FERC v. SHELL OIL CO.

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Argument of Howard Shapiro

Chief Justice Warren E. Burger: We'll hear arguments next in Federal Energy Regulatory Commission against Shell and the consolidated case.

You may proceed whenever you are ready Mr. Shapiro.

Mr. Howard Shapiro: Mr. Chief Justice and may it please the Court.

These consolidated cases involve the obligations of producers to supply natural gas under the Natural Gas Act of 1938.

The case concerns a statement of policy developed in an informal rule making proceeding conducted by the predecessor of the Federal Energy Regulatory Commission, the Federal Power Commission.

The Commission undertook to determine what standard of deliverability, a certificated producer of natural gas is required to live up to under the provisions of the Natural Gas Act.

The policy the commission eventually adopted requires producers of dedicated gas to produce gas they are required to supply under their certificates.

Under the standard of a prudent operator as that standard is reflected in state laws governing production.

There are two petitions here; the first is the petition of the Federal Energy Regulatory Commission, which inquires whether the production and gathering exclusion in Section 1B of the Natural Gas Act bars the Commission from adopting the prudent operator standard as the delivery criteria under the Natural Gas Act.

The second petition is by the Consumer Energy Council of America and it contends that the Commission has the authority to adopt a deliverability standard that affects production, but it goes on to say that the prudent operator standard is an inappropriate standard.

The Court of Appeals held that the Commission was barred by Section 1B of the Natural Gas Act, particularly the production and gathering exclusion in Section 1B from adopting a prudent operator standard.

So the Court of Appeal said that the Commission had gone too far in adopting the standard.

The consumers argue that the Commission did not go far enough and that the prudent operator standard doesn't meet the requirements of the Act.

The consumers have with the court's permission conceded three minutes to the Commission in the division of time in this case, so that the commission would have 23 minutes, the consumers 17.

Justice William H. Rehnquist: Mr. Shapiro, I wasn't quite as clear as you seem to be as to what question is presented by the Commission's brief, because I realize that the order adopted by the commission says that on or after July 30th, 1976 all Certificates of Public Convenience and Necessity will contain this provision.

And yet, if you turn to page 16 of the brief for the Commission.

The first sentence in the first full paragraph says, the principle issue in this case is whether the Natural Gas Act imposes an obligation on certificate holders, which the Commission has jurisdiction to enforce that they act as reasonably as prudent operators have maintained deliveries to interstate commerce of gas from dedicated reserves and you go on to say that this is going to have viable importance for many, many years, because apparently it is incorporated by force of the Natural Gas Act and certificates issued prior to 1976, is that your position?

Mr. Howard Shapiro: That is the position Your Honor.

Justice William H. Rehnquist: Well, that's a little different than saying that the Commission was empowered to choose this as a regulation implementing the statute isn't it.

That's saying that the statute required the Commission to do it.

Mr. Howard Shapiro: Well, essentially the Commission's position is, it has made an interpretation of the statute to define what the standard of deliverability is.

What it found in this rule making proceeding was that there was a great deal of uncertainty as to just what producers obligations were to deliver gas and it concluded in the ultimate decision Order Number 539 B, that there was implicit in the delivery obligation that exists under Section 7 of the Natural Gas Act.

An obligation to maintain delivery that reaches the duty to at least see that there is sufficient gas produced to meet the obligation.

The commission found that this was implicit in existing certificates and that it was inappropriate interpretation of the statute as the service obligation had been defined by this Court in –

Chief Justice Warren E. Burger: When was Gas Act adopted?

Mr. Howard Shapiro: 1938 Your Honor.

Justice William H. Rehnquist: And this is an interpretative regulation that was adopted by the Commission in 1976.

Mr. Howard Shapiro: Yes Your Honor.

One reason that the question had not come to the fore was because as long as there was more gas available then it could meet more gas available in the market would absorb.

There was a little question that every producer would try to deliver all the gas he could and market all the gas he could.

When the gas shortage of the late 60s and early 70s developed, questions began to arise as to just what the duty of the producer was.

Now the Commission's order in this case did not rest on any findings that there had been some diversion of gas to the unregulated intrastate market from the regulated interstate market, but the Commission did find that there was great uncertainty as to the scope of the deliverability obligation and it undertook to define that, it's ultimate answer was that implicit and existing certificates under this Court's decisions in Sunray and for that matter in California versus Southland was an obligation not simply to sell gas as a commodity, but also to deliver gas until there was an authorization from the commission to seize delivery.

Now Justice Rehnquist's questions have touched on another matter I should briefly mention.

In November of 1978, Congress passed the National Gas Policy Act.

That new statute changes the basis of regulation for the future rather significantly.

It extends price control to both the intrastate market and the interstate market.

However, it also expressly continues in effect non-price regulation under the Natural Gas Act for gas previously dedicated to interstate commerce.

That gas is therefore still impressed with the service obligation that would apply to dedicated gas under the Natural Gas Act and is still subject to the requirement that it continued to be delivered until abandonment authority is obtained.

The matter is significant because among other things, pricing under the new statute for gas previously dedicated to interstate commerce is somewhat lower than prices for other categories of gas.

Justice William H. Rehnquist: Do you think the Commission made this point quite as clearly to the Fifth Circuit as you are making it us?

Mr. Howard Shapiro: Well, the Natural Gas Policy Act hadn't been passed.

Justice William H. Rehnquist: No, but I mean the difference between a simple regulation by the Commission and a provision that is implicit in the Natural Gas Act.

Mr. Howard Shapiro: Yes, it did Your Honor it's expressly stated in that order what they expressly declared was that they made, they found this standard to be implicit in existing certificates and they said that this implicit standard should be made explicit in future certificates.

Now Section 1B defines the scope of the Natural Gas Act.

