# Appendix — Municipal Distributor Group v. Federal Power Commission > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385605_0361%3A01 ## Record - **Collection:** Supreme Court brief - **Document type:** Appendix - **Published:** January 1, 1970 - **Citation:** 400 U.S. 950 ## Text be . ‘ ry ff 7 ; : F . . . : } . . 5 nf * | ‘¢ ; P 2 m ‘ — ys I . f 4 ° e . > . sae aaah » | . on : * ‘ ! : . : | ; : ‘ ; ; | . : “es . . . . ad - . . . . © “ ' eo . . \ . * * | ” ‘ . as : . ‘ . . se . Sd , f ° . - . ; , . & @ > “i . t . : . 2 - . - | . ! - _ . ’ . . ®. ‘ ' « , : 4 ° . = * — . . 7 : . . e e ’ . * = Ris . . . . . ~. s e . . m4 . / - ‘ z . . a) e ~ - me . . bd ’ ’ a! . a . . . e a os) ’ . . . . , - . . . 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) ra X: > Nad ~ . ot e~Oharese — 7 ; . . © . . . * » 6 ; : « . ¢ , ¢ ; i . . : ° é i ~ e . _ | a . ame : ; | Ga ae : : . ae : ” ?¢ 3, . . 9 ‘ & : . : . “ . . : ? ‘ - ; : a : , ‘ ie - WY } : oh | ; . | 7 e ‘ : . 4 7 . ~ ‘eo’ ‘4 s . rs . : e . . ; . } ° , ‘ ‘ a) . , ‘ | | 7 ‘ Se e ; : . : ; . ; . © , ; ° : ° r ; | ‘ “ . : ? a ° ; - | } ; e ; : . ¥ \ : . . : | ‘ 2 . ° . . “ . - P " ‘ : : ° gt A : ‘ | ° . 7 ea P * . ; e . = P « ’ . . $ ¥ . . . Re ° . ’ ‘ | . z . * ° , . : 2g . e fags ys « a 2 e ; , o « . . ‘ ~ | ; , “* Py . . 4 } . 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 } ' 1 . th e+ -gii-* be . ' pee, Se o J as P : . 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 s 2 a 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. wr q -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. ft : 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 ra ~~ ‘ 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 é 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. e- The decision was modified in some respeets by a new opinion on ne in early 1969. -@ i 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 e ? 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") er 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. om +t es -AUSTRAL OIL, ET AL v. F.P.C. N Ne -_ 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 ee 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. : ee 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.” . oe __ 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 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. = a . 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 ° é 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- 9 - 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 0.48¢ Time lag of 1.57 years ee ae eeAD es SEN Oe 0.28 - Drilling costs — successful wel] OP eee 0.29 » Related 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 i 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- le 4 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 en ©. «+ 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 s . 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 $519 million, or about 18.4 cent§ ‘per wee Mcf.(not including sizeable revenues from con- dénsates and entrained liquids) and that these revenues will rise steadily... . - In our judgment, the reventies allowed... should foster an active exploratory program - consistent with both the financial needs of the industry and. the — of the public in- terest. ies —— ’ : 93We ‘do not think reviewing courts should-accépt such conclusion- : ary fimdings as this after the “experiment” “justification for affirmance no longer applies. The Commission should have looked directly to sources and availability of capital. 944 Joint Appendix, pt. 1, at 683d.2The finding as to the total ex- ‘pected revenue is commendably specific. Howev er, a is useless S. 4 - Fi A 52 AUSTRAL. OIL, ET AL ¥. FPS The Commission did not explain the. reasoning by which. _ it arrived at this conclusion. Finally, the Commission - examined the place of natural gas in the economy as a whole and-concluded that although other energy Sourcés are growing in- importance, “there seems .no doubt. that natural gas will be a major and vital source - of energy for many years to. come and nothing should be done at this time which. would prevent the explora- tion and development necessary to make available this clean, convenient, economical and increasingly popular energy source.”95 (2) The Cudvent Supply Seaiies Despite the Commnission’$ 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 . * 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- 4 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 ec 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- - a 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 . probable were not clearly so clear at the time%f the © 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). e* 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. ee / ‘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. 