Wisconsin v. Federal Power Commission/Opinion of the Court

Almost nine years have passed since this Court's decision in Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 74 S.Ct. 794, 98 L.Ed. 1035, holding that the Federal Power Commission has jurisdiction over the rates charged by an independent producer of natural gas. The present case, involving the same independent producer, Phillips Petroleum (Phillips), is a sequel to that earlier decision and strikingly illustrates the unique problems confronting the Commission in its efforts to achieve the goal of effective regulation

Following the remand in the Phillips case, the Commission, proceeding under § 5(a) of the Natural Gas Act, reinstituted its general investigation of the lawfulness of Phillips' rates with respect to its sales of natural gas in interstate commerce. Later, it consolidated with that investigation 12 proceedings under § 4(e) of the Act which involved the lawfulness of certain specific rate increases filed by Phillips under § 4(d) between June 1954 and May 1956. All of these rate increases had been suspended by the Commission for the maximum five-month period permitted by the statute (§ 4(e)) and had subsequently gone into effect subject to refund of any portion that might ultimately be found excessive (ibid.). With one minor exception, each of these increases had been superseded by a subsequent increase, all of which were in turn suspended and are the subject of separate § 4(e) proceedings not now before us.

Hearings in these consolidated proceedings did not begin until June 1956 and extended over a period of almost 18 months. All parties proceeded on the assumption that the lawfulness of Phillips' rates was to be determined on the basis of its jurisdictional cost of service for the test year 1954, and four full-scale cost-of-service studies were presented. A Commission Examiner in April 1959 issued a comprehensive decision (24 F.P.C. 590) comprising over 200 pages, in which he found that Phillips' jurisdictional cost of service for the test year was $57,280,218. He then ordered Phillips to calculate a rate which, when applied to 1954 volumes, would produce revenues substantially equal to its test year cost of service. This rate, with appropriate adjustments for quality, pressure, etc., was to be applied to all of the company's rate schedules on file with the Commission at the time of Commission approval.

Over one year later, in September 1960, the Commission issued the opinion that is the subject of the present litigation. 24 F.P.C. 537. Its basic conclusion was that the individual company cost-of-service method, based on theories of original cost and prudent investment, was not a workable or desirable method for determining the rates of independent producers and that the 'ultimate solution' lay in what has come to be known as the area rate approach: 'the determination of fair prices for gas, based on reasonable financial requirements of the industry' for each of the various producing areas of the country. 24 F.P.C., at 547. This means that rates would be established on an area basis, rather than on an individual company basis. As initial steps toward this end, the Commission did two things at the same time it issued the opinion in these proceedings. First, it promulgated a Statement of General Policy (S.G.P. 61-1), since amended on several occasions, in which it set forth area-by-area 'price levels' for initial and increased rate filings by producers, and stated that in the absence of compelling evidence it would not certificate initial rates, and would suspend increased rates, which exceeded these price levels. Second, the Commission announced that it would begin a series of hearings, each designed to cover a major producing area. (At least one of these hearings, involving the Permian Basin, is now well under way.)

The Commission, in its opinion here, gave several reasons for rejecting as unsuitable the individual company cost-of-service method. 24 F.P.C., at 542-548. In particular it emphasized that, unlike the business of a typical public utility, the business of producing natural gas involved no fixed, determinable relationship between investment and service to the public. A huge investment might yield only a trickle of gas, while a small investment might lead to a bonanza. Thus the concept of an individual company's 'prudent investment,' as a basis for calculating rates that would call forth the necessary capital and also protect consumers from excessive charges, seemed wholly out of place. Further, the Commission noted that the individual company cost-of-service method gave rise to staggering cost allocation problems, could result in such anomalies as widely varying prices for gas coming from a single field and even from a single jointly owned well, and would create an intolerable administrative burden in requiring a separate rate determination for each of the several thousand independent producers.

Returning to the proceedings before it, the Commission decided that, despite its disapproval of the cost-of-service method, the whole case having been tried on that basis, a final administrative determination of cost of service for the test year should be made. It then proceeded to resolve a number of difficult questions, including those relating to allocation of production and exploration costs, allocation of costs between natural gas and extracted liquids, and rate of return, and arrived at a system-wide jurisdictional cost of service for the test year of $55,548.054-a figure which substantially exceeded jurisdictional revenues ($45,568,291) for that year.

