Appendix — Illinois ex rel. Burris v. Panhandle Eastern Pipe Line Co.

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IN THE

Supreme Court of the United States

OCTOBER TERM, 199]

catieenh ieee a _—

STATE OF ILLINOIS, ex rel. ROLAND W. BURRIS,

Attorney General of the State of Illinois,

Petitioner,

Vv.

PANHANDLE EASTERN PIPE LINE COMPANY,

A Delaware Corporation,

me Respondent.

On Petition For Writ of Certiorari To The United States

Court of Appeals For The Seventh Circuit

APPENDIX TO

PETITION FOR WRIT OF CERTIORARI

Of Counsel: EDWARD J. BURKI .

ROLAND W. BURRIS RAYMOND J. SMITH*

Attorney General of the MARY PATRICIA BURNS

State of Illinois Special Assistant Attorneys

100 West Randolph Street — General

12th Floor BURKE, SMITH &

WILLIAMS

55 W. Monroe Street

Suite 1800

Chicago, Illinois 60603

(312) 853-3230

Chicago, Illinois 60601

*(Counsel of Record) Attorneys for Petitioner

mo Aw>

INDEX TO APPENDIX

PAGE

Opinion of the Court of Appeals ...... (A1-A36)

Opinion of the District Court ........ (Bi-B244)

Order of the Court of Appeals Denying

I as oa ao wes 5 ck oa eek 6 6s (C1)

Judgment of the Court of Appeals ..... (D1)

Text of Statutory Provisions Involved .. (E1-E4)

No. 91-

IN THE

Supreme Court of the United States

OCTOBER TERM, 1991

STATE OF ILLINOIS, ex rel. ROLAND W. BURRIS,

Attorney General of the State of Lllinois,

Petitioner,

Wa

PANHANDLE EASTERN PIPE LINE COMPANY,

A Delaware Corporation,

Respondent.

On Petition For Writ of Certiorari To The United States

Court of Appeals For The Seventh Circuit

APPENDIX TO

PETITION FOR WRIT OF CERTIORARI

A-1

In the

United States Court of Appeals

For the Seventh Circuit

No. 90-1231

STATE OF ILLINOIS, ex rel. ROLAND W. BurRis,* Attorney

General of the State of Illinois, in its proprietary capacity,

in its parens patriae capacity, and in its representative

capacity,

Plaintiff-Appellant,

v.

PANHANDLE EASTERN PIPE LINE COMPANY,

a Delaware corporation,

Defendant-A ppellee.

Appeal from the United States District Court

for the Central District of Illinois, Peoria Division.

No. 84 C 1048—Michael M. Mihm, Judge.

ARGUED JANUARY 7, 1991—DEcIDED JUNE 4, 1991

Before FLAUM, RIPPLE, and KANNE, Circuit Judges.

FLAUM, Circuit Judge. The state of Illinois brought this

antitrust suit on its own behalf and on behalf of a class

of residential and commercial consumers of natural gas

* Since this appeal was filed, Roland W. Burris has succeeded Neil

F. Hartigan as Illinois Attorney General. We have substituted Mr.

Burris’s name for Mr. Hartigan’s. See Fed. R. App. Pro. 43(cX1).

A-2 No. 90-1231

in central Illinois. The state alleges that the Panhandle

Eastern Pipe Line Company violated federal and state

antitrust laws in the early 1980s by refusing to transport

natural gas purchased by its principal commercial custom-

ers (the local distribution companies that distribute gas to

residential and most commercial and industrial end-users)

through its pipelines. After a bench trial, the district court

ruled that Panhandle’s conduct was not anticompetitive.

Illinois ex rel. Hartigan v. Panhandle Eastern Pipe Line

Co., 730 F. Supp. 826 (C.D. Ill. 1990). We agree, and af-

firm the judgment.

I. Background.

The late 1970s and early 1980s found the natural gas

industry in the throes of deregulation. Regulation in the

industry dated back to the 1930s when a handful of pipe-

line companies monopolized the purchase and distribution

of natural gas. Congress had responded by regulating the

pipelines and controlling natural gas prices at the well-

head. Under regulation, pipelines typically purchased the

gas from producers and resold it to their customers; “gas

flow{ed] from producer to pipeline to distributor to con-

sumer, with title passing at each change of possession.”

Pierce, Reconsidering the Roles of Regulation and Com-

petition in the Natural Gas Industry, 97 Harv. L. REv.

345, 348 (1983). The pipelines thus traditionally bundled

together two commodities—gas and pipeline transportation—

for their customers. Their profit, however, derived solely

from the return permitted by regulators on the transpor-

tation service; the commodity component of pipeline rates

reflected only a pass through of the price paid by the pipe-

line for the gas.

* We have limited our exposition of the facts to those that are

essential to an understanding of the issues raised on appeal. For

the complete story, the reader is referred to the district court’s

comprehensive opinion at 730 F. Supp. 826.

No. 90-1231 A-3

Shortages plagued the natural gas market under regula-

tion, leading Congress to reverse its course. In 1978, Con-

gress embarked on a program of phased deregulation—

embodied in the National Gas Policy Act (NGPA), 15

U.S.C. §§ 3301-3432—that established a graduated series

of increases in the maximum permissible price for natural

gas and culminated in the complete termination of well-

head (producer) price regulation in 1985. See Mobil Oil

Exploration v. United Distr. Co., 111 S. Ct. 615, 620-21

(1991). The NGPA also changed the regulations govern-

ing the distribution of natural gas, providing an impetus

for the Federal Energy Regulatory Commission (FERC)

to loosen the grip of pipelines on the territorial monopo-

lies regulation had preserved. Section 311 of the NGPA

authorized FERC to permit interstate pipelines to trans-

port gas purchased by local distribution companies (LDCs)

and large industrial end-users directly from producers,

although it did not authorize FERC to order the pipelines

to do so.

As deregulation progressed, many pipelines entered into

long-term contracts to purchase natural gas at high de-

regulated prices, anticipating continued shortages and con-

tinued growth in the demand for natural gas. Those prices

were subject to little regulatory control, since FERC re-

views pipeline gas acquisition costs only for “fraud or

abuse,” 15 U.S.C. § 3431(cX2), and permits pipelines to

include “purchase gas adjustment” clauses (PGAs) in their

contracts with distributors. Jd. at 350. These clauses per-

mit pipeline companies to adjust their rates regularly to

reflect changes in the cost of the gas they purchase.

Pierce, supra, at 350 n.33.

The Panhandle Eastern Pipe Line Company was no ex-

ception. Panhandle’s pipeline system stretches northeast

from the Gulf of Mexico into Michigan, and during the

early 1980s, Panhandle was the exclusive supplier of nat-

ural gas to 37 counties in central Illinois. Beginning in

1979, Panhandle launched an aggressive campaign to se-

cure what at that time were still scarce, and expensive,

gas supplies. Among its efforts to secure gas were two

A-4 No. 90-1231

very expensive projects: Panhandle contracted through

Trunkline Gas Company, a subsidiary pipeline, to purchase

liquified natural gas from Algeria, and joined a partner-

ship to construct pipelines to import gas from Canada.

Deregulation worked, however, and higher prices spurred

increased production of natural gas. But as production was

increasing, demand was decreasing because the prices of

alternative fuels were dropping and energy conservation

measures were intensifying. Despite warnings from its

customers that demand was slacking, Panhandle continued

to enter into long-term gas purchase contracts at the

maximum prices permitted by the NGPA phase-out price

levels. To compound the problem, Panhandle agreed to

significant take-or-pay provisions? in virtually all of its pur-

chase contracts without demanding force majeure or other

types of market-out clauses to limit their take-or-pay ob-

ligations. Increased production and reduced demand pro-

duced a glut of natural gas that depressed spot market

prices far below the price ceilings established by the NGPA,

and well below the levels mandated in Panhandle’s con-

tracts. In 1982, when the expensive gas from its Algerian

and Canadian projects became available, Panhandle’s costs

increased dramatically, much to the chagrin of its custom-

ers. By 1984, Panhandle’s rates were among the most

expensive in the country.

Consequently, Panhandle’s LDC customers (the parties

focus on Central Illinois Light Company (“CILCO”’), and

so will we) began exploring the possibility of buying gas

2 “A take-or-pay clause allocates part of the volume risk to the

purchaser—the pipeline company—by obligating the purchaser to

pay for a specified quantity of gas whether or not the purchaser

actually takes delivery of that gas.” Pierce, supra, at 355.

3 Panhandle’s gas purchases during this period have thus far sur-

vived regulatory and judicial review. See Office of Consumer's

Counsel v. FERC, 914 F.2d 290 (D.C. Cir. 1990) (upholding FERC

determination that Panhandle’s purchases from gas producers were

not abusive; remanding for further fact-finding on issue of whether

Panhandle’s purchases from Trunkline were prudent).

No. 90-1231 A-5

from sources other than Panhandle. Panhandle’s contracts

with these customers presented a huge obstacle, however,

for Panhandle had a “‘sole supplier” provision in the con-

tracts.4 This provision was part of Panhandle’s FERC-

+ Section 1.9 of the General Terms and Conditions applicable to

Panhandle’s G-2 tariff reads:

1.9 General Service Buyer. General Service Buyer is any

buyer which does not purchase gas from any other natural-

gas company, as defined in the Natural Gas Act [NGA], for

distribution in areas served with Seller’s gas; provided, how-

ever, a Buyer under the General Service Rate Schedule which

seeks from Seller an increase in contract demand and Seller

is unable to supply the increase in contract demand, then such

Buyer may purchase natural gas from other natural-gas com-

panies but shall remain a General Service Buyer under this

Tariff.

See Appellant’s Supplemental Appendix at 347 (emphasis added).

-The meaning of the phrase ‘‘as defined in the Natural Gas Act”

is a bone of contention between the parties, one that could affect

the outcome of the case. The state maintains that Panhandle’s

characterization of the G tariff as a “‘sole supplier’ contract is er-

roneous, and asserts therefore that the existence of the G tariff

was no justification for Panhandle’s refusal to transport gas dur-

ing the early 1980s. The state maintains that the G tariff did not

restrict G tariff customers from purchasing ‘‘new gas,” that is,

gas not committed or dedicated to interstate commerce as of No-

vember 8, 1978, see 15 U.S.C. § 3431(aX1XA) and (B), directly from

producers because producers are not “natural gas companies” un-

der the NGPA.

The NGPA didn’t change the definition of ‘‘natural-gas company”

under the NGA, however; it merely rendered the sale of “new

gas’’ an event over which the FERC is not entitled to exercise

jurisdiction. Panhandle Eastern Pipeline Co., 38 FERC 463,009

at 65,052-53 (1987). Moreover, the state concedes that producers

who sell natural gas for resale in interstate commerce were, before

enactment of the NGPA in 1978, natural gas companies under the

NGA (15 U.S.C. § 717(a)). Appellant’s Brief at 34. That is the only

definition relevant to the interpretation of the G tariff as that is

the definition incorporated by the tariff. It is true that in 1951,

when the G tariff was first approved, gas producers were not con-

sidered to be “‘natural-gas companies.’’ But producers sold almost

(Footnote continued on following page)

ant il

A-6 No. 90-1231

approved “G tariff’ rate schedule, which obligated Pan-

handle to use its best efforts to meet its customers’ de-

4 continued

exclusively to pipelines, so the omission of producers in the 1951

tariff was hardly significant.

Moreover, the industry understanding changed with the Supreme

Court’s decision in Phillips Petroleum v. State of Wisconsin, 347

U.S. 672 (1954), which held that producers were subject to regulation

as natural-gas companies under the NGA. /d. at 677. Customers

who contracted to purchase under the G tariff after Phillips

were on notice that the tart precluded urchases from gas pro-

ducers as well as from other pipelines. CILCO last renewed its

G tariff with Panhandle in 1970, well after Phillips, and well be-

fore enactment of the NGPA.

It is possible, we suppose, to read the reference to the NGA

definition in the G tariff as an attempt to incorporate all future

manifestations of the definition, but that is not the interpretation

adopted by the parties to the contract. Panhandle’s customers also

read the iff to require them to buy all their gas from Panhan-

dle; CILCO took that position when it challenged the provision

in its FERC complaint, after the NGPA modified the NGA defini-

tion of ‘“‘natural-gas company.” See Panhandle Eastern Pipe Line

Co. v. FERC (Panhandle I), 881 F.2d 1101, 1105 (D.C. Cir. 1989)

(per curiam). The administrative law judge who first ruled in the

case, the FERC, and the D.C. Circuit each treaced § 1.9 as re-

quiring G tariff customers to purchase all of their requirements

from Panhandle. See Panhandle Eastern Pipe Line Co., 32 FERC

q 63,085 at 65,321-26 (1985) (the CILCO Complaizit case); Panhan-

dle Eastern Pipe Line Co., 38 FERC 461,164 at 61,465 (1987)

(Opinion 265); Panhandle I, 881 F.2d at 1107. Absent language

irmatively contemplating and adopting future changes in that

definition, we agree that Panhandle’s interpretation of § 1.9 as a

sole supplier provision was reasonable.

The state cites evidence suggesting that Panhandle did not really

interpret § 1.9 to bar its customers from purchasing gas directly

from producers, but the district court found that Panhandle main-

tained the position that the G tariff was a sole supplier tariff and

that finding is not clearly erroneous. At any rate, a Panhan-

dle subjectively believed that the tariff was a sole supplier provi-

sion is largely irrelevant because the state concedes that concern

about take-or-pay liability animated Panhandle’s refusal to trans-

port “‘new gas” for its customers. The question in this case is

simply whether that motivation was anticompetitive within the

meaning of the antitrust laws.

No. 90-1231 A-7

mands for gas and permitted customers to vary the quan-

tity of gas purchased each month (demand for natural gas

typically decreases substantially during the summer). In

return, customers agreed to purchase their full require-

ments of gas from Panhandle. See Panhandle Eastern

Pipe Line Co., 10 F.P.C. 185 (Opinion No. 214), modified,

10 F.P.C. 322 (1951), further modified, 13 F.P.C. 53 (1954)

(Opinion 269), rev’d in part, 230 F.2d 810 (D.C. Cir. 1955).

As long as the price of natural gas was regulated, the

sole supplier provision was a small price for the G tariff

customers to pay for the security of a stable supply of

gas. Under price regulation, they could afford to be in-

different to their source of gas, and were: Panhandle’s

supply contracts with LDCs were typically long-term af-

fairs (its 1970 contract with CILCO had a term of eigh-

teen years), a fact that also contributed to Panhandle’s

own willingness to execute long-term purchase contracts

from gas producers.

Notwithstanding the G tariff, the move toward deregula-

tion gave Panhandle’s customers some muscle. Beginning

in 1979, FERC enacted a series of regulations under § 311

of the NGPA authorizing interstate pipelines to transport

natural gas purchased from sources other than the pipeline

itself. In 1982 FERC instituted the “Blanket Certificate

Program,”’ under which interstate pipelines were autho-

rized to transport nonsystem gas (gas to which they did

not have title) directly to high-priority end-users (hospitals,

schools, and essential agricultural users), so long as the

pipeline first received a certificate of public convenience

and necessity.

Despite these regulatory initiatives, Panhandle declined

to transport nonsystem gas. When CILCO made its first

formal request that Panhandle transport gas it had pur-

chased directly from producers in March 1983, Panhandle

refused on the ground that enabling its customers to ob-

tain gas from other sources would dramatically reduce de-

mand for the expensive gas it was contractually obligated

to purchase, exposing it to enormous take-or-pay liability.

CILCO had filed a complaint with FERC in 1982, seeking

A-8 No. 90-1231

authorization to interconnect with a natural gas pipeline

other than Panhandle; after Panhandle refused to trans-

port nonsystem gas, CILCO incorporated an attack on the

G tariff into its case. FERC prospectively invalidated the

sole supplier provision of the tariff in 1987 (Opinion No.

265, 38 FERC 461,164), but that opinion was vacated and

the case remanded for a determination of the reasonable-

ness of the sole supplier restriction. Panhandle Eastern

Pipeline Co. v. FERC, 881 F.2d 1101 (D.C. Cir. 1989) (per

curiam).

In 1983, the FERC issued orders 234-B and 319. 48 Fed.

Reg. 34872 (1983); 48 Fed. Reg. 34875 (1983). These or-

ders greatly expanded the class of end-users for which

interstate pipelines could obtain approval to transport gas

the consumers purchased directly from producers (as op-

posed to gas the pipeline had itself purchased for resale).

Distributors remained ineligible. Application under these

programs, as under the blanket certificate program, was

voluntary; pipelines were not required to transport gas

purchased from other sources. After FERC adopted Or-

ders 234-B and 319, it approved “Special Marketing Pro-

grams” (“SMPs”) that permitted certain pipelines, includ-

ing Panhandle, to obtain credits against their take-or-pay

contractual obligations by selling gas to “‘noncaptive”’ cus-

tomers (those price-sensitive industrial end-users able to

switch to different fuel sources) at the lower spot mar-

ket prices rather than at the contract prices. Panhandle’s

version of the SMP was its “PanMark” program. In Sep-

tember 1984, FERC renewed approval for SMPs such as

PanMark for another year, but added a requirement that

participating pipelines allow LDCs to purchase up to ten

percent of their monthly contract demand directly from

gas producers. The FERC order specifically provided for

a temporary limited waiver of the sole supplier provision

of the G tariff to allow LDCs to participate in the SMPs

without jeopardizing their G tariff status. Panhandle ob-

jected to the extension of the SMPs to captive LDCs, but

continued to participate in order to retard the defection

of noncaptive industrial customers.

