United Distribution Companies v. Federal Energy Regulatory Commission, Windward Energy & Marketing Company, Intervenors

Opinion for the Court filed PER CURIAM. *

Table of Contents

I. INTRODUCTION .1121

A. Background: Natural Gas Industry Structure.1122

B. Order No. 436: Open-Access Transportation.1123

C. Order No. 636: Mandatory Unbundling.1125

D. Issues on Review and Conclusions .1127

II. Open-Acoess Firm Transportation.1130

A. Unbundling.1130

1. Prohibition on unilateral customer release of transportation capacity_1130

2. Pipeline modification of contract-storage rights.1133

3. Capacity retention by transportation-only pipelines.1135

4. Eligibility date for no-notice transportation.1136

B. Right of First Refusal.1137

1. Pre-granted abandonment generally.1138

2. The twenty-year contract term.1140

3. Requirement to discount.1141

C. Curtailment.1142

1. Supply curtailment of pipeline gas.1144

2. Capacity curtailment.1146

3. Supply curtailment of third-party gas.1147

III. Capaoity Release.1148

A. Introduction .1149

B. Jurisdictional Challenges.1151

*1121 1. FERC’s jurisdiction to regulate capacity release.1152

2. Jurisdiction over LDCs’ capacity sales to their own end-users.1152

3. Jurisdiction over municipal capacity release.1158

4. Jurisdiction over “buy/sell” arrangements.1154

a. Introduction to federal preemption.1155

b. Analysis.1156

C. Substantive Challenges.1157

1. Exclusion of Part 157 shippers from capacity release.1157

2. The standard for determining the best bid.1159

3. Interruptible transportation revenue crediting.1160

D. Conclusion.1161

IV. Rate Design.1161

A.FERC’s Authority to Adopt SFV Rate Design.1161

1. MFV rate design’s anticompetitive effects.1161

2. SFV rate design and NGA § 5.1163

B. SFV Rate Design and Substantial Evidence.1167

1. MFV rate design’s distortions of the natural gas market.1167

2. FERC’s choice of SFV rate design .1168

a. LDCs’ claim.1168

b. PUCs’claim.1169

c. Electric Generators’ claim.1169

d. Small Distributors’ and Municipalities’ claim.1170

3. Regulatory Flexibility Act.1170

C. FERC’s Discretion to Adopt Mitigation Measures.1170

1. Background.1170

2. Justifications for mitigation measures.1171

3. Non-permanence of mitigation measures.1172

4. Impact on pipeline rate of return.1173

5. Individual customer vs. customer class.1173

6. Discounts for former customers of downstream pipelines.1174

7. Triennial rate review.1175

V. TRANSITION Costs.1176

A. Background to Transition Costs .1176

1. Order No. 436 and its successors.1176

2. Order No. 636 and petitioners’ challenges .1177

B. Stranded Costs and the “Used and Useful” Doctrine.1178

C. LDC Bypasses.1180

D. Above-Market Recovery for Great Plains Gas.1181

E. GSR Costs.1182

1. Ripeness of petitioners’' challenges to FERC’s treatment of GSR transition costs.1182

2. Gas producers’ exemption from GSR costs.1183

3. Allocation of GSR costs among customer classes.1184

a. “Cost spreading” and “value of service” .1184

b. Petitioners’ challenges.1185

1.) Limitation to bundled sales customers .1185

2.) Interruptible transportation customers.1186

4. Pipelines’ exemption from GSR costs 1188

F. Conclusion.1191

VI. Conclusion.1191

I. Introduction

In Order No. 636, 1 the Federal Energy Regulatory Commission (“Commission” or *1122 “FERC”) took the latest step in its decade-long restructuring of the natural gas industry, in which the Commission has gradually withdrawn from direct regulation of certain industry sectors in favor of a policy of “light-handed regulation” when market forces make that possible. We review briefly the regulatory background for natural gas.

A. Background: Natural Gas Industry Structure

The natural gas industry is functionally separated into production, transportation, and distribution. Traditionally, before the move to open-access transportation, a producer extracted the gas and sold it at the wellhead to a pipeline company. The pipeline company then transported the gas through high-pressure pipelines and re-sold it to a local distribution company (LDC). The LDC in turn distributed the gas through its local mains to residential and industrial users. See generally Edward C. Gallick, Competition in the NatuRal Gas INDUSTRY 9-12 (1993).

