Title: Potomac Edison Co. v. State Corporation Commission

State: virginia

Issuer: Virginia Supreme Court

Document:

PRESENT:  Hassell, C.J., Keenan, Koontz, Kinser, Lemons, and 
Millette, JJ., and Russell, S.J. 
 
THE POTOMAC EDISON COMPANY, 
D/B/A ALLEGHENY POWER 
 
v.   Record No. 080727 
 
 
 
    OPINION BY 
JUSTICE BARBARA MILANO KEENAN 
 
 
October 31, 2008 
 
STATE CORPORATION COMMISSION, ET AL. 
 
 
FROM THE STATE CORPORATION COMMISSION 
 
In this appeal, we consider whether the State Corporation 
Commission (the Commission) erred in setting an electric retail 
rate in an amount less than the rate requested by the Potomac 
Edison Company, doing business as Allegheny Power (AP), which 
rate AP had sought for the purpose of recovering certain 
purchased power costs under Code § 56-582(B)(i).  We focus our 
inquiry on the question whether in computing AP’s rate relief, 
the Commission properly interpreted language in a previous 
order that incorporated an agreement between AP and the 
Commission Staff (the Staff). 
I.  Historical Context 
In 1999, the General Assembly passed the Virginia Electric 
Utility Restructuring Act (the Act), former Code §§ 56-576 et 
seq., in order to deregulate the electricity market and create 
a new competitive market for the purchase and sale of 
electricity.1  The Act provided that during the transition to a 
competitive market, the Commission would establish capped rates 
for customers purchasing electricity from incumbent electric 
utilities,2 and that the capped rates would be effective from 
January 1, 2001 through July 1, 2007 (the capped rate period).  
Former Code § 56-582(A)(Supp. 1999). 
The Act also provided that the Commission would “direct 
the functional separation of generation, retail transmission 
and distribution of all incumbent electric utilities.”  Former 
Code § 56-590(B)(1)(Supp. 1999).  While the Commission was not 
permitted under the Act to require an incumbent electric 
utility to divest itself of generation or transmission assets 
in order to achieve “functional separation,” each incumbent 
utility was required to submit a plan for “functional 
separation of generation, transmission, and distribution” by 
January 2001.  Former Code § 56-590(B)(2)(Supp. 1999).  The Act 
permitted the Commission to impose conditions on its approval 
of any incumbent electric utility’s plan for functional 
separation, including a requirement that the incumbent electric 
                     
1 In 2007, the General Assembly passed legislation ending 
its initiative to create a competitive market in Virginia for 
electric generation supply.  2007 Acts chs. 888, 933.  
2 “ ‘Incumbent electric utility’ means each electric 
utility in the Commonwealth that, prior to July 1, 1999, 
supplied electric energy to retail customers located in an 
exclusive service territory established by the Commission.”  
Former Code § 56-576 (Supp. 1999). 
 
2
utility’s generating assets or their equivalent be made 
available for electric service during the capped rate period.  
Former Code § 56-590(B)(3)(Supp. 1999). 
In 2000, AP asked the Commission to approve AP’s plan to 
separate its generation facilities from its transmission and 
distribution facilities by transferring its generating 
facilities to an affiliate, Allegheny Energy Supply Company, 
LLC (GENCO).  The Commission approved AP’s requested generation 
divestiture plan by order (the divestiture order).  In re 
Potomac Edison Co., Case No. PUE-2000-00280 (July 11, 2000). 
In the divestiture order, the Commission adopted and 
incorporated a memorandum of understanding (MOU) that AP had 
reached with the Staff after “extensive negotiations.”  Id.  
The MOU contained certain representations that AP made to 
comply with the Act in order to ensure “that adequate and 
reliable service at just and reasonable rates will continue to 
be provided to Virginia retail customers” during the transition 
to a deregulated market.  Id. 
The divestiture order noted that AP’s “core pledge” in the 
MOU was AP’s commitment after divestiture of its generation 
assets to contract for generation sufficient to meet its 
default service3 demand, and that the pricing of such service 
                     
3 Default service means “service made available . . . to 
retail customers who (i) do not affirmatively select a 
 
3
would be based on a frozen unbundled generation rate during the 
capped rate period.  Id.  The MOU also contained the following 
relevant representations in its Paragraph 4: 
For ratemaking purposes, including any request to increase 
frozen rates due to financial distress, Virginia default 
service load will first be deemed to be served from a 
finite portion of the GENCO’s generation facilities, in an 
amount up to 367 MW, which equals the Virginia load now 
reflected in the allocation in AP’s generation costs to 
Virginia retail customers.  During the rate cap period, 
pricing of the 367 MW will be based on the Virginia 
unbundled frozen generation rate.  After the rate cap 
period, pricing of the 367 MW will be based on the then 
current generation costs of the portion of the existing 
system dedicated to serve retail Virginia load.  (Emphasis 
added.) 
 
