Appendix — Municipal Distributor Group v. Federal Power Commission

Supreme Court brief1970

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LIBRARY

SUPREME COURT, U. S.

Supreme Court,’ U.S”

: Fit &£H5-

“SEP 14 1970

| Supreme Court of

EAVER, CLERK.

fe Ved Sites

“Oc TOBER TERM, 1970

;

ContiveNTaL On COMPANY, ET AL., ee

ee es Petitioners,

hoe v.

; FEDERAL Power CoMMISSION, Pear eee Te

ay ey “Respondent. «

: = ° e - = ‘

APPENDICES TO PETITION FOR AW TOF |

samp oy TO THE UNITED STATES COURT OF

_APPEALS FOR THE FIFTH CIRCUIT. oats

- ae | CONTINENTAL Om Company .

: Tom Burton... |:

P.O. Box 2197 °, .

Houston Texas 77004

Mosit On. (‘ORPORATION

; Tom P. Hamill —

? Robert D. Haworth ae

P. O.. Box 1774 . 2 +

Houston, Texas 77001

- * . .

< *

¥ ‘FIDELETY PRINTING COMPANY, INC., HOUSTON

t aL a

CONTENTS | aan a ;

Appendix, {= Opinion of the United States «Court. of

A ppe ‘als for tlie Kifth, (ireuit, No. 27492, March; 19, 1970

hae ndix B— Opinion’ on Petition for Rehearing of the

United States Court of Appe als for the rifth Cbreuit,.

oS No. 27492, Jane 16, 1970 ‘A ; f

-° e a 5

‘Appendix Co Judeine nt and alae of te enited State ms 8

-Court of Appeals for the 3 ifth-4 ‘irenit, NO. 27492, Match

AY, 1970 of et OS ne Prgent 4

Appendix D—— Fede ral Power Commission Opinion No. 546,

Southern Louisiana Rate Proceeding, Dockets A R61-2

et al. Se ‘plembe r 25, 1968 eae cm coer :

Appendix ——_ I ederal Power Comission’ Opinion No. .

oAG-A, Southe rm Louisiana Area Rate | Proceeding, . f é

Docke ‘1s: ARGI. 2, ef al. March’ 20, 1969 ae YM 3 a

es : ve! ‘ ed

Appendix F = Statutes inyglved Natural (las Act Seetions a

4, o(a), ‘(e), 16, I9(b), June 21, 1938; ¢ hapter oO, as 4s

aumendgd of oe

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APPENDIX A:

Opinion, of the’ United States

Court of Appeals for the-Fifth Circuit |

_No. 27492, et al. :

Southern Louisiana Area Rate Cases:

‘(Margh 19, 1970)

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IN THE.

= United States oe: of Appeals

“FOR THE FIFTH circurt

_ No. 27492, etal"...

. ° 2 as cit we

‘SOUTHERN LOUISIANA AREA ‘RATE CASES us Fe

AUSTRAL OIL Co., ET AL, .

wet Petitioners,

versus

-| F EDERAL POWER COMMISSION,

_ Respondent. i

Petition for Review: of Orders ‘of ae Federal. Power

7 Commission ¢Texas Case) .

(March 19, 1970) a

mature THORNBERRY, COLEMAN and MORGAN,

Circytit oungen.

_"THORNBERRY. Cirtuit Judge: - This aS a. ‘proceed-

ing to review orders of the Federal Power Commission

setting maximum rates for wellhead sales of ‘natural

gas produced in’the Southern Louisiana area. Thirty-" -

seven producer petitioners’ "challenge the rates as too

low.} Eight pipeline companies are also involved in

In discussing the issues-in this case, we have usually simplified

the positions of the parties by considering them. as producers,

_ consumers, and the Commission. Our review of the. case, how- -

ever, has taken into account subtler. i see among the ia

} '

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2°. AUSTRAL OIL, ET/AL y. F.P.C.

the proceedings, and they. concur with the’ producers "

that the rates are too low.? On the other hand, certain

consumer interests have. intervened and attack the

rates as too high:* The Federal Power Commission

presents a third position by. arguing that its: ‘orders:

should be sustained. in full. The result of this trichot-

omy of conflicting positions — producers, consumers,

and the Commission — is a case as complex as it is

important. oA . :

We have determined that oe. orders of the Commis-

sion should be sustained in full. We add, howev er, “that,

parties. Most of ‘the. producers, for example, have joined a

single group, the Amerada group, in briefing their argument,

but others have chosen to present their arguments separately.

Particularly conspicuous among these separate petitioners are

several ‘small producers, and we have treated their special

arguments herein. ‘The method of presentation is.a question

_ for the parties themselves. We think, however, after consider-

ing this case, that it is to the great advantage of the parties

in a complex,, multi- -party, case to. , aearegate their arguments*

in so far as possible.

2The. _pipelines— purchase—gas—from— the producers, “and it seems |

anomalous at the outset that they are arguing that’ prices

are too low. The Commission found that the inelasticity of

~market demand for gas at the consumer level “tends to make

«price a second level consideration” to pipelines. 4 Joint Ap-

pendix, pt. 1, at 533d (Commission’s opinion). Pipelines some-

* times own production factors as well. A significant reason for

_ the pipelines’ alignment here, however, may be simply that

they are concerned that the price level will not elicit sufficient

supply for their needs. At oral argument, they. represented that

informal rationing procedures among pipeline purchasers were

_ now in effect and that formal agreements might be necessary

in the future.

‘3These parties include the New York Public Service ‘Commission

and the Municipal Distributors ——: a group of municipally”

owned gas distribution systems.

4It is supported in this position by the aietaia Distributors

Group (ADG) of intervenor$, a group of privately owned local

utility companies.

AUSTRAL OIL, ET. AL v. FPLC. ¥

this sitirmiauce does not reflect full satisfaction with

the performance that the Commission has turned in,

~ but rather a recognition that the process of producer’.

regulation is-a difficult one that the Commission myst °

have latitude to adapt to. changing conditions. In the

section of this opinion that immediately follows, we

describe this process, together with the legal events

that have led to-its development, and set out the Com-

mission’s actions in the cases before us. In a second

section, we deal with the consumer arguments that the

rates are too high. The third section takes up the pro- |

ducer arguments that the rates are too low. Herein,

-we discuss what we believe is the most serious problem

presented by these cases: The possibility that the Com-'

. mission has not adequately considered the problem

of new gas supply in relation to demand. There is evi-

~ dence of a serious supply ‘deficiency. Fourthly, we sum-,

marize, our conclusions and indicate improvements that

should be expected in the regulatory process. In this

final section, we also consider the stay that has pre-

vented the Commission’s order's — going into effect

Shrough this Bios ofr review.

Lk. THE PROCESS-OF AREA REGULATION

AND THE COMMISSION’S OPINIONS

The beginnings of -producer area regulation were

inauspicious. Ever sinte the enactment of the Natural

_ Gas Act in-1938,5 the FPC has had the responsibility of

- regulating sales by interstate pipeline companies, but

- it was not until 1954 that the Supreme Court held in

‘Phillips Petroleum €o. v. Wisco” sin,® that the Act also.

515 U.S.C. § 717 et seq: (1963); 52 Stat. 821 (1938).

6347 U.S. 672, 74 S.Ct. 794, 98 L.Ed. 1035. ier

4‘. AUSTRAL OIL, ET AL-v. F.P.C.

- gave the Commission power to regulate sales by in-

dependent producers at the wellhead. The Commission

was cu.ivinced that producer regulation would be im-

practical and consequently was reluctant to assume its

new role.? Congress was willing to° amend the Act to

exclude producers. But the aftermath of the Phillips

decision, as one commentator has described-it, included —

an accident of history that left the Commission still”

faced with its difficult new duty:®= ~

: Congress immediately ae [to Phillips}

by passing an act declaring that the 1956 Con-

gress did intend complete, exclusion of inde-

pendent producers,- and suggesting rather |

strongly that “the 1938 Congress probably did

so as well. Whereupon” the President, who

| strongly, supported the 1956 act, vetoed it for

reasons unrelated to the merits of the argu-

ments of either the Court or Congress. It has.

- tdken the eight years since 1954 for the industry

and the FPC to realize that they must mount

this unbroken nightmaré born of stulemate out

of avarice and ride it if-they are to move at

vias |) a

‘The Commission was as hopeful after 1954

that this ftlew-found, unwanted jurisdiction

would vanish as it had:‘once been fearful of.

7See F.P.C. Ann. Rep. 176-77 (1955); 36 F.P.C. Ann. Rep. 10 (1956);

37 foie Ann. Rep. 17- ae C1889); 39 — Ann. Rep, 12-13 .

(1959)

8Johnson, Producer Rate Regulation | in Natural Gas Certification

Proceedings: CATCO in Context, 62 Colum. L. Rev. 773, 783

- (1962); see also M. Merrill, The Public’s Concern with the Futl

. Minerals 104, (1960). :

AUSTRAL OIL, ET AL v. F.P.C. 5.

its coming. The. record it has amassed that

such regulation will not be successful is, formi-

dable. ager

Both economists and lawyers have questioned’ the

soundness of direct producer, price regulation,® . but

there is also support for the need for producer regula-

tion of some type'® and, whatever its merits, the law

onnlieenens

®Yee, e.g., M. Adelman, The Supply, and Price*of Natural Gas 39

; (1962); P. McAvoy, Price Formation in Natural.-Gas Fields

265 (1962); E. Neuner, The Natural Gas Industry 280-90 (1960)

(recommer ing that contracting, behavior rather than . price

be regulated, in light of a conclusion tHat industry structure,

at least, is competitive): Cram, Introduction to the Problem of

Developing Adequate Supplies of Natural Gas, in: Economics

_.of the Gas Industry: 24 (Southwestern Legal Foundation ed.

1962); Kail, The Evotution of Area Gas Pricing and Its Effects

on the Natural Gas Industry 18-22, January, 1968 (unpublished

thesis in- University of Texas Library); Kitch, Regulation of

e Field Market for Natural Gas by the Federal Power Com-

mission, 11 J. Law & Econ. 243 (1968): cf Kitch, The Permian

Basin Area Rate ‘Cases and. the Regulatory Determination of

Price, 116 U. Pa. L. Rev. 191, 194-99 (1967) (concluding that

area, rdte regulation resembles wartime: price control). .

These and other authorities, however, are relevant only to

the quasi-legislative function of the Commission in deciding —

how: producers are to be regulated. The decisions of the Su-

preme Court definitely indicate that the Commission , hat. a

“responsibility to take the steps necessary to assure that well-

head prices are in the public interest. The Commission does

not have to employ the area rate method, or for that matter

duty in that manner here. ; ‘

10The Commissign concluded ‘that there was an absence of effective

competition in wellhead sales. This absence seems to be strongly

evidenced by a rapid spiral of price increases over the years

regulate price directly at.all, but it has chosen to fulfill its

from 1950 to 1958, when the price went from less than 9 cents -

per Mcf to a peak of 24.05 cents. This spiral was apparently

caused by three factors. First, the contracting practice jn the

industry resulted in Oligopolistie behavior, because devices

such as -favored nation, periodic escalation, redetermination, .

‘and renegotiation clauses caused any price above in-line levels

6 AUSTRAL' OIL, ET AL v. F.P.C. -

* since 1954 has imposed the duty of regulation upon the

FPC. — | a

From 1954 to 1960, the Commission emia to dis-

charge its new responsibility in the same way that it

regulates pipelines, on a company-by-company basis,

setting the rates of éach producer according to his costs

.of service. This method, however, ‘required the Com-

mission to repeat lengthy hearing procedures for each

independent operator in the nation: It consequently led

to a breakdown in the administrative process,"! a rée-

sult that is easy to understand in view of the cumber-.

some nature even of the single consolidated cases with

which we are faced here. The Commission gravitated

toward lax ee of dob increases. ‘But ir¥-1960, the et

to trigger other price rises. (These contract terms are defined

in the Supreme Court’s Permian opinion, 390 U.S. at 765, 88 |

S. Ct. at 1358, n. 46.) Second, the producers were able to”

assert market power even though the market for sales to.

large pipelines appears at first glance to be oligopolistic, be-

cause the pipelines typically needed large blocks of reserves

at times not of their own choosing. Finally, the bargaining”

“motivation, of pipelines ‘themselves was diluted because pipe-

lines resold in .a. relatively inelastic market and hence could

pass price increases on to consumers. The Commission chose

_ to believe this evidence rather than to focus on concentration

« fratios, leadership turnovers, or conditions of entry, and on

appears to have been justified in so doing. 4 Joint Appendix

at 530d-34d (Commission’s Opinion).

At the same timé, there seems to be general agreement ‘that |

the market is at least structurally competitive. The Supreme

Court in Permian described producers as “intensively competi-

_ tive.” 390 U.S. at 757, 88 S. Ct. at 1354. See ‘also P. McAvoy,

supra note 9, at 7; E. Neuner, supra note 9, at 178-204, 280-281;

M. Adelman, The Supply and Price of Natural Gas 39 (1962).

11See J. Landis, Report on Regulatory Agencies to the President-

. Elect 54 (printed for the use of the Senate Comm. on —

Judiciary, 86th Cong., 2d Sess., 1960).

* >

AUSTRAL -OIL, ET ALv..F:P.C. + 7 7

} Supreme Court’s ‘CATCO'2. decision’ reversed an.FPC

certification order and-directed the Commission to take ©

steps to keep prices “in line.” The: Commission tempo-

rarily responded to this mandate by. the “in- -line” pricing .

policy, which stated that ‘the Commission would not.,

approve new certificates providing: “For gas salés at

prices higher than the prev ailing: rate in the area, and

by. the “guideline” doctrine, which gave notice that -

the Commission would not give advance .approval tors -

price increases above certain area maxima.'3 Price |

increases above these guidelines thus. Subjected sthe

aia ca to the possibility of refund obligations:

Also in. 1960;-the Commission began work on amore

thorough solution: to the problem with the first area

rate proceeding, which covered the Permian Basin area

of New Mexico and the Texas Panhandle.,JIn subsequent

years, the Commission simultaneously had examiners *

hold hearings on four other areas, of which the area in-

volved in the instant case was one. Jara ae

A. The Permian Basin Peer ae Cases

In Permian,'4 the first area rate.case, the FPC set

12Atlantic Ref’g Co. Vv. FPC, 1959, 360 U.S. 378, 79 S. Ct. 1246,:3

. L.Ed.24 1312 (known as the CATCO case). The Court urged

the Commission to: disallow or condition - new certifications

“where the proposed price is not. in keeping with the public

interest because it is out of line or ... might result in a trig-

gering of general. price rises or an increase in the applicant's

; existing rates... .”

13These matters webe. set out in the FPC’s Statement Of General

Policy No. 61-1, 1966, 24 F.P.C. 818.

14Permian Basin Area Rate Proceeding, 1965, 34 F.P.C. 159, af-.

firmed in part afid reversed in part sub. nom. Skelly. Oil Co.

v. FPC, 10th Cir. 1967, 375 F.2d 6,. .affirmed in full, in re

_Permian Basin Area Rate’ Cases, 1968, 390 U.S. 747, 88 S. Ct.

"1344, 20 L.Ed.2d 312.

-8 °° .AUSTRAL OIL, ET AL v. F.P.C.

. x & . 1) be - * ; - s :

maximum and minimum rates for an entire gas pro-.

ducing area on an industrywide basis. It did so by ex-

amining costs and setting a rate of return for the area’ S

. gas producing industry as a- whole. It" engaged. in a

degree of economic _experimentation by. creating a

double-tiered~ pr pricing arrangement; The -maximum

price for “ new” gas, gas not y et under contract of inter-

state sale by the cutoff date of January 1, 1961,'5 was. _

set higher than that for “old” gas in order to stimulate

exploration.'® Old gas was priced on a cost-recovery

basis on the theory that a price incentive would not |

encourage development of gas that had alfeady been

sold. Having set these maxima, the Commission fraze

them for two-and-one-half years by impesing.a mora-

torium on price increases in: excess of the ceilings. as

set. It stated that extraordinary circumistances would

induce it to allow petitions for relief from the ceilings

‘48This date was chosen for three reasons. First, it was the most

convenient date following 1960, the year of moyt data for old .

gas. Secondly, the in-line and guideline policies had been b-.

lished _in 1960. Thirdly, this. date reflected the Commission’s

- estimate of the time at which the industry acquired the capa-.

bility to drill “directionally,” i.e., to explore specifically for

gas rather than finding gas as a by- product of the.search for -

oil. 34 F.P.C. at 189. This directionality hypothesis is a major

basis of area rate regulation as the Commission has. imple-

mented it, becausé multi-price regulation depends upon the

function of greater prices to elicit gas exploration. The hy-

pothesis is not without its critics. See ‘Foster Associates Report,

December 18, 1949, at 9-10. ;

16The new gas ceiling was 16.5 cents per, thousand eubie feet

(Mcf) in Texas or 15.5 cents per Mcf in New Mexico, and the

_ old gas ceiling was "14.5 cents per Mcf in Texas or 13.5 cents

;per Mcf in New Mexico. The difference reflected the fact that

& ‘the Texas price included, state taxes while, the New Mexico

price did not. Casinghead gas was priced at-old gas ceilings

irrespective of its vintage. The Commission also set a mini-

mum price of 9 cents per Mcf.

Bes

AUSTRAL OIL, ETAL v. F.P.C. . 9

“but made it clear that the moratorium would not be ~

lightly acai an Lope a

"The Commission’ s decision was “appealed to the Tegth .

Circuit. That court sustained’ the Commission’s power’

to regulate producers by setting industry wide rates and

imposing moratoriums on increases,but remanded the .

case to the Commission because it found that the’Com-

mission had failed to include required findings as to

tle consequences of its order on the gas industry or to

specify with sufficient exactness the circumstances

-under which special relief from maximum rates would

be granted. The Tenth Circuit’s decision, in turn, was |

reviewed by the Supremé Court, which reversed, the

Circuit. and affirmed the Commission in full.. The Su-’

preme Court’s Permian opinion is thus the star by which

we must do most of our steering in this case.

In Permian, the Supreme ‘Court made sev eral dif-

ferent types of determinations. First, it concluded that’

the Commission had the authority, under the Constitu-

tion—and—Natural -Gas—Act,_to—set—industrywide_rates —

- and to impose ancillary regulations, such ‘as mora-

toriums, necessary to make area proceedings work.