The Natural Gas Act (NGA), ch. 556, 52 Stat. 821 (1938) (codified as amended at 15 U.S.C. §§ 717-717w (1994)), enacted in 1938, gave the Commission jurisdiction over sales for resale in interstate commerce and over the interstate transportation of gas, but left the regulation of local distribution to the states. 2 NGA § 1(b), 15 U.S.C. § 717(b). The NGA was intended to fill the regulatory gap left by a series of Supreme Court decisions that interpreted the dormant Commerce Clause to preclude state regulation of interstate transportation and of wholesale gas sales. See Arkansas Elec. Coop. Corp. v. Arkansas Pub. Serv. Comm’n, 461 U.S. 375, 377-80, 103 S.Ct. 1905, 1908-10, 76 L.Ed.2d 1 (1983). The overriding purpose of the NGA is “ ‘to protect consumers against exploitation at the hands of natural gas companies.’ ” FPC v. Louisiana Power & Light Co., 406 U.S. 621, 631, 92 S.Ct. 1827, 1833, 32 L.Ed.2d 369 (1972) (quoting FPC v. Hope Natural Gas Co., 320 U.S. 591, 610, 64 S.Ct. 281, 291, 88 L.Ed. 333 (1944)). Federal regulation of the natural gas industry is thus designed to curb pipelines’ potential monopoly power over gas transportation. 3 The enormous economies of scale involved in the construction of natural gas pipelines tend to make the transportation of gas a natural monopoly. 4 Indeed, even with the expansion of the national pipeline grid, or network, in recent decades, many “captive” customers 5 remain served by a single pipeline. 6 Order No. 436, ¶ 30,665, at 31,473. 7

*1123 Even though the market function potentially subject to monopoly power is the transportation of gas, for many years the Commission also regulated the price and terms of sales by producers to interstate pipelines. See Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 677-84, 74 S.Ct. 794, 796-800, 98 L.Ed. 1035 (1954). Producer price regulation was widely regarded as a failure, introducing severe distortions into what otherwise would have been a well-functioning producer sales market. See Stephen G. BREYER & Paul W. MaoAvoy, Energy Regulation by the Federal Power Commission 56-88 (1974). When a severe gas shortage developed in the 1970s, Congress enacted the Natural Gas Policy Act of 1978 (NGPA), Pub.L. No. 95-621, 92 Stat. 3351 (codified as amended at 15 U.S.C. §§ 3301-3432 (1994)), which gradually phased out producer price regulation. Under the NGPA’s partially regulated producer-price system, many pipelines entered into long-term contractual obligations, in what were known as “take-or-pay 5 ’ provisions, to purchase minimum quantities of gas from producers at costs that proved to be well above current market prices of gas. See Richard J. Pierce, Jr., Reconstituting the Natural Gas Industry from Wellhead to Bumertip, 9 Energy L.J. 1, 11-16 (1988).

The problem of pipelines’ take-or-pay settlement costs has plagued the industry and the Commission over the last fifteen years. The Commission’s initial response to escalating pipeline take-or-pay liabilities was to authorize pipelines to offer less expensive sales of third-party (non-pipeline-owned) gas to non-captive customers while still offering only higher-priced pipeline gas to captive customers. 8 The court struck down these measures because the Commission “ha[d] not adequately attended to the agency’s prime constituency,” captive customers vulnerable to pipelines’ market power. Maryland People’s Counsel v. FERC, 761 F.2d 780, 781 (D.C.Cir.1985) (MPC II); see also Maryland People’s Counsel v. FERC, 761 F.2d 768, 776 (D.C.Cir.1985) (MPC I). In response to the court’s decisions in MPC I and MPC II, the Commission embarked on its landmark Order No. 436 rulemaking. See Order No. 436, ¶ 30,665, at 31,467.

