Shell Oil Co. v. Federal Energy Regulatory Commission

TJOFLAT, Circuit Judge: Shell Oil Company and other natural gas producers bring this petition to review the Federal Energy Regulatory Commission’s (FERC) Order No. 539-B,-F.P.C.-, 41 Fed.Reg. 32,883 (1976), which established a regulation requiring a producer to act as a “prudent operator” in developing and maintaining deliverability from natural gas reserves.1 The primary issue before us is whether this Order exceeds the Commission’s jurisdiction to regulate the transpor [538] tation and sale of natural gas in interstate commerce. The FERC claims that the “prudent operator” obligation is an implied condition of the certificates of public convenience and necessity that are required under the Natural Gas Act before companies may transport or sell natural gas in interstate commerce. The Commission relies upon the concept expressed as “service” in the Natural Gas Act2 to establish its authority to hold certificate recipients to the “prudent operator” [539] standard. No separate statutory or regulatory grant of jurisdiction has been cited by the FERC. The producers, however, argue that the FERC is prohibited from issuing Order No. 539-B by the specific exclusion of “the production and gathering of natural gas” from the Commission’s jurisdiction and that the FERC cannot use the power to issue certificates to extend its jurisdiction into the excluded area.3 We agree with the producers and vacate the FERC’s Order. The jurisdiction of the FERC to regulate the natural gas industry is delineated by § 1(b) of the Natural Gas Act, 15 U.S.C. § 717(b) (1970): The provisions of this chapter shall apply to the transportation of natural gas in interstate commerce, to the sale in interstate commerce of natural gas for resale for ultimate public consumption for domestic, commercial, industrial, or any other use, and to natural gas companies engaged in such transportation or sale, but shall not apply to any other transportation or sale of natural gas or to the local distribution of natural gas or to the facilities used for such distribution or to the production or gathering of natural gas. The producers are subject to the jurisdiction of the FERC when they engage in activities that can be classified as sales or transportation rather than as production or gathering. Phillips Petroleum Co. v. State of Wisconsin, 347 U.S. 672, 74 S.Ct. 794, 98 L.Ed. 1035 (1954). Through the years, the “production or gathering of natural gas” exemption has been judicially narrowed. The progression can be seen by comparing FPC v. Panhandle Eastern Pipe Line Co., 337 U.S. 498, 69 S.Ct. 1251, 93 L.Ed. 1499 (1949) with United Gas Improvement Co. v. Continental Oil Co. (Rayne Field), 381 U.S. 392, 85 S.Ct. 1517, 14 L.Ed.2d 466 (1965). The Panhandle case held that gas leases relate to the production or gathering of natural gas and are thus outside the jurisdiction of the FERC. The Supreme Court narrowly construed Panhandle in Rayne Field when it held that leases that are in essence sales of the gas reserves are within the FERC’s jurisdiction. In Rayne Field the producers recast a conventional wellhead purchase of natural gas as a purchase of the leasehold interests in the natural gas field. The Supreme Court described this sale of leasehold interests as “very close in economic effect to [traditional] sales of natural gas,” id., 85 S.Ct. at 1520, and stated that: The “production or gathering” exemption relates to the physical activities, processes and facilities of production or gathering, but not to sales of the kind affirmatively subjected to Commission jurisdiction. This accommodation of the two relevant clauses of § 1(b) gives content to the national objectives of the Natural Gas Act as expanded in Phillips, and to the Commission’s jurisdiction to accomplish them, while in no way interfering with state regulatory power over the physical processes of production or gathering in furtherance of conservation or other legitimate state concerns. Id. 381 U.S. at 403, 85 S.Ct. at 1523. (Emphasis added.) The FERC can enforce “service obligations” contained in the certificates that it issues to producers, preventing producers from ceasing deliveries from fields admittedly capable of continuing production. This doctrine was developed in Sunray Mid-Continent Oil Co. v. FPC, 364 U.S. 137, 80 S.Ct. 1392, 4 L.Ed.2d 1623 (1960) and Sun Oil Co. v. FPC, 364 U.S. 170, 80 S.Ct. 1388, 4 L.Ed.2d 1639 (1960), based on the power to issue certificates, see note 2 supra, and prevents producers from beginning delivery to another party after the initial contracts expire. Another line of cases permits the FERC to regulate the “abandonment of service.” Mitchell Energy Corp. v. FPC, 533 F.2d 258 (5th Cir. 1976); Panhandle Eastern Pipe Line Co. v. Michigan Consolidated Gas Co., 177 F.2d 942 (6th Cir. 1949). [540] No case has been found, however, that extends FERC jurisdiction directly into the physical activities, processes, and facilities of production and development. The cases recognizing the broad scope of the FERC’s authority have nonetheless also recognized the “production or gathering” exclusion. In Colorado Interstate Gas Co. v. FPC, 324 U.S. 581, 65 S.Ct. 829, 89 L.Ed. 1206 (1945), after holding that the FERC could include production properties in the rate base of an interstate pipeline company, the Supreme Court stated: that does not mean that the part of § 1(b) which provides that the Act shall not apply “to the production or gathering of natural gas” is given no meaning. Certainly that provision precludes the Commission from any control over the activity of producing or gathering natural gas. For example, it makes plain that the Commission has no control over the drilling and spacing of wells and the like. Id. at 602-03, 65 S.Ct. at 839. In Continental Casualty Co. v. Associated Pipe & Supply Co., 447 F.2d 1041, 1052 (5th Cir. 1971), we echoed Mr. Justice Black’s definition of “the production or gathering of natural gas:” “Production” of gas [means] the act of bringing gas from the earth, and “gathering” [means] the act of collecting