FPC v. TEXACO INC.

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Argument of Mark L. Evans

Chief Justice Warren E. Burger: We'll hear arguments next in 72-1490, Federal Power Commission against Texaco and 1491, Dougherty and others against Texaco.

Mr. Evans.

Mr. Mark L. Evans: Mr. Chief Justice and may it please the Court.

These cases are here on writ of certiorari to the Court of Appeals for the District of Columbia Circuit.

They concern the validity of certain orders of the Federal Power Commission, adopting a new method of regulating the sales of natural gas producers -- sales by natural -- a class of natural -- small natural gas producers in interstate commerce.

Following my argument on behalf of the Commission, Mr. Vaughan will argue on behalf of the other petitioners for approximately five minutes.

They are among the class of small producers that are affected by the Commission’s orders in this case.

It is now almost universally recognized that we are experiencing an increasingly critical shortage of natural gas.

The orders at issue in this case are part of the Federal Power Commission’s vigorous program for combating that shortage by encouraging new exploration and development of the natural gas reserves in this country.

The orders rest on the Commission’s authority under Section 16 of the Natural Gas Act which gives it the authority to classify persons within its jurisdiction and to prescribe different requirements for different classes.

The class involved here is not a new one.

The Commission has previously given specialized rate treatment to this group of small producers and this Court held in the Permian Basin case that “the problems in public functions of small producers differ sufficiently to permit their separate classification.”

Those problems in public functions were described in some detail in the Permian opinion and the facts are the same today.

Small producers account for only about 10% to 15% of the gas that’s transported in interstate pipelines and their prices generally follow the prices that large producers are able to get for their gas.

But while they contribute only a small portion of the interstate gas, they have traditionally been responsible for about 80% of the exploratory drilling, much of it in the areas that have not previously been explored which makes it a highly risky operation.

The result is as this Court stated in Permian and I quote again, “Their contribution to the search for new gas reserves is significant, but it is made at correspondingly greater financial risks and at higher unit costs.

The principle impediment to the small producers’ exploratory efforts has been a lack of adequate financing.”

The comments submitted to the Commission in this proceeding for example at page 84 of the appendix suggest that small producers must rely principally on revenues from current sales in order to finance their exploratory activities.

That is so because the hazards of their exploration are such that it makes it difficult to depend upon debt financing and because the small producers unlike the large producers seldom have other operations to generate funds that they can use for exploration.

Given this situation, the Commission devised in this rulemaking proceeding, a new regulatory program designed to take advantage of the small producers’ unique situation.

I want to emphasize that that this Court has before it only the orders that would setup a program.

It is not reviewing any order applying this program to the facts of any particular case.

The court’s review consequently is a limited one.

The only question is whether the Act prohibits the Commission from experimenting along the lines that it has chosen to follow.

And this Court has stated on a number of occasions that one which challenges the validity of orders of the Federal Power Commission bears a heavy burden of showing that it will lead unjust and unreasonable results.

The Power Commission’s plan has these features.

First, instead of following the ordinary procedure of having each new sale of natural gas certificated in the public conven -- as in the public convenience and necessity, small producers are granted a blanket certificate which covers all sales up to a stated maximum annual volume.

This particular feature is not a new one either.

A similar blanket certificate procedure was established as part of the Permian proceeding and was approved by the Court in principal in that case. Second, the small producer acting under this blanket certificate may sell gas at whatever contract price he is able to negotiate even if it is higher than the area wide maximum rates that have been established by the Commission as just and reasonable for other purposes.

Now this aspect of the order is new.

The prior blanket certificate procedure -- permitted sales at rates up to area maximum, but not higher.

The purpose in this order was to give some play to market forces to see whether prices would in fact exceed the area maximums and if so whether they would make it more attractive and more feasible for the small producers to engage in the kind of exploratory drilling that been its history.

A third feature of the order is that in order to permit the small producer to rely on his current revenues and planning his exploratory program, the rates that are collected under the contracts are not subject to refund, even if the Commission later determines that the rates were un -- were higher than the just and reasonable rate.

Now this is in effect is an advanced determination by the Commission that it will serve the public interest to announce that it will not suspend and make subject to refund the new rates filed by -- new rates in the new small producer contracts, but rather will limit itself to acting prospectively under Section 5 of the Natural Gas Act to reduce any rate that it concludes is unreasonably high.

Under the Commission’s plan, its review of the reasonableness of the small producers' rates will take place not in a producer proceeding, but rather subsequently in a pipeline proceeding.

Under the plan, the pipelines are authorized to track the increased rates resulting from the new small producer contracts.

The tracking proceeding in which the pipelines seeks to pass on the increased rates to its customers is the one in which the Commission will determine the reasonableness of the underlying small producer rates.

The pipeline is required under the orders to show that its operating expenses, all of its operating expenses, in this case particularly its, purchased gas costs are not unreasonably high.

Justice William J. Brennan: well, I gather Mr. Evans, if in the pipeline proceeding it's determined that the producer rates are too high, there's no requirement that the small producers’ refund, (Voice Overlap).

Mr. Mark L. Evans: That’s right.

There's no -- there is no requirement that the small producer refund to the pipeline.

On the other hand, if the determination is made that the rates are unreasonably high, the pipeline is not permitted to pass on those increased rates to its customers.

This serves as a bond or protection for the ultimate consumer who thereby avoids having to bear the brunt of any unreasonably high rates.

Justice William J. Brennan: Judge Fay disagreed with that didn’t he?

Mr. Mark L. Evans: Well Judge Fay, he concluded that it would be appropriate to strike the no refund aspects of the -- of this order.

But really, that would destroy the heart of the program because, the ref -- the no refund assurance to the small producer is what the Commission is hoping will give him a sense of security in his current revenues that will permit him to make the planning that’s necessary.

At the same time it has the very important function of giving an incentive to the pipeline to bargain the prices down.

