Illinois Ex Rel. Hartigan v. Panhandle Eastern Pipe Line Co.

MEMORANDUM OPINION

MIHM, District Judge.

I. INTRODUCTION

This is an antitrust case. The Plaintiff, the State of Illinois, is suing in its proprietary capacity on behalf of certain state facilities, in its

parens patriae

capacity on behalf of all natural persons in the certified class below, and in its representative capacity on behalf of other indirect purchasers. This class was certified by the Court pursuant to Rule 23, Federal Rules of Civil Procedure, and described as follows:

All indirect purchasers of natural gas from Panhandle Eastern Pipe Line Company (“PEPL”) who reside in or are located in those Illinois counties or parts of Illinois counties served exclusively by PEPL’s interstate natural gas transmission system.

The area exclusively served by Panhandle involves part or all of 37 counties. Most of the indirect purchasers involved in this case were supplied their natural gas in those areas by three local distribution companies (“LDC’s”): Central Illinois Light Company (“CILCO”), Central Illinois Public Service Company ("CIPS”), and Illinois Power Company (“IP”).

The Defendant, Panhandle Eastern Pipe Line Company (“Panhandle” or “PEPL”), a Delaware corporation, is an interstate pipeline company. Panhandle’s pipeline system moves natural gas from a number of collection points outside the State of Illinois and distributes the gas elsewhere along its system, in Illinois and other states, primarily to LDC’s.

The Plaintiff charges that during the time in question, 1981 to the time of trial in 1986/1987, Panhandle engaged in conduct which constituted violations of federal and state antitrust laws. More specifically, Count I (Monopolization of Gas Sales), Count 3 (Attempted Monopolization of Gas Sales), Count 5 (Monopoly Leveraging), Count 7 (Essential Facility), and Count 9 (Illegal Tying) allege violations of Sections 1 and 2 of the Sherman Act, 15 U.S.C. §§ 1 , 2, and pray for damages pursuant to Section 4 of the Clayton Act, 15 U.S.C. § 15 .

Counts 2, 4, 6, 8, and 10 allege corresponding violations of Section 3 of the Illinois Antitrust Act, Ill.Rev.Stat. ch. 38, ¶ 60-3.

Section 1 of the Sherman Act provides in pertinent part as follows:

Every contract ... in restraint of trade or commerce among the several state ... is declared to be illegal.

15 U.S.C. § 1 .

Section 2 of the Sherman Act provides in pertinent part as follows:

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Every person who shall monopolize ... any part of the trade or commerce among the several states ... shall be deemed guilty....

15 U.S.C. § 2 .

Section 4 of the Clayton Act provides as follows:

Any person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws may sue therefor in any district court of the United States in the district in which the defendant resides or is found or has an agent, without respect to the amount in controversy and shall recover threefold the damages by him sustained, and the cost of suit, including a reasonable attorney’s fee.

15 U.S.C. § 15 .

Prior to trial, Panhandle moved to dismiss all indirect purchaser claims on grounds that such indirect claims were barred by the

Illinois Brick

doctrine, which prohibits most antitrust claims by indirect purchasers.

Illinois Brick v. Illinois,

431 U.S. 720 , 97 S.Ct. 2061 , 52 L.Ed.2d 707 (1977). This Court denied the Motion to Dismiss, citing the “cost plus exception” to the

Illinois Brick

doctrine. On interlocutory appeal, a panel of the Seventh Circuit Court of Appeals reversed the Court’s denial of the Motion to Dismiss on January 22, 1988.

State of Illinois ex rel. Hartigan v. Panhandle Eastern,

839 F.2d 1206 (7th Cir.1988). However, in an

en banc

decision dated July 18, 1988, the Seventh Circuit held that, while industrial indirect purchasers did not fall within the “cost plus exception” to the

Illinois Brick

rule, residential/commercial indirect purchasers did, and therefore claims on their behalf would not be dismissed.

State of Illinois ex rel. Hartigan v. Panhandle,

852 F.2d 891 (7th Cir.1988),

cert. denied,

— U.S. -, 109 S.Ct. 543 , 102 L.Ed.2d 573 (1988).

This lawsuit was filed on February 7, 1984. On December 13, 1984, after extensive hearing, the Court denied a Motion for Preliminary Injunction filed by Plaintiff. The trial on the merits on the bifurcated issue of liability was heard by the Court from November 17, 1986 to January 30, 1987. The Court stayed the matter during much of the time after trial when the interlocutory appeal was pending.

For the reasons stated in this Opinion, the Court finds in favor of the Defendant and against the Plaintiff on all claims.

This is a complex ease, and the Court’s ruling on the issue of liability will of necessity involve hundreds of specific findings of Fact and Law.

The Opinion is structured in the following way:

I. Narrative (historical background of the natural gas industry and the events leading up to the disputes between the parties in this case).

II. Findings of Fact (more specific discussion of certain factual bases for the legal conclusions).

III. Conclusions of Law.

NOTE: All matters contained in this Memorandum Opinion are to be considered as findings of the Court, whether the same are found in the Narrative or in the formal Findings of Fact or Conclusions of Law.

References to the injunction hearing and trial testimony are by witness and transcript page number; the injunction hearing and trial transcript have been numbered as one consecutive transcript by the parties. Citations to depositions are to the witness’ name and page number. PX citations refer to Plaintiff’s Exhibits; DX citations refer to Defendant’s Exhibits.

II. NARRATIVE

A.

Historical Background of the Natural Gas Industry

Natural gas has for some time been a major source of inexpensive energy in this country. Over time most homeowners, small businesses, and industrial facilities came to meet their heating needs with gas heat.

An interstate pipeline industry developed. Pipeline companies purchased natural gas from producers at the wellhead and moved the gas from the well to distant customers by way of their pipeline sys-

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terns. Panhandle, for example, purchases gas from extensive acreage located in Texas, Oklahoma, New Mexico, Colorado, Wyoming and offshore in Texas and Louisiana from Trunkline Gas Company (“TKL”). Panhandle’s pipeline, with lateral and gathering lines, runs northeastward generally from Oklahoma and Texas .to the Detroit, Michigan area. Panhandle sells virtually all of the natural gas it purchases to interstate pipeline companies, industrial end-users, and investor-owned and municipally-owned LDC’s serving several states including Central Illinois.

Until 1977, the regulatory agency supervising the natural gas industry was the Federal Power Commission (“FPC”). In that year, the FPC was replaced by the Federal Energy Regulatory Commission (“FERC” or “Commission”).

The statutory framework for regulatory control of the industry until 1978 was the Natural Gas Act (“NGA"), 15 U.S.C. §§ 717 -717w. Under the NGA, every sale of natural gas for resale and every transportation of natural gas in interstate commerce was subject to federal regulatory oversight. The NGA required that a regulatory body (the FPC) review each sale of gas to ensure that the price was “just and reasonable” and review all transportation facilities and transports of gas in interstate commerce to assure that they were “in the public convenience and necessity.” 15 U.S.C. §§ 717c, 717f.

The principal functions of the FERC in rate-making are to determine the costs the pipeline should be allowed to recover from its jurisdictional businesses, to apportion the costs on an equitable basis among the different services that are provided, and to develop rates that will give the pipeline a reasonable opportunity to recover those costs, including an appropriate return on the investment in facilities used to provide the services. (Williams 6365).

The NGA gave the FPC/FERC broad powers to regulate both price and non-price activities of interstate pipelines, defined as “natural gas companies” by 15 U.S.C. § 717a(6). Panhandle is such a natural gas company.

In the years leading up to 1978, Panhandle sold natural gas to LDC’s such as CILCO, CIPS, and IP pursuant to tariffs approved by the FPC/FERC, and in conformance with long-term service contracts.

In the late 1960’s, a natural gas shortage developed and spread throughout the natural gas industry. This shortage continued into the 1970’s and on occasion caused curtailment of delivery of natural gas to LDC’s because there was not enough natural gas available to meet demand. Naturally, in such an environment, LDC’s and the customers behind them clung to the pipelines serving their customer area. Pursuant to typical contract and tariff arrangements, LDC’s such as CILCO agreed that they would normally purchase all of their natural gas from a single interstate pipeline, such as Panhandle, and in return the pipeline agreed to give its “best efforts” to see that the LDC received whatever amount of natural gas was needed to meet its customers needs.

In furtherance of those long-term commitments to the LDC’s, pipelines entered into long-term contracts with natural gas producers to ensure an adequate flow of gas. Very often these pipeline/producer contracts, because of the oil shortage and tightly regulated price, contained provisions that guaranteed a certain level of “take” from the producer. In other words, the pipeline would guarantee to take a set amount of gas during a 12 month period. If the pipeline did not take the guaranteed amount of gas, it was still obligated to pay the producer for that amount of gas. These “take-or-pay” provisions were common in most contracts between pipelines and producers of natural gas from the mid-1970’s until the early 1980’s.

In 1978, Congress changed the “rules of the game” by passing the Natural Gas Policy Act (“NGPA”), 15 U.S.C. §§ 3301-3432 . The NGPA provided for gradual deregulation of the wellhead price of certain natural gas and for significant deregulation effective January 1,1985. One goal of the NGPA in deregulating gas producer prices was to provide sufficient incentive

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for increased exploration and development of new supplies.

With respect to sales of gas, the NGPA largely eliminated the requirement that gas be sold at “just and reasonable” rates and created instead several categories of gas, establishing for many a “maximum lawful price,” referred to commonly as a ceiling price. 15 U.S.C. §§ 3312-3319 . Ceiling prices were established for, among others, the following categories of gas:

“raw material gas,” referred to in the NGPA as “102 gas.”

“new, onshore production wells,” referred to in the NGPA as “103 gas,”

“high-cost natural gas,” referred to in the NGPA as “107 gas.”

Under the NGPA, gas in these categories, commonly referred to as “new gas,” could be sold at any price up to the ceiling price without regulatory review. The ceiling prices for 102, 103 and 107 gas were eliminated by the NGPA on January 1, 1985. 15 U.S.C. § 3331 .

Section 311 of the NGPA authorized the FERC to implement procedures that would facilitate the movement of gas between the intrastate and interstate markets without being subject to the requirements of Section 7 of the NGA. The FERC implemented procedures under Part 284 of its regulations to permit that type of transportation. This involved transportation by intrastate pipelines for interstate pipelines and LDC’s, and also by interstate pipelines on behalf of intrastate pipelines and LDC’s. (Williams 6386-6387, DX 1467).

Almost immediately thereafter, the FERC issued Order 60 under the NGA permitting interstate pipelines to perform the same type of service for one another that they could perform for intrastate pipelines. (Williams 6387, DX 1467).

Under Order 63 the FERC permitted Hin-shaw companies, i.e., primarily distribution companies that pick up gas and transport it within a state but don’t move it outside the state, to perform the same operations permitted intrastate pipelines. (Williams 6387, DX 1467).

Under the increased ceiling prices and monthly escalation mechanism in the NGPA, the producer price of natural gas rose steadily and gas supplies increased. However, because of a general decline in economic conditions, conservation efforts, and some limited amount of switching to alternative fuels, interstate gas industry sales to industrial consumers decreased.

As the country entered the 1980’s, a natural gas surplus developed, due to a combination of a shrinking market and the availability of new and increasing gas supplies. This surplus of gas led to the growth of a “spot market,” that is, lower priced gas available for purchase from natural gas producers by any willing buyer. The only rub was that the gas had to be moved from the well (producer) to the delivery point (purchaser), and the only way to move the gas was through the natural gas pipeline system.

In a sense, this litigation started with the passage of the NGPA.

B.

FERC Transportation Authorization

For many years pipelines such as Panhandle purchased natural gas and sold it to their LDC customers without those customers’ actively considering whether there was more than one product involved. In other words, the industry was regulated so strictly that there was no real opportunity for other alternatives, such as a transportation service only, to develop.

Departing from its historic policies, in 1975 the FPC responded to the gas shortage by establishing a general policy of permitting interstate pipelines with specific prior authorization to transport gas purchased directly from producers to industrial consumers in certain restricted circumstances. In 1979, the FERC expanded the direct purchase program to include essential agricultural users, use by schools and hospitals, and oil displacement use.

The FERC in 1982 instituted the Blanket Certificate Program. The blanket certificate program utilized Section 7(c) of the Natural Gas Act which provides that no natural gas company, or a company which will upon commencement of the relevant

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activities become a natural gas company, may commence any jurisdictional activities or construct any jurisdictional facilities without receiving a Section 7(c) certificate in advance. The FERC in its various blanket certificate programs designated categories of potential pipeline activities, including the transportation of natural gas, in which individualized FERC authorization would not be required so long as the pipeline first received a Blanket Certificate of Public Convenience and Necessity. The Certificate required such activity to be performed in compliance with conditions stated in the underlying regulations.

In 1983, responding this time to the deregulation of wellhead gas prices, a decline in demand for gas, and price competition from alternative fuels and resultant loss of industrial load, the FERC, through Orders No. 234-B and 319, authorized self-implementing transportation under a blanket certificate for any end-user, to become effective on or about August 1, 1983. The FERC acknowledged that this experimental program was undertaken in order to add “flexibility to the market and thereby partially mitigate market distortions that currently may exist or that may emerge in the near future.” 48 Fed.Reg. 34872 (Aug. 1, 1983). Transportation under Orders No. 234-B and 319 was voluntary. Under Order 234-B, “low priority” end-users, as defined by the FERC, could purchase gas from producers and arrange for transportation by pipelines. The transportation was self-implementing for the first 120 days. After 120 days, the transportation was conditioned on FERC authorization and was subject to a notice and protest procedure. Order 234-B, by its terms, was effective only through June 30, 1985.

Order 319 permitted “high priority” end-users, as defined in the Order, to purchase natural gas and arrange for transportation. It permitted purchase contracts of up to five years. Prior to Orders 234-B and 319, the FERC had approved the transportation of natural gas purchased by an end-user only on a case-by-case basis. This required obtaining a Section 7(c) Certificate.

On or about January 10, 1983, Panhandle was granted a blanket certificate of authority by the FERC pursuant to its Section 7(c) blanket certificate program. In August 1983, this blanket certificate automatically became usable under Orders No. 234-B and 319.

Order No. 234-B, as amended by Order No. 234-C, and the transportation-related portions of Order 319, as amended by Order No. 319-A, terminated on October 31, 1985 after the United States Court of Appeals for the District of Columbia in

Maryland People’s Counsel v. FERC,

761 F.2d 780 (D.C.Cir.1985)

(MPC II),

vacated the Orders. Thereafter, Order No. 436, established new regulatory requirements applicable to self-implementing transportation. (Stipulation ¶ 32).

On June 23,1987, in the case of

Associated Gas Distributors v. FERC,

824 F.2d 981 (D.C.Cir.1987)

(“AGD ”),

the court sent Order 436 back to FERC with directions to factor the take-or-pay problem into the equation of change in regulations and also to rectify some procedural problems regarding the contract demand reduction formula.

On August 7, 1987, the FERC, in response to

AGD,

promulgated Order 500 (Interim Rule and Statement of Policy, Docket No. RM 87-34-000). Order No. 500 essentially re-adopted the regulations originally contained in Order No. 436 but with modifications to address take-or-pay problems. Order 500 has now been remanded for further consideration by the FERC.

American Gas Association v. FERC,

888 F.2d 136 (D.C.Cir.1989).

C.

Events Leading Up To This Litigation

Much of the focus of this litigation is on the relationship which existed between Panhandle and the three LDC’s (CILCO, CIPS, and IP) which supplied natural gas to the relevant portions of the 37 county area of Illinois served exclusively by Panhandle. At the trial of this case, the major focus of evidence was on the conduct of Panhandle and CILCO. Most of the Memorandum will discuss that conduct as well.

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CILCO, IP, CIPS, and United Cities Gas Company are local distribution companies served by Panhandle. However, portions of the service areas of CILCO, IP, and CIPS are served by other pipelines, and Panhandle serves two portions of the Illinois portion of United Cities’ service area. (Stipulation ¶ 22).

CILCO has two service areas for gas distribution. One is a corridor connecting the Peoria area with the Springfield area representing 98% of CILCO’s sales; the second is around the town of Tuscola, representing 2% of CILCO’s sales. (Yergon 2837, 2344). CILCO bought gas entirely from Panhandle for the Peoria/Springfield service area and from Panhandle, TKL, Natural Gas Pipeline Company (“NGPL”) and Midwestern Gas Transmission Co. for the Tuscola area. (Vergon 2844). For the calendar years 1983, 1984, and 1985, 98% of CILCO’s total natural gas purchases were from Panhandle. (Stipulation H 23).