gas after it has been brought forth. Panhan-die Eastern Pipe Line Co., 337 U.S. 518, 69 S.Ct. at 1262 (Black, J., dissenting). See also Northern Natural Gas Co. v. State Corporation Comm’n, 372 U.S. 84, 90, 83 S.Ct. 646, 650, 9 L.Ed.2d 601 (1963) (“ ‘production’ and ‘gathering’ are terms narrowly confined to the physical acts of drawing the gas from the earth and preparing it for the first stages of distribution.”) Order No. 539-B clearly is intended to open the door to FERC involvement into forbidden production activities:4 This [prudent operator] standard encompasses the obligations to develop the properties consistent with the performance requirements of lease agreements with mineral owners and/or assignors; all valid rules and regulations of any Federal, state or local government having jurisdiction; and the standard of what a reasonably prudent producer would do with respect to the drilling completion, workover, recompletion or abandonment of wells. • — — F.P.C. at-, 41 Fed.Reg. at 32,884. (Emphasis added.) (Footnote omitted.) To hold that the power to issue Order No. 539-B is within the jurisdiction of the FERC would all but eliminate the “production or gathering” exclusion and would allow the FERC to encroach on areas reserved to the states.5 We cannot so extend [541] the authority of the Commission.6 VACATED AND REMANDED. Footnotes [2] Natural gas companies perform a service to the public, and the Commission’s authority extends to ensuring that the service is properly performed even if it is not specifically manifested in a contractual relationship. Sunray Mid-Continent Oil Co. v. FPC, 364 U.S. 137, 80 S.Ct. 1392, 4 L.Ed.2d 1623 (1960). This service is derived from the section of the Natural Gas Act empowering the FERC to issue certificates: . [a] certificate shall be issued to any qualified applicant therefor, authorizing the whole or any part of the operation, sale, service, construction, extension, or acquisition covered by the application, if it is found that the applicant is able and willing properly to do the acts and to perform the service proposed and to conform to the provisions of this chapter and the requirements, rules, and regulations of the Commission thereunder, and that the proposed service, sale, operation, construction, extension, or acquisition, to the extent authorized by the certificate, is or will be required by the present or future public convenience and necessity; otherwise such application shall be denied. The Commission shall have the power to attach to the issuance of the certificate and to the exercise [539] of the rights granted thereunder such reasonable terms and conditions as the public convenience and necessity may require. 15 U.S.C. § 717f(e) (1970). [3] Natural Gas Act § 1(b), 15 U.S.C. § 717(b) (1977). This was the position taken by Commissioner Watts in his dissent from Order No. 539-B. [4] During oral argument, the FERC’s counsel first stated that the FPC could require producers to drill new wells pursuant to Order No. 539-B; counsel later withdrew from this position and stated that the Commission could not do so because such a requirement would be beyond its power. The Commission staff, however, has not adopted a restrictive view of the authority granted to the FERC under Order 539-B. In its initial brief to the FERC in Docket No. RI75-112 (Dec. 6, 1976), the Staff stated: Immediate development of these known proved reserves will serve the public interest by increasing the supply of natural gas available to the interstate market. In the event that such development is not undertaken voluntarily by the producers, staff recommends that the Commission use its authority pursuant to Order 539-B to insure full and timely development of these dedicated proved reserves. An answer to the question of whether production from ‘‘behind the pipe” reserves should be accelerated by drilling new wells involves a policy determination based on a careful consideration of a number of factors . Id. at 213. (Emphasis added.) [5] The Supreme Court has discussed extensively the legislative history of the Natural Gas Act in Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672, 74 S.Ct. 794, 98 L.Ed. 1035 (1954) and FPC v. Panhandle Eastern Pipe Line Co., 337 U.S. 498, 69 S.Ct. 1251, 93 L.Ed. 1499 (1949). See also Panhandle Eastern Pipe Line Co. v. Public Service Comm’n of Indiana, 332 U.S. 507, 514-21, 68 S.Ct. 190, 193-97, 92 L.Ed. 128 (1947); Interstate Natural Gas Co. v. FPC, 331 U.S. 682, 689-90, 67 S.Ct. 1482, 1486-87, 91 L.Ed. 1742 (1947); Colorado Interstate Gas Co. v. FPC, 324 U.S. 581, 601-03, 65 S.Ct. 829, 838-39, 89 L.Ed. 1206 (1945); FPC v. Hope Natural Gas Co., 320 U.S. 591, 609-13, 64 S.Ct. 281, 291-92, 88 L.Ed. 333 (1944); Illinois Natural Gas Co. v. Central Illinois Public Service Co., 314 U.S. 498, 506-08, 62 S.Ct. 384, 397-98, 86 L.Ed. 371 (1942). It is clear that the Natural [541] Gas Act was passed to fill the gap in regulation of the natural gas industry created by judicial holdings precluding state regulation of interstate commerce: The Natural Gas Act was designed to supplement state power and to produce a harmonious and comprehensive regulation of the industry. Neither state nor federal regulatory body was to encroach upon the jurisdiction of the other. Congress enacted this Act after full consideration of the problems of production and distribution. It considered the state interests as well as national interests. Panhandle Eastern Pipe Line Co., 337 U.S. at 513, 69 S.Ct. at 1260. (Footnotes omitted.) [6] One final question raised concerns the “prudent operator” standard promulgated by Order No. 539-B. The argument is advanced that the “prudent operator” standard is inappropriate to FERC’s goal to increase production of natural gas because “prudent operator” is a term of art employed in state regulations which are concerned with increasing the total recovery of hydrocarbons through the conservation of natural gas fields rather than permitting operators to waste energy resources by exploitation of reserves. We do not reach the issue due to our disposition on jurisdictional grounds.