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Crude Co. v. F.E.R.C.

February 02, 1998

PLAINTIFF-APPELLANT, THE CRUDE COMPANY,
v.
FEDERAL ENERGY REGULATORY COMMISSION AND DEPARTMENT OF ENERGY AND THE UNITED STATES, DEFENDANTS-APPELLEES.



Appealed from: U.S. District Court for the District of Columbia judge Sporkin

Before Mayer, Chief Judge, *fn1 ( Schall, and Bryson, Circuit Judges.

The opinion of the court was delivered by: Bryson, Circuit Judge.

The Crude Company appeals from a decision of the United States District Court for the District of Columbia ordering it to pay $1,202,143.07, plus interest, to the United States. Crude Co. v. FERC, 923 F. Supp. 222 (D.D.C. 1996). The district court upheld the decision of the Federal Energy Regulatory Commission holding The Crude Company liable for violations of the Department's oil price control regulations. We agree with the district court that the underlying administrative action must be sustained, and therefore affirm.

I.

A.

During the oil crisis of the 1970s, the government controlled the price of crude oil through a complex set of regulations. The regulations established two levels of price-controlled oil (lower tier "old oil" and upper tier "new oil") in addition to free market priced oil. Domestic oil produced up to a certain quantity could not be sold above the "old oil" price, while domestic oil produced above that quantity could be sold at the higher "new oil" price. Foreign crude oil and certain other types of oil could be sold at free market prices. See United States v. Sutton, 795 F.2d 1040, 1051 (Temp. Emer. Ct. App. 1986). This multi-tiered price system was designed to minimize the inflationary impact of rising oil prices and to provide an incentive for increased domestic production. See Cities Servs. Co. v. Federal Energy Admin., 529 F.2d 1016, 1021 (Temp. Emer. Ct. App. 1975).

Because of disparities in access to price-controlled oil, the government set up an "entitlements" program that reallocated some of the cost benefits received by refiners who had access to large quantities of price-controlled oil to those refiners who relied on more expensive oil. Under the entitlements program, each refiner was issued monthly entitlements based on that refiner's proportionate share of all "old oil" refined on a nationwide basis. The program was based on the premise that all refiners should be allowed to refine an equal proportionate share of price-controlled oil each month. See Cities Servs., 529 F.2d at 1021. An entitlement was defined as the right of the refiner owning the entitlement to include one barrel of deemed old oil in its adjusted crude oil receipts in that month. 10 C.F.R. § 211.62 (1977).

If a refiner refined more "old oil" in a given month than its allocated number of entitlements, it was required to purchase additional entitlements. Conversely, if a refiner failed to use its allotted entitlements, it was required to sell its excess entitlements. The cost of an entitlement was set by the Department of Energy and was generally equal to the difference in price between the average cost of "old oil" and the average cost of non-price-controlled oil. Sutton, 795 F.2d at 1051-52; Cities Servs., 529 F.2d at 1021.

In order to determine how many entitlements each refiner should receive, the government required each refiner to report its crude oil receipts and crude oil refined on a monthly basis. 10 C.F.R. §§ 211.66(b), 211.66(h) (1977). Because not all refiners had the capacity to refine all the oil they owned, the regulations permitted refiners to enter into "processing agreements" under which another refiner would refine the oil, while the original refiner retained ownership of the products refined from the crude oil. 10 C.F.R. § 211.62 (1977). When one refiner arranged to have another refiner process its crude oil under such an agreement, the refiner that actually processed the oil was permitted to exclude the oil from its monthly report, and the refiner on whose account the oil was processed was required to include the oil on its report. 10 C.F.R. § 211.67(d)(1) (1977).

Because small oil refiners experienced disproportionately high operating costs during the oil crisis, the government in 1974 made additional entitlements available to small refiners. Those entitlements, referred to as "small refiner bias" (SRB) entitlements, were issued on the basis of the amount of oil the small refiner refined each month.

