Appendix — AMER-RADA HESS CORP. v. FEDERAL ENERGY REGULATORY COMMISSION (Nos. 77-697, 77-695)

Supreme Court brief1977

Ask Donna

What actually matters in this document.

Text

Supreme Court, U. S.

FILED

} NOV 15 1977

MICHAEL RODAK, JR., CLERK |

In The

SUPREME COURT OF THE UNITED STATES

October Term, 1977

no. FY -697

AMERADA HESS CORPORATION, ET AL.

Petitioners,

Vv.

FEDERAL ENERGY REGULATORY COMMISSION,

Respondent.

APPENDICES A & B TO

CONDITIONAL CROSS-PETITION FOR

A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE DISTRICT OF COLUMBIA CIRCUIT

APPENDIX A

made before the bound volumes go to press.

THE SECOND NATIONAL NATURAL GAS RATE CASES

No. 76-2000, et al.

AMERICAN PUBLIC GAS ASSOCIATION, et al., PETITIONERS °

Vv.

FEDERAL POWER COMMISSION, RESPONDENT *

* Consolidated with the following cases (identified by this

Circuit’s case number and petitioner) originally arising in

or transferred to this Circuit, in all of which the Federal

Power Commission is the respondent:

Originally filed in this Circuit: 76-2001, Senators James

Abourezk, John Durkin, and William Proxmire, and Repre-

sentatives Les Aspin, Berkley Bedell, William Brodhead, et al.;

76-2041, United Distribution Companies; 76-2053, Tennessee

Public Service Commission ; 76-2069, Phillips Petroleum Com-

pany; 76-2072, Public Service Commission of the State of

New York; 76-2108, Marathon Oil] Company; 76-2108, Belco

Petroleum Corporation ; 76-2137, Associated Gas Distributors;

76-2147, Laclede Gas Company; 77-1005, Mountain Fuel Sup-

ply Company; 77-1016, Ashland Oil, Inc.; 77-1022, Gulf Oil

Corporation :

From the First Circuit: 77-1117, Cabot Corporation;

From the Second Circuit: 77-1126, Mobil Oil Corpora-

tion; 77-1127, Exxon Corporation ;

From the Third Circuit: 77-1139, Texaco, Inc.; 77-1140,

Gulf Oil Corporation; 77-1141, Sohio Petroleum Company;

From the Fifth Circuit: 77-1039, Continental Oil Com-

pany; 77-1062, Superior Oil Company; 77-1060, Tenneco Oil

Petitions for Review of Orders of the

Federal Power Commission

Argued March 23, 1977

March 24, 1977

Decided June 16, 1977

Charles F. Wheatley, Jr., with whom William T. Miil-

ler and Stanley W. Balis were on the brief for petitioners

in No. 76-2000 and intervenors, American Public Gas

Association, et al.

James L. Feldesman was on the brief for petitioner,

Consumer Federation of America in No. 76-2000.

Warren Spannaus, Attorney General, State of Minne-

sota was on the brief for petitidner, State of Minnesota

in No. 76-2000.

Company ; 77-1063, General American Oil Company of Texas;

77-1064, Placid Oil Company; 77-1065, Shell Oil Company;

77-1066, Aminoil USA, Inc., et al.; 77-1067, Pennzoil Com-

pany, et al.; 77-1068, Aztec Oil and Gas Company; 77-1069,

Austral Oil Company, Inc; 77-1070, Enserch Exploration,

Inc.; 77-1071, Hunt Oil Company, et al.; 77-1072, Freeport

Minerals Company; 77-1073, Inexco Oil Company; 77-1074,

Ecee, Inc., et al.; 77-1075, Louisiana Land and Exploration

Company, et al.;

From the Seventh Circuit: 77-1120, Amoco Production

Company; 77-1121, Natural Gas Pipeline Company of

America;

From the Ninth Circuit: 77-1219, Getty Oil Company;

77-1220, Atlantic Richfield Company; 77-1221, Union Oil

Company;

From the Tenth Circuit: 77-1118, Kerr-McGee Corpora-

tion; 77-1119, Cities Service Oil Company; 77-1288, Skelly

Oil Company.

Cee ae Beng

Rodney A. Wilson, Special Assistant Attorney General,

State of Minnesota was on the brief for petitioner, Minne-

sota Public Service Commission in No. 76-2000.

Steven M. Schur, Chief Counsel, Public Service Com-

mission of Wisconsin was on the brief for petitioner,

Public Service Commission of Wisconsin in No. 76-2000.

David B. Graham was on the brief for petitioner,

Natural Rural Electric Cooperative Association in No.

76-2000.

John Gunther was on the brief for petitioner, United

States Conference of Mayors in No. 76-2000.

James F. Flug was on the brief for petitioner, Energy

Action Committee in No. 76-2000.

Stephen Schlossberg was on the brief for petitioner,

United Automobile, Aerospace and Agriculture Imple-

ment Workers of America in No. 76-2000.

Frank W. Frisk, Jr., was on the brief for petitioner,

American Public Power Association in No. 76-2000.

Charles Brannan was on the brief for petitioner, Na-

tional Farmers Union in No. 76-2000.

Lee D. Sinclair was on the brief for petitioner, Na-

tional Farmers Organization in No. 76-2000.

Leslie G. Foschio, Corporation Counsel, Buffalo, New

York was on the brief for petitioner, City of Buffalo,

New York in No. 76-2000.

William Straub, Erie County Attorney, was on the

brief for petitioner County of Erie, New York in No.

76-2000. James L. Magavern also entered an appearance

for petitioner in No. 76-2000.

Geoffrey L. Brazier was on the brief for petitioner,

Montana Consumer Counsel in No. 76-2000.

Felix G. Forlenza was on the brief for petitioner, New

Jersey Board of Public Utility Commissioners in No.

76-2000. Carla Vivian Bello also entered an appearance

for petitioner, New Jersey Board of Public Utility Com-

missioners in No. 76-2000.

Daniel Guttman, with whom Alan Roth was on the

brief for petitioners, in No. 76-2001 and intervenors

Senators James Abourezk, et al.

Richard A. Solomon, with whom Peter H. Schiff, Gen-

eral Counsel, Public Service Commission of the State of

New York and Sheila S. Hollis were on the brief, for pe-

titioner in No. 76-2072 and intervenor The Public Serv-

ice Commission of the State of New York.

Frederick Moring, with whom Philip M. Marston was

on the brief for petitioner in Nos. 76-2137 and 77-1013

and intervenors, Associated Gas Distributors. Dana Con-

tratto also entered an appearance for intervenor, As-

sociated Gas Distributors.

John F. Bates, with whom Robert S. Campbell, Jr.,

and R. G. Groussman, were on the brief, for petitioner

in No. 77-1005.

C. William Cooper and Tilford A. Jones for petitioners

in No. 76-2041 and intervenor United Distribution Com-

panies.

Gordon Gooch, with whom Charles M. Darling, IV,

John M. Young, Michael B. Silva and Phyllis Rainey

were on the brief, for petitioners in Nos. 77-1060 and

77-1067 and intervenors, Pennzoil Company, et al. and

Tenneco Oi! Company, et al.

Thomas G. Johnson for petitioner in No. 77-1065 and

intervenor, Shell Oil Company.

J. Evans Attwell, with whom Judy M. Johnson was

on the brief for petitioners in Nos. 76-2108, 77-1068,

pepe ee ae eee

77-1069 and intervenors, Austral Oil Company, Inc.,

Aztec Oil and Gas Company, Belco Petroleum Corpora-

tion and Transocean Oil, Inc.

Bernard A. Foster, III, with whom H. H. Hillyer, Jr.,

was on the brief for petitioners in No. 77-1075.

Paul W. Mallory, with whom Joseph M. Wells, Paul

E. Goldstein and Harry L. Albrecht were on the brief,

for petitioner in No. 77-1121 and intervenor, Natural

Gas Pipeline Company of America in Nos. 76-2053, 76-

2041 and 76-2072.

Drexel D. Journey, General Counsel Federal Power

Commission and Patrick J. Keeley, Attorney Federal

Power Commission with whom Robert W. Perdue, Deputy

General Counsel and Allan Abbot Tuttle, Solicitor, Fed-

eral Power Commission were on the brief, for respondent.

Philip R. Telleen, Attorney, Federal Power Commission

also entered an appearance for respondent.

John L. Williford was on the brief, for petitioner in

No. 76-2069 and intervenor Phillips Petroleum Company.

B. James McGraw and A. Randall Friday were on the

brief, for petitioner in Nos. 77-1022 and 77-1140 and

intervenor, Gulf Oil Corporation.

Derrill Cody and Patricia D. Robinson were on the

brief for petitioner in No. 77-1118 and intervenor Kerr-

McGee Corporation.

Tom P. Hamill, R. D. Haworth and Roscoe Elmore

were on the brief for petitioner in No. 77-1126 and in-

tervenor Mobil Oil Corporation.

W. B. Wagner, Jr., Pat E. Timmons, James M. Dun-

nam and David Bonderman were on the brief for pe-

titioner in No. 77-1052 and intervenor, The Superior Oil

Company.

Martin N. Erck, Paul W. Wright and Edmunds Travis,

Jr., were on the brief for petitioner in No. 77-1127 and

intervenor Exxon Corporation.

David M. Whitney was on the brief for petitioner in

No. 77-1066 and intervenors, Aminoil Production Com-

pany.

Wm. H. Emerson was on the brief for petitioner in

No. 77-1120 and intervenor Amoco Production Company.

R. F. Generelly was on the brief for petitioner in No.

77-1016 and intervenors Ashland Oil, Inc. and General

American Oil Company of Texas and also entered an

appearance for petitioner in No. 77-1063.

E. J. Kremer and D. Aston were on the brief for pe-

titioner in No» 77-1220 and intervenor Atlantic Rich-

field Company.

Edwin S. Nail was on the brief for petitioner in No.

77-1117 and intervenor Cabot Corporation.

Robert S. Wheeler and Sam Riggs, Jr., were on the

brief for petitioner in No. 77-1119 and intervenor Cities

Service Oil Company.

Tom Burton and John M. Badger were on the brief

for petitioner in No. 77-1039 and intervenor Continental

Oil Company. Gordon Gooch and Charles M. Darling,

IV, also entered an appearance for petitioner in No.

77-1039.

Scott P. Anger was on the brief for petitioner in No.

77-1070 and intervenor Enserch Exploration, Inc.

Wm. Neal Powers, Jr., was on the brief for petitioners

in Nos. 77-1072 and 77-1074 and intervenors Freeport

Minerals Company, Ecee, Inc., et al. and Estate of E.

Cockrill, Jr., et al.

Cloy D. Monzingo was on the brief for petitioner in

No. 77-1219 and intervenor Getty Oil Company. Jack

ae 6 heel Beal) > ~ toe ee.

L. Brandon also entered an appearance for Intervenor

Getty Oil Company.

Robert W. Henderson was on the brief for petitioners

in No. 77-1071 and intervenors, Hunt Oil Company, et

al.

Artiur S. Berner was on the brief for petitioner in

No. 77-1073 and intervenor, Inexco Oil Company. Wm.

Neal Powers, Jr., also entered an appearance for pe-

titioner in No. 77-1073.

William A. Sackman was on the brief for petitioner in

No. 76-2103 and intervenor Marathon Oil Company.

Paul W. Hicks was on the brief for petitioner in No.

77-1064 and intervenor Placid Oil Company. Jimmy C.

Bailey also entered an appearance for petitioner in No.

77-1064 and intervenor Placid Oil Company.

Richard F. Remmers was on the brief for petitioner

in No. 77-1141 and intervenor Sohio Petroleum Company.

Roger L. Brandt was on the brief for petitioner in

No. 77-1139 and intervenor, Texaco, Inc. William T.

Benham also entered an appearance for intervenor Tex-

aco, Inc.

Kenneth L. Riedman, Jr., and Richard F. Wornson

were on the brief for petitioner in No. 77-1221 and in-

tervenor Union Oil Company of California.

Gordon P. MacDougall, Special Assistant Counsel,

Commonwealth of Pennsylvania was on the brief for in-

tervenors Commonwealth of Pennsylvania and Pennsy)-

vania Public Utilities Commission in No. 76-2000.

Harold B. Scoggins, Jr., was on the brief for inter-

venor, Independent Petroleum Association of America in

Nos. 76-2000 and 76-2001.

Frank P. Saponaro, Jr., and J. Randolph Elliott were

on the brief for intervenor Statex Petroleum, Inc.

Gordon Gooch was on the brief for intervenors, Fel-

mont Oil Corporation, Coquina Oil Corporation and The

Rodman Company.

A. S. Lacy, was on the brief for intervenor Alabama

Gas Corporation in No. 76-2000.

Ben Stead, Assistant Attorney General for the Public

Utilities Commission of the State of South Dakota was

on the brief for intervenor Public Utilities Commission

State of South Dakota.

M. Howard Petricoff and Henry J. Bourguignon filed

a brief on behalf of the City of Toledo, Ohio as amicus

curiae urging reversal.

Philip C. Wrangle filed a brief on behalf of Sonat

Exploration Company and the Offshore Company as

amicus curiae urging reversal.

J. Evans Attwell and Judy M. Johnson filed a brief

on behalf of Small Producers as amicus curiae urging

reversal.

Eugene W. Ward and T. E. Midyett, Jr., entered ap-

pearances for petitioner in No. 76-2053.

J. David Mann, Jr. entered an appearance for pe-

titioner in No. 76-2147 and intervenor Laclede Gas Com-

pany.

H. Lamar Curtis entered an appearance for intervenor

J. M. Huber Corporation.

Jerome J. McGrath entered an appearance for inter-

venor, Interstate Natural Gas Association of America.

Ronald E. Jarrett and Ronald J. Jacobs entered ap-

pearances for intervenor, Skelly Oil Company.

James D. Olsen entered an appearance for intervenor

Sun Oi] Company (Delaware).

George W. Hugo and Bruce F. Kiely entered an ap-

pearance for intervenor Texas Gulf, Inc.

Thomas W. Lynch entered an appearance for inter-

venor Texas Pacific Oil Company, Inc.

Peter W. Hanschen, Malcolm H. Furbush and Daniel

E. Gibson entered appearances for intervenor Pacific

Gas and Electric Company.

David G. Stevenson entered an appearance for inter-

evnor Amerada Hess Corporation.

Justin R. Wolf entered an appearance for intervenors

The California Company, et al. and Chevron Oil Com-

pany Western Division.

T. Brooke Farnsworth and Wm. Neal Powers entered

appearances for intervenor Damson Oil Corporation.

Harold L. Talisman, Dale A. Wright, Melvin Richier,

Gregory Grady and Terence J. Collins entered appear-

ances for intervenors, Cities Service Gas Company and

Tennessee Gas Pipeline Company, etc.

Toney Anaya, Assistant Attorney General, New Mex-

ico and Cameron R. Graham, Special Assistant Attorney

General entered appearances for intervenor, State of

New Mexico.

Jeffrey A. Meith and Thomas D. Clarke entered ap-

pearances for intervenor Southern California Gas Com-

pany.

James L. Bomar, Jr., entered an appearance for in-

tervenor East Tennessee Group.

John B. Randolph entered an appearance for intervenor

Mississippi River Transmission Corporation.

Before: FAHY, Senior Circuit Judge, LEVENTHAL,

Circuit Judge and GERHARD A. GESELL,*

United States District Judge for the United

States District Court for the District of Co-

lumbia

* Sitting by designation pursuant to 28 U.S.C. § 292(a).

Opinions for the Court filed by LEVENTHAL, Circuit

Judge, and FAHY, Senior Circuit Judge.

Opinion dissenting in part by FaHy, Senior Circuit

Judge.

LEVENTHAL, Circuit Judge: This case presents peti-

tions to review the 1976 orders of the Federal Power

Commission in the second nationwide natural gas rate

proceeding.

The pertinent orders embrace Opinion No. 770, issued

July 27, 1976; clarifying orders issued in September and

October 1976; and Opinion No. 770-A, on rehearing,

issued November 5, 1976. In brief, the FPC’s orders

prescribed the following rates:

(a) $1.42 per Mef, for sales of gas from wells com-

menced on or after January 1, 1975—with provision for

escalation.’

(b) $0.93 Mcef—reduced from the $1.01 rate prescribed

in Opinion 770—for 1973-1974 biennium gas, i.e., sales

of gas from wells commenced on or after January l,

1973 and prior to January 1, 1975. This rate is also

subject to escalation.’

“renewal contracts” where a contract has expired by its

own terms. Again there is escalation.’

These rates represent increases from the nationwide

rate of $.52 per Mef, established by Opinion No. 699-

H, which was upheld in Shell Oil Co. v. FPC, 520 F.2d

‘Of one cent per quarter. The rate increased to $1.44 on

January 1, 1977, and to $1.45 on April 1, 1977.

? Of one cent per annum. It increased on January 1, 1977 to

$.94.

* Of one cent per annum. The rate increased to $0.53 per

Mcf on January 1, 1977.

1061 (5th Cir. 1975), cert. denied sub nom California

Co. v. FPC, 426 U.S. 941 (1976).

The impact of the increase was estimated by the

Commission at from $1 49 to $1.78 billions during the

next 12 months.

