Court Opinion

ID: 8910252
Source: CourtListenerOpinion
Date Created: 2022-11-27 02:40:28.425445+00
Date Added: 2024-06-11T17:08:27.946398
License: Public Domain

BARRETT, Circuit Judge,
concurring:
I concur in the analysis and interpretations of the subject contracts. In view of the fact that the cause is being remanded for further proceedings, including a determination of whether the “favored nations” clause is void as contrary to public policy, I am compelled to express my views on the public policy considerations.
The core of the controversy in this case centers around the question of whether the *1292phrase “other conditions of sale” in Article 8.4 of the contract herein includes the concept of “vintage pricing” as adopted by the Federal Power Commission, now the Federal Energy Regulatory Commission. In undertaking the assessment of this question, I believe, we must analyze: (i) the policies underlying the concept of “vintage pricing” as adopted by the Federal Power Commission; (ii) the purposes served by inclusion of “favored nations” clauses in gas purchase and sale agreements; and (iii) the public policy considerations affecting the inclusion and enforcement of such clauses, both in the interstate and intrastate market.
POLICIES UNDERLYING THE CONCEPT OF “VINTAGE PRICING” IN THE INTERSTATE NATURAL GAS MARKET
In 1924 the Supreme Court sowed the seeds for federal regulation of interstate sales of natural gas when it reviewed Missouri v. Kansas Natural Gas Co., 265 U.S. 298, 44 S.Ct. 544, 68 L.Ed. 1027 (1924). The court was there called on to determine whether a producer state could constitutionally regulate the price of natural gas sold to distributing companies for resale and consumption in other states. The court held that such regulation would unconstitutionally burden or impede the flow of interstate commerce, notwithstanding the absence, of federal occupation in the field. In reaching this conclusion, the court observed:
The contention that, in the public interest, the business is one requiring regulation, need not be challenged. But Congress thus far has not seen fit to regulate it, and its silence, where it has sole power to speak, is equivalent to a declaration that the particular commerce shall be free from regulation. (Citation). 265 U.S. at page 308, 44 S.Ct. at pages 545-546.
This decision,prompted Congress, through the Federal Trade Commission, to conduct detailed investigations into the structure of the natural gas industry. See: S.Res. 83, 70th Cong., 1st Sess., 69 Cong.Rec. 3054 (1928); S.Doc. No. 12, 70th Cong., 1st Sess. (1928-1936). Ultimately these investigations culminated in the passage of the Natural Gas Act, 15 U.S.C. Sec. 717 et seq. See: Davis, The Influence of the Federal Trade Commission’s Investigations on Federal Regulation of Interstate Electric and Gas Utilities, 14 Geo.Wash.L.Rev. 21 (1945); DeVane, Highlights of Legislative History of the Federal Power Act of 1935 and the Natural Gas Act of 1938, 14 Geo.Wash.L. Rev. 30 (1945).
Under the Natural Gas Act, the Federal Power Commission, now the Federal Energy Regulatory Commission, became primarily responsible for establishing the rate at which natural gas could be sold in interstate commerce. In formulating its regulatory scheme, the FPC was initially faced with a choice between two alternatives. First, it could employ common carrier regulation and set nationwide rate scheduling. Second, it could adopt a public utility approach based on individualized treatment of entities within its jurisdiction. See: Note, Natural Gas Rate Regulation: The Conflict in the Application of the Just and Reasonable Standard, 12 Tulsa L?J. 293 (1976). Adopting the public utility regulatory concept, the Commission employed a “prudent investment” approach and based pricing on “actual legitimate costs”. The Commission’s approach was sustained by the Supreme Court in Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944), wherein the court held that “[t]he fixing of ‘just and reasonable’ rates, involves a balancing of the investor and the consumer interests.” F.P.C. v. Hope Natural Gas Co., supra at 603, 64 S.Ct. at 288. Thus the “prudent investment” approach, which defined a new minimum return to which natural gas producers were entitled, turned on a delicate balancing of the natural tension found between the industry’s goal of maximizing profits and the consumer’s interest in paying the lowest possible price for natural gas.
