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

UMENTD

~

'

FOR AR¢

| Soavome Gourt, 0. &

FILED

No. 77-648 NOV 27 1978

> MIPAREL SUDAN Jit, cold |

dn the Supreme Court of the ii -———_

OcTOBER TERM. 1978

FEDERAL ENERGY REGULATORY COMMISSION,

PETITIONER

V.

PENNZOIL PRODUCING COMPANY, ET AL.

ON WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE FIFTH CIRCUIT

REPLY BRIEF FOR THE

FEDERAL ENERGY REGULATORY COMMISSION

Wave H. McCree, JR.

Solicitor General

Department of Justice

Washington, D.C. 20530

ROBERT R. NORDHAUS

General Counsel

Federal Energy Regulatory Commission

Washington, D.C. 20426

INDEX

Page

CITATIONS

Cases:

California v. Southland Royalty Co., No.

76-1114 (May 31, 1978) 0.0 6, 13-14

Columbia Gas Transmission Corp.,

Docket No. RP73-65 (Aug. |, ETN chiedeaaeuds 14

El Paso Natural Gas Co., Docket

No. RP72-150 (Feb. 16, 1977) ..............0000.. i4

FPC v. Texaco, Inc., 417 U.S. 380 ....... 10, Il, 12

Mobil Oil Corp. v. FPC, 417 U.S. 283 .......... 14

Sunray Mid-Continent Oil Co. v. FPC.

I, SY ice ee is 6

Statutes and regulations:

Natural Gas Act, 15 U.S.C. 717 ef seq.:

Section I(b), 15 U.S.C. PE a 6

Section 7(b), 15 U.S.C. 717f(b) 0.0.0.0... 2

Section 7(e), 15 U.S.C. 717fle) .................... 6

Section 19(b), 15 U.S.C. 7174(b) ................ 15

Natura! Gas Policy Act of 1978, Pub. L.

No. 95-621, 92 Stat. 3350:

I IE ha cad (lo 4

I cea 3, 6

Section 1O1(D)(4) ooocccccccccccccccecceccccecccecece.. 3, 6

Sections 102-109 ooo ccccccceccccecseceeeeeeececee. 3

TRUITT HIDES -siceeideninirsdaidieasmeedaanienaceceaduaecsenst 7

il iil

Page Page

Statutes and regulations continued: Miscellaneous-continued:

PY SN sichuictnmtaicin oo I H.R. 5289, 95th Cong., 2d Sess. (1978) .............. I

se ns Phe a co TE ae 3, 4, 5, 6 H.R. Conf. Rep. No. 95-1752, 95th Cong..,

Section 104(b) cecceccccccseeseeeecc } 26 Sess. (1978) ..........cccccccocorscoeee banners on |

; S. Conf. Rep. No. 95-1126, 95th Cong., 2d Sess.

I TTTOEIY as ncneonsgensnsnnssscrruvenessssece 3 OED see ee eee bat intvaer OIE l

Section 106(a) ...........cecccsssceseeees...... 3, 4, 5, 6

sist sore tapes, er 4

slates bates ee 7

UPI TITY betscirceiicicbietserindsaasincelel coi 7

I II iiicctcmnestiietneeenceatenieg 6

SS) cr 3

WAN INN snctnitsciiriiaiadiuces. oe. 4

Pub. L. No. 95-621, 92 Stat. 3350... 2

Pe D tenthieimcueeacen 15

IB CPLR. 157.40(b) occ ecccccccccecssesssseseeseesesecccc., 16

OS SC), rrr 5

1S CPR. 2SGBANMI) ........ccvcccesccvesseeseeecieooeeeee.... 5

Fe SO aici titianisaaisilarai es ett 14

Miscellaneous:

124 Cong. Rec. H13427 (daily ed.

aa thee ect BO EET ee ED |

124 Cong. Rec. $16265 (daily ed.

seg cE eth che A I

SP FOB. TG SIRID one cecscncesscorscaseesssecsssss......... 7

PF FOG. Meg, 9986 on. escccesscnesercnsecssssesonss........ 7

PF TOG. Rag, S902 .c.occscesescccesecsssevesseeeeeese....... 7

In the Supreme Court of the United States

OCTOBER TERM, 1978

No. 77-648

FEDERAL ENERGY REGULATORY COMMISSION,

PETITIONER

V.

