Case Name: The Peoples Natural Gas Company, Appellant, v. The Pennsylvania Public Utility Commission
Court: Superior Court of Pennsylvania
Jurisdiction: Pennsylvania
Decision Date: 1943-11-10
Citations: 153 Pa. Super. 475
Docket Number: Appeal, No. 214
Parties: The Peoples Natural Gas Company, Appellant, v. The Pennsylvania Public Utility Commission.
Judges: Before Keller, P. J., Stadtfeld, Rhodes, Hirt, Kenworthey and Reno, JJ. (Baldrige, J., absent).
Reporter: Pennsylvania Superior Court Reports
Volume: 153
Pages: 475–520

Head Matter:
The Peoples Natural Gas Company, Appellant, v. The Pennsylvania Public Utility Commission.
Argued April 29, 1943.
Before Keller, P. J., Stadtfeld, Rhodes, Hirt, Kenworthey and Reno, JJ. (Baldrige, J., absent).
Wm. A. Dougherty, with him C. W. Cooper, James B. Sayers, G. Kirby Herrington, William R. Scott and James L. White, for appellant.
Samuel Graff Miller, with him Harry M. Showalter, for appellee, Public Utility Commission.
Anne X. Alpern, City Solicitor, with her John Bentley, First Assistant City Solicitor, for City of Pittsburgh, intervenor.
Nathaniel K. Beck, Assistant County Solicitor, with him Walter P. Smart, County Solicitor, for Allegheny County, intervenor.
Richard H. Gilbert, for Borough of Tyrone, intervenor.
November 10, 1943:

Opinion:
Opinion by
Kenworthey, J.,
This appeal by the Peoples Natural Gas Company is from a final order of the Public Utility Commission declaring unreasonable and excessive the rates of appellant, directing substantial refunds for the years 1939 to 1941, inclusive, and ordering the filing of new tariff schedules which would reduce the revenues from domestic and commercial consumers and produce revenues from these classes of consumers not to exceed $6,108,143. In addition to necessary operating expenses it allowed a return of six and a half per cent (6%%) on a rate base of $21,566,085. The commission found the fair value of appellant's property, used and useful in rendering the service, as of the date of the order nisi (March 4, 1942), was $20,000,000 to which it allowed an addition of $1,566,085 for working capital.
The early history of the proceedings is set forth at length in our opinion on the previous appeal reported at 141 Pa. Superior Ct. 5, 14 A. (2d) 133, and will not be repeated here.
Pursuant to our order remanding the case, further hearings were held in September and November 1940, and the record was closed on November 15, 1940. On. March 4, 1942, the commission filed its order nisi; the final order was filed December 7, 1942.
The appeal raises a number of questions. We shall consider them and the facts material to each question under separate headings.
The Rate Base
Physical Property
The' commission found "that the reproduction cost of respondent's property at December 31, 1938, without deduction for accrued depreciation, was $72,236,739." It also found "that the original cost of all of its property in use at December 31, 1938, was $47,732,478." Based upon the estimates of the commission's expert, it found an over-all depreciation of forty-five per cent (45%) which, when applied to the reproduction cost reduced it to $39,730,207, and when applied to the original cost, to $26,252,863. In discussing present fair value, the commission also mentioned two other figures: (a) $9,869,793 which it called 'Book Value,' and (b) $12,-744,126 which it spoke of as 'Invested Capital' or the number of dollars which the owners invested in the corporation. The commission found: "After having considered each of the elements specifically mentioned in this section of our order, and having weighed carefully all other facts of record which might be considered relevant thereto, we find and determine that the fair value rate base of respondent as a going concern, exclusive of working capital, is $20,000,000 as of the date of this order."
It is to be noted that the commission's finding of fair value is little more than half the amount it found it would cost to reproduce the property, less depreciation. It was less than it found was the original cost, less depreciation. And the original cost figure used by the commission gave no consideration whatever to the uncontradicted evidence that, if the actual cost had been adjusted to reflect the price levels of December 31, 1938, it would have been approximately the same as reproduction cost.
It has been said that "to avoid danger of reversal, commissions [are] often at pains to camouflage the real basis of valuation by giving lip-service to 'considering' and 'giving due weight' to all factors mentioned in Smyth v. Ames." It is obvious that the commission here has adopted a rate base directly related to (though less than) depreciated original cost and has completely ignored its own finding that the cost of reproduction, less depreciation, was nearly $40,000,000.
It is important in a proceeding of this kind to bear in mind what is to be the rate base. If it is prudent investment, original cost or original cost less the depreciation reserve are necessary and perhaps controlling considerations. But prudent investment and fair value are wholly different things. The conception of Mr. Justice Brandéis, expressed in his dissent in the South western Bell Telephone case, which is a landmark in the controversy still waging over the merits of prudent investment versus fair value, was not that original cost was value but that prudent investment was a rate base more desirable than value.
