Respondents Brief — Federal Energy Regulatory Commission v. Pennzoil Producing Co.

IN THE

Supreme Court of the United States

OCTOBER TERM, 1978

No. 77-648

FEDERAL ENERGY REGULATORY COMMISSION,

Petitioner,

, J

PENNZOIL PRODUCING COMPANY, ET AL.,

Respondents.

BRIEF OF RESPONDENT SHELL OIL COMPANY

THOMAS G. JOHNSON

Attorney for

SHELL OIL COMPANY

One Shell Plaza

P. O. Box 2463

Houston, Texas 77001

October 5, 1978

NSE DSSS. REPORT SEE COTE

Alpha Law Brief Co., One Main Plaza, No. 1 Main St., Houston, Texas 77002

TABLE OF CONTENTS

Page

COUNTERSTATEMENT OF THE CASE ............ 1

COUNTERSTATEMENT OF QUESTIONS

eee eee cus cesccecsccecccecce's 6

SUMMARY OF ARGUMENT .......................

EE EE 10

I. The “Basic Principles Of Rate Regulation” Require,

Rather Than Preclude, The Commission To Hear The

Petitions Of Shell And Pennzoil For Special Relief On

ee wees ccccécceccccccece: 10

A. The Basis Of The Commission’s Decision ....... 10

B. The Holding Of F.P.C. v. Texaco Inc. ......... 13

C. Other “Basic Principles Of Rate Regulation” Re-

quire Affirmance Of The Court Of Appeals ...... 17

D. The Record Shows That Without The Relief Re-

quested, Shell’s Leases Will Be Confiscated ...... 20

1. Shell’s Lease Contracts Are Not “Unreasonable”

EEE 20

2. If The Requested Relief Is Denied, Shell Faces

Confiscation Of Its Leases ................. 21

3. If The State Court Settlement Is Destroyed By

Refusal Of The Commission Tu Grant Reliet,

There Is Subtsantial Risk That The Lessor

eC Ta eG uss 6b eds ccesesccscee 25

II. The Case Should Still Be Remanded To The Commis-

sion On The Abandonment Issue, Even Though The

Fifth Circuit’s Southland Decision Has Been Reversed 26

A. What Does The “Public Convenience And Neces-

TEMES ce 6bseGeeeseccecdescccces 26

B. The “Investor” Interest Is Entitled To Some Con-

Ne ee ccc ccavecccees 27

C. Where Lies The “Consumer” Interest? ......... 29

GC RGES Gs chasse esecesccccecccces 31

II

TABLE OF AUTHORITIES

CASES Page

American Public Gas Association v. F.E.R.C., 567 F.2d 1016

(1977), cert. denied, US. , 55 L.Ed.2d 499

OS GRRE RODS oe I LOIRE T IT ETT ENE 30

Arkansas Natural Gas Co. v. Sartor, 78 F.2d 924 (Sth Cir.

SODGD is ou 004apve neces ddvnecdennéses sue eénsenenees 2

Brent v. Natural Gas Pipeline Co. of America, F.Supp.

(N.D. Tex. Civil Action No. CA-2-75-167, August

SOFE ccccdcdebecesevacececesepsensscdanetawsncances 25

Brewster v. Lanyon Zinc Co., 140 F. 801 (8th Cir. 1905) . 2

Burlington Truck Lines v. United States, 371 U.S. 156

ELC LODE SEE NBL NA PEI S RIOIT SD 15

Butler v. Exxon Corp., 559 S.W.2d 410 (Tex. Cir. App. -

Be We FOND. bs cacebdnescacececcautsavencectsuaces 25

Continental Oil Co. v. F.P.C., 519 F.2d 31 (Sth Cir. 1975),

cert. denied sub nom., Superior Oil Co. v. F.P.C. 425

OB, Gee Chee 60-656 ceusuunesccacushouiesdaeseens 13

Federal Power Commission v. Hope Natural Gas Co., 320

ak Bee COED 60:666.60ddsc000esenvnanenbianestant 28

Federal Power Commission v. Natural Gas Pipeline Co.,

BES Ga Bee SOD bvecsdernstendediouscaaeesines 28

Federal Power Commission v. Texaco Inc., 417 U.S. 380

CRINGE. cccteveddhugsesaeseetdadenekenswans cited throughout

J.M. Huber Corporation v. Denman, 367 F.2d 104 (5th Cir.

SOGEE . és consbneds 06 ons cnn 5enck suecndsiensenmnenss 3,25

Kingery v. Continental Oil Co., 434 F.Supp. 349 (W.D.

WOE, BOFED vecccccecneccencpescscecccncenegeecessce, 25

Lightcap v. Mobil Oil Corp., 221 Kan. 448, 562 P.2d 1

1977), cert. denied, Mobil Oil Corp. v. Lightcap, 434 US.

876, Petition for Rehearing pending, Case No. 76-1694 .. 25

Mobii Oil Corp. v. F.P.C., 463 F.2d 256 (D.C. Cir. 1972)

ee £ Qe eB s BPPCCre rer rerrerr Tee 4

Moss v. Federal Power Commission, 502 F.2d 461 (D.C.

Cir. 1974), affirmed Federal Power Commission v. Moss,

456 CUB. GEG Gee Wi +44 0bnees cba trance cccscnéases 24

Northern Natural Gas Co. v. State Corporation of Kansas,

Bee Gk et COED. bxdwededcesncaus beeccnakombauss 4

Permian Basin Area Rate Proceeding, 34 F.P.C. 159,

affirmed Permian Basin Area Rate Cases, 390 U.S. 747

oS PRL ORR Ge MOD. Se Seth eh 8 Ai 2, 8, 28

Phillips Petroleum Co. v. Bynum, 155 F.2d 196 (Sth Cir.

POED 600060 000hend6eeuneeissiddnkes6ecéetaaeeenes 2

Phillips v. Wisconsin, 347 U.S. 672 (1954) ..........005. 21

Sartor v. United Gas Public Service Co., 186 La. 555, 173

A GEE ROGUE hednvedcnenceceueadécescasavaubeuenke 2

ee

III

CASES

Securities Exchange Commission v. Chenery Corp., 332 US.

“_ % YARRA Sere em yen

Shamrock Oil & Gas Corp. v. Coffee, 104 F.2d 409 (Sth

Se ME pu cacaetae dnd tee tk

National Rate Case for New Gas, Opinion 699, 52 F.P.C.

2212; Opinion 699-H, 52 F.P.C. 1604; affirmed Shell Oil

Co. v. F.P.C., 520 F.2d 1061 (Sth Cir. 1975), cert. denied

sub nom., California Co. v. F.P.C., 426 U.S. 941 (1976)

Page

15

2

CeCe UARGNECCEDDS UKE SEER ES ONEAESR EOE ROE Es ccs cited throughout

Shell Oil Co. v. F.P.C. (Other Southwest Area Rate Case),

484 F.2d 469 (Sth Cir. 1973), cert. denied sub nom.

Mobil Oil Corporation v. F.P.C., 417 US. 973 ........

Southland Royalty Co. v. F.P.C., 543 F.2d 1134 (1976)

reversed, California v. Southland Royalty Co. US.

12

, 98 S.Ct. 1955; 56 L.Ed.2d 505 (1978) ...... 9, 27, 28, 29

Southern Louisiana Area Rate Proceeding, 46 F.P.C. 86:

affirmed Placid Oil Company v. F.P.C., 483 F.2d 880

(Sth Cir. 1973); affirmed Mobil Oil Corp. v. F.P.C., 417

as Ge SPE Ane dnéceeddun eds cnankccncnes cited throughout

Tenneco Oil Co. v. Federal Energy Regulatory Commis-

sion, 571 F.2d 834 (Sth Cir. 1978)

SG8eeeteoeeesen 66 666

eee eee eens

Texas Gulf Coast Area Rate Proceeding, 45 F.P.C. 674:

reversed, PSC of NY v. F.P.C., 487 F.2d 1043 (D.C.

