Earl Warren: 90, 95, 98, 99, 100, 101, 102, 105, 117, 181, 261, 262, 266, and 388. Mr. Merrill.
Bruce R. Merrill: Mr. Chief Justice Warren, Mr. Justices, if it please the Court. I'm arguing for Continental Oil Company and Midhurst Oil Corporation. Of the many extremely important issues raised in the Permian Basin Area Rate Cases my argument is restricted to three issues which I believe to be the very foundation of these cases. These three issues go to the theory and method of produced regulation. My argument accepts the legality of producer regulation on an area and a group basis provided such regulation is not arbitrary, discriminatory or capricious that producer petitioners that will follow me in argument and the producers who are respondents only, who would follow them addressed themselves to different issues. A conscientious effort has been made to ensure that no issue will be argued by more than one producer counsel.
Earl Warren: May I ask you if you're in Court with all of your colleagues on that preliminary statement you just made?
Bruce R. Merrill: I believe I am Your Honor.
Earl Warren: Yes, I just want to know if there's any contrary between --
Bruce R. Merrill: I believe not Your Honor.
Earl Warren: Yes.
Bruce R. Merrill: Historically, the Commission had determined rates on utility rate base, cost to service method. Inherent in this method is a clear foreseeable relationship as to any particular service to be rendered for each utility entity and the cost of rendering that service. A certain number of dollars will provide a service for which a certain rate must be permitted. This is the heart of utility regulation and this system has worked very well in the utility industries. When this Court held that the Natural Gas Act applied to the producers of natural gas, spokesman for this industry vehemently urged that this industry was no count whatever to a public utility and that a utility method of regulation could not successfully be applied in the producing industry. The Commission staff urged rejection of this pleads. After all, it was expert in utility regulation that knew they were they method. This ideological battle weighs for seven years while the producers thought cost to service regulation and urged the method of regulation based upon the consideration of the economic characteristics of and the economic factors that work in the producing industry. Producers argued first that the cost of gas cannot be determined like the cost of public utility service with little joint cause but for gas in a joint product with oil and with natural gas liquids the best that could be done was to estimate the cost of gas using some cost in formula in flowing wholly arbitrary allocation method that allocates the joint cause. In no real sense could the cost of gas actually be determined. The producers argued second that the Commission owed a duty to induce an adequate continuing supply of gas for the interstate consumer and that even if the cost of gas could be determined, a cost determined rate could not perform the function of a listening supply due to the lack of relationship between expenditures and results. The forcibility, the dollars of input, the output and the rate that would provide an adequate return so characteristic in the utilities was absent in the producer industry. Nonetheless, during these seven years, the utility rate based cost of service method was employed by the Commission while each side shamelessly computed cost to service studies designed to yield a desired cost result. It was readily apparent that the joint cost constituted such a large percentage of the total cost that any desired cost result could be obtained and was obtained. Finally, the Commission recognized what foolishness this was. Concurrently with the second Phillips opinion, the Commission issued a statement of general policy in which it announced it was abandoning individual regulation in favor of regulation of an area and a group basis. For as reasons stated in the second Phillips that in the experience of the Commission and I've hoped has shown beyond any doubt that the traditional original cost, prudent investment rate base method of regulating utilities is not a sensible or even a workable method of fixing the rates of independent producers of natural gas. Producers of natural gas cannot by any stretch of the imagination be properly classified as traditional public utilities. Their result finally reached may give the illusion of accuracy since mathematical processes are involved and a definite prize for Mcf is the final result. But such a result must be tested against the realities of the marketplace. Thus, prices calculated solely on the cost rate base principle cannot be accepted if they are higher than a buyer pay or lower than the seller will accept when an unrealistic result is reached, they formulate for allocations must be changed in order to bring about a reasonable result. The allocation method has then become a means of supporting a result already arrived at rather than a means on arriving at a result which was previously unknown. From the foregoing, it follows that effective regulation of the price of natural gas must be on some more manageable plan than the rate base method.”
Speaker: Where do that come from?
Bruce R. Merrill: This comes from the second Phillips decision of the Commission, Opinion Number 338, Your -- Mr. Justice Harlan.
Earl Warren: What --
Bruce R. Merrill: The opinion of --
Earl Warren: -- year was that? What year was that, the --
Bruce R. Merrill: That was 1963 I believe. Six -- 1960 right, it preceded the --
Earl Warren: 1960?
Bruce R. Merrill: Preceded the commencement of the area rate proceeding, yes Your Honor. At this point in time, the Commission was --
Potter Stewart: Was that in the -- that's in a item -- opinion of the Commissioner's there or in the brief for Commission in this Court.
Bruce R. Merrill: No, that is in Opinion Number 338 of the Commission commonly known as the second Phillips decision.
Potter Stewart: And then that case came here?
Bruce R. Merrill: And -- yes Your Honor --
Speaker: That was the one --
Bruce R. Merrill: -- that case came here.
Speaker: -- that's involves --
Bruce R. Merrill: And that's the one of which you have found the Commission and its filings that it need not use cost of services in its regulation.
Potter Stewart: Well that was the first Permian Basin case, wasn't it?
Bruce R. Merrill: No, that was the forerunner of the Permian Basin case Your Honor.
Potter Stewart: Oh, no I --
Bruce R. Merrill: At this point in time, the Commission was completely correct and was supported in such findings by this Court in its second Phillips Act opinion. The Commission found that true in an order ruling on evidence to be considered in these proceedings, proscribing cost of service evidenced on either individual or a group basis. Subsequently however, there were important changes in the composition of the Commission and more than a year after the first ruling, a second ruling issued in which cost to service was to be permitted on a group basis. Such composite studies that the Commission found may not suffer from the same deficiencies as similar cost that is on an individual basis. The Commission should have known that its findings respecting unit costing would be as true for composite and area costing as it had been for individual costing.
Abe Fortas: Well, do --
Bruce R. Merrill: Now --
Abe Fortas: Why is there -- Mr. Merrill, was there also a change in the underlying facts that is to say, when did the directional technique of -- for finding gas oil -- gas oils of -- become an important factor in the industry? I don't know, let's review our --
Bruce R. Merrill: Mr. Justice Fortas --
Abe Fortas: But here you ask that (Voice Overlap) -- you heard the argument on that.
Bruce R. Merrill: I don't think anybody could put their finger on a point in time when directionality became a matter of significant change in the industry. Actually, a directionality is only the consequence of the amassing of drilling history so that the --you drill enough wells in one area and get the certain product as result of that drilling.You know that if you go to drill in that area, you're going to find either oil or gas --
Abe Fortas: I understand that --
Bruce R. Merrill: -- and it just cumulates it.
Abe Fortas: -- but I suppose -- let's supposed there did come a point of time that would show -- let us say a majority of the gas that were sold was a gas-well gas, is that right?
Bruce R. Merrill: Yes.
Abe Fortas: And can you approximate that point of time for us?
Bruce R. Merrill: No Mr. Justice Fortas, I cannot. I know that the --
Abe Fortas: You think it was in the Sixteenth --
Bruce R. Merrill: The national result is the reverse of the Permian Basin result but --
Abe Fortas: But would this have happened after the statement made by the Commission on the second Phillips case?
Bruce R. Merrill: I doubt if gas-well gas on a national basis ever exceeded, I mean that they're all oil gas on a national basis ever exceeded gas-well gas. I believe there's always been --
Abe Fortas: Alright, well let me just state to you what's running through my mind. I don't know whether its sound. But what's running through my mind is that the impression of the argument -- from the argument yesterday that there came a point of time when gas-well gas became a predominant importance in the industry. And the possibility that because of that change in the characteristics of the industry, a quotation that you just read from the Commission's second Philips case may not have had the same opinion, say in the same thrust that it had at the time that the Commission wrote that. Now --
Bruce R. Merrill: If that's --
Abe Fortas: Is that so or not?
Bruce R. Merrill: If that is so Mr. Justice Fortas, then it not be consequence of the predominance of gas-well gas. It may have some variant on the fact that the industry alleged for the first time during the course of the Permian Basin proceeding that it posses these directionality. But it really --
Abe Fortas: (Voice Overlap)
Bruce R. Merrill: -- really shouldn't have any bearing on the regulatory method insofar as the use or not -- non-use of cost.
Abe Fortas: Yes, I'm just trying to get the opposing contentions bear in my mind and if I correctly understand the situation, perhaps very likelihood I don't. At a time when the industry was dominated by gas that was produced jointly with oil, say, the Commission made the -- that at that time, the Commission said that the use of a cost data is not feasible because of the necessarily arbitrary characteristics of allocating joint cost. Then there came a point of time when it was not gas and association with oil but gas that had been produced more or less independently of oil. At that became dominant in the industry and the question that the arguments today and what you've said here raised in my mind is whether that may have made a difference in the logic of the Commission statement in the second Phillips.
Bruce R. Merrill: In this sense of the word Mr. Justice Fortas, it does, because the Commission after they accepted the proposition that there was directionality in the industries they were -- then we will endeavor to cost gas-well gas only leaving out of the cost data and the cost mass, the figures relating to oil well gas. And therefore, we will limit the allocation product. But to keep it in focus, the allocation column still goes to 55% of the cost even under the current cost of gas-well gas.
