Opinion ID: 1102627
Heading Depth: 2
Heading Rank: 1

Heading: Gulf States' Contentions

Text: As we apprehend Gulf States' position, it principally argues that the net operating income computed by the Commission for the test year should have been lower. (A lower income figure for the test year would necessitate additional revenues to be generated by a rate increase in order to produce the 8.7% rate of return on the rate base deemed to be the fair rate required.) In this regard, Gulf States principally contends: (A) The allowance as capitalized income of amount for funds devoted to construction work in progress (AFUDC) had the effect of adding the sum of $13,519,000 as phantom income, thus fictitiously decreasing the need for additional revenues to produce the 8.7% fair rate of return required. Gulf States suggests that, instead, the AFUDC income entry should be capitalized at $7.7 million, and that actual revenues should be provided by a rate increase so as to assure the utility a fair rate of return. (B) The expense items for state and federal income taxes should have been increased by $2,242,000 by permitting the utility to show its tax liability for the year in question by the accepted accounting method of the normalization of income. This would necessitate a rate increase to provide revenues to balance this additional expense item. Gulf States further argues, more comprehensively: (C) That the net effect or end result of the Commission's various rulings on these and other issues is that, in cumulation, insufficient present revenues are allowed to the utility for it to maintain its financial integrity and to attract the immense capital funds (estimated at $650,000,000 during 1977-78 alone) necessary for it to convert to fuel oil, coal, and nuclear generating facilities, due to the energy crisis presented by the unavailability in the future of natural gas. The utility further suggests that the fictitious income figure of $13,519,000 AFUDC (or at least that in excess of $7.7 million suggested as appropriate by the utility) has resulted in a cash flow crisis, by which the utility is forced to borrow money to pay dividends to its stockholders. These contentions will be discussed under subheadings A, B, and C of this part (I) of this opinion.
A general rule of utility regulation is that ratepayer-consumers should only pay the utility company a fair return on facilities and capital actually used and useable for production of service to these ratepayers. Under this principle, the utility has not usually been permitted in the past to include in its rate base, or to expense, the cost of construction work in progress (CWIP). (However, when the new construction is placed in service, the utility is entitled to earn a fair rate of return on and recover through depreciation (from then current ratepayers) all of its capital expenditures so incurred, including the cost of capital.) Arguably, however, the cost of such construction represents an expenditure for the ultimate benefit of present consumers, so that charging them in current rates for such costs is not unreasonable, especially insofar as the expenditures are for pollution-control or other social reasons not directly resulting from the intention to increase revenues. A minority of regulatory commissions do adopt this approach urged upon us by Gulf States. Gulf States strongly contends that, with the huge capital demands occasioned by the enormously expensive cost of converting generation facilities to nuclear and other sources of energy, this previously minority approach is the only fair one under the present energy-crisis conditions. The issue is not, however, what accounting approach seems most reasonable to the courts upon judicial review. It is, rather, whether the regulatory commission has adopted an unreasonable or arbitrary approach which prevents the utility company from receiving a fair return upon its investment. See South Central Bell (1977) quoted at length above, and authorities cited therein. A substantial number, probably a majority, of regulatory commissions do not permit the utilities to recover from present consumers the present cost of construction work in progress (CWIP) of facilities which will be devoted to the service of future consumers. In a number of American jurisdictions, the courts have upheld the actions of some of these regulatory commissions in completely excluding CWIP from the rate base. [2] Yet others of these regulatory commissions (i.e., those which do not require present consumers to pay for CWIP for future plant) follow, as does the Louisiana Public Service Commission, the widely accepted practice of permitting the utility to include CWIP in its rate base for purposes of calculating the rate of return, yet making an adjustment to income (AFUDC, or Allowance for Funds Used During Construction) to offset the inclusion of CWIP in income. [3] In the present case, for instance, the Commission permitted the utility to include within its rate base of $608,296,000 the sum of $155,395,000 of CWIP. The allowable 8.7 per cent fair rate of return upon this figure would require a return of $13,519,000 in additional revenues occasioned by the inclusion of CWIP in the rate base. To offset the inclusion of CWIP in the rate base (and thus to prevent present ratepayers from being charged for future plant not yet in service), the Commission calculated the offsetting AFUDC in the income column at the same figurei.e., $13,519,000, or 8.7% of the CWIP allowed in the rate base column. [4] This also approximates the 8.6% present interest-cost of acquiring capital by the issuance of bonds to accomplish the construction work, see Tr. 1758. Gulf States does not contest in principle the allowance in question (AFUDC), but only the inclusion of $2,002,000 of it as occasioned by construction work in progress related to non-revenue producing