Cir. 1973); vacated and remanded Shell Oil Co. v. PSC

Of HY, GAT OB. CH6 CIGPMD oon cucccccccnccaccocce,

ae States v. Southwestern Cable Co., 392 US. 157

RN atic ader deen ea Guea erne e

Weymouth v. Colorado Interstate Gas Company, 367 F.2d

Bw err ere

ry Oil Co. v. Boagni, 255 La. 67, 229 So.2d 702

SE SON eis ein ous Veena hae bsich ek oven:

Supreme Court of the United States

OCTOBER TERM, 1978

No. 77-648

FEDERAL ENERGY REGULATORY COMMISSION,

Petitioner,

Vv

PENNZOIL PRODUCING COMPANY, ET AL.,

Respondents.

BRIEF OF RESPONDENT SHELL OIL COMPANY

COUNTERSTATEMENT OF THE CASE

For over ten years the Commission has failed, or

refused, to cope with a growing problem in the natural

gas producing industry. This case represents a typical

example of that problem. The Commission is asking this

Court to determine that it has no jurisdiction to deal

with the problem, regardless of the merits of the pro-

ducers’ position.’

1. The Commission appears to concede that if the Court of

Appeals is sustained, and it is required to give the producers a fair

hearing on the merits, that individual relief “must be granted” in

many cases, if not in this case, see Brief, p. 24, 25.

2

The problem arose in this way. Before gas explora-

tion or development can begin, a company or an indi-

vidual in that business normally obtains an oil and gas

lease from the landowner. Such leases provide, in addition

to a cash bonus to the lessor, that the lessor shall receive

a percentage of either the proceeds received from the

sale of gas by the lessee, or a percentage of the market

value of the gas produced and sold from the lease. Absent

regulation there was no material difference in the two

provisions, as the lessee normally sold the entire gas

stream at the market value.”

The belief that lessor was ew ‘tied to his royalty factor

based on the price the lessee received for the gas* con-

tinued until the Commission’s decision in the Permian

Basin Area Rate Proceeding, 34 F.P.C. 159°, decided

August 5, 1965. In that proceeding the Commission

rejected the producers’ position that the ceiling rate

should reflect, as nearly as could be estimated, the price

which would be received in a free competitive market

2. The “market value” or “market price’ was determined by

reference to other sales of gas comparable in time, quality, and

availability, Phillips Petroleum Co. v. Bynum, 155 F.2d 196 (Sth

Cir. 1946); Texas Oil & Gas Corporation v. Vela, 429 S.W.2d 866,

872 (Tex. S. Ct. 1968); Arkansas Natural Gas Ceo. v. Sartor, 78

F.2d 924 (Sth Cir. 1935); Shamrock Oil & Gas Corp. v. Coffee,

140 F.2d 409 (Sth Cir. 1944); Sartor v. United Gas Public Service

Co., 186 La. 555, 173 So. 103 (1937).

3. Which under State law the lessee was not only authorized,

but obligated, to market the icssor’s share of the gas, see California

v. Southland Royalty Co., _US. , 98 S.Ct. 1955, 56 L.Ed.

2d 505, slip op. p. 9 (1978); 5 H. Williams & C. Meyers, Oil and

Gas Law, § 853 (1977); 2 Summers Oil and Gas Lew § 415; Brewster

v. Lanyon Zinc Co., 140 F. 801 (8th Cir. 1905); Walker, Property

Interest Created By An Oil and Gas Lease, 11 Tex. Law Rev. 399, 401.

4. Affirmed, Permian Basin Area Rate Cases, 390 U.S. (747

(1968).

3

(or the “market value”) and instead based the ceiling

rate on an industry-wide composite cost study for the

producing area involved.

The interrelationship between the Commission-imposed

ceiling rate and the market value royalty clause was

first considered by a court in the companion cases of

Weymouth v. Colorado Interstate Gas Company, 367

F.2d 84 (Sth Cir. 1966) and J.M. Huber Corporation

v. Denman, 367 F.2d 104 (Sth Cir. 1966). In lengthy

and lucid opinions by Chief Judge Brown, acting after

amicus briefs had been filed by the Commission on re-

quest of the Court of Appeals, the Fifth Circuit held

that as a matter of contract law the lessors were not

confined to the ceiling rate established by the Commission

for the lessee-producer, but that the lessors’ royalty

interest might also be subject to that ceiling rate. The

cases were remanded to await the initial determination

by the Commission whether it had jurisdiction over such

interest, and if so, what type of filings were required by

the lessors.

The Commission promptly instituted a proceeding to

resolve this question, and on July 23, 1969 issued its

Opinion No. 562 (42 F.P.C. 164), finding that it had

jurisdiction over the price attributable to the royalty

owner's share of the gas, and that he could not receive

a price in excess of the just and reasonable rate regardless

of his contract. The Commission also held that the royalty

owner could receive a rate higher than the “filed rate”

of the producer-lessee, if no ceiling rate was exceeded.

The case was appealed to the District of Columbia Cir-

cuit, which reversed the Commission, holding that the

royalty owner was not subject to Commission jurisdiction

4

because he had never made a “sale” of gas in interstate

commerce, Mobil Oil Corp. v. F.P.C., 463 F.2d 256

(D.C. Cir. 1972).

Sheli Oil Company participated in the case before

the Commission, arguing that even if the Commission

could not assert jurisdiction over the royalty owner be-

cause no sale had occurred, the Commission could still

fix the rate to which the royalty percentage would be

applied for the reason that otherwise an unreasonable

burden on interstate commerce would result, citing United

States v. Southwestern Cable Co., 392 U.S. 157 (1968)

and Northern Natural Gas Co. v. State Corporation Com-

mission of Kansas, 372 U.S. 84 (1962). The Commis-

sion relied on this argument as an “additional basis” for

asserting jurisdiction.” The D.C. Circuit rejected this

argument on the ground that:

“The record simply does not focus on what may be

involved in the possibility of recovery of royalty

calculated on the basis of ‘market prices’ higher than

ceilings.” (463 F.2d 256, 264).

This Court denied certiorari, 406 U.S. 976 (1972).

While the Mobil case was pending in the D.C. Circuit

on appeal, Mobil Oil Corporation sought relief on the

market value royalty problem in two area rate cases

then pending before the Commission, the Southern

Louisiana Area Rate Proceeding, 46 F.P.C. 86 and the

Texas Gulf Coast Area Rate Proceeding, 45 F.P.C. 674.

In these cases, the Commission based its decision on a

cost calculation which assumed that the producer would

pay royalty on the basis of 14 (Texas Gulf Coast Area

5. 42 F.P.C. at 172, 173.

a

5

Rate Proceeding, 45 F.P.C. 674, 842) to 15 (Southern

Louisiana Area Rate Proceeding, 46 F.P.C. 86, 132)

percent of price he received. Mobil appealed each of those

cases on the grounds that the area ceiling rate failed to

reflect any cost increment to compensate the producers

for the market value royalty problem.

In each case the Court of Appeals rejected Mobil’s

argument on the grounds that the record did not contain

sufficient evidence to enable the Commission to calculate

a cost increment to compensate the producers for the

market value, and the problem might not be sufficiently

severe to merit treatment on an industry-wide basis,

Public Service Commission of New York v. F.P.C., 487

F.2d 1043, 1061 (D.C. Cir. 1973);° Placid Oil Company

v. F.P.C., 483 F.2d 880, 910-911 (Sth Cir. 1973).

The issue was again raised by Mobil Oil Corporation

in Petitions for Certiorari to this Court. This Court

granted Mobil’s Petition (and others) from the Placid

decision, but affirmed the Commission and the Court

of Appeals on this specific issue, Mobil Oil Corp. v.

F.P.C., 417 U.S. 283 (1974) stating:

“We agree with the Court of Appeals that Mobil’s

argument is hypothetical at this stage and that in

any event an affected producer is entitled to seek

individualized relief.” (417 U.S. 283, 328) (Em-

phasis supplied)

In shifting from area rate regulation to nationwide

ceiling rates, the Commission continued to base its ceil-

ing rate on a cost study which calculated the producers’

6. Vacated and remanded on other grounds, Shell Oil Co. v.

Public Service Commission of New York, 417 U.S. 964 (1974).

6

royalty cost as a percentage of the rate permitted to be

charged, although the percentage was increased from

15 to 16 percent to reflect generally higher royalty per-

centages from offshore leases (National Rate Case for

New Gas, Opinion No. 699, 51 F.P.C. 2212, 2272).

