Appendix — Tennessee Gas Pipeline Co. v. Federal Energy Regulatory Commission
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‘Gupreme Court, U. &,
EILED
DEC 19 1979
“BICHABL ROBAK, JR., CLERR.
IN THE
Supreme Cowt of the United States
OcToBER TERM, 1979
_79-962*
No.
TENNESSEE GAS PIPELINE COMPANY,
a Division of Tenneco Ince.,
Petitioner,
v.
FEDERAL ENERGY REGULATORY COMMISSION,
Respondent.
APPENDIX TO
PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR THE
DISTRICT OF COLUMBIA CIRCUIT
MELVIN RICHTER
Harowp L. TALISMAN
DALE A. WrIGHT
LitTMAN, RICHTER, WRIGHT
& TALISMAN, P.C.
1050 17th Street, N.W., Suite 600
Washington, D.C. 20036
MICHAEL R. WALLER
General Counsel
P.O. Box 2511
Houston, Texas 77001
Attorneys for
Tennessee Gas Pipeline Company,
a Division of Tenneco, Inc.
Press or Byron S. ADAMS PRINTING, INC., WASHINGTON, D. C.
jew a Se etree Nana te
APPENDIX
APPENDIX
APPENDIX
APPENDIX
APPENDIX
INDEX TO APPENDIX
co taeda
SRA Sea I Ne 6 Fe nnn
APPENDIX A
Muited States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
No. 77-1496
TENNESSEE GAS PIPELINE COMPANY,
a division of Tenneco Inc., PETITIONER
Vi
FEDERAL ENERGY REGULATORY COMMISSION, RESPONDENT
PUBLIC SERVICE COMMISSION OF THE STATE OF NEw YorRK
ENTEX, INC.
COLUMBIA GAS TRANSMISSION COMPANY
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
NORTHERN ILLLINOIS GAS COMPANY
NEW ENGLAND CUSTOMER GROUP (BAY STATE GAs Co.),
INTERVENORS
No. 77-1498
PUBLIC SERVICE COMMISSION OF THE STATE OF NEW YorK,
PETITIONER
V.
FEDERAL ENERGY REGULATORY COMMISSION, RESPONDENT
la
2a
TENNESSEE GAS PIPELINE COMPANY
COLUMBIA GAS TRANSMISSION CORPORATION
NEW ENGLAND CUSTOMER GROUP, ET AL.
NORTHERN ILLINOIS GAs Co.
PUBLIC SERVICE ELECTRIC AND GAS CO., INTERVENORS
No. 77-1653
INTERSTATE NATURAL GAS ASSOCIATION OF AMERICA,
PETITIONER
Vv.
FEDERAL ENERGY REGULATORY COMMISSION, RESPONDENT
COLUMBIA GAS TRANSMISSION CORP.
TENNESSEE GAS PIPELINE Co.
PUBLIC SERVICE ELECTRIC AND GAS Co.
PUBLIC SERVICE COMMISSION OF THE STATE OF NEW YORK,
INTERVENORS
No. 77-1712
TRANSCONTINENTAL GAS PIPE LINE CORPORATION,
PETITIONER
Ve
FEDERAL ENERGY REGULATORY COMMISSION, RESPONDENT
COLUMBIA GAS TRANSMISSION CORP.
UNITED CITIES GAS COMPANY
PUBLIC SERVICE ELECTRIC & GAS COMPANY
TENNESSEE GAS PIPELINE Co.
PUBLIC SERVICE COMMISSION OF THE STATE OF NEW YORK,
INTERVENORS
- a eed
bo ia al CAE aS ANS NANA tle dere oy na eee Ne EA) tee - SOK, NeAdscndlen ett —
jay NO re pet
3a
No. 77-1719
MICHIGAN WISCONSIN PIPE LINE COMPANY, PETITIONER
Vv.
FEDERAL ENERGY REGULATORY COMMISSION » RESPONDENT
WISCONSIN NATURAL GAS Co.
ASSOCIATED NATURAL GAS Co.
MICHIGAN GAS UTILITIES CO., INTERVENORS
Petitions for Review of Orders of the
Federal Energy Regulatory Commission
Argued September 29, 1978
Decided June 20, 1979
Harold L. Talisman with whom Melvin Richter, Dale
A. Wright, Patricia A. Curran, Terence J. Collins, Greg-
ory Grady and Lilyan G. Sibert were on the brief, for
Tennessee Gas Pipeline Company, petitioner in No. 77-
1496, intervenor in Nos. 77-1498, 77-1658 and 77-1712
and amicus curiae in No. 77-1719.
Richard J. Flynn with whom Frederic G. Berner, Jr.
and Charles V. Shannon were on the brief, for Michigan
Wisconsin Pipe Line Company, petitioner in No. 77-1719
and amicus curiae in No. 77-1496.
Thomas F. Ryan, Jr. with whom Robert G. Hardy
was on the brief, for Transcontinental Gas Pipe Line
Corporation, petitioner in No. 77-1712.
Edward W. Hengerer and Norman A. Pedersen, At-
torneys, Federal Energy Regulatory Commission, with
whom Howard E. Shapiro, Solicitor, and Philip R. Tel-
arm
4a
leen, Attorney, Federal Energy Regulatory Commission,
were on the brief, for respondents.
Richard A. Solomon with whom Peter H. Schiff and
Sheila S. Hollis were on the brief, for Public Service
Commission of the State of New York, petitioner in No.
77-1498 and intervenor in Nos. 77-1496 and 77-1712.
Jerome J. McGrath, John H. Cheatham, III and J.
Evans Attwell were on the brief, for petitioner Inter-
state Natural Gas Association of America in No. 77-
1653.
John D. Daly and Giles D. H. Snyder and Stephen J.
Small were on the brief for intervenor Columbia Gas
Transmission Corporation in Nos. 77-1496, 77-1498, 77-
16538 and 77-1712.
Robert H. Gorske was on the brief, for intervenor
Wisconsin Natural Gas Company in No. 77-1719.
Irving Jacob Golub, Stephen A. Wakefield, William B.
Cassin and Phillip D. Endom were on the brief, for
amicus curiae United Gas Pipe Line Company in Nos.
77-1496, 77-1498 and 77-1653.
Also Allan Abbot Tuttle, Robert W. Purdue and Dennis
Lane, Attorneys, Federal Energy Regulatory Commission,
entered appearances for respondent.
Also Paul W. Fox and John W. Glendening, Jr. for
intervenor New England Customer Group in Nos. 77-
1496 and 77-1498.
Also J. Stanley Stroud entered an appearance for in-
tervenor Northern Illinois Gas Company in Nos. 77-
1496 and 77-1498.
Also Carl W. Ulrich, William R. Duff, Edward S.
Kirby and James R. Lacey entered appearances for in-
tervenor Public Service Electric and Gas Company in
Nos. 77-1496, 77-1498, 77-1653 and 77-1712.
ee int het hae ba ais saa
of 5a
Also Michael J. Manning and Patrick J. Keeley en-
tered appearances for intervenor Entex, Inc. in No. 77-
1496..
Also Jack M. Irion entered an appearance for inter-
venor United Cities Gas Company in No. 77-1712.
Also Richard M. Merriman, J. Richard Tiano and
Richard T. Witt entered appearances for intervenors
Associated Natural Gas Company and Michigan Gas
Utilities Company in No. 77-1719.
Before: LEVENTHAL and WILKEY, Circuit Judges, and
HAROLD GREENE,” District Judge, United
States District Court for the District of
Columbia.
Opinion for the Court filed by Circuit Judge LEVEN-
THAL, in which Circuit Judge WILKEY and District Judge
GREENE join.
Concurring opinion filed by Circuit Judge WILKEY.
LEVENTHAL, Circuit Judge: We consider petitions of
natural gas pipeline companies’ for review of Federal
Power Commission? rate making orders. The common
* Sitting by designation pursuant to 28 U.S.C. § 292(a)
(1976).
1 In addition to the principal pipeline petitioners, Tennessee
Gas Pipeline Company (No. 77-1496) (“Tennessee”), Trans-
continental Gas Pipe Line Corporation (No. 177-1712).
(“Transco”), Michigan Wisconsin Pipe Line Company (No.
77-1719) (“Michigan-Wisconsin’”’), there are petitions by the
Interstate Natural Gas Association of America (No. 77-1653)
(“INGAA”), Columbia Gas Transmission Corporation (In-
tervenor in No. 77-1496 et al.) (“Columbia”), and the Public
Service Commission of the State of New York (No. 77-1498)
(“PSC”). There also have been various cross-interventions
by the parties.
2 The Federal Power Commission went out of existence in
the fall of 1977. The Department of Energy Reorganization
Act of 1977, P.L. 95-91, 91 Stat. 565, codified at 42 U.S.C.
§§ 7107 ea seq. (1978), transferred most of the FPC’s func-
6a
element in these companion cases is the treatment of “ad-
vance payments,” pre-payments for future deliveries of
natural gas made by the pipelines in the context of an
experimental “advance payment program,” which was
designed to facilitate capital formation by producers to
finance development and production of additional gas
supplies, thus helping to alleviate the natural gas short-
_ age. In formulating “just and reasonable” pipeline rates
in each case, the Commission denied rate base treatment
for various expenditures. It deferred inclusion in rate
base for advance payments made during the test period
and not appropriately expended by the recipient produ-
cers within 30-days of the close of that period. We find
that the Commission failed to administer the advance
payment program with the required flexibility and thus
remand the treatment of advance payments for further
consideration. In certain respects, as will be noted, we
affirm the Commission’s other determinations.
I. FRONT-END ADVANCE PAYMENTS TO
DOMESTIC PRODUCERS
A. General Background
The unhappy saga of the advance payment pregram
has been detailed by this court on other occasions.* Con-
tions, including its rate making authority under both the
Federal Power Act and the Natural Gas Act, to the newly
created Federal Energy Regulatory Commission (FERC). 42
U.S.C.A. §§ 7172(a) (1) (B), (C) (1977). This change in
administration has no effect on the instant litigation, save for
the appropriate substitution of parties.
3 See The Second National Natural Gas Rate Cases, 186
U.S.App.D.C. 23, 59-64, 567 F.2d 1016, 1052-57 (1977), cert.
denied, 435 U.S. 907 (1978); United Gas Pipe Line Co. v.
FPC, 179 U.S.App.D.C. 274, 276, 551 F.2d 460, 462 (1977) ;
Michigan Wisconsin Gas Pipe Line Co. v. FPC, 171 U.S.App.
D.C. 352, 353-54, 520 F.2d 84, 85-86 (1975); Public Service
Com’n, State of N.Y. v. FPC, 167 U.S.App.D.C. 100, 511 F.2d
338 (1975) [hereafter cited as “PSC (Advance Payments)
NG itl AY RAT RIE Sit Nihal Ss cairn, eae
ee eet re
Ta
ceived as one method of alleviating the impending natural
gas shortage, the program was initiated in 1970 and
was governed successively by a series of five “advance
payment orders” until its termination at the end of
1975.‘ As originally formulated and approved by this
court, the program was designed to facilitate capital
formation by producers to finance development and pro-
duction of new gas supplies.’ It was contemplated that
pipelines would provide production capital in the form
II’’]; Public Service Com’n, State of N.Y. v. FPC, 151 U.S.
App.D.C. 307, 467 F.2d 361 (1972) [hereafter cited as “PSC
(Advance Payments) I’’].
Order No. 410, Accounting and Rate Treatment of Ad-
vance Payments to Suppliers for Gas and Amending F.P.C.
Form No. 2, Docket No. R-380, 44 FPC 1142 (1970) (gov-
erning advances made pursuant to contracts entered after
October 2, 1970) [hereafter cited as “Order No. 410”] ; Order
No. 410-A, Accounting and Rate Treatment of Advance Pay-
ments to Suppliers for Gas, and Amending F.P.C. Form No.
2, Docket No. R-380, 45 FPC 135 (1971) (amending the treat-
ment of advance payments governed by Order No. 410) [here-
after cited as “Order No. 410-A”’] ; Order No. 441, Accounting
and Rate Treatment of Advance Payments to Suppliers for
Exploration and Lease Acquisition of Gas Producing Proper-
ties, Docket No. 4-411, 46 FPC 1178 (1971) (governing ad-
vance payments contracts executed between November 10,
1971 and December 31, 1972) [hereafter cited as “Order No.
441”]; Order No. 465, Accounting and Rate Treatment of
Advance Payments Included in Account 166, Advance Pay-.
ments for Gas Development and Production, Docket No.
R-411, 48 FPC 1550 (1972) (governing contracts executed
between January 1, 1973 and December 31, 1973) [hereafter
cited as “Order No. 465”]; Order No. 499, Accounting and
Rate Treatment of Advances Included in Account No. 166, Ad-
vances for Gas Exploration, Development and Production,
Docket No. RM74-4, 50 FPC 2111 (1973) (governing con-
tracts executed between January 1, 1974 and December 31,
1975) [hereafter cited as “Order No. 499’’].
5 PSC (Advance Payments) I, supra note 3, 151 U.S.App.
D.C. at 309, 467 F.2d at 363.
8a
of pre-payments to producers (advance payments) for
future deliveries of natural gas. The order launching
the program provided that such payments could be capi-
talized and included in the pipeline’s rate base subject
to qualifications, including the requirement that advances
must be “reasonable and appropriate.” * The orders also
specified those producer expenditures permissible under
the program (“qualifying expenditures”). Producers
could be expected to seek advance payments because the
advances would provide them with a source of interest-
free capital.’ It was anticipated that pipeline participa-
tion in the program also would be assured if pipeline
rates could reflect a return on qualifying advance pay-
ments.* Current purchasers from the pipeline would
shoulder, in the rates they paid, the “carrying charges”
on these interest-free loans to producers, though the
benefits from expansion of natural gas supplies would
6 Order No. 410, supra note 4, 44 FPC at 1144. Advance pay-
ments were to be drawn down and removed from Account 166,
Advance Payments for Gas, as gas deliveries commenced or
as the pipeline was reimbursed in consideration other than
gas. The significant express qualifications governing advances
under the various orders are described in note 34 infra.
7 See Order No. 465, supra note 4, 48 FPC at 1554.
8 The “cost” to the pipeline of an advance payment was
the cost of financing the amount advanced, a factor prin-
cipally determined by interest rates in the bond market. The
“cost” to rate payers was determined by the rate of return
allowed on the pipeline’s rate base. A differential between
the allowed rate of return and the prevailing interest rate
in capital markets provided some opportunity for successful
arbitrage, but as interest rates rose during the relevant period
this incentive was minimized. The principal incentive for
pipeline participation lay in their ability to secure gas reserves
for the future while transferring to the rate payer the added
cost of making pre-payments (advance payments) for the
gas.
9a
flow to future, not current, rate payers.’ This departure
from the usual rule of public utility regulation (that
current rates should reflect the cost of supplying service
to current rate payers) was thought justified by the
“public interest in enlarging the field supply of natural
gas, needed for existing facilities and contracts.”
The program was conditionally approved by this court
in Public Service Commission, State of New York v.
FPC [PSC (Advance Payments) I[]," as a “justifiable
experiment in the continuing search for solutions to our
nation’s critical shortage of natural gas.” Resolving
doubts in favor of the program, we stressed its experi-
® Qualifying advance payments had to be made prior to de-
liveries under the advance payment contract. See, e.g., Order
No. 465, supra note 4, 48 FPC at 1556. Substantial lag times
were inevitable between the date of the advance and its full
repayment in gas, especially if the advance were made to fund
exploration or other pre-production producer expenditures.
See id. at 1553 (FPC assumption that all pre-Order No. 441
advances are fully recovered on the average in five years, with
a one-year lag between the advance and commencement of
recoupment). Where “front-end” advances were involved, the
time between the date of advance and its full repayment in
gas was considerably extended. For example, most of the
advance payments excluded for a period from Tennessee’s
rate base, though advanced in 1973, were not even fully
utilized by the recipient producers until 1975, and the weighted
average lag time between the end of the applicable test period
and the date when Tennessee’s producers would require the
advance to cover costs was calculated to be 22.8 months. JA in
No. 77-1496, et al. at 254, 256 (testimony of Staff witness
Robert H. Benna, unrebutted by petitioners in this respect) ;
see FERC Br. in No. 77-1496, et al. at 36.
10 PSC (Advance Payments) I, supra note 3, at 316, 467
F.2d at 370.
11151 U.S.App.D.C. 307, 467 F.2d 361 (1972).
12 Id. at 317, 467 F.2d at 371 (on petition for rehearing).
10a
mental character and the need for flexibility and re:
evaluation as it evolved. We perceived the three ad-
vance payment orders that had been issued as of that
time * “as an on-going effort by the FPC to determine
experimentally the proper solution with regard to ad-
vance payments to help alleviate the gas shortage,” and
we were “impressed with the fact that the FPC [had]
demonstrated a willingness to assimilate criticism .. .
and adjust its treatment of advance payments to con-
form with the realities of the natural gas market.’ ™
We emphasized that the agency, in reaching “an accom-
modation of conflicting interests,’ was “making policy
decisions of the type it was created to make.” But
this judicial approval was predicated on the Commission’s
willingness to continue to respond to “the realities of the
natural gas market” and to modify the program in light
of accumulated experience. We reiterated these concerns
in our response to New York Public Service Commis-
sion’s petition for rehearing.’®
18 Orders No. 410, No. 410-A, and No. 441, supra note 4.
14 PSC (Advance Payments) I, supra note 3, 151 U.S.App.
D.C. at 3138, 467 F.2d at 367.
