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Natural Gas Pipeline Co. v. Federal Power Commission


April 14, 1941


Petition for Review of Interim Order of the Federal Power Commission.

Author: Evans

Before EVANS and SPARKS, Circuit Judges, and LINDLEY, District Judge.

EVANS, Circuit Judge.

Presented for review is an interim order of the Federal Power Commission, directing the petitioners to reduce their rates on natural gas, so as to reflect an annual reduction in their operating revenues of not less than $3,750.000.

Petitioners own natural gas reserves in Texas. They produce the natural gas and transport it through their own pipe lines to the State of Illinois, where it is sold wholesale - 90% to one customer. They produce 75% of the gas they sell and purchase the remaining 25% from another producer. They were in business for nearly eight years before the Natural Gas Act, 15 U.S.C.A. § 717, et seq.,*fn1 became effective, June 21, 1938.

The interim order,*fn2 complained of, was entered by the Commission, July 23, 1940, accompanied by a detailed memorandum showing the basis for the order. There were also specific findings. It was made upon a motion by respondent, Illinois Commerce Commission, for an "immediate order." This motion was followed by petitioners' plea to the jurisdiction and an answer. The motion for the interm order was made before termination of a complete investigation, but after fifty-five days of hearing. The order was entered six months later.

Briefly stated, the Commission ordered the $3,750,000 reduction in revenues on the following fact assumptions:

Investment for rate base purposes . . . $74,420,424

(this made up of reproduction cost, value of gas reserves,


additions, and working capital.)

A return of 6 1/2% was allowed 6 1/2


Annual amortization was added 1,557,582

(The amount allowed for amortization covered a period of 23

years, from 1932 to 1954.)

Total deductions . . . 6,395,180

The adjusted average annual net income was . . . 9,362,032

The above determined required amount was . . . 6,395,180

Excess . . . 2,966,852

The lessening of petitioners' income by this amount would result in an income tax saving. Hence the total reduction ordered was increased from $2,966,852 to $3,750,000.

A many sided attack on the order is made by the petitioners.

First, they challenge the Commission's jurisdiction to enter this order because:

(a) The only authority given by the Act is to enter a final order.

(b) There is only authority to enter orders determining rates (Sec. 5, 15 U.S.C.A. § 717d), whereas here the order directed reduction of income and left the company to determine the rates, which burden is doubled because they have contracts with varying rates, and they are not instructed how to apportion the reduction.

(c) The constitutionality of the Act is attacked because the companies' business is a private business and this Act, contrary to the Fifth Amendment, makes it subject to regulation as a public utility, and they have not even an apportunity to withdraw from business.

(d) The companies are not the kind of companies meant to be covered by the Act.

(e) There has been a denial of due process because that has been no full hearing.

(f) Since the companies' existing rates are presumably reasonable, the Commission has the burden of showing the contrary, and it has not sustained its burden. It has merely provided for a return, barely non-confiscatory, rather than reasonable, and ignored the fact that the profits arose from the operator's engineering skill and the fact that the profits accruing are but a reasonable reward for the risk involved.

(g) The Illinois Commerce Commission has no legislative authority to move for such an order, and the Federal Power Commission in moving for such order is acting as prosecutor and court.

Second, they challenge the interim order of the Commission on its accounting theories:

(a) The "base" taken by the Commission is wrong because it excluded the item of going concern value of $8,500,000; it permitted only $3,808,399, instead of $6,046,286, for future capital expenditures, and it refused to exclude from the base $2,866,758, for "viewed" depreciation. So, the base taken by the Commission ($74,420,424) was $7,771,129, less than the base contended for by the companies, - i.e., $82,291,553.

(b) The 6 1/2% return used by the Commission was unreasonably insufficient, and unsupported by the evidence. Not less than an 8% return should have been allowed.

(c) The period taken for amortization was wrong, namely, it should have started from the effective date of the Act, and not from the beginning of the companies' business.

(d) The base used for amortization, i.e., $78,284,009, was too low; it should have been $84,341,218.

(e) The amortization reserve should have been figured on a straight line basis with the interest at the rate of 2% semi-annually, instead of on the sinking fund basis with interest at 6 1/2% compounded annually. The annual amortization allowance should have been $5,100,732, instead of $1,557,582.

