Public Service Commission of the State of New York v. Mid-Louisiana Gas Company – Oral Argument – March 22, 1983

Media for Public Service Commission of the State of New York v. Mid-Louisiana Gas Company

Audio Transcription for Opinion Announcement – June 28, 1983 in Public Service Commission of the State of New York v. Mid-Louisiana Gas Company

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Warren E. Burger:

We’ll hear arguments next in Public Service Commission of New York against Mid-Louisiana Gas.

Mr. Feit, you may proceed whenever you are ready.

Jerome M. Feit:

Mr. Chief Justice, may it please the Court.

This case poses a question of the statutory construction, whether Congress in the Natural Gas Policy Act of 1978 meant that natural gas produced by a pipeline is automatically entitled to the incentive pricing scheme under Title I of that Act.

Even though, as here, the gas is old gas long dedicated to the interstate market.

In our view, the Court in holding that the first sale prices and that the pricing scheme of Title I applied to this pipeline produced gas misconceived the legislative intent and argued, granted a profit to which the pipeline were not entitled, $200 million prospectively and something over $2 billion total projected.

These are complex matters under a complicated statutory scheme.

And I think it would be helpful as I use these words to indicate we’re talking about wellhead or field sales, mixed systems supply, commingling, downstream.

I think those terms are essential to the decision making in this case and they also have functional meaning in the history of pipeline regulation.

A pipeline gets its gas from many wells.

It can be, I guess, compared to a tree with roots.

Most of these wells are operated by independent producers.

Some are pipeline produced wells.

Normally, in the usual instance, these go through gathering lines, through processing plants and commingle in the pipeline and become part of fixed pipeline supply, mixed pipeline supply.

And they go downstream to the pipelines’… generally to the pipelines’ regular system customers.

A pipeline also, however, produces its own gas which it sells at the wellhead, principally to other pipelines, sometimes to other third parties.

In this sense… and that’s part of, essential of our argument… it functions like an independent producer.

These differences have very important regulatory considerations in the historical background.

First, very early in the application of the Natural Gas Act which was enacted in 1938, pipeline produced gas was deemed to be like other gas the pipeline transported in interstate commerce.

It was deemed to be part of the entire wholesale transaction.

Colorado Interstate, a decision of this Court, made that clear.

And it was subject to the cost-of-service methodology which, as the Court knows, places the initial risk on the consumer.

The gas of that nature is the gas involved here, where the risk, as I say, is the consumer risk.

On the other hand, as the Court will recall, it was not until 1954, when the Phillips case was decided, that the independent producer was deemed to be a natural gas company covered by the Act, by the Natural Gas Act.

As this Court recognized in Permian, the early years proved to be a time of very difficulty in any effort to regulate.

They didn’t… they weren’t natural gas companies in the traditional sense.

They didn’t transport in interstate commerce.

And individual cost-of-service regulation failed, as Permian points out.

The Commission then turned to a different way of regulating independent producers.

The regulation consisted of average industry costs based upon area and then national rates.

Jerome M. Feit:

This was essentially an incentive type pricing.

For example, the risk was on the investor.

If an independent producer produced only dry holes, he got no recovery.

If, on the other hand, he operated on less than average costs, dug a well which produced, then he was able to make a profit so that there was that investor risk approach.

Most pertinently as this development occurred, the affiliate of the pipeline, the affiliate of the pipeline, the producing affiliate of the pipeline was accorded the same treatment.

More to the point here the pipeline who sold at the wellhead was given this economic risk establishment, was also treated as an independent producer would be, that you have that kind of development.

At the same time, as the years went on, starting in ’69 when there was an indication of a gas shortage, the commission decided to give not cost based gas… all of that pre-’69 cost based gas was on cost-of-service… but mixed system supplied from a pipeline to be on parity, giving parity pricing to the independent producer, wellhead pricing, and to the pipeline, pricing of its wellhead sales.

But cost-of-service remained on cost-of-service.

As a matter of fact in the ’70’s, in the early ’70’s, the pipelines essentially either through agreements or through their own choice by saying we’d rather be on… we’d rather be on cost-of-service with… it serves our purposes better.

These special circumstance pipelines were allowed to be on cost-of-service.

Other pipelines as to this mixed system supply chose instead to get the area and national rates.

So you have at the time of the enactment of the Natural Gas Policy Act, that development coupled with the development that the result of the decision in the Phillips case had lead to an interstate regulated market and an intrastate unregulated market with regard to independent producer sales or sales like independent producers.

The consequence was that the market bifurcated.

The independent producer certainly, in shopping the market place as to his new wells, would prefer to sell it in the intrastate market, which he did… or which the producers generally did.

The consequences were there was less gas in the interstate market, more gas in the intrastate market, and high priced gas.

This was the bifurcation coupled with the fact that at that time the shortages commenced.

Now I would like, with that background, to turn to the statutory language.

Statutory language is set forth at page 2 of our main brief, or in the Appendix at E(1).

As the Court will note, the first portion of that statute, Section 2(21), was a definitional section.

It employed a term for sale.

And under that initial A of that section it appears that every sale… the universe of sales… was a first sales, kind of a jurisdictional marking point.

Every sale was a first sale.

The critical provision, however, is in subsection B, which says certain sales not included.

