Rationale: Learning
from the California Energy Crisis, 19 YALE J. ON REG. 471,
476-77 (2002). Also, utilities could benefit from economies of
scale, making a monopoly more efficient than a competitive
market. See HIRSH, supra, at 17-18.
  9
    Verizon concerned the Telecommunications Act of 1996, which is not
relevant to the present case. Verizon did, however, include a broader his-
torical discussion of utility regulation, see 535 U.S. at 477-89, that directly
relates to energy regulation.
19558           PUBLIC UTILITY DISTRICT v. FERC
   Second, these monopolies, like any monopoly, would be
tempted to abuse their market power. Moreover, because elec-
tricity cannot be stored, it needed to be produced at the same
time consumers demanded it. Shortages anywhere on an inter-
connected electricity grid could threaten the entire system.
The factors unique to the electric power industry made it par-
ticularly susceptible to abuse of market power: A local utility
could withhold power, demand higher rates, and credibly
threaten to disrupt a regional or national market. Regulation
would keep local utilities in check. Duane, supra, at 477-78.

   Early state and federal agencies created two categories of
regulated rates: “retail rates charged directly to the public and
wholesale rates charged among businesses involved in provid-
ing” the regulated good or service. Verizon, 535 U.S. at 478.
Under the FPA, the federal government regulates only inter-
state wholesale electric power sales and interstate electric
power transmission, leaving to the states the regulation of
rates charged to consumers. See 16 U.S.C. § 824(a), (b)(1).
State and local governments, therefore, generally focused on
rates “as between businesses and the public,” while the fed-
eral government regulated rates “as between businesses.”
Verizon, 535 U.S. at 479.

   As a result of these differences in their regulatory focus,
important differences in methodology developed between fed-
eral and state energy rate regulation. Knowing that state regu-
lators focused on rates charged directly to the public and
following Congress’s “acknowledg[ment] that contracts
between commercial buyers and sellers could be used in rate-
setting,” id. (citing section 205(d) and Mobile, 350 U.S. at
338-39), the Federal Power Commission (FPC) and, later,
FERC — both bound by Mobile-Sierra — became less
inclined to step in and alter filed rates charged among busi-
nesses in the energy industry. Even if those agencies wanted
to change contract rates, courts, applying Mobile-Sierra,
would generally assume that those rates were just and reason-
able and would probably not harm the public interest. The
               PUBLIC UTILITY DISTRICT v. FERC           19559
underlying assumption was that “[i]n wholesale markets, the
party charging the rate and the party charged were often
sophisticated businesses enjoying presumptively equal bar-
gaining power, who could be expected to negotiate a ‘just and
reasonable’ rate as between the two of them.” Id. The equal
market power of those businesses and the role of state regula-
tion of rates charged to consumers allowed the federal gov-
ernment to set a relatively high bar for proving that a
wholesale contract was unjust or unreasonable based on
impact on the public. Federal agencies, including the FPC and
its successor agency FERC, thus saw their “principal regula-
tory responsibility” as preventing discrimination “by favor-
able contract rates between allied businesses” as compared to
other businesses. Id. At the same time, Sierra’s admonition
that federal regulators should reform contracts if that was
“necessary in the public interest,” Sierra, 350 U.S. at 355
(internal quotation mark omitted), confirmed a continuing
federal responsibility to review the impact of wholesale con-
tracts on the public, even though the federal government did
not directly regulate rates charged to consumers.

   In contrast to federal regulators, state regulators “focused
more on the demand for ‘just and reasonable’ rates to the pub-
lic than on the perils of rate discrimination.” Verizon, 535
U.S. at 480. In California, for instance, the Public Utilities
Commission ensured that rates charged by the state’s three
primary utilities — Pacific Gas & Electric, Southern Califor-
nia Edison, and San Diego Gas & Electric — were just and
reasonable to the consuming public. See CAL. CONST. art. XII,
§ 6; Duane, supra, at 480.

  Within this two-tiered regulatory structure, case law devel-
oped an evolving definition of the “just and reasonable” stan-
dard. See Verizon, 535 U.S. at 481-89. After decades-long
debates not relevant here, courts and regulators settled on a
system that attempted to match rates to the cost to the utility
of providing the service, including “the cost of prudently
invested capital used to provide the service.” Id. at 485. This
19560          PUBLIC UTILITY DISTRICT v. FERC
“prudent-investor rule” was designed to provide incentives for
utilities to invest in necessary capacity-building by allowing
them to charge rates that would provide a fair rate of return
on those investments while at the same time “protect[ing]
ratepayers from supporting excessive capacity, or abandoned,
destroyed, or phantom assets.” Id. at 486. These competing
elements of cost of service regulation were intended to
“mimic natural incentives in competitive markets.” Id.; see
also Farmers Union Cent. Exch., Inc. v. FERC, 734 F.2d
1486, 1510 (D.C. Cir. 1984). As a result, cost of service regu-
lation would, in theory, lead to the same rates that would exist
in a properly functioning unregulated market.

  B.    Federal and State Regulatory Reform

   Our description thus far covers the regulatory landscape
through the mid-1990s. Beginning then, the electric power
industry saw “complementary initiatives by the FERC and
state agencies” to shift from a cost-based rate regulation
regime to a market-based regime. Carmen L. Gentile, The
Mobile-Sierra Rule: Its Illustrious Past and Uncertain Future,
21 ENERGY L.J. 353, 373 (2000).

  This move toward energy regulation reform was premised
on a new set of widely-shared assumptions:

   First, cost-based regulation did not effectively check public
utilities’ market power. See Verizon, 535 U.S. at 486 (“[T]he
prudent-investment rule in practice often [was] no match for
the capacity of utilities having all the relevant information to
manipulate the rate base . . . .”); Promoting Wholesale Com-
petition Through Open Access Non-Discriminatory Transmis-
sion Services by Public Utilities; Recovery of Stranded Costs
by Public Utilities and Transmitting Utilities, FERC Order
888-A, 62 Fed. Reg. 12,274, 12,275 (Mar. 14, 1997)
(“[A]bsent open access, undue discrimination will continue
. . . .”); HIRSH, supra, at 33-54 (describing how “[u]tility
[m]anagers [g]ain[ed] [d]ominance” within the earlier regula-
                  PUBLIC UTILITY DISTRICT v. FERC                    19561
tory scheme). Also, local utilities would often deny competi-
tors access to their transmission networks, protecting their
monopoly status within a geographic area. See Atl. City Elec.
Co. v. FERC, 295 F.3d 1, 4 (D.C. Cir. 2002).

   Second, with technological changes, public power utilities
no longer needed to be monopolies. Technological innova-
tions now permitted transmission of power over longer dis-
tances, allowing consumers to obtain power from beyond the
geographic range of their local utility. See Transmission
Access Policy Study Group v. FERC, 225 F.3d 667, 681 (D.C.
Cir. 2000) (per curiam) (upholding FERC’s 1996 reform
orders), aff’d sub nom. New York v. FERC, 535 U.S. 1 (2002).

   Third, the newly feasible market competition could drive
down wholesale prices and measure the cost of service,
including the cost of long-term investments, more accurately
than did the previous regulatory regime. Competition, this
thesis posits, “at least over the long pull,” will lead to prices
that “approximate [marginal] cost,” including a return on cap-
ital sufficient to ensure that companies have financial incen-
tives to provide power. Interstate Natural Gas Ass’n of Am.
v. FERC (INGAA), 285 F.3d 18, 31 (D.C. Cir. 2002).

   Based on these assumptions, FERC decided in 1996 to fun-
damentally reform its regulation of the nation’s interstate
wholesale electricity markets. FERC’s orders implementing
this electrical power reform, Orders 888 and 889, required
each utility that operates transmission lines to allow any other
utility in the interstate energy market to use its transmission
lines on the same terms applicable to the operating utility itself.10
  10
     According to FERC, open access is the first of “two central compo-
nents.” Order 888-A, 62 Fed. Reg. at 12,276. The second central compo-
nent of the 1996 Orders is their mechanism for allowing utilities to recover
“stranded costs,” that is, costs which they incurred under the previous reg-
ulatory regime based upon an expectation of repayment that may not occur
in newly competitive markets. Id.
19562           PUBLIC UTILITY DISTRICT v. FERC
Transmission Access, 225 F.3d at 681-82; Promoting Whole-
sale Competition Through Open Access Non-Discriminatory
Transmission Services by Public Utilities; Recovery of
Stranded Costs by Public Utilities and Transmitting Utilities,
FERC Order No. 888, 61 Fed. Reg. 21,540, 21,541 (May 10,
1996). Taking advantage of the newly available “open
access,” utilities would, in theory, have both the market incen-
tives and the legal right to compete with each other. This
competition would provide retail consumers with the opportu-
nity to purchase power from a wide variety of producers at
relatively lower rates. Transmission Access, 225 F.3d at 683.
A factory in Albany, California, for example, could, in theory,
purchase power from a power plant in Albany, New York, no
longer limited in its options to whatever the local utility
would sell. Local energy utilities, could, rather than producing
their own power to sell to the public, choose between various
competing producers and then transfer the expected savings
from this competition to the public. FERC estimated that, as
a result of such competition, consumers would benefit from
annual savings of $3.8 billion to $5.4 billion. Order 888-A, 62
Fed. Reg. at 12,276.

   A crucial element of FERC’s 1996 “open access” reforms
was the connection between “open access” and an “open
access” utility’s authority to charge whatever rates the market
would bear. “[A]pproximately a decade ago, companies began
to file market-based tariffs that did not specify the precise rate
to be charged,” and instead indicated that they would charge
market-based rates. Lockyer, 383 F.3d at 1012. FERC would
approve those tariffs if the public utility proved that it lacked,
or had adequately mitigated, any ability to significantly affect
market prices. La. Energy & Power Auth. v. FERC, 141 F.3d
364, 365 & n.1 (D.C. Cir. 1998); see also Sw. Pub. Serv. Co.,
72 F.E.R.C. ¶ 61,208, at ¶ 61,966 (1995) (summarizing
criteria for approving market-based rate tariffs). Such grants
of market-based rate authorization were open-ended. See, e.g.,
So. Co. Servs., Inc., 87 F.E.R.C. ¶ 61,214, at ¶ 61,847 n.3.
               PUBLIC UTILITY DISTRICT v. FERC           19563
   FERC’s 1990s reforms specified open access as one criteria
necessary to demonstrate the lack, or adequate mitigation, of
market power. When a public utility implemented an “open
access” policy, it demonstrated that it lacked market power
regarding “sales from its existing [power generation] capaci-
ty” and was thus entitled to market-based rate authority —
that is, the ability to charge whatever rates the market would
bear — when it sold power over open access transmission
grids. See Order No. 888, 61 Fed. Reg. at 21,553; see Lock-
yer, 383 F.3d at 1013 (describing FERC’s test for granting
market-based rate authority as “consist[ing] of a finding that
the applicant lacks market power (or has taken sufficient steps
to mitigate market power)”); cf. EDWARD KAHN, ELECTRIC
UTILITY PLANNING AND REGULATION 319 (1991) (describing the
lack of open access as allowing “market power [to] interfere
with market efficiency”).