Within seconds after Opinion 770-A issued, competing

petitions for review were filed in this circuit and in

other circuits. A panel of this court heard oral argu-

ment on the question of the proper venue for this pro-

ceeding and held that although petitions for review had

been filed simultaneously in this circuit and the Fifth

Circuit, the ultimate standard announced by 28 U.S.C.

§ 2112(a), “the convenience of the parties in the inter-

est of justice,” dictated that the case be heard in the

District of Columbia, American Public Gas Association

v. FPC, No. 76-2000, —— F.2d —— (D.C.Cir., Dec. 30,

1976).

This court issued orders for an expedited briefing

schedule. We heard oral argument on March 23 and

24, 1977. All petitioners complain that the FPC orders

violate pertinent statutory mandates, lack support in

substantial evidence and are arbitrary and capricious.

Essentially, the consumer petitioners complain that the

rates by the FPC are too high; the producer petitioners

complain that those rates are too low. There are also

other parties and positions, as will appear.

Pending disposition, this court provided for contingent

refunds. While Opinion 770 was under reconsideration

by the Commission, this court exercised its jurisdiction

under the All Writs Act, 28 U.S.C. $1651 (1970), to

preserve the possibility of a refund. See Order of Av-

gust 9, 1976, American Public Gas Association ». FPUC,

543 F.2d 356 (D.C.Cir. 1976). After issuance of Opin-

ion 770-A, this court stayed the FPC’s orders except

as to producers who undertook to refund portions of the

rate increases subsequently held unlawful and exce)t

as to gas from onshore wells commenced after July

27, 1976. Order of November 9, 1976, amended No-

vember 18, 1976, included as appendices to American

Public Gas Association v. FPC, No. 76-2000, —— F.2d

—— (1976).*

We have given due consideration to a vast number

of issues raised by the various petitioners. We cannot

practicably speak separately to each of the issues, but

the considerable discussion we provide, for the issues

of primary consequence, will fairly identify the bases of

our conclusion that the orders before us should be af-

firmed. For convenience, we interject a Table of Con-

tents identifying the topics specifically discussed by the

court.

* The order provided, however:

that the use of any refunds which might accrue there-

under shall be subject in the first instance to consider-

ation by the Commission, its conclusion with respect

thereto being subject to court review.

Several producers sought a writ of mandamus with re-

spect to this court’s action in the United States Supreme

Court. The panel which had entered the orders of August

9, November 9 and November 18, 1976, filed an explanatory

memorandum with that Court. Upon motion of the producers,

the petition was dismissed. Amerada Hess Corp., et al. v.

Fahy, et al., and American Public Gas Association, —— U.S.

—— (Jan. 25, 1977).

TABLE OF CONTENTS

OVERVIEW AND SCOPE OF REVIEW ........

A. Regulatory Background ..........00000

B. Procedure in FPC Docket .......0000

1. General FPC Approach...

2. Examination of Reasons and Changes...

8. Experimental and Dynamic features of

I eee

- PROCEDURAL ISSUES .....W ww... saciileteis

ITI.

REINSTATEMENT OF VINTAGING TO

AVOID EXCESSIVE PROFITS ...........

COST ALLOWANCE FOR INCOME TAXES

ARERR ERAS oe aa

A. Departure from Prior Policy ...............

B. Use of an Economic Model .....———

PRODUCTIVITY AND GAS RESERVES ........

. ATTACKS ON NATIONAL APPROACH TO

oo ES EE

A. Failure to Distinguish Between Onshore and

RT a

. COST IMPACT OF ADVANCE PAYMENTS.

VIII.

CONTINUATION OF THE OPINION 699

RATE FOR “ROLLOVER” GAS _..--.........

APPLICATION OF BIENNIUM RATES .

I. OVERVIEW AND SCOPE OF REVIEW

A. Regulatory Background

The FPC’s first venture into a national rate for new

natural gas came in its Docket No. R-389-B. This re-

sulted in Opinion 699 and amendments, culminating in

Opinion No. 699-H, issued December 4, 1974, which

fixed a nationwide base rate of 52¢ per Mcf throughout

the United States (except Alaska) for new gas (govern-

ing wells commenced and deliveries begun after January

1, 1973, and also new contracts replacing expired con-

tracts on “flowing gas”). Opinion 699 and its subse-

quent clarifications were affirmed in the 1975 Shell opin-

ion of the Fifth Circuit." That opinion sketches, and

we do not repeat, the background of previous develop-

ments in producer regulation—the FPC’s early abstin-

ence; the 1954 Phillips decision,” that the Natural Gas

Act provided for regulation of prices charged by natural

gas producers in interstate sales; and the FPC’s regula-

tion of producers by regional areas, upheld in the Per-

mian Basin Area Rate Cases, 390 U.S. 747 (1968).

Shortly after beginning Docket R-389-B, the FPC com-

menced a separate Docket No. R-478, to fix nationwide

rates for “flowing gas,” from wells drilled prior to

January 1, 1973. Opinion No. 749, issued on December

31, 1975, established a rate of 23.5¢ per Mcf, increasing

to 29.5¢, as of July 1, 1976, the date when the 22%

depletion tax allowance expired for regulated gas pro-

duction. That is pending on review in the Fifth Cir-

cuit.’

* Shell Oil Co. v. FPC, 520 F.2d 1061 (5th Cir. 1975), cert.

denied, California Co. v. FPC, 426 U.S. 941 (1976).

* Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672 (1954).

*Tenneco Oil Co., et al. v. FPC, No. 75-2960 (appeals by

both producer and consumer interests) .

B. Procedure in FPC Docket

On December 4, 1974,-the same day that Opinion 699-

H issued, the FPC instituted Docket RM-75-14, which

culminated in the orders and opinions (770 and 770-A)

currently under review. The notice projected need for

a revision of Opinion 699-H to govern new natural gas

for the 1975-1976 biennium and such changes as might

further the public interest.

The FPC did not propose specific rates in its Notice

but stated it would rely on responses by the parties

and Commission staff. The order designated as respond-

ents all interstate pipeline companies, and all producers

with jurisdictional sales exceeding 10 million Mcf per

annum, who have since participated as Indicated Pro-

ducer Respondents. Ultimately some 46 parties and

groups of parties, representing all segments of the nat-

ural gas industry and the consuming public, filed writ-

ten comments and cross-comments on a host of matters."

The ability of parties to comment was limited in one

respect much stressed to this court—concerning the mat-

ter of the Staff’s study of 31 off-shore Louisiana gas

leases in order to probe the issue of gas reserves.’

* The time for initial comments was extended to August 11,

1975, and for reply comments to September 11. There were

also supplemental reply comments; comments invited by FPC

order of June 16, 1975, as to the weight to be given to unregu-

lated intrastate gas prices; and comments invited by vari-

ous FPC orders (dated August 4, 1975, October 3, 1975, and

March 23, 1976) concerning several cost studies and rate

recommendations made by the FPC’s Bureau of Natural Gas

(BNG) and its Office of Economics (OEC).

*In June 1975 the FPC directed its Staff to update a pre-

vious study it had considered in Opinion 699-H concerning

the reporting of reserves in some 31 off-shore Louisiana gas

leases. The purpose was to investigate the gas reserve figures

compiled by the American Gas Association. The producers

compelled to submit their reserve estimates secured an inter-

C. Scope of Issues

Opinions 770 and 770A establish rates dramatically

higher than the national rates previously established in

Opinion 699-H: a near-tripling for new gas; for the

1973-74 biennium, an increase from 52 to 93 cents. As

already noted, the Commission estimated an impact of

the increase over the next year ranging from $1.49 to

$1.78 billions.

Commensurate with these figures are the complexity,

variety and range of the issues raised by the consumer

protests. Nor have the producers been supine. Their

complaints against the level of the rates, and their

perceived inadequacy, are sharpened by their anguish that

the FPC has reverted to the practice—abandoned in

Opinion 699-H—of vintaging gas prices according to the

period of production; and by resentment that Opinion

770-A, in response to consumer presentations on rehear-

ing, set a price for the 1973-74 biennium of 93 cents

instead of the $1.01 set in Opinion 770, and narrowed

the eligibility for higher new rates.

This is a major case. This court’s 1976 orders pro-

vided for submission on an expedited basis. The need for

expedition of the decision and opinion has been under-

scored by the increasing awareness that the country is

locutory order from the Fifth Circuit requiring these to be

kept in confidence pending determination of the producers’

appeals. Accordingly, the Commission did not release the

data for public comment “as it had originally intended.” On

June 21, 1976, the FPC incorporated into the record conclu-

sions from all of the data.” The FPC was subsequently au-

thorized by the court to release the data if it established an

appropriate basis therefor, Pennzoil Co. v. FPC, No. 75-2961

(5th Cir. July 2, 1976), but it decided against such release

on the ground that “the purposes of the 31 lease investiga-

tion have been largely accomplished”, Opinion 770 Mimeo at

8, R. 2503.

in the midst of an energy crisis, and is considering

measures to cope with it.

The court has also sought to expedite issuance of

its opinion. All issues tendered have been given care-

ful consideration, although they have not been discussed

in the detail used by the parties. Issues not discussed

in this opinion are technical; many concern matters

where we agree with the disposition in Shell, and they

would not account for any significant portion of the rate

increase under review.

D. Standards of Judicial Review

The matrix of a court’s consideration of the validity

of a natural gas rate order lies in the scope of and

standard for judicial review defined in pertinent de-

cisions.

“Judicial review begins at the threshold, with en-

forcement of the requirement of reasonable procedure,

with fair notice and opportunity to the parties to present

their case.” Greater Boston TV v. FCC, 143 U.S.App.

D.C. 383, 392, 444 F.2d 841, 850 (1970), cert. denied, 403

U.S. 923 (1971). The details and techniques differ, but

the essential principles apply even in proceedings gov-

erned by notice-and-comment disposition rather than evi-

dentiary hearings. Portland Cement Assn. v. Ruckel-

shaus, 158 U.S.App.D.C. 308, 486 F.2d 375 (19783),

cert. denied, 417 U.S. 921 (1974).

In substantive terms, the Administrative Procedure

Act describes the principal judicial function with the

direction that the reviewing court shall set aside agency

action found to be “arbitrary, capricious, an abuse of

discretion, or otherwise not in accordance with law.”

5 U.S.C. § 706(2) (A). The APA’s terms direct inquiry

whether the agency is “unsupported by substantial evi-

dence” only in a case subject to 5 U.S.C. $$ 556, 557,

or reviewed “on the record of an agency hearing pro-

vided by statute.” The Natural Gas Act does not ex-

pressly require a hearing on the record. United States

v. Florida East Coast Ry., 410 U.S. 224 (1973). Sec-

tion 19(b) of the Natural Gas Act, 15 U.S.C. § 717

et seq., does provide that the “finding of the Commission

as to the facts, if supported by substantial evidence, shal!

be conclusive.”

The issue of procedure—the permissibility of notice-

and-written comment (informal rule-making) —is consid-

ered separately, in Judge Fahy’s Opinion for the Court.

Some commentators have also put it that a statutory

reference to “substantial evidence’ requires a more

rigorous standard of review than the arbitrary-capricious

standard.’ We agree with Judge Friendly that the issue

is largely semantic, and that the two criteria “tend to

converge” in notice-and-comment rulemaking. Associated

Industries of New York v. Dept. of Labor, 487 F.2d 342,

348-350 (2d Cir. 1973). What is basic is the require-

ment that there be support in the public recor? for what

is done, City of Chicago v. FPC, 147 U.S.App.D.C. 312,

458 F.2d 731 (1971), cert. denied, 405 U.S. 1074 (1972).

The ultimate standard of reasonableness of Federal

Power Commission ratemaking was given an early gloss

by the Supreme Court in terms of the “end result” test.

FPC v. Hope Natural Gas Co., 320 U.S. 591 (1944).

The decision in Permian Basin Area Rate Cases, 390

U.S. 747 (1968) reshapes that test and guides us as to

the principal ingredients of the court’s functions.

(a) In assessing the numerous and disparate con-

tentions arising out of a lengthy proceeding, the court

has an authority “essentially narrow and circumscribed”

and need not examine every detail if the total effect be

reasonable. 390 U.S. at 766-67.

*° This view is implicit is some passages of the Shell opinion,

e.g., 520 F.id at 1081.

(b) A presumption of validity attaches to each exer-

cise of the Commission’s expertise and those who would

overturn its judgment have a heavy burden of making

a convincing showing that it is unjust and unreasonable

in its consequences. 390 U.S. at 767.

“reviewing courts will require criteria more discriminat-

ing than justice and arbitrariness if they are sensibly to

appraise the Commission’s orders.” 390 U.S. at 790.

(d) There is a “zone of reasonableness” in ratemak-

ing, and within this zone the Commission may employ

rates functionally to encourage production. 390 U.S.

at 796-8.

In a much-quoted passage Permian summed up the

ultimate criteria governing the reviewing court. See

390 U.S. at 791-92:

It follows that the responsibilities of a reviewing

court are essentially three. First, it must determine

whether the Commission’s order, viewed in light of

the relevant facts and of the Commission’s broad

regulatory duties, abused or exceeded its authority.

Second, the court must examine the manner in which

the Commission has employed the methods of regula-

tion which it has itself selected, and must decide

whether each of the order’s essential elements is

supported by substantial evidence. Third, the court

must determine whether the order may reasonably

be expected to maintain financial integrity, attract

necessary capital, and fairly compensate investors for

the risks they have assumed, and yet provide appro-

priate protection to the relevant public interests, both

existing and foreseeable. The court’s responsibility

is not to supplant the Commission’s balance of these

interests with one more nearly to its liking, but in-

stead to assure itself that the Commission has given

reasoned consideration to each of the pertinent fac-

tors. Judicial review of the Commission’s orders wil!

therefore function accurately and efficaciously only if

the Commission indicates fully and carefully the

methods by which, and the purposes for which, it

has chosen to act, as well as its assessment of the

consequences of its orders for the character and

future development of the industry. We are, in ad-

dition, obliged at this juncture to give weight to the

unusual difficulties of this first area proceeding; we

must, however, emphasize that this weight must sig-

nificantly lessen as the Commission’s experience with

area regulation lengthens. We shall examine the

various issues presented by the rate structure in

light of these interrejated criteria.

The Court’s concept of “reasoned decisionmaking” is

in essence the keystone of the Rule of Administrative

Law. “The function of the court is to assure that the

agency has given reasoned consideration to all the ma-

terial facts and issues.” Greater Boston TV v. FCC, 143

U.S.App.D.C. at 393, 444 F.2d at 851.

The Permian approach resonates as guidance for re-

viewing courts. Recent decisions underscore its vitality.

The “zone of reasonableness” has been identified as ac-

commodating a wide latitude to integrate cost factors

with non-cost and policy considerations. FPC v. Conway,

426 U.S. 271 (1976). Especially significant is Mobil

Oil Corp. v. FPC, 417 U.S. 283 (1974), wherein the

Court expatiated on the roles of the FPC and reviewing

court. The Supreme Court acknowledged that the pri-

mary responsibility for judicial review lay in the courts

of appeals. It stressed that the equity powers of those

courts properly accommodate to agency flexibility, so

that, e.g., affirmance of an order may retain agency

latitude for modification. 417 U.S. at 311. The agency’s

flexibility is viewed broadly, to permit “pragmatic ad-

justments” based on exigencies of administration. 417

U.S. at 329. The FPC may tolerate inequities where it

“squarely faced” up to the problem and deemed it less

significant than the pursuit of broad advantages to the

public interest. 417 U.S. at 321-23.

Throughout Mobil reflects an approach to the “sub-

stantial evidence” standard as requiring the reviewing

court to respect the agency’s wide latitude for difficult

policy choices, and in adjusting that standard “in this

time of acute energy shortage” to provide greater free-

dom for new proposals and techniques.’ Particular at-

tention is called to the Court’s discussion of the con-

clusion that refund credits and contingent escalation

constituted appropriate means to assist capital forma-

tion for exploration.* The parties raised a not insub-

stantial issue. The Court’s response identified the con-

text that the Commission had taken “massive evidence”

with voluminous exhibits and various cost estimates in

the record, and that the rates fixed, even with incentive

increments, were within the range of cost estimates. “Its

difficulties, while not minor, did not stem from any fail-

ure to seek answers.” 417 U.S. at 318, referring to n.48

at p. 313. That single sentence is a capsule of the re-

quirement of reasoned decisionmaking in the context of

the novel and exigent problem of seeking to enhance

natural gas supply in time of dire shortage while main-

taining fairness to consumers.

1. General FPC approach

Instructed by these Supreme Court guidelines, and

pretermitting discussion of specific contentions, we refer

for perspective to the Overview provided by the FPC of

its approach. At the outset: “This rate is fully cost-

based and justified. Additionally, non-cost factors have

"417 U.S. at 331.

2 Pub. Serv. Comm. of N.Y. v. FPC, 167 U.S.App.D.C. 100,

108, 511 F.2d 383, 346 (1975) (advance payments remand).

been examined to ensure that the cost-based rate is just

and reasonable.” (Opinion 770 mimeo at 1-2, R. 2497).