CIPS has three distinct service areas for gas distribution. The western division of the Northern Area encompasses the west-central portion of Illinois and is exclusively served by Panhandle. The eastern division of the Northern Area is located in the east central portion of Illinois. This division was served by TKL, NGPL, and Midwestern, with each pipeline exclusively serving a part of the division. The Southern Area encompasses an area of southern Illinois around Marion and Carbondale and is served by TKL, Texas Eastern, and NGPL with each pipeline exclusively serving a distinct area. Approximately 54% of CIPS service area, by volume, was exclusively served by Panhandle. (Houvenagle dep. 13-18).

IP has numerous service areas throughout Illinois, which were served by five interstate pipelines: NGPL, ANR Pipeline Company (“ANR”), MRT, TKL, and Panhandle. Two of the service areas were served exclusively by Panhandle, that being the areas around the towns of Jacksonville and Danville. These areas represent less than 10% of IP’s total service area, by volume. (Brodsky dep. 15, 19-20, 22, 24-25, 36-40, 44-45; DX 1246).

Panhandle sells gas to numerous municipal LDC’s throughout Illinois. These LDC’s typically only serve one town or city and purchase much smaller volumes of gas than the larger LDC’s. These LDC’s purchase gas under Panhandle’s SG tariff which is available to purchasers who purchase less than 10,000 Mcf per month and purchase gas exclusively from Panhandle. (PX 1006, Sixth Revised Sheet No. 33 and Twenty-Sixth Revised Sheet No. 47-A).

A tariff generally consists of a number of different parts. First, there are rate schedules which spell out the different authorized services that the pipeline provides. Second, the tariff contains terms of service which have general applicability. Third, there are forms of service agreements that apply to each rate schedule. Finally, there is generally a tariff sheet that summarizes all of the rates applicable to the separate services. A customer which wants to contract for service under a rate schedule would contract in accordance with that form of service agreement. Thus, the tariff spells out the services that are provided, the general terms and conditions applicable to those services, the persons eligible to contract for the services, and a summary of all of the rates charged under the separate rate schedules for the different services. (Williams 6363-6364).

Panhandle sells natural gas to its LDC’s, such as CILCO, under various FERC approved rate schedules. The general service, or “G,” tariff rate schedule was for those LDC’s which generally purchased their full requirements of natural gas from Panhandle. Under this rate schedule, Panhandle was to be the sole supplier of the LDC’s gas, except in circumstances where the LDC requested an increase in contract demand (gas supply) that Panhandle was unable to provide. Generally, Panhandle’s obligation was limited to “its best effort.”

Further consistent with the “best efforts” nature of Panhandle’s relationship with its LDC customers, was Section 6.2 of its G tariff:

If during one or more days in the billing month Seller is unable to deliver to Buyer, for any cause whatsoever, natural

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gas up to the Billing Demand established for the month, then the total Demand Charge shall be reduced by an amount computed as follows: Determine for each such day the number of Mcf which the Seller was unable to deliver as above stated and multiply the sum of all such days' deficiencies by the currently effective charge.

In other words, if Panhandle failed to deliver “for any cause whatsoever” its customer was entitled only to a credit against the Demand Charge (or reservation fee) for the gas not delivered. (PX 1006).

Panhandle’s G and SG customers (including those located within the Central Illinois Market) purchased their gas from Panhandle under tariffs that on their face prohibit gas purchases from any “natural gas company” other than Panhandle. Panhandle and CILCO have had a business relationship for many years. Since 1951, Panhandle has sold gas to CILCO under the G tariff.

The G and SG tariffs do not specify the prices to be paid by the LDC’s for their gas purchases from Panhandle. (PX 168; PX 169). Rather, the actual gas prices are determined through a special billing procedure whereby the cost of gas to Panhandle simply flows through to the LDC customer as a separate billing charge as the gas is actually purchased.

Actual purchase quantities are likewise not spelled out in the G or SG tariffs; rather, they are determined as the LDC makes purchases. (Vergon 3120; PX 168; PX 169). The maximum quantity, or contract demand level, that a customer can purchase is set out in the service agreement. When the purchases exceed 90% of the CD, the demand charge is based on the actual amount of gas taken. (DX 73).

The separate contract or “Service Agreement” entered into between Panhandle and each LDC does contain a contract demand or “CD” level. (PX 169). The CD levels do not necessarily reflect actual expected purchase levels; they are instead used to calculate a “reservation” or “demand” charge for pipeline capacity payable regardless of how much gas is actually taken. (Vergon 3169, 4411-4412, 4464, 4474-4475).

Panhandle’s tariff obligation with respect to the demand charge was to make that amount of pipeline capacity available if requested by CILCO; Panhandle’s supply obligation with respect to the gas was itself a “best efforts” obligation, with the tariff containing explicit language excusing failure to deliver for any reasonable cause. (Vergon 4464-4465; PX 1006).

The CD levels contained in Panhandle’s service agreements with its G and SG customers were for the most part negotiated between Panhandle and the customers in about 1970, under long-term (twenty year) contracts, with a 10% reduction occurring in 1984 as a result of settlement of a rate dispute between Panhandle and its customers. (Vergon 3022-3024, 4401).

As of 1970, when the CD levels were set, gas prices were still regulated at the wellhead by the FPC. (Tussing 4222-4223; Vergon 3029).

The advantage of the G rate to the LDC was that it provided for a variable monthly demand level, no minimum commodity bill, and a 90% ratchet on demand charges. Much less natural gas is consumed in the summer than in cooler seasons, since air conditioning is normally powered by electricity. Therefore, it was very much in the LDC’s interest to have a variable monthly demand level. The disadvantage to the LDC of the G rate was that, unless the LDC made a demand for more natural gas than Panhandle could expect to provide, the LDC would be required to purchase all of its natural gas from Panhandle.

In the late 1960’s and 1970’s, with a shortage of available natural gas available to consumers, LDC’s such as CILCO normally had no substantial interest in avoiding the sole provider provision of the G tariff. CILCO knew that Panhandle, in reliance on their long term contract and the G tariff, would make its “best efforts” to supply whatever amount of natural gas CILCO needed for its customers. CILCO had anticipated some growth in sales at the time it entered into the October 1970 sales

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agreement with Panhandle. (Vergon Trial Tr. 4403).

In the market of the 1960’s and 1970’s, the only advantage of having access to another pipeline (transportation service alone did not exist at that time except for unusual circumstances requiring specific prior FERC approval) was that, if the gas shortage were to become so acute that a curtailment of natural gas from Panhandle to CILCO occurred, the possibility existed that the other pipeline might be able to make up the difference.

All things considered, at the end of the 1970’s, CILCO had no substantial incentive to attempt to deal with anyone other than Panhandle. This was especially true for two other reasons:

1. CILCO’s only alternative to the G tariff was the “limited service” (“LS”) schedule. The LS tariff was a partial requirements rate schedule for the LDC’s which obtained a portion of their natural gas from natural gas companies other than Panhandle. The advantage of the LS tariff to the LDC was that it allowed the LDC to obtain natural gas from any other source. The disadvantage of the LS tariff to the LDC was that it provided for a level (year round) demand level, a minimum commodity bill, and no ratchet on demand charges. Again, because the contract demand was used as the basis for determining the minimum payment under the contract, an LDC such as CILCO (being situated in an area of the country with traditionally harsh winters) would have to have the contract demand set at such a high level to meet winter demands that the much lower summer consumption rate would cost CILCO millions of dollars for gas not purchased by customers in the summer.

So long as the natural gas market did not include as a component a spot market offering natural gas at a price substantially below the regular market price, there was no financial incentive to an LDC such as CILCO to consider switching to the LS rate. Also, because of the substantial payout resulting from the single (year round) contract demand charge, even if much cheaper natural gas were available from another company, the cost of paying the demand charge component would have outweighed (at least in 1982-1984) any savings resulting from the purchase of cheaper gas from someone other than Panhandle.

2. Because of the degree of regulation of. the natural gas industry by statute and regulatory agency, an LDC such as CILCO, which did not have immediate physical access to the gas pipeline of another natural gas company, could not simply agree with another company to have it build a pipeline to CILCO’s service area and start pumping natural gas to CILCO for its system supply. Rather, such interconnects could only occur with the approval of the FERC, and then only after extended proceedings during which everyone, including Aunt Mary, could object to the new interconnect and supply.

This regulatory review of such requests was not intended by FERC to be obstructionist. Rather, it existed to serve the public interest. The delivery of natural gas to the local communities of this country was considered by Congress and FERC too sensitive a matter to be left solely to the good intentions of a profit-motivated industry.

A G tariff was much to Panhandle’s liking, for obvious reasons. Because of the combination of the G tariff and long-term service contracts, Panhandle, in dealing with a G customer, did not have to worry about significant competition in making its business decisions. As long as the world stayed right side up, LDC’s such as CILCO would be satisfied with the long term commitment of Panhandle to provide the natural gas needs of CILCO’s customers. Under the NGA, as of 1978, the price of gas was strictly controlled, and a lower priced spot market supply did not exist.

In reliance on the assured business of the G tariff LDC, Panhandle could and did enter into many long term contracts with producers. Most of those contracts contained take-or-pay provisions. In addition, because of the shortages and curtailments of the 1970’s, Panhandle, with the support of its LDC’s and the Illinois Commerce Commission, entered into two long term projects (the Algerian liquid natural gas

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project and the Canadian gas project) which would ensure a greater supply of gas to meet customer needs, but also would involve more expensive gas than what was currently being contracted for in the United States.

Panhandle did not like the LS tariff. It did allow Panhandle to get “half a loaf” from LDC’s in markets where an LDC had access to more than one pipeline, but, according to the terms of the LS tariff, the customer could decide not to purchase any natural gas from Panhandle. In such event, the only payment that Panhandle would receive from the LDC would be the “minimum bill,” as determined from the flat contract demand. If the contract demand level was set relatively low, then such a customer could easily switch to another supplier which offered gas at a lower price.

In addition to the rigors of competition, Panhandle disliked the LS tariff for another reason: The LS tariff made it much more difficult to know how much natural gas needed to be secured for the future by long term contracts with producers. From Panhandle’s point of view, it was like a chef going to the market to buy groceries for a dinner party when the chef really did not know how many people were going to show up. Certainly, the chef would much prefer to plan the dinner party armed with guaranteed reservations, so that the chef would be stuck with neither a needlessly big food bill nor leftovers. Similarly, it was important for Panhandle to know in advance the amount of natural gas that would be needed to satisfy its customers’ demands.

D.

Panhandle’s Gas Purchase Strategy

Until 1977, the FPC, the predecessor agency of the FERC, set the price of gas at the wellhead, and every producer sale to interstate pipelines was subject to regulatory review. Spurred by dwindling supplies caused by artificially depressed gas prices, Congress, by means of the NGPA, enacted phased deregulation of the price of gas, and removed from the regulators the authority to review the prices passed through to customers. This legislation had the desired effect of spurring new exploration for and production of gas, both by major and independent producers.

During the 1970’s, there was intense competition among pipelines for new gas reserves because it was a period of gas shortage. The competition continued until about the early 1980’s when the market changed to a buyer’s market. (Dixon 5829). The shortage of gas during the 1970’s caused pipelines to compete for gas reserves on non-price terms, such as take- or-pay provisions and fixed volume clauses, for new supplies. (Carpenter 1636-37). Price differentials between the system supply cost of pipeline gas and spot market gas emerged due to the NGPA’s decontrol of wellhead prices. (Carpenter 1638).

In 1979, Panhandle entered into an aggressive gas purchase program in which it contracted for vast quantities of supplies at the NGPA ceiling, or the maximum allowable price. Initially, the program was a reaction to the curtailments of the mid-1970’s and was bolstered by internal company projections of high future sales. The purchasing program also reflected the projections of those LDC customers’ needs. A Planning Group (comprised of 10 LDC’s, six of whom were LS customers) at first projected huge future demand.

CILCO was a member of Panhandle’s Planning Group and submitted information to Panhandle as to CILCO’s projected gas sales. In May 1981, CILCO submitted to Panhandle its projections on future gas requirements in the period 1981 to 1990. (DX 158; Vergon 4404-4407). CILCO projected that its annual gas requirements would be 50.4 billion cubic feet (“Bcf”) in 1981 and increase to 53.1 Bcf in 1990, with a peak of 54 Bcf in 1982.

(Id.)

CILCO also projected an increase in residential and commercial customers at the rate of 1.5% annually from 1981 to 1985 and 1% annually from 1986 to 1990, and an annual population increase at a rate of 0.8%.

(Id.)

CILCO expected Panhandle to contract for gas supplies to meet CILCO’s projected sales requirements or actual usage. (Ver-gon 4411; 4417; 4445-4446). During the

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five years preceding the trial, CILCO purchased 100% of contract demand on certain peak winter days. (Vergon 4417).

But, as the 1980’s progressed, some LDC’s, including CILCO, began to warn the Planning Group that they would have to scale back their projections. The warnings did not deter Panhandle’s Gas Supply Committee, however. Through 1982, Panhandle continued to buy quantities pegged to the company’s and its customers’ (including the LS customers) most optimistic projections. With apparent disregard for what was happening in the marketplace, Panhandle agreed to significant take-or-pay provisions in virtually all of its purchase contracts, and demanded market-out clauses in virtually none of them. During the same time period, Panhandle committed itself to participation in a partnership that was constructing a pipeline that would deliver costly Canadian gas into its system, and Panhandle’s subsidiary and main supplier, TKL undertook the hugely expensive Algerian LNG project.

TKL is the principal subsidiary of Panhandle and owns and operates an interstate natural gas transmission system. TKL purchased gas from extensive acreage located in, and offshore of, the states of Texas and Louisiana. TKL’s pipeline generally runs from the Gulf Coast northward to Jackson, Michigan. It interconnects with Panhandle’s pipeline at Tuscola, Illinois. TKL is a “Natural Gas Company” under § 2 of the NGA.

The LNG project of TKL was certificated in 1977 after lengthy regulatory hearings. Panhandle’s Canadian gas purchases through Northern Border Pipe Line were approved in 1978. Both projects were initiated and approved during a period of intense curtailments. (Langenkamp 1511). Deliveries under these contracts did not commence until the Fall of 1982 due to the time necessary to construct transmission and other facilities. Other pipelines entered into similar long term gas supply contracts for Canadian gas and LNG. For example, NGPL vigorously pursued an LNG project but was unsuccessful in consummating the project. (Langenkamp 1512-1513).

The FERC approved the purchase of liquefied natural gas from Algeria by Panhandle. The ICC supported this purchase. (Tussing 830). When the LNG project was approved by the FERC in the mid-1970’s, a period of curtailment, CILCO was neutral on the issue. (Vergon 3176-3177).

In September of 1982 Panhandle was notified that Algerian LNG and Canadian gas would begin to flow. Panhandle had contracted for this gas during the 1970’s when the entire nation was experiencing a shortage of natural gas. The effect of these deliveries of new, high-priced gas was to change Panhandle’s gas supply from one of the cheapest in the Midwest to one of the most expensive.

This caused many of Panhandle’s customers, as well as state commissions like the ICC, which had supported the LNG and Canadian gas projects when Panhandle contracted for them, to petition for immediate cancellation of the projects. This resulted in lengthy hearings before the FERC and the U.S. Economic Regulatory Agency (“ERA”) in the Fall and Winter of 1982. TKL was contractually obligated to receive LNG, and it began to do so in the Fall of 1982 while these hearings were taking place. TKL and Panhandle sought recovery of these gas costs immediately, but approval was denied pending the outcome of the hearings. The FERC and the ERA upheld the LNG certificate and permitted the gas to continue to be accepted. The cost of this gas was first reflected in rates in March 1983 due to the delay caused by the hearings, and by that time a substantial deferred gas cost balance had accumulated, which created a significant financial burden for Panhandle and TKL. (Langenkamp 1409-1415).

On February 3, 1983, Phillip O’Connor, Chairman of the ICC, authored a letter to Congressman Edward R. Madigan regarding Algerian LNG. O’Connor was concerned with the ALJ’s decision of January 28, 1983 that there was no authority to revoke TKL’s importation certificate. He urged Congressman Madigan to have Con

*844

gress act to stop the importation of LNG. O’Connor noted that the ICC supported the LNG program in the 1970’s but stated:

It is evident to the Illinois Commerce Commission that the public interest in the LNG project has changed dramatically since the early 1970’s, and

Algerian LNG is no longer needed.

(DX 1098, emphasis in original).

TKL’s contract for Algerian LNG was made with Sonatrach in the mid-1970’s. Deliveries finally commenced in September of 1982. The contract provided for full deliveries of about 450 Mcf a day, but at first the deliveries were reduced. There was a gradual increase until early 1983, at which time the Algerians were at their full contract volume. In the spring of 1983, TKL notified Sonatrach that it was unable to purchase the full contract quantities and that it wanted to renegotiate the contract quantity. As a consequence, a 40% decrease in the contract volume was agreed upon, effective approximately April 1983.