And the certain sales not included… and I’d like to… I think this is essential to point to the Court… that it shall not include the sale of any volume of natural gas by any interstate pipeline, intrastate pipeline, or local distribution company, or any affiliate thereof… and now the critical language… unless such sale is attributable to volumes of natural gas produced by the pipeline, the interstate pipeline, or the local distribution company, or the affiliate.

The Court of Appeals said, well, while there is no sale we must set up if there’s a intra-corporate transaction.

When the production division of a pipeline transfers the gas to the transportation division of the pipeline there is a hypothecated first sale.

Therefore the higher pricing provisions of the Title I of the Natural Gas Policy Act would apply.

We think that this interpretation flies in the face of the statute.

Section 2(20), which is also printed at page 2 of our brief, makes it clear that the term “sale” means a transfer for value.

There is no transfer for value in the context of the Court of Appeals analysis.

Jerome M. Feit:

More significantly, or equally significantly, there’s no contract.

There’s no relationship which traditionally has been the basis of regulation by this commission… by the FERC… under the Natural Gas Act.

The Mobil Sierra doctrine, as this Court will recall, makes it clear that the contract to the parties are the basis for the relationship.

The same principle attaches quite clearly under the Natural Gas Policy Act.

As this Court’s decision the other day at agency… in energy reserves makes clear, the critical consideration is, you don’t get the contract, you don’t get the statutory price, you get the contract price or whichever is lower.

So it seems to me that the initial interpretation by the Court of Appeals cannot withstand the statutory language.

There’s another interpretation which the Court of Appeals rejected, but which is made by several of the petitioners.

John Paul Stevens:

Before you leave that interpretation, am I correct in recalling that if the pipeline had a subsidiary instead of a single corporate entity that transferred from its wholly-owned production subsidiary to its transmission subsidiary, that you would regard that as a sale?

Jerome M. Feit:

I would regard that as a sale.

Let me say this, Mr. Justice–

John Paul Stevens:

Unless they do exactly the same bookkeeping for a division.

Jerome M. Feit:

–No, but there’s a difference.

John Paul Stevens:

What is the difference?

Jerome M. Feit:

The difference is that the affiliate has been on cost.

He acts like an independent producer.

He sells under a contract.

He sells at the wellhead.

Functionally, he’s the equivalent of the independent producer, and economically in that the risk lays with the investor.

Conceptually the affiliate performs like an independent producer.

The problem that you point to in terms of perhaps intra-corporate, it’s the same thing.

The statute has an affiliate entities limitations which makes it clear that where an affiliate producer sells to his affiliated pipeline he must sell at the comparable price sold by an independent producer.

Now, historically, it’s not clear in the ’50’s how they treated the affiliate producer.

There’s some indication that they deemed him to be part of the pipelines at the transportation.

But starting, I think clearly, in the late ’60’s and the early ’70’s affiliate production was like independent producer production, both economically and both functionally.

John Paul Stevens:

Well, wouldn’t it be possible to organize a division so that economically it was the exact equivalent of–

Jerome M. Feit:

I think it… no, only in the sense of–

John Paul Stevens:

–I can understand the statutory difference, but as a matter of economics or ordinary business and investment and all the rest, why couldn’t you have your division doing the same kind of operating that a subsidiary would.

Jerome M. Feit:

–I guess you could have that, but two answers.

One, the statutory scheme does not talk about that kind of intra-corporate transfer.

The word production… affiliate… production affiliates notes contracts and on the face of it, of the statute, it seems to us that there is a clear statutory distinction.

Jerome M. Feit:

Now in terms of… in terms of parity pricing which is parity with independent producer sales, the commission has given parity pricing to mixed system supply sales by a pipeline, but that’s not a matter of statutory interpretation.

That’s a matter of agency interpretation based on our view that Congress left to the commission the task of harmonizing the Natural Gas Act with the Natural Gas Policy.

John Paul Stevens:

Would you say the statutory language is so clear that if the commission had adopted the same construction as the Fifth Circuit had adopted that would have been impermissible–

Jerome M. Feit:

No, on the contrary.

I, we do not take the position that the statutory language… it doesn’t leap from the page.

I think it quite clearly… the statutory language has to be read in the context of the legislative background coupled with the deference if there… the rule as I understand it clearly is if there are two possible interpretations and the commission or the regulatory agency’s interpretation is a rationally based interpretation.

John Paul Stevens:

–So you would say that the commission rationally could have read it either way?

Jerome M. Feit:

Yes, and I say that the Court of Appeals didn’t give us deference.

John Paul Stevens:

I understand.

Jerome M. Feit:

Because it said that we had no input into the first sale definition.

But, yes.

I… let me turn a bit to what we view the legislative history to mean it to say.

The Court of Appeals… the central assumption of the Court of Appeals… they thought that there should be no distinction between pipelines and producers.

If producers are entitled to monies and the sale price, similarly a pipeline.

That is a basic fallacy in terms of the statutory scheme.

If one reads the legislative history and looks at the other indicia in the statute, wellhead pricing, the need to harmonize Title 6 which retains Natural Gas Act jurisdiction, and it reads the background of the history, it’s clear that Congress was making a discriminating judgment.

Congress was trying to overrule Phillips.

The history is interesting in that regard.

The Senate bill purported to decontrol, deregulate old gas and keep new gas under regulation.

It had an affiliate entities rule which seem to cover… cover pipeline produced gas.

On the other hand, the House bill… the House bill clearly was aimed at what they called the 1954 decision.

