FERC v. PENNZOIL PRODUCING CO.

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Argument of B. Barnett

Chief Justice Warren E. Burger: We'll hear arguments next in Federal Emergency Regulatory Commission against Pennzoil and others.

Mr. Barnett, you may proceed whenever you're ready.

Mr. B. Barnett: Mr. Chief Justice and may it please the Court.

The principal question in this case is whether the Federal Power Commission, now the Federal Energy Regulatory Commission validly interpreted the Natural Gas Act when it held that it would be inconsistent with the Act for the Commission to approved as a just and reasonable rate above the otherwise applicable ceiling rate and for the Commission thus to pass through to interstate pipelines and hence to the consuming public incremental royalty costs based on the price of natural gas in the unregulated intrastate market.

Respondents Shell and Pennzoil produced gas from a field in Southern Louisiana and sell it in interstate commerce under certificates granted by the Commission to United Gas Pipeline Company, an interstate pipeline.

The gas is produced by Shell and Pennzoil under leases granted by the landowner lessor, Williams in 1934 and 1952.

The 1934 lease provides for royalty to Williams of one-eighth of the value of the gas produced.

The 1952 lease provides for royalty of the one-fourth of the value of the gas produced.

In each case, the value is to be calculated at the market price or the market rate prevailing at well.

Shell and Pennzoil had always computed and paid their royalties as fractions of the market rates that they actually received by selling the gas to United, rates in which since this Court's 1954 decision in the Phillips case have been set by the Commission.

Thus in 1975, the applicable commission rates to the gas in this case were approximately 31 cents and approximately 60 cents.

Beginning in 1973, however, Williams demand that payment from Shell and Pennzoil of royalties based on the market value of the natural gas in the unregulated intrastate market.

These values were said by Williams to range from 35 cents to 70 cents per Mcf for the period through mid 1974 and then from 1974 to 1975 from a $1.30 to $1.40 per Mcf.

When Shell and Pennzoil refused to pay these higher royalties, Williams purported to terminate the leases.

Shell and Pennzoil then sued Williams over this question in Louisiana state court.

Before the court made a ruling, the parties entered into a settlement agreement contingent on approval by the Commission.

The settlement provides that Shell and Pennzoil would apply to the Commission for permission to pay specified increased royalties to Williams and to pass through these increases to United.

The royalties provided for in the settlement were royalties based on, that is the appropriate fraction of either a price of 78 cents per Mcf increasing 1.5 cents a year after 1975.

Or based on a price of a 150% of the highest rate set by the Commission whichever was higher that is whichever the 78 cents or the 150% of the Commission rate was higher.

As an alternative, the settlement provided that Shell and Pennzoil would ask the Commission for permission to abandon the portion of the gas that was attributable to the royalty interest that is one-eighth or one-fourth so that that gas could be paid to Williams as a royalty in kind for sale by Williams, wherever Williams wanted to sell it presumably in the intrastate market.

Shell and Pennzoil then duly took this agreement to the Commission seeking its approval.

The Commission's Administrative Law Judge denied the petition for the special relief for the higher rate that would pass through this increment of royalties to the pipeline.

The judge concluded that special relief from an area or a national rate is warranted only when a producer can demonstrate that his overall cost from the operation in question are higher than the commission ceiling or that is out of pocket expenses will exceed revenues.

The judge found that Pennzoil had made no attempt to make any such cost showing and that while Shell had made such an attempt, Shell had failed.

The judge found in particular that if Shell were to pay royalties based on the 78-cent rate in the settlement, Shell will still make a profit of something like $290.00 a year, on the leases in question under the Commission's ceiling that is would not need a higher rate to make that profit.

The judge further found that even if Shell --

Chief Justice Warren E. Burger: In the abstract, these figures really aren't very meaningful, are they?

Mr. B. Barnett: Well, we think they are.

Chief Justice Warren E. Burger: As compared with what?

390,000

Mr. B. Barnett: Well, if the standard is whether -- if the standard is that in order to obtain special relief from a commission rate, you have to show that you're cost would exceed your revenues.

Chief Justice Warren E. Burger: Which is your hardship case?

Mr. B. Barnett: Well, if you like, yes.

Then it certainly is meaningful to show that you are making a profit rather than a loss.

Chief Justice Warren E. Burger: Well, you didn't define what kind of a profit that was.

You're talking about a net clear profit after all costs and that sort of thing?

Mr. B. Barnett: Well, after all costs that Shell showed here.

Shell was given an opportunity to show whatever costs it could and after all costs that showed, the Administrative Lawyer Judge found that it would still have a profit.

Chief Justice Warren E. Burger: And does the record show what their profit would have been if the decision of the Commission was correct?

Mr. B. Barnett: No, it does not, Your Honor, except that one can figure that out by adding the incremental royalties to the -- to what the Administrative Lawyer Judge found that their profit would be without it.

In addition to the denying the price relief, the Administrative Lawyer Judge also denied the alternative abandonment relief.

The Commission affirmed the denial of the requested rate increase but on a broader ground that the Administrative Lawyer Judge had taken.

The Commission found that the impetus for the settlement is the market value of the royalties and held that it would be inconsistent with the Natural Gas Act for it to allow the pass through as just and reasonable rates under the Act of such incremental royalty costs that were based on the market value of natural gas and the unregulated intrastate market.

Justice William H. Rehnquist: Mr. Barnett, did they actually take the position that they had no jurisdiction to consider them?

Mr. B. Barnett: The Commission never said it had no jurisdiction.

The Commission did put its holding in terms of lacking authority that it --

Justice William H. Rehnquist: Which is pretty much the same thing?

Mr. B. Barnett: I don't think it is because the Commission did consider the question.

The Commission had a full hearing and considered whether it should grant the relief requested and decided that it should not because to grant it would be inconsistent with the Act.

Now the Commission phrased that holding in terms of lacking authority under the Act but the Commission made the decision that it lack the authority.

