Opinion ID: 106611
Heading Depth: 1
Heading Rank: 1

Heading: gross errors in the cost of service computations.

Text: As the Court has pointed out, the Commission terminated not only the § 5 (a) proceeding but also 10 consolidated § 4 (e) proceedings against Phillips, the latter on the ground that the revenue received by it for the periods involved was less than cost of service. In view of this disposition it is necessary, aside from the contention that there was no basis for dismissal of those proceedings covering years subsequent to 1954 on that year's findings, for us to examine the basis of its cost-of-service findings for 1954. The dismissal orders are all predicated upon the 1954 cost of service and if it be erroneous the whole basis for the orders of dismissal falls. Thus, while the petitioners have not here argued the specific challenges raised before the Commission and the Court of Appeals, their contention that the Commission abused its discretion in terminating the § 4 (e) proceedings necessarily includes the question of the validity of the determination of cost of service. In addition, the likelihood that the Court's affirmance will be regarded as an approval of these highly questionable standards for cost-of-service determination, thus fostering their application in other cases, calls for discussion of them. Aside from its direct expenditure for purchased gas [4] the largest single item in Phillips' costs appears to be its exploration and development expense, which was allowed in the amount of some $58,313,230 before allocation. We first examine it and other items going into cost of service. (a) Exploration and development, depletion allowance, allocation and interest costs. Exploration and development expense for 1954 on the books of the company was $47,474,039, including undeveloped lease rentals, drilling tools, expired and surrendered leases, dry holes and land and geological activities. On these expenditures a return and taxes item was allowed of $10,839,194. Why the consumer should pay on these items, particularly dry holes ($11,306,964), expired and surrendered leases ($9,479,898) and undeveloped offshore leases ($17,765,332) is a matter for the experts; but it appears to me that since Phillips charged off the dry holes in its taxes and the consumers got nothing whatever in 1954 from expired and surrendered leases and undeveloped offshore leases, such expense should not be included in the rate base. This expense alone amounted to 4.281¢ per Mcf. of the total allowed cost of service of 11.1009¢. Moreover, in this connection, Phillips also enjoyed a tax depletion allowance of 27 1/2% on all gas production. This allowance for the year 1954 was $44,784,723, giving Phillips a tax saving of over $20,000,000. This latter sum was included in the rate base. However, depletion is allowed as an incentive to exploration and certainly its savings should be deducted from Phillips' total expense in this regard. Since the book deficit between total revenue and cost of service for 1954 was $8,900,000, it appears that a correction of this item alone would turn that deficit into a nice profit. (b) Allocation of cost between oil and gas. Much of the gas produced for interstate sale is associated gas, i. e., it is produced along with oil and is known as casing-head gas. Fifty-seven percent of Phillips' gas production is associated gas but it accounted for only 13.42% of its combined revenue. In addition some wells produce condensate liquids and condensate gas which must be separated through gasoline plants. The question is how much of the expense of exploration, operation, etc., of wells should be chargeable to gas. Phillips used a B.t.u. method which allocated 61.88% of the expense to gas. The Commission cut this to 32.742%, equivalent to 4.281¢ per Mcf. The Examiner had recommended 30.46% while the Wisconsin experts came up with 20.812% and Pacific with 23.98%. As is noted above only 13.42% of Phillips' combined revenue comes from associated gas while 86.58% comes from oil. Still the Commission has allocated almost one-third of the exploration cost to gas, which only brings in one-seventh of the combined revenue. This is a most important item since each 1% shift means over a half million dollars in the rate base. (c) Purchased gas. If allowed increased rates Phillips says its cost of gas will rise automatically under its percentage type purchase contracts. This item of $1,671,733 was disallowed by the Examiner since the suppliers were not shown to have been entitled to any increase. As the Commission points out an increase in rate would not increase the percentage Phillips was obligated to pay. It would require Phillips to pay the pro-rate increase in rates due on percentage gas, but it recoups this plus a profit when that gas is sold. I submit, as the Examiner found, that the allowance of this million and a half in the cost basis is erroneous. Increases through automatic escalator clauseswhich effect the same resultare not permitted because not based on any increase in cost of production. In approving this practice in percentage contracts the Commission creates a perfect loophole for these producers and invites more contracts of this nature. (d) Interest. Expense for money borrowed for 1954 amounted to $9,892,308. On its tax return Phillips claimed an allowance of only $3,743,077. This variance in cost of money seems to have occurred by reason of an exchange of Phillips' outstanding bonds for common stock. The Commission allowed the larger figure on the basis that it was a known change that probably would not occur in other years. It is interesting to note that the known change theory was not applied to the San Juan transfer made in 1955. [5] If applied there it would have made a difference against Phillips of some $8,000,000 in its 1954 rate base. Certainly common fairness would require the application of the known change theory to all cases, not simply an isolated one. It is readily apparent that the Commission's cost-of-service calculations for 1954 are full of holes. In addition, assuming, as I do not, that the 1954 cost is correct the Commission should not be permitted to extend that cost and the 1954 revenue into subsequent years through 1958 and hold that they too are deficit years. This is, on its face, not in keeping with rate-making procedures. Moreover, the record itself shows the error of the Commission's method. The Examiner found that, on Phillips' own presentation of its costs, the over-all deficiency for 1956 was not significantly higher than that derived in Phillips' 1954 test year cost of service. 24 F. P. C., at 773. Phillips' revenues, however, increased each year subsequent to 1954. In 1957 they were some $8,000,000 above 1954; they increased some $17,000,000 in 1958 and about $28,000,000 in 1959. In 1960 revenue was $90,856,248, which was practically twice that of 1954 ($45.6 million). These facts, all known to the Commission, required a reappraisal of the cost of service for all years subsequent to 1954, rather than the arbitrary use of the 1954 figures. The necessary data could have been quickly obtained from Phillips which, of course, had its total revenues readily available and, I am sure, had its cost basis for each § 4 increase likewise calculated. [6]