Opinion ID: 1918402
Heading Depth: 1
Heading Rank: 5

Heading: Short-Term Construction Work in Progress

Text: The Company further asserts that the Commission erred by excluding from the rate base $29.519 million of construction work in progress (CWIP). The revenue requirement of the Company's request is $3.723 million. Under traditional, well-settled ratemaking policy, ratepayers are only required to pay a utility company a fair return on facilities and invested capital actually used and useful for production of service to the ratepayers. Gulf States Utils. Co. v. Louisiana Pub. Serv. Comm'n, 364 So.2d 1266, 1269 (La.1978). A facility or invested capital is used and useful if it is (1) in service, and (2) reasonably necessary. Central Louisiana Elec. Co., 508 So.2d at 1367 (citing City of Evansville v. Southern Ind. Gas & Elec. Co., 167 Ind.App. 472, 339 N.E.2d 562 (Ind. App. 2d Dist.1975)). By definition, investment in CWIP does not meet the first criterion because the construction is not complete and thus not in service. Id. Under the used and useful principle, this Court previously addressed the exclusion of CWIP from rate base: the utility has not usually been permitted in the past to include in its rate base, or to expense, the cost of construction work in progress (CWIP). (However, when the new construction is placed in service, the utility is entitled to earn a fair rate of return on and recover through depreciation (from then current ratepayers) all of its capital expenditures so incurred, including the cost of capital.) Id. Although CWIP is not in service, Louisiana has recognized two methods which enable a utility to recover the cost of capital invested in CWIP. First, the Commission utilizes an allowance for funds used during construction (AFUDC) approach: Under this approach, the utility is allowed to include its CWIP expenditures in its rate base with an offsetting adjustment to its income. Although the rate base is increased by the CWIP expenditures, the utility's income is increased by the same amount thereby offsetting the effect of the increase in the rate base. Hence, these adjustments have no affect on the revenue required by the utility. Priest, Principles of Public Utility Regulation, Vol. 1, p. 179 (1969) (hereinafter Priest). Thus, the inclusion of CWIP in the rate base is fictional, not actual. The net result is ... [that] when the plant goes into service, all costs, including interest, are reflected in the rate base in order that the investors may recoup their entire investment. 40 La.L.Rev. at 1051. Id. In sum, the exclusion of CWIP from rate base accompanied by the accrual of AFUDC serves to defer recovery of the capital costs associated with CWIP; it does not deny the utility recovery of these costs. In the same case in which we recognized the AFUDC approach, we also stated that [u]ltimately, the issue is one of regulatory choice of the Commission and not of the courts. Gulf States Utils. Co., 364 So.2d at 1271. In that case, we additionally noted that: [a] substantial number, probably a majority, of regulatory commissions do not permit the utilities to recover from present consumers the present cost of construction work in progress ... which will be devoted to the use of future consumers. In a number of jurisdictions, the courts have upheld the actions of some of these regulatory commissions in completely excluding CWIP from the rate base. Id. Rather than blindly requiring the accrual of AFUDC to recover the cost of capital invested in CWIP, the Commission also has the discretion to include CWIP in the rate base if exigent financial circumstances warrant inclusion. The justification for controverting the used and useful rule is that utilities must be able to attract substantial capital to finance long-term construction projects. See L.P.S.C. Order U-14495. Additionally, the burden of obtaining capital at a reasonable cost is occasionally compounded by troubled or uncertain capital markets. Moreover, by including long-term, substantial CWIP in the rate base with an offsetting income adjustment, a utility's cashflow is disrupted. James W. Pierce, Jr., Note, Gulf States Utilities, The Public Service Commission, and The Supreme Court: On Raising the Electric Rates, 40 La. L.Rev. 1048, 1053 (1980). Once complacently accepted when construction costs were low and the time required for construction short, AFUDC is today being questioned before regulatory agencies with increasing fervor as costs soar and the time necessary for new plant construction perennially increases. Id. For example, the Washington Utilities and Transportation Commission has noted that: The advent of the energy shortage in this part of the country seriously threatened the financial integrity of electric utilities. Electric companies faced long-term commitments of capital for major construction projects without current earnings to support the debt resulting from such unavoidable commitments. Regulatory commissions understood that when they permitted partial allowance of CWIP to be included in rate base. Without the cash flow realized from including certain plant under construction in rate base, the capital required to build that plant could not be raised; therefore, certain CWIP was permitted to earn a rate of return notwithstanding the fact that it was not then used and useful in providing service to ratepayers. Washington Utils. & Transp. Comm'n v. General Tel. Co., Order No. U-80-38 (Wash. UTC 1981). At issue in this assignment of error is whether, in the absence of exigent financial circumstances, the Commission acted arbitrarily or capriciously or abused its authority by excluding from the rate base short-term CWIP not accruing AFUDC. Short-term CWIP includes investments involving relatively small amounts of capital or relatively short construction periods. The Company contends that by excluding from the rate base short-term CWIP not eligible for AFUDC, it is being denied an opportunity to recover capital costs incurred during the period of construction. In deciding to exclude the Company's short-term CWIP from rate base, the Commission reasoned that Gulf States' short-term CWIP has been excluded from