15 Id.
16 Jd. at 317, 467 F.2d at 371:
One of the important factors in reaching our decision
was the temporary character of the FPC order under
review (Order 441 remains in effect only through 31
December 1972), and our belief that it represented a
justifiable experiment in the continuing search for solu-
tions to our nation’s critical shortage of natural gas... .
Fundamental to the concept of any experiment is the
assumption that the data developed from the experience
thereunder will be subjected to meaningful review,
analysis, and evaluation before the expcrimental prac-
tice is allowed to continue or to become institutionalized
as a more permanent procedure. . . . We would accord-
ingly expect that the FPC will not continue, or extend
oe ——
1 la
The advance payment order approved by our March
1972 ruling in PSC (Advance Payments) I expired at
the end of that year. It was replaced in turn by the
two orders pertinent to the instant cases, Order No. 465,"
governing advance payments made during 1973, and
Order No. 499,'* governing the 1974-75 period. When
the program again came before this court in Public
Service Commission, State of New York v. FPC [PSC
(Advance Payments) II],’* we ruled that the Commis-
sion had failed in its obligation “to engage in ‘meaning-
ful review, analysis and evaluation’ of the experience
under the advance payments program” * and to “adjust
its treatment of advance payments to conform with the
realities of the natural gas market.’ *! In our view,
“(t]he data presented by the Commission as a justifica-
tion of its repeated extensions of the advance payments
program provide[d| an inadequate basis from which ‘to
determine whether its justifying objectives [were] being
satisfactorily met at an acceptable level of ultimate eco-
nomic cost to the nation’s gas consumers.’” ** Accord-
ingly, we remanded the record for further evidence and
the effective date of, the practices authorized by Order
441 without further proceedings in which New York and
all other interested parties will be given the opportunity
to demonstrate the effectiveness or the futility of this
experiment.
17 See note 4 supra.
18 See id.
19 167 U.S.App.D.C. 100, 511 F.2d 338 (1975).
20 Jd. at 104, 511 F.2d at 342 (quoting from PSC (Advance
Payments) I statement on petition for rehearing, note 16
supra).
21 Td. at 105, 511 F.2d at 343.
22 Id. at 104, 511 F.2d at 342 (quoting from PSC (Advance
Payments) I statement on petition for rehearing, note 16
supra).
12a
consideration by the FPC. In light of its subsequent
reevaluation, the agency allowed the program to expire
upon termination of Order No. 499 on December 31,
1975.8
Although the program has been terminated, existing
advance payment contracts retain their vitality,” and
continued administration is required as pipelines file with
the FERC for jurisdictional rate increases. In such rate-
making proceedings the Commission has been called upon
to determine whether specific advance payments qualify
for rate base treatment under the terms of the applicable
advance payment orders. This is the posture of the cases
here under review.
B. Nature of Front-end Advance Payments
The central controversy in these cases involves the
temporary exclusion from rate base of certain “front-
end advance payments” made in the United States.”
23 See Advances for Gas Exploration, Development and Pro-
duction, Docket Nos. R-411 & RM74-4 (orders issued Dec. 31,
1975 and Feb. 27, 1976).
24 Td.
25 The first of the two advance payment orders pertinent to
these cases restricted its coverage to advances made to pro-
ducers within the lower 48 states. Order No. 465, supra note
4, 50 FPC at 1555. The second pertinent order made accom-
modation for advances to producers in Alaska. Order No. 499,
supra riote 4, 50 FPC at 2116.
One of these cases, No. 77-1496 et al., also involves exclu-
sion from rate base of advances made to Canadian producers,
but the Commission’s decision was controlled by different
considerations since advances to producers on the North
American continent outside the United States were eligible
for rate base treatment but only on a case-by-case basis.
Advances to Suppliers for Gas Outside Continental United
States, Docket No. R-466, 38 Fed. Reg. 1055-56 (1973)
(notice of rulemaking). This issue is treated in section II-A
infra.
13a
These are a particular class of “advance payments.” In
general, the program provided for “advance payments”
in the sense that the payments were authorized to be
made in advance of the delivery of gas supplies. The
focus of concern in these cases is the so-called “front-
end advance payment,” which identifies a transfer to the
producer not only prior to gas deliveries, but also prior
to any producer expenditures associated with ultimate
production of the gas.
An advance payment has two aspects, and provides a
dual benefit to the recipient producer. First, it is a
source of capital, which supplements the funds available
to producers for development and production expendi-
tures. It is a loan, but one shaped as a pre-payment to
be credited against the purchase price of gas that will
flow from successful development efforts. Second, it is
an interest-free loan. When an advance payment sub-
stitutes for capital raised in financial markets, it re-
lieves the producer of financing costs. There is an extra
benefit to the producer in that the rate set for the pro-
ducer by the Commission incorporates an allowance for
financing cost, and no reduction in that rate is required
on account of the fact that part of the producer’s financ-
ing is cost-free.** Thus, advance payments provide a
26 See, e.g., JA in No. 77-1712 at 148-49, Transcontinental
Gas Pipe Line Corporation, Docket Nos. RP74-48 and PR75-3,
Presiding Administrative Law Judge’s Initial Decision on
Reserved Issues 31-32 (Dec. 22, 1975) [hereafter cited as
“Transcontinental Initial Decision’”] (“{T]he producer has
interest-free use of the funds until the day they must be spent
on eliciting gas, and this is a substantial bonus added to the
price he will receive for the gas from the pipeline. The pipe-
line receives no discount upon that pric2 because its funds
financed the producer’s venture. And the full price, commonly
the highest price permissible under FPC regulations, is ulti-
mately paid by the pipeline’s customers.”) ; JA in No. 77-1719
at 111, Michigan Wisconsin Pipe Line Co., Docket No. CP70-
14a
“bonus” to producers in the amount of the interest factor,
an amount which is never refunded.
In the Commission’s view, the objective of the advance
payment program was to expedite the development of
gas supply through the mechanism of providing pro-
ducers an additional source of capital. In theory, the
increased availability of capital would encourage invest-
ment, which in turn would yield additional gas supply.
The interest factor, and the “bonus” which it provided
to producers, has been construed as a subsidiary element
designed to provide incentive for producer participation,
a necessary cost to achieve the desired benefit.”
The Commission has come to focus on front-end ad-
vance payments as providing a still further bonus to the
producer—not only the interest-free availability of funds
during use for gas development, but their availability for
some period prior to the time of “qualifying expenditure”
by the producer. The Commission has recognized that
capital formation and the pertinent qualifying expendi-
ture may be facilitated by the transfer of an advance
to the producer a “reasonable time” prior to the expendi-
ture. However, the Commission has endeavored through
administration of the program to protect rate payers
from the cost of advance payments held by producers
for any “unreasonable” front-end period. Advance pay-
ments that were made (in the Commission’s view) an
“ynreasonable” time prior to their appropriate expendi-
22, Initial Decision Upon Inclusion of Advance Payments in
Rate Base 7 (Feb. 27, 1976) [hereafter cited as “Michigan-
Wisconsin Initia! Decision’’], JA in No. 77-1719 at 111 (“The
use of money for a period of time is itself worth money. The
advance payments at issue in this proceeding necessarily in-
volve the payment of substantial additional compensation to
the producers above and beyond the established price for gas
that they may discover and sell to the pipeline.’’).
27 See Order No. 465, supra note 4, 48 FPC at 1554.
15a
ture have been labeled “extravagant” by the agency. Since
the term “extravagant” begs the question, these pay-
ments will be referred to in this opinion as “extended
front-end advance payments” or “extended front-end
advances.”
C. The Critical Timing Requirement
Distilled to its essence, this case involves two ques-
tions: (1) whether the rate base treatment contemplated
by the program was inherently limited to advance pay-
ments made no more than a “reasonable time” prior to
their appropriate expenditure; and, (2) whether, if such
a limitation existed, the Commission acted within its
discretion in defining the permissible interval solely in
terms of traditional line-of-credit financing practices.
The timing element has assumed paramount impor-
tance due to the response of both pipelines and producers
to the realities of the natural gas market in the context
of the advance payment program. In an unregulated
economic environment, a period of supply shortage may be
expected to stimulate a rise in price until supply and
demand are once again in equilibrium. But on sales
of natural gas within FERC jurisdiction, both producers
and pipelines are foreclosed from an unencumbered re-
sponse to economic forces. Unless specifically excepted, |
producers must sell gas, and pipelines must buy it, at
regulated rates that may fall well below a “free-market”
price.” Further, the law imposes on the pipelines an
28 Section 4(a) of the Natural Gas Act, 15 U.S.C. § 717¢(a)
(1976), provides that “[a]ll rates and charges made, de-
manded, or received . . . shall be just and reasonable, and any
such rate or charge that is not just and reasonable is declared
to be unlawful.” Section 5, 15 U.S.C. § 717d (1976), authorizes
the Commission to review rates and set them at just and
reasonable levels. Section 7(c), 15 U.S.C. §717f(c) (1976),
16a
enforceable obligation to resist any temptation to ac-
quiesce in unlawful producer demands and to bid against
each other for available supplies of gas by offering higher
prices or their equivalents.” Still, the sanctions available
to the FERC have their limitations, and even in the
regulatory context market pressures retain some vital-
ity.
requires that new gas be sold under certificates of “public
convenience and necessity.” The Commission’s power to ex-
empt producers and pipelines from the regime of just and
reasonable rate regulation is limited. See generally FPC v.
Texaco Inc., 417 U.S. 380 (1974) ; Consumer Federation of
America v. FPC, 169 U.S.App.D.C. 116, 515 F.2d 347, cert.
denied, 423 U.S. 906 (1975).
29 See Natural Gas Act, §§ 20, 21, 15 U.S.C. §§ 717s, 717t
(1976).
30 Pursuant to section 4(e) of the Natural Gas Act, 15
U.S.C. §717c(e) (1976), the Commission may suspend a
filing for a jurisdictional rate for up to five months. At the
end of the suspension period, the rate may go into effect, sub-
ject to refund. Pipeline expenditures for the purchase of gas
beyond just and reasonable prices may be denied reimburse-
ment (i.e., ordered for refund) and the pipeline’s investors,
rather than its rate payers, mcy have to bear the disallowed
cost. Section 20 of the Act, 15 U.S.C. § 717s (1976), allows
the Commission to seek an injunction from a district court to
restrain on-going or prospective violations of the Act’s pro-
visions. Section 21, 15 U.S.C. § 717t (1976), subjects to crim-
inal penalties “{a]ny person who willfully and knowingly
does or causes or suffers to be done any act, matter, or thing
in this chapter prohibited or declared to be unlawful,” and
subjects to modest per diem fines “[a]ny person who willfully
and knowingly violates any rule, regulation, restriction, con-
dition, or order made or imposed by the Commission under
authority of this chapter.” Despite these deterrents to the
knowing payment of higher than just and reasonable prices
for natural gas, the Commission cannot take the ill-gotten gas
away from the offending pipeline once it has flowed to its
customers. One may anticipate circumstances where a pipe-
line’s investors might determine in their sound business
17a
The advance payment orders did not specify the per-
missible interval between the advance and its appropriate
expenditure. Perhaps emboldened by this indefiniteness,
producers pressed their bargaining advantage, inducing
pipelines to make advances long before the funds were
used for qualifying expenditures. These advances, cer-
tain of which the Commission has labeled “extravagant,”
and which we refer to as “extended front-end advances,”
gave producers valuable interest-free funds for their un-
restricted use during the interim period. By this mecha-
nism the price of natural gas effectively was raised above
the regulatory ceiling.** Competition for needed gas sup-
plies motivated pipelines to acquiesce in exorbitant pro-
ducer demands. The belief (or hope) that the Commis-
sion would permit rate-base treatment of extended front-
end advances, thus passing on the competitive cost to the
rate payers, may have contributed to the pipelines’
weakened resistance. Whatever the causes, extended
front-end advance payments emerged in the market and
are referred to in the testimony of witnesses for the
pipelines as a “term of trade” arising during the period
relevant to these cases.*?
The Commission has administered the advance pay-
ment program to defer inclusion in rate base of a pipe-
line’s front-end advances until the test period in which
those advances were used by the recipient producers for
appropriate purposes. The Commission has relied on its —
construction of the general objectives of the program
and on the administrative discretion inherent in an an-
nounced general policy that it would include in the rate
judgment to take the risks associated with obtaining needed
gas supplies, at least where there is a colorable legal argument
that questionable expenditures are permissible.
81 See note 26 supra.
32 See, e.g., Opinion No. 769-A, Tennessee Gas Pipeline Com-
pany, Docket No. RP73-113, Opinion and Order Denying
Rehearing 3 (May 31, 1977) [hereafter cited as “Opinion
No. 769-A”’], JA in No. 77-1496 et al. at 394.
18a
base only those advances found “reasonable and ap-
propriate.”
The initial advance payment order established Account
166, Advance Payments for Gas, and provided that “ad-
vance payments for gas would be recorded as prepay-
ments and unrecovered advance payments would be in-
cluded in the rate base as part of working capital.” *
Various express conditions limited the advance payments
that would be considered for inclusion in rate base. Some
of these conditions were modified in the subsequent ad-
vance payment orders.** Each. of the orders stated that
83 Order No. 410, supra note 4, 44 FPC at 1143.
34 Order No. 410 encompassed advance payments to inde-
pendent or affiliated producers for exploration, lease acquisi-
tion, development, or production of natural gas, “when such
advance payments are to be repaid by delivery of gas. Id.
at 1146. Advances had to be fully recovered within a “reason-
able period of time following commencement of deliveries,
and in any case “within a 5-year period.” Jd. The rate base
account had to be credited by the amount of non-recoverable
advances. Id.
Order No. 410-A, supra note 4, suspended rate-base treat-
ment for advances to affiliated producers for exploration and
lease acquisition costs. 45 FPC 135 (1971). Order No. 441,
supra note 4, limited the program to the period ending Dec. 31,
1972, and denied rate-base treatment to all advances for ex-
ploration and lease acquisition, as well as payments to both
affiliated and independent producers which resulted in a
working interest. 46 FPC at 1180-81. Where economic inter-
ests other than a working interest were received by a pipeline
as a result of an advance payment properly includable in the
rate base, any realization therefrom was to be treated so as to
reduce the pipeline’s most of service. Jd. at 1181. Advance
payments might be repaid by delivery of natural gas or by
other consideration, and full repayment was required within
five years from the date gas deliveries commenced or the date
it was determined that recovery would be in other than gas.
Id. at 1180.
Order No. 465, supra note 4. extended the program for one
year and reallowed rate-base treatment of advances for ex-
19a
“the Commission plans to consider those amounts re-
corded in Account 166, Advance Payments for Gas, as
rate base items, where found reasonable and appropri-
ate.” ** Thus, properly recording an advance in Account
166 was a necessary, but not a sufficient, condition for
inclusion in the rate base. The Commission also had to
be satisfied that the advance was “reasonable and appro-
priate.”
There has been no dispute that the advance payments
at issue in these cases complied with the express condi-
tions in the pertinent advance payment orders. What is
ploration while. continuing to deny it for lease acquisition
costs. 48 FPC at 1554. Advances by a pipeline to an affili-
ated producer were eligible for rate base treatment, even if
the affiliate obtained a working interest. Jd. at 1154-55. Ad-
vances had to be fully repaid within five years of the date
deliveries commenced, or the date it was determined that
repayment would be in other than gas; and the delivery-
commencement or alternative-determination date had to be
within five years from the date of the advance. Jd. at 1153-
54. A refund to customers was required if an advance re-
sulted in the finding of proven reserves, gas deliveries
commenced, but no gas flowed to the advancing pipelines. /d.
at 1554. |
Order No. 499, supra note 4, extended the program for
another two years and expanded its coverage to include
Alaskan advances made under future contracts (previously
only advances in the lower 48 states where eligible for rate
base treatment). 50 FPC at 2115. Advances to independent
producers resulting in the acquisition of a working interest
were permissible, and economic benefits derived from working
interest advances need not be credited against the pipeline’s
cost of service. Jd. at 2114.
3° Order No. 410, supra note 4, 44 FPC at 1144; Order No.
410-A, supra note 4, 45 FPC at 185 (by incorporation of Order
No. 410); Order No. 441, supra note 4, 45 FPC at 1181;
Order No. 465, supra note 4, 48 FPC at 1555, Order No. 499,
supra note 4, 50 FPC at 2115.
20a
contested is the Commission’s discretion to interpret and
administer the “reasonable and appropriate” guideline.
Two orders govern the advance payments in these
eases. Order No. 465, issued December 20, 1972, gov-
erns advance payment contacts made during 1973.
It contains an unelaborated statement of the reason-
able and appropriate standard.** On December 28, 1973,
the Commission issued Order No. 499, which governs
advance payment contracts made during 1974-75. In
that order, responding to public comments raising the
critical timing issue, the Commission emphasized the
applicability of the “reasonable and appropriate” stand-
ard to that issue. It did not adopt a strict timing rule,
but instead stated that as a “general policy” advances
must be appropriately expended by the producer within
a “reasonable time.” *
36 The Order provided: “Consistent with the amendments
to Section 154.62 of the Regulations under the Natural Gas
Act adopted herein, the Commission plans to consider those
amounts allowed in Account 166, as rate base items, where
found reasonable and appropriate.” Order No. 465, supra
note 4, 48 FPC at 1555.
