Public Service Commission of New York v. Federal Power Commission (511 F.2d 338, 1975)

LEVENTHAL, Circuit Judge:

In October 1970, the Federal Power Commission authorized natural gas pipelines to include in their rate bases certain advance payments made to natural gas producers for gas to be delivered at a future date. The FPC’s action was one of a number of efforts to spur capital formation for gas development in order to alleviate the critical shortage of natural gas. The Public Service Commission of the State of New York (New York) sought review in this court of the FPC order establishing rate base treatment of advance payments. Prior to the resolution of that appeal, the FPC modified its initial order, restricting its scope and limiting its duration to the period ending December 81, 1972.

This court sustained the advance payment scheme on the basis of “the temporary character of the FPC order” and “our belief that it represented a justifiable experiment in the continuing search for solutions to our nation’s critical shortage of natural gas.” Public Service Commission v. FPC, 151 U.S.App.D.C. 307, 317, 467 F.2d 361, 371 (1972). We stressed the need for further evaluation by the FPC prior to any continuation of rate base treatment of advance payments to producers.

Fundamental to the concept of any experiment is the assumption that the data developed from the experience thereunder will be subjected to meaningful review, analysis, and evaluation before the experimental practice is allowed to continue or to become institutionalized as a more permanent procedure.

In approving this temporary order, we had no intention of abridging that concept nor of approving capitalization of advance payments beyond its stated expiration date without the FPC having first carefully evaluated the experience under Order 441 to determine whether its justifying objectives are being satisfactorily met at an acceptable level of ultimate economic cost to the nation’s gas consumers.

Since our 1972 opinion, the FPC has twice reaffirmed the rate base treatment accorded advance payments to producers and has expanded the types of payments eligible for such treatment. Data compiled by the Commission reveal that as of July 30, 1973, pipelines had committed advance payments totalling over one and a quarter billion dollars to producers in the “lower 48” states and had actually advanced them over a billion dollars. The ultimate cost to the consumer attributable to the funds already advanced has been estimated to exceed half a billion dollars.

Although the FPC’s continuation of the program has been through orders for successive extensions of one year and two year periods and the FPC has directed its staff to continue its evaluation of the program during the present term, the rate base treatment of advance payments can no longer be viewed as a temporary, experimental approach to the supply problem. The Commission’s endorsement of rate base treatment in five orders and the huge sums involved in escalating advance payments commitments indicate that the initial experimental practice has “become institutionalized as a more permanent procedure.” The present case requires us to examine whether the FPC’s actions have been premised on the type of meaningful review, analysis, and careful evaluation of experience called for by our earlier opinion.

New York urges that the Commission has not developed “a proper factual predicate” to support the continuation of the advance payments program. New York does not call for the abolition of all rate base treatment of advance payments. Rather it contends that the present size and scope of the program cannot be sustained as a reasoned exercise of the Commission’s discretion based on the record as a whole.

After a thorough review of the record before us, we find that the FPC has failed to engage in “meaningful review, analysis, and evaluation” of the experience under the advance payments program. The data presented by the Commission as a justification of its repeated extensions of the advance payments program provide an inadequate basis from which “to determine whether its justifying objectives are being satisfactorily met at an acceptable level of ultimate economic cost to the nation’s gas consumers.” Accordingly, we remand the record for further evidence and consideration by the FPC.

I. THE ADVANCE PAYMENTS ORDERS

We begin with a brief review of the origin of the advance payments program and changes in its scope since its inception.

The first of the five advance payment orders was Order 410, issued October 2, 1970, which established new Account 166, Advance Payments for Gas, and provided that “advance payments for gas would be recorded as prepayments and unrecovered advance payments would be included in the rate base as part of working capital.” The order defined advance payments to include amounts paid to independent or affiliated producers for exploration, lease acquisition, development, or production of natural gas, “when such advance payments are to be repaid by delivery of gas.” Other provisions indicated that advances should be repaid within a five year period and that the rate base account must be credited by the amount of advances which become non-recoverable. The rationale underlying this procedure was that rate base treatment would allow the pipeline to pass on to the consumer the monetary cost of making advances — i. e., the rate of return on this part of the rate base, and thus would induce advance payments which would supply producers with capital required for the development of additional gas supplies.

The Commission was persuaded on rehearing to renotice Account 166 in order to afford further opportunity for comment. The renotice was set forth in a Notice of Proposed Rulemaking in Docket No. R-411, issued on January 8, 1971. The same day, the FPC issued Order 410 — A, which provided interim rate base treatment for “advances by pipelines to independent producers for exploration and lease acquisition costs.” That order reserved the question of the appropriate treatment of exploration and lease acquisition advances made by pipelines to their own affiliates for consideration in the upcoming docket.