The cost factors included “drilling productivity, drilling

costs and all of the other costs associated with the pro-

duction of natural gas.” The non-cost factors included

“the price of competitive fuels, the impact upon supply

and demand, inflationary pressures, the nation’s natural

gas shortage and conservation factors.” (Mimeo at 3,

R. 2499).

Costs were determined by “a discounted cash flow

analysis by costing the average successful well that is

drilled ir the test year 1976.” A 15% rate of return

was allowed.

The discounted cash flow analysis used in Opinion No.

699-H and approved in the Shell opinion was modified

in certain respects. Drilling costs were changed to re

flect higher costs actually incurred during 1973 and

1974. The productivity data were expanded from 7 years

(1966-1972) to include the reports for 1973 and 1974.

The depletion life was changed from 18 years to 15

years (with a pre-production period of 3 years). In view

of the repeal of the percentage depletion allowance, a

provision for income taxes payable was inserted, at the

marginal tax rate of 48%.

Opinion 770’s Overview concluded by allocating the

$1.5 billion added to consumers’ costs in the first

year (later adjusted in Opinion 770-A). “Of this amount,

approximately 55% goes to the Treasury in higher

taxes, 25% compensates for higher costs, and 20% ac-

crues to the producers. Over the longer run, we expect

consumers will benefit as a result of reduced reliance

on expensive alternate fuels. We believe that this de-

cision will lead to increased gas supply and to greater

gas conservation.” Mimeo at 5, R. 2500.

2. Examination of reasons and changes

These general statements are only prologue. With all

the latitude for expertise and specialization of the agency,

the court must still probe the essential particulars—to

assure itself that the Commission has seriously sought

answers and engaged in reasoned decision-making.

The court has been particularly alert to consider those

aspects in which the FPC’s approach differs from what

has been approved. An agency may of course reconsider

its approach even in the absence of any new evidence.

Mobil Oil Corp. v. FPC, 417 U.S. at 320. However, the

change in policy must be avowed and reasoned.

An agency’s view of what is in the public interest

may change, either with or without a change in cir-

cumstances. But an agency changing its course must

supply a reasoned analysis indicating that prior

policies and standards are being ya menange | changed,

not casually ignored, and if an agency glosses over

or swerves from prior precedents without discussion

it may cross the line from the tolerably terse to the

intolerably mute.

Greater Boston TV v. FCC, 143 U.S.App.D.C. at 394,

444 F.2d at 852.

3. Experimental and dynamic features of novel

regulation

When regulation features novelty, in subject, technique

or both, the narrow scope of review established by con-

ventional doctrine is further circumscribed. Thus Per-

mian noted that the court tempers its review to take into

account the “unusual difficulties” of the first proceeding.

Alongside was the countervailing caution that the force

of this restraint lessens as the Commission has time and

opportunity to gain experience and make adjustments.

See 390 U.S. at 792, quoted above. See also Shell Oil Co.

v. FPC, 520 F.2d at 1071, and cases cited.

These considerations were stressed in Shell on review

of Opinion 699-H, the first nationwide rate order. The

court used the metaphor of “kid glove” review as ap-

propriate circumscription in view of the “experimental

nature” of the regulation. 520 F.2d at 1071. Extra def-

erence is provided when the Commission articulates a

tentative balance on an issue, announcing that it is “pre-

pared to reevaluate the equilibrium it sought to achieve

in the biennial review.” 520 F.2d at 1077.

Yet the Fifth Circuit took occasion to sound a caution

against the FPC’s assumption that it could continue to

support essential elements of its orders “with little more

than ipse dixit.” The court said: “We must regret, how-

ever, that the FPC continues to issue orders which would

be inadequate but for our ‘kid glove’ treatment. * * *

[a] cautionary note should indicate that as experiment

lapses into experience, the courts may well expect the

Commission to justify its policies with reasoned projec-

tions of that once-prototypic policy’s probable net ef-

fect.” *

In this posture of matters, the court’s rule may require

it to affirm an order regardless of misgivings, but to dis-

charge the function of identifying problem areas that

call for reconsideration and that cannot be affirmed in

subsequent proceedings in the absence of reasoned sup-

port grounded in experience.

The underlying principle is broader than natural gas

regulation. The en banc opinion in American Airlines v.

CAB, 123 U.S.App.D.C. 310, 359 F.2d 624 (1966) pre-

sented a judicial approval of the blocked space program

as reasonable in projection, taking into account the agen-

cy’s capacity and duty to provide reappraisal in the light

of experience. (And see p. 633: “a month of experience

will be worth 4 year of hearings.”) In United States v.

** Shell, 520 F.2d at 1072.

CAB [American Airlines et al., ALPA, et al.], 167 U.S.

App.D.C. 318, 511 F.2d 1815 (1975), the court upheld

an October 1973 CAB order approving an air carriers’

agreement for capacity reduction as interim or emer-

gency action, but it set aside the July 1974 order of the

CAB extending its approval because of the agency’s fail-

ure to provide continuing consideration of the matter on

a non-emergency basis.

The principle has full vitality, however, in the field of

natural gas regulation, as is dramatized by this court’s

actions concerning the FPC’s program for advance pay-

ments to gas producers. In 1972, this court sustained the

order as a “justifiable experiment in the continuing

search for solutions to our nation’s critical shortage of

natural gas.” Public Serv. Comm. of N.Y. v. FPC, 151

U.S.App.D.C. 307, 467 F.2d 361, 371 (1972). The court

stressed the need for further evaluation. Subsequently,

this court held that the FPC had failed to engage in

meaningful! review, analysis and evaluation of experience

under the program, and declined to affirm an extension,

Public Serv. Comm. of N.Y. v. FPC, 167 U.S.App.D.C.

100, 511 F.2d 338 (1975). On remand, the FPC termi-

nated the program as of the end of 1975.

The need for flexibility and reevaluation is underscored

by the nation’s wide-ranging and comprehensive reevalua-

tion of energy policy. There is no direct impact on the

legal issues before us. Yet the reviewing court acts as

a court of equity in appraising the n_ d and method of

further consideration of issues. See Mobil Oil Co., 417

U.S. at 311. Equity historically takes into account chang-

ing circumstances. In present context, these may come

to include revision of the structure and functions of the

Commission whose orders are under review.

In the light of this broad perspective, we turn to the

more particular contentions raised by the consolidated

petitions for review.

II. PROCEDURAL ISSUES

With varying emphases, the consumer interests have

attacked the procedures used by the FPC. The basic

question is whether the notice-and-comment procedure of

informal rulemaking is permissible for an enterprise of

such magnitude and complexity. This issue has been

given special attention. Our discussion appears in the

opinion of Judge Fahy which approves the FPC’s basic

procedural approach.

The residual possibility that its procedure may have

been inadequate as to particular issues is subsumed under

separate sections of this opinion, dealing with the evi-

dence and reasoning pertinent to those issues.

Similarly those sections necessarily reflect the court’s

consideration of the contention that even where the agen-

cy is not required to institute more than a minimal notice

and written comment procedure, the court may call for

additional procedures as an adjunct enabling it to per-

form its task of providing “meaningful judicial review

of highly technical issues.” *

The producer interests have raised a different issue of

procedure, focusing on whether there has been a Congres-

sional role that has undermined the validity of the ad-

justments made by the FPC on reconsideration. This is-

sue has also been given special attention in the opinion

of Judge Fahy for the Court, in which we reject the pro-

ducers’ contention that the Commission is disqualified

to issue Opinion 770-A.

‘* Pickus v. U.S. Board of Parole, —— U.S.App.D.C. ——,

543 F.2d 240, 246 (1976) ; Portland Cement Assoc. v. Ruckel-

shaus, 158 U.S.App.D.C. 308, 486 F.2d 375 (1973), cert.

denied 417 U.S. 921 (1974). This doctrine is implicit in FPC

v. Transcontinental Gas Pipe Line Corp., 423 U.S. 326 (1976).

It can be furthered by a remand leaving the order in effect

and possibly by a remand of only the record, as contrasted

with a remand of the case that vacates the order. Pickus II,

543 F.2d at 246, n. 24.

III. REINSTATEMENT OF VINTAGING TO AVOID

EXCESSIVE PROFITS

We begin discussion of specific objections to the rate

order with the producers’ threshold-type contention that

the orders are invalid in providing for a vintaging ap-

proach, establishing separate rates for 1973-1974 bienni-

um gas and for 1975-1976 biennium gas.

The underlying premise of the producers is that natu-

ral gas must be regulated as an irreplaceable commodity,

not a service, and that vintaging compels the sale of

natural gas at prices below the cost of replacing the gas

consumed. This was rejected as long ago as the 1968

Permian opinion, where the Court accepted the Commis-

sion’s conclusion that “a two-price rate structure will

both provide a useful incentive to exploration and prevent

excessive producer profits.” 390 U.S. at 798. The Court

accepted as consistent with the Act a two-price system

adopted by the Commission on the premise of a lower price

for sales where “price could not serve as an incentive”

since any price “above average historical costs, plus an

appropriate return, would merely confer windfalls.” /d.

at 797.

Subsequent to Permian, the FPC has issued orders di-

verging from concepts of vintaging, and these have been

approved by the courts. Its Opinion 639 and follow-on

interpretations, authorizing new rates as contracts ex-

pired, were upheld as a reasonable attempt to phase out

“contract vintaging.” ** As we shall see in discussing the

“rollover” matter the precise issues are different, but we

acknowledge the parallels of theory. However, this is not

just a theory, but a balancing of the interests of producers

% Shell Oil Co. v. FPC, 491 F.2d 82 (5th Cir. 1974);

Pub. Serv. Comm. of N.Y. v. FPC, —— U.S.App.D.C. ——-,

548 F.2d 874, cert. denied, ——_— U.S. —— (1976).

and consumers. Like all issues of rate regulation the key

questions are likely to involve “pragmatic adjustments.” *°

That brings us to the producers’ proposition that Opin-

ion No. 699-H’s nationwide pricing exemplified a commit-

ment to a single uniform national rate for all gas, and

signaled the end of the “anachronism of vintaging.” “

The 1975 Shell opinion upheld the trend toward elimina-

tion of vintaging as within the latitude of agencies to re-

evaluate old experiments.”

The Commission has latitude to reconsider its experi-

ment in abandoning vintaging. The producers contend

that the problem of “excessive rents” was obviously be-

fore the Commission when it issued No. 699-H and there

was no new evidence to make a difference. In Opinion

No. 770, the FPC explained that its change of course was

due to the “magnitude of the increase of the rate” pre-

scribed for the post-1974 gas, leading the Commission to

conclude it must “abandon its intended policy” and “vin-

tage by a 1973-1974 cost grouping to preclude exaction

of excessive and unjustifiable economic rent from flowing

gas.” (Mimeo at 12, R. 2507). It referred to Opinion

699-H, stating “we did not anticipate at that time such

a dramatic increase in costs and decrease in productivity.”

(R. 2508). There was thus an explicit acknowledgment

of change, no stealthy deviation.

This change, say the producers, is only a difference in

degree from the situation before the FPC in 1975. Dif-

ferences in degree may become so wide as to justify dif-

ference in outlook and response. It was within the policy

‘© Natural Gas Pipeline Co. v. FPC, 315 U.S. 575, 586

(1942) ; Mobil Oil Corp. v. FPC, 417 U.S. 283, 329 (1974).

*“This uniform price will constitute a recognition of the

fact that gas is a consumable, irreplaceable commodity and

not a service which can be renewed by man.” 52 FPC at 1637-8.

**520 F.2d at 1077-78.

latitude of the Commission, in its balance of interests,

to emphasize, as it did here, its “responsibility to mini-

mize severe and harmful economic dislocation due to in-

creased rates.” *

The producers say this approach is at odds with the

function of rate regulation whereby the government simu-

lates what would have been achieved in a free market.

In support of this contention the producers cite, inter

alia, FPC v. Texaco, Inc., 417 U.S. 380 (1974). That is

ironic because that opinion specifically held Order No. 428

was not vulnerable because it set different levels of just

and reasonable rates for small producers and large pro-

ducers. 417 U.S. at 390. Not unexpectedly the Court re-

lied on Permian. In Texaco the Court rejected the

contention that the Commission was free to rely exclu-

sively on market prices when it was the legislative prem-

ise of regulation that there was no free competitive

market in the oil and gas industry. Simulation of what

would obt-'n in a free competitive market is a premise

of rate regulation but often a speculative one, and one

that is neither conclusive nor dominant over the need to

strive with pragmatic adjustments for a fair balance of

producer and consumer interests.

IV. Cost ALLOWANCE FOR INCOME TAXES

PAYABLE

We examine initially the Commission’s treatment of

the impact of federal income taxes on natural gas opera-

tions. The increment to price allowed for income taxes

payable constitutes the largest portion of the increase in

price over that allowed in Opinions 699 and 699-H.

Opinion 770 allows +3 cents per Mcf to cover the cost

of income taxes on gas within the 1975-76 biennium. This

*R. 2057, citing Area Rates for the Appalachian and

Illinois Basin Areas, 48 FPC 1299, at 1309-10, aff’d Shell Oil

Co. v. FPC, 491 F.2d 82 (5th Cir. 1974).

constitutes 26.7% of the total price of $1.61 and is some-

what less than the amount allowed for profits (48 cents).

The discounted cash flow methodology used by the Com-

mission adjusts for the impact of the federal tax code in

two ways. First, the model credits the producers with

the value of tax benefits which the producers can obtain

by deducting their various intangible drilling costs. The

mode] assumes that these costs will be expensed at the

earliest possible time, and tha’ the producer of the model

well will have other taxable income which these prepro-

duction deductions could offset. In order to reflect the

tax savings which the producer gains from a deductible

expense, the model reduces the gross cash outlay for that

expense by 48%, the statutory tax rate. Thus, when the

net outlay is adjusted by the discount factor to obtain

its present value, the consumer also gains the present

value of the tax deduction.’

The second adjustment made by the Commission was to

allow for the cost of paying income tax at 48% of profits.

This, too, is discounted to obtain its present value. As

previously noted, the increment to price consisting of an

allowance to cover these taxes is 43¢.

We now turn to the consumers’ objections, beginning

with the generalized and moving to the specific.

*° Because the Commission’s methodology fails to concretize

the savings from tax deductions, and accounts for them only

as a reduction from cash outlays, this method of accounting

is somewhat difficult to understand or explain. However, it

has exactly the same mathematical effect as a model in which

the cash value of each deduction is magnified by the discount

rate to obtain its present value, and then counted as a cash

inflow in the overall alignment of cash outflows with cash

inflows.

A. Departure from Prior Policy

The consumers challenge the Commission’s treatment

of tax effects on the ground that the Commission’s meth-

odology constitutes an unexplained departure from the

methodology of Opinion 699 and previous Commission

opinions." In Opinion 699 the Commission had reduced

costs to reflect tax credits generated by deductions but

had allowed for the payment of income taxes only to the

extent of those credits.* Where an individual producer

incurred a tax liability in excess of his credits, he could

petition for special relief, and could obtain it upon show-

ing with his actual tax return that he had in fact paid

tax. The consumers contend that the Commission’s move-

ment from the Opinion 699 procedure, which assumes

that the producers will have no net tax liability, to the

770 model, which gives an allowance for income taxes at

the statutory rate, constitutes an unexplained and unjusti-

fiable change in agency policy.

We find no merit in this contention. As we have al-

ready noted, Greater Boston TV Corp. v. FCC holds: “An

agency’s view of what is in the public interest may

change, either with or without a change in circumstances,”

as long as the agency changing its course supplies a

“reasoned analysis indicating that prior policies are being

deliberately changed, not casually ignored.” 143 U.S.

App.D.C. at 384, 444 F.2d at 852. In this case the Com-

mission’s modification of methodology is justified both

because it is responsive to changes in circumstance and

21 The consumers cite Permian Basin Area Rate Proceeding,

34 F.P.C. 159, 206-07 (1965), aff'd 390 U.S. 747 (1968);

Southern Louisiana Area Rate Proceeding, 40 F.P.C. 530,

585-86 (1968), aff'd sub nom Austral Oil Co. v. FPC, 428

F.2d 407, cert. denied sub nom Municipal Dist. Group v. FPC.

400 U.S. 950 (1970), as well as the opinions in the previous

national ratemaking.

*2 See Shell Oil Co. v. FPC, 520 F.2d at 1081 (5th Cir. 1975).

because it is the product of a conscientious reexamination

of the tax issue.

The Tax Reduction Act of 1975 ** reduced taxes for most

individuals, but was intended to increase taxes for the oil

and gas industry.** Effective July 1, 1976, it repealed the

percentage depletion allowance with respect to most pro-

ducers,** and limited the use of foreign tax credits to

foreign related income.** As the consumers recognize, the

repeal of the depletion allowance will alone have a sub-

stantial impact on the producers’ tax liability.*’ The

Commission estimates that 27¢ of the 43¢ allowed for

taxes is attributable to the repeal of the depletion allow-

ance. Others might provide different estimates. But it is

clear that this congressional action significantly affects

the tax setting in which current drilling is taking place.

In Opinion 770A, the Commission explained:

That action required a reconsideration of the overall

impact of the income tax law on the producer rate-

making methodology. The reconsideration of the is-

sue revealed that the premises on which prior deci-

sions were founded were inaccurate at the outset,

eroded by change in law, or properly accounted for in

the new gas costing model.

