# Petition — Federal Energy Regulatory Commission v. Pennzoil Producing Co.

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_0841%3A01

## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1979
- **Citation:** 439 U.S. 508

## Text

(7-648
N

0.

= a OTT AOAK, JR., CLERK

Iu the Supreme Court of the United States

OCTOBER TERM, 1977

FEDERAL ENERGY REGULATORY COMMISSION,
PETITIONER

‘
Ue

PENNZOIL PRODUCING COMPANY, ET AL.

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

WADE H. McCCREE, JR.,
Solicitor General,

RICHARD A. ALLEN,
Assistant to the Solicitor General,
Department of Justice,
Washington, D. C. 20530.

ROBERT R. NORDHAUS,
General Counsel,

PHILIP R. TELLEEN,
Attorney,
Federal Energy Regulatory Commission,
Washington, D. C. 20426.

INDEX

Page
Opinions below... 2
Jurisdiction = 2
Questions presented 2
Statutes involved eet 3
SR Ret bial sacl 3
Reasons for granting the writ - 9
Conclusion... * 20
Appendix A . AEC la
NE ae 10a
a 1 ET ST ee See | 12a
Appendix D SME ad wididiPrccahes 14a
Re TL

CITATIONS
Cases:

Atlantic Refining Company v. Public Serv-
ice Commission of New York, 360 U.S.
El Paso Natural Gas Co., 54 FPC 145, re-
versed sub nom. Southland Royalty Co.
v. Federal Power Commission, 543 F.
2d 1134, certiorari granted, June 27,
1977, No. 76-1587... 7, 8, 16
Federal Power Commission v. Sunray DX
ros Oe ee a 13
Federal Power Commission v. Texaco Ine.,
| SRN een oN mon fp
Federal Power Commission v. Transcon-
tinental Gas Pipe Line Corp., 365 U.S.

Il
Cases—Continued Page

Lightcap v. Mobil Oil, 221 Kan. 448, 562
P.2d 1, certiorari denied, October 3,

1977, No. 76-1694. 10, 18
Mobil Oil Corporation v. Federal Power
Commission, 417 U.S. 283 7,14

Mobil Oil Corporation v. Federal Power
Commission, 463 F. 2d 256, certiorari
denied, 406 U.S. 976 —s_—- 5, 10

Northern Natural Gas Co. v. State Cor-
poration Commission of Kansas, 372

I re NY 19
Phillips Petroleum Co. v. Wisconsin, 347

U.S. 672 _ eke 9,18
Securities and Exchange Commission v.

Ralston Purina Co., 346 U.S. 119 19
United States v. Bacto-Unidisk, 394 U.S.

784 . 19
United States \ v. . Southwestern Cable Co.,

392 U.S. 157. de tN Oe IA PR 19

Statutes:

Natural Gas Act, 52 Stat. 821, as amend-_
ed, 15 U.S.C. 717 et seq.:

Section 4,15 U.S.C. 717 12
Section 4(a), 15 U.S.C. 717¢(a) med 3
Section 5(b), 15 U.S.C. 717d(a). 12
Section 7(b), 15 U.S.C. 717f(b) . 6,15

Organization Act,

~ <Dab-e 95-91, 91 Stat. 565:

Section 402(a)(1)(C) ss 1
er 1
Miscellaneous:

Executive Order 12009, 42 Fed. Reg.
46267 _ ews ipabiahectamdeteate 1

ju the Supreme Court of the United States

OCTOBER TERM, 1977

No.

FEDERAL ENERGY REGULATORY COMMISSION,
PETITIONER

v~.
PENNZOIL PRODUCING COMPANY, ET AL.

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

The Solicitor General, on behalf of the Federal
Energy Regulatory Commission,’ petitions for a writ

*On September 30, 1977, pursuant to the provisions of the
Department of Energy Organization Act (DOE Act), Pub. L.
95-91, 91 Stat. 565 and Executive Order No. 12009, 42 Fed.
Reg. 46267, the Federal Power Commission ceased to exist.
Its functions and regulatory responsibilities were transferred
to the Secretary of Energy and the Federal Energy Regula-
tory Commission which, as an independent commission with-
in the Department of Energy, was activated on October 1,
1977. Pursuant to Section 402(a)(1)(C) of the DOE Act,
“the establishment, review, and enforcement of rates and
charges for the transportation and sale of natural gas” in
interstate commerce is “transferred to, and vested in,” the
Federal Energy Regulatory Commission. The “savings pro-
visions” of Section 705 of the DOE Act provide for the sub-
stitution of the Federal Energy Regulatory Commission for
the Federal Power Commission in pending litigation such as
this case.

(1)

2

of certiorari to review the judgment cf the United
States Court of Appeals for the Fifth Circuit.

OPINIONS BELOW

The opinion of the court of appeals (App. A,
infra, pp. la-9a) is reported at 553 F. 2d 485. The
initial opinion and order (No. 753) of the Federal
Power Commission (App. D, infra, pp. 14a-26a) and
its opinion and order (No. 753-A) denying rehear-
ing (App. E, infra, pp. 27a-38a) are not officially
reported.

JURISDICTION

The judgment of the court of appeals was entered
on June 6, 1977 (App. B, infra, pp. 10a-lla). The
Commission’s application for rehearing was denied on
September 1, 1977 (App. C, infra, pp. 12a-13a). The
mandate of the court of appeals issued on September
9, 1977. On August 26, 1977, Mr. Justice Powell
extended the Commission’s time for filing a petition
for a writ of certiorari to and including November
3, 1977. The jurisdiction of this Court is invoked
under 28 U.S.C. 1254(1) and Section 19(b) of the
Natural Gas Act, 52 Stat. 831, as amended, 15 U.S.C.
717r(b).

QUESTIONS PRESENTED

1. Whether the Commission has authority under
the Natural Gas Act to perinit lessee/producers of
natural gas to pass through to interstate customers
the producers’ royalty costs that are based on the
unregulated intrastate market price of natural gas.

2. Whether the Commission has authority under
the Natural Gas Act to permit lessee/producers of
natural gas to pay royalties “in kind” in the form of
natural gas that the landowner/lessors can then sell
on the intrastate market, and thus to permit pro-
ducers to abandon certificated interstate service in
quantities of gas solely for the financial benefit of the
lessors,

STATUTES INVOLVED

Section 4(a) of the Natura! Gas Act, 52 Stat. 822,
as amended, 15 U.S.C. 717¢(a), provides:

All rates and charges made, demanded, or re-
ceived by any natural-gas company for or in
connection with the transportation or sale of
natural gas subject to the jurisdiction of the
Commission, and all rules and regulations af-
fecting or pertaining to such rates or charges,
shall be just and reasonable, and any such rate
or charge that is not just and reasonable is de-
clared to be unlawful.

STATEMENT

Pennzoil Producing Company (Pennzoil) and Shell
Oil Company (Shell) sell gas produced from the Gib-
son Field, in Terrebonne Parish, Louisiana to United
Gas Pipe Line Company (United). The gas is pro-
duced under leases obtained by Pennzoil and Shell
from Williams, Inc. (Williams) dated August 29,
1934, and July 24, 1952. Each lease provides for pay-
ment of a royalty equal to a fixed percentage (14 in
the 1934 lease; 14 in the 1952 lease) of the value of

1

the gas preduced, calculated at the “market rate” or
“market price” prevailing at the well (App. D. in-
fra, p. 13a).

Royalties under the leases have always been paid
on the basis of the regulated rates at which the gas
from the leaseholds has actually been sold in inter-
state commerce. However, in 1973 and 1974 Williams
demanded payment by Shell and Pennzoil of royalties
based on intrastate market values of natural gas,
ranging from 35 cents to 70 cents per Mcf (1,000
cubic feet) for the period October 1, 1971 through
December 31, 1973, and 70 cents per Mcf thereafter.
These market values substantially exceeded the rate
ceilings established by the Commission for the sales
of gas by Shell and Pennzoil. By a letter of June 5,
1974 Williams purported to terminate the leases for
alleged underpayment of royalties due under the
leases (App. D, infra, p. 15a).

In 1974, Pennzoil and Shell filed a petition in a
state court in Louisiana praying for a judgment de-
claring that Pennzoil and Shell were properly dis-
charging their royalty obligations under the leases.
Williams filed an answer and a counterclaim claiming
royalty underpayments of $3,731,683.79 (App. D,
infra, p. 16a).

Shell, Pennzoil and Williams subsequently entered
into a settlement agreement, under which Pennzoil
and Shell would apply to the Commission for au-
thority to pay a royalty based, in essence, on the
higher of 78 cents per Mcf or 150 percent of the
highest area or national rate permitted by the Com-

5

mission. Alternatively, Pennzoil and Shell would seek
Commission authorization to abandon that portion of
the gas sold under the leases which is attributable to
Williams’ royalty interest, i.e., 4 and 14 of the gas
produced under the 1934 and 1952 leases, respectively,
so that that portion of the gas could be paid in kind
to Williams for sale on the intrastate market. Ac-
cordingly, Pennzoil and Shell filed petitions with the
Commission seeking special relief from the area and
national rates established by the Commission to per-
mit them to pass through to United the higher royalty
rates called for in the settlement or, if this relief
was denied, to permit them to abandon to Williams
the portion of the gas produced under the leases that
was attributable to Williams’ royalty interests (‘roy-
alty gas”) (App. D. infra, p. 16a).

