# Transcontinental Gas Pipe Line Corp. v. State Oil & Gas Board

> Supreme Court of the United States · March 24, 1986 · 474 U.S. 409

URL: https://www.frixlaw.com/law-library/cases/9430270

## Case

- **Full name:** TRANSCONTINENTAL GAS PIPE LINE CORP. v. STATE OIL AND GAS BOARD OF MISSISSIPPI Et Al.
- **Court:** Supreme Court of the United States
- **Decided:** March 24, 1986
- **Citations:** 474 U.S. 409; 106 S. Ct. 709; 88 L. Ed. 2d 732; 1986 U.S. LEXIS 47
- **Precedential status:** Published
- **Opinion:** Dissent by Rehnquist
- **Judges:** Blackmun, Brennan, Burger, Rehnquist, White
- **Cited by:** 88 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/9430270

## How later opinions describe it (automated extraction)

- explaining that “a federal decision to forgo regulation in a given area may imply an authoritative federal determination that the area is best left unregulated, and in that event would have as *1084 much preemptive force as a decision to regulate”
- reversing judgment of Mississippi Supreme Court that NGPA had vitiated Northern Natural Gas
- finding this brand of field preemption

## Opinion text

Justice Rehnquist,
with whom Justice Powell, Justice Stevens, and Justice O’Connor join, dissenting.
Section 601(a)(1) of the Natural Gas Policy Act of 1978 (NGPA), 92 Stat. 3409 , 15 U. S. C. § 3431 (a)(1), removes the wellhead sales of “high-cost natural gas” from the coverage of the Natural Gas Act (NGA), 15 U. S. C. §§717 -717w. Section 121(b) of the NGPA, 15 U. S. C. § 3331 (b), exempts such gas from any lingering price controls under the NGPA. The Court nonetheless holds that Mississippi’s application of its ratable-take rule to high-cost gas in order to “do equity between and among owners in a common pool of deregulated gas,” App. to Juris. Statement 28a, is pre-empted by the NGA and NGPA. The Court’s opinion misuses the preemption doctrine to extricate appellant Transcontinental Gas Pipe Line Corp. (Transco) from a bed it made for itself. I dissent because I do not believe that Mississippi’s ratable-take rule invades the exclusive sphere of the NGA, conflicts with the NGPA’s purpose of decontrolling the wellhead price of high-cost gas, or runs afoul of the implicit free market policy of the dormant Commerce Clause.
The imposition of a ratable-take rule is a familiar solution of oil and gas law to the problem of “drainage” in a commonly *426 owned gas pool. 1 When several individuals own gas in a common pool, each has an incentive to remove and capture as much gas as rapidly as possible in order to prevent others from “draining away” his share of the gas reserves. This practice results in a much faster removal rate than a single owner of the same pool would choose, and makes it more difficult to obtain the last amounts of gas in a pool. A ratable-take rule eliminates the perverse incentives of common ownership that otherwise give rise to such economic waste and sharp practice. See Champlin Refining Co. v. Oklahoma Corporation Comm’n, 286 U. S. 210, 233 (1932).
The controversy in this case centers around the Harper Sand Gas Pool (Harper Pool), which is a pool of “high-cost natural gas” within the definition of that term in § 107(c)(1) of the NGPA, 15 U. S. C. § 3317 (c)(1), because it lies more than 15,000 feet beneath the ground and surface drilling for its gas began in 1978. 2 By 1982, there were six wells drawing gas from the Harper Pool. Three were operated by Getty Oil Co., two by the Florida Exploration Co., and one by Tomlinson Interests, Inc. These operators were only part owners of the gas drawn up through their respective wells. *427 They shared ownership rights with a large number of other parties including appellee Coastal Exploration, Inc.