B. Order No. 436: Open-Access Transportation

In Order No. 436, the Commission began the transition toward removing pipelines from the gas-sales business and confining them to a more limited role as gas transporters. Under a new Part 284 of its regulations, 9 the Commission conditioned receipt of a blanket certificate for firm transportation of third-party gas on the pipeline’s acceptance of non-discrimination requirements guaranteeing equal access for all customers to the new service. 10 Order No. 436, ¶30,-665, at 31,497-518. In effect, the Commission for the first time imposed the duties of *1124 common carriers upon interstate pipelines. See Associated Gas Distributors v. FERC, 824 F.2d 981, 997 (D.C.Cir.1987) (AGD I), cert. denied, 485 U.S. 1006, 108 S.Ct. 1468, 1469, 99 L.Ed.2d 698 (1988). By recognizing that anti-competitive conditions in the industry arose from pipeline control over access to transportation capacity, the equal-access requirements of Order No. 436 regulated the natural-monopoly conditions directly. In addition, every open-access pipeline was required to allow its existing bundled firm-sales customers to convert to firm-transportation service and, at the customer’s option, to reduce its firm-transportation entitlement (its “contract demand”). Order No. 436, ¶ 30,665, at 31,518-33. Moreover, the Commission established a flexible rate structure under which transportation charges were limited to the maximum approved rate (based on fully allocated costs) but pipelines could selectively discount down to the minimum approved rate (based on average variable cost). Id. at 31,533-19.

The court largely approved Order No. 436, but the principal stumbling-block was the unresolved problem of uneconomical pipeline-producer contracts in the transition to the unbundled environment. The Commission had decided not to provide pipelines with relief from their take-or-pay liabilities, even though the introduction of open-access transportation in Order No. 436 would likely exacerbate the problem by reducing pipeline sales. 11 AGD I, 824 F.2d at 1021-23. After the court remanded the case on the ground that the Commission’s inaction on take-or-pay did not exhibit reasoned decision making in light of open access, id. at 1030, the Commission adopted various interim measures in Order No. 500. 12 First, it instituted a “crediting mechanism,” under which a pipeline could apply any third-party gas that it transported toward the pipeline’s minimum-purchase obligation from that particular producer. Order No. 500, ¶ 30,761, at 30,779-84. Second, the Commission adopted two alternative cost-recovery mechanisms. As customary, a pipeline could recover all of its prudently incurred costs in its commodity (sales) charges, although that could prove difficult for pipelines with shrinking sales-eustomer bases. In the alternative, under the equitable-sharing approach, a pipeline offering open-access transportation could, if it voluntarily absorbed between twenty-five and fifty percent of the costs, recover an equal share of the costs through a “fixed charge” and recover the remaining amount (up to fifty percent) through a volumetric surcharge based on total throughput (and thus borne by both sales and transportation customers alike). 13 Id. at 30,784-92; 18 C.F.R. § 2.104. Third, the Commission authorized pipelines not recovering take-or-pay costs in any other manner to impose a “gas inventory charge” (GIC), a fixed charge for “standing ready” to deliver gas — the sales analogue to a reservation charge. Order No. 500, ¶ 30,761, at 30,792-94; 18 C.F.R. § 2.105.

The Commission’s alternative solutions to the problem of take-or-pay settlement costs in Order No. 500 fared poorly on judicial review. First, the court remanded the cred *1125 iting mechanism for an explanation of whether the Commission had the requisite authority under § 7 of the NGA. American Gas Ass’n v. FERC, 888 F.2d 136, 148-49 (D.C.Cir.1989) (AGA I). After the Commission explained its § 7 authority for the crediting mechanism in Order No. 500-H, 14 the court upheld the crediting mechanism. 15 American Gas Ass’n v. FERC, 912 F.2d 1496, 1509-13 (D.C.Cir.1990) (.AGA II). Second, the court struck down the equitable-sharing cost-recovery mechanism on the ground that the Commission’s “purchase deficiency” method for calculating the “fixed charge,” which assigned costs to each customer based on how much its purchases had declined over the relevant preceding period, violated the filed-rate doctrine. Associated Gas Distributors v. FERC, 893 F.2d 349, 354-57 (D.C.Cir.1989) (AGD II), reh’g en banc denied, 893 F.2d 809 (D.C.Cir.), cert. denied, 498 U.S. 907, 111 S.Ct. 277, 278, 112 L.Ed.2d 233 (1990). The Commission responded to the invalidation of the “purchase deficiency” method in AGD II by adopting Order No. 528, 16 which allowed pipelines, in the “fixed charge,” to pass through a portion of costs to customers based on any of several measures of current (rather than past) demand or usage, with the intent of avoiding the filed-rate problem. Order No. 528, ¶ 61,-163, at 61,597-98. Finally, the court struck down the Commission’s approval of a GIC on a particular pipeline because it had given undue weight to the pipeline’s customers’ having agreed to the GIC and failed adequately to consider the interests of end-users. Tejas Power Corp. v. FERC, 908 F.2d 998, 1003-05 (D.C.Cir.1990).

