Opinion ID: 362296
Heading Depth: 1
Heading Rank: 3

Heading: challenges to the fpc's allowance of total project

Text: COSTS AS AN INCENTIVE
27 New York challenges the Commission's allowance of a rate of 80 cents per Mcf in this proceeding on the general ground that the rate was entirely unnecessary to secure new gas for the interstate market. New York raises several specific points. It notes that Pennzoil was willing to make the final requisite investments to produce this gas in the early 1970's when the areawide rate was only 26 cents per Mcf. It also notes that the gas at issue here came from an offshore federal lease, involving two special considerations: that full compensation to producers for lease acquisition costs needlessly spurs the upward spiral in lease bidding; and that the FPC's jurisdiction over offshore gas as contrasted with the lack of jurisdiction over onshore gas sold in intrastate commerce lessens the need for extra financial incentives to secure that gas for the interstate market. Finally, New York contends that there are fundamental inconsistencies between the average cost method of national ratemaking, under which high-cost production serves to enhance the average costs and the national price available to low-cost producers, and the standards of the optional certificate program, which compensates producers of high-cost gas on the basis of their own high costs alone. 28 The FPC and Pennzoil, intervenor on appeal, make two general responses to New York's contentions. 41 First, they argue that New York is challenging the core concept of the optional certification procedure, and this challenge, it is argued, was rejected in Moss v. FPC. However, this court has not previously upheld a total project cost standard under the optional certification program. As discussed above, Moss v. FPC upheld the novel procedural aspects of optional certification, notably the combination of Section 7 and 4 proceedings. We specifically noted that we were not presented at that time with FPC standards for reasonableness and that we were assuming that the standards eventually adopted would conform to the statute. On the present record, we said, we must Assume that the Commission will abide by the standards of the statute and the promises it has made. We cannot condemn the Commission on the theory that it may not do what it has promised to do. Moss v. FPC, supra, 164 U.S.App.D.C. at 7, 502 F.2d at 467 (emphasis supplied). We cannot sensibly uphold the Commission's standards now on the ground that this ruling was established in Moss v. FPC, when the fact is that we upheld the FPC in Moss as to procedure, on the Assumption that the standards issued in due course would be consistent with the statute. To provide judicial affirmance without judicial review through circularity or bootstrapping is not consonant with the review function entrusted to the courts. The Commission has now taken the step that it had not at the time of Moss, of setting forth the substantive principle the total project cost standard for optional certification. Now we must determine whether that principle is reasonable and consistent with the statute and the purpose of the optional certification program. 29 Our view of Moss is confirmed by our holding in Consumers Union, the same year as Moss, that the FPC's first set of optional certification standards violated the statute. We specifically noted in Consumers Union that standards based on individual project costs would have to be reconciled with prior FPC statements and ratemaking approaches. 42 It is precisely that reconciliation which the FPC has failed to perform. 30 The other FPC response, that if rates under the optional program were limited to the national rate there would be no point to the optional procedure, also fails to meet New York's arguments. This is not a situation of only two alternatives, of either making the national rate an inflexible ceiling on optional rates, or accepting unconditionally the FPC's total project costs approach. Rather, the issue is whether all the elements of the total project costs approach have been justified by reasoned consideration, in light of the principles of review for FPC programs. Change in administrative standards in light of the increased experience under them is appropriate, and may be desirable if flaws are discerned in the previous standards. However, change must be accompanied by reasoned consideration supporting the new standards. (T)he process of change in agency policy must be one that serves and does not erode the principle of reasoned decision making. Public Service Comm'n v. FPC, supra, 167 U.S.App.D.C. at 115, 511 F.2d at 353. As we have stated, Greater Boston Television Corp. v. FCC, 143 U.S.App.D.C. 383, 394, 444 F.2d 841, 852 (1970), Cert. denied, 403 U.S. 923, 91 S.Ct. 2229, 29 L.Ed.2d 701 (1971): 31 Judicial vigilance to enforce the Rule of Law in the administrative process is particularly called upon where, as here, the area under consideration is one wherein the Commission's policies are in flux. An agency's view of what is in the public interest may change, either with or without a change in circumstances. But an agency changing its course must supply a reasoned analysis indicating that prior policies and standards are being deliberately changed, not casually ignored, and if an agency glosses over or swerves from prior precedents without discussion it may cross the line from the tolerably terse to the intolerably mute.