Appellant Transco is an interstate pipeline company that purchases gas from the various owners of the Harper Pool. As each well was drilled between 1978 and 1982, Transco entered into long-term contracts with the well operators to ensure future gas supplies at a fixed price. In this way, Transco bound itself to purchase, and the well operators bound themselves to supply, the well operators’ shares of the gas drawn from the common pool. Transco also agreed to a “take-or-pay” clause in each contract, thereby promising to pay the well operators for their shares of the potential gas streams whether or not it took immediate delivery of the gas.
Until May 1982, Transco also purchased the production shares of all of the nonoperating owners. It did so by spot market purchases at prices roughly equal to those it was paying to the contract owners rather than pursuant to fixed-price long-term supply contracts. But Transco announced in May 1982 that, because of a glut in the natural gas market, it would no longer purchase gas on the spot market from the noncontract owners of the Getty and Tomlinson wells. Coastal, which had an ownership interest in gas from one of the Getty wells, thereupon attempted to sell its share of the gas on the spot market to another pipeline company. Failing in this attempt, it then offered to sign a long-term supply contract with Transco on terms identical to those in Transco’s contract with Getty. Transco refused Coastal’s offer, and made a counteroffer to Coastal which was in turn refused.
Coastal and various noncontract owners then sought relief from the Mississippi Oil and Gas Board (Board), arguing that Transco’s disproportionate purchasing of gas from the Harper Pool violated the Board’s ratable-take rule (Rule 48), which provides:
“Each person now or hereafter engaged in the business of purchasing oil or gas from owners, operators, or producers shall purchase without discrimination in favor *428 of one owner, operator, or producer against another in the same common source of supply.” Statewide Rule 48 of the State Oil and Gas Board of Mississippi as set forth in App. to Juris. Statement 129a.
Transco opposed the relief sought by Coastal because enforcement of the rule would require Transco to purchase the same percentage of each owner’s share of the pool’s allowable production as it purchased from any other owner’s share. Because of the “take-or-pay” obligations in its contracts with the operating owners, this would require it either to take more gas than it could profitably sell to its interstate customers or to pay the operating owners for the percentage of their shares that it did not presently take. Transco therefore urged the Board to reduce the allowable production from the common pool to reflect current market demand or to substitute a “ratable-production” rule for the existing “ratable-take” rule. Had the Board acceded to Transco’s proposals, Transco’s liability for its realized downside contractual risk resulting from the take-or-pay clauses would have been limited or avoided at the expense of the operating owners with whom it contracted. The Board instead ruled in favor of Coastal and against Transco, finding, inter alia:
“Transco’s course of conduct has been to discriminate against the owners (like Coastal) of relatively small undivided working interests in the . . . [w]ells and the common pool produced by the wells simply because they are owners of relatively small undivided interests.
“The Board finds that Transco’s refusal to ratably take and purchase without discrimination Coastal’s share of gas produced from the said common pool from which Transco is purchasing the operators’ gas produced from the common pool by [the] very same wells and other wells completed into the common pool (1) is discriminatory in favor of the operators against Coastal and thereby violates Rule 48 . . . ; (2) constitutes ‘waste’. . . *429 because, among other things, it abuses the correlative rights of Coastal in the common pool, results in nonuniform, disproportionate and unratable withdrawals of gas from the common pool causing undue drainage between tracts of land, and will have the effect and result of some owners in the pool producing more than their just and equitable share of gas from the common pool to the detriment of Coastal . . . App. to Juris. Statement 110a-llla.
The Board’s order was affirmed by the Circuit Court of Hinds County, Mississippi, and affirmed by the Supreme Court of Mississippi insofar as it required ratable taking, despite Transco’s claims of federal pre-emption and violation of the Commerce Clause. 457 So. 2d 1298 (1984).
The Court now reverses on pre-emption grounds. It holds that the ratable-take rule as applied to high-cost gas is preempted under the reasoning of Northern Natural Gas Co. v. State Corporation Comm’n of Kansas, 372 U. S. 84 (1963), even though the NGPA removed the wellhead sales of such gas from the coverage of the NGA. I believe that the NGPA’s removal of such gas from the NGA takes this case outside the purview of Northern Natural, and that a ratable-take rule such as that imposed by Mississippi is consistent with the NGPA’s purpose of decontrolling the wellhead price of high-cost gas.