No. 90-1231 A-9

Those customers of Panhandle ineligible for full participa-

tion in the PanMark program, including LDCs like CILCO,

continued to press Panhandle to transport nonsystem gas

under authority of its blanket certificate. In late 1983,

Panhandle developed the Market Area Transport (“MAT”)

program, which expanded the class of industrial customers

eligible to obtain transportation of gas purchased directly

from producers. Panhandle conditioned its agreement to

transport for these customers, however, on its right to

meet the price of the producer first; if it did, then the

customer was obligated to buy the Panhandle gas. The MAT

program was not available to LDCs; it too was intended

only as a measure to discourage noncaptive industrial con-

sumers from defecting. Panhandle did extend the MAT

program to LDCs who did not purchase under the G tariff

(those that purchased gas from other pipelines as well,

under a nonexclusive tariff), but continued to refuse to

include G tariff LDCs in the program.

In 1985, the D.C. Circuit vacated the FERC orders that

authorized the SMP and MAT programs. Maryland Peo-

ple’s Counsel v. FERC (MPC J), 761 F.2d 768 (D.C. Cir.

1985) (FERC opinions approving an SMP failed to ade-

quately justify the program’s exclusion of the pipeline’s

captive customers); Maryland People’s Counsel v. FERC

(MPC II), 761 F.2d 789 (D.C. Cir. 1985) (FERC orders

234-B and 319 failed to consider antitrust aspects of the

SMP programs); Maryland People’s Counsel v. FERC

(MPC III), 768 F.2d 450 (D.C. Cir. 1985) (per curiam) (no

_basis for limiting LDC participation in SMPs to 10% of

gas purchases).

In response to this series of decisions, FERC issued Or-

der 436. 50 Fed. Reg. 42408 (1985). This order reauthorized

pipelines to transport gas purchased from other sources,

but on a nondiscriminatory basis. The Order also permitted

pipelines to begin transporting on a provisional basis with-

out committing themselves to continue doing so in per-

petuity. Having reversed Orders 234-B and 319 in MPC

IT for failing to address the concerns of captive natural

gas consumers, the D.C. Circuit vacated Order 436 because

A-10 No. 90-1231

it failed to consider the “take or pay” problem faced by

the pipelines. Associated Gas Distribs. v. FERC, 824 F.2d

981, 1021-30 (D.C. Cir. 1987) (AGD).5

Panhandle initially shut down its MAT program rather

than participate in the Order 436 program. During 1986,

however, Panhandle began an interim program that con-

tinued to deny transportation services for nonsystem gas

to captive G tariff LDCs. It did so on the condition that

the captive LDCs would not request that Panhandle trans-

port direct-purchase gas for them. If any G tariff LDC

made such a request, Panhandle informed them, it would

terminate its interim 436 program for all. The LDCs pro-

tested, but ultimately capitulated, reasoning that even if

they couldn’t make use of the program themselves, they

also had a stake in preventing fuel-switchable industrial

consumers receiving gas directly from Panhandle from de-

fecting to other fuels and thereby increasing the percent-

age of the Panhandle’s fixed costs each would be required

to pay.

The state filed suit in February 1984 in its capacity as a

natural gas consumer and as parens patriae for a class of

5 The subsequent history of FERC’s efforts to resolve the take-

or-pay problem are not directly relevant to our case because all

of Pochiandie’s challenged conduct took place before Order 436 was

vacated. Nevertheless, the years spent by FERC and the courts

grappling with the issue are instructive, for they provide compel-

ling evidence of the intractable nature of the problem. After Order

436 was vacated, FERC next issued Order 500, an interim rule,

to temporarily address the take-or-pay problem while FERC con-

ducted rulemaking proceedings to comply with the concerns raised

in AGD. That order, too, was remanded. American Gas Ass'n v.

FERC, 888 F.2d 136 (D.C. Cir. 1989); see also Associates “as

Distribs. v. FERC, 893 F.2d 349 (D.C. Cir. 1989), cert. denied sub

nom. Berkshire Gas Co. v. Associated Gas Distribs., 111 S. Ct.

277 (1990) (vacating FERC Orders promulgated under Order 500

provisions). With Order 500-H, however, FERC finally resolved

the take-or-pay problem satisfactorily (with one minor exception).

See American Gas Ass'n v. FERC, 912 F.2d 1496 (D.C. Cir. 1990).

No. 90-1231 A-11

plaintiffs consisting of all of Panhandle’s indirect purchasers

residing in the central Illinois counties served exclusively

by Panhandle. The state’s complaint alleged that Panhan-

dle monopolized the sale of natural gas within central IIli-

nois by refusing to transport nonsystem gas purchased

by LDCs directly from independent producers, thereby

forcing them to purchase gas from Panhandle. The com-

plaint comprises ten counts, five under federal law, and

five parallel counts under Illinois law, alleging unlawful

monopolization (counts 1 and 2), attempted monopolization

(counts 3 and 4), monopoly leveraging (counts 5 and 6),

an unlawful denial of access to an essential facility (counts

7 and 8), and an unlawful tie of gas transportation to gas

purchases (counts 9 and 10).®

The district court denied the state’s motion for a pre-

liminary injunction in December 1984. Panhandle then filed

a motion to dismiss, predicated on the doctrine of Illinois

Brick v. Illinois, 431 U.S. 720 (1977), which held that, in

most cases, indirect purchasers cannot bring antitrust claims

against upstream suppliers. The district court denied the

motion in September 1985, but certified the question for

interlocutory appeal. We initially reversed, 839 F.2d 1206

(1988), but subsequently reheard the case en banc and af-

firmed, 852 F.2d 891 (7th Cir. 1988), cert. denied, 109 S.

Ct. 543 (1988), holding that Jllinois Brick did not bar the

claims of the indirect purchasers of Panhandle’s gas who

were unable to turn to alternative sources of fuel (CILCO’s

captive residential and commercial customers). While the

interlocutory appeal was pending, the district court con-

ducted a bench trial on the merits and found in favor of

Panhandle on all counts. The State appealed, and briefs

were filed in early 1989. On the day after the last brief

§ The state’s complaint alleges that the tie was an unlawful re-

straint of trade violating of $1 of the Sherman Act, rather than

an exclusionary practice violating § 2. In its brief on appeal, how-

ever, the state describes the tie as an exclusionary practice rele-

vant to its §2 monopolization claim, and, accordingly, that is how

we treat it.

A-12 No. 90-1231

was filed, the Supreme Court decided Kansas v. Utilicorp

United, Inc., 110 S. Ct. 2807 (1990), holding that the ‘“‘cost-

plus” exception to the Jllinois Brick doctrine did not per-

mit indirect purchasers of a regulated utility to sue for

antitrust damages. Panhandle moved for supplemental

briefing on whether Utilicorp disposed of state’s suit and

the motion was granted.

II. Utilicorp’s Impact

Our first order of business, then, is to determine whether

Utilicorp controls the outcome of this case. The Utilicorp

case addressed the issue of whether the customers of a

public utility had standing to sue when the utility’s sup-

pliers had allegedly violated the antitrust laws by over-

charging the utility for natural gas. In Illinois Brick v.

Illinois, the Court held that only direct purchasers may

sue sellers who violate the antitrust laws; the purchaser’s

customers (the “‘indirect’”’ purchasers) may not. 431 U.S.

at 736-47; see also Hanover Shoe, Inc. v. United Shoe Ma-

chinery Corp., 392 U.S. 481, 493-94 (1968). The rationale

for the indirect purchaser bar is that allowing suits by

parties all along the distribution chain could impose dupli-

cative liability on the antitrust violator, particularly since

it is difficult to apportion damages between successive dis-

tribution levels. That rationale suggested an exception to

the rule, however, in cases where the cost of the monop-

olistic overcharge was certain to be passed on to the next

distribution level due to the existence of a cost-plus con-

tract between the direct purchaser and its customers. See

Illinois Brick, 481 U.S. at 736; Hanover Shoe, 392 U.S.

at 494. The plaintiffs in Utiticorp sought the shelter of

the “‘cost-plus” exception, arguing that as customers of a

regulated public utility, they paid the entire anticompetitive

overcharge originally exacted from the utility by the nat-

ural gas producer.

The Court declined, however, ‘“‘to create an exception

{to the Jllinois Brick doctrine] for regulated public util-

ities.” 110 S. Ct. at 2813. The Court held that the “‘cost-

plus” exception applies only when “the direct purchaser

No. 90-1231 A-13

will bear no portion of the overcharge and otherwise suf-

fer no injury,” id. at 2818, and that is not the case, said

Court, when the direct purchaser is a public utility.

d.

Illinois maintains that its case is factually distinguishable

from Utilicorp. We note initially that the state took a dif-

ferent view of the significance of the factual distinctions

between the cases as an amicus curiae in the Utilicorp

case. In its brief in that case, the state observed:

The natural gas systém in Illinois operates in essen-

tially the same manner as the systems in place in

Kansas and Missouri. It is likely that the outcome

of this case will be dispositive of the identical issue

in Panhandle notwithstanding that the facts in Pan-

handle are somewhat stronger than the facts in the

instant case.

We agree with this assessment. The cases are factually

distinguishable, see 852 F.2d at 593, and Calkins, The Oc-

tober 1989 Supreme Court Term and Antitrust: Power,

Access, and Legitimacy, 59 ANTITRUST L.J. 339, 360-61

(1991), but the Court’s reasoning in Utilicorp eliminates

the significance of these distinctions. The Court made this

point explicitly when it stated that it had granted certi-

orani in Utilicorp “to resolve a conflict” between the 10th

Circuit’s decision in that case (holding that the cost-plus

exception was not available to residential consumers) and

our en banc decision in this case (holding that it was).

110 S. Ct. at 2811.

In Utilicorp, it was not clear what portion of the mo-

nopoly overcharge was in fact passed on to the consumers;

in our case, we know that prices paid by consumers reflect

100% of the overcharge. The Court rejected our view that

apportionment of the overcharge between the utility and

its customers therefore presents no difficulties, for two

reasons. ‘‘First, an overcharge may injure a utility, apart

from the question of lost business, even if the utility raises

its rates to offset its increased costs. . . . ‘if a cost rise

is merely the occasion for a price increase a businessman

_——————————

A-l4 No. 90-1231

could have imposed absent the rise in his costs, the fact

that he was earlier not enjoying the benefits of the higher

price should not permit the supplier who charges an un-

lawful price to take those benefits from him without be-

ing liable for damages.’”’ Jd. at 2813 (quoting Hanover

Shoe, 392 U.S. at 493 n.9). We recognized this possibility

in our opinion, but concluded that “‘the doubts here are

too small to warrant our insisting that this potentially

serious antitrust violation .. . shall go unremedied... .”’

852 F.2d at 898. The Supreme Court disagreed. It ac-

knowledged that regulators may prevent a utility from

raising rates in the absence of increased costs, but con-

cluded that ‘“‘state regulation does not simplify the prob-

lem but instead imports an additional level of complexity.

To decide whether a utility has borne an overcharge, a

court would have to consider not only the extent to which

market conditions would have allowed the utility to raise

its rates prior to the overcharge, as in the case of an

unregulated business, but also what the state regulators

would have allowed.” Jd. at 2813. Second, although ac-

knowledging that many gas utilities can, through the use

of PGAs, quickly recoup their costs, the Court observed

that even the minimal delays incurred in recouping over-

payment from the indirect purchasers works to the detri-

ment of the direct purchaser. “During any period in which

a utility’s costs rise before it may adjust its rates, the

utility will bear the costs in the form of lower earnings.”

Id. at 2814.

Both of these rationales, of course, apply with equal force

whether or not there is in force an explicit cost-plus con-

tract between purchaser and indirect purchaser. That fact

makes the state’s reliance on that distinction futile, and

indeed, raises questions about the viability of the cost-

plus exception in any context. See Calkins, supra, at 363

n.135. The “broader point” made by the Court that, “even

assuming that any economic assumptions underlying the

Illinois Brick rule might be disproved in a specific case,

we think it an unwarranted and counterproductive exer-

cise to litigate a series of exceptions,”’ id. at 2817, under-

scores the scope of its ruling in Utilicorp. The Court’s

No. 90-1231 A-15, ’

interpretation of the cost-plus exception appears so narrow

(setting up as it does a demand for rigorous proof of a

100% pass through and then suggesting an unwillingness

to consider such detailed evidence) as to preclude its appli-

cation in any case; it seems particularly unlikely, then,

that the Court intended to permit application of the ex-

ception by the indirect purchasers of a natural gas sup-

plier to turn on subtle factual distinctions among the sup-

plier’s indirect customers.

The state’s assertion that Utilicorp should not be applied

retroactively to bar the indirect purchaser claims in this

case has more plausibility than does its claim that Utilicorp

would not control the disposition of those claims if applied.

The ‘‘threshold test,’”’ United States v. Johnson, 457 U.S.

537, 550 n.12 (1982), in determining whether a decision

should be applied retroactively is whether it establishes

‘‘a new principle of law, either by overruling clear past

precedent on which litigants may have relied . . . or by

deciding an issue of first impression whose resolution was

not clearly foreshadowed... .’”’ Chevron Oil Co. v. Huson,

404 U.S. 97, 106 (1971). If Utilicorp eliminated the cost-

plus exception sub silentio, there may be something to

the state’s assertion that the case should not be applied

retroactively.

To adopt the state’s reasoning, however, we would have

to ignore the Court’s position that Utilicorp faithfully in-

terprets Hanover Shoe and Illinois Brick. 110 S. Ct. at

2813 & 2817. The Court said its decision was not new law,

and we are therefore unwilling to disagree, particularly

when getting the state over the “new law” threshold does

nothing to prevent the door from slamming shut on the

state’s claims anyway. It is not enough that a decision

announces a new rule of law; it must also, among other

things, work some inequity on the party against whom

it is applied. Chevron, 404 U.S. at 107. Applying Utilicorp,

however, works no hardship on the state of Illinois (other

than the adverse ruling it requires). Unlike the plaintiff

in Chevron, the state has not forgone any legal rights in

reliance on its view that its claims were not barred by

the Jllinois Brick doctrine; the applicability of the doc-

A-16 No. 90-1231

trine has been contested from the outset of the case. In-

deed, “retroactive application” is something of a misnomer

here, since this case has not been fully adjudicated. Our

decision to permit the state’s case to go forward is the

law of the case, but that law is subject to change if it

is determined to be clearly erroneous and would work a

substantial injustice if uncorrected. Weidner v. Thieret,

No. 90-2024, slip op. at 10 (7th Cir. May 138, 1991). In light

of the Court’s decision in Utilicorp, our previous decision

cannot stand. Federal claims are to be decided in accor-

dance with the law existing at the time of decision, Good-

man v. Lukens Steel Co., 482 U.S. 656, 662-63 (1987), and

Utilicorp bars the indirect purchaser claims in this case.

The state claims that it would be inequitable to apply Utili-

corp at this late stage in the litigation, but cannot provide

a convincing reason why. The district court conducted the

trial on the merits while the interlocutory appeal on the

Illinois Brick issue was pending before this court; the

state would thus have incurred virtually the entire costs

of litigating its case regardless of the final determination

as to the resolution of the Illinois Brick issue. Changing

the ruling on that issue at this time works no injustice to

the state; it merely results in the dismissal of its Sher-

man Act claims,’ claims that the district court denied on

the merits anyway.

All of which is not to say that Utilicorp mandates the

dismissal of the state’s entire case. The state’s complaint

contains pendent state law counts paralleling each federal

antitrust violation alleged, and Illinois law explicitly per-

mits indirect purchasers to sue under the state’s antitrust

laws to recover monopolistic overcharges passed on to

them. See ILL. REV. StaT. ch. 38, § 60-7(2). In California

vy. ARC America, 109 S. Ct. 1661 (1989), the Supreme Court

ruled that the Jllinois Brick rule does not bar indirect

7 We do not address the issue of whether Utilicorp bars the

state’s claims for injunctive relief, as we agree with Panhandle

that such relief is unavailable because Panhandle now makes its

transportation services available to its LDC customers.

No. 90-1231 A-17

purchasers from recovering damages flowing from viola-

tions of state antitrust law when, as here, there is an ex-

press state statutory provision giving such purchasers a

cause of action. Panhandle does not contest the relevance

of ARC America. Rather, it resurrects an argument re-

jected by the district court, namely, that Illinois’ state

antitrust law is preempted by the extensive federal reg-

ulation of the natural gas industry and that the law vio-

lates the commerce clause.

The state maintains that Panhandle waived its preemp-

tion claim by failing to raise ‘+ in its original brief. Pre-

emption, the state maintains, has nothing to do with the

applicability of Utilicorp, the issue on which this Court

ordered supplementary briefing. We disagree. Prior to

Utilicorp, the independent viability of the Illinois Anti-

trust Act claims was not at issue in this appeal, and Pan-

handle cannot be faulted for not addressing an irrelevant

issue in its original brief. After the Court decided Utili-

corp, however, those claims became critical, a fact the

state’s initial supplementary brief made plain. Panhandle’s

preemption theory was a direct response to the state’s

claim that notwithstanding Utilicorp’s affect on the federal

claims, the state law claims survived, and was both timely

and relevant.

That being said, we do not agree with Panhandle’s view

that the state law claims are preempted by federal regula-

tion of the natural gas industry. The arguments Panhandle

puts forth for preemption would apply with equal force

to federal antitrust law, but federal gas regulation does

not immunize natural gas companies from application of

the federal antitrust laws. California v. Federal Power

Comm'n, 369 U.S. 482 (1962). When state antitrust law

only mirrors federal antitrust law, there is no reason to

conclude that Congress intended to preempt the state law.