In an effort to work within the constraints of this “prudent investment” approach, the FPC conducted detailed investí-*1293gations into the financial condition of entities within its jurisdiction in order to arrive at “just and reasonable” rates. This individualized treatment, however, had to be abandoned when the Commission faced a tremendous increase in workload following the Supreme Court’s expansion of its jurisdiction in Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 74 S.Ct. 794, 98 L.Ed. 1035 (1954). The “move” from this individualized treatment approach began in Phillips Petroleum Co., 24 FPC 537 (1960), aff’d. Wisconsin v. Federal Power Commission, 373 U.S. 294, 83 S.Ct. 1266, 10 L.Ed.2d 357 (1963); wherein the Commission stated that the:
[ejxperience of the Commission . has shown, beyond any doubt, that the traditional original cost, prudent investment rate base method of regulating utilities is not a sensible, or even a workable method of fixing the rates of independent producers of natural gas . . . [T]he better method [of regulating the price of natural gas] would be to establish fair prices for the gas itself and not for each individual producer. . . . We are, simultaneously with the issuance of this opinion and order, promulgating a policy statement setting forth rate guidance levels for various producing areas of the country. We are thereby establishing two prices for each of these areas; (1) a price applicable to new contracts, above which we will not certificate new sales without justification of the price and; (2) a price pertaining to existing contracts, above which we shall suspend price escalations. [Emphasis supplied.] 24 F.P.C. 537 at pages 542, 547.
In the accompanying statement of general policy, the Commission observed:
Two price standards are set for each area. Initial prices in new contracts are, and in many cases by virtue of economic factors, must be higher than the prices contained in old contracts. For this reason, we have found it advisable to adopt two schedules of prices, one pertaining to initial prices in new contracts, and one pertaining to escalated prices in existing contracts. It is anticipated that these differences in price levels will be reduced and eventually eliminated as subsequent experience brings about revisions in the prices in various areas. [Emphasis supplied.] Statement of General Policy No. 61-1, 24 F.P.C. 818, 819 (1960).
Thus, although anticipated to be only a stop-gap measure, the concept of “vintage pricing” by contract date developed as early as 1960, some three years prior to the execution of the contract in this case.
Following the announcement of this “statement of general policy”, the Commission began proceedings under Section 5(a) of the Natural Gas Act, 15 U.S.C. Sec. 717d(a) to determine rates in the Permian Basin rate area. Hearings began on October 11, 1961, and closed on September 10, 1963. The Commission issued its decision on August 5, 1965. In its decision, the Commission embraced the concept of “vintage pricing” providing “one area maximum price for natural gas produced from gas wells and dedicated to interstate commerce after January 1, 1961. It created a second, and lower area maximum price for all other natural gas produced in the Permian Basin.” Permian Basin Area Rate cases, 390 U.S. 747, 759, 760, 88 S.Ct. 1344, 1356, 20 L.Ed.2d 312 (1968). [Footnote omitted.]
The Commission’s decision was affirmed by the Supreme Court in Permian Basin Area Rate cases, supra.
This area rate — two tier approach dominated until 1972 when the FPC “went on to virtually abandon the concepts of area pricing and contract vintaging,” [Shell Oil Company v. Federal Power Commission, 491 F.2d 82, 84 (5th Cir. 1974)], in Opinion 639, 48 F.P.C. 1299 (1972) aff’d. Shell Oil Co. v. Federal Power Commission, supra. With particular regard to “vintaging”, the Commission stated:
We believe vintaging to be an anachronism which we should now move to eliminate. Vintaging operates to discourage development of the full productive capacity of acreage committed to the interstate market, for even though such developmental drilling is undertaken at *1294current costs, gas production obtained thereby is priced at the lower of two rates, when it is the higher of the two that is Commission-designed to provide the incentive for development of additional gas supplies. 48 FPC at page 1309.