What the Commission has done is -- has freed the small producers and the pipelines to negotiate rates higher than the area maximum, but they wanted to leave some bite to the market forces that would otherwise be -- would be applied.

And if the pipeline is sure that it could it always either pass on its rates that are increased or get refunds if they’re ultimately determined to be unreasonably high, it has a free passage and it needn’t be terribly concerned about the rates barring, you know, the ultimate consumer, if it’s running into problems with other forms of energy.

Of course there are of different problems if they're on the line, but ordinarily he’s not going to be in that situation.

So, the no refund assurance is really at the very heart of this program and without it I don’t think the program has it all the -- the meat that the Commission it intended to have.

Well, the result of the features as I’ve described them is that the small producer is assured that his current revenues are not subject to refunds so that he can rely on them in making his plans for exploration.

The pipeline which faces this risk of absorbing the losses if it enters into contracts, they’re unreasonably high, has an incentive to bargain the prices down.

And finally, the consumer whose protection, the Act is principally designed, to assure is fully protected because there is no -- because no unreasonably high small producer rates will be permitted to be passed on by the pipeline.

Now, the plan is without doubt an experimental one and the Commission intends to monitor closely the results under the plan.

In particular, it stated at page 145 of the appendix that if it finds the program as adverse, the -- affecting the interest of consumers, it will take appropriate corrective action.

The Commission’s plan is attacked in a variety of grounds, but they can properly redo -- be reduced I think to three.

Justice William J. Brennan: Is there a definition of small producers?

Mr. Mark L. Evans: Small producers, Mr. Justice are defined, I’m not sure where in the order, but they’re defined similar -- similarly to the way they were defined in the Permian case to include all --

Justice William O. Douglas: Footnote 5 on page 6, page 5. Footnote 3 on page 5 of your brief.

Mr. Mark L. Evans: Oh!

They’re defined to include producers whose annual sales in interstate commerce are below the level of 10,000,000 Mcf, that is thousand cubic feet of natural gas.

The first argument that’s made against the validity of the Commission’s order is that it abandons the statutory standard of just and reasonable rates and this is the basis upon which the Court of Appeals relied in setting aside the order.

The second argument is that the Act does not permit rate review in this indirect manner that is postponing the review until the pipeline proceeding; and finally, its claim that the plan is unfair to the large producers and pipelines who purchase gas from small producers.

The Commission’s order specified that its review of the small producer, the reasonableness of small producer’s rates in the pipeline proceedings would be in accordance with this -- with a standard that I think it might be worth looking at closely, it appears at page 142 of the appendix.

It stated there slightly below the middle of the page that the standard will be whether or not the small producers’ rate, that is the increase that the pipeline seeks to pass on, is unreasonably high considering appropriate comparisons with highest contract prices for sales by large producers or the prevailing market price for intrastate sales in the same producing area.

The Court of Appeals thought this was a departure from the statutory just and reasonable standard because it erroneously assumed that the Commission was tying its reasonableness determination exclusively to the two market factors that the order mentioned, namely, the highest contract prices and the prevailing intrastate rates, neither of which of course the Commission regulates.

This reliance upon this reading of the order is made clear by the Court of Appeals at page 12 (a) of the appendix to the petition.

We don’t take the position here that an order tying reasonableness to those factors would never be appropriate.

In fact this Court in Permian suggested that in proper circumstances, it might be appropriate, but we do say this is not what the Commission did in this case.

The order does not suggest that the two factors that the Commission identified would be the only ones that will be taken into consideration.

The standard is one of unreason -- whether the rate is unreasonably high and the Commission emphasized that it would consider all relevant factors.

Justice Byron R. White: Well, the order isn’t all that fair, is it?

It takes a little bit of argument about it?

Mr. Mark L. Evans: I think that’s right.

It’s not the model of clarity, the (Voice Overlap).

Justice Byron R. White: Just as the Court of Appeals couldn’t read it like as you suggested, Mr. Evans?

Mr. Mark L. Evans: That’s right.

You say the Court of Appeals it’s in --

Justice Byron R. White: The Court of Appeals didn’t read it like --

Mr. Mark L. Evans: They didn’t read it that way, but I think it was an incorrect reading.

Justice Byron R. White: Why does that the Commission objects to putting it in another way?

Mr. Mark L. Evans: Well, the Commission believes that the --

Justice Byron R. White: I mean it’s a -- I suppose the Court of Appeals might come up with different result if you said in the -- plainly in your order, what you claim the order said.

Mr. Mark L. Evans: Well, the Commission certainly had that option at one point, it doesn’t have it at this point.

Justice Byron R. White: It certainly doesn’t though --

Mr. Mark L. Evans: But there is a substantial problem of delay here.

The Commission believed that if the order was clear enough and that there was no need to remedy any ambiguities with this -- after the Court of Appeals opinion.

And the -- to take it back and start all over would --

Justice Byron R. White: I suppose I -- this is one way of saying what it means, that you’re now saying this is precisely what it means and --

Mr. Mark L. Evans: That’s one way.

This Court in the sense --

Justice Byron R. White: So now you’re sending it back, now that you’ve said what it means.

Mr. Mark L. Evans: Well, in the sense there is no, you know, if the Court construes it the way we suggest it should be construed, that’s what the order means.

Justice William H. Rehnquist: This thing began in 1970, didn’t it?

Mr. Mark L. Evans: That’s right.

Well, while there is some ambiguity that I have to concede.

It seems to reasonably clear that while prevailing market prices are unquestionably among the factors that it be -- are to be taken into account, the Commission has not indicated that it is the only considerations that would be taken into account and for that reason it's not -- the standard is not an abandonment of the statutory just and reasonable standard.

The second issue is whether there is anything in the Act to prohibit the kind of indirect regulatory scheme that the Commission adopted in this case.