The reconsideration led to Order 441,. November 10, 1971, which adopted certain modifications and limited the advance payments program to the period ending December 31, 1972. It created Account 167, Other Advance Payments for Gas, a mechanism to record all advances not accorded rate base treatment. The FPC determined that rate base treatment would be denied to all advances for exploration and lease acquisition, as well as payments to both affiliated and independent producers which resulted in a working interest. Order 441 also provided that where economic interests other than a working interest were received by a pipeline as a result of an advance payment properly includable in the rate base, “any realization therefrom” was to be treated “so as to reduce the [pipeline’s] cost of service.” Further, the FPC confined its rate base treatment program to advances which required repayment in full “by either delivery of natural gas or other consideration” and added the requirement that, unless otherwise authorized, repayment must take place within five years after the date of advance.

In the March 1972 ruling that affirmed the FPC’s initial orders allowing rate base treatment of advance payments, this court relied on Order 441 as evidencing the Commission’s “willingness to assimilate criticism from parties such as New York, and adjust its treatment of advance payments to conform with the realities of the natural gas market.” Since our 1972 decision, however, the Commission has reversed course in Orders 465 and 499 and has significantly enlarged the types of advances includable in the pipeline’s rate base.

On July 3, 1972, the FPC issued a Re-notice of Proposed Rulemaking and Request for Comments in Docket No. R— 411, stating that the new proceeding would “undertake a careful evaluation of the experience under Commission Order No. 441.” The notice requested comment on the advisability of continuing rate base treatment beyond the December 31, 1972, expiration date, restoring advances for exploration and lease acquisition to Account 166, handling advances to pipeline affiliates like advances to independent producers, and requiring producers to pay 7% annual interest on advance payments. Comments were filed by 49 respondents, including 21 independent producers, 13 pipelines, and 8 affiliated companies. The Commission also collected data from all pipelines that had filed advance payment agreements under the prior orders and sought comments from interested parties on the summary tabulations.

Order 465, December 29, 1972, extended the advance payments program for one year and made several major modifications. First, the Commission reallowed rate base treatment for advances in aid of exploration but continued to deny it for lease acquisition advances. Second, rate base treatment was extended to advances by a pipeline to an affiliate even though the affiliate obtained a working or other economic interest. Third, the five year repayment in full requirement of Order 441, was replaced with a provision that all that need occur within the five year period was commencement of gas deliveries, or a determination that the repayment would be made in another form of consideration. This relaxation was accompanied by a provision mandating the immediate removal of an advance from Account 166 and a refund to the pipeline’s customers within twelve months if an advance “results in the finding of proven reserves of natural gas, gas deliveries commence, but no gas flows to the advancing pipeline.” The Commission declined to call for a 7% interest payment on producers receiving advances. After New York’s petition for rehearing of Order 465 was denied on February 27, 1973, New York filed the present action for review..

Following another round of comments, the Commission issued Order 499 on December 28, 1973. This order continued the program for two years and extended it to Alaskan advances made under future contracts. Advances to independent producers resulting in the acquisition of a working interest were made eligible for rate base treatment, and the FPC refused to require that economic benefits derived from working interest advances be credited against the pipeline’s cost of service. The only limitation was the announcement of a general policy to deny rate base treatment for advances “in excess of costs for exploration, development and production incurred by the producer within a reasonable time from the date such amounts advanced are included in the pipeline’s rate base.” In its order denying rehearing, the FPC rejected New York’s request for standards for the implementation of this policy and announced that it would “examine each advance on a case by case basis.” The Commission has directed its staff to conduct an ongoing evaluation of the program’s effectiveness in alleviating the gas shortage. New York’s petition for rehearing of Order 499 was denied on February 22, 1974, and its petition for review of the order was filed on March 1, 1974.

II. STANDARDS OF JUDICIAL REVIEW

Section 19(b) of the Natural Gas Act provides that in review of Commission orders by the courts of appeals “[t]he finding of the Commission as to the facts, if supported by substantial evidence, shall be conclusive.” The Supreme Court has stressed that a presumption of validity attaches to the informed judgment of the Commission and that “those who would overturn the Commission’s judgment undertake ‘the heavy burden of making a convincing showing that it is invalid because it is unjust and unreasonable in its consequences.’ ”

In the Permian Basin Area Rate Cases, the Supreme Court delineated the responsibilities of reviewing courts charged with the duty of applying the substantial evidence standard.

[The] responsibilities of a reviewing court are essentially three. First, it must determine whether the Commission’s order, viewed in light of the relevant facts and of the Commission’s broad regulatory duties, abused or exceeded its authority. Second, the court must examine the manner in which the Commission has employed the methods of regulation which it has itself selected, and must decide whether each of the order’s essential elements is supported by substantial evidence. Third, the court must determine whether the order may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection to the relevant public interests, both existing and foreseeable.