I. Constitutionality of Act as applied to petitioners. The argument supporting this view runs like this: (a) Petitioners are not in fact, or law,*fn3 a public utility, and the legislative declaration that they are, is unconstitutional*fn4 and ineffective to make them such. They do not sell to the public. 98% of their product is sold to wholesale customers. The price they charge has small effect on the consumer's cost because the service company's fixed charges are the dominant factor in ultimate cost to the public. Their gas is but an element in the product the public purchases, which also contains artificial gas. The fact that gas is widely used by the public is not important, for, they argue, so are meat, groceries, and many other unregulated commodities.*fn5 (b) The Act changes an existing, wholly private industry into a public utility, burdened with many iron-bound mandates - all this without giving petitioners a right to withdraw from the harshness of such supervision, and is therefore a violation of the Fifth Amendment.*fn6 They cite the fact that the Act delegates to the Power Commission the power to choose their customers for them (Sec. 7, 15 U.S.C.A. § 717f) and prohibits their dropping a customer, - unsatisfactory though he may be.

We conclude, without much doubt, that the Natural Gas Act is constitutional. It falls within the Commerce Clause of the Federal Constitution, article 1, § 8. The necessity for its enactment was legislatively declared in Sec. 1(a) (above quoted), and "it may not be annulled unless palpably in excess of legislative power."*fn7 Condemantion on this last-named ground lacks facutal support in the instant case.

We appreciate, and may concede, the force of petitioner's factual distinction of the Nebbia, the Sunshine and Appalachian Cases. They all involved, it is true, critical economic conditions which demanded legislative solution, and such critical condition and urgent necessity of immediate control are here absent. But, where a legislative determination is based upon a very extended administrative investigation, which concluded that an industry was affected with a public interest and that Federal regulation thereof was necessary and that said business or industry is producing and transporting natural gas to be sold to gas companies engaged in public utility business in cities and villages, there exists no basis for a successful attack on such determination.

The natural gas industry controls the source of a commodity of great public importance and widespread consumption, and therefore its regulation by Congress may well be required. At least, Congress, in its wisdom, may so conclude. Courts cannot, and should not, assume a greater wisdom than Congress, and find otherwise. The court's function, at most, would be limited to an inquiry as to the existence of facts which would support legislative determination.

II. Form of Order, i.e., ordering a reduction of income of a designated amount, and not determining precise rates to be charged. Petitioners challenge, and respondents do not discuss the challenge, that the Commission's authority is only to "determine the just and reasonable rate * * * and shall fix the same by order." Sec. 5, Title 15 U.S.C.A. Sec. 717d.

The order of the Commission found the existing rates unreasonable and excessive, and ordererd that they be reduced to reflect a decrease of $3,750,000 in operating revenues. This order did not "determine" the rates. But it evidenced the conclusion that the existing rates were too high and should be lowered such an amount as would reflect a specific reduction in profits.

The resulting rate might vary, depending upon which class of purchasers should be favored. It failed to name the customer (the utility, the commercial, or the industrial purchasers) and the degree of reduction to be allocated inter se. The Commission determined the underlying factors determinative of a rate sufficient to produce a fair and reasonable profit. The order left the companies free to apportion the reduction among the customers.

This action, while irregular and unusual, we believe, in rate determining commissions, was in no way harmful or prejudicial to the companies. In fact, it was favorable to them.It lodges a discretion - or play - in them whereby they might adjust the rates in the various classifications as may to them seem meet. Doubtless they will have some difficulty convincing their costomers of the fairness of the reduction.But the difficulty is present, whether the regulating commission or the utility makes the adjustment. The fact that the rate is lessened, rather than increased, should not be overlooked.

We are convinced, and so hold, that petitioners, to successfully attack an order of the Commission, must show they are aggrieved by the part of the order assailed. We find no prejudice to petitioners in the form which the order took.

III. Existence of Substantial Evidence to support Commission's finding that present rates are unreasonable.

This query brings us to the merits of this appeal - to the heart of the controversy.