Shortly after the Commission entered the divestiture 
order, AP entered into a contract with GENCO to purchase the 
power AP needed to meet all its default service obligations in 
Virginia during the capped rate period.  AP’s contract with 
GENCO stated an expiration date of June 30, 2007, the day 
before the end of the capped rate period. 
In 2004, however, the General Assembly amended Code § 56-
582, extending the capped rate period from 2007 until 2010.4  
2004 Acts ch. 827.  When AP’s contract with GENCO expired, AP 
                                                                 
supplier, (ii) are unable to obtain service from an alternative 
supplier, or (iii) have contracted with an alternative supplier 
who fails to perform.”  Former Code § 56-585(A)(Supp. 1999). 
4 In 2007, the General Assembly amended Code § 56-582(F) 
again to end the capped rate period in December 2008.  2007 
Acts chs. 888, 933. 
 
4
began meeting its default service obligations by procuring 
power from the competitive wholesale market. 
In addition to extending the capped rate period, the 2004 
amendments to Code § 56-582(B)(i) permitted a utility that had 
divested its generation facilities to seek adjustments to 
capped rates in connection with the utility’s “purchased power 
costs.”5  2004 Acts ch. 827.  According to this provision, 
however, an adjustment to capped rates would be subject to the 
terms and conditions of any Commission order approving the 
divestiture of generation assets.  Code § 56-582(B)(i). 
In April 2007, AP filed an application with the Commission 
to adjust capped rates, arguing that the Commission was 
required by the 2004 amendments to Code § 56-582 to allow AP to 
recover all its purchased power costs beginning July 1, 2007.  
The Commission determined that it was not mandated, as a matter 
of law, to adjust capped rates and was not required at that 
time to act in its legislative capacity because AP had not 
requested that the Commission so act to adjust rates.  This 
Court affirmed the Commission’s decision in an unpublished 
order.  Potomac Edison Co. v. State Corp. Comm’n, Record No. 
071566 (April 11, 2008). 
                     
5 Code § 56-582 also permits the Commission to adjust 
capped rates during the capped rate period in connection with 
several other situations, including, in subsection (iii) any 
financial distress of the utility beyond its control. 
 
5
II.  Facts & Proceedings 
In September 2007, AP filed an application with the 
Commission requesting a rate adjustment to permit recovery of a 
portion of its projected purchased power costs as permitted by 
Code § 56-582(B)(i).  In the application, AP requested a rate 
increase of about 26% beginning in October 2007, to recover a 
portion of the purchased power expenses that AP would incur to 
serve its Virginia default customers as of July 1, 2007.  AP 
stated that this rate increase would permit the company to 
recover $44.9 million,6 which represented the wholesale costs 
for purchasing power for the “load above 367” megawatts (MW) as 
referenced in Paragraph 4 of the MOU. 
In response to AP’s application, the Commission issued an 
order providing for notice and a hearing.  Comments were filed 
by the Division of Consumer Counsel of the Office of the 
Attorney General (Consumer Counsel) and by 18 local businesses 
affiliated with the Frederick County Industrial Development 
Authority. 
The evidence presented to the Commission by AP and the 
Staff included opposing interpretations of the language in 
Paragraph 4 of the MOU relating to the phrase “up to 367 MW.”  
AP presented testimony and exhibits to the Commission 
                     
6 In its application, AP originally sought to recover $44.9 
million but ultimately modified that requested amount to $37.2 
million. 
 