PENNZOIL PRODUCING COMPANY, ET AL.

ON WRIT OF CEKTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE FIFTH CIRCUIT

REPLY BRIEF FOR THE

FEDERAL ENERGY REGULATORY COMMISSION

Before addressing those contentions of the respondents

that warrant a brief reply (pages 7-16, infra), we wish to

advise the Court of a recent legislative development

relevant to this case. As noted in our principal brief (p. 17

n. 9), the 95th Congress was considering the Natural Gas

Policy Act of 1978 (“NGPA”), H.R. 5289, 95th Cong., 2d

Sess. (1978). On September 27, 1978, the bill as reported

by the conference committee (see S. Rep. No. 95-1126,

95th Cong., 2d Sess., to accompany H.R. 5289) was

approved by the Senate (124 Cong. Rec. $16265 (daily

ed.)), and on October 14, 1978, the same bill and the same

conference report (as H.R. Rep. No. 95-1752, 95th Cong.,

2d Sess.) were approved by the House (124 Cong. Rec.

H13427 (daily ed.)). The bill was signed into law by the

(1)

aD

President on November 9, 1978; Pub. L. No. 95-621. 92

Stat. 3350.!

We shall discuss the new Aci as it appears to bear on

the issues in this case.

The court of appeals set aside orders of the Commis-

sion refusing to authorize two producers, Pennzoil

Producing Company and Shell Oil Company, to pass

through to their interstate pipeline customer, the United

Gas Pipe Line Company—and hence to United's

customers —incremental royalty costs to be incurred ina

Proposed settlement by Shell and Pennzoil of their lessor’s

claims under “market value” royalty clauses in the

producers’ leases. The court also set aside the Com-

mission's rejection of an alternative settlement proposal

whereby the producers would have abandoned delivering

to United, and paid in kind to their lessor instead, the

portion of the gas attributable to the royalties claimed by

the lessor. The Commission found that the incremental

royalty costs proposed in the settlement were based on the

unregulated intrastate market price for natural gas, and

held that it was not authorized to allow the pass-through

of such costs as just and reasonable rates under the

Natural Gas Act. The Commission also held that since the

supply of gas in the leascholds had not been depleted, and

interstate service would have to continue even if the

Properties reverted to the lessor, no basis for abandon-

ment under Section 7(b) of the Natural Gas Act had been

shown.

A. The first question in this case is whether the Natural

Gas Act authorizes the Commission to include in its rates

for the interstate sale of natural gas, and thus to pass on

to interstate consumers. royalty costs based on the

‘Copies of the Act and of the Conference Report have recently

been lodged with the Clerk of the Court in connection with Nos, 77-

1652 and 77-1654.

unregulated price of natural gas in the intrastate market.

Under the Natural Gas Policy Act, all wellhead sales of

natural gas after December |, 1978, will be subject to

price ceilings specified in the Act. Thus, there will no

longer be an unregulated intrastate market. However.

there will still be considerable differences between the

allowable prices for intrastate sales and for interstate sales

of the kind involved here. Moreover, insofar as this case

involves sales of gas made by the respondent producers

before December |, 1978, the validity of the Commission’s

decision will govern the rights and liabilities of the parties

with respect to those sales.

The issue presented here remains significant with

respect to sales of natural gas made after December |.

1978. For such sales, Title 1 of the NGPA establishes a

series of specific maximum price levels to be applied to

particular categories of gas (Sections 101(b)(4), 102-109).

These ceilings encompass sales made in both interstate

and intrastate commerce. One of the categories is gas

previously dedicated to interstate commerce under the

Natural Gas Act (Sections 2(18), 104, 106(a))—such as

the gas involved in this case. Under Section 104(b), the

ceiling price for this gas will be the higher of (a) the just

and reasonable rate established by the Commission as of

April 20, 1977, augmented thereafter by a monthly

inflation factor, or (b) any just and reasonable rate

established by the Commission between April 20, 1977,

and November 8, 1978, which is applicable to the

particular gas involved. Section 104(b)(2) provides,

however, that the Commission by rule or order may

prescribe a ceiling price higher than the ceiling which

would otherwise be applicable under Section 104(b), if it

finds that the higher ceiling would be just and reasonable

within the meaning of the Natural Gas Act.