The holding would be no different if the Commission had simply said we hold that the grant relief based on incremental royalties based on the intrastate market would be inconsistent with the Act as interpreted by this Court in Texaco.

So while the decision is phrased largely in terms of lacking authority, it's also phrased in terms of being inconsistent with the Act.

The Commission decided that it lack authority, it was a decision made by the Commission and thus we submit that the question before the Court here is whether this was a valid interpretation of the Act by the Commission.

Justice William H. Rehnquist: It decided that it simply could not consider this fact?

Mr. B. Barnett: It considered this case and --

Justice William H. Rehnquist: You see I considered the case but it could not consider this particular fact?

Mr. B. Barnett: With particular factor.

I mean it decided that it could not grant relief for incremental royalties based on the intrastate market.

What it decided that it could not consider was whether this particular royalties were reasonably incurred and the reason it decided that it could not consider that was because it had decided as a matter of law that when the royalties are based on the intrastate market, to allow them would be inconsistent with the Act.

The only thing it refused to consider was the particularized question of whether these royalties were reasonably incurred.

The Commission also --

Justice Byron R. White: So you're saying that the Commission decided that it would violate the Act for them to grant relief in this case?

Mr. B. Barnett: Yes, the Commission decided that it would violate the Act as interpreted by this Court in the Texaco case for it to grant relief in this case or in any similar case where special relief is sought based on incremental royalties based on the unregulated market price.

Justice Byron R. White: Is that the position the Commission took in the Court of Appeals?

Mr. B. Barnett: I am not familiar with the Commission's brief in the Court of Appeals, Your Honor so I cannot answer that question.

I think it is the position that Commission took in its order and its orders on rehearing.

Justice Byron R. White: Do you think the Commission adequately states the reasons for its decision in its opinion?

Mr. B. Barnett: I think it does.

I think --

Justice Byron R. White: Are there ordinary administrative practices of explaining clearly enough what the grounds for the decision were?

Mr. B. Barnett: I think it does as in the previous case if I were writing the Commission's opinion just as if I were writing the Act of Congress.

I like to think I could a better job but I think here the Commission's decision is entirely adequately recent by the applicable standards.

The Commission made clear relying on this Court's holding in the Texaco case that it would be inconsistent with the Act for it to establish as a just and reasonable rate, royalties are rate that is based on cost based on the intrastate price, the unregulated intrastate price.

Justice Byron R. White: So that if someone comes in and just says, I'm now having to pay more for my gas than I used to and I want a rate adjustment.

And the Commission says, we have no power under the Act to grant that.

Mr. B. Barnett: Oh!

No, no, not at all, the Commission said we have no power under the Act to grant it or we decide under the Act that we will not grant it if the higher cost you are talking about are higher cost that are simply based on the unregulated price of gas which the Commission found that the cost here were.

Justice William H. Rehnquist: That is simply a factor which the Commission will not take into consideration in deciding whether a higher rate should be granted.

Mr. B. Barnett: No, no, the Commission took it into consideration here and decided that under the Act it may not grant a higher --

Justice Byron R. White: Well, so they have no power to grant it?

Justice William H. Rehnquist: They have no power to grant it?

Mr. B. Barnett: Well, the Commission decided here that it have no power.

Yes, based on its interpretation, yes.

Justice William H. Rehnquist: That's all I asked you.

Mr. B. Barnett: Well, yes but the point is that as respondents present the case that's simply a procedural matter and the Commission here has refused even to consider anything.

That is not how we think it was.

The Commission fully considered the issue and decided as a matter of law, as a matter of its interpretation of the Act that the grant to relief would be inconsistent with the Act.

It did consider the issue.

Justice William H. Rehnquist: We've had two or three cases here in the short time I've been on the Court coming from the predecessor of the FERC where the Commission started out taking the position.

We simply have no jurisdiction to consider this.

And by the time it gets here, it turns out they have jurisdiction by they could easily decided at the way they did on the basis -- in administrative basis.

Mr. B. Barnett: Well, that's true but in this case, Mr. Justice Rehnquist, the Commission never said it lack jurisdiction.

It did use the word authority.

But we assert that saying --

Justice William H. Rehnquist: It's just a legal decision?

Mr. B. Barnett: Yes, that it simply a legal decision.

There is no different effect between it saying it lacks authority under the Act and it saying as we interpret the Act it would be inconsistent with the Act for us to do this.

Justice William H. Rehnquist: Well, has the Commission always taken this position or not?

Mr. B. Barnett: Always in this case?

Justice William H. Rehnquist: No.

In other cases, similar cases.

Mr. B. Barnett: Well, this was the first case presented to it that presented this issue, Mr. Justice Rehnquist.

Justice Byron R. White: You mean about an independent producer?

Mr. B. Barnett: About a -- about a royalty based on market value royalty which was interpreted to refer to the unregulated intrastate market.

Justice William H. Rehnquist: What about the cases that depends -- refers to the pipeline cases?

Mr. B. Barnett: Oh!

I'm sorry.

Are you referring to El Paso and Kimberlin?

I thought you were referring to earlier cases?

Justice William H. Rehnquist: Well, I was.

But now I'm asking you about --

Mr. B. Barnett: Yes.

Well, they are distinguishable.

The El Paso case involves a pipeline as distinguished from an independent producer --

Justice William H. Rehnquist: But the same section?

Mr. B. Barnett: Well, it's the same section except that the section that provides Section 2.66 of the Commission's regulations does provide as Pennzoil states that pipelines as well as independent producers are subject to the applicable ceiling price.

However, in fact, El Paso was granted an exception from the provision in the very El Paso case.

And under that exception, El Paso's rates were established on a strict cost of service basis.

That is established individually for El Paso so it was not a question of special relief from an otherwise applicable rate.

Now in the Columbia case which is also cited.

That was a case involved that where a Pipeline made some purchases of gas which were held to be none -- which had previously been held to be non-jurisdictional purchases, that is the sale of the gas to the pipeline was not regulated by the Commission.