Earl Warren: Was there a date where you could reasonably say that the emphasis had shifted to gas-well gas rather than the other? That's all, I think that -- just support (Inaudible) --
Bruce R. Merrill: I think not Your Honor -- Mr. Justice -- Chief Justice Warren.
Earl Warren: Then -- and then you take the position that they are -- the other side is possibly wrong on the states that there was such a shift?
Bruce R. Merrill: I don't believe the other side Mr. Chief Justice Warren quite said that. I think that they said that the industry showed an ability to search directionally at a point in time, which was during the course of the Permian Basin hearing. I do not believe that they said that the importance of gas-well gas as compared to all of the gas that there was any shift in that at any point in time. And I do not believe that that is the case. The Commission went from out -- not at rejection of cost to service as a producer regulatory method to have a permission to adduce cost of service evidence on a group basis to predicate in this decision entirely upon unit cost estimations. And this was done in the phase of the fact that composite costing surface from all of the deficiencies of individual costing has all the same opportunities to arrive at any desired result. But even worse, suffers from the additional deficiencies of inadequate and inconsistent data and data sources. This course of action was also taken in the face of the fact that the Commission admitted in its opinion that two-thirds of the Permian Basin gas, the gas produced from oil well could not be -- I mean, if they cost even on a composite basis. Mr. Justice Jackson, with rare foresight, foretold the dilemma which must result in an effort to regulate the producing industry as a public utility. In FPC versus Hope, 320 U.S. 591, he -- it was perceived, the fundamental difference between the utility business of providing an inexhaustible service and the finding, developing and producing of irreplaceable gas at an unknown cost. The consequence of the relationship between inputs and outputs, sole characteristic in the utilities and so absent in the producing industry was clear to him. He said the service was to be measured by what was got out of the ground not by what was put in the ground and that there was no more relation between investment and result in a game of poker. He thought it easier to directly determine the fair market value of gas than to indulge in a round about way of rate based price fixing. A year later, in Colorado Interstate versus FPC, 324 U.S. 581, Mr. Justice Jackson was in even more prophetic. There he indicated he had not buy the end result test as to catch all solution to all problems nor the necessary correlative velocity that they -- and justifies the means. This was especially true where as in the rate of -- natural gas rate making the use of rate based figures was a little better than to draw figures from a hat. He bemoaned his lack of intuitive knowledge by which he may determine -- may decide that a rate so determined was just and reasonable. In that case, he laid down the foundation of what became the regulatory method advocated by the producers. He said and I quote, “Foresight of gas rate regulation will concern itself for the present and future rather than with the past as the rate base formula does.” It will take account of conditions and trends at the source of the supply being regulated. It was used price as a tool to bring goods to market, to obtain for the public service that needed amount of gas. Once the price is reached, that will do that. There is no legal or economic reason to go higher. On the other hand, if the supply is not too (Inaudible) and the price is not a sufficient incentive to exploit it and fails to bring forth the quality needed, the price is unwisely low even if it does square perfectly with somebody's idea of return on a rate base. Before going into the supply consequences of the present regulatory method, I will quickly enumerate the reasons why rate based regulation they produced in the industry is arbitrary, discriminatory and unlawful. One, the cost of gas as distinguished from the cost of the utility service cannot be determined. Two, a rate fixed at any estimated cost can perform the economic function of a listening supply only as the consequence of accident, such there's no relationship between cost incurred and supply added. Three, if a cost determined interstate rate is less than or equal to a free market determined in cost state rate available gas supply will tend to move to the intrastate market. Four, cost based rates are not amenable to the judicial review to its participants in a producer area rate proceeding are entitled. The Tenth Circuit said and I quote, “In arriving at the Permian Basin rates, the Commission used many sources of cost information that producers attacked these sources on many invalid grounds to take up each of these objections would increase the rate of this opinion to encyclopedic dimensions. From the information so obtained, the parties, the staff, and the Commission made many competitions and reached many results. The assumptions, allocations, formula, equations, averages, means, and massive calculations they intrigue a mathematician or a statistician but they have no attraction for us. We respectfully declined to be drawn into such a turmoil of numbers. We cannot in a few months unravel as null of statistics developed in the years of hearings.” A regulatory method which is too massive and too complicated to permit appellate review can hardly be deemed a valid method. And the end result test fails because the only thing against which the end result may be tested is the untested cost result. Five, cost to service discourages exploration because it uses past calls to set future rates without any adjustment contemplation. Sixth, in periods of declining explorations such as over the past 10 years, successive cost to service studies will use successively lower cost results which in turn will inspire further reduced exploratory expend -- investment. While each of these studies well appeared to provide the industry with the return, it is in fact liquidating in the day of gas shortage and gas ration and is being advanced. Seven, cost to service estimated area by area will discriminate against those consumers who draw their supplies from high cost areas and discriminate in favor of those consumers withdraw their supplies from low cost areas. Eight, the cost of gas has no relation to the commodity value of gas. To those members of the Court who may have a copy of my brief before them, I respectfully direct your attention to page 29 where all appears a most illuminating table. This table plainly tells us that under the empathies of Commission regulation, we are slowly running out of gas. However high, the Commission is to be graded, for providing the consumer with low rates for gas, it is lacking in providing the consumer with an adequate continuing supply of gas. Column B shows the plunge in successful exploratory drilling for the years 1960 to 1966 from 868 in the former years steadily down to 578 in the latter year. While in absolute figures, the total reserves in Column C show us nine increase, increase is nowhere near as great as to increase in actual demand showing in Column E with the attendant continuous decline in the proportion of reserves to production so in Column G. I wish I could tell this Court at 1967 would reverse this trends but I cannot. In 1967, successful exploratory well is drilled, will be down to only 445 if the percentage decline for the first nine months of 1967 compared to the first nine months of 1966 continues. Actual demand will be up to 18.4 trillion cubic feet. The reserve to production ratio will be down to only 15.7 to 1. This is practically down to the 15.5 to 1 which was the lowest figure that any party to these proceedings ever suggested it was safe to allow. If these trends are not reversed or rested, it is frightening to ponder what the supply-demand relationship to future prospects will be by 1970, only three years away. These are the economic forces that are working (Voice Overlap) --
Potter Stewart: What is the ratio in the oil industry here in United States?
Bruce R. Merrill: The oil industry, it has run generally by 12 to 13 to 1.
Potter Stewart: And (Inaudible) -- it's been rather steady.
Bruce R. Merrill: And cost that way for decades Mr. Justice Stewart. These -- the economic forces that worked in the industry, they are plain to see, they are easily evaluated at any point in time and they cannot be ignored in the process of ratemaking. The Commission's dual price rate design is demonstrably wrong and unlawful in several respects. One, the dual price system itself does not provide incentive as claimed by the Commission. A single high enough price will provide incentive. And incentive will not be supplied by prices which are too low no matter how many price differentials are provided according to dates of commitment to the interstate market.
Abe Fortas: Mr. Merrill, is there a different -- a legal distinction between the Commission's job and the job of their reviewing forth with respect to this consideration? That is to say, you argue and I think understand it, that an incentive -- price incentive has to be provided in the rate structure in the national intrastate, I quite understand that I think. The question is does a -- does that consideration apply with the same vigor in terms of the reviewing court's function as it does in terms of the administrative agency, that is to say are franchises not total that completes franchise? What your -- what do you say about that?
Bruce R. Merrill: Mr. Justice Fortas, I think that in the first instance, it is up to the regulatory agent to provide the regulatory system and the rate structure over that sort of thing. I think that in the file analysis is up to the Court could give the Commission guidance whether it is demonstrable that the Commission has come up with a system that is unworkable or arbitrary discriminatory.
Abe Fortas: Well, (Inaudible) arbitrary and discriminatory are different matters. And I was --
Bruce R. Merrill: Well --
Abe Fortas: -- talking to you about this matter providing an incentive for exploration. Well, do you derive that from the constitutional provision or from something in the statute or something in the legislative history that it is the judicially and forcible duty of the Commission to do that?
Bruce R. Merrill: Mr. Justice Fortas, it is my understanding that the Natural Gas Act at various cases have held that the Commission has a dual function. One is to provide adequate supply of gas to the consumer. And two, is at the lowest reasonable rate at which that first former function can be performed. And I think that the judiciary has the ultimate duty to see that the Commission is performing the -- its given function.
Abe Fortas: Well, I am -- what I'm trying to get to -- (Inaudible) is to what is there -- what specific provision on the constitution or what specific provision in the statute? Do you rely upon to say that it is the function of the Court's to require not only that the Commission pay or what Justice Jackson, that the Commission provide payment for a cost of producing the gas but also that the Commission provide rates that will give an incentive for exploration, kind of distinction that Mr. Justice Jackson made the -- in that quotation that you read. That's what I'm asking about. What is the specific provision of law on which you rely with respect from the question of public -- imperative public policy?
Bruce R. Merrill: Mr. Justice Fortas, I can't put my finger or anything in the Natural Gas Act nor the legislative history which specifically directs its intention to that. However, there are numerous recitations in the Commission opinions and Court opinions that the duty of the Commission is to induce an adequate supply to the interstate consumer as well as to regulate the rates that were in effect -- of the first function that can be performed at the lowest reasonable rate.
