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UNITED STATES v. EXXON CORP.

March 25, 1983

UNITED STATES OF AMERICA, PLAINTIFF,
v.
EXXON CORPORATION, DEFENDANT



The opinion of the court was delivered by: FLANNERY

 This matter is before the court on cross-motions for summary judgment. Plaintiff Department of Energy ("DOE") *fn1" alleges that defendant Exxon Corporation ("Exxon") from January 1975 to January 1981 violated federal two-tier oil price-control regulations by selling as higher-priced "new" oil what should properly have been sold as lower-priced "old" oil. DOE alleges Exxon overcharged crude oil purchasers by failing properly to establish a unit-wide base production control level -- the basis for calculations of "new" and "old" oil -- for the Hawkins Field Unit, which it operates near Hawkins, Texas. DOE asks that Exxon be ordered to pay into the United States Treasury the alleged amount of overcharges -- some $895 million -- with interest from the date of overcharge, and that Exxon be assessed civil penalties of about $38 million.

 In support of its cross-motion for summary judgment, Exxon argues that it is guilty of no overcharge because the rule DOE seeks to enforce against it is invalid as beyond the agency's statutory authority, arbitrarily and capriciously applied, issued without proper procedure, and finally, in any event, not applicable before September 1, 1976. In opposition to DOE's motion, Exxon argues that the regulations at issue, if valid, require the establishment of a unit base production control level only upon the occurrence of a "significant alteration in producing patterns ", which occurred at the Hawkins Field no earlier than March 1977 and which, in any event, presents a disputed question of fact which may not be resolved on a motion for summary judgment.

 For the reasons expressed below, plaintiff's motion for summary judgment is granted in part and denied in part. Defendant's motion is denied.

 I. Background

 A. The Regulatory Framework

 In 1970 Congress passed the Economic Stabilization Act, Pub. L. No. 91-379, 84 Stat. 799, as amended 12 U.S.C. § 1904 note, authorizing the President to issue such orders as he felt appropriate in order to stabilize prices. In the summer of 1971 the President imposed wage and price controls and delegated their enforcement to the newly-created Cost of Living Council ("CLC"). During the next few years these controls were gradually phased out, but because prices of petroleum products continued to climb, the CLC in August 1973 promulgated regulations applicable only to the oil industry. 6 C.F.R. Part 150, Subpart L (1974); 38 Fed. Reg. 22,536 (1973).

 Just a few months later, after the Arab oil embargo had caused oil prices to jump sharply, Congress in November 1973 passed the Emergency Petroleum Allocation Act ("EPAA"), Pub. L. No. 93-159, 87 Stat. 628, 15 U.S.C. § 751 et seq. (1976), requiring the promulgation of regulations within 15 days. EPAA § 4(a). In January 1974, the new Federal Energy Office ("FEO") reissued the CLC price regulations, with only minor changes, at 10 C.F.R. Part 212, Subpart D (1975), 39 Fed. Reg. 1924, 1952 (1974) where they remained until the decontrol of petroleum prices in January 1981.

 The heart of the petroleum price regulations was the application to domestically produced crude oil of a two-tier pricing structure designed to further the twin goals of combatting inflation while encouraging new domestic oil production. Cities Service Co. v. FEA, 529 F.2d 1016, 1020 (Em. App. 1975). Producers were required to sell "old" crude oil at the lower-tier price and were allowed to sell "new" crude oil at a higher price. 10 C.F.R. §§ 272.73, 212.74 (1975). *fn2" Amounts of "old" and "new" oil were calculated by comparing current production at a given property to that property's production in an earlier corresponding base period, its "base production control level" ("BPCL"). *fn3" Any excess of current production above the BPCL could be sold as higher-priced new oil. All current production up to the BPCL, however, had to be sold as lower-priced old oil. *fn4"

 While the regulations appear conceptually to be relatively straightforward, their application in some instances proved to be problematic. For example, the regulations required that a BPCL be established for every oil-producing "property." 10 C.F.R. § 212.72 (1975). "Property" was defined as "the right which arises from a lease or from a fee interest to produce domestic crude petroleum." Id.5 The question arose, which is now at the heart of this lawsuit, as to the proper method of calculating a BPCL for large, multilease tracts which during the base year had operated as independent, competing properties but which subsequent to 1972 had embarked upon the cooperative production process known as unitization. *fn6" Did the regulations require that the BPCL for fields unitized after 1972 be established field-wide, by totalling the 1972 production of all properties which made up the unit, or could the BPCL be calculated on an individual, lease-by-lease basis?