Justice Byron R. White: Has the commission ever taken a different view?

Mr. Howard Shapiro: With respect to it's jurisdiction and the nature of the delivery obligation, certainly not since Sunray.

Sunray clarified the nature -

Justice Byron R. White: Well, it should have taken a far more expensive view in this very proceeding?

Mr. Howard Shapiro: In this proceeding the commission first undertook to adopt what I would call a quantitative delivery obligation.

Justice Byron R. White: It didn't find that to be implicit in the Act did it or not?

Mr. Howard Shapiro: It found it to be implicit in certificates; it thought originally that it was reflected in certificates and in existing contracts that underlays.

Justice Byron R. White: In the statute or not?

Mr. Howard Shapiro: And it thought that it was permissible to impose the standard on the statute.

Justice Byron R. White: Permissible.

Mr. Howard Shapiro: That's right.

Justice Byron R. White: But not required.

Mr. Howard Shapiro: But not required.

Justice Byron R. White: And now the position is that that a prudent operator standard is implicit in the Act, but it is, that's required by the statute.

Mr. Howard Shapiro: A deliverability standard is required that assures the maintenance of delivery and this is the standard the Commission feels is the appropriate standard to achieve that result.

Now Section 1(b) defines the scope of the Natural Gas Act.

It affirmatively states that the Act covers transportation of natural gas in the interstate commerce.

Sale of natural gas in interstate commerce for resale to consumers.

And natural gas companies engaged in such transportation or sales.

It expressly excludes other transportation or sales, local distribution and distribution facilities and the exclusion involved here the production and gathering of natural gas.

This Court's decisions in Sunray and in California versus Southland however have made clear that the term “sale” as it is used in the statute both in Section 1(b) and elsewhere carries with it an additional concept, the concept of service and that service as applied to producers is an obligation to maintain delivery.

The Commission concluded after going through a rule making proceeding that moved from a quantitative requirement to the prudent operator standard, that existing certificates are subject to this implied requirement and they then defined it.

They said that the standard encompasses the obligation to develop producing properties consistent with lease agreements and with all valid rules and regulations of any Federal State or local government having jurisdiction and the standard of what a reasonably prudent operator would do with respect to the drilling, completion; work over, re-completion or abandonment of wells.

Justice Byron R. White: I take it the Commission's position is that its view of the prudent operator standard is a nationwide one or and that it's independent of State law?

Mr. Howard Shapiro: The Commission's view as to the content of the prudent operator standard has reflected in its order and I can take it no further than that at this time, is that it does refer directly to local, state and local conservation laws for example, statutory, regulatory requirements of the states relating to production.

It also refers to the standard as adapted from the law governing mineral leases between lessees between land owners and producers.

Justice Byron R. White: Well then does it have any content other than what it might have under the local law.

Does the Federal law, does this rule now just pick up local law, whatever it might be, is that the extent of it?

Mr. Howard Shapiro: As far as the Commission has taken it, it does make an obligation under the Natural Gas Act, the same duty that the producers are already under--

Justice Byron R. White: But as far as you can tell from the order it imposes, no further duty than the state law does.

Mr. Howard Shapiro: As far as the decision goes at present that is right.

Justice Byron R. White: And so, there might be a lot of different duties depending on what state you are in?

Mr. Howard Shapiro: Producers would be operating locally in different states and the nature of their duty might vary locally as a result.

There maybe some difference in conservation requirements.

This is just an example of a Federal law referring to a state standard.

Now the producers themselves in these proceedings argue that the Commission should not adopt any standard of deliverability affecting their production, because they were already subject to a prudent operator standard and the Commission concluded that they knew what the prudent operator standard meant since they themselves were making this argument.

Justice Byron R. White: But if -

Mr. Howard Shapiro: And they had adopted it to the Federal obligation.

Justice Byron R. White: But if the state hadn't allowed the rule about what the allowable production was, would the Commission, does this case suggest the Commission could set a different one or not?

Mr. Howard Shapiro: No, the Commission was quite careful not to try and setup as a result of this standard any requirement that would go beyond or go into conflict with what the state required with respect to production.

Any valid state production standard remains in effect today without regard to the adoption of this standard, it was not designed to set up a new standard, it was designed to apply under Section 7, the operating standard that the producers are already under.

Now there was a reason for that, they went to some length to avoid conflict with the state law, because as this Court has interpreted the production and gathering exclusion in Section 1(b) it has often said that it applies to the physical activities of producing gas, which are in the domain of the states.

The Commission is not trying to set itself up as a super conservation agency or a super production agency, what it is trying to do is to assure the maintenance of delivery under Section 7 under the Natural Gas Act.

Justice Lewis F. Powell: May I ask this question in that connection?

The word, “develop” is used in the Commission's order, the exclusion from the jurisdiction of the Commission uses a word “production,” what's the difference between develop and production as a practical matter?

Mr. Howard Shapiro: I don't know that for purposes of this case we would have to treat them as significantly different.

The development the Commission refers to and the production the Commission refers to is the development of dedicated acreage that is already subject to a service obligation under the Natural Gas Act.

In short, it is gas which has already been marketed, the acreage has been marketed and the gas producer has committed himself to, has undertaken the obligation to supply gas to a pipeline.

He has to continue that supply until he is authorized to abandon and if it's not depleted the essence of the Commission's position is, he's got to at least maintain enough production to meet his obligation to deliver gas.

Justice Lewis F. Powell: When acreage is committed, does that mean that all of the necessary drilling has been accomplished or does that lie ahead in the future?

Mr. Howard Shapiro: I think it sometimes means that there will be additional development.

For example, I have seen references to, I've seen leases, not leases but certificates with underlying contracts in which the dedication in effect says that we dedicate all gas that will be produced on this acreage to the service of some particular pipeline.