Although the opportunity to debate the respective merits of these wholly different theories of rate fixing offers an alluring challenge, an extended discussion would serve no useful purpose here. For the legislative mandate in this commonwealth is that the rate base is fair value (Solar Electric Co. v. P. U. C., 137 Pa. Superior Ct. 325, 335, 336, 9 A. (2d) 447), except that for the determination of temporary rates under Section 310, original cost less accrued depreciation may be used. The doctrine, irrespective of its merits, entrenched in our law until the legislature changes it, requires the commission to determine what the present fair value of the property really is and does not permit it to adopt the recommendation of the economists who argue that the commission's function should be one of choosing a proper rate base — of deciding how much the property should be permitted to be worth rather than of discovering how much it actually is worth.
What is competent evidence — what are the elements— of present fair value?
There has been much confusion, stemming, perhaps, from the somewhat vague and inconclusive dictum of Mr. Justice Harlan in Smyth v. Ames. The repeated lip-service which commissions and courts have given this formula has obscured rather than clarified the rate-base-finding process. For by 1926, the Supreme Court of the United States had virtually committed itself to reproduction cost at current prices as, in effect, the dominant basis of value under ordinary circumstances and reasonably stable prices. As late as 1939, this court pointed out that in an unbroken line of decisions of our Supreme Court and this court, "the cost of reproducing the property has consistently been held to be not only a relevant but also an essential element in the ascertainment of its 'fair value' for rate-making purposes." This is particularly true where, as here, according to the uncontradicted evidence there was little or no obsolescence and the property, if replaced, would be almost identically reproduced. See Ben Avon Boro v. Ohio Valley Water Co., 260 Pa. 289, 309, 103 A. 744.
This does not mean that in every case depreciated reproduction cost is, under our decisions, identical with present value. We have said it is not. See Bangor Water Co. v. P. S. C., 82 Pa. Superior Ct. 48, 55; City of Philadelphia v. P. S. C., 84 Pa. Superior Ct. 135, 150. In determining what is, from the facts of a particular case, the best evidence of present value, the commission and this court is under a duty to exercise an intelligent and discriminating judgment. But since the test is one of reason, the weight to which a par ticular element is entitled in a given situation will vary.
A brief discussion of tbe other so-called 'elements' which the commission said it 'considered' will demonstrate why they must assume a subordinate position— and some of them be entirely disregarded — in a proper determination of present fair value under the circumstances of this ease.
Original cost has been approved as a rate base where (1) there has been no great change in cost levels and (2) there has been a change but proper adjustment is made based upon competent evidence of price trends. See Clark's Ferry Bridge Co. v. P. S. C., 108 Pa. Superior Ct. 49, 165 A. 261, aff'd 291 U. S. 227, 54 S. Ct. 427, and Scranton-Spring Brook Water Servive Co. v. P. S. C., 119 Pa. Superior Ct. 117, 181 A. 77. As stated by the Supreme Court of the United States in McCardle v. Indianapolis Water Co., supra (note 8), at 411: "Undoubtedly, the reasonable cost of a system of water works, well planned and efficient for the public service, is good evidence of its value at the time of construction. And such actual cost will continue fairly well to measure the amount to be attributed to the physical elements of the property so long as there is no change in the level of applicable prices." (Italics supplied. )
In the present case, appellant started business in 1885. A substantial part of the property — about forty per cent (40%) — was put in service prior to 1917. It offered evidence, which was uncontradicted, that if the original cost figures were trended to reflect current prices of labor and materials the total original cost would approximate its estimate of reproduction cost. That there have been great changes is shown by many publications, statistical reports and other documents readily available. The extent to which these changes have increased the present value of appellant's property was a fact within the commission's province to determine. But it was wrong in taking the position there had been no changes in the face of the common knowledge that there had.
'Book Value.' This figure — $9,869,793—was arrived at by taking the total value of the physical property shown on appellant's balance sheet for December 31, 1938 ($39,283,989), and deducting from it the total reserve for depreciation ($29,414,196.)
The method used in arriving at this figure is the formula advocated by most of the supporters of prudent investment. The theory, simply illustrated, is as follows : The utility starts business with a capitalization of $50,000, all of which is invested in the plant. At the end of ten years, it has accumulated, through annual charges to the consumers, a depreciation reserve of $25,000, all of which it has invested in additions to the plant, and has invested an additional $25,000 out of earnings. The original cost would then be $100,000, and the amount invested by the owners as distinguished from the consumers is determined by the formula: original cost less depreciation reserve.