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 go 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 therein cited. © 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—— _.these: respects - ‘provided in comparable busi- © 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 _ will have upon the ability of the gas industry to serve © its market. There is no doubt that the Commission has the power ‘to set prices on the basis of cost and that a 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- voirs are harder to find, but we find somewhat more © persuasive the -producers’ argument that prodtcers will meet demand‘only if there are enough reservoirs { T 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. ~ s 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! e. 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." , 10 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 quality “gold standard” contraet.!2 P hiladelphia leet rié. proposed that all onshore ‘flowing and new casinghéad gas be priced at 16.25 cents per Mef, and new now associated gas at 17.01 cents per Mef. "Phe? Municipal Gas Distribufors (MG 1D) proposed single ceiling, of 16.25 cents pe r Mef for ull gas, Part of the-offshore area is within the State taxing jurisdiction of Louisiana, part is clearly outside its jurisdiction and under the control of the Federal government, and part lies within a disputed area. (See, generally, United States v. Louisiana, et al., 363 U.S. 1 (1960), 382 U.S: 288 (1965) ). As used herein and. in the attached Order, the “offshore” designation will bg synono- mous with the Federal domain area ‘and as meaning the: region outside the Louisiana taxing . jurisdiction. Conversely, the “onshore” reference will be used with regard to all areas within the State’s jurisdiction, both ashore and in the waters proximate thereto. : : — -_ 12 Witnesses for AGD referred to some 17 features which might be looked to in deciding whether a particular contract qualified under the concept. However, it has not itself set out the stand- ards for “gold standard” gas, apparently leaving these to be set by. the Commission. Discounts below the ceiling for gas not meeting the standard would be’ established by bargaining . between the producers and the pipelihe- purchasers. (308,051) 308,051 ee The producers have argued against ‘a rate differential for offshore gas, claiming that the higher costs and risk offshore requires that gas fo be priced équally with onshore gas. The Examiner’s reduction of 1.5 cents per Mef: follows the recommendations of staff and AGD. On the other hand, : MGD, Philadelphia Electric and the New York Commission object to allowing any “bonus” in the form of a cost reim- bursement for non- existent State taxes, and hence they would set the offshore gas price 2 2.3 cents per. Mef below the’ onshore price, the 2.3. cents being the amount of the severance tax imposed by the State within its taxing ju- tisdiction. The Examiner reljed heavily on the precedents estab- lished in the Commission’s Permian decision, Opinion No. | 468, He affirmed both. the two- -price system and the finding in Permian « concerning the directional exploring capability of the industry. ‘His major departure from that opmion was the addition of a.1-cent per Mef incentive allowance to his nationwide current cost determination in deriving the new gas ceiling. The allowance, as. he explained, was made in-recognition of “the particular importance of the | Southern Louisiana area to the nation’s required natural gas supply, both now and.for the foreseeable future — and . the importance, therefore, of providing an adequate addi- tional incentive, calculated to encourage a maximum level] . ef exploratory activity in the Southern: Louisiana area and to encourage the flow of capital: for such purposes into that area. ig Other than the addition of the 1-cent incentive inecre- ment, the Examiner’s recommended eccilings were based on. industry costs, national for new gas and, for the most part, 15 . ; ’ (308,051). ie area historical for flowing gas. Using the tice ‘estab: lished in Opinion No. 468, he determined a nationwide cost of 16.55 cents exclsuive of*the producer’s share of the Lou- ' ‘isiana tax, which when included resulted ‘in a total cost of 18.53 cents per Mef for new, non-associated gas. The pri- mary modification te the ‘national costs found in Permian was ‘in the use of a 14 percent national royalty”figure as against the 12.5 percent applied in the Commission’s earlier decision. Allowance of the higher Louisiana tax also served {o increase the national cost computation: ‘for new gas-well