Speaker: (Inaudible)
Bruce R. Merrill: They have acknowledged it as being their duty Mr. Justice Harlan, yes. My argument is that they're failing and --
Earl Warren: Can you speak a little louder please, it's unclear?
Bruce R. Merrill: Yes Mr. Chief Justice Warren. I said that the Commission has acknowledged that duty and it is argument that they are failing in that acknowledged duty.
Speaker: (Inaudible)
Bruce R. Merrill: My argument depends upon the existence of that duty Justice Harlan.
Speaker: (Inaudible)
Bruce R. Merrill: Yes, Mr. Justice Harlan.
Speaker: (Inaudible)
Bruce R. Merrill: That is precisely correct.
Speaker: (Inaudible)
Bruce R. Merrill: Well, my argument Mr. Justice Harlan is the function of this Court is to direct the Commission that unit cost estimations are an improper and unworkable method of accomplishing these objectives and that sincere and considered evaluation of the economic characteristics of the industry are necessary and obedient to whatever method they do evolve.
Hugo L. Black: Suppose Congress had passed this precise law etcetera, what would you say to that?
Bruce R. Merrill: Then I think this -- I think really it would be on the same posture as it is now. I don't believe it was necessary before --
Hugo L. Black: If you've gotten the power to do it?
Bruce R. Merrill: I believe that is right --
Hugo L. Black: (Inaudible)
Bruce R. Merrill: -- Mr. Justice Black.
Hugo L. Black: Would you challenge that constitutional power today?
Bruce R. Merrill: No, no. I will not challenge the constitutional power to do it.
Hugo L. Black: Then you would say that Congress could pass?
Bruce R. Merrill: Absolutely yes.
Earl Warren: Am I wrong in believing that the counsel yesterday argued that they -- the Commission had to left a cushion in there for exploration?
Bruce R. Merrill: Mr. Chief Justice Warren that is so only if you accept their computed cost study which of course I do not accept. They have a cost of service computation at which they claim that a portion of the exploratory cost component is an inducement to explore but I don't agree with that or accept that at all.
Earl Warren: I know, but we're dealing with something else here. I understood you to say a little while ago that the Commission rejected any responsibility for it, for having a cushion for exploration.
Bruce R. Merrill: I didn't intend to give that impression Mr. Chief Justice Warren.
Earl Warren: What was the -- what was -- what did you say in that regard?
Bruce R. Merrill: I did not address myself to the question of incentive in connection with the evaluation of their costing studies at all Mr. Chief Justice Warren. I am a little bit in a lost -- what (Inaudible), I must have misled you in some respect.
Earl Warren: You would -- but the -- you don't challenge the fact that the Commission undertook to make some provision for exploration and the search that it has done now, do you?
Bruce R. Merrill: No.
Earl Warren: You -- all you say is that they didn't do it properly?
Bruce R. Merrill: That is correct. I further say that is impossible to be correct and do it on a cost basis.
Earl Warren: I see, (Inaudible). Mr. Martin.
Crawford C. Martin: Mr. Chief Justice Warren, Associate Justices, may it please the Court. My name is Crawford Martin. I'm the Elected Attorney General of Texas and I appear here this morning representing the State of Texas in official capacity. I -- some of these producers maybe my constituents but they are -- I do not represent the producers here this morning. We are representing the state and we appear before you here presenting four points that have nothing to do with expert witnesses or the things in this lawsuit. It's only the state's interest and Mr. Boston Witt, Attorney General of New Mexico beyond the left will present the last two points, I will present two points. Our arguments will be brief as you see the producers after part of the time. But I will try to go as fast as I can on them Your Honor. The points that we have are listed at four points. I will cover the first two, they're actually all related. We first contend that the State of Texas presented evidence in this case before the Commission of the hearing examiner, the Commission rejected it on account of the holding in the Hope case and the Circuit Court of Den -- in Denver, Colorado upheld that particular point. There's only one little paragraph in the decision that we disagree with and that's what we're actually here this morning. As you know the Hope case was decided in 1944, some 10 years before this Court held that the producer came under the Natural Gas Act. We are -- appeal that we do not -- that that decision does not control as it now, the Act is now come into be. It was one pipeline, do you remember out of West Virginia and one producer -- or not producer, one distributor there or the consumers rather, and the Court in that case found that I would just -- it was a small of matter. West Virginia was trying to argue that they wanted to keep the price of gas up in order to protect coal and all that have an effect on the economy of the State of West Virginia and the Court rejected that. But we don't have that thing here this morning. The Court said in that case, in the Hope case that the results to West Virginia were -- in our -- I believe I quoted right, it was indirect and it was insignificant. Now we have in Texas and New Mexico, since we're arguing this jointly, a tremendous area out there. We have 4,700,000 acres of land in this basin. I believe New Mexico has around 3 million acres in the basin. Now this 4,700,000, the greatest majority of the fact in all of it is state owned land. The state owns the minerals under this land. They're producing -- the producers here made contract with landowner which -- acting as agent for the state are the state in most cases lately have been leasing the land themselves. We have grown up tremendous cities and an area. If you've been there, is not in the world but (Inaudible) less than 3 to 4 inches of the land a year not suited (Inaudible) there's no irrigation water. The ranching is all it can do outside of producing oil. It built up a tremendous economy in there. And we undertook before the examiner and to show the Commission that the production of oil and the production of gas had a tremendous impact on the economy of our state. Now we're not just talking about -- the one I'm talking about the Hope case. I'm not just talking about this particular case because as it was indicated yesterday they have hearings under way in which will cover -- blanket our entire estate. I don't know of any -- (Inaudible) left out I'm sure that they have tried to get (Inaudible). But those -- will have the last case, I believe the catchall. And I won't -- I want the Court to understand that we don't have a one plea here this morning that's all we're after. All we're interested in is that the State of Texas be allowed to present its evidence as to the effect that the Commission order might have on the state and its economy. I'm going to read those brief in and with our cut cover one or two then we -- and then will turnover to Mr. Witt. I -- the --
Byron R. White: (Inaudible)
William J. Brennan, Jr.: Didn't you have this opportunity?
Crawford C. Martin: Sir?
William J. Brennan, Jr.: Didn't you have this opportunity.
Crawford C. Martin: We had an opportunity to present. We presented one morning, I believe, of the evidence there but the Commission rejected it and said they will not consider it and they -- the -- didn't record. The way I read the decision, they said that they could not on account of the Hope case. They decided the Hope case and rejected our --
Potter Stewart: In the brief, what was your ultimate proof?
Crawford C. Martin: Sir, we offered a proof of -- on the conservation of gas. Our Railroad Commissioner Mr. Murray at the time testified as to how this would work with that and the other was offered by Mr. Stockton who was with the University of Texas and he offered testimony concerning that if the production of gas, exploration of gas is discontinued that this economy with million and millions of dollar would completely collapse, so there's nothing else to support. That was frankly offered but the Court decided the Hope case. What I want to try to tell you, (Inaudible) of the Hope case, in my opinion, there's no -- no longer apply to the facts or at least to -- as I understand. Now New Mexico they'd say, they have 3 million acres and about 45% of their education comes out of that particular basin. Now we feel that the Commission failed in the statutory responsibility to the public to protect the public. What is the public interest? That is -- that's the question that was -- that is the question that I could -- that we have here in front of us. I think the public interest includes a tremendous wide field. Is not -- and I think the Commission has taken that in view and we're a little bit alarmed if they didn't allow the full range and look at that testimony because we feel that the public interest includes all the states. And this is a constitutional question that we've mentioned in here about this place being only for footing. I know it's very easy to say, "Well, you're producing state and therefore you shouldn't have anything to do with it". As long as it is only cost basis, as long as it is strictly on a cost basis, I would probably agree with the Court. I don't disagree with the Hope case and original finding but I certainly disagree with it when you change it from and it seems that that's the direction the Commission is going at, when you're changing it from a cost basis over to other -- bringing other factors particular to explore for new gas. Then you would certainly bring in and Mr. Witt will cover that point adequately, the conservation of oil and gas. As I have stated, they have done a tremendous job and the Railroad Commission has -- we feel likely conserving oil and gas and the compact was renewed I believe only this -- here today for two more years. I wanted to state to the Court as my opinion, the Commission and the Court completely were in error and not lying this evidence in because of the public interest. There are two ways of looking at it. You can say well, that you're going to have -- just look at the consumer in the matter and I believe it's indicated by the arguments here yesterday that the consumer in this case, but we told it about it is a small consumer, that's what the State of California preceded. I say that there are two ways of looking at it and the way we like this Court to look at our end of it, there are high quantities and there are low quantities. As far as I'm concerned, I believed that the consumer in California and I have nothing against them. And I want to say that if the state is allowed in here, it may be the time come and it probably will come soon that we might be just as interested in the lower price of gas than we were in the higher price of gas. But the low consumer in California, I mean the low quantity as I see it in California, is testified here at least stated in the Court yesterday was around $6 to $8 at the most, maybe $10 per person out there. I slipped into the meddling of this area, El Paso, the person out there has a high quantity because he has a tremendous interest in the matter. Millions of dollars invested that each person draws a salary out of that and I certainly don't stand here in front of the Court to say that you should support something in order just to keep few people off. What we feel like that the Court should look at this and should allow us by all means to come in and present our evidence. If the Court doesn't -- if the Commission doesn't want to give us any consideration, we -- I would say, but we think it should be allowed to present it. Thank you.