After a hearing on the petitions, the Commission
in January 1976 issued an opinion (App. D, infra,
pp. 14a-26a) affirming the initial decision of the
administrative law judge denying the requested re-
lief. With respect to the requested rate increase, the
Commission observed that while it did not have juris-
diction over the royalty owners or over the royalty
payments made to them by producers,’ it did have
jurisdiction over the rates charged by producers to
an interstate pipeline (id. at 21a-22a). The Commis-
sion concluded that it had no authority under the
Natural Gas Act to grant the requested rate increase,
stating (id. at 22a-23a):

2 Mobil Oil Corporation v. Federal Power Commission, 463
F. 2d 256 (C.A. D.C.), certiorari denied, 406 U.S. 976.

6

In the instant proceeding, the impetus of the
settlement is the market value of the royalties
and no consideration has been given to regulated
rates. As such, we cannot permit any incre-
mental royalty costs resulting from this settle-
ment, or resulting from any judgment by a state
court regarding royalty payments, to be passed
on to the pipeline if these incremental royalty
costs are based on any other factors than the
regulated just and reasonable rate. On this point,
we note the Supreme Court’s warning in FPC v.
Texaco, [417 U.S. 380], that the Commission is
not free to equate just and reasonable rates with
the prices for gas in the marketplace. Accord-
ingly, we believe that we are not free to allow
royalty costs, whicn are based on market values,
to be passed on to the pipelines as just and rea-
sonable rates. A contrary result would not “.. .
afford consumers a complete, permanent, and ef-
fec.ive bond of protection from excessive rates
and charges” [quoting from Atlantic Refining
Company v. Public Service Commission of New
York, 360 U.S. 378, 388].

The Commission also concluded that abandonmert
of the royalty gas to Williams should not be author-
ized under 15 U.S.C. 717f(b) (App. D, infra, pp.
23a-24a). The Commission found that the supply of
natural gas in the leaseholds was not so depleted as
to warrant cessation of service, and that the public
convenience and necessity would not be served by
granting an abandonment authorization that would
“likely result in the subject gas being diverted from
the interstate market to the intrastate market” (App.

7

D, infra, p. 24a). The Commission subsequently de-
nied petitions for rehearing (App. E, infra, pp. 27a-
33a) in an opinion and order reaffirming the reasons
set forth in its initial opinion and rejecting conten-
tions that this Court’s decision in Mobil Oil Corp. v.
Federal Power Commission, 417 U.S. 283, established
the authority of the Commission to allow royalty
costs based on market value to be passed on to pipe-
lines. The Commission stated that “[w]hile indicat-
ing that relief on some grounds may be possible [ Mo-
bil Oil Corp.] does not state under what conditions
relief should be granted, nor does it define when the
right to gain relief matures” (App. E, infra, p. 29a).

The court of appeals reversed the Commission’s
orders (App. A, infra, pp. la-9a). The court viewed
Federal Power Commission v. Texaco Inc., 417 U.S.
380, as inapplicable, apparently because “[t]his case
deals with royalty cost under specific leases” (id. at

* Moreover, the Commission disagreed with Shell and Pennz-
oil that the Commission was forced to choose between losing
4 or 4 of the gas to the intrastate market as called for in
the settlement, and possibly losing aii of the gas if the leases
were cancelled as a result of the state court litigation. Rely-
ing on its previous decision in El Paso Natural Gas Co.. 54
FPC 145, ceversed sub nom. Southland Royaity Co. v. Federal
Power Commission, 543 F. 2d 1134 (C.A. 5), certiorari
granted, June 27, 1977, No. 76-1587, the Commission ex-
pressed the view that Williams could not unilaterally termi-
nate deliveries to United if he terminated the leases. “(ijt
the lease were cancelled and Williams were to undertake to
sell the subject gas, Williams would simply assume the obii-
gations of Pennzoil and Shell to continue service to United,”
unless the Commission authorized abandonment (App. D,
infra, p. 24a).

8

6). Inasmuch as Commission rate regulation is cost-
based, the court held that the Commission had erred in
determining that it was not permitted to pass through
to interstate customers the cost to lessee/producers
of market value royalty payments. The court relied
on Mobil Ow Corp. v. Federal Power Commission,
supra, for the proposition that producers are entitled
to special relief from the Commission if their royalty
payments are higher than those provided for by the
applicable area or natural rate established by the
Commission (id. at 7).

On the issue of alternative relief, the court directed
the Commission to reconsider its decision not to per-
mit abandonment of the royalty portion of the gas.
Relying on its decision in Southland Royalty Co. v.
Federal Power Commission, 543 F. 2d 1134 (C.A. 5),
certiorari granted, June 27, 1977, Federal Power
Commission v. Southland Royalty Co., No. 76-1587,
the court held that the Commission had been mis-
taken in concluding that the gas, having once been
dedicated to interstate commerce, could not be with-
drawn from that service by the lessor without aban-
donment authorization in the event that the leases
were terminated for failure to pay royalties based on
the unregulated market price.’

*On the Commission’s limited petition for rehearing, the
court deleted from its opinion the final statement that “[i]t
may well be that the ‘present or future public convenience or
necessity’ will suggest the propriety of abandoning a frac-
tion of the gas in Williams’ property, rather than lose the
entire amount from the interstate market. This decision is for

|

9

REASONS FOR GRANTING THE WRIT

This case presents two issues of substantial im-
portance to the administration of the Natural Gas
Act, 52 Stat. 821, as amended, 15 U.S.C. 717 ef seq.:
first, whether the Commission has authority to permit
a producer to pass through to interstate customers
royalty costs based on the unregulated market price
of gas; and second, whether the Commission, in lieu
of passing through such costs, may permit a producer
to abandon a portion of his gas from dedicated inter-
State service. The ruling of the court of appeals that
the Commission has authority to grant both types of
relief will, unless overturned, allow the rate set by
the Commission for sales of natural gas for resale in
interstate commerce to be based to a significant ex-
tent on the unregulated rate prevailing in the market
for intrastate sales. It will thus substantially under-
cut the Commission’s effective regulation of inter-
state sales pursuant to the authority recognized by
this Court in Phillips Petroleum Co. v. Wisconsin, 347
U.S. 672.°

the Commission.” (App. C, infra, pp. 12a-13a). In its opinion
on rehearing the court stated “[w]Je agree with the Commis-
sion that the statement was premature, if construed to be
decisional, and unnecessary with respect to our decision”
(id. at 18a).

* While it might be argued that the effect of the decision
below is limited because the court of appeals held only that
the Commission had authority to grant the requested relief,
not that it was compelled to grant such relief, the court’s
holding and rationale indicate otherwise. The decision below
rejected the Commission’s view that the grant of relief would

10

The two issues presented here are among a number
of related issues that all derive from the widespread
use in gas leases of clauses that require the producer
to pay royalties to the lessor based on the “market
value” or “market price” of the gas sold. The first is-
sue presented by such clauses is whether “market
value” clauses refers to the regulated interstate mar-
ket price at which the gas is actually sold, or the un-
regulated intrastate price which, in recent years, has
been substantially higher than the interstate price.°

be inconsistent with the regulatory scheme of the Act; it thus
forecloses the Commission from denying relief on that ground.
The decision would limit the Commission to reviewing the
circumstances of each case to determine whether particular
royalty costs were or were not permissible for other reasons—
for example, whether they were imprudently incurred. The
Commission would be precluded from denying relief on the
ground that use of unregulated market prices as a basis for
determining a significant component of the regulated rate
would undermine the basic purpose of the Act.

*In Lightcap Vv. Mobil Oil, 221 Kan. 448, 562 P.2d 1, certio-
rari denied, October 3, 1977, No. 76-1694, the Supreme Court
of Kansas construed certain “market value” royalty provi-
sions involved in that case to mean the unregulated intra-
state market, and required the producers to pay royalties on
that basis. In Mobil Oil Corp. v. Federal Power Commission,
463 F. 2d 256, 265 (C.A. D.C.), certiorari denied, 406 U.S.
976, however, the court suggested that such a construction not
only might “run counter to the intention of the parties, un-
less there is something to rebut the fair presumption that
they contemplated interstate movement and market prices
compatible therewith,” but also might contravene public policy
if not the Supremacy Clause. Although this Court denied cer-
tiorari in Lightcap, the petitioner has filed a petition for re-
hearing, and the Commission intends to file a memorandum
in support of that petition in view of the relationship between
the issue there and the issues presented in this case.