The method has no place and is entitled to no consideration in the determination' of value. This depreciation reserve is nothing more than a bookkeeping figure. It is not represented by cash or investments in bonds and stocks. It represents the total of the sums which annually the managers of appellant thought should be set up on the books to replace property which would be retired in the future. And the only effect of this accounting procedure was to make the portion of appellant's earnings thus set aside unavailable for dividends or for additions to surplus. And the funds thus withheld from the stockholders have been reinvested in property used in serving the public. If throughout the period this reserve has been accumulated appellant has consistently earned and paid liberal dividends, it may be argued that the property bought with these funds was, in fact, paid for by the ratepayers, not the owners, and that the owners, therefore, ought not to have the earnings from it. But this ought-not argument can be disposed of by pointing out that, under the existing law, the only test is the present fair value of the property used and useful in rendering the service. That appellant owns the property and is using it in the service is unquestioned. And, so long as present fair value is the test, it makes no difference whether appellant bought it, received it as a gift, or won it in a lottery. See Bd. of Commissioners v. N. Y. Tel. Co., 271 U. S. 23, 32, 46 S. Ct. 363.
Moreover, it cannot be argued that the depreciation reserve should be deducted from the book cost of the property on the theory that it represents the actual depreciation of the property. This argument would run counter to the commission's specific finding that the actual depreciation was forty-five per cent (45%) whereas the deduction of $29,869,793 from the assumed cost of $39,283,989 would indicate a depreciation of over seventy-five per cent (75%).
'Invested Capital.' This figure — $12,744,126—is what the commission found represented appellant's capitalization.
Even the severest critics of the present value doctrine. concede that capitalization is ordinarily no evidence of value. The history of the capitalization of appellant in the present case clearly demonstrates that it has not in the past, nor does it in the present, bear any direct relationship to value.
For example although between 1935 and 1939 appellant was constantly growing and, in 1938, acquired by merger property having an original cost of $10,751,407, its capitalization was reduced, during the same period, from $25,571,524 to $15,095,346.
Apparently appellant, throughout its history, has always been able to pay substantial dividends and has built up its properties by plowing back earned surpluses. This is strong evidence that, at least during the early years of its life, its earnings, and perhaps its rates, were unreasonably high. But this is not a proceeding to determine the reasonableness of the rates of appellant between 1885 and 1913 when the legislature first undertook the comprehensive regulation of the rates of public utilities. Such an attempt would require the determination of innumerable factors which are absent from the present record and could not possibly be supplied. The suggestion that either the present stockholders — who may be entirely different from the stockholders during the earlier period, although the stock has been wholly owned by the Standard Oil Co. of N. J., because the latter stockholders have changed from time to time — should be penalized because of the unjust enrichment of their predecessors, or that the present consumers should benefit from the high rates paid by earlier consumers does not appeal to us. The vague feeling that there may have been a past wrong we would like to right does not, in our opinion, furnish an adequate basis for taking property from the present owners and giving it to someone else.
The fact that it may have earned excessive returns in the past has no bearing whatever on what, under present-day regulatory procedure, it is entitled to earn on the basis of the fair value of the property presently dedicated to public use. Bd. of Public Utility Commissioners v. N. Y. Tel. Co., supra.
So long as present fair value is the rate base and since depreciated cost of reproduction is the best evidence of it offered in the present ease, the findings of the commission (1) that the depreciated reproduction cost was nearly $40,000,000, and (2) that present fair value was $20,000,000 are inconsistent and irreconcilable. These findings are analogous to a verdict of a jury with special findings which are inconsistent. The case will be returned so that these findings may be reconciled. For, although it is this court's function, in cases in which it is contended there is confiscation, to determine the facts as well as the law (Ben Avon Boro v. Ohio Valley Water Co., 253 U. S. 287, 40 S. Ct. 527; Solar Electric Co. v. P. U. C., supra, at 354) we ordinarily prefer that proper findings be first made by the commission as an aid to us in performing that function. See Scranton Spring Brook Water Service Co. v. P. S. C., supra, at 122, 123.
This is not to say that on rehearing the commission is bound to find that present fair value approximates $40,000,000. In spite of its express finding that depreciated reproduction cost approximated that amount, it indicated in its discussion that the evidence offered by appellant that it would cost $72,236,739 to reproduce the property new should not have been given full weight. It perhaps would not have been incorporated into its finding if the commission had fully understood that the finding was bound, under the law, to play such an important part in the determination of the ultimate finding of fair value. The commission should be given an opportunity to reconsider the weight of this evidence and, if it so desires and is in a position to do so, to offer in evidence its own estimate of reproduction cost. See Solar Electric Co. v. P. U. C., supra, at 348, 349. Or, in view of what we have said, the commission may use original cost as a base provided it makes proper adjustments for increases in prices.
