ENERGY RESERVES GROUP v. KANSAS POWER & LIGHT
The Kansas Power & Light Company (KPL) entered long-term contracts in 1977 governing its purchase of natural gas from the Energy Reserves Group (ERG), a Kansas-based oil company. The contracts contained "price escalator" clauses which provided for gas prices to rise to the levels set by governmental authorities. In 1978, the federal government established a new system for regulating natural gas prices under the Natural Gas Policy Act. The Act set maximum lawful prices that could be charged for different types of natural gas and applied these price levels to intrastate gas markets. The Act allowed states to set maximum price levels below federal levels, which Kansas did under the Kansas Natural Gas Price Protection Act (Kansas Act). When ERG tried to raise its prices to the higher federal levels using the "price escalator" clause, KPL insisted that it was only legally obligated to buy gas at the lower prices set by the Kansas Act. ERG claimed that KPL violated the contract by refusing to pay federal prices. In response, KPL argued that the Kansas Act clearly prohibited the use of federal price levels to trigger "price escalator" clauses. After a state trial court ruled in favor of KPL, ERG claimed that the Kansas Act violated the Contract Clause by preventing federal price changes from affecting state contracts. The Supreme Court of Kansas held that the Kansas Act did not violate the Contract Clause since it was a legitimate effort by the state of Kansas to protect its economy from rapid price changes.
Did the Kansas Natural Gas Price Protection Act violate the Contract Clause by preventing federal price controls on natural gas from affecting price adjustments made under intrastate contracts?
Legal provision: Article 1, Section 10, Paragraph 1: Contract Clause
No. Justice Harry Blackmun delivered the opinion for a unanimous court. The Court determined that ERG did not have its contractual rights "substantially impaired" and found that the state of Kansas had "significant and legitimate public purpose[s]" for passing the Kansas Act. The contract between ERG and KPL facilitated changes in prices according to governmental price controls, and the new state price controls adhered to federal guidelines. In passing the Kansas Act, the state "exercised its police powers to protect consumers from the escalation of natural gas prices." The Natural Gas Policy Act set maximum price levels for natural gas but explicitly permitted states to lower these levels. Therefore "price escalator" clauses included in intrastate contracts would adhere to lawfully enacted state price levels.
ORAL ARGUMENT OF GARY W. DAVIS, ESQ. ON BEHALF OF APPELLANT
Chief Justice Burger: We will hear arguments next in Energy Reserves Group against Kansas Power and Light.
Mr. Davis, I think you may proceed whenever you're ready.
Mr. Davis: Thank you, Mr. Chief Justice, and if the Court please:
The central issue in this case is whether or not a Kansas statute known by its framers as the Kansas Natural Gas Price Protection Act, is in violation of the contract clause of the United States Constitution.
There is no argument in this case that this particular Kansas statute does impair two natural gas purchase and sales contracts between Energy Reserves and Kansas Power and Light Company.
There is also no question that this impairment occurs from five to six years, and not only does it incur... not only does it prevent Energy Reserves from receiving a substantial portion of the consideration that they would have received, it also prevents it from receiving its contracted right of termination if it could not receive the money that it was supposed to receive under the contract.
Kansas Power and Light Company's answer to this impairment is that it violates... that it is within the reserve police power of the State of Kansas.
Underk the decisions of this Court in Home Building and Loan Association v. Blaisdell, United States Trust v. the State of New Jersey, Allied Structural Steel v. Spannaus, this Court set forth certain tests of reasonableness, and also that the statute must be of a character justifying the use of the police power.
The points that I want to make are four, and these are that in the first place, these contracts would not have been entered into without these pricing provisions that have been impaired.
Secondarily, I want to point out that the impairment to ERG, Energy Reserves, is severe.
Thirdly, I'd like to point out that this statute has an extremely narrow focus, is very limited in its application.
And the fourth point that I want to make is that this statute serves no broad societal benefit, and in fact, does not solve any emergency or any supposed emergency that it is supposed to solve.
The facts in this case are that in September of 1975, after months of negotiations, the parties finally agreed to the terms of these two contracts that are involved.
These are what you call long term natural gas contracts.
One is for the life of the gas field and the other is for the life of a gas processing plant.
They have a duration of 20 to 30 years.
The two pricing provisions that are involved, the first one is one that says that in the event that there is a price prescribed for the gas involved that is higher than the price that is being paid under this contract by any governmental authority, then that new price as prescribed by government would be the new price under the contract.
The second pricing provision that's involved here is what is known as a pricing redetermination provision.
It's in the... and what this does, it's every two years, Energy Reserves is entitled to come to KP&L and say that we want our price redetermined.
We want it redetermined on the basis of what is being paid for other gas in the State of Kansas under like contracts.
It's a pricing provision that is designed to, during the long term of these contracts, to assure Energy Reserves that it is always receiving a price that is akin to the market price.
Unidentified Justice: Mr. Davis, may I ask you whether the prices under the contract here had increased under that second clause before the Kansas legislature passed the act here?
Mr. Davis: Yes, Justice O'Connor it did.
The price increased at the first opportunity in 1977, and it increased from $1.52 a million Btu to $1.77 a million Btu.