TKL continued to purchase LNG at that reduced level until December 1983, at which time it suspended accepting deliveries of gas from Algeria. Sonatrach objected to the suspension and initiated arbitration proceedings for breach of contract. Those proceedings continued slowly until the middle of 1986, when the parties reached a settlement. As a result, TKL had no further obligation to buy Algerian LNG. (Dixon 5880-5881).

Over the last few years, Panhandle renegotiated the Canadian gas supply contract two or three times to reduce the price and volume obligations. (Dixon 5835-5836).

In all of these undertakings Panhandle was banking on its forecasts that the price of fuel oil would remain higher than the price of natural gas. However, to the extent that the purchase contracts and projects posed risks of unmarketability, Panhandle felt somewhat confident that its shareholders would not bear the financial consequences because, under the NGPA, all gas costs were passed through to the consumers, absent “fraud or abuse,” a never-applied standard.

By 1982, the price of fuel oil had unexpectedly plummeted, and although lower-priced gas was available from newly developed independent supplies, Panhandle was selling gas for which it — or its affiliate TKL — had contracted at NGPA ceiling prices, which far exceeded the price of both independent supplies and fuel oil. Thus, in the fourth quarter of 1982 Panhandle's commodity rate suddenly jumped from $2.68 per million cubic feet (“Mcf”) to $3.83/Mcf in October 1982, and eventually to $4.64/Mcf.

This increase was not unavoidable. Panhandle had inexpensive price-controlled gas under contract, but instead of purchasing it, Panhandle elected to purchase more costly gas. In addition, toward the end of 1982 Panhandle made the corporate decision, approved by its board of directors, to increase its purchases from TKL. TKL gas was even more expensive than that which Panhandle was purchasing from its producer suppliers, but TKL was facing serious take-or-pay problems. At about the same time the expensive Canadian gas came on line, and Panhandle chose to include this gas in its Purchase Gas Adjustments (“PGA’s”). The effects of all of these decisions combined to make Panhandle’s commodity rate very high.

As a result, Panhandle’s prices during the time in question were above the market clearing level. (Carpenter 7138-7140; Still-man 3973; Tussing 3587, 3618, 3632). As of the time of trial, although Panhandle essentially sold gas only to its G and SG customers, Panhandle possessed the highest rate of return of all pipelines featured in a study of major pipeline companies. (Carpenter 6783-6785).

A Panhandle memorandum dated February 10, 1984, described Panhandle gas as the 14th most expensive out of 15 major interstate pipelines that Panhandle analyzed. (PX 647). Panhandle’s prices were $1.00 or more per million cubic feet (“Mcf”) higher than NGPL’s prices on a comparable delivered basis to CILCO. (Vergon 2858-2859).

The service agreement between CILCO and Panhandle in effect at the time of trial

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was entered on December 31, 1970, with an expiration date of October 31, 1988. CILCO, anticipating growth in sales, increased the contract demand at the time it entered into the service agreement with Panhandle in 1970. The agreement was amended on May 14, 1984 to reduce the contract demand by 10% and to extend the agreement to December 31, 1989.

As of early 1981, CILCO was becoming disenchanted with Panhandle as its sole supplier. Likewise, CILCO’s industrial end-users, such as Keystone Steel & Wire Company and major hospitals in the Peoria area, were restless. The natural gas used to fuel their businesses was costing more and more. Industrial end-users were starting to consider the use of alternative fuels (such as coal and fuel oil) which, in the past, had been more expensive than natural gas. Energy conservation was also becoming a serious component of every company’s cost saving strategy.

For years, under the NGA, the cost of natural gas had been a fairly predictable component of the cost of doing business. In the 1980’s, the ever-escalating cost of energy for many businesses meant the difference between surviving or not surviving. The cost of energy also became a very important factor, along with the cost of labor, in the struggle to compete with foreign companies.

Neither CILCO nor Panhandle wanted any of its industrial customers to switch to an alternate fuel, because that would mean the loss of that customer for at least as long as the cost of the alternate fuel was less than the cost of purchasing natural gas from Panhandle through CILCO. In some cases, the loss might be permanent.

The commercial/residential consumer, on the other hand, was typically a captive customer. As the cost of energy increased, the small business owner or residential customer could realize some savings by cutting back on the consumption of natural gas, but that was a limited alternative. The same customer could switch to electric heat or fuel oil, but usually, except in the case of new construction, the capital outlay was too great to be realistic or cost effective. The customer could also substitute for some natural gas by using a wood-burning stove and/or space heaters, but any resulting savings was limited. The cost of purchasing those items was prohibitive for some customers, and the perceived danger to health and safety from use of wood-burning stoves and space heaters detracted from their usefulness on a community wide basis.

By November 1981, CILCO had determined to seek to interconnect with the next nearest interstate pipeline, NGPL. Under the terms of CILCO’s tariff, if CILCO requested an increase in contract demand which Panhandle declined to meet, CILCO would then be free to purchase an amount of gas up to the requested demand increase from the second pipeline.

On November 10, 1981, CILCO personnel met with Panhandle personnel. At that meeting, CILCO made an informal request for an increase in contract demand. According to CILCO officer Donald Samburg, CILCO did not need the increase in contract demand, nor did it anticipate using it. In other words, CILCO made a demand for an increase in gas which it knew was a sham. It did so in an attempt to trigger the sole supplier exception, be in a position to purchase a substantial amount of gas from NGPL, and still retain its G tariff status with Panhandle.

Initially, Panhandle informally indicated that it would decline to meet the requested increase, but then Panhandle, to CILCO’s surprise, reversed itself and agreed to provide the demand increase. Ironically, Panhandle’s response was also a sham, since it was not capable of delivering the entire amount of gas requested by CILCO.

So, in sum, the demand for increased gas supply by CILCO was phony, and the response of Panhandle was phony. Two corporations were playing out a bluff in a high stakes poker game.

In April of 1982, Panhandle informed CILCO that it might be necessary to curtail deliveries to CILCO during the 1982-1983 winter. CILCO responded by again advising Panhandle of its desire to obtain gas

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from NGPL. Panhandle declined to respond.

In spite of Panhandle’s failure to respond to CILCO’s request for increases of gas, CILCO and NGPL proceeded with plans for the interconnection.

As early as the fall of 1981, at the same time that CILCO first approached Panhandle about the proposed interconnect with NGPL, CILCO also requested that Panhandle negotiate a new tariff or service contract with it. At that time CILCO was seeking flexibility to purchase from another interstate pipeline, which is prohibited under the terms of the G tariff. In December 1981, CILCO formally requested that Panhandle enter such negotiations, but Panhandle ignored CILCO’s request. CILCO responded by filing a complaint with the FERC in June 1982, requesting that the G tariff be stricken as anticompeti-tive. Panhandle elected to follow the advice of Truett Kennedy (a Vice President of Panhandle at the time), who suggested that Panhandle could “tough it out.”

CILCO’s FERC complaint against Panhandle (Docket No. RP 82-105-000) stated that CILCO was seeking to purchase a portion of its supply of natural gas from NGPL; that if it did so it could not remain on the G rate schedule but would have to switch to the LS rate schedule; and that this would result in a dramatic rate increase for CILCO. CILCO further alleged that Panhandle’s tariff was unduly discriminatory, anticompetitive, and inconsistent with the NGPA’s purpose of furthering a competitive wellhead market for natural gas. CILCO requested the FERC to order amendments to the definition of “General Service Buyer” which would allow CILCO to remain on the G tariff while purchasing gas from a second interstate pipeline supplier.

From Panhandle’s point of view, what CILCO wanted would spell disaster, since it would free CILCO of its obligation to purchase all of its gas needs from Panhandle. Not only would the sales volume be lost, but the reduced purchases by CILCO for its system supply would expose Panhandle to an avalanche of take-or-pay liability because of a resultant drastically reduced take from Panhandle’s producers. If that happened, the interests of Panhandle’s shareholders would be endangered.

In the fall of 1982, NGPL filed a certificate of application with the FERC for approval of the interconnect. Panhandle intervened and opposed the certificate. In meetings related to that proceeding, Panhandle indicated that it would withdraw its opposition if CILCO would give Panhandle a right of first refusal on the sale of any gas transported to CILCO or CILCO’s customers through the interconnect. When CILCO declined to accede to the demand, Panhandle threatened to fight CILCO “to the death” over the issue.

In reaction to Panhandle’s price increases, the LDC’s on the Panhandle system reacted in a variety of ways. Those who had more than one supplier began to increase their takes from their other suppliers. Those who had only Panhandle as a supplier began to locate available independent supplies and request that Panhandle transport those supplies under Section 311 of the NGPA. (One of the primary purposes of Section 311 was to facilitate the transportation of natural gas by interstate pipelines to end-users).

At the same time, the more aggressive of the industrial customers, not content with the efforts of their LDC’s to obtain cheaper supply (and sometimes in economic desperation), began bombarding Panhandle with demands that it transport independent gas directly to them. In 1983, CILCO expressed concern to Panhandle about losing its industrial customers to alternate fuels due to increasing natural gas prices. CILCO estimated that this loss might approximate 20% of its annual sales.

Based on discussions with Panhandle that went back into the fall of 1981, CILCO believed in March 1983 that Panhandle’s interpretation of the G tariff was that, if CILCO bought gas from someone other than Panhandle, such purchase would constitute a violation of the G tariff. CILCO’s internal documents indicated that it wanted Panhandle to work toward a temporary waiver of the G tariff in March 1983, sub

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ject to FERC approval, so that CILCO could purchase NGPA categories 102 and 103 gas. CILCO believed that such a result would be preferable to forcing the FERC to interpret the definition of “natural gas company” in CILCO’s pending FERC complaint case.

On March 17, 1983, CILCO formally requested that Panhandle transport 102 and 103 gas, to be purchased from an independent producer, for its system supply under the authority of Section 311. Panhandle refused, because its top corporate officers had by then decided to refuse to transport independent gas for the system supply of LDC’s. Panhandle’s President, Richard O’Shields, and its Chief Executive Officer, Kenneth Kalen, acknowledged this policy, and Kalen justified it on this ground: “We have the commitment to supply these local distribution companies, we have an obligation to have long-term supply contract, and we need to be relieved from both of these obligations_” (Kalen dep. 34.)

On March 22, 1983, Truett Kennedy informed Kalen that Kennedy had tentatively resolved to deny CILCO’s request because the transport would “displace volumes from Panhandle.” (PX 29) Kalen, noting to other corporate officers that “Truett has already declined the request,” responded, “We are most anxious to hold off this type of request in favor of providing our customers an opportunity to purchase necessary volumes from our suppliers.” (PX 31)

Kennedy met with CILCO on April 11, 1983 and advised CILCO that Panhandle was not going to transport the requested volumes. CILCO asked that Kennedy put Panhandle’s position in writing. Informally, on April 12, Kennedy advised CILCO that Panhandle was “not going to transport volumes for customers since it was being swamped with such requests and it would make their own efforts meaningless.” (PX 35) On the same day Kennedy prepared a formal response. In a cover memo transmitting his draft to Panhandle’s in-house counsel, Kennedy stated that he “did not respond directly to their transportation request.” (PX 1012) Indeed, the letter sent to CILCO, dated April 15, 1983, avoided discussion of CILCO’s request.

On April 15, 1983, internal memoranda reported that the Panhandle’s “transportation strategy” was then “not [to] transport gas purchased from other than Panhandle’s eligible producers for customers of Panhandle.” (PX 72) This policy was again reflected in a document Panhandle filed with the FERC in April of 1983. Responding to a CILCO data request, Panhandle stated, “Under current transportation policy Panhandle and Trunkline would not be willing to transport gas purchased from third parties for CILCO’s overall system requirements.” (PX 36)

On April 29, Wayne Slone of CILCO wrote to Kennedy and again requested that Panhandle transport Section 102 and 103 gas. Panhandle did not respond.

During a July 1983 customers meeting in Springfield, Langenkamp told representatives of CILCO, CIPS, and IP that Panhandle would not transport gas from independent producers. A contemporaneous memo memorialized Panhandle’s decision to deny LDC and end-user requests for transportation of “non-Panhandle released gas.” (PX 217)

In August 1983, Citizens Gas, a G customer of Panhandle, requested that Panhandle transport to it for its system supply 102 and 103 gas that Citizens would purchase from independent producers. Kennedy met with in-house counsel, Michael Kelley, on August 30 to discuss this request. Kelley informed Kennedy that this transaction was permissible under the G tariff. Nevertheless, a few days later, Kennedy and Kelley met with Citizens’ general counsel and informed him that the transaction was

not

permissible under the G tariff.

In early 1983, both CIPS and IP made inquiries to Panhandle about Panhandle’s willingness to transport independent gas for their system supplies. With slight variations, Panhandle responded as it had responded to Citizens. Langenkamp wrote Illinois Power, “We are unable to provide a meaningful response.” He concluded with this statement:

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Certainly, interstate pipelines, most gas producers, and a number of local distribution companies are “natural-gas companies” as defined by Section 2(6) of the Natural Gas Act; and therefore, purchases from such natural-gas companies would be inconsistent with the longstanding terms of the G-2 Rate Schedule governing most of your purchases from Panhandle.

(PX 581). He wrote CIPS that “any sale of gas would be in violation of our [G] tariff.” (PX 579)

The facts dealing with CILCO’s March 17, 1983 request to transport gas and Panhandle’s response were presented to the FERC by CILCO during the proceedings on its complaint. CILCO thought it was in a “no-lose” situation in making its request on March 17, 1983 — it would either get the gas or use the refusal to help its FERC case.

In 1983, FERC enacted Special Marketing Programs (“SMP’s”) in order to give selective price cuts to the customers with the most sensitive demand. In the latter part of 1982, the average cost of gas to many pipelines was approaching, and in some instances exceeding, the price of No. 6 fuel oil. As a result, pipelines and their customers were experiencing a reduced demand for gas, which was exacerbating the take-or-pay problem of some pipelines, including Panhandle. In a Transcontinental Gas Pipe Line rate case, it was proposed that the pipeline release higher priced gas to producers who were willing to sell their gas at market clearing prices and that the pipeline would transport the gas into its market areas to retain fuel switchable loads or acquire new loads.

The FERC adopted the proposal and indicated that this appeared to be a reasonable approach to addressing both the rising cost of purchased gas and the take-or-pay problem faced by many pipelines. Thereafter, certain pipelines — including Panhandle and TKL through PanMark — adopted a similar arrangement. The FERC, in what where called “basket orders,” adopted the specific programs of certain pipelines and procedures but applied generic conditions to them. (Williams 6407-6408).

Approximately 35 producers and marketers had SMP’s. Only five pipelines had SMP programs, and only three actually operated their programs.

Panhandle’s reaction to these regulatory initiatives was mixed. It delayed making any decision about participating in the blanket certificate program for several months. By contrast, it eagerly embraced the SMP program, creating PanMark, which partially pacified certain of the industrial customers, while enabling Panhandle to obtain take-or-pay credit for each million cubic feet (“Mcf”) of gas it sold. Only “released gas” (or gas already under contract to Panhandle) was eligible for sale through SMP’s. Authorization for all SMP’s, including PanMark, was to expire on October 31, 1984.

On September 26, 1984, the FERC extended SMP’s for another year and allowed LDC’s to participate in SMP’s for up to 10% of their contract demand for system supply gas. The FERC order specifically provided for a temporary limited waiver of the terms and conditions of the G tariff to allow purchases for system supply by a G customer such as CILCO. Interstate pipelines, such as Panhandle, were given 30 days in which to decide whether to accept or reject the FERC’s order. Panhandle filed comments with the FERC in which Panhandle argued that the 10% rule had been adopted by the Commission without sufficient research or basis and would increase the unit cost of gas and result in a build up of the deferred account. Nevertheless, Panhandle participated under the 10% rule because it wanted to continue its PanMark program.

With the limited waiver of the G tariff, Panhandle transported gas for LDC’s system supply under the 10% feature. In 1984 and 1985, PanMark sold and Panhandle transported 31.9 billion cubic feet (“Bcf”) of natural gas to its LDC customers for system supply. This figure included 2.8 Bcf for CILCO, 1.2 Bcf for CIPS, and 3.9 Bcf for IP. In 1985, approximately 86% of the total volumes transported under Pan-Mark went to LDC customers. In addition, Panhandle transported 6.5 Bcf of gas from

*849

SMP’s other than PanMark to its LDC customers for system supply under the 10% rule. CILCO received 1.5 Bcf from the SMP’s of Yankee Resources (Yankee Resources’ SMP was called “YES”), City Service Oil and Gas Co. (“COGS”) and Entrade Corp. (“Enspeed”) during the period from July through October 1985. System supply gas purchased from SMP’s other than Pan-Mark by Panhandle’s LDC customers under the 10% rule was Panhandle-released gas for which Panhandle received take-or-pay relief.

