PHILLIPS PETROLEUM CO. v. DOE

449 F. Supp. 760 (1978) | Cited 0 times | D. Delaware | March 9, 1978

LATCHUM, Chief Judge.

Six oil companies 1" instituted these actions to challenge the Federal Energy Administration's ("FEA") belated interpretation of a regulatory scheme affecting prices from January 1, 1975 to February 1, 1976 ("the relevant period"). That interpretation required refiners to allocate monthly sales revenues first to the recoupment of all increased "product costs" (primarily the costs of crude oil and purchased petroleum products) and then to the recoupment of increased "non-product costs" (most operating and marketing costs). See 41 Fed.Reg. 5111, 5113 (February 4, 1976). The defendants are the Department of Energy ("DOE") and its Secretary, as successors in interest of the FEA and its Administrator. 2" In their complaints 3" the plaintiffs sought (1) a declaratory judgment concerning the meaning and validity of the regulations during the relevant period, (2) an injunction against the FEA's anticipated application of its interpretation of the regulations, (3) an estoppel against FEA enforcement of its interpretation against the plaintiffs on the basis of their good faith reliance on the conduct and statements of various FEA officials, and (4) a determination whether the plaintiffs' constitutional claims are substantial and should be certified to the Temporary Emergency Court of Appeals ("TECA").

On August 11, 1977, 435 F. Supp. 1239, the Court granted in part and denied in part the FEA's motion 4" to dismiss the actions or stay them pending completion of administrative consideration. 5" The Court held that the following legal issues were appropriate for immediate consideration: 6"

(1) What is the meaning of the applicable regulations in effect during the relevant period, e.g., did they permit or require the use of the Proportional Method to recover increased costs, (2) If the regulations were in effect as now interpreted by the FEA, are such regulations invalid because they (a) exceeded FEA's statutory authority, (b) were issued without notice and applied retroactively in violation of the Administrative Procedure Act, 5 U.S.C. § 553, or (c) were . . . issued without first obtaining an inflationary impact statement in violation of Executive Order No. 11821, 39 Fed.Reg. 41501 (Nov. 29, 1974).

435 F. Supp. at 1249. The parties have filed cross-motions for summary judgment 7" and this opinion addresses the issues raised by those motions.

One other prefatory remark is in order, however. The United States District Court for the Northern District of Ohio recently granted summary judgment against the FEA on issues 1 and 2(b) above in nine related actions brought in that District ("the Ohio litigation"). 8" This Court previously denied a motion by the FEA to transfer the instant actions to the Northern District of Ohio, or, alternatively, to stay the cases sub judice until a decision was rendered in the Ohio litigation. 9" The principal distinction between these cases and the Ohio litigation is that all of the plaintiffs here recovered their product and non-product cost increases on a pro-rata basis, while the majority of the Ohio plaintiffs recovered their non-product cost increases first. 10" The underlying facts are the same in both instances and have been set forth in detail in the two opinions filed by Judge Manos of the Northern District of Ohio. 11"

I. BACKGROUND FACTS

On August 19, 1973, the Cost of Living Council ("COLC") adopted a complex set of price regulations specifically applicable to the petroleum industry. 12" The regulations were promulgated under the Economic Stabilization Act of 1970, as amended, 12 U.S.C. § 1904 note, and Phase IV of the Economic Stabilization Program. In December 1973, the Federal Energy Office ("FEO") assumed the pricing authority of the COLC as it related to energy, 13" and on January 14, 1974, the FEO recodified the COLC's Phase IV Petroleum Price Regulations. 14"

The regulations in effect in January 1974 imposed a ceiling on the prices that the plaintiffs and other refiners could charge based on each refiner's selling prices on May 15, 1973. However, at the beginning of each month a refiner could increase its selling prices for the coming or "current" month to reflect the increased product costs it incurred in the preceding month ("the month of measurement"). The regulations permitted a refiner complete discretion to charge any price to a particular class of purchasers in the current month up to a price equal to the sum of (1) the weighted average price charged to the same class of purchasers on May 15, 1973 and (2) the increased product costs 15" incurred between the month of measurement and the month of May 1973. See 10 C.F.R. § 212.83(f), 39 Fed.Reg. 1953 (January 15, 1974). The latter price was known as the "base price" for a product. Thus a refiner could pass through its product cost increases ("PCI") on a dollar-for-dollar basis by charging a selling price equal to the base price in the month following the month in which the PCI were incurred. Any product cost increases which a refiner was unable to recover in a price increase in the current month, because of competitive market conditions or other reasons, 16" could be carried over or "banked" for use in determining base prices for a subsequent month. 17"

Besides enabling refiners to pass through increased product costs automatically as part of their base prices, the regulations authorized the pass-through of increases in non-product costs, such as labor and marketing costs, subject to certain limitations. Refiners could use their non-product cost increases ("NPCI") to justify a price exceeding the base price as long as they continued to incur those increases. However, a refiner first had to "prenotify" the FEO and then wait a minimum of thirty days before implementing the price increase. 18" The regulations also precluded a refiner from charging a price in excess of the base price in any fiscal year in which its profit margin exceeded the profit margin achieved during the base period (May 1973). 19" Non-product cost increases were computed using a "rate of increase" approach in contrast to product cost increases, which were computed using a "dollar amount" concept. 20" Finally, the regulations did not explicitly state whether NPCI could be banked.

The FEO became the Federal Energy Administration in June 1974. 21" In a notice of proposed rulemaking published on September 10, 1974, the FEA announced a "comprehensive revision" of the petroleum price regulations. 22" With respect to non-product cost increases, the FEA proposed to eliminate the "prenotification" procedure and to replace it with an automatic pass-through system similar to that used for the pass-through of increased product costs. 23" Effective December 1, 1974, the FEA adopted these changes and others which limited the categories of increased non-product costs that could be passed through to purchasers. 24" The base price concept was not altered.

In addition to finalizing several of the proposed amendments, the December 1974 rulemaking added a new provision [10 C.F.R. § 212.83(e)(4)], which prohibited the banking of unrecovered non-product cost increases. 25" This provision required refiners to absorb any non-product cost increases which they failed to recover through price increases in the month following the month in which the NPCI were incurred. The amount of NPCI a refiner would have to absorb in a given month depended, however, on the method or sequence used to allocate recoveries between product and non-product cost increases. The regulations did not explicitly specify a particular sequence of recovery; 26" consequently, refiners used at least three different methods. One method, the non-product cost increase first method ("NPCI First"), treated all non-product cost increases as having been recovered first, and the product cost increases as having been recovered last. A second method, the "NPCI Last" method, treated all product cost increases as having been recovered first, and non-product cost increases as having been recovered last. A third method, the "Proportional Method," treated product and non-product cost increases as having been recovered pro rata. 27" Phillips Petroleum Co. v. FEA, 435 F. Supp. 1239 (D.Del. 1977). The example in the footnote 28" below illustrates the effect of each method on the amount of NPCI a refiner must absorb when revenues do not permit recoupment of all cost increases.

Between January 1, 1975, when the amendments to the regulations first affected prices, and February 1, 1976, several FEA officials, through instruction manuals, directives, forms and worksheets issued to FEA auditors and later disseminated to many refiners, as well as through private statements to refiners, indicated that the agency construed its regulations to permit or require the use of the proportional method. 29" Each of the six plaintiffs and at least twenty-three other refiners used the proportional method during the relevant period. 30"

In order to reflect the pricing policies of Sections 401 and 402 of the Energy Policy and Conservation Act of 1975 ("EPCA"), 31" the FEA promulgated amendments to its petroleum price regulations effective February 1, 1976. 32" One of these regulations (10 C.F.R. § 212.85) explicitly required refiners to use the NPCI Last method to calculate recoupment of increased costs. 33" In addition to setting forth a prospective rule, the FEA, in the preamble to the February 1, 1976 rulemaking, publicly announced for the first time its position that the regulations affecting pricing during the period from January 1, 1975 to February 1, 1976 had always required that "increased non-product costs . . . be recouped last." 34"

The FEA's endorsement of the NPCI Last method provoked immediate and widespread criticism from the refiners, who objected to its application prospectively, as well as retroactively. In April 1976, after providing notice and holding public hearings, the FEA revoked retroactively to February 1, 1976 the regulation requiring use of the NPCI Last method 35" and the pre-existent regulation prohibiting the banking of non-product cost increases. 36" The FEA found that these two regulations, if in effect at the same time, would spur inflation, cause widely fluctuating prices for petroleum products, discourage refiners from building product inventories, reduce refinery production, and diminish capital investments. 37" Despite these findings, the FEA deferred any decision on "appropriate action . . . regarding the rules on recoupment of increased non-product costs prior to February 1, 1976." 38"

Thereafter, the agency steadfastly maintained the position that the regulations affecting prices from January 1, 1975 to February 1, 1976 implicitly required refiners to use the NPCI Last method. 39" On August 3, 1976, however, the FEA proposed a "class exception" to permit all refiners who were not constrained by the profit margin limitation to recompute their increased cost recoveries during the relevant period using "the 'proportional' cost recovery approach." 41 Fed.Reg. 33282, 33283 (August 9, 1976) (emphasis supplied). The agency noted that "many -- perhaps even a majority of -- refiners" had used either the proportional or the NPCI First method during the relevant period. Further, the FEA "[acknowledged] that refiners might have concluded in good faith that recoupment on a proportional basis was permitted as a result of possibly ambiguous language in § 212.83(d) and certain information disseminated by FEA." Id. at 33283.

The responses of 104 refiners surveyed regarding the proposed class exception showed that many refiners had computed cost recoveries using a method other than the NPCI Last method. 40" The FEA concluded that as a result approximately $1.3 billion in additional non-product cost increases had been passed through in prices. 41" This information appeared in the Wall Street Journal on September 10, 1976 and immediately elicited a critical response from the Honorable John D. Dingell, Chairman of the Subcommittees on Energy and Power of the House Committee on Interstate and Foreign Commerce. 42" In the wake of further criticism from Congressman Dingell and discussions between the Congressman and FEA Administrator Zarb and his subordinates, 43" the FEA obsequiously changed its position and publicly announced: (1) that it would not grant exceptions to the enforcement of the NPCI Last method interpretation on the ground of "good faith reliance on erroneous guidance from FEA personnel" 44" and (2) that it would not grant the proposed class exceptions but would require each refiner to "establish . . . that it is subject to a serious hardship or gross inequity as a result of the FEA regulatory requirements." 45"

In late 1976 and early 1977, various refiners began filing applications for exception relief. On March 23, 1977 the FEA announced it would evaluate three of the exception applications before it as "representative" of the applications which had been filed or could be expected. 46" After holding three hearings, the FEA decided in April 1977 that it would not review the correctness of its interpretation of the regulations or the lawfulness of them, as construed, in the exception proceedings. 47" The agency also failed to formulate rules governing the procedures to be followed in the exception proceedings. 48" Discouraged by the limited scope of the exception proceedings and the procedural uncertainties, the three representative parties selected by the FEA withdrew their exception applications. Immediately thereafter, five of the six plaintiff refiners in these cases filed suit in this Court.

II. CONTENTIONS OF THE PARTIES

The plaintiff refiners challenge the validity of the FEA's interpretation of the regulations on both substantive and procedural grounds. Substantively, the plaintiffs contend that the regulations in effect during the relevant period either required refiners to use the proportional method to compute cost recoveries or permitted them to do so, because there was no valid regulation prescribing a method for computing cost recoveries. The plaintiffs find support for an interpretation requiring use of the proportional method in numerous contemporaneous constructions of the December 1, 1974 regulations by FEA officials and auditors and also in the text of the regulations, specifically in 10 C.F.R. § 212.83(d). Moreover, the plaintiffs argue the regulations provide no support for the NPCI Last requirement which the FEA contends was applicable.

From a procedural standpoint, the plaintiffs assert that the purported regulation regarding the allocation of cost recoveries is invalid, because the FEA ignored all the applicable rulemaking requirements in promulgating it. The plaintiffs challenge the validity of the regulation prohibiting the banking of non-product cost increases for similar reasons, particularly the FEA's failure to provide adequate notice and opportunity to comment.