Unidentified Justice: Mm-hmm.
And that was when?
Mr. Davis: In 1977.
Unidentified Justice: Does the act retroactively apply, the Kansas act, to--
Mr. Davis: It definitely does retroactively apply, and the Supreme Court of Kansas so held.
The other provision in the contract that I'd like to call to the Court's attention is what's known as the intent provision; and this intent provision specifically provides that the point of these two price escalation provisions was to provide ERG during the term of the contract the anticipated increase in the natural gas price.
Now, I want to point out also that these price escalation provisions are not automatically imposed upon KP&L.
When a price escalation occurs under one of these pricing provisions, then KP&L is obligated to go to the Kansas Corporation Commission and seek its approval to pass through all or a part of any price increase under either one of these provisions.
And this KP&L did when the first price increase came around.
KP&L then has the obligation if it can't get it passed through, then KP&L can either say we're going to buy this gas and take it out of our profits, or they can tell Energy Reserves we couldn't get approval to pass it through; therefore, we're not going to pay the increased price.
And the Energy Reserves is then given an option under the contracts to terminate if it does not receive this increased price.
What happened was right after the 1977 or within a year after the 1977 redetermination the Natural Gas Policy Act of 1978 was passed.
This act authorized and prescribed a higher price for intrastate gas, which is what's involved here, than the price that was then being paid under the contract.
It was that time on December 1, 1978 that Energy Reserves requested an increased price.
As I say, the KP&L then applied twice, once in December of '78 and once in February seeking a pass-through.
Things were going on in the legislature about what to do about this.
And on May 29, 1979, approximately six months after this first price increase would have been due, this particular act was passed.
And what this particular statute does, it prevents either one of these clauses from ever coming into operation; and it also prevents Energy Reserves from exercising the contract right of determination if it doesn't receive one of these price increases.
Unidentified Justice: --Mr. Davis, if you were correct and your client were allowed to terminate its contracts, what price could it now charge under the Natural Gas Act, under the NGPA?
What section would control the price, if you were right?
Mr. Davis: There would be two possibilities.
One would be under this government escalation price which would be the Section 105 price under the Natural Gas Policy Act, which is... Congress when they passed the Natural Gas Policy Act created a special category for intrastate gas that was under contract at the time.
The other price provision that would of course control would be this price redetermination provision which is a market price redetermination.
Unidentified Justice: Is it clear that Section 109 would not apply?
Mr. Davis: Your Honor, under the Kansas act this is one of the things that they say that makes the statute reasonable is that in lieu of getting the 105 price or the price that we're entitled to under the contract, a market price, that we get the 109 price.
This Section 109 price of course is a special category of pricing that was set forth by the Natural Gas Policy Act.
It is a substantially different price than the Section 105 price which is prescribed for natural gas, and it's a different price than we would receive under competitive conditions.
Unidentified Justice: By "different" you mean lower?
Mr. Davis: Yes, Your Honor.
It definitely is.
Unidentified Justice: Well, if the contract... absent this contract what price could you charge?
Mr. Davis: You mean, Your Honor, if we didn't have a contract?
Unidentified Justice: Yes.
Well, suppose that... suppose... suppose the contract was in force and you wanted a price increase, and the utility said sorry, we won't pay it, and you say well, we will then exercise our option to cancel the contract, so no contract.
What price then would you--
Mr. Davis: The price would be the same.
It would be--
Unidentified Justice: --The price would be controlled by the Federal act.
Mr. Davis: --Which would be the Section 105 price.
That's exactly right.
Unidentified Justice: And not the 109 price.
Mr. Davis: Not the 109 price.
Unidentified Justice: Well, but the Section 105 price applies to gas that's under contract, right?
Mr. Davis: That's correct.
Unidentified Justice: But isn't it your position that the gas would not be under contract?
Mr. Davis: Your Honor, it wouldn't make any difference because the market price was precisely the same price as the 105 price.
Unidentified Justice: Well, but if it's not under contract and if 105 doesn't apply, clearly 102 would not apply, so wouldn't 109 apply, and if so, wouldn't you get an even lower price?
Mr. Davis: Your Honor, but these contracts were under contract--
Unidentified Justice: Well, but your position, as I understand, in this Court is that the contract doesn't cover this case.
Or have I got it backwards?
You're arguing that the gas... that the contract does apply, aren't you?
Mr. Davis: --We're arguing that certainly the contracts do apply and that we're entitled to the relief that was afforded to us under the contracts.
Unidentified Justice: I see.
The maximum relief you could get is be free of the contract.
Mr. Davis: Absolutely, Your Honor.
Unidentified Justice: And so if the utility said sorry, we won't pay the contract prices, your maximum release is to have no contract.
Mr. Davis: Then we could go out and sell our gas in the intra--
Unidentified Justice: To anybody you wanted to.
Mr. Davis: --To anybody we wanted to.
Unidentified Justice: But would it be subject at all to the Gas Policy Act?
Mr. Davis: No, Your Honor.
It would only be subject to the ceiling price as set forth for Section 105 gas.
Unidentified Justice: In Section 109, wouldn't it?
That's the point.
Mr. Davis: Section 105 applies to gas that was under contract at the time of the Natural Gas Policy Act.