Well, the 1954 decision was Phillips.

Nor throughout the history of the debates for over two years did any pipeline that I could find in the history say, oh, yes, we’re entitled to this price.

That view… that view, in our judgement, was the one that Congress enacted in the Natural Gas Policy Act.

A discriminating statutory construction approach which meant to deal with the problem, the problem of Phillips.

Pipelines were not involved in the bifurcated market.

Pipelines had system supply.

They served their customers, the mixed system supply.

True enough, their production increased in times of shortage and helped the market that they were in.

But that, the commission recognized by its parity pricing policy.

Jerome M. Feit:

The bifurcation was a producing problem.

Whether the producer was the independent producer or, in fact, the pipeline who sold at the wellhead.

And I might point out in that regard that pipeline… our figures indicate that pipeline production is about 5.

, 5.1 percent of the total production, so that we’re dealing with an independent producer statute which says only those whether they be affiliates, whether they be pipelines who perform functionally and economically as the independent producer, are entitled to the independent producer pricing.

Lewis F. Powell, Jr.:

Is it your submission that an interstate pipeline company that also produces gas but does not do so through a subsidiary is not entitled to the benefits of the Act of ’78.

Jerome M. Feit:

Is not entitled to the first sale, yes.

Lewis F. Powell, Jr.:

So there’s never a first sale–

Jerome M. Feit:

It’s not first sale, first, because as… the statute language doesn’t compel it.

It’s not a first sale because… as a matter of fact we think it points the other way.

Lewis F. Powell, Jr.:

–But, is the purpose of the Acts served by your position?

Jerome M. Feit:

That’s precisely our point.

We think the purpose of the Act was to meet the Phillips problem.

We think the error, the fatal error in the Court of Appeals was its assumption that this was an entitlement.

I mean because… it seems to me a strange legislative doctrine that because you’re meeting the problems of independent producing production by… to avoid the bifurcated market that at the same time… and this seems to be the argument… at the same time while we pipelines, we’re entitled to it, too.

It seems to me there had to be a basic reason why pipeline production other than wellhead sale production… wellhead sale was intended by Congress.

In that… in that regard the commission left… we, the NGPA, as leaving to the commission the problem of harmonizing the Natural Gas Act with the Natural Gas Policy Act.

In that harmonization we have… that is the commission have… has set up a basis of attributing pricing similar to our independent producer production.

And I… my–

Lewis F. Powell, Jr.:

May I follow that up a little bit?

If 25 percent of all the natural gas in the United States were produced by interstate pipeline companies, would you take a different view?

Jerome M. Feit:

–I would have to see how that gas is sold and how the impact is–

Lewis F. Powell, Jr.:

If it were sold the same way as the gas before the bill–

Jerome M. Feit:

–I think the logic of my position would be that the basic purpose of the statute was to overrule Phillips and that we would read the statute as not covering that gas unless it could be shown that that gas production has a very substantial impact on the bifurcated market.

Lewis F. Powell, Jr.:

–But would it not… would it not have a substantial impact on the extent to which gas is produced in the United States?

Jerome M. Feit:

Yes, it would.

Let me just make my point… I repeat, the critical consideration is a contract… a contractual relationship.

For example, in your situation there would be no contract, so the pipeline could get the highest maximum lawful price while the independent producer who was operating pursuant to a contract would get a lesser amount.

Lewis F. Powell, Jr.:

But if the country has a shortage of natural gas, it seems to me, your position is awfully technical.

Jerome M. Feit:

Awfully… I’m sorry.

Lewis F. Powell, Jr.:

Awfully technical.

Jerome M. Feit:

It wasn’t–

Lewis F. Powell, Jr.:

If they had a contract–

Jerome M. Feit:

–I don’t think the contract revisions is technical.

You’re right Mr. Justice.

The statute–

Lewis F. Powell, Jr.:

–Or whether or not you have a subsidiary.

Jerome M. Feit:

–The statute is a technical statute, undeniably.

It’s very technical.

And as I say, it doesn’t leap from the page.

But to the extent that the gas produced by pipelines would have an effect on the Phillips type problem, my answer to you would be yes.

And I assume the more you found the gas industry producing in that fashion, the more likely one would say that Congress didn’t act stupidly.

It acted to solve the problem.

So I assume I would reach a point which says, yes, even though there’s not a contract.

What I’m suggesting is that that’s not the case.

The case is that there were 5.1 percent produced.

There was no contract.

There is no economic… economic functional equivalence.

And more to the point here… and I would like to emphasize, we’re dealing with old gas, always on cost-of-service.

And as a result of which, to us, this would be a windfall.

Sandra Day O’Connor:

Mr. Feit, is your argument a little bit inconsistent with FERC’s own findings in connection with its Order 98, that extending the NGPA pricing to this production would encourage production and help eliminate the dual market.

Jerome M. Feit:

I think that it’s not an inconsistency, I think.

Maybe it could be rationalized Our position is this, that Order 98… which by the way is not here in terms of the substantive basis… was based on the notion that the commission believed that the Natural Gas Policy Act left the Natural Gas Act control of pipelines intact.

In exercizing its discretion under the Natural Gas Act, the commission recognized that there were gas shortages, that there was need for gas in the interstate market.

And it was based upon that notion that it adopted the parity policy… parity plan.

Our position is simply that the statutory development was based upon essentially to get rid of Phillips.

