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Fuels Research Council Inc. v. Federal Power Commission

February 24, 1967


Swygert, Fairchild, and Cummings, Circuit Judges.

Author: Swygert

SWYGERT, Circuit Judge.

The petitioners, three coal associations and a labor union,*fn1 seek review of an order*fn2 of the Federal Power Commission approving the existing rate designs of two interstate natural gas pipeline companies, Midwestern Gas Transmission Company and Natural Gas Pipeline Company of America. The order resulted from proceedings instituted by the Commission under section 5(a) of the Natural Gas Act, 15 U.S.C. § 717d (a), to determine whether the rate designs of Midwestern and Natural are "unjust, unreasonable, unduly discriminatory, or preferential." The principal questions concern the pipelines' twopart rate structures.

Natural Gas Pipeline Company is engaged in the transportation of natural gas through two interstate pipeline systems which commence in areas of production in Texas, Oklahoma, and Louisiana and which interconnect and terminate near Joliet, Illinois. Natural sells its product to customers located along its pipelines, but three of its four largest customers take delivery at the end of the pipelines in northeastern Illinois. These customers, The Peoples Gas Light and Coke Company, Northern Illinois Gas Company, and Northern Indiana Public Service Company (NIPSCO), are intrastate distribution companies which resell the gas to ultimate residential, industrial, and commercial consumers. Natural has been owned by Peoples since 1948.

Midwestern Gas Transmission Company transports natural gas through two separate interstate pipeline systems. In its southern system, the only one involved here, Midwestern purchases gas from its parent corporation, Tennessee Gas Transmission Company, at Portland, Tennessee and transports it to Joliet for sale to its only customers, Peoples, Northern Illinois, and NIPSCO.*fn3

Natural and Midwestern are both "natural-gas [companies]" within the meaning of section 2(6) of the Natural Gas Act, 15 U.S.C. § 717a, and are therefore subject to regulation by the Federal Power Commission. The local distribution companies are not subject to such regulation. Peoples sells gas exclusively within the City of Chicago. Northern Illinois serves the remaining portion of northern Illinois. NIPSCO, a gas and electric utility, operates in northwestern Indiana. The rates of the distributors are regulated by the Illinois Commerce Commission and the Public Service Commission of Indiana, respectively.

The consolidated rate design proceeding of Natural and Midwestern has a checkered history. Following one unsuccessful effort, Midwestern and its parent, Tennessee, obtained a certificate of public convenience and necessity from the Commission for the operation of Midwestern's southern system in 1959.*fn4 The Commission at that time tentatively accepted the rate schedules proposed for sales to the distribution companies, but directed Midwestern to file a new rate schedule within one month after the first year of operation. The Commission indicated that a section 5(a) proceeding to determine the reasonableness of the rate filed would then be instituted.

On December 14, 1960 Midwestern did as it was requested, proposing to continue the same rates. Thereafter, on February 13, 1961, the Commission commenced an investigation pursuant to section 5(a).*fn5

In the meantime, Natural, which has been in business since 1931, filed a rate increase. The Commission suspended the increase under section 4(e) of the act, 15 U.S.C. § 717c(e), and began hearings concerning the lawfulness of the rate. Eventually, on October 25, 1962, the Commission approved a settlement proposed by Natural and the staff of the Commission.*fn6 In its opinion approving the settlement the Commission noted, however, that Midwestern's rates were then under examination and stated that it would reopen the question of Natural's rate design under section 5(a) when it reviewed Midwestern's rate design. In February 1963, the Commission ordered the present investigation against Natural and consolidated it with the investigation against Midwestern.

The consolidated proceeding was set for hearing. The local distribution companies, Peoples, Northern Illinois, and NIPSCO, and the coal associations, among others, were permitted to intervene. The coal associations alone challenged the rate designs of Natural and Midwestern. All other participants, including the Commission staff, supported the existing structures.

At this point the elements comprising the rate designs being challenged and the principal considerations upon which these elements are based require explanation. The first step in setting the rates to be charged by a regulated pipeline is the determination of the pipeline's "cost of service," that is, the total revenues required to cover the pipeline's cost of operation plus a fair return on its investment. Once the cost of service has been ascertained, rates are "designed" to recover it. For reasons allegedly related to different types of services desired by different customers but more realistically attributable to the basic economic laws of supply and demand as they concern natural gas, the "designing" operation is not reducible to a simple mathematical exercise.

One "demand" for gas, the demand by those consumers who can be made to pay for both the pipeline and the gas flowing through it, is highly seasonal in the midwestern states. The desirability of gas for domestic and commercial space heating purposes in the winter, the "peak" period, is such that the demand for gas during that period by this type of consumer far exceeds the demand by the same consumer at other times of the year.*fn7 This economic fact creates a "valley" period, a capacity in the pipeline to supply other potential users during the "non-peak" season, including many whose "demand" is constant but so low that they would never become users if they were compelled to pay a proportionate share of the pipeline's cost of service. The valley periods might well go unfilled were it not for the principle, widely accepted by rate-makers, that a more complete utilization of existing facilities spreads the costs of the entire system to whatever extent the additional utilization contributes to the fixed costs of the facilities over and above the payment of variable costs.

The rate-making theory urged upon us blends a concept of "peak cost-responsibility" with a desire to take advantage of the above principle in the following manner. First, the proposition that a pipeline is built to serve the peak period demand is accepted as a fact.*fn8 Stated another way, the pipeline capacity provided to take care of the demand on peak days of the system is viewed as creating the bulk of the fixed costs of the pipeline company. These costs do not depend upon the amount of gas flowing through the pipeline. The variable or "volumetric" costs of pipeline operation are essentially related to the amount of gas transported and sold; they are incurred in proportion to the gas actually used. It follows that those responsible for the creation of the peak demand would bear the entire cost of pipeline operation were it not for the opportunity provided by "valley filling" or "off peak" sales. Sales during valley periods (sales to those who will take gas if the price is right), since they do not require the construction of additional facilities, may and should be made at variable cost plus (as the Commission puts it) "such amounts in addition thereto as may be determined to be a proper contribution to the fixed charges," so that the fixed costs can be spread over more sales units, thus reducing the per unit costs.

The theory just described and the recognition that a pipeline's cost of service encompasses both fixed costs and variable costs have been reflected by ratemakers in the form of two-part rates. The rates are split into "demand" and "commodity" components. The demand component is a charge intended to reflect the fact that a customer has contracted for the right to take a given quantity of gas during the peak period. The demand charge is imposed whether the gas is actually taken from the system or not. The commodity component is a charge based upon the volume of gas consumed by each customer. The combination of these charges, multiplied by the anticipated units of the demand component to be contracted for plus the anticipated units of gas to be actually sold is expected to generate revenues equal to the cost of service. The significant problem posed by the two-part formula concerns the allocation of the costs of pipeline operation to the demand and commodity components, more specifically, to the determination of what contribution to the fixed costs of the system is to be recovered by the commodity charge. In the instant case the problem is ...

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