Opinion ID: 1926458
Heading Depth: 1
Heading Rank: 1

Heading: Elements of Rate-Making

Text: The primary purpose of the ratemaking process is to set rates at such a level that the utility's revenue will be sufficient to permit the utility both to pay its legitimate operating expenses and to provide a return on investment adequate to compensate existing investors and attract new capital as it is required. See, Jones, Judicial Determination of Public Utility Rates: A Critique, 54 B.U.L.Rev. 873, 875 (1975) [hereinafter referred to as Jones]. When this level is achieved the utility's revenues produce a fair rate of return. The legal standard for determining a fair rate of return was articulated in two well known cases: Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 88 L.Ed. 333 (1944); Bluefield Waterworks & Improvement Co. v. Public Service Commission, 262 U.S. 679, 692-93, 43 S.Ct. 675, 67 L.Ed. 1176 (1923). In Federal Power Commission v. Hope Natural Gas Co., supra , the Supreme Court observed: Rates which enable the company to operate successfully, to maintain its financial integrity, to attract capital, and to compensate its investors for the risks assumed certainly cannot be condemned as invalid.    Id. 320 U.S. at 605, 64 S.Ct. at 289. Once the regulatory agency has determined the amount of annual revenue required by the utility to produce a fair rate of return the agency will consider the question of rate design: that is, the rates each class of consumers should pay in order to produce the annual revenues required for a fair rate of return. In the instant case we are not concerned with rate design, but our basic concern is whether the annual revenue requirement of the utility was fairly and reasonably determined by the public service commission. The general approach of a regulatory agency in determining whether an existing rate structure is producing inadequate or excessive revenues is well established. The agency first selects a test year, normally the most recent annual period for which complete financial data are available, and calculates the utility's revenues, expenses and investments during the test period. The utility's revenues minus its expenses, exclusive of interest, constitute the earnings or the return that is available to be distributed to the utility's stockholder and creditor investors. The total amount of investment in a utility employed in providing its service, the utility's rate base, is determined by adding the investment in physical properties to an allowance for working capital. The agency then decides whether the actual rate of return, the ratio of return to rate base, is deficient, adequate or excessive. Jones, supra, at 876. See also, J. Bonbright, Principles of Public Utility Rates, 147-283 (1961) [hereinafter referred to as Bonbright]; 1 A. Priest, Principles of Public Utility Regulation, 45-226 (1969) [hereinafter referred to as Priest]. For example, if a utility's rate base during the test year was $100,000,000 its test-year revenues $35,000,000, and its test-year expenses, exclusive of interest, were $28,000,000, then the utility's return would be $7,000,000 and its rate of return would be seven per cent. If the fair rate of return is six per cent, a rate reduction would be appropriate. If seven per cent is fair, no rate change would be required. If eight per cent is the fair rate of return, a rate increase would be justified. See Jones, supra, at 876. The final calculations involved in determining the utility's revenue requirement, as thus summarized, are relatively simple. However, to arrive at the ultimate figures used in these calculations requires extensive examination of the utility's operations and frequent exercise of informed judgment. Every aspect of the utility's operations during the test year must be examined in order to determine the extent to which the figures it has received from the utility are representative of the figures that will, or should, prevail in the future. Ideally, the agency should conduct an audit to insure that the utility's books accurately describe the revenues, expenses and investment and that proper accounting procedures have been followed. The auditing may lead the agency to question whether particular expenditures or investments are properly chargeable to utility operations, whether capital expenditures have been improperly charged to operating expenses or operating expenses improperly capitalized, whether accruals for reserves have been made at appropriate levels, and whether any expenses incurred during the test year are properly chargeable to some other period of time. If the rate making agency determines that any such matter has been improperly treated from a regulatory standpoint, appropriate adjustments must be made to the operating results. As we shall see, two of the contested issues in the instant case involve whether the public service commission acted reasonably in adjusting the utility's treatment of particular investment, expense or revenue items.