Opinion ID: 1305149
Heading Depth: 2
Heading Rank: 3

Heading: rate of return issues:

Text: Intermountain called two financial consultants to give their expert opinions upon the rates of return which the Commission should allow a company with Intermountain's capital structure. Mr. Barrie Wigmore, a member of the Public Utility Group in the firm of Goldman, Sachs & Co., of New York City, testified primarily upon the rate of return those with an equity interest in the company, the common stockholders, should receive. Wigmore testified that because on March 31, 1973, Intermountain's common stock represented only 28.32% of Intermountain's total capitalization, a precentage of capitalization which he recommended should be increased to 35% to protect the common share holders' investments, that the common shareholders were in a somewhat precarious position and would require a larger rate of return upon equity capital to protect their investment than shareholders in a company the common equity share of which was a higher percentage of total capitalization. In his opinion, the return on equity capital should be at least three times the amount required to service a utility's long term debt. Using this standard, he calculated that a 14.44% return upon the common shares was necessary to protect the common shareholders' interest in Intermountain. He also testified that it was necessary for Intermountain to sell additional shares of common stock at a price equal to or greater than the shares' book value in order to protect the common shareholders' equity interest. He further testified that Intermountain was unable to do this because its common stock was selling below book value. He felt that in order for Intermountain to be able to sell additional common stock at a price greater than its book value of $18.00 per share that the company needed to establish earnings of $2.61 per share to create a market for the stock, and that a 14.5% return upon equity capital was necessary to create such earnings per share. Mr. Michael Rascon, a consultant with the firm of H. Zinder & Associates, Inc., of Washington, D.C., gave his expert opinion upon both the overall rate of return and the rate of return upon equity capital that the Commission should allow Intermountain. The bulk of Rascon's testimony concerned his determination of the overall rates of return and the rates of return upon equity capital earned by comparable public utilities. Rascon selected 16 electric companies and 14 gas companies which he testified were comparable to Intermountain, the overall rates of return and rates of return upon equity capital of which were to be compared with Intermountain's. Rascon testified that in 1972 Intermountain had earned 8.82% on its average total capitalization while the comparable gas companies had earned 9.34% and comparable electric companies 9.06%. His exhibits showed that for the year 1972 Intermountain had earnings upon equity capital of 12.56% and for the three year period 1970-72 had earnings on equity capital of 12.07%, while he testified that the 14 comparable gas companies in 1972 had average earnings on equity capital of 13.18% and for the three year period 1970-72 had average earnings on equity capital of 13.28%. [5] He testified that the 16 comparable electric companies had average earnings upon their average equity capital of 13.33% in 1972 and 11.79% for the 1970-72 period. [6] His exhibits showed that during 1972 Intermountain's average equity ratio (the percent of total capitalization represented by common stock) had been 29.09% while he testified that during that same year the average equity ratio of the comparable gas companies had been 36.89% and of the comparable electric companies 38.95%. He further testified that although a rate of return upon equity capital of approximately 13.5% may be adequate for a utility with an equity ratio like those of the comparable utilites, Intermountain, which had a much smaller ratio of equity capital to total capitalization, must guarantee a return upon equity capital of from 14.5% to 15% in order to continue to attract new capital and that this rate of return upon equity capital could only be achieved by allowing an overall rate of return of between 9.118% and 9.264%. (In his revised exhibit submitted when he appeared for cross examination, he recommended an overall return to capital of 9.142% to 9.277%.) According to Rascon these figures for the overall rate of return and the rate of return upon equity capital were the proper rates of return to be allowed if Intermountain's earnings were to be on par with those of comparable companies and if the integrity of its equity capital was to be preserved. Although the testimony of these experts was uncontradicted, the Commission did not allow Intermountain the rates of return that the expert witnesses had testified were necessary. During cross examination, Rascon acknowledged that one of the gas companies he had selected as comparable to Intermountain, the Alabama-Tennessee Natural Gas Company, was not primarily a retail seller of gas with thousands of small customers, but was a wholesale gas pipeline company, a kind of business which is or may be more speculative than the retail distribution of gas. The Commission determined that Alabama-Tennessee was not a comparable company for this reason and excluded it from the list of utilities it considered to determine the returns made by comparable companies. Alabama-Tennessee had been by far the most profitable of the companies selected by