504 F.2d 225 | D.C. Cir. | 1974
This case is before the court on petition for review of an order of the Federal Power Commission (“the Commission”) granting United Gas Pipe Line Company’s (“United”) request for an increase in its annual depreciation rate to 5 percent. Petitioner, Memphis Gas Pipe Line Company (“Memphis”), an intervenor in the Commission proceedings, is a large, municipally-owned gas distribution company which indirectly purchases
The instant proceedings began when United filed,
Prior to the rate filing, United had been utilizing a composite depreciation rate of 2.88 percent. This rate had been established in 1943, based on a physical life estimate of the service lives of United’s systems.
On February 1, 1972 Chief Administrative Law Judge (then Presiding Examiner) Zwerdling issued his Initial Decision
It may be helpful, before addressing the facts of this particular case to examine briefly the concept of depreciation and the Commission’s articulated policies with respect thereto.
Depreciation is generally defined as “the loss, not restored by current maintenance, which is due to all the factors causing the ultimate retirement of the property.” Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 167, 54 S.Ct. 658, 664, 78 L.Ed. 1182 (1934).
The Commission may, after hearing, require natural-gas companies to carry proper and adequate depreciation and amortization accounts in accordance with such rules, regulations, and forms of account as the Commission may prescribe. The Commission may from time to time ascertain and determine, and by order fix, the proper and adequate rates of depreciation and amortization of the several classes of property of each natural-gas company used or useful in the production, transportation, or sale of natural gas.
the loss in service value not restored by current maintenance, incurred in connection with the consumption or prospective retirement of gas plant in the course of service from causes which are known to be in current operation and against which the utility is not protected by insurance. Among the causes to be given consideration are wear and tear, decay, action of the elements, inadequacy, obsolescence, changes in the art, changes in demand and requirements of public authorities, and, in the case of natural gas companies, the exhaustion of natural resources.
18 C.F.R. pt. 201, Definitions, ¶ ll.B. (1973).
This definition of depreciation, conveniently brings us back to the merits of the matter sub judice, that is, what factors or causes of loss in service value shall be given what weights in the context of the current national shortage of natural gas. In more concrete terms, the parties disagree over whether and to what extent diminished gas reserves should be considered in establishing United’s depreciation rate.
United’s now superceded depreciation rate of 2.88 percent was set in 1943, a time when there appeared to be abundant supplies of natural gas. Therefore, United, in keeping with industry practice, had determined the useful service life of its depreciable properties in terms of the physical life of those properties ; the underlying assumption being that gas reserves would be sufficient to insure that the useful life of the properties would approximate their physical life. In recent years, however, the gas reserve situation has dramatically worsened. United submitted evidence that its reserve life index
Petitioner characterizes the new depreciation rate as a “radical change”
Since exhaustion of natural resources has always been an articulated factor in depreciation calculation, and has been utilized in the past in specific factual situations where the Commission thought it appropriate, we do not accept petitioner’s characterization of the Commission Order here as revolutionary.
We now turn to the essential question presented for decision in this ease: whether the new depreciation rate of 5 percent ordered by the Commission is “proper and adequate” as required by the Act. 15 U.S.C. § 717h(a) (1970). The standards of judicial review of Commission action were clearly articulated by the Supreme Court in the Permian Basin Area Rate Cases, 390 U.S. 747, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968),
[T]he responsibilities of a reviewing court are essentially three. First, it must determine whether the Commission’s order, viewed in light of the relevant facts and of the Commission’s broad regulatory duties, abused or exceeded its authority. Second, the court must examine the manner in which the Commission has employed the methods of regulation which it has itself selected, and must decide whether each of the order’s essential elements is supported by substantial evidence. Third, the court must determine whether the order may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection to the relevant public interests, both existing and foreseeable.
390 U.S. at 791-792, 88 S.Ct. at 1373. Thus, while we recognize a duty to sustain Commission action which falls within a “zone of reasonableness,”
The Commission considered the question before it to be two-fold:
whether United has shown that its reserve outlook is such that the life of its reserves should become a major factor in estimating the useful service life of its gas plant and, if so, whether its proposed uniform 5% rate, which would decline in approximate 5-year stages to a maximum 20-year average of 3.88%, is an appropriate allocation of depreciation.
On the basis that the current gas shortage and United’s critically low reserve life index will not allow United to expand sales in the future as it has in the past, will probably force it to utilize much of its property at less than its full capacity, and could force it to abandon some of its property prematurely, we find it prudent and in the public interest to allow United to utilize a rate of depreciation which reflects the undeniable change in United’s gas supply which has occurred since the currently effective rate of 2.88% was established in 1943.
Opinion No. 645 at 11, J.A. at 236.
