c284:No. 76-2000

FAHY, Senior Circuit Judge
dissenting in part:
I concur generally in the opinion for the court written by Judge Leventhal. While recognizing its excellence I do have a reservation respecting its treatment of the scope of review, thought to be required by the Supreme Court, particularly as it may seem unduly to relax our reviewing responsibility with respect to the standard which requires that essential factual elements of a Commission order be supported by substantial evidence.
There are two respects in which I differ from the result reached by the court: the treatment of the income tax components, and the treatment of advance payments outstanding on November 5, 1976 (past advance payments). Moreover, while I concur in the treatment of future advance payments, I find much merit in the producers’ concern as to the mechanics of compliance with the Commission’s order in that respect. Although we do not mandate clarification, it seems to me clarification is due.
THE INCOME TAX COMPONENT
I respectfully dissent from the court’s approval of the inclusion in the rate for the gas from wells commenced in the 1975-76 biennium of an income tax component of 43.05$ per Mcf, nearly one-third of the total rate. I dissent also from affirmance of inclusion of a tax component, similarly calculated, in the adjusted rate for gas of the 1973-74 vintage.
In Permian Basin Area Rate Cases, 390 U.S. 747, 791-792, 88 S.Ct. 1344, 1373, 20 L.Ed.2d 312, one of the three responsibilities the Court placed upon the reviewing court is the following:
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.
The Commission in Opinions No. 699 and 699-H, in establishing the first nationwide rate for natural gas, refused to add an income tax component to the rates then established because there was no evidence of taxes paid, and because estimates would have involved unfounded speculation. The Commission endorsed, however, a special relief procedure should tax returns supply evidence warranting such an allowance. The Fifth Circuit affirmed, Shell Oil Co., et al. v. FPC, 520 F.2d 1061, 1080-81 (1975), cert. denied sub nom. California Company v. FPC, 426 U.S. 941, 96 S.Ct. 2660, 49 L.Ed.2d 394 (1976).
The Commission staff in the present proceeding similarly concluded that there was insufficient data on which to base an income tax component, and urged the Commission to obtain the necessary data. The industry resisted, and urged the present methodology as a substitute for actual income tax data, which it has refused to supply the Commission.' It contends that the virtual repeal of the percentage depletion allowance, effective July 1, 1976, is sufficient reason for now including a tax component. The Commission, in setting a nationwide vintage rate for pre-1973 gas by Opinion No. 749, had previously included such a component — 6$ per Mcf in a rate of 29.5$, This allowance, and the income tax liability it was intended to reimburse, were calculated by treating jurisdictional-producer activities as a separate entity and applying the maximum corporate statutory tax rate of 48%. Identical methodology is carried forward in the present proceeding, without the support of any historical tax-paid or current tax-liability data, and without any provision for gathering such data as it accumulates.
In substitution for such evidence the Commission employs in its model the 43.05$ per Mcf component based on a mathematical calculation which, I suggest, does not meet the test of substantial evidence. The component is arrived at by calculating the increment to price which, when added to the amount of other recoverable costs, will yield an amount of income sufficient to permit income taxes to be paid at the 48% statutory rate and still enable the producer to earn a 15% rate of return on its ratebase.
It is well to remind ourselves that the rates which include these income tax components are defended by the Commission as entirely cost-based:
This rate [$1.42] is fully cost-based and justified. Additionally, non-cost factors have been examined to ensure that the cost-based rate is just and reasonable.
Opinion No. 770, at 1.
The $1.42 rate is fully cost-justified, as is the $0.93 rate.
Opinion No. 770-A, at 3; and see, Id. at 13-14.
Thus, in contrast with the 52$ rate involved in the “roll-over” problem discussed in Judge Leventhal’s opinion for the court, none of the tax component is justified by the Commission as stimulating new supplies of gas or on any ground other than that it is needed to cover income taxes. It may not, therefore, be reassigned by the court to any other purpose. Moreover, it has no particular relationship to the gas shortage unless it enables the industry ^actually to recover whatever it expends as tax costs and still earn a 15% rate of return.