This move to eliminate “vintaging” continued in Opinion 699,—FPC—, reprinted [1974] 1 Fed. Power Serv. at 5-307, wherein the Commission abandoned area rate making for a uniform national base rate and allowed “old” gas to be sold at the price of “new” gas upon a “rollover” of the contract. The Commission’s action was sustained in Shell Oil Co. v. Federal Power Commission, 520 F.2d 1061 (5th Cir. 1975), cert. denied, 426 U.S. 941, 96 S.Ct. 2661, 49 L.Ed.2d 394 (1976). Later, however,' in Opinion 770,—F.P.C.—, reprinted at 41 Fed.Reg. 33364 (1976), the Commission repudiated its position of eliminating contract vintaging, stating:
We are aware of the problems occasioned by the continuance of the vintag-ing concept. The Commission, however has a responsibility to minimize severe and harmful economic dislocation due to increased rates. * * * Our decision to modify the policy set forth in Opinion 699-H, with respect to the effective date on which gas initially qualifies for a new rate, is based on a determination that the increased costs of exploration and production and the decreased productivity of wells should only be reflected in the rates for the corresponding period, and not for a prior period. 41 Fed.Reg. at p. 33666. [Emphasis supplied.] [Footnotes omitted.]
Opinion 770 was recently upheld in America Public Gas Ass'n. v. Federal Power Commission, 186 U.S.App.D.C. 23, 567 F.2d 1016 (1977), cert. denied 435 U.S. 907, 98 S.Ct. 1456, 55 L.Ed.2d 499 (1978).
Thus, the synthesis of these opinions indicates that, although “vintage pricing” has endured some turbulent times in the past, it nevertheless remains viable primarily because it is based on “a determination that the increased costs of exploration and production and the decreased productivity of wells should only be reflected in the rates for the corresponding period and not for a prior period.” Opinion 770, supra. “Vintage pricing” thereby serves the producer by allowing a “just and reasonable” return on his profit while at the same time preventing “windfall profits” thereby protecting the consumer.
MOST FAVORED NATIONS CLAUSES AND PUBLIC POLICY
Normally, gas purchase and sale contracts contain pricing provisions which provide for an increase in the price of gas purchased and sold under specified circumstances. See 4 Williams, Oil and Gas Law, Section 726. (1972). These escalation clauses, commonly referred to as “favored nations” clauses, are broadly classified into two categories: Two-party clauses and third-party clauses.
Two-party favored nations clauses provide: “that the price to be paid [a] Seller by [a] Buyer will be increased to match any higher price contracted to be paid by the same Buyer to any other seller in the same field or area.” 4 Williams, supra, at Sec. 726. Third-party clauses, on the other hand require “the Buyer to meet any higher price contracted to be paid by any other buyer in the same field or area.” 4 Williams, supra, at Sec. 726. Inasmuch as the provisions of Section 8.4 of the contract herein question can only be triggered by Western Slope, we are dealing with a two-party favored nations clause.
Professor Williams, in his treatise, states that the inclusion of such clauses in gas purchase and sales contracts has primarily resulted from governmental regulations— specifically the FPC’s requirement that gas producers dedicate their supplies to the interstate market for long periods of time. 4 Williams, supra, at Section 726. Such clauses, he argues, are necessary to protect a seller from potential losses due to increases in the market price of his product during the term of the contract. Texas Gas Transmission Corporation v. Shell Oil Company, 363 U.S. 263, 80 S.Ct. 1122, 4 L.Ed.2d 1208 (1970).
*1295Such clauses naturally grant an advan- . tage to the seller. As such, they have generally been construed in favor of the buyer and against the seller. Neither the courts, nor regulatory agencies dealing with such clauses, have looked upon them with favor. The Federal Power Commission has specifically declared that such two-party favored nations clauses are contrary to the public interest:
Considering all the circumstances, we are of the opinion that the two-party favored nation clauses in "Pure’s contracts with El Paso, and indefinite escalation clauses generally(3) are contrary to public interest. From the beginning of Commission regulation of independent producers under the Phillips decision in 1954(4) the undesirable and injurious' aspects of such escalation provisions generally have been forcibly impressed on us and proceedings were early instituted looking to the elimination of such provisions.(5) And although the record in this case was made with special reference to Pure’s two-party provisions, by reasonable implication it confirms our conclusion based upon our experience with other types of indefinite escalation provisions, that such provisions generally are contrary to the public interest.