Earl Warren: Thank you Attorney General. Attorney General Witt.
Boston E. Witt: Mr. Chief Justice, may it please the Court. My name is Boston Witt. I'm the Attorney General of New Mexico. I appear here on behalf of New Mexico in opposition to the Commission's order. Now, the Court please I could stand here during my allotted time and commiserate about how much tax money this decision will cost New Mexico. But it seems to me there is a far more important question at issue here. Far more important than any tax lost to New Mexico. Even more important than any profit, to any company involved in this case and in my judgment more important than the price of gas to the consumers in California. It seems to me that the more important question is, what will be the day when the consumers of California will it -- be able to buy gas, be unable to buy gas from the Permian Basin at any price. The question then of course is conservation. Now, we have to remember that in the discussion yesterday, it was pointed out that two-thirds of all gas produced in the Permian Basin is casinghead gas. That is to say gas produced in conjunction with oil. Casinghead gas is somewhat different form a gas-well gas, and that it must be produced at the same time that the oil is produced. When you produce the oil, you must by necessity produce the gas. At that point, two things can be done with the gas. One, it can be marketed if the cost involved in gathering it and bringing it up to pipeline standards are -- the price is sufficient to justify the cost. Or two, it can be vented to the atmosphere and flared. Now New Mexico in the 1930s, along with Texas were the leaders in the conservation measures in the hydrocarbon field.
Potter Stewart: Is there no way of storing it at that point?
Boston E. Witt: Not on casinghead gas.
Potter Stewart: That's what I'm talking about, I appreciate it.
Boston E. Witt: New Mexico and Texas led the nation in conservation of hydrocarbon energy. In the early 1930s, we passed a statute empowering our Oil Conservation Commission to prohibit the flaring of gas. Now we permitted them to flare gas for some period of time for the simple fact that it was uneconomical to gather at that point because the price was insufficient to justify the cost. But almost two decades ago, New Mexico has prohibited producers from flaring casinghead gas. We have -- we did so, because at that point, the price became economic enough that we could force them to market and gather it. Now this is in contradistinction of California. California had great and vast reserves of hydrocarbon energy. And today, they are barren. And I must say that California appeared before you yesterday as a consumer state as it must because its hydrocarbon energy now has been wasted, it has perhaps lead the nation in lack of conservation practices. So what appears before this Court today, or yesterday, and ask this Court to put its stamp of approval on a decision of this -- of the Federal Power Commission which will be the seed which might well destroy New Mexico's conservation practices. Now --
Earl Warren: I understand there are no laws in California against for --
Boston E. Witt: There --
Earl Warren: -- for the conservation of gas.
Boston E. Witt: Mr. Chief Justice, there are conservation measures in California. But California has never adopted the well spacing regulations, has never adopted the proration theory which we think are so necessary to the conservation of hydrocarbon energy.
Earl Warren: But there has been, not only been -- in legislation of that kind that there has been enforcement of it, is there not?
Boston E. Witt: That's correct.
Earl Warren: (Inaudible)
Boston E. Witt: That's correct. But I think it is a -- so clear that this Court may take judicial knowledge of it that California has not done nearly the job on conservation of its hydrocarbon energies as -- that New Mexico and Texas have done. I think testimony of the fact that their hydrocarbon energy is largely expanded at this point, it is proved of the point. Now, if we -- now I want to be very clear about this, we are not standing here saying that the price the Commission set for casinghead gas will -- is at that point, where it is uneconomic to produce it any longer. We think it -- that may be the case but we're not here saying that's the case. What we are saying is that we appeared in New Mexico as well as Texas appeared before the Commission and that offered testimony as to what effect their decision would have on New Mexico's conservation practices. As General Martin pointed out that testimony was rejected. We appeared in the Court of Appeals in the Tenth Circuit and again urged our position on the conservation to the Court of Appeals. And again, the Court of Appeals rejected our offer of proof. Now it seems to me that the question of conservation is not a parochial issue to New Mexico, indeed it is an issue of vital interest to the nation.
William J. Brennan, Jr.: May I ask --
Boston E. Witt: Yes sir?
William J. Brennan, Jr.: (Inaudible) the failure of the Commission to --
Boston E. Witt: Well --
William J. Brennan, Jr.: -- consider this position -- what does it -- concerns New Mexico (Voice Overlap) --
Boston E. Witt: Well the problem is, if they set the price of casinghead gas at a point so low that it is uneconomical --
William J. Brennan, Jr.: Which you're not --
Boston E. Witt: -- to harvest its --
William J. Brennan, Jr.: (Inaudible)
Boston E. Witt: We're not saying that they have reached that point. We're saying they did not consider our offer of testimony on that point. And we think the question of conservation is a necessary part of the public interest under the National Gas Act.
Byron R. White: Well, what's conservation have to do with the -- got to do with -- what are they (Inaudible)?
Boston E. Witt: Because if it is uneconomic, at a price to gather and produce the gas, the companies are going to flare it. They won't go to the expense of gathering the gas and putting it into the market, (Voice Overlap) flared it --
William O. Douglas: You're not talking about gas-well gas --
Boston E. Witt: We're talking about casinghead gas.
William O. Douglas: Casinghead gas, yes.
Boston E. Witt: Yes sir, which constitutes two-thirds of the Permian Basin.
William J. Brennan, Jr.: And (Inaudible) -- you're saying that the proofs beyond economic, that is a price --
Boston E. Witt: They will flare --
William J. Brennan, Jr.: -- that you're going to have to permit them to flare (Inaudible).
Boston E. Witt: Well, if we refuse to permit them to flare it and they cannot recover their cost by marketing it, it seems to me that our -- that the order of our Conservation Commission would be put in jeopardy on constitutional grounds.
William O. Douglas: Of course they were -- they relied as I gather on our Hope case --
Boston E. Witt: That's right.
William J. Brennan, Jr.: Although, Hope was decided before the Phillips case, wasn't it?
Boston E. Witt: That's correct (Voice Overlap).
William O. Douglas: That Hope doesn't involve these producers --
Boston E. Witt: That's right --
William O. Douglas: -- but interstate transit.
Boston E. Witt: The Federal Power Commission and the Court of Appeals said, however much we would like to consider this testimony, we are prohibited from doing so by the Hope case. Because the Hope case said, the interest of the producing states is not a part of the public interest. Now, our point as General Martin pointed out is, we think the evolution of the law has progressed further than that at this time. We think conservation is a national issue.
Abe Fortas: But General, do I understand that you're not attacking the rates fixed by the Federal Power Commission?
Boston E. Witt: We do not say here that the rate they set for casinghead gas will cause this effect.
Abe Fortas: Well, I --
Boston E. Witt: We are saying the --
Abe Fortas: I think I understand your point as a matter of fact mattered but, are you urging that the states are prejudiced by the decision?
Boston E. Witt: Yes sir for this reason.
Abe Fortas: How so?
Boston E. Witt: Not only as conserve -- there is no federal authority to conserve hydrocarbon energy in New Mexico.
Abe Fortas: I understand that, but I mean to say if you do -- if you are -- not, if you don't take the position that these rates are fixed so as to injure the conservation interest of the state, how is the state prejudiced (Voice Overlap)?
Boston E. Witt: Well, we say we don't know, we think this rate may reach this point.
Byron R. White: Well, would you want to offer evidence to prove that?
Boston E. Witt: Yes sir, yes sir.
Potter Stewart: You want to offer evidence to prove that.
Boston E. Witt: We would like to go in and offer our testimony on the impact of this decision, how important it is.
William O. Douglas: Well, you had entered it in there but you were denied.
Boston E. Witt: And it was not considered because they said we cannot under the Hope case.
Byron R. White: But you offered the evidence that the reason for offering them was to prove that the casinghead gas was not to be produced in an economic basis rate?
Boston E. Witt: We think the Commission when it decided --
Byron R. White: Well, isn't that what you offered before us?
Boston E. Witt: Yes sir, we offered it -- we offered testimony that whatever price they established would have a profound effect upon conservation in New Mexico which is directly related to --
Byron R. White: That maybe so. That may be quite so but were you also claiming that the pricing the Commission would -- suggested that were uneconomic?
Boston E. Witt: Well, we say -- we are saying we don't know at this point because nobody can tell. We're -- all I am saying to the Court is that in considering what is --
Byron R. White: Well, yes, the Commission knew that it is going to have to set the prices to be economic, isn't it? Well, I mean they have found that people from (Inaudible) that the average producer can make a profit of these rates.
Boston E. Witt: Well we don't know whether they can --
Byron R. White: Now let's assume that's true. Just assume with me for a moment that is true. Now how about if that's true, are the conservation of this -- New Mexico include it?
Boston E. Witt: Yes sir. Because -- now we're talking about two different questions, casinghead gas they said we are going to set it 14 and a half cents.
Byron R. White: Alright.