6
supporting its requested amount of purchased power costs for 
the “load above 367 MW.”  AP’s evidence showed that prior to 
divestiture, its generation facilities allocated to Virginia 
produced generation output at a capacity of only about 66%, 
because the units were subject to weather-related outages, 
scheduled and unscheduled maintenance requirements, and other 
disruptions.  In addition, AP presented evidence that in 2006, 
these same generation facilities were generating power at about 
the same 66% capacity.  AP maintained that based on this 
operational capacity, if AP had continued to own the divested 
generation facilities, AP would have been required to purchase 
wholesale power to serve Virginia customers at loads above an 
average of about 242 MW, or 66% of the 367 MW referenced in the 
MOU. 
The Staff filed comments with the Commission stating that 
AP’s calculation, assuming a 66% capacity factor, would allow 
AP to recover purchased power costs for the load above 242 MW.  
Thomas E. Lamm, a member of the Staff, testified that the Staff 
concluded that the language in the MOU referring to 367 MW “has 
nothing to do with the actual operations of any unit or set of 
units.”  Lamm stated that the reference to 367 MW in the MOU is 
“a negotiated ratemaking construct and refers to the level of 
default service load or generation output serving such load.” 
 
7
Lamm further testified that the MOU did not identify 
specific units from which the generation service must be 
provided and did not suggest any factor for operational 
performance reduction.  A portion of Lamm’s testimony was 
corroborated by the testimony of Mark A. Mader, Director of 
Rates for Allegheny Energy Service Corp., who agreed that the 
MOU did not obligate AP to contract with GENCO to meet AP’s 
default service requirements. 
Lamm also testified that in 2000, the demand from AP’s 
Virginia customers exceeded 367 MW and that the “embedded 
generation costs included in the rates charged to retail 
customers were much greater than the capacity and energy costs 
associated solely with the 367 megawatts.”  The Staff 
recommended to the Commission that if AP were permitted to 
recover purchased power costs for the load above 367 MW, 
without an adjustment in favor of AP due to the 66% capacity 
factor, AP could recover about $9.48 million, which represented 
an average rate increase of about 5.6%. 
In its final order, the Commission first determined that 
the 2004 amendments to Code § 56-582(B) authorized AP to seek 
recovery in accordance with the MOU of increased purchased 
power costs on and after July 1, 2007.  AP does not challenge 
this ruling on appeal. 
 
8
The Commission also determined in its final order the 
amount of purchased power costs that AP was permitted to 
recover under Paragraph 4 of the MOU.  The Commission concluded 
that the Staff’s calculations correctly implemented the 
ratemaking requirements in the MOU, which established a pricing 
mechanism for load above 367 MW, not for load incorporating an 
adjustment for a capacity factor.  The Commission granted AP a 
rate increase that resulted in AP’s recovery of about $9.48 
million in purchased power costs. 
AP filed an appeal from the Commission’s decision with 
this Court under Rule 5:21(c).  AP named as appellees the 
Commission, Consumer Counsel, and the Frederick County 
Industrial Development Authority.7 
III.  Analysis 
AP asserts that the retail rate set by the Commission was 
inconsistent with the language contained in the MOU and 
prevented AP from recovering all its purchased power costs that 
exceeded the load stated in the MOU.  AP argues that the 
Commission’s decision constitutes a mistake of law because it 
is inconsistent with the provisions in Code § 56-590(B)(3)(i) 
that refer to “generation assets or . . . their equivalent.”  
                     
7 The Frederick County Industrial Development Authority did 
not file a brief in this appeal. 
 
9
According to AP, this statutory language refers to specific 
generation facilities and their capabilities. 
AP also contends that the Commission’s decision is 
contrary to the purpose of the MOU, which was designed to treat 
AP as if it had not divested its generation assets in 2000.  AP 
argues that before the divestiture, AP’s generation facilities 
produced an average of 66% of 367 MW and that, therefore, AP 
should have been permitted to recover the costs AP incurred to 
purchase power above the amount of 242 MW that would have been 
generated. 
AP further argues that the MOU refers to the specific 
generation facilities AP owned before the divestiture, and that 
the term “367 MW” reflects the amount of total power generated 
by the divested facilities that was allocated to Virginia 
default service customers.  AP also maintains that the phrase 
“up to 367 MW” in the MOU reflects the fact that the divested 
facilities do not produce a constant output of 367 MW. 
In response, the Commission and Consumer Counsel 
(collectively, Consumer Counsel) contend that the evidence 
supports the Commission’s decision, which was rendered within 
the scope of the Commission’s expertise.  According to Consumer 
Counsel, the capped rates established in 2000 included AP’s 
costs to provide its default customers with all the electrical 
generation they demanded, up to and in excess of 367 MW.  
 
