Opinion ID: 1908051
Heading Depth: 2
Heading Rank: 1

Heading: Use of Post Test Year Experience.

Text: The company claims that the commission erroneously used stale information to reach its decision at the remand proceeding, in that it used data from the original hearing (hereinafter referred to as the 1974 data) instead of the company's most recent experience (hereinafter the 1976 data). [1] The argument is aimed in particular at the commission's use of the 1974 rate base to determine the erosion adjustment and the allowed rate of return. Our discussion of the company's claim will be structured as follows: first, we will set out the commission's actions with respect to erosion and the rate of return, and the company's objections thereto; second, we will discuss the general principles involved in the use of post test year data in a remand proceeding; and third, we will consider the commission's decision in light of these principles. A. The commission's decision. In its original order, the commission added an erosion adjustment [2] of 0.3 percent to the company's otherwise allowable rate of return. On appeal, we found that adjustment to be without evidentiary support and directed the commission to make a suitable erosion adjustment based on the evidence before it. New England Tel. & Tel. Co. v. Public Util. Comm'n, 116 R.I. at 371, 358 A.2d at 12. On remand, the commission found the most suitable means of establishing an erosion adjustment to be that originally proposed by the company in the first proceeding; namely, to add to the otherwise allowable rate base an amount equal to the company's average annual increase in investment. Accordingly, the commission calculated the increase in investment which occurred subsequent to the 1974 test year, from June 30, 1974 to March 31, 1976. It then took the average 12 month increase over this period and added that amount to the 1974 rate base. [3] It is this use of the 1974 rate base to which the company objects. The company argues that to achieve a meaningful erosion adjustment, the average increase in investment must be added to the actual rate base at the time of the remand. The company thus wants the rate base updated. Next, we turn to the commission's use of post test year data with respect to the rate of return. In both the original decision and the decision on remand, the commission followed the traditional path of determining the company's capital structure, then determining the cost of debt and equity, and finally combining these figures to obtain the allowed rate of return. This rate of return was then multiplied by the rate base to determine the allowed earnings. In its original decision the commission disallowed certain proposed construction costs and concluded that since the company's need to attract capital was thereby diminished, its required rate of return on equity could also be reduced. On appeal we found this portion of the decision to be without evidentiary support and directed the commission on remand to reconsider the rate of return. On remand the commission heard additional evidence on the issue, including post test year data, and made a completely new determination of the allowed return. In so doing, it used the company's 1975 capital structure, which differed from the 1974 capital structure. It then multiplied the new rate of return by the 1974 rate base, to determine the allowed earnings. The company again objects to the use of a 1974 rate base. It claims that when it is used in conjunction with a post test year capital structure, two undesirable consequences occur; one, a distorted view of the company's financial situation is created, and two, the company's right to use accelerated depreciation for purposes of federal income taxes is jeopardized. [4] B. General principles regarding use of post test year data. It is our task to decide whether the commission's failure to consider the company's 1976 rate base in the instances described above was unreasonable or otherwise not in accord with the law of this state. The rules of law are not in dispute. The commission must make rates for the future. Rhode Island Consumers' Council v. Smith, 113 R.I. 232, 319 A.2d 643 (1974). In so doing, it cannot shut its eyes to the company's actual operating results, nor can it rely on prophecy when the company's real experience is available. [E]laborate calculations which are at war with realities are of no avail. West Ohio Gas Co. v. Public Util. Comm'n, 294 U.S. 79, 82, 55 S.Ct. 324, 325, 79 L.Ed. 773, 776 (1935). The question before us in this case is to what extent the above principles obligate the commission to take into account post test year data in a remand proceeding. Perhaps because this issue has only recently grown to be a significant problem, there are few relevant cases, and none that we regard as controlling. For example, the company relies on Letourneau v. Citizens Util. Co., 128 Vt. 129, 259 A.2d 21 (1969), for the proposition that the commission must consider updated information on remand. However, in that case it was only decided that where a remand hearing would be held five years after the initial tariff filing, the commission did not abuse its discretion in considering updated information on remand. The case of Chenango & Unadilla Tel. Corp. v. Public Serv. Comm'n, 45 A.D.2d 409, 357 N.Y.S.2d 937 (1974) presents a factual situation which is widely divergent from the one before us. The thrust of the holding in that case is that if a commission takes into consideration post test year revenues to set rates, it must also take into account other post test year changes in a utility's position. A recent Massachusetts decision directed a regulatory agency to consider the most recent available data on remand of a rate case, but that direction was explicitly linked to a finding of confiscation. New England Tel. & Tel. Co. v. Department of Pub. Util., Mass., 354 N.E.2d 860, 866 (1976). No finding of confiscation was made by us prior to the remand in this case. The company