Congress completed the process of deregulating the producer sales market by enacting the Natural Gas Wellhead Decontrol Act of 1989, Pub.L. No. 101-60, 103 Stat. 157 (codified in scattered sections of 15 U.S.C.). As the House Committee on Energy and Commerce emphasized, the Commission’s creation of open-access transportation was “essential” to Congress’ decision completely to deregulate wellhead sales. H.R.Rep. No. 29, 101st Cong., 1st Sess. 6 (1989), U.S.Code Cong. & Admin.News 1989, pp. 51, 56. The committee report declared also that “[b]oth the FERC and the courts are strongly urged to retain and improve this competitive structure in order to maximize the benefits of decontrol.” 17 Id. The committee expected that, by ensuring that “[a]ll buyers [are] free to reach the lowest-selling producer,” id., open-access transportation would allow the more efficient producers to emerge, leading to lower prices for consumers, id. at 3, 7.

C. Order No. 636: Mandatory Unbundling

In Order No. 636, the Commission declared the open-access requirements of Order No. 436 a partial success. The Commission found that pipeline firm sales, which in 1984 had been over 90 percent of deliveries to market, had declined by 1990 to 21 percent. Order No. 636, ¶ 30,939, at 30,399 tbl. 1. On the other hand, only 28 percent of deliveries to market in 1990 were firm transportation, whereas 51 percent of deliveries used interruptible transportation. Id. at 30,-399 & n. 61. The Commission concluded that many customers had not taken advantage of Order No. 436’s option to convert from firm-sales to firm-transportation service because the firm-transportation component of bun- *1126 died firm-sales service was “superior in quality” to stand-alone firm-transportation service. Id. at 30,402. In particular, the Commission found that stand-alone firm-transportation service was often subject to daily scheduling and balancing requirements, as well as to penalties for variances from projected purchases in excess of ten percent. Moreover, pipelines usually did not offer storage capacity on a contractual basis to stand-alone firm-transportation shippers. Id. The result was that many of the non-converted customers used the pipelines’ firm-sales service during times of peak demand but in non-peak periods bought third-party gas and transported it with interrupti-ble transportation. The Commission found that “[i]t is often cheaper for pipeline sales customers to buy gas on the spot market, and pay the pipeline’s demand charge plus the interruptible rate, than to purchase the pipeline’s gas.” Id. at 30,400. Because of the distortions in the sales market, these customers often paid twice for transportation services and still received an inferior form of transportation (interruptible rather than firm). Id. Because of the anti-competitive effect on the industry, the Commission found that pipelines’ bundled firm-sales service violated §§ 4(b) and 5(a) of the NGA. Id. at 30,405.

The Commission’s remedy for these anti-competitive conditions, and the principal innovation of Order No. 636, was mandatory unbundling of pipelines’ sales and transportation services. By making the separation of the two functions mandatory, the Commission expects that pipelines’ monopoly power over transportation will no longer distort the sales market. Order No. 636, ¶ 30,939, at 30,406-13; Order No. 636-A, ¶ 30,950, at 30,-527-46; Order No. 636-B, ¶ 61,272, at 61,-988-92. To replace the firm-transportation component of bundled firm-sales service, the Commission introduced the concept of “no-notice firm transportation,” stand-alone firm transportation without penalties. Those customers who receive bundled firm-sales service have the right, during the restructuring process, to switch to no-notice firm-transportation service. Pipelines that did not offer bundled firm-sales service are not required to offer no-notice transportation; but if they do, they must offer no-notice transportation on a non-diseriminatory basis. Order No. 636, ¶ 30,939, at 30,421-25; Order No. 636-A, ¶ 30,950, at 30,570-77; Order No. 636-B, ¶ 61,272, at 62,006-10; see 18 C.F.R. § 284.8(a)(4).