R. 3636.

** Public Law 94-12, § 501(a), 89 Stat. 26 (March 28, 1975).

** An increase in producer liability is contemplated by 26

U.S.C. § 613A(b) (2) (B) (Supp. V 1975).

*° See 26 U.S.C. § 613A(a) (Supp. V 1975).

76 See 26 U.S.C. § 907 (Supp. V 1975).

*7 A study by the staff of the House Ways and Means Com-

mittee estimated that the Treasury revenue effect of the

repeal of percentage depletion for oil and gas would be $1.7

to $2.2 billion in 1975 and $2.7 billion in 1976. Committee

on Ways and Means, Summary of Major Provisions of Public

Law 94-14, Tax Reduction Act of 1975, (April 1, 1975),

cited in Opinion 770-A at 74, R. 3639.

This kind of thoroughgoing reexamination of the tax

issue was by no means precluded by the analysis in

Opinion 699 or in the judicial opinion affirming it. In

Shell Oil Co. v. FPC, 520 F.2d 1061, 1081 (1975), the

Fifth Circuit upheld the Commission’s “policy choice” to

exclude an average tax component on the ground that the

variation of tax liability between individual producers

was more significant than the overall industry liability.

Reconsideration of this point was clearly necessary in light

of the increase in producer liability under the 1975 Act.

The Court then went on to say:

The Commission also took note of the complexity of

federal income taxes provisions for gas producers,

the ability of producers in some circumstances to in-

definitely postpone tax liability and the impending

reduction of depletion allowances, all good reasons

for eschewing a simple tax component which would

be cemented into ratemaking for a long time to come.

These points were not cited in the Shell opinion as

confirming the accuracy of the 699 model, but as rea-

sons for eschewing a tax component which might unfairly

become permanent. They did not preclude a new look

in the light of the provisions of the 1975 Act that served

to simplify * as well as to increase the producers’ lia-

bility. The court’s opinion is permeated with an aware-

ness that the tax problems were in flux, and with a will-

ingness to tolerate the Commission’s tentative treatment

so as not to preclude a more refined analysis in the future.

This point was highlighted when the Shell panel issued

an opinion on rehearing for the sole purpose of stating

that its decision “should in no way be construed to fore-

close a de novo review of federal income tax in the cur-

rent biennial review proceeding in FPC Docket No. RM

2* By repealing the percentage allowance (which is calcu-

lated on a property by property basis) and by eliminating

the spill-over effects of the foreign tax credit.

75-14.” Shell Oil Co. v. FPC, 525 F.2d 1261, 1263 (5th

Cir. 1976) (denying petition for rehearing).

In conducting its rethinking of the tax issue, the Com-

mission teok into account not only the changes in the tax

code but also the increasingly grave shortage of natural

gas disrupting our national economy. The Commission

reasoned that “new supplies come from decisions to ex-

plore for and develop new fields,” and the “(m]arginal

income therefrom is likely to be taxed at the 48% rate.”

Opinion 770 at 85, R. 2580. Hence the Commission felt

that it was particularly appropriate to include a tax com-

ponent at the full statutory rate.

A commission may estimate costs on the high side of a

practical range and still stay within the limits of reason-

ableness. That is the message of Permian and Mobil,

particularly taking into account the need to conduct cost-

based ratemaking with due regard for the non-cost factor

of encouraging exploration for natural gas.

Were this court to construct a methodology for national

ratemaking, we might find it more elegant and theoreti-

cally proper to include such incentives for exploration

solely within the factor for rate of return. But that is

not our task, and we cannot say that the Commission was

arbitrary or capricious in taking account of this public

need within the context of its calculation of the tax com-

ponent.

We recognize that not all of the 43¢ increase in allow-

ance for taxes can be explained by changes in circum-

stances. Some part of it is undoubtedly due to the change

in method of accounting. But the judicially enforced re-

quirement that the agency explain any changes in policy

is not intended to bind the agency to prior methods. As

circumstances change and analytical techniques improve,

methods of accounting which once seemed sound enough

to guide agency action may be perceived as imperfect.

Precedent cannot be allowed to block the search for a

model more reflective of economic reality. Here, where

the agency had both meaningful reasons for changing

its methodology and, as we develop more fully below, a

logical explanation for the new approach it adopted, the

law does not hold the agency fast to its prior policy.

B. Use of an Economic Model

As a second objection to the Commission’s treatment of

the tax component, the consumers contend that there can

be no substantial evidence supporting an allowance for

income taxes unless the producers’ current tax returns

are put into evidence and subjected to comment. APGA

complains that “the producers prefer to rely on economic

models, which tell you nothing about the real world. . .”

Brief at 38 n.2. Elsewhere APGA aserts “Economic

‘models’, dreamed up by producer-sponsored consultants

and untested by cross-examination, do not begin to rise

to the status of ‘substantial evidence.’” Brief at 41 n.3.

With this contention we must express fundamental

disagreement. Reasoned decisionmaking can use an eco-

nomic model to provide useful information about eco-

nomic realities, provided there is a conscientious effort to

take into account what is known as to past experience

and what is reasonably predictable about the future.

In the world of today, model-building is not merely a

sport for youngsters and tiny planes. Models are central

to the forecasts and programs evolved by members of the

executive and legislative branches, concerned with such

searching questions as inflation and stabilization, produc-

tion and unemployment, and other problems of national

policy. These economic models are robed in the elegance

of high-speed computers, but they are at base extrapola-

tions from past experience, projections that must undergo

continual examination and revision. They do not always

have the reassuring concreteness of empirical observa-

tions, but they are the best we have to work with in

casting our programs. Provided that the assumptions

on which a model is based are adequately explained and

justified, we see no reason why this type of evidence may

not be used in support of a ratemaking application.

The Supreme Court has emphasized that the Commis-

sion must have considerable latitude in developing a meth-

odology responsive to its regulatory challenge:

We must reiterate that the breadth and complexity

of the Commission’s responsibilities demand that it

be given every reasonable opportunity to formulate

methods of regulation appropriate for the solution

of its intensely practical difficulties.

390 U.S. at 790. In Permian and subsequent decisions,

courts have approved the use of regional and national

averages, which include a hypothetical cost projection for

some producers, as a means of arriving at a reasonable

individual rate. E.g., City of Chicago v. FPC, 147 US.

App.D.C. 312, 387, 458 F.2d 731, 756 (1971), cert. de-

nied, 405 U.S. 974 (1972). More recently, the Fifth

Circuit sustained the use of a discounted cash flow meth-

odology as a basis for national ratemaking. 520 F.2d at

1079-80. In each of these cases the key question was not

the extent to which the Commission methodology con-

sisted of empirical observations, but whether its premises

were supported by substantial evidence and whether its

reasoning was sound. These are the demands which are

appropriately made of the Commission in this case.

Further, in the context of this particular ratemaking,

the Commission’s use of an economic model to estimate

tax liability reflects a well-reasoned choice of methodology.

The Commission specifically found that because of the per-

centage depletion allowance and the low return on in-

vestment prior to this ratemaking, “it is very unlikely

that any meaningful historical average tax would be

derived” from a study of the producers’ tax returns.

770-A Mimeo at 65, R. 3680. There is substantial founda-

tion for this as a reasoned conclusion when one considers

that the tax return reflects an aggregate of matters, and

that it would be well nigh impossible to undertake the

task of segregating gas operations from oil operations,

operations involving jurisdictional gas from those in-

volving nonjurisdictional gas, associated gas from nonas-

sociated gas, and then differentiating between the various

vintages of nonassociated jurisdictional gas. Given the

clear need for an allowance to cover the liability imposed

by the 1975 Act, and the difficulty—if not the impossi-

bility—of obtaining a meaningful tax figure from an his-

torical study, the Commission was clearly justified in

seeking to account for taxes through the use of a model.

The consumers would condemn the Commission’s effort

to estimate the producers’ tax liability on the ground

that the Commission has departed from the well-settled

principle of regulation that rates provided to cover tax

costs must be based on “actual taxes paid.” The con-

sumers interpret this principle to mean that an incre-

ment for taxes may be included in the price only after

tax returns have been used to demonstrate tax liability.

This involves misunderstanding of the case law dealing

with that principle. Although there are a number of

cases in this area,” we may usefully proceed from the

summarizing discussion in City of Chicago v. FPC, 458

F.2d at 754-57 (1971). There we explained that the

producers had for a long time argued that the proper

tax element of their rates was the tax that would have

been paid but for certain deductions, chiefly those for

* #.9., Cities of Lexington, Ky. v. FPC, 295 F.2d 109 (4th

Cir. 1961); El Paso Natural Gas Co. v. FPC, 281 F.2d 567

(5th Cir. 1960), cert. denied sub nom California v. FPC,

366 U.S. 912 (1961).

depletion, intangible expenses and accelerated deprecia-

tion. The producers contended that because these deduc-

tions were intended to provide an incentive for par-

ticipation in the production of a wasting asset, the com-

panies should be allowed to retain any tax savings. The

courts held, however, that since the ratemaking structure

already included an allowance both for incentive and for

depletion, the proper tax element was taxes actually

paid. Tax savings were to be passed through the com-

panies to the consumers.

The Commission’s model is entirely consistent with this

principle. At the very earliest date that the producers

incur the cost of production, i.e. the pre-production ex-

pense of lease acquisition and drilling, the producers

must reduce yield through a current credit for current

tax savings. All applicable types of tax deductions are

included. Hence, we find no deviation from the “actual

taxes paid principle” in the Commission’s use of an eco-

nomic model.

In rate regulation there is no mystique requiring that

expenses be actually “paid.” Regulated companies are

routinely permitted to set up reserves against the prob-

able expenses of obligations undertaken now yet falling

due in the future even when the amount of obligation

is subject to revision—as in the case of a bus company

that has switched from street car to bus operations and

has an obligation to take up the street car tracks. De-

preciation reserves are everywhere based on a service

life that is only estimated and often exceeded; and while

these have the safeguard of costs originally paid out,

there is a substantial difference in rates needed to cover

a current expense as against a fair return on plant in

service. Thus, there is no historical basis for petitioners’

simplistic interpretation of the “actual taxes paid” prin-

ciple.

But even if that principle had been stated in the past

as rigidly as petitioners suppose, it would not preclude

a different approach by the agency for the future. Dur-

ing the years that the “taxes actually paid” doctrine

emerged there was experience under the tax laws in

being, and a forecast for the future rising to the level

of strong probability, that to a large extent taxes would

either never be paid, or would arise for actual payment

in a future too remote for present acknowledgement.

Given the workings of the compound interest table, or

the equivalent discount tables, an event 40 years hence

can be ignored for the present in many practical con-

cerns. But the 1975 change in tax law announces a

policy and determination that marks a significant change.

Perhaps its exact consequences cannot be spelled out

in mathematical detail, but the combination of the higher

probability that substantial taxes will be paid and the

likelihood that there will not be acquiescence in in-

definite deferral of tax revenue makes a difference real

enough to support a change in policy as rational.

In sum, the Commission’s reliance on an economic

model for computation of the tax component was con-

sistent with regulatory theory and fully justified in light

of the specific evidence available.

C. Specific Objections to the Model

The third type of argument pressed by the consumers

against the Commission’s treatment of the tax issue is

that the Commission’s model fails to account for severz]

phenomena which are likely to reduce the producers’ tax

liability. We take these specific objections to the work-

ings of the Commission’s model most seriously, for in

the absence of empirical confirmation of accuracy, we

believe that the Commission is obligated to provide a

complete analytical defense of its model—to respond to

each objection with a reasoned presentation. Neverthe-

less, after careful study, we believe that the Commission’s

Opinions fully answer or account for all points raised

by the consumers.

1. Consolidated Returns

The consumers contend that the Commission’s model

fails to account for any tax saving which may occur

from the filing of consolidated tax returns covering both

jurisdictional and non-jurisdictional —activities. They

argue that the Supreme Court’s decision in FPC v.

United Gas Pipe Line Co., 386 U.S. 237 (1967), re-

quires that the consumer receive the benefit of any re-

duction in taxes arising from the combination of juris-

dictional gains with nonjurisdictional losses. The con-

sumers point out that Commission opinions following a

different course have never received judicial approval.*

The Commission responds that the United Gas Pipe

Line decision, supra, did not mandate a specific formula

for the allocation of tax savings but merely reversed a

court of appeals” which had refused to defer to Com-

mission discretion. In support of this interpretation the

Commission cites the Supreme Court’s second decision

in the United Gas Pipe Line case, 393 U.S. 71 (1968),

which again reversed the court of appeals,” this time

for netting the losses of other affiliates against the non-

* In two cases involving pipelines, the FPC did not require

the pipelines to reduce their rates to reflect tax savings from

participation in consolidated tax returns, Florida Gas Trans-

mission Co., 47 F.P.C. 341 (1972); Natural Gas Pipeline, 50

F.P.C. 789 (1973), but neither of these cases was appealed

and one was the result of a settlement.

The same policy ostensibly was followed in Opinion 699,

but because no allowance for tax liability was included, that

aspect of the decision was not appealed by the consumers.

"' 357 F.2d 230 (5th Cir. 1966).

** 388 F.2d 385 (5th Cir. 1968).

jurisdictional gains of the United affiliate, without giv-

ing the Commission an opportunity to consider the issue.

The Commission claims that it is within its discretion

to hold that “regulated activities are properly viewed

a8 a separate corporate entity and the Federal income

tax allowance computed accordingly.” Opinion 770 at

83, R. 2578 quoting Opinion 749-C.

We do not find it necessary to reach the legal issues

raised by these arguments for we agree with the Com-

mission that in the context of this national ratemaking

proceeding, the savings which some producers may ob-

tain from consolidation will not have industry-wide signi-

ficance. Even the broadest reading of the decisions cited

by the consumer interests could not reasonably preclude

the Commission from making a net calculation on un-

regulated activities (setting losses off against gains from

other nonjurisdictional activities) before combining the

net figure with profits from jurisdictional sales. Thus,

before a reduction of the tax component could be re-

quired, there would have to be a projection of a net non-

jurisdictional loss on an industry-wide basis. The Com-

mission specifically considered this possibility and dis-

missed it as neither supported by evidence nor “plausible”

as a projection.

[I]f any tax losses from non-jurisdictional activities

are to be first allocated to offset non-jurisdictional

profits, we wou!d be required to find that the overall

petroleum industry has sufficient tax losses to offset

all income from production, refining, and marketing

petroleum products and any other related or unre-

lated business activity. There is no evidence to sup-

port such a conclusion nor is it plausible.

Opinion 770-A at 88, R. 3648.

This is the kind of determination that must be chal-

lenged head on if at all, but we find no such challenge

by any of the petitioners. Hence we need not rule on

whether or under what circumstances the Commission

would be obiigated to reduce “cost” of natural gas pro-

duction because of nonjurisdictional loss.** We hold that

the implausibility of net nonjurisdictional loss for the

producers—at least in the absence of contrary evidence

from the petitioners—renders unnecessary any inquiry

into savings from consolidated returns.

2. Increased Intangible Drilling Costs

The next major criticism leveled by the consumers

against the Commission model is that it does not fully

take into account the tax savings which the producers

may achieve by taking as deductions the higher intangible

drilling costs which will result in future production.

The consumers assert that the Commission’s model of the

cash flow of the average well operates “in a vacuum”—

that the Commission assumes that the producer will be

paying income tax on the revenues generated by that well

when, in fact, those revenues will be offset by the de-

ductions from the drilling of additional wells. APGA

Brief at 47. Pushing the point a bit further, APGA

visualizes “constantly increasing amounts of exploration

and development in the future resulting in real resource

growth ... which would generate additional tax deduc-

** As for the possibility that the gas producers may suffer

losses in a variety of non-jurisdictional non-gas operations,

a possibility mentioned in Judge Fahy’s opinion dissenting in

part, there is no evidence, and certainly no substantial evi-

dence, that the producers seeking diversifiaction (a kind of

industrial “insurance”’) and higher profit will be losing money

individually, let alone on an industry-wide scale. But beyond

that, we are not aware of any principled basis for saying that

natural gas consumers should pay less for gas simply be-

cause the unlikely hypothesis materializes and, say, Mobil

Oil loses money in its Montgomery Ward investment.

tions” (APGA Brief at 48), and the Public Service Com-

mission of New York refers to the possibility of “a

series of staggered deferrals result{ing) in a permanent

reduction in the company’s tax obligations.” N.Y. Reply

Brief at 24.

The Commission addressed itself to this consumers’

contention. Initially, in Opinion 770, the Commission

put it that increases in unit costs arising from inflation

or decreased productivity would be reflected in the rate

calculations for subsequent biennia and that an assump-

tion of constantly increasing real resource growth for

the industry was unrealistic. Opinion 770 at 84-5, R.

2579-80. On reconsideration, in Opinion 770-A, the Com-

mission articulated its position that the validity of its

model is not dependent on assumptions about the real

resource growth of the industry, one way or the other.

Further consideration leads to the conclusion that the

methodology employed in Opinion 770 takes accoynt

of all future increases in intangible drilling costs de-

ductions whether caused by increasing unit costs or

real resource growth. (emphasis added)

Opinion 770-A at 78, R. 3643.

