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Cities Service Gas Co. v. Federal Power Commission

Rehearing Denied July 5 1946.: April 30, 1946.

CITIES SERVICE GAS CO.
v.
FEDERAL POWER COMMISSION ET AL. (STATE CORPORATION COMMISSION OF KANSAS ET AL., INTERVENERS).



Murrah

Before PHILLIPS, HUXMAN and MURRAH, Circuit Judges.

MURRAH, Circuit Judge.

This appeal brings here for review under Section 19(b) of the Natural Gas Act of 1938, 15 U.S.C.A. § 717r(b), an order of the Federal Power Commission entered July 28, 1943, directing the Cities Service Gas Company (herein called petitioner) to file on or before September 1, 1943, new schedules of rates and charges for natural gas sold in interstate commerce for resale, which would effect a reduction of "not less than" $4,445,871, as applied to its regulable sales for the test year 1941.

Petitioner is a wholly owned subsidiary of the Empire Gas and Fuel Company, which is in turn controlled by the Cities Service Company. Organized February 1, 1922 as the Natural Gas Pipe Line Company, petitioner acquired the properties of a number of other producing and transportation companies; was reorganized in November 1926 under its present name, and acquired the properties of still other producing and transportation companies, all the latter of which were owned or controlled by its parent, the Cities Service Company. As a result of these and other transactions with affiliated companies, petitioner, at all times presently material, was one integrated natural gas system, devoted to the production, transportation and sale of natural gas for resale for ultimate public consumption, and direct sales to industrial customers. As such, it owned extensive proven and producing gas reserves in the Panhandle Field of Texas, the Hugoton Field in Kansas and Oklahoma, and numerous other fields in Oklahoma and Kansas. It owned a pipe line system consisting of 4300 miles of main branch and field lines, with interconnections and connections with other pipe line companies, together with appurtenant and ancillary facilities, including 33 compressor stations, 3 dehydrating plants, a purification plant, 4 principle gas storage fields, meter stations, and about 1800 miles of telephone lines and circuits. The pipe line system is connected to its producing wells in the Panhandle and other fields in Kansas and Oklahoma, and these lines extend to and connect with local distribution systems, which serve about 265 cities, towns and communities in Kansas, Oklahoma, Missouri and Nebraska, including the metropolitan areas of Kansas City, St. Joseph, Joplin and Springfield, Missouri, and Kansas City, Lawrence, Topeka, Leavenworth, Wichita, and Hutchinson, Kansas. At these points, the gas is sold at the distribution gates under various contracts of "sale for resale", and to a considerable number of industrial and other direct sale customers.

During the test year of 1941, petitioner sold for resale 61,425,000 M.c.f. of natural gas, for which it received $12,903,500, and sold direct 40,700,000 M.c.f. for $4,335,500. The petitioner produced from its own wells in the Panhandle of Texas, Kansas and Oklahoma, 43% of its total natural gas requirements, and the remainder was purchased in the states of Kansas and Oklahoma, for which it actually paid the total sum of $2,716,722, or an average of $.0458 per M.c.f.

In arriving at a rate base for the purpose of determining the reasonableness of petitioner's regulable interstate wholesale rates, the Commission adopted and used the prudent investment formula, or actual legitimate cost, less existing depreciation and depletion, plus working capital. After adjustments to the Company's plant account as of December 31, 1941*fn1 the Commission found from the evidence that the actual legitimate cost of all the properties used and useful in the production and transmission of all the natural gas sold by it to be $66,977,654. From this amount, it deducted $20,779,558 for existing depreciation, and $1,024,891 for depletion of reserves, added $1,576,357 to cover construction work in progress, and $1,818,194 as a reasonable allowance for working capital, thus arriving at "the reasonable rate base for Cities Service Gas Company as an assembled whole and a natural gas utility" in the sum of $48,567,756.*fn2 The Commission allowed an annual rate of 6 1/2% on this rate base or a return of $3,156,904, which it found to be "fair and liberal."