mandatory pollution control facilitieswhich (as a social requirement for both present and future ratepayers) should, the utility argues, be expensed and charged to current ratepayers, instead of being capitalized and added to the rate base only after the construction work is completed (at which time only the ratepayers whom the facilities are actually serving will pay for them). The utility also contends that the Commission arbitrarily used the rate of return of 8.7% upon such funds (as fictitious income) instead of 7.5%, the rate previously used by the Commission; using this lower percentage would additionally reduce the AFUDC income by $1,864,000. Considering the purposes of AFUDC to compensate for the inclusion of CWIP in the rate baseas well as the widely if not universally accepted regulatory principle that regulatory commissions may within their discretion prevent the utilities from charging present ratepayers for the cost of CWIP for plant not yet in serviceit seems apparent that the Commission did not act arbitrarily in its treatment of the CWIP-AFUDC issue. In accordance with accepted principles applicable within its discretion, it did not require present ratepayers to pay for plant not yet in use (whether constructed for pollution-control or for other purpose). Further, it was not arbitrary in calculating AFUDC based on the present cost of capital and fair rate of return of 8.7%, rather than on the basis of the 7.5% allowed as to this utility in the past based on the cost and return allowable in the past under the then -current market conditions. Ultimately, the issue is one of regulatory policy within the constitutional choice of the Commission and not of the courts. As the Commission stated, in explaining its choice (made accordingly to widely accepted regulatory principles), Tr. 1740: The question of whether to capitalize AFUDC, which represents the capital costs associated with CWIP, then, is philosophical in nature: should a present-day ratepayer be required to pay for all or part of the capital costs associated with a plant not used or useful to him, or should these costs be capitalized and depreciated later, which has the effect of passing those costs along to future ratepayers who will actually use that plant? The principle of capitalizing AFUDC reflects the latter type of treatment. The Commission believes that it is appropriate to adhere to the accepted regulatory principle that ratepayers should pay only for that plant which presently benefits them. Future ratepayers will benefit from construction work in progress and from the capital costs associated with this construction. In the absence of special circumstances, these costs should be deferred until the plant is in service and recouped by the company at that time; therefore, capitalization of AFUDC is appropriate.
Gulf States contends that the Commission was arbitrary in refusing to allow it to use, for rate-making purposes, an accepted accounting procedure which normalizes (i.e., hypothesizes tax liability as if incurred on such a basis) tax liability in accordance with straight-line depreciation of the utility's property. Instead, the Commission required the utility to show as an expense the lesser tax liability which actually resulted from the utility's actual use, for tax purposes, of the accelerated depreciation of capital items permitted by tax regulation to lessen the actual tax liability for the period in question. What Gulf States proposed to doand was overruled by the Commissionwas to take the accelerated depreciation for tax purposes (thus decreasing the actual taxes paid), but to charge ratepayers by including only normal depreciation in the expenses for purposes of calculating net incomeas if it had paid greater taxes on this latter basis. Again, we have a choice of policy by the regulatory Commission which is in accord with the practice of a number of other regulatory agencies and which does not appear to be an unreasonable choice of accounting method for rate-making purposes. See Appendix 1, for full quotation from the Commission's reasons in its order. Under accepted principles of judicial review of regulatory agency determinations within its expertise and constitutionally entrusted to its authority, we cannot set aside the Commission's determination as unreasonable or arbitrary. C. The End Result of Commission Order Allegedly Fails to Take into Account the Deteriorating Financial Condition of the Utility and its Necessity for a Rate Increase to Maintain its Financial Integrity. More comprehensively, Gulf States argues that, whatever the individual merits of the Commission's various rulings, in cumulation they did not produce as an end result a fair and equitable rate of return. It cites the principle enunciated by the United States Supreme Court, In re Permian Basin Rate Cases, 390 U.S. 747, 791-92, 88 S.Ct. 1344, 1372-73, 20 L.Ed.2d 312 (1968): The Commission cannot confine its inquiries either to the computation of costs of service or to conjectures about the prospective responses of the capital market; it is instead obliged at each step of its regulatory process to assess the requirements of the broad public interests entrusted to its protection by Congress. Accordingly, the `end result' of the Commission's orders must be measured as much by the success with which they protect those interests as by the effectiveness with which they `maintain    credit and    attract capital.' It follows that the responsibilities of a reviewing court are essentially three. First, it must determine whether the Commission's order, viewed in light of the relevant facts and of the Commission's broad regulatory duties, abused or exceeded its authority. Second, the court must examine the manner in which the Commission has employed the methods of regulation which it has itself selected, and must decide whether each of the order's essential