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KENTUCKY WEST VIRGINIA GAS CO. v. PENNSYLVANIA PUC

December 23, 1986

KENTUCKY WEST VIRGINIA GAS COMPANY, and EQUITABLE GAS COMPANY, a division of Equitable Resources, Inc., Plaintiffs
v.
PENNSYLVANIA PUBLIC UTILITY COMMISSION, LINDA C. TALIAFERRO, FRANK FISCHL, AND BILL SHANE, Commissioners, FEDERAL ENERGY REGULATORY COMMISSION, Defendants



The opinion of the court was delivered by: CALDWELL

 I. Introduction.

 Plaintiff, Equitable Gas Company (Equitable), a division of Equitable Resources, Inc., produces, purchases, transports and sells natural gas in both interstate and intrastate commerce. As part of its business, it retails natural gas to approximately 240,000 customers in southwestern Pennsylvania. During the twelve month period ending June 30, 1984, Equitable purchased quantities of gas from one of its suppliers, Kentucky West Virginia Gas Company (Kentucky West), a wholly-owned subsidiary of Equitable Resources, Inc., to meet the demands of its Pennsylvania customers. In a subsequent proceeding before the Pennsylvania Public Utility Commission (PUC) Equitable sought to recover the cost of the purchased gas by increasing the rates charged to retail customers. The PUC disallowed the requested rates because it concluded that Equitable could have obtained less expensive gas from its own production and from quantities available from other suppliers. Equitable and Kentucky West thereafter filed this lawsuit, contending that the PUC action violated the commerce clause, *fn1" the supremacy clause, *fn2" and the first, fifth, and fourteenth amendments, *fn3" along with two federal statutes, the Natural Gas Act (NGA), 15 U.S.C. § 717 et seq. and the Natural Gas Policy Act (NGPA), 15 U.S.C. § 3301 et seq. Plaintiffs seek a permanent injunction against the PUC, prohibiting it from inquiring into Equitable's choice of natural gas from among competing gas suppliers. This request is bottomed upon the approval by the Federal Energy Regulatory Commission (FERC) of Kentucky West's gas rates as just and reasonable for the purposes of federal law. Plaintiffs also seek, among other things, a declaratory judgment that the Pennsylvania legislation, the Act of May 31, 1984, Act No. 1984-74 (hereinafter "Act 74"), enabling the PUC to disallow Equitable's purchased gas costs is unconstitutional. *fn4"

 A hearing on the appropriateness of preliminary injunctive relief was held on October 30, 1985. Thereafter, we abstained from exercising our jurisdiction. See Kentucky West Virginia Gas Co. v. Pennsylvania Public Utility Commission, 620 F. Supp. 1458 (M.D. Pa. 1985). The Court of Appeals for the Third Circuit reversed that determination, 791 F.2d 1111 (3d Cir. 1986), and remanded the case to us for a disposition on the merits. A hearing was held for that purpose on August 21, 22 and 28, 1986 and thereafter the parties briefed the issues which are now ripe for disposition. For the reasons set forth below, we will grant judgment in favor of defendants on all of the plaintiffs' claims. *fn5"

 II. Background.

 From the testimony at the hearings and the stipulation of facts that the parties have been able to agree upon, the following is the background of this litigation. *fn6"

 As noted previously, Equitable sells natural gas at retail in southwestern Pennsylvania. It has approximately 240,000 customers in Pennsylvania which include residential and industrial users. Equitable also retails gas in West Virginia and Kentucky on a much smaller scale. Its West Virginia customers number 11,000 and its Kentucky customers approximately 4,000. Equitable's retail sales in these three states are regulated by the appropriate state administrative body; in Pennsylvania, the PUC, in West Virginia, the West Virginia Public Service Commission, and in Kentucky, the Kentucky Public Service Commission. These retail sales are not subject to FERC approval.

 Equitable has three main sources of gas. First, Equitable has its own production from wells it controls in West Virginia and Pennsylvania. Second, gas is acquired from independent producers in those states under contracts with Equitable. Third, Equitable receives gas from three interstate pipelines, Kentucky West, Texas Eastern Transmission Corporation (Texas Eastern) and Tennessee Gas Pipeline Company (Tennessee).