This gas was under contract.
Unidentified Justice: You're saying "was under contract".
Mr. Davis: Right.
Until KP&L refused to pay the price increases.
I want to point out, Your Honor, that the Section 109 price is a vastly different price than this Section 105 price of the market price that would be obtained.
As a matter of fact, KP&L at length... testified at length concerning these contracts in 1975 before the Kansas Corporation Commission, and one of the things that they said was that Energy Reserves had a right at that time to alternatively not sell us gas for $1.53 but sell it to the city of Wichita for $2.04.
The price that would become effective on December 1--
Chief Justice Burger: We'll resume there at 1:00.
Mr. Davis: --Right, Your Honor.
Chief Justice Burger: You may continue, Mr. Davis.
ORAL ARGUMENT OF GARY W. DAVIS, ESQ., ON BEHALF OF THE APPELLANT -- Resumed
Mr. Davis: Thank you, Mr. Chief Justice, and if the Court please:
On this impairment question I want to just clarify one point, and that is that under Section 105, which is the section that applies to intrastate gas under the Natural Gas Policy Act, what that provides is in effect that you get the Section 102 price, which is a price substantially higher than the 109 price; and it also says that the effective thing is having a contract in existence on the effective date of the act, which was December 1, 1978, and then it also applies to any successor contract.
And under Section 101--
Unidentified Justice: Well, what about the time when there isn't any contract?
Mr. Davis: --Your Honor, I'm sure that there--
Unidentified Justice: It's irrelevant.
If a contract expires, it's irrelevant because it was covered by a contract on the date of the act, is that it?
Mr. Davis: --A... a success... right, Your Honor.
A successor contract is a contract that would come on after this contract--
Unidentified Justice: Yeah.
Mr. Davis: --Was terminated, and it would not need to be between the same parties, for example.
Unidentified Justice: I see.
Mr. Davis: I just... and also on this impairment question I want to point out that the Section 109 price is vastly different from the Section 102 price.
It's about a dollar a million BTU right now.
In 1978, however, it was approximately 30 cents a million BTU, and it has gone up with inflation.
On the question of inducement, a member of the Board of Directors and officer of Kansas Power and Light Company testified at length in 1975 that these contracts would not have been entered into except for these escalation provisions.
He also testified that the price of gas was going to increase everywhere, and he also testified concerning the fairness of these contracts, and that he pointed out that Energy Reserves had an option to sell its gas at that time rather than $1.53 at $2.04.
The $2.04 price is substantially the same price that existed under the Natural Gas Policy Act in 1978, December 1, 1978.
In other words, the price that would be afforded to ERG under its contract with this first price increase that's prevented is substantially the same price that KP&L testified ERG could have sold its gas for three years earlier.
This act is also bad and improper from the standpoint that it is extremely narrow in its focus.
It covers only six per... something less than six percent of all the gas produced in Kansas.
It covers something less than 10 percent of the gas consumed in Kansas.
It applies only to contracts that have these type of price escalation provisions which you would find in a long-term contract.
In other words, their price where there are indefinite price escalator clauses as opposed to fixed price escalator clauses.
A fixed price escalator clause could in fact result in a much higher price, and that is certainly not equitable.
And, again, it applies only to contracts that were executed before April 20th, 1977.
It applies only to contracts that are of long term.
Unidentified Justice: Well, Mr. Davis, certainly the legislature has some right to target a particular area of perceived danger or problem, doesn't it, without making the rule that adopts for that area applicable right across the board.
Mr. Davis: There can be no reasonable justification, Justice Rehnquist, for just picking out a few contracts having a few types of contract clauses.
There's no reasonable distinction that I can think of for picking out these particular contracts and applying it to this particular gas.
I think possibly the worst thing about these contracts is that it really doesn't serve the benefit that it's supposed to serve.
Who gets the savings from this gas?
On the testimony before the committee 69 percent of the gas that KP&L... KP&L buys goes to other utilities; it goes for industrial uses; it goes for sales to themselves for the generation of electricity.
And so there is no real finding that any benefit goes to any of the people who are supposed to be benefitted by this act.
As... just to quote the majority report that recommended this bill to the legislature, it would provide a modicum relief to some people who have the need for utility use of this gas.
It's just extremely limited in nature, and its narrow scope totally condemns it.
Unidentified Justice: Did the Federal act set a ceiling on the price of this gas?
Mr. Davis: Yes, Your Honor, it did, which is--
Unidentified Justice: And despite any provision in the contract.
Mr. Davis: --That is correct, Your Honor.
Unidentified Justice: And that wouldn't be unconstitutional?
You don't claim the Federal act was unconstitutional.
Mr. Davis: No, sir, Your Honor.
The contract clause just applies to State action, not to Federal action.
Unidentified Justice: But if there were some... you don't think the Federal act is vulnerable at all under provision of the Constitution.
Mr. Davis: I personally do not, Your Honor.
I think it's interesting to contrast the position of what was going on with the Natural Gas Act when the Federal Power Commission was regulating things and this Court, for example, in the Permian Basin Area Rate Cases where the Federal government was regulating price escalation provisions.