also refers to many cases holding that rates are made for the future and cannot be based on stale information. But the extent to which those cases impose an obligation to hear post test year information is precisely the question before us. Nor can we find any answers in cases cited by the commission. It places primary reliance on Mountain States Tel. & Tel. Co. v. Public Util. Comm'n, 180 Colo. 74, 502 P.2d 945 (1972). There, the company's subsequent experience was not considered on remand. However, that remand was much more clearly limited in scope than the proceeding in this case. In our opinion, in deciding the extent to which the commission must consider post test year results we must strike a balance between competing interests. On the one hand, there is the importance of prospective rates. There is no doubt that use of recent information will insure a more accurate picture of the company's needs than the continued use of old data. On the other hand, we think that a remand is not the same as an original rate hearing. It is a proceeding to correct specific errors in a prior proceeding. If the commission must consider all new data on remand, then the remand becomes in effect a new rate case. The statutory method of setting rates is bypassed as a result, and the prospect of a never ending, continually updated rate case looms. Such a result seems to us clearly wrong. Therefore, in deciding the extent of the commission's obligation to consider the most recent data available to it on remand, we must take into consideration and give appropriate weight to the character of the remand proceeding. An appropriate balance would have been struck between these competing interests, in our opinion, if the commission had used post test year data in the remand only with respect to the required reconsideration of the erosion adjustment. With respect to the other issues heard at the remand proceeding in this case, the commission should have based its decision on data which related back to the time period used in the original hearing. This standard is described in further detail below, but we wish to note at the outset that whether it is reasonable to consider post test year data may depend on the circumstances involved. However, in the absence of special circumstances, the commission should act in accord with the standards contained herein. We feel that treating the erosion adjustment differently from other aspects of the commission's decision is a reasonable procedure for several reasons. First, it seems to us to comport with common sense. A remand should not be an open ended affair, but should be an attempt by the commission to reach the result it would have reached had no mistakes been made. Accordingly, it is appropriate that the commission in general limit itself to considering data from the original time period. Second, an erosion adjustment is truly distinguishable from the other parts of the commission's decision. It, much more than the remainder of the commission's decision, is intended to be a forecast of future economic events. After the commission computes the test year rate base, revenues, expenses, and adjustments thereto for known future changes, and all the other factors which go into determining the allowed rate of return, the commission tries, in effect, to estimate how this allowed rate of return will be affected by future inflation. It then makes what it hopes will be an adequate erosion adjustment. Accordingly, if this forecast is challenged on appeal and the commission is instructed to correct it on remand, it seems appropriate and reasonable for the commission to compare its forecast with the company's actual subsequent results. It seems unreasonable for the commission on a remand in 1976 to attempt to predict what effect inflation will have in 1975 and 1976, based only on 1974 data, when the actual facts are known. In short, calculations which were originally intended to be statements of current economic fact (such as test year rate base, expenses, etc.) should be recalculated on the basis of information available at the time of the original proceeding. Calculations which were intended as forecasts (such as the erosion adjustment) should be compared to the latest available figures to see if they were correct or not. [5] Third, to the extent that failure to use current figures harms the company, that harm is caused by inflation. Since the erosion adjustment is specifically intended to compensate for inflation, New England Tel. & Tel. Co. v. Department of Pub. Util., Mass., 354 N.E.2d at 865, it makes sense to use post test year results with respect to that adjustment. Fourth, it is supported by our prior cases, at least insofar as we have previously ordered the commission to look at post test year results in determining the accuracy of an erosion adjustment. We said in Rhode Island Consumers' Council v. Smith, 111 R.I. at 298, 302 A.2d at 773. Inasmuch as the commission must in any event reconsider its decision, it can as part of that reconsideration compare the company's actual rate of return since that decision with its earlier prognostications. It will then be in a position to make suitable adjustments which can reflect whatever erosive trends may be disclosed. Fifth, this rule has the salutary effect of providing no updating at all in a totally noninflationary economy. This, we think, is proper. The need for updating springs primarily from inflation. In a noninflationary economy, the company's remedy of filing a new tariff request would provide adequate protection against increased revenue requirements. Sixth, this rule promotes procedural simplicity. There is no need for the commission on remand to revise all of its former determinations. Only the erosion adjustment requires resort to later data. [6] Finally, we think that this course is preferable to other options. As we see it, the commission has only three other choices. It can consider no updated information at all, it can consider only updated information, or