John Marshall Harlan II

“ The Commission recognized that producers are hostages to good fortune; they must expect that their programs of exploration will frequently prove unsuccessful, or that only gas of substandard quality will be found. ”

“ We turn first to questions of the Commission's constitutional and statutory authority to adopt a system of area regulation and to impose various supplementary requirements. The most fundamental of these is whether the Commission may, consistently with the Constitution and the Natural Gas Act, regulate producers' interstate sales by the prescription of maximum area rates, rather than by proceedings conducted on an individual producer basis. ”

“ Each of the area maximum rates adopted for the Permian Basin includes a return to the producer of 12% on average production investment, calculated from the Commission's two series of cost computations. The Commission assumed for this purpose that production commences one year after investment, that gas wells deplete uniformly, and that they are totally depleted in 20 years. The rate of return was selected after study of the returns recently permitted to interstate pipelines, but, in addition, was intended to take fully into account the greater financial risks of exploration and production. ”

“ The Commission declared that a producer should be permitted 'appropriate relief' if it establishes that its 'out-of-pocket expenses in connection with the operation of a particular well' exceed its revenue from the well under the applicable area price. ”

“ Individual producers would not have been prevented by the moratorium from seeking relief from the maximum area rates; relief would have been possible both through the Commission's provisions for special exemptions and through motions for modification or termination of the moratorium. This is not a case in which the Commission has sought to bind producers, without recourse and in the face of changing circumstances, to an unchanging rate structure. ”

“ The Commission initially sought to determine whether producers' rates were just and reasonable within the meaning of §§ 4 (a) [8] and 5 (a) by examination of each producer's costs of service. [9] Although this method has been widely employed in various rate-making situations, [10] it ultimately proved inappropriate for the regulation of independent producers. Producers of natural gas cannot usefully be classed as public utilities. [11] They enjoy no franchises or guaranteed areas of service. ”

“ It appears to be conceded that the quality of gas produced in the Basin is character-istically lower than the Commission's standards, and that the standards are therefore likely to be more significant than they might be in other producing areas.
The producers urge, and the Court of Appeals held, that this arrangement is doubly erroneous. First, it treats as a risk what properly is a cost, and thus evades the necessity of appropriate findings on the revenue consequences of the quality adjustments. ”

“ The producers assert that the Commission has now committed the error that it avoided in Pure Oil. The Commission rejoins that it has not stricken the escalation clauses; it has merely limited their application to prices no higher than the area maximum rates. Alternatively, the Commission avers that even if the contracts have been frustrated, neither the public nor the producers can suffer, since producers' prices may be as high as, but not higher than, the area maximum. ”

“ Second, the Commission concluded that price could usefully serve as an incentive to exploration and production only if it were computed according to the method by which gas is produced. Natural gas produced jointly with oil is necessarily a relatively unimportant by-product. The value of oil-well gas is on average only one-seventeenth that of the oil with which it is produced. ”

“ Once an increase has been obtained by the larger producers, the escalation clauses have guaranteed similar increases to others. [65] In contrast, consumers have been left without effective protection against steadily rising prices. Their alternative sources of energy are in practice few, and the demand for natural gas, particularly in California, is therefore relatively unresponsive to price increases. [66] The consumer is thus obliged to rely upon the Commission to provide 'a complete, permanent and effective bond of protection from excessive rates and charges.' Atlantic Rfg. ”

“ The allowances included in the return for the uncertainties of exploration were, however, paralleled by a system of quality and Btu adjustments. [26] The Commission held that gas of less than pipeline quality must be sold at reduced prices, and it provided for this purpose a system of quality standards. The price reduction appropriate in each sale is to be measured by the cost of the processing necessary to raise the gas to pipeline quality; these costs are to be determined by agreement between the parties to the sale, subject to review and approval by the Commission. ”

“ The price differential which the Commission expects to serve as an incentive is the product of difference in the time periods and geographical areas for which costs were computed, and not of noncost additives to cost components. Finally, the Commission, by its adoption of a moratorium until January 1, 1968, created a temporary price freeze in the Permian Basin. ”

“ We cannot, given the apparent stability of production costs, the Commission's relative inexperience with area regulation, and the administrative burdens of concurrent area proceedings, hold that this arrangement was impermissible. ”

“ They are intensely competitive vendors of a wasting commodity they have acquired only by costly and often unrewarded search. Their unit costs may rise or decline with the vagaries of fortune. The value to the public of the services they perform is measured by the quantity and character of the natural gas they produce, and not by the resources they have expended in its search; the Commission and the consumer alike are concerned principally with 'what (the producer) gets out of the ground, not * * * what he puts into it * * *.' FPC v. ”