*Under Section 601(b) of the NGPA, amounts paid by natural gas

companies in purchasing natural gas after December |, 1978, will be

Section 106(a) prescribes the ceiling price ot gw

rollover contracts” executed after November 9, 1978

that is, contracts replacing earlier contracts for the sale of

gas that was dedicated to interstate commerce before

enactment of the NGPA (see Sections 2(12), 106(a)). The

ceiling prescribed by Section 106(a) is 54 cents per million

Btu's, adjusted for inflation, unless the Commission-

established rate previously applicable to the expiring

contract is higher, in which case the ceiling is the rate

applicable to the expiring contract, augmented by a

monthly inflation factor. Under Section 106(c), however,

the Commission may prescribe a higher ceiling price than

otherwise would be appi’cable under Section 106(a), if it

finds that the higher ceiling is just and reasonable within

the meaning of the Natural Gas Act.

Thus, under Sections 104 and 106(a) of the NGPA, the

rates previously established by the Commission under the

just and reasonable standard of the Natural Gas Act

continue to affect sales of gas previously dedicated to

interstate commerce—such as the gas involved in this

case—and the Commission continues to have authority to

prescribe a higher ceiling price for such gas under the

same standard.

At the time of the administrative hearing, the gas

involved in this case was subject to rates established under

the FPC’s Opinions Nos. 598 (Southern Louisiana Area

Rate) and 699 (First National Natural Gas Rate). The gas

covered by the Southern Louisiana rate had a ceiling price

of 31.11 cents per Mcf, including all adjustments; the gas

covered by the National Rate had a ceiling of 59.88 cents

per Mef, including all adjustments (A. 42, 66-67). These

deemed “just and reasonable” for the purposes of the rate-setting

provisions of the Natural Gas Act if they do not exceed the applicable

ceiling established by the NGPA. And under Section 60\(c). amounts

meeting that test may be passed through by natural gas companies to

their customers.

amounts, as adjusted by subsequent Commission orders.’

will constitute the base price to which the monthly

inflation factor will be applied under Sections 104 and

106(a) of the NGPA to determine the ceiling price after

December |, 1978, for gas from these leaseholds flowing

under existing contracts, and subsequently under any

rollover contracts.

The incremental royalty that Pennzoil and Sheil seek

the Commission's approval to pass through here would,

of course, raise their rates (by the amount of the

increment) above these applicable ceilings. The question

whether the Commission may approve the pass-through

of such incremental royalty costs as “just and reason-

able” under the standard of the Natural Gas Act—that is,

the question presented in this case—thus persists under

the new Act, although its practical significance for the

future may be decreased as the differential between

interstate and intrastate prices is decreased.

Moreover, if the court of appeals is correct in holding

that incremental royalty costs based on the previously

unregulated market price may constitute just and

reasonable prices passed through to pipelines under the

Natural Gas Act, then the base price under Sections 104

and 106(a) of the NGPA will be substantially inflated.

Thus, with respect to gas dedicated to interstate

commerce and hence subject to Sections 104 and 106(a) of

NGPA, the question whether incremental royalty costs

arising from “market value” leases referring to the

‘unregulated market may be passed through to

producers—that is, held “just and reasonable” under the

standard of the Natural Gas Act—will remain significant

under the new Act.

‘The gas covered by Opinion No. 598 is now subject to the rates

Prescribed in Opinion No. 749 (18 C.F.R. 2.56b(a\1)). The gas

covered by Opinion No. 699 is now subject to the rates prescribed in

Opinion No. 770 (18 C.F.R. 2.56a(a){3)).

B. The second question in this case is Whether the

Commission properly denied a request to permit lessee

Producers of natural gas to abandon volumes of gas

dedicated to interstate service so that those volumes could

be paid as royalties in kind to landowner lessors for sale

on the intrastate market.

The NGPA expressly codifies the concept established

by decisions under the Natural Gas Act that reserves from

which gas is sold in interstate commerce for resale are

“committed or dedicated” to interstate commerce.+ Under

Sections 2(18) and 601(a) of NGPA. future sales of gas

that was so dedicated on November 8, 1978, remain

within the Commission's jurisdiction under Section I(b)

of the Natural Gas Act (subject, however, te NGPA's rate

ceiling provisions, and with certain Categories of gas

excepted). Future sales of gas from reserves so dedicated

will therefore remain subject to the conditions of

certificates previously issued under Section 7(e), and to

the requirement that the service of supplying gas from

such reserves may not be abandoned without the

Commission's approval. These Provisions assure that

Pipelines presently relying on supplies of dedicated gas

may continue to do so. Even though, after December |.