Boston E. Witt: But --
Byron R. White: Let's assume that the average producer can make a profit at that rate.
Boston E. Witt: Well, now -- that's not going to be the actual rate Mr. Justice.
Byron R. White: Let's just -- let's assume that he can make a profit there.
Boston E. Witt: Well I -- on what the -- in fact rate, on casinghead gas will be in the Permian Basin is quite a different matter from the rate they set in the order because as was pointed out --
Byron R. White: All of the adjustments?
Boston E. Witt: Sir?
Byron R. White: Because of the quality adjustments?
Boston E. Witt: That's right. The price will be closer to 9 cents than it will be closer to 14. And we think on that basis we may very well get to the position where the companies are going to come to us and say we can't make a profit on the casinghead gas because of the adjustments.
Byron R. White: Yes, but let's assume that that's not so. Assume that they can make a profit. Now your conservation interests are well served in that case. I mean they're not damaged in anyway.
Boston E. Witt: Not only are interested, it seems to me they're the interest of the nation.
Byron R. White: Well, isn't that (Voice Overlap) -- yes, but if it's true that they can make a profit at this rate then your interests are not damaged.
Boston E. Witt: Well, our -- New Mexico's interest are not damaged but if --
Byron R. White: Alright. That's enough (Inaudible). New Mexico's interest aren't damaged so the question gets back to whether or not the Commission -- the reasonableness, the justice, the reason was – of the rates the Commission fixed. Now, that question to say, now whether -- whatever your conservation is concern.
Boston E. Witt: Well, only and that can --
Byron R. White: If there're just and reasonable in this interest, they -- that they can make a profit where interests are not damaged.
Bruce R. Merrill: If the law requires that they consider the public interest in setting a rate, it seems to me that it -- they must buy the nature of the -- definition of public interest consider conservation in determining their rate they didn't do so.
Byron R. White: Yes, but considering it won't change the result.
Bruce R. Merrill: It (Inaudible) very well.
Byron R. White: No, it wasn't -- all they would have to do -- all they would do is to ensure that the rate is just and reasonable. And that the --
Bruce R. Merrill: Considering the conservation question of casinghead gas alone.
Earl Warren: Mr. Varner.
Herbert W. Varner: Mr. Chief Justice and may it please the Court. My name is Herbert Varner and I'm appearing on behalf of the Superior Oil Company. The Superior Oil Company is a large nonintegrated producer of oil and gas. We have no refining operations, no retail marketing of any kind. We do not engage in the federal chemical business, on the plastics business, (Inaudible). Our operations are limited exclusively to exploring far and producing that oil and gas which is sold generally in the (Inaudible). Because of the limited nature of our operations, relatively more allow a capital is expanded annually for exploration, than that of most other companies. More than that perhaps in the integrated company, because necessarily their budgets must include their exploration function and accommodate to the other aspects of their business which are vary in their needs from year to year, more than the so-called small producers, merely because of our size. Our operations are identical with that of the so-called small producer. Because of the fact that we need to drill more wells and deep wells, we are what is known as a high cost company. We do not gold plate our wells. Dr. Warren (ph), a witness for the Commission, explained in -- explaining why there was a variation in annual cost of the various companies for drilling and exploration, that primarily it results from what he call the well mix, the well mix being the type of well and the depth of well. And he said these are the factors that lead to add cost, not extractions, not improvements. He did point out that there was a great range in cost from here to here between the various companies. But he did not point out and it is not true, that a high cost operator who continues to do the same thing won't continue doing a high cost operation. It's just inherent in the nature of the business. As I say, there are some changes in some of the companies. Now, the argument has been made that even though they don't get their money back this year, next year they're the low cost companies can get it. That argument to me runs right into the phase of regulatory rules that future rates will not be made to compensate the past losses. Now I would assume that present rates will not be fixed to compensate for potential savings which may or may not ever develop. But this fact explains why superior takes the position that we do, that group rate fixing is invalid. The fact is that high cost companies get the benefit of the reduced rate that results from average whereas the low cost companies get a part of their cost, a part of the high company cost which go into their averages and permit the computation of a rate of return for them on figures which are in fact actually higher than their cost.
Byron R. White: Well, do you object to group rate fixing?
Herbert W. Varner: Yes sir.
Byron R. White: And -- regardless with the basis?
Herbert W. Varner: Yes Your Honor.
Byron R. White: So you do different from continentals?
Herbert W. Varner: I do quite differently from continental. I take the position that group rate fixing under the Natural Gas Act is not provided for in the Act.
Byron R. White: Whether its deal price basis or --
Herbert W. Varner: Right.
Byron R. White: -- cost figure?
Herbert W. Varner: Right. I may give you an exception later of suggesting method if you want it.
William J. Brennan, Jr.: Well let's see, is it -- are you -- are -- is this the position of the dissent in the second Philips case?
Herbert W. Varner: I did not --
William J. Brennan, Jr.: Is your position the position of the dissent in second Phillip?
Herbert W. Varner: Yes in part. It is in part, yes Your Honor. I would say basically so. I think this, if I must put myself in a nutshell, I'd say my position is that the Hope decision is correct. Now, as I say I am going to address myself primarily to the issue of legality. And the basis of (Inaudible) is that the natural gas itself at work, requires individual rate fixing. Furthermore the decisions of this Court, the intent of Congress in passing the Act as this Court has described it, the Natural Gas Pipeline Case, the Hope Case and the Colorado Interstate case, I think leads a no conclusion other than that individual rate fixing is absolutely required. Furthermore, I would like to show that if the Natural Gas Act does not provide for the establishment of individual just and reasonable rate, then the Act doesn't have any standard of regulation whatsoever. It is with that question then, I believe, an unlawful, unconstitutional delegation of legislative power. Because then, they are legislating rates and they have no standard whatsoever. Now the Act was passed in 1938, and as the court below found, all of its wording goes to the (Inaudible). Now, the general counsel for the Commission told you a particular attention to Section 4 and I'd like to do the same thing. He urged going here, that any rate has to be just and reasonable. I will look at the same Section because it says all rates of any natural gas company must be just and reasonable and if they're not, they're unlawful. This was the rate standard under which the Natural Gas Act was held constitutional in natural gas pipe. There, with reference to the just and reasonable rate and the lowest reasonable rate permitted under Section 5, the Court said, by long standing usage in the field of rate regulation, a just and reasonable rate or the lowest reasonable rate is one which is not confiscatory in the constitutional sense. The constitutional sense itself is an individual consent. It applies to a person or a company. Now I admit it that the constitution doesn't find rate fixing or agencies to the use of a single formula, but the leeway to choose a formula for fixing has absolutely nothing with meeting the standard of rate fixing which again is just and reasonable. Now this was the precise holding as I understand the Hope Natural Gas case. There, they said that at the end result is just and reasonable. It doesn't make much difference how they got that. They can use any formula they choose. And they said to be just and reasonable the rate must be one that will produce revenue sufficient to cover the operating cost and the capital cost of the business. It must be rates which from the investor or a company point, will lead capital cost the ability to pay interest on debt, pay dividends, to have sufficient return to measure what the risk in several enterprises to maintain confidence in the financial integrity of the business, to permit that business, to maintain its credit and attract more capital. The obtaining and maintaining of credit, the payment of dividends, the attraction of capital, even the payment of operating expenses are all individual company obligations and abilities. The industry does not have these capabilities, it does not have these obligations. Since you cannot comply, the Hope case to the industry as such, then it seems to me you are in the position where there is no standard whatsoever under the Natural Gas Act. Now, there cannot be any question as to the fact that Hope did in fact require individualized rate fixing. The very option was suggested in the dissenting opinion of Mr. Justice Jackson, there he pointed out that because and incidentally these are the same reasons now put forth for the group rate method, because of the erratic nature and the peculiar characteristic of this business, the erratic nature between investment and results. That it was improper to use any sort of cost of service. Incidentally, I do not insist on the cost of service, that doesn't have to be the method. But -- then he said what he would like to do, is to fix the price of gas on some sort of a commodity, a basis that didn't assure a fair return to any producer. In his own words, his views were rejected by the majority of the Court because Congress in passing the Natural Gas Act intended to and did provide for regulation along recognized in more or less standardized matter. They then -- conceivable to me that the individual rate fixing requirement opposed in 1944 is not equally applicable today even though it may be inconvenient with the administrative agency. Certainly, since 1938 when this Act was passed, neither the purpose nor the intent of Congress has changed. Furthermore, it's rather unbelievable to me that a rate fixing agency would propose a matter which by design is going to provide far in the words or the court below of bankruptcy rate for a high percentage of the industry and less than a fair rate for 50% of it. This is the exact --
Potter Stewart: Do you claim that the -- your client Superior Oil Company is -- that the rate has that effect upon Superior Oil Company?
Herbert W. Varner: Yes Mr. Justice.
Potter Stewart: Is there evidence in the record to that?
Herbert W. Varner: Yes sir. I would refer you to the cost of service exhibit of the Superior Oil Company which was offered refused of course because there was a preliminary order to the effect that individual cost would not be considered or heard.
William J. Brennan, Jr.: Did I understand you to say that this rate of Superior is a bankruptcy rate?