The statute, Sec. 19, Title 15 U.S.C.A. § 717r, provides:

"The finding of the Commission as to the facts, if supported by substantial evidence, shall be conclusive."

It also provides that,

"No objection to the order of the Commission shall be considered by the court unless such objection shall have been urged before the Commission in the application for rehearing unless there is reasonable ground for failure so to do."

Petitioners contend that the record is absolutely wanting in any evidence that their existing charges are unreasonable, "unless it be the circumstance that their earnings exceed a 6 1/2% rate of return * * * ," and they further contend that returns must be "'enormously disproportionate' before they are even 'some' evidence that the charge yielding the return may be excessive."

They present an amazingly interesting picture of the difficulties of long distance transportation of natural gas, of the tremendous effort, skill, and risk taken by these companies, of the extraordinary improvements necessary in pipe construction and other apparatus, of economic management of business - securing fill-in contracts in slack periods, and maintaining high loads in pipe lines, without which petitioners' business would be on the financial rocks (or invoking Sec. 77B of the Bankruptcy Act, 11 U.S.C.A. § 207) instead of perplexing commissions and courts with questions arising out of large profits.

They most urgently point out that a profit which exceeds a barely non-confiscatory return is not ipso facto an unreasonable or illegal return.*fn8 Therefore, the Commission's reduction of profit based solely on a finding of unreasonableness because the profit exceeded said barely non-confiscatory return is without evidentiary support, and the Commission's order must fall.

The Commission answers this argument by pointing out the precedents announced in the Labor Act Cases, specifically the Link Belt Labor case, National Labor Relations Board v. Link-Belt Co., 61 S. Ct. 358, 85 L. Ed. , decided January 6, 1941, and other Federal Act Cases involving review of action taken by administrative boards, by courts, and say, if there be any evidence to support the finding it must stand. In fact, it is then removed from the field of judicial inquiry and review.

The Commission also points out that the companies nowhere raised the point of lack of substantial evidence, and so are now (by virtue of the statutory provision in review, above quoted) precluded from so objecting. A complete answer to the contention that the companies failed to object to the substantiality of the evidence to support the finding is to be found in petitioners' assignment of error in their petition for rehearing -

"The Commission erred in finding that the rates and charges presently charged by petitioners are unjust, unreasonable, unlawful and violative of the provisions of the Natural Gas Act."

While the assignment is broad, it is supplemented by others which make it clear, what must have been obvious throughout the many days when testimony was being taken, that petitioners were denying, as a matter of fact, the unreasonableness of the rates in force. Other assignments of error, in the petition for rehearing before the Commission, complained of related points, to-wit:

"The Commission erred in not holding that the proper rate base is the present value of the property, which, under the uncontradicted evidence, is made up of * * * ."


"The Commission erred in holding that the sum of $8,500,000 claimed by applicants as going concern value is an arbitrary claim not supported by substantial evidence."

"It is supported by substantial evidence which is uncontradicted."

Petitioners attack the order because "The Commission is without power and jurisdiction to enter an interim order."

The fatal weakness of this contention lies in counsel's failure to choose a true prospective - make a proper approach to the policy of governmental regulation (as evidenced by this legislation), of the natural gas industry, which includes its production, transportation, and distribution. Like other legislation of this character, it should be liberally construed and interpreted, so as to embrace, within its scope, the implied powers necessary to an exercise of the expressly granted powers.In petitioners' argument, there is a tendency, which is somewhat characteristic of arguments in cases which attack powers of Congress and the procedure of the regulating commission, to observe, "I do not find it written in the bond."

There can be no question that the Act confers upon the Commission the power to make a final order. Had the Commission closed its hearing and then made the order in question, it would have come within its expressly delegated powers.

We take it that this argument goes so far as to deny to the Commission, authority to do anything else; that it could not make an interim order even upon consent of the parties. In other words, if we accept this contention, a hearing might proceed to a point where all the petitioners' testimony was received, and they had rested their case; upon which showing it was conceded an order reducing charges should be made; that the utility's consent thereto was formally given, - even then the Commission would be powerless to make an order, because perchance it wished to inquire further into certain practices and charges which affected rates only indirectly, which matters the petitioners were particularly anxious to have settled. Such a holding would do violence to the purpose and object of the legislation.