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
38 The FPC's approval of Pennzoil's proposed rate was based on the total of all Pennzoil's project costs, including the lease acquisition cost (the original cost of acquiring the offshore lease from the federal government). In other words, the FPC's standard guaranteed reimbursement for lease acquisition costs in the same way it guaranteed reimbursement for exploration and development costs. Such an approach has serious prospective consequences. New York argued before the Commission on rehearing that if such a guarantee is allowed to cover total project costs including lease acquisition costs its primary effect in the offshore area could well be to permit those producers with ready access to capital to bid up offshore leases above their present overly high level. 52 On appeal, New York renewed its argument, contending that the main effect of such a system (and a main vice of the Commission's present opinion) could well be to remove the last restraints on the already spiralling (offshore lease) bonus payments, with no real increase in gas exploration and production. 53 The Commission has failed to give adequate consideration to the increasingly significant problem of offshore lease acquisition costs in rate proceedings. In the optional certification context, the FPC has given no consideration at all to the problem, despite the conflict between the program's objective of increasing exploration and development and the effect of an incentive for lease acquisition expenditure. 39
40 We begin by noting the dimensions of the lease acquisition issue. According to statistics compiled by the Department of the Interior and used by the FPC, the costs of lease acquisition for offshore oil and gas have grown enormously in the past decade. Those costs rose from less than $3 billion in the five years from 1967-71, to $2 billion in 1972, $3 billion in 1973, and $5 billion in 1974, for a total of over $13 billion in 196774. 54 Leasing at high bidding levels has continued since 1974. 55 Much of this cost will eventually be reflected in oil rather than gas prices, but lease acquisition costs constitute a large and increasing share of rising natural gas prices. Moreover, the long lead time between leasing and production ensures that present lease acquisition incentives will affect rates for decades to come. 41 The courts have repeatedly admonished the FPC in various contexts that the much larger lease acquisition costs offshore, and other related differences between offshore and onshore gas, must be the subject of reasoned consideration in ratemaking. In The Second National Natural Gas Rate Cases, supra, 186 U.S.App.D.C. at 56, 567 F.2d at 1049, we stated: 42 The objection that has given us distinct pause is the contention that there is no validity to the Commission's continued insistence upon treating as a single gas source onshore gas subject to unregulated intrastate competition, and offshore gas from the Federal domain over which the Commission exercises plenary authority and to which the interstate market must look for most of its new gas supplies. 43 We affirmed the FPC's national ratemaking order only with the limitation that the FPC would have to give more attentive consideration to the special situation of offshore costs, Id. at 57-58, 567 F.2d at 1050-1051; See also id. at 67, 567 F.2d at 1060. 44 Similarly, in Public Service Comm'n v. FPC, supra, 167 U.S.App.D.C. at 114, 511 F.2d at 352 (footnotes omitted), in remanding for further consideration of advance payments, we addressed the FPC's failure to take into account in advance payment orders the great difference between onshore and offshore in regulatory power and practical circumstances:SU The Commission's treatment of advances related to offshore gas blandly sidesteps all and any mention of the critical fact of its plenary power to prevent diversion of gas from wells on leases in the federal domain to the interstate market. Whatever role advance payments may play in attracting onshore gas from the intrastate and to the interstate market, this justification is absent in the case of advances to offshore producers. Any reasoned assessment of the relation of costs and benefits of the advance payments program involves manifestly different calculations for offshore and onshore advances. The complete failure on the part of the FPC to focus on this issue is a failure to seek answers. 45 Moreover, the Commission declined to respond to submissions by New York which cast doubt on the need for advances to spur acceleration of the exploration and development of offshore reserves. 46 Moreover, in our most recent optional certification case, Consumers Union of U.S., Inc. v. FPC, supra, 166 U.S.App.D.C. at 281-82, 510 F.2d at 661-62, we took special note on rehearing of producers' contentions about the higher offshore lease acquisition costs. In upholding the 1974-75 national ratemaking proceeding, the Fifth Circuit, too, noted the boom in lease acquisition costs and explicitly warned that the Commission is Surely obligated to monitor these developments . . . . Shell Oil Co. v. FPC, supra, 520 F.2d at 1082 (emphasis supplied). The FPC's sole response to the trend in offshore leasing costs has been to average older, lower lease costs with recent costs in computing national ratemaking averages, thereby temporarily deferring the impact on rates of high recent costs. 56 The record in this areas is thus one of repeated FPC failures to study and consider in active policy formulation the major developments in offshore gas and lease acquisition costs, even though they threaten large future increases in nonproductive expenses, returns on investments, and gas prices. 47