Justice Lewis F. Powell: Well under this order, is it your view that the Commission could say it to a company that had dedicated say a 1000 acres, you aren't drilling enough holes to accomplish the deliverability that we think is appropriate and you must accelerate the drilling of holes or wells I suppose you would say?

Mr. Howard Shapiro: What the Commission would look to is whether it would be prudent under the state standards for the operator to drill additional holes in order to meet his delivery obligation.

However, these are questions which are somewhat in the future since the Commission has gone no further here and got no further then to announce what the standard would be -

Justice Byron R. White: Mr. Shapiro I suppose the law has said that, keep your nose out of production and gathering even if it serves some deliverability and I suppose you can say then, Congress just said don't use this means of guaranteeing the service obligation.

Mr. Howard Shapiro: That I think -

Justice Byron R. White: But you don't think the statute says that -

Mr. Howard Shapiro: No, Your Honor.

Justice Byron R. White: It says that production of gathering is not your business, but you say it is your business as long as it serves a service obligation.

Mr. Howard Shapiro: Yes sir, the analysis really is that Section 1(b) anything that is within the affirmative grant in Section 1(b) of jurisdiction over sales is not barred by the production and gathering exclusion that's what the Court has held in cases like Interstate Natural Gas Company against FPC in 331.

The production and gathering exclusion doesn't take away what is affirmatively granted, but if as we in the court has held the term “sales” includes a service obligation to deliver gas, it necessarily has to include an obligation to produce enough gas to deliver, because if there is no production, there is no delivery.

Justice William H. Rehnquist: But that just leaves the exclusion out of the Act?

Mr. Howard Shapiro: It leaves in place the state's jurisdiction over the manner in which production will be -

Justice William H. Rehnquist: But it's enforceable, the thing that is excluded by the Act is then enforceable by the Commission, is it not?

Mr. Howard Shapiro: It does make the state standard –

Justice William H. Rehnquist: It shows some rational connection with the service obligation.

Mr. Howard Shapiro: Yes sir.

Justice William H. Rehnquist: But you said that -

Mr. Howard Shapiro: Well, the consequence otherwise is to leave an enormous gap in the regulatory scheme that Congress intended to fill.

Justice Byron R. White: That maybe so, but the Commission hadn't discovered that enormous gap for quite a while.

Mr. Howard Shapiro: Well, the need for defining it as I have explained became more and more urgent in the late 70s.

Justice Byron R. White: Of course, it took quite sometime for there to be discovered any obligation over producers at all.

Mr. Howard Shapiro: It took many years, it was 1954 before that was fully developed and it was 1964 before Sunray, so that this been a process of gradual development.

Now the point about the gap is that if you leave the statute where the Court of Appeals has left it, producers retain an unregulated choice as to whether to supply natural gas, because they can say we do not wish to produce if they left the wells -

Justice Byron R. White: What if some State dismantled its enforcement and its rules and said that we're going to deregulate it, you know, just turn the producers lose, we aren't going to put them under any conservation orders or anything else.

Does that put you out of business in that State as far as any prudent operator standards considered?

Mr. Howard Shapiro: I think that in the absence of specific conservation requirements by statute and regulation within the State, the Commission would look to the general common law applicable to relationships among lessors and lessees, which also implies a prudent operator standard and an obligation not to produce in a way that damages the property.

Justice Byron R. White: So there is some, so you suggested as soon the Commission decides that some State standard doesn't satisfy it, it will go off on its own.

Mr. Howard Shapiro: No, I think that the Commission will look to what are already valid state standards.

Now the law provides and this Court has held at some state standards are invalid, because they're irrational, because they're not related to conservation, because they seek to regulate price or embargo shipment that kind of standard would be invalid, but the Commission has attempted to coordinate its standard fully otherwise.

Argument of Charles Hill

Chief Justice Warren E. Burger: Mr. Hill.

Mr. Charles Hill: Mr. Chief Justice, may it please the Court.

Our basic contention in this litigation is that the Commission has acted contrary to the terms of the Natural Gas Act by adopting as the standard and the exclusive standard governing producer delivery obligations under the Act, a body of state law which has been developed in the various producers states, which has been developed for reasons altogether different than continuation of steady and reliable supply of natural gas in interstate commerce.

There's of course also a fundamental jurisdictional question here that is whether or not the Commission has the authority to enforce those obligations, which in fact certificate.

I would like to leave that jurisdictional question largely to our briefs into the argument of Mr. Shapiro, but I would like to make one comment and that is the comment that focuses on the distinction between what we say the Act requires, and what the Commission has done here.

We say the act requires an extension of the provisions or an application of the provisions of Section 4(d) and Section 7(b) to significant declines in service.

That means that the Commission would be interposed between the producer and the ultimate consumer and would pass upon the justification for significant declines in delivery.

That also means that an order from the Commission would not be in the form of an order telling a producer to drill a particular well in this place or take some action in some other place, which might be the case under a prudent operator standard, but the order that would emanate from the Commission is basically the sort of order that would emanate from the Commission when a producer currently comes to the Commission and says under 4(d), we would like to reduce service or under 7(b) we would like to have a partial abandonment that is either yes or no, we accept your justification for a decline in service or we don't accept that justification.

So the orders that we can see coming from the Commission in the course of applying a proper delivery standard will not embroil the Commission in questions of where a particular well should be located or what actions should be taken in the field.

Now, this case takes its significance from the fact that a vast network of investment from that of the pipeline to the end-user, power plant, factory or consumer has been built upon the supply obligations under the Natural Gas Act, and these investments and the interest of those end-users will be placed significantly at risk if the Commission lacks the jurisdiction to enforce delivery obligations under the Act or fails to do so under a proper standard.

It is clear from Section 4 and Section 7 of the Act that one of the prime purposes of the Act is to ensure a steady and reliable service or supply of gas in the interstate market.

