Petitioners Reply Brief — FEDERAL ENERGY REGULATORY COMMISSION v. TENNECO OIL CO. (Nos. 83-1618, 83-1321, 83-1432, 83-1433, 83-1442, 83-1443)

Office-Supreme Court, U.S.

FILED

No. 83-1618 - MAY 25 1984 .

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CLERK

Iu the Supreme Court of the United States

OCTOBER TERM, 1983

FEDERAL ENERGY REGULATORY COMMISSION,

PETITIONER

Vv.

TENNECO OIL COMPANY, ET AL.

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

REPLY MEMORANDUM FOR THE PETITIONER

REX E. LEE

Solicitor General

Department of Justice

Washington, D.C. 20530

(202) 633-2217

TABLE OF AUTHORITIES

Cases :

Consumer Federation of America Vv. FPC, 515 F.2d

347, cert. denied, 423 U.S. 906 ............................-.

Continental Oil Co. v. FPC, 370 F.2d 57, cert. de-

a a re ee Ae deed

El Paso Natural Gas Co., 25 F.E.R.C. § 61,292......

El Paso Natural Gas Co., 57 F.P.C. 989 ..................

FERC Vv. Pennzoil Producing Co., 489 U.S. 508......

pe a ee nee

Phillips Petroleum Co. Vv. Wisconsin, 347 U.S. 672..

Public Service Commission v. Mid-Louisiana Gas

Co., No. 81-1889 (June 28, 1983) —.......................

Tennessee Gas Transmission Co., 30 F.P.C. 759....

United Gas Improvement Co. v. Continental Oil

ie ot eee) ee ea

Statutes :

Natural Gas Act, 15 U.S.C. 717 et seq. ....................

Natural Gas Policy Act of 1978, 15 U.S.C. 3301

et seq.:

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In the Supreme Court of the United States

OCTOBER TERM, 1983

No. 83-1618

FEDERAL ENERGY REGULATORY COMMISSION,

PETITIONER

v.

TENNECO OIL COMPANY, ET AL.

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

REPLY MEMORANDUM FOR THE PETITIONER

In our petition, we contended that the decision of

the court of appeals—holding that the lease sale

agreements at issue are not subject to Commission

reguiation under the Natural Gas Act, 15 U.S.C. 717

et seq.—constitutes a clear departure from the funda-

mental teachings of this Court in Phillips Petrolewm

Co. v. Wisconsin, 347 U.S. 672 (1954), and United

Gas Improvement Co. v. Continental Oil Co., 381 U.S.

392 (1965) (Rayne Field). We also argued that, un-

less the decision below is reversed, respondents would

(1)

2

reap an enormous windfall—at the expense of the

pipelines and/or their customers—for many years to

come.’ The points raised by respondents warrant

only a few brief comments.

1. It is common ground that, in determining

whether the Commission has jurisdiction over lease

sale agreements, the dispositive question is whether

what was sold was gas reserves or merely the right

to explore for gas. Respondents contend (PLA Resp.

Br. in Opp. 14; Tenneco Oil Br. in Opp. 12-13) that

under Rayne Field, “substantiality of development”

is an absolute prerequisite to a finding of Commission

jurisdiction. We disagree. The central teaching of

Rayne Field, which respondents ignore, is that the

jurisdictional question turns on the overall economic

and commercial realities of the transaction, not on

application of a rigid, mechanistic formula.

Viewed in these terms, the lease sale transactions

at issue must be regarded as subject to the Commis-

sion’s jurisdiction. As we demonstrated in our peti-

tion (at 19-20), the economic realities support the

Commission’s conclusion that the respondent gas pro-

ducers were not leasing the right to explore land for

gas but were selling gas in place. The record con-

vincingly shows that the producers sold proven gas

reserves * for resale in interstate commerce pursuant

1 For example, the GLA respondents are presently receiv-

ing “royalties” of about $3.50 per MMBtu—a rate that ex-

ceeds by more than 400% the current NGPA price for “old”

or “flowing” gas. As we explain below (see note 5, infra),

this rate could almost triple by next year.

2 Where lease sale acreage is proven, the economic reality

is that gas, not exploration rights, is being sold. The court of

appeals in this case acknowledged (Pet. App. 15a) that “the

record reveals the reserves in the [San Juan] Basin may well

3

to contracts that were similar in substance to con-

ventional wellhead sales contracts.* Moreover, these

reserves were sufficiently developed to permit the two

pipeline companies to obtain the regulatory approval

and financial commitments necessary to construct

major segments of their pipelines.* In short, “[t]he

have been ‘proven’ at least within reasonable estimates.” As

the ALJ observed, the particular geological structure of the

Basin “tended to assure that gas would be encountered at

virtually any location” (Pet. App. 53a (footnote omitted) ).

The ALJ cited the testimony of a witness for Northwest, who

stated that the pipeline had drilled several hundred wells

in the Basin and had never encountered a dry hole (id. at 53a

n.47).

