Opinion ID: 1970117
Heading Depth: 1
Heading Rank: 2

Heading: Rate Base Calculation

Text: The rate base of a publicly regulated utility is a dollar amount representing the utility's net plant investment. The usual formula for calculating rate base is capital investment plus improvements minus depreciation. In re Towne Hill Water Co., 139 Vt. 72, 75, 422 A.2d 927, 928 (1980). After determining a utility's rate base, the Board determines rates for the utility that represent a fair rate of return on that investment. Green Mountain Power Corp., 162 Vt. at 381, 648 A.2d at 376. Straightforward application of this formula to QSC is complicated, however, by the gaps and inconsistencies in QSC's financial records. QSC has not operated as a regulated utility for most of its twenty-year history. Neither the Board nor the parties had the benefit of the type of complete and careful financial records required of regulated utilities. Rather, the Board had the difficult task of calculating a rate base for a company with fragmentary financial records, casual financial connections with affiliates, and multiple changes of ownership. No audited financial statements were available for QSC, and few were available for its affiliates. In the face of these obstacles, the Board attempted to apply the formula to achieve a just and reasonable result, based on the information available to it. Choosing a method to calculate rate base is a matter that is within the Board's expertise. In re Young's Community TV Corp., 141 Vt. 53, 56, 442 A.2d 1311, 1313 (1982); see also Duquesne Light Co. v. Barasch, 488 U.S. 299, 315-16, 109 S.Ct. 609, 619-20, 102 L.Ed.2d 646 (1989) (constitution does not compel single theory of ratemaking; within broad limits, states are free to decide what methodology best meets their needs in balancing interests of utility and public); Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 287, 88 L.Ed. 333 (1944) (agency not bound to use of any single formula in determining rates; it is result reached, not method used, that is controlling). We will uphold the Board's determination unless it is shown to be clearly erroneous. Green Mountain Power Corp., 162 Vt. at 380, 648 A.2d at 376.
In calculating QSC's rate base, the Board was concerned with crediting QSC's customers for both the depreciation of QSC's assets since construction, and for the contributions in aid of construction made by QSC customers. [1] See id. at 383, 648 A.2d at 378 (once customers have returned portion of utility's investment, they should not be required to pay for that portion again). The Board's rate base calculation thus begins with the original cost, and reduces that amount by the percentage of the cost recovered through sales of lots. The unrecovered original cost is then depreciated. Finally, expenditures for additions subsequent to the original investment are added to the depreciated unrecovered original cost to yield QSC's rate base. QSC's first objection to the Board's rate base calculation is the reduction based on the percentage of cost recovered through sales of lots. Although recognizing that its original cost must be reduced to some extent for customer contributions in aid of construction, QSC argues that those contributions should be calculated based solely on the connection fees paid by purchasers of lots in the subdivision to connect to the sewer system. The Board chose instead to calculate customer contributions using the percentage of QLC's development costs recovered through lot sales. That is, the Board assumed that each time QLC sold a lot, it recovered a proportional share of its overall development costs, including the cost of constructing the sewer plant. While part of that cost may have been labelled connection fee, the rest would have been built into the price of the lot. The Board's decision is supported by the evidence. QSC is part of a larger development scheme. The Board found that QLC expected to recover all of its investment cost, including investment in sewage facilities, through lot sales and connection fees. Cf. In re Eastman Sewer Co., 138 N.H. 221, 636 A.2d 1030, 1031 (1994) (upholding finding of public utility commission that sewer company recovered the cost of its system through condominium and lot sales). By calculating customer contributions using percentage of costs recovered through lot sales, rather than the amounts labelled connection fees, the Board merely recognized that buyers of land are generally concerned only with the total price, not with the relative amounts included within that price. Although challenging the Board's calculation of customer contributions as result oriented, QSC's argument is limited to a claim that only those payments from customers labelled connection fees should be subtracted from rate base. QSC does not attempt to explain the fatal flaws in its argument: if QLC recovered the cost of the sewer facilities only through connection fees, then QLC (1) recovered none of its cost from hundreds of purchasers of condominiums, who paid no connection fee, and (2) would not have recovered the entire cost of the sewer facilities even if every lot in the subdivision sold, because the connection fees were not sufficient to repay QLC for its investment