In explaining this conclusion the Commission stressed

that its model gave the consumer the full time value of

every tax deduction, and that as the model was applied

in future biennial ratemaking proceedings, the consumer

would fully recoup any tax savings which the companies

had gained from increased expenses:

Whenever a producer makes future investment for

the exploration or development of new gas, the value

of the tax deductions resulting therefrom will be sub-

tracted from the gross outlays used to compute the

just and reasonable rate for gas from wells drilled

at that time. Thus the time value of the deferral in

tax liability obtained by that investment will be re-

turned to the consumer through the price of that gas,

consistent with the decision in Alabama-Tennessee

Natural Gas Co. v. FPC.

Opinion 770-A at 78, R. 3643.

The soundness of this position of the Commission is

reflected in the opinion of Commissioner Smith. Al-

though he disagreed with several of the Commission’s

other major conclusions, he concurred in the Commis-

sion’s treatment of taxes. His concern lay only in the

need for assurance that there be forward consistency in

this income tax analysis to assure reasonableness of fu-

ture rates:

It is mandatory that this treatment of the income

tax deductions continues in the future. If the meth-

odology were changed in the future to account for

the value of income tax deductions on a capitalization

or “carry-forward” basis, as was argued in this pro-

ceeding, the future rates would be unduly and un-

justly biased upward.

770-A Dissenting Opinion at 3, R. 3814.

After careful study, we conclude that the Commis-

sion’s discounted cash flow methodology fully accounts

for any tax savings from potential increases in intan-

gible drilling costs. Initially, we consider the APGA’s

assertion that the Commission model operates “in a

vacuum.” If this is only another way of saying that

rate regulation can never proceed by constructing a

model, we merely reiterate our prior discussion. If this

means that the particular model has the defect of treat-

ing test period production in isolation from the rest of

producers’ activities, it is inaccurate. Opinion 770-A at

79, R. 3644. The model well postulated by the Com-

mission’s methodology produces no revenues during its

preproduction years, yet the analysis assumes that the

expenses generated in those years yield a current tax

savings, in other words, assumes there will be other

income, and that the tax due on that other income wil!

be reduced.

In this way the model takes into account the interac-

tion between wells with overlapping lifetimes. Assume,

for example, that Well I has reached its productive

period, and is producing taxable income. During this

period drilling for Well IJ is commenced, and intangible

drilling costs are incurred in connection therewith. It

is true that the tax deductions generated by Well //

may be applied against the income from Well J, and may

reduce or eliminate the tax liability for Well J during

those years. It is also true that this savings will not be

reflected in the rate calculation for Well J. But because

the model assumes that preproduction deductions wil! be

used to offset income from other activities, the tax sav-

ings from the overlap of the two wells will be reflected

in the rate calculation for Well IJ. Moreover, because

the model recognizes the full time value of this savings,

the consumer gains the full benefit of the deferral of the

tax obligation.”

Once this fundamental point is understood, it is easier

to see why the reasons for increases in intangible drilling

costs are irrelevant to the validity of the model. If for

some reason the unit cost of drilling increases, it will

produce a larger tax savings per Mcf and that larger

tax savings will be reflected in the rate calculations for

gas from the wells that are being drilled. This point is

entirely sound, and recognized as such in the thoughtful

brief filed by the New York Public Service Commission.”

Even projecting there may be no change in the unit

cost of drilling for gas, and that there will be an in-

** See page 30 and n. 20, supra.

** N.Y. Brief at 18.

crease in gross tax deductions arising solely from real

resource growth in the natural gas industry, the con-

sequent tax savings would still be reflected in rate-

making under the Commission methodology. In that cir-

cumstance, the tax saving reflected in the price of each

Mcf of gas produced in future biennia would not be any

greater, but because there would be more Mcf of gas

produced and sold, the greater aggregate tax savings

would be fully recouped. In short, under the Commis-

sion model every time a tax deduction is taken, the value

of the savings is noted, increased to reflect its value over

time, and reflected in the price of subsequently produced

gas.

The Commission’s methodology is fully capable of han-

dling a long series of tax deferrals. In the same way

that the Commission’s model adjusts for the tax savings

from the interaction between Wells I and II, it can ad-

just for any further savings resulting from the inter-

action of Wells II and III, and so on. Because the model

adjusts for the savings from each incremental] deferral,

it provides adjustment for the aggregate impact of an

entire series of staggered wells.** As long as the meth-

odology is consistently applied, the producers will have

no “savings” from taxes that do not also inure to the

benefit of the consumers.

One caveat is critical. The fairness of the Commis-

sion’s methodology depends directly on the assumption

** The consumers put it that the tax model might be con-

fronted with an infinite series of tax deferrals. This is con-

ceptual, and not sufficiently probable to warranted extended

consideration. But even in that extreme situation, the Commis-

sion methodology would not break down. The value of each

successive deferral would be reflected in lower rates for the

gas produced in subsequent biennia. For discussion of the

consequences of future deregulation, see pages 49-50.

that it will be consistently applied in future biennial

ratemaking proceedings. If the Commission were to adopt

some other method of accounting which failed to adjust

for the full value of current deductions, the producers

could indeed achieve a tax “savings” that is permanent

and would not inure to the benefit of consumers.

We revert to Commissioner Smith’s observation, con-

curring in the treatment of taxes, but noting that “con-

tinuity of methodology . . . is an essential underlying

premise of the rate established herein.” R. 3814. We

stress that our approval of these rates is conditioned

on the continuation of such treatment. We see no need

to spell out in this opinion the operation an: conse-

quences of this condition. It suffices to say that any

new biennial rates that did not adjust price for the

full time value of tax deductions taken, but not pre-

viously accounted in offsets for the benefit of consumers,

would be “arbitrary and capricious.”

One possibility of a “windfall” for producers is the

prospect that in the not too distant future regulation

of producers’ gas rates may be discontinued. In that

event, there would be no ongoing opportunity for a

regulatory commission to assure that tax reserves al-

ready treated as an expense but deferred will be cap-

tured for the benefit of consumers. As to this, perhaps

all that can and need be said is that though a system

of regulation may be revoked tomorrow, while it is here

today it must use the premise of continuing regulation

as the only rational anchor.

Neither the agency nor the court can fairly be re-

quired to speculate on whether there will be deregula-

tion, of its how and when, or whether it can be ac-

companied by other measures assuring reasonable pro-

tection to the consumers at that time.

D. Conclusion

The FPC’s previous treatment of the tax problem

in Opinion 699 was deliberately left tentative for further

consideration. The repeal of the depletion allowance

necessitated a new approach. We are aware that the

Commission’s methodology yields a greater amount than

the depletion allowance alone. The ultimate point is

that the Commission’s approach reflects a determination

to be both comprehensive and fair. The Commission’s

need to set rates in 1976 means that it could not await

the audit and analysis of tax returns under the new

act. More important, the Commission made a reasoned

judgment that it was implausible that historical tax re-

turns would yield useful information about the tax li-

ability accruing from 1975-76 jurisdictional gas. The

Commission’s model is designed to give the producer full

compensation for any tax payments and the consumer

the full benefit of any tax savings. It is a logical

model, that takes into account all experience that is

known and that can reasonably be anticipated.

We have given the most respectful consideration to

the views of our colleague Judge Fahy dissenting on this

point, and to his concern that major oil companies may

find ways of deferring taxes not presently reflected in

the Commission model. Nevertheless, we think that the

Commission’s approach to this thorny issue is a reason-

able one, and should be sustained at this time.

Implicit in much of Judge Fahy’s concern is an as-

sumption of losses in nonjurisdictional activities (and

tax benefits from using those losses to reduce taxes due

on jurisdictional sales). The Commission found it im-

plausible that the producers as a whole would sustain

losses in their unregulated activities while making gains

in sales of regulated interstate gas. There is no evi-

dence in the record to challenge that conclusion. It is

certainly not unreasonable to presume, in the absence

of contrary evidence, that the sphere of unregulated

prices is likely to be more profitable.

If there are other tax events that reduce the pro-

ducers’ tax liability, the parties can bring these to the

attention of the Commission, so that its model can be

refined. Our approval here of the basic framework of

the Commission’s model is not intended to preclude fur-

ther analysis and adjustment. Indeed, we perceive no

basis that would support a Commission’s refusal to con-

sider such information as may emerge regarding taxes

paid, and the implications concerning the accuracy of

its model. If this type of analysis can be achieved, and

discloses a flaw in the model, the tax component can be

adjusted as to future sales, just as the cost of service

was adjusted for the 1973-1974 biennium for actual

changes in productivity. And the quarterly escalation

contemplated by Opinion 770 provides a rather obvious

and simple mechanism for implementing such adjust-

ments.

In sum we believe it would be unfair to deny to the

producers any allowance for taxes at all because of un-

certainty as to the precise liability they will shoulder.

As Judge Fahy’s own analysis demonstrates, the pro-

ducers’ tax returns pertaining to revenues from wells

drilled in the most recent biennium would not be avail-

able until, at the earliest, 1977-78. The Commission’s

model obvitates the long wait for filing of returns, and

the incredibly difficult task of calculating taxes on specific

wells from overall returns.

If experience should develop defects in its method-

ology, for reasons that are not foreseen by the Com-

mission or the court, at least on any basis now projected

by consumer interests, that would be a reason for a

different approach for the future. For the present, what

we have conforms in full measure to the requirement

that the agency make a conscientious effort to seek an-

swers, and apply its knowledge and analysis with rea-

soned decisionmaking.

V. PRODUCTIVITY AND GAS RESERVES

We turn next to the calculation of productivity, an

issue both important and difficult.

We begin by voicing malaise. The FPC’s support for

its approach is thin, Commissioner Smith’s divergent

opinion suggesting modest modifications seems cogent, the

Commission’s rejoinder weak. Yet we admonish our-

selves that ours is not the function of decision but of

circumscribed review, limited to saying whether the pre-

sumption favoring FPC’s reasonableness has been over-

come, whether it has been shown that the FPC failed to

seek reasoned answers.

The consumer interests charge that the FPC’s course

was a systematic determination to resolve all cost issues

on the high side to get gas prices as close as possible to

the intrastate level. The contention is that the FPC

may not abdicate to the uncontrolled market, and may

not reasonably act like a cat trying to chase its tail

when the tail is free to go where it will. Yet courts

rarely have basis for undercutting officials’ statements

of reasons by inquiring into subjective motivations.

Looking at objective data, we are constrained to find

that there is a bare minimum to support the FPC’s

rulings. We can and do caution that on any future

rate order there will be need for a more solid under-

girding of result. That may be provided by the govern-

ment’s quest for more firm data on gas reserves. If a

future proceeding is governed by a change in statutory

ground rules whereby intrastate sales are controlled,

the process may become more manageable and realistic.

At this juncture we announce our approval, but with

more of a sigh than a whoop.

The Fifth Circuit’s Shell opinion describes why ‘“pro-

ductivity” is a key application of a cost-based formula.

See 520 F.2d at 1067. Productivity is an index that

measures the amount of natural gas that will be added

to reserves for every foot of drilling that results in some

addition to reserves.

In FPC methodology, this factor (calculated for non-

associated gas)*’ determines successful well cost per Mef.

This in turn underpins determination of dry hole cost

per Mcf, lease acquisition cost per Mcf, cost of other pro-

duction facilities and other exploration costs per Mef.

In this proceeding the Commission obtained its figures

for the number of successful feet of drilling in the years

under analysis from a publication of the American Pe-

troleum Institute," and there is relatively little contro-

versy about those figures.

For data concerning the proven reserves discovered,

the Commission relied on data supplied by the American

Gas Association, a private association of natural gas

producing companies. The AGA figures for “reserves

added” in a given year are computed on a net basis:

they include not only proven reserves newly discovered

during the course of the year but also upward and down-

ward revisions due to producer re-estimation of the ex-

tent of known proven reserves."

" That is, omitting data for “associated gas” produced as a

by product of oil operation.

* Quarterly Review of Drilling Statistics for the United

States, published by the American Petroleum Institute. The

Commission notes that over the years there has been sub-

stantial agreement between these figures and those compiled

by other reputable sources. Opinion 770 at 33 n. 75, R. 2528

n. 75.

” These “revisions” must be distinguished from “exten-

sions” attributable to current development drilling.

In order to lessen the impact of year-to-year varia-

tion, the Commission did not focus on the most recent

year for which productivity data are available (1975), but

instead looked to a range created by two multi-year

averages. Because the AGA data show a very substantial

downward trend in productivity over the past 9 years,

the producers urged that the FPC consider a relatively

short multi-year period (i.e., four-five years). The Com-

mission, however, calculate’ average productivity for the

past eight years (323 Mcf/ft) and for the past nine

years (279 Mcf/ft) and then selected a figure at the

center of that range (300 Mcf/ft) as the basis for its

calculation of the national rate. Through the same

methodology. the Commission settled on a figure of 378

Mef /ft for 1973-74 gas, in lieu of the estimate of 485

Mef /ft in Opinion 699-H.

The consumer petitions opposing the rate increase as

excessive challenge the Commission’s calculation of pro-

ductivity at several levels. First, as the most basic level,

they attack the FPC’s decision to rely on unverified

data supplied by an industry association. They point

out that many of the members of the Southern Louisiana

Subcommittee,” for example, are employees of the major

natural gas producers, and are paid by those companies

for time spent serving on the Subcommittee." Peti-

tioners charge that Subcommittee members responsible

for reporting particular areas may have limited or no

access to proprietary data, other than that possessed by

the member’s own employer,” and that there is no pro-

“ The AGA data is compiled by the various area Subcom-

mittees of the AGA Committee on Natural Gas Reserves.

" Petitioners quote portions of a memorandum prepared

by the Federal Trade Commission's Bureau of Competition,

released March 23, 1975, in support of this assertion. R. 1055.

* Brief filed on behalf of 3 Senators (Abourezk et al.) and

14 congressmen (Aspin et al.) at 26-27 (hereinafter “con-

gressmen”). The FPC’s own Staff Report on the Updated

cedure for verifying the estimates submitted by the re-

porters.“ Because the Subcommittees work with confi-

dential data, they meet in private, and except for isolated

audits, there is no public or Commission access to the

raw data.“* The Commission concedes that it does not

even know some of the assumptions on which the AGA

estimates are based.*

Petitioners recognize that the Supreme Court approved

the Commission’s reliance on AGA data in Permian, 390

U.S. at 801 n. 78, but point out that then collection of

that data could not have been biased by knowledge of

the role it would play in industry rate-setting.’ Peti-

tioners point out that ever since the Supreme Court’s

decision made clear that AGA reserves added data would

be used in the rate computation, those statistics have

81-Lease Investigation, issued June 21, 1976, explains:

“Many instances can be demonstrated in the current study

where producers who do not own interest in all the blocks

in a field or who own no interest in any block in the field

have reported the field reserves to the AGA ... [T]he

producer who has access to all the necessary geological and

engineering data is not always the one who reports the block

of field reserves to the AGA.” R. 2448.

* Congressmen’s Brief at 27, citing Bureau of Competition

Memorandum. :

** Congressmen’s Brief at 23, citing National Gas Survey,

Vol. I, Chap. 5, (Preliminary draft issued in advance of Com-

mission approval) (no date).

** In response to the argument that the AGA historical data

did not take into account the increase in feasible reserves

resulting from a significant increase in price, the Commission

replied, inter alia, “we do not know what rate-cost factors

have been assumed in initial reserve addition estimates.”

Opinion 770-A at 52, R. 3617. The FPC Staff Study on the

31 Lease Investigation, supra note 6, also disclosed “There

is no standard procedure for determining the exect date of a

field discovery” and that neither the AGA nor the reporting

producers follow the exact AGA definition. R. 2461.

** Congressmen’'s Brief at 20.

shown a marked decline.*’ Although petitioners do not

offer an alternative set of data, they argue that in-

dustry data collected after Permian and not subject to

Commission verification are an inadequate basis on which

to fix a new national rate. Petitioner APGA puts it:

“Nothing short of a full investigation and independent

audit by the Commission’s staff of all industry reserves

and drilling data and an evidentiary hearing at which

the consumers and Staff are permitted to cross-examine

those who prepared this data will suffice to remove the

taint from the present industry figures. . .” “

The Commission implicitly acknowledges that the in-

formal industry reporting system is not the most de-

sirable source of data, but explains that its own efforts

to collect such data by means of compulsory forms have

heen stayed by court order.” See Union Oil Co. of Calif.

v. FPC, 542 F.2d 1086 (9th Cir. 1976). In Opinion

770-A the Commission states :*”

We were faced with the choice of further delaying

the issuance of the new national rate opinion until

sufficient “in house” data could be gathered and used

in this proceeding, or proceeding with the AGA and

API data as done in Opinion No. 699. We concluded

that the judicious use of this data and the prompt

issuance of Opinion No. 770 would be better than

further delay.

‘The Brief of the APGA, at 58-59, highlights the relevant

figures. In the years 1955-68, reported nonassociated gas

reserve additions ranged from a low of 11,449 Bef in 1960

to a high of 18, 294 Mcf in 1965. In 1968, the year of the

Supreme Court's Permian Basin decision, the reserves added

figure was 12,385 Bcf. The following year it dropped to al-

most half, 6,875 Bef, and the annual AGA figure has not

since returned to the 5-digit level.

* APGA Brief at 66.

’ Opinion 770-A at 42, R. 3608.

” Opinion 770-A at 44, R. 3609.