While the practice and construction of powers of a court of equity are not necessarily controlling, they supply a lamp to guide courts in determining the extent to which they may imply powers from the grant of express powers. Not seriously would it be argued that a court of equity given jurisdiction of a subject and granted the express power to make a final order to fix rates was powerless, on a proper showing, to make an interim order limiting profits.

We must, and do, hold that upon a proper showing, and when the hearing has reached a stage where the Commission may determine that a reduction (or an increase) of rates should be made, it may (and should) make such order, even though the hearing be not completed.

Rate of Return. Petitioners advance three propositions in respect to the findings and the deductions from said findings of the Commission upon the rate of return. The Commission found a return of 6 1/2% was fair and reasonable. Petitioners say: (a) Their earnings, which exceeded this rate, do not evidence unreasonableness, (b) Reasonableness of rates is determined "not by what profit it is reasonable to make, but what is reasonable to charge for the services rendered"; (c) The rate of return fixed by the Commission at 6 1/2% was, in view of the facts of this case, grossly inadequate.

We reject, without extended discussion, the contentions (a) and (b). They ignore the well-established holdings, backed by reason and experience, to the effect that a fair rate of return, on a fairly established rate base, supplies the correct test of reasonableness.*fn9 The value of the service to users is neither a reasonable rule, nor supported by judicial decisions.

This seems too elementary to require elaboration or supporting argument. Likewise, it must be apparent, on this theory of correct rate making, that the rate of return not only may, but, in a utility rate case, must be, the largely determinative factor of reasonableness.

(c) The reasonableness of a 6 1/2% rate of return presents a question altogether different from (a) and (b). It is perplexing and incapable of determination with certainty, in view of the peculiar facts of this case. Out of the mass of decisions pertaining thereto, a rule may be stated with comparative ease, but its application is quite as difficult as the statement is easy.

A fair return is to be largely measured by the usual returns in like investments in the same vicinity over the same period of time.

What are like investments? What are the years we must use to ascertain the going rate of return for said like investment? Relativity seems to be highly present both in the term "like investment" and in the years for which fair earnings must be ascertained.

Ignoring, for the moment, the kind of investment involved, and looking only to rate of return, as such, on investments only, we take judicial notice of the fact that interest rates in most fields have declined in the last decade as much as 75%.For example, call money rates in New York dropped from 8% in 1929 to 1/8-1/4 of 1%. Interest rates on Class AAA bonds have dropped enormously. Secure, but less highly rated, bonds have shown a like lowering of interest return.

What years should be chosen to determine the fair rate of yield? More uncertain still, what will the thirteen future years bring forth? Will the rise in rate of return be as great and as rapid as has been the decline during the last decade?

But, if there be doubt and uncertainty as to the correct dates and rates, past and future, for interest charge determination on safe investments, they are inconsequential as compared to the variance in returns on well secured, as compared to returns on highly speculative investments.

The demanded rate of return, since the crash of '29 and the bank failure period immediately following it, has been almost fatal to speculative investments. The investing public has emphasized safety, and shied from the speculative. That the investment in petitioners' enterprise in '32 was highly speculative, can not be successfully gainsaid. A "fair rate of return," on this highly speculative investment, should not be affected by the extraordinary success which has marked its record for the latter part of its existence. The ascertainment of a fair return should be approached as of the year 1932, with the trier looking forward, rather than from the seat in the reviewing stand erected in 1940 and looking backward to 1931.

Even today, with a splendid record of current success behind it, the investment belongs in the speculative class.

This enterprise is based on a deposit of natural gas some four thousand feet beneath the surface of the earth. It is in Texas, some nine hundred miles from the consumer. Its successful operation necessitated a capital of from seventy-five to eighty-four million dollars. Its life is limited to the time when the wells will be exhausted. This will be in 1954. At least a tenth of the period was devoted to construction, during which time there was no income.

Upon such a fact statement, and notwithstanding the expert opinion of geologists, scientists, and engineers there are factors which necessitate the use of a question mark after many a fact statement or opinion.