gas. Using historical area 308,052 a es costs reported i in the ‘aie B and C filings. he found an onshore flowing gas cost of 18.18 cents per Mef, which he then rounded upward to an. 18.25-cent ceiling. The Examiner established standards for several quality factors and for delivery pressure, and recommended price adjustments for, deviations therefrom based on the net cost of processing the gas to bring it,up to standard. Except . ‘with respect to Btu, however, he would apply these adjust- ments only to sales under contracts dated: subsequent to the Conmission’s final order in this proceeding. Since nearly. all gas presently. sold in Southern Louisiana is of pipeline quality, ‘the Examiner concluded that’ impleméntation of | the complex procedures set out in Permian for making quality price adjustments would serve no useful purpose for gas: under existing contracts. Btu adjustments. would apply to all contracts nek ae of date. As in Opinion No. 468, the xaminer also recommended a conventionally-determined 12 percent rate of return for ~ ‘both new and flowing gas; he concluded ‘that the reduced risk of —* low — gas in Southern Louisiana as 16 | (308, 053) compared to Dicuian: was counterbalanced by the impor- tance of Southern Louisiana gas. Consistent also with Per- -mian he recommended: (1) No-allowance for Federal in-: come taxes, on the ground that there was no evidence that _the industry had an actual liability; (2) Refund of all.’ amounts collected under rates subject to Section 4(e) pro- ceedings in excess of the applicable adjusted area rate (with the issue of refunds below the “last clean rate” left open for further consideration pending its application in a specific situation) ; (8) A 214 year moratorium on above- ceiling rate .inereases commencing with the date of: the (ommission’s decision ; (4) Establishment of minimum rates of 13.75 cents tax inclusive and 12.25 vents for off- shore gas; and (5) Simplified filing procedures for small producers. The decision made no express provision for special: relief from area rates. | The Dinaniner noted that Pore had left the door open for further consideration “of the Discounted Cash "Flow (DC F) or project method of establishing a new gas price but concluded that the uncertainties ‘and problems. con- nected with the method a : | 308,053. fi ae, | ee 7 as disclosed in the present record rendered it unreliable. as a costing method for new gas. He held that the method depends on a number of unsupported assuinptions and that, ‘hile it may be used by individual producers in choosing between alternative investments, the record does not sup- port its actual use on‘an industry wide basis for making ‘investments or as a tool for fixing just and rw a ee c =) : The Examiner found that, on a unit basis, new gas-well | gas costs in Southern Louisiana were no greater than-those. which existed nationally and that no upward. adjustment Pee >. 17 (308, 053) was required i in translating ‘ieaiuneis costs into area sell He also found that fieunit costs had not risen since the test year and are unlikely to do so in the reasonable future, either in the_area or* ‘nationw ide. ~ : Finally, the Examiner found that the 19, 5-cent.. new gas_ . ceiling for onshore gas would generate revenues. in 1964 of: about 18.64 cents, slightly higher than his 18. 53-cent new ; gas cost. As to new offshore gas, he found: all post-1960 contracts appeared contractually entitled to the 18.0-cent__ - eéiling rate. No defermination. was made as ‘to the adverse. '.revenue effect, if any, of contract prices lower than the’ ceiling rates for old gas. AREA RATEMAKING UNDER THE NATURAL GAS ACT ‘THE PERMIAN DECISION - .The history of the dev elopment of the area approach to - > producer regulation was set out in Opinion No. 468.13 In that proceeding we conicluded that the’ area approach as therein practiced w as bot. Statutorily. and constitutionally - legal and that it “. . . offers a regulatory method which is best adapted to the discharge of our responsibilities for protecting. natural gas consumers while providing the great- ‘est incentive. to producers to continue their search for ‘. needed additions to our gas supply.”?*. . -* 308,054 5 |) pa Contract prices were rejected as a basis for regulation . * and the reserves to production ratio was declared to’ be an = inappropriate regylatory standard or ‘tool by which to - ig evaluate the adequacy ae and reasonable prices. Con- . 18 34 FPC at p. 174-176. 