With this determination in hand, the Commission turned to the consolidated § 4(e) proceedings, involving specific rate increases filed through May 1956, and found that those increases had produced increased revenues of only about $5,250,000 annually, or considerably less than the total deficit for the test year. It also stated that there was nothing in the record to show that any of the increased rates were 'unduly discriminatory or preferential.' It then concluded that since it could not order refunds of any portion of these increases, in view of the continuing deficit, and since all increases had been superseded, there would be no purpose in continuing the § 4(e) proceedings and, with two exceptions, they were were terminated.

The two exceptions concerned rate increases under 'spiral escalation' clauses in Phillips' contracts, and these two proceedings were kept open because the proper amount of the particular increases depended on the amount of increases, if any, allowed to certain pipeline customers of Phillips in their own rate proceedings then pending before the Commission. The Commission refused to hold such spiral clauses void ab initio, and in fact a rate increase in one of the 10 terminated § 4(e) proceedings had resulted from the operation of a spiral escalation clause.

The Commission recognized that there remained almost 100 other § 4(e) proceedings, involving increases filed by Phillips, that had not been consolidated in this case. It said that since the present record indicated that Phillips' costs exceeded revenues at least through 1958 it was inviting Phillips to file motions to terminate all § 4(e) proceedings relating to increases filed prior to 1959, thus limiting future consideration of Phillips' rates to 1959 and after. Whether this invitation has been accepted by Phillips is not disclosed, but in any event none of these other § 4(e) proceedings is before us now.

Turning to the § 5(a) investigation of the lawfulness of Phillips' existing rates, the Commission first noted that there was considerable disagreement over how these rates should be set whether they should be approximately uniform throughout the country or should vary from area to area. It then said that it was aware that both costs and prices had greatly increased since 1954 (and especially after 1958) and it therefore did not 'deem it appropriate to prescribe or require that Phillips file rates for the future based upon the present record.' 24 F.P.C., at 575-576. Concluding that the public would be adequately protected by Phillips' potential refund obligations under § 4(e), by the area pricing standards announced in the Statement of General Policy, and by the area rate proceedings to be intiated, the Commission ordered the termination of the present § 5(a) investigation.

On application for rehearing, the Commission rejected the suggestion that it should reopen the case for submission of 1959 cost data. 24 F.P.C. 1008. It said that the 'interest of consumers and the exigencies of regulation will be better served in rate proceedings brought on an area basis rather than on an individual company basis,' and that the area method would lead to 'more effective and expeditious regulation of the producer sales.' 24 F.P.C., at 1009. It also rejected the claim that it had erred in terminating the § 4(e) proceedings because some of the increased rates were inexcess of the average unit cost of service, reiterating that there had been no showing of undue discrimination or preference and that the total revenue resulting from the increases did not make up the deficit shown by the test year determination.

On review, the Court of Appeals, in a thorough and informative opinion, affirmed the decision of the Commission. 112 U.S.App.D.C. 369, 303 F.2d 380. Judge Fahy, dissenting in part, argued that whether or not the area rate method of rate regulation was the ultimate solution, the Commission having gone so far in this proceeding should have finished it by deciding on a cost-of-service basis the justness and reasonableness of Phillips' past increases and of its present rates. To have failed to do so, he believed, was a clear abuse of discretion. We granted certiorari because of the importance of this case in the administration and future operation of the Natural Gas Act. 369 U.S. 870, 82 S.Ct. 1139, 8 L.Ed.2d 275.

The arguments of the parties, both in their briefs and at the bench, have covered a broad range of subjects, including a number of other administrative actions and proceedings-past, present, and future-that are not before us today. We lay these collateral subjects to one side and focus on the three precise questions that have been brought here for review: whether the Commission erred (1) in refusing to reject certain increased rates because they were based on spiral escalation clauses; (2) in terminating the 10 consolidated § 4(e) proceedings involving increases now superseded and in leaving two such proceedings open only for a limited purpose; or (3) in discontinuing the § 5(a) investigation of the lawfulness of Phillips' current rates. Of these three questions, which will be considered in the order stated, the third is the only one vigorously pressed by all petitioners and is clearly the principal issue in the case

California, alone among the petitioners, challenges the Commission's refusal to declare void ab initio the spiral escalation clauses in Phillips' contracts on which rate increases in three of the 12 § 4(e) dockets were based. Such clauses, California contends, are manifestly inconsistent with the public interest, because they constitute a price mechanism by which '(c)onsumers of natural gas are caught in a maelstrom.'

But we have at least grave doubts that this question may be raised by California at this time. As to two of the three dockets, the claim would appear premature, since the dockets are still pending, and the increases there involved may eventually be disallowed if the pipeline increases on which they depend are themselves disallowed by the Commission. As to the third docket, the particular increase has been made fully effective by termination of the § 4(e) proceeding, but since the sale in question is to the Michigan-Wisconsin pipeline and appears to affect no California interests, no one whom California may properly represent is 'aggrieved' (§ 19 (b)) by the Commission's order.