11

A second issue is whether the Commission has juris-
diction over royalty agreements.’ A third issue, pre-
sented in this case, is whether, if “market value”
royalty provisions refer to the intrastate market, the
Commission has the authority to include the higher
royalty in the producer’s cost basis, and thus pass
through the higher costs to interstate consumers. A
fourth issue, also presented in this case, is whether
the Commission alternatively may permit a producer
to pay royalties in the form of gas that the lessor
may then sell on the intrastate market, and thus
abandon a portion of his gas from dedicated inter-
state service.

While this petition addresses the issues presented
in this ease, those issues cannot be considered in isola-
tion from the other issues that are different facets of
the same problem.

1. The decision below that the Commission may
permit producers to base their interstate prices on
royalty costs that are in turn based on the unregu-
lated intrastate market value of natural gas is, we

*In Mobil Oil Corp. v. Federal Power Commission, 463 F.
2d 256 (C.A. D.C.), certiorari denied, 406 U.S. 976, the court
of appeals, reversing the Commission, concluded that royalty
owners were not “natural gas companies” subject to Commis-
sion jurisdiction under the Act. The court did not appear to
view its decision as having a decisive impact on royalty levels, —
however, since it apparently believed that the presumed in-
tention of the parties to gas leases, as well as considerations
of public policy and federal regulation, would lead courts to
construe “market value” clauses to mean the regulated market
at which the gas was actually sold and expected to be sold.

See note 6, supra.

12

submit, contrary to decisions of this Court. In Federal
Power Commission vy, Texaco Inc., 417 U.S. 380, this
Court reaffirmed the well-established principle that
the Commission’s responsibility under the Natural
Gas Act is to establish interstate rates at levels that
are “just and reasonable” (15 U.S.C. 717c, 717d(a) ),
and tat this responsibility is not met by establishing
an interstate rate that is based solely on the unregu-
lated marketplace. In that case the Court rejected a
Commission rate order that sought to regulate the
rates of small producers indirectly through the Com-
mission’s regulation of the rates of large producers
and of pipelines who purchased gas from the small pro-
ducers and whose cost of service was therefore based
in part on the prices paid to small producers. Since
the order appeared to permit the large producers and
pipelines automatically to pass through prices paid to
the small producers that were based on the prevailing
unregulated market, the Court rejected it, stating
(417 U.S. at 397-399):

[W]e * * * stress that in our view the prevailing
price in the marketplace cannot be the final meas-
ure of “just and reasonable” rates mandated by
the Act. It is abundantly clear from the history
of the Act and from the events that prompted its
adoption that Congress considered that the natu-
ral gas industry was heavily concentrated and
that monopolistic forces were distorting the mar-
ket price for natural gas. * * * In subjecting
producers to regulation because of anti-competi-
tive conditions in the industry, Congress could
not have assumed that “just and reasonable”

13

rates could conclusively be determined by refer-
ences to market price [footnote omitted }.

See also Federal Power Commission y. Sunray DX
Oil Co., 391 U.S. 9, 25.

The same principles apply here. It is evident that
for the Commission to permit a producer to base his
interstate rate on royalty costs based on the intra-
state market price would result in interstate rates
which are in significant part “conclusively * * * de-
termined by reference to market price.” °

The court of appeals stated that Texaco was “in-
applicable” to this case, but gave little indication of
its reasons for that conclusion (App. A, infra, p. 6a).
As Texaco itself indicates, the fact that royalty costs
are one of several components of the producers’ cost
is immaterial; they are a significant component, and
the principles affirmed in Texaco do not suggest that
the Commission can determine a part of the inter-
state rate that it promulgates solely on the basis of
the unregulated market so long as it does not deter-
mine the whole rate on that basis. The Act does not
permit the Commission to depart from its obligation
to establish just and reasonable rates up to a point,
so long as it adheres to that standard the rest of the

* Contrary to the court of appeals’ view (App. A, infra, p.
7a), royalty costs that are based on the intrastate market
price of gas are different from other costs (e.g., drilling costs),
because allowing a producer to pass such royalty costs through
to interstate customers results in a price for interstate gas
that is based in part on the unregulated market price of gas,
contrary to the principles established in Texaco and other

decisions.

14

way.’ As the Court said in Texaco, supra, 417 U.S.
at 399, “the Act makes unlawful all rates which are
not just and reasonable, and does not say a little un-
lawfulness is permitted.”

2. The Commission’s decision in this case is not
inconsistent with Mobil Oil Corp. v. Federal Power
Commission, 417 U.S. 283, relied on by the court be-
low (App. A, infra, p. 7a). The Court in Mobil
upheld an area rate promulgated by the Commission.
In response to Mobil’s objection that the Commission
had failed to provide for automatic rate adjustments
to accommodate anticipated increased royalty costs,
the Court observed that “Mobil’s argument is hypo-
thetical at this stage and * * * in any event an affected
producer is entitled to seek individualized relief.”
417 U.S, at 328. In making that observation, the
Court did not discuss or purport to determine the
entitlement to relief under all circumstances, or to
decide in particular whether a producer would be

* Moreover, in practice, as in this case, the Commission is
usually required to discharge its responsibilities under the Act
by determining the justness and reasonableness of particular
cost components presented to it for consideration. Accord-
ingly, in this case the Commission stated (App. D, infra, p.
22a):

[W]e cannot permit any incremental royalty costs * * * to
be passed on to the pipeline if these incremental royalty
costs are based on any other factors than the regulated
just and reasonable rate.

The Commission’s conclusion was not incorrect simply because
other cost components of the producers’ rate were just and
reasonable.

Es eter | ee ee

~ ee ence.

15

entitled to a rate increase to reflect royalty costs based
on the unregulated market.

This Court in Mobil merely recognized that the
Commission may grant special relief in some in-
stances where actual costs are higher than those pro-
vided for in the regulated rate. It does not follow
that the Commission may permit royalty payments
based on the unregulated price of the very commodity
that is subject to federal regulation—natural gas—
to be borne ultimately by the consumers of gas sold in
interstate commerce. If royalty costs determined by
the unregulated price of gas sold in intrastate com-
merce were passed on to the interstate consumer,
a different category of interstate gas would be created,
the price for which would be determined in substan-
tial part by intrastate market values and would
fluctuate with those values. As recognized in Texaco,
this would be no regulation at all.

3. The court below also erred in concluding that
the Commission had authority under the Act to per-
mit the producer, in lieu of passing through increased
royalty costs to its interstate customers, to pay its
lessors royalties in the form of gas which they could
sell on the intrastate market, thus abandoning that
gas from the interstate service to which it had been
dedicated. As the Commission correctly found, neither
of the two conditions for abandonment under Section
7(b) of the Act, as amended, 15 U.S.C. 717f(b), had
been met. First, the available supply of gas had not
been “depleted to the extent that continuation of serv-
ice is unwarranted.” Second, there was no basis for

16

finding that “the present or future public conven-
ience and necessity permit such abandonment.” The
standard by its terms refers to the public conven-
lence and necessity; it does not justify abandonment
simply to serve the financial interests of royalty own-
ers or producers.”

4. If, as we contend, the Commission may not
under the Natural Gas Act permit producers to pass
through royalty costs based on unregulated market
prices, or alternatively to abandon a portion of their
gas, we recognize the possibility—which concerned the
court below (App. A, infra, p. 8a)—that producers
might be caught between state court decisions that
“market value” leases refer to the unregulated market
and the Commission’s refusal to pass through such
market value royalty costs or permit abandonment
of dedicated gas.*’ While we believe that in any event

'? Moreover, the Commission concluded that there was no
basis for permitting abandonment of a portion of the gas
through payment in kind to avoid abandonment of all of it
in the event the lessors terminated the leases since under the
Commissions decisions, a lessor may not terminate certified
interstate service commenced by his lessee without abandon-
ment authority from the Commission under Section 7(b). The
validity of those decisions is now pending before this Court in
Federul Power Commission Vv. Southland Royalty Co., No. 76-
1587, certiorari granted, June 27, 1977, and this aspect of the
instant case should at least await resolution of that case.

‘' As yet there has been no state court ruling in this case
on the meaning of the royalty clauses in the leases involved;
the parties by their settlement pretermitted that question
pending the outcome of this proceeding. As the Commission
recognized, however (App. D, infra, p. 22a), “the impetus of
the settlement” was the unregulated market price of gas.

17

the Commission’s position is mandated by the Act and
the Act’s purpose to protect interstate consumers of
gas, it should be noted that there are possible ave-
nues of relief for producers faced with demands
from lessors that their royalty costs be based on the
unregulated price of natural gas.

One type of relief could be this Court’s limited
reshaping of the holding by the court of appeals in
Mobil Oil Corp. v. Federal Power Commission, 463
F. 2d 256 (C.A. D.C.), certiorari denied, 406 U.S.
976, that landowner/lessors are not natural gas
companies under the Act and that accordingly neither
they nor their royalty agreements are subject to
Commission jurisdiction. Such a reshaping would
not necessarily require a determination that land-
owner/lessors are fully jurisdictional in the sense.
for example, of being required to make filings with
the Commission. Rather, it would be sufficient for
this Court to determine that despite the nonjurisdic-
tional status of landowner /lessors, royalty payments
are nevertheless subject to regulation in the sense
that producer /lessees need not pay royalties which
exceed the amounts permitted by the Commission to
be passed on to jurisdictional pipelines.