147d. at p. 180. : ~ * s (308,054) cluding that the evidence supported producers’ claims that the gas industry now has and utilizes a substantial e apabil- ity to search for gas reservoirs separately from oil reser- voirs, the Commission found that a system which priced: new gas-well gas, the| only gas to which the directional searching applied, on a basis different from that used in : pricing all other gas should be adopted as the best means of providing fain prices to the producer while also assuring adequate supplies. j In the Permian decision the just and reasonable base area rate for new gas-well gas of pipeline quality was found to ~ be 16.5 cents. per Mef (including taxes) in Texas and 15.5. ‘cents per Mef plus applicable state and local taxés in. New Mexico. For all other: pipeline quality gas, and for gas-well gas under contracts dated before January 1, 1961, the just aa reasonable base area‘tate was found to be lower by 2 ‘eents per Mef. The difference in. prices. reflected adoption of the two-price system. The: new gas-well gas price was based on a current cost study,, Aevclaues on a nationwide basis, designed to show current finding costs, including both. the costs of replacing current production and of making — _ additional findings to meet: growing demands. The price for old g gas-well gas, was determined’ primarily on the basis of the historical costs of Permian Basin gas-well gas. As a check on, the. determination. of the historical costs, the new gas-w ell gas costs were back-trended; the results under the two ypethodsw ere similar. Oil well gas; including resi- due gas derived: therefrom, which the Commission found on the record could not be costed realistically for pricing pur- ‘poses, was found to have a value equivalent to old gas- well gas of the same,quality and accordingly was given the same ceiling price. » Standards were’ specified for pipeline quality gas and the decision required’ adjustments to the base prices for aoe . : boy / be Be ee An (308,069) 125) that -area data have been available for too short a_ time to permit a reliable unit cost ‘determination; but that: the preponderance of the available evidenggp indicates that area-costs, 81? balaneé, are equat to or sli#®itly low er. than. national average new gas costs, : ii* : ’ Finally, the area approach “whieh Caleo suggests does not, in fact, ideftify E&D costs to the Southern Louisiana area. Only. the dry hole costs are largely traced to ‘the | area. The. other costs such’ as unproved and abandoned °° leases, Which account for two-thirds of the total E&D cal- culated by Caleo, liave been allocated, not identified, to the area, The considerations favoring an area approach to E&D, unconvincing to begin ‘with, are not Lest by methods which allocate’ national costs to the area 308, 069 "7 ; e aes hg. ae a . - Dry Hole Costs tsi The Exatniner used.the 1958 Census, 5 cost of $8, 92 per foot, adjusted downward by 3. 5 percent, foK the 1958-60 trend in dry hole drilling costs Shown i in the Appendix A data, all developed in the Permian proceeding and included inthis: ‘record -as Item’ Hoby reference. The Examiner’s $8.60 per foot cost compayes closely with the final 1963 Census Wwost of 8.69°per foot for dry hole expense. The 1963.Census data confirms ‘the trend which. was estimated and projected by AGD witness Roseman in his new eas- well gas cost study. ; gs a basis for adjusting the 1958 Census cost toa 1960 cost. and is consistent with our own conclusions on the trend i in unit eosts. . oe : : ses ’ Both Roseman and’produeer witness Park allocated dry hole footage to gas-in proportion to suecesstful gas well foot- ‘age separately for exploratory ane deyclopment frilling.- Roseman deriv ed a combined ratio of 0. 898 feet of dry hole ~ ® ee MO AN nee ae hc a _ per success gas well foot drilled | ‘on the average for the _ period 1951-61, whereas Park, using . a shorter. -(1956- 61). 7 period*arr ived ata ratio of 0,879. Park multiplied his allo- © cated dry hole gas ° fyotage by a.$10.56 dry hole cost per foot obtained trom-the. Joint Association Survey, dividing the result by. the ave erage y early addétions to non- associated gas ‘supply i in the hase period to obtain a final ftgure of 1.58 ‘cents per Mef, Roseman divided his: 0.898-ratio into ‘a “successful gas well producti ity figure of 587 Mef per foot drilled to yield a figure for the reserve additions per allo- cated drv hole foot ‘of 654 Mef. This was then divided into * the cost"per foot of dry holes, 49), 3] as ROE. 21 to derive a final. cost of 142 cents.- -°- ‘ As pointed: out by the Examiner, the use of the.JAS ° stallion. Was criticized: by the Commission in Opinion No. ' 468 as re flecting a constderable amount of self selection and over: ‘representation of the lar ger producers andAs. inferior "to the. trended 1958 Census costs. No ertidence has been ad: | -dueed in this proceeding which would cause us to réachva* » different cgonelusion. ra loebal Sate eT cay toe | 308,070 EG tale a § The major poe by the producers to the Roseman method are the failure to use the unadjusted 1958 Census . . figure for dry hole costs and to the use of: the 587 Mef per Soot figure as the average of gas. reserves added per foot . of successful drilling in the period 1947-61. As. noted, we.