The defendants on the other hand strenuously contend the requirement that non-product cost increases be recovered last, if at all, had been implicit in the petroleum price regulations for refiners from the beginning of Phase IV in the latter part of 1973 until the revision of the regulations, effective February 1, 1976. During that period, the FEA asserts, any method of cost recovery which would have permitted non-product cost increases to be recovered before all product cost increases had been recovered clearly would have contravened three regulatory provisions: (1) the "base price/price in excess of base price" rule; (2) the provision authorizing the banking of unrecovered increased product costs; and (3) the prohibition against banking unrecovered increased non-product costs. The FEA dismisses Change Notice 3-1975-1 49" and the other communications cited by the plaintiffs, which required or permitted refiners to recover costs on a pro rata basis, as being nothing more than "unauthorized and unofficial guidance . . . disseminated by auditors during the first half of 1975 . . . which was plainly erroneous on its face." 50" While conceding that this allegedly erroneous advice may constitute a predicate for relief on grounds of detrimental reliance -- an issue remanded to the agency for consideration in the first instance -- the FEA argues that it should not be considered in determining the meaning of the regulations, because only the agency's lawyers have the authority to interpret its regulations. Further, the FEA contends that throughout the relevant period its official constructions of the regulations consistently required the use of the NPCI Last method and that its senior legal advisors did not "focus" on the problem of cost recovery until February 1976.

Because it contends the regulations implicitly required use of the NPCI Last method prior to and throughout the relevant period, the FEA responds to the procedural arguments of the plaintiff refiners by attempting to show that each of the regulations giving rise to the implication of the NPCI Last requirement was promulgated in accordance with the requisite rulemaking procedures.

These cases are presently before the Court on cross-motions for summary judgment. Having concluded that there is no genuine issue as to any material fact and that all material issues can be decided as a matter of law, the Court finds these cases appropriate for disposition by way of summary judgment. Fed.R.Civ.P. 56.

III. THE MEANING OF THE REGULATIONS

It is undisputed that the regulations at issue here contained no explicit provision governing the method of allocating product and non-product cost recoveries. The FEA, however, urges the Court to find that the regulations, as construed by it, implicitly required the use of the NPCI Last method for computing cost recoveries. Whether the regulations required use of this method or simply failed to require the use of any particular method, as the plaintiffs contend, depends on (A) the meaning of the regulations in effect prior to the relevant period, (B) the meaning of the amendments to the regulations adopted in December 1974 and the effect of those amendments on the overall regulatory scheme, and (C) the contemporaneous construction of the amendments by the agency and its officials. The Court now turns to an examination of those matters.

A. The Regulations in Effect Prior to the Relevant Period.

The base price and banking concepts, as they are applicable here, originated in Phase IV of the Economic Stabilization Program. Under Phase IV, large manufacturers other than refiners could increase their prices above based prices (the average price charged during a historical base period) only in order to pass through allowable cost increases. Manufacturers who charged prices in excess of base prices were subject to profit margin limitations and had to prenotify their cost increases to the COLC at least 30 days before implementing a price increase. 51" On August 17, 1973 the COLC adopted special regulations governing the pricing of petroleum products, which defined "base price" as the refiner's selling price on May 15, 1973 plus the increased costs of imports and domestic crude petroleum above the May 15, 1973 cost. 52" Due to this unique definition of base price, refiners could pass through automatically on a dollar-for-dollar basis their product cost increases. With respect to other allowable cost increases (non-product cost increases), however, refiners were subject to the same constraints as large manufacturers. Such costs could be used to justify a price in excess of base price, but only if the refiner met the profit margin limitation and prenotified the COLC of its "weighted average percentage price increase justified [by increased non-product costs]" at least 30 days before the effective date of the price increase. 53"

On September 18, 1973 the COLC introduced procedures for "banking" unrecouped product cost increases. 54" Because the initial banking provision created some confusion, it was amended in November 1973 to make clear that if, for any reason, the prices charged for a particular product resulted in revenues insufficient to recoup all product cost increases allocated to that product, the refiner could bank the unrecouped costs for use in computing base prices for a subsequent month. 55" The regulations in effect prior to December 1, 1974 did not state explicitly whether non-product cost increases could be banked.

The only public explanation for the special treatment of refiners' product cost increases in the Phase IV regulations was the following statement contained in a press release issued by Dr. John Dunlop, Chairman of the COLC, on August 10, 1973:

The Council has been very concerned that the final regulations strike a delicate balance between constraining prices while at the same time encouraging the necessary increase in supplies which the country must have. The Council is aware that energy prices must be allowed to rise in order to stimulate development of new energy reserves and make possible the purchase of higher cost foreign oil. At the same time, we must prevent unnecessary price increases.

Docket Item 79, exh. C-5. The COLC especially wanted to avoid price gouging in sales of products like gasoline and heating oil, for which there was high consumer demand and relatively little demand elasticity (i.e., products consumers would buy at almost any price). Therefore, the regulations distinguished between two broad categories of products. The first category, later referred to as "special products," consisted of gasoline and distillates (No. 2 diesel fuel and No. 2 heating oil). The second category included all other covered products and was denominated "covered products other than special products."

By the end of 1973, the COLC had adopted mathematical formulas for allocating both product and non-product cost increases among the various special products and covered products other than special products for purposes of determining prices. 56" The regulations provided general formulas for computing the amount of increased product costs attributable to each of the three product categories.

Under these formulas, the total dollar amount of increased product costs attributable to a particular product category for the current month equaled the sum of four cost components: (1) the increased cost of crude oil allocated to that product category, (2) the increased cost of purchased products of that category, (3) the amount of unrecovered PCI (the "bank"), and (4) the amount of PCI reallocated to products other than special products by the refiner (represented by the symbol "H"). The formulas allocated the total increased cost of crude oil incurred by a refiner in the month of measurement (represented by the symbol "t") among the three product categories based on the percentage of the total volume of sales in a historical reference period attributable to each category. The "H" factor manifested the COLC's desire to hold down prices on special products. The regulations permitted a refiner to reallocate PCI otherwise attributable to sales of special products to the category of covered products other than special products for the purpose of computing base prices, but not vice versa. 57"

For the two special products, distillates and gasoline (represented by the symbols "i=1 and 2", respectively), the amount of PCI available for application to prices in the current month (represented by the symbol "u") was divided by the sales volume expected during that month to determine the increment in cents per gallon (represented by the symbol "D[i]u") which could be added to the May 15, 1973 selling prices of that product to compute base prices. The regulations did not require refiners to convert the total dollar amount of PCI attributable to covered products other than special products (represented by the symbol "D [i]u") into a cents-per-gallon figure. Instead, the refiners could apportion the total dollar amount of PCI available among the various covered products other than special products (such as residual oil and jet fuel) in whatever amounts they deemed appropriate. 58" A further explanation of the mathematical formulas involved appears in the footnote. 59"

The method for computing non-product cost increases was significantly different. First, a refiner determined the percentage rate of increase in non-product costs from the base period to the current period. 60" This figure was then converted into a percentage price increase justified by non-product cost increases, 61" which, if approved upon prenotification, could be used to increase prices above base prices throughout the consecutive 12-month period, provided the increased non-product costs continued to be incurred. As in the case of PCI, the regulations required refiners to convert the percentage price increase into a cents-per-gallon figure for each of the special products. 62" The computed price increment could be added to base prices in each of the following 12 months.

For covered products other than special products, however, refiners had to compute only the total dollar amount available for addition to base prices in the consecutive 12-month period as a result of increased non-product costs. 63" The regulations afforded refiners broad discretion in deciding which products in the "other covered products" category should bear the price increases and, more importantly for purposes of the instant litigation, how much of the increased costs should be passed through in any one month. 64" The only limitation on this flexibility was the requirement that "for any fiscal quarter, the weighted average of all price increases . . . in [that product category] . . . not exceed the percentage of cost justification." 65"

On January 14, 1974, the FEO recodified and renumbered the COLC's Phase IV petroleum price regulations. 66" Sections 150.355 and 150.356 of the Phase IV regulations were recodified at 10 C.F.R. §§ 212.82 and 212.83, respectively. No other changes material to this litigation were made before the relevant period.

1. The Base Price Rule

The FEA contends that permitting refiners to recover their increased product and non-product costs proportionately, as the plaintiffs did here, would contravene the "base price/price in excess of base price" rule. This rule enabled refiners to pass through product cost increases automatically and permitted them to increase prices above base prices only in order to pass through increased non-product costs. 67" According to the FEA, the base price rule imposed a sequence for including costs in the calculation of the maximum allowable price -- May 15, 1973 selling prices, first, all PCI second, and NPCI third. The FEA further contends that refiners should have inferred the NPCI Last method of cost recovery from this pricing sequence.

The FEA's arguments rest on two important premises, both of which the plaintiffs have challenged: (1) that the base price is "fixed", 68" that is, for a particular product and class of purchaser in a given month the base price is equal to the May 15, 1973 selling price plus all product cost increases allocated to that product; and (2) that the base price rule establishes a sequence for determining prices which also governs the recovery of costs from revenues at the end of the month.

As the court observed in Standard Oil II,69 the FEA must establish the validity of both of the above premises in order to make out its "base price" argument. In Standard Oil II Judge Manos considered the fixed base price issue and held that the regulations did not "require refiners to include all product costs in their base prices before they could apply increased non-product costs over their base [prices]." 70" For the reasons discussed below, this Court has concluded that the base price rule, regardless of whether base price is fixed or flexible, does not require the use of a particular method or sequence of cost recovery. Accordingly, the Court finds it unnecessary to consider the first of the two above-mentioned premises and assumes arguendo that base price is fixed.

Turning to the issue of whether the "base price/price in excess of base price" rule established a sequence for the recovery of increased product and non-product costs, the Court notes first that there is absolutely no indication in the regulations that the base price concept applies to anything other than pricing. From the inception of the Phase IV petroleum price regulations 71" until the end of the relevant period on February 1, 1976, the pertinent provision of the regulations provided in effect:

(c) Allowable price in excess of the base price. A refiner may only charge a price in excess of the base price of a covered product in order to recover on a dollar-for-dollar basis increased non-product costs incurred between the month of measurement and the month of May 1973. . . . 72"

The clear intent of this regulation is to keep prices down. It explicitly prohibits a refiner from implementing a price increase for any reason other than to recoup increased costs, but it does not address the issue of cost recovery. Contrary to the repeated assertions of the FEA's counsel at oral argument, the above-quoted regulation does not say to refiners: "If you charged a price in excess of the base price at the beginning of the month, you could recover non-product costs [at the end of the month]. If you did not, you could not." 73" Indeed, the FEA admits that a refiner that received revenues sufficient to recover more than all of its available PCI could have applied the excess to the recoupment of NPCI, even if the selling price had been below the base price. 74"

The official communications and decisions cited by the FEA as evidence that it contemporaneously construed the base price regulations to require use of the NPCI Last method of cost recovery are equally unpersuasive. The strongest support for the FEA's position appears to be the so-called "Gulf Appeal," which concerned a two-sentence proviso the FEA included in several orders approving prenotified refiner price increases in the latter part of 1974. 75" The first sentence of the proviso merely stated FEA's position that the base price is fixed; it clearly related only to pricing. The second sentence virtually defies comprehension and the Court will not hazard a guess about its meaning.

Gulf received a prenotification decision and order containing a similar proviso on October 18, 1974 and immediately asked for an explanation. An FEA official apparently advised Gulf that all product cost increases, including banked PCI, had to be recovered before any non-product cost increases could be recovered. 76" Asserting that the regulations did not require such a sequence of recovery, Gulf appealed. In the instant litigation the FEA quoted at length from Gulf's appeal memorandum, which clearly challenged the NPCI Last method and requested that the proviso be deleted from the prenotification order. The defendants herein cite the FEA's refusal to delete the proviso as evidence of the FEA's interpretation of the regulations to require use of the NPCI Last method.

An examination of the FEA's decision on the Gulf appeal, however, reveals that the agency never explicitly addressed the method of cost recovery. The FEA held "there is no merit to Gulf's contention that Section 212.82 does not authorize the provision of the . . . Order which prohibits Gulf from applying any portion of the price increase authorized by the Order to any covered product which is being sold below base price levels." 77" In other words, the FEA upheld the fixed base price concept and, because the proviso embodied that concept, the FEA refused to delete it from the prenotification Order. Similarly, the language quoted by the defendants from the decision on the Gulf appeal merely restates the agency's interpretation of base price as fixed 78" -- an interpretation this Court has assumed to be valid. The fact that the FEA must resort to quoting the arguments presented to it by a refiner in order to find express support for its argument that the sequence for setting prices established by the base price rule also governs the sequence of cost recovery further demonstrates the weakness of its position.