When the two antitrust regimes differ, federal regula-

tion that does not preempt federal antitrust law may pre-

empt state antitrust law, see, e.g., Connell Constr. Co.

v. Plumbers & Steam Local Union No. 100, 421 U.S. 632,

635-37 (1975), but we face no divergent antitrust aims in

A-18 No. 90-1231

this case. Sections 3(3) and 3(4) of the Illinois Antitrust

Act, on which the state law claims in this case are based,

were modeled after sections 2 and 1 of the Sherman Act,

respectively, and Illinois law provides that its courts should

use the construction of federal antitrust law by federal

courts to guide their construction of those state antitrust

laws that are substantially similar to federal antitrust law.

ILL. REv. Stat. ch. 38, § 60-11. Illinois courts therefore

look to federal law when construing these provisions. Col-

lins v. Associated Pathologists, Litd., 844 F.2d 473, 481-82

(7th Cir. 1988); People v. College Hills Corp., 91 Ill. 2d

138, 150 (1982). There is, therefore, no conflict between

state and federal antitrust law to create a preemption ques-

tion. Illinois law does permit indirect purchaser suits while

federal law does not, but that difference reflects different

judgments about the feasibility of trying such claims and

the potential danger of duplicative recoveries rather than

different judgments about the implied immunity of the

natural gas industry from the application of the substan-

tive provisions of the federal and state antitrust laws

which, in this case anyway, are identical. Illinois’ pendent

state law claims therefore survive application of Utilicorp

and we must reach the merits of the state’s appeal of the

dismissal of those claims.

III. Panhandle’s Conduct

Despite its complex regulatory backdrop, this is a straight-

forward case. In force between Panhandle and its G tariff

customers, like CILCO, was an exclusive dealing contract,

approved originally by the Federal Power Commission

(FERC's predecessor) in 1951, that required those cus-

tomers to purchase all of their natural gas requirements

from Panhandle. In exchange for this sole supplier pro-

vision, Panhandle incurred an obligation to use its best

efforts to meet its customers’ supply requirements. To sat-

isfy that obligation, Panhandle entered into a number of

long-term contracts to secure gas for the future. When

Congress deregulated wellhead prices, however, a market

No. 90-1231 A-19

that historically had been characterized by chronic short-

ages quickly found itself awash in natural gas; spot market

prices soon fell well below the level at which many pipe-

lines, including Panhandle, had contracted to purchase gas.

At that point many LDCs, like CILCO, balked at paying

above market rates for their gas and sought to escape

their contractual obligations under the G tariff by demand-

ing that Panhandle transport gas they wanted to purchase

from other sources. At the same time, these customers

wanted to hold Panhandle to its obligation to supply their

contract demand quantities, should they desire to purchase

them. In the words of the district court, “CILCO wanted

to have its cake and eat it too.’ 730 F. Supp. at 886.

Panhandle, obligated by its own purchase contracts to buy

expensive gas, refused these demands and tried to keep its

G tariff in force. The question presented in this case is

simply whether Panhandle’s efforts to maintain its G tariff

in the face of the regulatory changes sweeping the indus-

try violated the antitrust laws.® In other words, did Pan-

handle violate the antitrust laws when it wouldn’t give

CILCO another slice?

The district court said no. It found that Panhandle did

possess monopoly power in the relevant market, power

that was not effectively constrained by regulation.'!° Never-

8 Alternatively, in the words of FERC:

Purchasers of natural gas, seeing the availability of supplies

in the field at prices below the rolled-in average cost of all

gas, are seeking to purchase gas directly in the field and have

it transported to the city-gate or burner-tip in competition with

the system supplies which the pipeline retains under certain

uneconomic long-term contracts.

FERC Order 436, 48 Fed. Reg. at 42421.

9 The state does not claim that the G tariff was originally vio-

lative of the antitrust laws.

‘0 Panhandle disputes these findings, but our agreement with the

district court’s finding that Panhandle lacked anticompetitive in-

tent makes it unnecessary to address them.

A-20 No. 90-1231

theless, the district court concluded that Panhandle’s ef-

forts to maintain its G tariff did not violate the antitrust

laws because it found that Panhandle’s refusal to transport

gas for G tariff customers was not an effort to maintain a

monopoly in sales of natural gas. It was, the district court

found, merely a “lawful refusal to cut its own throat.”""}

730 F. Supp. at 883; see also id. at 915-22.

The district court, like many courts addressing monop-

olization claims, spoke in terms of Panhandle’s “‘intent’’ to

monopolize, leading the parties to debate whether “intent”’

is an element of the offense of monopolization. “Intent”

is relevant to the offense of monopolization. Aspen Skiing

Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585, 602

(1985). But we have to be clear about what is meant by

“intent,” for in the context of a monopolization case “‘in-

tent” is an elusive concept. The “intent’’ to achieve or

maintain a monopoly is no more unlawful than the posses-

sion of a monopoly. Indeed, the goal of any profit-maxi-

mizing firm is to obtain a monopoly by capturing an ever

increasing share of the market. Virtually all business be-

havior is designed to enable firms to raise their prices

above the level that would exist in a perfectly competitive

market. Economic rent—the profit earned in excess of the

return a perfectly competitive market would yield—pro-

vides the incentive for firms to engage in and assume the

risk of business activity. Monopolies achieved through su-

perior skill are no less intentional than those achieved by

anticompetitive means (as Learned Hand observed, ‘‘no

monopolist monopolizes unconscious of what he is doing’’’*),

so the intent relevant to a § 2 Sherman Act claim is only

11 By contrast, the district court did find that Panhandle’s adop-

tion of its “Transportation Guidelines” for industrial end-users was

anticompetitive. /d. at 891-94, 921. The district court concluded,

however, that Panhandle did not have monopoly power over those

users, saving it from antitrust liability on that score as well. Id.

at 888, 922.

12 United States v. Aluminum Co. of America (“Alcoa”), 148 F.2d

416, 432 (2d Cir. 1945).

No. 90-1231 A-21

the intent to maintain or achieve monopoly power by anti-

competitive means. Section 2 forbids not the intentional pur-

suit of monopoly power but the employment of unjustifiable

means to gain that power. 3 P. AREEDA & D. TURNER,

ANTITRUST Law {626c at 76 (1978); see also Olympia Equip.

Leasing Co. v. Western Union Tel. Co., 797 F.2d 370, 373,

cert. denied, 480 U.S. 934 (1986) (The offense of monop-

olization requires proof of ‘‘conduct designed to maintain

or enhance [monopoly power] improperly.’’).

When courts consider the “intent” of a firm charged

with monopolization, they look not to whether the firm

intended to achieve or maintain a monopoly, but to whether

the underlying purpose of the firm’s conduct was to enable

the firm to compete more effectively. Did the firm engage

in the challenged conduct for a legitimate business reason?

Or was the firm’s conduct designed solely to insulate the

firm from competitive pressure? Intent is relevant, then,

because intent determines “whether the challenged con-

duct is fairly characterized as ‘exclusionary’ or ‘anticom-

petitive.’ ’’ Aspen Skiing, 472 U.S. at 602. When courts

speak of a firm’s intent in a monopolization case, they refer

to the legitimacy of the firm’s conduct as measured by

its intended effect on the competitive process. In United

States v. Grinnell Corp., 384 U.S. 563, 570 (1966), for ex-

ample, when the Court stated that one of the elements

of monopolization is ‘the willful acquisition or maintenance

of [monopoly] power,” it went on to define “willful acqul-

sition or maintenance” by distinguishing it from “growth

or development as a consequence of a superior product,

business acumen, or historic accident.” /d.; see also Aspen

Skiing at 608 n.39 (‘‘ ‘the law can usefully attack [exclu-

sionary conduct] only when there is evidence of specific

intent to drive others from the market by means other

than superior efficiency.’ "’) (emphasis added) (quoting R.

Bork, THE ANTITRUST PARADOX 157 (1978)). Conduct that

tends to exclude competitors may therefore survive anti-

trust scrutiny if the exclusion is the product of a “nor-

mal business purpose,” Aspen Skiing, 472 U.S. at 608-

10, for the presence of a legitimate business justification

reduces the likelihood that the conduct will produce un-

A-22 No. 90-1231

desirable effects on the competitive process. /d. at 608

n.39 (‘Proof of specific intent to engage in predation may

be in the form of . . . evidence that the conduct was not

related to any apparent efficiency.’’); Olympia Equipment,

797 F.2d at 378. Whether valid business reasons motivated

a monopolist’s conduct is a question of fact, Aspen Skiing,

472 U.S. at 604-05; our task, like the Court’s in Aspen

Skiing, is simply to determine whether the trial court’s

finding that Panhandle’s actions were motivated by a jus-

tifiable business purpose is defensible.

The state attempts to read “intent” out of the monop-

olization equation by resurrecting a notion long discarded

in antitrust law, namely, that antitrust laws exist to pro-

tect competitors. In the state’s view, “[mJaintenance of

monopoly power . . . is ‘wilful’ . . . whenever the con-

duct of the defendant has caused anticompetitive or injuri-

ous effects to the defendant’s competitors and ultimately

to consumers ... .”’ Appellants’ Reply Brief at 7. The

standard aphorism is that antitrust law protects competi-

tion and not competitors, Copperweld Corp. v. Indepen-

dence Tube Corp., 467 U.S. 752, 767 n.14 (1984); as we

reformulated it in Olympia Equipment, “the emphasis of

antitrust policy [has] shifted from the protection of com-

petition as a process of rivalry to the protection of com-

petition as a means of promoting economic efficiency.’ 797

F.2d at 375. In Olympia Equipment, we reversed a jury

verdict that Western Union had monopolized the market

for telex terminal equipment on the ground that it had

no duty to promote sales of its competitors’ products. Its

actions were reasonable, we held, because there was no

evidence to suggest that they were part of a scheme de-

signed to exclude competitors from that market; rather,

they were motivated only by Western Union’s desire “to

liquidate its supply of telex terminals faster.” 797 F.2d

at 378. That type of conduct, we said, is not “objectively

anticompetitive,” id. at 380, because it was an objectively

reasonable business decision. The state’s approach would

render business justifications and efficiency considerations

irrelevant, an approach we rejected in Olympia Equipment

and the Supreme Court rejected in Aspen Skiing. See

No. 90-1231 A.23

Easterbrook, On Identifying Exclusionary Conduct, 61

Notre Dame L. Rev. 972, 975 (1986) (‘“{T]he Court’s posi-

tion [in Aspen Skiing] resolves to a conclusion that a domi-

nant firm that imposes large costs on its rival must have

a good business justification (one consistent with ‘efficien-

gf ene |

The state claims, however, that Panhandle’s reasons for

refusing to transport nonsystem gas are irrelevant because

Panhandle’s pipelines are “essential facilities.” And indeed,

“{slome cases hold . . . that a firm which controls a facility

essential to its competitors may be guilty of monopolization

if it refuses to allow them access to the facility.” Olym-

pia Equipment, 797 F.2d at 376. In essential facilities

cases, however, liability hinges on the feasibility of com-

petitors developing competing facilities and of the owner

providing access to the facility. MCI Communications Corp.

v. American Tel. & Tel. Co., 708 F.2d 1081, 1132-33 (7th

Cir. 1982), cert. denied, 464 U.S. 891 (1983). In this case,

neither condition is satisfied. The first condition goes to

whether access to the facility is, in fact, essential to com-

pete with the monopolist. In this case, access to Panhan-

dle’s pipeline was not essential. The district court found

that it would have been economically feasible for competi-

tors to duplicate much of Panhandle’s system within cen-

tral Illinois by means of interconnections between compet-

ing pipelines and the construction of new pipelines. 730

F. Supp. at 928. That finding was not clearly erroneous, as

evidenced by the fact that by 1987 Panhandle faced sub-

stantial competition within central Illinois from other pipe-

lines for transportation of natural gas to industrial end-

users. /d. at 872-73. The primary barrier to entry into the

central Illinois natural gas market through the period of

this litigation was not capital but the Panhandle’s G tariff,

which effectively deterred LDCs from dealing with other

pipelines and from buying gas directly from producers.

The state’s essential facility claim also fails because to

be liable for monopolizing an essential facility, providing

access to the facility must have been feasible for the owner.

This second prerequisite to essential facility liability sug-

gests that essential facilities cases are no different con-

A-24 No. 90-1231

ceptually than cases involving other monopolization theories,

because it reintroduces “intent” (a.k.a. “business justifica-

tion’’) back into the monopolization equation and excuses

refusals to provide access justified by the owner’s legitimate

business concerns. See MCI, 708 F.2d at 1133 (evidence

supported jury finding that AT&T could have feasibly pro-

vided FX and CCSA interconnections as ‘“‘no legitimate

business or technical reason was shown for AT&T’s denial

of the requested interconnections”). Panhandle had such

concerns—in spades. According to the district court, Pan-

handle faced over $4 billion in potential take-or-pay liabil-

ity. 730 F. Supp. at 862 (combined exposure of Panhan-

dle and Trunkline). The state disputed Panhandle’s actual

exposure to take-or-pay liability under its long-term con-

tracts, presenting evidence that such claims had been set-

tled, on average, for ten cents on the dollar. But as the

court observed, even at that level, Panhandle’s potential

liability was extremely large, and there was no guarantee

that Panhandle would be able to limit its exposure to that

extent in the future.

The district court found that Panhandle’s intransigence

regarding the G tariff was genuinely and reasonably moti-

vated by the need to limit its potential take-or-pay liabil-

ity, not by a desire to maintain its monopoly position by

excluding competition in the sale of natural gas. In the

district court’s view that concern, when coupled with the

regulatory flux the natural gas industry was undergoing

at the time, was sufficient to negate the possibility that

Panhandle was motivated by anticompetitive intent.'* That

13 The district court rejected, however, Panhandle’s view that its

concern about take-or-pay liability was sufficient to constitute a

defense, adopting a more narrow view of the type of business jus-

tification that constitutes a defense. In the district court’s view,

“(ijt is not a legitimate business justification for antitrust purposes

that the defendant sought to protect itself from added costs or

lost profits.” 730 F. Supp. at 932-33.

We do not believe that the distinction among types of business

justifications drawn by the district court is a viable one. The dis-

(Footnote continued on following page)

No. 90-1231 A-25

finding is one of fact to which we must defer since there

was ample evidence to support it. Aspen Skiing, 472 U:S.

at 611.

In any event, it is one with which we agree. “A plausi-

ble response to the gas shortages of the 1970s, [take-or-

pay clauses have] created significant dislocations in light

of the oversupply of gas that has occurred since. Today

many purchasers face disastrous take-or-pay liability with-

out sufficient outlets to recoup their losses.’’ Mobile Oil

Exploration, 111 S. Ct. at 627. Panhandle assumed its con-

tractual obligations knowing that its LDC customers would

buy all the gas they needed from Panhandle; the G tariff

thus mitigated some of the risks posed by the take-or-

pay provisions. Under “the pattern of contractual arrange-

ments developed by the industry during previous eras of

pipeline expansion and supply curtailment, such as take-

or-pay . . . provisions, customers of pipelines have been

allocated a large part of the risk that gas supplies dereg-

ulated by the NGPA might prove unmarketable over the

life of contracts signed by producers and pipelines.” FERC

Order 436, 48 Fed. Reg. at 42421. What the state labels

‘monopolization’ was nothing more than the enforcement

of legitimate contracts designed to allocate risk between

Panhandle and its customers; what the state asks us to

do is reallocate those risks. We decline the invitation. Pan-

handle had incurred obligations itself in reliance on the

G tariff and to satisfy its regulatory obligations to antici-

13 continued

trict court cited Otter Tail Power Co. v. United States, 410 U:S.

366, 380-81 (1973), for the proposition that only measures that pro-

duce “superior service, lower costs, and improved efficiency” support

a business justification defense, without considering that measures

designed to avoid higher costs are essentially measures designed

to lower costs. Whether the lack of business justification is viewed

as an element of the offense or the presence of a business justifica-

tion constitutes an affirmative defense goes to the allocation of

burdens of proof. It says nothing about the type or quality of jus-

tification required, and we can see no reason for imposing 4 more

demanding test in one case than the other.

A-26 No. 90-1231

pate and meet future customer demand. City of Misha-

waka v. American Elec. Power Co., 616 F.2d 976, 985

(7th Cir. 1980), cert. denied, 449 U.S. 1096 (1981).!4 CILCO

and Panhandle’s other LDC customers were, in turn, obli-

gated to buy their full requirements for gas from Panhan-

dle. We do not believe that it was ‘‘anticompetitive”’ for

Panhandle to hold them to that deal.

Monopolists needn’t acquiesce to every demand placed

upon them by competitors or customers; a monopolist’s

duties are negative—to refrain from anticompetitive con-

duct—rather than affirmative—to promote competition.

Olympia Equipment, 797 F.2d at 375-76. Just as the mo-

nopolist has no duty to deter the sale of its own equip-

ment by promoting that of a competitor, id., so too it has

no duty to incur contractual liability itself by excusing its

customers from their contractual obligations. We recog-

nized the sufficiency of exactly that type of “self-serving”’

business justification in Olympia Equipment, where we

observed that “{clonsumers would be worse off if a firm

14 The state’s claim that Panhandle’s status as a utility is irrele-

vant since it was not required by regulation to enforce its G tariff

is misleading. Panhandle was required by the FERC, pursuant to

the FERC’s authority under § 7(a) of the NGA, to extend service

to many of its customers. Order 436, 50 Fed. Reg. at 42440. To

serve all of its customers, Panhandle was required by regulation

to anticipate their future requirements for natural gas. See, ¢.g.,

18 CFR § 2.61 (generally requiring pipelines to demonstrate abil-

ity to meet projected demand for next twelve years). Moreover,

as the district court observed, “{ojnce a pipeline has commenced

service .. . it may not abandon or terminate that service unless

it first obtains a certificate of abandonment from the FERC. A

pipeline is required by FERC to continue providing service to an

LDC customer even after the expiration of the service agreement

with the customer.” 730 F. Supp. at 877. In any event, the state

exaggerates the significance of a regulatory imperative. Whether

Panhandle’s efforts to enforce the G tariff were required by regula-

tion is not, as the state seems to suggest, dispositive of Panhan-

dle’s liability. The existence of affirmative regulatory obligations

is merely a factor to be considered in determining whether a util-

ity’s conduct was intentionally anticompetitive.