Mobil and other producers, including Shell, continued to

argue for a cost increment in the nationwide rate to re-

flect the market value royalty problem. In each case

these arguments were rejected by the Commission; Opin-

ion No. 699, Docket No. R-389-B, 51 F.P.C. 2212, 2272;

52 F.P.C. 1604; affirmed Shell Oil Co. v. F.P.C., 520

F.2d 1061, 1068 (Sth Cir. 1975), cert. denied, sub nom.

California Co. v. F.P.C., 426 U.S. 941 (1976); Opinion

No. 749-C, F.P.C._.__._ (slip opinion p. 27) issued

July 19, 1976; affirmed Tenneco Oil Co. v. F.E.R.C.,

571 F.2d 834, 848 (Sth Cir. 1978).

It was in the context of this legal background that

Shell and Pennzoil filed their Petitions for “individualized

relief’ described in Petitioners’ Statement.

COUNTERSTATEMENT OF QUESTIONS

PRESENTED

1. Whether the National Gas Act, as interpreted by

this Court in Federai Power Commission v. Texaco Inc.,

417 U.S. 380 (1974), precludes the Commission from

considering the fact that a producer may incur royalty

costs substantially in excess of the percentage utilized by

the Commission in establishing the ceilings applicable

to the gas being sold from the leases in question, in a

proceeding for individualized relief, for the reason that

such royalty costs may be based in part on unregulated

intrastate gas prices, along with other factors.

7

2. Whether the Commission is required by the Due

Process Clause of the United States Constitution to ad-

dress the question whether the producers’ lease is being

confiscated by refusal of the Commission to allow the

producer a rate which is high enough to recover his

costs, in some proceeding in which producers’ rates are

being determined, on either a national, area, individual

company, or individual lease basis.

3. Whether, in a case before the Commission to grant

abandonment of the royalty owners’ percentage interest

in the gas being sold in interstate commerce on the

grounds that such abandonment is in the public con-

venience and necessity, the Commission can refuse to

consider any issue other than the legal question whether,

if the royalty owner is successful in canceling the lessee-

producer's lease, that the lessor-royalty owner will be

required to continue the sale in interstate commerce.

SUMMARY OF ARGUMENT

This proceeding represents the last chance for pro-

ducers to obtain relief from confiscation of their leases

through a chain of court decisions, detailed in the State-

ment, supra, which twisted the lease contract into a docu-

ment never conceived of by the parties at the time the

contracts were made. Step by step, the Commission has

(i) fixed the lessee-producer’s gas price at below market

value; (ii) been found lacking in jurisdiction to fix the

lessor’s price at the same level; (iii) refused to consider

or take into account this situation in calculating the

royalty component of an area cost study used to calcu-

late producer rates on an area basis; (iv) refused again to

take this factor into account in making the same calcu-

8

lation on a national basis; (v) refused to calculate rates

on the basis of individual producer company costs’;

(vi) and finally, in this proceeding, asks this court

to affirm that it has no jurisdiction to consider this issue

in a specific proceeding brought for this purpose.”

This refusal to consider the question of increased

royalty costs’ occasioned by fixing ceiling rates below

market value is made in the face of a clear direction by

this Court in Mobil Oil Corp. v. F.P.C., 417 U.S. 283,

328 (1974), that this is precisely the type proceeding

in which this issue should be addressed.

The Commission’s position rests primarily, if not

totally, on an erroneous reading of this Court’s opinion

in Federal Power Commission v. Texaco Inc., supra,

decided in the same term as Mobil, supra. The Com-

mission reads Texaco as precluding the use of the market

prices to determine the royalty component of producer

costs, even though by contract the amount of royalty

to be paid must be determined with reference to such

prices. Texaco not only does not require such a result,

it flatly holds that “market prices may be taken into ac-

count along with other factors” in determining producer

rates, 417 U.S. 380, 399.

7. Permian Basin Area Rate Cases, 390 U.S. 747 (1968);

Petitioner’s Brief, page 18.

8. The Commission has also refused to consider this issue on

a Petition for a Declaratory Order under Section 1.7(c) of the

Commission’s Rules (18 C.F.R. §1.7(c)), see Exxon Corporation,

Docket No. RI76-29, PIPL. , issued May 18, 1976, a

copy of which is attached hereto as Appendix A.

9. As the Fifth Circuit held in Placid, supra, there is no ques-

tion that “royalty obligations of the producers are cost components

of the rate structure”, 483 F.2d 880, 911. We do not understand the

Commission to contend otherwise.

9

In remanding the case to the Commission for rehear-

ing on the merits, the Court of Appeals did not require

the Commission to find for the producer. The Commission

was merely required to consider the merits of the pro-

ducers’ position, after giving them an opportunity, on a

reopened record, to attempt to prove their case. The

Commission is apparently unwilling to accept that re-

sult because it indeed believes that so many producers

are incurring such additional costs as to affect the

national average royalty figure, or that it cannot re-

fuse to provide individualized relief to many producers

if it ever fairly considers the issue (Brief, pp. 23-25).

The Commission did not consider the evidence of eco-

nomic hardship (i.e., costs versus revenues) in the re-

cord in arriving at its decision, as it concedes (Brief, p.

9). Therefore, the supporting arguments of counsel, to

the effect that Shell could still make a profit and pay the

higher royalty cost (p. 34), or the possibility that Shell

and Pennzoil may yet prevail in the State Court action

against the lessor (pp. 35, 36) need not be considered by

this Court, as they were not considered by the Com-

mission below.

On the alternative relief proposal for the granting of

abandonment authority on the percentage of the gas

attributable to the lessor’s interest, the Commission takes

the positic. that reversal by this Court of the Fifth

Circuit decision in Southland Royalty Co. v. F.P.C..,

543 F.2d 1134 (1976), in California v. Southland

Royalty Co., U.S._._., 98 S.Ct. 1955, 56 L.Ed.2d

505 requires reversal on this issue. While we concede

that the grounds on which the Court of Appeals reversed

the Commission are no longer present, this does not

mean the Commission can look only at one narrow facet

10

of the public convenience and necessity, ignoring all

other considerations affecting both producer and con-

sumer. The case should be remanded on this issue as

well, for a full consideration of all factors affecting the

public convenience and necessity.

ARGUMENT

I. The “Basic Principles Of Rate Regulation” Re-

quire, Rather Than Preclude, The Commission

To Hear The Petitions Of Shell And Pennzoil For

Special Relief On The Merits.

A. The Basis Of The Ccommission’s Decision.

On the question whether the producers are entitled to

a hearing on their Petitions for Special Relief, the Com-

mission’s decision rests on very narrow grounds. Those

grounds, set forth in Opinion No. 753, at pages 453 and

454 of the record (A. pp. 260, 261) and reiterated in

Opinion No. 753-A \A. pp. 291-293) are summarized

in the following sentence:

“The Commission does not have the power to base

a part of the regulated price [i.e., the royalty cost

component used to determine the regulated price]

on the unregulated market value of intrastate gas.”

(A. p. 293)

This is true, says the Commission’, even where, as

as in this case, the royalty cost component is not based

solely on the “unregulated market value of intrastate

gas” but is based on a number of other factors, including

10. Brief, pp. 4, 28.

11

the Commission’s ceiling rates'’, a desire to settle State

Court litigation which could result in even higher royalty

costs'*, and a desire to clear the cloud on title caused by

the Williams’ lawsuit, so that the lease could be further

developed to obtain additionai gas for United’s cus-

tomers. **

Conceding that royalty costs are only one component

of the producers’ ceiling rate, the Commission says that

this component cannot be used because it is based on

price which the Commission does not regulate.

The fallacy in th reasoning was exposed by the Court

of Appeals below."*

“Determination of the reasonableness of a cost

necessarily requires consideration of a market price.

In all probability, the reasonableness of a great

many costs of gas production must be determined

by the prevailing market price in an uncontrolled

market. The Commission has failed to suggest

why royalty costs in an uncontrolled market are any

— than any other cost.” (Op., p. 7a; Br.,

p.

The Commission attempts to justify its position on the

basis that the royalty costs are different from other un-

regulated costs because they are based on unregulated

gas prices (Br., p. 29). The short answer to the

Commission’s position is that Congress did not authorize

11. Appendix, pp. 44, 64, 65.

12. Brief, p. 4; Appendix, p. 56, 72-74, 119-121, 160-161.

i3. Appendix, p. 47, 48, 67.