2. The PCI Banking Provision

Another basis advanced by the FEA for inferring a requirement that non-product costs be recovered last is the banking provision contained in section 212.83 prior to the relevant period. The FEA contends the computational requirements of section 212.83, as implemented by Form FEO-96 79" and the instructions thereto, cannot be squared with any recovery method other than the NPCI Last method. Section 212.83(d) authorized banking of PCI, whenever the prices charged "[resulted] in the recoupment of less total revenues than the entire amount of increased product costs calculated for that product." 39 Fed.Reg. 1956 (January 15, 1974). The instructions to Form FEO-96 directed refiners to compute the "bank" for each product category by subtracting " the total amount of revenues received, during the Period of Measurement, in excess of the May 15, 1973 selling prices " of products in that category from "the total number of dollars of increased [product] costs which were attributable to [that product category] and available for recovery in the Period of Measurement." 80" Neither the regulations nor the instructions to Form FEO-96 specified a method for computing the amount of non-product cost increases recovered each month.

The FEA interprets the above mentioned provisions to require a refiner charging a price above base price to apply all revenues received in excess of the May 15, 1973 selling price toward the recovery of available product cost increases before applying any portion of those revenues toward the recovery of non-product cost increases. Thus, under the FEA's interpretation, a refiner that (1) had a total of $1,000,000 in PCI available for recovery in the current month, (2) had $200,000 in approved prenotified NPCI, (3) had established a selling price at the beginning of the current month which included all those costs, and (4) as a result, had received revenues in excess of the May 15, 1973 selling price totaling $1,100,000, would recover all $1,000,000 of its PCI and $100,000 of the available NPCI. As the plaintiffs point out, however, the computations required by section 212.83(d) and the instructions to Form FEO-96 yield no NPCI recovery in the situation posited above; instead, they produce a PCI overrecovery of $100,000, which would have to be subtracted from the May 15, 1973 selling price to compute the base prices for the subsequent month. The FEA deftly avoids this anomalous result by construing the silence of the regulations concerning the recovery of NPCI to mean that such costs must be recovered last. As is demonstrated below with respect to the issue of NPCI banking prior to the relevant period, an equally plausible explanation for the absence of any reference to NPCI recovery is that the methods of handling PCI and NPCI during the prenotification period were conceptually so different that there was no need to discuss recovery of NPCI. The same sort of imprecision evident in the use of "total revenues" in section 212.83(d) instead of "total revenues in excess of May 15, 1973 selling price" may have existed in the instructions to Form FEO-96; that is, the latter term may have been intended to include only those revenues generated by the price increment based on product cost increases. The point is the agency's silence on the method of cost recovery is ambiguous. Thus, the banking provision and Form FEO-96 do not require use of the NPCI Last method.

3. The Prohibition Against Banking Non-Product Cost Increases

Finally, the defendant asserts that use of the proportional method of recovery would contravene the prohibition against the banking of non-product cost increases. The FEA contends the banking prohibition was implicit in the regulatory scheme in effect during the prenotification period. For the reasons given below, the Court disagrees.

Before December 1974, the methodologies used to compute and pass through product and non-product cost increases were qualitatively different. Non-product cost increases were computed in terms of the "rate of increase" of such costs in the month preceding prenotification over the same costs incurred during a historical base period. These rates of cost increases were converted into "weighted average percentage price increases," which, if approved after prenotification, could be added to base prices throughout the consecutive twelve-month period. 10 C.F.R. § 212.82(b), (c), 39 Fed.Reg. 1952-53 (January 15, 1974). Under this system, the FEA in effect used the rate of increase in non-product costs as an indicator or forecast of the level of non-product costs in the succeeding twelve-month period. This is particularly evident in the provision that makes the application of an approved prenotified price increase contingent upon whether the refiner continues to incur the prenotified non-product cost increases. Id. § 212.82(b), (d).

In contrast, the method for computing price increases based on product cost increases, which has been referred to as the "dollar-cost pool" method, operated retrospectively. At the beginning of each month, refiners determined the total amount of PCI available for pass-through that month by adding the amount of PCI incurred in the preceding month to the amount of previously incurred but as yet unrecovered PCI. The refiners then could increase their prices for the current month by an amount calculated to permit recovery of all or some portion of the product cost pool allocated to each of the three product categories. If the additional revenues resulting from the price increases above the May 15, 1973 selling prices were not sufficient to recoup all the available PCI, the unrecovered costs could be "banked" for inclusion in the cost pool for the following month.

Banking served two purposes in the dollar-cost pool methodology: (1) it provided pricing flexibility by enabling refiners to pass through less than all their available PCI in the current month without forfeiting the right to pass through the remainder later; (2) it provided a mechanism to control the effect of errors in estimating sales volumes.

The FEA contends the regulations implicitly prohibited the banking of NPCI, because the rate of increase method contained nothing analogous to banking and the regulations expressly provided for banking only with respect to PCI. The Court finds the first reason unpersuasive because the regulations governing NPCI contained provisions that to a large extent fulfilled the same purposes as banking did with respect to PCI. The FEA has admitted that, at least as to covered products other than special products, 81" the regulations did permit refiners to forego charging a prenotified price increase in one month and still recover the underlying non-product cost increases by adding a greater price increment in another month in the same fiscal quarter. 82" The banking provision protected against overrecoveries of PCI due to underestimation of sales volume by requiring refiners to subtract the amount of any overrecovery from the following month's cost pool. 83" The requirement that refiners continue to incur prenotified non-product cost increases during the effective period of an approved price increase served the same purpose. Approval of a prenotified price increase above the base price meant that the refiner could increase its selling prices by the prenotified amount in each of the following twelve months regardless of whether the additional revenues in any particular month were less than or greater than the NPCI incurred.

Likewise, the Court does not consider the silence of the regulations concerning NPCI banking indicative of an intent to prohibit such banking. More probably, it reflects the fact that the concept of banking with the requisite matching of previously incurred costs against revenues has no place in the prospectively applied "rate-of-increase" scheme for passing through increased non-product costs. Viewed in this light, the failure to provide for NPCI banking while, at the same time, permitting PCI banking, reasonably can be construed as meaning that the agency has taken no position on the issue of NPCI banking whatsoever. 84" Thus, the absence of a provision authorizing NPCI banking is ambiguous at best.

In summary, the FEA has failed to establish that the regulations in effect prior to the relevant period implicitly required use of a non-product cost last method of recovery. The "base price/price in excess of base price" rule and the formulas pertaining to the banking of product cost increases do not necessarily preclude the application of alternative methods of cost recovery, such as the proportional method. Further, the Court concludes the regulations in effect during the prenotification period did not prohibit, implicitly or otherwise, the banking of non-product cost increases.

B. Regulations Affecting Prices During the Relevant Period.

On September 10, 1974 the FEA issued a notice of proposed rulemaking announcing the "first proposed comprehensive revision" of the petroleum price regulations since the end of 1973. 85" Regarding the pass-through of non-product cost increases, the FEA proposed to eliminate the "prenotification" procedure and to replace it with an automatic pass-through for certain increased non-product costs on a basis which retained the profit margin limitation on the pass-through of such costs, but which was otherwise similar to the procedure used for the pass-through of increased product costs. 86" In the same notice, the FEA proposed to limit the extent to which refiners could pass through banked product cost increases in subsequent months.

On November 1, 1974, 87" the FEA adopted final amendments to the banking regulations. The regulations, as amended, limited the amount of banked increased product costs that could be passed through in any month to ten percent of the total amount of the bank.

One month later the FEA adopted with a few modifications the amendments relating to the pass-through of non-product cost increases that had been set forth in the September 10, 1974 notice. The amendments became effective on December 1, 1974, but because they provided for a 30-day lag in the recovery of all costs, the amendments did not affect prices until January 1, 1975. The new regulations lessened the differences in the handling of product and non-product cost increases. Besides deleting the prenotification procedure, the FEA eliminated the "rate-of-increase" method of computing NPCI and required refiners to calculate product and non-product cost increases using the same "dollar amount" or "dollar cost pool" method. 39 Fed.Reg. 42368 (December 5, 1974). The agency adopted several of the other proposed amendments at the same time, including a new section (10 C.F.R. § 212.87), which defined the categories of increased non-product costs that a refiner could pass through. 88" Finally, the December 1, 1974 rulemaking contained a provision which had not been set forth explicitly in the notice of proposed rulemaking; this provision expressly prohibited the banking of NPCI. 89"

The other regulations affecting the pass-through of non-product cost increases remained unchanged. The FEA retained the base price rule and the requirement that a price in excess of the base price be charged only "in order to recover on a dollar-for-dollar basis increased non-product costs incurred between the month of measurement and the month of May 1973 and measured pursuant to the provisions of § 212.87." 90" The regulations, as amended, still subjected a refiner that charged a price in excess of the base price to the profit margin limitation. 91"

The December 1, 1974 regulations, like those in effect during the prenotification period, contained no explicit provision specifying a method for allocating product and non-product cost recoveries. The FEA, relying on the same three regulatory provisions discussed earlier in relation to the prenotification period, contends the regulations as amended required use of the NPCI Last method. This argument appears to have two distinct bases: (1) that the regulatory scheme implicitly requires refiners to recover non-product cost increases last and (2) that the FEA so interpreted the regulations during the relevant period. To establish the first proposition the FEA must show the NPCI Last requirement is the only reasonable interpretation which the language of the regulations will bear. 92" This subsumes a secondary issue in these cases, viz., whether the regulations reasonably could be construed to permit use of the proportional method of recovery. If the regulations do not compel use of the NPCI Last method, the Court must examine the FEA's contemporaneous construction of the regulation for guidance in resolving the resultant ambiguity. 93" For the Supreme Court has held that in interpreting "an administrative regulation a court must necessarily look to the administrative construction of the regulation if the meaning of the words used is in doubt." Bowles v. Seminole Rock & Sand Co., 325 U.S. 410, 414, 89 L. Ed. 1700, 65 S. Ct. 1215 (1945). In examining the regulatory scheme and the FEA's contemporaneous construction of it, the Court adopts the viewpoint taken by the Second Circuit in Tobin v. Edward S. Wagner Co., 187 F.2d 977 (C.A. 2, 1951), that:

"regulations, precisely because they particularize, ought not be as generously interpreted as the statute. In fairness to the regulated, the provisions of the regulations should not be deemed to include what the administrator, exercising his delegated power, might have covered but did not cover. True, in deciding what they do cover, we must not regard their literal terms merely, but must also give much weight to administrative interpretive rulings which have been published and of which the regulated are thus on notice."

Id. at 979, quoted in Standard Oil II, supra, F. Supp. at , slip op. at 66.

Having concluded the regulations in effect during the prenotification period contained no implicit NPCI Last requirement, the Court need only consider whether the December 1, 1974 amendments to the regulatory scheme give rise to such an implication. The FEA made three changes relevant to this litigation: (1) the elimination of the prenotification procedure, (2) the change from a "rate of increase" to a "dollar cost pool" method of calculation, and (3) the prohibition of non-product cost banking. The agency described these changes as procedural and emphasized its intent to conform the procedures for handling NPCI to those for PCI, "while retaining the essential substantive features of the [pre-existing] non-product cost pass-through regulations." 39 Fed.Reg. 32721 (September 10, 1974). The only restriction that the agency cited as applying to the pass-through of NPCI but not of PCI was the profit margin limitation. Id. at 32721. The profit margin limitation by its terms applied only to firms which charged prices in excess of the base prices at any time during a fiscal year; 94" like the base price rule, it did not impose a sequence of cost recovery. In light of the minimal substantive significance the FEA attached to the elimination of the prenotification procedure and the changeover to a "dollar cost pool" method for calculating NPCI, it is highly unlikely that a refiner would have inferred an NPCI Last requirement from either or both of those changes. See Standard Oil II, supra, F. Supp. at , slip op. at 58-59. The contrast between the total absence of comment on the method of cost recovery prior to the adoption of the December 1974 amendments 95" and the outcry from refiners in February 1976 when the FEA publicly announced that it interpreted the regulations to require non-product cost increases to be recovered last attests to the validity of this conclusion.

Because the amendments required both product and non-product cost increases to be computed and passed through on a dollar cost pool basis, the reasons for rejecting the FEA's argument that the banking provision and the instructions to Form FEO-96 implicitly imposed a sequence of recovery must also be reconsidered. Aside from the prohibition against NPCI banking, the December 1974 regulations do not mention the recovery of non-product cost increases. The FEA did promise to issue a new Form FEA-96 to replace the old Forms FEO-96 and CLC-22, 96" but it did not adopt a new form until after the relevant period had ended. A proposed revision of Form FEO-96 was issued in April 1975, but it provided no guidance concerning the proper method for recovering non-product costs. 97" Indeed, the record indicates that the failure to adopt a final revision of FEO-96 may have been due in part to the comments received from refiners demanding clarification 98" of the sequence of recovery and the inability of the FEA's Office of Compliance and Office of General Counsel to resolve their differences on that issue. 99" Because the FEA did not revise either the regulations or Form FEO-96 to reflect clearly that non-product costs were to be recovered last, the Court finds no reason to alter its conclusion that no such requirement is implicit in either the banking provision or the instructions to Form FEO-96.

