City of Chicago, Illinois v. Federal Power Commission, 23740.

Citation458 F.2d 731
Decision Date02 December 1971
Docket NumberNo. 23740.,23740.
PartiesCITY OF CHICAGO, ILLINOIS, et al., Petitioners, v. FEDERAL POWER COMMISSION, Respondent, Pipeline Production Group et al., Intervenors.
CourtUnited States Courts of Appeals. United States Court of Appeals (District of Columbia)

COPYRIGHT MATERIAL OMITTED

Mr. Charles F. Wheatley, Jr., Washington, D. C., with whom Messrs. George E. Morrow, Memphis, Tenn. and Reuben Goldberg, Washington, D. C., were on the brief, for petitioners.

Mr. Peter H. Schiff, Solicitor, Federal Power Commission, at the time of oral argument, with whom Messrs. Gordon Gooch, Gen. Counsel, Abraham R. Spalter, Asst. Gen. Counsel, and Joseph J. Klovekorn, Atty., Federal Power Commission, were on the brief, for respondent.

Mr. Raymond N. Shibley, Washington, D. C., with whom Messrs. James J. Flood, Jr., and Wm. Warfield Ross, Houston, Tex., were on the brief, for intervenor, Pipeline Production Group.

Messrs. J. C. Ohrt and William B. Cassin, Houston, Tex., were on the brief for intervenor, Pennzoil Producing Co.

Mr. Melvin Richter, Washington, D. C., was on the brief for intervenor, Tennessee Gas Pipeline Co. Mr. Harold L. Talisman, Washington, D. C., also entered an appearance for intervenor, Tennessee Gas Pipeline Co.

Mr. Norman A. Flaningam, was on the brief for intervenors, Consolidated Gas Supply Corporation et al.

Messrs. John E. Watson, and Barclay D. McMillen, were on the brief for intervenor, Tenneco Oil Co.

Messrs. John T. Ketcham, and Vernon W. Woods, Shreveport, La., entered appearances for intervenor, Mid Louisiana Gas Co.

Before MacKINNON, ROBB and WILKEY, Circuit Judges.

Certiorari Denied April 17, 1972. See 92 S.Ct. 1495.

MacKINNON, Circuit Judge:

This case is before us on a petition under Section 19(b) of the Natural Gas Act1 to review a decision issued by the Federal Power Commission on October 7, 19692 directing that gas produced by natural gas pipeline companies from leases acquired after October 7, 1969 and which is used on-system3 should be valued for ratemaking purposes at the area rate applicable to independent producers.4 For reasons to be discussed below, we affirm the Commission's decision with two reservations.

I. Background

In order to place the instant controversy in its proper perspective, a brief discussion of the FPC's recent regulatory effort with respect to natural gas is necessary. Three sections of the Natural Gas Act give the Commission its primary tools for regulating natural gas rates. Under Section 7(e),5 a producer of natural gas must obtain from the Commission a certificate of convenience and necessity before it can make sales in interstate commerce. In the so-called CATCO case,6 the Supreme Court held that before such certificates are issued, the Commission must insure that the rates to be charged by the producer are "in line" with those being charged for gas sold by other producers and extracted from the same general area. The Commission thus has some measure of responsibility for the initial prices a producer sets for his gas. When price increases are effected, the second of the Commission's three major tools comes into play. Under Section 4(e)7 of the Act, the Commission has the power to suspend any proposed rate increases for a maximum of five months while it conducts an investigation to determine whether the proposed rates will be "just and reasonable". If five months elapse before the investigation is completed, the new rate goes into effect, but the producer must post a bond conditioned upon refunds being made in case the increase is held unlawful and a refund is ordered by the Commission. Finally, under Section 5(a),8 the Commission may at any time commence an investigation into whether a given rate is "just and reasonable." If it finds that the rate does not meet this standard, it may fix an appropriate rate for the future, but Section 5(a) does not empower the Commission to order refunds.

The Natural Gas Act became law in 1938 and was initially applied by the Commission only to pipeline companies, i. e., those companies which were engaged in the interstate transmission of natural gas. While the methods used by the Commission to determine which rates were just and reasonable underwent some changes over the years, the concept that rates should be based on each individual company's "cost of service" remained at the heart of the regulatory scheme.