They pointed out that one of the... one of the things that provided some equity to the matter was the fact that even there where the Federal government was action, the part... Federal government was acting, the parties could terminate the contracts.
They didn't have to continue to sell them at these prices.
And, of course, this is one thing that makes the impairment in this case.
Not only must ERG continue to sell its gas at prices far below what it bargained for, but it can't even terminate the contracts.
Unidentified Justice: Did... did... is there a preemption issue here?
Mr. Davis: Your Honor, the Section 602 of the Natural Gas Policy Act provides that the states may enact lower prices for gas produced in the state than that prescribed by the act.
It's not mandatory that they do so, and it's not an invitation that they do so.
There is a question... in one of the amicus briefs in quoting the legislative history it was pointed out and believed that this was a ceding of the Interstate Commerce Power, and that this Section 602 not only provided a right in the states to prescribe a rate for intrastate gas but also for interstate gas.
Unidentified Justice: But even if it did, it wouldn't reach the contract clause issue.
Mr. Davis: That is correct, Your Honor.
Unidentified Justice: It just would be a commerce issue.
Mr. Davis: That's exactly right, but that's... that's what... if that's correct, that makes this statute even worse, because we're not talking... it's just that much smaller percentage of the gas that you're regulating.
It's just that much smaller of the gas that could be regulated, and it makes it that much more discriminatory; in other words, where you just pick out intrastate gas and then you just pick out a piece of that intrastate gas to regulation.
Unidentified Justice: Well, did the... did the Kansas court rely on the federal act as precluding the operation of these clauses?
Mr. Davis: No, Your Honor, it did not.
It was strictly on the Kansas acts, and it's only the Kansas act that precludes the operation of these two price provisions.
Unidentified Justice: With respect to your point about kind of chopping up the market and it's just a small part of the market, doesn't the federal scheme work in somewhat the same way by differentiating between new gas and old gas and putting a lower price on the old gas?
Mr. Davis: Your Honor, it also differentiates with regard to intrastate gas.
As a matter of fact, under the legislative history of the Natural Gas Policy Act one of the things they were doing was sanctifying the present intrastate contract because there they were dealing with an area where... where, for one, the gas would be covered by contracts that were not regulated.
And that's why they set up, in my... set up a special provision for intrastate gas prior to the NGPA and set a price that was comparable to the Section 102 price.
I'd just like to say in summary that in this case there has been... there's no question that the parties would not have entered into these contracts but for these price escalation provisions.
There is no question that ERG has been substantially impaired by this Kansas statute.
There is no question that it is a statute that is extremely limited in scope.
And there is no question... and as I say, possibly the worst part of the statute is there is no finding that it really serves any benefit that is supposed to be served.
One of the amicus briefs, for example, said for KP&L, was to the effect that they had no way of knowing what relief, if any, was being afforded to the people who might really need some help as a result of increasing prices.
Chief Justice Burger: Mr. Kelsey.
ORAL ARGUMENT OF BASIL W. KELSEY, ESQ., ON BEHALF OF THE RESPONDENT
Mr. Kelsey: Mr. Chief Justice, and may it please the Court:
The one issue necessarily before the Court in this case today is the constitutionality of state natural gas price controls.
The Kansas Natural Gas Price Protection Act amounts to the intrastate corollary of the Natural Gas Policy Act which was signed by the President four years ago today.
Before I begin my argument, however, I should like to clear up a question that Justice White put to Mr. Davis.
Unidentified Justice: I hope you're clearing up the question, not the answer.
Mr. Kelsey: Thank you for correcting me, Your Honor.
I'll try to give you a clear answer.
Unidentified Justice: Well, that's all right.
Mr. Kelsey: I think Your Honor inquired as to what this gas could receive if it were to be sold in the interstate market upon the expiration of this contract.
This gas is in fact controlled by Section 105(b)(1) of the Natural Gas Policy Act so long as this contract remains in effect.
When the contract expires by its own terms, it would then be what is known under the NGPA as a rollover contract under Section 106 of the Natural Gas Policy Act.
That section provides--
Unidentified Justice: Would it be known that... would it be classified that way if it expired by cancellation?
Mr. Kelsey: --No, it wouldn't, Your Honor.
It would then be known as a successor contract and would be treated under--
Unidentified Justice: Well, suppose... suppose the... suppose the utility, your client... is that your client, the utility?
Mr. Kelsey: --Yes.
The Kansas Power and Light Company.
Unidentified Justice: Yes.
Suppose the utility said well, you've purported to increase the price.
We just won't pay it.
And then the pipeline or the producer or the other side of the contract said we cancel the contract pursuant to its terms.
Is that an expiration or--
Mr. Kelsey: No, it isn't.
Then any new contract entered into would be what is called a successor contract which is anything but a rollover contract.
Unidentified Justice: --And what would that... then what would the controlling section be?
Mr. Kelsey: The controlling section would remain 105, and the price that the producer could obtain under the new successor contract would be two different answers: one, assuming the Price Protection Act remains in effect, it would get the maximum the Price Protection Act allowed.
If the price protection act is not in effect, the producer could then receive for its gas whatever that former contract would have permitted, whatever its terms would have called for subject to the federal maximum.
Unidentified Justice: Um-hmm.
