Opinion ID: 695143
Heading Depth: 1
Heading Rank: 3

Heading: the transition obligation

Text: 13 Under NEP's rate proposal, it will recover the cost of the transition obligation--the accumulated but unrecognized obligation to current employees--in rates over the next twenty years. Norwood challenges this arrangement, arguing that imposing the transition obligation on ratepayers over the next twenty years unfairly saddles them with a double obligation for both past and current accrual costs and that it constitutes unlawful retroactive ratemaking.
14 The Commission follows a general ratemaking principle of matching, by which ratepayers are charged with the costs of producing the service they receive. 61 F.E.R.C. at 62,214. The Commission's overall goal in authorizing the switch to accrual accounting is to conform the practice to the matching principle. The accrual method charges current customers for the costs associated with present employment. Under the pay-as-you-go method, by contrast, the matching principle is consistently violated, because current ratepayers are paying for retiree medical costs associated with past service. 15 The transition obligation, however, entails some violation of the matching principle. Under the new accrual method, the costs of the transition obligation are now deemed to have accrued in the past, and thus are associated with past service. The Commission recognized that [c]harging current ratepayers for the transition obligation is unquestionably charging for costs incurred to provide service to other, earlier ratepayers. 61 F.E.R.C. p 61,331 at 62,215. It concluded, however, that the transition obligation was not fatal to the switch because (1) the switch to the accrual method is overall more faithful to the matching principle, and (2) under Commission policy, some violation of the matching principle is acceptable when ratemaking conventions involving future expenses change. In particular, when ratemaking conventions change to recognize a previously unrecognized cost, some of which has already accumulated, the Commission allows the utility to make up for the amount that has already accumulated: the make-up provision is a permissible way to make a utility whole for properly deferred, prior period costs. Id. 16 The Commission has consistently allowed make-up provisions for prior deferred expenses similar to the one at issue here. For instance, the Commission has authorized utilities to amortize over ten years the costs of disposing of previously spent nuclear fuel once the utilities realize that the fuel must be disposed of rather than reprocessed as originally planned, see Virginia Electric & Power Co., 15 F.E.R.C. p 61,052 at 61,105, modified, 17 F.E.R.C. p 61,150 (1981), and has done the same with respect to previously unrecognized nuclear decommissioning costs. 61 F.E.R.C. p 61,331 at 62,215 (citing cases). Thus, the Commission's treatment of the transition obligation is squarely within Commission precedent, which allows exceptions such as this one to the general matching principle.
17 Nor does the transition obligation violate the proscription against retroactive ratemaking. The retroactive ratemaking doctrine prohibits the Commission from authorizing or requiring a utility to adjust current rates to make up for past errors in projections. If a utility includes an estimate of certain costs in its rates and subsequently finds out that the estimate was too low, it cannot adjust future rates to recoup past losses. City of Piqua v. FERC, 610 F.2d 950, 954 (D.C.Cir.1979) (quoting Nader v. FCC, 520 F.2d 182, 202 (D.C.Cir.1975)). As detailed below, however, the transition obligation does not run afoul of the retroactive ratemaking proscription, because NEP has not shifted any costs that it tried but failed to collect in the past: it always planned to collect these costs from future ratepayers, the only shift is timing within the future. 18 This court has upheld a transition provision much the same as the one at issue here against charges of retroactive ratemaking on the grounds that the past costs collected during the transition were costs that the utility had always planned to charge to future ratepayers. Thus, in Public Systems v. FERC, 709 F.2d 73, 84-85 (D.C.Cir.1983), we approved FERC's transition treatment of the switch from flow-through to tax normalization accounting. Like the transition at issue in this case, that transition required companies to collect money from future ratepayers that they would have accumulated from past ratepayers if they had been using tax normalization all along. 19 Both the shift to tax normalization and the shift to accrual accounting result in a sudden deficit that must be made up. To understand this parallel, a brief and schematic description of tax normalization is necessary. Tax normalization involves the accounting treatment of accelerated depreciation. For tax purposes, companies are authorized to use accelerated depreciation in certain circumstances. Under accelerated depreciation, the company pays less tax than it would under straight-line depreciation in the early years of the life of the equipment, and more tax than it would under straight-line depreciation in the later years of the life of the equipment. 20 This difference between accelerated and straight-line depreciation can be accounted for in two different ways. Under flow-through accounting, the company passes the difference between straight-line and accelerated depreciation directly to the ratepayers: ratepayers get the surplus between accelerated and straight-line depreciation in the early years, and they are charged for the deficit in the later years. Under tax normalization, by contrast, ratepayers are shielded from these effects of accelerated depreciation. The company charges the ratepayers the tax that they would be responsible for under straight-line depreciation throughout the life of the equipment. Thus, in the early years, the company collects more in rates than it pays in taxes to the IRS; in the later years, it collects less in rates than it pays in taxes. The company holds onto the surplus from the early years in a deferred tax account, and uses this surplus to make up for the deficit in the later years. 21 When the company switches from flow-through to tax normalization accounting, it does not have any accumulated surplus in its deferred tax account. Thus, for older equipment in its last years, the company owes more money in taxes than it can collect from its ratepayers under its new tax normalization procedure. The transition requires it to make up for this underfunding by collecting the money that it would have accumulated in its deferred tax account if it had been using tax normalization all along 3 --in much the same way that the transition from pay-as-you-go to accrual accounting requires the company to make up for money that would have been accumulated by that point if it had been using accrual accounting all along. 