And the question was whether the price that the Pipeline paid in an unregulated purchase could be included in the Pipeline's rate and the Commission held that it could.

Well, apart from the fact that --

Justice William H. Rehnquist: Yes, but that was an individual case.

It already been a ceiling price establish in Columbia, hadn't there?

Mr. B. Barnett: I think so, Your Honor.

Justice William H. Rehnquist: Now, what's the difference between that case and this?

Mr. B. Barnett: Well, I think the difference between that case and this case is that that is a special case involving jurisdictional purchases of gas to how else are you going to treat that?

Justice William H. Rehnquist: Non-jurisdictional purchase.

Mr. B. Barnett: I'm sorry.

Non-jurisdictional purchase.

Justice William H. Rehnquist: Well, this is non-jurisdiction here too.

Mr. B. Barnett: That's right, the royalties are non-jurisdictional too.

We think --

Justice William H. Rehnquist: And what's the difference?

Mr. B. Barnett: Well, we think the Commission was justified and thinking that there is a difference because if you allow the past through of non-jurisdictional market value royalty rates, market value royalties being so common.

You are going to completely undermine the regulated rates for the sales that the producers make.

Whereas to do it in an individual case like Columbia, those non-jurisdictional purchases which do not underlie a whole --

Justice William H. Rehnquist: But you're still construing the same section of the statute.

Mr. B. Barnett: You're still construing the same statute but the Commission could make the decision that if it granted a relief and the market value royalty cases, it would be undermining the entire regulatory scheme as this Court pointed out in Texaco which was another case where a whole regulatory scheme would be undermined and there is no such effect in an individual case of non-jurisdictional purchases such as Columbia.

Justice William H. Rehnquist: So I take it that the Commission didn't agree with the Administrative Law Judge?

Mr. B. Barnett: The Commission did not address itself to the Administrative Law Judge's holding that this case turned --

Justice William H. Rehnquist: Because the Administrative Law Judge sought that the Commission had legal power under the statute that the Commission said it didn't have.

Mr. B. Barnett: The Administrative Law Judge really address the question the Commission addressed either.

He simply said, the threshold for such relief is, can you show that you're operating at a loss and this had not been shown.

The Commission didn't look at that question, it's --

Justice William H. Rehnquist: It said -- it said, we can't get there?

That's it.

It's illegal for us to get to that question.

Mr. B. Barnett: Well, it said that under the Act it would be illegal for us to grant relief in this case.

The Commission did not however and as we point out in our reply brief, the Commission's holding is not applicable to a case where that kind of a showing was made.

If the producer did show that their costs exceeded their revenues, so that they had made a case for confiscation, the Commission has not addressed that issue.

The Commission's decision --

Justice William H. Rehnquist: Then they would -- then suddenly, it would be legal to recognize the extra royalty cost there?

Mr. B. Barnett: Well, yes it might be.

The Commission here does not interpret the Act to require or to do something unconstitutional which it would be to impose a confiscatory rate.

And thus again, the Commission's decision is an interpretation of the Act as applied to market value royalties based on the unregulated market in a situation that does not present a case of confiscation.

Now the reason the Commission interpreted the Act this way was largely this Court's decision in Texaco where the court made quite clear as it said that the prevailing price in the marketplace cannot be the final measure of just and reasonable rates mandated by the Act.

And if further pointed out there that while the Commission had said that the rates would be subject to refund if they were unreasonable, reasonableness was apparently to be judged by the standard of the marketplace.

Now, there are one or two factual differences between this case and Texaco which I assume my colleagues will point out and which I would therefore like to address.

It is -- there are two what I would call quantitative differences only.

It is true that in Texaco, it was the entire rates of the small producers whose reasonableness was to be judged by the standard of the marketplace whereas here the royalties are only a fraction of the market price, one-fourth or one-eighth here as against the entire market price in Texaco.

Another quantitative difference is that here again you would -- here, that in Texaco, again, you are talking about the entire price charged by the small producers whereas here the royalty increment is only a portion of the price that the producers would be charging the pipelines.

We submit that neither of these quantitative differences changes the applicable principle.

The second difference can be readily dismissed as a matter of law because the incremental royalty here, even though it's only an increment.

Even though it would only be a part of the price that producer's charge the pipeline, was the entire rate that the producers are asking the Commission to approve as just and reasonable.

It was the entire incremental royalty that had to be shown to be just and reasonable and thus the Commission's refusal to find it just and reasonable and the Commission exactly said as much that it had to find the entire incremental royalty to be just and reasonable is completely consistent with Texaco.

Now, the other difference, one-fourth and one-eighth versus the whole thing is again clearly not a difference in principle.

The Court said as much in Texaco 417 U.S. at 399 where it said “Even if the effect of increased small producer prices would make a small dent in the consumer's pocket when compared with the rates charged by large producers, the Act makes unlawful all rates which are not just and reasonable and does not say a little unlawful -- a little unlawfulness is permitted.”

Thus, it's true of the incremental rate that the producer's wanted pass through here just as it was true of the rate in Texaco that it would be just exclusively by the market price and thus, we submit the Commission was entirely justified in relying on Texaco for its conclusion that it would be inconsistent with the Act to allow the pass through as just and reasonable rates of royalties based on the unregulated market.

Another reason for the Commission's decision is pointed out by the effect of the Court of Appeals decision below.

The decision that we asked the Court to reversed.

Respondents attempt to address that decision in Sheik's Clothing and argue that it's simply a procedural issue that's at stake here seizing on the Commission's language about authority and thus for example, if Shell says in its brief, the Court of Appeals did not require the Commission of fine for the producer.

The Commission was merely required to consider the merits of the producer's position.

Well, that sounds fine.

The short answer first is that the Commission here did consider the merits of the producer's position.

It did consider whether it should grant the producers the relief they seek.

And it decided not to, it decided that it would not do so, it could not do so because to do so would be inconsistent with the Act as interpreted by this Court in Texaco.

But further, the fact is that the Court of Appeals decision clearly would require the Commission to grant relief and not simply to consider doing so.