The case was one which hardly permitted of enlightenment from expert witnesses, who gave their opinions to the Board (and to us) respecting a fair rate of return. They were overwilling, and the indifference of soem of them to opinions expressed by them on other occasions lessened the weight of their evidence.

Moreover their opinions showed differences were unavoidable and traceable to the varying influences of different factors.

Bearing in mind that our function is to review, not to make, findings of fact, and also keeping to the front the current low rates of return on all investments, and also bearing in mind that the future may bring changes by the Commission in its finding of 6 1/2% as a fair rate of return, we conclude that there is substantial evidence to support the Commission's finding.*fn10

Rate Basis. We now approach petitioners' several contentions respecting the Commission's failure

(a) to include a sum for going value,

(b) to fix the proper period for amortization,

(c) to make adequate allowance for future capital additions,

(d) to take 2% instead of 6 1/2% interest on the sinking fund.

We need only discuss the first two contentions. If we accept either of them, the order must fall.

The facts are not much in dispute. Petitioners place the lowest figure for going value at $8,500,000. The Commission refused any sum for this factor.

Petitioners contend the amortization period should be fourteen years and five months. The amount to be amortized was $84,341,218. The Commission fixed the amortization period at twenty-three years and the amount to be amortized at $74,420,424.

We are persuaded of the soundness of both of petitioners' contentions, (a) and (b).

(a) Going value. An allowance for going value is necessitated, due to facts peculiar to this case. In the ordinary public utility case, with no unusual fact or circumstance to affect a court's consideration of it, we may assume, at least for the purpose of this argument, that going value, as a properly includable item in the rate base, should and would be rejected. Driscoll v. Edison Power & Light Co., 307 U.S. 104, 117, 59 S. Ct. 715, 83 L. Ed. 1134. Our duty, to follow the Supreme Court rulings on this and all other questions, necessitates our making all the turns in the road, both left and right, which the teaching of experience has caused our guide to blaze through new and untraveled fields of regulation of quasi public businesses.

The factors present in the instant case, not found in the old and well-established field of public utility regulation, which affect (b) as well as (a), are: The period of petitioners' life is fixed and rather short; the natural gas field will be exhausted in '54 (the date and the fact are not in dispute). Distinguishably different is the electric light and power field where the life of the enterprise has, in some instances, already exceeded five decades and may go on growing in strength and stability indefinitely. Moreover, great uncertainty marks this 13-year period and the constancy of petitioners' natural gas wells.

Another difference is to be found in the fact that Congress had not declared its public policy to regulate petitioners' business when it started this enterprise. Nor did Congress act until one-third of petitioners' life had expired. During that period, their business was built on the theory that they must find and satisfy their customers - must act on the assumption that rates and volume of business must depend upon and find justification in the future, rather than in the present, business.

Still another difference, however, was the newness of natural gas in Chicago, and therefore the uncertainty of customers and business. Then, too, there were the difficulties incident to the engineering problems, which arose from the task of converying natural gas one thousand miles over mountains and under rivers to unknown prospective customers. The successful and satisfactory mixing of natural with artificial gas presented, in 1932, problems which the well-established gas companies and their engineers viewed with deepest doubt and dire misgivings.

The losses of the first years supplied persuasive evidence that the investment was highly speculative and an adequate return on the capital invested depended largely upon the business acumen, the engineering skill, and administrative efficiency of their officers, to overcome these losses and develop a profit in this newly regulated industry. Under such circumstances it seems that fairness necessitates the capitalization and inclusion of such skill - aye, and hazards - as legitimately as the cost of pipes. the natural gas was valueless as it lay in the Texas wells, four thousand feet beneath the surface of the earth, over one thousand miles from Chicago.What gave it value? Not alone pipes to carry it, nor pumps to pump it. It was the courage of the investors, and their willingness to take a chance in a speculative venture, the vision to see and to forecast, the integrity of management, and the knowledge of geologists, etc., which gave to the enterprise its life; and the product of these combined factors made for a going value, which, in the realities of the business world, is justly recognized as part of the value of the investment. It is the existing fact situation peculiar to this case which calls loudly for the inclusion of a sum for going value, as such. Nor can we fairly apply the law, save as we first study the facts and get the proper setting of the natural gas industry in the utility field. The Commission has not included its equivalent in any of the items which went to make up its rate base. If allowable at all, there can be no serious objection to fixing the sum, as the petitioners contend, at $8,500,000.