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The record establishes that Pure’s favored nation clauses are contrary to the public interest in a number of ways. First, they are, in the context of Commission regulation of producers under the Act, by their nature and in their effects inherently unreasonable. As indicated previously, under Pure’s provisions, the company’s prices are subject to triggering if El Paso pays any other producer within the specified area a higher price. There need be no‘economic or other substantial justification for the increase; the mere fact that a higher price is paid to some other producer would be sufficient to activate the increase. In our view, such an artificial ground for a proposed increase, operating in such a mechanical and arbitrary manner, and lacking any substantial relationship to the factors which bear on the value of gas or on a determination of a reasonable level of rates for it, does not constitute a proper basis for filing proposed increased rates or a sufficient justification for our giving effect to such a filing, at least if the rate contained therein is in excess of those in our producer price Policy Statement 61-1, as amended.(6)
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Assuming that indefinite escalation clauses in producer contracts had some justification years ago, when a lack of purchase outlets and lack of consumer demand forced prices to abnormally low levels, this justification no longer exists today, when purchasers of gas are numerous, consumer demand is strong, and buyers are competing eagerly for available supplies of gas. In our judgment, in the light of continuing increases in the price of gas in recent years and the present high level of prices, escalation clauses such as Pure’s have by now outlived whatever economic function they may have had. Opinion No. 341, 25 F.P.C. 383, (1961) aff’d. Pure Oil Company v. Federal Power Commission, 299 F.2d 370 (7th Cir. 1962). [Footnotes omitted.]
See also: Opinion No. 546, 40 F.P.C. 530 (1968), aff’d. sub nom., Austral Oil v. Federal Power Commission, 428 F.2d 407 (5th Cir. 1970); on rehearing, 444 F.2d 125 (5th Cir. 1970), cert. denied sub nom., Municipal Distributor Group v. Federal Power Commission, 400 U.S. 950, 91 S.Ct. 241, 27 L.Ed.2d 257 (1970); Order No. 242, 27 F.P.C. 339 (1962), rev’d. Texaco v. Federal Power Commission, 317 F.2d 796 (10th Cir. 1963), rev’d. Federal Power Commission v. Texaco, Inc., 377 U.S. 33, 84 S.Ct. 1105, 12 L.Ed.2d 112 (1964); Order No. 232-A, 25 F.P.C. 609 (1961).
Similarly, the Súpreme Court has declared:
Indefinite escalation clauses “cause price increases ... to occur without reference to the circumstances or economics of the particular operation, but solely because of what happens under another *1296contract.” 34 F.P.C., at 373. There is substantial evidence(48) that in design and function they are “incompatible with the public interest . . . ” Order No. 232, 25 F.P.C. 379, 380. Indeed, this Court has already entirely sustained the Commission’s 1962 order. FPC v. Texaco, 377 U.S. 33, 84 S.Ct. 1105, 12 L.Ed.2d 112. [Footnote omitted.] Permian Basin Area Rate Cases, supra, 390 U.S. at pp. 782-783, 88 S.Ct. at 1368.
Perhaps more significantly, however, inasmuch as this is a diversity of citizenship case, is the view of the Public Utilities Commission of the State of Colorado:
[T]he Commission will expect Peoples [a public utility], in all future renegotiations of existing contracts, or negotiations for new contracts, with wellhead producers vigorously to oppose inclusion of “favored nation clauses” in such contracts. In the Commission’s view, such clauses have resulted in increased rates to Peoples’ ratepayers without any justification in terms of cost or even market factors. From the cost point of view, it is quite clear that the cost of producing gas from an older well is not related to the price that the utility may be paying for gas from a more recent vintage well. Also, the market conditions, as between interstate and intrastate production were changed in FPC Opinion No. 770A, and subsequent errata notices thereto, in that if the wellhead producer, who previously had been serving intrastate commerce, decides to dedicate his gas to interstate commerce, he can only obtain the applicable vintage price dependent upon his well commencement date. Thus, in all future filings by Peoples, any cost increase which is attributable to a so-called “favored nations clause” included in a contract entered into after the date of this decision will be subjected to close scrutiny and may be disallowed as an expense for ratemaking purposes. Colorado PUC Decision No. 90563, modifying and adopting Colorado PUC Decision No. 90030, aff’d. Peoples Natural Gas v. Public Utilities Commission, 590 P.2d 960 (Colo.1979).
