In re Permian Basin Area Rate Cases. — 102, 105 117, 181 261, 262 266, 388, Nos. 90

CourtUnited States Supreme Court
Writing for the CourtHARLAN
Citation88 S.Ct. 1344,390 U.S. 747,20 L.Ed.2d 312
Decision Date01 May 1968
Docket NumberNos. 90,95,98
PartiesIn re PERMIAN BASIN AREA RATE CASES. —102, 105, 117, 181, 261, 262, 266, 388

390 U.S. 747
88 S.Ct. 1344
20 L.Ed.2d 312
Nos. 90, 95, 98—102, 105, 117, 181, 261, 262, 266, 388.
Argued Dec. 5, 6 and 7, 1967.
Decided May 1, 1968.
Rehearing Denied June 10, 1968.

See 392 U.S. 917, 88 S.Ct. 2050.

[Syllabus from pages 747-751 intentionally omitted]

Page 752

Richard A. Solomon, Washington, D.C., for Federal Power commission.

J. Calvin Simpson, San Francisco, Cal., for Public Utilities Commission of Calif.

Malcolm H. Furbush, San Francisco, Cal., for Pacific Gas and Electric Co.

John Ormasa, Los Angeles, Cal., for Pacific Lighting Gas Supply Co. and others.

C. Hayden Ames, San Francisco, Cal., for San Diego Gas and Electric Co. All in support of order of the Federal Power Commission.

Bruce R. Merrill, Houston, Tex., for Continental Oil Co.

Crawford C. Martin, Hillsboro, Tex., for State of Texas.

Boston E. Witt, Santa Fe, N.M., for State of New Mexico.

Herbert W. Varner, Houston, Tex., for Superior Oil Co.

Robert W. Henderson, Dallas, Tex., for Hunt Oil Co.

J. Evans Attwell, Houston, Tex., for Perry R. Bass and others.

Justin R. Wolf, Washington, D.C., for Standard Oil Co. of Texas.

James L. Armour, Houston, Tex., for the Mobil Oil Co.

Louis Flax, Washington, D.C., for Sun Oil Co.

Carroll L. Gilliam, Washington, D.C., and Oliver L. Stone, New York City, for Amerada Petroleum Corp. and others. All in opposition to order of Federal Power Commission.

[Argument of Counsel from pages 752-754 intentionally omitted]

Page 754

Mr. Justice HARLAN delivered the opinion of the Court.

These cases stem from proceedings commenced in 1960 by the Federal Power Commission under § 5(a) of the Natural Gas Act,1 52 Stat. 823, 15 U.S.C. § 717d(a), to determine maximum just and reasonable rates for sales in interstate commerce2 of natural gas produced in the

Page 755

Permian Basin.3 24 F.P.C. 1121. The Commission conducted extended hearings,4 and in 1965 issued a decision that both prescribed such rates and provided various ancillary requirements. 34 F.P.C. 159 and 1068. On petitions for review, the Court of Appeals for the Tenth Circuit sustained in part and set aside in part the Commission's orders. 375 F.2d 6 and 35. Because these proceedings began a new era in the regulation of natural gas producers, we granted certiorari and consolidated the cases for briefing and extended oral argument. 387 U.S. 902, 87 S.Ct. 1691, 18 L.Ed.2d 620; 388 U.S. 906, 87 S.Ct. 2117, 18 L.Ed.2d 1346; 389 U.S. 817, 88 S.Ct. 68, 19 L.Ed.2d 67. For reasons that follow, we reverse in part and affirm in part the judgments of the Court of Appeals, and sustain in their entirety the Commission's orders.


The circumstances that led ultimately to these proceedings should first be recalled. The Commission's authority to regulate interstate sales of natural gas is derived entirely from the Natural Gas Act of 1938. 52 Stat. 821. The Act's provisions do not specifically extend to producers or to wellhead sales of natural gas,5 and the Commission declined until 1954 to regulate sales by

Page 756

independent producers6 to interstate pipelines.7 Its efforts to regulate such sales began only after this Court held in 1954 that independent producers are 'natural-gas compan(ies)' within the meaning of § 2(6) of the Act. 15 U.S.C. § 717a(6); Phillips Petroleum Co. v. State of Wisconsin, 347 U.S. 672, 74 S.Ct. 794, 98 L.Ed. 1035. The Commission has since labored with obvious difficulty to regulate a diverse and growing industry under the terms of an ill-suited statute.