It is clear from our discussion above that the Commission can certainly take “exhaustion of natural resources” into account in establishing proper depreciation rates. However, in any specific determination of depreciation, the Commission is obligated to ascertain the useful life of the particular piece of depreciable property involved. The substitution, as here, of a higher reserve life based depreciation rate for a lower physical life based rate will necessarily increase gas prices to current consumers. It has long been recognized that one of the primary purposes of the Natural Gas Act is to “ensure that natural gas be distributed at the lowest possible price.”
United offered evidence that while its reserve life index was at 29.91 years in 1948,
Both petitioner
The only record evidence supporting the change in depreciation rate came from Mr. Brooks, who testified that the higher rate was needed to implement a
The Commission made the prediction that, declining gas reserves “could force [United] to abandon some of its property prematurely.” If there were evidence that United contemplated the abandonment of any of its property, this would, of course, have a direct bearing on the useful life of such property. However, the record contains no evidence that any United property will be abandoned prior to the exhaustion of its physical life. Indeed, if the evidence supports any inference, it is to the contrary.
Further, the Commission stated that it would be impossible for “United to expand sales in the future as it had in the past.” We repeat that nowhere in the record is there any estimate of United’s future reserves or future gas sales. The Commission cannot reach the conclusion that the useful life of any property has diminished based only on Exhibit 21, which was prepared on an assumption not even arguably related to United’s probable future. Further, even if United’s sales should “fail to increase,” this cannot support an inference that the useful life of its property has lessened. As pointed • out by petitioner,
We recognize that a decline in sales, if it occurs, will mean a rate increase to the consumer even though the depreciation rate is not increased. The amount of annual depreciation, though constant in dollars, will increase in unit cost of service, per Mcf., as the total depreciation cost is divided among a smaller number of units. The Commission now asserts that the spectre of such a situation, unsupported by any evidence that it could occur in fact, justifies the new depreciation rate. This argument cannot substitute for the requisite finding here lacking: that the useful life of United’s depreciable property has in fact been reduced.
Finally, the Commission found that the gas shortage “will probably force [United] to utilize its property at less than full capacity.” By this, we presume that the Commission meant less than the full capacity of individual pieces of property, e. g., pipelines will carry less than 100 percent of the gas that each pipeline could carry. However, there is no evidence in the record, nor reason to assume, that the service
As we have noted above, a forecast of future decline in volume might warrant a present increase in depreciation rates, but to do so would require a projection based on evidence of probable future reserves and sales. In this case, the Commission has essentially accepted United’s proposed depreciation rate as not “irrational or unreasonable.” Opinion No. 645 at 13, J.A. at 238. However, it is for the Commission, not the utility, to determine a depreciation charge that is proper and adequate. The Commission cannot indulge the utility in an abstract projection which is premised on termination of service and which amounts to a “worst case” analysis. Even assuming continued serviceable life, declining use of pipeline facilities might conceivably lead in future years to depreciation dollars per unit of gas so high as to be unreasonable. The natural gas company would have a direct interest only if there were a showing that its investment in the pipeline will not be recapturable out of depreciation reserves — a showing not remotely made in the present record.
The Commission recognized, and we agree, that the decision was a difficult one which must be made, in part, by extrapolation from less than extensive empirical evidence. Opinion No. 645 states:
We do not have available to us the complete empirical data which we would like to have in order to render this decision. We do not find fault in the fact that United did not present such data to us for, as we have indicated, the impact of the gas supply shortage is at this time largely unquantifiable. We may not, however, refuse to recognize its effect simply because the solution we must reach may be less than ideal — all alternatives open to us at this point present the same difficulty.
Opinion No. 645 at 14, J.A. at 239. The Commission now contends
It is true that the Commission’s decision rests on its reading of the future. But clairvoyance is part of the daily grind of a regulatory agency. Whether flow-through or normalization is the rule, the agency must base the rule on some projection into the future.
Id. at 339. However, the court continued:
On the record before us and the facts outside of the record which the Commission properly notices, the Commission’s ruling is based on substantial evidence of present conditions and a fair guess as to future conditions in the pipeline industry.
Id. (Emphasis added.) The court in Alabama-Tennessee clearly identified the need for record evidence as to present conditions and “a fair guess as to future conditions.” The record here contains no evidence which can support an inference that the present depreciation rate is inadequate. More importantly, the Commission has developed no evidence as to future conditions. It has made no “fair guess” as to United’s future reserves, and no findings at all on the present useful life of United’s depreciable property.