“ The Commission found that 1960 cost data should be used, and historical data disregarded, because only relatively current cost data would adequately guarantee an effective incentive for future exploration and production. The Commission was obliged to obtain the relevant cost data from a variety of sources. Natural gas producers have not yet been required to adopt any uniform system of accounts, and no private or public agency had in 1965 collected all the pertinent information. ”

“ Casinghead gas is 'the common name for gas produced from oil wells in conjunction with the production of oil.' 34 F.P.C., at 208. Residue gas is 'the gas remaining after casinghead gas or gas-well gas has been processed to remove liquids present in the raw gas stream in the form of vapor or droplets.' Id., at 210. Associated gas is ' (f) ree natural gas in immediate contact, but not in solution, with crude oil in the field or reservoir.' American Gas Association, 1966 Gas Facts 246 (1966) . Dissolved gas is that 'in solution with crude oil in the reservoir.' Ibid. ”

“ Finally, the Commission announced that, by further order, it would require refunds of the difference between amounts that individual producers had actually collected in periods subject to refund, and the amounts that would have been permissible under the applicable area rate, including any necessary quality adjustments. [31] Small producers, although obliged to make refunds, are not required to take into account price reductions for quality deficiencies, unless they wish to take advantage of upward adjustments in price because of high Btu content. ”

“ On rehearing, the court also held that the Commission's treatment of refunds was erroneous; it concluded that refunds were permissible only if aggregate actual area revenues have exceeded aggregate permissible area revenues, and only to the amount of the excess, apportioned on 'some equitable contract-by-contract basis.' The Court of Appeals ordered the cases remanded to the Commission for further proceedings consistent with its opinions. 375 F.2d 35. ”

“ It is plain that the Constitution does not forbid the imposition, in appropriate circumstances, of maximum prices upon commercial and other activities. A legislative power to create price ceilings has, in 'countries where the common law prevails,' been 'customary from time immemorial * * *.' Munn v. ”

“ The record before the Commission, however, supports its conclusion that competition cannot be expected to reduce field prices in the Permian Basin to the 'lowest possible reasonable rate consistent with the maintenance of adequate service in the public interest.' Atlantic Rfg. ”

“ Area Rate Proceeding No. AR61-1, 24 F.P.C. 1121.↑ The various parties before the Court have taken quite disparate positions. The distributing companies, with the exception of amici, and the public authorities, with the exceptions of the States of Texas and New Mexico, have all supported the Commission's orders in their entirety. They urge that 'consumers . . . have waited long enough,' and assert that 'no good purpose can be served by further proceedings.' See Joint Brief for the City of San Diego and the City and County of San Francisco 24. Certain of the producers support the judgment below ”

“ Indefinite escalation clauses 'cause price increases * * * to occur without reference to the circumstances or economics of the particular operation, but solely because of what happens under another contract.' 34 F.P.C., at 373. There is substantial evidence [48] that in design and function they are 'incompatible with the public interest * * *.' Order No. 232, 25 F.P.C. 379, 380. Indeed, this Court has already entirely sustained the Commission's 1962 order. ”

“ Finally, for a general examination of the usefulness of the competitive model for regulation, see Bon-bright, supra, at 106 108.↑ It should be observed that the significance of the escalation clauses will presumably be diminished by the Commission's series of orders restricting their use.↑ Some 85% of the gas sold in interstate commerce from the Permian Basin is ultimately consumed in California. 34 F.P.C., at 174, 312. The demand for natural gas among residential and commercial consumers, once they have purchased the necessary equipment, is relatively inelastic. ”

“ Its Statement of General Policy tentatively designated various geographical areas as producing units for purposes of rate regulation; in addition, the Commission there provided two series of area guideline prices, [21] which were expected to help to determine 'whether proposed initial rates should be certificated without a price condition and whether proposed rate changes should be accepted or suspended.' [22] The Commission consolidated three of the producing areas listed in the Statement of General Policy for purposes of this proceeding. ”

“ It emphasized that exceptions to the area rates would not be readily or frequently permitted, but declined to indicate in detail in what circumstances relief would be given.
This rate structure is supplemented by a series of ancillary requirements. First, the Commission provided various special exemptions for producers whose annual jurisdictional sales throughout the United States do not exceed 10,000,000 Mcf. The prices in sales by these relatively small producers need not be adjusted for quality and Btu deficiencies. ”