- “see no problem with the use of the questionnaire data .in , establishing ‘an industrywide trend in. these, coats. W ith’: regan]: to the productivity of drilling figures, .the producer 4 7 “1 The difference between this. stnee aaa the $8.60 per’ Saat: “as referred. .to above represents other adjustments .to refleet the - . greater ayerage depth of gas wells and related higher costs and the greater success “ohio of gas wells at the greater depths. 34 EPC 291-2 2. ‘ point out that rece ont revisions Yor the perioti indicate: that the wet ui il produce tivity of dr ilfing dropped from 587 to ays Mef per foot as the result of changed data on the amount vo OES a of footage drilled, However, as found in the, Kxaminer’s - initial decision, the more -recent figures reveal an inerease* in prode tivity of drilling, reae hing a92 Mef per foot dr illo forthe period 1950-1964, slightly higher than the 587 Mef determined in Pe rmian, The: final. figure of 142 cents per | Met does hot: appear te be the subject of any substanti l oxce ptions and i is ae aie | j ‘Other Exploratory | Costs | . Other exploratory costs 9 pare 08 ul, geophysical and land dep: irtmient expenses plus. exploratory vy overhead.” _ Witnesses -Park and’ Roseman centinue to use different ry yo . a6 . - - ‘ 1s data sources and ditférent- estimating. techniques: See 34, EPC at 193. We continue to prefer the Roseman approach: which relates the G& &, efe. to funetiomally related OX. 2 penditures. However, the witnesses computed approxi-/ mately the same level of expenditures ‘for these items. The parties are thus agreed on the amounts. As showrr in the inith decision the final allowance for this item is «: ul- culated at as cost of 1.60 conts per “Mef. _ Adjustment for Exploration’ in Excess of Production The Commission found in Opinion No. 468; that the an- nnal additions to proved reserves have exéeedéd production on-a national basis. To encourage a level of bxploration whieh = -2 ai he ee ° « 4 ' * 22 (Overheads, as ealeulated’ here and in our Permién opinion, actually include more than ‘exploratory overheads ; they also _ include overhead allowances related to producing leases, ete. This overlaps ye rtain* other overhead allowances elsewhere, a matter which we take account of below in Production Operating” Expense’ The record doés not permit correction of overheads — here to the anpropriate lev el of E&D. : eee , 39, - (308,071) 7. Pae apt ex | I fn os ‘ ae te . . would continue .to prov vide for findings ‘in excess. of ’ pro- duetion, the Commission. charged. current production with . ‘an additional atlowance to provide the indu&try with the reve nues needed to: maintain, the. relations ship. between the current findings and production. The propricty of suc ‘h iin adjustment owas explained in-our.Permiun opinion. (34 “RPC: 198-194). The question Is, how muel, additional al-— lowance i is in the public inte est es “\ * it, apparent that no similar. adjustment. is, realitued shite doen costs are capitalized rather than ee ‘See 34 Oa rc 193- 199.) ; As we tioted i in.our Permian opinion, “The aperenriate ratio for these purposes is a matter for careful judgment rathey ‘th: an sciéntific formula.” One material consida ation was and is the recent history of findings-producti ion rela- —. tionships, Findings have av eraged D87 Mef (at 14,65\psi) . per foot of gas-well drilling. We rely on this. average he re for reasons of consistency with our other calculations and because of the fluetualions of annual. finding rs data over short periods. | At 587-Mef the total findings can be esti oe “mated: by trultiplying times gas footage drilled. Compari- - sons car then be made with gas-well gas production datas: Ree Ree ee esarA - MMM¢cf of : ~ World Oil Sy ‘ MM Wet of : _ AGA Gas- ‘ Tone Gas-Well '. Findings: - Well Gas ‘Year. _ Drilling-Footage _ “ Footage x 587 " Production ‘1961 -- 2992: " 17,194 ° 9.7407 1962 | 28, 950 ¢? SO ot ees 1963... “224,533 - 14,401, 10.866 1964 | w 95,597 oe SES 1965 > JERSE OB . 12,302 1966 . , Sess . 