Opinion ID: 1265995
Heading Depth: 1
Heading Rank: 2

Heading: Jurisdiction and FPC Regulation

Text: Before doing so, however, it is appropriate to examine the jurisdiction of the courts to order royalties to be paid on any other basis than the FPC approved sales price to the producer. Obviously if such jurisdiction is lacking, no further inquiry into the terms of the leases is required. We are cited to no case where this question has been squarely determined, but we think the fair implication from the federal decisions in the area is that such jurisdiction does exist. We begin with the companion cases of Weymouth v. Colorado Interstate Gas Company, 367 F.2d 84 (5th Cir.1966), and J.M. Huber Corporation v. Denman, 367 F.2d 104 (5th Cir.1966). In each the court looked at gas leases with royalty clauses requiring payments based on market value, and carefully distinguished them from proceeds leases. The result, it concluded, was that the market value of the gas for royalty payments was not necessarily the same as the actual proceeds from the sale of the gas under the FPC ceiling. The lessee-producer in Huber argued, however, that by committing the gas to the interstate market and thus subjecting its price to FPC regulation the parties had determined the market in which market value was to be determined. The court responded to this argument: We do not minimize the beguiling appeal of the Lessee-Producer's theory. Without a doubt, with the Lessors' full approval, this committed until the exhaustion of the reserves all of the gas to this contract and hence to this `market.' But the `market' as the descriptive of the buyer or the outlet for the sale is not synonymous with its larger meaning in fixing price or value. For in that situation the law looks not to the particular transaction but the theoretical one between the supposed free seller vis-a-vis the contemporary free buyer dealing freely at arm's length supposedly in relation to property which neither will ever own, buy or sell. It was not, as this theory would make it read, an agreement to pay 1/4th of the price received from the market on which this gas is sold. Rather, it was to pay 1/4th of the `market price' or `market value' as the case might be. (367 F.2d at 109-10.) Huber thus stands for the proposition that a market value lease on its face calls for payment at the theoretical free market value. Having decided that much, however, the court encountered the fact that if the market value of the gas were proven to be the amount claimed by the lessors there would be a substantial impact on the lessee's regulated operation. It went on to say, there is a serious question whether a Court, state or federal, either initially or ultimately, may allow any amounts fixed by jury, court, or both as increased royalty payments without express prior approval of the Federal Power Commission if, as would these, the price thus fixed would exceed levels prescribed by the FPC. ( Id. at 110-11.) The court therefore directed that trial proceedings to determine the free market price of the gas be held in abeyance until a ruling could be obtained from the FPC on whether that agency had jurisdiction over royalty rates. The result was Mobil Oil Corporation v. Federal Power Commission, supra, in which the District of Columbia Circuit reversed the FPC's assertion of jurisdiction over royalty rates. Various producers there argued for FPC jurisdiction on the basis of the potential impact on interstate commerce and the burden on consumers which might result from royalties based on market values in excess of the producers' rates fixed by the FPC. On the first issue it found the record insufficient to stretch the act beyond its terms on the score of necessity. As to the second ground it observed: ... [T]he FPC's opinion gives no concrete indication of whether, in what circumstances, or to what extent, there may be an economically meaningful problem of `market prices' in excess of ceilings. In the Huber case the judgment entitling the royalty owners to pursue their claim made no determination of amounts of recovery. Apparently such litigation may come to involve substantial sums even if pursued so as to recover royalties based on ceilings higher than filed rates. This we infer from the fact that Mobil Oil and other producers have appealed from the ruling of the FPC that although the royalty owners' filing obligations are met by virtue of the filings made by the producers, a royalty owner is not limited to the rate filed by the producer and may enforce his contract as calling for a higher rate if permitted by the Act. The record simply does not focus on what may be involved in the possibility of recovery of royalty calculated on the basis of `market prices' higher than ceilings. ( Id. at 264.) The court then went on to observe: ... To avoid any misunderstanding we interject that we have not been made uneasy by the contentions the producers have presented to us, for we see no theoretical impediment to producers' being held on the basis of a contract to a royalty payment related to a base higher than the producers' filed rate. United Gas Pipe Line Co. v. Mobile Gas Service Corp., 350 U.S. 332, 76 S.Ct. 373, 100 L.Ed. 373 (1956). ( Id. at 264-5. Emphasis added.) The end result was that Mobil left it open to the courts, either state or federal, to determine lease controversies between royalty owners or lessees. It noted, but only and expressly by way of dictum: We can certainly visualize the possibility that a court confronted with a contention of entitlement to a market price basis higher than the producer's ceiling would consider it to run counter to the intention of the parties, unless there is something to rebut the fair presumption that they contemplated interstate movement and market prices compatible therewith. ( Id. at 265.) It also suggested public policy considerations, and problems under the supremacy clause, both of which might be obviated by a reference to the FPC. All such factors have been considered by the court in its decision here. In a southern Louisiana area rate case the Fifth Circuit affirmed rates fixed by the FPC despite claims by Mobil that they failed to take into account the possibility that under the Mobil decision royalty obligations might be based on a rate higher than the FPC ceiling. ( Placid Oil Company v. Federal Power Commission, 483 F.2d 880 [5th Cir.1973].) The court held that this possibility was no basis for disturbing the FPC rate, saying: Of course the royalty obligations of the producers are cost components of the rate structure. Any alteration of this component would necessarily alter the departure point of the rate calculations. And under the holding of the D.C. Circuit in Mobil, this would be an Erie determination of the contract stating the royalty percentage based upon the applicable principles of state law  totally beyond the control of the federal regulatory agency charged with the responsibility of regulating natural gas rates. But we are not willing to alter