Herbert W. Varner: Yes sir. I would also --
William J. Brennan, Jr.: Yet, it will not cover your out-of-pocket cost or whatever or all covered cost, (Inaudible)?
Herbert W. Varner: It -- I won't say it won't cover out-of-pocket cost --
Byron R. White: By ordinary accounting principles this -- you -- will roughly cover your costs?
Herbert W. Varner: You have placed me in a terrible position Mr. Justice White.
Byron R. White: Well I know but you can give me -- you're placing us in it.
Herbert W. Varner: Alright, may I answer it this way?
Byron R. White: Perhaps you're saying this rate won't --
Herbert W. Varner: Well, you asked me --
Byron R. White: -- by the bankruptcy (Voice Overlap) --
Herbert W. Varner: -- by ordinary accounting methods.
Byron R. White: All I just want to know is what you mean by that?
Herbert W. Varner: Very well, let me explain. You asked by ordinary accounting methods, ordinary --
Byron R. White: Well, what if -- by whatever method you were talking about.
Herbert W. Varner: Alright sir. By the methods that I believe were used here on a composite basis, that would be the result. I would give you an example that is in the record of some variant between the cost, there is an exhibit here put in by the staff witness Wright. It's Exhibit Number 174, found at record of 499E and 500E. And it shows the cost for raw gas, total raw gas of some 60 producers in the Permian Basin which includes among others the Superior Oil Company.
William J. Brennan, Jr.: Are you casinghead or (Voice Overlap)?
Herbert W. Varner: We're both.
William J. Brennan, Jr.: You are --
Herbert W. Varner: And I think you will find that everybody in the industry in the Permian Basin is both primarily because --
William J. Brennan, Jr.: Any proportion one -- for you, I mean sort of --
Herbert W. Varner: If you won't rule me to this, I'd say we do not have --
William J. Brennan, Jr.: (Inaudible)
Herbert W. Varner: -- in all probability in a gas-well gas. I believe it's all --
William J. Brennan, Jr.: (Inaudible)
Herbert W. Varner: -- associated gas. I believe that happens to be our particular situation. If you look at that exhibit that I've pointed to you, you'll have to look the company number 48 because the companies are not named. The rate there shown for the Superior Oil Company is 14.7. You will observe and somebody asked this question yesterday so I'll get to it now. That somebody asked a question, what is the variants of cost between the companies? The com -- the variants here, and this is not total cost, but this is a cost concept that Mr. Wright developed on this particular item and it shows there it ranged from 4 cents per thousand to 28.9 cent per thousand for all except the last company. The last company, the 60th with a dollar 22, so that's pretty high. Now, the fact is that if you'd --
William J. Brennan, Jr.: If you -- if you're casinghead you're -- would not the case of bankruptcy just take into account the oil revenue?
Herbert W. Varner: No sir, it doesn't take into account the oil revenue and for the very simple reason that oil isn't regulated, but we have made allocations. Now of course in this particular case they did not. They used -- they determined cost for gas-well gas for the reason that they said there are fewer allocations. The -- someone has pointed out, you still have 55% of the total cost is an allocated cost. But be that as it might they could -- they imputed that cost over to the associated gas. Now as I say, this ratemaking method, by design is going to result in a high percentage of the companies going out of business or being required to go out of business every time there's a successive hearing because obviously if the high cost -- the highest cost producers here are eliminated, the next time you got a low rated average and so you are going to eliminate those and pretty soon you're going to get down to where there are no others. Then that effect of it -- it seems to me it's totally contrary to general national policy.
Byron R. White: Well without the gas production, you wouldn't produce oil in there?
Herbert W. Varner: Without the -- no. Without the oil production, we probably would not have produced this gas. Now the thing is this, if we do not continue to produce the gas as General Witt pointed out, we can't produce the oil because it is now prohibited to flare gas.
Earl Warren: Because of what?
Herbert W. Varner: Prohibited to flare gas for the sole production of -- sole purpose of producing oil that maybe I think pointed out some exceptional circumstances where economics will not permit it. Now unless we have this economics imposed on us, we've been able to -- forward to gather it and sell it. Now I would point out too, the Natural Gas Act certainly does not require a uniform. A uniform price is alien to the industry. It hasn't even been a matter that the purchasers have embarked upon their prices in the same field at the same time are generally are the same. But between purchasers, there's always been a difference in price. There is in a situation here that have been pointed to where they say, but you can't make money anyhow. The fact to the matter is that we've been getting along very well at our contract rates and the contract rates, high, low or otherwise have been rates that the public not only could afford but found sufficiently interesting to increase their demand for the product. I certainly can assure you that if you can eliminate any high percentage of the 50% of the companies who will not make a just and reasonable rate in their gas production, there is an absolute shortage tomorrow if that's when it becomes effective. Now, I would also call to you -- to the Court's attention that in Justice Jackson's dissent in Hope, he recognized that in this situation if the party who's rate was -- did not yield a fair return, wanted to get out of the business and was compelled by some other reasons to stay in, then the Court -- he was suggesting would not meet constitutional requirements and that's exactly what's happened here. Now, what I wanted to say a moment ago was that there can be absolutely no question as to the effect of the holding in Hope. And for that, I would call to the Court's attention, the decision in Bowles versus Willingham which involved a wartime federal rent control statute. That opinion written less than 90 days after Hope, again, by Mr. Justice Douglas speaking on behalf of the majority of the Court, pointed out that there was a distinction between this rent control line and the Natural Gas Act because Congress in passing the Natural Gas Act provided the fixing a rates which are just and reasonable in their application to particular companies or particular parties and he cited Hope of course with that to review. Now then, if we assume, which I don't, that Hope is not governing here and I do not see how group rate fixing can be established without overruling Hope. And I certainly do not think that second Phillips did that because second Phillips relied in fact on Hope. Second Phillips says, "First, we're not going to render advisory opinions, which of course is nothing new in history of this Court, and they didn't". But they did say this, they said, "We can't -- now determine that the method employed will necessarily result in a rate which is not just to the consumer and not just and reasonable to the producer, a rate to which they each have a right". That's that right I am here insisting upon. Now, if the Act doesn't provide for group rate fixing and certainly I think everybody concedes it does not provide for it and the question is does it prohibit? Then if it doesn't, then by what standard must the composition of groups be determined by the Federal Power Commission. The Act provides none. Now obviously if the Federal Power Commission can pick any group it chooses, then by the very constitution of the group itself you foreclose and foreordain what the average rate will be and what appears to be a just and reasonable rate. Now if the answer of it that -- well it doesn't say one way or another so obviously the implication is that they may create reasonable groups, then if that'd be the case in this particular proceeding we have all been deprived the due process of law for the reason of that. With the institution of the proceeding here, the Commission also provided in the very same law that they would not entertain objections or a contention to the effect that the group fixed was not sufficient for rate making purposes. And we have been deprived of that and therefore as I say we have been deprived of due process of law. Thank you.
Earl Warren: Mr. Henderson.
Robert W. Henderson: Mr. Chief Justice, may it please the Court. My name is Robert W. Henderson. I represent Hunt Oil Company and several other independent producers. We are petitioners in Number 101. It is not our position before this Court that group area ratemaking per se is unlawful. It is our position that the application of the method by the Commission in this case is unlawful. First, it violates the individual constitutional rights of the independent producer by lowering their revenues below the cost incurred by those producers without taking into consideration, the cost incurring factors of the gas itself. The second reason that the method used by the Commission in this case is unlawful is because it does not provide for a just and reasonable rate for the group nor for the individual oil and gas producers. Because it fails to provide for the lowest possible reasonable rate, it is inconsistent with the maintenance of adequate service in the public interest. First I would like to point out some pertinent facts which should be considered by this Commission in determining whether or not the method applied by the Commission violates the constitution or the statute. That is reference should be made to the exhibits in the record which appear at 519E, 520E which is basically the Exhibit 174 prepared by the staff witness Wright. It shows the individual cost of the producers whose cost reduced by the Commission in arriving at the average. Of course that exhibit uses a 9.5% rate of return. So therefore for the exhibit to actually be comparable with what the Commission determined in Opinion 468, the return component of that exhibit would have to be raised from 9.5% to 12%. Basically that is what we have done in the Appendix 1 to our brief where we have taken the individual cost of the 44 producers, raised the rate of return from 9.5% to 12% and have shown exactly what the individual cost of the companies would be and this is what it showed.
Abe Fortas: But why did you take the 9.5%, the preparation of the exhibit --
Robert W. Henderson: The --
Abe Fortas: -- initially?
Robert W. Henderson: It is a -- original staff exhibit. What the Commission did, they applied a 12% rate of return --
Abe Fortas: I understand that.
Robert W. Henderson: -- to the cost of 44 producers.
Abe Fortas: But where did the 9.5% figure come from?
Robert W. Henderson: The 9.5% figure Your Honor came from the recommendation of the staff witness, the entire staff's case was built on the proposition of the 9.5% rate of return should be used.
Abe Fortas: Did you object to the 9.5%?
