Court Opinion

ID: 9652829
Source: CourtListenerOpinion
Date Created: 2023-08-23 17:33:06.140869+00
Date Added: 2024-06-11T18:12:54.449122
License: Public Domain

PHILLIPS, Circuit Judge
(dissenting).
My associates are of the opinion that the questions here presented are foreclosed by recent decisions of the Supreme Court. Were I certain of the correctness of that conclusion, my task would be simple. It is my view, however, that certain of the important questions here presented are left at large by the opinions of the Supreme Court in the gas rate cases, and I am, therefore, impelled to state my views.
It has been authoritatively determined by the Supreme Court that, in determining the value of property included in the rate base, the Commission is not bound to the use of any single formula or combination of formulae;1 and that if the Commission conforms to the requirement of the statute fixing its authority and proceeds, after notice, and accords fair hearing and fixes “rates which enable the company to operate successfully, to maintain its financial integrity, to attract capital, and to compensate its investors for the risks assumed” such rates cannot be condemned as invalid, even though they produce only a meager *706return on a so-called “fair value” rate base.2
I.
The Commission’s Jurisdiction.
Section 1(b) of the Natural Gas Act3 reads: “The provisions of this chapter shall apply to the transportation of natural gas in interstate commerce, to the sale in interstate commerce of natural gas for resale for ultimate public consumption for domestic, commercial, industrial, or any other use, and to natural-gas companies engaged in such transportation or sale, but shall not apply to any other transportation or sale of natural gas or to the local distribution of natural gas or to the facilities used for such distribution or to the production or gathering of natural gas.”
The “shall not” provision of this Act expressly withholds from the Commission jurisdiction over direct sales of natural gas, over local distribution thereof, over facilities used for local distribution, and over production or gathering of natural gas. It confines the Commission’s jurisdiction expressly and solely to transportation of natural gas in interstate commerce, and to the sale in interstate commerce of natural gas for resale for ultimate public consumption. See the construction of analogous provisions of the Federal Power Act of 1935, 16 U.S.C.A. § 791a et seq., in Connecticut Light & Power Co. v. Federal Power Commission, 324 U.S. 515, 528-531, 65 S.Ct. 749, 89 L.Ed. 1150.
II.
The Rate Base.
The Commission adopted and applied a rate base purporting to embrace all the property of the Cities Service Gas Company.4 It found that $66,977,654 was the actual legitimate cost of the property in service on December 31, 1941. It deducted therefrom $21,804,499 for accrued depreciation and depletion. It added $1,576,357 for construction work in progress and $1,-818,194 for working capital, thereby arriving at a rate base of $48,567,756. From the actual earnings of the Company in the test year, it subtracted an amount equal to 6% per cent of the rate base, thereby arriving at what it found to be excess earnings before allocation. It then allocated the properties and earnings as between the jurisdictional, or sales for resale, and the non jurisdictional, or direct sales, by a so-called cost of service method apportioning approximately 70 per cent to sales for resale, and 30 per cent to direct sales. It thereby found that the earnings from sales for resale were excessive to the extent of $5,499,665.
It found the estimated cost of the proposed Hugoton Pipeline to be $15,000,000. It determined that 6% per cent of that amount, or $975,000, was a fair return thereon and that 3% per cent of $15,-000,000, or $525,000, was a fair allowance for depreciation. Of the aggregate of the two latter amounts, it apportioned $1,-053.794 to jurisdictional sales and $446,206 to nonjurisdictional sales. It allowed $1,-053.794 as a tentative additional allowance for the cost of procuring gas. It deducted that amount from $5,499,665, and thereby arrived at $4,445,871 as the amount of the rate reduction.
III.
The Treatment of Petitioner’s Leaseholds and Natural Gas Rights in the Rate Base.
Petitioner owns gas leases in the Texas Panhandle field, fields in Kansas and Oklahoma, and in the Hugoton field. The Commission included in the rate base what it found to be the legitimate cost to petitioner's predecessors of such leases, administrative cost of acquisition, and cost of physical structures. At the time such properties were devoted to public use the leases, because of development, had greatly enhanced in value.
Where no bonus or consideration was paid for a lease, the Commission allowed no cost in the rate base for the lease itself. For example, 68,086 acres of leases in the Panhandle field, constituting one of the most valuable proven gas reserves in *707the world,5 were put in the rate base at zero, because no bonus or consideration was paid for such leases. It allowed $1,-776.74 for expenses of title papers and title examinations in connection with such leaser. For 34,041 acres of leases, it allowed an acquisition cost of $554,697.08, which amount included bonuses paid and also a small amount expended for title papers and title examinations.
For 424,969 acres in the Oklahoma and Kansas- fields, exclusive of the Hugoton field, the Commission allowed an acquisition cost of $545,374.18, which amount included bonuses where paid and a small amount expended for title papers and title examinations.
For 182,182 acres in the Hugoton field, the Commission allowed $542,501, which amount included bonuses paid and a small amount expended for title papers and title examinations.
The aggregate of the foregoing amounts, after deducting depletion, was included in the rate base as the adjusted cost of the leases.
Thus, the allowances in the Oklahoma and Kansas fields were approximately 11.4 cents per M.c.f. of gas reserves, whereas, the allowances in the Panhandle field and the Hugoton field were a nominal fraction of a mill per IVLc.f. of gas reserves.