 Kentucky West, Texas Eastern and Tennessee, natural gas companies under section 1 of the NGA, 15 U.S.C. § 717, sell gas in interstate commerce. They receive supplies of gas from producers at the wellhead. FERC controls the pipelines' tariffs. That federal agency approves many different tariffs for the sale of natural gas and the price at which gas is sold under each tariff may be different. Approval of the tariffs, or rates at which a pipeline sells gas, does not guarantee the pipeline any particular sales volume. Kentucky West sells approximately 70% of its gas to Equitable.

 Equitable has long term contracts with each of its interstate pipeline suppliers. The contracts contain the following two provisions, typically included in contracts for the wholesale purchase of natural gas. One provision entitles Equitable to purchase a maximum amount of gas per day, "a maximum daily volumetric entitlement." The other provision is a "minimum commodity bill," requiring Equitable, for a portion of the period relevant to this action, to pay the full commodity charge for a minimum volume of gas regardless of whether Equitable actually needs or wants the gas. *fn7" A minimum commodity bill does not require Equitable to physically take the gas paid for. See Wisconsin Gas Co. v. FERC, 244 U.S. App. D.C. 349, 758 F.2d 669, 672 (D.C. Cir. 1985) (per curiam).

 The minimum commodity bill is similar to a provision pipelines have in their own contracts with producers of natural gas. Called a "take or pay" provision, it "require[s] a pipeline to take a specified percentage of the gas which it is contracturally obligated to purchase, or to pay for such gas." Id. at 673 n.8 (brackets added).

 As noted previously, Equitable made certain purchasing decisions during 1983 and 1984, taking from among the sources of gas available to it, a certain quantity from its affiliated pipeline, Kentucky West. On March 1, 1985, Equitable sought approval of new rates for its retail customers in Pennsylvania by filing a computation of Annual Purchased Gas Adjustment pursuant to 66 Pa.Con.Stat. § 1307(f)(1), a part of Act 74.

 The PUC investigated the justness and reasonableness of the new rates pursuant to section 1307(f)(2) and under the standard promulgated in 66 Pa.Con.Stat. § 1318. *fn8" It concluded that Equitable had not pursued "a least cost fuel procurement policy" as required by section 1318, and that its proposed rates were accordingly not just and reasonable. Specifically, in an opinion and order, adopted August 28, 1985, the PUC concluded that Equitable, for the period between July 1, 1983 and June 30, 1984, had unnecessarily purchased more expensive gas from Kentucky West when it had available to it lower priced local production and its own supplies. It imputed to Equitable the purchase of the less expensive gas and disallowed the rates it had requested based upon its actual gas purchases. This action resulted in a failure to recover $14.3 million in purchased gas costs for gas already delivered to and consumed by Pennsylvania customers. The PUC also concluded for the then upcoming period between September 1, 1985 and August 31, 1986, that Equitable should increase its purchases from Texas Eastern and reduce purchases from Tennessee. Concerned about the close corporate relationship between Kentucky West and Equitable, the PUC also ordered those entities to retain separate counsel and separate support staff in Kentucky West's future FERC proceedings. This lawsuit followed.

 In the meantime, Equitable has complied with the PUC Order. It has reduced its purchases from Tennessee and increased its purchases from independent gas producers in Pennsylvania and West Virginia.

 III. Discussion.

 A. Act 74 Does Not Violate the Supremacy Clause.

 We preface our discussion of the supremacy clause claim with the following remarks by the Supreme Court on the "dilemma" often presented by federal and state regulation of utilities:

 
Maintaining the proper balance between federal and state authority in the regulation of electric and other energy utilities has long been a serious challenge to both judicial and congressional wisdom. On the one hand, the regulation of utilities is one of the most important of the functions traditionally associated with the police power of the States. See Munn v. Illinois, 94 US 113, 24 L Ed 77 (1877). On the other hand, the production and transmission of energy is an activity particularly likely to affect more than one State, and its effect on interstate commerce is often significant enough that uncontrolled regulation by the States can patently interfere with broader national interests. See FERC v Mississippi, 456 US 742, 755-757, 72 L Ed 2d 532, 102 S Ct 2126 (1982); New England Power Co. v New Hampshire, 455 US 331, 339, 71 L Ed 2d 188, 102 S Ct 1096 (1982).

 Arkansas Electric Cooperative Corp. v. Arkansas Public Service Comm'n, 461 U.S. 375, 377, 103 S. Ct. 1905, 1908-09, 76 L. Ed. 2d 1, 6 (1983).