In contrast to the continued regulation of the transportation market, the Commission essentially deregulated the pipeline sales market. The Commission issued every Part 284 pipeline a blanket certificate authorizing gas sales. Although acknowledging that “only Congress can ‘deregulate,’” the Commission “instituted] light-handed regulation, relying upon market forces at the wellhead or in the field to constrain unbundled pipeline sale for resale gas prices within the NGA’s ‘just and reasonable’ standard.” Order No. 636,¶ 30,939, at 30,440. The Commission reasoned that open-access transportation, combined with its finding that “adequate divertible gas supplies exist in all pipeline markets,” would ensure that the free market for gas sales would keep rates within the zone of reasonableness. Id. at 30,437-43; Order No. 636-A, ¶ 30,950, at 30,609-24; Order No. 636-B, ¶ 61,272, at 62,024-25; see 18 C.F.R. §§ 284.281-284.288.

The Commission also undertook several measures to ensure that the pipeline grid, or network, functions as a whole in a more competitive fashion. First, open-access pipelines may not inhibit the development of “market centers,” which are pipeline intersections that allow customers to take advantage of many more transportation routes and choose between sellers from different natural gas production areas. Similarly, open-access pipelines may not interfere with the development of “pooling areas,” which allow the aggregation of gas supplies at a production area. Order No. 636, ¶ 30,939, at 30,427-28; Order No. 636-A, ¶ 30,950, at 30,581-82; Order No. 636-B, ¶ 61,272, at 62,011-12; see 18 C.F.R. §§ 284.8(b)(6), 284.9(b)(5). Finally, as part of the move toward open-access transportation, the Commission required Part 284 pipelines to allow shippers to deliver gas at any delivery point without penalty and to allow customers to receive gas at any receipt point without penalty. Order No. *1127 686, ¶ 30,939, at 30,428-29; Order No. 636-A, ¶ 30,950, at 30,582-86; Order No. 636-B, ¶ 61,272, at 62,012-13; see 18 C.F.R. § 284.221(g)-(h).

Even though this is the court’s first occasion to address Order No. 636, which was enacted in 1992, we do not write on a clean slate. Beginning with MFC I and MPC II, the court has consistently required the Commission to protect consumers against pipelines’ monopoly power. No longer reluctantly engaged in the unbundling enterprise, the Commission has responded by initiating sweeping changes with Order No. 636. Accordingly, we review the Commission’s exercise of its authority under the NGA in light of the principles that the court has already applied in this area.

D. Issues on Review and Conclusions

After two comprehensive rehearing orders, Orders No. 636-A and No. 636-B, the Commission denied further rehearing. 18 62 F.E.R.C. ¶ 61,007 (1993). The Judicial Panel on Multidistrict Litigation consolidated all the petitions for review of the Order No. 636 series and transferred them to the Eleventh Circuit by random selection pursuant to 28 U.S.C. § 2112(a)(3). On February 15, 1994, the Eleventh Circuit transferred the petitions for review to this court. We consolidated with this case petitions for review of the Commission’s decision to prohibit buy/sell agreements, 19 and of the Commission’s decision to end capacity-brokering programs. 20 We ordered the petitioners to file briefs in consolidated industry groups: pipelines; local distribution companies (LDCs); small distributors and municipalities; industrial end-users; electric generators; and public utility commissions (PUCs). 21

The petitioners do not challenge the mandatory unbundling remedy itself. At issue on review are numerous other aspects of Order No. 636 involving changes that the Commission undertook as part of its comprehensive restructuring of the natural gas industry. In Part II of our opinion, we discuss the challenges to the Commission’s rules on Part 284 firm transportation. Part III addresses the challenges to the Commission’s new capacity-release program. Part IV covers the requirement that pipelines use the straight fixed/variable rate-design methodology. Finally, in Part V we deal with challenges to the Commission’s handling of transition costs.