The respondents argue that the Act requires direct review in a pipeline proceeding, but they have pointed to nothing in the Act that so specifies and this Court has repeatedly held in Power Commission cases that under the just and reasonable standard, it is the result that matters and not the regulatory method that’s used.

Since this scheme in our view is reasonably designed to result in just and reasonable rates, it does not matter that the indirect method is the one that is used and it does not matter that the Commission has departed from its prior practice of viewing these matters in direct proceedings in producer proceedings.

In fact this Court in the Sunray DX case 391 U.S. upheld a similar indirect regulatory scheme.

The issue there was whether the Commission was required under the Act to consider in a producer certificate proceeding whether there was a public need for the gas contracted for.

The Court upheld the Commission’s determination that the question could more appropriately be considered in the pipeline proceeding and the Court held that the Act requires no more than that there’d be an adequate forum in which the issue is to be ventilated and that the pipeline proceeding was an adequate form in which to ventilate it.

Finally the pipelines argue that the Commission’s plan will be unfair to them because it will impose upon them what they refer to as no burdens and due risks and because the reasonableness standard articulated in the order in their view is to vague.

The fact is, however, that the pipelines have always borne the risk that an operating expanse will be deemed by the Commission to be unreasonably high.

In the past, the Commission has not required special justification of purchased gas costs because it was clear at that point that the cost were reasonable, the Commission having already made that determination.

But there is no reason to think that the pipeline has by virtue of this practice and tradition become insulated to closer scrutiny of those purchased gas costs where their reasonableness has not been determined in advance.

The Commission here has not invented a new burden or risk.

It has simply highlighted an existing one.

There's no question that the pipelines would be happier were they guaranteed the right to pass on any rates that they were able to negotiate with --

Justice Byron R. White: Do you -- the Commission doesn’t contend that the order would permit refunds, you -- your regulation is going to be wholly prospective, I take it?

Mr. Mark L. Evans: With respect to the producer rates, it does permit refunds if the pipelines file for an increase to pass --

Justice Byron R. White: Oh!

I understand that.

Mr. Mark L. Evans: Yes sir.

Justice Byron R. White: So maybe the pipelines are on the hook, but --

Mr. Mark L. Evans: Yes.

Justice Byron R. White: -- the producer, if you determine that producers have been charging unreasonable rates to the pipeline --

Mr. Mark L. Evans: That’s right.

Justice Byron R. White: -- you’ve committed yourself apparently not to order any refund?

Mr. Mark L. Evans: That’s correct.

Now that does not --

Justice Byron R. White: Even though the rate is determined to be unreasonable?

Mr. Mark L. Evans: Right and, you know, the Act does not require the Commission to order refunds in any case.

It’s wholly within the Commission’s discretion.

I don’t even believe that it’s a matter that can be reviewed by the courts whether in a particular case a raise should be suspended and made subject to refund.

And what the Commission has done here is made that determination, exercised its discretion with respect to a class of the sales.

Justice Byron R. White: How about the -- what about under the Federal Power Act, is there any independent cause of action for a refund by a consumer or a pipeline?

Mr. Mark L. Evans: Under the Natural Gas Act?

Justice Byron R. White: Natural Gas Act.

Mr. Mark L. Evans: I don’t believe there is.

I frankly confess ignorance.

I've never seen one so I assume there's not.

I believe it -- that the Commission --

Justice Byron R. White: If there was, it wouldn’t do you much good to say that we’re not going to order any refunds?

Mr. Mark L. Evans: Well, I guess right, except I suppose the Commission could, by rule make -- Oh!

For their independent, no, I agree but I don’t believe that there is such a private cause of action.

Justice Byron R. White: (Voice Overlap) for managed business, there’s an independent you can sue for it?

Mr. Mark L. Evans: Right.

I believe the only way that a refund is going to be ordered under the Natural Gas Act is by the Commission in a proceeding under Section 4 (e) of the Act.

I know of no other basis for refunds.

Finally, the pipelines claim that the standard is too vague for them to apply, but that claim really is in the present posture one that could be made with respect to any standard that has not yet been applied.

In fact the statutory just and reasonable standard could be certainly attacked on the same ground as being too vague.

The problem is, we’re dealing with the standard in the abstract and the Commission has indicated two of the factors that it will take special account of in making its reasonableness determination.

The only way to find out whether the standard is really clear enough to be workable is to let it be put into practice and to see what happens.

The Commission of course must be judged in the end by the justness and reasonableness of the results that ensue under the Act.

But it's not at this point, there is no reason to anticipate that the standard here will be so unworkable that the Commission should not be permitted to put it into effect on an experimental basis.

Chief Justice Warren E. Burger: Mr. Vaughan.

Argument of Ben F. Vaughan Iii

Mr. Ben F. Vaughan Iii: Mr. Chief Justice, may it please the Court.

I represent eight individuals, small producers, none of whom sell more than 2,000,000 Mcf of gas a year at prices ranging from 14 to 24 cents.

The point which is central to this case and apparently concerns this Court the most is the risk of a refund obligation existing and yet not being paid by the party who received the money.

That certainly is the crux to the case.

What then is the risk that there will be a charge by a small producer that is too high and then we must look to the position of the small producer --

Justice Byron R. White: Well, but the refund obligation never comes from the part imposed by the Commission?

Mr. Ben F. Vaughan Iii: It -- Your Honor, it maybe brought in action by a Public Service Commission, but it must be brought in the forum of the Commission and must be brought by the Commission.

Justice Byron R. White: Well, if the -- what's the source of the obligation to refund, only if Commission determines it?

Mr. Ben F. Vaughan Iii: Only if the Commission determines that it -- that the rate that was charged was unjust and unreasonable, Your Honor.

Justice Byron R. White: I thought that -- does it automatically follow that there is a -- that there's a refund obligation if the rate is determined to be unjust and unreasonable?