14. The Court of Appeals’ Opinion appears as Appendix A to

the Petition for Certiorari. Pages of the Court of Appeals’ Opinion

are cited by the pagination in that Appendix, i.e., Op. p. la, etc.

12

it to regulate intrastate gas prices any more than it

authorized it to regulate the cost of steel drill pipe.

The Commission always has the power, specifically

recognized the Court of Appeals in the sentence preced-

ing the quoted language above (Op., p. 7a) to consider

the reasonableness of the cost occurred. The problem

here is that the Commission refuses to hold a hearing

where the reasonableness of such costs can be con-

sidered, because it is afraid it may indeed be forced to

find these costs to be reasonable (Br., p. 25).

This is not the first case in which the Commission

has considered unregulated intrastate prices in determin-

ing the reasonableness of producer rates. In Shell Oil Co.

v. F.P.C. (Other Southwest Area Rate Case), 484 F.2d

469 (5th Cir. 1973), cert. den. sub nom. Mobil Oil

Corporation v. F.P.C., 417 U.S. 973, the Court of Ap-

peals upheld the Commission’s consideration of intra-

state prices as “one of the relevant factors” in determin-

ing interstate rates, 484 F.2d 469, 479.

In the first national rate proceeding, the Commission

again considered a comparison of its rate structure

with intrastate prices and was sustained in so doing by

the Courts, Shell Oil Co. v. F.P.C., 520 F.2d 1061, 1083-

84 (Sth Cir. 1975), cert. den. sub. nom. California v.

F.P.C., 426 U.S. 941 (1976). The Court of Appeals

(Fifth Circuit) held that although the Commission could

utilize a comparison with intrastate prices, it could not

place “exclusive reliance” on suci prices in determining

the ceiling rate, citing this Court’s decision in Texaco,

supra.

In fact, the Commission has promulgated a special

form, Form No. 45, to collect intrastate pricing data for

13

use in determining producer rates, and successfully de-

fended this procedure in the Court of Appeals, see

Continental Oil Co. v. F.P.C., 519 F.2d 31 (Sth Cir.

1975), cert. den., sub nom. Superior Oil Co. v. F.P.C.,

425 U.S. 971 (1976).

B. The Holding Of F.P.C. v. Texaco Inc.®

The Commission’s conclusion quoted above rests prin-

cipally, if not totally, on its construction of Texaco. A

careful examination of that decision is therefore war-

ranted.

In Texaco, the Commission attempted to effectively

“deregulate” small producers'® (417 U.S. at 383), by

exempting them from all filing requirements and rate

ceilings prescribed in the Natural Gas Act and the Com-

mission’s Rules for other producers, and to place the

burden on the pipeline purchaser of such producer not

to pay an “unreasonable” rate, on the penalty of having

a portion of their purchased gas cost component in the

pipeline cost-of-service disallowed in a future pipeline

rate case.*’

15. 417 U.S, 380, 94 S.Ct. 2315, 41 L.Ed.2d 141.

16. “Small producer” was defined as an independent producer,

unaffiliated with a natural gas pipeline company, whose total juris-

dictional sales did not exceed 10,000,000 Mcf per year, 417 U.S.

at 383, 45 F.P.C. 454.

17. Although the Texaco opinion speaks throughout of purchases

from small producers by large producers, as well as by gas pipelines,

the burden of the indirect regulation fell almost entirely on the

pipelines, not the large producers. Both large and small producers’

normally sell gas to interstate pipeline companies, which are regu-

lated on an individual company cost-of-service basis by the Com-

mission. Interstate pipelines are the only purchasers who are entitled

to recover a “cost of purchased gas” on a cost-of-service basis.

Large producers operate gas processing plants in some areas of the

14

The Commission’s Order was challenged in the Court

of Appeals by pipeline companies (Tennessee Gas Pipe-

line Company, the Independent Natural Gas Association

of America (an association of pipelines) and Consoli-

dated Gas Supply Corporation), large producers (Texaco

Inc., Phillips Petroleum Company and Warren Petroleum

Company), the Public Service Commission of New York,

(representing the consumer interest), and one small

producer, James Forgotson, Sr. The D.C. Circuit held

that the practical effect of the Commission’s Order was

to exempt one class of producers from regulation, which

it had no authority to do, and reversed the Commission,

Texaco Inc. v. F.P.C., 474 F.2d 416 (1972).

This Court reversed the Court of Appeals and sustained

the Commission on the question whether the Commis-

sion had the power to indirectly regulate the small pro-

ducers by regulating the rate of the pipeline purchaser

(417 U.S. at 387-393), but affirmed the Court of

Appeals’ conclusion that the Commission could not

relieve the small producer from his obligation under the

Natural Gas Act not to sell his gas in interstate com-

merce at more than the just and reasonable rate (417

U.S. at 394).

The Commission contended that its Order No. 428 did

require 2 finding that the small producers’ rate was “just

country, notably the Texas Panhandle and Permian Basin, where

they purchase gas from small producers in the field and resell the

gas to an interstate pipeline at the plant tailgate after removing

the liquid hydrocarbons. As large producers are not regulated on

an individual cost-of-service basis, continuation of these plant opera-

tions depends on the Commission’s permission to sell the gas to

the interstate pipeline at a rate at least equal to the rate they are

permitted to pay the buyer. But in no sense is the small producers’

sale price considered a “cost” for rate purposes in determining the

large producers’ rate.

15

and reasonable”, because it required the pipeline pur-

chaser to reduce its sales price to exclude that portion of

the small producer price “which is unreasonably high con-

sidering appropriate comparisons with higher contract

prices for sales by large producers or the prevailing

market price for intrastate sales” (417 U.S. at 396).

Upon consideration of this language in the Order, this

Court concluded that the only basis for a determination

of the “reasonableness” of the price was a comparison

to the marketplace standard. Assertions by Commission’s

counsel that the Commission would consider other “rela-

vant factors” were rejected as post hoc rationalizations

of counsel, see 417 U.S. at 397, citing Burlington Truck

Lines v. United States, 371 U.S. 156, 168-169 (1962)

and S.E.C. v. Chenery Corp., 332 U.S. 194, 196 (1947).

Significantly, this Court said at that point in the Opinion:

“Had the order unambiguously provided what the

Commission now asserts it was intended to provide,

we would have a far different case to decide.” (417

U.S. at 397). (n. omitted)

Then appears the language quoted by the Commission

and relied on at page 20 of its Brief. The Commission’s

error lies in reading this language, in which the Court

clearly states that the market price cannot be the “final

measure” (417 U.S. at 397) or the “conclusive” determi-

nant (417 U.S. at 399) or the “exclusive reliance” (417

U.S. at 400) as meaning that the Commission cannot

utilize or rely at all on market prices for any cost com-

ponent of the total rate permitted to be charged by the

producer, even though it retains the power to examine

this cost component for reasonableness, and even though

this cost component is determined in part with reference

16

to other factors, and even though many other considera-

tions enter into the final rate determination.

The Commission's interpretation is clearly foreclosed

by the following language by the Court:

“This does not mean that the market price of gas

would never, in our individual case, coincide with

the just and reasonable rates or not be a relevant

consideration in the setting of area rates, see,

Permian Basin Area Rate Cases, 390 U.S. at 793-

795; 20 L.Ed.2d 312; it may certainly be taken into

account along with other factors, Southern Louisiana

Area Rate Cases, 428 F.2d 407, 441 (CA 5) cert.

denied, sub nom. Associated Gas Distributors v.

Austral Oil Co., 400 U.S. 950, 27 L.Ed.2d 257,

91 S.Ct. 241 (1970).” (417 U.S. at 399) (Em-

phasis supplied).

In this case, the settkement which the Commission was

asked to approve did not place “exclusive reliance” on the

intrastate market price as a determinant of the royalty cost

to be flowed through to the pipeline. The price on which

the royalty percentage would be based was 78 cents per

Mef plus an escalation of 1.5 cents per Mcf per year, or

150 percent (later reduced to 100%, see Pennzoil’s Bric!

in Opposition to Petition for Certiorari, p. 4, n. 4) of the

applicable ceiling rate determined by the Commission,

whichever was higher. If the Commission in a later pro-

ceeding increased the ceiling rates (31.11 cents and 59.88

cents in 1975, Br., p. 4) applicable to this sale, above

the 78-cent level, then the Commission’s ceiling rate would

control without any reference to the intrastate market

price. More importantly, if the intrastate market price

increased above 78 cents, plus 1.5 cents per year, the

royalty would still be based on the 78-cent price. Accord-

17

ing to the evidence in the record, this has in fact occurred.