The prohibition against NPCI banking represents the only substantive amendment to the regulations governing non-product costs adopted in December 1974. The FEA argues that to permit recoveries to be computed using any method other than the NPCI Last method would allow refiners, in effect, to bank non-product costs, thereby rendering the banking prohibition a nullity. The Court disagrees. The regulation provides in pertinent part:

(4) Increased non-product costs calculated pursuant to § 212.87 for the month of measurement which are not recouped in the current month . . . may not be carried forward for use in computing allowable prices in excess of base prices in any subsequent month.

10 C.F.R. § 212.83(e)(4), 39 Fed.Reg. 42372 (December 5, 1974). Nothing in this provision addresses the method of cost recovery. Situations in which at least some non-product costs could be recovered before all product costs had been recovered come readily to mind. For example, under the proportional method, a refiner that incurred $100,000 in NPCI and $900,000 in PCI in the month of measurement, but received revenues in excess of the May 15, 1973 selling prices of only $700,000 in the current month, would deem ten percent or $70,000 of the $700,000 to represent the recoupment of its NPCI and ninety percent or $630,000 to be the recoupment of its PCI. The refiner could bank the $270,000 in unrecovered product cost increases but would lose forever the $30,000 in unrecovered non-product cost increases. This result does not contravene the manifest intent or the express language of the regulation prohibiting refiners from carrying forward unrecouped NPCI.

In addition, the Court notes that the FEA adopted section 212.83(e)(4) without providing any explicit notice or any explanation of its purpose. In such circumstances, the Court is not disposed to stretch the language of the banking prohibition and the other regulations cited by the FEA to obtain a construction which would require use of the NPCI Last method.

This case is very similar to Sampson v. Clark, 162 F.2d 730 (Em.App. 1947), which involved the application of the Office of Price Administration's ("OPA") maximum allowable price regulations to the plaintiff, a "new manufacturer." The regulations required manufacturers to compute a maximum price which in turn necessitated determination of direct labor costs. The regulations provided: "'Direct labor costs' shall be calculated on the basis of wage rates paid by you on March 31, 1942." The plaintiff was not in business on that date; therefore, he argued the maximum price regulations, which failed to indicate the method for computing wage rates in such circumstances, did not apply to him. Id. at 732-33. An OPA Board of Review held against the plaintiff because "[the] structure of the regulation . . . certainly afforded [him] a rather direct clue to the prices which he might assume would be valid." Id. at 733 (emphasis supplied). The Administrator admitted the existence of "some indefiniteness as to the method of determining wage rates," but nevertheless upheld the Board, stating the plaintiff had a duty to seek a clarification from the OPA with regard to any doubts he had as to the meaning of the regulations. Id. at 733.

The OPA's argument in Sampson v. Clark bears a striking resemblance to the argument advanced by the FEA in these cases. The Emergency Court of Appeals, however, rejected the OPA's position and held the regulatory scheme, even though clearly intended to include new manufacturers, like the plaintiff, did not apply because the regulations furnished no standard by which new manufacturers could calculate wage rates. Id. at 735. In the instant case, the regulations do not clearly prescribe any method for determining cost recoveries. The FEA argues that the "base price/price in excess of base price" rule, the PCI banking provision, and the prohibition against banking NPCI, when taken together preclude the use of any method of recovery other than the NPCI Last method. The agency easily could have spelled out a sequence of recovery through an amendment to the regulations or perhaps through a ruling or an official interpretation during the relevant period. It would be inappropriate for this Court to infer an NPCI Last rule from the several regulations collectively relied upon by the FEA. The foundation is too tenuous to support a rule having so substantial an impact on the firms regulated.

This conclusion does not mean, however, that the agency could not reasonably have construed the regulations to require use of the NPCI Last method. Because the plaintiffs seek a declaration that the regulations required or permitted use of the proportional method, the Court must consider two further questions: (1) whether the FEA interpreted the regulations in effect during the relevant period to require that non-product cost increases be recovered last; and if not, (2) whether an interpretation which would permit costs to be recovered proportionally is reasonable and consistent with the language of the regulations. Based on the record of contemporaneous construction in these cases, the Court concludes that both issues must be resolved in the plaintiffs' favor. 100"

C. Contemporaneous Constructions of the Regulations.

When faced with regulations whose meaning is ambiguous or uncertain, courts generally place great weight on the interpretations given to those regulations by the officers or agency charged with the responsibility of administering them. See, e.g., Udall v. Tallman, 380 U.S. 1, 16, 13 L. Ed. 2d 616, 85 S. Ct. 792 (1965); Bowles v. Seminole Rock & Sand Co., 325 U.S. 410, 414, 89 L. Ed. 1700, 65 S. Ct. 1215 (1945); California Molasses Co. v. California & Hawaiian Sugar Co., 551 F.2d 1230, 1232 (T.E.C.A. 1977); University of Southern California v. COLC, 472 F.2d 1065, 1068 (T.E.C.A. 1972), cert. denied, 410 U.S. 928, 35 L. Ed. 2d 590, 93 S. Ct. 1364 (1973). An agency's contemporaneous construction of its own regulations deserves great deference. As Mr. Justice Cardozo said in Norwegian Nitrogen Products Co. v. United States, 288 U.S. 294, 315, 77 L. Ed. 796, 53 S. Ct. 350 (1933):

"administrative practice, consistent and generally unchallenged, will not be overturned except for very cogent reasons if the scope of the command is indefinite and doubtful. . . . The practice has peculiar weight when it involves contemporaneous construction of a statute by the men charged with the responsibility of setting its machinery in motion, of making the parts work efficiently and smoothly while they are yet untried and new." (Citation omitted).

There is a dispute in this case, however, over what, if any, interpretation of the regulations the FEA adopted during the relevant period. The plaintiffs cite numerous public statements by FEA personnel endorsing the proportional method and contend that the FEA construed the regulations in effect during the relevant period to permit use of that method. The FEA attempts to dismiss the pronouncements on which the plaintiffs rely as clearly erroneous and merely the unauthorized and unofficial views of several of the agency auditors. The FEA further avers that it has always interpreted the regulations in effect during the relevant period as impliedly requiring refiners to use the NPCI Last method of cost recovery.

Before reviewing the evidence of the agency's contemporaneous construction of the regulations affecting prices from January 1, 1975 to February 1, 1976, the Court will address the more general objections raised by the FEA concerning the statements made by its auditors and others. First, the agency's argument that only the FEA's General Counsel and his staff had the authority to issue official interpretations of its regulations, does not deprive statements by auditors and other officials of the agency of their value as evidence of contemporaneous construction. This is especially true here because the Court has assumed arguendo that the FEA did not officially interpret the regulations to require use of the proportional method, and therefore will examine the evidence of contemporaneous construction only to determine whether the FEA construed the regulations during the relevant period to require use of the NPCI Last method and whether the language of the regulations supports an interpretation which would permit use of the proportional method. Given the limited extent of the inquiry, it is clearly appropriate to resort to the experience and informed judgment of auditors, compliance officials, staff attorneys and others within the FEA for guidance. Courts consider contemporaneous expressions of opinion by low-ranking officials highly relevant and material evidence of the general understanding of ambiguous regulatory provisions. 101" For example, in California Molasses Co. v. California & Hawaiian Sugar Co., 551 F.2d 1230 (T.E.C.A. 1977), a private party brought an action under Section 210 of the Economic Stabilization Act of 1970 to enforce the Phase IV price regulations against a competitor. The plaintiff challenged the interpretation of the regulations held by the IRS, which at that time had responsibility for effecting compliance with the price regulations. Of particular relevance here, the court in California Molasses rejected the plaintiff's argument that "the IRS rulings were routine reviews by local personnel and accordingly were of a type or level not entitled to the deference customarily given to administrative agency determinations." Id. at 1235. Noting that the IRS and its agents had "delegated authority and expertise in reviewing price control compliance," the court upheld the IRS determination on the ground that it was a reasonable interpretation of regulations which "were ambiguous at best." Id. at 1235, 1239. Similarly, this Court will not discount the importance of statements of the FEA's auditors and compliance officials simply because they were not authorized to issue formal interpretations of the agency's regulations.

Many of the statements supporting the proportional method appeared in instructional materials and manuals prescribing operating procedures for auditors. Deference has been accorded to the views expressed in staff manuals and other guidance issued to an agency's personnel in several cases. 102" A division of the Office of Compliance distributed explanatory material to the FEA's auditors in the field with instructions to use the proportional method until the FEA revised Form FEO-96. The FEA itself recently recognized the importance of such information in disposing of an appeal under the Freedom of Information Act, Fulbright & Jaworski, 3 FEA P 80,505 (November 11, 1975). The agency ordered the disclosure of an intra-agency memorandum which "[discussed] certain portions of the FEA mandatory price regulations and [applied] the conclusions reached to specific factual situations." In that case, the FEA's Office of Compliance Policy and Management had circulated the memorandum to its field personnel with instructions to act in accordance with it. This fact caused the FEA to conclude:

"Until modified, the documents therefore constitute the FEA's policy concerning certain questions arising under the Mandatory Petroleum Price Regulations and must be disclosed." Id. at p. 80,519.

The only difference between the memorandum at issue in the Fulbright & Jaworski appeal and the manuals and notices disseminated to auditors in these cases is that the former originated in the Office of General Counsel instead of the Office of Compliance. While this distinction arguably might affect the extent to which the guidance binds the agency, it does not undermine the probative value of the evidence regarding the general interpretation of the regulations or excuse the agency's failure to modify the allegedly erroneous advice given to the auditors by the Office of Compliance.

In sum, the opinions of the FEA's auditors and compliance officials do not deserve significantly less deference solely because those officials were not authorized to issue binding interpretations of the regulations. The weight afforded each of those judgments

will depend upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control. 103"

With these criteria in mind, the Court proceeds to describe some of the statements made during the relevant period.

Shortly after the regulations became effective, three members of the FEA's Refinery Audit and Review Program ("RARP") drafted a document designed to explain to FEA audit teams across the country the non-product cost aspects of the December 1974 amendments. 104" The document, entitled Regulation Change Notice 3-1975-1 ("Change Notice"), was distributed to auditors in the field in January 1975. 105" The Change Notice indicated that product and non-product cost increases should be recovered proportionally and provided three concrete examples of the application of the proportional method. 106" Andrew Drance, the principal draftsman of the Change Notice, stated that he and his supervisor, Donald Clyman, believed the intent of section 212.83(d), entitled "Allocation of increased non-product costs," was "to establish a proportional mechanism for the recovery of increased product and non-product costs." 107" Both men recognized that section 212.83(d) expressly applied only to the allocation of NPCI at the beginning of the month among the various product categories for purposes of computing allowable prices in excess of base prices.108 The language in the Change Notice directing the use of the proportional method reflected this fact.

Problem: How are recoveries computed when both PCI and NPCI are included in computing price adjustments to May 15, 1973 selling prices? (This is not addressed in Section 212.83(d)).

Method: The ratio of NPCI to total CI would be used. This maintains the ratio of NPCI to PCI as required by 212.83(d). Docket Item 79, exh. A-3, p. 3 (emphasis supplied).

The RARP auditors decided section 212.83(d) implicitly required use of a proportional method of recovery partly because they perceived a conflict between section 212.83(d) and section 212.87(b), which also seemed to prescribe a method for allocating NPCI among the various product categories for purposes of computing prices in excess of base prices. 109" However, both Mr. Drance and Mr. Clyman also believed a proportional method of recovery was "reasonable as a matter of regulatory policy." 110"

Before he began drafting Change Notice 3-1975-1, Drance contacted Peter Luedtke, then the FEA's Assistant General Counsel for Pricing, to check out the proportional recovery theory. 111" Drance described the ensuing conversation as follows:

I briefly explained to Mr. Luedtke that we were going out with advice to the field which essentially specified a proportional recovery of product and non-product costs based upon our understanding of the underlying intent of § 212.83(d). I do not recall the precise words I used to describe our proposed advice or our understanding of § 212.83(d). My recollection is that, after I described our interpretation, he said "that's what it should have said," or words to that effect. It was a very brief conversation. . . .

Drance Aff'd, Docket Item 83, par. 8.

