Opinion ID: 362296
Heading Depth: 2
Heading Rank: 2

Heading: Treatment of pre-1972 Sunk Costs

Text: In its argument, New York 43 32 does not dispute that higher producer rates based on project cost considerations may be justified if it can be shown, generally or in individual situations, that they are required in order to provide needed additional gas supplies to the interstate market at prices compatible with consumer interests. But there can be no basis for guaranteeing producers more than their production costs in the absence of such a showing. 33 Specifically, New York argues that even if the total project cost (without allowing for any return on investment) were 65 cents per Mcf, the gas here would have been forthcoming at a lower price than that. Allowance of a rate based on total project cost thus constituted a windfall to the producer without any demonstrable connection to increasing the supply of gas. 34 The support for the validity of New York's contention lies in the economic logic of sunk costs. In 1960-61, without, of course, any expectation of optional certification treatment, Pennzoil sank large sums into lease acquisition and drilling. It had no success during that period. In 1972-73, when Pennzoil had to make a decision as to whether to renew its efforts, those older costs were irretrievably sunk and could no longer be reallocated or left unspent in light of new inducements to invest elsewhere. The only relevant considerations for Pennzoil in 1972-73 were whether the new inducements warranted new expenditures. Roughly speaking, of the 65 cents per Mcf eventually expended by Pennzoil, 33 cents had been sunk in the 1960's, while only 32 cents were newly expended in the 1970's. 44 The areawide rate of 26 cents per Mcf in 1972, with a likely prospect of significant increase in the near future, was adequate to induce the further investment, without any guarantee it would cover both that further investment and the previously sunk outlays. 35 Where, as here, an agency has established national rates on an average cost basis, and individual exceptions escalating the price above the national rate are established in the interest of increasing supply, there must be a connection between such increased funding and the increased exploration and development of new gas sources alleged to result. This principle has been stated in a number of ways: that there must be a Quid pro quo  for the extra funding; 45 that there must be an inquiry into the incremental increase in gas supply attributable to the program; 46 and that there must be symmetry between the funding and increase in production. 47 In the Supreme Court's words, the program must provide increased funding while assuring that such increase would not be levied upon consumers unless accompanied by increased supplies of gas. Mobil Oil Corp. v. FPC,417 U.S. 283, 318, 94 S.Ct. 2328, 2350, 41 L.Ed.2d 72 (1974). On occasion, an experimental program may be allowed to commence a tentative existence without such a showing of a connection if the FPC is committed in its continuation of the program to monitoring in order to verify that such a connection exists. 48 Such programs are subject to being vacated if the Commission fails to make the requisite demonstration. 49 36 In its programs to provide incentive for new expenditures the FPC has long been concerned with avoiding payment for expenditures sunk before the announcement of the incentive, I. e., with avoiding a windfall for old expenditures. In its policy of vintaging, particularly with regard to gas in renewal contracts (rollover gas), recently upheld by this court, the Commission has declined to allow new, high rates to be paid to producers who invested before the prospect of such rates. 50 It is difficult to see how (a) higher rate could reasonable have been expected to encourage retrospectively, exploration and production that had already occurred. Permian Basin Area Rate Cases, 390 U.S. 747, 798, 88 S.Ct. 1344, 1376, 20 L.Ed.2d 312 (1968). Here, in its novel extension of total project costs as a basis for rates to include sunk costs of a period before the onset of the program, the Commission has failed to give  'reasoned consideration' to the shaping of its order in an effort to protect consumers from paying substantially more than necessary to bring forth the needed supplies. 51 37