8750 FPC 2111, 2115 (1973):
[A]s a general policy we shall not consider amounts ad-
vanced to be “‘reasonable and appropriate” for inclusion
in rate base where such amounts are in excess of costs for
exploration, development and production incurred by the
producer within a reasonable time from the date such
amounts advanced are included in the pipeline’s rate base.
The Commission declined to formulate specific timing stand-
ards, determining instead to “examine each advance on a case
by case basis.” Accounting and Rate Treatment of Advances
Included in Account No. 166, Advance for Gas Exploration,
Development and Production, Docket Ne. RM74-4, Order
Denying Rehearing of Order No. 499, 51 FPC 818, 819 (1974).
2la
Huge sums in extended front-end advances were trans-
ferred to producers under contracts subject to Order
No. 465. Despite the Commission’s signal in Order No.
499 that it intended to focus on the critical timing re-
quirement, the flood did not abate.*®
D. The Administrative Proceedings
The administrative proceedings commenced with sep-
arate filings by petitioners for jurisdictional rate in-
creases pursuant to section 4 of the Natural Gas Act.*®
Each filing was initially suspended, then became effective
subject to refund.*°
In the ensuing hearings the pipelines proposed that
all advance payments made during the test period that
complied with the express conditions of the relevant ad-
38 A report prepared on the basis of Commission files cal-
culated that a total of $5.5 billion had been committed in
advance payments as of February 1, 1976. Of that total it
would appear that little more than 1% was advanced on a 30-
day line-of-credit basis. INGAA Br. in No. 77-1496, e¢ al. at 5
n.3; JA in No. 77-1496, et al. at 370. Of this total, more than
$4.2 billion in front-end advance payments were reportedly
committed between August, 1973 and February, 1976. JA in:
No. 77-1496 et al. at 370.
3° 15 U.S.C. 717c (1976).
40 Filing by Tennessee Gas Pipeline Co. (No. 77-1496 et
al.) occurred on June 15, 1973, was accepted and suspended
on August 1, and became effective subject to refund on Janu-
ary 1, 1974. JA in No. 77-1496 et al. at 321.
Transcontinental Gas Pipeline Corp. (No. 77-1212) made
its pertinent filing on July 16, 1974. It was accepted and
suspended by the Commission on Aug. 31, 1974, with the rates
becoming effective subject to refund on Feb. 1, 1975. JA in
No. 77-1712 at 165-66.
Michigan Wisconsin Pipeline Co. (No. 77-1719) filed for
its rate increase on November 15, 1974. The rates became
effective subject to refund on January 1, 1975. JA in No.
77-1719 at 104.
22a
vance payment order should be included in the rate base.
The Commission Staff argued that a reasonable timing
element was inherent in the reasonable and appropriate
standard and that the payment of advances could only
be justified as necessary to provide producers a line of
credit for current obligations. The Staff relied on the
testimony of Robert H. Benna, who stated in part: “*
Based on my experience with Shell, I understand
that producers are normally allowed 30 days from
the date of billing to pay for contract work and
materials. Thus, from the producers’ standpoint,
receipt of an advance one month prior to the date
the related payment is due should allow ample time
to pay the bill. The important factor, to the pro-
ducer, is that he has a commitment by a financially
stable pipeline to make advances in amounts and
at the time necessary to cover exploration and de-
velopment costs.
In the Staff’s view, an advance was not reasonable
and appropriate for inclusion in the rate base unless it
was appropriately expended by the producer within 30
days of receipt. It was argued that the pipelines’ stock-
holders, rather than their rate payers, should bear ti-
carrying charges on front-end advances paid more than
30 days prior to their expenditure. Adapting this stand-
ard to the test-period methodology employed in rate
making, the Staff proposed to disallow inclusion of ex-
tended front-end advance payments made during the
test period but not appropriately expended within 30
days of its close.** The Staff would have allowed an
41 JA in No. 77-1712 at 64; JA in No. 77-1719 at 42-43;
see JA in No. 77-1496 et al. at 6-7.
42 JA in No. 77-1496 et al. at 309; JA in No. 77-1712 at
145-46; JA in No. 77-1719 at 108-11. It may be noted that
this approach allowed certain advances to be included in
rate base even if they were expended more than 30 days after
23a
exception to this rule when it was demonstrated that a
financial savings to the rate payer would result from
the terms of a particular advance payment contract that
— the added cost of deviation from the 30-day
rule.
In response, the pipelines submitted extensive evidence
of the competitive circumstances obtaining during the
period in which the challenged advance payments were
made. The pipelines argued that, in this environment,
refusal to bid competitively for gas reserves by offering
extended front-end advances would have left any hesitant
pipeline without gas to meet its commitments, and that
such a refusal would have been irresponsible in light of
the pipeline’s obligations to its customers.“* Thus, it
receipt. Though an advance made on the last day of a one year
test period would have to have been expended within 30 days
to qualify, advances made on the first day of that test period
would qualify if expended anytime within the subsequent
13 months. Thus it might be argued that the effective timing
reqirement (i.e., the average permissible front-end lag time)
was considerably in excess of 30 days.
*8 JA in No. 77-1712 at 145; JA in No. 77-1719 at 116.
** See Opinion No. 769, Tennessee Gas Pipeline Company,
Docket No. RP73-113, Opinion and Order Affirming in Part
and Reversing in Part Initial Decision Establishing Just and
Reasonable Pipeline Rates (July 9, 1976) (hereafter cited as —
“Opinion No. 769”) (opinion of Commissioner Holloman,
dissenting at 2) (“A pipeline such as Tennessee faced with
this competitive climate would be remiss in its attempts to
attach new supplies of gas on behalf of itself and its cus-
tomers if it did not use this tool to enter into new gas supply
contracts.”) JA in No. 77-1496, et al. at 359; Opinion No.
769-A, note 32 supra (opinion of Commissioner Holloman,
dissenting, at 1) (“For the plain fact is this program was
thrust upon the pipeline companies, leaving them little choice
but to negotiate for these arrangements or abandon the field
to competing pipelines. Obviously, considered in the context
of growing curtailments and deteriorating gas supply, the
24a
was argued, an advance made in good faith response to
competitive conditions was both reasonable and appro-
priate and should be fully included in the rate base.
The administrative law judges in the proceeding be-
fore us, while diverging somewhat in particular results,
were congruent with each other in critical aspects.”
latter course would have evidenced a willful disregard of
Tennessee’s responsibilities to its customers bordering on
negligence.”), JA in No. 77-1496 et al. at 406.
** Tennessee sought inclusion in rate base of nearly $197
million in advance payments to domestic producers, all gov-
erned by Order No. 465. JA in No. 77-1496 et al. at 313. The
administrative law judge rejected Staff’s 30-day rule as “un-
duly restricted and arbitrary.” Jd. at 311. In general, the pipe-
line’s unchallenged good faith and business judgment was
found to qualify advances as reasonable and appropriate. /d.
at 310-11. However, the ALJ perceived an important differ-
ence with respect to $59 million of the total, comprising ad-
vances to affiliated producers. He found that these advances
did not constitute an “arm’s length transaction” since the un-
earmarked affiliate funds were advanced near the close of the
test period and were available for uses unrelated to gas de-
velopment. Approximately $28 million in unexpended intra-
corporate domestic advances were excluded from rate base. /d.
at 314-15.
Transco’s advances, totaling approximately $15 million,
were governea in part by Order No. 465 and in part by Order
No. 499. The pipelines’ business judgment rule was accepted
with respect to the Order No. 465 advances. JA in No. 77-
1712 at 147. However, the ALJ viewed the articulation in
Order No. 499 of a reasonable timing requirement as a sharp
change in Commission policy. All Order No. 499 advances
not expended at the close of the test period were excluded
from rate base. Jd. at 152-54.
Approximately $11.5 million in advance payments, governed
by Order No. 499, are involved in the Michigan-Wisconsin
proceeding. The ALJ found that all the front-end advances,
including those made to an affiliated producer, satisfied the
reasonable timing requirement even though they did not
comply with Staff’s 30-day rule. JA in No. 77-1719 at 112-14.
25a
Each was receptive to the competitive conditions justifica-
tion proffered by the pipelines. Each perceived the ex-
press mention in Order No. 499 of the timing require-
ment as a shift in Commission policy. By and large,
each rejected the Staff’s 30-day rule.
The Commission overruled the initial decisions, adopt-
ing the Staff’s position that a reasonable timing require-
ment was inherent in the reasonable and appropriate
standard of both Order No. 465 and Order No. 499. In
its view, the advance payment program was designed to
benefit rate payers by providing capital to finance ex-
ploration and development of additional gas supplies and
to expedite development of existing reserves. It was not
intended to provide a license for pipelines to bid against
each other for available gas. The Commission concluded
that there was no inherent justification in terms of the
purposes of the program for advances made prior to the
time they were reesonably required to facilitate qualify-
ing producer expenditures. While these extended front-
end advances provided a benefit to producers, no public
service benefit could be discerned. In the Commission’s
view, only one consideration was relevant in determining
whether a timing relationship satisfied the reasonable
and appropriate standard: the financial requirements of
the transaction, i.e., the lag time required to allow a
smooth transfer and expenditure of funds. The Com-
mission regarded the Staff’s 30-day line-of-credit rule
as a well-pleaded presumption, subject to rebuttal, as to
producer needs and pipeline abilities. Since there had
been no showing by the pipelines that producers re-
quired funds more than 30 days prior to appropriate
expenditure, nor that pipelines needed more time to
finance advances, the Staff’s rule was applied to de-
termine inclusion in the rate base.“® The Commission
** Opinion No. 769, supra note 44, at 29-84, JA in No. 77-
1496, et al., at 348-51; Opinion No. 769-A, supra note 82, at
26a
stated: * '
[While we do not find that a maximum time lag of
thirty days between advance and expenditure is
necessarily the only reasonable and appropriaic
standard, it was well pleaded and completely un-
rebutted. ...
The Commission adopted the Staff’s proposal that any
advances failing to satisfy the 30-day test would be
included in rate base only if the terms of the particular
advance payment contract would “save the ratepayer
more in advance payment carrying charges than would
be saved by insisting upon Staff’s 30 day installment
rule.” *® The Commission did not consider that its ex-
press reference to the timing requirement in Order No.
499 represented a dramatic shift in policy from its
earlier orders. Rather, the reference merely highlighted
4-10, JA in No. 77-1496 et al. at 395-401; Opinion No. 801
Transcontinental Gas Pipe Line Corp., Docket Nos. RP74-48
& RP75-3, Opinion and Order Affirming in Part and Reversing
Initial Decision on Reserved Issues and Establishing Just and
Reasonable Pipeline Rates 21-23 (May 31, 1977) [hereafter
cited as “Opinion No. 801”], JA in No. 77-1212 at 185-87;
Michigan Wisconsin Pipe Line Co., Docket No. CP70-22, et al.,
Order Reversing Initial Decision 2-4 (June 3, 1977) [hereafter
cited as ‘““Michigan-Wisconsin Order”’], JA in No. 77-1719 at
116-20. The Commission declined to differentiate between
advances to affiliated and to non-affiliated producers, thus
differing from the reasoning of the ALJ in the Tennessee
proceeding. But the same result was achieved—exclusion of
unexpended intracorporate advances from the rate base—on
the basis of the 30-day standard.
‘7 Opinion No. 769-A, supra note 82, at 5, JA in No. 77-1496,
et al. at 396; Michigan-Wisconsin Order, supra note 46, at 4,
JA in No. 77-1719 at 119.
‘8 Opinion No. 801, supra note 46, at 22, JA in No. 77-1712
at 186; see Opinion No. 769, supra note 44, at 32, JA in No.
77-1496, et al. at 351; Michigan-Wisconsin Order, supra
note 46 at 3, JA in No. 77-1719 at 118.
27a
one element of the reasonable and appropriate standard.
Thus, the same criteria were applied to both Order No.
465 and Order No. 499 advances.
The net effect of the Commission’s advance payment
determinations was the temporary exclusion from the
rate base of advances not satisfying the timing re-
quirement. It is important to note that this was a de-
ferral, not a disqualification. Subsequent filings for rate
increases would entail new test periods; ultimately, when
the expenditure was in fact made during a test period
or within 30 days after its close, the deferred advances
would be included in the appropriate rate base. This
deferral aspect must be distinguished from outright
disqualification resulting when advances failed to satisfy
one or more of the express conditions stated in the ad-
vance payment orders. Nevertheless, substantial sums
were involved and deferral has resulted in considerable
losses for the pipelines’ stockholders.
KE. Interpretation of the Advance Payment Orders
The pipelines assert that the advance payment orders
contemplated the use of extended front-end advance pay-
ments as a mode of competition for available supplies of
gas. From this it is argued that the Commission’s cur-
rent interpretation constitutes retroactive rule making.
The pipelines rely principally on various excerpts from
the text of the orders, and draw additional support from
language in previous administrative decisions. Moreover,
it is asserted that to the extent the Commission’s cur-
rent interpretation might at one time have been a reason-
able and legally supportable construction, that approach
has been foreclosed by the Commission’s repeated re-
newal of the program without appropriate modification
in the face of actual and constructive notice that ex-
tended front-end advances had become a term of trade.
The express mention of a reasonable timing standard in
28a
Order No. 499 is viewed as an inadequate reaction to a
crying need. Indeed, the generality of the Commission’s
response to specific comments is cast as further evi-
dence that the Commission did not intend at the time to
curtail extended front-end advances. Finally, as to the
Commission’s use of Staff’s 30-day rule as a presumption
subject to rebuttal, petitioners challenge its evidentiary
basis, and more fundamentally its premise that the only
factor relevant to application of the reasonable and ap-
propriate standard was the financial requirements of the
transaction.
The essence of petitioner’s arguments is this: multiple
factors encouraged extended front-end advances, and no
specific Commission direction restricted their use. As-
serting that each pipeline’s good faith business judgment
should prevail over the Commission’s present interpreta-
tion, petitioners propose this clear-cut rule: “the sole test
for determining whether the advance payments made
under these orders were to be included in rate base as
‘reasonable and appropriate’ [should have been] whether
they were made in order to obtain commitments for addi-
. tional gas supplies.” *
We find that petitioners’ arguments in support of their
interpretation are undercut by consideration of the char-
acter of the advance payment program as an experimen-
tal departure from well accepted and understood prin-
ciples of regulatory law. The Commission has correctly
construed the underlying purposes of the program as it
was understood by this court in PSC (Advance Pay-
ments) I & II and has not abused its discretion in
discerning a reasonable timing requirement and in re-
jecting petitioners’ “business judgment rule” as the “sole
*® Tennessee Br. in No. 77-1496, et al. at 15 (emphasis
deleted).
29a
test” for the program’s administration.*” Compictely sep-
arate, however, is the question whether the Commission,
in choosing a manner of administering the reasonable
timing requirement, gave due consideration to all perti-
nent factors. As discussed in section I-F infra, we con-
clude that it did not, and remand. But first we turn
to those considerations that support rejection of peti-
tioners’ business judgment rule.
1, Petitioners have the burden of demonstrating an
affirmative authorization for extended front-end advances.
In Smyth v. Ames," the Supreme Court articulated the
guiding principle that “the basis of all calculations as
to the reasonableness of rates to be charged by a | pub-
lic utility] must be the fair value of the property being
used by it for the convenience of the public.” Although
methods for determining values of rate base items have
evolved since Smyth v. Ames," the precept endures that
an item may be included in a rate base only when it is
°° Although we employ the term “business judgment rule”
to characterize the pipelines’ suggested approach, we do not
intend to import the extensive jurisprudence that has de-
veloped in connection with use of the term as a standard
for measuring the duty of corporate directors and other
fiduciaries.
*' 169 U.S. 466, 546 (1898) (emphasis supplied).
"2 See FPC v. Hope National Gas Co., 320 U.S. 591, 605
(1944) ; FPC v. Natural Gas Pipeline Co., 315 U.S. 575, 599-
608 (1942) (concurring opinion of Black, Douglas and
Murphy, JJ.) ; Driscoll v. Edison Light & Power Co., 307 U.S.
104, 122-24 (1939) (Frankfurter, J., concurring) ; McCart v.
Indianapolis Water Co., 302 U.S. 419, 423-41 (1988) (Black,
J., dissenting) ; Missouri ex rel. Southwestern Bell Tel. Co. v.
Public Service Com’n., 262 U.S. 276, 289-312 (1928) (opinion
of Brandeis, J.) ; City of Detroit v. Panhandle Eastern Pipe
Line Co., 3 FPC 273, 278-80 (1942) ; Chicago District Elec-
tric Generating Corp., 2 FPC 412, 416-20 (1941).
30a
“used and useful” in providing service. In other words,
current rate payers should bear only legitimate costs of
providing service to them. The FPC early adopted the
“used and useful” standard and has not departed from it
without careful consideration of the wisdom of requir-
ing current rate payers to bear costs of providing future
service.*®
533 F.g., Mississippi River Fuel Corp., 4 FPC 340, 344 (1945)
(“It has been the general practice of this Commission to deter-
mine the rate base bv ascertaining the net investment in the
gas plant used and useful in rendering service, and adding ;
reasonable allowance for working capital.”’) ; Chicago Distric
Electric Generating Corp., 2 FPC 412, 420 (1941). The “used
and useful” standard was expressly incorporated into the de-
preciation provisions of section 9 of the Natural Gas Act, 15
U.S.C. §717h (1976), which provide in part: The eee
mission may from time to time ascertain and determine, an
by order fix, the proper and adequate rates of depreciation
and amortization of the several classes of property of each
natural-gas company used and useful in the production, trans-
portation or sale of natural gas.”