For the year 1941, petitioner's books showed operation, exploration and development cost in the sum of $10,625,724. Of this sum, the Commission disallowed $380,000 as excessive profits realized by one of petitioner's affiliates, Cities Service Oil Company, under a contract for the extraction of natural gasoline and other residuals, for the asserted reason that the affiliate's profits under the contract exceeded by that amount a fair return on the property devoted to the process. It also adjusted the Federal income tax liability allowable as an expense to eliminate $1,822,148, leaving $7,810,137 as allowable operating, exploration and development costs for 1941.*fn3 Thus the Company was allowed to earn its expenses in this sum, plus the allowable return of $3,156,904, or a total of $10,967,041. Rents and other miscellaneous gas revenues totalling $121,782 was credited against this cost, leaving a net of $10,845,259, which the Commission denominated as "total cost of service including return". From total operating revenues (including regulable and non-regulable sales for the year 1941), the Commission deducted the allowable operating expense of $7,810,137, and the annual 6 1/2% return on the rate base, $3,156,904, to arrive at $6,393,889, which it called excess earnings before allocation to jurisdictional and non-jurisdictional sales.

In order to arrive at the cost of service for the jurisdictional sales, the Commission allocated the total cost of service between jurisdictional and non-jurisdictional sales, and by applying the so-called "demand and commodity" method, it found that $7,264,986 represented the total cost of service, including a fair return, for the jurisdictional sales, while $3,580,273 represented the cost of service for direct or non-jurisdictional sales. By subtracting the allocated cost of service for the jurisdictional sales from the gross revenue for such sales ($12,764,651), the Commission concluded that the petitioner's rates were excessive by the sum of $5,499,665. However, it made an additional allowance of $1,053,794 for cost of service for the petitioner's gas sales, subject to its jurisdiction, from a proposed transmission line connecting its properties in the Hugoton Field to its other marketing facilities, thus arriving at the ordered reduction in the wholesale rates.

The petition for rehearing contains thirty-three specifications of error, and they are brought forward in the petition for review under Section 19(b) of the Act. However, these objections have been regrouped for briefing and argument here, and they will be treated substantially in the order presented.

Jurisdiction of the Commission and scope of review - It is of first importance to take account of the respective provinces assigned to the Commission and the courts on review in order that we may perform the functions assigned to us without trespass upon the administrative prerogatives. The primary aim of the Natural Gas Act of 1938, 15 U.S.C.A. § 717 et seq., was to "protect consumers against exploitation at the hands of natural gas companies." Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 610, 64 S. Ct. 281, 291, 88 L. Ed. 333. To effectuate that purpose, the Act provides that all rates and charges subject to the jurisdiction of the Power Commission shall be just and reasonable, and declares that any charge which is not just and reasonable is unlawful. Sec. 4(a). To that end, the Commission is specifically authorized, after hearing, to determine "the just and reasonable rate", and to fix the same by order. Sec. 5(a).Any aggrieved party to an order of the Commission may obtain a review to the appropriate circuit court of appeals, which is vested with "exclusive jurisdiction to affirm, modify, or set aside such order in whole or in part. * * *" But, "the finding of the Commission as to the facts, if supported by the substantial evidence, shall be conclusive." Sec. 19(b).In delineating the scope of review, the courts have left no doubt of their disposition to give the Commission a free rein in the effectuation of the Congressional purpose. The administrative process is no longer fettered by judicial notions of the "economic merits" of the rate order.