It is a fact of considerable importance that most of the decisions of our own appellate courts and, for that matter, of the Supreme Court of the United States, establishing the elements of fair value for rate-making purposes were rendered before our legislature adopted the Public Utility Law of 1937 and wrote 'fair value' into Section 311 (66 PS §1151) and that standard, minus a detailed list of the elements constituting fair value, was carried over from the Public Service Act of 1913. It is a settled rule of construction: "That when a court of last resort has construed the language used in the law, the Legislature in subsequent laws of the same subject matter [may be presumed to] intend the same construction to be placed upon such language." And it is important to bear in mind that, even though the Supreme Court of the United 'States as presently constituted, may, in the near future, overrule some of its former decisions and uphold as constitutional something other than fair value as a rate base, such change of position would not effect a change in the law of this commonwealth. Since the legislature put fair value into our law, together with what in 1937, when the law was passed, was universally understood to have been the elements of fair value, that body alone can take it out and substitute something else in its place. If and when the change comes — the concurring justices in Federal Power Com. v. Natural Gas Pipeline Co., 315 U. S. 575, 606, 62 S. Ct. 736, suggest that it has already taken place— it will simply mean that a constitutional limit on the power of the legislature to experiment or innovate will have been removed.
Depreciation
The finding that appellant's physical property had depreciated forty-five per cent (45%) was largely based upon the testimony of Farstadt, the commission's engineer. His contribution consisted of estimates of lives of the various types of plant classified according to accounts. For example, he estimated life of field measur ing station structures to be forty years, field line construction thirty-three years, drilling and cleaning equipment thirty years, etc. He based these estimates primarily upon studies which he made of treatises, and of tables furnished by the Interstate Commerce Commission and the U. S. Bureau of Internal Revenue. Although he said that they were also based "upon my general familiarity, with conditions in the particular territory involved," he clearly indicated elsewhere he had made no attempt to base them on the observed condition of appellant's plant. He admitted that he made no investigation of appellant's experience with the retirement of various types of its property. Although the quality of maintenance of property is a vital factor in determining its life, he apparently made no special effort to consider it. He gave meters an estimated life of forty years. Although he said the depreciable portion of meters would not be more than twenty-five per cent (25%) to thirty per cent (30%) he had no knowledge when, how often and how recently these depreciable parts had been replaced "and had they been [recently] replaced, the meters would be in as good a condition as new, for all practical purposes." Almost every type of machinery or equipment might have its age constantly reduced as well as its life indefinitely extended by the replacement of wearing parts. A pipe line built in 1900 might, in the year 1940, through periodic replacements of sections of it, have an average or over-all age .of ten years. Although Farstadt estimated the life of compressing station equipment at thirty-three years, he testified that one of appellant's stations (Brave) had been in operation for more than thirty-three years and "this plant is in good operating condition."
The difficulty with any theoretical method of estimating lives is perhaps apparent from the foregoing discussion of Farstadt's testimony. Even though the tables be the best available, they are open to the same objections which have induced our Supreme Court to restrict the admission of human mortality tables in negligence cases.
But even if the commission's method of arriving at the estimated lives of the various classes of property were acceptable, there are other difficulties presented by the method in which it estimated the average existing ages of the property. The • commission claims to have made these estimates from the company's own records. If the company had kept adequate property records indicating exactly when various types of property were dedicated to the public use and the various additions and retirements these records would undoubtedly have served the purpose. But the records merely showed, by accounts, the year-by-year expenditure of dollars for the various classes of property. The difficulty with attempting to determine the average age of a particular class of property such as meters from the records showing the years in which a given number of dollars were expended for installing them is that it assumes, to have any validity, that the price of the meters installed remained constant throughout. If, as was the case here, the prices were constantly undergoing change, the number of meters or other kinds of property installed in a particular year could not be determined from the number of dollars invested.
