General Crude Oil Co. v. Department of Energy

• Decision Date: 12 October 1978
• Docket Number: No. 5-29.,5-29.
• Citation: 585 F.2d 508
• Parties: GENERAL CRUDE OIL COMPANY, Plaintiff-Appellee, v. DEPARTMENT OF ENERGY, Defendant-Appellant, and The United States of America, Counterclaimant-Appellant.
• Court: U.S. Temporary Emergency Court of Appeals Court of Appeals

585 F.2d 508

GENERAL CRUDE OIL COMPANY, Plaintiff-Appellee, v. DEPARTMENT OF ENERGY, Defendant-Appellant, and The United States of America, Counterclaimant-Appellant.

No. 5-29.

Temporary Emergency Court of Appeals.

Argued August 31, 1978.

Decided October 12, 1978.

Rehearing Denied November 9, 1978.

Arthur E. Gowran, with whom Robert G. Heiss, Dept. of Energy, Washington, D. C., and Dina R. Lassow, Washington, D. C., with whom Dennis G. Linder and Barbara Allen Babcock, Asst. Atty. Gen., Dept. of Justice, Washington, D. C., on brief for defendant-appellant.

James V. Carroll, III, with whom Edith H. Jones, Andrews, Kurth, Campbell & Jones, Houston, Tex., on brief, for plaintiff-appellee.

Hugh Steven Wilson, William A. Long and John S. Chang, Latham, Watkins & Hills, Washington, D. C., on brief, for Sunland Refining Corporation, amicus curiae.

Before ESTES, JOHNSON and GEWIN, Judges.

ESTES, Judge.

General Crude Oil Company (General Crude) is the owner of a 50% working interest in the Banning Lease in the West Newport Field, in Newport Beach, California, which it purchased in 1966 from G. E. Kadane and Sons (Kadane). Kadane remains a 50% working interest owner, while General Crude has been the operator of the lease since 1966. Production on the lease by Kadane began in 1948; however, due to a rapid decline in production and low estimates of ultimate oil recovery, an enhanced recovery method, in situ combustion, was begun in 1958.

In situ combustion, or fire flooding, involves the ignition and controlled burning under controlled pressure of part of the heavy crude oil in the reservoir. This process cracks the hydrocarbons into lighter fractions, thereby altering the chemical composition of the crude oil from the natural state in which it existed in the underground reservoirs. G. E. Kadane and Sons, 3 FEA ¶ 80,516 (December 5, 1975). The chemical change is insubstantial.

By letter of December 4, 1974, Kadane requested an interpretation of FEA pricing regulations as they applied to the production from the Banning Lease. The FEA determined that although the product might arguably satisfy the technical specifications of residual fuel oil, it had been sold to Standard Oil of California (SOCAL) as crude oil for use as feedstock and that to apply the new item price rule would require a "radical departure from the historical treatment of the Banning Lease production by Kadane itself." Interpretation No. 75-29, July 12, 1975. The interpretation was affirmed on administrative appeal by FEA's Appeal Decision and Order of December 5, 1975, which concluded that the proper classification of Kadane's Banning Lease operation under the pricing regulations is the production of domestic crude oil; that the production from the Banning Lease is "crude oil" and Kadane is a "producer" of "crude oil" within the meaning of FEA's pricing regulations. G. E. Kadane and Sons, 3 FEA ¶ 80,516.

General Crude sold its share of the crude oil production from the Banning Lease to SOCAL until December 1, 1973. On May 18, 1973, General Crude provided SOCAL with six months' notice of cancellation of their contract so that it might secure a higher price for its share of the Banning Lease production. On November 15, 1973, General Crude contracted with Armour Oil Company (Armour) to supply that company with residual fuel oil at a price higher than General Crude had been receiving from SOCAL. General Crude subsequently installed certain above-ground treating and blending facilities on the Banning Lease, at a cost of approximately $10,000, for the purpose of blending non-cracked reservoir fluids with the cracked product in order to produce what it called "Product 15" for sale to Armour. General Crude has priced "Product 15" under the refiner price rules in 10 C.F.R. Part 212 and since December, 1973, has sold its share of the Banning production for use as residual fuel oil. Kadane, however, has continued to sell its share of such production to SOCAL as crude oil at a price determined pursuant to the producer price rules, in accordance with its historical practice and the FEA Appeal Decision and Order in G. E. Kadane and Sons, 3 FEA ¶ 80,516 (December 5, 1975). R. 344-355.

