By Rich Heidorn Jr.

In a split decision for financial traders, an appellate court Monday sent a dispute regarding PJM’s overcollection of line-loss revenues back to the Federal Energy Regulatory Commission.

The U.S. Court of Appeals for the D.C. Circuit upheld (Case No. 08-1386) FERC’s decision denying financial traders a share of surplus line-loss revenues. But the court ordered the commission to justify its rationale for demanding repayment of $37 million in surplus funds awarded to the traders in 2009.

The money at stake is the result of PJM’s “marginal loss pricing” method for collecting transmission line-loss payments, which treats every transmission as if it were the last transmission in the system. Because this method charges each buyer for the most problematic load transmission at the time, it collects far more than actual losses.

The alternative, average loss pricing, is more accurate in the aggregate, but overcharges loads close to generation and undercharges loads far from generation.  It was outlawed in a 2006 FERC order.

The result of the marginal loss method is “a large pot of money,” as the court described it, with “no clear owner.” About $18 million was overcollected in 2011.

The commission approved PJM’s plan to distribute the surplus to recipients based on their contributions to the transmission system’s fixed costs. The commission said that financial traders – those who make “virtual” trades that are settled financially – had no claim because they do not transmit or take delivery of power.

FERC had ordered PJM not to use the money to “reimburse” market participants for their transmission loss payments, fearing that it would distort trading. The commission said any system that paid virtual marketers according to trading volume would create incentives for them to increase those disbursements by increasing trading volume through uneconomic trades.

The court Monday upheld FERC’s ruling denying virtual traders a share of the surplus, but said the commission had failed to justify its attempt to “claw back” $37 million distributed to the traders in 2009, before the commission changed its position on the matter.

The court said that the disparate treatment of virtual traders was justified because they “perform different roles from load-serving entities within the market and that the system will limit virtual marketers’ incentives to engage in market manipulation.”

But it said FERC had not justified its 2011 decision ordering PJM to “claw back” $37 million awarded to virtual marketers in 2009 for their share of fixed costs paid through up-to-congestion trades.

The court backed the traders’ argument that FERC’s about-face threatened to undermine their confidence in the market.

“In addition to explaining why it should have denied the refunds in the first place, FERC must explain why recouping is warranted. Because FERC failed to explain how it analyzed this crucial aspect of the case, we hold that the Commission acted arbitrarily and capriciously,” the court said. “It may well be that FERC’s policy reasons for effectively ordering recoupment outweigh its negative effects, but FERC must analyze that question, not ignore it. “

The court did not vacate FERC’s recoupment order, however, saying it was “plausible” that the commission could provide a sufficient argument for its decision.