Secondly, it sustained the Commission’ s use of the cost

method for pricing, its determination of rate of return,

and its double rate structure; or, in other words, it ap- -

_ proved the components ‘of the rates as set. Thirdly, it

approved the overall effect of-the rates, holding that™

‘Commission findings supported by substantial ev idence

indicated that the rates would produce adequate ag-.

gregate revenue, would generate sufficient growth, and

would not create unjust results on individual producers.

This approval of “overall effect” findings reflects a

‘

10. . AUSTRAL OIL, ET AL ¥. F.P.C.

* f . .

‘somewhat charitable interpretation of the Commission’s

work, '7 one that the Court emphasized, was. warranted. .

_ because the. Commission’ was at an experiment stage

_in a new and difficult: ‘undertaking. At the same time,’

the Court- apparently agreed with the: Tenth Circuit

hat the paucity of findings as to the consequences of. :

‘the order was a major deficiency, because it: stated

dL. that it expected the Commission to-do better in ath ;

profeedings.

The Permian decision thus indicates that a review- _

* ing court must look to both individual components and

overall effect of rates set by the Commission, but that

the Commission has broad discretion that is not to be

ineffectuated by either theoretical disagreement with.

its methods or. by discovery of inadequacies that are

’ caused mainly by the difficulty of the regulatory under- :

-taking. The Commission is to he affirmed if it has

followed the ‘correct legal standards and acted on the

basis of substantial evidence, and under any fair inter-

-- pretation of Permian it appears that the legal stand-

ards themselves are’ to be construed liberally when ap-

plied to a regulatory effort still ‘in the experimental »

stage. This “experiment” doctrine, together with the

‘substantial evidence rule, is background for our con-*

sideration of most. of the issues presented on this ap-

ines

17The Connisdeitns made -no assessment of the effect of its prices

----~--On-supply, demand,’ reserves, or. industry structure. -The -Su- -

preme Court advised that in future cases the Commission should

State more “fully and carefully ... its assessment of the con- |

sequences of its orders for the character ‘and future develop- |

ment of the industry.” 390 U.S. at 792, 88'S. Ct. at 1373.

AUSTRAL OIL,:ET AL‘ v- F.P.C. 11 -

-B. The. = Louisiana Area Rate Cases

All paities t are in- ‘agreement that Southern: Louisiana

- is the most important gas-producing area in the coun- “

_ try. The FPC has defined this area to include all parts

of the state south of the thirty-first parallel, together

. with all offshore: territory'® in the federal domain that

would be bounded by the Louisiana borders extended

into the Gulf: At present,-Southern Louisiana ‘accounts

for approximately one-third of the nation’s gas produc-. :

tion, and its untapped, unproven reserves, particularly .

those in the: offshore portion, are among the nation’s .

most promising. Natural. gas, in turn, is the nation’s

most important, or at least most .widely used, source of

energy.'® 3 -

Proceedings to set rates for this area began in: 1961,

nearly a decade ago. The initial hearing ended in 1965

and the examiner rendered his decision in 1966, after

the Commission. had written its Permian opinion. /The

Commission rendered its final decision in 1968, a few |

_ months after the Supreme Court had decided Permian.

The decision was modified in some respeets by a new

opinion on ne in early 1969.

18“Offshore” gas production, ' in this opinion,. means production

outside state boundaries and thus not subject to state nee,

taxes, i.e., that in the federal domain. > me

19In 1965, the year the record ‘in.this case closed, Bureau of Mines

figures attributed 35. 7 percent of this nation’s total energy...

~ production to natural ‘gas. The percentage has’. been steadily

‘increasing over the years. For 1968, the producers quote a

figure of 37.5 percent. Brief for Amerada iiss at —

B-2. :

o : . } . r ; |

ae Cone AUSTRAL OIL, ET AL v. F.P.C.

‘ Lf

(1) The Rate Structure . )

The Commission repeated in Southern ‘Louisiana the |

multiple rate structure it had“ihtroduced in Permian,

this time sétting three different price levels for what.

it dénorninated as first, second, and third vintage .gas. /,

‘For.first vintage gas, that for which contracts of inter-

state sale had been made prior to 1961, the Commission

set-a cefling of 18.5 cents per thousand cubic feet (Mcf).. -

-For second vintage. gas, /that contracted for between

the dates of. January 1, 196J, and October 1, 1968,2° it -

set a ceiling of 19.5 cents. For third vintage gas, that |

contracted for after October. 1, 1968, it.set a ceiling of =

20 cents. For offshore gas in the federal domain, which

is not subject+to the Louisiana severance. tax, it set

prices for each of ‘the three vintages 1. 5 cents below

onshore tevels. For casinghead gas (gas preduced in -

: ‘association with oil), the Commission set prices equal

to those of first vintage gas irrespective of the v intage.

~The Commission found that casinghead gas is discov er- o

_.ed largely as a product of the search for oil and explo- ( :

ration for it thus could not be encouraged by the 7 =

prices of second and third vintage gas.

The price structure thus established is eieakeeiond

in the following chait:

Vintage or Typé Onshore Price Offshore-Price

. First vintage. 18.5 cents’ . 17.0 cents

. Second vintage ‘19.5 cents- 18.0 cerits ~ *

Third vintage © 20.0 cents =‘ 18.5 cents

Casinghead * 18.5 cents . 17.0 cents

20The oa for the establishment of the January 1, 1961. date

weye similar to those for its establishment in, Permian: See .

note 15 supra. The October 1, 1968 date marked the approxi-

mate end of these proceedings before the Commissiozl.

’

oe AUSTRAL OIL, ETAL yv.F.PC . 13

The prices,for new, nonassociated gas are higher than .

those for all other vintages and well ‘types, because >

the Commission determined, as it has in Permian, that

price should be used to elicit the ‘appropriate level of

future exploration and development. In order to enforce

_ these ceilings far gas of first and second vintages that

;, had already -been produced and consumed, the Com- _

mission ordered substantial refunds of moneys collected

in excess of its maximum rates.2!

(2) The Commission’s Cost Determinations

Although the rate. structure contains some noncost

elements, it is closely tied to cost computations.22 The

Commission used two different methods of computing.

costs, one of which it applied to old gas (first and second

vintage) and thesother to new gas (third vintage). New

gas is priced to allow for the appropriate level of ex-

ploration, and the Commission determined that explo-

ration for gas was and’ should be undertaken on a

nationwide basis;-~so new gas costs are based upon

present costs for the entire nation. Old gas is priced

so as to allow recovery of costs actually incurred in its

production, and therefore the costs used are historical

‘area costs, Le., those _of the Southern Louisiana area

- itself during the periods covered by the earlier vintages.

. . e e

J °

21The Commission ruled that, by further order, it would require

; - Tefun“s of the difference between the amounts collected and

\ amounts that gould have been received“under the applicable .

> ao area rate (or the amounts that would have been received

‘under firm certificates or settlement tatesif those rates were

higher than the’area rate). ° fy Fee. eee

22The Commission. relied upon published .data, testimony, and

questionnaires filled out by producers to collect its raw cost ©

data. - we apa

14°: .. ‘AUSTRAL GIL, ET AL v. F.PC:

The bulk of the Commission’s’ opinion is devoted to ©

computation and explanation of costs. Included. in -its

total is an allowance for a rate of return of 12 percent,

- which is the same rate that was set and approved in

Permian. We have set out the other élements of the -

Commission’s cost findings in tabular form in the foot-

note below.23 2

(3) Moratoriums on “Ipcbhanes in ‘Excess of

sy a Rates

_In establishing rate ceiling freezes, the Commission

went substantially farther than it. had hazarded.in, its

earlier Permian decision. It imposed a moratorium of

a little more than five years — lasting until. January

‘1, 1974 — on rate increases for third vintage gas in ex-

cess of the maximum prices it set. For first and second

vintages, the moratoriums were to last indefinitely.

These moratoriums mean that the vintage ceilings are’

to remain in effect throughout their duration, and that

23Item New Gas Flowing Gas

Exploration and Devetanment ; 4.14 - 4.17

Production Operating Expense a 2.70 1.93

Liquid Credit - 2 (3. 30) —-

Depletion, Depreciation, tex

Amortization Sey oe 04 °3.19

Return on Investment yehta 5.17:

Return on Working Capital ~ 0.35 aa

‘Regulatory Expense ; 0.15 — 0.17

Royalty - 2.24 ° ——

Area Gathering é . O51 0.51 -

Production Tax ‘ a 2.30 2.30

‘TOTAL | ; ; : 18.80 18.36

_ All figures given are unit costs, in cents per Mcf. The group-

- ing of flowing gas costs is different from that for new gas;

the flowing gas E&D computation, for example, contains some

f")

AUSTRAL OIL, ET AL v. EPC. 15

producers cannot collect prices in excess of maximum

rates even subject to refund.

However, the Commission provided, as: it. had-in

Permian, that it would always be open to a petition to:

lift moratoriums for individual producers or to modify

area rates as a whole in the event that changed cir-

cumstances made either of these steps advisable. More-

over, it quoted language’ of the Supreme Court stating

that it would be “desirable” ifthe Commission specified

more precisely the conditions for relief and, inresponse

to this language, gavé example: of changes that would

cause it to lift moratoriums or change rates.24

24Area rates “will be modified if a Showing is made that unit costs

— reflecting amounts ‘Spent and reserves foyfid ~—have in-

creased to such an extent that an increase in.area fates is re-

quired.” As to individual producers, the Commission recog-

nized that it was avoiding. “precise specification of circum-

stances that would justify special relief,” but stated that: *

“However, certain principles have been established.

Overall high cost of service of an individual producer

is not a. ground for relief. The fact that current rev-

enue from a particular well is less than the costs of

* continuing.its production is a ground for relief. The

’ fact that a producer can obtain a higher price else-

.where is not a ground for relief. Certain producers

’ have already requested price relief, contending that

unusually high pressure, great volume, concentrated

delivery points, delivery of large quantities at one

_ point, unusually high gas quality, unusually good de-

liverability and the availability of gas for swing pur- .

‘ poses justify an increased price. We have determined ©

that none ‘of these, nor. all of them together, are

. grounds for price relief.” —

These and other statements of the Commission, taken together,

-probably constitute as specific an exposition of circumstances

for relief as can be expected at this stage in area regulation.

16 . AUSTRAL OIL, ET AL v. F.P.C.

In addition to setting maximum rates, ordering re-

funds, and imposing moratoriums, the Commission took

action along a number of other lines that are of lesser ©

’ significance in this case.?5 ;

(4) Commencement ‘of New Proceedings for

— Area : |

On December 15, 1969, shortly before oral argu-

ment in /the instant case was heard, the Commission

instituted new “proceedings to reconsider all major

actions lit had taken in the orders before us. In other

words, the Commission iss now holding hearings that

will probably result in substantial modifications of

the rates set in this case. In its’ order initiating the

proceedings, the Commission advised the parties ‘iat

it would receive evidence concerning “the adequacy

of gas supply and adequacy of service to consumers,

the demand for gas, the cause of a gas shortage, if any,

the effect of price on gas supply and demand, and

other relevant @gonomic evidence, together with data

as to the ois cai ans cost of finding and. pro-

ducing nonassociadted. gas."6 Similar considerations

_— /

25The Commission established a system of quality discounts that

were to be used in adjusting maximum rates, outlawed certain

types of flexible pricing clauses resulting in increases over

ceilings, created special exempt types of producer sales, ex-

empted “small” producers. from certain requirements, and de-

termined that minimum rates need not be established.

26Order Enlarging Investigation and Proposed Rulemaking, 1969,

me Sf oo [No. AR69-1; slip opinion dated December

15, 1969, at 3]. The Commission indicated that. “we desire to

have this proceeding expedited in every way possible.” Pre-

hearing was set for January 27, 1970.

The Commission had already set part of the offshore terri-

tory for reconsideration in its opinion on rehearing. The Order

AUSTRAL OIL, ET AL v.F.PC. © 17

are to be taken up-with respect to old gas, and the

- moratoriums are to be re-examined. as

Since the new proceeding may affect rates for all

vintages, and since.the data the Commission has called

for reflects the possibility of a radical change in ap-

proach, this Court was naturally concerned about the

effect of the new proceeding upon our disposition of

the instant appeal. At oral argument, however, all

parties agreed that. the proceeding should have no ef-

fect upon our review, and we now agree.27 Above all,

we do not view the new proceeding as ‘a “‘confession

of error” by the Conimission as the producers have

invited us to do. It is true that the Commission now rec-

Ognizes the ‘possibility of a serious supply deficiency

and that it did not recognize this possibility in the deci-

sion we are reviewing.28 This awareness, however, '

and the Commission’s prompt action upon jit, militate

in favor of affirmancé rather than reversal. The new :

proceeding is evidence of the Commission’s ability to

adapt the regulatory process to changing circum-

stances. We conclude that the indications that there

is a supp?y deficiency should be examined in this

second-round proceeding before the Commission. The

of December 15 enlarged that proceeding to include the entire

area.

27The maximum rates that the Commission has set, in addition to

* the moratoria, are to remain in effect throughout the new pro-

ceeding, which may last for years. Moreover, it was never

contemplated that there should te a single area_ proceeding

setting rates once and for all; rather the Commission has al-

ways made it clear that it intended to review the rates it had

set whenever the circumstances made it advisable to do so.

See note 24 supra.

28See section III D infra.

es -AUSTRAL OIL, ET AL v. F.P.C.

-_ evidence that there is a deficiency seems very strong,

but given the Commission’s actions we are convinced

that it can now deal with the problem as effectively

as present circumstances will allow. ~~

At this point, we proceed into analysis of the specific

arguments made by the consumer interests on the one

hand and by the one s on the other.

II. THE CONSUMER ARGUMENTS

There are three main arguments: advanced by the

intervenmg parties on this appeal. First, these parties

contend that the Commission ov erstated certain of.its

calculated costs. Second, they argue that the record

does not furnish substantial evidence to justify a rate

of-return as high as 12 percent. Thirdly, they “argue

that the Commission committed reversible error in

adding noncost factors to a rate based upon’ the costs °

(including return) it had computed. We take up the

consumer issues in this order. .

A. The Commission’s Cost Determination

The consumer interests contend that the Commission

overstated -production operating. expense for old gas

by excluding casinghead gas, which is cheaper to

produce, from consideration.’ vd They also attack the

‘29About fourteen percent of gas produced. in eine Louisiana

is casinghead, and the Commission, states that “we are well

aware that its indicated cost is substantially below that of

gas-well gas.” The ADG has calculated the difference in cost

~ at about 3 cents. Assuming this figure to be correct (which we ©

cannot really assume because joint costing of oil and gas is

. ‘

re an

AUSTRAL OIL, ET AL v. F.P.C. 19°: .

Commission's allocation. of expleration “and develop=--

=“ment Costs between oil’ and casinghead gas where oil

and gas are discovered together.3° They attack the

judgmental), the inclusion. of casinghead gas into the compu-

tation of costs for the first vintage would result in a. total

decrease in first-vintage price from 18.5. cénts to approximately

18.3 cents by our calculation, ora difference of just over one

percent. Especially in view of the cost-computation structure

as a whole, which has frequently involved the .Commission in

the approximations of interpreting joint costs, we consider

this‘ amount de minimis, even conceding its accuracy. But

our rejection of. this argument is based upon more funda-

mental considerations. The assignment of costs to products

jointly produced, as are oil and ‘casinghead gas, is not an

.exact un§ertaking, and we think the Commission has acted

onthe basis of substantial evidence, particularly since it has

set a rate structure under which casinghead gas of all vintages

_ is assigned the lowest price, that of first vintage. The Supreme

‘ Court approved a similar calculation in Permian. Cf. ICC,

Bureau of Accounts, Statement No. 4-54, Explanation of Rail

Cost Finding Procedures and Principles Relating to the Use of

Costs, Ch. 1, pt.4 (1954)¢ ,

30It seems clear that oil, which is more valuable than a volume

of gas of the same heat content, should bear more of the ex-

ploration and development cost. The Commission, as its first

step in assignirig these ‘costs, determined a ‘unit-by which gas

‘and oil could be compared: the amount of each that is re-

quired to produce a Btu of heat. It then determihed what it

called the “economic factor,” which is the number of gas units

that equaled in value a unit of oil. By strict:computation, the

Commission arrived at an economic factor of 4.0. This factor

would have indicated the assignment of four times as much

of the cost to oil as to gas. It then adjusted this factor to

3.5, however, to allow for the fact that revenues from flowing .

gas should be expensed against present ‘drilling, which is under-

going a continuing shift away from searches directed solely at

discovering oil toward searches ig eee: at finding gas. ‘We

_think it is feasonable for current evenues from: flowing -gas

to be compared with current expenses in exploration for new

gas. Thus the Commission adopted an allocation that assigned

h’gher costs to exploration for gas than would its straight cal-

culation, but it justified this modification by a qualitative find-

ing that is based upon substantial evidence.

20. , ° AUSTRAL OIL, ET AL v. F.P.C.

allowance for “plant gathering,’ or short-distance

- pipelining from ‘wellhedd to the producer’s plant for the

purpose of extracting salable liquids.*' Finally, they

contend that the Commission: understated: the credit

for salable liquids extracted from the gas stream,

which is subtracted from.gas préduction costs.32 We’

consider each of these matters in footnotes appended |

hereto.

~ On the whole, we » find each of these cont criticisms

defective for one or both of two réasons. First, they

deal-mainly with amounts: that are small compared to

the accuracy that can be expected of computations of

. —_ consumer interests argue that these plant gathering costs

shoutt rather be assigned to those salable liquids, since they

are incurred in producing them. On rehearing, the Commission

indicated that the allowance might have been overstated slight-

ly, but that “. . . the entire allowance is only 0.33 cents. The

amount of possible excesses doe’. not ‘seem worth the burden

of further hearings on other allocation methods:’ The Com-

mission indicated that a significant portion of the 0.33 cents

is chargeable against gas because part of the liquid revenues

do not go to the producers at ali but rather are paid to the

leasehold, reducing its cost. Another significant. part is also

chargeable to gas, because transportation to a plant is usually

done in furtherance not only of liquid extraction but also of

moving the gas stream itself closer: to the centralized point

at which it, must be delivered. Therefore,” we agree with the

Commission that possible excesses in the 0.33 cent figure,

which is itself less than 2 percent of the total price, would

_be de minimis, and we hold that the a gathering allowance

is based upon substantial evidence.