   FERC thus based its 1996 reform — and, as this case
makes clear, much of its subsequent regulation — on the
belief that “open access” would create market forces helping
to ensure that no utility could exercise market power when
selling wholesale power. See Order No. 888, 61 Fed. Reg. at
21,554 (“[I]ncreased competition resulting from open access
transmission may reduce or even eliminate generation-related
market power in the short-run market . . . .”); id. at 21,555
(“[T]he Commission expects this Rule to facilitate the devel-
opment of competitive bulk power markets . . . .”). FERC
tempered this expectation by promising to “continue our case-
by-case approach” to granting market-based rate authority. Id.
FERC’s “case-by-case approach” includes ensuring that sell-
ers seeking market-based rate authority lack, or have suffi-
ciently mitigated, market power and that FERC has a
sufficient “means of monitoring the market in which [the sell-
er’s] sales will take place.” Entergy Servs., Inc., 58 F.E.R.C.
¶ 61,234, ¶ 61,753-54 (1992); see also Lockyer, 383 F.3d at
1016 (requiring a market-based regime to include “implied
enforcement mechanisms sufficient to provide substitute rem-
edies for the obtaining of refunds”); Transwestern Pipeline
19564           PUBLIC UTILITY DISTRICT v. FERC
Co., 43 F.E.R.C. ¶ 61,240, at ¶ 61,650 (1988) (requiring a
finding that “competition in the relevant markets will operate
as a meaningful constraint on the exercise of market power”).
Following the Entergy approach, FERC also promised to
“modify our market rate criteria if and when appropriate,” but
specified that any such modification would “not upset transac-
tions entered into pursuant to existing market-based rate
authority.” Order 888, 61 Fed. Reg. at 21,555.

   Like FERC, California challenged the monopoly power of
electric power utilities. California’s efforts to foster competi-
tion between utility monopolies had begun after the energy
crises of the 1970s. See Duane, supra, at 482-87. Federal law
then allowed a “qualifying small power production facility” to
compete in wholesale power markets. See Public Utility Reg-
ulatory Policies Act of 1978, Pub. L. No. 95-617, §§ 201, 210,
92 Stat. 3117, 3134-35, 3144-47 (codified at 16 U.S.C.
§§ 796(17)(C), 824a-3). California pursued these new options
particularly aggressively so that, by 1991, California received
a third of its energy from producers other than the monopolies
held by local utilities. HIRSH, supra, at 93. Those producers
demonstrated that a utility could efficiently produce power
without taking advantage of economies of scale that suppos-
edly made electricity monopolies “natural.” Through these
reforms and market changes, the monopoly status of local
utilities and the methodology of state regulation of monopoly
utilities was eroding.

   California A.B. 1890, passed in 1996, sought to accelerate
this breakup of local utility monopolies by requiring them to
divest a substantial amount of their electricity generation
facilities. Act of Sept. 23, 1996, ch. 854, 1996 Cal. Legis.
Serv. 854 (West). Local utilities also were required to sell
power generated by remaining facilities to the California
Power Exchange Corporation (CalPX), which was to serve as
                 PUBLIC UTILITY DISTRICT v. FERC         19565
an auction market for wholesale electricity sales. Lockyer, 383
F.3d at 1008-09.11

  C.    Shifting Authority to FERC

   When combined with federal preemption law, one crucial
result of these energy market regulatory reforms has been “a
massive shift in regulatory jurisdiction from the states to the
FERC.” Gentile, supra, at 373. As noted, a “bright line” exists
between state and federal jurisdiction, with wholesale power
sales — the type of sales at issue in the challenged contracts
in this case — falling on the federal side of the line. Nanta-
hala Power & Light Co. v. Thornburg, 476 U.S. 953, 966
(1986) (quoting Fed. Power Comm’n v. S. Cal. Edison Co.,
376 U.S. 205, 215 (1964)). FERC’s jurisdiction to determine
the reasonableness of wholesale rates is exclusive. Miss.
Power & Light Co. v. Mississippi ex rel. Moore, 487 U.S.
354, 371 (1988). Prior to 1996, vertically-integrated state
monopolies would charge public consumers rates regulated by
state entities and would purchase power from interstate utili-
ties at rates regulated by FERC. The 1996 FERC reforms
opened up local monopolies to competition among suppliers
in the wholesale power market, resulting in a sharp increase
in wholesale power sales — subject to FERC’s exclusive
jurisdiction — as utilities shopped among suppliers. See Gen-
tile, supra, at 373; Pub. Util. Dist. No. 1 v. Idacorp Inc.
(Grays Harbor), 379 F.3d 641 (9th Cir. 2004). Additionally,
state regulatory reform laws, like California’s A.B. 1890,
resulted in a less active role for state regulators and a more
active one for FERC, as the breakup of vertically integrated
utilities created the need for many more wholesale transac-
tions. In California, for example, regulators “ceded most of
their authority for regulating generator or trader behavior to
FERC through A.B. 1890.” Duane, supra, at 507.
  11
    The details of A.B. 1890 are discussed below.
19566           PUBLIC UTILITY DISTRICT v. FERC
   The upshot of these federal and state innovations in elec-
tricity regulation is that state regulators, despite their contin-
ued authority over rates charged directly to consumers, have
much less actual authority over those rates than they did when
Mobile and Sierra were decided. Local utilities now obtain
power largely through wholesale contracts subject to FERC’s
exclusive regulation, rather than through self-generated and
self-transmitted power. As a result, state regulators ordinarily
must set retail rates with the wholesale rates as an established
cost factor. FERC recognized this dynamic when issuing its
reform orders, noting that customers will obtain more power
delivered via “unbundled” wholesale transactions — in which
the generation and transmission are separately traded rather
than provided by an integrated local utility monopoly — mak-
ing “[t]he exercise of our jurisdiction over rates, terms and
conditions of unbundled retail transmission . . . more impor-
tant.” Order 888-A, 62 Fed. Reg. at 12,279.

   Accordingly, while the state and federal regulatory reforms
of the 1990s did not end regulation of the electric energy
industry, they did begin a new regulatory era. Although state
regulators formerly took an extremely active role so as to
ensure the just and reasonable retail power rates, FERC has
exclusive jurisdiction over the wholesale rates that now drive
the electric power market and, as a practical matter, largely
determine the rates ultimately charged to the public. These
changes profoundly affect this case and require us to ensure
that FERC’s application of the Mobile-Sierra doctrine reflects
both the historical and regulatory purpose of the doctrine and
contemporary regulatory reality.

   With the history of electric rate regulation thus in mind, we
now turn to the facts of the particular contracts at issue and
then consider whether FERC applied the correct legal stan-
dard to review of these challenged contracts.
                   PUBLIC UTILITY DISTRICT v. FERC                     19567
           III.   Factual and Procedural Background

  A.     The Western Energy Crisis of 2000-2001

   This is not the first case, and it will not be the last, that
requires this court to address the western energy crisis of
2000-2001, the basic facts of which are outlined elsewhere.
See Pac. Gas & Elec. Co. v. FERC, 464 F.3d 861, 863-66 (9th
Cir. 2006); Pub. Utils. Comm’n of Cal. v. FERC, 462 F.3d
1027, 1035-46 (9th Cir. 2006); Bonneville Power Admin. v.
FERC, 422 F.3d 908, 911-14 (9th Cir. 2005); Lockyer, 383
F.3d at 1008-11; California ex rel. Lockyer v. Dynegy, Inc.,
375 F.3d 831, 835-36 (9th Cir. 2004), cert. denied, 544 U.S.
974 (2005); S. Cal. Edison Co. v. Lynch, 307 F.3d 794, 800-
01 (9th Cir. 2002); Duke Energy Trading & Mktg., L.L.C. v.
Davis, 267 F.3d 1042, 1045-46 (9th Cir. 2001); Cal. Power
Exch. Corp. v. FERC (CalPX), 245 F.3d 1110, 1114-19 (9th
Cir. 2001); see also Duane, supra, at 511-24; Michael A. Yuf-
fee, California’s Electricity Crisis: How Best To Respond to
the “Perfect Storm,” 22 Energy L.J. 65, 65-84 (2001).
Accordingly, we summarize here only those facts most rele-
vant to this case.

   As noted, in 1996, the California legislature deregulated the
power industry in California through passage of A.B. 1890.
The bill froze residential and small commercial consumer
retail rates12 and required that the three largest California
investor-owned utilities13 divest most of their electricity gen-
eration facilities. See CalPX, 245 F.3d at 1114-15. Addition-
ally, the bill created the CalPX, which operated a single-day
  12
      The legislature froze rates at a level utilities expected to be far above
rates utilities were likely to have to pay, thus allowing them to recoup
“stranded costs” as California’s energy market shifted to a new regulatory
era. See Duane, supra, at 501.
   13
      The three largest investor-owned utilities were San Diego Gas and
Electric Company, Southern California Edison, and Pacific Gas and Elec-
tric Company (PG&E). CalPX, 245 F.3d at 1114.
19568             PUBLIC UTILITY DISTRICT v. FERC
auction for day-ahead and day-of trading in wholesale elec-
tricity, known as the “spot market.” Id. at 1114.14

   In the summer of 1999, CalPX also opened up a “forward
market” to facilitate long-term wholesale electricity contracts.
Id. The California Public Utilities Commission, however,
allowed the investor-owned utilities to purchase only a limited
amount of electricity from the CalPX forward markets. The
great bulk of their load still had to be purchased from the
CalPX spot markets. Id. at 1115.

   In the summer of 2000, there was a dramatic spike in the
price of wholesale electricity in the spot markets. Id. For
example, “[t]he CalPX’s constrained day-ahead price peaked
at $1,099/MWh [megawatts/hour] on June 28, 2000 — an
astounding 15-fold increase over the pre-restructuring average
cost of $74/MWh.” Id. at 1115 n.2.

   On November 1, 2000, FERC issued an order explaining
that, in its view, this dramatic increase was primarily the
result of three factors:

   First, “competitive market forces played a major role in the
run-up of prices through significantly increased power pro-
duction costs combined with increased demand due to unusu-
ally high temperatures and a scarcity of available generation
resources throughout the West and California in particular.”
San Diego Gas & Elec. Co., 93 F.E.R.C. ¶ 61,121, at ¶ 61,354
(2000).

  Second, “[m]any of the market dysfunctions in California
and the exposure of California consumers to high prices can
be traced directly to an over reliance on spot markets.” Id.
  14
    The term “spot market” refers to deals for energy provided over peri-
ods generally not exceeding 24 hours and entered into the day of or day
prior to delivery. It contrasts with the term “forward market,” in which
energy is delivered some time beyond 24 hours after the sale.
                PUBLIC UTILITY DISTRICT v. FERC            19569
¶ 61,359. The rules requiring investor-owned utilities to pur-
chase primarily through the spot markets precluded any sig-
nificant reliance on forward markets. “And other retail
suppliers who would have been free to implement appropriate
risk management strategies could not be induced to participate
in California’s market because the low retail rate, frozen at 10
percent below historical levels, thwarted competitive opportu-
nities for new participants to enter the market.” Id.

   Third, FERC suggested that there was the opportunity for
abuse of the markets through the exercise of market power,
but could not point to specific instances. Id. ¶ 61,376. FERC’s
staff later issued a report concluding that the spot market was
dysfunctional, partially due to market manipulation by sellers;
that conclusion is assumed by all parties here. See STAFF OF
THE FEDERAL ENERGY REGULATORY COMMISSION, FINAL REPORT
ON PRICE MANIPULATION IN WESTERN MARKETS: FACT-FINDING
INVESTIGATION OF POTENTIAL MANIPULATION OF ELECTRIC AND
NATURAL GAS PRICES [“Staff Report”] (2003), available at
www.ferc.gov/legal/maj-ord-reg/land-docs/PART-I-3-26-
03.pdf.

   California is part of a single integrated electricity market in
the West. Its energy problems therefore created a “dysfunc-
tional marketplace both in California and the remainder of the
West.” See San Diego Gas & Elec. Co. (June 19 Order), 95
F.E.R.C. ¶ 61,418, at ¶ 62,556 (June 29, 2001). For example,
in the Pacific Northwest, prices have historically averaged
approximately $24/MWh. During this period, short term
prices spiked to unprecedented levels, peaking at $3,300/
MWh in early December of 2000, and during the summer and
fall of 2000 averaged between $200/MWh and $500/MWh.
Markets were also marked by unprecedented levels of price
volatility. In response to this volatility, between August 2000
and December 19, 2001, FERC issued nearly 75 orders pro-
viding for spot market mitigation measures, see, e.g., id., most
aimed at reducing the size of the spot market. San Diego Gas
19570           PUBLIC UTILITY DISTRICT v. FERC
& Elec. Co., 97 F.E.R.C. ¶ 61,275, at ¶ 62,171 (Dec. 19,
d2001).