This Court has repeatedly recognized that purpose as recently as last May in the Southland decision where the Court held that the obligation to continue service even in the face of terms in a private agreement, which may run contrary to that obligation, was nevertheless essential to carry out the purposes of the Act.

Justice Byron R. White: You weren't up against any express limitation on the Commission's jurisdictions either.

Mr. Charles Hill: That's right Mr. Justice White.

And the question here is I suppose among others whether this prudent operator rule is within the production and gathering exclusion.

Well, we would like to see that issue cast slightly differently and that is whether or not –

Chief Justice Warren E. Burger: I don't blame you.

I don't blame you.

Mr. Charles Hill: Excuse me.

Justice Byron R. White: I don't blame you.

Mr. Charles Hill: And that is whether or not the Commission has the authority to utilize and in fact is required to utilize the provisions of Section 4(d) and 7(b) to significant declines in service.

I don't want to defend jurisdictionally what the Commission is trying to do here.

Justice Byron R. White: You don't.

Suppose they haven't got the jurisdiction to do what the Commission is doing, where does that leave you?

Mr. Charles Hill: Well, my hope is that the Court in deciding that.

I would hope that the Court would decide favorably to the Commission on that issue, but then move on to our issue.

Justice Byron R. White: So you're defending that?

Mr. Charles Hill: In that sense, yes.

Chief Justice Warren E. Burger: You maybe just weren't going to defend it in your argument.

Mr. Charles Hill: That's right.

What the Commission has done here and what Mr. Shapiro clearly admits is adopt wholesale as the exclusive federal standard, a body of State law which has been designed to do two things.

One, a body of state statutory and regulatory law, which has been designed to place limits on production in order to avoid waste and another body of state law, which has been designed to govern the lessor/lessee agreement.

I hope that we have made clear in our brief at page 39 to 41 of the initial brief and 12 to 15 of our second brief that the principles under each of those two bodies of law we're not designed to assure continuation of service and in fact in various instances will militate against that purpose.

Therefore, we believe that the Commission has simply violated the Act or has not followed the Act's mandate by adopting this body of state law.

Justice William H. Rehnquist: Do you believe that some body of law is implicit in the Act such as Mr. Shapiro has said.

Mr. Charles Hill: I believe that building upon this Court's decision in Sunray and Southland that they're clearly are obligations to continue service under the Act and that obligation requires a producer when he's contemplating a significant reduction in service to come to the Commission and say these are the reasons that I can't meet the production level that I've been providing and I want a reduction in service under Section 4(d) or to accomplish a partial abandonment under Section 7(b) of the Act.

Justice William H. Rehnquist: But that isn't the reason the Commission gave is it for its interpretative regulation?

Mr. Charles Hill: Well, the Commission repeatedly refers to the Sunray case and the Sun Oil case in Order 539(b) and actually going back to Order 539 and they repeatedly rely upon the Southland case in their brief for this Court.

So they seem to think that those decisions give them some authority, but they think that authority allows them to reach out and grab a body of diverse state laws and use that as the Federal standard.

And we say that those decisions don't authorize that and that there's nothing in the Act or the legislative history, which would authorize that sort of step to develop a Federal service standard.

Justice William H. Rehnquist: But you say there's something either in this Court's decision or in the statute which authorizes the development of some sort of a Federal service standard.

Mr. Charles Hill: That's right Mr. Justice Rehnquist, clearly so.

So our problem with –

Justice William H. Rehnquist: Clearly in the Act or clearly in this Court's decision?

Mr. Charles Hill: Well, I think it's found in-between the two and I think it becomes clear when one imagines the step passed Sunray and Southland.

Shell Oil has argued that the private contract between the pipeline and producer contains no firm delivery obligation.

In that case, one can imagine the next step in the Sunray or Southland situation where the producer says not that my contract is come to an end and therefore I want to stop service, but that my contract allows me to supply whatever I want to supply at my discretion and for that reason I won't even go to the Commission to get approval under 4(d) or 7(b) for that reduction in service.

Justice William H. Rehnquist: Where does that leave the exclusion?

Mr. Charles Hill: That leaves the exclusion of the operation of the exclusion in essentially the same place that it is with respect to the Commission's current application of 4(d) or 7(b).

The Commission currently when a producer comes in and says I would like to abandon this particular field, listens to it's justification and decides whether or not that abandonment is in fact justified and if it decides that the abandonment is not justified, it issues an order that says no, you shall continue to serve the interstate market.

And all we are asking for and all we think the Act requires is an application of that principle to the situation of significant declines during the course of the contract and during the course of a certificate.

I might point out that in the Sunray case at 364 U.S. 156, the Court especially refereed to Section 4(d) of the Act in saying that its decision in that case did not make the producer a captive of the Commission.

The producer always had the opportunity to come to the Commission and ask for a reduction in service under Section 4(d) of the Act.

I believe that there is a third reason why the Commission's activity here has run a file of Natural Gas Act and that is what the Commission has essentially done by adopting a body of state law is to pull the service obligation out from under a firm Federal standard under the Natural Gas Act.

The Commission has resisted our efforts to point to the FPC versus Texaco case in this regard, what we think that the commission has done essentially the same thing in a service area here that it attempted to do there.

They tried to pull small producer rates out from under the regulatory scheme of the Act and leave them to be governed by free market decisions of the small producer and the pipeline involved.

Here what the Commission is sought to do is to pull service obligations out from under the Act and allow those service obligations to be governed by the free market decision between the lessor and lessee and as this Court indicated in Texaco that, that form of price deregulation was not authorized by the Act.

I think also this form of service deregulation is not authorized by the Act.

Now the Commission does not contest our position on the merits.

The Commission does not claim that there is a particular provision in the Act that authorizes this effort to pick up a body of state law and have that be the delivery obligation under the Act.