Robert W. Henderson: The industry of which -- we were supporting the industry witness was contending a 16% rate of return to be used. The Commission about to -- a 12% rate of return. So the appendix to our brief raises the figures from 9.5% to 12% and sets forth the cost of the 44 producers whose cost reduced by the Commission of arriving at the average. Among the 44 producers there is a wide dispersion of cost. This wide dispersion is shown in Schedule 2, of Appendix 1 attached to our brief. That appendix shows of the per unit cost was as low as 5 cents per Mcf and it all further shows the 16 producers of the 44 had cost below the 14.5 some average, and that 28 of the producers had cost above 14.5 set price. Of the 28 producers who had cost above the 14.5 cents, well, had cost between 14.5 to 20 cents. Sixteen of the 28 had cost even above 20 cents per Mcf. If you would take an average of the cost of the producers who have cost below the 14.5, their cost would average 12.6 cents. If you were to take an average of the 28 producers who have cost above the 14.5, their cost would average 23 cents. The Commission attempts to leave the impression that cost above the average is extravagant or wasteful cost and cites to Acker versus U.S., 298 U.S. 426 for the proposition that regulatory agencies should not allow such cost. We do not contend that extravagant or wasteful cost should be allowed. We have no gold plated wells. Acker versus U.S. should be cited for the proposition that the method used by the Commission in this case is inappropriate. In that case, this Court stated and I quote, “The Secretary was not bound to and indeed he could not adopt anyone agency's cost or an average of the cost irrelevant. To do so would be to leave out a consideration, relative size, relative volume and relative efficiency of individual agencies”, end of quote, page 429. In this case, the Commission has not considered any fact other than the average cost of a select group of companies representing only 16% of the gas in the average. No consideration has been given to the size, volume or other cost incurring factors which are inherent in the gas itself. The Commission in this case has not made any findings to the effect that the cost incurred by the producers were extravagant or wasteful. In fact, all of the cost of the selected group of 44 producers were included in the cost finding. This inclusion should by implication stand for the proposition that the cost so included was not extravagant or wasteful. The wide variations in per unit cost between producers is not a question of extravagant or wasteful cost but is an inherent characteristic of the gas producing industry.
Abe Fortas: Is it your position that this rate is confiscatory as to the Hunt Oil Company (Voice Overlap)?
Robert W. Henderson: Yes sir.
Abe Fortas: And is it your position that the record contains evidence to demonstrate that?
Robert W. Henderson: We, like Superior Oil Company tendered the -- a complete cost showing with reference to Hunt Oil Company. But pursuant to the Commission's order with reference to individual company cost, the examiner excluded all of the cost material.
Abe Fortas: What percentage if you can tell me, as your cost as shown with -- related to exploration?
Robert W. Henderson: I can say this Justice Fortas that our cost with reference to exploration would be somewhat higher than the average of 4.08 cents. I believe it would be approximately 6% -- excuse me, --
Abe Fortas: Well, do you --
Robert W. Henderson: -- 6 cents. But Your Honor, most of the cost is embedded cost that is cost in drilling deep wells.
Abe Fortas: Yes, but however that may be, is it your position that to determine the (Inaudible) the lower rates confiscatory that your coal exploration cost has to be taken into account?
Robert W. Henderson: That is a most difficult question Your Honor.
Abe Fortas: That's a constitutional question.
Robert W. Henderson: I personally --
Abe Fortas: And I'm asking it to you for your -- I'm asking about it because of its (Inaudible).
Robert W. Henderson: I believe Your Honor that sufficient amount of exploration expenditure should be included in determining whether or not confiscation has resulted. Now, what amount it should be, I -- at this moment I cannot say. It should at least be that amount --
Abe Fortas: It should be some. That would be (Voice Overlap) --
Robert W. Henderson: Yes sir. It should be at least that amount which would replace the volumes that you are -- presently so.
Abe Fortas: Fine. Now, on a reasonable basis.
Robert W. Henderson: Yes sir.
Abe Fortas: Now the question is that the industry average is 4% and the history shows that the volume and assume for the moment that the history shows that the volume has been that has been sold -- has been replaced, is it -- would it still be your position that Hunt Oil should be allowed to call such a percent?
Robert W. Henderson: If I understand the question Justice Fortas, you're assuming that the industry has an average of 4% per Mcf exploration expense?
Abe Fortas: (Inaudible)
Robert W. Henderson: That basically Hunt Oil Company would have an average of 6 cents exploration --
Abe Fortas: Because (Voice Overlap) --
Robert W. Henderson: -- expenditures and has been able to replace the volumes that they have been currently selling. I would say in that situation Your Honor that basically the industry by incurring the 4 cents exploration expenditure has basically replaced the volumes that the industry had sold. That we've got (Inaudible) to just maintain the status quo. Definitely --
Abe Fortas: So (Voice Overlap) --
Robert W. Henderson: -- I believe from a confiscatory standpoint, that should be included.
Abe Fortas: So you'd have to discount this cost on that (Inaudible)?
Robert W. Henderson: I would say from the confiscatory standpoint that there is certainly some latitude in allowing a confiscation, maybe all of the exploration development expenditures may not be allowed. But Your Honor, most of the cost with reference to confiscation comes from the actual amount of investment that you have in the wells on the profit, the operating expense.
Abe Fortas: Well let's say that perhaps, can you tell me, if you took only the fair return, whatever that might be on the amount of your investment in the existing oil wells and your operating expenses excluding exploration, would the results still be confiscatory as to Hunt Oil Company under these rates?
Robert W. Henderson: Yes sir it would be. Not only for Hunt Oil Company but for all of the in -- small independent producers, --
Abe Fortas: But you're not a small independent producer, are you?
Robert W. Henderson: We are a large independent producer somewhat like Superior Oil Company --
Abe Fortas: That's what I --
Robert W. Henderson: -- but we are primarily --
Abe Fortas: (Inaudible)
Robert W. Henderson: -- excuse me sir.
Abe Fortas: And you still -- you say that excluding all cost for exploration that a rate of return -- fair rate of return on the investment, I won't ask you what that is, plus your our of pocket operating expenses, if these rates, you would not be covering those two items?
Robert W. Henderson: Justice Fortas I believe you said, excluding all exploration and development expenditures.
Abe Fortas: But -- for the moment, yes sir because that's what I understood you argue in your last statement I -- to the time you made which I'm sorry --
Robert W. Henderson: And my prior answer to you was with the idea that a reasonable amount of exploration development expenditure would be included in considering what the confiscation resulted. In some areas Your Honor, I cannot state for a fact about Permian Basin. In some areas, the cost actually put into the well investment is at the revenue level.
Abe Fortas: I understand that, we're talking only about Permian Basin. It's not covered for us at the moment.
Robert W. Henderson: In 19 six --
Hugo L. Black: I don't quite understand. Are you saying that -- suppose you have 6% (Inaudible) in the -- including the amount, certain amount by exploration, 6 cents? But that wasn't enough, would you say that that was -- your property was (Inaudible) confiscating?
Robert W. Henderson: Your Honor, I construe confiscation in the oil and gas industry as being that you should have a return of your capital. And I believe that is --
Hugo L. Black: Well I --
Robert W. Henderson: -- is depreciation --
Hugo L. Black: I think if we get 50 cents or a dollar per gallon, everybody can use the interest (Inaudible). Would you say that you could then say that because the exploration cost included (Inaudible), is your proposition to confiscate?
Robert W. Henderson: I believe Your Honor that anytime you consider the oil and gas industry, you have to include a certain amount of exploration expenditures --
Hugo L. Black: But suppose it includes enough so that you're getting a great deal more than that --
Robert W. Henderson: Well that -- there would be --
Hugo L. Black: -- a dollar a gallon.
Robert W. Henderson: That would be a different question Your Honor. If I understand your question --
Hugo L. Black: I thought you said that that would be a confiscation? I couldn't believe it is. You do not say that?
Robert W. Henderson: I don't completely understand your question Justice Black.
Hugo L. Black: Well, I mean this, supposed it cost you 10 cents to do the exploring, you know that?
Robert W. Henderson: Yes sir.
Hugo L. Black: They looked at and they decide they want to give you credit and take care of everything if they can't (Inaudible). They want to give you something else, they give you a dollar a gallon. Largely more than this -- the whole thing cost (Inaudible). Could you say that there was anybody who could possibly (Inaudible) confiscatory because they had conserved the exploration cost (Inaudible)?
Robert W. Henderson: No sir, no, no, that situation, I might -- there should be enough revenues for that to cover the ordinary replacement cost of the products that yourself and if that happens --
Hugo L. Black: Well, I'm assuming -- I'll put it $20 a gallon if you would.
Robert W. Henderson: Right.
Hugo L. Black: Anything you want, would you then say it's confiscatory that -- not to give me the whole cost including that somewhere and say we are including the complete cost for exploration, could you claim confiscation?
Robert W. Henderson: I would not stand before this Court and claim constitution --
Hugo L. Black: Well, not for the (Voice Overlap) --
Robert W. Henderson: -- confiscation under those circumstances, no Your Honor.
Hugo L. Black: I thought you (Inaudible).