   The order issued on December 15, 2000, is of particular rel-
evance to the issues here. See San Diego Gas & Elec. Co.
(December 15 Order), 93 F.E.R.C. ¶ 61,294 (Dec. 15, 2000).
That order strongly urged investor-owned utilities to move to
long-term contracts of two years or more. Id. ¶ 61,993. “To
address concerns about potentially unjust and unreasonable
rates in the long-term markets,” FERC agreed to “monitor
prices in those markets” and established a “benchmark” rate
of $74/MWh to “use as a reference point in addressing any
complaints regarding the pricing of long-term contracts nego-
tiated over the next year.” Id. ¶ 61,994-95. In response to the
contention that such a shift would only transform the forward
market into another strong sellers’ market resembling the
then-dysfunctional spot market, FERC declared that it would
“be vigilant in monitoring the possible exercise of market
power” in the forward market. Id. ¶ 61,994. FERC’s monitor-
ing, the agency promised, would “also provide customers pro-
tection by providing early review of as-bid prices that may not
be just and reasonable and prompt rate relief for prices that
are mitigated.” Id. ¶ 61,997.

  B.     Contracts at Issue Here

  This consolidated appeal involves three separate sets of
contracts, all of which were made pursuant to the Western
Systems Power Pool Agreement (Power Pool Agreement), an
umbrella agreement that established standardized terms for
wholesale energy transactions. All the utilities involved in this
case are signatories to that agreement.

    1.    Snohomish

   In response to the extreme spike of spot market prices
(reaching as high as $3,300/MWh) during December 2000,
Snohomish, a public utility for Snohomish County in Wash-
                   PUBLIC UTILITY DISTRICT v. FERC                   19571
ington, determined that it was no longer viable to rely on the
spot markets. On December 22, 2000, Snohomish issued a
request for proposals to 17 power suppliers, seeking bids for
one-to-three year contracts, providing a total of approximately
75-100 megawatts of electricity for 2001.

   Snohomish received five bids, but two were unresponsive
to Snohomish’s needs. Of the three responsive bids, no sup-
plier would offer more than 25 MW, so Snohomish accepted
all three bids and negotiated contracts with each supplier.15
That year, Snohomish’s Board of Commissioners had previ-
ously approved an unprecedented thirty-five percent increase
in retail rates, allowing for an average contract price of $125/
MWh. Unfortunately, none of the three offers would allow
Snohomish to meet this price, and Snohomish chose not to
ask its ratepayers for another double-digit rate increase in the
same year.

   Consequently, Snohomish asked Morgan Stanley — an
electrical energy commodities dealer — what term would be
necessary to secure a $100/MWh price for its contract; Mor-
gan Stanley demanded a ten-year term. The parties ultimately
agreed to a nine-year term at $105/MWh. Additionally, Mor-
gan Stanley required Snohomish to accept credit terms articu-
lated in a contractual provision termed the “Collateral Annex.”16

  Snohomish claims that it suffered losses between January
2001 and March 2002 in excess of $25.7 million and that
those losses will escalate over the term of the contract as mar-
ket rates remain close to traditional levels. FERC specifically
  15
      One of the three contracts, signed with Enron Corporation, was termi-
nated in November 2001, as Enron’s credit deteriorated. Snohomish
sought reform of the other contract, with American Electric Power, and
the parties settled that case. The remaining contract, here at issue, is with
Morgan Stanley Capital Group (“Morgan Stanley”).
   16
      Among other requirements, the “Collateral Annex” required Snoho-
mish to post, on two days notice, specified collateral. This requirement has
required Snohomish to post as much as $101 million in collateral.
19572          PUBLIC UTILITY DISTRICT v. FERC
found that the Morgan Stanley contracts accounted for an
eight percent increase for retail ratepayers over 2001 rates,
and other contracts accounted for a fifty-one percent increase.
Nev. Power Co. (November 10 Order), 105 F.E.R.C.
¶ 61,185, at ¶ 61,986 (Nov. 10, 2003). Snohomish here chal-
lenges the term of the contract and the imposition of the Col-
lateral Annex.

    2.   Southern Cal Water

   Southern Cal Water owns and operates an electric utility
distribution system that serves approximately 21,600 custom-
ers in San Bernadino County, California. Southern Cal Water
purchases, subject to regulation by the California Public Utili-
ties Commission, an average electric load of about 16.3 MW.

   The A.B. 1890 requirements that investor-owned utilities
purchase in the spot market did not apply to Southern Cal
Water, which owned no transmission lines and generated no
electricity. To avoid relying entirely on the spot markets,
which it viewed as significantly risky, Southern Cal Water
executed a one-year contract with Illinova in April 1999, pro-
viding for purchase of 12 MW of uninterruptible around-the-
clock energy at a price of $28/MWh. One year later, Southern
Cal Water renewed the contract with Dynegy (Illinova’s suc-
cessor), to run from May 1, 2000, to May 1, 2001, for the
same load, at the increased price of $35.50/MWh.

   California enacted A.B. 1 on February 1, 2001, allowing
the California Department of Water Resources to purchase
energy for the then-collapsing large investor-owned utilities
and power suppliers. See Act of Feb. 1, 2001, 2001 Cal.
Legis. Serv. 1st Ex. Sess. 4 (West). At that point, Dynegy
informed Southern Cal Water that it was not interested in
renewing its contract with Southern Cal Water, because it
could sell its entire generation output to the State of Califor-
nia. With the present contract expiring at the end of April
                  PUBLIC UTILITY DISTRICT v. FERC                  19573
2001, Southern Cal Water engaged in a hurried bidding pro-
cess.17

   On March 7, 2001, Southern Cal Water issued a request for
proposals for 15 MW of power to six power companies oper-
ating in California and requested bids by March 14, 2001. The
company requested bids of one to seven years, without speci-
fying a preferred or maximum price. The three bids submitted
ranged from $194.50/MWh for a one-year contract to $84/
MWh for a seven-year contract. After receiving firm offers at
higher prices, Southern Cal Water accepted Mirant’s offer of
$95/MWh for five years, as the offer that best balanced price
against contract length. In light of this increase in Southern
Cal Water’s wholesale electricity costs, the California Public
Utilities Commission allowed the company to recover a por-
tion of the costs of the contract, resulting in a weighted aver-
age retail rate of $77/MWh.

   Southern Cal Water maintains that its ratepayers have seen
an overall thirty-eight percent increase in their electric bills.
FERC found that there was no rate increase for Southern Cal
Water’s ratepayers who are permanent residents, and that the
other group of Southern Cal Water ratepayers, those with sec-
ond homes in certain areas, paid an average monthly electric
bill of only $35.13. Order on Rehearing, 105 F.E.R.C. at
¶ 61,986.
  17
    Noting that, in October 2000, Southern Cal Water rejected an offer by
Dynegy to extend its contract on a “blend and extend” basis of between
$46.50/MWh to $54.50/MWh depending on the length of the proposed
contract, Order on Rehearing, 105 F.E.R.C. at ¶ 61,988 (internal quotation
marks omitted), FERC found that Southern Cal Water chose to wait until
March 2001 to solicit bids. This statement is misleading. Southern Cal
Water could only have become aware that Dynegy would not renew its
contract on any terms because of the disincentive to doing so created by
A.B. 1 after that law was passed, which was in February of 2001. As noted
above, it was Dynegy’s pullout that induced Southern Cal Water’s fren-
zied bidding process.
19574            PUBLIC UTILITY DISTRICT v. FERC
       3.   Nevada Power Companies: Nevada Power and
            Sierra Pacific

   The challenge brought by Nevada Power and Sierra Pacific
seeks to modify over two hundred forward market contracts
with various energy sellers for supply of 25-100 MW blocks
of power.18 These contracts range in price from $33/MWh to
$290/MWh, and were entered into in 2000-2001 with ten
energy companies. FERC found that these contracts were
standard products arranged through independent third-party
brokers, and concluded that Nevada Power and Sierra Pacific
were price-takers, meaning that those utilities took the price
the market yielded rather than bargaining or demanding a cer-
tain price. Nev. Power Co. (June 26 Order), 103 F.E.R.C.
¶ 61,353, at ¶ 62,398 (June 26, 2003). According to FERC,
the Nevada companies did not pursue purchase of a diverse
mix of products and therefore failed to hedge the risk that spot
market prices might fall. Id.

   FERC also found that the Nevada companies pursued an
aggressive procurement strategy, purchasing more power than
necessary to serve the expected load of their local customers.
Id. FERC suggests that the Nevada companies were trying to
buy as much power as they could before sellers discovered
their precarious financial situation. Id.

   FERC found that if these contracts are not modified, the
resulting increase to ratepayers would be no more than five
percent. Id. ¶ 62,397. The Nevada companies recognize that
the retail rates have decreased since they agreed to the chal-
lenged contracts, but they maintain that Nevada customers
will still pay significantly more than they would pay if the
contracts were modified to reflect just and reasonable rates.
Order on Rehearing, 105 F.E.R.C. at ¶ 61,986. Nevada Power
  18
     The Nevada companies recently settled their disputes with Morgan
Stanley, El Paso Merchant Energy, and Enron Power Marketing. These
settlements have no bearing on the legal issues we address.
                  PUBLIC UTILITY DISTRICT v. FERC                  19575
and Sierra Pacific therefore seek to modify their contracts
with the energy sellers. Nev. Power Co. (April 11 Order), 99
F.E.R.C. ¶ 61,047, at ¶ 61,185 (Apr. 11, 2002). Nevada Power
is seeking relief for contracts that had not yet gone to delivery
at the refund effective dates set by FERC (between late Janu-
ary and April of 2002, depending on docket number).19 Id.
¶¶ 61,185, 61,192.




  19
    Upon setting a section 206 complaint for hearing, FERC establishes
a “refund effective date,” which is a date establishing the period from
which complainants may attain relief should the proceedings extend
beyond that established date. In other words, if a party makes a complaint
on January 1, 2004, but FERC does not set the complaint for hearing until
July 1, 2004, FERC may establish a “refund effective date” of March 1,
2004, so that the complainant will not suffer from the agency’s delay or
from continued agency proceedings.
PUBLIC UTILITY DISTRICT v. FERC       19577
                              Volume 2 of 2
19580           PUBLIC UTILITY DISTRICT v. FERC
  C.     Agency Proceedings

   The agency actions challenged here arise from a series of
orders issued by FERC with regard to the complaints filed by
the local utilities.

    1.    Order Setting the Local Utilities’ Complaints for
          Hearing (April 11 Order)

   On April 11, 2002, pursuant to section 206 of the FPA,
FERC set a hearing concerning the contracts “entered into
during the time period from November 1, 2000 through June
20, 2001, and that have not yet concluded,” because FERC
has “no authority to order refunds for contracts or transactions
that conclude prior to the refund effective date.” Id. ¶ 61,191
(footnote omitted). FERC also set refund effective dates for
each of the complaints. Id. ¶ 61,192.

   FERC explained in its April 2002 order that it did not have
enough information yet to address the Mobile-Sierra issues
definitively. The agency clarified that “[f]or all but one of the
contracts identified by the complainants, Section 6.1 of the
umbrella [Power Pool] agreement appears to be the only spe-
cific contractual provision which may affect parties’ rights to
make changes to contracts.” Id. § 61,190. The remaining con-
tract, between PUD and Morgan Stanley, has a separate provi-
sion addressing both FPA sections 205 and 206. Id. ¶ 61,190
& n.11. FERC also noted a key dispute between the parties:
whether the “spot markets had an adverse effect on the long-
term, bilateral markets in California, Nevada and Washing-
ton.” Id. ¶ 61,191. The hearing, designed to illuminate these
questions, was to address “whether the dysfunctional Califor-
nia spot markets adversely affected the long-term bilateral
markets, and, if so, whether modification of any individual
contract at issue is warranted.” Id. (footnote omitted). FERC
specifically excluded “issues concerning the Commission’s
policies on granting market-based rate authority or on regula-
tion of sellers with such authority.” Id.
                PUBLIC UTILITY DISTRICT v. FERC            19581
    2.   Initial Decision of the Administrative Law Judge
         (Initial Decision)

   On December 19, 2002, after an extensive hearing, Admin-
istrative Law Judge Carmen Cintron issued a lengthy initial
decision on the complaints. Nev. Power Co., 101 F.E.R.C.
¶ 63,031 (Dec. 19, 2002). She ultimately concluded that (1)
the Mobile-Sierra “public interest” standard is the applicable
standard of review, id. ¶ 65,277, and (2) the complainants
failed to demonstrate that the spot market sufficiently
adversely affected the forward market to merit revision of the
contracts under the Mobile-Sierra doctrine, id. ¶ 65,295.