in the sewer facilities. In light of these unlikely propositions, the Board reasonably concluded that QLC intended to recover its investment in the sewer facilities through lot sales as well as connection fees. QSC further argues that if the Board reduces its rate base by the percentage of costs recovered through lot sales, then the Board may not also reduce QSC's rate base by straight-line depreciation. According to QSC, this calculation double counts QSC's depreciation, because the Board is treating the sewer facility as both a separate depreciable asset and as a component of QLC's cost of nondepreciable real estate inventory. [2] The Board, QSC claims, may apply only one method of calculating rate base: either by depreciation and connection fees as established by QSC, or by costs recovered through lot sales and connection fees. In calculating QSC's rate base, the basic question before the Board was how much of the cost of the sewer facilities was paid for by QSC's customers. We do not accept QSC's argument that the Board could consider customer contributions either through lot sales, or through depreciation, but not both. Had QSC been a regulated company, depreciation would have reduced QSC's rate base over the past twenty years. See, e.g., Green Mountain Power Corp., 162 Vt. at 384, 648 A.2d at 378 (Board erred by failing to adjust rate base for interim-year accumulated depreciation). Customers may pay for utility plant costs both through contributions in aid of construction, which reduce the utility's net investment, and through depreciation, which is charged to customers over time. As depreciation is based on investment net of contributions in aid of construction, this calculation does not double-count depreciation. Moreover, the Board found that QSC's rates, particularly in the five years preceding regulation, were sufficiently high to repay investors for their depreciation expense. QSC contends, however, that labelling a portion of its preregulatory profits as depreciation constitutes retroactive ratemaking. QSC claims that the Board, in effect, is attempting to refund customers for excessive past rates by reducing QSC's rate base. QSC is correct that the Board may not set rates for regulated utilities that are intended to redress past inequities. That is, the Board may not set rates that credit customers for past overpayments or repay the utility for past shortfalls. In re Central Vt. Pub. Serv. Corp., 144 Vt. 46, 53, 56, 473 A.2d 1155, 1159, 1160 (1984). In the context of this case, the Board would be engaging in retroactive ratemaking if it set artificially low rates for QSC to make up for purportedly excessive rates paid by customers in past years. But there is no dispute here with the prospective rates set by the Board. Rather, QSC challenges the Board's conclusion that a certain portion of the monies collected by QSC through its preregulatory rates must be deemed depreciation. The Board made an assumption, one that, in our view, was reasonable under the circumstances of this case, that over the many years since the sewer facilities were built, QSC's customers have been funding depreciation expense on the unrecovered cost of the sewer facilities. This assumption is supported by the fact that QSC's rates were sufficiently high to include a charge for depreciation. Moreover, depreciation is a normal operating expense for a utility, as for any business with substantial capital investment. See City of Knoxville v. Knoxville Water Co., 212 U.S. 1, 13-14, 29 S.Ct. 148, 152, 53 L.Ed. 371 (1909) (before coming to question of profit, utility has both right and duty to set aside earnings sufficient to make good depreciation on its property). Indeed, if the Board had not reduced QSC's rate base to account for depreciation, QSC's customers would have been forced to pay a portion of the plant investment twice, once as depreciation expense and again as a return on plant value. Green Mountain Power Corp., 162 Vt. at 383, 648 A.2d at 378. Nor do we accept QSC's claim that the Board improperly based its rate base calculation on the fair value of its sewer facilities. QSC has mischaracterized the Board's decision. The Board did note the effects of time on the sewer facilities, pointing out that QSC's property is in poor condition. In so doing, however, the Board merely underlined the unfairness that would result if QSC's rate base were not adjusted for depreciation. QSC's dispute with the Board's methodology can be summarized as a complaint that the Board deviated from generally accepted utility accounting principles in calculating QSC's rate base. QSC fails to suggest, however, how those principles can be applied to a utility that for twenty years failed to follow them. Preregulation, QSC was not obligated to follow the principles applicable to public utilities, and is therefore entitled to some latitude with respect to its financial records. Nevertheless, QSC cannot insist that the Board now adhere strictly to those principles in calculating QSC's rate base, where to do so would produce an unfair result. Although QSC has suggested alternative approaches to calculating the company's rate base, QSC has not demonstrated that the method chosen by the Board was clearly erroneous.