 To address this issue, the Federal Energy Administration ("FEA") in August 1975 issued Ruling 1975-15 interpreting the existing regulations. 40 Fed. Reg. 40,832 (1975). *fn7" In Ruling 1975-15 the FEA emphasized that the property concept in the regulations was based on the right to produce crude oil, however arising, and on the need to ensure a meaningful comparison between current and base year production. Id. Accordingly, the FEA ruled that in the case of properties unitized after 1972, the producer was required to calculate a unit-wide BPCL by totalling the individual 1972 monthly production for each of the leases constituting the unit. Id. Lease-by-lease calculations were not allowed.

 Ruling 1975-15 sparked criticism from the oil industry that the unit BPCL requirement would discourage unitization and hence retard efforts to increase domestic production. See 41 Fed. Reg. 1564, 1569 (1976). *fn8" Furthermore, in December 1975 Congress passed the Energy Policy and Conservation Act ("EPCA"), Pub. L. No. 94-163, Title IV, 89 Stat. 871, 941 (1975), 15 U.S.C. §§ 757 et seq, which among other things directed the FEA to promulgate amendments to the oil price regulations which would stimulate domestic production while at the same time combatting inflation in the prices of petroleum products. EPCA § 401(a); S. Rep. No. 516, 94th Cong., 1st Sess. 116-17, 120-21 (1975). To achieve these sometimes conflicting goals, Congress directed the FEA to create different classifications of crude oil which would bear different prices. 15 U.S.C. § 757(a). The weighted average price per barrel was not to exceed $7.66. Id. To ensure that higher prices would reward only real increases in production, Congress provided specifically in Section 401(a) of the EPCA that no amendment to the regulation could allow the price of any old oil to increase above the existing ceiling, unless the President specifically found that such an amendment would give positive incentives for enhanced recovery techniques, or was necessary to take into account declining production at a property, and would likely result in production greater than what would have occurred in the absence of the amendment. EPCA § 401(a); 15 U.S.C. § 757(b)(2). *fn9" "Old oil production" was defined in the EPCA as the average production of old oil, as defined in Section 212.72, at a particular property in the months of September, October, and November of 1975. 15 U.S.C. § 757(b)(3).

 In reaction to the industry criticism, and pursuant to the Congressional directives in the EPCA, the FEA in February 1976 amended the oil price regulations. 41 Fed. Reg. 4931 (1976). In response to the Congressional desire for increased production, *fn10" the amendments addressed three different but overlapping objectives: to provide production incentives generally, to provide incentives for the maintenance of existing units, and to remove disincentives to prospective unitization. *fn11"

 The FEA noted in the preamble to the amendments that production had so declined at older properties that producers could no longer realistically expect to boost volume above 1972 levels, thereby rendering ineffective the lure of higher new oil prices. Id. at 4932. Accordingly, the FEA first amended Section 212.72 to provide producers at all properties the option of choosing a more recent, and presumably lower, BPCL based on average old oil production in 1975, rather than 1972. Id. at 4933; see n. 3, supra. In the same spirit, the FEA eliminated all deficiencies which had accumulated prior to February 1, 1976. 41 Fed. Reg. at 4933. In effect, all properties could begin afresh with a new BPCL and a more realistic chance of producing new oil. Id.

 In addition, the FEA provided other incentives specifically for unitized properties. The first, applicable to both existing units and those to be formed on or after February 1, 1976, provided that Ruling 1975-15 was rescinded ab initio insofar as it required the unit operator to calculate a unit-wide BPCL as of the date of unitization. Id. at 4937. Instead, operators could continue to account for production on a lease-by-lease basis until enhanced recovery operations had begun or a significant alteration in producing patterns occurred within the unit. Id.

 The agency defined "enhanced recovery" as "any method of recovering crude oil in which part of the energy employed to move the crude oil through the reservoir is applied from extraneous sources by the injection of liquids or gases into the reservoir." Id. at 4941. A definition of "significant alteration" proved more elusive. The FEA hinted that a significant alteration might occur before an enhanced recovery project had begun operating when "production from certain leases is reduced or discontinued in preparation for enhanced recovery operations." Id. at 4937. Although the agency used the term "substantially altered" in its unit BPCL rule, it did not then formally define the term, choosing instead to issue a later Ruling to clarify its meaning. Id.