    3.   Order on Initial Decision

   On June 26, 2003, FERC issued a lengthy opinion in which
it affirmed the Initial Decision. Order on Initial Decision, 103
F.E.R.C. at ¶ 62,400. FERC’s primary findings included: (1)
Section 6.1 of the Power Pool agreement’s express reserva-
tion of joint modification under section 205 of the FPA
impliedly waived the right to seek unilateral modification, id.
¶ 62,388; (2) this waiver meant that review was limited to the
Mobile-Sierra “public interest” standard, id. ¶¶ 62,388-89; (3)
applying the three factors articulated in Sierra and consider-
ing “the totality of the circumstances,” complainants failed to
meet the “public interest” standard because “[t]he fact that a
contract becomes uneconomic over time does not render it
contrary to the public interest,” id. ¶ 62,384; and (4) the total-
ity of the circumstances evidence analyzed by the ALJ further
demonstrated that “the challenged transactions were the result
of [the local utilities’] voluntary choices,” and there was “no
evidence of unfairness, bad faith, or duress in the original
negotiations,” id. ¶¶ 62,399-62,400. Because modification
was therefore not warranted, FERC denied the complaints. Id.
¶ 62,400.

  Although FERC acknowledged that it had set the ALJ hear-
ing in large part to decide “whether the dysfunctional Califor-
19582             PUBLIC UTILITY DISTRICT v. FERC
nia ISO and PX spot markets adversely affected Western
long-term bilateral markets,” Id. ¶ 62,385, FERC concluded
that evidence showing the spot market’s effect on the forward
market — including that reviewed in the Staff Report20 —
“would be relevant to contract modification only where there
is a ‘just and reasonable’ standard of review.” Id. ¶ 62,397.
FERC further explained, applying the Mobile-Sierra public
interest standard, that “to justify contract modification it is not
enough to show that forward prices became unjust and unrea-
sonable due to the impact of spot market dysfunctions; it must
be shown that the rates, terms, and conditions are contrary to
the public interest,” a showing the local utilities failed to
make. Id.

   Commissioner Massey issued a vigorous dissent, disagree-
ing with all of the Commission’s major findings and analysis.
He explained that “[o]ur primary calling under the Federal
Power Act is to ensure that prices are just and reasonable 24
hours a day, seven days a week.” Id. ¶ 62,403 (Massey,
Comm’r, dissenting). Furthermore, even under a “public inter-
est” standard, which he maintained was not applicable to
these contracts, Commissioner Massey determined there was

       simply no persuasive public interest rationale for
       protecting and sanctifying contracts negotiated in
       this unprecedented and extraordinary environment.
       . . . It would simply defy logic to conclude that the
       high prices in these contracts were not adversely
       influenced by market conditions that included the
       exercise of market power and widespread market
       manipulation.

Id. ¶ 62,408.
  20
     FERC at first stated that it “t[ook] into consideration the findings of
the Staff Report,” Order on Initial Decision, 103 F.E.R.C. at ¶ 62,396, but
later stated its conclusion that those findings were not “relevant” under
Mobile-Sierra, the standard FERC determined appropriate. Id. ¶ 62,397.
                 PUBLIC UTILITY DISTRICT v. FERC          19583
    4.    Order on Requests for Rehearing and Clarification

   Complainants applied for rehearing. On November 10,
2003, FERC reaffirmed its previous holdings. Order on
Rehearing, 105 F.E.R.C. at ¶ 61,980. FERC, however, revised
its previous factual findings to recognize that the customers of
Snohomish and Southern Cal Water did experience a retail
rate increase. FERC concluded, however, that these increases
either were not significant or were not pertinent, because the
local utilities did not prove the cause of the increases. Id.
¶¶ 61,986-87. FERC also rejected petitioners’ claims that two
of the Commissioners violated procedural requirements and
the Sunshine Act by engaging in ex parte communications. Id.
¶¶ 61,991-94. The local utilities then filed this petition for
review of FERC’s decision.

   We review FERC’s orders to ensure that they are not “arbi-
trary, capricious, an abuse of discretion, or otherwise not in
accordance with law.” 5 U.S.C. § 706(2)(A). We review de
novo the question whether FERC complied with and under-
stood its statutory mandate. City of Fremont v. FERC, 336
F.3d 910, 914 (9th Cir. 2003); Am. Rivers v. FERC, 201 F.3d
1186, 1194 (9th Cir. 2000). We “defer to the Commission’s
interpretations of the statutory provisions it administers, but
we remain ‘the final authority on issues of statutory construc-
tion and must reject administrative constructions which are
contrary to clear congressional intent.’ ” Am. Rivers, 201 F.3d
at 1194 (quoting Natural Res. Def. Council v. U.S. Dep’t of
the Interior, 113 F.3d 1121, 1124 (9th Cir. 1999). FERC’s
factual findings are conclusive so long as they are “supported
by substantial evidence.” 16 U.S.C. § 825l(b).

         IV.   Prerequisites To Applying Mobile-Sierra

   [1] As explained above, there is but one statutory standard
addressing the lawfulness of wholesale electricity rates. That
standard requires that all rates be “just and reasonable.” While
19584              PUBLIC UTILITY DISTRICT v. FERC
there is language in some cases suggesting otherwise,21 we are
convinced that Mobile-Sierra establishes one means of review
under the just and reasonable standard, applicable in certain
limited circumstances. The statute will admit of no other con-
clusion, and the Supreme Court case law supports it.

   Sierra framed its analysis as a determination as to whether
the Federal Power Commission met its “condition precedent”
to a section 206 remedy, a “finding that the existing rate is
‘unjust, unreasonable, unduly discriminatory or preferen-
tial.’ ” 350 U.S. at 353. It then faulted the Commission’s find-
ing that the established rate was invalid not because it applied
the usual section 206(a) “unreasonable” standard, but because
“the Commission holds that the contract rate is unreasonable
solely because it yields less than a fair return on the net
invested capital.” Id. at 354-55. As the Sierra Court
explained,

       [W]hile it may be that the Commission may not nor-
       mally impose upon a public utility a rate which
       would produce less than a fair return, it does not fol-
       low that the public utility may not itself agree by
       contract to a rate affording less than a fair return or
       that, if it does so, it is entitled to be relieved of its
       improvident bargain. . . . [T]he purpose of the power
       given the Commission by § 206(a) is the protection
       of the public interest, as distinguished from the pri-
       vate interests of the utilities . . . . When § 206(a) is
       read in the light of this purpose, it is clear that a con-
       tract may not be said to be either ‘unjust’ or ‘unrea-
       sonable’ simply because it is unprofitable to the
       public utility.
  21
    Boston Edison Co., 233 F.3d at 65, for example, refers to Mobile-
Sierra as establishing a “public interest standard,” separate from the statu-
tory just and reasonable requirement, and referring to that standard as hav-
ing been “created out of whole cloth.”
               PUBLIC UTILITY DISTRICT v. FERC            19585
Id. at 355. Sierra, then, simply held that considerations as to
what is “unjust” or “unreasonable” differ in the context of an
established bilateral contract, not that the statutory standards
no longer govern. The Supreme Court confirmed this under-
standing in Verizon, explaining that “[i]n wholesale markets,
the party charging the rate and the party charged were often
sophisticated businesses enjoying presumptively equal bar-
gaining power, who could be expected to negotiate a ‘just and
reasonable’ rate as between the two of them.” 535 U.S. at
479.

   Beginning with that understanding of Mobile-Sierra, we
turn to the limited circumstances in which its presumption
applies. Although no case has outlined these conditions suc-
cinctly, we derive three prerequisites from the context of
Mobile-Sierra and from later cases employing the doctrine.

  A.   Contractual Waiver

   [2] As an initial matter, the contested contract by its own
terms must not preclude the limited Mobile-Sierra mode of
review. See Texaco Inc. v. FERC (Texaco II), 148 F.3d 1091,
1096 (D.C. Cir. 1998); Ne. Utils. Serv. Co. v. FERC (Ne.
Utils. I), 993 F.2d 937, 960 (1st Cir. 1993). Mobile-Sierra
presumes that private parties have negotiated an agreement
that they view as just and reasonable over the time period
covered. If, by the very terms of their agreement, the parties
indicate otherwise, FERC cannot assume the mutual satisfac-
tion of the parties.

   For example, parties can include in a contract an express
reservation of a right to make changes unilaterally, known as
a “Memphis clause.” See United Gas Pipe Line Co. v. Mem-
phis Light, Gas & Water Div., 358 U.S. 103, 105, 112 (1958).
Such a clause will preclude application of the Mobile-Sierra
presumption. The rationale for enforcing such clauses is that
if the contract does not settle rates as between the parties for
the term of the agreement or call for limited, Mobile-Sierra
19586           PUBLIC UTILITY DISTRICT v. FERC
review, then application of Mobile-Sierra does not stabilize or
protect the sanctity of contract. See id. at 112 (noting that the
“decisive difference” between Memphis and Mobile was that
“in Mobile one party to a contract was asserting that the Natu-
ral Gas Act somehow gave it the right unilaterally to abrogate
its contractual undertaking, whereas here petitioner seeks sim-
ply to assert, in accordance with the procedures specified by
the Act, rights expressly reserved to it by contract”) (emphasis
added). In other words, Mobile-Sierra serves to protect con-
tracts from unilateral change, but that purpose is not served
when the parties expressly have permitted such change.

  B.     Regulatory Context

   Even if it is established that the parties contracted with the
intent that Mobile-Sierra apply, a further barrier remains: The
regulatory context in which the contracts were initially
formed must provide a sound basis to believe that the result-
ing rates are just and reasonable. Absent such assurances,
FERC’s reliance on the presumption would amount to a com-
plete abdication of its statutory responsibility under the FPA.
As the following sub-sections explain, two related conditions
operate to ensure that a foundation for the presumption exists:
(1) timely and procedurally effective review of rates — which
in the contemporary regulatory regime can be limited to
review of a utility’s market-based rate authority in the first
instance, and (2) meaningful substantive standards for review
of the circumstances of contract formation.

    1.    Timely and Effective Review of Rates

   To justify the Mobile-Sierra mode of review, the regulatory
scheme in which the contracts are formed must provide FERC
with an opportunity for initial review of the contracted rate.
In Mobile and Sierra, for example, the rates had been submit-
ted to the agency previously under section 205 and allowed to
remain in effect. See Mobile, 350 U.S. at 336; Sierra, 350
U.S. at 352. Such an initial review is an important precondi-
               PUBLIC UTILITY DISTRICT v. FERC            19587
tion to Mobile-Sierra because, as FERC has explained, apply-
ing the doctrine in “first review cases would mean that ‘[the
agency’s] ability to protect the public interest would be negli-
gible and public regulation would consist of little more than
rubber-stamping private contracts.’ ” Potomac Elec. Power
Co. v. FERC (PEPCO), 210 F.3d 403, 409 (D.C. Cir. 2000)
(quoting Ne. Utils. Serv. Co., 66 F.E.R.C. ¶ 61,332, at
¶ 62,087 (1994), aff’d, 55 F.3d 686 (1st Cir. 1995)); see also
PEPCO, 210 F.3d at 406 (noting that challenged contracts
had “been found to be just and reasonable when originally
approved” by FERC).