Not surprisingly, Drance thought Luedtke had concurred in RARP's proportional recovery theory. 112"

Attached to the Change Notice distributed to auditors nationwide on January 17, 1975 was a set of worksheets entitled Non-Product Cost Increase Schedule ("NPCI Schedule"), 113" which set forth in detail the procedure for calculating cost recoveries under the proportional method. The Change Notice described the NPCI Schedule as something "the companies should prepare to provide detailed information to the audit team, until such time as the information is reported on the revised FEO-96." Consequently, the FEA's auditors distributed the NPCI Schedule to many refiners and instructed them to file it as a supplement to Form FEO-96 for each month in which they passed through non-product costs. 114"

In March 1975 the paragraph of the Change Notice prescribing the use of a proportional method of recovery was incorporated into the FEA's Basic Refiner Audit Course Manual. 115" A section entitled "Desk Review of FEO-96" in Chapter VII of the Audit Course Manual contained the following reference to the NPCI Schedule attached to the Change Notice:

Important Postscript

In order for the FEO-96 to be [a] meaningful document and for the correct calculations of the Maximum Lawful Prices, it is important that the refiners make their calculations in accordance with the following schedules until formal schedule requirements are issued and a new FEO-96 is revised:

a. Supplemental Schedule A

b. Non-Product Cost Schedule (See CARD Audit Handbook 3-1975-1 [i.e. Change Notice]). Calculations deviating from the methodology of the above listed schedules may be considered as potential violations.116

Approximately ninety auditors received copies of this manual while attending one of three Basic Refiner Audit Courses conducted in the Spring of 1975. 117"

For purposes of computing prices, the NPCI Schedule allocated available NPCI among the various product categories on the basis of sales volume in accordance with section 212.87(b). 118" In early March 1975 an official of the Gulf Oil Company convinced Mr. Drance that the use of section 212.87(b) to allocate non-product costs at the beginning of the month for pricing purposes was erroneous. Shortly thereafter Drance drafted a new schedule which used section 212.87(b) only to measure the total amount of NPCI allocable to covered, as opposed to exempt, products and used section 212.83(d) to allocate NPCI among the various products for purposes of computing both price increases and recoveries. 119" Under section 212.83(d), the percentage of the total available NPCI allocated to a particular product could not exceed the percentage of the total PCI allocated to that product.

The amended schedule, later denominated "Worksheet B," was distributed to RARP audit teams nationwide on March 12, 1975 as part of a draft of "Audit Module A, Desk Review of the FEO-96 ". 120" Fred W. Stuckwisch, Director of RARP and later the FEA's top compliance official, 121" distributed Audit Module A, including Worksheet B, in final form on May 19, 1975. The cover letter under which this material was distributed stated:

These modules are now final and should be inserted in your audit manuals as the Official Guidelines, subject of course to revisions due to future regulation changes.

* * *

The worksheets and instructions for completing Worksheets A and B of Module A can now be shown to the refiners. The refiners may use these worksheets until the revised FEA-96 is issued. . . .

Docket Item 79, exh. A-10 (emphasis supplied).

Messrs. Stuckwisch and Drance met with a representative of the General Counsel's Office, W. Mayo Lee, and several other FEA officials on March 5, 1975 to discuss the revision of Form FEO-96. At this meeting the failure of the regulations to specify a method for computing cost recoveries was discussed and the fact that the FEA had instructed refiners to use the proportional method was noted. 122" Mr. Lee interpreted the regulations to require the recovery of non-product cost increases last. 123" In a memorandum dated March 20, 1975 to Donald Clyman, who supervised the effort to revise Form FEO-96, Lee and another member of the General Counsel's staff stated: "The pro-rata recovery of product vs. non-product costs is not set forth in the regulations." 124" This comment caused the committee revising Form FEO-96 to strike from the first draft of the new form language that would have required recoupment of cost increases on a pro-rata basis. 125" On April 24, 1975, the FEA issued a notice of a proposed revision of Form FEO-96. 40 Fed.Reg. 19120 (May 1, 1975). Line 18 of the proposed new form, which was referred to as Form FEA-P110-M-1, called for entry of the "non-product cost increases recovered in the month of measurement" for each of the product categories. 126" Neither the form nor the instructions provided any guidance concerning how to compute such recoveries, however. 127" In any event, the FEA failed to adopt a final revision of Form FEO-96 during the relevant period.

Mr. Drance "[attempted] to obtain clarification from the Office of General Counsel as to the correct method of recovery" several times in 1975. 128" On April 11 Drance sent a memorandum to Peter Luedtke, the Assistant General Counsel for Pricing, in which he clearly stated that RARP had instructed refiners to use the proportional method of recovery even when they charged a price less than the maximum permissible price in excess of base price. Drance concluded: "This principle, if proper, needs to be spelled out by an amendment to the regulations." 129" Mr. Lee, a member of Mr. Luedtke's staff, drafted a proposed amendment to section 212.83(d) of the regulations which expressly would have required use of the proportional method of cost recovery. 130" When his superiors 131" failed to act upon the proposed amendment, Lee revised it to require use of the NPCI Last method. 132" In an affidavit, Lee stated:

I hoped issuance of this notice would end all objections to using the non-product cost last sequence of recoupment and would persuade RARP to abandon its position in favor of pro rata recovery, which was necessary if we were to be able to finalize the proposed [revision of Form FEO-96].

Docket Item 97A, par. 18. The comments of Mr. Drance on Lee's second proposal made it clear that RARP had not abandoned its position. To the contrary, Drance argued strongly in favor of permitting a proportional method of cost recovery, "regardless of whether or not base price had been reached," stating RARP considered such an option "the only feasible method to allocate and recover non-product costs." 133" On August 27, 1975, the FEA adopted some of the changes proposed in Lee's second draft but the agency took no action with respect to the method for computing cost recoveries. 134"

About the same time the FEA issued Ruling 1975-16 -- the strongest support for its contention that it interpreted the regulations in effect during the relevant period to require that non-product costs be recovered last. Ruling 1975-16 applied to resellers and retailers and interpreted the regulations governing such entities to require the NPCI Last method of cost recovery. 40 Fed.Reg. 40834 (September 4, 1975), reprinted in 3 CCH Energy Management para. 16,056.

In September 1975 a paragraph entitled "Latest Developments" was added to the section of the Basic Refiner Audit Course Manual that dealt with the allocation of allowable NPCI. This paragraph, which followed the examples illustrating the proportional method, stated "now the position is being taken that until a firm has exceeded its BASE PRICE there has not been an application of non-product cost." 135" Notably, the course manual still contained both the language advising auditors to use the proportional method and the language indicating that failure to perform calculations in accordance with Worksheet B could be considered a potential violation.

The apparent inconsistency between Ruling 1975-16 and the Change Notice rekindled RARP's interest in obtaining a clarification from the General Counsel's office. 136" Mr. Drance drafted an amendment to the Change Notice specifying that "all available product cost increases . . . must be recovered before any non-product cost increases can be recovered." 137" Drance discussed the draft amendment and the recovery of non-product cost increases in general with Messrs. Luedtke, Lee and Biondi of the Office of General Counsel on October 22, 1975. 138" Thereafter, Drance drafted a memorandum to be sent from Gordon Harvey, Director of the Office of Compliance Program Development, to Peter Luedtke summarizing the issues discussed at the meeting and presenting the recommendations of the Office of Compliance. 139" Mr. Harvey transmitted the memorandum to Mr. Luedtke on November 12, 1975 without any material changes. It contains several statements relevant to the disposition of this case. For example, the memorandum stated:

Although the recovery of the non-product cost increases was not specifically covered by [section 212.83(d)], the general interpretation held by both General Counsel and Compliance [in December 1974] was that recoveries of non-product cost increases was [sic] to be made on a pro-rata basis with the recovery of increased product costs.

Docket Item 79, exh. A-16, p. 1 (emphasis supplied). Apparently, everyone at the October 22 meeting interpreted base price as fixed and recognized that the pro-rata method of recovery did "allow some finagling with the profit margin rule." 140" The Office of Compliance, however, took the position that section 212.83(d) could be interpreted to permit pro-rata recoveries of product and non-product cost increases even when the selling price was below base price. 141" As to whether a ruling or rulemaking procedure would be required to clarify the purported intent of section 212.83(d) to require use of the NPCI Last method, Mr. Harvey observed:

I believe that because of the fact that most of the refiners who are passing through non-product cost increases are doing so on a pro-rata basis, without regard to their full-base price, at a minimum a ruling is required [to impose an NPCI Last sequence]. If a strong enough argument can be made that the pro-rata language is actually contained in 212.83(d) (and I think it is), then a rulemaking is required.

Docket Item 79, exh. A-16, p. 4 (emphasis supplied). Finally, the Office of Compliance recommended against the adoption of the strict interpretation of the regulation (mandating recovery of all product costs first) contained in the amendment to the Change Notice drafted by Mr. Drance. Id. at 5.

The FEA did not adopt the draft amendment submitted by Mr. Drance or any other amendment to the Change Notice before February 1, 1976 (the end of the relevant period). Instead, the General Counsel's Office seems to have kept the matter under advisement. In a memorandum dated December 23, 1975, responding to a request from Mark Silverman, Associate Assistant Administrator for Regulation Development, for a review of "various inconsistencies or omissions in the FEA's nonproduct rules," 142" Mr. Luedtke said:

[The] question of "pro rata" recovery of non-product cost increases for refiners under § 212.83(d) . . . is already the subject of inter-office discussion and review (see Gordon Harvey's memorandum to me of November 12, 1975 . . .). 143"

On January 7, 1976 the FEA proposed amendments to the petroleum price regulations to reflect the pricing policies of sections 401 and 402 of the Energy Policy and Conservation Act. 144" The amendments concerned the pass-through of banked PCI, but the notice of proposed rulemaking did not discuss the method of allocating cost recoveries. Many refiners complained about the FEA's failure to specify a sequence of cost recovery, and, as a result, it added a provision explicitly requiring use of the NPCI Last method when it adopted the proposed regulations on February 1, 1976. 145" The agency also stated in the preamble that, except for certain complexities introduced by the EPCA and not relevant here, "the order specified in the new § 212.85 is the same as that under the regulations previously in effect." That is, "[increased] non-product . . . costs must be recouped last." 41 Fed.Reg. 5113 (February 4, 1976). This statement represents the only explicit endorsement of a method of cost recovery for refiners, other than the proportional method, and it was published by the FEA after the relevant period.

As noted earlier, the FEA repealed the regulation specifying the NPCI Last method only two months after it had been adopted. 146" Nonetheless, the agency has stood by its assertion that the regulations affecting prices from January 1, 1975 to February 1, 1976 required all product costs to be recovered before any non-product costs could be recovered.

The preceding review of the undisputed record of contemporaneous construction in these cases permits the Court to draw several conclusions. First, a dispute existed within the FEA from at least March of 1975 over the proper method under the regulations for allocating cost recoveries. The Office of Compliance supported a liberal interpretation of the regulations that would have required costs to be recovered on a pro rata basis, while the Office of General Counsel supported a strict interpretation that would have required non-product cost increases to be recovered last. Staff members from these two Offices met several times during the relevant period to attempt to resolve their differences and clarify the agency's position on the issue but to no avail. Finally, on February 1, 1976 the FEA publicly announced that it interpreted the regulations to require use of the NPCI Last method.

Second, the public pronouncements of the FEA's auditors and several of its officials during the relevant period overwhelmingly supported the proportional method of recovery. Although the FEA undermined the strength of that support when it failed to mention the proportional method in the proposed Form FEA-P110-M-1 and when it issued Ruling 1975-16, which expressly required resellers and retailers to recover NPCI last, none of the agency's actions indicated unequivocally that refiners should use a method of recovery other than the proportional method. The Change Notice remained in effect until after the end of the relevant period.

The record of contemporaneous construction suggests that confusion existed within the FEA and among refiners regarding the proper method for computing cost recoveries, and that the FEA, which presumably could have eliminated the confusion by interpreting the regulations to require a particular method, did not decide which method was correct until the end of the relevant period. The FEA, however, contends the proportional method introduced by the Change Notice was clearly erroneous and that by early 1975 the auditors who advocated its use had retracted their support. Further, the FEA avers no one "forcefully" brought the fact that the auditors had advised refiners to use the proportional method to the attention of any high agency officials and once such officials became aware of the problem they acted swiftly to remedy it. According to the FEA, the regulations clearly required use of the NPCI Last method and the Office of General Counsel consistently so interpreted them; therefore, the agency had no reason to do anymore than it did.