It doesn't point to anything in the legislative history and it doesn't really point to anything firm in the decisions of this Court, which would seem to authorize that rather unusual effort to develop a Federal service standard.

Indeed, there a number of decisions this Court which have found very heavily upon that sort of patch work result and I might as in aside point out that at page 17 of our reply brief, we sight to a report which lays out the various provisions of state law and I think that the Court from looking at that Commission report that we sighted in a footnote on page 17 can see then in fact state laws will differ widely in terms of their obligations.

The obligations they place upon the producer on questions of allocation, on questions of pooling, on questions of space.

So what the Commission really is doing here is adopting sort of a patch work solution of the Federal service standard, but indicates that the Commission does not point anything in the Act to legislative history or the decisions of this Court, which would seem to authorize this rather unusual step in developing a Federal service standard.

Rather it says that the decision of the Commission is due grade deference from this Court.

Our first response of that is that whatever standard this Court might apply this standard; this effort is so far beyond the reaches of the Act that it should be set aside, but I think the Court need not go that far in terms of applying a different standard.

What the Commission has said here is that it is interpreting the service obligations that flow from Section 7 of the Act and I believe that the Court of Appeals in the Fifth Circuit fully recognized that at page 3(a) and 4(a) of our petition for certiorari where we have reprinted the Court's opinion.

It is apparent that the court realized that what the Commission was doing was engaging in an Act of interpretation.

As such, under the past opinions of this Court, I don't believe that, that effort of statutory interpretation is due grade deference.

The Commission was not here exercising the sort of authority that it has under Section 5 of the act, which is basically a legislatively delegated rule making function.

It was simply engaging the statutory of interpretation.

Thus the decision of this Court last term in National Citizen's Committee for Broadcasting versus FCC, I think is in apposite as are the other opinions, which have been sighted by the Commission.

Under the proper standard of review, no undue deference is required here and in fact, seeing this as an effort at statutory construction, it is important to note this is neither a consistent or a long standing interpretation.

This is not a interpretation that people have relied upon as was the case in Natural Resources Defense Council versus Train, which was decided by this Court several years ago and which has been relied upon by the Commission nor is it a decision that draws heavily upon a great deal of experience from the Commission, because as Mr. Shapiro has admitted this constitutes, this Order 539(b) constitutes the Commission's first effort at interpreting or defining the service standard, which flows from the Act.

And as such, in reaching out for this body of state law, the Commission in fact justified its actions simply by saying that it was doing so, because the producers had become acquainted with it.

I submit that, that is hardly a sound basis for deference on the part of this Court to a decision of the Commission.

A question has been raised as to whether or not interpreting the service obligation on the Act may pose some problems of retroactivity.

I think what the Commission should have done here, what the Commission says it did was to interpret those obligations and as in the Sunray case where again the Commission was interpreting a certificate obligation, which had retroactive effect.

That statutory interpretation; that defining of the service obligation raises no retroactivity problems.

In addition, as long as the Commission adopts an approach, which allows the producer to come in and show justification for declining reserves or declining deliveries, then I think further there is no problem of confiscation or unfairness to the producer.

So, in summary, we submit that the Commission has acted beyond the authority granted it and reaching out for this body of state law and defining it as the Federal service standard that it is position here deserves no grade deference.

And that this Court should reverse the Court of Appeals decision and remand this action back to the Commission for further consideration in light of other requirements of Section 7 and section 4 of the Act.

Thank you.

Chief Justice Warren E. Burger: Mr. Johnson.

Mr. Thomas Johnson: Mr. Chief Justice.

May it please the Court.

My name is Thomas G. Johnson representing Shell Oil Company and appearing here on behalf of the producer respondents.

In this case, the court is again asked to reexamine the distinction between production and gathering, which is excluded from the Commission's jurisdiction under the Natural Gas Act and sale for resale, which is specifically included.

For some 20 years, since this Court's decision in Philips this distinction was thought to be cleared by the industry and by the Commission.

And to read what the Court said in Philips in this regard.

I would like to the quote the following.

“In FPC versus Panhandle Eastern, we observed that the natural and clear meaning of the phrase “production or gathering of natural gas” is that it encompasses the producing properties and gathering facilities of the Natural Gas Company.

Similarly, in Colorado Interstate versus FPC, we stated the transportation in sale does not include production and gathering and indicated that the production and gathering exemption applies to the physical activities, facilitates and properties used in the production and gathering of natural gas.

In the Philips case, the producer had argued that he was in the business of producing and gathering natural gas and that sale for resale was incidental to that business.

And therefore was not subject to Commission jurisdiction.

The Commission so found, but this Court disagreed and said that there was distinction between the physical activity, which the producer was engaged in and was excluded from the Commission's jurisdiction and the sale for resale which was covered by Commission jurisdiction.

In this case, the Commission makes exactly the opposite argument.

They argue that production is incidental to the sale and therefore the Commission must regulate production in order to assure that the sale will continue.

That argument should be rejected for the same reason that the producers' argument in Philips was rejected and that reason is that it destroys the clear distinction imposed by congress between production and gathering and sale for resale.

The only other case which this Court has dealt with the distinction between production and gathering and sale is UGI versus Continental Oil Company, Rayne Field case.

And there again, the Court reiterated this distinction in this language, “We conclude that even though a sale of natural gas and interstate commerce occurs before production or gathering is ended, it is nonetheless subject to regulation and the context to such a sale as distinguished from the situation on FPC versus Panhandle Eastern Pipe Line Company to be discussed hereafter.

The production or gathering exemption relates to the physical activities, process and facilities of production or gathering, but not to sales of the kind that are primarily subject to Commission jurisdiction.