10
Consumer Counsel contends that the MOU ensured that at least 
367 MW of the total load provided by AP to its default 
customers would continue at cost-based rates after the capped 
rate period expired. 
Consumer Counsel also asserts that the MOU does not 
contain any language suggesting an adjustment for actual 
generating unit output.  Consumer Counsel argues that the term 
“367 MW” in the MOU refers to “load,” which is the demand for 
electricity, and does not refer to “supply,” which is the 
amount of generated electricity.  Finally, Consumer Counsel 
contends that the language “up to 367 MW” recognizes the fact 
that AP’s default service load would be reduced if its 
customers chose to receive service from one of AP’s 
competitors. 
In considering the parties’ arguments, we initially 
observe that the Constitution of Virginia gives the Commission 
broad powers in the control and regulation of public service 
corporations, and charges the Commission with administrative, 
judicial, and legislative functions.  See Va. Const. art. IX; 
Northern Virginia Elec. Coop. v. VEPCO, 265 Va. 363, 368, 576 
S.E.2d 741, 743 (2003); Board of Supervisors v. Appalachian 
Power Co., 216 Va. 93, 105, 215 S.E.2d 918, 927 (1975).  In 
recognition of these constitutional duties, we have held that 
the Commission is an expert tribunal established by law and 
 
11
informed by experience.  Northern Virginia Elec. Coop., 265 Va. 
at 368, 576 S.E.2d at 743; Lawyers Title Ins. Corp. v. Norwest 
Corp., 254 Va. 388, 390-91, 493 S.E.2d 114, 115 (1997); Swiss 
Re Life Co. Am. v. Gross, 253 Va. 139, 144, 479 S.E.2d 857, 860 
(1997). 
When we review a Commission decision in which the 
Commission has applied its expertise, we begin by according the 
decision a presumption of correctness.  Northern Virginia Elec. 
Coop., 265 Va. at 368, 576 S.E.2d at 743; Farmers & Merchants 
National Bank v. Commonwealth, 213 Va. 401, 404, 192 S.E.2d 
744, 747 (1972); see Tanner v. State Corp. Comm’n, 265 Va. 148, 
152, 574 S.E.2d 525, 527 (2003); Gross, 253 Va. at 144, 479 
S.E.2d at 860; Lawyers Title Ins. Corp., 254 Va. at 390, 493 
S.E.2d at 115.  Depending on the nature of the particular 
Commission decision, however, our standard of review will vary. 
When a Commission decision is based on the application of 
principles of law, we will affirm the decision if the 
Commission has correctly applied the controlling legal 
principles.  See Northern Virginia Elec. Coop., 265 Va. at 368, 
576 S.E.2d at 743-44; Tanner, 265 Va. at 152, 574 S.E.2d at 
527; Gross, 253 Va. at 144, 479 S.E.2d at 860; Lawyers Title 
Ins. Corp., 254 Va. at 390-91, 493 S.E.2d at 115.  However, we 
are required to reverse a Commission decision if it is based on 
a mistake of law.  Northern Virginia Elec. Coop., 265 Va. at 
 
12
368, 576 S.E.2d at 743-44; Tanner, 265 Va. at 152, 574 S.E.2d 
at 527; First Virginia Bank v. Commonwealth, 213 Va. 349, 351, 
193 S.E.2d 4, 5 (1972). 
In fixing utility rates under the powers delegated by the 
General Assembly, the Commission exercises a legislative 
function.  Hopewell Cogeneration Ltd. P’ship v. State Corp. 
Comm’n, 249 Va. 107, 115, 453 S.E.2d 277, 281-82 (1995); 
Commonwealth v. Potomac Edison Co., 233 Va. 165, 170-71, 353 
S.E.2d 785, 788 (1987); Old Dominion Power Co., Inc. v. State 
Corp. Comm’n, 228 Va. 528, 532, 323 S.E.2d 123, 125 (1984); 
Central Tel. Co. v. State Corp. Comm’n, 219 Va. 863, 874, 252 
S.E.2d 575, 581 (1979); see Va. Const. art. IX, § 2.  When the 
Commission has acted in this legislative capacity and has not 
based its decision on the resolution of an issue of law, we 
will set aside the Commission’s decision only if the Commission 
clearly has abused its legislative discretion.  Potomac Edison 
Co., 233 Va. at 171, 353 S.E.2d at 788-89; Old Dominion Power 
Co., Inc., 228 Va. at 532, 323 S.E.2d at 125; Central Tel. Co., 
219 Va. at 874, 252 S.E.2d at 581-82. 
Based on these distinctions, we first must decide whether 
the decision before us was based on the application of legal 
principles or on purely an exercise of the Commission’s 
legislative authority.  In making this determination, we 
 