32They argue that the credit of 3.5 cents for lease-extracted liquids

and that of 0.50 cents for plant-extracted liquids is too low.

The Commission calculated the lease liquid credit at 4.18 cents,

but it reduced this figure to allow for a trend of decreasing

revenues from these liquids. It reduced the plant liquids credit

from a calculated 0.75 cent to 0.50 cent to allow for a dupli-

cation of credits elsewhere. These actions are supported by

‘substantial evidence.

AUSTRAL OIL, ET AL v. F.P.C. >!

this nature.33 Secondly, and more importantly, they:

place too much emphasis upon abstract manipulation

of figures. There is nothing in the substantial evidence

rule that prevents the Commission from performing *

calculations . based upon neécesSarily imperfect as-

sumptions when it explains the reasens ‘for those as-

sumptions. Likewise, there is nothing to prevent it i

from re-examining and adjusting the result of a calcula-

tion based upon imperfect premises, provided it justi-

fies its actions eer of the record.34

B. The Rate of Return

Next, the consumer interests argue that the Com-

mission acted arbitrarily, discriminatorily, or without:

substantial evidence in establishing a rate of return

as high as 12 percent. The argument appears to be

based upon the fact that the “special circumstances” |

33A generous reduction-for all four cost criticisms considered here,

if all of them were ‘accepted, would certainly not exceed 1.5 ._

sents. Commissioner Carver, on the other. hand, indicates rea-

sonable changes that could result in an increase of 4.0 cents,

if all were adopted, in his dissent to the opinion on rehearing.

See note 85 infra. The inherent, unavoidably approximate na-

ture of rate regulation under legislative standards: has been

noted by ‘both econoniists and courts, including the Supreme

‘Court in Permian, 390 U.S. at 790, 88 S. Ct. at 1372°n. 59; see

also J.. Bonbright, Principles of Public Utility Rates'27, 67

(1960), Of course, the inaccuracy of pricing techniques is one

* reason why the FPC is required separately to determine the

consequences of its pricing actions. See section III (D) infra.

34Provided it meets other requirements of law, the Commission

may employ any “formula or combination of formulas” it finds

appropriate. It may “make the pragmatic adjustments which

may be ¢alied for by the circumstances.” FPC v. Natural Gas

_ Pipeline Co., 1942, 315 US. 575, 586, 62 S. Ct. 736, 743, 86

L.Ed. 1037; see also Permian, 390 U.S. at 800, 88'S. Ct. at 1377.

22°. AUSTRAL OIL, ET AL v. F.P.C.

cited in’ Permian as justification for the 12 percent

rate of return: — namely, that the gas was frequently

of inferior quality so that the return was likely to be

lowered — are not present in Southern - Louisiana,

- where, nearly all of the gas is of high quality.35 Al-

~~.

ternatively, it is baSed upon the contention that the

Commission did not: comply With the “comparable ~

earnings” test of FPC v..Hope- Natyral Gas Co., 1944, .

320 U.S. 591, 64S. Ct. 281, 88 L. Ed. 333.

We are not impressed with the argument that cir-.

cumstances present in, Permian are not present here,

because even if, arguendo, we concede the relevance

-. of this proposition,:we find circumstances not present

in Permian that are important here. The Southern

Louisiana area is a crucially important gas-produc- .

ing region in which new exploration needs. especially

to be encouraged: A great portion of the discoverable

reserves of gas can be found without a significant rise

in unit costs is premised’ in part upon the increasing

use of new technology,?® and the need to adapt produc-

35We: recognize possible validity in the consumers’ argument that

Cemmission reliance on such matters as hurricanes in fixing -

It might have been more appropriate to treat these matters

as above-the-line costs (refletted, for example, in .in nce

premiums) rather than as a risk upon which one obtains re-

‘8 12 percent rate of return for Southern Louisiana is omg

turn. Permian, however, indicates that arguments of this type

should be addressed to the discretion of the Commission. 390

U.S. at 811, 88 S. Ct. at 1383. Furthermore, we do not need

.to rely heavily upon these factors, because the, Commission

‘has advanced other justifications for the rate of return.

36See 3 Joint Appendix, pt. 1, at 239d (Initial Decision). ‘The Com-

mission relied heavily upon the examiner’s findings in fixing

the rate of return. :

“gas. in the area is far offshore. The finding that new —

~~ AUSTRAL OIL, ET AL v. F.P.C.- 23

tion to a constantly changing technology involves risks

that definitely justify a high rate of return even for an

industry taken as a whole.37 Furthermore, the possibil-

ity of a supply deficiency, a possibility that has become

stronger during the pendency of this review, strength-

ens. our conviction that*substantial evidence supports

_areturn as high as 12 percent. pees: ‘

Nor do we find any merit to.the argument thatthe.

Commission failed to apply the comparable, earnings:

test correctly.2¢ In discussing the required rate of re- Me

Aarn, the parties varied in their recommendations from

9-9.5. percent (presented by consumer interests) to |

20-24 percent (presented by the Hunt Oil group of

producers).3® The Commission considered all evidence,

37See G. Stigler, Capital and Rates of Return in Manufacturing:

Industries 90-91 (1963); ¢f. J. Galbraith, The New Industrial

State (1967). ' bore Sy ry ee

38We note at the outset that the Commission -is not required to

compute rate of return on the basis of the comparable earn-

ings test. The Permian decision states that “other tests might

- properly: have been employed.” (The Court cites ‘with ap-

parent approval the examiner’s discussion of rate of return in

this yery case, the’ Southern Louisiana proceeding). 390 U.S.

at 805, 88S: Ct. at 1380 & n. 1; see also J. Bonbright, supra,”

note -33, at 240-83. However, we review the Commission’s de- ©

cision under. the comparable earnings test because that is the

standard it evidently followed. eae ae .

The test has been formulated as follows: Return should ‘be.

“equal to that generally. being made at the Same‘ time and in

-the same general part of the country on investments -in. other

business undertakings -which: are attended- by corresponding

risks and uncertainties.” Bluefield Water Works. & Improve- ;

_ ment Co. v. PST, 1923, 262 U:S. 679, 692, 43 S. Ct. 675, 679, 67

L.Ed. 1176; FPC v. Hope Natural Gas Co., 320: U.S. at 603, 64

S. Ct. at 288. ae ;

39The Amerada group of producers argued for a 16-18 percent _

rate of return. The FPC Staff recommended 9.5 percent. and

asserted that 12 percent “can well be considered as in excess

24° | AUSTRAL OIL, ET.AL v. F.P.C.

- then made its determination by abstracting the rate

of return earned by a group: of unintegrated gas pro-

- ducers over the years 1958 to 1962.4 It adjusted this

figure slightly, in ways that it thought appropriate, to

allow for possible inadequacies in its data. base.4* The

_Commission chose unintegrated gas producers be-

cause it quite reasonably decided that these companies |

would he most representative of the risks the industry

was facing, and it chose the period 1958 to 1962 be-

cause that. was the most recent for which the record

_ furnished reliable data. In light of the standard of re-

view, which is whether the Commission’s findings are

supported by substantial evidence, we are, particularly -

unimpressed with the’ argument of one intervening

party that the .FPC “erroneously failed to consider

relevant ‘evidence.” There is substantial evidence to

support a rate of return as high as 12-percent, and the

. Commission properly applied the test axpresked in

Hope. “8

_ of the upper limit of the range of reasonableness.” See 3 Joint

_ Appendix, pt. 1, at 164d, 173d, 185d, n. 1. (Initial Decision).

- 40See 4 Joint ‘Appendix, pt. 1; at 567d-74d (Commission’s Opinion).

41“'Wile recognize that the limited available data on non-integrated

companies reférs to a few unusually successful producers. Also,

earnings-book ratios of integrated companies deserve to be

given some weight.” Id. at 573d.

42The comparable-earnings standard is a general one, edisemgncsing 78

several indicia of earnings and requiring both ability to attract

’ capital and a fair return on equity. Williams v. Washington

Metropolitan Area Transit Comm., D. C. Cir. 1968, 415 F.2d

_ 922, 933. Certain types of computation are unacceptable, see

_ Id at 970 & n. 294, but the Commission has broad power to

select the evidence upon which it should rely..We find that

the Commission was obviously attempting to apply. the com-

parable earnings test. The sole questions it struggled with

were what companies’ risks were comparable and what the

earnings of those companies were. Its choice of evidence is

reviewable under the substantial evidence standard. :

A -*

AUSTRAL OIL, ETALv.F.P.C- —— 25.

; ,

/C. Noncost Elements in the Computed Prices:

| ~ \ , oe

As was previously mentidned, the Commission added

Small noncost elements to \several of its maximum

rates. It incredsed the second vintage ceiling by 0.7

cent over cost, the third vintage ceiling by 1.2 cents, |

and the ceiling on all offshore gas by an. additional

0.8 cent.4* The consumer interests attack these in--

crements vigorously, destribing them as “cushions,”

“bonuses,” “lagniappes,” and other: labels implying

‘that-the producers are the object Of open, unvarnished.

FPC generosity. They cite’ authority purportedly to'the -

_ effect that a‘ public utdlity cannot. add noncost elements

to a cost-based rate, relying heavily upon the recent

_en bane decision of the Court of Appeals for the District \

of Columbia Circuit in Williams. v. Washington Metro-

' 43We are singularly unimpressed with. the characterization of this -

offshore factor as a “phantom tax” by. both the MDG and the

New York Commission. These parties begin by stating that the "

computed cost difference between offshore and onshore is 2.3

cents (the amount of the.Louisiana severance tax), go on to

show that the, Commission’s ceiling for offshore is only 1.5

cents, and from this.conclude that the Commission has allowed

0.8 cent for “phantom” taxes inapplicable to offshore, which

is outside Louisiana’s taxing jurisdiction. The conclusion is

the baldest of sophistry, for the 0.8.cent allowance has nothing

to do with the. Louisiana tax. It is-a noncost element intention-

ally added by the Commission, and we consider. it as such.

It is only fair to add, however, that this sophistry was, made

possible, if not plausible, by the Commission’s failure to label

noncost factors specifically and to justify them in a way clearly

independent -of costs. It is also a product of conflicting impli-

cations in the Commission’s findings. See sections IV A (1), (4):

infra. The raising of phantom issues such as this one waste-

fully consumes. the efforts of ‘a reviewing court.-~ :

eo AUSTRAL OIL, ET AL v. F-P.C.

eolttan Area Transit. Commission, sei Cir. 1968, 415

F':2d 922.44

The Williams case is part of a heavy volume of liti-

gation concerning regulation of mass: transit ‘in the

District of Columbia. The excellent opinion of the court

of appeals deals with a number of issues that are re-

manded to the Transit Commission. The issue that re-

lates to our case concerns a “cushion” in the computed

“rate, of return, constituting the amount ‘the Transit

“Commission thought was “required-to enable [the D.C.

Transit System, Inc.] to-maintain a sufficient surplus’

to cover contingencies and to assure the financial

' stability of Transit.’”’45 The court concluded that a fair.

and reasonable rate of return would -itself include

. 44The main ‘thrust of. the MDG sieuient is that the Commission

failed to include adequate justification for the noncost factors

in its opinion, an argument with which we would be inclined

to agree were it not for the newness of ‘area regulation. See

Colorado-Wyoming Gas Co. v. FPC, 1945, 324 U. S. 626, 65 S. Ct:

850, 89 L.Ed. 1235; United States.v. Carolina. Carriers Corp.,

1940, 31 U.S. 475, 62 S. Ct. 722, 86 L. Ed. 971. This is a pro-

cedural issue crucial té appellate review. See — 110-11 infra

and accompanying text.

} 45All other issues remanded ‘to the Transit ‘Commission were so

treated because of a lack of required findings, but the court

disapproved completely the cushion in the rate of return. The

Transit Commission had included the amount because of the

possibility that its-‘‘conservative” cost and revenue findings

_ might be inaccurate. ‘It expressed a ._ preference for adding a

* . cushian above’ costs to cover this possibility rather than allow-

ing for it in its cost: findings because adjustment in cost find-

ings would be compounded by .the - addition of return. The -

court did not dispute this proposition, which indeed is indis-

putable, but stated that “{nlotwithstanding the uncertainty that .°

attends.all prophesy, a regulatory agency is bound ‘to. make

its forecasts as’ accurate as it possibly can, and a reviewing

‘court is entitled to assume that it has done so.” .

__ AUSTRAL OIL, ET AL v. F.P.C. 27

assurance of financial stability and that under the

circumstances the return added to costs was all that

- the Transit Commission should have allowed.

_.Even if we were to construe this case as broadly dis-

approving noncost. elements, the application to the

sprawling, wildcatting gas producing industry of prin-

ciples developed: in regulating bus and telephone com-

_ panies would require major adjustments.*® But this is

not the extent of our disagreement with the argument

advanced by. these intervening parties. We do not un-:

derstand the law of industry regulation, including the

Williams case,47 to prohibit noncost. elements that are

46The gas industry is different from metropolitan transit in that

; - it requires a constant infusion of entrepreneurship of the. high-

est order if even basic public needs are to be satisfied. Thé |

D.C. Transit System will continue to operate even if the re-

turn its investors expect in a given year is poor, because it

is a true public utility subject to the orders: of the Transit -

Commission. Its service may not be of the best quality if

. . rates are too low,-or, more importantly, its owners may have

fi Constitutional claim against the Government, but the public

will not be irreparably injured. Ori the other hand. we count

upon persons who ‘carefully weigh investment risks for our

supply-of natural gas. We think the Commission here, having

ealculated the dangers involved in allowing the gas supply

. to lapse; and the probabilities that its estimates might be too

low, is justified in having added’ the small noncost factors it

thought were necessary. It found that it needed to do so. to

protect the public interest-and not to assure any rights of gas

producers. However, as the Williams case indicates; the use

of noncost factors to allow for possible’ inaccuracies is not

_ favored. Inaccuracy, if that is really the*concern (and not higher |

costs), can result in a windfall to producers as easily as in a

loss. See note. 47 infra. We approve the use of noncost factors

for this purpose undef the facts of this case only.

47Williams is distinguishable from our case in several respects;

it is so clearly so, in fact, that we feel justified in concluding

that it is based not on disapproval of noncost increments but

28. .. AUSTRAL OIL, ET‘AL v. F.P.C.

based upon appropriate grounds. In Permian, the Su-

preme Court unequivocally stated that the FPC is not

bound by the sum ‘of cost. and return .even if it adopts

costs as the primary basis of its calculations.4® The

most persuasive reason for this rule is that cost pric-

ing is circular, Past production has taken place at a

given level; if a regulatory body fixes prospective

prices at the cost of that production, it may be freez-

ing the level of production, too.*® We think that the

need for dramatically increased production from Sou-

thern Louisiana justifies the noncost factors added

here, and that the FPC has power to include noncost

elements that reflect its assessment of the need to use

price as a tool to influence such economic relations.

These are propositions that apply generally to regu-

lation of utilities and quasi-utilities.

The Commission explained the reasons for its non-,

cost additions as follows. The ‘0.8 cent cushion added

to offshore gas prices Was a reflection of the growing

importance that offshore will have to assume if future

development of reserves is to meet demand and also

upon disapproval ‘of egregiously -inattentive regulation. The

cushion had been added ostensibly to allow for inaccuracies

_ in cost computations, but the court found that as the compu-

tations had been made any inaccuracies would lie on the side

of generosity to the Transit Company. Moreover, in earlier

years regulation by the Transit Commission had allowed, in

reality, a return of equity of 21 percent for the Company, as

versus a “comparable earnings” return computed at 7.5-8.7

percent. The Transit Commission had made no findings as to

comparable earnings. 415 F.2d at 936-37, 973-74.

48390 U.S. at 815, 88 S. Ct. at 1385 & nn. 97-99 °

49This argiment is widely accepted; indeed, it was cited with ap-

proval in Permian. See Id. at n. 99 and authorities therein

cited. Ane

AUSTRAL OIL, ET AL v. F.P.C. 29

of the unavoidable uncertainty of cost data concerning -

offshore, since offshore drilling in deep water is a rel-

atively new undertaking.£° The noncost increments

on. second and third vintage gas prices were cushions

against the possible adverse effects of cost changes

or inaccuracies during a lengthy price ceiling freeze.5!

The Commission found that price stability over a

_ longer ‘period of time would be more in the public in-

terest than a rate that was lower by a few percentage °

points, and we conclude that. the length of these pro-

ceedings by itself furnishes’ substantial ‘evidence t6

support this finding. We have no hestitation, moreover,

in holding that this purpose is an appropriate one for

inclusion of noncost élements in: a ‘cost-based. price.52

However, the Commission’s fulfillment of its proce-

dural duty.of making findings leaves much to be de

sired.5? In view of the Commission’s failure to relate

50These considerations are in apparent conflict with the Com-

mission’s finding that “it has not been demonstrated that the

unit cost of gas is greater offshore than onshore.” 4 Joint

Appendix, pt. 1, at 622d. The Commission could have recon-

ciled this conflict by indicating, for example, that it had some .

reason for thinking costs ‘might be higher: or that the new-

ness of the undertaking and. the consequent unavailability : of .

cost data was itself a risk justifying a higher return.

51This finding should have been discussed in light of the Com- ‘

mission’s finding that costs were unlikely to rise. Evidently

the Commission recognized some probability that costs would

rise slightly, and the amount of the cushion is tied to this prob-

ability — but the Commission’ has not exposed its reasoning.

52Cf.390 U.S. at.815, 88 S. Ct. 1385, n. 98. : 5

53The Supreme Caurt affirmed in Permian, however, while being

- forced to read the Commission’s mind even more than we. are.

_ The Commission there had said that ‘no [noncost] adjustments

_ are required in the Permian Basin.” 34 F.P.C. at 207. But the

Supreme Court found that the Commission had actually used

four separate types of noncost factors and had justified each.

390 U.S. at 815, 88 S. Ct. at 1385 n.98, | ce |

30. . AUSTRAL OIL. ET AL v. F.P.C.

its noncost additions to specific probabilities concern-.

ing influences upon supply or to make any showing

as to the demand they are needed to meet,54 we are

hesitant to sustain the use of these increments and

do so only because the Commission is still in the ex-

perimental stages. of area regulation. We shall have

more to say about these deficiencies. below. At this

point, we emphasize the fact. that the Commission has

‘justified the noncost factors by reference to considera- -

tions that ostensibly affect not private but broad public |

interests.55 . |

_We conclude that the: arguments ieAcnce by these

intervening parties are without merit.