Such a determination, we submit, would be con-
sistent with this Court’s recognition that when Con-
gress passed the Natural Gas Act, it “did not desire
* * * that an important aspect of this field be left un-
regulated,” but intended instead to establish a compre-
hensive regulatory scheme. Federal Power Commis-
sion v. Transcontinental Gas Pipe Line Corp., 365

18

U.S. 1, 19. The Act “was so framed as to afford
consumers a complete, permanent and effective bond
of protection from excessive rates and charges.” At-
lantic Refining Co. v. Public Service Commission of
New York, 360 U.S. 378, 388. See also Phillips Pe-
troleum Co. v. Wisconsin, 347 U.S. 672, where this
Court, reversing the Commission, held that the Com-
mission had jurisdiction not only over pipelines and
their rates but also over the rates at which producers
sell natural gas to pipelines for resale in interstate
commerce, on the ground that those rates “may have
a direct and substantial effect on the price paid by
the ultimate consumers.” 347 U.S. at 685.

An alternative, though related, type of relief for
producers would be a determination by this Court
that lower courts err when they Anterpret “market
value” leases that underlie interstate sales as requir-
ing royalty paymenis based on the intrastate market
price of the gas. One such state court determination
was the basis of a petition for a writ of certicrari
to the Kansas Supreme Court, Mobil Oil Corp. v.
Harry Lightcap, et al., No. 76-1694. Although this
Court denied certiorari in that ease on October 3.
1977, we are advised that the petitioner on October
28, 1977, filed a petition for rehearing of the decision
denying certiorari. As noted (note 6, supra), the Com-
mission intends to file a memorandum in support of
that petition for rehearing. In view of the relation-
ship between that issue and the other issues discussed
in this petition, we believe that the construction of a
“market value” lease provision is not solely a ques-
tion of state law, but is a question of federal law

19

under the Natural Gas Act. Our belief rests on the
principle that “[t]he federal regulatory scheme
leaves no room either for direct state regulation of
the prices of interstate wholesales of natural a? **
or for state regulations which would indirectly achieve
the same result.” Northern Natural Gas Co. v. State
Corporation Commission of Kansas, 372 U.S. 84, 91;
footnote omitted. A decision by this Court that mar-
ket value leases underlying interstate sales must be
interpreted in light of the regulated rate of those sales
would obviate any bind on producer/lessees between
royalties based on intrastate prices and the impermis-
sibility of the Commission’s allowing the flow-through
of sucl. market value royalty costs.

5. It is axiomatic that the Natural Gas Act, like
other federal regulatory legislation, should be in-
terpreted in furtherance of the Act’s general pur-
pose to protect consumers by effective regulation of
natural gas wholesale rates. Cf. Securities and Ex-
change Commission v. Ralston Purina Co., 346 U.S.
119; United States v. Southwestern Cable Co., 392
U.S. 157; United States v. Bacto-Unidisk, 394 U.S.
784. The Commission, accordingly, concluded that it
is not permitted to pass through market value royalty
payments that are based on the unregulated price of
natural gas or to permit abandonment of gas dedi-
cated for interstate service solely to accommodate
the financial interests of private parties. The con-
trary holding of the court of appeals would signifi-
cantly impair the Commission’s ability to implement
one of the Act’s basic objectives, and therefore war-
rants review by this Court.

20
CONCLUSION

For the foregoing reasons, the petition for a writ |
of certiorari should be granted. |

Respectfully submitted.

WADE H. McCREE, JR.,
Solicitor General.

RICHARD A. ALLEN,
Assistant to the Solicitor General.

ROBERT R. NORDHAUS,
General Counsel,

PHILIP R. TELLEEN,
Attorney,
Federal Energy Regulatory Commission.

NOVEMBER 1977.

la
APPENDIX A

UNITED STATES COURT OF APPEALS
FIFTH CIRCUIT

Nos. 76-1626, 76-1831 and 76-2128

PENNZOIL PRODUCING COMPANY, SHELL OIL COMPANY,
UNITED GAS PIPE LINE COMPANY, PETITIONERS

Vv.

FEDERAL POWER COMMISSION, RESPONDENT
June 6, 1977

Petitions for Review of an Order of Federal Power
Commission (Texas Cases).

Before CLARK, RONEY and TJOFLAT, Circuit
Judges.

RONEY, Circuit Judge:

Caught in the squeeze between the regulated price
of its gas, which price included royalty costs at the
interstate price, and the claims of landowners for
increased royalty payments based on higher intra-
state rates, the gas producers petitioned the Federal
Power Commission for relief. Two alternatives were
given the Commission: first, let the producers’ inter-
State price be increased by the amount of increased
royalty the producers will have to pay as determined
by state litigation or settlement of pending lawsuits;
or, second, let the producers “abandon” the royalty

2a

portion of gas produced so that gas can be delivered
to the royalty owner in kind, unburdened by the re-
strictive interstate price.

As to the first alternative, the Federal Power Com-
mission failed to realize it had the authority to grant
relief. As to the second, the Federal Power Commis-
sion misunderstood the law as it has now been defined
in Southland Royaliy Co. v. FPC, 543 F.2d 1134 (5
Cir. 1976). We reverse and remand for further
consideration.

Due to the gross disparity between the higher un-
regulated prices of intrastate gas sales and the lower
regulated prices of interstate sales,’ lessors, whose
royalty payments are determined by the “market
value” or the “market price” of the gas, have brought
numerous suits against the interstate producers-
lessees claiming royalty payments based on rates
higher than those prescribed by the Federal Power
Commission.* Many of these long-term leases were
entered into long before this disparity in prices arose,
and some even before the Commission began regulat-
ing rates for interstate gas sales.’ Thus, neither lessor

‘See Southland Royalty Co. v. FPC, 543 F.2d 1134 (5th
Cir. 1976).

* See, e.g., Phillips Petroleum Co. v. Bynum, 155 F.2d 196
(5th Cir.), cert. denied, 329 U.S. 714, 67 S.Ct. 44, 91 L.Ed.
620 (1946) ; Foster v. Atlantic Refining Co., 329 F.2d 485 (5th
Cir. 1964); Texas Oi! & Gas Corp. Vv. Vela, 429 S.W.2d 866
(Tex. 1968).

* Pennzoil Producing Company and Shell Oil Company sell
in interstate commerce natura! gas produced from Louisiana
acreage leased from Williams, Inc. Pennzoil operates under a

8a

nor lessee anticipated the problem that would arise
over the nondefined terme in the leases: “market
value” and “market price.”

In a lawsuit filed on May 24, 1974, and currently
pending in Louisiana state court,‘ a lessor asserted a
royalty claim based on intrastate prices for natural
gas, which greatly exceed the ceiling rates established
by the FPC for interstate sales. After Williams, Inc.
demanded by letter payment of royalties based on
intrastate rates, Shell and Pennzoil brought the law-
suit seeking a judgment declaring that their reyalty
obligations were properly discharged by payments
based on Commission-established rates. Williams
counterclaimed for undePpayment of royalty obliga-
tions in the amount of $3,731,783.79. On June 18,
1975, Shell, Pennzoil and Williams entered into a set-
tlement agreement providing two major alternatives
—one involving monetary payments, and the other
involving payments of gas in kind—either being de-
pendent on FPC authorization.

The first alternative provided that the payment
of royalties would be based on the higher of the fol-
lowing prices: (1) 7&¢ for Mef for 1975 with annual

1934 lease, while Shell operates under a 1°‘ and a 1952 lease.
The 1934 lease provides for royalty payments equal to one-
eighth of the value of the gas produced, calculated at the
“market rate” prevailing at the well. The 1952 lease contains
a similar provision, requiring royalty payments equal to one-
fourth of the value of the gas produced, calculated at the
“market price” prevailing at the well.

* Shell Oil Co. & Pennzoil Producing Co. v. Williams, I nc.,
et al., Docket No. 573-581, Civ.D.Ct., Orleans Parish, La.

4a

increases of 1.5¢ per Mcf; or (2) 150% of the high-
est area or national rate permitted by the FPC.
Pennzoil and Shell would then flow through these in-
cremental royalty costs to their customer, United Gas
Pipe Line Company. Although the FPC does not have
jurisdiction over the amount paid royalty owners,
Mobil Oil Corp. v. FPC, 149 U.S.App.D.C. 310, 463
F.2d 256 (1971), cert. denied, 406 U.S. 976, 92 S.Ct.
2409, 32 L.Ed.2d 676 (1972), it does have authority
over interstate rates charged by the producers. Phil-
lips Petroleum Co. v. Wisconsin, 347 U.S. 672, 74
S.Ct. 794, 98 L.Ed. 1035 (1954) ; section 4 of N atural
Gas Act, 15 U.S.C.A. § 717c. Thus, special relief
from the ceiling rates established in FPC Opinion
Nos. 598 * and 699° is required for petitioners to pass
these costs on to United.