Congress passed the NGA in 1938 in response to this Court’s holding that the Commerce Clause prevented States from directly regulating the wholesale prices of natural gas sold in interstate commerce. See Missouri v. Kansas Natural Gas Co., 265 U. S. 298 (1924). The purpose of the NGA was “to occupy the field of wholesale sales of natural gas in interstate commerce.” Exxon Corp. v. Eagerton, 462 U. S. 176, 184 (1983). Section 1(b) of the NGA, 52 Stat. 821 , 15 U. S. C. § 717 (b), defined the NGA’s scope:
“The provisions of this Act shall apply to the transportation of natural gas in interstate commerce, to the sale in *430 interstate commerce of natural gas for resale for ultimate public consumption for domestic, commercial, industrial, or any other use, and to natural gas companies engaged in such transportation or sale, but shall not apply to any other transportation or sale of natural gas or to the local distribution of natural gas or to the facilities used for such distribution or to the production and gathering of natural gas.” (Emphasis added.)
Initially, the Federal Power Commission (predecessor to the Federal Energy Regulatory Commission (FERC)) interpreted § 1(b) to extend the NGA’s coverage to gas sales at the downstream end of interstate pipelines, but not to sales by local producers to interstate pipelines. See, e. g., Phillips Petroleum Co., 10 F. P. C. 246 (1951); Natural Gas Pipeline Co., 2 F. P. C. 218 (1940). In 1954, however, this Court gave § 1(b) a broader reading. See Phillips Petroleum Co. v. Wisconsin, 347 U. S. 672 (1954). It interpreted the NGA as creating exclusive federal jurisdiction over the regulation of natural gas in interstate commerce, and § 1(b) as extending the NGA’s coverage to both downstream and local sales, though not to the production and gathering of natural gas. Id., at 677-678; see also id., at 685-686 (Frankfurter, J., concurring).
Northern Natural Gas Co. v. State Corporation Comm’n of Kansas, supra, was decided against this backdrop. In Northern Natural, the Court held that a state ratable-take rule as applied to the purchases of natural gas by interstate pipelines was pre-empted by the NGA because it constituted an “inva[sion into] the exclusive jurisdiction which the Natural Gas Act has conferred upon the Federal Power Commission over the sale and transportation of natural gas in interstate commerce for resale.” Id., at 89. The Court rejected the argument that ratable-take rules “constitute only state regulation of the ‘production or gathering’ of natural gas, which is exempted from the federal regulatory domain by the terms of § 1(b) of the Natural Gas Act.” Id., at 89-90. It *431 explained that because such rules apply to purchasers, they involve the regulation of wellhead sales. Id., at 90. It also rejected the argument that they do not “threate[n] any actual invasion of the regulatory domain of the Federal Power Commission since [they] ‘in no way involv[e] the price of gas.’” Ibid, (emphasis added). The Court reasoned that the NGA “leaves no room either for direct state regulation of the prices of interstate wholesales of natural gas, ... or for state regulations which would indirectly” regulate price. Id., at 91. Because ratable-take rules apply to purchasers, they indirectly regulate price and therefore “invalidly invade the federal agency’s exclusive domain” of sales regulation. 3 Id., at 92. Finally, the Court explained that although “States do possess power to allocate and conserve scarce natural resources upon and beneath their lands,” id., at 93, they may not use means such as ratable-take rules that “threaten effec-tuation of the federal regulatory scheme.” Ibid.