It hardly seems necessary or appropriate to reiterate what has already been so emphatically said concerning the "broad area of discretion" committed to the Commission in the exercise of its statutory jurisdiction, to determine just and reasonable rates for the transportation and sale of natural gas subject to its jurisdiction, or to remind ourselves that if the Commission's order prescribing "just and reasonable rates", when viewed in its entirety, produces no arbitrary result, judicial inquiry is at an end. It is said that a finding of reasonableness made after a full hearing by the Commission is the product of "expert judgment", which carries with it a strong presumption that it meets the statutory requirements. And since the constitutional requirements are no more exacting than the statutory standards of the Act, there is an almost conclusive presumption that an order which meets the statutory standards does not exceed the bounds of due process. 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., supra, 320 U.S. at page 602, 64 S. Ct. at page 287, 88 l.Ed. 333; Colorado Interstate Gas Co. v. Federal Power Commission, 10 Cir., 142 F.2d 943, 945.Thus, the Commission is statutorily and constitutionally free to use any ratemaking formula it chooses, so long as the end result it produces will allow the regulated company to operate successfully, maintain its financial integrity, attract capital, and compensate its investors for the risk assumed. Federal Power Comm. v. Hope Natural Gas Co., supra; Colorado Interstate Gas Co. v. Federal Power Comm., supra; Federal Power Comm. v. Natural Gas Pipeline Co., supra.

Regulation of Producing and gathering of natural gas - Petitioner contends that in arriving at its rate order, the Commission exceeded its statutory authority by exercising regulatory jurisdiction over the production and gathering of natural gas.

It is true that the adopted rate base includes all of the production and gathering facilities of the petitioner, and it is also true that the Natural Gas Act specifically provides that its provisions "shall not apply * * * to the production or gathering of natural gas." Sec. 1(b). But the objections to the inclusion of these properties in the rate base for the purpose of determining just and reasonable rates for natural gas transported and sold interstate for resale has already been squarely met and conclusively decided. In the Colorado Interstate Gas case, the Commission included in the adopted rate base the production and gathering properties of the Canadian River Gas Company because, as here, they were an integral part of a natural gas utility. In that case we failed to find anything in the Act which prohibited the Commission from inquiring into and considering the production and gathering properties in respect to depreciation, operating expense, and revenues insofar as they had bearing upon the exercise of its jurisdiction to determine just and reasonable rates of natural gas transported interstate for resale for public consumption. On certiorari, the Supreme Court, after review and discussion of the applicable provisions of the Act, was of the opinion that it did not "preclude the Commission from reflecting the production and gathering facilities of a natural gas company in the rate base, and determining * * * the reasonableness of rates subject to its jurisdiction."*fn4 The late Mr. Chief Justice Stone, speaking for the minority, succinctly stated and upheld the contentions of the Company there and here, to the effect that the regulatory authority of the Commission began only with the delivery of gas into the petitioner's transmission pipe lines, and included only the interstate transportation and sale of the gas for resale; "That, since the wells and gathering facilities are not subject to Commission regulation, the cost or value of the gas upon its delivery to petitioner's transmission line must, for purposes of rate regulation of the regulated business of transportation and sale, be taken at its fair market value." Colorado Interstate Gas Co. v. Federal Power Commission, 324 U.S. 581, 617, 65 S. Ct. 829, 846, 89 L. Ed. 1206.

It is thus clear that under the prevailing view, the Commission did not exceed its jurisdiction by the inclusion of the production and gathering facilities in the rate base for purposes of determining just and reasonable rates for the transportation for resale of natural gas.

Rate Base - As we have seen, the Commission's adopted rate base for the purpose of calculating the allowable return is predicated solely upon actual legitimate cost of all properties devoted to the enterprise.*fn5 All proffered evidence of fair value was rejected for the asserted reason that the actual cost was accurately ascertainable from the books and records of the Company; that reproduction cost was at best "synthetic" and not taken from the books, did not purport to represent cost of actual investment, therefore the consideration of fair value of reproduction cost was unnecessary. The petitioner argues that fair value is inherent in ratemaking as the end product of the process, and that evidence of it is certainly admissible and its rejection reversible error. In particular, petitioner complains not only of the Commission's inclusion of its leaseholds and natural gas rights in the rate base at their nominal cost to its predecessors before they were first devoted to public service, but also of its disallowance of certain items which it contends represents actual legitimate cost.