 We turn now to the supremacy clause claim and note that it must be judged against the following standard:

 
It is a familiar and well-established principle that the Supremacy Clause, US Const, Art VI, cl 2, invalidates state laws that "interfere with, or are contrary to" federal law. Gibbons v Ogden, 22 U.S. 1, 9 Wheat 1, 211, 6 L Ed 23 (1824) (Marshall, C. J.). Under the Supremacy Clause, federal law may supersede state law in several different ways. First, when acting within constitutional limits, Congress is empowered to pre-empt state law by so stating in express terms. Jones v Rath Packing Co., 430 US 519, 525, 51 L. Ed 2d 604, 97 S Ct 1305 (1977). In the absence of express pre-emptive language, Congress' intent to preempt all state law in a particular area may be inferred where the scheme of federal regulation is sufficiently comprehensive to make reasonable the inference that Congress "left no room" for supplementary state regulation. Rice v Santa Fe Elevator Corp., 331 US 218, 230, 91 L Ed 1447, 67 S Ct 1146 (1947). Pre-emption of a whole field also will be inferred where the field is one in which "the federal interest is so dominant that the federal system will be assumed to preclude enforcement of state laws on the same subject." Ibid.; see Hines v Davidowitz, 312 US 52, 85 L Ed 581, 61 S Ct 399 (1941).
 
Even where Congress has not completely displaced state regulation in a specific area, state law is nullified to the extent that it actually conflicts with federal law. Such a conflict arises when "compliance with both federal and state regulations is a physical impossibility," Florida Lime & Avocado Growers, Inc. v Paul, 373 US 132, 142-143, 10 L Ed 2d 248, 83 S Ct 1210 (1963), or when state law "stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress," Hines v Davidowitz, supra, at 67, 85 L Ed 581, 61 S Ct 399, See generally Capital Cities Cable, Inc. v Crisp, 467 US 691, 81 L Ed 2d 580, 104 S Ct 2694 (1984).

 Hillsborough County v. Automated Medical Laboratories, Inc., 471 U.S. 707, 713, 105 S. Ct. 2371, 2375, 85 L. Ed. 2d 714, 721 (1985); see also Cipollone v. Liggett Group, Inc., 789 F.2d 181 (3d Cir. 1986), petition for cert. filed, 55 U.S.L.W. 3364 (U.S. Oct. 6, 1986) (No. 86-563).

 Plaintiffs claim that Act 74 conflicts with federal law because it permits Pennsylvania to regulate indirectly the price of Kentucky West's gas in interstate commerce. They point specifically to section 1318(d) as being unconstitutional on its face. *fn9" That section provides as follows:

 
Other regulatory approvals. -- The fact that a contract or rate has been approved by a Federal regulatory agency for interstate ratemaking purposes shall not, in and of itself, be adequate to satisfy the utility's burden of proof that gas prices and volumes associated with such contract or rate are just and reasonable for purposes of this section.

 Plaintiffs claim that the statutory refusal to recognize a rate established by a federal agency is improper. We disagree. "It is well established that the courts will not invalidate a statute on its face simply because it may be applied unconstitutionally, but only if it cannot be applied consistently with the Constitution." Robinson v. New Jersey, 806 F.2d 442, 446 (3d Cir. 1986) (emphasis in original). Section 1318(d) can be applied constitutionally because it merely recognizes explicitly what has been accepted for decades in utility regulation jurisprudence - that states may legitimately exercise authority over intrastate utility rates. See Arkansas Electric, supra. Hence, the refusal to accept federal approval of interstate rates is valid because Act 74 is intended to reach only intrastate rates. The use of the phrase, "just and reasonable" in both federal law, see 15 U.S.C. §§ 717c(a), 717d(a), and state law is irrelevant when the jurisdictional reach of the laws is different. Section 1318(d) is not unconstitutional on its face.

 Plaintiffs and the amicus, American Gas Association, rely heavily upon Nantahala Power And Light Co. v. Thornburg, 476 U.S. 953, 106 S. Ct. 2349, 90 L. Ed. 2d 943 (1986) to buttress their contention that Act 74 violates the supremacy clause and is in conflict with the NGA. *fn10" In their view, the Supreme Court held in Nantahala that "state regulators must recognize that wholesale energy costs incurred by local utilities are reasonable and prudent as a matter of law." (Kentucky West's and Equitable's initial brief at p. 29). We find no support in Nantahala for this expansive reading of the opinion.