The second alternative provided that in lieu of the
increased monetary royalty payments, Shell and Penn-
zoil would deliver to Williams its royalty share of the
gas in kind for sale in any market, which presumably
would bring the higher intrastate prices. This sec-
ond proposal would require the FPC’s consent to the

° Southern Louisiana Area Rate Proceeding, 46 FPC &6
(1971), aff'd sub nom., Placid Oil Co. v. FPC, 483 F.2d 880
(5th Cir. 1973), aff'd sub nom., Mobil Oil Corp. Vv. FPC, 417
U.S. 283, 94 S.Ct. 2328, 41 L.Ed.2d 72 (1974).

* Just and Reasonable National Rates for Sales of Natural
Gas From Wells Commenced on — January 1, 1973, and
New Dedications to Interstate Co merce on or after Janu-
ary 1, 1973, 51 FPC 2212, aff’d sub nom., Shell Oil Co. v. FPC,
520 F.2d 1061 (5th Cir. 1975), cert. denied, 426 U.S. 941, 96
S.Ct. 2661, 49 L.Ed.2d 394 (1976).

5a

abandonment of that portion of gas attributable to
Williams’ royalty interests, as required by section
7(b) of the Natural Gas Act, 15 U.S.C.A. § 717¢.
Sunray Mid-Continent Oil Co. v. FPC, 364 U.S. 137,
153, 80 S.Ct. 1392, 4 L.Ed.2d 1623 (1960).

In FPC Opinion Nos. 753‘ and 753-A,* the Commis-
sion denied either form of relief. First, the Commis-
sion denied it had authority to allow producers of nat-
ural gas to increase their rates above the FPC ceiling
set for gas sold in interstate commerce to reflect the
increased cost of “market value” or “market price”
royalty obligations under existing leases. Second, the
Commission held that “present or future public con-
venience or necessity” did not permit the abandon-
ment of the royalty portion of the gas, which had
been dedicated to interstate commerce by the lessees.
Section 7(b) of Natural Gas Act, 15 U.S.C.A. § 717f
(b). The petitions for review attack both of these
decisions.

Opinion 753 defined the “real issue” in this case to
be whether the FPC “can legally grant any form of
rate relief above either an area or nationwide just
and reasonable rate solely because the producer selling
the gas in interstate commerce may be obligated to
make a royalty payment based not upon the regu-
lated price the producer receives for the gas, but
rather on the ‘market value’ of the gas.” Relying on

* Opinion and Order Denying Special Relief and Abandon-
ment, FPC Docket Nos. RI 76-8, -10 (January 30, 1976).

‘Opinion and Order Denying Rehearing, FPC Docket Nos.
RI 76-8, -10 (February 27, 1976).

—_—

6a

FPC v. Texaco, Inc., 417 U.S. 380, 94 S.Ct. 2315, 41
L.Ed.2d 141 (1974), the Commission concluded that it
was “not free to allow royalty costs, which are based
on market values, to be passed on to the pipelines as
just and reasonable rates.”

Texaco, however, is inapplicable to the instant case.
Texaco dealt with the question of the effect of intra-
state prices of gas on interstate rate regulation. The
Supreme Court held that the final measure of “just
and reasonable” rates, mandated by sections 4 and 5
of the Act, could not be the prevailing price in the
unregulated marketplace. Prompting this holding was
the historical justification for general regulation of
interstate prices, to prevent excessive profiteering by
members of the heavily concentrated and monopolistic
natural gas industry through distorted market prices.
417 U.S. at 397-398, 94 S.Ct. 2315. Thus, the Su-
preme Court held that other factors must be taken
into consideration. 417 U.S. at 399, 94 S.Ct. 2315.
This case deals with royalty cost under specific leases.

The Federal Power Commission has taken a cost
plus profit approac) to gas rate regulation. A cost-
based methodology was approved by the Supreme
Court in Permian Basin Area Rate Cases, 390 U.S.
747, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968). One of the
components of a producer’s costs is clearly its royalty
expense, representing the amount a producer must pay
to the landowner for the privilege of extracting gas
from the reserves underlying his land. Shell Oil Co.
v. FPC, 520 F.2d 1061, 1068 (5th Cir. 1975), cert.
denied, 426 U.S. 941, 96 S.Ct. 2661, 49 L.Ed.2d 394

Ta

(1976). This cost petitioners seek to pass through to
their customer, United, through a rate increase. They
do not seek to increase their profits but merely to
maintain those margins already determined by the
Commission to be just and reasonable in its earlier
rate proceedings. Because the Commission does not
have jurisdiction over the amount of royalties charged
by the lessor under a natural gas lease, Moti! Oil
Corp. v. FPC, 149 U.S.App.D.C. 310, 463 F.2d 256,
263, cert. denied, 406 U.S. 976, 92 S.Ct. 2409, 32
L.Ed.2d 676 (1972), the only way in which petition-
ers-lessees can protect themselves from loss of profits
in the event of an adverse state court decision is to
ask for an increase in the allowable rates to be
charged their customers.

This is not to say that every additional cost must
be passed through to the customer to protect a pro-
ducer’s level of profits. The Commission has author-
ity to consider the reasonableness of any costs in-
curred. Mobil Oil Corp. v. FPC, supra, at 263. Deter-
mination of the reasonableness of a cost necessarily
requires consideration of market price. In all proba-
bility, the reasonableness of a great many costs of gas
production must be determined by the prevailing mar-
ket price in an uncontrolled market. The Commission
has failed to suggest why royalty costs in an un-
controlled market are any different from any other
cost. Permian and Shell Oil should have been looked
to for guidance by the Commission, rather than
Texaco.

8a

Petitioners followed the proper procedures in peti-
tioning the Commission for special relief and were
entitled to a determination of the merits of their
requests. In Mobil Oil Corp. v. FPC, 417 U.S. 283,
94 S.Ct. 2328, 41 L.Ed.2d 72 (1974), aff'd Placid Oil
Co. v. FPC, 483 F.2d 880 (5th Cir. 1973), decided the
same day as Texaco, the Supreme Court, in response
to Mobil’s complaint that the FPC failed to provide
automatic adjustments in area rates to compensate for
anticipated higher royalty costs, reiterated the Court
of Appeals’ finding that “ ‘[i]f, as subsequent events
develop, the producers are put in a bind by their
royalty obligations, they may certainly petition FPC
for individualized relief.’” 417 U.S. at 328, 94 S.Ct.
at 2355. Pennzoil and Shell have been put in such a
bind. If they lose the state court litigation, they are
faced either with termination of their leases, which
could divert the entire amount of gas from interstate
commerce, or with increased royalty payments, which
would absorb funds otherwise available for explora-
tion and development.

In denying abandonment of the royalty portion of
the gas, which is allowed under section 7(b) of the
Natural Gas Act only when “the available supply of
natural gas is depleted to the extent that the continu-
ance of service is unwarranted,” or when “the present
or future public convenience or necessity permit such
abandonment”, the Commission relied on its decision
in El Paso Natural Gas Co., et al., FPC Opinion
No. 737 (July 11, 1975), appeal then pending sub
nom., Southland Royalty Co. v. FPC, 5 Cir., 543 F.2d

ee

9a

1134 (1976). The Federal Power Commission held
in El Paso that once a fixed-term lessee dedicates gas
to interstate commerce, the lessor cannot withdraw
that gas from interstate commerce absent Commission
approval, upon termination of the lease. Thus the
Commission was under the impression that Williams’
gas was trapped in the interstate market, whether or
not the leases were terminated.

This Court reversed the Commission’s decision in
Southland Royalty Co. v. FPC, supra, and held that a
lessee could not dedicate to interstate commerce the
gas remaining at the expiration of his fixed-term
lease. Thus the Commission was acting under the
wrong legal premise. It is appropriate to remand this
issue to the Commission for reconsideration in light
of Southland Royalty. It may well be that the “pres-
ent or future public convenience or necessity” will
suggest the propriety of abandoning a fraction of the
gas in Williams’ property, rather than lose the entire
amount from the interstate market. This decision is
for the Commission.

REVERSED AND REMANDED.

10a
APPENDIX B

UNITED STATES COURT OF APPEALS
FIFTH CIRCUIT

OCTOBER TERM, 1976

76-1626
Nos. 76-1831
76-2128

FPC Nos. RI76-8 and RI76-10
PENNZOIL PRODUCING COMPANY, ET AL., PETITIONERS
versus

r

FEDERAL POWER COMMISSION, RESPONDENT

Petitions for Review of an Order of the
Federal Power Commission (Texas Cases)

Before CLARK, RONEY and TJOFLAT, Circuit
Judges.

lla
JUDGMENT

This cause came on to be heard on the petitions of
Pennzoil Producing Company, Shell Oil Company and
United Gas Pipe Line Company for review of an
order of the Federal Power Commission of the United
States, and was argued by counsel:

ON CONSIDERATION WHEREOF, It is now
here ordered and adjudged by this Court that the
order of the Federal Power Commission in this cause
be, and the same is hereby reversed: and that this
cause be, and the same is hereby remanded to the
Federal Power Commission in accordance with the
opinion of this Court.