Ten percent of contract demand exceeded 10% of actual purchases by an LDC. In fact, in some months, 10% of contract demand turned out to be in excess of 100% of some of the LDC’s actual requirements. CILCO’s purchases from SMP’s represented from 14.7% to 59% of its actual monthly purchases.

PanMark did not, however, provide a total solution. Industrial and other large consumers ineligible for PanMark continued to press for access to direct sale independent gas through the blanket certificate program. Thus, the stage had been set for crucial corporate decisions about whether to transport independent gas under the blanket certificate program (Market Area Program) (“MAT”), and if so, for which customers. Panhandle also had to decide how to fashion a transportation program that would enable Panhandle to avoid to the maximum extent possible the influx of independent gas into its markets.

Even as Panhandle created the MAT Program and commenced transporting to some end-users, the Company did not change its decision to deny transportation to LDC’s. In October 1983, while Panhandle was still formulating the parameters of the MAT Program, R.C. Dixon, Vice President of Gas Supply, instructed Robert Reed, who was in charge of coordinating the transportation program, “Don’t let LDC buy cheap gas for system supply to offset our sales. Must be for system supply going to specific end-user.” (PX 92). In Panhandle’s November 1983 internal draft on its transportation program, Panhandle specifically states that the program was “not intended for general system supply.” (PX 102)

The MAT plan Panhandle developed in 1983 contained certain significant features that have given rise to this lawsuit: Under the plan, Panhandle would not transport independent gas to its captive G LDC customers; Panhandle would limit the classes of consumers eligible to participate in transportation programs; and, as to these eligible consumers, Panhandle would insist that they submit to bid-out, or right of first refusal, as a prerequisite to receiving transportation service.

In November 1983, in order to pacify its fuel switchable customers, Panhandle formally adopted its Transportation Guidelines (“Guidelines”), pursuant to which it would transport off-system supplies to an end-user. To stem erosion of its take-or-pay position with its on-system suppliers and to discourage the flow of independent gas into its pipeline system, Panhandle insisted on a right of first refusal as a condition precedent to transporting independent non-Panhandle system gas. Contracts for transportation of off-system supplies were terminable every six months to allow rebidding by on-system Panhandle suppliers. Also, for the purpose of avoiding unreasonable administrative burdens, the minimum volume for which transportation would be provided was set at 100,000 Mcf/year.

Panhandle held meetings with its LDC customers in November of 1983 to explain the transportation policy and Guidelines. A shorthand version or summary of the Guidelines was prepared and distributed to the LDC customers, with the expectation that the LDC’s would inform their customers (i.e., end-users) about the Guidelines.

The mechanics of the first refusal process were to be accomplished through a bid-out and rebid system involving the following key features: (1) the program would be available to end-users (not LDC’s) using at least 100,000 Mcf of gas per year; (2) at 90 day intervals a qualified end-user could request a desired reduced price and Panhandle would make a single offer of the requested price to its on-system suppliers for possible matching; (3) qualified end-

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users could alternatively line up specific set deals with off-system producers for transportation by Panhandle, but only after the deals had first been “bid-out” to Panhandle on-system producers for possible matching; (4) if matching occurred, the end-user then had to purchase from the matching on-system Panhandle producer, after negotiating the specific terms of the purchase; (5) off-system deals that were not matched had to be “rebid” to Panhandle on-system producers every six months. (Kennedy 1146-1147; Reed 1286-1287, 1295-1296; PX 101; PX 102; PX 102). The rebid procedure was eliminated in January 1985. (DX 82).

From the beginning, Panhandle intended that the Guidelines would only apply to industrial end-users and not to G tariff LDC’s for system supply. (Kennedy 1137, 1146, 1207; Reed 4925-26, 5121-22; PX 92; PX 101; PX 102; PX 103; PX 268). The reason for this was obvious: If the Guidelines had been available to G LDC’s, then Panhandle would, in effect, have been cutting its own corporate throat. As long as the Guidelines served as an economic safety valve in the marketplace to keep the industrial end-users from moving away from natural gas, Panhandle was resigned to the use of the Guidelines; but if a G tariff LDC could use the Guidelines to purchase natural gas, then Panhandle would have lost a critical captive market.

It appears that Panhandle’s initial idea was not to transport gas for system supply of

any

LDC. However, as time passed, and as LDC’s continued to put pressure on Panhandle to grant them access to transportation services, Panhandle concluded that the proper response was to say that an LS tariff customer did have access to the Guidelines, but a G customer did not. This was justified on the basis that to have allowed a G customer to purchase gas from a non-Panhandle supplier and have it transported on Panhandle’s pipeline to the LDC for system supply would have violated the “sole supplier” provision of the G tariff and the sales contracts between Panhandle and the LDC.

As far as Panhandle was concerned, if CILCO, for example, had wanted to buy gas from someone other than Panhandle, it would have had to suffer all of the consequences of an involuntary shift from a G to an LS tariff. Of course, if that change in status had occurred in 1983 or 1984, the net economic consequences to CILCO would have been disastrous, no matter how low priced the gas that CILCO was able to buy on the spot market.

Panhandle required the end-user to submit the following information for the bid-out under the Guidelines: (a) a representation that the end-user had an agreement with a supplier; (b) information as to whether the supplies were off-system or on-system; (c) the supplier price; (d) the quantity of gas to be purchased; (e) the contract term, and (f) the Panhandle pipeline delivery points. Identity of the supplier or producer was not required. (Reed 4742-4743). Panhandle then submitted to its on-system producers under the bid-out: (a) the type of customer, i.e., indirect customer behind an LDC, but not the name of the customer; (b) the price; (c) the volume; and (d) the term. (Reed 4743; DX 298).

Panhandle did not require end-users seeking transport of on-system Panhandle released gas to go through the bid-out and rebid process under the Guidelines. (Reed 4764). End-users desiring transportation of off-system (non-Panhandle supplier) gas

were

required to go through the bid-out process. If they refused to comply, transportation was denied. (Reed 4920).

The information Panhandle required from the end-user as part of the bid-out process, such as price, volume, contract terms, and delivery points, was not information which could have been kept confidential by the end-user on a permanent basis. That information had to be filed in the public files of the FERC upon commencement of the transportation of the gas, but in the marketplace it was information that would not otherwise have been available to the competing on-system suppliers prior to the consummation of a binding agreement.

Because the bid-out and most other conditions of the Guidelines were so restrictive, some off-system producers simply re

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fused to consider submitting to the Guidelines. Several other end-users would have liked to have entered into contracts of one to two years in length, but, because of the six month rebid, could not guarantee a price for longer than six months.

Panhandle contends that it neither permitted nor prohibited negotiations by an end-user for a lower price from its off-system producer after an unsuccessful bid-out, but there is no indication in the record that Panhandle ever presented this possibility to the end-users. Also, while Panhandle neither permitted nor prohibited an end-user from conducting an “auction” between the matching on-system producer and the off-system producer for a lower price, there is no indication in the record that the “auction” possibility was ever announced by Panhandle to its industrial customers.

Since the Guidelines did not provide for an auction between an interested off-system producer and an interested on-system producer, end-users were basically left to purchasing gas at a price that might have been lower had the parties been free to “haggle” over price until the lowest price to the consumer was reached.

The first transportation under the Guidelines was provided for Quincy Soybean (an industrial end-user behind CIPS) starting in January 1984. The request had been submitted to Panhandle’s bid-out procedure at the beginning of December 1983 and had not been matched.

In 1984, Panhandle transported 16.8 Bcf of gas involving 52 transportation agreements. Approximately 15 Bcf, or approximately 90%, was off-system supply, that is, supply not matched by on-system producers in the bid-out procedure. Of the total, 9.3 Bcf, or 55%, were transported to end-users in Illinois under 29 transportation agreements. In 1985, Panhandle transported 103.6 Bcf of gas under the Guidelines. That amount involved 149 transportation agreements. Approximately 90 Bcf, or 87%, were from off-system supply and 22.3 Bcf were transported to end-users in Illinois involving 55 transportation agreements. Approximately 93% of the Illinois transports were off-system supply.

Thus, in 1984 and 1985, Panhandle transported approximately 120.4 Bcf under the Guidelines, of which 31.6 Bcf were to Illinois end-users (i.e., 10.3 Bcf involving 17 transportation agreements were transported to end-users served by CILCO; 2.5 Bcf involving 14 transportation agreements were transported to end-users served by CIPS; and 16.1 Bcf involving 16 transportation agreements were transported to end-users served by IP).

In late 1983 and 1984, Panhandle’s main desire was to ship on-system gas to all of its customers, but its secondary position was to ship

any

gas to industrial end-users. Initially, Panhandle’s hypertechnical construction of the Guidelines and the cumbersome details of the front end of the process, made for a frustrating, maddening, and time-consuming situation for any industrial end-user which utilized the Guidelines.

The time consumed by the bid-out process (i.e., the time from Panhandle’s receipt of the request for transportation to the giving of notice to the end-user of the outcome of the bid-out), took 43 days in the fourth quarter of 1983. By October of 1985 the time required to perform the bid-out had been reduced to two days. A number of factors — including action taken by Panhandle — contributed to the reduction of the bid-out time. First, the Guidelines went into effect during the winter heating season in December 1983, when on-system producers were not inclined to respond to bid-out requests since they were selling gas to Panhandle. During the spring and summer of 1984, as less gas was being purchased by Panhandle, producers became more responsive to the bid-out and more familiar with the Guidelines. Second, starting in September 1984, Panhandle stopped mailing bid-out letters to on-system producers. Having accumulated information on eligible and available on-system supplies from earlier bid-out requests, Panhandle was able to utilize the information for matching in-house. Finally, the MAT staff’s increased size and greater efficiency helped shorten the bid-out time.

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Despite the reduction in the bid-out time, transportation could still be delayed substantially for reasons beyond Panhandle’s control. For example, in one case the bid-out process took only two days, but, because the end-user’s LDC had not agreed to transport gas, over nine months elapsed before the end-user and the LDC reached agreement and Panhandle could start transporting the gas.

Even without the bid-out, transportation could not start the day after receipt of a request for a

new

transportation transaction (as opposed to amending an existing transaction). This was because the time necessary to begin transportation also depended upon the end-user’s completion of negotiations with the producer on the supply contract and with the LDC and Panhandle on the transportation agreement.

During 1984, 32 transactions went through the six-month rebid but only five were matched by on-system producers. In no case was there an interruption of transportation due to the rebid. In some cases, matching under the six-month rebid resulted in a lower price to the end-user, because the off-system producer lowered its price to the end-user after the match. (Reed 4776-4780; DX 1409). In other cases, the opposite was true. However, due to the administrative burden involved, Panhandle eliminated the six-month rebid feature from the Guidelines in January 1985. Panhandle notified the industry and end-users that this feature had been eliminated.

On March 6, 1984, after the filing of this suit, CILCO requested that Panhandle transport up to 15 MMcf/day of NGPA category 102 natural gas from a producer in Texas. This request by CILCO for transportation of natural gas was premised on CILCO’s retaining its status as a G customer. Langenkamp responded in a letter dated April 6, 1984, that he did not have sufficient facts to affirm or deny CILCO’s interpretation of the tariff but that he was willing to meet with CILCO to learn additional details.

At a meeting with CILCO on May 15, 1984, Langenkamp stated that Panhandle interpreted the G tariff to mean that, if CILCO were to buy natural gas which was sold and transported in interstate commerce from any other supplier, including NGPA categories 102 and 103 gas, those purchases would be purchases from a “natural gas company” and would disqualify CILCO as a G rate customer. Langen-kamp emphasized that Panhandle was willing to sell gas to CILCO under other existing rate schedules, including the LS schedule, or to negotiate some alternative rate schedule, either of which would allow CILCO to make purchases from alternate suppliers.

Meanwhile, CILCO enlarged the scope of relief it was seeking in its FERC complaint. By August 1984, CILCO was seeking an interpretation of the G tariff to permit it to purchase 100% of its supply in the form of “certificate deregulated” gas, i.e., Section 102, 103, and 107 gas, from the spot market. CILCO’s March 17, 1983 letter coupled its request for transportation with a request for confirmation that it would remain on the G tariff. Panhandle’s refusal to interpret the language of the G tariff to favor CILCO if Panhandle transported such gas, as requested in CILCO’s letter of March 1983, was raised in the FERC proceeding.

As stated earlier, the limited service or “LS” rate schedule had a level year-round monthly demand level, a minimum commodity bill for natural gas purchases, no ratchet on demand charges, and it permitted the buyer to purchase natural gas from sources other than Panhandle. This tariff would not have been as favorable to CILCO as the G tariff, and CILCO estimated in 1983 that it would have had to pay approximately $50 to $60 million per year more for its gas under the LS tariff than the G tariff.

In the summer of 1983, in an effort to settle the CILCO FERC case, Panhandle proposed a temporary waiver of the G tariff and certain rate terms as a means of permitting G customers to purchase gas from other sources for system supply. CILCO rejected this proposal because it wanted a permanent change in the G tariff. As part of Panhandle’s 1982 FERC rate

*853

case settlement, Panhandle in early 1984 agreed to remove the gas commodity charge from the minimum bill. With that cost removed from the minimum bill, CILCO would have had to pay approximately $5 million more per year under the LS tariff than under the G tariff. These were the minimum amounts, in each relevant time period, which CILCO would have had to offset with spot market savings before a switch to LS tariff would have been a reasonable economic decision. Transportation could also have driven up the cost of CILCO’s remaining purchases from Panhandle, and CILCO would also have had to offset these amounts. In hindsight, if CILCO had significantly increased spot market purchases, the $5 million increased cost might have been offset completely as spot market prices fell below $2.10 Mcf.

On March 22, 1984, executives of CILCO and Panhandle met in Peoria to discuss the new limited general service (“LGS”) tariff proposed by Panhandle which would allow CILCO to purchase gas from other suppliers. CILCO calculated that under this proposed tariff, it would incur an additional gas cost of $55 million (above the G tariff rate) prior to buying any gas from other source. That calculation was made with a minimum bill that included gas costs. At the time, Panhandle was still resisting the deletion of gas costs from the minimum bill. However, at the time it was known in the industry that the FERC was proposing to eliminate gas costs from all minimum bills.

In the summer of 1984, the FERC issued Order 380, which precluded pipelines from charging their customers for gas not taken through minimum bills. Panhandle’s LS customers, all of which had minimum bills, took advantage of this development by reducing their purchases from Panhandle even more dramatically and increasing takes from their alternative sources of supply. Thus, whereas in 1980 Panhandle’s sales to LS customers had comprised 43 percent of its total sales, by 1984 that percentage had dropped to 32.8 percent. Panhandle, experiencing the adverse effects of the lost revenue from its LS customers, had two alternatives: It could lower its commodity rate or it could open its transportation program to its LS customers in order to generate transportation revenues from them. Lowering its commodity rate was obviously unacceptable, because regulations prevented the company from lowering its rate to LS customers without also lowering rates to the captive G customers. This would have put Panhandle’s shareholders, instead of the captive customers, at risk for Panhandle’s oversupply of expensive gas.

As a result, Panhandle modified its policy of wholesale refusal to transport to LDC’s, replacing it with a policy under which transportation to LS, but not G, LDC’s would be permitted. In 1984, Panhandle did not transport gas for the system supply of any LDC pursuant to the Guidelines. In 1985, Panhandle transported gas for the system supply of two LS LDC’s: 40.4 Bcf were transported to Michigan Consolidated under two transportation agreements, and 3.6 Bcf were transported to East Ohio.

By 1986, Panhandle’s sales to LS LDC's had dropped to 4.6 percent of its total sales volumes, but its transportation volumes to these customers increased in corresponding amounts. In other words, Panhandle was able to generate transportation revenues to substitute for lost sales revenues from non-captive customers, revenues it had sacrificed when its commodity rate rose to and remained at a supracompetitive (substantially above the spot market) level. The loss of these LS LDC’s as sales customers, however, made it even more crucial for Panhandle'tó retain its hold on the captive G markets, for they were now Panhandle’s only remaining customer for its and TKL’s uncompetitively (in relation to the spot market) priced gas.

In September of 1984, CILCO presented Panhandle with a tariff counterproposal containing a 50% minimum bill. Under the proposal, CILCO could purchase up to 50% of its total purchases from sources other than Panhandle without penalty and pay an alternate supply charge of $.42/Mcf only on such purchases. However, Panhandle would still be obligated to have gas re

*854

serves to supply 100% of CILCO’s contract demand. Panhandle rejected the counter-proposal.