The Commission’s treatment of gas reserves more graphically appears from the tabulation set forth in the margin.6
Ordinarily, the owner of land in an unproven area cannot risk the cost of exploration for oil and gas. It -is more desirable for the ordinary landowner to lease his land on a royalty basis. Exploration in unproven areas involves the cost of geological and geophysical investigation, drilling costs, and, if oil or gas is found in paying quantities, the incidental costs *708of connections with transportation facilities to available markets. Only an operator who acquires large blocks of leases or otherwise spreads his operations, can afford to risk the cost of exploration for oil and gas in unproven areas.
While the accuracy of geological and geophysical reports through the adaptation and use of the seismograph and other scientific instruments has been greatly improved, whether oil or gas will or will not be found in paying quantities can only be determined through drilling. Not infrequently, oil or gas is discovered by an adventurous driller on structures where (he report of the geologist is unfavorable, and frequently an area, as to which the report from the geologist is very favorable, is found, on drilling, to be barren of oil or gas. It follows that one who expends large sums for investigation and drilling in unproven areas assumes the risk of losing his entire outlay in the venture.
Under the test laid down in Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 605, 64 S.Ct. 281, 88 L. Ed. 333, with respect to the end result theory, the return must compensate the investor, among other things, for the risk assumed, and enable the concern whose rates are fixed to attract capital.
Does a rate base on the nominal consideration paid for a lease in an unproven area compensate for the risk assumed by the lessee who expends large sums for investigation and for drilling, knowing the entire expenditure may be lost?
From time to time, petitioner, as it exhausts its present gas reserves, either will have to acquire additional reserves through acquisition and development of leases in unproven areas, or will have to abandon the production end of its business and buy gas from other producers. Can it hope to attract capital for acquisition of such new reserves when its earnings are based on the nominal cost of new leases, and when such new leases, although gas is discovered in paying quantities, will go into the rate base at the nominal cost, and no consideration will be given to their greatly enhanced value through development, nor to the risk assumed in such development?
In his concurring opinion in Colorado Interstate Gas Co. v. Federal Power Commission, 324 U.S. 581, 610, 65 S.Ct. 829, 843, 89 L.Ed. 1206, Mr. Justice Jackson said that the rate base method adopted produced “delirious results.” He further said: “These cases furnish another example oi the capricious results of the rate-base method in this kind of case. The Commission has put five of the most important leaseholds, containing approximately 47,00C acres, in the rate base at $4,244.24, some-1 thing under 10 cents per acre. Three such leases are put in the rate base at zero. This is because original cost was used, and these were bought before discovery of gas thereon. The Company which took the high risk of wildcat exploration is thus allowed a return of 6% per cent on nothing for the three leases and a return of less than $300 a year on the others. Their present market value is shown by testimony to be over 3 million dollars.”
While the question under consideration was raised in the Colorado Interstate Gas Co. case, supra, it was not directly passed on by this court, and was not within the scope of the review granted by the Supreme Court. In the opinion, 324 U.S. at page 605, 65 S.Ct. at page 289, 89 L.Ed. 1206, it said: “* * * we cannot say as a matter of law that the Commission erred in including the production properties in the rate base at actual legitimate cost. That could be determined only on consideration of the end result of the rate order, a question not here under the limited review granted the case.”
It seems to me that on a consideration of the end result, the rates fixed, for the reasons indicated, are unjust and unreasonable.
Section 6 of the Natural Gas Act7 authorizes the Commission to “investigate and ascertain the actual legitimate cost of the property of every natural-gas company, the depreciation therein, and, when found necessary for rate-making purposes, other facts which bear on the determination of *709such cost or depreciation and the fair value of such property.”
Here, it seems to me, nominal cost of leases is an arbitrary and unreasonable criterion, and that it was necessary for the Commission, for rate-making purposes, to ascertain other facts bearing on the determination of the fair value of the property included in the rate base.
IV.
Regulation of Production and Gathering Facilities.
Section 1(b) of the Natural Gas Act8 provides that the provisions of the Act shall not apply “to the production or gathering of natural gas.”
In Colorado Interstate Gas Co. v. Federal Power Commission, 324 U.S. 581, at page 616, 65 S.Ct. 829, at page 845, 89 L. Ed. 1206, the late .Chief Justice Stone, in his dissenting opinion, in which three of the Associate Justices joined, said: “ * * * It [the Commission] valued the wells and gathering facilities at their prudent investment cost of many years ago, a valuation drastically less than their present market value. It then restricted petitioner’s return to 6%% of the rate base, including the wells and production facilities, constituting approximately two-thirds of the total rate base. It thus subjected petitioner’s production and gathering property to the same regulation as that which the statute imposes upon petitioner’s property used and useful in the interstate transportation and sale of gas for resale. This, we think, the Natural Gas Act in plain terms prohibits.”