The 1954 decision that appears in the House bill, it appears–

Sandra Day O’Connor:

It does seem there is a little tension between the articulations of FERC’s findings and your argument.

Jerome M. Feit:

–I would say there is a tension and perhaps FERC could have done it somewhat differently.

But it read the statute as essentially a matter with a functional and the economic equivalence were entitled to first sale status.

Sandra Day O’Connor:

Was any of the gas production by affiliates of interstate pipelines formerly subject to the cost-of-service treatment?

Jerome M. Feit:

It’s hard to say.

I would say early on… early on… in the early interpretation, affiliates who sold to their pipelines, that went into system supply, and the chances are yes.

But I want to emphasize that as we get into this late ’60’s and ’70’s we find that affiliate production is treated like independent producer production.

That is… as a matter of fact, they’d only sell to their pipelines.

Our figures show that they’d sell one third of their sales to a third parties.

The concern that the Court has with regard to the form over substance… that is, why should there be a difference between the two… it seems to us rests upon contract and Congress took care of that by saying that where an affiliate produced and sold gas to its pipelines, not to its third party… produced and sold to its pipeline, that in that situation there was an affiliate entities limitation.

The price had to be comparable.

Another point I would make in this regard.

There may be an argument that says that now they can spin it off.

The commission has indicated that it will look very closely at that possibility.

So it seems to me, in summary, and I’d like to preserve a bit of time, that this functional economic division remains.

The statute permits that reading.

The Court misconceived the history of the act and did not give this agency the deference in this very technical and difficult area.

Sandra Day O’Connor:

May I ask one more question, which is, do you agree with the petitioner, Arizonia Electric Coop.

, that the Court of Appeals should have remanded to FERC rather than vacating Order 98 once it determined that Order 58 was void?

Jerome M. Feit:

Of course my position is that 58 was–

Sandra Day O’Connor:

Yes, I know.

Jerome M. Feit:

–Was valid.

I… presumably yes, it should have sent it back.

Thank you, I’ll reserve what I have.

Warren E. Burger:

Mr. McKinney.

James D. McKinney, Jr.:

Mr. Chief Justice, may it please the Court.

This case is far less complicated than Mr. Feit would suggest.

Simply stated, the question in this case is simply whether Congress intended to include or to exclude natural gas produced by pipelines and distribution companies from the coverage of the Natural Gas Policy Act of 1978.

Now, Mr. Feit spent a great deal of time at the beginning of his argument talking about the Natural Gas Act of 1938, and that just isn’t relevant to this proceeding.

What we’re concerned with here is interpreting what Congress intended to do in the Natural Gas Policy Act and this Court itself on January 4th of this year found, in the Energy Reserves case, that for gas sold in the interstate market the Natural Gas Policy Act replaced the federal price controls that had been established under the Natural Gas Act.

Now petitioners argue that the Congress generally intended to exclude the production by pipelines and distributors from the coverage of the Act.

The Court of Appeals unanimously disagreed.

It found that the deference that’s normally viewed, agency determination, could not justify an interpretation that was contrary to the plain meaning and the purposes and the legislative history of the Act.

And there is no basis whatever for disturbing that decision.

James D. McKinney, Jr.:

In support of their position, the petitioners argue that Congress generally could not have intended to include pipeline production because this would be inconsistent with commission cost-of-service regulation for certain periods when the commission regulated production under the Natural Gas Act.

They also argue that the Court of Appeals erred, therefore, in not deferring to their interpretation and that the Court of Appeals decision would create a substantial reworking of state and federal regulatory schemes and that the pipelines would reap a windfall.

Now, in examining these arguments, the starting point is not the Natural Gas Act of 1938.

The starting point is to recognize the reasons leading to the passage of the Natural Gas Policy Act and the structure of the pricing provisions that Congress created to deal with the problem it was confronted with in 1978.

The Act was passed because of shortages that had developed in the interstate market in the 1970’s that had resulted from commission regulation under the Natural Gas Act.

It had two fundamental purposes.

The first purpose was to eliminate the disparity between the interstate and the intrastate markets.

And the second purpose was to provide incentive prices to encourage production.

To accomplish this the Act establishes a comprehensive pricing structure applicable to all categories of natural gas production.

Each of those pricing categories of gas production applies to any first sale of gas.

Therefore, the definition of first sale in Section 2(21) is very important, and that definition defines first sale broadly to mean any sale of any volume of natural gas.

By this broad definition, Congress plainly intended that the pricing structure of the Act would apply to all gas production sold in interstate or intrastate commerce.

However, without any further qualification, the ceiling prices would have applied to all downstream sales by pipelines where they were reselling gas that they had purchased by… from others.

Now to avoid this, Subsection B of Section 2(21)–

William H. Rehnquist:

Mr. McKinney, where in the briefs do we find these sections that you’re quoting?

James D. McKinney, Jr.:

–They are… throughout the briefs you will find the… Section 2(21).

It’s–

William H. Rehnquist:

I think page two and three of the government’s briefs is where it should be.

James D. McKinney, Jr.:

–It’s at page two of the brief of the mid-law respondents.

Now in Subsection B of the definition… this subsection generally provides that sales by pipelines are indeed not included within the first sale definition.

And if Congress had wanted to exclude pipeline production from the price ceilings of the act, if could have stopped right there.