Except for the mortality of plant caused by Are, floods and other accidents, which should not be considered in determining present value (a brand-new compressor is still brand-new although it may be destroyed by an explosion tomorrow), there are but two factors which determine mortality, (1) physical deterioration and (2) obsolescence. In determining these factors, it seems that there never can be an adequate substitute for actual observation of the condition of the property coupled with a study of its state of obsolescence. We have said so — see Clark's Ferry Bridge Co. v. P. S. C., supra, at 74, 75 — although we have also said that theoretical age-life estimates are entitled to consideration. [Appellant's engineer made what from his testimony seemed to be adequate studies of the physical condition of the property. He estimated the over-all depreciation at 26.02%. The commission was not bound to accept his figure. But, on the basis of the present record, it was the commission's duty to give some weight to it and, in wholly disregarding it and accepting the theoretical estimates of the commission's witness, its action was arbitrary. It should not have closed its eyes to the present condition of the property and computed depreciation on the basis of mere formulas alonej
Exclusion of Expensed Items
In determining the rate base, the commission excluded $7,558,226 (the actual mechanics were that it found depreciated original cost, $26,252,863, and then deducted an additional $4,157,024 which represented $7,558,226 depreciated by forty-five per cent (45%). On the basis of the present record, it is conclusively settled that the deducted sum represented capital investment because the commission included it in its finding that the original cost of the property was $47,732,478. Under the system of accounting in use prior to 1920 (and apparently authorized), the items representing this investment which consisted principally of cost of drilling wells, pipe lines, etc., were treated as expenses. The position which the commission took in the order nisi was that appellant had been reimbursed in full for these expenditures and was, therefore, not entitled to have them considered as an element of the rate base "to be paid for again by the consumers." In its final order, it said: "If the past records were truthful and are now relied upon, no one is hurt by such reliance; if the records were false, and such falsification resulted in over-charge to another party, the story they tell cannot now be altered so that the injured party must repeat payment of the over-charge."
The books of the company are, of course, not conclusive. This is well settled. Solar Electric Co. v. P. U. C., supra, at 351, 352; Missouri ex rel. Southwestern Bell Telephone Co. v. P. S. C., supra, note at 295. The real merit in the argument, if there is any, must rest on an equitable basis. If throughout the period these capital investments were treated as expenses the company was nevertheless able to earn a fair net return on the value of the property dedicated to the public use it would be some evidence, at least, that the rates, during that period, were too high. We have already indicated the reasons why this argument is without merit so long as present fair value is the base.
The identical question is discussed by Judge Parker. in Hope Natural Gas Co. v. Federal Power Commission, supra, Note 2. His conclusion is aptly expressed at page 303: "If the property were being condemned, no one would suggest that items which went into the cost of producing it should not be considered as a part of its cost, whatever method of accounting it had employed. If it were being sold on the basis of cost, no court would exclude such items from consideration. And there is as little ground for excluding them from consideration in a proceeding like this, where value is being determined as a basis for rates which must compensate the company for the gradual sale of its property through use as well as provide a return upon its investment. Certainly if the company had charged to capital investment items which should have been charged to expense, there would be no excuse for not eliminating them in the valuation of the property; and there is as litttle excuse for not considering as capital investment items erroneously charged to expense. Bookkeeping which does not reflect realities must not be allowed to obscure the real nature of the inquiry."
Working Capital
The allowance for working capital of $1,566,085 was probably a little low under the evidence although we are not persuaded that it was erroneous.
Rate of Return
The six and one-half per cent (6%%) allowed by the commission was not unreasonably low. As we pointed out in the Solar Electric case, in which we sustained a rate of return of six per cent (6%), the factors involved in the exercise of judgment as to what constitutes a fair rate of return are so varied and complex that each case must necessarily stand on its own feet and no arbitrary yardstick is possible.
The Supreme Court of the United States said in Bluefield Water Works v. Public Service Commission, 262 U. S. 679, 693, 43 S. Ct. 675: "A rate of return may be reasonable at one time and become too high or too low by changes affecting opportunities for investment, the money market and business conditions generally." And in United Railways and Electric Co. v. West, 280 U. S. 234, 249, 50 S. Ct. 123, the same court said: "What is a fair return within this principle cannot be settled by invoking decisions of this court made years ago based upon conditions radically different from those which prevail today. The problem is one to be tested primarily by present-day conditions."
Appellant offered the evidence of a financial expert who undertook to demonstrate, by the use of statistical data, that a fair and reasonable return should be not less than seven and eight tenths per cent (7.8%). But what we said in the Solar Electric case (pp. 387, 388) about similar evidence and the numerous considerations in determining a fair rate is equally applicable here. In our opinion the rate was not confiscatory.
Annual Expenses
Depreciation Allowance
The commission allowed $600,000; appellant's wit ness, Rhodes, contended the allowance should have been $1,300,000. Recognizing the fundamental principle that the annual depreciation allowance must be correlated with accrued depreciation, the commission criticized the witness for inconsistency in not more intimately tying the two things together. It pointed out that if the observed depreciation contended for by the witness was only 26.02%, the annual allowance asked for was too high. A possible valid explanation of the discrepancy might be found in the claim of appellant that it was entitled to some consideration for the depletion of oil wells and leases not reflected in the observed depreciation of appellant's physical plant. And the criticism of Rhodes' inconsistency is equally applicable to the commission because it did not allow as much as required by a direct tie-up with the finding the plant was forty-five per cent (45%) depreciated. But apart from this, what the commission actually did in computing the allowance, as distinguished from the discussion, is the thing of importance.