Mr. Ben F. Vaughan Iii: Not at all, Your Honor.

It's within the Commission’s discretion and indeed the court, this Court denied certiorari in the case called Prado Oil Company in which the Commission had taken equitable factors into consideration and had not ordered the --

Justice Byron R. White: But there's never going to be any -- under this order there's never going to be any refund obligation then?

Mr. Ben F. Vaughan Iii: No, Your Honor and I would suggest to the Court --

Justice Byron R. White: I mean there’s nothing of --

Mr. Ben F. Vaughan Iii: I -- beg your pardon Your Honor, please finish your question, I --

Justice Byron R. White: I would suppose you could restate that the worry is being that maybe there ought to be a refund obligation, is that what you’re suggesting?

Mr. Ben F. Vaughan Iii: Yes.

It did -- it appeared to me that the Court was worried that there should have been a refund obligation and it's my suggest that the market position which is occupied by the small producers will produce a rate which the Commission could reasonably conclude would be a refund for, that the market price should be the refund for, where it is reviewed continuously by the Commission albeit perspectively.

That the incentive granting by permitting the small producer to receive his market price will enhance exploratory effort of the explore -- of the small producer and at least it should -- could show -- so be determined by the Commission that this enhancement would transpire.

The small producer does not have either historically or under the terms of Order 428, the power to charge whatever price he likes.

Historically, the small producer leases land or sub-leases land, it's called farming out from the large producer.

He is all set by the large producer.

He takes the land and does the drilling and earns a small portion of the acreage that the large producer has.

If he’s successful in his exploratory wells, the large producer then drills developmental wells offsetting him.

A pipeline comes to the large producer who is directly regulated and says, “Will you sell me your gas?”

The large producer said, “Yes,” he comes to the small producer with the same rate.

He says, “Will you sell me your gas?”

Small producer says, “No.”

Pipeline says, “Fine, will just drain you by buying it from the large producer.”

He has no market if he doesn’t agree.

Secondly, --

Justice Harry A. Blackmun: Mr. Vaughan, what is the economic reason that as Mr. Evans stated, 80% of the exploratory work is by the small producer rather than the large one, theoretically the small one doesn’t have the funds to do this?

Mr. Ben F. Vaughan Iii: Why does all this transpire?

Well, Your Honor it -- for one, I think two basic reasons.

One is that the large producers tend to hunt for big game and another phenomenon, that transpires in the industry is that the geophysical techniques, the science of oil exploration does not yield and has not yielded an increased success ratio in the -- over the years.

They’re finding the same number of wells per -- same number of productive wells per wells drill now that they were in the 20’s and the large producer says, “Small producer, you go out and drill.

We’ll invest our capital in large leased box, so that if you do find something then we can spend all our money in development.”

The second class of gas of course is your flowing gas and they -- the contract prices now prevail for flowing gas for small producers, but if we look at how much of the contract prices will exceed, the directly regulated just in area rates, we will see that there is only about 25% of the contract provisions which permit the gas, the small producers, indeed the gas of all producers, according to the study, gas of all producers to exceed the just and reasonable area rate and it is this increment, this 25% increment of the small producer -- production or approximately 3% of the total gas upon which the small producer must rely to finance his exploratory efforts.

I thank the Court.

Chief Justice Warren E. Burger: Very well, Mr. Vaughan.

Mr. Boland.

Argument of Christopher T. Boland

Mr. Christopher T. Boland: Mr. Chief Justice and may it please the Court.

I -- I’m representing the Interstate Natural Gas Pipeline Association of America which includes in its membership virtually all the major pipelines in the United States.

I’m also arguing for the major producers in this case.

Mr. Schiff who is the general counsel in New York Public Service Commission will follow me.

We have a rather unusual situation here and this maybe a first, a first time in my memory that the three segments of the industry are unified.

We find the pipelines, we find the major producers, we find the consumers represented by Mr. Schiff, all unified in their attack against Order 428 issued by the Commission.

Now, I would like to make one point very clear in the -- at the outset.

No one of us is opposed to giving the small producer a higher rate.

We think that based upon a proper record that the Federal Power Commission may well justify a higher rate which is just unreasonable for the small producer under the circumstances, but such is not the case here.

There is no record in this case.

There are few comments in the transcript of an informal conference and that’s all we have.

Now, our friends here in the Government have told us in their reply brief that the issue is not whether the FPC can exempt the small producer from the Natural Gas Act and they say that the Commission hasn’t claimed this authority and they say they don’t argue that the statute permits it and they say that the contention of the Act requires all producer rates to be just and reasonable is beside the point.

Now, the real issue as we see it is the exemption of the small producer and the how -- no matter how you twist or turn it, that is exactly what the Commission did in Order 428 and in its notice, the original notice issued in the rulemaking proceeding, it was frankly captioned, “Exemption of small producers in regulation” at joint appendix 1.

The notice also stated that the small producers would be exempt from all the provisions of the Natural Gas Act and Regulations other than an annual report on volumes and sale and this in the notice.

So let's go with the Order and in the Order, the Commission told the small producers, “We seek to assure the small producers that when he enters into a new contract for the interstate sale of gas, the provisions of his contract will not, will not be subject to change” joint appendix 137.

Now we think that these, taken together, clearly indicate that the Commission contemplated an exemption and indeed the Court of Appeals wasn’t mislead on this point.

But in the exemption, the counterpart of the exemption in order to give some camouflage to some sort of regulation, what they did was to shift the regulatory responsibility from the Federal Power Commission to the pipelines and large producers.

And this at a time when the pressures are on us as purchasers to pay the market price, they are asking us to substitute our regulation for theirs under the Natural Gas Act.

As mentioned the two standards in 428 were given as the highest contract price by large producers or the prevailing market price.

Now, we had some problems in the vagueness of these two terms, but much less than we have as a result of the reply brief filed by our friends here and I’ll get to that a little later.