The Commission argues further that it did not simply

accept the AGA data without question, that it diligently

examined such data to assure its reasonableness. In sup-

port of this contention it cites the Report of the staff of

its Bureau of Natural Gas on the Updated 31-Lease In-

vestigation *' and the National Gas Reserves Study of

1973."

We are reluctant to approve the AGA data series, for

we recognize the problems created by the Commission’s re-

liance on essentially unverified industry data. But, under

the circumstances, we do not find the Commission ap-

proach unreasonable, as a provisional response pending

independent derivation of data. The Commission’s choice

to use the best available data, and to make whatever

adjustments appeared necessary and feasible, is within

its competence. “Courts ‘cannot fairly demand the per-

fect at the expense of the achievable.’” ** While we would

"Staff Report on the Updated 31-Lease Investigation,

Docket No. RM 75-14 (June 21, 1976), 41 F.R. 26573. The

Commission emphasizes the Staff’s conclusion that “the esti-

mates in total are reasonable.” R. 2447. The petitioners argue

that this statement must be read in context, in light of the

following sentence that states that there was only a minor

difference in totals for the 19 fields on which the staff, pro-

ducer and AGA all had reserves estimates for 1971-72 dis-

coveries, and that this conclusion was not intended to apply

to those fields on which the AGA failed entirely to include

a report within the time period. Because of the ambicuity

in this particular conclusion, we do not relv on it. Neverthe-

less, we note that the Staff report did not recommend against

use of the AGA data, but rather spoke of the need for «ome

form of trending or averaging.

“* National Gas Reserve Study, A Staff Report, prepared by

the FPC Staff for the National Gas Survey, revised September

1973. Congressmen pointed out that this study covers only

reserves proven through 1970.

* Pub. Serv. Comm. of N.Y. v. FPC, 167 U.S.App.D.C. 100,

108, 511 F.2d 338, 346 (1974) (advance payments).

expect the Commission to use its own revised procedures

to gather data for the next national ratemaking proceed-

ing,’ at this juncture we cannot hold that, given the

context of the FPC’s efforts at and program for further

analysis and cross-checking, the AGA date is so devoid

of substance that it cannot serve as “substantial evi-

dence.”

At the next level, petitioners argue that there are spe-

cific inaccuracies in the AGA statistics which call for

their rejection or for additional adjustments. Petitioners

cite several studies, including a study prepared by the

Bureau of Competition of the Federal Trade Commis-

sion,” a House of Representatives subcommittee staff

study,” and the BNG study on which the Commission

also relied.”

“% The Ninth Circuit prevented the Commission from using

Form 40 to gather data on the grounds that the record

lacked sufficient evidence to overcome the producers’ con-

tention that a reservoir-by-reservoir accounting was unduly

burdensome. Union Oil Co., supra, at 1042-44. The court

also found that the Commission had not sufficiently justified

its provisions for public disclosure of the daia. 542 F.2d at

1044-45. These objections do not appear to be of the kind that

would preclude other Commission efforts to collect data on

the growth of proven reserves, and we note that the Commis-

sion presently has this matter under its consideration.

“ Staff Memorandum to the Federal Trade Commission in

American Gas Association, et al., File No. 711-0042 (March

25, 1975). The entire memorandum is not in the record, but

portions are quoted in Appendix 1 to the Initial Comments

of the APGA, R. 1052-1067.

Hearings on Natural Gas Supplies Before the House Sub-

comm. on Oversight and Investigations of Comm. on Inter-

state and Foreign Commerce, 94th Cong., 2d Sees., January 21,

1976 (testimony of Dr. John Galloway).

" Staff Report on the Updated 31-Lease Investigation,

Docket No. RM 75-14 (June 21, 1976), 41 F.R. 26583.

According to the BNG study, a principal source of in-

accuracy in the AGA data is that new reserves are often

not reported in the year of their discovery.” As a result

of this “lag” in reporting, the AGA “reserves added” fig-

ure for a given year will not reflect all the discoveries

made in that year. However, it may include reserves

actually discovered in a prior year. Hence, as the Report

points out, the use of multi-year averages tends to mini-

mize the impact of any lag in reporting.” In light of

this analysis, the Staff did not recommend the rejection

of the AGA data, but rather cautioned that the AGA

figures be used with “discretion,” and commended the

Commission’s past use of multi-year averages.”

In Opinion 770, the Commission acknowledged the utili-

ty of the multi-year average in accounting for misreport-

ed discoveries and, in fact, chose to look at a longer period

than that used in Opinion 699." For that earlier national

ratemaking proceeding, the Commission had initially pro-

jected a range from 7 to 10 years,” but had ultimately

settled on a ( year period as the basis for its productivity

calculation. This choice was upheld in Shell. As al-

ready noted, Opinion 770 selected a figure midway in the

8 to 9 year ranges. Thus, the Commission did grapple

with the problem, and made an attempt to reduce the

impact of any lag in reporting additions to gas reserves.

A second potential source of inaccuracy identified by

petitioners is the inclusion of revisions in the AGA re-

* R. 2447.

* R. 2448.

Id.

** Opinion 770 Mimeo at 34-38, R. 2529-2533.

51 F.P.C. 2212, 2246 (1974).

51 F.P.C. at 2281.

* Supra note 5.

serves added data. As the Commission stated in its

Opinion 699: *

A significant factor in the decline [in reserve addi-

tions] is the sharp increase in net negative revisions

to existing nonassociated gas reserves that was first

reported in 1969 and which has continued to this

day.

The AGA figures show that the first year in which the

net revisions statistic was negative was 1969, and that

for the eight year period 1968-1975, negative revisions

exceeded positive revisions by 7,502 Bef. These net

negative revisions reduce productivity for a given year

even though some of them may be adjustments to re-

serves discovered in prior years.

The Commission has recognized this potential deficiency

in its revision data, but concluded that revisions are an

“important piece of information.” The Commission

points out that, to the extent that the revisions relate to

discoveries made in a year covered by the data series, the

inclusion of these adjustments is necessary to obtain an

accurate picture of reserves added during the multi-year

period. But because the AGA does not identify the year

to which the revisions relate, it is impossible to tell which

revisions should be included in the muiti-year average.

Faced with a difficult choice between utilizing revision

data to adjust historical! figures or excluding it altogether,

the Commission decided to incorporate these adjustments.

This was upheld by the Fifth Circuit in Shell, 520 F.2d

at 1079. We do not find warrant for reversal at the

present time. We expect, however, that the Commission

°° 51 F.P.C. 2212, 2247 (1974).

*° Opinion 699, 51 F.P.C. 2212, 2342 (Appendix A).

“? Opinion 770-A at 49, R. 3614.

** Opinion 770 at 143, R. 2638.

will make efforts to improve the quality of the revision

data. It has not been asserted that this would be impos-

sible, either by identifying the years to which the spe-

cific revisions relate, or in a more general fashion, deter-

mining the extent to which the revisions relate to the

current period.

Reviewing the Commission’s productivity calculation as

a whole, we find that the comments of the parties and its

own staff studies provided minimally adequate evidence

to support its use of the 300 Mcf/f figure. Petitioners

protesting the increase have identified some deficiencies

in the data used by the Commission,” but these potential

inaccuracies do not undermine the Commission’s basic

conclusion that productivity has declined substantially

over the past decade.

°° In addition to the arguments discussed in text, petitioners

make two further points. First, they argue that the Commis-

sion erroneously computed the average productivity for the

8 and 9 year periods by dividing the total drilling footage

by the total reserves added during the multi-year period,

rather than using an average of annual averages. The Com-

mission’s method of calculation, say the challengers, gives

too much weight to recent years in which the drilling footage

was larger. That calculation is undeniable. But whether

sound statistical theory counsels an average of averages,

rather than such a weighting, is too debatable for us to lay

down a choice either way as mandated by law. It lies within

the realm of policy latitude.

A second contention of petitioners is that the Commission

failed to take into account the fact that the increase in price

contemplated by Opinion 770 will itself increase the reserves

whose recovery is economically feasible. Here again, the Com-

mission did consider this point, and did seck answers, but

found no means of adjusting historical figures to take thi«

projected effect into account. Opinion 770-A at 55, R. 3617

As in so many issues of government, it is easier to state tho

problem than a solution. Petitioners provide no compelling

answer.

We take into account the Commission’s attempt to cor-

rect for the weaknesses of its data by using an 8-9 year

average, as a means of minimizing any lag in reporting

or misreporting of reserves. We cannot say the Com-

mission has failed “to seek answers.” Mobil Oil, 417

U.S. at 318. And we cannot say at the present juncture

either that the Commission’s determination is irrational

or that the underlying data are too insubstantial to

permit the agency to grapple with the serious problems

of covering the costs of natural gas in a time of gas

shortage and declining productivity.

Further adjustment of the AGA data might ave been

desirable even at this time. Commisioner Smith provided

an analysis concluding that revisions should be excluded

and that reserves added data should be lagged one year

behind drilling footage. These comments appear to have

force, but they are more for consideration by the agency

than dictation by the court.

Petitioners attack the Commission’s response as amount-

ing in effect to a statement that a lag in reporting re-

serves is not provided because the agency is unable to

quantify the lag precisely, and as contrary to the legal

requirement that an agency use its best judgment to

salvage the inadequate, rather than abdicate to recognized

deficiencies. That does not end the discussion, for the

Commission put it that in addition to the lag in report-

ing reserves (tending to increase costs) there was a lag

in reporting drilling (tending to decrease costs). What is

abdication to petitioners is prudent to the Commis-

sion, what to them is best judgment is to the Commis-

sion a wild guess. The matter is muddy, but in the end

we are left with the view that we cannot say that peti-

tioners have met their heavy burden of demonstrating

refinements necessary for validity. We cannot say that

the FPC was obligated to undertake these refinements, at

least at this juncture.

We have also considered the petitioners’ suggestion that

this case be remanded to the Commission for further pro-

ceedings exploring the accuracy of the AGA data or the

possibility of further adjustments. In that event, how-

ever, the producer petitioners point out that they would

be entitled to refine other figures in the record with more

current data showing cost increases. The problem is not

insubstantial.*” Additional proceedings, together with a

second round of appeals would create additional uncer-

tainty for the industry at a time when some stability is

necessary to encourage growth. While our orders pen-

dente lite have preserved the possibility of a contingent

refund in the event of a judicial declaration of invalidity,

the context of the national emergency bids us make such

a declaration, one way or the other, if we fairly can,

rather than hold matters in suspense. The kind of af-

firmance we provide will not prevent the Commission

from taking corrective action in the light of new informa-

tion, see Mobil, 417 U.S. at 311.

As for the impact of our ruling on future ratemaking,

preparation for the ratemaking for the 1977-78 bienr‘um

has already begun." The Commission is building an ad-

ministrative record for its Form 40, to permit its gather-

ing of direct information on producers reserves, rather

than through statistical appraisal by the industry com-

mittee. While we do not rest on the point, we cannot

ignore the possibility that future ratemaking may be

governed by a new statute and may be conducted by a

new agency.

The ultimate question is whether the finding and con-

clusion before us is minimally adequate under our cir-

* The producers claimed at oral argument before this court

that recently published JAS figures for actual drilling cost in

1975 showed a 20°7 increase. Transcript at p. 8. March 24,

1977.

"FPC Docket No. RM 77-13, 42 F.R. 13048 (March 8,

1977).

cumscribed power of review. It is our judgment that our

review as a court of equity, concerned with the overall

interest of justice, 28 U.S.C. § 2106, is best fulfilled by

affirmance of the ruling under review at this juncture.

To sum up: We do not approve or embrace the AGA

figures; we simply tolerate them for purposes of this

proceeding. We expect that by the next biennium the

Commission will have put into effect its own procedures

for gathering reserves data. To the extent AGA data

remain for consideration, we contemplate that the Com-

mission will have acquired information to permit further

adjustments to the data supplied by the AGA. In the

specific circumstances of this proceeding, we find that the

Commission’s productivity calculation is adequately sup-

ported.”

VI. ATTACKS ON NATIONAL APPROACH TO COSTS

AND PRICES

In this opinion we are accepting and affirming the

Commission’s course in prescribing nationwide ceiling

rates based on composite nationwide figures of nationwide

costs. Two objections have been leveled. Considered sub-

sequently is the objection of producers in the Rocky

Mountain area that their costs are higher, and therefore

their ceiling prices should be higher.

A. Failure to Distinguish Between Onshore and Offshore

Gas Costs

The objection that has given us distinct pause is the

contention that “there is no validity to the Commission’s

continued insistence upon treating as a single gas source

onshore gas subject to unregulated intrastate competition,

*? The dissenting Commissioner concluded that productivity

should have been 354 Mcf/ft rather than 300 Mcf. R. 2692.

From the judicial perspective, the zone of reasonableness may

well embrace both figures.

and offshore gas from the Federal domain over which the

Commission exercises plenary authority and to which the

interstate market must look for most of its new gas

supplies.” **

APGA and Congressmen press the objection as to all

gas. New York presses it as to flowing gas, acquiescing

in a $1.42 price for new gas on a noncost basis to seek

onshore gas for the interstate market. Commissioner

Smith’s dissent to Opinion No. 770 questioned part of the

upward revision in the 1973-4 biennium. Accepting the

decision to “vintage” the 1973-4 natural gas, and the

need for an income tax allowance for future delivery of

that gas, his question was as to other costs. “The at-

tempt to reconstruct an average ‘actual’ nationwide cost

for 1973-74 results in compensating the producers for

costs that, for the most part, were not incurred with

respect to gas sold in interstate commerce.” (Opin. at

11, R. 2693). He continues:

[I]t would appear that the vast majority of that

higher cost natural gas was intended for and sold in

the intrastate market. [W]hen the Commission en-

gages in retrospective compensatory ratemaking,

should not costs actually incurred with respect to the

particular gas that is being repriced provide the

guideline for the repricing decision? (Id.)*

Starting with the most modest objection, there would

be at least a substantial question whether the Commission

has been arbitrary in raising prices to the consumers

(for offshore as well as onshore gas produced during

the 1973-4 biennium) if it develops that the underlying

reason was really higher costs incurred on onshore gas,

*s Quoted from p. 11 of brief of New York Public Service

Commission.

** Commissioner Smith agreed that prospective rates should

cover the “full marginal cost to the producer . .. else the

position of the interstate market vis-a-vis the intrastate

market would deteriorate even more.”

and those costs had already been recouped by unregu-

lated price increases in the unregulated intrastate market.

There is no doubt of the reality of higher prices in the

intrastate market for all pertinent periods. Indeed, Opin-

ion No. 770 itself reveals how intrastate prices had

climbed by the first quarter of 1976, well before the is-

suance of Opinion 770,"° to an average in excess of $1.50

per Mef. By the time Opinion No. 770-A issued on Nov.

5, 1976, there was another jump in intrastate prices,

not unexpected in view of the $1.42 price set in Opinion

No. 770."

In Opinion No. 770-A, the Commission addressed itself

to the arguments of petitioners for separate pricing of

offshore gas. The Commission challenged the implicit

“assumption that onshore costs are highe# than offshore

costs. The cost analysis below indicates that the contrary

is probably true.” Mimeo at 138, R. 3703. The Commis-

sion’s exhibits (#14 and 15) show that while offshore

gas has “many times higher” productivity (1641 as

against 196), it has higher drilling costs, dry hole costs

= lease acquisition costs. The “bottom line’’ of these

exhibits is an average cost of $1.63, with $1.51 for on-

shore and $1.84 for offshore. The FPC acknowledges

that this 33¢ difference would be reduced “if, as some

' The data show an average price of $1.54 for new con-

tracts with 57‘ of volume above $1.50, and $1.78 for re-

newotiated contracts, with 80° of volume in excess of $1.50

Mef. Opinion 770, Exh. 27, R. 2609.

‘The FPC informs us in another pending case, p. 31 of

Brief filed Dec. 28, 1976, in =75-2105, APGA and Constuniur

Federation v. FPC, citing FPC News Release No. 22711, Nov.

4, 1976: “new contract rates for intrastate sales are now

[1976] averaging $1.59, with 70‘: of those contracts at rate

levels exceeding $1.51, and 7.4% ... at rates between $2.01

and $2.50... [R]enegotiated .. . intrastate contracts now

[1976] average $1.66 per Mcf. 76% of those intrastate sales

are at rate levels exceeding $1.51 and 9.3% are between $2.01

and $2.50.”

parties claim, and the sparse UDC data indicates,” off-

shore rates-of-take are faster than those employed in

Opinion No. 770 [which assumed a 15-year rate-of-take}.

It concludes that “a split between onshore and offshore

pricing would lead to no appreciable differences.” Mimeo

at 139, R. 3704.

In this state of the record, the court cannot find a

lack of either substantial evidence or rationality.”