I have no doubt that by repeal of the percentage depletion allowance Congress sought to obtain increased income 'taxes from the petroleum-gas industry, nor do I doubt that in light of the repeal the Commission is well within its authority in reconsidering its treatment of the income tax problem. Yet neither the need to do so nor the likelihood of increased tax liability justifies an allowance which fails to be supported by substantial evidence, or which otherwise is unacceptable. Large sums are being or will be paid by consumers without assurance of their need or use for the purpose for which paid.
As indicated above, the Commission model is framed in the belief that “regulated activities are properly viewed as a separate corporate entity and the Federal income tax allowance computed accordingly”. The very complexity of determining exactly how much tax is paid by producers in any given year due to a specific vintage of jurisdictional gas renders the separate entity policy unreliable. The computation of the component proceeds as if all producers of jurisdictional gas engage only in finding, drilling, producing and selling gas in interstate commerce. This fails to take account of the fact that a great amount of gas weighted with this 43.05$ per Mcf tax cost is produced by integrated corporations such as Exxon, Mobil, Texaco, Gulf and Shell, engaged in a variety of far-flung non-gas activities through divisions, affiliates, and subsidiaries. Under the Internal Revenue Code of 1954 they may file consolidated tax returns aggregating all those operations, thus rendering inapplicable the separate entity theory. Moreover, such producers, as well as producers whose corporate operations are limited to gas production, market gas in the intrastate as well as the interstate market. While the income tax returns of the latter are not complicated by non-gas activities, as are the consolidated returns of the larger companies, both types of producers earn taxable income on production from, and deduct as expenses pre-production outlays related to, reserves which may be dedicated to the intrastate market. Deductions stemming from non-jurisdictional gas production will also be applied by the producers against all income, including that from jurisdictional sales. The model thus fails in two distinct ways to take account of the situation which pertains in reality, and by doing so does not justify characterizing the component as a recoverable cost supported by substantial evidence.
If the 43.05$ per Mcf for the 1975-76 vintage gas does not become a part of the income tax revenues, but is retained by the producer because deductions or losses in its operations as a whole have reduced or eliminated its taxable income, money is being collected from consumers to pay taxes but it is not finding its way to the Treasury. The action of the producer in using the non-jurisdictional deductions to reduce or eliminate its taxable income deprives the Commission’s separate entity policy of reality. The point is not whether the deductions are lawful, but whether in establishing a rate the Power Commission should itself follow a method which results in including an amount for income taxes to be borne by consumers' which does not have the support of evidence that it is needed for income taxes. Unlike all other recoverable costs, the tax cost of producing gas cannot be determined until after production has begun and taxable income earned, a fact which the Commission’s model ignores in establishing the component and in failing to provide for its correction.
If the component were required by the Commission actually to be utilized to pay income taxes in the amount the model attaches to each Mcf of gas, or to be refunded, the expectation of increased revenues following upon Congress’ repeal of the percentage depletion allowance might be realized. But under the model — under the Commission’s Opinions — the producer is free to avoid paying or assuming liability for the full computed amount because of: 1) higher-than-anticipated jurisdictional expenses; 2) allowable deductions or tax losses associated with non-jurisdictional prepro-duction activities, or 3) tax benefits associated with non-gas operations on a consolidated return. Biennial review of rates is not a substitute for substantial evidence, nor is the fact that biennial rates for later vintages might be lowered compensatorily in the effort to correct error. Moreover, the component authorized is not a temporary arrangement. Revision can only be made prospective for the remainder of the fifteen-year well life.