Further, we see no merit in California's contention. It is true that the Commission has announced prospectively that it would not accept for filing contracts containing such clauses, but it would have been quite a different matter for the Commission to have declared that past rate increases were ineffective simply because they were based on spiral provisions. The effect of a contract clause of this type, of course, is only to permit the producer to resort to the filing provisions of § 4(d) of the Act. If the increase is challenged, the producer must still establish its lawfulness wholly apart from the terms of the contract. Thus we have sustained the right of a seller to file an increase under a contract which, in effect, authorized him to do so at any time. United Gas Pipe Line Co. v. Memphis Light, Gas and Water Division, 358 U.S. 103, 79 S.Ct. 194, 3 L.Ed.2d 153. The spiral clauses here are far more limited in scope, depending as they do on the occurrence of external events.

The claim that the Commission erred in terminating 10 § 4(e) dockets, and leaving two others open only for a limited purpose, is pressed primatrily by Wisconsin and New York. In considering their contentions, it should be noted again that all of the rate increases involved were filed prior to the end of 1956, and have since been superseded or 'locked in' by subsequent increases which, with one exception, have been suspended and made the subject of separate § 4(e) proceedings.

The Commission's termination of these § 4(e) dockets was a decision on the merits. It was based on the finding that the annual increase in revenue produced by these increased rates was substantially less than the deficit for the test year 1954. Petitioners' principal objection appears to be that Phillips' overall, and unit (per Mcf.), revenues increased so substantially that they may have exceeded costs during the 1955-1959 period for which the increases were allowed. But the fact is that Phillips' average unit revenues during this period never rose significantly above its test year unit revenue requirements as determined by the Commission. Moreover, petitioners do not claim, nor could they on this record, that the test year cost of service was higher per unit than in subsequent years. And assuming that unit costs did not decline, it is clear that the increases here did not even bring unit revenues up to those unit costs. Whether other subsequent increases involved in separate proceedings not before us resulted in revenues exceeding cost of service in later years has no effect on the propriety of terminating these § 4(e) dockets. Thus the factors that may have made the record stale for purposes of determining in the § 5(a) investigation whether Phillips' present rates are unjust or unreasonable do not make the record stale for purposes of determining the lawfulness of these past increases.

Petitioners also claim that the Commission terminated the § 4(e) proceedings improperly because it failed to make any finding that the increased rates in question were just and reasonable. But this contention goes to the form and not the substance of what the Commission did. Since these increased rates were 'locked in,' their validity for the future was not at issue; the sole question was whether all or any part of the increases had to be refunded by Phillips. Having decided on the basis of substantial evidence that the increases did not bring revenues up to cost of service, the Commission properly concluded, on the only matter before it with respect to these dockets, that no refund obligation could be imposed.

It was urged on rehearing before the Commission, and in the court below, that some of the increased rates were above average cost of service and that at most the Commission should have terminated only those § 4(e) dockets in which the increased rates did not exceed the average unit cost of service. The Commission rejected this contention, stating that Phillips' rates would normally vary greatly because sales were made at widely separated points and under different conditions, and that there was little or nothing to be gained by entering a protracted investigation of allocation of costs to particular past rates 'when it is already known that Phillips was not earning its whole cost of service.' 24 F.P.C., at 1009.

We believe this conclusion was justified, and petitioners appear to have all but abandoned the theory that some of the § 4(e) dockets were improperly terminated merely because the particular increased rates in those dockets exceeded average cost. Rather, they now urge that the variation in the increased rates was so great as to compel the conclusion that they were 'discriminatory and preferential per se.' The Commission noted that there was nothing in the record to show unlawful discrimination, and it is clear that mere differences in rates under this Act are not per se unlawful. But in any event, we need not reach the merits of the claim of discrimination because it is not properly before us. It was not presented to the court below, nor was it adequately raised on application to the Commission for rehearing, a step required by § 19(b) of the Act in order to preserve a point for judicial review. See, e.g., Sunray Mid-Continent Oil Co. v. Federal Power Comm'n, 364 U.S. 137, 157, 80 S.Ct. 1392, 1403-1404, 4 L.Ed.2d 1623.

The final question is whether the Commission was justified in terminating the § 5(a) investigation of the reasonableness of Phillips' current rates. Preliminarily, it is important to observe that the Commission's accomplishments since the original Phillips case, the validity of the Statement of General Policy 61-1, the actions taken pursuant to it, and the lawfulness of the area pricing method are not themselves before the Court for review. To a limited extent, however, these matters do bear upon the propriety of the Commission's decision to terminate this § 5(a) proceeding.