 Finally, to further encourage prospective unitization, the FEA enacted a new regulation applicable only to properties unitized after February 1, 1976. Id. at 4938. Such units could benefit, first, from a special rule allowing the BPCL to be calculated not on the basis of 1972 or 1975 production, but on the basis of average production in the twelve months preceding the calculation of a unit BPCL, i.e., preceding the date on which a significant alteration in producing patterns occurred or enhanced recovery operations were implemented. Id. In addition, the new regulation allowed a modified carryover of the stripper well lease exemption. See n. 4, supra. Producers at new units could sell at upper-tier prices a volume of crude oil equal to the average volume of stripper well lease production in the twelve months preceding the establishment of a unit BPCL. 41 Fed. Reg. at 4941.

  In August 1976 the FEA furnished the promised clarification of "significant alteration in producing patterns," defining it as "the occurrence of either (1) the application of extraneous energy sources by the injection of liquids or gases into the reservoir, or (2) the increase of production allowables for any property that constitutes the unitized property." 41 Fed. Reg. 36,172, 36,184 (1976). *fn12" At the same time, to eliminate any remaining disincentives to prospective unitization, the FEA adopted a special rule, applicable to units formed after September 1, 1976, to ensure that once a unit BPCL was established there could be no decrease in the absolute volumes of new oil. Producers at such units would be allowed to sell at upper-tier prices a volume of oil equal to the average volume of new oil produced from the constituent properties in the twelve months preceding establishment of a unit BPCL. Id. at 36,182, 36,184.

 Finally, to dispel any remaining confusion as to the effect of the 1976 amendments to the regulations, the FEA in January 1977 issued Ruling 1977-2. 42 Fed. Reg. 4409 (1977). In that Ruling the FEA made clear that the partial recission in February 1976 of Ruling 1975-15 allowed operators of units formed before February 1, 1976 to wait, before establishing a unit BPCL, until a significant alteration in producing patterns occurred. Accounting for volumes of new and old oil after the 1976 amendments depended on when the unit was formed and when a significant alteration occurred or enhanced recovery operations were implemented. Section 212.72 applied to units formed before February 1, 1976, and those units received none of the incentives of Section 212.75. *fn13" Units formed after February 1, 1976 received those benefits of Section 212.75 in effect at the time the operator had to calculate a unit BPCL -- the special unit BPCL rule and imputed stripper oil provisions after February 1, 1976, and the provisions for imputed new oil after September 1, 1976. Id. at 4415; see n.33, infra.

 B. Facts

 1. Hawkins Field

 In December 1940, oil was discovered at the Hawkins Field, a ten thousand acre field twenty miles north of the town of Tyler in Wood County, Texas. By the late 1940's, more than 200 individuals and companies produced oil from the Hawkins field on more than 300 leases or tracts within the field. To promote rational exploitation of the field, the Texas Railroad Commission ("TRRC") regulated the number of oil wells within the field, as well as the number of barrels of oil each well could produce, termed production "allowables." PX 5. *fn14" In addition, the TRRC established a Maximum Efficient Rate ("MER") of production for the field, a limit on the number of barrels which daily could be pumped from the field as a whole. Id. Still, by the mid-1960's years of competitive exploitation had so drained the field that natural reservoir pressure declined, allowing the invasion of the crude oil bearing formations by water and the irrevocable loss of oil into the field's original gas cap. Def. Mem. at 14-17. The Hawkins Field interest owners, led by Exxon, *fn15" owner of two-thirds of the field's production, concluded that this declining trend could be reversed, and the life of the field prolonged, only by means of a cooperative enhanced recovery project. Def. Mem. at 19.