But Congress knew that while pipelines function primarily as resellers they also produce their own natural gas for sale by their systems.

And in this respect they perform the same service as any other producer and should be subject to the incentives and ceilings of the Title I pricing structure.

Congress therefore added a critically important provision.

Congress said that a pipeline or distribution company sale is excluded unless… unless such sale is attributable to volumes of natural gas produced by such interstate pipeline, intrastate pipeline, or local distribution company or any other affiliate thereof.

Now this language on its face plainly is intended to provide that natural gas produced by pipeline companies should be subject to the price ceilings of the act and that the pricing structure of the act apply to volumes attributable to gas produced by the pipeline.

It doesn’t go on to say, but only to the extent the FERC in its discretion permits, or any other limiting language.

Petitioner’s interpretation simply would leave… would read the unless cause of the act.

Now Petitioners argue however that their interpretation would still leave some meaning to the unless clause while they acknowledge that pipeline production would be excluded from the acts coverage.

They argued that certain sales by the pipelines into their systems other than their… into other systems than their own, would still be covered.

James D. McKinney, Jr.:

Now the interpretation is based on the following reasoning, that the intracorporate transfer of gas from a pipeline’s producing properties is not a first sale within the meaning of the act, and secondly, that the downstream sale of the gas produced by the pipeline is mixed with other gas purchased by the pipeline and that the sale of those volumes is not exclusively comprised of the pipeline’s production, words the petitioners would add to the act.

However, neither of these arguments is supportable in any way.

The basic rationale that petitioners give for their positions is that their interpretation would give meaning to past commission regulation of certain pipeline production on a cost-of-service basis.

That is it, the entire rationale they rely upon.

Now first of all, this rationale is not supported even by the nature of past commission regulation itself.

Cost-of-service regulation hadn’t been applied to pipeline production or to pipeline affiliate production from leases acquired after 1969 or to any production developed since 1973.

And the reason that the commission had abandoned cost-of-service regulation, had abandoned that methodology because it, itself, had found that the methodology had been a failure in encouraging the pipelines to produce their own gas.

It made that finding in 1969 and abandoned the methodology.

Now, in addition, it should be recognized that contrary to what Mr. Feit has said this morning, or this afternoon, pipeline affiliates and pipelines themselves for their own production were treated exactly the same for comparable categories of production under Natural Gas Act regulation.

There was absolutely no difference.

Now even assuming arguendo then that the rationale they have put forward had any merit, it would apply with equal force to pipeline affiliate production.

And they make no argument that pipeline affiliate production is not expressly covered by the Natural Gas Policy Act of 1978.

No, the rationale they put forward doesn’t apply at all to intrastate pipeline production or distributor production.

The commission didn’t regulate that under the Natural Gas Act, and yet, Congress extended its regulation under the Natural Gas Policy Act to state production.

Moreover, Mr. Feit gave you no citation anywhere in the legislative history of this act which even remotely suggests that Congress sought to carve out in-production from the sweeping coverage of the act.

And you can’t real… you can’t read the conference report accompanying this legislation and come away with anything but the distinct impression Congress meant to establish a comprehensive uniform pricing structure to apply to all gas production sold in the United States whether interstate or intrastate.

Finally, the rationale would produce absurd results.

Apart from the fact that the rationale would treat pipeline affiliate production differently than pipeline affiliate… than pipeline production when they were treated the same under Natural Gas Act regulation, it also should be recognized that new gas, which is one of the categories under the Title I pricing structure, that new gas is no less new gas simply because it’s produced by a pipeline.

Yes, produced from certain high cost geological formations, has to be produced from that formation irrespective of whether a pipeline or an independent producer produces the gas.

There are many wells throughout the country that are jointly owned by a pipeline with other producers.

It is the height of absurdity to believe that the gas produced from that well by a pipeline should be valued any different than the gas from the same well owned by an independent producer or by a pipeline affiliate.

Now apart from the lack of support in the plain meaning of Section 2(21), there are other provisions of the act that also support the Court of Appeals decision.

Section 203(b) defines the cost of gas to be passed through to certain industrial customers.

The general rule of that section speaks of first sale acquisition costs is the price paid by the pipeline.

However, Subsection 2 had to state a separate rule applicable to pipeline production.

The separate rule expressly recognizes that the FERC must fashion rules governing the first sale acquisition cost for pipeline production.

Now the reference to first sale acquisition costs for pipeline production clearly evidences that Congress envisioned pipeline production would be the subject of a first sale at the intracorporate transfer point, where there is no price paid.

Otherwise, there is absolutely no meaning to that provision of the Act.

Notably also, the conference report accompanying the Act states that Section 501 provides authority to the commission to establish rules applicable to intracorporate transactions under the first sale definition.

Now it doesn’t say that the commission can exclude sales from the coverage of the act.

James D. McKinney, Jr.:

It says that the commission may establish rules applicable to intracorporate transactions under the first sale definition.

That clearly means the intracorporate transfers were considered by Congress to be under the first sale definition.

In fact, there is nothing in the Act which even remotely suggests that Congress intended to give the commission power to exclude production from the Act’s coverage.

The commission was only given the power to prevent the circumvention of the prices established in that Act.

Now, petitioners argue that intracorporate transfers do not involve certain conventional indicia of a sale such as a change of title or payment of cash.

Petitioners’ arguments in this respect are refuted by the plain meaning of the Act and by the commission’s own regulatory methods.