Mr. Kelsey: If, as I started out by saying, the contract expired by its own terms and it were a rollover contract, the maximum price the producer could then receive under the terms of Section 106 would be the price being paid during the month in which that contract terminated by its own terms.
That would be the ceiling.
Your Honors, Energy Reserves must overcome the presumption of constitutional validity to which the Price Protection Act is entitled.
The Kansas Power and Light Company will address three issues raised by appellants in this appeal.
First, the contracts between the Kansas Power and Light Company and the appellant have not been substantially impaired.
Energy Reserves is receiving exactly and precisely what it contracted for.
It has no right to rely on anything other than the price federal and state law allows.
Therefore, the constitutional inquiry may be ended at this stage.
Second, the Price Protection Act serves a legitimate public purpose, and that is the moderation of sudden increases in price for a fuel vital to Kansas agricultural economy and the welfare of its citizens.
Energy Reserves has admitted that Kansas may constitutionally set maximum prices to protect its consumers.
The thrust of Energy Reserves' argument seems to be its specious claim that the Price Protection Act is somehow special legislation that benefits the Kansas Power and Light Company and other gas distributors.
The only beneficiaries of this Price Protection Act are the approximately two million consumers of intrastate gas in Kansas who pay, penny for penny, all costs of the gas they consume.
As to the cost of gas paid to producers, utilities are nothing more than a conduit of dollars from the consumer to the producer.
In fact, for the 12 months ended September 30, 1982, 91 percent of Kansas Power and Light Company's gas department revenues amounted solely to gas costs paid to consumers, to purchasers.
Third, the legitimate public purpose of the Price Protection Act has been achieved on reasonable conditions which have been appropriately tailored to the goal with great deference to producers.
The Price Protection Act in fact strikes at 100 percent of the evil perceived by the legislature by imposing prices which have been deemed reasonable by the Congress.
Energy Reserves' contracts have not been substantially impaired for two specific reasons.
It is receiving exactly what it contracted for, no more and no less; and that is a price controlled by both state and federal regulation.
Sections 18 and 20 of these gas supply contracts, respectively, provide that the contracts are expressly subject to and incorporate all future state and federal laws.
Unidentified Justice: Well, Mr. Kelsey--
Mr. Kelsey: --Yes.
Unidentified Justice: --Supposing that in the Allied Structural Steel case the pension contract between Allied Structural Steel and the pension trustees had provided that it was subject to all provisions of state law, or state and federal law... a provision I think is probably not uncommon in most contracts.
Do you think that would have resulted in the Allied Structural Steel case coming out differently?
Mr. Kelsey: Your Honor, while I think that this provision is uncommon in gas supply contracts, in answer to your question I think that the Allied Structural Steel would have not had an argument that it contracts had been substantially impaired.
It might well have had other arguments, but it could not have argued that having incorporated the state law into its contracts that somehow later then a future state law could impair the terms of that contract which embodied the law.
The Price Protection Act and the--
Unidentified Justice: May I ask this question in that connection?
The Kansas Commission approved the escalation clause initially, did it not?
Mr. Kelsey: --Yes, it did, Your Honor.
Unidentified Justice: But under your assumption of what it could be done, could the Commission now independently of the federal act change its position with respect to the escalation clause and hold it null and void, of no effect?
You say that the parties have what they contracted for because the state reserved the right to regulate rates, but having approved this clause could the State of Kansas independently of the federal act have revoked the escalation right?
Mr. Kelsey: Yes, I think, Your Honor, the State of Kansas, either through the legislature or perhaps through the State Corporation Commission, could have purported to have declared these clauses null and void.
Unidentified Justice: Well, is there any authority in Kansas on that point?
Can the Supreme Court--
Mr. Kelsey: For the State Corp--
Unidentified Justice: --Yes.
Mr. Kelsey: --For the State Corporation Commission--
Unidentified Justice: Yes.
Mr. Kelsey: --Dealing with the terms of the gas contract and declaring them null and void?
Unidentified Justice: Yes.
Mr. Kelsey: No, there isn't, Your Honor, and in fact, the State Corporation Commission when it adopted the order which requires the immediate and automatic pass-through of all natural gas costs paid to consumers, in Docket Number 106-850 said in April of 1977:
"Since energy costs are largely outside the control of the utility, they ultimately must be passed through to the consumer, and an appropriately designed clause is the most efficient method to accomplish this pass-through. "
So the Commission has not taken it upon itself to... to renegotiate the terms of the contracts between the parties.
These very contracts were the subject of an extensive hearing in 1975 before the State Corporation Commission, and the escalator clauses were inquired into extensively in that hearing.
And the State Corporation Commission authorized the Kansas Power and Light Company to commence purchases of gas under those contracts, including those terms.
So today the law of the State of Kansas is those terms are approved.
Your Honors, it is our position that the Natural Gas Policy Act and the Price Protection Act are part of the terms of these contracts.
These contracts were executed in an atmosphere of pervasive regulation of natural gas by federal and state governments.
Kansas has regulated all aspects of natural gas for more than 75 years.
The parties foresaw state and federal law and regulations and incorporated them into their contracts.
When a contract incorporates state law, that law by definition is a part of that contract, and the law cannot impair itself.