This accommodation of the two relevant clauses of Section 1(b) gives content to the national objectives of the Natural Gas Act as expounded in Philips and to the Commission's jurisdiction to accomplish them, while in no way interfering with the state regulatory power over the physical processes of production or gathering in furtherance of conservation or other legitimate state concerns.

We believe Mr. Justice Rehnquist that the reason why the Commission had never sought to exercise jurisdiction over the production activities prior to this case was that those activities were actively being regulated by the states.

This was the case even before the Natural Gas Act was passed in 1938.

As early as 1931, this Court and Champlin Refining Company versus Corporation Commission affirmed the power of the states to regulate production activities.

This palaces this distinction under another line of cases by this Court led by Panhandle Eastern versus Public Service Commission, which held that the Congress in passing the Natural Gas Act intended to fill the regulatory gap, which this Court had held in the Attleboro and Missouri versus Kansas Gas cases, the states had no power to regulate.

Justice William H. Rehnquist: But Mr. Johnson aren't the states still regulating it?

Mr. Thomas Johnson: Yes sir, they are Your Honor and we don't believe there is any gap in regulation.

Justice Byron R. White: There was any gap to inspect just production and gathering.

Mr. Thomas Johnson: We believe Your Honor that the states are regulating the production activities.

As I understand that was the distinction that the Court made in the Philips and Rayne Field case.

Justice Byron R. White: But at the time the Natural Gas Act was passed.

There wasn't any gap in respect to production and gatherings.

Mr. Thomas Johnson: No, I think that -

Justice Byron R. White: Had it been held at the interstate Commerce of Commission for bad the states from a regulating production and gathering.

Mr. Thomas Johnson: No sir, I think the states were doing that.

Yes sir that is my point.

Justice William H. Rehnquist: But I thought you are already saying that the reason the Commission never got around this until 1976 was because the states were actively regulating.

Mr. Thomas Johnson: Yes.

Justice William H. Rehnquist: My question is, why did they get around to it in ‘76 if the states haven't ceased regulating.

Mr. Thomas Johnson: We have a great deal of difficulty answering that question.

We don't think they should have.

Justice William H. Rehnquist: May be I should ask you –

Mr. Thomas Johnson: The Commission argument that regulation -

Justice John Paul Stevens: The market price has something to do with it, in the ratio between the interstate price and the intrastate price –

Mr. Thomas Johnson: Your Honor, we believe that this whole proceeding as a result of erroneous assumption on part of the Commission on the consumer advocates that producers will not produce their gas unless the Commission makes them do it.

We believe that there argument defies reason, because the only source of the income that a producer has is the gas which he produces.

Justice John Paul Stevens: Yes, but isn't it conceivable that he can get a highest amount of income by selling in the local market rather then selling in interstate commerce.

Mr. Thomas Johnson: Your Honor that argument.

Justice Byron R. White: It is theoretically possible they say.

Mr. Thomas Johnson: Your Honor that argument was made before the Commission in the Court of Appeals prior to the enactment of the Natural Gas Policy Act in November of last year.

I do not believe it is any longer possible, because the Natural Gas Policy Act fixes a sealing price for intrastate sales as well as interstate sales.

So, if there ever was any incentive on the part of a producer to withhold gas to receive a higher price that was removed but the Natural Gas Policy Act.

Now the consumers make the argument there are different categories of gas under that Act and that the producers may somehow adjust gas between those categories.

We submit that's not true, we think Congress went to great lengths to avoid that very thing and they provided as nearly as they could that producers must continue to produce gas from existing fields, from existing wells and they can't get any higher price for it.

Justice John Paul Stevens: Because the regulation was adopted before the ‘78 statute was passed.

Mr. Thomas Johnson: That's right and what I'm saying is -

Justice John Paul Stevens: Are you entirely on the ‘78 statute –

Mr. Thomas Johnson: No sir.

Unknown Speaker: If we look at it without regard to the ‘78 statute, is it not possible at the time the regulation was passed that a producer might have had a economic motive for desiring to get out of federal regulation, be free to sell in the local market that is theoretically possible isn't it.

Mr. Thomas Johnson: Your Honor the problem with that theory is that once a producer has dedicated his gas to interstate commerce, he must continue to deliver that gas in the interstate commerce; we don't contest that and the problem -

Unknown Speaker: Well, couldn't you have a problem where say if you drilled another well or made some improved capital investment of some kind.

You might get a return on your investment at the local price, but not get a return on your investment at the interstate price.

So, if you are stuck with the interstate market you just wouldn't make the investment.

Mr. Thomas Johnson: Your Honor this Court held in Sunray and we don't challenge that once the gas from a particular field is dedicated to interstate commerce through a contract and a certificate, the producer can't remove that gas.

He can't drill another well on that same field on that same lease and sell it anywhere else.

He has to sell it to the interstate purchaser that's what the law says.

Unknown Speaker: Not if he gets abandonment approval.

Mr. Thomas Johnson: Yes, but the Commission and --

Unknown Speaker: And isn't it possible that at one set of price level, you could get abandonment approval by not making further capital improvements.

I don't know may be it seemed to me it was the theoretically possible.

Mr. Thomas Johnson: Your Honor, I believe the Commission's practices have been consistent over the last 15 years of universally denying abandonment in any situation where the wells will continue to produce.

So, I don't think it's a practical answer to say that the Commission would grant abandonment and allow the producer to sell somewhere else.

It is practical matter, they don't do that.

Unknown Speaker: What is your real objection to the present regulation of the Commission?

Mr. Thomas Johnson: Our real objection Your Honor is that the commission is seeking on this proceeding to second gas, the production decisions of the producers and they come about in this way.

Keep in mind that a gas field is continually declining in production and that's the problem with the standard which says that a producer must maintain service, because that's usually physically impossible for the producer to do because the gas field is continually declining and the ability of the wells to produce is continually being reduced.