The term 2(20), but broadly to include any sale, exchange or other transfer for value.

Now the Court of Appeals properly rejected the narrow interpretation because it would have frustrated the comprehensive application of the act, and because it would have resulted in a rational discrimination between like categories of gas production.

Contrary to petitioners’ argument the intracorporate transfer does have significant legal and economic effects and they are transfers for value.

Transfer triggers the payment by the pipeline of royalties on the value of the production.

The transfer triggers the payment of state severance taxes on the value of the production.

And the transfer to the pipelines transmission system requires it.

William H. Rehnquist:

Mr. McKinney, your argument seems to have concentrated, just as I believed Mr. Feit’s did, on this section of the Act that defines first sale, and I realize the Court of Appeals concentrated on that too.

How does the first sale definition tie in to the other operative sections of the Act?

James D. McKinney, Jr.:

Well, there’s only one definition section for the entire Act, so any definition that’s set forth at the beginning of the Act is encompassed and is used for all of the titles of the Act so that the other–

William H. Rehnquist:

What’s the practical consequence of the commission’s definition of first sale?

I mean, what does that enable it to do or prohibit it from doing that it couldn’t have otherwise done?

What other sections of the Act are involved?

James D. McKinney, Jr.:

–Well the commission has… I think the commission is relying upon Section 2(21) which is in the definition section at the outset of the Act and they are saying that that section does not authorize them to regulate under the Natural Gas Policy Act intracorporate transactions by pipeline companies where they transferred their own production into their systems.

And I think they’re relying directly upon Section 2(21).

They may be referring to other sections of the Act, too.

We think other sections of the Act do support the fact that Congress intended that intracorporate transactions would be treated as first sales.

I’ve just cited the Section 203 and I plan to mention the Section–

William H. Rehnquist:

Well, what has the commission done insofar as regulating or not regulating by virtue of its definition of first sale, particularly the one that’s in contest here?

James D. McKinney, Jr.:

–They simply have failed to recognize that the definition of first sale does indeed include a sale by a pipeline of its own production.

William H. Rehnquist:

Well, how is that hurting your clients?

James D. McKinney, Jr.:

Well, because I represent the pipelines that have their own production and who are not therefore being given the incentive prices that Congress intended by the Natural Gas Policy Act of 1978.

But the commission wants to retain the very kind of regulation under the Natural Gas Act that lead to natural gas shortages in this country.

Sandra Day O’Connor:

Well, I guess your clients would receive substantial amounts of additional money if they were given first sale pricing on these intracorporate transfers.

James D. McKinney, Jr.:

That’s true, Justice O’Connor.

James D. McKinney, Jr.:

And there are some–

Sandra Day O’Connor:

And now that gets to the windfall argument and I would be interested to know how much of a windfall that would be.

Are we talking about a one time major pricing effect or would it even out after that, or what are we really talking about?

James D. McKinney, Jr.:

–I’d like to address the windfall argument right now.

The commission argues that because certain pipeline production was treated on a cost-of-service basis under the Natural Gas Act regulation, that the pipeline enjoyed certain benefits and less risk than independent producers.

From this premise they further argue that applying the Natural Gas Policy Act prices to pipeline producers would grant them a windfall.

This argument has no basis at all.

First of all, a pipeline can receive no greater price under the Natural Gas Policy Act for its production than is received for comparable categories of gas produced by independent producers and pipeline affiliates.

Secondly, the Act’s pricing structure itself–

John Paul Stevens:

May I interrupt right there.

Their argument, as I understand it, is that your risks of exploration and the rest have already been recouped through the cost-of-service pricing which was different than the others had so that they are different.

Are they wrong on that?

James D. McKinney, Jr.:

–Absolutely wrong.

First of all, a great deal of production developed with the pipelines.

The risks were taken for that production before there was a Natural Gas Act or any commission regulation under the Act.

The risks of whether they found gas were taken long before the Natural Gas Act of–

John Paul Stevens:

Confine yourself to the period in which there was cost-of-service pricing.

James D. McKinney, Jr.:

–Even during that period the question of whether or not a pipeline was returned the revenues required for it to be encouraged to go on with production was dependent upon a myriad of factors.

John Paul Stevens:

Well, but wait a minute.

Go through that again.

Assume it was inadequate, was it nevertheless different from other production… a different system of pricing?

James D. McKinney, Jr.:

Well, there was first of all… there was no difference at all between pipelines and pipeline affiliates.

John Paul Stevens:

Well, I understand that, but take a totally independent producer–

James D. McKinney, Jr.:

But between the independent producers… when Congress first embarked upon regulation of independent producers in 1954 up until 1960 they tried to regulate independent producers on a cost-of-service basis.

In 1960, in the second Phillips case, why, they abandoned that and went to area rate making.

Now under area rate making… incidentally, they abandoned it, they abandoned cost-of-service rate making for pipelines themselves in 1969, only nine years later.

In area rate making the commission determined a cost-of-service for an entire area.

And it allowed the same costs for that… in that determination as it would allow for an individual company cost-of-service.

There was no difference in the classification of the cost that went into that cost-of-service.

They were the same costs that went into the cost-of-service.

James D. McKinney, Jr.:

Now the argument of the commission is, well, but you were guaranteed somehow that you would get your exploratory costs back, your dry hole costs back, as a result of being on an individual company cost-of-service basis.

