Opinion ID: 2329066
Heading Depth: 2
Heading Rank: 3

Heading: Residual Ratemaking

Text: The FCC's average schedules, like its Part 36 cost-based separations method, label a certain portion of a telephone company's costs as interstate costs. Therefore, some state regulators simply subtract these interstate costs from the company's total costs and treat the residuum as intrastate costs. Crockett, 963 F.2d at 1567. This intrastate ratemaking method is known as residual or total company ratemaking. Id. The residual ratemaking process, in the context of an average schedule company, has been described as follows: [First] the commission determines a reasonable level of expense and a reasonable return on the net investment rate base for the total company. The commission then deducts the amount of average schedule payments from the total company revenue requirement to determine the intrastate portion of the total company revenue requirement. Intrastate rates are then established to recover this residual amount. Peoples Tel. Co., 100 P.U.R.4th 272, 275-76 (Wisc.P.S.C.1989). In other words, state regulators using residual ratemaking assume that the intrastate revenue requirement is equal to the company's total revenue requirement less revenues deemed by the average schedules to be interstate. Id. In the case at bar, Pine Tree attempted to use a jurisdictional cost-separations study to calculate its intrastate revenue requirement. [8] The commission rejected that approach and decided to use residual ratemaking, holding: Pine Tree's interstate cost allocation is determined by the amount of revenue it receives pursuant to its interstate average schedules. This amount is then deducted from the Company's total revenue requirement to determine its intrastate revenue requirement. The commission reasoned that using residual ratemaking will guarantee 100% recovery, no more, no less. [9] Pine Tree first argues that the commission's approach violates the Supremacy Clause of the United States Constitution. See U.S. Const. art. VI. The Supremacy Clause provides Congress and federal agencies, acting within the scope of their congressionally delegated authority, the power to preempt state regulation. Louisiana Public Service Comm'n v. FCC, 476 U.S. at 368-69, 106 S.Ct. at 1898-99. The FCC has specifically declined to preempt the use, by State regulators, of residual ratemaking with average schedule companies. See Mid-Plains Tel. Co., 5 F.C.C.R. at 7054 (holding that [state regulator's] use of residual ratemaking for determining a telephone company's intrastate revenue requirements does not contravene the Communications Act or any rule of this Commission.). The Court of Appeals for the District of Columbia Circuit affirmed the FCC's decision, concluding: [Use of an] average schedule interstate cost calculation, in conjunction with residual intrastate calculation, does not violate the Communications Act. The power of the state to employ the residual method is not preempted by federal regulation. Crockett, 963 F.2d at 1574. We, therefore, reject Pine Tree's assertion that the commission's use of a residual ratemaking methodology violated the Supremacy Clause. Second, Pine Tree asserts that the commission's use of residual ratemaking results in an unconstitutional taking because the commission's actions take revenue earned from Federal operations and use that money to subsidize State callers. In support of its position, Pine Tree points in particular to the commission's application of an overall rate of return of 10.586% to Pine Tree's interstate as well as its intrastate revenues. [10] Pine Tree asserts that this, at the very least, deprives the company of the interstate return requirement of 12%. [11] The commission apparently decided not to adjust Pine Tree's rate of return to reflect any differences in the interstate and intrastate return requirement. Pine Tree correctly points out that the United States Supreme Court has analyzed regulatory action under the takings clause of the Fifth and Fourteenth Amendments. See Duquesne Light Co. v. Barasch, 488 U.S. 299, 306-10, 109 S.Ct. 609, 615-17, 102 L.Ed.2d 646 (1989) (upholding state statute excluding utility plant not yet in use from a utility's rate base finding no unconstitutional talking of utility's property). The Court held that the Constitution protects utilities from being limited to a charge for their property ... which is so `unjust' as to be confiscatory. Id. 488 U.S. at 307, 109 S.Ct. at 615. The Court continued, [i]f the rate [set by the