Furthermore, as noted above, the Commission has made no provision for ascertaining what in reality occurs as to payment of or liability for income taxes, so as to be able to adjust the 43.05$ component. There is no collection of evidence .of the actual taxable income of even a sample of producers, or of the share to be allocated to each biennium of jurisdictional gas. Specific types of offsets and deductions are not even charted in an effort to assure that the model is complete and kept up-to-date. It is not sufficient to say that the model has room for every tax benefit and payment conceivable under the Code; it must be shown that the component calculated by the model is based upon the tax events actually in use. The model postulates only an assumption of tax liability based upon sale price in interstate commerce and expected deductions; it does not reflect what turns out to be the taxable income of the producer when it files its return or compare taxes paid with the sums collected from consumers. And yet the amount of the theoretical component is laid upon the consumer in dollars and cents for the life of the producing wells without provision for testing its accuracy by evidence either existing or to be obtained.
A somewhat more technical series of problems with the tax component arises when the assumptions underlying it are compared with the expenditure-timing assumptions of the discounted cash flow model. Examining the Commission’s model, capital formation is deemed to occur at time —3, well commencement at time —1, first production at 0, and depletion (end of production) at +14. For 1975 well commencements (the first half of the biennium), 17% of all preproduction expenses per Mcf are deemed to be incurred in the year —3 (1973), 31% to occur in the year —2 (1974), and 51% to occur in year —1 (1975, the well commencement year). But income from those wells does not commence to flow until year 0 (1976), according to the model. Expenses and income for wells commenced in 1976 (the second half of the biennium) would occur at the same assumed ratios but one year later. Thus taxable income would not be earned by gas from wells commenced during the 1975 — 76 biennium until 1976-77 at the earliest, and would not be reported until 1977-78. Thus, the tax component which has been collected on biennial gas since July 27, 1976, could not be tested for accuracy against taxes paid until after corporate returns were filed in 1977-78. In practical fact, this argues against a tax component set in one proceeding and later adjusted, because of the long interval during which consumers must pay the unadjusted tax component.
According to Exhibit 4 to Opinion No. 770-A, preproduction expenses made in year —3 and in year —1 constitute the tax reductions from expensing. Thus, when wells commenced in the 1975-76 biennium begin to produce and generate otherwise taxable income in years 1976 and 1977, that taxable income will be reduced by prepro-duction expensing in the —3 year of wells to be commenced in 1978 and 1979, and such expensing in the —1 year of wells commenced in 1976 and 1977. As indicated above in general terms, it is the amount of those preproduction expenses that will determine (absent any other, hidden complications) whether a net tax of 43.05$ per Mcf will be paid. This contingency would remain, even if the Commission’s unrealistic view of jurisdictional gas taxable as an entity were true.
The Commission does realize that even if its model does not understate jurisdictional preproduction expenses for successive years, producers may not pay the full 43.05$ per Mcf tax share when taxes are computed in the real world with reference to non-jurisdictional or non-gas activities.
[producers’] tax liability may also differ [from 43.05$ per Mcf] because . their tax situation is different than we would expect it to be on the basis of jurisdictional activities. If it is so because of non-jurisdictional activities which result in tax losses or credits, such factors lie beyond our jurisdiction.
Opinion No. 770-A, at 68. This admission by the Commission would seem to act as a bar to the single entity model.
I think that to the extent the Internal Revenue Code permits, and producers, not adopting the separate entity concept in calculating their tax, and not paying to the United States the tax component recovered from consumers under that concept, take advantage of the offset of income tax liability afforded by non-entity activities, the Commission should not treat the jurisdictional operations as a separate entity and should allow only special relief according to income taxes assumed in fact by the producers. Where producer-by-producer regulation has of necessity given way to regulation by a model based upon nationwide averages, that model should not, it seems to me, ignore the fact that some producers will file tax returns merging jurisdictional and non-jurisdictional activities, or mingling gas operations with non-gas affiliates’ activities (the consolidated return situation).
