NW Cent. Pipeline v. Kans. Corp. Comm'n
489 U.S. 493 (1989)

Annotate this Case

U.S. Supreme Court

NW Cent. Pipeline v. Kans. Corp. Comm'n, 489 U.S. 493 (1989)

Northwest Central Pipeline Corp. v. State Corporation

Commission of Kansas

No. 86-1856

Argued November 29, 1988

Decided March 6, 1989

489 U.S. 493

APPEAL FROM THE SUPREME COURT OF KANSAS

Syllabus

The issues for decision are whether a regulation adopted by appellee State Corporation Commission of Kansas (KCC) (1) was preempted by the federal Natural Gas Act (NGA) or (2) violates the Commerce Clause of the Constitution. Interrelated market, contractual, and regulatory factors have led interstate pipelines to cut back their purchases of "old," federally regulated natural gas from producers at the Kansas-Hugoton field. The KCC found that the cutbacks had caused an imbalance between underproduced Hugoton wells supplying interstate pipelines and overproduced wells supplying the intrastate market, resulting in drainage between wells that posed a threat to producers' correlative property rights in the field's common gas pool. To protect correlative rights, the KCC adopted a regulation providing that producers' entitlements to assigned quantities of Hugoton gas would permanently be canceled if production were too long delayed. The KCC reasoned that, were permanent cancellation of production underages the alternative to their timely production, purchasers and producers would have an incentive to run more gas out of the field, and thereby reduce existing underages, deter future underages, and restore balance to the field. In dismissing a challenge to the regulation by appellant, an interstate pipeline having a long-term contract for Hugoton gas, the KCC rejected the contention that the regulation was preempted by the NGA, which gives the Federal Energy Regulatory Commission (FERC) exclusive jurisdiction over the transportation and sale for resale of regulated gas in interstate commerce, including interstate pipelines' purchasing policies and pricing practices. On judicial review, a county court agreed that the regulation was not preempted, and the Kansas Supreme Court affirmed.

Held:

1. Congress has not exercised its power under the Supremacy Clause of Art. VI of the Constitution to preempt the KCC regulation, and therefore the judgment of the Kansas Supreme Court holding that the Commission's regulation was not preempted is affirmed. Pp. 489 U. S. 509-522.

(a) The regulation does not encroach upon a field that Congress has marked out for comprehensive and exclusive federal control, but, in fact, regulates in a field that Congress expressly left to the States. Section 1(b) of the NGA carefully divides up regulatory power over the natural

Page 489 U. S. 494

gas industry, conferring on FERC exclusive jurisdiction over interstate transportation and sales, but expressly reserving to the States the power to regulate, inter alia, "production or gathering." Since the latter phrase and the NGA's legislative history clearly establish Congress' intent not to interfere with the States' traditional power to regulate production -- and therefore rates of production over time -- as a means of conserving natural resources and protecting producers' correlative rights, the KCC's regulation represents precisely the sort of scheme that Congress intended to leave within a State's authority. To find field preemption merely because the regulation might affect gas purchasers' costs, and hence interstate rates, would be largely to nullify such state authority, for there can be little if any regulation of production that might not have at least an incremental effect on purchasers' costs in some market and contractual situations. Northern Natural Gas Co. v. State Corporation Comm'n of Kansas,372 U. S. 84, and Transcontinental Pipe Line Corp. v. State Oil and Gas Bd. of Mississippi,474 U. S. 409, which invalidated state regulations directed to interstate purchasers, distinguished. Pp. 489 U. S. 510-514.

