Opinion ID: 398885
Heading Depth: 3
Heading Rank: 2

Heading: Inclusion of Yankee Investment in Total Capital Structure.

Text: 104 Using a capital market-oriented approach (the Discounted Cash Flow or DCF method) in R-10, FERC determined the rate of return which investors required before investing their money in the NEES enterprise, in light of available alternative investment opportunities, to be 12.75%. FERC also found that rate an appropriate proxy for the NEP composite rate, 24 noting that the testimony on derivation of NEP's rate of return value was primarily premised on the capital structure of NEP composite rather than on that of NEP operating alone. 25 FERC explained: 105 In this case, NEP witnesses argued against excluding NEP-Yankee investments from total (composite) NEP capital structure. The implication of this observation is that when they used NEES-based information to estimate a rate of return value, it was a value intended to be applied to both the capital invested in NEP's own rate base and the capital invested in the Yankees. Consequently, although the witnesses did not explicitly state this, such a rate of return value probably is intended to reflect NEP-composite rather than just the NEP operating component. We note, for example, that NEP Witness Benderly's direct testimony listed common equity at $288,984,425 which is (rounded) the $289 million figure we used for NEP-composite investment in Opinion No. 49. (Emphasis in original.) 106 FERC's method took account of the integration of Yankee data into NEP's overall capital structure and investment risk. Recognizing that NEP would earn approximately 10% on its Yankee investments, supra, note 23, FERC determined that NEP must be afforded the opportunity to earn a 13.28% return on its investment in its own operating rate base facilities, if it were to have the opportunity to earn 12.75% on a composite basis. FERC stated: 107 The Commission's approach, which falls somewhere between that of NEP and the customers, is really quite straightforward: we find that NEES more closely resembles NEP-composite than it does NEP-operating. The investment in and earnings from the Yankee investment is a component of NEES and a component of NEP-composite; it is not a component of NEP-operating. Thus, we conclude that the rate of return we have determined appropriate for NEES is also appropriate for NEP-composite. The rest of the analysis is simply arithmetical: if NEP-composite is to have an opportunity to earn 12.75%, and the portion of NEP-composite reinvested in the Yankees is earning approximately 10%, then the return from NEP-operating must be in excess of 12.75%. This approach does not, as customers contend, result in an equalization of return on investment for NEP-operating and NEP-Yankees. Neither does it flow from a perception that the respective risks are equal. To the contrary, implicit in the approach is a recognition that the risk and appropriate returns are different. Furthermore, by this process, the Commission has not improperly guaranteed earnings to shareholders, as the customers have argued. Instead, the rate of return determination represents no more than a measure of NEP-operating's cost of capital, given what we know about NEES shareholders' risks and required returns. (Footnote omitted.) 108 The Committee and intervenors argue that FERC is allowing NEP, as a shareholder, to collect rates for Yankee companies' power which exceed those companies' FERC-approved rate schedules. Although FERC's method does not change the rate which Yankee companies collect from their customers, the Committee says the method effectively allows FERC to structure rates whereby NEP is able to earn a return on its Yankee investments greater than that envisaged in the Yankees' filed rate schedule and thus violates the filed rate doctrine. 109 The Supreme Court, in originating the filed rate doctrine, stated that (a utility) can claim no rate as a legal right other than the filed rate, whether fixed or merely accepted by the Commission .... Montana-Dakota Utilities Co. v. Northwestern Public Service Co., 341 U.S. 246, 251, 71 S.Ct. 692, 695, 95 L.Ed. 912 (1951). The considerations underlying the (filed rate) doctrine ... are preservation of the agency's primary jurisdiction over reasonableness of rates and the need to insure that regulated companies charge only those rates of which the agency has been made cognizant. City of Piqua v. FERC, 198 U.S.App.D.C. 8, 610 F.2d 950, 955 (1979) quoting City of Cleveland v. FPC, supra, 525 F.2d at 854. 110 FERC's predecessor agency recognized that differences in rates allowed individual utilities and associated returns are justified when predicated on differences in facts or management conditions. St. Michaels Utilities Commission v. FPC, 377 F.2d 912 (4th Cir. 1967). Although St. Michaels Utilities Commission deals with rate classes of one utility, not with a relationship between rates of two separate utilities, its underlying rationale is applicable here. The difference in return levels of NEP's Yankee investment and its investment in its own generating facilities is attributable to residence of those investments in two distinct sets of separate utilities, namely NEP-operating and the Yankee companies. Differences in rates and returns associated with those two sets of investments result from independent ratemaking processes, where the circumstances of each specific utility are considered. The return authorizable for NEP is therefore not necessarily limited to that authorized the Yankee facilities or to that authorized any other regulated industry in which NEP may have an interest. 26 111 Moreover, FERC methodology is more accurately characterized as separating, rather than as creating an upward adjustment of return on, NEP's Yankee investment. Hence FERC's method does not violate the filed rate doctrine. Nor do we consider the difference between the 12.75% rate of return and the 13.28% NEP-operating rate of return to have resulted from an adjustment in the latter to take further account (beyond that resulting from DCF analysis) of a shift in risk; rather, the difference comes about through a separation of the components of NEP-composite, and a calculation of a weighted average of the respective components' rates of return to deduce the implied 13.28% rate of NEP-operating. 112 The Committee claims that the return on equity rate is not just and reasonable when considered under the end result test of Permian Basin, supra, and other authorities. To upset FERC's determination, however, the Committee bears a heavy burden. FPC v. Hope Natural Gas, 320 U.S. 591 (1944) at 602, 64 S.Ct. 281 at 287, 88 L.Ed. 333. Ratemaking is a complicated process involving many factors, e.g., money market conditions, financial health of the utility, and financial risks. As the ALJ noted, 113 Mathematical computations used to support desired results relating to rates of return have the ring of authority, but simplistic formula approaches cannot be relied upon as sole determinants of a reasonable level of earnings for a regulated utility. Prudent judgment, consideration of the earnings of comparable companies and the requirements of the traditional Bluefield and Hope doctrines must be the basis for the determination of fair levels of earnings for regulated utilities. (Footnote omitted.) 114 The approaches used by witnesses for both NEP and other parties in deriving their recommendations for an equitable return for NEP are predicated upon the same basic data relating to earnings of comparable companies, historic earnings patterns of NEES, market prices of NEES securities, and related factors. In addition, these witnesses have made liberal use of various judgmental and subjective factors, including arbitrary adjustments relating to the estimated cost of equity, differences between cost of equity and bond yields, stock prices and other measures. 115 As we have noted, in arriving at just and reasonable rates, FERC is not bound to the service of any single formula or combination of formulas. FPC v. Natural Gas Pipeline Co., supra, 315 U.S. at 586, 62 S.Ct. at 743. The ALJ found a 13.5% return on equity reasonable. FERC reduced that rate to 13.28%. Further, the testimony and evidence indicating a required rate of return on equity ranging from 11.21% to 13.8% supports FERC determination of a 13.28% return. That determination, supported by substantial evidence, falls within the zone of protection from the authority of courts to set it aside. FERC v. Penzoil Producing Co., supra, 439 U.S. at 517, 99 S.Ct. at 771; Permian Basin, supra, 390 U.S. at 767, 88 S.Ct. at 1360. It cannot on this record be gainsaid that FERC's rate of return on equity determination may reasonably be expected to maintain NEP's financial integrity while providing appropriate protection to the relevant public interests, both existing and foreseeable. Permian Basin, supra, 390 U.S. at 792, 88 S.Ct. at 1373. FERC's rate of return on equity determination must therefore be upheld. 116