The -- for example the Court of Appeals said, this is page 7 (a) in the appendix to the petition.

This is not to say that every additional cost must be past through to the customer to protect the producer's level of profits.

The Commission has authority to consider the reasonableness of any cost incurred.

But the kicker is under that ad hoc reasonableness standard.

The Commission would be required to find the cost to be reasonable in any case of a market value royalty that was held to apply to the intrastate market.

Shell and Pennzoil when they depart momentarily from their minimalist portrait of the decision below, admit as much, they argued that the Commission would be required to grant them relief for several reasons.

That these leases were entered into before the Natural Gas Act or before Phillips that the royalty provisions were consistent with the industry standard at that time and that the price increase would generate no profits since it would simply be pass through.

Well, that would be true generically, typically of market value leases in any state where such leases had been held or might be held to refer or the intrastate market.

Thus, if all the Commission could consider was whether a particular royalty had been entered into reasonably, it would have to find that it was.

And that's what at stake here is not simply a procedural issue but whether the Commission must grant relief on a generic basis for such market value royalties and the Commission held consistently with Texaco that it may not do so.

I'd like to reserve the rest of my time.

Justice Harry A. Blackmun: Mr. Barnett, before you sit down.

Mr. B. Barnett: Sure.

Justice Harry A. Blackmun: Your reply brief filed yesterday which is at my desk just this morning.

Mr. B. Barnett: I'm sorry Mr. Justice Blackmun we filed that in typescript with the permission of the clerk last Wednesday.

We did have a printing problem --

Justice Harry A. Blackmun: I'm not being critical, I knew they would like to have you make one or two sentence comment on the effect of the 78 Act because it seems to me that the new Act makes the underlying rational of Texaco almost inapplicable from here on end.

Mr. B. Barnett: Well, we don't' think --

Justice Harry A. Blackmun: I was just trying to downplay it in your brief but maybe I should ask this question in closing counsel but at least I'd like some comment from you.

Mr. B. Barnett: Well, we don't try to downplay it.

We – that is the Commission's view of the impact of the Act.

The Act has considerable impact in many ways.

However, as we point out in the brief, the ceiling price for -- the ceiling price provided by the new Act for gas that was already dedicated to interstate commerce under the old Act would remain the ceiling price that had been set by the Commission as adjusted for inflation or that had been increased by the Commission under the just and reasonable rates of the new Act.

Thus, the prices applicable to this gas under the new Act are based on the prices applicable under the old act and that in very brief is why we think the issue is still alive and needs decision although admittedly in the future as the two markets converge the practical significance of the issue may be expected to decrease.

Thank you.

Argument of Jeron Stevens

Chief Justice Warren E. Burger: Mr. Stevens.

Mr. Jeron Stevens: Mr. Chief Justice and may it please the Court.

I must say that I've been increasingly intrigued as this case has developed on its way from the Fifth Circuit Court of Appeals, particularly in the position that the Commission's been taking.

I didn't prepare these remarks to begin this way but let me take a few minutes of my time and tell you why I'm so intrigued.

That is the Commission in its opinion and the opinion on the case below said, “We cannot permit any incremental royalty costs resulting from this settlement or resulting from any judgment by state court regarding royalty payments to be based on -- to be passed on to the pipeline if these incremental royalty costs were based on any further factors than the regulated just and reasonable right.

They did not say, we cannot permit any right based on intrastate rates to be passed on.

They said any factor other than the just and reasonable rate.

And of course there are number of other factors that should be involved in any case like this and they're involved in the case below that we had witnesses valid and all that.

The interesting thing about this is the Commission decided it had no authority.

This case was tried in the Fifth Circuit as a question of authority.

Justice Byron R. White: Well, I know but that's an ambiguous term too, I supposed.

Mr. Jeron Stevens: Jurisdiction, if you will Your Honor.

Justice Byron R. White: Well, there's no word about jurisdiction in this opinion.

Mr. Jeron Stevens: I agree and that's why we --

Justice Byron R. White: And there isn't in the Court of Appeals didn't refer to it as jurisdiction?

Mr. Jeron Stevens: No, sir.

I certainly agree with that.

Justice Byron R. White: And you could sensibly call it a matter of authority if the question was, is it legal under the Act?

Mr. Jeron Stevens: Yes, sir.

Justice Byron R. White: But suppose to do what the Commission was asked to do was illegal under the Act you could say that they had no authority to grant it.

Mr. Jeron Stevens: That's the word I would use.

I certainly agree with that.

The interesting thing about it though is, that as the record below shows the settlement in this case, it was a settlement of royalty litigation under market value lease.

The settlement had the royalty to either 78 cents or 150% of the national rate.

At the time the settlement was executed, the Commission had before it in the rulemaking proceeding, the proposal to permit small producers to collect 150% of the national right.

This settlement was tied exactly to that.

At that time the national rate as reflected in the record below is 52 cents per Mcf and 78 cents is exactly 150% of that.

This settlement was tied directly to commission set rates and not to intrastate rates. Unfortunately, the only direct testimony in this point was produced by Pennzoil's witness Gray, which is found at page 36 of the transcript in this case which because why the case's brief in the Fifth Circuit is not in the joint appendix.

Of course it is viable to the ourt, if the court wish we would file that as a supplemental appendix.

Those are the facts of how that case got to the Fifth Circuit.

Now, we've been seeing this evolving argument and it comes out very expressly for the first time at page 12 of the reply brief that was filed last Wednesday.

When the Commission finally makes the assertion that the Commission based its decision, and I'm sorry Your Honor, I'm talking about the typewritten copy and not the printed copy.

Chief Justice Warren E. Burger: I believe that we don't use it if we get the typewritten copy, once the --

Justice William H. Rehnquist: Well, what's the argument made by the plaintiff?

Mr. Jeron Stevens: That is that the Commission based its holding on the record to the effect that this settlement royalty was based on intrastate rates.

That is just not the fact.