However, we also acknowledge concern that the factor

of rate-of-take, obviously a key consideration in the

Commission’s discounted-cash-flow methodology, is treated

with a glancing reference to “sparse data” and the

“guesstimate” of what it signifies. If the future brings

parity in prices for intrastate and interstate gas, as is

sought by the Administration’s energy proposal to regu-

late intrastate rates," the issue disappears for the fu-

ture. If the future maintains marked differences between

unregulated intrastate prices and regulated interstate

prices, the Commission has a responsibility to give more

" Citing Exhibit 13 to Opinion 770. :

* Opinion No. 770-A approaches the question broadly, with-

out specific reference to Commissioner Smith's request in

Opinion No. 770 for further exploration of the issue for the

1973-74 biennium. Mr. Smith’s opinion in No. 770-A did not

reiterate this question as an objection. Viewing the problem

in context, as a portion of the 98¢/Mcf rate, we note that the

upward revision for income tax factor brings the price set in

opinion 699 up to 83¢/Mcf. Thus, the issue of offshore cost«

for the past biennium is at most 10¢/Mcf. By implication, the

Commission's Opinion 770-A would support for the past bien-

nium as well as for the future the gross estimate of no xig-

nificant cost difference between onshore and offshore gas. The

problem as to depletion period would require full reconsider-

ation. We conclude it is not required as a matter of law for

the past period.

™ S. 1469, 95th Cong., Ist Sess. (Introduced May 5, 1977)

(as to “new natural gas,” as defined).

attentive consideration to the contention that it is ar-

bitrary to average high costs for onshore gas | which

recoup unregulated prices} and lower costs for offshore

gas, for which there is a claim of an 8-year depletion

The public interest contemplates a fair interstate price

based on average cost, but it is questionable whether

such an average may fairly include gas that is identified

as most unlikely to go interstate in any event. Any

average would in any event be subject to increases un-

der the optional procedure of Section 2.75 of the Com-

mission’s Rules for particular packages of gas. The

Supreme Court’s Permian opinion underscores the validity

of rates that are just and reasonable for the average or

group and accommodate higher-cost incremental gas

through special adjustment provisions.

B. Claimed Need for Area Rate Regulation

Mountain Fuel Supply Company," argues in effect that

the Commission was required to revert to its prior pro-

gram of area rate regulation, either as a matter of the

Commission’s jurisdiction under the Natural Gas Act,

or as a matter of the requirements of reasonableness,

taking into account fundamental differences of cost and

market for the sale of natural gas in the Rocky Moun-

tain Area.

In essence, this is an attack on the concept of national

rate-making for national gas. We accept and approve

the determination of this question in Shell Oil Co. v.

FPC, 520 F.2d 1061 (5th Cir. 1975), cert. denied, Cali-

See p. 45, n.25, brief of N.Y. Public Service Commission.

" Petitioner in No. 77-1005, which has been consolidated for

disposition, Mountain Fuel is a producer of some natural! gas

but its interest in this proceeding is primarily as a purchaser,

as an integrated utility handling natural gas from the pro-

ducer level to the ultimate consumer.

fornia Co. v. FPC, 426 U.S. 941 (1976). While that

approval of national gas rate-making is not fixed in con-

crete, and is subject to reexamination, petitioner has

not made a showing that its immediate maintenance is

unreasonable.

The Commission addressed itself to particular prob-

lems presented by Mountain Fuel, the instantaneous ef-

fect of the national rate increase, the most-favored

clauses permitting indefinite escalation raising prices of

intrastate gas, and the lack of state commission au-

thority pass along the price increase in higher rates.

All these, said the Commission, did not undercut the

national rates, but were matters requiring action as to

state law and by state commissions. (Opinion 770-A at

168ff., R. 3733 ff.) We approve its reasoning.

Vii. Cost Impact oF ADVANCE PAYMENTS

Under the advance payment program sponsored by

the FPC from 1970 through 1975, an interstate pipe-

line could include in its rate base payments to a producer

for gas to be delivered at a future date. Opinion 770

did not analyze the impact of these interest-free loans

on the cost of gas, and this failure was criticized in the

dissent of Commissioner Smith and in the petitions on

rehearing of several consumer groups. In response, the

Commission held in Opinion 770-A that a producer who

accepted an advance payment after November 5, 1976

(pursuant to a pre-existing contract) would be required

to make rate adjustments reflective of the lower cost

of capitai. In particular, the Commission held that such

a producer would be required to charge a rate covering

only out-of-pocket costs, i.e. not including a return on

investment or accompanying income tax, on all gas cov-

ered by the agreement, until the producer had effec-

tively returned to the pipeline through that reduced rate

the full amount which the pipeline had collected from

its customers as a result of the inclusion of the advance

in the rate base.

On appeal to this court, the Commission’s treatment

of the advance payments problem is attacked from all

sides. The producers’ viewpoint is presented by the

Louisiana Land & Exploration Co., the SONAT Ex-

ploration Co. and a group of small producers. They

argue, inter alia, that the Commission’s action on ad-

vance payments was taken without notice and an oppor-

tunity for comment, that its resolution is inconsistent

with the Commission’s prior disposition in its order of

December 31, 1975, and that Opinion 770-A is unfairly

retroactive insofar as it fails to fulfill producer ex-

pectations concerning existing contracts. The Natural

Gas Pipeline Co. makes many of the same arguments,

but adds the point that the Commission’s action may

give the producers a basis for refusing to deliver to the

interstate market gas previously committed under ad-

vance payment agreements. Lastly, two of the con-

sumer petitioners, the Public Utilities Commission of

South Dakota and the Congressmen, say that the Com-

mission did not give consumers enough relief: they at-

tack the Commission for its failure to factor into its

calculation those interest free advance payments already

received by the producers.

Before analyzing these various contentions, we pause

to note that this court has been sensitive to the difficult

issues of law and policy raised by the Commission’s

advance payments program. Although we sustained the

Commission’s commencement of the program on the

ground that it was an “experiment in the continuing

search for solutions to our national critical shortage of

natural gas,” we noted our assumption that the data

developed from experience under the program would be

subjected to meaningful review and reevaluation. Public

Service Commission of New York v. FPC, 467 F.2d 361,

871 (D.C. Cir. 1972). On a subsequent challenge, we

found that the Commission had not engaged in adequate

reappraisal, that the record as it stood was not sufficient

proof that the program was eliciting new supplies of

gas to justify extension of the program without such

reappraisal, and we remanded for further consideration.

Pub. Serv. Comm. of N.Y. v. FPC, 511 F.2d 338 (D.C.

Cir. 1975). The Commission made further inquiry and

concluded that, on balance, the program had not func-

tioned as had been intended. By order issued December

81, 1975, the Commisison discontinued the program."

However, the Commission announced that it would con-

tinue rate base treatment for advance payments made

pursuant to the executory portions of existing contracts.

We turn first to the producers’ attack on the rate

adjustments required by the Commission. We are not

“* Docket Nos. R-411, RM 74-7, Order on Remand from

Court Opinion Terminating Investigation and Terminating

Advance Payment Program with Conditions, 41 F.R. 2276

(Issued Dec. 31, 1975). The Commission concluded that while

some advances had aided the development of offshore re-

serves, the program did not have the significant impact ex-

pected at the inception of the program, and hence as a matter

of policy it allowed the offshore portion to expire. The Commis-

sion found that onshore advance payments did attract new or

additional quantities of gas, but accepted the pipelines’ con-

tention that while this was beneficial, the Commission could

best assure such development and dedication through rate

relief (Mimeo 10-11). On the issue of whether refunds should

be required, the Commission agreed with the New York Com-

mission and Louisiana Land and Exploration that the issue

required a balancing of the equities, under, e.g., Consumer

Federation v. FPC, 169 U.S.App.D.C. 116, 515 F.2d 347

(1975) (which terminated the 180-day emergency sale pro-

gram), took account of the evidence that the program was in

part a success, and concluded that the equities weighed

against a refund requirement.

persuaded by their claim that they failed to receive

adequate notice of the Commission’s intention to take

advance payments into account in determining just and

reasonable rates. The producers were well aware of the

Commission’s cost based approach; the dissent of Com-

missioner Smith in Opinion 770 and the petitions for

rehearing of several consumer groups focused attention

on the impact of the interest free loans on the cost of

capital; and the Commission, in its order granting the

petitions for rehearing,” explicitly invited oral argu-

ment on “the effect of advance payments on the cost of

capital.” R. 3089. The producers had adequate notice

that this issue would be considered.”

Nor was the Commission’s consideration of this issue

precluded by its treatment of contractual obligations in

its Order on Remand of December 31, 1975. That order

did not say that the producers were entitled to both com-

pletion of existing contracts and collection of the full

interstate rates; it simply permitted the pipelines to

continue to include in their rate bases advance payments

mandated by existing contracts. This action was neces-

"Order Granting Petitions for Rehearing for Purposes of

Further Consideration, Granting Interventions ard Providing

for Oral Argument, issued September 2, 1976, R. 2086.

“ Similarly, we reject the contention of the small producer

group that they were not adequately apprised of the Commis-

sion’s scope of inquiry. While it is true that they were not

made respondents to the proceeding, they were aware that

the rate applicable to their sales was directly related to the

rate of large producers. To the extent that they are cur-

rently relying on the point that the Commission's approach

to the executory portions of advance payment agreements

will have a greater adverse impact on small producers, they

are essentially questioning the adequacy of the adjustment

provided in the small producer proceeding. Opinion No. 742,

Docket No. R-39%, issued August 28, 1975. We do not think

that the Commission was recuired to deal with that point in

the context of this national ratemaking.

sary, the Commission explained, because “the pipelines

would be required to make advances whether or not this

Commission allowed the pipelines rate treatment for such

advances,” and the pipelines might otherwise be placed

in “financial jeopardy.” Opinion 742 Mimeo at 18-19. We

see nothing in that decision which would prevent the

Commission from designing rates reflective of the lower

capital costs for producers participating in the program.

._ Moreover, even assuming that there was a shift in

course in Opinion 770-A, towards discouragement of par-

ticipation in the program, we think there was adequate

support for such a shift. The Commission reasoned:

We recognize that capital generated through the

advance payments program should no longer be re-

quired to bring badly needed gas supplies to the in-

terstate market. The rate structure set forth in this

Opinion is designed to achieve the capital formation

objective.

Mimeo at 150, R. 3715. Given the full return on invest-

ment included in the new national rates, and the ad-

ditions to capital from the non-cost based rate for roll-

over contracts (discussed in section VIII of this opinion).

we find substantial evidence supporting the Commission’s

conclusion that advance payments were no longer needed.

The producers argue that the Commission’s rate deter:

mination has an unfair retroactive effect on drilling

projects already launched on the basis of existing advance

payment agreements. However, as the Commission points

out throughout Opinions 770 & 770-A, the rates set there-

in are intended to be high enough to attract additional

capital to finance producer expansion. In any event, it

should be noted that Opinion 770-A does not prohibit

the producers from accepting the payments to which they

are entitled under existing contracts. We wil] not dis-

turb the Commission’s implicit judgment that the alleged

hardship to the producer is outweighed by the public’s

interest in cost-based rates.**

We turn to the plea of the Natural Gas Pipeline Co.

that the Commission’s determination of separate rates

for producers receiving advance payments may provide

these producers an opportunity to withdraw from exist-

ing advance payment agreements and to sell the gas

covered by those agreements to intrastate purchasers.

If this were in fact the effect of the Commission’s rate

structure, it would seriously undercut the central objec-

tives of Opinion 770-A. The consequences of the Com-

mission’s action will largely depend, however, on the

regulatory framework within which existing contracts

are renegotiated. The Commission’s brief before this

court states (at p. 135):

To the extent that consumers have paid for past ad-

vances (by inclusion in the rate base) and pipelines

have relied on such agreements to plan future levels

of resale and construct new facilities, it would not be

in the public interest for the Commission to permit

such gas to escape the interstate market as agreed

by the contracting parties.

While this is not a Commission opinion, and we do not

strictly rely on this representation, it is our view that we

can assume, from the Commission’s manifested inten-

tion in the handling of this thorny issue, that the Com-

mission will continue to exercise its regulatory powers in

** Because the Commission’s rates are ultimately based on

the lower cost of capital for producers receiving advance

payments, we reject the contentions that these rates imnper-

missibly discriminate against or penalize those producers. We

recognize that the carrying charges are higher than those the

producers would have to pay on conventional loans, but the

Commission’s decision to give to the consumers the rate of

return allowed to the producers on their own investments

falls within the Commission’s range of discretion in much

the same way as does its estimate of productivity.

the public interest, and that central to the public in-

terest is the continuation of consumer access to those

supplies previously committed to the interstate market.

We contemplate that the Commission will guard against

any abusive use of the opportunity for renegotiation pro-

vided by Opinion 770-A.

For much the same reason we reject the claim of

Louisiana Land & Exploration Co. that the Commission’s

“carrying charge credit” plan is impermissibly vague.”

This petitioner recognizes that the outlines of the Com-

mission’s rate scheme are clear: the producer must charge

a reduced rate until a sufficient volume of gas is de-

livered at the lower rate to offset the amounts previ-

ously borrowed from customers of the pipeline. Louisi-

ana’s claim is that a producer cannot calculate at the

time it accepts an advance what the ultimate cost will

be, for the producer cannot know with precision what

sums the pipeline will collect from its customers as a

result of including the advance in the pipeline’s rate

base. There is no indication whether many or any pro-

ducers will now need or want more advance payments

within the Commission’s framework. Moreover the finan-

cial world is not unaware of instances in which in some

respects there is uncertainty in permitted return (a

commonplace, indeed for investors in utilities) or even

in interest obligation (as in the case of indexed of var

able debt). If there are differences of approach Jetween

producers and pipelines on this matter, it is only one of a

number of points on which they must realistically nego-

tiate. To the extent that this poses a real problem for

producers, we think that the solution is not a reversal

of the Commission’s basic mandate in Opinion 770-A,

and the principle embodied, but a request to the Com-

mission for clarification and conceivably refinement and

adjustment.

We turn now to the contentions of the two consumer

petitioners who attack the Commission for its failure

to adjust rates to reflect payments advanced prior to

the issuance of Opinion 770-A. We begin with the rec-

ognition that once a complex regulatory program is im-

plemented, its effects are not easily undone. The pro-

ducers’ objections to the Commission’s application of re-

duced rates to subsequently received payments suggest

the even more serious problems of disruption and unfair-

ness which might have been created by retroactive ap-

plication of these rates to payments already received

under the program. We conclude that the Commission’s

regulatory mission does not require that it fully erase the

impact of the program it undertook in the interest of

expanded supply.

It is unfortunate that the program was not more suc-

cessful in expanding reserves for the interstate market.

But the program was valid while it was in operation—

as an experiment. In the nature of things, some experi-

ments lead to the rejection rather than the confirmation

of a prediction. It would be unsound to view this as an oc-

casion for taking the Commission to task for a past mis-

take. Our present function is only to review the agency’s

formulation of policy for the future, to insure that the

Commission action is an exercise of reasoned discretion

within the broad limits set by the statute.

With this definition of our role in mind, we uphold the

Commission’s treatment of the advance payments pro-

gram. Opinion 770 did not discuss this issue, apparently

because it was not raised by the comments of the parties

in the preceding comment period. But once the possible

collateral impact of the program had been called to the

Commission’s attention through the dissent of Commis-

sioner Smith and the comments of the parties on re-

hearing, the Commission recognized the problem and

grappled with it. It devised a formula for the calcula-

tion of rates that would discourage further advances

under the executory portions of outstanding contracts

and that would, in any event, ensure that no producer

obtained a windfall from subsequent receipt of funds

under an advance payment contract. The Commission

chose not to modify its national rates to reflect funds

already advanced pursuant to these contracts but it did

so advertently, not casually. Opinion 770-A states:

Certainly, it would be improper to penalize a pro-

ducer without any prior notice by reducing its pro-

spective rates hecause of its prior acceptance of ad-

vance payments under a Commission-approved pro-

gram. Furthermore. these outstanding advance pay-

ments have provided additional capital for explora-

tion and development activities, during the period

(January 1, 1973-July 27, 1976) when the rates co!-

lected were below levels which we herein have deter-

—— be just and reasonable. (Mimeo at 150, R.

3715).

Because the advance payments issue did not appear to

be central to the computation of a new national rate, and

because of the many other important issues implicated by

this rate setting, the Commission’s justification of its

action in this area is succinct. But the Commission’s

statement of reasons is “tolerably terse” rather than “in-

tolerably mute.”” It outlines a rational approach.

First, the Commission points out that “it would be im-

proper to penalize a producer without any prior notice by

reducing its prospective rates because of its prior ac-

ceptance of advance payments under a Commission-ap-

proved program.” In the context of opinions 770 and 770-

A, we think it plain that this was not a technical pro-

cedural objection inhibiting the Commission from taking

account of a factor because it was not noticed at the

commencement of the proceeding. As we fairly discern

““ Greater Boston TV v. FCC, 444 F.2d 841 (D.C. Cir. 1970),

cert. denied, 403 U.S. 923 (1971); WAIT Radio v. FCC, 459

F.2d 1203 (D.C.Cir.), cert. denied, 409 U.S. 1027 (1972).

its path, the Commission was here referring to a more

substantial equitable consideration: the producers who

accepted the advances were not told at the time the

program was approved, and the contracts were negotiated,

that the benefits given to them as an inducement would

later be the subject of compensating reductions of rates.