(b) The regulation does not conflict with the federal scheme regulating interstate purchasers' cost structures. Appellant has not asserted that there exists any conflict so direct that it is impossible for pipelines to comply with both the regulation and with federal regulation of purchasing practices and pricing. Moreover, Kansas' threat to cancel underages does not prevent the attainment of FERC's regulatory goals, because the regulation imposes no direct purchasing requirements on pipelines, but simply defines producers' rights to extract gas; because FERC will make its own regulatory decisions with the KCC's regulation in mind, and because, if the regulation operates as a spur to greater production of low-cost Hugoton gas as Kansas intends, this would be congruous with current federal goals. Further, the purpose of the regulation is to protect the correlative rights of producers, and the means adopted are plausibly related to that legitimate state goal. The KCC's asserted purpose is not rendered suspect by the fact that the regulation might worsen correlative rights problems if underages are actually canceled, since the KCC's assumption that the regulation would likely increase production is not implausible in light of supporting evidence in the record. Pp. 489 U. S. 514-519.

(c) The regulation is not preempted under §§ 7(c) and 7(b) of the NGA, which respectively require that producers who sell gas to pipelines for resale in interstate commerce obtain a certificate of public convenience and necessity from FERC and obligate certificated producers to continue supplying "old" gas in the interstate market until FERC authorizes an abandonment. Plainly meritless is appellant's argument

Page 489 U. S. 495

that, since a producer's available reserves are a factor in FERC's certification decision, and since cancellation of underages under the regulation will work an abandonment through the noncompensable drainage of dedicated reserves, such an abandonment without FERC's approval undercuts the certification and abandonment process. FERC's abandonment authority encompasses only gas that operators have a right under state law to produce, and the regulation has settled that right in Kansas. Nor is there merit to appellant's argument to the effect that the regulation stands as an obstacle to the objective Congress sought to attain when it gave FERC authority over certification and abandonment -- assuring the public a reliable source of gas. That goal is entirely harmonious with the regulation's aim of assuring that producers have an opportunity to extract all the reserves underlying their leases before the Hugoton field is exhausted. Pp. 489 U. S. 520-522.

2. The KCC regulation does not violate the Commerce Clause of Art. I, § 8, of the Constitution. Pp. 489 U. S. 522-526.

(a) The regulation does not amount to per se unconstitutional economic protectionism, since it is neutral on its face, providing for the cancellation of producers' underages regardless of whether they supply the intrastate or interstate markets, and since its effects on interstate commerce are incident to Kansas' legitimate efforts under § 1(b) of the NGA to regulate production to prevent waste and protect correlative rights. Moreover, current federal policy is to encourage the production of low-cost gas, so that, were the regulation to increase Kansas takes at the expense of States producing more costly gas, this would not disrupt interstate commerce, but would improve its efficiency. Although Kansas may fail in its efforts to encourage production of underages, and the regulation might, as a result, engender noncompensable drainage to producers for the intrastate market, such indirect and speculative effects on interstate commerce are insufficient to render the regulation unconstitutional. Pp. 489 U. S. 522-525.

(b) The regulation is not invalid under the balancing test set forth in Pike v. Bruce Church, Inc.,397 U. S. 137, 397 U. S. 142, since it applies evenhandedly, regardless of whether the producer supplies the intrastate or interstate market, and is an exercise of Kansas' traditional and congressionally recognized power over gas production. Moreover, the regulation's intended effect of increasing production is not clearly excessive in relation to Kansas' substantial interest in controlling production to prevent waste and protect correlative rights, and the possibility that it may result in the diversion of gas to intrastate purchasers is too impalpable to override the State's weighty interest. Appellant's claim that the regulation must be invalidated because Kansas could have achieved its aims without burdening interstate commerce simply by establishing production

Page 489 U. S. 496

quotas in line with appellant's conception of market demand levels is rejected, since appellant has not challenged the KCC's determination of allowables, and has identified nothing in the record that could adequately establish that the KCC might have achieved its goals as effectively had it adopted a different allowables formula. Pp. 489 U. S. 525-526.

240 Kan. 638, 732 P.2d 775, affirmed.

BRENNAN, J., delivered the opinion for a unanimous Court.

JUSTICE BRENNAN delivered the opinion of the Court.