’ The contracts provided for: (1) a specified sum per Mcf

subject to periodic escalation; (2) rate redetermination at the

end of a fixed term; and (3) favored nations clauses and take-

or-pay clauses. In addition, the contracts imposed strict drill-

ing requirements on the pipelines.

*To be sure, the San Juan Basin fields here involved were

not as developed as was Rayne Field. As we explained in our

petition, however, under the practical approach applied in

Continental Oil Co. v. FPC, 370 F.2d 57 (5th Cir. 1966), cert.

denied, 388 U.S. 910 (1967) (Ship Shoal), the fields here

certainly “reached the stage of proof and development neces-

sary to satisfy the Rayne criteria” (370 F.2d at 64).

In an effort to distinguish this case from Ship Shoal, re-

spondents argue (Union Oil Br. in Opp. 19-21; PLA Resp.

Br. in Opp. 19-21) that the field in Ship Shoal was sub-

stantially developed, whereas the fields involved in the in-

stant lease sale transactions were not. Respondents’ argu-

ment is wide of the mark. At the time of the transfer in

Ship Shoal, only two of the estimated 36 to 42 completions

needed to develop the field for gas production were in place.

Of the twelve wells that had been drilled, only one was a gas

well; the others were oil wells or dry holes. The subsequent

drilling of five potential gas wells to which respondents refer

(PLA Resp. Br. in Opp. 20) was done by the pipeline pur-

chasers (following closing), not by the producers. See Ten-

4

crucial fact here, as in Rayne, is that the assignment

of the leases accomplished the transfer of large

amounts of substantially proven * * * gas reserves to

an interstate pipeline for eventual resale in inter-

state commerce * * *.” Ship Shoal, 370 F.2d at 67.

By contrast, respondents’ analysis defies economic

reality. As we pointed out in our petition (at 7 n.9,

16), the special overriding royalties involved here,

which are payable on the net interest assigned (as in

Rayne Field and Ship Shoal), are about six to seven

times greater than typical land owner royalties (70%-

80% v. 1214%). Respondents do not explain why

this “royalty” level is so high if, under their theory

of the case, the transactions merely involved the right

to explore otherwise worthless land for gas. More-

over, respondents’ theory rests on the wholly invalid

assumption that the Commission and the financial

community would approve major pipeline construc-

tion solely on the basis of exploration rights. The

simple economic reality is that these transactions in-

volved the sale of natural gas reserves in place.

2. Respondents contend (PLA Resp. Br. in Opp.

16-19; Union Oil Br. in Opp. 10-11) that the decision

below can have no prospective impact on natural gas

consumers because, under this Court’s decision in

Public Service Commission v. Mid-Louisiana Gas Co.,

No. 81-1889 (June 28, 1983), the rates charged by

nessee Gas Transmission Co., 30 F.P.C. 759, 798, 808 (1968).

Respondents’ submissions to this Court overstating the level

of development in Ship Shoal stand in sharp contrast to the

producers’ petition for a writ of certiorari in Ship Shoal, in

which the producers stated that “only one gas well had been

completed, no gas had been produced, and at the time of

transfer 34 to 40 completions were anticipated for develop-

ment” (Continental Oil Co. v. FPC, petition for cert., No. 1823,

at 6 (Oct. Term, 1966) ).

5

E] Paso and other pipelines for first sales of pipeline-

produced gas may not exceed the applicable ceiling

rates in Title I of the Natural Gas Policy Act of

1978, 15 U.S.C. 3301 et seg. (NGPA). On the con-

trary, we submit that the future ramifications of this

one case alone are themselves sufficiently substantial

to warrant certiorari.

Respondents do not dispute the assertion in our

petition (at 22) that the lease sale acreage involved

in this case presently contains estimated reserves of

approximately three trillion cubic feet of gas. In ad-

dition, the GLA respondents cannot dispute that, at

present, they are receiving “royalty” payments of

more than $3.50 per MMBtu for “old” natural gas,

the current NGPA ceiling price for which is well un-

der $1.00 per MMBtu. Nor do respondents dispute

that this approximate “400% monetary gap” will

widen as the remaining reserves are utilized in future

years.’ Rather, respondents assert (Union Oil Br. in

Opp. 14-15; Tenneco Oil Br. in Opp. 24-26) that the

impact of the “400% monetary gap” will fall on the

pipelines, not the consumers—a consequence that,

respondents suggest, does not justify review by this

Court.

To be sure, as we acknowledged in our petition

(at 21) and as respondents emphasize (Union Oil

Br. in Opp. 10-11; PLA Resp. Br. in Opp. 18-19;

*The 400% differential between the “royalty” being paid

respondents and the NGPA ceiling price for the gas may be

dwarfed by future differentials. In June 1985, following the

scheduled deregulation of new gas under the NGPA (see 15

U.S.C. 8331 (a) (1)), El Paso will be required to pay royalties

to respondents based on the average of the three highest prices

the pipeline pays for gas. At that point, the 400% differential

could almost triple.