Now, as to the large producers, they had a third standard and they had have a market differential that was prevailing in the area, but the purpose of Order 428 was absolutely obvious.

It was to give the small producers a price in excess of the just and reasonable price.

Otherwise there was absolutely no purpose in the Commission issuing Order 428.

It’s clear that this is what they had in mind.

And in so doing, and giving these standards, they gave the pipelines what we thought was somewhat of an assurance.

They said, “The standards, these two standards, the standards also provide pipelines with a more concrete guide for their future actions than what exists in the absence thereof.”

Simply put the Commission wanted the pipelines to know in advance the boundaries within which they could freely contract the small producers.

As I’ve indicated, we think that that is -- the Order 428 adds up to complete exemption for the small producers.

We think that it’s in absolute contravention of the clear and unequivocal terms in the Natural Gas Act and the Natural Gas Act says, Section 4 says, “All rates shall be just and reasonable and any rate that is not just and reasonable is hereby declared to be unlawful.”

Section 4 (d) says, “No natural gas company, and there is no argument that a sale by a small producer here involved in interstate commerce for resale is a natural gas company within the meaning of the Act.”

Section 4 (b) says, “No natural gas company shall make any claim, undue preference or maintain any unreasonable difference in rates.”

Section 4(c) says, “Every natural gas company shall file with the Commission, schedule showing all rates for any transportation and sale.

Section 5 is likewise clear.

It says, “Whenever the Commission shall find any rate charged by any natural gas company is unjust, the Commission shall fix the rate as the just and reasonable rate.”

Now, the Commission in Order 428, and that’s what we’re dealing with here relied for its exemption, relied on the fact that Sections 4, 5, and 7 which is a certificate provision, are not mandatory, but discretionary.

This is what they said in the order.

They’re not arguing that now before this Court, but this is what they said in the Order, that it’s not mandatory and they’ve cited Mr. Justice Clark’s comments in FPC v. Hunt and also the Permian case.

Now, Mr. Justice Clark’s statement was pure dictum.

He was talking about NLRB Act which allowed the Natural Labor Relations Board to decide whether or not it would exempt certain types of activities.

There’s no such similar provisions than the Natural Gas Act and in the Permian case, the Permian case has no precedent for what the Commission purported to do in 428.

In the Permian case, the Commission had taken small producers, classified them separately, issued a blanket certificate and said, “As long as you do not exceed the 10 billion cubic feet a year, you don’t need any further certificate authorization for your sales in interstate commerce as long as and only under the condition that your rate to the pipeline purchaser does not exceed the just and reasonable rate and that’s precisely what the Permian case says were and has no basis at all for the Commission’s exemption.

Justice Byron R. White: Oh!

Mr. Christopher T. Boland: Yes.

Justice Byron R. White: What would you -- what argument would you make if the order actually said what the Commission says it said?

Let’s assume the order says in plain language, is precisely what the Commission claims it says.

Mr. Christopher T. Boland: Are you saying what they claim here?

Justice Byron R. White: Yes.

Mr. Christopher T. Boland: Before the Court?

Justice Byron R. White: Yes.

Mr. Christopher T. Boland: I would say that the Act precludes it, absolutely precludes it.

There is no way -- what they initially relied on were these two citations to the Section 16.

And Section 16, is merely a catchall provision on many statutes but gives the power to issue regulations to carry out the purposes of the Act and to classify certain acts to carry out the purpose of the Act.

Justice Byron R. White: But they say, they haven’t exempted any one and they say they are regulating --

Mr. Christopher T. Boland: They say that (Voice Overlap)

Justice Byron R. White: -- in this Order.

Mr. Christopher T. Boland: They say they’re regulating indirectly through the pipeline.

Justice Byron R. White: And that when -- when and if they find a small producer charging unreasonable rate, they will correct it.

Mr. Christopher T. Boland: Through the pipeline rates?

Justice Byron R. White: Well, that’s what they -- they say that --

Mr. Christopher T. Boland: Well, they say that.

Justice Byron R. White: Yes.

They say that.

Mr. Christopher T. Boland: And they say that the standards now, that the market standards are the just and reasonable standards.

They’re not claiming that they’re --

Justice Byron R. White: Well, let’s say that they are two -- it does have two other the factors they take it in consideration, that’s all they say.

Mr. Christopher T. Boland: Well, the -- yes.

But going back to and --

Justice Byron R. White: Well, I want to say -- I want to just to accept the -- their Order as they say it now as -- except that -- except the fact that the Order means what they say it means now.

Mr. Christopher T. Boland: I -- you mean that the all other relevant factors really gave them the power to take into consider all -- raising all the things they’re now talking about.

Justice Byron R. White: They say that, they say that -- that they do take into a lot -- they -- that they plan to take into consideration a lot more than just those two factors, that’s what they say.

Mr. Christopher T. Boland: Yes, they do.

Justice Byron R. White: Well, I’ll accept that for the moment.

Mr. Christopher T. Boland: Alright.

Justice Byron R. White: Now, what's illegal about their proceeding along this route?

Mr. Christopher T. Boland: I think the standard is an impossible one to -- for the pipelines to live by.

Justice Byron R. White: It may be impossible, but is it illegal under the statute?

Mr. Christopher T. Boland: Yes.

I think that’s illegal.

Justice Byron R. White: Why is it?

Mr. Christopher T. Boland: I think in all the decisions, just and reasonable rate does not mean the market price.

Now, that maybe reasonable or prudence, in our opinion, there's this vast difference in regulatory statutes and also the decisions of all the courts between a prudent act of a pipeline, let's say in going out and buying that any -- at a price not in excess to the market, but that may not be the just and reasonable price --

Justice William H. Rehnquist: When they say market price, it’s just one factor.

They don’t say they’re going to rely on it?