In the State Court action Williams was contending the

market price had reached $1.40 per Mcf by January 1,

1975 (A., p. 44). Mr. Lamar Smith, witness for the

purchaser, United Gas Pipe Line Company, testified that

by July 1975 the unregulated market price in South

Louisiana was “well above $1.50” per Mcf (A., p. 56).

Mr. Smith cited a number of contracts which his company

had entered into in this area for non-jurisdictional gas at

prices ranging from $1.0804 per Mcf to $1.5786 per Mcf

(A., pp. 57, 58). The most recent publication by the

Commission shows the average new contract price in

Southern Louisiana to be $1.949 per Mef for the first

quarter’® of 1978. It is readily apparent that the 78-cent

price is a compromise figure arrived at to settle a lawsuit,

and is not based entirely on unregulated prices.'®

C. Other “Basic Principles Of Rate Regulation”

Require Affirmance Of The Court Of Appeals.

One of the most basic principles of rate regulation is

that the regulated company be afforded some forum to

show the reasonable costs which it has incurred, and if

the rate to be charged is to be based on costs as the

Commission has insisted, that some adjustment or pro-

vision be made for the recovery of those costs. In making

this assertion, Shell is not arguing the merits of an indi-

Py Publication is attached hereto as Appendix B, see pp. 22, 23

infra.

19. Contrary to the Commission’s implication (Br., pp. 21-22),

the price on which the royalty is calculated under the settlement

with the royalty owners, 78 cents plus 1.5 cents annual escalations,

does not “fluctuate” with further increases in the intrastate market

price. This is the principal advantage when Sheil and Pennzoil, as

well as United and its customers, derive from the settlement.

er er we omece eee

18

vidual company or individual project cost basis for rates

as opposed to area or national rates, as the Commission

implies (Br., p. 33). The point is, that the Commission

has already expressly refused to consider this type of cost

in area and national rate proceedings, and its refusal has

been affirmed by the Court of Appeals and this Court,

Placid Oil Co. v. F.P.C., 483 F.2d 880, 910-911 (Sth

Cir. 1973), affirmed Mobii Oil Corp. v. F.P.C., 417 US.

283, 328; Opinion No. 749-C, ___. F.P.C. ___., issued

July 19, 1976, slip opinion, p. 27 affirmed Tenneco Oil

Co. v. F.E.R.C., 571 F.2d 834, 848 (Sth Cir. 1978);

Opinion Nos. 699 and 699-H, 51 F.P.C. 2212, 2272, 52

F.P.C. 1604, affirmed Shell Oil Co. v. F.P.C., 520 F.2d

1061, 1068, cert. den. sub nom. California Co. v. F.P.C.,

426 U.S. 941 (1976).

Having made the decision not to consider the question

of additional royalty costs incurred by producers in an

area or national rate decision, if the Commission has no

power to consider the question in a proceeding for indi-

vidualized relief as it insists, the producer is left without

any proceeding at all in which this issue will be con-

sidered.

The error of the Commission’s position is made even

clearer by reference to the language used by this Court,

and by the Fifth Circuit, in affirming this Commission’s

earlier decision not to consider this issue in an area

rate case. This Court said:

“We agree with the Court of Appeals that Mobil’s

argument is hypothetical at this stage and that in

any event an affected producer is entitled to seek

individualized relief. The Court of Appeals said:

‘ .. . we are not willing to alter or stay the

implementation of area wide rates for the entire

19

industry merely on the basis of what might hap-

pen to some producers’ costs if the [D. C. Cir-

cuit’s} statement of the law prevails.

‘If, as subsequent events develop, the producers

are put in a bind by their royalty obligations, they

may certainly petition FPC for individualized re-

lief. Permian contemplated it.’ 483 F.2d, at 911

(italics in original).” 417 U.S. at 328)

The Commission's attempt to avoid the clear instruc-

tion of this Court in Mobil is difficult to follow and im-

possible to understand (Br., pp. 30-32). The Commis-

sion launches into a discussion of whether the special

relief should be granted in the hearing for individualized

relief ordered by the Court. The fallacy in that discus-

sion is that in this case, no such hearing has ever been

held. The truncated and high pressure proceeding’ which

the Commission ordered on this issue was disregarded by

the Commission in reaching its decision, because it found

it had no jurisdiction even to consider the issue (Br., p.

34). All the Court of Appeals did was remand this issue

to the Commission for a decision on the merits (Op., A. p.

8a). The Court is not being asked to review a decision

by the Commission on the merits of the question whether

the producers have incurred a cost which is unreasonable

and should not be flowed through to the pipeline. The

Court is instead being asked by the Commission to find

that it has no jurisdiction to hold a hearing to determine

whether these costs are unreasonable or not! The Court

of Appeals was clearly correct in remanding the case to

the Commission for consideration of this issue.

20. The nature of the hearing before the Commission is discussed

further at pages 23, 24, infra.

20

D. The Record Shows That Without The Relief

Requested, Shell’s Leases Will Be Confiscated.

Although conceding that the Commission's decision

rested entirely on jurisdictional grounds (Br., p. 34),

Petitioner proceeds to make three further arguments

against Shell’s position. These are: (i) there is no reason

to impose a higher rate on consumers because of an im-

provident contract made by Shell and Pennzoil (Br., p.

22, n. 12); (ii) Shell could absorb the higher royalties

and still make a profit on its leases (Br., pp. 7-8, 34);

and (iii) Shell and Pennzoil may prevail in the State

Court litigation against the lessor, so the Petition for

Special Relief is premature and possibly unnecessary. (Br.,

pp. 35-36). We will answer these points seriatim.

1. Shell’s Lease Contracts Are Not “Unreason-

able” Or Improvident.

At several places in its Brief (pp. 18, 22, n. 12), the

Commission refers to the rule that it is not required to

flow through a producer cost which results from an “ex-

cessive or unreasonable” (p. 18) contract made by the

producer. As the Commission has made no such finding,

this argument cannot support reversal of the Court of

Appeals’ decision directing the Commission to hold a

hearing to address this very question (Op., A. p. 7a).

However, a short discussion of the issue is appropriate in

light of the Petitioner’s implication.

If Shell were to enter into these lease contracts today,

with the knowledge of the decisions set out in the State-

ment, supra, it could well be contended that the con-

tracts were improvident and it must absorb any addi-

21

tional costs resulting therefrom.*' But the leases in-

volved here were entered into on August 29, 1934, be-

fore the Natural Gas Act was passed, and July 24, 1952,

before this Court’s decision in Phillips v. Wisconsin, 347

U.S. 672 (1954). Shell had no reason to suspect at the

time these leases were obtained, that the royalty per-

centage set out in those leases would be calculated on

any price which would be different than that price received

for the sale of the gas, despite the use of the terms “mar-

ket value” and “market price”. The royalty percentages

(1/8th and 1/4th) conformed with the industry practice

in the area at the time, and were necessary in order to

purchase the leases. On these facts, it is apparent that

any holding by the Commission that the royalty pro-

visions of these leases were “excessive or unreasonable”

would be arbitrary and capricious.

2. If The Requested Relief Is Denied, Shell

Faces Confiscation Of Its Leases.

The Commission would lead the Court to believe that

Shell can absorb the additional royalty required to be

paid if it loses the State Court case with the lessor, and

still make a profit on these leases (Br., pp. 7-8, 34).

This is incorrect.

The $290,000 annual profit figure calculated by the

Administrative Law Judge is based on the 78 cents per

Mcf price in the settlement agreement. If the Commis-

sion denies the relief requested, there is no settlement,

and Shell must proceed with the State Court action

21. Except in. the case of leases from State or Federal Govern-

ments, where the lease forms are prescribed by law.

22

against the lessor. If the lessor prevails, the royalty

will be based on current intrastate prices.