The NGPA was passed in 1978 in response to chronic interstate gas shortages caused by price ceilings imposed pursuant to the NGA. Its purpose was to decontrol the wellhead price of natural gas sold to interstate pipelines, allowing prices to rise according to market conditions and causing shortages to vanish. To accomplish this purpose, it divided *432 the supply of gas into three major categories: high-cost gas, new gas, and old gas. See Pierce, Natural Gas Regulation, Deregulation, and Contracts, 68 Va. L. Rev. 63 , 87-89 (1982). It removed the wellhead sales of high-cost and new gas from the coverage of the NGA. NGPA § 601(a)(1)(B), 15 U. S. C. § 3431 (a)(1)(B). It then established formulas for the gradual decontrol of the wellhead prices of such gas. See NGPA §§ 102(b), 103(b), 107(a), 15 U. S. C. §§ 3312 (b), 3313(b), 3317(a). The wellhead price of high-cost gas was totally decontrolled in November 1979. See NGPA § 121(b), 15 U. S. C. § 3331 (b); Pierce, supra, at 87-88. Ceilings continue to apply to the wellhead prices of old gas. See id., at 88-89. Because gas from the Harper Sand Gas Pool qualifies as high-cost gas, the NGA no longer covers its wellhead price. Moreover, to the extent the NGPA ever controlled the wellhead prices of such gas, cf. Public Service Comm’n of New York v. Mid-Louisiana Gas Co., 463 U. S. 319 (1983), those controls have long since been eliminated. 4 Therefore, Northern Natural does not govern this case. Rather, the issue is whether Mississippi’s ratable-take rule stands as an obstacle to the full accomplishment of the NGPA’s purpose. See Silkwood v. Kerr-McGee Corp., 464 U. S. 238, 248 (1984).
The purpose of the NGPA with respect to high-cost gas is to eliminate governmental controls on the wellhead price *433 of such gas. 5 State regulation that interferes with this purpose is pre-empted. See Arkansas Electric Cooperative Corp. v. Arkansas Public Service Comm’n, 461 U. S. 375, 384 (1983). State regulation that merely defines property rights or establishes contractual rules, however, does not interfere with this purpose. Markets depend upon such rules to function efficiently.
Ratable-take rules serve the twin interests of conservation and fair dealing by removing the incentive for “drainage.” On its face, the ratable-take rule here is completely consistent with the free market determination of the wellhead price of high-cost gas. Like any compulsory unitization rule, it gives joint owners the incentive to price at the same level as a single owner. But it will not affect the spot market price of gas in any other way. It is similarly price neutral in the context of long-term contracting. The rule is merely one of a number of legal rules that regulates the contractual relations of parties in the State of Mississippi as in other States. The *434 Court, however, seems to equate Mississippi’s rule requiring equitable dealing on the part of pipeline companies purchasing from common owners of gas pools as akin to a tax or a subsidy, both of which do tend to distort free market prices.
Unlike taxes or subsidies, however, rules regulating the conditions of contracts have only an attenuated effect on the operation of the free market. Their effect is often to promote the efficient operation of the market rather than to inhibit or distort it the way a tax or subsidy might. A ratable-take rule applied to a common pool eliminates the inefficiencies associated with the perverse incentives of common ownership of a gas pool. It is different from a rule that would require any out-of-state pipeline that purchases gas from one in-state pool of gas to purchase equal amounts from every other in-state pool. This latter type of rule might well burden interstate commerce or violate the free market purpose of the NGPA. But a ratable-take rule applied to a common pool promotes, rather than inhibits, the efficiency of a competitive market. Moreover, States have historically included ratable-take rules in developing the body of law applicable to natural gas extraction. See, e. g., Champlin Refining Co. v. Corporation Comm’n of Oklahoma, 286 U. S. 210, 233 (1932); Cities Service Gas Co. v. Peerless Oil & Gas Co., 340 U. S. 179 (1950). One may agree that Congress wished to return to the free market determination of the price of high-cost gas without concluding that Mississippi’s ratable-take rule frustrates that wish.