22 When FERC ordered the switch from flow-through to tax normalization accounting, it included a make-up provision, allowing utilities to collect over time that amount of money for their deferred tax account that they would have had if they had been using tax normalization all along. This court upheld the make-up provision against a charge that it constituted retroactive ratemaking: 23 Petitioners argue that the make-up provision is illegal retroactive ratemaking. Unlike the agency action in the cases cited by petitioners, however, the provision does not adjust for shortfalls in prior rates. It only adjusts future rates so that tax costs will not fall disproportionately on one rate-payer generation. Ratepayers are not charged for a greater tax allowance under the provision than they otherwise would be; they merely incur the cost over a different time period. 24 Public Systems, 709 F.2d at 85. 25 In sum, the switch from flow-through to tax normalization accounting is very similar to the switch from pay-as-you-go to accrual accounting. In each case, there is a quantity of money that the company (a) planned to collect from future ratepayers under the earlier method, but (b) would have collected from past ratepayers if it had been using the new method all along. In Public Systems, this court held that it is not retroactive ratemaking for the company to collect this quantity of money from future ratepayers over a set period of time because it was expected all along that this money would be collected from future ratepayers. The make-up provision changed only the timing of collection; it did not burden future ratepayers with charges that they would never have borne under the old system. By the same reasoning, the transition provision at issue in this case is not retroactive ratemaking. 26 Similarly, although Norwood points to Public Service Co. v. FERC, 600 F.2d 944 (D.C.Cir.), cert. denied, 444 U.S. 990, 100 S.Ct. 520, 62 L.Ed.2d 419 (1979), to support its claim of retroactive ratemaking, that case actually supports FERC's position. In Public Service, this court concluded that the collection of deferred costs did not constitute retroactive ratemaking so long as those costs were intended to be deferred all along. See id. at 950. Only if the company is not, in fact, collecting deferred costs, but instead attempting to make up for errors in earlier approximations of actual costs, does it engage in impermissible retroactive ratemaking. See id. 27 Public Service involved a company's transition between two methods of setting fuel costs. Under its original system, the company used a formula based on prior fuel costs to compute current fuel charges. Under the new system, the company used a formula that incorporated the actual cost of the fuel in the current billing month. In making the transition, the company sought to impose a temporary surcharge to make up for what it described as deferred charges still due under the earlier system: charges to make up the difference between the estimated and the actual cost. FERC disallowed this surcharge as retroactive ratemaking, and this court agreed. 28 This court explained that if the old system had simply been one of deferred billing, in which the intent all along was that the purchaser should pay the actual cost-of-service, but, due to difficulties in ascertaining that cost, the purchaser paid the prior cost on delivery and subsequently made up the difference--or deferred charge--then the companies could have collected the deferred costs after the transition. The court concluded, however, that this was not the intent of the old system. Rather, the old system used a formula based on the prior cost, but it was intended to approximate the actual cost. Because the old system was designed as a proxy, the company could not now go back and say, Our estimate was wrong, so make up the difference now. Thus, in the court's words, [w]hether approval of the proposed surcharges would be retroactive ratemaking depends upon one's characterization of the superseded fuel adjustment clauses: 29 If those clauses are viewed (as [the company does] as cost of service tariffs with deferred billing, then the requested surcharges--which merely assure that the utilities recover their fuel costs--would not be retroactive rate increases. But if the superseded clauses are viewed (as the Commission does) as fixed rate tariffs which used past costs as a proxy for the actual current cost, then the proposed surcharges would indeed be retroactive rate increases. 30 600 F.2d at 950. The court agreed with FERC that the earlier charges were intended as proxies for the actual costs and that the surcharges were thus impermissible retroactive ratemaking. 31 Thus, it is permissible for a company to defer collection of certain charges until the point at which they become ascertainable, so long as the ratepayers have notice that the charges will be collected in the future. It is not, however, permissible for a company to devise a formula intended to estimate actual charges--to serve as a proxy for actual charges--and then go back and collect any shortfall caused by imperfections in that proxy. 32 In this case, no party contends that NEP collected pension medical benefits on a pay-as-you-go basis as a proxy for the actual pension medical liability accruing to its current employees. Norwood argues only that the pay-as-you-go costs can serve as a proxy, not that they were intended to serve as a proxy. Thus, Norwood points to the finding of the ALJ that: 33 [H]owever it may offend purists in the accounting profession, the pay-as-you-go costs can be accepted as an approximation of the costs attributable to the current service period, even if they are not calculated on that basis. 34 60 F.E.R.C. p 63,006 at 65,084 (emphasis added). This claim that pay-as-you-go costs can serve as a proxy for the costs attributable to the current service period is highly contestable, 4 and at any rate irrelevant, because the relevant inquiry under Public Service is whether the pay-as-you-go costs were designed as a proxy for actual costs accruing for current employees. On that score, no one claims that NEP intended the pay-as-you-go costs as a proxy for the actual costs it was accruing. 35 In sum, because the transition provision only shifts the timing of collection of PBOP costs among future ratepayers, it does not constitute retroactive ratemaking under the law of this circuit.