No. 90-1231 A-27

with monopoly power had a duty to extend positive as-

sistance to new entrants, or having extended it voluntarily

a duty to continue it indefinitely. The imposition of such

a duty would make firms that possessed or might be thought

to possess monopoly power, however laudably obtained,

timid about . . . competing with new entrants.” 797 F.2d

at 379. By the same token, consumers would be worse

off if a firm had a duty under the antitrust laws to release

customers from their contractual obligations; it is anything

but efficient for a firm to abandon its contractual rights

at the behest of customers who are no longer happy with

their bargain, even when consumers might be better off

(at least in the short run) if they did so. Imposing that

type of affirmative obligation on a monopolist—whether

explicitly or by refusing to acknowledge the legitimacy

of such refusals—would penalize the monopolist for refus-

ing to surrender a lawfully obtained monopoly, a result

courts have long foresworn.

To cite just one example, we addressed quite similar

claims in MCI, when MCI claimed that ATT violated the

antitrust laws by refusing to grant it access to intercon-

nections that would have given it access to AT&T’s en-

tire nationwide long-distance network. In MCI the FCC,

like the FERC in this case, appeared to be opening the

telecommunications industry to competition, but had not

directed AT&T to provide access to its long-distance net-

work to competitors. We concluded that AT&T’s refusal

to voluntarily assume “the extraordinary obligation to fill

in the gaps in its competitor’s network,” id. at 1149, did

not suffice to support a finding that it was trying to main-

tain its monopoly of long-distance telephone service by

anticompetitive means. “[G]iven the unsettled regulatory

status of the telecommunications industry at the time of

these events,’”’ we held that MCI had failed to present

sufficient evidence ‘‘to permit a finding that AT&T’s de-

nial of interconnection for multipoint service was primarily

motivated by an illegal intent to monopolize.” Jd.

To support its position the state, not surprisingly, points

to cases in which courts have held that a monopolist’s ac-

A-28 No. 90-1231

tions evinced an attempt to exclude competition from the

market rather than an attempt to minimize costs. The

cases it cites are factually distinguishable, however, and

do nothing to undermine the validity of the district court’s

factual finding in this case. We need not address every

case in which courts have found a monopolist’s actions

were animated by anticompetitive intent to make the point;

the state relies most heavily on Otter Tail Power Co. v.

United States, 410 U.S. 366 (1973), and it is enough to

point out the distinctions between that case and this one.

In Otter Tail, the Court held that an electricity producer’s

refusal to sell or ‘“‘wheel” (transport) electricity to towns

that sought to end their reliance on its retail electric dis-

tribution system by establishing their own systems con-

stituted illegal monopolization of the retail sale and dis-

tribution of electricity. The state says that Panhandle

has done the same thing by refusing customer requests

to transport gas purchased from other sources. Critical

to the Court’s analysis in Otter Tail, however, was the

fact that Otter Tail’s franchise contracts with the towns

had expired; they were no longer contractually bound to

use Otter Tail’s distribution facilities. Panhandle’s G tariff

customers, by contrast, were contractually obligated to

purchase their gas requirements from Panhandle, and Pan-

handle had itself entered into contractual obligations with

gas producers in reliance on the demand anticipated from

its customers.!5

iS Litton Systems, Inc. v. American Tel. & Tel., 700 F.2d 785

(2d Cir. 1983), cert. denied, 464 U.S. 1073 (1984), is distinguishable

for the same reason. In Litton, AT&T had filed a tariff with the

FCC (which the Commission ultimately rejected) that required cus-

tomers that had purchased equipment from its competitors to pur-

chase an unnecessary “interface” device in order to access AT&T's

telephone system. The jury found that AT&T's tariff evidenced

its intent to create barriers to entry in the telephone equipment

market and held it (along with AT&T’s efforts to convince the FCC

to approve the tariff) to be anticompetitive and the Court of Ap-

peals affirmed. Panhandle’s tariff, by contrast, had been approved

since 1951, and Panhandle had assumed long-term contractual ob-

ligations in reliance on the tariff.

No. 90-1231 A-29

These distinctions make all the difference. Otter Tail’s

business justification was simply that it could not compete

if forced to abandon practices designed to eliminate com-

petition in the market for retail electrical transmission:

the district court therefore found, and the Supreme Court

agreed, that “Otter Tail’s refusals to sell at wholesale or

to wheel were solely to prevent municipal power systems

from eroding its monopolistic position.” 410 U.S. at 378.

Panhandle, by contrast, does not claim that it cannot com-

pete on a level playing field; it merely objects that it is

unreasonable to expect it to permit its customers to avoid

their contractual obligations when to do so would be to

expose itself to enormous take-or-pay obligations. As the

district court correctly observed, Otter Tail “does not

stand for the proposition that a utility must renegotiate

extant long-term service agreements to enable a customer

to supplant the utility as its sole supplier.” 730 F. Supp.

at 909 (emphasis in original).

Despite the dire predictions of the state, this does not

mean that there now exists a “contract immunity” defense

to antitrust liability. The existence of a contract in this

case does not immunize Panhandle from antitrust liability;

it is merely a factor that is relevant to the question of

Panhandle’s intent to monopolize. The existence of a con-

tract that was itself an unreasonable restraint of trade,

violating § 1 of the Sherman Act, would do little to dispel

an inference of anticompetitive intent. In Otter Tail, for

example, the utility attempted to invoke contractual pro-

visions in its contracts with other suppliers that forbade

the suppliers from providing electricity to any of the util-

ity’s retail customers, past or present. That provision, as

the Supreme Court observed, was simply a territorial allo-

cation scheme designed to insulate the utility from com-

petition in the sale of electricity and had no legitimate

justification. 410 U.S. at 378-79. Panhandle’s exclusive deal-

ing contract with its G tariff customer, by contrast, was

a legitimate means of ensuring that it would not be stuck

holding expensive natural gas for customers who had de-

cided to purchase unexpectedly plentiful and cheap gas

A-30 No. 90-1231

from others, one that had been given regulatory sanction.

Contrary to the state’s suggestion, when Congress enacted

the NGPA, Panhandle’s tariffs did not become invalid or

illegal. Recognizing the obligations Panhandle incurred in

reliance on the tariffs does not elevate a private contract

above national policy as the state suggests.

The state has its own theory about Panhandle’s motives,

but its conjecture does little to make us question the

soundness of the district court’s findings. According to the

state, Panhandle refused to adopt an open access transpor-

tation policy because it wanted to exact monopoly profits

from the gas it sold to its G tariff customers. It did so,

according to the state, by tying the purchase of its mo-

nopolistically priced gas to the purchase of its regulated

pipeline capacity and by unlawfully segmenting the cen-

tral Illinois natural gas market and price discriminating

between gas consumers who were able to switch to an

alternate fuel and those who did not.

Panhandle, however, didn’t profit on its sales of gas to

the LDCs. Panhandle’s gas was priced above the spot

market, but that price merely reflected the price it was

paying for gas as the result of the long-term contracts it

agreed to in order to secure gas that was both high-priced

and scarce during the early days of deregulation. Panhan-

dle’s rate of return was based on its transportation ser-

vice, not its gas prices, a fact that suggests that absent

a fear of take-or-pay liability it would have had little re-

ason to object to transporting gas purchased from other

sources. The state’s brief acknowledges this point but, in-

explicably, goes on to rail against “the profits of Panhan-

dle and its subsidiaries on gas sales.”’ Brief of Appellant

at 35. The inconsistency is explained later, when the state

reveals that what it calls ‘‘profits’’ on the sale of gas are

‘more accurately” characterized not as profits but as losses

avoided. Brief of Appellant at 39. Translated, the state's

theory is simply that Panhandle’s desire to avoid take-

or-pay liability constituted an antitrust violation because

Panhandle enforced the G tariff rather than reducing its

rate of return by recouping less than 100% of its gas

No. 90-1231 A-31

prices. Panhandle was entitled to pass through 100% of

the cost of its gas to its customers, however; it had no

duty to voluntarily reduce its rate of return below the

‘‘just and reasonable”’ level authorized by regulators. Cf.

Town of Concord v. Boston Edison Co., 915 F.2d 17, 27

(1st Cir. 1990). This is not to say, of course, that a util-

ity can engage in anticompetitive conduct in order to in-

crease its earnings to the authorized level. Nor do we say

that there can never be a case in which a utility’s refusal

to voluntarily take action that would reduce its profit

margin is anticompetitive. The plaintiff in that case, how-

ever, will have to present a more plausible theory than

Illinois has presented here.

The state points out that Panhandle was vertically inte-

grated, which meant that it might have been able to force

consumers to pay a supracompetitive price for gas by pur-

chasing gas at above market rates from affiliated producers,

but there is no evidence that this was the reason that its

costs were high. The evidence suggested that its high costs

were due principally to its Algerian and Canadian ventures,

neither of which were with affiliated producers. True, Pan-

handle bought the liquified Algerian gas from an affiliated

pipeline, Trunkline, but self-dealing is a danger when a

regulated company and an unregulated company are ver-

tically integrated, see Jefferson Parish Hosp. Dist. No. 2

v. Hyde, 466 U.S. 2, 36 n.4 (1984) (O’Connor, J., concur-

ring), not when two regulated companies are affiliated hor-

izontally. Trunkline, like Panhandle, merely passed on the

above market rate it paid to unaffiliated gas producers.

But what of Panhandle’s willingness to transport for its

noncaptive customers? By mollifying them, the state main-

tains, Panhandle engaged in “price discrimination’”’ and

“market segmentation,” facilitating its ability to charge

supracompetitive prices for the gas it sold to captive cus-

tomers and chev perfecting its monopoly over those

customers. This is exactly the argument raised by peti-

tioners when they challenged FERC Orders 234 and 319

in MPC II, see 761 F.2d at 784, and it succeeded there,

but there are several reasons why it fails here.

A-32 No. 90-1231

First, we should be clear about the state’s complaint.

The discrimination it objects to related not to the price

of gas Panhandle sold to consumers who could switch be-

tween gas and other fuels (producers, not Panhandle, sold

gas at the lower spot market rate), but to the discrim-

inatory access Panhandle gave those consumers to cheaper

sources of gas by agreeing to transport it. In this respect,

the state’s theory merely restates its claim, discussed

above, that the G tariff did not preclude LDCs from pur-

chasing gas directly from producers. See supra note 2.

The state maintains that Panhandle selectively applied its

interpretation of the G tariff—that the tariff applied to

direct sales from producers to consumers—to captive cus-

tomers, but fails to explain that the end-users who ob-

tained transportation for nonsystem gas were not them-

selves G tariff customers, and were under no contractual

obligation to Panhandle. Of course, neither were the cap-

tive residential and industrial consumers to whom the

LDCs distributed gas, but those consumers didn’t pur-

chase gas directly from the wellhead. The district court

found that the fuel-switchable end-users eligible for the

MAT program did, and the state points to no contrary

evidence. The captive residential and commercial LDC

customers could, in theory, have purchased gas from pro-

ducers directly, but most LDCs, including CILCO, “had

transportation tariffs which either expressly precluded

transportation services for residential end-users or effec-

tively precluded transportation for residential end-users

by imposing a volumetric limitation... . In addition...

most producers and brokers were unwilling to enter into

contracts for small volumes of gas.” 730 F. Supp. at 890.

We therefore agree with the district court’s conclusion

that Panhandle did not selectively enforce the G tariff;

‘the ‘discrimination’ apparent in Panhandle’s transporta-

tion policy was a legitimate enforcement of that G tariff’

against those who were bound by it. 730 F. Supp. at 921.

After FERC issued Order 436, discrimination on the basis

of sole supplier clauses was no longer legitimate; the FERC

order required pipelines offering transportation to make

No. 90-1231 An33

the option available to all customers, regardless of the

existence of full requirements or sole supplier clauses in

their gas purchase contracts. See 50 Fed. Reg. 42445.

Rather than comply, Panhandle initially shut down its

MAT program, and only resumed it after its G tariff cus-

tomers agreed not to request unbundled transportation

services. The G tariff customers agreed to this condition

because they, too, had a stake in keeping fuel-switchable

industrial consumers on line; keeping the industrials on

line helped spread the fixed cost component of Panhandle’s_

rates among a wider customer base, and helped support

their own revenues by maintaining high through-put vol-

umes to these end-users (the LDCs, like Panhandle, were

effectively selling transporting services to these customers).

This agreement did not, as the state suggests, violate the

terms of Order 436, for the Order also required “‘full re-

quirements” customers to switch to a partial requirements

tariff to obtain transportation, recognizing that ‘{t]here

can be differences in the costs of providing full and par-

tial requirements service.”’ 50 Fed. Reg. at 42445; see also

FERC Order 436-A, 50 Fed. Reg. 52217 (1985) (reiterating

requirement that full requirements customers switch to

partial requirements tariff to receive pipeline transporta-

tion services). Panhandle’s G tariff customers thus had the

option to obtain transportation by switching to a partial

requirements tariff, but were unwilling to give up the se-

curity of the G tariff to do so; Panhandle therefore had

no obligation to transport for them. These events effec-

tively demonstrate that if the state (and the residential

consumers it represents) have a quarrel with a utility, it

should be with CILCO and other LDCs rather than with

Panhandle. Faced with a choice of obtaining access to low-

priced gas supplies or giving up stable gas supplies, CILCO

and other LDCs opted for the latter.

The second reason the state’s price discrimination theory

fails is that, as noted above, there is no evidence suggest-

ing that self-dealing was the cause of Panhandle’s high

gas prices. The real culprits were long-term supply con-

tracts. When the self-dealing charge is deflated, the state’s

A-34 No. 90-1231

price discrimination theory collapses as well because Pan-

handle had no monopoly profits to hide. Panhandle un-

doubtedly wanted to pass on the full amount of its gas

costs, but that is a far cry from extracting monopoly prof-

its. The state’s theory ignores the fact that, under its Pan-

Mark program, Panhandle received take-or-pay credit from

producers for volumes its fuel-switchable customers pur-

chased from them directly. Panhandle did not always re-

ceive take-or-pay credit for the gas transported under the

MAT program (although the MAT program did yield over

$50 million in take-or-pay credits), but that program too

was designed to help mitigate the problems created by

the discrepancy between the spot market price of natural

gas and the price Panhandle was contractually obligated

to pay. PanMark enabled Panhandle to recover its gas

costs by giving it take-or-pay credits for gas sold at low

spot market prices, and MAT enabled Panhandle to ob-

tain some take-or-pay relief by keeping large industrial

end-users from switching, or converting, to other fuels.

FERC may or may not have adequately justified its rea-

sons for approving such programs, see MPC I, 761 F.2d at

774, but that fact is not relevant to the issue of whether

Panhandle’s actions under the FERC programs constituted

an unlawful exercise of monopoly power. As unbundled

transportation became the norm in the industry, the

FERC programs were the principal means available to

Panhandle for resolving its take-or-pay dilemma. Panhan-

dle’s implementation of these programs reinforces the con-

clusion that it was the discrepancy between spot market

and contract prices for gas, rather than exclusionary ani-

mus, that drove Panhandle’s policies. Had Panhandle’s

goal been to exclude other sellers from central Illinois,

it would not have transported gas under any program,

whether or not it provided take-or-pay credit.

IV. Conclusion

This case is essentially a dispute about who should bear

the cost of the transformation of the natural gas industry

from a regulatory to a competitive regime. Panhandle re-

No. 90-1231 A-35

fused to transport natural gas for its G tariff customers

out of concern for its take-or-pay exposure. The state main-

tains that enforcing the G tariff was anticompetitive be-

cause it was at odds with the changes wrought by enact-

ment of the NGPA and FERC’s moves to give consumers

access to a competitive gas market. FERC’s reluctance to

jump with both feet into an open access transportation

policy, however, rebuts the state’s claim that the FERC’s

initial sallies in that direction stripped the G tariff of its

mantle of regulatory sanction. Panhandle had to respond

to those changes mandated by law and by regulation, but

was unwilling to go further than required because to do

so would have been to expose itself to huge losses. Pan-

handle abided by the terms of FERC’s transportation in-

itiatives, and relied on them in good faith, a fact that,

while not rising to the level of a regulatory justification

defense (the FERC did not require pipelines to participate

in the programs), leads us to agree with the district court

that Panhandle’s programs were the product of legitimate

business concerns and not a naked desire to deny natural

gas producers access to the central Illinois market. FERC

itself was reluctant to move ahead too quickly; it didn’t

require pipelines offering unbundled transportation to do

sO on a nondiscriminatory basis until it adopted Order 436

in late 1985, and that Order was later vacated because

it did not adequately address the dilemmas faced by pipe-

lines like Panhandle. None of FERC’s attempts to manage

the deregulatory transition have completely satisfied the

courts; it is hardly reasonable to expect that Panhandle

should have jumped on the open access bandwagon after

FERC’s initial, tentative, moves to get that wagon roll-

ing. The district court attributed Panhandle’s reserve in

the face of regulatory flux to caution and self-preservation

rather than to monopolistic excess, a determination we

find eminently reasonable. The decision of the district

court is therefore

AFFIRMED.