 Based on engineering studies conducted at that time, the owners concluded that their enhanced recovery efforts would require the construction of a plant for the production of inert gas to be injected underground in order to increase reservoir pressure. Id. Before the program could be implemented, however, the field had to be unitized, in part so that the costs of the inert gas plant could be spread among the owners, but also because the injection of gas would cause crude oil to flow underground across lease lines. Id. at 20; see n. 6, supra. Accordingly, as early as 1969 Exxon began promoting unitization. Def. Opp. at 6. Its efforts began in earnest in the summer of 1971 when it first met with the more than 300 other working interest owners of the field. Id. Negotiations with these owners, as well as the more than 2200 royalty interest owners, continued for the next few years and culminated in the signing of a Unit Agreement in 1974. DX Intro-4. The agreement named Exxon as unit operator, and provided for the sharing of costs of the inert gas enhanced recovery project. Id. art. 11.1. Production, too, was to be shared, according to a formula by which the imputed share attributed to each tract was based on estimates of the recoverable reserves under each tract. Id. arts. 5, 6. The TRRC approved the agreement on November 26, 1974, permitting Exxon to take the steps necessary to implement the enhanced recovery project, and providing Exxon with a unit production allowable as of the effective date of unitization, January 1, 1975. DX Intro. 2. Under prior TRRC orders, the production allowables of a shut-in well could be transferred only pro rata among the other wells at the Hawkins Field. The unit allowable, equal to the then existing MER of approximately 112,000 barrels per day, would allow Exxon to transfer production among wells in the unit at will.

 At the same time that Exxon began its unitization efforts in 1969, it sought and received permission from the TRRC for an interim conservation project designed to curb the loss of crude oil at the field during the years needed to unitize the field and to implement the inert gas recovery project. The interim project called for the injection of up to 20 million cubic feet of natural gas per day, extraction of water, and increasing crude oil production. See PX 4 at 4. Accordingly, in its order approving the interim project, the TRRC authorized the increase of the Hawkins Field MER from 87,000 barrels per day to 112,000 barrels per day. PX 5. Shortly thereafter the rate of production was boosted up to the new, higher MER, and Exxon began injecting natural gas. It continued the natural gas injections throughout the succeeding years, beyond the effective date of unitization, until the completion of the inert gas plant. The inert gas plant, completed at a cost of some $57 million, commenced operations in March 1977. Def. Mem. at 4.

 As noted above, *fn16" the CLC in August 1973 promulgated the initial oil price regulations. Those regulations required the calculations of a BPCL for each "property." "Property" was defined as "the right which arises from a lease or from a fee interest to produce domestic crude petroleum." At the time the CLC regulations were promulgated, Exxon already operated several multilease units. Consequently, Exxon had to determine how the regulations would apply to those units. In the fall of 1973 Exxon issued instructions to its employees to treat each unit as a single "property" under the regulations with a single, unit BPCL. PX 46. Indeed, Exxon provided specific instructions for units which, as would be the case of Hawkins Field, were formed after 1972, the base year designated in the regulations for the calculation of the BPCL. For such units, Exxon instructed its employees that:

 
To arrive at the base production control level for the unit, sum by individual months the determined . . . base production control level for each accounting lease . . . contributed to the unit.

 Id. at 7. In accordance with those instructions, Exxon applied an aggregated, unit BPCL at units it operated in Texas, California, Alabama and Florida. PX 76.

 Exxon departed from its prior practice, however, at the Hawkins Field unit. In February 1974, Mr. Sidney J. Reso, Production Manager of Exxon's East Texas Division and supervisor of the effort to unitize Hawkins Field, suggested in a memorandum to his superiors that old and new oil at the Hawkins Field unit be calculated on a lease-by-lease, rather than a unit basis. PX 56. To do otherwise, Mr. Reso warned, would result upon unitization in an 80% reduction in the amount of new, released and stripper oil to be claimed by prospective unit participants. Id. In the spring of 1974 a task force was formed at Exxon to study Mr. Reso's suggestion. Def. Opp. at 17. That task force solicited the views of Exxon's in-house counsel as to the legality of Mr. Reso's suggestion under the regulations. On August 8, 1974, Mr. Fred W. File, an attorney in Exxon's legal department, issued a three-page opinion concluding that Mr. Reso's proposal would be acceptable under then applicable FEA regulations. PX 77. Mr. File identified the purpose of the regulations' two-tier pricing system as being to promote additional recovery of crude oil. Id. at 2. The application of a unit BPCL to the Hawkins Field unit would result, as Mr. Reso had noted, in a reduction in the amount of new and released oil which unit participants would be able to claim. Such a result, Mr. File concluded, was inconsistent with the regulations' purpose and therefore was "clearly not within [their] intent." Id. Mr. File qualified his opinion, however, by noting that "FEA regulations are subject to frequent interpretations and revisions" and that sale of oil from the unit would be controlled by regulations in effect on the date of sale. Id. at 3. Nevertheless, he concluded, it would be appropriate to advise other Hawkins Field interest owners that lease-by-lease calculations would be acceptable under the regulations then in effect. Id.