1978, all producer sales of natural gas, whether interstate

Or intrastate, will be Subject to ceiling prices under NGPA

(Section 101(b)(4)), there are significant differences

between the ceilings for dedicated gas set by Sections 104

and 106(a) and the ceilings for gas that is not dedicated

and hence is not subject to the abandonment requirement

of the Natural Gas Act.’ Thus, if the royalty gas claimed

‘See. e.g., California \. Southland Rovalty Co.. No. 76-1114 (May

31. 1978); Sunray Mid-Continent Oil Co. v. FPC. 364 U.S. 137

(1960).

‘For example. under Section 104. the maximum unadjusted

December 1978 delivery price for dedicated “flowing gas” (i.¢., gas

produced from a well on which drilling commenced prior to January

by the iessors under the “market value” clauses should

have been abandoned to them prior to NGPA, as

respondents contend, there may be substantial price

consequences, even if the lessor sells the gas to the same

interstate pipeline to which it Was delivered under the

prior dedication. The abandonment issue therefore

remains significant notwithstanding the enactment of the

NGPA.

Il.

A. Respondents present the decision of the court of

appeals as one that would not require the Commission to

allow the Pass-through of the royalty costs in question,

but would only require the Commission to consider

whether to do so. As Pennzoil states (Br. at 10 n. 16): “All

the decision stands for is the Proposition that the

Commission has authority to grant relief if 4 review

on the merits demonstrates that such relief would meet

the statutory tests.” Pennzoil argues that “the Commis-

sion has authority to review royalty costs and permit their

recovery in rates if found on the merits to be just and

reasonable” (id. at 13-14), and that “the Commission must

at least consider on the merits whether the public interest

requires that producers be allowed to recover market

value royalty costs * * *” (id. at 22-23). See also id. at 9 n.

15, 10, 11, 15 n. 20. Pennzoil appears to ask only for “a

full inquiry into whether such costs were prudently

incurred” (id. at 20). Shell presents the case in the same

minimal and procedural light:

In remanding the case to the Commission for

rehearing 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

——

'973 (43 Fed. Reg. 53270, 53342)is $0.332 per million Btu. 43 Fed.

Reg. 53334. In contrast. under Section 109. the maximum unadjusted

delivery price for the same month for undedicated natural gas not

governed by other Provisions (¢.g., Sections 102. 103, 108. 109) is

$1.630 per million Btu. /bid

” —

merits of the producers’ position, after giving them an

Opportunity. On a reopened record. to attempt to

prove their case. \

Shell Br. at 9: see also /d. at 12. 15. 19. 3].

But respondents also seek to have it the other way, and

in so doing they betray a more accurate recognition of

What this case is about. Pennzoil and Shell both take the

position that, at least in the case of the rate relief they

seek on the basis of their proposed state court settlement

with their lessor, the Commission would indeed be

required to grant the relief. Pennzoil says (Br. at 23): “on

that question there can be no dispute,” since “[t]he price

increase would generate absolutely no profit because it

does nothing more than recover increased costs, and no

one has claimed the costs to be recovered were other than

prudently incurred.” And Shell argues (Br. at 20-21) that

since the leases were entered into before the Natural Gas

Act or before the Phillips decision. and since the royalty

Percentages “conlormed with the industry practice in the

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

the leases” “{o]n these facts. it is apparent that any

holding by the Commission that the royalty provisions of

these leases were ‘excessive or unreasonable’ would be

arbitrary and capricious.”