A-36 No. 90-1231

A true Copy:

Teste:

Clerk of the United States Court of

Appeals for the Seventh Circuit

USCA 79004—Midwest Law Printing Co., Inc., Chicago—6-4-91—500

B(i)

UNITED STATES DISTRICT COURT

CENTRAL DISTRICT OF ILLINOIS =

STATE OF ILLINOIS, ex rel. NEI F. )

HARTIGAN, Attorney General of the

State of Illinois, in its proprietary

capacity, in its parens patriae capacity,

and in its representative capacity,

Plaintiff, } Case No. 84-1048

,

PANHANDLE EASTERN PIPE LINE

COMPANY, a Delaware corporation,

Defendant. |

MEMORANDUM OPINION

B-1

UNITED STATES DISTRICT COURT

CENTRAL DISTRICT OF ILLINOIS

STATE OF ILLINOIS, ex rel. NEIL F.

HARTIGAN, Attorney General of the

State of Illinois, in its proprietary

capacity, in its parens patriae capacity,

and in its representative capacity,

q

Plaintiff’ Case No. 84-1048

Vv.

PANHANDLE EASTERN PIPE LINE

COMPANY, a Delaware corporation,

Defendant. |

MEMORANDUM OPINION

I. INTRODUCTION

This is an antitrust case. The Plaintiff, the State of

[llinois, is suing in its proprietary capacity on behalf of

certain state facilities, in its parens patriae capacity on behalf

of all natural persons in the certified class below, and in its

representative capacity on behalf of other indirect

purchasers. This class was certified by the Court pursuant to

Rule 23, Federal Rules of Civil Procedure, and described as

follows:

All indirect purchasers of natural gas from

Panhandle Eastern Pipe Line Company (“PEPL”’)

who reside in or are located in those Illinois counties

or parts of Illinois counties served exclusively by

PEPL’s interstate natural gas transmission system.

B-2

The area exclusively served by Panhandle involves part

or all of 37 counties. Most of the indirect purchasers involved

in this case were supplied their natural gas in those areas by

three local distribution companies (““LDC’s’’): Central

Dllinois Light Company (“CILCO”), Central Illinois Public

Service Company (“CIPS”), and Dlinois Power Company

(“IP”).

The Defendant, Panhandle Eastern Pipe Line Company

(“Panhandle” or “PEPL”), a Delaware corporation, is an

interstate pipeline company. Panhandle’s pipeline system

moves natural gas from a number of collection points outside

the State of Illinois and distributes the gas elsewhere along its

system, in Illinois and other states, primarily to LDC’s.

The Plaintiff charges that during the time in question,

1981 to the time of trial in 1986/1987, Panhandle engaged in

conduct which constituted violations of federal and state

antitrust laws. More specifically, Count I (Monopolization of

Gas Sales), Count 3 (Attempted Monopolization of Gas

Sales), Count 5 (Monopoly Leveraging), Count 7 (Essential

Facility), and Count 9 (Illegal Tying) allege violations of

Sections 1 and 2 of the Sherman Act, 15 U.S.C. §§1, 2, and

pray for damages pursuant to Section 4 of the Clayton Act, 15

U.S.C. §15.

Counts 2, 4, 6, 8, and 10 allege corresponding violations

of Section 3 of the Illinois Antitrust Act, Ill.Rev.Stat. ch. 38,

§60-3.

Section ! of the Sherman Act provides in pertinent part

as follows:

Every contract ... in restraint of trade or

commerce among the several state . . . is declared

to be illegal.

15 U.S.C. §1.

B-3

Section 2 of the Sherman Act provides in pertinent part

as follows:

Every person who shall monopolize . . . any part

of the trade or commerce among the several

states . . . shall be deemed guilty... .

15 U.S.C. §2.

Section 4 of the Clayton Act provides as follows:

Any person who shall be injured in his business or

property by reason of anything forbidden in the

antitrust laws may sue therefor in any district court

of the United States in the district in which the

defendant resides or is found or has an agent,

without respect to the amount in controversy and

shall recover threefold the damages by him

sustained, and the cost of suit, including a

reasonable attorney’s fee.

15 U.S.C. §15.

Prior to trial, Panhandle moved to dismiss all indirect

purchaser claims on grounds that such indirect claims were

barred by the Jilinois Brick doctrine, which prohibits most

antitrust claims by indirect purchasers. J/linois Brick v.

Illinois, 431 U.S. 720 (1977). This Court denied the Motion

to Dismiss, citing the “cost plus exception” to the J/linois

Brick doctrine. On interlocutory appeal, a panel of the

Seventh Circuit Court of Appeals reversed the Court’s denial

of the Motion to Dismiss on January 22, 1988. State of

Illinois ex rel. Hartigan v. Panhandle Eastern, 839 F.2d 1206

(7th Cir. 1988). However, in an en banc decision dated

July 18, 1988, the Seventh Circuit held that, while industrial

indirect purchasers did not fall within the “‘cost plus

exception” to the Ji/linois Brick rule, residential/commercial

indirect purchasers did, and therefore claims on their behalf

B-4

would not be dismissed. State of Illinois ex rel. Hartigan v.

Panhandle, 852 F.2d 891 (7th Cir. 1988), cert. denied,

U.S. —___., 109 S.Ct. 543 (1988).

This lawsuit was filed on February 7, 1984. On

December 13, 1984, after extensive hearing, the Court denied

a Motion for Preliminary Injunction filed by Plaintiff. The

trial on the merits on the bifurcated issue of liability was

heard by the Court from November 17, 1986 to January 30,

1987. The Court stayed the matter during much of the time

after trial when the interlocutory appeal was pending.

For the reasons stated in this Opinion, the Court finds in

favor of the Defendant and against the Plaintiff on all claims.

This is a complex case, and the Court’s ruling on the

issue of liability will of necessity involve hundreds of specific

findings of Fact and Law.

The Opinion is structured in the following way:

I. Narrative (historical background of the natural

gas industry and the events leading up to the disputes

between the parties in this case).

II. Findings of Fact (more specific discussion of

certain factual bases for the legal conclusions).

Ill. Conclusions of Law.

NOTE: All matters contained in this Memorandum

Opinion are to be considered as findings of the Court,

whether the same are found in the Narrative or in the formal

Findings of Fact or Conclusions of Law.

References to the injunction hearing and trial testimony

are by witness and transcript page number; the injunction

hearing and trial transcript have been numbered as one

consecutive transcript by the parties. Citations to depositions

are to the witness’ name and page number. PX citations refer

a

B-5

to Plaintiffs Exhibits; DX citations refer to Defendant’s

Exhibits.

Il. NARRATIVE

A. HISTORICAL BACKGROUND OF THE

NATURAL GAS INDUSTRY

Natural gas has for some time been a major source of

inexpensive energy in this country. Over time most home-

owners, small businesses, and industrial facilities came to

meet their heating needs with gas heat.

An interstate pipeline industry developed. Pipeline com-

panies purchased natural gas from producers at the wellhead

and moved the gas from the well to distant customers by way

of their pipeline system. Panhandle, for example, purchases

gas from extensive acreage located in Texas, Oklahoma, New

Mexico, Colorado, Wyoming and offshore in Texas and Loui-

siana from Trunkline Gas Company (“TKL”). Panhandle’s

pipeline, with lateral and gathering lines, runs northeastward

generally from Oklahoma and Texas to the Detroit, Michigan

area. Panhandle sells virtually all of the natural gas it

purchases to interstate pipeline companies, industrial end-

users, and investor-owned and municipally-owned LDC’s

serving several states including Central Illinois.

Until 1977, the regulatory agency supervising the natu-

ral gas industry was the Federal Power Commission (““FPC”’).

In that year, the FPC was replaced by the Federal Energy

Regulatory Commission (““FERC” or ““Commission’”’).

The statutory framework for regulatory control of the

industry until 1978 was the Natural Gas Act (“NGA”), 15

U.S.C. §§717-717w. Under the NGA, every sale of natural gas

for resale and every transportation of natural gas in interstate

commerce was subject to federal regulatory oversight. The

NGA required that a regulatory body (the FPC) review each

B-6

sale of gas to ensure that the price was “just and reasonable”

and review all transportation facilities and transports of gas

in interstate commerce to assure that they were “in the public

convenience and necessity.” 15 U.S.C. §§717c, 717f.

The principal functions of the FERC in rate-making are

to determine the costs the pipeline should be allowed to

recover from its jurisdictional businesses, to apportion the

costs on an equitable basis among the different services that

are provided, and to develop rates that will give the pipeline a

reasonable opportunity to recover those costs, including an

appropriate return on the investment in facilities used to

provide the services. (Williams 6365).

The NGA gave the FPC/FERC broad powers to regulate

both price and non-price activities of interstate pipelines,

defined as “natural gas companies” by 15 U.S.C. §717a(6).

Panhandle is such a natural gas company.

In the years leading up to 1978, Panhandle sold natural

gas to LDC’s such as CILCO, CIPS, and IP pursuant to tariffs

approved by the FPC/FERC, and in conformance with long-

term service contracts.

In the late 1960’s, a natural gas shortage developed and

spread throughout the natural gas industry. This shortage

continued into the 1970’s and on occasion caused curtail-

ment of delivery of natural gas to LDC’s because there was

not enough natural gas available to meet demand. Naturally,

in such an environment, LDC’s and the customers behind

them clung to the pipelines serving their customer area. Pur-

suant to typical contract and tariff arrangements, LDC’s such

as CILCO agreed that they would normally purchase all of

their natural gas from a single interstate pipeline, such as

Panhandle, and in return the pipeline agreed to give its “best

efforts” to see that the LDC received whatever amount of

natural gas was needed to meet its customers needs.

liieeeteeeeeeeneereeeeeseeesenensmssstesssamaiitaseasiasiiiiiiiiiiis

B-7

In furtherance of those long-term commitments to the

LDC’s, pipelines entered into long-term contracts with natu-

ral gas producers to ensure an adequate flow of gas. Very

often these pipeline/producer contracts, because of the oil

shortage and tightly regulated price, contained provisions

that guaranteed a certain level of “take” from the producer.

In other words, the pipeline would guarantee to take a set

amount of gas during a 12 month period. If the pipeline did

not take the guaranteed amount of gas, it was still obligated to

pay the producer for that amount of gas. These “‘take-or-pay”

provisions were Common in most contracts between pipelines

and producers of natural gas from the mid-1970’s until the

early 1980s.

In 1978, Congress changed the “rules of the game” by

passing the Natural Gas Policy Act (“NGPA”), 15 U.S.C.

§§3301-3432. The NGPA provided for gradual deregulation

of the wellhead price of certain natural gas and for significant

deregulation effective January 1, 1985. One goal of the NGPA

in deregulating gas producer prices was to provide sufficient

incentive for increased exploration and development of new

supplies.

With respect to sales of gas, the NGPA largely elimi-

nated the requirement that gas be sold at “just and reason-

able” rates and created instead several categories of gas,

establishing for many a “maximum lawful price,” referred to

commonly as a ceiling price. 15 U.S.C. §§3312-3319. Ceiling

prices were established for, among others, the following cate-

gories of gas:

“raw material gas,” referred to in the NGPA as “102

””

gas.

“‘new, onshore production wells,” referred to in the

NGPA as “103 gas,”

B-8

“high-cost natural gas,” referred to in the NGPA as “107

gas.

Under the NGPA, gas in these categories, commonly

referred to as “new gas,” could be sold at any price up to the

ceiling price without regulatory review. The ceiling prices for

102, 103 and 107 gas were eliminated by the NGPA on Janu-

ary 1, 1985. 15 U.S.C. §3331.

Section 311 of the NGPA authorizes the FERC to imple-

ment procedures that would facilitate the movement of gas

between the intrastate and interstate markets without being

subject to the requirements of Section 7 of the NGA. The

FERC implemented procedures under Part 284 of its regula-

tions to permit that type of transportation. This involved

transportation by intrastate pipelines for interstate pipelines

and LDC’s, and also by interstate pipelines on behalf of intra-

state pipelines and LDC’s. (Williams 6386-6387, DX 1467).

Almost immediately thereafter, the FERC issued Order

60 under the NGA permitting interstate pipelines to perform

the same type of service for one another that they could

perform for intrastate pipelines. (Williams 6387, DX 1467).

Under Order 63 the FERC permitted Hinshaw compa-

nies, i.e., primarily distribution companies that pick up gas

and transport it within a state but don’t move it outside the

state, to perform the same operations permitted intrastate

pipelines. (Williams 6387, DX 1467).

Under the increased ceiling prices and monthly escala-

tion mechanism in the NGPA, the producer price of natural

gas rose steadily and gas supplies increased. However,

because of a general decline in economic conditions, conser-

vation efforts, and some limited amount of switching to alter-

native fuels, interstate gas industry sales to industrial

consumers decreased.

B-9

As the country entered the 1980s, a natural gas surplus

developed, due to a combination of a shrinking market and

the availability of new and increasing gas supplies. This sur-

plus of gas led to the growth of a “spot market,” that is, lower

priced gas available for purchase from natural gas producers

by any willing buyer. The only rub was that the gas had to be

moved from the well (producer) to the delivery point (pur-

chaser), and the only way to move the gas was through the

natural gas pipeline system.

In a sense, this litigation started with the passage of the

NGPA.

B. FERC TRANSPORTATION

AUTHORIZATION

For many years pipelines such as Panhandle purchased

natural gas and sold it to their LDC customers without those

customers’ actively considering whether there was more than

one product involved. In other words, the industry was regu-

lated so strictly that there was no real opportunity for other

alternatives, such as a transportation service only, to develop.

Departing from its historic policies, in 1975 the FPC

responded to the gas shortage by establishing a general policy

of permitting interstate pipelines with specific prior authori-

zation to transport gas purchased directly from producers to

industrial consumers in certain restricted circumstances. In

1979, the FERC expanded the direct purchase program to

include essential agricultural users, use by schools and hospi-

tals, and oil displacement use.

The FERC in 1982 instituted the Blanket Certificate

Program. The blanket certificate program utilized Section

7(c) of the Natural Gas Act which provides that no natural gas

company, or a compary which will upon commencement of

the relevant activities become a natural gas company, may

B-10

commence any jurisdictional activities or construct any juris-

dictional facilities without receiving a Section 7(c) certificate

in advance. The FERC in its various blanket certificate pro-

grams designated categories of potential pipeline activities,

including the transportation of natural gas, in which individ-

ualized FERC authorization would not be required so long as

the pipeline first received a Blanket Certificate of Public Con-

venience and Necessity. The Certificate required such activ-

ity to be performed in compliance with conditions stated in

the underlying regulations.

In 1983, responding this time to the deregulation of well-

head gas prices, a decline in demand for gas, and price compe-

tition from alternative fuels and resultant loss of industrial

load, the FERC, through Orders No. 234-B and 319, author-

ized self-implementing transportation under a blanket certifi-

cate for any end-user, to become effective on or about

August 1, 1983. The FERC acknowledged that this experi-

mental program was undertaken in order to add “flexibility to

the market and thereby partially mitigate market distortions

that currently may exist or that may emerge in the near

future.” 48 Fed.Reg. 34872 (Aug. 1, 1983). Transportation

under Orders No. 234-B and 319 was voluntary. Under Order

234-B, “low priority” end-users, as defined by the FERC,

could purchase gas from producers and arrange for transpor-

tation by pipelines. The transportation was self-implement-

ing for the first 120 days. After 120 days, the transportation

was conditioned on FERC authorization and was subject to a

notice and protest procedure. Order 234-B, by its terms, was

effective only through June 30, 1985.

Order 319 permitted “high priority” end-users, as

defined in the Order, to purchase natural gas and arrange for

transportation. It permitted purchase contracts of up to five

years. Prior to Orders 234-B and 319, the FERC had

approved the transportation of natural gas purchased by an

B-11

end-user only on a case-by-case basis. This required obtaining

a Section 7(c) Certificate.

On or about January 10, 1983, Panhandle was granted a

blanket certificate of authority by the FERC pursuant to its

Section 7(c) blanket certificate program. In August 1983, this

blanket certificate automatically became usable under Orders

No. 234-B and 319.

Order No. 234-B, as amended by Order No. 234-C, and

the transportation-related portions of Order 319, as amended

by Order No. 319-A, terminated on October 31, 1985 after

the United States Court of Appeals for the District of Colum-

bia in Maryland People’s Counsel v. FERC, 761 F.2d 789

(D.C. Cir. 1985) (MPC II), vacated the Orders. Thereafter,

Order No: 436, established new regulatory requirements

applicable to self-implementing transportation.

(Stipulation 132).

On June 23, 1987, in the case of Associated Gas Distribu-

tors v. FERC, 824 F.2d 981 (D.C. Cir. 1987) (“AGD”), the

court sent Order 436 back to FERC with directions to factor

the take-or-pay problem into the equation of change in regu-

lations and also to rectify some procedural problems regard-

ing the contract demand reduction formula.

On August 7, 1987, the FERC, in response to AGD,

promulgated Order 500 (Interim Rule and Statement of Pol-

icy, Docket No. RM 87-34-000). Order No. 500 essentially re-

adopted the regulations originally contained in Order

No. 436 but with modifications to address take-or-pay

problems. Order 500 has now been remanded for further

consideration by the FERC. American Gas Association v.

FERC, No. 87-1588 (D.C. Cir., Oct. 16, 1989).

B-12

C. EVENTS LEADING UP TO THIS

LITIGATION

Much of the focus of this litigation is on the relationship

which existed between Panhandle and the three LDC’s

(CILCO, CIPS, and IP) which supplied natural gas to the

relevant portions of the 37 county area of Illinois served

exclusively by Panhandle. At the trial of this case, the major

focus of evidence was on the conduct of Panhandle and

CILCO. Most of the Memorandum will discuss that conduct

as well.