   [3] Consistent with its previous rulings, FERC concedes
here that an opportunity for initial review of whether a rate is
just and reasonable is necessary for Mobile-Sierra to apply.
The Intervenor-Respondents, however, cite to a thirty-year
old D.C. Circuit decision, see Borough of Lansdale v. Fed.
Power Comm’n, 494 F.2d 1104, 1112-14 (D.C. Cir. 1974),
and argue that an opportunity for initial review is not neces-
sary to trigger the Mobile-Sierra presumption. We disagree.

   The analysis in Lansdale is not applicable to this case. In
Lansdale, a seller, joined by the Commission, sought to
ignore a rate in a contract to which it had previously agreed
but which it had not properly filed with the Commission, and
instead file a higher rate, “as if the contract had never been
negotiated.” Id. at 1112; see also id. at 1107-08. The D.C.
Circuit refused to allow this unilateral revision of an agree-
ment, holding that the Commission could not permit the
higher rate of the second contract to go into effect unless and
until it found that the original rates were unlawful. See id. at
1117.

  Lansdale did not allow the seller to “convert its statutory
duty to file into a vehicle for breaching the 1971 contract with
Lansdale.” Id. at 1112. In other words, Lansdale focused on
whether Mobile-Sierra review allows the adoption of a second
contract with a higher rate when the first was never correctly
19588           PUBLIC UTILITY DISTRICT v. FERC
filed with the Commission. As such, Lansdale primarily
reflected concern over a seller’s abuse of the rate-filing
requirement. Lansdale did not decide, because the question
was not before it, that the Mobile-Sierra presumption always
applies to the filing of an initial rate, regardless of the circum-
stances.

   In this case, the answers to the questions presented turn in
part upon whether Mobile-Sierra applies to the rate first set in
a contract entered into under a seller’s market-based rate
authority, rather than only to a later challenge maintaining
that earlier-established rates are no longer just and reasonable.
The local utilities do not maintain that the original contract is
void because it was never filed, but rather that the rates set
were unjust and unreasonable when established and should be
modified. Lansdale’s position that a seller may not profit by
failing properly to file a rate-setting contract it freely entered
into is hardly remarkable, but is also not particularly pertinent
to the questions at issue here.

   Indeed, just a year before Lansdale was decided, the
Supreme Court recognized the importance of an opportunity
for an initial just and reasonableness review to the overall
statutory scheme. In Federal Power Commission v. Texaco,
Inc. (Texaco I), 417 U.S. 380 (1974), the Court struck down
an indirect regulatory scheme adopted by the Commission
that would have provided a “blanket certificate procedure for
small producers of natural gas.” See id. at 382, 395. One of
the primary reasons for the decision was that “[t]here was no
finding that these contemplated increased rates for flowing
gas would be just and reasonable. The Commission merely
asserts in its brief here that it was familiar with the existing
contracts and must have considered the rates reserved to be
acceptable under the Act.” Id. at 396.

   In short, FERC is correct to recognize that the Mobile-
Sierra doctrine apples only if a newly-entered contract
                PUBLIC UTILITY DISTRICT v. FERC          19589
remains in effect after there is an opportunity for plenary,
“just and reasonable” agency review.

     2.   Meaningful Review of the Circumstances of Contract
          Formation

   [4] Not only must FERC have an opportunity for some ini-
tial review of rates, but the scope of that review must permit
consideration of the factors relevant to the propriety of the
contract’s formation. See Atl. City Elec. Co., 295 F.3d at 14
(holding that Mobile-Sierra applies “assuming that there was
no reason to question what transpired at the contract forma-
tion stage”) (citing Town of Norwood v. FERC, 587 F.2d
1306, 1312 (D.C. Cir. 1978)). The original premise of Mobile-
Sierra was that as long as the rate was just and reasonable
when the contract was formed, there would be a presumption
— based on both the need to protect stability of contract and
the likelihood that market participants entering into long-term
contracts can protect their own interests — that the reason-
ableness continued throughout the term of the contract. See
Verizon, 535 U.S. at 479 (“In wholesale markets, the party
charging the rate and the party charged were often sophisti-
cated businesses enjoying presumptively equal bargaining
power, who could be expected to negotiate a ‘just and reason-
able’ rate as between the two of them.”). In the present regu-
latory regime, these relevant factors focus on whether the
original negotiations occurred in a functional marketplace
such that we may presume the contracted rates were originally
just and reasonable.

              V.   Application of Mobile-Sierra

A.   Contractual Waiver of Section 206 Rights

  Having established the prerequisites to Mobile-Sierra
review under the current regulatory regime, we address first
whether the contracts at issue permit Mobile-Sierra review.
19590              PUBLIC UTILITY DISTRICT v. FERC
   In this case, FERC determined that there was no express
reservation of unilateral modification. As FERC noted, “[f]or
all but one of the contracts identified by the complainants,
Section 6.1 of the umbrella [Power Pool] Agreement appears
to be the only specific contractual provision which may affect
parties’ rights to make changes to contracts entered into under
the [Power Pool] agreement.” April 11 Order, 99 F.E.R.C. at
¶ 61,190.21

   The relevant portion of section 6.1 states:

       Nothing contained herein shall be construed as
       affecting in any way the right of the Parties to jointly
       make application to FERC for a change in the rates
       and charges, classification, service, terms, or condi-
       tions affecting [Power Pool] transactions under Sec-
       tion 205 of the Federal Power Act and pursuant to
       FERC rules and regulations promulgated thereunder.

Id. ¶ 61,190 n.10. Applying the interpretive doctrine of
expressio unius est exclusio alterius,22 FERC viewed the res-
ervation of joint section 205 rights as confirming the parties’
intention otherwise to abide by the contractual terms for the
time period covered. Order on Initial Decision, 103 F.E.R.C.
at ¶ 62,388.
  21
      FERC found that Section 39B of the Snohomish-Morgan Stanley Con-
firmation Agreement expressly restricts the parties’ rights to amend under
both FPA sections 205 and 206. April 11 Order, 99 F.E.R.C. at ¶ 61,190
& n.11. FERC noted, however, that even if Snohomish could overcome
the restriction in Section 39B, it would still be restricted by Section 6.1 of
the Power Pool agreement. Order on Initial Decision, 103 F.E.R.C. at
¶ 62,389. Because we hold the Power Pool agreement, both standing alone
and taking Section 6.1 into account, is consistent with Mobile-Sierra
review, we have no need to consider Section 39B of the Snohomish-
Morgan Stanley Confirmation Agreement.
   22
      The Latin phrase means the “express[ion] or inclu[sion of] one thing
implies the exclusion of the other.” BLACK’S LAW DICTIONARY 620 (8th ed.
1999).
                PUBLIC UTILITY DISTRICT v. FERC            19591
   [5] “FERC is entitled to some deference in construing con-
tracts where the sales are subject to FERC regulation.” Boston
Edison, 233 F.3d at 66 (citing Memphis, 358 U.S. at 114); see
also City of Seattle v. FERC, 923 F.2d 713, 716 (9th Cir.
1991) (granting FERC deference in the interpretation of con-
tracts). With or without that deference, we agree with FERC
that these contracts do not preclude Mobile-Sierra review, but
we do not rely on the expressio unius precept in so conclud-
ing. Instead, like the D.C. Circuit in Texaco II, 148 F.3d at
1096, we hold that private long-term contracts can be gener-
ally governed by Mobile-Sierra if such review is otherwise
appropriate, unless there is a specific indication in the contract
that section 205 or 206 rights have been reserved.

   Texaco II considered a boilerplate clause that said that the
contract “shall comply with all applicable laws, statutes, ordi-
nances, safety codes and rules and regulations of governmen-
tal authorities having jurisdiction.” Id. The D.C. Circuit held
that such a general clause does not reserve compliance with
section 206 standards. In so deciding, the D.C. Circuit stated,
in essence, a default rule, explaining: “The law is quite clear:
absent contractual language ‘susceptible to the construction
that the rate may be altered while the contract[ ] subsist[s],’
the Mobile-Sierra doctrine applies.” Id. (alterations in origi-
nal) (quoting Appalachian Power Co. v. Fed. Power Comm’n,
529 F.2d 342, 348 (D.C. Cir. 1976)). After Texaco II, the pre-
vailing rule of contract interpretation with regard to the pres-
ervation of limited Mobile-Sierra review, according to the
First Circuit, is that general statements that the law will “oth-
erwise be binding” do not “negate the ordinary, default rule
that Mobile-Sierra govern[s] FERC-proposed changes.” Bos-
ton Edison, 233 F.3d at 67 (citing Texaco II, 148 F.3d at
1096).

   The trio of authorities cited by the local utilities, all from
the D.C. Circuit and all pre-Texaco II, are not inconsistent
with this interpretive principle. See Union Pac. Fuels, Inc. v.
FERC, 129 F.3d 157 (D.C. Cir. 1997); Papago Tribal Util.
19592          PUBLIC UTILITY DISTRICT v. FERC
Auth. v. FERC, 723 F.2d 950 (D.C. Cir. 1983); Kansas Cities
v. FERC, 723 F.2d 82 (D.C. Cir. 1983). In two of these cases,
the court inferred an intent to permit full FERC review from
a provision restricting review in narrow circumstances. See
Papago, 723 F.2d at 954; Kansas Cities, 723 F.2d at 86-90.
To infer from a narrow restriction on unilateral changes an
intent otherwise to allow such changes, as Kansas Cities and
Papago permitted, is quite different from inferring from a nar-
row authorization of joint authority to make changes an intent
to allow unilateral changes, as the local utilities here insist
FERC was required to do.

   By contrast with Papago, Kansas Cities, and this case, the
disputed contracts in Union Pacific Fuels did include a Mem-
phis clause. See Union Pac. Fuels, 129 F.3d at 161. The con-
tracts, however, also included a clause restricting the ability
of the parties to seek a change to the “modified fixed variable
rate design.” Id. (internal quotation mark omitted). In these
unusual circumstances, the D.C. Circuit upheld FERC’s order
requiring a provider to file proposed changes to its rate struc-
ture under section 5 of the Natural Gas Act despite that nar-
row restriction and noted:

    Nothing in the contracts expressly exempted the pri-
    vate agreement from rate changes initiated by FERC
    under NGA § 5. . . . While Petitioners protest that
    boilerplate language acknowledging rate changes by
    FERC should not render [the] Mobile-Sierra doctrine
    inapplicable, . . . they do not explain why they could
    not have adopted language that would simply and
    clearly have invoked Mobile-Sierra.

Id. at 161-62. Texaco II, issued by the same court a year later,
explained that this language in Union Pacific Fuels does not
have application beyond the situation there presented, in
which the contract contains a clause that does, generally,
negate the default Mobile-Sierra rule. See Texaco II, 148 F.3d
at 1096 (noting that in Union Pacific Fuels, the court “inad-
                PUBLIC UTILITY DISTRICT v. FERC            19593
vertently lent support to the inference” that absent express
language invoking Mobile-Sierra, FERC ordinarily is free to
review rates without regard to the Mobile-Sierra presumption
(emphasis added)).

   [6] We agree with the D.C. and First Circuits that the
Mobile-Sierra presumptions are, in essence, self-executing.
Adoption of a Memphis clause permitting a party to an energy
contract to modify its terms unilaterally demonstrates that the
parties were not seeking to establish the stability of energy
contracts the Mobile-Sierra doctrine seeks to foster. Absent
such a clause, the Mobile-Sierra balance between preserving
the stability of private contracts and protecting the public
interest in just and reasonable rates prevails. Preserving joint
modification does not negate the default application of the
Mobile-Sierra presumption when that presumption is other-
wise appropriate, as the Mobile-Sierra presumption applies to
unilateral, not joint, rate changes. Indeed, parties to energy
contracts, like parties to any other contract, are free, by agree-
ment, to vary the terms of the contract mid-term, with or with-
out a prior pact allowing them to do so. When parties to an
energy contract do so vary an agreement, sections 205 and
206 apply according to their express terms.