The propriety of including a tax component in the regulated interstate rates for natural gas depends solely upon whether the producer has in fact paid or becomes liable for the amount of the component. If not, it is as improper a cost component to be recovered from consumers as is an overstated costs for drilling rigs, labor or capital. By permitting a possibly overstated tax component to be collected, without determining if a like amount of taxes per Mcf is to be paid or liability therefor assumed, the Commission may enable the industry to enjoy funds received from consumers to compensate for costs which in fact are not incurred. Since no part of the tax component is related to incentive, any excess of it above actual costs, “would merely confer windfalls” — Permian, 390 U.S. at 797, 88 S.Ct. 1344.
While the Tax Reduction Act of 1975 did not in terms deny oil and gas producers the statutory option of a consolidated return, neither did it entitle them in my view to a combination of taxes lowered by consolidated returns and federal rate regulation premised upon reimbursement for maximum taxes otherwise calculated. However producers ratably lower their tax liability allocated to jurisdictional gas for a given vintage, taxes actually due should constitute the upper limit of reimbursement demanded of consumers.
I disagree with the tax component as incorporated into the 1975-76 and 1973-74 vintage rates because the method employed to calculate the sums collected from consumers — jurisdictional gas allegedly to be treated as a separate entity, vintage-by-vintage — differs substantially from the method employed by producers to calculate taxes owing and paid — a flat percentage of all taxable income polled without respect to whether earned by jurisdictional gas, non-jurisdictional gas, or non-gas activities.
As we have indicated, the means approved in Shell by which tax costs could be recovered by producers could now be reinstated; it does not appear that it resulted in hardship to producers. If a better means consistent with the substantial evidence requirement can be devised, we should of course accept it. Producers are not to be deprived of the right to recover their income tax costs. And here, as in other aspects of national ratemaking, averaging is accepted, exactitude is not required and reasonable inequities are tolerated in deference to the over-all interests to be served. Moreover, experiment may be utilized, but when the task is to ascertain costs experiment is not a substitute for evidence, nor is ease of administration in the circumstances; the industry has access to the evidence, has the burden of proof, and of course is capable of making the evidence available for consideration by the Commission.
At this time of deepening concern over the shortage of natural gas, with consequent economic and even more personal burdens to be borne by consumers, it seems especially important that these burdens not needlessly be increased by the tax components here discussed. As Commissioner Smith said with respect to the rates as a whole, I think these particular components are “too high” in the absence of factual evidence supporting them.
While the Commission, as it states, does not have jurisdiction over non-jurisdictional activities it does have jurisdiction to consider their effect upon what if any tax component should be established. See FPC v. Conway Corp., 426 U.S. 271, 96 S.Ct. 1999, 48 L.Ed.2d 626 (1976). In that regard we are entitled to know what income taxes the regulated sector of the industry pays or assumes which are attributable to its jurisdictional operations. This the model does not disclose, and the Commission does not undertake to ascertain.
References in Judge Leventhal’s opinion to my above dissenting views lead me to add the following:
The court states that implicit in my concern about this matter is an assumption of losses in non-jurisdictional gas activities of producers, and the court attributes to the Commission a finding of implausibility that the producers as a whole would sustain losses in their unregulated gas activities while making gains in sales of federally regulated gas. I read thé Commission’s opinion at the point to which the court refers only to find implausible that such losses will ever exceed all non-jurisdictional income. My position regarding the use by producers of any deductions or losses due to their unregulated activities, as such use bears on our income tax problem, has been stated. See particularly p.-of 186 U.S.App.D.C., 1076 of 567 F.2d, supra. It should be noted that my concern with this question is not entirely focused upon a producer’s non-jurisdictional gas operations, but also upon losses which might occur from the variety of other operations of corporate conglomerates which may file consolidated returns. And even in the absence of non-gas losses, heavy expenditures of drilling and other preproduction activities for wells which later produce non-jurisdictional gas are permitted to offset current jurisdictional income.