Here, the Commission included all the gas reserves and all the gathering and production facilities in the rate base and fixed the; return that might be earned thereon through direct sales. It thus regulated the return, through direct sales of gas, from leases and gathering and production facilities. I do not think the Congress intended to subject such properties to that
sort of regulation. It would be a work of supererogation for me to undertake to add to the reasons so ably expressed by the late Chief Justice for his conclusion.
Is the question still open? In the Hope case, the question was not passed upon by the Supreme Court, United States Court of Appeals, or the Commission.9 The only issue presented related wholly and specifically to constructed physical facilities.
It is true that Mr. Justice Jackson concurred in the Colorado Interstate Gas Company case, but he reiterated his views expressed in the Hope case, and again severely criticized the methods used by the Commission, and based his concurrence with respect to the question here under consideration on the ground that the Commission was “free to take evidence as to conditions and events quite beyond its regulatory jurisdiction where they are thought to affect the cost of that whose price it is directed to determine.”
But it seems to me that the Commission did more. It is true that its final action was a rate order. However, the effect of such order was to regulate the return from the gas reserves and production and gathering facilities of petitioner from direct sales, on the basis of what it found to be the legitimate cost of such properties, and thus to exercise its rate-making jurisdiction over such properties. I have no quarrel with my associates for feeling that they are bound by the decision in the Colorado Interstate Gas Company case, but feel that the question is enough at large that it is not inappropriate for me to express my views.
V.
Excess Profits from Natural Gasoline Operations.
Petitioner and Cities Service Oil Company10 are subsidiaries of Empire Gas & Fuel Company. The Oil Company extracts gasoline, butane, and propane from part of the natural gas produced by petitioner. While this operation is profitable and ren*710ders the natural gas more readily marketable and transportable, the gas can be, and in fact much of it is, transported and marketed without such residuals being extracted. The extraction of gasoline and other residuals reduces the heat content and consumes a certain volume of natural gas. Under a contract between petitioner and the Oil Company the latter pays for the products extracted at the rate of 7$ per M.c.f. of 1100 B.t.u. equivalent gas for the loss in heat value resulting from the extraction. The petitioner includes the amounts so received in its operating revenue.
The Commission determined the Oil Company’s net investment in property devoted to the extraction of residuals from petitioner’s gas and allowed a rate of return thereon, after providing for operating expenses, depreciation, and taxes, of 6% per cent. It concluded that the excess of the revenues received by the Oil Company, thus computed, represented excess profits, which should be credited to the natural gas operations of the petitioner. It thus regulated the rate of return received by the petitioner from direct sales of residuals extracted from the natural gas produced by petitioner and regulated the earnings of the Oil Company, an affiliate of petitioner.
Since the contract between petitioner and the Oil Company was between affiliated corporations, the Commission had the right to inquire into and scrutinize the fairness of the contract price and, if the price paid by the Oil Company was not fair and reasonable, to fix a reasonable price for the residuals sold to its affiliate. There are many contracts entered into at arm’s length between producers of natural gas and extractors of residuals in the Panhandle field, and there would have been no difficulty in determining the reasonable market value of such residuals.11 But that the Commission did not do. In substance and effect, it undertook to regulate the charges the petitioner should make for the direct sales of its residuals on the basis of a fair return on the properties of the Oil Company, matters which were clearly not within the regulatory jurisdiction of the Commission.
VI.
Federal Income Taxes.
The Commission, in arriving at the amount of the rate production with respect to indirect sales, made no allowance for federal income taxes. It assigned all of such taxes to the earnings from direct sales. The Commission undertakes to justify its action on the theory that if all of petitioner’s rates were subject to regulation, and petitioner had been limited to an overall fair return of 6% per cent, it would not have paid any federal income taxes. I am unable to determine from this record any basis for that conclusion. On its face, it would seem that a return which would not result in net earnings subject to federal income taxes is unreasonably low. Petitioner’s single system serves both direct sale purchasers and purchasers who resell for ultimate public consumption. The unregulated direct sales business in general has a higher load factor than the regulated sales for resale business, and the combination of the two types of business works to the advantage of both classes of purchasers. Moreover, federal income taxes are levied upon the petitioner's business as a single operating unit. For all other purposes than federal income taxes, the Commission treated the petitioner, its property, its revenues, its expenses, its return, jurisdictional and nonjurisdictional, as unitary. But, for the specific purpose of tax computation, the nonjurisdictional earnings in excess of 6% per cent are saddled with all federal income taxes. It seems to me, therefore, that there should have been a reasonable allocation of federal income taxes between jurisdictional and nonjuris-dictional earnings.
I think the order of the Commission should be set aside.