The royalty owner contended that the market value,

based on intrastate price in 1975, was $1.40 per Mcf

(A. p. 137). If the royalty owner’s position prevails

in the State Court, Shell would be required to pay

out as royalty 35 cents per Mcf under the 1952

lease. The record establishes that Shell would owe

5.25 cents per Mcf to the State of Louisiana for sever-

ance taxes, and incur 4.5 cents per Mcf as operating

costs, which were uncontested by any party and ac-

cepted by the Law Judge (A. 137-138, 178). The

revenue realized by Shell under Commission ceiling

rates on the 1952 lease was 41.6 cents per Mcf. Thus,

Shell would lose 3.15 cents for each Mcf of gas pro-

duced from this lease, should the lessor prevail (A. 137).

The royalty cost will increase as the “market value”

of the gas increases. According to the recent report issued

by the Office of Pipeline and Producer Regulation in May

1978,** the average price received in Louisiana for new

intrastate contracts for the first quarter 1978 was $1.949

per Mcf, and the highest new contract price was $2.14 per

Mcf. Therefore, there is basis for a finding by the State

Court that the “market value” or “market price” is cur-

rently $1.95 per Mcf. Under Texas Oil & Gas Corpora-

tion v. Vela, 429 S.W.2d 866, 871 (Tex. Sup. Ct. 1968),

the “market price” to which the royalty is applied is

22. A copy of the press release, cover sheet, and the page

dealing with Louisiana intrastate prices, are attached hereto as

Appendix B.

23

determined on the day the gas is delivered to the pur-

chaser, not the time the contract is entered into.

The Law Judge included $112,664 annual condensate

revenues as an offset against operating costs (A. 179).

These revenues would ve more than offset by the

damages owed to lessor for failure to pay past royalties

based on market prices. While these damages cannot be

quantified down to date, as of April 30, 1975 they were

$197,689.49, assuming the lessor prevails in the State

Court case (A. 68). For the period after April 30, 1975,

these damages would be substantially higher, because of

the rapid escalation in intrastate prices.

We would note again that the cost-revenue comparison

shown above involves only current operating costs, and

contains no allowance for amortization of capital in-

vestment, return on that investment, or federal income

taxes. This is not because such costs were not incurred

by Shell - obviously, wells had to be drilled to produce

the gas in question. Instead, this was a result of the

manner in which the hearing was conducted by the

Commission. Initially the Commission denied Shell's

Petition for Special Relief summarily, and ordered a hear-

ing only on the abandonment issue (A. 32-36). Applica-

tions for Rehearing were filed, and on the day Shell’s

counsel appeared at the hearing he was advised that

the Commission had reversed its position and ordered

a hearing on the special relief question also (A. 37-

39). Shell was given a sharply limited time period within

which to file cost evidence, because the hearing was >Seing

held on an expedited basis. Because these leases are in-

cluded in ten separate units invoiving other owners

and other lands, which differ in configuration due to

24

the reservoir involved, the cost calculation is extremely

complex (see tabulations and map at A. 151-155). There

simply was not time to develop a cost study showing

capital investment, return, income taxes, etc. (A. 69-

71) applicable to these leases and their share of the

respective units.

Moreover, the Commission gave no clear direction of

what cost evidence it desired, or what use, if any, it

would make of such evidence.** The Commission’s con-

vening orders merely refer to “overall costs higher than

those set forth in Opinion 699-H” (A. 34, 37) without

indicating whether these costs are to be computed on a

lease, company, area, or national basis. In response to

a specific question, Staff counsel was equally ambiguous

(A. 70). Faced with this uncertainty, Shell used the

nationwide costs used by the Commission in Opinion

No. 699-H, substituting the specific lease costs for operat-

ing expenses and royalty developed on this record.”*

These studies showed total costs substantially above

revenues for both leases, even considering the liquid

revenue credit (A. 139-140). This approach was rejected

by the Law Judge (A. 177-178).

Before the Commission can reject Shell’s Petition for

Special! Relief on a cost basis, Shell is entitled to the

reasonable opportunity to present cost evidence after

being informed what type of evidence is required.

23. The Commission’s final order disregarded the record entirely.

24. This method had been approved by the Commission in other

cases as an acceptable way of determining costs, see Order No. 455,

affirmed Moss v. F.P.C., 502 F.2d 461 (D.C. Cir. 1974), affirmed

F.P.C. v. Moss, 424 US. 494 (1976).

Se ee

25

3. If The State Court Settlement Is Destroyed

By Refusal Of The Commission To Grant

Relief, There Is Substantial Risk That

The Lessor May Prevail.

We agree with the Commission that thc State Cou-ts

of Louisiana have not resolved the question whether

under a “market value” lease the lessor is limited to a

royalty based on the price received by the lessee for the

gas (Br., p. 5, n. 4).*° The Huber and Weymouth cases

discussed supra, page 3, hold for the lessor. In Texas

Oil & Gas Corporation v. Vela, supra, the Texas

Supreme Court resolved the issue squarely in favor of

the lessor, see also Butler v. Exxon Corp., 559 S.W.2d

410 (Tex. Civ. App.—El Paso 1977); Kingery v. Con-

tinental Oil Co., 434 F.Supp. 349 (W.D. Tex. 1977);

Brent v. Natural Gas Pipeline Co. of America, —__F.

Supp. (N.D. Tex., Civil Action No. CA-2-75-167,

August 1978).

The issue was also resolved in the lessor’s favor by

the Supreme Court of Kansas in Lightcap v. Mobil Oil

Corp., 221 Kan. 448, 562 P.2d 1 (1977), cert. denied

Mobil Oil Corp. v. Lightcap, 434 U.S. 876, petition for

rehearing pending, Case No. 76-1694.

Therefore, while the issue has not been resolved in

Louisiana, the lessor has prevailed on this issue in Texas

and Kansas, two major gas producing states, and also

in the United States Court of Appeals for the Fifth

Circuit. It therefore cannot be said that there is no merit

to the lessor’s position.

25. Whitehall Oil Co. v. Boagni, 255 La. 67, 229 So.2d 702,

704-05 (1969) does contain dicta favorable to the lessee’s position.

However, as the Commission concedes, this was not the issue de-

cided by the Court.

26

lil. The Case Should Still Be Remanded To The

Commission On The Abandonment Issue, Even

Though The Fifth Circuit’s Southland Decision

Has Been Reversed.

A. What Does The “Public Convenience And

Necessity” Require?

Section 7(b) of the Act, quoted by the Commission

at page 38, prohibits abandonment of service unless the

Commission finds “that the public convenience and

necessity permit such abandonment”. In support of its

position that the public convenience and necessity favored

abandonment as to the lessor’s percentage share of the

gas stream, Shell made the following arguments:

1. Should the lessor prevail in his State Court

action, Shell was faced with the loss of its lease,

including its entire capital investment, rights to

future production, and liability in damages for prior

underpayment of royalties, either by order of the

court for breach of contract, or by the establishment

of a royalty which was so high as to make further

operation of the lease uneconomic, therefore caus-

ing expiration of the lease by its terms. This would

amount to confiscation of Shell’s leasehold estate

by regulatory action.

2. Should the lessor prevail, and Shell’s leases

terminate, the entire gas stream, not merely one-

eighth (1/8th) of one-fourth (1/4th) of the gas,

would be lost to United and the interstate comsumer.

3. Assuming arguendo that Shell is in error on

Point 2, United Gas Pipe Line Company and its

~ .

27

interstate customers would still suffer a detriment

if Shell’s leases are terminated, though:

(a) Loss of additional gas supplies obtained

by additional wells planned by Shell and Pennzoil

which would never be drilled.

(b) Higher prices paid to the lessor because

of his status as a small producer, and the rate

structures adopted by the Commission.

The Commission did not address Shell’s first and third

contentions in either of its Opinions, its Briefs to the

Court of Appeals, or its Brief here. It dealt only with the

second issue, relying on its decision in El Paso Natural

Gas Co., Opinion No. 737. As the Commission explains

(Br., pp. 37-41), the Fifth Circuit reversed this decision

in Southland Royalty Co. v. F.P.C., 543 F.2d 1134

(1976), and relied on that reversal to reverse the Com-

mission below (Op., p. 9a). Shell concedes that the

grounds for reversal relied on by the Court of Appeals

was wiped out by this Court’s opinion in California v.

Southland Royalty Co., __.. U.S. ___ 98 §.Ct. 1955, 56

L.Ed.2d 505 (1978). But this does not mean that the

case should not be remanded to the Commission on the

abandonment issue as well.