June 6, 1977

12a
APPENDIX C

UNITED STATES COURT OF APPEALS
FIFTH CIRCUIT

Nos. 76-1626, 76-1831, 76-2128
PENNZOIL PRODUCING COMPANY, ET AL., PETITIONERS

Vv.

FEDERAL POWER COMMISSION, RESPONDENT

Sept. 1, 1977

Petitions for Review of an Order of Federal Power
Commission (Texas Cases).

ON PETITION FOR REHEARING
(Opinion June 6, 1977, 5 Cir., 1977, 553 F.2d 485)

Before CLARK, RONEY and TJOFLAT, Circuit
Judges.

PER CURIAM:

In its petition for rehearing, the Federal Power
Commission asserts that language in the opinion may
erroneously indicate the prejudgment of an issue not
before the Court, i.e., the effect of our decision in
Southland Royalty Co. v. FPC, 543 F.2d 1134 (5th
Cir. 1976) on a state court termination of a lease,
particularly one not limited by a fixed-term.

13a

In order to pull from the opinion any indication as
to how Southland might apply to the facts of this
case, we delete from our opinion the last two sen-
tences found at the end of the final paragraph, which
read as follows:

It may well be that the “present or future public
convenience or necessity” will suggest the pro-
priety of abandoning a fraction of the gas in
Williams’ property, rather than lose the entire
amount from the interstate market. This decision
is for the Commission.

We agree with the Commission that the statement was
premature, if constructed to be decisional, and unnec-
essary with respect to our decision.

IT IS ORDERED that the petition for rehearing
filed in the sbove entitled and numbered cause be and
the same is hereby DENIED.

l4a
APPENDIX D

UNITED STATES OF AMERICA
FEDERAL POWER COMMISSION

Before Commissioners: Richard L. Dunham, Chair-
man; Don 8S. Smith, John H.
Holloman III, and James G.
Watt.

Docket No. RI76-8
Docket No. RI76-10

PENNZOIL PRODUCING COMPANY
SHELL OIL COMPANY

OPINION NO. 753

OPINION AND ORDER
DENYING SPECIAL RELIEF
AND ABANDONMENT

(Issued January 30, 1976)

Pennzoil Producing Company (Pennzoil) on July 1,
1975, and Shell Oil Company (Shell) on July 18,
1975, filed applications seeking special relief from the
just and reasonable rates * established under Opinion

* Sections 4(a) and 5(a) of the Natural Gas Act, require
that all rates received by a “natural gas company” be “just and
reasonable”. 52 Stat. 822, 823 (1938); 15 U.S.C. §§ 717c(a),
717d(a) (1970).

See, e.g., FPC v. Texaco Inc., 417 U.S. 380 (1974).

l5a

Nos. 598 * and 699° in order to flow through to their
customer, United Gas Pipe Line Company (United),
higher royalty rates called for in a settlement agree-
ment dated June 18, 1975, with their lessors, Wil-
liams, Ine. and others (Williams).

The gas involved is produced in the Gibson Field,
Terrebonne Parish, Louisiana, from leases with Wil-
liams dated August 29, 1934, and July 24, 1952. The
1934 lease provides for payment of a royalty equal to
one eighth (1x) of the value of the gas produced cal-
culated at the “market rate” prevailing at the well.
The 1952 lease provided for a royalty of one-fourth
of the value of the gas calculated at the “market
price” prevailing at the well. By letters dated June A
1973, and March 27, 1974, Williams demanded pay-
ment by Shell and Pennzoil of royalties based on mar-
ket values ranging from 35 cents to 70 cents per Mcf
for the period October 1, 1971, through December 31,
1973, and 70 cents per Mef thereafter. By letter of
June 5, 1974, Williams purported to terminate the
leases (Exhibit No. 3).

* Area Rate Proceeding et al. (Southern Louisiana Area),
46 FPC 86 (1971), aff'd sub nom. Placid Oil Co. v. FPC, 483
F.2d 880 (5th Cir. 1973); aff’d sub nom. Mobil Oil Corp. V.
FPC 417 U.S. 283 (1974).

* Just And Reasonable National Rates For Sales Of Natural
Gas From Wells Commenced On Or After January 1, 1978,
And New Dedications To Interstate Commerce On Or After
January 1, 1973, Docket No. R-389-B, Opinion No. 699, 51
F.P.C. 2212 (June 21, 1974), reh. denied, Opinion No. 699-H,
52 F.P.C. —— (December 4, 1974, aff'd sub nom. Shell Oil Co.
v. FPC, 520 F.2d 1061 (5th Cir. 1975).

l6a

On May 24, 1974, Sheil and Pennzoil filed a petition
in the Civil District Court in the Parish of Orleans,
Louisiana * praying for a Judgment declaring that the
petitioner’s interpretation of “market rate” and “‘miar-
ket price” was correct, that they have properly dis-
charged their royalty obligations on the basis of
Commission established rates and that the leases are
still in effect (Exhibit No. 4). They also asked for a
temporary restraining order, which was granted.
Williams filed an answer and reconventional demand
(counterclaim), with an amendment alleging market
prices for the gas for the period October 1, 1971, to
April 30, 1975, ranging from $.35 to $1.40 per Mcf
and underpayments of $3,731,683.79 (Exhibit Nos.
5, 6).

In the settlement of June 18, 1975, Pennzoil and
Shell would apply to the Commission for authority
to pay a royalty based on a price of 78 cents per Mcf
for 1975 and 1.5 cents per Mcf more each year or
150 percent of the highest area or national rate per-
mitted, plus Louisiana severance tax, Federal taxes
and Btu adjustment. Alternatively, Pennzoil and
Shell would ask for authority to deliver to Williams
one-eighth or one-fourth, as the case may be, of the
gas attributable to their respective interests, and to
abandon their sales of this gas to United.

If the Commission approves the price alternative,
Pennzoil and Shell would pay a royalty for 1974 equal

* Shell Oil Company and Pennzoil Producing Company V.
Williams Inc., et al, Civ.D.Ct. Orleans Parish, La., Docket
No. 573-581.

17a

to what would have been paid based on a price of
45 cents per Mcf, but only to the extent the Commis-
sion permits them to recover such amounts from
United. If the Commission approves the alternative
delivery of the gas to Williams, Pennzoil and Shell
would pay an additional royalty until the date of a
final order.

After the Commission’s order becomes final and
non-appealable the parties would dismiss their Louisi-
ana civil suit. Pennzoil and Shell are to use their
best efforts to obtain the approval of the Commission.
If the Commission refuses to do so on or before Febru-
ary 1, 1976, either Williams or Shell and Pennzoil,
acting together, may terminate the agreement. In
separate agreements United agreed to make the addi-
tional payments or to release the royalty gas (Ex-
hibit Nos. 7, 8).

In its order of August 29, 1975, the Commission
denied the petitions of Pennzoil and Shell for special
relief and prescribed a hearing on the issue relating
to the abandonment of the royalty gas. On Septem-
ber 22, 1975, the Commission granted rehearing and
provided that the hearing cover the issue of special
relief. The hearing was held before Presiding Admin-
istrative Law Judge Samuel Z. Gordon on Septem-
ber 23, 1975, at which Shell, Pennzoil and United pre-
sented evidence. Shell was afforded additional time to
present certain factual data as to prices, volumes and
cost and did so on September 29, 1975. The costs it
presented were derived from national costs with a
figure for operating expenses from the 1934 and 1952

18a

leases substituted for the national figure. Shell was
given opportunity to file additional cost data but ad-
vised that it did not intend to do so (Exhibit No. 10),
although it filed answers to written interrogatories
submitted by the Commission staff.

In his initial decision issued November 24, 1975,
the Judge denied special relief on the ground that
the producer must establish that his overall costs in-
curred in the operation of the particular well or group
of wells are higher than area or nationwide rates, or
that his out-of-pocket expenses will exceed revenues.
Pennzoil, he said, had made no such showing and
Shell had attempted to use the nationwide costs with
a 4.5 cents figure for operating costs and a royalty
figure based on $1.40 per Mcf market value.

The Judge also determined that Pennzoil and Shell
have not established that abandonment of the royalty
interest is permitted by the public convenience and
necessity. Williams has agreed to accept higher roy-
alty payments computed on the basis of 78 cents per
Mef, he pointed out, and Shell has shown that it
could absorb higher royalty costs while Pennzoil has
not made a showing that it could not. Furthermore,
the abandonment should be denied because William’s
claim is unadjudicated. He would also deny the re-
quested surcharge for past royalties.

Exceptions were filed by Pennzoil, Shell, United,
stobil Oil Corporation (adopting those of Pennzoil
and Shell) and the State of Louisiana, and a brief
opposing exceptions was filed by Staff.