These claims by respondents document our contention

that the decision of the court of appeals “seems thus to

establish a presumption that such relief must be granted

unless exceptional circumstances are present” (Commis-

sion Opening br. at 13; see also id. at 22-25).° Respondents

assert that even though their proposed “market value”

royalty increments are based not on a State court

judgment or precedent but only on a proposed settlement.

the Commission would be required to find them “just and

‘Compare Pennzoil Br. at 10 n. 16. calling this contention

“absurd.”

reasonable” and to let them be passed through to

pipelines and interstate consumers. Respondents’ argu-

ments would apply generally—that is, in the absence

of exceptional circumstances—to any royalty costs based

on “market value” leases that were held, or that might be

held, to refer to the intrastate market. It will typically be

the case that such leases were entered into before the

Natural Gas Act or before the Phillips decision, and that

the royalty percentages in the leases conformed with

industry practice in the area at the time and hence were

necessary in order to purchase the leases.’ It will always

be the case that the requested pass-through relief “would

generate absolutely no profit” because it would simply

pass through the increased royalty costs.

Given these generic characteristics of claims for

“market value” royalties based on the intrastate market, it

is illusory to suggest that the decision of the court of

appeals would only require the Commission “to hear and

review individual requests for rate relief and to determine

whether, on the merits, they should be granted” (Pennzoil

Br. at 10). Exceptional cases aside, those “individualized”

proceedings (id. at 17; Shell Br. at 9) would offer nothing

individual for the Commission to consider. The facts that

are present here—and that respondents contend compel

the Comifiiission to grant relief—would be present on a

State-wide basis in any state whose courts had held, or

might hold, that “market value” royalty clauses refer to

the intrastate market. Unless the Commission may ex-

clude such royalty costs from its interstate rates on a

"The court of appeals also suggested that these facts would compel

the granting of relief: “Determination of the reasonableness of a cost

necessarily requires consideration of 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 different from any other cost.” Pet.

App. 7a.

10

generic basis. on the ground that their inclusion would be

improper under the Act.* it will be required to include

them on a generic basis, and thereby undermine the

regulatory scheme. There is no middle ground.

B. The choice made by the Commission was compelled

by this Court's decision in FPC v. Texaco, Inc., 417 U.S.

380, 394-399 (1974). See our opening brief at 19-21.9

Respondents contend that the Commission misconstrued

that decision (Pennzoil Br. at 15-20; Shell Br. at 13-17).

They emphasize particular words from the Court's

statements that “the prevailing price in the marketplace

cannot be the final measure of ‘just and reasonable’ rates

mandated by the Act.” that “Congress could not have as-

sumed that ‘just and reasonable’ rates could conclusively

be determined by reference to market price.” and that

“the Commission jacks the authority to place exclusive

reliance on market prices” (417 U.S. at 397, 399. 400,

emphasis added; see Shell Br. at 15). They similarly stress

the underlined phrase in the Court's Passage:

This does not mean that the market price of gas

would never, in an individual case, coincide with just

and reasonable rates or not be a relevant considera-

tion in the setting of area rates. see Permian Basin

Area Rate Cases, 390 US. at 793-795; 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

‘Pennzoil agrees with us that the decision of the court of appeals

precludes the Commission from taking such a position. Pennzoil Br.

at 10.

*For example, the Court in Texaco found unacceptable “the

implication *** that reasonableness would be judged by the

standard of the marketplace.” /d. at 396.

oeeetenneeeeeeie e

U.S. 950 (1970). It does require, however, the

conclusion that Congress rejected the identity

between the “true” and the “actual” market price.

417 U.S. at 399, emphasis added (case name italics

omitted); see Shell Br. at 16. Respondents thus contend

that royalties based on the price of gas in the unregulated

market can be included by the Commission in_ its

determination of reasonable rates—indeed, must be

included if they were “prudently incurred”! -s0 long as

they are not the “exclusive” or “entire” component (Shell

Br. at 16-17). |

Besides ignoring the thrust of the Court’s decision and

opinion in Texaco. respondents misapprehend the

Commission's decision here. Respondents’ characteriza-

tion to the contrary (see Shell Br. at 16-17) notwithstand-

ing. the Commission determined that the incremental!

royalty embodied in the Proposed settlement of the state

court suit for royalties based on the unregulated market

was indeed based on nothing other than the price in the

unregulated market. The Commission found that it was

being called on to authorize. as in Texaco (see 417 U.S. at

384-385), an automatic “tracking increase” based on the

market price for intrastate sales in the same producing

area (A. 181-182, 261). Of course. the proposed settlement

between Pennzoil, Shell, and their lessor—since it was a

settlement—did not pass through the full amount of the

“market value” royalties claimed by the lessor. But the

Commission found that “the impetus of the settlement is

the market value of the royalties and no consideration has

been given to regulated rates” (A. 261). Again on

rehearing, the Commission found it “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

"E.g., Pennzoil Br. at 20, 23: Shell Br. at 12, 20-21; see pages 7-10,

supra.