Indeed, had such a penalty or burden been announced

at the start, it would obviously have cut across the Com-

mission’s purpose to induce otherwise unavailable activity,

to encourage more investment and dedication to the inter-

state market. The Commission’s undoubted latitude to

make policy judgments, which the court may not question

unless they are arbitrary, includes a broad discretiog -to

make equitable judgments, and to conclude that it would

be unfair to reduce the rates of those producers who had

accepted the advance payments with very different ex-

pectations. The Commission is not a court of equity, but

it has authority to take equitable considerations into ac-

count in forming policy.*’ In a matter such as this

equitable considerations undergird reasonableness and

the Commission’s ongoing credibility. An agency which

must consider incentives, as part of overall just and

reasonable rates, may reasonably seek to avoid an unan-

ticipated burden on those members of the industry that

had participated in a Commission-sponsored program.

The Commission’s Order on Remond, issued December

31, 1975 (supra note 82), indicates that there were

substantial numbers of cases in which the interest-free

loans were needed to undertake additional activities and

where they were used for that purpose.

An argument might be made that the full benefit of the

new national rate should not be allowed to those pro-

ducers for whom the advance payments were really

premiums, and not an inducement to expanded invest-

** See, e.g., Niagara Mohawk Power Co. v. FPC, 126 U.S.

Apn.D.C. 376, 379 F.2d 153 (1967).

ment. Any rate scheme based on distinctions between

these two types of situations would have inevitably been

drawn into time-consuming and necessarily speculative

judgments about the capacities and motivations of the

producers participating in the program. The Commis-

sion’s avoidance of such complexities is a choice that

deserves deference. “An agency confronted with a com-

plex task may rationally turn to simplicity in ground

rules, and administrative convenience, at least where no

fundamental injustice is wrought.” Gulf Oil Corp. v.

Hickel, 140 U.S.App.D.C. 368, 374, 435 F.2d 440, 446

(1970).

Opinion 770-A identifies why we cannot say that a

“fundamental injustice” is created by the Commission’s

decision to retain its uniform national rate despite some

variation in costs due to the advance payments program.

The Commission points out that from January 1, 1973, to

July 27, 1976, (the date of issuance of Opinion 770),

the producers were selling gas at rates lower than those

judged to be just and reasonable in the context of this

proceeding. In linking this deficiency in revenues with

the availability of interest-free loans from the advance

payments program, the Commission perceived a kind of

rough justice between consumers and producers. We can-

not say this was perverse or arbitrary.

Moreover, there is an even broader justice in the

Commission’s approach to the whole advance payments

issue. The Commission may not have recaptured for the

consumer the full value of sums already advanced, but

it forces the producers who take subsequent advances to

make payment at a rate higher than was expected at the

time of the contract. In this way it protects the pro-

ducers’ reliance interest in previously received payments,

but gives both producers and pipelines an interest in re-

negotiating the executory portions of contracts that have

in general worked out contrary to the public interest.

The advance payments program was an experiment that

was unsuccessful on balance. It provided some producers

with a “premium” price for their gas. But the Com-

mission’s brief analysis is sufficient to preclude any ju-

dicial requirement that forces the Commission to re-

coup that premium through lower national rates. The

wreckage of the program lies across the natural gas in-

dustry like the debris of an airplane crash. Because

of its scattered uneven impact, a uniformly lower na-

tional rate would be unfair to some producers, and a

system” of rates which took into account varying de-

grees of participation would be extraordinarily difficult

to design and administer. Rather than incorporate into

its new national rate all of the complications arising

from its discontinued experiment, the Commission chose

to make a “clean start”—to disregard those payments

advanced prior to the new rates, but to adjust strictly

for any payments made in the future. As we have al-

ready noted, the context was one of past inadequacies of

revenues. The common law of public utility regulation

pragmatically accepts the futility of embroiling current

and future rate regulation with a function of making

correctives for excess or insufficiencies of rates charged

in the past.” Similarly in the present context, we think

the Commission’s course was a reasonable exercise of its

latitude, which gives regulatory agencies an authority for

“pragmatic adjustment.” FPC v. Natural Gas Pipeline

Co., 315 U.S. 575, 586 (1942).

VIII. CONTINUATION OF THE OPINION 699 RATE

FOR “ROLLOVER” Gas

We turn next to the Commission’s treatment of the

oldest (pre-1973) vintages of flowing gas. Prior to Opin-

"Board of Public Utility Commissioners v. New York

Telephone Co., 271 U.S. 28, 31-32 (1926).

ion 770, prices for that gas were specified by two Com-

mission Opinions. Opinion 749, issued December 31, 1975,

announced a rate of 29 cents for gas from wells com-

menced prior to January 1, 19738. Opinion 699, though

issued earlier, is best understood as establishing an ex-

ception to the general rate, an exception for gas sold

pursuant to a certificate of unlimited duration and under

a renewal contract executed after January 1, 1973. This

gas, known as “rollover gas’ from its renewal char-

acteristic, was priced at the then (1974) national rate of

52 cents per Mcf, with a one cent per year escalator.

Opinion 699 made this rollover rate available only if

the renewal contract replaced a contract that had expired

by its own terms. This rate and its eligibility require-

ments were sustained on review in the 5th Circuit’s

Opinion in Shell, 520 F.2d at 1076-77.

In Opinion 770, the Commission decided to maintain

the same basic rate for gas sold under renewal contracts,

i.e. the 52 cent base rate with the one cent per year es-

calator. Thus, as of January 1, 1977, the rate for gas

sold under a replacement contract would be 53 cents.

This price, the Commission explained, would avoid a large

increase in the rate for “flowing gas” while insuring “ad-

ditional revenues . . . for expanded exploration and de-

velopment programs which are necessary to discover and

produce new supplies of natural gas.” Opinion 770 at 16,

R. 2511. On reconsideration in Opinion 770-A, the Com-

mission adhered to the 52 cent base rate for rollover gas.

The producers object because Opinion 770, while main-

taining the basic 52 cent rate for rollover gas set in

Opinion 699, did not follow Opinion 699 in the method-

ology of setting the same rate for rollover gas as for new

wells. Under Opinions 770 and 770-A, the rate for re-

newal gas is considerably below that for new gas, of

either the 1973-74 or 75-76 biennia. But as we pointed

out earlier in this opinion, the Commission was well

within its discretion in returning to vintaging, as a

means of preventing windfall profits to producers from

the greatly increased rate and of mitigating the impact

of that rate on consumers. This kind of protection is

especially appropriate as to renewal gas, the gas that

is oldest and associated with lowest costs.

The consumers argue that the Commission acted un-

lawfully in allowing a price for renewal gas above that

held to be cost-justified in Opinion 749. They urge, in

effect, a strict form of vintaging, in which the price of

the oldest vintage is based on its lower cost.

The Commission recognizes that the 52 cent rate can-

not be defended on the basis of cost, but argues that this

price is justified as an adjustment to assure equity in

its overall rate design. Huge sums of money—the Com-

mission estimates $3.5 billion per year—will be needed

to finance exploration and development of new sources of

gas over the next decade. The very high rates for gas

from wells commenced in the most recent biennia will

help provide this capital, but, in the Commission’s view,

“it is only fair that consumers of “flowing gas” share

the burden of financing the added exploration.” Opinion

770-A at 19, R. 3584.

This rationale for pricing renewal gas was sustained—

at least tentatively—by the Fifth Circuit in Shell, al-

though that was in a context of abandonment of vintag-

ing. In any event, we approve it for Opinion 770. In

general vintaging is a method of pricing gas on the

basis of cost at the time of production. However, the

agency is not bound strictly to cost. The Commission

“must be free . . . to devise methods of regulation capable

of equitably reconciling diverse and conflicting interests.”

Mobil, 417 U.S. at 331, quoting Permian, 390 U.S. at 767.

The access of some consumers to older, low-cost gas is

largely an historical accident. The Commission is entitled

to place on these consumers a portion of the burden of

new capital formation, so as to achieve an equitable

balance between different consumer groups. See Mobil,

417 U.S. at 320. Here the Commission’s allocation of that

burden cannot be attacked as unfair. By reintroducing

vintaging the Commission has avoided the jarring impact

of a rate increase. By continuing the rate established

by Opinion 699, the Commission also insures equity as

between rollover contracts, without inserting a discrim-

ination according to the date of termination of the prior

contract.

New York does not challenge the general principle

that consumers of old gas should bear a part of the

burden of replacing the commodity they are presently

exhausting, but does take issue with the application of

that principle in the circumstances of this case. New

York and some of the other consumer petitioners raise

two principal objections: first, that in view of other

available sources of capital, the need to raise capital

from consumers of old gas is not as pressing as the

Commission believes; and second, that consumers who

contribute capital for expansion of the natural gas re-

serves should receive some guarantee that the funds

* New York makes an additional argument: that the

initial judicial decision approving a higher rate for rollover

contracts, Shell Oil Co. v. FPC, 491 F.2d 82, 89 (5th Cir.

1974), rested in part on the need to eliminate vintaging,

and in particular on the disincentive effects of low rates

for new wells on fields already dedicated to interstate com-

merce. New York points out that Opinion 699, by allowing

vintaging according to well commencement date rather than

field dedication date, removed this disincentive.

We note, however, that the Fifth Circuit did not rely on

the disincentive argument when it affirmed the 52 cent rate

in Shell, 520 F.2d at 1077, and the Commission does not

press this argument now. The Commission makes the point

that the hicher rates for replacement contracts may encourage

reworkine of older wells, Opinion 770-A at 25, R. %590 but

it ia not central, either in the Commission's opinion or ours.

will be used for that purpose, and not for other profitable

enterprises.

In support of its first objection, New York asserts

that the 29 cent rate for flowing gas established by Opin-

ion 749 contained a generous component for future ex-

ploration and development costs which makes unnecessary

the full increase granted by the Commission for renewal

gas. New York points out that the cost of flowing gas

in Opinion 749 was based upon 1972 levels of explora-

tion and development expenditures. Since these cost levels

were undoubtedly far higher than those in the years

when the bulk of the gas was actually discovered, New

York submits that the 29 cent rate for flowing gas it-

self includes a substantial noncost component which can

be used to finance new exploration.

New York further asserts that the Commission did

not really adopt this rate as a result of reasoned re-

flection, beginning with an estimate of the total capital

required, and then structuring a rate profile that al-

located burden as between flowing gas and new gas. New

York submits that the rate structure adopted by the Com-’

misison is the result of chance rather than integrated

design, and provides an aggregate amount of capital

from flowing gas prices, together with that attraced by

the 15% rate of return for new gas, well in excess of

the producers’ needs.

New York’s argument has considerable force. The

Commission does not explain why it feels that the 29

cent rate for flowing gas will not contribute to capital

formation. The gap is the more conspicious in that it

is identified in Commissioner Smith’s dissenting view.

(R. 3825). Opinion 770 would be more persuasive if it

contained a more complete or explicit analysis of antici-

pated sources of capital and their interaction.

Yet in the context before us, we do not require a

remand. The Commission is limited at this time to pro-

jections about the effects of its rates and about the

producers’ needs. Further consideration will still leave

the matter in prediction, not proof. The public interest

requires exploration and development; rate regulation

may properly take into account the need to provide capi-

tal funds, as Permian and Mobil establish; there is no

assurance at present of defining the exact rate of capi-

tal accumulation and allocation of burden that will fur-

ther the public interest. Experience, however, will per-

mit the Commission and the nation to ascertain whether

under the rates set in Opinion 770-A producers would

accumulate more capital than they can efficiently rein-

vest. It is the hallmark of the administrative process

that it can proceed with flexibility and re-examination.

Public Serv. Comm’n of N.Y. v. FPC, 151 U.S.App.

D.C. 307, 407 F.2d 361 (1972); 167 U.S.App.D.C. 100,

511 F.2d 338 (1975) (advance payments). On some

issues “a month of experience is worth a y:°r of hear-

ings.” American Airlines v. CAB, 128 U.S.App.D.C.

210, 319, 8359 F.2d 624, 633 (en banc, 1966), cert. denied,

385 U.S. 843 (1966).

The need of the courts to hearken to “pragmatic ad-

justments””’ by a regulatory agency betokens a prin-

cipled pragmatism in the courts. These are extraordinary

times in matters of energy, and the courts can serve

their function of review by insisting that the agencies

given primary responsibility steadfastly re-examine their

assumptions. Our affirmance, then, is on the condition

that the Commission monitor closely both the producers’

needs and the capital being raised from internal and

external sources. It is our premise that the Commission

would determine the contributions to capital of the oldest

flowing gas, rollover gas, and the newer vintages. With

” FPC v. Natural Gas Pipeline, 315 U.S. 575, 586 (1942),

Mobil Oil v. FPC, 417 U.S. 283, 329 (1974).

this prospect of continuing inquiry in the light of ex-

perience, we discharge our obligation to further the in-

terest of justice, 28 U.S.C. § 2106, without insistence

on a more extended and plenary analysis of predictions.

We have, however, pondered the second challenge

pressed by the consumer petitioners against continuation

of the Opinion 699 rate for rollover gas, that the rates

presently put into effect by the Commission are unac-

companied by any condition or other action to assure

that the funds raised through these rates are used to

add supplies to the interstate market. The consumer pe-

titioners point out that the 52 cent base rate for rollover

gas was only provisionally approved by the Fifth Circuit

in Shell, 520 F.2d at 1077. At that time the Commission

had claimed that the pipelines would be able to bargain

for an expansion of interstate supply by refusing to

sign replacement contracts (and thereby holding the pro-

ducers to the old rates or the prospect of abandonment

proceedings). The consumers had strenuously disagreed,

arguing that “in this time of an ever-increasing short-

fall of supply the pipelines will simply not be in the

position to bargain for or gain any quid pro quo.” 520

F.2d at 1077. On review, the court noted that

the Commission does not consider the matter finally

determined. It has expressly reserved for considera-

tion the question of whether the pipelines are neogti-

ating in good faith or trying to take advantage of the

producer’s locked-in position, and whether or not the

additional funds generated by the application of the

new rate increase “the level of monies committed to

exploration and development programs and the vol-

umes of new gas supplies dedicated to interstate pipe-

lines under long-term contracts.” Opinion 699-H,

Appendix pp. 564-65 and n. 121.

Shell at 1077. The consumers argue that the Commis-

sion has not made such an analysis in the context of

this biennial ratemaking and that the court should there-

fore require the Commission to discontinue the 52 cent

rate or at least impose some condition on that rate, de-

signed to guarantee that the funds generated will be

used to expand interstate supplies. The consumers were

pressed by the court at oral argument for the specifics

of such a requirement, but did not adduce a satisfactory

answer. They insist that with some thought the Com-

mission could develop a workable “connecting rod” be-

tween profits from rollover gas and new investment.

The Commission makes three basic points in response.

First, it points out that between 1974 and 1975, reserve

additions and footage drilled increased by approxi-

mately 8%. “In view of the inadequacy of the national

rate established in Opinion 699-H”, says the Commission,

“the ‘rollover’ treatment therein undoubtedly provided

part of the necessary capital for such drilling activities.”

Opinion 770-A at 23, R. 3584. Second, the Commission

asserts that it is now undertaking to measure more

precisely the effect of the “rollover” prices, by gathering

from the producers on its Form 64 the amounts the

producers have spent on exploration and development.

Third, Commission counsel put it during oral argu-

ment that a good and sufficient “connecting rod’”’ between

the funds to be generated by the renewal contract rate

and investment for expansion of interstate reserves is

price—that the higher prices available under Opinion

770-A for new gas will induce the producers to invest

internally generated capital in further exploration and

development.

We cannot put the matter wholly at rest. The Com-

mission’s general observations concerning additions to

reserves are not more informative, perhaps less, than

the general statistics unsuccessfully offered as a full de-

fense of the advance payments program in Public Service

Comm’n of New York v. F.P.C., 167 U.S.App.D.C. 100,

109, 511 F.2d 338, 347 (D.C. Cir. 1975). The present

state of affairs is best reflected in the Commission’s ad-

mission that “we cannot precisely quantify [the] effect

{of the rollover treatment) herein.” Opinion 770-A at 23,

R. 3584. The Commission has not analyzed the replace-

ment contracts filed by the pipelines, to evaluate whether

they have been able to negotiate expanded supplies in

exchange for the higher rate, and whether the funds

generated by the rollover treatment are actually being

reinvested in exploration for the interstate market.

As for the Commission’s contention that the higher

prices allowed for interstate gas will induce the invest-

ment of rollover capital in interstate gas operations, this

too is conjectural. Experience may indicate this for off-

shore gas in the Federal domain, which must go inter-

state if produced at all, without establishing attraction

for other gas so long as it has the option to go to un-

regulated markets at higher prices. Consumer petitioners

reiterate that at least one prominent oil company has

seen fit to invest its funds in Montgomery Ward. Pro-

ducers may seek other investments in quest of higher

return, diversification of risk, or other objectives. More-

over, the assumption of a price of gas under Opinion

770-A high enough to attract the producers’ internally

generated funds would also, with some logic, support the

conclusion that other private funds will be attracted.

It may be that such logic will be undercut by experience,

but if experience confirms logic it would obviate the basis

for taxing the consumers of old gas for this capital.

We do not press any further with this kind of dis-

section of the Commission’s reasoning. Obviously, the

Commission cannot present at this time a full empirical

analysis of the efficacy of its rollover treatment. We

note, however, that this proceeding began less than two

months after the Fifth Circuit’s Opinion in Shel!, and

that Opinion 770 was issued less than nine months after

Shell came down. The Commission could certainly have

moved more vigorously to appraise the effects

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.