As we discuss in Part II.A, the petitioners challenge four peripheral aspects of the Commission’s unbundling remedy. We uphold the Commission’s rule that customers must retain contractual firm-transportation capacity for which the pipeline receives no other offer. See 18 C.F.R. § 284.14(e). Further, insofar as the Commission may have stated that a § 7(b) abandonment proceeding is never required for pipeline changes to contract-storage withdrawal and injection schedules, we grant relief, but we defer review of possible challenges to specific pipeline changes. The challenge to the Commission’s rule that transportation-only pipelines may not acquire capacity on other pipelines has been rendered moot by virtue of an intervening Com *1128 mission decision. We remand for further explanation the Commission’s decision that only those customers who received bundled firm-sales service on May 18, 1992, are entitled to the new no-notice transportation service.

Part II.B concerns the Commission’s award of pre-granted abandonment to long-term firm-transportation service, subject to the existing shipper’s “right of first refusal” (ROFR). Under this provision of the rules, pipelines are no longer required to go through § 7 abandonment proceedings when a transportation contract expires. In return, the existing customer has the right to retain service if it matches the terms of a competing offer for that capacity. Such bids are capped at the maximum rate approved by the Commission for that service, and the contract length may not exceed twenty years. Order No. 636, ¶ 30,939, at 30,448-52; Order No. 636-A, ¶ 30,950, at 30,627-36; Order No. 636-B, ¶ 61,272, at 62,025-28; see 18 C.F.R. § 284.221(d). While we conclude that in its basic structure the right-of-first-refusal mechanism complies with § 7, we remand the right-of-first-refusal mechanism to the Commission for further explanation of why it adopted a twenty-year term-matching cap. We uphold the Commission’s decision not to require pipelines to discount rates in the right-of-first-refusal process.

The Commission also re-visited its policies for the curtailment of gas in times of a supply shortage or a capacity interruption. Gas can be curtailed on an end-use basis, meaning that high-priority users have priority in times of curtailment, or on a pro rata basis, meaning that each user’s deliveries are curtailed proportionally. The Commission found that it was statutorily obligated to require pipelines to adopt an end-use curtailment plan for shortages in the supply of pipeline gas. On the other hand, the Commission declined to require pipelines to adopt end-use curtailment for capacity interruption. Order No. 636, ¶ 30,939, at 30,429-31; Order No. 636-A, ¶ 30,950, at 30,586-93. In Part II.C, we affirm the Commission’s decision that title IV of the NGPA requires end-use supply curtailment and conclude that the issue of curtailment compensation is not ripe for review. We also deny the petitions for review of the Commission’s capacity-curtailment policies, but we do not examine whether pure pro rata capacity curtailment is always appropriate because the Commission has examined that issue on a pipeline-specific basis in the restructuring proceedings. Finally, we uphold the Commission’s policies for supply shortages of third-party gas.

Part III addresses the Commission’s adoption of a uniform capacity-release program — a regulated market that allows capacity-holders to re-sell the rights to pipeline firm-transportation capacity. An existing shipper that finds itself with excess capacity may list that capacity on the pipeline’s electronic bulletin board (EBB), which functions as a central clearinghouse for the secondary capacity market. Order No. 636, ¶ 30,939, at 30,416-21; Order No. 636-A, ¶ 30,950, at 30,-550-65; Order No. 636-B, ¶ 61,272, at 61,-994-62,003; see 18 C.F.R. § 284.243. We uphold the Commission’s jurisdiction to regulate the re-sale of interstate-transportation rights in general, as well as specifically its jurisdiction over LDCs who broker capacity to local end-users and over municipal LDCs. We also uphold the Commission’s decision that state-authorized “buy/sell arrangements” 22 are pre-empted by the Commission’s capacity-release program. Finally, we uphold the Commission’s decision to exclude Part 157 shippers and conclude that other challenges to the substance of the capacity-release program are not ripe for review.