CILCO, IP, CIPS, and United Cities Gas Company are

local distribution companies served by Panhandle. However,

portions of the service areas of CILCO, IP, and CIPS are

served by other pipelines, and Panhandle serves two portions

of the IHinois portion of United Cities’ service area.

(Stipulation 122).

CILCO has two service areas for gas distribution. One is

a corridor connecting the Peoria area with the Springfield

area representing 98% of CILCO’s sales; the second is around

the town of Tuscola, representing 2% of CILCO’s sales.

(Vergon 2837, 2344). CILCO bought gas entirely from Pan-

handle for the Peoria/Springfield service area and from Pan-

handle, TKL, Natural Gas Pipeline Company (“NGPL”) and

Midwestern Gas Transmission Co. for the Tuscola area.

(Vergon 2844). For the calendar years 1983, 1984, and 1985,

98% of CILCO’s total natural gas purchases were from Pan-

handle. (Stipulation 123).

CIPS has three distinct service areas for gas distribution.

The western division of the Northern Area encompasses the

west-central portion of Illinois and is exclusively served by

Panhandle. The eastern division of the Northern Area is

located in the east central portion of Illinois. This division

B-13

was served by TKL, NGPL, and Midwestern, with each pipe-

line exclusively serving a part of the division. The Southern

Area encompasses an area of southern Illinois around Marion

and Carbondale and is served by TKL, Texas Eastern, and

NGPL with each pipeline exclusively serving a distinct area.

Approximately 54% of CIPS service area, by volume, was

exclusively served by Panhandle. (Houvenagle dep. 13-18).

IP has numerous service areas throughout Dlinois, which

were served by five interstate pipelines: NGPL, ANR Pipe-

line Company (“ANR”), MRT, TKL, and Panhandle. Two of

the service areas were served exclusively by Panhandle, that

being the areas around the towns of Jacksonville and Dan-

ville. These areas represent less than 10% of IP’s total service

area, by volume. (Brodsky dep. 15, 19-20, 22, 24-25, 36-40,

44-45; DX 1246).

Panhandle sells gas to numerous municipal LDC’s

throughout Illinois. These LDC’s typically only serve one

town or city and purchase much smaller volumes of gas than

the larger LDC’s. These LDC’s purchase gas under Panhan-

dle’s SG tariff which is available to purchasers who purchase

less than 10,000 Mcf per month and purchase gas exclusively

from Panhandle. (PX 1006, Sixth Revised Sheet No. 33 and

Twenty-Sixth Revised Sheet No. 47-A).

A tariff generally consists of a number of different parts.

First, there are rate schedules which spell out the different

authorized services that the pipeline provides. Second, the

tariff contains terms of service which have general applicabil-

ity. Third, there are forms of service agreements that apply to

each rate schedule. Finally, there is generally a tariff sheet that

summarizes all of the rates applicable to the separate services.

A customer which wants to contract for service under a rate

schedule would contract in accordance with that form of ser-

vice agreement. Thus, the tariff spells out the services that are

provided, the general terms and conditions applicable to

B-14

those services, the persons eligible to contract for the services,

and a summary of all of the rates charged under the separate

rate schedules for the different services. (Williams

6363-6364).

Panhandle sells natural gas to its LDC’s. such as CILCO,

under various FERC approved rate schedules. The general

service, or “G,” tariff rate schedule was for those LDC’s

which generally purchased their full requirements of natural

gas from Panhandle. Under this rate schedule, Panhandle was

to be the sole supplier of the LDC’s gas, except in circum-

stances where the LDC requested an increase in contract

demand (gas supply) that Panhandle was unable to provide.

Generally, Panhandle’s obligation was limited to “its best

effort.”

Further consistent with the “best efforts” nature of Pan-

handle’s relationship with its LDC customers, was Sec-

tion 6.2 of its G tariff:

If during one or more days in the billing month

Seller is unable to deliver to Buyer, for any cause

whatsoever, natural gas up to the Billing Demand

established for the month, then the total Demand

Charge shall be reduced by an amount computed as

follows: Determine for each such day the number of

Mcf which the Seller was unable to deliver as above

stated and multiply the sum of all such days’ defi-

ciencies by the currently effective charge.

In other words, if Panhandle failed to deliver “for any cause

whatsoever” its customer was entitled only to a credit against

the Demand Charge (or reservation fee) for the gas not deliv-

ered. (PX 1006).

Panhandle’s G and SG customers (including those

located within the Central Illinois Market) purchased their

gas from Panhandle under tariffs that on their face prohibit

B-15

gas purchases from any “natural gas company” other than

Panhandle. Panhandle and CILCO have had a business rela-

tionship for many years. Since 1951, Panhandle has sold gas

to CILCO under the G tariff.

The G and SG tariffs do not specify the prices to be paid

by the LDC’s for their gas purchases from Panhandle.

(PX 168; PX 169). Rather, the actual gas prices are deter-

mined through a special billing procedure whereby the cost of

gas to Panhandle simply flows through to the LDC customer

as a separate billing charge as the gas is actually purchased.

Actual purchase quantities are likewise not spelled out in

the G or SG tariffs; rather, they are determined as the LDC

makes purchases. (Vergon 3120; PX 168; PX 169). The maxi-

mum quantity, or contract demand level, that a customer can

purchase is set out in the service agreement. When the

purchases exceed 90% of the CD, the demand charge is based

on the actual amount of gas taken. (DX 73).

The separate contract or “Service Agreement” entered

into between Panhandle and each LDC does contain a con-

tract demand or “CD” level. (PX 169). The CD levels do not

necessarily reflect actual expected purchase levels; they are

instead used to calculate-a “reservation” or “demand” charge

for pipeline capacity payable regardless of how much gas is

actually taken. (Vergon 3169, 4411-4412, 4464, 4474-4475).

Panhandle’s tariff obligation with respect to the demand

charge was to make that amount of pipeline capacity avail-

able if requested by CILCO; Panhandle’s supply obligation

with respect to the gas was itself a “‘best efforts” obligation,

with the tariff containing explicit language excusing failure to

deliver for any reasonable cause. (Vergon 4464-4465;

PX 1006).

The CD levels contained in Panhandle’s service agree-

ments with its G and SG customers were for the most part

B-16

negotiated between Panhandle and the customers in about

1970, under long-term (twenty year) contracts, with a 10%

reduction occurring in 1984 as a result of settlement of a rate

dispute between Panhandle and its customers. (Vergon

3022-3024, 4401).

As of 1970, when the CD levels were set, gas prices were

still regulated at the wellhead by the FPC. (Tussing

4222-4223; Vergon 3029).

The advantage of the G rate to the LDC was that it

provided for a variable monthly demand level, no minimum

commodity bill, and a 90% ratchet on demand charges. Much

less natural gas is consumed in the summer than in cooler

seasons, since air conditioning is normally powered by elec-

tricity. Therefore, it was very much in the LDC’s interest to

have a variable monthly demand level. The disadvantage to

the LDC of the G rate was that, unless the LDC made a

demand for more natural gas than Panhandle could expect to

provide, the LDC would be required to purchase all of its

natural gas from Panhandle.

In the late 1960’s and 1970’s, with a shortage of available

natural gas available to consumers, LDC’s such as CILCO

normally had no substantial interest in avoiding the sole pro-

vider provision of the G tariff. CILCO knew that Panhandle,

in reliance on their long term contract and the G tariff, would

make its “best efforts” to supply whatever amount of natural

gas CILCO needed for its customers. CILCO had anticipated

some growth in sales at the time it entered into the October

1970 sales agreement with Panhandle. (Vergon Trial

Tr. 4403).

In the market of the 1960’s and 1970's, the only advan-

tage of having access to another pipeline (transportation ser-

vice alone did not exist at that time except for unusual

circumstances requiring specific prior FERC approval) was

B-17

that, if the gas shortage were to become so acute that a curtail-

ment of natural gas from Panhandle to CILCO occurred, the

possibility existed that the other pipeline might be able to

make up the difference.

All things considered, at the end of the 1970’s, CILCO

had no substantial incentive to attempt to deal with anyone

other than Panhandle. This was especially true for two other

reasons:

1. CILCO’s only alternative to the G tariff was the

“limited service” (““LS’’) schedule. The LS tariff was a partial

requirements rate schedule for the LDC’s which obtained a

portion of their natural gas from natural gas companies other

than Panhandle. The advantage of the LS tariff to the LDC

was that it allowed the LDC to obtain natural gas from any

other source. The disadvantage of the LS tariff to the LDC

was that it provided for a level (year round) demand level, a

minimum commodity bill, and no ratchet on demand

charges. Again, because the contract demand was used as the

basis for determining the minimum payment under the con-

tract, an LDC such as CILCO (being situated in an area of the

country with traditionally harsh winters) would have to have

the contract demand set at such a high level to meet winter

demands that the much lower summer consumption rate

would cost CILCO millions of dollars for gas not purchased

by customers in the summer.

So long as the natural gas market did not include as a

component a spot market offering natural gas at a price sub-

stantially below the regular market price, there was no finan-

cial incentive to an LDC such as CILCO to consider

switching to the LS rate. Also, because of the substantial

payout resulting from the single (year round) contract

demand charge, even if much cheaper natural gas were avail-

able from another company, the cost of paying the demand

charge component would have outweighed (at least in 1982-

B-18

1984) any savings resulting from the purchase of cheaper gas

from someone other than Panhandle.

2. Because of the degree of regulation of the natural gas

industry by statute and regulatory agency, an LDC such as

CILCO, which did not have immediate physical access to the

gas pipeline of another natural gas company, could not simply

agree with another company to have it build a pipeline to

CILCO’s service area and start pumping natural gas to

CILCO for its system supply. Rather, such interconnects

could only occur with the approval of the FERC, and then

only after extended proceedings during which everyone,

including Aunt Mary, could object to the new interconnect

and supply.

This regulatory review of such requests was not intended

by FERC to be obstructionist. Rather, it existed to serve the

public interest. The delivery of natural gas to the local com-

munities of this country was considered by Congress and

FERC too sensitive a matter to be left solely to the good

intentions of a profit-motivated industry.

A G tariff was much to Panhandle’s liking, for obvious

reasons. Because of the combination of the G tariff and long-

term service contracts, Panhandle, in dealing with a G cus-

tomer, did not have to worry about significant competition in

making its business decisions. As long as the world stayed

right side up, LDC’s such as CILCO would be satisfied with

the long term commitment of Panhandle to provide the natu-

ral gas needs of CILCO’s customers. Under the NGA, as of

1978, the price of gas was strictly controlled, and a lower

priced spot market supply did not exist.

In reliance on the assured business of the G tariff LDC,

Panhandle could and did enter into many long term contracts

with producers. Most of those contracts contained take-or-

pay provisions. In addition, because of the shortages and

B-19

curtailments of the 1970’s, Panhandle, with the support of its

LDC’s and the Illinois Commerce Commission, entered into

two long term projects (the Algerian liquid natural gas project

and the Canadian gas project) which would ensure a greater

supply of gas to meet customer needs, but also would involve

more expensive gas than what was currently being contracted

for in the United States.

Panhandle did not like the LS tariff. It did allow Panhan-

dle to get “half a loaf’ from LDC’s in markets where an LDC

had access to more than one pipeline, but, according to the

terms of the LS tariff, the customer could decide not to

purchase any natural gas from Panhandle. In such event, the

only payment that Panhandle would receive from the LDC

would be the “minimum bill,” as determined from the flat

contract demand. If the contract demand level was set rela-

tively low, then such a customer could easily switch to

another supplier which offered gas at a lower price.

In addition to the rigors of competition, Panhandle dis-

liked the LS tariff for another reason: The LS tariff made it

much more difficult to know how much natural gas needed to

be secured for the future by long term contracts with produc-

ers. From Panhandle’s point of view, it was like a chef going

to the market to buy groceries for a dinner party when the

chef really did not know how many people were going to show

up. Certainly, the chef would much prefer to plan the dinner

party armed with guaranteed reservations, so that the chef

would be stuck with neither a needlessly big food bill nor

leftovers. Similarly, it was important for Panhandle to know

in advance the amount of natural gas that would be needed to

satisfy its customers’ demands.

D. PANHANDLE’S GAS PURCHASE STRATEGY

Until 1977, the FPC, the predecessor agency of the

FERC, set the price of gas at the wellhead, and every producer

B-20

sale to interstate pipelines was subject to regulatory review.

Spurred by dwindling supplies caused by artificially

depressed gas prices, Congress, by means of the NGPA,

enacted phased deregulation of the price of gas, and removed

from the regulators the authority to review the prices passed

through to customers. This legislation had the desired effect

of spurring new exploration for and production of gas, both

by major and independent producers.

During the 1970's, there was intense competition among

pipelines for new gas reserves because it was a period of gas

shortage. The competition continued until about the early

1980’s when the market changed to a buyer’s market. (Dixon

5829). The shortage of gas during the 1970’s caused pipelines

to compete for gas reserves on non-price terms, such as take-

or-pay provisions and fixed volume clauses, for new supplies.

(Carpenter 1636-37). Price differentials between the system

supply cost of pipeline gas and spot market gas emerged

due to the NGPA’s decontrol of wellhead prices.

(Carpenter 1638).

In 1979, Panhandle entered into an aggressive gas

purchase program in which it contracted for vast quantities of

supplies at the NGPA ceiling, or the maximum allowable |

price. Initially, the program was a reaction to the curtailments

of the mid-1970’s and was bolstered by internal company

projections of high future sales. The purchasing program also

reflected the projections of those LDC customers’ needs. A

Planning Group (comprised of 10 LDC’s, six of whom were

LS customers) at first projected huge future demand.

CILCO was a member of Panhandle’s Planning Group

and submitted information to Panhandle as to CILCO’s pro-

jected gas sales. In May 1981, CILCO submitted to Panhan- |

dle its projections on future gas requirements in the period

1981 to 1990. (DX 158; Vergon 4404-4407). CILCO pro-

jected that its annual gas requirements would be 50.4 billion

ieee

B-21

cubic feet (“Bcf”) in 1981 and increase to 53.1 Bcf in 1990,

with a peak of 54 Bcf in 1982. (Jd.) CILCO also projected an

increase in residential and commercial customers at the rate

of 1.5% annually from 1981 to 1985 and 1% annually from

1986 to 1990, and an annual population increase at a rate of

0.8%. (Id.) CILCO expected Panhandle to contract for gas

supplies to meet CILCO’s projected sales requirements or

actual usage. (Vergon 4411; 4417; 4445-4446). During the

five years preceding the trial, CILCO purchased 100% of con-

tract demand on certain peak winter days. (Vergon 4417).

But, as the 1980’s progressed, some LDC’s, including

CILCO, began to warn the Planning Group that they would

have to scale back their projections. The warnings did not

deter Panhandle’s Gas Supply Committee, however. Through

1982, Panhandle continued to buy quantities pegged to the

company’s and its customers’ (including the LS customers)

most optimistic projections. With apparent disregard for

what was happening in the marketplace, Panhandle agreed to

significant take-or-pay provisions in virtually all of its

purchase contracts, and demanded market-out clauses in vir-

tually none of them. During the same time period, Panhandle

committed itself to participation in a partnership that was

constructing a pipeline that would deliver costly Canadian

gas into its system, and Panhandle’s subsidiary and main

supplier, TKL undertook the hugely expensive Algerian LNG

project.

TKL is the principal subsidiary of Panhandle and owns

and operates an interstate natural gas transmission system.

TKL purchased gas from extensive acreage located in, and

offshore of, the states of Texas and Louisiana. TKL’s pipeline

generally runs from the Gulf Coast northward to Jackson,

Michigan. It interconnects with Panhandle’s pipeline at Tus-

cola, Illinois. TKL is a “Natural Gas Company” under §2 of

the NGA.

B-22

The LNG project of TKL was certificated in 1977 after

lengthy regulatory hearings. Panhandle’s Canadian gas

purchases through Northern Border Pipe Line were approved

in 1978. Both projects were initiated and approved during a

period of intense curtailments. (Langenkamp 1511). Deliv-

eries under these contracts did not commence until the Fall of

1982 due to the time necessary to construct transmission and

other facilities. Other pipelines entered into similar long term

gas supply contracts for Canadian gas and LNG. For exam-

ple, NGPL vigorously pursued an LNG project but was

unsuccessful in consummating the project. (Langenkamp

1512-1513).

The FERC approved the purchase of liquefied natural

gas from Algeria by Panhandle. The ICC supported this

purchase. (Tussing 830). When the LNG project was

approved by the FERC in the mid-1970’s, a period of curtail-

ment, CILCO was neutral on the issue. (Vergon 3176-3177).

In September of 1982 Panhandle was notified that Alge-

rian LNG and Canadian gas would begin to flow. Panhandle

had contracted for this gas during the 1970’s when the entire

nation was experiencing a shortage of natural gas. The effect

of these deliveries of new, high-priced gas was to change Pan-

handle’s gas supply from one of the cheapest in the Midwest

to one of the most expensive.

This caused many of Panhandle’s customers, as well as

state commissions like the ICC, which had supported the

LNG and Canadian gas projects when Panhandle contracted

for them, to petition for immediate cancellation of the

projects. This resulted in lengthy hearings before the FERC

and the U.S. Economic Regulatory Agency (“ERA”) in the

Fall and Winter of 1982. TKL was contractually obligated to

receive LNG, and it began to do so in the Fall of 1982 while

these hearings were taking place. TKL and Panhandle sought

recovery of these gas costs immediately, but approval was

B-23

denied pending the outcome of the hearings. The FERC and

the ERA upheld the LNG certificate and permitted the gas to

continue to be accepted. The cost of this gas was first reflected

in rates in March 1983 due to the delay caused by the hear-

ings, and by that time a substantial deferred gas cost balance

had accumulated, which created a significant financial burden

for Panhandle and TKL. (Langenkamp 1409-1415).

