Opinion ID: 1435591
Heading Depth: 3
Heading Rank: 1

Heading: Whether the finding of an 8.95% rate of return is supported by reliable, probative and substantial evidence.

Text: In Decision and Order No. 4123 at pp. 22-23 the Commission found that: (1) HELCO is not earning the 8.95 rate of return allowed by the Commission in Decision and Order No. 3499, Docket No. 2186 (1974) but rather a rate of return substantially lower than allowed in that case; (2) HELCO's composite cost of capital has increased from 8.95% in 1973 to 9.32% at the end of the test year 1974 because of increased embedded cost of bonds and preferred stock (utilizing the same 13% return on common equity);       (4) due to continued inflation and increased costs of capital since Decision and Order No. 3499 in Docket 2186 (1974), there is evidence to justify in this case a rate of return of 8.95%; and (5) since the Company has only requested an 8.95% rate of return and has based its rate increase request on this figure, the Commission adopts an 8.95% rate of return in its order. The Division argues that the record reflects no reliable, probative, substantial evidence to support the Commission's finding that 8.95% was a reasonable or fair rate of return. A return is deemed fair or reasonable if it produces a fair rate of return on the rate base. Mechanic Falls Water Co. v. Public Utilities Commission, supra, 381 A.2d at 1095; Pennsylvania Gas and Water Co. v. Commonwealth, 33 Pa. Cmwlth. 143, 381 A.2d 996 (1977); Peoples Natural Gas Division v. Public Utilities Commission, Colo., 567 P.2d 377 (1977). A fair return is the percentage rate of earnings on the rate base allowed a utility after making provision for operating expenses, depreciation, taxes and other direct operating costs. Honolulu Gas Co. v. Public Utilities Commission, 33 Haw. 487 (1935); Narragansett Electric Co. v. Harsch, 117 R.I. 395, 368 A.2d 1194 (1977); Providence Gas Co. v. Burman, R.I., 376 A.2d 687 (1977); Mechanic Falls Water Co. v. Public Utilities Commission, supra, 381 A.2d at 1095. Out of such allowance the utility must pay interest and other fixed dividends on preferred and common stock. Honolulu Gas Co. v. Public Utilities Commission, supra, 33 Haw. at 518-519; 1 Priest, Principles of Public Utility Regulation 191 (1969). In determining a rate of return, the Commission must protect the interest of a utility's investors so as to induce them to provide the funds needed to purchase plant and equipment, and protect the interests of the utility's consumers so that they pay no more than is reasonable. Honolulu Gas Co. v. Public Utilities Commission, supra, 33 Haw. at 495; Providence Gas Co. v. Burman, supra, R.I., 376 A.2d at 699-700; Narragansett Electric Co. v. Burke, R.I., 381 A.2d 1358 (1977), cert. denied, 435 U.S. 972, 98 S.Ct. 1614, 56 L.Ed.2d 63 (1978); In re Application of Wilmington Suburban Water Corp., 367 A.2d 1338 (Super.Ct.Del. 1976); Commonwealth v. Virginia Electric and Power Co., 211 Va. 758, 180 S.E.2d 675 (1971). To calculate the rate of return, the costs of each component of capital  debt, preferred stock and common equity  are weighted according to the ratio each bears to the total capital structure of the company and the resultant figures are added together to yield a sum which is the rate of return. South Central Bell Telephone Co. v. Louisiana Public Service Commission, La., 352 So.2d 964 (1977), cert. denied, 437 U.S. 910, 98 S.Ct. 3103, 57 L.Ed.2d 1142 (1978); City of Evansville v. Southern Indiana Gas and Electric Co., Ind. App., 339 N.E.2d 562 (1975). The proper return to be accorded common equity is the most difficult and least exact calculation in the whole rate of return procedure since there is no contractual cost as in the case of debt or preferred stock. South Central Bell Telephone Co. v. Louisiana Public Service Commission, supra, La., 352 So.2d at 964; Narragansett Electric Co. v. Harsch, supra, 117 R.I. at 425, 368 A.2d at 1211; Butler, The Rate of Return in Texas  The Neglected Issue, 28 Baylor L.Rev. 937 (1976). As the court pointed out in South Central Bell Telephone Co. v. Louisiana Public Service Commission, supra, La., 352 So.2d at 973: Equity capital does not always pay dividends; all profits after fixed charges accrue to it and it must withstand all losses. The cost of such capital cannot be read or computed directly from the company's books. Its determination involves a judgment of what return on equity is necessary to enable the utility to attract enough equity capital to satisfy its service obligations. The Commission adopted 13% as the return on equity which HELCO would achieve at an 8.95% rate of return and the Division argues that the 13% return to equity capital is not supported by the evidence. The Commission agreed with HELCO that it could utilize HECO's cost of equity as its own cost of equity since HECO supplies all of the common equity for HELCO. The Division questions the propriety of using HECO's cost of equity capital to determine the adequacy of HELCO's rate of return. The Commission's adoption of HECO's cost of equity capital as HELCO's cost of equity capital is hardly unprecedented. HELCO, as we have stated earlier, is a wholly-owned subsidiary of HECO. HELCO, as a wholly-owned subsidiary, issues no stock to the public. Consequently, HELCO's cost of equity is determined solely by HECO's cost of equity since a portion of each share of HECO's common stock represents an investment in HELCO. Use of the parent's capital structure has been criticized on the grounds that it fails to recognize, inter alia, that each subsidiary may experience significant differences in operating and financial risks. South Central Bell Telephone Co. v. Louisiana Public Service Commission, supra, La., 352 So.2d at 971. Nevertheless, when a parent owns all or virtually all of the common stock of a subsidiary, the cost of equity to the subsidiary can only be reckoned on the basis of the cost of equity capital to the parent and most commissions have recognized this relationship between a corporate subsidiary and its parent. Re United Telephone Co. of the West, 12 P.U.R.4th 462 (1975); Re Southwestern Bell Telephone Co., 98 P.U.R.3d 30 (1973); Re Columbia Gas of Kentucky, Inc., 2 P.U.R.4th 109 (1973); Re Northern