As to the court’s position that the parties can bring to the Commission’s attention other tax events that reduce the producer’s tax liability so that the model can be refined and flaws remedied, I have several problems. First, the burden has been and remains upon the producers to establish tax liability in actuality commensurate with the 43.05$ per Mcf allowed to be collected. The Commission’s position rests entirely upon the model without any contemplated Commission testing of it against actual data respecting taxes paid or for which liability accrues. The court’s approach might result in a wholly unjustified tax component being charged because consumers do not have access to the evidence upon which income taxes are based, and cannot prove the component to be excessive. Second, nothing in the Commission’s opinions nor in the court’s opinion would supply, or require to be supplied to consumers, the evidence about tax events or transactions employed by producers to calculate their taxes. The Commission did not examine such evidence in establishing the 43.05$ component, and does not indicate any intention to obtain it so as to refine that component at the two-year mark (biennial review). It is more likely that the component may be revised, within the plan of the model, when predictably higher drilling, leasing and other costs will be applied, all without examination of any actual tax-accrual data.
My reference to the unavailability until 1977-78 of tax returns pertaining to revenues from wells drilled in the recent biennium affords no basis for approving now the present tax components or for assuming, as the court seems to, that tax returns when filed will be made available to the Commission. Given the methodology employed, I doubt the wisdom of trying to calculate, prior to accrual, an accurate tax allowance. But if, as the court suggests, some tax component should be allowed to be collected before the tax accrues, I should be willing to consider an interim conditional amount, subject to refund or other appropriate adjustment consistent with the substantial evidence rule, were the court willing to do so.
The court’s opinion endorses the Commission view that it is extremely difficult, even with tax returns in hand, to tell how much tax has been paid upon income earned by jurisdictional gas from a specific vintage. How much more difficult it must be to estimate that amount before any tax accrues, and yet that is what the Commission’s model purports to do, and what the court affirms, with no provision for verifying the correctness of the estimate by actual tax-paid or tax-accrued data.
PAST ADVANCE PAYMENTS
I also respectfully dissent from the court’s approval of the Commission’s failure to give effective consideration to the advance payments which were outstanding at the time of the issuance of Opinion No. 770-A, November 5, 1976, and which have not yet been fully repaid (past advance payments). Some $1.5 billions of capital had been supplied to producers during the 1975-76 biennium, prior to July 27, 1976. An additional unquantified amount of advance payments was received from pipelines by producers during the 1973-74 biennium, and earlier, back to 1970. All these contributions of capital were supplied ultimately by consumers due to the addition of sums thus advanced to the ratebases of the advancing pipelines. Very substantial savings of producers’ capital costs resulted. It is unclear under the Commission’s costing model which biennium of gas ought to be associated with cost-free capital received in a given year. But as Commissioner Smith pointed out in his dissent in Opinion No. 770 — A, the producers have continued over a considerable period to have the use of the capital so provided and not repaid in cash or gas. Nevertheless, Opinion No. 770-A takes no account of these savings in its cost calculations which led to the 93$ base rate for the 1973-74 vintage, and to the $1.42 base rate for the 1975-76 vintage. Nor does it indicate that those cost savings are associated with some future gas vintage, base rates for which are to be set in some future proceeding. The only justification for this failure offered by the Commission is as follows:
* * * it would be improper to penalize a producer without any prior notice by reducing its prospective rates because of its prior acceptance of advance payments under a Commission-approved program. Furthermore, these outstanding payments have provided additional capital for exploration and development activities, during the period (January 1, 1973-July 27, 1976) when the rates collected were below the levels which we herein have determined to be just and reasonable.
Opinion No. 770-A, at 150.