15,048 - | 13.241 ener | |: 93,296.) :,. “67,688 ; eee 6, Pe " . -* (308,072): Thus, for reeent years, the finding- production ratio has been 1.378. ¢ La F percent, adjustment previously rejects 1 after full consid- . Amerada’s exceptions, reiterate ‘the. argument: for a 75 eration >. : Wnts 308,072 oo Sn I by the Examiner. W e adhere. to eur conclusion in- -Permian that the adjustment shoulé be 0.37, so that the total E&D allow ance will be 1.37 -times the eost before adjustment. A 37 percent adjustment times the E&D figure of 3.02 cents . results in 1.12 cents as the additional allewance appro- | priate in our cost study that expenses the dry. holes and other exploratory costs. PRODUCTION OPERATING EXPENSE The record’ here is similar-in all essential respects 5. that in Permian with regard to the allowance for produc-- tion operating expense. The various estimates are based on the Appendix B and C questionnaire data. In Permian flect industrywide rather than questionnaire lease. con-- the Commission modified, witness Roseman’s allowance for this item to reflect the allocation. of overhead expense .on the basis of direct: lease costs and eXPeNses | exclusive of QD&A. The result was 2.70 cents per Mef. Roseman’s computation contained an adjustment to re- _densate and gas production. Since the questionnaire re- flected .a disproportionately large amount of condensate production, and since operating - costs are significantly higher on the condensate léases, the adjustment to the lower industrywide level of condensate production resulted . in a downward adjustment in the production operating ex- pense item. . -~ Sek a ING SS (308,072) ; . . ‘The producers now argue that it is not proper to make —, a dewnward adjustment from questionnaire data in de- e termining production_operating expense -while-at the-saie— " time making an upward adjustment to'industry wide data in determining the liquid credit item, The implication ,is that the same amount of, lease condensate. production should — be reflected in. both items. The essence of the argument is that we have determined a liquid credit for new gas-well gas, but have determined a production operating expense for all (old and new) gas-well gas.: The Examiner made reference in his opinion to the ap- parent inconsistent treatment “of these items,. and found that if the condensate production of 108.8 million barrels’ per year implicit in the ‘liquid credit computation were substituted for nationwide condensate production in éal- culating production operating expense, the allowance would become 2.89 cents per Mef rather 308,073 a als than the 2.70 cents. per Mcf Uetermined in Permian. Ad- justed for a royalty of 14 percent instead of the 121% percent allowed in Permian, the figure becomes 2.84 cents. per Met “before royalty allowance.24 : | We agree that the operating expense should ‘reflect eon- _ densate production in amounts consistent with other new gas cost determinations. However, there is an offsetting *4The Exantiner reduced this amount to attribute some costs to reinjected vclumes. We agree with the exception taken by the Amerada group that such an adjustment is erroneous beeause ; lew gas costs are calculated on a net “dry” basis. Attribut ng costs to reinjected volumes, appropriate for flowing gas, pro- vides a way of allocating costs to liquids ‘that’ reinjection| is designed to recover. However; in our new gas costing we have already taken account of the cost of liquids through the liquid - eredit. determination. : . , re .} ? (308,074) ~ consideration; it concerns overheads in the operating ex- pense. Over 10 gata of the 2.84 Gents “operating expense peree nt or more is for area, district t, and : field costs. x hese ov erhéad tteams thus- account for 4 mills or more of the 2.84 cents (15 percent times 2.84). However, overheads * have already, been coveted elsewhere in a sub-component called “exploratory and developmental overheads” ; Which was aétually ‘aleulated by witness Roseman to cover both production and. E&D overheads. (‘There appears to be a further duplication of overhe: uds; off-lease facilities include, some overhead allowances.) A correction : should, it seems, be made in the E&D allowance, but the record is inadequate for this’ purpose, We look forward to an improved record in’ future cases which will permit correction of these dupli- cations, where and to the extent appropriate, In the mean- time We shall retain the 2.70. cents determination, rather than use 2.84 cents, as an interim step in the right direction. NETLIQUIDCREDIT _—_ The Commission deetded in Permian that it is-appropri- ate in the eosting of new gas-well gas to eredit producer revenues received from the sale of liquids ag rainst the costs ° of finding and produeing the gas- “well gas reservoirs in which the liquids are entrained. ., | - 308,074 Pee. oe The lease liquid portion of the eredit reflects reventes received from the sale of condensates separated from gas- well gas at the lease. This credit should reflect industry trends in condensate pr [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385605_0361%3A01. Public record. Not legal advice.