Public Service Commission of State of N. Y. v. Federal Energy Regulatory Commission, 76-1352

• Decision Date: 28 September 1978
• Docket Number: No. 76-1352,76-1352
• Citation: 589 F.2d 542
• Parties: PUBLIC SERVICE COMMISSION OF the STATE OF NEW YORK, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, * Respondent, Pennzoil Producing Co., Intervenor. District of Columbia Circuit
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 542

589 F.2d 542

191 U.S.App.D.C. 19

PUBLIC SERVICE COMMISSION OF the STATE OF NEW YORK, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, ^* Respondent, Pennzoil Producing Co., Intervenor.

No. 76-1352.

United States Court of Appeals,District of Columbia Circuit.

Argued March 30, 1977.

Decided Sept. 28, 1978.

Richard A. Solomon, Washington, D. C., with whom Peter H. Schiff, Gen. Counsel, Public Service Commission of State of N. Y., Albany, N. Y., was on the brief, for petitioner.

Allen M. Garten, Atty., Federal Energy Regulatory Com., Washington, D. C., with whom Drexel D. Journey, Gen. Counsel, Robert W. Perdue, Deputy Gen. Counsel, and Allan Abbot Tuttle, Sol., Federal Energy Regulatory Com., Washington, D. C., were on the brief, for respondent.

Alvin M. Owsley, Jr., Houston, Tex., with whom Jeron Stevens and John M. Young, Houston, Tex., were on the brief, for intervenor.

Before BAZELON, LEVENTHAL and ROBB, Circuit Judges.

Opinion for the Court filed by Circuit Judge LEVENTHAL.

Dissenting opinion filed by Circuit Judge ROBB.

LEVENTHAL, Circuit Judge:

In this case we review an order of the Federal Power Commission (FPC). The order is one that approves a certificate for a natural gas producer under the optional certificate program. As indicated, we vacate the order and remand for further consideration by the FPC's successor, the Federal Energy Regulatory Commission (FERC). ¹

AN OVERVIEW

Since our discussion of issues must, of necessity, be technical and extended, we provide a preliminary sketch of this opinion's highlights.

The FPC has developed a number of regulatory programs aimed at alleviating the natural gas shortage. Starting in 1972, the FPC developed the program involved here, the optional certification program. Optional certification gave producers favorable procedures and rate standards as an incentive to increase their exploration and development of new gas sources. In 1974, we upheld the program's procedures. We remanded the program's rate standard, which had used a "test year" basis instead of the requisite actual cost data. ²

Without adequate explanation, the FPC has adopted an optional certification standard under which it will approve rates that return to producers the total cost of gas projects. We find that standard incompatible in several respects with its asserted aim of increasing exploration and development. The chief problem is that the standard is not coordinated with the FPC's main ratemaking procedure, its national ratemaking. National ratemaking already takes care of high cost projects; producers are reimbursed for such projects by their inclusion in the national average cost base. Optional certification would reimburse producers a second time, directly, for the same high cost projects, without any coordination with national ratemaking. There is thus a plain risk of "double counting" billing consumers twice for the same high costs. It may be that the FPC has authority to permit such a double burden on consumers as a reasonable exercise of discretion, but it must at a minimum show there is a deliberate exercise of discretion, by identifying the problem, and its reasons for its approach. This it has not done.

The allowance of some of the costs now included in the "total cost" standard would simply bail out high cost projects. This means a windfall rather than an incentive as to existing projects with costs already sunk. We note that part of the producer's total costs in this case were spent in the 1960's, long before this optional certification program was envisioned. If there is a justification as to existing projects, it has not been advanced by the Commission. A different objection arises as to the provision for new projects whereby outlays to bid on offshore leases are included in total costs. This may give producers an incentive to bid higher for lease acreage. However, insofar as acreage would be leased anyway (at lower bids), it is hard to see how inclusion of such costs would increase the gas supply. Again, the Commission has not advanced any justification. The Commission cannot just shrug off the requirement of justification because another federal agency manages offshore leasing. It has an independent responsibility to consider national concerns which relate to its statutory duties.

The FPC must engage in the reasoned consideration necessary to formulate and justify its rate standards. ³ On remand, it will have the opportunity to engage in such consideration.

I. THE OPTIONAL CERTIFICATION PROCEEDINGS

A. Development of Optional Certification Standards

We begin with a brief review of the origin and changes in the optional certification program.