12

prices” (A. 292). Thus. the Commission's ruling rests on

its characterization of the record. The Commission found

that it was being asked to approve as “just and

reasonable,” and to pass through to consumers, incremen-

tal royalty costs springing exclusively from the un-

regulated price for natural gas—the very defect the Court

found in the Commission's order in Texaco (417 US. at

399).!!

C. Shell contends (Br. at 20-24: A. 285-286) that the

Commission’s refusal to grant the relief it requested denies

it due process and may be confiscatory. Neither Shell nor

Pennzoil, however, laid an adequate foundation in the

hearing before the administrative law judge for any claim

of confiscation. Pennzoil made no showing of either its

''The Commission's finding was not only reasonable but in-

escapable. Respondents have not Suggested any motive for the

settlement other than the desire to eliminate the claim being settled.

And if it would be improper for the Commission to pass through to

consumers the full payment of such claims. settlements must be

treated likewise, else the vice is simply discounted. As the Court held

in Texaco, “the Act makes unlawful all rates which are not just and

reasonable, and does not say a little unlawfulness is permitted.” 417

U.S. at 399.

Disregarding the impetus for the settlement, Shell and Pennzoil

contend that its computation was based on factors other than the

unregulated market price, including the Commission's ceiling rates

(Shell Br. at 10-11; Pennzoil Br. at 6-8). It is hard to see why this

would make a difference— suppose the settlement was computed as

ten times the regulated rate—but in any event the record does not

Support the claim. The record shows only the settlement formula.

under which the royalty was to be based on the higher of 78 cents per

Mef (with adjustments) or 150% of the highest Commission-set area OU

national rate (A. 17-18). The record provides no support for

Pennzoil’s claim (Br. at 7) that the 78-cent figure was calculated as

150% of the Commission's then-existing national rate, so that in

either form “the incremental royalty is tied directly to Comiitission set

rates and not at all to intrastate rates” (ibid.; footnote omitted). If

this were true, it would be at odds with the settlement’s alternative

provision for abandonment of the “royalty gas” (A. 20-21), which is

plainly designed to allow sale of that gas in the intrastate market.

13

overall or its out-of-pocket costs for Operating the

Properties involved (A. 175-176). Shell effered some

evidence concerning its costs and revenues, but none

concerning its capital costs. and none with respect to

revenues from condensates produced from the wells in-

volved (A. 175-180). Moreover, Shell's claims of opera-

tion at a loss were computed on the basis of the un-

adjudicated $1.40 per Mcf “market value” figure/claimed

by the lessor, not the 78 cents per Mcef figure agreed

to by the lessor in the Proposed settlement that was

before the Commission (A. !80). The administrative

law judge found that on the basis of that settlement,

without reference to capital costs or condensate

revenues, Shell would earn a profit from gas operations

under the 1934 and 1952 leases of $178,951 in 1975

(A. 178-179), 12

Because Shell and Pennzoil failed to make a case for

confiscation, there is no occasion on this record to

determine whether the Commission's adherence to this

Court’s holding in Texaco would ever present a

confiscation issue. The Commission's decision here does

not preclude—under the Constitution and the Act it could

not preclude—consideration of the issue if it should be

adequately presented. See California v. Southland Roy-

the re. f requested, there is no settlement * * *” (id. at 21). Thus,

having presented the settlement to the Commission for 4 ruling, Shell

complains that the Commission ruled on it. As the administrative law

judge pointed out (A. 180), if the settlement is terminated because of

the Commission's refusal to grant the relief sought, that will be the

choice of Shell or Pennzoil, not of the lessor (and not of the

14

ally’ Co., No. 76-1114 (May 31, 1978).(op.\slip.8:; Mobil

Oil Corp. v. FPC. 417 U.S. 283. 328 (1974).'3 It was not

adequately presented here.'+

D. Respondents concede that this Court’s decision in

California v. Southland Royalty Co., No. 76-1114 (May

13, 1978), wipes out the court of appeals’ ground for

setting aside the Commission’s refusal to permit them to

abandon delivery of the royalty portion of the gas and

pay it in kind to the lessor. They contend, however, that

the public convenience and necessity required abandon-

ment, even though the gas supply was not depleted,

‘The Commission noted the speculative and premature nature of

the “bind” in which Shell and Pennzoil claimed to find themselves:

