Opinion ID: 184742
Heading Depth: 2
Heading Rank: 2

Heading: Commission Rate-Setting Practices

Text: 4 The Commission sets pipeline rates by dividing revenue requirements by projected demand to attain a dollar-per-unit-of-service figure. To begin, the Commission sets a pipeline's basic costs by totaling operation and maintenance expenses, depreciation, and taxes, including ad valorem taxes. As it is ordinarily impossible for a pipeline to know at the time of filing what its actual costs will be during the effective period of the filed rates, the Commission has adopted a test period approach for this stage of rate making. Under this approach, a pipeline submits data in support of its rate proposal that reflects actual experience over the most recent twelve consecutive months (the base period), adjusted for changes that are known and measurable with reasonable accuracy at the time of filing, and that will become effective within nine months after the last month of actual experience (the adjustment period). See 18 C.F.R. § 154.303(a)(4) (1998). (Separate test period regulations govern rate setting in the electric utility context. See id. § 35.13.) Under certain circumstances, the Commission has discretion to make adjustments in light of actual, post-test period data. See Exxon Corp. v. FERC, 114 F.3d 1252, 1263 (D.C.Cir.1997). For the most part, however, the Commission develops rates using the representative cost data available at the time of filing. The test period underlying the rates in this case consisted of a twelve-month base period ending January 31, 1992 and a nine-month adjustment period ending October 31, 1992. 5 Next, the Commission adds to this basic cost of service figure a reasonable profit, computed by multiplying the rate base by the rate of return. See Boston Edison Co. v. FERC, 885 F.2d 962, 964 (1st Cir.1989). The rate base, which is not at issue in the present case, represents total historical investment minus total prior depreciation. Id. (internal quotation omitted). The rate of return, which is very much at issue in the present case, represents a weighted average of the costs of the three elements comprising the pipeline's capital structure: long-term debt, preferred stock, and common equity. See North Carolina Utils. Comm'n v. FERC, 42 F.3d 659, 661 (D.C.Cir.1994). The cost of common equity is frequently, as it is here, a point of contention in rate making. NEPCO Mun. Rate Comm. v. FERC, 668 F.2d 1327, 1335 (D.C.Cir.1981). 6 To calculate a pipeline's rate of return on common equity, the Commission first develops a zone of reasonableness, which gauges returns experienced in the industry, ordinarily by reference to a proxy group of publicly-traded companies for which market data is available. North Carolina, 42 F.3d at 661-62. To arrive at this zone of reasonableness, the Commission favors a discounted cash flow (DCF) model, which projects investor growth expectations over the long term by adding average dividend yields to estimated constant growth in dividends over the indefinite future. The premise of the DCF model is that the price of a stock is equal to the stream of expected dividends, discounted to their present value. Once the Commission has defined a zone of reasonableness in this manner, it then assigns the pipeline a rate within that range to reflect specific investment risks associated with that pipeline as compared to the proxy group companies. See id. at 661. This figure, combined with the long-term debt and preferred stock figures, represents the overall rate of return used to calculate the pipeline's profit allowance. 7 In the final rate-making step, the Commission divides the total revenue requirement--cost of service plus reasonable profit--by the total demand. Demand corresponds with throughput volume on the pipeline system, which, like cost of service, is computed by reference to a test period. See Exxon Corp., 114 F.3d at 1263-64. This calculation yields the per-unit price necessary to cover the pipeline's revenue requirement, which, in turn, represents a reasonable price that the Commission will permit the pipeline to recover. See Boston Edison, 885 F.2d at 964.