We realize the question here concerns unknown future gas sales of presently unacquired future gas reserves. However, the fact remains that even in 1943, no natural gas companies enjoyed a reserve life index equal to or greater than the physical life of their plant. There is now, as there always has been, the certainty that “[t]he ultimate exhaustion of the supply is inevitable in the case of all natural gas companies.” FPC v. Hope Natural Gas Co., 320 U.S. 591, 606, 64 S.Ct. 281, 289, 88 L.Ed. 333 (1944). We have no doubt that with a declining reserve life index, the risk that depletion of natural resources will shorten the useful life of physical assets has increased. An eight year reserve life index logically entails more risk of future abandonment than does a 25 year index. We are not satisfied with a record that contains only a recitation of the decline of the reserve life index. In order to be “just and adequate”, a reserve life depreciation rate must be based upon the useful life of the particular property involved. We therefore believe that it is the Commission’s obligation to make some reasoned estimate of the useful life of the property here involved,
In arriving at such a reasoned estimate, the Commission must exercise its own judgment based upon evidence pertinent to what it really expects will happen. In doing so, the Commission will, of course, have the benefit of United’s submissions which, as we have indicated, must be directed to probable future conditions. In addition, the Commission should take into account current Commission policies designed to increase or to sustain industry-wide gas supply. Further, the Commission might be able to develop evidence concerning the probable extent and location of reserves which United might utilize at some future date. In this regard, we note that the United system is located in Louisiana, Texas, and Mississippi, an area containing 73 percent of the United States’ total gas reserves.
We recognize that there is no one “correct” depreciation rate; thus, the Commission could develop a range of rates which would fall within a “zone of reasonableness.” Such findings would be, of course, sustained if supported by
We reiterate our statement that the Commission is certainly correct in taking into account the exhaustion of natural resources when it establishes the proper depreciation rate for a particular natural gas company. The problem in this case is that the Commission attempted to cry “shortage” and then to take action without establishing that the useful life of this depreciable property had been adversely affected. The Commission must attempt to identify the useful life of United’s property. There must be a rational connection shown between the declining reserve life index and the Commission’s response to it.
For the reasons stated above, the Order under review is reversed and the matter remanded to the Commission for further proceedings consistent with this opinion.
Reversed and remanded.
. Memphis purchases all of its gas from another pipe line company which in turn obtains a substantial portion of its gas from United. Petitioner’s Br. at 2.
. FPC Docket No. RP71-41, filed November 13, 1970.
. 15 U.S.C. § 717c(e) (1970) (hereafter “the Act”).
. FPC Docket No. G-148 reported at 3 FPC 402 (1943).
. Initial Decision, FPC Docket No. RP7141 (February 1, 1972). The decision appears at 195-207 of the Joint Appendix (hereafter J.A.).
. Opinion No. 645 (issued January 11, 1973) (unpublished), J.A. at 226-40.
. Id. at 240. The effective dates for the new depreciation rate were later changed to June 1, 1971 through May 31, 1976 in Opinion No. 645-A (issued March 9, 1973) (unpublished), J.A. at 243-45.
. Opinion No. 645-A, supra note 7, J.A. at 245.
. See generally 1 A. Priest, Principles of Public Utility Regulation 112-16 (1969) ; J. Bonbright, Principles of Public Utility Rates 192-223 (1961).
. City of Knoxville v. Knoxville Water Co., 212 U.S. 1, 29 S.Ct. 148, 53 L.Ed. 371 (1909); Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 54 S.Ct. 658, 78 L.Ed. 1182 (1934); FPC v. Natural Gas Pipeline Co., 315 U.S. 575, 62 S.Ct. 736, 86 L.Ed. 1037 (1942); FPC v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944).
. Reserve life index is a ratio: the numerator being the company’s total existing gas reserves; the denominator being the total production for a given year. The resulting figure therefore represents the number of years the company could continue to produce gas at the level of the given year if no additional gas reserves were added.
. Petitioner’s Br. at 13.
. Id. at 14.
. Id. at 23.
. 18 C.F.R. pt. 201, Definitions, ¶ ll.B. (1973).
. See Uniform System of Accounts Prescribed for Natural Gas Companies Subject to the Provisions of the Natural Gas Act, Order 141, 12 Fed.Reg. 8461, 8608 (December 19, 1947). While not formally codified until 1947, the system of accounts became effective on January 1, 1940. 12 Fed.Reg. at 8607.
. Opinion No. 645 at 10, J.A. at 235.
. See also Canadian River Gas Co. v. Public Serv. Comm’n of Colorado, 3 FPC 32, 47 (1942); Interstate Natural Gas Co., Inc., 3 FPC 416, 423-24 (1943).
. This case concerned the establishment of area-wide gas producer rates. Such rates are required to be “just and reasonable” under sections 4(a) and 5(a) of the Natural Gas Act. 15 U.S.C. §§ 717c(a), 717d(a) (1970). Although Permian did not directly construe section 717h concerning depreciation rates, we believe that the standards established for judicial review of Federal Power Commission action are fully applicable here. The depreciation element, after all, must be “proper and adequate” if the end result, i. e. the rate, is to pass muster under the rubric of “just and reasonable.”