Following the issuance of a Notice of Probable Violation (NOPV) to General Crude on October 17, 1975, citing violations of the pricing regulations in 10 C.F.R. Part 212 in the pricing of "Product 15," the FEA, on May 21, 1976, issued a Remedial Order determining that "Product 15" should have been priced in accordance with the producer price regulations. The Remedial Order was based on the findings that the product had been treated historically as crude oil, the product met the regulatory specifications for crude oil, the firm met the regulatory definition of producer in 10 C.F.R. § 212.31, and the producer pricing provisions under Part 212 were the most suitable for the proper price of the product.

The Remedial Order was affirmed on appeal upon a finding that the firm had violated Cost of Living Council and FEA pricing regulations by charging refiner prices for its share of the Banning Lease production. General Crude Oil Company, 4 FEA ¶ 80,552 (October 22, 1976). The FEA determined that the in situ combustion technique is a manner of extracting crude oil, rather than a refining process. The agency reasoned that even though the process produces an incidental alteration in the chemical composition of the substance, the subsequent treating and blending do not substantially alter the nature of the product after its emergence from the ground, nor do they represent the complexity and sophistication normally associated with refining.

The agency further found that the product had been treated historically as crude oil and was denominated as residual fuel oil only after the promulgation of the CLC regulatory programs.

General Crude appealed the FEA Appeal Decision and Order to the United States District Court for the Southern District of Texas, where the case was heard on the parties' cross motions for summary judgment on December 13, 1977. On March 14, 1978, the District Court entered its Memorandum Decision and Judgment granting General Crude's Motion for Summary Judgment. The court concluded that "Product 15" met the definitions of crude oil and residual fuel oil contained in 10 C.F.R. § 212.31, and that General Crude's activities in making "Product 15" should be considered refining because "General Crude changes a raw, unusable product to residual fuel oil suitable for use by an ultimate consumer without further treatment and sells Product 15 for use as residual fuel oil." R. 1094. The District Court further found that the "FEA's decision is inherently arbitrary because it is not consistent with FEA regulations, it is directly contrary to the policy objectives of the Emergency Petroleum Allocation Act of 1973 and it contravenes Congressional intent as expressed in the EPAA." R. 1094. Upon motion of General Crude to alter or amend the judgment, the District Court, on May 12, 1978, supplemented its March 14, 1978 Memorandum with findings that the "Federal Energy Administration's finding that General Crude Oil Company is a `producer' of `crude oil' on the Banning Lease is not supported by substantial evidence" and that the "agency's Remedial Order to General Crude Oil Company is in excess of agency authority because it irreconcilably conflicts with agency regulations and Congressional and statutory directives, while failing to achieve any purpose entrusted to the agency." R. 1114. On April 13, 1978, the Department of Energy (DOE)¹ and the United States of America, counterclaimant, filed a notice of appeal from the final judgment entered on March 14, 1978, holding the May 21, 1976 Remedial Order and the October 22, 1976 Appeal Decision and Order invalid.

The Department of Energy states the issue on appeal as:

Whether the District Court erred in declaring invalid and enjoining the enforcement of a Remedial Order and Appeal Decision and Order issued by the Federal Energy Administration ("FEA").

and presents the following questions:

1. Whether the District Court erred in finding that the May 21, 1976 Remedial Order ("Remedial Order"), as affirmed by the October 22, 1976 Appeal Decision and Order ("Appeal Decision"), which determined that the operator of a lease using an in situ combustion process is subject to the producer, rather than the refiner, price rules, is unsupported by substantial evidence.

2. Whether the District Court erred in finding that the Remedial Order, affirmed by the Appeal Decision, is inherently arbitrary because it contravenes the policy objectives of the Emergency Petroleum Allocation Act of 1973 ("EPAA") and the Congressional intent behind the EPAA.²

According to General Crude:

The issue is whether the District Court erred by declaring invalid and enjoining the enforcement of FEA's Order that would require General Crude to sell Product 15 under a "crude oil" price.

and the questions presented are:

(1) Whether the FEA's conclusion that General Crude is a "producer" of "crude oil" rather than a "refiner" of "residual fuel oil" at the Banning Lease under its regulations is unsupported by substantial evidence or exceeds the agency's authority.

(2) Whether the administrative procedures employed by FEA in handling General Crude's Remedial Order and Appeal proceedings comported with a "substantial evidence" standard of review or with constitutional due process.³

From 1966 through November, 1973, General Crude sold all of its crude oil production to SOCAL for use as feedstock. As required by the CLC regulations, General Crude certified to SOCAL that the Banning Lease production was crude oil. While General Crude then made a new contract with Armour Oil Company for the sale of the product as residual fuel oil, Kadane continued to sell its share of production as crude oil to SOCAL. General Crude's price increase to Armour coincided with the CLC's $1 increase in...