The Court considers first whether the Change Notice was clearly erroneous. 147" As previously noted, the drafters of Change Notice 3-1975-1 decided to advise auditors to compute cost recoveries proportionally based on an inconsistency they perceived between sections 212.83(d) and 212.87(b) and their belief that proportional recovery made sense from a policy standpoint. 148" The FEA contends no inconsistency existed between the sections cited by Mr. Drance at the time RARP issued the Change Notice. To the contrary, the FEA argues each of the regulations affecting prices after January 1, 1975 clearly had a distinct purpose.

[The] amended regulations contained straightforward language for measuring the amount of a refiner's nonproduct cost increases (§ 212.87), allowing such increases to be passed through in prices in excess of base prices (§ 212.82(c)), and specifying the manner of applying such increases to base prices (§ 212.83(d)). The banking regulation and the FEO-96 then dictated the order in which these nonproduct costs and product costs could be recovered. 149"

The simplicity of this explanation is appealing, but it demonstrates only the ability of the FEA's lawyers, after nearly two years of trying, to create an appearance of order and clarity in an area where the record shows nothing but confusion actually existed. The tortuous path the FEA has asked this Court to follow in these cases represents a poor substitute for straightforward language like: a refiner must recover all its available product cost increases before it may recover any non-product cost increases. The Court already has held that the banking provision and Form FEO-96 did not dictate a method or sequence of cost recovery. If those provisions had clearly required use of the NPCI Last method, as the FEA contends, it is difficult to understand why Mr. Drance, whose principal function during the nine months immediately preceding the adoption of the December 1974 amendments "was to review product cost recoveries and computations in the Forms FEO-96 being filed by certain refiners," 150" did not realize it.

Concerning the purported inconsistency between sections 212.83(d) and 212.87(b), the Court finds the auditors' conclusion reasonable and not clearly erroneous. Section 212.87(b) defined increased non-product costs for each month of measurement to be the sum of the increases in certain specified cost categories, such as labor costs, "multiplied by V [i]n/Vn." 151"

The same ratio symbol "V [i]n/Vn" appeared in the formulas for calculating the amount of increased product costs available for inclusion in the base prices of distillates, gasoline, and covered products other than special products (i=1, 2 and 3, respectively). 152" In the latter context, the symbol "V [i]n/Vn" represented the ratio of the total volume of products in category "i" sold in the period "n" (represented by the symbol "V [i]n") to the total volume of all products, covered and exempt, sold in that same period. Being familiar with the ratio "V [i]n/Vn" from their work with PCI computations during the prenotification period, the compliance officials who drafted the Change Notice assumed it meant the same thing in section 212.87(b) as it did in the formulas for computing PCI. 153" Under this interpretation of the ratio, section 212.87(b) yielded three figures each month, representing the amount of NPCI available for application to the base prices of each of the product categories.

The definitions of "V [i]n" in sections 212.87(b) and 212.83(c)(2) were not the same, however. In section 212.87(b), V [i]n represented the "total dollar volume of covered products. . . sold in the period 'n'." Under this definition, section 212.87(b) yielded only one figure -- the total amount of NPCI available for all covered products. Thus, whether section 212.87(b) provided a mechanism for allocating NPCI among product categories for pricing purposes depended on the interpretation of the term "V [i]n" in that section. For the reasons given in the footnote, 154" the Court concludes the auditors reasonably could have interpreted "V [i]n/Vn" as referring to three distinct ratios.

In addition to the apparent inconsistency between the two allocation provisions, several other considerations supported the auditors' conclusion that the proportional approach specified in section 212.83(d) should be applied to cost recoveries. These include the absence of an express provision specifying a method of cost recovery, the fact that few provisions other than section 212.83(d) gave any indication of the proper relationship between PCI and NPCI, the admitted obsolescence of Form FEO-96, 155" and the cogent policy arguments in favor of a proportional method of recovery. 156" Against this background, the Court finds the auditors' interpretation of the regulations to permit the proportional method of recovery, regardless of whether the prices charged by a refiner exceeded base prices, to be reasonable and consistent with the regulatory scheme. 157"

The contemporaneous construction of the regulations during the relevant period belies the FEA's contention that the RARP auditors retracted their support for the proportional method early in 1975. In July 1975, after reviewing a proposed amendment to the regulations circulated by an attorney in the Office of General Counsel that would have spelled out the NPCI Last requirement, Mr. Drance commented:

There are two viable options as we see it. The first is the very restrictive one which has been described above. The second would be a more liberal one, in which a pro-rata recovery would be permitted, regardless of whether or not base price had been reached.

In our opinion, this second option is the only feasible method to allocate and recover non-product costs. 158"

On November 12, 1975, after more discussion with the General Counsel's staff, Gordon Harvey, the Director of the Office of Compliance Program Development, stated "If a strong enough argument can be made that the pro-rata language is actually contained in 212.83(d) (and I think it is), then a rulemaking is required" to impose an NPCI Last requirement. 159" These statements demonstrate the thoroughness with which the agency's compliance officials considered their position and the consistency of their support for the proportional method of recovery. 160" The well-considered opinions of experienced compliance officers like Mr. Drance and Mr. Harvey bolster the Court's conclusion that the proportional method was consistent with the regulatory scheme.

The only remaining issue is whether the FEA interpreted the regulations during the relevant period to require use of the NPCI Last method. The record clearly indicates it did not. The FEA attempts to explain the public silence of the General Counsel's Office regarding the method of cost recovery by arguing: (1) there was no need to say anything because the regulations clearly required non-product cost increases to be recovered last, (2) the General Counsel consistently so interpreted them, and (3) no one "forcefully" brought the fact that RARP had advised refiners to use the proportional method to the attention of "high agency officials" until late 1975, and shortly thereafter (February 1, 1976), the FEA explicitly required use of the NPCI Last method.

Because the regulations did not implicitly require use of any particular method of cost recovery and could have been construed to permit proportional recovery, the failure of the FEA to publicly interpret the regulations to require that non-product costs be recovered last during the relevant period is fatal to its argument here. None of the administrative interpretations and contemporaneous constructions cited by the FEA dealt specifically with the issue of cost recovery, except Ruling 1975-16, 161" which alone deserves further discussion. 162" Issued on August 29, 1975, Ruling 1975-16 interpreted the pricing sequence in the regulations governing resellers and retailers163 to require use of the NPCI Last method of cost recovery. According to the FEA, this explanation of the sequence of cost recovery was directly relevant to refiners, since prices under the reseller and retailer price regulations were comprised of precisely the same elements as refiners' prices -- i.e., May 15, 1973 selling prices, plus increased product costs, plus increased non-product costs.

Again the defendants' argument fails. Ruling 1975-16 makes no mention of refiners, who are governed by a different subpart of the regulations than resellers and retailers. 164" The differences between these two sectors of the industry often required differing treatment under the regulations. Mr. Luedtke, the Assistant General Counsel for Pricing, defended some of the regulatory distinctions in a letter, dated December 23, 1975, to the Associate Assistant Administrator for Regulation Development. 165" Mr. Luedtke acknowledged that the Office of Compliance had permitted refiners to recover NPCI on a pro-rata basis but stated the issue was "already the subject of interoffice discussion and review." 166" Such a noncommittal response to a letter criticizing the pro-rata method suggests that the General Counsel's Office did not consider the NPCI Last rule for resellers and retailers announced four months earlier in Ruling 1975-16 controlling with respect to refiners.

Finally, the record does not support the agency's argument that no one in a position to resolve the cost recovery problem knew that Compliance had disseminated "erroneous" advice endorsing the proportional method until it was too late. Mr. Lee described Mr. Luedtke as someone "in a position to get this matter resolved," 167" and he had notice early in 1975. On April 11, 1975 Mr. Drance sent a memorandum to Mr. Luedtke, stating that RARP had advised refiners to recover PCI and NPCI on a pro-rata basis. 168"

In addition, several refiners informed high-ranking FEA officials that they were recovering product and non-product cost increases proportionally. On February 5, 1975, representatives of the Shell Oil Company met with four members of the FEA Operations, Regulations and Compliance staff and informed them that Shell interpreted the regulations to require use of the proportional method of cost recovery. 169" According to Shell, the FEA employees confirmed its interpretation and gave the Shell representatives a copy of the NPCI Schedule. 170" More importantly, Shell sent a letter to the Assistant Administrator for Operations, Regulations and Compliance on February 24, 1975 summarizing the meeting and indicating that Shell understood the FEA to have confirmed the proportional method. 171" Later, the plaintiff Continental Oil Company submitted written comments on the proposed Form FEA-P110-M-1, noting the omission from it of any guidance concerning cost recovery and stating Continental's assumption that proportional recovery was intended. 172" As additional examples, the Court notes that in May 1975 Mobil 173" and Exxon 174" both communicated to high ranking FEA officials the view that the regulations did not require refiners to recover NPCI last.

Finally, in August 1975 an FEA staff attorney recommended to Avrom Landesman, Assistant General Counsel for Compliance, that a ruling be issued describing the proper method to be used by refiners in recovering product and non-product costs. 175"

The frequency with which refiners and the FEA's auditors, compliance officials and staff attorneys raised the method of recovery issue during the relevant period leads inescapably to the conclusion that the FEA knew about the confusion but chose to remain silent until February 1, 1976. 176" In the face of so many public indications that non-product cost increases did not have to be recovered last, this Court owes no deference to the contrary opinions expressed within the agency but not announced publicly during the relevant period. Therefore, the Court holds that the FEA did not interpret the regulations affecting prices during the relevant period to require use of the NPCI Last method until after the period had ended.

Furthermore, there is no basis for according the February 1, 1976 interpretation of the regulations retroactive effect. Courts should not permit administrative agencies to apply new standards to regulated firms retroactively, unless the need to avoid "a result which is contrary to the statutory design or to legal and equitable principles" outweighs the ill effects of the retroactive application on the regulated. SEC v. Chenery, 332 U.S. 194, 203, 91 L. Ed. 1995, 67 S. Ct. 1575 (1947); California v. Simon, 504 F.2d 430, 438-39 (T.E.C.A. 1974). In Retail, Wholesale & Department Store Union v. NLRB, 151 U.S. App. D.C. 209, 466 F.2d 380, 390 (1972), the court elaborated on the balancing requirement as follows:

Which side of this balance preponderates is in each case a question of law, resolvable by reviewing courts with no overriding obligation of deference to the agency decision . . .; and courts have not infrequently declined to enforce administrative orders when in their view the inequity of retroactive application has not been counterbalanced by sufficiently significant statutory interests. (Citations omitted) (emphasis supplied).

In that case, the District of Columbia Circuit identified five considerations that enter into a resolution of the retroactivity issue; in the case sub judice three of those factors are determinative. 177" They are: (1) the extensive reliance of refiners on the absence of a required NPCI Last method of recovery, (2) the significant burden a retroactive imposition of an NPCI Last rule would have on refiners (the rule would force a reduction of approximately $1.3 billion in refiners' banks), 178" and (3) the absence of any substantial statutory interest which would be served by applying the rule retroactively given the reliance of the plaintiffs and others on the auditors' advice to use the proportional method. 179" In light of these factors, the Court will not permit the FEA to cure the omission of a recovery rule in the regulations by retroactively interpreting them to require use of the NPCI Last method. 180"

IV. COMPLIANCE WITH THE APPLICABLE RULEMAKING REQUIREMENTS

Even if this Court were to accept the substantive arguments of the FEA, it would hold the regulations prescribing a method of cost recovery and prohibiting NPCI banking invalid, because the FEA adopted those regulations without providing adequate notice and opportunity to comment under the applicable statutes. 181" Sections 4(b) and (c) of the Administrative Procedure Act ("APA"), 5 U.S.C. § 553(b), (c), prescribe the notice and comment requirements applicable to the predecessors of the FEA. 182" Section 553(b)(3) requires publication in the Federal Register of "either the terms or substance of [a] proposed rule or a description of the subjects and issues involved" in a proposed rulemaking. Under Section 553(c), an agency must give interested persons an opportunity to comment and provide a concise general statement of the basis and purpose of any rule it adopts.