And to some extent, if you assumed that cost-of-service regulation, in fact, did work… and it didn’t… if you assume that it worked there would be some merit to their argument, but the point is that both the commission with respect to independent producer regulation abandoned the methodology, and then later abandoned it with respect to pipeline production as well.

And as I say, since 1969, they haven’t regulated pipeline or pipeline affiliate production on the basis of that methodology.

Sandra Day O’Connor:

–Well, Mr. McKinney, they… it did apply, did it not, the cost-of-service pricing, but your point is just that it was done on an area basis so it didn’t focus on individual companies?

James D. McKinney, Jr.:

With respect to independent producers, between 1960 and 1969, there was a difference between independent producers and pipelines and pipeline affiliates.

Pipeline and pipeline affiliates were treated on a cost-of-service basis.

Independent producers were treated on an area basis.

Later–

Sandra Day O’Connor:

But we’re talking about the pipelines, of course, here.

And so you were treated on a cost-of-service basis, and therefore the argument is that your clients would now get a windfall by application of this first sale pricing.

James D. McKinney, Jr.:

–But it simply is not a windfall.

The pipelines can’t get any more for their production than independent producers or pipeline affiliate producers.

Sandra Day O’Connor:

Well, call it what you will.

It would be more money.

James D. McKinney, Jr.:

They would get more money than if the commission were allowed to continue regulation they don’t have power under the Natural Gas Policy Act to administer, yes.

We wouldn’t be here if it weren’t for that.

But let me put that money in context.

There’s an Appendix D filed to the Consolidated Natural Gas Company brief in this proceeding which clearly shows that the impact of applying Natural Gas Policy Act prices to pipeline production is less than one and one half percent of the total impact of the Natural Gas Policy Act for the period of 1979 to 1981.

Now pipelines during that period contributed about five percent of U.S. production and this would strongly suggest that independent producer prices rise more than pipeline production under the Natural Gas Policy Act.

And I think it should be noted by this Court that the commission hasn’t brought to you any comparative analysis of the impact upon independent producers or pipeline affiliate producers of the Natural Gas Policy Act.

They’re only talking with one side of the aperture, one side of the coin–

Sandra Day O’Connor:

Weren’t pipeline affiliate producers getting cost-of-service pricing before?

James D. McKinney, Jr.:

–If there were… if I understand your question, Justice O’Connor, if there were a windfall, that windfall would be just as applicable to pipeline affiliate producers as it would be to pipeline producers.

Sandra Day O’Connor:

Well, that’s the point of the question.

James D. McKinney, Jr.:

Yes, and it would be.

And they were treated exactly the same under Natural Gas Act regulation.

If the affiliate sold his gas to the pipeline under Natural Gas Act regulation part of the price that he got back… because he was regulated on a cost-of-service basis for comparable periods, too… the price he got back was to reimburse him for his exploratory expenses as well, just as in the case of pipeline production that was taken directly into the system.

I’d like to say, just briefly, that there is no basis… we cover completely in our briefs the fact that the application of Title I prices either by state commission or by a federal commission doesn’t interfere with their regulatory processes one iota.

They can regulate the same as they always have the transmission costs of interstate pipelines or the distribution costs of distributors.

All they have to do is apply the Title I price at the point where the gas is actually produced.

James D. McKinney, Jr.:

And I might add, the commission itself does that when it regulates independent producer sales that are made far beyond the wellhead, either at the outlet of a processing plant or at a central point in the field.

The point of the sale isn’t the consideration, it’s whether or not gas is sold that’s the real point.

And that’s what Congress was trying to get across.

If you sell gas produced in the United States, we want it covered by this policy.

And they carved out absolutely no exceptions.

John Paul Stevens:

May I ask one other question.

As I understand you, the pipeline affiliates were on cost-of-service pricing before the new statute was passed.

And independent producers were on an area wide pricing, and you say well there really isn’t much difference because the same elements went into the calculation of the area wide pricing.

Were the price levels generally about the same or was there a material difference between the two?

James D. McKinney, Jr.:

I’m very glad you asked that.

The price levels would have varied, of course, from pipeline to pipeline but I certainly represent a pipeline where… which would have given its left arm to have had area rate making because the cost-of-service pricing that the commission administered on that pipeline was well below the area prices they would have been entitled to.

John Paul Stevens:

How typical was that situation?

James D. McKinney, Jr.:

I think it probably would have been more typical than not typical, although that would be quite a judgment to try to make.

Warren E. Burger:

Mr. Feit.

Jerome M. Feit:

Mr. Chief Justice, may it please the Court.

I just want to make a few points.

First, Justice Stevens, if the affiliate production by the late ’60’s and 70’s, the affiliate production were making wellhead sales and were costed at investor risk under the parity and national rates, so that there was a difference, cost-of-service gas was based upon the normal prudential investments which the consumer paid.

John Paul Stevens:

On their wellhead sales, but insofar as a pipeline affiliate production went into the pipeline transmission system, was that priced on a cost-of-service basis?

Jerome M. Feit:

In the ’70’s it was not.

John Paul Stevens:

It was not, so the two of you disagree–

Jerome M. Feit:

Unless it was… unless I’m… in general, it was not.

Unless, as I understand it, 569 was a ’69 order.

If it were… I don’t know… less than ten percent or more than ten percent or less… but in the ’70’s it was… even if it were sold to the pipeline.