Il. THE en ARGUMENTS

The producers present the following four major

_ arguments. to this Court: First, that the moratoriums

“are unlawful; secondly; that the Commission failed to

’ follow the comparable earnings test in | assessing a

4Noncost factors will often in the ultimate analysis relate to these

market variables, although there are other possible justifica-

tions for’ them. Where noncost elements are used to relate

supply and demand, the level of each and the relationship be-

tween them must be explored. Here, adequate supply, even

though the Commission has not examined it, is obviously a

major - -consideration lurking behind the noncost additions,

expressed in the Commission’s frequent allusions to the “im-

portance” of the Southern Louisiana area. A finding as to “im-

portance,”’ without any identification of or discussion of the

specific characteristic of the region that is important, is of little

benefit to a reviewing court. %

55See note 46 supra; cf. note 47 supra.

AUSTRAL OIL, ET AL v. F.P.C. 31

rate of vetirn. as low as 12. percent; thirdly, that the

Commission’s cost determinations are unlawful or

erroneous; and finally, that the Commission failed to

make the findin igs necessary to relate supply, demand

/_ and price according to the “end result” test.of the Hope

and Permian cases.’ We take up the issues in this or-

der, with particular emphasis on the Supply problem

presented in the last argument.

A. The Moratorium Provisions ©

The producers’ attack on the moratoriums is based.

upon the fifth amendment to the Constitution, the Nat-

ural Gas Act, the Administrative Procedure Act, and

factual issues pertaining to the case. In Permian, as

we have noted, the Supreme Court affirmed the Com- >

-mission’s imposition of a two-and-one-half year niora-

torium on rate filings in excess of ceilings. However,

it did so only for the limited circumstances before it,

and left the question of longer moratorium legality

almost completely open: ee a

We cannot, given the apparent stability of

production costs, the Commission’s relative ”

inexperience with area regulation, and the ad-'

ministrative burdens of concurrent area pro-

ceedings, hold that this arrangement was im-

permissible. We need not’ attempt to prescribe

the limitations of the Commission’ s authority

under §$ 5 and.16 to impose moratoria upon

§ 4(d) filings; in -particular, we intimate ‘no

views on the propriety of moratoria created

32 AUSTRAL OIL, ET AL v. F-:P.C.

in.circumstances of changing costs. These and

other difficult issues may more properly await . .

‘both. clarification of the Commission’s -inten-

‘tions and the hecessities of the particular cir- ~

/ cumstances. We hold: only that. this relatively

brief moratorium did not, in the circumstances

here presented, exceed or abuse the Commis-

sion's authority.5®

Consideri ing this language. we think it incunihent upon

this Court to meet the produgers’. arguments against

these lengthier moratoriums. as undecided questions.

At the outset, we find little merit to the producers’

' Constitutional complaints. The possibility that they

may be depri ived of property without due process of.

law is speculativ e. and remote, a and if such a depriva-

tion occurs both courts and Commission will stand

ready to remedy it. For the present: we find ng such

deprivation. Economic regulation under the commerce

power, affecting an industry generally, is not a taking

of property if the value of property is thereby reduced

or business risks increased.5? The producers have a

56390 U.§. at 782, 88 S. Ct. at 1367 ee ae added).

57No constitutional objection arises from the imposition of maxi-

mum prices merely because “high cost operators may be more

seriously affected * * * than others,’ Bowles v. Willingham,

supra, 321 U. S. at 518, 64 S. Ct., at 649, or because the value

of regulated perty is reduced as a consequence of regula- -

tion. FPC vf Hope Natural Gas Co., supra, 320 U. S. at 601,

- 64 St. Ct. at 281; Permian, 390 U.S. at 769, 88 S. Ct. at. 1361.

See also West Coast Hotel Co. v. Parrish, 1937, 300 U.S. 3791,

57 S. Ct. 478, 81 L. Ed. 703; Nebbia v. New York, 1934, 291

U.S. 502, 54 S. Ct. 505, 78 L. Ed: 940;:Munn v. Hlinois, 1877,

94 U.S. 113, 24 L. Ed. 77.

AUSTRAL OIL, ET AL v.F.PC 33

fifth amendment right not to be forced to sell or sur-

render their property without either, due process: or

just compensation, but the Constitution gives them no

right to raise prices irrespective of Commission aj-

2 . proval in the absence ofa deprivation of property.

Similarly, we find no merit to the producers’ argu-

ment under the Administrative Procedure Act.5®

The moratorium provisions were validly promul-.

gated after adequate. notice , when the rate proceed-

ing began.5° With these’ considerations disposed of,. we

turn to the-more difficult questions -presented under

the Natural Gas Act. =

The procedure €oritemplated by Section 4 of the Nat- -

ural Gas Act®° is designed to protect sellers from the

made upon formal hearing and riot upon the’ “informal” pro-

cedures established here, and second, ‘that the issuance of the

moratorium order. was not preceded by the publie notice re-

quired by section 4(b) and other sections of the APA. The

answer to the first argument is that the instant proceeding is

the rate order required to comply with sections 7 and 8; we

_ do not think these sections apply to the decision whether to

grant individual relief after the just and reasonable rdtes have

been set. This is the clear import of the Permian approval of

group regulation. See 390 U.S.’at 744, 88 S.Ct. at 1364, ° dis-

tinguishing Bowles v. Willingham, supra. The second argument

garding the commencement of area proceedings, and the notice

IN.our view was sufficient to inform all parties that ancillary

regulations would be considered. 26 Fed. Reg. 4296 (1960).

6015 U.S.C. § 717c (1963).. eg

4\ i ‘

34 AUSTRAL OIL, ET.AL v. F.P.C.

possibility of. property deprivation through confisca-

tory rates that might not be increased ‘quickly enough ':

under ordinary hearing procedures. Section 4 provides

that . “Cujnless the Commission otherwise. orders,”

a natural gas company must file a notice of rate in-

crease thirty days before the effective date if it in-

creases its rate unilaterally, The Commission may sus- :

pend the rate increase for a period of no more than:

five months, during which time it must begin hearings

to determine whether the increased rate is just and

reasonable. If the hearings ‘are not completed by. the

end of five’ months, the gas company may collect ™

the increased rate subject to refund. Limited en-—

croachments upon this procedure have been permitted

the Commission when they were necessary to-effectua-

tion of other requirements of the Act, the most not-

able being the » Supreme Court’s approval of. the Per-

mian gis a 61 :

In apieidevioe the legality of moratorium provisions

generally; we begin with the proposition that under

section 5(a)®? of the Act the Commission may deter-

mine rates and prescribe the “rule, regulation, -prac-

I ‘

Xs °

6!1The Court in Permian also approved Commission orders of in-

- definite duration prohibiting increases above maximum rates

brought about by flexible. pricing clauses. 390 U.S. at 782-83,

88 S. Ct. at 1368- 69. See also Atlantic Ref’g Co. v. FPC, 1959,

360 U.S. 378, 79 S. Ct. 1246, 3 L. Ed. 2d 1312 (approving pros-

pective ceilings on price in section 7 proceedings); cf. United ©

Gas Improvement Co. v. Callery Properties, Ine., 1965, 382 U.S.

22, 86 S.Ct. 360, 15 L. Ed. 2d 284.

6215 U.S.C. § 717d(1963). Moreover, section 16'of.the Act, 15 U. S.C.

-§ 7170 (1963), pve the Commission power ‘‘to perform any and

. AUSTRAL OIL, ET AL v. F.P.C. ~ 35

tice, or contract to be thereafter observed.” Thus sec- - -

, tion.4 does not give producers an “invincible right to_

raise prices subject only toa six-month delay and re-

fund liability.’®? ‘The section provides. only, that “a

change cannot be made without the proper notice to

the Commission; it does not say under what. circum-

stances a change can be made.”¢4 Thus the Commis-

sion is not required to follow the procédure that sec-

tion 4 contemplates for each individual producer.

Moreover, once a’ just and reasonable rate has been

established, the Commission has a responsibility to

prevent rate increases in excess of that rate without |

changes in circumstances:, The Supreme Court recog-

“nized this Commission responsibility with regard to

gas producers inthe Phillips‘and CATCO cases, and it

recognized that the Natural Gas Act contemplates FPC ,

power to carry out ‘its: purposes realistically.6® If the

Commission is to. discharge its duty of regulating pro-

duction, it must use -the area rate ‘ceiling method or.

some analogous industry wide approach. It cannot reg-

ulate individual .producers ‘simply because the strain

that approach would.put upon its time and resources

would be. prohibitive. And moratoriums are necessary

- if the area regulation method is to work at all. Uni-

- all acts, and to prescribe, issue, make, amend, and rescind such

orders, rules, and regulations as it may find necessary or ap- .

propriate to carry, out the provisions of this chapter.”

- 63United_Gas Improvement Co. v. Callery Properties, Inc., 1965,

- 382 U.S. 223, 232, 86 S. Ct. 360, 365, 15- L.Ed. 284 (separate

opinion of Mr. Justice Harlan). =“ Dear “5

64United Gas Pipeline Co. v. Mobile Gas Service Corp.,.1956, 350

U.S. 332, 339, 76 S.Ct. 373, 378, 100 L.Ed. 373. at

65See notes 5-13 supra and accompanying text.

'36«2©=| CAUSTRAL Oly, Bt At < EEC |

lateral producer price increases in excess of the “ail

ings would otherwise involve the Commission immedi-

‘ately in the task of détermining whether each increas-

ed rate was just and reasonable in terms of the finan-

cial position of each individual producer, which is pre--

cisely the problem the Commission -faced before area

regulation and so badly needs. to avoid,®* By putting

a ceiling on rates in. such a manner that ‘the ceil-

ing is likely to cover the just and. reasonable rate for

a-number of years, and imposing a moratorium ‘that

lasts no longer than the period that the ceilings are

likely to be adequate the Commission can discharge its

’ regulatory responsibilities with minimum encroach-

ment on the salutary procedures contemplated by |

section 4.87

66Certain of the producers urge that §§ 4 and 5 must in. combina- .

tion be understood to preclude moratoria upon filings under

§,4¢d). They assert that the period of, effectiveness of a rate

determination under § 5(a) is limited, by § 4(e); they reason

that § 4(d) creates an unrestricted right: to file rate changes,

and that such changes may, under § 4(e), be suspended for a _

period no longer than five months. If this construction were

-agcepted, it would follow that area proceedings would termi-

. nate in rate limitations that could be. disregarded by pro-

-ducers five months-after their promulgation. The- result, as

‘the Commission observed, would be that “the conclusion of

one area proceeding would only signal the beginning of the

next, and’ just and reasonable rates for consumers would al-

; ways be one area proceeding away.” 34 F.P.C., at’ 228.

390 U.S. a¥781, 88 S. ct. a 1367. Phe same conditions, of course, are

present here. .

67It is to be. eee em that .the moratorium provisions ‘do not

prohibit increaseii rate filings..They prohibit rate filings in...

excess of the ceilings. These ceilings are A maximum prices

that the Commission feels can be considered just and rea-

sonable. The Commission has added noncost increments to the

rates that ponent the greatest danger = inadequacy, and it

€ 7

AUSTRAL OIL, ET AL vy. FP.P.C. |. 37

It remains to consider whether the moratoriums ac- | .

‘ually imposed here are factually supportable — wheth-

er they are in fact. reasonable and based, upon substan-

tial evidence. Our discussion,above indicates that these

factors should be examined in-light of two considera-—

tions: First, whether the moratoriums as. ordered

are necessary to effective area regulation, and second,

whether substantial evidence indicates that they are‘

unlikely to result in inadequate ceilings later in their

_duration.*® If moratoriurns may be approved in prin- -

ciple, we have ‘little. difficulty in approving a mora-.

torium of five years under the circumstances here. In

- Permian, the two-and-one-half year moratorium. was

exhausted before. the Commission’s order Was finally

affirmed by the Supreme Court.®® To prescribe a mor-

atorium of.five years on a finding that’ stable prices

for the ar€éa are desirable, we think, is within the ’-..

discretion ‘of the Commission, especially when the

procee ing to establish ‘those.rates has been longer:

than “five years ‘and appeHate-_review promises to

lengthen ithe period substantially. A five-year mora-

has nediiding avenues of extraordinary relief, both industry-

wide and on. an individual-producer basis, whereby the mora--

toriums may be: lifted. We do not.think that the moratorium

‘ provisions; which are necessary to the area regulation process,

“write section 4 out of the: Act,” as; the producers have con-

- tended: oa ae

S8These two considerations can also be extracted from the follow-

» ing Permian language: “We cannot, given the apparent stability

of production costs, the Commission’s relative inexperience With

area regulation, and the administrative burden of concurrent’

area proceedings,-‘hold that this [ moratorium] arrangement

was impermissible.” 390 U.S, at 781, 88 S. Ct. at 136%.

69 Moreover: the .Tenth Circuit had stayed the moratorium order’

7 “

and it consequently had no effect at all throughout its dura-

tion. 390 U.S. at 777, 88 S.Ct. at 1365. re =

38° ~~ AUSTRAL OIL, ET AL v..F.P.C.

torium in this case is also justified by the Commis-

sion’s observance of recent trends and its conclusion

. that costs are remarkably: stable or even slightly de-

‘clining. This finding, together with the -noncost fac-. ¢

tors, makes it reasonable to conclude that. the rates

will not in the future become unfairly low provided |

they are set. at just, and reasonable levels now. Of

course, the practical | ‘effect of ‘our approval of: this’

moratorium is.minimal, however, since the Commis-

sion is reviewing’all moratoriums in the new proceed-

ings,. and supply problems, if they exist, will re-

a quire quick remedies. ,

We have greater difficulty with the indefinite mora-

toriums imposed, upon first- and- ‘second-vintage prices.

Our trouble is based not qnly upon the fear that these

provisions could. some day result, in inadequate ceil-

ings — even tKhough the Commission has madé’ find-

ings based upon substantial evidence that cost increas-

es in the near future are unlikely — but also upon oyr |

apprehension that they are in excess of what is rea-

sonably necessary for area regulation to function. Con-

sequently, although we have determined that the Com-

mission should be affirmed in full, we limit our ap-

proval of the indefinite moratoriums to the circum-

stances present on this appeal. We stress the fact.that

the Commiission is holding hearings now to deter-

mine whether the moratoriums should be modified;

‘and that the result of this determination should be re-

viewed without reference to approval on this appeal.7°

; ¥ ' ;

70Specifically, considerations relating to the law of the case should

be accorded only limited significance, since experience with

area regulation may ingrease — to such.an extent as: to consti-

tute a change in circumstances.

: < |

a”

AUSTRAL OIL, ET AL v. F.P.C. 39

We also emphasize that the experimental nature of

producer regulation makes ‘us as yet reluctant to re-

_verse the Commission on a \matter which has little

present impact”! and which can be’ corrected, if ex-

“ perience shows it errgneous, in the future. These con-:

siderations, together with the Commission’s findings

and its demonstrated: willingness to use the avenues’

of relief it has provided, elicit our qualified affirmance

of the moratorium provisions. | :

B. The Rate. of Return

The producers attack the rate of return mainly on

the ground that the Commission failed to follow prop-

erly the comparable earnings test expressed in Blue-

field Water Works & Improvements Corp. v. PSC, 1923,

262 U.S. 679, 43 S.Ct. 675, 67 L.Ed. 1176, and FPC. v.

Hope Natural Gas Co., 1944, 320 USS. 591, .64 S.Ct.

281, 88 L.Ed. 333.714 They particularly claim that the.

period chosen by the Commission was unrepresenta-

tive, and present persuasive evidence to that effect.72

71Theoretically speaking, the indefinite nature of the moratorium

will assert. itself only/in the future. Practically, ‘it. will, have

. Some effect on industry expectations’ and hence industry cen-

duct. But since the new proceedings before the Commission

create expectations that ceilings may be changed, we consider:

the present effect. of the indefinite moratorium to be minimal.

71AWe reiterate, as the producers seem to lose -sight of the fact,

that the Commission is not required to compute return by the

‘comparable earnings test. See note 38 supra. ‘ ;

72The producers’ most easily comprehended presentation is a graph

over the years 1947 to 1968 of rates of return they considered

comparable. The 1958-1962 period chosen by the Commission

- is decidedly a dip in the curve, reflecting a recession during

these years. Also, the producers attack the Commission’s cheice

of companies to compare and failure-to consider evidence show-

ing a rise in earnings since 1963. Persuasive evidence, however,

40° ° - AUSTRAL OIL, ET AL v.’F.P.C.

The trouble is that we have already determined, in our

discussion of the consumer-interest contentions con-

cerning this issue, that there is also persuasive evidence

to support the Commission’s findings and the Commis-

sion followed proper legal standards. Reliance upon ~

returns earned by unintegrated ‘producers during the

datest period for which the Commission felt it had re-

liable. data was appropriate, in light of ‘the widely

divergent evidence presented ‘in this case. Producer

contentions to the contrary amount to an attack on the

Commission’s choice as to which evidence to believe.

C. The Commission’s Cost Determinations ©

' Producer attacks on the cost Computations are many |

and varied. Most are cognizable under the substan-

tiat evidence-standard. At the outset, however, we are

met with the contention that the very method of ‘cost

pricing is too imprecise to be used in regulating the

gas- -producing industry. We must reject this conten-

tion. In a situation wherein the Commission has -found

that market imperfections tend to force price to ex-

supports the Commission’s action, and we are not engaged in

finding these facts anew.

Furthermore, the rate of return even as set may be higher

than 12 percent. Noncost ‘factors, if they are viewed as addi-

tions to the return — and this is a logical way to view them,

_ Since they must go either to pay costs or to increase return

-—— would increase return -to 14-16 percent for new gas. Earn-

‘ings on equity at a 12. percent rate on capital, of course, are

higher than 12: percent because they are leveraged by debt;

. here they amount to about 13.3 percent. Finally, the producers’

argument for a 16-18 percent rate of return is defective be-

cause it includes early years in which very’ high returns — well

over 20 percent — distort the figure so that it is unreliable for

prese nt use. =i

VAUSTRAL OIL, ETAL v.F.PC. 41

cessive levels, it would be self-defeating to regulate |

on the basis of market forces, and the most logical

| “alternative is usually cos pricing. Thus. the ‘fact that,

it cannot be-made absolutely precise is not ‘grounds

for rejecting ‘Cost *pricing when market conditions

make its use advisable.73 Indeed, Some courts have

held that costs must be at least the starting point for

fixing just and reasonable rates in the gas industry.