Now the question is whether the producer can do something at some point in time to delay that decline or differ the loss of production from these wells and those are very difficult questions.

The question usually comes out if a well loses production, can that production be restored by drilling a new well or can it be restored by installing pumping facilities to remove the waters, which is encroached and chocked off the gas or can explosives are acid be used to increase the permeability of the wells.

All of these things are decisions requiring expert judgments.

Now, we think if the effect of this decision is that the Commission supervises all of those production decisions that the producers will be embroiled in litigation before the Commission repeatedly in an attempt to justify their production decisions and we think that's gong to detract from the search for new gas supply, which is the only way that the gas supply can really be increased.

Unknown Speaker: Do you think you can live with the state authorities, but you don't want another level of regulation.

Do you accept the Commission's statement represented in here that the rule they have adopted seats only to implement what each specific state would implement.

Mr. Thomas Johnson: I would answer that in two ways Your Honor.

I think the Commission is caught in a dichotomy.

They say on the one hand that there is a gap in a regulation.

And yet they say that the state regulation is adequate over production facilities and we certainly do not contest that once the gas is produced we must continue to deliver to the interstate purchaser.

So, if that is the Commission's position then there is certainly no regulatory gap.

If the Commission's position on the other hand is that there is a regulatory gap then they must be saying there is something wrong with the state regulation over production activity and we intend to change it, we don't know what those changes will consist of.

Justice William H. Rehnquist: I suppose even if the Commission agreed there was no gap, do you believe them.

You would still object to another level of regulation?

Mr. Thomas Johnson: Yes Your Honor, we believe it's unnecessary and we believe it conflicts with the intent of Congress when they enacted the Natural Gas Act, because we think that Congress intended to leave that regulation over production activities to the states.

It is difficult to see what more the producer can be required to do then what he is required to do under the state standards, which is to operate with due diligence and as a reasonably prudent operator under the circumstances of case.

He certainly can't be required to maintain service from the gas field where the gas is already been produced.

So, the simple explanation, which the consumer advocate proposes isn't impractical one, because if the field will no longer maintain service, the question the Commission or any regulatory body has to answer is why.

And if the reason why is that the gas is depleted then there is nothing the producer or anybody else can do about it.

It's only if the producer has been negligent or has not operated his lease properly that the regulatory body takes some action.

Justice John Paul Stevens: Mr. Johnson, I would like to address your attention to the example the Commission gives in its reply brief.

Where I assume you are extremely negligent, you just don't make elementary repairs or maintenance or anything in your supply therefore terminate.

Do they have the authority to prevent that?

Mr. Thomas Johnson: Your Honor I'll answer the question this way.

First of all, we think that example is completely contrary to reason.

It doesn't make any sense for a producer to spend hundreds of thousands of dollars drilling a gas well and then refused to spend the few dollars necessary to maintain that well if his only source of incoming is coming from that well.

Now, we think that dividing line is this -

Justice John Paul Stevens: Well, but supposing they did it.

Mr. Thomas Johnson: We think what - let me say what I think the Commission can do and what I think they can't do.

Justice John Paul Stevens: I don't mind as long as eventually you tell me what the answer is to the question.

Mr. Thomas Johnson: I'm sorry I didn't to avoid the question.

Justice John Paul Stevens: The question is, assume the absurd hypothetical the government had deposited, do they have regulatory jurisdiction to step in that particular case?

Mr. Thomas Johnson: We believe that the Commission does not have regulatory jurisdiction to require the producer to make additional capital investments.

Justice John Paul Stevens: What about ordinary maintenance that is the example they give having undertaken the most elementary maintenance of its production facility.

So, they fall into disrepair's with the resulted production and hence delivery is ceased.

Now you say that's absurd to think that would ever happen, but my question is assuming it did happen would the Commission have statutory power to say no you got to do some maintenance work?

Mr. Thomas Johnson: I think they would Your Honor, because the Court of Appeals below said this.

They said that the Commission has the power to require producers to continue deliveries where the wells are capable of producing and paying quantities.

Now if the wells are capable of producing and paying quantities even given some minor maintenance operation, we believe that the Commission could require that, that be done.

Now, what we don't believe however, is that the Commission can require new wells to be drilled or the capital expenditures can -

Justice John Paul Stevens: How do we know the Commission is going to require anything more then this in interpreting this regulation anything else is –

Mr. Thomas Johnson: Your Honor that's what they said in their order.

Justice John Paul Stevens: That they are going to require to drill a new well.

Mr. Thomas Johnson: Yes sir that's what order --

Justice John Paul Stevens: They said they would consider that didn't they, as the questions of speculations were reserved didn't they?

Mr. Thomas Johnson: Yes, what the Commission said was that if we find it necessary to maintain the service, we are going to require producers to drill new wells or take whatever measures we find that is necessary to maintain this service.

That is what the Commission's Order 539(b) said.

Justice John Paul Stevens: The Commission has told us the other day that it assumes it has the power to do that under this order that I understood Mr. Shapiro said that.

He said that they hadn't decided whether they would, but that they have the power under this Order.

Is there any argument about that --

Mr. Thomas Johnson: Your Honor, it seems to me that if they are arguing that they have the power under the order they intend to exercise that power at some point in time.

They very carefully avoided any discussion of how this jurisdiction will be exercised.

Chief Justice Warren E. Burger: Didn't they just reserve the exercise, but assert the power.

Mr. Thomas Johnson: I think that's right Your Honor.

But our point is that in discussing whether or not have they power, the Court should consider how this power should be exercised, is going to be exercised and if it is going to be exercised in a way that interferes with the state jurisdiction over production activates, then we think it conflicts with the jurisdiction of the state and exceeds the Commission jurisdictions.