If that is now the argument that the Commission is relying on, then I suggest that they have a serious problem under Section 19 (b) of the Act because that would be a factual finding.

And as I read Section 19 (b) of the Gas Act, it requires all factual findings to be supported by substantial evidence and there is not only no substantial evidence, there is no evidence.

Justice William H. Rehnquist: Well, but do you suggest that what the Government argues here in its reply brief or elsewhere does not agree with what the Commission itself found in its opinion?

Mr. Jeron Stevens: Yes, sir.

I suggest exactly.

Justice William H. Rehnquist: So, you're saying that they want affirmance on the ground different from what?

Mr. Jeron Stevens: Yes, sir.

I'm suggesting exactly that.

Chief Justice Warren E. Burger: Why would you --

Mr. Jeron Stevens: Your Honor?

Chief Justice Warren E. Burger: Would you follow that by saying we can't reach the ground not considering the Commission?

Of course, it's held 25 years ago.

Mr. Jeron Stevens: Well, Your Honor, I'm certainly aware that this Court has held that it would be improper to -- in the Burlington Trucking line -- Trucking case to affirm lower a Commission decision based on post talk rationalization.

And yes sir, I'm suggesting if that's the basis of the primary thrust of their argument at this point that the Court cannot and should not affirm it on that basis.

Now, if the Court wishes to affirm it on the question of authority, which is what we briefed in the Fifth Circuit argued there and I thought we were arguing here, then of course, the Court is free to do that because the Commission did address that issue also.

And I will suggest that the basic reason that the Commission has reached the position that's it's in, in this case, is because it did read Texaco but it misread it.

We read Texaco as being the case basically where the Commission was attempting to deregulate small producer rates by tying them directly and solely to intrastate process.

We read Texaco as holding that the Commission cannot deregulate something over which it has the right jurisdiction.

But that if the Commission wishes to regulate indirectly, it must consider all factors and not solely intrastate price levels.

We're not asking permission in our case to deregulate anything.

As Mr. Barnett candidly admitted, Commission has no jurisdiction over royalty cost.

They do that jurisdiction over our entire right.

Now, we brought forth a request for inquiries on that regulated right.

And we ask them to consider all the relevant factors and there were several put out in the testimony and case below at the hearing before --

Justice Byron R. White: The Commission itself found that the, I think that this is an accurate quote that the Commission found that the impetus of the settlement is the market value of the royalties and no consideration has been given to regulative rates.

So the Commission equated this request with an intrastate unregulated market request.

Mr. Jeron Stevens: Your Honor, certainly, we agree that the impetus of the litigation and the impetus of the settlement and the impetus of our application for relief was the litigation that was requesting market value be based on intrastate or other process.

Simply because that is what that cause this whole thing to get going.

It doesn't mean that that's what the settlement was based on.

We view their holding as set out on page 261 of the joint appendix and the second sentence, the one I quoted earlier as saying they have no authority.

And that certainly laid the Commission brief to the Fifth Circuit and that's the way we briefed it.

I would suggest that since we're not asking the Commission to based any component of our right on intrastate rights solely, even assuming that our process were based in part on intrastate rights, we can't see how as a matter of logic the answer of the question of whether the Commission has authority should be any different.

Though we think what the Commission has done in this case is to do the same thing it did in Texaco and that is to focus solely on one comparison that is the comparison of the settlement right here with intrastate process and then to say, “We're sorry Pennzoil, we're sympathetic to your plot but Texaco tells us that we can't focus solely on this comparison and grant your rate increase.”

Pennzoil believes that our argument is consistent, our reading of Texaco, pardon me, is consistent with the purposes of the Act and with this Court's previous decisions and with the Commission's previous representations to the Court.

And I'm talking specifically here about the Mobil case in review of the Southern Louisiana Area Rate case.

In the Commission's brief in that case, they specifically told the Court that the producers in a market value royalty bond could petition for individualize relief.

We believe that that was the basis upon which the Commission was affirmed in setting area rights on that point.

Justice Byron R. White: Do you think that Columbia cases consistent with Texaco?

I know that one is a pipeline and the other isn't connected.

Mr. Jeron Stevens: Yes, sir, I do.

Justice Byron R. White: Although there the request was based on an unregulated rate or unregulated cost.

Mr. Jeron Stevens: Yes, sir.

There --

Justice Byron R. White: In the market price?

Mr. Jeron Stevens: Yes, sir.

There, Your Honor, the item in question that was being priced was not an item over the -- for which the Commission had direct jurisdiction.

Justice Byron R. White: Right.

Mr. Jeron Stevens: And they did over the small producers in Texaco.

The Commission look at the merits as I understand it in the Columbia case of the process --

Justice Byron R. White: They didn't have any -- they didn't have any jurisdiction over the prices that were being charged in unregulated market.

Just like they didn't have any -- they don't any jurisdiction over the royalty charges here.

Mr. Jeron Stevens: That's right.

Your Honor, our view, the Columbia case, the Texaco case, and Pennzoil's position on this case is being entirely consistent.

And the Columbia case what the Commission did basically was to look at those costs that were being included those purchase costs that were being included in the Pipeline's flow through and their rights.

And so we don't have jurisdiction over those.

We can't automatically exclude them because solely because they're equal to or based upon or tied to or related to in some way market value cost though we do have the authority to review them on the merits and determine whether or not they make statutory section for just and unreasonable test.

And that's what we're here claiming the Commission has authority to do in our case.

I think this is also consistent with El Paso case which you asked about earlier.

In the El Paso case, the Commission in fact granted the flow through and the jurisdictional right of a royalty component that's virtually identical to the one that Pennzoil is asking for the flow through, Your Honor, virtually identical to it.

Though, they tried to distinguish that in their brief and in this argument, on the basis that that's a pipeline and their cost of service is regulated individually.

The face of the order in that opinion at page 5 shows that they in fact had to waive the National Rate Regulations which were then applicable to El Paso's rights in order to grant them relief.

It also shows the 25% of El Paso's production would continue with price that the applicable national rate for producers.