E.g., City of ‘Detroit v. FPC, D.C. Cir.« 1955, 230 F.2d

810. Even mote persuasive is the fact that the Supreme

- Court upheld the use of cost pricing on a record sim-

ilar to ours in its Permian decision.

Similarly, the producers make a broad attack on the

use of average, rather than individual producer costs.

_ We reject this attack as the Suprerhe Court rejected

it in Permian.7* There is nothing in either the Con-

stitution or the Natural Gas Act that prevents the Com-

mission from adopting price: ceilings under which

some producers will make more money than others or

even under which some producers may be in danger of

going out of business. The gas-producing industry, as

-the producers have pointed out to us, is not a true

public utility, and one of its characteristics is the pos-

sibility of exit from the market.’5 This being the case,

we find from the record that the use of average costs,

whether it providés a fair return for all. businesses -

73Imprecision is, however, one of the reasons for the requirement

that a regulatory body: reassess its rates in terms of purpose

and consequences. See section IV A (3) infra.

74390 U.S. at 818-20, 88 S.Ct. at 138 -87. Cf. 390 U.S. at 829-38, 88

S.Ct. at 1392-97 (dissenting inher Mr. Justice Douglas).

75See 3 Joint Appendix, pt. 1, at 77d (examiner’s discussion of testi- ©

- mony and exhibits regarding rates of entry and exit).

\ .

42. AUSTRAL OIL, ET AL v. F.P.C.

or not, is lawful and based upon substantial evi-

dence.76

. In addition to these arguments, which are consid-

erably weakened by their rejection in Permian, the

producers have pressed one novel argument of a gen-

_—eral nature against the’cost determinations. They con-

tend that the use of national costs to fix the price of

- new gas in this case is not substantial evidence be-

cause national data contain. elements that seriously

distort the costing of gas in Southern‘ Louisiana. The

producers’ authority of strongest reliance is the Su-

preme Court’s post-Permian ‘decision in Baltimore &

Ohio R.A. v. Aberdeen & ‘Rockfish ‘R.R., 1968, 396

U.S. 87, 89, S.Ct. 290, L.Fd.2d . The case con-

demns the use in railroad price regulation of average ~

costs for an. aggregate region when cost elements from

part of the region may distort the calculation.77

There are several reasons, however, why we find that

decision inapplicable to the case before us. In the first

place, the use of national figures here is based in part

upon findings that these costs are the best available

76A different question would be presented if the persons regulated

were prevented in some manner from going out of business

even when revenues fell below costs.

77The Court held that: railroad rates for a wail spenatne we :

- . territories, served by two or more carriers in cooperation, can-

not be divided among the carriers on the basis of costs for both

territories taken together if the costs of lines in one territory

distort the cost findings so derived for lines in the other. In

- the absence of a finding that there is no distortion, said the

Court, the unadjusted costs for. either ‘territory or for the

whole are not substantial evidence.

_AUSTRAL OIL, ETAL v.F.P.C 43

index to costs in Southern Louisiana,7® despite inclu-

sion of areas that are not of.the same character as

this region.”® Secondly, the Commission, has found that

new exploration and development is national in scope.

The operation of a particular piece of railroad track-

age, on the other hand, is local to’ the place to be

. served; the supply of railroad service cannot be .

moved wherever it can be provided at least expense.®°

We accordingly hold that Aberdeen &-Rockfish. does

‘not modify Permian approval of national costing in

gas producer regulation and that it does not require

reversal in this case. : 2 ie. o | .

Next, we must deal with the ‘producers’ contention

‘ that the Commission relied upon stale, unrepresenta-

_ tive data in making its cost findings. The staleness

of the record is a serious problem. It is now 1970,

and we are reviewing a case in which the record be-

fore the examiner closed in 1965. It is a case setting

rates for a fast-growing, changing industry in ‘a

changing economy. The full Commission, which rend-°

ered its decision in 1968, was able to consider some

‘data covering years as recent at 1966, and even this

ae ‘

78The examiner, after extensive consideration, concluded that

Southern Louisiana costs were probably slightly lower than

those for the nation. 3 Joint Appendix, pt. 1, at 221d-31d.

78The producers contend, for example, that costs for the Hugoton-

Anadarko area are significantly lower since reservoirs are shal-

lower and should be excluded. The examiner's overall come

parison of Southern Louisiana: with national costs, however, is

more to the point. pat, ber -

s0There are limits to the movability of gas exploration, too, since

a pipeline “cannot be moved ‘around like a gardenshose.” See

E. Neuner,. supra note 9, at 282; note 101, infra; Staff Report

at 17. : : ;

44. (AUSTRAL OIL, ET AL v. F.P.C.

is data that there is’ reason to expect may already be

stale.®! Staleness of the record, however, is not it-

self a reason | for reversal. ICC v. Jersey City, 1944,

322 U.S 503, 514-15, 64 S.Ct. /i129, 1134-35, 88 L.Ed.

1120;82 see also United States b. ICC, 1970, 38 U.S.L.W.

4129, 4137. Much of the problem is attributable to the

- difficulty of the regulatory undertaking in light of the

procedures currently ‘available. Procedures must im- .

prove as the experiment of area regulation becomes

better understood. Turning to another type of stale-

ness argumerit, we are not impressed with the pro-

ducer’s complaint that the Commission chose to base

.some of its findings 6n older data than the most re-

cent-available. These choices were based upon find-

ings as to greater reliability or representativeness of

the data used.*3 Moreover, in such cases the Com-

mission did not fail to consider the most.recent data

in the record, and it adjusted its findings to allow for

rising or falling cost trends. Most importantly, it made

a’ finding that costs as a whole during this decade

had been remarkably stable (or were even? declining

slightly) and were likely to remain so, and this find-

ing is based upon substantial evidence. —.

. Having made these determinations, and having in-

spected the producer’s objections to specific cost cal-

81Compare, e.g., 4 Joint Appendix, pt. 1, at 546d (Commission’s

Opinion, calculating FP ratio at 1.37 for ‘recent years in 1966)

with Brief for Amerada Group at 17 (indicating FP ratio of

approximately 0.62 for 1968, calculated from Bureau of Mires

figures).

82It is to be noted that the Permian case, aa: was eight years. old

when the Supreme Court issued its opinion.

83See, e.g., note 72 supra.

84See-4 Joint Appendix, pt. 1, at 666d- 76d (Commission’ s Opinion).

AUSTRAL OIL, ET AL v. EPC 45

culations, we find that detailed discussion of these cal-

culations would be of little value at this point. The

producers point ‘to, and adopt in part, the dissent of

Commissioner Carver to the Commission’s opinion on

rehearing, which. raises disturbing criticisms as to’

nine .different types of cost determinations, which, if: .

they had been determined differently, could be aggre-

gated to increase the total by about 4.0 cents.85 We think

this imprecision in cost pricing is completely unavoid-

able, but the law allows the Commission to use cost

pricing nevertheless. ' Moreover, Commissioner Car- :

ver did not present his four-cent increase for general

approval, but instead stated that “it is certainly evi-_

dent that not all of the above ‘adjustments should be

accepted.” The thrust of the dissent, we think, is that

85The Commissioner’s computations. produced the following:

Item -: : Impact in ¢/Mcf

22-year depletion period ............. > 0.48¢

Time lag of 1.57 years ee ae eeAD es SEN Oe 0.28

- Drilling costs — successful wel] OP eee 0.29 »

Lease-acquisition . _ Sec eay 0.09

Return allowance log ia hs da 0.43 .

_ Unit capitalized outlay | 2 oa 0.31

Exploration and ‘development... _- fp 1.90

Dry Hole Jou eke re Leo

Liquids credit ° . 0.25

. He added ‘that “I have no idea that all or any of these figures

lengthen an already lengthy discussion (cf. notes 29-32 supra),

we find each to be supported ‘by substantial evidence.

46. AUSTRAL. OIL, ET AL v. F.P.C.

the Commission should not have relied upon: cost cal-

culations floating in a vacuum but should have re-

viewed its’ computations in light of supply, demand,

and other market forces (a proposition with which we

definitely’ agree), and should have’ given greater at-

tention to the settlement agreement proposed by sev-

eral of the parties.®* We reject the contention that cost_

pricing is so. imprecise as to make its use unlawful

and hold that the Commission’s findings here are

based upon substantial evidence. We proceed next to

the important issues of supply and market, which we

consider to be the key to the producer’ s attacks on the

imprecision of cost pricing.

D. Commission Findings d's. to the Consequences of -

Its Orders on the Gas Industry — —— The

Supply Problem

(1) Commission Findings and the cand Stand-

ards , /

We have anita the most serious issue in this case

for last. The producers contend tha® the Commission

— : e

864 Joint Appendix, pt. 1, at 1000d (dissenting opinion). The Com-

es mission¢r stated that he could not decide: this case on the

basis of any cost record. ° : -

In light of the imprecision of ‘conta, broad snpinart for the

settlement; evidence that the niarket has at least a procompeti- °

tive structure, and cumbersome nature of price regulation, it

may be that the settlement arguments advanced by Commis-

_ sioner Carver are persuasive. In this case, the settlement is

‘championed by the producers, . and before the Commission it

was supported by gas distributors (whom we classify as repre-.

. senting consumer interests) accounting for over 87 percent of

delivery volume. Id. at 1001d. Widespread use of the settle+

ment technique would result in negotiation pitting market

forces against each other on an aggregate scale, overseen by the

Commission. ;

AUSTRAL OIL,-ET AL v. FP'C AT

improperly tailed to consider projdcted consumer de-

‘mand for gas in relation to Supply and that it thus -

Violated the. “end result” test of the Hope and Blue-

field cases. These contentions are closely related® to.

the argument that the Commission’s cost determina-

tions. are imprecise, for tke “end result” test is sim-

ply that whatever method a regulatory body. uses,

the result of its effects must be demonstrably in keep-

ing with the purposes of regulation.®”? The FPC must

| evaluate each rate set against Policies as broad as

‘the Natural Gas Act itself. Colorado Interstate Gas Co.

v. FPC, 324 US. 581, 605, 65 S.Ct, 829, 840, 89 L.Ed.

1206. The purposes of the Act encompass ‘not only’

ne er

87It is-not theory but the impact of the rate order which counts.

may contain infirmities is not then important. ;

‘FPC v. Hope Natural Gas Co., supra, 320 US. at 602, 64 S. Ct. - >

at 288.

48 _ AUSTRAL OIL, ET. AL\y, F.P.C.

reasonably low rates‘ but ‘maintenancé.,of adequate

‘service for the consumer, and the latter objective is the

- reason for the Hope requirement that rates ‘aust be

“sufficient to assure confidence in the financial integ-

rity of the enterprise, so as Yo maintain its credit and

to attract capital. "ee

The bese Court, while affirming the , Commis-

sion in Permian, made it clear that adequate —

along these lines would be required in the future: “Ju-

dicial review of’ the Commission’s orders -will there-|

fore function accurately and efficaciously only if the

Commission indicates fully and carefully the meth-

ods. by which, and the purposes for which, it has

chosen to act, as well as its assessment of the con-

sequences of its orders for the character and future ‘

development of the industry.”®® P

: a . ’ } * >

IA this case, as in Pe®mian, the Commission refused

to. make findings as to overall demand for gas either

in the nation or from the Southern Louisiana area,

aid it likewise declined to estimate future supply un-

der its order. Similarly, the Commission refused to

make findings as to the advisable level of the RP

(reserves to production) or FP (findings to produc-

tion) ratios, or to agsess the consequences of its or-

88Indeed, the Hope case interprets the policy of the Act as involving

both consumer interests and the autonomous interests of the

- industry. The Commission must “balance ... the investor and

' consumer interests.” 320 U.S. at 603, 64 S. Ct. at 288.

89390 U.S. ot 792, 88 S. Ct. at 1373.

»~

Pree

boas

; . | ae “*

AUSTRAL OIL, ET AL vy. F.P.C_. 49

. ders on these ratios.9° The closest that the. Commis-. :

sion came to direct exploration’ of these problems is

in its discussion of the FPC Staff's Econometric Stud-

ies, A lengthy set of calculations based upon empirical

economic relations and designed to show how price, sup-

ply and demand. are interrelated in the national econo- ©

my. The Commission: rejected these studies as unreli-

able.°' Having rejected this quantitative approach, how-

20The Commission’s most specific finding as to demand appears to

' . be that “there seems no doubt that natural gas will be a major

and vital source of energy for many years to come.” 4 Joint

Appendix, pt. 1, at 664d. This assessment is practically use-.

less and should be made with far greater specificity in future. .

proceedings. , - -

‘The Commission also Stated that “fwle must reject the find-

ings-to-production and reserves-to production ratios as not

substantially indicative for fixing ceiling rates in this proceed-

ing.” 4 Joint Appendix, pt. 1, at 529d. But see note 122*infra.

The ratios need not have been directly considered in price cam-

putation, but the effect ‘of the price on them should have been

assessed. - == ee

21We agree that the econometric Studies were fatally defective, .° -

' for. the reasons set out in the examiner’s decision. 3 Joint Ap- ° ~

pendix, pt. 1, at 380d-408d. Their most basic ahd serious defect

is their tacit underlying hypothesis that demand will call forth .

sufficient exploration to meet it regardless of cost or profit

considerations. The: examiner oted the following argument

advanced by Amerada: oh ge 3

. .. Thus, Staff’s projections thdicate that total ex-

_ ploratory wells in 1970 will be 8,900: at the 17¢ as-

sumed national average ceiling price and with comipet-

; ing fuel prices remaining proportional. A 14¢ ceiling

‘price would yield 10,130 ‘exploratory wells while a 20¢

, ceiling price indicates only 8,380 would be drilled.

Turning to the same year and under the same assump-

tions, Staff’s alternative model suggests 624 successful]

“gas exploratory wells will be drilled in 1970 if prices

remain at current levels, with 742 at a 21¢ ceiling

‘and 581 ata 22¢-ceiling. Even more: wells are pre-

dicted to be drilled at lower ceiling prices'such as 10¢.

per Mcf. However, there is nothing in Staff’s economic

hypothesis ‘or in the exploratory equations utilized

which requires that we Stop at the 10¢ assumed ceiling

©.

«+ oe

50 AUSTRAL OIL, ET, AB v. F-PC.

Y . -

ever, thé Commission failed to approach manly and de-

‘mand i in either a semi-quantitative or qualitative way..

t . -

¢ Pa ‘ ® “

‘Instead, the Commission, made, less extensive. find-

ings ‘as to the effect of its rates. on the industry. It

feund, for example, that the costs it had caléulated

were ‘likely to remain stable for some time to come.

This’ finding is supported by substantial evidence,

sincé costs had, in the past, shown: a pattern of sta-

. bility or even a slight downward trend, and_all com-

ponents of cost, except possibly’ produetion operat-

ing expense, were shown unlikely to change signifi-

‘cantly.92 Also, the ‘Gommission found that the rate

price. Thus, the Staff equation: at a 2¢ ceiling price

would predict that the industry would in 1970 drill

268.310 exploratory wells (Ex. 156, p. 9).- ; 2 ;

.’ This, of course, is more exploratory wells than have

* been drilled in total: since 1.940. The reason for such

_ absurd results is that Staff’s exploratory equation fails

to consider any cost ¥etated to “expleration or produc-

tion; it continues to. blindiy forecast increases in’ pro-

duction due to! the supposed stimulating effect.of low: --

; _ Brice on demand.” (Amerada reply brief, pp. 21-22) .

Although we approve the Commission’s action in rejecting these

studies, we do nqt approve of its failure-to consider supply in

_\ relation to demand. It should. be pointed out that in doing so

the Commission has itself committed an error similar to Staff's.

The error is not so serious as that of utterly failing to cona

sider the profit incéntive, but the Commission has assumed,

‘without supporting findings, that the cost- -plus-return prite will

. be sufficiently profitable to elicit supply to meet demand, what-

ever the level of demand. This is circular pricing, If demand

rises and cannot be satisfied out of reservoirs that are easily

enough found to. allow the, entrepreneur his profit, demand

‘Will not be satisfied. Having found that rigorous niathematical

equations could not solve this problem, the Commission should

have confronted it in a semiquantitative or qualitative .way.

Cie 92See 4 Joitit Appendix, pt. 1, at 667d-73d. .

AUSTRAL OIL, ET AL v. F.PiC. -** +51 _

_of- return it had set was commensufate with that of -

industries with similar risks, and it concluded that

- eonsequently the industry should be, able to attract’

- Capital sufficient to satisfy demand.®® Its overall as-

sessment: of the revenues that would be produced un-

Ser its rates and their effect was as: follows: .

ee 5 et Paes ae

Annual revenue reduction from —

Gas-well ahd oil-well gas under

_ ‘pre-1961 contracts | * $ 41.4 million

_Oil-swell. gas under post- 1960 iy

-contracts ‘ $. 0.1 million

. Gas-well gas under. subsequent :

-* contracts : ~ .§ 7.5 million

\ Total . $,49,0 million

"We also estimate that under the maximum

rates here allowed ,.. [annual revenues], would S

amount to $519 million, or about 18.4 cent§ ‘per wee

Mcf.(not including sizeable revenues from con-

dénsates and entrained liquids) and that these

revenues will rise steadily... .

- In our judgment, the reventies allowed...

should foster an active exploratory program

- consistent with both the financial needs of the

industry and. the — of the public in-

terest. ies

—— ’ :

93We ‘do not think reviewing courts should-accépt such conclusion- :

ary fimdings as this after the “experiment” “justification for

affirmance no longer applies. The Commission should have

looked directly to sources and availability of capital.

944 Joint Appendix, pt. 1, at 683d.2The finding as to the total ex-

‘pected revenue is commendably specific. Howev er, a is useless S.

52 AUSTRAL. OIL, ET AL ¥. FPS

The Commission did not explain the. reasoning by which.