Compare Cities Service Gas Co., 3 FPC 459, 490 (1943)
(‘While a strict interpretation of rate making principles
might require no allowance for return and depreciation on
the Hugoton [pipeline] project u. ‘il it is completed and in
service, we believe that, because of use urgent necessity for
relieving the gas transportation shortage during the war
emergency, it is in the public interest presently to make
such an allowance in connection with the interim reduction of
rates ordered in this pruceeding.”) ; General Policy and Inter-
pretations, Inclusion of Construction Work in Progress in
Rate Base, 41 Fed. Reg. 51392, 51393 ( 1976) (“The ques-
tion of the proper treatment for ratemaking purposes of
capital expenditures which have not yet been placed in service
is one which is subject to a play of conflicting principles. On
the one hand, public utility regulation has generally adhered
to the principle that a rate base should only include items
which are ‘used and useful.’ On the other hand, regulation
has also always recognized that the expense of financing con-
struction to serve customers is itself a legitimate expense
which must ultimately be borne by the ratepayers.’’) ; Order
3la
One such departure was the advance payment program.
At the very least it contemplated that current rate pay-
ers would shoulder the costs (i.¢., the financing charges)
of qualifying advance payments. This was intended to
expedite the development of additional gas reserves by
providing supplemental sources of capital, which would
be used to provide service for future rate payers. Such
a modification of the “used and useful” principle was
thought justified in view of the discouraging supply
forecasts and the general correspondence between ciasses
of current and future rate payers. Consumers would
eventually have to bear the costs of developing needed gas
supplies. In theory, the advance payment program
promised to provide that gas at the lowest ultimate cost.”
The Commission has taken the position that any de-
parture from such a well-rooted regulatory principle
must be affirmatively authorized and that an authorized
departure must be presumed limited to its express terms.
We agree with the analysis that agency silence in these
circumstances must be construed to mean that tradi-
tional principles retain their vitality.» We are not so
clear that authorization for a departure from settled
principles must be expressly set forth in an order (as
contrasted with what is fairly discernible as the intent
No. 566, Changes in Accounting and Rate Treatment for Re-
search, Development and Demonstration Expenditur ., Docket
No. RM76-12 (June 3, 1977). Regulations permitting rate-
base treatment of R & D expenditures, with certain qualifica-
tions, are codified at 18 CFR 201(108) (1978).
** PSC (Advance Payments) I, supra note 3, 151 U.S.App.
D.C. at 316, 467 F.2d at 370.
°5 See NLRB v. Majestic Weaving Co., 355 F.2d 854, 860 (2d
Cir. 1966) ; NLRB v. International Bhd. of Teamsters, 225
F.2d 343, 348 (8th Cir. 1955). See Standard Oil Co. v. Dept.
of Energy, No. 6-18, slip op. at 20-56 (Temp. Emer. Ct. App.
12/13/78) (reaching a different result where there existed
no previously well-settled rule).
32a
of an order), but it must be established with reference
to the order.
This conclusion allows us to by-pass petitioners’ factual
assertions that, during the pendency of the program, the
Commission had actual and constructive notice that it
was widely understood within the industry to be acquiesc-
ing in extended front-end advances. It is urged that the
Commission’s failure expressly to restrict extended front-
end advances gave such payments an affirmative blessing,
or—what is the same thing—estops the Commission from
now asserting an interpretation contrary to that held by
the pipelines. We accept arguendo petitioners’ factual
assertions of notice, and reject their proffered conclu-
sion. Though a belief that the agency was cognizant of
widespread employment of extended front-end advances
may have further encouraged their use, the Commission’s
inaction cannot be construed to change existing law
where the Commission resists such a change and has
given no indication that it intended a wholesale abandon-
ment of traditional principles. Any modification of tradi-
tional principles broad enough to permit extended front-
end advances must be derived from the advance payment
orders themselves, not from Commission inaction. Fur-
ther, since the Commission relies on well-established
principles of public utility law, it is not sufficient for
petitioners to come forward with some conceivable inter-
pretation of language in the advance payment orders
that supports their view. At the very least, the burden
must fall on petitioners to demonstrate that a preponder-
ance of the interpretative evidence is favorable to their
position.
2. The program was intended to provide additional
sources of capital to expedite development of gas sup-
plies, not to give license for competition among pipelines.
Petitioners attempt to carry their burden of showing an
affirmative authorization for extended front-end advances
33a
by citing specialized provisions of the advance payment
orders, which they construe to support their position. The
first problem is that the cited passages, often less than
clear, are subject to conflicting interpretations.** But a
more fundamental difficulty with petitioners’ approach is
the premise that the underlying purposes of the program
5° For example, petitioners place substantial reliance on the
statement in Order No. 441, supra note 4, that: “Advances
may be recorded in Account 166 and shall be included in rate
base where such payments are reasonable, necessary and
appropriate in order to contract for gas supplies by agree-
ment executed not later than December 31, 1972.” 46 FPC at
1180 (emphasis supplied). Petitioners focus our attention on
the facially directory langauge. It may be noted first that fol-
lowing this statement, the order iterates, “the Commission
plans to consider those amounts recorded in Account 166, Ad-
vance Payments for Gas, as rate base items, where found
reasonable and appropriate.” Jd. at 1181. An harmonious
construction of these two sentences is that need “‘to contract
for gas supplies” is a necessary, but not a sufficient condition
for inclusion in rate base. We may note secondly that the key
ingredient added to the order by the relied-upon sentence is
specification of the order’s termination date as December 31,
1972. Concentration on the sentence’s primary purpose may
have caused the Commission to overlook careless drafting.
Insofar as petitioners’ argument is premised on a justifiable
reliance on the directory language, it is undercut by the Com-
mission’s paraphrase of the critical sentence in the Order of
Clarification and Denial of Rehearing or Modification, 47
FPC 57, 58 (1972):
Tennessee is uncertain as to whether a return will be
allowed on the unamortized balances of non-recoverable
advances. It is our stated position in the fourth para-
graph of page 1180 of Order No. 441, that advances re-
corded in Account 166 may be included in rate base
where such payments are reasonable, necessary and ap-
propriate in order to contract for gas supplies by agree-
ment executed not later than December 31, 1972. There
is no provision for the inclusion in rate base of amounts
that must be eliminated from Account 166.
(Emphasis supplied.)
34a
were sufficiently ambiguous to admit of an interpretation
favorable to extended front-end advances. We find over-
whelming the Commission’s evidence as to the purposes
of the program, as intended by the Commission and as
understood by this court in PSC (Advanced Payments) I.
Thus we need not pause to consider in depth the particu-
lars of petitioners’ references (and the Commission’s
strenuous rebutta!s) but may proceed to consider the
evidence supporting the Commission’s narrower view.
In the introductory paragraphs to Order No. 441, the
advance payment order conditionally approved in PSC
(Advance Payments) I, the Commission stated: °7
In our area rate opinions for Southern Louisiana
and Texas Gulf Coast (Opinion Nos. 598, 46 FPC 86,
and 595, 45 FPC 674), we recognized that it is the
function of a just and reasonable rate for inde-
pendent producers to elicit requisite gas supply, and
that costs, in economic terms, reflects the required
level of capital formation to elicit that level. In
other words, the just and reasonable area rate in
these recent opinions did not consider “non-cost”
items. Having acknowledged, as we do, that provi-
sions for special rate treatment of advance payments
by pipelines have been justified in the past on the
basis of providing additional incentives in this ex-
perimental undertaking, we nevertheless seek to
hy separate, non-price incentives as much as pos-
sible.
A critical shortage of gas exists in the United
States; capital formation for gas development is
difficult. The objectives of providing capital to ac-
celerate the addition of new gas supplies supports
our continuation for the limited period of the rate
treatment of advance payments provided herein. We
recognize that the just and reasonable area rates
5? Order No. 441, supra note 4, 46 FPC at 1179-80.
35a
for independent producers will hopefully alleviate
this gas supply shortage over the long-run; however,
for the immediate term, (namely through 1972) our
advance payments policy has been designed to in-
crease directly the funds available for the necessary
exploration and developmental effort. It is our in-
tention that rate base treatments for advances in-
cluded in Account 166 be terminated for advances
resulting from contracts executed after December
31, 1972, unless otherwise ordered.
The Commission’s starting point was its recognition
of the role of just and reasonable area rates for pro-
ducers in “elicit{ing] requisite gas supply.” For the
long-run, the articulated policy was to incorporate in the
certificated rate all required incentives to assure requisite
supply; ‘“‘non-price incentives” were to be avoided “as
much as possible.” Contrary to this long-term policy, ad-
vance payments embodied a “non-price incentive” in the
“bonus” inherent in the interest-free loan of capital.
Nevertheless, since the Commission recognized that a
“critical shortage of gas exist[ed]” and “capital forma-
tion for gas development was difficult,” the “objective
of providing capital to accelerate the addition of new gas
supplies” justified continuation “for the immediate
term” of a policy “designed to increase directly the
funds available for the necessary exploration and develop-
mental effort.” It was apparent on the face of the order
that the purpose of an advance payment was to provide
“reasonable and appropriate” developmental capital for
“qualifying expenditures.” Yet, the pipelines argue that
the orders approve] all extended front-end advances, con-
tary to the Commission’s view that for the extended
period between receipt and expenditure many of these
advances made no such contribution of developmental
capital while providing producers with a non-rrice incen-
tive of the type the program explicitly sought to avoid
“as much as possible.” In the face of such a clear ex-
36a
pression of limited purpose, we find untenable the argu-
ment of the pipelines for carte blanche authority to
make advances.
One of petitioners’ arguments that figures prominently
in any defense of the pipelines’ behavior asserts that the
advance payment program contemplated competition
among pipelines for available gas through the use of
extended front-end advance payments, which would ef-
fectively raise the price of natural gas and thus inevita-
bly contribute, in an indirect way, to the alleviation of
the natural gas shortage. The fatal weakness in this
argument is that it confuses an incentive with a justifi-
cation. Certainly the Commission contemplated that the
prospect of obtaining additional gas reserves for an in-
dividual gas distribution system would encourage a pipe-
line to offer advance payments. But the mere fact that
an advance payment made good business sense to the
advancing pipeline was not alone sufficient to authorize
its use. Advance payments were not an end in them-
selves. They were legitimate only insofar as and to the
extent that they provided producers with a source of
developmental capital for use in qualifying expenditures.
In the passage from Order No. 441 quoted above, the
stimulating effect on gas supply of the price-incentive
aspect of advance payments was expressly excluded by
the Commission as an objective of the advance payment
program; rather, the price-incentive aspect was tolerated
as a necessary and subsidiary adjunct to the capital-
formation objective. .
The conclusion that the Commission had no intention
of encouraging internecine bidding among gas-starved
pipelines is fortified by the pervasive tone of the advance
payment orders, exemplified by the above-quoted pas-
sage, that the overall goal in both the long-run and the
58 See note 8 supra.
37a
immediate-term was to elicit requisite gas supply for the
nation as a whole, not for any particular pipeline system
at the expense of others.
In another provision of Order No. 441, the Commis-
sion showed a particularized concern that advances should
not be used for competitive purposes but rather should be
cost-justified in terms of the consumer benefit derived
from furtherance of the program’s objectives :*
Our review of the various comments and available
data has persuaded us that advances for explora-
tion and lease’ acquisition have not [been] shown
to be an effective vehicle for stimulating the wide-
spread participation in natural gas production for
which their encouragement was intended. Moreover,
there is some indication that the availability of ad-
vances for such purposes by creating competition
among pipelines to make such advances may be hav-
ing the effect of increasing the amounts expended
on lease acquisition without a proportionate improve-
ment in gas supply.
The Commission excluded from the category of “qualify-
ing expenditures” advance payments for exploration and
lease acquisition since they could be identified as an entire
category that did not further the justifying objectives
of the program, but were instead fostering undesirable
competition among pipelines without an offsetting con-
sumer benefit. When this court affirmed the program in
PSC (Advanced Payments) I, we highlighted this ad-
justment as an example of the Commission’s flexibility
and willingness to modify the program, which we con-
sidered a prerequisite to sound administration.”
5° Order No. 441, supra note 4, 46 FPC at 1180 (emphasis
supplied).
%° PSC (Advance Payments) I, supra note 3, 151 U.S.App.
D.C. at 313, 467 F.2d at 367.
38a
In PSC (Advance Payments) 1, we unambiguously un-
derstood the program’s objective to be the creation of an
additional source of capital to facilitate the natural gas
development and production necessary to alleviate the
gas shortage. In one illustrative passage, we noted:®
The rationale behind this decision is that the ad-
vance payments will help to give the gas producers
the necessary investment capital to finance the de-
velopment and production needed to alleviate the
gas shortage, and the pipelines will be encouraged
to make such advance payments if they are allowed
to include the payments in their rate base, thus
virtually simultaneously shifting the cost of the ad-
vance payments to the pipelines’ customers, the nat-
ural gas consumers.
There was no hint in PSC (Advance Payments) I that a
justifying objective of the program was the encourage-
ment of competition among pipelines for scarce supplies
of gas. On the contrary, by consistently referring to
“producers,” “pipelines” and “consumers” throughout the
opinion, we evidenced our conviction that the revelant
interests were nationwide in scope, not those of any par-
ticular pipeline or its customers.
It is a crucial aspect of this case, refuting the pipe-
lines’ basic retroactive rule making contention, that the
limited purposes of the advance payment program were
unambiguously articulated, in both Order No. 441 and
in the affirming opinion of this court, well prior to the
date of any advance payment contract involved in these
cases.
In PSC (Advance Payments) I we had made clear that
continued approval of the program was dependent. on the
Commission’s ongoing modification and evaluation to as-
1 Jd, at 809, 467 F.2d at 363. See also id. at 317, 467 F.2d
at 871 (on petition for rehearing).
39a
sure that the program was accomplishing its ultimate
purposes—alleviation of the gas shortage—at an ac-
ceptable cost to the natural gas consumer. This process
was undertaken in both Order No. 465 and Order No.
499. In the opening sentence of each, the Commission
stated that the focus of its inquiry was “to determine
whether the advance payment program [was] stimulat-
ing activity toward increasing the supply of natural gas
sufficiently to justify the extension of rate base treat-
ment of advances.” In Order No. 465 the Commission
concluded: “in view of our analysis of all the responses
. and our review of the program of advances in gen-
eral, we find that rate base treatment of advances to
producers has ‘represented a justifiable experiment in
the continuing search for solutions to our nation’s critical
shortage of natural gas.’” [Quoting from PSC (Ad-
vance Payments) [| In Order No. 499 the Commis-
sion stated: “review of the data... indicates that the
advance payment program has continued to meet its
objectives of bringing additienal gas supplies into the
interstate market at an acceptable cost to the nation’s
gas consumers,” and “that pipeline advances have con-
tinued to accelerate the capita: formation which led to
the exploration, development and dedication of 10.27 Tef
of proven reserves of natural gas as well as 9.57 Tef of
potential reserves of natural gas to the interstate mar-
ket.” Neither Order No. 465 nor Order No. 499 severed
the tie between the objective of capital formation and the
authorized use of advance payments. Each Order con-
tinued to assess the program in terms of nationwide gas
supply, not improvement for some pipeline systems at the
62 Order No. 465, supra note 4, 48 FPC at 1550; Order No.
499, supra note 4, 50 FPC at 2111.
*3 48 FPC at 1553.
50 FPC at 2112-13.
40a
expense of others. Again, there was direct evidence that
competition among pipelines was not a desirable nor in-
tended effect of the program.” Although we found the
Commission’s review of the data inadequate in PSC
(Advance Payments) II, we found no inconsistency of
purpose in the Commission’s orders and reiterated our
understanding of the program as expressed in PSC (Ad-
vance Payments) I and in the previous orders.”
The Commission consistently referred. to the purpose
of capital formation to accelerate improvement in overall
gas supply as the purpose of the program and never put
forward the purpose of facilitating for its own sake the
enhancement of producer prices through competition
among pipelines for available gas supplies. Had the Com-
mission advocated such an objective, we discern no basis
on which we would have approved it as permissible under
the Natural Gas Act.
8. Leyul infirmity of a program approving all front-
end advances, The Natural Gas Act requires the Com-
mission to anchor its regulation of producers in the main-
tenance of just and reasonable rates. In T'exaco,"’ which
issued at a time when the strain of natural gas shortage
* In Order No. 465, supra note 4, the Commission stated:
It is clear then that advances for exploration and lease
acquisition have resulted in significant production activ-
ity. However, the comments indicate that advances for
lease acquisition may have been a contributing factor in
bidding up of the price of leases. Therefore we shall
henceforth allow advances for exploration in rate base
while continuing to exclude advances for lease acquisition
from rate base.
48 FPC at 1554 (1972).
PSC (Advance Payments) II, supra note 3, 167 U.S.App.
D.C. at 103-04, 111-18, 511 F.2d at 341-42, 349-51.
* FPC v. Texaco Inc., 417 U.S. 380 (1974).