Panhandle and CILCO executives and legal counsel met again in Houston on December 5, 1984. Panhandle’s LGS proposal made in March was discussed; even though the additional cost to CILCO under this tariff would have been approximately $5 million, due to elimination of gas costs from the minimum bill, it was unacceptable to CILCO. CILCO’s September 1984 proposal was also discussed but was not accepted by Panhandle. Following this meeting, Panhandle advised CILCO that it was unwilling to enter into any additional negotiations for a new tariff or service agreement.

On September 6, 1985, an administrative law judge of the FERC rendered an initial decision in the CILCO Complaint Case confirming the sole supplier nature of the G tariff and rejecting CILCO’s request to amend Section 1.9 of the G tariff to permit CILCO to purchase from another supplier while remaining on the tariff.

On November 21,1986, CILCO requested Panhandle to provide firm transportation for system supply for 15 Mmcf per day starting February 1, 1987. CILCO did not expressly request that the transportation be conditioned on retaining the G tariff, because it hoped that the FERC would issue a final decision in its complaint case in its favor by February 1. If there was no decision, it could decide on February 1 whether or not to proceed with the transportation request.

Panhandle had two reliable weapons upon which to draw in its struggle to prevent independent gas from entering its captive system supply markets. One was its ability to refuse to transport independent supplies to the captive customers; this was a powerful weapon since Panhandle’s pipeline was the only physical source of transportation access at the time. The other weapon was its G/LS tariff structure. Of course, CILCO could object to Panhandle’s construction of the tariff by filing a complaint with the FERC, which it had done.

These tariffs and their companion service agreements were really just contracts for the delivery of gas. Unlike most contracts for the purchase and sale of goods, they contained no price terms, because at the time that the tariffs were entered in 1950, federal regulators tightly controlled the price of gas. The purchasers, therefore, had relied upon the regulators to assure that they paid a fair price for the goods Panhandle was providing. Of course, the purchasers lost their protection in 1978 when Congress, in passing the NGPA, removed the regulators’ control over gas prices.

On appeal to the full Commission, the FERC, in Opinion No. 265, issued on February 20, 1987, again confirmed the sole supplier nature of the G tariff but reversed the AU and ordered that Section 1.9 of the G tariff be modified

prospectively

to eliminate the sole supplier provision so as to permit CILCO to purchase from another supplier while remaining on the tariff. At the same time, the full Commission eliminated the fixed cost minimum commodity bill from the LS tariff, virtually obliterating all distinctions between G and LS service, with the exception of variable contract demand and the 90% demand charge ratchet in the G tariff. The FERC believed that, under current market conditions and the FERC’s recent policy favoring competition and transportation, the sole supplier provision was a “vestige” of past policy and was no longer appropriate. Nevertheless, the FERC’s opinion clearly affirmed Panhandle’s long-standing interpretation of Section 1.9 as a sole supplier provision that precluded CILCO from purchasing gas from another supplier while remaining on the G tariff. It also held that “full requirements” tariffs, which would identically impact transport of off-system supplies, generally would be upheld.

While the Court was in the process of finalizing this Memorandum Opinion, the United States Court of Appeals for the District of Columbia in

Panhandle Eastern Pipeline Co. v. Federal Energy Regulatory Commission,

881 F.2d 1101 (D.C. Cir.1989), remanded two issues arising out

*855

of the FERC’s ruling in Order 265. Those two issues were:

(1) The fairness of FERC’s release of G tariff customers from their obligation (pursuant to the sole supplier provision) to purchase all of their natural gas from Panhandle, while at the same time “ordering Panhandle to continue to provide them with G schedule benefits.”

Id.

at 1104 .

(2) The reasonableness of FERC’s action in order 265 allowing Panhandle’s customers “... to nominate low levels of service (thereby reducing demand charges), while at the same time requiring the pipeline to stand ready to serve them at the level described in its operating certificate.”

Id.

E.

FERC Order 136

In mid-1985, programs such as Panhandle’s Transportation Guidelines and Pan-Mark were struck down by the District of Columbia Court of Appeals as being anti-competitive and discriminatory.

Maryland People’s Counsel v. FERC,

761 F.2d 768 (D.C.Cir.1985)

(“MPC I”), Maryland People’s Counsel v. FERC,

761 F.2d 780 (D.C.Cir.1985) ("M

PC II”),

and

Maryland People’s Counsel v. FERC,

768 F.2d 450 (D.C.Cir.1985)

(“MPC III”).

The programs were allowed to continue until November 1, 1985, at which time FERC was to announce new rules governing the provision of nondiscriminatory transportation services by interstate pipelines.

The FERC initiated a Notice of Proposed Rulemaking in May of 1985 which culminated in the issuance of Order No. 436 in October, 1985. Panhandle filed comments in that rulemaking proceeding opposing the issuance of the proposed order. Panhandle opposed the rulemaking because it believed the proposal failed to deal with the take-or-pay problem of pipelines, and because it would allow Panhandle’s customers to reduce the contract demand in their service agreements to zero without dealing with the pipeline’s long term gas supply contracts entered to meet the customers’ contract demand. (Bray 5574-5579).

The FERC required in Order No. 436 that pipelines file new transportation tariffs which provided unbundled transportation rates or rates which separately stated the cost components that made up the transportation rate. Order No. 436 allowed the use of a separate demand charge or reservation charge only in a tariff for firm transportation. Panhandle filed new transportation rates pursuant to the conditions in Order No. 436. These rates were in effect subject to refund and were being reviewed by the FERC at the time of trial. Order No. 436 also required that pipelines’ state a maximum rate — which included all of the pipelines applicable costs — and a minimum rate which included only the applicable variable costs. Panhandle’s new transportation rates stated a maximum rate of approximately 40c per Mcf and a minimum rate of approximately 2<? per Mcf. Panhandle did charge a rate below the maximum rate for transportation services rendered after its new rates went into effect. (Bray 5579-5582).

These rules, contained in the FERC Order 436, were announced in October 1985 and became effective November 1, 1985. Under Order 436, pipelines were informed that, while they could continue offering transportation services, they could no longer do so in a way that discriminated against captive LDC residential/commercial purchasers. Volumetric limitations were permitted and full requirements customers were not eligible for transportation absent conversion to a partial requirements tariff.

However, Order 436 and Order 436-A, which was issued in December 1985, imposed substantial conditions on pipelines’ accepting blanket certificate transportation authority, such as the right of an LDC under an existing long-term service agreement with the pipeline to reduce unilaterally its contract demand to zero and convert its contract demand to firm transportation. Order 436 also required that a pipeline which chose to transport on a self-implementing basis must do so on a non-discriminatory basis. In the alternative, the Order allowed a pipeline to seek authorization for transportation under Section 7(c) of the NGA on a case-by-case basis.

Order 436, coupled with Order 380, constituted a major restructuring of the regu

*856

latory apparatus governing the gas industry. This, and to some extent the take-or-pay provisions in supply contracts, created a significant industry transition problem. The transition problem had to do with restructuring the menu of services that a gas pipeline offers its customers to meet long-term needs, while at the same time restructuring the terms of its long-term relationships with its suppliers. (Carpenter 6885-6886).

In addition to authorizing non-discriminatory Section 7(c) certificates, Order 436 further authorized the use of a special “interim Section 311” blanket transportation program. This program was first made available on November 1, 1985, and was later extended. (FERC Orders 436, 436A, 436B). Under the interim Section 311 program, pipelines could transport gas to direct-buying end-users and LDC’s for their system supply, on an interim basis to June 30, 1986,

without

committing themselves to actual participation in the Order 436 program. (Reed 4993). The purpose of this program was to facilitate the continued flow of competitive non-pipeline gas to LDC’s as well as individual end-users while pipelines decided whether to adopt a full-blown Order 436 program. (FERC Order 436).

After October 31, 1985, Panhandle continued the transportation agreements that were “grandfathered” by Order 436. Panhandle’s Guidelines ended on October 31, 1985. (Vergon 2925; PX 380). End-users that had previously received transportation under the Guidelines and that now found their transportation discontinued were informed that Panhandle would, if requested, seek individual certificates (termed “7(c) certificates”) from the FERC to authorized renewed transportation. (PX 380; PX 770). The use of individual 7(c) certificates was specifically provided for in Order 436, so long as they were used in a non-discriminatory manner. (FERC Order 436).

Panhandle received $5.3 million in take- or-pay relief in 1984, and $46 million in 1985, for a total of $51.3 million, as a result of transporting on-system gas under the MAT program Guidelines. Panhandle received approximately $27 million in take-or-pay relief in 1986 under “grandfathered” MAT transports and new Section 311 transports that utilized on-system supplies. There were no matches of gas under the bid-out for which Panhandle did not get take-or-pay relief.

Within six months of its issuance of Order 436, FERC issued over 90 “clarifications” in response to industry and consumer uncertainty regarding the meaning of the Order. Initially, the Order had given pipelines until December 15, 1985 to elect whether to participate under it. The FERC later “clarified” the fact that transportation under Section 311 was allowed on an interim basis without triggering LDC contract demand reductions. It became obvious that December 15 was an unreasonable date, so the FERC extended that date until February 15, 1986, and then until July, 1 1986. It was further extended for some pipelines until December 31, 1986 and later yet until May 1, 1987.

TKL, which had very few captive customers and therefore was not concerned about becoming a

de facto

436 carrier, began interim Section 311 transportation almost immediately. TKL did so because ANR had commenced interim transportation outside of its own market areas, and Consumers Power Company, TKL’s one remaining major customer, was contemplating using this service. TKL believed the adverse implications of this occurring at that time would be very severe. (Bray 5619-5620). Panhandle did not begin interim Section 311 transportation immediately, because it feared that interim transportation would commit it to the open access provisions of Order 436, and thus commit it to begin transporting even to its captive G customers.

Instead of immediately joining FERC’s interim 311 program so that its end-users could continue to obtain their off-system gas without interruption, Panhandle shut down its MAT Transportation Program and advised its end-users to apply for Section 7(c) transportation certificates. Not only were these certificates costly ($12,000 apiece, to be paid by the end-user), but

*857

Panhandle’s encouragement of the end-users was substantially a sham. In February 1986, when Panhandle filed for the certificates, it knew that it would normally take at least six months to secure them from FERC, but the certificates filed by Panhandle were to terminate on June 30, 1986. Thus, the certificates would have expired at about the same time they were finally approved. One Panhandle official, G.J. Rizzo, commented that this strategy was “essentially holding our ability to provide 7(c) transportation service hostage.” Rizzo recommended that all new requests for 7(c) certificates be given a two year term. Panhandle was not swayed. The Company’s position, as expressed by Michael Bray, was “no end-user transport. Keep pressure on LDC’s to maintain load.” (PX 770) No two year certificates were offered.

By February of 1986, even one of Panhandle’s own officers was urging that the company begin interim § 311 shipments. Richard Pemberton complained that because sales to LS customers were virtually zero, Panhandle should at least recommence transporting to them. Thus, Panhandle decided to take the plunge.

Panhandle began an intensive effort in January of 1986 to structure a program for operation under Order 436 that took into consideration the circumstances of Panhandle and its customers. Panhandle had a number of meetings with customers regarding its proposals for operating under Order No. 436 from January through June, 1986. (Bray 562). Panhandle proposed a completely new form of tariff to its customers in March, 1986. This proposal called for elimination of Panhandle’s G and LS tariffs and replaced them with a single tariff and rate schedule in which customers would be allowed to establish an interrelated Winter and Summer Contract Demand. (Bray 5623-5625). Panhandle’s customers did not find this proposal acceptable.

Panhandle presented a second tariff proposal to customers for operation under Order No. 436 in April and May of 1986. (Kelley 6111; PX 439; PX 915; DX 917). This proposal asserted Panhandle’s willingness, based on the comments received from customers, to phase in Panhandle’s original proposal presented in March 1986. The first phase would run from October 1, 1986, to September 30, 1988, and the second phase would run from October 1, 1988, to September 1990. The second proposal included a direct billing mechanism for take-or-pay settlement amounts.

During the first phase, G customers would be permitted to purchase a portion of their requirements from parties other than Panhandle. The proposal included a ratchet in Panhandle’s obligation to serve LS customers based on volumes purchased in a prior time period, and it provided for crediting of transport volumes against the minimum bill. The proposal contained an express feature that there would be no cost shifting among classes of customers during the first phase of the program. (Kelley 6113-6114).

Many of Panhandle’s customers notified Panhandle that it was appropriate for them to bear some portion of Panhandle’s take- or-pay costs, but they expressed many differing views as to how that should be done. Panhandle’s partial requirements customers expressed continued objection to the ratchet feature. By June of 1986, Panhandle and its customers were unable to agree on the terms of Panhandle’s second new tariff proposal. (Kelley 6112-6118). Panhandle then suggested to the customers in meetings in June 1986 that they attempt to work out a proposal which would only address the first phase, which was the time period until most of Panhandle’s major service agreements would expire in September 1988. Panhandle then filed its Order 436 certificate request in late June of 1986. (Kelley 6118-6119).

Panhandle believed that the new tariff proposals it submitted to customers in March and May of 1986 were consistent with Order No. 436. Panhandle’s May 1986 proposal contained provisions regarding contract demand reduction which differed from those set out in Order No. 436, but these provisions were based on an interpretation of what the FERC’s intent was in Order No. 436 and were not inconsistent

*858

with that Order. The FERC had approved Order No. 436 proposals of other pipelines which contained provisions that differed from those set out in the Order itself. (Kelley 6129). When Panhandle made its new tariff proposals in March, April, May, and June of 1986, it was willing to negotiate changes in those proposals with customers; it so advised its customers, and it attempted to do so.

Panhandle’s Order No. 436 certificate application proposed a direct billing mechanism for take-or-pay settlement payments. It also provided for a 10% optional reduction or conversion in sales Contract Demand by customers over two years. The proposal did not alter Panhandle’s G and LS tariffs. It provided that if a G customer wished to convert 10% of its sales Contract Demand to firm transportation Contract Demand or to transport gas for system supply on an interruptible basis, the customer must execute an LS service agreement. (Bray 5628-5630, 5635-5637).

CILCO sent notice to Panhandle on August 14, 1986 that CILCO would request a 10% reduction of its Contract Demand with Panhandle in accordance with Panhandle’s Order 436 filing. (DX 999C). Jim Vergon discussed this action in an internal CILCO memorandum dated August 12, 1986. (DX 999C). Vergon noted that CILCO reduced its CD by 10% as a result of the settlement of the 1982 Panhandle rate case; CILCO thus saved its customers $1.3 million, even after incurring an additional $200,000 in carrying costs on additional storage. Ver-gon further stated:

The objective in considering another reduction in contract demand with Panhandle is to determine if by doing so we can further minimize the cost of gas supply to our customers without unduly undermining or sacrificing security of supply. It is interesting to note that even though our combined sales and transportation service volumes have fallen from approximately 59 Bcf in 1982 to 39 Bcf in 1985, our peak day requirements have changed little falling from 443,000 MCF in 1982 to our current projection of 426,000 MCF based on a 1982 peak day send out.

(DX 999C).

Before committing itself to interim 311 transport, Panhandle contacted its G and SG customers by letter and telephone in March and early April, 1986, and demanded their express assurances that, if Panhandle adopted an interim Section 311 program for industrial end-users, the LDC’s would not request Panhandle to transport independent gas for their system supply. (Vergon 3004: PX 422; PX 433; PX 430).

Further, Panhandle informed them that if

any

G or SG LDC violated this condition, the interim Section 311 program would be promptly terminated for all. (Vergon 3007-3009). When making this demand, Panhandle was aware that the FERC intended for interim 311 transportation to be offered to LDC’s as well as industrial end-users. (Kelley 6322-6234, 6238-6239).

Objections were voiced by certain of the LDC’s including CILCO that the interim Section 311 program was intended for LDC system supply as well as industrial end-users and that the condition imposed by Panhandle violated the non-discriminatory requirements of the program. (Vergon 3006-3007). Nevertheless, all G and SG customers eventually capitulated and agreed to the restriction in order to get cheaper gas flowing to at least their industrial customers, who they feared would switch to other fuels. (Vergon 3009-3010; PX 423; PX 430; PX 432; PX 433; PX799; PX 802; PX 805; PX 807).

As summarized in an April 11, 1986, internal Panhandle memorandum from R.D. Pemberton to D.B. Kelley, “[a]ll G customers have agreed to refrain from transporting for system supply_” (PX 433). Ten days later, on April 21, 1986, Panhandle announced that it would provide interim Section 311 transportation. (PX 819).

When a media spokesman for Panhandle was contacted by an industry reporter the following month, on May 8, 1986, and was asked whether Panhandle had imposed LDC restrictions as a condition to “opening up to 311 transport,” he responded that “such an idea was nonsense” and that

*859

“Panhandle would be stupid for inviting litigation in such a fashion.” (PX 876).