it can consider updated information only with respect to those issues which are to be redetermined on remand. The problem with the first choice is that there would then be an inadequate allowance for inflation, even though the issue was before the commission and the commission was perfectly capable of making an appropriate adjustment. This would be inconsistent with West Ohio Gas Co. The problem with the second option, totally updating all information, is that it would fundamentally alter the rate hearing process. A remand proceeding would bear no relation to the original proceeding; it would in effect be an entirely new rate hearing, based on entirely different information. The anomalous result of a complete update on remand would be that no error in the original proceeding, no matter how small, could be corrected on remand; the error and remand would trigger a new rate case instead. If a new rate case is to be heard, it should be initiated in the manner provided by statute, not on the coattails of an order of this court. The third alternative is to consider the company's most recent experience only with respect to those portions of the original decision which were determined on appeal to be erroneous. This apparently is the position the commission took. The commission relied on post test year data in redetermining the rate of return and erosion adjustment, but refused to update the rate base to which these results were applied. We agree with the company that this results in a distorted view of the company's operations. It is crucial to correlate each piece of financial data with every other piece from the same time period in order to obtain an accurate picture of the company's position. For example, consider what would happen if, on appeal, this court determined that the commission was incorrect only insofar as it had failed to properly determine certain revenues. On remand, if the commission were to look at recent experience only regarding issues open on remand, the latest revenue figures would be used but, since by hypothesis expense figures had been properly determined in the original decision, it would continue to use the original expense data. Clearly this would be a distortion. Nor can this problem be solved simply by updating expenses also. That would simply move the problem one step down the line. That is, if both revenues and expenses were updated, earnings would not be distorted, but when that current earnings figure was used with the old rate base to determine the company's rate of return, the rate of return would be distorted. This kind of mismatch did in fact occur in this case. The commission used a 1974 rate base and a 1975 capital structure. The resulting earnings requirement can hardly be said to relate to 1974 or 1975. Therefore, considering post test year figures only with regard to issues open on remand is in general an inferior procedure to the one we have chosen. For all of the foregoing reasons, we think that in the absence of special circumstances the commission's obligation to make rates for the future and consider current data compels the following procedure on a remand: where an erosion allowance has been determined to be erroneous and must be corrected on remand, the commission should compare the original erosion allowance to the actual subsequent experience of the company and correct the allowance accordingly; however, the remainder of the commission's decision on remand should in general relate back to the figures used in the original hearing. While the rule which we here announce requires updating in the event reconsideration of an erosion allowance is at issue, nothing we say herein should be construed as indicating that there are no other situations where updating may be required. We realize that this is at best an imperfect solution. There is, after all, no exact way of isolating the effects of inflation on the company's operations. However, we do not write on a clean slate. So long as the rate setting process involves the use of an historical test year and a separate erosion adjustment for inflation, this dichotomy will exist. It seems to us that other methods might be more desirable. See e. g., Note, The Use of the Future Test Year in Utility Rate-Making, 52 B.U.L.Rev. 791 (1972). But it is not up to us to determine which method the commission should use to determine the rate base or to account for inflation so long as the result is just and reasonable. Rhode Island Consumers' Council v. Smith, 111 R.I. at 280, 302 A.2d at 764. We repeat that what is a reasonable use of post test year data may vary from case to case. If, for example, a remand hearing were held an extraordinarily long time after the original hearing, the commission might reasonably decide that it was procedurally simpler to consider a new test year on remand. See Letourneau v. Citizens Util. Co., 128 Vt. 129, 259 A.2d 21 (1969) (within discretion of commission to consider new test year where remand delayed five years). But the commission must act in accord with the principles set out above. C. Application of principles to commission's decision. The commission's decision on remand with respect to erosion was, in part, as follows: The Company has presented evidence that demonstrates that the Company has, from February 1970 through the present, continually failed to earn its authorized return. This fact was substantially unrebutted. Consequently, we are constrained, in this case only, to provide a suitable attrition allowance. How is this allowance to be determined? The Company has suggested that `the simplest and surest way of making some compensation for erosion' is, in essence, to add to rate base a figure which represents the projected increase in net investment over the 12-month period following the effective date of new rates. The figure suggested at our prior proceeding was $12.8 million. The Commission concludes that this method has validity in this case. Consequently, the Commission will add to the Company's rate base $13,290,000. This amount represents the Company's annual increase in investment based on its 21-month experience beyond the test period. We are compelled to note that these findings are rather sparse. The commission concludes that it is appropriate to add the entire annual increase in investment to the rate base to adjust for erosion, but does not direct our attention to any evidence which supports that position. Taken by itself it seems to us that increase in investment is hardly an adequate measure of erosion. If, through technological improvements, growth in services provided, increase in productivity of labor or any of a number of other factors the company's revenues increase or expenses decrease, any growth in investment may be more than offset and rate of return may not decline. See State v. New Jersey Bell Tel. Co., 30 N.J. 16, 152 A.2d 35 (1959); Re Southwestern Bell Tel. Co., 34 P.U.R.3d 257 (Kan.Corp.Comm'n 1960). Average increase in investment is a valid measure of erosion of earnings only if there is evidence in the record which supports such a relationship. 1 Priest, Principles of Public Utility Regulation at 204 (1969). The commission has not explicitly directed our attention to any such evidence. Likewise, failure to earn the authorized rate of return is not necessarily caused solely by attrition. It could be due to many factors. An authorized rate of return is not a guarantee of that return; an erosion adjustment should not be based on a mere failure to achieve such earnings. It is not our function, when reviewing a decision of the commission, to search the record for evidence in support of that decision. United Transit Co. v. Nunes, 99 R.I. 501, 209 A.2d 215 (1965). However, we will assume, keeping in mind that the commission need not set out specific factual bases for its decision where such bases may reasonably be implied from its language or actions, New England Tel. & Tel. Co. v. Public Util. Comm'n, 116 R.I. at 363, 358 A.2d at 7, that in approving the company's method of computing the erosion adjustment, the commission adopted the supporting testimony of Mr. John O'Neill, the company's general accounting manager. This assumption is supported by the commission's statement in its supplementary order that, with respect to the company's evidence of failure to earn its authorized return, This fact was substantially unrebutted. Mr. O'Neill testified that due to inflation the rate base had increased, and that there was no compensating increase in earnings. In fact, he testified that the company was experiencing a negative earnings growth. He presented the following estimates of the company's actual rate of return: [7] DOCKET 1092 REMAND DOCKET 1170 Effective Aug. 13, 1973 Effective July 21, 1975 Rate of Return Allowed 8.38% Rate of Return Allowed 8.72% 1974 1915 1975. 1976 July 7.01% Jan. 6.77% July 6.26% Jan. 6.39% Aug. 6.94 Feb. 6.62 Aug. 6.27 Feb. 6.47 Sept. 6.87 Mar. 6.56 Sept. 6.35 Mar. 6.48 Oct. 6.86 Apr. 6.48 Oct. 6.34 Nov. 6.82 May 6.37 Nov. 6.28 Dec. 6.87 June 6.32 Dec. 6.24 In addition, O'Neill calculated the company's rate of return using the method followed by the commission in the original hearing, but with current data, and showed that the company's rate of return decreased from 9.02% (calculated by the commission in its original order as of June 30, 1974) to 7.08% (as of March 31, 1976). The 9.02% rate included the original erosion allowance of 0.3%. The fact that the rate dropped 1.94%, instead of only 0.3%, indicates that the original erosion allowance was inadequate. We note first that Mr. O'Neill's calculations represent a comparison of the company's actual results with the erosion allowance in question. This is in accord with the previously discussed principles. However, the commission failed to carry this consideration of post test year data far enough. It allowed an erosion adjustment which was based only on one year's experience; that is, it made an annual adjustment. When making a prospective adjustment, this would be appropriate. Forecasts are unreliable, and it would not be unreasonable to limit an economic forecast to the effects expected to occur within one year after the test period. But the situation on remand is different. The commission is capable of ascertaining with certainty the effects of inflation right up to the time of the remand. Whether this is one year, or 21 months as in the present case, is irrelevant. So long as the erosion adjustment is going to be updated, there is no reason for arbitrarily limiting it to a one year period. In accord with the standards of reasonableness we have set out, the commission should have made an erosion adjustment on remand which comported with the actual figures up to the time of the remand, and, in addition, reflected the expected erosion for a foreseeable period in the future. Since the commission in effect found that the company's failure to earn its authorized rate of return was due to erosion, it was obligated to make a suitable allowance. Inasmuch as it chose to compensate for erosion by adding to the 1974 rate base an amount equal to the increase in investment, it should at least have added the increase in investment attributable to the entire 21 month period preceding the remand, and, in addition, added the projected annual increase of $13,290,000. This augmented rate base, when combined with the other 1974 data, would yield a more meaningful allowed earnings level. We next turn to the commission's decision with regard to the company's capital structure. In keeping with our decision today, the commission should have relied on 1974 data, in the absence of circumstances indicating a contrary result. In fact, the commission used a 1975 capital structure, which significantly differed from that of 1974 in the proportion of debt and cost-free capital. This resulted in a lower authorized rate of return. Accordingly, the rate of return should be recomputed using the 1974 capital structure which the commission found in its original decision.