4la
was acute, the Supreme Court held that the Commission
had acted impermissibly in exempting small producers
from direct rate regulation and rejected as inadequate the
Commission’s contention that it was sufficient to regulate
small producers indirectly, by reason of the consequences
of regulation of pipelines and of large producers. Indirect
regulation was permissible, but only when and if the
Commission developed safeguards to ensure that the rates
paid by pipelines, and ultimately borne by consumers,
remained just and reasonable."*
In Consumer Federation of America v. FPC,” we dis-
approved a program in which the Commission attempted
to authorize competitive bidding for needed gas supplies
by pipelines experiencing critical short-term supply diffi-
culties. That program granted producers 180-day exemp-
tions from rate limitations and permitted them to enter
into contracts with eligible pipelines without risk of re-
fund. The order provided that gas costs “shown to have
been required by the public interest” were to be passed on
to consumers." We invalidated the program, even though
it was proffered as an experiment responding to a supply
crisis, since it failed to provide adequate assurance that
just and reasonable rates would be maintained. We con-
cluded :*'
[T]he Commission has exceeded its authority under |
the Act. In essence, it has attempted to remedy the
shortfall of supply in the interstate market by au-
"* Td, at 401.
169 U.S.App.D.C. 116, 515 F.2d 347 (1975).
Order No. 491-B, 50 FPC 1463, 1470 (1978). The pro-
gram reviewed in Consumer Fedcration was governed by
Order No. 491, 50 FPC 742 (1973); Order No. 491-A, 50
FPC 848 (1973); Order No. 491-B, supra; and Order No.
491-C, 50 FPC 1684 (19738).
169 U.S.App.D.C. at 129, 515 F.2d at 360, quoting PSC
(Advance Payments) I, supra note 8, 167 U.S.App.D.C. at
116, 511 F.2d at 354.
42a
thorizing a supplemental injection of large quanti-
ties of gas through sales freed from the constraints
of meaningful regulation. We reject the FPC’s
claim that § 7(c) [of the National Gas Act] sup-
ports this substantial, partial deregulation, and find
that the Commission has neglected its rate control
responsibilities under the Act. Congress has yet to
embrace proposals for deregulation of new gas sup-
plies. Until it acts to alter the present “system of
regulation by an agency subject to court review, the
courts may not abandon their responsibility by ac-
quiescing in a charade or a rubber stamping of non-
regulation in agency trappings.”
To adopt petitioners’ contention, which would validate
any “timing” arrangement that a pipeline found justified
as a matter of business judgment were it to compete
successfully for gas supply in a shortage crisis, would be
nothing more nor less than acceptance of a deregula-
tory approach, a ruling that cannot be reconciled with the
teaching of Texaco and Consumer Federation. A _pro-
ducer receiving an extended front-end advance, to use
without restriction for a significant period prior to ex-
penditure, is in effect given a sum of money. There is no
meaningful distinction between receipt of unrestricted
funds for a period and receipt of a sum equivalent to the
“return” (at a minimum, interest) procurable from use
of the funds. In both circumstances producers will be
compensated in excess of certificated rates. The business-
judgment rule would permit pure competitive bidding by
pipelines using the device of extended front-end advance
payments.
Had the Commission articulated the approach now
advanced by the petitioners as an interpretation, we
would have disapproved it as an abdication of the agency’s
regulatory responsibilities. This is not to say that the
deployment of funds must be instantaneous. What is
43a
inappropriate is unrestricted transfer for more than a
reasonable period—a concept to which we shall return.
Any permission to transfer advances prior to gas de-
livery (even as to funds used immediately or in a reason-
able time for qualifying developmental expenditures)
entailed some variance from the previous situation, in
terms of benefit to producer and of cost to pipeline and
customer. However, the ultimate cost to the consumer
was projected to remain within the just and reasonable
range because of the compensating benefit of expedited
gas development, and the maintenance of restrictions
relating the cost to the benefit.** This justification, and
these safeguards, were lacking as to the extended front-
end advances made without restriction other than the
competitive “business-judgment rule.”
4. Claim of retroactive rule making. The foregoing
analysis undercuts petitioners’ contention that a reason-
able timing requirement amounted to retroactive rule
making. The pipelines had fair notice both of traditional
regulatory principles and that the advance payment pro-
gram exception was put forward and affirmed on a basis
that did not encompass the departure asserted by peti-
tioners.
In Natural Gas Pipeline Co. v. FERC, the Seventh
Circuit recently ruled that the Commission’s interpreta-
tion of the reasonable and appropriate standard to im-
pose a relatively inflexible “30-day rule” constituted im-
** These restrictions include the maximum allowable pay-
back period (see note 34 supra), economic motivations for
producers to proceed expeditiously with development once ad-
vances have been “sunk” in qualifying expenditures, and the
continued supervision of all aspects of timing and amount of
advance payments under the reasonable and appropriate
standard.
590 F.2d 664 (7th Cir. 1979).
44a
permissible retroactive rule making. It viewed the case
as falling within a doctrine, articulated in Bell Aerospace
Co. v. NLRB," whereby an agency’s broad discretion to
announce policy in adjudication is subject to an exception
in a case of severe impact and justifiable reliance on coli-
trary agency pronouncements.** It stated: *°
The consequences to the appellant of denying rate
base treatment to the advances are very severe. It
would mean the imposition of a large liability with
regard to the advances in the present case. Further-
more, the appellant’s entering into these agreements,
under these terms, was in reliance upon the prior
orders of the Commission, and the policies reflected
in those orders, specifically the policies encouraging
the advance payment program, with few restrictions,
and the promulgation of a flexible standard with re-
gard to the advance-expenditure time relationship.
We believe that the aforementioned facts require that
the Commission’s discretion to proceed by adjudi-
cation as opposed to by rulemaking be restricted so
as to prevent the imposition of a “30 day rule” in
this proceeding.
We differ from the Seventh Circuit in that, in our ap-
praisal, the Commission’s current interpretation of the
limited purpose of the' advance payment orders does. not
reverse a policy that had been the subject of reasonabie
reliance.
The Commission’s rulings on appeal are rooted in basic
principles of regulation and in petitioners’ notice of the
limited purpose of the advance payment exception. We ao
4 416 U.S. 267 (1974).
75 Jd, at 295.
76 590 F.2d at 669.
45a
not discern the substantial claim of justifiable reliance
that is needed to invoke the Bell Aerospace exceptions.”
In support of its rulin oretnaneas
NEG g the Seventh Circuit
decision in Consumer Federation: 78 cited our
While the factual pattern of Consumer Federa-
tion of America, supra, is not identical to the pres-
ent case, the opinion does demonstrate an effort be-
ing made to protect the pipeline companies from the
Squeeze which results if the pipeline incurs expenses
for emergency gas which is not refundable. A very
similar type of problem to that discussed in Con-
sumer Federation of America, supra, is present in
this case. Through Order No. 499, and the four
previous orders, the Commission encouraged a pro-
gram of advances by interstate pipelines to pro-
ducers to secure commitments of natural gas. Furth-
™ The limitations on permissible retroactivity m i
cerned from SEC v. Chenery Corp., 332 U.S. 194 oer wae
NLRB v. Majestic Weaving Co., 355 F.2d 854 (2d Cir. 1966)
(Friendly, J.). The relevant factors include the degree of
retroactivity, the need for administrative flexibility, and the
hardship on the affected parties. With respect to advance
payments, the Commission has not changed an explicit past
policy (Majestic Weaving) but rather has reaffirmed eal.
established regulatory principles. The need for flexibility is
evident in a case, such as this, where “the agency may ger
have had sufficient experience with a particular problem to
sein: gine es tentative judgment into a hard and
ule. enery, 332 U.S. at 202. Th issi
cifically noted the need for a case-by-case ee
timing question. See note 37 supra. Hardship to the pipelines
is mitigated by two factors. First, the Commission merel
has deferred rate-base treatment, not forever disqualified
extended front-end advances from inclusion in rate base
Second, even during the deferral period, the pipelines have
the assurance that their rates will remain at compensato
levels. FPC v. Texaco, 417 U.S. 380, 391-92 (1974) : FPC e
Natural Gas Pipeline Co., 315 U.S. 575, 585 (1942). S
78 590 F.2d at 670.
eee eg eg ee
46a
ermore, inherent within the Commission’s orders
was an attitude of experimentation and flexibility
as reflected in the “reasonable time” standard which
the Commission chose to include in Order No. 499.
Nevertheless, in electing to utilize a “reasonable
time” standard, by itself, the Commission failed to
furnish the pipelines with any sort of guidelines
which might be followed in contracting with pro-
ducers for commitments of gas reserves. Then
after the agreements are entered into and the ad-
vances made, the Commission wants a “reasonable
time” to be defined as “30 days”, with the obvious
effect of such action being that the pipeline would
be forced to absorb huge costs which are not capable
of being reflected in its rate base. To follow the
course set forth by the Commission would be to con-
travene the policy expressed by the court in Con-
sumer Federation of America, supra.
The Seventh Circuit’s citation of our opinion in Con-
sumers Federation is a subsidiary point in its approach,
dependent on its major premise of justified reliance. In any
event, we did not intend Consumers Federation to express
a general solicitude for all pipelines caught in a “squeeze”
to obtain gas. In that case there was a wholesale deregu-
lation of producers, and we found that the indefinite indi-
cation that pipelines would be held to a “public interest”
limit on prices paid was not enough to assure mainte-
nance of just and reasonable rates. In the present case,
there was a continuing regulation, not a deregulation, and
the advance payment order that was judicially approved
articulated a reasonable and appropriate standard which
the Commission, and this court, find was not discarded,
as to the matter of timing of payments, in favor of a
competitive business judgment rule.
While we differ from the Seventh Circuit both on the
issue of justifiable reliance and on the meaning of Con-
sumers Federation, we agree with that court in its dis-
47a
approval of the Commission’s relatively rigid “30-day
rule.” We concur in its view that “inherent within the
Commission’s orders was an attitude of experimentation
and flexibility,” * which in turn involves flexibility in
administration. We develop our views in the next section
of this opinion, but interpolate at this point that the
remand which we order can be implemented by the Com-
mission with results that do not violate the remand by
the Seventh Circuit.
F. Improper FERC Administration of the Advance Pay-
ment Program
We have concluded that the Commission acted within
its discretion in rejecting both the pipelines’ interpreta-
tion of the advance payment orders and their proposed
competitive business judgment rule for administration of
the “reasonable and appropriate” standard. We now turn
to a consideration of the Commission’s administration of
the “reasonable timing requirement,” which in light of
the program’s justifying objectives was implicit in the
reasonable and appropriate standard.
We recognize the limited scope of our review function.
Although a court may not supplant the Commission’s
well-reasoned judgments with those more nearly to its
liking, it must assure itself that “the Commission has
given reasoned consideration to each of the pertinent fac-
tors.” Permian Basin Area Rate Cases, 390 U.S. 747, 792
(1968).
1. Defining the reasonable timing requirement. In
evaluating the timing relationship between an advance
payment and its qualifying expenditure, the Commission
focused solely on the timing requirements of conventional
financing transactions.” It relied on the testimony of its
? Id.
89 See text accompanying note 46 supra.
48a
staff engineer Robert H. Benna set forth earlier in this
opinion.** His testimony, based on his earlier employment
by Shell, was submitted as evidence that producers could
satisfactorily arrange for payment of contract and ma-
terials costs on the basis of a continuing commitment and
specific payments thirty days in advance of due date.
From this the Commission evolved a 30-day line-of-credit
approach, which it established as a presumption subject
to rebuttal. It found that in the cases before it the rule
was unrebutted by evidence of financial inability on the
part of either producer or pipeline to arrange for pay-
ments due under advance payment contracts to be trans-
ferred on a line-of-credit basis. We find the Commission’s
approach unduly restrictive in that it failed to take ac-
count of all factors relevant to the “reasonable timing”
inquiry.
We agree with the Commission that its advance pay-
ment orders do not imply either a competitive business
judgment rule as the sole standard for timing of ad-
vances, or authority for the extravagant costs of extended
front-end advances not accompanied by reasonable con-
trols on the timing of expenditures. However this does
not mean that its orders disclosed a requirement that the
pipelines adopt the “tight” timing practices of conven-
tional financing transactions employed by producers like
Shell in their arrangements with contractors. No strict
line-of-credit requirement could fairly be implied from
the terms of the advance payment orders. By so restrict-
ing the scope of its “reasonable timing” inquiry, the Com-
mission failed to evaluate fully and fairly the reasonable-
ness of the protective mechanisms adopted by particular
pipelines to fulfill their obligation of vigilance in the con-
sumers’ interest.”
81 See text accompanying note 41 supra.
82 Had the Commission considered all pertinent factors, we
would ot lightly overturn its result merely because of severe
49a
The advance payment program was accepted by all
concerned aS an experimental and unconventional method
of financing producer expenditures. The program em-
bodied an important element of flexibility. This was a
key feature both of our approval of the program in PSC
(Advance Payments) I, and of our subsequent remand in
PSC (Advance Payments) II. Nothing in the advance
payment orders, not even in Order No. 499 with its
express reasonable timing requirement, hinted that the
pipelines were limited to line-of-credit or other conven-
tional banking practices in the development of practical
financing packages that would facilitate capital forma-
tion by producers while adequately protecting consumer
interests, thus keeping advances within the confines of
the program. Order No. 499 provided that as a general
policy an advance should be appropriately expended
within a reasonable time from “the date such amounts
advanced are included in the pipeline’s rate base.” * The
language of the order is instinct with latitude.
The Commission’s failure to take into account the in-
herent flexibility of the advance payment program was
the basis for our ruling in United Gas Pipe Line Co. v
FPC." In that case, involving latitude of choice of ian
cing methods, we vacated the Commission’s summary re-
hardship for pipeline investors. As recent]
Pennzoil Producing Co., 99 S.Ct. 765 (1979), pein
Court has suggested that the Commission’s discretion to with-
hold relief from harsh application of familiar regulatory
principles is not abused unless rate levels border on the con-
fiscatory. Id. at 772. That case involved the Commission’s
equitable discretion, not the review of a determination, as in
this case, of applicable legal standards arising in the context
of an experimental, conditionally approved program.
83 See note 37 supra.
** 179 U.S.App.D.C. 274, 551 F.2d 460 (1977).
ee
50a
jection of rate-base treatment for United’s complex finan-
cing arrangement, which entailed an interest-reimburse-
ment scheme rather than the lump-sum transfer of capital
more typical of advance payment contracts. The arrange-
ment contemplated that United would assist the pro-
ducer to locate sources of developmental capital, and then
reimburse the producer’s financing costs. In our opinion
for remand we noted that we found nothing in the ad-
vance payment orders precluding this method of facili-
tating capital formation.
In the pending case involving Transcontinental Gas
Pipeline Corporation (Transco) ,® the advance payment
contracts “provided for payment by Transco on January
10 and July 10 of each year of the estimated expendi-
tures for the subsequent six months, with adjustments
semi-annually and annually to ref&ct overexpenditures,
or underexpenditures, respectively.” ** The Commission
did not say one way or the other whether the pipeline
acted reasonably in fashioning this procedure as a tech-
nique for controlling producer expenditures. Instead, it
applied its line-of-credit rationale to exclude from rate
base all advances not expended within 30 days of the close
of the test period. It appears that Transco’s approach of
periodic accounting and adjustment, with a semi-annual
review of expenditures, constituted a prima facie
showing of an effort to tie payments to “qualifying
expenditures.” We agree with the position of the Public
Service Commission of the State of New York, intervenor
in the Transco proceeding, that in such a case “the shoe
is on the other foot” and it is incumbent upon the Com-
mission to articulate why this attempt to protect the
85 No. 77-1712.
8 Transco Br. in No. 77-1712 at 17-18.
5la
consumers’ interest falls outside the zone of reasonable-
ness contemplated by the advance payment orders.”
We remand the cases before us for a more extensive
and flexible inquiry by the Commission into the reason-
ableness of attempts to protect the rate payers from ex-
cessive costs. If it concludes that contracts such as those
presented by Transco did provide for reasonable timing
protections, the Commission would have latitude as a mat-
ter of equitable discretion to conclude that the kind of
interval found reasonable in a case such as Transco’s
could be accepted as a general bench mark, even as to
contracts that did not contain precisely the same pro-
visions. On the other hand, based on the circumstances
of a particular case, the Commission may determine that
a much shorter timing interval was reasonable. For ex-
ample, we note that in the proceeding involving Tennessee
Gas Pipeline Co.,* Tennessee transferred $59 million in
domestic advance payments to an affiliated producer.
These advances were effected within the last 35 days of
the test period, involved a mere bookeeping transfer with-
out restrictions on the timing or nature of expenditures,
and to the greater extent were not put to use in qualify-
ing expenditures for many months.® The ALJ disallowed
the unexpended portion of these advances because in his
judgment they did not constitute an arm’s length trans-
action. The Commission reached the same result on a
different rationale, deferring rate-base treatment on the
basis of the 30-day rule. On remand, the Commission
may determine that such advances to affiliated producers
present one example of unjustifiable misuse of the advance
payment program.”
87 PSC Br. in No. 77-1712 at 4.
88 No. 77-1496 et al.
89 JA in No. 77-1496 et al. at 318-14.
°° We construe the pertinent advance payment orders as
permitting advances to affiliated producers to be included in
52a
It is evident that a broad range of financing practices
were employed under the advance payment program.