What the commission did was this: It took appellant's retirement experience for the period between 1921 and 1937 and computed the average annual capital loss due to retirements at 1.035%. It then applied this percentage to what it found to be the undepreciated original cost ($38,865,972 — $47,732,478 less 'expensed' items) which produced a figure of $402,263. It then said: "After consideration of all of the evidence of record, we are of the opinion that $600,000 constitutes an adequate allowance for annual depreciation."
Appellant complains that the commission made no allowance for the depletion of wells and leases and the cost of abandonments. It is true that no specific allowance was made for either of these items and they were not reflected in the table of retirements experience which the commission used in its computation. But the commission made an allowance of $200,000 over and above what it calculated to be the average annual capital loss due to retirements and, since there are no other specific items which appellant contends were omitted from the calculation, it seems fair to assume the commission gave them some consideration. The real question is whether it gave them enough. Appellant's evidence indicated the allowance for depletion of wells and leases should have been in the neighborhood of $400,000 a year and that the additional allowance for cost of abandonments should have been about $75,000 per year. But this evidence was not binding on the commission nor on this court and the record indicates the commission made a substantial allowance for these two items. It would have perhaps been a little better if it had discussed these claims specifically and indicated why it was making an allowance of only $200,000 when appellant's uncontradieted evidence indicated it should have been in the neighborhood of $475,000. But we find no reversible error.
Cost of Gas Purchased from Independent Producers
Apparently a substantial part of appellant's gas supply is purchased from a large number of independent Pennsylvania producers. Contracts were made with them in the 1920's that called for a price of approximately 22# per thousand cubic feet. Because of the tremendous reduction in appellant's sales caused by the depression, in 1933 appellant went to all these producers and got most of them, but not all, to agree to an amendment, under the terms of which the price was to be reduced to 18#, with the proviso that, in the event its rates should be increased, there would be an increase in the price equivalent to 30% of the increase in the average rate for gas sold to domestic consumers.
The new rates which are challenged by this proceeding went into effect on July 1, 1940, and using the formula in the contracts above referred to, the price to the independent producers was increased to 21.6#. The commission disallowed the increase and figured operating expenses for the last half of 1940, for the years 1941 and 1942, and for the future at the 18^ rate.
We do not understand that the commission challenged the bona fides of the contracts made with the independent producers nor their reasonableness nor their validity. It seems clear that since the commission disallowed the increase in appellant's rates it concluded that under the terms of the contraéis with the producers appellant was not obliged to pay the higher price for the gas.
In the event some portion of the increase in rates is ultimately allowed, the commission will undoubtedly allow the correlated increase in the price which appellant is required, under the terms of the contracts, to pay for the gas it purchases. To an extent, at least, therefore, appellant's objection to this part of the order may be automatically taken care of.
If the full increase in rates is not allowed, appellant would not be required to pay 21.6^ for its gas but some lesser sum which would be related to the increase in rates allowed. In that event the fact that appellant has already paid the higher price for the two and a half years involved may present a difficulty. But if there is a difficulty, it is of the appellant's own making. It was bound to know that an increase in its rates might be challenged and that they would not become final until and unless approved by the commission. It seems that it could and should have taken some precaution to protect itself against the ultimate disallowance of the increase. If the producers have been overpaid, appellant may have a right to recover back or to establish a credit to the extent of the over-payments. It probably would have been safer to have deposited the sums representing the increase in prices in escrow or to have withheld the payments until the question of its liability for them was ultimately established.
When the commission ultimately determines the amount of appellant's rates it need not concern itself about the predicament in which appellant has voluntarily placed itself.
Appellant presents a subsidiary argument in this connection based on the fact that the commission, in calculating the purchase price of the gas, used a flat 18# rate prior to July 1, 1940, and a flat 21.6^ rate thereafter. It points out that because not all of the independent producers agreed in 1933 to reduce the rate to 18# the average price paid on all contracts prior to July 1, 1940, exceeded 18‡, and since that date the average price has exceeded 21.6^. The error in this method of computation seems to be clear and, although it does not involve a lot of money, it should be corrected on the return of the case to the commission.
Rate Case Expense
Appellant made the following expenditures for making the studies and procuring the data required by the commission in this proceeding:
1937 . $150,648.50
1938 . 340,873.58
1939 . 354,186.85
1940 . 25,361.00
1941 . 7,782.00
The commission allowed these as proper expenses and, at the suggestion of appellant, agreed that they should be amortized over a five-year period at the rate of $169,806 per year.