Panhandle did not impose similar restrictions on its non-captive partial requirements LDC’S respecting their use of interim Section 311 program. (Vergon 3010). Panhandle provided interim 311 transportation in 1986 for two of its largest LS customers, Michigan Consolidated and East Ohio Gas, while providing no transport for captive G and SG customers. (DX 1420).

On June 23, 1987, in the case of

Associated Gas Distributors v. FERC,

824 F.2d 981 (D.C.Cir.1987)

(“AGD”),

the court sent Order 436 back to FERC with directions to factor the take-or-pay problem into the equation of change in regulations and also to rectify some procedural problems regarding the contract demand reduction formula.

It is noteworthy that in the

AGD

case the court clearly found that FERC had the power to order an open access commitment on any pipeline which either secured a blanket certificate to provide gas transportation (7(c) of the NGA, 15 U.S.C. 717f (1982)), or actually provided transportation under § 311 of the NGPA (15 U.S.C. 3371 (1982)). The pipelines had argued that imposing such conditions went beyond the scope of FERC’s authority. 824 F.2d at 997-1007.

The

AGD

case also upheld in principle the allowance of various types of discounting, including “value-of-service” discounting depending on differing demand characteristics.

Id.

at 1010, 1012.

On August 7, 1987, the FERC, in response to

AGD,

promulgated Order 500 (Interim Rule and Statement of Policy, Docket No. RM 87-34-000). Order No. 500 re-adopted the regulations originally contained in Order No. 436, and made four modifications:

(1)in order to permit pipelines to minimize the incurrence of take-or-pay liability because of open access transportation ... a producer must offer to credit gas transported by a pipeline against that pipeline’s take-or-pay liability to a producer accruing under certain pre-June 23, 1987 gas purchase contracts;

(2) in order to provide for equitable sharing, between pipelines and their customers, of the costs of settling already accrued take-or-pay obligations and reforming existing contracts, the Commission adopts a policy as to the acceptable mechanisms for the passthrough of take- or-pay buyout and buydown costs;

(3) in order to avoid the future recurrence of the kind of take-or-pay problems that exist today, the Commission adopts principles on which pipelines may base future gas supply charges; and

(4) while the Commission compiles a record to justify contract demand reductions the Commission eliminates the contract demand reduction option in former § 284.10(c) of its regulations but in order to maintain some meaningful access to transportation for sales customers, the Commission retains the contract conversion option in former § 284.10(d) of its regulations.

On October 16, 1989, the United States Court of Appeals for the District of Columbia in the case of

American Gas Association v. FERC, (“AGS”),

888 F.2d 136 (D.C.Cir.1989), ruled that “... the interim rule does not comply with the mandate in

AGD.

Therefore, we retain jurisdiction of this matter and remand the record for the Commission to issue a final rule within 60 days.”

AGS,

888 F.2d at 142 .

The Court expressed several concerns about both the substance of Order No. 500 and the justification for certain provisions. The holding is succinctly summarized as follows:

The AGD mandate was straight forward: it required that the Commission give a reasonable explanation for its decision to act or not to act in particular ways. We instructed the Commission either to take steps to address the take-or-pay problem, explaining the reasoning behind the mechanism it chose and the reasons for preferring that mechanism over others, or to justify its decision not to take those steps. Nonetheless, during the two years since we decided AGD, the Commission has not done so; it has failed to engage in reasoned decision-making, ei

*860

ther in promulgating an interim rule in Order No. 500, or by issuing a final rule.

AGS,

at 147.

In terms of this litigation, Order No. 500 constitutes the latest chapter in the unfolding revolutionary changes occurring in the natural gas industry beginning with the passage of the NGPA in 1978, through the chaos of the middle 1980’s (especially 1983 to 1987).

F.

NGPL And ANR Interconnection With CILCO

At the time that this lawsuit was filed, Panhandle was the only pipeline connected to CILCO’s Peoria/Springfield service area. However, as early as CILCO’s 1981 proposal to buy gas from NGPL, it was able to interconnect with another pipeline. In October 1983, NGPL filed an application with the FERC seeking a Section 7(c) certificate authorizing construction of interconnection facilities with CILCO. The application stated that the purpose of the proposed facilities was to furnish gas for “CILCO’s system supply in the event of an emergency or for other lawful purposes.” In 1984, the FERC approved construction of the interconnection but, in accordance with the application, limited NGPL’s use of the interconnection to “emergencies.”

In October 1983, when NGPL filed its Section 7(c) petition to build and use an interconnect to serve CILCO, it may also have had the ability to proceed on a self-implementing basis under Section 311 or its blanket certificate to build an interconnect and provide transportation for CILCO’s system supply. Since this was a self-implementing transaction, unless a limitation was subsequently imposed on the use of such an interconnect, it was, or could arguably have been, a direct competitive threat to Panhandle sales.

In February 1984, the Illinois Commerce Commission (“ICC") approved CILCO’s request to construct a pipeline approximately 23 miles long from Henry, Illinois to Princeton, Illinois to interconnect with NGPL. CILCO delayed its pipeline construction and interconnection with NGPL until November 1985. CILCO chose an initial interconnect capacity for this pipeline of 60 MMcf per day, although the actual capacity of the pipeline is at least 180 MMcf per day. The actual capacity can be increased by building another parallel pipeline.

On January 10, 1986, NGPL filed an application with the FERC under Section 7(c), seeking to expand the use of its interconnection to include end-user transportation, specifically for Caterpillar Tractor Company. In September 1986, the application was granted only as to Caterpillar. An earlier and broader authorization might have been granted if it had been requested.

On December 1, 1986, NGPL, on a self-implementing basis under Section 311 or blanket certificate authority, completed a separate duplicate interconnection with CILCO, through which NGPL has provided transportation services to CILCO’s customers. NGPL chose a design capacity for this interconnect of 180 MMcf per day. Archer Daniels Midland, Keystone Wire & Steel, Pekin Energy, Quaker Oats, and B.F. Goodrich, in addition to Caterpillar, were as of the end of this trial receiving transportation services from NGPL. Caterpillar has had the gas transported pursuant to Section 7(c), and the others pursuant to Section 311.

As of the time of trial, ANR had constructed, or was in the process of constructing, an interconnect with CILCO at approximately the same point as the NGPL interconnection at Princeton, Illinois. Construction was scheduled to be completed in December 1986 or January 1987. ANR chose a design capacity for this interconnect in the range of 150 to 200 MMcf per day. ANR, at the time of trial, had a transportation agreement with Archer Daniels Midland Co.

Approximately 55% of CILCO’s total market system, that part located north of Pekin, Illinois, is or will be capable of receiving gas transported over either ANR or NGPL through these interconnections. The Springfield service area, representing approximately 40% of CILCO’s total service area, will not be capable of being served by the NGPL or ANR interconnections at

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Princeton, Illinois. However, NGPL has proposed to build an interconnection between its Gulf coast line and CILCO’s system to serve the Springfield service area; NGPL estimated that the pipeline, with a capacity of 100 MMcf a day, would cost approximately $20 to $21 million. Moreover, studies performed by CILCO during the 1970’s suggested that the Peoria market area could be connected to the Springfield market area at a cost of about $20 to $25 million. Authorization to construct any of these facilities might have been obtained at any time if requested.

Immediately following the FERC’s directive eliminating the sole supplier provision from the G tariff, CILCO began purchasing gas and physically transporting it to Peoria through NGPL’s Section 311 interconnection. The impediment or restriction on CILCO’s receipt of system supply gas through NGPL’s Section 311 interconnect and ANR’s Section 311 interconnect was its desire to continue doing business with Panhandle under the G tariff. Prior to the issuance of FERC Opinion No. 265 on February 20, 1987, CILCO had not requested transportation of system supply gas over NGPL’s or ANR’s pipeline because of its concern that the FERC would not modify the G tariff to permit the purchase of such gas and remain on that tariff. That is, CILCO wished to be supported by a FERC opinion or order before proceeding to request such transportation.

At the time of trial, NGPL had not requested and did not have authority from the FERC to sell gas to CILCO for its system supply through the two interconnection at Princeton, Illinois. Such authorization would have to be received through FERC certificate proceeding. In January 1985, the FERC (in NGPL’s “load growth” proceeding, C-82-355), expressly rejected CILCO’s request to increase its entitlements from NGPL by 25,000 MMcf per day.

G.

CILCO’S Rates, Tariffs

During the 1970’s and early 1980’s, Panhandle’s prices were among the lowest pipeline prices in the Midwest. However, Panhandle’s commodity rate to CILCO reached an all-time high in March 1983, primarily as a result of the start of higher-priced Canadian gas and LNG deliveries into Panhandle’s system. Thereafter, Panhandle’s prices gradually declined as it reduced its gas costs in response to competition. The cost of Panhandle gas reached 85% of CILCO’s burner tip price in 1983, but accounted for only approximately 65% in 1986.

CILCO’s rates are designed to recover both its fixed and variable costs and to earn its authorized rate of return on the assumption that a certain sales level is achieved. CILCO representatives have testified that it is very important to CILCO to be allowed to earn its authorized rate of return. As of the time of trial, CILCO was authorized by the ICC to earn a return of 11.6% on its rate base of $142 million.

CILCO charged different rates for its customer classes because of load pattern differences, the difference in reliability of service (that is, firm or interruptible), social acceptability of the rates; and the difference in the cost of providing the service to each class. CILCO charged more for firm service because it cost CILCO more money to assure the firm sale customer that the service and product would be available whenever the customer needs them. This is true despite the fact that CILCO had no take-or-pay obligation (i.e., no minimum commodity bill) under its contract with Panhandle.

H.

Take-or-Pay

“Take-or-pay exposure” is a pipeline’s estimate of the dollar amount it would have to pay, subject to its success in asserting various legal defenses, if it fails to purchase the volumes specified in its gas purchase contract. The exposure is calculated by multiplying the difference between volumes that it was obligated to purchase and those it actually purchased by the contract prices.

Pipelines incur take-or-pay exposure when they fail to take the volume of gas called for in their gas purchase contracts and may be called on to pay for the difference between what they take and the con

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tract level. Take-or-pay exposure is exacerbated when the pipelines’ customers reduce their purchases from the pipelines, either because of transportation or because the customers’ needs have decreased. The take-or-pay exposure problem in the natural gas industry is complicated by the competing rights and interests of the procedures, the pipelines, and the pipelines’ customers.

“Deliverability” is the ability of a well to produce gas into a pipeline under a certain set of conditions that are defined in the contract. Deliverabilities are determined by actually testing flow of the wells. A typical take-or-pay contract based on deliv-erability would require that a pipeline take 80% of the well’s deliverability over a period of a year. If the pipeline failed to buy 80% of the deliverability, it must pay the difference. Deliverabilities go down as the well depletes; therefore, there may be some disagreement with a producer on the level of deliverability during a particular test period. The differences between a pipeline and a producer are reconciled in negotiating the take-or-pay liability under the contract.

TKL’s take-or-pay exposure for the period 1982 through 1986 was estimated to be $2.86 billion. Panhandle’s take-or-pay exposure for the same period was estimated to be $1,299 billion. For the period 1982 through 1986, TKL paid $25 million and Panhandle paid $87 million in “straight” take-or-pay payments, that is, payment of 100% of that take-or-pay liability. In addition, in the same period, TKL paid $252 million to settle an additional $2,138 billion in take-or-pay exposure, and Panhandle paid $13 million to settle an additional $188 million in take-or-pay exposure. The remaining take-or-pay exposure for the 1982 to 1986 period was $699.2 million for TKL and $1,024 billion for Panhandle. Most of the take-or-pay settlements for TKL and Panhandle in 1983 and 1984 were approximately ten cents on the dollar.

Notwithstanding everything Panhandle has had to say about the severe impact of take-or-pay during this lawsuit, its own internal documents and its public filings with the Securities and Exchange Commission paint a somewhat different picture. After stating that Panhandle and TKL “could” incur take-or-pay obligations of up to $100 million and $960 million respectively for 1983-1984, Panhandle’s Form 10K for 1982 concludes:

The actual take or pay obligations which will be incurred by PEPL and Trunkline will be dependent upon a number of factors, including sales levels and the success of remedial efforts under way or yet to be initiated. Management is confident that these remedial efforts will bring this matter to a satisfactory posture during the 1983-1984 period and that actual take-or-pay payments required of PEPL and Trunkline will be substantially less than those indicated above.

(PX 502).

In its 1983 Form 10K Panhandle stated that “approximately 73 percent of [take-or-pay] exposure relates to Trunkline.” Panhandle represented that:

Commercial and other conditions surrounding the domestic gas purchase problem provide reasons to believe that [take-or-pay] can be reduced to manageable proportions.

Referring specifically to “the uncertainty” surrounding take-or-pay, Panhandle disclosed also that “no accruals with respect to unpaid potential obligations for gas not taken under domestic gas purchase agreements in 1983 were made in the financial statements for the year ended December 31, 1983.” (PX 503).

In its 1984 Form 10K Panhandle stated: “PEPL and Trunkline believe that significant legal questions exist both as to the enforceability of take-or-pay provisions and the level of damages payable if such provisions are ultimately found to be enforceable.” It predicted: “Based upon the significant substantial progress made in 1984, the Company believes that the ongoing negotiations with producers will be successful in obtaining additional [take-or-pay] settlements.” It disclosed also that it was

still

not making any accruals for take-or-pay on its financial statements. (PX 504).

In its 1985 Form 10K Panhandle stated that although “significant potential expo

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sure” remains, “the Company believes that taking into account all of the circumstances the problem of take-or-pay exposure under domestic gas purchase agreements will continue to be manageable.” (PX 505). It disclosed also that it was

still

not making any accruals for take-or-pay on its financial statements. (PX 505).

With respect to actual take-or-pay payments made by both Panhandle and TKL, Panhandle stated in its 1984 and 1985 Form lOK’s that prepayments had been made in only “a limited number of cases” and that: “It is the opinion of the Company that in virtually all of these cases, these amounts can be recovered in the form of future gas production or in cash.” (PX 504; PX 505).

With respect to the carrying costs for prepayments actually made and settlements paid out by Panhandle and TKL, Panhandle in its 1985 Form 10K disclosed that such costs were being passed through to its customers:

The cost of service in the pending PEPL general rate filing, referred to under “PEPL Base Rates,” includes a five-year amortization of amounts paid to producers, as of May 31, 1985, to settle take-or-pay claims. The settlement amount reflected in the rate filing is $1.1 Million annually. This filing is subject to possible refund.

The Trunkline settlement agreement, referred to under “Trunkline Base Rates,” provides for recovery, commencing March 1, 1985, of approximately 20 percent ($33 Million) annually of the Trunk-line settlement amounts which were paid as of January 31, 1985. Approximately $28 Million was recovered in 1985 under the approved Trunkline rate settlement. The carrying costs relating to Trunkline prepayments are being recovered under a provision of an approved rate settlement. Carrying costs related to $32 Million of the PEPL amount are included in the cost of service in the pending rate filing, which is subject to possible refund.

(PX 505).

As a consequence of all of the above, Panhandle did not absorb a single dollar of gas-associated take-or-pay costs, but was recovering all such costs from its customers. (Bray 5670-5671; Lasseter dep. 94-6).

Panhandle’s Legal Department directed Panhandle personnel to refer to “exposure” rather than “liability” when discussing take-or-pay. (Dixon 5965). Take-or-pay is not a liability “until it is claimed by the producer and the producer’s position on the level of that claim is confirmed.” (Dixon 5966).

Consistent with this, in a November 29, 1983, Panhandle internal memorandum, Panhandle’s Controller observed:

a) The accrual of take or pay liability, and an offsetting prepurchased gas asset, in amounts to be calculated by reference only to the Company’s contracts,

could significantly misstate the take or pay situation which will actually confront the Company as the matter develops. In particular, a significant level of producer forbearance is anticipated.

This anticipation is supported by reference to experience in respect to 1982 take or pay and to contracts with various major producers, indicating anything from general reluctance to enforce take or pay to a firm decision not to do so. In the present state of affairs, the Company is not able to estimate the dollar range of forbearance which should be anticipated.

b) Also, the Company believes that significant legal questions exist as to the enforceability of take or pay provisions, and assumes that similar questions enter into producer decisions on the topic. Furthermore, the Company has taken steps with producers, at the FERC and in its market place with the design of significantly reducing its ultimate take or pay outlays.

(PX 265, emphasis added).

The memorandum concluded that Panhandle would

not

book take-or-pay as a liability:

In summary, the accumulation of all these factors introduces a degree of uncertainty a to whether take or pay payments will be made, their amount and

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their timing. This uncertainty is of such a degree as to render impossible the accrual of any particular liability and offsetting asset ... Likewise, the degree to which an amount can be estimated with reasonable reliability is extremely low to nonexistent.

