Opinion ID: 721438
Heading Depth: 2
Heading Rank: 2

Heading: Stranded Costs and the Used and Useful Doctrine

Text: 256 A separate class of Order No. 636 transition costs are stranded costs, which are those incurred by pipelines in connection with their bundled sales services that cannot be directly allocated to customers of the unbundled services. Order No. 636, p 30,939, at 30,460. To be denominated stranded, an investment (1) must have been prudently made, Order No. 636-A, p 30,950, at 30,662, but (2) must be no longer used and useful after Order No. 636, Order No. 636-B, p 61,272, at 62,041. Examples include upstream pipeline capacity for which a downstream pipeline cannot find a buyer, and storage capacity that a pipeline no longer needs when the volume of its sales service shrinks. Order No. 636, p 30,939, at 30,460. According to the Commission, pipelines can recover their stranded costs in NGA § 4 rate filings. Id.; see also Order No. 636-B, p 30,950, at 62,042 (The Commission will allow pipelines to make limited section 4 filings to recover ... the costs of stranded facilities that are currently incrementally priced.... However, pipelines must file to recover the costs of most, if not all other stranded facilities in general section 4 rate proceedings.). 257 The PUCs challenge the Commission's ruling, see Order No. 636-B, p 61,272, at 62,041, that pipelines may recover 100% of their stranded costs. Their presentation is straightforward: items that are not currently used and useful may not be included in a utility's rates. In support, the PUCs invoke the Commission's statement in New England Power Co., 42 F.E.R.C. p 61,016, at 61,078 (1988), that [i]n general, the used and useful standard provides that an asset may be included in a utility's rate base only when the item is used and useful in providing service. They also cite to this Court's statement in Tennessee Gas Pipeline v. FERC, 606 F.2d 1094, 1109 (D.C.Cir.1979), that the precept endures that an item may be included in a rate base only when it is 'used and useful' in providing service. 258 In its brief, the Commission replies along two fronts. First, it contends that the PUCs' objection is premature, given that in Order No. 636, the Commission stated that, in subsequent restructuring proceedings, it would consider arguments about whether particular facilities are used and useful, or whether the costs should be recoverable as transition costs in § 4 rate proceedings. Order No. 636-A,p 30,950, at 30,662. Second, the Commission contends that the used and useful principle invoked by the PUCs, while generally sound, does not apply to facilities that have been stranded only because of the Commission's own action. In other words, the pipelines should recover on their investments as they would have had Order No. 636 never been promulgated. 259 While we ultimately affirm the position taken by the Commission in the administrative proceedings, we believe that both the PUCs and the Commission itself may have overlooked a relevant distinction on appeal: the difference between a utility's rates and its rate base. The rate allowed a utility is the sum of (1) its cost of service, and (2) its rate base multiplied by its rate of return. Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168, 1172 (D.C.Cir.1987) (en banc). Generally, the rate base is comprised of total capital invested in facilities minus depreciation plus cash working capital. The rate of return, on the other hand, is a [319 U.S.App.D.C. 116] weighted average of different rates applied to debt, preferred stock and common stock. Id. at 1203 (Mikva, J., dissenting). Calculation of rate base is a critical step in establishing maximum rates, since the product of rate base multiplied by allowed rate of return is the total sum of money the agency allows to investors in the firm. RICHARD J. PIERCE, JR. & ERNEST GELLHORN, REGULATED INDUSTRIES 102 (3d ed.1994). 260 The cases cited by the PUCs, and not challenged by the Commission, stand for the proposition that the items in a utility's rate base generally should currently be used and useful to consumers. As a result, investors generally profit only from those investments that presently benefit consumers. However, that principle does not answer the question whether investments that are not used and useful may nonetheless be included in the utility's rates, i.e., still treated as part of the utility's cost of service. 90 261 Viewed in this light, the general statement in Order No. 636 that pipelines will recover 100% of their stranded costs still leaves the Commission with a number of options in the § 4 rate proceedings. For example, the Commission could decide that stranded costs should merely be included in the pipeline's cost of service, recoverable through amortization over time. In such an instance, FERC has already moved somewhat in the direction of balancing competing interests by permitting recovery of the costs of building the plant in the cost of service. Investor interests have not, therefore, been entirely ignored. Jersey Central, 810 F.2d at 1192 (Starr, J., concurring). The Commission might also allow the pipeline to recover not only the amortization, but also interest, i.e., the cost of the unamortized portion of the investment. The Commission could further decide to include stranded investments in the utility's rate base and thereby generate a profit for investors. 