19a

Since the filing of the exceptions Pennzoil on Janu-
ary 20, 1976, filed a motion for leave to lodge a docu-
ment with the Commission and to comment on the
Commission’s Opinion No. 749 ° prescribing rates for
flowing gas. The document is a letter dated Janu-
ary 5, 1976, from counsel for Williams requesting
answers to interrogatories in the Louisiana litigation
and stating that Williams intended to reactivate the
state proceedings as soon as possible under the settle-
ment agreement. In its comments on Opinion No. 749
Pennzoil says that, as to the old gas, the royalty
increment under the settlement would be added to
the Opinion No. 749 rate,’ rather than to the South-
ern Louisiana Area rate. Pennzoil argues that the
Opinion No. 749 rate should apply even though it is
granted special relief here* because this is not a
typical relief case since all increased sums will be
passed directly to the lessors. Since we are denying
the requested relief as discussed below, it is not neces-
sary to determine this issue.

Pennzoil objects to the Judge requiring project cost
evidence, saying that the cost inquiry should be limited
to the costs and revenues associated with the price

° Just And Reasonable National Rates For Sales Of Natural
Gas From Wells Commenced Prior To January 1, 1978,
FPC , Opinion No. 749, Docket No. R-478, —— F.P.C.
—— (December 31, 1975).

° The Opinion No. 749 rate is 23.5 cents per Mef 23.5 cents
per Mcf prior to July 1, 1976, and 29.5 cents per Mcf there-
after, subject to adjustments.

* See Opinion No. 749, at 48-49.

a 2
.

20a

increase. It argues that the risks of the Williams
litigation render the current price inappropriate and
lease termination is a serious possibility. If Williams
wins in the litigation, Pennzoil says, it might be able
to sell the gas in intrastate commerce, or it might sell
all of the gas under a new contract at 130 percent of
the national rate under Section 2.56a(a) (2) (iii) of
the Regulations * and Opinion No. 742°, and for all
of the gas this would be 27 cents per Mcf more than
Pennzoil is currently collecting. It further contends
that market value royalties involve considerations dif-
ferent from those involved in the determination of
other items of cost since royalties are flowed-through
to the lessor. Finally, it notes that substantial risks
are avoided by an increase in average price from
40.91 cents per Mcf to 44.55 cents per Mcf or 3.64
cents, none of which inures to Pennzoil’s benefit.

Shell makes similar arguments about the lack of
necessity for showing overall costs, saying that proof
of overall costs is not required in a special relief case.
Likewise Shell argues that failure to approve the set-
tlement risks interstate gas supply and threatens
higher prices, and asks the Commission to consider
the end result. United urges that the settlement be
approved in the public interest as concerned with the
certainty of gas supply and reasonable prices. Louisi-
ana argues that the Judge failed to apply proper
°18 C.F.R. § 2.56a(a) (2) (iii).

*Small Producer Regulation, Docket No. R-393, Opinion
No. 742, FPC ——.

2la

standards in denying rate relief contending that
changed circumstances have made no longer appro-
priate the royalty cost assumptions that went into
the applicable rate structures, and Louisiana supports
the settlement as a reasonable and appropriate resolu-
tion of the issues. On the other hand the staff argues
against reliance on non-cost factors and Shell’s use of
national cost figures, which it points out are only
averages.
PRICE RELIEF

The real issue in this proceeding is whether the
Federal Power Commission can legally grant any
form of rate relief above either an area or nation-
wide just and reasonable rate solely because the pro-
ducer selling the gas in interstate commerce may be
obligated to make a royalty payment based not upon
the regulated price the producer receives for the gas,
but rather on the “market value” of the gas. More-
over, as in this proceeding, the question becomes some-
what speculative because of litigation between pro-
ducer lessees and lessors over the extent of such roy-
alty obligations.

While sympathetic to the plight of the producers
who face or may face litigation on the value of roy-
alties, we today must find that such producers are
not entitled to rate relief. While we admittedly do
not have jurisdiction over royalty owners as such ”
and, therefore, over royalty payments by producers to

*°See Mobil Oil Corporation v. FPC, 463 F.2d 256 (D.C.
Cir. 1972).

22a

lease owners, we do have jurisdiction over the rates
charged by producers to the pipelines for sales of gas
for resale in interstate commerce and those rates
must be “just and reasonable”." Hence, if a producer
desires to compute royalty payments based on a rate
in excess of our applicable just and reasonable rate,
he may unilaterally do so. However, if a producer
attempts to flow this cost through to the pipeline and
ultimately to the consumer, we must determine if
this incremental royalty cost is just and reasonable.
Yet, in making this finding, it would be inconsistent
and contrary to the Commission’s mandate to estab-
lish a just and reasonable rate and at the same time
allow a producer selling at that just and reasonable
rate to increase this rate for additional royalty pay-
ments which are based on other factors than the
regulated rate.

In the instant proceeding, the impetus of the settle-
ment is the market value of the rovalties and no con-
sideration has been given to regulated rates. As such,
we cannot permit any incremental royalty costs re-
sulting from this settlement, or resulting from any
judgment by a state court regarding royalty pay-
ments, to be passed on to the pipeline if these incre-
mental royalty costs are based on any other factors
than the regulated just and reasonable rate. On this
point, we note the Supreme Court’s warning in FPC
v. Texaco, supra, that the Commission is not free to

“See Mobil Oil Corporation v. FPC, et al., 417 U.S. 283
(1974); FPC v. Texaco, Inc., 417 U.S. 380 (1974).

23a

equate just and reasonable rates with the prices for
gas in the marketplace. Accordingly, we believe that
we are not free to allow royalty costs, which are based
on market values, to be passed on to the pipelines as
just and reasonable rates. A contrary result would
not “. . . afford consumers a complete, permanent, and
effective bond of protection from excessive rates and
charges.” *
ABANDONMENT

Pennzoil argues that abandonment of the royalty
portion of the gas should be allowed under Section
7(b) of the Natural Gas Act ™ as in the public con-
venience and necessity if price relief is not granted.
Pennzoil says the choice here is between losing one-
eighth of the gas and risking the loss of all of the
gas. While United prefers the requests for increased
rates, it says the Commission should approve the

* See Atlantic Refining Company V. Public Service Commis-
sion of the State of New York, 360 U.S. 378, 388 (1959).

8 Section 7(b) provides:

No natural-gas company shall abandon all or any por-
tion of its facilities subject to the jurisdiction of the
Commission, or any service rendered by means of such
facilities, without the permission and approval of the
Commission first had and obtained, after due hearing,
and a finding by the Commission that the available sup-
ply of naturai gas is depleted to the extent that the con-
tinuance of service is unwarranted, or that the present
or future public convenience or necessity permit such
abandonment.

52 Stat. 824 (1938); 15 U.S.C. § 717f(b) (1970).

24a

requests to abandon the royalty portion of the gas if
price relief is denied.

We find no reason to grant abandonment on the
basis of this record. There is no showing “that the
available supply of natural gas is depleted to the
extent that the continuation of service is unwarranted,
or that the present or future public convenience or
necessity” requires that abandonment be authorized.

The supply of natural gas involved in this case is
not depleted so abandonment may not be approved
for that reason. Moreover, the public convenience and
necessity, present or future, is not served by granting
an abandonment authorization that would likely re-
sult in the subject gas being diverted from the inter-
state market to the intrastate market.

Since “there can be no withdrawal of that supply
[of natural gas] from continued interstate move-
ment without Commission approval” ™ once the gas
is dedicated, we do not share the concern of Pennzoil
and United that Williams could terminate deliveries
to United even if the leases were cancelled as a result
of state court litigation. If the lease were cancelled
and Williams were to undertake to sell the subject
gas, Williams would simply assume the obligations of
Pennzoil and Shell to continue service to United. El
Paso Natural Gas Company, Texaco Inc., Docket Nos.
CP75-209, CI75-594, Opinion No. 737, —— F.P.C.
—— (July 11, 1975), rehearing denied, Opinion No.
737-A, F.P.C. (September 3, 1975), re-

** Atlantic Refining Co. v. Public Service Commission of
New York, 360 U.S. 878, 389 (1959).

25a

hearing granted on limited issue, Opinion No. 737-B,
— F.P.C. (December 18, 1975), appeal pend-
ing sub nom. Southland Royalty Co. v. F.P.C., No. 75-
2851 (5th Cir.). In such a case, Williams would not
be entitled to the status afforded a royalty owner by
Mobil Oil Corp. v. F.P.C., 463 F.2d 256 (D.C. Cir.
1971), but would be a natural gas company making
sales for resale of natural gas in interstate commerce
subject to the Commission’s jurisdiction. Phillips
Petroleum Company vy. Wisconsin, 347 U.S. 672
(1954). We, therefore, deny the alternative requests
for abandonment.

SURCHARGE

Pennzoil argues that the surcharge contained in
the settlement to pay Williams for alleged past under-
payment of royalties was not settled in the Commis-
sion’s orders, is not a retroactive rate increase, repre-
sents less than the full claim and should be allowed.
For the reasons set forth above in denying the re-
quested price relief, we also deny the requested sur-
charge.