_ it arrived at this conclusion. Finally, the Commission -

examined the place of natural gas in the economy as

a whole and-concluded that although other energy

Sourcés are growing in- importance, “there seems .no

doubt. that natural gas will be a major and vital source

- of energy for many years to. come and nothing should

be done at this time which. would prevent the explora-

tion and development necessary to make available

this clean, convenient, economical and increasingly

popular energy source.”95

(2) The Cudvent Supply Seaiies

Despite the Commnission’$ optimistic conclusion, the

circumstances that have developed since its decision

“indicate a possibility, indeed pefhaps a certainty, that

the supply of gas is dangerously low. A serious short- ’

age, in fact, may already be unavoidable because ‘pres-

ent conditions may render any remedial action | ip-

effective in light of the lag time between remedy and

result: Thus the producers point out to us that the FP

ratio, for the first time. since World War II, shows

that findings hawe declined below production. In other: :

words, the gas industry. in 1968 took more gas out of:

the ground than it discovered. Together with a growing

_ productior curve, ‘this fact is alarming, ‘especially

since it is likely. that the FP ratio will remain below

1.0 for the” foreseeable future.2* The producers also

. :

. ° Cd

to persons not privy to the Commlssion’s expertise, because the a

Commission has <0 :+y stated a/figure floating in a vacuum

and concluded wii. ut more that this figure bis “foster an

actiye exploratory prog wm.’

954 Joirit Appendix, pt. 1, at 664d.

96See FPC, Staff Report on Nationa! Gas hataie and Demand: 11

(1969) (projecting FP ratio as declining’ steadily from 0: 92 in

’ 1969 to 0.73 in.1975). ° ‘

: . % .

- . . -

@ . .

- AUSTRAL OIL, ET AL v. 2 ae

contend a the RP ratio is dangerously low,‘ and

despite the frequency wifh*which this argument has

been effectively se nt as. a “cry of wolf,”97

We are concerned. about it here. A majority.of the |

_Commissioners ‘on the FPC have alluded in piiblic ..

“speeches to the seriousness of the. supply problem.°®

87The New York Commission states that “In every major appeal, *

the producers’ ‘major issue’ has been the claim that if the

producer position were rejeeted, the result would be a wide-

spread shortage of natural gas. -. .” Reply Brief for New York

Public Serviee’ Commission at 14. In Permian, the Supteme

Court noted that one party had characterized the producers’.

- concern for the RP ratio. as'a “neurotic preoccupation.” 390 -

U.S. at 817, 88S. Ct. at 1386 n. 103. The producers there had °

argued that:the ratio should be kept at a minimum of ‘20 to x

and there was substantial evi@ence that lower ratios svere ac-

—_ ___ceptable-—Fhe-€ourt evaluated the significance of these ratios

’ asfollows: - j eo.

Nothing in’ the record establishes as proper or even

minimal any particular ratio. We do not. suggest, nor (

did the Commission, that the Commission should not

continuously assess the level and success of- explora- Ar

tion, or that the relationship Shiny reserves and pro- —

duction is not a useful bench-mark of the industry’s’

future. We hold only that the Commission here per-:

missibly discounted the producers’ reliance upor this

relationship to establish the inadequacy -of its rate”

————

; . Structure. pat : y ;

‘88See Address by Chairman White, A Regulator. Looks at the Elec-

_ ° tric and Gas Industries with a Sidelong Glance at Investment

Analysis, before the Financial Analysts’ Federation, May 16,

1969; Address by ‘Commissioner O'Connor, Prospects for Future .

Gas Supplies, before the National Ass’n of Regulatory Utility

.Commissionérs, October 7, 1969: Address by Commissioner

Brooke, before the Independent Natural Gas Ass’n of America,

September 9, 1969; Address ‘by Commissioner Bagge, The FPC

. and Area Pricing: The Need for Re-examination, before the ;

Gas Industry Seminar at Oklahoma State University, May 13,

1969. ee ‘ ,

We take judicial notice of the concerns these speeches ex-

press. See C McCormick, Evidence § 328 at 704 (1954). (We

al “

remain before demand will outrun supply.”9?

54: AUSTRAL OIL, ET AL v. F.P.C..

And an even more persuasive indication of the im-

mediacy of the problem is the recent FPC Staff Re-

port on National Gas Supply and Demand, issued

October 1, 1969, which concludes that “only a few years

The Staff Report is, at least from appearances, a

careful, considered document. The record.in this case

does disclose instances in. which Staff has been.egre-

giously, in error,’°° but we think there is something

* to its supply and demand report. The report is based-

upon quantitative projections..ef- demand and several

indicia of-sapply.— precisely ‘the kind of - ‘assessment

of ‘cénsequences” “that we find lacking in the Com-

mission’s' decision here. Demands for Southern Louis-

iana’s gas, according to the Staff report, will be ‘double |

its 1969 level in. 1975. The FP ratio will remain below.

1.0. The RP. ratio will decline below 11 by 1973 even

under the best of cireumstances, and there is nothing

that can- bé done at: this time to maintain the’ ratio

at its, present level. The report further argues, -and -

argues persuasively, that the inevitable decline .in the

RP ratio will probably ‘¢ cause regional supply deficien-

cies to come into existence as early as 1973.2! And _

et ae : Moe . '

4 . * . : ae e

do not, of course, take judicial notice of the specific: facts they

state forthe purpose of resolving contested issues. Id.)

s9Staff Report at 1.

100See note 91 supra (Econometric siaiaa: | : ‘

101A critical ratio will ultimately be reached in each. area below

: which the RP ratio cannot be decreased, meaning that at that

point production cannot be increased without .réserve addi-

tions, according to the Staff Report. But reserve levels at any

given time are determined by previous levels of exploration,

and there is a) lag: ‘before new exploration results in addition of:

usable: reserves. Staf has° calculated the criticat RP ratio for

Southern Louisiana at, ‘approximately 8. It has projected the

AUSTRAL OIL, ET AL v. F.P.C. 55.

+ aside from ‘probable short-term deficiencies that ‘can:

net be prevented, Staff concludes that “la] major new .

~ government-industry program is needed immediately :

_, to insure the continuéd. growth .of natura] gas service |

during the next decade."102 | | :

The projection in the Report focuses on: the next

five years, and. Staff announces its intention to update

ae it at five-year intervals, but Some predictions are made

for longer‘terms. It is not too: early to begin consider-"

ing the effect of. present-gas use on our resources in

the far future.'°3 The Staff Report, if it is correct,

future of the RP ratio and determined that the critical level . ;

: will be reached about 1973 or 1974 under a “business as usual” >

. * regulatory program. At that time production; having kept up?”

'. with demand, will not be capable of beihg’ increased, and: dec

=a ae . ficiéncies will céme about which. productidrtfrom other areas —

will not be able to pick up because of lack of delivery Yines $s

and because: they. will ‘be approaching thé critical ratio. See

Staff Report at 14-17. of

102Staff Report at4. -

* 103The supply of natural gas is, of course, ultimately’ limited not

by exploration but by the.amount of recoverable reserves.

The Potential Gas: Committee, a group of experts from all

- Segments of the gas industry, has rent sdtimated the total |

recoverable reserves in and offshere to thé United States and

Alaska at. 1,227 trillion cubic feet, divided into probable sup-

it eas _ ply, possible supply, ‘and speculative -stipply. Consumption in

ae 1968 was 19 trillion cubic feet. ddress by Commissioner

can O’Connoy, supra -note 98. In other words, production for some-

nas ¢ ‘thing over sixty years would exhaust. this estimated _,supply

even at present levels. The situation is aggravated by (1) grow- .

ing demand and (2) increasing difficulty of finding reserves

as one goes from probable to speculative supply areas, See

Terry, Future Life of the Natural Gas Industry, ‘in Economics :

: we Of the Gas. Industty 275 (Southwest Legal Foundation ed.

- 1962). Of course, supply from other couatriés, pipelined in, or-

; - brought in, as liquid (LNG,), synthetic gas and other seurces,

* could have an impact on this problem. Staff-Report at 47-76.’

. Fars'ghted gas regulation, however, would take into. account

. P . ~ .

56. .AUSTRAL OIL, ET AL v. F.PC.

‘shows that unavoidable gas supply problems in the

near future, ‘the middle future, and the-far future are

not only possible but probable.'°* This prospect needs

only to be considered against the huge and. growing

- importance of natural gas in this nation’s —— mix, "s

(3) Giacdien of the’ Supply Problem at this

Stage of Review

The possibility of severe gas ‘shortages, together

_ with the Commission’s failure to make thorough find-

ings on the matter, present by far the most important

and most. difficult question in this case.. We ‘have ©

serious misgivings about affirming the-Commission. _

Nonetheless, after having considered dll factors we

find relevant, we have determined that affirmance is -

the best course. eee

First, veeasaal fetes a.limited remand would serve

little ‘purpose in this case. We think our opinion,

and indeed probably the circumstances themselves,

will notify the ‘Commission that it cannot in the’ future

* sét. prices by.cost considered in a vacuum. The Com- |

mission has itself recognized the _possibility that its

prior. orders were inadequate and has set new pro-.

ceedings that! will consider precisely the questiops

troubling-us and may well modify the entire. scheme

‘here reviewed, If there is a need to do so, the Com-

the rational development of this depletable supply, perhaps even

to. the extent of. having that development influence present

area rates. “See note 121 infra. y

104Staff Report at 19 (graph showing supply, demand, and de-

“ficiency accuses into the late 1980’s).

° re “oe .

ae |

ee o 8 %

é AUSTRAL OIL, ET:AL V.F.P.C,~ 2+ 57

. mission may, and has in part, ‘set aside the a reo

order pending further determination. The long and the

short of it is that the Federal Power Commission is

vested with the responsibility to make. certain that the.

gas industry serves the public interest, and insofar

as we can tell it would. perform this ‘function equally

competently . whether we affirmed this case or re-

versed it. Indeed; if immediate action is called for

here, we. think a reversat ° in this case would unduly

interfere with the Commission’s. performance.

Secondly, we can understand the circumstances that

led to ‘the Commission’é S order, and we are not sure th&t

its. making thorough findings in the instant cage would

have avoided entirely the possibilities that Staff has

raised. It is ‘@ertain, for example, that’ Staff did not

communie¢ate these possibilities to the Commission in

any . coherent way during the consideration of this

case; in fact, Staff appears to have made major errors

that would have aggravated the. situation except for

the Commission’s refusal to _adopt them.!°5 Further-:

more, the producers, ‘who are possessed of most of the

information.essential to effective regulation, have not -

always actually advanced the goal of effective regula-

tion. All in all, indications that supply deficiencies are .

decision we. are reviewing as ‘Staff makes them seem

now. Certainly, the Commission is now as aware of this

new information as we are. We therefore think it ap- |

propriate, rather than specting the Commission’ s de-

= . >

.105See ie 39, 91 supra (soncerning econometrie studies and rate

Pe a

_ of return).

58. AUSTRAL OIL, ET AL v. F.P&.

° ‘ _«

cision by hindsight, to allow the Coinmi: ssion to pro- |

ceed with its new hearings with the benefit of the. new -

information that has been ee to us.

‘Thirdly, this Court cannot itself jvaleaie the supply ~

situation or determine what action - ‘is needed, We do

not know whether the: information. that has reached us

oe cor rect or. not. Staff states that, “For purposes of

this report we ‘have accepted at ny value all industry-

furnished data. Our conclusions -must therefore be

weighed against the: assumed accuracy of our data

base.”"'°* It also states that it is setting forth only. ane:

of several possible ‘forecasts, albeit it is the one it

thinks most probable. Clearly, even if-immrediate, de-

cisive action is needed, this Court cannot take- it. Since

'- we have concluded that the Commission is‘on the right

course now, our best course is to keep within the proper-

sphere of a reviewing court. The point is that the prob- .

ability of* shortage based on new evidence is not before

- us for review; all that is before us is the. legal ade-

quacy, and not the wisdom, ‘of the Commission or-

- ders.

Finally, and most importantly, in light of Permian -

_ we.think we are required ta hold that the Commis-

.sion’s orders in this case are procedurally and sub- >"

stantively adequate under the law. Whether they are

ultimately wise.is a question to be presented not to —

this Court but to the Commission. In ‘Permian, the

' Supreme Court affirmed the. Commission on a’ ree-

ord similar to the one we have before us. It reversed

106Staff Report at 2-3.

ener neeeesesseeneneesennteneenestieamendinese

. .

‘AUSTRAL OIL, ET AL vy. F.P.C. 59

the Tenth Circuit, which. expressed concerns’ similar

to ours. It ‘is trué that in sustaining the. Commission,

_ the Court indicated that it expected the Commission to

perform its procedural duty of fact firneling better. ine

the: ‘future. We do not think that a- great| deal of im-’

provement can be expected over ‘the Chmisbions

Permian opinion, howev er, ‘since hearings‘in this case,

had béen going on for seven years when the Supreme

| Court issued its opinion,.and the decision -here came

-~ out a few. months after that decision.. Proceedings

over those seven years inev itably caused. the ‘Com-

. mission to focus on certain issues to the exclusion of.

> |

others. In other words, we think that the ‘ ‘experim@nt”:

doctrine of Permian is still relevant to our ev aluatyon

of‘the legal: Sufficiency of the: Commission's effo\ts. '

It should be added that the Commission has respond- .

_ed to the difficult task mandated by the ‘Phillips and.

< CATCO cases by creating a regulatory: ‘procedure that ;

is at least potentially workable, and: that ‘in itself” n°

_ he mean accemplishment. aad

At the same’ tine, we emphasize that our affirmance.

should not be taken- ‘In any manner as. a judgment that *

the supply problem | is not .serious enough to require :

immediate’ modification of the order heréin sustained.

We do not’ reachsthis question. It is possible that the.

Commission may find it adv isable to make such an

; immediate modification or that it might se} aside ‘the

order. affirmed here. The Commission has power to. -.

take theSe acti6ns if it finds them. appropriate. We can

orily reiterate our. concern over what - wwe consider to

2 '

: , ‘

. ‘

* ata eS t4

‘ zs on

_ 907See notes 5-13 i < Hf es a

60 + AUSTRAL OIL, ET AL v.-F.P.C.

ke strong evidence. that a supply deficiency is immi- |

_nent, but_we think it. especially important, at this un- _

certain time, to resist hasty action and to place some

degr ee of faith in the body to which Congress Bas eri-

‘trusted this question.

Ww. CONCLUSIONS AND RECOMMENDATIONS

Phecusnout this discussion, we “have been foréed to

navigate between ‘the Scylla of ‘disobeying Permian

and the Charybdis of condoning inadequate Commis-

. Sion findings ‘in the. face of a possible supply defi-

ciency. We think Permian requires affirmance. How-

ever, we are disturbed by what we consider to*be ex<

cessive relienee by the Commission upon the mere

result of the Permian decision. 08 This reliance shows

that the Commiission. has not read Permian carefully

C : ‘ +

enough. At numerous points-in its opinion, the Supreme °

Court indicated that it was affirming’ the Commission

on an inadequate record and that it was doing 80 only °

because area rate proceedings: were new. Here, we

think it appropriate to place a greater emphasis on

the ways in which we hope the Commission will do

better. :

The most serious problem, as we > have said, is that

of- possible Sire deficiencies, together with the CGF>___-

108As we have yreviously stated, reliarice ‘on Darniie is justified

by the “experiment doctrine.’ The case had been commenced

‘seven years before Permian and the’ Commission’s opinion is-

sued five months after Permian. Nevertheless, we think some

deference to the expectations of the Supreme Court would have

been appropriate, if only to show the Commission’s aware-

- ness of them, especially in light of the advance warning given

’ by the opinion of the Tenth Circuit... ~ . 3

AUSTRAL OIL, ET AL v. EPC. 61

relative failure of the Commission ‘to consider Supply

and demand. Our discussion of the issues should be

“understood in light of this order of importance.

A. Needed Improvements in the. ~Commission’s

Presentation of Cases for Review ;

(1) Identification and ‘Explanation of Rate

Components |

As the Supreme Court stated in Permian, “we*would

expect that the Commission will hereafter itidicate

more precisely the method by which it intends to pro-

ceed,.’”199 In computing costs, as we have stated, we

think the Commission has adequately explained its .

findings. It should be more precise, however, about its

noncost ‘elements and the reasons for their use. .Non-

cost elements influencing a cost-based rate should be’

clearly labelled as such and their basis explained: as

‘ specifically as possible.""° Non-cost factors may be

used to influence market variables such as Supply and

demand, to create—price stability, to influence .indus-

: _ try structure, to simplify a rate schedule, and for many

109390 U.S. at 800, 88 S. Ct. at 1377. The Supreme Court had dif-

ficulties similar to ours with noncost elements. 390 U.S. at 815,

ee 88'S.Ct. at 1385 n. 97. The Court charitably observed that “the _

‘ Commission’s exposition of these questions might have been

more carefully drawn.’* : h

’ 410It should not be possible, for example, for a party on appeal

to characterize a noncost element as a “phantom” tax allow-

* ance. The characterization in this case is absurd, but the pos-

sibility for it arose as a result of the Commission’s: timid treat-

ment of the matter. See note 43 supra. It would be far better

if both courts and parties got down immediately to the real

issue — whether the noncost element can be justified.

62° ‘-AUSTRAL OIL, ET AL v..F.P.C.

other purposes,™! but only if they are’ clearly identified

and explained. If the Commission approaches these

mattérs forthrightly, it can expect a reviewing court

to give great deference to its expertise, even when it

ventures intg new territory.

(2) Ansektinank of Consequences upon the

; Industry :

We have already cited the Supreme Court’s language

calling for more specific mapecsrpent ( of consequences

upon the industry. This asséssment showjd encompass

the ‘following three variables, among others: (1) The

character and .number of: individual enterprises that

will remain when the order has had its effect (i.e., in- —

-dustry -structure); (2) the capital ‘actually available”

_ to. the industry as a whole; and (3): most importantly,

the industry’s probable conduct and performante as a

-result of the order. : :

Maintenance of a healthy industry structure is an

impo tant_FPC responsibility."'? We have heard |. pro-

ducer complaints that the use of unexamined av erage

costs will prevent large segments of the industry from

. investment and will lead to greater con-

111See 390 U.S. at 815, 88'S. Ct. at 1885, nn. 97-99 and authorities

112The natural gas industry, even thous regulated, is subject to

antitrust legislation, and thé policies of that legislation should

not conflict” with the impact of the rate order. If a significant’

decline in the number of ‘competitors appeared probable, it .

would be a matter of concern in antitrust law even in a large,

fragmented market. See United States v. Von’s Grocery Co.,

1966, 384 U.S. 270, 86 S. Ct. 1478, 16 L.Ed.2d 555.