 Federal Power Commission v. Natural Gas Pipeline Co., 315 U.S. 575, 586, 62 S.Ct. 736, 86 L.Ed. 1037; Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 88 L.Ed. 333.

 Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 605, 64 S.Ct. 289, 88 L.Ed. 333.

 15 U.S.C.A. § 717(b).

 Hereinafter called petitioner.

In re Canadian River Gas Co., 43 P.U.R..N.S., 205, 222, the Commission said: The Commission takes note of the fact that the Texas Panhandle -field and the adjacent Hugoton field are the largest known reservoirs of natural gas in the world. Natural gas companies relying upon these fields, directly or indirectly, for their source of supply may be expected to continue in business for many years to come.”

 LEASEHOLDS AND NATURAL GAS RIGHTS

 15 U.g.C.A. § 717e(a).

 15 U.S.C.A. § 717(b).

 Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333; Hope Natural Gas Co. v. Federal Power Commission, 4 Cir., 134 F.2d 287, 293, 294; Cleveland and Akron v. Hope Natural Gas Co., 44 P.U. R.,N.S., 1.

 Hereinafter called the Oil Company.

 See Smith v. Illinois Bell Telephone Co., 282 U.S. 133, 151-153, 51 S.Ct. 65, 75 L.Ed. 255; Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 156, 157, 54 S.Ct. 658, 78 L.Ed. 1182; Western Distributing Co. v. Public Service Commission, 285 U.S. 119, 124, 125, 52 S. Ct. 283, 76 L.Ed. 655.