Mr. Christopher T. Boland: Well, they did, Mr. --

Justice Byron R. White: What would they be doing now?

Mr. Christopher T. Boland: They don’t know, that’s right.

But what they do substituted for it is, they say that the sophisticated pipeline purchaser can at the time he’s negotiating a contract that he can ask the producer for his costs.

Now the Federal Power Commission has been after producer cost for 20 years and hasn’t been successful yet.

But notwithstanding this, they have suggested that one of the things that we do is ask the producer for his cost.

Now, that’s going to be one of the guides that they would take into consideration.

At the time they determined whether we have to refund or whether we don’t.

They’ve also said, “Okay, the pipelines need for the gas,” the availability of other gas supplies, the amount of gas dedicated under contracts, the rates of other small producers and recent sales and what?

And any other consideration that may suggest the reasonableness of the rate.

What kind of a standard is that?

What kind of a guideline is that?

And what the Commission has done here, here we are in a sellers’ market, there is no question that it’s a sellers’ market.

There is a terrific demand for gas, unmet and the Commission is shifting the rate responsibility, the regulatory responsibility to the pipeline purchaser in a sellers’ market and expects us to regulate the rates so that it will come up with the just and reasonable rate.

Now, we say that that’s impossible task and one that’s absolutely contrary to clear language of the Natural Gas Act.

Justice Byron R. White: And there might be some problems with the pipelines getting together, it might be?

Mr. Christopher T. Boland: [Laughter] Yes, I think there could be problems in pipelines getting together and then the producers are well aware of that.

But in any event, I’ve covered the Permian, what -- what's happened here is, we’ve seen a patchwork post hoc by the Federal Power Commission all the way through this.

The first thing that happened was the notice.

On the notice there was clear language that the pipelines would be able to pickup any increase or any price paid.

I use the word tracking, that’s what tracking means in our order before the Commission.

In the -- in the order that came out, they said, “No, we’re going to put indirect regulation.

We’re going to hold you responsible.”

And at this point there was no change in the producer price at all, prospective or otherwise, nothing.

The first time we came across a reduction in producer price was before the Court of Appeals in the briefs filed by the Government, in their briefs in the Court of Appeals.

But at that time they were still adhering to the fact that the provisions of the Natural Gas Act were discretionary and that they were recognizing in fact that they were exempting the small producer, but within the purview of their powers under Section 16 of the Natural Gas Act.

But now, before you, they’ve abandoned all that and they now say, “That’s all beside the point, that’s all beside the point.”

When we’ve got a new ball game here and what we’re saying to this Court is that the rate -- ultimately will be a just and reasonable rate were abandoning the standards at all.

And the indirect regulation is nothing more than Sunray DX.

Sunray DX had to do with the need for gas, not rates, which is the heart of the Act as found by this Court in the famous Hope case.

The heart of the regulatory scheme is the rate section.

But what they’re talking about is the certificate case, where the need for the gas, do you determine that in the pipeline case or do you determine it in the producer case.

I think that’s a totally different case than the one we have here as to the direct rate responsibility being shifted to the pipelines when the clear responsibility is vested in the Federal Power Commission.

We think all of this is contrary to the rule of the Chenery case.

We don’t think that they come and patch their order up.

We think that this Court will decide this on the basis of 428.

Chief Justice Warren E. Burger: What do you about to say Mr. Boland about the current power of the Commission to experiment with (Voice Overlap) --

Mr. Christopher T. Boland: I’m glad you mentioned that Mr. Chief Justice because this is not an experiment and they keep talking about this and Mr. Justice Rehnquist raised the question well wasn’t this started in 1970, it was.

The notice issued was in -- issued on July 23rd, 1970 and the Order 428 was issued on March 18th, 1971.

That’s all -- that’s one month’s short of three years.

There wasn’t anything experimental in the Act, I mean in the Order.

The Commission didn’t purport as my recollection to do it on an experimental basis, but even if they had, they’ve had three years.

Three years to develop a record a -- there is no record in this case, to support what they’ve done.

Justice William H. Rehnquist: Is this what they have been in effect during that time or has it been stayed?

Mr. Christopher T. Boland: No.

This has been in effect.

Now, it could be that when the Court of Appeals issued its decision that might have had a modifying effect on action, but notwithstanding that has never been stayed.

Justice Byron R. White: Well, why --

Mr. Christopher T. Boland: The order is in effect.

Justice Byron R. White: Was the Court of Appeals’ judgment stayed?

Mr. Christopher T. Boland: No.

And Your Honor --

Justice William H. Rehnquist: Well, so the Federal Power Commission has been proceeding under this system --

Mr. Christopher T. Boland: Oh!

Yes.

Justice William H. Rehnquist: -- for three years?

Mr. Christopher T. Boland: Right.

And it’s interesting to note.

It’s interesting to --

Justice Byron R. White: But so the Court of Appeals is set to decide?

Mr. Christopher T. Boland: The Court of Appeals set to decide, that’s right.

But the Commission is still operating under this and just last month, all that was in anticipation of this argument --

Justice Byron R. White: How can they be operating under, let's say, if their judgment, if their Order was set aside?

Mr. Christopher T. Boland: Well, the pipelines are still entering into contracts and we have one just in January, Trunkline, Pipeline --

Justice Byron R. White: No, I -- if the Court of Appeals set their Order aside, they set it aside, then that judgment hasn’t been stayed, has it?

Mr. Christopher T. Boland: No.

No Your Honor.

Chief Justice Warren E. Burger: Well, are they violating the Order?

Have the Court of Appeals’ mandate then?

Mr. Christopher T. Boland: Well, as far as I know, they haven’t done anything one way -- well, they haven’t done anything to indicate that they're not operating under this thing and as I mentioned on July 31st of -- I mean January 31st, almost in anticipation of this oral argument, the Commission for the first time issued an order against --

Justice Byron R. White: Is there an application for a stay here?