On February 3, 1983, Phillip O’Connor, Chairman of

the ICC, authored a letter to Congressman Edward R. Madi-

gan regarding Algerian LNG. O’Connor was concerned with

the ALJ’s decision of January 28, 1983 that there was no

authority to revoke TKL’s importation certificate. He urged

Congressman Madigan to have Congress act to stop the

importation of LNG. O’Connor noted that the ICC sup-

ported the LNG program in the 1970’s but stated:

It is evident to the Dlinois Commerce Commission

that the public interest in the LNG project has

changed dramatically since the early 1970’s, and

Algerian LNG is no longer needed.

(DX 1098, emphasis in original).

TKL’s contract for Algerian LNG was made with Sona-

trach in the mid-1970’s. Deliveries finally commenced in Sep-

tember of 1982. The contract provided for full deliveries of

about 450 Mcf a day, but at first the deliveries were reduced.

There was a gradual increase until early 1983, at which time

the Algerians were at their full contract volume. In the spring

of 1983, TKL notified Sonatrach that it was unable to

purchase the full contract quantities and that it wanted to

renegotiate the contract quantity. As a consequence, a 40%

decrease in the contract volume was agreed upon, effective

approximately April 1983.

TKL continued to purchase LNG at that reduced level

until December 1983, at which time it suspended accepting

Se

B-24

deliveries of gas from Algeria. Sonatrach objected to the sus-

pension and initiated arbitration proceedings for breach of

contract. Those proceedings continued slowly until the mid-

die of 1986, when the parties reached a settlement. As a

result, TKL had no further obligation to buy Algerian LNG.

(Dixon 5880-5881).

Over the last few years, Panhandle renegotiated the

Canadian gas supply contract two or three times to reduce the

price and volume obligations. (Dixon 5835-5836).

In all of these undertakings Panhandle was banking on

its forecasts that the price of fuel oil would remain higher

than the price of natural gas. However, to the extent that the

purchase contracts and projects posed risks of

unmarketability, Panhandle felt somewhat confident that its

shareholders would not bear the financial consequences

because, under the NGPA, all gas costs were passed through

to the consumers, absent “fraud or abuse,” a never-applied

standard.

By 1982, the price of fuel oil had unexpectedly plum-

meted, and although lower-priced gas was available from

newly developed independent supplies, Panhandle was sell-

ing gas for which it — or its affiliate TKL — had contracted at

NGPA ceiling prices, which far exceeded the price of both

independent supplies and fuel oil. Thus, in the fourth quarter

of 1982 Panhandle’s commodity rate suddenly jumped from

$2.68 per million cubic feet (“Mcf’”) to $3.83/Mcf in October

1982, and eventually to $4.64/Mcf.

This increase was not unavoidable. Panhandle had inex-

pensive price-controlled gas under contract, but instead of

purchasing it, Panhandle elected to purchase more costly gas.

In addition, toward the end of 1982 Panhandle made the

corporate decision, approved by its board of directors, to

increase its purchases from TKL. TKL gas was even more

B-25

expensive than that which Panhandle was purchasing from its

producer suppliers, but TKL was facing serious take-or-pay

problems. At about the same time the expensive Canadian

gas came on line, and Panhandle chose to include this gas in

its Purchase Gas Adjustments (“PGA’s’’). The effects of all of

these decisions combined to make Panhandle’s commodity

rate very high.

As a result, Panhandle’s prices during the time in ques-

tion were above the market clearing level. (Carpenter 7138-

7140; Stillman 3973; Tussing 3587, 3618, 3632). As of the

time of trial, although Panhandle essentially sold gas only to

its G and SG customers, Panhandle possessed the highest rate

of return of all pipelines featured in a study of major pipeline

companies. (Carpenter 6783-6785).

A Panhandle memorandum dated February 10, 1984,

described Panhandle gas as the 14th most expensive out of 15

major interstate pipelines that Panhandle analyzed. (PX

647). Panhandle’s prices were $1.00 or more per million

cubic feet (““Mcf”) higher than NGPL’s prices on a compara-

ble delivered basis to CILCO. (Vergon 2858-2859).

The service agreement between CILCO and Panhandle

in effect at the time of trial was entered on December 31,

1970, with an expiration date of October 31, 1988. CILCO,

anticipating growth in sales, increased the contract demand

at the time it entered into the service agreement with Panhan-

dle in 1970. The agreement was amended on May 14, 1984 to

reduce the contract demand by 10% and to extend the agree-

ment to December 31, 1989.

As of early 1981, CILCO was becoming disenchanted

with Panhandle as its sole supplier. Likewise, CILCO’s indus-

trial end-users, such as Keystone Steel & Wire Company and

major hospitals in the Peoria area, were restless. The natural

gas used to fuel their businesses was costing more and more.

B-26

Industrial end-users were starting to consider the use of alter-

native fuels (such as coal and fuel oil) which, in the past, had

been more expensive than natural gas. Energy conservation

was also becoming a serious component of every company’s

cost saving strategy.

For years, under the NGA, the cost of natural gas had

been a fairly predictable component of the cost of doing busi-

ness. In the 1980's, the ever-escalating cost of energy for

many businesses meant the difference between surviving and

not surviving. The cost of energy also became a very impor-

tant factor, along with the cost of labor, in the struggle to

compete with foreign companies.

Neither CILCO nor Panhandle wanted any of its indus-

trial customers to switch to an alternate fuel, because that

would mean the loss of that customer for at least as long as the

cost of the alternate fuel was less than the cost of purchasing

natural gas from Panhandle through CILCO. In some cases,

the loss might be permanent.

The commercial/residential consumer, on the other

hand, was typically a captive customer. As the cost of energy

increased, the small business owner o¢ residential customer

could realize some savings by cutting back on the consump-

tion of natural gas, but that was a limited alternative. The

same customer could switch to electric heat or fuel oil, but

usually, except in the case of new construction, the capital

outlay was too great to be realistic or cost effective. The cus-

tomer could also substitute for some natural gas by using a

wood-burning stove and/or space heaters, but any resulting

savings was limited. The cost of purchasing those items was

prohibitive for some customers, and the perceived danger to

health and safety from use of wood-burning stoves and space

heaters detracted from their usefulness on a community wide

basis.

B-27

By November 1981, CILCO had determined to seek to

interconnect with the next nearest interstate pipeline, NGPL.

Under the terms of CILCO’s tariff, if CILCO requested an

increase in contract demand which Panhandle declined to

meet, CILCO would then be free to purchase an amount of

gas up to the requested demand increase from the second

pipeline.

On November 10, 1981, CILCO personnel met with

Panhandle personnel. At that meeting, CILCO made an

informal request for an increase in contract demand. Accord-

ing to CILCO officer Donald Samburg, CILCO did not need

the increase in contract demand, nor did it anticipate using it.

In other words, CILCO made a demand for an increase in gas

which it knew was a sham. It did so in an attempt to trigger

the sole supplier exception, be in a position to purchase a

substantial amount of gas from NGPL, and still retain its G

tariff status with Panhandle.

Initially, Panhandle informally indicated that it would

decline to meet the requested increase, but then Panhandle,

to CILCO’s surprise, reversed itself and agreed to provide the

demand increase. Ironically, Panhandle’s response was also a

sham, since it was not capable of delivering the entire amount

of gas requested by CILCO.

So, in sum, the demand for increased gas supply by

CILCO was phony, and the response of Panhandle was

phony. Two corporations were playing out a bluff in a high

stakes poker game.

In April of 1982, Panhandle informed CILCO that it

might be necessary to curtail deliveries to CILCO during the

1982-1983 winter. CILCO responded by again advising Pan-

handle of its desire to obtain gas from NGPL. Panhandle

declined to respond.

B-28

In spite of Panhandle’s failure to respond to CILCO’s

request for increases of gas, CILCO and NGPL proceeded

with plans for the interconnection.

As early as the fall of 1981, at the same time that CILCO

first approached Panhandle about the proposed interconnect

with NGPL, CILCO also requested that Panhandle negotiate

a new tariff or service contract with it. At that time CILCO

was seeking flexibility to purchase from another interstate

pipeline, which is prohibited under the terms of the G tariff.

In December 1981, CILCO formally requested that Panhan-

dle enter such negotiations, but Panhandle ignored CILCO’s

request. CILCO responded by filing a complaint with the

FERC in June 1982, requesting that the G tariff be stricken as

anticompetitive. Panhandle elected to follow the advice of

Truett Kennedy (a Vice President of Panhandle at the time),

who suggested that Panhandle could “tough it out.”

CILCO’s FERC complaint against Panhandle (Docket

No. RP 82-105-000) stated that CILCO was seeking to

purchase a portion of its supply of natural gas from NGPL;

that if it did so it could not remain on the G rate schedule but

would have to switch to the LS rate schedule; and that this

would result in a dramatic rate increase for CILCO. CILCO

further alleged that Panhandle’s tariff was unduly discrimina-

tory, anticompetitive, and inconsistent with the NGPA’s pur-

pose of furthering a competitive wellhead market for natural

gas. CILCO requested the FERC to order amendments to the

definition of “General Service Buyer” which would allow

CILCO to remain on the G tariff while purchasing gas from a

second interstate pipeline supplier.

From Panhandle’s point of view, what CILCO wanted

would spell disaster, since it would free CILCO of its obliga-

tion to purchase all of its gas needs from Panhandle. Not only

would the sales volume be lost, but the reduced purchases by

CILCO for its system supply would expose Panhandle to an

B-29

avalanche of take-or-pay liability because of a resultant dras-

tically reduced take from Panhandle’s producers. If that hap-

pened, the interests of Panhandle’s shareholders would be

endangered.

In the fall of 1982, NGPL filed a certificate of applica-

tion with the FERC for approval of the interconnect. Panhan-

dle intervened and opposed the certificate. In meetings

related to that proceeding, Panhandle indicated that it would

withdraw its opposition if CILCO would give Panhandle a

right of first refusal on the sale of any gas transported to

CILCO or CILCO’s customers through the interconnect.

When CILCO declined to accede to the demand, Panhandle

threatened to fight CILCO “to the death” over the issue.

In reaction to Panhandle’s price increases, the LDC’s on

the Panhandle system reacted in a variety of ways. Those who

had more than one supplier began to increase their takes from

their other suppliers. Those who had only Panhandle as a

supplier began to locate available independent supplies and

request that Panhandle transport those supplies under Sec-

tion 311 of the NGPA. (One of the primary purposes of

Section 311 was to facilitate the transportation of natural gas

by interstate pipelines to end-users).

At the same time, the more aggressive of the industrial

customers, not content with the efforts of their LDC’s to

obtain cheaper supply (and sometimes in economic despera-

tion), began bombarding Panhandle with demands that it

transport independent gas directly to them. In 1983, CILCO

expressed concern to Panhandle about losing its industrial

customers to alternate fuels due to increasing natural gas

prices. CILCO estimated that this loss might approximate

20% of its annual sales.

Based on discussions with Panhandle that went back

into the fall of 1981, CILCO believed in March 1983 that

B-30

Panhandle’s interpretation of the G tariff was that, if CILCO

bought gas from someone other than Panhandle, such

purchase would constitute a violation of the G tariff.

CILCO’s internal documents indicated that it wanted Pan-

handle to work toward a temporary waiver of the G tariff in

March 1983, subject to FERC approval, so that CILCO could

purchase NGPA categories 102 and 103 gas. CILCO believed

that such a result would be preferable to forcing the FERC to

interpret the definition of “natural gas company” in CILCO’s

pending FERC complaint case.

On March 17, 1983, CILCO formally requested that

Panhandle transport 102 and 103 gas, to be purchased from

an independent producer, for its system supply under the

authority of Section 311. Panhandle refused, because its top

corporate officers had by then decided to refuse to transport

independent gas for the system supply of LDC’s. Panhandle’s

President, Richard O’Shields, and its Chief Executive Officer,

Kenneth Kalen, acknowledged this policy, and Kalen justi-

fied it on this ground: “We have the commitment to supply

these local distribution companies, we have an obligation to

have long-term supply contract, and we need to be relieved

from both of these obligations. . . . ” (Kalen dep. 34.)

On March 22, 1983, Truett Kennedy informed Kalen

that Kennedy had tentatively resolved to deny CILCO’s

request because the transport would “displace volumes from

Panhandle.” (PX 29) Kalen, noting to other corporate officers

that “Truett has already declined the request,” responded,

“We are most anxious to hold off this type of request in favor

of providing our customers an opportunity to purchase neces-

sary volumes from our suppliers.” (PX 31)

Kennedy met with CILCO on April 11, 1983 and

advised CILCO that Panhandle was not going to transport the

requested volumes. CILCO asked that Kennedy put Panhan-

dle’s position in writing. Informally, on April 12, Kennedy

B-31

advised CILCO that Panhandle was “not going to transport

volumes for customers since it was being swamped with such

requests and it would make their own efforts meaningless.”

(PX 35) On the same day Kennedy prepared a formal

response. In a cover memo transmitting his draft to Panhan-

dle’s in-house counsel, Kennedy stated that he “did not

respond directly to their transportation request.” (PX 1012)

Indeed, the letter sent to CILCO, dated April 15, 1983,

avoided discussion of CILCO’s request.

On April 15, 1983, internal memoranda reported that

the Panhandle’s “transportation strategy” was then “‘not [to]

transport gas purchased from other than Panhandle’s eligible

producers for customers of Panhandle.” (PX 72) This policy

was again reflected in a document Panhandle filed with the

FERC in April of 1983. Responding to a CILCO data request,

Panhandle stated, ““Under current transportation policy Pan-

handle and Trunkline would not be willing to transport gas

purchased from third parties for CILCO’s overall system

requirements.” (PX 36)

On April 29, Wayne Slone of CILCO wrote to Kennedy

and again requested that Panhandle transport Section 102

and 103 gas. Panhandle did not respond.

During a July 1983 customers meeting in Springfield,

Langenkamp told representatives of CILCO, CIPS, and IP

that Panhandle would not transport gas from independent

producers. A contemporaneous memo memorialized Pan-

handle’s decision to deny LDC and end-user requests for

transportation of “non-Panhandle released gas.” (PX 217)

In August 1983, Citizens Gas, a G customer of Panhan-

dle, requested that Panhandle transport to it for its system

supply 102 and 103 gas that Citizens would purchase from

independent producers. Kennedy met with in-house counsel,

Michael Kelley, on August 30 to discuss this request. Kelley

informed Kennedy that this transaction was permissible

B-32

under the G tariff. Nevertheless, a few days later, Kennedy

and Kelley met with Citizens’ general counsel and informed

him that the transaction was not permissible under the G

tariff.

In early 1983, both CIPS and IP made inquiries to Pan-

handle about Panhandle’s willingness to transport indepen-

dent gas for their system supplies. With slight variations,

Panhandle responded as it had responded to Citizens.

Langenkamp wrote Illinois Power, ““We are unable to provide

a meaningful response.” He concluded with this statement:

Certainly, interstate pipelines, most gas producers,

and a number of local distribution companies are

“‘natural-gas companies” as defined by Section 2(6)

of the Natural Gas Act; and therefore, purchases

from such natural-gas companies would be inconsis-

tent with the long-standing terms of the G-2 Rate

Schedule governing most of your purchases from

Panhandle.

(PX 581). He wrote CIPS that “any sale of gas would be in

violation of our [G] tariff.” (PX 579)

The facts dealing with CILCO’s March 17, 1983 request

to transport gas and Panhandle’s response were presented to

the FERC by CILCO during the proceedings on its com-

plaint. CLLCO thought it was in a “no-lose” situation in mak-

ing its request on March 17, 1983 — it would either get the

gas or use the refusal to help its FERC case.

In 1983, FERC enacted Special Marketing Programs

(““SMP’s”’) in order to give selective price cuts to the custom-

ers with the most sensitive demand. In the latter part of 1982,

the average cost of gas to many pipelines was approaching,

and in some instances exceeding, the price of No. 6 fuel oil.

As aresult, pipelines and their customers were experiencing a

reduced demand for gas, which was exacerbating the take-or-

B-33

pay problem of some pipelines, including Panhandle. In a

Transcontinental Gas Pipe Line rate case, it was proposed

that the pipeline release higher priced gas to producers who

were willing to sell their gas at market clearing prices and that

the pipeline would transport the gas into its market areas to

retain fuel switchable loads or acquire new loads.

The FERC adopted the proposal and indicated that this

appeared to be a reasonable approach to addressing both the

rising cost of purchased gas and the take-or-pay problem

faced by many pipelines. Thereafter, certain pipelines —

including Panhandle and TKL through PanMark — adopted

a similar arrangement. The FERC, in what were called “bas-

ket orders,” adopted the specific programs of certain pipe-

lines and procedures but applied generic conditions to them.

(Williams 6407-6408).

Approximately 35 producers and marketers had SMP’s.

Only five pipelines had SMP programs, and only three actu-

ally operated their programs.

Panhandle’s reaction to these regulatory initiatives was

mixed. It delayed making any decision about participating in

the blanket certificate program for several months. By con-

trast, it eagerly embraced the SMP program, creating

PanMark, which partially pacified certain of the industrial

customers, while enabling Panhandle to obtain take-or-pay

credit for each million cubic feet (“Mcf”) of gas it sold. Only

“released gas” (or gas already under contract to Panhandle)

was eligible for sale through SMP’s. Authorization for all

SMP’s, including PanMark, was to expire on October 31,

1984.