B. The “Investor” Interest Is Entitled To

Some Consideration.

The statutory determination whether abandonment is

in “the public convenience and necessity” rests on a

broader base than merely the question of whether failure

to grant abandonment could occasion loss of the entire

gas stream to the interstate market. All major decisions

28

by this Court enjoin the Commission to consider the “end

results” of its actions, and to “balance both investor and

consumer interests”, see F.P.C. v. Hope Natural Gas Co.,

320 U.S. 591, 603 (1944); Permian Basin Area Rate

Cases, 390 U.S. 747, 770 (1968); Mobil Oil Corp. v.

F.P.C., 417 U.S. 283, 307 (1974); F.P.C. v. Texaco, 417

U.S. 380, 388-389 (1974).

If the “end result” of the Commission’s action in deny-

ing abandonment is complete destruction of the investor

interest, it is difficult to see how that interest has even

been considered, much less balanced against the con-

sumer interest. The granting of abandonment on the

lessor’s interest merely means that this gas will be sold

on the intrastate, rather than the interstate market. There

is no finding, or any basis for a finding, that public policy

favors the interstate consumer over the intrastate

consumer.

As discussed at page 22, supra, on one of Shell's

two leases the total revenue is already exceeded by oper-

ating expenses, State taxes, and lessor’s royalty, if the

lessor prevails in the State Court. If the trend in increas-

ing market prices continues, the other lease will shortly

be in this posture. There is no question that affirmance

of the Commission will place Shell squarely at the mercy

of the State Court action against the lessor. This Court

has held that the Commission cannot fix confiscatory

rates, California v. Southland Royalty Co., U.S. ,

98 S.Ct. 1955, 56 L.Ed.2d 505, slip opinion p. 8;

F.P.C. v. Natural Gas Pipeline Co., 315 U.S. 575 (1942);

F.P.C. v. Hope Natural Gas Co., 320 U.S. 591, 602-

603 (1944).

fitmie a >

29

C. Where Lies The “Consumer” Interest?

The Commission concludes that under this Court’s

opinion in California v. Southland Royalty Co., supra,

should Shell’s lease terminate the lessor will be required

to continue the sale to United Gas Pipe Line Company,

and therefore its inquiry into the merits of abandonment

is at an end. The Commission has not considered, and if

affirmed by this Court will never consider, the impact

on the consumer that would result from the termination

of Shell’s lease.

This Court in Southland found that the service obliga-

tion to continue the sale of gas in interstate commerce

continued until the Commission granted abandonment,

even though the leasehold estate had terminated. But it

did not hold that the lessor was bound by the contract to

sell gas entered into by the lessee. Indeed, the thrust of

the Court’s opinion is that the service obligation con-

trolled over private contractual arrangements. At page 7

of the slip opinion, the Court said:

“ _.. [T]he Act is concerned with the continuation

of ‘service’ rather than with particular sales of gas

or contract rights.”

Therefore, as we read Southland, the lessors would

be obligated to continue the sale to United, but would

not be bound by the contract entered into between Shell

and United. Thus, the lessors would be entitled to enter

into a “replacement contract” with United. Under the

rate structure set up by the Commission in Opinion No.

699-H** and reaffirmed in Opinion No. 770-A, affirmed

26. Affirmed Shell Oil Co. v. F.P.C., supra.

30

American Public Gas Asvociation v. F.E.R.C., 567 F.2d

1016 (1977), cert. den., US. , 55 L.Ed.2d 499,

the ceiling applicable to this “replacement contract” would

be the 59.88-cent rate authorized in Opinion No. 699-H

(A. 42, 67). Thus, instead of paying the prices paid to

Shell under present ceilings of 39.0 cents on the 1934

lease (A. 136) and 41.6 cents on the 1952 lease (A.

136). United’s customers would have to pay 59.88 cents

per Mef for the entire gas stream.

There is a strong probability that the lessor could

qualify for an even higher rate. In Order No. 568 issued

July 14, 1977, __F.P.C.__, the Commission held that a

“small producer”” was entitled to a higher just and

reasonable rate than a large producer, specifically 130

percent of the base ceiling rate established in Opinion

No. 699, et seg. (18 C.F.R. 157.40(c) (1)). Therefore,

if the Williams qualify as “small producers” they will be

entitled to a ceiling rate of 74.96 cents (52¢ x 130% =

67.6¢, plus Btu and tax adjustments of approximately

7.36¢) for the entire gas stream.** Thus, the consumer

will suffer substantial price increases if Shell’s leases

terminate, because of the different rate structures estab-

lished by the Commission.

Nor is it likely that the consumer will suffer any de-

crease in supply if abandonment is granted on the

lessor’s interest. While the percentage of the current

production going to the interstate consumer (but not

the overall market, as the intrastate consumer would re-

ceive these supplies) would te decreased by one-e.ghth

27. Defined as a producer selling less than ten million Mcf

per year in interstate commerce.

28. This compares with 42.6¢ and 50.6¢ per Mcf paid to Shell

if the special relief were granted, A. 136.

ee ae

31

(1/8th) and one-fourth (1/4), respectively, the total!

supply of the gas is likely to increase. This is true because

both Shell and Pennzoil have indicated additional wells

may be drilled on these leases if this litigation can be

resolved in accordance with the terms of the settlement

with the lessor (A. 47, 48, 67). There is no evidence that

the lessor has the capital, or the inclination, to do any

additional driiling. If Shell and Pennzoil are allowed to

proceed with their plans free of the cloud created by

this litigation, it is likely that the supply of gas to the

interstate consumer may be increased, not decreased.

On this issue also, this Court’s review is premature

because the Commission never considered the impact of

denying abandonment on the producers, the intrastate

consumers, or the interstate consumers. It considered

only the narrow question whether this gas must continue

to be sold in interstate commerce if Shell’s and Pennzoil’s

leases terminated. The case should be remanded to the

Commission on the abandonment issue also, with in-

structions to consider all aspects of the “public con-

venience and necessity”.

CONCLUSION

This case is prematurely before this Court, as the

Commission has not considered either of the two types

of relief requested on the merits. There is no prohibition,

either in the Act or this Court’s Texaco decision which

preclude this consideration by the Commission. The

32

Court of Appeals’ decision remanding this case to the

Commission should be affirmed.

Respectfully submitted,

/8/ Tomas G., Jounson

“Thomas G. Jounson

erat for

SHELL OIL COMPANY

October 5, 1978

eT

Al

APPENDIX A

UNITED STATES OF AMERICA

FEDERAL POWER COMMISSION

DECLARATORY ORDER—ROYALTY

Before Commissioners: Richard L., Dunham, Chairman;

Don S. Smith, John H. Hollo-

man III, and James G. Watt.

Exxon Corporation Docket No, R176-29

ORDER GRANTING INTERVENTION AND

RESPONDING TO PETITION FOR A

DECLARATORY ORDER

(Issued May 18, 1976)

On September 18, 1975, Exxon Corporation (Exxon)

filed a petition for declaratory order pursuant to Sections

4, 7, 14, and 16 of the Natural Gas Act' and Section 1,7

(¢) of the Commission's Rules of Practice and Proce-

dure.” The petition requests the Commission to answer

certain questions, hereinafter discussed, which relate to

pending litigation between Exxon and certain lessors re-

garding the sale of natural gas in interstate commerce for

resale, 27 parties filed petitions to intervene ( Appendix

A) and 9 parties filed untimely petitions to intervene

(Appendix B),

Exxon's question and our answers are as follows:

1. 18 U.S.C. $8 717e, f, m and o.

2. 18 CPLR. § 1.7 (e),

A-2

1, Will the Commission declare that its applicable

just and reasonable ceiling rates, or a producer's effective

rate, are the “market prices” for purposes of meeting

royalty obligations under leases from which gas is pro-

duced and sold in interstate commerce?