Robert W. Henderson: I'm sorry, I meant -- I've left that impression Your Honor. The wide variations of per unit cost between producers is a cost incurring factor in the gas itself depends upon the time the gas was discovered and developed, it depends upon the depth on which the gas is discovered. It depends upon the size of the reservoirs and the rate of production that those reservoirs are produced by. That is why we have the wide dispersion of cost of the gas and that is the reason why you have the wide dispersions of cost with reference to individual producer. Moreover, it depends in part of whether the producer is an active explorationist or whether he is depleting his inventory without replacement. Now the period of time in which gas is discovered and developed as a material effective on cost, the examiner found the cost increased by approximately 75% from 1948 to 1960. Costs prior to 1948 relating to 25% of the volumes has been included in the composite on which the Commission has determined the 14.5 cents price. The Commission itself recognized that drilling cost decreased by approximately 6% from 1958 to 1960. If gas cost 16.5 cents of 1960, the gas discovered and developed in 1958 would have the cost 17.5 cents, not 14.5. The size of the reservoir discovered in the rate -- such reservoir is depleted is substantially material on the per unit cost of gas. The record shows in this proceeding that in the 1960 test year, in the Permian Basin area when you are considering only gas-well gas, two fields in that entire Permian Basin area accounted for 52.5% of the gas, 13 fields accounted for 17 -- excuse me, 76% of it, 24% of the gas-well gas in 1960 produced in the Permian Basin came from 358 (Inaudible). However, there is no record -- evidence as to whether the cost used by the Commission relating to the group of 44 producers came entirely from the two field or whether it came from the 13 fields or whether there was a dispersion among the other 358 fields. It cannot be disputed that you have two reservoirs and the cost of each reservoir is the same. And one reservoir contains twice as much gas. The smaller reservoir and the gas produced from it, the gas cost is going to be twice as high thus a cost incurring factor of gas, etcetera.
Abe Fortas: Alright, I think I follow on this but I hate to take more of your time, the problem that perplexes me in this field is, how you can really be in anywhere with respect to the confiscation argument in view of the fact that the exploration cost here are absolutely with -- are almost absolutely within the control of the producer. Now this to say that the argument assumes that the -- that if a producer at all -- if the argument assumes that all a producer's exploration cost are properly part of the cost base for purposes of confiscation, then if a producer can go out and -- to enlarge his own supply and spend all the money that he can beg or borrow for exploration just to enlarge his own position in the industry and his own share of market and that -- all of that cost would go to this cost base and he'll use it for purposes of measuring confiscation and that's a concept that -- does not at all like the usual thing that lawyer encounters in this or -- with the respect to the constitutional standard.
Robert W. Henderson: Justice Fortas I believe there could be a very simple answer to that. Let's take over -- let's -- don't take one test of year, let's take over a period of years, three-year supply. This particular producer was replacing double the reserves produced, he was adding reserves twice the amount produced. So let's assume his exploration expenditures were 10 cents. In that situation, then I would I say from a confiscatory standpoint, on a constitutional standpoint, that basically he should be allowed at least that proportion of the exploration expenditures which would let him replace the reserves he is producing, which would be one-half --
Abe Fortas: Alright. Now --
Robert W. Henderson: -- and that the (Voice Overlap) --
Abe Fortas: Now my question to you is, does this record with respect to your client -- does this record contain information sufficiently specific individualized and precise so as to permit a judgment on that point either in terms of the evidence that was admitted or in terms of the ultimate proof.
Robert W. Henderson: Your Honor, I'm at -- based upon the Commission's orders about no individual cost evidence, the evidence does -- on the individual company basis does not go that far.
Abe Fortas: May I ask you about including the offer of -- any offer of proof (Voice Overlap)?
Robert W. Henderson: There is an offer of proof Your Honor, but the evidence does not go that far.
Earl Warren: Mr. Attwell.
J. Evans Attwell: May it please the Court. My name is Evans Attwell, and I appear here on behalf of Perry R. Bass et al. Petitioners in Number 105. My clients have the somewhat dubious distinction of offering the largest single reduction of any firm certificated price in the Permian Basin area as a result of the area rates prescribed by the Commission in this case. During the time allotted me for oral argument, I would like to focus your attention on the failure of the Commission to include any amount in its cost base area rate to compensate producers such as my client for a substantial out-of-pocket cost incurred in rendering, gathering and treading services which are of demonstrable value to the consumer in which if performed by a pipeline would admittedly be included in the pipeline's cost of service to its customers. If my time permits, perhaps after lunch, I would also like to briefly comment on a procedural due process question concerning the quality standard set by the Commission. From the consumer standpoint, the natural gas business is divided into four basic functions. First, the gas must be found and produced at the well bed, then it must be gathered for many different wells, might I say this gathering function is necessary whether it's oil-well gas, whether it's gas-well gas, whether it's new gas, whether it's old gas. In some instances, the gas contains impurities and must be cleaned. In other instances, the pressure of the gas is too low and it must be compressed before it can be delivered to the interstate pipeline companies which transport at long distances to distribution companies which in turn sell it to the housewives and to the other consumers. Now each of these functions must be performed if gas is to be made available to the consumer at the burned tip. It is undisputed that the area rates in this case were fixed on the basis of the Commission's computation of the cost of gas at the wellhead that is before gathering, before any treading. We don't challenge any of those false computations. What we do challenge is that the Commission admittedly did not determine or make any allowance to compensate producers such as my clients for the cost they incurred performing services beyond the wellhead.
Byron R. White: Did they address themselves to it at all? Did they deal with the issue?
J. Evans Attwell: Yes they did. I think that Mr. Solomon dealt with it yesterday. Mr. Justice -- alright, I believe that he said that --
Potter Stewart: (Inaudible)
J. Evans Attwell: I was -- I'm planning to touch on that and meet that issue --
Potter Stewart: That'd be fine.
J. Evans Attwell: But as I understand his position, he says that if they bring the gas up to the quality standard, they're compensated because they get the ceiling price. I think that the answer to that is threefold. First, I want to make it very clear to the Court that no processing or treading cost were included anywhere in the cost computations used by the Commission in determining its area rates. I think secondly, the argument of the Commission ignores the fact that these processing and treading services actually exceed the minimum standards prescribed by the Commission. In other words, my client for instance, they compressed the gas 20% more than the Commission would require and yet they get no compensation for that, no compensation for the extra cost that they incur to doing. And of course, the Commission's quality standard by bringing it up to the quality standard has nothing to do with gathering whatsoever. If the gas is delivered at the wellhead the area price applies. If it's gathered over many, many miles and many, many thousands of acres, the price is the same. Oh, I think that that's the answer to that. What we really challenge here is that the Commission admittedly did not determine or make any allowance for such cost. We submit that in fixing area rates the Commission simply cannot regard -- disregard actual legitimate cost of gathering and treading gas after it was produced but before it is delivered to pipelines. This cost benefit the consumer and some allocated portion should have been allowed by the Commission in fixing just and reasonable rates in the Permian Basin. Such gathering and treading cost actually involves millions and millions of dollars. For example, my clients alone own and operate the equivalent of 253 miles of 3-inch pipeline that connect and gather gas from hundreds of wells over many thousands of acres. We have installed over 24,000 horsepower compression to compress the gas to the pressure required by the pipeline, which I have just stated is actually 20% higher than the Commission standard. Our investment in this gathering in the compression plant is our equipment is -- in excess of $13.8 million. Of course the total investment of the other producers in the Permian Basin rendering similar services is much greater. There is no question that if these services had been performed by pipelines, they would have been included in the pipelines cost of service. This Court had so held on many different occasions. It follows that when producers such as my client provide identical services, they too should be compensated for their cost. Now the Tenth Circuit attempted to wash its hands of this problem. It says --
Abe Fortas: When you say they should be compensated for that cost, you mean that they ought to be a rate plus something else fixed by the Commission or do you mean -- or are you suggesting that there was error in the failure to include this in cost basis?
J. Evans Attwell: Mr. Justice Fortas, they have cost of gas at the wellhead.
Abe Fortas: I understand --
J. Evans Attwell: I say --
Abe Fortas: -- but I'm asking you which -- for which position are you contending?
J. Evans Attwell: I'm contending that if that wellhead price is correct, we will assume that for the sake of argument that then they got to put an increment on top of that --
Abe Fortas: Well, (Voice Overlap) --
J. Evans Attwell: -- of area basis to compensate --
Abe Fortas: Alright.
J. Evans Attwell: -- those producers in the area adduced in these amounts.
Abe Fortas: Let's see if we can try to very clear about this. Are you saying that the order we have before us is an error or failure of the Commission to include and increment over and above the rate fixed?
J. Evans Attwell: Precisely.
Potter Stewart: For certain producers?
J. Evans Attwell: For certain producers. The Tenth Circuit attempted to wash its hands to this issue with. It said -- it stated and I quote that it involved the troublesome field of cost allocations. This is misleading because the Court failed to recognize that the Commission made no allocation of the cost of gathering and treading gas. It simply did not include allowance of any kind for these services. Our complaint is not that the Commission erred in allocating the cost of gathering and treading but that it completely disregarded such cost despite the fact that they are actual, legitimate and necessary cost which benefit the consumer and therefore must be included in any lawful scheme of area rate regulation. Certainly, there's going to be an allocation of these costs between gas and liquid. It has going to have to be made but it is our position that this is a matter that should be made in the first instance by the Commission.
Earl Warren: We'll recess now.