But that's not really the point.

The point really is that Section 4, the Natural Gas Act, applies equally to producers on the pipelines.

And if they have the authority to do it for pipelines, they have the authority to do for producers.

Now, we're not here arguing and we didn't argue before the Fifth Circuit that the Commission is compelled to regulate producers the same way it regulates pipelines.

If it can find reasonable reasons for distinguishing, for putting one method of regulation for pipelines and one for producers, we have no quarrel with that assuming they can support that on some reasonable basis.

Our only point is that it's the same statute and the authority basically has to be the same.

And I characterize the question of authority as more quite frankly than merely procedural.

I believe it is more than procedural.

The National -- the Natural Gas Policy Act of 1978, of course we have not filed a brief on that, I only have one brief comment on it, and that is that under Section 502 (c) of that statute, it appears to expressly grant the Commission, the authority to permit rate relief to any individual gas producer.

Notwithstanding that the end result of that rate would no longer be just and reasonable under the Section 4 of the Natural Gas Act.

We are not arguing that as a basis for overturning the Commission's opinion because it is not in effect at that time.

But I thought it would be pertinent to at least call it the Court's attention.

Justice Byron R. White: And you think the Commission has required to grant you, your client the relief you asked?

Mr. Jeron Stevens: No, sir.

That is not our point.

We believe that on remand on the merits, we will be able to show that our request is just and reasonable that it was prudently incurred and it's in the best interest of the gas consumers, of United Gas Pipeline and of Pennzoil and we'll show in fact and did show in fact that more gas will be produced for the consumers and that's why United has been supporting this case all the way along.

Thank you very much.

Argument of Thomas G. Johnson

Chief Justice Warren E. Burger: Mr. Johnson.

Mr. Thomas G. Johnson: Mr. Chief Justice and may it please the Court.

My name is Thomas G. Johnson representing Shell Oil Company.

I would like to address first the question or the basis of the Commission's decision which I believe is clear from the face of the opinion.

If the Court will refer to page 27261 of the appendix, the Commission said at that point we cannot permit any incremental royalty cost resulting from this settlement or resulting from any judgment by state court regarding royalty payments to be passed on to the Pipeline if this incremental royalty costs are based on any other factors than the regulated just and reasonable rate.

I believe the Commission is saying and reading Texaco is that they do not have the authority to grant the relief requested by Shell and Pennzoil in this case.

Justice Byron R. White: The sentence starts out as such.

And I suppose that refers to the previous sentence?

Mr. Thomas G. Johnson: Yes, Your Honor.

In the previous sentence to make the record complete says that an impetus of the settlement is the market value of the royalties and no consideration has been given to regulated rates.

And that's the way the Commission reads Texaco.

If confirmation is needed, I believe it appears in the Court of Appeals opinion at pages 6 (a) of the appendix to the petition for certiorari.

And the Court of Appeals said, the Commission concluded that it was not free to allow royalty costs which are based on market values to be passed on to the pipelines as just and reasonable rates.

Justice Byron R. White: Well, that's still the very language of the Commission used in the same paragraph.

Mr. Thomas G. Johnson: Yes, Your Honor, it is and I believe what it says is that the Commission did not reach the issue of whether the increase royalty cost would result in a ceiling rate being imposed on Shell and Pennzoil which is consistent toward.

It is our position that it is the Administrative Law Judge disagreed with our position.

The Commission did not reach it.

With reference to, another issue which the Commission did not decide because of its position is whether the increase royalty cost was prudently and reasonably incurred.

This was specifically reserved by the Court of Appeals to the Commission on remake.

If this issues, if the Commission's position is affirmed here, the Commission will never reach these issues because it contends that it has no authority to decide them.

I would now like to discuss the reference to Justice Blackmun's question about the Natural Gas Policy Act and whether Congress has undermined the import of Texaco.

We believe that while the Natural Gas Policy Act fixes different categories, price categories for gas, it still makes a difference as to whether the gas was sold on the intra or interstate market.

That as far as the rational of Texaco is concerned it is no longer material because the ceiling prices set up prospectively in the Natural Gas Policy Act apply across the Board whether the sale is interstate or intrastate.

In fact, as a portion of that Act, Section 105 the Congress specifically approved the intrastate contract prices for past periods as being the maximum lawful price permitted under the Act.

We therefore believe that the Commission in this Court's earlier concern about the unrated regulated market is no longer material under this Act.

As Mr. Stevens pointed out, this Commission has itself utilized the intrastate prices along with other factors in determining producer rates in past cases.

In the area rate proceedings, specifically the other southwest area rate case, the Commission did utilize intrastate prices in determining the producer rates.

This use was attacked on appeal on the Fifth Circuit and was specifically affirmed by the Fifth Circuit.

This Court denied certiorari.

In the first national rate proceeding on this gas, Shell Oil Company v. FPC at 520 F. 2d, the issue was again raised in the National Rate case.

The Commission relied on intrastate prices as one of the factors that it looked at in determining producer raised.

It was again affirmed by the Circuit Court, this Court again denied certiorari.

Mr. Stevens has already referred to the Pipeline cases which we believe are squarely in point here.

The Commission also in dealing with the prices on emergency sales for natural gas, and limit the terms sales, by producers has reference to comparable prices in the intrastate market in determining whether these sales are reasonable or unreasonable.

The Commission collects data on the intrastate market on Form 45 and quarterly publishes reports of that data which it utilizes in Producer rates.

We therefore do no believe the Commission Acts consistently when it says that it cannot look to intrastate prices for any purpose.

We would also like to point out that we believe that this case is distinguishable from Texaco because the royalty provides only one of the cost components which the Commission looks to in determining producer rates.

The price of the other cost components, steel pipe, labor, federal income taxes is not subject to Commission regulation either.

But as the Court of Appeals pointed out, these prices are used as determinates in the commission rate.

I would like to refer to a quotation which appears in the State of Louisiana brief from the Mississippi River fuel case decided by the D.C. Circuit because it's very pertinent here “Expenses are facts".