Commission] does not afford sufficient compensation, the State has taken the use of utility property without paying just compensation and so violated the Fifth and Fourteenth Amendments. Id. 488 U.S. at 308, 109 S.Ct. at 616. Because Pine Tree does not argue that the rates set by the commission are confiscatory, but instead argues that the commission is subsidizing intrastate activities with revenues from interstate activities, its challenge to the commission's setting an overall rate of return is also better analyzed as a federal preemption question as was the commission's decision to use residual ratemaking in general. In its order upholding the use of residual ratemaking for average schedule companies, the FCC implicitly allowed State regulators to apply an overall rate of return even if that rate of return differs from the federal rate. In that proceeding, Mid-Plains Telephone Company challenged an order by the Wisconsin Public Service Commission in which the Wisconsin Commission, using residual ratemaking, applied an overall rate of return different from the federal rate. Mid-Plains Tel. Inc., No. 3650-DR-100, 3650-TR-100, 3650-TI-101, slip op. at 14, 18 (Wisc.P.S.C.1989). The FCC concluded that the Wisconsin Commission's use of residual ratemaking does not contravene the Communications Act or any rule of [the FCC], Mid-Plains Tel. Co., 5 F.C.C.R. at 7054. This conclusion demonstrates the FCC's implicit approval of the Wisconsin Commission's use of an overall rate of return. Moreover, if Pine Tree had wanted to ensure that it recovered the federal rate of return, it could have elected to follow the cost-based separations method of Part 36 rather than the average schedule approach. We also reject Pine Tree's contention that the commission's decision improperly deprives the company of incentive earnings from the Federal average schedule method. The FCC has stated that the economic incentive of retain[ing] the benefits that accrue from increases in productivity and reductions in expenditures is a rationale underlying the use of average schedules. Policy and Rules Concerning Rates for Dominant Carriers, 5 F.C.C.R. 6786, 6820 (1990). Nevertheless, the FCC rejected the argument that the use of residual ratemaking by state regulators, i.e., allowing companies to recover only 100% of their costs, was contrary to FCC policy stating: [I]t has always been our view as a matter of public policy that it would be inequitable for a company to recover more than its total costs. In fact, this Commission has previously declared that [n]o company has a legal or equitable right to obtain more than its full costs. Mid-Plains Tel. Co., 5 F.C.C.R. at 7054 (quoting MTS and WATS Market Structure Average Schedule Companies, 103 F.C.C.2d 1017, 1027 (1986)). Although the FCC's refusal to preempt use of residual ratemaking may appear inconsistent with its stated goal of allowing a utility to retain benefits that accrue from average schedule treatment, the FCC's decision was upheld by the Court of Appeals for the District of Columbia in Crockett, 963 F.2d at 1571-72, 1574 (specifically rejecting the inconsistency argument). Finally, Pine Tree, citing Maine Water Co. v. Public Util. Comm'n, 482 A.2d 443, 456-57 (Me.1984), asserts that the commission's approach use[s] revenues generated from interstate customers to benefit intrastate customers violat[ing] the State's prohibition against cross-subsidization. In Maine Water Co., we acknowledged that a fundamental objective of ratemaking is to avoid cross-subsidization so that one class of customers is neither burdened by the losses from other service nor benefitted from its profits. Id. at 456. In Maine Water Co., we struck down an attempt by the Commission to effect a dollar-for-dollar `flowthrough' of gains realized by Maine Water Company in selling [another of its] division[s]. Millinocket Water Co. v. Public Util. Comm'n, 515 A.2d 749, 753 (Me.1986). We distinguished the commission's actions in Millinocket Water from those in Maine Water because in Millinocket Water, the commission was using a Company's parent as proxy for determining [the] cost of equity and did not attempt to effectuate a flowthrough. Millinocket Water, 515 A.2d at 753. The commission's actions in the case before us can be similarly distinguished from Maine Water; here, the commission relied on average schedules as a proxy to determine Pine Tree's interstate costs and did not attempt to effect a flow-through of gains from Pine Tree's interstate activities to subsidize its intrastate activities.