(PX 265).

Similarly, a Panhandle internal memorandum reflects that Panhandle’s outside independent auditor, Peat Marwick, had advised that take-or-pay should not be booked as a liability unless a producer had actually invoiced Panhandle. (PX 625). Only a few of Panhandle’s 3,000 on-system producers have actually invoiced Panhandle for take- or-pay and even fewer have initiated litigation over take-or-pay. (Dixon 5958; PX 661).

Panhandle’s testimony at trial concerned projections of take-or-pay “exposure” and not “liability.” (Dixon 5838-5852). Panhandle itself has referred to take-or-pay as “the legal justification for refusing to transport off-system supplies unconditionally.” (PX 97).

Panhandle’s LS customers were able to avoid the deferred account surcharge and take-or-pay costs included in Panhandle’s sales rates by drastically cutting back on their purchases of Panhandle gas. Panhandle’s captive G and SG customers, however, were not able to cut back their purchases of Panhandle gas. As a result, while the G and SG customers accounted for only 57% of Panhandle’s gas sales as of 1980, by 1986, with the almost total abandonment of Panhandle by its LS customers, G and SG customers accounted for fully 95% of Panhandle’s gas sales. (Means 3315-16; PX 1027-A).

TKL has been more successful than Panhandle in settling take-or-pay exposure because TKL’s suppliers are major oil companies or large independent producers who have very substantial financial resources and an understanding of the pipeline’s dilemma and are willing to negotiate settlements. By contrast, Panhandle’s suppliers consist of many small independent producers, some of whom are not as sophisticated as the major oil companies, and most of whom are without the same financial staying power as the major producers.

“Recoupment” means that the pipeline has a period of time, usually five years, to take the gas for which the take-or-pay payment was a pre-payment. Under some contracts, if, at the end of that period, not enough gas has been taken to offset the prepayment, the producer pays back the deficiency in dollars. The $13 million paid by Panhandle to settle take-or-pay exposure did not include recoupment rights. A portion of the $87.3 million paid by Panhandle in straight take-or-pay payments is subject to recoupment rights.

Panhandle and a producer usually disagreed on the take-or-pay liability under a contract. The producer was interested in getting the take-or-pay bill as high as possible. There were many areas for disagreement on liability under a take-or-pay contract, such as deficiencies in deliveries,

force majeure,

and level of well deliverability. The differences between Panhandle and the producer were reconciled in many cases by negotiating the take-or-pay liability under the contract. Usually, a producer would not send a take-or-pay bill or invoice to Panhandle, since it was hesitant to tip its hand as to what level of take-or-pay it thought was due. Panhandle’s estimate might show that Panhandle owed it more than it had estimated; perhaps its estimate was in error. Generally the parties would get together and try to agree on the deficiency under the contract, or the takes, for the period involved. The negotiations usually commenced within 30 or 60 days following the end of the contract year.

There were approximately 1,000 producers with several thousand contracts on the Panhandle system. The end of the contract year for the different supply contracts varied and was spread throughout the year. While several producers had not, as of the time of trial, pressed take-or-pay claims, Panhandle was involved in lawsuits with approximately ten different producers who were pressing damage claims approximating $20 million. The lawsuits first started to be filed in late 1984 or during 1985.

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It appears that the real impact of take-or-pay on Panhandle, as of the time of trial, was considerably less than the amount of take-or-pay exposure might indicate. However, as of the time of trial, a tremendous amount of take-or-pay exposure remained, with no guarantees that Panhandle would settle all claims at a rate of 10$ on the dollar, and no way of knowing how the FERC would ultimately deal with the take- or-pay matter in a way acceptable to the Court of Appeals for the District of Columbia.

I.

The Proprietary Claim

In January 1983, the Illinois Commerce Commission (“ICC”), through Phillip O’Connor, its new Chairman, decided to become more active and to criticize and blame Panhandle for the increase in natural gas prices due to costly Algerian LNG. The ICC staff decided to begin an effort to “scream bloody murder.” This campaign was undertaken even though the ICC had supported the Algerian LNG project in the 1970’s.

In September 1983, the Illinois Department of Central Management Services (“CMS”), at O’Connor’s request, surveyed state institutions to determine which institutions purchased natural gas from CILCO, CIPS, and IP. The ICC staff made the decision to limit the survey to CILCO, CIPS, and IP, which were LDC’s served by Panhandle.

At the same time, Gerald Keenan, Manager of ICC’s Consumer Affairs Division, contacted various natural gas producers. He learned that the State would need to purchase at least 750 to 1,000 Mcf/day of gas to interest producers in dealing with the State. This amounts to 274,000 to 365,-000 Mcf/year. He also learned that some producers would only deal in quantities greater than 1,500 Mcf/day.

On November 30, 1983, Gary L. Hunt, Manager of ICC's Public Utilities Division, wrote a letter to Langenkamp, requesting Panhandle to transport 1,400 Mcf/day of gas from Xena Energy commencing on December 12, 1983, and continuing through and including April 15, 1984. Of the seven state institutional customers named in Paragraph 13 of the Second Amended Complaint, only three — the State Capitol complex (i.e., Office of the Secretary of State), McFarland Zone Center and Adolph Meyer Zone Center — were named in the November 30 letter as the intended end-users of natural gas. The letter requested transportation at the rate set forth in Panhandle’s Added Incentive Charge (“AIC”) tariff. At this time, Panhandle’s AIC tariff had only been filed; it was not conditionally approved until December 2, 1983, and the program of which it was a part was later repealed by the FERC as a failed experiment.

After the November 30, 1983 letter had been mailed, the ICC staff learned that the State Capitol Complex would not need natural gas. The Secretary of State’s license facility in Springfield, Illinois, was substituted although it did not use as much natural gas as anticipated for the Capitol Complex. To obtain the additional requisite purchase volume, Hunt, in early December, contacted Richard Poorman, President of Lincoln Land Community College, and Alex B. Lacy, President of Sangamon State University, to request that these institutions participate in the pooling arrangement. On December 19, 1983, Hunt presented the proposal to the Board of Trustees of Lincoln Land Community College.

On December 1, 1983, Langenkamp telephoned Hunt and told him Panhandle would transport the gas pursuant to the Transportation Guidelines. He explained the Guidelines and told Hunt that they were intended to help solve Panhandle’s take-or-pay exposure. Langenkamp followed up on the telephone call by sending a copy of the Guidelines to Hunt on December 5, 1983.

Thereafter, in December 1983, the ICC staff prepared a draft letter to Panhandle providing the necessary information for the bid-out procedure under the Transportation Guidelines. That letter was never sent because O’Connor had concluded that the Guidelines violated antitrust laws. O’Con-nor made that decision even though he

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knew that would result in the State institutions not receiving cheaper natural gas and would cost the taxpayers money.

When the seven state institutions involved in the State's proprietary claims refused to acquiesce to the bid-out and other conditions of the Guidelines, their transportation request was refused. (Reed 4921). It would appear that, had the State institutions submitted their proposal to the bid-out, they would have received the gas at the price they sought.

On January 3, 1984, Hunt telephoned Langenkamp and told him the State would not follow the Guidelines. Langenkamp again informed Hunt that the Guidelines were intended to help relieve take-or-pay exposure and that such relief would benefit all customers. Hunt stated that he would check with the State agencies to determine their preferences, but he never did so.

Hunt followed up the telephone call with a letter to Langenkamp dated January 4, 1984. He stated that the State's objection was based on a belief that the bid-out procedure caused delays, was inconsistent with FERC’s blanket certificate program, and was likely to suppress open competition. Subsequently, this lawsuit was filed.

FINDINGS OF FACT

COUNTS I AND II

Monopolization

A.

The relevant product market is the sale of natural gas to G and SG LDC’s for system supply, plus alternate fuels and energy conservation, with a submarket of the indirect sale of natural gas to residential/commercial customers, plus alternate fuels and energy conservation.

Because of the manner in which gas costs automatically flow through LDC’s to the ultimate end-use customers, the LDC is — with respect to gas costs — essentially in the nature of a purchasing agent on behalf of the ultimate end-user customer. The LDC’s demand is a derived demand, reflecting the demand characteristics of final consumers of natural gas. (Carpenter 7244-7245; Tussing 3727; Vergon 2839).

As a consequence, when identifying the relevant product market, it is appropriate not only to look at Panhandle’s immediate customers, LDC’s and direct-buying end-users but also to consider the demand characteristics of the ultimate end-use consumers to whom the LDC markets gas. Of course, one must also look at the products with which natural gas competes.

Panhandle’s position that the sale of gas to LDC’s does not constitute a relevant market depends entirely on its assertion that spot market gas was available to LDC’s. During the relevant time period, however, spot market gas was not available to Panhandle’s G and SG customers in the Central Illinois Market.

The LDC customers to which Panhandle sold gas for system supply did not make up a homogeneous group; rather, they fell into two broad market segments characterized by significantly different demand characteristics. (Means 3310-3315; Stillman 3999-4000; Tussing 3587, 3702; PX 823; PX 261; PX 930).

One segment consisted of so-called General Service (“G”) and Small General Service (“SG”) LDC customers. (Means 3310-3311; Tussing 3587, 3702, 3800). These customers accounted for 57% of total gas sales by Panhandle as of 1980. (PX 1027-A). By 1986, sales to other Panhandle customers had declined to such an extent that sales to G and SG customers accounted for approximately 95% of total Panhandle gas sales. (Means 3315-3316; PX 1027-A). All LDC’s in Central Illinois were G or SG customers of Panhandle. (PX 1006).

The second segment of Panhandle LDC customers consisted of “partial requirements” customers who purchased gas from Panhandle under one of any of the following tariffs: LS, CS or SS. (PX 523; PX 1006). These customers were physically connected to other pipeline systems, and their tariff-contract arrangements with Panhandle made it economically feasible for them to purchase gas from other suppliers, (Means 3310-3315; Tussing 3624;

*867

4227-4228), at least after the entry of Order No. 380 in 1984.

As of 1980, partial requirements customers accounted for 43% of total Panhandle gas sales. (PX 1027-a). By the end of 1986, the percentage of total Panhandle sales accounted for by this group had declined to only 5%. (Means 3315-3316; PX 1027-A).

Internal Panhandle documents recognized the distinction between the G customers and LS customers. For example, a May 7, 1986 memorandum from Panhandle’s R.D. Pemberton to D.B. Kelley provides: “The system supply market can be broken down to our pipeline’s solely supplied LDC’s and the pipeline’s partial requirements customers.” It notes further that “[i]f our pipeline prices are uncompetitive with fuel oil, spot market and other pipeline rates, the only sales we will make will be to our solely supplied LDC’s for their residential and small commercial customers.” (PX 823).

Thus initially, the product market must be narrowed to exclude direct sales to LDC’s not purchasing pursuant to a G or SG tariff. Even within this narrowed market, however, are two discrete groups of end-use customers possessing significantly different demand characteristics: (a) residential and small commercial end-use customers with limited ability to switch to other fuels, and (b) industrial end-use customers with significantly greater actual or potential fuel-switching capability. (Rana dep. 60-1; Stillman 501; Tussing 3585, 3618; Vergon 2838-2841, 2926-2948; 3003; PX 378).

Panhandle officers acknowledged at trial the distinction between residential/commercial end-users and industrial end-users. For example, Panhandle’s Langenkamp testified that the Panhandle PanMark and MAT programs were specially structured for industrial end-users, since these were the customers that Panhandle’s LDC customers feared losing. (Langenkamp 1417). Similarly, Panhandle’s D.B. Kelley drew a distinction between residential/commercial end-users and fuel-switchable industrial end-users (Kelley 6166-6167), as did Panhandle’s J.T. Kennedy. (Kennedy 5357). Industrial and large commercial end-users constituted the marginal demand Panhandle faced (DX 37.5, 37.34, 38.8, 38.17)'in its broad market, but in the more narrow market of G and SG system supply the residential/commercial customers constituted the marginal demand.

Panhandle’s expert witness Dr. Carpenter similarly acknowledged the distinction between residential/commercial and industrial end-users. He described the Panhandle special marketing program, PanMark, as providing “selective price cuts to certain classes of customers — those that have the most sensitive demands” (Carpenter 1654), and conceded that when Panhandle’s sales fell off after 1982, elastic demand customers were the ones who stopped purchasing gas from Panhandle, leaving the more inelastic customers on the Panhandle system. (Carpenter 1727-1728). He further conceded that if a pipeline has the ability to discriminate against residential consumers, then the residential group does not belong in the same competitive market as industrial customers. (Carpenter 7149-7150).

Economists try to examine the elasticity of supply into the firm’s markets and the elasticity of demand that the firm itself faces. Internal Panhandle documents reflect the distinction between inelastic residential/commercial end-users and elastic industrial end-users. For example, a May 7, 1986 internal Panhandle memorandum expressly distinguished the industrial “end-use market” from the LDC “system supply market.” (PX 823).

Similarly, a March 14,1984 memorandum captioned “Pipeline Renegotiation Strategy” recommended the following strategy to “improve marketability of Panhandle/Trunkline gas: ‘Split pipeline to provide several separate services with different supplies and prices.’ ” Following this general strategy was a more specific recommendation to make “spot market” gas available to the “industrial market” while continuing to sell “average cost gas” (i.e., the costlier Panhandle gas) to the “residential market.” (PX 129).

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The definition of the relevant market is further shaped by the sources of competition for both supply and demand facing the pipeline in question. Because gas competes directly with alternate fuels and energy conservation products, and because the demand for gas is affected by the relative price of gas and alternate fuels, the sales of alternate fuels and of energy conservation products must be included in the definition of the relevant product market.

Energy sources other than natural gas are in direct competition with natural gas for all of the principal uses of gas by end-users (i.e., space heating, appliance fuel, industrial process use, electric power generation) and among all types of end-users (i.e., residential, commercial and industrial). These include No. 6 fuel oil, No. 2 fuel oil or distillate, electricity, propane, kerosene, wood and coal.

Many industrial end-users have in place alternate fuel capabilities which allow instantaneous switching between fuels. Others can convert to alternate fuels or install dual fuel equipment for a comparatively reasonable capital cost.

Within Central Illinois, some commercial and industrial customers have dual fuel boilers which can use either fuel oil or natural gas. For certain types of fuel oil the switchover from natural gas to fuel oil is just a matter of flipping a switch. Some end-users monitor the price of fuel oil and will switch to fuel oil when the price is cheaper than natural gas. (T. Weed 2479-2481). In February 1983, CILCO obtained prices of alternative fuels to natural gas and knew that they were in danger of losing customers to alternative fuels. (Ci-sel dep. 32-33; DX 1235).

In certain circumstances coal also competes with natural gas. Some Peoria schools installed coal-fired equipment in place of natural gas equipment. CILCO and Caterpillar are also fairly significant users of coal in Central Illinois. (T. Weed 2481-2482).

Although “conservation” cannot accurately be called a fuel “source,” it also provided a significant “source” of competition, at least on the demand side. In particular, conservation, the only practical alternative source for residential/commercial end-users, significantly reduced demands for natural gas, as illustrated by the examples below.

Residential consumers of natural gas can reduce their use of natural gas to some extent through energy conservation. (Houvenagle dep. 64). CILCO had incentive rates to encourage the use of off-peak electricity and the new use of electricity. CILCO, CIPS and IP also had programs to encourage the use of electric heat pumps. The CILCO program applied to residential and commercial customers. (Weed 2482-2483).

Smaller commercial and residential end-users have used electric and kerosene space heaters which also allow limited instantaneous switching between fuels. These end-users can also partially convert to alternate fuels by installing electric heat pumps or oil-fired burners and by purchasing electric appliances. The utility companies which distribute gas and electric power have engaged in numerous promotional efforts and have put into effect incentive rates which demonstrate that gas and electricity are in direct competition.

Propane heaters and electric space heaters are short term alternatives for residential gas consumers. (Carpenter 1759). For example, Common Place has its offices in the Howett Street Christian Church. Because of higher gas bills, the church lowered the thermostat. Common Place made use of electric space heaters which it purchased at a price estimated at $30 per month. (Rakoff 2716, 2719-2720).

From 1983 to the time of trial, conservation efforts by residential customers decreased consumption of natural gas by approximately

3%

per year. Some residential customers can afford to conserve natural gas by increasing the amount of insulation, and installing high-efficiency furnaces and appliances. (Hardy 6526; T. Weed 2478-2479). Residential customers who can’t afford to make such changes only have the option of turning down the thermostat or turning it off. This drastic option is best characterized as the “heat or eat” option.

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In a March 16, 1984 report entitled Technological Change and Competition in Telecommunications and Energy, the Policy Analysis and Research Division of the ICC concluded after examining a number of conservation products that:

Conservation is a substitute for energy; electric utilities “compete against energy saving measures.”