The Commission further finds:

The initial decision issued November 24, 1975, in
these proceedings denying the applications of Pennzoil
and Shell for special relief or abandonment, and a
surcharge should be affirmed for the reasons set forth
above.

26a

The Commission orders:

(A) The initial decision issued November 24, 1975,
in these proceedings is affirmed for the reason set
forth above.

(B) The petitions otf Pennzoil and Shell requesting
special relief or abandonment and a surcharge are
denied.

(C) The motion to lodge a document and comment
filed on January 20, 1976, is granted.

(D) Exceptions not granted are denied.

By the Commission.

[SEAL]
KENNETH F. PLUMB,
Secretary.

27a
APPENDIX E

UNITED STATES OF AMERICA
FEDERAL POWER COMMISSION

Before Commissioners: Richard L. Dunham, Chair-
man; John H. Holloman III,
and James G. Watt.

Docket No. RI76-8

PENNZOIL PRODUCING COMPANY

Docket No. RI76-10

SHELL OIL COMPANY

OPINION NO. 753-A
OPINION AND ORDER DENYING REHEARING
(Issued February 27, 1976)

Pennzoil Producing Company and Shell Oil Com-
pany on February 13, 1976, and United Gas Pipe
Line Company (United) on February 26, 1976, have
filed applications for rehearing of the Commission’s
Opinion No. 753 and order issued January 30, 1976.
The Opinion and order relate to gas produced by
Pennzoil and Shell in the Gibson Field, Terrebonne
Parish, Louisiana and sold to their customer, United
Gas Pipe Line Company. The lessors in the Field,
Williams, Inc. end others (Williams), had demanded
higher royalties based on the market price for the gas;

28a

a civil suit in Louisiana had commenced on the ap-
plicability of the market price; and on June 18, 1975,
Pennzoil, Shell and Williams had entered into a set-
tlement agreement under which Pennzoil and Shell
would apply to the Commission for authority, among
other things, to pay a royalty based on a price of 78
cents per Mcf, or alternatively abandon the royalty
gas to Williams. Pennzoil and Shell also agreed to
pay Williams a surcharge for alleged past underpay-
ment of royalties and proposed to flow through the
increased royalties and the surcharge to United.

In its Opinion No. 753 and order the Commission,
in adopting the initial decision of the Administrative
Law Judge, denied the special relief, the surcharge
and the abandonment. Pennzoil and Shell contend
that the Commission is in error and, Pennzoil states
that, while the settlement agreement was subject to
cancellation by February 1, 1976, Williams has agreed
that the settlement will not be cancelled before
March 1, 1976.

In the first place Pennzoil contends that the Com-
mission has authority to allow increased rates to re-
flect royalty payments based on prices in excess of
ceiling rates. The Commission said that it was not
free to allow royalty costs, which are based on market
values, to be passed on to the pipeline as just and
reasonable rates. Pennzoil cites Placid Oil Co. v.
F.P.C., 483 F.2d 880 (CA5, 1973), where the Court
said that if producers are put in a bind by their
royalty obligations they may petition the F.P.C. for
individualized relief, and Mobil Oil Corp. v. F.P.C..,

29a

417 U.S. 283 (1974), affirming Placid and saying that
a producer affected by higher royalty obligations is
entitled to seek individualized relief. While indicating
that relief on some grounds may be possible, this case
does not state under what conditions relief should be
granted, nor does it define when the right to gain
relief matures.

In F.P.C. v. Texaco Ine., 417 U.S. 380 (1974), the
Commission was instructed to insure “that the rates
paid by pipelines, and ultimately borne by the con-
sumers, are just and reasonable” and that “the pre-
vailing price in the market place cannot be the final
measure of just and reasonable rates mandated by the
Act.” While Pennzoil argues here that the price in-
crease is based on a number of factors, including the
risks of the Williams litigation, the propriety of the
settlement, and the fact that it is not based on the
full market price, it is plain that the royalty is to be
based on 78 cents, which is the settlement’s reflection
of market prices, that are above the area ceiling
prices.

The area ceiling prices are intended to be just and
reasonable rates. The Commission was upheld in de-
termining just and reasonable rates for the Southern
Louisiana arez in Mobil, supra. The Commission de-
termined just and reasonable national rates in Opin-
ions Nos. 699 and 699-H and was affirmed on ap-
peal." In arriving at the national rates costs of pro-

' Just and Reasonable National Rates for Sales of Natural
Gas from Wells Commenced on or after January 1, 1973, Opin-
ion No. 699, 51 FPC 2212 (1974); Opinion No. 699-H, ——

30a

duction were used and royalties were computed at
16 percent of total costs. (51 FPC at pp. 2272-2273)
It is for these reasons that the Commission is not
free to allow royalty costs, which are based on market
values, to be passed on to the pipelines as just and
reasonable rates.

Pennzoil argues that it is an entirely different
question when we are dealing with an incremental
price that does not generate excessive profits, but
Texaco says that “a little unlawfulness” is not per-
mitted. In this connection American Petrofina Com-
pany of Texas (Operator), et al., FPC :
Docket Nos. RI75-17 and RI75-19, issued March 3,
1975, is not in point. In that case the company was
given relief because of the costs of additional neces-
sary compression. There was no question of the rea-
sonableness of compression costs or whether they were
determined on the basis of lower interstate prices or
higher intrastate prices. Nor are the El Paso Natural
Gas Company, FPC , Docket No. RP74-22,
et al., orders issued November 29, 1974, and Janu-
ary 29, 1975, in point. In that case the Commission
had originally prevented El Paso from collecting a
rate increase based on increased royalties which had
not yet been paid, but in the cited orders we allowed
such rate increases to go into effect subject to refund
saying that E] Paso had begun paying the increased
royalty charges but our review raised a number of
issues relating to the justness and reasonableness of

FPC , Docket No. R-389-B, issued December 4, 1974; aff’d
Sub. Nom. Shell Oil Co. v. F.P.C., 520 F.2d 1061 (CA 5, 1975).

On ee

TA At SR Al Manel aT ie ares bits Oe

Orem Usenet LE

3la

the proposed rates that required further considera-
tion by the Commission. Thus in El Paso the validity
of the increased charges based on royalties was not
determined.

Pennzoil further argues that the price increase is
just and reasonable, pointing out the risks of the
Williams litigation and contending that the gas may
be diverted from the interstate market. Pennzoil also
notes that no one has contended that the costs in-
volved were improvidently occurred. These considera-
tions are not controlling. The Commission does not
have the power to base a part of the regulated price
on the unregulated market value of intrastate gas.
Pennzoil also objects to the statement that the Com-
mission cannot permit incremental royalty costs re-
sulting from any judgment by a state court from being
passed on to a pipeline if the incremental costs are
based on any other factors than the regulated just and
reasonable rate. Pennzoil says that this is dicta and
it should be eliminated. Since there is no state court
judgment and it is indeed dicta, it will not be neces-
sary to discuss it further at this time. Pennzoil’s
arguments on the issues of abandonment and sur-
charge are sufficiently covered in the original opinion,
and need not be addressed again.

Shell has listed specifications of error that relate
lo the discussion of the Administrative Law Judge as
well as to our discussion in Opinion No. 753. These
matters have largely been covered. Shell contends,
inter alia, that we have not considered the end result
of our decision on the consumer, saying that the gas

32a

supply may be lost. The gas supply here that is dedi-
cated to interstate commerce cannot be diverted to
intrastate commerce. At the same time, if royalty
costs could be based on higher intrastate market
values, the impact on the consumer could extend far
beyond this case. It is not in the public interest that
national rates be distorted in the manner contemplated
by Shell, which would create a new species of inter-
state gas which would rise and fall with intrastate
market values.

Also Shell says that the Commission has foreclosed
any consideration of the market value royalty problem
in any forum and has therefore deprived Shell of its
property without due process of law. In this proceed-
ing a hearing was held; the Presiding Judge issued
an initial decision to which exceptions were taken:
and the Commission considered the issues on the basis
of the record. There is no dispute whatever about the
facts relating to the computation of the proposed
rates based upon market value royalties. Pennzoil,
Shell and United have expressed their views, and the
Commission determined that special relief should not
be granted on the basis of market value royalties.
United’s contentions are covered by Opinion No. 753
and this Opinion.

The Commission further finds:

The assignments of error and grounds for rehearing
of Opinion No. 753 and order in the applications for
rehearing filed by Pennzoil, Shell, and United present
no facts or legal principles that would warrant any

33a

change in or modification of the Commission’s Opin-
ion No. 753 and order as supplemented by the above
discussion.

The Commission orders:

The applications for rehearing filed by Pennzoil and
Shell on February 13, 1976, and United on Febru-
ary 26, 1976, are denied.

By the Commission.

[SEAL]
KENNETH F. PLuMp,
Secretary.
WG. 8. Government painting orice, 1977 249467 983

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_0841%3A01. Public record. Not legal advice.