The second specific reason there's been no substantial impairment of these contracts is that Energy Reserves has no right to rely on anything more than Section 105 of the NGPA, and that is a maximum price subject to Kansas' right to limit the operation of the contractual escalator clauses below that maximum price.
The Price Protection Act merely represents Kansas' exercise of that specific right.
Energy Reserves purports to rely on the NGPA for its claim to higher prices, and yet it claims the Price Protection Act impaired its contracts.
We agree that the contracts are subject to the Natural Gas Policy Act.
We do not agree, however, that Energy Reserves is subject only to the price limitations of the NGPA it prefers to the exclusion of other, more stringent limitations in that act it does not prefer.
Prior to the NGPA there were no limitations on the operation of these indefinite price escalator clauses in the contracts.
The sky was the limit.
The NGPA placed two specific, separate limitations on the operation of these clauses.
First, Section 105 provides that in no event may escalator clauses operate to produce a price in excess of the NGPA Section 102 price.
But for this limit, Energy Reserves could today obtain a much higher price for its gas than that Section 102 price.
The second limitation intended by Congress in Section 105 is the specific right of Kansas to prescribe more stringent limitations on the operation of these escalator clauses.
In response, Kansas, and Oklahoma for that matter, have prescribed modestly more stringent limitations on the operation of these clauses.
Energy Reserves has, therefore, no right to cheerfully rely on and in fact unconditionally demand one price limitation set by Congress to the exclusion of the other.
That maximum price set by Congress was said to be subject to Kansas' further limitation on those escalator clauses.
Energy Reserves' reliance, therefore, on these contracts in the NGPA may not exceed the price permitted by both conditions.
Just... they may not, as they would have it, just rely on one condition which would permit it the higher incentive price for its old non-incentive gas.
Energy Reserves has no new wells as defined in the NGPA which provides that higher price for new wells.
This is all old gas wells drilled in the '50s and '60s primarily.
Unidentified Justice: And it's also intrastate gas.
Mr. Kelsey: --I'm sorry, Your Honor.
Unidentified Justice: It's also intrastate gas.
Mr. Kelsey: It is indeed intrastate gas subject to the terms of Section 105 which say the price of that gas is whatever the price is under the terms of your contract, but in nor than in excess of Section 102 unless the states further limit the operation of those escalator clauses.
Unidentified Justice: Well, are you saying, in effect, that even had Congress not passed this statute, which seems to be the subject of most of the discussion of the case, that Energy Reserves would be in no better position?
Mr. Kelsey: Even if--
Unidentified Justice: Or say in no worse position?
Mr. Kelsey: --Even if Congress had not passed the statute?
Unidentified Justice: If the Kansas legislature hadn't passed the statute.
Mr. Kelsey: If the Kansas legislature had not passed the statute, then in 1981 in November Energy Reserves' contract under its price redetermination escalator clause that Mr. Davis referred to, its price would have been redetermined to a maximum price of that Section 102 price provided Energy Reserves could have produced three contracts that... in the area that were comparable and met the terms of the contracts that were calling for that price, that were receiving prices.
So, in fact, in November of 1981 there was a price redetermination under these contracts.
There has been a price increase since--
Unidentified Justice: Are you saying that the Kansas statute had no effect on what Energy Reserves was entitled to receive?
Mr. Kelsey: --It had no effect on what they were entitled to receive for the reason that I mentioned.
It is only entitled to receive what the state law allows it.
In specific response to Your Honor's question, it is receiving less in all likelihood than it would have been receiving had the Price Protection Act not been passed.
In all likelihood it would today be receiving the NGPA Section 102 price for November of 1981 because these redeterminations occur every two years.
But instead, in 1981 in November, of redetermining to that higher 102 price, the parties met, and as the Price Protection Act permits, redetermined to that NGPA Section 109 price.
Unidentified Justice: I thought the 102 applied to new gas.
Mr. Kelsey: 102 does apply to new gas, Your Honor, under the NGPA.
Unidentified Justice: But this is old gas.
Mr. Kelsey: It is old gas, that is correct.
And therein lies the sense of the structure of Section 105(b)(1) of the Natural Gas Policy Act.
In the intrastate market there were various prices being paid in the gas-producing states, none of them regulated by the states.
There were high prices being paid in Texas.
We have contracts as low as 25 cents per MCA.
Congress simply said the terms of those contracts are the price... is the price that you should be paid.
There were some escalator clauses in those contracts, and so Congress said but in no event may those escalator clauses carry you above Section 102; the new gas price is an absolute maximum.
Unidentified Justice: I see.
Well, isn't your theory quite different from that of the Kansas Supreme Court?
Mr. Kelsey: On the--
Unidentified Justice: Isn't the theory you're now arguing different from that in which the Kansas Supreme Court upheld the act, the Kansas act?
Mr. Kelsey: --I don't think so, Your Honor.
The Kansas Supreme Court addressed itself to the appropriateness of the terms and the fact that the statute was directed to a public purpose and the like.
Unidentified Justice: Yeah, but the Kansas Supreme Court obviously felt obligated to deal with the Energy Reserves claim of impairment of contract obligation, and it didn't go off on the ground that you now urge that we do, that the contract had a provision that said it would be subject to all state law.