(DX 351).

Thus, conservation products act just like alternate fuels as substitutes for gas. They are a limited short term constraint on a pipeline’s ability to increase rates. (Carpenter 1668-1669).

Despite Panhandle’s speculation about alternative fuels in the residential/commercial sector, Mr. Houvenagle of CIPS testified fuel oil, coal, electricity and propane are not viable alternatives to gas for CIPS’ residential/eommercial customers because they are not in a position to readily convert their heating system to an alternative fuel. (Houvenagle dep. 63).

Panhandle’s own witness, James Hardy of Kokomo Gas, testified that, to the extent it faced load loss of certain industrial customers with dual fuel capability, Kokomo did not face such load loss with respect to residential customers. (Hardy 6576). Hardy testified further he was not aware of any residential customers who had converted from natural gas to electricity. (Hardy 6594).

Panhandle’s Form 10K filed with the SEC for 1982 explains that “[hjigher prices for natural gas will have the greatest impact on sales volumes in the industrial sector,” thus admitting the relative inelasticity of demand of residential/commercial users of natural gas. (PX 502).

Natural gas competes, but effectively so, with alternate fuels, such as fuel oil, electricity, and propane, for commercial and residential customers. Natural gas sales to residential consumers are somewhat sensitive to price; i.e., there is some price elasticity with respect to residential demand for natural gas. Residential users of natural gas have other options to using natural gas, including fuel oil, electric heat pumps, and conversion to electricity. (Lin-demann dep. 24-26; DX 1311; McDonald dep. 27); however, with the exception of new construction or the outlay of substantial money to switch to an alternate fuel, residential users options are usually limited to various types of energy conservation.

Regarding residential/commercial consumers, natural gas as an energy source does not significantly compete with electricity, propane, fuel oil, wood or kerosene, except in the very limited situation of new construction. (Weed 2469-2471). In the case of end-users with real or potential fuel switching capability, natural gas does face serious competition from alternate fuels.

Any ability on the part of resi-' dential/commercial customers to conserve or switch fuels appears to have reached its practical limits by the end of 1983, so that, for example, during the period 1983 through 1986, the requirements of CILCO, CIPS, and Illinois Power residential space heating customers remained relatively flat. (Vergon 2926; Vergon 3128, DX 1017). However, from 1983 to the time of trial, LDC’s continued to experience reductions in residential demand due to energy conservation.

CILCO and other LDC customers have no meaningful alternate fuel options, since their pipeline systems are designed to carry only natural gas. (PX 1001; PX 1003; PX 1005). CILCO’s system, for example, constitutes a fixed capital investment of approximately $250 million incapable of carrying coal, fuel oils, or other fuels. (Vergon 2932-2933; PX 610).

Demand elasticity for gas in the industrial sector is substantially higher than in the residential/commercial sector, reflecting the fact that some industrial end-users can economically switch to coal, fuel oil or electricity if the cost of gas is at a supracom-petitive level. (Stillman 508, 638; Tussing 802, 835). This is seen by the fact that load loss by pipelines and LDC’s in response to rising gas prices after 1982 came primarily from the industrial sector. (Hughes 328; Stillman 508). Load loss experienced by Panhandle as a result of rising gas prices came from all types of end-users. But the

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major loss, comparatively, came from industrial end-users.

During the period 1983 through 1985, while demand by CILCO’s residential/commercial customers remained relatively constant, even in the face of high Panhandle gas prices, industrial end-users capable of using other fuels either made the conversion to other fuels or switched to transporting non-Panhandle gas over the CILCO system, causing the residential/commercial percentage of total CILCO sales to jump from approximately 70% in 1983 to nearly 90% in 1985. (Vergon 2926-2927).

The bottom line on the competition of alternative fuels with natural gas is that alternate fuels effectively compete with natural gas at the margin in the case of large commercial and industrial end-users. Some of those consumers could and did avoid Panhandle’s exercise or attempted exercise of monopoly power by switching to an alternate fuel, such as coal, or No. 6 fuel oil. As to them, Panhandle was not in a position to exert monopoly power. The State agencies involved in the Plaintiff’s proprietary claim are included in this category.

As to the residential/small commercial users of natural gas, the result is the opposite. As to them, alternate fuels and conservation did

not

effectively compete with natural gas. It is certainly true that, because of the use of alternate fuels (e.g., wood stoves, space heaters, etc.) and energy conservation (e.g., insulation and turning down the thermostat on the gas furnace), residential/commercial consumers did reduce their consumption of natural gas. But these savings were inherently limited in scope, and the conservation measures were often one-time measures (e.g., insulation) which could not be repeated for additional savings.

For all these reasons, the Court finds that the relevant product market is the sale of natural gas to G and SG LDC’s for system supply, plus alternate fuels and energy conservation, with a submarket of the indirect sale of natural gas to residential and commercial customers, plus alternate fuels and energy conservation.

B.

The Panhandle system of G and SG LDC’s is the relevant geographic market. The area designated as the “Central Illinois Market" constitutes a valid submarket.

Panhandle’s pipeline system consists of a series of local geographic market segments characterized by their relative access—or lack of access—to other pipeline delivery systems. An individual geographic area representing a concentration of demand along a pipeline can by itself be considered a market. But Panhandle, in dealing with its LDC customers, was obligated to utilize a particular tariff in the same way as to any LDC operating under that tariff, no matter where that LDC is located on the Panhandle system.

Panhandle’s rates and the terms and conditions of its services were established on a system-wide basis. Panhandle did not charge different sales or transport rates for service under the same tariff, with the exception of the zone differentials which were part of the actual rate design approved by the FERC and were based on differences in the allocated cost of service. The experts who testified regarding relevant geographic market were essentially in agreement that, because of these features of FERC regulation, the area of effective competition in which Panhandle operated was at least as wide as its entire system.

Panhandle itself considered discrete geographic areas along its pipeline to be separate markets. In a speech given June 5, 1984, Panhandle’s President K.E. Kalen presented slides analyzing Panhandle’s pipeline in just this way, identifying a separate “St. Louis Market” and “Detroit Market” and isolating Columbia Gas Company and East Ohio Gas Company, two large LS customers of Panhandle with access to other supplies of gas, as separate markets. (PX 263; PX 530; PX 531).

Panhandle argues that the relevant market should be defined solely in terms of supply side considerations and not in terms of the options that were available to consumers being served in particular locations. However, an analysis disregarding the buy

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ers and focusing solely on what the sellers do would not be meaningful.

Panhandle’s own expert witness, Dr. Carpenter, has written: “The dependence for transmission on pipelines could well give rise to pockets of local market power.” (Carpenter 7229). He testified at deposition in this suit that “the question of the geographic market is essentially irrelevant to this case.” However, he admitted at trial that determining the geographic market is an important issue in any antitrust case.

Panhandle’s regulatory expert, Mr. Williams, testified that an individual geographic area representing a concentration of demand along a pipeline can by itself be considered a market. (Williams 6665-6667).

The 37 county area identified in the Stipulation of Facts as the “Central Illinois Market” is made up of a series of local LDC service areas. (Tussing 3560-3577). All of the LDC’s in the Central Illinois Market purchased gas from Panhandle under the G or SG tariff. (PX 523). Each of them, therefore, were held contractually bound by virtue of Panhandle’s enforcement of the “sole supplier” provision of their G and SG tariff-contract arrangements.

A particularly important common characteristic of the Central Illinois Market is that, since at least 1983, competing producers in the gas-producing regions of Oklahoma, Colorado and Texas have sought access to LDC and end-use customers located within this area, where the Panhandle pipeline system has been the only effective physical means available for delivering the gas of the competing gas producers to the LDC’s and end-users. (Ballard dep. 14; Dar dep. 32-33; Kuenz dep. 13; Robinow-itz 2293, 2303, 2315; Rothchild 2533; D. Wilson 2274; PX 55). This situation was common to Panhandle’s entire system, as well as the service areas of many other competing pipelines in the Midwest and does not by itself establish the existence of a separate market in Central Illinois. It does, however, validate the Central Illinois Market as a legitimate submarket for analysis purposes, and it does indicate the existence of a barrier of entry into the market, no matter how the geographic market is defined.

Thus, the Court finds that the Central Illinois submarket of Panhandle’s system of G and SG LDC’s is the relevant geographic market.

C.

Panhandle held monopoly power over natural gas sales to LDC’s for use by residential/commercial customers within the Central Illinois Market.

Evidence at trial established that Panhandle significantly controlled access to the pipeline system, controlled the cost of gas, and was capable of segmenting the market and discriminating within the market. These facts, discussed below, lead the Court to find that Panhandle did possess monopoly power in the relevant market.

Panhandle controlled the only pipeline delivery system into all portions of the Central Illinois Market except the Peoria portion of CILCO’s service area.

As to the Peoria portion of CILCO’s service area, Panhandle’s pipeline was the sole connected pipeline into the area until November 1985; thereafter, because of FERC limitations on the use of the NGPL interconnect and tariff-contract constraints on CILCO’s purchases from other suppliers, Panhandle remained virtually the sole supplier of natural gas to CILCO. Thus, during the years from 1981 through 1986, Panhandle accounted for approximately

98%

of the gas purchased by CILCO. (Vergon 2844; Stipulations 1/30/87, ¶ 23).

Panhandle’s control over the exclusive pipeline delivery system into the Central Illinois Market has given it monopoly power over residential/commercial customers by virtue of its ability effectively to exclude competitive gas sales into the area. (Stillman 496-497; Tussing 3586-3587, 3806-3807). This has been made possible principally because of the barriers to entry by other pipelines, the major barrier being the regulations of the FERC and the G tariff.

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The experience of LDC’s within the Central Illinois Market during the period of prolonged gas shortages that existed between 1970 and 1978 showed their dependence on the Panhandle system; even though Panhandle cut back deliveries by as much as 40% during this period, the only responsive options of the LDC’s were to stop connecting new customers and to curtail service to existing customers. (Sam-burg 48; Slone 233-234; Hardy 6590-6591).

A particularly compelling example of Panhandle’s own recognition of its inherent monopoly power over LDC’s (and the residential/ commercial customers behind them) was a June 23, 1986 memorandum from R. Pemberton, Director of Marketing of Panhandle, to his superior D.B. Kelley, in which he discussed the ability of Panhandle to force its LDC customers to negotiate on take-or-pay and other matters by using “[t]he ‘stick’ ” of being able “to discontinue transportation ... at any time.” (PX 930).

An April 1, 1984 memorandum from Panhandle’s Langenkamp to J.T. Kennedy discussed the creation of a new brokerage entity to market spot gas for delivery through the Panhandle system, but added: “End-users located behind our distributors with no means other than Panhandle or Trunkline to have gas transported to them would not be assisted by our brokerage operation since we would not elect to compete with ourselves.” (PX 121).

Based upon Panhandle’s market share and control over pipeline transportation of gas, Arlon Tussing, an economic and regulatory expert for the State, concluded that Panhandle had monopoly power over both transportation and sales of natural gas for system supply to each of the individual LDC service areas located within the Central Illinois Market. (Tussing 3561-3587). Dr. Tussing further concluded that, in the aggregate, the service areas of such LDC’s included in the Central Illinois Market constituted an area within which Panhandle had monopoly power over gas transportation and sales. (Tussing 3576-3577).

A substantial portion of Panhandle’s service area is presently interconnected, both directly and indirectly, to other interstate pipelines. This includes all of Panhandle’s large partial requirements customers— MichCon, Michigan Gas Storage, East Ohio Gas Co., Columbia Gas Transmission Co.— and several of its G customers — IP, Michigan Gas Utilities Co., Southeastern Michigan Gas Co., Great River Gas Co., Ohio Gas Co., Northern Indiana Fuel and Light, Northern Indiana Public Service Co., Koko-mo Gas and Fuel Co., the Quincy service area of CIPS and the Peoria service area of CILCO.

As of the time of trial several of Panhandle’s large G customers had physical interconnections to other interstate pipelines or were engaged in efforts to effect such interconnections:

(1) IP was interconnected to NGPL and ANR, and NGPL had a Section 7(c) certificate to sell gas to Illinois Power Co.;

(2) Michigan Gas Utilities Co. had a physical connection to ANR;

(3) Ohio Gas Co. had a physical connection to ANR and had transported gas over that interconnection for its system supply;

(4) Great River Gas Co. in Missouri had a physical connection to ANR or NGPL in a service are contiguous to that which Panhandle served as a G customer. As of the time of trial Great River had made application to the FERC to interconnect its two service areas with the express intent of buying gas from both pipelines in both service areas;

(5) Northern Indiana Fuel and Light was interconnected to ANR;

(6) Southeastern Michigan Gas Co. was interconnected to ANR and Southeastern had transported gas over this interconnection for its system supply;

(7) Northern Indiana Public Service Co. was interconnected to several interstate pipelines;

(8) CILCO’s Peoria service area was interconnected to NGPL and ANR was constructing an interconnect to that service area in late. 1986;

(9) NGPL had offered to CILCO to construct an interconnect to CILCO’s Springfield, Illinois service area;

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(10) Citizens Gas & Coke Co. had notified Panhandle that it would interconnect with Texas Gas Transmission Co. (Kelley 6050-6052, 6059-6060, 6068-6069; DX 641).

CIPS purchased gas from six interstate pipelines: Panhandle, Texas Gas Transmission Company, Texas Eastern Transmission Company, TKL, NGPL and Midwestern Gas Transmission Company. Each supplier exclusively served a discrete service area of CIPS. (Houvenagle dep. 12-13). In the Summer of 1986 CIPS interconnected with Northern Illinois Gas to serve the Quincy area. (Houvenagle dep. 27). In 1983, CIPS identified to the ICC five potential interconnects which would serve to reduce the amount of gas purchased from Panhandle by 95%. These interconnects would be with NGPL and/or Michigan Wisconsin (ANR). (Houvenagle dep. 24-26; DX 1290).

In 1985, 54% of the volume of CIPS’ service area was served exclusively by Panhandle. (Houvenagle dep. 17-18). In 1984, between 54% and 56% of CIPS gas volumes were purchased from Panhandle. In 1983, 56% to 57%, and in 1982, 71% of CIPS volumes were purchased from Panhandle. (Houvenagle dep. 19).

CIPS cannot purchase the volumes presently purchased from Panhandle from another supplier and deliver those volumes into the areas supplied exclusively by Panhandle without transporting the gas over Panhandle. (Houvenagle dep. 21-22).

CIPS has three storage facilities which it uses on winter peak days to avoid exceeding its contract demand with Panhandle. CIPS could use these storage facilities to lower its gas costs in a limited way by injecting low cost gas into storage when such gas was available. (Houvenagle dep. 33-35).

It is feasible, through existing or potential interconnects on the Panhandle system for the partial duplication of Panhandle’s facilities to occur. Complete physical duplication is not necessary to achieve complete economic duplication. But under certain circumstances, complete physical duplication is possible. As of trial, Panhandle also faced some potential competition through new interconnects for sales and transports in both its G and LS service areas. This potential competition is illustrated by the following examples:

(a) Northern Border Pipeline has applied to extend their mainline facilities. (DX 1063). (Carpenter 7078-7079).

(b) The Texas Gas interconnect to Citizens Gas & Coke is greater than 30 miles and is feasible. (Carpenter 7270-7271).

(c) Midwestern Gas' Transmission Co. could interconnect with part of CILCO’s Tuscola service area currently served exclusively by Panhandle with the construction of a five-mile pipeline. (Vergon 3188-3192).

(d) ANR constructed an interconnect to CILCO on a self-implementing basis in late 1986. ANR currently has an agreement with Archer Daniels Midland Co. to transport gas over the interconnect.

(e) NGPL proposed to CILCO in July, 1985 construction of a new 60 mile long interconnect to CILCO’s Springfield service area at a cost of $21 million. This pipeline would be capable of delivering 100 Mcf per day.

(f) The existing ANR and NGPL interconnects to CILCO are presently capable of being used to transport gas for CILCO’s system supply.

(g) NGPL constructed a new interconnect with CILCO in late 1986 by using self-implementing blanket certificate authority and commenced transportation by December of 1986 for end-users on a self-implementing basis under § 311 of the NGPA. (Tussing 3758-3759).

(h) In 1986, ANR presented a proposal to CILCO which involved interconnecting with CILCO; then ANR would transport gas to industrial end-users behind CILCO. (Doyle 5173). On September 18, 1986, ANR sent Keystone a letter offering to transport gas for Keystone over the interconnect once it was completed. (DX 1444).

(i) Keystone began receiving gas it purchased from Mid-Con Marketing Corp. over NGPL in October or November, 1986. Mid-Con Marketing is a subsidi

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ary of Mid-Con Corporation, which also owns NGPL. In December, 1986, Keystone took more gas over NGPL than over Panhandle. (Doyle

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