In summary, I find that there is a consensus among the courts and agencies, both at state and federal levels, that “favored nations” clauses are contrary to the public interest, in that they cause excessive and unreasonable price increases which operate in “a mechanical and arbitrary manner” and lack “any substantial relationship to the factors which bear on the value of gas or on a determination of a reasonable level of rates for it.” FPC Opinion No. 341, supra.
THE TRIPARTITE PROBLEM: VINTAGE PRICING, FAVORED NATIONS CLAUSES AND THE INTRASTATE CONTRACT
It is clear that the Federal Power Commission, now the Federal Energy Regulatory Commission, cannot exercise its jurisdiction over intrastate sales of natural gas. See: Central States Electric Co. v. City of Muscatine, 324 U.S. 138, 65 S.Ct. 565, 89 L.Ed. 801 (1945). However, this jurisdictional limitation does not prevent courts from drawing upon the experience and expertise of the FPC in interpreting intrastate contracts when the policies of the FPC do not conflict with state policy.
We have already seen that “favored nations” clauses, such as the clause found in Article 8.4 of the contract herein, are generally contrary to the public interest, in that they encourage artificial price escalations without regard to “the factors which bear on the value of gas or on a determination of a reasonable level of rates for it.” Opinion No. 341, supra. As such, these escalation clauses cause windfall profits and substantially increase the cost to consumers for a commodity without which they may well not be able to live. The impact of such escalations on the general public could well be devastating in states where consumers are highly dependent upon the use of natural gas. As such, the interpretation of “fa- 0 vored nations” clauses should be subjected to close scrutiny.
On the other hand, we have seen that the “vintage pricing” policies of the Federal *1297Power Commission, were designed to allow producers only a “just and reasonable” return on their capital investment. As pointed out by both the Federal Power Commission, and the Public Utilities Commission of Colorado, the “cost of producing gas from an older well is not related to the price . for gas from a more recent vintage well.” Colorado Public Utilities Commission Decision No. 90563, supra. The creation of the “vintage pricing” technique resulted from a carefully drawn balance between the natural tension of the industry’s goal of maximizing profits and the consumers’ interest in paying only reasonable rates for natural gas.
It is clear, from the opinions of the FPC and Colorado Public Utilities Commission, that the courts may be justified in declaring the “favored nations” clause here in question void as against public policy. However, it is well settled that contracts are presumed to be legal and enforceable and that an ambiguously worded contract should not be interpreted to render it illegal and unenforceable, where the wording lends itself to a logically acceptable construction which renders it legal and enforceable. Walsh v. Schlecht, 429 U.S. 401, 97 S.Ct. 679, 50 L.Ed.2d 641 (1977). In this case, the wording “other conditions of sale” in Article 8.4 of the contract, does lend itself to a logically acceptable construction which renders the contract as a whole legal and enforceable. That interpretation, of course, is to include the concept of “vintage pricing” in the phrase “other conditions of sale” and allow Superior only a “just and reasonable” return on its investment in those wells commenced prior to January 1, 1973.1 These expressions are, of course, my views on the public policy matter the District Court is to consider on remand.

. In the only other case brought to this Court’s attention involving the “favored nations” clause versus “vintage pricing” concept, Continental Oil Company v. Southern Union Gas Co., No. 48543 (Santa Fe, N.M. Dist., filed Oct. lo, 1975), the court held, as I would, that the “favored nations” clause was void as against public policy, if it were construed to exclude “vintage pricing”.