6

Tenneco Oil Br. in Opp. 9-10), the decision whether

to shift financial responsibility from the pipelines

to the ultimate consumers through special rate re-

lief is a matter within the ultimate discretion of

the Commission. See 15 U.S.C. 3314(b) (2); FERC

v. Pennzoil Producing Co., 439 U.S. 508 (1979). But

respondents miss the point when they assert simplistic-

ally that the Court should not be concerned about the

adverse future impact of the decision below because

the financial fallout may fall on the pipelines rather

than on the ultimate consumers. Respondents’ argu-

ment is based on an unduly restrictive view of the

scope of the Commission’s responsibility to protect the

public interest under both the Natural Gas Act and

the NGPA. The “public interest” over which the

Commission stands watch encompasses all segments

of the natural gas industry—consumers, distributors,

state commissions, pipelines and producers. See, e.g.,

NAACP vy. FPC, 425 U.S. 662, 669-670 (1976). As

the court pointed out in Consumer Federation of

America v. FPC, 515 F.2d 347, 357-358 (D.C. Cir.),

cert. denied, 423 U.S 906 (1975), this Court has

consistently rejected the notion that the Commission

need not concern itself with the level of producer

rates “on the ground that the pressures built up by

producer rate increases could somehow be contained

at the pipeline level by invoking a regulatory agency’s

authority to disallow ‘excessive’ costs.” It is clear

that either the pipelines or the ultimate consumers

will suffer severe financial dislocation absent reversal

of the court of appeals’ erroneous decision.°

* Respondents’ attempt to cast the impact of the court of

appeals’ decision on future gas prices as essentially a pri-

vate dispute between themselves and El Paso (£.g., Union

7

In our petition (at 20-21), we pointed out that if

the Commission is held to have jurisdiction, gas con-

sumers would be able to assert claims for more than

$1 billion in refunds for the special overriding royal-

ties paid to respondents in the period between 1974

and 1983.’ Respondents, not surprisingly, dispute

Oil Br. in Opp. 14-15) is misleading. In order to mitigate the

enormous future impact of the decision below on the pipe-

lines, both El Paso and Northwest have entered into settle-

ments with some of the respondents. The settlement between

Northwest and Phillips has already been approved by the

Commission. In approving that settlement, the Commission

noted that “Phillips is offering to accept rates under PLA-5

that could save Northwest, and eventually its consumers, as

much as $50 million a year.” El Paso Natural Gas Co., 25

F.E.R.C. { 61,292, at 61,674 (1983) (emphasis added). The

settlements between E] Paso and Union (Union Oil Co. of

California, Docket No. CI84-141-000 (filed Dec. 18, 1983) )

and between E] Paso and both Tenneco and Conoco (El Paso

Natural Gas Co., Docket No. CP74-314, et al. (filed May 18,

1984) ), which have not yet been approved by the Commission,

raise numerous complex issues relating to future gas cost and

gas supply.

With regard to the impact of the decision below on the

pipelines, respondents’ argument (Union Oil Br. in Opp. 14-

15; Tenneco Oil Br. in Opp. 24-25) that application of Mid-

Louisiana to the El Paso system will be beneficial to the pipe-

line overall is wholly irrelevant. The fact that E] Paso is en-

titled, under Mid-Louisiana, to additional revenues for its

production from other properties has no bearing on whether

the lease sale transactions at issue are subject to the Com-

mission’s jurisdiction and, if so, whether the rates paid by

El Paso to respondents for the gas are unjust and unrea-

sonable.

T Respondents erroneously suggest (Tenneco Oil Br. in Opp.

22-23) that the Commission, in El Paso Natural Gas Co., 57

F.P.C. 989 (1977), approved the level of these special over-

riding royalties as being just and reasonable. The Commis-

these claims (Union Oil Br. in Opp. 12-14; PLA

Resp. Br. in Opp. 25-27).° It is clear, however, that

unless the court of appeals’ decision is overturned,

the affected natural gas consumers would be deprived

of any opportunity to assert their refund claims.

For the foregoing reasons and those stated in our

petition, it is respectfully submitted that the petition

for a writ of certiorari should be granted.

REx E., LEE

Solicitor General

May 1984

sion simply held that E] Paso had acted prudently in enter-

ing into settlements after the Sun Oil arbitration award.

Indeed, the Commission specifically stated that it was “not

deciding whether the amounts received by the special over-

riding royalty interest owners, were they found to be juris-

dictional, are just and reasonable” (57 F.P.C. at 1000).

® Even if there were merit to respondents’ assertion that

refunds should not be ordered for the period prior to Sep-

tember 25, 1980 (the date of the Commission’s decision on

jurisdiction), a point we do not concede, refunds of nearly

half a billion dollars have been claimed for the period sub-

sequent to that date.

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