262 In the administrative proceedings, the Commission assiduously avoided announcing a general standard that would control the manner in which stranded costs may be recovered. Thus, Order No. 636, at 30,460 (emphasis added), states that while most of the costs of new facilities would be includable in rate base, ... there is no way of anticipating the nature and amount of the stranded costs, and thus no way at this time of devising an appropriate billing mechanism on a generic basis. Similarly, in Order No. 636-B, p 61,272, at 30,662, the Commission deferred until individual rate cases a party's objection that costs associated with physical plant that is no longer used and useful ... should ... no longer be includable in the rate base. 263 The PUCs' objection therefore is ripe for review only to the extent that they contend that pipelines should not recover 100% of their Order No. 636 stranded costs in any fashion. We cannot at this point address the specific question of whether pipelines should be permitted to include stranded costs in their rate base, and thereby receive a profit on the investment, because Order No. 636 adopted no such rule. Accord, e.g., Columbia Gas Trans. Corp., 64 F.E.R.C.p 61,060 (1993) (deferring determination of rate base treatment of stranded cost recovery to § 4 proceeding); National Fuel Gas Supply Corp., 63 F.E.R.C. p 61,291 (1993) (same). In fact, in at least one NGA section 4 rate proceeding, the Commission expressly refused to permit such treatment of stranded costs, explaining: 264 Included in [the pipeline's] claim for stranded cost treatment for the production facilities, is a pretax return allowance on the unamortized balance.... As discussed above, in order for [the pipeline] to receive stranded cost treatment for these facilities, they must no longer be used and useful. It is long standing Commission policy that when facilities are not used and useful, they do not qualify for rate base treatment. In addition, the recovery of stranded costs is designed to compensate pipelines for out-of-pocket costs that they [319 U.S.App.D.C. 117] have no other means of recovering. While the costs of facilities are out-of-pocket costs, equity return and related income taxes are not. Therefore, [the pipeline] should not be allowed a pretax return allowance on the unamortized balance. The Commission will limit [the pipeline's] recovery to interest on the unamortized amount.... 265 This is consistent with the way the Commission has treated other costs of a transitional nature that are being amortized over a period of years to reduce the rate impact on customers, e.g., GSR cost amortizations or take-or-pay buyout and buydown cost amortizations. The interest treatment prescribed above adequately compensates the pipeline for the time value of the outstanding unamortized balance, but recognizes the nature of the costs being amortized. 266 Equitrans, Inc., 64 F.E.R.C. p 61,374, at 63,601 (1993); cf. National Fuel Gas Supply Corp., 71 F.E.R.C. p 61,031, at 61,138 (1995) (A rate of return on the amount of written down facilities would be inappropriate since this allows a return on facilities that are not economically viable, and may also result in a competitive advantage for the pipeline. The pipeline would, however, be allowed to recover interest on the unamortized portion of its written-down plant over a reasonable amortization period, as this will keep the pipeline whole for the direct cost of its investment in the facilities.). 267 We reject the PUCs' claim (now properly limited to the argument that the used and useful principle per se prohibits pipeline recovery of stranded costs even when merely amortized as part of the cost of service), because it was previously rejected in NEPCO Municipal Rate Committee v. FERC, 668 F.2d 1327, 1333 (D.C.Cir.1981) (NEPCO). In NEPCO, we considered whether FERC's refusal to include project expenditures in the rate base, while allowing their recovery as costs over time, is a valid approach to allocating the risks of project cancellation. We found such an approach acceptable because, in that case, the Commission's decision was based on substantial evidence and had adequately balanced the interests of investors and ratepayers. Id.; see also Jersey Central, 810 F.2d at 1183 (rejecting claim that NEPCO adopted per se bar to including in rate base items not currently used and useful). So long as the Commission's decisionmaking in the individual § 4 proceedings satisfies that standard, it will survive any subsequent challenge brought on used and useful grounds.