The Commission's jurisdiction over royalty payments

by producers to lessors was rejected by the Court in

Mobil Oil Corporation vy. F.P.C., 463 F.2d 256 (D.C,

Cir. 1972), cert, den'd, 406 U.S. 976 (1976). The Court

held that although the Commission had jurisdiction over

rates charged by a producer, it had no jurisdiction over

the rate utilized in computing the royalty payment. Ac-

cordingly, the above contract question posed by Exxon

would be one for the appropriate court to decide, The

court in Mobil mentioned the possibility that, “(T]he

court handling the contract clause could avoid becoming

embroiled in the ascertainment of the Federal ceiling by

referring the issue to the FPC.” (Mobil at 265), How-

ever, as intervenors Jane Alida Baugh Beard ef al. have

correctly pointed out, it is only upon proper reference

from the court handling such a contract clause that we

could become involved, to any extent, in the contract

issue, That not being the case here, we decline further

comment.

2. Will the Commission allow the automatic adjust-

ment of a producer's applicable ceiling rate when that

producer shows that it is required to pay a royalty to its

lessor(s) on a basis higher than such applicable just and

reasonable rate?

Recently, in Opinion No, 753° we discussed this issue

5. Pennzoil Producing Company and Shell Oil Company, Opinion

No, 758 (Issued January 30, 1976); Opinion No, 753-A (Issued

February 27, 1976); Opinion No, 753-B (Issued March 26, 1976),

ee

A-3

in the context of a proposed settlement agreement. re-

garding royalty payments between the lessors-royalty own-

ers and lessees-producers, We stated there that a producer

is always at liberty to compute royalty payments on the

basis of a rate in excess of the ceiling rate, but that if he

“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,” (Opinion

No. 753 at 6). We held that incremental royalty costs

could not be based on any other factors than the just and

reasonable rate, citing F.P.C. v. Texaco.’ The foregoing

discussion was specifically with reference to the proposed

settlement agreement therein in issue. As we noted in both

Opinion Nos, 753-A and B, our conclusions were not

based upon the existence of a state court judgment and

our reference in Opinion No. 753 at page 7 to such judg-

ments is indeed dicta,

In light of our response to this question, additional

comments on questions 3 and 4 are unnecessary,

5. If the answers to questions lythrough 4, above are

“No”, will the Commission permit the abandonment of

the fractional portion of gas reserves dedicated to a con.

tract attributable to the royalty interest in the event than

the lessee-producer is required to pay royalties on a basis

higher than the just and reasonable ceiling rate applic-

able to such gas?

This precise issue was raised in connection with the

alternative application for abandonment filed by Penn-

zoil and Shell in Opinion 753, In that case we denied the

request for abandonment finding neither that the gas sup-

ply had been depleted to the extent that the continuation

4, FPC v, Texaco, Ine., 417 US. $80 (1974)

A-4

of service was unwarranted or that the present or future

public convenience or necessity required authorization

of abandonment. We will not permit abandonment of the

royalty gas merely because a producer is required to pay

royalties on the basis of a rate above that which the pro-

ducer is entitled to collect under the Natural Gas Act.

The Commission orders:

(A) Good cause exists to grant intervention in these

proceedings to those parties listed in Appendix A and B,

subject to the rules and regulations of the Commission;

Provided, however, that participation of such intervenors

shall be limited to matters affecting asserted rights and

interests as specifically set forth in the petitions to inter-

vene; and provided, further, that the admission of such

intervenors shall not be construed as recognition by the

Commission that they might be aggrieved because of any

order of the Commission entered in these proceedings.

(B) The questions raised in Exxon's petition are

answered in the text of this order.

By the Commission,

(SEAL)

Kenneth F, Plumb,

Secretary

A-5

Docket No. RI76-29 APPENDIX

Shell Oil Company

Mobil Oil Company

The California Company, Division of Chevron Oil

Company

Chevron Oil Company, Western Division

Amerada Hess Corporation

Phillips Petroleum Company

Tenneco Oil Company

Pennzoil Producing Company

Texaco, Ine,

Continental Oil Company

Atlantic Richfield Company

Jane Alida Baugh Beard, er ai.

Michigan Wisconsin Pipe Line Company

United Gas Pipe Line Company

State of Louisiana

LaGloria Royalty Owners Association, Inc.

Enserch Corporation, Inc.

Natural Gas Pipeline Company of America

Gulf Oil Corporation

Tennessee Gas Pipeline Company

Austral Oil Company, Inc.

General American Oil Company of Texas

Ada Resources, Inc,

Crystal Oil Company

Inexco Oil Company

Estate of E, Cockrell, Jr., Deceased, et al.

Perry R. Bass, Inc.

ee

A-6

Docket No. R176-29 APPENDIX B

William M. Fuller

Damson Oil Corporation

Cities Service Oil C ompany

Northern Natural Gas Company

Union Oil Company of California

Burmah Oil and Gas Company. Burmah Oil Develop-

ment, Inc. and Signal Petroleum

Amoco Production C ompany

Getty Oil Company

Marathon Oil Company

B-1

APPENDIX B

DEPARTMENT OF ENERGY

FEDERAL ENERGY REGULATORY COMMISSION

NEWS RELEASE WASHINGTON, D.C. 20426

(SEAL) IMMEDIATE RELEASE

June 13, 1978 FE-316

FERC RELEASES SUMMARY OF INTRASTATE

NATURAL PRICES FOR FIRST QUARTER 1978

The Federal Energy Regulatory Commission today

released a staff report summarizing prices which natural

gas producers subject to FERC regulation received for

intrastate gas sales contracted for during the first quarter

of 1978.

The average price for new contracts was $1.78 per

thousand cubic feet in the first 1978 quarter, compared

with $1.85 for the previous quarter. Prices ranged from

75 cents per thousand cubic feet in Oklahoma to $2.30

in Texas.

Prices for renegotiated or amended contracts in the

first 1978 quarter averaged $2.03 per thousand cubic

feet, compared with $1.79 for the previous quarter.

Average prices ranged from 43 cents to $2.53, both in

Texas.

The report covers independent natural gas producers

with more than one billion cubic feet of annual juris-

dictional sales. This is the tenth summary issued since

the Commission’s January 1975 order (No. 521) estab-

lishing a new form (No. 45) for collection of this data.

In view of the interest in recent natural gas sales at

or above $1.75 per thousand cubic feet. this report in-

cludes percentages of volumes contracted at this price or

B-2

higher. These percentages are 59 percent for all new

contract volumes, and 92 percent for renegotiated or

amended contract volumes.

Form 45 reports were filed by 80 producers represent-

ing 414 intrastate contracts executed during the first

quarter. The data excludes contracts having terms of less

than one year, contracts for percentage sales and con-

tracts not reporting volumes.

Individual Form 45 reports were found by the U.S.

Court of Appeals for the Fifth Circuit to contain pro-

prietary information which the Court said must not be

made public. The report issued today therefore contains

only aggregated data in compliance with the Court’s

decision.

The entire report, which includes summary tables by

state and pricing area, accompanies this news release.

-FERC-

For further information

call, Stephen P. Siegel, 275-4006

(Area Code 202)

: ee ets

]

B-3

FEDERAL ENERGY REGULATORY COMMISSION

INTRASTATE NATURAL GAS PRICES

OF FERC JURISDICTIONAL NATURAL GAS

COMPANIES SELLING MORE THAN

ONE MILLION MCF PER YEAR

IN INTERSTATE COMMERCE

SUMMARY BY STATE AND FERC

GAS PRICING AREA, JANUARY,

FEBRUARY, MARCH 1978

OFFICE OF PIPELINE AND PRODUCER

REGULATION STAFF REPORT

Washington, D.C.

May, 1978

B-4

Louisiana

NEW CONTRACTS

¢/Mcf

January February March January-

March

High 214.00 180.37 199.26 214.00

Average 194.38 180.37 198.62 194.90

Low 165.00 180.37 178.43 165.00

% Contract

~ olumes

Sold Between

201 - 250¢ 16.5 14.0

151 - 200 83.5 100.0 100.0 86.0

101 - 150

51 - 100

0 - 50

Contract

Volumes Mcf_ 14,516,400 110,000 2,447,500 17,073,900

RENEGOTIATED OR AMENDED CONTRACTS

High 218.63 212.85 182.35 218.63

Average 202.88 181.40 182.35 186.74

Low 127.45 155.36 182.35 127.45

% Contract

Volumes

Sold Between

201 - 250¢ 49.7 26.3 31.3

151 - 200 50.2 73.7 100.0 68.7

101 - 150 01

51 - 100

0 - 50

Contract

Volumes Mcf 2,761,580 8,035,550 372,311 11,169,441