Appellant contends the method of amortization works a hardship because it is compelled to absorb the yearly proportion of the expenses in two years (1937 and 1938) in which its rates were not too high; that the only method by which it can be wholly reimbursed for this expense is to collect it from the consumers during the years in which its rates were found to be excessive by having it allowed during those years as a proper expense.
Logically, this argument seems unanswerable; in fact, the commission does not attempt to meet it. Under the commission's order appellant simply cannot recover $339,612 (2 x $169,806) of the expenses to which it was put by the inquiry into its rates.
But our decisions indicate there is no hard and fast rule which requires the commission to allow the entire rate case expense. In the Solar Electric case where the utility was defending its existing rates against attack, we held it was entitled to reimbursement. But we distinguished Scranton-Spring Brook Water Service Co. v. P. S. C., supra, at 143, 144, where the utility, as here, initiated the action by filing a tariff schedule raising its rates to an extent found excessive and unreasonable. Under the authority of the latter case the commission, in view of its main conclusion that the new rates were excessive might have refused to allow any part of these expenses; under the circumstances its action in allowing appellant to collect three-fifths (3/5ths) from the public seems liberal.
The problem will require reconsideration when the case goes back. If the new rates are substantially upheld (see Scranton-Spring Brook case) the expenses should all be allowed or at least to the extent they will be recoverable under the new rates. If the increased rates are allowed in toto the problem will be forgotten since appellant would have no way of securing reimbursement without a further increase in its rates for the specific purpose.
Federal and State Income Taxes
Of course, these figures will require revision if the allowable income is changed when the commission reconsiders the case. Appellant's principal complaint is that the commission used figures for the years 1939,1940 and 1941 taken from one of appellant's exhibits which apparently showed accruals for taxes during these years, and that, if appellant had been given an adequate opportunity to explain or qualify them, it would have appeared that the actual liability for taxes was substantially in excess of the amounts which the commission allowed. It is also contended that certain permissible deductions were taken during these years which would not be available to appellant for 1942 and future years. It does not appear from the record that appellant was deprived of a full opportunity to explain. But clearly such opportunity should be, and we assume will be, given when the case is returned for further consideration.
Refunds
The commission ordered refunds for the following years and amounts:
1939 . $ 260,882.00
1940 . 745,752.00
1941 . 1,140,324.00
These amounts represent the excess earned during these years over and above the commission's allowed return.
Pointing out the rates charged for 1939 and until July 1, 1940, when its new tariff schedule became effective, were commission-made rates, appellant contends that as to that period the order was invalid on the authority of Cheltenham & Abington Sewerage Co. v. P. U. C., 344 Pa. 366, 25 A. (2d) 334.
The commission, in its brief, virtually concedes the validity of this contention. It contends we should not consider it because it was not raised before the commission nor made the basis of a specific assignment of error in this court. And, in effect, it urges us to disregard the decision of the Supreme. Court and that, "......if this Court [the Superior Court] will repeat its views, the Commission will do its utmost to sustain them if questioned on appeal."
The Supreme Court decided the Cheltenham case about three weeks after the commission's order nisi and perhaps it had not come to the commission's attention by the time the final order was filed. Under the decision the order for refunds prior to the effective date of the new rates was clearly erroneous. We, of course, cannot overrule the Supreme Court and when the case goes back we have no doubt the question will be properly presented to the commission and that it will follow the decision.
Appellant also argues that in determining the amount of refunds the commission's attitude was arbitrary and unreasonable in failing to compute the refunds by taking an average of a number of years in which were included several years during which appellant earned less than the commission's allowed return. The argument is without merit in view of the rule of the Cheltenham case which should give appellant all the protection needed. It seems to us the proper application of that case would not only excuse appellant from making refunds for the year 1939 and the first half of 1940, but also for earnings in subsequent years up to the date of the commission's order nisi (March 4, 1942) which were not attributable to the higher rates put into effect on July 1, 1940. Appellant concedes in its brief it is not entitled to rely on the Cheltenham case to relieve it entirely from the duty to make refunds for the period July 1, 1940 to March 4, 1942. And it does not make the distinction we are suggesting. But since appellant's returns reached a point where they were substantially in excess of the commission's allowed return even under the old rates, the effect of the order was to compel appellant to file a schedule lower than the old commission-made rates and to that extent it could not be required to make refunds prior to the date of its order. In other words, the refund order should be limited to the period July 1, 1940 to March 4, 1942, and to the amount of excess returns due to whatever portion of the attempted increase in rates is ultimately disallowed.
Effect of Appellant's Estimate of Income Under New Eates
When appellant filed its new tariffs, it also prepared and filed an exhibit showing an estimate, of net income for normal future years which was substantially less than the income the commission allowed. The commission argues this indicates that, at least when the new rates were filed, appellant felt such income would be reasonable and adequate, and that since the commission actually allowed more appellant should be satisfied. The fallacy of this argument is apparent.