Rule 48 was promulgated by the Mississippi Board long before the enactment of the NGPA, and the fact that it had not previously been applied to this type of transaction affords no argument against its validity based on federal pre-emption. Indeed, the implication in the Court’s opinion that a midstream expansion in the coverage of a state regulation justifies pre-emption if the party to whom the rule is applied claims disappointed expectations is nothing less than Contract Clause jurisprudence masquerading as pre-emption. A *435 party runs the risk of reasonably foreseeable applications of new principles of state law to its activities, see Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U. S. 400 (1983), and that is the most that can be said to have happened here. The only reason the ratable-take rule has any adverse effect on Transco is that Transco entered supply contracts with the well operators that included “take-or-pay” obligations. The NGPA gives Transco no basis for insisting that state law be frozen as of the moment it entered the “take-or-pay” agreements, protecting it from the imposition of any additional correlative obligations to noncontracting owners. 6
Because of my conclusion that Mississippi’s ratable-take rule is not pre-empted, I also address appellant’s contention that the rule violates the “dormant” Commerce Clause. The analysis is much the same as under the NGPA. Indeed, the implicit “free market” purpose of that Clause would seem to add little to the express congressional purpose to decontrol prices, which is the focus of the pre-emption analysis. Here the statute regulates evenhandedly to effectuate a legitimate local public interest — the interest in both fair dealing on the part of joint owners and conservation — and its effects on interstate commerce are incidental at most. The question of burden, therefore, is “one of degree,” Pike v. Bruce Church, Inc., 397 U. S. 137, 142 (1970).
In Cities Service Gas Co. v. Peerless Oil & Gas Co., supra, this Court held that ratable-take rules do not violate the dormant Commerce Clause because they do not place a significant burden on the out-of-state interests in a free market. *436 That analysis should control this case. Transco’s interest in a free market is not significantly burdened because the ratable-take rule creates no discriminatory burden independent of Transco’s supply contracts. The validity of a state rule should not depend on whether, in combination with private contracts, it contributes to a short-run burden. Similarly, enforcement of the ratable-take rule in combination with the take-or-pay obligations does not significantly burden the free-market interest of out-of-state natural gas consumers because the combination will have virtually no effect on consumer prices. High-cost gas makes up only a tiny fraction of the aggregate supply of natural gas. See Pierce, 68 Va. L. Rev., at 88, n. 98 (about 1%). Thus, any increased costs associated with it will tend to be a mere drop in the bucket. Moreover, the rule leaves pipelines free to minimize their losses by simply paying the contract owners their contractual due, and to pay no more than the current spot market price for any noncontract gas it takes. Therefore, enforcement of the rule is unlikely to affect the downstream price that consumers will pay in any significant way.
Nor was it unreasonable for Mississippi to enforce its ratable-take rule when a “ratable-production” rule might have been a less restrictive means of serving the State’s legitimate conservation interest. The burden on interstate commerce imposed by the “ratable-take” rule is so minimal and attenuated that there is no occasion to inquire into the existence of a “less restrictive” means. Moreover, a “ratable-production” rule, as even appellant Transco agrees, would place greater administrative and enforcement burdens on the Mississippi regulatory authorities:
“[A]n order directed to the purchaser of the gas rather than to the producer would seem to be the most feasible method of providing for ratable taking, because it is the purchaser alone who has a first-hand knowledge as to whether his takes from each of his connections in the field are such that production of the wells is ratable. An *437 order addressed simply to producers requiring each one to produce ratably with others with whose activities it is unfamiliar and over whose activities it has no control would create obvious administrative problems.” Northern Natural Gas Co. v. State Corporation Comm’n of Kansas, 372 U. S., at 100-101 (Harlan, J., dissenting) (footnotes omitted).
I believe that Mississippi’s ratable-take rule as applied to high-cost gas offends neither FERC’s jurisdiction, the applicable provisions of the NGPA, or the Commerce Clause. I would therefore affirm the judgment of the Supreme Court of Mississippi.