QSC also contests some of the numbers used by the Board in the rate base calculation. Specifically, QSC argues that the Board overestimated the percentage of investment costs recovered through lot sales. The Board concluded that QLC recovered its cost for the sewer facilities only from the sale of lots that could be served by the sewer facilities. As most of these lots were sold, under the Board's calculation most of the cost was recovered. QSC argues that the cost of the sewer facilities was, like other capital costs, intended to be spread across all of the potential lot sales. Because a large number of the lots that QLC obtained legal approval to sell were never sold, or in some cases even subdivided, using QSC's suggested figures yields a much smaller percentage of recovered investment costs. The hearing officer in his report to the Board used the figures now suggested by QSC. The hearing officer found that QLC had the right to sell a total of 2154 lots and that it had sold approximately 1269 lots. The latter figure uses memberships in the homeowner's association as a proxy for the number of lots sold. Using these numbers, the hearing officer estimated that 58.1% of the investment in the sewer facilities had been recovered. Rejecting this calculation, the Board instead found that only 1532 of the Quechee lots could actually be served by QSC, and that QSC itself reported that 1470 lots had been sold. The Board thus concluded that 95.95% of the investment costs had been recovered. The numbers used by the Board, however, were based on an exhibit that contained a clerical error. Recognizing this error, we remanded the case to the Board for reconsideration of the rate base calculation. On remand, the parties agreed to two numbers: first, that the subdivision contains 1522 separate properties that are able to receive sewer services, and second, that of those properties, 1493 have been sold or transferred in such a way that the developer had an opportunity to recover its investment costs. Based on these numbers, 98.095% of the investment in the sewer facilities has been recovered. As the parties now agree on the relevant figures, the only question for this Court is whether the Board erred in concluding that QLC recovered the cost of the sewer facilities only through sales of lots able to receive sewer services. The Board's conclusion is supported by the record. QSC is not capable of serving 2154 lots; only 1522 lots are benefitted by sewer mains. The Board reasonably assumed that QLC intended to recover its investment in the sewer facilities from the purchasers of lots served by those facilities. The Board's calculation does not conflict with its finding that QLC considered the sewer system to be a development cost, like road construction and the clubhouse complex, that would be recovered through lot sales. The Board did treat the sewer system as a development cost recovered through lot sales. Unlike amenities intended for the use of all potential purchasers of lots, however, the sewer system serves only a certain number of lots. If, for example, QLC had built a golf course for use only by owners of single-family homes in the subdivision, QLC would not have intended to recover that cost from purchasers of condominium units. Similarly, the purchaser of a lot not served by the sewer system would not expect to be charged for the construction of that system. As QLC sold 98.095% of the lots served by the sewer system, the Board did not err in calculating that QLC recovered the same percentage of its investment in the system.
QSC also argues that the Board confiscated its rate base in violation of the Fourteenth Amendment to the United States Constitution. As we have previously recognized, public utilities in Vermont have a right to a reasonable, nonconfiscatory rate of return. See Arlington Selectmen v. Arlington Water Co., 136 Vt. 495, 498, 394 A.2d 1130, 1131-32 (1978). That right has a constitutional dimension. See Duquesne Light Co., 488 U.S. at 310, 109 S.Ct. at 617 (At the margins, these questions [as to whether specific rates are unjust or unreasonable] have constitutional overtones.). QSC's investors are entitled to a return on their investment, however, not on the investment of others; that is why customer contributions to plant investment are deducted from rate base. See Eastman Sewer Co., 636 A.2d at 1032. As the Board reasonably concluded that most of the investment in the sewer system was recovered from QSC's customers, the Board did not confiscate QSC's rate base by excluding those customer contributions from its rate base calculation.