rate base in the past, that the Company failed to cite any regulatory principle or case supporting inclusion of short-term CWIP not accruing AFUDC in rate base, and that no exigent circumstances were demonstrated to justify inclusion. L.P.S.C. Order No. U-21485 at 10. However, the Company contends that a showing of exigent circumstances is merely an alternative method of allowing the Company a return on its investment; it is not a factor when the Company cannot accrue AFUDC. Moreover, the Company argues that the Commission has previously included CWIP in rate base without any showing of exigent circumstances. See L.P.S.C. Order Nos. U-12977, U-13644, & U-14495-B. In fact, the Company observes, the Commission in a 1995 rate order included in rate base short-term CWIP not accruing AFUDC. See L.P.S.C. Order No. U-20925 at 4. Finally, according to the Company, accounting rules do not permit the accrual of AFUDC on short-term CWIP; therefore, the only proper course of action is to include short-term CWIP in the rate base. Supplemental Post-hearing Brief on Behalf of Entergy Gulf States, Inc. of 11/2/98, at 18. The Commission does not dispute that it permitted recovery of short-term CWIP not accruing AFUDC in a 1995 rate order involving Entergy Louisiana, Inc. Instead, the Commission counterargues that, beginning in 1988, the Commission has traditionally excluded all CWIP, including short-term CWIP, from Gulf States ' rate base, and that different practices have applied to the two companies for years. Id. Thus, the Commission contends the instant order is consistent with its previous orders. Moreover, the Commission argues that it does not prohibit the accrual of AFUDC on short-term CWIP, and that the Company offers no explanation of the accounting rule and its inescapable prohibition against accruing AFUDC on short-term CWIP. Post Hearing Reply Brief on Behalf of the La. Pub. Serv. Comm'n of 11/12/98, at 16. Citing the Company's own Lead/Lag Summary, the Commission surmises that the reason the Company's accounting policy does not permit accrual is that short-term CWIP generally does not require financing because projects last thirty days or less, yet payment lag to vendors exceeds thirty days. The Commission observes that the Company's accountants would have difficulty justifying an AFUDC accrual, and thus there is no basis to require ratepayers to bear a nonexistent financing requirement. Id. at 16. In New England Telephone & Telegraph Co. v. Public Utilities Commission, 448 A.2d 272, 293-94 (Maine 1982), the Supreme Court of Maine addressed the issue of whether a Commission must defer to the accounting practices of a utility for ratemaking purposes: Generally speaking, the Commission is not bound by a utility's books of account in setting rates. 1978 NET Case, 390 A.2d at 23. However, if the Commission prescribes the method by which the utility must keep its books, the Commission may not disregard those books arbitrarily and without reason in the process of ratemaking. Id. In this case, we cannot find that the Commission acted arbitrarily in going beyond the prescribed method of accounting, as it did, in order to determine the rate base in accordance with its traditional practice. Although 47 C.F.R. S 31.100:2, as incorporated in the Commission's regulations, may be read as requiring NET to carry short-term CWIP in rate base for accounting purposes, the Commission was justified in this case in not regarding that accounting treatment as creating an absolute substantive limitation on its determination of NET's rate base and test-year income statement. If short-term CWIP were included in rate base without an AFUDC adjustment in NET's test-year income statement, the effect would be to authorize revenue on telephone plant not in service during the test year. Since the purpose of the test-year concept is to match revenues, expenses and rate base during a particular twelve-month period, the Commission is correct in deciding that inclusion of a short-term CWIP without an offsetting AFUDC adjustment would distort the test-year computations. The result would be that ratepayers would pay for construction work that yielded them no services during the test year. Before it comes on line, construction work in progress or telephone plant under construction is not property... used in [the utility's] service to the public within the State. See 35 M.R.S.A. S 52.... That NET included short-term CWIP in a rate-base account pursuant to an accounting regulation is not dispositive .... [w]e cannot hold that the Commission [acted] arbitrarily or capriciously.... Id.; see Southwestern Bell Tel. Co. v. Pub. Serv. Comm'n Mo., 645 S.W.2d 44, 53-54 (Mo.App.1982) (upholding commission order excluding short-term CWIP from rate base even though FCC-ordered accounting rules required inclusion); see also Washington Utils. Transp. Comm'n v. General Tel. Co., Order No. U-80-38 (Wash. UTC 1981) (rejected utility's proposal to include short term CWIP in rate base because inclusion is unnecessary to maintain utility's financial integrity). On this point, we agree with the Supreme Judicial Court of Maine. Ratepayers are not required to pay for facilities or capital investments that are not used and useful during the test year. The Company's proposal to include in the rate base short-term CWIP not accruing AFUDC plainly and unjustifiably circumvents this longstanding principle of ratemaking. Furthermore, the record is virtually devoid of any explanation of the accounting rule to which the Company adheres and which precludes the accrual of AFUDC; the Commission reasonably concludes that the Company's accounting policy does not permit accrual of AFUDC on short-term CWIP because short-term CWIP generally does not requiring financing due to payment lag. Additionally, we do not find improper the Commission's consideration of the financial integrity of a utility when determining whether to exclude from rate base short-term CWIP not accruing AFUDC. [16] Accordingly, regarding this assignment of error, we hold that the Commission did not act arbitrarily or capriciously or abuse its authority, and that the Commission's ruling is supported by the record.