The withdrawal of gas from a common pool causes changes in pressure, resulting in the migration and spreading out of the remaining gas over the entire pool. This migration is called “drainage” because, from the viewpoint of each owner, the withdrawal of gas by another causes gas to migrate or “drain” away from his end of the pool.
The NGPA defines “high-cost natural gas” as any gas
“(1) produced from any well the surface drilling of which began on or after February 19, 1977, if such production is from a completion location which is located at a depth of more than 15,000 feet;
“(2) produced from geopressured brine;
“(3) occluded natural gas produced from coal seams;
“(4) produced from Devonian shale; and
“(5) produced under such other conditions as the Commission determines to present extraordinary risks or costs.” NGPA § 107(c), 92 Stat. 3366 , 15 U. S. C. § 3317 (c).
In Silkwood v. Kerr-McGee Corp., 464 U. S. 238 (1984), this Court explained that “state law can be pre-empted in either of two general ways.” Id., at 248 .
“If Congress evidences an intent to occupy a given field, any state law falling within that field is pre-empted. ... If Congress has not entirely displaced state regulation over the matter in question, state law is still preempted to the extent it actually conflicts with federal law, that is, when it is impossible to comply with both state and federal law, ... or where the state law stands as an obstacle to the accomplishment of the full purposes and objectives of Congress.” Ibid.
The reasoning of Northern Natural is that a state ratable-take rule is preempted if it invades the jurisdictional coverage of a statute that falls within the first category of the Kerr-McGee pre-emption test — statutes designed to “occupy a given field” to the exclusion of state regulation.
FERC’s remaining jurisdiction to prevent interstate pipelines from fraudulently, abusively, or otherwise illegitimately passing on higher wellhead prices to ultimate consumers, see 15 U. S. C. § 3431 (c)(2), does not include jurisdiction over wellhead price levels. Cf. Exxon Corp. v. Eagerton, 462 U. S. 176, 184 (1983) (state statute directly prohibiting interstate pipelines from passing on severance tax to consumers invades FERC’s pass-on jurisdiction); Maryland v. Louisiana, 451 U. S. 725, 746-752 (1981) (state statute indirectly requiring interstate pipelines to pass on severance tax to consumers invades FERC’s pass-on jurisdiction); id., at 747, n. 22 (question whether tax conflicted with FERC’s authority to control price of gas expressly reserved).
The majority also mentions “supply” and “demand” as economic variables that Congress intended to decontrol. There is no support for this in the legislative history, and the use of these variables unnecessarily complicates and distorts the pre-emption analysis. The NGPA was concerned with supply only to the extent that price ceilings create shortages. The Court has always acknowledged that conservation of the supply of natural gas is traditionally a function of state power. See, e. g., Northern Natural Gas Co. v. State Corporation Comm’n of Kansas, 372 U. S. 84, 93 (1963). Thus, it has upheld the common state practice of placing ceilings, called “allowables,” on the amount of gas that a particular well or pool may produce during a given period. See, e. g., Champlin Refining Co. v. Corporation Comm’n of Oklahoma, 286 U. S. 210 (1932). Such absolute restrictions on output have the potential of raising wellhead prices above competitive equilibrium. Ratable-take rules, by themselves, do not.
There is even less reason to infer a purpose to decontrol demand. To the extent central planners even have the power to control demand, their control is limited to the manipulation of output and price. Planners have no obvious control over individual preferences. It therefore makes little sense to consider “demand” to be an independent object of the NGPA’s decontrol purpose.
Nor does the ratable-take rule conflict with the NGPA’s alleged uniformity or consumer protection purposes. While the congressional desire to decontrol prices uniformly throughout the Nation includes an intent to prevent States from enacting regulation to re control them, it does not imply an intent either to create an anarchistic regulatory gap free from property rights and contract rules, or to create a national law of contracts to govern natural gas relationships.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/9430270. Public record. Not legal advice.