The Commission initially sought to determine whether producers' rates were just and reasonable within the meaning of §§ 4(a)8 and 5(a) by examination of each producer's costs of service.9 Although this method has been widely employed in various rate-making situations,10 it ultimately proved inappropriate for the regulation of independent producers. Producers of natural gas cannot usefully be classed as public utilities.11 They en-

Page 757

joy no franchises or guaranteed areas of service. They are intensely competitive vendors of a wasting commodity they have acquired only by costly and often unrewarded search. Their unit costs may rise or decline with the vagaries of fortune. The value to the public of the services they perform is measured by the quantity and character of the natural gas they produce, and not by the resources they have expended in its search; the Commission and the consumer alike are concerned principally with 'what (the producer) gets out of the ground, not * * * what he puts into it * * *.' FPC v. Hope Natural Gas Co., 320 U.S. 591, 649, 64 S.Ct. 281, 310, 88 L.Ed. 333 (separate opinion). The exploration for and the production of natural gas are thus 'more erratic and irregular and unpredictable in relation to investment than any phase of any other utility business.' Id., at 647, 64 S.Ct., at 309. Moreover, the number both of independent producers and of jurisdictional sales is large,12 and the administrative burdens placed upon the Commission by an individual company costs-of-service standard were therefore extremely heavy.13

Page 758

In consequence, the Commission's regulation of producers' sales became increasingly laborious, until, in 1960, it was described as the 'outstanding example in the federal government of the breakdown of the administrative process.'14 The Commission in 1960 acknowledged the gravity of its difficulties,15 and announced that it would commence a series of proceedings under § 5(a) in which it would determine maximum producers' rates for each of the major producing areas.16 One member of the Commission has subsequently described these efforts as 'admittedly * * * experimental * * *.'17 These cases place in question the validity of the first such proceeding.18

The perimeter of this proceeding was drawn by the Commission in its second Phillips decision and in its Statement of General Policy No. 61—1. The Commission in Phillips asserted that it possesses statutory authority both to determine and to require the application through-

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out a producing area of maximum rates for producers' interstate sales.19 It averred that the adoption of area maximum rates would appreciably reduce its administrative difficulties, facilitate effective regulation, and ultimately prove better suited to the characteristics of the natural gas industry. Each of these conclusions was reaffirmed in the Commission's opinion in these proceedings.20 Its Statement of General Policy tentatively designated various geographical areas as producing units for purposes of rate regulation; in addition, the Commission there provided two series of area guideline prices,21 which were expected to help to determine 'whether proposed initial rates should be certificated without a price condition and whether proposed rate changes should be accepted or suspended.'22 The Commission consolidated three of the producing areas listed in the Statement of General Policy for purposes of this proceeding.

The rate structure devised by the Commission for the Permian Basin includes two area maximum prices. The Commission provided one area maximum price for natural gas produced from gas wells and dedicated to inter-

Page 760

state commerce after January 1, 1961.23 It created a second, and lower, area maximum price for all other natural gas produced in the Permian Basin. The Commission reasoned that it may employ price functionally, as a tool to encourage discovery and production of appropriate supplies of natural gas. It found that price could serve as a meaningful incentive to exploration and production only for gas-well gas committed to interstate commerce since 1960; the supplies of associated and dissolved gas,24 and of previously committed reserves of gas-well gas, were, in contrast, found to be relatively unresponsive to variations in price. The Commission expected that its adoption of separate maximum prices would both provide a suitable incentive to exploration and prevent excessive producer profits.

Page 761

The Commission declined to calculate area rates from prevailing field prices. Instead, it derived the maximum just and reasonable rate for new gas-well gas from composite cost data, obtained from published sources and from producers through a series of cost questionnaires. This information was intended in combination to establish the national costs in 1960 of finding and producing gas-well gas; it was understood not to reflect any variations in cost peculiar either to the Permian Basin or to periods prior to 1960. The maximum just and reasonable rate for all other gas was derived chiefly from the historical costs of gas-well gas produced in the Permian Basin in 1960; the emphasis was here entirely local and historical. The Commission believed that the uncertainties of joint cost allocation made it difficult to compute accurately the cost of gas produced in association with oil.25 It held, however, that the costs of such gas could not be greater, and must surely be smaller, than those incurred in the production of flowing gas-well gas. In addition, the Commission stated that the exigencies of administration demanded the smallest possible number of separate area rates.

Each of the area maximum rates adopted for the Permian Basin includes a return to the producer of 12% on average production investment, calculated from the

Page 762

Commission's two series of cost computations. The Commission assumed for this purpose that production commences one year after investment, that gas wells deplete uniformly, and that they are totally depleted in 20 years. The rate of return was selected after study of the returns recently permitted to interstate pipelines, but, in addition, was intended to take fully into account the greater financial risks of exploration and production. The Commission recognized that producers are hostages to good fortune; they must expect that...

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