The new tariffs were filed in March 1939. During the previous year (1938) appellant, under the old rates, had an operating deficit of about $500,000. Obviously, unless its sales in the future were to substantially increase or unless it could maintain the existing sales at increased rates, the enterprise would have ended in bankruptcy. But the amount which, in the judgment of appellant's management, the increased rates would produce did not necessarily represent the amount which, in its judgment, would produce a fair return on the present value of its property. A utility cannot merely by the simple device of increasing its rates, increase its net income to whatever amount it desires. Throughout most of the recent economic depression the majority of the railroads of the country were earning considerably less than a fair return; yet, with few exceptions, the device of increasing rates was not attempted. The reason is obvious. When rates are increased above a certain maximum, the public is apt to turn to competitors or so curtail their consumption that the net result is a loss rather than a gain to the utility.
The increases in rates, particularly to domestic consumers, were substantial. It is quite likely the increases represented what, in the judgment of appellant's management, were the maximum increases that the traffic would bear. And if this be true, appellant's estimate of the income they would produce is nothing more or less than a forecast. There is nothing in the record to indicate that appellant was satisfied — or, for that matter, dissatisfied — with what the forecast of the future seemed to hold.
Rate Differential Between Domestic and Commercial Consumers
Because the commission disallowed the increases in their entirety, the question of the validity of appellant's distribution of the increases, as between domestic and commercial consumers, was not directly before it and, therefore, not before this court. However, we think it would be well, in concluding this opinion, to point out we agree with much the commission said about the inequitable burden placed upon the domestic consumers.
Order
To the extent herein indicated the order is reversed and the record is remanded for further proceedings in accordance with this opinion; each party to pay the cost of printing its own briefs, the cost of printing the record to be divided equally between appellant and the commission.
Baldrige and Reno, JJ., took no part in the consideration or decision of this case.
Bauer & Gold, Public Utility Valuation (1934), 103.
In fairness, it should be said that in its disposition of all of the points raised, the commission was undoubtedly very much influenced by the decision of the Federal Power Commission in Pa. P. U. C. v. Hope Natural Gas Co., 44 P. U. R. (N. S.) 1 (1942), a case instituted by the commission against an affiliate of this appellant. But, on appeal, the order of the Federal Power Commission was reversed by the Circuit Court of Appeals for the Fourth Circuit (one judge dissenting) in a comprehensive opinion by Judge Parker for whose industry and wisdom we acknowledge a considerable debt. See Hope Natural Gas Co. v. Federal Power Commission, 134 Fed. (2d) 287. (Certiorari allowed, 63 S. C. 1165).
Missouri ex rel. Southwestern Bell Telephone Co. v. P. S. C., 262 U. S. 276, 289, 43 S. Ct. 544.
His argument was that all the fourteenth amendment guar antees is a reasonable net return on the capital invested; that the use of such a rate base has obvious practical advantages for the purpose of rate regulatory procedures; and that its adoption would avoid the hardship on consumers compelled to pay high rates during periods of high prices and the hardship on investors compelled to accept a low return during periods of low prices which necessarily result from the use of a fair value base. In other words, Mr. Justice Brandéis' objective was to adopt a base which would not vary with the fluctuations in value.
Act of May 28, 1937, P. L. 1053, 66 PS §1150.
The constitutionality of this base has been upheld by a statutory federal court on the ground that the utility is given, by the section, a right of recoupment in the event that the final determination of fair value indicates the rates thus fixed were too low. Beaver Valley Water Co. v. Driscoll, 28 F. Supp. 722. The question, however, has not been passed upon by either of the appellate courts of this state nor by the Supreme Court of the United States. See Solar Electric case at 347, 348.
169 U. S. 466, 546, 547, 18 S. Ct. 418.
McCardle v. Indianapolis Water Co., 272 U. S. 400, 412, 47 S. Ct. 144. The court intimated that, if prices were not reasonably stable, that is if they were inordinately high or low and might reasonably be expected to change in the near future, the prospective change could be taken into consideration or an average of costs over a period of years taken. See discussion of this case by Bauer & Gold, supra, at 98-103.
Solar Electric Co. v. P. U. C., supra, at 344.
See Harry R. Booth, Prudent Investment, Fair Value and Public Utility Regulation, 1 National Lawyers Guild Quarterly, 229, 233,
Act of July 25, 1913, P. L. 1374 Art. V. §20.
Act of May 28, 1937, P. L. 1019, §52, 46 PS §552.
See Paul G. Kauper, Wanted: A New Definition of the Rate Base, 37 Mich. L. Rev. 1209, 1233.