But I want to make another point in that regard.

John Paul Stevens:

–Well this is quite important to me because it’s a rather dramatic difference between what the Court is being told by the two adversaries here.

You’re a hundred percent sure you’re right on this?

Jerome M. Feit:

Not… never a hundred percent sure I’m right.

I’m suggesting two things.

One, first, one third of the sales are made non… not to–

John Paul Stevens:

Well I understand, though, the wellheads–

Jerome M. Feit:

–The history is not, back here in the ’50’s.

My understanding is that the ’60’s and ’70’s, it was, whether sold to the pipeline… it was costed on area national rates.

Now I would like if the Court would wish me to submit a memorandum referring–

John Paul Stevens:

–No it’s… your whole argument is that all they want to do is overrule Phillips.

And if, to the extent that he’s right on what he’s represented to the Court, that’s a big hole in your argument.

Jerome M. Feit:

–Well I don’t–

John Paul Stevens:

Because if that was cost-of-service pricing for this body of production, however significant it may be, the commission has changed and maybe that’s because the statutory language is clear.

Jerome M. Feit:

–As my understanding is, by the ’70’s whether it was sold to the pipeline or to a third party, it was on area national rates.

Justice Rehnquist, you refer to what what other provisions of the Act would refer to… Title 6 deals with interstate pipelines and the costing of interstate pipelines.

It talks about a first sale as if obviously the pipeline purchased that from the producer.

At the bottom of the case though, it seems to me, that we’re talking about cost-of-service gas which is always been priced on traditional cost-of-service pricing.

There is nothing in this statute that suggests that Congress wanted to overrule that determination.

And it seems to us that if it had it would have said something.

What appears here constantly is reference primarily or basically to Phillips and independent producer pricing.

Unless the Court has any further questions.

John Paul Stevens:

Let me just ask this one question.

If your opponent were right about the affiliate gas, and then by the definition of sale, Congress did say something as to that gas, because clearly there is a sale within the literal language of the statute when a sale from a subsidiary to the parent.

And it did say something if he is right on his–

Jerome M. Feit:

If, in fact… if, in fact, that was a first sale, right.

John Paul Stevens:

–But it would be under the plain language of the statute.

Jerome M. Feit:

Well if… if–

John Paul Stevens:

Which would probably explain why the commission now draws that distinction.

Jerome M. Feit:

–Well it draws the distinction since the early ’70’s.

Unless the Court has any further questions.

Sandra Day O’Connor:

How significant, on the increase that we’re talking about–

Jerome M. Feit:

Yes, I wanted to mention that.

We haven’t retroactively determined the amounts, but speculatively we’re talking about $200 million a year.

And somewhere over $2 billion until this old gas… let me just make a reference… you reminded me… it’s about $2 billion total.

The real issue here is economically a stripper well gas, which means a well is depleted.

Cost-of-service his… the consumer has borne the risk.

Jerome M. Feit:

This is the highest price of regulated gas under the Natural Gas Policy Act pricing scheme if first sale prices were attributed to it, the pipeline company would be able to charge off all of the expenses of redeveloping that well on the highest… or one of highest NGPA pricing structures.

And it seems to us that in a section floor proceeding the normal way a pipeline gets its rates, prudent costs would apply.

But here you’re saying that a consumer has borne all the risks.

Its an old well, and suddenly incentive pricing permits these kinds of prices to go to interstate pipelines.

Lewis F. Powell, Jr.:

–May I ask this question?

In the conversation about windfall and about increased costs of gas, did not Congress contemplate that there would be an increase in the cost of gas as a result of the 1978 Act?

Jerome M. Feit:

Congress did but–

Lewis F. Powell, Jr.:

At least initially, the theory was that over time as more gas was produced, the economics of it would bring the price back down.

Jerome M. Feit:

–Yes, but I think in terms of a response to you, there was nothing in the Congressional debates that one of the incentive pricing schemes would apply to any other than independent producers and those that function like independent producers.

Lewis F. Powell, Jr.:

What about affiliates?

Jerome M. Feit:

That’s… my point is, you’re getting a response to the question, that affiliates up to the late ’60’s and early ’70’s functioned like independent producers.

The history is such that the Court must remember that up until the decision in Phillips the question of production ingathering was a problem.

An affiliate might not very well have been even deemed to be covered by the Act.

And it was in the late ’60’s where affiliate production became more and more like independent producer production.

The commission’s approach in the ’70’s and in Order 98, at the enactment of the 1978 Act, was precisely that.

That the affiliate, whether he sold to a third party or through his pipeline, is selling like an independent producer, and in our view, is entitled to that kind of pricing while the pipeline… as long as he doesn’t make a first sale… if he makes a first sale, as Herweg defined it, is not… a mixed system supply is not entitled to first sale pricing.

Lewis F. Powell, Jr.:

But apart from everything else our duty, as you suggested at the outset, is to construe the language of the Act and its legislative history to ascertain Congressional intent.

Jerome M. Feit:

That’s exactly what would be–

Lewis F. Powell, Jr.:

Without regard to who loses what where.

Jerome M. Feit:

–Without regard except that it suggests itself to me that Congress would hardly have adopted a theory without any affirmative statement to that effect which would have lead to what we think are the windfall pricing that would follow from treating pipeline production as a first sale.

Thank you.

Warren E. Burger:

Thank you, gentlemen.

The case is submitted.