_ AUSTRAL OIL, ET AL v. F.P.C. 63

centration in the industry, particularly since ‘small.

producers as a class are subjeqt to higher risks than: | =

large ones. We do not. know whether, this dire predic- —

tion represents truth or an ‘overactive imagination, . 9

and more importantly we cannot tell from the Com-

mission’s opinion whether it knows.''3 The Commis-

sion could have cleared up the problem by a few

simple findings that should have been a part of its —

determination — findings as to the approximate num-

ber of producers, if any, who might abandon business

as a result of the rates as set and as to the subsequent

degree of concentration in the industry. If concentra-

tion: ig increasing, the ihcrease should be justified in

_ terms of the — interest. ”

-As to the crucial, issue of sources for adequate fi-

nancing, the Commission’s findings, and for that mat-

ter the evidence, are. almost nonexistent. The Com- x,

‘mission has made only conclusionary statements to

the effect that -capital from outside sources will be

i available at the rate it has set. This is a tenuous basis

-for-our-affirmanee.Another- -court reviewing a-regula-—————____ a

Sty

%13In this connection, the Commission might well, consider ‘the |

recommendations of Mr. Justice Douglas in Permian: rather than

emphasizing,’ as it has in its brief, that his was a “solitary” ¢ °

dissent.. The use of average costs without examination of re--

__.____sults_troubled him. and_troubles_us._We agree, as did Justice _ sz

ee Douglas, that the Commission may certainly use average costs,

but it should’ make some finding of effects so that it will be

sure that their use is in the public interest. The majority opinion

in Permian is authority for the proposition that the Commission

does not have to make the assessment Justice ‘Douglas . would

have required, but the making of-that assessment would by rfo -

means be incompatible with the majority opinior and would. - Par

be in the public interest. Cr. notes 77-80-supra and a

ing text.

\ Pd \ " : ? ‘ 3 | ot

64° AUSTRAL OIL, ET AL v. F.P.C.

_ tory commission stated, with. regard to adequate fi-

nancing, that a commission must make ees

. inquiries and findings - judgmental as' the

latter may often be’ because ratémakers must

be prophets of the future as well as historians -

of the. past - into ‘such things as the capital

' programs in prospect, what such programs

entail in terms of dowh-payments as well as

financing, the cost of borrowing money, work-

ing capital needs, the desirable ratio of debt’

to equity, the incentives iequired by afstock- . .

holder to keep his money in the business and

_ the dividends and growth rates requisite to

supply these’ incentives, the opportunities—in——

nesses, and the related matters which must be ,

prayerfully explored by the conscientious:

regulator before he can begin to say why. he

ov fixed upon 4.87 rather than 6.5 or 3.2.1'4

.—+—— Fhe-Commission-has-considered few of these matters 0

sie in this case either prayerfully or otherwise, &nd this

deficiency is of great concern to a reviewing court. .

‘ . With’ regard to conduct and performance, the Com- .

—mission- must—assess how circumstances other. than |

structure and capital will affect the orderly develop-

ment of the industry. These concerns necessarily in-

volve some consideration of supply and demand, which

is the subject we consider next.

ry toe

114D.C. Transit System, Inc. v. Washington Metropolitan Area -

Transit Comm., D. C. Cir. 1965, 350 F.2d 928.

« Zz r . 2 .

AUSTRAL OIL, ET AL v.F.P.C. | 65.

er: Findings as to Market Variables: Sup-

? ply and Demand ; ae .

The Commission must’ Setuae the effect its order _

its market. There is no doubt that the Commission has

the power ‘to set prices on the basis of cost and that

market. variables .do not necessarily have to influence

’ the calculation,’but it must examine even a ‘cost-eom- _

puted rate against the ultimate statutory purposes it

is supposed to be carrying out. This is not a navel prop-

osition. A classic statement of it appears in Colorado

peteveyere. Gas Cov v, FPC, Ww ritten in 1945:. ,

Far-sighted gas-rate regulation will concern

itself with the present and future, rather -than

with the past, as the rate-base formula does.

It. will take account of conditions and trends at:

* the source of the “supply being .regulated. It

will. use . price as a tool to bring -goods to.

. . market — to obtain for the public service the .

_ needed amount of gas. Once a price is reached

that will do that, there is no legal er economic

eason, to go higher and any rate above one

‘ that will perform this function is’ unwarranted.

*** On the other hand, if the supply is not too

plentiful and the price is not sufficient incen-

tive to exploit it and fails to bring forth the

quantity. needed, the price is unwisely low, eyen .

if it does square perfectly with somebody’ s

idea of return on a “rate base.”’"'5 |

(115324 US. 581, 612, 65 S. Ct. 829, 843, 89 L.Ed. 1206 (concurring

opinion of Mr. J ustice J. ackson)

- 66 — AUSTRAL OIL, ET AL v. F.P.C.

fl = 3 ni te “E

In Permian, the Supreme Court stated that the Com:

mission would-be expected in the future to explain “the

o _ purposes for which it has chose to act."

. ; | }: — A ‘

__-+From the Commission’s findings ‘we cannot know

-~*. whether the demand for Southern. Louisiana’s gas is

| going to double, sextuple, or increase tenfold over the

next decade, or whether it is going to remain stable

-- or even decline. From data as to past demand, we,

. ! have.a fair idea that if current conditions hold it will |

grow at. about five percent a year."7-Predictions along

> , this line are subject to obvious infirmities, but at least

the possibilities can be identified and probabilities as-_

signed to them. ay

Such predictions are necessary because the supply

of natural gas must be considered in light of demand.

Some areas are more promising than others. The Com-

mission appears.tg assume, without so stating, that a

rate that gives adequate return Will elici, enough drill-.

—_—+——ing to satisfy future demand_eve though somt_reser-

persuasive the -producers’ argument that prodtcers

will meet demand‘only if there are enough reservoirs

{

116390 U.S. at 792, 88 S. Ct. at 1373. We interpret “the purposes

for whith it has chosen to act” to mean the condtct and level

.Of performance, or other characteristics, that the Commission

& ° _ _is trying to elicit from the regulated industry, and the public

‘interest that it is trying to further thereby.

117See Staff Report at 11 (chart showing past and projected pro-

‘ duction). Staff forecasts about six percent.

AUSTRAL OIL, ET AL v. fee So ae

that promise sufficient return. at the rate set. fe The

Commission should make findings as to the increased

difficulty of finding greater volumes of gas.119 From

this. finding, it should estimate. the supply that a’ J en.

- rate will elicit. 120 , | ‘

are

We do not mean to imply that the, Commission must

set rates according to supply and demand. In a situa-

tion where the market leads to excessive prices, that .

would of course be self: -defeating, We do not think

even that the Commission is necessarily bound, as

the producers contend, to set rates that will “‘satisfy”’

demand; demand is itself a function of rates: and there —

; might be good redson for not matching it to supply.'2!

118This proposition, we think, isa logical corollary of the proposi-

tion that cost pricing is ultimately circular. See notes 48- 49, 91

' supra. If present demand is satisfied at a price at which only

» promising areas are explored, there is no assurance that the

same price will cause higher demand to be. satisfied. Indeed,

there is-assurance that ‘it will not if increased production. re-

quires exploration ‘of less promising (i.e., more expensive)

areas, because entrepreneurs will not explore those areas.

The Commission has found that thére are huge virgin areas _

in Southern Louisiana “untouched by the drill,” but this find-

ing, without more, does not show that these areas will be de-

veloped to satisfy increasing demand at the price set.

1 19In particular, it should make predictions as to the probability

of.an anomaly in the supply-demand relationship, such as. the

‘imminent reaching of a critical ratio. See Staff Report at 15.

1z0We. are well aware that the producers have not helped the

Commission te-make this prediction. See 4 Joint Appendix, pt:

1, at 885d. Nevertheless, it is the Commission’s responsibility —

to make a prediction of this nature as best it can. Indeed, we

think the. process of area regulation is only as good .as are

numerous such forecasts made by the Commission, either tacitly

or expressly. We would prefer they be express.

121For example, the Commission has power to curtail wasteful

uses of natural gas. FPC v. Transcontinental Gas Pipe Line Co.,

1961, 365 U.S. 1, 81 S. Ct. 435, 5 L. Ed.2d 377. Besides _—

68 -AUSTRAL OIL, ETAL v-F.PC, z

explain the relationship between the gevel of service,

the demand for service, and the price it sets. A re-

viewing coprt -contemplating” the “endgresult” test

cannot in good conscience affirm the Commission ‘

unless it knows what the: Commission is trying to do.

In’ evaluating its rate; then, the Commission should

go through the following three’ steps relating to indus--

’ try performance. It should first estimate the needs of

" consumer setvice — in’ this case, the demand. for

gas. Next, ‘it should use this determination to fix.the .

- level of servi ice at which it is aiming, explaining how |

‘that level is related to actual demand in the event de

mand, is not to be fully satisfied. It must then make

findings, as sp¢cifically as possible, as to how the rate

it has set will affect the industry’s tendency ‘to meet.

that level of service. This last step means estimating

the gas Supply that the rate will bring forth. These

are difficult, matters to predict, but that is more reason

at them. More importantly, if the Commission sets 3

| rate on.a cost basis and does not: itself consider these

questions carefully, its conclusionary, ‘statements to

the effect that. the rate is adequate or that there. will |

probably be no need for changes in the future (these

are statements that the Commission has made here)’

amount only to so much whistling in the dark.

-'.

price as a tool to elicit supply, we think it probably has power

to use it to provide for the orderly hapa Vanes of limited re-

serves. Cf. note 103 supra.

Al that we are heldinig is that oe Commission must ait

why -areviewing-court-should-not-be required to guess —_ ate

AUSTRAL OIL, ET AL v. PC. 69

(4) saeconcitiotion of Conflicting Statements

Consistency i is the hobgoblin of small minds, and We |

have tried to avoid undué concern when we have found

implications in the Commission’ Ss -findifigs to be in

conflict with each other. 122 The Supreme Court faced

the same probtem in Permian and commented upon

* « it.123 We think, however, that the Commission ought at

least to recognize inconsistencies and explain why they

are present. Unexplained, they cause the efforts of ae

reviewing court to be Fasietally: consumed. —

B. ‘Disposition of the Case

The orders of the Commission are sustained in full.

The mandate of this Court should not, however, be. in- |

terpreted: to interfere with Commission action that

‘would change” the rates ‘we have approved here. We

specifically gand emphatically ‘reject the contention

advanced. ‘by the MGD that. the Commission has no

—____._ power to set. -aside rates-onee- -determined- by—it-tobe—_—_—_ —

ae and reasonable when it has Teason to believe its

122We have had difficulty, for caneagie, with the Commission’s

categorical elimination of the FP ratio from consideration as

compared with its use of the FP ratio.to calculate new-gas

exploration costs. ,4 Joint Appendix, pt. 1, at 529d, 546d. The

‘latter reflects either arbitrary, intentionally circular pricing

or a judgment that preserving a certain FP ratio does matter.

This is an example of a conflict whose resolution would’ go to

the very heart of our doubts about this case.-See alsé notes 50-51

supra.

123S¢ee, e.g., 390 US. at ania 88. S. Ct. at 1385 nn. 97- 98

70 AUSTRAL OIL, ET AL v. AM P.C.

has 7 : ' ; s |

determinations may. have been erroneois.'*4 In fact,

the existence of the new proceedings, which as we un-

dersti ind then will take hito’ account many ‘of the: is- :

sues whese absence has conc erned us here, has b¢éen

one vf the factors we have considered” in dec iding to

athe “m the C ominiission’ s deci isions.

. x * “ 3

‘ s

~~ .

a renrains for us bo wo) onsider the’ st: Ly ordered by

this Court when this appeal began, which’ has to.date.

prevented the c onimission’ s decision from going into

effect. We hav e- determined that, subject. to the usu: i

solved unless further aihiacaile This deter mination is

mate without: prejudice, however, to the Commission’s

power to stay its own order or to take any other ap-

propr iate. action affecting this case. ~ ;

‘

a ~ ? "

mi e

124Section 16 of the ‘Natural Gas Act,- 15 U.S.C. § 7170 (1963),

ives. the Commission power to “perform any and all acts,

extensions, provided by Rule 41, F-R.A.P., for petitions.

“for rehearing ‘and certiorari, the stay should be dis-

<r as

and to prescribe, issue, make, amend, and rescind such orders -

as it may find necessary or appropriate to carry out the pro-

visions of this chapter” eens added).

_ APPENDIX B :

Opinion ‘on Petitions for Rehearing of the

United: States Court. of Appeals for the Fifth Circuit »

. No. 27492, et al.

Southern Louisiana Area Rate Cases

2 ene 16, 1990)

IN THE

United States Court of Appeals |

FOR THE FIFTH CIRCUIT

No. 27492

SOUTHERN LOUISIANA AREA RATE CASES

AUSTRAL OIL CO., — |

* eal Petitioners,

versus

FEDERAL POWER COMMISSION,

. Respondent.

* : ~

Petitions for Review of Orders of the

Federal Power Commission (Texas Case)

ON PETITION FOR REHEARING

(June 16, 1970)

Before THORNBERRY, COLEMAN and MORGAN,

Circuit Judges.

PER CURIAM: In our original opinion, we indicat-

ed that there was new evidence of a possible impend-

ing gas supply shortage. Our affirmance of the Com-

mission’s orders is structured so as to allow the Com-

_mission great flexibility in dealing with this problem.

2 SOUTHERN LOUISIANA, ETC., ET AL v. F.P.C.

To this end, we indicated: that the Commission had au-

thority under section 16 of the Natural Gas Act to stay, ,

modify or rescind any part of its order, notwithstand-

ing our affirmance, if circumstances appearing since

the issuanée of the orders make a changé advisable.

Petitioners on rehedring, however, have argued to this

Court that the Commission may exercise this power

prospectively: only; that is, petitioners argue that af-

firmance by this Court would’preclude the Commission

from reexamining revenues from gas that has already

been delivered. We wish to make crystal clear the au-

thority of the Commission in this case to reopen any

part of its order that circumistances require be reopen-

ed. Under section 19(b) of the Natural Cx. Act, ‘this

Court has the broad remedial powers that inhere in a

court of equity, and pursuant to our equitable powers

we make it part of the remedy .in this case that the au-

thority of the Commission to reopen any part of its or-

ders, including those affecting revenues from gas al-

réady dalivered, is left. intact. The Commission -can

make ret ospectiv eas well as prospective adjustments

in this cage if it finds that it is in the public interest to

do so. :

‘At the same time, we emphasize that our judgment is

an affirmance.and not a remand. The appropriate place. —

for originally considering what parts of the orders must

be reopened in light of new evidence is before the Com-

mission. It may be that the Commission will decide

that the refunds it has ordered are just and reasonable

or at least that their significance to the public interest”

is outweighed ‘by the confusion and delay that would

result from their reopening. In this event, the Com-

SOUTHERN LOUISIANA, ETC., ET AL v. F.P.C.- 3

mission will allow its refund orders to stand as they .

are. Or it may be that the refunds are too burdensome °

_ in light of new evidence to be in. the public interest.

In that case, it is our judgment that the Commission

Shall have the power and the duty to remedy the situ-

ation by changing its orders.

In all other respects, the original opinion of this Court

is the final disposition of this appeal.

UNITED STATES COURT -OF APPEALS*." .

For Tue Furry Circvir

; October TERM, 1969

No. 27492, Et Al.

SouTHERN Louisiana ArgEA Rate Cases

_ AcsrraL Ow Co., Er Ax,

Petitioners,

mae

-FeperaL Powe. r CoM MISSION, |

Respondent.

PETITION FOR REVIEW. OF ORDERS OF THE FEDERAL |

= sicees COMMISSION (Texas CasE.)

Before: THORNBERRY, COLEMAN and MORGAN,

’ Circiit Judges.

JUDGMENT . .

- This cause came to be heard onthe petition of Austral

Oil Co., Et Al, for review of orders of the Federal Power |

Commissiow in Docket “No. AR 61-2 and RI 60- 18, Et Al,

and was argued by counsel;

ON CONSIDERATION WHERBOF, It is now here

ordered, adjudged and decreed by this Court.that the or-

ie ders of the Federal Power Commission in this CAUSE be and

- the same are hereby affirmed.

:_ \

It is further ordered that the stay ordered by thle Court,

subject to the usual extensions provided by Rule 41, FRAP,

for petitions for rehearing. and certiorari, should be dis-

solved unless further ordered, without ‘prejudice, to the

Commission’s power to stay its own order or-to take any

ather appropriate. action affecting this case:

It is further ordered ‘that petitioners pay-to respondent,

the costs on appeal to be taxed by the Clerk of this Court.

| Mareh 19, 1970

Issued as Mandate.

Filed July 14, 1970

New. Orleans, Louisiana

(308,032)

308,032

UNITED STATES OF AMERICA

FEDERAL POWER COMMISSION

me i .

Docket Nos.

AR61-2

RI60-18, et al.

Area Rate Proceeding |

(Southern Louisiana Area)

Avcnnane’Prinotat u‘C ORPORATION, et al.

OPINION NO. 546

OPINION AND ORDER DETERMINING JUST .-

' AND REASONABLE RATES FOR NATURAL

GAS PRODUCERS IN THE SOUTHERN |

LOUISIANA AREA

Issued: -September 25, 1968

DC-52

hw.