Some may have evidenced a reasonable attempt to protect
rate payers from excessive costs; others, perhaps, did not.
We do not prejudge the result in any particular case;
such determinations are for the Commission in the first
instance.
In sum, we remand these cases because the Commission
failed to apply the proper legal criteria when it ad-
minstered the “reasonable timing” aspect of the “reason-
able and appropriate” standard. The advance payment
orders did not require adherence to strict line-of-credit
or other conventional banking practices, but rather were
- instinct with the attitude of flexibility and experimenta-
tion that motivated the advance payment program. The
Commission correctly determined both that good faith
response to competitive pressures was an inadequate
justification for advance payments and that the pipelines
had a responsibility to protect their rate payers from
excessive costs, ¢.g., to take reasonable steps to ensure
that the timing of advances was tied to that of “qualify-
ing expenditures.” But the advance payment orders al-
lowed a certain discretion to the pipelines and encouraged
them to develop practical financing packages that would
facilitate capital formation by producers while adequately
protecting consumer interests, thus keeping advances
within the confines of the program. Application of the
correct legal standard on remand requires consideration
of the various factors pertinent to a determination of the
reasonableness vel non of the pipelines’ efforts in ‘this
- direction.
Account 166 on the same basis as advances to non-affiliated
producers. However, there is no limitation in the orders re-
stricting the Commission’s ability to consider the affiliate re-
lationship as one factor pertinent to application of the reason-
able and appropriate standard in determining which advances
included in Account 166 qualify for rate base-treatment.
53a
2. Latitude on remand. The Commission has latitude
under its statute to use its equitable discretion and to
choose alternative procedures or mechanisms to formulate
and io effectuate its judgment; * the result need not re-
quire a painstaking readjustment of rate base in each
case.
The Public Service Commission of the State of New
York, an active and helpful participant in all phases of
the development, administration, and review of the ad-
vance payment program, cails our attention to the inter-
relationship between the Commission’s ruling on the ad-
vance payment question and its determination on rate-of-
return. In the Tennessee proceeding,*? the Commission
readjusted upwards the return on rate base allowed by
the administrative law judge, on the basis of a revised
assessment of the risks faced by the industry in these
times of acute supply shortages. In the Commission’s
view, the “pendulum has definitely swung in a direction
substantially contrary to the interests of the investor. A
time of adjustment is clearly called for.” ** One of the
risks incurred by the pipelines has been the “regulatory
risk” that an experimental program such as advance pay-
ments might miscarry, and that administrative readjust-
ment would not prevent substantial adverse impact. Com-
missioner Smith, whose vote in Tennessee was necessary
te form the majority, expressly premised his conecurrenc2
on the 1ink between treatment of advance payments and
rate of return.“ On remand the Commission will have
"' FCC v. Pottsville Broadcasting Co., 309 U.S. 134 (1940) :
Vermont Yankee Nuclear Power Corp. v. NRDC, 435 U.S. 519
(1978).
92 No. 77-1496 et al.
*§ Opinion No. 769, supra note 44, at 22; JA at No. 77-
496 ec? al. at 341.
4 Id., Commissioner Smith, concurring, at 4; JA in No. 77-
1496 ec al. at 357 (“The overai: result [on rate of return] is
54a
discretion to consider this interrelationship in reaching
a just result. In the other two cases before us, the rate-
of-return issue was settled prior to determination of the
advance payment question. If the Commission prefers to
use rate of return as the vehicle for adjustment, it may
consider whether it should reopen these settlement agree-
ments.* Another mechanism for effecting the final just
and equitable result is the ordering of only partial re-
funds, rather than the readjustment of rate base. The
Commission retains a broad discretion in such matters.”
One other significant factor that the Commission may
consider in exercising its latitude on remand is the im-
pact on the industry of the entire course of Commission
action in the development and administration of the
advance payment program.”
supportable only because of the treatment given advance pay-
ments.’’).
% By purporting to “settle” rate of return yet leaving open
the treatment of advance payments, such settlements may
have been rooted in an erronecus premise that these issues
could be put in separate analytic compartments and resolved
independently.
% As noted in Niagara Mohawk Corp. v. FPC, 126 US.
App.D.C. 376, 382, 379 F.2d 153, 159 (1967), “the breadth of
agency discretion is, if anything, at zenith when the action ...
relates primarily not to the issue of ascertaining whether con-
duct violates the statute, or regulations, but rather to the
fashioning of policies, remedies and sanctions.”
7 In another context, we approved the Commission’s deter-
mination to ignore the varied impact on producers of the ad-
vance payment program, and to make a “clean start” in its
prescription of a national rate. The Second National Natural
Gas Rate Cases, 186 U.S.App.D.C. 23, 59-64, 567 F.2d 1016,
1052-57 (1977), cert. denied, 485 U.S. 907 (1978). But that
situation involved allocation among producers of uneven gains,
and prescription of rates for the future. The pipelines are in
a different posture. The Commission has latitude to consider
whether the pipelines were caught between a rock and a hard
55a
It is appropriate to conclude our discussion of Latitude
on Remand, before going on to subsidiary issues, to em-
phasize that while the court has identified a number of
factors for consideration by the Commission, it is aware
that the appraisal and weighing of these factors is the
function of the agency and not of the court. It is not an
encroachment on the agency’s ultimate discretion either
that the court has identified a number of factors for
consideration, or that Judge Wilkey has indicated that
in his view a particuiar emphasis should be given to
certain factors. The court’s role, permitting intervention
for error of law or arbitrary action, still leaves the agency
place and took actions which they reasonably believe were in
the best interests of their customers. This appears to be the
thinking of the Public Service Commission of the State of
New York. PSC Br. in No. 77-1498 at 14.
There is the further consideration that the ambiguity of the
advance payment orders on the timing question may have
served the producers as a kind of legal lever to overcome pipe-
line resistance. In the context of an exception to settled prin-
ciple, which permitted some “advance” payments, the combi-
nation of FERC indefiniteness in the first instance and inac-
tion later on may have given momentum to extended front-end
advances. If the FERC takes the view that the ability of the
pipelines to resist untoward advances was materially weakened
by the agency’s handling of the issue, it has latitude to take
this into account. In this regard it would be appropriate for
the Commission to consider the contrast between Order No.
465, with its absence of any explicit reference to the timing
issue, and the notice provided to both pipelines and producers
in Order No. 499 that advances must be appropriately ex-
pended by the producer within a “‘reasonable time.”
The impact on the natural gas industry of the advance pay-
ment program has been likened to the mark left on a land-
scape by the wreckage from an airplane disaster. The Second
National Natural Gas Rate Cases, supra, 186 U.S.App.D.C.
at 64, 567 F.2d at 57. The Commission has latitude in the
circumstances to fashion an equitable allocation of burdens
between the rate payers and the vipeline investors.
56a
with a function broader in scope than the court’s.”
Although our ruling pertains to the rate-base es
nations raised by the petitions before us, the Commission
has flexibility to consolidate these with other cases, to
engage in rule making, or to adopt other procedures. In
the end, the Commission may choose to adopt a simplify-
ing formula in the interests of feasible administration ;
but such a resolution must reflect a reasoned considera-
tion of all the pertinent factors, demonstrating the flexi-
bility that always has been inherent in the advance pay-
ment program.
II. OTHER ISSUES IN No. 77-1496, e¢ al.,
Tennessee Gas Pipeline Co. v. FERC
We turn to two subsidiary questions raised by the
petitions for review.
A. Canadian Advance Payments
The first question is whether the Commission properly
excluded from Tennessee’s rate base advance payments
made to a Canadian producer. We approve the Commis-
sion’s determination.
The Commission affirmed the ALJ’s decision to exclude
from rate base $37.5 million in advance payments made
by Tennessee to an affiliated Canadian producer, for use
in exploration and development activities in the Canadian
Artic Islands, a remote area in the northern reaches of
Canada.” We discern that the principal basis of the
% The vitality of these principles appears from their early
statement, e.g., FCC v. Pottsville Broadcasting Co., 309 U.S.
134 (1940), and their recent reiteration, e.g., FERC v. Penn-
zoil Producing Co., 99 S.Ct. 765 (1979), discussed in note 81
supra.
Opinion No. 769, supra note 44, at 33-34, JA in No. 77-
1436, et al. at 352-53; Opinion No. 769-A, supra note 32, at
10-18, JA in No. 77-1496, et al. at 401-04. See JA in No. 77-
1496, et al. at 297 (map).
57a
Commission’s determination was Tennessee’s failure to
demonstrate “that receipt by the appropriate American
consumers of the Canadian gas . . . will most likely
occur.” '°
The advance payment orders were expressly limited to
domestic advances.'*' The Commission stated that “[t]he
sole basis for even considering Canadian advance pay-
ments is our prior statement that pending a Canadian
advance payment rulemaking such advances ‘shall be
treated on a case by case basis.’” '°* The Canadian ad-
vances were made in 1973 and Tennessee sought to have
them charged to the contemporaneous rate payers, though
it concedes that no gas will be forthcoming until the mid-
1980’s.'"* These advances were not “used and useful” for
providing service to then current rate payers, and tradi-
tional rate making principles would call for exclusion
from rate base.’* The Commission’s analysis seems to
contemplate an exception from traditional principles,
permitting rate base inclusion on a showing that a par-
ticular advance payment served the same purposes, and
promised an equivalent benefit to rate payers, as those
envisioned for domestic advances complying with the
advance payment orders.
The fundamental objective of the advance payment
program was to help elicit requisite gas supply by pro-
viding capital for expedited development and production
during the interim period until an upward revision in
100 Opinion No. 769-A at 12, JA in No. 77-1496, et al. at 408.
101 See note 25 supra.
102 Opinion No. 769-A at 11, JA in No. 77-1496, et al. at 402,
quoting Notice of Rulemaking, supra note 25, 38 Fed. Reg. at
1056.
103 Td. at 138, JA in No. 77-1496 et al. at 404; Tennessee Br.
in No. 77-1496, et al. at 66.
104 See text accompanying notes 51-55 supra.
58a
producer rates would accomplish this objective.’ The
ends of the program could not be furthered unless the
investments that were precipitated by advance payments
inured to the benefit of jurisdictional rate payers. For
this reason the program expressly assured that rate pay-
ers would not be charged for advances that did not pro-
duce gas, or that produced gas which did not flow to the
advancing pipeline.’ Similarly, as to Canadian ad-
vances, the Commission here required that the gas result-
ing from such advances must be shown “most likely” to
flow to the advancing pipeline’s domestic rate payers.
This general approach was well within the Commission’s
broad discretion and consistent with that taken in previ-
ous adjudications.'”
More specifically, the Commission concluded that Ten-
nessee had not carried its burden of showing that Arctic
Islands gas would “most likely” flow to rate payers in the
United States. Several uncertainties remained, e.g.: (1)
whether reserves in the Arctic Islands region were suf-
ficient to justify construction of a pipeline; (2) whether,
at the time this gas would become available for market,
Canada’s total reserve situation would justify granting of
the necessary export authorizations by the National Ener-
gy Board of Canada (NEB); and, (3) whether, assum-
ing the existence of adequate reserves, the NEB would
grant the required authorizations, rather than authoriz-
ing additional exports from other gas-producing regions,
or otherwise modifying Canadian energy policy. As we
recently have had occasion to note, in the present era of
uncertainty for natural gas supply any attempt to pre-
105 See text accompanying notes 56-66 supra.
106 See note 34 supra.
107 F’.g., Opinions No. 672 & 672A, Texas Eastern Transmis-
sion Corp., Docket No. RP70-29, et al., 50 FPC 1419 (1973),
51 FPC 258 (1974), aff'd, 171 U.S.App.D.C. 25, 517 F.2d 1299
(1975).
59a
dict NEB export policy is highly speculative.‘°* The very
existence in this case of a genuine dispute over the in-
terpretation of a series of inconsistent and conflicting
NEB reports is sufficient to support the Commission’s
judgment that the issue is not free from substantial
doubt. We will not disturb the Commission’s informed
judgment when it acts as here, within an area of its
special expertise and discretion.
B. Rate of Return
The second subsidiary issue is whether the Commission
erred in allowing Tennessee a 13.75% return on equity.
In proceedings before the administrative law judge,
Tennessee argued for a 13.35% rate of return on equity;
Staff proposed an 11.6% return. The ALJ concluded that
a return of 12.5% on equity was “reasonably in line with
earnings of enterprises with comparable degrees of risk,
and which have similar ratios of common equity capi-
tal.” *°° The Commission set aside this determination and
adopted a return of 13.75%. In the Commission’s view,
the “pendulum [had] definitely swung in a direction sub-
stantially contrary to the interests of the investor. A
time of adjustment [was] clearly called for.” 1°
108 Midwestern Gas Transmission Corp. v. FERC, —— U.S.
App.D.C. ——, 589 F.2d 603 (1978) (ruling, inter alia, that
certain of petitioner’s claims were not ripe for review since
they depended on the speculative effect on future NEB export
policy of FERC action regarding the Alaska Natural Gas
Transportation System). See id. at 622 n.107.
109 Initial Decision in No. 77-1496 et al. at 23, JA in No. 77-
1496, et al. at 307. This ruling would have resulted in overall
return on rate base of 8.787%. Id.
0 Opinion No. 769-A at 22, JA in No. 77-1496, et al. at 341.
This ruling resulted in an overall return on rate base on
9.25%. Id. at 23, JA in No. 77-1496 et al. at 342.
bi
:
4
60a
New York Public Service Commission argues that the
Commission’s ruling on rate of return was inextricably
bound to its advance payments determination.""' PSC
also challenges the reasonableness of the allowed return
on equity. We have suggested that on remand for recon-
sideration of the advance payments determination, the
Commission should again evaluate the rate of return
' question, which it would have full authority to do even
if the allowed return were valid in all respects, FCC v.
Pottsville Broadcasting Co., 309 U.S. 1384 (1940). We
think it appropriate to refrain from entering a ruling at
this time on this issue, pending further consideration on
remand.
III. OTHER ISSUES IN No. 77-1712,
Transcontinental Gas Pipe Line Corp. v. FERC
Two subsidiary issues are raised by Transco’s petition
for review: (1) whether the Commission erred in ex-
cluding from Transco’s rate base expenditures for un-
successful alternative gas supply projects; and, (2)
whether the Commission properly rejected an offer of
settlement. We affirm the Commission’s rulings.
A. Expenditures for Alternative Gas Supply Projects
The Commission affirmed the ALJ’s exclusion from
rate base of over $22 million expended by Transco in
four unsuccessful projects related to the production of
synthetic natural gas (SNG).' The pipeline argued
111 See text accompanying hotes 92-95 supra.
112 Expenditures of $10.1 million related to a study of the
technical and economic viability of converting Middle Eastern
crude oil into synthetic natural gas of pipeline quality. Over
$9.8 million was devoted to a project for conversion of naptha
feedstock into SNG. A study of a program to use natural gas
reserves located overseas by converting the gas to crude
methanol at its source, transporting the methanol by conven-
tional tankers to the United States, and converting the meth-
6la
that these amounts should be included in rate base to
be amortized as expense items for inclusion in cost of
service. Thus Transco sought both a return on, and the
return of its investments. The Commission found that
the expenditures were not “used and useful” in providing
service and should not be charged to the rate payers.'"®
Since the projects did not produce any jurisdictional gas,
this ruling clearly was a proper exercise of discretion.
We find without merit the claim that the Commission
had established a policy, relied on by Transco, creating
an exception from the traditional “used and useful”
principle with respect to expenditures for SNG develop-
ment."* The Commission had established such an excep-
tion for research and development costs, but the Transco
projects failed to qualify for special R & D treatment.?"*
anol into natural gas cost $1.4 million. Over $920.000 was
spent on a project to produce methane from coal. Initial Deci-
sion in No. 77-1712, supra note 26, at 5-7, JA in No. 77-1712
at 122-24.
113 Opinion No. 801-A, supra note 46, at 2-8, JA in No. 77-
1712 at 202-03.
114 See text accompanying notes 51-55 supra.
115 The Commission had previously demonstrated its reliance
on this principle in Tennessee Gas Pipeline Co., Opinion No.
624, 48 FPC 149 (1972), aff'd, 159 U.S.App.D.C. 318, 487
F.2d 1189 (1973) (grant of a certificate to construct liquified
natural gas facilities conditioned to prevent rate-base treat-
ment of costs if the project proved unsuccessful). In addition,
the Commission’s uniform System of Accounts for Natural
Gas Companies, 18 CFR 201 (1978), provided clear notice
that pipeline investors must absorb costs of abandoned projects
involving “preliminary survey plans, investigations, etc. made
for the purpose of determining the feasibility of utility proj-
ects under contemplation . . . to provide a future supply of
natural gas.” See PSC Br. in No. 77-1712 at 11.
116 See 18 CFR 201(103) (1978) (requiring, inter alia, use
of experimental technology and prior Commission approval—
62a
These expenditures were prudent investments, argues
Transco; however, for rate base inclusion expenditures
must satisfy not only the necessary condition of prudent
investment but.also must be “used and useful” in provid-
ing service. The Commission did not abuse its discretion
when it applied a policy “that SNG expenditures which
do not qualify as R & D can be recovered, if at all, only
through the price paid for actual SNG production sold
in interstate commerce.” ’
B. Rejection of Transco’s Settlement Offer
On the basis of the above reasoning, we affirm the
Commission’s concise rejection of a settlement offer that
proposed to exclude these project costs from rate base,
yet to amortize most of them over a five-year period for
inclusion in cost of service, thus allowing Transco to
recover its unsuccessful investments.**
Affirmed In Part; Remanded In
Part For Further Consideration.
both absent from Transco’s projects) ; Opinion No. 801-A at
3, JA in No. 77-1712 at 203.