   [7] We therefore uphold FERC’s interpretation of section
6.1 of the Power Pool agreement as reasonable.

  B.   Timely and Effective Review of Rates

   As the parties intended Mobile-Sierra review to apply, we
next consider whether, as FERC maintains, its blanket grant
of market-based rate authority qualifies as sufficient prior
review and approval of all contracts made under that authori-
zation to trigger the Mobile-Sierra presumption in any later
section 206 challenge. If not, then the contracts here were not
subject to “first review” by FERC under the FPA and do not
trigger the Mobile-Sierra doctrine. We hold that although
market-based rate authority can qualify as sufficient prior
19594             PUBLIC UTILITY DISTRICT v. FERC
review to justify limited Mobile-Sierra review, it can only do
so when accompanied by effective oversight permitting
timely reconsideration of market-based authorization if mar-
ket conditions change.

   [8] Two fairly recent decisions of this circuit considered the
role of market-based rate authority under the FPA. In Grays
Harbor, we held that a contract entered into during the Cali-
fornia energy crisis pursuant to the market-based rate regime
was protected under the “filed rate doctrine.”23 See 379 F.3d
at 651-52. We relied heavily on FERC’s contention that the
regime offered continued and ongoing oversight and thereby
“assured that the market-based rates charged comply with the
FPA’s requirement that rates be just and reasonable.” Id. at
651. On that basis, Grays Harbor concluded that, “while
market-based rates may not have historically been the type of
rate envisioned by the filed rate doctrine, . . . they do not fall
outside the purview of the doctrine.” Id.

   [9] More recently, we again stressed the need for oversight
in a market-based rate regime in holding “that market-based
tariffs do not, per se violate the FPA.” Lockyer, 383 F.3d at
1014. Lockyer held the initial grant of market-based rate
authority alone was not enough to assure just and reasonable
rates, as FERC recognized when it “affirmed in its presenta-
tion before us that it is not contending that approval of a
market-based tariff based on market forces alone would com-
ply with the FPA or the filed rate doctrine.” Id. at 1013
(emphasis added). The court clarified further that “a market-
based tariff cannot be structured so as to virtually deregulate
an industry and remove it from statutorily required oversight.”
Id. at 1014.
  23
     The filed rate doctrine provides that state law and some federal law
(e.g. antitrust) may not be used to strike down a rate subject to FERC’s
exclusive jurisdiction. See Grays Harbor, 379 F.3d at 650; see also Davel
Commc’ns, Inc. v. Qwest Corp., 460 F.3d 1075, 1084-86 (9th Cir. 2006)
(discussing the filed rate doctrine).
                PUBLIC UTILITY DISTRICT v. FERC            19595
   Lockyer’s emphasis on the need for continued oversight of
contract rates is critically important to our current inquiry. In
Lockyer, California sought relief under section 205 from rates
established by wholesale energy companies (many of whom
are Intervenor-Respondents here) while there were dysfunc-
tions in the spot market during the California energy crisis.
The Court made the following observation regarding FERC
“oversight” at the time:

    Despite the promise of truly competitive market-
    based rates, the California energy market was sub-
    jected to artificial manipulation on a massive scale.
    With FERC abdicating its regulatory responsibility,
    California consumers were subjected to a variety of
    market machinations, such as “round trip trades” and
    “hockey-stick bidding,” coupled with manipulative
    corporate strategies, such as those nicknamed “Fat-
    Boy,” “Get Shorty,” and “Death Star.”

Id. at 1014-15 (emphasis added) (footnotes omitted). Under
these circumstances, the court concluded, “[t]o cabin FERC’s
section 205 refund authority . . . would be manifestly contrary
to the fundamental purpose and structure of the FPA . . . . The
FPA cannot be construed to immunize those who overcharge
and manipulate markets in violation of the FPA.” Id. at 1017.

   The requirement of continued oversight in a market-based
rate regime applies equally to the section 206 context, and to
the application of the Mobile-Sierra doctrine in section 206
review. Lockyer flatly stated that the FPA does not allow a
market-based regime absent “implied enforcement mecha-
nisms sufficient to provide substitute remedies for the obtain-
ing of refunds for the imposition of unjust, unreasonable and
discriminatory rates.” Id. at 1016. Furthermore, Lockyer indi-
cates that even in a properly approved market-based rate
regime, section 206 remedies are still fully available. See id.
at 1017 (noting that the “only remedies [under section 206]
are prospective”).
19596          PUBLIC UTILITY DISTRICT v. FERC
   [10] Taken together, these recent circuit decisions support
the following conclusion: Market-based rate authority pro-
vides a meaningful opportunity for prior review and approval
of rates under the FPA, an essential prerequisite to the
Mobile-Sierra mode of rate review, only insofar as FERC
implements and uses an effective oversight mechanism after
the market-based rate authorization is initially granted. Only
then can FERC meet its statutory duty to ensure that all rates
are “just and reasonable.”

   This conclusion is bolstered by the judicial treatment of
two similar regimes instituted by FERC in the past. In Texaco
I, the Supreme Court considered the Federal Power Commis-
sion’s attempt to utilize a “blanket certificate procedure for
small producers of natural gas” that would “relieve[ ] them of
almost all filing requirements.” 417 U.S. at 382. The Federal
Power Commission’s rationale was that small producers
would be subject to the forces of the market and could there-
fore only charge what the market would bear. See id. at 390.
The Federal Power Commission’s rationale in Texaco I thus
was essentially the same as FERC’s rationale here: That
case’s “small producers,” like the market-based rate authority
producers here, were asserted to lack market power and were
therefore authorized to set rates with no further oversight. The
assumption was that the rates set would necessarily be com-
petitive and would therefore tend to reflect the cost of produc-
tion, including the cost of attracting investment.

   The Court affirmed that such a system of “indirect regula-
tion” was permissible under the Natural Gas Act, see id., but
struck down the order because it did not sufficiently assure
oversight to meet the statutory requirement of “just and rea-
sonable” review. See id. at 395-96. The Court so held despite
the FPC’s assurances that it would review the prices of con-
tracts made pursuant to this authority, see id. at 396-97, stat-
ing:

    [W]e should also stress that in our view the prevail-
    ing price in the marketplace cannot be the final mea-
               PUBLIC UTILITY DISTRICT v. FERC            19597
    sure of “just and reasonable” rates mandated by the
    Act. It is abundantly clear from the history of the Act
    and from the events that prompted its adoption that
    Congress considered that the natural gas industry
    was heavily concentrated and that monopolistic
    forces were distorting the market price for natural
    gas. . . . In subjecting producers to regulation
    because of anticompetitive conditions in the indus-
    try, Congress could not have assumed that “just and
    reasonable” rates could conclusively be determined
    by reference to market price.

Id. at 397-99 (emphasis added) (footnotes omitted).

   The D.C. Circuit followed Texaco I’s approach when con-
sidering a FERC regulation for the oil industry based on the
premise that “competitive market forces should be relied upon
in the main to assure proper rate levels.” See Farmers Union,
734 F.2d at 1490. That court was adamant in holding
“FERC’s largely undocumented reliance on market forces as
the principal means of rate regulation to be . . . misplaced. It
is of course elementary that market failure and the control of
monopoly power are central rationales for the imposition of
rate regulation.” Id. at 1508 (citing STEPHEN BREYER, REGULA-
TION AND ITS REFORM 15-16 (1982)) (footnote omitted).
Indeed, the “fundamental flaw in the Commission’s scheme”
was that “nothing in the regulatory scheme itself acts as a
monitor to see if [competition drives rates into the ‘zone of
reasonableness’] or to check rates if it does not.” Id. at 1509.

   [11] Here, FERC failed to adopt any monitoring mecha-
nism before applying deferential Mobile-Sierra review to the
challenged contracts. When FERC encouraged the local utili-
ties to purchase power in the forward market, the agency
promised to oversee the forward market contracts to ensure
their justness and reasonableness. See December 15 Order, 93
F.E.R.C. at ¶ 61,994. FERC later held, however, that its
approval of energy sellers’ market-based rate authority —
19598           PUBLIC UTILITY DISTRICT v. FERC
long prior to the market failures that gave rise to the Decem-
ber 15 Order — allowed it to apply the Mobile-Sierra doctrine
without any direct inquiry into whether the resulting rates
were in fact “just and reasonable,” and also without any
inquiry into the actual state of the market at the time contracts
were negotiated. See Order on Initial Decision, 103 F.E.R.C.
at ¶ 62,388-89.

   In light of the foregoing discussion, we must answer the
crucial question: Did FERC provide sufficient oversight for
contracts made under market-based rate authority to ensure
that the resulting rates were within the statutory “just and rea-
sonable” range in the first instance, thereby permitting reli-
ance on the Mobile-Sierra doctrine as to the continuing
effectiveness of those contracts? We hold that it did not.

   FERC asserted in its Order on Initial Decision that the grant
of market-based rate authority is sufficient predetermination,
so that it was “not required specifically to review each agree-
ment” made pursuant to the grant of market-based rate author-
ity. Id. ¶ 62,389. In other words, FERC contends that because
it requires, before granting market-based rate authority, a
showing of lack of market power and regular reporting, it has
therefore fulfilled its oversight role, and no further oversight
is necessary. FERC asserted the same position on rehearing,
maintaining that its decision in Lockyer supports that result.
Order on Rehearing, 105 F.E.R.C. at ¶ 61,982-83.

   In FERC’s Lockyer decision, the agency held that once
market-based rate authority is granted, additional oversight is
a “compliance issue.” California ex rel. Lockyer, 99 F.E.R.C.
¶ 61,247 at ¶ 62,063 (2002); see also Lockyer, 383 F.3d at
1015. We rejected this aspect of FERC’s Lockyer decision,
however, because without active oversight, “effective federal
regulation is removed altogether.” Lockyer, 383 F.3d at 1015.
We reject FERC’s reliance on that same proposition as a pillar
of FERC’s invocation of the Mobile-Sierra mode of review in
this case.
                PUBLIC UTILITY DISTRICT v. FERC            19599
   [12] FERC’s position here, as in Lockyer, is that it fulfills
its monitoring obligation by imposing on sellers with market-
based rate authority the requirement that they file Quarterly
Transaction Reports, make the Reports available for public
review, and submit data on a triennial basis to confirm the
continued lack (or mitigation) of market power. This data col-
lection activity, however, was insufficient to fulfill FERC’s
statutory obligation with respect to the contracts challenged
here. As demonstrated by what actually happened during the
California energy crisis, this sporadic data collection approach
is pragmatically unlikely to expose in a timely manner the
impact of market changes — in this instance, the impact on
the forward market of acknowledged severe market changes
within the dysfunctional spot market. That such impacts can
occur without affecting FERC’s continuing approval of
market-based rate authority undercuts FERC’s assertion that
initial just and reasonableness review occurred with regard to
the challenged contracts sufficient to trigger the Mobile-
Seirra mode of review.

   In particular, the quarterly reporting requirement, standing
alone, permits review of the grounds for market-based rate
authority only with regard to contracts entered into after the
impact of the market dysfunction or market power on long-
term bilateral contracts has already occurred, affecting the
likelihood that the contracts in fact set rates within the statu-
tory “just and reasonable” range. There is a crucial difference
between this review — that is, purely prospective review,
affecting only future contracts — and one that permits consid-
eration of the market conditions at the time a challenged for-
ward contract was entered. See El Paso Elec. Co., 108
F.E.R.C. ¶ 61,071, at ¶ 61,370 n.10 (2004) (“A revocation of
market-based rates . . . would not void contracts that parties
may have signed . . . .”). The latter kind of remedy is the kind
the local utilities ask for here: They seek modification of the
contracts here at issue, prospectively from the refund effective
date but based on the market circumstances that prevailed at
the times the contracts were negotiated.
19600          PUBLIC UTILITY DISTRICT v. FERC
   A hypothetical explains the dilemma with FERC’s present
“oversight scheme”: Seller A receives market-based rate
authority in Year 1. In Year 5, prices increase dramatically in
short-term markets. Buyer B, needing to escape these mar-
kets, agrees to long-term contracts X, Y, and Z to buy whole-
sale energy from Seller A. Buyer B agrees to the contract
terms because in a frantic market Seller A is one of the only
suppliers willing to enter into a long-term contract, and Buyer
B needs to ensure that its supply is able to meet the load
required by its retail customers. In its next required quarterly
report in Year 6, Seller A dutifully transfers the proper infor-
mation about its rates to FERC. FERC — perhaps reviewing
contracts X, Y, and Z — discovers that the assumption of a
functioning market underlying its approval of market-based
rate authority for Seller A does not accord with the rates being
charged in forward contracts generally, or in those entered by
Seller A in particular. FERC therefore revokes Seller A’s
market-based rate authority. FERC’s action, however, will do
nothing to reform those troubling contracts.