During the prenotification period no notice appeared in the Federal Register indicating the substance of either the NPCI Last requirement or the NPCI banking prohibition or announcing that the COLC or FEO intended to consider those subjects. The FEA, therefore, must establish that these purported regulations fell within one of the two exceptions to the notice provisions of section 553(b). 183" First, the APA notice and comment requirements do not apply to "interpretative rules." In Pharmaceutical Manufacturers Association v. Finch, 307 F. Supp. 858, 863 (D.Del. 1970), this Court held the exception for interpretative rules does not apply "when a proposed regulation of general applicability has a substantial impact on the regulated industry." The touchstone in determining whether a rule is interpretative is the basic purpose of the statutory notice and comment requirements. "When an agency action has 'palpable effects' upon the regulated industry and the public in general, it is necessary to expose the action 'to the test of prior examination and comment by the affected parties.'" National Helium Corp. v. FEA, supra, 569 F.2d at 1137, 3 CCH Energy Management para. 26,088 at p. 26739; National Motor Freight Traffic Association v. United States, 268 F. Supp. 90, 96 (D.D.C. 1976) (three judge court), aff'd per curiam, 393 U.S. 18 80 S. Ct. 49, 21 L. Ed. 2d 19 (1968). As noted earlier, the regulations in effect during the prenotification period afforded refiners considerable flexibility in passing through non-product costs increases. Thus, a regulation effectively prohibiting NPCI banking, and thereby eliminating this flexibility, would have had a substantial impact on refiners. A regulation imposing an NPCI Last sequence of cost recovery would have had an even greater impact. Thus, neither the banking prohibition nor the NPCI Last requirement falls within the interpretative rule exception. See Pharmaceutical Manufacturers Association v. Finch, supra; St. Francis Memorial Hospital v. Weinberger, 413 F. Supp. 323, 328-29 (N.D.Cal. 1976). 184"

The second exception to the notice and comment requirements of Section 553 applies only where there has been an express finding for good cause "that notice and comment are impracticable, unnecessary or contrary to the public interest." 5 U.S.C. § 553(b)(3)(B). There was no express finding of good cause regarding either of the two regulations at issue here. 185" Accordingly, the Court holds invalid and unenforceable any NPCI Last requirement or prohibition on NPCI banking which may have been implicit in the regulations prior to the relevant period.

The rulemaking procedures of the Federal Energy Administration Act of 1974 ("FEAA") 186" govern adoption of the regulations affecting prices during the relevant period. Although the Act incorporates the procedures of the APA, 187" sections 7(i)(1)(B) and (C) impose on the FEA publication and comment requirements even more rigorous than those provided for in the APA. These FEAA provisions require that the FEA: (1) publish the proposed rule, regulation or order in the Federal Register, (2) provide an opportunity to comment for a minimum of 10 days following publication unless waived by a statutorily specified finding, and (3) afford an opportunity for oral presentation of "views, data and argument," if the rule, regulation or order is likely to have a substantial impact either on the nation's economy or on a large number of individuals or businesses. 188" The FEA adopted the two regulations at issue here without satisfying either the second or third of these requirements. 189"

The FEA first published the provision prohibiting the banking of non-product cost increases on December 5, 1974 -- four days after the regulation became effective. 190" Therefore the promulgation of the banking prohibition violated the 10-day notice provision of the FEAA, unless the FEA waived the requirements of notice and opportunity to comment. 191" The FEAA provides an exception to the notice and opportunity to comment requirements only

where strict compliance is found to cause serious harm or injury to the public health, safety, or welfare, and such finding is set out in detail in such rule, regulation, or order.

15 U.S.C. § 766(i)(1)(B). The rule adopted in December 1974 contained no express finding of serious harm or injury. Hence, the Court holds that the FEA failed to provide the requisite 10-day notice and comment period when it adopted the regulation prohibiting the banking of NPCI. See Standard Oil II, supra, F. Supp. at , slip op. at 75-76.

Similar procedural infirmities afflict the purported requirement that non-product costs increases be recovered last. This requirement became effective on February 1, 1976 but was not published in the Federal Register until February 4, 1976. The FEA provided no notice before the effective date of the regulation and no 10-day comment period. The February 1, 1976 rulemaking contained no express waiver of the notice and comment requirements of section 7(i)(1)(B) of the FEAA. 15 U.S.C. § 766(i)(1)(B).

Even if, contrary to this Court's holding, the NPCI Last requirement were implicit in the regulatory scheme in effect throughout the relevant period, 192" that requirement would be invalid and unenforceable due to the FEA's failure to provide notice and an opportunity to comment. The legislative history of the FEAA evidences Congress' intent to ensure the FEA is alert to the views of industry and the public before it promulgates significant rules or regulations. See Shell Oil Co. v. FEA, supra, 440 F. Supp. at 882-84, 887. A requirement that non-product costs increases be recovered last instead of proportionally with product cost increases would have affected many refiners and caused substantial reductions in their banks, as well as changes in their pricing policies. The repeal of the NPCI Last requirement almost immediately after the FEA first subjected it to the harsh light of public scrutiny further demonstrates that the rule should have been promulgated in full compliance with the notice and comment requirements of the applicable statutes. This Court concurs fully with the following assessment made by Judge Manos in Standard Oil II, supra:

In adopting the all product costs first theory of increased cost recovery [i.e., NPCI Last method], the FEA and its predecessor agencies never complied with [the] procedural requirements [of the FEAA or the APA]. The FEA continues to rely on the masquerade that compliance with these requirements was not necessary because it never changed the implicit requirements of the regulations. Yet, this court has found that nowhere prior to the February 1, 1976 rulemaking did the agency ever give notice that it required an all product cost first sequence for the recoupment of increased product and non-product costs. The agency did not furnish advance notice of the subject matter or the issues presented by such a rule. The agency did not furnish advance notice of the rule itself, or provide the public with the required opportunity for the presentation of written comments. Nowhere did the FEA furnish the public the required opportunity for oral comment, despite the rule's enormous impact, and nowhere did the agency publish a statement of basis and purpose for such a rule.

F. Supp. at , slip op. at 73.

Finally, the record indicates that application of the NPCI banking prohibition and the NPCI Last rule during the relevant period would have had a "substantial impact" within the meaning of section 7(i)(1)(C). Therefore, the FEA also had a duty to afford interested persons an opportunity for " oral presentation of views, data, and arguments." 193" The agency violated this procedural requirement in adopting both the banking prohibition and the NPCI Last rule.

The appropriate remedy for a violation of the notice and comment provisions of the FEAA is to declare the regulation void ab initio. Shell Oil Co. v. FEA, supra, 440 F. Supp. at 887. 194" Accordingly, the Court holds that no valid and enforceable regulation prohibiting the banking of NPCI or requiring use of the NPCI Last method of cost recovery existed during the relevant period.

CONCLUSION

The plaintiffs seek a declaratory judgment that prior to February 1, 1976 the FEA's regulations permitted them to use the proportional method of cost recovery, and an injunction prohibiting the FEA from enforcing against them any regulation that purports to require use of the NPCI Last method. In the alternative, plaintiffs seek to invalidate any NPCI Last requirement and the prohibition against the banking of non-product cost increases on the ground that those regulations were adopted in violation of the applicable statutory rulemaking requirements. The FEA contends the regulations in effect since September 1973 always implicitly required that non-product cost increases be recovered last, because any other method of recovery would contravene the base price rule, the PCI banking provisions, and the prohibition against NPCI banking. The Court examined the regulations affecting prices in effect before December 1, 1974 and concluded that the regulations did not contain a tacit prohibition against NPCI banking. Further, the Court concluded the base price rule and the PCI banking provision did not implicitly require the use of the NPCI Last method of cost recovery.

The FEA substantially revised the procedures for passing through NPCI on December 1, 1974, adopting, among other things, an express provision banning the banking of non-product cost increases. The regulations did not refer explicitly to the allocation of cost recoveries issue, and the Court found nothing in them that implicitly precluded the use of the proportional method. The substantial amount of evidence of contemporaneous construction available to the Court in these cases clearly established two additional points. First, even if the regulations reasonably could have been interpreted to require that NPCI be recovered last, they also could have been interpreted to require that product and non-product cost increases be recovered proportionally. In the face of such an ambiguity, the FEA could not remain silent. Yet, the second conclusion to be drawn from the contemporaneous construction of the regulations is that the FEA did not decide to require use of the NPCI Last method until the very end of the relevant period. Further the agency did not publicly announce that decision until February 1, 1976. Finding this belated interpretation of the regulations did not qualify for retroactive application, the Court concluded the regulations affecting prices from January 1, 1975 to February 1, 1976 did not require the use of any particular method of cost recovery. The Court also concluded that the proportional method reasonably comports with the express regulatory provisions affecting NPCI during the relevant period.

Finally, the FEA and its predecessors never complied with the notice and comment provisions of the APA and the FEAA in conjunction with the purported adoption of either the prohibition of NPCI banking or the NPCI Last requirement. As a result both provisions, to the extent they existed, are void and unenforceable.

Accordingly, the Court will enter an order granting summary judgment in favor of plaintiffs and against defendants and awarding plaintiffs the abovementioned declaratory and injunctive relief.

An Order will be entered in accordance with this Opinion.

[EDITOR'S NOTE: The following court-provided text does not appear at this cite in 449 F. Supp.]

ORDER

For the reasons set forth in the Court's opinion entered in these actions on this date, it is

ORDERED

1. Summary judgment is hereby entered in favor of the plaintiffs and against the defendants on the following issues:

(a) Whether the FEA regulations affecting refiner prices from January 1, 1975 to February 1, 1976 permitted refiners to recover product and non-product cost increases proportionally, regardless of whether selling prices exceeded base prices.

(b) Whether the FEA failed to provide notice and an opportunity for comment in promulgating the prohibition against NPCI banking and the alleged requirement that refiners use the NPCI Last method of cost recovery, in violation of the applicable statutory rulemaking requirements.

2. Judgment is hereby entered declaring:

(a) That the FEA regulations affecting prices from January 1, 1975 to February 1, 1976 did not require the use of any particular method of computing cost recoveries, and further that those same regulations permitted the plaintiff-refiners to use the proportional method of allocating cost recoveries between available product and non-product cost increases;

(b) That if any FEA regulation in effect during the relevant period did prohibit the use of the proportional method of cost recovery, such regulation was not issued in compliance with the applicable notice and comment requirements and therefore is void; and

(c) That the prohibition against the banking of unrecovered non-product cost increases contained in 10 C.F.R. § 212.83(e)(4), 39 Fed.Reg. 42372 (December 5, 1974), was not issued in compliance with the notice and comment requirements of the Federal Energy Administration Act and therefore is void.

3. The defendant Department of Energy ("DOE"), its officers and employees, and successor agencies are hereby permanently enjoined from enforcing or threatening to enforce against the plaintiffs in these actions:

(a) any regulations that purport to have prohibited plaintiffs from using the proportional method of cost recovery during the period from January 1, 1975 to February 1, 1976; and

(b) the explicit ban on banking unrecovered non-product cost increases stated in 10 C.F.R. § 212.83(e)(4), 39 Fed.Reg. 42372 (December 5, 1974).

4. Given the Court's disposition of the issues raised by the cross motions for summary judgment, it is unnecessary to reach the constitutional issues raised by the plaintiffs' complaints. Therefore, the Court hereby declines to certify to the Temporary Emergency Court of Appeals, pursuant to 12 U.S.C.A. § 1904, Note 211(c), any of the constitutional issues presented in these cases.

Dated: March 9, 1978.

1. The following five plaintiffs filed their suits in March and April 1977: Phillips Petroleum Company, Tenneco Oil Company, Pennzoil Company, Coastal States Gas Corporation, and Continental Oil Company. The sixth oil company, Amerada Hess Corporation, did not file suit until October, 1977, but by stipulation of the parties its action has been consolidated with the others. Docket Item 77 (unless otherwise noted, references to the record pertain to Civil Action No. 77-90).

2. F.R.Civ.P. 25. The FEA became part of the DOE on October 1, 1977. Pub.L.No. 95-91, §§ 301(a), 705(e), 91 Stat. 565; Exec. Order No. 12009, 42 Fed.Reg. 46267 (September 15, 1977). Because the administrative activity at issue in this case occurred before the creation of the DOE, the defendant will be referred to as the FEA herein. The Secretary has been named as a defendant in only four of the six suits; references throughout the opinion to the FEA include the Secretary.

3. See Docket Item 1.

4. Docket Item 9.

5. Phillips Petroleum Co. v. FEA, 435 F. Supp. 1239 (D.Del. 1977). The Court dismissed the plaintiffs' estoppel claims and their claims that the regulations were invalid because they were not supported by a rational basis, because those issues were not ripe for judicial determination. Id. at 1246 n. 8, 1249.

6. The Court deferred indefinitely consideration of whether the plaintiffs' constitutional claims should be certified to TECA. Id.

7. Docket Items 78 and 86.

8. Standard Oil Co., et al. v. FEA, et al., ("Standard Oil II"), 453 F. Supp. 203, (N.D.Ohio, 1978). In a prior opinion the Ohio court denied a motion by the FEA to dismiss the actions on the ground of ripeness. Standard Oil Co. v. FEA, ("Standard Oil I"), F. Supp. , 3 CCH Energy Management P 26,079, p. 26,614 (N.D.Ohio 1977).

