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

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_2188%3A2

## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1992
- **Citation:** 502 U.S. 1094

## Text

¥
a] 973 . | |
: Gierama fourt 0S
; pupre s Ci - ‘

No. 91-

f
Ros The cNK
Urttyu

= se

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 an

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_2188%3A2. Public record. Not legal advice.