   The problem raised by this hypothetical is that FERC has
no opportunity to review whether contracts X, Y, and Z are
just and reasonable before they are entered. As FERC recog-
nizes, revocation of market-based rate authority in Year 6 in
the above hypothetical can only provide relief for contracts
made thereafter. See id. If a contract is entered into in Year
5, FERC cannot consider whether the basis for market-based
rate authority had so atrophied by this time that the economic
basis for assuming the rates established would be within the
statutorily mandated “just and reasonable” range had evapo-
rated. Instead, FERC applies the most-forgiving version of
review, the Mobile-Sierra presumption that long-term bilat-
eral contracts will reflect just and reasonable rates, without
any opportunity for initial review of such contractual rates,
whether cost or market based.

  This case is precisely parallel to the above hypothetical. For
example, Enron, an Intervenor-Respondent in this case, did
               PUBLIC UTILITY DISTRICT v. FERC            19601
have its market-based rate authority revoked, because of the
actions it took during the time period in which the contracts
at issue here were entered into. Enron Power Mktg., Inc., 103
F.E.R.C. ¶ 61,343, at ¶ 62,302 (2003). By revoking that
power, FERC restricted Enron’s prospective power to enter
into contracts. Id. ¶¶ 62,307-10. The very day after revoking
Enron’s market-based rate authority, however, FERC denied
Nevada Power’s request to reform its contracts with Enron
even though they were made during the very period FERC
identified Enron as grossly abusing and violating its market-
based rate authority. See Order on Initial Decision, 103
F.E.R.C. at ¶ 62,397. FERC accomplished this result by
applying a Moble-Sierra “public interest” standard to the con-
tract reformation proceedings. See id. By doing so, FERC nei-
ther performed the full scope of “just and reasonable” review
nor revisited the market circumstances in which the agree-
ments were entered to determine whether those circumstances
were sufficiently functional that they were likely to yield
long-term contracts within the “just and reasonable” range.

   This approach to section 206 review simply cannot be
squared with the statutory scheme. Section 206 commands
prospective revision of rates that, as of the refund effective
date, are not just and reasonable: When FERC determines that
a rate is unjust or unreasonable, “the Commission shall deter-
mine the just and reasonable rate, charge, classification, rule,
regulation, practice, or contract to be thereafter observed and
in force, and shall fix the same by order.” 16 U.S.C.
§ 824e(a). By layering Mobile-Sierra review on top of a
market-based rate authority that can be revoked only prospec-
tively from the refund effective date, FERC abdicates its stat-
utory responsibility to provide such rate revision when
appropriate.

   FERC represents in its post-argument submission that the
local utilities could have challenged the sellers market-based
rate authority at the time they entered into the challenged con-
tracts. That representation is true, but beside the point. Any
19602           PUBLIC UTILITY DISTRICT v. FERC
such challenge, even if successful, could not have been a basis
for reforming the challenged contracts, even if the excessively
high rates established by the contracts were strong indications
that market-based rate authority should be revoked. Rescis-
sion of market-based rate authority still would have affected
only later contracts, leaving the challenged agreements sub-
ject to limited Mobile-Sierra public interest review.

   As a result of FERC’s refusal to consider the abrogation of
market-based rate authority except with respect to future con-
tracts, and given the dramatic and sudden nature of the onset
of the California energy crisis and the limited period of time
that the local utilities had to respond to it, the local utilities
here had no meaningful opportunity to institute a challenge to
these sellers’ market-based rate authority before entering the
disputed agreements. For example, in February 2001, Califor-
nia enacted legislation allowing its Department of Water
Resources to purchase power on behalf of its deteriorating
investor-owned utilities. Southern Cal Water’s previous sup-
plier, Dynegy promptly told Southern Cal Water that it was
“not interested in extending or renegotiating” its previous one
year contract with Southern Cal Water that expired in April
2001, as Dynegy “could sell its generation output to the State
of California.”

   Southern Cal Water was thus left with less than two months
to obtain power for the following year and only three
“choices”: (1) immediately negotiate a long-term contract that
could take effect in April 2001; (2) shift to the spot markets,
by then recognized by FERC as manipulated and dysfunc-
tional markets that had already caused hyper-pricing and
bankrupted several utility companies; or (3) shut down opera-
tion and fail to provide electricity for its retail customers.
Faced with these choices, Southern Cal Water entered into a
forward contract based on a bidding period of little more than
two weeks. Under these time constraints, Southern Cal Water
could not have challenged the seller’s market-based rate
authority, obtained an order from FERC, and then negotiated
               PUBLIC UTILITY DISTRICT v. FERC           19603
a forward agreement and signed a contract with the very seller
whose market-based rate authority it had just challenged.
There was simply no realistic way that Southern Cal Water
could continue to participate in the forward market while
assuring meaningful “just and reasonable” review.

   Ultimately, the fatal flaw in FERC’s approach to “over-
sight” is that it precludes timely consideration of sudden mar-
ket changes and offers no protection to purchasers victimized
by the abuses of sellers or dysfunctional market conditions
that FERC itself only notices in hindsight. For example, on
December 15, 2000, FERC issued an order encouraging the
adoption of long-term contracts and establishing a benchmark
price of $74/Mwh. See December 15 Order, 93 F.E.R.C. at
¶¶ 61,994-95. FERC promised that it would “be vigilant in
monitoring the possible exercise of market power . . . [t]o
address concerns about potentially unjust and unreasonable
rates in the long-term markets.” Id. ¶ 61,994. In fact, because
of its flawed processes, FERC was never able to “address
concerns about potentially unjust and unreasonable rates in
the long-term markets,” because it had no means to revoke
market-based rate authority before the precipitously entered
contracts went into effect and became, in FERC’s view, no
longer subject to cost-based “just and reasonable” review. As
a result, FERC failed to detect that, according to its own
benchmarks, something was awry in the forward markets that
produced these contracts.

   As in Lockyer, we do not dispute that FERC may adopt a
regulatory regime that differs from the historical cost-based
regime of the energy market, or that market-based rate author-
ity may be a tenable choice if sufficient safeguards are taken
to provide for sufficient oversight. FERC, however, cannot
use that choice to excuse its duty to maintain effective over-
sight and then invoke Mobile-Sierra as a ground for preclud-
ing ordinary rate review, including review of the propriety of
market-based rate authority at the time the contracts became
effective. Any other conclusion would permit FERC to abdi-
19604            PUBLIC UTILITY DISTRICT v. FERC
cate entirely its statutory responsibility under the FPA to
ensure that all rates, including bilateral contract rates, are
“just and reasonable.”

  C.     Meaningful Review of Contract Formation

   This fundamental procedural error was compounded by
FERC’s substantive adherence to Mobile-Sierra without
regard to the market conditions in which the contracts at issue
were formed. As we have explained, Mobile-Sierra cannot
apply without a determination that the challenged contract
was initially formed free from the influence of improper fac-
tors, such as market manipulation, the leverage of market
power, or an otherwise dysfunctional market.

   The local utilities argue here that the frenzied market con-
ditions of the California energy crisis in the spot market influ-
enced the forward market in such a manner as to raise a
question about what transpired during formation of the for-
ward contracts here at issue. The most important evidence
supporting this position is the FERC Staff Report concerning
price manipulation in the western United States at the time
these contracts were formed. The FERC staff concluded:

       Our analysis shows . . . that forward power prices
       negotiated during 2000-2001 in the western United
       States were significantly influenced by the then-
       current spot power prices. This tells us that the
       trauma of the dysfunctional spot power prices at that
       time so influenced buyers that they placed great
       weight on these prices in forming future expecta-
       tions.

Staff Report at ES-9 (emphasis added). The report noted that
the influence was greatest for one-to-two year forward con-
tracts,24 and that there is a “statistically significant relation-
ship” between the spot price and forward price. Id.
  24
    Most of the contracts challenged by Nevada Power and Sierra Pacific
are within that time range.
                   PUBLIC UTILITY DISTRICT v. FERC                   19605
   Although it noted the Staff’s findings, FERC held them
irrelevant because they did not demonstrate that the rates in
the forward contracts affected the “public interest.” Order on
Initial Decision, 103 F.E.R.C. at ¶ 62,397. FERC therefore
did not consider the staff findings in determining whether the
Mobile-Sierra doctrine was applicable to these contracts;
instead, FERC discarded the findings after determining, for
independent reasons, that the Mobile-Sierra doctrine was
applicable. The upshot is that FERC failed ever to consider
whether the influence of the spot markets on the forward mar-
kets reached a level sufficient to question whether FERC
could assume that two private parties had negotiated a “just
and reasonable” contract in the first instance and therefore
apply the Mobile-Sierra presumption.

   FERC’s very limited factual findings regarding the state of
the market at the time the challenged contracts were negoti-
ated are thus not responsive to the theory advanced by the
local utilities here. FERC held only that because the local util-
ities entered into the challenged contracts “voluntarily” and
because “there is no evidence of unfairness, bad faith, or
duress in the original negotiations [of the forward contracts],
the [local utilities] are not entitled to change their bargains.”
Id. at ¶¶ 62,399-62,400. But the local utilities do not allege
that the energy companies manipulated their negotiations of
the contracts here at issue; the local utilities challenge the
context, not the conduct, of those negotiations. Consistently
with the Staff Report’s findings, the local utilities are main-
taining that factors exogenous to the forward market, the dys-
function and manipulation of the spot market, artificially
influenced the rates in the forward market, creating market
dysfunction in the forward market.25 The local utilities’ argu-
  25
     FERC’s premise, never examined in its orders and opinions, is that the
spot and forward markets can and should be analyzed separately. Many of
the participants in the two markets are the same, however, as is the prod-
uct sold — electric power. The only difference is the time frame for deliv-
ery of that product. For present purposes, we accept FERC’s assumption
that the two markets are sufficiently separate that there is at least a ques-
tion as to the scope of the impact of the dysfunctional spot market on the
forward market.
19606          PUBLIC UTILITY DISTRICT v. FERC
ment is that when such market dysfunction occurs and there
is no opportunity to revisit the propriety of the market-based
rate authority in effect when the contract was entered, FERC
cannot assume that contractual terms were just and reasonable
as between the contracting parties when the agreement was
negotiated. As a result, FERC cannot focus only on “public
interest” considerations when the rates established are thereaf-
ter challenged.

   [13] In this case, the questions raised by the Staff Report
— whether and how the manipulated spot market influenced
the forward markets — are relevant to determining whether
the Mobile-Sierra doctrine applies, because they raise ques-
tions about the market conditions at the time of contract for-
mation and thus about the propriety of relying on a regime of
market-based rate authority at that time to produce just and
reasonable rates. Although FERC “is not obligated to justify
deviations from an approach suggested by its own staff,”
when “the conceptual underpinnings of the staff’s approach”
are “critical to a reasoned resolution of the problem,” then
FERC must address them. Pub. Utils. Comm’n v. FERC, 817
F.2d 858, 862-63 (D.C. Cir. 1987).