or stay the implementation of area wide rates for the entire industry merely on the basis of what might happen to some producers' costs if this statement of the law prevails. If, as subsequent events develop, the producers are put in a bind by their royalty obligations, they may certainly petition FPC for individualized relief. (483 F.2d at 911.) The closest the United States Supreme Court has come to ruling on the question was in affirming the Placid decision, sub nom., Mobil Oil Corp. v. FPC, 417 U.S. 283, 41 L.Ed.2d 72, 94 S.Ct. 2328 (1974). Of the same contention by Mobil which had been rejected below, the court said: Mobil also complains that the Commission failed to provide automatic adjustments in area rates to compensate for anticipated higher royalty costs. It relies on Mobil Oil Corp. v. FPC, 149 U.S. App. D.C. 310, 463 F.2d 256 (1972), where the Court of Appeals for the District of Columbia Circuit reversed a Commission holding that subjected royalties to FPC administrative ceilings. Mobil argues that under that decision the 1971 rate schedules must take into account the possibility of higher royalty obligations. We agree with the Court of Appeals that Mobil's argument is hypothetical at this stage and that in any event an affected producer is entitled to seek individualized relief.  (417 U.S. at 328. Emphasis added.) The Court then quoted with approval the last two paragraphs of the Fifth Circuit opinion quoted above. Thus the possibility that a royalty base might exceed the FPC ceiling was clearly recognized. And cf., FPC Texaco Inc., 417 U.S. 380, 395, 397-8, 41 L.Ed.2d 141, 94 S.Ct. 2315, where the court emphasizes that the market value of gas and just and reasonable rates for gas utility regulation are two separate and distinct things. (Approaching the problem from the other end, the court in that case held that the FPC would be abdicating its statutory rate setting function if it permitted the market value of gas sold to fix the rates to be charged by any producers under its jurisdiction.) We think this concept furnishes the answer to Mobil's argument that the public interest and the supremacy clause require that the FPC ceiling be accepted as fixing the market value of the gas for royalty purposes. The FPC fixes the rates which the producer (Mobil) may charge its pipeline purchaser (Northern) as a matter of utility rate setting. That is, it fixes a rate basically designed to allow the producer its reasonable costs of production plus a reasonable return on its investment. (See, e. g., Placid Oil Company v. Federal Power Commission, supra; Forest Oil Corporation v. F.P.C., 263 F.2d 622 [5th Cir.1959]; City of Detroit, Michigan v. Federal Power Com'n, 230 F.2d 810 [D.C. Cir.1955].) One of the complaints against area rate setting was that it failed to account for variances in the costs of individual producers. This argument was first rejected in the Permian Basin Area Rate Cases, 390 U.S. 747, 20 L.Ed.2d 312, 88 S.Ct. 1344 (1968). One basis for the rejection, as recognized by the Supreme Court in the southern Louisiana area rate cases ( Mobil Oil Corp. v. FPC, supra) was the availability of individualized relief to a producer whose costs, including royalties, were unusually high. A producer required to pay royalties in excess of those contemplated by the FPC in establishing its original rates may seek rate relief from the FPC. The fact that such relief cannot be retroactive is immaterial. An argument based on similar grounds was made in FPC v. Texaco Inc., supra, where the court was considering an FPC order which had the effect of removing the rates charged by small producers from direct FPC regulation. Large producers and pipelines, who bought from the small producers, were to make their own bargains and thus to pay market value. The costs thereby incurred could be initially passed on to the consumer, subject to refund if it were later determined that such costs were excessive. Although the FPC order was found deficient, it was not because of the economic hazards it imposed on the regulated companies. The Court said: This leads to the contention of the pipelines and the large producers that the scheme of indirect regulation envisioned by Order No. 428 unfairly subjects them to the risk of later determination that their gas costs are unjust and unreasonable and to the obligation to make refunds which they cannot in turn recover from the small producers whose rates have been found too high. But those whose rates are regulated characteristically bear the burden and the risk of justifying their rates and their costs. Rate regulation unavoidably limits profits as well as income.... All that is protected against, in a constitutional sense, is that the rates fixed by the Commission be higher than a confiscatory level. (417 U.S. at 391-2.) It boils down to this: Mobil contends that the rate it is permitted to charge puts a ceiling on the royalty costs it may incur. As the court reads the cases cited above, the process begins at the other end. The royalties to be paid are first to be determined under state law, based on the terms of the lease. The royalties so determined then become a component cost, to be considered by the FPC in determining the rates it will permit Mobil to charge. In this respect royalties paid are costs to a gas producer in the same way as fuel bills are costs to an electric utility. Neither cost is directly under the jurisdiction of the utility's regulatory agency, but both are considered in the agency's rate making function. On this issue Mobil also points to a clause appearing in most if not all of the leases involved here: All express or implied covenants of this lease shall be subject to all Federal and State Laws, Executive Orders, Rules or Regulations, and this lease shall not be terminated, in whole or in part, nor lessee held liable in damages, for failure to comply therewith, if compliance is prevented by, or if such failure is the result of, any such Law, Order, Rule or Regulation. It argues that this language subjects all terms of the leases to federal regulation, and thereby subjects the royalty clause to FPC rate setting. The argument reads too much into a fairly standard lease clause. If FPC rate setting were applicable to royalties, then of course the royalty clause in the lease would perforce yield to the federal regulation. The clause relied on makes that clear. But, as the D.C. Circuit opinion in Mobil says, FPC regulation does not reach the royalties to be paid under a lease. Hence compliance with the royalty clause is not prevented by any federal regulation, and the clause relied on so heavily by Mobil never comes into play. The clause subordinates the lease only to applicable rules and regulations, and FPC rules and regulations are not applicable. We hold, therefore, that the existence of federal regulation over the rates which a gas producer may receive is no obstacle to the fixing of a higher rate as the market value of the gas it sells for the purpose of computing royalties.