Petitioner owned 720,252 acres of proven leaseholds and natural gas rights, consisting of approximately 113,000 acres in the Panhandle Field of Texas, 180,000 acres in the Hugoton Field in Oklahoma, and approximately 425,000 acres located in other parts of Oklahoma and Texas. As of December 31, 1941, these producing properties were carried on petitioner's books at a capital cost of $2,207,758, and petitioner contends that the actual legitimate cost of these leases as of the above date was $2,174,122. The Commission included all these leaseholds in the rate base as used and useful in rendering gas service, but found that only $1,644,349 of the amount claimed should be included in the rate base as actual cost of the leasehold. The balance of $529,733, representing past operating expenses, cost of abandoned leases, and capitalized interest thereon, was disallowed for the stated reason that since these expenses had been treated as operating expenses by the affiliated company which had acquired them, they could not be brought forward as capital cost in the rate base.

Most of the leaseholds and natural gas rights were originally acquired by petitioner's affiliates (especially those in the Texas Panhandle), while exploring for oil, and at a time when gas was considered a nuisance, and enormous quantities were being wasted because there was no marketable use for it. Consequently, large blocks of acreage (including 63,000 acres in one block in the Texas Panhandle), were acquired at a nominal cost, and in consideration of covenants to develop and pay royalties. When in 1935 these leases were sold and transferred to petitioner as a reservoir for markets which had been tapped in metropolitan areas, by the construction of large transmission lines from the producing area, they had of course become exceedingly valuable to the enterprise.

The Commission rejected proffered evidence of the fair value of these leaseholds as an essential part of the natural gas utility, on the grounds that it was wholly "immaterial and irrelevant" to the determination of just and reasonable rates, based upon actual investment of the properties devoted to the regulated business. The Texas Panhandle leases, on which was located 98 producing wells, and which in 1941 supplied 43% of the gas sold by petitioner, were included in the rate base at an actual legitimate cost of $392,610.84 (including top ground equipment). These leases were transferred by the Empire Gas and Fuel Company to the Cities Service Pipe Line Company in 1928, and in 1935 they were sold to petitioner for the sum of $1,056,000, actually paid.

In substance, the petitioner argues that although actual legitimate cost may be a permissible rate-making formula under the Natural Gas Act, yet it is not an inexorable rule which binds the Commission in the face of fundamental considerations of fairness to the contrary. It is pointed out that the allowance of the actual cost of the acquisition of the leases to the petitioner's predecessor at a time when natural gas was worthless at the point of production, is to overlook and fail to compensate for the going concern value of a complete natural gas utility, and fails to recognize the risk involved in the speculative field of exploring and developing adequate reserves, and transmitting the same to market.

There are some who hold to the principle that "realization from the risk of an investment in a speculative field, such as natural gas utilities, should be reflected in the present fair value." See Mr. Justice Reed dissenting in the Hope Gas case, supra, 320 U.S. at page 622, 64 S. Ct. at page 297, 88 L. Ed. 333. But if, under the prevailing view, the economic merits of a rate base is of no judicial concern (see special concurring opinion in Federal Power Commission v. Natural Gas Pipeline Co., supra, 315 U.S. at page 606, 62 S. Ct. at page 752, 86 L. Ed. 1037, and concurring opinion in Driscoll v. Edison Light & Power Co., 307 U.S. 104, 122, 59 S. Ct. 715, 83 L. Ed. 1134), we have not the right to intercede unless it is conclusively shown that failure to give consideration to the fair value of properties, including the valuable leasehold estates, will prevent the company from operating successfully as a public utility. It is said that "rates cannot be made to depend upon 'fair value' when the value of the going enterprise depends on earnings under whatever rates may be anticipated." Hope Natural Gas Co. case, supra, 320 U.S. at page 601, 64 S. Ct. at page 287, 88 L. Ed. 333. In other words, fair value is the end product and not the means of the rate-making process.*fn6 Fair value is no longer deemed an essential ingredient of an economic rate base for rate-making purposes. Federal Power Commission v. Natural Gas Pipeline Co., supra; Hope Natural Gas Co. case, supra; Colorado Interstate Gas Co. v. Federal Power Commission, 324 U.S. 581, 65 S. Ct. 829, 89 L. Ed. 1206.