Justice Byron R. White: I'm surprised you answered Mr. Justice Stevens with a yes on his hypothetical.

It is just as much production and gathering.

Negligent production and gathering is negligent production and gathering, it is still production and gathering.

Justice John Paul Stevens: I thought your whole position was within the exclusion was no power.

Mr. Thomas Johnson: Your Honor, I think our position is that the Commission has no power to control the production and gathering activity.

Now, I understood Justice Stevens question to be limited to a fact situation where it would simply be a matter of turning the valves back on or to --

Unknown Speaker: But it is still production and gathering, where did they get the power to do that.

Mr. Thomas Johnson: Your Honor, I would be very content if this Court would hold --

Unknown Speaker: No, you were asked what your position was and seemed to say, construe the act to permit the Commission to do that.

Mr. Thomas Johnson: Your Honor I think I was --

Unknown Speaker: You totally agree with the Court of Appeal.

Mr. Thomas Johnson: I beg your pardon.

I agree with the Court of Appeals when the Court of Appeals says it.

That if the well is capable of producing in paying quantities that the Commission has the power to make those wells to require the producer to deliver the gas.

In other words that the producer just turns the valve.

Unknown Speaker: That and do engage in some activity that would make the producer have the wells of up to their potential.

Mr. Thomas Johnson: Your Honor, I think that this gets over --

Unknown Speaker: Is that production and gathering?

Mr. Thomas Johnson: I certainly think if the Commission requires anything affirmative on the part of the producer to produce the wells that it is production and gathering and would be excluded from their jurisdiction.

I think the difference in the dividing line is a question of whether or not if something more is required then simply turning a valve or whether the Commission is seeking to require the producer to actually in someway control its production operations and we believe that is what is excluded from Commission jurisdiction.

Unknown Speaker: Mr. Johnson.

Mr. Thomas Johnson: Yes sir.

Unknown Speaker: Aren't we talking about situations where reserves have been dedicated under contracts say with natural gas pipeline companies.

Aren't there contracts obligating producers to deliver gas to the --

Mr. Thomas Johnson: Yes Your Honor, the contracts obligate the producer to deliver all of the gas from which is produced and that's important, which is produced from a certain field.

Unknown Speaker: Right, but let me follow that up.

Suppose a producer was manifest with negligent as suggested in the hypothetical that you and Mr. Justice Stevens have been discussing where the party to the contract said if the natural gas pipeline company have a cause of action under the terms of the contract for failure to perform as required by the contract itself.

Mr. Thomas Johnson: If the contract did require that the producer --

Unknown Speaker: Do these contracts require?

Mr. Thomas Johnson: Normally, they do not Your Honor, because the production decisions in the contracts are normally reserved to the producer and the pipeline is not the body that polices the producer's actions in those matters.

It is the state agencies and the lessors in the state proceedings, which assure that the producer will proceed diligently.

Unknown Speaker: If you represented a pipeline company that had a contract for the deliver of natural gas and you found that the producer would just not spend a nickel on maintenance and repairs and therefore couldn't fulfill the contract or you would take no action?

Mr. Thomas Johnson: Your Honor.

First as I said before, I think that's not a realistic --

Unknown Speaker: I agree with that.

Mr. Thomas Johnson: But assuming that the pipeline did have that – that was the situation, I think it would depend on whether the contract gave the pipeline that power or whether the contract simply said that the pipeline had the right to buy the gas if as and when produced as many of them do.

Justice John Paul Stevens: In any event, the royalty holder would have some interest.

Mr. Thomas Johnson: The royalty owner would certainly vigorously prosecute the producer.

Justice John Paul Stevens: It is almost guaranteed that he would have the power obviously.

Mr. Thomas Johnson: There is not any question about that Your Honor.

Your Honor, if I could close with just one sentence.

We believe that the Commission is seeking to assert jurisdiction in an area which is precluded from asserting by congress and we think the Court of Appeal should differ.

Rebuttal of Howard Shapiro

Chief Justice Warren E. Burger: Do you have anything further Mr. Shapiro.

Mr. Howard Shapiro: One very brief statement Your Honor.

First, the State's do not require production in aid of interstate delivery obligation under the Natural Gas Act.

That is the regulatory gap.

Second, the producers have stated the obligation is to deliver only what they choose to produce, if they choose not to produce or they choose not to maintain their equipment, there will be no gas to deliver, hence there is no delivery obligation and that will destroy, seriously undermine the dedication concept recognized in Sunray and subsequent cases.

Unknown Speaker: You mean, there would be no contract delivery obligation.

Mr. Howard Shapiro: There will be no delivery obligation under the statutes Your Honor, because the contract obligation is not what controls under the Natural Gas Act, but the service obligation resulting from the certification of the sale that's the doctrine of summary.

Unknown Speaker: I mean you are conceding that if they deliberately don't maintain their equipment, they don't have any obligation?

Mr. Howard Shapiro: No, you said no contract obligation.

Unknown Speaker: So you are saying that is their view of the statute.

Mr. Howard Shapiro: I'm sorry I misunderstand your question.

There remains a duty under the statute to deliver.

The Court of Appeals rather inconsistency said the FERC, this is a petition on Page 7(a) the FERC can enforce service obligations contained in the certificates that it issues to producers preventing producers from ceasing delivers from fields admittedly capable of continuing production.

Now the word admittedly I assume refers to admitted by the producer, but if in fact the field can produce and all it is required is the ordinary prudent actions to keep it producing then what the Commission is saying here is simply that they should take those steps to assure that they produce what they have undertaken to deliver and that is the essence of the prudent operator standard.

Finally, the consumers argue that the standard goes too far, but the standard is designed to accommodate with state law, it is not designed to conflict with it.

It does not conflict with it.

Chief Justice Warren E. Burger: Thank you gentlemen.

The case is submitted.