As the petitioners recognize, the issue is whether the termination constituted an abuse of discretion, a discretion which in general is broad but which the petitioners urge is a good deal narrower in a proceeding that has gone this far than in the case of a decision whether or not to initiate an inquiry. See Minneapolis Gas Co. v. Federal Power Comm'n, 111 U.S.App.D.C. 16, 294 F.2d 212. Underlying petitioners' position are their claims that the result of the termination is little or no effective regulation in the interim period before the development of area rate regulation, that such regulation may take many years to evolve, and that the method may eventually be held invalid.

1. The petitioners are not of one mind as to the feasibility and lawfulness of the area rate method of regulation, although no one questions the Commission's right to undertake the experiment. California appears to come closest to the view that the individual company cost-of-service method is the only lawful basis for rate regulation and that the invalidity of the area approach is therefore predictable. If we believed that such a departure from present concepts had little, if any, chance of being sustained, we would be hard pressed to say that the Commission had not abused its discretion in terminating this § 5(a) proceeding while undertaking the area experiment. For if area regulation were almost sure to fail, and if the individual company cost-of-service method of determining the reasonableness of rates had been abandoned, then there would be virtually no foreseeable prospect of effective regulation. Difficult as the problems of cost-of-service regulation may be, they would not warrant a breakdown of the administrative process.

But to declare that a particular method of rate regulation is so sanctified as to make it highly unlikely that any other method could be sustained would be wholly out of keeping with this Court's consistent and clearly articulated approach to the question of the Commission's power to regulate rates. It has repeatedly been stated that no single method need be followed by the Commission in considering the justness and reasonableness of rates, Federal Power Comm'n v. Natural Gas Pipeline Co., 315 U.S. 575, 62 S.Ct. 736, 86 L.Ed. 1037; Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333; Colorado Interstate Gas Co. v. Federal Power Comm'n, 324 U.S. 581, 65 S.Ct. 829, 89 L.Ed. 1206, and we reaffirm that principle today. As the Court said in Hope:

'We held in Federal Power Commission v. Natural Gas Pipeline     Co., supra, that the Commission was not bound to the use of      any single formula or combination of formulae in determining      rates. Its rate-making function, moreover, involves the     making of 'pragmatic adjustments.' Id., 315 U.S. at page 586,      62 S.Ct. at page 743, 86 L.Ed. 1037. And when the     Commission's order is challenged in the courts, the question      is whether that order 'viewed in its entirety' meets the      requirements of the Act. Id., 315 U.S. at page 586, 62 S.Ct. at page 743, 86 L.Ed. 1037. Under the statutory standard of     'just and reasonable' it is the result reached not the method      employed which is controlling.' 320 U.S. at 602, 64 S.Ct., at      287, 288, 88 L.Ed. 333.

More specifically, the Court has never held that the individual company cost-of-service method is a sine qua non of natural gas rate regulation. Indeed the prudent investment, original cost, rate base method which we are now told is lawful, established, and effective is the very one the Court was asked to declare impermissible in the Hope case, less than 20 years ago.

To whatever extent the matter of costs may be a requisite element in rate regulation, we have no indication that the area method will fall short of statutory or constitutional standards. The Commission has stated in its opinion in this proceeding that the goal is to have rates based on the 'reasonable financial requirements of the industry' in each production area, 24 F.P.C., at 547, and we were advised at oral argument that composite cost-of-service data will be considered in the area rate proceedings. Surely, we cannot say that the rates to be developed in these proceedings will in all likelihood be so high as to deprive consumers, or so low as to deprive producers, of their right to a just and reasonable rate.

We recognize the unusual difficulties inherent in regulating the price of a commodity such as natural gas. We respect the Commission's considered judgment, backed by sound and persuasive reasoning, that the individual company cost-of-service method is not a feasible or suitable one for regulating the rates of independent producers. We share the Commission's hopes that the area approach may prove to be the ultimate solution.