48 We may assume for present purposes that the FPC can include all reasonable lease acquisition costs in national ratemaking. 57 However, the optional certification program has been developed as an exception to the national rate, to escalate rates in order to provide an incentive necessary for exploration and development. Absent justification by the FPC, a standard guaranteeing reimbursement for all lease acquisition costs incurred cannot be upheld under that objective. 49 The optional program provides reimbursement for expenditures because of the connection between an incentive for higher expenditure and supplies of new gas. There is an obvious connection between an incentive spurring expenditures for exploration and development, and gas supply since for practical purposes in the short term, the opportunities to employ such expenditures to augment supply are unlimited. There is no such obvious value for the consuming public in escalating expenditures for lease acquisition. 58 The acreage which is made available by the federal government for lease bidding is limited. The Commission has not explained on what basis a spur for higher acquisition expenditures goes beyond raising the bids made for acreage that would be leased anyway, or has a substantial effect in increasing acreage. 50 Any reimbursement for lease acquisition costs through the optional certification program must address the problem of delay between expenditures and reimbursement. In this case, Pennzoil's lease expenditures were made thirteen years before project completion and reimbursement, and in general, lease outlays are made long before reimbursement. At the time when producers bid on leases, optional certification is no more than a distant possibility. Reimbursement for lease costs operates as a bailout at the end of a losing project, but the question is whether it is a significant incentive at the time of bidding on leases. Reimbursement for lease costs contrasts in this respect with reimbursement for development outlays. Development outlays are made later in the production cycle, so optional certification is a closer, more calculable and influential prospect. 51 At bottom, the issue is whether companies that make a lease bid largely on calculation of the relative likelihood of high production or dry holes can obtain an exception over and above average lease acquisition costs to transfer high costs to consumers in the intermediate case that the project produces medium-sized volumes of high-cost gas. It would be anomalous if producers received handsome returns because of high volume in highly productive fields, and also high optional rates in less productive fields. An incentive must also be related to its objectives. 52 The Commission did not give any consideration whatever, much less reasoned consideration, to the problem of undesirable effects from reimbursement for lease acquisition costs. Producers have limited budgets for spending on all aspects of the production cycle from leasing to operating. Incentives for one kind of spending induce a shift away from other kinds of spending. An incentive which makes it more desirable to put in high lease bids may thus divert funding from exploration and development. Such an incentive may actually be counter-productive for the program's purposes. Also, the present lease acquisition system may have built-in anticompetitive aspects in terms of benefiting the larger, cash-rich producers which are best able to make high cash bonus bids. A program which gives a large share of incentive funding as reimbursement for lease bids may perpetuate and strengthen those anticompetitive aspects. 59 It is well settled that the Commission must take into account the effects of its programs on competition as well as on production. 60 53