They are to be ascertained not created by regulatory authorities.

If properly incurred they must be allowed as a part of the composition of the rates, otherwise, the so-called allowance on the return of investment as being amount over and above expense would be a farce.

Justice Byron R. White: Let me ask you, sir.

Suppose the Commission had talked about authority or what the statute required also rights.

What you just said that we've been setting area rates and our rule is and we think it's consistent with the statute.

Our rule is we'll change an area rate to just base on some single cost factor.

Or at least we will grant no exceptions from an area rate that we've set for an individual producer.

Unless he shows that there's some confiscatory element in the picture.

We might have authority to have a different rule but this is our rule.

We're just not going to grant any individual exceptions to an area rate.

If royalties go up or something like that, maybe we will set a new area rates sometime.

But until somebody is being put into business, we're not granting any exceptions, would that be in consistent with the Act?

Mr. Thomas G. Johnson: Mr. Justice White, I'd like to answer that question in three ways.

First of all, your question accepted the question of confiscatory rates.

Justice Byron R. White: Yes.

Mr. Thomas G. Johnson: And we believe that is one of the issues in this case which the Commission refused to consider.

Justice Byron R. White: Yes.

Mr. Thomas G. Johnson: Secondly, in the Permian case, part of the reason why this Court affirmed the area rate was the exception which the Commission said it would grant in special cases like this case.

And thirdly, in the Mobil case, the Commission expressly was faced with the situation here and asked by the Producers in the Texas Gulf Coast area rate proceeding and the Southern Louisiana area rate proceeding which became the Mobil case in this Court to allow relief or this very problem, the market value roll the question on an area or national basis.

The Commission refused to do so.

And in saying it refused to do so on a national or an area rate basis, it said that it took the position that producers could bring special relief cases like this case in order to get those question result.

The Fifth Circuit specifically affirmed the Commission on that basis and the Fifth Circuit's language if I could just quote it is this, “If a subsequent advanced developed the producers are put in a bind by their royalty obligations, they may certainly petition the FPC for individualize relief.

That language from the Fifth Circuit was quoted in this Court's opinion in Mobil with approval.

Now, the Producers are here before this Court asking for the specific kind of individualize relief which this Court indicated in Mobil it would grant.

Excuse me.

Justice Byron R. White: My question was, would it be contrary to the Act for the Commission to have the rule that I posited and you said, up to now it hasn't, it doesn't seem to have that rule that's all you said so far.

But is it your position that it would be contrary to the Act if the Commission said we're just not going to grant any exceptions.

We'll unless there's some kind of confiscatory rates?

Mr. Thomas G. Johnson: Your Honor, again, I would refer to the Permian case and as I read Permian, that was one of the basis that this Court utilize in affirming --

Justice Byron R. White: So your position is that it would be contrary to the Act?

Mr. Thomas G. Johnson: I think it would be contrary the Act if the Commission in so doing imposed a confiscatory rate.

And the purpose of the exception, specific exception for individual case is to allow the Commission to consider this question.

And I believe other cases in this Court have indicated that the Commission cannot impose a confiscatory rate, even an area rate case.

Justice Byron R. White: Well, would you be satisfied in this case if the Commission said that we'll grant you relief when and if you show that it is confiscatory?

Mr. Thomas G. Johnson: Your Honor, what we're asking for in this case --

Justice Byron R. White: That isn't all you're asking.

Mr. Thomas G. Johnson: -- is the precise --

Justice Byron R. White: That isn't all you're asking.

Mr. Thomas G. Johnson: Well, --

Justice Byron R. White: You're asking them to -- in any event that they must or at least they got the authority to re-determine the just and reasonableness of a rate base on new royalty cost in any case whether it's confiscatory or not.

Isn't that the --

Mr. Thomas G. Johnson: Your Honor, I think if I could restate our position.

I think what we're asking is this.

Since the Commission expressly refused to consider this problem in the area in National cases and told this Court that this was the kind of case they would consider that we believe we're entitled to that kind of consideration.

Now the Commission can hold against us on the merits.

And if this Court affirms the Court of Appeals, that will the case would go back before the Commission on remand and it will consider the merits of the confiscation question.

On the other hand, if the Commission is affirmed this question will never be considered because the Commission will have been found without authority to consider.

Justice Byron R. White: You'd be satisfied then if the only thing that were left open on remand is whether or not the result would be confiscation if your request is not --

Mr. Thomas G. Johnson: Your Honor, I think the answer to that would not be satisfied.

Justice Byron R. White: You wanted more than that, I would think --

Mr. Thomas G. Johnson: Yes, Your Honor, I think what we want is a fair trial on the merits and that's what we're asking.

Justice Byron R. White: And the merits are more than just the question of confiscation?

Mr. Thomas G. Johnson: Yes, I think the merits also go to the question if whether royalty cost is reasonable and prudently incurred.

Justice Byron R. White: Right.

Mr. Thomas G. Johnson: This is the --

Justice Byron R. White: So you don't --

Mr. Thomas G. Johnson: -- the historic test which the Commission is utilized and determined why the costs are granted.

Justice Byron R. White: Confiscation item that you want.

Mr. Thomas G. Johnson: That is correct.

And as I understood Your Honor's question when addressed to me that was what the Commission would be required under the law.

But we believe they should also consider whether or not these costs are prudently incurred.

If I could turn now to another point, the end result test is the test which this Court has historically imposed on Commission decisions.

I would like if it consider for this Court's attention just for a moment, the end result on the parties of the Commission's opinion when Shell got in this bind as described by the Court of Appeals by executing its lease in 1934, before the Natural Gas Act was even passed.

And secondly, lease 1952 was executed two years before this Court's Phillips decision and the Commission was not regulating producers.

It wasn't until 1965 in the Permian case when the Commission decided that it would reject the individual company cost of service as the method of regulation of producers and would also reject the market value studies, economic studies or market value and would rely instead on the composite industry-wide cost of service which incidentally included a royalty cost of 12-1/2%.