Mr. Christopher T. Boland: No.

No sir.

Justice Byron R. White: Never been stayed.

Mr. Christopher T. Boland: No, Your Honor.

But on January 31st, just last month, for the first time, they issued an Order against Trunkline -- Pipeline Company where they filed a tracking increase and they suspended it because the price being paid to a small producer maybe unreasonably excessive.

As the first monitoring that we’ve seen in three years of this great monitoring, my friend, Mr. Evans has indicated, I see my time is up.

Thank you.

Chief Justice Warren E. Burger: Mr. Schiff.

Argument of Peter H. Schiff

Mr. Peter H. Schiff: Mr. Chief Justice, may it please the Court.

New York’s basic concern in this case is that the Commission’s action which we believe amounts to deregulation of small producer rates will result in passing on excessive cost to consumers and inevitably so under just about any construction of the Commission’s order.

But I think it’s quite clear that even if one accepts the possibility of indirect regulation through the use of the pipeline proceeding, that the Commission’s order don’t provide for a determination of a just and reasonable rate and notwithstanding your question Mr. Justice White as to looking at the Order the way they’re now interpreting it, I would at least for the time being, in my limited time try to say what the Commission’s orders in fact said and the Court of Appeals construed it quite correctly, I don’t think any amount of rewriting can really change it.

Justice Thurgood Marshall: Mr. Schiff, before you get there, how much of this cost has to come to the consumer over these three years?

Mr. Peter H. Schiff: I can’t answer that.

I don’t know that -- no way --

Justice Thurgood Marshall: Well, what’s your --

Mr. Peter H. Schiff: There's no way of telling.

Justice Thurgood Marshall: Well, what is your complaint?

Mr. Peter H. Schiff: Well --

Justice Thurgood Marshall: You say -- you said you started off by saying, this high cost will be passed on to the consumer and now you say it hasn’t.

Mr. Peter H. Schiff: We can’t tell exactly what is being passed on because these rates are not being regulated.

We can’t tell how much is above the contract prices.

The scheme that the Commission -- the scheme of the Commission --

Justice Byron R. White: (Voice Overlap) the pipeline rates that you’re paying, I take it you’re paying the pipeline?

Mr. Peter H. Schiff: We’re paying the pipeline rates.

Justice Byron R. White: And the -- those are regulated.

Mr. Peter H. Schiff: Well, let me answer those in terms because if you would turn to page 142 of the joint appendix which is the Commission’s Order 428 which is under review, the Commission set a standard.

The Commission determined that in order to encourage the small producers to receive more money and that the pipelines would contract the above what had been fixed to the just and reasonable rate for the large producers that it was necessary to provide the pipelines with some assurance of certainty.

They established the standard which Mr. Evans has read to you saying that the pipelines will be subject to refund, a reduction and refund with respect to new small producer sales, but only as to that part of the rate which is unreasonably high considering appropriate comparisons with the highest contract prices for sales by large producers or the prevailing market price for intrastate sales.

Now the next sentence is what I want to concentrate on says, “Tracking increases to the extent they reflect small producer prices for new sales above the standards set forth above may be suspended and if so will be collected subject to refund.”

Now, two sentences later, the Commission says, “Where there has been a suspension,” now, remember this is only where it is above the standard, then the Commission shall consider all relevant factors and we don’t deny that the Commission may consider the relevant factors mentioned in the footnote 3 of the Government’s reply brief, but that only comes into play as the court below, I think recognized, is when the rates are -- that have been paid or above the standard fixed.

Now the standard fixed is an in -- is the highest prices paid by -- to a large producer, contract price, I misspoke because it’s very important.

Traditionally the way the contracting has been done under the Natural Gas Act at least since Phillips in 1954, pipelines, pay or contract at higher prices than the Commission actually allows, certainly that’s been true since there had been real regulation by the Federal Power Commission and what is dishonorable as we point out in our brief from the files of the Federal Power Commission is that there are -- the contract price maybe 20, 30, or even 40 cents above the rate that has been determined just and reasonable.

Now, it is this high price which I suppose can be a market standard, but it’s an artificial market standard at that which the Commission says, “Anything up to that, we will allow without tracking, without going through it all.”

And that is what the Commission’s Order does in this thing and I don’t see how the Government can say that they have now rewritten it.

They just don’t understand their own order or at least they don’t accept the impact of that.

Now the Court -- the courts have traditionally said that the reason for regulation of sales by producers whether they -- it is direct or indirect is because the market is not an adequate basis for determining the just and reasonable rate.

At least where gas is in short supply and it’s a sellers’ market and we most assuredly have the biggest sellers’ market that there has been since the Phillips case.

And Permian is -- which the Government promised and sought a conflict with -- in their petition, is not inconsistent with that.

It’s conceivable that there are times when the market may be such that there is buyers’ market that competition will in fact produce a just and reasonable rate or indeed as in Permian, the Commission did look to market prices to look at how to balance rates between different types of sales.

But there is no suggestion that the unregulated market price could be a just and reasonable standard.

Now, there's another problem with this Order.

The Commission in dealing with the pipelines or in both 428 and 428 (b), the Commission said, “We have always been able to examine the cost of purchase -- gas in a pipeline proceeding and the cost of other expenses” and the Commission’s order expressly, if I may for a second, at page 139 said, “The Commission has ample authority to inquire in these cases, into the reasonableness of all operating expenses and to disallow items of costs which are imprudent.”

Now, this is very important.

Of course it’s true.

Imprudent expenses can be disallowed and they sometimes are termed as excessive or not reasonable from the point of view of the purchaser, but that is not the same as looking at it from the point view of the seller as to whether a seller’s rate is just and reasonable which is essentially related to costs, at least it’s a surrogate for cost whether it has to be based expressly on cost or not.