117 Opinion No. 801-A at 4, JA in No. 77-1712 at 204.
118 See Opinion No. 801 at 8, JA in No. 77-1712 at 172.
63a
WILKEY, Circuit Judge concurring: I concur in Judge
Leventhal’s carefully reasoned and skillfully crafted opin-
ion for the court. I add this note as a concurrence-for-
emphasis.'
In Judge Leventhal’s opinion for the court the Com-
mission has properly been allowed wide discretion in fash-
ioning a new and more flexible rule on remand. The
point I wish chiefly to emphasize is that the Commission
on remand must give careful consideration to arguments
raised by petitioning pipelines concerning market pres-
sures, the ambiguity of the Commission’s orders on timing
of payments, and the contribution of advance payments
to capital development by producers and to enhancement
of gas supply. Thus I believe the court’s opinion must be
read as not allowing the Commission discretion to institute
a new rule that is little more forthcoming in its allow-
ances for advance payments than the now-void thirty-
day rule.
As we have noted, the advance payment program
constituted a significant and recognized departure from
traditional regulatory principles.2 This departure was
deemed necessary to serve the important public purpose
of “facilitat{ing] capital formation by [natural gas]
1 See Citizens to Save Spencer County v. United States En-
vironmental Protection Agency, No. 78-1002 et al. (D.C. Cir.
27 March 1979) (Leventhal, J., concurring).
2 See, e.g., slip op. at 9 (advance payment program was a
recognized “departure from the usual rule of public utility
regulation . . . that current rates should reflect the cost of
supplying service to current rate payers .. .”); id. at $1
(describing advance payment program as a clear “departure”
from, and “modification” of the “used and useful” principle) ;
id. at 43 (“Any permission to transfer advances prior to gas
delivery . . . entailed some variance from the. . . [regulatory]
situation [prior to the commencement of the advance pay-
ments program], in terms of benefit to producer and of cost
to pipeline and customer.’’).
\+ ay a2 a
64a
producers to finance development and production of new
. . . supplies” in order to “alleviat[e] the impending
natural gas shortage.”* The program aimed to stimulate
the process of capital formation by allowing the transfer
from pipelines to producers of interest-free sums reason-
ably targeted for purchase or expenditures for produc-
tion of identified gas supplies.‘ Natural gas producers
were thus relieved of financing costs ordinarily associated
with the accumulation of capital for exploration and
development of new supplies.
With such significant advantages to be gained from
advance payments, it is certainly correct, as Judge Leven-
thal has pointed out, that producers could be “expected”
to bargain with the pipelines for advance payments to be
made.® Likewise, producers could be expected to press
the pipelines for advances to be made on the most favor-
able terms possible—i.e., as long as possible in advance of
their eventual “qualifying” expenditure.* This pressure
for what we have termed “extended front-end” advances *
was increased because the availability to producers of
interest-free advance payments became one of the few
8 See id. at 7. See also id. at 14 (“theory” of the program
was that “increased availability of capital would encourage
investment, which in turn would yield additional gas
supply”).
4 See id. at 42 (“A producer receiving an extended front-end
advance, to use without restriction for a significant period
prior to expenditure, is in effect given a sum of money.”).
5 See id. at 8.
6 The court’s opinion has employed the term “qualifying
expenditure” to identify “those producer expenses permissible
under the [advance payments] program.” See id. at 8.
7 The court has devised the novel and useful term “extended
front-end advance” to describe those advance payments barred
from current rate base treatment by Commission orders here
under review. See id. at 14.
65a
negotiable terms of gas supply contracts in the other-
wise closely regulated natural gas market.
As a result of tight gas supplies during the years of
the program at issue here,* bargaining attempts of the
producing companies met with particular success as pipe-
lines scrambled to secure supplies of gas for customers.
Since it was in order to relieve this plight of tight supply
that the program was initiated, however, this superior
bargaining position of the producers and their conse-
quent bargaining success should have come as no sur-
prise to the Commission.
Furthermore, no evidence on the record suggests that
contracts providing for advance payments were negotiated
covertly. Instead, all available information suggests that
the high degree of administrative, judicial, and public
scrutiny afforded the advance payment program made
the terms of the vast majority of advance payment con-
tracts well known to outside parties, and certainly to the
responsible regulators.
It is thus particularly astonishing that, as noted in
the court’s opinion, “[t]he advance payment orders [is-
sued by the Commission during the program] did not
specify the permissible interval between the advance and
its appropriate expenditure.” * Order No. 465 contained
what has properly been described as a totally “unelabo-
rated statement” that advance payments would be al-
lowed only where “reasonable and appropriate,” with no
specific reference to the critical issue of how long in ad-
vance of designated use such payments could be made.”®
Subsequently, Order No. 499 made a completely unim-
pressive advance toward specificity by declaring that
8 These years were 1973, governed by FERC Order No. 465,
and 1974-75, governed by FERC Order No. 499. See id. at 11.
® See id. at 17.
10 See id. at 20.
66a
only those advances made within a “reasonable time” of
eventual expenditure would be allowed."' Until long after
the expiration of the advance payment program, there-
fore, the Commission through its applicable Orders pro-
vided only the most cryptic and ambiguous guidelines
concerning the issue central to the present litigation.”
It thus was practically inevitable that the “flood” of
advance payments propelled by Order No. 465 did not
abate during the time between the two advance payment
orders, or thereafter.'* The Commission bears much re-
sponsibility for this situation, for the opacity of the Com-
mission’s orders on the issue of permissible timing could
only have contributed to the disruptive effect of
advance payment bargaining on the otherwise tightly
metered minuet of producers, pipelines, consumers, and
regulators."
11 See id.
12 The Commission order barring current rate base treat-
ment to certain “extended front-end advances’ made by
Tennessee Gas Pipeline Company, for example, was issued on
9 July 1976, see FPC Docket No. RP73-113, Opinion No. 769,
more than six months subsequent to the expiration of the ad-
vance payment program on 31 December 1975.
18 See slip op. at 21 (“Despite the Commission’s signal in
Order No. 499 that it intended to focus on the critical timing
requirement, the flood [of advance payments] did not abate.’’)
14 As noted in the court’s opinion, producers may have
been “emboldened by ... [the] indefiniteness [of the advance
payment orders on timing]” and therefore the “producers
pressed their bargaining advantage, inducing pipelines to
make advances long before the funds were used for qualifying
expenditures.” Jd. at 17. See also id. (pipelines’ “weakened
resistance” to competitive pressures was materially aided by
“(t]he belief (or hope) that the Commission would permit
rate-base treatment of extended front-end advances ... .”).
Though the court’s opinion in other language has not ac-
cepted petitioners’ argument that the Commission must be
67a
The court’s opinion has bent over backward to em-
phasize that the lack of clear regulatory guidance weak-
ened the resistance of pipelines to the “untoward ad-
vances” of producers in eliciting extended front-end pay-
ments by pipelines.'"*> We have been somewhat less defi-
“estopped” from denyirg current rate base to advance pay-
ments because the Commission was on notice of the payments
and the pipelines relied justifiably on agency silence, see id.
at 44-47, the court’s view on this issue is perhaps best summed
up in its exceedingly cautious statement that “agency silence
. .. [with regard to the scope of a departure from a well-
rooted regulatory principle] must be construed to mean that
traditional [regulatory] principles retain their vitality.” Jd.
at 31. This modest statement, however, must be placed side
by side with the court’s repeated observation that the ad-
vance payment program constituted an express departure
from recognized regulatory principles. See id. at 9, 31 & 43.
Thus it is certainly consistent with the court’s position to
argue that the “vitality” of the Commission’s regulatory
principles has been diminished at least to the extent that the
Commission itself has backed away from those principles.
It would be insupportable for the Commission to bind an in-
dustry to regulatory principles from which the Commission
has itself departed; thus I believe it is only with some diffi-
culty that we conclude that “agency silence” on the issue of
timing of advance payments did not convey a tacit and irre-
versible assurance that advance payments would be upheld if
made in full view of the Commission and in arguable compli-
ance with the Commission’s ambiguous regulations.
15 We have suggested, for example, that the Commission
on remand has “latitude to take . . . into account . . . the
view that the ability of the pipelines to resist untoward ad-
vances was materially weakened by the agency’s handling
of the issue ... ,” id. at 55 n.98, and “whether the pipelines
were caught between a rock and a hard place and took actions
which they reasonably believe were in the best interests of
their customers,” id. at 54-65 n.97. The Commission also has
been urged to take into consideration more generally the “sig-
nificant factor” of “the impact on the industry of the entire
course of Commission action in the development and admin-
istration of the advance payment program.” Id. at 54.
68a
nite, however, in suggesting the extent of the relief that
should be afforded the pipelines on remand. We have
noted that the objective of the advance payment program
was to facilitate the development of capital by producers
in order to enhance gas supply,’* and that advance pay-
ments by definition involve the transfer of capital from
pipelines to producers.” We have also noted the argu-
ment of the pipelines that all advance payments must be
sustained fu ' reason of such a capital contribution, and
the contrary argument of the Commission that no allow-
ance should be made for many payments that “for the
extended period between receipt [by the producers] and
expenditure . . . made no. . . contribution of develop-
mental capital [for ‘qualifying expenditures’] while pro-
viding producers with a non-price incentive of the type
the program explicitly sought to avoid ‘as much as pos-
sible.’ ” *®
The opinion of the court, however, adopts a middle
position. While rejecting the pipeline’s argument for
carte blanche authority to make advances,’® we have also
rejected the Commission’s overly narrow view of the role
of advance payments in enhancing capital formation and
gas supply. Any front-end advance payment, according
to this court’s definition, is one made prior to its use
for “qualifying expenditures.” 7° Also we have noted that
only a sub-class of front-end advance payments may
properly be disallowed current rate base treatment. This
16 See, e.g., id. at 6-7 & 14.
17 See id. at 138 (an advance payment, as an interest-free
loan, “substitutes for capital raised in financial markets’) ;
id. at 42 (“A producer receiving an extended front-end ad-
vance... is in effect given a sum of money.”)
18 See id. at 35.
19 See id. at 35-36.
20 See id. at 18.
69a
class of payments on remand will necessarily be smaller
than that excluded by the Commission according to the
thirty-day rule. Thus we have not determined that every
advance is insupportable for the simple reason of its pay-
ment prior to expenditure; instead, we urge strict scru-
tiny only of those payments that may have been “extrava-
gant” because they were made too long in advance of
qualifying expenditures.
We reach this conclusion, I believe, in part because pay-
ments made at any interval (whether thirty days or
much longer) in advance of qualifying expenditures in-
evitably enhanced the formation of capital in the hands
of producers, and, unless diverted eventually for other
non-“qualifying” purposes, may have facilitated the de-
velopment of new gas supplies by reenforcing the capital
foundation of the producing firms and freeing other
funds for immediate productive use. It will be the task
of the Commission on remand to define with some spe-
cificity and with greater latitude than previously those
advance payments that were, and those that were not,
“reasonable and appropriate” in conforming to the stated
objectives of the program in thus aiding capital develop-
ment for the purpose of enhancing gas supplies.
I have some difficulty, however, with the court’s dis-
cussion of the undesirable consequences of competition
among pipelines for supplies of gas. Though bidding
among pipelines for gas by offering advance payments
inevitably had the effect of raising prices, it cannot lightly
be assumed that an increase in prices did not lead to a
corresponding increase in supply. As a general matter,
only in a situation of total inelasticity of supply can an
increase in prices not be expected to lead to a correspond-
ing increase in supply. No such situation of total inelas-
ticity has been demonstrated here, and as Judge Leven-
thal notes, “Even in the regulatory context, market
, al oe
70a
pressures retain some vitality.” *' Thus it is clearly with-
in the purview of our decision for the Commission to
give close consideration to the extent to which bidding for
gas supplies had the effect of raising prices and thus
enhancing natural gas supply, in keeping with the overall
goals of the advance payment program. I believe that
the burden of proof rests with the Commission to demon-
strate that the new rule it derives on remand distin-
guishes effectively between those advance payments that
reasonably could, and those that reasonably could not
lead to an increase in supply commensurate with any
increase in price.
The Commission on remand will also want to take
careful note of the losses incurred by the pipelines as
a result of the Commission’s rate base ruling. Though
Judge Leventhal has noted for the court that the Com-
mission’s action to date has been to defer, rather than
indefinitely to disqualify certain advance payments for
rate base, he has also noted that “substantial sums were
involved” and that “deferral has resulted in considerable
losses for the pipelines’ stockholders” because of interest
lost during the period of deferral.?? Such losses are not
to be taken lightly, and clearly a very close question is
presented as to whether these losses are substantial
enough to bar the admittedly retroactive clarification by
the Commission of the ambiguous language of its earlier
orders on the issue of timing.”*
The Commission will also wish to consider the equities
in specific cases of a denial of current rate base to pipe-
line companies that may have exercised reasonable judg-
21 See id. at 16.
22 See id. at 27.
23 See cases cited in id. at 45 n.77 (hardship on the
affected parties a factor to consider in evaluating limitations
on retroactivity of agency action).
$
a
Tla
ment in making advance payments in the context of tight
gas supplies and ambiguous regulatory guidance. The
pipelines have made out a convincing case that their re-
sponsibility to obtain adequate supplies for consumers
during a period of scarce supply compelled them to “bid
competitively for gas reserves by offering extended front-
end advances.” *“* Though we have not endorsed applica-
tion of any “competitive business judgment” rule in this
case, we have noted that circumstances may be “antici-
pate[d] ... where a pipeline’s investors might determine
in their sound business judgment that they should take
the risks associated with obtaining needed gas supplies,
at least where there is a colorable legal argument that
... [the] expenditures are permissible.” *°
I believe that under the circumstances of this case
there was at least a “colorable legal argument” that many
of the advance payments made would subsequently be
approved by the Commission, and that any exercise of
sound judgment by pipeline companies in weighing fac-
tors of consumer demand, scarce supply, and ambiguous
regulation must not be lightly rebuffed by the Commission
on the basis of an imputed greater wisdom of hindsight.
All of the considerations discussed above I understand
to be subsumed within the court’s instruction that the
Commission on remand devise a new and more flexible
24 See id. at 23-24; id. at n.44 (quoting dissenting view of
Commissioner Holloman that, inter alia, “A pipeline... faced
with... [the] competitive climate [in the natural gas market]
would be remiss in its attempts to attach new supplies of gas
on behalf of itself and its customers if it did not use... [the]
tool [of offering extended front-end advances] to enter into
gas supply contracts.’’)
25 Jd. at 16-17 n.30. We have also noted that at least one
administrative law judge ruling on this case found that a pipe-
line company’s “unchallenged good faith and business judg-
ment... qualif[ied] advances as reasonable and appropriate.”
Id. at 24 n.45.
72a
rule concerning advance payments. As noted in the
court’s opinion, “The advance payment orders . . . were
instinct with the attitude of flexibility and experimenta-
tion” and “allowed a certain discretion to the pipelines
and encouraged them to develop practical financing pack-
ages....” *° Though the pipelines have erred in arguing
for an overbroad and overgenerous rule of universal al-
lowances,”’ they certainly have not erred in resisting the
Commission’s correspondingly narrow and _ excessively
rigid thirty-day rule. As has been made amply clear in
the court’s opinion, there is nothing pernicious about
advance payments per se; ** instead, I believe, only those
advance payments that overstrain the bounds of reason-
ableness may be denied current rate base treatment by
the Commission. Having failed once, a serious burden
rests with the Commission to buttress its new rule with
reasoned support.
26 Td. at 52.
*7 As noted in the court’s opinion, pipelines have argued
that “the sole test for determining whether the advance
payments made . . . were to be included in rate base...
[should have been] whether they were made in order to obtain
commitments for additional gas supplies.” Jd. at 28.
28 See, e.g., id. at 14.
73a
APPENDIX B
UNITED STATES OF AMERICA
FEDERAL POWER COMMISSION
Before Commissioners: Richard L. Dunham, Chairman;
Don S. Smith, John H. Holloman III, and James G.
Watt.
TENNESSEE Gas Pireting CoMPANy
(A Division of Tenneco, Inc.)
Docket No. RP73-113
Oprtnion No. 769
OPINION AND ORDER AFFIRMING IN PART AND
REVERSING IN PART INITIAL DECISION ESTAB-
LISHING JUST AND REASONABLE PIPELINE RATES
(Issued July 9, 1976)
This proceeding arises under Section 4 of the Natural
Gas Act and concerns the justness, reasonableness and law-
fulness of increased rates and charges proposed by Ten-
nessee Gas Pipeline Company.
PROCEDURAL HISTORY
On June 15, 1973, Tennessee Gas Pipeline Company (Ten-
nessee) filed revised PC Gas Tariff Sheets incorporating
a proposed annual rate increase from jurisdictional sales of
$150,194,754. Then on August 1, 1973, the Commission ac-
cepted these revised tariff sheets for filing, suspended the
proposed rates for the full five month statutory period, to
become effective subject to refund on J anuary 1, 1974, and
set the matter for hearing. It did, however, state that Ten-
nessee must file revised tariff sheets to eliminate any facili-
ties which had not been certificated by January 1, 1974
Beck
74a
(the Commission had noted that Tennessee included in rate
base for its June 15, 1973, filing over $18 million of non-
certificated facilities). In response to this Commission di-
rective Tennessee filed on November 30, 1973, further
revised tariff sheets in which the annual jurisdictional rate
increase had been reduced to $141,719,530.