Rascon. According to the Commission's calculation, excluding it from the list of comparable gas companies reduced the average return on common equity of the remaining 13 gas companies to 12.19% on an average equity ratio of 36.86%. Using these figures, the Commission determined the allowable rate of return in the following manner: If the rate earned on equity capital were adjusted to a percentage a little above the average return earned by the sixteen electric companies of 11.79 percent, and the return earned by the thirteen gas companies, after eliminating Alabama-Tennessee Natural Gas Company, of 12.19 percent, but lower than the earnings used by the witnesses of 14.5 percent to 15 percent, in the range of 13.0 percent to 13.5 percent, the overall cost of capital then becomes 8.681 percent and 8.827 percent respectively. This would indicate that the fair rate of return to be earned by the Applicant on the rate base should be in the range of 8.5 percent to 8.8 percent. Order No. 11507, June 26, 1974, pp. 9-10. Sec. Tr., Vol. II, pp. 389-90. The Commission allowed an overall rate of return of 8.73%. (See footnote 3, supra, for the effect of this determination of a fair rate of return upon the requested rate increase.) Intermountain argues that the rate of return adopted by the Commission is insufficient to allow Intermountain to attract new capital and is less than the rate of return earned by comparable utilities. Thus, it concludes that its constitutional rights have been violated, citing for that proposition two cases decided by the Supreme Court of the United States. In the earlier of the two cases, Bluefield Waterworks & Improvement Co. v. Public Service Commission of West Virginia, 262 U.S. 679, 43 S.Ct. 675, 67 L.Ed. 1176 (1923), the Court said: The question in the case is whether the rates prescribed in the commission's order are confiscatory and therefore beyond legislative power. Rates which are not sufficient to yield a reasonable return on the value of the property used at the time it is being used to render the service are unjust, unreasonable and confiscatory, and their enforcement deprives the public utility company of its property in violation of the Fourteenth Amendment. This is so well settled by numerous decisions of this court that citation of the cases is scarcely necessary: ... 262 U.S. at 690, 43 S.Ct. at 678. The Court then set forth the so-called comparable earnings test: The company contends that the rate of return is too low and confiscatory. What annual rate will constitute just compensation depends upon many circumstances, and must be determined by the exercise of a fair and enlightened judgment, having regard to all relevant facts. A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs for the convenience of the public 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; but it has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or speculative ventures. The return should be reasonably sufficient to assure confidence in the financial soundness of the utility and should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise the money necessary for the proper discharge of its public duties. A rate of return may be reasonable at one time and become too high or too low by changes affecting opportunities for investment, the money market and business conditions generally. 262 U.S. at 692-693, 43 S.Ct. at 679. In the second of the two cases cited by Intermountain, Federal Power Commission v. Hope Natural Gas Company, 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944), the Supreme Court set forth the so-called capital attraction test, which listed additional factors that rate-making bodies must take into consideration along with those listed in Bluefield. The Court said: [T]he investor interest has a legitimate concern with the financial integrity of the company whose rates are being regulated. From the investor or company point of view it is important that there be enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock. By that standard the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital. 320 U.S. at 603, 64 S.Ct. at 288. (Citation omitted). Intermountain argues that because the testimony of its two expert witnesses was uncontradicted that the Commission was bound to accept their conclusions upon the rates of return earned by comparable companies and the rates of return that Intermountain must earn in order to attract capital. It further argues that since the Commission was bound to accept the rates of return given by these witnesses that an order allowing Intermountain a lesser rate of return was a confiscation of its property in violation of the Fourteenth Amendment to the Constitution of the United States and the due process clause of the Constitution of Idaho. We disagree. First, the Commission's finding that Alabama-Tennessee Natural Gas Co. was not a comparable company was supported by the record. There was evidence in the record  Rascon's acknowledgment that Alabama-Tennessee was a wholesale gas pipeline supplier engaged in a kind of business that is frequently of a more speculative nature than retail gas distribution  to support the Commission's finding that Alabama-Tennessee was not a comparable company and thus that finding is binding upon us. Washington Water Power Co. v. Idaho Public Utilities Commission, supra . Therefore, the Commission was justified in rejecting an expert's opinion which was based upon the capital structure and earnings record of a company which was not comparable. Neither was it obligated