In the Colorado Interstate Gas Company case, vast acres of gas producing properties of the Canadian Gas Company, located in the same Texas Panhandle Field, were put in the rate base of an integrated gas utility at their nominal cost to the utility's predecessors. We approved the action of the Commission in disallowing the difference between the actual original cost of the leases, and the sale price of the same to the utility first devoting them to public use, on the grounds that the difference between the actual cost and their cash sale price to an affiliated company was a "synthetic inflation", which had no place in the field of rate making. In support of certiorari, the Canadian River Gas Company, as the owner of the properties devoted to the integrated enterprise, strenuously complained of the refusal of the Commission to include the producing properties in the rate base at the cash sale price paid by the company first devoting them to public use. That point was taken on certiorari, 323 U.S. 807, 65 S. Ct. 427, 89 L. Ed. 644, and specifically treated on appeal. 324 U.S. at page 604, 65 S. Ct. at page 840, 841, 89 L. Ed. 1206. The majority of the court could not "say as a matter of law that the Commission erred in including the production properties in the rate base at actual legitimate cost". 320 U.S. at page 605, 65 S. Ct. at page 841, 89 L. Ed. 1206. But see Mr. Justice Jackson concurring, 320 U.S. at page 610, 65 S. Ct. at page 843, 89 L. Ed. 1206, and dissent of the late Mr. Chief Justice Stone, 320 U.S. at page 616, 65 S. Ct. at page 845, 89 L. Ed. 1206. A like contention was made and rejected in Panhandle Eastern Pipe Line Co. v. Federal Power Commission, 324 U.S. 635, 648, 65 S. Ct. 821, 89 L. Ed. 1241.

In view of these pronouncements, we regard the question no longer a debatable one in this court. Moreover, petitioner has offered no evidence from which we would be justified in concluding that the failure of the Commission to base the allowable return upon the fair value of the leaseholds at the time they were first devoted to public use results in the impairment of the financial integrity of the company as a public utility.

The exclusion of $529,723, representing past operating expenses, cost of abandoned leases, and capitalized interest, from the rate base, is fully supported by the Hope Gas case, wherein the majority of the Court expressed its views in the words of the Commission, "No greater injustice to consumers could be done than to allow items as operating expenses and at a later date include them in the rate base, thereby placing multiple charges upon the consumers." 320 U.S. at page 599, 64 S. Ct. at page 286, 88 L. Ed. 333.

Existing depreciation and depletion - As we have seen, the Commission deducted from the actual legitimate cost of the properties $20,779,558 for accrued and existing depreciation, and $1,024,891 for depletion of the producing properties. In so doing, it followed the recommendations of its staff, which computed both the annual and accrued depreciation on the average ascertained service life of the various classes of property included in the rate base. The accrued depreciation was calculated as the sum of the annual depreciation expense from the beginning of the property, less total net cost of the property retired.This formula was used and approved both in the Hope Gas case and the Colorado Interstate Gas Case, and has been acclaimed by the American Public Utility Bureau as the most practical and reasonable method of determining accrued depreciation under the actual legitimate cost formula of ratemaking.*fn7

We do not understand that the petitioner finds fault with the so-called "straight line economic life" method of determining annual and accrued depreciation, but it does contend that deprecistion is a fact, not a mere book entry or accounting concept, and that in arriving at its ...


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