 In Nantahala, the Nantahala Power & Light Company (Nantahala) and Tapoco, Inc. (Tapoco), wholly owned subsidiaries of Alcoa, each owned hydroelectric plants on the Little Tennessee River and surrendered all the power generated by the plants to the Tennessee Valley Authority (TVA). In return, both received a fixed supply of low cost "entitlement power," and Nantahala could purchase a variable amount of high cost "purchased power." Nahtahala served retail and wholesale customers. Tapoco sold all its power to Alcoa.

 Certain agreements between TVA, Nantahala and Tapoco, conferred upon Tapoco 80% of the entitlement power and upon Nantahala 20%. In 1976, Nantahala filed a proposed wholesale rate increase with FERC. Upon objection by a wholesale customer, FERC determined that the allocation of entitlement power was unfair and that Nantahala should receive 22.5% of that power. FERC therefore required Nantahala to file rates which took into account FERC's allocation of the entitlement power.

 Nantahala had also sought to raise its intrastate rates in North Carolina. The Utilities Commission of North Carolina used a methodology, and assumptions concerning available power, at odds with the analysis of FERC and concluded that Nantahala should calculate its costs for state ratemaking as if it received 24.5% of the entitlement power.

 The Supreme Court concluded that the state Utilities Commission could not engage in this inquiry. Based upon the "filed rate doctrine," the Commission had to accept the allocation of entitlement power determined by FERC. The Court stated:

 
We acknowledge that this case does not present the typical application of the filed rate doctrine, in which a middleman faces a FERC-fixed wholesale rate charged by a power supplier. In that situation, for a state ratemaking agency to disregard a FERC-filed rate would clearly be inconsistent with the exclusive federal regulatory scheme over interstate wholesale power prices. The FERC-approved rate at which the middleman purchased power would not be fully recognized as a cost in the retail market, thereby forcing the middleman to sell power at less than its reasonable cost as determined by the federal agency.
 
Here, in contrast, Nantahala both owns some of the facilities that produce the relevant electricity and sells that power to its retail customers, rather than to a distributor. But FERC's regulation of wholesale power rates nonetheless has a direct effect on Nantahala's costs of producing retail power. Nantahala has, through the NFA, contracted with TVA for the latter to control eight of Nantahala's eleven hydroelectric facilities, and that arrangement was approved by FERC in the course of rate proceedings over which FERC clearly had exclusive jurisdiction. FERC also examined the AA, a document filed in conjunction with the same proceeding, and concluded that the reasonable allocation of entitlement power was to give 77.5% of that power to Tapoco and 22.5% of that power to Nantahala. From Nantahala's point of view, then, it is in a situation quite similar to that of a purchaser of wholesale power at FERC-approved rates: Nantahala is entitled to include only a certain, FERC-specified amount of low-cost entitlement power among the sources of power from which it can draw in providing retail power. The fact that NCUC is setting retail rates does not give it license to ignore the limitations that FERC has placed upon Nantahala's available sources of low-cost power.

 Id. at , 106 S. Ct. at 2358, 90 L. Ed. 2d at 956.

 The case at bar is easily distinguishable. Neither of the plaintiffs in this case is in the situation in which Nantahala found itself. Kentucky West is an interstate pipeline and makes no retail sales subject to PUC jurisdiction. Equitable, for the purposes of this action, is an intrastate retailer of natural gas which has available to it several sources of natural gas, *fn11" one of which is Kentucky West. No single entity, simultaneously serving as wholesaler and retailer, is subject to the potential of conflicting orders from federal and state agencies. There is accordingly no risk of "trapped costs" and the filed rate doctrine is inapplicable here.

 That Nantahala cannot control this case is made clear by the following remarks from the opinion:

 
The North Carolina Supreme Court erred in relying on cases treating the reasonableness of purchasing from a particular source of, rather than paying a particular rate for, FERC-approved power. See Pike County Light & Power Co. v Pennsylvania Public Utility Comm'n, 77 Pa Commw 268, 273-274, 465 A.2d 735, 737-738 (1983); Kansas-Nebraska Natural Gas Co. v State Corp. Comm'n, 4 Kan App 2d 674, 679-680, 610 P. 2d 121, 127 (1980). Without deciding this issue, we may assume that a particular quantity of power procured by a utility from a particular source could be deemed unreasonably excessive if ...

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