It went through a constitutional analysis.
I understand from your argument that that really isn't necessary.
Mr. Kelsey: Your Honor, under the case of United States Mortgage v. Matthews it's our understanding that this Court is the court the determines the requirements for applying the constitutional test under the contract clause.
And as Allied Structural Steel indicated, if there is no substantial impairment, the inquiry may be ended.
In summary, Energy Reserves is receiving everything it contracted for at a price permitted by state and federal law, and having received its legitimate contractual expectations, the contract inquiry... the contract clause inquiry may be ended.
Unidentified Justice: What about their argument that they've lost their right to terminate?
Mr. Kelsey: Your Honor, the right to terminate is specifically conditioned in the contract on an increased price.
Absent an increased price, there is no right to terminate.
It's as clear and simple as that.
Unidentified Justice: You mean a contractually allowed increased price.
Mr. Kelsey: Yes.
Unidentified Justice: And you're saying the contract wouldn't allow an increased price because the state law was to the contrary.
Mr. Kelsey: Exactly, Your Honor.
As well as the federal law above 102.
Unidentified Justice: 102, yeah.
Mr. Kelsey: Kansas' right to set natural gas prices is without question.
Natural gas is a vital fuel to Kansas.
Seventy-five percent of the homes are heated with gas.
It is the single most important fuel for irrigation pumping and fertilizer production.
Energy Reserves admits that Kansas may set maximum prices for all natural gas to protect its customers, its consumers.
This inquiry... this admission should end the constitutional inquiry of public purpose, because the Price Protection Act was intended to and it has the effect of regulating the price to consumers of natural gas produced and consumed in Kansas.
Energy Reserves purports to make, however, an argument that the Price Protection Act somehow benefits the Kansas Power and Light Company.
The state legislature's conclusions and orders of the State Corporation Commission, as I have indicated, completely belie that conclusion.
As the legislature knew and concluded when it enacted this law, utilities cannot benefit economically by an increased or decreased cost of gas.
That was the testimony of the chairman of the State Corporation Commission to the legislation.
And as I've indicated, we are serving... we are buying gas under these contracts pursuant to the Commission's approval of these pricing clauses.
We are passing through in 1981 $137 million of purchased gas cost to producers without adding one shred of interest on the utility's part.
Ninety-one percent of our revenues from gas operations are merely purchased gas costs.
The legislature, the trial court, and the Kansas Supreme Court all concluded that but for the Price Protection Act, Kansas consumers would pay the higher new gas costs for the old gas they were using.
The legislature further concluded that absent the Price Protection Act, the burden of increased costs will be passed on to consumers, and that savings to those consumers is ample reason to support the act.
The presence of the State Corporation Commission, the Kansas Legal Services representing persons of low income in Kansas in amici briefs to the court confirmed that the $128 million in gas cost reductions wrought by this law will be received only by the two million persons of the... 2,400,000 people in the state.
Unidentified Justice: Mr. Kelsey, what justification is there for the Kansas statute to allow increases under these indefinite escalator clauses for old intrastate gas in contracts executed after April 20, 1977 but not for contracts executed before that date?
Mr. Kelsey: Two specific answers, Your Honor.
First, the legislature perceived that for those persons who had intrastate gas to sell and who entered into them after that date, April 20, 1977, when the President announced the national energy plan, the legislature perceived that those persons might have some greater right to rely on a higher price for their gas.
Unidentified Justice: Based on the President's speech.
Mr. Kelsey: Yes.
On the announcement of that national energy plan.
Secondly, if the act covered contracts executed after that date and into the future, producers of intrastate gas in Kansas who had gas to sell could conceivably receive a higher price in the interstate market for that gas, and it would tend to diminish the availability of gas in Kansas.
Your Honors, Energy Reserves has complained that the terms and conditions of this statute are unreasonably narrow.
Kansas' goal of moderating gas price increases has been achieved on very reasonable conditions, carefully tailored to the goal, with extraordinary deference to these very producers.
Of all the gas being consumed in Kansas, only intrastate gas subject to escalator clauses had the potential for sudden increases which concerned the legislature.
The Price Protection Act reaches 100 percent of that gas.
Yet, Energy Reserves complains that the Price Protection Act reaches an insufficient volume of gas; Mr. Davis says 10 percent of the gas, intrastate gas consumed in Kansas.
The facts are that 75 percent of all the gas consumed in Kansas is interstate in origin and beyond the reach of the legislature.
Moreover, all that interstate gas is priced, as a result of the NGPA, at or lower than, much lower than in many instances, the maximum price set by Kansas for intrastate gas.
Sixty percent of the gas consumed in Kansas which is produced in Kansas is not subject to these escalator clauses.
Mr. Davis indicated that fixed price escalator clauses could take the price over 102, and therefore the statute was narrow.
The only contracts before the legislature when it considered this legislation were contracts with fixed price escalator clauses of one or two cents a year, one percent a year.
Obviously, when we're talking about kinds of increases permitted here, they could never reach the Section 102 price.
Moreover, the Natural Gas Policy Act itself in Section 105 has the effect of limiting the price for that intrastate gas not subject to escalator clauses in effect freezing the price to what was being received in real terms on the day the act became a law.