54 The FPC has sometimes attempted to justify a failure to give consideration to problems of lease acquisition costs by asserting a lack of information or authority to deal with them. As the Commission declared in its most recent national ratemaking proceeding, Opinion 770-A, 41 Fed.Reg. 50199, 50208-09 (1976): 55 At the same time, we determined that lease acquisition costs are legitimate actual costs which must be recouped by producers as part of their cost-of service. Mobil Oil Corp. v. F.P.C., supra. The suggestion of APGA to disallow pass-through of certain costs, therefore, would be unlawful. 56 NYPSC does not object to our current treatment of lease acquisition costs, but suggests: 57 The Commission should expressly announce in its Opinion on Rehearing that its future nationwide rate determination will not utilize any ratio which exceeds the 1.1 figure utilized in Opinion No. 770, with any higher figure which might be applicable in specific cases as a result of lease sale bonus payments in 1975 or 1976 being the subject of special relief applications. 58 While we appreciate the motivation behind NYPSC's suggestion, we cannot so limit our future rate determinations. Just as this Commission could not deter mine the allowable amount of state production or severance taxes for inclusion in the allowed rate, similarly this Commission has no authority to determine the method or amount of lease payments to the Department of the Interior. While we are mindful of our responsibility not to allow unreasonable costs in our cost-based rate determination, we cannot arbitrarily conclude that lease acquisition costs beyond some set ratio are unreasonable without substantial and timely information. 59 The foregoing FPC analysis made in its ratemaking opinion does not relieve it of the responsibility to consider whether to provide an incentive for lease acquisition in optional certification. Optional certification is an exception to national ratemaking allowing higher rates to encourage exploration and development. It is not the prescribed channel for passthrough of producers' costs; 61 that is the function of national ratemaking. The elements of an optional certification incentive must be connected to incentive objectives. The fact that a lease has been arranged by another federal department is a matter for that department, and is not in and of itself reason for a special-exception program by the Commission. There is no indication that the Interior Department has put it forward that its leasing efforts require or depend on special provision for its lessees. 60 Moreover, in carrying out its functions, the FPC has been required when appropriate to give independent policy consideration to matters which are also the responsibility of other federal agencies. National antitrust policy is principally the responsibility of the Department of Justice and the Federal Trade Commission, yet the FPC is required to give its own independent consideration to competitive factors in its decisions. See, e. g., Conway Corp. v. FPC, 167 U.S.App.D.C. 43, 49, 510 F.2d 1264, 1270 (1975), Aff'd, 426 U.S. 271, 96 S.Ct. 1999, 48 L.Ed.2d 626 (1976); City of Pittsburgh v. FPC, 99 U.S.App.D.C. 113, 126, 237 F.2d 741, 754 (1956), Cited with approval, California v. FPC, 369 U.S. 482, 485, 82 S.Ct. 901, 8 L.Ed.2d 54 (1962). National environmental policy is the responsibility of many federal agencies yet the FPC is required to give its own independent consideration to environmental factors in its decisions. See, e. g., Udall v. FPC, 387 U.S. 428, 87 S.Ct. 1712, 18 L.Ed.2d 869 (1967). See generally NAACP v. FPC, 172 U.S.App.D.C. 32, 44, 520 F.2d 432, 444 (1975), Aff'd, 425 U.S. 662, 668, 96 S.Ct. 1806, 48 L.Ed.2d 284 (1976). Conversely, because offshore leasing implicates the energy policy alternatives of many agencies, we have required the Department of the Interior to assess energy factors including FPC activity in its environmental statements on offshore leasing. Natural Resources Defense Council v. Morton, 148 U.S.App.D.C. 5, 15, 458 F.2d 827, 837 (1972); Cf. Continental Oil Co. v. FPC, 370 F.2d 57, 67 (5th Cir. 1966) (leasing act does not block FPC offshore gas regulation). We need not consider how much weight the FPC may give to national leasing policy in ratemaking because it has not yet discussed the matter at all. We hold only that the FPC cannot abdicate its responsibility to give reasoned consideration simply because leasing involves another department. 62 61 The initial statute providing for offshore leasing, the Outer Continental Shelf Lands Act of 1953, expressly staked out an FPC role in regulation of gas pipelines from the leased lands to take account of conservation. 63 Beyond that is the overriding requirement of regulation in the public interest, which can take account of national policy. As for any administrative difficulties of coordination, this did not justify a total lack of effort by the FPC in the past, and may be more tractable in the future, since the Department of Energy Organization Act makes the FERC part of the new Department of Energy which has inherited offshore leasing responsibilities. 64 That Department and the FERC will be in a position on remand to take an enhanced overview of the policy concerns to be coordinated here. 65 62 Since the Commission has failed to give any consideration at all to pertinent factors, we must remand for further consideration. In view of the absence of Commission analysis, we observe that our comments do not constitute implacable prohibition against incentives for leasing; (W)e have, however, identified substantial problems that the FPC will have to consider on remand. Public Service Comm'n v. FPC, supra note 59, 159 U.S.App.D.C. at 203, 487 F.2d 1043 at 1074. 66 63