It was not until Hubert and Valor cases were decided in 1966 and 1968 that the producers suspected that the lessor would be entitled to describe a higher price to their royalty percentage and the lessee was permitted to charge under regulation.

It was not until the Mobil case decided with the D.C. Circuit in 1971 that the Commission was held not to have the authority to impose the same ceiling on the lessor.

When the producers found out they were in this bind to ask the Commission for relief in the Texas Gulf Coast and Southern Louisiana Area Rate cases, the Commission was assured that if we came back in an individual relief case, they would grant relief there.

This is that case in the Commission now contends they do not have jurisdiction to grant this relief.

If I could turn for just a moment to the abandonment question, here again, we believe the Commission has not fully considered the case on the merits.

The only point considered by the Commission was whether that if Shell's leases were cancelled and the lessor became the owner of all of the gas and the leases.

It would be required to continue to sell that gas in interstate commerce.

Of course, this Court have and opinion holds that the lessor would be so required.

But I believe the Commission's duty under the public convenience and necessity test of Section 7 goes further.

Now, we believe that Commission must consider the end-result on all the parties.

From the standpoint of the lessee, the end result of the denial of the abandonment is -- the end result of the denial of the abandonment is the confiscation of the lessee's leases.

From the standpoint of the lessor and the standpoint of the consumer, the consumer's price will go up and I'll leave that discussion to my brief.

Thank you, Your Honor.

Rebuttal of B. Barnett

Chief Justice Warren E. Burger: Do you have anything further, Mr. Barnett?

Mr. B. Barnett: Just a couple of brief points, Mr. Chief Justice.

First of all with respect to the Mobil case which my brothers rely on.

The Court said there that Mobil's argument is hypothetical at this stage and that in any event and effective producer is entitled to seek individualize relief.

The Court went on to quote the D.C. Circuit which said, if there are subsequent events developed.

The producers are put in a bind by their royalty obligations, they may certainly petition FPC for individualize relief.

Permian contemplated it and of this Court's quote.

Well, we would say first of all that producers here were entitled to seek individualize relief.

They did seek it and the Commission decided that it would be inconsistent with the Act to grant it.

Further, we were denied that the producers here have been put in a bind in the terms of the Mobil decision.

The Court went on to say Permian contemplated it.

Well, what did Permian contemplate?

If one looks at the relevant language in the Permian decision, 390 U.S. at 770, the court there said the Commission declared that our producer should be permitted appropriate relief if it establishes that it's out of pocket expenses in connection with the operation of a particular well exceed its revenue from the well under the applicable area price.

The Commission acknowledged that there might be other circumstances in which relief would be given but decline to enumerate them.

Chief Justice Warren E. Burger: In your view, the language of Mobil, I think it was being in bind does not occur until the rates are confiscatory.

Mr. B. Barnett: Yes, we would interpret it that way and we would rely on the reference to Permian which did precisely interpret the relief provision that way.

To respond to the point about whether the Commission here did in fact rely on the fact that these proposed incremental royalties were based on the intrastate rate, we submit that that's clear.

At page 8261 of the appendix, the Commission said in the instant proceeding, the impetus of the settlement is the market value of the royalties and no consideration has been given to regulated rates.

On rehearing 8290, the Commission said, I'm sorry, 291 to 292, “It is plain that the royalty has to be based on 78 cents which is the settlement's reflection of market prices that are above the area ceiling prices.”

The Court of Appeals petition appendix 3 (a) stated that in the Louisiana state court, a lessor asserted royalty claim based on intrastate prices for natural gas which greatly exceed the ceiling rates to establish by the FPC for interstate sales.

Similar statements can be found in the appendix and the initial decision at (a) 116 --

Justice Lewis F. Powell: Mr. Barnett, what was the connection between 78 cents and the intrastate market price?

Mr. B. Barnett: The record does not disclose what the connection was Mr. Justice.

Justice Lewis F. Powell: But it was 150% of the regulated rate?

Mr. B. Barnett: The alternative to the 78 cents -- Oh!

Yes, the --

Justice Lewis F. Powell: 78 cents was.

Mr. B. Barnett: The --

Justice Lewis F. Powell: You mean 150%

Mr. B. Barnett: The 78 cents was in fact a 150% of the regulated rate for small producers.

Justice Lewis F. Powell: This evidence are based on the regulated price?

Mr. B. Barnett: Well, --

Justice Lewis F. Powell: And it had no relationship as I understand you to the unregulated price?

Mr. B. Barnett: Well, it may well have if the unregulated price was about -- the claim was about 140 or 150 or 78 cents may well have been thought to be about half of it.

But the short answer is --

Justice Lewis F. Powell: There is no evidence that they did that and the recent testimony not in the appendix is --

Mr. B. Barnett: Yes, but --

Justice Lewis F. Powell: -- that it was based on the regulated rate.

Mr. B. Barnett: Well, so my colleague says but we would submit --

Justice Lewis F. Powell: You disagree with that?

Mr. B. Barnett: I haven't seen it, I certainly wouldn't challenge it.

Justice Lewis F. Powell: But is there any evidence in the record that it was based on the intrastate?

Mr. B. Barnett: Well, there's less – Yes, for example, 855 testimony of Mr. Smith for United Gas Pipeline Company, who says the 78 cents price is very -- which I feel is very reasonable in light of today's market prices.

856, we are prepared to show what the latest arm's-length intrastate prices are in this area of South Louisiana and it will show and I read this numbers, the very reasonable price level of 78 cents for the settlement.

But a part from all that --

Justice Byron R. White: But others wouldn't hurt?

Mr. B. Barnett: Yes.

But apart from all that, we would say the computation, the mode of computation is irrelevant.

It's clear that the suit was for market value royalties based on the intrastate rate price.

The settlement is to get rid of the suit.

The means of computation that has no legal impact we would say.

Thank you very much.

Chief Justice Warren E. Burger: Thank you gentlemen.

The case is submitted.