9. Phillips Petroleum Co. v. FEA, 435 F. Supp. 1234 (D.Del. 1977).

10. See id. at 1236, 1238.

11. See note 8 supra.

12. 6 C.F.R. Part 150, Subpart L, 38 Fed.Reg. 22356 (August 22, 1973).

13. The President established the FEO pursuant to his authority under the Emergency Petroleum Allocation Act ("EPAA"), 15 U.S.C. § 751 et seq., which became law on November 27, 1973. See Exec. Order No. 11,748, 38 Fed.Reg. 33575 (December 6, 1973).

14. 39 Fed.Reg. 1952 (January 15, 1974); the FEO also renumbered the regulations so that those governing refiners appeared at 10 C.F.R. Part 212, Subpart E. Id.

15. The regulations defined "increased products costs" as the sum of (1) the difference between the total cost of crude petroleum during the month of measurement and the total cost of crude petroleum during the month of May, 1973 plus (2) the difference between the total cost of petroleum product during the month of measurement and the total cost of petroleum product during the month of May, 1973 . . . . 10 C.F.R. § 212.83(b), 39 Fed.Reg. 1954-55 (January 15, 1974).

16. Estimation errors may cause over- or underrecoupment of costs. For example, even if a refiner included all its PCI in selling prices for the current month, the revenues received at the end of that month would not be sufficient to recoup all the PCI if the refiner had overestimated the sales volume for the current month when he established the selling price.

17. 10 C.F.R. § 212.83(c), 39 Fed.Reg. 1924, 1955 (January 15, 1974).

18. 10 C.F.R. §§ 212.83(b), (c), 39 Fed.Reg. 1952, 1953 (January 15, 1974). Non-product cost increases were reduced to reflect productivity gains. Id.

19. 10 C.F.R. § 212.83(i), 39 Fed.Reg. 1954 (January 15, 1974).

20. 10 C.F.R. § 212.83(c), 39 Fed.Reg. 1953 (January 15, 1974); for an explanation of the two methods, see 39 Fed.Reg. 32721 (September 10, 1974).

21. Exec. Order No. 11790, 39 Fed.Reg. 23185 (June 27, 1974). The Federal Energy Administration Act of 1974 ("FEAA"), 15 U.S.C. § 761 et seq., became law on May 7, 1974. Pub.L. No. 93-275, 88 Stat. 97.

22. 39 Fed.Reg. 32720 (September 10, 1974).

23. Id. The FEA proposed to compute and pass-through NPCI using the same "dollar amount" concept that was being used for product cost increases.

24. See 10 C.F.R. § 212.81 et seq. (December 5, 1974). Because of the one-month delay imposed by the cost pass-through provisions, these amended regulations governed refiners' prices beginning on January 1, 1975. The categories of NPCI which could be passed through were: refinery fuel costs, labor costs, additive costs, certain marketing costs, and utility, pollution control, interest and container costs. 10 C.F.R. § 212.87(c), 39 Fed.Reg. at 42373-74.

25. 39 Fed.Reg. at 42372.

26. The FEA has admitted that the regulations did not explicitly address the sequence of recovery issue. See Docket Item 79, exh. D-2, p. 1 (memorandum from General Counsel of FEA to the Administrator); Id., exh. D-6, p. 3 (Statement of Gorman C. Smith Before the Subcommittee on Energy and Power, Committee on Interstate and Foreign Commerce, House of Representatives, September 20, 1976). Congressman John Dingell, before whose subcommittee Mr. Smith was to have testified, refused to allow Mr. Smith to deliver his statement for reasons explained below. The statement had been cleared within the agency, however, and represented the agency's official position. Smith Dep., Docket Item 75A, pp. 195-96, 461-63.

27. In a letter, dated September 14, 1976, to Representative John E. Moss, Chairman of the Oversight and Investigations Subcommittee of the House Committee on Interstate and Foreign Commerce, FEA Administrator Zarb stated: "The regulations in effect during [the relevant] period contained ambiguities with respect to whether increased non-product costs could be recovered on [a proportional] basis." Docket Item 79, exh. D-4.

28. Assume that in a given month a refiner had incurred increased product costs of $70 and increased non-product costs of $30, a total of $100. Assume, however, that the refiner actually recovered during the following month only $90 (that is, 90 percent) of its increased costs. (This could happen, for example, because the refiner misestimated its sales when setting prices or because the market precluded charging the maximum allowable sales price.) Under the NPCI First method, the refiner would be deemed to have recovered $30 in non-product costs and $60 in product costs; it could bank the remaining $10 of product costs for recovery in later months. Under the NPCI Last method, the refiner would be deemed to have recovered $70 in product costs and $20 in non-product costs; it would lose forever the remaining $10 of non-product costs. Under the Proportional Method, the refiner would be deemed to have recovered $63 in product costs (90 percent of $70) and $27 in non-product costs (90 percent of $30); it could bank $7 of product costs for recovery in later months and would lose forever the remaining $3 of non-product costs.

29. Phillips Petroleum Co. v. FEA, 435 F. Supp. 1239, 1243 (D.Del. 1977); these communications are described in detail Part III.C, infra.

30. See 41 Fed.Reg. 40559, 40560 (September 20, 1976).

31. Pub.L. No. 94-163, 89 Stat. 946 (codified at 15 U.S.C. § 753). Section 401 made explicit the FEA policies of permitting refiners to pass through product cost increases on a dollar-for-dollar basis and of requiring the pass-through of product cost decreases as well. Section 402, among other things, limited the time allowed for the recoupment of PCI and the amount of "banked" PCI which could be passed through in a single month.

32. 41 Fed.Reg. 5111 (February 4, 1976).

33. 41 Fed.Reg. at 5120.

34. See id. at 5113. The notice of proposed rulemaking issued on January 7, 1976 contained no mention of the proper method or sequence of cost recovery. See 41 Fed.Reg. 1680 (January 9, 1976). In the preamble of the February 1, 1976 rulemaking, the FEA stated that the many comments it had received complaining about its silence on this issue had prompted the promulgation of the regulation requiring use of the NPCI Last method. 41 Fed.Reg. at 5113. The preamble contains the following explanation of the NPCI Last requirement: Under FEA price regulations (both prior to today's amendment and as amended), refiners determine their "increased product costs" (composed of increased crude oil and purchased product costs) on a calendar month basis. . . . The total dollar amount of increased crude oil (and product) costs which is thus determined for a calendar month may not be passed through in prices for products which are above a refiner's May 15, 1973 prices until the calendar month following the month in which they were incurred and measured. To the extent that the total amount of a refiner's increased costs of crude oil incurred in one calendar month (the "month of measurement") is not recovered in prices charged during the following calendar month (the "current month"), such increased costs may be carried forward or "banked" and passed through in prices charged in subsequent months, subject to certain limitations. Non-product costs may not be "banked" and are therefore considered to be recouped only after all available "increased product costs" . . . have been applied to establish "base prices." . . . Except for the complexities introduced by [the EPCA] . . ., the order specified in the new § 212.85 is the same as that under the regulations previously in effect. Id. (Emphasis supplied).

35. 41 Fed.Reg. 15330, 15331 (April 12, 1976).

36. Id. In a notice of proposed rulemaking published on March 3, 1976, the FEA stated that the purpose of requiring refiners to use the NPCI Last method was "to prevent refiners from carrying forward or banking increased non-product costs" in violation of § 212.83(e)(9). The "practical effect" of using either the NPCI First or the proportional method, according to the FEA, was to permit the banking of non-product cost increases. 41 Fed.Reg. 9199 (March 3, 1976).

37. 41 Fed.Reg. 15331 (April 12, 1976).

38. Id. at 15330, 15333.

39. For a list of several occasions since February 4, 1976 on which the FEA has officially expressed this view, see Phillips Petroleum Co. v. FEA, supra, 435 F. Supp. at 1243.

40. The survey indicated that 29 refiners had recovered product and non-product cost increases proportionally; 29 other refiners recovered non-product costs first. 41 Fed.Reg. 40560 (September 20, 1976).

41. Id. at 40560.

42. See Standard Oil II, supra, F. Supp. at , slip op. at 30. On September 17, 1976 Congressman Dingell issued a press release criticizing the FEA's proposal to permit refiners to retain overcharges stemming from a "good faith" misunderstanding of the regulations and scheduling a subcommittee hearing on the matter for September 20, 1976. Docket Item 79, exh. D-5.

43. The communications between Congressman Dingell and his staff and various FEA officials are described in Standard Oil I, supra, F. Supp. at , 3 CCH Energy Management para. 26,079, pp. 26,628-29, and Standard Oil II, supra, F. Supp. at , slip op. at 29-32.

44. 122 Cong.Rec. E 5298, 5299 (daily ed., September 27, 1976) (letter from FEA Administrator Zarb to Congressman Dingell).

45. 41 Fed.Reg. 43953, 43954 (October 5, 1976).

46. Apco Oil Corp., 5 FEA P 83109 (March 23, 1977). One of the three applications had been filed by Continental Oil Company, a plaintiff herein.

47. Docket Item 10A, Att. G, p. 59.

48. Id. pp. 3-7; Id. Att. M, pp. 36-40.

49. Docket Item 79, exh. A-3. This Change Notice was issued by members of FEA's National Compliance Office staff in January 1975 and instructed the agency's auditors to compute increased cost recoveries on a proportional basis.

50. Opening Memorandum in Support of Defendant's Motion for Summary Judgment, Docket Item 80, p. 85.

51. See 6 C.F.R. Part 150, 38 Fed.Reg. 21592 (August 9, 1973). Manufacturers and petroleum refiners alike were subject to similar regulations under Phase II. See 6 C.F.R. Part 300 (1972).

52. 6 C.F.R. Part 150, Subpart L, 38 Fed.Reg. 22536 (August 22, 1973); id. § 150.358(g), 38 Fed.Reg. 22541.

53. Id. § 150.358(c), 38 Fed.Reg. 22541 (August 22, 1973). Refiners, as well as manufacturers, prenotified their allowable price increases as a "rate" or percentage of the base price. Form CLC-22 was used to prenotify price increases above base price and to justify such increases by way of increased non-product costs. See Docket Item 79, exh. C-22. COLC had the authority to defer, delay, modify or disallow prenotified price increases. See 6 C.F.R. § 150.358(d), 38 Fed.Reg. 22541 (August 22, 1973); 6 C.F.R. § 150.154, 38 Fed.Reg. 21608 (August 9, 1973).

54. 6 C.F.R. § 150.356(c), 38 Fed. Reg. 25688 (September 14, 1973).

55. The original banking regulation permitted a refiner that "establishes a base price . . . which does not include the entire amount of increased [product] costs" to bank the unapplied costs. 6 C.F.R. § 150.356(c), 38 Fed.Reg. 25686, 25688 (September 14, 1973). This language implied that a refiner could establish a "base price" which did not include all of the applicable product cost increases. The language of the regulation, as amended on November 2, 1973, does not support such an inference. See 6 C.F.R. § 150.356(d), 38 Fed.Reg. 30271 (November 2, 1973). The November amendment expressly permitted banking when underrecoupment of costs resulted from an overestimation of sales value for the current month -- a situation not addressed in the initial banking regulation. Id.

56. See 6 C.F.R. § 150.356, 38 Fed.Reg. 25686 (September 14, 1973), as amended in 38 Fed.Reg. 30270 (November 2, 1973) and 38 Fed.Reg. 33579 (December 6, 1973) (formulas for allocating product cost increases); 6 C.F.R. § 150.355, 38 Fed.Reg. 33578 (December 6, 1973) (formula for allocating non-product cost increases).

57. 6 C.F.R. § 150.356(c)(1)(i), 38 Fed. Reg. 33580 (December 6, 1973).

58. 6 C.F.R. § 150.356(c)(2), 38 Fed.Reg. 33580 (December 6, 1973). n59 The FEA provided the following description of the formula for computing diu when gasoline is the special product being considered: At(V [i]n) d [i]u = The dollar Total in- Total in- Total in- Increasedincrease which creased creased creased productmay be applied cost of costs of product costsin the current crude oil gasoline costs allocablemonth ("u") to incurred purchased allocable to gasolinethe May 15, = in the + or landed + to gaso- - which the1973 selling month of in the line not refinerprice of measure- month of recouped chooses togasoline ("i") ment alloc- measure- in sales allocate toto compute the able to ment of gaso- otherbase price of gasoline line coveredgasoline to through productseach class the monthof purchaser of measure -ment

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