 Within a few weeks of the issuance of Mr. File's opinion, Exxon so notified the prospective Hawkins Field unit participants. When Hawkins Field was formally unitized on January 1, 1975, and in the many months thereafter, Exxon did in fact apply individual, lease-by-lease BPCL calculations.

 On January 6, 1976, the FEA published a notice of such a rule making, advancing the proposals which were eventually embodied in the February 1976 amendments to the oil price regulations. In its comments on the proposed regulations, Exxon embraced several of the FEA proposals, but suggested that the provision for lease-by-lease calculation of exempt oil should be extended for two years after formation of the unit or until implementation of the injection operations of an enhanced recovery project. PX 188 at 9. Moreover, to prevent the dissolution of existing units, Exxon requested that the same rules be applied to units formed before February 1, 1976. Id. Instead, the FEA in the February amendments chose to apply only some of the newly created incentives to preexisting units, and provided that new Section 212.75 would apply only prospectively. The "significant alterations" test, applicable to both, was not defined.

 Although heartened by the recission of Ruling 1975-15, Exxon remained uncertain as to the proper method of accounting for oil at the Hawkins Field Unit, due to the absence of any definition of "significant alteration in producing patterns." After meeting again in mid-February with FEA officials, DX Opp. CS-61, Exxon concluded that until the FEA clarified the meaning of the new regulations, it would be proper to continue its lease-by-lease calculations at the Hawkins Field, and so advised the other Hawkins interest owners. DX Opp. CS-62.

 In April 1976, the FEA sought comments as to how best to determine when there occurred "a significant alteration in producing patterns." Exxon responded as it had earlier, namely, suggesting that "significant alteration" be defined as "the initiation of the major injection or other programs contemplated by the unit, provided however that the date will be no longer than two years from the formation of the unit." DX Opp. CS-68 at Appendix 3, p. 2. In August the FEA finally published the long-promised clarification defining "significant alteration in producing patterns," effective September 1, 1976, as either the injection of liquids or gases into the reservoir or the increase of production allowables for any property constituting the unit. Although still puzzled by this definition as it applied to the Hawkins Field Unit, Exxon attorney Fred File concluded that it did require the calculation of an aggregated, unit BPCL. DX Opp. CS-75. Accordingly, Exxon did calculate such a unit BPCL for the Hawkins Field Unit, but, noting that no definition had existed before that time, did so only as of September 1, 1976, and then under the more generous provisions of Section 212.75. Exxon continued to account for oil production at the Hawkins Field Unit in this manner until the repeal of the oil price regulations in January 1981.

 From January 1975 through August 1976 production at the Hawkins Field remained relatively stable at about 112,000 barrels per day. See PX 288. Thereafter, despite the implementation of the inert gas enhanced recovery project in March 1977, production began to decline, to about 90,000 barrels per day in July 1977, and finally dropping to about 45,000 barrels per day in January 1981 at the time oil prices were decontrolled. Id. Despite the steady decline in production, an increasing percentage of oil was accounted for by Exxon as upper-tier, higher-priced oil, until beginning June 1, 1979, almost all of the then 62,000 barrels per day was classified as new oil. Id.; see Plaintiff's Appendix of Charts and Graphs, F.

 In January of 1978 the DOE issued to Exxon a Notice of Probable Violation, charging it with violating the oil price regulations in its sale of crude oil produced at the Hawkins Field Unit. On June 8, 1978, the DOE brought this enforcement action.

 II. The Unit Property Rule

 DOE maintains that the Hawkins Field Unit, because it was formed before February 1976, has always been subject solely to the requirement of 10 C.F.R. § 212.72 that a unit BPCL be established as of the date of unitization. DOE asserts further that the validity of this requirement, referred to herein as the unit property rule, has been definitively resolved by the Temporary Emergency Court of Appeals ("TECA") in Pennzoil Co. v. DOE, 680 F.2d 156 (Em. App. 1982), cert. dismissed, 459 U.S. 1190, 103 S. Ct. 841, 74 L. Ed. 2d 1032 (1983) and that the test of significant alteration in producing patterns, ...


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