elements is supported by substantial evidence. Third, the court must determine whether the order may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection to the relevant public interests, both existing and foreseeable. The court's responsibility is not to supplant the Commission's balance of these interests with one more nearly to its liking, but instead to assure itself that the Commission has given reasoned consideration to each of the pertinent factors. (Italics supplied by us.) Gulf States argues that, unless a rate increase is ordered, it cannot perform its legal obligation to provide reliable electric service to meet the future needs of Louisiana consumers. Due to the energy crisis and the shortage and approaching unavailability of natural gas supplies, the utility must convert its generating facilities to those fueled by heavy oil, coal, and nuclear powerfar more expensive generating facilities than needed under past conditions, requiring much longer construction periods (and thus tying up much greater proportions of capital, upon which no revenues may be generated through utility rates) than in the past. In brief, the utility points out: In order to fulfill that obligation, and based upon conservative projections of future demand growth, the Company has had to undertake a construction program that will require the raising of $1.6 billion over the next 5 to 6 years. This monumental capital undertaking, which is an amount equal to the total assets of this 50 year-old company, translates into external financing of $950,000,000 through the sale of long-term debt, preferred stock, and common stock, with the remaining $650,000,000 of funds to be internally generated through depreciation, retained earnings, and deferred taxes. Gulf States points out a number of indicia of its deteriorating financial condition. See Appendix 2 for listing. It argues that it is in a cash flow crisis (instanced, for example, allegedly by the utility's necessity to borrow funds to pay dividends), largely resulting from the immense construction in progress required to provide for future needsand resulting also from the allowance as phantom income of AFUDC credits to decrease rate-generated revenues to an extent and in a proportion unimaginable under past social conditions. Gulf States forcefully argues that, because of these factors, its deteriorating financial position will make it impossible for it to attract the equity investors and bondbuyers necessary to raise the huge amount of capital outlay immediately required in order for Gulf States to provide for the future needs of Louisiana consumers of electricity. Forceful as these arguments are, neither the present record nor the statistics concerning other utilities indicate that Gulf States is in any immediate financial crisis or that in the immediate future it will have difficulty in raising funds needed for the capital outlay necessary to construct the generating facilities required. Gulf State's financial condition, while perhaps less strong than formerly, is not shown to have suffered adverse effects not comparable to those experienced by similar utilities under the conditions of energy crisis and inflation of the Seventies. Gulf States, for instance, still enjoys an AA bond rating, enabling it and the minority of other electric utilities so rated to borrow money at a lower rate (the record shows 8.6% for the test year) than the other 73 electric utilities with a lower rating. Under analysis, the claim that Gulf States had to borrow money to pay its dividends is unimpressively based on the circumstance that the company's borrowing, during the test year that the amount of dividends were paid, exceeded the net income (or cost of (return on) equity) allocable for rate-making purposes for that purpose. This condition, however, was shared by 22 of the 40 comparable electric utilities. The argument fails to take into consideration that, for rate-making purposes, many non-cash items (available in fact for distribution as dividends) are likewise treated as an expense item, in determining the fair rate of return on the rate base. The return on equity allowed as a cost in computing net operating income for rate-making purposes, being the amount necessary to attract new capital and to compensate present investors fairly, does not necessarily coincide with the actual dividends paid, which may additionally be based upon profits reflected (for rate-making purposes) as non-cash expensed items or from past profits. The borrowing of the utility during the year was no more for the purpose of paying dividends than it was for the purpose of paying wages; indeed, the sums were simply borrowed in the ordinary course of the utility's business, in accordance with customary practices of other utilities and large corporations. The Commission found that during the test year Gulf States enjoyed a rate of return of 9.15% on its rate base and a return of 13.84% on equity, at rates more than sufficient to attract the capital needed for expansion. [5] These findings are supported by the record, under the Commission's reasonable evaluation of the evidence. We find no reason to disturb these findings, under accepted principles of judicial review of a regulatory agency's determinations. In so holding, we note the Commission's concern, see Tr. 1744, 1759, and our own, over the large construction outlays required of Gulf States and that these outlays may, at some point in the future, require the Commission to reevaluate its traditional treatment of Construction Work in Progress (CWIP) and Allowance for Funds Used During Construction (AFUDC), so as to require present consumers to pay at least a portion of such costs. Ultimately, we are unable under the present record to find that the Commission was unreasonable or arbitrary in its determination that such point in time has not yet been reached.