In essence cost of service includes, in addition to operating costs, depreciation, etc., the "return" to the company which the Commission calculates by providing a fair rate of return on a rate base equal to the amount prudently invested in utility property, and the "expense" of Federal income tax payable on the allowed return.9

In 1954, however, in the case of Phillips Petroleum Co. v. Wisconsin, 347 U. S. 672, 74 S.Ct. 794, 98 L.Ed. 1035 (1954), the Supreme Court held that the Natural Gas Act applied to all independent producers of natural gas who made sales in interstate commerce. This was the first application of the regulatory features of the Act to independent producers. The effect of this decision on the Commission's regulatory effort was both immediate and spectacular, for Phillips, in effect, recognized that 3000 additional companies were under the Act. The practice of making independent cost-of-service calculations for each of these companies rapidly proved to be so time-consuming that for a while it appeared that the regulatory process itself would be brought to a halt.10

In addition to the length of time required for the necessary calculations, rates based on individual company cost of service exhibited certain other deficiencies. First of all, largely speculative cost allocations made the rates obtained somewhat unrealistic.11 Secondly, because oil and gas wells were typically the product of joint ventures in which several independent producers had an interest, rates based on individual company cost-of-service resulted in great anomalies in the prices paid to producers for gas by both pipeline companies and consumers.12 Finally, unlike the case with the "traditional" public utilities, there was little relationship between an individual producer's expenditures and his income, for luck is an important factor in the discovery of gas as a result of any particular exploratory effort.13 Together, the above factors made questionable the wisdom of attempts to regulate the natural gas industry on the traditional basis of cost of service in a test year.

Recognizing the above deficiencies and spurred by the increasingly large administrative burden with which it was faced, the Commission announced in a statement in 1960 that in the future all natural gas produced and sold by independent producers would be priced at the just and reasonable "area rate". It divided the country into twenty-three geographic areas and set initial or "guideline" prices for all gas produced from wells within each of the areas.14 Full hearings were to be held to determine the just and reasonable rate for each area and the guideline prices were to be used until such determinations were made.

In the Permian Basin Area Rate Cases, 390 U.S. 747, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968), the Supreme Court reviewed the Commission's first area rate determination, giving approval to both the area rate method of regulation and the prices which had been set.15 As developed in the Permian proceeding, an area rate is essentially a rate predicated on a composite rather than an individual cost-of-service. Cost data are gathered from all producers engaged in natural gas production in a given area and weighted average costs plus an appropriate rate of return are used to derive a price for gas produced in that area and sold in interstate commerce.16 In addition to alleviating many of the problems associated with individual company cost of service, area rates were designed to spur the search for new deposits of natural gas. To this end, higher rates were allowed for "new" gas than were allowed for "old" or "flowing" gas.17

In the Permian case, and in the Southern Louisiana Area Rate Cases18 which followed, area rates were applied only to gas produced and sold in interstate commerce by independent producers.19 Pipeline companies which produced gas and used it on-system were not permitted to value such gas for rate making purposes at the area rates. Instead, the expenses incurred in production were included in the pipeline company's cost of service, along with the expenses incurred in obtaining the compression, transmission and other facilities needed for transporting the gas to market.20

The instant proceeding began as a part of the Hugoton-Anadarko Area Rate Proceeding21 when the Commission issued an order enlarging the issues in that proceeding to include the question of whether on-system gas produced by a pipeline company or its affiliate should be valued for ratemaking purposes on an area rate basis.22 This issue was included in the Hugoton-Anadarko proceeding because the Commission believed that the area was one of considerable pipeline production activity and that the proceeding would thus be an "appropriate vehicle" for examination of the issue.23 It soon became apparent, however, that pipeline production in the Hugoton-Anadarko area was not typical of pipeline production throughout the United States. Accordingly, on motion of the Commission's staff, the pipeline question was severed from the proceeding, and a new inquiry, divided in two phases, was instituted.24 The precise issue presented in Phase I, the only phase presently before us, was articulated by the Commission:

What is the most appropriate pricing method to be applied to natural gas utilized in a pipeline\'s interstate system which is produced by the pipeline or its affiliated producing company from leases acquired after the date of determination of this issue.25

Thirty-seven pipeline companies, all those involved...

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