So it's only 40 percent of the gas consumed in Kansas that's produced in Kansas which was subject to escalator clauses where the legislature perceived the evil of sudden increases in price.
Therefore, the Kansas legislature regulated that, and it regulated 100 percent of that evil.
And it did so on very reasonable terms, adopting the pricing scheme of the NGPA.
It did so by saying for old non-incentive gas such as the gas under these contracts, we will allow the maximum price if your contracts otherwise call for it... the NGPA 109 price, which happens to be the very same price as the maximum price for old interstate gas as see in Section 104.
It did so by saying but for your new gas, any wells the surface drilling of which was commenced on and after February 19, 1977, your contract clauses may escalate the price for that new gas on up to that NGPA Section 102 ceiling in order to encourage exploration.
It further said and moreover, for low production or stripper well gas, as defined in the NGPA in Section 103, the Price Protection Act will allow Kansas intrastate producers that very same maximum gas if your contract calls for it.
As Energy Reserves concedes, Kansas has the constitutional authority to set maximum prices.
Therefore, we submit, the Price Protection Act's much less stringent limitations on prices are constitutional.
The legislature was merely deferring to the producers' interest in achieving its goal.
Energy Reserves has in fact described the economic policy of the NGPA as reasonable, but when that policy is applied by the Kansas legislature to its contracts, it complains that the scheme is unconstitutionally narrow and constitutes special legislation.
The Kansas legislature limited sudden price increases--
Unidentified Justice: Well, the complaint is that it violates a specific provision of the Constitution limiting state authority.
Mr. Kelsey: --And I'm... and I'm addressing my comments, Your Honor, to if there is in fact a substantial impairment, which we think there is not, that the goal was a clearly legitimate one, as the NGPA's very goal was of limiting sudden price increases for old gas, because it froze the price of old interstate gas.
Unidentified Justice: Well, that just turns the contract clause into a due process limitation.
Mr. Kelsey: It meets the... I'm speaking to the reasonableness with which the state legislature sought to achieve that proper public purpose.
It tailored a pricing system.
It reached all the gas it could reach.
It's of no benefit, none whatsoever, to the Kansas Power and Light Company.
your Honors, if the Price... if the contract clause has any flexibility when vital interests are served, as Energy Reserves concedes in its reply brief that it must, a major gas-producing state such as Kansas may impose modest and temporary restrictions on sudden increases in price for natural resource fuel it has regulated for 75 years.
Natural gas is absolutely essential to the health and welfare of Kansas people, as well as to the principal industry of the state, and that's agriculture.
This position is particularly true when the suppliers of that essential commodity specifically made those state restrictions a part of the contract price terms and when the pricing system embodied in those restrictions is one that Congress has found as reasonable.
Chief Justice Burger: Do you have anything further, Mr. Davis?
ORAL ARGUMENT OF GARY W. DAVIS, ESQ., ON BEHALF OF THE APPELLANT -- REBUTTAL
Mr. Davis: I just want to make a few points, Your Honor.
First off, this is the first time I've ever heard this argument that the Section 105 and the Section 102 price is anything different.
Secondarily, there is... until this moment I thought there was no argument that our contracts have been impaired.
Looking at page 23A of the Appendix to Jursidictional Statement, which is the Supreme Court of Kansas decision, it says,
"The statute obviously was intended to and does impair the rights of ERG under the contracts. "
With regard to this applicable laws provision that Mr. Kelsey has talked about, first off, that is a standard provision that you see in almost every contract.
Secondarily, I see no way that it can possibly be construed to mean that it means that it's subject to invalid state laws.
And furthermore, as just a last point on the intent of the parties under that applicable laws provision, there is the last sentence that says,
"In effect, notwithstanding any such applicable laws, such applicable laws shall not prevent Energy Reserves from exercising its right of termination if it did not receive the price increases promised by these two price escalation provisions. "
The other provision, throughout this case KP&L has tried to picture itself as a benevolent institution.
In the testimony in which they were justifying these contracts before the Kansas Corporation Commission, their vice president and a member of their Board of Directors testified at length.
He testified that if KP&L was not entitled to enter into these contracts that they would lose the value of their investment of $3,600,000 because they would lose the value of the gas-gathering facilities.
To say that they don't have a financial interest is ridiculous.
Secondarily, KP&L doesn't think themselves that they have a right to pass this through.
When the price increase was triggered in 1978, what'd they do?
They applied to the Kansas Corporation Commission for permission to pass it through.
They did the same thing in February of 1979.
And they know as well as I do that these price increases are in nowise automatics.
I would simply... I would ask the Court to do one other thing, and that is to look at 55-1408.
We call it the Section 8 of the act.
What that cat authorizes the parties to do is to renegotiate the price provisions to any price they want up to the legal ceiling.
Obviously, Energy Reserves wants the price that it contracted to receive.
What that means is that the Kansas legislature has delegated to Kansas Power and Light the power and authority to totally avoid all of the price limitations that are contained in this Kansas act.
They've turned a bilateral contract into a totally unilateral contract.
Chief Justice Burger: Thank you, gentlemen.
The case is submitted.