Part IV deals with the Commission’s requirement that pipelines adopt a new rate-design methodology known as straight fixed/variable (SFV). 23 Under SFV, pipe *1129 lines must allocate fixed costs to the reservation charge, and variable costs to the usage charge. 24 The Commission mandated SFV so that fixed costs, which vary greatly between pipelines, would no longer affect the usage charge and thus distort the national gas-sales market that Order No. 686 fosters. Because the shift from the previous modified fixed/variable (MFV) rate design 25 would disadvantage low-load-factor customers, 26 the Commission adopted various SFV mitigation measures to protect those customers. Order No. 636,¶ 30,939, at 30,431-37; Order No. 636-A, ¶ 30,950, at 30,593-609; Order No. 636-B, ¶ 61,272, at 62,013-24; see 18 C.F.R. § 284.8(d). We uphold the Commission’s authority under § 5 to adopt SFV rate design and conclude that substantial evidence supports the Commission’s findings that MFV rate design distorted the producer sales market and that SFV is an appropriate rate-design methodology. Although we uphold the Commission’s SFV mitigation measures against most challenges, we conclude that the Commission failed to explain why it ordered some mitigation measures on an individual-customer basis and others on a customer-class basis and why it did not require pipelines to offer small-customer discounts to former customers of downstream pipelines. Accordingly, we remand those issues to the Commission.

Finally, as we explain in Part V, the Commission addressed the transition costs involved with implementing Order No. 636. The Commission allowed pipelines, whose role as gas merchants was greatly reduced, to pass through to transportation customers all the costs of reducing contractual purchase obligations from producers, known as gas-supply realignment (GSR) costs. Unlike the Order No. 500 equitable-sharing cost-recovery mechanism for take-or-pay costs from pipeline-producer contracts, Order No. 636 imposes all the costs of realigning unneeded producer-pipeline contracts on pipeline customers. The Commission authorized pipelines to recover 90% of the GSR costs from current firm-transportation customers (including customers who converted from being bundled firm-sales customers under Order No. 436) and 10% of the GSR costs from interruptible-transportation customers. Order No. 636, ¶ 30,939, at 30,457-62; Order No. 636-A, ¶ 30,950, at 30,641-64; Order No.636-B, ¶ 61,272, at 62,031^15. We uphold the Commission’s decision to allow pipelines to recover GSR costs from customers who converted to open-access transportation before Order No. 636, but remand the decision that pipelines must allocate 10% of GSR costs to interruptible-transportation customers for further explanation. We also remand the decision that pipelines can pass through all their GSR costs to customers for further consideration by the Commission in light of the equitable-sharing procedures in Order No. 500 and the general cost-spreading principles of Order No. 636. We affirm the Commission’s treatment of LDC by-pass, GSR costs for the Great Plains coal gasification project, and stranded costs.

*1130 The Commission resolved issues that it considered generic to all pipelines in the Order No. 636 rulemaking, but deferred many issues associated with the implementation of mandatory unbundling to restructuring proceedings. Every Part 284 pipeline is required to go through an individual pipeline restructuring proceeding, to conform its operations to the new regulations and to address pipeline-specific issues. 18 C.F.R. § 284.14; Order No. 686, ¶ 30,939, at 30,462-69; Order No. 636-A, ¶ 30,950, at 30,664-73. The Commission has by now completed the restructuring proceedings, and in the proceedings for some pipelines interested parties have petitioned for review. 27 In this decision, we review only the Order No. 636 rulemaking, although on some issues we have necessarily had to consider the interaction between the rulemaking and the subsequent restructuring proceedings.

II. Open-Access Firm Transportation

A. Unbundling

The petitioners challenge four aspects of the Commission’s unbundling remedy: the rule that customers must retain contractual firm-transportation capacity for which the pipeline receives no other offer; the Commission’s policy on pipelines’ ability to modify existing storage contracts without abandonment proceedings; the rule that transportation-only pipelines may not acquire capacity on other pipelines; and the eligibility date for no-notice transportation service.

1. Prohibition on unilateral customer release of transportation capacity

When the Commission concluded that the pipelines’ bundled firm-sales service violated §§ 4(b) and 5(a) of the NGA, Order No. 636, ¶ 30,939, at 30,405, the Commission found also that “the continued enforcement of a pipeline sales customer’s purchase obligations, agreed to before implementation of unbundling under this rule, is unjust and unreasonable, and unduly discriminatory.” Id. at 30,453. Accordingly, all existing bun-died firm-sales customers were given the option to reduce or terminate their contractual pinchase obligations during the pipeline’s restructuring proceedings. 18 C.F.R. § 284.14(d)(1). By contrast, those customers were not relieved of their contractual transportation obligations unless either an alternative, creditworthy shipper offered to assume the capacity at the same or a higher rate (up to the maximum approved rate), or the pipeline agreed to reduce or terminate the transportation obligation. Id. § 284.14(e)(2). If a customer wished to reduce or terminate its transportation obligation, and either a replacement shipper assumed the capacity or the pipeline agreed, then the pipeline was authorized to abandon the service under the prior contract. Id. § 284.14(e)(3). In effect, existing bundled firm-sales customers remained contractually bound to receive firm-transportation service on the pipeline.