On the other hand, the prudency reasonable test is a market test, the very test which is not permissible as a basis for regulation under the Natural Gas Act.

Now, this is no different than when a pipeline purchases steel pipe.

The pipeline can’t determine what the costs are of U.S. Steel.

The question of whether its prudent or not is the matter of whether the pipeline has exercised reasonable contracting practices and has paid -- hasn’t just gone out to the layman, paid much more than it had to under market conditions.

Now, I know of no authority and this is where I want to get to Mr. Justice White’s question, Mr. Boland, I know of no authority under which the FPC could disallow the cost based on a -- anything other purchased gas expenses in a pipeline proceeding on other -- anything other than the prudency test or reasonableness from the point of view of the buyer test.

The only exception that I know of in regulatory annals is where there is an affiliation question where the seller buys from its affiliate, then you can get the cost but otherwise it’s a market test.

And so that the Commission has to rewrite its Order not only in the first where that we discussed, but also has to rewrite the Order on what prudency means and it has no legal authority to do that and this is where the consumer will bear the brunt because the test isn’t the same test.

Now, finally --

Justice Byron R. White: If the Commission’s Order says, the Act I take it here in our view does not constitute the regulations in by small producers who will continue to regulate such sales, to produce at the pipeline level by reviewing the purchased gas cost of each pipeline is purchasing.

Now, is that just inconsistent with what they said elsewhere in the order?

Mr. Peter H. Schiff: Well, the regulation that they are promising is a regulation of the purchases and the standard that they are setting is a market standard which is not the proper standard for what is a just and reasonable price.

And the prudency test is not a proper test and it’s the only legal test for determining what is a just and reasonable price.

So, they are saying they’re regulating, but the practical effect is that the nature of the regulation is precisely the kind of regulation that did exist before this court’s decision in Phillips in 1954.

It doesn’t change one iota, notwithstanding my friends’ comments in their reply brief.

That -- that was not considered regulation under the Natural Gas Act so that -- I think that’s my answer to you and that very basic to it though is that there just is no authority, whether it is -- when our Commission, the New York Commission regulates a distribution company or the Federal Power Commission relate -- regulates a pipeline company, there's no basis on which we can disallow costs simply because they exceed what the just and reasonable level would have been for the seller.

It’s a prudency test and that’s all the authority that a regulatory Commission has and the FPC can change it by saying it has some other authority and it’s free.

The Commission’s order is much more careful as to its authority in this respect I would say --

Justice Byron R. White: Are you suggesting Mr. Schiff that the -- if we go along the Commission, that’s pro tanto a withdrawal from what we held in Phillips?

Mr. Peter H. Schiff: I think yes, inevitably so.

An issue which is not really here, but --

Justice Byron R. White: Well, it is.

Justice William J. Brennan: [Laughter] If you say so.

Justice Byron R. White: That he is right?

Mr. Peter H. Schiff: Well, --

Justice William J. Brennan: Are you suggesting we go the whole way?

Mr. Peter H. Schiff: Well, I certainly do not suggest you go the whole way.

I suggest that if you did that here, you do it with respect to all of producer regulation and I suggest that -- after 18, 19 years that this is a decision to be made in Congress.

There has been various Bills proposed in Congress for deregulation.

That, Your Honors, is a proper forum for the attempt to deregulate.

Now, I think this is what the Commission is doing, but this isn’t the right forum.

I want to say with respect to existing contracts that the Commission did not even make a pretense at indirect regulation, under existing contracts which my have been below the contract price, the just and reasonable price.

They let them go off, let them be passed through, no indirect regulation.

I suggest that contrary to what it said in the reply brief of the Government that we properly raise that.

Thank you very much.

Chief Justice Warren E. Burger: Mr. Evans, you have about four minutes left.

Rebuttal of Mark L. Evans

Mr. Mark L. Evans: Let me respond first to the question that -- what the Commission has been doing in the interim since the Court of Appeals decided the case.

Prior to the decision in the Court of Appeals, the Commission had been issuing certificates under the Order.

When the Court of Appeals set aside the order, the Commission ceased issuing permanent certificates under the order and begun issuing what they called temporary certificates which in effect leave the matter entirely open, pending ultimate disposition.

The -- they are -- the certificates that have been issued since the Court of Appeals ruling have a condition -- had a condition that the producer will be subject to refund if the court, if this Court ultimately determines that the Court of Appeals was correct.

Along the same lines, it’s very difficult to -- for me understand the argument that we have had three years to experiment.

These three years have been years of obvious uncertainty which is exactly what the order is designed to eliminate until judicial review is at the end there is no fair basis for judging whether the Order will have the intended effects.

Mr. Schiff has emphasized to some degree that the market is -- the market prices are not the proper test for just and reasonable rates.

We don’t say that that’s the case.

We don’t argue that the Commission has used it, but I might point out that this Court in the Sunray DX case said that the true market price is the just and reasonable rate.

The problem with the natural gas industry is that pipelines have traditionally been permitted to pass on their purchased gas costs in the form of increased rates and as a consequence there has been no incentive for the pipeline to bargain the prices down.

Well, the purpose of the Commission’s order among other things is to give some sense of reality to the market here and make it more of a genuine market.

So to that extent we have -- we contemplate -- the Commission contemplates something approaching, a true market price which would be the just and reasonable rate.

And I might add also that this Court in Permian made it quite plain that it was permissible for the Commission to take into account market factors in determining the just and reasonable rates.

Finally, there seems to be a suggestion to Mr. Schiff’s argument that the standard of prudence is something that inheres in the constitution.

There is no constitutional requirement that the Commission apply a prudent standard.

The constitutional limit is one of confiscation, that’s all.

The statutory standard is what matters here and that standard is just and reasonable and that is the standard that the Commission intends to apply when it reviews the small producers’ rates at the pipeline level.

Chief Justice Warren E. Burger: Thank you gentlemen.

The case is submitted.