   [14] We conclude that FERC’s decision to treat the market-
function evidence as irrelevant to the question whether
Mobile-Sierra applies, and its resulting application of the
Mobile-Sierra doctrine, was fundamental error. In a regula-
tory regime predicated on the grant of market-based rate
authority, the decision whether to apply Mobile-Sierra to sub-
sequent contracts formed under that authority requires FERC
and reviewing courts to determine if the contracts at issue
were initially entered into in fully functioning markets.
FERC’s application of the Mobile-Sierra doctrine without
considering the contract formation issues was error.

  D.    Effect on the “Public Interest”

  [15] FERC’s error in its approach to deciding whether to
apply the Mobile-Sierra presumption was compounded by its
                    PUBLIC UTILITY DISTRICT v. FERC                  19607
use of an erroneous standard for determining whether the
challenged contracts affect the public interest. As our histori-
cal summary shows, electric utility deregulation has made it
increasingly necessary for FERC to consider wholesale power
contracts’ effect on the consuming public. In its efforts to
determine the impact on the public interest under Mobile-
Sierra, however, FERC relied on the wrong legal standard,
applying factors taken from the context of a low-rate chal-
lenge rather than those relevant to the high-rate challenge
present in this case.

   As we discussed in Part II, state agencies in the past regu-
lated heavily the rates charged directly to the public. Electric
rate regulation reform, however, has significantly limited the
role state regulators play and simultaneously increased the
importance of federal regulation for the prices paid by retail
ratepayers. FERC’s increased responsibility for protecting the
public’s interest makes its obligation to ensure that wholesale
rates do not unjustifiably adversely affect the public —
always a part of FERC’s statutory mandate — more important
than it was when the Mobile-Sierra doctrine first developed.
Because, at present, FERC, not state regulators, “is perhaps in
the best position to reach the most equitable result and to act
in the public interest,” Miss. Indus. v. FERC, 808 F.2d 1525,
1549 (D.C. Cir. 1987) (per curiam) (quoting Middle S. Serv.,
Inc., 30 F.E.R.C. ¶ 63,030, at ¶ 65,151 (1985)), FERC must
give predominant weight in determining whether to modify a
contract under section 206 to the impact of a challenged
wholesale contract on the rates paid by the consuming public
who use the energy covered by the contract. Tested against
this protocol, the agency’s narrow conception of “public inter-
est” review does not suffice.

   FERC determined that the challenged contract rates did not
impact the public interest principally because the local utili-
ties presented little evidence relevant to the three public inter-
est factors specifically mentioned in Sierra.26 Order on Initial
  26
       In such circumstances [when the public interest test satisfies
       FERC’s duty to ensure just and reasonable rates] the sole concern
19608              PUBLIC UTILITY DISTRICT v. FERC
Decision, 103 F.E.R.C. at ¶ 62,397. Similarly, FERC’s briefs
in this court, assume, erroneously, that Sierra established a
three-prong public interest standard applicable across all cir-
cumstances, an assumption with which we do not agree. In
particular, the “excessive burden” reference in Sierra, heavily
relied upon by FERC in this case in concluding that there was
no impact on the public interest, has no application here.

   As the text from Sierra, reproduced in the margins, demon-
strates, the three Sierra factors were specifically identified as
relevant to the low-rate challenge presented in that case. Rates
asserted to be lower than those FERC would approve ab initio
will not ordinarily directly affect the most obvious “public
interest” underlying the FPA — namely, avoidance of unnec-
essarily high rates for the consuming public. That Sierra does
not mention such a consideration is thus no wonder. See Ne.
Utils. Serv. Co. v. FERC (Ne. Utils. II), 55 F.3d 686, 691 (1st
Cir. 1995) (applying a broader definition of “public interest”
in a high-rate challenge because “[i]t all depends on whose ox
is gored and how the public interest is affected”); cf. Permian
Basin Area Rate Case, 390 U.S. 747, 783-84 (1969) (approv-
ing Federal Power Commission’s setting of maximum rates
because of the impact on the public interest). Indeed, the D.C.
Circuit has characterized Sierra as establishing the rule that “a
heavy burden must be met before a customer who has negoti-
ated a fixed-price contract can be deprived against his will of
the benefit of his bargain.” Town of Norwood, 587 F.2d at
1310 (emphases added). When a customer has negotiated a
low contract rate, FERC must meet a high burden before rais-
ing that rate. By contrast, in this case, the customer is com-

    of the Commission would seem to be whether the rate is so low
    as to adversely affect the public interest — as where it might
    impair the financial ability of the public utility to continue its ser-
    vice, cast upon other consumers an excessive burden, or be
    unduly discriminatory.
Sierra, 350 U.S. at 355 (emphasis added).
                PUBLIC UTILITY DISTRICT v. FERC            19609
plaining of a high rate. The concerns in such a high-rate case
are not entirely parallel to those in a low-rate case.

   The primary “public interest” at issue in a low-rate chal-
lenge, such as Sierra, is in keeping utilities in operation so the
public is not deprived of services. Sierra also mentioned
avoidance of rates “so low as to . . . cast upon other consum-
ers an excessive burden.” 350 U.S. at 355 (emphasis added).
The reason for concern with “excessive burden” on “other
consumers” is that charging rates in some wholesale contracts
that are too low to recoup production costs and a fair profit
could lead utilities burdened with such low rate agreements to
recoup their costs and profit margins by charging higher rates
than are just and reasonable to other wholesale customers.
Such a burden is “excessive” because it requires third parties
to pay for costs, including the cost of capital, that properly
should have been borne by the consumers who purchase
energy covered by the challenged contract. Contrary to
FERC’s supposition in this case, the reference to an “exces-
sive” burden in Sierra did not signal that it is fine to burden
customers with unjustifiably higher rates as long as those
rates are not so high as to be “excessive” in some absolute
sense.

   In contrast, the key “public interest” in a high-rate chal-
lenge, such as this one, is assuring that the consuming public
pays fair rates for the very energy covered by the challenged
contracts. Sierra’s limitation of relief to cases where “other”
customers endure an “excessive burden” has no application to
this direct pass-through concern. Instead, if a challenged con-
tract imposes any significant cost on ultimate customers
because of a wholesale rate too high to be within a zone of
reasonableness, see INGAA, 285 F.3d at 31, that contract
affects the public interest.

   To be sure, the stability of contract considerations that
underlie the Mobile-Sierra doctrine do carry over to chal-
lenges by buyers rather than sellers. See Mobile, 350 U.S. at
19610           PUBLIC UTILITY DISTRICT v. FERC
344 (holding that no party may “unilaterally” change contract
because “preserving the integrity of contracts . . . permits the
stability of supply arrangements”). Those considerations,
however, do not justify abnegation of FERC’s statutory
responsibility to protect the public from unjustifiably high
rates in wholesale contracts.

   The public interest standard, consequently, must be
adjusted to give appropriate weight to that concern. In particu-
lar, in determining whether a challenged rate affects the pub-
lic interest, FERC must take into account the Supreme Court’s
admonition that even “a small dent in the consumer’s pocket”
is relevant to the determination of fair rates. Texaco I, 417
U.S. at 399. In the context of a high-rate challenge, conse-
quently, a high-rate public interest determination should focus
on whether consumers’ electricity bills have been affected by
the challenged rates — not necessarily whether the electricity
bills have increased since the signing of the contracts, but
whether those bills are higher than they would otherwise have
been had the challenged contracts called for rates within the
just and reasonable range.

   [16] This is not to say that any direct impact on consumer
rates is enough to demonstrate a public interest effect suffi-
cient to displace the countervailing Mobile-Sierra concern
with protecting the stability of contract. Market-based rate
regulation presumes — appropriately — that a functioning
marketplace will drive prices towards marginal cost, and
therefore toward such a reasonable range, “at least over the
long pull.” INGAA, 285 F.3d at 31. Even if a particular rate
exceeds marginal cost, however, it may still be within this
reasonable range — or “zone of reasonableness” — if that
higher-than-cost-based price results from normal market
forces and is part of a general trend toward rates that do
reflect cost. See id. at 32 (noting that brief spikes in pipeline
rates “are completely consistent with competition”). Thus, the
proper standard for the Mobile-Sierra “public interest” mode
               PUBLIC UTILITY DISTRICT v. FERC           19611
of review in a high-rate challenge is not whether the con-
tracted rates pose an “excessive burden” on consumers, but
whether the wholesale energy contract is outside the “zone of
reasonableness” and results in retail rates higher than would
be the case if that zone were not exceeded. This standard mir-
rors that endorsed by the D.C. Circuit for determination of a
just and reasonable rate under a market-based rate regulation
regime, see INGAA, 285 F.3d at 31-36, and provides an
appropriate context for the Supreme Court’s “small dent”
admonition in such a regulatory environment.

   [17] After reviewing the record carefully, we are certain
that FERC did not properly assess the public interest of any
of the contracts before it in this case.

    1.   Snohomish

   Snohomish had already increased its retail rates by 35 per-
cent to accommodate the payment of increased prices for
power, averaging $125/MWh. Because Snohomish could not
obtain forward contracts that allowed it to bring the retail
rates back within a normal range, it appears that the contracts
at issue did, in fact, impact Snohomish’s customers. Contrary
to FERC’s assertion, it does not matter whether a rate increase
occurred before or after a petitioner signed one of the chal-
lenged contracts. See Order on Rehearing, 105 F.E.R.C. at
¶ 61,986. In either case, the contract could cause customers to
pay higher rates than they would have without the contract.
Further, FERC specifically found that the challenged Morgan
Stanley contract accounted for an eight percent increase for
retail ratepayers over 2001 rates. Id.

    2.   Southern Cal Water

   FERC acknowledged that the challenged contracts led to
electric bills of $35.13 per month for some Southern Cal
19612          PUBLIC UTILITY DISTRICT v. FERC
Water customers. FERC held, however, that Southern Cal
Water had not proven that such a bill “amounts to an exces-
sive burden on the ratepayers.” Id. (emphasis added). FERC’s
rejection of Southern Cal Water’s claim because this increase
did not amount to an “excessive burden,” id., is in error
because, as stated above, the “excessive burden” standard,
which referred in Sierra to the impact on third parties of a
wholesale contract so low as to necessitate that costs be
recouped from other buyers, does not apply in this case, and
did not in any event sanction impacts on consumers as long
as not in some absolute sense “excessive.”

    3.   Nevada Power

   Nevada Power’s retail rates decreased after the challenged
contracts were negotiated. Id. This circumstance, however,
cannot alone determine whether those contracts negatively
affected the public interest. The decrease from peak rates
charged during the crisis does not show that the slightly lower
rates that resulted from the forward contracts did not affect
the public interest. It is entirely possible that rates had
increased so high during the energy crises because of dsy-
function in the spot market that, even with the acknowledged
decrease in rates, consumers still paid more under the forward
contracts than they otherwise would have. FERC should have
performed a more sophisticated economic analysis to deter-
mine if the challenged contract affected the public interest.

                        *      *     *

   y18For the foregoing reasons, we determine that a remand
is necessary so that FERC can apply the proper statutory stan-
dards to determine, first, whether Mobile-Sierra review of the
challenged contracts is appropriate; second, if so, to apply the
modified form of Mobile-Sierra review outlined in this opin-
ion; and finally, if not, to apply full just and reasonable
review to the challenged contracts. The petition for review is
                  PUBLIC UTILITY DISTRICT v. FERC                    19613
hereby granted. We remand this case to FERC for proceed-
ings consistent with this opinion.27

 PETITION             FOR       REVIEW           GRANTED             AND
REMANDED.




  27
     Petitioner Snohomish also claims (1) that two FERC commissioners
engaged in ex parte communications with wholesale energy sellers in vio-
lation of Snohomish’s due process rights; (2) that these same communica-
tions violated the Sunshine Act, 5 U.S.C. § 552b; and (3) that certain
evidentiary rulings of the Administrative Law Judge violated Snohomish’s
due process rights. Because our remand order requires FERC to consider
the complaints again in the first instance, we do not reach these additional
issues.