2. This is not a case in which the Commission has walked right up to the line and then refused to cross it-a case, in other words, in which all the evidence necessary to a determination had been received but the determination was not made. Here, the Commission concluded that the record, relating to the test year 1954, was too stale in 1960 to permit a finding as to the justness and reasonableness of Phillips' current rates. In view of this inadequacy, and since the Commission must establish the unlawfulness of present rates before taking further action in a § 5(a) proceeding, continuation of the proceeding would have required remanding the case for the receipt of evidence as to costs in at least one subsequent test year. None of the petitioners specifically challenges the Commission's conclusion that, for § 5(a) purposes, the record was stale in 1960; a fortiori it is stale today9

Thus the question whether the Commission abused its discretion in terminating the proceeding must be measured against the only alternative: remanding for additional evidence. Such a remand undoubtedly would have consumed considerable time and energy, including that of the Commission and its staff, and would almost certainly have involved another decision by a hearing examiner, another appeal to the Commission, another petition for rehearing and further judicial review of complex and difficult issues. In short, the alternative rejected by the Commission would not have resulted in definitive regulation of Phillips' rates immediately or in the near future. Indeed, several years might have elapsed before even the method of regulation which the Commission regards as unsuitable would have become effective as to even this one producer.

3. It is contended that, as a result of the decision to terminate this § 5(a) proceeding, the public will receive significantly less protection against the charging of excessive prices by Phillips (and others) in the interim period before the area method sees the light of day. Were this the case, it would bear importantly on our review of the Commission's exercise of its discretion. But in this connection several factors should be noted. First, the record before us does not paint a picture of the public interest sacrificed on the altar of private profit. Indications are that at least until 1959 Phillips' jurisdictional revenues did not catch up to its cost of service. Although revenues increased substantially after that time, the Commission observed that costs have also risen dramatically, and we have no basis for assuming that current rates are grossly unreasonable.

Second, most of Phillips' increased rates now in effect are the subject of pending § 4(e) proceedings and are thus being collected subject to refund. Refund obligations, it is true, do not provide as much protection as the elimination of unreasonable rates, see Federal Power Comm'n v. Tennessee Gas Transmission Co., 371 U.S. 145, 154-155, 83 S.Ct. 211, 216-217, 9 L.Ed.2d 199, but they are undoubtedly significant and cannot be ignored, as some of the petitioners would have us do.

Third, it is clear that since the Commission's decision in this proceeding, the upward trend in producer prices has been substantially arrested, and in at least one important area the trend has actually been downward. Although the Statement of General Policy did not purport to establish just and reasonable rates, see note 7, supra, the price levels declared in that statement, along with implementation of the program there announced, appear to have played a significant role in accomplishing this result.

Fourth, it must be remembered that the problem of this transitional period would still exist if the present § 5(a) proceeding were reopened for the taking of new evidence; there is no way of predicting how much time would be required for a final decision to be rendered, but it would inevitably be substantial. It is therefore evident that the choice is not between protection or no protection. There will in either event be some protection, though doubtless with room for improvement, for several years.

Petitioners claim that forcing the Commission to reopen this § 5(a) investigation will not unduly delay area rate proceedings and will in fact provide useful information for area rate-making purposes. The Commission, with equal vigor, states that it does not have the facilities to reopen this case (and all others that have reached approximately the same stage) and at the same time to proceed expeditiously with its area investigations. It estimates that the Permian Basin area proceedings, a case involving some 35% of Phillips' jurisdictional sales and roughly 10% of sales by all producers, will be completed in about the same time that would be required to complete a remanded § 5(a) proceeding relating to Phillips alone. It warns that if it is required to reopen this and similar proceedings, the result may be to delay unduly the area investigations, while compelling adherence to a method the Commission deems unworkable, thus providing significantly less protection for the public both in the long and the short run.

The Court cannot resolve this dispute against the Commission and tell it that it has made an error of law-abused its discretion in deciding how best to allocate its resources. The case might be different if the area approach had little or no chance of being sustained; if the present record were now ripe for determination of reasonable rates for Phillips on an individual company cost-of-service basis; or if it were manifest that the public would receive significantly less protection in the interim period than if the proceeding had not been terminated. But as we have already concluded, none of these conditions exists, and in their absence a reversal of the Commission would be a sheer act of interference in the details of the administrative process. Indeed, it might well have the effect of postponing even further the time when effective regulation will be realized.

Finally, the fact that the Commission in this case terminated the § 5(a) proceedings, rather than merely holding them in abeyance as it did in Hunt Oil Co., 28 F.P.C. 623, is a circumstance of no significance. At the oral argument general counsel for the Commission assured us that the Commission remains free to reactivate the investigation of Phillips' individual rates if the area proceedings are unduly delayed or if circumstances should otherwise warrant. The distinction between termination and suspension of the § 5(a) proceedings is thus on of form and not of substance. In either event the Commission retains the flexibility it must have at this still formative period in a difficult area of rate regulation.

Affirmed.

MR. JUSTICE CLARK, with whom THE CHIEF JUSTICE, MR. JUSTICE BLACK and MR. JUSTICE BRENNAN join, dissenting.