In this appeal, we must decide whether a regulation adopted by the State Corporation Commission of Kansas (KCC) to govern the timing of production of natural gas from the Kansas-Hugoton field violates either the Supremacy or the Commerce Clause of the Constitution. We hold that it does not.

Page 489 U. S. 497

I

At issue is a KCC regulation providing for the permanent cancellation of producers' entitlements to quantities of Kansas-Hugoton gas. Designed as a counterweight to market, contractual, and regulatory forces that have led interstate pipelines to cut back purchases from Kansas-Hugoton producers, the KCC's regulation seeks to encourage timely production of gas quotas by providing that the right to extract assigned amounts of gas will permanently be lost if production is too long delayed. Appellant Northwest Central Pipeline Corporation, an interstate pipeline, argues that the KCC's regulation is preempted by federal regulation of the interstate natural gas business because it exerts pressure on pipelines to increase purchases from Hugoton producers, and so affects their purchase mixes and cost structures, and because it impinges on exclusive federal control over the abandonment of gas reserves dedicated to interstate commerce. Northwest Central also urges that the regulation violates the Commerce Clause because it coerces pipelines to give Kansas producers a larger share of the interstate gas market at the expense of producers in other States, or, alternatively, causes the diversion of gas from the interstate to the intrastate market.

Kansas' regulation of the Hugoton field is an effort to solve perplexing problems in assigning and protecting property rights in a common pool of gas and in preventing waste of limited natural resources. Gas migrates from high-pressure areas of a pool around shut-in (or slow-producing) wells to low-pressure areas around producing (or faster producing) wells. As a consequence of this phenomenon a single producing well might exhaust an entire gas pool, though rights in the pool belong to many different owners. Absent countervailing regulation or agreement among all owners, the fact that gas migrates to low-pressure, heavily produced areas creates an incentive for an owner to extract gas as fast as

Page 489 U. S. 498

possible, in order both to prevent other owners draining gas it might otherwise produce and to encourage migration to its own wells that will enable it to capture a disproportionate share of the pool. A rush to produce, however, may cause waste. For example, gas may be produced in excess of demand; more wells may be drilled than are necessary for the efficient production of the pool; or the field may be depleted in such a way that it is impossible to recover all potentially available mineral resources (in particular oil, which is recovered using reservoir energy often supplied by associated natural gas reserves). See generally McDonald, Prorationing of Natural Gas Production: An Economic Analysis, 57 U.Colo.L.Rev. 153 (1985-1986).

The common law rule of capture, whereby gas was owned by whoever produced it from the common pool, left unchecked these twin problems of perceived inequities between owners of rights in the pool and of waste resulting from strong economic disincentives to conserve resources. Ibid. In response, producing States like Kansas have abandoned the rule of capture in favor of assigning more equitable correlative rights among gas producers, and of directly regulating production so as to prevent waste. Kansas, by statute, prohibits waste, Kan.Stat.Ann. § 55-701 (1983); directs the KCC to "regulate the taking of natural gas from any and all common sources of supply within this state in order to prevent the inequitable or unfair taking of natural gas from a common source of supply," Kan.Stat.Ann. § 55-703(a) (Supp.1987); and gives content to the concept of equitable taking of natural gas by obliging the KCC to regulate so that producers

"may produce only that portion of all the natural gas that may be currently produced without waste and to satisfy the market demands, as will permit each developed lease to ultimately produce approximately the amount of gas underlying the developed lease and currently produce proportionately with other developed leases in the common

Page 489 U. S. 499

source of supply without uncompensated cognizable drainage between separately-owned, developed leases or parts thereof."

Ibid.

Pursuant to statutory authority, the KCC in 1944 adopted the Basic Proration Order for the Hugoton field, after finding that uncompensated drainage caused by disproportionate production had impaired the correlative rights of owners of developed Hugoton leases. See Basic Proration Order

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