The real issue in this proceeding is Whether the _

Commission 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 regulated price

the producer receives for the gas, but rather on the “marke*

Value” of the gas. Moreover, as in this proceeding, the question

b.comes somewhat speculative because of litigation between

producer lessees and lessors over the extent of such royalty

obligations. [Pet. App. 21a: emphasis in original.]

‘*Pennzoil cites (Br. at 20-25) two Commission decisions as

supporting the pass-through of royalty costs based on the unregulated

market. Those decisions are inapplicable here. In E/ Paso Natural

Gas Co., Docket No. RP72-150 (Feb. 16. 1977), the Commission

noted that “unlike in Pennzoil, this case does not involve a request

for special relief above applicable Commission determined and Court

approved just and reasonable ceiling rates” (slip op. 15). The case

involved special circumstances concerning a pipeline; the Com-

Mission's rate-setting scheme for pipeline-owned production allows an

individual cost-of-service approach in special circumstances. See 18

C.F.R. 2.66. In Columbia Gas Transmission Corp., Docket No.

RP73-65 (Aug. !. 1977), the Commission held that a pipeline’s

purchased gas costs tor non-jurisdictional gas should not be excluded

from its base so long as they were reasonable and prudent. The

Present case involves jurisdictional! gas.

15

because if the lessor Prevails in state court, respondents

might lose the leases or be required to cease drilling

additional wells. Shell Br. at 26-31; Pennzoil Br. at 25-28.

In addition, they contend that if the Property reverts to

the lessor, the lessor might qualify as a small producer

entitled to charge higher rates than those presently

applicable. See 18 C.F.R. 157.40; Shell Br. at 30: Pennzoil

8r. at 27. Respondents contend that the Commission did

not deal explicitly with these arguments and that the case

should now be remanded for it to do so (Shell Br. at 27.

31; Pennzoil Br. at 27-28).

The Commission's rejection of the abandonment

Proposal was, however, inclusive. It found “no reason to

grant abandonment on the basis of this record,” and

further that “the public convenience and necessity, present

or future, is not served by granting an abandonment

authorization that would likely result in the subject gas

being diverted from the interstate market to the intrastate

market” (Pet. App. 24a). In any event, respondents did

not raise on rehearing the arguments they now say the

Commission should consider. Pennzoil contended only

that the substitution of the lessor for itself and Shell

would substitute an inexperienced royalty owner for

experienced producers (A. 280). Shell argued only that the

Commission should have permitted one of the alternatives

provided in the Proposed settlement, and that it erred in

failing to consider that rejection of both might result in

victory for the lessor in the lawsuit and hence in loss of

the gas supply to the Pipeline (A. 283-284). Thus, the

arguments now put forward were not preserved on

rehearing as required by Section 19(b) of the Natural Gas

Act, 15 U.S.C. 717r(b).

United Gas Pipe Line Company did argue on rehearing

that even if the gas remained in interstate commerce, ihe

lessor might qualify for the small producer rates, thus

increasing the price for the gas (A. 287-288). United,

however, does not make this argument in its brief in this

16

Court (see United Br. at 20-23).'5 In any event, none of

the parties before the Commission presented any evidence

in this record indicating that the possibility of an increase

in rates from national to small producer levels warranted

abandonment of service under the eXisting contracts.

CONCLUSION

For the reasons Stated jn the Commission's principal!

brief and in this reply bydjf. the judgment of the court of

appeals should be reversed.

Respectfully submitted.

Wapbe H. McCrer. Jr.

Solicitor General

ROBERT R. NorRDHAUS

General Counsel

Federal Energy Regulatory Commission

NOVEMBER 1978

'SThe contention is unsupported in any event. The administrative

law judge found that the lessor, Williams. could not quality tor the

small producer rate, since sales from these leases exceed 10 million

Mef a vear (A. 184: see 18 C.F.R. 157.40(b)).

DOJ-1978.11