These three duties are in effect summarized in Justice Harlan’s next sentence, which crystallizes the court’s function: “The court’s responsibility is not to supplant the Commission’s balance of these interests with one more nearly to its liking, but instead to assure itself that the Commission has given reasoned consideration to each of the pertinent factors.”

In its recent decision in Mobil Oil Corp. v. FPC the Supreme Court identified that the courts of appeals — rather than the Supreme Court with its “narrow and circumscribed” authority — had been assigned the major responsibility for assuring that the agency has given reasoned consideration to the material factors, and determining whether there was substantial evidence to support each of the essential elements of the agency’s actions.

In reviewing orders of the Federal Power Commission the courts are attentive to the requirement of “reasoned consideration” — the ultimate issue in judicial review of its determinations. In 1972, we said in pity of Chicago v. FPC, that in applying the “substantial evidence test . . . reasoned conclusions are the hallmark of regularity.” In 1973, we ruled, in Public Service Commission v. FPC (Texas Gulf Coast Area Rate Cases), that Commission efforts to obtain needed gas supplies “must be accompanied by reasoned consideration and coming to grips with issues.” In 1974, in Macdonald v. FPC, we held that the evidentiary record developed by the Commission must demonstrate that “it ‘has given reasoned consideration’ and ‘appropriate protection’ to the public interest in not paying prices for gas substantially in excess of those needed to induce production of an adequate gas supply.”

The Supreme Court’s recent decision in Mobil Oil does not alter the standard of judicial review set forth in its earlier opinions, although it provides a gloss for applying that standard to Commission efforts to remedy the nation’s pressing gas supply problems. In Mobil Oil, the Court affirmed the Fifth Circuit’s decision upholding the Southern Louisiana Area rate orders which included contingent escalation and refund credit provisions designed to induce gas producers to expand exploration and production. The Mobil Oil opinion relied extensively on the Permian Basin decision and expressly endorsed the “criteria governing the scope of judicial review” set forth in Justice Harlan’s opinion in that case. Mobil Oil stated that the court of appeals had not “misapprehended or grossly misapplied the substantial evidence standard” in adjusting that test “in this time of acute energy shortage” to provide greater freedom for novel Commission proposals.

For present purposes, the most pertinent aspect of Mobil Oil is its discussion of the Fifth Circuit’s conclusion that the refund credits and contingent escalations constituted appropriate means to assist capital formulation. The Court found that an inability to “determine the precise amount of additional gas supply that would be found and dedicated to interstate sales” as a result of the incentive formula was not fatal where “[t]he Commission took massive evidence on supply, demand, and the relation between the two” and where “[i]ts difficulties . . . did not stem from any failure to seek answers.” . Courts “cannot fairly demand the perfect at the expense of the achievable” and ought not insist on findings which are “unrealistically and unnecessarily refined.” However, problems which preclude precise quantification do not excuse the Commission’s abdication of its duty to indicate “fully and carefully the methods by which, and the purposes for which, it has chosen to act, as well as the consequences of its orders for the character and future development of the industry.”

We turn to an analysis of the extent to which the FPC has discharged this duty.

III. CHALLENGES TO THE ADVANCE PAYMENTS ORDERS

A. The Commission’s Analysis of the Experience under the Initial Advance Payment Orders

1. Data Advanced by the Commission in Support of its Orders

In the various rulemaking notices issued after our 1972 decision, the FPC proposed to undertake an “in-depth analysis of developments under the advance payment agreements.” The sum of its undertaking in each of these proceedings consisted of the solicitation of comments of interested parties on the general performance and selected aspects of the advance payments procedure and the compilation of data from all pipeline companies that had filed advance payment agreements. The information obtained from the pipelines included: (1) the amount of advances committed to producers; (2) the amount of funds actually advanced, divided into payments for lease acquisitions and exploration, development drilling, and proven reserves; (3) the quantity of proven and potential gas reserves associated with the advance; and (4) the dollar amount of advances recovered and estimated to be non-reeoverable.

In Order 465 the Commission relied primarily on the data provided by the participating pipelines to justify the extension of the program for one year beyond the initial December 31, 1972 expiration date. The Commission found that:

Attachment D schedules 11(a) and (b) show that Proved Reserves obtained in the Lower 48 [states] amount to 8.7 trillion cubic feet (Tcf) from advances subject to Order Nos. 410 and 410-A and 0.8 Tcf from advances subject to Order No. 441 for a total of 9.5 Tcf. Assuming that the total of pre441 advances in the lower 48 states ($481,849,239) are recovered on the average in 5 years, there is a one year lag between the advance and commencement of recoupment and an average cost to the consumer of 13% for return and taxes; we estimate that the added cost to the consumer for the 8.7 Tcf of proven reserves will be approximately 2.5