to accept conclusions based upon inconsistent data and exhibits concerning comparable companies. See footnotes 5 and 6, supra. Moreover, even if Alabama-Tennessee Natural Gas Company were a comparable company, that does not necessarily mean that the Commission was bound to award Intermountain the rate of return to which the expert witnesses testified it was entitled under the capital attraction or comparable earnings tests. The determination of reasonable rates of return by application of the capital attraction or comparable earnings tests, or by application of any other tests or considerations, is a legislative function. United States v. Jones, 336 U.S. 641, 69 S.Ct. 787, 93 L.Ed. 938 (1949); Petition of Mountain States Telephone and Tel. Co., supra . In performing such a function within its area of expertise, the Commission may draw its own conclusions from the facts without the aid of expert testimony, Market Street Railway Co. v. Railroad Commission of State of California, 324 U.S. 548, 65 S.Ct. 770, 89 L.Ed. 1171 (1945), and may make determinations contrary to the uncontradicted opinions of the experts, Central Illinois Public Service Company v. Federal Power Commission, 338 F.2d 682 (7th Cir.1964); New Haven Water Co. v. Public Utilities Commission, 30 Conn.Sup. 149, 305 A.2d 863 (Conn.Com.Pl. 1972). As the Supreme Court of the United States said in Hope, The rate-making process under the [Natural Gas] Act, i.e., the fixing of `just and reasonable' rates, involves a balancing of the investor and the consumer interests. 320 U.S. at 603, 64 S.Ct. at 288. Some thirty years later, in the case of In re Permian Basin Area Rate Cases, 390 U.S. 747, 88 S.Ct. 1344, 20 L. Ed.2d 312 (1968), that Court said that the factors enumerated in Hope and Bluefield are not the exclusive criteria by which the constitutionality of a rate-making process may be judged. The Court in Hope found appropriate criteria by inquiring whether `the return to the equity owner [is] commensurate with returns on investments in other enterprises having corresponding risks,' and whether the return was `sufficient to insure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital.' These criteria ... remain pertinent, but they scarcely exhaust the relevant considerations.  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. Judicial review of the Commission's orders will therefore function accurately and efficaciously only if the Commission indicates fully and carefully the methods by which, and the purposes for which, it has chosen to act.... 390 U.S. at 790-792, 88 S.Ct. at 1372-1373. (Citations and footnote omitted, emphasis added). Our function upon appeal is to determine whether the commission has regularly pursued its authority, including a determination of whether the order appealed from violates any right of the appellant under the constitution of the United States or of the state of Idaho. I.C. § 61-629. In reaching its decision allowing an overall rate of return of 8.73% and a return to equity capital in the range of 13.0% to 13.5%, the Commission has regularly pursued its authority, i.e., it has not abused or exceeded its authority or made findings unsupported by substantial evidence or improperly employed its own methods of rate determination. Thus, so long as we determine that 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, we will not set aside the order of the Public Utilities Commission on the ground that it has violated Intermountain's rights under the due process clauses of the Constitutions of the United States and of the state of Idaho. As the Supreme Court said in Permian Basin : [T]he just and reasonable standard of the Natural Gas Act `coincides' with the applicable constitutional standards, and any rate selected by the Commission from the broad zone of reasonableness permitted by the Act cannot properly be attacked as confiscatory. Accordingly, there can be no constitutional objection if the Commission, in its calculation of rates, takes fully into account the various interests which Congress has required it to reconcile. 390 U.S. at 770, 88 S.Ct. at 1361. (Citation omitted). Thus, the Commission is not constitutionally bound to base its decision solely on the comparable earnings and capital attraction tests. Therefore, even if the Commission were bound to accept the experts' opinions upon the necessary rates of return under the comparable earnings or capital attraction tests, that does not mean that the Commission would be constitutionally required to award those rates of return. Our examination of the rates of return earned by the comparable companies (which, of course, were deemed comparable to Intermountain by application of criteria which is necessarily inexact and arbitrary to some degree) shows that their rates of return vary over a broad spectrum. The Constitution permits a broad zone of reasonableness in rates of return, and we will not hold that any rate of return lower than the precise average rate of return of comparable companies or beneath the rate of return that expert witnesses testify is necessary under the capital attraction or comparable earnings test is necessarily beyond the broad zone of reasonableness permitted by the Constitution. The Commission's award was within the zone of reasonableness. We conclude that the rate of return awarded by the Commission is not confiscatory and not in violation of Intermountain's rights under the Fourteenth Amendment to the Constitution of the United States or the due process clause of the Constitution of Idaho.