The Commission argues that in fixing the value of the rate base as high as $74,420,424, it gave full recognition to petitioners' business as a going business concern. this statement is contrary to the memorandum filed by the Commission with its findings. the $74,420,424 was made up of

Reproduction Cost New of

Physical Properties $56,302,250

Value of Gas Reserves 13,334,775

Capital additions for the period

June 1, 1939 to December 31, 1942 3,808,399

Working Capital 975,000

Total Rate Base $74,420,424

The total is the amount which the Commission adopted as its rate base. It does not include going value.

Moreover, in its opinion, the Commission said, "The Companies' claim of $8,500,000 for going concern value must be disallowed. The amount obviously is an arbitrary claim, not supported by substantial evidence warranting its allowance. Its allowance would mean the acceptance of a deceptive fiction, resulting in an unfair imposition upon consumers."

In the face of this statement we must assume that the Commission did not allow any sum for going value.

Period of Amortization. Here, again, we find of dominating importance, the newness and lack of precedent among the conditions similar to those found in this industry. In ascertaining petitioners' profits, the amount deducted for amortization is most important. Petitioners assert the period should be fourteen years, five months, - the difference between the date of these proceedings and the date when the gas will be exhausted. Respondents, on the other hand, begin their period in 1932. In other words, the Commission adopted a twenty-three year period, whereas petitioners figured on a fourteen year five month period.

In addition to the reasons for our conclusions respecting contention (a), the significance of the date when the business enterprise became subject to governmental regulation is of dominant significance. It is important, too, as bearing on the rate making power of Congress.Avoidance of conflicts with the Fifth Amendment of the Constitution is involved. Petitioners' position avoids the conflicts; respondents' creates an unavoidable clash.

Before Congress enacted this legislation in '38, petitioners were free to contract and did contract with customers on a basis which they deemed wise. After that Act passed, their business, and particularly their rates, were subject to regulation and fixation by respondents. The size of their profits depends upon their earnings for the next thirteen years. These, in turn, depend largely upon the sums allowed for amortization of the value of the property as it then existed and was then valued. Petitioners assert an annual amortization sum of $5,100,732. Respondents fixed the sum at $1,557,852.

The position we take in no wise reflects upon the wisdom of the new legislation. That legislation looks to the future protection of the public. It deals with conditions which existed at the time the legislation was enacted. It neither gave, nor took away, value to going concerns, whose lives were short and limited by fact conditions which neither the producer nor the consumer could change. For these reasons, we conclude the amortization period, for rate making purposes, should be fourteen years, five months, instead of the period of twenty-three years adopted by the Commission.

As was said in United Railways & Electric Co. v. West, 280 U.S. 234, 50 S. Ct. 123, 126, 74 L. Ed. 390, "It is the settled rule of this court that the rate base is present value."

See also Brooks-Scanlon Corp. v. United States, 265 U.S. 106, 123, 44 S. Ct. 471, 68 L. Ed. 934; United Fuel Gas Co. v. Railroad Comm., 278 U.S. 300, 49 S. Ct. 150, 73 L. Ed. 390.

It would seem to follow logically that if the rate base is determined as of the date of the hearing the amortization period would be for the life of the property from that same date. All the cases dealing with this subject are distinguishable in at least one respect. In the instant case, the end of the period is fixed by the exhaustion of the natural gas wells. In other words, the end is near. In the ordinary electric light, gas, or water rate case, the amortization period is long - covering the life of the pipes - well-nigh a century.

In the absence of authority, it would seem fair and reasonable to fix the amortization period not earlier than the date when Congress subjected the industry to regulation.

Other attacks upon the orders are presented by the petitioners, which we believe it unnecessary to pass upon. The hearing is not completed and some findings of fact may be changed, and the proof may be so conclusive that no attack will then be made.

All such evidence will, of course, be heard and passed upon by the Commission before entering its final order.

The order of the Commission is vacated and set aside.

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