. Permian Basin Area Rate Cases, 390 U.S. 747, 767, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968).
. See FPC v. United Gas Pipe Line Co., 393 U.S. 71, 72-73, 89 S.Ct. 55, 21 L.Ed.2d 55 (1968) quoting Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 167-168, 83 S.Ct. 239, 9 L.Ed.2d 207 (1962).
. It could be argued that the second half of the question necessarily includes the first in that the 5 percent rate allowed could not be “an appropriate [presumably meaning ‘proper and adequate’ within section 717h of the Act] allocation” if the evidence revealed that declining reserves would in no way affect the useful life of the depreciable property. As we indicated above, our view of the question presented focuses upon whether the 5 percent figure meets the statutory standard of “proper and adequate.”
. Atlantic Refining Co. v. Public Serv. Comm’n, 360 U.S. 378, 388, 79 S.Ct. 1246, 3 L.Ed.2d 1312 (1959); Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 685, 74 S.Ct. 794, 98 L.Ed. 1035 (1954); FPC v. Hope Natural Gas Co., supra, 320 U.S. note 10 at 611, 64 S.Ct. 281; Alabama-Tennessee Natural Gas Co. v. FPC, 359 F.2d 318, 331 (5th Cir.), cert. denied, 385 U.S. 847, 87 S.Ct. 69, 17 L.Ed.2d 78, rehearing denied, 385 U.S. 964, 87 S.Ct. 390,17 L.Ed.2d 310 (1966).
. United Ex. 21, Table 1, J.A. at 177; United Ex. 32, Schedule 1, J.A. at 192.
. Testimony of Mr. Barnett of United, J.A. at 97-99. Mr. Barnett prepared and sponsored United Ex. 32, and his testimony at J.A. 97-99 served to augment Schedule 1 of Ex. 32 for calendar year 1970.
. United Ex. 32, Schedule 1, J.A. at 192.
. Direct examination of witness Brooks, J. A. at 16-35; cross-examination of witness Brooks, J.A. at 113-47; redirect examination of witness Brooks, J.A. at 148-58.
. United Ex. 21, J.A. at 173-90.
. J.A. at 27, 31.
. J.A. at 32; see United Ex. 32, Schedule 3, J.A. at 194. The figures in Ex. 32, Schedule 3 were those used by witness Brooks in his depreciation exhibit; United Ex. 21, Table 2, J.A. at 178.
. Petitioner’s Br. at 7-9.
. J.A. at 200.
. Testimony of witness Brooks, J.A. at 30; Testimony of witness Barnett, J.A. at 41.
. “[W]e do not conclude that United will not be in the gas business in 1990. On the contrary, we would expect United to be in the gas business for many years after 1990.” Opinion No. 645 at 11, J.A. at 236.
. The Commission agrees with this statement of the issue. See Respondent’s Br. at 15.
. See, e. g., United Fuel Gas Co., 31 FPC 1342 (1964).
. J.A. at 26.
. See supra notes 33, 34 and accompanying text.
. The Commission in its Brief makes the statement: “[T]he Company demonstrated that its then-effective 2.88% depreciation rate had become unrealistic and inadequate.” Respondent’s Br. at 14. In support of this statement, the Commission directs our attention to three sources: (1) Opinion No. 645 at 10, J.A. at 235; (2) Opinion No. 645 at 12, J.A. at 237; and (3) United Ex. 32, Schedule 2, J.A. at 193. Items (1) and (2) are, of course, not record evidence, but rather the Commission’s conclusions. Item (3), a chart showing United’s historical gas reserves 1948-1969, contains no information whatsoever relating to the adequacy of the depreciation rate. We think it significant that the Commission is unable to direct us to record evidence supporting its conclusion that the old rate had become “unrealistic and inadequate.”
.Petitioner’s Br. at 14.
. The Commission’s opinion contains not even the glimmer of a thought that annual depreciation requirements would zoom so high as to be unreeapturable in fact, and thus result in an instance of economic obsolescence.
. Respondent’s Br. at 16-20.
. It is possible that insufficient reserves could have a greater effect on one type of company property, or property located in one area, than on other property. In such a case, the Commission could arrive at a composite depreciation rate, taking into account potentially differing useful lives, rather than as here, a uniform rate systemwide.
. J.A. at 201. See supra note 43.
. City of Chicago v. FPC, 128 U.S.App.D.C. 107, 385 F.2d 629, 637 (1967), cert. denied, 390 U.S. 945, 88 S.Ct. 1028, 19 L.Ed.2d 1133 (1968).