States Power Co., 3 P.U.R.4th 388 (1973); Re Columbia Gas of New York, Inc., 97 P.U.R.3d 489 (1972). In this case as is typical, to support the recommended 13% common equity return rate, HELCO's expert witness relied on comparable earnings studies which consisted of evidence showing the earnings rate of other companies. HELCO presented four exhibits containing information on the return on common equity for various companies. The first exhibit shows the average return on common equity earned by thirteen utilities during 1970-1974, which average ranged from 11.7% to 13.8%. The second exhibit lists the authorized average return on common equity (14.15%) for the same thirteen utilities. The third exhibit shows the average return on common equity (13.8%) authorized for twenty-four utilities in their most recent rate cases. Finally, the fourth exhibit provides the average return on common equity actually earned (14%) for 1200 companies representing nearly every business activity in the nation. In short, HELCO relied on the language of the United States Supreme Court in Bluefield Water Works & Improvement Co. v. Public Service Commission, 262 U.S. 679, 692, 43 S.Ct. 675, 679, 67 L.Ed. 1176 (1923), indicating that utilities should be permitted to earn rates equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding risks and uncertainties. [2] The Division argues that the exhibits, which represent HELCO's comparable earnings test, do not reflect reliable, probative and substantial evidence of HELCO's return on common equity because the companies are not comparable in risk and uncertainty with HELCO, but with HECO. However, as we have already decided that use of HECO's cost of common equity was not improper, we find no merit in the Division's contention. The Division further argues that, even assuming that use of HECO comparables is proper, the companies included in the four exhibits were not shown to have risks comparable to HECO. Despite the limitations of the comparable earnings test, these comparable earnings studies present useful information in assisting the Commission to arrive at an equity return cost. [A] comparison of companies within a relatively wide range of risk with appropriate adjustments is proper... Leventhal, Vitality of the Comparable Earnings Standard for Regulation of Utilities in a Growth Economy, 74 Yale L.J. 989, 999 (1965). In some manner, every utility is unique and individual. No utility has a risk corresponding exactly to that of another. But comparisons between utilities provide an important method to arrive at a fair return on common equity. Therefore, imperfect but reasonable comparisons are permissible. See Mechanic Falls Water Co. v. Public Utilities Commission, supra, 381 A.2d at 1098. The Division has failed to demonstrate that the Commission's authorization of an 8.95% rate of return was clearly erroneous. Basically, it overlooks the discretion conferred upon the Commission in determining a reasonable rate of return and the limited nature of our judicial review. The standard for determining a fair rate of return appears to be deceptively simple and has been articulated by this court in Honolulu Gas Co. v. Public Utilities Commission, supra, 33 Haw. at 518-519, quoted in In re Application of Kauai Electric Division, supra, 60 Haw. at ___, 590 P.2d at 540. There we said that: There is no particular rate of compensation which must in all cases be regarded as fair earnings for capital invested in business enterprises. Locality, risks incurred and prevailing local rates on similar investments are all factors to be considered. Fair return is the percentage rate of earnings on the rate base allowed the utility after making provision for operating expenses, depreciation, taxes and other direct operating costs... . Fair return is something over and above the usual interest rate on well-secured loans to compensate for the risks and hazards of business and for the profits of management. Questions concerning a fair rate of return are particularly vexing as the reasonableness of rates is not determined by a fixed formula but is a fact question requiring the exercise of sound discretion by the Commission. Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944); Mountain States Telephone and Telegraph Co. v. New Mexico State Corporation Commission, 90 N.M. 325, 563 P.2d 588 (1977); Mechanic Falls Water Co. v. Public Utilities Commission, supra, 381 A.2d at 1098; Mississippi Public Service Commission v. Mississippi Power Co., 337 So.2d 936 (Miss. 1976); New England Telephone & Telegraph Co. v. State, 113 N.H. 92, 302 A.2d 814 (1973). It is often recognized that the ratemaking function involves the making of pragmatic adjustments and that there is no single correct rate of return but that there is a zone of reasonableness within which the commission may exercise its judgment. Mountain States Telephone and Telegraph Co. v. Public Utilities Commission, 345 F. Supp. 80 (D.Colo. 1972); Commonwealth v. Virginia Electric and Power Co., supra, 211 Va. at 769, 180 S.E.2d at 683-684; Potomac Electric Power Co. v. Public Service Commission, 380 A.2d 126 (D.C.App. 1977); Mountain States Telephone and Telegraph Co. v. Public Utilities Commission, 186 Colo. 260, 527 P.2d 524 (1974). Thus, when a commission order is challenged, the only question on appeal is whether the decision meets the statutory requirement of HRS § 269-16 (1976) which is the basis for the commission's authority. As the United States Supreme Court concluded in the Hope case, supra, 320 U.S. at 602, 64 S.Ct. at 288: Under the statutory standard of just and reasonable it is the result reached and not the method employed which is controlling... . It is not theory but the impact of the rate order which counts. If the total effect of the rate order cannot be said to be unjust [or] unreasonable, judicial inquiry ... is at an end. Although HELCO presented evidence which supported a rate of return of at least 8.95% the Division presented no evidence to indicate a lower figure. Since the fair rate of return should cover the cost of capital, see Honolulu Gas Co. v. Public Utilities Commission, supra, 33 Haw. at 518-19, we cannot say that the Commission's determination of 8.95% as a fair rate of return was clearly erroneous.