On September 26, 1984, the FERC extended SMP’s for

another year and allowed LDC’s to participate in SMP’s for

up to 10% of their contract demand for system supply gas.

The FERC order specifically provided for a temporary lim-

ited waiver of the terms and conditions of the G tariff to allow

B-34

purchases for system supply by a G customer such as CILCO.

Interstate pipelines, such as Panhandle, were given 30 days in

which to decide whether to accept or reject the FERC’s order.

Panhandle filed comments with the FERC in which Panhan-

dle argued that the 10% rule had been adopted by the Com-

mission without sufficient research or basis and would

increase the unit cost of gas and result in a build up of the

deferred account. Nevertheless, Panhandle participated

under the 10% rule because it wanted to continue its

PanMark program.

With the limited waiver of the G tariff, Panhandle trans-

ported gas for LDC’s system supply under the 10% feature. In

1984 and 1985, PanMark sold and Panhandle transported

31.9 billion cubic feet (““Bcf’’) of natural gas to its LDC cus-

tomers for system supply. This figure included 2.8 Bcf for

CILCO, 1.2 Bcf for CIPS, and 3.9 Bef for IP. In 1985, approx-

imately 86% of the total volumes transported under PanMark

went to LDC customers. In addition, Panhandle transported

6.5 Bcf of gas from SMP’s other than PanMark to its LDC

customers for system supply under the 10% rule. CILCO

received 1.5 Bcf from the SMP’s of Yankee Resources (Yan-

kee Resources’ SMP was called ““YES”’), City Service Oil and

Gas Co. (“COGS”) and Entrade Corp. (“Enspeed”’) during

the period from July through October 1985. System supply

gas purchased from SMP’s other than PanMark by Panhan-

dle’s LDC customers under the 10% rule was Panhandle-

released gas for which Panhandle received take-or-pay relief.

Ten percent of contract demand exceeded 10% of actual

purchases by an LDC. In fact, in some months, 10% of con-

tract demand turned out to be in excess of 100% of some of

the LDC’s actual requirements. CILCO’s purchases from

SMP’s represented from 14.7% to 59% of its actual monthly

purchases.

B-35

PanMark did not, however, provide a total solution.

Industrial and other large consumers ineligible for PanMark

continued to press for access to direct sale independent gas

through the blanket certificate program. Thus, the stage had

been set for crucial corporate decisions about whether to

transport independent gas under the blanket certificate pro-

gram (Market Area Program) (“MAT”), and if so, for which

customers. Panhandle also had to decide how to fashion a

transportation program that would enable Panhandle to

avoid to the maximum extent possible the influx of indepen-

dent gas into its markets.

Even as Panhandle created the MAT Program and com-

menced transporting to some end-users, the Company did not

change its decision to deny transportation to LDC’s. In Octo-

ber 1983, while Panhandle was still formulating the parame-

ters of the MAT Program, R.C. Dixon, Vice President of Gas

Supply, instructed Robert Reed, who was in charge of coordi-

nating the transportation program, “Don’t let LDC buy

cheap gas for system supply to offset our sales. Must be for

system supply going to specific end-user.” (PX 92). In Pan-

handle’s November 1983 internal draft on its transportation

program, Panhandle specifically states that the program was

“not intended for general system supply.” (PX 102)

The MAT plan Panhandle developed in 1983 contained

certain significant features that have given rise to this lawsuit:

Under the plan, Panhandle would not transport independent

gas to its captive G LDC customers; Panhandle would limit

the classes of consumers eligible to participate in transporta-

tion programs; and, as to these eligible consumers, Panhandle

would insist that they submit to bid-out, or right of first

refusal, as a prerequisite to receiving transportation service.

In November 1983, in order to pacify its fuel switchable

customers, Panhandle formally adopted its Transportation

B-36

Guidelines (““Guidelines’’), pursuant to which it would trans-

port off-system supplies to an end-user. To stem erosion of its

take-or-pay position with its on-system suppliers and to dis-

courage the flow of independent gas into its pipeline system,

Panhandle insisted on a right of first refusal as a condition

precedent to transporting independent non-Panhandle sys-

tem gas. Contracts for transportation of off-system supplies

were terminable every six months to allow rebidding by on-

system Panhandle suppliers. Also, for the purpose of avoiding

unreasonable administrative burdens, the minimum volume

for which transportation would be provided was set at

100,000 Mcf/year.

Panhandle held meetings with its LDC customers in

November of 1983 to explain the transportation policy and

Guidelines. A shorthand version or summary of the Guide-

lines was prepared and distributed to the LDC customers,

with the expectation that the LDC’s would inform their cus-

tomers (i.e., end-users) about the Guidelines.

The mechanics of the first refusal process were to be

accomplished through a bid-out and rebid system involving

the following key features: (1) the program would be available

to end-users (not LDC’s) using at least 100,000 Mcf of gas per

year; (2) at 90 day intervals a qualified end-user could request

a desired reduced price and Panhandle would make a single

offer of the requested price to its on-system suppliers for

possible matching; (3) qualified end-users could alternatively

line up specific set deals with off-system producers for trans-

portation by Panhandle, but only after the deals had first been

“‘bid-out” to Panhandle on-system producers for possible

matching; (4) if matching occurred, the end-user then had to

purchase from the matching on-system Panhandle producer,

after negotiating the specific terms of the purchase; (5) off-

system deals that were not matched had to be “rebid” to

Panhandle on-system producers every six months. (Kennedy

B-37

1146-1147; Reed 1286-1287, 1295-1296; PX 101; PX 102;

PX 102). The rebid procedure was eliminated in January

1985. (DX 82).

From the beginning, Panhandle intended that the

Guidelines would only apply to industrial end-users and not

to G tariff LDC’s for system supply. (Kennedy 1137, 1146,

1207; Reed 4925-26, 5121-22; PX 92; PX 101; PX 102; PX

103; PX 268). The reason for this was obvious: If the Guide-

lines had been available to G LDC’s, then Panhandle would,

in effect, have been cutting its own corporate throat. As long

as the Guidelines served as an economic safety valve in the

marketplace to keep the industrial end-users from moving

away from natural gas, Panhandle was resigned to the use of

the Guidelines; but if a G tariff LDC could use the Guidelines

to purchase natural gas, then Panhandle would have lost a

critical captive market.

It appears that Panhandle’s initial idea was not to trans-

port gas for system supply of any LDC. However, as time

passed, and as LDC’s continued to put pressure on Panhandle

to grant them access to transportation services, Panhandle

concluded that the proper response was to say that an LS tariff

customer did have access to the Guidelines, but a G customer

did not. This was justified on the basis that to have allowed a

G customer to purchase gas from a non-Panhandle supplier

and have it transported on Panhandle’s pipeline to the LDC

for system supply would have violated the “sole supplier”

provision of the G tariff and the sales contracts between Pan-

handle and the LDC.

As far as Panhandle was concerned, if CILCO, for exam-

ple, had wanted to buy gas from someone other than Panhan-

dle, it would have had to suffer all of the consequences of an

involuntary shift from a G to an LS tariff. Of course, if that

change in status had occurred in 1983 or 1984, the net eco-

nomic consequences to CILCO would have been disastrous,

B-38

no matter how low priced the gas that CILCO was able to buy

on the spot market.

Panhandle required the end-user to submit the following

information for the bid-out under the Guidelines: (a) a repre-

sentation that the end-user had an agreement with a supplier;

(b) information as to whether the supplies were off-system or

on-system; (c) the supplier price; (d) the quantity of gas to be

purchased; (e) the contract term, and (f) the Panhandle pipe-

line delivery points. Identity of the supplier or producer was

not required. (Reed 4742-4743). Panhandle then submitted

to its on-system producers under the bid-out: (a) the type of

customer, i.e., indirect customer behind an LDC, but not the

name of the customer; (b) the price; (c) the volume; and

(d) the term. (Reed 4743; DX 298).

Panhandle did not require end-users seeking transport of

on-system Panhandle released gas to go through the bid-out

and rebid process under the Guidelines. (Reed 4764). End-

users desiring transportation of off-system (non-Panhandle

supplier) gas were required to go through the bid-out process.

If they refused to comply, transportation was denied. (Reed

4920).

The information Panhandle required from the end-user

as part of the bid-out process, such as price, volume, contract

terms, and delivery points, was not information which could

have been kept confidential by the end-user on a permanent

basis. That information had to be filed in the public files of

the FERC upon commencement of the transportation of the

gas, but in the marketplace it was information that would not

otherwise have been available to the competing on-system

suppliers prior to the consummation of a binding agreement.

Because the bid-out and most other conditions of the

Guidelines were so restrictive, some off-system producers

B-39

_ simply refused to consider submitting to the Guidelines. Sev-

eral other end-users would have liked to have entered into

contracts of one to two years in length, but, because of the six

month rebid, could not guarantee a price for longer than six

months.

Panhandle contends that it neither permitted nor pro-

hibited negotiations by an end-user for a lower price from its

off-system producer after an unsuccessful bid-out, but there is

no indication in the record that Panhandle ever presented

this possibility to the end-users. Also, while Panhandle

neither permitted nor prohibited an end-user from con-

ducting an “auction” between the matching on-system pro-

ducer and the off-system producer for a lower price, there is

no indication in the record that the “auction” possibility was

ever announced by Panhandle to its industrial customers.

Since the Guidelines did not provide for an auction

between an interested off-system producer and an interested

on-system producer, end-users were basically left to purchas-

ing gas at a price that might have been lower had the parties

been free to “haggle” over price until the lowest price to the

consumer was reached.

The first transportation under the Guidelines was pro-

vided for Quincy Soybean (an industrial end-user behind

CIPS) starting in January 1984. The request had been submit-

ted to Panhandle’s bid-out procedure at the beginning of

December 1983 and had not been matched.

In 1984, Panhandle transported 16.8 Bcf of gas involv-

ing 52 transportation agreements. Approximately 15 Bcf, or

approximately 90%, was off-system supply, that is, supply not

matched by on-system producers in the bid-out procedure. Of

the total, 9.3 Bcf, or 55%, were transported to end-users in

Dllinois under 29 transportation agreements. In 1985, Pan-

handle transported 103.6 Bcf of gas under the Guidelines.

B-40

That amount involved 149 transportation agreements.

Approximately 90 Bcf, or 87%, were from off-system supply

and 22.3 Bcf were transported to end-users in Illinois involv-

ing 55 transportation agreements. Approximately 93% of the

Illinois transports were-off-system supply.

Thus, in 1984 and 1985, Panhandle transported approx-

imately 120.4 Bcf under the Guidelines, of which 31.6 Bcf

were to [inois end-users (i.e., 10.3 Bcf involving 17 transpor-

tation agreements were transported to end-users served by

CILCO; 2.5 Bcf involving 14 transportation agreements were

transported to end-users served by CIPS; and 16.1 Bcf involv-

ing 16 transportation agreements were transported to end-

users served by IP).

In late 1983 and 1984, Panhandle’s main desire was to

ship on-system gas to all of its customers, but its secondary

position was to ship any gas to industrial end-users. Initially,

Panhandle’s hypertechnical construction of the Guidelines

and the cumbersome details of the front end of the process,

made for a frustrating, maddening, and time-consuming situ-

ation for any industrial end-user which utilized the

Guidelines.

The time consumed by the bid-out process (i.e., the time

from Panhandle’s receipt of the request for transportation to

the giving of notice to the end-user of the outcome of the bid-

out), took 43 days in the fourth quarter of 1983. By October

of 1985 the time required to perform the bid-out had been

reduced to two days. A number of factors — including action

taken by Panhandle — contributed to the reduction of the

bid-out time. First, the Guidelines went into effect during the

winter heating season in December 1983, when on-system

producers were not inclined to respond to bid-out requests

since they were selling gas to Panhandle. During the spring

and summer of 1984, as less gas was being purchased by

Panhandle, producers became more responsive to the bid-out

B-41

and more familiar with the Guidelines. Second, starting in

September 1984, Panhandle stopped mailing bid-out letters

to on-system producers. Having accumulated information on

eligible and available on-system supplies from earlier bid-out

requests, Panhandle was able to utilize the information for

matching in-house. Finally, the MAT staffs increased size

and greater efficiency helped shorten the bid-out time.

Despite the reduction in the bid-out time, transportation

could still be delayed substantially for reasons beyond Pan-

handle’s control. For example, in one case the bid-out process

took only two days, but, because the end-user’s LDC had not

agreed to transport gas, over nine months elapsed before the

end-user and the LDC reached agreement and Panhandle

could start transporting the gas.

Even without the bid-out, transportation could not start

the day after receipt of a request for a new transportation

transaction (as opposed to amending an existing transaction).

This was because the time necessary to begin transportation

also depended upon the end-user’s completion of negotia-

tions with the producer on the supply contract and with the

LDC and Panhandle on the transportation agreement.

During 1984, 32 transactions went through the six-

month rebid but only five were matched by on-system pro-

ducers. In no case was there an interruption of transportation

due to the rebid. In some cases, matching under the six-

month rebid resulted in a lower price to the end-user, because

the off-system producer lowered its price to the end-user after

the match. (Reed 4776-4780; DX 1409). In other cases, the

opposite was true. However, due to the administrative bur-

den involved, Panhandle eliminated the six-month rebid fea-

ture from the Guidelines in January 1985. Panhandle notified

the industry and end-users that this feature had been

eliminated.

B-42

On March 6, 1984, after filing of this suit, CILCO

requested that Panhandle transport up to 15 MMcf/day of

NGPA category 102 natural gas from a producer in Texas.

This request by CILCO for transportation of natural gas was

premised on CILCO’s retaining its status as a G customer.

Langenkamp responded in a letter dated April 6, 1984, that

he did not have sufficient facts to affirm or deny CILCO’s

interpretation of the tariff but that he was willing to meet with

CILCO to learn additional details.

At a meeting with CILCO on May 15, 1984,

Langenkamp stated that Panhandle interpreted the G tariff to

mean that, if CLILCO were to buy natural gas which was sold

and transported in interstate commerce from any other sup-

plier, including NGPA categories 102 and 103 gas, those

purchases would be purchases from a “natural gas company”

and would disqualify CILCO as a G rate customer.

Langenkamp emphasized that Panhandle was willing to sell

gas to CILCO under other existing rate structures, including

the LS structure, or to negotiate some alternative rate sched-

ule, either of which would allow CILCO to make purchases

from alternate suppliers.

Meanwhile, CILCO enlarged the scope of relief it was

seeking in its FERC complaint. By August 1984, CILCO was

seeking an interpretation of the G tariff to permit it to

purchase 100% of its supply in the form of “certificate deregu-

lated” gas, i.e., Section 102, 103, and 107 gas, from the spot

market. CILCO’s March 17, 1983 letter coupled its request

for transportation with a request for confirmation that it

would remain on the G tariff. Panhandle’s refusal to interpret

the language of the G tariff to favor CILCO if Panhandle

transported such gas, as requested in CILCO’s letter of March

1983, was raised in the FERC proceeding.

As stated earlier, the limited service or “LS” rate sched-

ule had a level year-round monthly demand level, a minimum

B-43

commodity bill for natural gas purchases, no ratchet on

demand charges, and it permitted the buyer to purchase natu-

ral gas from sources other than Panhandle. This tariff would

not have been as favorable to CILCO as the G tariff, and

CILCO estimated in 1983 that it would have had to pay

approximately $50 to $60 million per year more for its gas

under the LS tariff than the G tariff.

In the summer of 1983, in an effort to settle the CILCO

FERC case, Panhandle proposed a temporary waiver of the G

tariff and certain rate terms as a means of permitting G cus-

tomers to purchase gas from other sources for system supply.

CILCO rejected this proposal because it wanted a permanent

change in the G tariff. As part of Panhandle’s 1982 FERC rate

case settlement, Panhandle in early 1984 agreed to remove

the gas commodity charge from the minimum bill. With that

cost removed from the minimum bill, CILCO would have

had to pay approximately $5 million more per year under the

LS tariff than under the G tariff. These were the minimum

amounts, in each relevant time period, which CILCO would

have had to offset with spot market savings before a switch to

LS tariff would have been a reasonable economic decision.

Transportation could also have driven up the cost of CILCO’s

remaining purchases from Panhandle, and CILCO would also

have had to offset these amounts. In hindsight, if CILCO had

significantly increased spot market purchases, the $5 million

increased cost might have been offset completely as spot mar-

ket prices fell below $2.10 Mcf.

On March 22, 1984, executives of CILCO and Panhan-

die met in Peoria to discuss the new limited general service

(“LGS”) tariff proposed by Panhandle which would allow

CILCO to purchase gas from other suppliers. CILCO calcu-

lated that under this proposed tariff, it would incur an addi-

tional gas cost of $55 million (above the G tariff rate) prior to

buying any gas from other source. That calculation was made

abs

with a minimum bill that included gas costs. At the time,

Panhandle was still resisting the deletion of gas costs from the

minimum bill. However, at the time it was known in the

industry that the FERC was proposing to eliminate gas costs

from all minimum bills.

In the summer of 1984, the FERC issued Order 380,

which precluded pipelines from charging their customers for

gas not taken through minimum bills. Panhandle’s LS cus-

tomers, all of which had minimum bills, took advantage of

this development by reducing their purchases from Panhan-

dle even more dramatically and increasing takes from their

alternative sources of supply. Thus, whereas in 1980 Panhan-

dle’s sales to LS customers had comprised 43 percent of its

total sales, by 1984 that percentage had dropped to 32.8 per-

cent. Panhandle, experiencing the adverse effects of the lost

r

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