While the payments were made under a Commission-approved program, also judicially upheld as the court has noted, neither of these approvals gave assurance that the savings in cost resulting from the advance payments would not be considered in a subsequent proceeding to establish cost-based rates. In initiating the proceedings the Commission was not under a duty to specify all items affecting costs which might be considered, nor barred from consideration of an item not specified in the notice. The Commission’s brief, in rejecting the objection that no notice was given that the Commission would restrict the new $1.44 per Mcf rate to gas from wells commenced after January 1, 1975, states:
[T]he Commission gave no assurance that there would not be changes and modifications based on actual experience.
Br. at 50.
We can well substitute for “actual experience” “a known factual situation.” We think this is particularly appropriate with respect to a cost factor. Some $2.2 billions of advance payments were outstanding when Opinion No. 770-A was issued, November 5, 1976. As Commissioner Smith’s dissent points out, “. . . the producers have had the continuing use of capital provided by advances made previously that have not been repaid.” Opinion No. 770-A, at Dissent, p. 15. Not only had Commissioner Smith raised the advance payments question in his initial dissent to Opinion No. 770, but it was raised by petitions for rehearing, as well. Senator James Abour-ezk, et al. (Congressmen) pressed the issue strongly, contending:
The Opinion’s calculations are premised on the assumption that the cost of capital to producers is 15%. To the extent that advance payments have been available as capital, the premise is not correct. The rate allowed producers must be adjusted downward in consideration of the advance payments.
. The rate is a biennial rate, for 1975-76, and must be based on costs for that period. Indeed, it is strange that the Commission premises its $1.01 rate for 1973-74 gas on a post hoe actualization of 1973-74 costs, while, in its treatment of advance payments, it argues that actual costs must be ignored.
The consumer is certainly not protected by a willful decision to ignore dollars he has contributed to the industry.
R. 2785. Similar objection was made by the South Dakota Public Utilities Commission’s petition for rehearing. R. 3064.
Moreover, adequate notice to producers that cost savings from receipt of advance payments would be factored into relevant rates inheres in the fact that the Opinion No. 770 series is a cost-based ratemaking.
As we have seen, the Commission also stated as a reason for not otherwise considering past advance payments that they provided additional capital for exploration and development from January 1, 1973, to July 27, 1976, “when the rates collected were below the levels which we herein have determined to be just and reasonable.”
The above reason if acceptable would limit the effect of past advance payments to the years immediately preceding issuance of Opinion No. 770-A. By the Commission’s own model, however, assembly of capital takes place two years before drilling commences, and three years prior to first production. While during the period January 1,1973, to July 27,1976, the 52$ rate set by Opinion No. 699-H (or a lower earlier rate) had not been superseded by the 93$ and $1.42 rates found to be just and reasonable by Opinion No. 770-A, the outstanding capital advanced to producers since 1970 may be found to be associated with the gas of the 1973-74 vintage as well as with that of the 1975-76 and subsequent vintages. Clearly it would appear that the value of the outstanding capital advances extends into the period covered by the present higher rates, and perhaps to the rates to be set for the next biennium. The present rates are based upon cost and a reasonable rate of return. In arriving at the rates the Commission included a cost factor representing the cost of capital, without evidencing any value attributed to the savings to producers of the cost-free capital supplied by past advance payments then outstanding. The reasons given for this omission do not justify it. Further consideration in my opinion accordingly is required of the possible impact of these payments upon the cost-of-capital component included in the rates established by Opinion No. 770-A.
I do not forecast the result of further consideration by the Commission. If it leads to attaching a value to the capital thus supplied which should be but has not been accounted for it is possible that an additional carrying charge credit or some other mechanism should be developed. Consideration might, or might not, lead also to a possible distinction between producers who received the payments and those who did not. The Commission of course should reach its determination with the aid of submissions by the interested parties.
The substance of the matter is that I cannot agree that either of the reasons advanced by the Commission justifies the present situation. Aside from the question of notice previously discussed, the general unanalytical statement by which the Commission disposed of the issue of possible impact upon the new rates of some billions of dollars of outstanding advance payments does not seem to me to be an exercise of the expertise or discretion which calls for our deferential acceptance.

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