Hearings were held intermittently from March 26, 1974
through October 29, 1974, before Administrative Law Judge
Samuel Kanell, who thereafter on February 3, 1975, issued
an initial decision resolving all of the issues presented by
the parties. Briefson exception to this initial decision were
filed by Tennessee, Staff, Columbia Gas Transmission Cor-
poration and Consolidated Gas Supply Corporation (Co-
lumbia and Consolidated), Berkshire Gas Company, et al.
(Berkshire), the Public Service Commission of New York
State (New York), and Trunkline Gas Company (Trunk-
line). Briefs opposing these exceptions were thereafter
filed by Tennessee, Staff, Berkshire, New York, Columbia
and Consolidated, Northern Illinois Gas Company (North-
ern Illinois), East Tennessee Natural Gas Company (Kast
Tennessee), and Northern Indiana Public Service Company
and Peoples Gas Light and Coke Company (Northern
Indiana).
SUMMARY
We find that the following findings in the initial decision
should be affirmed: (1) Tennessee Gas Pipeline Company’s
(Tennessee) composite depreciation rate should be in-
creased from 3.6% to 4% as Staff recommended, not to
5.75% as Tennessee filed. (2) Tennessee’s Canadian and
Non-Canadian unexpended intracorporate advance pay-
ments should be disallowed, as Staff recommended. (3)
Tennessee’s rate base should be reduced because Staff’s
larger DDA reserve should be utilized. (4) Tennessee’s rate
base should further be reduced to account for the disal-
lowance of minimum bank balances from working capital.
75a
(5) Tennessee’s rate base should also be reduced to reflect
use of Staff’s larger reserve for accumulated deferred Fed-
eral income taxes. (6) Tennessee’s cost of service should
be reduced to reflect the amortized portion of the Bastian
Bay deferred revenue fund being credited to Bastian Bay
expenses. (7) Tennessee’s cost of service should also be
reduced to account for the tax allowance deduction of inter-
est on short-term debt. (8) Tennessee’s cost of service
should moreover not be reduced by the deduction from tax
allowance of geological and geophysical expenses, as rec-
ommended by Staff. (9) Tennessee’s cost of service should,
however, be reduced to reflect lower ad valorem taxes, but
not to the full extent sought by Staff. (10) Finally, Ten-
nessee’s cost of service should be reduced to reflect Staff’s
franchise tax figure. (11) Tennessee’s method of cost classi-
fication, allocation, and rate design, with minor exception,
should be accepted, and all the specific customer proposed
alterations rejected, except for Staff’s change to the SO-4
rate.
We also find, however, that the following findings in the
initial decision should be reversed: (1) The composite de-
preciation rate increase to 4% should not permit a corre-
sponding income tax allowance. (2) Front-end advance pay-
ments unexpended by January 1, 1974, should not be dis-
allowed from Tennessee’s rate base. (3) Tennessee’s cost
of service should not be reduced as Staff sought to reflect
greater hydrostatic testing expenses and greater research
and development expenses.
FACTUAL BACKGROUND
The major elements of Tennessee’s proposed rate in-
crease are a depreciation rate increase from 3.6% to
9.75%, inclusion of substantial additional advance payments,
and an increased overall rate of return of 9.25%. Numerous
other cost of service and rate base increases were also pro-
posed by Tennessee.
76a
Staff alone presented evidence and argument against
Tennessee’s cost of service as it took the position that only
$15,696,391 out of the $141,719,530 proposed annual rev-
enue increase should be authorized by the Commission, leav-
ing a $126 million differential between Tennessee and Staff.
Tennessee’s filing is based upon a test year ended February
28, 1973, adjusted for known and measurable changes
through November 30, 1973.
The other parties to the proceeding, mainly wholesale
customers or state commissions, took an active role in this
proceeding only in regard to the issues of cost classifica-
tion, allocation and rate design.
DISCUSSION AND RESOLUTION OF ISSUES
I. Depreciation
Tennessee’s annual depreciation rate had been 3.6% as
a result of the last rate settlement, but it sought an increase
to 5.75% for an initial five year period based on declining
gas production. Staff, on the other hand, would have in-
creased the rate to 4%. Tennessee’s rate would result in
$33,326,358 more depreciation expense than Staff’s rate
would, and both Staff and Tennessee'estimated $65,186,870
of additional revenues needed to provide the 5.75% rate,
of which $32,095,207 represents the associated effect upon
the income tax allowance in the cost of service.
The Administrative Law Judge adopted Staff’s 4% rate
and its straight-line depreciation method, rejecting Ten-
nessee’s use of the accelerated unit of production method.
He found that Staff and Tennessee both basically agreed
upon an annual average depreciation rate of 4% but that
they disagreed as to the method. He viewed Tennessee’s
unit of production method as being based on the growing
gas shortage, the anticipated reduced plant service life, and
an avoidance of excessive future depreciation charges per
unit of gas delivered. While he noted prior Commission
77a
approval of accelerated depreciation,’ he distinguished it
because Tennessee has adequate depreciation accruals for
prior years.
The Administrative Law Judge found Tennessee’s meth-
od to be arbitrary in that it unwarrantedly assumes no
additional future supplies and charges more depreciation
expense to present seryice. This method was also rejected
for Tennessee employs it on a system-wide basis, not relat-
ing specific gas reserves to useful life of specific plant.
In authorizing a depreciation rate increase to 4%, how-
ever, he conditioned it so as not to include a corresponding
increase in Federal income tax liability for no Internal Rev-
enue Service approval of this depreciation methodology
change had been received.
Staff only excepts to the tax portion of this ruling, argu-
ing that Tennessee should be allowed to realize the in-
creased depreciation allowance after taxes have been paid.
Tennessee’s exception to the initial decision is multi-
farious: It first of all asserts that the unit of production
method * is appropriate in cases of supply instability, such
as natural gas, and points to various record evidence of its
declining supplies * to stress the declining usefulness of its
*United Gas Pipe Line Company, Opinion No. 645, 49 FPC
141 (1973).
*The unit of production method (depletion accounting) estab-
lishes a rate of depreciation by using the total units of gas to be
sold during a given time period. Unlike the straight-line method
in which time is the basis and the useful life of plant is the cen-
tral focus, with the unit of production method the difference be-
tween original cost and net salvage value is distributed by the
ratio of annual production of gas to the remaining recoverable gas
reserves.
*The nationwide reserve-life index has declined to 9.7 years
by 1973, Tennessee’s reserve-life index being 10.8 years for the
same period. Also new reserves are being far outstripped by
present deliveries, Present Tennessee curtailment is also noted.
78a
system, quite apart from the traditional service life under
straight-line depreciation. It moreover asserts that the unit
of production method should be used because it fairly and
evenly apportions its remaining investment between present
and future consumers. In addition Tennessee contends that
its method does assume additional future supplies‘ and
that the five year review provision protects the consumer
if its gas supplies increase more than already estimated.
It also contests the finding that Tennessee’s unit cost of
depreciation would decline from 7.5¢ per Mef for the first
ten years to 4¢ for the last ten years, pointing to the impact
of increasing interim retirements, which the Judge did not
consider. Tennessee furthermore would depreciate the dis-
tinction made in the initial decision between its case and
‘nited, supra note 1, arguing first of all that the inade-
quacy of past depreciation charges is not controlling for
it should be forward-looking, and secondly that its system
is newer than United’s and therefore has more undepre-
ciated investment to recoup.
Tennessee attacks Staff’s method which includes all esti-
mated future additions as present supplies, an allegedly
faulty assumption in light of the failure of SNG and LNG
projects: If forecasted supplies do not materialize, Staff’s
method would result in either inadequate depreciation
accrual or substantially increased unit cost of depreciation
for future consumers at a time when the cost of gas supply
will also be much higher.’ It also questions Staff’s failure
to include the plant investment necessary to attach all the
supply additions Staff assumes will result, as well as
*One of Tennessee’s studies (Table 2, Exhibit 1) shows 8 Tcf
addition over 20 years from traditional supply areas, and the
other (Table 3, Exhibit 1) shows this same 8 Tef, as well as
another 14 Tef from non-traditional sources.
5Such eventualities resulting from a deferral of depreciation
recovery to the future under Staff’s method are asserted to vio-
late the Commission’s statutory obligation to establish ‘‘ proper
and adequate rates of depreciation’’ under Section 9 of the Natural
Gas Act.
79a
Staff’s interim retirements figure. Tennessee also reads
Staff’s study to require a 5.15% depreciation rate, thereby
rendering the holding of 4% devoid of record. evidence
support. It attributes this discrepancy to Staff only using
three of the twenty years covered by the study. It also
controverts the Judge’s conciusion that Tennessee’s study
also renders a 4% average annual rate, arguing that it is
error to extrapolate the 20 year study to 25 years for major
retirements were not considered in the study.
Finally Tennessee excepts to the tax impact finding. It
alleges that its depreciation rate for taxes has always been
higher than for book or ratemaking purposes, and it argues
that, since in its prior rate cases this excess tax deduction
was used to reduce its cost of service, it would be incorrect
to now require use of the same rate for book and tax pur-
poses. Also Tennessee cites prior Commission orders in
which the book and tax depreciation rates were not identical.
We find that the initial decision should be affirmed as
to the increase in depreciation rate to 4%. Therefore, Ten-
nessee’s depreciation expense for cost of service should be
reduced from $116,602,993 to Staff’s proposed depreciation
charge of $83,276,635. Tennessee did not meet its burden of
proof to justify its substantial depreciation rate increase:
Its evidence (Exh. 1, T-1, T-10, T-19, 65-69) is primarily
a recitation of various reserve-life indices and the focus
of its rationale echoes Opinion No. 645, which is no longer
viable.” While the Court in Memphis recognized that the
Commission can take into account the exhaustion of natural
resources in establishing depreciation rates for a natural
gas company, it held that the Commission must first of all
find that such exhaustion of natural resources has in fact
caused the useful life of the company’s property to be
° Staff’s study employed a .2% interim retirement rate instead
of Tennessee’s .5% interim retirement rate.
* United, supra note 1, rev’d sub nom, Memphis Light Gas and
Water Division v. F.P.C., 504 F.2d 225 (D.C. Cir. 1974).
80a
reduced to the extent that depreciation based solely on
physical life is inadequate. The Court continued by stating
that, although evidence of a declining reserve life index
increases the risk of a shortened useful life, it was ‘‘not
satisfied with a record that contains only a recitation of
the decline of the reserve life index.’’* Tennessee’s evi-
dentiary presentation would not satisfy the Court and does
not satisfy the Commission.
Staff if the only other party to introduce evidence con-
cerning an increase in the depreciation rate. (Exh. 39, 40,
41, 42, 42A, 43, 43A, 44, 45, 46, 47, 48, S-6, S-7, S-8, and
S-9). Is proposed increase to 4% as adopted in the initial
decision, should be approved. We completely endorse Staff’s
methodology which is discussed below; however, we note
that since the time Staff prepared its evidence the alter-
nate sources of supply relied upon by Staff (SNG, LNG,
Canadian natural gas) have not been realized to the extent
advanced by Staff. Accordingly, this 4% depreciation rate
could well be inadequate, but we are constrained to adopt
this 4% rate: Tennessee failed to satisfy its burden of
proof, and the record upon which we must rely does not
afford us the opportunity to sua sponte forge a different de- |
preciation rate.
It should first of all be explained, however, that, unlike
Tennessee’s system-wide approach, Staff classified its de-
preciable property and assigned separate depreciation rates
to each property class ® which resulted in a composite rate
of 4%.
. Memphis, supra note 7, 504 F.2d at 235.
®* Property Classification Annual Depreciation Rate
Offshore Gathering 6.00
Products Extraction 2.71
Underground Storage 2.42
Transmission 3.83
General 4.00
(Exh. 8-9, p. 7).
8la
Staff then used the unit of production method, supra
note 2 to establish the 6% depreciation rate for gathering
plant since its useful life is related to the useful life of the
gas reserves supplying it. Such a limited application of the
unit of production method is reasonable since the useful
life of gathering plant is necessarily defined by the ascer-
tainable present and future reserves. (xh. S-9, p. 9).
The depreciation rates for the other classes of plant were
developed using the straight-line remaining life method.
This was also a reasonable approach since Staff recognized
that possible changing gas flow patterns would have an im-
pact upon the useful lives of extraction, storage and trans-
mission plant. (Exh. 8-9, p. 10).
The Court in Memphis specifically directed Commission
consideration of ‘‘current Commission policies designed to
increase or sustain industry-wide gas supply,’’ as well as
‘‘the probable extent and location of reserves which United
might utilize at some future date.’’ Supra note 7, 504 F.2d
at 235. Staff introduced evidence in this regard (Exh. S-9,
pp. 11-22): Alaskan reserves, reserves in the lower 48
states, coal gasification, liquified natural gas from Alaska
and overseas, and importation of natural gas from Canada.
Staff related these factors to both industry-wide activities
and also specifically to Tennessee, concluding that ‘‘we are
fast approaching a change-over from almost complete re-
liance upon our own natural gas resources to diversified .
sources international in scope.’’ Staff then applied these
changing gas supply patterns to the various portions of
Tennessee’s plant to ascertain the proper service life, look-
ing specifically for possible resulting material under-utiliza-
tion of plant (major retirements). Staff assigned a 28 year
average remaining service life to storage plant and that
portion of transmission plant which could utilize imported
LNG, Midwestern SNG and Canadian gas. It then assigned
an 18 year average remaining service life to the remainder
of Tennessee’s transmission plant and its extraction plant,
82a
that which can only rely on Tennessee’s historic southwest
gas supply.
From the perspective of the 1972 and 1973 adjusted test
period Staff made the ‘‘reasoned estimate”’ of the useful
life of Tennessee’s plant as required in Memphis, and Staff
is moreover correct in rejecting use of Tennessee’s unit of
production method other than for gathering plant because
the total number of units to be transported cannot be as-
certained with any degree of certainty. The future prospects
of LNG importation, SNG and importation of Canadian gas
appear dimmer than when Staff prepared its evidence, but
based upon the record in this docket, the nature of the Com-
mission’s depreciation rate inquiry under Section 9 of the
Natural Gas Act (the Commission must make a ‘‘reasoned
estimate’’ of the useful life of plant, and its conclusion
must fall within a ‘‘zone of reasonableness’’) warrants
continued cognizance of the potential impact of such event-
ualities upon Tennessee’s gas supply patterns.
We do find, however, that the income tax condition placed
in the initial decision should be removed. Even with this
increase in the book depreciation rate from 3.6% to 4%,
there will be no need to change the tax depreciation rate
since it has been 4.55%. The income tax component of cost
of service is the proper forum in which to consider the
tax impact.
II. Rate of Return
There are two contested issues with respect to the ap-
propriate rate of return to be allowed Tennessee in this
proceeding, viz., the proper earnings level for equity funds
devoted to natural gas transmission operations, and the fair
treatment of discounts arising from the reacquisition of
previously issued debt securities. We turn first to rate of
return to be allowed on the equity portion of Tennessee’s
overall rate of return.
83a
Evidence on rate of return was introduced by our Staff
and Tennessee, although other parties argued the issues on
brief. Evidence on behalf of our Staff was introduced
through the Chief, Division of Finance and Statistics, Ms.
Georgia LeDakis; and that for Tennessee by a private con-
sultant, Mr. W. R. Field, supplemented as to the need for
additional financing by the President of Tenneco, Inc., Mr.
R. EK. McGee. Ms. LeDakis found the then current cost of
equity to Tennessee to be 11.6%, while the evaluation by
Mr. Field yields a range between 13.5% and 14%. The
Administrative Law Judge determined the appropriate al-
lowance to be 12.5% to which both Tennessee, the Staff as
well as other parties except.
Witness LeDakis presented testimony discussing the vari-
ous analytical approaches toward financing cost evaluation
—with particular emphasis on the cost of equity—followed
by a description of the general economic condition of the
country, the pipeline industry, Tennessee and other com-
panies found to be comparable to Tennessee.
Much in Witness LeDakis’ testimony and supporting ex-
hibits is not subject to serious challenge by any party on
cross examination, rebuttal testimony or on brief—nor could
it be, having been based on sound regulatory principles and
economic analysis. We shall therefore utilize Ms. LeDakis’
testimony to set forth several principles which must serve
as the foundation upon which to construct a sound rate of
return judgment in this proceeding.
We begin with the fundamental legal precepts required
in a rate of return calculation. Ms. LeDakis correctly states
at page 24 of her direct testimony: ~
As established by judicial precedent, the prescribed
rate of return under the Comparable Earnings Test
must be:
(a) sufficient to assure confidence in the financial
integrity of the enterprise so as to maintain its
credit standing and to attract capital;
ry eniern erento eameemaneneny
i te aa
84a
(b) it must be commensurate with returns on in-
vestment in other enterprises with corresponding
risk; and
(c) it must recognize the necessity of maintaining
a balance between the interests of investors and
consumers alike.
As indicated above there appears to be little q
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