Under § 7(e) of the Natural Gas Act of 1938, 15 U.S.C. § 717f (1976), the FPC issues certificates of public convenience and necessity for new sales of natural gas. To do so, the FPC must approve the rates charged for those sales. ⁴ Since the task of particularized scrutiny of individual sales was too burdensome, in the 1960's the FPC adopted the practice, approved by the Supreme Court, of issuing § 7 certificates without such particularized scrutiny at rates close to the contemporary rates authorized under §§ 4 and 5 of the Act, 15 U.S.C. §§ 717c and 717d (1976). ⁵ Generally, the FPC would not subsequently require producers to refund rates certified in this way. ⁶ However, refunds were occasionally ordered, and producers were left in some uncertainty. ⁷

To diminish this producer uncertainty, which had "impeded domestic exploration and development," the FPC issued Order No. 455 in 1972. ⁸ That order established an optional procedure for certification. Under the procedure, the FPC conducts an individualized proceeding which determines both whether a § 7 certificate should issue and also whether the proposed rate is reasonable under § 4. If all determinations are favorable, the proposed rate is a firm "refund floor," and no refunds can be ordered. Producers also receive other desirable benefits from such a certificate. ⁹

Order No. 455 did not state what standard would be used in determining the reasonableness under § 4 of proposed rates, or what kind of factors would be considered. The FPC only promised that "certification shall conform to the standards of Sections 4 and 7 of the Natural Gas Act." ¹⁰ However, the Commission declared in a crucial holding that absent "special circumstances," a term of art which invoked very strict standards, ¹¹ it would "accept as conclusive the cost findings embodied in our area rate decisions." ¹² The Commission also declared in a negative way that proposed rates would be considered "notwithstanding that the (proposed) contract rate may be in excess of an area ceiling rate established in a prior opinion or order of this Commission." ¹³

In Moss v. FPC, supra, note 9, we upheld the optional certification procedures. We noted that since no standards for reasonableness had yet been prescribed, "we must assume that the Commission will abide by the standards of the statute and the promises it has made." ¹⁴ Shortly thereafter, we reviewed the FPC's approval of an optional certificate and its first standards. The FPC made clear that it intended to approve higher rates by optional certification than it had by an areawide ratemaking. It certified a rate of 45 cents per Mcf, at a time when the corresponding area rate was 26 cents per Mcf, relying on a "supply project" approach with vague standards as to what was reasonable and in consideration of both non-cost factors and national "test year" cost data. ¹⁵

In reviewing that certification, we noted that the fundamental notion of a "supply project" approach "requiring the Commission to rely on individualized cost data . . . would have to be reconciled with this court's opinion in Moss, which approved, by implication, the Commission's avowed intent to rely on ' "cost findings embodied in our area rate decisions." ' " Consumers Union of U.S., Inc. v. FPC, 166 U.S.App.D.C. 276, 278, 510 F.2d 656, 658 (1974). It was unnecessary in Consumers Union to determine whether the Commission had reconciled its new supply project approach with its prior statements because we reversed the certification for failure to consider actual cost data.

After oral argument in Consumers Union but before our opinion was issued, the FPC changed to a new set of standards for optional certification. It declared that individual actual cost data would henceforth be "relevant" in optional procedures. ¹⁶ It was apparently intended that the standard for reasonableness henceforth would be whether the proposed rate provided full reimbursement plus a full return on projects' total actual costs. ¹⁷ At that time, and in subsequent opinions, the Commission gave almost no justification for its new total-project-cost standard, which was a complete change from the premise of Order No. 455 as originally issued, and a radical departure from the policy of setting reasonable rates based on Average costs of many projects. There was thus no reasoned consideration given to the novel problems of incentive effect and coordination created by a total cost standard for individual projects.

B. Factual Background and Proceedings

In 1960, Union Producing Company (Pennzoil) ¹⁸ made a successful bid in the Department of the Interior's offshore leasing program and acquired an interest in a lease for Ship Shoal Block 186, a 5000 acre area 100 miles off the Louisiana coast. Initial drilling and a tentative sale in the 1960's were unsuccessful. In 1972, when it seemed likely that the FPC would soon approve a rate of 26 cents per Mcf in its areawide ratemaking, the decision was made to drill a new well. That well was successful. In August, 1973, Pennzoil entered into a contract, with United Gas Pipe Line Co. (United), to supply gas from the project at 47 cents per Mcf. ¹⁹ In October, 1973, Pennzoil and United submitted the contract as an application for an optional certificate. As provided under...