Over time, some small refiners began to abuse the SRB benefits system by engaging in paper transactions to obtain SRB entitlements for oil that they did not really own. In such transactions, a large processing refiner would purport to sell crude oil to the small refiner. The large refiner would then refine that oil for the small refiner's account. The small refiner would include the oil in its monthly report, thereby obtaining SRB entitlements. After the oil was processed, the small refiner would purport to sell the refined products back to the large processing refiner. These paper transactions would be entered into only to generate SRB entitlements by seemingly introducing the small refiner into the chain of ownership. See Thriftway Co. v. Department of Energy, 920 F.2d 23, 24 (Temp. Emer. Ct. App. 1990).

In May 1976, the government issued a new regulation that eliminated SRB entitlements for processing agreements in which the crude oil was purchased from and the refined products were sold back to the processing refiner. Thriftway, 920 F.2d at 24 (citing 10 C.F.R. § 211.67(e)(2) (1977)). The preamble to the new regulation explained that it was "intended to prevent refiners from entering into processing agreements to process crude oil for a small refiner for no valid business purpose other than obtaining a portion of the benefits of the small refiner bias." 41 Fed. Reg. 9393 (1976). Nevertheless, refiners and crude oil owners continued to use processing agreements to manipulate the SRB entitlement program. Accordingly, as of June 1, 1977, the government amended the regulation to bar all processing agreements from qualifying for benefits under the SRB entitlements program. Thriftway, 920 F.2d at 24.

B.

In the 1970s, Southwestern Refining Company Inc. (SRCI) operated a small refinery in Wyoming that qualified for SRB entitlements. The Crude Company (TCC) was a crude oil reseller also located in Wyoming. Champlin Petroleum Company (Champlin) was a major refiner and marketer of petroleum products located in Corpus Christi, Texas. Between January and May of 1977, the three companies entered into a series of transactions that resulted in the generation of SRB entitlement benefits.

The transactions among the parties were documented in three agreements: (1) an agency agreement between SRCI and TCC; (2) a purchase and sale agreement between SRCI and TCC; and (3) a processing agreement between SRCI and Champlin. Under the agency agreement, TCC would deliver crude oil directly to Champlin. TCC would handle all the paperwork for the refining services and would pay the refining fees directly to Champlin. TCC would then arrange for delivery of the refined products. The agency agreement was backdated to reflect a previous oral agreement between SRCI and TCC.

Under the terms of the TCC-SRCI purchase and sale agreement, SRCI purported to purchase crude oil from TCC, refine the oil pursuant to the processing agreement with Champlin, and sell the refined product back to TCC. Although the agreement was purportedly executed on December 29, 1976, it was backdated, and in fact it was not even drafted until March or April of 1977, several months after the transactions had been under way.

The TCC-SRCI purchase and sale agreement provided that title to crude oil SRCI purportedly purchased from TCC would pass to SRCI as the crude oil entered Champlin's refining facilities; title to the refined products would pass back to TCC as the products left the refinery. While SRCI purportedly held legal title to the oil during the time it was in Champlin's refinery, the processing agreement between Champlin and SRCI provided that Champlin would bear the risk of loss for the oil during that time. After the refining process was completed, Champlin would deliver the refined products to TCC. TCC would then sell the refined products and pay SRCI 25 cents per barrel from the proceeds of the sale. The purchase and sale agreements provided that the entire arrangement would be terminated if SRCI failed to qualify for SRB benefits.

As a result of the three agreements, SRCI was not required to perform any services or assume any financial risk in connection with the acquisition and processing of the crude oil or the sale of the refined products. TCC was to acquire and pay for the crude oil; TCC was to arrange for delivery of the crude oil, pay for its processing, and purchase the refined products; and TCC had the sole authority to set the prices for SRCI's purchase of the crude oil and the sale of the refined products back to TCC.

TCC benefited from the arrangement because the SRB benefits reduced TCC's costs for the refined products it marketed, and because it obtained the proceeds of the sale of SRCI's excess entitlements. SRCI benefited from the arrangement by earning 25 cents per barrel ...


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