: (308,040)

308,040 | ro,

"| TABLE OF CONTENTS -

| cy ; = 33 Page

UNTRODUCTION @.ccccssscsscssesssscene ee

SUMMARY OF COMMISSION'S DEC STON cocccccccce 4

THE SOUTHERN LOUISIANA AREA ........ ea) ee

PRICE RECOMMENDATIONS AND

‘SUMMARY OF EXAMINER'S DECISION ........... 7

AREA -RATEMAKING UNDER THE NATURAL =

GAS ACT—THE PERMIAN DECISION ............ 1

PRELIMINARY CONSIDERATIONS s...cceccsseescee “ewe “14

CONTRACT PRICES AND THE :

EFFECTIVENESS OF COMPETITION 0.0... 16

DATE OF DIVISION. secsiccssssscscssssesssssssssssesenssesssscteceees 20°

NEW GAS-WELL GAS COST wi. See |

EXPLOR ATION AND DEVELOPMENT COSTS . as

__Dry Hole COBES ......cs0csseee. Ft bs A RN Ment OPC PN - 7

| Other Exploratory CMD siscecscsecsncsaci sage Siacansonilony 28

Adjustment for Exploration i in Excess . :

“ue of Production seanlehia ice ustaadslel cates ina acid (Tiss oo bea O MPEP? 28

PRODUCTION OPERATING EXPENSE POCO et 30

NET LIQUID CREDIT .....cisssessssssscssccssscccccseosegstecsecsssssvece 31

REGULATORY EXPENSE =... ee % Fes

DEPLETION, DEPRECIATION AND |

AMORTIZATION OF PRODUCTION |

INVESTMENT. COSTS... Se tene ‘iene

| Successful Well Costs e ena ating ihe heaton sia faanceanes 34

Lease Acquisition Costs ... canine easiest bectiAeaisistanaete 85

Other Production Facilities ....c.cccccccececcsesesseee: cconitess 36

(308,041) ?

| 308,041

a ee

Page

RATE BASE AND RETURN ALLOWANCE leer

Rate of Rettrn ......cccccccsscsesesesees iieesiadidideiasaie Yee 44

Return on Working. Capital - Seagate Sapeatal 51

FEDERAL INCOME TAXES .....ccccee Ge ag

PRODUCTION TAXMS (220023. lg gencticdacais, et

MOO MN ice guide Ries 60°

PROCKSSING FOR QUALITY DEFICIENCIES scan 60

AREA GATHERING wccscssssscssssncccdoeleseecnea 61.

NATIONWIDE NEW GAS-WELL COST o.oo. 62

FLOWING GAS COST i Te PCE ED I Meee 64

_ EXPLORATION, AND DEVELOPMENT COSTS .... 67

~ PRODUCTION COSTS oscccsssscccssssscesseiscrssssssesjeesssnsessssee 71

MT eee eessncstesciantt 78

PLANT LIQUID OBEDIT ..scsicienenncieunencunanese 81

INCOME TAXES iecisscssssssssscsssesenessene hae 81

REGULATORY EXPENSE, cscssccscsscecccsocene ors

_ PRODUCTION TAXES wecscsalisencjeiususinsnacneeneee 81

GATHERING. COSTS. ......cccsssessssssesccssssessessssssseseci shes

SUMMARY OF.FLOWING GAS COST cesses 83.

PRICE ADJUSTMENTS TO REFLECT - |

QUALITY DIFFERENTIALS wccssessesnennnniies 84 '

’ Existing COntracts ....esereecnecssees os Seale iin Dale R4

(308,042)

7 308,042 Mae

—iii— abe

| Page

Future Contracts ........... AMA Se Ree NS AO 85

Hydrogen Sulphide and Total Sulphur 00:0. 86

Water Content IF EM ROR RE IE SID 86

Carbon Dioxide ..c.ssesssssscsessssee-s ENO MESN SAAB .. 86

, Other Tepparities « ...i......ccccscssecsselscsccessoss ree. din ae

‘ . Delivery Pressure MEN rat to isin 87

Delivery POint .....s-s:sssee0e: Peat rt hoe 88

Btu Content .....i.csecciccccmcccccscsssseeses seveseceses SNR. Feb a 90

Quality and Btu Adjustment Procedure ............. «.: 93

SMALL PRODUCER EXEMPTION .........csc00 aon

PETITIONS FOR SPECIAL EXEMPTIONS .......... 99

SPECIAL TYPES OF PRODUCER SALES ............ 105.

FLEXIBLE PRICING CLAUSES .......0:00 ee

“APPLICATION OF ORDER ..ecssesesetecunenein 110

DEPOT NUN DRT ai nscsniscscencctinccinennnessinscocie ne. tae

ECONOMETRIC STUDIES octccscssssulcsssutuseeieeld 3

REFUNDS. ocecsecsersenses ROME ONUET OC MMCrI Gaus

PREPAY MENTS onccicccscocsssccsscsisoscnssctsssseseisseneseonss sisal

‘SETTLEMENT PROPOSAL .....c:.esessese00 -sscuenessssnssoesigeeA AD

_ PRICES AND: GAS SUPPLY esses eoseud 24

PRICE STRUCTURE AND PRICE STABILITY ....128

FINDINGS AND ORDER usc Sa i 142°.

APPENDICES ....ecsscssersssresenenen i iochashicaisaek,

(308,043) | (\ :

, ——\. 308,043

‘ oa \

'¢ UNITED STATES OF AMERICA:

FEDERAL ROWER COMMISSION -

AREA RATES; C ERTIFICATES — Sniall ici

CONTRACT PRIGES; COSTS; DCF-PROJECT “METH-

OD; GAS SUPPLY; INDEPENDENT PRODUCER;

MINIMUM RATES; NATURAL’ GAS ACT — Sections

4(e), 5(a), 16; PWPELINES — Offshore Transportation;

_ PRICE STRUETURE; QUALITY DIFFERENTIALS;

~ QUALITY STATEMENT; RATES — Independent Pro-

. ducer; RATE DESIGN; RATE INCREASES; REFUNDS

— Independent Producer ; : REGULATIONS — Filing ;

|. SETTLEMENT; SPECIAL EXEMPTIONS

. Before

Commissioners: Lve C.’ White, Chairman; L. J. O’Con-

nor, Jr., Charles R. Ross, Carl: E. -

Bagge, and John A. Carver, -Jr:

Docket Nos.

AR61-2 |

(Southern Louisiana Area) ;

RI60-18; et al.

Area Rate Proceeding ,

Amsnaba Pestionzvs Corporation, et al.

T Na

OPINION NO. 546

OPINION AND ORDER DETERMINING JUST

AND REASONABLE RATES FOR NATURAL

GAS PRODUCERS IN THE SOUTHERN

: * LOUISIANA AREA

(Issued September 25,1968) _

“WHITE, Chairman:

6 ,

| - (308,044)

INTRODUCTION

_ .This is the second proceeding instituted by the Commis-

sion.to determine just and reasouable rates for natural gas |

producers under the area rate. approach..The first area rate

: hearing was initiated on December 23, 1960, to determine —

just and reasonable rates in the Permian Basin-area. The .

decision in that case was issued on August 5, 1965.1 The -

subject matter of the present proceeding is

308,044

, —2—

_the Southern’Louisiana area consisting of the portion of

the State of Louisiana lying south of the 31° parallel and;,

including all areas, both State and Federal, in the Gulf of

| Mexico off the shore of Louisiana. The Southern Louisiana

area, including the offshore area, constitutes at the present.

time and for the foreseeable future a principal area of, de-

velopment of.natural gas in the’ United States, and the

just and reasonable price for gas from that area is thus

- “of prime importance to the natural gas consumer and to the

natural gas industry as a whole.”

Pursuant to Section 5(a) of the Natural Gas Act we are

hive establishing future rates for jurisdictional sales of gas

by producers in the Southern Louisiana area. In the order

instituting the proceedings® a number of Section 4(e) in-

creased rate filings and Section 7(c) certificate applica-

-1 Area Rate Proceeding, Docket No. AR61-1, Opinion No. 468,

34 FPC 159; rehearing denied; Opinion No. 468-A, 34 FPC

1068, modifiéd 34 FPC 1286; Commission’s orders sustained

in their te — Basin Area Rate -Cases, 390 U.S.

747 (1968).

2—In terms of total ‘capital investment the natural, gas industry

is the sixth largest in the industry.

3 Order issued May st 1961, 25 FPC 942.

- (308,044)

tions were included. The certificate proceedings subse-

quently were severed and decided separately. In addition

to the 252 present respondents to the Section 5 investiga-

- tion, 199 Section 4(e) proceedings are before us for decision

involving 70 producers.? .

As in the Permian proceeding, the Commission required.

_ those respondents having companywide jurisdictional sales

of mor¢ than 10 million Mef-in 1960 to file certain nation- :

wide and area cost, revenue, production, and other opera-

tional data for that year on what has become known as

the “Appendix B” questionnaire form.’ Respondents mak-

ing companywide jursdietional sales of less than 10 million

Mef annually were permitted to report on.a separate, sim-

plified form designated “Appendix C”. In addition, all

respondents who during 1960 were operators of any lease-

hold in the Southern Louisiana area from which gas was.

produced and ‘sold subject to the Commission’s jurisdic-

tions filed certain operating data, chiefly drilling

308,045

ta chee

costs, required by an “Appendix A” questionnaire. . The,

composites were distributed to the parties. Although some.

questionnaires sent out were not returned, and the data

‘provided in a number of others proved to be not composit-:

able,® staff was able to prepare ising composite eost-

4A complete listing of the parties is contained in Riedie A.

to this opinion. t

5 Order issued May 25, 1962, 2% FPC 1038.

§ Out of an original 248 respondents, 119 filed either Appendix B

or. Appendix C. Of 49. Appendix B respondents, two were

deleted by Commission order, with data from the other 47 being

composited. Of the Appendix C filings, 34 out of 70 were usable.

The Appendix A filings totaled 131, of which eight were rejected

as incomplete or deficient and thus not composited.

(308,046)

of-service studies-representing 47 Appendix B companies

and 34 Appendix C producers. The 81 companies whose

information was composited accounted for almost 85 per-

cent of the natural gas production and 87 percent of the

liquid production in the Southern Louisiana area reported

in the Louisiana Conservation Commission’s report for .

1960. Of this amount 82 percent of the gas and 85 percent

of the liquids come from the larger Appendix B companies.

The proceeding is before us at this time on.exceptions

to the initial decision of Chief Examiner Zwerdling, issued

on December 30, 1966. Twenty-five briefs on exceptions

were filed individually or jointly, representing two States,

&. producer-respondents, 10 interstate pipeline companies,

111 gas distributors and a number of other interested par-

ties and associations and: the Commission staff.’ We are

indebted

. 308,046

f =

for the excellent presentations, both in the form of the

evidentiary development and in the briefing made by all

parties to the proceeding and especially those made by

the group participants, riotably the Amerada Group (Am-

erada), an association of a large number of the major

producers, and the Associated Gas Distributors (AGD)

7 Briefs on exceptions were filed by: Hunt Qil Company, et al.;

Placid Oil Company; Bradco Properties, Inc., et al.; E. Cock-

rell, Jr.; The Superior Oil Company; Perry R. Bass (Operator),

et al. ; Philadelphia Electric-Company; P. R. Rutherford; The

Atlantic Seaboard Corporation, et ql.; Alfred C. Glassell, Jr.,

et al.; Independent Petroleum Association of America; Public

Service Commission of the State of New York; The California

Company, a Division of Chevron Oil Company ; Sun Oil Com-

pany; Southern Natural Gas Company, .et al.; Union Texas

Petroieum,.a Division of (footnote continued on

next page)

(308,046)

and Municipal Gas Distributors (MGD), two groups of

distribution company intervenors.’ A two-day oral ‘argu-

ment was held on May 15 and 16, 1967.

SUMMARY OF. CONCLUSIONS

To summarize our conclusions at the outset, we herein

set base area prices for gas’ subject to the Louisiana sev-

erance tax of 18.5 cents per Mef for all casinghead gas

therefrom) ; 19.5 cents per Mef for gas-well gas sold under

contracts dated January 1, 1961 through September 30,

1968; and 20 cents-per Mef for gas-well gas sold under

contracts dated October 1, 1968 and thereafter. For gas -

not subject to the Louisiana tax the base area.rates are.

‘set at 1.5 cents per Mef below those prescribed ‘for taxed

-sales. The rates so established will be. continued until such

time as they are changed by the Commission. These rates

will not be subject to refund if the rates are later

308,047 .

a ae.

lowered, and the filing and collection of increases above -

such rates, subject to refund, will not be permitted unless

7 (eontinued ) .

Allied Chemical Corporation ; Municipal Gas - Dieteibutors

Group; Southwest Gas’ Producing Co., Ine.: the Associated

. Gas Distributors; Amerada Petroleum Corporation, et al.; Shell

Oil Company ; Joinder by Colorado Oil and Gas Corporation,

et al.; Agnes Cullen Arnold, et al.; State of Louisiana ; and °

Commission staff.

The following parties filed briefs opposing exceptions: Shell

Oil. Company ; E. Cockrell, Jr.; Philadelphia Electric Company ;

Bradeco Properties, Ine., et al.; Hunt Oil Company et al.; The

California Company, a Divi ision of Chevron Oil Company; The

Associated Gas Distributors; Amerada Petroleum Corporation.

et al.; Municipal Gas Distributors; Sun Oil) Company; .and

Commission staff.

8 Other groups which participated on. a collective basis are listed

early in the Examiner’s decision and Appendix B thereto.

(308,048)

and until the Commission grants permission for ‘such rate

increase filings.

A proportional Btu adjustment is. provided, downward

for all gas having a Btu content less than 1,000 Btu per |

cubic foot and upward. for gas rated at more than 1,050

Btu per cubic foot. No adjustment is made for gas coming

within these limits. Other quality adjustments are pro-

vided in the Opinion, but are made applicable anly to con- . ’

tracts dated on and after October 1, 1968. Refunds are

ordered of excessive amounts collected in the Seetion 4(e)

dockets consolidated in the proceeding.

As in Opinion No. 468 we have provided that individual

producers may seek special relief from the area rates. We

have ‘also simplified the certificate and rate filing proce-

dures for small producers, Finally, we have reviewed the

evidence concerning the need for minimum rates and con-

clude that minimum rates ‘are’ unnecessary in Southern

Louisiana. , an

308,048 ik

‘ = ead 6 Pals

THE SOUTHERN LOUISIANA .

PRODUCTION AREA

_ Prior to summarizing the Examiner’s decision, it is ap-

propriate to review briefly certain’ well established facts

regarding the Southern Louisiana area in order to place

the proceeding in perspective. As related by the Examiner,

“The Southern Louisiana area here involved covers ap-

proximately 54,000 square miles with similar geological |

characteristics, almost equally divided between land and

offshore waters.”? Although gas production in the area

ean be traced back to the 1920’s, it did not reach significant

— levels prior'to the middle and later 1930’s and early 1940’s.

Development of reserves-eontinued during the war years,

2 : a 1ll-

(308,048)

1941-1945, and by the end of the war large supplies of

natural gas were awaiting a:connection with gas-hungry

markets. Largeé.scale interstate transportation did not

begin until after the war. The post-war: period likewise

say the commencement of offshore exploration, resulting

in the discovery and development of huge new reserves.

In terms of total proved reserves of natural gas, Southern

Louisiana accounted for 22.7 percent of the United States

total at the end of 1961, 25.5 percent at the end of 1963,

and 27.8 percent at the end of 1967 according to the most

recent American Gas Association estimate. In the 1956-

1963 period, the area, according to A.G.A. statistics, ac-

counted for more than one-third of the total natural gas

reserves , _ -

. 308,049

omen f camee

added in the United States. For the years 1960-1962; South-

ern Louisiana contributed 41.2 percent of the nation’s new

~. gas supply and 20.6 percent of its net production. During

1962. offshore leases, from which production has become

increasingly important, accounted for 20° pereent of the

Southern Louisiana area’s total gas production. There are

currently 47 major producers (producers whose annua]

® The geographical definition of the-area is limited only by the

extent of the Continental Shelf insofar as its seaward extension .

is concerned. As a practical matter, however, it is cireumscribed

by the industry’s technologieal ability as of a particular time

to drill and explore in, waters .of increasing depth. Thus, al-

though the adjacent Continental Shelf extends out to. include

water depths up to .600. feet, as of 1963 offshore oil and gas

development essentially was limited to water depths of 100 -

feet or less. We note, however, that recent case materials relating

to exploration and development in the Southern Louisiana off-

shore area show that the industry has developed an ability to -~

drill, explore and lay transmission pipeline in waters as deep

as 300 feet or more. Teinessee Gas Transmission Co., et al..

Docket. No. CP65-356, Tr. p41986-87.)

(308,049) -

sales of natural’ gas are over ten million Mef)-in the area

and, in 1960, they accounted for approximately 90> percent

of the area’s total jurisdictional gas sales.

Nolarger proportion of ‘the @as reserves: in Southern

Louisianacis non associated gas than is the case nationally.

At the end-of 1963, non associated: gas reserves amounted:

to SS pereent of fhe total gas reserves in the area compared

to a nationwide figure of 72.9 pereent and a Texas fie ure

of 66.60 percent. Most of the gas produced in Southern

Louisiana is high pressure, sweet gas and is delivered to.

pipelines at or beyond, a central point in- the. field) rather

than at the wellhead. -

Pipelines whith purchase natural gas in Southern Louis

anaat the present time serve 2S states in the central and

eastern United States and the Distriet ‘of Columbia, This

area-aeeounts for over 70 pereent of the poprtation, of the

eountry. From oa national standpoint, Southern Louisiana

is both the most important and the most productive natural

‘ ° na eC

gas area in the entire nation.

PRICE RECOMMENDATIONS AND

SUMMARY OF EXAMINER’S DECISION.

In his initial decision the Examiner has recommended

tax-inclusive onshore. ceiling rates of 19.5 cents per: Mef

for gas-well gas and residue eas derived therefrom, under

-eontraets dated January 1, 1961 and later (new gas), and

18.25 cents per Mef for all other (old or flowing) gas."

All at 15.025 psia. The cost calculations, with the exception of

regulatory expense, royalty, Louisiana produetion tax and

ineremental gathering eosts were made at 14.65 psia and there-

after converted.

—

e-.

(308,050) a ee : :

et hea 308, 050 |

Sales of gas produced in the offshore Federal domain area!!

would, according to the Wxaminer, carry ceiling, rates 1.5

cents per Mef dess, or 18.0 cents per Mef for new {as- well

gas and 16.75 cents per Mef for flowing gas..The onshore

eeilings are below those recommended by the producer

respondents, which vary between 24.0 to 27.0 cents per Mef,

and above the recommendations of staff and the distributor

antervenors. Staff recommended 18.25 cents per Mef for new

gas and 18.0 cents per Mef for flowing gas; ADG reeom-

mended 19.0 mid, 18.0 cents, respectively, with the: 19.0-cent

rate being applicable only to a high qua

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