13
consider AP’s application, the language of the MOU, and the 
substance of the Commission’s decision. 
In its application, AP requested that the Commission 
exercise its authority “to adjust [AP’s] capped rates, to 
approve this Application, and to permit purchased power 
recovery at $0.01450 per kWh.”  This request for relief 
illustrates that AP was asking the Commission to exercise its 
ratemaking authority, a legislative function delegated to the 
Commission by the General Assembly.  See Hopewell Cogeneration 
Ltd. P’ship, 249 Va. at 115, 453 S.E.2d at 281-82; Potomac 
Edison Co., 233 Va. at 170-71, 353 S.E.2d at 788; Old Dominion 
Power Co., Inc., 228 Va. at 532, 323 S.E.2d at 125. 
The language of Paragraph 4 of the MOU stated that the 
MOU’s terms were applicable “[f]or ratemaking purposes.”  
Viewed in this context, the Commission’s interpretation of 
Paragraph 4, in effect, determined the allowable rate 
adjustment under the divestiture order for amounts exceeding 
367 MW. 
The fact that the Commission was required to interpret the 
language of the MOU did not transform the issue before the 
Commission from a legislative matter to a question of law.  The 
disputed language in the MOU was not subject to resolution 
under contract principles, but was part of the divestiture 
order to be interpreted by the Commission within its capacity 
 
14
as an expert tribunal.  Moreover, the terms of the MOU provided 
the actual framework for the Commission’s adjustment of the 
capped rates, and the Commission was not required to resolve 
any disputed statutory language or other issue of law in making 
this rate adjustment.  Based on these considerations, we hold 
that the Commission’s decision was purely an exercise of its 
legislative ratemaking authority and was not based on any 
disputed issue of law.8 
Because the Commission exercised its legislative authority 
in the present case, its decision is subject to our review 
under an abuse of discretion standard.  See Potomac Edison Co., 
233 Va. at 171, 353 S.E.2d at 788-89; Old Dominion Power Co., 
Inc., 228 Va. at 532, 323 S.E.2d at 125; Central Tel. Co., 219 
Va. at 874, 252 S.E.2d at 581-82.  We hold that the present 
record, as set forth above, provides ample support for the 
conclusion that the Commission did not abuse its discretion. 
Included in this record is Thomas Lamm’s testimony that 
the reference in the MOU to 367 MW was unrelated to the actual 
operation of any equipment or generation unit, but was a 
                     
8 AP argues, nevertheless, that the Commission’s decision 
is inconsistent with Code § 56-590(B)(3)(i), which provides for 
conditions that the Commission is authorized to impose as part 
of its approval of a divestiture order.  We do not consider 
this argument, however, because AP’s assignments of error do 
not address this issue, but instead challenge whether the rate 
set by the Commission was contrary to the terms of the MOU and 
was based on an improper “methodology.”  See Rule 5:21(i). 
 
15
“negotiated ratemaking construct” addressing the “level of 
default service load or generation output serving such load.”  
In addition, and of particular note, the Commission’s decision 
is supported by the absence of any language in the MOU stating 
that the 367 MW should be reduced by a capacity factor.  Thus, 
we hold that the Commission did not abuse its legislative 
ratemaking authority in determining that the MOU established a 
pricing mechanism for load above 367 MW, not load incorporating 
an adjustment for a capacity factor, and that, therefore, AP 
should be permitted to recover about $9.48 million in purchased 
power costs. 
 
We also find no merit in AP’s second assignment of error 
that the Commission improperly relied on the Staff’s 
methodology in determining AP’s requested rate.  The 
Commission’s apparent acceptance of Lamm’s calculations 
contained in Exhibit 14, which was submitted after the hearing, 
was a matter clearly within the Commission’s discretion.  
Additionally, AP’s failure to challenge these calculations, 
apart from criticizing the Staff’s failure to account for the 
operational capacity factor of 367 MW, shows that AP was merely 
restating the same argument regarding a capacity factor that 
the Commission rejected in its interpretation of the MOU. 
Finally, we do not consider the merits of AP’s alternative 
argument that the Commission failed to set a just and 
 
16
 
17
reasonable rate, and that the Commission should have inquired 
into AP’s financial condition before setting the retail rate in 
this case.  AP has not assigned error to the “reasonableness” 
of the adjusted rate fixed by the Commission, and AP did not 
ask the Commission to consider its financial condition as a 
component of its ratemaking decision. 
For these reasons, we will affirm the Commission’s order. 
Affirmed.