On rehearing, Northern Indiana Public Service Company (NIPSCO) maintained that the Commission’s actions entirely abrogated the existing pipeline-customer bundled firm-sales contracts, and that the Commission could not require the LDCs to enter into new transportation contracts. The Commission denied that it had abrogated the contracts: the pipelines remained contractually obligated to provide separate sales and transportation services. “[T]he fact that LDCs have an opportunity to revise their sales entitlements under existing contracts with their pipeline suppliers does not mean they should also have an unqualified right to terminate their obligations for the costs of transportation capacity under those contracts.” Order No. 636-A, ¶ 30,950, at 30,638. The Commission also explained that if it released former bundled-sales customers from transportation obligations, “these capacity costs could be shifted from the customer who has contracted for the capacity to the pipeline or other customers that have no need for the capacity.” Id. at 30,637.

NIPSCO, joined by other LDC petitioners, 28 contends that, by holding pipeline *1131 customers to the transportation component of bundled firm-sales contracts, the Commission essentially imposed a new contract upon the customers, which is beyond the Commission’s § 5 authority. Section 5(a) provides that, whenever the Commission has found that an existing contract is “unjust, unreasonable, unduly discriminatory, or preferential,” it “shall determine the just and reasonable contract to be thereafter observed and in force, and shall fix the same by order.” 15 U.S.C. § 717d(a). NIPSCO contests not the Commission’s underlying finding that the bundled firm-sales contracts violated §§ 4(b) and 5(a), but only the remedy imposed under § 5. Our review is limited to whether the Commission’s reading of § 5 to authorize it to hold LDCs to the remaining terms of a modified pipeline-customer contract is a reasonable construction of its statutory authority. See AGD I, 824 F.2d at 1001.

The bundled firm-sales contracts between pipelines and LDCs were subject to the Commission’s § 5 authority. The regulatory structure of the Natural Gas Act is contract-based: it “permits the relations between the parties to be established initially by contract, the protection of the public interest being afforded by supervision of the individual contracts.” United Gas Pipe Line Co. v. Mobile Gas Serv. Corp., 350 U.S. 332, 339, 76 S.Ct. 373, 378, 100 L.Ed. 373 (1956). Under § 5, “the Commission has plenary authority to limit or to proscribe contractual arrangements that contravene the relevant public interests.” Permian Basin Area Rate Cases, 390 U.S. 747, 784, 88 S.Ct. 1344, 1369, 20 L.Ed.2d 312 (1968). For example, in Wisconsin Gas Co. v. FERC, 770 F.2d 1144 (D.C.Cir.1985), cert. denied, 476 U.S. 1114, 106 S.Ct. 1968, 1969, 90 L.Ed.2d 653 (1986), the court affirmed the Commission’s decision in Order No. 380 that “minimum bill” provisions in existing contracts were “unjust and unreasonable” under § 5. 29 The court upheld the Commission’s remedy, eliminating the minimum bill from the contracts, against the claim that such a remedy “unlawfully alter[ed] the terms of existing contracts,” on the ground that “section 5 gives the Commission authority to alter terms of any existing contract found to be ‘unjust’ or ‘unreasonable.’ ” Id. at 1153 n. 9.

NIPSCO also maintains that the Commission has construed its § 5 authority to extend beyond the limits in § 1(b) on the Commission’s jurisdiction. Regardless of the Commission’s authority to impose modified contractual obligations on pipelines, NIPSCO contends that the Commission lacks such authority over LDCs because LDCs are “non-jurisdictional” entities. Under § 1(b), the Commission’s jurisdiction over “the transportation of natural gas in interstate commerce” does not apply to “the local distribution of natural gas or to the facilities used for such distribution.” 15 U.S.C. § 717(b). But the local-distribution exception applies only to the movement of gas within an LDC’s local mains and not to the movement of gas in high-pressure interstate pipelines. FPC v. East Ohio Gas Co.,